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Republic of the Philippines

SUPREME COURT

Manila

EN BANC

G.R. No. L-30460 March 12, 1929

C. H. STEINBERG, as Receiver of the Sibuguey Trading Company, Incorporated, plaintiff-appellant,

vs.

GREGORIO VELASCO, ET AL., defendants-appellees.

Frank H. Young for appellant.

Pablo Lorenzo and Delfin Joven for appellees.

STATEMENT

Plaintiff is the receiver of the Sibuguey Trading Company, a domestic corporation. The defendants
are residents of the Philippine Islands.

It is alleged that the defendants, Gregorio Velasco, as president, Felix del Castillo, as vice-
president, Andres L. Navallo, as secretary-treasurer, and Rufino Manuel, as director of Trading
Company, at a meeting of the board of directors held on July 24, 1922, approved and authorized
various lawful purchases already made of a large portion of the capital stock of the company
from its various stockholders, thereby diverting its funds to the injury, damage and in fraud of the
creditors of the corporation. That pursuant to such resolution and on March 31, 1922, the
corporation purchased from the defendant S. R. Ganzon 100 shares of its capital stock of the par
value of P10, and on June 29, 1922, it purchased from the defendant Felix D. Mendaros 100
shares of the par value of P10, and on July 16, 1922, it purchased from the defendant Felix D.
Mendaros 100 shares of the par value of P10, each, and on April 5, 1922, it purchased from the
defendant Dionisio Saavedra 10 shares of the same par value, and on June 29, 1922, it purchased
from the defendant Valentin Matias 20 shares of like value. That the total amount of the capital
stock unlawfully purchased was P3,300. That at the time of such purchase, the corporation had
accounts payable amounting to P13,807.50, most of which were unpaid at the time petition for
the dissolution of the corporation was financial condition, in contemplation of an insolvency and
dissolution.

As a second cause of action, plaintiff alleges that on July 24, 1922, the officers and directors of
the corporation approved a resolution for the payment of P3,000 as dividends to its stockholders,
which was wrongfully done and in bad faith, and to the injury and fraud of its creditors. That at
the time the petition for the dissolution of the corporation was presented it had accounts payable
in the sum of P9,241.19, "and practically worthless accounts receivable."

Plaintiff prays judgment for the sum of P3,300 from the defendants Gregorio Velasco, Felix del
Castillo, Andres L. Navallo and Rufino Manuel, personally as members of the Board of Directors,
or for the recovery from the defendants S. R. Ganzon, of the sum of P1,000, from the defendant
Felix D. Mendaros, P2,000, and from the defendant Dionisio Saavedra, P100, and under his
second cause of action, he prays judgment for the sum of P3,000, with legal interest against the
board of directors, and costs.

For answer the defendants Felix del Castillo, Rufino Manuel, S. R. Ganzon, Dionisio Saavedra and
Valentin Matias made a general and specific denial.

In his amended answer, the defendant Gregorio Velasco admits paragraphs, 1, 2 and 3 of each
cause of action of the complaint, and that the shares mentioned in paragraph 4 of the first cause
of action were purchased, but alleges that they were purchased by virtue of a resolution of the
board of directors of the corporation "when the business of the company was going on very
well." That the defendant is one of the principal shareholders, and that about the same time, he
purchase other shares for his own account, because he thought they would bring profits. As to
the second cause of action, he admits that the dividends described in paragraph 4 of the
complaint were distributed, but alleges that such distribution was authorized by the board of
directors, "and that the amount represented by said dividends really constitutes a surplus profit of
the corporation," and as counterclaim, he asks for judgment against the receiver for P12,512.47
for and on account of his negligence in failing to collect the accounts.

Although duly served, the defendant Mendaros did not appear or answer. The defendant Navallo
was not served, and the case against him was dismissed.

April 30, 1928, the case was tried and submitted on a stipulation of facts, based upon which the
lower court dismissed plaintiff's complaint, and rendered judgment for the defendants, with
costs against the plaintiff, and absolved him from the cross-complaint of the defendant Velasco,
and on appeal, the plaintiff assigns the following errors:

1. In holding that the Sibuguey Trading Company, Incorporated, could legally purchase its own
stock.
2. In holding that the Board of Directors of the said Corporation could legally declared a dividend
of P3,000, July 24, 1922.

JOHNS, J.:

It is stipulated that on July 24, 1922, the directors of the corporation approved the purchase of
stocks as follows:

One hundred shares from S. R. Ganzon for P1,000;

One hundred shares from Felix D. Mendaros at the same price; which purchase was made on
June 29, 1922; another

One hundred shares from Felix D. Mendaros at the same price on July 16, 1922;

Ten shares from Dionisio Saavedra at the same price on June 29, 1922.

That during such times, the defendant Gregorio Velasco purchased 13 shares for the corporation
for P130; Felix del Castillo — 42 shares for P420; Andres Navallo — 15 shares for P150; and the
defendant Mendaros — 10 shares for P100. That during the time these various purchases were
made, the total amount of subscribed and paid up capital stock of the corporation was P10,030,
out of the authorized capital stock 2,000 shares of the par value of P10 each.

Paragraph 4 of the stipulation also recites:

Be it also admitted as a fact that the time of the said purchases there was a surplus profit of the
corporation above-named of P3,314.72.

Paragraph 5 is as follows:

That at the time of the repeatedly mentioned various purchases of the said capital stock were
made, the said corporation had Accounts Payable in the total amount of P13,807.50 as shown by
the statement of the corporation, dated June 30, 1922, and the Accounts Receivable in the sum
of P19,126.02 according to the books, and that the intention of the Board of Directors was to
resell the stocks purchased by the corporations at a sum above par for each stock, this
expectation being justified by the then satisfactory and sound financial condition of the business
of the corporation.

It is also stipulated that on September 11, 1923, when the petition for the dissolution of the
corporation was presented to the court, according to a statement made June 30, 1923, it has
accounts payable aggregating P9,41.19, and accounts receivable for P12,512.47.

Paragraph 7 of the stipulation recites:

That the same defendants, mentioned in paragraph 2 of this stipulation of facts and in the same
capacity, on the same date of July 24, 1922, and at the said meeting of the said Board of
Directors, approved and authorized by resolution the payment of dividends to its stockholders, in
the sum of three thousand pesos (P3,000), Philippine currency, which payments were made at
different dates, between September 30, 1922, and May 12, 1923, both dates inclusive, at a time
when the corporation had accounts less in amount than the accounts receivable, which
resolution was based upon the balance sheet made as June 30, 1922, said balance sheet showing
that the corporation had a surplus of P1,069.41, and a profit on the same date of P2,656.08, or
a total surplus amount of P3,725.49, and a reserve fund of P2,889.23 for bad and doubtful
accounts and depreciation of equipment, thereby leaving a balance of P3,314.72 of net surplus
profit after paying this dividend.

It is also stipulated at a meeting of the board of directors held on July 24, 1922, as follows:

6. The president and manager submitted to the Board of Directors his statement and balance
sheet for the first semester ending June 30, 1922 and recommended that P3,000 — out of the
surplus account be set aside for dividends payable, and that payments be made in installments so
as not to effect the financial condition of the corporation. That stockholders having outstanding
account with the corporation should settle first their accounts before payments of their dividends
could be made. Mr. Castillo moved that the statement and balance sheet be approved as
submitted, and also the recommendations of the president. Seconded by Mr. Manuel. Approved.

Paragraph 8 of the stipulation is as follows:

That according to the balance sheet of the corporation, dated June 30, 1923, it had accounts
receivable in the sum of P12,512.47, due from various contractor and laborers of the National
Coal Company, and also employees of the herein corporation, which the herein receiver, after his
appointment on February 28, 1924, although he made due efforts by personally visiting the
location of the corporation, and of National Coal Company, at its offices, at Malangas,
Mindanao, and by writing numerous letters of demand to the debtors of the corporation, in order
to collect these accounts receivable, he was unable to do so as most of them were without goods
or property, and he could not file any suit against them that might have any property, for the
reason that he had no funds on hand with which to pay the filing and sheriff fees to Malangas,
and other places of their residences.

From all of which, it appears that on June 30, 1922, the board of directors of the corporation
authorized the purchase of, purchased and paid for, 330 shares of the capital stock of the
corporation at the agreed price of P3,300, and that at the time the purchase was made, the
corporation was indebted in the sum of P13,807.50, and that according to its books, it had
accounts receivable in the sum of P19,126.02. That on September 11, 1923, when the petition
was filed for its dissolution upon the ground that it was insolvent, its accounts payable amounted
to P9,241.19, and its accounts receivable P12,512.47, or an apparent asset of P3,271.28 over
and above its liabilities. But it will be noted that there is no stipulation or finding of facts as to
what was the actual cash value of its accounts receivable. Neither is there any stipulation that
those accounts or any part of them ever have been or will be collected, and it does appear that
after his appointment on February 28, 1924, the receiver made a diligent effort to collect them,
and that he was unable to do so, and it also appears from the minutes of the board of directors
that the president and manager "recommended that P3,000 — out of the surplus account to be
set aside for dividends payable, and that payments be made in installments so as not to effect the
financial condition of the corporation."

If in truth and in fact the corporation had an actual bona fide surplus of P3,000 over and above
all of its debt and liabilities, the payment of the P3,000 in dividends would not in the least impair
the financial condition of the corporation or prejudice the interests of its creditors.

It is very apparent that on June 24, 1922, the board of directors acted on assumption that,
because it appeared from the books of the corporation that it had accounts receivable of the face
value of P19,126.02, therefore it had a surplus over and above its debts and liabilities. But as
stated there is no stipulation as to the actual cash value of those accounts, and it does appear
from the stipulation that on February 28, 1924, P12,512.47 of those accounts had but little, if
any, value, and it must be conceded that, in the purchase of its own stock to the amount of
P3,300 and in declaring the dividends to the amount of P3,000, the real assets of the corporation
were diminished P6,300. It also appears from paragraph 4 of the stipulation that the corporation
had a "surplus profit" of P3,314.72 only. It is further stipulated that the dividends should "be
made in installments so as not to effect financial condition of the corporation." In other words,
that the corporation did not then have an actual bona fide surplus from which the dividends
could be paid, and that the payment of them in full at the time would "affect the financial
condition of the corporation."

It is, indeed, peculiar that the action of the board in purchasing the stock from the corporation
and in declaring the dividends on the stock was all done at the same meeting of the board of
directors, and it appears in those minutes that the both Ganzon and Mendaros were formerly
directors and resigned before the board approved the purchase and declared the dividends, and
that out of the whole 330 shares purchased, Ganzon, sold 100 and Mendaros 200, or a total of
300 shares out of the 330, which were purchased by the corporation, and for which it paid
P3,300. In other words, that the directors were permitted to resign so that they could sell their
stock to the corporation. As stated, the authorized capital stock was P20,000 divided into 2,000
shares of the par value of P10 each, which only P10,030 was subscribed and paid. Deducting the
P3,300 paid for the purchase of the stock, there would be left P7,000 of paid up stock, from
which deduct P3,000 paid in dividends, there would be left P4,000 only. In this situation and
upon this state of facts, it is very apparent that the directors did not act in good faith or that they
were grossly ignorant of their duties.

Upon each of those points, the rule is well stated in Ruling Case Law, vol. 7, p. 473, section 454
where it is said:

General Duty to Exercise Reasonable Care. — The directors of a corporation are bound to care for
its property and manage its affairs in good faith, and for a violation of these duties resulting in
waste of its assets or injury to the property they are liable to account the same as other trustees.
Are there can be no doubt that if they do acts clearly beyond their power, whereby loss ensues to
the corporation, or dispose of its property or pay away its money without authority, they will be
required to make good the loss out of their private estates. This is the rule where the disposition
made of money or property of the corporation is one either not within the lawful power of the
corporation, or, if within the authority of the particular officer or officers.

And section 458 which says:

Want of Knowledge, Skill, or Competency. — It has been said that directors are not liable for
losses resulting to the corporation from want of knowledge on their part; or for mistake of
judgment, provided they were honest, and provided they are fairly within the scope of the
powers and discretion confided to the managing body. But the acceptance of the office of a
director of a corporation implies a competent knowledge of the duties assumed, and directors
cannot excuse imprudence on the ground of their ignorance or inexperience; and if they commit
an error of judgment through mere recklessness or want of ordinary prudence or skill, they may
be held liable for the consequences. Like a mandatory, to whom he has been likened, a director is
bound not only to exercise proper care and diligence, but ordinary skill and judgment. As he is
bound to exercise ordinary skill and judgment, he cannot set up that he did not possess them.

Creditors of a corporation have the right to assume that so long as there are outstanding debts
and liabilities, the board of directors will not use the assets of the corporation to purchase its own
stock, and that it will not declare dividends to stockholders when the corporation is insolvent.

The amount involved in this case is not large, but the legal principles are important, and we have
given them the consideration which they deserve.

The judgment of the lower court is reversed, and (a), as to the first cause of action, one will be
entered for the plaintiff and against the defendant S. R. Ganzon for the sum of P1,000, with
legal interest from the 10th of February, 1926, and against the defendant Felix D. Medaros for
P2,000, with like interests, and against the defendant Dionisio Saavedra for P100, with like
interest, and against each of them for costs, each on their primary liability as purchasers of stock,
and (b) against the defendants Gregorio Velasco, Felix del Castillo and Rufino Manuel, personally,
as members of the board of directors of the Sibuguey Trading Company, Incorporated, as
secondarily liable for the whole amount of such stock sold and purchased as above stated, and
on the second cause of action, judgment will be entered (c) for the plaintiff and jointly and
severally against the defendants Gregorio Velasco, Felix del Castillo and Rufino Manuel,
personally, as members of the board of directors of the Sibuguey Trading Company, Incorporated,
for P3,000, with interest thereon from February 10, 1926, at the rate of 6 per cent per annum,
and costs. So ordered.

Johnson, Street, Malcolm, Ostrand, Romualdez and Villa-Real, JJ., concur.

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Republic of the Philippines

SUPREME COURT

Manila

THIRD DIVISION

G.R. No. 111008 November 7, 1994

TRAMAT MERCANTILE, INC. AND DAVID ONG, petitioners,

vs.

HON. COURT OF APPEALS AND MELCHOR DE LA CUESTA, respondents.

Emilio G. Abrogena for petitioners.

Constante B. Albano for private respondent.

VITUG, J.:

This petition for review on certiorari challenges the 04th March 1993 decision of the Court of
Appeals and its resolution of 01 July 1993 denying the motion for reconsideration.

On 09 April 1984, Melchor de la Cuesta, doing business under the name and style of "Farmers
Machineries," sold to Tramat Mercantile, Inc. ("Tramat"), one (1) unit HINOMOTO TRACTOR
Model MB 1100D powered by a 13 H.P. diesel engine. In payment, David Ong, Tramat's president
and manager, issued a check for P33,500.00 (apparently replacing an earlier postdated check for
P33,080.00). Tramat, in turn, sold the tractor, together with an attached lawn mower fabricated
by it, to the Metropolitan Waterworks and Sewerage System ("NAWASA") for P67,000.00. David
Ong caused a "stop payment" of the check when NAWASA refused to pay the tractor and lawn
mower after discovering that, aside from some stated defects of the attached lawn mower, the
engine (sold by de la Cuesta) was a reconditioned unit.

On 28 May 1985, de la Cuesta filed an action for the recovery of P33,500.00, as well as
attorney's fees of P10,000.00, and the costs of suit. Ong, in his answer, averred, among other
things, that de la Cuesta had no cause of action; that the questioned transaction was between
plaintiff and Tramat Mercantile, Inc., and not with Ong in his personal capacity; and that the
payment of the check was stopped because the subject tractor had been priced as a brand new,
not as a reconditioned unit.

On 02 November 1989, after the reception of evidence, the trial court rendered a decision, the
dispositive portions of which read:

WHEREFORE, in view of the foregoing consideration, judgment is hereby rendered:

1. Ordering the defendants, jointly and severally, to pay the plaintiff the sum of P33,500.00
with legal interest thereon at the rate of 12% per annum from July 7, 1984 until fully paid; and

2. Ordering the defendants, jointly and severally, to pay the plaintiff the sum of P10,000.00
as attorney's fees, and the costs of this suit.

SO ORDERED. 1

An appeal was timely interposed by the defendants. On 04 March 1993, the Court of Appeals
affirmed in toto the decision of the trial court. Defendant-appellants' motion for reconsideration
was denied.

Hence, the instant petition.

We could find no reason to reverse the factual findings of both the trial court and the appellate
court, particularly in holding that the contract between de la Cuesta and TRAMAT was one of
absolute, not conditional, sale of the tractor and that de la Cuesta did not violate any warranty on
the sale of the tractor to TRAMAT. The appellate court, in its decision, adequately explained:

If the perfection of the sale was dependent upon acceptance by the MWSS of the subject tractor
why did the appellants issue a check in payment of the item to the appellee? And long after
MWSS had complained about the defective tractor engine, and after the appellee had failed to
remedy the defect, why did the appellants still draw and deliver a replacement check to the
appellee for the increased amount of P33,500.00?

These payments argue against the claim now made by the defendants that the sale was
conditional.

According to the appellee, the additional amount covered the cost of replacing the oil gasket of
the tractor engine when it was repaired in Soledad Cac's gasoline station in Quezon City. The
appellants, on the other hand, claims the amount represented the freight charges for
transporting the tractor from Cauayan, Isabela to Metro Manila.

The appellants should have explained why they failed to include the freight charges in the first
check. The tractor was transported from Isabela to Metro Manila as early as April 1984, and the
first check was drawn at about the same time. The freight charges cannot be said to have been
incurred when the tractor engine was delivered back to the supplier for repairs. The appellants
admitted that the engine was not brought back to Isabela. The repairs were done at Soledad
Cac's gasoline station in Quezon City.

Anent the first assigned error, We sustain the trial court's finding that at the time of the
purchase, the appellants did not reveal to the appellee the true purpose for which the tractor
would be used. Granting that the appellants informed the appellee that they would be reselling
the unit to the MWSS, an entity admittedly not engaged in farming, and that they ordered the
tractor without the power tiller, an indispensable accessory if the tractor would be used in
farming, these in themselves would not constitute the required implied notice to the appellee as
seller.

xxx xxx xxx

In regard to the second assigned error, We do not agree that the appellee should have been held
liable for the tractor's alleged hidden defects. . . .

It has to be noted in this regard that, to satisfy the requirements of the MWSS, the appellants
borrowed a lawn mower from the MWSS so they could fabricate one such mower. The
appellants' witness stated that the kind of mid-mounted lawn mower was being manufactured
by their competitor, Alpha Machinery, which had by then stopped supplying the same (tsn,

Nov. 29, 1988, pp. 73-74). There is no showing that the appellants had had any previous
experience in the fabrication of this lawn mower. In fact, as aforesaid, they had to borrow one
from the MWSS which they could copy. But although they made a copy with the same
specifications and design, there was no assurance that the copy would function as well as with
the model.

xxx xxx xxx

Although the trial court discussed it in a different light, We view the matter in the same way the
trial court did — that the lawn mower as fabricated by the appellants was the root of the parties'
problems.

Having had no previous experience in the manufacture of lawn mowers of the same type as that
in litigation, and in a possibly patent-infringing effort to undercut their competition, the
appellants gathered enough daring to do the fabrication themselves. But the product might have
proved too much for the subject tractor to power, and the tractor's engine was strained beyond
its limits, causing it to overheat and damage its gaskets.

No wonder, then, it was a gasket Soledad Cac had to replace, at a cost chargeable to the
appellants. No wonder, furthermore, the appellants' witness declared that even after the
replacement of that one gasket, the engine still leaked oil after being torture-tested. The integrity
of the other engine gaskets might have been impaired, too. Such was the burden placed on the
engine. The engine malfunctioned not necessarily because the engine, as alleged by the
appellants, had been a reconditioned, and not a brand new, one. It malfunctioned because it was
made to do what it simply could not.2

It was, nevertheless, an error to hold David Ong jointly and severally liable with TRAMAT to de la
Cuesta under the questioned transaction. Ong had there so acted, not in his personal capacity,
but as an officer of a corporation, TRAMAT, with a distinct and separate personality. As such, it
should only be the corporation, not the person acting for and on its behalf, that properly could be
made liable thereon.3

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 —

1. He assents (a) to a patently unlawful act of the corporation, or

(b) for bad faith, or gross negligence in directing its affairs, or (c) for conflict of interest, resulting
in damages to the corporation, its stockholders or other persons;4

2. He consents to the issuance of watered stocks or who, having knowledge thereof, does
not forthwith file with the corporate secretary his written objection thereto;5

3. He agrees to hold himself personally and solidarily liable with the corporation;6 or

4. He is made, by a specific provision of law, to personally answer for his corporate action.7

In the case at bench, there is no indication that petitioner David Ong could be held personally
accountable under any of the abovementioned cases.
WHEREFORE, the petition is given DUE COURSE and the decision of the trial court, affirmed by
the appellate court, is MODIFIED insofar as it holds petitioner David Ong jointly and severally
liable with Tramat Mercantile, Inc., which portion of the questioned judgment is SET ASIDE. In all
other respects, the decision appealed from is AFFIRMED. No costs.

SO ORDERED.

Bidin, Romero and Melo, JJ., concur.

Feliciano, J., is on leave.

#Footnotes

1 Rollo, p. 20.

2 Rollo, pp. 26-30.

3 RCPI vs. Court of Appeals, 143 SCRA 657.

4 See Section 31, Corporation Code.

5 See Section 65, Corporation Code.

6 See De Asis & Co., Inc. vs. Court of Appeals, 136 SCRA 599.

7 Exemplified in Article 144, Corporation Code; see also Sec. 13, Presidential Decree 115
(Trust Receipts Law).

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