Chapter XI – Financing the Corporation; Capital
Structure
Sources of financing
Three main sources:
— Equity investments; Contributions of SHs
o Investor making equity investments expects that his returns shall be
tied up with the success or loss of the operations of the corporation
 Return of equity investor is intricately woven into the
business affairs of the corporation and participates in the
income
 Investor/SH is given a say in the management—he is entitled
to participate in the election of the board and cast votes on
corporate matters where SHs are required to give ratificatory
action
 Absence of carrying cost since corporation is not bound to
pay any return on investment unless there are profits and
subject to business judgment of the board in declaring
dividends
o Equity investment generally non-withdrawable for so long as the
corporation has not been dissolved
o Investors of equity can only receive a return of their investment only
from the remaining assets after payment of creditors
— Debt contracts: Loans/advances by creditors
o Person extending a loan or debt looks at the financial condition and
operations of the corporations as a means of gauging capacity to
pay
 Creditor puts no stake on the operations of the business; his
relationship to the corporation is based on contract
 Contractual obligation of corporation to pay the stipulated
return (in the form of interest) remains even when losses are
incurred
o Expected return: creditor can only demand the stipulated fixed
return/interest
o Legal preference in payment from corporate properties—once
insolvent, the corporation shall devote and prefer all corporate
assets towards the payment of creditors
— Profits of the corporation
Capital structure
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— Refers to the aggregate of the securities issued by the corporation
— Two classes of securities:
o Shares of stock
o Debt securities
o Senior securities: those which have a prior but limited claim upon
corporate earnings (such as debt and typical PS)
o Equity securities: those which have the residual interest in
corporate earnings (such as CS and participating PS)
— Important characteristics of securities as forms of investments:
o Right to any early claim on the income before other security
holders
o Right to residual income
o Right to vote
— Only 25% of authorized capital stock need be subscribed initially
o Promoters are not bound to limit the starting capital needed by
the business
o Other sources of capital may be tapped, at the initial stages or
when the corporation is already a going concern
— Two questions to consider:
o What should be the relation between basic equity interests and
senior securities?
o What type of senior securities should be issued?
Capital and Capital Stock Distinguished
— 137: total shares of stock issued to subscribers or SHs, whether or
not fully or partially paid, provided there is a binding subscription
agreement; composed of (2) items:
o portion paid by the SHs (paid-up capital)
o portion which is to be paid on the subscriptions (subscription
receivables)
— Capital stock: the amount fixed by the AOI to be subscribed and
paid in or secured to be paid in by the SHs, either in money, property,
or services
o Represents the legal and proportional standing of the SHs with
respect to the corporation and corporate matters
o Represents the financial and proprietary claim of the SHs to the
net assets of the corporation upon dissolution
o Totality of the portion of the corporation’s assets and receivables
covered by the trust fund doctrine and are deemed protected for
the benefit of corporate creditors
o The corporation does not have to issue all shares at one time
o Remains the same unless the AOI are amended to either increase
or decrease
 o Cannot be used to declare dividends
— Capital: actual property of the corporation, including cash, real and
personal property
o Includes all corporate assets—contributions of SHs, loans by
creditors, earnings less losses
o Fluctuates depending on current profits or losses of the business
Shares of Stock; Kinds
Sec 6
— Defn: Share of stock: a unit or several units of interest acquired when
a person contributes capital to a corporation by way of equity
o Units into which the capital stock is divided
o Represents the interest of the holder:
 to participate in the management of the corporation,
 to share proportionally in the profits, and
 upon liquidation, to obtain an aliquot part of the corporate
assets after creditors are paid
o GR: SH cannot get back his investment until dissolution or
liquidation of the corporation
o Ownership of shares do not make the SH the owner of any specific
property of the corporation, but the shares owned are his own
personal property which he may transfer, mortgage, pledge, or
otherwise dispose of
o Not to be confused with certificate of stock—evidence of the interest
of the SH in the corporation
Nature of shares of stock
— Constitute personal property of the SH which he can contract with as in
any other form of property
— Represent aliquot parts of the corporation’s capital or the right to share
in the proceeds; holder is not the owner of any part of the capital of the
corporation nor is he entitled to any definite portion of the property and
cannot be treated as a co-owner or tenant-in-common (SHs of Guanzon
v. RoD)
— Holders do not own any part of the assets nor are they entitled to
possession
— Do not represent proprietary rights of SHs to the corporate assets or
properties
Rights of the corporation with respect to shares:
a) To call for payment of unpaid subscriptions subject to contrary
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stipulation in the subscription agreement (67)
b) To impose interest on unpaid subscriptions (66)
c) To refuse to issue certificates covering shares where subscription
has not been fully paid (64)
d) To refuse to recognize and register the sale or assignment of any
share where subscription is not fully paid (63)
e) To refuse to recognize a sale or assignment which has not been
duly registered in the stock and transfer book (63)
Corporation does NOT have the power to:
a) demand for the repurchase of shares unless classified as
redeemable in the AOI (Sec 8)
b) refuse to pay dividends to SHs as declared and not been declared
delinquent in order to apply to the unpaid subscription (Sec 71)
c) bid delinquent shares and obtain greater profit for itself (68)
Power to issue shares:
— Power to issue shares or sell them inherent and express in the
corporation, lodged with the board
o SH meeting not required on the issuance of unissued authorized
capital stock (first issuance from corporation to SH)
— Limitations on power to issue shares:
o 62: Cannot be issued for a consideration less than the par or
issued value
 Sec 9: except treasury shares so long as the price is
reasonable
o 62: Cannot be issued in exchange for PNs or future services
o 59: if consideration not in cash: value shall be determined by the
incorporators or the board subject to SEC approval
Power to classify shares
— Sec 6: shares may be divided into classes or series or both, any of
which may have rights, privileges, or restrictions stated in the AOI
o No share may be deprived of voting rights except those classified
and issued as “preferred” and “redeemable” shares
o Any or all shares or series of shares may have par or no par value
— Code adopts presumption of equality of the rights and features of
shares when nothing is expressly provided to the contrary in the AOI
or when AOI is silent
o In the absence of restrictions in the AOI, PS shall would be voting
shares having the same rights as CS
— Code provides for voting rights for all types of shares on matters of
fundamental importance; Sec 6: non-voting shares shall be entitled to
vote on:
o Amendment to the AOI
 o Adoption and amendment of by-laws
o Sale, lease, exchange, mortgage, pledge or any disposition of all or
substantially all corporate property
o Incurring, creating or increasing bonded indebtedness
o Increase or decrease of capital stock
o Merger or consolidation
o Investment in another corporation or another business
o Dissolution of the corporation
— All other corporate acts: non-voting shares not entitled to vote
— Minimum restrictions on classification, provided that there be a class
with complete voting rights
— NOTE: rights of PS and bondholders are a matter of contract
Trust relations on shares of stock
— A trust relationship may be created involving shares of stock of a
corporation
— Sec 10: each incorporator must own or be a subscriber to at least one
(1) share
— Sec 23: every director must own at least one (1) share of stock, which
shall stand in his name on the books of the corporation of which he is a
director
— Nominal ownership in shares is all that is required under Sec 23 even
when it is shown that the registered SH is only a nominee or trustee of
another person
— Nominee and trustee arrangements do not violate public policy but such
nominees and trustees must still comply with the applicable legal
restrictions and formalities
Kinds of shares
1. Common stocks—one which entitles the owner to an equal pro rata
division of profits; one SH having no advantage, priority or
preference over any other SH in the same class
— Most common classification
— Do not have special contract rights or preferences
— Represents the greatest proportion of the corporation’s capital
structure and bears the greatest risk of loss in the event of
failure
— Represents the residual ownership interest in the corporation
2. Preferred Stocks—entitles holder to some preference either in the
dividends or in distribution of assets upon liquidation, or both, or to
other preferences not inconsistent with the code
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— Designed to induce persons to subscribe for shares of a
corporation
— No more a debt than CS, and until a dividend is declared the
holder of PS is not a creditor of the corporation
— Rights of PS holder are subordinate to the rights of creditors
— Entitlement to preferences:
o Cannot be deemed absolute and must be interpreted in
accordance with the Code and jurisprudence
o Under 43, stock dividends cannot be issued without approval of
2/3 OCS at a meeting called for the purpose
— Underscores the principle that payment of dividends to
SHs is not a matter of right but a matter of consensus
o There is no guarantee that the PS will receive any dividends
— Declaration of dividends is dependent upon the
availability of surplus profit or unrestricted retained
earnings
— Preferences do not give PS holders a lien upon the
corporate property
— Two limitations:
o Can only be issued with a stated par value;
o Preferences must be stated in both the AOI and the stock
certificate; otherwise, each share shall be equal to every other
share
(1) Preference as to dividends
— Dividends are payable only when there are profits earned
— GR: even if there are existing profits, the board has the
discretion to determine w/n to declare dividends
— Gives the holder the right to receive dividends on said
shares to the extent agreed upon before any dividends at
all are paid to the holders of CS
Types:
i. Participating and non-participating—shares in
which after getting their fixed dividend
preference, they share with the CS the rest of the
dividends; unless otherwise stipulated, PS are
NON-participating shares
ii. Cumulative and non-cumulative
— Cumulative PS: entitle the holders to payment not only
 of current dividends but also of back dividends not
previously paid, when and if dividends are declared, to the
extent agreed before CS are paid
— If PS dividends are not paid in full in a given year, whether or
not earned, the deficiency must be made up before any
dividend may be paid on the CS
— PS are deemed to be cumulative
— In any given year(s) where no dividends declared, the
arrears for such year have to be made up in subsequent
years before dividends are paid to CS
— Non-cumulative PS: entitle the holder to payment of
current dividends that are paid, to the extent agreed, before
CS holders are paid
iii. Discretionary dividend type—right of SH to get
dividends would depend on the discretion of the
board, even if the corporation earns profits
iv. Mandatory dividend type—imposes a positive duty
on directors to declare preferred dividends every
year that profits are earned, and failure to declare
would not deprive holders of his dividend rights for a
particular year (Burk v Ottawa Gas)
v. Earned cumulative or dividend credit type—gives a
right to arrears in dividends where there were profits
earned during the years when dividends were not
declared
1. SH may not compel payment of dividends
and must wait until the board decides to
declare
(2) Preference as to voting rights
— GR: PS are denied by contract the right to vote
— Exception: if the right is not clearly withheld in the certificate
or AOI, since voting is incidental to ownership
Ellingwood v. Wolf’s Head Oil Refining Co. F: Ellingwood is a preferred
SH of the Wolf’s Head Oil Co. At a SH meeting, the corporation was in
default in the declaration and payment of dividends for 2 years on the
PS. The AOI provides that PS holders are entitled to cumulative
dividends, and gives exclusive voting power to holders of CS. PS holders
have no voting rights, but is the corporation is in default in the payment
of dividends, the majority PS holders shall have an election to exercise
the sole right to vote for the election of directors and all other purposes,
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to the exclusion of the CS holders, until the corporation declares and
pays dividends for a full year on the PS. Thereafter the right to vote
shall revert to the CS holders. Ellingwood contends that the clause
“until the corporation pays for a one year period dividends on the PS”
restricts the above provision in the AOI as to the duration of time
when PS holders shall have the right to vote. TC ruled that PS were
entitled to vote at the SH meeting.
H: The AOI of the company evidences an intention to make provision
for the protection of PS holders. When a dividend for a full year is
paid on PS, the sole right to vote reverts to the CS holders,
notwithstanding that dividends for 2 years are still due on PS. It
clearly appears therefore that when the annual meeting of the
corporation was held, dividends were accrued and unpaid on the PS,
thus the company was in default, and therefore the PS holders were
entitled to vote for the election of directors and all other purposes as
stipulated in the AOI.
(3) Preferences upon liquidation (preferences as to assets)
— GR: PS holders participates pro rata with the CS holders,
since each share is presumed to be equal
— Exception: PS holder may be given preference in the
distribution of corporate assets
— Gives the holder preference in the distribution of assets
of the corporation in case of liquidation
Hay v Hay. F: The Big Bend Co. is a real estate business concern. It
amended its articles, stipulating that holders of PS are entitled to
receive cumulative dividends, such that if in any year dividends shall
not have been paid, the deficiency shall be paid before dividends are
declared or paid upon the CS. It also provides: that out of any surplus
profit remaining after payment of full dividends on PS for all dividend
periods and after full dividends have been paid in full, then dividends
may be paid to CS; and in the event of any liquidation of the
corporation the holders of PS shall be entitled to be paid in the full
the par value thereof, and all accrued unpaid dividends thereon
before any sum shall be paid to any assets distributed among the
holders of CS. No creditors are involved. No dividends on cumulative
PS have been declared or paid. No surplus profits are available with
which to pay dividends. A plan of liquidation, distribution, and
dissolution of the corporation was adopted. It appears that the net
assets were sufficient to redeem the PS at par, but if the PS holders
received the promised dividends per the amended AOI, assets instead
of surplus profits would be used. The result will be that the CS holders
will get no part of such assets. The liquidating trustees, being in doubt
as to who was entitled to receive the assets upon liquidation after
redemption of the PS, sought a declaratory judgment from the court.
It is contended that the phrase “all accrued unpaid dividends” means
that before there can be a dividend, there must be surplus profits, and
that since none ever existed, the right to the dividends never accrued
and therefore none are payable. A counterargument is raised that the
provisions of the amended AOI relate to the payment of dividends to PS
holders out of surplus profits while the corporation is a going concern,
but that it authorizes payment of accumulated and unpaid dividends out
of assets upon liquidation of the corporation, even though there is no
surplus profits available.
I: W/N holders of cumulative PS upon liquidation of the corporation are
entitled to be paid accrued dividends from corporate assets before the
common SHs become entitled to participate in the distribution thereof,
the corporation having earned no surplus or net profits.
H: The contract stating the rights of the PS has a double aspect. The
provision on annual dividends payable out of the surplus profits was
founded on the hope and prospect of a profitable business. Such
dividends could be paid by a corporation financially successful. There
can be no dividends declared by a corporation in financial distress. But if
there were provision for the rights of PS holders even in the event of a
business disaster resulting in voluntary winding up or dissolution of the
corporation, they would be entitled to receive in full both the amount of
their shares and the unpaid dividends accrued. In this case the words of
preference were designed to be operative even under conditions of
adversity. The advantages of holders of PS are not restricted to
conditions of prosperity, but general in scope and intended to be
operative in all the hazards of business. In the present case, the holders
of PS are entitled to both the par value of their stock and to dividends
which have not been declared or paid but which would have been so,
had the company experience surplus profits.
An investor places his money in cumulative PS because it has a
guaranteed dividend and certain preferences, as set forth in the stock
agreement. If this agreement gives preferences as to dividends in the
liquidation proceedings, the stock would normally be considered as a
better business risk. The clause “unpaid dividends accrued” would thus
mean that it gives preference to holders regardless of any consideration
of profits or surplus.
Dissent: Differences of opinion usually arise when on liquidation, PS
holders sought to have a preference in the distribution of assets to
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reimburse them, because the corporation may not have earned any
net profits out of which dividends can be paid. Two schools of
thought: (1) a dividend can come into being and exist only by
affirmative declaration of the corporation, and only if there is surplus
profits. No surplus profits, no right to the dividends accrues, and thus
cannot be demanded in liquidation; (2) dividends, if not regularly paid
out of available earnings, may be amassed, whether earned or not, at
regular dividend rates, and may be paid out of assets when the
corporation is liquidated if the AOI so provide.
(4) Preferred stockholder is not a creditor
— PS holder is an equity holder and not a creditor
— Investment is still subject to all risks of ownership
Augusta Trust Co. v. Augusta, Hallowell & Gardiner Railroad Co et
al. F: Augusta Railroad had outstanding bonds secured by mortgage.
These bonds gave the holders the right to convert into preferred
stock of the company. The corporation contends that the certificates
of PS issued in exchange for bonds were in fact certificates of
indebtedness and not stock.
I: W/N the rights of the holders of preferred shares to share in the
proceeds on the sale of mortgaged property
H: It is within the power of the legislature to prescribe that
corporations may issue certificates in the form of certificates of PS,
making the holders creditors of the corporation as well as SHs, and
giving them a lien upon the corporate property with a priority over
other creditors. This is not ordinary PS, nor technically PS at all. It is
sui generis, not governed by the ordinary rules. The preferences
given the holders of the PS in this case were not authorized by
statute when made. The stock was not statutory PS of the kind
described.
PS may be issued in such a way as to make the certificates thereof
merely evidence of indebtedness and the holders creditors and not
SHs. Here all facts and circumstances characterize the PS issued by
the corporation as PS, and not bonds. SHs voted increases in capital
stock by the creation of PS. The certificates delivered to the holders
of the bonds exchanged for it designated the stock as PS. The holders
had the right to vote. The certificates contain every essential feature
of a certificate of PS and none of a contract of indebtedness. By
surrendering their bonds, and taking in lieu thereof PS, the
bondholders ceased to become creditors and became mere SHs.
Those who have no made the exchange are entitled to the security of
the mortgages, excluding the illegal conversion agreements. The PS
are not entitled to share in the assets of the corporation until all
creditors are paid in full.
3. Par and no-par shares
— Par value: the minimum issue price of a share
o Must be stated in stock certificate, which cannot be issued until
paid in full by subscriber
o Shares cannot be sold at less than par; otherwise they would be
watered stock and SH would still be liable for the difference
— No par value: issued price is not stated in the stock certificate, but
may be fixed in the AOI or by the board or in the by-laws, or by the
SHs themselves
o Sec 6: no par value shares shall be deemed fully paid and non-
assessable and the holder thereof shall not be liable to the
corporation or to its creditors
o Subscriber must pay its full consideration
o Such consideration shall be treated as capital and is not
available for distribution as dividends
o Delpher case: no par value share does not represent any stated
proportionate interest in the capital stock, but only an aliquot
part of the whole number of such shares issued
 Capital stock of a corporation issuing no par shares is
not set forth by a stated sum of money, but is expressed
to be divided into a stated number of shares
 By removing the par value, the attention of persons
interested in the financial condition of the corporation is
focused upon the value of the assets and debts
o Limitations on the issuance of no-par value shares:
a) Once issued, are deemed fully paid and therefore non-
assessable
b) Consideration cannot be less than P5.00
c) Entire consideration for the issuance constitutes capital
d) Cannot be issued as PS
e) Cannot be issued by banks, trust companies, etc
f) AOI must state the fact that no-par shares were issued
4. Treasury shares
Sec 9: shares issued and fully paid for, but subsequently reacquired by the
issuing corporation by purchase, redemption, donation, or through other
lawful means
— No voting rights nor preemptive rights
— Not entitled to dividends
— May be sold for any amount the board may fix
— SEC: treasury shares have no effect on the stated capital of the
6
corporation until and unless they are cancelled or retired
— Acquisition of treasury shares does not reduce the number of
issued shares nor the amount of stated capital and their sale
does not increase the number of issued shares or amount of
stated capital
5. Redeemable shares
— Sec 8: may be issued by the corporation when expressly so
provided in the AOI
— Redeeming shares: shares issued by a corporation which the
corporation can purchase or take up from holders as
expressly provided for in the AOI and stock certificates
— Redemption: repurchase, reacquisition of stock by a
corporation which issued it in exchange for property, whether
or not the stock is canceled, retired, or held in the treasury
o Corporation gets back some of its stock, distributes cash
or property as payment, and continues its business as
before
— May be purchased or taken up by the corporation upon the
expiration of a fixed period, regardless of unrestricted
retained earnings
— May be redeemed regardless of whether or not there are
unrestricted retained earnings, provided the corporation has
sufficient assets in its books to cover debts and liabilities
— SEC Rules: in issuing redeemable shares, corporations must
set up and maintain a sinking fund
— If the option to redeem is clearly vested in the corporation,
the redemption is an “optional” one and the SH is without
right to either compel or refuse the redemption
— Amount of unrestricted retained earnings equivalent to the
cost of treasury shares held shall be restricted from being
declared and issued as dividends
6. Founder’s shares
— Sec 7: founder’s shares classified as such in the AOI may be
given certain rights and privileges not enjoyed by owners of
other shares
— If it involves the exclusive right to vote and be vote for in the
election of directors, it shall not exceed 5 years
Nature of Subscription Contract
— Underpins the relationship between the SH and the corporation
— 72: holders of subscribed shares not fully paid which are not delinquent
shall have ALL the rights of a SH
o it is the subscription to shares, and not the payment, that create the
legal relationship between the SH and the corporation (Fua Cun case
infra)
o full payment of the subscription value and/or issuance of the
covering certificates are not important ingredients for transfer of
ownership (72)
o registration of the subscription is also not essential to constitute
subscription and issuance of shares; it is merely meant to govern the
binding effects of sale and dispositions of shares as to third persons
(63)
— two ways to become a SH:
o by subscription to shares before or after incorporation
o by acquisition of already issued shares from an existing SH
— Def’n of subscription: a contract for the acquisition of unissued stock of
a corporation whether existing or still to be formed
o subscription price need not be paid in full at the time of the contract
o once perfected, SH becomes a debtor to the corporation and may be
liable to pay any unpaid portion upon call by the board
 no interest unless by-laws provide
 SH personally liable for the financial obligations of the
corporation to the extent of his unpaid portion
— When shares deemed subscribed
o 60: any contract for the acquisition of unissued stock in an existing
corporation or one still to be formed shall be deemed a subscription
agreement
 even if the parties refer to it as some other contract
o The entering into any contract for the acquisition of UNISSUED stock,
which shall be deemed as a subscription agreement, would itself
constitute the tradition by which the subscriber becomes a SH of the
corporation and through which he becomes the owner of the shares
and thus exercise acts of ownership
60-60: pre-incorp contracts are valid & enforceable;
 A subscription agreement constitutes
necessarily the very
binding mode
on the by
corporation; EXC: when the subscriber
which shares are thereby issued and then owned
 It exists upon the meeting of the minds of the corporation
and the subscriber as to the number and value of the
subscription of shares
 The covered shares would then be deemed issued by the
corporation at that point in time
• The sale of unissued shares of stock may be treated
wholly as a sale of shares governed by the law on
sales (Bayla)
• The entire shareholdings of a SH, even when not
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fully paid for, belong in ownership to him with
legal authority to sell or mortgage the same (Fua
Cun)
— Is a valid subscription agreement enforceable even when it is not
reduced in writing?
o Villaneuva: yes! Corporation can adduce oral evidence on a
verbal agreement
Characteristics of Subscription agreements
— There can be a subscription only with reference to UNISSUED shares
of stock
o Original issuance from authorized stock at the time of
incorporation
o Opening of a portion of the original but unissued authorized
capital stock to subscription
o Increase of authorized capital stock through formal amendment
of the AOI and approval of the SEC
— On ISSUED shares: any transaction thereon is NOT a subscription
agreement, and is therefore governed by the Law on Sales
— 60: agreements for the acquisition of unissued shares shall be
deemed a subscription agreement
o affords protection to corporate creditors so that any and all
transactions relating to the issuance of shares of stock is a
subscription agreement
o in case of insolvency, corporate creditors may enforce even
against one denominated as a purchaser
— Stipulations in subscription agreements of unissued shares that the
subscriber’s right to be treated as a SH and enjoy the rights thereof
would commence upon full payment of the subscription would be
VOID
o Affects the ability or liability of the subscription agreement
o Agreement will not be treated as a sale of shares; falls under Sec
60
o areIt types
is onlyofwhen
promoter’s contracts…
delinquency GR: a that
is declared promoter’s contractthe
would deprive is not
corp received the benefits
rights ofat the time of its creation
a SH
Sec 66
Garcia v. Lim Chu Sing. F: Lim Cuan Sy is the debtor of the
Mercantile Bank of China, by virtue of a trust account with the bank,
in the form of trust receipts guaranteed by CMs and by Defendant
Lim Chu Sing as the surety of Lim Cuan. Lim Chu is also a SH of the
bank iao P10000. When the obligation became due, the bank
foreclosed the CMs without the knowledge of the surety Lim Chu. The
bank also required Lim Chu as surety to execute a PN, where in the
event of Lim’s default in payment of any installment as they become
due, the entire amount or unpaid balance becomes due and
demandable. Lim leaves a balance of P9,105.17. The bank is under
liquidation at the time of the action.
I: W/N it is proper to compensate Lim’s indebtedness with the sum of
P10000 in shares of stock with the Mercantile Bank of China.
H: A share of stock or the certificate thereof is not an indebtedness to
the owner nor evidence of indebtedness, and is thus not a credit. SHs
are not creditors of the corporation. The capital stock of a corporation is
a trust funds to be used for the security of the creditors of the
corporation, who deal with it on the credit of the capital stock. SC ruled
that Lim Chu not being a creditor of the Bank, although the latter is a
creditor of the former, there is no sufficient ground to justify a
compensation.
1. Pre-incorporation subscription
— Theories on the binding effect of pre-incorporation subscriptions:
o Offer theory: such subscriptions are only continuing offers to the
proposed corporation which do not ripen into contracts until
accepted by the corporation when organized
 Thus subscribers are allowed to withdraw their subscription
at any time before the corporation comes into existence and
accepts the offer
o Contract theory: becomes a binding contract and is irrevocable from
the time of subscription unless cancelled by all parties before
acceptance by the corporation
 Prevents subscribers from withdrawing unless consented to
by all subscribers
— Sec 61: Corpo Code adopts the view that when a group of persons sign a
subscription contract, they are deemed not only to make a continuing
offer to the corporation but also to have contracted with each other as
well
— 61: GR: a pre-incorporation subscription shall be IRREVOCABLE for a
period of at least 6 months from date of subscription
o Exceptions:
 When all the other subscribers consent to the revocation
 Incorporation fails to materialize within 6 months or longer
as may be stipulated in the subscription agreement
o Fusion of the best features of the offer and contract theories
 Contract between subscriber and the to-be-formed
corporation
60: any contract
 for the
Contract acquisition
between and of unissued
among stock in an thus it is
the subscribers;
existing or tobeyond
be formed corp shall be deemed a subscription,
the powers of the board to release the subscribers
notwithstanding reference by the parties as a purchase or some
other contract
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since the consent of all is necessary (Velasco v Poizat
infra)
o Consistent with 25% minimum requirement
o After 6 month period, a pre-incorporation subscriber may revoke
his subscription agreement without the consent of the other
subscribers
o But if AOI have already been submitted to SEC, there can be no
more revocation even if other subscribers consent and even after
6 month period
o Once perfected, each subscriber has to comply with his contract
and pay his subscription; not even the corporation can release
him
Sec 13
Sec 61
Wallace v. Eclipse Pocahontas Coal Co. F: Case involves a contract
entered into by Wallace and the promoters of the Eclipse Pocahontas
Coal Co. Wallace was to transfer and assign an option for a lease to
the promoters and from the promoters to the corporation, in
exchange for money to pay for the purchase price for the lease, and
once the corporation is up and running, Wallace was to have a 1/5
interest in the property fully-paid up, and a 1/5 interest in the
corporation fully paid up. Wallace was also to be entitled to 50 shares
of the corporation, but only 5 shares were issued to him. Wallace
alleged that the corporation and its promoters failed to perform their
part of the contract. TC ruled that Wallace was to recover a little over
$1000 from each of the defendants, or a total of $4300, which the
court found to be the value of 43 shares which he had been deprived,
being 1/5 of the shares issued less 5 shares delivered to him. The
corporation was not held liable. Wallace contends that he was
erroneously limited to money decrees against the promoters and
seeks a judgment against the entire property and plant of the
corporation as a trust therein his 1/5 undivided interest or a judgment
to order the issuance and delivery of 43 additional shares, or a
judgment for the actual, not par value of the shares.
H: Promoters are indeed solidarily liable to Wallace for the stock to
which he is entitled, and so is the corporation. The corporation and
the other subscribing SHs accepted and benefited from the contract
with Wallace. Thus, not only did the corporation have notice of
Wallace’s right but all the SHs of the corporation participating in the
1st SH meeting of the corporation had notice that Wallace had at least
some interest or claims based on his contract.
Wallace is definitely a subscriber to the stock of the corporation. His
contract was to sell or convey to the corporation the leasehold and
accept payment in fully paid up stock to the value of the property leased
when fully equipped for the business purposes of the corporation. Being
entitled to this amount of stock easily ascertainable when the
equipment was completed, he became entitled to the stock, and a court
of equity can compel specific performance to deliver the shares to him.
One who has paid for his subscription may sue in court to compel the
issuance of proper certificates therefor.
The TC was therefore wrong in limiting Wallace to a money decree
severally against the promoters and not including the corporation.
2. Post-incorporation subscription
— Distinction between purchase and subscription of shares erased by Sec
60
— Since anyone who acquires unissued shares is a subscriber, then he
enjoys all rights of a SH regardless of w/n he has fully paid for his
subscription (unless he becomes delinquent)
— Since he is a debtor to the corporation, the subscriber remains liable to
pay the balance of his subscription price
Bayla et al v Silang Traffic Co Inc. F: Bayla et al are SHs who file an
action to recover certain sums of money which they had paid to the
corporation on account of shares of stock they individually agreed to
take and pay for under certain specified conditions. The action is based
on a resolution by the board of Silang Traffic Inc. The resolution revokes
the rescission of the agreement. Silang argues that the resolution does
not apply to Bayla because on the date thereof the subscribed shares
had already automatically reverted to the corporation, and the
installments paid had already been forfeited, without need for demand,
and that the resolution itself had been revoked. TC ruled ifo Silang
Traffic, invoking the ruling in Velasco v Poizat that a corporation has no
legal capacity to release an original subscriber to its capital stock from
the obligation to pay for its shares, and any agreement to this effect is
invalid. CA affirms. The parties, TC and CA treated the agreement as a
contract of subscription to the capital stock of Silang Traffic. It should be
noted that the agreement is entitled, “Agreement for Installment Sale of
Shares in the Silang Traffic Co. Inc, and that while the purchaser is
designated as a “subscriber”, the corporation is described as “seller.”
The agreement took effect long after incorporation of the company.
I: W/N the contract in question is a subscription or a contract of sale.
H: Whether a particular contract is a subscription or a sale of stock is a
matter of construction and depends upon its terms and intention of the
parties. A subscription to a stock in an existing corporation is, as
9
between the subscriber and the corporation, simply a contract of
purchase and sale. Thus the terms of the contract indicate that they
are contracts of sale and not of subscription.
A subscription is the mutual agreement of the subscribers to take and
pay for the stock of a corporation, while a purchase is an independent
agreement between the individual and the corporation to buy shares
at a stipulated price. Likewise, the rule that the corporation has no
legal capacity to release an original subscriber to its capital stock
from the obligation to pay for his shares, is inapplicable to a contract
of purchase of shares. The contract being one of purchase and not
subscription there is no legal impediment to its rescission by
agreement of the parties. The rescission was made for the good of
the corporation and in order to terminate the pending civil case.
Since the civil case was eventually dismissed, and that the
purchasers of stock would be able to benefit by the resolution. It
would be an unjust discrimination to deny the same benefit to Bayla.
There is also no intimation that the corporation is insolvent, or that
the right of any creditor was prejudiced by the rescission.
I: W/N under the contract, the failure of the purchaser to pay any of
the installments automatically gave rise to the forfeiture of the paid
installments.
H: the contract did not expressly provide for automatic forfeiture and
cancellation without necessity of demand. Under the CC persons
obliged to deliver or do something are not in default until the amount
the creditor judicially demands the same, unless the obligation or the
law expressly provides that demand shall not be necessary or that by
reason of the nature and circumstances of the obligation it shall
appear that the designation of the time when the thing is to be
delivered or service rendered was the principal inducement to the
creation of the obligation.
— The nature of a contract covering unissued shares after incorporation
was either a subscription contract or a purchase of shares of stock,
depending on the terms of the agreement and intent of the parties
— Subscription agreements are mutual agreements among subscribers
to take and pay for the stock of a corporation, and it is not possible
for SHs to withdraw from such an agreement without the consent of
the other subscribers
— Purchase agreements are independent agreements between the
individual and the corporation to buy shares at a stipulated price
Preemptive Right to Shares
1. Basis of right; common law rule

— Preemptive right: option privilege of an existing SH to subscribe to a
proportionate part of shares subsequently issued by the corporation
before the same can be disposed in favor of others
o Common-law right granted to SHs of a corporation to be granted
the first option to subscribe to any opening of the unissued
capital stock, or to any increase from the authorized capital
stock
— Economic aspect: right to invest capital—the right becomes valuable
when the enterprise has demonstrated that it will earn a higher rate
of return on the capital than the SH could get were he to invest it in
the open market
— Limited to shares issued in pursuance of an increase in the
authorized capital stock; does not apply to additional issues of
originally authorized shares forming part of the existing capital stock
— An original subscriber is deemed to have taken his shares knowing
that they form a definite proportionate part of the whole number of
authorized shares
— When unsubscribed shares are later reoffered, the SH cannot claim
that his interest would be diluted
— Preemptive rights are not statutory rights, but common law rights
— Preemptive rights are personal rights of the SH
o Need not be stipulated in the AOI or by-laws
o May be removed, denied, or altered only through specific
provisions in the AOI or amendment thereto
o SEC: vote by majority of SHs to waive the right is NULL and
VOID; such waiver must be given individually by the SHs
concerned
 But unanimous vote of all will bind them
2. Extent and limitations of preemptive right under Code
Sec 39: all SHs of a stock corporation shall enjoy pre-emptive rights to
subscribe to all issues and dispositions of shares of any class, in proportion
to their respective shareholdings
— Exceptions:
o If denied by the AOI or an amendment thereto
o On shares issued in compliance with laws requiring stock offerings or
minimum stock ownership by the public
o On shares to be issued in GF, approved by at least 2/3 OCS in
exchange for property for corporate purposes
o On shares to be issued in GF, approved by at least 2/3 OCS, in
payment of a previously contracted debt
Coverage of preemptive right…
10
— All issues or disposition of shares of any class
— Includes issues from the existing unsubscribed portion of
authorized capital stock
— Includes not only new shares but also previously unissued shares
which form part of the existing authorized capital stock
— Includes reissuance and sale treasury shares
— SEC: does not include subscription deposits; these are payments
received for the future issuance of stock which may or may not
materialize
… except…
— When shares are issued in exchange for property needed for
corporate purposes, or for a debt previously contracted, the SH
cannot demand his preemptive right
— Where all shares are issued by a corporation in exchange for
shares in another corporation (merger), the preemptive right
does not exist, provided the issue is made with approval of 2/3
SHs (Thom case)
— In widely held corporations, where future financing plans may be
seriously hindered by the existence of the preemptive right
— Code allows waiver or denial provided it is in the AOI, either as an
original provision or as an amendment
Effects of exercise and waiver of preemptive right
— Exercising SHs still retain their relative and proportionate voting
strength, which will not be affected thereby
— Waiving SHs’ shares may be offered to non-SHs of record on a
first-come-first-served basis
o Not necessary that the shares will again be offered on a pro-
rata basis to SHs who availed of the right
3. In close corporations
— Balance of power in close corporations may be disturbed by an
indiscriminate issuance of new shares without regard to
preemptive right of SHs
— In a close corp, exceptions in Sec 39 are not applicable
Sec 102
4. Waiver of preemptive right
— GR: Any prior waiver or denial should appear in the AOI
o Ordinary waiver agreement is not sufficient
— Exception: If all existing SHs unanimously agree to a waiver,
 although not in the AOI, they will be bound by such agreement
Datu Tagoranao Benito v. SEC. F: Benito subscribed to 460 shares of
the Jamiatul Philippine-Al Islamis Inc. The corporation increase its capital
stock, with an additional issuance of worth P110,980.00. Benito files a
complaint with the SEC alleging that the issuance was made in violation
of his pre-emptive right to the additional issue and that the SHs of
record were not notified of the meeting. SEC ruled that the issuance was
valid, and that his preemptive rights are inapplicable.
H: Issuance is not invalid even without notice to the SHs. The power to
issue shares of stocks is lodged in the board and no SH meeting is
necessary to consider it because additional issuance of shares does not
need SH approval.
GR: preemptive right is recognized only with respect to new issue of
shares, and not with respect to additional issues of originally authorized
shares. The theory is that when a corporation at its inception offers it
first shares, it is presumed to have offered all of those which it is
authorized to issue. The original subscriber is deemed to have taken his
shares knowing that they form a definite proportionate part of the whole
number of authorized shares. When the shares left unsubscribed are
later reoffered, he cannot therefore claim a dilution of interest.
5. When the issue is in breach of trust
— SHs can still object even if preemptive right does not exist or comes
within exceptions in Sec 39 if the directors acted in breach of trust or
to “freeze out” the minority (Ross Transport case)
6. Remedies when right violated
— Aggrieved SH can obtain an injunction or mandamus
— Derivate suit proper, not only in the violation of preemptive right but
also where the violation resulted in waste and mismanagement of
corporate assets
Stokes v. Continental Trust Co. F: Stokes is one of the original SHs of
Continental Trust Co, owning 221 shares at the time of the controversy.
Blair & Co. proposed that if the company decides to increase the capital
stock, they would purchase the new shares at a higher price, and
acquire the right to nominate their people to the board of trustees. The
SH were informed of the Blair offer, and Stokes made his demand to
exercise his preemptive right. Stokes at the SH meeting for the purpose
of increasing the capital stock, demanded the right to subscribe for 221
11
shares of the new stock at par, but was refused. As a result, he now
has only ½ voting power that he had before, because the number of
shares had been doubled while he still owns 221. After the sale to
Blair, Stokes renewed his demand but was again refused. At this time
the stock rose in value, from 450 to 550 to 750. Stokes sued. TC ruled
that Stokes had the right to subscribe, and was entitled to recover the
difference between the market value at the time of increase and its
par value. CA reversed.
I: W/n Stokes had the legal right to subscribe and take the same
number of new stock he held of the old.
H: A vote to increase the capital stock, if it was not the creation of
new and disjointed capital, was in its nature an agreement among the
SH to enlarge their shares in the amount or in the number of the
extent required to effect that increase. If the right claimed by Stokes
was a right of property belonging to him as SH, he could not be
deprived of it by the joint action of the other SHs and of all directors
and officers of the corporation. He has an inherent right to his
proportional share of any dividend declared, or of any surplus arising
upon dissolution, and he can prevent waste or misappropriation of
the property of the corporation by those in control. Hence the power
of the individual SH to vote in proportion to the number of his shares
is vital and cannot be cut off or curtailed by the action of all other SHs
even with the cooperation of the other directors and officers.
The ownership of stock is in the nature of an inherent but indirect
power to control the corporation. The stock, when issued ready for
delivery, does not belong to the corporation, but is held by it with not
power of alienation, and in trust for the SHs, who are the beneficial
owners and become the legal owner upon paying therefor. The new
stock issued by the corporation did not belong to it, but was held in
trust for the SHs.
In this case, the new stock came into existence through the exercise
of a right belonging wholly to the SHs. As the right to increase
belonged to them, the stock when increased belonged to them also,
as it was issued for money and not for property or for some other
purpose other than the sale for money. By the increase in stock the
voting power of Stokes was reduced ½, and while he consented to the
increase he did not consent to the disposition of new stock which
belonged to them. In other words, it was a partial division of property
of the old SHs.
The corporation cannot dispose of the shares to strangers against the
protest of any SH who insists that he has a right to his proportion.
Otherwise the majority could deprive the minority of their proportionate
power in the election of directors and of their proportionate right to
share in the surplus, each of which is an inherent, preemptive, and
vested right of property. It is inviolable and can neither be taken away
nor lessened without consent or a waiver implying consent.
A share of stock is a share in the power to increase stock, and belongs to
the SHs the same as the stock itself. When that power is exercise, the
new stock belongs to the old SHs in proportion to their holding of old
stock, subject to compliance with the lawful terms upon which it is
based.
A SH has an inherent right to a proportionate share of a new stock
issued for money only and not to purchase property for the purposes of
the corporation or to effect a consolidation, and while he can waive that
right, he cannot be deprived of it without his consent except when the
stock is issued at a fixed price not less than par and he is given the right
to take at that price in proportion to his holding, or in some other
equitable way that will enable him to protect his interest by acting on his
own judgment and using his own resources.
After the price was fixed it was the duty of the corporation to offer him
his proportion at that price, for it had notice that Stokes had not
acquiesced in the proposed sale of his share, but wanted it for himself.
The directors were under the legal obligation to give him an opportunity
to purchase at the price fixed before they could sell his property to a
third party, even with the approval of a large majority of the SHs. By
selling to strangers without thus offering to sell him, the corporation
wrongfully deprived him of his property and is liable for such damages.
Thom v Baltimore Trust Co. F: Thom, owner of 6416 of 70000 shares, is
a SH of the Baltimore Trust Co who wants to exercise his preemptive
right to purchase a due proportion of a supplemental issue of its capital
stock. The Baltimore Trust Co wanted to merge with the National Union
Bank of Maryland, and that the company would issue 150000 shares at
$112 to acquire the 10000 shares of National Union Bank at $168/share,
and would require delivery of 70% of the stock. A resolution was passed
to increase the capital stock of Baltimore, which also stipulated that the
SH shall have the pro rata preferential right to subscribe at such price
and terms as the board may fix. In any additional issuance, the directors
may issue without preferential subscription rights and on such terms as
the board may deem proper. Thom protested and voted against the
merger, alleging the corporation disregarded the proportional purchase
right of SHs.
12
H: The preemptive right of SHs are said to be inherent in their stock
ownership. The SHs of a corporation have a preferential right to
purchase new issues of its shares, to the proportional extent of their
respective interests in the capital stock then outstanding. The right
adheres in stock ownership as an essential means of enabling a SH to
maintain the existing ration of his proprietary interest and voting
power in the corporation. In transactions involving the acquisition of
property by corporations in exchange for shares of stock, the
determining consideration to the owners of the property may be the
advantage of sharing as SHs in the profits of the corporation with
which they are contracting. In this case, the preemptive rights of
Thom et al are recognized and protect by the amendment to its AOI.
In declaring the right as to sales of stock for cash, and in restricting it
as to issues of stock for accomplishing merger or acquisition of
property, the amendment is valid.
Ross Transport Inc v Crothers. F: Derivative suit by SH Crothers to
set aside the issuance of stock dividends to 4 SHs and ordering them
to repay Ross Transport Inc the dividends received on stock declared
to be illegally issued. The corporation’s business is to operate a fleet
of buses to service the transport needs of employees of the Triumph
Explosives Inc. The company was an immediate financial success. It
was engaged in a special business, of which it had a monopoly. The
company then issued new stock to the family of the directors and the
president, and had the effect of increasing the outstanding stock.
There was no meeting, no notice, and no offer to the other SHs. The
company declared dividends 3 times, and authorized salary
payments to the officers. The benefit of the dividends would not only
increase the value of the stock, but the first two declared dividends
would pay back all the subscribers had invested, leaving any future
earnings and distributions pure profit. Under these circumstances,
they took the opportunity they thought they had to increase their
investment. Crothers et al contend that changed conditions make it
unnecessary to use the remaining unsold stock to obtain capital.
H: Existing SHs are the owners of the business, and are entitled to
have the ownership continued in the same proportion. Therefore,
when additional stock is issued, those already having shares, are held
to have the first right to buy the new stock in proportion to their
holdings. This is the preemptive right. An exception would be where
the stock about the be issued is part of the original issue. This is
based on the fact that the original subscribers took their stock on the
implied understanding that the incorporators could complete the sale
of the remaining stock to obtain the capital necessary to start the
business. The exception to the exception would be where conditions
have changed since the original issue.
Trustees and directors of corporations cannot purchase, directly or
indirectly, at their own sale. Such a transaction is entirely voidable at the
option of the party interested. The transaction may not be ipso facto
void, but it is necessary to establish that there had been actual fraud or
imposition practiced by the party holding the confidential or fiduciary
relation. In this case, the directors have not shown the company needed
the money so badly and was such in a financial condition that the sale of
additional stock to themselves was the only way the money could be
obtained. On the contrary, the corporation appears to be in a very good
financial condition. The sale must be set aside as a constructive fraud
upon the other SHs.
At the time of the supposed ratification, the principal must have been
fully aware of every material aspect of the transaction, the real value of
the subject of the contract, and his act of ratification must have been an
independent and substantive act founded on complete information and
of perfect freedom of volition.
Debt securities
— Debt contracts one of the two basic sources by which a
corporation is able to finance its operations
— Debt securities (bonds): do not represent an ownership interest
but creates a debtor-creditor relationship between the
corporation and the bondholder
o A person who extends a loan or debt looks at the financial
condition and operations of the corporation as a means of
gauging the ability to pay back the loan
o Creditor (or bondholder) puts no stake on the operations of
the corporate enterprise, and thus the contractual obligation
of the corporation to pay the stipulated return remains even
when operations are incurring losses or there are no
unrestricted retained earnings
o Returns in a loan placement in a corporation: bondholder
would only be able to demand the stipulated fixed returns
even if corporation is hugely profitable because of the loan
o Creditors are legally preferred in payment from a corporation
in a state of insolvency; such corporation must devote and
prefer all corporate assets towards the payment of creditors
o Interest paid on debt securities are deductible to the
corporation for income tax purposes, but generally taxable
to the holder thereof
13
1. Form of borrowings
2. Bonds and debentures
3. Convertible securities; stock options
— Warrants: a type of security which entitles the holder the right to
subscribe to the unissued capital stock of a corporation or to
purchase issued shares in the future, evidenced by a warrant
certificate which may be sold or offered for sale to the public
o Who may issue? Two (2) types of issuers recognized by SEC
 a domestic corporation duly registered
 a person or group of persons who issues or proposes to
issue warrants
o Two types of warrants:
 Subscription warrant-- entitles the holder the right to
subscribe to the unissued capital stock of a corporation
 Covered warrant-- entitles the holder the right to
purchase issued shares in the future
— Stock options: a privilege granted to a party to subscribe to a certain
portion of the unissued capital stock of the corporation within a
specified period and under terms and conditions of the grant,
exercisable by the grantee at any time within the period granted
o No corporation shall grant any stock option unless approved by
the SEC
o Formal board resolution + detailed statement of the stock options
plan
o No exercise shall be valid unless accompanied by payment of not
less than 40% of the total price of shares issued
 25% for employees/officers not directors
 initial payment not required for services already rendered
o guidelines on stock options (SEC)
 may be granted on the basis of proportionate interests of
SHs in the capital stock
 those granted to employees/officers not directors/board
members allowed after review of the stock options
scheme
 those granted to non-SHs allowed upon showing that the
board is duly authorized to grant the same by its AOI or
resolution of SHs 2/3 OCS
 granted to directors/mgt groups/corporate officers must
be approved in a SH meeting, vote of at least 2/3 OCS
 exercisable within a period of 3 years from SEC approval
 no transfer without SEC approval
Merritt-Chapman & Scott Corp v. New York Trust Co. F: Stock
purchase (option) warrants were issued by Merritt-Chapman (MC) in
bearer form. The bearer would be entitled to purchase fully-paid and
non-assessable shares of CS, no par value, at $30/share. To insure that
the stock to be purchased under the warrants would be available, the
trust deed requires that stock certificates for an aggregate amount of
40,000 shares be delivered to the trustee and made the Trust co the
agent of the corporation to receive the purchase price and deliver the
stock certificates. The board of the corporation issued a resolution
declaring a stock dividend iao 40%/shares of no par CS on each legally
issued and outstanding share of CS. The resolution fixed the price at
$20/share, and directed the warrant holders outstanding and to the trust
company the 60-day notice required incase the corporation shall pay
any stock dividend upon the outstanding CS. The corporation contends
that the warrant holder must exercise his warrant before a certain date
in order to share in the dividend. The trustee contends that the
corporation must first deposit with the trustee, stock certificates in the
amount equal to 40% of the certificates now on deposit with the trustee,
and that the holder who wishes to exercise the warrant must pay the
basic purchase price before he will be entitled to receive 1.4 share.
H: The warrants gave the holders the privilege, unlimited in time, to
purchase 40,000 authorized but unissued shares. Had the warrant
holders exercise their option, they would have acquired a definite
percentage of the CS. A stock dividend does not change the proportional
interest of each SH in the corporate enterprise; it changes only the
evidence which represents that interest. It is a mere “watering” of
outstanding shares. If the corporation were at liberty to declare stock
dividends without making provision for warrant holders, the percentage
of interest in the CS capital of the corporate enterprise which the
warrant holders would acquire could be reduced to practically the point
of extinction. The privilege the warrant holders originally had of
acquiring a definite proportional interest in the CS would be lost without
recourse unless their contract with the corporation contained some
provision to protect it. By this covenant the corporation recognized the
possibility that a stock dividend might be declared and paid on
outstanding shares before the warrants had been exercised, and
promised in that event to deposit with the trustee stock certificates
representing that proportion of dividend shares which the shares subject
to the warrants bore to all the CS, and that the trustee would deliver
such dividend shares without additional consideration.
4. Hybrid securities
— Equity securities: represent an ownership interest in the
corporation and includes both CS and PS
14
Jordan & Co. v. Allen. F: The Jordan Company issues “Debenture
Stock.” The company believes that the pay-outs made on the
debentures were actually interest, and thus entitling them to
deductions from their taxable income. The IRS claims the pay-outs
were dividends to the holders.
I: W/N payments made to the holders of Debenture stock of the
Jordan Company were payments of interest on outstanding
obligations or dividends paid on invested capital.
H: The answer rests on what the payments actually are, and not what
the payments are called. Although there is no precise formula, the
usual factors considered are the ff: (1) treatment by the parties; (2)
maturity date and right to enforce collection; (3) rank/preference
during dissolution; (4) uniform rate of interest or income payable; (5)
participation in the management and right to vote.
(1) voting rights: if security holders had such rights, this would
strongly indicate that the securities were stocks; the absence
or extremely limited rights is of little probative value, because
it is common both to bonds and preferred stock
(2) treatment by the parties: in this case the company itself
treated the debenture stocks as an obligation and the
payments as interest. No evidence as to how the holders
treated the same.
(3) Preference/rank in dissolution: GR holders of obligations are
secured or general creditors of the corporation and rank as
such on dissolution. Here the holders ranked ahead of the
other SHs but inferior to general creditors. One of the most
important considerations is whether the right to share in the
assets of the corporation in case of dissolution is subject to
the rights of creditors. If subject to such rights, there is a
strong presumption that the interest in question is that of a
SH
(4) Payment out of profits: the debentures provide for payment of
interest at a prescribed rate to paid out of the profits only.
This fact loses significance when considered in conjunction
with the provision that holders should rank inferior to general
creditors
(5) Maturity date and right to enforce payment. Of utmost
significance. The existence of a fixed maturity date for the
principal sum, together with the right to enforce payment as
debt in case of default, is the most essential feature of a
 debtor and a creditor as opposed to a SH relationship. One of the
most fundamental characteristics of a debt is a definite
determinable date on which the principal falls due. The
obligation in the debenture stock clearly had no maturity date.
There was no time when the holders could demand their money;
they were at the mercy of the company’s fortunes and payment
was merely a way of distributing profit. Although the officers
considered the debenture stock as matured after 20 years, mere
opinion of corporate officers cannot override the provisions of
the certificates themselves and the charter and by-laws. It is to
be noted that when the issue was retired, after officers
considered it matured, they retired it at a premium. Payment of
premiums is certainly more consistent with the retirement of
stock than with payment of past due obligations. The contention
of the officers that the term of the debenture matures upon
termination of corporate existence is also untenable. Termination
of corporate existence cannot be considered the maturity of the
debenture stock as it would not be a fixed or determinable date
set in advance, but could be constantly moved forward simply by
corporate action.
5. Trust indenture
Alladin Hotel Co v Bloom. F: Bloom is a minority bondholder of bonds
issued by the Alladin Hotel Co. The bonds are secured by a deed of trust
by which was mortgaged certain real estate, with the Mississippi Valley
Trust Co as trustee. The deed of trust contained provisions empowering
bondholders of not less than 2/3 to modify and extend the date of
payment of the bonds. The Joneses are majority bondholders as well as
the majority SHs of the company who entered into an agreement with
the company to extend the maturity date of the bonds. The changes
were certified by the trust company and has the consent of holders of
2/3 the principal amount of the bonds. Bloom objects to the change,
contending that these were invalid for not being made in GF and that it
was not for the benefit of the minority bondholders and deprived them
of their rights and property. She added that the Joneses acted in a dual
capacity as trustees for the other bondholders, being the majority, and
therefore must not act detrimental to the rights of the other holders. She
also added that the modifications are void for not giving notice to the
other bondholders. TC held that the changes did not benefit the minority
bondholders and that the bondholders were entitled to notice. But it held
that the decree should be limited to a money judgment only. The hotel
appeals.
H: the modifications were made in strict compliance with the provisions
15
of the trust deed, which did not provide for notice to the bondholders.
The changes were approved by 2/3 of the bondholders. The rights of
the bondholders are to be determined by their contract and courts
will not make or remake a contract merely because one of the parties
may become dissatisfied with the provisions. There is no question
that the provisions in the trust deed and the bonds were legal
provisions which violated no principle of public policy or private right.
No notice was required so far as the parties to the contract were
concerned. Their rights must be determined by their contract and not
by any equitable doctrine, and notice to the other bondholders could
have served no possible purpose. There is no substantial evidence
warranting BF, fraud, or corruption on the part of the Joneses. The
changes made in the provisions of the trust deed were made before
Bloom acquired her bonds, and were in fact past due when she
purchased them. Bloom, with notice of the changes made, and with
knowledge that she had no notice of the application for the changes,
made no effort to repudiate it until she brought the suit, but accepted
interest payable under the provisions of the contract.
Trust Fund doctrine
— A corporate theory which seeks to protect the interest of corporate
creditors
o Capital stock of the corporation, especially its unpaid
subscription, is a trust fund for the benefit of the general
creditors of the corporation
o When a corporation is solvent, the theory that its capital stock is
a trust fund upon which there is any lien for the payment of its
debts has in fact, very little foundation.
o No general creditor has any lien upon the fund under such
circumstances, and the right of the corporation to deal with its
property is absolute so long as it does not violate its charter or
the applicable law.
— Proper scope of the doctrine is that capital stock of a corporation
(insolvent), as well as all its other property and assets are generally
regarded in equity as a trust fund for the payment of corporate debts
— In RP jurisdiction trust fund doctrine applies in four cases:
a) Where the corporation has distributed its capital among
the SHs, without providing for the payment of creditors
b) Where it had released the subscribers to the capital stock
from their subscriptions
c) Where it has transferred the corporate property in fraud
of creditors
d) Where the corporation is insolvent
— The doctrine as applied to a corporation not insolvent, would only be
 up to the extent of the capital stock of the corporation
o Retained earnings not covered since it does not constitute capital
stock
o Thus corporations are at liberty to declare and pay out its assets by
way of dividends up to the extent of its unrestricted retained
earnings
— Phil Trust v Rivera (infra): subscriptions to the capital of the corporation
constitute a fund to which the creditors have a right to look for
satisfaction of their claims and that the assignee in insolvency can
maintain an action upon any unpaid stock subscription in order to realize
assets for payment of its debts
Requirements under the Revised Securities Act
1. Purpose and History of Revised Securities Act
2. Registration of securities
3. Exempt securities and exempt transactions
4. Registration of brokers, dealers, and salesmen
5. Registration of stock exchange
6. Remedies of investor; SEC powers
Underwriting Securities
Can never create preferences where SHs would
have attributes of creditors over other SHs
Debtor-creditor= SH-corp? yes as to unpaid
subscription
Preemptive right: benefits orig subscriber
Pay up, or lose whole subscription (min 25%)
Once paid, rights accrue
If business is profitable, orig subscribers should
have 1st crack at additional issuances
Dilution: noone can exercise preemptive right
Consequences: shift in control/management
Usually denied in listed corporations
Immediate opportunity to raise funds
Otherwise deprive corporation of opportunity
89: contractual arrangements
public offering
opportunity to corporation for financing
denial would also benefit SHs!
Might enhance value of subscription
Merger
Bigger business, more clients
Read dissent in Hay: more reasonable
Merritt Chapman: consideration for warrant is
separate and distinct from the shares
Holders of stock options are not owners of the
stock; no stock has been issued or purchased by
them, thus not entitled to dividends paid
Whether equity or loans, these funds end up ultimately as assets of the
corporation
Investment and credit are two separate and distinct sources of funds
Loans/debt:
Creditors have a lien on corporate assets
Revenues that ff will be earmarked for payment of obligations
SHs do not have any definite right over the amount loaned or assets
earmarked
An indebted corporation is not barred from declaring dividends
Creditor has fixed return based on interest due
Lien on corporate assets
w/n corporation is healthy, I still get paid
I get paid 1st before everyone else
Secured/unsecured= preference is undistinguished as to SHs
Equity:
Expectancy/inchoate: no guarantee to SHs
Risk involved; be prepared to lose
Recoverability of investment depends on viability of business
But SHs can get dividends resulting from revenues
SHs: not fixed return, so long as company is healthy
Depends on profitability= unrestricted retained earnings
Dividends, but more onerous risk
Preferences: control (board seats, voting), or economic benefits
(depends on extent of contribution and unrestricted retained earnings)
Givens:
No guarantee on investment
Cannot be same stature among them
Consideration
Proprietary rights
Money
SH prerogative of paying in full or hope that the business will be good
and pay dividends to take care of business
Min paid up: 25%
If I don’t pay and business is bad (i.e. no dividends), I am suspended, I
cannot exercise my rights as SH
Sec 7: founder’s shares: “mayayabang lahat”
Market price may be higher than issued value
For those who want control, economic benefits, and bragging rights
Sec 6: classifications
CS: control through common shares
Voting for BOD and corporate acts
Same or different par values
16 Same voting rights regardless of value
PS: Preference on dividends
Coupon returns/year
10-redeemable