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INTRODUCTION
——
1
Enacted on 1 March 1906 by the Philippine Commission, and took effect on 1 April
1906. Section 1 of Act No. 1459 specifically provides that “The short title of this Act shall
be ‘The Corporation Law.’”
2
A more detailed discussion of this approach is found in Chapter 20 on Legal
Theory of Philippine Corporate Law.
but often such legislative enactments are meant to officially incorporate
already existing commercial practices into statutory language.
The study of Philippine Corporate Law, and the interpretation and
application of the various provisions of the Corporation Code and other
suppletory statutory provisions in Philippine jurisdiction, should therefore
take their approach on what the Philippine Supreme Court held in a
leading case:3 that "Corporation Law must be given a reasonable not an
unduly harsh, interpretation which does not hamper the development of
trade relations and which fosters more friendly commercial intercourse
among countries. The objectives . . . are even more relevant today when
we view commercial relations in terms of a world economy, when the
tendency is to re-examine the political boundaries separating one nation
from another insofar as they define business requirements or restrict
marketing conditions."4
—oOo—
CORP. MANUSCRIPT\01-INTRODUCTION\11-22-2002
3
Home Insurance Co. v. Eastern Shippine Lines, 123 SCRA 434 (1983).
4
Ibid, at p. 435.
CHAPTER 2
BRIEF HISTORY OF
PHILIPPINE CORPORATE LAW
——
1
Mead v. McCullough, 21 Phil. 95,106 (1911).
The introduction in late 1888 of the sociedades anónimas as commercial
medium of doing business did not prosper under Philippine setting, since by
1898, the American occupation had began. The American authorities lost no time
introducing into the Philippine legal system various aspects of the common law
system, especially in commercial and procedural matters, to enhance
commercial activities between the new colony and the United States.
Harden v. Benguet Consolidated Mining Co.,2 gave a vivid description on
the background on the enactment of The Corporation Law into Philippine
jurisdiction:
2
58 Phil. 141 (1933).
3
Ibid, at p. 145-146.
4
Benguet Consolidated Mining Co., v. Pineda, 98 Phil. 711 (1956).
Under Section 191 of the then Corporation Law, sociedades anónimas
which did not opt to reform and organize under the Corporation Law, shall
continue to be governed by the laws that were in force prior to the passage of the
Corporation Law, particularly the provisions of the Code of Commerce on
sociedades anónimas, "in relation to their organization and method of transacting
business and to the rights of members thereof as between themselves."
Philippine jurisprudence recognized the difference between a corporation
and a sociedad anónima and did not interchange the two. In Phil. Products Co.
v. Primateria Society Anonyme Pour Le Commerce Exterieur,5 the Supreme
Court refused to apply the provisions of then Section 68 of the Corporation Law
requiring "foreign corporations" to obtain a license to do business in the
Philippines to an entity that was deemed to be a sociedad anónima.
Today, the sociedad anónima constitutes nothing more than an historical
relic under Philippine Corporate Law since no new entity can be organized and
registered as a sociedad anónima under existing laws.
2. Cuentas en Participacion
Early on, Philippine jurisprudence recognized the concept or set-up of
cuentas en participacion. Bourns v. Carman,6 described a cuentas en
participacion as a sort of an accidental partnership constituted in such a manner
that its existence was only known to those who had an interest in the same, there
being no mutual agreement between the partners, and without a corporate name
indicating to the public in some way that there were other people besides the one
who ostensibly managed and conducted the business, governed under Article
239 of the Code of Commerce.
Those who contract with the person under whose name the business of
such accidental partnership of cuentas en participacion is conducted, shall have
only a right of action against such person and not against the other persons
interested in the venture, and the latter, on the other hand, did not have any right
of action against third person who contracted with the manager unless such
manager formally transfers his right to them.7
5
15 SCRA 301 (1965).
6
7 Phil. 117 (1906).
7
Ibid, at p. 120.
The present Corporation Code, or Batas Pambansa Blg. 68, became
effective on 1 May 1980. It adopted various corporate doctrines previously
enunciated by the Supreme Court under the old Corporation Law. It clarified the
obligations of corporate directors and officers, expressed in statutory language
established principles and doctrines, and provided for a chapter on close
corporations.
The Code was enacted "to establish a new concept of business
corporations so that they are not merely entities established for private gain but
effective partners of the National Government in spreading the benefits of
capitalism for the social and economic development of the nation."8
—oOo—
8
Explanatory Note to Cabinet Bill No. 3, which became the basis for the Corporation Code
enacted by the then Interim Batasang Pambansa, and which took effect on 1 May 1980.
CHAPTER 3
——
1
This portion is taken from the introduction of the published article entitled "Corporate
Contract Law: Unifying Theme on Theories Relating to Promoter's Contracts, De Facto
Corporations, Corporations by Estoppel, Articles of Incorporation, By-Laws, and Ultra Vires Acts,"
37 ATENEO L.J. 1 (No. 2, June 1994).
2
Sec. 2, Corporation Code.
The present statutory definition of the corporation is essentially a narrow
and antiquated view of the corporate vehicle. It looks at only one aspect—the
relationship between the corporation and the State—of the otherwise
multifaceted relationships that a corporation would have in the business
environment. The statutory definition views the corporation merely as a creature
of the law, when actually juridical personality is merely one aspect of corporate
existence. The corporate setting embodies contractual relationships of varying
degrees, and consequently, principles of Contract Law, Agency Law, and even
Labor Law, tend to be enmeshed into Corporate Law principles. The resulting
interactions between principles of Corporate Law and other legal disciplines have
continued to create tension and sometimes hybrid legal products, that animate
the Philippine legal system.
1. Theory of Concession
Tayag v. Benguet Consolidated, Inc.,3 characterized a corporation as an
artificial being, created by operation of law. . . "It owes its life to the state, its birth
being purely dependent on its will."
Tayag expressly denied the application of the genossenschaft theory
enunciated by Friedmann4 which treated a corporation as "the reality of the group
as a social and legal entity, independent of state recognition and concession." 5 It
held that a corporation is "a creature without any existence until it has received
the imprimatur of the state acting according to law," and that "[i]t is logically
inconceivable therefore that it will have rights and privileges of a higher priority
than that of its creator. . . [and] cannot legitimately refuse to yield obedience to
acts of its state organs, certainly not excluding the judiciary whenever called
upon to do so."6
Ang Pue & Co. v. Secretary of Commerce and Industry,7 would hold that to
"organize a corporation or a partnership that could claim a juridical personality of
its own and transact business as such, is not a matter of absolute right but a
privilege which may be enjoyed only under such terms as the State may deem
necessary to impose."
Torres v. Court of Appeals,8 in invalidating the act of the principal
stockholder of a family corporation in canceling stock certificates and issuing new
3
26 SCRA 242, 252 (1968)
4
LEGAL THEORY, pp. 164-168 (1947); also Holdsworth, English Corporation Law, 31 YALE
L.J. 382 (1922).
5
26 SCRA 242, 253.
6
Ibid.
7
5 SCRA 645, 647 (1962).
8
278 SCRA 793 (1997).
once and not coursing the same through the Corporate Secretary, held that “[a]ll
corporations, big or small, must abide by the provisions of the Corporation Code.
Being a simple family corporation is not an exemption. Such corporations cannot
have rules and practices other than those established by law.”
Under the theory of concession, although fiction cannot be created unless
there is an enterprise or group upon whom it may be conferred, and in spite of
the underlying contract among the persons wanting to form the corporation, the
grant is only by virtue of a primary franchise given by the State. It is within the
power of the State whether to grant it or not. The theory of concession is also the
underlying basis for the ultra vires doctrine.
The theory of concession, therefore, looks at a corporation simply as a
creature of the State, completely within the control of the latter. This is the theory
covered by Section 2 of the Corporation Code as it defines a corporation.
9
Berle, The Theory of Enterprise, 47 COL. L. REV. No. 3 (April, 1947).
10
Ibid, at 345.
11
Ibid.
the law, which may tend to project to their business dealings done through the
corporation.
Although generally the enterprise entity theory has to a great extent been
discarded in American corporate literature, its basic flaw may not pertain to
Philippine setting because we have in our jurisdiction a different principle on
juridical personality. While under American common law, a partnership does not
have a personality separate and distinct from the partners, under Philippine civil
law tradition, although a partnership is inherently a contractual relationship, the
Civil Code grants to it a personality separate and distinct from the partners.12
Therefore, other than a general code provision granting it a juridical personality,
the partnership personality becomes a reality by two or more persons deciding to
contribute money, property or industry to a common fund with the intention of
dividing the profits among themselves without need of a grant of specific
authority by the state.
To a great extent, once a corporate entity comes into being it has certain
rights almost independent of the whims of its creator. Even though the
corporation is a creature of the State, the underlying relationship is still
composed of moral individuals who are not at all creatures of the State. For
example, the State would not destroy the group nor the business, without
observing the due process clause of the Constitution. In Bache & Co. (Phil.), Inc.
v. Ruiz,13 the Court held that a corporation is entitled to immunity against
unreasonable searches and seizures. It recognized that "[a] corporation is, after
all, but an association of individuals under an assumed name and with a distinct
legal entity. In organizing itself as a collective body it waives no constitutional
immunities appropriate for such body. Its property cannot be taken without
compensation. It can only be proceeded against by due process of law, and is
protected against unlawful discrimination."
In Philippine Stock Exchange, Inc. v. Court of Appeals,14 the Court
recognized that “[a] corporation is but an association of individuals, allowed to
transact under an assumed corporate name, and with a distinct legal personality
[and that in] organizing itself as a collective body, it waives no constitutional
immunities and perquisites appropriate to such a body.” The Court held that
although the Securities and Exchange Commission (SEC), under the Revised
Securities Act, Pres. Decree 902-A, and other pertinent laws, has been entrusted
the serious responsibility of enforcing all laws affecting corporations and other
forms of associations not otherwise vested in some other government office,
nevertheless, the SEC did not have absolute control on the management
prerogatives of the Board of Directors of the Philippine Stock Exchange (PSE),
12
Art. 1768 of the Civil Code provides: “The partnership has a juridical personality separate
and distinct from that of each of the partners,” even in case of failure to comply with the
requirements of the law on registration. In contrast there now provision in the Corporation Code
that expressly provides a juridical personality of a corporation “separate and distinct from that of
each of the stockholders or members” that compose it. See also Campos Rueda & Co. v. Pacific
Commercial Co., 44 Phil. 916 (1922).
13
37 SCRA 823 (1971).
14
281 SCRA 232, 88 SCAD 589 (1997).
since the “PSE is, after all, a corporation authorized by its corporate franchise to
engage in its proposed and duly approved business.”
The enterprise theory therefore hinges itself on the fact that there can be
no corporate existence without persons to compose it; there can be no
association without associates.15 The separate juridical existence granted to a
corporation is mere legal fiction, and therefore whenever necessary for the
interests of the public or for the protection or enforcement of the rights of the
members, courts will disregard the legal fiction and operate upon both the
corporation and the persons composing it.
The recognition of the organizational existence of a groups of individuals
extant any State grant or recognition is now more recognized in the case of
unincorporated associations. On matters involving affairs of an unincorporated
association, such as election contests for officers of civic clubs, the courts
generally will not interfere in the ruling of its policy-making body.16 If the State
would consider binding among the associates in an unincorporated associations
their acts and actuations, then the more so in a duly incorporated association,
which has a juridical personality.
To a great extent, this underlying relationship between and among
individuals as the root of every corporate setting is recognized and reinforced by
the Corporation Code itself that requires that no corporation can be organized
unless formed by "[a]ny number of natural persons not less than five (5) but not
more than fifteen (15), all of legal age and a majority of whom are residents of
the Philippines."17
15
Arnold v. Willets & Patterson, Ltd. 45 Phil. 634 (1923).
16
Lions Club International v. Amores, 121 SCRA 621 (1983).
17
Sec. 10, Corporation Code.
(d) Between the corporation and third parties or "outsiders",
which is essentially governed by Contract Law; and Labor
Law when it comes to relationship with officers and
employees.
18
VALIX & PERALTA, FINANCIAL ACCOUNTING (Vol. One), 1976 ed., pp. 13 and 18.
19
Luzon Brokerage Co., Inc. v. Maritime Building Co., Inc., 86 SCRA 305 (1978).
20
Philippine National Bank v. Court of Appeals, 83 SCRA 237 (1978)
21
See more exhaustive discussions in Chapter 4 on Corporate Juridical Personality and
Doctrine of Piercing the Veil of Corporate Fiction.
22
Tan Boon Bee & Co., Inc. v. Jarencio, 163 SCRA 205 (1988).
23
Arnold v. Willits & Patterson, Ltd., 44 Phil. 634 (1923).
24
Ibid, at p. 644, quoting THOMPSON ON CORPORATIONS, 2d ed. Vol. I, Sec. 10.
CORPORATION AS A CREATURE OF THE LAW
1. Constitutional Provisions
The power to create corporations is one of the attributes of sovereignty. 25
The exercise of the power is legislative in character, and that Legislature may,
subject to the restrictions of the Constitution, create a particular corporation by
direct act, or make provisions, by general law, for the organization of
corporations by natural persons upon compliance with the prescribed
conditions.26
Under the Constitution,27 Congress cannot, except by general law, provide
for the formation, organization, or regulation of private corporations. The same
constitutional provisions allows government-owned or -controlled corporations to
be created or established by special charters in the interests of the common
good and subject to the test of economic viability. Consequently, it has been held
that a private corporation created pursuant to a special law is a nullity, and such
special law is unconstitutional for being violative of the Constitution.28
The constitutional provision taking away from Congress the power to grant
specific franchises to private corporations comes from a history of corruption
when such power was exercised by Legislatures in common law jurisdiction,
where only the rich and powerful could obtain such franchises, and therefore be
able to have monopolies of certain endeavors.
In Philippine jurisdiction, the Corporation Code is the general law under
which private corporations are organized pursuant to the mandates of the
Constitution.29
30
11 SCRA 634 (1964).
31
Ibid, p. 638, quoting from Gulf Refining Co. v. Cleveland Trust Co., 108 So., 158.
32
74 Phil. 560 (1944).
33
Ibid, at pp. 566-567.
come into being by mere consent of the parties; there must be a law granting it,
and once granted form the primary franchise of the corporation.
There must first be an underlying contract among the individuals forming
the corporation upon which the state grant may be conferred. Therefore, you
have an inter-play of State grant and contractual relations between the parties.
Which principle has precedence in resolving conflict would depend upon the
public interest or issue to be resolved. This issue is discussed more in details in
Chapter IV, on Corporate Contract Law.
3. Right of Succession
The corporation has the capacity for continuous existence despite the
death or replacement of its shareholders or members, for it has a personality
separate and distinct from those who compose it. The strong legal personality of
the corporation is an attribute that has made it most attractive to businessmen
when compared to other media.
34
Subsec. 5.2 of Republic Act No. 8799.
35
Dated 21 November 2000.
36
San Juan Structural and Steel Fabricators, Inc. v. Court of Appeals, 296 SCRA 631, 645,
99 SCAD 281, 298 (1998).
37
Art. 1816 of the Civil Code provides that “All partners are liable pro rata with all their
properties and after partnership assets have been exhausted, for all partnership debts.
Art. 1817 provides that “Any stipulation against personal liability of partners for partnership
debts is void, except as among them.”
Art. 1824, provides that “All partners are liable solidarily with the partnership for everything
chargeable to the partnership when caused by the wrongful act or omission of any partner acting
Of course, through contractual stipulations, there are many ways to go
around the limited liability feature of a corporation and to make major
shareholders still liable for more than their actual or promised investments in the
corporation. For example in case of bank loans, bankers sometimes demand
additional security or may require that in addition corporate officers make
themselves also personally liable for the corporate debt.
The advantage of the corporate setting is the default rule of limited liability
affords a more efficient means to encouraging investments in the venture, and
additional economic cost is spent only when parties attempt to go around the
limited liability feature. A corporation and its stockholders may therefore choose
whether or not to concede the advantage or protection of limited liability, while in
a partnership, there is already an implied contract that if the partnership's assets
are insufficient, the partners separate properties would be liable.
4. Centralized Management
A corporation's management is centralized in the board of directors.
Shareholders are not agents of the corporation, nor can they bind the
corporations, unlike in a partnership setting, where each partner may bind the
partnership,39 even without the knowledge of the other partners. Therefore, in its
legal relationship, a corporation presents a more stable and efficient system of
governance and dealings with third parties, since management prerogatives are
centralized in its board of directors. By imposition of law, and except in
in the ordinary course of business of the partnership or with authority from the other partners and
for partner‟s act or misapplication of properties.”
38
CLARK, CORPORATE LAW, (Little Brown and Company, 1986 ed.), p. 3.
39
In the absence of contractual stipulation, all partners shall be considered agents and
whatever any one of them may do alone shall bind the partnership. Arts. 1803(1) and 1818, Civil
Code.
particularly designated instances, stockholders are bound by the management
decisions and transactions of the board of directors of the corporation, whether
they like it or not.
5. Double Taxation
The corporation has traditionally been subjected to heavier taxation than
other forms of business organizations; the profits of the corporation which are
already subjected to corporate income tax when declared and distributed as
dividends to the stockholders are again subjected to further income tax.
With the trust of Government to encourage both local and foreign
investments in the country, and to entice the use of the corporation as the vehicle
for such investments, many of the previous tax laws that tended to make
corporate vehicles expensive have been abolished. Except for dividends
declared by domestic corporation in favor of foreign corporation,42 dividends
received by individuals from corporation,43 as well as inter-corporate dividends
between domestic corporations,44 were subject to zero rate of income taxation.
There had also been an abolition of the personal holding companies tax and tax
on unreasonably accumulated surplus of corporations.45
However, with the passage of the Tax Reform Act of 1997, beginning
1998, there has been imposed the following tax burdens on the means of doing
business through the medium of the corporation:
42
Sec. 25(a) and (b), National Internal Revenue Code of 1977.
43
Sec. 21, National Internal Revenue Code of 1977.
44
Sec. 24, National Internal Revenue Code of 1977.
45
Executive Order No. 37 (1986).
46
Sec. 24(B)(2), National Internal Revenue Code of 1997.
47
Sec. 27(E), National Internal Revenue Code of 1997.
48
Sec. 29, National Internal Revenue Code of 1997.
COMPARING THE CORPORATION WITH
OTHER MEDIA OF BUSINESS ENDEAVORS
1. Sole Proprietorships
Sole proprietorships are less saddled with the many requirements and
regulations which corporations are often subjected to by law. The owner is in
command of his whole business and he stands to lose as much as he puts in and
even more to the extent of all his personal holdings.
This is in contrast to a corporation where control belongs to the board of
directors, and there is limited liability on the part of the shareholders.
Consequently, sole proprietorships work well only for carrying-on simple or
small business endeavors, and do not function well in cases of large enterprises
which require huge capital investments and specialized management skills.
2. Partnerships49
Article 1768 of the Civil Code provides that the partnership has a juridical
personality separate and distinct from that of each of the partners, even in case
of failure to comply with the registrations requirements of the Code.50
The most important distinction between the corporation and the
partnership are their legal capacities. A corporation has a stronger legal
personality, enabling it to continue despite the death, insolvency or withdrawal of
any of its stockholders or members. In a partnership, the withdrawal, death or
insolvency of any partner would automatically bring about the dissolution of the
partnership.51
Limited liability is a main feature in a corporate setting, whereas partners
are liable personally for partnership debts not only to what they have invested in
the partnership but even as to their other properties.52
Generally, every partner is an agent of the partnership53 and by his sole
act, he can bind the partnership,54 whereas in a corporation, only the board of
directors or its agents can bind the corporation.
49
Please see capsule on Philippine Partnership Law, Appendix A.
50
See Art. 1772, first paragraph, Civil Code.
51
Arts. 1828 and 1830, Civil Code.
52
Arts. 1816, 1817, 1824, and 1839, Civil Code.
53
Arts. 1803(1), 1818, and 1819, Civil Code.
54
Arts. 1822 and 1823, Civil Code.
When five or more persons come together to contribute money or property
to a venture with the intention of receiving profits therefrom and intending to form
a corporation, but because of certain defects no corporation is formed under the
law, do we then consider at the very least, that a partnership with a separate
juridical personality has been created? The author believes that the answer
would be in the negative, based on two grounds:
First, both corporate and partnership relationship are fundamentally
contractual relationship created by the co-venturers who consent to come
together under said relationship. If the parties had intended to create an
association in the form of a corporation, a partnership cannot be created in its
stead since such is not within their intent, and therefore does not constitute a part
of their consent to the contractual relationship.
Second, the important differences between the corporation and the
partnership cannot lead one to the conclusion that in the absence of the first, the
contracting parties would have gone along with the latter. Limited liability,
centralized management and easy transferability of the units of ownership in a
corporation are by themselves strong factors for parties' intention to be bound in
the corporate relationship, and one cannot presume that if these features are not
met that they would in the alternative wish to be covered by a partnership
relationship, which has generally would involve unlimited liability, mutual agency
among the partners, and the delectus personarum feature.
It is the legal principle that when parties come together and all the
elements of a particular contract are present, although the parties may have
nominated it otherwise, the law will impose such contractual relationship upon
them. In other words, the contract or relationship is what the law says it is, not
how the parties wish to call it. Therefore, when five or more persons come
together to contribute money or property to a common venture or fund with the
intention of dividing the profits among themselves, the parties may wish to call it
otherwise; however, under the definition of the Article 1767 of the Civil Code, it
would still be a partnership, even if the parties had intended a corporation but did
not materialize because of certain registration deficiencies.
Nevertheless, such principle cannot apply, since the essence of what
constitutes the contractual relationship of partnership under Article 1767 is the
coming "together" or what is known in partnership law as "delectus personarum"
and not just the joint venture. The essence of partnership is the personal
relationship, i.e., that each would-be partner goes into the venture precisely
because he wants the other co-venturers, and no other persons, to be with him in
the venture. A venturer who seeks to enter into a corporate relationship perhaps
does not even care about the personality of the other co-venturers, and fully
aware that he himself and others have the ability to transfer their investments to
outsiders.
On the other hand, there seems to be indications of contrary view to the
above. Under Section 21 of the Corporation Code, when parties act and pretend
to be a corporation, when in fact none exist, the law would impute to them a
juridical personality to validate the contract under the corporation by estoppel
doctrine; however, it would treat the parties as partners since it expressly makes
them liable as "general partners."
Under such contrary view, the main issue would be the priority between
the personal creditors of the "partners" in a corporation by estoppel doctrine, and
the "corporate" creditors of the corporation by estoppel, as to the assets invested
into the venture. The author would presume that it would have to be the
corporate creditors that would have priority over the “corporate” assets as this
seems to be the moving spirit of the corporation by estoppel doctrine.
This position of the author has been partially justified by the discussions of
the Supreme Court in Pioneer Insurance & Surety Corp. v. Court of Appeals,55
when it resolved the issue of "What legal rules govern the relationship among co-
investors whose agreements was to do business through the corporate vehicle
but who failed to incorporate the entity in which they had chosen to invest?" 56
Quoting from American jurisprudence, the Supreme Court in Pioneer
Insurance held that there has been the position that as among themselves the
rights of the stockholders in a defectively incorporated association should be
governed by the supposed charter and the laws of the state relating thereto and
not by the rules governing partners,57 nevertheless it has been held that
“ordinarily persons who attempt, but fail, to form a corporation and who carry on
business under the corporate name occupy the position of partners inter se,58
and their rights as members of the company to the property acquired by the
company will be recognized.”59
Notwithstanding the foregoing, the Supreme Court took the position that
such partnership relationship does not exist, "for ordinarily persons cannot be
made to assume the relation of partners, as between themselves, when their
purpose is that no partnership shall exist . . . and it should be implied only when
necessary to do justice between the parties; thus, one who takes no part except
to subscribe for stock in a proposed corporation which is never legally formed
does not become a partner with other subscribers who engage in business under
the name of the pretended corporation, so as to be liable as such in an action for
settlement of the alleged partnership and contributions. . . A partnership relation
between certain stockholders and other stockholders, who were also directors,
will not be implied in the absence of an agreement, so as to make the former
liable to contribute for payment of debts illegally contracted by the latter.60 Nor will
it make the investor to a would-be corporation liable for losses sustained from its
55
175 SCRA 668 (1989).
56
Ibid, at p. 681.
57
Quoting from CORPUS JURIS SECUNDUM which cited Cannon v. Brush Electric Co., 54 A.
121, 96 Md. 446, 94 Am. S.R. 584.
58
Ibid, citing Lynch v. Perryman, 119 P. 229, 29 Okl. 615, Ann. Cas. 1913 A. 1065.
59
Ibid, citing Smith v. Schoodoc Pond Packing Co., 84 A, 268m 109 Me. 555; Whipple v.
Parker, 29 Mich 369.
60
Ibid, at p.683, quoting from CORPUS JURIS SECUNDUM, Vol. 68, p. 464.
operations under a partnership inter se theory.”61 The key elements in resolving
the issue seem to have been in Pioneer Insurance those of intent and
participation in business activities.
The doctrinal pronouncement is Pioneer Insurance can be summarized as
follows: When parties come together intending to form a corporation, but no
corporation is formed due to some legal cause, then:
3. Business Trusts
As compared to a corporation, a business trust is simply a deed of trust
which is easier and less expensive to constitute for it is not bound by any legal
requirements like the former. It does not have a separate juridical personality,
and is mainly governed by contractual doctrines and the common law principles
on trust. Trust relationship is centered upon properties, and which places naked
titled in the trustee, and beneficial title in the beneficiary.
4. Joint Ventures62
The Supreme Court has held that the legal concept of a joint venture is of
common law origin, and has no precise legal definition. Under Philippine law, a
joint venture is a form of partnership and should thus be governed by the law of
partnerships,63 which would then include the features of separate juridical
personality, mutual agency among the co-venturers, and unlimited liability.
61
Ibid, at p. 685.
62
For a more comprehensive discussion on joint ventures, see Appendix C on Philippine
Law on Joint Ventures.
63
Aubach v. Sanitary Wares Mfg. Corp., 189 SCRA 130 (1989). In that case the Supreme
Court held also: "It has been held that while generally a corporation cannot enter into a
The element of a joint ventures, being basically those of the partnership,
has been affirmed in Kilosbayan, Inc. v. Guingona, Jr.:64
5. Cooperatives66
A cooperative is a duly registered association of persons, with a common
bond of interest, who have voluntarily joined together to achieve lawful common
social or economic end, making equitable contributions to the capital required
and accepting a fair share of the risks and benefits of the undertaking in
accordance with universally accepted cooperative principles.67
A cooperative, like an ordinary corporation, has a juridical personality
separate and distinct from its members, and has limited liability feature. 68
Unlike an ordinary corporation, cooperatives are governed by principles of
democratic control where the members in primary cooperatives shall have equal
voting rights on a one-member-one-vote principle;69 where the board of directors
manages the affairs of the cooperative, but it is the general assembly of full
membership that exercises all the rights and performs all of the obligations of the
cooperative;70 and are under the supervision and control of the Cooperative
Development of Authority71 and not the SEC.
Unlike an ordinary stock corporation which is organized for profit, and a
non-stock corporation which can be organized for any eleemosynary purpose
and no part of the net income is to be distributed to the officers and members
thereof, the primary objective of every cooperative is self-help: "to provide goods
partnership contract, it may however engage in a joint venture with others. Some features of a
joint venture agreement, carried out in the form of a corporation, are that a minority group is given
a specified number of seats in the board of directors, i.e., three directors in a board of nine
directors; the minority group is entitled to designate a member of the executive committee and his
vote is required for certain transactions; the quorum is required for amendment of the articles and
by-laws is more than the number specified in the law, i.e. 75 % of outstanding shares of stock."
64
232 SCRA 110, 143 (1994).
65
Ibid, citing BLACK‟S LAW DICTIONARY, Sixth ed., at p. 839.
66
More detailed discussions on legal requirements covering cooperatives are found in
Chapter 17 on Non-Stock Corporations and Foundations.
67
Art. 3, Cooperative Development Authority Act (R.A. 6938)
68
Arts. 12 and 30, ibid.
69
Art. 4(2), ibid.
70
Arts. 5(3) and 34, ibid.
71
The Cooperative Development Authority Act (R.A. 6939).
and services to its members and thus enable them to attain increased income
and savings, investments, productivity, and purchasing power and promote
among them equitable distribution of net surplus through maximum utilization of
economies of scale, cost-sharing and risk-sharing without conducting the affairs
of the cooperative for eleemosynary or charitable purposes."72
The Law on cooperatives declares it a policy of the State to foster the
creation and growth of cooperatives as a practical vehicle for promoting self-
reliance and harnessing people power towards the attainment of economic
development and social justice.73
72
Art. 7, The Cooperative Code of the Philippines (R.A. 6938).
73
Art. 2, ibid.
74
40 Phil. 136 (1919).
75
Ibid, at p. 144.
76
20 SCRA 383 (1967).
said officers. It held that the legality of a seizure can be contested only by the
party whose rights have been impaired thereby; and the objection to an unlawful
search is purely personal and cannot be availed of by third parties, such as
officers of the corporation who interpose it for their personal interests.
In Bache & Co. (Phil.), Inc. v. Ruiz,77 the Court held that a corporation is
entitled to immunity against unreasonable searches and seizures. "A corporation
is, after all, but an association of individuals under an assumed name and with a
distinct legal entity. In organizing itself as a collective body it waives no
constitutional immunities appropriate for such body. Its property cannot be taken
without compensation. It can only be proceeded against by due process of law,
and is protected, under the 14th Amendment, against unlawful discrimination."78
In the same case, however, the Court denied that corporations have a
right to claim protection on the constitutional right against self-incrimination. By
applying American doctrine, the Court held that the privilege against self
incrimination "is a personal one, applying only to natural individuals," 79 and a
corporation may be compelled to submit to the visitorial powers of the State even
if this result in disclosure of criminal acts of the corporation.80
In Bataan Shipyard & Engineering Co., Inc. v. PCGG,81 the Court held that
the right against self-incrimination has no application to juridical persons: "While
an individual may lawfully refuse to answer incriminating questions unless
protected by an immunity statute, it does not follow that a corporation, vested
with special privileges and franchises, may refuse to show its hand when
charged with an abuse of such privilege."82
The denial of the right against self-incrimination is extensively quoted in
Bataan Shipyard from Wilson v. United States:83
77
37 SCRA 823 (1971).
78
Ibid, at p. 837, quoting from Hale v. Henkel, 201 U.S. 43, 50 L.Ed. 652.
79
United States v. White, 322 U.S. 694, 698 (1944).
80
Hale v. Henkel, 201 U.S. 43 (1906); Wilson v. United States, 221 U.S. 361 (1911). See
also BERNAS, CONSTITUTIONAL RIGHTS & DUTIES (Vol. I, 1974 ed.) pp. 299-300.
81
150 SCRA 181 (1987).
82
Ibid, at p. 234, quoting from Hal v. Henkel, 201 U.S. 43.
83
55 L.Ed. 771,780.
how these franchises had been employed, and whether they
had been abused, and demand the production of the corporate
books and papers for that purpose. The defense amounts to
this, that an officer of the corporation which is charged with a
criminal violation of the statute may plead the criminality of
such corporation as a refusal to produce its books. To state
this proposition is to answer it. While an individual may lawfully
refuse to answer incriminating questions unless protected by
an immunity statute, it does not follow that a corporation,
vested with special privileges, and franchise may refuse to
show its hand when charged with an abuse of such privileges.
84
U.S. v. Tan Teng, 23 Phil. 145, 152 (1912).
85
Tayag v. Benguet Consolidated, Inc., 26 SCRA 242, 248 (1968).
86
83 SCRA 237 (1978).
87
Ibid, at p. 247, citing 10 FLETCHER CYCLOPEDIA CORPORATION, 1970 ed., pp. 266-267.
as in the Philippine National Bank case, or having taken advantage of such an
tortuous act the corporation, through its board, expressly or impliedly ratifies such
an act or is estopped from impugning such an act.
Since the board of directors of a corporation is the embodiment of the very
power and prerogatives of a corporation, the act of the board in directing or
undertaking a tortuous act is necessarily that of the corporation. In short, the act
of the board is essentially that of the corporation, and therefore corporate assets
cannot escape enforcement of the claims for damages of the tort victim. The tort
liability of the corporation is without prejudice to a derivative suit being filed by
the stockholders to recover from the responsible board members and officers the
damages suffered by the corporation.
Sergio F. Naguiat v. NLRC,88 although admitting that “[o]ur jurisprudence
is wanting as to the definite scope of „corporate tort‟,” nevertheless sought to
encompass corporate tort to “consists in the violation of a right given or the
omission of a duty imposed by law . . , tort is a breach of a legal duty.” In that
case, for failure of the corporate employer to grant separation pay to employees
in case of closure or cessation of operations of establishments or undertaking not
due to serious business losses or financial reverses as mandated in Article 283
of the Labor Code, the Court held the corporate employer liable for tort, including
its stockholder who was actively engaged in the management or operation of the
business.
88
269 SCRA 564, 80 SCAD 502 (1997).
89
27 Phil. 401 (1914).
90
Ibid, at p. 407-408.
creatures of statute have only those powers conferred upon them by statute,
which would naturally come from Spanish and not from common law sources.
The Court went on to say -
95
39 SCRA 303 (1971).
96
121 SCRA 655 (1983).
97
Ibid, at p. 662. For example, under Section 1 (2) of Pres. Decree 772, if the offense of
squatting is committed by a corporation or an association, the penalty imposed by law shall be
meted out on the president, director, manager or managing partners of the corporation or
association who shall be liable thereon.
the ones to assume the criminal liability; otherwise this liability
as created by the law would be illusory, and the deterrent
effect of the law, negated.98
At the time of Sia, Pres. Decree 115 had not been enacted making it
expressly a case of estafa for violating the terms of the trust receipts and
imposing expressly the criminal liability upon the responsible officer, directors,
officers, employees or other officials of a corporation. Since at the time of Sia the
act alleged to be a crime was not in the performance of an act directly ordained
by the law to performed by the corporation, and that the crime imputed would
only arise based on the intent and the agreement of the parties to the trust
receipt, and not by the direct provision of law, then "[t]he intention of the parties,
therefore, is a factor determinant whether a crime was committed or whether a
civil obligation alone [was] intended by the parties."99
The Court then held in the absence of an express provision of law making
the President liable for the criminal offense committed by the corporation, the
existence of a criminal liability on his part may not be said to be beyond any
doubt, as is the quantum of evidence required in criminal cases. "In all criminal
prosecutions, the existence of criminal liability for which the accused is made
answerable must be clear and certain. The maxim that all doubts must be
resolved in favor of the accused is always of compelling force in the prosecution
of offenses."100
Although before Sia, the Court had convicted an individual liable for estafa
under a trust receipt transaction in Samo v. People,101 it held that it was
inapplicable since in that case the individual was shown to be acting for his own
behalf and not in behalf of a corporation. The Court held in Sia that it "has thus
far not ruled on the criminal liability of an officer of a corporation signing in behalf
of said corporation a trust receipt of the same nature as that involved herein." 102
Such pronouncement of the Court would mean that when an officer does
an act for and in behalf of the corporation, his intent would not be ascribed to him
in his personal capacity, but should be ascribed as the intent of the corporation
as it pertains to the transaction. This would amount to respecting the separate
juridical personality of a corporation, even in criminal cases, so that the intent
and motivation of corporate officers acting for in behalf of the corporation would
be ascribable to the corporation as corporate offenses, and the responsible
officer liable for the criminal act as the "personification" of the corporation in the
real world.
Such an implied conclusion can be drawn-out from the concurring opinion
of then Justice Teehankee in Sia when he ruled that —
98
Ibid.
99
Ibid, at p. 663.
100
Ibid.
101
5 SCRA 354 (1962).
102
Samo v. People, 5 SCRA 354, 663.
. . . Petitioner personally cannot be charged and
convicted for the crime of estafa for failure of the corporation
(MEMAP) represented by him as president and general
manager to pay . . .
All these acts were corporate acts with the accused duly
representing the corporation as its president and general
manager: the application for bank financing, the deposit (which
was from corporate funds, and not a deposit made by the
petitioner, as wrongly alleged in the information), the receipt of
the steel sheets, then manufactured into finished products
(which could not technically be done under the terms of the
trust receipt required by the bank, under which the very sheets
were supposed to be sold by the corporation) and the non-
payment of the credit extended by the bank. There is not the
slightest evidence nor intimation that these corporate acts
were unauthorized or that petitioner personally had committed
any fraud or deceit in connection therewith or that he had
personally been responsible for or benefited from the
corporation's failure to pay the bank the balance due under the
trust receipt.103
103
121 SCRA 655, 668.
104
Ibid, at p. 662.
Finally, the Supreme Court clarified in Cometa v. Court of Appeals,105 that
although a criminal case can only be filed against the officers of a corporation
and not against the corporation itself, it does not follow that the corporation
cannot be a real-party-in-interest for the purpose of bringing a civil action for
malicious prosecution for the damages incurred by the corporation for the
criminal proceedings brought against its officer.
105
301 SCRA 459, 102 SCAD 360 (1999).
106
Mambulao Lumber Co. v. Philippine National Bank, 22 SCRA 359 (1968). See also
People v. Manero, 218 SCRA 85 (1993).
107
Ibid, at p. 380.
108
Prime White Cement Corp. v. Intermediate Appellate Court, 220 SCRA 103, 113-114
(1993); also Solid Homes, Inc. v. Court of Appeals, 275 SCRA 267, 84 SCAD 366 (1997).
109
300 SCRA 579, 101 SCAD 1028 (1998).
110
301 SCRA 589, 102 SCAD 459 (1999).
contemplation, it has no feelings, no emotions, no senses. It
cannot, therefore, experience physical suffering and mental
anguish, which can be experienced only by one having a
nervous system. The statement in People v. Manero [218
SCRA 85 (1993)] and Mambulao Lumber Co. v. PNB [130
Phil. 366 (1968)], that a corporation may recover moral
damages if it “has a good reputation that is debased, resulting
in social humiliation” is an obiter dictum. . . The possible basis
of recover of a corporation would be under Articles 19, 20 and
21 of the Civil Code, but which requires a clear proof of malice
or bad faith.
NATIONALITY OF CORPORATIONS
The nationality of a corporation "serves as a legal basis for subjecting the
enterprise or its activities to the laws, the economic and fiscal powers, and the
various social and financial policies, of the state to which it is supposed to
belong."111
In Philippine jurisdiction, the principal doctrine on the test of nationality of
a corporate entity is the place of incorporation test: that a corporation is a
national of the country under whose laws is has been organized and registered.
This is embodied in Section 123 of the Corporation Code which provides that "a
foreign corporations is one formed, organized or existing under any laws other
than those of the Philippines and whose laws allow Filipino citizens and
corporations to do business in its own country or state."
The other test of nationality is the control test, under which the nationality
of a corporation is determined by the nationality of the majority of the
stockholders on whom control is vested.
Nationality is only one basis by which a state controls the affairs of the
corporation. The place of principal business test is also applied to determine
whether a state has jurisdiction over the existence and legal character of a
corporation, its capacity or powers, internal organization, capital structure, the
rights and liabilities of directors, officers, and shareholders towards each other
and to creditors and third persons.112 Under that test, the corporation is a
"national" or subject to the jurisdiction of the place where its principal office or
center of management (siege social) is located.
Although the place of incorporation test is the primary test of nationality of
corporations in the Philippines, in the following cases, in addition to the place of
incorporation test, the control test is also applied:
111
SALONGA, PRIVATE INTERNATIONAL LAW (1979 ed.), p. 338.
112
SALONGA, ibid, at pp. 348-350.
Section 2, Article XII of the Constitution provides that "[a]ll lands of the
public domain, waters, minerals, coal, petroleum, and other mineral oils, all
forces of potential and other natural resources are owned by the State. . . The
State may directly undertake such activities, or it may enter into co-production,
joint venture, or production sharing agreements with Filipino citizens, or
corporations or associations at least sixty per centum of whose capital is owned
by such citizens."113
The policy of the State to ensure that the exploitation of natural resources
or the pursuit of activities deemed to be of public or national interest are in the
control of Filipinos.
In addition, the section authorizes the President to enter into agreements
with foreign-owned corporations involving either technical or financial assistance
for large-scale exploration, development, and utilization of minerals, petroleum,
and other mineral oils according to general terms and conditions provided by law,
based on real contributions to the economic growth and general welfare of the
country. However, the President shall notify the Congress of very contract
entered into within 30 days from its execution.
Even if the corporation is a creature of the State, which can be controlled,
there was a need to further safeguard the exploitation of our natural resources. If
a creature of the Philippine law does not assure the Legislature of its control,
then a creature created by another state must necessarily be disqualified.
Allegiance, by virtue of nationality of said corporation, is owed to the State which
created it.
The constitutional provision114 on limiting the exploitation of natural
resources to corporations at least 60% of the capital stock is owned by Filipino
citizens, does not contain the place of incorporation test. But it must necessarily
be presumed that the control test provided in the Constitution would pertain only
to domestic corporations; and that necessarily a foreign corporation even though
controlled by Filipino citizens would not be qualified to exploit our natural
resources.
The constitutional provision does not distinguish between voting shares
and non-voting shares. So that, even if the voting shares are controlled by
Filipinos, if the total shareholdings of the company (both voting and non-voting)
does not meet the minimum 60% Filipino ownership requirement of the
Constitution, such corporation would still not be qualified to engage in activities
that seek to exploit our natural resources. The broadness of the constitutional
language by not distinguishing voting from non-voting shares seems to square
with Section 6 of the Corporation Code, where in eight fundamental corporate
restructuring or transactions, all shares, including non-voting shares, would be
entitled to vote. Therefore, in those eight case enumerated in Section 6, even
foreigners who hold non-voting shares would be entitled to vote.
113
Emphasis supplied.
114
Sec. 2, Art. XII, 1987 Constitution.
Register of Deeds of Rizal v. Ung Sui Si Temple 115 laid down the principle
"that the purpose of the sixty per centum requirement is obviously to ensure that
corporations or associations allowed to acquire agricultural land or to exploit
natural resources shall be controlled by Filipinos; and that the spirit of the
Constitution demands that in the absence of capital stock, the controlling
membership should be composed of Filipino citizens."116 In that case, the Court
disqualified a non-incorporated religious organization, whose trustees and whose
members were Chinese nationals, from acquiring by donation a piece of land.
In Roman Catholic Administrator of Davao, Inc. v. The LRC and the
Register of Deeds of Davao,117 held that a corporation sole would have no
nationality at all to disqualify it from owning land in the Philippines even though
its only corporator was a Canadian citizen.
Studying the history of the Roman Catholic Apostolic Church in the
Philippines, the Court held that —
115
97 Phil. 58 (1955).
116
Ibid, at p. 61.
117
102 Phil. 597 (1957).
118
Ibid, at p. 612.
for the benefit of the Roman Catholic faithful of their respective locality or
diocese.
The reasoning of the majority decision in Roman Catholic Administrator
has serious flaws. As observed by Justice J.B.L. Reyes in his dissenting opinion,
"[i]n requiring corporations or associations to have 60% of their capital owned by
Filipino citizens, the constitution manifestly disregarded the corporate fiction, i.e.,
the juridical personality of such corporations or associations. It went behind the
corporate entity and looked at the natural persons that composed it, and
demanded that a clear majority in interest (60%) should be Filipino." 119 He
observed the doctrine in Ung Siu Si Temple, that if the association had no
capital, its controlling membership must be composed of Filipinos "[b]ecause
ownership divorced from control is not true ownership."120
Since under the rules governing corporation sole, the members of the
religious association cannot overrule or override the decisions of the sole
corporator, then it would be wrong to conclude that the control of the corporation
sole would be in the members of the religious association.
What the Court held in Roman Catholic Administrator as "the unhappy
freak of English law" has certainly now become a freak in Philippine Corporate
Law.
119
Ibid, at p. 636.
120
Ibid, at p.637.
121
93 Phil. 333 (1953).
already in existence but without the requisite proportion of Filipino capital.
Quasha therefore draws the distinction between the primary franchise of a
corporate entity by virtue of which it is constituted as a body politic endowed with
separate juridical personality, and the secondary franchise that it may receive
during its life for the exercise of a privilege granted by law, such as the operation
of a public utility.
The ruling in Quasha can be pointed to as the basis to show that the
constitutional provision122 prohibiting Congress, except by general law, to provide
for the formation, organization, or regulation of private corporations, really serves
no useful benefit, since all that it covers is the primary franchise, which merely
constitutes the corporation into a juridical entity. It is the secondary franchise by
which the corporation may be granted special privileges, licenses or benefits not
enjoyed by other corporations, where the real abuse may be committed. And yet,
there is no doubt that under the Constitution, Congress has the power to directly
grant secondary franchises to private corporations.
The Quasha doctrine was reiterated in Tatad v. Garcia, Jr.,123 which held
that although the Constitution requires in no uncertain terms that a franchise for
the operation of a public utility can be granted only to corporations at least 60%
of the capital of which is owned by Filipinos; however, "it does not require a
franchise before one can own the facilities needed to operate a public utility so
long as it does not operate them to serve the public. In law, there is a clear
distinction between the „operation‟ of a public utility and the ownership of the
facilities and equipment used to serve the public."124 Therefore, the Court held
that in a railway system, while a foreign corporation may own the rail tracks,
rolling stocks like the coaches, rail stations, terminals and the power plant, and
although a franchise is needed to operate these facilities to serve the public, they
do not by themselves constitute a public utility. "What constitutes a public utility is
not their ownership but their use to serve the public."125 The Court held that in
law, there is a clear distinction between the "operation" of a public utility and the
"ownership" of the facilities and equipment used to serve the public.126
3. Mass Media
Under Section 11, Article XVI of the 1987 Constitution, the ownership of
mass media shall be limited to citizens of the Philippines, or to corporations,
cooperatives or associations, wholly-owned and managed by such citizens. Mass
media includes radio, television, and printed media and does not include
122
Sec. 16, Art. XII, 1987 Constitution.
123
243 SCRA 436, 60 SCAD 480 (1995).
124
Ibid, at pp. 452-453.
125
Ibid, at pp. 453, citing Iloilo Ice & Cold Storage Co. v. Public Service Board, 44 Phil. 551
(1923).
126
Ibid, at pp. 452-453, citing Iloilo Ice & Cold Storage Co. v. Public Service Board, 44 Phil.
551, 557-558 (1923).
commercial telecommunications, which are considered as public utilities, nor the
advertising industry.127
The term "mass media" shall mean the gathering, transmission of news,
information, messages, signals, and forms of written, oral and all visual
communication and shall embrace the print medium, radio, television, films,
movies, advertising in all its phases, and their business managerial.128 The
distinctive features of any mass media undertaking is the dissemination of
information and ideas to the public, or a portion thereof.129 It is divided into the
print media and the broadcast media; the broadcast media includes radio and
television broadcasting in all their aspects and all other cinematographic or radio
promotion and advertising.130 The term covers any medium of communication, a
newspaper, radio, motion pictures, or television, designed to reach the masses
and that tends to set the standards, ideals and aims of the masses. 131 The term
has also been opined to include cable television.132
Although the constitutional provision governing mass media does not
expressly include the place of incorporation test, the same shall be deemed
included under the same principle governing exploitation of natural resources. In
fact, the ancillary control test for mass medium under the Constitution is actually
more stringent than in other defined areas, since it requires not only 100%
Filipino ownership of the capital stock of the corporation, but also 100%-Filipino
management of the entity.
4. Advertising Industry
Section 11, Art. XVI of the 1987 Constitution provides that the advertising
industry is impressed with public interest, and shall be regulated by law for the
protection of consumers and the promotion of the general welfare.
Only Filipino citizens or corporations or associations at least seventy
percent (70%) of the capital of which is owned by such citizens shall be allowed
to engage in the advertising industry. It also provides that the participation of
127
BERNAS, THE CONSTITUTIONS OF THE REPUBLIC OF THE PHILPPINES—A COMMENTARY
(1988 ed.), p. 563; Chapter 1, Rules and Regulations for Mass Media in the Philippines.
128
Pres. Decree 36, as amended by Pres. Decrees 191 and 197.
129
DOJ Opinion No. 120, series of 1982.
130
Section 2, Pres. Decree 576; SEC Opinion, 24 March 1983, addressed to Justice Manuel
Lazaro.
131
DOJ Opinion 163, s. 1973; SEC Opinion dated 15 July 1991, XXV SEC Q UARTERLY
BULLETIN, 31 (No. 4, Dec. 1991).
132
The National Telecommunications Commission (NTC), which regulates and supervises
the cable television industry in the Philippines under Section 2 of Executive Order No. 436, s.
1997, has provided under NTC Memorandum Circular No. 8-9-95, under item 920(a) thereof
provides that “Cable TV operations shall be governed by E.O. No. 205, s. 1987. If CATV
operators offer public telecommunications services, they shall be treated just like a public
telecommunications entity.” Under DOJ Opinion No. 95, series of 1999, the Secretary of Justice,
taking its cue from Allied Broadcasting, Inc. v. Federal Communications Commission, 435 F. 2d
70, considered CATV as “a form of mass media which must, therefore, be owned and managed
by Filipino citizens, or corporations, cooperatives or associations, wholly-owned and managed by
Filipino citizens pursuant to the mandate of the Constitution.”
foreign investors in the governing body of the entities in such industry shall be
limited to their proportionate share in the capital thereof, and all the executive
and managing officers of such entities must be citizens of the Philippines.
5. War-Time Test
In Filipinas Compañia de Seguros v. Christern,133 the Court held that in
times of war, the nationality of a private corporation is determined by the
character or citizenship of its controlling stockholders. The Court considered the
juridical entity an enemy based on the fact that the "majority of the stockholders
of the respondent corporation were German subjects." It ruled that the control
test was applicable only in war-time. It refused the sole application of the place of
incorporation test during war-time to determine the nationality of an enemy
corporation.
The war-time test enunciated by Filipinas Compañia has since been
adhered to in subsequent decisions of the Court.134
It must be stressed however, that the afore-quoted SEC rule applies only
for purposes of resolving issues on investments. The SEC was quick to add:
133
89 Phil. 54 (1951).
134
Davis Winship v. Philippine Trust Co., 90 Phil. 744 (1952).
135
DOJ Opinion No. 18, s. 1989.
136
SEC Opinion, 23 November 1993, XXVIII SEC QUARTERLY BULLETIN 39 (No. 1, March
1994); SEC Opinion, 14 April 1993, XXVII SEC QUARTERLY BULLETIN 29 (No. 3, Sept. 1993); SEC
Opinion, 23 March 1993, XXVII SEC QUARTERLY BULLETIN 15 (No. 3, Sept. 1993); SEC Opinion, 6
August 1991, SEC QUARTERLY BULLETIN 44 (No. 4, Dec. 1991); SEC Opinion, 30 May 1990, XXIV
SEC QUARTERLY BULLETIN 52 (No. 3, Sept. 1990); SEC Opinion, 14 December 1989, XXIV SEC
QUARTERLY BULLETIN 7 (No. 2, June 1990); SEC Opinion, 6 November 1989, XXIV S EC
QUARTERLY BULLETIN 56 (No. 1, March 1990.
"However, while a corporation with 60% Filipino and 40% Foreign equity
ownership is considered a Philippine national for purposes of investment, it is not
qualified to invest in or enter into a joint venture agreement with corporations or
partnerships, the capital or ownership of which under the constitution or other
special laws are limited to Filipino citizens only." 137 A joint venture arrangement
would mean that such corporation has become a partner and is deemed then to
be acting or involving itself in the operations of a nationalized activity by the acts
of the local partners by virtue of the principle of mutual agency applicable to
partnerships.
Under Section 3(a) of the Foreign Investment Act of 1991, the term
"Philippine national" as it refers to a corporate entity shall mean a corporation
organized under the laws of the Philippines of which at least sixty percent (60%)
of the capital stock outstanding and entitled to vote is owned and held by citizens
of the Philippines. However, it provides that where a corporation and its non-
Filipino stockholders own stocks in a SEC-registered enterprise, at least sixty
percent (60%) of the capital stock outstanding and entitled to vote of both
corporations must be owned and held by citizens of the Philippines and at least
sixty percent (60%) of the members of the Board of Directors of both
corporations must be citizens of the Philippines, in order that the corporation
shall be considered a Philippine national. The law therefore, limits the test to
voting shares, but however, makes it more stringent when it comes to actual
control by making a double 60% rule requirement as to both holding and held
company, as well as their board of directors.
How many levels should grandfather rule be applied? In the early case of
Palting v. San Jose Petroleum Inc.,138 the Supreme Court refused the registration
and sale into the Philippines of securities of a Panamanian registered company
the proceeds of which were to be exclusively used to finance the oil exploration
efforts of a domestic corporation, which was owned 90% by the Panamanian
company. The Panamanian company sought authority to issue the securities on
the basis of the parity rights under the Laurel-Langley Agreement.
It was the contention of the Panamanian company that since its majority
shareholdings are owned by another Panamanian company, which in turn was
owned 100% by two (2) Venezuelan companies whose shares were being traded
in the stock exchanges in the United States, then it was qualified to exercise the
privileges granted under the Laurel-Langley agreement.
In refusing to apply the long chain of ownership source to find control to be
with American citizens in the United States who have bought the shares of the
two (2) Venezuelan companies, the Court held that "with a long chain of
intervening foreign corporations . . . is to unduly stretch and strain the language
and intent of the law. For, to what extent must the word 'indirectly' be carried?
Must we trace the ownership or control of these various corporations ad infinitum
137
SEC Opinion, 14 December 1989, XXIV SEC QUARTERLY BULLETIN 7 (No. 2, June 1990).
138
18 SCRA 924 (1966).
for the purpose of determining whether the American ownership-control-
requirement is satisfied?"139
In short, the message of Palting is that the application of the grandfather
rule to determine the nationality of the ultimate controller of a subject corporation
cannot go beyond the level of what is reasonable. The further away the level of
ownership from the subject corporation, the less can one practically associate
control of the subject corporation.
In a 1977 internal memorandum issued by the SEC applying the
grandfather rule, it suggested that the rule be applied on two (2) levels of
corporate relations for publicly-held corporations or where the shares are traded
in the stock exchanges; and to apply the rule on three (3) levels for closely held
corporations or the shares of which are not traded in the stock exchange. On the
other hand, under Central Bank Circular No. 1171,140 the Monetary Board in
applying the grandfather rule in corporate ownership in banking institutions
directed application up to the fourth level or fourth tier of corporate ownership.
Aside from the General Banking Law of 2000 which expressly provides for
the application of the grandfather rule,141 the Investment Houses Law also applies
the rule.142
143
See Vasquez, Nationality of Juridical Persons: Evaluation and Departure, 60 PHIL. L.J.
292 (1985).
144
SALONGA, PRIVATE INTERNATIONAL LAW, (U.P. Law Center, 1979 ed.), pp. 136-137.
PARAS, PHILIPPINE CONFLICT OF LAWS, (Rex Book Store, 1979 ed.), pp. 108-109.
CLASSIFICATIONS OF CORPORATIONS
For purely academic purposes, certain classes of corporations will be
discussed hereunder. However, for a better philosophical approach on certain
classifications other chapters of this book should be referred to.
The substantial issues relating to de facto corporations and the
corporation by estoppel doctrine are discussed in Chapter 5 on Corporate
Contract Law. The underlying doctrine on non-stock corporations, as
distinguished from stock corporations, is thoroughly discussed in Chapter 16 on
Non-Stock Corporations and Foundations. The substantial aspect of doing
business in the Philippines of foreign corporations, as distinguished from
domestic corporation, is discussed in Chapter 17 on Foreign Corporations and
the Concept of Doing Business.
146
91 Phil. 359 (1952).
continue to be private corporations, such as the National Development
Corporation, the Philippine National Railways, etc.
3. Quasi-Public Corporations
There is a group of corporations that seem to be a cross between private
corporations and public corporations, and they are classified as quasi-public
corporations. These usually cover school districts, water districts, and the like.
Marilao Water Consumers Association, Inc. v. Intermediate Appellate
147
Court, held that water districts organized under Pres. Decree 198, although
considered as quasi-public corporations and authorized to exercise the powers,
rights and privileges given to private corporations under existing laws, are
entirely distinct from corporations organized under the Corporation Code, and not
within the jurisdiction of the SEC.
PNOC-Energy Development Corp. v. Leogardo,148 PNOC-Eneregy
Development Corp. v. NLRC,149 and Davao City Water District v. Civil Service
Commission,150 held that the doctrine that employees of government-owned and
controlled corporations, whether created by special law or formed as subsidiaries
under the general corporation law are governed by the Civil Service Law and not
by the Labor Code, has been supplanted by the 1987 Constitution. The present
doctrine is that: The test in determining whether a government-owned or
controlled corporation is subject to the Civil Service Law is the manner of its
creation, such that government corporations created by special charter are
subject to its provisions while those incorporated under the general corporation
law are not within the coverage, and therefore are governed by the Labor Code.
Boy Scouts of the Philippines v. NLRC,151 held that although Boy Scouts of
the Philippines does not receive any monetary or financial subsidy from the
Government, and that its funds and assets are not considered government in
nature and not subject to audit by the Commission of Audit, the fact that it
received a special charter from the government, that its governing board are
appointed by the Government, and that its purpose are of public character, for
they pertain to the educational, civic and social development of the youth which
constitute a very substantial and important part of the nation, it is not a public
corporation in the same sense that municipal corporation or local governments
are public corporation since its does not govern a portion of the state, but it also
does not have proprietary functions in the same sense that the functions or
activities of government-owned or -controlled corporations such as the National
Development Company or the National Steel Corporation, is may still be
considered as such, or under the 1987 Administrative Code as an instrumentality
147
201 SCRA 437 (1991).
148
175 SCRA 26 (1989).
149
201 SCRA 487 (1991).
150
201 SCRA 593 (1991).
151
196 SCRA 176 (1991).
of the Government. Therefore, the employees are subject to the Civil Service
Law.
Under Rep. Act 7656, which required government-owned or controlled
corporations to declare dividends to the National Government, the term
"government-owned or controlled corporations" has been specifically defined as
"corporations organized as a stock or non-stock corporation vested with functions
relating to public needs, whether governmental or proprietary in nature, and
owned by the Government directly or through its instrumentalities either wholly
or, where applicable as in the case of stock corporations, to the extent of at least
fifty-one percent (51%) of its capital stock." The term also includes financial
institutions, owned or controlled by the National Government, "but shall exclude
acquired asset corporations."
AS TO PLACE OF INCORPORATION
1. Domestic Corporations
A domestic corporation is one incorporated under laws of the Philippines.
Under Section 123 of the Corporation Code, "a foreign corporation is one formed,
organized or existing under any laws other than those of the Philippines and
whose laws allow Filipino citizens and corporations to do business in its own
country or State. It shall have the right to business in the Philippines after it shall
have obtained a license to transact business in the country in accordance with
this code and a certificate of authority from the appropriate government agency."
2. Foreign Corporations
A foreign corporation may be licensed by the SEC to do business in the
Philippines only under the principle of reciprocity, after securing a certificate of
authority from the Board of Investments under Executive Order 226, or the
Omnibus Investments Code, and after complying with the conditions for issuance
of the license on application forms, structural organizations and capitalization.
The objectives of the statutory provisions prescribing conditions under
which foreign corporations are permitted to do business in a state other than that
of their creation:
AS TO LEGAL STATUS
1. De Jure Corporation
A corporation has de jure existence if there is a full or substantial
compliance with the requirements of an existing law permitting organization of
such corporation as by proper articles of incorporation duly executed and filed.
Generally, its juridical personality is not subject to attack in the courts from any
source.
If a corporation is a de jure corporation, its due incorporation cannot be
successfully attacked even in a quo warranto proceeding by the State. Therefore
if such proceeding is brought against a corporation and the State has a prima
facie case, the corporation must show that it is a de jure corporation.
2. Corporation De Facto
A corporation has de facto existence where there is a bona fide attempt to
incorporate, colorable compliance with the statute and user of corporate powers.
Under Section 20 of the Corporation Code, the "due incorporation of any
corporation claiming in good faith to be a corporation . . . and its right to exercise
corporate powers, shall not be inquired into collaterally in any private suit ot
which such corporation may be a party." Such inquiry may be made by the
Solicitor General in a quo warranto proceeding.154
The doctrine grew out of the necessity to promote the security of business
transactions and to eliminate quibbling over irregularities. It would be a rare case
where a third persons dealing with a corporation is prejudiced by its recognition
152
Filipinas Compania de Seguros v. Christern, Huenefeld & Co., Inc., 89 Phil. 54 (1951);
Davis Winship v. Philippine Trust Co., 90 Phil. 744 (1952); Haw Pia v. China Banking Corp., 80
Phil. 604 (1948).
153
See discussions on doing business in Chapter 17 on Non- Stock Corporations and
Foundations.
154
Ibid.
as a separate entity despite some minor defects in its incorporation. It would be
unfair to allow a claimant against the alleged corporation to insist on the
individual liability of innocent investors merely because of some minor flaws in its
incorporation.
A more thorough discussion of the de facto corporation doctrine is
provided for in Chapter 5 on Corporate Contract Law.
3. Corporation by Estoppel
Although an entity may not be a corporation de jure or de facto, a
particular person or party may, by estoppel or admission, be precluded from
denying its corporate existence. A group of persons may assume to do business
as a corporation without having gone far enough to give a de facto existence to
the entity.
Under certain circumstances and for certain purposes, either the group or
third persons contracting with the purported corporation may be estopped to
deny its corporate status.
Under Section 21 of the Corporation Code, "[a]ll persons who assume to
act as a corporation knowing it to be without authority to do so shall be liable as
general partners for all debts, liabilities and damages incurred or arising as a
result thereof; Provided, however, That when any such ostensible corporation is
sued on any transaction entered by it as a corporation or on any tort committed
by it as such, it shall not be allowed to use as a defense its lack of corporate
personality.”
In addition, the same section provides that "[o]ne who assumes an
obligation to an ostensible corporation as such, cannot resist performance
thereof on the ground that there was in fact no corporation."
The corporation by estoppel doctrine is founded on procedural
convenience, avoidance of inquiries into irrelevant formalities, and fairness to all
parties concerned.
The corporation by estoppel doctrine is properly discussed in Chapter 5 on
Corporate Contract Law.
4. Corporation by Prescription
The Roman Catholic Church is a corporation by prescription, with
acknowledged juridical personality inasmuch as it is an institution which
"antedated by almost a thousand years any other personality in Europe, and
which existed „when Grecian eloquence still flourished in Antioch and when idols
were still worshipped in the temple of Mecca.‟"155
155
Barlin v. Ramirez, 7 Phil. 41 (1906).
AS TO EXISTENCE OF SHARES OF STOCKS
1. Stock Corporations
Corporations which have a capital stock divided into shares and are
authorized to distribute to the holders dividends. If not authorized by the by-laws
to distribute the dividends, but it is a stock corporation, can a corporation
distribute dividends to its shareholders? The answer seems to be in the
affirmative, since one of the expressed powers granted to stock corporations
under Section 43 of the Corporation Code is the power to declared dividends.
2. Non-Stock Corporations
Section 87 of the Corporation Code provides that a non-stock corporation
is one where on part of its income is distributable as dividends. Under the Code,
a non-stock corporation is one where no part of its income is distributable as
dividends to its members, trustees or officers, subject to the provisions on
dissolution, provided that any profit which a non stock corporation may obtain as
an incident to its operations shall, whenever necessary or proper be used for the
furtherance of the purpose or purposes for which the corporation was organized,
subject or the provisions of this title.
This provisions governing stock corporations, when pertinent shall be
applicable to non-stock corporations, except as may be covered by specific
provisions of this title.
Section 88 provides that non-stock corporations may be formed or
organized for charitable, religious, educational professional, cultural, recreational,
fraternal, literary, scientific, social, civic service, or similar purposes, like trade,
industry, agriculture and like chambers, or any combination thereof, subject to
the special provisions of this title governing particular classes of non stock
corporations.
In Collector of Internal Revenue v. Club Filipino,156 the Club Filipino was a
civic organization created for recreational purposes, and neither in the articles of
incorporation nor in the by-laws was there a provision relative to dividends and
their distribution, although it is covenanted that upon its dissolution, the club's
remaining assets, after paying debts, shall be donated to a charitable institution.
Whatever profits the club had were used to defray its overhead expenses and to
improve its golf course. The issue is whether or not the club is liable to pay
business taxes. The Court found that the plain and ordinary meaning of business
is restricted to activities or affairs where profit is the purpose. Having found that
the club was organized to help develop and cultivate sports; that whatever profit
it derives are actually used to defray its over head expenses, it stands to reason
that the club is not engaged in the business of an operation of a bar and
restaurant.
156
5 SCRA 321 (1962).
It would seem therefore that for a stock corporation to exist, two requisites
must be complied with: (a) a capital stock divided into shares; and (b) authority to
distribute dividends. However, it is to be noted that nowhere in its articles or by
laws could be found an authority for the distribution of its dividends or surplus
profits.
There is no authorization to declare dividends and this authorization can
only be found either in the articles, the by-law or the resolutions.
Thus, every time there is an express authorization in either the articles of
incorporation or by-laws of a corporation to declare dividends, it is undoubtedly a
stock corporation. When there is no express prohibition not to distribute
dividends, it would seem that the corporation is a non-stock corporation. And like
the Club Filipino case, where there is no express authorization, no express
prohibition, and practice of the corporation shows that it has never declared
dividends in the past and the purpose of the corporation is eleemosynary, it is a
non-stock corporation.
2. Affiliate Company
An affiliate is a company which is subject to common control of a mother
or holding company and operated as part of a system. 158 An "affiliate" is defined
by SEC as a person that directly or indirectly, through one or more
intermediaries, controls or is controlled by, or is under common control with, the
person specified, through the ownership of voting shares, by contract, or
otherwise.159
157
SEC Opinion, 30 September 1986, XX SEC QUARTERLY BULLETIN (Nos. 3 & 4, Sept. &
Dec, 1986), p. 308, quoting from BALLANTINE LAW ON CORPORATIONS.
158
Ibid.
159
Rule 1-2, SEC Rules on Form and Content of Financial Statements Required to Filed by
Corporations Whose Shares of Stock are Sold Or Offered for Sale to the Public. (1973).
person is an affiliate controlled by such person, directly or indirectly, through one
or more intermediaries.160
When it comes to listed companies, the SEC Rules on Form and Content
of Financial Statements161 require consolidated financial statements to be filed
combining the operations of both the parent and the subsidiary companies.
The SEC Rules define the term "control" as the possession, directly or
indirectly, of the power to direct or cause the direction of the management and
policies of the corporation, either through the ownership of its voting shares or by
the existence of a contract or by any other lawful means. In general, the SEC
rules provide that any corporation owning 20% of the outstanding voting shares
of another shall be presumed to be in control of the other.162
Other factors shall also be considered, other than the control factor, thus:
160
Ibid.
161
Issued under SEC Circular No. 2, Series of 1973.
162
Rule 1-2, SEC Rules on Form and Content of Financial Statements Required to Filed by
Corporations Whose Shares of Stock are Sold Or Offered for Sale to the Public (1973).
restrictions, controls or other governmentally imposed
uncertainties so severe that they cast significant doubt on
the parent's ability to control the subsidiary.
—oOo—
163
See also Sandiego, Director, Examiners and Appraisers Dept., SEC, Accounting Times
(1st Quarter, 1993).
CHAPTER 4
Introduction
Main Doctrine of Separate Juridical Personality
Application of Piercing Doctrine
Nature and Consequences of Piercing Doctrine
Piercing Application Has Only Has Res Judicata Effect
Piercing Application is to Prevent Fraud or Wrong and Not Available
for Other Purposes
“Victim” Standing
Piercing Application is Essentially of Judicial Prerogative
Piercing Application Must Be Shown to Be Necessary and With
Factual Basis
Classification of the Piercing Cases
Fraud Cases
Piercing Doctrine Cannot Be Employed to Commit Fraud
Corporate Fiction Must Be Employed to Commit Fraud
Tax Evasion Cases
Alter-ego Elements in Fraud Piercing Cases
Evasion of Lawful Obligations
Liability of Officers
Rules in Labor Cases
Probative Factors
In Summary
Alter Ego Cases
Manner of Operating the Corporate Enterprise
Tax Avoidance Cases
Under-Capitalization
Forum-Shopping
Parent-Subsidiary Relationship
Affiliated Companies
Transfer of Business Enterprise
Disturbing Developments Adopting the Umali Doctrine
In Summary
1
This chapter is based on the article entitled Restatement of the Doctrine of Piercing the
Veil of Corporate Fiction, published in 37 ATENEO L.J. 19 (No. 2, June, 1993).
Equity Cases
Piercing Doctrine and Due Process Clause
Corporations in Sequestration Issues
Final Observations
——
INTRODUCTION
The aim of this chapter is to emphasize the complementary relationship of
the piercing doctrine to the main doctrine that a corporation has a juridical
personality separate and distinct from the stockholders or members who
compose it.
Looking at the number of decisions rendered by the Supreme Court where
it has pierced the veil of corporate fiction, compared with the handful of decisions
by which it has refused to apply the piercing doctrine and instead affirmed the
main doctrine of separate juridical personality, may give one the impression that
the main doctrine has lost some of its vitality, and that the piercing doctrine has
grown lush and vital.
It is always comforting to note, however, especially for businessmen for
whom the corporate entity has undoubtedly become the most popular medium to
pursue business endeavors, that the viability and vitality of a doctrine is to be
tested not by the times it has been challenged and overcome in court decisions,
but by the usefulness and frequency of its employment in the market place. The
enormity of the number of Supreme Court decisions applying the piercing
doctrine without hitch does not even begin to show the thousands and thousands
of daily transactions negotiated and completed employing the main doctrine of
separate corporate entity.
When dealing with piercing cases, it is always important to consider that
the aim which is, or at least should be, sought to be achieved by the Court is not
to use the piercing doctrine as a ram to break down the ramparts of the main
doctrine of separate juridical personality, but more properly for the ancillary
piercing doctrine to act as a regulating valve by which to preserve the powerful
engine that is the main doctrine of separate juridical personality.
It is important therefore to consider that the vitality of the main doctrine of
separate juridical personality is essential in preserving and promoting the
corporation as an entity by which the business community can continue to
harness capital resources and undertake either risky or large-scale enterprises;
and that the development of the piercing doctrine should not act in competition
with, but rather to complement and make more vital, the main doctrine of
separate juridical personality.
MAIN DOCTRINE OF SEPARATE JURIDICAL PERSONALITY
Since its 1906 introduction in the Philippines,2 the corporation has been
defined3 as "an artificial being created by operation of law, having the right of
succession and the powers, attributes and properties expressly authorized by
law or incident to its existence." The definition is the basis of the primary doctrine
that a corporation being a juridical person has a personality separate and distinct
from the stockholders or members who compose it.4
In one case, the Supreme Court has summarized the primary doctrine to
be that a corporation is a juridical entity with legal personality separate and
distinct from those acting for and in its behalf and, in general, from the people
comprising it; and that obligations incurred by the corporation, acting through its
directors, officers and employees are its sole liabilities.5 In another case, it held
that “[a] corporation is an entity separate and distinct from its stockholders.
While not in fact and in reality to a person the law treats the corporation as
thought it were a person by process of fiction or by regarding it as an artificial
person distinct and separate from its individual stockholders.”6
The granting to the corporate entity of a strong separate juridical
personality has been considered as the attribute or privilege most characteristic
of the corporations.7 Unlike the cumbersome juridical personality of its nearest
rival today, the partnership, the separate juridical personality of the corporation,
has features that has made it most attractive to businessmen: right of
succession, limited liability, centralized management, and generally free-
transferability of shares of stock. In addition, the strong separate juridical
personality of the corporation facilitates and preserves the "going concern value"
of the underlying business enterprise, saves on transaction costs, and prevents
disruption of that value because of investors who withdrawal or who are
deceased. Therefore, an undermining of the separate juridical personality of the
corporation, such as the abusive application of the piercing doctrine, necessarily
dilutes any or all of these attributes.
The stability of the main doctrine of separate juridical personality is
inextricably linked with the attractiveness of the corporation as an efficient
medium by which businessmen can pursue business enterprises. The
undermining of the main doctrine would also compel businessmen to have to
enter into inefficient and costly contractual relations to fill the gaps created by a
flawed main doctrine.
2
Act No. 1459 passed by the then Philippine Commission, known as “The Corporation Law.”
3
Sec. 2, Act No. 1459, and Sec. 2, Batas Pambansa Blg. 25.
4
When studying Corporate Law, there is little direct consciousness that the doctrine of
separate juridical personality also finds basis from Article 44 of the Civil Code which recognizes as
juridical persons “[c]orporations, partnership and associations for private interests or purposes to
which the law grants a juridical personality, separate and distinct from that of each shareholder,
partner or member.”
5
Santos v. NLRC, 69 SCAD 390, 254 SCRA 673, 96 SCAD 561 (1996).
6
Remo, Jr. v. Intermediate Appellate Court, 172 SCRA 405, 408 (1989).
7
BALLANTINE, Sec. 287.
The Supreme Court has not been wanting in paying lip service to the main
doctrine of separate juridical personality, especially in recent years, when it
seems, at every turn, a proposition to pierce the veil of corporate fiction has
become a knee-jerk reaction in most litigations involving corporate parties.
However, the Court has not really taken a clear and direct path on the main
doctrine vis-a-vis the piercing doctrine.
In Stockholders of F. Guanzon and Sons, Inc. v. Register of Deeds of
Manila,8 the distribution of the corporate properties to the stockholders was
deemed not in the nature of a partition among co-owners, but rather a disposition
by the corporation to the stockholders, as opposite parties to a contract. It held
that "[a] corporation is a juridical person distinct from the members composing it
[and that] [p]roperties registered in the name of the corporation are owned by it
as an entity separate and distinct from its members. While shares of stock
constitute the personal property, they do not represent property of the
corporation. . . A share of stock only typifies an aliquot part of the corporation's
property, or the right to share in its proceeds to that extent when distributed
according to law and equity, but its holder is not the owner of any part of the
capital of the corporation, nor is he entitled to the possession of any definite
portion of its property or assets. The stockholder is not a co-owner or tenant in
common of the corporate property."9
Manila Gas Corp. v. Collector of Internal Revenue,10 held that the tax
exemptions granted to a corporation do not pertain to its corporate stockholders
due to their separate corporate personalities: "A corporation has a personality
distinct from that of its stockholders, enabling the taxing power to reach the latter
when they receive dividends from the corporation. It must be considered as
settled in this jurisdiction that dividends of a domestic corporation which are paid
and delivered in cash to foreign corporations as stockholders are subject to the
payment of the income tax, the exemption clause to the charter [of the domestic
corporation] notwithstanding."11
Likewise, attempts by stockholders to intervene in suits against their
corporations have been struck down in Magsaysay-Labrador v. Court of
Appeals,12 on the basic premise that a party may intervene under remedial
provisions if the stockholder has a legal interest in the matter in litigation; but that
stockholders' right in corporate property is purely inchoate and will not entitle
them to intervene in a litigation involving corporate property.
Magsaysay-Labrador held that a majority stockholder's interest in
corporate property, "if it exists at all, . . . is indirect, contingent, remote,
conjectural, consequential and collateral. At the very least, their interest is purely
inchoate, or in sheer expectancy of a right in the management of the corporation
and to share in the profits thereof and in the properties and assets thereof on
8
6 SCRA 373 (1962).
9
Ibid, at 375-376.
10
62 Phil. 895 (1936).
11
Ibid, at p. 898.
12
180 SCRA 266 (1989).
dissolution, after payment of the corporate debts and obligations." 13 It also held
that while a share of stock represents a proportionate or aliquot interest in the
property of the corporation "it does not vest the owner thereof with any legal right
or title to any of the property, his interest in the corporate property being
equitable or beneficial in nature. Shareholders are in no legal sense the owners
of corporate property, which is owned by the corporation as a distinct legal
person."14
In Saw v. Court of Appeals15 the Court refused the petition for intervention
filed by the stockholders in a collection case covering the loans of the
corporation on the ground that the interest of shareholders in corporate property
is purely inchoate; and this purely inchoate interest will not entitle them to
intervene in a litigation involving corporate property.16 And vice-versa, in Sulo ng
Bayan v. Araneta, Inc.17 where an attempt by a non-stock and non-profit
corporation organized for the benefit of its members to bring a suit in behalf of its
members for the recovery of certain parcels of land owned by the members was
not allowed by the Court.
In the same manner, in Asset Privatization Trust v. Court of Appeals,18 the
Court held that even when there was wrongful foreclosure on the assets of the
corporation, the stockholders would have no standing to recover for themselves
moral damages; otherwise, it would amount to the appropriation by, and the
distribution to, such stockholders of part of the corporation’s assets before the
dissolution of the corporation and the liquidation of its debts and liabilities.
In Traders Royal Bank v. Court of Appeals,19 an action sought to make
officers and stockholders liable for corporate debts on the basis of such
relationship alone was turned down by the Court: "The corporate debt or credit is
not the debt or credit of the stockholder nor is the stockholder's debt or credit
that of the corporation."20
Cruz v. Dalisay,21 held that the mere fact that one is president of the
corporation does not render the property he owns or possesses the property of
13
Magsaysay-Labrador v. Court of Appeals, 180 SCRA 266, 271 (1989).
14
Ibid, at pp. 271-272, citing BALLANTINE 288-289; Pascual v. Del Sanz Orozco, 19 Phil. 82,
86 (1911).
15
195 SCRA 740 (1991).
16
Ibid, at pp. 744-745.
17
72 SCRA 347 (1976).
18
300 SCRA 579, 617, 101 SCAD 1028 (1998).
19
177 SCRA 789 (1989): The mere fact that an individual bound himself as surety for a
corporations obligations does not vest the SEC exclusive jurisdiction over said individuals or over
the latter's person or property in a rehabilitation and receivership proceedings pending with the
SEC over the corporate entity. Traders Royal Bank v. Court of Appeals, 177 SCRA 788, 792
(1989).
20
177 SCRA 789, 792.
21
152 SCRA 487 (1987).
the corporation, since the president, as an individual, and the corporation are
separate entities.22
In National Power Corp. v. Court of Appeals,23 the Court held that the
finding in the trial court’s judgment of solidary liability among the corporation and
its officers and directors would patently be baseless when the decision contains
no allegation, finding or conclusion regarding particular acts committed by said
officers and members of the board of directors that show them to have been
individually guilty of unmistakable malice, bad faith, or ill-motive in their personal
dealings with third parties. The Court emphasized that when corporate officers
and directors are sued merely as nominal parties in their official capacities as
such, they cannot be held liable personally for the judgment rendered against the
corporation.
24
In Sebreño v. Court of Appeals, the mere showing that three
corporations had one common director sitting the boards of all the corporations,
without further allegation and proof that one or another of the three (3)
corporations concededly related companies used the other two (2) as mere alter
egos or that the corporate affairs of the other two (2) were administered and
managed for the benefit of one, did not authorize piercing their separate juridical
personalities.
In the same manner, in CKH Industrial and Development Corp. v. Court of
Appeals,25 the Court held that the interests of payees in promissory notes cannot
be off-set against the obligations between the corporations to which they are
stockholders in the absence of any allegation, much less, even a scintilla of
substantiation, that the parties interests in the corporation are so considerable as
to merit a declaration of unity of their civil personalities.
In Good Earth Emporium, Inc. v. Court of Appeals,26 the Court, in refusing
to allow execution of a corporate judgment debt against the officer, held that
being an officer or stockholder of a corporation does not by itself make one's
property also of the corporation, and vice-versa, for they are separate entities,
and that shareholders are in no legal sense the owners of corporate property
which is owned by the corporation as a distinct legal person.27
In Development Bank of Philippines v. NLRC,28 the Court held that
ownership of a majority of capital stock and the fact that a majority of directors of
a corporation are the directors of another corporation created no employer-
employee relationship, nor did it make the controlling stockholder liable for
employees' claim of the subject corporation.
22
Ibid, at p. 486. See also Sulong Bayan, Inc. v. Araneta, Inc., 72 SCRA 347, 354-355
(1976).
23
273 SCRA 419, 83 SCAD 360 (1997).
24
222 SCRA 466 (1993).
25
272 SCRA 333, 82 SCAD 509 (1997).
26
194 SCRA 544 (1991).
27
Ibid, at p. 550, citing Traders Royal Bank v. Court of Appeals, 152 SCRA 482 (1989) and
Cruz v. Dalisay, 152 SCRA 482 (1989).
28
186 SCRA 841 (1990).
Earlier, Liddell & Co. v. Collector of Internal Revenue,29 expressed the
principle that mere ownership by a single stockholder or by another corporation
of all or nearly all capital stocks of the corporation is not by itself sufficient
ground for disregarding the separate corporate personality. 30 Likewise, Umali v.
Court of Appeals,31 held that the mere fact that the businesses of two or more
corporations are interrelated is not a justification for disregarding their separate
personalities, absent sufficient showing that the corporate entity was purposely
used as a shield to defraud creditors and third persons of their rights. 32
The Supreme Court has therefore consistently held that substantial
ownership in the capital stock of a corporation entitling the shareholder a
significant vote in the corporate affairs allows them no standing or claims
pertaining to corporate affairs;33 nor does substantial identity of the incorporators
of two corporation necessarily imply fraud.34 It is now a well-established doctrine
that mere ownership by a single stockholder or by another corporation of all or
nearly all of the capital stock of a corporation is not of itself sufficient ground for
disregarding the separate corporate personality.35
29
2 SCRA 632, 640 (1961)
30
See also Palay, Inc. v. Clave, 124 SCRA 638 (1983); Pabalan v. NLRC, 184 SCRA 495
(1990).
31
189 SCRA 529, 543 (1990).
32
Ibid, at p. 543. Also Diatagon Labor Federation v. Ople, 101 SCRA 534 (1980).
33
PNB v. Phil Neg. Oil Co., 49 Phil. 857, 853, and 862 (1927); Liddel v. Court of Industrial
Relations, 93 Phil. 160 (1961); Pabalan v. NLRC, 184 SCRA 495 (1990).
34
Tantoco v. Kaisahan ng Mga Manggagawa sa La Campana, 106 Phil. 199 (1959); Del
Rosario v. NLRC, 187 SCRA 777 (1990); North Davao Mining Corp. v. NLRC, 254 SCRA 721, 69
SCAD 430 (1996).
35
Asionics Philippines, Inc. v. NLRC, 290 SCRA 164, 94 SCAD 351 (1998).
36
So commonplace has the incantation been that even the Philippine Supreme Court when
it says the mantra, does not even cite the case of United States v. Milwaukee Refrigerator Transit
Co., 142 Fed. 247 (1905).
37
142 Fed. 247 (1905).
defend crime, the law will regard the corporation as an
association of persons.38
38
at 255.
39
San Juan Structural and Steel Fabricators, Inc. v. Court of Appeals, 296 SCRA 631, 645,
99 SCAD 281 (1998); First Philippine International Bank v. Court of Appeals, 252 SCRA 259, 67
SCAD 196 (1996).
40
189 SCRA 529 (1990).
41
Umali v. Court of Appeals, 189 SCRA 529 (1990).
42
77 Phil. 496 (1946).
43
Ibid, at pp. 504-505.
only the parties to the case only to the matters actually resolved therein. Even
when a corporation's legal personality had been pierced in case, it was held in
Tantongco v. Kaisahan ng mga Mangagawa sa La Campana and CIR,44 that
such corporation still possessed such separate juridical personality in any other
case, or with respect to other issues.
a. “Victim” Standing
44
106 Phil. 199 (1959).
45
Ibid, at p. 543.
46
211 SCRA 470 (1992).
47
290 SCRA 198, 94 SCAD 381 (1998).
48
Subsection 5.2 of the Securities Regulation Code has transferred corporate rehabilitation
cases to the jurisdiction of regular courts.
In Traders Royal Bank v. Court of Appeals,49 the Court held that the
piercing doctrine is an equitable remedy, “and may be awarded only in cases
when the corporate fiction is used to defeat public convenience, justify wrong,
protect fraud or defend crime or where a corporation is a mere alter ego or
business conduit of a person.” It could not be employed by a corporation to be
able to complete its claims against another corporation, and cannot therefore be
employed by the claimant who does not interpose to be the victim of any wrong
or fraud. The Court further held:
49
269 SCRA 601, 80 SCAD 12 (1997).
50
192 SCRA 487, 486 (1987)
51
Koppel (Philippines, Inc. v. Yatco, 77 Phil. 496 (1946); Yutivo Sons Hardware v. Court of
Tax Appeals, 1 SCRA 160 (1961); Liddell & co. v. Collector of Internal Revenue, 2 SCRA 632
(1961); Commissioner of Internal Revenue v. Norton and Harrison, 11 SCRA 714 (1964); Marvel
Building v. David, 94 Phil. 376 (1954).
4. Piercing Application Must be Shown to
Be Necessary and With Factual Basis
Luxuria Homes, Inc. v. Court of Appeals,52 reiterated the ruling that to
disregard the separate juridical personality of a corporation, the wrongdoing must
be clearly and convincingly established, and that it cannot be presumed. In that
case, the Supreme Court refused to pierce the veil of corporate fiction and held
that the organization of the corporation at the time when the relationship
between the landowner and the developer were still cordial cannot be used as a
basis to hold the corporation liable later on for the obligations of the landowner to
the developer under the mere allegation that the corporation is being used to
evade the performance of obligation by one of its major stockholders.
In Laguio v. NLRC,53 the Court held that mere substantial identity of the
incorporators of two corporations does not necessarily imply fraud, nor warrant
the piercing of the veil of corporate fiction, and that in the absence of clear and
convincing evidence to show that the corporate personalities were used to
perpetuate fraud, or circumvent the law, the corporations are to be rightly treated
as distinct and separate from each other.
The main distinction between the fraud cases of piercing from the mere
alter ego cases of piercing is that in the former there is always an element of
malice or evil motive, while in the latter case, even in the absence of an evil
motive, piercing would be allowed. However, it is also true that when the
corporate entity is used to commit a wrong or to achieve fraud, although
52
302 SCRA 315, 102 SCAD 892 (1999).
53
262 SCRA 715, 75 SCAD 92 (1996).
54
Azcuna in his article The Doctrine of Piercing the Veil of Corporate Fiction: A Review and
Analysis of Philippine Supreme Court Decision from Willets to Ramirez, 18 ATENEO L.J. 9 (Vol. I),
groups them only into two classes: (1) when the corporate entity is used to promote fraud,
injustice, illegality of wrong; and (2) the corporate entity is a mere alter ego, business, conduit,
branch or agency of a person, natural or another corporation. (at p. 34). However, Umali v. Court
of Appeals, 189 SCRA 529 (1990), has impliedly recognized three (3) groupings (at p. 542).
necessarily you may also achieve an alter ego scenario, the same would
primarily fall within fraud cases.
The third category of equity cases has mainly become the "dumping
ground," or perhaps the "added flourish" of the Court, when it had to apply the
piercing doctrine but could find it convenient to do so because no evil had been
sought to be achieved, but at the same time the corporate juridical personality of
the subject corporation cannot be respected in order to achieve justice.
The three (3) cases of piercing may appear together as in R.F. Sugay v.
Reyes,55 where an attempt by the corporation to avoid liability by distancing itself
from the acts of the its President, Mr. Romulo F. Sugay, alleging that he acted as
agent for another corporation was brushed aside by the Court when it held that
"the dual roles of Romulo F. Sugay should not be allowed to confuse the facts
relating to employer-employee relationship . . . [i]t being a legal truism that when
the veil of corporate fiction is made as a shield to perpetrate a fraud and/or
confuse legitimate issues (here, the relation of employer-employee), the same
should be pierced. Verily, the R.F. Sugay & Co., Inc. is a business conduit of
R.F. Sugay."56
FRAUD CASES
1. Piercing Doctrine Cannot
Be Employed to Commit Fraud
Gregorio Araneta, Inc. v. Tuason de Paterno and Vidal,57 held that the
piercing doctrine is employed to prevent the commission of fraud and cannot be
employed to perpetuate a fraud. In that case, Tuason sold lots to G. Araneta Inc.
Subsequently, the corporation filed a case against Tuason to compel delivery of
clean title to said lots. Tuason claimed that the sale was made to her agent, Jose
Araneta, president of the buying corporation, and therefore the corporate fiction
should be disregarded, the sale being not valid as it was made to an agent of the
seller.58
The Court ruled that corporate fiction will not be disregarded because the
corporate entity was not used to perpetuate fraud nor circumvent the law and the
disregard of the technicality would pave the way for the evasion of a legitimate
and binding commitment, especially since Tuason was fully aware of the position
of Mr. Araneta in the corporation at the time of sale.
2. Corporate Fiction Must
55
12 SCRA 700 (1964).
56
Ibid, at p. 705.
57
91 Phil. 786 (1952).
58
Under Article 1491 of the Civil Code, a purchase by an agent of the property of the
principal is void.
Be Employed to Commit Fraud
Since the piercing doctrine is meant to prevent the commission of fraud; it
has no application to allow persons or entities to gain advantages. 59 In addition,
the application of the piercing doctrine is a remedy of last resort and will not be
applied, even in case of fraud, if other remedies are available to the parties.
In Umali v. Court of Appeals,60 the Court refused to apply the piercing
doctrine since the petitioners were "merely seeking the declaration of the nullity
of the foreclosure sale, which relief may be obtained without having to disregard
the aforesaid corporate fiction attaching to respondent corporations, [especially
since] petitioners failed to establish by clear and convincing evidence that private
respondents were purposely formed and operated, and thereafter transacted
with petitioners, with the sole intention of defrauding the latter." 61
3. Tax Evasion Case
In Commissioner of Internal Revenue v. Norton and Harrison62 where the
parent corporation owned all the outstanding stocks of the subsidiary
corporation, and financed all the operations of the subsidiary, and treated the
subsidiary's employees as its own; where the officers of both corporations were
located in the same compound; where the board of the subsidiary was
constituted in such a way to enable the parent to actually direct and manage
subsidiary's affairs by making the same officers of the board for both
corporations; and where the fiction of corporate entity was being used as a shield
for tax evasion by making it appear that the original sale was made by the parent
corporation to the subsidiary corporation in order to gain tax advantage, the
Court did not hesitate to pierce the veil of corporate fiction and treat as void the
sales between the corporations.
Since Norton and Harrison is a fraud case, you begin to wonder why there
was a need to show that the subsidiary corporation was being used as an
instrumentality or conduit of the parent corporation, since even in the absence of
such evidence, piercing to prevent fraud (i.e., tax evasion) would have been
warranted.
4. Alter-ego Elements
in Fraud Piercing Cases
59
In Burnett Commissioner v. Clarke, 287 US 410, 53 S.Ct. 207, 77 L.Ed. 397, the United
States Supreme Court refused to allow a taxpayer to use the piercing doctrine to gain a tax
advantage. In that case, Clarke indorsed his notes for a corporation of which he was majority
stockholder. He sustained losses by virtue of such endorsement. Such losses could not be
deducted on his income tax returns, because first, it did not result from any operation of any trade
or business regularly carried on by a taxpayer and, more importantly, because a corporation and
its stockholders are generally to be treated as separate entities, and only under exceptional
circumstances can the difference be disregarded.
60
189 SCRA 529 (1990).
61
189 SCRA 529, 543 (1990).
62
11 SCRA 714 (1954).
Fraud case need not necessarily be accompanied by alter ego elements
to make the fraud case stick, because fraud is a matter of proof, and often it is a
state of the mind being founded on malice. In order to establish the state of mind
of the stockholders or officers to make them liable for corporate debts, or as in
the case of Norton and Harrison, in order to consider two separate entities as
one and the same, there may be an imperative need to detail the circumstances
which show that the corporate fiction is being used consciously as a means to
commit a fraud. In short, the alter ego circumstances may be needed to prove
the malicious intent of the parties.
In NAMARCO v. Associated Finance Co.,63 it was held that where a
stockholder, who has absolute control over the business and affairs of the
corporation, entered into a contract with another corporation through fraud and
false representations, such stockholder shall be liable jointly and severally with
his co-defendant corporation even when the contract sued upon was entered
into on behalf of the corporation.
Namarco demonstrates when a fraud case overlaps an alter ego case, as
held by the Court: "We feel perfectly justified in ‘piercing the veil of corporation
fiction’ and in holding Sycip personally liable, jointly and severally with his co-
defendant, for the sums of money adjudged in favor of the appellant. It is settled
law in this and other jurisdictions that when the corporation is the mere alter ego
of person, the corporate fiction may be disregarded; the same being true when
the corporation is controlled, and its affairs are so conducted as to make it
merely an instrumentality, agency or conduit of another." 64
Other than having entered in the name of a corporation a fraudulent
contract, which normally the board of directors would never have approved of,
there is no finding in Namarco of a consistent practice of Sycip using the
corporation as an alter ego. Therefore, in fraud cases, the alter ego concept
pertains to employing the corporation even for a single transaction, to do evil,
unlike in pure alter ego cases, where the courts go into findings of systematic
disregard and disrespect of the separate juridical person of the corporation.
63
19 SCRA 962 (1967).
64
Ibid, at p. 965.
65
5 SCRA 1011 (1962).
In Villa Rey Transit, Inc. v. Ferrer,66 the Court held that when the fiction of
legal entity is "urged as a means of perpetrating a fraud or an illegal act or as a
vehicle for the evasion of an existing obligation, the circumvention of statutes,
the achievement or perfection of a monopoly or generally the perpetration of
knavery or a crime, the veil with which the law covers and isolates the
corporation from the members or stockholders who compose it will be lifted to
allow for its consideration merely as an aggregation of individuals."67 In that
case, the Court pierced the veil of corporate fiction to enforce a non-competition
clause entered into by its controlling stockholder in his personal capacity.
6. Liability of Officers
The general rule is laid down in Palay, Inc. v. Clave,68 that unless
"sufficient proof exists on record" that an officer (in that decision, a President and
controlling stockholder) has "used the corporation to defraud private respondent"
he cannot be made personally liable "just because he `appears to be the
controlling stockholder.'"69 "Mere ownership by a single stockholder or by
another corporation of all or nearly all of the capital stock of a corporation is not
of itself sufficient ground for disregarding the separate corporate personality." 70
Even in the early case of Mindanao Motor Line, Inc. v. Court of Industrial
Relations,71 dealing on claims for backwages, the Court had ruled that the
resident manager and general manager of the corporation cannot be made
solidarily responsible with the corporation for the payment of backwages, when it
is clear from the records that they were merely agents who acted within the
scope of their corporate positions, and there was no showing that they had acted
negligently or in bad faith.72 "It is a well-known principle of law that an agent who
acts in behalf of a disclosed principal within the scope of his authority cannot be
held liable to third persons."73
Pabalan v. NLRC,74 held that "[t]he settled rule is that the corporation is
vested by law with a personality separate and distinct from the persons
composing it, including its officers as well as from that of any other entity to
which it may be related . . . [and an officer] acting in good faith within the scope
of his authority . . . cannot be held personally liable for damages."75
Pabalan refused to hold the officers of the corporation personally liable for
corporate obligations on employees' wages, since "[i]n this particular case
66
25 SCRA 845 (1968).
67
Ibid, at pp. 857-858.
68
124 SCRA 638 (1983).
69
Ibid, at pp. 648-649.
70
Ibid, at p. 649.
71
6 SCRA 710 (1962).
72
Ibid, at pp. 714-715.
73
Ibid, at p. 715, citing Art. 1897 of the Civil Code, Banque Generale Belge v. Walter Bull &
Co., 84 Phil. 164 (1949).
74
184 SCRA 495 (1990).
75
Ibid, at p. 499.
complainants did not allege or show that petitioners, as officers of the
corporation deliberately and maliciously designed to evade the financial
obligation of the corporation to its employees, or used the transfer of the
employees as a means to perpetrate an illegal act or as a vehicle for evasion of
existing obligation, the circumvention of statutes, or to confuse the legitimate
issues."76
In R.F. Sugay v. Reyes77 an attempt by the corporation to avoid liability by
distancing itself from the acts of the its President was struck down, with the Court
holding that a corporation may not distance itself from the acts of a senior officer:
"the dual roles of Romulo F. Sugay should not be allowed to confuse the facts." 78
To the same effect is the ruling in Paradise Sauna Massage Corporation v. Ng,79
where it was held that an officer-stockholder who is a party signing in behalf of
the corporation to a fraudulent contract cannot claim the benefit of separate
juridical entity: "Thus, being a party to a simulated contract of management,
petitioner Uy cannot be permitted to escape liability under the said contract by
using the corporate entity theory. This is one instance when the veil of corporate
entity has to be pierced to avoid injustice and inequity." 80
76
Ibid, at p. 500.
77
12 SCRA 700 (1964).
78
Ibid, at p. 705.
79
181 SCRA 719 (1990).
80
Ibid, at p. 729.
81
142 SCRA 269 (1986).
82
187 SCRA 777 (1990).
judgment rendered against the corporation which was later found without assets
on the ground that "[b]ut for the separate juridical personality of a corporation to
be disregarded, the wrongdoing must be clearly and convincingly established. It
cannot be presumed." In addition, it was held that "[t]he distinguishing marks of
fraud were therefore clearly apparent in A.C. Ransom. A new corporation was
created, owned by the same family, engaging in the same business and
operating in the same compound." In short, Del Rosario re-affirmed the original
doctrine before A.C. Ransom pronouncement that in order for a corporate officer
or stockholder to be held liable for corporate debts it must clearly be shown that
he had participated in the fraudulent or unlawful act.
The principle was reinforced in Western Agro Industrial Corporation v.
Court of Appeals,83 which held that a corporate officer cannot be held personally
liable for a corporate debt simply because he had executed the contract for and
in behalf of the corporation. It held that when a corporate officer acts in behalf of
a corporation pursuant to his authority, it is "a corporate act for which only the
corporation should be made liable for any obligations arising from them." 84
Two months after Del Rosario, the Court in Maglutac v. NLRC,85 held a
corporate officer liable for the claims against the corporation, relying upon the
A.C. Ransom ruling but only with respect to the doctrine that the responsible
officer of a corporation who had a hand in illegally dismissing an employee
should be held personally liable for the corporate obligations arising from such
act.
In Rustan Pulp & Paper Mills, Inc. v. IAC,86 the Court reiterated the
principle that the President and Manager of a corporation who entered into and
signed a contract in his official capacity, cannot be made liable thereunder in his
individual capacity in the absence of stipulation to that effect due to the
personality of the corporation being separate and distinct from the person
composing it.87
8. Probative Factors
The Supreme Court in Concept Builders, Inc. v. NLRC,88 summarized the
probative factors that are considered when the corporate mask may be lifted and
the corporate veil may be pierced, when a corporation is but the alter ego of a
person or of another corporation:
83
188 SCRA 709 (1990).
84
Ibid, at p. 718.
85
189 SCRA 767 (1990).
86
214 SCRA 665, 672 (1992).
87
Ibid, at p. 672, citing Banque Generale Belge v. Walter Bull and Co., Inc., 84 Phil. 164
(1949).
88
257 SCRA 149, 70 SCAD 764 (1996).
(b) Identity of directors and officers;
(c) The manner of keeping corporate books and records; and
(d) Methods of conducting the business.
The Court held that the "conditions under which the juridical entity may be
disregarded vary according to the peculiar facts and circumstances of each case.
No hard and fast rule can be accurately laid down, but certainly, there are some
probative factors of identity that will justify the application of the doctrine of
piercing the corporate veil."
The Court in Concept Builders adopted the following tests in determining
the applicability of the doctrine of piercing the veil of corporate fiction:
9. In Summary
From all the foregoing, what clearly comes out as the guiding rule is that
piercing is allowed in fraud cases only when the following elements are present:
(a) There must have been fraud or an evil motive in the affected
transaction, and the mere proof of control of the corporation
by itself would not authorize piercing;
89
Ibid.
(b) The main action should seek for the enforcement of
pecuniary claims pertaining to the corporation against
corporate officers or stockholders, or vice-versa;
(c) The corporate entity has been used in the perpetration of the
fraud or in the justification of wrong, or to escape personal
liability.
90
44 Phil. 634 (1923).
91
The Court found that "There is no claim or pretense that there was any fraud or collusion
between plaintiff and Willits, and it is very apparent that Exhibit B was to the mutual interests of
both parties." - Ibid, at p. 643
case the creditors' committee of the corporation opposed the payment of
compensation due to the plaintiff Arnold under a contract-letter signed by Willits,
the controlling stockholder, without board approval. The signing president was
the controlling stockholder of the corporation. The Court held the validity of
contract and "[a]lthough the plaintiff was the president of the local corporation,
the testimony is conclusive that both of them were what is known as a one man
corporation, and Willits, as the owner of all the stocks, was the force and
dominant power which controlled them."92The Court expressed the language of
piercing doctrine when applied to alter ego cases, as follows: "Where the stock
of a corporation is owned by one person whereby the corporation functions only
for the benefit of such individual owner, the corporation and the individual should
be deemed the same."93
In La Campana Coffee Factory v. Kaisahan ng Manggagawa,94 Tan Tong
and his family owned and controlled two corporations, one engaged in the sale of
coffee and the other in starch. Both corporations had one office, one
management and one payroll; and the laborers of both corporations were
interchangeable. The 60 members of the labor association in the coffee and
starch factories demanded for higher wages addressed to "La Campana Starch
and Coffee Factory." La Campana Coffee Factory sought dismissal of the
petition on the ground that the starch and coffee factory are two distinct juridical
persons. The Court disregarded the fiction of corporate existence and treated the
two companies as one.
It should be noted that cases like La Campana Coffee Factory, where the
issue was the jurisdiction of the Court of Industrial Relations to hear the matter,
show that unlike in fraud cases where there must be a pecuniary claim as
enunciated in Umali, in alter ego cases no such pecuniary claim need be
involved to allow the courts to apply the piercing doctrine.
In Ramirez Telephone Corp. v. Bank of America95 Ramirez had unpaid
rents due Herbosa. The latter sought to garnish Ramirez's bank account, but no
such personal account existed, and only an account in the name of Ramirez
Telephone Company could be found and was garnished. The Court held that the
corporate bank account could be garnished despite the fact that Ramirez himself
leased Herbosa's premises because: although Ramirez was the tenant, the
company in truth occupied the premises; Ramirez paid the rents with checks of
the telephone company; and 75% of the shares of the company belonged to
Ramirez and his wife.
In Madrigal Shipping v. Oglivie,96 the crew members of "SS Bridge"
brought an action against Madrigal Shipping Company for recovery of unpaid
salaries. However, it seemed that Madrigal & Co. was the registered owner of
92
Ibid, at p. 641.
93
Ibid, at p. 645, quoting from U.S. Gypsum Co. vs. Mackay Wall Plaster Co., 199 Pac.,
249.
94
93 Phil. 160 (1953).
95
29 SCRA 191 (1969).
96
SUPREME COURT ADVANCED DECISION, October, 1958 issue; 55 O.G. No. 35, p. 7331.
such vessel. The Court held that granting that it was not the Madrigal Shipping
Co. that owned the vessel but actually Madrigal & Co., a corporation with a
juridical personality distinct from the former, yet as the former was the subsidiary
of the latter, and as found by the facts that it was a business conduit for the
latter, the fiction of corporate existence may be disregarded to make the former
liable for the claims.
Sibagat Timber Corp. v. Garcia,97 held that "where it appears that two
business enterprises are owned, conducted, and controlled by the same parties,
both law and equity will, when necessary to protect the rights of third persons,
disregard the legal fiction that two corporations are distinct entities, and treat
them as identical."
2. Tax Avoidance Cases
In Marvel Building v. David,98 where corporate properties were sought to
be sold by the BIR in order to enforce payment of the tax liabilities of its
stockholder, Castro. It was found that Castro and ten others incorporated Marvel
Building Corporation. The BIR assessed against Castro war profit taxes for
properties formerly in the name of Castro but which were later transferred to the
corporation. It seemed that the ten other incorporators were mere dummies. The
Court upheld the BIR finding that the corporation was a mere alter ego of the
Castro as it appeared that she had enormous profits and accordingly had the
motive to set up such a title-holding shield; that duplicate stock certificates had
been issued to various purported stockholders lacking the means to pay their
alleged subscriptions and no receipts issued for subscriptions paid; that no
stockholder's or director's meeting was held; that the books of account treated
everything as belonging to and controlled by Castro. Although it would seem that
Marvel should be classified as a fraud case (evasion of taxes), this would not
seem to be so under that case.
In Yutivo Sons Hardware v. Court of Tax Appeals99 Yutivo Sons and
Hardware Co. imported cars and trucks, which it sold to Southern Motors Inc.
Sales taxes were paid by Yutivo on this first sale. Southern Motors sold the
vehicles to the public. The Collector of Internal Revenue sought to impose sales
tax not on the basis of Yutivo's sales to Southern Motors but on Southern Motor's
higher sales to the public. To this the Court agreed. Although it found that
Southern Motors was not organized to perpetuate fraud; however, Southern
Motors was indeed actually owned and controlled by Yutivo as to make it a mere
subsidiary or branch of the latter. Yutivo, through common officers and directors
exercised full control over Southern Motor's cash funds, policies, expenditures
and obligations.
In Liddell & Co. v. Collector of Internal Revenue,100 Liddell & Co was
engaged in importing and retailing cars and trucks. Frank Liddell owned 98% of
97
216 SCRA 470 (1992).
98
94 Phil. 376 (1954).
99
1 SCRA 160 (1961).
100
2 SCRA 632 (1961).
its stocks. Later Liddell Motors Inc. was organized to do for retailing for Liddell &
Co. Frank's wife owned almost all its stocks. Since then, Liddell & Co. paid sales
tax on the basis of its sales to Liddell Motors. But the Collector of Internal
Revenue considered the sales by Liddell Motors to the public as the basis for the
original sales tax. The Court, agreeing with the Collector, held that Frank owned
both corporations as his wife could not have had the money to pay her
subscriptions. Such fact alone though not sufficient to warrant piercing, but under
the proven facts of the case, Liddell Motors was the medium created by Liddell &
Co. to reduce its tax liability. A taxpayer has the legal right to decrease, by
means which the law permits, the amount of what otherwise would be his taxes
or altogether avoid them; but a dummy corporation serving no business
purposes other than as a blind, will be disregarded.
Yutivo and Liddell (and therefore Marvel) are alter ego cases and not
fraud cases although the clear intention of parties was to minimize taxes and the
Court clearly decreed that no imposition of surcharge by virtue of fraud was
imposable by the BIR. The Court held in a language sweet to the ears of
businessmen and tax lawyers that "the legal right of a taxpayer to decrease the
amount of what otherwise would be his taxes, or altogether avoid them, by
means which the law permits, cannot be doubted . . . [and] a taxpayer may gain
advantage of doing business thru a corporation if he pleases, but the revenue
officers in proper cases, may disregard the separate corporate entity where it
serves but as a shield for tax evasion and treat the person who actually may take
the benefits of the transactions as the person accordingly taxable."101
Therefore, no less than the Court has stated that the use of the corporate
entity to gain a vantage (such as minimization of taxation) is not by itself a
fraudulent scheme. The corporate entity is there for both businessmen and
lawyers to tinker with, to gain every advantage available under the law, and that
alone is not a reprehensible act.
3. Under-Capitalization
In McConnel v. Court of Appeals,102 a forcible entry case, the corporation
was ordered to pay damages, but such corporation was later found without
enough assets, so the defendant went after the properties of the stockholders.
The Court decided for piercing, holding the stockholders liable for the deficiency.
Although it held that mere ownership of all and nearly all of the stocks does not
make a corporation a business conduit of the stockholders, but in that case, the
operation of the corporation was so merged with those of the stockholders as to
be practically indistinguishable. Furthermore, they had the same office, the funds
were held by the stockholders, and the corporation had no visible assets.
One cannot be sure whether McConnel is clearly an alter ego case or a
fraud case of piercing, since the Court had cited and fused together the
Milwaukee chant on piercing in fraud cases together with the alter ego formula.
No fraud seems to have been intimated in the decision since it based its
101
Ibid, at p. 641, citing Gregory v. Helvering, 293 U.S. 465, 7 L.Ed. 596, 599, 55 S.Ct.
102
1 SCRA 722 (1961).
conclusion more on the findings of the lower court that "[t]he evidence clearly
shows that these persons completely dominated and controlled the corporation
and that the functions of the corporation were solely for their benefits."103
However, it is in McConnel where the Court took special notice of the fact
that "[t]he corporation itself had no visible assets, as correctly found by the trial
court, except perhaps the toll house, the wire fence around the lot and the signs
thereof. It was for this reason that the judgment against it could not be fully
satisfied."104 Does McConnel imply that the incorporation of an entity without
reasonable assets to support the undertaking or venture for which it is organized
constitute a fraud against the corporate creditors? From the language in
McConnel, it would not seem so, since after noting the lack of visible assets of
the corporation, the Court held:
103
Ibid, at 725.
104
Ibid, at 726.
105
Ibid, at p. 726.
106
"In one line of cases [in the United States], the fact that the sole owner of stock in a
corporation has embarked the concern in large operations with no adequate capital or assets to
support such operations, is held to justify the conclusion that this insufficently outfitted entity did
4. Forum-Shopping
A recent area where the piercing doctrine has been applied is in attempts
to go around the remedial law provisions against forum shopping. In First
Philippine International Bank v. Court of Appeals,107 the Court held that "[i]n
addition to the many cases where the corporate fiction has been disregarded, we
now add the instant case, and declare herewith that the corporation veil cannot
be used to shield an otherwise blatant violation of the prohibition against forum-
shopping. Shareholders, whether suing as the majority in direct actions or as the
minority in a derivative suit, cannot be allowed to trifle with court processes,
particularly where, as in this case, the corporation itself has not been remiss in
vigorously prosecuting or defending corporate causes and in using and applying
remedies available to it. To rule otherwise would be to encourage corporate
litigants to use their shareholders as fronts to circumvent the stringent rules
against forum shopping."
5. Parent-Subsidiary Relationship
The alter ego doctrine has had an uneven application in the area of
parent-subsidiary relationship. We start with the premise laid down in Liddell &
Co., Inc. v. Collector of Internal Revenue:108
not really conduct a separate enterprise, and the parent corporation is held liable for its
obligations. Some of these cases . . . suggest that to preserve the independence of an enterprise
which is needed to support the continuance of separate legal personality, the stockholder must
provide the entity with separate assets sufficient to give it at least a reasonable business chance
to carry out its asserted function. In these . . . the court's rulings construct a new entity, this time
out of spare parts distributed among component corporation. . ." Berle, The Theory of Enterprise
Entity, 47 COL. L. REV. No. 3, 343, 345.
107
252 SCRA 259, 67 SCAD 196 (1996).
108
2 SCRA 632 (1961).
109
Ibid, at p. 640.
In Koppel (Phil.), Inc. v. Yatco,110 the Supreme Court held that virtual
control of the shareholdings of a corporation would lead to certain legal
conclusions. The Court could not overlook the fact that in the practical working of
corporate organizations of the class to which the two entities belonged, the
holder or holders of the controlling part of the capital stock of the corporation,
particularly where the control is determined by the virtual ownership of the totality
of the shares, dominate not only the selection of the board of directors but, more
often than not, also the action of that board.
The Court was wont to conclude that "[a]pplying this to the instant case,
we can not conceive how the Philippine corporation could effectively go against
the policies, decisions, and desires of the American corporation . . . Neither can
we conceive how the Philippine corporation could avoid following the directions
of the American corporation in every other transaction where the had both to
intervene, in view of the fact that the American corporation held 99.5 per cent of
111
the capital stock of the Philippine corporation. . ." We seem to draw from
Koppel the principle that control of the shareholdings of the corporation
necessarily means by itself control of the operations of the corporation.
Fortunately, the pronouncements in Koppel should not constitute
precedents in alter ego cases simply because Koppel actually involved a fraud
case of piercing, and there were in fact numerous findings in the decision where
the subsidiary corporation was made an instrumentality of the parent
corporation.112
The afore-quoted Liddell pronouncements have been re-affirmed in
Development Bank of the Philippines v. NLRC,113 where although DBP was the
majority stockholder of Philippine Smelters Corporation (PSC), and that majority
of the latter's board members came from DBP, and DBP was the mortgagee to
practically all the latter's properties, still the Court refused to pierce the veil of
corporate fiction to make DBP liable for the claims of the employees of PSC.
"We do not believe that these circumstances are sufficient indicia of the
existence of an employer-employee relationship as would confer jurisdiction over
the case of the labor arbiter." To the same effect is the earlier ruling in Diatagon
Labor Federation v. Ople.114
However, in Philippine Veterans Investment Development Corporation v.
Court of Appeals115 things took a different turn.116 In that case, PHIVIDEC sold
110
77 Phil. 497 (1946).
111
Ibid, at pp. 508-509.
112
The subsidiary corporation bore the expenses of the parent company; used its own
inventory to cover orders from the parent company; answered for the drafts of the parent
company; had key officers residing in the United States; and employed simple booking entries for
credits due from the parent company.
113
186 SCRA 841 (1990).
114
101 SCRA 534 (1980).
115
181 SCRA 669 (1990).
116
The author is always apprehensive of Supreme Court decisions that seek to oversimplify
things, as Justice Cruz enunciated in his opening statement in Philippine Veterans Investment
Development Corporation: "The concept of piercing the veil of corporate fiction is a mystique to
its controlling equity interests in PRI to PHILSUCOM, with a stipulation that
PHIVIDEC shall hold PHILSUCOM free and harmless against all liabilities of
PRI. PHILSUCOM subsequently formed the Panay Railways, Inc. to operate the
railway assets acquired from PHIVIDEC. Borres, a prior creditor of PRI sued
both PRI and Panay Railways, and the latter in turn filed a third-party complaints
against PHIVIDEC.
In the judgment, PHIVIDEC was held liable with PRI on the claims of
Borres. PHIVIDEC contended that it could not be held liable for the debts of PRI
since they are entirely distinct and separate corporations although the latter was
its subsidiary; that the transfer of shares of stock of PRI to PHILSUCOM did not
divest PRI of its juridical personality or of its capacity to direct its own affairs and
conduct its own business under the control of its own board of directors; and that
by the same token it PRI was answerable for its own obligations, which cannot
be passed on to PHIVIDEC.
Aside from the fact that PHIVIDEC agreed expressly to hold PHILSUCOM
(and also consequently the latter's subsidiary PRI which filed the third-party
complaint against PHIVIDEC) free and harmless against claims arising before
the transfer of PRI, the Court held for the piercing of the corporate fiction on the
following principle:
The factual basis used by the Court in order to enforce the above-quoted
doctrine is the finding of the trial court that "PHIVIDEC's act of selling PRI to
PHILSUCOM shows that PHIVIDEC had complete control of PRI's business."118
Perhaps there were other considerations in the lower court's findings showing
that indeed PHIVIDEC had complete control over PRI, but they certainly were
not mentioned in the Court's decision.
It is therefore unfortunate, and perhaps even tragic, that to allow a
piercing under the alter ego doctrine, the Court would use the sale by a parent
company of its shareholdings in a subsidiary to demonstrate complete control
over the subsidiary. The result of such a doctrine would be that in cases of
"equity transfers" as discussed below, contrary to the ruling in Edward J. Nell
Company v. Pacific Farms, Inc.,119 the applicable rule would be that the
transferor is always liable for the corporate liabilities of the corporation whose
many people, especially the layman. But it is not as esoteric as all that as this case will
demonstrate." at p. 670.
117
Ibid, at p. 673, citing Jabney v. Belmont Country Club Properties, Inc. 279 Pac. 829.
118
Ibid, at p. 674.
119
15 SCRA 415 (1965).
shares are transferred in complete derogation of the main doctrine of separate
juridical personality.
Logically, a stockholder has always complete and almost absolute control
over the share of stocks he holds in a corporation. But that does not necessarily
mean that he has actual complete control over the affairs and transactions of the
corporation. Perhaps the Court forgot its own pronouncements that shares of
stock in a corporation do not mean any interest in corporate properties as held in
Stockholders of F. Guanzon and Sons, Inc. v. Register of Deeds of Manila,120
Magsaysay-Labrador v. Court of Appeals,121 Saw v. Court of Appeals,122 and
Sulo ng Bayan, Inc. v. Araneta, Inc.123
More in point is the ruling in Remo, Jr. v. Intermediate Appellate Court,124
where the Court held: “The mere fact that a stockholder sells his shares of stock
in the corporation during the pendency of a collection case against the
corporation, does not make such stockholder personally liable for the corporate
debt, since the disposing stockholder has no personal obligation to the creditor,
and it is the inherent right of the stockholder to dispose of his shares of stock
anytime he so desires.”125
6. Affiliated Companies
In Guatson International Travel and Tours, Inc. v. NLRC,126 the other
affiliated corporations were also made liable by the NLRC for the separation pay
and backwages for which a corporate-employer was held liable. In contesting the
inclusion of the other corporations to the liability, on the ground that they were
separate and distinct legal personalities, the Court took the following proven
facts into consideration in piercing the veil of corporate fiction: the three
companies were owned by one family, such that majority of the officers of the
companies are the same; the companies are located in one building and use the
same messengerial service; the terminated employee was not paid separation
fee when he was absorbed by the other affiliate company, nor was he made to
resign from the first corporation.
In Azcor Manufacturing, Inc. v. NLRC,127 the Supreme Court delineated
the effect of applying the piercing doctrine to affiliated companies, when by the
120
6 SCRA 373 (1962).
121
180 SCRA 266 (1989).
122
195 SCRA 740 (1991).
123
72 SCRA 347 (1976).
124
172 SCRA 405, 413-414 (1989).
125
Ibid, at p. 14. The Court further held therein: “Even when the corporation is guilty in a
fraudulent transaction, a stockholder cannot be made personally liable for the resulting corporate
debt, when no evidence shows that the particular stockholder had any part or participation in the
perpetuation of the fraudulent transaction. Fraud must be established by clear and convincing
evidence. If at all, it is the principal character on whom fault should be attributed, the President,
who should be held personally liable, and not every stockholder.”
126
230 SCRA 815, 49 SCAD 329 (1994).
127
303 SCRA 26, 103 SCAD 293 (1999).
act of the managements of the two companies, its employees are placed at a
disadvantage, thus:
Tomas Lao Construction v. NLRC,128 held that where it appears that three
business enterprises are owned, conducted and controlled by the same parties,
both law and equity will, when necessary to protect the rights of third persons,
disregard the legal fiction that the corporations are distinct entities and treat them
as identical. In that case the three corporations were informally referred to as the
“Lao Group of Companies,” all of which were engaged in the construction of
public roads and bridges, and they entered into joint venture agreements among
each other to undertake their projects either simultaneously or successively so
that, whenever necessary, they would lease tools and equipment to one another,
each one would also allow the utilization of their employees by the other two.
Those proven facts where found proper bases for piercing the veil of corporate
fiction as to workers’ claims.
128
278 SCRA 716, 86 SCAD 746 (1997).
129
189 SCRA 529, 542 (199).
The doctrine in Umali, which is a fraud case, seems to have been derived
from the doctrine in Diatagon Labor Federation v. Ople,130 where the Court
struck down the holding of the Director of Labor Relations treating two
corporations as single bargaining unit for "because the two companies are
indubitably distinct entities with separate juridical personalities" despite clear
showing close relationship between them, which in many other cases decided by
the Court would have been enough basis to pierce.131 We can only surmise that
such holding of refusal to pierce was because the issue involved was not money
or damage claims, nor did it seek to hold any corporate officer or stockholder
liable, but merely "whether two companies should be regarded as a single
collective bargaining unit."132
Lately, in the case of Indophil Textile Mill Workers Union v. Calica,133
although it was shown that two corporations business are related, that some of
the employees of the two corporations are interchanged, and that the physical
plants, offices and facilities are situated in the same compound, were not
considered sufficient bases to pierce the veil of corporate fiction in order to treat
the two corporations as one bargaining unit. In coming to this conclusion, the
Court relied upon not only Diatagon Labor Federation, but also the doctrine in
Umali that "the legal corporate entity is disregarded only if it is sought to hold the
officers and stockholders directly liable for a corporate debt or obligation."
However, Umali is a fraud case and the doctrine enunciated there finds
rationale support because piercing in fraud cases is resorted to enforce liability
on the persons employing fraud. But both Diatagon Labor Federation and
Indophil Textile Mill are merely alter ego cases and the requirement that a
monetary claim should be interposed should not have been made applicable,
especially in the light of other alter ego cases decided by the Court applying the
piercing doctrine even when the issue involved merely one on jurisdiction.134
9. In Summary
From all the foregoing there seem to be four (4) policy bases for piercing
the veil of corporate fiction in alter ego cases:
Firstly, even when the controlling stockholder or managing officer intends
consciously to do no evil, the use of the corporation as an alter ego, and in some
cases as the private checkbook of the controlling stockholder, is in direct
violation of the central principle in Corporation Law of treating the corporation as
a separate juridical entity from its members and stockholders. Consequently,
those whose acts and actuations directly violate this central doctrine, make
130
101 SCRA 535 (1980).
131
The employees were formerly employees of one of the corporations transferred to the
other; even after the transfer, the affected employees continued to use the pay envelopes and
identification cards of their former employer; the two companies had common management and
represented by the same lawyers.
132
101 SCRA 535.
133
205 SCRA 697 (1992).
134
La Campana Coffee Factory v. Kaisahan ng Maggagawa, 93 Phil. 160 (1953).
themselves personally liable for having themselves cast away the protective
characteristic of limited liability of the separate juridical personality.
Secondly, and more importantly, by not respecting the separate juridical
personality of the corporation, others who deal with the corporation are not also
expected to be bound by the separate juridical personality of the corporation,
and may treat the interests of both the controlling stockholder or officer and the
corporation as the same.
This finds rational justification from the fact that the lack of respect for the
separate affairs of the corporation, makes its difficult for the public to monitor
exactly what properties and funds pertain to the corporation and those that
pertain separately to the stockholders or officers; and that to allow such random
interchange of assets and funds would probably lead to the defraudation of the
creditors who deal with the corporation. Although no actual fraud is committed,
unless the alter ego cases are upheld, then it is up to the dealing public to
carefully keep tab or close accounting of what assets do pertain to the
corporation.
Such a situation would increase overseeing transaction costs to those
who deal with corporate entities if the burden is placed on their shoulders, and in
fact would make the corporate entity a less attractive medium to transact with.
Therefore the application of the piercing doctrine to alter ego cases provides for
a more efficient policy because it throws the burden to the person or persons
who are in the best position to account properly and treat arms-length corporate
properties and affairs.
Thirdly, piercing in alter ego cases may prevail even when no monetary
claims are sought to be enforced against the stockholders or officers of the
corporation. Note must be taken of the disturbing developments in Diatagon
Labor Federation and Indophil Textile adopting the Umali doctrine in fraud cases
to alter ego cases.
Fourthly, when the underlying business enterprise does not really change
and only the medium by which that business enterprise is changed, then there
would be occasion to pierce the veil of corporate fiction to allow the business
creditors to recover from whoever has actual control of the business enterprise.
However, this aspect is more property discussed in Chapter 13.
EQUITY CASES
Equity cases applying the piercing doctrine are what are termed the
"dumping ground", where no fraud or alter ego circumstances can be culled by
the Court to warrant piercing. The main features of equity cases is the need to
render justice in the situation at hand or to brush aside merely technical
defenses. Often, equity cases of piercing appear in combination with other types
of piercing.
In Telephone Engineering and Service Co., Inc. v. Workmen's
Compensation Commission135 the veil of corporate fiction was not allowed to be
availed of, and piercing was allowed when the corporate fiction was made as a
scheme to confuse the legitimate issues, such when the defense of separate
juridical personality is interposed for the first time on appeal.
In Emilio Cano Enterprises v. Court of Industrial Relations136 where a suit
for reinstatement was filed against the corporate officers in such capacities, but
which did not include the corporation, the judgment debt was sought to be
enforced against the corporate assets. Although Emilio Cano Enterprises is
essentially an alter ego case, the Court had occasion to apply the rationale for
equity cases of piercing, thus:
135
104 SCRA 354 (1981).
136
13 SCRA 291 (1965).
137
Ibid, at p. 293.
138
22 SCRA 1156 (1968).
139
Church Assistance Program v. Sibulo, (21 March 1989); Filamer Christian Institute v.
Court of Appeals, 190 SCRA 485,192 (1990).
Often the piercing doctrine is sought to be applied against the controlling
stockholders or officers after a judgment debt against the corporation cannot be
enforced because the corporation is found to be without sufficient assets. It has
been rightly argued in several cases, that to enforce a writ of execution to satisfy
a judgment rendered against the corporation on the separate assets of the
stockholders or officers would be in violation of the due process clause in cases
where such stockholders or officers where not even summoned as parties to the
case brought against the corporation.
In McConnel v. Court of Appeals,140 when the judgment debt could not be
satisfied from corporate assets, an entirely new case was filed by the judgment
creditor against both the corporation and the controlling stockholders, and
pleaded therein the application of the piercing doctrine to make the stockholders
liable for the judgment debt of the corporation.
In Emilio Cano Enterprises v. Court of Industrial Relations,141 a suit for
reinstatement was filed against Emilio Cano and Rodolfo Cano in their capacities
as officers of Emilio Cano Enterprises. Inc., which did not include the corporation
as defendant. The Court rendered judgment against the two, for reinstatement
due to the fact that the stockholders belong to a single family. A writ of execution
of the judgment debt was issued directed against the properties of the
corporation, instead of those of the properties of the respondents officers. The
Court denied the action to quash the writ of execution on the ground that the
judgment sought to be enforced was not rendered against the corporation which
is a juridical personality separate and distinct from its officers. The Court held
that a factor that should not be overlooked is that the officers where sued, not in
their private capacities, but as officers of the corporation, and "[h]aving been
sued officially their connection with the case must be deemed to be impressed
with the representation of the corporation." 142 A corporation is a fiction, it can
only act through its officers, so there would be no denial of due process in this
case even if the corporation was not made a party defendant.
In NAMARCO v. Associated Finance co., Inc.143 where corporate liability
was sought to be enforced against the President who fraudulently entered into a
contract in the name of the corporation, the piercing of the veil of corporate
fiction was sought with the President being already made a defendant at the
onset together with the corporation.
In Jacinto v. Court of Appeals,144 it was held that the piercing doctrine may
be applied by the courts even when the complaint does not seek its
enforcement, so long as evidence is adduced during trial as the basis for its
application can be had. In other words, there must be evidential basis for
application of the piercing doctrine during the trial on the merits.
140
1 SCRA 723 (1961).
141
13 SCRA 291 (1965).
142
Ibid, at p. 292.
143
19 SCRA 962 (1967).
144
198 SCRA 211 (1991).
In Arcilla v. Court of Appeals145 a judgment rendered against a person "in
his capacity as President" of the corporation was enforceable against the assets
of such officer when the decision itself found that he merely used the corporation
as his alter ego or as his business conduit.
Again, in Labor Law the doctrine takes a different twist when invoking the
piercing doctrine to make stockholders and officers liable for corporate debts at
the point of execution.
This issue was raised in A.C. Ransom Labor Union-CCLU v. NLRC,146
where corporate officers were sought to be made personally liable for a judgment
for backwages rendered against the corporation. In allowing judgment to be
executed against officers who were not parties to the case filed against the
corporation, the Court relied upon the provisions of the Labor Code that defined
the liable "employer" to "include any person acting in the interest of an employer,
directly or indirectly."147 The Court held:
145
215 SCRA 120 (1992).
146
142 SCRA 269 (1986).
147
Ibid, at p. 273, citing Article 212(c) of the Labor Code.
148
Ibid, at pp. 273-274. The A.C. Ransom doctrine was reiterated in Gudez v. NLRC, 183
SCRA 644 (1990); Maglutac v. NLRC, 189 SCRA 767 (1990); and Chua v. NLRC, 182 SCRA 353
(1990).
149
172 SCRA 876 (1989).
150
127 SCRA 390 (1984).
However, the later case of Lim v. National Labor
Relations Commission151 clarified that the A.C. Ransom
doctrine applies only when the corporation no longer exists:
The case of Ransom v. NLRC is not in point because
there the debtor corporation actually ceased operations after
the decision of the Court of Industrial Relations was
promulgated against it, making it necessary to enforce it
against its former president. Sweet Lines is still existing and
able to satisfy the judgment in favor of the private
respondent.152
But even the broad application of the A.C. Ransom doctrine was refused
subsequently unless fraud is shown on the part of the officer sought to be made
153
personally liable. That is the reason why subsequently Del Rosario v. NLRC,
refused to apply A.C. Ransom pronouncement and denied enforcement of a writ
of execution against the officers for an unsatisfied judgment against the
corporation because it found that "[i]n the case before us, not only has there
been a failure to establish fraud, but it has also not been shown that petitioner is
the corporate office responsible for private respondent's predicament." 154 In
other words, to warrant application of piercing to make a corporate officer or
stockholder liable for the corporate debts or obligations, evidence must be shown
that such officer or stockholder was responsible for the corporate act, and that
stage can only come during the hearing on the merits.
Subsequently, De Guzman v. NLRC,155 further clarified the A.C. Ransom
doctrine not to be applicable to all types of officers, such as the general
manager, even if he is the highest ranking officer, when such officers is neither a
stockholder or a member of the board of directors.
In Western Agro Industrial Corporation v. Court of Appeals,156 where the
corporate officer was sued with the corporation to enforce a corporate obligation,
the Court refused to apply the piercing doctrine to make the corporate officer
liable for the corporate obligation since "[i]n this case there is no showing that
[the corporate officer] was not authorized by the corporation to enter into
purchase contracts . . . [and] [m]oreover, the respondent corporation has not
shown any circumstances which would necessitate the piercing of the corporate
veil so as to make [the corporate officer] personally liable for the obligations
incurred by the petitioner."157 Therefore, if in a clear case were a corporate
officer or stockholder is made a party jointly with the corporation to enforce
corporate debts and obligation, such corporate officer or stockholder cannot be
made personally liable without evidence adduced to warrant the piercing such as
151
171 SCRA 328 (1989).
152
Ibid, at p. 335.
153
187 SCRA 777 (1990).
154
Ibid, at p. 782.
155
211 SCRA 723 (1992).
156
188 SCRA 709 (1990).
157
Ibid, at p. 718.
fraud, then the more they cannot be belatedly made personally liable for a
corporate judgment debt at the point of execution for indeed the tribunal is at that
point without further jurisdiction to receive evidence on the merits.
This very issue was raised in Pabalan v. NLRC,158 where the corporate
officers sought to be made personally liable for a judgment rendered against the
corporation argued that no jurisdiction was acquired over them "as they have not
been served with summons and thus they were deprived of due process." 159 In
addressing this issue, the Court held:
In other words, when confronted with the issue of due process, the Court
would consider it a legitimate and serious issue and would determine, as it did in
Pabalan, whether such constitutional guarantee has been violated.
Lately, in EPG Construction Company, Inc. v. Court of Appeals161 it was
reiterated that where it is not shown that the President of a corporation "had
acted maliciously or in bad faith" and there is no evidence adduce to show why
he should be made liable with the corporation for the latter's obligation, such
officer may not be made personally liable for corporate contracts entered in his
official capacity.
158
184 SCRA 495 (1990).
159
Ibid, at p. 498.
160
Ibid, at pp. 498-499.
161
210 SCRA 230 (1992).
162
240 SCRA 376 (1995).
sub rosa, or by private individuals, with the use of public funds or property or
assets otherwise illegally acquired, or in breach of public trust or violation of
fiduciary duty; or in the case of existing firms, that their stock had been
purchased by or for public officers and their relatives, friends and associates,
with the use of public funds or illegally acquired money, or in violation of law or
fiduciary duty, etc. Elsewise stated, following the classic pattern of a money-
laundering operation, they were either sham, ‘shell’ or ‘dummy’ corporations
serving as fraudulent devises or conduits for private gain of public officers and
employees; or companies from which stock has been acquired, or firms into
which capital had been infused, or shares of stock purchased, with the use of
illegally acquired assets, and which therefore constituted the res: the thing or
object treated of in the action."163
With respect to corporation organized with ill-gotten wealth, the Court held
that the corporations themselves are not guilty of misappropriation, fraud or other
illicit conduct—in other words, the companies themselves are the object or things
involved in the action, the res thereof—there is not need to implied them either.
"Indeed, their impleading is not proper on the strength along of their having been
formed with ill-gotten funds, absent any other particular wrongdoing on their part.
The judgment may simply be directed against the shares of stock shown to have
been issued in consideration of ill-gotten wealth."164
FINAL OBSERVATIONS
Of the three (3) types of piercing cases, it would seem therefore that the
most restricted ones are the fraud piercing cases since the Supreme Court has
required that allegations of fraud must clearly be proven to make a stockholder
or officer liable for corporate debts and that piercing is available only when there
is a claim for recovery against such stockholders or officers.
The alter ego cases of the piercing tend to have wider leeway in their
applications and even without intending to do malice or just by being practical in
costing by taking shortcuts such as housing together under closely inter-related
operations two or more corporate businesses, the controlling stockholders or
officers may find themselves liable personally for corporate debts.
The most unwieldy class are the equity cases, when often in a fit of
laziness, the courts may just tend to pierce and not carefully go through the facts
of the case to rely on other doctrines to do justice. Fortunately, the equity cases
often are resorted to as additional grounds (supportive roles) in fraud and alter
ego cases; however, the tendency to abuse is there.
But all three types of piercing have an underlying theme that often does
not draw the proper attention to which it is entitled to: In all of the piercing cases
discussed, the effect of piercing has always been to make the active or
intervening stockholder or officer liable for corporate debts and obligations.
163
Ibid, at p. 465.
164
Ibid, at pp. 465-466.
Therefore, what is clear, especially for publicly-listed companies, is that the main
doctrine of separate juridical personality, and all its ancillary attributes, including
limited liability, remain firm and formidable to mere passive investors in a
corporation.
This proves the point that the corporate entity is meant primarily to attract
investors to place their money in the hands of professional managers (a
divorcement of ownership from control) and that most corporate doctrines were
intended for such a set-up. Close supervision of one's investment should be
more compatible with other forms of media such as partnership and sole
proprietorship. In fact, the Corporation Code has given a special type of vehicle
for investors who wish to actively manage their investments: the close
corporations, which have been termed as incorporated partnership and for which
intervening stockholders are made personally liable for corporate debts and
obligations.165
—oOo—
165
See Sec. 100, Corporation Code. Please see Chapter 16 on Close Corporations.
CHAPTER 5
1
The chapter is an updated and revised version of the article with the same title published
in 37 ATENEO L.J. 1 (No. 2, June 1994).
Corporate Dealings with Directors and Officers
Comparison with Principles in Unenforceable Contracts
FINAL OBSERVATIONS
————
2
Art. 1318, Civil Code of the Philippines.
unaware that a corporation has not been duly constituted. The first situation
refers to what the author would generically term as promoter's contracts or pre-
incorporation contracts. The second situation is what is termed as contracts
entered into with a defectively formed corporation, which would include the de
facto corporations and the corporations by estoppel.
3
Rep. Act No. 8799 (May, 2000).
4
Sec. 3.10, ibid.
5
Navarro, Two Points of Reform of Philippine Corporate Law, 27 PHIL. L.J. 669 (1952). "The
„offer' theory is worked out from the law of contracts. The analogy, however, fails for while in
ordinary contracts, there are both offerors and offerees, in our case the contemplated corporation
has not yet come into existence. To consider the offer as continuing and, therefore, as if made at
the time the corporation comes into existence is a twisting of the facts, for it is not so made in
fact. Neither may analogy be drawn between the contemplated corporation and a conceived child
for no one ever imagines contracting with it, except, perhaps, giving a gift to it, which does not
theory is that it allows withdrawal of subscriber at least before the corporation
comes into existence and accepts the offer.
Under the contract theory, a subscription agreement among several
persons to take shares in a proposed corporation becomes a binding contract
and is irrevocable from the time of subscription, unless cancelled by all the
parties before acceptance by the corporation.
It can be seen therefore that Sections 60 and 61 have fused the essential
features of both theories in their provisions. A subscription contract is essentially
a contract between the corporation and the subscribing person. The essence of
the stock subscription is an agreement to take and pay for original unissued
shares of a corporation, formed or to be formed.6
In the case of a pre-incorporation subscription agreement, Contract Law
would consider the subscription contract void, because one of the parties of the
contract, the corporation, does not exist. Yet Sections 60 and 61, as special
provisions in the Corporation Code, override the general provisions of Contract
Law, and mandate that pre-incorporation contracts are valid and enforceable. In
fact, Section 61 goes to the extent of saying that pre-incorporation subscription
agreements are irrevocable for a period of six (6) months from the date of
subscription. Under one point of view, there is no necessity under Section 61 for
the corporation to accept the subscription agreements, and it seems to bind the
corporation upon formation, as much as it binds the subscriber.
However, under another point of view, the provisions under Section 61 of
the Corporation Code making irrevocable pre-incorporation subscription
agreements pertains to the subscriber and between the subscribers among
themselves, and does not and cannot pertain to the corporation, because legally
speaking irrevocability (which the said section strictly covers prior to the fact of
incorporation of the corporation) cannot apply to a party who during that period
does not yet exist.
In addition, a pre-incorporation agreement is a type of promoter's contract,
and the prevailing theories in the Philippine jurisdiction (i.e., the contract theory
and the offer theory) are consistent with the fact that a promoter's contract is not
necessarily binding on the corporation once it is formed or organized and may be
refused by the corporation once formed. The only time when the corporation is
bound by a promoter's contract is when it has at the time of its constitution
received benefits from the contract. This appears to be the more logical and
forceful view.
Subscription agreements are "special contracts" in the sense that they go
beyond what we would term as ordinary contracts. Although subscription
agreements are contracts between the subscriber and the corporation, they are
come within the purview of contract law. It is not any good to consider the subscriptions as made
with an agent of the proposed corporation, for then there would be an agent for a principal that
does not exist. Again, if we grant the legal possibility of there being an agent of a non-existing
principal, this destroys the theory, as the subscription becomes perfected contract between two
able parties." Ibid, at p. 671.
6
Delpher Trades Corp. v. Intermediate Appellate Court, 157 SCRA 349, 353-354 [1988],
quoting Rohrlich 243, cited in AGBAYANI, COMMENTARIES AND JURISPRUDENCE ON THE
COMMERCIALS LAWS OF THE PHILIPPINES, Vol. III, 1980 ed., at p. 430.
at the same time deemed to be contracts among the stockholders of the
corporation. Such a "special relationship" among the subscribers of a corporation
can be sustained only if we look beyond the pale of the corporate fiction and see
that actually, beneath the corporate shell, is an association of warm-bodied
persons who decided to band together in the corporation in pursuit of a business.
This is clear from the fact that under Section 61, a pre-incorporation agreement is
generally irrevocable within the stipulated 6 month period "unless all of the other
subscribers consent to the revocation."
7
Sec. 30(C), National Internal Revenue Code of 1997.
8
65 Phil. 223 (1937).
9
Ibid, at pp. 227-228, quoting Gent v. Manufacturers and Merchants' Mutual Insurance
Company, 107 Ill. 652, 658.
But more importantly, while the Court conceded that there are
circumstances where "the acts of promoters of a corporation [may] be ratified by
the corporation if and when subsequently organized . . . but under the peculiar
facts and circumstances of the present case we decline to extend the doctrine of
ratification which would result in the commission of injustice or fraud to the
candid and unwary."10 The Court elaborated thus:
It would seem that the ratio in Cagayan Fishing is that ratification is the
key element in upholding the validity and enforceability of promoter's contracts.
Without ratification by a corporation after its due incorporation, a contract entered
into in behalf of a corporation yet to be organized or still in the process of
incorporation is void as against the corporation. In Cagayan Fishing the Court
found significant, the fact that the deals involving the properties were treated not
as corporate assets but as the personal assets of the Taboras; as well as the fact
that the titles of the parcels of land were not even registered in the name of the
corporation: "In fact, to this day, the lands remain inscribed in Tabora's name.
The defendant always regarded Tabora as the owner of the lands. He dealt with
Tabora directly. Jose Ventura, president of the plaintiff corporation, intervened
only to sign the contract, Exhibit B, in behalf of the plaintiff. Even the Philippine
National Bank, mortgagee of the four parcels of land, always treated Tabora as
the owner of the same." These all pointed to a lack of a bona fide ratification of
the deed of sale of the properties in favor of the corporation.
In Rizal Light & Ice Co., v. Municipality of Morong, Rizal,12 a franchise
awarded in favor of a corporation was sought to be annulled on the ground that
at the time the application was filed, the corporation was then only in the process
of incorporation. In dismissing the action, the Court held that although a franchise
may be treated as a contract, the eventual incorporation of the applicant
corporation after the grant of the franchise, "and its acceptance of the franchise
as shown by its action in prosecuting the application filed with the Commission
for the approval of said franchise, not only perfected a contract between the
respondent municipality and Morong Electric but cured the deficiency pointed out
by the petitioner in the application of Morong Electric."13
10
Ibid, at pp. 227-228, citing FLETCHER CYC. OF CORP., Perm. Ed., 1931, Vol. I, Secs. 207 et
seq.
11
Ibid, at p. 228.
12
25 SCRA 285 (1968).
13
Ibid, at p. 305.
The Court also clarified in Rizal Light that in deciding Cagayan Fishing
"this Court did not say in that case that the rule is absolute and that under no
circumstances may the acts of promoters of a corporation be ratified or accepted
by the corporation if and when subsequently organized. Of course, there are
exceptions. It will be noted that American courts generally hold that a contract
made by the promoters of a corporation on its behalf may be adopted, accepted
or ratified by the corporation when organized."14
In Caram, Jr. v. Court of Appeals,15 the Court stated that it would not
resolve the issue of whether it is the promoters or the corporation itself that shall
be responsible for the expenses incurred in connection with such organization.
Nevertheless it ruled that investors who were not the "moving spirit" behind the
organization of the corporation, but who were merely convinced to invest in the
proposed corporate venture on the basis of the feasibility study undertaken, are
not liable personally with the corporation for the cost of such feasibility study.
"The most that can be said is that they benefited from such services, but that
surely is no justification to hold them personally liable therefor. Otherwise, all the
other stockholders of the corporation, including those who came in later, and
regardless of the amount of their shareholdings, would be equally and personally
liable also with the petitioners for the claims of the private respondents."16
Although Justice Cruz in Caram, Jr. stated at the onset that "[f]or purposes
of resolving this case before us, it is not necessary to determine whether it is the
promoters of the proposed corporation, or the corporation itself after its
organization, that shall be responsible for the expenses incurred in connection
with such organization," the issue was in fact resolved in Caram, Jr. since the
Court took pains to point out that the majority investing incorporators were not
included in the definition of "promoter":
CONTRACTS OF DEFECTIVELY-FORMED
OR NON-EXISTENT CORPORATIONS
1. De Facto Corporation
a. Rationale of Doctrine
It should be borne in mind that the de facto doctrine is not limited in its
application to Corporate Law; it is also a well-developed concept in the Law on
Public Corporations and the Law on Public Officers. The common feature of the
de facto doctrine in those legal fields, is that it prevents any party from raising the
defect of authority as a means to avoid fulfillment of a contract or a transaction
entered into in good faith.
Tayko v. Capistrano,19 which discussed the policy of the doctrine as
applied to public officers, held that "[t]he principle is one founded in policy and
convenience, for the right of one claiming a title or interest under or through the
proceedings of an officer having an apparent authority to act would be safe, if it
were necessary in every case to examine the legality of the title of such officer up
to its original source, and the title or interest of such person were held to be
invalidated by some accidental defect or flaw in the appointment, election or
qualification of such officer, or in the rights of those from whom his appointment
or election emanated; nor could the supremacy of the laws be maintained, or
their execution enforced, if the acts of the judge having a colorable, but not a
legal title, were to be deemed invalid."20
The de facto doctrine's essence is to protect the sanctity of dealings by the
public with persons or entities whose authority emanates from the State, to allow
the public to take such authority at face value, provided nothing is clearly shown
to be defective in such authority. Even if it should be proven that such authority
was indeed defective, such defect cannot be used as an excuse to set aside a
relationship or transaction entered into in good faith.
In the field of Corporate Law, the de facto corporation doctrine is meant to
protect the enforceability of corporate dealings and contracts, to allow the public
to take at reasonable face value the authority of the corporation to enter into valid
18
Ibid, at p. 375.
19
53 Phil. 866 (1928). See also Gamboa v. Court of Appeals, 108 SCRA 1 (1981).
20
Ibid , at p. 873.
and binding contracts, thereby providing a healthy system by which to encourage
the public to deal with corporate entities. The de facto corporation doctrine is
therefore meant to apply to the level of existence that pertains to the relationship
of the corporation with the dealing public; and is not meant to govern nor be
applicable to other levels of existence, such as those pertaining to intra-corporate
relationships.
23
Ibid, at p. 606.
24
274 SCRA 452 (1997).
The valid statute under which most private corporations are organized
today would be the Corporation Code, which therefore supplies the first element
of what would constitute a de facto corporation existing in Philippine jurisdiction.
Can there be a de facto corporation organized under an enabling statute
that is an unconstitutional? Following the "orthodox view" that "an
unconstitutional act, whether legislative or executive, is not a law, confers no
rights, imposes no dues, and affords no protection,"25 the enabling statute being
unconstitutional would be absolutely void, and no corporation organized under it
can achieve the status of being de facto corporation. Therefore, the prevailing
view is that an unconstitutional enabling law has the same effect as though there
is no law under which to organize, and even if the associates organize in good
faith in reliance upon it, the resulting association cannot claim to be a de facto
corporation.
There is, however, the "qualified view" that the "actual existence of a
statute prior to such a determination [of unconstitutionality], is an operative fact
and may have consequences which cannot always be erased by a new judicial
declaration."26 Under that theory, a corporation defectively organized under the
law before it was declared unconstitutional can claim to be a de facto corporation
(presuming that other requisites are present), since it was organized under color
of law, that the statute is presumptively constitutional until it has been judicially
declared to be invalid, and that until it is so declared, men have a right to act and
contract under such presumption. Consequently, the acts and contracts of such a
defectively formed corporation, before the enabling law under which is was
organized is declared unconstitutional, cannot be avoided as against the
interests of the public, or of third persons who have invested or acted in good
faith in reliance upon their validity, by any ex post-facto declaration or decision
that the law under which they act was void.
After declaration of the invalidity or unconstitutionality of the enabling
statute, any corporation organized under it can no longer claim the status of
being a de facto corporation, since at that point the element of good faith would
no longer exist.
Hence, a distinction should be made when dealing with a corporation that
has been organized under an enabling law that has been declared
unconstitutional. If the constitutionality of the statute is raised for the first time in
an action wherein it is sought to prevent the future incurring of rights and
obligations, it will be proper to permit collateral attack; where the constitutionality
of the statute is raised for the first time in litigation seeking enforcement of
contracts or transaction which have been fully or partially consummated,
collateral attack on the juridical personality of the corporation should not be
permitted, since the corporation should be treated as a de facto corporation.
Courts have, however, through jurisprudence, arrived at the same result
as that upheld by such minority opinion, holding that a corporation organized
under a statute subsequently declared unconstitutional may nevertheless be
25
Fernandez v. Cuerva, 21 SCRA 1095, 1106 (1967).
26
Ibid. Also De Agbayani v. Philippine National Bank, 36 SCRA 429 (1971).
considered a corporation by estoppel, where there have been previous dealing
between the parties on a corporate basis.
27
Hall v. Piccio, 86 Phil. 603 (1950).
28
SEC Opinion, 17 January 1985, SEC ANNUAL OPINIONS 1985, at p. 9.
"Organization" as used in reference to corporations, has a well-understood
meaning, which is the election of officers, providing for the subscription and
payment of the capital stock, the adoption of by-laws, and such other steps as
are necessary to endow the legal entity with the capacity to transact the
legitimate business for which it was created. Under a statute providing that, until
articles of incorporation should be recorded, the corporation should transact no
business except its own organization, it is held that the term "organization"
means simply the process of forming and arranging into suitable disposition the
parties who are to act together in, and defining the objects of, the compound
body, and that this process, even when complete in all its parts, does not confer
a franchise either valid or defective, but, on the contrary, it is only the act of the
individuals, and something else must be done to secure the corporate
franchise.29
29
Benguet Consolidated Mining Co. v. Pineda, 98 Phil. 711, 720 (1956).
30
86 Phil. 603 (1950).
31
Sec. 20, Corporation Code.
corporation which has used fraud in the process of its incorporation, clearly
indicating that prior to such revocation, the corporation has all the powers and
attributes of a corporation de facto.
In addition, to allow the collateral attack on the personality of a corporation
because of existing defects known to the corporation and its board would
circumvent the very rationale of the de facto doctrine which seeks to prevent any
party from raising the defect of authority as a means to avoid fulfillment of a
contract or a transaction entered into.
On the other hand, in a suit between and among the parties who knew
that there was a defect in the incorporation of the corporation, there certainly is
no good faith on their part and in their case, the de facto doctrine cannot be
availed of in order to further their fraud.
a. Rationale of Doctrine
Estoppel is essentially a common law principle, and has been the source
of many rules which seek to work out justice or equity between the parties, on the
theory that an admission or representation is rendered conclusive upon the
person making it, and cannot be denied or disproved as against the person
relying thereon.33 The doctrine of estoppel has its origins in equity, and is based
on moral right and natural justice,34 and is designed to prevent injustice and
unfairness.35 The doctrine therefore permeates and goes beyond Corporate Law
considerations.
The doctrine is meant to hold contractual parties to their representations
or expectations at the time the contract was perfected; and it does not allow
parties to draw on a basic defect—lack of one contracting party—to avoid the
enforcement of the contract. The doctrine has evolved in Corporate Law primarily
as a rule to promote the integrity of commercial contracts; the basic role of the
32
In an opinion rendered by the SEC, it characterized the advantages of a corporation from
an unregistered corporation: "A corporation is a legal entity deriving its existence from a
franchise, whereas, as association in the narrow sense of the term is a creature of contract
without legal personality separate and distinct from the individuals composing it. An unregistered
association cannot sue and be sued; it cannot enter into contracts in the name of the association
and neither can it acquire properties under its common name. Contracts entered into in its behalf
make the persons signing or executing them liable to the other contracting party. It is not
competent to act or appoint agents or confer upon another authority to act on its behalf, and
those who act or purpose to act as its representatives or agents do so at their own risk. It is only
when the association is incorporated under the Corporation Code that it acquires juridical
personality, distinct and separate from its stockholders or members. Such incorporation enables
the association to exercise the powers which its charter and the Corporation Code grant to said
association." SEC Opinion, 22 August 1989, XXIV S EC QUARTERLY BULLETIN 2 (No. 1, March
1990).
33
Report of the Code Commission, p. 59, Introduction to Title IV of the Civil Code on
Estoppel.
34
Mirasol v. Municipality of Tabaco, 43 Phil. 610 (1922).
35
Lozano v. De los Santos, 274 SCRA 452, 83 SCAD 898 (1997).
doctrine of corporation by estoppel is to promote the public's underlying faith in
contracts drawn with corporate entities, rather than to promote corporate
principles. For this reason, the doctrine as it has evolved in Section 21 seems
convoluted from a strict Corporate Law point of view; or at least, the basic
elements of the doctrine as expressed in Section 21 seem to be contradictory or
antithetical.
A review of jurisprudential history up to the adoption of Section 21 clearly
show that an uneven path had to be followed by our courts in applying the
original versions of the doctrine. Section 21 had to cut through the logical maze
to practically dictate a solution long sought by the courts, which they had been
unable to logically reach through accepted legal principles of those times.
36
46 Phil. 144 (1924).
37
5 Phil. 660 (1906).
38
14 Phil. 222 (1909).
39
Ibid, at p. 145 citing 14 C.J. 227 and Chinese Chamber of Commerce v. Pua Te Ching, 14
Phil. 222 (1909).
However, if one were to examine further this element of the doctrine, one
would see that to uphold the validity of a contract, both parties thereto must
recognize the corporate party even when one does not exist. Consequently, the
recognition of a corporate entity which in fact did not exist, in order to uphold the
validity of the contract, would lead to the application of the doctrine that once a
corporate entity exists, then it has a personality separate and distinct from the
stockholders or members who compose it. The separate juridical personality
doctrine requires that officers and stockholders acting for the corporation cannot
be held personally liable for corporate debts and liabilities. The conclusion is that
the persons who purport to act for a non-existent corporation would be held to
the existence of such corporate entity, and logically the corporate contract cannot
be enforced against them because of the separate juridical personality that is a
consequence of the recognition of the corporation.
This was the logical wall that faced the courts with the application of the
then version of the corporation by estoppel doctrine, as amply demonstrated in
Hall v. Piccio40 previously discussed above. The Supreme Court found in Piccio
that all parties to the contract were aware that the certificate of incorporation had
not yet been issued. The Court also held that the parties knew, or ought to have
known, that the personality of a corporation begins to exist only from the moment
such certificate is issued. Since "nobody was led to believe anything to his
prejudice or damage, the principle of estoppel does not apply [and] [o]bviously
this is not an instance requiring the enforcement of contract with the corporation
through the rule of estoppel."
The implication in Piccio is that the corporation by estoppel doctrine
applies only when at least one party to a contract was under the impression that
the other, corporate party was a duly incorporated entity. When both parties, as
in Piccio, are aware that a corporation has not been duly organized, then the
corporation by estoppel doctrine does not apply. Piccio therefore establishes one
of the elements of the doctrine: that at least one of the contracting parties was
under the impression or belief that the corporate entity party to the contract was
duly incorporated.
But if we were to take Piccio to its logical conclusion then it would
practically mean that the doctrine of corporation by estoppel will never apply,
since under Piccio all parties, whether incorporating stockholders or third-parties,
are mandated by law to be aware that corporate existence begins only upon the
issuance of the certificate of incorporation by the SEC.41 And since the issuance
or non-issuance of a certificate of incorporation is a matter of public record, even
third parties are charged with constructive knowledge of the fact of such non-
issuance. In fact, it would seem to be an obligation of one who deals with a
corporate entity to know whether such certificate has been issued, since this is
easily verifiable with the SEC.
If such a certificate is indeed issued but there is a defect in the
incorporation process of a contracting corporate entity, pursuant to Piccio, the
doctrine of de facto corporation would come into play. However, if no such
certificate of incorporation has been issued, then even the corporation by
40
86 Phil. 603 (1950).
41
Sec. 19, Corporation Code.
estoppel doctrine would be inapplicable, because both the associates in the
purported corporation and the other party to the contract cannot plead ignorance
of the fact that no corporation existed, since they are chargeable with the
knowledge of the non-issuance.
One conclusion that may be drawn from all this is that, following Piccio,
the corporation by estoppel doctrine cannot apply when no certificate has been
issued. It can only apply when a certificate is issued but where, for lack of the
other criteria, the de facto corporation doctrine cannot apply. This does not seem
to be a good doctrine. What we can reasonably draw as a conclusion from Piccio
is that the non-issuance of a certificate of incorporation affects the good faith only
of the corporate insiders, mainly the incorporating stockholders or members. The
lack of the certificate does not prevent the application of the estoppel doctrine to
a third party who entered into a contract with the purported corporation, believing
it to be duly incorporated.
As was pointed earlier, it was wrong for Piccio to have discussed the
applicability of the corporation by estoppel doctrine in a suit between and among
corporate insiders. As was said much later on in Lozano v. De los Santos,42 the
doctrine applies when persons assume to form a corporation and exercise
corporate functions and enter into business relations with third persons, and
therefore has no application “[w]here there is no third person involved and the
conflict arises only among those assuming the form of a corporation.”
Nevertheless, Piccio is clear in stating the proposition that in a purported-
corporation setting, when the de facto corporation doctrine cannot be applied, it
does not necessarily mean that the corporation by estoppel doctrine becomes
the applicable doctrine.
Subsequently in Vda. de Salvatierra v. Hon. Garlitos,43 the Court added a
new twist. Salvatierra, as owner of a piece of land, entered into a contract of
lease with a corporation allegedly "duly organized and existing under the laws of
the Philippines," represented by its president. When the obligations imposed
under the contract of lease on the corporate lessee were not complied with,
Salvatierra brought an action for accounting, rescission and damages. Judgment
was rendered against the corporation. When a writ of execution was sought to be
enforced, no properties in the name of the corporation could be located, and
consequently properties registered in the name of its president were levied upon.
The president sought to have the levy against his properties lifted, since he was
not even a party to the case against the corporation. On the other hand,
Salvatierra showed that the case was brought against the corporation in the
belief that it was duly incorporated, and that he found out only after judgment that
it had not been duly registered with the SEC.
Under those proven facts, the Supreme Court held the president
personally liable on the contract entered into on behalf of the purported
corporation. In resolving the case, the Court in Salvatierra refused to apply the
corporation by estoppel doctrine:
42
274 SCRA 452, 83 SCAD 898 (1997).
43
103 Phil. 757 (1958).
. . . While as a general rule a person who has contracted
or dealt with a corporate body is estopped from denying the
same in an action arising out of such transaction or dealing . . .
yet this doctrine may not be held to be applicable where fraud
takes a part in the said transaction. In the instant case, on
plaintiff's charge that she was unaware of the fact that the
Philippine Fibers Producers Co., Inc. had no juridical
personality, defendant Refuerzo gave no confirmation or
denial and the circumstances surrounding the execution of the
contract lead to the inescapable conclusion that plaintiff
Manuela T. Vda. de Salvatierra was really made to believe that
such corporation was duly organized in accordance with law.44
46
13 SCRA 84 (1965).
47
Ibid, at pp. 86-87l.
The corporation-by-estoppel doctrine has not been
invoked. At any rate, the same is inapplicable here. Aruego
represented a non-existent entity and induced not only the
plaintiff but even the court to believe in such a representation.
He signed the contract as “President” of “University Publishing
Co., Inc.,” stating that this was a “corporation duly organized
and existing under the laws of the Philippines,” and obviously
misled plaintiff (Mariano A. Albert) into believing the same.
One who has induced another to act upon his willful
misrepresentation that a corporation was duly organized and
existing under the law, cannot thereafter set up against his
victim the principle of corporation by estoppel (Salvatierra [sic]
vs. Garlitos, 56 O.G. 3069).48
However, in Albert, the Court discussed how the then version of the
estoppel doctrine could be applied to hold the actors behind the purported
corporation, personally liable for the contract, at the same time that corporate
liability was upheld:
The implication of Albert is clear: even with the then version of the
estoppel doctrine, we could uphold the validity and enforceability of a contract by
upholding the fiction of the contracting corporation's existence, (although in fact it
cannot exist); but nonetheless, under the piercing doctrine, we can pierce the veil
of the recognized corporate party and make the actors liable personally for the
obligations arising from the contract.
Although Albert itself refused to apply the estoppel doctrine, it was such a
thesis that eventually found itself embodied as the corporation by estoppel
doctrine in Section 21. Albert therefore offers us the "philosophical bridge"
between the two doctrines: the first, that a corporation can be deemed to exist
when in fact none may exist, in order to validate a contract; and the second, that
although the veil of corporate fiction is set up, it will be pierced to enforce the
contract, to hold the actors behind such misrepresentation liable for the
obligations arising from such contract.
The remaining issue is why we need to adopt such a crisscrossing
estoppel doctrine at all under Section 21, when Salvatierra's agency doctrine—
that of making the agent of an inexistent principal liable on the contract—already
achieves with clearer logic the same ends sought to be achieved by Section 21?
48
Ibid, at p. 87, emphasis supplied.
49
Ibid, at pp. 87-88.
The reason is that Salvatierra is sufficient only when there is fraud or
misrepresentation on the part of one of the contracting parties. It has no
application to a situation where both parties to the contract acted in the honest
belief that a contracting corporate entity did exist. In such a case, Salvatierra
cannot apply, since only an agent who knew that his purported principal did not
exist can be held personally liable. In a no-fraud or no-misrepresentation case,
since the "agent" cannot be held as principal to the contract to validate it, there is
an issue as to the validity and enforceability a contract where a contracting party
is missing.
It is in such no-fraud or no-misrepresentation cases that Salvatierra is
clearly inadequate. This is where the present statutory version of the corporation
by estoppel doctrine applies, since its applicability does not require fault or
conscious misrepresentation.
This latest ruling of the Supreme Court in Lim is in stark contract to its
rulings in Pioneer Insurance v. Court of Appeals,52 where the liabilities of parties
to a corporate venture was sought to be determined when it was shown that the
corporation intended to be formed was never duly incorporated. The Court held
in that case that:
50
271 SCRA 621, 88 SCAD 898 (1997).
51
317 SCRA 728 (1999).
52
175 SCRA 668 (1989).
While it has been held that as between themselves the
rights of the stockholders in a defectively incorporated
association should be governed by the supposed charter and
the laws of the state relating thereto and not by the rule
governing partners . . . it is ordinarily held that persons who
attempt, but fail, to form a corporation and who carry on
business under the corporate name occupy the position of
partners inter se. . . Thus, where persons associate
themselves together under articles to purchase property to
carry on a business, and their organization is so defective as
to come short of creating a corporation within the statute, they
become in legal effect partners inter se, and their rights as
members of the company to the property acquired by the
company will be recognized. . . However, such a relation does
not necessarily exist, for ordinarily persons cannot be made to
assume the relation of partners, as between themselves, when
their purpose is that no partnership shall exist. . ., and it should
be implied only when necessary to do justice between the
parties; thus, one who take no part except to subscribe for
stock in a proposed corporation which is never legally formed
does not become a partner with other subscribers who engage
in the business under the name of the pretended corporation,
so as to be liable as such in an action for settlement of the
alleged partnership and contribution. . . A partnership relation
between certain stockholders and other stockholders, who
were also directors, will not be implied in the absence of an
agreement, so as to make the former liable to contribute for
payment of debts illegally contracted by the latter. . . 53
The resulting doctrine would therefore be that when there was clear
intention to form a partnership venture through a corporate vehicle, which
essentially means that the partners had intended to be active participants in the
business of the corporation, then even those who did not directly participate in
the contract or transaction being sued upon, but benefited therefrom may be held
liable as general partners under the corporation by estoppel doctrine. On the
other hand, when the investors intended only to invest in a corporate venture with
no intention of participating in its corporate affairs, and the corporation was not
formed, no partnership relation is deemed established by the failure to
incorporate, and such investors cannot even be held liable for the contracts and
transaction sued upon even when such contracts and transactions were entered
into by the corporate actors in the name of an ostensible corporation.
It should be borne in mind that Section 21 is merely a "freeze-frame" of
Congress‟ appreciation of the doctrine as it stood at the time of the adoption of
the Corporation Code. However, the doctrine itself existed even prior to attaining
statutory definition, and is based on the common law principle of estoppel.
Therefore, despite the language of Section 21, it should be expected that since
the corporation by estoppel doctrine is meant to be used to render justice, it will
continue to evolve and to be developed by judicial and quasi-judicial bodies to
53
Ibid, at pp. 682-683.
make it an optimum means of rendering justice, or achieving equitable solutions
to issues involving the use of the corporate medium.
54
Articles 1411 and 1412 of the Civil Code provide that neither contracting parties may
recover what he has given by virtue of the contract, or demand the performance of the other's
undertaking.
55
103 Phil. 757, at pp. 763-764.
powers and attributes of a corporation; it cannot create agents or confer authority
on another to act in its behalf. In contracts entered into for such purported
corporations, where both parties knew that no such corporation existed, the
actors enter the contract without authority and at their own risk. An elementary
principle in law is then applied: when actors to a contract act or allow others to
act as agents without authority or without a principal, the law considers such
agents as principals, possessed of all the rights and subject to all the liabilities of
a principal. Such agents may be considered by all the actors to have assumed
the privileges and obligations of the purported principal corporation, and become
personally liable for contracts entered into, or for other acts performed, by them
as such agents.
The reverence of the law, and of the courts, the binding effect of the
provisions of the articles of incorporation on the parties thereto is such that
amendments thereto can be made by one party only with the consent of the other
parties under the strict provisions of the Corporation Code,59 but also, the
contents thereof as mandated by law60 and are treated with strictness. Thus, the
use of a corporate name other than that provided for in the articles was not
allowed in Red Line Trans. Co. v. Rural Transit Co.,61 which stated that the
incorporators "constitute a body politic and corporate under the name stated in
the certificate" and that a corporation has the power "of succession by its
corporate name" and by "that name alone is it authorized to transact business."62
2. By-Laws
56
52 Phil. 699 (1929).
57
Ibid, at p. 702.
58
Ibid, at p. 703.
59
Sec. 16, Corporation Code.
60
Sec. 14, Corporation Code.
61
60 Phil. 549 (1934).
62
Ibid, at pp. 554-555. Parenthetically, though, the Supreme Court has stated in Republic
Planters Bank v. Court of Appeals, 216 SCRA 738 (1992), that a change in the corporate name
when approved by the SEC does not make a new corporation, and has no effect on the identity of
the corporation, or on its property, rights, or liabilities.
By-laws, unlike the articles of incorporation, are meant to be an intramural
document, to govern the relationship between and among the members of a
corporate family. As held in Rural Bank of Salinas v. Court of Appeals,63 "[b]y-
laws are intended merely for the protection of the corporation, and prescribe
regulation, not restrictions." Thus, Rural Bank of Salinas held that restrictions
affecting the assignment or transfer of shares cannot validly be provided for in
the corporation's by-laws, and any such provisions in the by-laws are void.64
The rule, therefore, is that although the power of the corporation to adopt
by-laws is an inherent right, by-law provisions cannot contravene the law.65 The
validity or reasonableness of a by-law provision is a question of law, and in such
cases the issue to be resolved would be whether a by-law provision conflicts with
a provision of law, or with the charter of the corporation; or is in the legal sense
unreasonable and therefore unlawful.66
On the basis of their nature and their functions one may therefore
conclude that provisions of the articles of incorporation prevail over by-law
provisions. This seems however to be a sweeping statement, because of the
consequences that such a notion would have on the dealings of corporations with
third parties: since the articles of incorporation define the powers and purposes
of the corporation as it deals with the world, they would therefore bind a third
person dealing with the corporation, whether or not such person was aware of
the provisions of the articles of incorporation.
On the other hand, since by-law provisions are intramural in nature and
are not meant to bind parties outside the corporate family, it stands to reason that
the public dealing with the corporation is not supposed to be interested in the
provisions of the corporation's by-laws, and therefore should not be bound
thereby. This seems to be the principle followed in ultra vires cases decided by
the Supreme Court, especially as ultra vires goes into the power and authority of
corporate officers.
However, the case of Peña v. Court of Appeals,67 seems to negate this
proposition on the non-binding character of by-laws on third parties. In that case,
the Supreme Court ruled that the "by-laws of a corporation are its own private
laws which substantially have the same effect as the laws of the corporation.
They are in effect, written into the charter. In this sense they become part of the
fundamental law of the corporation with which the corporation and its directors
and officers must comply."68
Peña would then elevate by-law provisions to the level of provisions of the
articles of incorporation, and give them the same binding effect over third parties
63
210 SCRA 510 (1992).
64
This doctrine should be understood to mean that restrictions on transfers provided in the
by-laws contrary to law cannot have legal effect. It is possible to provide in the by-laws
procedures on the transfer of shares, provided they are consistent with law. Nava v. Peers
Marketing Corporation, 74 SCRA 65 (1976), has earlier held that a corporation can include in its
by-laws rules, not inconsistent with law, governing the transfer of its shares of stock. See further
discussions on the matter in Chapter 10.
65
Government of the Philippine Islands v. El Hogar Filipino, 50 Phil. 399 (1927).
66
Gokongwei v. SEC, 89 SCRA 336, 361-362 (1979).
67
193 SCRA 717 (1991).
68
Ibid, at p. 729, citing 8 FLETCHER CYC. CORP., Perm. Ed., pp. 750 -751.
dealing with the corporation. This conclusion is inevitable from Peña, which was
a suit between corporate "outsiders", with the highest bidder in a public auction of
corporate property on the one hand, and the buyer of the right of redemption of
the corporation on the other.
In that case, the Supreme Court held as void, the board resolution selling
the corporation's right to redeem the property, as well as the subsequent sale
thereof, because the resolution was adopted in a manner contrary to the
procedure outlined in the corporation's by-laws for special meetings.
On the other hand, in Board of Liquidators v. Heirs of Maximo Kalaw,69 the
Court held that it is possible for an express provision of the by-law to be violated
and the board may, in certain corporate actions, bind the corporation in spite of
the fact that it is contrary to the by-law provision. It held that there are two ways
by which corporate actions may come about through the corporation's board of
directors, either the board may empower or authorize the act or contract, or it can
be ratificatory act on the part of the board. As long as there is a corporate
approval through the board of directors, whether implied or express, it is valid to
bind the corporation.
In Yao Ka Sin Trading v. Court of Appeals,70 the Court in nullifying a
cement supply contract entered into by the President and Chairman of the
cement manufacturing company, but without prior board resolution, made
expressly binding on the purchaser the provisions of the company's by-laws
which provided that board resolution is required, although the President may be
the one to execute the resulting contract for the company. However, it should be
noted that in Yao Ka Sin Trading that before the contract could be implemented,
the board did pass a resolution expressly repudiating the same.
Post-Peña decisions of the Supreme Court clearly reiterate the non-
binding effects of by-laws to third parties who deal with the corporation without
specific knowledge of applicable by-law provisions.
69
20 SCRA 987 (1967).
70
209 SCRA 763, 81 SCAD 184 (1992).
71
270 SCRA 503, 85 SCAD 846 (1997).
third party and the shareholders was entered into, in this case, at the time the
pledge agreement was executed. In that case, the Court held that the corporation
could have easily informed pledgee of its by-laws when it sent notice formally
recognizing pledgee of its shares registered in the name of a stockholder of
record. The corporation‟s belated notice of said by-laws at the time of foreclosure
did not suffice to overturn the rights of the pledgee. The Court reiterated the
principle on the binding effects of by-laws as to third parties, thus:
73
Baretto v. La Previsora Filipina, 57 Phil. 649 (1932).
2. Test to Determine Ultra Vires of the First Type
Montelibano v. Bacolod-Murcia Milling Co., Inc.,74 clarified the extent of the
application of the ultra vires doctrine. At issue was the validity and binding effect
on the corporation of an amended milling contract that granted favorable terms to
planters. Although the amended milling contracts were approved by the board of
directors, it was interposed for the corporation that the resolution was null and
void ab initio, being in effect a donation that was ultra vires, beyond the powers
of the corporate directors to adopt. The Supreme Court upheld the authority of
the board acting for the corporation to modify the terms of the amended milling
contract for the purpose of making its terms more acceptable to the other
contracting parties. It gave the formula for determining the applicability of the
ultra vires doctrine:
The test uses the rather stringent terms "direct and immediate" only with
reference to the business of the corporation; whereas, it uses the rather liberal
terms of "fairly incident" and "reasonably necessary" with reference to powers of
the corporation.
When the business of a corporation is used as the reference point, much
latitude is given to the corporation to enter into various contracts as long as they
have a logical relation to the pursuit of such business. Thus, in one early case,76
the Supreme Court upheld a purpose clause in the articles of incorporation which
allowed the corporation to engage in what were rather broadly worded activity as
"mercantile purposes." The Court construed that as allowing the corporation to
"engage in such incidental business as may be necessary and advisable to give
effect to, and aid in, the successful operation and conduct of the principal
business."77
On the other hand, when the purpose clause of a corporation's articles of
incorporation has unwittingly used limiting words, such as describing its business
as "transportation by water," the Court will hold the corporation to such limited
business and will refuse to construe the same to allow the corporation to engage
74
5 SCRA 36 (1962).
75
Ibid, at p. 42 quoting 6 FLETCHER CYC. CORP. Rev. Ed. 1950, pp 266-268. Emphasis
supplied.
76
Uy Siuliong v. Director of Commerce and Industry, 40 Phil. 541 (1919).
77
Ibid, at p. 544.
in the land transportation business.78 In such instances, the corporation has no
one but itself (and perhaps its legal counsel who prepared the articles of
incorporation) to blame for tying its own hands.
Another example would be the sale of land owned by the corporation. In
San Juan Structural and Steel Fabricators, Inc. v. Court of Appeals,79 the Court
held that a corporation whose primary purpose is to market, distribute, export and
import merchandise, the sale of land is not within the actual or apparent authority
of the corporation acting through its officers, much less when acting through the
treasurer. The Court also pointed out that Articles 1874 and 1878 of the Civil
Code require that when land is sold through an agent, the agent‟s authority must
be in writing, otherwise the sale is void.
Another example would be the obtaining of loans by the corporation.
China Banking Corp. v. Court of Appeals,80 held that the power to borrow money
is one of those cases where even a special power of attorney is required under
Art. 1878 of the Civil Code, and therefore there is invariably a need of an
enabling act of the corporation to be approved by its board of directors. The
Court held that the argument that the obtaining of loan was in accordance with
the ordinary course of business usages and practices of the corporation was
devoid of merit because the prevailing practice in the corporation was to explicitly
authorize an officer to contract loans in behalf of the corporation.
78
Luneta Motor Company v. A.D. Santos, Inc., 5 SCRA 809 (1962).
79
296 SCRA 631, 645, 99 SCAD 281 (1998).
80
270 SCRA 503, 81 SCAD 184 (1997).
81
Republic v. Acoje Mining Co., Inc., 3 SCRA 361 (1963).
judgment rule." The business judgment rule states that courts will not sit in
judgment to substitute their business judgment for that of the directors; and that
as much as possible, directors, in the exercise of their business judgment, should
be given leeway to adopt corporate policies and to engage in transactions as
they deem best for the corporation, and the same cannot be claimed to be
beyond their powers or ultra vires.
Montelibano itself said that "[a]s the resolution in question was passed in
good faith by the board of directors, it is valid and binding, and whether or not it
will cause losses or decrease the profits of the central, the court has no authority
to review them."82 The Court added that "[i]t is a well-known rule of law that
questions of policy or management are left solely to the honest decision of
officers and directors of a corporation, and the court is without authority to
substitute its judgment [for that] of the board of directors; the board is the
business manager of the corporation, and so long as it acts in good faith its
orders are not reviewable by the courts."83
Furthermore, the demands of business are such that it is impossible to
anticipate all possible contingencies at the time the articles of incorporation are
drawn. In the face of unreasonably strict application of ultra vires principles, there
would be a need for corporations to continually amend or revise charters simply
to keep abreast with the various aspects of the very businesses they were meant
to engage in.
Carlos explained the law's attitude towards the ultra vires doctrine: "The
defense is by some courts regarded as an ungracious and odious one, to be
sustained only where the most persuasive considerations of public policy are
involved, and there are numerous decisions and dicta to the effect that the plea
85
Carlos v. Mindoro Sugar Co., 57 Phil. 343 (1932).
86
Pirovano v. De la Rama Steamship Co., 96 Phil. 335 (1954).
87
Republic v. Acoje Mining Co., Inc., 3 SCRA 361 (1963).
88
Land Bank of the Philippines v. Commission on Audit, 190 SCRA 154 (1990).
89
See Pirovano v. De la Rama Steamship Co., 96 Phil. 335 (1954), where the Supreme
Court had to go through several hair-splitting distinctions to validate a donation given by the
corporation to the minor children of its late president who was to a large extent responsible for the
rapid and very successful development and expansion of the activities of the corporation.
90
57 Phil. 343 (1932).
91
Ibid, at p. 353, quoting from Coleman v. Hotel de France Co., 29 Phil. 323 (1915).
should not as a general rule prevail whether interposed for or against the
corporation, where it will not advance justice but on the contrary will accomplish a
legal wrong."92
Carlos pointed out that the great weight of authority is to the effect that,
where a transaction is merely ultra vires and not malum in se or malum
prohibitum, although it may be made a basis for forfeiture of the corporate charter
or dissolution of the corporation, such transaction is, if performed by one party,
not void as between the parties, and an action may be brought directly upon the
transaction and relief had according to its terms.93
Therefore, even in the case of ultra vires acts which are not per se illegal,
a corporation cannot be heard to complain that it is not liable for the acts of its
board, because of estoppel by representation. In Republic v. Acoje Mining Co.,
Inc.,94 the Court, in making a distinction between ultra vires acts and illegal acts,
held:
3. Illegal Acts
Curiously enough, even when confronted with what was obviously an
illegal act or a contract contrary to law, the Supreme Court has tended to uphold
the result of the contract with respect to the contracting parties, which contract
should have been void ab initio.
In Harden v. Benguet Consolidated Mining Co.,98 the mining company,
Benguet Consolidated Mining Company, in violation of the express prohibitions of
the then Corporation Law, held shares of stock in another mining corporation, the
Balatoc Mining Company. The shareholders of the Balatoc Mining Company filed
an action against Benguet Mining Company to annul the certificates of stock
issued in favor of the latter, and to recover money collected by the latter from the
arrangements.
In upholding the dismissal of the complaint by the trial court, the Court
noted that, although the contract between the two mining companies was illegal
for contravening the Corporation Law, the statutory provision in question was
adopted by the legislature with the intention that public policy should be
controlling in the granting of mining rights. The Court said that the violation of the
prohibition is of such a nature that it can be proceeded upon only by way of a
criminal prosecution, or by action of quo warranto, which can be maintained only
the State.
The Court observed that, insofar are the parties were concerned, no civil
wrong had been committed between them, and if public wrong had been
committed, then the directors of Balatoc Mining Company and the plaintiff
Harden himself, were the active inducers of the commission of that wrong. But
more importantly, the Court observed:
The lesson from Harden therefore is that, even where corporate contracts
are illegal per se, when only public or government policy is at stake and no
private wrong is committed, the courts will leave the parties as they are, in
accordance with their original contractual expectations.
106
San Juan Structural and Steel Fabricators, Inc. v. Court of Appeals, 296 SCRA 631, 645,
99 SCAD 281, 294 (1998).
107
First Philippine International Bank v. Court of Appeals, 252 SCRA 259, 67 SCAD 196
(1996).
108
People’s Aircargo and Warehousing Co., Inc. v. Court of Appeals, 297 SCRA 170, 184-
185, 99 SCAD 482, 497-498 (1998).
109
People’s Aircargo and Warehousing Co., Inc. v. Court of Appeals, 297 SCRA 170, 183-
184, 99 SCAD 482 (1998).
110
Ibid.
111
38 Phil. 634 (1918).
112
Ibid, at p. 644.
applies equally where the defendant intends to challenge the
power of its officer or agent to execute in its behalf the contract
upon which the action is brought and where it intends to
defend on the ground of a total want of power in the
corporation to make such a contract.113
113
Ibid, at p. 644 quoting THOMPSON ON CORPORATIONS, 1st ed., Vol. 6, Sec. 7631.
114
Ibid, at pp. 645-646.
115
Ibid.
116
Ibid.
117
94 SCRA 357 (1979).
118
The principle was reiterated in The authority of a corporate officer in dealing with third
persons may be actual or apparent. . . the principal is liable for the obligations contracted by the
agent. The agent's apparent representation yields to the principal's true representation and the
contract is considered as entered into between the principal and the third person First Philippine
In Francisco v. Government Service Insurance System119 at issue was the
binding effect of an acceptance telegram sent by the general manager of the
corporation, which contained provisions contrary to the terms approved by the
board of directors, covering the terms of settlement of an obligation. In upholding
the binding effect of the acceptance telegram on the corporation the Court held:
International Bank v. Court of Appeals, 252 SCRA 259, 67 SCAD 196 (1996), where the Supreme
Court held that "[t]he authority of a corporate officer in dealing with third persons may be actual or
apparent. . . the principal is liable for the obligations contracted by the agent. The agent's
apparent representation yields to the principal's true representation and the contract is
considered as entered into between the principal and the third person."
119
7 SCRA 577 (1963).
120
Ibid, at p. 583.
121
Ibid, at p. 584.
122
Ibid, at pp. 584-585 quoting BALLANTINE, LAW ON CORPORATIONS, Sec. 112.
123
Ibid, at pp. 583-584 quoting from Curtis Land & Loan Co. v. Interior Land Co., 137 Wis.
341, 118 N.W. 853, 129 Am. St.Rep. 1068; as cited in 2 FLETCHER'S ENCYCLOPEDIA, PRIV. CORP.,
Perm. Ed., at p. 263,
In Areola v. Court of Appeals,124 the corporate insurer was held liable for
damages for cancellation the insurance policy of the insured for alleged failure to
pay the premium, when in fact the premium had been paid to the branch
manager who failed to remit them to the head office. The Court held that a
corporation acts solely through its employees, and the latter's acts are
considered as its own for which it can be held to account.
In People’s Aircargo v. Court of Appeals,125 the Court held the corporation
liable to a second contract of service that was entered into by the President
without prior board authorization, when the facts showed that a first contract of
service was paid by the corporation when it was entered into by the President
also without prior board authorization. The Court held that when the first contract
was consummated and paid with full knowledge of the board of directors, it
clothed the President with power to bind the corporation and consequently the
contractor cannot be faulted for believing that President‟s conformity to the
second contract was also binding on the Company. The Court also held that by
having accepted the benefits from the services of contractor for the second
contract, the corporation is estopped from denying the enforceability of the
second contract.
The Court in People’s Aircargo also recognized the peculiar position of the
President with respect to corporate operations, that inasmuch as a the President
is often given general supervision and control over corporate operations, the
strict rule that said officer has no inherent power to act for the corporation is
slowly giving way to the realization that such officer has certain limited powers in
transactions of the usual and ordinary business of the corporation, thus:
c. “Timely-Repudiation” Ruling
124
236 SCRA 643, 55 SCAD 478 (1994).
125
297 SCRA 170, 99 SCAD 478 (1998).
126
Ibid, at p. 186.
On the other hand, the recent case of Yao Ka Sin Trading v. Court of
Appeals127 presents what seems to be a reversal of the Ramirez doctrine. Yao Ka
Sin invalidated a contract to supply cement entered into by a cement company by
Mr. Maglana, its President and Chairman of the board of directors. Aside from
the fact that the by-laws of the cement company did not give the President the
authority to enter into contracts without prior board approval, the Court held that
application of the doctrine of apparent authority is the burden of the outsider
dealing with a corporation to show: "It was incumbent upon the petitioner to prove
that indeed the private respondent had clothed Mr. Maglana with apparent power
to executive Exhibit `A' or any similar contract. This could have been easily done
by evidence of similar acts executed either in its favor or in favor of other parties.
Petitioner miserably failed to do that." Upon the other hand, private respondent's
evidence overwhelmingly shows that no contract can be signed by the president
without first being approved by the Board of Directors."128
More importantly, in Yao Ka Sin, within a number of days (23 days) from
the execution of the President of the unauthorized contract, the board of directors
of the cement company passed a resolution repudiating the contract and given
due notice thereof to the other party when the contract was still as the executory
stage. In other words, there was no omission or misconduct on the part of the
board in Yao Ka Sin for the doctrine of estoppel or ratification to come in.
Although one would first get the impression that Yao Ka Sin may have
reversed the Ramirez doctrine, by shifting the burden in the doctrine of apparent
authority from the corporation to the other contracting party, but taken in its
entirety, Yao Ka Sin did not reverse the Ramirez doctrine, but rather completed
the cycle.
Yao Ka Sin did not repudiate the Ramirez doctrine that if the corporation
desires to set up the defense that the contract was executed by one not
authorized as its agent, it must plead and prove such fact; so that the burden is
initially on the shoulders of the corporation. However, the facts as they reach the
Supreme Court in Yao Ka Sin shows that indeed the cement company had
already discharged such burden by showing by clear evidence that its President
was not so authorized. Yao Ka Sin therefore holds, that once the corporation has
discharged its obligation under the Ramirez doctrine that acting officer was not in
fact authorized, then the burden of proof now shifts to the contracting party to
show that indeed by previous acts and actuations the acting officer had been
clothed by the corporation with apparent authority for the public to have taken
such authority at face value.
Vicente v. Geraldez,129 declared non-binding on the corporation, a
compromise agreement entered into by counsel without a prior special power of
attorney having been granted by the corporation. The Supreme Court refused to
apply the doctrine of estoppel or ratification even when it was shown that the
administrative manager had signed the compromise or had pursued an act
pursuant to the compromise agreement under the ruling that, it is only the board
of directors of the corporation that has the power to ratify a previously
127
209 SCRA 763 (1992).
128
Ibid, at p. 784.
129
52 SCRA 210 (1973).
unauthorized corporate act. The Court held that "ratification can never be made
`on the part of the corporation by the same persons who wrongfully assume the
power to make the contract, but the ratification must be by the officer or
governing body having authority to make such contract and, as we have seen,
must be with full knowledge.'"130
Vicente is not really a radical departure since it involved power to
compromise in suits, which is governed by particular provisions of the Rules of
Court, and therefore, it cannot be expected that proceedings on compromise,
especially involving a corporate party, would be pursued on the basis of apparent
authority. The Court held "the Rules require for attorneys to compromise the
litigation of their clients, a special authority. And while the same does not state
that the special authority be in writing the court has every reason to expect that, if
not in writing, the same be duly established by evidence other than the self-
serving assertion of counsel himself that such authority was verbally given
him."131
Crisologo-Jose v. Court of Appeals,132 held that accommodation contracts
on negotiable instruments executed in behalf of the corporation would not bind
the corporation without previous board authorization.133 The issuance or
indorsement of negotiable instruments in the name of a corporation without
consideration and for the accommodation of another was deemed to be ultra
vires, and the person who takes the instrument with knowledge of the
accommodation nature thereof cannot recover against a corporation which is
only an accommodation party.134
Crisologo-Jose stands as one of the few contemporary cases where the
Court has upheld the defense of ultra vires as validly exempting liability on the
part of the corporation for a contract entered into its name by an unauthorized
officer. In that case, the payee of the check issued by the corporation as an
accommodation party, was fully aware that the corporation was not receiving any
benefit from the transaction and that the issuance of the check was not for the
benefit of the corporation, and was therefore fully aware that the corporate
signatories to the check had not been duly authorized by the board of directors.
Therefore, the principles of ratification by acceptance of benefits or the doctrine
of apparent authority, nor the principle of estoppel espoused by the Court to
undermine the defense of ultra vires were inapplicable to favor the payee as
against the corporation since in his case estoppel could not apply being fully
aware of the lack of authority. It is unfortunate that Crisologo-Jose did not clearly
point out in this clear manner the reason why the ultra vires doctrine prevailed in
that instance when normally it is brushed aside by the courts.
Mendezona v. Phil. Sugar Estates Dev. Co.,135 had long before ruled that
the declarations of an individual director relating to the affairs of the corporation,
but not made in the course of, or connected with, the performance of the
130
Ibid, at p. 229, quoting from 2 FLETCHER, CYCLOPEDIA CORPORATIONS, 1067-1069, (1969
Rev. Volume).
131
Ibid, at p. 225.
132
177 SCRA 594 (1989)
133
Ibid, citing Oppenheim v. Simon Reigel Cigar Co., 90 N.Y.S. 355, cited in 11 C.J.S. 309.
134
Ibid, at p. 599, citing 11 C.J.S. 309, 14A C.J. 732.
135
41 Phil. 475, 491-492 (1921), citing 2 THOMPSON, par. 1073 and 1408.
authorized duties of such director, are held not biding on the corporation. False
statements made by a single director, for the purpose of defrauding the creditors
of the corporation, including the corporation itself, could not affect or bind it. The
general rule is that officers of corporations acting within the scope of their
authority may bind the corporation in the same way and to the same extent as if
they were the agents of natural persons, unless the charter or by-laws, otherwise
provide. They cannot, in general, bind the corporation by acts in excess of the
authority with which they are clothed unless such acts are ratified.
From the foregoing, it would seen that in the realm of contract
enforcement, the ultra vires doctrine has found very little application. It has
become more of a technical defense raised by or against the corporation, which
courts have readily brushed aside. However, the ultra vires doctrine still stands
as a principle of Corporate Law, and it reigns supreme in a purely intramural
corporate setting. In cases where the protagonists remain within the corporate
setting, or when the contract with an outsider is still executory as not to have
caused yet damage to the latter, the doctrine has been applied by courts with
vigor, for indeed it goes into the root of corporate relationship.
Prime White Cement held that a director holds a position of trust and as
such, he owes a duty of loyalty to his corporation, and his contracts with the
corporation must always be at reasonable terms, otherwise the contract is void
or voidable at the option of the corporation. The Court found that the terms of the
Dealership Agreement were unreasonable for the corporation and that the
unfairness in the contract was a basis which renders a contract entered into by
the President, without authority from the board of directors, void or voidable,
although it may have been in the ordinary course of business.
141
Ibid, at p. 110.
142
Ibid.
9. Comparison With Uneforceable Contract Principles
The principles applied by the Supreme Court in deciding issues pertaining
to the ultra vires acts or contracts, other than the third type which are violative of
the law or public policy, is similar to principles of Contract Law on unenforceable
contracts.
Unenforceable contracts under Philippine jurisdiction cannot be sued upon
or enforced, unless ratified, but once ratified, they have the effect of valid
contracts.143
Under Article 1403 of the Civil Code of the Philippines, unless they are
ratified, contracts entered into by "in the name of another person by one who has
given no authority or legal representation, or who has acted beyond his powers"
are deem to be unenforceable. Under Philippine jurisprudence, uneforceable
contracts are valid but cannot be enforced or effected, unless there has been
ratification, in which case the contract become valid and enforceable contracts. In
addition, unenforceable contracts, once ratified validates them from the
inception.144 Also, unenforceable contracts cannot be assailed by third persons.145
In addition, the principle of unenforceability of such contracts is deemed waived
when such contracts have been partially or fully executed by one of the parties
thereto.
In the case of the two (2) types of ultra vires contracts, i.e., those entered
into beyond the powers or purpose of the corporation, and those entered into by
unauthorized corporate officers or representatives, such contracts are similarly
located to unenforceable contracts entered into on behalf of the corporation, by
representatives who were not authorized by the corporation or acted beyond the
authorized powers granted to them. Consequently, the treatment of such ultra
vires contracts should be the same as those of similar unenforceable contracts.
This seems to be the path that has been followed by the Supreme Court as it has
applied principles pertaining to unenforceable contracts to such types of ultra
vires contracts, including the principles of estoppel and ratification, including the
fact that it has refused to disturbed contracts that have been executed, which is
equivalent to ratification.
FINAL OBSERVATIONS
What is clear from all the foregoing discussions is that in the field of
commercial transactions as they involve corporate entities, the principles of
Corporate Law are made to harmonize with other disciplines in order to sustain
the validity of contracts and transactions entered into by corporations with the
dealing public, in accordance with legitimate contractual and business
expectations that the corporations would be bound thereby, without the need of
costly and protracted verification as to the powers and authority of such
corporations, and the persons who act in their behalf. Rarely will the courts apply
pure corporate doctrines on their own merits, and courts will not apply them at all
143
PARAS, CIVIL CODE OF THE PHILIPPINES ANNOTATED (Vol. IV, 1994 ed.), at p. 766.
144
Art. 1407, Civil Code of the Philippines.
145
Art. 1408, Civil Code of the Philippines.
when their application would promote injustice and permit parties to skirt
contractual obligations they clearly assumed when the contracts were drawn.
Even in the case of acts or contracts of corporations which are illegal per
se, the State has often declined to fuse public interests with private affairs.
Courts have refused to invalidate the effects of such contracts on the parties in
order to enforce the State's interests, where the contract has created private
wrongs. The State will then seek its own cause against the erring corporation,
usually in a quo warranto proceeding to have the corporation's charter declared
forfeited.
—oOo—
ARTICLES OF INCORPORATION
——
1
Government of the P.I. v. Manila Railroad Co., 52 Phil. 699 (1929).
2
strict rules to be followed in its registration and the manner by which any portion
thereof may be amended. Nevertheless, it is pointed out in the discussions in
that chapter that the limiting effects of provisions of the articles of incorporation
on corporate contracts with the public, has been tempered by the Supreme
Court by the manner is has applied the ultra vires doctrine.
The purpose of the present chapter is really to discuss more the
mechanical features of adopting and amending the articles of incorporation and
to look into its basic provisions.
2
Sec. 14, Corporation Code
3
Sec. 17, Corporation Code.
4
Sec. 6(k), Pres. Decree 902-A.
3
5
Rep. Act 8791.
4
1. Treasurer's Affidavit
The SEC shall not accept articles of incorporation of a stock corporation
unless accompanied by a sworn statement by the Treasurer that at least twenty-
five percent (25%) of the total capital stock authorized is subscribed and at least
twenty-five percent (25%) of such have been fully paid in cash or property—fair
valuation of which is equal to at least twenty-five percent (25%) of the said
subscription. Such paid-up capital shall be no less than P5,000.00.
5
6
SEC Opinion, 18 April 1995, XXIX SEC QUARTERLY BULLETIN 41 (No. 3, Sept. 1995).
7
Sec. 1, SEC GUIDELINES FOR THE VERIFICATIONS OF THE PAID-UP CAPITAL (CASH) OF
CORPORATIONS (1976).
8
Sec. 2, ibid.
9
SEC Opinion, 8 October 1993, XXVIII SEC QUARTERLY BULLETIN 24 (No. 1, March 1994),
citing Wise Co., Inc. v. Man Sung Lung, 69 Phil. 308 (1940).
6
The SEC also requires that incorporators are required to submit a written
undertaking to change their partnership or corporate name in case there is
another person, firm or entity with a prior right to the use of the said name or one
similar to it.10
CORPORATE NAME
The incorporators "constitute a body politic and corporate under the name
stated in the certificate."11 A corporation has the power "of succession by its
corporate name."12 The name of a corporation is therefore essential to its
existence; it cannot change its name except in the manner provided by the
statute; by that name alone is it authorized to transact business;13 and it is by
that name that a corporation can sue and be sued, and perform all other legal
acts.
Since the corporate name is the main practical means of identifying
corporation from its members or stockholders, and other entities, the
Corporation Code does not allow a corporation to adopt a name identical or
deceptively or confusingly similar or to any other name already protected by law
or which is patently deceptive, confusing or contrary to existing laws.14
In Red Line Trans. v. Rural Transit,15 it was held that a corporation may
use another name as a business or brand name, but a corporation cannot use
another corporation's name because it will only confuse the public. The name of
the corporation is essential to its existence.
In Laureano Investment and Development Corp. v. Court of Appeals,16it
was held that a corporation has no right to intervene in a suit using a name other
than its registered name, and if the corporation legally and truly wanted to
intervene, it should have used its corporate name as the law requires and not
another name which it had not registered.
Nevertheless, the Supreme Court has held that there would be no denial
of due process when a corporation is sued and judgment is rendered against it
10
SEC GUIDELINES IN THE APPROVAL OF CORPORATE AND PARTNERSHIP NAMES (1977).
11
Section 19, Corporation Code.
12
Ibid.
13
Red Line Transportation Co v. Rural Transit Co., 60 Phil. 549 (1934).
14
Sec. 18, Corporation Code.
For as long as the corporation is still existing, regardless of whether or not it is in
operation, its corporate name cannot again be used by any other group. This is clear from the
provision of Section 18 of the Corporation Code which provides that no corporate name may be
allowed by the SEC that is identical or deceptively or confusingly similar to that of “any existing
corporation.” SEC Opinion, 21 September 1993, XXVIII SEC QUARTERLY BULLETIN 7 (No. 1,
March 1994).
15
60 Phil. 549 (1934).
16
272 SCRA 253 (1997).
7
under its unregistered trade name, holding that “[a] corporation may be sued
under the name by which it makes itself known to its workers.17
17
Pison-Arceo Agricultrual and Development Corp. v. NLRC, 87 SCAD 175, 279 SCRA
312 (1997).
18
SEC Memorandum No. 14, Series of 2000 (24 October 2000).
8
PURPOSE CLAUSE
The significance of the purpose clause in the articles of incorporation is
that it confers, as well as limits, the powers which a corporation may exercise.
The purpose clause must specify which is the corporation's primary purpose and
19
34 SCRA 252 (1970).
20
SEC Opinion, 2 October 1986, XX SEC QUARTERLY BULLETIN 40 (Nos. 3 & 4, Sept. &
Dec., 1986).
10
which are the secondary purpose. The secondary purpose or purposes need not
be related to the main purpose.
Some of the other reasons for indicating purpose in the charter of the
corporation are so that:
21
40 Phil. 541 (1919).
22
Sec. 6(k)7, Pres. Decree 90-2A.
23
18 SCRA 924 (1966).
11
The Court held that the impact of the questioned provisions of the articles
of incorporation upon the traditional fiduciary relationship between the directors
and the stockholders of a corporation would be too obvious to escape notice by
those who are called upon to protect the interest of investors. The Court found
that the provisions would authorize the directors and officers of the company to
do anything, short of actual fraud, with the affairs of the corporation even to
benefit themselves directly or other persons or entities in which they are
interested, and with immunity because of the advance condonation or relief from
responsibility by reason of such acts.
Asuncion v. De Yriarte,25 held that when on the face of the articles of
incorporation presented for registration it is shown that it is organized for a
purpose contrary to law or public policy, the same may be denied outright
registration. In Asuncion where the purpose in the articles of incorporation
sought to take possession and control of municipal property within a barrio and
administer the same exclusively for the benefit of the residents of the barrio, said
articles of incorporation showed the object of the incorporation to be unlawful in
that it sought to deprive the municipality in which the barrio was situated of its
property and its citizens of the right of enjoying the same and would, if permitted,
disrupt and destroy the government of the municipalities of the State and
abrogate the laws relating to the formation and government of municipalities.
The articles were denied outright registration.
Asuncion held also that although the duties of the official concerned
happened to be ministerial, it does not necessarily follow that he may not, in the
administration of his office, determine question of law. It is his duty to determine
whether the objects of the corporation as expressed in the articles of
incorporation are lawful pursuant to the then Corporation Law. And just because
the articles of incorporation are perfect in form, it does not mean that the division
of the archives must accept and register them and issue the corresponding
24
Ibid, at pp. 942-943.
25
28 Phil. 67 (1914).
12
1. Residence of Corporation
Article 51 of the Civil Code provides that "when the law creating or
recognizing them, or any other provision does not fix the domicile of juridical
persons, the same shall be understood to be the place where their legal
representation is established or where they exercise their principal functions."
Clavecilla Radio System v. Antillon,32 held that the residence of a
corporation is the place where its principal office is established; it can be sued in
that place, not in the place where its branch office is located.
A corporation in a metaphysical sense is a resident of the place where its
principal office is located as stated in the articles of incorporation and cannot be
allowed to file a personal action in a place other than that place.33
Sy v. Tyson Enterprises, Inc.,34 held that the residence of the President
for purposes of venue and service of summons is not the residence of the
corporation because a corporation has a personality separate and distinct from
that of its officers and stockholders.
For purposes of venue in intra-corporate suits, under Section 1, Rule 1 of
the Interim Rules of Procedure for Intra-corporate Controversies, when the
articles of incorporation indicate that the principal place of business is “Metro
Manila,” as allowed under Section 51 of the Corporation Code, then the action
must be filed in the city or municipality where the head office is actually located.
31
Ibid.
32
19 SCRA 379 (1967).
33
Young Auto Supply Co v. Court of Appeals, 223 SCRA 670, 42 SCAD 673 (1993).
34
119 SCRA 367 (1982).
14
In one case35, the Supreme Court noted that the rationale of all rules for
service of process on corporation is that service must be made on a
representative so integrated with the corporation sued as to make it a priori
supposable that he will realize his responsibilities and know what he should do
with any legal papers served on him. It then held that service of summons upon
the assistant general manager has served the purpose of the law.
CORPORATE TERM
Section 11 of the Corporation Code provides that a corporation shall exist
for a period not exceeding fifty (50) years from the date of incorporation unless
sooner dissolved or unless said period is extended.
The corporate term, as originally stated in the articles of incorporation,
may be extended for period not exceeding fifty (50) years in any single instance
by an amendment in the articles of incorporation, provided that no extension can
be made earlier than five (5) years prior to the original or subsequent expiry date
unless there are justifiable reasons for an earlier extension.36
The corporation may virtually have a perpetual lifespan renewable every
fifty years. The limit of a fifty-year term emphasizes the contractual nature of the
corporation: people would be discourage to invest if it lasted forever;
management would theoretically be more honest—a renewal of the corporate
term would be a vote of confidence by the stockholders or members.
Benguet Consolidated Mining Co. v. Pineda,37 discussed the importance
of the corporate term as it is co-terminous with its possession of an independent
legal personality, distinct from that of its component members: "The State and
its officers also have an obvious interest in the term of life of associations, since
the conferment of juridical capacity upon them during such period is a privilege
that is derived from statute. . . And the State is naturally interest that this
privilege be enjoyed only under the conditions and not beyond the period that it
sees fit to grant; and, particularly, that it be not abused in fraud and to the
detriment of other parties; and for this reason it has been ruled that „the
limitation (of corporate existence) to a definite period is an exercise of control in
the interest of the public.‟"38
35
Villa Rey Transit, Inc. v. Far East Motor Corp., 81 SCRA 298 (1978).
36
Sec. 11, Corporation Code.
37
98 Phil. 711 (1956).
38
Ibid, at p. 719, citing Smith v. Eastwood Wire Manufacturing Co., 43 Atl. 568.
15
stated in the articles of incorporation for the period of the time mentioned
therein, unless said period is extended or the corporation is sooner dissolved in
accordance with law.
39
Government of the Philippine Islands v. El Hogar Filipino, 50 Phil. 399, 460-461 (1929).
40
Navarro, Two Points of Reform of Philippine Corporation Law, 35 PHIL. L. J. 598. "Not
much light is shed by writers and court decisions on the policy of the doctrine as stated in the
beginning. Historically, if credence be given to Kyd, the spectacle of one corporation being inside
another would be nothing new." (at p. 682).
16
The same author posited that the power to hold stock in other
corporations was not conferred or implied under the old practice. The holding
company was impossible. It was against this background that courts also held
that corporations could not themselves be incorporators. And although
corporations are now generally empowered by general laws to own stocks in
other corporations, we still carry to this day a relic of the past. The principle we
are discussing, thus, draws support exclusively from the "fiction" theory of
corporate personality.42 The same author further said:
41
Ibid, at p. 683.
42
Ibid, at p. 684.
43
Ibid.
44
SEC Opinion, 23 May 1967, SEC FOLIO 1960-1976, at p. 284; Also, SEC Opinion, 14
November 1978.
45
SEC Opinion, 23 May 1967, SEC FOLIO 1960-1976, at p. 284.
46
SEC Opinion, 29 June 1976, SEC FOLIO 1960-1976, at p. 936.
17
47
SEC Opinion, 11 October 1971, SEC FOLIO 1960-1976, at p. 495.
48
SEC Opinion, 7 January 1974, VIII SEC QUARTERLY BULLETIN 21 ( No. I, Jan. 1974).
18
49
Guevarra, The Right of Incorporation Under Philippine Incorporation Law, 33 PHIL. L.J.
349 (1958).
19
50
Sec. 137, Corporation Code.
51
Guevarra, The Right of Incorporation under the Philippine Incorporation Law, 33 PHIL.
L.J. 349,350 (1958), quoting from SEC Order, dated 2 January 1958.
52
16 Wall., U.S. 390, 21 L. Ed. 361 (1873).
53
Guevarra, The Right of Incorporation Under the Philippine Incorporation Law, 33 PHIL.
L.J. 349, 357 (1958).
20
If no par value shares will be issued by the corporation, such fact must be
stated in the articles, and the consideration of their issuance cannot be less than
the issued value, which in turn cannot be less than five pesos for each.
The consideration for which no-par value shares may be issued is
referred to as its "issued value," may be fixed in any of three ways:
54
Sec. 62, Corporation Code.
55
Ibid.
56
Ibid.
57
Sec. 6, Corporation Code.
58
Sec. 16, Corporation Code.
59
Ibid.
21
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CORPORATION LAW\CORPMAN.DIR\07-29-2002
CHAPTER 7
BY-LAWS
——
1
89 SCRA 336 (1979).
being essential to enable the corporation to accomplish the
purpose of its creation.2
2
Ibid, at p. 365, citing McKee & Company v. First National Bank of San Diego, 265 F.Supp.
1 (1967), citing Olincy v. Merle Norman Cosmetics, Inc., 200 Cal. App. 20, 260, 19 Cal. Reptr.
387 (1962); and FLETCHER, CYCLOPEDIA CORPORATIONS.
3
Rural Bank of Salinas v. Court of Appeals, 210 SCRA 510 (1992), quoting from THOMSON
ON CORPORATIONS, Sec. 137.
4
47 Phil. 583 (1925).
The Court declared void the by-law provision which granted to the
stockholders a right of first refusal over shares sought to be disposed by other
stockholders. In voting down the by-law provision, the Court relied upon the
provision of then Section 35 of the Corporation Law that provided that "shares of
stock so issued are personal property and may be transferred by delivery of the
certificate indorsed by the owners or his attorney in fact or other person legally
authorized to make the transfer." Under the doctrine that a corporation can adopt
by-law provisions only insofar as their are not inconsistent with any existing law,
the right of first refusal was deemed void. In supporting this contention, the Court
relied upon American rulings that "The power to enact by-laws restraining the
sale and transfer of stock must be found in the governing statute or the charter."
A careful review of the Court's reasoning in Fleischer shows an intent to
put by-laws in their proper hierarchical place, i.e., that it is not the function of by-
laws to take away or abridge the substantial rights of stockholders. However, the
same reasoning recognized that the same may be done either pursuant to a
statutory provision or in the articles of incorporation. This doctrine has remained
consistent with the provisions of Section 6 of the Corporation Code that requires
that any privilege or restriction pertaining to shares of stock should be found in
the articles of incorporation.
In addition, Fleischer seems to support the opinion that by-law provisions
are essentially intramural covenants and do not bind a dealing member of the
public, who had no knowledge of their provisions, thus:
5
Ibid, at p. 592.
6
193 SCRA 717 (1991).
7
Ibid, at p. 729, citing 8 FLETCHER CYC. CORP., Perm. Ed., pp. 750 - 751.
Appeals,8 holds that by-laws may be necessary for the “government” of the
corporation by they nevertheless are subordinate to the articles of incorporation,
as well as to the Corporation Code and related statutes. It acknowledged that
there are in fact cases where by-laws are unnecessary to corporate existence or
to the valid exercise of corporate powers. Thus —
8
276 SCRA 681, 85 SCAD 420 (1997).
9
Government of the Philippine Islands v. El Hogar Filipino, 50 Phil. 399 (1927).
10
26 SCRA 242, 248 (1968).
the corporation to issue new certificates of stock in lieu of those which were
physically outside of Philippine jurisdiction.
By way of illustration, in Government of Philippine Islands. v. El Hogar
Filipino,11 the by-laws provided that the board of directors of the association, by
the vote of an absolute majority of its members, is empowered to cancel shares
and to return to the owner thereof the balance of resulting from the liquidation
thereof whenever, by the reason of their conduct, or for any other motive, the
continuation as members of the owner of such share is not desirable." The Court
held that the by-law provision was a patent nullity, since "it is in direct conflict with
the latter part of Section 187 of the Corporation Law, which expressly declares
that the board of directors shall not have the power to force the surrender and
withdrawal of unmatured stock except in case of liquidation of the corporation or
forfeiture of the stock for delinquency."
In another case,12 a provision sought to be included in the by-laws
granting to a stockholder a permanent representation in the board of directors of
the corporation was held to be contrary to the provisions of the Corporation Code
requiring all members of the board to be elected by the stockholders or
members. The Court held that even when the members of the association may
have formally adopted the provision, their action would be of no avail because no
provision of the by-laws can be adopted if it is contrary to law.13
Reiterating the Fleischer ruling, in Thomson v. Court of Appeals,14 the
Court held that the authority granted to a corporation to regulate the transfer of its
stock does not empower the corporation to restrict the right of a stockholder to
transfer his shares, but merely authorizes the adoption of regulations as to the
formalities and procedure to be followed in effecting transfer.
11
50 Phil. 399 (1927).
12
Grace Christian High School v. Court of Appeals, 281 SCRA 133, 88 SCAD 281 (1997).
13
Ibid.
14
298 SCRA 280, 100 SCAD 415 (1998).
The validity or reasonableness of a by-law provision is a question of law,
and in such case the issue to be resolved would be whether a by-law provision
conflicts with a provision of law, or with the charter of the corporation; or is in the
legal sense unreasonable and therefore unlawful.15
This rule is subject to the limitation that "where the reasonableness of a
by-law is a mere matter of judgment, and one upon which reasonable minds
must necessarily differ, a court would not be warranted in substituting its
judgment instead of the judgment of those who are authorized to make by-laws
and who have exercised their authority."16
It should be noted that early on, the Supreme Court held that the
circumstance that one of the provisions contained in the by-laws of a corporation
is invalid as conflicting with the express provision of law is not a misdemeanor on
the part of the corporation for which the corporation can be penalized by the
forfeiture of its charter; the proper remedy is to render such offending provision
invalid and of no force and effect.17
15
Gokongwei v. Securities and Exchange Commission, 89 SCRA 336, 361-362 (1979).
16
Ibid, at pp. 361-362, citing People ex rel. Wildi v. Ittner, 165 Ill. App. 360, 367 (1911).
17
Government of the Philippine Islands v. El Hogar Filipino, 50 Phil. 399 (1927).
18
276 SCRA 681, 88 SCAD 420 (1997).
19
Sec. 46, Corporation Code.
The by-laws shall be signed by the stockholders or members voting for
them and shall be kept in the principal office of the corporation, subject to the
inspection of the stockholders or members during office hours. A copy thereof,
duly certified to by a majority of the directors or trustees and countersigned by
the secretary of the corporation, shall be filed with the SEC which shall be
attached to the original articles of incorporation.20
In all cases, by-laws shall be effective only upon the issuance of the SEC
of a certification that the by-laws are not inconsistent with the Corporation
Code.21
The SEC shall not accept for filing the by-laws or any amendment thereto
of any bank, banking institution, building and loan association, trust company,
insurance company, public utility, educational institution, or other special
corporations governed by special laws, unless accompanied by a certificate of
the appropriate government agency to the effect that such by-laws or
amendments are in accordance with law. 22
The failure to adopt and file the by-laws do not automatically operate to
dissolve a corporation, but is considered a ground by which the SEC may seek
the corporation's dissolution.23 Under Section 6(l)(5) of Pres. Decree 902-A, the
SEC may suspend or revoke, after proper notice and hearing, the franchise or
certificate of registration of a corporation for its failure to file by-laws within the
period required by law.
20
Ibid.
21
Ibid.
22
Ibid.
23
Chung Ka Bio v. Intermediate Appellate Court, 163 SCRA 534 (1988).
24
Sec. 14, Rep. Act 8791.
(b) Time and manner of calling and conducting regular and
special meetings of the stockholders or members;25
(c) Required quorum in meetings of stockholders and the
manner of voting;
(d) Form for proxies of stockholders and members and manner
of voting;
(e) Qualifications, duties and compensation of
directors/trustees, officers, and employees;
(f) Time for holding annual election of directors or trustees,
mode and manner of giving notice thereto;
(g) Manner of election or appointment and the term of office of
all officers except directors or trustees;
(h) Penalties for violation of by-laws;
(i) Manner of issuing stock certificate; and
(j) Such other matters necessary for the proper means of
corporate business and affairs.
Although any and all the foregoing matters go into internal matters of the
corporation and rightly belong to the by-laws, the express provision of Section 7
of the Corporation Code implies, that if any of the above-enumerated matters are
also governed by the articles of incorporation, then the latter's provision shall
prevail.
25
Under Sec. 51 of the Corporation Code, the place for meeting of stockholders or
members of a corporation can only be in the city of municipality where the principal office of the
corporation is located and if practicable in the principal office of the corporation. However, Metro
Manila is to be considered a city or municipality. Any provision in the by-laws changing such
place shall be illegal.
26
Sec. 24, Corporation Code.
27
Sec. 25. ibid.
28
Sec. 30. ibid.
(e) Date of the annual meeting or provisions of special meetings
of the stockholders or members of the corporation;30
(f) Quorum on meetings of stockholders or members of the
corporation;31
(g) Providing for the presiding officer at meetings of the directors
or trustees, as well as of the stockholders or members;32
(h) Procedure for issuance of certificates of shares of stock;33
(i) Providing for interest on unpaid subscriptions;34
(j) Entries to be made in the stock and transfer book;35 and
(k) Providing for meetings of the members in a non-stock
corporation outside of the principal office of the
corporation.36
29
Sec. 35. ibid.
30
Secs. 50 and 53. ibid.
31
Sec. 52. ibid.
32
Sec. 54. ibid.
33
Sec. 63. ibid.
34
Sec. 66. ibid.
35
Sec. 74. ibid.
36
Sec. 93. ibid.
37
Sec. 24. ibid.
38
Sec. 25. ibid.
39
Sec. 89. ibid.
40
Sec. 90. ibid.
41
Sec. 91. ibid.
42
Sec. 92. ibid.
(g) Manner of distribution of assets in non-stock corporations
upon dissolution;43 and
(h) Providing for staggered board in educational institutions;44
43
Sec. 94. ibid.
44
Sec. 108. ibid.
45
Sec. 98. ibid.
46
193 SCRA 717 (1991).
47
Ibid, at p. 729, citing BALLANTINE, p. 130.
48
Sec. 6, Corporation Code.
49
Sec. 7, ibid.
50
Sec. 8, ibid.
51
Secs. 14, 15, 36(11) and 45, ibid.
52
Secs. 11, 14 and 37, ibid.
(g) Corporate name;54 and
(h) Denial of pre-emptive rights;55
AMENDMENTS TO BY-LAWS
Under Section 48 of the Corporation Code, the board of directors or
trustees, by a majority vote thereof, and the owners of at least a majority of the
outstanding capital stock, or at least a majority of the members of a non-stock
corporation, at a regular or special meeting duly called for the purpose, may
amend or repeal any by-laws or adopt new by-laws.
The owner of two-thirds (2/3) of the outstanding capital stock, or two-thirds
(2/3) of the members in a non-stock corporation, may delegate to the board of
directors of trustees the power to amend or repeal any by-laws or adopt new by-
laws; provided, that any power delegated to the board of directors or trustees to
amend or repeal any by-laws or adopt new by-laws shall be considered revoked
when ever stockholders owning or representing a majority of the outstanding
capital stock or a majority of the members in non-stock corporation, shall so vote
at a regular or special meeting.56
Whenever any amendment or new by-laws are adopted, such amendment
or new by-laws shall be attached to the original by-laws in the office of the
corporation, and a copy thereof, duly certified under oath by the corporate
secretary and a majority of directors and trustees, shall be filed with the SEC the
same to be attached to the original articles of incorporation and original by-laws.
The amended or new by-laws shall only be effective upon the issuance by
the SEC of a certification that the same are not inconsistent with this Code.
The Supreme Court has held that the amendment of a by-law provision to
undermine the right to security of tenure of a regular employee of the corporation
cannot be allowed. In Salafranca v. Philamlife (Pamplona) Village Homeowners
Association, Inc.,57 it held:
53
Secs. 13 and 14, ibid..
54
Secs. 14 and 18, ibid..
55
Sec. 39, ibid..
56
Sec. 48, Corporation Code.
57
300 SCRA 469, 479 (1998).
amending its by-laws and providing that his/her position shall
cease to exist upon the occurrence of a specified event.
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CORP. MANUSCRIPT\07-BY-LAWS\07-29-2002
58
Tayag v. Benguet Consolidated, Inc., 26 SCRA 242, 252 (1968).
CHAPTER 8
——
1
See more in-depth discussions of the ultra vires doctrine in Chapter 5, Corporate Contract
Law.
EFFECTS OF UNDERLYING CONTRACTUAL THEORY
ON EXERCISE OF CORPORATE POWERS
The primary rule under Section 23 of the Corporation Code is that "unless
otherwise provided in" the Corporation Code, all corporate powers shall be
exercised, and all corporate business shall be conducted, by the board of
directors of the corporation. The source of power of the board of directors is
therefore primary, and is not a delegated power from the stockholders or
members of the corporation.
Nevertheless, there are specified instances in the Corporation Code,
where the particular exercise of power of the corporation by the board, in order to
be binding and effective, requires the consent or ratification of the stockholders
or members, and on the part of the State. When the consent of all members of
the corporate relationships, i.e., the corporation acting through its board, the
stockholders or members, and the State, is required to be obtained in order to
validate or give legal effect to a corporate power, that shows that in each of those
specified instances, the underlying contractual relationship is being amended or
altered, and therefore, the approval or consent of all the parties concerned must
be obtained.
The principle of corporate power being primarily vested in the board of a
corporation is therefore circumscribed by the greater doctrine of the underlying
corporate contractual relationship between and among the members of a
particular corporate family, in line with the principle in Contract Law, that a party
to a contract cannot relieve himself from the contractual terms and conditions,
much less amend or alter them, without the consent or approval of the other
party or parties.
In the case of the group of stockholders or members, as constituting a
"party" to the contractual corporate relationship, there is a need to determine how
their consent or dissent on a particular amendment or alteration of the tenets of
the relationship, is deemed to be expressed, since they constitute of several
individuals. As a “party-group”, their consent or dissent is recognized either by
their majority vote or qualified two-thirds (2/3) vote, as the case may be, and their
decisions generally affect even those who did not vote for, or voted against, the
wishes of the majority. However, even between and among the stockholders or
members, although for efficiency of running of corporate affairs the "rule of the
majority" has been adopted, the Code still recognizes in certain instances that
one who does not agree with the decision of the majority and whose contractual
expectations has either been frustrated or altered by the decision of the majority,
should be given the right not to have to stay within confines of the corporate
contractual relationship and is granted an option to withdraw from such
relationship, by the exercise of appraisal right.
2
Gokongwei v. Securities and Exchange Commission, 89 SCRA 337 (1979).
There are other express powers granted to corporations in other sections
of the Corporation Code. In addition to the express powers granted under the
Code, a corporation's other express powers are those provided for in its articles
of incorporation, as recognized under Section 45 of the Code.
The sources of express powers of a corporation are therefore those
provided for by law and those enumerated in its charter.
The Supreme Court has held that even in the exercise of express powers
of the corporation, in the absence of an authority from the board of directors, no
person, not even the officers of the corporation, can validly bind the corporation.
In one case, the Court has ruled that in the absence of any board resolution
authorizing the filing of a suit for the corporation, then any suit filed on behalf of
the corporation should be dismissed; the power of the corporation to sue and be
sued in any court is lodged with the board of directors that exercises its corporate
powers.3 The SEC has opined that investments of a corporation in another
corporation in the form of shares of stock constitute part of the assets or property
of the investor corporation, and cannot be legally disposed of by mere
endorsement of the President, since the such shares fall within disposition of
properties being part of the management powers of the board of directors. 4
It has also been held that as a rule, a corporation exercises its powers,
including the power to enter into contracts, through its board of directors; and that
while a corporation may appoint agents to enter into a contract in its behalf, the
agent should not exceed his authority.5
2. Incidental Powers
Incidental powers of the corporation, in addition to its express powers, are
recognized also under Section 2 of the Corporation Code which defines a
corporation as having "the powers, attributes and properties expressly authorized
by law or incident to its existence."
Powers incident to corporate existence are those that attach to a
corporation at the moment of its creation without regard to its express powers or
particular primary purpose, and may be said to be inherent in it as a legal entity
or a legal organization. These powers include the power to sue and be sued, to
grant and receive, in the corporate name; the power to purchase, hold, and
convey real and personal property for such purposes as are within the objects of
its creation; the power to have a corporate seal; the power to adopt and amend
by-laws for its government; and the power, in the proper cases, to disenfranchise
or remove members.
Powers that go into the very nature and extent of a corporation's juridical
entity cannot be presumed to be incidental or inherent powers. The juridical entity
3
Premium Marble Resources v. Court of Appeals, 264 SCRA 11, 76 SCAD 9 (1996); Bitong
v. Court of Appeals, 292 SCRA 503 (1998).
4
SEC Opinion, dated 21 August 1995, XXX SEC QUARTERLY BULLETIN 12 (No. 1, June
1996).
5
Assets Privatization Trust v. Court of Appeals, 300 SCRA 579, 101 SCAD 1028 (1998).
of a corporation is State-granted and cannot be altered or amended without State
authority. For example, the right of succession is not inherent or incidental power
of a corporation and does not exist by the fact that a corporation is granted a
juridical entity. The argument is that when the State grants to an aggregation of
individuals a separate juridical entity, such grant is specific and does not extend
to others not originally part of the group without a further grant by the State of the
power of succession. This is best demonstrated in the case of the partnership,
where, although a separate juridical entity is granted by law into the venture, no
power of succession is presumed to exist when a member of the group dies,
resigns or withdraws from the venture. In any event the power of succession is
expressly granted to corporations under Section 36 of the Corporation Code.
Another example would be the power to merge or consolidate with another
corporate entity. Such power cannot be implied to exist outside of State-grant
merely from the fact that a corporation has been granted juridical entity.
Corporations cannot, without State authorization, vary the composition of those
to whom it grants a juridical entities by merger or consolidation.
The test uses the rather stringent terms "direct and immediate" only with
reference to the business of the corporation; whereas, it uses the rather liberal
terms of "fairly incident" and "reasonably necessary" with reference to powers of
the corporation.
When the business of a corporation is used as the reference point, much
latitude is given to the corporation to enter into various contracts as long as they
have a logical relation to the pursuit of such business. In one early case, 10 the
Court upheld a purpose clause in the articles of incorporation which allowed the
corporation to engage in what were rather broadly worded activity as "mercantile
purposes." The Court construed that as meaning to "engage in such incidental
business as may be necessary and advisable to give effect to, and aid in, the
successful operation and conduct of the principal business."11
On the other hand, when the purpose clause of a corporation's articles of
incorporation has unwittingly used limiting words, such as describing its business
as "transportation by water," the Court will hold the corporation to such limited
8
5 SCRA 36 (1962).
9
Ibid, at p. 42 quoting 6 FLETCHER CYC. CORP., Rev. Ed. 1950, pp 266-268. Emphasis
supplied.
10
Uy Siuliong v. Director of Commerce and Industry, 40 Phil. 541 (1919).
11
Ibid, at p. 544.
business and will refuse to construe the same to allow the corporation to engage
in the land transportation business.12
As the Montelibano test showed, the attitude of courts towards corporate
acts and contracts which are not per se illegal or prohibited, is quite liberal. That
is because of two public policies, one in the realm of Contract Law, the other in
the realm of Corporate Law. The policies involving the ultra vires doctrine are
thoroughly discussed in Chapter 5 on Corporate Contract Law.
2. Nature of Power
12
Luneta Motor Company v. A.D. Santos, Inc., 5 SCRA 809 (1962).
13
Sec. 37, Corporation Code.
14
Ibid.
The power to extend corporate life is not a inherent power of a
corporation, since the corporate term is not only a matter that constitutes an
integral clause of the articles of incorporation, but also the State in granting
juridical personality to a corporation is presumed to have granted only for the
period of time provided in the corporation's charter.
On the other hand, the power to shorten corporate life, although an item
that would cover an amendment of the articles of incorporation, is for practical
purposes, an inherent right on the part of the corporation, since the decision to
shorten the business life of a business endeavor should really be addressed to
the business decision of the business venturers. Although the State would have
to approve formally the shortening of the original corporate term of a corporation,
for all practical purposes, the State really compels the underlying enterprise to go
on when the co-venturers have decided to cease operations. This goes into the
aspect of dissolution, as in fact Section 120 of the Corporation Code now
expressly recognizes shortening of corporate life as a means of dissolving the
corporation.
15
Sec. 38, Corporation Code.
(b) The amount of the increase or diminution of the capital
stock;
(c) If an increase of the capital stock, the amount of capital stock
or number of shares of no-par stock thereof actually
subscribed, the names, nationalities and residences of the
persons subscribing, the amount of capital stock or number
of shares of no-par stock subscribed by each, and the
amount paid by each on his subscription in cash or property,
or the amount of capital stock or number of shares of no-par
stock allotted to each stockholder if such increase is for the
purpose of making effective stock dividend therefor
authorized;
(d) The actual indebtedness of the corporation on the day of the
meeting;
(e) The amount of stock represented at the meeting; and
(f) The vote authorizing the increase or diminution of the capital
stock, or the incurring, creating or increase of any bonded
indebtedness.16
Any increase or decrease in the capital stock shall require prior approval
of the SEC. The SEC shall not accept for filing any certificate of increase of
capital stock unless accompanied by the sworn statement of the treasurer of the
corporation showing that at least twenty-five percent (25%) of such increased
capital stock has been subscribed and that least twenty-five percent (25%) of the
amount subscribed has been paid either in actual cash to the corporation or that
there has been transferred to the corporation property the valuation of which is
equal to twenty-five percent (25%) of the subscription.17
More importantly, the section expressly provides that no decrease of the
capital stock shall be approved by the SEC, if its effect shall prejudice the rights
of the corporate creditors.18
From and after approval by the SEC and the issuance its certificate of
filing, the capital stock shall stand increased or decreased as the certificate of
filing may declare.19
1. Nature of Power
The power to increase or decrease capital stock is not an inherent power
of the corporation, not only because it touches upon an item expressly required
to be provided for in the articles of incorporation, but also the capital stock of a
corporation is governed by common law doctrines, such as the trust fund
16
Ibid.
17
Ibid.
18
Ibid.
19
Ibid.
doctrine, and pre-emptive rights. Therefore, in increasing or decreasing the
capital stock of the corporation, the corporation must not only comply with the
provisions of Section 38, but also with the provisions of Section 16 of the Code
governing the amendment of the articles of incorporation.
The formal procedures provided for in Section 38 clearly show that an
increase or decrease of the capital stock amends the underlying contractual
relationships between and among the members of the corporate family; which is
the reason for requiring the contractual parties to give their consent before the
exercise of such power can be validly implemented.
21
Sec. 1, Rules Requiring Definite Dates for the Exercise of Pre-Emptive or Other Rights or
For the Issuance of Stock Dividends (1973).
22
XXII SEC QUARTERLY BULLETIN 92-96 (No. 1, March 1988).
23
SEC Opinion, 29 April 1987, XXI SEC QUARTERLY BULLETIN 21-22 (No. 3, Sept. 1987).
See also SEC Opinion, 6 April 1990, XXIV SEC QUARTERLY BULLETIN 28-29 (No. 3, Sept. 1990).
24
Ibid.
25
Sec. 38, Corporation Code.
26
Ibid.
Any incurring, creating or increasing of bonded indebtedness shall require
prior approval of the SEC. The same requirements for registration with the SEC
for the increase or decrease of capital stock practically applies to the exercise by
the corporation of the power to incur, create or increase bonded indebtedness.
The SEC is expressly granted authority to determine the sufficiency of the terms
thereof.
4. Nature of Power
The power to incur or create liabilities is an inherent power on the part of
business corporations, since it is presumed that they would need to incur or
create liabilities as part of the normal operations of the business and the pursuit
of the purpose of the corporation. Such power is also part of the express powers
granted to all corporations organized under the Corporation Code, under Section
36 thereof.
Ordinarily, the incurring, creating or increasing of indebtedness really does
not go into or amend the corporate contractual relationship between and among
the members of the corporate family. However, when it comes to bonded
indebtedness, Section 38 imposes the same procedural requisites as the
increase or decrease of capital stock, since they create special burdens on the
corporation, such as the need to provide for a sinking fund to answer for the
maturity value of the bonds and the creation of first liens of important assets of
the corporation. Usually bonded indebtedness involve very large amounts and
the burdens created on the operations of the corporation usually covers a long
period of time.
The rationale for the rather strict requirements under the Code for the
incurring, creating or increasing of bonded indebtedness is to ensure that not
only the board of directors alone can bind the corporation to such burdensome
affairs, but that the qualified concurrence of the stockholders or members should
be obtained.
Note also that no appraisal right is granted to dissenting stockholders
when the corporation either validly incurs, creates or increases bonded
indebtedness since, the granting of such appraisal right under such
circumstances would drain the corporation of financial resources contrary to the
purpose for which the power is exercise to raise funds for corporate affairs. Also,
the incurring, creation or increasing of bonded indebtedness does not really go
into the original intent or corporate relationship of the stockholders or members
with the corporation. Even when such indebtedness is not bonded under the
principles of the trust fund doctrine, corporate creditors have priority over the
assets of the corporation; therefore, adding the feature of being a bonded
indebtedness did not really take anything from the position of the stockholders or
members that they would have had if the indebtedness were not a bonded
indebtedness.
1. Nature of Power
The exercise of the power to sell or dispose of all or substantially all of the
assets of the corporation is deem to undermine the contractual relationship of
two members of the corporate relationship, namely, the corporation acting
through its board on one hand, and the group of stockholders, on the other hand.
The exercise of such power does not really affect the relationship of the
corporation with the State, since it not only goes into the exercise of the business
judgment of the board of what best to do with the affairs of the corporation, but
more so since a corporation in such instance does not really lose its juridical
entity.
In other words, the exercise of such a power really affects the business
enterprise level of corporate set-up, an area much left by the State to the
27
Sec. 40, Corporation Code.
judgment of the managers, and does not in any way affect or alter the juridical
entity granted by the State. Consequently, nowhere is the consent of the State
required or referred to under Section 40 when the corporation sells or disposes of
all or substantially all of its assets.
28
247 SCRA 183, 192, 63 SCAD 494, 503 (1995).
Section 40 likewise provides for a formula where the ratificatory vote of
stockholders or members is required in the sale, lease, mortgage, pledge or
disposition of "substantially all" of the property or assets by the corporation: A
sale or other disposition shall be deemed to cover substantially all the corporate
property and assets if thereby the corporation would be rendered incapable of:
29
In one opinion, the SEC held that the disposition by the Forbes Park Association, Inc. of
its water system to MWSS, did not require the ratificatory vote of its members "on the assumption
that the water system constitutes merely a part of the assets of Forbes Park Association, Inc.,
such that the assignment thereof in favor of MWSS for such other property or consideration as
the board of directors may deem expedient will not render the Association incapable of continuing
the business or accomplishing the purpose for which it was incorporated." XXI SEC QUARTERLY
BULLETIN 6-7 (No. 1, March 1987).
30
Act No. 3952, as amended by Rep. Act No. 111.
31
For a more substantive discussions on the applicability of the Bulk Sales Law, see
Chapter 16, VILLANUEVA, LAW ON SALES, Rex Book Store, (1998 ed.).
pledge or other disposition of property and assets, subject to the rights of third
parties under any contract relating thereto, without further action or approval by
the stockholders or members.
Therefore, the entering into the sale, disposition or encumbrance of all or
substantially all of the assets of the corporation should be treated as being within
the governing doctrine of ultra vires contracts of the third type (i.e., those entered
into by unauthorized officers or representatives of the corporation) and should be
construed and disposed under the doctrine prevailing on such ultra vires
contracts.
Peña v. Court of Appeals,32 seems to indicate that the sale of the only asset
of the corporation made by the board without the appropriate stockholders’s
approval would render the contract void. Subsequently, in Islamic Directorate of
the Philippines v. Court of Appeals,33 the Supreme Court confirmed that the sale
by the board of trustees of the only property of the corporation without
compliance with the provisions of Section 40 of the Corporation Code requiring
the ratification of members representing at least two-thirds (2/3) of the
membership, would make the sale null and void.
8. Appraisal Right
Any dissenting stockholder may exercise his appraisal right in case of sale
of all or substantially all of the corporate assets or property. Unlike in the case of
shortening of corporate life which actually triggers a dissolution of the corporation
and return of the residual value of the corporation, if any, to the stockholders, the
sale or disposition of all or substantially all of the assets of the corporation does
not necessarily lead to dissolution. The exercise therefore of appraisal right
should be accorded to dissenting stockholders in such instance, otherwise, they
continue to be locked into a venture which no longer pursues, or is able to
pursue, the original purpose or objective for which dissenting investors made
their investments.
The appraisal right is accorded to dissenting stockholders as a matter of
equity and fairness since they should be allowed to plough their investments into
ventures they feel they could get a better return rather than with a corporation
that is no longer capable of pursuing the business.
32
193 SCRA 717, 730 (1991).
33
272 SCRA 454, 82 SCAD 618 (1997).
1. When Power May Be Exercised
By way of illustration, the section enumerates the following as legitimate
corporation purposes for a stock corporation purchasing its own shares:
34
Salonga, The Purchase by a Corporation of Its Own Shares, 27 PHIL. L.J. 686-687 (1952).
35
52 Phil. 953 (1929).
36
Salonga, The Purchase by a Corporation of Its Own Shares, 27 PHIL. L.J. 686-687 (1952).
the use of such power a method for secret withdrawal and distribution of the
current assets of the corporation which may be needed in the business, or a
means of speculating with corporate funds.
He also observed that treasury stock may also be availed of to perpetuate
control of the enterprise without the expensive requisite of a majority of voting
stock. Since treasury stock cannot be voted, by using corporate funds to
purchase the majority shares and retire it from the voting arena, what was before
a minority in the controlling group can be converted into a majority and their
control may thereby be continued indefinitely.37
A detailed discussion of the power as it applies under the trust fund
doctrine is found in Chapter 12, Capital Structures of Corporations.
4. Redeemable Shares
Under Section 8 of the Corporation Code, in the case of redeemable
shares, the same may be acquired or redeemed by the corporation even without
existence of unrestricted retained earnings. The redemption of redeemable
shares in the absence of unrestricted retained earnings does not prejudice
corporate creditors.
Redeemable shares can only be provided when they are so classified and
they are indicated as such in the articles of incorporation. When the corporate
creditors decide to extend credit to the corporation, they would or should know
for a fact that the corporation has issued redeemable shares.
1. Rationale of Rule
37
Salonga, ibid at pp. 686, 689.
38
Sec. 43, Corporation Code.
When a corporation, through its board, invests funds in another
corporation or business other than pursuant to its primary purpose, even if it
seeks to pursue a secondary purpose provided for in the articles of incorporation,
the ratification of the stockholder or members under Section 42 is still required. In
other words, whenever the corporation seeks to engage into a secondary
purpose allowed under its articles of incorporation, although intra vires, it must
seek the approval of the stockholders or members of the corporation.
The law therefore presumes rather strongly that when stockholders invest,
or members join, a corporation, it is with the primary expectation that the
corporation, through its board, will only pursue the primary purpose indicated in
the articles of incorporation, and if the board feels that it is propitious to pursue a
secondary purpose, then it would do so only if the stockholders or members have
had a chance to evaluate and decide upon such diversion of corporate funds
from the primary business of the corporation.
39
XXIX SEC QUARTERLY BULLETIN 2 (No. 2, June 1995).
Therefore, any corporation, whatever its primary purpose, has a choice of
placing such fund either in a savings or time deposit account, or in money market
placements, or treasury bills, or even in shares of stocks of other corporations
which are traded in the stock exchange. The exercise of such business judgment
on the part of the board in consistent with the primary purpose, since it is
expected even from the stockholders to believe, that it is within the ordinary
business discretion of the board to place the corporation's investible fund in the
form of investment that would yield the best possible return to the corporation,
and would not require the ratification of the stockholder or members each time.
For example, a fishing company, through its board, should be allowed to place
say its investible fund of P100,000.00 in PLDT or San Miguel commercial papers
or even perhaps their shares, if they offer the best return at that point in time for
the corporation, without need of obtaining stockholders' approval; much less
should such investments trigger any appraisal right on the part of dissenting
stockholders.
40
Sec. 43, Corporation Code.
41
26 SCRA 540 (1968).
42
Even under the old Corporation Law, the SEC had issued the Rules Governing the
Distribution of Excess Profits of Corporations (1973), which provides that "All corporations which
have surplus profits in excess of necessary requirements for capital expansion and reserves shall
declare and distribute the excess profits as dividends to stockholders.” (Sec. 1)
43
SEC RULES GOVERNING THE DISTRIBUTION OF EXCESS PROFITS OF CORPORATIONS provides
that the amounts appropriated for such purpose shall be segregated from the free surplus; and
that upon completion of the expansion program, the reserve established shall be declared as
stock dividends.
(b) 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
(c) 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.44
2. Report to SEC
Any declaration of dividends, whether cash or stock, shall be reported to
the SEC within fifteen (15) days from the date of declaration. For corporations
whose shares or securities are listed in the stock exchange or registered and
licensed under the Revised Securities Act (now the Securities Regulation Code),
the report shall be filed with the SEC before or simultaneously with the release or
publication of the notice of declaration of dividends to stockholders.46
3. Restrictions on Banks
Under Section 57 of the General Banking Law of 2000,47 no bank or quasi-
bank shall declare dividends greater than its accumulated net profits then on
hand deducting therefrom its losses and bad debts. Neither shall the bank or
quasi-bank declare dividends, if at the time of declaration:
51
247 SCRA 183, 192 (1995).
52
See the rationalization that had to be resorted to before the Corporation Code in Pirovano
v. De la Rama Steamship, Inc., 96 Phil. 335 (1954).
law of its creation. . . A corporation can act only through its duly authorized
officers and agents and is not bound by the acts of anyone else, while in a
partnership each member binds the firm when acting within the scope of the
partnership."53
The doctrine is grounded on the theory that the stockholders of a
corporation are entitled, in the absence of any notice to the contrary in the
articles of incorporation, to assume that their directors will conduct the corporate
business without sharing that duty and responsibility with others.54
1. Jurisprudential Rule
Tuason v. Bolaños,55 recognized at that time in Philippine jurisdiction the
doctrine in Anglo-American jurisprudence that "a corporation has no power to
enter into a partnership."56 Nevertheless, Tuason recognized that a corporation
may validly enter into a joint venture agreement, "where the nature of that
venture is in line with the business authorized by its charter."57
A joint venture is essentially a partnership arrangement, although of a
special type, since it pertains to a particular project or undertaking.58 Although
Tuason does not elaborate on why a corporation may become a co-venturer or
partner in a joint venture arrangement, it would seem that the policy behind the
prohibition on why a corporation cannot be made a partner do not apply in a joint
venture arrangement. Being for a particular project or undertaking, when the
board of directors of a corporation evaluate the risks and responsibilities
involved, they can more or less exercise their own business judgment is
determining the extent by which the corporation would be involved in the project
and the likely liabilities to be incurred. Unlike in an ordinarily partnership
arrangement which may expose the corporation to any and various liabilities and
risks which cannot be evaluated and anticipated by the board, the situation
therefore in a joint venture arrangement, allows the board to fully bind the
corporation to matters essentially within the boards business appreciation and
anticipation.
It is clear therefore that what makes a project or undertaking a "joint
venture" to authorize a corporation to be a co-venturer therein is not the name or
nomenclature given to the undertaking, but the very nature and essence of the
undertaking that limits it to a particular project which allows the board of directors
of the participating corporation to properly evaluate all the consequences and
likely liabilities to which the corporation would be held liable for.
53
FLETCHER CYC. CORPORATIONS (Perm. Ed.) 2520.
54
BAUTISTA, TREATISE ON PHILIPPINE PARTNERSHIP LAW (1978 Ed.), at p. 9.
55
95 Phil. 106 (1954).
56
Ibid, at p. 109.
57
Ibid, quoting from Wyoming-Indiana Oil Gas Co. v. Weston, 80 A.L.R., 1043, citing
FLETCHER CYC. OF CORP., Sec. 1082.
58
BAUTISTA, supra, at p. 50. In Torres v. Court of Appeals, 278 SCRA 793, 86 SCAD 812
(1997), the Supreme Court held unequivocally that a joint venture agreement for the development
and sale of a subdivision project would constitute a partnership pursuant to the elements thereof
under Article 1767 of the Civil Code that defines when a partnership exists.
2. SEC Rules
The SEC, in a number of opinions, has recognized the general rule that a
corporation cannot enter into a contract of partnership with an individual or
another corporation on the premise that it would be bound by the acts of the
persons who are not its duly appointed and authorized agents and officers, which
is inconsistent with the policy of the law that the corporation shall manage its own
affairs separately and exclusively.59
However, the SEC has on special occasions allowed exceptions to the
general rule when the following conditions are complied with:
The second condition set by the SEC would have the effect of allowing a
corporation to enter as a general partner in general partnership, which would still
have contravened the doctrine of making the corporation unlimitedly liable for the
acts of the other partners who are not its authorized officers or agents. This
interpretation of the second condition was confirmed by the SEC in 1994, to
mean that a partnership of corporations should be organized as a "general
partnership" wherein all the partners are "general partners so that all corporate
partners shall take part in the management and thus be jointly and severally
liable with the other partners."62
The rationale given by the SEC for the second condition was that if the
corporation is allowed to be a limited partner only, there is no assurance that the
corporate partner shall participate in management of the partnership which may
create a situation wherein the corporation may not be bound by the acts of the
partnership in the event that, as a limited partner, the corporation chooses not to
participate in the management.63
59
SEC Opinion, 22 December 1966, SEC FOLIO 1960-1976, at p. 278; citing 13 Am. Jr.
Sec. 823 (1938); 6 FLETCHER CYC. CORP., Perm. Ed. Rev. Repl. 1950, at p. 2520.
60
SEC Opinion, 29 February 1980.
61
Ibid.
62
SEC Opinion, dated 23 February 1994, XXVII SEC QUARTERLY BULLETIN 18 (No. 3, Sept.
1994).
63
Ibid.
However, in 1995, the SEC reversed such interpretation and practically
dropped the second requirement, when it admitted the following reasoning for
allowing a corporation to invest in a limited partnership, thus:
In that opinion, the SEC conceded on the points raised by confirming that
"inasmuch as there is no existing Philippine law that expressly prohibits a
corporation from becoming a limited partner in a partnership, the Commission is
inclined to adopt your view on the matter,"65 provided that the power to enter into
a partnership is provided for in the corporation's charter.
The SEC went on to say: "We agree with your statements that a
reconsideration of the present policy of the Commission on the matter is timely in
order to permit the Philippine commercial environment to maintain its pace in
terms of legal infrastructure with similar developments in the international arena
with a view to encouraging and facilitating greater domestic and foreign
investments in Philippine business enterprise."66
it must in its application with the SEC state the reasons or causes for said action
in the resolution of the stockholders or board of directors approving the same,
which resolution must be signed and attested by the president and secretary of
the corporation.
64
SEC Opinion, 17 August 1995, XXX SEC QUARTERLY BULLETIN 8-9 (No. 1, June 1996).
65
Ibid.
66
Ibid.
67
November, 1971.
The Rules also provide that when a corporation invests funds in any other
corporation or business or for any purpose other than the main purpose for which
the corporation is organized pursuant, it shall file with the SEC a copy of the
resolution adopted by the affirmative vote of the stockholders holding at least
two-thirds (2/3) of the voting power authorizing the board of directors to invest in
another corporation or business.
—oOo—
DIRECTORS, TRUSTEES,
AND OFFICERS
——
This chapter covers the discussions on the power and authority, duties
and functions, and the obligations of directors, trustees, officers and other
representatives of corporations. Discussions on the binding effect of acts and
contracts entered into in behalf of corporations by unauthorized officers or
representatives are covered in the third type of ultra vires acts found in Chapter 5
on Corporate Contract Law.
In another case,2 the Court was emphatic in saying that in the absence of
an authority from the board of directors, no person, not even the officers of the
corporation, can validly bind the corporation. It held that in the absence of any
board resolution authorizing the filing of a suit for the corporation, then any suit
filed on behalf of the corporation should be dismissed, since the power of the
corporation to sue and be sued in any court is lodged with the board of directors
that exercises its corporate powers.3
1
ABS-CBN Broadcasting Corporation v. Court of Appeals, 301 SCRA 572 (1999).
2
Premium Marble Resources v. Court of Appeals, 264 SCRA 11, 76 SCAD 9 (1996).
3
Ibid.
Corporate elections furnish one of the primary remedies for internal
dissentions, as the majority must rule so long as it keeps within the powers
conferred by the corporate charter. The common law principles on duties of
obedience, diligence and loyalty, which have been incorporated as specific
provisions in the Corporation Code, provide for the other corporate features to
prevent abuse on the part of the corporate managers.
4
Prime White Cement Corp. v. Intermediate Appellate Court, 220 SCRA 103, 110 (1993).
5
Ibid, quoting from Gokongwei v. Securities and Exchange Commission, 89 SCRA 336
(1979).
6
Sec. 23, Corporation Code.
7
38 Phil. 634 (1918).
the stockholders may have all the profits but shall turn over the complete
management of the enterprise to their representatives and agents, called
directors. Accordingly there is little for the stockholders to do beyond electing
directors, making by-laws, and exercising certain other special powers defined by
law. In conformity with this idea it is settled that contracts between a corporation
and third persons must be made by the directors and not by the stockholders.
The corporation, in such matters, is represented by the former and not by the
latter.8 This conclusion is entirely accordant with the provisions of section 28 of
our Corporation Law [now Section 23 of the Corporation Code]."9
11
5 SCRA 36 (1962).
12
Ibid, at p. 42.
13
Ibid, quoting from 2 FLETCHER ON CORP., at p. 390.
14
90 SCRA 40 (1979).
15
Guevarra, The Social Function of Private Corporations, 34 PHIL. L.J. 464, 466 (1959).
benefit of strangers; he conducts it solely for his own
private gain and never to those with whom he deals
only the duty of carrying out such bargains as he may
make with them. . .
“A business corporation is organized and carried
on primarily for the benefit of the stockholders, and that
the directors cannot conduct the affairs of a corporation
for the merely incidental benefit of shareholders and for
the primary purpose of benefiting others."
16
2 FLETCHER ON CORP., at p. 390.
17
281 SCRA 232, 88 SCAD 589 (1997).
In Philippine Stock Exchange, the Supreme Court upheld the management
prerogatives of the Board of Directors of the Philippine Stock Exchange as
against the control of the SEC, through the reiteration of the business judgment
rule, thus:
2. Coverage of Rule
From the foregoing, it can be seen that the business judgment rule
actually has two (2) applications, namely:
(a) When the director willfully and knowingly vote for patently
unlawful acts of the corporation;18
(b) When he is guilty of gross negligence or bad faith in directing
the affairs of the corporation;19 and
(c) When he acquires any personal or pecuniary interest in
conflict with his duty as such directors.20
18
Sec. 31, Corporation Code.
19
Ibid.
20
Secs. 31 and 34, Corporation Code.
Philippine Stock Exchange defined the meaning and coverage of “bad
faith” on the part of the board of directors of a corporation as to warrant an
exemption from the business judgment rule, thus: “bad faith does not simply
connote bad judgment or negligence, but „imports a dishonest purpose or some
moral obliquity and conscious doing of wrong. It means a breach of a known duty
through some motive or interest of ill will, partaking of the nature of fraud.‟”
21
The SEC has opined that directors and trustees can only exercise their power as a board,
not individually. They shall meet and counsel each other and any determination affecting the
corporation shall be arrived at only after consultation at a meeting of the board attended by at
least a quorum. SEC Opinion, 10 March 1972, SEC FOLIO 1960-1976, at p. 526.
22
247 SCRA 183, 63 SCAD 494 (1995).
23
38 Phil. 634 (1918).
nevertheless held that a treasurer has no independent authority to bind the
corporation by signing its name to the documents; and that under then Section
28 of the Corporation Law (now Section 23 of the Corporation Code) all
corporate powers shall be exercised and all corporate business conducted by the
board of directors. The by-laws of the corporation even provided that the power
to make contracts shall be vested in the board of directors. Although the by-laws
provided that the president shall have the power, and it shall be his duty, to sign
contracts, the Court nevertheless construed this provision to refer to the formality
of reducing to proper form the contracts which are authorized by the board and is
not intended to confer an independent power to make contracts binding on the
corporation.
Nonetheless, the Court held that the fact that the power to make corporate
contracts is vested in the board of directors does not signify that a formal vote of
the board must always be taken before contractual liability can be fixed upon a
corporation; for the board can create liability, like an individual, by other means
than by a formal expression of its will.24 The Court held that when the corporation
acts through its officers, certain things are presumed, and by virtue of business
and commercial customs, the officer is presumed to have power, and that he acts
with the board's authority. "The authority of the subordinate agent of a
corporation often depends upon the course of dealings which the company or its
directors have sanctioned. It may be established sometimes without reference to
official record of the proceedings of the board, by proof of the usage which the
company had permitted to grow up in the business, and of the acquiescence of
the board charged with the duty of supervising and controlling the company's
business."25
The implication is clear from Ramirez in reference to outsiders dealing
with the corporation, that not all corporate actions need formal board approval.
The board need not come together and act as a body to perform a corporate act.
In many cases no act is required of the members of the board in order to bind the
corporation; the fact that they know of a particular corporate transaction or
contract, and they stayed silent about it, or worse, they allowed the corporation to
gain by the transaction or contract, would already bind the corporation.
Ramirez also discussed the principal in procedural law as it pertained to
corporations, that when an actionable document is used as the basis in a suit
against the corporation, it becomes incumbent upon the corporation, if it desires
to question the authority of the purported agent who signed the document, to
deny the due execution of said contract under oath. The failure of a corporation
to deny the genuineness and due execution of an actionable document would be
an admission not only of the signature of the corporate officer therein, but also of
his authority to make the contract in behalf of the corporation, and of the power of
24
Ibid, at pp. 648-649.
25
Ibid, at pp. 649-650 quoting from Robert Gair Co. v. Columbia Rice Packing Co., 124 La.,
194.
the corporation to enter into such contract.26 Ramirez rationale for the doctrine
was as follows:
EXECUTIVE COMMITTEE
Under Section 35 of the Corporation Code, the by-laws of a corporation
may create an executive committee, composed of not less than three (3)
members of the board, to be appointed by the board. The executive committee
may act, by majority vote of all its members, on such specific matters within the
competence of the board, as may be delegated to it in the by-laws or on a
majority vote of the board, except with respect to:
The executive committee can do any act because the power of the board
to delegate certain specific acts is unlimited. However, by the language of
Section 35 of the Corporation Code, ultimate power must remain with the board
of directors, and it would be against corporate principle to empower the executive
committee with authority that the board itself cannot countermand.
30
20 SCRA 526 (1967).
31
Ibid, at p. 533.
Nothing in the Corporation Code prevents the creation of an executive
committee by board resolution, even in the absence of an enabling clause in the
by-laws. The creation of such executive committee would be in line with full
authority of the board to appoint agents and delegates. But taking the cue from
Section 35 of the Code, such executive committee, its composition and powers,
would be subject to the same limitations provided for by the Code, since the
board by mere resolution cannot create an executive committee that will have
greater powers than one sanctioned by law.
The SEC, however, in an opinion held that by virtue of Section 35 of the
Corporation Code, an executive committee can only be created by virtue of a
provision in the by-laws and that in the absence of such by-law provision, the
board of directors cannot simply create or appoint an executive committee to
perform some of its functions.32
32
SEC Opinion, dated 27 September 1993, XXVIII SEC QUARTERLY BULLETIN 12 (No. 1,
March 1994).
33
Sec. 92, Corporation Code.
34
205 SCRA 752 (1992).
trustee is required. . . No disqualification arises by virtue of the phrase `in his own
right' provided under the old Corporation Code (sic)."35
Lee therefore concluded that with the omission of the phrase "in his own
right" under the present Corporation Code, the election of trustees and other
persons who in fact are not the beneficial owners of the shares registered in their
names on the books of the corporation becomes formally legalized and therefore,
is a clear indication that in order to be eligible as a director, what is material is the
legal title to, not the beneficial ownership of, the stock as appearing on the books
of the corporation.36
Lee held that the disposition by a director of all of the shares in the
corporation, through a voting trust agreement, had the legal effect of him ceasing
to be a director of the corporation and creating a vacancy in the board, since as a
consequence of the execution of the voting trust agreement, such director
ceased to own at least one share standing in his name in the books of the
corporation.
35
Ibid, at p. 761.
36
Ibid, citing 2 FLETCHER, CYCLOPEDIA OF THE LAW OF PRIVATE CORPORATIONS, sec. 300, p.
92 (1969), citing People v. Lihme, 269 Ill. 351, 109 N.E. 1051.
37
Sec. 26, Corporation Code.
38
See SEC Opinion, 2 June 1986, XX SEC QUARTERLY BULLETIN (Nos. 1 & 2, March &
June, 1986); SEC Opinion, 16 July 1985, SEC ANNUAL OPINIONS 1985, at p. 125; SEC Opinion,
26 June 1969, SEC FOLIO 1960-1976, at p. 381.
The board of directors of a bank shall have at least two (2) “independent
directors,” which shall be persons other than an officer or employee of the bank,
its subsidiaries or affiliates or related interests.39
Listed and public companies and those with registered securities shall
have at least two (2) independent directors or they shall constitute at least twenty
percent (20%) of such board, whichever is lesser, which shall mean a person
other than an officer or employee of the corporation, its parent or subsidiaries, or
any other individual having a relationship with the corporation, which would
interfere with the exercise of independent judgment in carrying out the
responsibilities of a director.40
2. Disqualifications
A directors must not have been convicted of an offense punishable by
imprisonment of exceeding six (6) years or has not committed any violation of
Corporation Code within five (5) years prior to his election.41
Under Section 19 of the General Banking Law of 2000, except for rural
banks, no appointive or elective public official, whether full-time or part-time shall
at the same time serve as officer of any private bank, save in cases where such
service is incident to financial assistance provided by the government or a
government-owned or controlled corporation to the bank or unless otherwise
provided under existing laws.
39
Sec. 15, The General Banking Law of 2000 (RA 8791).
40
Sec. 38, The Securities Regulation Code (RA 8799).
41
Sec. 27, Corporation Code.
42
89 SCRA 336 (1979).
43
Ibid.
ELECTION OF BOARD OF DIRECTORS
Under Section 24 of the Corporation Code, at all elections of directors or
trustees, there must be present, either in person or by representatives authorized
to act by written proxy, the owners of the majority of the outstanding capital
stock, or if there be no capital stock, a majority of the members entitled to vote.
The election must be by ballot if requested by any voting stockholder
entitled to vote shall have the right to vote in person or by proxy the number of
shares of stock standing, at the time fixed in the by-laws, in his own name on the
stock books of the corporation, or where the by-laws are silent, at the time of the
election. No delinquent stock shall be voted.
Any meeting of the stockholders or members called for an election may
adjourn from day to day or from time to time but not sine die or indefinitely if, for
any reason, no election is held, or if there are no present or represented by
proxy, at the meeting, the owners of a majority of the outstanding capital stock, or
if there be no capital stock, a majority of the members entitled to vote.
CUMULATIVE VOTING
Section 24 of the Corporation Code expressly provides for cumulative
voting in the election of the directors of stock corporations. The provisions for
cumulative voting are mandatory.
Under that section, at all elections of directors, a stockholder may vote
such number of shares for as many persons as there are directors to be elected
or he may cumulate said shares and give one candidate as many votes as the
number of directors to be elected multiplied by the number of his shares shall
equal, or he may distribute them on the same principle among as many
candidates as he shall see fit, provided that the total number of votes cast by him
shall not exceed the number of shares owned by him as shown in the books of
the corporation multiplied by the whole numbers of directors to be elected.
Cumulative voting therefore is a voting procedure wherein a stockholder is
allowed to concentrate his votes and give one candidate as many votes as the
number of directors to be elected multiplied by the number of his shares shall
equal. The policy of cumulative voting is to allow minority stockholders the
capacity to be able to elect representatives to the board of directors.44 No
exception is provided for in Section 24 so that the articles may not provide for
restriction or suppression of the principle of cumulative voting in stock
corporations.
In contrast to cumulative voting, which allows for an opportunity for
minority representation in the board, straight voting allows a simple majority of
the shareholders to elect the entire board of directors leaving the minority
44
Glazer, Glazer, & Grofman, Cumulative Voting In Corporate Elections: Introducing
Strategy into the Equation, 35 S. CAROLINA L. REV. 295 (1934).
shareholders unrepresented. Under straight voting, each shareholder simply
votes the number of shares he owns for each director nominated.
Cumulative voting is reckoned to be equitable since it allows stockholders
the opportunity for representation on the board of directors in proportion to their
holdings. Such minority representation is believed not to interfere with the
principle of majority rule since the number of directors elected by each group will
vary with its proportion of ownership. It is also believed that minority interests
have a voice on the board since stockholders and management often have
different goals. Finally, it is believed that since corporate and securities laws
generally create a balance of power in favor of insiders and controlling interest,
some counterveilling power in the hands of outside minority interest is
desirable.45
On the other hand, the system of cumulative voting has been criticized by
other sectors because in tends to partisan representation in the board, which is
inconsistent with the notion that a director properly represents all interest groups
in the corporate setting. It is said to breed disharmony in the board which
dissipates the energies of management and leads to an atmosphere of
uncertainty at the top level. Often, cumulative voting is used by persons who are
motivated by narrow, selfish interests.46
1. Classic Formula
The formula that has become popular in many corporate literature
applying the cumulative voting system is credited to Cole,47 which is as follows:
S x D1
S1 = ______ + 1
D+1
Where,
S1 = Number of shares owned by some shareholders or group
of shareholders [Bloc I]
S = Total number of shares voting at the meeting
D1 = Number of directors Bloc I desires to elect
D = Total number of directors to be elected at the meeting
45
Williams, Cumulative Voting, 33 HARV. BUS. REV., May-June 1955, at 108, 111.
46
Ibid. See also Glazer, Glazer, & Geofman, Cumulative Voting in Corporate Elections:
Introducing Strategy into the Equation, supra.
47
Cole, Legal and Mathematical Aspects of Cumulative Voting, 2 S.C.L.Q. 225 (1954).
For example, Mr. Cruz owns 66 shares of stock of ABC Corp. If there are
5 directors to be chosen, Mr. Cruz is entitled to 330 votes obtained by multiplying
66 by 5. Mr. Cruz is at liberty to distribute any or all of the votes he is entitled to
cast among any of the candidates.
In a situation where ABC Corporation has 100 outstanding capital stock,
using the Cole Formula, Mr. Cruz would be assured to electing 4 members
thereof computed as follows:
500 x D1
330 = ________ + 1
5+1
500 x D1
330 - 1 = ________
6
6 x (330-1) = 500 x D1
1,974
________ = D1
500
D1 = 2.9 or 4
48
Ibid at 230.
49
Glazer, Glazer and Geofman, Cumulative Voting in Corporate Elections: Introducing
Strategy into the Equation, 35 S. CAROLINA L. REV. 295 (1984).
50
Ibid, at p. 299.
51
Glasser, Game Theory and Cumulative Voting, 5 Mgmt. Sci. 151 (1959).
D x S1 D x S11
Integer _______ is greater than Integer __________
D1 D + 1 - D1
1 2 3 4 5
1/2
Bloc I 330 165 110 82 66
2/3 1/2
Bloc II 170 85 56 42 34
52
Glazer, Glazer and Geofman, supra, at p. 302. "The discrepancy should remind corporate
management and its counsel that the absolute number of shares to be issued to each
shareholders group as well as the relative proportional interests of each such group are important
in planning a corporation's shareholders structure." at p. 303.
53
B. Grofman, A Review of Macro-Election Systems, German Political Yearbook (R.
Wildenmann ed. 1975); Balinski and Young, Stability, Coalitions, and Schisms in Proportional
Representation Systems, 72 Am. Pl. Sci. Rev. 848 (1978).
54
Ibid, at p. 305.
55
Ibid.
56
Ibid, at pp. 305-306.
57
Ibid, at p. 305.
The article goes on to say: "The smallest circle entry in the top row
appears in column 3, whi ch means that Row 1 can guarantee itself three seats.
The smallest circled entry in the bottom row appears in column 2, indicating that
Bloc II can guarantee itself two seats. Each bloc should always nominate at least
the number of candidates it is certain in electing. . . In this case, however, Bloc I
can safely nominate more than three candidates. That is, the fourth entry in the
top row, 82½ , is larger than the first uncircled entry in the bottom row, 56-2/3.
Hence, Bloc I can safely nominate four candidates. But should Bloc I nominate
more than four candidates? Yes. The fifth entry in the top row, 66, is greater
than the first uncircled number in the bottom row. Therefore, Bloc I should
nominate five candidates, the same result obtained earlier through a somewhat
different line of reasoning. If Bloc I divides its votes for two candidates, Bloc I will
still elect three candidates since Bloc II will exhaust its votes on its two
candidates. If Bloc II divides its votes among three candidates instead of two,
Bloc I will elect all five of its candidates since Bloc I can give 66 votes to each of
its five while Bloc II can only give 56-2/3 votes to its three candidates. Bloc I
cannot lose and may achieve a significant gain. . . Generally, a bloc can safely
vote for a directors if the at entry in that bloc's row in the table is greater than the
first uncircled entry in the competing bloc's row."58
In a three-cornered battle, the article gives the following illustrative table:59
1 2 3 4 5
2/3
Bloc I 200 100 66 50 40
The article compares the accuracy of the D'Hondt Remainder Table with
the Cole Formula, thus: "Consider the following election. There are three blocs, I,
II, and III. The blocs shareholdings are SI = 40, SII = 25, SIII = 25, so that S = 90
and D the number of directors to be elected) 5. According to Cole's formula, the
maximum number of seats Bloc I is certain of winning in two.
As long as Bloc II and III do not join forces to vote for the
same candidates, Bloc I can elect more candidates by dividing
its votes among three candidates, giving each one (5)(40)/3 =
662/3 votes. Since this number is less than 662/3 (the number
of votes cast for each of Bloc I's three candidates). Bloc I is as
58
Ibid.
59
Ibid, at p. 307.
assured of filing three seats, rather than two, contrary to the
outcome given by Cole's formula. . .
Once again the D'Hondt Reminders Table gives the
correct answer. Table 2 is generated by dividing the number of
votes which can be cast by Blocs I, II, and III (i.e. 200,125, and
125) by the integers 1 through D (i.e, 1 through 5). Again, the
five largest entries in the table are circled. This process
indicates that Bloc I is guaranteed of electing three directors if
each of the blocs votes for a different set of candidates.
Similarly, Blocs II and III are assured of electing one director
each.
As stated previously, the D'Hondt Reminders Table
indicates the number of directors a bloc is certain of electing
as well as the number of directors for whom it should vote.
The number in the fourth column of the top row, 50, is smaller
than the largest of the uncircled entries in the other rows,
621/2. Thus, Bloc I should not vote for four directors.
Similarly, the number in the fifth column of the top row, 40, is
less than the largest of the circled entries in the other rows,
125, so that Bloc 1 should not vote for five directors. Instead, it
should spread its votes evenly among three candidates, the
number it is certain of electing. Following the same procedure
for Bloc II, the first uncircled entry in the middle row, 621/2 is
not greater than the largest uncircled entry in the other rows,
621/2 Bloc II and III should vote therefore for one candidates.60
60
Ibid, at pp. 35-36.
61
Sec. 138, Corporation Code.
but may not cast more than one vote for one candidate. Candidates receiving the
highest number of votes shall be declared elected.
In non-stock corporations, the default rule in the election of trustees is
straight voting. Unlike the mandatory rule for cumulative voting for stock
corporations, in non-stock corporations, it is possible to provide for other types of
voting in either the articles of incorporation or the by-laws of the corporation.
VACANCY IN BOARD
Under Section 29 of the Corporation Code, any vacancy occurring in the
board of directors or trustees other than by removal by the stockholders or
members or by expiration of term, may be filled by the vote of at least a majority
of the remaining directors or trustees, if still constituting a quorum; otherwise,
said vacancies must be filled by the stockholders in a regular or special meeting
called for that purpose. A director or trustee so elected to fill a vacancy shall be
elected only for the unexpired term of his predecessor in office.
62
Grace Christian High School v. Court of Appeals, 281 SCRA 133, 88 SCAD 499 (1997).
Any position in the board to be filled by reason of an increase in the
number of directors or trustees shall be filled only by an election at a regular or at
a special meeting of stockholders or members duly called for the purpose, or in
the same meeting authorizing the increase of directors or trustees if so stated in
the notice of the meeting.63
Therefore, vacancies in the board other than by removal or expiration of
term may be filled by the vote of majority of remaining directors or trustees, if
there is quorum; if there is no quorum, it may be filled by stockholders or
members in a regular or special meeting called for that purpose.
Vacancy by reason of an increase in members of the board can be filled-
up only by election of the stockholders or members of the corporation.
63
Sec. 39, Corporation Code.
64
264 SCRA 11, 76 SCAD 9 (1996).
legally constituted to bind the corporation in bringing of any suit in behalf of the
corporation.
65
Sec. 23, Corporation Code.
66
The Corporation Code does not require the taking of an oath of office to qualify the
elected directors and officers. Election alone does not make the person elected, a director but
there must be an acceptance, either express or implied, although he is rebuttably presumed to
accept upon notification, or enters upon the duties of an office after his election or appointment.
SEC Opinion, 21 January 1986, XX SEC QUARTERLY BULLETIN (Nos. 1 & 2, March & June, 1986).
67
94 Phil. 81 (1953).
68
Sec. 54, Corporation Code.
69
Ibid.
70
Ibid.
71
Ibid.
In the election of officers, however, the vote of the majority of all the
members of the board is necessary.72
72
Ibid.
73
Sec. 26, Corporation Code; SEC Opinion, 22 May 1998, XXXII SEC QUARTERLY BULLETIN
13 (No. 1, June 1998).
74
Lopez v. Ericta, 45 SCRA 539 (1972).
75
See SEC Opinion, 7 February 1994,XXVIII SEC QUARTERLY BULLETIN 4 (No. 3, March
1994).
proper recording of the minutes thereof and the safekeeping of the electronic
recording mechanism as part of the records of the corporation.76
CORPORATE OFFICERS
1. Theory on the Power of Board to Delegate its
Authority to Corporate Officers
Although Section 23 of the Corporation Code provides that the power and
the responsibility to decide whether the corporation should enter into a contract
that will bind the corporation is lodged in the Board, nevertheless, just as a
natural person may authorize another to do certain acts for and on his behalf, the
81
278 SCRA 216, 86 SCAD 315 (1997).
82
Ibid, at 223, citing AGBAYANI, COMMENTARIES AND JURISPRUDENCE ON THE COMMERCIAL
LAWS OF THE PHILIPPINES, Vol. 3, 1988 ed., p. 259.
board of directors may validly delegate some of its functions and powers to
officers, committees or agents.83 The authority of such individuals to bind the
corporation is generally derived from law, corporate by-laws, and authorizations
from the board, either expressly or impliedly by habit, custom or acquiescence in
the general course of business.84
Consequently, the general principles of agency govern the relation
between the corporation and its officers or agents, subject to the articles of
incorporation, by-laws, or relevant provisions of law. The Supreme Court has
therefore held: “A corporate officer or agent may represent and bind the
corporation in transactions with third persons to the extent that the authority to do
so has been conferred upon him, and this includes powers which have been
intentionally conferred, and also such powers as, in the usual course of the
particular business, are incidental to, or may be implied from, the powers
intentionally conferred, powers added by custom and usage, as usually
pertaining to the particular officer or agent, and such apparent powers as the
corporation has caused persons dealing with the officer or agent to believe that it
has conferred.”85
83
People’s Aircargo and Warehousing Co., Inc. v. Court of Appeals, 297 SCRA 170, 182,
99 SCAD 482, 495 (1998).
84
Ibid.
85
San Juan Structural and Steel Fabricators, Inc. v. Court of Appeals, 296 SCRA 631, 645,
99 SCAD 281, 294 (1998); also BA Finance Corporation v. Court of Appeals, 211 SCRA 112
(1992).
3. Theory on Power of Board to Appointment/
Terminate Corporate Officers
Officers of the corporation are within the business judgment of the board
of directors to terminate in the absence of a specific period of employments
provided in their contracts or in the by-laws. It has been held by the Supreme
Court that “[a] corporate officer‟s dismissal is always a corporate act, or an intra-
corporate controversy, and the nature is not altered by the reason or wisdom with
which the Board of Directors may have in taking such action.86
In Mita Pardo de Tavera v. Philippine Tuberculosis Society, Inc.,87 it was
held that since the letter of appointment as Executive Secretary to the Board of
the officer did not contain a fixed term, the implication is that appointee held an
appointment at the pleasure of the appointing power, which in essence was
temporary in nature, and co-extensive with the desire of the board of directors.
When the board opted to replace the incumbent, technically there was no
removal but only an expiration of the term and in an expiration of term, there is
no need of prior notice, due hearing or sufficient grounds before the incumbent
can be separated from office.
The ruling in De Tavera case was founded on the fact that the disputed
position of Executive Secretary was also provided for in the Code of By-Laws of
the Philippine Tuberculosis Society, Inc.
86
Tabang v. NLRC, 266 SCRA 462, 78 SCAD 174 (1997); Fortune Cement Corporation v.
NLRC, 193 SCRA 258 (1991). Tabang also held: “An „office‟ is created by the charter of the
corporation and the officer is elected by the directors or stockholders (2 Fletcher Cyc. Corp. Ch.
II, Sec. 266). On the other hand, an “employee” usually occupies no office and generally is
employed not by action of the directors or stockholders but by the managing officer of the
corporation who also determines the compensation to be paid to such employee.”
87
112 SCRA 243 (1982).
The issue of who are corporate officers was essential in determining who
had proper jurisdiction in cases involving officers, whether it was the SEC under
Section 5 of Pres. Decree 902-A or the NLRC. Pursuant to Section 5.2 of the
Securities Regulation Code,88 the quasi-judicial jurisdiction of the SEC under
Section 5 of the Decree has been transferred to the Regional Trial Courts (RTC).
The issue therefore as to who are properly the officers of a corporation would still
be relevant as to determining whether it is the RTC or the NLRC which would
have proper jurisdiction over cases involving the appointment and termination of
corporate officers.
5. President
People’s Aircargo and Warehousing Co., Inc. v. Court of Appeals,90
discussed the nature of the position of the President and the powers vested in
him by reason of such position, thus:
88
Rep. Act No. 8799.
89
Sec. 92, Corporation Code.
90
297 SCRA 170, 99 SCAD 482 (1998).
corporation is slowly giving way to the realization that such
officer has certain limited powers in transactions of the usual
and ordinary business of the corporation. In the absence of a
charter or bylaw provision to the contrary, the president is
presumed to have the authority to act within the domain of the
general objectives of the corporation‟s business and within the
scope of his or her usual duties. Hence, it has been ruled in
other jurisdiction that the president of the corporation
possesses the power to enter into a contract for the
corporation, when the “conduct on the part of both the
president and the corporation [shows] that he had been in the
habit of acting in similar matters on behalf of the company and
that the company had authorized him so to act and had
recognized, approved and ratified his former and similar
actions. Furthermore, a party dealing with the president of a
corporation is entitled to assume that he has the authority to
enter, on behalf of the corporation, into contracts that are
within the scope of the powers of said corporation and that do
not violate any statute or rule on public policy.91
6. Corporate Secretary
Torres, Jr. v. Court of Appeals,92 had held that in the absence of
provisions to the contrary, the corporate secretary is the custodian of corporate
records—he keeps the stock and transfer book and makes proper and necessary
entries therein. It is the duty and obligation of the corporate secretary to register
valid transfers of stock in the books of the corporation; and in the event he
refuses to comply with such duty, the transferor-stockholder may rightfully bring
suit to compel performance.
When a Secretary‟s Certificate is regular on its face, it can be relied upon
by a third party who does not have to investigate the truths of the facts contained
in such certification; otherwise business transactions of corporations would
become tortuously slow and unnecessarily hampered.93
7. Corporate Treasurer
A corporate treasurer‟s function have generally been described as “to
receive and keeps funds of the corporation, and to disburse them in accordance
with the authority given him by the board or the properly authorized officers.”
Unless duly authorized, a treasurer, whose power are limited, cannot bind
the corporation in a sale of its assets. Selling is obviously foreign to a corporate
treasurer‟s function. When the corporation categorically denies ever having
authorized its treasurer to sell the subject parcel of land, the buyer had the
91
Ibid, at pp. 185-186.
92
278 SCRA 793, 86 SCAD 812 (1997).
93
Esguerra v. Court of Appeals, 267 SCRA 380, 78 SCAD 741 (1997).
burden of proving that the treasurer was in fact authorized to represent and bind
the allegedly selling corporation in the transaction. And failing to discharge such
burden, and failing to show any provision of the articles of incorporation, bylaws
or board resolution to prove that the treasurer possessed such power, the sale is
void and not binding on the alleged selling corporation.94
94
San Juan Structural and Steel Fabricators, Inc. v. Court of Appeals, 296 SCRA 631, 645,
99 SCAD 281, 295 (1998).
95
296 SCRA 7, 98 SCAD 665 (1998).
96
312 SCRA 65, 71-72 (1999).
a construction project manager;97 a corporation‟s assistant manager;98 ordinary
clerk of a corporation;99 private secretary of corporate executives;100 retained
counsel;101 officials who had charge or control of the operations of the
corporation, like the assistant general manager;102 or the corporation‟s Chief
Finance and Administrative Officer.103
In that case the Court held: "The impact of these provisions upon the
traditional fiduciary relationship between the directors and the stockholders of a
corporation is too obvious to escape notice by those who are called upon to
protect the interest of investors. The directors and officers of the company can do
anything, short of actual fraud, with the affairs of the corporation, even to benefit
themselves directly and other persons or entities in which they are interested,
and with immunity because of the advance condonation or relief from
responsibility by reason of such acts. This and the other provisions which
authorized the election of non-stockholders as directors, completely disassociate
the stockholders from the government and management of the business in which
they have invested."106
Prime White Cement Corp. v. Intermediate Appellate Court,107 also
recognized that the fiduciary obligations of the directors and trustees of a
corporation, as they are now set out in the Corporation Code, merely incorporate
well-settled principles in Corporate Law.108
It is clear therefore that the duties and obligations of directors, trustees
and officers of the corporation have their bases in common law, derived from the
nature and relationships created in the corporate setting and the fiduciary nature
of the positions held by such persons. Therefore, the attempt under the
Corporation Code to define in statutory form the nature of the duties and
obligations of directors, trustees and officers can only be construed as an attempt
to cover most of the such situations, but cannot be considered as to exclude
other forms of violations of such duties as to be outside of corporate sanction.
For example, the violation of the duty of loyalty found in Sections 33 and
34 of the Corporation Code where a conflict of interest is present either in direct
dealings of an officer with the corporation or in dealings between corporations
having interlocking directors. In a situation where there would still be conflict of
interests that may work injustice to a corporation by a director or trustee who is in
a conflict situation, but that the circumstances do not squarely fall within the
coverage of Sections 33 and 34 of the Corporation Code, nevertheless a cause
of action would still arise in favor of the corporation to annul such a contract
entered into its name.
105
Ibid, at pp. 942-943.
106
Ibid.
107
220 SCRA 103 (1993).
108
Ibid, at p. 112.
GENERAL RULE ON DUTIES AND LIABILITIES OF
DIRECTORS, TRUSTEES AND OFFICERS
The general rule is that members of the board and officers of a corporation
who purport to act for and in behalf of the corporation, keep within the lawful
scope of their authority in so acting, and act in good faith, do not become liable,
whether civilly or otherwise, for the consequences of their acts. Those acts, when
they are such a nature and are done under such circumstances, are properly
attributed to the corporation alone and no personal liability is incurred by such
officers and Board members.109
Even in a situation where a contract was entered into with the corporation
and it specified that it was signed in consideration of the President of the
corporation and that if the latter should cease to be the manager of the
corporation that the contract would terminate, did not make the President liable
personally under the contract since the Supreme Court considered it as
"elementary that a corporation has a personality separate and distinct from the
persons composing it," and nothing in the contract provided that the President
would be bound in his personal capacity.110
A corporate officer cannot be held personally liable for a corporate debt
simply because he had executed the contract for and in behalf of the corporation.
It held that when a corporate officer acts in behalf of a corporation pursuant to his
authority, is "a corporate act for which only the corporation should be made liable
for any obligations arising from them."111
The President and General Manager of a corporation who entered into
and signed a contract in his official capacity cannot be made liable thereunder in
his individual capacity in the absence of stipulation to that effect due to the
personality of the corporation being separate and distinct from the persons
composing it.112
The proper appreciation of the director's role and function would require
that although a director may have been voted into office by a block of
shareholders, it is the director's duty to vote according to his own independent
judgment and his own conscience as to what is in the best interests of the
corporation.113
DUTY OF OBEDIENCE
Since the Corporation Code still adheres to the ultra vires doctrine,114 then
the Board of Directors or Trustees of a corporation are bound to observe the duty
109
Benguet Electric Cooperative, Inc. v. NLRC, 209 SCRA 55, 63 (1992).
110
Banque Generale Belge v. Walter Bull & Co., Inc., 84 Phil. 164, 167 (1949).
111
Western Agro Industrial Corporation v. Court of Appeals, 188 SCRA 709 (1990).
112
Rustan Pulp & Paper Mills, Inc. v. IAC, 214 SCRA 665 (1992), citing Banque Generale
Belge v. Walter Bull and Co., 84 Phil. 164 (1949).
113
San Miguel Corp. v. Kahn, 176 SCRA 447, 463 (1989).
114
Sec. 45, Corporation Code.
of obedience, which means that they will direct the affairs of the corporation only
in accordance with the purposes for which it was organized. Section 26 of the
Corporation Code expressly provides that “directors or trustees and officers to be
elected shall perform the duties enjoined on them by law and by the by-laws of
the corporation.”
As one author has said: "Although the corporate powers of private
corporations organized under the Corporation Law are exercised and controlled
by a board of directors, yet these powers of the board are necessarily limited,
because all the limitations imposed by law on private corporation are necessarily
imposed also on the board of directors who act in behalf of the corporation. In
other words, what is ultra vires or beyond the power on the part of the
corporation must also be ultra vires or beyond the power on the part of its board
of directors."115
DUTY OF DILIGENCE
Under Section 31 of the Corporation Code, directors or trustees who
willfully and knowingly vote for or assent to patently unlawful acts of the
corporation or who are guilty of gross negligence or bad faith in directing the
affairs of the corporation, shall be liable jointly and severally for all damages
resulting therefrom suffered by the corporation, its stockholders or members and
other persons.
The liability of guilty directors shall be jointly and severally; the solidary
obligation is availabe not only to the corporation but also to stockholders and
others who might suffer from such wrongful act.
The liability is such that a director need to have voted for in order to be
liable, but mere assent to a wrongful act or contract would make him liable.
Therefore, when an unlawful act or contract is for decision of the board, it is not
enough that the director abstains from voting; i is important to cast a negative
vote and allow such to be placed of record in order to escape liability.
Benguet Electric Cooperative, Inc. v. NLRC,116 held that Section 31 of the
Corporation Code applies even to government-owned and -controlled
corporations, pursuant to the provisions of Section 4 of the Code that renders the
provisions of the Corporation Code applicable in a supplementary manner to all
corporations, including those with special or individual charters so long as those
provisions are not inconsistent with such charters.
Benguet Electric Cooperative also held "[t]he dismissal of an officer or
employee in bad faith, without lawful cause and without procedural due process,
is an act that is contract legem. It cannot be supposed that members of the
boards of directors derive any authority to violate the express mandates of law or
the clear legal rights of their officers and employees by simply purporting to act
115
Guevarra, The Social Function of Private Corporations, 34 PHIL. L.J. 464, 465 (1959).
116
Guevarra, The Social Function of Private Corporations, 34 PHIL. L.J. 464, 465 (1959).
for the corporation they control."117 In addition, it held that the corporation would
then have a right to be reimbursed from the board of directors for any amounts
that the corporation is adjudged to have to pay to a third party claimant by reason
of the unlawful decision of the board of directors. "Such right of reimbursement is
essential if the innocent members [of the corporation] are not to be penalized for
the acts of respondent Board members which were both done in bad faith and
ultra vires. The liability-generating acts here are the personal and individual acts
of respondents Board members, and are not properly attributed to [the
corporation] itself."118
When it comes to the acts and contracts of the board of directors and
officers of the corporation, Board of Liquidators v. Kalaw,119 defined the meaning
and coverage of "bad faith," thus:
Rightfully had it been said that bad faith does not simply
connote bad judgment or negligence; it imports a dishonest
purpose or some moral obliquity and conscious doing of
wrong; it means breach of a known duty thru some motive or
interest or ill will; it partakes of the nature of fraud. Applying
this precept to the given facts herein, we find that there was no
"dishonest purpose," or "some moral obliquity," or "conscious
doing of wrong," or "breach of a known duty," or "some motive
or interest or ill will:” that "partakes of the nature of fraud.”
Nor was it even intimated here that the NACOCO
directors acted for personal reasons, or to serve their own
private interests, or to pocket money at the expense of the
corporation. We have had occasion to affirm that bad faith
contemplates a "state of mind affirmatively operating with
future design or with some motive of self-interest or ill will or
for ulterior purpose,"120 . . ."Upon a close examination of the
reported cases although there are many dicta no easily
reconcilable, yet I have found no judgment or decree which
has held directors to account, except when they have
themselves been personally guilty of some fraud on the
corporation, or have known and connived at some fraud in
others, or where such fraud might have been prevented had
they given ordinary attention to their duties. . ."121 Plaintiff did
not even dare charge its defendant-directors with any of these
malevolent acts.122
117
Ibid, at p. 66.
118
Ibid.
119
20 SCRA 986, 1006-1007 (1967)
120
Citing Air France v. Carascoso, 18 SCRA 155 (1966).
121
Briggs v. Spaulding, 141 U.S. 132, 148-149, 35 L.Ed. 662, 669, quotes with approval
from Judge Sherwood in Sperings Appl., 71 Pa. 11.
122
Ibid.
The general rule however that mere ownership of majority of the shares of
stock in a corporation, or mere officership itself does not make one personally
liable:
Even under the old Corporation Law, which unlike the present Corporation
Code, did not have specific provisions governing the liabilities of directors,
trustees, or officers, nevertheless the duties of diligence and loyalty were clearly
recognized to exist.
An example of violation of the duty of diligence covering a conflict-of-
interests situation is found in Steinberg v. Velasco.124 In that case, the directors
of the corporation were held personally liable for causing the corporation to
purchase their own shares of stock and declaring dividends, which because of
the failure to take into consideration of worthless receivables, worked to the
detriment of the creditors. The Supreme Court held that the directors did not act
with diligence in taking the word of their chairman and not making an informed
123
Vazquez v. Borja, 74 Phil. 560, 566-568 (1944).
124
52 Phil. 953 (1929).
decision based on the facts then available to them and on not relying on other
documents available to them.
(a) While they both cover the same subject matter which is
business opportunity but they concern different personalities;
Section 34 is only applicable to directors and not to officers,
while Section 31, is applicable to directors, trustees and
officers;
(b) Section 34 allows a ratification of a transaction by a self-
dealing director by the vote of stockholders representing
two-thirds (2/3) of the outstanding capital stock; Section 31
does not cover ratification, and even if 99% of the
stockholders affirm the transactions, the remaining minority
shareholders can still oppose such a self-dealing transaction
and file a derivative suit for and in behalf of the corporation.
125
136 SCRA 365, 385 (1983).
(a) The presence of such director or trustee in the board
meeting in which the contract was approved was not
necessary to constitute a quorum for such meeting;
(b) The vote of such director or trustee was not necessary for
the approval of the contract;
(c) The contract is fair and reasonable under the circumstances;
and
(d) In the case of an officer, the contract with the officer has
been previously authorized by the board of directors.
Where any of the first two conditions set forth in the preceding paragraph
is absent, in the case of a contract with a director or trustee, such contract may
be ratified by the vote of the stockholders representing at least two-thirds (2/3) of
the outstanding capital stock, or of two-thirds (2/3) of the members, as the case
may be, in a meeting called for the purpose. However, in order that such
ratificatory vote would be valid, it is required that there be full disclosure of the
adverse interest of the directors or trustees involved is made.
In Mead v. McCullough,126 it was held that while a corporation remains
solvent, there is no no reason "why a director or officer, by the authority of a
majority of the stockholders or board of managers, may not deal with the
corporation, loan it money or buy property from it, in like manner as a stranger.
So long as a purely private corporation remains solvent, its directors are agents
or trustees for the stockholders. They owe no duties or obligations to others. But
the moment such a corporation becomes insolvent, its directors are trustees of all
the creditors, whether they are members of the corporation or not, and must
manage its property and assets with strict regard to their interest; and if they are
themselves creditors while the insolvent corporation is under their management,
they will not be permitted to secure to themselves by purchasing the corporate
property or otherwise any personal advantage over the other creditors.
Nevertheless, a director or officer may in good faith and for an adequate
consideration purchase from a majority of the directors or stockholders the
property even of an insolvent corporation, and a sale thus made to him is valid
and binding upon the minority."127
Mead held that where a director in a corporation accepts a position in
which his duties are incompatible with those as such director it is presumed that
he has abandoned his office as director of the corporation.
Prime White Cement Corp. v. Intermediate Appellate Court,128 recognizing
that the provisions of Section 31 of the Corporation Code on self-dealing merely
incorporated well-established principles in Corporate Law, applied the procedure
required therein for determining the validity of a contract entered into by the
corporation with its director.
126
21 Phil. 95 (1911).
127
Ibid, at pp. 113-114.
128
220 SCRA 103 (1993).
The facts in that case showed that a director entered into a Dealership
Agreement with the corporation, signed by its chairman and president, for the
corporation to supply 20,000 bags of white cement per month for five years at a
fixed price of P9.70 per bag. Subsequently, the Board refused to abide by the
contract unless new conditions are accepted providing for new price formula. The
dealing director sued for specific performance on the contract. The Court held
that although the general rule when it comes to President entering into a contract
for the corporation is that when the contract is in the ordinary course of business,
provided the same is reasonable under the circumstances, the contract binds the
corporation, nevertheless the rule does not apply when the contract is entered
into with a director or officer of the corporation itself. A director holds a position of
trust and as such, he owes a duty of loyalty to his corporation, and his contracts
with the corporation must always be at reasonable terms, otherwise the contract
is void or voidable at the option of the corporation.
The Court found that the terms of the Dealership Agreement were
unreasonable for the corporation. It held that the dealing director was a
businessman himself and must have known, or at least must be presumed to
know, that at that time, prices of commodities in general, and white cement in
particular, were not stable and were expected to rise. "At the time of the contract,
petitioner corporation had not even commenced the manufacture of white
cement, the reason why delivery was not to begin until 14 months later. . . no
provision was made in the `dealership agreement' to allow for an increase in
price mutually acceptable to the parties." It held that the unfairness in the
contract is also a basis which renders a contract entered into by the President,
without authority from the Board of Directors, void or voidable, although it may
have been in the ordinary course of business. Finally, it noted that there was no
showing that the stockholders had ratified the agreement or that they were fully
aware of its provisions.
129
This section originally appeared as part of the article Restatement of the Doctrine of
Piercing the Veil of Corporate Fiction, published in 37 ATENEO L. J. 19 (Number 2, June, 1993).
130
124 SCRA 638 (1983).
131
Ibid, at pp. 648-649.
132
Ibid, at p. 649.
133
184 SCRA 495 (1990).
134
Ibid, at p. 499.
135
Ibid, at p. 500.
136
12 SCRA 700 (1964).
137
Ibid, at p. 705.
138
181 SCRA 719 (1990).
contract by using the corporate entity theory. This is one instance when the veil
of corporate entity has to be pierced to avoid injustice and inequity." 139
Tramat Mercantile, Inc. v. Court of Appeals,140 holds that personal liability
of a corporate director, trustee or officer along (although not necessarily) with the
corporation may so validly attach, as a rule, only when:
In addition, jurisprudence has also held that the officer of the corporation
can be held solidarily liable with the corporation for simulated or fraudulent
contracts entered into in behalf of the corporation.142
National Power Corp. v. Court of Appeals,143 held that the finding of
solidarily liable among the corporation and its officers and members of the Board
of Directors would be patently baseless when the decision of the trial court
contains no such allegation, finding or conclusion regarding particular acts
committed by said officers and directors that show them to have individually
guilty of unmistakable malice, bad faith, or ill-motive in their personal dealings
with an entity which dealt with their corporation; and that in fact it was only in the
dispositive portion of the decision of the trial court that solidary liability as such
was first mentioned. It also ruled that when the corporate officers and directors
are sued merely as nominal parties in their official capacities as such, by that
reason alone they cannot be made personally liable for the judgment against the
corporation.
139
Ibid, at p. 729.
140
238 SCRA 14, 56 SCAD 450 (1994).
141
The listing was reiterated in Santos v. NLRC, 254 SCRA 673, 682, 69 SCAD 390, 398
(1996); Uichico v. NLRC, 273 SCRA 35, 83 SCAD 31 (1997).
142
Paradise Sauna v. Ng, 181 SCRA 719 (1990).
143
273 SCRA 419 (1997).
2. Different Strain in Labor Law
In the field of labor, however, liability of corporate officers for corporate
obligations to employees seems to have taken two different strains.
In A.C. Ransom Labor Union-CCLU v. NLRC,144 the Court in interpreting
the Labor Code held that since a corporate employer is an artificial person, it
must have an officer who can be presumed to be the employer, being the
"person acting in the interest of (the) employer" as provided in the Labor Code. 145
Therefore, A.C. Ransom held that "the responsible officer of the employer
corporation can be held personally, not to say even criminally, liable for non-
payment of backwages; and that in the absence of definite proof as to the identity
of an officer or officers of the corporation directly liable for failure to pay
backwages, the responsible officer is the president of the corporation jointly and
severally with other presidents of the same corporation."
In effect, A.C. Ransom would hold a corporate officer liable for corporate
obligations by the mere fact that he is the highest officer even when there is no
proof that he acted in the particular matter for the corporation.
Later, in Chua v. NLRC,146 the vice-president of the company was made
personally liable also for being the highest and most ranking official of the
corporation next to the President who was dismissed, for the latter's claim for
unpaid wages.
In Del Rosario v. NLRC,147 the Court (stating that the doctrine in A.C.
Ransom inapplicable without further explanation) refused to allow a writ of
execution against the properties of officers and stockholders for a judgment
rendered against the corporation which was later found without assets on the
ground that "[b]ut for the separate juridical personality of a corporation to be
disregarded, the wrongdoing must be clearly and convincingly established. It
cannot be presumed." In addition, it was held that "[t]he distinguishing marks of
fraud were therefore clearly apparent in A.C. Ransom. A new corporation was
created, owned by the same family, engaging in the same business and
operating in the same compound."
In short, Del Rosario re-affirmed the original doctrine before A.C. Ransom
pronouncement that in order for a corporate officer or stockholder to be held
liable for corporate debts it must clearly be shown that he had participated in the
fraudulent or unlawful act.
The principle was reinforced in Western Agro Industrial Corporation v.
Court of Appeals,148 which held that a corporate officer cannot be held personally
liable for a corporate debt simply because he had executed the contract for and
144
142 SCRA 269 (1986).
145
The decision interpreted the meaning of the word "employer" from Art. 212(c) of the
Labor Code, which provided: "(c) `Employer' includes any person acting in the interest of an
employer, directly or indirectly. . ." Ibid, at p. 273.
146
182 SCRA 353 (1990).
147
187 SCRA 777 (1990).
148
188 SCRA 709 (1990).
in behalf of the corporation. It held that when a corporate officer acts in behalf of
a corporation pursuant to his authority, is "a corporate act for which only the
corporation should be made liable for any obligations arising from them."149
Two months after Del Rosario, the Court in Maglutac v. NLRC,150 held a
corporate officer liable for the claims against the corporation, relying upon the
A.C. Ransom ruling but only with respect to the doctrine that the responsible
officer of a corporation who had a hand in illegally dismissing an employee
should be held personally liable for the corporate obligations arising from such
act.
Prior to A.C. Ransom, the ruling of the Supreme Court in Garcia v.
NLRC,151 is that personal liability of corporate officers to dismissed employees
depends on whether such officer acted with evident malice and bad faith, and
when no evidence is adduced to show any of these circumstances, even the
acting officer dismissing the employees cannot be held personally liable. This
ruling was reiterated recently in Seaborne Carriers Corporation v. NLRC.152
Recently in Santos v. NLRC,153 clarified that Article 289 of the Labor
Code154 cannot be applied to hold the President of the corporation liable
personally because the provisions refers only to the imposition of penalties under
the Code." It held that when the termination of an officer is due , collectively, to
the need to further mtigiation of losses, the onset of the rainy season, the
insurgency problem in the area and the lack of funds to further support the
mining operations of the corporation, then the provision of Article 289 do not
apply.
The Court held that that the A.C. Ransom and Chua cases, which involved
holding the President and Vice-President, respectively, liable personally in the
absence of clear identification of the officer directly responsble for failure to pay
backwages, applied only because in both cases involved family-owned
corporations and rightfully applied the doctrined of piercing the veil of corporation
fiction.155 The Court upheld the basic rule enunciated in Sunio that "It is basic that
a corporation is invested by law with a personality separate and distinct from
those of the persons composing it as well as from that of any other legal entity to
which it may be related. Mere ownership by a single stockholder or by another
corporation of all or nealry all of the capital stock of a corporation is not of itself
149
Ibid, at p. 718.
150
189 SCRA 767 (1990).
151
153 SCRA 639 (1987).
152
237 SCRA 343, 55 SCAD 842 (1994).
153
254 SCRA 673, 69 SCAD 390 (1996).
154
Art. 289 of the Labor Code reads: "ART. 289. Who are liable when committed by other
than natural person.--If the offense is committed by a corporation, trust, firm, partnership,
association or any other entity, the penalty shall be imposed upon the guilty officer or officers of
such corporation, trust, firm, partnership, association or entity."
155
254 SCRA 673, 683-684.
sufficient ground for isregarding the separate corporate personality," and that
"the Sunio doctrine still prevails."156
Reahs Corporation v. NLRC,157 reviewed the A.C. Ransom doctrine of
imposing solidarily liability on the highest officers of the corporation for judgment
on labor claims rendered against the corporation pursuant to Article 283 of the
Labor Code, and reviewed its application in subsequent cases of Maglutac,
Chua, Gudez and Pabalan. It reiterated the main doctrine of separate personality
of a corporation which should remain as the guiding rule in determining corporate
liability to its employees, and that at the very least, to justify solidary liability,
“there must be an allegation or showing that the officers of the corporation
deliberately or maliciously designed to evade the financial obligation of the
corporation to its employees,” or a showing that the officers indiscriminately
stopped its business to perpetuate an illegal act, as a vehicle for the evasion of
existing obligations, in circumvention of statutes, and to confuse legitimate
issues.
In Reahs the Supreme Court held that while there was no sufficient
evidence to conclude that the officers have indiscriminately stopped the entity‟s
business, at the same time, they have opted to abstain from presenting sufficent
evidence to establish the serious and adverse financial condition of the company.
The Court held:
A review of the recent decisions of the Supreme Court clearly indicates that
the highest court of the land still has not figured out yet which doctrine it shall
uphold in Labor Laws.
Gudez v. NLRC,158 held that the President of a corporation that has closed
its business even upon the order of the Philippine Constabulary which
necessitated the termination of the employees was made jointly and solidary
liable for the termination benefits due to the separated employees, the Court
holding: “Thus, where the employer corporation is no longer existing and unable
156
Ibid, at pp. 684-685.
157
271 SCRA 247, 81 SCAD 634 (1997).
158
183 SCRA 644 (1990).
to satisfy the judgment in favor of the employee, the officers should be held liable
for acting on behalf of the corporation.”
Similarly in Carmelcraft Corporation v. NLRC,159 the Court rejected the
contention of the officer that she cannot be held personally liable for the labor
claims of employees of the corporate employer since it "is a distinct and separate
entity with a legal personality of its own . . . [and she] was only an agent of the
company carrying out the decisions of its board of directors.” The Court affirmed
the joint and soidary liable of the officer with the corporate employer especially
when it was found that she was “in fact and legal effect the corporation, being not
only its president and general manager but also its owner.”
In Valderrama v. NLRC,160 the Court reiterated that since a “corporation
can only act through its officers and agents . . . that any decision against the
company can be enforced against the officers in their personal capacities should
the corporation fail to satisfy the judgment against it . . . where the employer
corporation is no longer existing and unable to satisfy the judgment in favor of the
employee, the officer should be held liable for acting on behalf of the
corporation.”
AHS/Philippines v. Court of Appeals,161 held that corporate officers are not
personally liable for money claims of discharged employees unless they acted
with evident malice and bad faith in terminating their employment.
Uichico v. NLRC,162 held that in labor cases, particularly, corporate
directors and officers are solidarily liable with the corporation for the termination
of employment of corporate employees done with malice or in bad faith. In that
case, it is undisputed that the corporate officers have a direct hand in the illegal
dismissal of the employees. They were the one, who as high-ranking officers and
directors of the corporation, signed the Board Resolution retrenching the
employees on the feigned ground of serious business losses that had no basis
apart from an unsigned and unaudited Profit and Loss Statement which, to
repeat, had no evidentiary value whatsoever. This is indicating of bad faith on the
part of the corporate officers for which they can be held jointly and severally
liable with the Corporation for all the money claims of the illegally terminated
employees.
In Asionics Philippines, Inc. v. NLRC,163 the Court reiterated that when
there is nothing on record to indicate that the President and the majority
stockholder of a corporation acted in bad faith or with malice in carrying out the
retrenchment program of the company, he cannot be held solidarily and
personally liable with the corporation.
159
186 SCRA 393 (1990).
160
256 SCRA 466, 70 SCAD 382 (1996).
161
257 SCRA 319, 71 SCAD 99 (1996).
162
273 SCRA 35, 83 SCAD 31 (1997).
163
290 SCRA 164, 94 SCAD 351 (1998).
Brent Hospital, Inc. v. NLRC,164 held that a corporation, being a juridical
entity, may act only through its directors, officers and employees and obligations
incurred by them, acting as corporate agents, are not theirs but the direct
accountabilities of the corporation they represent.
In Nicario v. NLRC,165 the Supreme Court held that the manager of a
corporation are not personally liable for their official acts unless it is shown that
they have exceeded their authority. There is nothing on record to show that the
manager deliberately and maliciously evaded the corporation‟s financial
obligation to the employee; hence, there appearing to be no evidence on record
that the manager acted maliciously or deliberately in the non-payment of benefits
to the employee, the manager cannot be held jointly and severally liable with the
corporate employers. A reading of the decision in Nicario would show that there
was a determination of whether the corporate employer had no assets with which
to pay the claims of the employee.
Nevertheless, in Restuarante Las Conchas v. Llego,166 the Supreme Court
had apparently returned to the A.C. Ransom principle that “[a]lthough as a rule,
the officers and members of a corporation are not personally liable for acts done
in the performance of their duties, this rule admits of exceptions, one of which is
when the employer corporation is no longer existing and is unable to satisfy the
judgment in favor of the employee, the officers should be held liable for acting on
behalf of the corporation.” In that case, the restaurant business had to be closed
down because possession of the premises had been lost through an adverse
decision in an ejectment case. The Court held: “In the present case, the
employees can no longer claim their separation benefits and 13th month pay from
the corporation because it had already ceased operation. To require them to do
so would render illusory the separation and 13tj month pay awarded to them by
the NLRC. Their only recourse is to satisfy their claim from the officers of the
corporation who were, in effect, acting in behalf of the corporation.”
164
292 SCRA 304, 96 SCAD 34 (1998).
165
295 SCRA 619, 98 SCAD 545 (1998).
166
314 SCRA 24 (1999).
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.
167
This section is based on a section taken from the article Jurisprudential Analyses of SEC
Jurisdiction in Intra-Corporate Disputes, and Investments Devices and Schemes, the original
version of which was published in T HE LAWYERS REVIEW , Vol. VI, (No. 10, Oct. 1992). The article
had been updated and included as Appendix to the 1998 edition of the book. The Appendix no
longer appears in this edition of the book due to the removal of quasi-judicial powers of the SEC
under Section 5.2 of the Securities Regulation Code.
168
Sec. 28, Corporation Code.
169
Ibid.
minority through cumulative voting, he may not be removed without cause even if
there is two-thirds (2/3) vote.
174
103 Phil. 553 (1958).
175
SEC Opinion, 15 May 1969, SEC FOLIO 1960-1976, at p. 377.
176
SEC Opinion, 19 October 1971, SEC FOLIO 1960-1976, at p. 498.
177
112 SCRA 243 (1982).
that appointee held an appointment at the pleasure of the appointing power and
was in essence temporary in nature, co-extensive with the desire of the Board of
Directors. When the Board opted to replace the incumbent, technically there is no
removal but only an expiration of the term and there is no need of prior notice,
due hearing or sufficient grounds before the incumbent can be separated from
office. The Supreme Court took note in Tavera that the disputed position of
Executive Secretary was also provided for in the Code of By-Laws of the
Philippine Tuberculosis Society, Inc.
In PSBA v. Leaño,178 the Court, in holding that the SEC (now RTC) has
jurisdiction over the ouster of the Executive Vice-President, took note that said
position was provided for in the corporate by-laws.
However, it is interesting to note that in PSBA, Justice Melencio-Herrera
concluded her ratiocination with the cryptic denouement: "The matter of whom to
elect is a prerogative that belongs to the Board, and involves the exercise of
deliberate choice and the faculty of discriminative selection. Generally speaking,
the relationship of a person to a corporation, whether as officer or as agent or
employee, is not determined by the nature of the services performed, but by the
incidents of the relationship as they actually exist."179
The ponente cited the American case of Bruce v. Travelers Ins. Co.,180
which reiterated the doctrine in common law jurisdiction that the distinction
between an agent or employee and an officer is not determined by the nature of
the work performed, but by the nature of the relationship of the particular
individual to the corporation:
The evolving test of the Supreme Court in determining who are corporate
officers therefore follows closely the American doctrine on the matter.
So also in the case of Dy v. NLRC,182 where the board of directors ousted
by non-election the bank manager, the Supreme Court took note that the position
is an elective position provided for in the by-laws of the corporation.
178
127 SCRA 778, 781 (1984).
179
Ibid, at p. 783; emphasis supplied.
180
266 F2d 781.
181
266 F2d 781, at pp. 784-785.
182
145 SCRA 211 (1986),
Espino v. NLRC,183 reiterated the ruling that the SEC (now the RTC) and
not the NLRC "has original and exclusive jurisdiction over cases involving the
removal from employment of corporate officers." In that case, in controversy was
the position of Executive Vice President-Chief Operating Officer of the Philippine
Airlines, which position was provided for in the by-laws of the airline company.
Pearson & George, (S.E. Asia), Inc. v. NLRC,184 held that "[a]ny question
relating or incident to the election of the new Board of Directors, the non-
reelection of Llorente as a Director, his loss of the position of Managing Director,
or the abolition of the said office are intra-corporate matters. Disputes arising
therefrom are intra-corporate disputes which, if unresolved within the corporate
structure of the [corporation], may be resolved in an appropriate action only by
the SEC [now the RCT] pursuant to its authority under paragraph (c) and (d),
Section 5 of P.D. No. 902-A."185
The Court also held that the reliance on LEP International Philippines, Inc.
v. NLRC, was misplaced since what was challenged in that case was not the
jurisdiction of the SEC (now the RTC) but its act of upholding the validity of the
dismissal of LEP's Chief Executive, who was not a stockholder, much less a
director, of LEP but was merely a managerial employee of the said company.186
The foregoing rulings are still relevant in determining the proper
jurisdiction of the RTC over disputes involving officers and directors under
Section 5(c) of Pres. Decree 902-A.
183
240 SCRA 52, 58 SCAD 46 (1995).
184
253 SCRA 136, 67 SCAD 698 (1996).
185
Ibid, at pp. 142-143.
186
Ibid, at p. 145.
187
266 SCRA 462 (1997).
under the by-laws of a corporation to create additional offices
as may be necessary.188
The ruling with respect to the clause “and such other officers” was obiter
because the position in controversy was that of Medical Director which was
specifically provided for in the quoted by-law provision, thus “[t]o appoint a
Medical Director, Comptroller/Administrator, Chiefs of Services and such other
officers as it may deem necessary and prescribe their powers and duties.” On the
basis of the quoted by-law provision, the Court held that “such specifically
designated positions should be considered „corporate officers‟ position, and the
determination of the rights and the concomitant liability arising from any ouster
from such positions, would be intra-corporate controversy subject to the
jurisdiction of the SEC,” which now falls within the jurisdiction of the RCT.
Section 25 of the Corporation Code defines a position to be an officer
position “as may be provided for in the by-laws,” and seems to imply that an
officership position becomes such only when the by-laws so provide for them,
and would rule out creation of the position by virtue of a by-law enabling
provision. This position seems sensible because an enabling provision in the by-
law does not really create a power that was not with the Board of Directors; even
without such enabling by-law provision, the Board of any corporation is always
considered to have the power to appoint “officers” as part of the corporate
powers under Section 23 of the Corporation Code, and therefore, when any such
position is created it would be an “employee” position that would be governed by
the provisions of the Labor Code.
The employment of an enabling clause in the by-laws to create an “officer”
position could also lead to absurd ends where by simply providing for such
clause in the by-laws of the corporation, the Board of Directors are able to
periodically and by means of a resolution to “create and appoint” officers to any
position in the organization, who would not be protected by the security tenure
clause.
Ongkingco v. NLRC,189 held that the dismissal or non-appointment of a
corporate officer is clearly an intra-corporate matter and jurisdiction properly
belonged to the SEC (now the RTC). Section 5(c) of Pres. Decree 902-A
expressly covers both election and appointment of corporate directors, trustees,
officers and managers, and that jurisdiction pertains to the SEC (now the RTC)
even if the complaint by a corporate officer includes money claims since such
claims are actually part of the perquisites of his position, and therefore interlinked
with his relations with the corporation.
188
Tabang v. NLRC, 266 SCRA 462 (1997), citing SEC Opinion, 25 March 1983; J.
CAMPOS, JR., THE CORPORATION CODE, COMMENTS, NOTES AND SELECTED CASES, Vol. I, 383-384.
189
270 SCRA 613, 81 SCAD 252 (1997).
5. Branching the Officership Test
In Dy v. NLRC,190 where the board of directors ousted by non-election the
bank manager, the Supreme Court took note that the position is an elective
position provided for in the by-laws of the corporation. However, the Supreme
Court in sustaining that the SEC (now the RTC) had jurisdiction over the
controversy held that:
6. Stockholder-Officer Combination
A special relationship has been placed upon officers of the corporation
being stockholders at the same time to vest jurisdiction over an illegal dismissal
suit with the SEC, now a matter falling within the jurisdiction of the RTC.
In Paguio v. NLRC,195 the Supreme Court put much weight on relationship
of being stockholders of the corporation and at the same time being officers. It
held that the NLRC has no jurisdiction over case where the petitioners are
stockholders and officers of respondent corporation. "They filed a complaint
against private respondent for illegal dismissal. Such being the case, it is the
Securities and Exchange Commission (SEC) that has jurisdiction over the case
as will be expansively discussed hereinafter. It is no hindrance to SEC's
jurisdiction that a person raises in his complaint the issues that he was illegally
dismissed and asks for remuneration where, as in this case, complainant is not a
mere employee but a stockholder and officer of the corporation."196
193
193 SCRA 258 (1991).
194
Also Lozon v. NLRC, 240 SCRA 1 (1995); Espino v. NLRC, 240 SCRA 52 (1995).
195
253 SCRA 166, 67 SCAD 337 (1996).
196
Ibid, at pp. 171.
197
126 SCRA 31 (1983).
exercise proper jurisdiction over any party, even when he does not fall within the
intra-corporate relationship.
In PSBA v. Leaño,198 Tan, who was one of the principal stockholders of
PSBA, was also elected director and the Executive Vice-President enjoying
salaries and allowances. The PSBA board at its regular meeting declared all
corporate positions vacant, except those of the President and Chairman, and at
the same time elected a new set of officers, with Tan not being re-elected as
Executive Vice-President. Tan filed with the NLRC a complaint for illegal
dismissal, with prayer for full payment of backwages and without loss of other
benefits. In upholding the jurisdiction of the SEC (now the RTC) on the ground
that the matter was essentially intra-corporate controversy, and ordering the
dismissal of the case pending with the NLRC, the Supreme Court impliedly held
that even as to issues pertaining to backwages and employments benefits, the
same would be within the power of the SEC to rule upon, as part and parcel of
the main controversy of whether the corporation, through its board directors, had
authority to remove Tan from his corporate office.
In Dy v. NLRC,199 Vailoces who was a manager of the corporate rural
bank, as well as director and stockholder thereof, was, by board resolution of a
newly constituted board, removed as bank manager. Vailoces filed an action for
illegal dismissal with the labor arbiter, with prayer for damages. A judgment was
rendered by the labor arbiter declaring that Vailoces was illegally dismissed and
ordering the petitioners to pay salary differentials, cost of living allowances, back
wages from date of dismissal up to the date of reinstatement. The judgment was
affirmed by the NLRC. On petition to the Supreme Court, the Court found that the
controversy came under Section 5(c) and was within the original and exclusive
jurisdiction of the SEC, and thereupon annulled and declared void the awards of
the arbiter. In ruling so, the Court held:
198
127 SCRA 778 (1984)
199
145 SCRA 211 (1986).
200
Ibid, at p. 222.
So also in Cagayan de Oro Coliseum, Inc. v. Office of the MOLE,201 the
Supreme Court, in determining which agency had jurisdiction over a case filed by
the President for non-payment of wages and other benefits, the ruling in Dy was
affirmed:
201
192 SCRA 315 (1990).
202
Ibid, at p. 319. The Dy doctrine was also affirmed in Fortune Cement Corporation v.
NLRC, 193 SCRA 258 (1991).
203
172 SCRA 442 (1989).
204
Ibid, at p. 445.
Lately, Lozon v. NLRC,205 reiterated Dy when it held that the renumeration
being asserted by an officer of a corportion is "not a simple labor problem but a
matter that comes within the area of corporate affairs and managment, and is in
fact, a corporate controversy in contemplation of the Corporation Code."
205
240 SCRA 1, 58 SCAD 1 (1995).
206
228 SCRA 705, 46 SCAD 1036 (1993).
207
Ibid, at p. 712.
208
Sec. 2, Rule 6, Interim Rules.
The complaint in an election contest must be filed within fifteen (15) days
from the date of the election if the by-laws of the corporation do not provide for a
procedure of resolution of the controversy, or within fifteen (15) days from the
resolution of the controversy by the corporation as provided in its by-laws.209 In
addition, it is required that the plaintiff should have exhausted all intra-corporate
remedies in election cases as provided for in the by-laws of the corporation.210
Election contest suits are summary in nature, with the trial courts
mandated within two (2) days from the filing of the complaint, upon a
consideration of the allegations thereof, to dismiss the complaint outright if it is
not sufficient in form and substance, or, if it is sufficient, order the issuance of
summons which shall be served, together with a copy of the complaint, on the
defendant within two (2) days from its issuance;211 and the defendant having a
period of ten (10) days within which to file an answer. 212 The parties are
mandated to attach to their pleadings the affidavits of witnesses, documentary
and other evidence in support thereof.213 The courts are required to render a
decision based on the pleadings, affidavits and documentary and other evidence
within fifteen (15) days from receipt of the last pleading, or from the date of the
last hearing as the case may be;214 and the decisions are immediately
executory.215
209
Sec. 3(1), Rule 6, Interim Rules.
210
Sec. 3(2), Rule 6, Interim Rules.
211
Sec. 3, Rule 6, Interim Rules.
212
Sec. 5, Rule 6, Interim Rules.
213
Sec. 6, Rule 6, Interim Rules.
214
Sec. 9, Rule 6, Interim Rules.
215
Sec. 4, Rule 1, Interim Rules.
216
Emphasis supplied.
The constitutional language on the right of “all workers” to security of
tenure provides for no exception. The Labor Code and case-law on the matter
clearly recognize two (2) levels of “employees,” the managerial and supervisory
employees and the rank-and-file employees,217 both of which are recognized to
enjoy security of tenure afforded to all workers.218
The close proximity of the powers and functions of managerial employees
to the business endeavors and management powers necessarily has given rise
to varying treatment as contrasted to rank-and-file employees. For example, by
law managerial employees are prohibited from joining, assisting, or forming any
labor union,219 and can be removed for loss of confidence provided there is
substantial proof and observance of due process.220
And yet the standing jurisprudential ruling when it comes to corporate
officers, although Labor Law would clearly consider them as employees enjoying
security of tenure, is that they enjoy no such security of tenure and their
incumbency is within the business judgment discretion of the board of directors
or trustees. The only conclusion that can be drawn from this is that in spite of the
clear language of the Constitution which provides for no exception, corporate
officers do not enjoy the constitutional guarantee to security of tenure, which can
be justified on the following grounds:
Firstly, the prerogative of management to hire and fire all employees was
the original prevailing doctrine that encompassed all employees of a business
enterprise; and the notion of security of tenure of employees was considered
contrary to the rights of ownership.221 In fact, the absolute right of management to
hire and fire employees was then still the prevailing doctrine at the time Gurrea v.
Lezama222 was decided, which was actually the first reported decision in
corporate law on the matter.
When the security of tenure clause did appear in the 1973 Constitution, it
was merely a declaration of principle that “The State shall assure the rights of
workers to self-organization, collectively bargaining and security of tenure,” which
found statutory implementation under the Labor Code. But even then the
interpretation of the statutory rule on security of tenure under the Labor Code
217
Art. 212(m), Labor Code of the Philippines. Managerial employees are defined as those
who are vested with the power and prerogatives to lay down and execute management policies to
hire, transfer, suspend, lay off, recall, discharge, assign or discipline employees; while
supervisory employees are those who, in the interest of the employer, effectively recommend
such managerial actions if the exercise of such actions is merely routine or clerical in naturebut
requires the use of independent judgment. All other employees who do not fall within the
managerial or supervisory levels are considered rank-and-file employees.
218
Dosch v. NLRC, 123 SCRA 296 (1983); De Leon v. NLRC, 100 SCRA 691 (1980);
Maglutac v. NLRC, 189 SCRA 767 (1990); Estiva v. NLRC, 225 SCRA 170 (1993).
219
Art. 245, Labor Code of the Philippines.
220
Estiva v. NLRC, 225 SCRA 170 (1993).
221
Gutierrez v. Bachrach Motor Co., Inc., 105 Phil. 9 (1959); Amador Capiral v. Manila
Electric Company Co., Inc., 9 SCRA 804 (1963).
222
103 Phil. 553 (1958).
exempted expressly under case-law corporate officers whose term of office were
deemed to be within the business judgment of the Board of Directors or Trustees.
Therefore, when the 1987 Constitution elevated the security of tenure
clause from mere declaration of principles to self-enforcing provisions, it must be
understood that the constitutional precept embodied the same nuances that
pertained to it and interpreted by the Supreme Court under the 1973 Constitution,
which includes an exemption therefrom of corporate officers.
Secondly, the non-coverage of corporate officers from the security of
tenure clause under the Constitution is now well-established principle by
numerous decisions upholding such doctrine under aegis of the 1987
Constitution223 in the face of contemporary decisions of the same Supreme Court
likewise confirming that “security of tenure covers all employees or workers
including managerial employees”224
Thirdly, the decisions of the Supreme Court upholding the business
judgment prerogatives of the board of directors on the termination of corporate
officers clearly would recognize that the essential legal relationship prevailing is
that of Agency, that corporate officers essentially are appointed as agents of the
corporation, and necessarily since trust imbues is such relationship, they are
essentially revocable. This is in stark contrast to the security of tenure clause
where the relationship sought to be governed is that essentially of employer-
employee, and seeks to safeguard the right to livelihood.
Finally, just as the security of tenure clause under the civil service system
provides for exemption for positions that are policy-determining, highly
confidential or highly technical employees,225 the Supreme Court has now began
to fashion similar exemptions applicable to the security of tenure clause for
private employees.
The only problem with such analogy is that under the civil service system,
the nature, duties and functions of the position are critical in determining whether
such office is not within the coverage of the security of tenure clause;226 whereas,
in the case of corporate officers, the Supreme Court has employed the
peremptory test under Gurrea (i.e., that only those officers who are declared
such under the law or provided for in the by-laws are within Board‟s business
judgment prerogative to terminate at its discretion) and has in fact held in
Philippine School of Business Administration that “the relationship of a person to
a corporation, whether as officer or as agent or employee, is not determined by
the nature of the services performed, but by the incidents of the relationship as
they actually exist."227
223
Ongkingco v. NLRC, 270 SCRA 612, 81 SCAD 252 (1997); Tabang v. NLRC, 266 SCRA
464, 78 SCAD 174 (1987).
224
Maglutac v. NLRC, 189 SCRA 767 (1990)
225
Sec. 2(3), Art. IX-B, 1987 Constitution.
226
Laurel v. Civil Service Commission, 203 SCRA 195 (1991).
227
Ibid, at p. 783; emphasis supplied.
There is no decision yet rendered by the Supreme Court where the
constitutional issue has clearly been put at issue, and it should be expected that
once the constitutional issue is pushed further before the Supreme Court‟s
determination, rulings would be issued to the effect that the nature of the position
of an officer should also be determinative of whether it should be exempted from
the coverage of the security of tenure clause.
—oOo—
SHARES OF STOCK,
SUBSCRIPTION AGREEMENTS,
AND CERTIFICATES OF STOCK
——
1
Boyer-Roxas v. Court of Appeals, 211 SCRA 470 (1992).
2
Magsaysay-Labrador v. Court of Appeals, 180 SCRA 266, 271-272 (1989); Stockholders
of F. Guanzon and Sons, Inc. v. Register of Deeds of Manila, 6 SCRA 373 (1962); Pascual v. Del
Sanz Orozco, 19 Phil. 82, 86 (1911).
3
180 SCRA 266, 271 (1989).
4
Ibid, at p. 271.
5
Sec. 67, Corporation Code.
6
Sec. 66, Corporation Code.
7
Sec. 64, Corporation Code. The SEC has opined that a subscription is one, entire and
indivisible whole contract. It cannot be divided into portions to allow the stockholder to be entitled
to a certificate of stock until he has remitted the full payment of his subscription together with
interests and expenses. SEC Opinion, 12 November 1993, XXVIII SEC QUARTERLY BULLETIN 36
(No. 1, March 1994).
8
Sec. 63, Corporation Code.
(e) To refuse to recognize a sale or assignment of shares of
stock which have not been duly registered in the stock and
transfer book.9
On the other hand, the corporation does not have power on its own
volition to:
(a) Demand for the repurchase of its shares of stock unless the
shares are classified as redeemable shares in the articles of
incorporation;10
(b) Refuse to pay to the stockholders dividends declared on
shares which have not been declared delinquent to apply
them to the payment of the unpaid subscription;11 and
(c) Bid delinquent shares, and thereby to obtain for itself profit,
for a value greater than the balance due on the unpaid
subscription, plus accrued interest, costs of advertisement
and expenses of sale.12
It has also been ruled that the unpaid subscription of a stockholder which
has not become due by call through a formal board resolution cannot be off-
setted against a money claim of the employee-stockholder against the employer-
corporation; or even when a proper call has been made, such off-setting would
still not be authorized as being violative of the prohibition against unauthorized
deductions under the Labor Code.13
SUBSCRIPTION AGREEMENT:
ROOT OF THE STANDING OF STOCKHOLDERS
The subscription agreement underpins the relationship between the
stockholder and the corporation. The subscription agreement therefore is a
special contract in Corporate Law; although it is governed by the Law on
Contracts, specifically as a species of sale contracts, a subscription agreement
has special features that go beyond such discipline, and delve into the very heart
of Corporate Law.
Section 72 of the Corporation Code provides expressly that "[h]olders of
subscribed shares not fully paid which are not delinquent shall have all the rights
of a stockholders." Clearly therefore, it is subscription to shares of stock that
creates the legal relationship between the stockholder and the corporation; it is
9
Sec. 63, Corporation Code; Price v. Martin, 58 Phil. 707 (1933).
10
Sec. 8, Corporation Code.
11
Sec. 71, Corporation Code.
12
Sec. 68, Corporation Code.
13
Apocada v. NLRC, 172 SCRA 442, 445-446 (1989).
subscription, and not the payment of such subscription, that grants to the
stockholder the statutory and common rights granted to stockholders.14
14
Fua Cun v. Summers, 44 Phil. 705 (1923).
15
Bayla v. Silang Traffic Co., Inc., 73 Phil. 557 (1942).
16
Fua Cun v. Summers, 44 Phil 705 (1923).
and issuance as to a particular share of stock happen exactly at same point in
time, being merely opposite sides of the same coin.
What can be drawn from the provisions of Sections 60, 63, and 72 is that
the entering into any contract for the acquisition of unissued stock, which shall be
deemed as subscription agreement, would constitute itself the tradition by which
the subscriber becomes a stockholder of the corporation, and through which he
becomes the owners of the shares of stock subscribed and exercise acts of
ownership, subject to the limiting provisions under the Corporation Code, such as
the lien which the corporation has over not fully paid shares under the second
paragraph of Section 63. In other words, unlike the species sale, which
constitutes merely a title and not a mode by which ownership of the subject
matter is transferred, a subscription agreement constitutes the very mode by
which the covered shares are thereby issued and then owned by the subscriber.
17
See Chapter XIV of the author’s book LAW ON SALES (Rex Book Store, 1998 ed.), on the
characteristics of assignment of intangibles, like shares of stock, as a species of sale.
18
47 Phil. 649 (1925).
19
Ibid, at p. 652.
the situation which was not within the contemplation of the subscriber, and which
allowed him to rescind the agreement. It therefore looked at the arrangement as
a sale of unissued shares of stock.
In Bayla v. Silang Traffic Co., Inc.,20 the petitioner bought shares of stock
from the corporation on installment basis. The title of the contract was
"Agreement for Installment Sale of Shares." Since the corporation had become
insolvent, there was a call on the subscription, and the issue was whether the
contract was a subscription contract which rendered the obligation demandable
upon insolvency of the corporation, or a purchase agreement, which would grant
the purchaser the legal authority to rescind the contract by reason of insolvency
of the seller-corporation.
Bayla held that the nature of a contract covering unissued shares made
after its incorporation, the contract was either a subscription contract or a
purchase of stock, depending upon the terms of the agreement and the
intentions of the parties. It held that a subscription is a mutual agreement among
the subscribers to take and pay for the stock of a corporation, and therefore it
was not possible to withdraw from such an agreement without the consent of the
other subscribers, and even if the corporation should become insolvent because
of the enforcement of the trust fund doctrine. In contrast, the Court recognized
that a "purchase" of shares of stock is an independent agreement between the
individual and the corporation to buy shares of stock from it at a stipulated price,
and the insolvency of the corporation makes it incapable of complying with its
obligation, which grants to the purchaser the right to rescind the agreement.
Bayla, which was decided under the Corporation Law, laid down the
distinctions between a subscription contract and a purchase agreement as
follows:
21
The citation at 64 Phil. 1053-1054 referred to an unpublished decision Lusk v. Stevens,
G.R. No. 45473, 13 March 1937. However, Lusk v. Stevens, G.R. No. 45325, 27 February 1937,
appears as a published decision in 64 Phil. 154 and does not discuss any Corporate Law
principle at all.
or resolutory. . . In conditional obligations, the acquisition of
rights as well as the extinction or loss of those already
acquired, shall depend upon the event constituting the
condition. . . That the acceptance by the company of S's offer
to subscribe was made under a suspensive condition, and
does not confer on the latter the rights of a stockholder until
the condition is fulfilled. To hold otherwise would be to brand
the contract with illegality and render it ineffective, a result
which should be avoided. . . The doctrine enunciated by the
courts that by the act of incorporation, without more, the
original subscribers became members of the corporation,
entitled to all the rights and privileges of membership,
including the right to vote, does not apply to subscriptions to
stock on a condition precedent. Such subscription do not
render the subscriber stockholders until the condition is
performed."22
22
At 64 Phil. 1053-1054 (1937).
3. Pre-Incorporation Subscription Agreements
Under the old Corporation Law, while generally there was no issue as to
the binding effect of subscription to shares of stock after incorporation, there
were several conflicting positions as to the binding effect of such subscription
before incorporation.23
As to subscriptions to shares before incorporation, there was the "offer"
theory which construed subscriptions as only continuing offers to the proposed
corporation which do not ripen into contracts until accepted by the corporation
when organized. Under such theory, the subscribers are allowed to withdraw
their subscription at any time before the corporation comes into existence and
accepts the offer.24 A subscriber can thus speculate without financial risk to
himself, such that if there is over-subscription, he can take his shares and sell
them at a premium; otherwise, he withdraws from the situation before the
corporation accepts the subscription.25
Under the "contract theory," followed only in a few jurisdiction in the United
States, a subscription agreement among several persons to take shares in a
proposed corporation becomes a binding contract and is irrevocable from the
time of subscription unless cancelled by all the parties before acceptance by the
corporation.26 The difficulty of the theory is the legal standing of the corporation
formed to enforce the subscription agreements, not being the direct party thereto.
It was posited under such theory that the right of the corporation to enforce the
subscription agreement is sustained under the theory that the corporation was a
third party beneficiary under an agreement pour autrui.27 One drawback of the
contract theory, which prevents a subscriber from withdrawing from the
arrangement, was that if the corporation is not organized within a reasonable
time, the subscriber is tied up for a long time to a project which, may not come
through, which would be detrimental to the economic welfare of society.28
23
Navarro, Two Points of Reform of Philippine Corporate Law, 25 PHIL. L.J. 598. "The `offer'
theory is worked out from the law of contracts. The analogy, however, fails for while in ordinary
contracts there are both offerors and offerees, in our case the contemplated corporation has not
yet come into existence. To consider the offer as continuing and, therefore, as if made at the time
the corporation comes into existence is a twisting of the facts, for it is not so made in fact. Neither
may analogy be drawn between the contemplated corporation and a conceived child for no one
ever imagines contracting with it, except, perhaps, giving a gift to it, which does not come within
the purview of contract law. It is not any good to consider the subscriptions as made with an
agent of the proposed corporation, for then there would be an agent for a principal that does not
exist. Again, if we grant the legal possibility of there being an agent of a non-existing principal,
this destroys the theory, as the subscriptions become perfected contracts between two able
parties. The Bryant case indicated, though holding otherwise, that there must be an offeree, for
the formative subscription is a mere „nudum pactum’ — a promisor without a promisee; a
contractor without a contractee. In fact every element of a binding contract is wanting." (at p.
671).
24
Ibid, at p. 670.
25
Ibid.
26
Ibid, at p. 673.
27
Ibid, at p. 674
28
Ibid, at p. 676.
It was observed that under the old Corporation Law the two theories
supporting pre-incorporation agreements were "vain justifications of varying
policies" and although "both seek to extend their roots into contract law," they
were not even remote relations of the latter.29 Thus, it was held that "[t]he law
developed by courts on formative subscriptions is peculiar to corporate law and is
quite apart from the law of contracts."30
There was also the issue on the binding effect of subscriptions appearing
in the articles of incorporation. Although there was consensus that subscriptions
appearing in the articles of incorporation, when such subscriptions are required
by statute as preliminary to incorporation, are binding and irrevocable from the
time the articles are drawn, it was observed that the same pertain only to
subscribers who signed the articles of incorporation.31
Section 61 of the Corporation Code has now provided a statutory basis for
the theories covering the binding effects of pre-incorporation agreements to
shares of stock. It provides that a subscription for shares of stock of a corporation
still to be formed shall be irrevocable for a period of at least six (6) months from
the date of subscription, except:
29
Ibid, at p. 676.
30
Ibid.
31
Ibid, at pp. 676-677, citing Hughes v. Antietam Mfg. Co. (1871) 34 Md. 316; Lake Ontario,
A. & N.Y.R. Co. v. Mason (1857) 16 N.Y. 451; Johnson v. The Wabash & Mt. Vernon Plank-Road
Co., (1861) 16 Ind. 389; Jones v. Milton & R. Turn. Co., (1856) 7 Ind. 547; Poughkeepsie & S. P.
Pl. Road Co. v. Griffin, (1861) 24 N.Y. 150; Sodus Bay & C.R. Co. v. Hamlin, (1881) 24 Hun
(N.Y.) 390; Seacoast Packing Co. v. Long, 116 S.C. 406; Louiville & B.R.R. Co. v. Elliot, 101 N.Y.
Supp. 328; Anderson v. The Newcastle and Richmond Railroad Co. (1859) 12 Ind. 376; Rehbein
v. Rahr, (1901) Wis. 136; Campbell v.Rayen (1913) 176 Mich. 208.
agreement. The pre-incorporation agreement is replaced by the promoter's
contract, although this is merely an expectancy.
It also recognizes the contractual relationship among all the subscribers.
Whether it is a pre-incorporation agreement or an ordinary subscription
agreement, a subscription is essentially an agreement among the stockholders.
This is the second relationship and the reason why it is provided in Section 61
that a subscriber can only withdraw from the contract or agreement when there is
consent of all subscribers. Under this concept, a subscription agreement is in a
sense a contract among the several subscribers, and no one of the subscribers
can thus withdraw from the contract without the consent of all the others and
thereby diminish, without the universal consent of all the others, the common
fund in which all have acquired an interest.32
One of the implications of considering the subscription contract to be one
entered into among stockholders is that it is beyond the powers of the board of
directors to release the subscribers since the consent of all subscribers is
necessary.33 And even if the all the subscribers would approve the release of a
particular subscriber it is still not possible if the creditors would be prejudiced,
under the trust fund doctrine.
35
Sec. 62, Corporation Code.
36
Ibid.
The better issue to be resolved is why on the books of the corporation
"subscription receivable" (an obligation to pay cash in the future) is valid
consideration under a subscription contract, and yet Section 62 expressly
prohibits promissory notes (or for that matter the creation of "accounts
receivable") to be accepted as consideration for subscription of shares of stock,
when both "notes receivable" and "accounts receivable" may constitute
essentially the same undertaking by the same subscriber to pay cash in the
future, just like "subscription receivable."
The prohibition under Section 62 may be based on two factors: firstly, on
the underlying difference in legal consequences between "notes receivable" or
“accounts receivable” on one hand, and "subscription receivable," on the other
hand; and, secondly, the philosophical basis that underlies the trust fund
doctrine, that the capital stock of a corporation, especially the paid-up portion
thereof, should be backed-up by assets which have their own intrinsic value other
than the promise of a person to pay in the future. In fact, when property other
than cash is paid for subscription, their proper valuation must be proved before
the SEC to ensure that shares are not issued in exchange of properties which do
not have value equal to the par or issued values of such shares.
If a note receivable is accepted as payment for subscription of shares of
stock, the face value of the note would appear as an addition to the assets of the
corporation's balance sheet, without corresponding deduction on the capital stock
of the equity portion. Consequently, creditors who examine the financial
statements of such corporation would be led to believe on face value alone that
the entire paid-up capital stock of the corporation has been paid in cash or
property that has intrinsic value that is not dependent upon the fulfillment of the
promise or credit standing of a person. One should also appreciate the notion
that notes or accounts receivable arising from dealings with third parties tend to
have better valuation since they are the product of arms-length transactions, than
notes or accounts receivable received from an insider, where conflicts-of-
interests situation may lead to compromising the valuation or event he collection
efforts, to the detriment of the corporation and consequently, the corporate
creditors.
On the other hand, subscription receivables are correctly treated not as
assets of the corporation, and are reflected properly in the balance sheet of the
corporation as deductions from stockholder's equity and the difference shows
only a net amount of the stockholder's equity which is backed-up by assets
actually received by the corporation (such as cash or property) which have
values that do not depend on the credit standing of another person. In short, the
presentation of subscription receivable in the corporation's balance sheet clearly
informs the creditors of the actual net amount of capital stock which is truly
backed-up by realizable assets.
2. Property Consideration
The property which a corporation may accept in exchange for its stock
must be of a kind which the corporation may lawfully acquire and hold in carrying
out the purposes of its incorporation, and which is necessary or proper for it to
own in carrying on its business.37 It cannot lawfully issue stock for property which
its charter does not authorize it to acquire, or for property acquired for an
unauthorized purpose.
For example, real property may be accepted as payment on subscription
to the capital stock only when the same can be used in the business of the
corporation, as in real estate development, subdivision, agro-industrial business,
and the like, as well as for the establishment of offices.
The property must be of substantial nature, having a pecuniary value
capable of being ascertained, and must be something real and tangible as
distinguished from something constructive or speculative; and it must be of such
character that it can be delivered to the corporation, instead of being merely
communicated to its officers or employees. It must also be such as is capable of
being applied to the payment of debts and of distribution among the
stockholders.
The SEC has ruled that property, such as financial instruments and
receivables, may be legally accepted as capital contributions, subject to the
following conditions:
37
Sec. 62, Corporation Code.
38
SEC Opinion, 25 January 1995, XXIX SEC QUARTERLY BULLETIN 36 (No. 2, June 1995)
39
SEC Opinion, 17 December 1993, XXVIII SEC QUARTERLY BULLETIN 17 (No. 2, June
1994); SEC Opinion, 25 January 1995, XXIX SEC QUARTERLY BULLETIN 36 (No.2, June 1995).
the corporation provided the transaction is in good faith and no fraud is
perpetrated upon other stockholders. Compensation payable for services actually
rendered to the corporation is credit which is property and whose value is
ascertainable.
An agreement to issue stock for services to be rendered in the future is
void under Section 62 of the Corporation Code, and the corporation should not
be estopped to deny that the services constituted payment of the stock
subscription even though it has received the benefit thereof.
Although a previously incurred debt is valid consideration for subscription,
future services would are not allowed as consideration for subscription because
the value of such service to the corporation in exchange for shares of stock
would again depend on the future performance of the subscriber of the service
offered, and there would be a tendency to short-change the corporation. In the
case of a previously incurred debt, their valuation would have been established
at arms-length prior to even negotiating on the subscription agreement, and they
would more often represent the true value of services which the corporation has
received.
In an opinion,40 the SEC ruled that movie star contracts cannot be
accepted as payment for subscription inasmuch as the services of movie stars
under such contracts are not yet considered as actually rendered/received as
their services will still be performed in the future.
40
SEC Opinion, 6 November 1995, XXX SEC QUARTERLY BULLETIN 2 (No. 2, Dec. 1996).
Stock dividends are in the nature of shares of stock, where the
consideration is the amount of unrestricted retained earnings converted into
equity in the corporation‟s books.41
Declaration of stock dividends should be distinguished from
reclassification or conversion of shares which do not really affect the integrity of
capital stock which has been paid-up previously but only changes its composition
or manner of classification.
WATERED STOCK
In giving added "teeth" to Section 62 which governs what considerations a
corporation may accept for the issuance of shares of stock, the Code makes
directors and officers liable for watered stocks under Section 65, thus: "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."
Sections 62 and 65 are substantial adoptions of the relevant portions of
Sections 5 and 16 of the old Corporation Law, and include in the enumerations
other items which, although not enumerated under the old Corporation Law, were
41
Lincoln Philippine Life v. Court of Appeals, 293 SCRA 92, 96 SCAD 542 (1998).
nevertheless generally accepted as valid consideration for issuance of stock,
such as previously incurred debts and services already rendered.
Shares issued as fully paid when in truth the consideration received is
known to be less than the par value or issued value of the shares are called
"watered stock". The term sometimes is used to include "bonus shares" under an
agreement that nothing shall be paid to the corporation for them, and "discount
shares" issued at a discount under an agreement to pay less than the par value
in money.
Stock watering is prohibited because of the injuries caused to:
Basically, three (3) theories have been advanced as basis for holding
stockholders and officers liable for watered stocks.
Firstly, under the "subscription contract theory," which holds that the
subscription contract is the source and measure of the duty of a subscriber to
pay for his shares; if the contract releases him from further liability, the subscriber
ceases to be liable.43
The subscription contract theory is unacceptable in our jurisdiction
because of the peremptory language of then Section 16 of the Corporation Law,
and now Sections 62 and 65 of the Corporation Code.
Secondly, under the "fraud theory" previously discussed, which holds a
shareholder liable for watered stock on the basis of tort or misrepresentation.
According to the theory, the wrong done to the creditor is fraud or deceit in falsely
42
BALLANTINE, 794.
43
BALLANTINE, 802.
representing that the par value has been paid or agreed to be paid in full. Under
this theory, subsequent creditor without notice is presumed to have been
deceived by this misrepresentation; but prior creditors with notice are not
protected. This was the ruling in Hospes v. Northwestern Manufacture & Car
Co.,44 even as it rejected the trust fund doctrine:
Thirdly, under the trust fund doctrine, under which all corporate creditors
would have legal basis to recover against stockholders and guilty officers.
Despite the views of foreign authors that the fraud theory is the prevailing
46
view, it would seem that in Philippines jurisdiction, the trust fund doctrine on
watered stock prevails. In Philippine Trust Corp. v. Rivera,47 the Supreme Court
held -
44
48 Minn. 174, 50 NW 117.
45
Ibid.
46
BALLANTINE, 806; THOMPSON, 3429.
47
44 Phil. 469 (1923).
such release; and as against creditors a reduction of the
capital stock and take place only in the manner and under the
conditions prescribed by the statute or the charter or the
articles of incorporation. Moreover, strict compliance with the
statutory regulations is necessary.48
48
Ibid, citing Velasco vs. Poizat, 37 Phil. 802 and 14 C.J., 498, 620.
49
SALONGA, supra, p. 497; AGBAYANI, COMMERCIAL LAW oF THE PHILIPPINES, Vol. 3, 1984
ed., pp. 454-455.
50
93 Phil. 404 (1953). See also Phil. Trust Co. v. Rivera, 44 Phil. 469 (1923), and Nava v.
Peers Marketing Corp., 74 SCRA 65 (1976).
by consideration, [which] will be effectual as against dissenting stockholders and
subsequent and existing creditors." Note, however, that the exceptions
mentioned in Lingayen Gulf really do not constitute a gratuitous release since a
valuable consideration is actually received by the corporation, such as
cancellation of corporate debt. Even under Section 62 of the Corporation Code a
bona fide debt is sufficient consideration for the issuance of a share.
In the United States there is the view that a pre-incorporation subscription
merely constitutes a continuing offer since the corporation still to be formed has
yet not legal existence, and therefore the pre-incorporation subscription may be
revoked anytime prior to legal incorporation.51
Section 61 of the Corporation Code has rejected that view and in effect
adopts the other view that pre-incorporation contract is a binding contract among
the subscriber and no party may revoke the contract without the consent of the
other. The section provides that a subscription for shares of stock of a
corporation still to be formed shall be irrevocable for a period of at least six (6)
months from the date of subscription, unless all of the other subscribers consent
to the revocation, or unless the incorporation of said corporation fails to
materialize within the 6-month period or within a longer period as may be
stipulated in the contract of subscription. However, it provides that no pre-
incorporation subscription may be revoked after the submission of the articles of
incorporation to the SEC.
In Philippine Trust Co. v. Rivera,52 Rivera subscribed to 450 shares of
stock in the corporation. The corporation later became insolvent, and Philippine
Trust Company became its assignee in bankruptcy. PhilTrust instituted an action
to recover the stock subscription of Rivera who claimed that his failure to pay
was due to the fact that the company's capital was reduced by 50% during
stockholder's meeting prior insolvency and that such reduction released him from
payment of the unpaid subscription.
The Supreme Court ruled that the resolution releasing the stockholder's
from their obligation to pay the 50% of their subscriptions was an attempted
withdrawal of so much capital from the fund upon which the company's creditors
were entitled ultimately to rely on and having been effected without compliance
with the statutory requirements, was wholly ineffectual. The Court held that
subscription to the capital of a corporation constitute a fund to which creditors
have a right to look for satisfaction of their claims and that the assignee in
insolvency can maintain an action upon any unpaid stock subscription in order to
realize assets for the payment of its debts. The Court added:
51
Collines v. Morgan Grain Co., 16 F. 2d 253; BALLANTINE, 444; FLETCHER, 91-94.
52
44 Phil 469 (1923).
take place only in the manner and under the conditions
prescribed by the statute or the charter or the articles of
incorporation. Moreover, strict compliance with the statutory
regulations is necessary.53
53
Ibid, at pp. 470-471, citing 14 C.J., 498, 620.
54
57 Phil 619 (1932).
55
Ibid, at p. 627, quoting from FISHER, THE PHILIPPINE LAW ON STOCK CORPORATIONS, at p.
97.
56
Ibid, at p. 628.
contract. In the first case, payments to the subscription must be made on said
dates, without need of a call; and non-compliance with said date can be
converted to a delinquency status. However, in the second case, a call is
necessary in order for delinquency to set in. In Miranda's case, he was to make
payment to his subscriptions based on a schedule embodied in the subscription
contract.
In Velasco v. Poizat,57 Poizat was a stockholder of the Philippine Chemical
Product Co. from the inception of the enterprise; fifteen (15) of those shares
subscribed by Poizat and the other 15 shares subscribed by Infante, were not
fully paid. The board of directors adopted two resolutions, the first to make good
by new subscriptions in proportion to their respective holdings the 15 shares of
Infante which have been surrendered by Infante; the other was to require Poizat
to pay the amount of his subscription upon the 15 shares and should Poizat
refuse to pay, the company would undertake judicial collection proceedings.
When the company went into voluntary insolvency, the assignee, Velasco, filed a
complaint against Poizat seeking to recover his deficiency. Poizat contended that
the call of the board of directors was not made pursuant to the requirements of
the Corporation Law and that the action was instituted before the expiration of
the 30 days specified in the Section 38 of the old Corporation Law.
The Court held that Poizat continued to be liable on his subscription.
When insolvency supervenes upon a corporation and the court assumes
jurisdiction to wind it up, unpaid stock subscriptions become payable on demand,
and are at once recoverable in an action instituted by the assignee in insolvency.
In Philippine National Bank v. Bitulok Sawmill, Inc.,58 Pres. Roxas
organized the Philippine Distributing Agency for the purpose of insuring the
steady supply of lumber to enable the war sufferers to rehabilitate their
devastated homes. The President convinced the lumber produces to form a
lumber cooperative and to pool their resources together. Roxas promised and
agreed to finance the agency by making the government invest P9.00 for every
peso the members would invest. Relying on the assurance, Bitulok and several
others subscribed to the stocks of Phil. Distributing Agency. The Legislature was
not able to appropriate the counterpart fund to be put up by the government,
hence, Pres. Roxas instructed PNB to grant the Phil. Distributing Agency. The
loan was not paid, as a consequence, PNB filed a suit their subscriptions to the
Phil. Distributing Agency. May PNB collect the balance on the subscription in
spite of the conditions attached thereto which were not fulfilled.
The Court held that it is a well-settled principle that with all the vast
powers lodged in the President, he is still devoid of the prerogative of suspending
the operation of any statute or any of its terms. The power of suspending the
laws is lodged with the Legislature, which has indicated that the obligation for the
payment of subscription by the defendants shall be governed by the Corporation
Law. The President could not suspend the effectivity of the Corporation Law;
57
37 Phil 802 (1918).
58
23 SCRA 1366 (1968).
therefore, the defendants remain liable to the balance of their subscription.
The Philippine National Bank case gives the essence of a subscription
contract. It is indeed a species of the Law on Contracts, but the principles in
Corporate Law prevail. One of the principles in Corporate Law is that when one
enters into a subscription agreement, one cannot deny the obligation to pay,
even when the corporation becomes insolvent.
When one enters into a subscription agreement, the principles of
Corporate Law become part and parcel of the contract. The cases therefore hold
that any contradiction to modify the condition of the obligation to pay is
essentially void. It does not avoid the subscription agreement, but avoids the
condition. The obligation to pay then becomes a purely simple obligation.
59
SEC Opinion, 31 August 1995, XXX SEC QUARTERLY BULLETIN 25 (No. 1, June 1996).
60
SEC Opinion, 31 August 1995, XXX SEC QUARTERLY BULLETIN 25 (No. 1, June 1996).
61
Ibid.
62
Ibid.
63
93 Phil. 404 (1953).
64
Ibid, at p. 409, citing 14 C.J. 639.
Lingayen Gulf, as in the case of Velasco v. Poizat,65 also distinguished the
requirements when the corporation becomes insolvent, in which case all unpaid
stock subscriptions become payable on demand and are immediately
recoverable in an action instituted by the assignee. However, citing foreign
sources, Lingayen Gulf seems to recognize, by way of exception, when a
subscriber may be released from his subscription: "In particular circumstances,
as 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."66 Note
that even in such "exceptions" the release is for valuable consideration.
The release according to Lingayen Gulf, must have the consent of all
other stockholders since "[a] contract of subscription is, at least in the sense
which creates an estoppel, a contract among the several subscribers. For this
reason none of the subscribers can withdraw from the contract without the
consent of all the others, and thereby diminish, without the universal consent, the
common fund in which all have acquired an interest."67
In summary, Lingayen Gulf held: "In conclusion we hold that under the
Corporation Law, notice of call for payment for unpaid subscribed stock must be
published, except when the corporation is insolvent, in which case, payment is
immediately demandable. We also rule that release from such payment must be
made by all the stockholders."68
Edward A. Keller & Co., Ltd. v. COB Group Marketing, Inc.,69 affirmed that
the "stockholder is personally liable for the financial obligations of a corporation
to the extent of his unpaid subscription,"70 even when the corporation itself, which
was the main creditor for the obligation, was not shown to be insolvent. This
presumes that the liability of stockholders for unpaid subscription to corporate
obligations is direct and they can be sued in their personal capacity with the
corporation even when the latter is still very much solvent.
Velasco v. Poizat,71 held that "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 a liability by the by-laws of the corporation. The
subscriber is as much bound to pay the amount of the shares 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."
65
37 Phil. 805 (1918).
66
Ibid, at p. 411, quoting from 18 CJS 874.
67
Ibid, at pp. 411-412, quoting 2 THOMPSON ON CORPORATIONS, p. 194.
68
Ibid, at p. 413.
69
141 SCRA 86 (1986).
70
Ibid, citing Vda. de Salvatierra v. Garlitos, 103 Phil. 757, 763 (1958).
71
37 Phil. 802 (1918).
DELINQUENCY SALE
Under Section 68, 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 notice 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.
Under Section 67 of the Corporation Code, it is specifically provided that
the unpaid subscription “shall be made on the date specified in the contract of
subscription or on the date stated in the call made by the board . . . If within thirty
(30) days from the said date no payment is made, all stocks covered by said
subscription shall thereupon become delinquent.” The SEC has ruled that the
use of the word “shall” shows that a prior call or board resolution demand
payment is not necessary if a specific date of payment is specified in the
subscription contract; and neither is there a need of a formal declaration of the
board for an unpaid subscription to become delinquent in the event of failure to
pay the unpaid subscription within the prescribed 30 day period from the date
specified in the subscription contract.72
72
SEC Opinion, 13 March 1998, XXXII SEC QUARTERLY BULLETIN 3 (No. 1, June 1998).
treasury shares and may be disposed of by said corporation as the case of other
treasury shares.
Remaining shares go to the delinquent stockholder for the simple reason
that Section 68 protects the delinquent stockholder himself. Corporations are not
supposed to make money out of the sale.
4. Effects of Delinquency
Under Section 71, 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 rights of a stockholder except the right to dividends in
accordance with the provisions of this Code, until and unless he pays the amount
73
44 Phil 755 (1923).
due on his subscription with accrued interest and the costs and expenses of
advertisement, if any.
Delinquency is achieved in either one of two ways:
Once a stock has become delinquent, it has the following effects on its
holder:
74
SEC Opinion, 13 March 1998, XXXII SEC QUARTERLY BULLETIN 3 (No. 1, June 1998).
75
Ibid.
76
Ibid.
77
67 Phil 441 (1939).
claimed that he was released from such obligation by the president of the
corporation.
The Court ruled that the action has not prescribed, since the period begins
to run from the time payment becomes demandable, which in the case of
subscription of shares begins to run only from the time the board of directors
declares that balance are due and demandable. The prescriptive period does not
begin to run from the date of the subscription. The Court held: "Of course, the
obligation to pay arises from the date of the subscription, but the coming into
being of an obligation should not be confused with the time when it becomes
demandable."78 Moreover, a corporation or its officers have no legal capacity to
release a subscriber to its capital stock from the obligation to pay for his shares,
and any agreement to this effect is invalid.
CERTIFICATE OF STOCK
1. Rights to Issuance of Certificate of Stock
Under Section 63 of the Corporation Code, the capital of the stock
corporation shall be divided into shares for which certificates signed by the
president or vice-president, countersigned by the secretary or assistant
secretary, and sealed with the seal of the corporation shall be issued in
accordance with the by-laws. Shares of stock so issued are personal property
and may be transferred by delivery of the certificate or certificates indorsed by
the owner or his attorney-in-fact or other person legally authorized to make the
transfer.
Under Section 64 of the Corporation Code, no certificate of stock shall be
issued to a subscriber until the full amount of his subscription together with
interest and expenses (in case of delinquent shares), if any is due, has been
paid. A subscriber must first totally pay his subscription before a certificate of
stock covering shares subscribed and paid for could be issued to him. But an
unpaid subscription (not declared delinquent) can be voted upon in corporate
meetings. Such delinquent shares are also entitled to dividends, subject to the
rules set forth in Section 43 of the Corporation Code on delinquent shares.
The purpose of the prohibition is to prevent the partial disposition of a
subscription which is not fully paid, because if it is permitted, and the subscriber
subsequently becomes delinquent in the payment of his subscription, the
corporation may not be able to sell as many of his subscribed shares as would
be necessary to cover the total amount due from him, which is authorized under
Section 68 of the Corporation Code.
Before the rule under Section 64 was established under the Corporation
Code, the Supreme Court in Baltazar v. Lingayen Gulf Electric Power Co. Inc.,79
had occasion to rule upon the old corporate practice that covered procedure of a
78
Ibid, at p. 444.
79
14 SCRA 522 (1965).
corporation in issuing certificates of stock to its individual subscribers for unpaid
shares of stock. In order to maintain their control of the corporations, defendant,
who constituted a majority of the holdover board of directors passed a resolution
prohibiting unpaid shares of stock from voting.
This resolution was held invalid by the trial court, which ruled that if the
entire subscribed shares of stock were not paid, the paid shares of stock may not
be deprived of the right to vote. The Supreme Court held that since it was the
practice and procedure of the corporation to issue certificates of stock to its
individual subscribers, it may not take away the right to vote granted by such
certificates. Also, unless prohibited by its by-laws, certificates of stock may be
issued for less than the number of the shares subscribed for provided the par
value of each of the stocks represented by each of the certificates has been paid.
The provisions under Section 64 do not actually prohibit the same results
in Baltazar, but actually operates as a legal basis on the part of the corporation,
through its board of directors and officers, to refuse any claim by a subscriber to
issue certificate of stock covering the extent of shares that have been paid-up
while leaving the remaining balance unpaid. But nothing is Section 64 prohibits
the corporation from "dividing" the subscription of a subscriber by considering
portion thereof as fully paid and issuing a corresponding certificate over the paid-
up shares. But pursuant to Section 64, such option is only granted to the
corporation.
In the absence of provisions in the by-laws to the contrary, a corporation
may apply payments made by subscribers on account of their subscriptions
either as:
Under Section 43.2 of the Securities Regulation Code,80 the SEC may, by
specific rule or regulation, allow corporations to provide in their articles of
incorporation and by-laws for the use of uncertificated securities.
“Uncertificated security” is defined as security evidenced by electronic or
similar records.81
80
Rep. Act 8799 (May, 2000).
81
Sec. 3.14, The Securities Regulation Code (R.A. 8799).
2. Nature of Certificates of Stock
De los Santos v. Republic,82 held that in Philippine jurisprudence, a
certificate of stock is not a negotiable instrument, but is regarded as quasi-
negotiable in the sense that it may be transferred by endorsement, coupled with
delivery, but it is not negotiable because the holder thereof takes it without
prejudice to such rights or defenses as the registered owners or transferor's
creditor may have under the law, except insofar as such rights or defenses are
subject to the limitations imposed by the principles governing estoppel.
De los Santos based its ruling on the fact that under Section 35 of the
Corporation Law (now Section 63 of the Corporation Code), a sale of shares of
stock, even when coupled with endorsement and delivery of the covering stock
certificates, “shall not be valid, except as between the parties,” until it is “entered
and noted upon the books of the corporation,” and that such sale is “absolutely
void” and, hence, as good as non-existent,” as far as third parties and the
corporation is concerned.83
Tan v. Securities and Exchange Commission,84 discussed the nature and
function of 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 representative 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 share represented thereby, but is not in law the equivalent of such ownership.
It expresses the contract between the corporation and the stockholder, but it is
not essential to the existence of a share in stock or the creation of the relation of
shareholder to the corporation."85
Tan held that the lack of endorsement of a certificate of stock which had
been previously delivered to the corporation by the registered stockholder for
cancellation (and eventually returned to the stockholder for his endorsement)
would not prevent the corporation from cancelling in the books of the corporation
of such certificate and issuance of a new certificate in favor of the new owner of
the shares.
The statement in Tan that the certificate of stock does not represent
ownership of the shares covered therein should be understood in the light that
Tan essentially involved issues between intra-corporate members, namely the
corporation and the stockholder. The detailed provisions under the Corporation
Code on the issuance, registration and treatment of certificates of stock is meant
to protect the quasi-negotiable nature of the certificate of stock and its
acceptance in the world of commerce.
The SEC has aptly ruled that a person may own shares of corporate stock
without possessing a stock certificate which after all is merely an evidence of
82
96 Phil. 577 (1955).
83
Ibid, at p. 599.
84
206 SCRA 740 (1992).
85
Ibid, at pp. 749-750, citing 13 Am.Jr.2d 769.
ownership of the stock; and that for as long as the subscriber to the stock is duly
recorded in the stock and transfer book of the corporation as the owner, he is
considered a stockholder or record and is entitled to all the rights of a
stockholder.86
93
SEC Opinion, 8 January 1987, XXI SEC QUARTERLY BULLETIN 1 (No. 1, March 1987); SEC
Opinion, 9 June 1988, XXII SEC QUARTERLY BULLETIN 18 (Nos. 3, Sep. 1988).
94
SEC Opinion, 1 September 1995, XXX SEC QUARTERLY BULLETIN 27 (No. 1, June 1996).
95
292 SCRA 503, 96 SCAD 205 (1998).
(a) There must be delivery of the stock certificate;
(b) The certificate must be endorsed by the owner or his
attorney-in-fact or other persons legally authorized to make
the transfer; and
(c) To be valid against third parties, the transfer must be
recorded in the books of the corporation.
96
96 Phil. 577 (1955).
97
Ibid, quoting from 12 FLETCHER CYC. CORP., at 521-534).
98
89 Phil. 780 (1951).
consideration. She delivered it to R.J. Campos and Co., another brokerage firm,
to comply with the latter's requirement that she deposit something on account if
she wanted to buy shares of another mining corporation. Campos thereafter
delivered to a bank the said certificate duly indorsed to said bank pursuant to a
letter of hypothecation executed by Campos in favor of said bank. The said
certificate was delivered to the bank in the ordinary course of business, together
with many other securities, and the time it was delivered the bank had no
knowledge that the shares represented by the certificate belonged to Mrs.
Santamaria for it was in the for of a street certificate transferable by mere
delivery.
The Court held that she could not recover the certificates since she could
have asked the corporation that issued it to cancel it and issue another in lieu
thereof in her name. Her negligence was the immediate cause of the damage,
since the certificate was endorsed by her to constitute as a street certificate.
Upon its face, the holder was entitled to demand its transfer to his name from the
issuing corporation. The bank is not obligated to look beyond the certificate to
ascertain the ownership of the stock at the time he received it from Campos, it
having been given pursuant to a letter of hypothecation.
Of recent vintage is the ruling in Neugene Marketing, Inc. v. Court of
Appeals,99 where the Supreme Court held that when the certificates of stock
have been endorsed in blank for purposes of showing the nominee relations, the
eventual delivery and registration of the shares in violation of the trust
relationship and after their having been stolen, would be void, even when such
transfers have been registered in the stock and transfer book.
The proven facts in Neugene Marketing indicated that the registered
owners of the stock certificate had endorse them in blank for custody and
safekeeping of the beneficial owners thereof, who kept them in a family vault, but
where subsequently stolen. No negligence was found to have actuated the acts
of the registered owners. In addition, the proper corporate officers of the
corporation were aware of the blank endorsement of the certificates and
therefore were adjudged to have acted in bad faith in assigning the certificates to
other parties and in recording the transfers in the stock and transfer book.
The Court therefore held that since the certificates were endorsed in blank
and delivered for safekeeping and not in the process of negotiation, it was
essential that the beneficial owners must give their approval for the transfer of
the certificates that the beneficial owners for such transfers to be valid and
effective. Finally, the Court ruled in Neugene Marketing that the lack of
consideration for the transfers also made such transfers void and inexistent.
99
303 SCRA 295, 103 SCAD 526 (1999).
Under Section 73, the following procedure shall be followed for the
issuance by a corporation of new certificate(s) of stock in lieu of those which
have been lost, stolen or destroyed:
The registered owner of certificate(s) 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(s) were lost, stolen or
destroyed, the number of shares represented by each certificate, the serial
number(s) of the certificate(s) and the name of the corporation which issued the
same. He shall also submit such other information and evidence which he may
deem necessary.
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(s) of stock which have been lost, stolen or
destroyed.
The notice shall state the name of said corporation, the name of the
registered owner and the serial number(s) of said certificate(s) and the number of
shares represented by such certificate(s), and that after the expiration of one (1)
year from the date publication, if no contest has been presented to said
corporation regarding said certificate(s) of stock, the right to make shall such
contest shall be barred and said corporation shall cancel in its books the
certificate(s) of stock which have been lost, stolen or destroyed and issue in lieu
thereof new certificate(s) of stock, unless the registered owner files a bond or
other security in lieu thereof as may be required, running for period of one (1)
year for a sum 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 one (1) year period provided therein.
If a contest has been presented to said corporation or if an action is
pending in court regarding the ownership of said certificate(s) of stock which
have been lost, stolen or destroyed, the issuance of the new certificate(s) of
stock in lieu thereof shall be suspended until the final decision by the court
regarding the ownership of said certificate(s) of stock which have 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(s) of stock in lieu of those lost, stolen or
destroyed pursuant to the procedure above described.
Section 73 seeks to avoid duplication of certificates to the detriment of the
rightful owner. It is without prejudice to any court action over the lost certificates
of stock.
In an opinion,100 the SEC held that the requirements under Section 73 of
the Corporation Code are not mandatory, thus:
100
SEC Opinions, 28 January 1999 XXXIII SEC QUARTERLY BULLETIN 50 (No. 1, June 1999).
According to the SEC, foreign jurisprudence is replete with authorities to the effect that a
corporation may voluntarily issue a new certificate of stock in place of an original certificate which
has been lost or destroyed and it can be compelled to issue a new certificate without any
indemnity where upon the facts, it is reasonably certain that the original certificate will not
reappear, as where there is a clear proof that the original had been destroyed, or that it had been
lost or stolen, not having an assignment by the owner, or where the certificate was lost by the
corporation itself by carelessness, or if the corporation was otherwise protected, for in such a
case the corporation could not incur any liability by reason of the original certificate. While Section
73 of the Corporation Code appears to be mandatory, the same admits exceptions, such that a
corporation may voluntarily issue a new certificate n lieu of the original certificate of stock which
has been lost without complying with the requirements under Section 73 of the Corporation Code,
provided that the corporation is certain as to the real owner o the shares to whom the new
certificate shall be issued. SEC Opinion, 28 January 1999, XXXIII SEC QUARTERLY BULLETIN 50
(No. 1, June 1999).
(a) If so resolved by its Board of Directors and agreed by a
shareholder, issue shares to, or record the transfer of some
or all of its shares into the name of said shareholders,
investors or, securities intermediary in the form of
uncertificated securities;
(b) The use of uncertificated securities shall be without prejudice
to the rights of the securities intermediary subsequently to
require the corporation to issue a certificate in respect of any
shares recorded in its name; and
(c) If so provided in its articles of incorporation and by-laws,
issue all of the shares of a particular class in the form of
uncertificated securities and subject to a condition that
investors may not require the corporation to issue a
certificate in respect of any shares recorded in their name.
A transfer made pursuant to the foregoing has the effect of the delivery of
a security in bearer form or duly indorsed in blank representing the quantity or
amount of security or right transferred, including the unrestricted negotiability of
that security by reason of such delivery.101
However, transfer of uncertificated shares shall only be valid, so far as the
corporation is concerned, when a transfer is recorded in the books of the
corporation so as to show the names of the parties to the transfer and the
number of shares transferred.102
101
Sec. 43.3, The Securities Regulation Code.
102
Ibid.
book-entry security holdings of the participants or members held on behalf of the
clients.103 However, the corporation shall not be bound by the foregoing
transactions unless the corporate secretary is duly notified in such manner as the
SEC may provide.104
103
Sec. 44, The Securities Regulation Code.
104
Ibid.
105
Sec. 45, The Securities Regulation Code.
106
Ibid.
107
Ibid.
108
Ibid.
109
Sec. 46, The Securities Regulation Code.
(a) Validate the transfer of securities by book-entries rather than
the delivery of physical certificates;110
(b) Establish when a person acquires a security or an interest
therein and when delivery of a security to a purchaser
occurs;111
(c) Establish which records constitute the best evidence of a
person‟s interests in a security and the effect of any errors in
electronic records of ownership; 112
(d) Codify the rights of investors who choose to hold their
securities indirectly through a registered clearing agency
and/or other securities intermediaries; 113
(e) Codify the duties of securities intermediaries (including
clearing agencies) who hold securities on behalf of
investors;114 and
(f) Give first priority to any claims of a registered clearing
agency against a participant arising from a failure by the
participant to meet its obligations under the clearing
agency‟s rules in respect of the clearing and settlement of
transactions in securities, in a dissolution of the participant,
and any such rules and regulations shall bind the issuers of
the securities, investors in the securities, any third parties
with interests in the securities, and the creditors of a
participant of a registered clearing agency. 115
110
Sec. 47.1, Ibid.
111
Sec. 47.2, ibid.
112
Sec. 47.3, ibid.
113
Sec. 47.4, ibid.
114
Sec. 47.5, ibid.
115
Sec. 47.6, ibid.
(d) Such other entries as the by-laws may prescribe.
1. Where Kept
The stock and transfer book shall be kept in the principal office of the
corporation or in the office of its stock transfer agent and shall be open for
inspection to any director or stockholder of the corporation at reasonable hours
on business days.116
116
Sec. 74, Corporation Code.
117
Ibid.
118
Ibid.
119
278 SCRA 793, 86 SCAD 812 (1997).
120
XX SEC QUARTERLY BULLETIN 125 (Nos. 3 & 4, Sept. & Dec 1986).
5. BIR Certification to Effect Transfer of Shares
Under Section 97 of the 1997 National Internal Revenue Code, the
corporate secretary is not authorized to effect transfer of shares to any new
owner in the books of a corporation, unless accompanied by a certification from
the Commissioner of Internal Revenue that the taxes, either estate tax, donor's
tax, have been paid.
121
Bitong v. Court of Appeals, 292 SCRA 304, 96 SCAD 205 (1998).
which are or should be recorded in the corporate books and
records may be admitted where the original corporate records
are lost, mislaid or destroyed, or are otherwise inaccessible.
Proper foundation proof explaining the failure to produce the
original books and records must first be laid for the
introduction of other evidences. Such secondary evidence,
ordinarily consists of copies of the records, either certified or
sworn to, or parol testimony.122
122
SEC Opinion, 12 January 1994, XXVIII SEC QUARTERLY BULLETIN 33 (No. 2, June 1994),
citing I5 FLETCHER CYC. CORP., 1976 rev. vol., Sec. 2196 at p. 643; FLETCHER Sec. 2196, at p.
644; and FLETCHER, Sec. 2197, at p. 648.
123
Tan v. SEC, 206 SCRA 740 (1992).
The SEC has opined that the certificates of stock for fully paid shares may be issued
directly to the nominee provided it is with the subscriber‟s instructions. SEC Opinion, 14 January
1994, XXVIII SEC QUARTERLY BULLETIN 39 (No. 2, June 1994).
124
292 SCRA 304, 96 SCAD 205 (1998).
In Neugene Marketing, Inc. v. Court of Appeals, 125 the Court held that
when the certificates of stock have been endorsed in blank for purposes of
showing the nominee relations, the eventual delivery and registration of the
shares in violation of the trust relationship and after their having been stolen,
would be void, even when such transfers have been registered in the stock and
transfer book.
The Court also held in Neugene Marketing that the approval of the
beneficial owners of the shares held in trust is necessary for the validity and
effectivity of the transfer of the stock certificates. Likewise it was also held that
the lack of consideration for the transfer would make such transfers void and
inexistent.
125
303 SCRA 295, 103 SCAD 526 (1999).
126
Thomson v. Court of Appeals, 298 SCRA 280, 100 SCAD 415 (1998).
127
SEC Opinion, 8 August 1995, XXX SEC QUARTERLY BULLETIN 21 (No. 1, June 1996);
SEC Opinion, 20 February 1995, XXIX SEC QUARTERLY BULLETIN 4 (No. 3, Sept. 1995); SEC
Opinion, 13 January 1994, XXVIII SEC QUARTERLY BULLETIN 37 (No. 2, June 1994); SEC Opinion,
13 Oct. 1964, SEC FOLIO 1960-1976, at p. 217.
128
Ibid.
Under Section 63 of the Corporation Code, no shares of stock against
which the corporation holds any unpaid claim shall be transferable in the books
of the corporation. Therefore, a corporation may refuse to acknowledge and
register a sale or assignment of shares which are not fully paid, and may
continue to hold the original subscriber liable on the payment of the subscription.
However, China Banking Corp. v. Court of Appeals,129 has reiterated the
principle that Section 63 of the Corporation Code which provides that “no share
of stock against which the corporation holds any unpaid claim shall be
transferable in the books of the corporation” cannot be utilized by the corporation
to refuse to recognize ownership over pledged shares purchased at public
auction. The term “unpaid claims” refers to “any unpaid claims arising from
unpaid subscription, and not to any indebtedness which a subscriber or
stockholder may owe the corporation arising from any other transactions.
Obligations arising from unpaid monthly dues do not fall within the coverage of
Section 63.”
129
270 SCRA 503 (1997).
130
SEC Opinion, 9 October 1995, XXX SEC QUARTERLY BULLETIN 48 (No. 1, June 1996);
SEC Opinion, 3 June 1994, XXVIII SEC QUARTERLY BULLETIN 24 (No. 4, Dec. 1994); SEC
Opinion, 8 March 1990, XXIV SEC QUARTERLY BULLETIN 9 (No. 3, Sept. 1990).
131
Ibid.
132
SEC Opinion, 9 October 1995, XXX SEC QUARTERLY BULLETIN 48 (No. 1, June 1996);
SEC Opinion, 3 June 1994, XXVIII SEC QUARTERLY BULLETIN 24 (No. 4, Dec. 1994); SEC
Opinion, 17 September 1990, XXV SEC QUARTERLY BULLETIN 17 (No. 1, March 1991).
consonance with the principle in Contract Law that the substitution of the party of
the obligor can be made only with the express consent of the obligee, the
corporation being considered the obligee in a subscription contract.
In Uson, the Supreme Court resolved the issue of whether a bona fide
transfer of shares of a corporation, not registered or noted on the books of the
corporation, would be valid as against a subsequent lawful attachment of said
shares, regardless of whether the attaching creditor had actual notice of said
transfer or not. The Court held that transfer would be void.
The Court, through Mr. Justice Butte, held that the language of the then
Corporation Law was plain to the effect that the right of the owner of the shares
of stock of a corporation to transfer the same by delivery of the certificate,
whether it be regarded as a statutory or common right, was limited and restricted
by the express provision that "no transfer, however, shall be valid, except, as
133
61 Phil. 535 (1935).
134
Ibid, at p. 540, quoting from In re Murphy, 51 Wis., 519; 8 N.W., 419. Emphasis supplied.
between the parties, until the transfer is entered and noted upon the books of the
corporation."
Recently, in Garcia v. Jomouad,135 the Court reiterated and affirmed the
ruling in Uson, holding that “the transfer of the subject certificate . . . was not
valid as to the . . . judgment creditors, as the same still stood in the name of . . .
the judgment debtor, at the time of the levy on execution.” The Court also held
that the entry in the minutes of the meeting of the Club‟s board of directors noting
the resignation of the seller as proprietary member did not constitute compliance
with Section 63 of the Corporation Code, because said provision strictly requires
the recording of the transfer in the books of the corporation, and not elsewhere,
to be valid as against third parties.
The rationale for the Uson doctrine was explained in Escano v. Filipinas
Mining Corporation,136where the Supreme Court enumerated the following
reasons for holding registration of a sale or disposition of shares of stock valid
only when registered in the stock and transfer book of the corporation, thus:
(a) To enable the corporation to know at all times who its actual
stockholders are, because mutual rights and obligations
exist between the corporation and its stockholders;
(b) To afford to the corporation an opportunity to object or refuse
its consent to the transfer in case it has any claim against
the stock sought to be transferred, or for any other valid
reason; and
(c) To avoid fictitious or fraudulent transfers.
135
323 SCRA 424 (2000).
136
74 Phil. 711 (1944).
the stock and transfer book of transactions pertaining to shares over which no
certificate of stock has been issued by the corporation, thus:
137
Ibid.
138
292 SCRA 304, 96 SCAD 205 (1998).
3. Non-Exclusivity of Section 63 on Modes of Registration
Strictly speaking, Section 63 governs only the sale or assignment of
shares of stock, and specifically covered by a stock certificates. The use of the
word "may" in the section indicates that the endorsement and delivery of the
certificate and the registration of the transfer in the book of the corporation is only
one of the modes recognized by law by which to legally and effectively sale and
assign shares of stock that would be binding not only upon the contracting
parties, but also to the corporation and its officers and third parties who will deal
with the covered shares.
Embassy Farms, Inc. v. Court of Appeals,140 held that "[f]or an effective
transfer of shares of stock the mode and manner of transfer as prescribed by law
must be followed. . . As provided under Section 63 of . . . the Corporation Code
of the Philippines, shares of stock may be transferred by delivery to the
transferee of the certificate property indorsed. Title may be vested in the
transferee by the delivery of the duly indorsed certificate of stock."141
Tan v. Securities and Exchange Commission,142 held that delivery of the
certificate of stock in not essential in order to effect the transfer thereof in the
books of the corporation, "where is appears that the persons sought to be held as
stockholders are officers of the corporation, and have the custody of the stock
book."143 However, Tan should be viewed from the essence that the ruling was
issued involving intra-corporate parties, the corporation and the stockholder.
Tan also held that the mode of endorsement and delivery of certificate
provided for in Section 63 of the Corporation Code, is only one of the modes
recognized by the provision because of the use of the term "may" 144 and
considered the fact that when the parties to the sale, including the officers of the
corporation, have undertaken actions to recognized the sale of the shares, such
as the issuance of replacement certificate in the name of the transferee and the
registration thereof in the stock and transfer book, with full knowledge of the
transferor, the same should be recognized as a valid mode of sale of the covered
shares that binds not only the parties to the sale, but also the corporation, its
officers, and third parties who will deal with the shares, especially when the
transfer has been reported to the SEC, and the transferee had been exercising
rights of ownership over the covered shares.
But whatever may have been the mode of effecting the sale or assignment
of shares of stock, Magsaysay-Labrador v. Court of Appeals,145 holds that the
sale or assignment must be registered in the stock and transfer book of the
corporation in order to be binding on third parties. In that case, the Court held
139
Ibid; reformatted to enumerative format.
140
188 SCRA 492 (1990).
141
Ibid, at p. 498.
142
206 SCRA 740, 749 (1992).
143
Ibid, quoting from Tuazon v. La Previsora Filipina, 67 Phil. 36 (1938).
144
Ibid, at p. 748, citing Chua v. Samahang Magsasaka, 62 Phil 472 (1935).
145
180 SCRA 266 (1989).
that a transferee cannot claim a right to intervene as a stockholder in corporate
issue on the strength of the transfer of shares allegedly executed by a registered
stockholder. The transfer must be registered in the books of the corporation to
affect third persons and also the corporation. This principle was reiterated in
Bitong v. Court of Appeals.146
On the other hand, Razon v. Intermediate Appellate Court,147 held that
oral testimony to show that one is the principal or beneficial owners of shares of
stocks for which he has allowed a certificate of stock to be issued in the name of
his alleged nominee will not be sufficient basis to claim rightful ownership over
the shares of stock. The Court held that "[f]rom the point of view of the
corporation . . . the petitioner who claims ownership over the questioned shares
of stock must show that the same were transferred to him by proving that all the
requirements for the effective transfer of shares of stock in accordance with the
corporation's by laws, if any, were followed or in accordance with the provisions
of law. . . The petitioner failed in both instances. . . In the absence of the
corporation's by-laws or rules governing effective transfer of shares of stock, the
provisions of the Corporation Law are made applicable to the instant case. The
law is clear that in order for a transfer of stock certificate to be effective, the
certificate must be properly indorsed and that title to such certificate of stock is
vested in the transferee by the delivery of the duly indorsed certificate of
stock."148
146
292 SCRA 304 (1998).
147
207 SCRA 234 (1992).
148
Ibid, at pp. 240-241.
149
19 Phil. 138 (1911).
where there is no intention to part with the title thereto but merely to guaranty the
payment of a loan.
Thus, today we have at the back of certificates of stock the following
inscription, and signed by the registered shareholder in the certificate:
150
Won v. Wack Wack Golf & Country Club, 104 Phil. 466 (1958)
151
147 SCRA 4, 8 (1987).
The SEC recognizes the well-settled principle that shares of stock in a
corporation are personal property and the owner thereof has an inherent right, as
an incident of his ownership, to transfer the same at will, which would include the
power to encumber said shares.152
The SEC has, however, as a matter of policy, allowed reasonable
restrictions on the right of shareholders to encumber their shares if the
restrictions comply with the provisions of Article 93 of the Corporation Code,
namely, that the restriction must appear in the articles of incorporation, by-laws
and the certificates of stock, and that said restrictions shall not be more onerous
than granting the existing stockholders or the corporation the option to purchase
the shares of the transferring stockholder with such reasonable terms, conditions
or period stated therein.153
Therefore, if the restriction on the right to pledge or mortgage shares of
stock absolutely prohibits the stockholders from pledging or mortgaging their
shares without the consent of the board of directors, it would be violative of the
statutory right of the stockholders to encumber shares of stock as allowed in
Section 55 of the Corporation Code.154
However, when the restriction merely allows the corporation or existing
stockholders to accept the offer within the option period, and thereafter, if no one
accepts the offer, the stockholder is free to pledge or mortgage his shares in
favor of any third party, such provision is reasonable, valid and binding. 155
152
SEC Opinion, 8 August 1995, XXX SEC QUARTERLY BULLETIN 21 (No. 1, June 1996).
153
Ibid.
154
Ibid.
155
Ibid.
156
44 Phil 705 (1923).
may be assigned and that the assignment is valid as between the parties and as
to persons to whom notice is brought home."157
Nevertheless, the Court admitted to the difficulty in pinning down notice of
a chattel mortgage over shares of stock on third parties: "an equity in shares of
stock is of such an intangible character that it is somewhat difficult to see how it
can be treated as a chattel and mortgaged will furnish constructive notice to third
parties."158 The Court observed:
However, the Court is Fua Cun did not have to answer such an issue,
since the facts of the case clearly showed that the bank had been given prior
notice of the chattel mortgage over the shares by the mortgagee before bank
enforced any lien on the shares. The Court noted that prior lien existed in favor of
the bank because "[a]t common law a corporation has no lien upon the shares of
stockholders for any indebtedness to the corporation."160
It should be noted however that a limited lien has been placed in favor of
the corporation under Section 63 of the Corporation Code that provides that "No
shares of stock against which the corporation holds an unpaid claim shall be
transferable in the books of the corporation." However, the same is not a lien for
the claims of the corporation against the stockholder on contractual obligations,
and certainly does not cover encumbrances since the statutory language only
157
Ibid, at pp. 709-710.
158
Ibid, at pp. 708-709).
159
at p. 709, quoting from Spalding v. Paine's Adm'r., 81 Ky. 416.
160
Ibid.
covers "transfers". It merely authorizes the corporation not to recognize any sale
or assignment of shares over which the subscription has not been fully paid and
to hold the original subscriber liable for the payment of the subscription.
In addition, the Court held that Fua Cun's right did not only cover half of
the shares paid, but actually the entire numbers of shares subscribed even
though only half of the subscription had only been paid by Chua. "The plaintiff's
rights consist in an equity in five hundred shares and upon payment of the unpaid
portion of the subscription price he becomes entitled to the issuance of a
certificate for said five hundred shares in his favor."161 This supports the issue
that it is subscription, and not payment of the subscription, that determines the
right and standing of a stockholder in the corporation and the equity interest he
has, and that generally an obligation to pay subscription is not a divisible
obligation.
Therefore, under Section 72 of the Corporation Code, holders of
subscribed shares not fully paid which are not delinquent shall have all the rights
of a stockholder. The paid-up portion is only essential and affects the right of a
stockholder in the event of a call and delinquency proceedings.
161
Ibid, at p. 710.
162
58 Phil. 469 (1933).
as to the other can only refer to "transfers" or dispositions and not to
encumbrances or security arrangements involving shares of stock.
The Court therefore held that "the chattel mortgage is not the transfer
referred to in [Section 63 of the Corporation Code], which transfer should be
entered and noted upon the books of the corporation in order to be valid, and
which, as has already been said, means the absolute and unconditional
conveyance of the title and ownership of a share of stock."163 In short, Monserrat
held that when it comes to mortgages and other encumbrances covering shares
of stock "which are not a complete and absolute alienation of the dominion and
ownership thereof, its entry and notation upon the books of the corporation is not
necessary requisite to its validity."164
Monserrat clearly implies that a notation in the stock and transfer book
covering transfer of ownership or dominion over shares, binds the world even
when no actual notice thereof is obtained by third parties dealing with the share,
and that notation of such disposition or transfer must be made in the stock and
transfer book, not only for notice, but also validity of the transition. Whereas,
when it comes to encumbrances on shares of stock, not only is the notation
thereof in the stock and transfer book not necessary for its validity, but the
notation thereof in the stock and transfer book would not even bind the world or
third parties dealing with the shares without actual knowledge.
Parenthetically, the ratiocination in Monserrat using the language of
Section 63 could lead to the absurd conclusion that if annotation of an
encumbrance in the stock and transfer book is not necessary for its validity, then
annotation of a disposition of shares of stock is necessary in the stock and
transfer book for the validity of such disposition. That would mean that
registration in the stock and transfer book is the fourth requisite for the validity of
a disposition of shares (aside from consent, cause and consideration). So that if
an assignment of shares of stock is not annotated in the stock and transfer book,
it is valid as to the parties, and void as to everybody else. That means also, that
actual knowledge of a third person of such a disposition means nothing since the
same is void anyway, and until the fourth requisite is complied with, i.e.,
registration in the stock and transfer book, actual knowledge would not validate
the disposition.
Such an implication cannot be reasonably inferred from the reasoning in
Monserrat, since Fua Cun itself has said that "[t]here can be no doubt that an
equity in shares of stock may be assigned and that the assignment is valid as
between the parties and as to persons to whom notice is brought home."165
In Chua Guan v. Samahang Magsasaka, Inc.,166 the registered owner
mortgaged the shares, and the mortgagee not only registered the mortgage with
the registry of deeds, but also in the books of the corporation. When the
163
Ibid, at p. 474.
164
Ibid, at p. 474.
165
Ibid, at p. 710.
166
62 Phil. 472 (1935),
mortgagee foreclosed on the mortgage, the officers of the corporation refused to
issue new certificates in the name of the mortgagee as the winning bidder thereof
in the auction sale, on the ground that before the mortgagee made his demand
upon the corporation, writs of attachments had been served upon and registered
in the books of the corporation against the mortgagor, which the mortgagee
refused to have annotated in the new certificate to be issued to him.
To resolve the issue of whether the mortgage took priority over the writs of
attachment, the Court had to determine whether the registration of the chattel
mortgage in the registry of chattel mortgages in the office of the register of deeds
was equivalent to constructive notice to the attaching creditors.
The Court first settled the issue by affirming the Monserrat doctrine that
"the registration of the said chattel mortgage in the office of the corporation was
not necessary and had no legal effect."167 It also held that the annotation of such
mortgage on the certificate does not also produce legal effect.
Taking its cue from the Chattel Mortgage Law,168 the Court held:
167
Ibid, at p. 477.
168
Act No. 1508, as amended.
169
Ibid, at p. 478.
170
Ibid, at p. 480, quoting 11 FLETCHER CYC. PRIVATE CORP.,par. 5106. Cf. sections 430 and
450, Code of Civil Procedure.
The Court then held that "considering the ownership of shares in a
corporation as property distinct from the certificates which are merely the
evidence of such ownership, it seems to us a reasonable construction . . . to hold
that the property in the shares may be deemed to be situated in the province in
which the corporation has its principal office or place of business. If this province
is also the province of the owner's domicile, a single registration is sufficient. If
not, the chattel mortgage should be registered both at the owner's domicile and
in the province where the corporation has its principal office or place of business.
In this sense the property mortgaged is not the certificate but the participation
and share of the owner in the assets of the corporation."171
The requirements do not seem practical. If a contract more onerous than
encumbrance, such as the assignment of shares, could validly be annotated in
the stock and transfer book to affect the whole world, why not provide the same
requirement for a contract less invasive as a mortgage. The law should be
interpreted, if not amended, to read that both encumbrances and transfer of
shares should be valid only as against the parties and void as against third
persons unless annotated in the stock and transfer book.
Chua Guan also held that although under Section 63 the surrender of
certificate is necessary to effect the transfer of shares, nevertheless, the "use of
the verb „may‟ does not exclude the possibility that a transfer may be made in
different manner." That means that the execution of a deed of assignment can be
a valid mode of transferring title covering shares of stock.
However, the broad statement in Chua Guan was modified in the later
case of Nava v. Peers Marketing Corporation.172 In Nava, Po subscribed 80
shares of stock of the corporation of which only 20 shares were unpaid by him,
leaving to the corporation an unpaid claim of P6,000 as the balance due on his
subscription. The 20 shares were not covered by any stock certificate. He
subsequently transferred the 20 shares to Nava. Nava asked the corporation to
enter in its book his name as the owner of the 20 shares. When the corporation
refused, Nava brought an action for mandamus.
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 (now
Section 63 of the Corporation Code). "As a rule, the shares which may be
alienated are those which are covered by certificates of stock as governed by
Section 35 of the Corporation Law." Moreover, the Court noted that "the
corporation has a claim on the said shares for the unpaid balance of Po's
subscription. A stock subscription is a subsisting liability from the time the
subscription is made. The subscriber is as much bound to pay his subscription as
he would be to pay any other debt. The right of the corporation to demand
payment is no less incontestable."173 Hence, under the facts of the case, the
171
Ibid, at pp. 480-481.
172
74 SCRA 65 (1976).
173
Ibid, at p. 69.
Court held that there was no clear duty on the part of the officers of the
corporation to register the twenty shares in Nava's name, and therefore no cause
of action for mandamus.
The Court also took into consideration the assertion of Nava that in the
case of Baltazar v. Lingayen Gulf Electric Power Co.,174 he should be issued a
certificate of stock to the portion of the shares already paid for. The Court said
that the doctrine of Baltazar only applies if indeed a certificate of stock had been
issued by the corporation. "As already stressed, in this case no stock certificate
was issued to Po. Without the 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."175 and that "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."176
Bachrach Motor Co. v. Lacson Ledesma,177 held that a mortgage or
pledge over shares of stock is governed also by the principle in the Civil Code
that in order to be effective as against third persons, evidence of its date must
appear in a public instrument; however, this principle has been modified by the
Chattel Mortgage Law in the sense that a contract of pledge and that of chattel
mortgage, to be effective as against third persons, need not appear in public
instruments provided that thing pledged or mortgaged be delivered or placed in
the possession of the creditor. Consequently, it held that the pledge of shares of
stock covered by a certificate is valid and binds third parties, when certificate of
stock has been endorsed and delivered to the creditor, notwithstanding the fact
that the contract does not appear in a public instrument. In sustaining such
doctrine, the Court held:
174
14 SCRA 522 (1965).
175
Supra, at p. 71, citing Davis v. Wachter, 140 So. 361.
176
Ibid, at p. 71, citing Samllwood v. Moretti, 128 So. 2d 628.
177
64 Phil. 681 (1937).
instruments, in passing from hand to hand, especially where
they are accompanied by an assignment and power of
attorney, executed in blank, to transfer them to anyone who
may obtain possession as holders, even though such
assignment and power are under seal.178
It should be noted that both Chua Guan and Bachrach Motors covered the
issue on what type of registration would constitute valid constructive knowledge
to third parties on encumbrances covering shares of stock. Both cases covered
shares of stock for which certificates of stock have been issued. Chuan Guan
held that to be binding on third parties, the encumbrance must be registered with
the registry of deeds of the place of principal office of the corporation and
residence of the mortgagor; whereas Bachrach Motors held that no such
registration is necessary to bind third parties when the certificate of stock
evidencing the shares mortgaged or pledged is endorsed and delivered to the
mortgagee.
Perhaps in finding our way through the conflict, it is important to note that
in Chua Guan, it was the corporation itself that refused to recognize the
mortgage over shares, where previously attachments thereon had been served
upon the corporation. On the other hand, Bachrach Motors involved a suit
between the creditors of the registered stockholder and the mortgagee of the
shares. However, it would seem from the language of Chua Guan, that it meant
to confront the issue that if registration were the mode to bind third parties, what
type of registration would that be. Thus, Chua Guan held:
178
Ibid, at pp. 695-696, quoting from 14 C.J., 665, sec. 1034; South Bend First Nat. Bank v.
Lanier, 20 Law. Ed., 172; Weniger v. Success Min. Co., 227 Fed 548; Scott v. Pequonnock Nat.
Bank, 15 Fed. 494.
179
Ibid, at p. 479.
on third parties. Whereas, in the absence of such delivery, then Chua Guan tells
us that double registration with the proper registers of deeds should be complied
with to make the encumbrance binding on third parties.
Lately, the Supreme Court reiterated in Lim Tay v. Court of Appeals,180 the
doctrine that when shares of stocks are pledged by means of endorsement in
blank and delivery of the covering certificates to secure a mortgage loan, the
pledgee does not become the owner of the shares simply by the failure of the
registered stockholder to pay his loan. Consequently, without proper foreclosure,
the lender cannot demand that the shares be registered in his name, since a
contract of pledge of shares does not make the pledgee the owners of the shares
pledged.
180
293 SCRA 634 (1998).
181
62 Phil. 472 (1935).
attachments received by the corporation and noted on its records before the
corporation received notice from the mortgagee Chua Chiu of the mortgage of
the 5,894 shares in June, 1931.
In its decision, the Supreme Court noted that "[n]o question is raised as to
the validity of the said mortgage or of said writs of attachment and the sole
question presented for decision is whether the said mortgage takes priority over
the said writs of attachment."182 In addition, the Court noted that "[i]t is not
alleged that the said attaching creditors had actual notice of the said mortgage
and the question therefore narrows itself down to this: Did the registration of said
chattel mortgage in the registry of chattel mortgages in the office of the register of
deeds of Manila . . . give constructive notice to the said attaching creditors?"183
In resolving the issue against Chua Guan, the Court noted in passing that
"the registration of the said chattel mortgage in the office of the corporation was
not necessary and had no legal effect . . . [and that the] long mooted question as
to whether or not shares of a corporation could be hypothecated by placing a
chattel mortgage on the certificate representing such shares we now regard as
settled by the case of Monserrat vs. Ceron. . ."184
Looking at the provisions of the Chattel Mortgage Law185 the Supreme
Court noted that there are generally two ways of executing a valid chattel
mortgage "which shall be effective against third persons. First, the possession of
the property mortgaged must be delivered to and retained by the mortgagee;
and, second, without such delivery the mortgage must be recorded in the proper
office or offices of the register or registers of deeds."186 When possession of the
property cannot be delivered to the mortgagee, the Court noted the provisions of
the Law which required that if the property is situated in a different province from
that in which the mortgagor resides, the mortgage shall be recorded in the office
of the register of deeds, of both the province in which the mortgagor resides and
that in which the property is situated.
The Court then in Chua Guan laid down the rule of double registration
when it comes to chattel mortgage involving shares of stock in a corporation:
182
Ibid, at p. 477.
183
Ibid.
184
Ibid.
185
Sec. 4, Act No. 1508.
186
Supra, at p. 479.
domicile and in the province where the corporation has its
principal office or place of business. In this sense the property
mortgage is not the certificate but the participation and share
of the owner in the assets of the corporation.187
Consequently, the Court in Chua Guan held that since the chattel
mortgage in favor of Chua Guan, although registered in the stock and transfer
book, but was not registered in the register of deeds in the principal place of
business of the corporation, then the attaching creditors are entitled to priority
over the defectively registered mortgage of Chua Guan.192
187
Ibid, at pp. 480-481.
188
Ibid, at p. 478.
189
Ibid, at p. 480.
190
Ibid.
191
Ibid, citing FLETCHER, CYC. ON THE LAW OF PRIVATE CORP., par. 5106.
192
Ibid, at p. 482.
3. Attaching or Levying Creditors Versus Other Creditors
Subsequently, in the unreported case of Samahang Magsasaka, Inc. v.
Chua Guan,193 the summary report indicated the salient facts to be that in the
decision of the trial court it was held that "Gonzalo Chua Guan is the legal owner
of the 5,894 shares of stock in question and has a better right to said shares than
each and every one of the attaching creditors."
The summary reported that the Supreme Court reversed the decision of
the lower court holding that the rights of the attaching creditors to the 5,894
shares of stock in Samahang Magsasaka, Inc. enjoy priority over the rights of
Chua Guan since "as between the two appellants the right of the first enjoys
priority over the second, it having been registered ahead on the books of the
corporation." The holding would still be consistent with the facts as reported in
the earlier Chua Guan case where the Supreme Court noted that first eight of the
nine (9) attachments were received by the corporation and noted on its records
before the corporation received notice from the mortgagee Chua Chiu of the
mortgage of the 5,894 shares in June, 1931.
Placing priority in the registration in the stock and transfer book as the
determining factor seems to be a good rule-of-thumb since the only objective
basis by which third parties who deal with the shares of stock of a judgment
debtor would be to verify the stock and transfer book to determine whether he is
still the rightful owner. Since attachments and levy are involuntary dealings on
the shares of stock of the registered stockholder, who may himself be unaware of
their application over his shares, it is only correct to make the registration in the
stock and transfer book the final arbiter as to priority among several attaching
creditors and even as to buyers or assignees of the shares sold or assigned by
the seller in good faith being unaware of the application of a writ of attachment or
levy upon his shares.
Earlier, in Chua Guan, the Supreme Court had recognized the situation
that shares standing in the name of the debtor in the books of the corporation will
be liable to seizure by attachment or levy on execution at the instance of other
creditors even when the debtor had previously sold or assigned the shares to a
third party and indorsed and delivered the covering stock certificates. 194
193
96 Phil. 974 (1955).
194
62 Phil. 472, 481.
195
251 SCRA 257, 66 SCAD 557 (1995).
agreement executed by Garcia. In July 1985, the writ was enforced against
Garcia's shares of stock with Chemphil which were garnished, but the writ was
not annotated in Chemphil's stock and transfer book. When the judgment was on
appeal with the Court of Appeals, a compromise agreement was entered into.
Subsequently, Garcia sold his Chemphil shares which ultimately were
assigned to CEIC. In June 1989, the shares were registered and recorded in the
corporate books of Chemphil in CEIC's name and the corresponding stock
certificates were issued to it.
Meanwhile, because of Garcia's failure to comply with the compromise
judgment, in July 1989, the consortium filed a motion for execution and among
the properties levied were Garcia's shares in Chemphil previously garnished. The
consortium became the highest bidder of the Chemphil shares at public auction.
On motion of the consortium, the trial court issued an order directing the
corporate secretary of Chemphil to enter in its stock and transfer books the
sheriff's certificate of sale, to cancel the certificates of stock of "Garcia and all
those which may have subsequently been issued in replacement and/or in
substitution thereof," and to issue new certificates of stock in the name of the
banks in the consortium.
CEIC filed a motion to intervene seeking the recall of the order on the
grounds that it is the rightful owner of the disputed shares, having bought them
from Garcia. The consortium filed their opposition alleging that their attachment
lien over the disputed shares of stocks must prevail over the private sale in favor
of the CEIC considering that said shares of stock were garnished in the
consortium's favor as early as July 1985.
In ruling for CEIC, the trial court, among other things found that CEIC
acquired the shares without knowledge of the previous attachment in favor of the
consortium since it was not annotated in the stock and transfer books of
Chemphil. It also cited the unreported case of Samahang Magsasaka, Inc. v.
Chua Guan,196 where it was held that "as between two (2) attaching creditors, the
one whose claims was first registered on the books of the corporation enjoy
priority."197 It ruled that "a levy on the shares of corporate stock to be valid and
binding on third persons, the notice of attachment or garnishment must be
registered and annotated in the stock and transfer books of the corporation."
The Court of Appeals overturned the decision of the lower court on the
ground that under Section 7(d), Rule 56 of the Rules of Court, a notice of
garnishment is duly served by the sheriff on the President of Chemphil, and this
would be binding on third parties.
On appeal, the Supreme Court sustained the decision of the Court of
Appeals that found that to be valid and binding on third parties, no law requires
that an attachment of shares of stock be recorded in the stock and transfer book
of the corporation.
196
96 Phil. 974 (1955)
197
251 SCRA 257, 270, 366 SCAD 557, 580 (1995).
In addition, the Supreme Court held that the rule laid down in Samahang
Magsasaka, Inc. v. Chua Guan did not have application in the case since CEIC
was not an attaching creditor.198 It added also that "[n]owhere in the said decision
was it categorically stated that annotation of the attachment in the corporate
books is mandatory for its validity for the purpose of giving notice to third
persons."199
The Court held that attachment of shares of stock are not included in the
term "transfer" as provided in Section 63 of the Corporation Code, since only
absolute transfers of shares of stock are required to be recorded in the
corporation's stock and transfer book in order to have "force and effect as against
third persons,"200 since an attachment does not constitute an absolute
conveyance of property but is primarily used as a means "to seize the debtor's
property in order to secure the debt or claim of the creditor in the event that a
judgment is rendered."201
Therefore, according to the Supreme Court since the claim of CEIC over
the Chemphil shares was based on the Deed of Sale, it is a settled rule that a
purchaser of attached property acquires it subject to an attachment legally and
validly levied thereon.202
The difficulty with the Chemphil doctrine on attachment is that although
granting that the attachment of shares of stock by service of the writ on the
proper corporate officer is valid, the doctrine would make it binding on any third
party who deals with the shares even when he purchases the shares in good
faith and for value, i.e., without notice of the attachment. Under the Chemphil
ruling, in order for a would-be buyer to determine the whether the registered
stockholder still has the rightful ownership of the shares registered in the stock
and transfer book in his name, the would-be buyer would still necessarily have to
determine from the proper corporate officers whether the subject shares have
been previously garnished or attached which process have not yet been
registered, and according to the doctrine need not be registered, in the stock and
transfer book of the corporation. The public dealing with shares of stock do not
therefore have the unbiased stock and transfer book to rely upon, but actually
must rely upon the fortitude, and perhaps even honesty of corporate officers.
In a contest therefore between a buyer in good faith and the attaching
creditor over the shares of stock of the seller-judgment debtor, the buyer in good
faith cannot rely alone on what appears in the stock and transfer book and the
fact that the covering certificates have been duly endorsed and delivered to him
by the registered owner thereof, since his rights would be defeated by a
judgment creditor who has been able to previously serve a writ on the proper
corporate officer although nothing at all is indicated in the stock and transfer
book.
198
Ibid, at p. 281.
199
Ibid, at p. 285.
200
Ibid, at pp. 283-284.
201
Ibid.
202
Ibid, at p. 285.
The effect of the Chemphil doctrine is to dilute the quasi-negotiable
character of the certificate of stock. The proper solution should be the same as
that provided for in the case of negotiable documents of title under Article 1519 of
the Civil Code which provides that when the document of title issued is
negotiable in character, the goods covered thereby "cannot be attached by
garnishment or otherwise or be levied under an execution unless the document
be first surrendered to the bailee or its negotiations enjoined." In the same
manner where the shares of stock are covered by a certificate of stock, in order
to protect the public who takes the certificate of stock in the form of a quasi-
negotiable instrument, then there should not be allowed an attachment or levy of
the underlying shares unless the certificate is also attached or levied upon or its
negotiation enjoined; and the simplest manner by which this can be done is to
require that the attachment or levy must first be annotated in the stock and
transfer book in order to be valid and binding as against third parties.
—oOo—-
203
Chua Guan v. Samahang Magsasaka, Inc., supra, at p. 482.
CHAPTER 11
——
(a)The default rule is that all stockholders have equal rights and
obligations, expressed in the last paragraph of Section 6 that
provides: “each share shall be equal in all respects to every
other share.”
(b) When preferences or restrictions are made to apply to a
class of shares, then such preferences on restrictions shall
exists and be valid only when the particular form and
procedure mandated by the Code, which under the same
section provides that it be “provided in the articles of
incorporation and stated in the certificate of stock.”
Section 6 provides in clear terms that although the default rule is that all
shareholders have equal rights and obligations, nevertheless, when authorized
by the articles of incorporation, the board of directors, may fix the terms and
conditions of preferred shares of stock or any series thereof, or to classify its
shares for the purpose of insuring compliance with constitutional or legal
requirements;1 however, such terms and conditions shall be effective upon filing
of a certificate thereof with the SEC.2
Cojuangco Jr. v. Roxas,3 recognized the important rights of stockholders,
which continue to remain with the stockholders even when the shares have been
sequestered, to be the following: (a) the right to vote; (b) the right to receive
dividends; (c) the right to receive distributions upon liquidation of the corporation;
and (d) the right to inspect the books of the corporation. Such rights pertain to all
stockholders without the need for any express or enabling provision in the
articles of incorporation, or the by-laws.
Other rights to which stockholders are entitled to, such as the right to
transfer or dispose of his fully paid shares of stock and the right to file derivative
suit, also underscore the proprietary nature of the shares as medium of
investments on the part of stockholders, a purely business relationship not
focused on any personality relationship, as consistent to the "for profit" nature of
stock corporations, and consistent with the corporate feature of presenting to the
commercial world “freely-transferable units of ownership.”
2. Rights of Members
On the other hand, the eleemosynary nature of non-stock corporations
define the characteristic of membership therein as being essentially personal in
nature and therefore not generally transferable.
Section 89 of the Corporation Code specifically provides that the right of
members of any class or classes to vote “may be limited, broadened or denied to
the extent specified in the articles of incorporation or the by-laws” of a non-stock
corporation.
The SEC has opined that the rule in Section 6 allowing non-voting shares
to vote on specified fundamental matters does not apply to non-voting members
of a non-stock corporation; that insofar as members of a non-stock corporation,
the applicable provision is not Section 6 but Section 89 of the Code, which
specifically provides that members may be denied entirely their voting rights in
the articles of incorporation or by-laws of the corporation.4
Section 89 also provides that the right of members to vote by proxy may
be denied under the articles of incorporation or by-laws of a non-stock
corporation.5
1
Sec. 6, Corporation Code.
2
Ibid.
3
195 SCRA 797 (1991).
4
SEC Opinion, 4 September 1995, XXX SEC QUARTERLY BULLETIN 29 (No. 1, June 1996).
5
See also SEC Opinion, 20 September 1994, XXIX SEC QUARTERLY BULLETIN 20 (No.1,
March 1995).
Under Section 90 of the Code, membership in a non-stock corporation and
all rights arising therefrom are personal and non-transferable, unless the articles
of incorporation or the by-laws otherwise provide.
Under Section 91 of the Code, membership shall be terminated in the
manner and for the causes provided in the articles of incorporation or the by-
laws. Termination of membership shall have the effect of extinguishing all rights
of a member in the corporation or in its property, unless otherwise provided in the
articles of incorporation or the by-laws.
PRE-EMPTIVE RIGHT
Section 39 of the Corporation Code provides that all stockholders of a
stock corporation shall enjoy pre-emptive rights to subscribe to “all issues or
disposition” of shares of any class, in proportion to their respective
shareholdings.
Pre-emptive right refers to the common law right granted to the
stockholders of a corporation to be granted the first option to subscribe to any
opening of the unissued capital stock, or to any increase of the authorized capital
stock, of the corporation.
The recognition of the pre-emptive right is intended to protect both the
proprietary and voting rights of a stockholder in a corporation. The proportionate
interests of a stockholder in a corporation determines his proportionate power to
vote in corporate affairs when the law gives the stockholders a right to affirm or
deny board actions. The proportionate interest of the stockholder to the
outstanding capital stock also determines his proportionate share in the
dividends declared by the corporation, as well as his proportionate right to the
remaining assets of the corporation upon dissolution of the corporation. 6
6
SEC Opinion, 11 August 1997, XXXII SEC QUARTERLY BULLETIN 15 (No. 2, Dec. 1997);
SEC EAD Memo, dated 29 July 1997.
(a) When such right is denied by the articles of incorporation or
an amendment thereto;
(b) Stockholders have no pre-emptive rights to the issuance of
shares from the capital stock of the corporation:
12
SEC Opinion, 14 January 1993, XXVII SEC QUARTERLY BULLETIN 16 (No. 2, June 1993).
13
Ibid, at p. 18.
A "right of prior consent" provision would require that any stockholder who
may wish to sell, assign or dispose of his shares in the corporation may do so
only when he obtains the consent of the board of directors or other stockholders
of the corporation. Such stipulations are void since they unduly restrain the
exercise of the stockholder of his proprietary interest in the shares, as illustrated
in a situation where a stockholder cannot dispose of his shares because of failure
to obtain such consent.
A "buy-back agreement" exists in situations when shares are given or
assigned to officers or employees under the condition that should they resign or
be terminated from employment, the corporation shall be granted the right to buy-
back the shares. Such stipulations are valid so long as the terms and the
consideration are reasonable.
An absolute prohibition to transfer shares, even when contained in the
articles of incorporation, would be void since it would violate the provision of
Section 63 of the Corporation Code which treats of shares of stock as personal
property of which the stockholder has the inherent right to dispose as incident of
his ownership.14
14
SEC Opinion, 20 February 1995, XXIX SEC QUARTERLY BULLETIN 4 (No. 3, Sept. 1995).
15
26 Phil. 588 (1914).
alienation of stock, limiting ourselves to the statement that the suspension in this
particular case is legal and valid."
Although the SEC may render the shareholder agreement imposing
restrictions on transfer of shares uneforceable against third-party purchasers
without notice, restriction on the power to transfer shares of stock in a
shareholder‟s agreement, even if not provided for in the articles of incorporation
or by-laws, was held to be binding upon the stockholders who are parties thereto
since they are chargeable with notice, unless palpably unreasonable under the
circumstances as to justify the restriction overriding the general policy against
restraint on alienation of personal property.16
b. Restriction in By-Laws
In Fleischer v. Botica Nolasco Co.,17 Manuel Gonzales was the original
owner of the 5 shares of stock of the Botica Nolasco, Inc., which he indorsed and
delivered said shares to plaintiff Henry Fleischer, in consideration of a large sum
of money owed by Gonzales to Fleischer. The secretary-treasurer of said
corporation, offered to buy from Henry Fleischer, on behalf of the corporation,
said shares of stock, at their par value of P100 a share, for P500 by virtue of
article 12 of the by-laws giving said corporation the preferential right to buy from
Gonzales said shares.
The plaintiff Fleischer refused to sell to the defendant and requested
corporate secretary to register said shares in his name, but the request was
refused by the corporate secretary contending that it would be in contravention of
the by-laws.
The Supreme Court declared void the by-law provision which granted to
the stockholders a right of first refusal over shares sought to be disposed by
other stockholders. In voting down the by-law provision, the Court relied upon the
provision of then Section 35 of the Corporation Law that provided that "shares of
stock so issued are personal property and may be transferred by delivery of the
certificate indorsed by the owners or his attorney in fact or other person legally
authorized to make the transfer." Under the doctrine that a corporation can adopt
by-law provisions only insofar as they are not inconsistent with any existing law,
the right of first refusal was deemed void. In supporting this contention, the Court
relied upon American rulings that "[t]he power to enact by-laws restraining the
sale and transfer of stock must be found in the governing statute or the charter."
A careful review of the Court's reasoning in Fleischer shows it was not the
ruling to declare void provisions on rights of first refusal per se, but more properly
the ruling was meant to put by-laws in their proper hierarchical value, that is, it is
not the function of by-laws to take away or abridge the substantial rights of
stockholders. In fact, the ruling recognized that the same may be done either
pursuant to a legal provision or in the articles of incorporation. This doctrine has
remained consistent with the provisions of Section 6 of the Corporation Code that
16
SEC Opinion, 8 June 1995, XXIX SEC QUARTERLY BULLETIN 32 (No. 4, Dec. 1995)
17
47 Phil. 583 (1925).
requires that any privilege or restriction pertaining to shares of stock should be
found in the articles of incorporation.
In addition Fleischer seems to support the opinion that by-law provisions
are essentially intramural covenants and do not bind the public, thus:
However, in Padgett v. Babcock & Templeton, Inc.,19 the Court held that
the indication on the face of the stock certificate that it is "nontransferable" alone
does not compel the corporation to buy back the shares from the stockholder,
and held that "in the absence of a similar contractual obligation and of a legal
provision applicable thereto, it is logical to conclude that it would be unjust and
unreasonable to compel the said defendants to comply with a non-existent or
imaginary obligation."20
The Fleischer ruling was reiterated in Rural Bank of Salinas v. Court of
Appeals,21 where the Court held that the only limitation imposed by Section 63 of
the Corporation Code is when the corporation holds any unpaid claim against the
shares intended to be transferred, and that “[a] corporation, either by its board, its
by-laws, or the act of its officers, cannot create restrictions in stock transfers,
because „xxx Restrictions in the traffic of stock must have their source in
legislative enactment, as the corporation itself cannot create such impediment.
By-laws are intended merely for the protection of the corporation, and prescribe
relation, not restriction; they are always subject to the charter of the corporation.‟”
18
Ibid, at p. 592.
19
59 Phil. 232 (1933).
20
Ibid, at 235.
21
210 SCRA 510 (1992).
22
G.R. No. 82188, 30 June 1988 [unreported].
belongs only to the stockholders of the corporation, who then would have the
sole authority to waive it.23
The SEC, as a matter of policy, allows restrictions on transfer of shares in
the articles of incorporation if the same is necessary and convenient to the
attainment of the objective for which the company was incorporated, unless
palpably unreasonable under the circumstances.24 The underlying test as to
whether the restriction are valid and enforceable is whether the restriction is
sufficiently reasonable as to justify the restriction overriding the general policy
against restraint on alienation of personal property. 25 The SEC has ruled that the
period of one month is deemed reasonably sufficient for the existing stockholder
of corporation within which to signify their desire to buy the shares of stock being
offered for sale by any stockholder before the same may be offered to third
parties. 26
23
The SEC has ruled that the transfer of naked ownership in shares of stock to qualify the
nominee merely to be voted into the board of directors of the corporation is not a violation of the
provisions in the charter granting to the corporation or other stockholders the right of first refusal,
provided that the transfer contains a description that the nominees hold the stocks merely as
trustees thereof. SEC Opinion, 12 February 1985, 1985 SEC ANNUAL OPINIONS 33; SEC Opinion,
21 May 1986, XX SEC QUARTERLY BULLETIN 83 (Nos. 1 & 2, March and June, 1986).
24
SEC Opinion, 20 February 1995, XXIX SEC QUARTERLY BULLETIN 4 (No. 3, September
1995).
25
Ibid.
26
Ibid.
27
SEC Opinion, 2 May 1995, XXIX SEC QUARTERLY BULLETIN 2 (No. 4, Dec. 1995); SEC
Opinion, 13 January 1994, XXVIII SEC QUARTERLY BULLETIN 37 (No. 2, June 1994); SEC
Opinion, 13 October 1964, SEC FOLIO 1960-1976, at p. 217.
28
25 SCRA 845 (1968), quoting from CORBIN ON CONTRACTS, Vol. 6, Sec. 1385, p. 483.
and to enjoy the same business relations with other men. He is willing to pay
much more if he can get the „good will‟ of the business, meaning by this the good
will of the customers, that they may continue to tread the old footpath to his door
and maintain with him the business relations enjoyed by the seller. . . In order to
be well assured of this, he obtains and pays for the seller's promise not to reopen
business in competition with the business sold." The Court went on to say in Villa
Rey Transit:
29
Ibid, citing Del Castillo v. Richmond, 45 Phil. 679, 683 (1924), citing Anchor Electric Co. v.
Hawkes, 171 Mass. 101; Alger v. Tacher, 19 Pickering (Mass.) 51; Taylor v. Blanchard, 13 Allen
(Mass.) 370; Lurking Rule Co., v. Fringeli, 57 Ohio State 596; Fowle v. Park, 131 U.S. 88, 97;
Diamond Match Co. v. Reeber, 106 N.Y. 473; National Benefit Co., v. Union Hospital Co., 45
Minn. 272; Swigert & Howard v. Tilden, 121 Iowa 650; Ollendorf v. Abrahamson, 38 Phil. 585
(1918).
The jurisprudential history of “restraint of trade” doctrine in the Philippines
looks at the “intrinsic reasonableness” of any provision tending to restrain a
person from engaging trade or calling, and that such restrictions may be upheld
when not contrary to the public welfare and not greater than is necessary to
afford a fair and reasonable protection to the party in whose favor it is imposed, 30
and such reasonableness seem to apply whenever the restraint or prohibition is
limited in both time and place.31
In Lambert, the Supreme Court found the provision in the contract
between the parties imposing a penalty for one disposing of his shares within the
prohibited one-year period to comply with the twin test of reasonable restraint: (a)
"has a beneficial purpose, results in the protection of the corporation as well as of
the individual parties to the contract;” and (b) “reasonable as to the length of time
of the suspension." In fact, the provision in Lambert did not declare the
disposition of shares void or annullable, but merely subjected the violating party
to penalty for breach of the prohibition.
The doctrinal thrust under Section 63 of the Corporation Code is that
shares of stock are personal property of the stockholder and should be within his
power to dispose, and which would be consistent with the one of the
advantageous features of the corporate medium promoted under Corporate Law
of "free transferability of the units of ownership.” Consequently, the
“reasonableness” of any provision restraining the disposition by a shareholder of
his shares in the corporation would be tested or whether such provision in effect
would undermine his ability to eventually be able to dispose of such shares.
Consequently, a stipulation prohibiting a stockholder from disposing of his
shareholder, even when found in the articles of incorporation, would be void
because directly divest the ability of the stockholder to dispose of his shares.
Likewise, a provision that invalidates a sale or disposition of shares of stock
without the consent of the corporation and/or the other stockholders would be
void, since by their withdrawal of such consent, a stockholder would be forced to
maintain his shareholdings in the corporation.
A right of first refusal that grants to the corporation or the other
stockholder the first option to purchase the shares of a disposing stockholder is
in principle valid because it does not in effect prevent the disposing stockholder
from eventually being able to dispose of the shares, and it generally should not
matter to him that the eventual buyer would be the corporation or another
stockholder. However, when the term or period upon which the option may be
30
Ollendorf v. Abrahamson, 38 Phil. 585 (1918): “In the course of time this opinion was
abandoned and the American and English courts adopted the doctrine that where the restraint
was unlimited as to both time and space it was void, but that agreements limited as to time but
unlimited as to space, or limited as to space but unlimited as to time were valid. In recent years
there has been a tendency on the part of the courts of England and America to discard these
fixed rules and to decide each case according to its peculiar circumstances, and make the validity
of the restraint depend upon its reasonableness. If the restraint is no greater than is reasonably
necessary for the protection of the party in whose favor it is imposed it is upheld, but if it goes
beyond this it is declared void.” at p. 591.
31
Del Castillo v. Richmond, 45 Phil. 679 (1924).
exercised by the corporation or stockholder is unreasonable, as for example
when the option can be exercised within an extended period of more than one
year before the disposing stockholder could sell his shares to a third party, then it
becomes unreasonable restraint of trade. An unduly long period of time of
restraint, or when the terms unduly complicate and burden the disposing
stockholder who may have a ready and willing third-party buyer, would make
such provisions not comply with the reasonableness requirement mandated by
jurisprudence.
The SEC has given the parameters on what constitutes reasonable
restrictions, thus: 32
(a) The restrictions shall not be more onerous than granting the
existing stockholders or the corporation the option to
purchase the shares of the transferring stockholder with
such reasonable terms, conditions or period stated therein;
(b) A restriction clause is no valid and enforceable if it absolutely
prohibits the sale or transfer of stock without the consent of
the existing stockholders, as this would violate the general
law on free alienability of shares of stock;
(c) Reasonable option period may range from 30 to 60 days or
even more, depending on the circumstances surrounding the
case; and
(d) After the option period has expired the stockholder is free to
sell his shares of stock to anyone.
4. Non-Competition Clause
The SEC has opined that a non-competition clause may be properly
provided for as a condition for being a stockholder in the articles of incorporation
or by-laws of the corporation.33
The SEC ruled that such disqualification provision is a valid and
reasonable exercise of corporate authority since a corporation, under the
principle of self-preservation, has the inherent right to preserve and protect itself
by excluding competitors or hostile interests.34 The provision is made obviously
to prevent a stockholder from creating an opportunity to take advantage of the
information which he may have acquired as such to promote his individual
interest to the prejudice of the corporation and other stockholders.35 The
stockholders have a fiduciary relation with their corporation for the collective
benefit of the stockholders.36 Any person who intends to buy sock in a
32
SEC Opinion, 8 June 1995, XXIX SEC QUARTERLY BULLETIN 32 (No. 4, Dec. 1995).
33
SEC Opinion, 12 August 1998, XXXIII SEC QUARTERLY BULLETIN 14 (No. 1, June, 1999).
34
Ibid.
35
Ibid.
36
Ibid.
corporation does so with the knowledge that its affairs are governed by the
articles of incorporation and by-laws; and with such knowledge, the stockholder
may be considered to have consented to the disqualification to engage in the
same line of business and thus, it cannot be said that the stockholder‟s right is
infringed. 37
RIGHT TO VOTE
1. Varying the Voting Rights
Under Section 6 of the Corporation Code, no share may be deprived of
voting rights except those classified and issued as "preferred" or "redeemable"
shares. In addition, there shall always be a class or series of shares which have
complete voting rights.38 The creation of a class of shares with multiple voting
rights appears to be effective where the purpose is to unequally distribute voting
power so as to confer larger participation in management on a shareholder or
class of shareholders.39
Where the articles of incorporation provide for non-voting shares in the
cases allowed by the Corporation Code, the holders of such shares shall
nevertheless be entitled to vote on the following matters;
37
Ibid.
38
Sec. 6, Corporation Code.
39
Ferrer, Varying a Shareholder's Statutory Participation in Management by the Use of Non-
Statutory Devices, 9 ATENEO L.J. 10 (1959)
40
Sec. 6, Corporation Code.
41
Ibid.
Under Section 137 of the Corporation Code, the term "outstanding capital
stock" means "the total shares of stock issued to subscribers or stockholders,
whether or not fully or partially paid (as long as there is a binding subscription
agreement), except treasury shares." Although Section 137 in defining
"outstanding capital stock" expressly excludes only treasury shares, it is not
meant to cover non-voting shares whenever it is used in relation to voting
requirements because of the qualification under Section 6.
42
Sec. 89, Corporation Code.
43
Ibid. Also Sec. 24, Corporation Code.
44
Ibid.
45
Sec. 24, Corporation Code.
46
58 Phil 707 (1933).
if the transfer is not duly made upon request he has, as his remedy, to compel it
to be made.47
The sequestration of shares does not entitle the government to exercise
acts of ownership over the shares; consequently, even sequestered shares may
be voted upon by the registered stockholder of record.48
The SEC has also opined that it would be illegal for a corporation adopt a
rule that a stockholder who fails to attend the meeting or appoint a proxy is
deemed to have appointed the Chairman of the meeting as his proxy, since
Section 58 of the Corporation Code clearly provides that a proxy to be valid must
be in writing and signed by the stockholder.49
Since the appointment of proxy is purely personal, and the right to vote is
inseparable from the right of ownership of stock without the owner‟s consent, and
therefore a proxy to vote stock, to be valid, must have been given by the person
who is the legal owner of the stock and entitled to vote the same at the time it is
to be voted.50
47
Ibid.
48
Cojuangco Jr. v. Roxas, 195 SCRA 797 (1991).
49
SEC Opinion, 3 December 1993, XXVIII SEC QUARTERLY BULLETIN 5 (No. 2, June 1994).
50
Ibid.
51
SEC Opinion, 9 May 1995, XXIX SEC QUARTERLY BULLETIN 12 (No. 4, Dec. 1995).
Executors, administrators, receivers, and other legal representatives duly
appointed by the court may attend and vote in behalf of the stockholders or
members without need of any written proxy. 52 In spite of what may be provided
for in the by-laws on a non-stock corporation on the suspension of voting rights of
a deceased member, it would seem that under Section 55 the power to vote on
the membership is by operation of law transferred to the administrator of the
estate of the deceased member.
The SEC has opined that based on the said section of the Code, an
administrator of a deceased member may vote on corporate matters and
therefore, should be counted in determining the requisite vote approving a
corporate act.53
The SEC has also opined that generally restrictions on the right of
shareholders to pledge or mortgage their shares would be unlawful.54 The SEC
has, however, as a matter of policy, allowed reasonable restrictions on the
transfer of shares in the articles of incorporation if the restrictions comply with the
provisions of Article 93 of the Corporation Code, namely, that the restriction must
appear in the articles of incorporation, by-laws and the certificates of stock, and
that said restrictions shall not be more onerous than granting the existing
stockholders or the corporation the option to purchase the shares of the
transferring stockholder with such reasonable terms, conditions or period stated
therein.55
Therefore, if the restriction on the right to pledge or mortgage shares of
stock absolutely prohibits the stockholders from pledging or mortgaging their
shares without the consent of the board of directors, it would be violative of the
statutory right of the stockholders to encumber shares of stock as allowed in
Section 55 of the Corporation Code.56 However, when the restriction merely
allows the corporation or existing stockholders to accept the offer within the
option period, and thereafter, if no one accepts the offer, the stockholder is free
to pledge or mortgage his shares in favor of any third party, such provision is
reasonable, valid and binding.57
6. Treasury Shares
Under Section 57 of the Corporation Code, treasury shares shall have no
voting rights as long as such stock remains in the treasury. The philosophy
behind the prohibition is that to give voting rights to treasury shares could enable
the directors to prolong their stay in office against the wishes of the holders of the
majority of the stock.
52
Sec. 55, Corporation Code.
53
SEC Opinion, 3 March 1986, XX SEC QUARTERLY BULLETIN (Nos. 1 & 2, March & June,
1986).
54
SEC Opinion, 8 August 1995, XXX SEC QUARTERLY BULLETIN 21 (No. 1, June 1996).
55
Ibid.
56
Ibid.
57
Ibid.
In case of resale or reissue, treasury shares regain whatever voting rights
and dividends to which they were originally entitled in the hands of the third-party
buyer.
58
Sec. 24, Corporation Code.
59
Ibid.
60
Ibid.
However, where the investment by the corporation is reasonably
necessary to accomplish its primary purpose as stated in the articles of
incorporation, the approval of the stockholders or members shall not be
necessary.61
Written notice of the proposed investment and the time and place of the
meeting shall be addressed to each stockholder or member at his place of
residence as shown on the books of the corporation and deposited to the
addressee in the post office with postage pre-paid or served personally.62
61
Sec. 42, Corporation Code.
62
Ibid.
63
Sec. 77, Corporation Code.
64
Ibid.
65
Ibid.
Under Section 38 of the Corporation, no corporation shall increase or
decrease its capital stock, unless approved by a majority vote of the board of
directors and at a stockholders' meeting duly called for the purpose, two-thirds
(2/3) of the outstanding capital stock shall favor the increase or diminution of the
capital stock.
Written notice of the proposed increase or diminution of the capital stock is
to be considered, must be addressed to each stockholder at his place of
residence as shown on the books of the corporation and deposited to the
addressee in the post office, with postage pre-paid, or served personally.
66
You may wish to refer to the right-up of rules affecting proxies in Appendix D on Proxy
Rules and Appreciation.
integral part of the security by which a loan or indebtedness is to be paid or
liquidated.
The SEC has appropriately observed that a person acting as proxy for a
stockholder is in the eyes of the law, the latter‟s agent and as such, a mere
fiduciary who has the duty of acting in strict accord with requirements of a
fiduciary relation; and that accordingly, the proxy holder must act in accordance
with the instructions given to him/her by the stockholder and any violation of such
fiduciary duty shall be governed by the pertinent laws on Agency, not by the
Corporation Code.67
The SEC has opined that if the by-laws of the association do not prescribe
a particular form for proxy, the imposition of a particular form by the corporation
would be void, and the members may use other forms of proxies as long as they
are executed in accordance with Section 58 of the Corporation Code, which
provides that proxies shall be in writing, signed by the stockholder or member
and filed before the schedule meeting with the corporate secretary. 72
For purposes of determining quorum and entitlement to vote or to
participate in stockholders meeting, the proxy must be filed/registered with the
corporate secretary prior to the stockholders meeting, and unless filed in
accordance with the provisions of the Corporation Code or the by-laws, the proxy
holder is not entitled to any right.73
Finally, when the by-laws of a corporation are silent on the time of
submission of proxies, the corporation cannot fix the deadline, since it is clear
under Section 58 that when no deadline or period of filing/submission of the
proxies is provided for in the by-laws, then proxies may be filed anytime before
the scheduled meeting.74
(a) It is in writing and notarized, and shall specify the terms and
conditions thereof; and
(b) A certified copy of such agreement shall be filed with the
corporation and with the SEC.79
79
Sec. 59, Corporation Code.
80
Ibid.
81
Ibid.
82
Ibid.
83
Ibid.
84
Ibid.
The trustee is the legal title holder or owner of the shares so transferred
under the agreement. He is, therefore, qualified to be a director.
(a) The voting rights of the stock are separated from the other
attributes of ownership;
(b) The voting rights granted are intended to be irrevocable for a
definite period of time; and
(c) The principal purpose of the grant voting rights is to acquire
voting control of the corporation.86
Lee also recognized that a voting trust agreement may confer upon a
trustee not only the stockholder's voting rights but also other rights pertaining to
his shares as long as the voting trust agreement is not entered for the purpose of
circumventing the law against monopolies and illegal combination in restraint of
trade or used for purposes of fraud:87
The other differences between a voting trust agreement and a proxy are
as follows:
85
205 SCRA 752 (1992).
86
Ibid, citing 5 FLETCHER CYC. LAW ON PRIVATE CORP., Sec. 2075 (1976), at p. 331.
87
Ibid, at p. 758, citing Sec. 59, Corporation Code.
88
Ibid, at pp. 758-759.
(b) Both the proxy and the voting trust agreement are fiduciary
in nature. A voting trust agreement is not revocable because
the parties are bound by the contractual relationship created.
A proxy is, however, generally revocable unless coupled with
an interest. This feature of irrevocability provides for stability
in the voting trust relationship.
(c) A proxy can only act the specified stockholders' or members'
meeting (if the proxy is not continuing in nature), while a
trustee is not limited to any particular meeting.
(d) The proxy has no right to receive dividends; whereas, a
trustee will receive the dividends declared on the shares
held in trust, but with obligation to dispose of them for the
benefit of the beneficial owner
(e) The proxy does not have the right to inspect and such right
was not granted under the proxy; whereas, in a voting trust
arrangement, trustee is the person entitled to exercise the
right to inspect.
(f) The proxy does not have the appraisal right; in a voting trust
arrangement, it is the trustee, as the naked owner of the
shares, who will exercise the appraisal right, but subject to
his trust obligations with the beneficial owner.
91
163 SCRA 153 (1988).
It is clear that what was assigned to NIDC was the power
to vote the shares of stock of the stockholders of Batjak,
representing 60% of Batjak's outstanding shares, and who are
the signatories to the agreement. The power entrusted to
NIDC also included the authority to execute any agreement or
document that may be necessary to express the consent or
assent to any matter, by the stockholders. Nowhere in the said
provisions or in any other part of the Voting Trust Agreement is
mention made of any transfer or assignment to NIDC of
Batjak's assets, operations, and management. NIDC was
constituted as trustee only of the voting rights of 60% of the
paid-up and outstanding shares of stock in Batjak. . The
acquisition by PNB-NIDC of the properties in question was not
made or effected under the capacity of a trustee but as a
foreclosing creditor for the purpose of recovering on a just and
valid obligation of Batjak.92
The Supreme Court therefore failed to appreciate the fact that the voting
trust was obtained from the shareholders of the borrowing corporation precisely
to allow PNB-NIDC to have management and undertake control in the operations
of the borrowing corporation. Although National Investment Development Corp.
would hold that "a voting trust transfers only voting or other rights pertaining to
the shares subject of the agreement, or control over the stock," 93 it failed to
appreciate that the voting trust arrangement was part and parcel of the loan
arrangement of the borrowing corporation, and therefore must be construed not
by its technical set-up (as a contract basically on the shares between the
transferring stockholders and the lending institution) but actually as a means by
which the lending institution obtains control over the management or operation of
the borrowing corporation during the loan period.
Therefore, when it decided National Investment and Development Corp.
the Supreme Court was not ready to import into Philippine jurisprudence the
concept of "lender's liability" by which a lender becomes liable as trustee for the
operations and management of the company to which it had extended loans by
reason of its allowed itself to be involved in the management and operations of
the borrowing corporation.94
4. Hierarchy of Enforceability
The voting trust agreement is the most effective of the arrangement, being
based on the law on trust, the relationship cannot be arbitrarily terminated except
for proper cause provided by law. Proxy, being based on the Law on Agency, can
be terminated at will by the principal, even when the contrary is provided for in
the proxy agreement. On the other hand, although the pooling agreement is
based on Contract Law, since it covers an obligation to do, specific performance
is not an available remedy.
95
Sec. 50, Corporation Code.
Notice of any meeting may be waived, expressly or impliedly, by any
stockholder or member.96
4. Quorum
Under Section 52 of the Corporation Code, unless otherwise provided for
in the Code itself or in the by-laws, a quorum shall consist of the stockholders
representing a majority of the outstanding capital stock or a majority of the
members in the case of non-stock corporations.
In those cases in which the law determines the number of shareholders or
members whose concurring votes are necessary to make their action binding on
the corporation, no less than such number is necessary to constitute a quorum at
a meeting called to transact such business. In such cases, the by-laws may
provide for a greater quorum.
In other cases, the by-laws may provide for the holding of meetings with
the presence of any number of stockholders or members, even less than a
majority, provided that there are at least two. It is customary however, to provide
in the by-laws that the presence of the registered holders of a majority of the
outstanding shares is necessary to constitute a quorum, but that a smaller
number may meet and adjourn to a later date, and that at such adjourned
meeting, the shareholders attending shall constitute a quorum.
101
Sec. 50, Corporation Code.
102
SEC Opinion, 17 June 1998, XXXII SEC QUARTERLY BULLETIN 6 (No. 2, Dec. 1998).
The SEC has opined that where a corporation encounters several
unsuccessful attempts or it it would be impossible for the corporation to get the
required quorum of the stockholders/members necessary to transact business, it
may, pursuant to the provisions of Pres. Decree 902-A, petition the SEC for the
appointment of a management committee to undertake the management
thereof.103
5. Minutes of Meeting
Under Section 74 of the Corporation Code, the corporation shall, at its
principal office, keep and carefully preserve a record of all minutes of all
meetings of stockholders or members, in which it shall be set forth in detail the
time and place of holding the meeting; how authorized; the notice given; whether
the meeting was regular or special; if special, its object those present and
absent; and every act done or ordered done at the meeting.
Upon the demand of any director, trustee, shareholder or member, the
time when any director, trustee, shareholder or member entered or left the
meeting must be noted in the minutes; and on a similar demand, the yeas and
nays must be taken on any motion or proposition, and a record thereof carefully
made. The protest of any director, trustee, shareholder or member or any action
or proposed action must be recorded in full on his demand.104
Without the signature of the secretary of the meeting, an alleged minutes
taken at that meeting has no probative value nor credibility.105
103
SEC Opinion, 10 July 1998, XXXII SEC QUARTERLY BULLETIN 10 (No. 2, Dec. 1998).
104
Sec. 74, Corporation Code.
105
SEC Opinion, 30 June 1971.
106
89 SCRA 336 (1979).
therefore, an incident of ownership of the corporate property, whether this
ownership or interest be termed an equitable ownership, a beneficial ownership,
or a quasi-ownership. This right is predicated upon the necessity of self-
protection.”107
Africa v. PCGG,108 and Republic v. Sandiganbayan,109 upheld the principle
that the right of the registered stockholder to inspect or examine corporate
records and to obtain excerpts thereof is not affected by the fact that the shares
have been sequestered, since sequestration by itself does not severe ownership
over the shares of the registered stockholder.
107
Ibid, at pp. 384-385.
108
205 SCRA 39 (1992).
109
199 SCRA 39 (1991).
110
Sec. 74, Corporation Code.
111
Ibid.
112
40 Phil. 471 (1919).
Within ten (10) days from receipt of a written request of any stockholder or
member, the corporation shall furnish to him its most recent financial statement,
which shall include a balance sheet as of the end of the last taxable year and a
profit or loss statement for said taxable year, showing in reasonable detail its
assets and liabilities and the result of its operations.113
At the regular meeting of shareholders or members, the board of directors
or trustees shall present to such shareholders or members a financial report of
the operations of the corporation for the preceding year, which shall include
financial statements, duly signed and certified by an independent certified public
accountant.114
However, if the paid-up capital of the corporation is less than P50,000, the
financial statements may be certified under oath by the treasurer or any
responsible officer of the corporation.115
113
Sec. 75, Corporation Code.
114
Ibid.
115
Ibid.
116
Sec. 141, Corporation Code.
117
Under SEC rules, within thirty (30) calendar days following the date of the annual
stockholders' or members' meeting, and organizational meeting of the board, the corporation is
supposed to fill-up and submit to the SEC the General Information Sheet which includes the
names, nationality and residence of corporate officers, directors or trustees, the capital structure
(g) Report of election of directors, trustees and officers within
thirty (30) days after such election.118
of the corporation, it earnings for the year, its existing retained earnings, and investments of
corporate funds.
118
Sec. 26, Corporation Code.
119
47 Phil 964 (1924).
120
40 Phil 471 (1919).
The right may be regarded as personal, in the sense that only
stockholders may enjoy it; but the inspection and examination may be made by
another. Otherwise, it would be unavailing in many instances. The stockholders
may be aided by experts and counsel, so as to make the inspection valuable to
them.
121
89 SCRA 336 (1979).
122
Ibid, at pp. 384-385.
123
89 SCRA 336 (1989).
124
Ibid, at p. 384.
125
57 Phil 266 (1932).
corporation at all reasonable times. Pretexts may not be put forward by the
officers of a corporation to keep a director or stockholders from inspecting the
books and minutes of the corporation, and the right of inspection cannot be
denied on the grounds that the director or stockholders is on unfriendly terms
with the officers of the corporation whose records are sought to be inspected.
Nevertheless, the Court also held that a director or stockholders has no absolute
right to secure certified copies of the minutes of a corporation until these minutes
have been written up and approved by the directors.
The proviso in Section 74 of the Corporation Code makes the prevailing
rule now to be that the motive of the stockholder in requesting to inspect the
corporate records material. Africa v. PCGG,126 clearly interprets Section 74 of the
Corporation Code as to have placed the right of inspections to be subject to three
limitations:
126
205 SCRA 39, 41 (1992). The Supreme Court held that even the stockholders of
sequestered shares is not deprived of his proprietary right to inspect corporate records.
127
122 SCRA 489 (1983).
Finally, Republic v. Sandiganbayan,128 held that "[w]hile it may be true that
the right to inspections granted by Section 74 of the Corporation Code is not
absolute, as when the stockholder is not acting in good faith and for a legitimate
purpose . . . or when the demand is purely speculative or merely to satisfy
curiosity . . . [it is still with the corporate officers] to discharge the burden of proof
to show that the private respondent's action in seeking examination of the
corporate records was moved by unlawful or ill-motivated designs which could
appropriately call for a judicial protection against the exercise of such right. Save
for its unsubstantiated allegations, petitioner could offer no proof, nay, not even a
scintilla of evidence that respondent . . . was motivated by bad faith; that the
demand was for an illegitimate purpose or that the demand was impelled by
speculation or idle curiosity. . ."129
Republic therefore reiterated the principle set in Gokongwei that "the
impropriety of purpose such as will defeat enforcement must be set up (by) the
corporation defensively if the Court is to take cognizance of it as a
qualification."130
In an opinion,131 the SEC has succinctly summarized the legal basis and
the extent of the right to inspect:
128
199 SCRA 39 (1991).
129
Ibid, at p. 47.
130
199 SCRA 39 (1991); Gokongwei, Jr. v. Securities and Exchange Commission, 89
SCRA 336 (1979).
131
SEC Opinion, 14 September 1998, XXXIII SEC QUARTERLY BULLETIN 23 (No. 1, June,
1999).
The right of the stockholders to inspect the corporate
books and records is based on the principle that a stockholder
has the right to be fully informed as to the status and condition
o the corporation, the manner its affairs are conducted and
how its capital to which they have contributed is employed or
managed. Said right may be exercised either by himself or by
any proper representative or attorney-in-fact, who may be an
accountant or a lawyer or any other person who can help the
stockholder understand and interpret the corporate records,
and either with or without the attendance of the stockholder.
The right to inspect is not absolute and the corporation may
show in defense that the stockholder is acting from wrongful
motives, since the exercise of the right to inspect should be for
a legitimate purpose, which means that it must be germane to
the interest of the stockholder as such, as where the purpose
is to find out the actual financial condition of the corporation
and how his investment is being used. Likewise, the purpose
should not be contrary to the interest of the corporation nor
should it be made merely to gratify a stockholder‟s curiosity.
Purposes which may warrant denial of the right of inspection, because the
purpose is improper, are as follows:
b. Damages
The stockholder or member who was wrongfully denied such right may
also file, in the same action, for damages against the director, trustee,
shareholder or member who denied him the right.
c. Criminal Suit
The stockholder or member who was wrongfully denied his right of
inspection may also bring criminal suit against the offending officer punishable
under Section 144 of the Corporation Code.
Under Section 74 of the Corporation Code, any officer or agent of the
corporation who shall refuse to allow any director, trustee, stockholder or
member of the corporation to examine and copy excerpts from its records or
minutes, in accordance with the provision of this Code, shall be liable to such
director, trustee stockholder or member for damages, and in addition, shall be
guilty of an offense which shall be punishable under Section 144 of the
Corporation Code. If such refusal is pursuant to a resolution or order of the board
of directors or trustees, the liability under this section for such action shall be
imposed upon the directors or trustees who voted for such refusal.
132
89 SCRA 336 (1979).
incident of ownership of the corporate property, whether his ownership or interest
be termed an equitable ownership, a beneficial ownership or a quasi-ownership.
The Court took into consideration the fact that the foreign subsidiary is
wholly-owned by SMC and therefore, under its control, it would be more in
accord with equity, good faith and fair dealing to construe the statutory right of
petitioner as shareholder to inspect the books and records of the corporation as
extending to books and records of such wholly-owned subsidiary which are in
SMC's control.
APPRAISAL RIGHT
1. Nature of Appraisal Right
Appraisal right refers to a stockholder‟s right to demand payment of the
fair value of his shares, after dissenting from a proposed corporate action
involving a fundamental change in the corporate setting, in the specific cases
provided for in the Corporation Code.
The appraisal right is given to a stockholder in a particular situation where
there has been a radical change in the contractual relationship presumably
agreed upon between the stockholder and the corporation, a change which the
dissenting stockholder could not have reasonably anticipated may happen at the
time he invested into, or created his contractual relationship with, the corporation.
133
Sec. 82, Corporation Code.
134
Ibid.
135
Sec. 83, Corporation Code.
136
Sec. 86, Corporation Code.
137
Ibid.
7. How Payment of Fair Value Effected
If the proposed corporate action is implemented or effected, the
corporation shall pay to such stockholder, upon the surrender of the certificates
of stock representing his shares, the fair value thereof as of the day prior to the
date on which the vote was taken, excluding any appreciation or depreciation in
anticipation of such corporate action.138 The formula is given to prevent
speculation in view of the pending action; because of certain action that will be
taken, it is possible that others dissent in order to gain an advantage where the
majority took a risk.
If within a period of sixty (60) days from the date the corporate action was
approved by the stockholders, the withdrawing stockholder and the corporation
cannot agree on the fair value of the shares, it shall be determined and appraised
by three (3) disinterested persons, one of whom shall be named by the
stockholder, another by the corporation, and the third by the two thus chosen. 139
The law does not say for how long or within what period the board of appraisers
may determine the price of the shares.
The findings of the majority of the appraisers shall be final, and their
award shall be paid by the corporation within thirty (30) days after such award is
made.140
Upon payment by the corporation of the agreed or awarded price, the
stockholder shall forthwith transfer his shares to the corporation.141
138
Sec. 82, Corporation Code.
139
Ibid.
140
Ibid.
141
Ibid.
142
Ibid.
143
Sec. 84, Corporation Code.
In the following cases, even when such demand has been made, it can be
withdrawn by the dissenting stockholder:
144
Ibid.
145
Sec. 85, Corporation Code.
member of the corporation, he need not waive, because there is really no
compulsion for him to waive except for valuable consideration.
146
64 Phil. 697 (1937).
147
Ibid, at p. 706.
148
First Philippine International Bank v. Court of Appeals, 252 SCRA 259, 67 SCAD 196
(1996).
149
292 SCRA 503, 96 SCAD 205 (1998).
judgment or abuse of discretion, and intracorporate remedy is
futile or useless, a stockholder may institute a suit in behalf of
himself and other stockholders and for the benefit of the
corporation, to bring about a redress of the wrong inflicted
directly upon the corporation and indirectly upon the
stockholders. The stockholder‟s right to institute a derivative
suit is not based on any express provision of the Corporation
Code but is impliedly recognized when the law makes
corporate directors or officers liable for damages suffered by
the corporation and its stockholders for violation of their
fiduciary duties.
Hence, a stockholder may sue for mismanagement,
waste or dissipation or corporate assets because of a special
injury to him for which he is otherwise without redress. In
effect, the suit is an action for specific performance of an
obligation owed by the corporation to the stockholders to
assist its rights of action when the corporation has been put in
default by the wrongful refusal of the directors or management
to make suitable measure for its protection.
The basis of a stockholder‟s suit is always one in equity,
However, it cannot prosper without first complying with the
legal requisites for its institution. The most important of these
is the bona fide ownership by a stockholder of a tock in his
own right at the time of the transaction complained of which
invests him with standing to institute a derivative action for the
benefit of the corporation.
1. Definition
A derivative suit is one which is instituted by a shareholder or a member of
a corporation, for and in behalf of the corporation for its protection from acts
committed by directors, trustees, corporate officers, and even third persons.
Western Institute of Technology, Inc. v. Salas,150 held that “[a] derivative
suit is an action brought by minority shareholders in the name of the corporation
to redress wrongs committed against the corporation, for which the directors
refuse to sue. It is a remedy designed by equity and has been the principal
defense of the minority shareholders against abuses by the majority.”
150
278 SCRA 216, 86 SCAD 315 (1997).
151
176 SCRA 447 (1989).
(a) The party bringing suit should be a shareholder as of the
time of the act or transaction complained of, and at the time
of the filing of the suit, the number of his shares not being
material;152
(b) The party has tried to exhaust intra-corporate remedies, i.e.,
has made a demand on the board of directors for the
appropriate relief, but the latter has failed to refused to heed
his plea;153 and
(c) The cause of action actually devolves on the corporation, the
wrongdoing or harm having been, or being caused to the
corporation and not to the particular stockholder bringing the
suit.154
152
Citing Pascual Orozco, 19 Phil. 82; Republic v. Cuaderno, 19 SCRA 671.
153
Citing Everett v. Asia Banking Corporation, 49 Phil. 512 (1926); Angeles v. Santos, 64
Phil. 697 (1937).
154
Citing Evangelista v. Santos, 86 Phil. 387 (1950).
155
176 SCRA 463.
156
19 Phil 83 (1911).
maintain suits of this character, unless such transactions continue and are
injurious to such stockholder or affect him especially or specifically in some other
way.
A close reading of Pascual would clearly show that the rationale for the
rule was that there is in the in the United States jurisdiction, two sets of court
system—the federal judicial system and the state judicial systems. In order to
prevent forum shopping, the rule in the United States is such that when a
derivative suit is brought it is essential that the relator should have been a
stockholder both at the time the act complained of occurred and at the time the
derivative suit is filed. The prevailing rule then was that a shareholder who was
one at the time of the institution of the action may bring a derivative suit. It was
then quite easy and in fact possible to bring a suit out of state court and bring it to
federal court by just making sure that you transfer a share to someone outside of
the state. If the suit is filed in California, what can be done is transfer one share
to a resident of Florida to grant federal courts jurisdiction. In order to correct this
collusion, the requisite was imposed that the relator must be a shareholder at the
time the cause of action accrued.
The ruling is Pascual needs to be critically reviewed and perhaps set-
aside altogether. There seems to be little basis under Philippine laws to require
that relator was a stockholder only at the time of the institution of the action but
not at the time the cause of action accrued when it is the corporation that is really
the interested party. The main consideration in Pascual of forum-shopping holds
no merit under Philippine jurisdiction which does not have separate federal-states
sets of judicial system.
The ruling in Pascual, however provided that "[a] stockholder in a
corporation who was not such at the time when alleged objectionable
transactions took place, or whose shares of stock have not since devolved upon
him, by operation of law, cannot maintain suits of this character, unless such
transaction continue and are injurious to such stockholder or affect him especially
or specifically in some other way."157 Therefore, a person who was not a
stockholder at the time the cause of action accrued may bring a derivative suit
when the covered transactions continue and are injurious to such shareholder or
affect him especially or specifically in some other way. However, such
stockholder may not institute the derivative suit:
157
Ibid, at p. 99.
bring an action for and in behalf of the corporation, then the
transferee cannot also institute the derivative suit.
As will be noticed from the Interim Rules, they not only maintain the
jurisprudential requirements for “standing” of the relator, but require specifically
that during the pendency of the suit, the relator maintains his shareholdings in
the corporation, which does not conform to the procedural rule that jurisdiction of
the tribunal is determined by the alleged facts at the time of the filing of the
petition or complaint.
In addition, the Interim Rules provide that a derivative action shall not be
discontinued, compromised or settled without the approval of the court, which
shall determine that the interests of the stockholders or members, will be
substantially affected by the discontinuance, compromise or settlement, and that
158
Formally adopted by the Supreme Court in February 2001, pursuant to the transfer of the
quasi-judicial powers of the SEC to the RTC under the Securities Regulation Code.
the court may direct that notice be given, by publication or otherwise, to the
stockholders or members whose interests it determines will be so affected.
The Interim Rules seem to presume that a derivative action is for the
benefit of the stockholders or members of the corporation, when jurisprudence
has ruled that a derivative action is essentially for the benefit of the corporation
as a separate juridical entity.
159
19 SCRA 671 (1967).
160
Central Cooperative Exchange, Inc. v. Tibe, Sr., 33 SCRA 593,598 (1970).
161
Western Institute of Technology, Inc. v. Salas, 278 SCRA 216, 86 SCAD 315 (1997).
a. Wastage and Diversion of Corporate Funds
It may be considered a wastage or diversion of corporate funds to hire
officers and appoint directors whose main purpose is to shield the chairman from
criminal prosecution.
Republic v. Cuaderno,162 held that a "stockholder in a banking corporation
has a right to maintain a suit for and on behalf of the corporation, but the extent
of such right depends upon when and for what purpose he acquired the shares of
stock of which he is the owner."
b. Violation of Laws
Reyes v. Tan,164 also gave a valid basis the violation of laws allowed by
the board as basis for a derivative suit. The Court held that where the director of
the corporation permitted the fraudulent transaction to go unpunished by allowing
the importation of finished textile instead of raw cotton for the textile mill, and
nothing appears to have been done to remove the erring purchasing managers,
the appointment of receiver may have been thought of by the court so that the
dollar allocation for raw material may be reviewed and the textile mill placed on
an operating basis, because it is possible that a receiver in which the Central
Bank may have confidence is appointed, the dollar allocation for raw material
may be restored.
162
19 SCRA 671 (1967).
163
Ibid, at p. 677.
164
3 SCRA 198 (1961).
165
86 Phil 387 (1950).
complaint prayed for judgment requiring defendant, among others, to pay
plaintiffs the value of their respective participation in said assets on the basis of
the value of the stocks held by each of them.
The Court held that the suit would not prosper. The stockholders brought
the action not for the benefit of the corporation but for their own benefit since they
asked that the defendant make good the losses occasioned by his
mismanagement and pay them the value of their respective participation in the
corporate assets on the basis of their respective holdings. The Court held that
the relief sought could not be done until all corporate debts, if there be any, are
paid and the existence the corporation terminated by the limitation of its charter
or by lawful dissolution.
Since it is the corporation which is the real party in interest, then the reliefs
prayed for must be for the benefit or interest of the corporation. When the reliefs
prayed for do not pertain to the corporation, then it is an improper derivative suit.
7. Appointment of Receiver
Chase v. CFI of Manila,166 held that in addition to the right to file a
derivative suit, a shareholder, in order to ensure that during the pendency of the
derivative suit, the corporation is ran properly, he can also ask for the
appointment of a receiver to take management away from the board and instead
place it in the hands of a receiver. The power of the court to appoint a receiver in
a derivative suit was reiterated in Reyes v. Tan.167
The Chase doctrine now finds statutory implementation in Pres. Decree
902-A which grants the SEC the power to appoint on its own or by petition a
receiver or a management committee as ancillary to the exercise of exclusive
jurisdiction over corporations.
170
19 SCRA 671, 676 (1967).
defendants Cuaderno and Dizon, which they contend to be the result of
corporate acts with which plaintiff, as stockholder, cannot interfere. The Supreme
Court held that "[n]ormally, this is correct, but Philippine jurisprudence is settled
that an individual stockholder is permitted to institute a derivative or
representative suit on behalf of the corporation wherein he holds stock in order to
protect or vindicate corporate rights, whenever the official of the corporate refuse
to sue, or are the ones to be sued or hold the control of the corporation."
In Reyes v. Tan,171 the complaint was filed by stockholders to appoint a
receiver and recover damages against the directors of the corporation for the
resulting loss of foreign exchange allocation of the corporation due to failure of
the directors to take proper action against the defrauding corporate officer to
violation of Central Bank regulations on importation of textile raw materials. The
Court held that "[i]t is not denied by petitioner that the allocation of dollars to the
corporation for the importation of raw materials was suspended. In the eyes of
the court below, as well in our own, the importation of textiles instead of raw
materials, as well as the failure of the board of directors to take action against
those directly responsible for the misuse of dollar allocations constitute fraud, or
consent thereto on the part of the directors. Therefore, a breach of trust was
committed which justified the derivative suit by a minority stockholder on behalf
of the corporation."172
But in addition in Reyes it was argued that the management has been
changed and the new management has not been afforded a chance to show
what it can do. The Court held: "The supposed new management, alleged as a
ground for the reversal of the order of the court below appointing a receiver, is
not in itself a ground of objection to the appointment of a receiver. The parties
found to be guilty of the fraud, as a cause of which receivership proceeded were
instituted, were the Board of Directors, which took no action to stop the
anomalies being perpetrated by the management. But it appears that
management must have acted directly under orders of the Board of Directors.
The appointment of a new management, therefore, would not remedy the
anomalous situation in which the corporation is found, because such situation
was not due to the management alone but principally because of the direction of
the Board of Directors."173
In Pascual v. Del Saz Orozco,174 the Court held that although the counsel
has not been actually authorized by the board of directors to appear for and in
behalf of the respondent corporation, the fact that counsel is the secretary-
treasurer of the respondent corporation and a member of the board, and that the
other members of the board, the president and his wife, who should normally
initiate the action to protect the corporate properties and interests are the ones to
be adversely affected thereby, a single stockholder under such circumstance
may sue in behalf of the corporation. The ruling was reiterated in Republic v. Phil.
171
3 SCRA 198 (1961).
172
Ibid, at p. 202.
173
at 204-205.
174
19 Phil. 82 (1911).
Resources Dev. Corp.,175 where it was held that counsel as stockholder and
director of the respondent corporation may sue in its behalf and file the
complaint-in-intervention in the proper court.
175
102 Phil. 960, 967 (1958).
—oOo—
CAPITAL STRUCTURES
OF CORPORATIONS
——
1
Republic Planters Bank v. Agana, 269 SCRA 1, 80 SCAD 1 (1997).
corporation is also reflected in the retained earnings component of the
stockholders‟ equity and from which he could expect to receive dividends.
For the corporation, the advantage of equity investment is the absence of
"carrying cost," since the corporate enterprise is not bound to pay any return on
the investment unless there are profits, and even then, the board of directors is
generally granted business discretion to determine when to declare such return
in the form of dividends. The corporate enterprise also has the flexibility of
declaring dividends in the form of stock dividend which does not drain the
finances of the enterprise, and yet allows the stockholders to "cash-in" on the
stock dividends by selling them in the open market.
Secondly, an equity investment in a corporate enterprise is generally non-
withdrawable for so long as the corporation has not been dissolved. This assures
the corporate enterprise and its managers that they will have such resources at
their disposal so long as the corporate enterprise remains a going concern.
On the other hand, a person who extends a loan or debt to the
corporation, only looks at the financial condition and operations of the corporation
as a means of gauging the ability of the corporation to pay-back the loan at the
specified period. But a creditor puts no stake on the operations of the
corporation, and therefore, the contractual obligation of the corporate enterprise
to pay the stipulated return (interest) remains even when the operations are
incurring losses. Since the relationship is essentially contractual in a loan
placement with a corporation, the investor has every right to demand the
payment of the placement upon its maturity.
Consequently, the expected return between the two types of investment
would be different. In a loan placement in a corporation, since the investor places
no stake in the results of the operations, he can only demand the stipulated fixed
return of his investment even if by the use of the borrowed funds, the enterprise
is able to reap huge profits. In the case of an equity investor, since he has placed
his stake in the results of operations, he generally participates in all income
earned by the venture.
The SEC has opined that the object of a corporation is to earn money for
the stockholders, and that when a corporation earns profit over and above the
amount of its capital, the stockholders are entitled to have a share in such profit
in proportion to their shareholdings and the fund being set apart for this purpose
is called dividend.2
Thirdly, the difference in legal expectations between a debt investor and
an equity investor, also dictates the legal preference in payment from corporate
properties of the first as compared to the latter. Since a debt investor places no
stake in the corporate operations and his rights are based on contract, then the
corporate venture must in case of insolvency, devote and prefer all corporate
assets towards the payment of its creditors. On the other hand, since the equity
2
SEC Opinion, 5 October 1994, XXIX SEC QUARTERLY BULLETIN 22 (No.1, March 1995),
citing 11 FLETCHER Sec. 5318.
investors clearly undertook to place their investment to the risk of the venture,
they can only receive a return of their investment only from the remaining assets
of the venture, if any, after the payment of all liabilities to creditors.
3
Stockholders of F. Guanzon and Sons, Inc. v. Register of Deeds of Manila, 6 SCRA 373
(1962).
4
Sec. 36, Corporation Code.
5
Dee v. Securities and Exchange Commission, 199 SCRA 238 (1991).
6
SEC Opinion, 12 January 1995, XXIX SEC QUARTERLY BULLETIN 28 (No.2, June 1995).
7
Sec. 62, Corporation Code.
8
Sec. 9, Corporation Code.
Shares of stock cannot be issued in exchange for promissory notes or
future services.9 It would seem that the negotiable instruments other than the
promissory note such as checks can be used in payment of stocks but they shall
produce the effect of payment only when they have been cashed, or when
through the fault of the creditor, they have been impaired.10
When the consideration is other than actual cash, or consists of intangible
property, the value thereof shall be initially determined by the incorporators or the
board of directors, subject to the approval by the SEC.11
CAPITAL STOCK
The term "capital stock" or "outstanding capital stock" is defined under
Section 137 of the Corporation Code to mean "the total shares of stock issued to
subscribers or stockholders, whether or not fully or partially paid (as long as there
is a binding subscription agreement), except treasury shares."
The SEC has ruled that the term “capital stock” or “authorized capital
stock” is the amount fixed in the articles of incorporation to be subscribed and
paid by the stockholders of the corporation. When shares are subscribed out of
the authorized capital stock, that portion of the paid-in capital arising from the
subscriptions becomes the legal capital of the corporation which cannot be
returned to the stockholders in any form during the lifetime of the corporation
unless otherwise allowed by law.12
The definition of capital stock clearly shows that its composed of two
items, namely: (a) the portion which have been paid by the stockholders,
represented by the account "Paid-up Capital"; and (b) the portion which is to be
paid on the subscriptions, represented by the account "Subscription
Receivables."
In one case,13 the Supreme Court has defined “paid-up capital” as “that
portion of the authorized capital stock which has been both subscribed and paid;”
and clarified that “not all funds or assets received by the corporation [from
stockholders] can be considered paid-up capital, for this term has a technical
signification in Corporation Law, [which requires that such] must form part of the
authorized capital stock of the corporation, subscribed and then actually paid up.”
Consequently, any amount paid to the corporation which is in payment for future
subscriptions to anticipated increases in the authorized capital stock is not
9
Sec. 62, Corporation Code.
10
Art. 1249, Civil Code.
11
Sec. 59, Corporation Code.
12
SEC Opinion, 11 August 1997, XXXII SEC QUARTERLY BULLETIN 15 (No. 2, Dec. 1997).
13
MSCI-NACUSIP Local Chapter v. National Wages and Productivity Commission, 269
SCRA 173, 80 SCAD 155 (1997).
deemed to be part of capital stock until the corporation's capital is actually
increased with the approval of the SEC.14
In defining the relationship between the corporation and its stockholders,
the capital stock represents the legal and proportional standing of the
stockholders with respect to the corporation and corporate matters, such as their
rights to vote and to receive dividends.
In financial terms, the capital stock of the corporation as reflected in the
financial statement of the corporation, represents the financial or proprietary
claim of the stockholders to the net assets of the corporation upon dissolution. In
addition, the capital stock represents the totality of the portion of the corporation's
assets and receivables which are covered by the trust fund doctrine and provide
for the amount of assets and receivables of the corporation which are deemed
protected for the benefit of the corporate creditors and from which the corporation
cannot declare any dividends.
In one case,15 the Supreme Court held that the capital stock of a
corporation represents the interest and is the property of stockholders in the
corporation, who can only be deprived thereof in the manner provided by law,
and therefore cannot be levied nor attached to enforce a judgment debt of the
corporation.
The capital stock of a corporation cannot be subject to levy by corporate
creditors as to allow them to operate the affairs of the corporation. The capital
stock of the corporation represents the interest and is the property of
stockholders in the corporation, who can only be deprived thereof in the manner
provided by law.16
CLASSIFICATION OF SHARES
1. Policies on Classification of Shares
The Corporation Code provides three (3) basic policies on share
classification.
Firstly, it expressly recognizes the freedom and power of a corporation to
classify shares. Under Section 6 of the Corporation Code, the shares of stock of
stock corporations may be divided into classes or series of shares, or both, any
of which classes or series of shares may have rights, privileges, or restrictions as
may be stated in the articles of incorporation. However, no share may be
14
Central Textile Mills, Inc. v. National Wages and Productivity Commission, 260 SCRA368
(1996).
15
J.R.S. Business Corp. v. Imperial Insurance, Inc., 11 SCRA 634, 639 (1964), citing
Therebee v. Baker, 35 N.E. Eq. [8 Stew.] 501, 505; In re Wells' Estate, 144 N.W. 174, 177, Wis.
294, cited in 6 W ORDS AND PHRASES, 109.
16
Ibid.
deprived of voting rights except those classified and issued as "preferred" or
"redeemable " shares, unless otherwise provided in the Corporation Code.17
Any or all of the shares or series of shares may have a par value or have
no par value as may be provided for in the articles of incorporation.18 However,
banks, trust companies, insurance companies, public utilities, and building and
loan associations shall not be permitted to issue no-par value shares of stock.19
A corporation may furthermore classify its shares for the purpose of
insuring compliance with constitutional or legal requirements.20
Secondly, the Code expressly adopts the presumption of equality of the
rights and features of shares when nothing is expressly provided to the contrary.
Under Section 6, "Except as otherwise provided in the articles of incorporation
and stated in the certificate of stock, each share shall be equal in all respects to
every other share." In other words, although a corporation has the power to
classify its shares of stock, provide for preferences and other conditions, when
nothing has been provided for in the articles of incorporation, no presumption
should exist to distinguish one share from another.
In one case,21 the Supreme Court has held that: “Both common and
preferred shares are part of the corporation‟s capital stock. Both stockholders are
no different from ordinary investors who take on the same investment risks.
Preferred and common shareholders participate in the same venture, willing to
share in the profits and losses of the enterprise. Moreover, under the doctrine of
equality of shares—all stocks issued by the corporation are presumed equal with
the same privileges and liabilities, provided that the Articles of Incorporation is
silent on such differences.”
The SEC has ruled that the mere classification of shares into preferred
shares does not necessarily deprive them of voting rights. In the absence of any
restrictions in the articles of incorporation or by-laws of the corporation, preferred
shares would be voting shares having the same rights as common shares, since
under Section 6 of the Corporation Code, all shares shall equal rights except
when otherwise provided in the articles of incorporation and state in the
certificate of stock. Consequently, where the articles of incorporation and the
certificates of stock are silent on the matter of voting rights, all issued shares,
regardless of their class nomenclature, shall be considered to have equal voting
rights.22
17
The SEC opined that common shares classified as “C” shares cannot validly be denied
votings rights even under the articles of incorporation, since under Section 6 of the Corporation
Code, only preferred shares may be denied voting rights. Even the mandatory feature of
assigning the voting rights of such class “C” shares to a trustee would be a virtual denial of such
voting rights and therefore illegal. SEC Opinion, 15 July 197, XXXII SEC QUARTERLY BULLETIN 5
(No. 2, Dec. 1997).
18
Sec. 6, Corporation Code.
19
Ibid.
20
Ibid.
21
Commissioner of Internal Revenue v. Court of Appeals, 301 SCRA 152 (1999).
22
SEC Opinion, 16 July 1996, XXX SEC QUARTERLY BULLETIN 22 (No. 2, Dec. 1996).
Thirdly, the Code provides for voting rights for all types of shares on
matters it considers as fundamental measures. Under Section 6, there shall
always be a class or series of shares which have complete voting rights. Where
the articles of incorporation provide for non-voting shares, the holders of such
shares shall nevertheless be entitled to vote on the following matters:
2. Common Shares
Corporations are generally authorized by statute to issue two or more
classes of stock, which may vary with respect to their rights to dividends, their
voting rights, and their right to share in the assets of the corporation on
liquidation. The most common classification of stock is into common and
preferred shares.
Common stock do not have any special contract rights or preferences.
Frequently it is the only class of stock outstanding. It generally represents the
greatest proportion of the corporation's capital structure and bears the greatest
risk of loss in the event of failure of the enterprise. Bearing the risk of loss, along
with participation in corporation assets after all claims are paid, management of
the corporation, and participation in profits are the foremost elements of common
shares.
In one case, the Supreme Court has defined a common stock to represent
“the residual ownership interest in the corporation. . . a basic class of stock
ordinarily and usually issued without extraordinary rights or privileges and entitles
the shareholder to a pro rata division of profits.”23
3. Preferred Shares
23
Commissioner of Internal Revenue v. Court of Appeals, 301 SCRA 152 (1999).
A preferred share of stock is one “which entitles the holder thereof to
certain preferences over the holders of common stock . . . designed to induce
persons to subscribe for shares of a corporation.”24 Although preferred shares
may take a multiplicity of forms, the most common forms may be classified into
two: (a) preferred shares as to assets; and (b) preferred shares as to dividends.25
Preferred shares as to assets gives the holder thereof preference in the
distribution of the assets of the corporation in case of liquidation. Preferred
shares as to dividends give the holder the right to receive dividends on said
shares to the extent agreed upon before any dividends at all are paid to the
holders of common stock.26
The contractual rights and preferences of an issue of preferred stock must
be provided for in the articles of incorporation. Under Section 6 of the
Corporation Code, preferred shares issued by any corporation may be given
preference in the distribution of the assets of the corporation in case of liquidation
and in the distribution of dividends, or such other preferences as may be stated
in the articles of incorporation which are not violative of the provisions of the
Corporation Code.
Preferred shares of stock may be issued only with a stated par value. 27
The board of directors, where authorized in the articles of incorporation, may fix
the terms and conditions of preferred shares of stock or any series thereof.28
Under the policy of the Corporation Code that does not grant benefits to a
share unless expressly provided for in the articles of incorporation, the naming of
shares as "preferred" without indicating what preferential rights they are
accorded, would not give such preferred shares any right in addition to those
enjoyed by common shares.
But even when preferred shares are granted special rights and
preferences that distinguish preferred from common stocks, both represent a
contribution to the capital of the corporation. A preferred stock is no more a debt
than common stock, and until a dividend is declared the holder of preferred
shares is not a creditor of the corporation. Furthermore, the rights of preferred
shareholders are subordinate to the rights of all of the creditors of the
corporation.
24
Republic Planters Bank v. Agana, 269 SCRA 1, 80 SCAD 1 (1997).
25
Ibid.
26
Republic Planters Bank v. Agana, 269 SCRA 1, 80 SCAD 1 (1997).
27
Sec. 6, Corporation Code.
28
Ibid. “Preferred stocks are those which entitle the shareholder to some priority on
dividends and asset distribution.” Commissioner of Internal Revenue v. Court of Appeals, 301
SCRA 152 (1999).
common shares are paid. The fundamental characteristic of cumulative stock is
that if the preferred dividend is not paid in full in any year, whether or not earned,
the deficiency must be made up before any dividend may be paid on the
common stock.
Non-cumulative preferred shares entitle the holders merely to the payment
of current dividends that are paid, to the extent agreed upon before the holders of
common shares are paid.
Prior to the adoption of the rule in Section 6 of the Corporation Code that
no preference or other right can be presumed to exist in favor of any share
unless clearly provided for in the articles of incorporation, there was
jurisprudence and general commercial acceptance that in the absence of any
stipulation, preferred shares are deemed to be cumulative.29
b. Entitlement to Preferences
The preference lawfully granted to preferred shares must be interpreted
and construed in accordance with applicable Corporate Law doctrines, and
cannot be deemed absolute.
For example, in one case,30 the Supreme Court has held that although the
certificates of stock granted the stockholder the right to receive quarterly
dividends of 1%, cumulative and participating, the stockholders did not become
entitled to the payment thereof as a matter of right without necessity of a prior
declaration of dividends. The Court held: “Both Sec. 16 of the Corporation Law
and Sec. 43 of the present Corporation Code prohibit the issuance of any stock
dividend 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. These provisions underscore the fact that payment of
dividends to a stockholder is not a matter of right but a matter of consensus.
Furthermore, „interest bearing stocks,‟ on which the corporation agrees
absolutely to pay interest before dividends are paid to the common stockholders,
is legal only when construed as requiring payment of interest as dividends from
net earnings or surplus only.”31
In spite of the specific preferences granted to preferred shares, there is no
guaranty, that the share will receive any dividends, or that the preferred
shareholders will have preference to corporate assets greater than the corporate
creditors, thus:
29
Fidelity Trust Co. v. Leigh Valley R. Co., 215 Pa. 610, 64 A. 829; Hazel Atlas Glass Co. v.
Van Dyke & Reeves, Inc., 8 F.2d 716; Bank of America Nat'l. Trust & Savings Assn. v. West End
Chemical Co., 100 P.2d 318).
30
Republic Planters Bank v. Agana, 269 SCRA 1, 80 SCAD 1 (1997).
31
Ibid.
Code, in Section 43, adopting the change made in accounting
terminology, substituted the phrase “unrestricted retained
earnings,” which may be a more precise term, in place of
“surplus profits arising from its business” in the former law.
Thus, the declaration of dividends is dependent upon the
availability of surplus profit or unrestricted retained earnings,
as the case may be. Preferences granted to preferred
stockholders, moreover, do not give them a lien upon the
property of the corporation nor make them creditors of the
corporation, the right of the former being always subordinate to
the latter. Dividends are thus payable only when there are
profits earned by the corporation and as a general rule, even if
there are existing profits, the board of directors has the
discretion to determine whether or not dividends are to be
declared. Shareholders, both common and preferred, are
considered risk takers who invest capital in the business and
who can look only to what is left after corporate debts and
liabilities are fully paid.32
4. Redeemable Shares
Section 8 of the Corporation Code provides that redeemable shares may
be issued by the corporation when expressly so provided in the articles of
incorporation. They may be purchased or taken up by the corporation upon the
expiration of a fixed period, regardless of the existence of unrestricted retained
earnings in the books of the corporation, and upon such terms and conditions as
may be stated in the articles of incorporation, which terms and condition must
also be stated in the certificates of stock representing said shares.33
It has been held that when the certificates of stock recognizes redemption,
but the option to do so is clearly vested in the corporation, the redemption is
clearly the type known as “optional” and rest entirely with the corporation and the
stockholder is without right to either compel or refuse the redemption of its
stock.34
32
Republic Planters Bank v. Agana, 269 SCRA 1, 80 SCAD 1 (1997).
33
Sec. 8, Corporation Code.
34
Republic Planters Bank v. Agana, 269 SCRA 1, 80 SCAD 1 (1997).
“Redemption” has been defined as the “repurchase, a reacquisition of
stock by a corporation which issued the stock in exchange for property, whether
or not the acquired stock is cancelled, retired or held in the treasury [and that]
[e]ssentially, the corporation gets back some of its stock, distributes cash or
property to the shareholder in payment for the stock, and continues in business
as before.35
The SEC Rules Governing Redeemable and Treasury Shares,36 expressly
define "redeemable shares" as shares of stock issued by a corporation which the
corporation can purchase or take up from their holders as expressly provided for
in its articles of incorporation and certificates of stock representing said shares.
The Rules provide that all corporations which have issued redeemable
shares with mandatory redemption features are required to set up and maintain a
sinking fund, which shall be deposited with a trustee bank and not be invested in
risky or speculative ventures. The Rules also provide that redeemable shares
may be redeemed, regardless of the existence of unrestricted retained earnings,
"provided that the corporation has, after such redemption, sufficient assets in its
books to cover debts and liabilities inclusive of capital stock."
In addition, the SEC Rules provide that redeemable shares reacquired
shall be considered retired and no longer issuable, unless otherwise provided in
the articles of incorporation of the redeeming corporation.
In various ways, the SEC Rules seek to safeguard corporate creditors, as
by requiring full payment of subscriptions and preventing any return to
shareholders out of capital, if claims of creditors would be impaired.
Consequently, a purchase by a corporation of its own shares is objectionable
from the standpoint of creditors when the purchase price is paid out of capital,
that is, if corporate assets are paid out below the limit fixed by the legal capital. If
shares are acquired by purchase and payment is made out of a surplus of assets
over liabilities, including the legal capital, creditors have no cause for complaint.
The express provisions of Section 8 which allows redemption "regardless
of the existence of unrestricted retained earnings" would now constitute a clear
exception to the trust fund doctrine. Under Section 8, redeemable shares may be
issued by the corporation when expressly so provided in the articles of
incorporation. They may be purchased be purchased or taken up by the
corporation upon the expiration of a fixed period, regardless of the existence of
unrestricted retained earnings in the books of the corporation, and upon such
other terms and conditions stated in the articles of incorporation, which terms and
conditions must also be stated in the certificate of stock representing said shares.
Nevertheless, the consistency of policy of protecting corporate creditors is
still there in the sense that creditors will not be misled since it is required that the
redemption feature must be stated both in the articles of incorporation and the
certificates of stock.
35
Commissioner of Internal Revenue v. Court of Appeals, 301 SCRA 152 (1999).
36
Issued by the SEC on 26 April 1982. See SEC Rules and Regulations (1986 ed.), at p.
256.
These issues have been dealt with particularity in Republic Planters Bank
v. Agana,37 thus:
5. Founders' Shares
Section 7 of the Corporation Code, provides that founders' shares
“classified as such in the articles of incorporation” may be given certain rights
and privileges not enjoyed by the owners of other stocks, provided that where the
exclusive right to vote and be voted for in the election of directors is granted, it
must be for a limited period not to exceed 5 years subject to the approval of the
SEC. The five-year period shall commence from the date of the aforesaid
approval by the SEC.
37
269 SCRA 1, 80 SCAD 1 (1997).
38
Emphasis supplied.
39
Commissioner of Internal Revenue v. Court of Appeals, 301 SCRA 152 (1999).
a. Which Are Founders’ Share?
Perhaps the most obvious feature of founders‟ share is that they are
issued basically to the founders or initial organizers of the corporation, but
nothing in the language of Section 7 expressly so provides. In fact, under Section
7 the classification of founders‟ share may be interpreted to be based on two
aspects: (a) nomenclature; or (b) certain exclusive rights granted to such shares.
The issue therefore is whether founders‟ shares are such because they
have been classified and have been given the nomenclature of “founders‟ share”
under the articles of incorporation. This does not seem to be within the spirit of
Section 6 of the Corporation Code that in effect provides that it is not
nomenclature that gives rights and preference to shares of stock.
Consequently, we must presume that what makes shares as founders‟
shares would be that they are given the exclusive rights not given to other
stockholders, and specially the right to vote and be voted for in the election of
directors. The existence of founders‟ shares must necessarily include the fact
that there are other shares that do not enjoy such rights, and would necessarily
include the existence of common shares, which ordinarily would have the right to
vote and be voted into the board of directors. That would have to be the rationale
basis for the restriction provided in Section 7 that such exclusive rights shall not
exceed five (5) years and subject to the approval of the SEC.
It would then also be reasonable to conclude that a class of shares, even
when not given the nomenclature of “founders‟ share”, would necessarily fall
within the provision of Section 7 (and therefore be classified as founders‟ share)
whenever such class of shares are given the exclusive right to vote and be voted
for in the election of directors, and necessarily such exclusive rights shall have a
limited period of five (5) years.
7. Treasury Shares
Section 9 of the Corporation Code provides that treasury shares are
shares of stock which have been issued and fully paid for, but subsequently
reacquired by the issuing corporation by purchase, redemption, donation, or
through some other lawful means. Such shares may again be disposed of for a
reasonable price fixed by the board of directors.
Treasury shares are therefore shares that a corporation acquires after it
has issued them.
The SEC has opined that treasury shares have no effect on the stated
capital of the corporation unless and until they are cancelled or retired, in which
event the stated capital is reduced by the amount then representing the shares. 42
Treasury shares must be distinguished from the authorized but unissued shares:
the acquisition of treasury shares does not reduce the number of issued shares
or the amount of stated capital and their sale does not increase the number of
issues shares or the amount of the stated capital.43
A corporation may sell treasury shares for any amount the board of
directors determines, even if the shares have a par value that is more than the
sale price. Treasury shares do not have voting rights nor pre-emptive rights. In
addition, no dividends are paid on treasury shares.
41
Delpher Trades Corp. v. Intermediate Appellate Court, 157 SCRA 349, 353-354 [1988],
quoting directly from AGBAYANI, COMMENTARIES AND JURISPRUDENCE ON THE COMMERCIAL LAWS OF
THE PHILIPPINES, Vol. III, 1980 Ed., p. 107).
42
SEC Opinion, 18 March 1987, SEC QUARTERLY BULLETIN (No. 1, March 1987), at pp. 19-
20.
43
Ibid.
In Commissioner of Internal Revenue v. Manning,44 the Supreme Court
discussed the various features of treasury shares, as follows:
The SEC Rules Governing Redeemable and Treasury Shares provide that
treasury shares do not revert to the unissued shares of the corporation but are
regarded as property acquired by the corporation which may be reissued or sold
by the corporation at a price to be fixed by the Board of Directors.
The amount of unrestricted retained earnings equivalent to the cost of the
treasury shares being held shall be restricted from being declared and issued as
dividends. The dividend restriction on retained earnings on account of the
treasury shares shall be lifted only after the treasury shares causing the
restriction are reissued or retired. The retirement of treasury shares shall be
effected by decreasing the capital stock of the corporation in accordance with
Section 38 of the Corporation Code for the purpose of eliminating treasury
shares.46
Treasury shares shall have no voting rights as long as such shares remain
in treasury.47
Treasury shares may be declared as property dividend to be issued out of
the retained earnings previously used to support their acquisition, provided that
the amount of the said retained earnings has not been subsequently impaired by
44
66 SCRA 14 (1975).
45
Ibid, at pp. 23-24.
46
Sec. 4(2), Sec Rules Governing Redeemable and Treasury Shares (1982).
47
Sec. 5(2), Ibid.
losses.48 Any declaration and issuance of treasury shares as property dividend
shall be disclosed and properly designated as property dividend in the books of
the corporation and in its financial statements.49
Rule on Treasury Shares for Banks — No bank shall purchase or
acquire shares of its own capital stock or accept its own shares as a security for
a loan, except when authorized by the Monetary Board; and in every case the
stock so purchase or acquired shall, within six (6) months from the time of its
purchase or acquisition, be sold or disposed of at a public or private sale.50
8. Hybrid Securities
Two of the principal sources of capital formation in corporations involve
debt and equity investment securities. The sale of equity securities provides an
initial and often continuing source of corporate funds.
"Equity securities" represent an ownership interest in the corporation and
include both common and preferred stock. In addition, corporations finance
much of their continued operations through debt securities.
"Debt securities," or bonds, do not represent an ownership interest in the
corporation but rather create a debtor-creditor relationship between the
corporation and the bondholder.
Debt securities have the advantageous of allowing a return to the investor
whether or not the corporation has unrestricted retained earnings. Interest paid
on the debt securities are deductible to the corporation for income tax purposes.
Equity securities payments, being dividends are not tax deductible to the
corporation. However, equity securities usually grant a voting right to the holder,
allowing participation in certain management aspects of the corporation. Also,
under present tax legislation, dividends are subject to zero rate of income tax;
whereas, interest paid on debt securities are generally taxable to the holder
thereof.
In the early case of Government v. Philippine Sugar Estates Co.,51 the
Supreme Court, in determining whether the arrangement between two
corporations was a contract of partnership or a loan arrangement,52 noted the
following features in the contract in ruling that it is partnership (i.e., equity)
arrangement:
48
Sec. 5(3), Ibid.
49
Ibid.
50
Sec. 10, The General Banking Law of 2000 [RA 8791].
51
38 Phil. 15 (1918).
52
The issue arose from an alleged violation of then Section 13 of the old Corporation Law
which provided that no corporation shall be authorized to conduct the business of buying and
selling real estate or be permitted to hold or own real estate except such as may reasonably
necessary to enable it to carry out the purposes for which it has been created; however, the
section authorized a corporation to loan funds upon real estate, security, and purchase of real
estate when necessary for the collection of loans, but it shall dispose of real estate so obtained
within five years after receiving the title.
(a) There was no period fixed in the contract for the repayment
of the money, except that the first return from sale of the
land was to be devoted to the payment of the capital, and
there was no date fixed for such payment;
(b) The entire amount of the "credit" was not to be turned over
at once but was to be used by the "borrowing" company as it
was needed;
(c) The return on the capital was not by a fixed rate of interest
but 25% of the profits earned by the "borrowing" company in
"todos los negocios;"
(d) The "lending" company agreed to pay 25% of all general
expenditures true and necessary that the "borrowing"
company must make for the development of its business;
(e) The consent of the "lending" company was necessary when
the "borrowing" company desired to sell the land at below an
agreed market price, but was not required if the selling price
was over the benchmark figure; and
(f) The "lending" company acted as treasurer of the entire
enterprise.
The foregoing terms and conditions of the contract between the two
corporations indicated to the Court that although denominated as a loan
agreement, the arrangement between the companies was actually one of
partnership, with the amount "loaned" constituting actual equity investment in the
venture.
The Court held: "It is difficult to understand how this contract can be
considered a loan. There was no date fixed for the return of the money and there
was no fixed return to be made for the use of the money. The return was
dependent solely upon the profits of the business. It is possible for the defendant
to receive a return from the business even after all of the `capital' has been
returned. The „capital‟ was to be returned as soon as the land was sold and
apparently . . there were to be no profits until this „capital‟ was returned. The
defendant was not to receive anything for the use of said sum until after the
capital had been fully repaid, which is not consistent with the idea of loan. It is not
impossible to provide that the capital be repaid first but the usual method is to
pay the interest first. . ."53
The other practical consideration for investors in choosing between equity
or loan investments in a corporation boils down to tax considerations: the
interests returns on loans or credit investments are taxable to the lending
53
Ibid, at p. 24.
company, whereas dividend returns on equity investments are subject to zero
rate of income tax.54
1. Historical Background
The trust fund doctrine is a judicial invention credited to Justice Story,
which he first enunciated in the 1824 decision in Wood v. Drummer.56 A suit in
equity was brought by creditors of banking corporation to hold the stockholders of
such corporation personally liable, it appearing that the greater part of the capital
of the corporation had been distributed to the stockholders as dividends, thereby
rendering the bank insolvent and leaving the creditors unpaid. Justice Story
announced the doctrine as follows:
57
As reported in FLETCHER, 7370.
58
New Albany v. Burke, 11 Wall. (U.S.) 96, 20 L. ed. 155; Burke v. Smith, 16 Wall. (U.S.)
390, 21 L. Ed. 361; Sawyer v. Hoag, 17 Wall. (U.S.) 610, 21 L. Ed. 731; Sangor v. Upton, 91 U.S.
56, 23 L. Ed. 220.
for the benefit of creditors. Thus, in invoking the doctrine it was contended that a
corporation debtor does not stand on the same footing as an individual debtor;
that while the latter has supreme dominion over his own property, a corporation
is a mere trustee, holding its property for the benefits of its stockholders and
creditors, and that if it fails to pursue its rights against third persons, whether
arising out of fraud or otherwise, it is a breach of trust, and corporate creditors
may come into equity to compel an enforcement of the corporate duty.59
To such a legal position the U.S. Supreme Court held:
The U.S. Supreme Court held in clearer language in another case: "When
a corporation is solvent, the theory that its capital stock is a trust fund upon which
there is any lien for the payment of its debts has in fact very little foundation. No
general creditor has any lien upon the fund under such circumstances, and the
right of the corporation to deal with its property is absolute so long as it does not
violate its charter or the law applicable to such corporation."61
It is generally accepted that the proper scope of the trust fund doctrine is
that the capital stock of a corporation, as well as all its other property and assets
are generally regarded in equity as a trust fund for the payment of corporate
debts, the creditors of the corporation have the right to priority payment over any
stockholder thereof.62 However, this broad definition that encompasses all
"property and assets" is more accurately applicable to corporation that is
insolvent.
59
Cf. Graham v. La Crosse & R. Co., 102 U.S. 148, 26 L. Ed. 106.
60
Ibid.
61
McDonald v. Williams, 174 U.S. 397, 43 L. Ed. 1022, 19 Sup. Ct. 743.
62
Chicago Rock Island & Pac. R.R. Co. v. Howard, 7 Wall 392, 19 L. ed. 117; Sawyer v.
Hoag, 17 Wall. 610, 21 L. ed. 731; Pullman v. Upton, 96 U.S. 328, 24 L. ed. 818.
An examination of the various cases on the matter has shown that the
trust fund doctrine usually applies in four cases:
(a) Where the corporation has distributed its capital among the
stockholders without providing for the payment of creditors;
(b) Where it had released the subscribers to the capital stock
from their subscriptions;
(c) Where it has transferred the corporate property in fraud of its
creditors; and
(d) Where the corporation is insolvent.63
The doctrine itself has to a great extent been marginalized in the United
States, mainly because of its misleading name; nevertheless, in Philippine
jurisdiction, our own Supreme Court seems to accept the doctrine as a given.
The definition that has been much adhered to in Philippine jurisdiction is
one given by Fletcher: "The capital stock of a corporation, or the assets of an
insolvent corporation representing its capital, is a trust fund for the benefit of the
company's creditors."64
Our Supreme Court had formally adopted the principle of the doctrine in
Philippine Trust Co. v. Rivera,65 when it held that: "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."
Garcia v. Lim Chu Sing,66 held that "Stockholders, as such, are not
creditors of the corporation.67 It is the prevailing doctrine of the American courts,
repeatedly asserted in the broadest terms that the capital stock of a corporation
is a trust fund to be used more particularly for the security of creditors of the
corporation, who presumably deal with it on the credit of its capital stock.”68
Under the Corporation Code the Supreme Court in Boman Environmental
Dev't. Corp. v. Court of Appeals,69 reaffirmed the application of the doctrine in our
jurisdiction when it held that -
70
Ibid, at p. 548.
71
301 SCRA 152 (1999).
3. Fraud Theory
Due to the difficulties met with the terminology and application of the trust
fund doctrine, there have been advocates of the position that most issues relating
to capital stock or corporate assets and as to unpaid subscriptions properly
belong to the question of fraud rather than trust fund.72 Under this theory, the
actionable wrong is the fraud or misrepresentation by directors, officers, or
stockholders in falsely representing that the capital stock has been fully paid or
covered by binding subscription contracts. Consequently, only creditors who may
have been defrauded are entitled to relief; creditors who had notice are not
protected.
This varies with the principle under the trust fund doctrine that seeks to
protect all corporate creditors.
72
THOMPSON, 3429.
73
SEC Opinion, 11 August 1997, XXXII SEC QUARTERLY BULLETIN 15 (No. 2, Dec. 1997).
In Accounting, "capital stock" is deemed to cover only "legal capital." In the
case of par value stock, capital stock or legal capital is represented by the
aggregate par value of all shares issued and subscribed.74 If the par value shares
are sold at a premium, the excess is not treated as legal capital; but it can only
be declared as stock dividends and not any other form of dividends.75 Since stock
dividends has a manner of capitalizing the portion of the retained earnings or
excess of paid-in capital, then rightly it can be concluded that subscription in
excess of par value in the case of par stock, is within the ambit of the trust fund
doctrine.
In case of no-par value stock, the legal capital is the total consideration
received for the shares of stock. Under Section 6 of the Corporation Code, the
entire consideration received from no-par shares shall be treated as capital, and
shall not be available for distribution as dividends. In such case, there is no issue
as to the proper coverage of the "capital stock" as encompassing every
consideration paid, or promised to be paid, for subscription of shares in a
corporation.
In relation to the trust fund doctrine, the Supreme Court held in Central
Textile Mills, Inc. v. National Wages and Productivity Commission,76 that funds
received by the corporation to cover subscription payment on increase in
authorized capital stock prior to approval thereof of the SEC would not be
covered within the ambits of the trust fund doctrine. The Court held: "As a trust
fund, this money is still withdrawable by any of the subscribers at any time before
the issuance of the corresponding shares of stock, unless there is a pre-
subscription agreement to the contrary. . . Consequently, if a certificate of
increase has not yet been issued by the SEC, the subscribers to the
unauthorized issuance are not to be deemed as stockholders possessed of such
legal rights to vote and dividends."
5. Observations
An examination of the relevant provisions of the Corporation Code shows
that to a great extent the trust fund doctrine has been engrafted and sometimes
strengthened in our jurisdiction. In few instances, such as on redeemable shares
and in allowing a corporation to purchase its own shares, the doctrine has been
relaxed, if not discarded, in response to legitimate needs of corporate entities to
respond to business imperatives. But generally, the need to preserve the capital
stock of the corporation as fund "to which creditors may look upon for the
satisfaction of their claim" has been preserved.
And although there have been much criticism against the doctrine, there
are some who may find solace in what was said in Witt v. Nelson,77 that the
74
VALIX AND PERALTA, FINANCIAL ACCOUNTING (1981 Ed.), Vol. Two, p. 404 .
75
Ibid.
76
260 SCRA368, 73 SCAD 109 (1996).
77
169 S.W. 381.
"theory is not obsolete, and will not become obsolete anywhere until honesty
shall become obsolete."
DIVIDENDS
The concept of the trust fund doctrine is acknowledged and its scope
clearly delineated, in the power of the corporation to declare dividends, as
defined under Section 43 of the Corporation Code.
Section 43 of the Corporation Code, which governs the power of a
corporation to declare dividends, provides that the board of directors of a stock
corporation may declare dividends only 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.78
78
While it is normal corporate practice to declared dividends after the end of the fiscal year
when the company could definitely determine whether it made profits and the amount thereof, in
its opinions, the SEC has allowed the declaration of dividends from current accumulated net
earnings of the company earned during an interim period, provided the company has sufficient
retained earnings for the purpose which will not be impaired by losses, whether or expected or
not, during the remaining period of the fiscal year. SEC Opinion, dated 22 October 1974, SEC
FOLIO 1960-1976, at p. 746; SEC Opinion, 15 January 1986, XX SEC QUARTERLY BULLETIN 1 & 2
(March & June, 1986).
There was also issue on what is covered by the phrase "capital stock or
property," and whether it covered the authorized capital stock, which the
maximum number of shares that a corporation may issue without amending its
articles of incorporation; or whether it covered the outstanding stock, which
covers the shares actually subscribed and issued to stockholders.
Salonga, in his treatise,79 discussed the controversy in this manner:
79
SALONGA, PHILIPPINE LAW ON PRIVATE CORPORATIONS, 1968 ed., pp. 524-525.
In Accounting, the term "retained earnings" is a technical term that has a
definite coverage. It represents the cumulative balance of periodic net income
dividend distributions, prior period adjustments [on prior year's net income, and
special distributions to stockholders resulting from capital adjustments [quasi-
reorganization];"80 it represents "the accumulated net income of a corporation
from the date of incorporation (or from the date of the latest date when a deficit
was eliminated in quasi-organization), after deducting therefrom distribution to
stockholders and transfers to capital stock or other accounts."81 In simple terms,
retained earnings represents the accumulation of net profits of the corporation
over the years and likewise losses sustained, as well as deductions made upon
previous dividends declared; if the accumulation resulted in a net loss over the
years, it is called a "deficit."
"Restricted" or "appropriated" retained earnings is that portion of the
retained earnings specifically earmarked or "set-aside" for specific purpose such
as to meet contingent liabilities, or planned expansion of facilities. Restriction of
retained earnings is but a memorandum notation in the books of accounts as a
reminder that the amount restricted should not be declared anymore as
dividends. "Unrestricted" or "unappropriated" retained earnings represents that
portion which is free and can be declared or dividends to stockholders.82
With the use of the term "unrestricted retained earnings" under the
Corporation Code, many of the old issues have been laid to rest in that:
(a) Any and all items included in retained earnings (i.e., income
of all types, prior period adjustments net income, special
distribution to stockholders resulting from [quasi-
reorganization] can be declared as dividends, unless
restricted);
(b) All other items not falling within the term "retained earnings"
are necessarily included in "capital" and are unavailable for
dividend declaration (e.g., donated assets or funds, paid-in
surplus arising from issuance of no-par stock, premium paid
on par value shares, revaluation surplus created to write-ups
of the assets).
It should be noted that when the corporation incurs a deficit (i.e., negative
retained earnings), the operations have actually "eaten-up" into the capital stock
and there is actually a capital impairment. Even if the corporation manages to
make profits in succeeding years, no dividends can be declared until the deficit is
"wiped-out" and the retainer earnings shows a positive amount.
80
VALIX & PERALTA, FINANCIAL ACCOUNTING, Vol. Two, p. 492.
81
Bulletin on Accounting Principles No. 10, dated November, 1975, issued by the Philippine
Institute of Certified Public Accountants (PICPA).
82
VALIX & PERALTA, supra.
The decision in the case of Steinberg v. Velasco,83 indicates that in
determining the legality of declared dividends, the existence of unrestricted
retained earnings alone cannot be the test. In that case, the board of directors
passed and implemented a resolution authorizing the purchase of a substantial
portion of the shares of stockholders and the declaration of dividends of
P3,000.00. At the time of the adoption of the resolution, the corporation had a
"surplus profit" of P3,314.72 and had as assets (accounts receivables) that far
exceeded its liabilities. It turned out that the assets were practically worthless.
The evidence indicated that the directors in adopting the resolution were either
acting in bad faith or with the use of ordinary care could have determined the
non-existence of "surplus profit".
In holding the directors solidarily liable to corporate creditors to the extent
of the dividends paid-out, the Court held that the existence a "surplus profit"
alone does not suffice but that the corporation should "have an actual bona fide
surplus from which the dividends could be paid, and that the payment of them in
full at that time would not affect the financial condition of the corporation."
As applied to Section 43 of the Corporation Code, Steinberg is a clear
indication that only dividends declared from a bona fide unrestricted retained
earnings is legally permissible. Thus, although a corporation's balance sheet
provides for an unrestricted retained earnings, if the figure does not register the
true value of the assets (such as when worthless assets have not been written-
off), dividends declared on that basis would be illegal.
Steinberg also indicates the remedy available in case of illegal distribution
of dividends: that directors who are in bad faith or are grossly ignorant of their
duties shall be held solidarily liable for the reimbursement of the amount declared
as dividend.
83
52 Phil. 953 (1929).
refer to the accumulated undistributed earnings or profits realized by the
corporation arising from the transaction of its business and the management of
its affairs, out of current and prior years.
Such retained earnings or portion thereof are said to be unrestricted and
therefore free for dividend distribution to stockholders, if they have not been
reserved or set aside by the board of directors for some corporate purpose or for
some other purpose in accordance with legal or contractual requirements.
To justify the declaration of dividends, there must be an actual bona fide
surplus or profits or earnings over and above all debts and liabilities of the
corporation. Hence, earnings of the corporation which have dividends may be
paid.
Dividends may not be declared so long as a deficit exists, whether
resulting from its operations of preceding years, or the present. It does not
likewise include increases in value of fixed assets, nor borrowed funds.
84
SEC Opinion, 23 September 1986, XX SEC QUARTERLY BULLETIN (Nos. 3 & 4, Sept. &
Dec., 1986), citing BALLANTINE ON CORPORATION, pp. 539-540.
85
Ibid, quoting from the Minutes of the 31st meeting of the Committee on Revision of Laws
and Codes and Constitutional Amendments at the VIP Lounger at Room "A", Batasan Complex,
Quezon City, Metro Manila on 10 March 1980.
86
Ibid, citing CAMPOS AND LOPEZ-CAMPOS, COMMENTS, NOTES AND SELECTED CASES,
CORPORATION CODE, pp. 771-772.
a. Consideration Received for No-Par Value Shares
Section 6 of the Corporation Code provides that in case of no-par value
shares, "the entire consideration received by the corporation for its no-par value
shares shall be treated as capital and shall not be available for distribution as
dividends." In case of no-par value shares, the entire consideration (including
paid-in surplus) received from the same shall be treated as capital and shall not
be available for distribution as dividends. The theory is that the stockholders
intended that all such consideration shall constitute the basic business fund of
the corporation to be permanently devoted in the prosecution of the corporate
business.
4. Concept of Dividends
A stock corporation exists to make a profit and to distribute a portion of the
profits to its stockholders. A dividend is that portion of the profits of a corporation
set aside, declared and ordered by the directors to be paid ratably to the
stockholders on demand or at fixed time. It is payment to the stockholders of a
corporation as a return upon their investment. It is a characteristic of a dividend
that all stockholders of the same class share in it is proportion to the respective
amounts of stock which they hold. The term dividend indicates that there must be
a surplus or profits to be divided. However, the word has also been used to
87
XXIX SEC QUARTERLY BULLETIN 104 (No. 3, Sept. 1995).
describe distributions made to stockholders on liquidation of the corporation and
to distribution of assets upon a reduction of the capital stock.
88
Lincoln Philippine Life v. Court of Appeals, 293 SCRA 92, 96 SCAD 542 (1998).
89
Nielson v. Co. vs. Lepanto Consolidated, 26 SCRA 540 (1968).
it cannot without his consent be reverted to the surplus account of the
corporation.
Stock dividend declarations may be revoked prior to actual issuance
thereof. In the case of scrip dividend declaration, they are, just like stock
dividends, revocable before actual issuance.
No dividends can be declared out of capital except liquidating dividends
and the so-called "dividends" from investment in a wasting asset corporation.
c. Property Dividends
The SEC Rules Regulating the Issuance of Property Dividends,90 provide
for the following guidelines for all stock corporations which declare property
dividends:
90
XXVI SEC QUARTERLY BULLETIN 115 (No. 3, Sept. 1992).
mistakenly paid out. Since they do not act in a corporate capacity in receiving
the dividends, they do not thereby ratify the illegal act of the board as to preclude
a subsequent recovery.
If the directors acted in good faith, and without negligence, they are not
liable to the corporation or to the creditors for declaring and paying dividends
when they should not have done so, and thereby diminishing the capital stock.
But if they have been guilty of fraudulent breach of trust, or of gross negligence,
in paying dividends when they had no right to pay them, they are personally
liable to creditors.
7. Liquidating Dividends
Under the law, dividends other than liquidating dividends (which form part
of the capital) may be declared and paid out of the unrestricted retained earnings
of the corporation. A corporation cannot make a valid contract to pay dividends
other than from retained earnings or profits and an agreement to pay such
dividends out of capital is unlawful and void. The power of the corporation to
acquire its own share is likewise subject to the condition that there be
unrestricted retained earnings in its books to cover the shares to be purchased.
The reason for the rule is that the capital stock of the corporation is a trust
fund for the security of the creditors and cannot be distributed to their prejudice to
the stockholders as dividends, the creditors being precluded from holding the
stockholders personally liable for their claims.
For purposes of the general rule, the capital or capital stock which may not
be impaired or depleted by dividends is not the entire net assets of the
corporation; rather it is the legal capital of the corporation in the strict sense,
referring to that portion of the net assets directly or indirectly contributed by the
stockholders as consideration for the stocks issued to them upon the basis of
their par or issued value.
Under the old Corporation Law, the exercise of the appraisal right was
subject to the following condition: “A stockholder shall not be entitled to payment
for his shares under the provisions of this section unless the value of the
corporate assets which would remain after such payment would be at least equal
to or aggregate of its debts, liabilities and the aggregate value and/or issued of
the remaining subscribed capital stock.” On the other hand, Section 82 of the
Corporation Code on the exercise of appraisal right provides in part "[t]hat no
payment shall be made to any dissenting stockholder unless the corporation has
unrestricted retained earnings."
The effect of the change in phraseology under Section 82 of the
Corporation Code may be best explained by way of illustration, taking a
corporation which has the following financial condition:
Under the old Corporation Law, in the exercise of appraisal right, the most
that a corporation could purchase on the shares of dissenting stockholders is
P1,000,000 (or 1/3 of the capital stock, since the two-thirds (2/3) would have
voted for the corporate transaction to be valid). Mathematically, there would be
no legal obstacle to paying to the extent of P1,000,000 to dissenting stockholders
since the net result of the payment would always be that the remaining assets
would always be equal to the total amounts of liabilities and the remaining capital
stock. This can be appreciated from the fact that for every peso of capital stock
reduced due to purchase, there is a corresponding decrease of an equivalent
peso on the assets used as payment; thus, the equality of both sides of the
balance sheet is always maintained.
91
Sec. 17-1/2, Act No. 1459.
92
Sec. 18, Act No. 1459.
93
Sec. 28-1/2, Act No. 1459.
This observation would not apply of course if we construe that when the
old Corporation Law used the term "value" for the remaining assets, it referred
their fair market value or realizable value. But this is unlikely the intention since
for the covered transactions the corporation is still to function as a "going
concern" and therefore the assets continue to be valued at their book value.
Using the same illustration above, under the Corporation Code, the most
that the corporation can be obliged to pay to dissenting stockholders (whose
shares may amount to as high as P1,000,000) is only P500,000 since that is only
the extent of the unrestricted retained earnings. In effect, the Corporation Code
offers a more stringent formula before it allows a corporation to buy-out a
dissenting stockholders in instances allowed by law.
Under the old Corporation Law, it would seem that the accepted view was
that a corporation generally has no power to purchase its own shares and
reduced the stated capital, and this was expressed in Steinberg v. Velasco:94
94
52 Phil. 953 (1929).
95
Ibid, at p. 961.
96
167 SCRA 540 (1988). See Note 13.
retained earnings, the corporate creditors are deemed protected. This is also an
implied acknowledgment that the trust fund doctrine applies only to the
subscribed capital stock as distinguished from the retained earnings.
Allowing a corporation to purchase its own shares to the extent of its
unrestricted retained earnings has been viewed as equivalent to subjecting
dividend declaration to the extent of unrestricted retained earnings. 97 It has been
insisted that the purchase of a corporation's own share should be always from its
own surplus.98 But requiring the existence of unrestricted retained earnings does
not directly achieve such an end and it is not comparable to the situation of
declaring dividends.
Dividends when declared and paid-out are charged directly against
retained earnings as is the standard accounting procedure. On the other hand,
when a corporation acquires its own shares (which thereby become treasury
shares), the amount of acquisition is charged to the account "Treasury Shares"
which is not directly deducted from the retained earnings, but is presented
normally as a deduction from the total stockholders' equity (the sum total of
capital stock and retained earnings).99 Therefore, in order to preserve legal
capital, the retained earnings is usually appropriated or restricted to the extent of
the cost of the treasury stock, and the same cannot be declared as dividends
until the treasury stock is subsequently resold.100 To that extent therefore the
safeguards under the trust fund doctrine are met.
The difficulty comes with the disposition or resale of the treasury stock.
Whatever the method of accounting adopted by the corporation on treasury
shares,101 any "loss" in the disposition of treasury shares later on is first charged
to capital stock, and only when the capital stock or premium on capital stock is
not enough to cover the "loss" will the amount be charged to retained earnings. 102
In other words, although no dividends may be declared from restricted retained
earnings cover the shares reacquired by the corporation as treasury shares (and
thereby effectively prevents the declaration of dividends that will eat-up into the
legal capital), nevertheless, the disposition of treasury shares would effectively
reduce first the capital stock portion, rather than the retained earnings portion.
To illustrate, in a corporation that has a capital stock of P1,000,000 and
retained earnings of P500,000, legally it can acquire its shares for legitimate
purpose up to the extent of P500,000. The results would be:
97
CAMPOS AND LOPEZ-CAMPOS, CORPORATION CODE, 1981 ed., p. 804; AGBAYANI, supra, pp.
341-343.
98
BALLANTINE, 605.
99
Par. 6, Statement of Financial Accounting Standards No. 18 (SFAS No. 18 September
1987); VALIX & PERALTA, FINANCIAL ACCOUNTING, Vol. Two, 1981 ed., pp. 458-459.
100
VALIX & PERALTA, FINANCIAL ACCOUNTING, Vol. Two, 1981 ed., pp. 458-459.
101
Under the "cost method," the treasury stock is recorded at cost, regardless of whether
the cost is more or less than the original issue price of the stock. Under the "retirement method,"
the cost of acquisition of the treasury stock is charged firs to the par value or original issuance
cost, and any difference is charged first to capital stock, the premium on paid-in capital stock, and
lastly to retained earnings. See VALIX & PERALTA, supra, at pp. 460-462.
102
VALIX & PERALTA, supra, at pp. 460-464.
BEFORE SHARE ACQUISITION AFTER SHARE ACQUISITION
Capital Stock P1,000,000 Capital Stock P1,000,000
Less: Treasury Shares 500,000
Net Capital Stock P 500,000
Retained Earnings 500,000 Retained Earnings 500,000
Stockholders' Equity P1,500,000 Stockholders‟ Equity P1,000,000
Even after the acquisition of the shares, there is still available retained
earnings of P500,000 because acquisition of shares is charged against Capital
Stock, and not against retained earnings. Strictly speaking, nothing prevents the
corporation from thereafter declaring cash dividends because of the availability of
retained earnings should be deemed restricted to the extent of the value of the
shares acquired by the corporation. If the retirement of shares is permanent for
all intents and purposes the affected portion of the retained earnings has been
"capitalized".
The accounting treatment for the purchase by the corporation of its own
shares should be as stated by Prof. Nemmers that "Purchases as to be restricted
to earned surplus and are to be cumulatively shown as charged to that account
on the balance sheet. Gains from purchases upon resale should be credited to
capital surplus and losses charged to earned surplus."103
103
Purchase by a Corporation of Its Owns Shares, 1942 W IS. L. REV. 161, 188.
104
SEC Opinion, 18 June 1986, XX SEC QUARTERLY BULLETIN (Nos. 1 & 2, March and
June, 1986), citing 15 FLETCHER, 1961 Rev. Vol., secs. 7201.
105
SEC Opinion, 14 Sept. 1998, XXXII SEC QUARTERLY BULLETIN 21 (No. 1, June, 1999).
(b) By the reduction of a corporation's capital stock through the
formal filing of an application for amendment of its articles of
incorporation with the SEC.106
106
Ibid.
107
See SEC RULES AND REGULATIONS (1986 ed.), at p. 246; SEC Opinion, 18 August 1994,
XXIX SEC QUARTERLY BULLETIN 7 (No.1, March 1995).
quasi-reorganization on the financial condition of the
company.
3. Debt-to-Equity Conversions
Other that the two (2) commons forms of quasi-reorganization discussed
above, a corporation may negotiate with its creditors for authority to convert their
claims against the corporation into equity. In situations where there is greater
likelihood that the creditors would be able to recover their exposures to the
corporation by allowing it to be unburdened with the interests and other charges
of liability accounts, the creditors may be willing to change their status to being
equity holders of the corporation.
The long-term view of such creditors would be that the continued
operation of the corporate debtor would best preserve the value of their claims,
and that other than future receipt of dividends declared once the corporation
becomes financially viable again, they would anticipate the market value of their
equity holdings as a means to recoup their exposure in the future.
Under this scheme, the corporation may convert existing liabilities into
equity accounts which the consent of the corporate creditors. Sometimes debts
and liabilities are converted into capital surplus or additional paid-in capital and
then later on by using the same account to wipe out or reduce the deficit of the
corporation.
SPECIAL TREATMENTS RELATING TO SHARES
1. Warrants
Under the SEC Amended Rules Governing Warrants,108 a "warrant" is
defined as "a type of security which entitles the holder the right to subscribe to,
the unissued capital stock of a corporation or to purchase issued shares in the
future, evidenced by a Warrant Certificate, whether detachable or not, which may
be sold or offered for sale to the public but does not apply to a right granted
under an Option Plan duly approved by the [SEC] for the benefit of employees,
officers and/or directors of the issuing corporation."109
The SEC Amended Rules now recognize two (2) types of Issuers of
warrants, namely:110
108
XXVIII SEC QUARTERLY BULLETIN 78 (No. 2, June 1994).
109
Sec. 1(1), ibid.
110
Sec. 1(11), ibid.
111
Sec. 1(2), ibid.
112
Sec. 1(3), ibid.
113
Sec. 1(8), ibid. In case of detachable warrants, the Covered Warrant Certificate must
state on its face that the Covered Warrant does NOT represent shares of stock, but a mere right
to purchase an indicated class or type of stock owned by the Issuer under the terms and
condition stated therein. Sec. 7, ibid.
(b) ”Non-detachable warrant” which cannot be sold, transferred
or assigned to any person by the warrantholder separate
from, or independent of the Beneficiary Securities.114
Warrantholders may exercise their right granted under a warrant within the
period approved by the SEC which shall not be less than one (1) year, nor more
than five (5) years from the date of the issue of the warrants.115
The exercise price for the warrants shall be the price per share at which
the Issuer is required to sell the Underlying Shares, upon the exercise of the
rights granted in the warrant, which shall be at a price fixed at the time of
application for registratio of the warrant or computed using the stated formula
approved by the SEC.116 The exercise price must be paid in full upon exercise,
and shall not be less than the par value of the Underlying Shares, or not less that
P5.00 per share, if the Underlying Shares are withou par value.117
All warrants authorized for issuance by the SEC shall be transferable
without need of approval from the SEC.118
An Issuer of warrants must provide for a Warrants Registry Book
maintained by the warrants registrar independent of the Issuer.119 Any sale,
transfer, or assignment of a warrant must be duly recorded in the Warrants
Registry Book, and unless recorded in therein, the transfer of warrants shall not
be binding on the Issuer.120
2. Stock Options
The SEC has issued the Rules Governing the Grants of Stock Options,
which defines a stock option as "a privilege granted to a party to subscribe to a
certain portion of the unissued capital stock of a corporation within a specified
period and under the terms and conditions of the grant, exercisable by the
grantee at any time within the period granted."121
The Rules provide that no corporation shall grant any stock option unless
approval by the SEC is first obtained.122 Aside from a formal board resolution
authorizing the grant of the option, the Rules require that the application with
SEC should contain a detailed statement as to the plan or scheme by which the
option shall be exercised.
No exercise of the right of the option shall be valid unless accompanied by
the payment of not less than 40% of the total price of the shares so purchased,
114
Secs. 1(9) and 12, ibid.
115
Sec. 1(12), ibid.
116
Sec. 11(13), Ibid.
117
Sec. 10, ibid.
118
Sec. 12, Ibid.
119
Sec. 11, ibid.
120
Sec. 12, ibid.
121
Sec. 1, Rules Governing the Grants of Stock Options (1977).
122
Ibid.
which payment shall be properly receipted for by the corporate treasurer, except
where the grantee is an employee or officer who is not a director of the
corporation in which case only 25% of the total price shall be required, or allow a
planned payroll deduction scheme.123 If the option shall be for compensation or
payment of services already rendered, then the initial payment shall not be
required.124
The Rules also provide for the following guidelines:
123
Sec. 2(g), Rules Governing the Grants of Stock Options (1997).
124
Ibid.
125
Sec. 3, ibid.
126
Sec. 6, ibid.
Such subscriptions shall not also be transferable until full payment
thereof.127 If the shares are to be disposed of or sold, the price should not be
lower than par or less than 80% of the market price at the time of the exercise, or
if there is no transaction at the time of exercise, then the last asked price
whichever is higher; provided that if the shares are not listed, the 80% referred to
shall be based on book value.128
3. Stock Splits
In a stock split, each of the issued and outstanding shares is simply
broken up into a greater number of shares, each representing a proportionately
smaller interest in the corporation. The usual purpose of a stock split is to lower
the price per share to a more marketable price and thus increase the number of
the potential shareholders. They encourage investment.
Under Accounting Standards, when the number of additional shares
issued as a stock dividend is so great that it has, or may reasonably be expected
to have, the effect of materially reducing the share market value, the transaction
partakes of the nature of a stock split.129 An issuance of additional shares of 20%
or more of the number of previously outstanding shares is regarded as a stock
split.130
4. Stock Consolidations
On the other hand, in stock consolidations, new shares are issued in
replacement of old shares with a higher par or issued value, without affecting the
total value of the issued shares. Stock consolidations are resorted to make each
share have a higher par or issued value and thereby make them more expensive
in acquiring and to bring the stock within higher end of the market.
127
Ibid.
128
Ibid.
129
Statement of Financial Accounting Standards No. 18, par. 10.
130
Ibid.
131
Commissioner of Internal Revenue v. Court of Appeals, 301 SCRA 152 (1999).
132
Ibid.
once a subscriber disposes of his entire interests and not when there is still
maintenance of proprietary interest. 133
—oOo—
133
Ibid.
CHAPTER 13
CORPORATE ACQUISITIONS,
MERGERS & CONSOLIDATIONS
——
1. "Assets-Only" Level
In the "assets-only" acquisition, the purchaser is only interested in the
"raw" assets and properties of the business, perhaps to be used to establish his
own business enterprise or to be used for his on-going business enterprise. In
such an acquisition, the purchaser is not interested in the entity of the corporate
owner of the assets, nor of the goodwill and other factors relating to the business
itself.
In other instances, the purchaser is interested only in purchasing the
assets to ensure that he would not be embroiled in issues relating to the liabilities
and other contractual commitments of the business enterprise or those pertaining
to the transferor.
2. "Business-Enterprise" Level
In the "business-enterprise" level, the purchaser's interest goes beyond
the assets or properties of the business enterprise. The purchaser‟s primary
interest is essentially to obtain the “earning capability” of the venture. However,
the purchaser in such is not interested in obtaining the juridical entity that owns
the business enterprise, and therefore purchases directly the business from the
corporate entity.
As will be shown in the discussions hereunder, the essence of the
"business-enterprise" transfer is that the effect is that the transferee merely
continues the same business of the transferor.
3. "Equity" Level
The "equity" level constitutes looking at the entirety of the business
enterprise as it is owned and operated by the corporation. The purchaser takes
control and ownership of the business by purchasing the shareholdings of the
corporate owner. The control of the business enterprise is therefore indirect,
since the corporate owner remains the direct owner of the business, and what
the purchaser has actually purchased is the ability to elect the members of the
board of the corporation who run the business.
1
15 SCRA 415 (1965).
2
Ibid, at p. 417. The enumeration has been re-arranged to follow the pattern of the
discussions in this chapter.
(c) In an equity transfer, the transferee is not liable for the
debts and liabilities of the transferor, except where the
transferee expressly or impliedly agrees to assume such
debts.
ASSETS-ONLY TRANSFERS
1. Rationale for Non-Assumption of Liability
In an assets-only transfer, the transferee is not liable for the debts and
liabilities of the transferor, except where the transferee expressly or impliedly
agrees to assume such debts.
In an assets-only transfer it is logical that the transferee would not be
liable for the debts and liabilities of his transferor since there is no privity of
contract over the debt obligations between the transferee and the transferor's
creditors.
The modification of an obligation with the substitution of a new debtor,
would necessarily require not only the consent of the creditors, but also the
consent of the person who is sought to be substituted as the new debtor. The
Law on Contracts, particularly those pertaining to sale properly govern the
transfer of liabilities in an asset-only transfer.
3
Act No. 3952, as amended by Rep. Act No. 111.
4
The Court of Appeals in People v. Wong, 50 O.G. 4867, has held that the Bulk Sales Law
applies only to merchandising business or establishments, and has no application to other forms
of activities such as in that case the sale of the equipment, tools and machineries of a foundry
shop.
5
See discussions in VILLANUEVA, LAW ON SALES (Rex Book Store, 1998 ed.), pp. 301-304.
compliance by the seller, mortgagor, transferor, or assignor of the obligations
mandated by the Law, whether or not known to the buyer, mortgagee, transferee
or assignee, would nevertheless render the transaction in specified instances
discussed above as "fraudulent and void." Consequently, such buyer,
mortgagee, transferee or assignee would find himself not entitled to the goods or
wares, or the business for which he had paid good money for. He may still find
himself at the end of a suit brought by the business creditors to recover what he
has obtained from a bulk sale, or even liable for damages for having conspired
with the seller, mortgagor, transferor or assignor to defraud the creditor.6
BUSINESS-ENTERPRISE TRANSFERS
1. Nature of Business-Enterprise
A business enterprise, apart from the juridical personality under which is
operates, has a "separate being" of its own. Properly speaking, a business
enterprise comprises more than just the properties of the business, but includes
a "concern" that covers the employees, the goodwill, list of clientele and
suppliers, etc., which give it value separate and distinct from its owners or the
juridical entity under which it operates. This is what is termed as the "economic
unit", "the enterprise", "the going concern", or the "financial unit", recognized in
other disciplines, such as Economics and Accounting.
In Accounting, although a business enterprise is carried on in the form of a
single proprietorship (and therefore has no separate juridical personality) it is
6
Ibid.
7
174 SCRA 377 (1989).
considered and accounted for as a separate accounting unit apart from the other
assets and businesses of the proprietor.
A business enterprise by itself is a "concern" that has a separate
economic or selling value from its owners' other assets; and that businessmen
evaluating whether to purchase such business enterprise do not only look at the
properties of the business, but many other intangibles that really have no definite
monetary value, except when expressed as goodwill, 8 and assigned a value
under principles in Accounting, such as the moral and technical competence of
the employees and middle-management, the list of its valued clientele, location of
the business, etc. Although, jurisprudence refuses to recognize a separate
existence of the business enterprise apart from the juridical personality which the
State grants in corporations,9 and partnerships,10 such separate existence of the
business enterprise does exist and is recognized in the business world.
Villa Rey Transit, Inc. v. Ferrer,11 recognized that when purchaser buys
the business of another as a going concern, he usually wishes to keep it going;
he wishes to get the location, the building, the stock in trade, and the customers;
he wishes to step into the seller's shoes and to enjoy the same business relations
with other men. The buyer "is willing to pay much more if he can get the „good
will‟ of the business, meaning by this the good will of the customers, that they
may continue to tread the old footpath to his door and maintain with him the
business relations enjoyed by the seller."12
2. Statement of Doctrine
Jurisprudence has held that in a business-enterprise transfer, the
transferee is liable for the debts and liabilities of his transferor.
The purpose of the jurisprudential doctrine is to protect the creditors of the
business by allowing them a remedy against the new controller or owner of the
business enterprise. Otherwise, creditors would be left "holding the bag," since
they may not be able to recover from the transferor who has "disappeared with
the loot," nor against the transferee who can claim that he is a purchaser in good
faith and for value.
8
"Recent cases have enlarged the concept of goodwill over the behavioristic resort of old
customers to the old place of business. It is now recognized that „It may include in addition to
those factors all that goes with a business in excess of its mere capital and physical value, such
as reputation for promptness, fidelity, integrity, politeness, business sagacity and commercial skill
in the conduct of its affairs, solicitude for the welfare of customers and other tangible elements
which contribute to successful commercial venture.‟" Villa Rey Transit, Inc. v. Ferrer, 25 SCRA
845 (1968), footnote no. 35 at pp. 859-860, quoting from W ILLISTON ON CONTRACTS, Vol. 5, p.
4592.)
9
Tayag v. Benguet Consolidated Inc., 26 SCRA 242 (1968). It rejected the genossenchaft
theory of Friedman that would recognize the corporate entity as "the reality of the group as a
social and legal entity independent of state recognition and concession."
10
Ang Pue & Co. v. Sec. of Commerce and Industry, 5 SCRA 645 (1962). The formation of
a corporate entity or a partnership is not a matter of right, but rather of a privilege.
11
25 SCRA 845 (1968).
12
Ibid, quoting from CORBIN ON CONTRACTS, Vol. 6, Sec. 1385, p. 483.
3. Application of Doctrine
Many of the applications of the business-transfer transfer doctrine seem to
be related by the Supreme Court to the application of the piercing doctrine, so as
to raise the issue of whether the business-transfer transfer doctrine is merely a
sub-classification of the piercing doctrine. It will be noted that in the various
decisions on the matter, the Court has never considered fraud as an essential
ingredient for the application of the business-enterprise transfer doctrine.
In Rivera v. Litam & Company, Inc.,13 a new corporation was organized
which provided in its articles of incorporation that it was taking over the assets
and properties of a corporation that was dissolved. It turned out that the old
corporation was part of a fraudulent scheme to exclude from the estate of a
deceased stockholder the shares held in the old corporation. The Court ruled that
since the new corporation acquired the assets and properties of the old
corporation, it was bound to assume also the obligations and liabilities as
provided for in the articles of incorporation.14
In A.D. Santos v. Vasquez,15 a judgment in suit for workmen's
compensation was filed against the corporate taxi cab company. Despite the
testimony of the claimant that he was employed not by the taxi cab company, but
rather by the majority stockholder in the latter's personal capacity, the Court
nevertheless upheld the judgment against the taxi cab company observing that
although in truth the majority stockholder operated the business under a sole
proprietorship scheme, it was subsequently transferred to the taxi cab company.
However, in this case, the Court also applied the doctrines of piercing the veil of
corporate fiction.
In Buan v. Alcantara,16 the Court held that a new corporation taking over
all of the mortgaged assets of an old corporation in exchange for all the old
corporation's capital stock and continuing to operate the business formerly
operated by the old corporation is an alter ego of the old corporation so as to be
liable to pay the obligations of the old corporation, notwithstanding that the old
corporation retained titled to the mortgaged assets. Similarly, where the
administrator of the estate of a decedent incorporated the assets of the estate
into a corporation and continued the business of the latter, the administrator and
the corporation so formed are alter egos, each in respect to the other, so that the
administrator would still be liable for the obligations of the corporation, just as the
corporation would be liable for the debts of the administrator.
In Quimson v. Alaminor Cooperative Marekting Assn., Inc.,17 and
Detective & Protective Bureau, Inc. v. United Employees' Welfare Assn.,18 the
Court took note of the general rule, that a corporation is not liable on or for
13
4 SCRA 1072 (1962).
14
Ibid, at p. 1084.
15
22 SCRA 1158 (1968).
16
127 SCRA 834 (1984).
17
73 Phil. 342 (1941).
18
98 Phil. 582 (1956).
contracts or debts of a pre-existing partnership because the two entities are
distinct and separate, unless the corporation has expressly or impliedly and on
sufficient consideration adopted or assumed the same. However, the Court held
that when it goes down to the level of the enterprises between the two sets of
entities, such as where a corporation has been formed by the members of a
partnership subsequent to the incurring of debts, the former partnership being the
only members of the corporation and the assets of the partnership have been
transferred to the corporation for the continuation of the business, in exchange
for stock and without other consideration, the corporation thereby assumes the
partnership debts and is prima facie liable therefor, since the legal entity of the
corporation and the partners may be disregarded and the members of the
partnership may be said to have simply put on a new coat.
In Cagayan Valley Enterprises, Inc. v. Court of Appeals,19 it was held that
when a single proprietorship is registered as a corporation, the corporation is
managed by the owner of the single proprietorship and is engaged in the same
line of business and in the same place as that of the latter, it can be said that the
corporation is a continuation of the single proprietorship and may be held liable
for the latter's act, said circumstances justifying piercing the veil of corporate
entity.
Nevertheless, in many other decisions of the Supreme Court on the
matter, it has applied the business-enterprise transfer doctrine without reference
to, and independent from, the piercing doctrine.
In San Teodoro Development Enterprises, Inc. v. Social Security
System,20 although the business enterprise was originally held under a
partnership scheme and latter the business was transferred to a corporation, the
business enterprise was deemed to have been in operation for the required two-
year period as to come under the coverage of the SSS Law, thus:
Although there was no fraud intended, San Teodoro held that the
possibility of fraud allowed the application of the piercing doctrine.
To the same effect is Laguna Trans. Co., Inc. v. Social Security System,22
where the Court held that "[t]he corporation continued the same transportation
business of the unregistered partnership, using the same lines and equipment.
There was, in effect, only a change in the form of the organization of the entity
engaged in the business of transportation of passengers."23 It further held that
"[w]hile it is true that a corporation once formed is conferred a juridical personality
separate and distinct from the persons composing it, it is but a legal fiction
introduced for purposes of convenience and to subserve the ends of justice. The
concept cannot be extended to a point beyond its reasons and policy, and when
invoked in support of an end subversive of this policy, will be disregarded by the
courts."24
The doctrine of Laguna Transportation therefore is that where a
corporation is formed by, and consisted of members of a partnership whose
business and property was conveyed and transferred to the corporation for the
purpose of continuing its business, in payment for which corporate capital stock
was issued, such corporation is presumed to have assumed partnership debts,
and is prima facie liable therefor.
Oromeca Lumber Company, Inc. v. Social Security Commission,25 held
that where the business of a partnership is merely absorbed and continued by a
corporation, the corporation must be deemed to be engaged in business from the
time the partnership it had succeeded started it business and activities.
21
Ibid, at pp. 99-100.
22
107 Phil. 833 (1960).
23
Ibid, at p. 837.
24
Ibid, at p. 837, citing 13 AM.JUR. 160.
25
4 SCRA 1188 (1962).
26
It would be instructive to see the judicial attitude to the extension of credit as underpinning
a clear intention to establish a long-term business. On the issue of whether a foreign corporation
intended to engage in business in the Philippines, in Eriks Pte. Ltd. v. Court of Appeals, 267
SCRA 567 (1997), the Supreme Court found that the extension of credit terms to be indicative of
shoulder of the person who is in the best position to protect himself, namely the
transferee, by obtaining certain guarantees and protection from his transferor.
The doctrine also finds support in the Bulk Sales Law, 27 which declares as
void and fraudulent the bulk sale of all or substantially all of the business
enterprise without applying the purchase proceeds to the pro-rata payment of
bona fide claims of the creditors of the business enterprise.
EQUITY TRANSFERS
1. Rationale of Doctrine
In an equity transfers, the transferee is not liable for the debts and
liabilities of the transferor, except where the transferee expressly or impliedly
agreed to assume such debts.
The logic of the doctrine in equity transfer finds support in the main
doctrine of separate juridical personality, that by purchasing the shares in a
intent to do business in the Philippines for an indefinite period, thus: "More than the sheer number
of transactions entered into, a clear and unmistakable intention on the part of petitioner to
continue the body of its business in the Philippines is more than apparent. . . Further, its grant
and extension of 90-day credit terms to private respondent for every purchase made, unarguably
shows an intention to continue transaction with private respondent, since in the usual course of
commercial transactions, credit is extended only to customers in good standing or to those on
whom there is an intention to maintain long-term relationship.”
27
Act 3952, as amended by Rep. Act No. 111.
corporation that owns a business, the stockholder does not by that reason alone
become the owner directly of the business assets and does not become
personally liable for the debts and liabilities of the business.
In addition, the buyer of the controlling shares of stock in a corporation
may take advantage of the “limited liability” feature that is part of such corporate
set-up.
28
181 SCRA 669 (1990).
29
254 SCRA 721, 69 SCAD 430 (1996).
corporation, it remains only a stockholder thereof, and under existing laws and
prevailing jurisprudence, a stockholder as a rule is not directly, individually and/or
personally liable for the indebtedness of the corporation. The obligation of the
corporation cannot be considered the obligation of the national government,
hence, whether the latter be solvent or not is not material. "The respondent have
not shown that this case constitutes one of the instances where the corporate veil
may be pierced. From another angle, the national government is not the
employer of private respondent and his co-complainants, so there is no reason to
expect any kind of bailout by the national government under existing law and
jurisprudence.”
32
SEC Opinion, 4 August 1998, XXXII SEC QUARTERLY BULLETIN 14 (No. 2, Dec. 1998);
SEC Opinion, 10 September 1993, XXVIII SEC QUARTERLY BULLETIN 5 (No. 1, March 1994); SEC
Opinion, 25 March 1981.
33
Ibid.
34
Sec. 77, Corporation Code.
35
Ibid.
f. Submission of Financial Statements Requirements
Under current SEC rules, the applying constituent corporations are
required to submit their respective financial statements which serve as the basis
of fixing the shares to be issued in favor of the merged corporation vis-a-vis the
net assets to be absorbed by the surviving corporation as of a specific date. The
date is important because it indicates the values of said assets as of that date. In
fact, it is required that the articles of merger or consolidation should be filed not
more than 120 days from the date of the long form audit report for each of the
constituent corporations.
g. Approval by SEC
The articles of merger or consolidation, signed and certified as required by
law, shall be submitted to the SEC in quadruplicate for its approval.37
In the case of merger or consolidation of banks or banking institutions,
building and loan associations, trust companies, insurance companies, public
utilities, educational institutions, and other special corporations governed by
special laws, the favorable recommendation of the appropriate government
agency shall first be obtained.38
Where the SEC is satisfied that the merger or consolidation of the
constituent corporations is not inconsistent with the provisions of the Corporation
Code and existing laws, it shall issue a certificate of merger or consolidation, as
the case may be, at which time and merger or consolidation shall be effective. 39
If, upon investigation, the SEC has reason to believe that the proposed
merger or consolidation is contrary to or inconsistent with provisions of existing
laws, it shall set a hearing to give the corporations concerned the opportunity to
be heard.40 Written notice of the date, time and place of said hearing shall be
given to each constituent corporation at least two (2) weeks before said
hearing.41 The SEC shall decide based on the results of the hearing.42
The Supreme Court has held that a merger does not become effective
upon the mere agreement of the constituent corporations, and that the procedure
prescribed under the Corporation Code would clearly show that the the merger
shall be effective only upon the issuance by the SEC of a certificate of merger. 43
The effectivity date of the merger is crucial for determining when the merged or
absorbed corporation ceases to exist; and when its rights, privileges, properties
as well as liabilities pass on to the surviving corporation.44
36
Art. 78, Corporation Code.
37
Sec. 79, Corporation Code.
38
Ibid.
39
Ibid.
40
Ibid.
41
Ibid.
42
Ibid.
43
Associated Bank v. Court of Appeals, 291 SCRA 511, 95 SCAD 372 (1998).
44
Ibid.
4. Effects of Merger or Consolidation
Section 80 of the Corporation Code provides for the following legal effects
of a merger or consolidation:
The legal effect of either merger or consolidation is not to disturb the legal
continuity of the underlying "business enterprises" of each of the constituent
corporations. Associated Bank v. Court of Appeals,45 described what would be
the effect of merger on the constituent corporations:
45
291 SCRA 511, 95 SCAD 372 (1998).
Ordinarily, in the merger of two or more existing
corporations, one of the combining corporations survives and
continues the combined business, while the rest are dissolved
and all their rights, properties and liabilities are acquired by the
surviving corporation. Although there is a dissolution of the
absorbed corporations, there is no winding up of their affairs or
liquidation of their assets, because the surviving corporation
automatically acquires all their rights, privileges and powers,
as well as their liabilities. . . The effectivity date of the merger
is crucial for determining when the merged or absorbed
corporation ceases to exist; and when its rights, privileges,
properties as well as liabilities pass on to the surviving
corporation.
46
250 SCRA 243, 66 SCAD 53 (1995).
goals, the Republic foregoes or defers taxing the income of the
pioneer enterprise until after that enterprise has recovered or
offset its earlier losses. The statutory purpose can be served
only if the accumulated operating losses are carried over and
charged off against income subsequently earned and
accumulated by the same enterprise engaged in the same
registered operations.47
47
Ibid.
48
91 Phil. 305 (1952).
49
Ibid, at 309.
The separate juridical personalities of the constituent corporations would
remain, and consequently, the successorship provisions of Section 80 of the
Corporation Code would not come into play. However, the jurisprudential rules on
the successorship of liabilities under business-enterprise transfers would apply,
such that the acquiring corporation would then be liable for the liabilities
pertaining to the business enterprise it has acquired.
In order to temper the effects of the successorship issues on liabilities, a
modification may be introduced whereby the acquiring corporation first organizes
a subsidiary, which would be the medium that will acquire the business
enterprise of the target corporation and therefore the liabilities pertaining thereto
would be directly enforceable against the subsidiary and not against the
acquiring mother corporation.
SPIN-OFFS
A spin-off has the opposite effect of merger or consolidation, whereby a
department, division or portions of the corporate business enterprise is sold-off or
assigned into a new corporation that will arise by the process which may
constitute it into a subsidiary of the original corporation.
American literature describes "a spin-off to exist when a parent
corporation organizes a subsidiary, to which is transferred part of parent's assets
in exchange for all of capital stock of subsidiary and stock of subsidiary is
transferred to parent's shareholders without surrender of their stock in parent."50
It is also described as one "where part of assets of corporation is transferred to a
new corporation and stock of transferee is distributed to shareholders of
transferor without surrender by them of stock in the transferor."51
Unlike in merger or consolidation where the Corporation Code has
provided for specific procedures and voting requirements to accomplish the
same, spin-offs are not regulated specifically under the Code. The nearest
provision of the Code by which spin-offs may be governed would be Section 40
which provides that in the sale, lease, exchange, mortgage, pledge or other
disposition of all or substantially all of the corporations property or assets
"whereby the corporation would be rendered incapable of continuing the
business," would require the majority vote of the board of directors or trustees,
and ratified by the vote of stockholders representing at least two-thirds (2/3) of
the outstanding capital stock, or two-thirds (2/3) of the entire membership, as the
case may be.
1. Assets-Only Transfers
In an asset-only transfer, the transferee is not bound to retain the
employees of the transferor, since the former does not really step into the shoes
of the latter. In addition, the transferee is not liable for any of the claims against
the transferor, even if the sale of the business assets of the transferor should
result in the shutting down of the transferor's operations and the laying-off of the
transferor's employees.
The issue of “whether or not the purchaser of the assets of an employer
corporation can be considered a successor employer of the latter‟s employees”
was directly raised in Sundowner Development Corp. v. Drilon.52 In that case, the
Mabuhay Hotel, Inc. which was leasing the hotel premises it was operating, by
way of amicable settlement in an ejectment case, surrendered the premises to
the lessor and sold its assets to the new lessee, the Sundowner Development
Corporation. The employees of Mabuhay Hotel subsequently sought labor rights
against Sundowner Development Corporation, and the Secretary of Labor
50
BLACK'S LAW DICTIONARY, p. 1256 (1979).
51
Ibid.
52
180 SCRA 14, 15 (1989).
directed the latter to absorb the old employees of Mabuhay Hotel which had
completely ceased operations. The Court overturned the ruling of the Secretary,
and laid down the principle involved in assets-only transfers, thus:
53
245 SCRA 134, 61 SCAD 881 (1995).
54
79 SCRA 40 (1977).
manufacture of dairy products, sold the plant and part of its assets to another
company, the Court held that the buyer of the assets cannot be held liable for the
labor claims interposed against the corporate-seller, thus: “There is no law
requiring that the purchaser of MDII‟s assets should absorb its employees. As
there is no such law, the most that the NLRC could do, for reasons of public
policy and social justice, was to direct [the buyer] to give preference to the
qualified separated employees of MDII in the filling up of vacancies in the
facilities. . .”55
2. Business-Enterprise Transfers
Following the applicable general rule, in a business-enterprise transfer,
the transferee should be bound to retain the services of the employees of the
business that it has acquired, although it is not liable for the violations that the
transferor had committed in the past and for which the transferor remains solely
liable.
This legal flow of things in business-enterprise transfers was recognized
early on in Sunio v. NLRC,56 which involved the sale by two (2) sister
corporations of their ice plant to another corporation. The Court held that "the
sale of a business of a going concern does not ipso facto terminate the
employer-employee relations insofar as the successor-employer [the transferee]
is concerned, and that change of ownership or management of an establishment
or company is not one of the just causes provided by law for termination of
employment."57 Nevertheless, the Court took into consideration that the case did
not just involve a “simple change of ownership” since before the sale of the
business enterprise, the transferors-corporations had already terminated their
employees and the latter had voluntarily accepted the payment of their
termination pay.
In effect, the termination of employment by the transferor and payment of
all proper benefits prior to actual sale is recognized by Sunio as the proper
means to avoid a situation where the transferee shall then be bound to continue
with the employments of the employees of the assumed business enterprise.
Nevertheless, the ruling in MDII (which is as asset-only transfer decision)
began to be applied in business-enterprise transfer cases.
Central Azucarera del Danao v. Court of Appeals,58 had helped
unnecessarily to dramatically change the basic rule for labor claims in business-
enterprise transfers. The facts of the decision showed that Central Azucarera
sold substantially all of its business, a sugar mill, to Danao Development
Corporation (Dadeco). Although the contract of sale made no express mention of
the continued employment status of the old employees of Central Azucarera
upon the consequent change of its ownership and management, Dadeco hired
55
Ibid at p. 47.
56
127 SCRA 390 (1984).
57
Ibid, at p. 395.
58
137 SCRA 295 (1985).
the regular and permanent employees but in accordance with its own hiring and
selection policies.
Three employees were subsequently terminated during their employ with
Dadeco. Claims for termination pay were filed by employees against both
Dadeco and Central Azucarera. Central Azucarera interposed the defense that
even on claims covering the period prior to the transfer of the sugar mill to
Dadeco, it cannot be held liable since the claims should be interposed only
against Dadeco, who is deemed to have assumed such responsibility by taking
over all the assets of the business.
The decision raised the issue decisively: “The issue that arises then is,
whether or not a change of ownership or management of an establishment or
corporation by virtue of the sale or disposition of all or substantially all of its
properties and assets operates to insulate the selling corporation . . . from its
obligation to its employees.”59 The ruling means to primarily dispose of the issue
of liability of the transferor, but it also ruled upon the issue of whether Dadeco
could also be held liable for such claims.
The Supreme Court held that the change of ownership or management of
a business establishment or enterprise is not one of the just causes under the
law,60 and cannot be construed as synonymous with nor analogous to closing or
cessation of operation of an establishment or enterprise and therefore cannot
exempt the transferor from liability for separation pay. However, it recognized as
well-established the principle "that it is within the employer's legitimate sphere of
management control of the business to adopt economic policies to make some
changes or adjustments in their organization or operations that would insure
profit to itself or protect the investments of its stockholders. As in the exercise of
such management prerogative, the employer may merge or consolidate it
business with another, or sell or dispose all or substantially all of its assets and
properties which may bring about the dismissal or termination of its employees in
the process," provided it is done in good faith,61 and in which case it is not liable
for terminated employees to claim for termination pay.
On the other hand, the Court also held that the immediate transferee of
the business enterprise has no liability to the employees of the transferor to
continue employing them; nor is the transferee liable for past unfair labor
practices of the previous owner, except, when the liability therefor is assumed by
the new employer under the contract of sale, or when liability arises because of
the new owner's participation in thwarting or defeating the rights of the
employees.
59
Ibid at pp. 303-304.
60
The old Termination Pay Law, Rep. Act No. 1052.
61
Ibid, at pp. 304-305. See also Majestic & Republic Theaters Employees Association v.
Court of Industrial Relations, 4 SCRA 457 (1962); Fernando v. Angat Labor Union, 5 SCRA 248
(1962); H. Aronson v. Associated Labor Union, 40 SCRA 7 (1971); Philippine Land-Air-Sea Labor
Union (PLASLU) v. Sy Indong Company Rice and Corn Mill, 11 SCRA 277 (1964); Cruz v.
PAFLU, 42 SCRA 68 (1971).
The Court held that "there is no law requiring that the purchaser should
absorb the employees of the selling company." 62 Since no arrangements were
made with Dadeco on the latter's hiring of the employees of the sugar mill, the
Court therefore considered the sale by Central Azucarera of its milling business,
not as a cessation of business, but one which effectively terminated employment
of its employees and for which it was liable for termination pay.
In San Felipe Neri School of Mandaluyong, Inc. v. NLRC,63 the entire
school premises was sold by the former corporate owners to a new entity, who
then began to rehire all of the employees and teachers of the old school. The
employees then sought to be paid separation pay on the basis of their having
been terminated from employment by the sale of the school to a new entity and
their being re-hired anew by the entity. They also sought to have the new owning
entity liable for such separation pay.
The Court characterized the transaction merely as equivalent to only a
sale of assets: “It is not disputed that San Felipe Neri School of Mandaluyong,
Inc. sold its properties and assets to RCAM . . . but RCAM did not buy the school
nor assumed its liabilities. Immediately thereafter, RCAM, as the transferee-
purchaser, continued the operation of the school, but applied for a new permit to
operate the same. . . In short, there was a change of ownership or management
of the school properties and assets.”64 In holding the original owner liable, the
Court held:
62
Ibid, at p. 305, citing MDDII Supervisors & Confidential Employees Association (FFS) v.
Presidential Assistant on Legal Affairs, 79 SCRA 40 (1977).
63
201 SCRA 478 (1991).
64
Ibid at p. 484.
In determining the liability of the transferee-RCAM, the Court took into
consideration the deed of sale which provided for no express stipulation
whatsoever relative to the continued employment by the transferee of the
employees and “[o]n the contrary, records show that RCAM expressly manifested
its unwillingness to absorb the . . . school‟s employees or to recognize their prior
service. . . And there is no law which requires the purchaser to absorb the
employees of the selling corporation.” In absolving the transferee-RCAM from
obligations to the employees, the San Felipe relied upon the rulings in MDII,
which essentially was an assets-only transfer, and of course Central Azucarera
del Danao.
65
245 SCRA 134, 61 SCAD 881 (1995).
66
Citing First Integrated Bonding and Insurance Company, Inc. v. Hernando, 199 SCRA
796 (1991).
67
Citing Miranda v. Court of Appeals, 71 SCRA 295 (1976).
68
Citing PY Eng Chong v. Herrera, 70 SCRA 130 (1976).
The Court also held that the use by Twin Ace of similar sounding or almost
identical business name of TDI was an obvious device to capitalize on the
goodwill which the name has built over the years; but that by itself did not make
the Twin Ace liable for the debts and obligations of the TDI to its employees,
thus:
69
245 SCRA 134, 144. citing Diatagon Labor Federation Local 110 of the ULGWP v. Ople,
101 SCRA 534 (1980) and Palay, Inc. v. Clave, 124 SCRA 638 (1983).
70
Ibid, at p. 145, citing Indophil Textile Mill Workers Union v. Calica, 205 SCRA 697 (1992).
71
93 Phil. 160 (1953).
Factory, Inc. and La Campana Gaugau Packing were substantially owned by the
same person. They had one office, one management, and a single payroll for
both businesses. The laborers of the gaugau factory and the coffee factory were
also interchangeable, the workers in one factory worked also in the other
factory."
It compared also its ruling with the results in Clarapols v. Court of
Industrial Relations,72 where it held "the Clarapols Steel and Nail Plant, which
was ordered to pay its workers backwages, ceased operations on June 30, 1956
and was succeeded on the very next day, July 1, 1956, by the Clarapols Steel
Corporation. Both corporations were substantially owned and controlled by the
same person and there was not break or cessation in operations. Moreover, all
the assets of the steel and nail plant were transferred to the new corporation.”
Yu therefore seems to clarify that in the field of Labor Law doctrine of
business-enterprise transfer as to make the transferee liable for the business
obligations of the transferor is really a species of piercing doctrine and would
require a certain degree of continuity of the same business by the same owners
using the corporate fiction as a shield, and that the transferor has ceased to exist
and operate on its own.
72
65 SCRA 613 (1975).
73
210 SCRA 277 (1992). Reiterated in Pepsi-Cola Distributors of the Philippines, Inc. v.
NLRC, 247 SCRA 386, 63 SCAD 684 (1995), and also in Corral v. NLRC, 258 SCRA 704, 72
SCAD 171 (1996).
not stop at the time PCD bowed out and PCPPI came into
being. There is no evidence presented showing that PCPPI, as
the new entity or purchasing company is free from any
liabilities incurred by the former corporation.
Pepsi-Cola Bottling Co. therefore reiterated the doctrine that when the
business enterprise is sold or transferred even to an entirely new entity, the
transferee is deemed to assume liabilities of the business enterprise, and the
burden of proof is with the transferee to show his non-liability.
What may have convinced it to rule as it did in Pepsi-Cola Bottling Co.
was the Court‟s finding that in the surety bond put to cover the appeal, both PCD
and PCPPI bound themselves to answer the monetary awards of the private
respondent in case of an adverse decision of the appeal, which clearly implied
that PCPPI as a result of the transfer of the franchise bound itself to answer for
the liability of PCD to its employees.
In Avon Dale Garments, Inc. v. NLRC,74 the dismissed employees
demanded that in the computation of their separation pay the period during which
the latter were employed by Avon Dale Shirt Factory should be included against
its successor-in-interests Avon Dale Garments, Inc. Although an articles of
dissolution was filed by the Avon Dale Shirt Factory with the SEC, the Supreme
Court held that the mere filing thereof without more is not enough to support the
conclusion that actual dissolution of an entity in fact took place. It therefore held
that the prevailing circumstances was that the Avon Dale Garments, Inc. is not
distinct from its predecessor Avon Dale Shirt Factory, but in fact merely
continued the operations of the latter under the same owners, the same business
venture, at same address, and even continued to hire same employees. "Thus,
conformably with established jurisprudence, the two entities cannot be deemed
as separate and distinct where there is a showing that one is merely the
continuation of the other."75
The lesson in Avon Dale Garments is therefore that for a new enterprise to
take over the business concerns of the other as not to make the new owners or
business entity liable for the labor claims against the predecessor-in-interests,
there must be a formal and substantial termination and break from the operations
of the predecessor as to constitute the transferee a separate business entity.
3. Equity Transfers
In an equity transfer, since the only result of the transaction is a change in
the ownership or control of the corporate employer, the employees remain with
the corporate employer in exactly the same manner as before the equity transfer,
and therefore the purchaser does not assume any personal liability to the
employees.
74
246 SCRA 733, 63 SCAD 268 (1995).
75
Ibid, at p. 737, citing Cagayan Valley Enterprises, Inc. v. Court of Appeals, 179 SCRA 218
(1989).
For example, in Development Bank of the Philippines v. NLRC,76 the
Supreme Court held that the fact that instead of foreclosing on the mortgaged
assets, DBP converted its loans to equity making it the controlling stockholder of
a bank, and although the majority of the members of the board of directors of the
bank were designated by DBP, the same did not make DBP an employer of the
bank employees, nor did it make DBP liable for the wage claims of the bank's
employees. The clear implication is that in equity transfers, the corporate-
employer remains liable for its employment contracts and the claims that may
arise therefrom.
Unfortunately, in Manlimos v. NLRC,77 the Supreme Court, through then
Justice Davide, went to the extreme case of applying to an equity purchase the
business-enterprise transfer doctrine of Central Azucarera del Danao. It was
obvious that Manlimos did not appreciate the difference between an equity
transfer and a business-enterprise transfer.
In Manlimos, the complete ownership and management of Super
Mahogany Plywood Corporation, a domestic corporation engaged in plywood
manufacturing, were taken over by a new group of investors who bought the
controlling shareholdings thereof. The employees of the corporation were
informed of such change of ownership, who continued to work for the "new
owner" and were considered terminated, with their conformity, up to a short
period and at the end of which they received separation pay, 13th month pay and
other benefits. Later, the separated employees sought reinstatement on the
ground that their termination was illegal since they remained regular employees
of the corporation regardless of the change of management.
The Court, in upholding the separation of some of the employees who
were not re-hired, held that a change of ownership in a business concern is not
proscribed by law,78 relying upon the rulings in Sunio and Central Azucarera del
Danao, both of which were business-enterprise transfer cases. The Court held in
Manlimos: "Where such transfer of ownership is in good faith, the transferee is
under no legal duty to absorb the transferor's employees as there is no law
compelling such absorption. The most that the transferee may do, for reasons of
public policy and social justice, is to give preference to the qualified separated
employees in the filling of vacancies in the facilities of the purchaser."79 The
ruling cited two other cases as the basis for such ruling, namely MDII
Supervisors and Confidential Employees Association v. Presidential Assistant on
Legal Affairs,80 which involved essentially an asset-only transfer, and San Felipe
Neri School of Mandaluyong, Inc. v. NLRC,81 which involved a business-
enterprise transfer.
76
186 SCRA 841 (1990).
77
242 SCRA 145, 59 SCAD 445 (1995).
78
Ibid, citing Sunio v. NLRC, 127 SCRA 390 (1984).
79
Ibid.
80
79 SCRA 40 (1977).
81
201 SCRA 478 (1991).
The logic of the reasoning in Manlimos is flawed, since with the change of
majority ownership of a corporation, the relationship of employer-employee in the
business does not change, and the corporate-employer, which has a juridical
personality separate and distinct from the new set of stockholders, remains the
same employer to the employees of the business.
Robledo v. NLRC,82 would make the successor enterprise liable for the
debts of the previous enterprise on the basis of piercing doctrine scenario. In that
case, the BASEC corporation was organized to be engaged in operating security
agency, having as one of its incorporators Bacani, who also had at that time a
security agency operated as a single proprietorship. Later, Bacani closed down
his operations and terminated his employees. His terminated employees sought
to hold the BASEC corporation liable for unpaid overtime and legal holiday pays,
contending that Bacani intentionally closed his operations to allow expansion of
the business through BASEC. They contended that the Bacani family merely
continued the operation of the business by creating BASEC in order to avoid the
obligations of the former, contending that Bacani became an incorporator of
BASEC together with his wife and daughter.
The Court held that the doctrine of piercing the veil of corporate entity is
used whenever a court finds that the corporate fiction is being used to defeat
public convenience, justify wrong, protect fraud, or defend crime, or to confuse
legitimate issues, or that a corporation is the mere alter ego or business conduit
of a person or where the corporation is so organized and controlled and its affairs
are so conducted as to make it merely an instrumentality, agency, conduit or
adjunct of another corporation.83 The Court refused to make BASEC liable for the
claims of the terminated employees since the facts showed that BASEC already
existed prior to closure of Bacani of his operations; that Bacani was merely one
of the five incorporators with the lease number of shares in BASEC; and there
was no showing that the assets of the single proprietorship were even transferred
to BASEC.
82
238 SCRA 52, 56 SCAD 485 (1994).
83
Ibid, at p. 57.
84
156 SCRA 123 (1988).
employer with respect to the claims of employees of the constituent corporation,
even with respect to CBA deadlock situations which existed right before the
merger of the companies.
The ruling of the Court in Filipinas Port Services, Inc. v. NLRC,85 that the
employees of a predecessor-constituent corporation cannot avail of their
previous tenure when determining their termination benefits with the surviving
corporation in the merger, is in direct opposition to the subsequent ruling in
Filipinas Port Services, Inc. v. NLRC,86 that the employees have a right to their
retirement benefits computed from the time worked with the predecessor-
constituent corporations, saying there was no break in the employer-employee
relationship.
In First General Marketing Corp. v. NLRC,87 the Court ruled that because
of the specific provision in the merger document expressly provide that the
surviving corporation would assume all the benefits derived from the existing
CBA, then the contractual stipulation was binding. But the ruling was more an
application of contract law principles.
5. Spin-off
In San Miguel Corp. Employees Union-PTGWO v. Confessor,88262 SCRA
81 (1996), where San Miguel Corp. spun-off its Magnolia ice cream division to a
new Magnolia Corporation, and the feeds and livestock division into the San
Miguel Feeds, Inc., the Supreme Court held that spin-offs were done for valid
business cause and in good faith, and therefore valid spin-offs. The Court denied
the SMC union‟s petition to include the employees in the spun-off divisions to be
within the SMC bargaining unit, and held that the employees in the new
corporations constitute new bargaining units. MSCve cnlude 8it
—oOo—
85
177 SCRA 203 (1989).
86
200 SCRA 773 (1991).
87
223 SCRA 337, 42 SCAD 349 (1993).
88
262 SCRA 81, 74 SCAD 465 (1996).
CHAPTER 14
SUSPENSION OF PAYMENTS,
REHABILITATION, AND INSOLVENCY
PROCEEDINGS
SUSPENSION OF PAYMENTS
Under Insolvency Law
Under Pres. Decree 902-A
Laws Applicable to Corporate Suspension of Payments
Two Types of Suspension of Payments Proceedings
CORPORATE REHABILITATION
Basis of RTC Power to Undertake Corporate Rehabilitation
Nature and Purpose of Corporate Rehabilitation
Rules on Rehabilitation
Appointment of Management Committee/Rehabilitation Receiver
Power of RTC to Appoint a Management Committee
Legal Effect of Appointment of Management Committee/Rehabilitation Receiver;
the Automatic Stay
Rationale of Automatic Stay on Existing Suits and Causes of Action
Meaning of "Claims"
Creditors Covered by Automatic Stay
Suspension of Employees’ Claims
Jurisdiction Over Non-Corporate Debtor
Powers of the Management Committee/Rehabilitation Receiver
Approval of Rehabilitation Plan; Cram Down Power of RTC
POWER TO LIQUIDATE CORPORATIONS
INSOLVENCY PROCEEDINGS
Governing Law and Jurisdiction
Voluntary Insolvency
Filing of Petition
Effect of Order of Insolvency
Appointment of Assignee
Effect of Appointment of Assignee
Function of Assignee
Involuntary Insolvency
Filing of Petition
Qualifications of Petitioning Creditors
Standing Foreign Corporate Creditors to Petition
Acts of Insolvency
Effects of Order of Insolvency and Appointment of Receiver
Procedure
General Effect of Corporate Insolvency Proceedings
——
SUSPENSION OF PAYMENTS
UNDER INSOLVENCY LAW
As far as corporations are concerned, the Insolvency Law 1 provides that a
corporation "possessing sufficient property to cover all [its] debts . . . but foresees
the impossibility of meeting them when they respectively fall due, may petition
that [it] be declared in the state of suspension of payments by the court."2
The following procedure, requirements and legal consequences are
provided for in the Law:
5
Sec. 6, Ibid.
6
Sec. 6, ibid.
7
Ibid.
8
Sec. 5, Ibid.
9
Sec. 8, ibid.
10
Sec. 8(e)(1), Ibid.
11
Sec. 10, ibid.
12
Ibid.
13
Sec. 9, ibid.
11. If the decision of the meeting be negative, or if no decision is
had in default of such number of majorities, the proceedings
shall be deemed terminated without recourse, and the
parties concerned shall be at liberty to enforce the rights
which may correspond to them;14
12. If the proposed agreement is validly approved, and in spite of
opposition thereto heard by the court, the court shall issue
an order directing the agreement to be made effective and
binding on all creditors included in the schedule and properly
summoned, but not upon secured creditors and those who
have employment claims against the corporation;15 and
13. If the corporation fails wholly or in part to perform the
approved agreement, all the rights which the creditors had
against the corporation before the agreement shall revest to
them, and the corporation may be made subject to
insolvency proceedings.16
The implication and conclusion are clear, that since Pres. Decree 902-A
has not expressly repealed the provisions of the Insolvency Law as they apply to
corporations and other juridical entities, they must be construed as still binding
on the SEC, now the RTC, on suspension of payments and insolvency
proceedings validly filed, insofar as they have not been amended or supplanted
by specific provisions of the Decree.
18
201 SCRA 190 (1991).
19
Ibid, at p. 198.
20
Ibid, at p. 202.
A comparison of the Insolvency Law and the relevant provisions of Pres.
Decree 902-A, as they have been interpreted by the Supreme Court, would
reveal the basic differences between the two (2) types of suspension of
payments proceedings involving corporate debtors:
(a) Under the Insolvency Law, the suspensive effect of the order
issued pursuant to the petition does not cover secured
creditors, while the suspensive effect under Pres. Decree
902-A upon appointment of the management
committee/rehabilitation receiver, would cover all corporate
creditors, both secured and unsecured;
(b) Under the Insolvency Law, in the absence of any agreement
among the corporate creditors, the automatic stay would
expire after three (3) months; under Pres. Decree 902-A, the
automatic stay has no time limit and prevails for so long as
the corporate debtor is under a management
committee/rehabilitation receiver and there is no directive to
liquidate its assets;
(c) The final agreement on the manner of payment of the
obligations of the corporate debtor is subject to the qualifying
majority votes required under the Insolvency Law; while
under Pres. Decree 902-A, the management
committee/rehabilitation receiver is granted sufficient powers
to take such measures as are necessary to bring back to
financial health the distressed company without need to
obtain creditors‘ approval.
CORPORATE REHABILITATION
BASIS OF RTC POWER TO UNDERTAKE
CORPORATE REHABILITATION
Under the declared government policy of encouraging investments and
more active participation in the affairs of private corporations and enterprises
through which desirable activities may be pursued for the promotion of economic
development and to promote a wider and more meaningful equitable distribution
of wealth, creating therefore a need to have an agency to be invested with ample
powers to protect such investment and the public,21 the powers and jurisdiction of
the SEC and its organization were enhanced and streamlined under Pres.
21
First Whereas clause of Pres. Decree 902-A.
Decree 902-A. The SEC under the Decree was granted powers to pursue the
management or rehabilitation of private corporations through the appointment of
a management committee or a rehabilitation receiver.
Pursuant to the terms of Section 5.2 of the Securities Regulation Code,
such jurisdiction over corporate rehabilitation proceedings has been transferred
to the RTC, which should therefore continue to act under such mandate.
RULES ON REHABILITATION
As of the writing of this chapter, the Supreme Court had approved the
Interim Rules of Procedure on Corporate Rehabilitation (2000), which were
based primarily on the provisions of the SEC Rules on Corporate Recovery.
The rehabilitation proceedings are mandated under the Interim Rules to
be in rem, summary and non-adversarial in nature.25 The orders issued by the
RTC in such proceedings are immediately executory.26
The Interim Rules provide for the following basic steps for rehabilitation:
22
Balgos, Corporate Rehabilitation: Should Secured Creditors Queue?, 8 PHIL. L. GAZ. 1
(Nos. 6-7), citing BLACK'S LAW DICTIONARY, p. 1451.
23
Ruby Industrial Corp. v. Court of Appeals, 284 SCRA 445, 90 SCAD 407 (1998).
24
Rubberworld (Phils.), Inc. v. NLRC, 305 SCRA 721, 105 SCAD 485 (1999).
25
Sec. 1, Rule 3, Interim Rules of Procedure on Corporate Rehabilitation.
26
Sec. 5, Rule 3, ibid.
27
Sec. 4-1, Interim Rules of Procedure on Corporate Rehabilitation.
(a) Corporate debtor which foresees the impossibility of meeting
its debts when they respectively fall due; or
28
Sec. 2, Rule 4, ibid.
29
Only a rehabilitation plan and list of nominees to position of rehabilitation receiver need to
be annexed to the Petition when filed by creditors. Sec. 4, Rule 4, ibid.
4. Issuance of the stay order30 not later than five (5) days from
the filing of the Petition which, among others, shall:
(a) Appoint a rehabilitation receiver for the petitioning
corporate debtor;
(b) Stay all actions for claims against the debtor, which
shall cover both secured and unsecured creditors or
claimants;31
(c) Set an initial hearing for the Petition; and
(d) Direct the creditors and other interested parties to file
their verified commend on or opposition to the Petition
not later than ten (10) days before the initial hearing
and putting them on notice that their failure to do so
would bar them from participating in the proceedings;
5. Publication of the stay order in a newspaper of general
circulation in the Philippines once a week for two (2)
consecutive weeks,32 which makes the proceeding in rem in
nature;33
6. Initial hearing on the Petition not earlier than forty-five (45)
days but not laterthan sixty (60) days from the filing of the
Petition;34
7. Referral of rehabilitation plan to rehabilitation receiver who
shall submit his recommendation thereon to the RTC not
later than ninety (90) days from the initial hearing;35
8. Meetings between corporate debtor and/or rehabilitation
receiver with the creditors and other interested parties, which
should take place before the final revision of the plan prior to
its final submission to the RTC for approval;36
9. Modification or revision by the debtor of the rehabilitation plan
in the light of the comments, opposition or discussions with
the rehabilitation receiver, creditors and other interested
parties;37
30
Sec. 4-6, ibid.
31
The stay order covers both secured and unsecured creditors, in line with the principle of
―equality is equity‖ doctrine in rehabilitation proceedings since allowing the secured creditors to
enforce their liens may hinder or prevent the rescue of the corporate debtor. See B.F. Homes,
Inc. v. Court of Appeals, 190 SCRA 262 (1990); Alemar’s Sibal & Sons, Inc. v. Elbinias, 186
SCRA 94 (1990); and Bank of the Philippine Islands v. Court of Appeals, 229 SCRA 223 (1994).
32
Sec. 6, Rule 4, ibid.
33
Sec. 1, Rule 3, ibid.
34
Sec. 6, Rule 4, ibid.
35
Sec. 9, Rule 4, ibid.
36
Sec. 21, Rule 4, ibid.
37
Sec. 22, Rule 4, ibid.
10. Submission of a final rehabilitation plan to the RTC for
approval;38
11. The Petition shall be dismissed (which results into the
automatic lifting of the stay order unless otherwise ordered
by the RTC) if no rehabilitation plan is approved by the RTC
after one-hundred-eighty (180) days from the date of the
initial hearing;39
12. Approval or disapproval of the rehabilitation plan by the RTC:
(a) If approved, implementation of the plan and
modifications in the course thereof if necessary to meet
the desired business targets;40 or
(b) If not approved, the Petition shall be dismissed.41
38
Sec. 22, Rule 4, ibid.
39
Sec. 11, Rule 4, ibid.
40
Sec. 26, Rule 4, ibid.
41
Sec. 11, Rule 4, ibid.
the interest of minority stockholders, parties-litigants or the
general public.
The powers granted to the SEC under Section 6 of the Decree are
"intended to effectively exercise such jurisdiction" enumerated under Section 5 of
the Decree. The enumerated jurisdictions do not only cover proceedings for
suspension of payments, but also in intra-corporate disputes, fraud scheme
proceedings, and election of officers and directors.42 Consequently, such powers
are also vested with the RTC‘s in the exercise of their jurisdiction under Section 5
of Pres. Decree 902-A.
The Interim Rules of Procedure on Corporate Rehabilitation (2000) do not
contain any provisions for the appointment of a Management Committee, and in
effect only recognize the appointment of a Rehabilitation Receiver. The
Rehabilitation Receiver under the Interim Rules, ―shall not take over the
management and control of the debtor but shall closely oversee and monitor the
operations of the debtor during the pendency of the proceedings, and for this
purpose shall have the powers, duties and functions of a receiver under
Presidential Decree No. 902-A, as amended, and the Rules of Court.43
Subsequently, however, the Supreme Court issued the Interim Rules of
Procedure Governing Intra-Corporate Controversies, which under Rule 9
recognizes that ―as an incident to any of the cases filed under this Rules or the
Interim Rules on Corporate Rehabilitation, a party may apply for the appointment
of a management committee for the corporation.‖ Under the Interim Rules, the
management committee would have the extensive powers under Sec. 6 of Pres.
Decree 902-A.
47
213 SCRA 830, 838 (1992).
48
275 SCRA 497, 84 SCAD 560 (1997).
49
237 SCRA 446, 56 SCAD 67 (1994).
litigants as well as the interest of the investing public or
creditors. . .50
The suspension of all actions under Pres. Decree 902-A ―is intended to
give enough breathing space for the management committee or rehabilitation
receiver to make the business viable again, without having to divert attention and
resources to litigations in various fora.‖51
b. Meaning of "Claims"
Finasia also has held that the "claims" covered by Section 6(c) of the
Decree "refers to debts or demands of a pecuniary nature. It means ‗the
assertion of a right to have money paid. It is used in a special proceedings like
those before administrative court, on insolvency.‘"52 Therefore, in spite of the
appointment of a rehabilitation receiver for a corporation under Pres. Decree
902-A, an action against a corporation seeking the nullification of the corporate
documents cannot be suspended by reason thereof, since the civil action does
not present a monetary claim against the corporation.
50
Ibid, at p. 451.
51
Rubberworld (Phils.), Inc. v. NLRC, 305 SCRA 721, 105 SCAD 485 (1999).
52
Ibid, at p. 450. The Court also quoted the definition of BLACK'S LAW LEGAL DICTIONARY
(5th ed.) of "claim": "Right to payment, whether or not such right is reduced to judgment,
liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal,
equitable, secured, or unsecured; or right to an equitable remedy for breach of performance if
such breach gives rise to a right to payment, whether or not such right to an equitable remedy is
reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured,
unsecured." at p. 224.
53
Sec. 1, Rule 2.
54
172 SCRA 436 (1989).
holding a mortgage, pledge or any lien on the property unless they give up the
property, security or lien in favor of all the creditors."55
The PCIB ruling was abrogated in several subsequent decisions of the
Supreme Court,56 interpreting the proper coverage of the automatic stay upon the
SEC's appointment of a management committee or rehabilitation receiver, ruling
that whenever a distressed corporation has asked the SEC for rehabilitation and
suspension of payments, preferred creditors may no longer assert such
preference, but shall stand on equal footing with other creditors.
Alemar's Sibal & Sons, Inc. v. Elbinias,57 held that during rehabilitation
receivership, the assets are held in trust for the equal benefit of all creditors to
preclude one from obtaining an advantage or preference over another by the
expediency of attachment, execution or otherwise. The Court held:
BF Homes, Inc. v. Court of Appeals,59 also explained that the reason for
suspending actions for claims against a corporation is to enable the management
committee or rehabilitation receiver to effectively exercise its/his powers free
from any judicial or extra-judicial interference that might unduly hinder the
"rescue" of the debtor company.60
Bank of the Philippine Islands v. Court of Appeals,61 held that even
foreclosure of mortgage shall be disallowed so as not to prejudice other creditors
or cause discrimination among them. If foreclosure is undertaken despite the fact
55
Ibid, at p. 440, citing Chartered Bank v. Imperial and National Bank, 48 Phil. 931.
56
Alemar's Sibal & Sons v. Elbinias, 186 SCRA 945 (1990); BF Homes, Inc. v. Court of
Appeals, 190 SCRA 262 (1990); Araneta v. Court of Appeals, 211 SCRA 390 (1992); Rizal
Commercial Banking Corp. v. Intermediate Appellate Court, 213 SCRA 830 (1992); and State
Investment House, Inc. v. Court of Appeals, G.R. No. 123240, 5 Feburary 1996 (unrep.).
57
186 SCRA 94 (1990).
58
Ibid, at pp. 99-100.
59
190 SCRA 262 (1990).
60
Ibid, at p. 269.
61
229 SCRA 223, 47 SCAD 186 (1994).
that a petition for rehabilitation has been filed, the certificate of sale shall not be
delivered pending rehabilitation. If that has already been done, no transfer
certificate of title shall likewise be effected within the period of rehabilitation. The
Court held that the rationale behind Pres. Decree 902-A, is to effect a feasible
and viable rehabilitation, which cannot be achieve if one creditor is preferred over
the others.62
Ruby Industrial Corp. v. Court of Appeals,63 held that when a distressed
company is placed under rehabilitation, the appointment of a management
committee follows to avoid collusion between the previous management and
creditors it might favor, to the prejudice of the other creditors: "All assets of a
corporation under rehabilitation receivership are held in trust for the equal benefit
of all creditors to preclude one from obtaining an advantage or preference over
another by the expediency of attachment, execution or otherwise. As between
the creditors, the key phrase is equality in equity. Once the corporation
threatened by bankruptcy is taken over by a receiver, all the creditors ought to
stand in equal footing. Not any one of them should be paid ahead of the others.
This is precisely the reason for suspending all pending claims against the
corporation under receivership."
In Rubberworld (Phils.), Inc. v. NLRC,64 the Court held that the credit
preferences provided for by law, particularly the preferential rights of workers and
employees under Article 10 of the Labor Code, were no longer applied in
rehabilitation proceedings, thus: ―The preferential right of workers and employees
under Article 110 of the Labor Code may be invoked only upon the institution of
insolvency or judicial liquidation proceedings. Indeed, it is well-settled that ‗a
declaration of bankruptcy or a judicial liquidation must be present before
preferences over various money claims may be enforced.‗ But debtors resort to
preferences of credit – giving preferred creditors the right to have their claims
paid ahead of those of other claimants – only when their assets are insufficient to
pay their debts fully. The purpose of rehabilitation proceedings is precisely to
enable the company to gain a new lease on life and thereby allow creditors to be
paid their claims from its earnings. In insolvency proceedings, on the other hand,
the company stops operating, and the claims of creditors are satisfied from the
assets of the insolvent corporation.‖
In the earlier version of this work, the author had opined:
62
Rizal Commercial Banking Corp. v. Intermediate Appellate Court, 213 SCRA 830, 838;
State Investment House, Inc. v. Court of Appeals, G.R. No. 123240, 5 February 1996.
63
284 SCRA 445, 90 SCAD 407 (1998).
64
305 SCRA 721, 105 SCAD 485 (1999).
65
172 SCRA 436 (1989).
still relevant when it decreed that "We take judicial notice of
the fact that the SEC order for the dissolution and liquidation of
Philfinance has already been upheld by this Court . . . In view
of this development, it appears that the Rehabilitation Receiver
has no more right to enjoin the auction sale since its prayer for
injunctive relief was based on the order for suspension of
payments."66
Clearly when rehabilitation is no longer pursued in the
case of a corporate debtor, the suspensive effect provided for
by Pres. Decree No. 902-A upon the appointment of the
management committee or rehabilitation receiver, ceased to
have any further hold, and the corporate creditors are then at
liberty to pursue their claims in different fora against the
corporate debtor.
The author‘s position has sinced been validated by the Supreme Court in
the 9 December 1999 resolution in Rizal Commercial Banking Corporation,67
where it held:
66
Ibid, at p. 441.
67
G.R. No. 74851, 9 December 1999.
This suspension shall not prejudice or render ineffective
the status of a secured creditor as compared to a totally
unsecured creditor. P.D. 902-A does not state anything to this
effect. What it merely provides is that all actions for claims
against the corporation, partnership or association shall be
suspended. This should give the receiver a chance to
rehabilitate the corporation if there should still be a possibility
for doing so. (This will be in consonance with Alemar’s, BF
Homes, Aranaz and RCBC insofar as enforcing liens by
preferred creditors are concerned.)
However, in the event that rehabilitation is no longer
feasible and claims against the distressed corporation would
eventually have to be settled, the secured creditors shall enjoy
preference over the unsecured creditors (still maintaining PCIB
ruling), subject only to the provisions of the Civil Code on
Concurrence and Preferences of Credit (our ruling in State
Investment House, Inc. vs. Court of Appeals, 277 SCRA 209
[1997]).
68
305 SCRA 721, 105 SCAD 485 (1999).
69
177 SCRA 788 (1989).
over his person or properties. The Securities and Exchange
Commission was empowered, as rehabilitation receiver, to
take custody and control of the assets and properties of PBM
only, for the SEC has jurisdiction over the corporations only
not over private individuals, except stockholders in an intra-
corporate dispute (Sec. 5, P.D. 902-A and Sec. 2 of P.D.
1758). Being a nominal party in SEC Case No. 2250, Ching's
properties were not included in the rehabilitation receivership
that the SEC constituted to take custody of PBM's assets.
Therefore, the petitioner bank was not barred from filing a suit
against Ching, as surety for PBM. An anomalous situation
would arise if individual sureties for debtor corporations may
escape liability by simply co-filing with the corporation a
petitioner for suspension of payments in the SEC whose
jurisdiction is limited only to corporations and their corporate
assets.70
70
Ibid, at p. 791-792.
Union Bank of the Philippines v. Court of Appeals,71 held that the inclusion
of an individual petitioner in a suspension of payments/rehabilitation proceedings
filed with the SEC in behalf of the corporate petitioner, does not justify a prayer
for the dismissal of the entire petition because of the inclusion of the wrong party-
petitioner. What the SEC can do is to dismiss the petition insofar as it pertains to
the individual petitioner under the rules pertaining to misjoinder of parties.
Modern Paper Products, Inc. v. Court of Appeals,72 held that the petition
for suspension of payment filed for the corporate petitioner should be dismissed
insofar as it included spouses-petitioners on the ground that SEC had no right to
assume jurisdiction over individual petitioners, and could not include them in the
order of suspension of payments. The Court did not accept the argument of the
spouses-petitioners that the claims against them, the payments of which they
sought to have suspended through their petitioner before the SEC, were not
personal in nature because such claims were incurred by them in their capacity
as officers of the corporate petitioner and while acting for and in behalf of the
corporation, thus: ―To subscribe to such theory that they had acted for and in
behalf of the corporate petitioner when they executed the suretyship agreements
would result in an absurd situation wherein the corporation, acting through its
officers, would actually be acting as surety for itself.‖
The issue on jurisdiction over non-corporate debtor has now been
rendered moot since regular courts, while exercising jurisdiction under Sec. 5 of
Pres. Decree 902-A, would still have jurisdiction over non-corporate debtors
under their general jurisdiction powers under the Rules of Court.
(a) To take custody of, and control over, all the existing assets and
property of such entities under management;
(b) To evaluate the existing assets and liabilities, earnings and
operations of such corporations, partnerships or other
associations;
(c) To determine the best way to salvage and protect the interest of
the investors and creditors;
(d) To study, review and evaluate the feasibility of continuing
operations and structure and rehabilitate such entities if
determined to be feasible by the SEC (now the RTC);
71
290 SCRA 198, 94 SCAD 381 (1998).
72
286 SCRA 749, 92 SCAD 58 (1998).
(e) To report and be responsible to the SEC ( now the RTC) until
dissolved by the SEC (now the RTC); and
(f) May overrule or revoke the actions of the previous management
and board of directors of the entity or entities under the
management notwithstanding any provision of law, articles of
incorporation or by-laws to the contrary.
(a) The plan would likely provide the objecting class of creditors
with compensation greater than that which they would have
received if the assets of the debtor were sold by a liquidator with
a three (3) month period;
73
Last paragraph of Sec. 6(d), Pres. Decree 902-A.
74
Sec. 14, Rule 4, Interim Rules.
75
Sec. 23, Rule 4, Interim Rules.
76
Ibid.
Under the Interim Rules, the approval of the rehabilitation plan by the RTC
shall result in the following:
(b) The corporate debtor shall comply with and take all actions
necessary to carry out, the provisions of the plan;
(d) Contracts and other arrangements between the debtor and its
creditors shall be interpreted as continuing to apply to the extent
that they do not conflict with the provisions of the plan; and
On motion or motu proprio, within ninety (90) days from the approval of
the RCT may revoke the approval thereof on the ground that the same was
secured through fraud.78
Whether the ―cram-down‖ power of the RTC to impose the terms of the
rehabilitation plan against opposing secured creditors, which would effectively
novate their security arrangements or specific corporate property, would
withstand constitutional attack on the basis of violation of the due process and
non-impairment of contract clauses of the Constitution remains to be seen.80
77
Sec. 24, Rule 4, ibid.
78
Sec. 25, Rule 4, ibid.
79
Sec. 26, Rule 4, ibid.
80
You may wish to see author‘s position on such constitutional issues in REVISITING THE
PHILIPPINE LAW ON CORPORATE REHABILITATION, XLII ATENEO L. J.(No. 2, May 1999).
such corporation or entity would not be feasible or profitable nor work to the best
interest of the stockholders, parties-litigants, creditors, or the general public, and
order the dissolution of such corporation or entity and its remaining assets
liquidated accordingly.
Such power to liquidated an insolvent corporation should now be deemed
vested with the regular courts in the exercise of their jurisdiction under Section 5
of Pres. Decree 902-A.
INSOLVENCY PROCEEDINGS
GOVERNING LAW AND JURISDICTION
Corporate insolvency proceedings, whether voluntary or involuntary,
should not fall within the jurisdiction of the SEC under Pres. Decree 902-A (which
makes no reference to insolvency at all), but with the regular courts under the
provisions of the Insolvency Law. Ching v. Land Bank of the Philippines,81 held:
Ching refused the proposition that Section 5(d) effectively repealed the
Insolvency Law as to transfer and confer upon the SEC jurisdiction theretofore
enjoyed by the regular courts over proceedings for voluntary and involuntary
insolvency.83 It held that ―Section 5(d) of Pres. Decree 902-A should be
construed as vesting upon the SEC original and exclusive jurisdiction only over
petitions to be declared in a state of suspension of payments, which may either
be: (a) a simple petition for suspension of payments based on the provisions of
the Insolvency Law, or (b) a similar petition accompanied by a prayer for the
creation/appointment of a management committee and/or rehabilitation receiver
based on the provisions of 902-A. Said provision cannot be stretched to include
petitions for insolvency."84
Ching therefore laid down the following permutations covering a financially
distressed corporation:85
81
201 SCRA 190 (1991).
82
Ibid, at pp. 197-198.
83
Ibid, at p. 198.
84
Ibid, at pp. 198-199.
85
Ibid, at p. 199.
(a) Where the petition filed is one for declaration of a state of
suspension of payments due to a recognition of the
inability to pay one's debts and liabilities, and where the
petitioning corporation either:
(i) has sufficient property to cover all its debts but
foresees the impossibility of meeting them when
they fall due (solvent but illiquid); or
(ii) has no sufficient property (insolvent) but is under
the management of a rehabilitation receiver or a
management committee,
the applicable law is P.D. No. 902-A pursuant to section 5
of par. (d) thereof;
(b) Where the petitioning corporation has no sufficient assets
to cover its liabilities and is not under rehabilitation receiver
or management committee created under P.D. No. 902-A
and does not seek merely to have the payments of its
debts suspended, but seeks a declaration of insolvency, as
in this case, the applicable law is Act 1956 on voluntary
insolvency, specifically section 14 thereof.
VOLUNTARY INSOLVENCY
1. Filing of Petition
Under the Law, a corporate debtor suffering from absolute insolvency
whose liabilities exceed One Thousand Pesos (P1,000.00),86 may file a petition
for voluntary insolvency, through an officer authorized by the board of directors,87
with the RTC of the province or city where the petitioning corporation has resided
for six (6) months next preceding the filing of the petition.88
86
Sec. 14, The Insolvency Law.
87
Sec. 52, ibid.
88
Sec. 14, ibid.
The petition is to be accompanied by a verified schedule and inventory in
the same manner as in a petition for suspension of payments.89
Upon the filing of the petition and its accompanying documents, the RTC
shall issue an order declaring the petitioner insolvent, and directing the sheriff to
take possession of, and safely keep, until the appointment of the receiver or
assignee, all the corporate documents, properties, estate, and effects of the
petitioning corporation.90
3. Appointment of Assignee
The RTC order shall also contain a call for the creditors to convene for the
purpose of electing an assignee.93 The assignee is elected by a double majority
of the creditors who have proved their claims.94 If no assignee is elected or
qualified, the RTC has power to appoint an assignee.95
The clerk of court then assigns and conveys to the assignee all the
property of the debtor not exempt from execution.96 The assignee requires title to
such property, which title shall relate back to the date of filing of the petition.97
Pursuant thereto, the sheriff shall deliver to the assignee all the property of the
debtor under his possession and safe-keeping.
89
Ibid.
90
Sec. 18, ibid.
91
Ibid.
92
Unson and Lacson v. Abeto, 47 Phil. 42, 44 (1924).
93
Sec. 18, The Insolvency Law.
94
Sec. 30, ibid.
95
Sec. 31, ibid.
96
Sec. 32, ibid.
97
Ibid.
98
Sec. 32, Ibid.
aside any judgment entered in any action commenced within thirty days
immediately prior to the commencement of insolvency proceedings.99
5. Functions of Assignee
The main responsibility of the assignee is to convert all of the assets of the
corporate debtor into cash,100 and that three (3) months after his appointment, or
earlier when the RTC so directs, he shall render an account of the corporate
debtor's estate at a hearing called for by the court.101 At the hearing, the RTC will
determine the rights of claimants to participate and may order a payments to
corporate creditors whose claims have been proven and allowed.102 Further
accounts and dividends shall be made as often as occasion requires until such
time as the final account is rendered.103
INVOLUNTARY INSOLVENCY
1. Filing of Petition
A petition for involuntary insolvency may be filed by three (3) or more
creditors against the corporation,104 who feel that their interests should be
protected against acts of insolvency such as absconding from the country,
absence with an intent to defraud creditors, etc., being done by the corporate
debtor.
However, the literal interpretation of Section 52 of the Law would seem to
imply that the petition of only one creditor of the corporation would be sufficient to
effect an involuntary insolvency thereof: "this Act shall apply to corporations . . .
upon a creditor's petition made and presented in the manner provided in respect
to debtors, like proceedings shall be had and taken as are provided in the case of
debtors." One author has opined that whether one or three creditors should file
the petition for involuntary insolvency of a corporation is not a settled rule.105
99
Sec. 32, ibid.
100
Sec. 39, ibid.
101
Sec. 43, ibid.
102
Ibid.
103
Ibid.
104
Sec. 20, ibid.
105
PEREZ, THE INSURANCE CODE AND INSOLVENCY LAW (University Book Supply, Inc., 1976
ed.), at p. 406.
2. Qualifications of Petitioning Creditors
The petitioning creditors must be residents of the Philippines, whose
credits accrued in the Philippines, the aggregate amount of which credits is not
less than One Thousand Pesos (P1,000.00), and that none of the creditors has
become a creditor by assignment within thirty (30) days prior to the filing of said
petition.106
4. Acts of Insolvency
Under the Insolvency Law, "acts of insolvency" on the part of the debtor
which would warrant the filing of a petition for involuntary insolvency by creditors
include the following:109
106
Ibid.
107
203 SCRA 9 (1991).
108
Ibid, at p. 22.
109
See Sec. 20, The Insolvency Law.
(i) Conveyance, assignment or transfer of property in
contemplation of insolvency;
(j) Default of a merchant or tradesman to pay current obligations
for a period of thirty (30) days;
(k) Failure to pay money on deposit or received in a fiduciary
capacity for a period of thirty (30) days after demand; and
(l) Insufficiency of property to satisfy an execution against the
debtor.
6. Procedure
The same rules for involuntary insolvency proceedings apply to voluntary
insolvency proceedings, except as follows:
(a) The petition is filed with the RTC of the province or city in which
corporate debtor has its principal place of business,114 which
shall be accompanied by a bond to answer for all costs,
110
199 SCRA 373 (1991).
111
Ibid, at p. 379-380.
112
Ibid.
113
Ibid.
expenses, attorney's fees and damages incurred by the debtor
in the event that the petition is dismissed or withdrawn by the
petitioners, or if the debtor shall not be declared an insolvent.115
(b) A hearing is conducted for the purpose of affording the
corporate debtor the opportunity to show cause why it should
not be declared insolvent.116
(c) When the circumstances warrant, the RTC shall adjudge the
debtor insolvent,117 and a meeting is called for the creditors to
elect an assignee.118
(d) The assets of the corporate debtor are conveyed to the
assignee, who shall liquidate them into cash and pay the debts
of the corporate debtor.119
—oOo—
114
Sec. 20, The Insolvency Law.
115
Ibid.
116
Sec. 23, ibid.
117
Sec. 24, ibid.
118
Sec. 30, ibid.
119
Sec, 33, ibid.
120
Sec. 52 of The Insolvency Law expressly provides that "Whenever any corporation is
declared insolvent, its property and assets shall be distributed to the creditors; but no discharge
shall be granted to any corporation."
CHAPTER 15
NATURE OF DISSOLUTION
Dissolution of a corporation signifies the extinguishment of its franchise
and the termination of its corporate existence for business purpose. The mere
fact that the corporation has ceased to do business does not necessarily
constitute a dissolution, if it is still solvent and has not gone into liquidation.
The dissolution of a corporation may either be de jure or de facto. A de
jure dissolution is one adjudged and determined by administrative or judicial
sentence, or brought about by an act of the sovereign power, or which results
from the expiration of the charter period of corporate life. A de facto dissolution is
one which takes place in substance and in fact when the corporation by reason
of insolvency, cessation of business, or suspension of all its operations, as the
case may be, goes into liquidation, still retaining its primary franchise to be a
corporation. This is actually a dissolution only of the "business enterprise," while
leaving intact the juridical entity.
1
Gonzales v. Sugar Regulatory Administration, 174 SCRA 377 (1989).
2
Ibid, at pp. 385-386.
METHODS OF DISSOLUTION
A corporation formed or organized under the Corporation Code may be
dissolved either voluntarily or involuntarily. 3 There are three modes of voluntary
dissolution:
7
Ibid.
8
Ibid.
9
Please see discussions on corporate rehabilitation in Chapter 14, Suspension of
Payments, Rehabilitation and Insolvency Proceedings.
10
Sec. 119, Corporation Code.
(b) If the petition is sufficient in form and substance, the SEC, by
an order reciting the purpose of the petition, shall fix a date
on or before which objections thereto may be filed by any
person, which date shall not be less than thirty (30) days nor
more than sixty (60) days after the entry of the order.11
(c) Before such date, a copy of the order shall be published at
least once a week for three (3) consecutive weeks in a
newspaper of general circulation published in the
municipality or city where the principal office of the
corporation is situated, or if there be no such newspaper,
then in a newspaper of general circulation of the Philippines,
and a similar copy shall be posted for three (3) consecutive
weeks in three (3) public places in such municipality or city. 12
(d) Upon five (5) days' notice, given after the date on which the
right to file objections as fixed in the order has expired, the
SEC shall proceed to hear the petition and try any issue
made by objections filed; and if no such objection is
sufficient, and the material allegations of the petition are
true, it shall render judgment dissolving the corporation and
directing such disposition of its assets as justice requires,
and may appoint a receiver to collect such assets and pay
the debts of the corporation.
11
Ibid.
12
Ibid.
13
Sec. 120, Corporation Code.
(d) The latest audited financial statements of the corporation
which must not be earlier than the date of the stockholders'
or membership meeting approving the amendment to the
articles of incorporation, and a BIR clearance on the tax
liabilities of the corporation. 14
14
SEC Opinion, 5 July 1979, the XIII SEC QUARTERLY BULLETIN 3 (No. 4, Oct. 1979).
15
Sec. 20, Corporation Code.
16
Sec. 11, Corporation Code; Philippine National Bank v. Court of First Instance of Rizal,
Pasig, Br. XXI, 209 SCRA 294 (1992).
17
24 SCRA 269 (1968).
INVOLUNTARY DISSOLUTION
A corporation may be dissolved by the SEC upon filing of a verified
complaint and after proper notice and hearing on grounds provided by existing
laws, rules and regulations.18
18
Sec. 121, Corporation Code.
19
Sec. 22, Corporation Code.
20
Sec. 22, Corporation Code. Under Sec. 6(l)(4) of Pres. Decree 902-A, the SEC may
suspend, or revoke, after proper notice and hearing, the franchise or certificate of registration of
corporations for continuous inoperation for a period of at least five (5) years.
21
Under Sec. 2(b), Rule 66 of the Rules of Court, a ground for quo warranto proceedings
against a corporation exists when the corporation has forfeited its privileges and franchise by
non-user. The section has since been deleted under the new version of Rule 66 of the 1997
Rules of Civil Procedure.
22
Sec. 6(l)(5), Pres. Decree 902-A; Chung Ka Bio v. Intermediate Appellate Court, 163
SCRA 534 (1988).
23
Sec. 2(a), Rule 66, Rules of Court.
24
Sec. 2(c), Rule 66, Rules of Court.
25
Sec. 2(d), Rule 66, Rules of Court.
(g) When on the basis of findings and recommendations of a
duly appointed management committee or rehabilitation
receiver, or based on the SEC's own findings, the
continuance of the business of the corporation would not be
feasible or profitable nor work to the best interest of the
stockholders, parties-litigants, creditors, or the general
public;26
(h) When the corporation is guilty of fraud in procuring its
certificate of registrations;27
(i) When the corporation is guilty of serious misrepresentation
as to what the corporation can do or is doing to the great
prejudice of or damage to the general public;28
(j) Refusal of the corporation to comply or defiance of any lawful
order of the SEC restraining commission of acts which would
amount to a grave violation of its franchise;29 and
(k) Failure of the corporation to file required reports in
appropriate forms as determined by the SEC within the
prescribed period.30
(a) Adoption of the by-laws and the filing and approval of the
same with and by the SEC in the event the same is not
adopted and filed simultaneously with the articles of
incorporation;
(b) Election of the board of directors or trustees and of the
officers;
26
Sec. 6(d), Pres. Decree 902-A.
27
Sec. 6(l)(1), Pres. Decree 902-A.
28
Sec. 6(l)(2), Pres. Decree 902-A.
29
Sec. 6(l)(3), Pres. Decree 902-A.
30
Sec. 6(l)(6), Pres. Decree 902-A.
31
98 Phil. 711, 720 (1956).
32
XXVIII SEC QUARTERLY BULLETIN 90 (No. 3, June 1994).
(c) Establishment of the principal office;
(d) Providing for the subscription and payment of the capital
stock and the taking of such other steps as are necessary to
endow the legal entity with capacity to transact the legitimate
business for which it was created.
33
Sec. 2 and 3, Rule 66 of the old Rules of Court.
34
Sec. 4, Rule 66, Rules of Court.
forfeiture, judgment shall be rendered that it be ousted from the continuance of
such offense and the exercise of any power usurped by it.35
The provisions under the Rules of Court one forfeiture of franchise have
since been deleted under Rule 66 of the 1997 Rules of Civil Procedure on
recognition that the matter is governed by the provisions of Pres. Decree 902-A,
and within the original and exclusive jurisdiction of the SEC. Nevertheless, the
Interim Rules on Intra-Corporate Controversies do not also provide rules
governing involuntary dissolution of corporations, under the premise that such
proceedings do not fall with the corporate jurisdiction of the RTC.
(a) To take custody of, and control over, all existing assets and
properties of such entities under management; to evaluate
the existing assets and liabilities, earnings and operations of
such corporations, partnerships or other associations; to
determine the best way to salvage and protect the interest of
the investors and creditors; to study, review, and evaluate
the feasibility of continuing the operations and restructure
35
Sec. 12, Rule 66, Rules of Court.
and rehabilitate such entities if determined to be feasible by
the SEC
(b) It shall report and be responsible to the SEC until dissolved
by order of the SEC; provided, however, that the submission
may, on the basis of the findings and recommendation of the
management committee, or rehabilitation receiver, board or
body, or on its own findings, determine that the continuance
in business of such corporation or entity would no be
feasible or profitable nor work to the best interest of the
stockholders, parties-litigants, creditors, or the general
public, order the dissolution of such corporation or entity and
its remaining assets liquidated accordingly.
(c) It may overrule or revoke the actions of the previous
management and board of directors of the entity or entitles
under management notwithstanding any provision of law,
articles of incorporation or by-laws to the contrary.
(d) It shall not be subject to any action, claim or demand for, or
in connection with, any act done or omitted to be done by it
in good faith in the exercise of its powers herein conferred.
It is not clear whether the SEC still has such powers with the transfer of its
quasi-judicial jurisdiction under Sec. 5 of Pres. Decree 902-A to the RTC
pursuant to Sec. 5.2 of the Securities Regulation Code.
36
XXVIII SEC QUARTERLY BULLETIN 90 (No. 3, June 1994).
In any of the foregoing instances, the SEC shall mail to the corporation
and the controlling stockholder a show-cause-order directing them to show cause
within thirty (30) days from receipt thereof why the certificate of registration shall
not be suspended or revoked.
A second show-cause-order shall be published in a newspaper of general
circulation, directing the corporation which failed to respond to the first order to
appear before the SEC at a hearing on the date, time and at the place stated in
the order.
If the corporation, through its officers/directors, shall not comply with the
directives for the submission of the required reports, or when the corporation fails
to appear, the SEC may issue the lesser sanction which is suspension which
shall immediately be executory. The corporation shall then have ninety (90) days
from receipt thereof within which to file a petition for reconsideration of the order.
After the lapse of the ninety (90) day period and no petition for reconsideration
has been filed, the order of revocation shall be issued which shall become final
and executory.
The SEC has opined that even under Section 22 of the Corporation Code,
there can be no automatic dissolution of a corporation after its incorporation has
been approved by the SEC. It shall continue to exist as a juridical entity
notwithstanding its non-operational status until its certificate of registration is
formally revoked by the SEC after due notice and hearing.37
37
SEC Opinion, 4 May 1995, XXIX SEC QUARTERLY BULLETIN 4 (No. 4, Dec. 1995); SEC
Opinion, 22 May 1998, XXXII SEC QUARTERLY BULLETIN 12 (No. 1, June 1998).
38
89 SCRA 336 (1979).
39
Ibid, at p. 366.
40
93 Phil. 678 (1953).
mismanagement and fraudulent conduct of corporate affairs, and seeking that
the corporation be dissolved. The suit was opposed on the ground that it sought
dissolution of the corporation whereas according to law a suit for the dissolution
of a corporation can be brought and maintained only by the State through its
legal counsel, namely the Solicitor General, and that minority stockholders have
no personality to maintain the action for dissolution.
The Court held that although it is "[t]rue it is that the general rule is that
the minority stockholders of a corporation cannot sue and demand for its
dissolution. However, there are cases that hold that even minority stockholders
may ask for dissolution, this, under the theory that such minority members, if
unable to obtain redress and protection of their rights within the corporation, must
not and should not be left without redress and remedy."41 The Court went on to
say —
41
Ibid, at p. 680
42
Ibid, at p. 681.
JURISPRUDENTIAL ATTITUDE TOWARDS INVOLUNTARY DISSOLUTION
Republic v. Bisaya Land Transportation Co.,43 describes well the solicitous
attitude of the courts in remedying violations committed by corporations, before
resorting to the extreme punishment of forfeiture of franchise and dissolution. In
that case the Bisaya Land Transp. Co. (Bisaya) was engaged in the business of
land and water transportation. The Solicitor General filed a petition for quo
warranto for the dissolution of Bisaya alleging that it had violated and offended
the provisions of the Corporation Law and other statutes of the Philippines by
having committed acts amounting to a forfeiture of its franchise, rights, and
privileges and through various means misused and abused the terms of its
franchise, some of which were as follows: falsely reconstituted its articles of
incorporation by adding new purposes not originally included; acquiring public
lands and timber concessions; leasing of a pasture land; operating a general
merchandise store which is neither necessary for nor accomplishment of its
principal purpose; engaging in mining operations.
After a very careful and deliberate consideration of the evidence
presented by the Solicitor General came to the conclusion that the same did not
warrant a quo warranto that could justify to terminate corporate life, and that the
corporate acts or omissions complained of had not resulted in substantial injury
to the public. Hence the Solicitor General withdrew the quo warranto proceedings
filed against Bisaya.
The issue before the Supreme Court was whether the Solicitor General
vested with the full power to manage and control the State's litigation, which
includes the power to discontinue such litigation if and in his opinion this could be
done. The Court held that the general rule is that the Solicitor General may do so
with the approval of the court. The purpose of the motion for the dismissal of the
quo warranto is to take the State out of an unnecessary court litigation.
According to the Court, dissolution is a serious remedy granted to the
courts against offending corporations. Courts, as a general rule, should not resort
to dissolution when the prejudice is not a prejudice against the public or not an
outright abuse of, or violation of the corporate charter. Even if the prejudice is
public in nature, the remedy is to enjoin or correct the mistake. Only when it
cannot be remedied anymore then dissolution can come in.
Government v. El Hogar Filipino,44 held that the holding of real property by
a savings and loan association which it had previously foreclosed beyond the five
(5) year holding period allowed by law shall not be a ground for forfeiture of its
franchise, especially when the corporation was shown to have acted in good
faith. The Supreme Court held that the penalty of dissolution would be
excessively severe and fraught with consequence altogether disproportionate to
the offense committed.
43
81 SCRA 9 (1978).
44
50 Phil 399 (1927).
In Government v. Phil. Sugar Estates Co.,45 the Court refused to order
right away the forfeiture of franchise by a corporation seriously offending its
charter, but first directed the ousting of the corporation from the unlawful act. In
that case, Philippine Sugar Estates Co. (PSEC) entered into a contract with the
Tayabas Land Company for the purpose of engaging in the business of
purchasing lands along the right of way of the Manila Railroad Company through
the province of Tayabas with a view of reselling the same to the Manila Railroad
Company. PSEC by its charter was authorized to engage in any mercantile or
industrial enterprise. For a period of eighteen (18) months it had misused its
corporate authority, franchises, and privileges and had assumed privileges and
franchises not granted. PSEC contended that the money given to Tayabas Land
Company was in a form of a loan.
The Court found that the purpose of the intervention of PSEC was for
profit, to enrich itself at the expense of the taxpayers. The franchise granted to
PSEC should be withdrawn and annulled and that it be disallowed to do and to
continue doing business in the Philippine Islands, unless it shall within a period of
six (6) months after final decision, liquidate, dissolve and separate absolutely in
every respect and in all of its relations with Tayabas Land Company.
On the other hand, in Republic v. Security Credit & Acceptance Corp.,46
the Court directed immediately the forfeiture of franchise of an offending
corporation, since damage to the public was imminent. In that case, the Security
Credit & Acceptance Corp. did not have authority to engage in banking
corporations as required by the General Banking Act. Security Credit
nevertheless received deposits from the public regularly. Such deposits were
treated in the Corporation's financial statements as conditional subscriptions to
capital stock. Out of the funds obtained from the public through the receipt of
deposits or the sale of securities, loans are made regularly to any person by
Security Credit. The legal counsel of the Central Bank of the Philippines (CB)
rendered an opinion stating that Security Credit was engaged in the business of
banking within the purview of R.A. No. 337. A resolution was passed by the CB
declaring that Security Credit should first comply with the provisions of R.A. No.
337. Notwithstanding the resolution passed by the CB, Security Credit still
continued the function and activities which had been declared to constitute illegal
banking operations.
The Court found the illegal transactions thus undertaken by Security
Credit warranted its dissolution. It was apparent from the fact proven that the
misuser of the corporate funds and franchise affects the essence of its business,
that it is willful and has been repeated 59,643 times and that its continuance
inflicts injury upon the public, owing to the number of persons affected.
45
38 Phil. 15 (1918).
46
19 SCRA 58 (1967).
OBTAINING OF TAX CLEARANCE
Under Section 52(C) of the NIRC of 1997, every corporation shall, within
thirty (30) days after the adoption of a resolution or plan for its dissolution, or for
the liquidation of the whole or any part of its capital stock, including corporations
which have been notified of possible involuntary dissolution by the SEC, or for its
reorganization, file the necessary return with the BIR, setting forth the terms of of
such resolution or plan; and that prior to the issuance of the SEC of the certificate
of dissolution or reorganization, such corporation must secure a certificate of tax
clearance from the BIR to be submitted to the SEC.
Under Section 2 of BIR-SEC Regulations No. 1, whenever a corporation
undergoes dissolution, whether voluntarily or involuntarily, a tax clearance must
be obtained from the Bureau of Internal Revenue, by filing with the Bureau an
income tax returns covering the income earned by them from the beginning of
the taxable year to the date of dissolution. The SEC is required to furnish the
Commissioner of Internal Revenue a copy of any order of involuntary dissolution
or suspension of the primary franchise or certificate of registration of a
corporation.47
The SEC shall issue the final order of dissolution only after a certificate of
tax clearance has been submitted by the dissolving corporation. However, in the
case of involuntary dissolution, the SEC may nevertheless proceed with the
dissolution if thirty (30) days after the receipt of the suspension order no tax
clearance has yet been issued.
47
A corporation whose corporate powers cease and are deemed dissolved because it was
not formally organized and did not commence the transaction of its business within two (2) years
from its incorporation need not secure a certificate of tax clearance. BIR Ruling No. 242, 10
November 1986.
48
China Banking Ciorp. V. M. Michelin & Cie, 58 Phil. 261 (1933).
49
Chua v. NLRC, 190 SCRA 558 (1990).
Philippine jurisdiction. Therefore, Section 122 of the Corporation Code expressly
provides that "[e]xcept by decrease by decrease of capital stock and as
otherwise allowed by this Code, no corporation shall distribute any of its assets
or property except upon lawful dissolution and after payment of all its debts and
liabilities."
METHODS OF LIQUIDATION
In our jurisdiction, there are three (3) recognized methods of liquidation of
corporate affairs.
50
China Banking Ciorp. V. M. Michelin & Cie, 58 Phil. 261 (1933).
limited in its duration by the deed of trust, there is no time limit which the trustee
must finish the liquidation, and he may sue or be sued even beyond the three (3)
year period.
In Board of Liquidators v. Kalaw,51 the Court held that the placing of the
affairs and assets of the NACOCO in the hands of a Board of Liquidators upon
dissolution, did not terminate the power of the Board to continue with the
liquidation process of NACOCO even after the lapse of the three (3) year period,
because the Board of Liquidators became the trustees; the Board took the place
of the corporation after the expiration of its affairs. Since no time limit has been
tacked to the existence of the Board and its functions of closing the affairs of the
corporation, it was held that the Board can still cases pending even after the
three (3) year period.
Gelano v. Court of Appeals,52 would hold the term "trustee" under the
Corporation Code should be understood in its general concept which could
include the counsel to whom was entrusted in a pending case, the prosecution of
the suit filed by the corporation. The Court held:
51
20 SCRA 987 (1967).
52
103 SCRA 90 (1981).
53
Ibid, at p. 99.
54
242 SCRA 717, 723 (1995).
55
301 SCRA 342, 102 SCAD 285 (1999).
56
58 Phil. 261 (1933).
does not empower the court to hear and pass on the claims of
the creditors of the corporation at first hand. . . all claims must
be presented for allowance to the receiver or trustee or other
proper persons during the winding up proceedings which in
this jurisdiction would be within the three years provided by
sections 77 and 78 of the Corporation Law as the term for the
corporate existence of the corporation, and if a claim is
disputed or unliquidated so that the receiver cannot safely
allow the same, it should be transferred to the proper court for
trial and allowance, and the amount so allowed then presented
to the receiver or trustee for payment. The rulings of the
receiver on the validity of claims submitted are subject to
review by the court appointing such receiver though no appeal
is taken to the latter‟s ruling.
57
67 Phil. 721 (1939).
made to apply, and the assignee may institute all actions leading to the
liquidation of the assets of the corporation even after the expiration of said three
(3) years.
When liquidation is done, either by a trustee or receiver, the corporate
personality is not important. For the next three (3) years after dissolution, there is
corporate personality to do business other that to pursue liquidation. After the
three (3) year period, there is no more corporate personality either in this two
cases (trustee or receiver), but even then it no longer matters, since from the
time the assets of the corporation are transferred to a trustee or receiver
pursuant to a liquidation all such assets are then held by and in the name of the
trustee or receiver who can lawfully proceed with liquidation even if the
corporation no longer exists, because he has title to the assets.
58
2 SCRA 989 (1961).
59
100 Phil. 86 (1956).
invoiced in the name of Dee, in trust for the corporation. The corporation was
therefore assessed a deficiency sales tax by the Collector. When the corporation
appealed the assessment to the Court of Tax Appeals, the Solicitor General
moved for dismissal of the appeal on the ground that the corporation no longer
had the capacity to sue because the three (3) year term of liquidation had
expired.
The Court held that the State cannot insist on making tax assessment
against a corporation that no longer exists and then turn around and oppose the
appeal questioning the legality of the assessment precisely on the ground that
the corporation is non-existent, and has no longer capacity to sue. The State
cannot adopt inconsistent stand and thereby deprive the officers and directors of
defunct corporation of the remedy to question the validity and correctness of the
assessment for which, if sustained, they would be held personally liable as
successors-in-interest to the corporate property.
The Court observed that it may be true that in so far as the corporation is
concerned, it no longer exists and therefore no suits can be maintained for and
against it. In case of taxes, the law specifically says that responsible corporate
officers shall be personally liable for deficiencies. When a corporation has
distributed its properties, those who received the properties are in fact liable for
corporate taxes. The answer therefore as what is the remedy of the corporate
creditors after the three (3) year period is to trace where the corporate assets
have gone, wherever they rested, be he a stockholder or a non-stockholder. The
cause of action is to file an action against that person who has a control of the
corporate assets.
To the same effect is the ruling in Republic v. Marsman Development
Company,60 where the Court held that while Section 77 of the Corporation Law
[now section 122 of the Corporation Code] provides for a three year period for
the continuation of the corporate existence of the corporation for purposes of
liquidation, there is nothing in said provision which bars an action for the recovery
of the debts of the corporation against the liquidator thereof, after the lapse of the
said three-year period: “It immaterial that the present action was filed after the
expiration of the three years . . . for at the very least, and assuming that judicial
enforcement of taxes may not be initiated after said three years despite the fact
that actual liquidation has not terminated and the one in charge thereof is still
holding the assets of the corporation, obviously for the benefit of all the creditors
thereof, the assessment aforementioned, made within the three years, definitely
established the Government as a creditor of the corporation for whom the
liquidator is supposed to hold assets of the corporation.”
60
44 SCRA 418 (1972).
Gelano v. Court of Appeals,61 held that a corporation with a pending court
action may still continue prosecuting or defending the same even after the lapse
of the three (3) years of liquidation, and that the counsel of record can be
considered as the trustee in such case, with full authority to continue prosecuting
or defending the suit.
Finally, De Guzman v. NLRC,62 held that although a corporate officer,
such as a general manager, is not liable for corporate obligations, such as claims
for wages, and no suit against him can be filed for the account of a corporation in
liquidation; nevertheless, when such corporate officer obtains corporate property
to apply to his own claims, such corporate officer shall be liable to the extent
thereof to corporate liabilities, since knowing fully well that certain creditors had
similarly valid claims, he took advantage of his position as general manager, and
applied the corporation's assets in payment exclusively to his own claims.
61
103 SCRA 90 (1981).
62
211 SCRA 723 (1992).
63
Sec. 122, Corporation Code.
64
Ibid.
65
Ibid.
pursue its business; and the only remnants of its legal personality is that of
transacting its liquidation during the given three (3) year period.
2. Summary on Dissolution
and Liquidations Proceedings
Recently, Clemente v. Court of Appeals,67 revisited the procedures of
dissolution and liquidation. In that case, the Supreme Court refused the petition
filed by alleged stockholders of a sociedad anonima for the declaration of the
corporate assets to pertain to them in the absence of showing any transfer or
disposition by the corporation in their favor. The Court said that in the absence of
a corporate liquidation, it is the corporation, not the stockholders, which can
assert, if at all, any title to the corporate assets. "If indeed, the sociedad has long
become defunct, it should behoove petitioners, or anyone else who may have
any interest in the corporation, to take appropriate measures before a proper
forum for a peremptory settlement of its affairs."68
The Court then proceeded to lay down the procedures and effects of
dissolution and liquidation of a corporation as provided for in Sections 117 to 122
of the Corporation Code, and existing jurisprudence, thus:
66
108 Phil. 472 (1960).
67
242 SCRA 717 (1995).
68
Ibid, at p. 722.
69
See Gonzales v. Sugar Regulatory Administration, 174 SCRA 377 (1989).
and close its affairs, culminating in the disposition and
distribution of its remaining assets;
(c) It may, during the three-year term, appoint a trustee or a
receiver who may act beyond that period;
(d) If the three-year extended life has expired without a trustee
or receiver having been expressly designated by the
corporation within that period, the board of directors or
trustees themselves, following the rationale of the Supreme
Court's decision in Gelano v. Court of Appeals70 may be
permitted to so continue as "trustees" by legal implication to
complete the corporate liquidation;
(e) Still in the absence of a board of directors or trustees, those
having any pecuniary interest in the assets, including not
only the shareholders but likewise the creditors of the
corporation, acting for and in its behalf, might make proper
representations with the SEC, which has primary and
sufficient broad jurisdiction in matters of this nature, for
working out a final settlement of the corporate concerns.
REINCORPORATION
This section discusses the legal feasibility of reincorporating a corporation
that has already reached the point of dissolution.
70
103 SCRA 90 (1981).
71
301 SCRA 342, 102 SCAD 285 (1999).
Under Section 121 of the Corporation Code, a corporation may be
dissolved by the SEC upon filing of a verified complaint and after proper notice
and hearing on grounds provided by existing laws, rules and regulations.
Under Section 6(l), of Pres. Decree 902-A, the SEC has the power to
revoke the certificate of registration of a corporation when there is fraud in
procuring its certificate of registration.
The legal effectS of such revocation of the certificate of registration of a
corporation, as spelled-out in Section 122 of the Corporation Code, is that such
corporation "shall nevertheless be continued as a body corporate for three (3)
years after the time when it would have been so dissolved, for the purpose of
prosecuting and defending suits by or against it and enabling it to settle and
close its affairs, to dispose of and convey its property and to distribute its assets,
but not for the purpose of continuing the business for which it was established."
Section 122 provides that "[a]t any time during said three (3) years, said
corporation is authorized and empowered to convey all of its property to trustees
for the benefit of stockholders, members, creditors, and other persons in interest.
From and after any such conveyance by the corporation of its property in trust for
the benefit of its stockholders, members, creditors and others in interest, all
interest which the corporation had in the property terminates, the legal interest
vests in the trustees, and the beneficial interest in the stockholders, members,
creditors or other persons in interest."
In addition, Section 40 of the Corporation Code authorizes the board of
directors, upon ratification by stockholders holding two-thirds (2/3) of the
outstanding capital stock of a corporation, "to sell, lease, exchange, mortgage,
pledge, or otherwise dispose of all or substantially all of its property and assets,
including its goodwill, upon such terms and conditions and for such
consideration, which may be money, stocks, bonds or other instruments for the
payment of money or other property or consideration, as its board of directors . . .
may deem expedient."
76
163 SCRA 534 (1988).
77
Ibid, at p. 535.
78
Ibid, at p. 539. There is a presumption in favor of a corporation that all requirements of the
law have been complied with. U.S. v. Asensi, 34 Phil. 671 (1916).
79
Ibid, at p. 539.
prohibited by the Corporation [Law]. In fact, it was expressly allowed by Section
28-1/2."80
As the Court found in Chung Ka Bio, both Sections 77 and 28-1/2 of the
old Corporation Law "are now Sections 122 and 40, respectively, with
modifications, of the Corporation Code."81 Even under the provisions of the
present Corporation Code, nothing prohibits the old board of directors of a
dissolved corporation to negotiate and transfer the assets of the dissolved
corporation to the new corporation intended to be created as long as the
stockholders have given their consent, and such consent by stockholders is
expressly allowed in Section 40 of the said Code.
—oOo—
80
Ibid, at p. 540.
81
Ibid, at p. 539.
CHAPTER 16
CLOSE CORPORATIONS1
Introduction
General Concept of Corporation Code on Nature of Corporation
Concept of Close Corporation
Statutory Definition of Close Corporations
Problems with Statutory Definition
De Facto Close Corporations
Likely Jurisprudential Solutions
Need for a Close Corporation
Title XII on Close Corporations
Classification of Shares and Restriction of Transfer
Classification of Directors
Provisions for Greater Quorum or Voting Requirements
Stockholders as Corporate Managers
Agreements Among Stockholders
Board Meetings Unnecessary
Pre-emptive Rights
Deadlocks and Dissolution
Repurchase of Shares of Stock
Piercing the Veil of Corporate Fiction
Conclusion
——
INTRODUCTION
There has always been a wide consensus among Corporate Law
practitioners that if statistics are taken on existing corporate entities in the
Philippines, a vast majority would be what are termed as close corporations,
while the rest would be publicly-held corporations. The distinctions between a
close corporation and a publicly-held corporation not only has legal significance,
but more importantly, such distinctions were, and still continue to have, practical
repercussions in the enforcement of rights and obligations in the business world.
With the adoption of the Corporation Law2 in 1906, no conscious and definitive
attempt was made to establish different sets of rules to govern the affairs of close
corporations, and the same sets of rules for publicly-held corporations were
made to apply to close corporations.
1
The chapter is an expanded version of the article Philippine Close Corporations, originally
published in 32 ATENEO L. J. 1 (No. 2, March, 1988).
2
Act No. 1459.
Yet even under the old Corporation Law, the features of the close
corporation were recognized, thus:
5
McKim v. Odom, Md., 3 Bland, 407, 416
6
Brooks v. Willcuts, D.C. Minn., 9 F. Supp. 19, 20.
7
SEC Opinion, 7 February 1994, XXVIII SEC QUARTERLY BULLETIN 3 (No. 3, Sept. 1994):
"Where business associates belong to a small, closely-nit group, they usually prefer to keep the
organization exclusive and would not welcome strangers, since it is through their efforts and
managerial skill that they expect the business to grow and prosper, it is quite understandable why
they would not trust outsiders to hare whatever fortune, big or small, the the business may bring.”
(b) All of the issued stock of all classes shall be subject to
one or more specified restrictions on transfer permitted
by Title XII of the Corporation Code; and
(c) The corporation shall not list in any stock exchange or
make any public offering of any of its stock of any class.
8
See note 1.
The objective test of "what is provided in the articles of incorporation,"
which can be defeated by the test of "actual disposition of shares of stock," gives
rise to instability and downright confusion. A corporation may be a close
corporation today, not a close corporation tomorrow, and again is a close
corporation the next day, depending on how many stockholders hold its shares of
stock. What would be worse is the prospect that a group of stockholders can
determine whether or not to place corporate affairs within the ambit of Title XII of
the Corporation Code, by the simple expedient of having the shareholdings in a
close corporation exceed the maximum twenty (20) shareholders provided for in
Section 96.
Under Title XII of the Corporation Code, the legal status of being a close
corporation carries with it certain rights, obligations, special procedures and
rules, as well as legal advantages and disadvantages. It is difficult to imagine our
lawmakers having built on shaky foundation the legal concept of what would
constitute a close corporation.
The Dulay and Sergio F. Naguiat rulings demonstrate a tendency that may
be followed in the future: (a) the coverage of "close corporation" may expand
beyond the definition provided for in the Corporation Code; or (b) principles
pertaining peculiarly to close corporations under Title XII of the Corporation Code
would be expanded to apply even to non-close corporation, i.e., de facto close
12
269 SCRA 564, 80 SCAD 502 (1997).
corporations, or even publicly-held corporations. At any rate, with the statutory
recognition of the strict close corporation, it can be anticipated that the Supreme
Court would by jurisprudence expand the doctrines into and recognize the de
facto close corporations.
Nevertheless, in 1998, in San Juan Structural and Steel Fabricators, Inc.
v. Court of Appeals,13 the Court looked into the requisites under Section 96 to
determine whether to consider a corporation a close corporation, and thereby
would allow the enforcement of corporate liability upon its corporate officers. In
San Juan the Court held just because the corporate treasurer and her husband
together owned 99.866% of the outstanding capital stock of the corporation “does
not justify a conclusion that it is a close corporation which can be bound by the
acts of its principal stockholder who need no specific authority, “ thus:
The Court sought to distinguish its ruling in Dulay thus: “The principle in
Manuel R. Dulay Enteprises, Inc. v. Court of Appeals, 225 SCRA 678 (1993), do
not apply because in Dulay the sale of real property was contracted by the
president of a close corporation with the knowledge and acquiescence of its
board of directors.”
13
296 SCRA 631(1998).
14
Ibid, at p. 645.
Under a free-market system, businessmen should be left a liberty to adopt
a business medium which they feel is best for the pursuit of their commercial
affairs, so long as the route chosen by them is not contrary to law, morals, public
policy and public order. The separate personality, limited liability and right of
succession are all features of a corporate entity which the law upholds and which
businessmen may avail of. The feature of delectus personae, general
management by all partners of business affairs are attractive features of a
partnership which the law guarantees and supervise. That businessmen take the
best features of a corporation and a partnership and combine them in a business
organization called the close corporation by itself cannot be considered
reprehensible or against any legal norm. Our lawmakers explicitly recognize the
acceptability of such a business scheme by giving formal recognition to close
corporations under Title XII of the Corporation Code.
When our Legislature, as policy determining body, enacted Title XII as
part of the Corporation Code, did they intend the same to be a recognition of the
reality that close corporations are here to stay and should be given legal and
judicial accommodation? On the other hand, by enacting Title XII of the
Corporation Code was it the intention that only the close corporation defined in
Section 96 thereof be given "living space", while all others would fall under the
broad category of publicly-held corporation?
A review of the deliberations of what was then Cabinet Bill No. 3 does not
really shed much light into the legislative intent, for indeed there was practically
no discussion on close corporations. Nevertheless, what was stated by the
sponsor of the bill, then Minister Estelito Mendoza, about close corporations is
worth noting:
15
Records of the Interim Batasan Pambansa, 5 November 1979, Vol. III, p. 1212.
16
63 NE 934.
corporation. . . Furthermore, looking at the stock as property, it
might be said that as far as it appears and probably in fact, it
was called into existence with this restriction inherent in it, by
the consent of all concerned. . . Stock in a corporation is not
merely property. It also creates a personal relation analogous
otherwise than technically to a partnership. . . There seems to
be no greater objection to restraining the right of choosing
ones associates in a corporation than in a firm.17
In the 1925 case of Fleischer v. Botica Nolasco Co.18 a provision in the by-
laws of the corporation gave to the corporation a preferential right to buy the
shares of stockholders who wished to dispose of their shareholdings. In holding
that the provision in the by-laws was void, the Supreme Court held:
In the earlier case of Lambert v. Fox,21 the Court had already held valid an
agreement between shareholders not to dispose of the shareholdings in the
corporation for a designated reasonable period of time. The Court held that the
suspension of the power to sell had a beneficial purpose, resulted in the
protection of the corporation as well as of the individual parties to the contract,
and was reasonable as to length of time of suspension.
19
Ibid, quoting from 4 THOMPSON ON CORPORATIONS, Sec. 4334, pp. 818, 819.
20
Ibid, quoting from 10 CYC., p. 578.
21
26 Phil. 588 (1914).
Lately, the doctrine was reiterated in Rural Bank of Salinas v. Court of
Appeals,22 which held that a corporation, either by its board of director, its by-
laws, or the act of its officers, cannot create restriction in stock transfers,
because restrictions in the traffic of stock must have their source in legislative
enactment or its charter, as the corporation itself cannot create such impediment.
The right of first refusal, therefore, should be available even to de facto
close corporations provided that same is delineated in the articles of
incorporation and indicated in the certificate of stock (to give notice to third
parties) and is reasonable in its operation as not to amount to a deprivation of a
stockholders right to ultimately dispose of his shareholdings.
The right-of-first-refusal feature in a close corporation setting is meant to
provide a default feature which need not be the subject of costly bargaining
procedures, where clearly the intention of the parties is to limit the management
of the underlying corporate enterprise only among the investors themselves,
much similar to the delecties personarum in a partnership. It is a feature that
insures to the other investors that they would not have within their midst a person
who might not have the requisite management trust that original investors came
together in the first place.
2. Classification of Directors
Section 97(2) of the Corporation Code provides that the articles of
incorporation of a close corporation may provide for "a classification of directors
into one or more classes, each of which may be voted for and elected solely by a
particular class of stock."
The power to classify the directors in ordinary corporations seems to be
denied under Section 24 of the Corporation Code which provides for the election
of directors in the following manner:
23
Ferrer, supra.
(d) Section 58 for the first time lays down the requirements for
proxies; and
(e) Section 59 provides the requirements of voting trusts.
26
26 Phil. 588 (1914).
(d) All the directors have express or implied knowledge of the
action in question and none of them makes prompt objection
thereto in writing.
6. Pre-emptive Rights
Section 102 of the Corporation Code provides that the pre-emptive rights
of stockholders in close corporations shall extend to all stock to be issued,
including re-issuance of treasury shares, unless the articles of incorporation
provide otherwise.
This right is similar to that granted to stockholders of ordinary corporations
under Section 39. Said section grants a pre-emptive right to stockholders in
respect to all issues or dispositions of shares of any class, unless such right is
27
7 SCRA 361 (1963).
28
38 Phil. 634 (1917).
29
20 SCRA 526 (1967).
denied in the articles of incorporation. However, under Section 39, the pre-
emptive right is not applicable in the following instances:
31
Ramirez Telephone Corp. v. Bank of America, 29 SCRA 191 (1969); NAMARCO v.
Associated Finance Co., 19 SCRA 962 (1967); Yutivo Sons Hardware Co. v. Court of Tax
Appeals, 1 SCRA 160 (1961); A.D. Santos v. Vasquez, 22 SCRA 1156 (1968); Liddell & Co., Inc.
v. Collector of Internal Revenue, 2 SCRA 632 (1961); Palacio v. Fely Transportation Co., 5 SCRA
1011 (1962); R.F. Sugay & Co. v. Reyes, 12 SCRA 700 (1964); Arnold v. Willits and Patterson,
44 Phil. 634 (1923); La Campana Coffee Factory v. Kaisahan Manggagawa sa La Campana, 93
Phil. 160 (1953); Emilio Cano Enterprises, Inc., v. C.I.R., 13 SCRA 291 (1965); Marvel Building
Corporation v. David, 94 Phil. 376 (1954); Laguna Transportation Co., Inc. v. SSS, 107 Phil. 83
(1960); McConnel v. Court of Appeals, 1 SCRA 722 (1961); San Teodoro Development
Enterprises, Inc. v. SSS, 8 SCRA 96 (1963); Koppel (Phil.) Inc. v. Yatco, 77 Phil. 496 (1946);
Commissioner of Internal Revenue v. Norton and Harrison Company, 11 SCRA 711 (1964).
On the other hand, for the de facto corporations, they would be
susceptible to the application of the doctrine for being mere conduits or alter-
egos of their stockholders. This aspect may prove to be attraction for
incorporators to incorporate a close corporation under the provision of Section 96
of the Corporation Code.
However, it must be noted that in the case of Dulay, the Supreme Court
after classifying the corporation as a close corporation (actually a de facto close
corporation since it did not go through the requirements of Section 96),
nevertheless applied the piercing doctrine to make the corporation liable for the
contract entered into by its controlling stockholder and president without the
appropriate board resolution.
CONCLUSION
From the foregoing discussions, it can be drawn that although the
Corporation Code has not made formal recognition of, and laid down provisions
for, the de facto close corporations, by and large, such a de facto close
corporations may avail themselves of some advantages and grants much similar
to those afforded to de jure close corporations under Title XII of the Corporation
Code. Much has yet to be attained towards the full legal acceptance of close
corporations as distinct vehicles of business endeavors. But the most significant
step has been taken towards that direction with the recognition, albeit in a limited
scope, of the close corporation under the Corporation Code. The legal gap that
still remains certainly poses a worthy challenge to both Philippine corporate
practitioners and lawmakers to fill-up.
——oOo——
NON-STOCK CORPORATIONS,
FOUNDATIONS AND COOPERATIVES
Essence of Non-Stock Corporation
Eleemosynary Purpose and Non-Distribution of Profits
Distribution of Net Assets and Profits upon Dissolution
Applicability of Stock Corporation Provisions
Theory on Non-Stock Corporations
Members in Non-Stock Corporations
Membership Purely Personal
Juridical Persons as Members of Non-Stock Corporation
Nature of Members’ Voting Right
Proxy Rules for Members
Effects of Delinquency in Membership
Manner of Voting
Place of Meeting
Trustees and Officers
Right and Manner of Voting in Non-Stock Corporations
Number and Election of Trustees
Juridical Persons as Members of Board of Trustees
Election of Officers
Specific Rules Applicable to Non-Stock Corporations
For-Profit Purpose in Articles of Incorporation
Power to Adopt Rules and Regulations
Assessment of Membership Dues
Non-Applicability of Rules on Subscription and Pre-emptive Rights
Rules on Increases in Capital Contributions
Selling of Raffle Tickets and Other Profit-Seeking Activities
Continuation of Activities After Dissolution
Distribution of Assets of Non-Stock Corporation
Conversion of Non-Stock Corporation to Stock Corporation
FOUNDATIONS
Foundations Not a Special Category under Corporation Code
Tax-Exempt Status
Charitable Contributions
Application by Foundations with BIR
Requirements on Donors to Foundations
BIR Reportorial Requirements
In Summary
CONDOMINIUM CORPORATIONS
Basis of Membership
Cutting-off of Utility Services
Express Provisions in By-laws
No Express Provisions in By-laws
Rules on Uniformity of Leasing-Out of Units
Bingo and Other Fund-Raising Activities
EDUCATIONAL INSTITUTIONS
Incorporation
Pre-requisites to Incorporation
Conversion of Non-Stock Educational School to Stock Corporation
Board of Trustees
Benefits and Privileges of Educational Institutions
RELIGIOUS CORPORATIONS
Corporate Sole
Acquisition of Land
Articles of Incorporation
Submission of Articles of Incorporation
Acquisition and Alienation of Property
Filling-up of Vacancies
Dissolution
Religious Societies
Term of Existence of Religious Corporations
COOPERATIVES
Rationale for Cooperative System
Definition of "Cooperative"
Main Objective of Cooperative
Organization and Members of Cooperatives
Democratic Set-Up in Cooperative
Capital and Distribution of Net Surplus
Board of Directors
General Assembly
Other Features of Cooperatives
——
1
Sec. 87, Corporation Code.
articles of incorporation, "a non-stock corporation may not include a purpose
which would change or contradict its nature as such."
The definition and treatment of non-stock corporation under the
Corporation Code is quite interesting in that it clearly recognizes that a non-stock
and non-profit corporation may actually earn profits from its operations so long as
the profits are devoted for its eleemosynary purpose.
The SEC has ruled that the mere fact that a non-stock corporation may
earn profit does not make it a profit-making corporation where such profit or
income is used to carry out the purposes set forth in the articles of incorporation
and is not distributed to its incorporators, members, trustees or officers.2
Likewise, nowhere does the definition exclude the existence of stock in the
capital stock of the corporation from being qualified to be considered a non-stock
corporation. However, the non-existence of stocks in a non-stock corporation
would be well-implied from the fact that stocks are by express provision of law,
entitled to receive dividends,3 which would then contravene the primary character
of a non-stock corporation that does not allow the distribution of profits and
dividends to its members.
The essence of a non-stock corporation is therefore not the non-existence
of shares of stock to cover its capital, but its primary purpose should be
eleemosynary in nature, and there is a prohibition in its articles of incorporation
or by-laws that no part of the income or any form of dividend is distributable to
the members, officers and trustees of the corporation,4 even though the
corporation may earn profits from its operations.5
2
SEC Opinion, 13 November 1990, XXIV SEC QUARTERLY BULLETIN 63 (No. 1, March,
1990).
3
Sec. 43, Corporation Code.
4
Collector of Internal Revenue v. Club Filipino, Inc. de Cebu, 5 SCRA 321 (1962).
5
Collector of Internal Revenue v. University of the Visayas, 1 SCRA 669 (1961).
6
Secs. 94 and 95, Corporation Code.
the benefit of private individuals or entities for profit but only as a consequence of
dissolution.
7
Sec. 87 of the Corporation Code.
8
SEC Opinion, 12 May 1995, XXIX SEC QUARTERLY BULLETIN 16 (No. 4, Dec. 1995).
9
Hansmann, The Role of Nonprofit Enterprise, 89 YALE L.J. 835 (1980); Clark, Does the
Nonprofit Form Fit the Hospital Industry?, 93 HARV. L. REV. 1416 (1980); CLARK, CORPORATE LAW
(Little, Brown and Company, 1986 ed.), pp. 699-703.
10
CLARK, CORPORATE LAW (Little, Brown and Company, 1986 ed.), at pp. 699-700.
general terms, it denotes high monitoring and enforcement costs.11 The
prohibition in non-stock corporations against distribution of profits to its members
and officers "is supposed to be helpful in such situations because it gives the
buyer some reason to believe that those who appoint and control the actual
providers of service and goods will not have an incentive to take advantage of his
vulnerability as consumer."12
On the other hand, in a stock corporation, both the shareholders and the
officers, who control the provision of the service bought, have an incentive not
only to be as efficient as possible and thus to outperform competitors, but also to
take advantage of all market imperfections.
In case of an activity such as the delivery of tangible products, the product
itself is an objective gauge of whether the purchaser thereof is receiving equal
value for the amount he has paid therefore. On the other hand, in a enterprise
such as education, it is very difficult to monitor whether the services bargained
for have been properly and adequately delivered or performed, or whether the
providers thereof, in order to increase their profit margin, have in fact cut corners.
In the case of education therefore, it would be better to allow the pursuit thereof
in a non-stock enterprise, since the legal inability of the providers to gains
anything personal from the cutting of corners (since they cannot obtain profits
from the operations) would be more incentive for such providers to deliver the
quality services expected from them. And since there is disincentive for any
personal gains on the part of the providers, there is much less need on the part
of the purchaser of the services to having to spend more time and resources in
order to monitor the rendering of such services.
Under the American theory on non-profit enterprise, "[w]henever general
goals cannot be reduced or agreed upon to, operationally defined set of
particular objectives and results, it is obviously difficult or impossible to monitor
and assess performance of those who undertake to provide services aimed at
achieving the general goals. Accordingly, consumers may have a preference for
nonprofit service-delivery organizations."13
The American theory applies equally to Philippine setting, not only
because of the legal constraint for non-stock corporations in distributing any profit
to their members and officers, the directive towards devoting any profits earned
to the purpose for which the corporation is formed, but by limiting the purposes
for which non-stock corporations can be formed to eleemosynary purposes
(charitable, religious, educational, professional, cultural recreational, fraternal,
literary, scientific, social, civic service, or similar purposes, like trade, industry,
agriculture, and like chambers, or any combination thereof), which by nature
cannot be provided with objective verifiable indicators, and if carried on by a
profit corporation, would entail much monitoring costs.
11
CLARK, supra, at p. 700.
12
Ibid.
13
CLARK, supra, at p. 701.
MEMBERS OF NON-STOCK CORPORATIONS
1. Membership Purely Personal
Membership in a non-stock corporation, and all rights arising therefrom,
are personal and non-transferable, unless the articles of incorporation or the by-
laws provide otherwise.14
Membership shall be terminated in the manner and for the causes
provided in the articles of incorporation or the by-laws.15
Termination of membership shall have the effect of extinguishing all rights
of a member in the corporation or in its property, unless otherwise provided in the
articles of incorporation or the by-laws.16
14
Sec. 90, Corporation Code.
15
Sec. 91, Corporation Code.
16
Ibid.
17
SEC Opinion, 16 April 191, citing 2 FLETCHER CYC. OF CORP., 1982 Rev. Vol., Sec. 300 at
93; SEC Opinion, 12 May 1995, XXIX SEC QUARTERLY BULLETIN 16 (No. 4, Dec. 1995).
18
Sec. 89, Corporation Code.
19
Ibid.
20
SEC Opinion, 4 September 1995, XXX SEC QUARTERLY BULLETIN 29 (No. 1, June 1996);
SEC Opinion, 30 August 1994, XXIX SEC QUARTERLY BULLETIN 13 (No.1, March 1995).
4. Proxy Rules for Members
Unless otherwise provided by the articles of incorporation or the by-laws,
a member may vote by proxy.21
Proxy representation may be denied entirely in a non-stock corporation
provided it is done through appropriate provisions in the articles of incorporation
or the by-laws.22
6. Manner of Voting
Under Section 89 of the Corporation Code, voting by mail or other similar
means by members of non-stock corporations may be authorized by the by-laws
with the approval of, and under such conditions which may be prescribed by, the
SEC.
Nevertheless, the provisions of Section 89 should be treated as a general
provision for non-stock corporation applicable only in the absence of a specific
provision in the Corporation Code on a particular subject matter.25 Therefore, in
the case of mergers and consolidations, Section 77 of the Corporation Code
specifically provides for the procedure in approving merger agreements
applicable to both stock and non-stock corporations, which requires corporate
mergers to be approved by the stockholders or members at a meeting duly called
for the purpose. Being a specific provision, it should be treated as an exception
to Section 89.26
21
Ibid.
22
SEC Opinion, 20 September 1994, XXIX SEC QUARTERLY BULLETIN 20 (No.1, March
1995).
23
Sec. 71, Corporation Code.
24
SEC Opinion, 16 June 1998, XXXIII SEC QUARTERLY BULLETIN 4 (No. 1, June, 1999);
SEC Opinion, dated 17 August 1998, XXXIII SEC QUARTERLY BULLETIN 4 (No. 1, June, 1999).
25
SEC Opinion, 4 August 1998, XXXII SEC QUARTERLY BULLETIN 14 (No. 2, Dec. 1998);
SEC Opinion, 10 September 1993, XXVIII SEC QUARTERLY BULLETIN 5 (No. 1, March 1994); SEC
Opinion, 25 March 1981.
26
SEC Opinion, 4 August 1998, XXXII SEC QUARTERLY BULLETIN 14 (No. 2, Dec. 1998).
The SEC has opined in several cases that where the law requires a duly
called meeting to carry out a corporate transaction, “constructive” or “electronic
presence” is not a substitute for actual presence.27
7. Place of Meetings
The by-laws may provide that the members of a non-stock corporation
may hold their regular or special meetings at any place even outside the place
where the principal office of the corporation is located, provided it is within the
Philippines and that proper notice is sent to all members indicating the date, time
and place of the meeting.28
27
SEC Opinion, 4 August 1998, XXXII SEC QUARTERLY BULLETIN 14 (No. 2, Dec. 1998);
SEC Opinion, 10 September 1993, XXVIII SEC QUARTERLY BULLETIN 5 (No. 1, March 1994); SEC
Opinion, 25 March 1981.
28
Sec. 93, Corporation Code. SEC Opinion, 24 September 1997, XXXII SEC QUARTERLY
BULLETIN 20 (No. 2, Dec. 1997).
29
Sec. 24, Corporation Code.
30
Sec. 92, Corporation Code.
(15) in number as may be fixed in their articles of incorporation or by-laws,31
shall, as soon as organized, so classify themselves that the term of office of one-
third (1/3) of their number shall expire every year; and subsequent elections of
trustees shall be held annually and trustees so elected shall have a term of three
(3) years. Trustees thereafter elected to fill vacancies occurring before the
expiration of a particular term shall hold office only for unexpired period.32
4. Election of Officers
It is usually the board of trustees that appoints the officers of a non-stock
corporation, similar to the rules under stock corporations. However, in a non-
stock corporation, unless otherwise provided for in the articles of incorporation or
the by-laws, officers of a non-stock corporation may be elected directly by the
members.35
If the officers in a non-stock corporation are directly elected by the
members, as allowed under Section 92 of the Corporation Code, the power to
remove them is vested directly in the members.36
31
Ibid.
32
Ibid.
33
SEC Opinion, 12 May 1995, XXIX SEC QUARTERLY BULLETIN 16 (No. 4, Dec. 1995).
34
SEC Opinion, 16 April 191, citing 2 FLETCHER CYC. OF CORP., 1982 Rev. Vol., Sec. 300 at
93.
35
Ibid.
36
SEC Opinion, 24 April 1995, XXIX SEC QUARTERLY BULLETIN 52 (No. 3, Sept. 1995).
SPECIFIC RULES APPLICABLE TO NON-STOCK CORPORATIONS
1. For Profit Purpose in Articles of Incorporation
Non-stock corporations by their nature are not empowered to engage in
business with the object of making income or profit, hence, it cannot include a
purpose in its articles of incorporation which would change or contradict its
nature as such. This is clear from the provision of Section 14 of the Corporation
Code which provides that “a non-stock corporation may not include a purpose
which would change or contradict its nature as such.”37
4. Non-applicability of Rules on
Subscriptions and Pre-emptive Rights
The SEC has rendered an opinion41 that the rules in the Corporation Code
on 25%-25% subscription and paid-up requirements, and pre-emptive rights, are
not applicable to non-stock corporations, even when they involve proprietary
membership in country clubs, since such rules pertain only to stock corporations
and have no application to non-stock corporations.
37
SEC Opinion, 11 September 1995, XXX SEC QUARTERLY BULLETIN 36 (No. 1, June 1996).
38
39
SEC Opinion, 16 October 1995, XXX SEC QUARTERLY BULLETIN 55 (No. 1, March 1996).
Ibid.
40
SEC Opinion, 16 June 1995, XXIX SEC QUARTERLY BULLETIN 38 (No. 4, Dec. 1995).
authorized capital stock, is applicable only to stock corporations, and has no
application to non-stock corporations. For non-stock corporations, it is sufficient,
for purposes of updating the SEC records on the matter, that it is reflected in the
financial statements.42
41
SEC Opinion, 30 August 1994, XXIX SEC QUARTERLY BULLETIN 13 (No.1, March 1995).
42
SEC Opinion, 2 April 1998, XXXII SEC QUARTERLY BULLETIN 93 (No. 1, June 1998).
43
SEC Opinion, 7 September 1995, XXX SEC QUARTERLY BULLETIN 33 (No. 1, June 1996);
SEC Opinion, 19 September 1995, XXX SEC QUARTERLY BULLETIN 39 (No. 1, June 1996).
44
As amended by Pres. Decree 1564.
45
SEC Opinion, 20 January 1999, XXXIII SEC QUARTERLY BULLETIN 48 (No. 1, June 1999).
46
SEC Opinion, 16 December 1993, XXVIII SEC QUARTERLY BULLETIN 15 (No. 2, June
1994); SEC Opinion, 18 February 1993, XXVII SEC QUARTERLY BULLETIN 42 (No. 2, June 1993).
47
SEC Opinion, 25 September 1995, XXX SEC QUARTERLY BULLETIN 43 (No. 1, June 1996).
DISTRIBUTION OF ASSETS OF NON-STOCK CORPORATION
Under Section 94 of the Corporation Code, in case of dissolution of a non-
stock corporation, it assets shall be applied and distributed as follows:
48
Sec. 95, Corporation Code.
Written notice setting forth the proposed plan of distribution or a summary
thereof, and the date, time and place of such meeting shall be given to each
member entitled to vote, within the time and in the manner provided in the
Corporation Code for the giving of notice of meetings to members.49
Such plan of distribution shall be adopted upon approval of at least two-
thirds (2/3) of the members having voting rights present or represented by proxy
at such meeting.50
49
Ibid.
50
Ibid.
51
SEC Opinion, 20 March 1995, XXIX SEC QUARTERLY BULLETIN 15 (No. 3-Sept. 1995);
SEC Opinion, 13 May 1992, XXVI SEC QUARTERLY BULLETIN 12 ( No. 3, Sept., 1992); SEC
Opinion, 10 December 1992, XXVII SEC QUARTERLY BULLETIN 6 (No. 2-June 1993); SEC Opinion,
24 February 1989, XXIII SEC QUARTERLY BULLETIN 2 (No. 2-June 1989); SEC Opinion, 19
September 1988, XXII SEC QUARTERLY BULLETIN 28 (No. 4, Dec. 1988).
52
SEC Opinion, 24 February 1989, SEC QUARTERLY BULLETIN (No. 2, June 1989); SEC
Opinion, 13 May 1992, XXVI SEC QUARTERLY BULLETIN 12 (No. 3, Sept. 1992).
The SEC has held that for purposes of transformation, it is fundamental
that the non-stock corporation must be dissolved first under any of the methods
allowed by law and thereafter, the members may organize a stock corporation
directed to bring profits or pecuniary gains to themselves.53
The Corporation Code prohibits a non-stock corporation during its
corporate life from distributing any part of the profit or dividends to the members,
officers or trustees; and the remaining assets of the corporation can only be
distributed to the members only upon dissolution.54
The amendment of the articles of incorporation to convert the non-stock
corporation does not seek to dissolve the corporation but to change it nature to
stock corporation, the crediting of the member's equity to stockholders' equity
would constitute a distribution of the profits or dividends of the corporation to the
members which is prohibited by the Corporation Code. Whereas before the
corporate change the members only had membership which was essentially non-
transferable and from which no commercial value can be placed, the
transformation would put in the hands of the members-then-stockholders shares
of stock which are transferable in nature and for the value of the book value of
the assets of the corporation, which should not have been realizable by them
during the corporate term of the corporation.
Also, the change of the purpose clause to profit or mercantile venture
would violate Section 14(2) of the Corporation Code, which in enumerating the
contents of the articles of incorporation, clearly prohibits a non-stock corporation
in including in the purpose clause of its articles of incorporation any purpose
which would change or contradict its nature as such.
FOUNDATIONS
1. Foundations Not a Special Category
under Corporation Code
The Corporation Code contains no separate provisions, nor does it even
refer to "foundations" as separate types of corporations different from non-stock
corporations. Foundations are essentially non-stock corporations governed by
the same Title XI of the Code. What therefore makes foundations different from
regular non-stock corporations are the privileges granted to it by special laws,
essentially in the field of Taxation.
2. Tax-Exempt Status
Under Section 30 of the National Internal Revenue Code of 1997
("NIRC"), the following corporations, among others, are exempt from corporate
income taxation:
53
Ibid.
54
Secs. 94 and 95, Corporation Code.
(a) Non-stock corporations or associations organized and
operated exclusively for religious, charitable, scientific,
athletic, or cultural purposes, or for the rehabilitation of
veterans, no part of its net income or asset shall belong to or
inure to the benefit of any member, organizer, officer or any
specific person;
(b) Business leagues, chamber of commerce, or board of trade,
not organized for profit and no part of the net income of
which inures to the benefit of any private stockholder or
individual;
(c) Civic league or organization not organized for profit but
operated exclusively for the promotion of social welfare;
(d) Non-stock and non-profit educational institution;
55
Sec 24, Revenue Regulations No. 2.
56
100 Phil. 127 (1956).
From the point of view of tax-exemption, foundations enjoy the same
privilege, and must undertake the same application process with the BIR to enjoy
such privilege, as with regular non-stock corporations.
3. Charitable Contributions
Under Section 34(H)(1) of the NIRC governing the computation of taxable
net income, taxpayers are allowed to deduct from their taxable gross income
contributions and gifts actually paid and made within the taxable year "to
domestic corporations or associations organized and operated exclusively for
religious, charitable, scientific, youth and sports development, cultural or
educational purposes or for the rehabilitation of veterans, or to social welfare
institutions, no part of the net income of which inures to the benefit of any private
stockholder or individual."
The extent by which a taxpayer may deduct from his taxable net income
the charitable contributions and gifts to regular non-stock corporations organized
for any of the purposes enumerated in Section 34(H)(1) is as follows:
On the other hand, under Section 34(H)(2)(c) contributions and gifts made
to "foundations" or “nongovernment organization” may be deductible in full by the
taxpayer from his taxable gross income. It actually is Section 34(H)(2)(c), which
now refers to "foundations" as "accredited nongovernment organizations," and
defines and distinguishes them from other corporate entities, as follows:
6. In Summary
For purposes of Corporate Law, with respect to corporate powers and
capabilities, and rules on internal management and membership relations, there
are no distinctions between foundations and regular non-stock corporations, and
there is no advantage enjoyed in this realm by foundations over regular non-
stock corporations. In fact, a foundation would suffer a diminution of the extent of
power by which to distribute its net assets in the event of dissolution, as
compared to a regular non-stock corporation.
In the realm of income taxation, both a foundation and a non-stock
corporation can equally enjoy tax-exempt status.
When it comes to charitable contributions, a foundation is limited in the
manner by which it disburses the same by the 30% limitation on its administrative
expenses, whereas no such limitation applies to regular non-stock corporations.
57
BIR Form No. 1702-A.
In addition, both the donors to, and the management of, foundations are saddled
with reportorial requirements on donations given and received, as the case may
be. On the other hand, because donations to foundations which have qualified as
donee-institutions are deductible in full, there may be greater motivation from
benefactors to give to foundations rather than to a regular non-stock corporation.
CONDOMINIUM CORPORATIONS
1. Basis for Membership
The SEC has ruled58 that a buyer may not on the basis of the sale
contract, insist on being registered the owner of the unit and member of the
condominium corporation, since membership in a condominium corporation is
evidenced by a title issued upon full payment of the unit. Accordingly, only those
persons under whose names the condominium certificates of titles (CCTs) are
issued can be considered as the members of the condominium corporation.
58
SEC Opinion, 10 January 1994, XXVIII SEC QUARTERLY BULLETIN 30 (No. 2, June 1994).
59
SEC Opinion, 22 June 1998, XXXIII SEC QUARTERLY BULLETIN 6 (No. 1, June, 1999).
60
SEC Opinion, 22 June 1998, XXXIII SEC QUARTERLY BULLETIN 6 (No. 1, June, 1999).
Board by virtue of its management power, to determine whether or not the such
enforcement can properly be regarded as an act of management of corporate
affairs and whether or not such form of sanction by mere Board resolution is
reasonably necessary under the circumstances to keep and maintain the
corporation. In the exercise of such prerogative, the Board should exercise best
care and god judgment solely in the interest of the corporation, and acts of the
Board done in good faith and in the exercise of an honest judgment are
presumed to be regular and valid.61
EDUCATIONAL CORPORATIONS
1. Incorporation
Educational corporations shall be governed by special laws and by the
general provisions of the Corporation Code.64 The Education Act of 198265
provides for requirements on corporate structure of educational institutions.
2. Pre-requisites to Incorporation
61
Ibid.
62
SEC Opinion, 4 January 1994, XXVIII SEC QUARTERLY BULLETIN 27 (No. 2, June 1994).
63
SEC Opinion, 17 January 1995, XXIX SEC QUARTERLY BULLETIN 30 (No.2, June 1995);
SEC Opinion, 5 April 1995, XXIX SEC QUARTERLY BULLETIN 34 (No. 3, Sept. 1995).
64
Sec. 106, Corporation Code.
65
Batas Pambansa Blg. 232, and later amended by Republic Act 7798 (1994).
The SEC shall not accept or approve the articles of incorporation and by-
laws of any educational institution, except upon favorable recommendation of the
Department of Education and Culture.66
Section 25 of the Education Act of 1982 provides that all schools shall be
established in accordance with law.
The establishment of new national schools and the conversion of existing
schools from elementary to national secondary schools or to tertiary schools shall
be by law.
Any private school proposed to be established must incorporate as a non-
stock educational corporation in accordance with the provisions of the
Corporation Code. The requirement may be waived in the case of family-
administered pre-school institutions. Likewise, pursuant to an amendment of
Section 25 under Republic Act 7798, private schools may be incorporated as
stock educational corporations in capital-intensive courses of study as
determined by the Department of Education, Culture and Sports (DECS), the
Commission on Higher Education (CHED), and the Department of Sciences and
Technology (DOST), as the case may be.
Under Section 4(2), Article XIV of the 1987 Constitution, educational
institutions, other than those established by religious group and mission boards,
shall be owned solely by citizens of the Philippines or corporations or association
at least sixty percent (60%) of the capital of which is owned by such citizens.
Congress may, however, require increased Filipino equity participation in all
educational institutions. The control and administration of all educational
institutions shall be vested in Filipino citizens.
In addition, it provides that no educational institution shall be established
exclusively for aliens and no group of aliens shall comprise more than one-third
(1/3) of the enrollment in any school. Those provisions however shall not apply to
schools established for foreign diplomatic personnel and their dependents and,
unless otherwise provided by law, for other foreign temporary residents.
66
Sec. 107, Corporation Code.
67
SEC Opinion, 20 March 1995, XXIX SEC QUARTERLY BULLETIN 15 (No. 3, September
1995); SEC Opinion, 24 February 1989, XXIII SEC QUARTERLY BULLETIN (No. 2, June 1993).
corporate assets would in effect be treated as paid-in capital or subscription
payments of the stockholders.
The proper procedure would be to dissolve it first under any of the
methods specified in Title XIV of the Corporation Code so that the corporate
assets shall be liquidated in accordance with the distribution procedure for non-
stock corporations, and thereafter register it as a new stock corporation subject
to the requirements of the Department of Education, Culture and Sports.68
4. Board of Trustees
Trustees of educational institutions organized as non-stock corporation
shall not be less than (5) nor more than (15), provided, that the number of
trustees shall be in multiples of five (5),69 and may hold office for a term of five (5)
years.70 The number of directors for schools organized as stock corporations
may be any number between five (5) and fifteen (15),71 and shall hold office for
one year.72
The multiples of five (5) in the board of trustees in an educational
institution must be complied, since the provisions of Section 108 are mandatory
provision, otherwise, the Legislature would have provided for an exception to the
same.73
Unless otherwise provided in the articles of incorporation, or the by-laws,
the board of trustees of incorporated schools, colleges, or other institutions of
learning shall, as soon as organized, so classify themselves that the term of
office of one-fifth (1/5) of their number shall expire every year. Trustees
thereafter elected to fill vacancies, occurring before the expiration of term shall
hold office only for the unexpired period. Trustees elected thereafter to fill
vacancies caused by expiration of term shall hold office for five (5) years.74
A majority of the trustees shall constitute a quorum for the transaction of
business. The powers and authority of trustees shall be defined in the by-laws.75
For institutions organized as stock corporations, the number and term of
directors shall governed by the provisions on stock corporations.76
68
Ibid
69
Sec. 108, Corporation Code; Se. 108, Batas Pambansa Blg. 68.
70
Sec. 108, Batas Pambansa Blg. 68.
71
Sec. 10, Batas Pambansa Blg. 68.
72
Sec. 23, Batas Pambansa Blg. 68.
73
SEC Opinion, 17 November 1994, XXIX SEC QUARTERLY BULLETIN 5 (No.2, June 1995).
74
Ibid.
75
Ibid.
76
Ibid.
All revenues and assets of non-stock, non-profit educational institutions
used actually, directly, and exclusively for educational purposes shall be exempt
from taxes and duties.77
Upon the dissolution or cessation of the corporate existence of an
educational institution, its assets shall be disposed of in the manner provided by
law.78
Proprietary educational institutions, including those cooperatively owned,
may likewise be entitled to such exemptions subject to the limitations provided by
law including restrictions on dividends and provisions for reinvestments.79
Subject to the conditions prescribed by law, all grants, endowments,
donations, or contributions used actually, directly, and exclusively for educational
purposes shall be exempt from tax.80
RELIGIOUS CORPORATIONS
Religious corporations may be incorporated by one or more persons. Such
corporations may be classified into corporations sole and religious societies.81
Religious corporations shall governed also by the general provisions on
non-stock corporations insofar as they may be applicable.82
The SEC has ruled that since the Corporation Code does not provide for
the term of a religious corporation, whether sole or aggregate, therefore a
religious corporation may exist in perpetuity.83
1. Corporation Sole
For the purpose of administering and managing, as trustee, affairs,
property and temporalities of any religious denomination, sect or church, a
corporation sole may be formed by the chief archbishop, bishop, priest, minister,
rabbi or other presiding elder of such religious denomination, sect or church.84
a. Acquisition of Land
In Roman Catholic Apostolic Adm. of Davao, Inv. v. Land Registration
Commission85 it was held that a corporation sole is a special form of corporation
usually associated with clergy designated to facilitate the exercise of the
functions of ownership of the church and to regulate the holding and transmission
of such temporalities to the successor of head of the religious sect. It therefore
77
Sec. 4(3), Art. XIV, 1987 Constitution.
78
Ibid.
79
Ibid.
80
Sec. 4(4), Art. XIV, 1987 Constitution.
81
Sec. 109, Corporation Code.
82
Ibid.
83
SEC Opinion, 10 December 1981, XVI SEC QUARTERLY BULLETIN 24 (No. 1, Jan. 1981).
84
Sec. 110, Corporation Code.
85
102 Phil. 596 (1957).
had no nationality. In addition, Roman Catholic held that even if a corporation
sole had a nationality, the same would be determined, not by the national of the
sole corporator, but by the nationality of the constituent of the religious members
constituting the sect. It was therefore, held that a corporation sole was not
disqualified under the constitutional provision providing that only Filipino citizens
or corporations of which at least sixty percent (60%) of the capital stock are
qualified to hold land in the Philippines.
In Director of Lands v. Intermediate Appellate Court,86 in reversing the
priorly adhered doctrine on the matter, held that alienable public land held by a
possessor, personally or through his predecessor-in-interest, openly,
continuously and exclusively for the prescribed statutory period of 30 years under
the Public Land Act is converted to private property by the mere lapse or
completion of said period, ipso jure. Consequently, the requirements of the Public
Land Act qualifying only individuals to acquire public land, cannot apply to
corporate entities who have acquired land by such prescription since the same
would then be private land, not covered by the Public Land Act. The doctrine was
reiterated in Republic v. Intermediate Appellate Court.87
The Director of Lands therefore overturned the previous doctrine that a
corporation sole is disqualified to acquire or hold alienable lands of the public
domain, because of the constitutional prohibition qualifying only individuals to
acquire land of the public domain and the provision under the Public Land Act
which applied only to Filipino citizens or natural persons in the cases of Republic
v. Villanueva,88 and Republic v. Iglesia Ni Cristo.89
The SEC has ruled that when a corporation sole is headed by a foreigner,
it may acquire land in the Philippines only when records are submitted showing
that the members of the Church or religious denomination represented by it
constitute at least 60% Filipinos. 90
b. Articles of Incorporation
Under Section 111 of the Corporation Code, in order to become a
corporation sole, the chief archbishop, bishop, priest, minister, rabbi or presiding
elder of any religious denomination, sect or church must file with the SEC articles
of incorporation setting forth the following:
86
146 SCRA 510 (1986).
87
168 SCRA 165 (1988).
88
114 SCRA 875 (1982).
89
127SCRA 687 (1984).
90
SEC Opinion, 21 September 1993, XXVIII SEC QUARTERLY BULLETIN 11 (No. 1, March
1994); SEC Opinion, 8 August 1994, XXIX SEC QUARTERLY BULLETIN 2 (No. 1, March, 1995).
(b) That the rules, regulations and discipline of his religious
denomination, sect or church are not inconsistent with his
becoming a corporation sole and do not forbid it;
(c) That as such chief archbishop, bishop, priest, minister, rabbi
or presiding elder, he is charged with the administration of
the temporalities and the management of the affairs, estate
and properties of his religious denomination. sect or church
within his territorial jurisdiction, describing such territorial
jurisdiction;
The articles of incorporation may include any other provision not contrary
to law for the regulation of the affairs of the corporation.
91
Sec. 112, Corporation Code.
92
Ibid.
Any corporation sole may purchase and hold real estate and personal
property for its church, charitable, benevolent or educational purposes, and may
receive bequests or gifts for such purposes.93
Such corporation may mortgage or sell real property held by it upon
obtaining an order for that purpose from the Regional Trial Court of the province
where the property is situated; but before the order is issued, proof must be
made to the satisfaction of the court that notice of the application for leave to
mortgage or sell has been given by publication or otherwise in such manner and
for such time as said court may have directed, and that it is to the interest of the
corporation that leave to mortgage or sell should be granted.94
The application for leave to mortgage or sell must be made by petition,
duly verified, by the chief archbishop, bishop, priest, minister, rabbi or presiding
elder acting as corporation sole, and may be opposed by any member of the
religious denomination, sect or church represented by the corporation sole. In
cases where the rules, regulations and discipline of the religious denomination,
sect or church, religious society or order concerned represented by such
corporation sole regulate the method of acquiring, holding selling and mortgaging
real estate and personal property, such rules, regulations and discipline shall
control, and the intervention of the courts shall not be necessary. 95
e. Filling-up of Vacancies
The successors in office of any chief archbishop, bishop, priest, minister,
rabbi, or presiding elder in a corporation sole shall become the corporation sole
on their accession to office; and shall be permitted to transact business as such
on the filing with the Securities and Exchange Commission of a copy of their
commission, certificate of election, or letters of appointment, duly certified by any
notary public.96
During any vacancy in the office of the chief archbishop, bishop, priest,
minister, rabbi, or presiding elder of any religious denomination, sect or church
represented by the corporation sole, the person or persons authorized and
empowered by the rules, regulations or discipline of the religious denomination,
sect or church represented by the corporation sole to administer the temporalities
and manage the affairs, estate and properties of the corporation sole during the
vacancy shall exercise all the powers and authority of the corporation sole during
such vacancy.97
f. Dissolution
93
Sec. 113, Corporation Code.
94
Ibid.
95
Ibid.
96
Sec. 114, Corporation Code.
97
Ibid.
A corporation sole may be dissolved and its affairs settled voluntarily by
submitting to the SEC a verified declaration of dissolution.98 The declaration of
dissolution shall set forth:
2. Religious Societies
Under Section 116 of the Corporation Code, any religious society or
religious order, or any diocese, synod, or district organization of any religious
denomination, sect, or church, unless forbidden by the constitution, rules,
regulations, or discipline of the religious denomination, sect or church of which it
is a part, or by competent authority, may, upon written consent and/or by an
affirmative vote at a meeting called for the purpose of two-thirds (2/3) of its
membership, incorporate for the administration of its temporalities or for the
management of its affairs, properties and estate by filing with the SEC, articles of
incorporation verified by the affidavit of the presiding elder, secretary, or clerk or
other member of such religious society or religious order, or diocese, synod, or
district organization of the religious denomination, sect, or church, setting forth
the following:
98
Sec. 115, Corporation Code.
99
Ibid.
100
171 SCRA 13, 20 (1989).
(c) That the incorporation of the religious society or religious
order, or diocese, synod, or district organization desiring to
incorporate is not forbidden by competent authority or by the
constitution, rules, regulations or discipline of the religious
denomination, sect, or church of which it forms a part;
(d) That the religious society or religious order, or diocese,
synod, or district organization desires to incorporate for the
administration of its affairs, properties and estate;
(e) The place where the principal office of the corporation is to
be established and located, which place must be within the
Philippines; and
(f) The names, nationalities, and residences of the trustees,
elected by the religious society or religious order, or diocese,
synod, or district organization to serve for the first year or
such other period as may be prescribed by the laws of the
religious society or religious order, or the diocese, synod, or
district organization, the board of trustees to be not less than
five (5) nor more than fifteen (15).
COOPERATIVES
1. Rationale for Cooperative System
Cooperatives are species of non-stock corporation which are entirely
governed by a special law, The Cooperative Development Authority Act.102 Under
the Act, the State fosters the creation and growth of cooperatives "as a practical
vehicle for promoting self-reliance and harnessing people power towards the
attainment of economic development and social justice."103 The State "shall
encourage the private sector to undertake the actual formation and organization
of cooperatives and shall create an atmosphere that is conducive to the growth
and development of these cooperatives."104
101
SEC Opinion, 8 August 1997, XXXII SEC QUARTERLY BULLETIN 13 (No. 2, Dec. 1997);
SEC Opinion, 23 October 1995, XXX SEC QUARTERLY BULLETIN 59 (No. 1, March 1996).
102
Rep. Act 6939.
103
Art. 2, Rep. Act 6938.
104
Ibid.
2. Definition of "Cooperatives"
A cooperative is a duly registered association of persons, with a common
bond of interest, who have voluntarily joined together to achieve a lawful
common social or economic end, making equitable contribution to the capital
required and accepting a fair share of the risks and benefits of the undertaking in
accordance with universally accepted cooperative principles.105
105
Art. 3, Rep. Act 6938.
106
Art. 7, Rep. Act 6938.
107
Ibid.
108
Art 5(1), ibid.
109
Art. 10, ibid.
(f) To acquire lands and provide housing benefits for the
members;
(g) To insure against losses of the members;
(h) To promote and advance the economic, social and
educational status of the members;
(i) To establish, own, lease or operate cooperative banks,
cooperative wholesale and retail complexes, insurance and
agricultural or industrial processing enterprises, and public
markets;
(j) To coordinate and facilitate the activities of cooperatives; and
(k) To undertake any and all other activities for the effective and
efficient implementation of the Cooperative Code of the
Philippines.110
110
Art. 6, Rep. Act 6938.
111
Art. 4, ibid.
112
Art. 36, ibid.
113
Art. 37, ibid.
114
Ibid.
115
Ibid.
116
Art. 36, ibid.
Share capital in a cooperative shall receive a strictly limited rate of
interest.117 Net surplus arising out of the operations of a cooperative belongs to
its members and shall be equitably distributed for cooperative development,
common services, indivisible reserve fund, and for limited interest on capital
and/or patronage refund in the manner provided for in the Act and in the articles
of cooperation and by-laws.118
7. Board of Directors
The board of directors of the cooperative is the body entrusted with the
management of the affairs of the cooperative under its articles of cooperative and
by-laws.119 The board of directors of the cooperative shall direct and supervise
the business, manage the property of the cooperative and may, by resolution,
exercise all powers of the cooperative as are not reserved for the general
assembly under the Act and the by-laws.120
The conduct and management of the affairs of the cooperative shall be
vested in a board of directors which shall be composed of not less than five (5)
nor more than fifteen (15) members elected by the general assembly for a term
of two (2) years and shall hold office until their successors are duly elected and
qualified, or until duly removed; however, no director shall serve for more than
three (3) consecutive terms.121
8. General Assembly
The general assembly is composed of members who are entitled to vote
under the articles of cooperation and by-laws of the cooperative.122 It shall
constitute the highest policy-making body of the cooperative and shall exercise
such powers as are provided by law, those stated in the articles of cooperation
and the by-laws of the cooperative.123
Under the Act, the general assembly shall have the following exclusive
power which cannot be delegated:
117
Art. 4(3), ibid.
118
Art. 4(4), ibid.
119
Art. 5(3), ibid.
120
Art. 39, ibid.
121
Art. 38, ibid.
122
Art. 33, ibid.
123
Ibid.
(d) Such other matters requiring a two-thirds (2/3) vote of all the
members of the general assembly as provided in the Act.124
——oOo——
124
Art. 34, ibid.
125
Arts. 12 and 30, ibid.
126
Art. 13, ibid.
127
Art. 16, ibid.
CHAPTER 18
——
2
Marshall-Wells Co. v. Henry W. Elser & Co., 46 Phil. 70, at p. 74 (1924).
3
Avon Insurance PLC v. Court of Appeals, 278 SCRA 312, 86 SCAD 401 (1997).
4
Times, Inc. v. Reyes, 39 SCRA 303 (1971), citing Perkins v. Dizon, 69 Phil. 186 (1939).
5
Ibid, citing Paul v. Virginia, 8 Wall. 168 (1869); Sioux Remedy Co. v. Cape and Cope, 235
U.S. 197 (1914); Cyclone Mining Co. v. Baker Light & Power Co., 165 Fed. 996 (1908).
6
SALONGA, PRIVATE INTERNATIONAL LAW, 1979 ed., p. 344.
other states has been the subject of jurisprudential rules and municipal
legislations, especially in the fields of taxation,7 foreign investments, and capacity
to obtain reliefs in local courts and administrative bodies.
Consent, as a requisite for jurisdiction over foreign corporations, is
founded on considerations of due process and fair play. As held in Pennoyer v.
Neff,8 the jurisdiction of courts to render judgment in personam is grounded on
their de facto power over the defendant's person. Therefore his presence within
the territorial jurisdiction of a court is prerequisite to its rendition of judgment
personally binding him. International Shoe Co. v. State of Washington9 expanded
the coverage by stating that due process requires only that in order to subject a
defendant to a judgment in personam, if he not be present within the territory of
the forum, he must have certain minimum contacts with it such that the
maintenance of the suit does not offend "traditional notions of fair play and
substantial justice."
International Shoe Co. held that "[s]ince the corporate personality is a
fiction, although a fiction intended to be acted upon as though it were a fact, it is
clear that unlike an individual its „presence‟ without, as well as within, the State of
its origin can be manifested only by activities carried on in its behalf by those who
are authorized to act for it. To say that a corporation is so „present‟ there as to
satisfy due process requirements . . . is to beg the question to be decided. For
the terms „present‟ or „presence‟ are merely used to symbolize those activities of
the corporation's agent with the State which courts will deem to be sufficient to
satisfy the demands of due process." Thus, it deemed that "presence" in a forum
state will not be doubted when the activities of the corporation there have not
only been continuous and systematic, but also give rise to liabilities sued on,
even though no consent to be sued or authorization to an agent to accept service
of process has been given.
A foreign corporation may be subjected to jurisdiction by reason of
consent, ownership of property within the State, or by reason of activities within
or having an effect within the state.10 For example, the filing of an action by a
foreign corporation before Philippine courts would mean that by voluntary
appearance, the local courts have actually obtained jurisdiction over the "person"
of the foreign corporation.11
Another basis by which a host state is deemed to have authority over a
foreign corporation is under the doctrine of "doing business" within the territorial
jurisdiction of the host state. It is an established doctrine that when a foreign
corporation undertakes business activities within the territorial jurisdiction of a
host state, then it ascribes to the host state standing to enforce its laws, rules
7
The chapter does not cover nor discuss the concept of "doing business" in the field of
taxation, as the subject is itself a technical matter that deserves a separate discussion.
8
95 U.S. 714, 733, 24 L.Ed. 565 (1877).
9
326 U.S. 310, 66 S.Ct. 154, 90 L.Ed. 95 (1945).
10
SALONGA, supra, citing Goodrich (Scoles), 136.
11
Communication Materials and Design, Inc. v. Court of Appeals, 260 SCRA 673, 73 SCAD
374 (1996).
and regulations. In the same manner, in order to regulate the basis by which a
foreign corporation seeks to do business and the manner by which it would seek
redress within the judicial and administrative authorities within the host state,
have given rise to the requirement that a license be obtained under the penalty
that failure to do so would not give it legal standing to sue in local courts and
administrative bodies exercising quasi-judicial powers.
On the other hand, when a foreign corporation's activities within the host
state do not fall within the concept of "doing business," the requirements of
obtaining a license to engage in business are generally not applicable to it, and it
would still have legal standing to sue in local courts and administrative agencies
to obtain relief.
In such an instance, the jurisdiction by local courts and administrative
bodies over a foreign corporation seeking relief would be the clear consent
manifested by the filing of the suit.
The Philippine Supreme Court has held that "the recognition of the legal
status of a foreign corporation is a matter affecting the policy of the forum, and
distinction drawn in our Corporation Law between the standing of a corporation
which does not engage in business in the Philippines and does not require a
license to sue, and a foreign corporation which engages in business in the
Philippines, and is required to obtain a license to sue, is an expression of that
policy."12 A state may therefore restrict the right of a foreign corporation to
engage in business within its limits, and to sue in its courts.13
Outside of consent, the concept of "doing business" therefore becomes
the crucial point to determine whether foreign corporations and multinational
enterprises have come within the territorial jurisdictions of the host countries and
consequently to determine to what extent they are bound to obtain licenses
within various host countries before they can sue with local courts and
administrative bodies.
12
Mentholatum Co., Inc. v. Mangaliman, 72 Phil. 524, 530 (1941).
13
Marshall-Wells Co. v. Henry W. Elser & Co., 46 Phil. 70, 74.
Although wrongly placed, the inclusion of the element of reciprocity in the
definition of foreign corporations emphasizes the Philippines' policy that unless
our own nationals are granted business access in a foreign state, then the
corporate entities of such foreign state would likewise not be granted legal
business access in Philippine territory. This is clear in the succeeding sentence
of Section 123 that provides that foreign corporations from state that grant
reciprocity rights to Philippine nationals "shall have the right to transact business
in the Philippines after it shall have obtained a license to transact business in this
country in accordance with this Code and a certificate of authority from the
appropriate government agency."
14
Sec. 125, Corporation Code.
15
Ibid. Sec. 127 of the Corporation Code provides that the resident agent may either be an
individual residing in the Philippines who must be of good moral character and sound financial
standing or a domestic corporation lawfully transacting business in the Philippines.
16
Sec. 128, Corporation Code.
occurred in the Philippines, service of any summons or other legal process may
be made upon the SEC and that such service shall have the same force and
effect as if made upon the duly authorized officers of the foreign corporation at its
home office.17
Whenever such service of summons or other process shall be made upon
the SEC, it must, within ten (10) days thereafter, transmit by mail a copy of such
summons or other legal process to the corporation at its home or principal office.
The sending of such copy by the SEC shall be a necessary part of and shall
complete such service.18
5. Deposit of Securities
Within sixty (60) days from issuance of the license to do business, such
foreign corporation shall deposit with the SEC, for the benefit of its present and
future creditors, Philippine securities21 in the actual market value of at least
P100,000.00, subject to further deposit of additional securities every six months
after each fiscal year equivalent in actual market value to two percent (2%) of the
amount by which the foreign corporation's gross income for that fiscal year
exceeds P5,000,000.00.
Furthermore, the SEC may require further securities in the event the
deposit has decreased by at least ten percent (10%) of the actual market value at
the time they were deposited.22
17
Ibid.
18
Ibid.
19
Sec. 134, Corporation Code.
20
Sec. 128, Corporation Code.
21
Sec. 126, Corporation Code enumerates them to consist of bonds or other evidence of
indebtedness of the Philippine Government, its political subdivisions and instrumentalities, or
government-owned or controlled corporations and entities, shares of stocks in "registered
enterprises," shares of stocks of listed domestic entities, or shares of stock in domestic insurance
companies and banks, or any combination of these kinds of securities -
22
Sec. 126, Corporation Code.
6. Effects of Being Issued License
When a foreign corporation is issued the license to do business in the
Philippines, it may commence to transact its business in the Philippines and
continue to do so for as long as it retains its authority to act as a corporation
under the laws of the country or state of its incorporation, unless such license is
sooner surrendered, revoked, suspended, or annulled.23
The Corporation Code therefore takes pain to ensure that in allowing a
foreign corporation to engage in business activities in the Philippines, proper
safeguards are taken to allow obtaining jurisdiction over such foreign corporation
in case of suit and that proper securities are present within Philippine jurisdiction
to answer for a foreign corporation's obligations to locals. The Supreme Court
has held: "The purpose of the law is to subject the foreign corporation doing
business in the Philippines to the jurisdiction of our courts. It is not to prevent the
foreign corporation from performing single or isolated acts, but to bar it from
acquiring a domicile for the purpose of business without first taking steps
necessary to render it amenable to suits in the local courts."24
Such strict rules are necessary since a foreign corporation doing business
in the Philippines is bound by all laws, rules and regulations applicable to
domestic corporations of the same class, except for matters that go into creation,
formation, organization or dissolution of corporations or such as to fix relations,
liabilities, responsibilities or duties of stockholders, members, or officers of
corporation to each other or to the corporation, or simple intra-corporate
disputes.25
23
Sec. 126, Corporation Code.
24
Eriks Pte. Ltd. v. Court of Appeals, 267 SCRA 567, 76 SCAD 70 (1997). The Court also
held in that case: "It was never the intent of the legislature to bar court access to a foreign
corporation or entity which happens to obtain an isolated order for business in the Philippines.
Neither, did it intend to shield debtors from their legitimate liabilities or obligations. But it cannot
allow foreign corporations or entities which conduct regular business any access to courts without
the fulfillment by such corporation of the necessary requisites to be subjected to our
government's regulation and authority. By securing a license, the foreign entity would be giving
assurance that it will abide by the decisions of our courts, even if adverse to it."
25
Sec. 129, Corporation Code.
26
57 Phil. 607 (1932).
Philippine Islands." The Court held that having regard for the reason of the law
allowing issuance of writs of attachments for the protection of creditors of a non-
resident, the same reason does not apply to a foreign corporation doing business
in the Philippines and licensed to do so by Philippine authority.
The Court held that unlike a natural person who does not reside in the
Philippines, such foreign corporation is required by law to appoint a resident
agent for service of process; must prove to the satisfaction of the Government
before it does business here, that it is solvent and in sound financial condition;
has had to pay license fee and its business subject at anytime to investigation by
the Government authorities; and that his right to continue do business is subject
to revocation by the Government; and books and papers subject to examination
at any time by the Government; and is bound by all laws, rules and regulations
applicable to domestic corporations; all designed to protect the creditors and the
public. The Court further held:
27
Ibid, at p. 612.
for and in behalf of any foreign corporation or entity not duly licensed to do
business in the Philippines.
It seems clearly implied from the languages of both Sections 133 and 134,
that the failure of a foreign corporation to obtain a license to do business when
one is required, does not affect the validity of the transactions of such foreign
corporation, but simply removes the legal standing of such foreign corporation to
sue. Although such foreign corporation may still be sued, the Corporation Code
fails to indicate that once sued, if such foreign corporation can interpose
counterclaims in the same suit.
35
138 SCRA 118 (1985).
36
Ibid, at p. 130.
consequence that petitioner is not entitled to the relief prayed
for in this case.37
2. Doctrine of Estoppel
In Merrill Lynch Futures, Inc. v. Court of Appeals,39 the Supreme Court
came out with a diametrically opposed ruling to the pari delicto principle of Top-
Weld Manufacturing.
In that case, Merrill Lynch Futures, Inc., through a domestic corporation,
was found to be engaging in business (commodity futures) in the Philippines
without obtaining the proper license. It brought a suit in Philippine courts to
enforce a claim against local investors. Although the Court found the foreign
corporation to have engaged in business in the Philippines without the requisite
license, it overturned the dismissal of the suit, on the ground that if the local
investors knew that the foreign corporation had no license to do business in the
37
Ibid, at p. 131. Emphasis supplied.
38
Ibid, at p. 131, citing Bough v. Cantiveros, 40 Phil. 210 (1919).
39
211 SCRA 824 (1992).
Philippines, then they are estopped from using the lack of license to avoid their
obligations, thus—
In addition, the Court took into serious consideration the fact that the
foreign corporation did not actually "sell sugar and derive income from the
Philippines," but actually bought sugar from the Philippine government and
allegedly paid for it in full. The theory therefore would seem that the activity to be
undertaken in the Philippines to be considered engaged in business is one that is
for profit-making activity and not one where the foreign corporation merely seeks
to enter into a purchase or acquisition transaction which by itself it does not
derive profit. The Court then went on to quote from Antam Consolidated, Inc. v.
Court of Appeals,43 which it deemed similar in facts and held that the doctrine of
lack of capacity to sue based on failure to acquire a local license is based on
considerations of sound public policy. The license requirement was imposed to
subject the foreign corporation doing business in the Philippines to the
jurisdiction of its courts and never intended to favor domestic corporation who
enter into solitary transactions with unwary foreign firms and then repudiate their
obligations simply because the latter are not licensed to do business in the
country.
The rulings of the Supreme Court would also imply that when a foreign
corporation doing business in the Philippines has not obtained the requisite
license is sued, then by the principle of estoppel, it may interpose the proper
counterclaims.
42
Ibid, at pp. 469-470 citing Merrill Lynch Futures, Inc. v. Court of Appeals, 211 SCRA 824
(1992).
43
143 SCRA 288 (1986).
44
260 SCRA 673, 73 SCAD 374 (1996).
A foreign corporation doing business in the Philippines
may sue in Philippine courts although not authorized to do
business here against a Philippine citizen or entity who had
contracted with and benefited by said corporation. To put it
another way, a party is estopped to challenge the personality
of a corporation after having acknowledged the same by
entering into a contract with it. And the doctrine of estoppel to
deny corporate existence applies to a foreign as well as to
domestic corporations. One who has dealt with a corporation
of foreign origin as a corporate entity is estopped to deny its
corporate existence and capacity. The principle will be applied
to prevent a person contracting with a foreign corporation from
later taking advantage of its noncompliance with the statutes
chiefly in cases where such person has received the benefits
of the contract.
The Court held that the doctrine of lack of capacity to sue based on the
failure to acquire a local license is based on considerations of sound public
policy. The license requirement was imposed to subject the foreign corporation
doing business in the Philippines to the jurisdiction of its courts. It was never
intended to favor domestic corporations who enter into solitary transactions with
unwary foreign firms and then repudiate their obligations simply because the
latter are not licensed to do business in this country.45
45
Quoting from National Sugar Trading Corp. v. Court of Appeals, 246 SCRA 465, 63
SCAD 31 (1995).
Eriks Pte. Ltd. v. Court of Appeals,46 has answered the issue that to
prevent a foreign corporation to sue on a contract would be unjust enrichment for
the local counterpart, albeit not in express reference to the estoppel doctrine. In
that case it was argued by the foreign corporation that its denial of access to
Philippine courts would afford unjust enrichment to the defendant. The Court
held: "a judgment denying a foreign corporation relief from our courts for failure to
obtain the requisite license to do business, should not be construed as an
attempt to foreclose the ultimate right to collect on an obligation. . . Res judicata
does not set in a case dismissed for lack of capacity to sue, because there has
been no determination on the merits. Moreover, this Court has ruled that
subsequent acquisition of the license will cure the lack of capacity at the time of
the execution of the contract."
Under the negative list concept of the Act, a non-Philippine national, upon
registration with the SEC, may do business in the Philippines or invest in a
domestic enterprise up to one hundred percent (100%) of its capital, unless
46
267 SCRA 567, 76 SCAD 70 (1997).
47
Rep. Act 7042.
48
Executive Order 226.
49
Sec. 3(a), Foreign Investment Act of 1991.
participation of non-Philippine nationals in the enterprise is prohibited or limited to
a smaller percentage by existing law and/or under the negative lists of the Act.50
Although the Act has removed the requirement of registration with the BOI
for foreign investors to do business in the Philippines outside the negative lists,
nevertheless it confirms the need for such foreign corporation, before engaging in
business in the Philippines, to register with, and obtain a license to do business
from, the SEC.
Under the Implementing Rules and Regulations issued by the Department
of Trade and Industry, a foreign corporation is defined as "one which is formed,
organized or existing under laws other than those of the Philippines."51
The Act defines "doing business" to include the following by express
enumeration:
On the other hand, the Act makes clear that "doing business" does not
include the following acts and activities:
50
Sec. 5, Foreign Investment Act of 1991.
51
Sec. 1(c), Implementing Rules and Regulations of FIA „91.
52
Sec. 3(d), Foreign Investment Act of 1991; emphasis supplied.
(c) Appointing a representative or distributor domiciled in the
Philippines which transacts business in its own name and
for its own account.53
53
Ibid.
54
Sec. 1(f), Implementing Rules and Regulations of FIA „91.
55
246 SCRA 465, 63 SCAD 31 (1995).
56
278 SCRA 312, 86 SCAD 401 (1997).
The purpose of the law in requiring that foreign
corporations doing business in the country be licensed to do
so, it to subject the foreign corporations doing business in the
Philippines to the jurisdiction of the courts, otherwise, a foreign
corporation illegally doing business here because of its refusal
or neglect to obtain the required license and authority to do
business may successfully though unfairly plead such neglect
or illegal act so as to avoid service and thereby impugn the
jurisdiction of the local courts.
The same danger does not exist among foreign
corporations that are indubitably not doing business in the
Philippines. Indeed, if a foreign corporation does not do
business here, there would be no reason for it to be subject to
the State‟s regulation. As we observed, in so far as the State is
concerned, such foreign corporation has no legal existence.
Therefore, to subject such foreign corporation to the courts‟
jurisdiction would violate the essence of sovereignty.
57
138 SCRA 118 (1985).
local company shows that they are highly restrict in nature, thus making the local
company a mere conduit or extension of the foreign corporations.
In spite of the provisions of the Act and the Implementing Rules and
Regulations, therefore, even when the local agents, brokers, or indentors of
foreign corporation transact sales in their own names, but the covering licensing
or representative agreements with foreign corporations contain highly restrictive
terms as to render the locals merely conduits or extensions of foreign
corporations, the latter would still be considered as "doing business" in the
Philippines.
The doctrine was reiterated in Communication Materials and Design, Inc.
v. Court of Appeals,58 which found the following provisions in the Master Service
Agreement of the foreign corporation with the local company as highly restrictive
as to make the latter merely a conduit or extension of the foreign company:
58
260 SCRA 673, 73 SCAD 374 (1996).
59
Georg Grotjahn GMBH & Co. v. Isnani, 235 SCRA 216, 54 SCAD 289 (1994).
Regional headquarters are not regulated nor licensed under Section 123
of the Corporation Code, but under Executive Order 226 (otherwise known as the
Omnibus Investment Code of 1987), and therefore do not need a separate
license from the SEC in order to operate as an area or regional headquarters in
the Philippines for a multinational company. No license is required since area or
regional headquarters are established only to supervise, coordinate and
communicate with their own affiliates, subsidiaries or branches in the Asia Pacific
region, and are not allowed to do business in the Philippines like the branch or
representative offices of foreign corporations licensed pursuant to the
Corporation Code.60
Republic Act 8756, which amended the Omnibus Investment Code, has
provided for the establishment within Philippine jurisdiction of “regional operating
headquarters,” which means “foreign entity which is allowed to derive income in
the Philippines by performing qualifying services to its affiliates, subsidiaries or
branches in the Philippines, in the Asia-Pacific Region and in other foreign
markets.” Once is has obtained the appropriate license as a regional operating
headquarters, it does not need to acquire a separate license to do business in
the Philippines.
60
SEC Letter reply to Atty. Cesar L. Villanueva, dated 31 January 1996.
61
46 Phi. 70 (1924).
business in the Philippine. In construing what is not included in the term "doing
business," Marshall-Wells did indicate that an "isolated" transaction would not
place a foreign corporation within the term "doing business."
The Supreme Court in Marshall-Wells discussed the rationale behind then
Section 69 of the Corporation Law (now Section 133 of the Corporation Code),
thus:
62
Ibid, at p. 75. Emphasis supplied.
63
51 Phil. 115 (1927).
64
Ibid, at p. 128.
In 1941, the Supreme Court in Mentholatum Co., Inc. v. Mangaliman,65
began to fashion a jurisprudential test of what constitutes "doing business" in the
Philippines for foreign corporations. In that case, Mentholatum Company, an
American corporation, and its exclusive Philippine distributing agent, Philippine-
American Drug Company, instituted an action for infringement of trademark and
unfair competition against defendants Mangaliman. Mentholatum had in previous
years registered the trademark "Mentholatum" for its products consisting of
medicament and salve. The defendants Mangaliman had prepared a
medicament and salve named "Mentholiman" which they sold to the public
packed in containers of the same size, color and shape as "Mentholatum".
Although the trial court found for the plaintiffs, on appeal the Court of Appeals
reversed the decision, holding that the activities of Mentholatum were business
transactions in the Philippines, and that, by Section 69 of the Corporation Law, it
could not maintain any action.
In a petition for certiorari filed with the Supreme Court, the plaintiffs-
petitioners claimed that although Mentholatum may be covered by the provision
of then Section 69 of the Corporation Law on the effects of doing business
without a license, the complaint was also filed by Philippine-American Drug
Company, a domestic corporation, which had sufficient interest and standing to
maintain the complaint. In addition, it was shown that Mentholatum itself had not
sold any of its products in the Philippines, and it was Philippine-American Drug
Co., Inc. and fifteen other local entities which imported the products and sold
them locally.
It determining whether Mentholatum fell under the category of doing
business in the Philippines, which thereby required it to obtain a license to do
business, the Court held:
65
72 Phil. 524 (1941).
66
Ibid, at pp. 528-529, citing Traction Cos. v. Collectors of Int. Revenue [C.C.A. Ohio] 223
F. 984, 987; Griffin v. Implement Dealer's Mut. Fire Ins. Co., 241 N.W. 75, 77; Pauline Oil & Gas
Co. v. Mutual Tank Line Co., 246 P. 851, 852, 118 Okl. 111; Automotive Material Co., v.
American Standard Metal Products Corp., 158 N.E. 698, 703, 327 Ill. 367). Emphasis supplied.
In deciding that Mentholatum was indeed engaged in business in the
Philippines, the Supreme Court took cognizance of the allegation in the complaint
that clearly stated that the "Philippine-American Drug Co., Inc., is the exclusive
distributing agent in the Philippine Islands of the Mentholatum Co., Inc., in the
sale and distribution of its products known as the Mentholatum." The Court
therefore concluded that whatever transactions the Philippine-American Drug
Company had executed in view of the law, the Mentholatum did itself. The Court
held therefore that since Mentholatum is a foreign corporation doing business in
the Philippine without a license, it may not prosecute the action for violation of
trademark and unfair competition. In addition, neither may the Philippine-
American Drug Company maintain the action for the reason that the
distinguishing features of the agent being its representative character and
derivative authority, and could not, to the advantage of its principal, claim an
independent standing in court apart from Mentholatum.
What is significant in Mentholatum is its drawing of the two tests to
determine whether a foreign corporation is engaged in business in the
Philippines:
First, it considered as the "true test" of doing business in the Philippines
as to whether a foreign corporation is maintaining or continuing in the Philippines
"the body or substance of the business or enterprise for which it was organized
or whether is has substantially retired from it and turned it over to another."
Second, it defined "doing business" to necessarily imply "a continuity of
commercial dealings and arrangements, and contemplates, to that extent, the
performance of acts or works or the exercise of some of the functions normally
incident to, and in progressive prosecution of, the purpose and object of its
organization."
Taken together, the characterization by Mentholatum of "doing business"
in the Philippines covers transactions or series of transactions in pursuit of the
main business goals of the corporation, and done with intent to continue the
same in the Philippines. It re-affirmed the early characterization of Marshall-Wells
that an "isolated transaction" by a foreign corporation cannot qualify as "doing
business" since it lacks the element of continuity. Notice that the element of profit
results did not figure into the test.
Commissioner of Internal Revenue v. British Overseas Airways Corp.,67
held that when an international airline maintains a general sales agent in the
Philippines, which engaged in the selling and issuing of tickets, breaking down
the whole trip into series of trip—each trip in the series corresponding to a
different airline company, receiving the fare from the whole trip, and allocating to
the various airline companies on the basis of their participation in the services
rendered through the mode of interline settlement, then those activities constitute
67
149 SCRA 395 (1987).
doing business in the Philippines for which it could be held liable for income tax
liabilities as a resident foreign corporation under the Philippine Tax Code.68
Top-Weld Manufacturing, Inc. v. ECED, S.A.,69 summarized it well when it
held that:
68
Reiterated in Commissioner of Internal Revenue v. Japan Air Lines, Inc., 202 SCRA 450
(1991).
69
138 SCRA (1985).
70
256 SCRA 696, 75 SCAD 160 (1996).
corporation is engaged in business in the Philippines, since other circumstances
must be considered. Where a single act or transaction of a foreign corporation is
not merely incidental or casual but is of such character as distinctly to indicate a
purpose on the part of the foreign corporation to do other business in the state,
such act will be considered as constituting business.
71
267 SCRA 567, 76 SCAD 70 (1997).
72
Columbia Pictures, Inc. v. Court of Appeals, 261 SCRA 144, 73 SCAD 674 (1996).
73
Ibid.
74
Advanced Decisions Supreme Court, April 1955 Vol., p. 100-A.
instituted. On appeal, the Supreme Court held that the plaintiff was not doing
business in the Philippines under the contract, and there was no necessity for it
to obtain a license before it can maintain the suit.
In holding that the plaintiff foreign corporation was not doing business in
the Philippines by virtue of the contract covering copra to be processed and
delivered from the Philippines, the Supreme Court took cognizance of the fact
that the subject contract was entered into in the United States by the parties; that
payment of the price was to be made at San Francisco, California, through a
letter of credit to be opened at a bank thereat; and with respect to the delivery of
the copra, it was stipulated to be at "c.i.f., Pacific Coast" which meant that
delivery is to be made only at the port of destination since the seller (defendant)
obliged himself to take care of the freight until the goods have reached
destination. Thus, although it was found by the Supreme Court that the plaintiff
foreign corporation had also bought copra from other exporters in the Philippines,
it took note of the fact that those transactions were undertaken under similar
circumstances.
The Pacific Vegetable Oil doctrine does not consider the twin
characterization tests of Mentholatum of substance of the transactions pertaining
to the main business of the corporation and the continuity or intent to continue
such activities. It would seem that even if the twin characterization tests of
Mentholatum obtained in a case, under the Pacific Vegetable Oil doctrine, so
long as the perfection and consummation of a series of transactions are done
outside Philippine territorial jurisdiction, the same would not constitute doing
business in the Philippines, even if the products themselves should be
manufactured or processed in the Philippines by locals.
The implication of this doctrine is that if the salient points of a contract do
not find themselves in the Philippines, Philippine authorities have no business
subjecting the parties to local registration and licensing requirements.
The doctrine had a follow-up in Aetna Casualty & Surety Company v.
Pacific Star Line.75 In that case, a foreign insurance company, as subrogee of the
insured, instituted civil actions in the then court of first instance of Manila to
recover sums pertaining to damages on stolen cargo it insured, against local
companies which handled the goods. In their amended answers, the defendants
alleged that plaintiff is a foreign corporation not duly licensed to do business in
the Philippines and, therefore, without capacity to sue.
Upon stipulation of facts showing that plaintiff was not licensed to engage
in business in the Philippines, and that in fact it had filed thirteen (13) other civil
cases in the Philippines of similar nature, the trial court dismissed the complaint
ruling that although a foreign corporation may file a suit in the Philippines in
isolated cases, but where the plaintiff has been filing actions in the Philippines
not just in isolated instances, but in numerous cases and therefore has been
doing business in the country without obtaining a license.
75
80 SCRA 635 (1977).
On appeal, the Supreme Court held that the foreign insurance company
was not doing business in the Philippines, and therefore was not prohibited from
maintaining a suit in Philippine courts. The Court found that the contract of
insurance was entered into in New York; that payment was made to the
consignee in its New York branch and that since the corporation "was merely
collecting a claim assigned to it by the consignee, it is not barred from filing the
instant case although it has not secured a license to transact insurance business
in the Philippines."76
Subsequently, in Universal Shipping Lines, Inc. v. Intermediate Appellate
77
Court, it was held that a foreign insurance company may sue in Philippine
courts upon the marine insurance policies issued by it abroad to cover
international-bound cargoes shipped by a Philippine carrier, even if it has no
license to do business in the Philippines, "for it is not the lack of the prescribed
license (to do business in the Philippines) but doing business without such
license, which bars a foreign corporation from access to our courts." 78 The
Supreme Court considered the activities as not doing business in the Philippines.
The Rules and Regulations implementing the Omnibus Investments Code
of 1987,79 expressly included in the definition of "doing business" the "soliciting of
orders, purchases (sales) or service contracts." In fact, it provided that "Concrete
and specific solicitations by a foreign firm or by an agent of such foreign firm, not
acting independently of the foreign firm, amounting to negotiations or fixing of the
terms and conditions of sales or service contracts, regardless of where the
contracts are actually reduced to writing, shall constitute doing business even if
the enterprise has no office or fixed place of business in the Philippines." In
addition, the Rules and Regulations expressly provided that "The arrangements
agreed upon as to manner, time and terms of delivery of the goods or the
transfer of title thereto is immaterial." Effectively therefore, the Board of
Investments, by the implementing Rules and Regulations, had attempted to
override the Pacific Vegetable doctrine.
The Implementing Rules and Regulations to the Foreign Investment Act of
1991, while retaining "soliciting orders" as doing business in the Philippines has
dropped entirely the explicit provisions seeking to override the Pacific Vegetable
doctrine. However, its retaining "soliciting orders" as constituting doing business
in the Philippines indicates a bias against the Pacific Vegetable doctrine.
In addition, the Supreme Court in Communication Materials and Design,
Inc. v. Court of Appeals,80 has held that "[i]n determining whether a corporation
does business in the Philippines, or not, aside from their activities within the
forum, reference may be made to the contractual agreements entered into by it
with other entities in the country." It referred to the case of Top-Weld
76
Ibid, at p. 644.
77
188 SCRA 170 (1990)
78
Ibid, at p. 173.
79
Executive Order 226.
80
260 SCRA 673, 73 SCAD 374 (1996).
Manufacturing, Inc. v. ECED S.A.,81 where the highly restrictive terms in the
License and Technical Agreement and the Distributor Agreement with locals
became the basis of treating the foreign corporations as doing business in the
country; and to the case of Merill Lynch Futures, Inc. v Court of Appeals,82 where
the futures contract entered into by the foreign corporation with locals weighed
heavily in the Court's ruling finding it engaging in business in the Philippines.
The Court held that although Section 1(g) of the Implementing Rules and
Regulations of the Omnibus Investments Code lists among others the "soliciting
orders, purchases (sales) or service contracts, and the appointing of
representative or distributor who is domiciled in the Philippines," as constituting
81
138 SCRA 118 (1985).
82
211 SCRA 824 (1992).
83
261 SCRA 144, 73 SCAD 674 (1996).
doing business, the mere fact that foreign movie companies are copyright owners
or owners of exclusive distribution rights in the Philippines of motion pictures or
films did "not convert such ownership into an indicium of doing business which
would require them to obtain a license before they can sue upon a cause of
action in local courts, such as in this case seeking protection for the intellectual
properties."
The Court stressed that as a general rule, a foreign corporation will not be
regarded as doing business in the State simply because it enters into contracts
with residents of the State, where such contracts are consummated outside the
State. In fact, a view is taken that a foreign corporation is not doing business in
the State merely because sales of its products are made there or other business
furthering its interest is transacted there by an alleged agent, whether a
corporation or a natural person, whether such activities are not under the
direction and control of the foreign corporation but are engaged in by the alleged
agent as an independent business.
It is generally held that sales made to customers in the State by an
independent dealer who has purchased and obtained title from the corporation of
the products sold are not a doing of business by the corporation. Likewise, a
foreign corporation which sells its products to person styled "distributing agents"
in the State, for distribution by them, is not doing business in the State so as to
render it subject to service of process therein, where the contract with these
purchasers is that they shall buy exclusively from the foreign corporation such
goods as it manufactures and shall sell them at trade prices established by it."
As discussed hereunder, the contract test has also been applied as part of
the jurisprudential ruling subjecting the foreign corporation not doing business in
the Philippines to the jurisdiction of local courts on isolated contracts that have
been entered into or performed within Philippine territorial jurisdiction.84
84
Hyopsung Maritime Co., Ltd. v. Court of Appeals, 165 SCRA 258 (1988); Signetics
Corporation v. Court of Appeals, 225 SCRA 737, 44 SCAD 357 (1993).
85
278 SCRA 312 (1997).
86
Citing Moris Co. v. Scandinavia Ins. Co., 279 U.S. 405 (1929).
DOCTRINE ON ISOLATED TRANSACTIONS
The doctrine is that for isolated transactions, foreign corporation are not
required to obtain a license in order to obtain relief from local courts or agencies.
In one case,87 the Court held that the phrase "isolated transaction" has a
definite and fixed meaning, i.e., "a transaction or series of transactions set apart
from the common business of a foreign enterprise in the sense that there is no
intention to engage in a progressive pursuit of the purpose and object of the
business organization."
The Court held that it was never the intent of the legislature to bar court
access to a foreign corporation or entity which happens to obtain an isolated
order for business in the Philippines. "Neither, did it intend to shield debtors from
their legitimate liabilities or obligations. But it cannot allow foreign corporations or
entities which conduct regular business any access to courts without the
fulfillment by such corporation of the necessary requisites to be subjected to our
government's regulation and authority. By securing a license, the foreign entity
would be giving assurance that it will abide by the decisions of our courts, even if
adverse to it."88
In Eastboard Navigation, Ltd. v. Juan Ysmael and Co., Inc.,89 it was held
that when a foreign shipping company entered into a charter party arrangement
with a local company for a vessel to load cargo of scrap iron in the Philippines for
Buenos Aires, the transaction entered into in the Philippines was held not to
qualify it to be considered as being engaged in business, although on a previous
occasion its vessel was chartered by the National Rice and Corn Corporation to
carry rice cargo from abroad to the Philippines, since the two transactions were
not related. It was held therefore, that such foreign corporation had capacity to
sue in the Philippines even without a license.
In Antam Consolidated, Inc. v. Court of Appeals,90 the Supreme Court
sustained the lower court in not dismissing a complaint filed by a foreign
corporation on the basis of three contracts of purchase and sale of coconut oil
from local companies. The Court found that from the facts alone it could be
deduced that there was only one agreement between the petitioners and the
respondent and that was the delivery by the former of 500 long tons of crude
coconut oil to the latter, who in turn, must pay the corresponding price for the
same. The only reason why the respondent entered into the second and third
transactions with the petitioners was because it wanted to recover the loss it
sustained from the failure of the petitioners to deliver the crude coconut oil under
the first transaction and in order to give the latter a chance to make good on their
obligation. The Court discussed the policy behind the rule:
87
Ericks Pte. Ltd. v. Court of Appeals, 267 SCRA 567, 76 SCAD 70 (1997).
88
Ericks Pte. Ltd. v. Court of Appeals, 267 SCRA 567, 76 SCAD 70 (1997).
89
102 Phil. 1 (1957).
90
143 SCRA 288 (1986).
The doctrine of lack of capacity to sue based on failure to
first acquire a local license is based on consideration of sound
public policy. It was never intended to favor domestic
corporations who enter into solitary transactions with unwary
foreign firms and then repudiate their obligations simply
because the latter are not licensed to do business in this
country.91
91
Ibid, at p. 297.
92
8 Phil. 766 (1907).
93
25 SCRA 633 (1968).
94
41 SCRA 50 (1971).
95
130 SCRA 104 (1984).
96
142 SCRA 1 (1986).
97
180 SCRA 254 (1989).
98
201 SCRA 137 (1991).
99
201 SCRA 137 (1991).
100
Ibid, at p. 7145.
SPECIAL RULES PERTAINING TO ACTIONS ON
CORPORATE NAMES, TRADENAMES AND TRADEMARKS
Justice Moran rendered a dissenting opinion in Mentholatum that the
provisions of Section 69 of the Corporation Law do not apply to suits brought by
foreign corporations for infringement of trademarks and unfair competition, the
theory being that "the right to the use of the corporate name and trade name of a
foreign corporation is a property right, a right in rem, which it may assert and
protect in any of the courts of the world even in countries where it does not
personally transact any business," and that "trade mark does not acknowledge
any territorial boundaries but extends to every mark where the traders' goods
have become known and identified by the use of the mark."101
Although Western Equipment had previously held that the right to the use
of the corporate name and trade name of a foreign corporation is a property right,
a right in rem, which it may assert and protect in any of the courts of the world
even in countries where it does not personally transact any business, the same
ruling could not then apply in Mentholatum, since unlike in Western Equipment
where there was an expressed finding or stipulation that the foreign corporation
never engaged in business in the Philippines, in Mentholatum the foreign
corporation was found to have engaged in business in the Philippines without
obtaining the requisite license; therefore, by public policy expressed in Section
69 of the then Corporation Law, the Court declared In Mentholatum that it could
not sue in Philippine courts.
The remarks of Justice Moran in his dissenting opinion state only the
positive rule discussed in Western Equipment that when a foreign corporation
does not do business in the country, it needs no license to bring suit to enforce
its rights within the local courts. However, the remarks forget that the purpose of
then Section 69 of the Corporation Law was that when a foreign corporation
indeed does business in the Philippines without obtaining a license, there is a
public policy of prohibiting it from seeking any remedy from Philippine courts and
administrative bodies.
However, the matter as to trademarks and tradenames had become moot
with the adoption of Section 21-A102 of then Republic Act 166 (The Trademark
Law), which expressly provided that a foreign corporation, whether licensed to do
business or not in the Philippines, with a mark or tradename registered in the
Philippines, may bring an action before Philippine courts for infringement, unfair
competition, false designation of origin and false description, if the country of
101
at pp. 530-531.
102
Sec. 21-A states: "Any foreign corporation or juristic person to which a mark or
tradename has been registered or assigned under this Act may bring an action hereunder for
infringement, for unfair competition, or false designation of origin and false description, whether or
not it has been licensed to do business in the Philippines under Act numbered Fourteen Hundred
and Fifty-Nine, as amended, otherwise known as the Corporation Law, at the time it brings the
complaint; Provided, That the country of which the said foreign corporation or juristic person is a
citizen, or in which it is domiciled, by treaty, convention or law, grants a similar privilege to
corporate or juristic persons of the Philippines."
which the foreign corporation is a citizen, or in which it is domiciled, by treaty,
convention, or law, grants a similar privilege to corporations or juristic persons of
the Philippines.
In Leviton Industries v. Salvador103 the Supreme Court held that pursuant
to the terms of Section 21-A of Rep. Act 166, failure of a foreign corporation to
allege in its complaint two essential conditions, namely, that the trademark or
tradename has been registered with the Philippine Patent Office and that the
country of which the foreign corporation is a domiciliary grants similar privileges
to Philippine corporations, would be fatal to its cause of action and would subject
the complaint to dismissal.
Previously it was held in General Garments Corporation v. Director of
Patents,104 that when the action brought by a foreign corporation is not one under
Section 21-A, but rather under Section 17 of Rep. Act. 166 for the administrative
cancellation of the trademark which is alleged to have been infringed, then
registration of the trademark with the Philippine Patent Office would not be
necessary.
Subsequently, in La Chemise Lacoste, S.A. v. Fernandez, 105 it was held
that a foreign corporation not doing business in the Philippines, has personality to
commence criminal proceedings for violation of Article 189 of the Revised Penal
Code for unfair competition on the use of trademarks and tradenames, without
having to allege the qualifying circumstances under Section 21-A of Rep. Act
166. In that case, the Court also took judicial cognizance of the Philippine duties
and obligations under the Paris Convention for the Protection of Industrial
Property to assure the nationals of "countries of the Union" have an effective
protection against unfair competition in the same way that they are obliged to
similarly protect Filipino citizens and firms.
The current legislation is reflected in Converse Rubber Corporation v.
Universal Rubber Products, Inc.,106 which struck down the reasoning of the
Director of Patents when he concluded that a foreign corporation not licensed to
do business in the country is actually not doing business on its own in the
Philippines, and therefore has no name to protect in the forum. The Court held
that a foreign corporation has a right to maintain an action in the forum even if it
is not licensed to do business and is not actually doing business on its own
therein to protect its corporate and tradenames, since it is a property right in rem,
which it may assert to protect against all the world, in any of the courts of the
world—even in jurisdiction where it does not transact business—just the same as
it may protect its tangible property, real or personal, against trespass, or
conversion.107
103
114 SCRA 420 (1982).
104
41 SCRA 50 (1971).
105
129 SCRA 373 (1984).
106
147 SCRA 154 (1987).
107
Ibid, at pp. 164-165. This is a reiteration of the same doctrine held in Converse Rubber
Corporation v. Jacinto Rubber & Plastic Co., Inc., 97 SCRA 158 (1980) and Universal Rubber
Products, Inc. v. Court of Appeals., 130 SCRA 104 (1984). To the same effect were the rulings in
Converse Rubber Corporation recognized that such ruling is in
consonance with the Convention of the Union of Paris for the Protection of
Industrial Property to which the Philippines became a party on 27 September
1965. Article 8 thereof provides that "A trade name shall be protected in all the
countries of the Union without the obligation of filing or registration, whether or
not it forms part of the trademark."108 The mandate of the Convention finds its
implementation in Section 37 of Rep. Act 166.
Nevertheless, the Supreme Court has also held that when a foreign
corporation seeks to obtain the extraordinary writ of preliminary injunction against
a local company alleged to be using its tradename, the fact that it is not engaged
in business in the Philippines would show that the matter should be decided on
the merits and that in the meantime no preliminary injunction should be granted
since, not being engaged in business in the Philippines, no grave or irreparable
damage can be shown to be caused in the writ of injunction is not issued.109
In 1997, the Intellectual Property Code was promulgated to consolidate all
laws relating to intellectual properties. Section 160 of the Code, which effectively
replaced Section 21-A of The Trademark Law, provides that “Any foreign national
or judicial person who meets the requirements of Section 3110 of this Act and
does not engage in business in the Philippines may bring a civil or administrative
action hereunder for opposition, cancellation, infringement, unfair competition, or
false designation of origin and false description, whether or not it is licensed to do
business in the Philippine under existing laws.”
The wordings of Section 160 do not seem to comprehend the thrust of
Section 21-A of The Trademark Law, and the new qualification that such foreign
corporation must not be engaged in business in the Philippines contradicts the
provision that dispenses with the need to obtain a license to do business in the
Philippines to qualify a foreign corporation to seek remedy under the Code. It can
therefore be reasonably anticipated that the courts will eventually interpret
Section 160 of the Code to have the same meaning and application as Section
21-A of The Trademark Law, which would qualify any foreign corporation, even
when doing business in the Philippines without appropriate license, to be able to
obtain remedies and reliefs under the Code.
Puma Sportschuhfabriken Rudolf Dassler, K.G. v. Intermediate Appellate Court, 158 SCRA 233
(1988) and Philips Export B.V. v. Court of Appeals, 206 SCRA 457 (1992).
108
Ibid, at p. 165.
109
Philip Morris, Inc. v. Court of Appeals, 224 SCRA 576, 43 SCAD 400 (1993).
110
Section 3 provides: “. . .Any person who is a national or who is domiciled or has a real
and effective industrial establishment in a country which is a party to any convention, treaty or
agreement relating to intellectual property rights or the repression of unfair competition, to which
the Philippines is also a party, or extends reciprocal rights to nationals of the Philippines by law,
shall be entitled to benefits to the extent necessary to give effect to any provision of such
convention, treaty or reciprocal law, in addition to the rights to which any owner of an intellectual
property right is otherwise entitled by this Act.”
TRANSACTIONS AND CONTRACTS WITH
AGENTS, BROKERS AND INDENTORS
In Mentholatum, it was held that the sale of the products of a foreign
corporation through a local company was equivalent to the foreign corporation
doing business in the Philippines, because the actions of the agent in the
Philippines pertain to its foreign principal, and thereby without obtaining a license
in the Philippines, both the foreign corporation and the agent have no capacity to
sue in Philippine courts.
La Chemise Lacoste, S.A. v. Fernandez,111 clarified that not every sale to
an exclusive agent in the Philippines by a foreign corporation would constitute
the latter as doing business in the Philippines. It held that the principle in
Mentholatum is applicable only when it is found that the local company or
representative is selling the foreign company's products in the latter's name or for
the latter's account. In that case, the marketing of the products of the French
company in the Philippines "is done through an exclusive distributor, Rustan
Commercial Corporation. The latter is an independent entity which buys and then
markets not only products of the petitioner but also many other products bearing
equally well-known and established trademarks and tradenames. In other words,
Rustan is not a mere agent or conduit of the petitioner."112
In addition, the Court in La Chemise Lacoste took cognizance of "the rules
and regulations promulgated by the Board of Investments pursuant to its rule-
making power under Presidential Decree 1789, otherwise known as the Omnibus
Investment Code," which define "doing business" as one which excludes "a
foreign firm which does business through middlemen acting on their own names,
such as indentors, commercial brokers or commission merchants . . . Appointing
[of] a representative or distributor who is domiciled in the Philippines [who] has
an independent status, i.e., it transacts business in its name and for its account,
and not in the name or for the account of a principal."113
In Schmid & Oberly, Inc. v. RJL Martinez Fishing Corp.114 a local fishing
company, RJL Martinez Fishing Corp. filed an action against Schmid & Oberly,
Inc. to recover the purchase prices of twelve (12) generators it had bought on the
theory that Schmid was the vendor of the generators, as such vendor, was liable
under its warranty against hidden defects. The generators were ordered by RJL
Martinez Fishing Corp. from Schmid & Oberly who arranged to have them
imported from abroad from Nagata Co. of Japan. Schmid & Oberly, Inc. by way
of defense allege that being merely indentor in the sale between Nagata Co., the
exporter and RJL Martinez, the importer, it was not liable on the contract, much
less for warranty for hidden defects.
The Court took cognizance of the fact that under the Rules and
Regulations to Implement Pres. Decree 1789 (the Omnibus Investment Code),
111
129 SCRA 373 (1984).
112
Ibid, at p. 383.
113
Ibid, at pp. 383-384.
114
166 SCRA 493 (1988).
"indentors' are defined together with "commercial brokers" and "commission
merchants": "A foreign firm which does business through the middlemen acting in
their own names, such as indentors, commercial brokers or commission
merchants, shall not be deemed doing business in the Philippines. But such
indentors, commercial brokers or commission merchants shall be the ones
deemed to be doing business in the Philippines."
The Court therefore recognized that foreign corporations who sell their
products in the Philippines through commercial brokers, commercial merchants
or indentors, are not deemed to be doing business in the Philippines, and are not
required to obtain a license to do business in the country: "Thus, the chief feature
of a commercial broker and a commercial merchant is that in effecting a sale,
they are merely intermediaries or middlemen, and act in a certain sense as the
agent of both parties to the transaction. . . It would appear that there are three
parties to an indent transaction, namely, the buyer, the indentor, and the supplier
who is usually a non-resident manufacturer residing in the country where the
goods are to be bought. . . An indentor may therefore be best described as one
who, for compensation, acts as a middlemen in bringing about a purchase and
sale of goods between a foreign supplier and a local purchaser."115
From the reasoning in Schmid & Oberly it is clear therefore that the sales
in an indent contract is between the local purchaser and the foreign seller, and
the indentor merely is an agent for both. That would mean that, had it not been
for the provisions of the Implementing Rules and Regulations to the Omnibus
Investment Code, the foreign corporation is indeed doing business in the
Philippines, and for which it needs to obtain the license.
It is with curiosity to note therefore why such a foreign corporation would
not be considered being engaged in business in the Philippines for in such a
case an important part of the contract (delivery of the subject matter) takes part
within Philippine territory under the contract theory of Pacific Vegetable.
Likewise, such transactions conform to the twin characterization enunciated in
Mentholatum.
In fact, the Supreme Court turned down the contention in Schmid & Oberly
to hold the local indentor liable for the penal provisions of the then Section 69 of
the Corporation Law:
115
Ibid, at p. 502.
from the Rules implementing Republic Act No. 5455,
recognizes the distinct role of an indentor, such that when a
foreign corporation does business through such indentor, the
foreign corporation is not deemed doing business in the
Philippines.116
In other words, had it not been for the implementing rule provision, a
foreign corporation selling its products in the Philippines would be doing business
here for indeed the contract is strictly between the foreign exporter and the local
buyer, with the indentor merely acting as agent for both. The implementing rules
has therefore afforded foreign corporations the route of "circumvention by foreign
corporations of licensing requirements through the device of employing local
[indentors]." Indeed, this is the logic of Schmid & Oberly since it expressly found
the indentor not to be liable on the warranty on hidden defects since it was not
considered the seller of the products. What is not explained in Schmid & Oberly,
though, is how the Supreme Court could accept that an administrative rule and
regulation provision can override clear statutory requirements for foreign
corporations engaging in business in the Philippines from obtaining a license. It is
a settled principle in our jurisdiction, that rules and regulations issued by
administrative agencies cannot amend the law or go beyond the limits of the law
which they seek to implement.117
Further, it is to be noted that the present applicable Implementing Rules
and Regulations of the Foreign Investment Act of 1991 have totally dropped the
provisions exempting from the definition of doing business transactions by
foreign corporations done through indentors, commercial brokers or commission
merchants. However, the rules and regulations have retained the provision
excluding from "doing business" the appointing of a representative or distributor
domiciled in the Philippines which transact business in the representative's or
distributor's own name and account.
Both the La Chemise Lacoste and the Schmid & Oberly rulings overlooked
the fact that although the sales made by middlemen, distributors or
representatives "in their own name or for their own accounts" in the Philippines
do not pertain to the foreign principals abroad, nevertheless the purchase and
importation by such middlemen, distributors or representatives of such products
from abroad undeniably constitute a body of transactions in the Philippines of
which their foreign principals are direct parties.
And yet in Wang Laboratories, Inc. v. Mendoza,118 the Supreme Court
treated differently a foreign corporation being represented in the Philippines by a
independent distributor. In that case, although the foreign corporation Wang
Laboratories, Inc. had an exclusive distributor in the Philippines, and a local firm
had entered into direct contract with the local distributor, the Supreme Court
refused allow the motion to dismiss filed by the foreign corporation on the ground
116
Ibid, at p. 505.
117
U.S. v. Barrias, 11 Phil. 327 (1908); Young v. Rafferty, 33 Phil. 276 (1916); Olsen v.
Aldenese, 43 Phil. 64 (1922) ; Santos v. Estenzo, 109 Phil. 419 (1960),
118
156 SCRA 44 (1987).
that not doing business in the Philippines, the court below had not obtained
jurisdiction over the person of the foreign corporation, by serving summons on its
local exclusive distributor. In finding that Wang Laboratories, Inc. was doing
business in the Philippines, the court took into consideration the appointment of
the local distributor as indicated of doing business, and various advertisements
showing the local company to be the representative of the foreign corporation
and that admission in the reply to the opposition to the motion to dismiss by the
foreign corporation that "it deals exclusively with [the local company] in the sale
of its products in the Philippines,"119 clearly indicating that the sales and deliveries
by foreign corporation to its distributor in the Philippines constitutes doing
business, regardless of whether the distributor sells the same products to the
public for its own account.
The subsequent case of Granger Associates v. Microwave Systems,
120
Inc., which did not expressly overrule La Chemise Lacoste and Schmid &
Oberly, offer us further insight.
In that case, Granger Associates, an American corporation with no license
to do business in the Philippines, entered into a series of agreements with the
local company, Microwave Systems, Inc., principally constituting the local
company as the licensee to manufacture and sell the licensor's products in the
Philippines, together with a loan extended to the licensee. An action was latter
on brought by Granger Associates against the local company to collect sums not
paid on the agreements. The local company invoked Section 133 of the
Corporation Code to dismiss the complaint on the ground that Granger
Associates, having done business in the Philippines without obtaining a license,
has no authority to maintain the suit. Granger Associates argued that the various
transactions with the local company "were mere facets of the basic agreement
licensing MSI to manufacture and sell Granger's products in the Philippines [and]
[a]ll subsequent agreements were merely auxiliary to the first contract and should
not be considered separate transactions coming within the concept of `doing
business in the Philippines.'"121
Although the Court found that many agreements entered into dealt on
other matters as to constitute doing business, the Court went on to hold that
"[e]ven if it be assumed for the sake of argument that the subject matter of the
first contract is of the same kind as that of the subsequent agreements, that fact
alone would not necessarily signify that all such agreements are merely auxiliary
to the first. As long as it can be shown that the parties entered into a series of
agreements, as in successive sales of the foreign company's regular products,
that company shall be deemed as doing business in the Philippines."122
The Court also found that Granger Associates saw to it that it was assured
of at least one seat in the board of directors of the local company, "without
prejudice to the right of Granger to request additional seats as its interest may
119
Ibid, at p. 51.
120
189 SCRA 631 (1990).
121
Ibid, at p. 635.
122
Ibid, at p. 637. Emphasis supplied.
require." The fact that it was directly involved in the business of the local
company was also manifested in another stipulation where Granger Associates
"acknowledged and confirmed" the transfer of a block of stocks from one
shareholder to another group of investors. Such approval was considered by the
Court as not normally given except by a stockholder enjoying substantial
participation in the management of the business of the company.123
Although the rules and regulations of the Board of Investments provide
that mere investment in a local company by a foreign corporation should not be
construed as doing business in the Philippines, however the Court in Granger
Associates found that the investment of the foreign company was quite
substantial, "enabling it to participate in the actual management and control of
MSI [and] it appointed a representative in the board of directors to protect its
interest, and this director was so influential that, at his request, the regular board
meeting was converted into an annual stockholder's meeting to take advantage
of his presence."124
Noteworthy are the statements of the Court that "At any rate, the
administrative regulation, which is intended only to supplement the law, cannot
prevail against the law itself as the court has interpreted it. It is axiomatic that the
delegate, in exercising the power to promulgate implementing regulations, cannot
contradict the law from which the regulations derive their very existence. The
courts, for their part, interpret the administrative regulations in harmony with the
law that authorized them in the first place and avoid as much as possible any
construction that would annul them as an invalid exercise of legislative power."125
On the argument that a foreign corporation must be shown to have dealt
with the public in general to be considered as transacting business in the
Philippines, the Court held that "it is the performance by a foreign corporation of
the acts for which it was created, regardless of volume of business, that
determines whether a foreign corporation needs a license or not."126
Finally, Granger Associates reiterated the rationale of the doctrine:
123
Ibid, at p. 638.
124
Ibid, at p. 639.
125
Ibid, at pp. 639-640. Emphasis supplied.
126
Ibid, at p. 640, citing Tabios, Severino S., Fundamentals of Doing Business by a Foreign
Corporation in the Philippines, 142 SCRA 10.
condition to respect and be bound by Philippine law in proper
cases, as in the one at bar.127
127
Ibid, at p. 642.
128
Sec. 3(d), Rep. Act No. 7042.
129
15 SCRA 301 (1965).
130
Ibid, at p. 306.
131
266 SCRA 537, 78 SCAD 20 (1997).
the Philippines within the meaning of the Foreign Investments Act of 1991 an the
Rules and Regulations implementing the Omnibus Investment Code of 1987, 132
and the trial court did not acquire jurisdiction over the foreign corporation.
The Court found the following allegations in the complaint to be sufficient
to show that the foreign corporation was doing business in the Philippines
through its local representative: the local representative took orders for the cars
and transmitted them to the foreign company; that the foreign company upon
receipt of the orders, fixed the downpayment and pricing charges, notified the
local representative of the scheduled production month for the orders, and
reconfirmed the orders by signing and returning to him the acceptance sheets; all
documents and invoice being in the forms of the foreign company; payment was
made by the buyer directly to the foreign company; title to the cars purchased
passed directly to the buyer and the local representative never paid for the
purchase price of the cars sold in the Philippines, and merely received
commissions.
132
E.O. No. 226.
133
Replaced Section 14, Rule 14 of the Rules of Court.
134
266 SCRA 537, 78 SCAD 240 (1997).
1. Nexus of "Doing Business in the Philippines"
Perkins v. Dizon,135 had clearly discussed the general principle when it
held that "when the defendant is a non-resident and refuses to appear voluntarily,
the court cannot acquire jurisdiction over his person even if the summons be
served by publication, for he is beyond the reach of judicial process. No tribunal
established in one State can extend its process beyond its territory so as to
subject to its decisions either persons or property located in another State . . .
and a personal judgment upon constructive or substituted service against a non-
resident who does not appear is wholly invalid."136
The basic premise as it applies to foreign corporation is laid down in
Times, Inc. v. Reyes,137 that "a fundamental rule of international jurisdiction [is]
that no state can by its laws, and no court which is only a creature of the state,
can by its judgments or decrees, directly bind or affect property or persons
beyond the limits of that state."138
In addition, Times, Inc. held that a foreign corporation may, by writ of
prohibition, seek relief against the wrongful assumption of jurisdiction by a trial
court which refuses to dismiss an action filed against said foreign corporation
where no proper jurisdiction has been obtained. "And a foreign corporation
seeking a writ of prohibition against further maintenance of a suit, on the ground
of want of jurisdiction, is not bound by the ruling of the court in which the suit was
brought, on a motion to quash service of summons, that it has jurisdiction."139
In Pacific Micronisian Line, Inc. v. Del Rosario,140 the then Workmen's
Compensation Commission sought to obtain jurisdiction over the foreign
corporation, Pacific Micronisian Line, by service of summons to its agent in the
Philippines. The foreign corporation filed a special appearance with the
Commission for the sole purpose of asking the dismissal of the claim on the
ground that the Commission had no jurisdiction over it because it is a foreign
corporation not domiciled in this country, it is not licensed to engage and is not
engaging in business therein, has no office in the Philippines, and is not
represented by any agent authorized to receive summons or any other judicial
process in its name and behalf.
In construing the proper service of summons for a foreign corporation
under the old Section 14, Rule 14 of the Rules of Court, the Court held that "in
order that services may be effected in the manner above stated, said section also
requires that the foreign corporation be one which is doing business in the
Philippines. This is a sine qua non requirement. This fact must first be
established in order that summons can be made and jurisdiction acquired. This is
not only clear in the rule but is reflected in a recent decision of this Court. We
135
69 Phil. 186 (1939).
136
Ibid, at p. 189.
137
39 SCRA 303 (1971).
138
Ibid, at p. 313, citing Perkins v. Dizon, 69 Phil. 186 (1939); 14 Am Jur. 418.
139
Ibid, at p. 315.
140
96 Phil. 23 (1954).
there said that `as long as a foreign private corporation does or engages in
business in this jurisdiction, it should and will be amenable to process and the
jurisdiction of local courts.'"141
Pacific Micronisian therefore recognized the doctrine that the law of a
state cannot become operative upon a foreign corporation until it comes within
the state to "do business."142
In that case, the Court did not consider as doing business the act of the
foreign corporation which is exclusively engaged in the business of carrying
goods and passengers by sea between Guam and the Trust Territories of the
Pacific Islands, in having a local agent in the Philippines secure the services of
an individual to act as cook and chief steward in one of the vessels. It was noted
that the foreign corporation had never sent its ships to the Philippines, nor has it
transported nor even solicited the transportation of passengers and cargoes to
and from the Philippines, nor does it have properties or office in the Philippines.
Since the act was considered an isolated one, incidental, or casual, and "not of a
character to indicate a purpose to engage in business" within the meaning of the
rule, then it follows that the agent in the Philippines who recruited the individual
cannot be authorized to receive service of summons.
145
88 Phil. 125 (1951).
146
Ibid, at p. 134.
147
88 Phil. 741 (1951).
148
88 Phil. 750 (1951).
149
Ibid, at p. 753.
150
Ibid, at p. 746.
on the assumption that men holding such relationship "will be
prompt to protect their own interest, and diligent in the
discharged (sic) of their duties to those who have reposed
confidence in them."151
151
Ibid, at p. 746.
152
Ibid, at pp. 743-744, quoting 5 AM. JUR. p. 313, and citing Taylor v. Granite State
Provident Association, 136 N.Y. 343, 32 N.E. 9922, 32 American St. Rep. 749 and Moore v.
Freeman's National Bank, 92 N.C. 590).
153
28 Phil. 597 (1914).
154
The doctrine was reiterated in H.B. Zachry Company International v. Court of Appeals,
232 SCRA 329, 51 SCAD 207 (1994).
155
225 SCRA 737, 44 SCAD 357 (1993).
156
256 SCRA 696, 75 SCAD 160 (1996).
157
165 SCRA 258 (1988).
Lately, French Oil Mills Machinery Co., Inc. v. Court of Appeals,158 seems
to have declared the matter settled, thus:
When it is shown that a foreign corporation is doing
business in the Philippines, summons may be served on (a) its
resident agent designated in accordance with law; (b) if there
is no resident agent, the government official designated by law
to that effect; or (c) any of its officers or agent within the
Philippines. The mere allegation in the complaint that a local
company is the agent of the foreign corporation is not sufficient
to allow proper service to such alleged agent. Although there
is no requirement to first substantiate the allegation of agency,
yet it is necessary that there must be specific allegations in the
complaint that establishes the connection between the
principal foreign corporation and its alleged agent with respect
to the transaction in question. Nowhere in the case of
Signetics Corporation v. Court of Appeals, did the Court state
that if the “complaint alleges that defendant has an agent in
the Philippines, summons can validly be served thereto even
without prior evidence of the truth of such factual allegation; it
is only in the headnote of the reporter which is not part of the
decision.
160
87 Phil. 313 (1950).
161
Ibid, at p. 321.
162
Ibid, at p. 734, citing 17 FLETCHER CYC. OF CORPORATIONS, sec. 8470, pp. 572-573.
163
278 SCRA 312, 327 (1997).
164
89 SCRA 131 (1979).
cannot claim exemption from being sued in Philippine courts for acts done
against a person or persons in the Philippines."165
The logic is flawed because although the first part of the obiter is correct,
the second part did not necessarily flow as a logical consequent of the first part.
Although a foreign corporation not doing business in the Philippines is beyond
the jurisdiction of our courts, nevertheless by filing a complaint in our courts, it
voluntarily surrenders jurisdiction over its "person" to the courts. But the reverse
does not necessarily follow. Since a foreign corporation is not doing business in
the Philippines, short of voluntary surrender to local jurisdiction, there can be no
legal basis by which our local processes may be served upon such corporation to
allow local courts to have jurisdiction over its "person" as a party defendant in a
case. In addition, the minimum requirement of "presence" as a notion of due
process is not present in such a situation.
After all, it was already held previously by the Supreme Court in Philippine
Columbian Enterprises Co. v. Lantin,166 that "actions by foreign corporations are
governed by rules different from those in actions against them."167 In that case,
when the trial court refused to rule on a motion to dismiss a complaint filed by a
Japanese corporation on the ground that the ground relief upon (that the plaintiff
was doing business in the Philippines without a license) did not appear
indubitable, the defendants refused such deferment and to file an answer since
the filing of a counterclaim would be recognizing the legal capacity of the plaintiff
corporation which they are precisely questioning.
In setting aside such argument, the Court held that "A counterclaim
partakes of the nature of a complaint and/or cause of action against the plaintiff,
so that if the petitioners-defendants should file a counterclaim, the private
respondent-plaintiff . . . would be a defendant thereto, in which case the said
foreign corporation would not be maintaining a suit and, consequently, Section
69 of the Corporation Law would not apply." Clearly, therefore, the restrictive
effects of Section 69 (now section 133) on failure to obtain the necessary license
to do business have no application at all when a foreign corporation is sued as a
defendant in Philippine courts.
Fortunately, the pronouncements of Justice Makasiar in Facilities
Management were merely obiter since the facts showed that the foreign
corporation in that case was engaged in business in the Philippines without
obtaining a license by the appointment of a liaison officer in the Philippines to
recruit personnel. The Court took cognizance of the rules and regulations of the
Board of Investments implementing Rep. Act No. 5455 enumerating the
appointment of liaison officers in the Philippines as indicative of doing business in
the country.
165
Ibid, at p. 139.
166
39 SCRA 376 (1971).
167
Ibid, at p. 385.
Unfortunately, FBA Aircraft, S.A. v. Zosa,168 subsequently affirmed the
obiter in Facilities Management as its ratio decidendi in resolving the issue
raised. In that case, a complaint with prayer for issuance of a writ preliminary
attachment was filed against FBA Aircraft, Inc., a foreign corporation not
engaged in business in the Philippines. A writ of attachment was issued and
enforced against three aircrafts and engines in the Philippines. The complaint
was subsequently dismissed "for lack of jurisdiction over the persons of the
defendant and the writ of attachment dissolved." On the issue of whether a
foreign corporation can be sued in the Philippines on the basis of an isolated
transaction, the Supreme Court held on appeal, quoting from Facilities
Management, that "if a foreign corporation, not engaged in business in the
Philippines, is not barred from seeking redress from courts in the Philippines, a
fortiori, that same corporation cannot claim exemption from being sued in
Philippine courts for acts done against a person or persons in the Philippines." In
addition, the Court held that since the foreign corporation's properties have been
attached within the Philippines, extraterritorial service of summons clearly may
be effected under Rule 14, Section 17 of the Rules of Court.
The logical juxtaposition in Facilities Management cannot be the basis for
allowing suit against a foreign corporation not doing business in the Philippines,
for that would be a denial of due process. However, FBA Aircraft was correct in
its resolution since indeed a writ of attachment has been obtained in the
Philippines on properties of the foreign corporation, converting the action to one
in rem.
Later, in the case of Wang Laboratories, Inc. v. Mendoza,169 the Supreme
Court, relying upon the Facilities Management pronouncement, held in sweeping
terms that "the issue on the suability of foreign corporation whether or not doing
business in the Philippine has already been laid to rest. The Court has
categorically stated that although a foreign corporation is not doing business in
the Philippines, it may be sued for acts done against persons in the
Philippines."170 However, since the Court found in Wang Laboratories that the
defendant foreign corporation was indeed engaged in business in the Philippines
by having appointed an agent and installed its computer products in various
establishments in the Philippines, the pronouncement should be taken as obiter.
Recently in Royal Crown Internationale v. NLRC,171 the Court used the
Facilities Management obiter as though it were gospel truth. In that case, a
foreign corporation, through a local placement company, Royal Crown
Internationale, hired the services on a Filipino architectural draftsman for work in
Saudi Arabia. When the Filipino was terminated abroad, he brought a suit in the
Philippines against both the foreign corporation and the placement agency for
illegal termination. Service of summons upon the foreign corporation was served
168
110 SCRA 1 (1981).
169
156 SCRA 44 (1987).
170
Ibid, at pp. 52-53. Emphasis supplied.
171
178 SCRA 569 (1989).
by extra-territorial service under Section 17, Rule 14 of the Rules of Court. 172
From a judgment holding both the foreign corporation and the local placement
agency jointly and severally liable to the Filipino, a petition for certiorari was with
Supreme Court for nullification of such judgment on the ground, among others,
that it cannot be held liable solidarily with the foreign corporation since the NLRC
had not acquired jurisdiction over the latter through an extra-territorial service of
summons.
The Court held that "It is well-settled that service upon any agent of a
foreign corporation, whether or not engaged in business in the Philippines,
constitutes personal service upon that corporation, and accordingly, judgment
may be rendered against said foreign corporation,"173 citing Facilities
Management.
Therefore we have a situation where the doctrine that a foreign
corporation not doing business in the Philippines can be sued in Philippine courts
for an isolated contract entered into in the Philippines is found in three cases
(Facilities Management, FBA Aircraft and Wang Laboratories) where indeed the
doctrine was not at all essential for the Supreme Court to resolve the jurisdiction
over the foreign corporation since it was either truly engaged in business in the
Philippines or the action is an action in rem; and in one case (Royal Crown
Internationale) where the affected foreign corporation was not the one raising the
issue (for indeed it was not "present") but a co-defendant local company.
Lacking the nexus of "doing business" in the Philippines, and in the
absence of consent, a foreign corporation cannot be made a defendant in
Philippine courts in an action personam and judgment rendered against such
foreign corporation would be void.
176
Ibid, at pp. 263-264. Emphasis supplied.
177
190 SCRA 105 (1990).
account as principal. These circumstances, taken singly or in
combination, constitute “doing business in the Philippines”
within the contemplation of the law.178
178
Ibid, at p. 110.
179
225 SCRA 737, 44 SCAD 357 (1993).
180
96 Phil. 23 (1954).
corporation, although not engaged in business in the Philippines, may still look
up to our courts for relief; reciprocally, such corporation may likewise be `sued in
Philippine courts for acts done against a person or person in the Philippines."
The Court went on to say that Signetics right to question the jurisdiction of
the court over its person is now to be deemed a foreclosed matter since -
This was a curious proposition on the part of the Court, since by adopting
the Facilities Management doctrine, whether or not a foreign corporation is
engaged in business in the Philippines has now become legally irrelevant, and
the fact of not doing business in the Philippines is not a proper defense for a suit
brought in Philippine courts against a foreign corporation. The point that matters
with the full adoption of the Facilities Management doctrine is whether the
requirements of due process and fair play could be complied with against a
foreign corporation not doing business in the Philippines, i.e., whether the proper
process of obtaining jurisdiction over its "person" have been complied with.
This point at least was recognized in Signetics Corporation when the
Court went to stress that -
181
Ibid, at p. 746.
182
Ibid.
183
278 SCRA 312, 324, 86 SCAD 401, 412 (1997).
In the alternative, private respondents submits that
foreign corporation not doing business in the Philippines are
not exempt from suits leveled against them in courts, citing the
case of Facilities Management Corporation vs. Leonardo Dela
Osa, et al.,. . . We are not persuaded by the position taken by
the private respondent. In Facilities Management case, the
principal issue presented was whether the petitioner had been
doing business in the Philippines, so that service of summons
upon its agent as under Section 14, Rule 14 of the Rules of
Court can be made in order that the Court of First Instance
could assume jurisdiction over it. The Court ruled that the
petitioner was doing business in the Philippines, and that by
serving summons upon its resident agent, the trial court had
effectively acquired jurisdiction. In that case, the court made
no prescription as the absolute suability of foreign corporations
not doing business in the country, but merely discounts the
absolute exemption of such foreign corporations from liabilities
particularly arising from acts done against a person or persons
in the Philippines.
187
Ibid.
188
Ibid, at p. 528.
189
Ibid.
190
12 Phil. 414 (1909).
191
Ibid, at p. 419.
192
46 Phil. 70, 76 (1924).
193
65 Phil. 385 (1938).
194
17 SCRA 1037 (1966).
claims on a local insured company for losses sustained on cargoes handled by
the defendant. The trial court, on motion, dismissed the complaint for failing to
state that the plaintiffs were duly licensed foreign corporation to transact
business in the Philippines. On appeal, the plaintiffs contended that the
requirement for allegation of licensed being obtained is required only if the
plaintiff foreign corporation is engaged in business in the Philippines; but that if a
foreign corporation is not doing business in the Philippines, it is not barred from
seeking redress in Philippine courts in proper cases, as when it sues on an
isolated transaction.
However, although the Supreme Court sustained the principle upon which
the plaintiffs appealed the dismissal, it nevertheless upheld the dismissal since
the complaint filed with the lower court only alleged that the plaintiffs are foreign
corporation, without further indicating that they are exempt from the requisite of a
license because they are not engaged in business in the Philippines:
Atlantic Mutual went on to say that where the law denies to a foreign
corporation the right to maintain suit unless it has previously complied with a
certain requirement, then such compliance, or the fact that the suing corporation
is exempt therefrom, becomes a necessary averment of the complaint. "These
are matters peculiarly within the knowledge of appellants alone, and it would be
unfair to impose upon appellee the burden of asserting and proving the contrary.
It is enough that foreign corporations are allowed by law to seek redress in our
courts under certain conditions: the interpretation of the law should not go so far
as to include, in effect, an inference that those conditions have been met from
the mere fact that the party suing is a foreign corporation."196
Commissioner of Customs v. K.M.K. Gani,197 held that "[t]he fact that a
foreign corporation is not doing business in the Philippines must be disclosed if it
195
Ibid, at p. 1040.
196
Ibid, at p. 1041.
197
182 SCRA 591 (1990).
desires to sue in Philippine courts under the `isolated transactions rule.' Without
this disclosure, the court may choose to deny it the right to sue." 198 In addition, it
stated that the "isolated transaction rule" applies only to foreign corporations, and
not a foreign partnership or a foreign "firm".
In any event, Rule 8, Section 4, of the 1997 Rules of Civil Procedure now
require that in case of foreign corporations, "facts showing the capacity of a party
to sue or be sued . . . must be averred."
New York Marine Managers, Inc. v. Court of Appeals,199 found occasion to
reiterate the rule. The Court therein found the complaint filed by the foreign
corporation to be fatally defective for failing to allege its duly authorized
representative or resident agent in [Philippine] jurisdiction. It ruled that the
signature of its counsel on the pleading was not enough: "The pleadings filed by
counsel . . . do not suffice. True, a lawyer is generally presumed to be properly
authorized to represent any cause in which he appears . . . But the presumption
is disputable. Where said authority has been challenged or attacked by the
adverse party the lawyer is required to show proof of such authority or
representation in order to bind his client. The requirement of the production of
authority is essential because the client will be bound by his acquiescence
resulting from his knowledge that he was being represented by said attorney." 200
IN SUMMARY
From all the foregoing, we can therefore summarize the current state of
the Philippines doctrine of "doing business" as it applies to foreign corporations:
1. Coverage
"Doing business" in the Philippines covers transactions or series of
transactions that have the twin-characterization of: (a) in pursuit of the main
business goals of the corporation; and (b) done with intent to continue the same
198
Ibid, at p. 596.
199
249 SCRA 416 (1995). "The issue on whether a foreign corporation can seek the aid of
Philippine courts for relief recoils to the basic question of whether it is doing business in the
Philippines or has merely entered into an isolated transaction. This Court has held in a long line
of cases that a foreign corporation not engaged in business in the Philippines may exercise the
right to file an action in Philippine courts for an isolated transaction. However . . . to say merely
that a foreign corporation to doing business in the Philippines does not need a license in order to
sue in our courts does not completely resolve the issue. When the allegation in the complaint
have a bearing on the plaintiff's capacity to sue and merely sate that the plaintiff is a foreign
corporation existing under the laws of the United States, such averment conjures two alternative
possibilities: either the corporation is engaged in business in the Philippines, or it is not so
engaged. In the first, the corporation must have been duly licensed in order to maintain the suit; in
the second, the transaction sued upon is singular and isolated, no such license is required. In
either case . . . [it] cannot be inferred from the mere fact that the party suing is a foreign
corporation. The qualifying circumstance being an essential part of the plaintiff's capacity to sue
must be affirmatively pleaded . . . Failing in this requirement, the complaint filed by the [foreign
corporation] with the trial court, it must be said, fails to show its legal capacity to sue." Ibid.
200
Ibid. Same ruling in Hahn v. Court of Appeals, 266 SCRA 537, 78 SCAD 240 (1997).
in the Philippines; and in fact a single transaction showing such twin
characterization would qualify as doing business.
Except that there is an isolated body of jurisprudence that holds that even
when such twin characterization is present in a series of transaction, when the
main features of the contract, of perfection or execution, payment and effects of
delivery are outside Philippine territorial jurisdiction, the same would not
constitute doing business in the Philippines.
However, the implementing rules of the BOI has tended to overcome such
an isolated transaction doctrine by including in the definition of "doing business"
the soliciting of orders in the Philippines.
3. Consequences
The consequences of failure of a foreign corporation to obtain a license
when it conducts business in the Philippines would be:
201
Home Insurance Company v. Eastern Shipping Lines, 123 SCRA 424, 435 (1983).
202
Ibid, at p. 435.
203
Northwest Orient Airlines v. Court of Appeals, 241 SCRA 192, 58 SCAD 797 (1995).
204
State Investment House, Inc. v. Citibank, N.A., 203 SCRA 9 (1991); Northwest Orient
Airlines v. Court of Appeals, 241 SCRA 192, 58 SCAD 197 (1995).
another; its legal domicile is the state of its creations presents no impediment to
its residence in a real and practical sense in the state of its business activities. 205
Under our jurisprudence, pending extraterritorial service of summons to a
foreign corporation, an attachment of a foreign corporation's properties in the
Philippines may be maintained.206
RESIDENT AGENT
A resident agent may be either an individual residing in the Philippines,
must be of good moral character and of sound financial standing, or a domestic
corporation lawfully transacting business in the Philippines.207
The SEC shall require as a condition precedent to the issuance of the
license that the foreign corporation file a written power of attorney designating
some person who must be resident of the Philippines, on whom any summons
and other legal processes may be served in all actions or other legal proceedings
against such corporation, and consenting that service upon such resident agent
shall be admitted and held as valid as if served upon the duly authorized officers
of the foreign corporation at its home.208
Whenever such service of summons or other process is made upon the
SEC, it must, within ten (10) days thereafter, transmit by mail a copy of such
summons or other legal process to the corporation at its home or principal office.
The sending of such copy by the SEC is a necessary part of and shall complete
such service. All expenses incurred by the SEC for such service shall be paid in
advance by the party as whose instance the service is made. In case of a change
of address of the resident agent, it shall be his or its duty to immediately notify in
writing the SEC.209
205
Ibid.
206
FBA Aircraft v. Zosa, 110 SCRA 1 (1981).
207
Sec. 127, Corporation Code.
208
The specific wordings required under Sec. 128 reads: "The (name of foreign corporation)
does hereby stipulate and agree, in consideration of its being granted by the Securities and
Exchange Commission a license to transact business in the Philippines, that if at any time said
corporation shall cease to transact business in the Philippines, or shall be without any resident
agent in the Philippines, or shall be without any resident agent in the Philippines on whom any
summons or other legal processes may be served, then in any action or proceeding arising out of
any business or transaction which occurred in the Philippines, service of any summons or legal
process may be made upon the Securities and Exchange Commission and that such service shall
have the same force and effect as if made upon the duly-authorized officers of the corporation at
its home office."
209
Sec. 128, Corporation Code.
the same class, save and except such only provide for the creation, formation,
organization or dissolution of corporations or such as fix the relations, liabilities,
responsibilities, or duties of stockholders, members, or officers of corporations to
each other or to the corporation.210
An illustration of this principle can be found in Grey v. Insular Lumber
Co.211 In that case, the foreign corporation doing business in the Philippines was
organized under the laws of New York. According to the then Stock Corporation
Law of New York, only stockholders owning at least 3% of the shares of the
corporation may inspect the books and records of the corporation. Plaintiff Grey
held less than 3% of defendant corporation stockholdings. Grey invoked the
provision of Philippine laws which allowed stockholders owning less than 3% of
shares to inspect books and records of a corporation. The Supreme Court held
that intramural matters such as the qualification to inspect corporate records are
governed by the laws where the corporation was incorporated.
215
Ibid.
216
Sec. 134, Corporation Code.
Upon the revocation of any such license to transact business in the
Philippines, the SEC shall issue a corresponding certificate of revocation,
furnishing a copy thereof to the appropriate government agency in the proper
cases. The SEC shall also mail to the corporation at its registered office in the
Philippines a notice of such revocation accompanied by a copy of the certificate
of revocation.217
——oOo——
217
Sec. 135, Corporation Code.
218
Sec. 136, Corporation Code.
CHAPTER 19
——
1
Sec. 143, Corporation Code.
(a) Registration and stamping of the stock and transfer book or
the membership book, within thirty (30) days from the date of
the issuance of the certificate of incorporation;
(b) Filing of the General Information Sheet within thirty (30) days
from the date of actual meeting of the stockholders or
membership meeting;
(c) The filing of two (2) copies of the financial statements duly
stamped "received" by the Bureau of Internal Revenue
(BIR), within 105 days after the end of the fiscal year as
specified in the by-laws;
(d) The filing of an Affidavit of Non-Operation or Board
Resolution or Affidavit of Cessation of Business Operations,
within one-hundred-five (105) days after the end of the fiscal
year as specified in the by-laws for corporations that have
ceased operations and no longer prepare financial
statements;
(e) Filing of the notice of postponement of annual meeting, at
least ten (10) days before the date of the annual meeting as
specified in the by-laws, in case the meeting cannot be held
as provided; and
(f) Filing of the Affidavit of Non-Holding of Annual Meeting,
together with the General Information Sheet, within thirty
(30) days before the date of the annual meeting as specified
in the by-laws in case of non-holding of the annual meeting.
2
Sec. 142, Corporation Code.
applicable to them, supplemented by the provisions of the Corporation Code,
insofar as they are applicable.3
3
Sec. 147, Corporation Code.
4
Sec. 148, Corporation Code.
5
Ibid.
6
301 SCRA 342, 102 SCAD 285 (1999).
laws or parts thereof inconsistent with any provision of this Code shall be
deemed repealed."
Since the Corporation Code is meant to cover the whole body of law on
Corporate Law, despite the implied repeal provisions of Section 146 thereof, the
old Corporation Law is deemed repealed in toto.
Also, the explanatory note to then Cabinet Bill No. 3 which became the
basis for the Code states that the "bill is intended to supplant the present
Corporation Law, Act No. 1459."
Certain provisions of the old Corporation Law are still quite instructive,
such as the definitional differences between public corporations and private
corporations.
7
This section was first published with the title "The Penal Provision Under Sec. 144 of the
Corporation Code," with THE LAWYERS REVIEW, Vol. X, No. 2, 29 February 1996.
the actuations and decisions of the directors, trustees, and corporate officers, as
to necessarily cramp the exercise of their business judgment.
Lately, practitioners have began to look at the seemingly all-
encompassing provisions of Section 144 to effectively obtain results on their
demands or claims against the corporation, by dangling a threat of criminal suit
against corporate directors and officers.
8
U.S. v. Taylor, 28 Phil. 599, 604 (1914).
9
Ibid.
10
U.S. v. Abad Santos, 36 Phil. 243 (1917); People v. Yu Hai, 99 Phil. 725 (1956); People
v. Terrado, 125 SCRA 648 (1983).
11
People v. Gatchalian, 104 Phil. 664 (1958).
12
People v. Padilla and Von Arend, 71 Phil. 261 (1941).
13
People v. Abuyen, 52 Phil. 722, 726 (1929).
14
Ibid.
2. Elements of the Criminal Offense Under Section 144
Looking at the language of Section 144, one can see that it seems all-
encompassive in nature as it imposes criminal liability for "Violations of any of the
provisions of this Code or its amendments not otherwise specifically penalized
therein." This is further bolstered by the fact that in addition, Section 144 does
not mean to cover other provisions of the Corporation Code which provides for
specific penalties (as Section 74 on violation of the right of inspection as
discussed hereunder) because is uses the phrase "not otherwise specifically
penalized therein."
It is difficult to construe Section 144 to mean that all non-compliance with
the provisions of the Corporation Code would be criminally punishable. For
example, under Section 26 of the Corporation Code, it is provided that within
thirty (30) days after the election of the directors, trustees and officers of the
corporation, the secretary, or any other officer of the corporation, shall submit to
the SEC, the names, nationalities and residences of the directors, trustees and
officers elected. If a corporate secretary fails to comply with this provision, would
he then be subject to a criminal penalty under Section 144?
Such a construction would seem too harsh, and effectively discourages
competent and well-meaning individuals from accepting positions within the
corporate setting. It would then make the corporation a very unattractive medium
for commerce.
15
BLACK'S LAW DICTIONARY, 5th Ed.
16
W ORLD BOOK DICTIONARY, 1983 Ed., Doubleday & Company, Inc. Chicago Illinois.
There are other provisions in the Corporation Code where it would seem
clear that civil sanction for damages is imposed rather than the criminal sanction
under Section 144 thereof. Under Section 31 thereof, a director or trustee who
willfully and knowingly votes for or assents to patently unlawful acts of the
corporation or who are guilty of gross negligence or bad faith in directing the
affairs of the corporation or acquire any personal or pecuniary interest in conflict
with their duty as such directors or trustees shall be liable jointly and severally for
all damages resulting therefrom suffered by the corporation, its stockholders or
members and other persons. Under Section 32, where a director, by virtue of his
office, acquires for himself a business opportunity which should belong to the
corporation, thereby obtaining profits to the prejudice of such corporation, he
must account to the corporation for all such profits by refunding the same.
Under Section 65, 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.
In all the foregoing instances, it would not be proper to subject erring
directors, trustees, or corporate officers to criminal penalty under Section 144
since the specific provisions themselves provide for the proper remedies in each
case. This is the proper and reasonable interpretation of the phrase in Section
144 "not otherwise specifically penalized therein" to mean that even when the
provisions seems to be mandatory and the violation thereof is a serious breach,
when the particular provision already provides for a specific penalty or sanction,
the penal sanction under Section 144 should not be made to apply.
There is a specific provision of the Corporation Code where the
Legislature has made it clear or apparent that it seeks to impose the penal
sanctions under Section 144 for non-compliance therewith. Under Section 74,
any officer or agent of the corporation who shall refuse to allow any director,
trustee, stockholder or member of the corporation to examine or copy excerpts
from its records and minutes, in accordance with the provisions of this Code
"shall be liable to such director, trustee, stockholder or member for damages, and
in addition, shall be guilty of an offense which shall be punishable under Section
144 of this Code."
Section 74 of the Corporation Code is therefore a clear example of the
intent of Legislature that when it seeks to impose the criminal sanction under
Section 144 for violation of the provision of the Code, then it uses clear words to
so indicate.
At present, only Section 74 of the Corporation Code refers to Section 144,
so that effectively only violation of the right of inspection under Section 74 are
criminally punishable under Section 144.
In effect, the broad coverage of Section 144 is meaningless since it is
applicable only to Section 74 of the Code. If that is the legal effect, then it could
be argued that Legislature, when it enacted Section 144 of part of the
Corporation Code, had not intended it to be a practically useless provision since
the penal sanctions provided therein could have effectively been stated in
Section 74 if it is indeed the only violation applicable to said provision. However,
such a position fails to consider that indeed Section 144 was meant to be the
over-all penal sanction under the Code, if and when Legislature deems it
appropriate to impose a penal sanction for violation thereof not only based on the
current provisions of the Code, but also "its amendments" in the future.
It should also be noted that although a penal provision like Section 144 is
usual in special laws, nevertheless, the implementation dura lex, sed lex of such
penal provisions under most special laws is without controversy because the
subject thereof is limited and the acts covered therein are clearly defined. Such
position cannot be equated to Section 144, since the Corporation Code, indeed is
a "code" that necessary covers a broad subject and almost innumerable acts.
The Court held that although the section uses the word "shall" the
provision on dissolution should be interpreted to mean "may". It held another way
to put the same conclusion is to say that the expression "shall be dissolved by
quo warranto proceedings" means in effect, "may be dissolved by quo warranto
proceedings in the discretion of the court." The Court also held that "[t]he
proposition that the word `shall' may be construed as `may', when addressed by
the Legislature to the courts is well supported in jurisprudence."20
Nevertheless, El Hogar declared the section invalid for lack of adequate
title to the Act. Subsequently, the Philippine Legislature re-enacted substantially
17
SALONGA, PHILIPPINE LAW ON PRIVATE CORPORATIONS, p. 629 (1968 Ed.).
18
Act No. 1459.
19
50 Phil. 399 (1927).
20
Ibid, at p. 414, citing Becker v. Lebanon and M. St. Ry. Co., 188 Pa., 484.
the same penal provision in section 21 of Act No. 3518, under a title sufficiently
broad to comprehend the subject matter.
Harden v. Benguet Consolidated Mining Co,21 held that violation of the
provisions of the old Corporation Law prohibiting one mining corporation from
acquiring interest in another was held not to permit repudiation of the contract for
such interest, though it might subject the corporation to quo warranto or criminal
proceedings. What is important is the ruling in Harden is the pronouncement of
the Court that Section 190 "was adopted by the lawmakers with a sole view to
the public policy that should control in the granting of mining rights. Furthermore,
the penalties imposed in what is now section 190(A) of the Corporation Law for
the violation of the prohibition in question are of such nature that they can be
enforced only by a criminal prosecution or by an action of quo warranto. But
these proceedings can be maintained only by the Attorney-General in
representation of the Government."22
The implication in Harden is that, as dissolution of a corporation is a
matter addressed to the courts, and can be commenced only by the State,
through the Solicitor General, when enforcing a public policy, as distinguished
from answering a private wrong; so also criminal prosecutions under Section
144, as a derivative from the old Section 190 of the Corporation Law, can be
proceeded by the State only for violations of the provisions of the Corporation
Code that go into prohibitory provisions of the Code covering fundamental public
policy, and can only be commenced by the Solicitor General, and now the SEC,
in representation of the Government, and not upon the complaint of any ordinary
citizen.
5. Contrary View
It should be noted, however, that Guevarra, in his treatise on the old
Corporation Law23 took the contrary position that the Law "provides special
penalties for violations of some provisions of the Corporation Law and also a
general penalty for violations not specifically penalized therein."24
We must also take note of the obiter expressed in Home Insurance
Company v. Eastern Shipping Lines.25 In that case, Home Insurance Company, a
foreign corporation, which admittedly had engaged in business in the Philippines,
had issued insurance contracts in the Philippines without obtaining the necessary
license. Subsequently, it obtained the license before filing the cases for collection
under the insurance contracts. The lower court dismissed the complaint and
declared that pursuant to its understanding of the basic public policy reflected in
the Corporation Law, the insurance contracts executed before a license was
21
58 Phil. 141 (1933).
22
Ibid, at p. 149; emphasis supplied.
23
GUEVARRA, CORPORATION LAW (Phil. Jur. Series I), 1978 Ed., U.P. Law Center.
24
Ibid, at p. 250.
25
123 SCRA 424 (1983).
secured must be held null and void, and the subsequent procurement of the
license did not validate the contracts.
The Supreme Court, although it recognized there were conflicting schools
of thought both here and abroad which are divided on whether such contracts are
void or merely voidable, took its cue from the doctrine laid down in Marshall-
Wells Co. v. Elser,26 that the doctrine of then Section 69 of the old Corporation
Law "was to subject the foreign corporation doing business in the Philippines to
the jurisdiction of our courts . . . and not to prevent the foreign corporation from
performing single acts, but to prevents it from acquiring domicile for the purpose
of business without taking the necessary steps to render it amenable to suit in
the local courts."
However, although the issue of criminal sanction was not at issue, Justice
Gutierrez in Home Insurance held that Section 133 of the present Corporation
Code, which unlike its counterpart Section 69 of the Corporation Law provided
specifically for penal sanctions for foreign corporations engaging in business in
the Philippines without obtaining the requisite license, should be deemed to have
a penal sanction by virtue of Section 144 of the Corporation Code, thus:
Home Insurance in dealing with the scope and reach of Section 144, has
not only expressed an obiter, but more importantly has not looked into the
implications of such broad pronouncements on the basis of Criminal Law
principles, since such principles have not been raised, discussed nor focused
into appropriately in the rendering of the decision. When the appropriate case is
brought to the Supreme Court, and the proper factual basis and principles of
Criminal Law are discussed and detailed before the Court, we believe that the
Court will take a contrary position on ratio decidendi considerations. After all, it
26
46 Phil. 70 (1924).
27
Ibid, at pp. 438-439. Emphasis supplied.
was in Home Insurance where the Court itself expressed the position that "[t]he
Corporation Law must be given a reasonable, not an unduly harsh, interpretation
which does not hamper the development of trade relations." 28 Otherwise, Section
144, hangs like a damocles sword ready to chop off the neck of corporate
directors, trustees, and officers.
—oOo—
CORP. MANUSCRIPT\19-MISECLLANYCORPMAN.DIR\8-02-2002
CHAPTER 20
——
Philippine Corporate Law therefore must function and evolve within such
milieu.
6
Harden v. Benguet Consolidated Mining Co., 58 Phil. 141 1933, referred to the original
Corporation Law (Act No. 1459) "a sort of codification of American corporate law."
7
U.S. v. Cuna, 12 Phil. 241 (1908), held that "Neither English nor American common law is
in force in these island; nor are the doctrines derived therefrom binding upon our courts, save
only insofar as they are founded on sound principles applicable to local conditions, and are not in
conflict with existing law." (at p. 244)
8
96 Phil. 577 (1955)
9
27 Phil. 401 (1914).
10
Fua Cun v. Summers, 44 Phil. 704 (1923), demonstrate clearly the applicability of
common law doctrines even in the absence of statutory recognition. At the time of Fua Cun is was
not yet generally recognized that a valid mortgage could be constituted over shares of stock in a
corporation. The Court held "At common law a corporation has no lien upon the shares of
stockholders for any indebtedness to the corporation . . . and our attention has not been called to
any statute creating such a lien here." It would even seem from Fua Cun that common law
principles prevail in such common law subjects such as Corporate Law, unless suppressed by
statutory denials.
It would be wrong for a Filipino jurist or legal practitioner to go to either
extreme, and to treat the Corporation Code as though it were either purely a
code in the civil law sense, or a purely common law product. The underlying
philosophy governing corporations, and its legal consequences within the hybrid
legal system, have been evaluated in the various chapters of this book. Hopefully
such a study would contribute to a better understanding of the basic
characteristics of the Philippine hybrid legal system.11
11
The author has previously published in the Philippine Law Journal an article dealing on
the theory of judicial precedents under the Philippine hybrid legal system: Comparative Study of
the Judicial Role and Its Effect on the Theory on Judicial Precedents in the Philippine Hybrid
Legal System, 65 PHIL. L. J. Vols. 1 & 2.
12
See JOHN HENRY MERRYMAN, THE CIVIL LAW TRADITION 26-27 (1985).
13
GLENDON, GORDON & OSAKWE, COMPARATIVE LEGAL TRADITIONS 126-128 (1982).
14
"This more or less tracks the method of exegesis where the judge is merely to apply the
text of the law as the conscious will of the legislator, or, where the text is obscure, to discover the
legislative intent, the legislative history of the text and the accepted doctrine at the time when the
law was adopted were first to be examined. If this research failed to reveal the legislative intent,
the judge is to find a solution by the application of logical processes to the written text, namely,
reasoning by analogy, reasoning a contrario, and, most important, reasoning by induction to find
the general rules, and by deduction, to apply the general rules to a particular case." Arthur von
Mehren, Book Review, 63 HARV. L. REV. 370, 371 (1949).
of the code purporting to embody a common law doctrine or rule will be
construed in the light of common law decisions on the same subject." 15 A fortiori,
where the code remains silent, it does not affect existing common law at all. 16
It has been observed that even in the United States, where the legal
system has been more innovative and flexible than in England, no matter how
numerous and important statutes have become, they are viewed with some
discomfort, because they are not the normal expression of legal rule. Statutory
rules are only truly assimilated into the American legal system once they have
been judicially interpreted and applied, and it is then possible to refer to the court
decisions applying them rather than to the legislative text themselves. "Enacted
law and regulations are traditionally thought of as complement or rectifications to
a pre-existing body of law—the Common law in stricto sensu."17
Nevertheless, the important differences still recognized to exist between
the two legal traditions are as follows:18 (a) In the civil law system, authoritative
starting points for legal reasoning normally take the form of legislation; while in
the common law system, reliance is largely on judicial decisions; and (b) in the
civil law system legal propositions are stated more abstractly and systematically
than in the common law system; the former also generally places greater value
than does the latter on coherence, structure, and high-level generalization.19
These distinctions result from the belief under the civil law tradition that
the sources of the law are primarily statutory, a belief however that is said to be
on the wane.20
If the Philippine were a purely civil law jurisdiction, then the philosophy
applicable to Philippine Corporate Law would be the general rule that law is a
"rule of conduct intimately linked to ideas of justice and morality;" and that the
task of formulating the law would pertain to a legal scholar who would be
absorbed more by the theoretical aspect and be less interested in their actual
administration and practical application.21
15
Ibid.
16
Ibid; see also DAVID, MAJOR LEGAL SYSTEMS IN THE W ORLD TODAY (1985) at p. 450.
17
DAVID, supra note, at p. 407-408.
18
VON MEHREN, LAW IN THE UNITED STATES, at p. 3. A third distinction is included in Prof. Von
Mehren's work: In the civil law system Roman influence was various and profound; while common
law system was little influenced by Roman law.
19
Although the "starting point" distinction is important, it is not by itself satisfactory, since it
does not tell us if from distinct starting points, the modes of legal reasoning traject to basically the
same resolution of achieving justice for the same legal problem. Both civil law and common law
systems, in their respective modes of legal reasonings, seek to achieve resulting justice in their
processes; nevertheless, the process that each employs varies, and, consequently, so may the
qualities of the results. The main distinctions between the legal minds in both systems are the
ideology and the legal attitude in the sources of the law and the limits pressed upon the use of
such sources.
20
Merryman points that the present civil law system recognizes three sources of law,
namely, statutes, regulations, and customs, with the listing traditionally thought to be exclusive
and arranged in the descending order of authority, and customs thought only to fill statutory gaps.
MERRYMAN, CIVIL LAW TRADITION, supra, at 22-23.
21
DAVID, supra, at 22.
On the other hand, if we were to isolate and compartmentalize Philippine
Corporate Law as being wholly governed by the common law system, then the
Corporation Code and other companion statutes could be looked upon as a set
of legal rules meant to provide solutions to trials, rather than as a code of general
rules of conduct for the future. The Code would then be much less abstract than
the legal rules in civil law system.
However, in a hybrid legal system, the solution is not so simple. When a
legal system is installed in a given state, it tends to permeate the entirety of the
legal system. This results from the fact that the same legal actors act in most
branches of the law, be they private or public laws. In most national legal
systems, there may be a dominating set of legal traditions that is continually
influenced by legal developments from other jurisdictions. Even as the "foreign"
elements are imported into the prevailing system, how they metamorphose and
transform are in great part dictated by the system's underlying legal philosophy.
This is the situation found in the Philippine legal system.
It must be emphasized, therefore, that Philippine Corporate Law is a
transplant from United States common law; and though we have a Corporation
Code that provides for statutory principles, Philippine Corporate Law is
essentially the product of commercial developments. Much of this development
can be expected to take place by way of jurisprudential rules that try to apply and
adapt corporate principles to changing concepts and mechanisms within the
world of commerce. The statutory principles embodied in the Corporation Code
should therefore be considered as dated rules or legal expressions of approved
corporate practices, since they hark back to a time when such principles were the
prevailing view, or at least the general controlling influence. Unless the statutory
provisions so clearly state, such provisions are by no means be taken to restrict
and define future developments.
In other words, the high regard with which we hold the Civil Code cannot
also be accorded the Corporation Code. True, both sets of codes represent the
people's will, expressed through their Legislature, of the fields that they cover.
Nevertheless, the difference in their coverage also dictates the difference in
treatment of the two codes. The Civil Code is meant to regulate private relations
of members of civil society, determining their respective rights and obligations. 22
The reverence and respect we place upon the Civil Code is justified by the idea
that it embodies "timeless truths" since it goes into the very essence of man and
his relationships. Through different periods in time, the essence of man does not
change, and the basic relationships that result likewise do not change.
On the other hand, the Corporation Code is meant to be a collection of
rules governing only a particular medium of doing business in the Philippines, the
corporation, and which actually expresses in statutory form the accepted practice
as borne out by jurispruduential rules. Our Corporation Code therefore
constitutes an attempt by Legislature to reflect, at the time of its passage, some
22
TOLENTINO, CIVIL CODE OF THE PHILIPPINES, Vol. I, 1990 ed., p. 11.
of the prevailing accepted practices and customs of businessmen regarding the
corporate vehicle.
But commercial practices evolve, and so too must the commercial media
employed, as well as the legal principles and concepts applicable thereto.
Business dynamics are characterized by swift adaptation in the face of
technological, scientific, and social developments. To consider therefore the
Corporation Code as embodying eternal truths is folly; reverence to the
provisions of the Corporation Code should be upheld only insofar as it continues
to be relevant to the needs of business and commercial transactions.
Of course this is not to condone anarchic transgression of such provisions
of the Corporation Code as one considers no longer acceptable or practical.
Rather, it is the treatment of, and reverential attitude towards the Code, that must
be defined. Philippine Corporate Law must evolve a philosophy that allows both
flexibility and stability.
Which view has become the primary influence in our society's perception
of the corporation, necessarily dictates the molding of Philippine legal philosophy
towards the corporation.
It is believed by certain sectors of Philippine society that "private
enterprise must discharge its social responsibility towards society in a way which
befits its unique competence. It should involve itself more and more in social
development for the total well-being of the nation."25 It is believed that "[f]or an
Asian company, corporate social responsibility is part of a social contract with the
community [and that] [t]he company observes this unwritten covenant not out of
fear of being vulnerable to criticism or any untoward action, but because it does
business with an innate social conscience."26
One author holds that "the real and obvious truth about private
corporations is, that once they have voluntarily agreed to do business in a
community, they thereby become at once members of that community, with
duties and obligations which cannot be far different from the duties and
25
Statement of Commitment of the Philippine Business for Social Progress.
26
Soriano, Andres III, Beyond Being A Mere Contributor of Funds, BUSINESS W ORLD
PUBLICATION ON CORPORATE CITIZENSHIP (1993).
obligations ordinarily expected of members in an organized, progressive, and
progressing society."27
In an association such as the PHILIPPINE BUSINESS FOR SOCIAL PROGRESS,
the top corporations of the Philippines have pledged to set aside out of their
operating funds an amount for social development equivalent to one percent
(1%) of the each year's net profit before income taxes, of which twenty percent
(20%) shall be delivered to a common social development foundation, which will
manage and allocate it.28
Nowhere in the Corporation Code does it expressly say that profit
maximization is the primary role of the corporation, or the fundamental duty of the
board; but these are quite obvious from the basic set-up of the corporation, and
from provisions covering the same. The norm of profit maximization provides a
better monitoring mechanism, and encourages investors to invest in the
corporation.29 The fact that our Corporation Code provides a special chapter for
non-stock corporations does not itself mean that business corporations should be
without social conscience or social responsibility, just as the existence of priests,
nuns, and social workers in society should not preclude ordinary citizens from
making benevolent gestures. Likewise, even the business judgment rule will not
shield directors and officers from personal liability in engaging in activities that
are clearly geared towards profit maximization, when such would be immoral or
unlawful.
Yet the extent to which the notion of "corporate social responsibility"
actually shapes the legal philosophy behind Philippine Corporate Law is still an
open question. Philippine Corporate Law is meant to cover basically the main
norm that the corporation is a vehicle for businessmen and investors; however,
our corporate philosophy does suggest clearly that our business corporations
should have a social conscience. This is obvious from provisions now expressly
allowing the board of directors of corporations to "make reasonable donations,
including those for public welfare or for hospital, charitable, cultural scientific,
civic, or similar purposes."30
27
Guevarra, The Social Function of Private Corporations, 34 PHIL. L.J. 464 (1959). "So,
some men are beginning to realize that private corporations are not strictly private, that they do
not exist solely for their own benefit, but that they are deemed legitimate members of an organic
society in which they move about. They may freely do things, in spite of the legal limitations
surrounding a corporate entity, if such an act is intended and will directly benefit the community.
In other words, the doctrine of ultra vires does not apply, and should not be applied, to acts done
in favor of the public. Society is a living, growing organism, and its amelioration is a function of all
its members, whether natural or juridical." Ibid.
28
Ibid.
29
This is the view that Clark terms as "dualism" or "traditionalist view" which regards the
private and public sphere as having distinct functions that ought to be kept distinct. Therefore a
corporation's directors and officers have a fiduciary duty to maximize shareholder wealth, subject
to numerous duties to meet specific obligations to other groups affected by the corporation.
CLARK, ibid, at pp. 677-679.
30
Sec. 36(9), Corporation Code.
Except for such isolated provisions, the Corporation Code has not gone
all-out in pushing corporations to assume social responsibility as an integral part
of their functions. In fact, it is other statutes, such as our tax laws, that encourage
corporations to undertake charitable work, where the legislature has sought to
imbue business corporations with a social conscience. This is because the
controlling mechanism in our jurisdiction is that corporate responsibility is better
addressed and monitored by making profit-maximization the core of our
corporate legal philosophy. Other relationships that have to do with corporations
are better served by other disciplines, such as labor laws, torts, criminal law, and
environmental laws.
31
See the interesting write-up of James L. Barksdale, Communications Technology in
Dynamic Organizational Communities, in THE COMMUNITY OF THE FUTURE OF THE DRUCKER
FOUNDATION; Jossey-Bass Publishers, San Francisco, U.S.A., 1998 ed.
The new technology is helping to bring about a whole
new attitude about how to communicate. Organizations of the
future will place a high priority on building communities of
interest that cross traditional boundaries of structure, system,
time, and space. Such community building can help in forging
the long-term relationships between people that provide the
needed stability for these organizations to prosper in a rapidly
changing world.32
—oOo—
32
Ibid, at p. 98.