DUTIES OF DIRECTORS AND CONTROLLING STOCKHOLDERS

Duties and Liabilities of Directors

WHAT IS THE 3-FOLD DUTY THAT DIRECTORS OWE TO THE CORPORATION?

(1) Diligence
(2) Loyalty
(3) Obedience

Obedience - directors must act only within corporate powers and are liable for
damages if they acted beyond their powers unless in good faith. Assuming that they
acted within their powers, liability may still arise if they have not observed due
diligence or have been disloyal to the corporation.

WHEN DOES LIABILITY ON THE PART OF DIRECTORS, TRUSTEES OR OFFICERS ARISE?

In general, liability of directors, trustees or officers arises when they either:

(1) willfully and knowingly vote for or assent to patently

unlawful acts of the
corporation; or
(2) are guilty of gross negligence of bad faith in directing the
affairs of the corporation; or
(3) acquire any personal or pecuniary interest in conflict with their duty as such
directors or trustees.

In such cases, the directors or trustees shall be liable jointly and severally for
all damages resulting therefrom suffered by the corporation, its stockholders or
members and other persons.

When a director, trustee or officer attempts to acquire or acquires, in

violation of his duty, any interest adverse to the corporation in respect of any
matter which has been reposed in him in confidence, as to which equity imposes a
disability upon him to deal in his own behalf, he shall be liable as a trustee for
the corporation and must account for the profits which would otherwise have accrued
to the corporation. (Sec. 31)

In addition to this general liability, the Corporation Code provides

for specific rules to govern the following situations:

(1) Self-dealing directors (Sec. 32)

(2) Contracts between interlocking directors (Sec. 33)
(3) Disloyalty to the corporation (Sec. 34)
(4) Watered stocks (Sec. 65)

Duty of Diligence: Business Judgment Rule.

WHAT IS THE BUSINESS JUDGMENT RULE?

As a general rule, directors and trustees of the corporation cannot be held liable
for mistakes or errors in the exercise of their business judgment, provided they
have acted in good faith and with due care and prudence. Contracts intra vires
entered into by the board of directors are binding upon the corporation, and the
courts will not interfere unless such contracts are so unconscionable and
oppressive as to amount to a wanton destruction of the rights of the minority.

However, if due to the fault or negligence of the directors the assets

of the corporation are wasted or lost, each of them may be held responsible for any
amount of loss which may have been proximately caused by his wrongful acts or
omissions. Where there exists gross negligence or fraud in the management of the
corporation, the directors, besides being liable for damages, may be removed by the
stockholders in accordance with Sec. 28 of the Code. (Campos & Campos)

GENERAL RULE: Contracts intra vires entered into by BoD are binding upon
the corporation and courts will not
interfere.

EXCEPTION: When such contracts are so unconscionable and oppressive

as to amount to a wanton destruction of the
rights of the minority.

WHAT KIND OF DILIGENCE IS EXPECTED OF DIRECTORS?

Directors are expected to manage the corporation with reasonable diligence,

care and prudence, i.e. the degree of care and diligence which men prompted by
self-interest generally exercise in their own affairs. Thus, they can be held
liable not only for willful dishonesty but also for negligence.
Although they are not expected to interfere with the day-to-day
administrative details of the business of the corporation, they should keep
themselves sufficiently informed about the general condition of the business.

WHAT FACTORS SHOULD BE CONSIDERED IN DETERMINING WHETHER REASONABLE DILIGENCE HAS

BEEN EXERCISED?

The nature of the business, as well as the particular circumstances of each

case. The court should look at the facts as they exist at the time of their
occurrence, not aided or enlightened by those which subsequently took place.
(Litwin v. Allen)

The self-dealing director

WHAT IS A SELF-DEALING DIRECTOR? (Sec. 32)

A self-dealing director is one who enters into a contract with the

corporation of which he is a director.

WHAT IS THE NATURE OF CONTRACTS ENTERED INTO BY SELF-DEALING DIRECTORS?

Voidable at the option of the corporation, whether or not it suffered

damages. It is possible that the self-dealing director may have the greatest
interest in its welfare and may be willing to deal with it upon reasonable terms.

However, such contract may be upheld by the corporation if all of the

following
conditions are present:

(1) The presence of the self-dealing director or trustee in the board meeting
for which the contract was approved was not necessary to constitute a quorum for
such meeting;
(2) The vote of such self-dealing director or trustee was not necessary for the
approval of the contract;

(3) The contract is fair and reasonable under the circumstances;

(4) In the case of an officer, the contract has been previously authorized by the
Board of Directors.

In the event that either of or both conditions (1) and (2) are absent (i.e., the
presence of the director/trustee was necessary for a quorum and/or his vote was
necessary for the approval of the contract), the contract may be ratified by a 2/3
vote of the OCS or all of the members, in a meeting called for the purpose. Full
disclosure of the adverse interest of the directors or trustees involved must be
made at such meeting.

DOCTRINE: A director of a corporation holds a position of trust and as such,

he owes a duty of loyalty to his corporation. In case his interests conflict with
those of the corporation, he cannot sacrifice the latter to his own advantage and
benefit. As corporate managers, directors are committed to seek the maximum amount
of profits for the corporation. This trust relationship "is not a matter of
statutory or technical law. It springs from the fact that directors have the
control and guidance of corporate affairs and property and hence of the property
interests of the stockholders." (Prime White Cement Corp. v. IAC, 220 SCRA 103;
1993)

MEAD V. MCCULLOUGH (21 Phil. 95; 1911)

Issue: validity of sale of corp. property and assets to the directors who approved
the same.

Gen Rule: When purely private corporations remain solvent, its directors are agents
or trustees for the SH.

Exception: when the corp. becomes insolvent, its directors are trustees of all the
creditors, whether they are members of the corp. or not, and must manage its
property and assets with strict regard to their interest; and if they are
themselves creditors while the insolvent corp is under their management, they will
not be permitted to secure to themselves by purchasing the corp property or
otherwise any personal advantage over the other creditors.

Exception to Exception: A director or officer may in good faith and or an adequate

consideration purchase from a majority of the directors or SH the property even of
an insolvent corp, and a sale thus made to him is valid and binding upon the
minority.

In the case at bar, the sale was held to be valid and binding. Company was losing.
4 directors present during meeting all voted for the sale. They likewise constitute
majority of SH. Contract was found to be fair and reasonable.

Using inside information

USE OF INSIDE INFORMATION: Do directors and officers of a company owe any duty at
all to stockholders in relation to transactions whereby the officers and directors
buy for themselves shares of stock from the stockholders?

MINORITY RULE: YES. Directors and officers have an obligation

to the stockholders individually as well
as collectively.
 MAJORITY RULE: NO. Directors and officers owe no fiduciary
duty at all to stockholders, but may
deal with them at arm’s
length. No duty of disclosure of facts known to the
director or officer exists. Nondisclosure cannot
constitute constructive fraud.

SPECIAL FACTS DOCTRINE: IT DEPENDS. Where special circumstances

or facts are present which make in inequitable to
withhold information from the stockholder, the duty
to disclose arises, and concealment is fraud.

In the case of Gokongwei v. SEC (89 SCRA 336; 1979), the Supreme Court,
quoting from the US case of Pepper v. Litton (308 U.S. 295-313; 1939) stated that a
director cannot, "by the intervention of a corporate entity violate the ancient
precept against serving two masters … He cannot utilize his inside information and
his strategic position for his own preferment. He cannot violate rules of fair
play by doing indirectly through the corporation what he could not do directly. He
cannot use his power for his personal advantage and to the detriment of the
stockholders and creditors no matter how absolute in terms that power may be and no
matter how meticulous he is to satisfy technical requirements. For that power is
at all times subject to the equitable limitation that it may not be exercised for
the aggrandizement, preference, or advantage of the fiduciary to the exclusion or
detriment of the cestuis."

Seizing Corporate Opportunity (Sec. 34)

If a director acquires for himself, by virtue of his office, a business opportunity

which should belong to the corporation, thereby obtaining profits to the prejudice
of the corporation, he must account to the corporation for all such profits by
refunding the same. However, if his act was ratified by 2/3 stockholders' vote, he
need not refund said profits. This provision applies even though the director may
have risked his own funds in the venture.

Note: This provision is to be distinguished from Sec. 32 on contracts of

self-dealing
directors: contracts of self-dealing directors are voidable at the option of the
corporation even if it has not suffered any injury; on the other hand, Sec. 34
applies only if the corporation has been prejudiced by the contract.

Interlocking directors

WHAT IS AN INTERLOCKING DIRECTOR?

An interlocking director is one who occupies a position in 2 companies

dealing with each other.

WHAT IS THE RULE ON CONTRACTS INVOLVING INTERLOCKING DIRECTORS?

Except in cases of fraud, and provided the contract is fair and

reasonable under the circumstances, a contract between 2 or more corporations
having interlocking directors shall not be invalidated on that ground alone. This
practice is tolerated by the Courts because such an arrangement oftentimes presents
definite advantages to the corporations involved.
However, if the interest of the interlocking director in one corporation is
substantial (i.e., stockholdings exceed20% of the OCS) and his interest in the
other corporation or corporations is merely nominal, he shall be subject to the
conditions stated in Sec. 32, i.e., for the contract not to be voidable, the
following conditions must be present:

(1) The presence of the self-dealing director or trustee in the board meeting
for which the contract was approved was not necessary to constitute a quorum for
such meeting;
(2) The vote of such self-dealing director or trustee was not necessary for the
approval of the contract;
(3) The contract is fair and reasonable under the circumstances;
(4) In the case of an officer, the contract has been previously authorized by
the Board of Directors.

In the event that either of or both conditions (1) and (2) are absent (i.e., the
presence of the director/trustee was necessary for a quorum and/or his vote was
necessary for the approval of the contract), the contract may be ratified by a 2/3
vote of the OCS or all of the members, in a meeting called for the purpose. Full
disclosure of the adverse interest of the directors or trustees involved must be
made at such meeting.

Note: The Investment House Law prohibits a director or officer of an investment

house to be concurrently a director or officer of a bank, except as otherwise
authorized by the Monetary Board. In no event can a person be authorized to be
concurrently an officer of an investment house and of a bank except where the
majority or all of the equity of the former is owned by the bank. (P.D. 129, Sec.
6, as amended)
The Insurance Code likewise prohibits a person from being a director
and/or officer of an insurance company and an adjustment company. (Sec. 187)

Watered stocks (Sec. 65)

Any director or officer of the corporation:

(1) consenting to the issuance of stocks for a consideration less than its par
or issued value or for a consideration in any form other than cash, valued in
excess of its fair value, or
(2) who, having knowledge thereof, does not forthwith express his objection in
writing and file the same with the corporation secretary

shall be solidarily liable with the stockholders concerned to the corporation and
its creditors for the difference between the fair value received at the time of the
issuance of the stock and the par or issued value of the same.

Fixing compensation of directors and officers

GENERAL RULE: Directors as such are not entitled to compensation for

performing services ordinarily attached to their office.

EXCEPTIONS: (1) If the articles of incorporation or the by-laws

expressly so provide;
(2) If a contract is expressly made in
advance.

WHO FIXES THE COMPENSATION? The stockholders only (majority of the OCS)

EXCEPTION: Per diems, which can be fixed by the directors

themselves
APPLICABILITY OF COMPENSATION: Only to future and NOT past services.

MAXIMUM AMOUNT ALLOWED BY LAW: Total yearly income of the directors shall
not exceed 10% of the net income before income tax of the corporation during the
preceding year (Sec. 30)

Close Corporations

Sec. 97 provides that the AOI of a close corp. may specify that it shall be managed
by the stockholders rather than the BoD. So long as this provision continues in
effect:

· No stockholder’s meeting need be called to elect directors;

· Generally, stockholders deemed to be directors for purposes of this Code,

unless the context clearly requires otherwise;

· Stockholders shall be subject to all liabilities of directors. The AOI

may likewise provide that all officers or employees or that specified officers or
employees shall be elected or appointed by the stockholders instead of by the BoD.

Further, Sec. 100 provides that for stockholders managing corp. affairs:

· They shall be personally liable for corporate torts (unlike ordinary

directors liable only upon finding of negligence)

· If however there is reasonable adequate liability insurance, injured

party has no right of action v. stockholders-managers

Duty of Controlling Interest

A SH/director is still entitled to vote in a stockholder’s meeting even if his

interest is adverse to a corporation. But a stockholder able to control a corp. is
still subject to the duty of good faith to the corp. and the minority.

Persons with management control of corporation hold it in behalf of SHs and can not
regard such as their own personal property to dispose at their whim.

The ff. acts are legal:

· Transfer of managerial control through BoD resignation & seriatim

election of successors if concomitant with the sale and actual transfer of majority
interest or that which constitutes voting control;

· Disposal by controlling SH of his stock at any time & at such price he

chooses

The ff. are illegal:

· Selling corp. office or management control by itself, that is NOT

accompanied by stocks or stocks are insufficient to carry voting control;
· Transferring office to persons who are known or should be known as
intending to raid the corporate treasury or otherwise improperly benefit themselves
at the expense of the corp. (Insuranshares Corp. V. Northern Fiscal);

· Receiving a bonus or premium specifically in consideration of their

agreement to resign & install the nominees of the purchaser of their stock, above
and beyond the price premium normally attributable to the control stock being sold;

Duty to Creditors

General rule: Corporate creditors can run after the corp. itself only, and not the
directors for mismanagement of a solvent corp.

If corp. becomes insolvent, directors are deemed trustees of the creditors and
should therefore manage its assets with due consideration to the creditor’s
interest.

If directors are also creditors themselves, they are prohibited from gaining undue
advantage over other creditors.

Personal Liability of Directors

In what instances does personal liability of a corporate director, trustee or

officer validly attach together with corporate liability?

When the director / trustee / officer:

I. (1) assents to a patently unlawful act of the corporation;

(2) is in bad faith or gross negligence in directing the affairs of the
corporation;
(3) creates a conflict of interest, resulting in damages to the corporation, its
stockholders or other persons

II. Consents to the issuance of watered stocks, or who, having

knowledge thereof, does not forthwith file with the corporate secretary his written
objection thereto;

III. Agrees to hold himself personally and solidarily liable with

the corporation;

IV. Is made, by a specific provision of law, to personally answer

for his corporate action.

(Tramat Mercantile v. CA, 238 SCRA 14)

CORPORATE BOOKS AND RECORDS
AND
THE RIGHT OF INSPECTION

Corporate Books and Records

WHAT BOOKS AND RECORDS MUST A CORPORATION KEEP? (Sec. 74)

(1) Record of all business transactions;

(2) Minutes of all meetings of stockholders or members;
(3) Minutes of all meetings of Board of Directors or Trustees;
(4) Stock and Transfer book

WHAT IS A STOCK AND TRANSFER BOOK? (Sec. 75)

A stock and transfer book is a record of all stocks in the names of the
stockholders alphabetically arranged. It likewise contains the following
information:

· Installments paid and unpaid on all stock for which subscription has been
made, and the date of any installment;

· A statement of every alienation, sale or transfer of stock made, the date

thereof, and by whom and to whom made;

· Such other entries as the by-laws may prescribe

The stock and transfer book shall be kept in the principal office of the
corporation or in the office of its stock transfer agent, and shall be open for
inspection by any director or stockholder of the corporation at reasonable hours on
business days.

WHAT IS A STOCK TRANSFER AGENT? (Sec. 75)

A stock transfer agent is one who is engaged principally in the

business of registering transfers of stocks in behalf of a stock corporation. He
or she must be licensed by the SEC; however, a stock corporation is not precluded
from performing or making transfer of its own stocks, in which case all the rules
and regulations imposed on stock transfer agents, except the payment of a license
fee, shall be applicable.

WHO IS THE CUSTODIAN OF CORPORATE RECORDS?

In the absence of any provision to the contrary, the corporate

secretary is the custodian of corporate records. Corollarily, he keeps the stock
and transfer book and makes the proper and necessary entries. (Torres, et al. vs.
CA, 278 SCRA 793; 1997)

Basis of the Right of Inspection

Ordinary stockholders, the beneficial owners of the corporation,

usually have no say on how business affairs of the corp. are run by the directors.
The law therefore gives them the right to know not only the financial health of the
corp. but also how its affairs are managed so that if they find it unsatisfactory,
they can seek the proper remedy to protect their investment.
WHAT IS THE NATURE OF THE RIGHT TO INSPECT?

PREVENTIVE : deterrent to an ill-intentioned management knowing its acts

are subject to scrutiny; and

REMEDIAL: A dissatisfied SH may avail of this right as a

preliminary step towards seeking more direct and appropriate remedies against
mismanagement.

What Records Covered

1. Records of ALL business transactions

This includes book of inventories and balances, journal, ledger, book for copies of
letters and telegrams, financial statements, income tax returns, vouchers,
receipts, contracts, papers pertaining to such contracts, voting trust agreements
(sec. 59)

2. By-laws

These are expressly required to be open to inspection by SH/members during office

hours (Sec. 46). Note: There is no similar provision as to AOI, but these are
filed with the SEC anyway.

3. Minutes of director’s meetings

This is to inform stockholders of Board policies. Such right arises only upon
approval of the minutes, however.

4. Minutes of stockholders' meetings

5. Stock and transfer books

These are records of all stocks in the names of the stockholders alphabetically
arranged. contain all names of the stockholders of record. Useful for proxy
solicitation for elections. SEC has however ruled that a SH cannot demand that he
be furnished such a list but he is free to examine corp. books.

6. Most recent financial statement

Sec. 75 of the Code provides that within 10 days from the corporation's receipt of
a written request from any stockholder or member, the corporation must furnish the
requesting party with a copy of its most recent financial statement, which shall
include a balance sheet as of the end of the last taxable year and a profit or loss
statement for said taxable year.

Note: Under the Secrecy of Bank Deposits Act, records of bank deposits of the
corporation are NOT open to inspection, EXCEPT under the following circumstances:

(1) Upon written consent of concerned depositor (presumably the

corporation);
(2) In cases of impeachment;
(3) Upon court order in cases of bribery or
dereliction of duty of a public
official; and
(4) In cases where the money deposited / invested is the subject matter
of litigation
(5) Upon order of a competent court in cases of unexplained wealth
under RA 3019 or the Anti-Graft and Corrupt Practices Act
(6) Upon order of the Ombudsman

Extent and Limitations on Right

1. The exercise of this right is subject to reasonable limitations similar to

a citizen’s exercise of the right to information. Otherwise, the corp. might be
impaired, its efficiency in operations hindered, to the prejudice of SHs.

2. Such limitations to be valid must be reasonable and not inconsistent with

law ( Sec. 36[5] and 46).

3. A corp. may regulate time and manner of inspection but provisions in its
by-law which gives directors absolute discretion to allow or disallow inspection
are prohibited.

Limitations as to time and place:

· Exercise of right only at REASONABLE HOURS on BUSINESS DAYS.
· Such business days should be THROUGHOUT THE YEAR. BoD cannot limit such
to merely a few days within the year. (Pardo v. Hercules Lumber)

4. By-laws cannot prescribe that authority of president must first be

obtained.

5. Inspection should be made in such a manner as not to impede the efficient

operations

6. Place of inspection: Principal office of the corp. SH cannot demand that

such records be taken out of the principal office.

7. As to purpose:

· PRESUMPTION: that SH’s purpose is proper. Corp. cannot refuse on the

mere belief that his motive is improper (sec 74).

· BURDEN OF PROOF: lies with corp. which should show that purpose was
illegal.

· To be legitimate, the purpose for inspection must be GERMANE to the

INTEREST of the stockholder as such, and it is not contrary to the interests of the
corporation.

Legitimate: inquiry about failure to declare dividends

Not legitimate: for mere satisfaction or speculation.

· Belief in good faith that a corp. is being mismanaged may be given due
course even if later, this is proven unfounded.

· If motive can be clearly shown as inimical to corp., right may be denied.

Who May Exercise Right

Every director, trustee, stockholder, member may exercise right personally or
through an agent who can better understand and interpret records (impartial source,
expert accountant, lawyer).

As to VTA: both voting trustee and transferor

SH of parent corp. over subsidiary:

If the two are operated as SEPARATE entities : NO

right of inspection

If they are ONE AND THE SAME with respect

to management and control, and inspection is
demanded due to mismanagement of subsidiary
by the parent’s directors who are also
directors of the subsidiary : With
right of inspection

If the subsidiary is wholly-owned by the parent,

and its books & records are in the possession
and control of the parent corporation : With right
of inspection
(Gokongwei v. SEC)

Remedies available if Inspection Refused

WHAT REMEDIES ARE AVAILABLE IF INSPECTION IS REFUSED BY THE CORPORATION?

(1) Writ of mandamus.

NOTE: Writ shall not issue where it is shown that the petitioner’s
purpose is improper and inimical to the interests of
the corporation.

Writ should be directed against the corporation. The

secretary and the president may be joined as party
defendants.

(2) Injunction

(3) Action for damages against the officer or agent refusing inspection. Also,
penal
sanctions such as fines and / or imprisonment (Sec. 74; Sec. 144)

What defenses are available to the officer or agent?

(1) The person demanding has improperly used any information secured through
any prior examination; or
(2) Was not acting in good faith; or
(3) The demand was not for a legitimate purpose.
DERIVATIVE SUITS

Nature and Basis of derivative suit

Suits of stockholders/ members based on wrongful or fraudulent acts of directors or

other persons:

a. Individual suits - wrong done to stockholder personally and not to other

stockholders
(ex. When right of inspection is denied to a stockholder)

b. Class suit - wrong done to a group of stockholders

(ex. Preferred stockholders' rights are violated)

c. Derivative suit - wrong done to the corporation itself

· Cause of action belongs to the corp. and not the stockholder

· But since the directors who are charged with mismanagement are also the
ones who will decide WON the corp. will sue, the corp. may be left without redress;
thus, the stockholder is given the right to sue on behalf of the corporation.

· An effective remedy of the minority against the abuses of management

· An individual stockholder is permitted to bring a derivative suit to

protect or vindicate corporate rights, whenever the officials of the corp. refuse
to sue or are the ones to be sued or hold the control of the corp.

· Suing stockholder is merely the nominal party and the corp. is actually
the party in interest.

· A SH can only bring suit for an act that took place when he was a
stockholder; not before. (Bitong v. CA, 292 SCRA 503)

Requirements Relating to Derivative Suits

WHAT ARE THE LEGAL PRINCIPLES CONCERNING DERIVATIVE SUITS?

1) Stockholder/ member must have exhausted all remedies within the corp.

2) Stockholder/ member must be a stockholder/ member at the time of acts or

transactions complained of or in case of a stockholder, the shares must have
devolved upon him since by operation of law, unless such transaction or act
continues and is injurious to the stockholder.

3) Any benefit recovered by the stockholder as a result of bringing

derivative suit must be accounted for to the corp. who is the real party in
interest.

4) If suit is successful, plaintiff entitled to reimbursement from corp. for

reasonable expenses including attorneys' fees.
FINANCING THE CORPORATION

Sources of Financing

WHERE CAN CAPITAL TO FINANCE THE CORPORATION BE SOURCED?

1) Contributions (stockholders); also known as stockholder equity/equity

investment
2) Loans or advances (creditors)
3) Profits (corporation itself)

Capital Structure

WHAT IS MEANT BY CAPITAL STRUCTURE?

This refers to the aggregate of the securities -- instruments which represent

relatively long-term investment -- issued by the corporation. There are basically
2 kinds of securities: shares of stock and debt securities.

Capital and Capital Stock Distinguished

CAPITAL STOCK CAPITAL

DEFINITION
the amount fixed, usually by the corporate charter, to be subscribed and paid in or
secured to be paid in by the SHS of a corporation, and upon which the corporation
is to conduct its operation
actual property of the corporation, including cash, real, and personal property.
Includes all corporate assets, less any loss which may have been incurred in the
business.

CONSTANCY
CONSTANT, unless amended by the AOI
FLUCTUATING

Shares of Stock: Kinds

COMMON PREFERRED PAR NO PAR* TREASURY REDEEMABLE FOUNDER’S

DEFINITION
Stock which entitles the owner of such stocks to an equal pro rata division of
profits
Stock which entitles the holder to some preference either in the dividends or
distribution of assets upon liquidation, or in both
Shares that have been issued and fully paid but subsequently reacquired by the
issuing corporation by lawful means.
Shares issued by the corporation that may be taken up by the corporation upon
expiration of a fixed period.
à regardless of the existence of unrestricted retained earnings
Special shares whose exclusive rights and privileges are determined by the AOI.

VALUE

Depends if it’s par or no par

Stated par value
Fixed in the AOI, and indicated in the stock certificate. May be sold at a value
higher, but not lower, than that fixed in the AOI.
Value not fixed in the AOI, and therefore not indicated in the stock certificate.
Price may be set by BOD, SH’s or fixed in the AOI eventually.

VOTING RIGHTS
Usually vested with the exclusive right to vote
Can vote only under certain circumstances
Depends if it’s common or preferred.
Depends if it’s common or preferred.
No voting rights for as long as such stock remains in the treasury (Sec. 57)
Usually denied voting rights.

PREFERENCE UPON LIQUIDATION

No advantage, priority, or preference over any other SH in the same class
First crack at dividends / profits / distribution of assets

NOTE: Only preferred and redeemable shares may be deprived of the right to vote.
(Sec. 6, Corporation Code)
EXCEPTION: As otherwise provided in the Corporation Code.

* No-par value shares may not be issued by the following entities: banks, trust
companies, insurance companies, public utilities, building & loan association (Sec.
6)

Nature of Subscription Contract

WHAT IS A SUBSCRIPTION CONTRACT?

It is any contract for the acquisition of unissued stock in an existing corporation

or a corporation still to be formed. This is notwithstanding the fact that the
parties refer to it as a purchase or some other contract. (Sec. 60)

WHAT IS THE NATURE OF A SUBSCRIPTION CONTRACT?

· Subscriptions constitute a fund to which the creditors have a right to

look for satisfaction of their claims.

· The assignee in insolvency can maintain an action upon any unpaid stock
subscription in order to realize assets for the payment of its debts.

· A subscription contract is INDIVISIBLE (Sec. 64).

· A subscription contract subsists as a liability from the time that the
subscription is made until such time that the subscription is fully paid.

GARCIA V. LIM CHU SING (59 Phil. 562; 1934)

A share of stock or the certificate thereof is not an indebtedness to the owner nor
evidence of indebtedness and therefore, it is not a credit. Stockholders as such
are not creditors of the corporation.

The capital stock of a corporation is a trust fund to be used more particularly for
the security of the creditors of the corporation who presumably deal with it on the
credit of its capital.

Pre-incorporation subscription

RULE: 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. Thus, no one may revoke the contract even prior to
incorporation without the consent of all the others.

WHEN IS A PRE-INCORPORATION SUBSCRIPTION IRREVOCABLE?

1) For a period of at least 6 months from the date of subscription;

EXCEPTIONS: (1) unless all of the other subscribers consent to the

revocation; or

(2) unless the incorporation of said

corporation fails to materialize
within the said period or within a longer period as
may be stipulated in the contract of subscription

2) After the AOI have been submitted to the SEC (Sec. 61)

Post-incorporation subscription

NOTE: Under the Corporation Code, there is no longer any distinction

between a
subscription and a purchase. Thus, a subscriber is liable
to pay for the shares even
if the corporation has become insolvent.

The Preemptive Right to Shares

WHAT IS THE PRE-EMPTIVE RIGHT?

It is the option privilege of an existing stockholder to subscribe to a

proportionate part of shares subsequently issued by the corporation, before the
same can be disposed of in favor others.

WHY A PRE-EMPTIVE RIGHT?

 To protect existing stockholder equity. If the right is not recognized, the
SH’s interest in the corporation will be diluted by the subsequent issuance of
shares.

Basis of Right; Common Law Rule

Under the prevailing view in common law, the preemptive right is limited to shares
issued in pursuance of an increase in the authorized capital stock and does not
apply to additional issues of originally authorized shares which form part of the
existing capital stock.

This common law principle which was generally understood to be applicable in this
jurisdiction has now to give way to the express provisions of the Corporation Code
on the matter.

Extent and Limitations of Preemptive Right under the Code

WHAT IS THE EXTENT OF THE PRE-EMPTIVE RIGHT?

All stockholders of a stock corporation shall enjoy pre-emptive right to subscribe

to
all issues or dispositions of shares of any class, in proportion to their
respective
shareholdings.

Exception: When such right is denied by the AOI or an amendment thereto.

LIMITATIONS: The pre-emptive right does not extend to: (Sec. 39)

1) Initial Public Offerings (IPOs);

2) Issuance of shares in exchange for property needed for corporate purposes,

including cases wherein an absorbing corporation issues new stocks to the SH’s in
pursuance to the merger agreement (Sec. 39)

Why? (a) Because it is beneficial for the corporation to save its

cash;
(b) A swap is more expedient than determining the monetary
equivalent of the property.

3) Issuance of shares in payment of a previously contracted debt (Sec. 39)

Why? (a)
The obligation is extinguished outright;
(b) Corporation does not have to shell out money to fulfill its
obligations;
(c) Money that would have otherwise been used for interest
payments can be channelled to more productive
corporate activities.

Note: In Nos. (2) and (3), such acts require approval of 2/3 of the
OCS or
2/3 of total members.

In Close Corporations
In close corporations, the preemptive rights extends to ALL stock to be issued,
including re-issuance of treasury shares, EXCEPT if provided otherwise by the AOI.
(Sec. 102). Note that the limitations in Sec. 39 do not apply.

Waiver of Preemptive Right

The waiver of the preemptive right must appear in the Articles of Incorporation or
an amendment thereto in order to be binding on ALL stockholders, particularly
future stockholders. (Sec. 39)

If it appears merely in a waiver agreement and NOT in the AOI, and was unanimously
agreed to by all existing stockholders:

· The existing stockholders cannot later complain since they are all bound to
their
private agreement.

· However, future stockholders will NOT be bound to such an agreement.

Any stockholder who has not exercised his preemptive right within a reasonable time
will be deemed to have waived it.

When the issue is in breach of trust

The issue of shares may still be objectionable if the Directors have acted in
breach of trust and their primary purpose is to perpetuate or shift control of the
corporation, or to “freeze out” the minority interest.

Remedies when right violated/denied

WHAT ARE THE REMEDIES WHEN THE PRE-EMPTIVE RIGHT IS UNLAWFULLY DENIED?

(1) Injunction;
(2) Mandamus;
(3) Cancellation of the shares (NOTE: but only if no innocent 3rd parties
are prejudiced)
(4) In certain cases, a derivative suit

Debt Securities

Borrowings

Borrowings are usually represented by promissory notes, bonds or

debentures.

Oftentimes, a financial institution will be willing to lend large

amounts to private corporations only on the condition that such institution will
have some representation on the Board of Directors. The role of such
representative is to see to it that his institution's investment is protected from
mismanagement or unfavorable corporate policies.
Bonds and Debentures

BONDS: à secured by a mortgage or pledge of corporate property

à must be registered with the SEC, as provided by Sec. 38 of the

Corporation Code

DEBENTURES: à issued on the general credit of the corporation

à not secured by any collateral; THEREFORE, are not bonded indebtedness in the
true sense, and stockholder approval is NOT required (although it would generally
be a good idea to obtain it)

Convertible securities; stock options

NOTE: Under the SEC rules, stock option must first be approved by the SEC.
Also, if the stock option is granted to non-stockholders, or to directors,
officers, or managing groups, there must first be SH approval of 2/3 of the OCS
before the matter is submitted to the SEC for approval.

Of course it goes without saying that the corporation must set aside enough of
the junior securities in case the holders of the option decide to exercise such
option.

Hybrid securities

Because preferred shares and bonds are created by contract, it is possible to

create stock which approximates the characteristics of debt securities. Hybrid
securities, as the name implies, therefore combine the features of preferred shares
and bonds.

Determining the true nature of the security is crucial for tax purposes. The
American courts use the following criteria:

(1) Is the corporation liable to pay back the investor at a fixed maturity date?
(2) Is interest payable unconditionally at definite intervals, or is it dependent
on earnings?
(3) Does the security rank at least equally with the claims of other creditors, or
is it subordinate to them?

The following criteria should be used in determining whether a payment is for

interest or dividends:
(1) maturity date and the right to enforce collection;
(2) treatment by the parties;
(3) rank on dissolution;
(4) uniform rate of interest payable or income payable only out of profits;
(5) participation in management and the right to vote.

It must be noted that these criteria are not of equal importance and cannot be
relied upon individually. E.g. treatment accorded the issuance by the parties
cannot be sufficient as this would allow taxpayers to avoid taxes by merely naming
payments as interest.

The trust indenture

Here, the bond issue usually involves 3 parties:

(1) debtor-corporation
(2) creditor-bondholder
(3) trustee: representative of all the bondholders

CONSIDERATION FOR ISSUANCE OF SHARES

Form of Consideration

WHAT FORMS OF CONSIDERATION ARE ACCEPTABLE FOR ISSUANCE OF SHARES?

· cash;
· property actually received by the corporation: must be necessary or
convenient for its use and lawful purposes;
· labor performed for or services actually rendered to the corporation
(NOTE: Future services are NOT acceptable!);
· previously incurred indebtedness by the corporation;
· amounts transferred from unrestricted retained earnings to stated
capital;
· outstanding shares exchange for stocks in the event of reclassification
or conversion

WHAT FORMS ARE UNACCEPTABLE?

· future services
· promissory notes
· value less than the stated par value

HOW IS THE ISSUED PRICE OF NO-PAR SHARES FIXED?

It may be fixed as follows:

(1) In the AOI; or

(2) By the BOD pursuant to authority conferred upon it by the AOI or the by-
laws; or

(3) In the absence of the foregoing, by the SHs representing at least a

majority of the outstanding capital stock at a meeting duly called for the purpose
(Sec. 62)

IF THE CONSIDERATION FOR SHARES IS OTHER THAN CASH, HOW IS THE VALUE THEREOF
DETERMINED?

It is initially determined by the incorporators or the Board of Directors,

subject to approval by the SEC. (Sec. 62)

Watered Stocks
WHAT IS WATERED STOCK?

Stocks issued as fully paid up in consideration of property at an

overvaluation. Oftentimes, the consideration received is less than the par value
of the share.

NOTE: No-par shares CAN be watered stock: when they are issued for less
than their issued value as fixed by the corp. in accordance with law.

WHAT ARE THE WAYS BY WHICH WATERED STOCK CAN BE ISSUED?

(1) Gratuitously, under an agreement that nothing shall be paid to the

corporation;

(2) Upon payment of less than its par value in money or for cost at a
discount;

(3) Upon payment with property, labor or services, whose value is less than
the par value of the shares; and

(4) In the guise of stock dividends representing surplus profits or an

increase in the value of property, when there are no sufficient profits or
sufficient increases in value to justify it.

WHAT IS THE LIABILITY OF DIRECTORS FOR THE ISSUANCE OF WATERED STOCK?

Directors and officers who consented to the issuance of watered stocks are
solidarily liable with the holder of such stocks to the corp. and its creditors
for the difference between the fair value received at the time of the issuance and
the par or issued value of the share.

The liability will be to all creditors, whether they became such prior or
subsequent to the issuance of the watered stock. Reliance by the creditors on the
alleged valuation of corporate capital is immaterial and fraud is not made an
element of liability.

NOTE: In the Philippines, it is the statutory obligation

theory that is controlling
(cf. Sec. 65).

Issuance of Certificate

Certificate of stock

CONDITION FOR ISSUANCE: payment of full amount of subscription price plus

interest, if any is due (Sec. 64)

CERTIFICATION THAT: person named therein is a holder or owner of a

stated number of shares in the corporation.

INDICATES: 1. kind of shares

2. date of issuance
 3. par value, if par value shares

BEARS: Signatures of the proper officers,

usually president
or secretary, as well as the corporate seal

AMOUNT ISSUED: For no more than the number of shares authorized

in
articles of incorporation; excess would be void

Nature and function of a certificate of stock

A certificate of stock is not necessary to render one a stockholder in

a corporation. Nevertheless, a certificate of stock is the paper representation or
tangible evidence of the stock itself and of the various interests therein. The
certificate is not stock in the corporation but is merely evidence of the holder's
interest and status in the corporation, his ownership of the shares represented
thereby, but is not in law the equivalent of such ownership. It expresses the
contract between the corporation and the SH, but it is not essential to the
existence of a share in stock or the creation of the relation of shareholder to the
corporation. (Tan v. SEC, 206 SCRA 740)

Requisites for valid issuance of formal certificate of stock (Sec. 63)

(1) The certificates must be signed by the President / Vice-President,

countersigned by the secretary or assistant secretary, and sealed with the seal of
the corporation.

à A mere typewritten statement advising a SH of the extent of his ownership in a

corporation without qualification and/or authentication cannot be considered as a
formal certificate of stock. (Bitong v. CA, 292 SCRA 503)

(2) Delivery of the certificate

à There is no issuance of a stock certificate where it is never detached from the

stock books although blanks therein are properly filled up if the person whose name
is inserted therein has no control over the books of the company. (Bitong v. CA,
292 SCRA 503)

(3) Par value of par value shares / Full subscription of no par value shares
must be fully paid.

(4) Surrender of the original certificate if the person requesting the issuance
of a certificate is a transferee from a SH.

BITONG V. CA (292 SCRA 503)

Stock issued without authority and in violation of law is void and

confers no rights on the person to whom it is issued and subjects him to no
liabilities. Where there is an inherent lack of power in the corporation to issue
the stock, neither the corporation nor the person to whom the stock is issued is
estopped to question its validity since an estoppel cannot operate to create stock
which under the law cannot have existence.
Unpaid Subscriptions

· Unpaid subscriptions are not due and payable until a call is made by the
corporation for payment. (Sec. 67)

· An obligation arising from non-payment of stock subscriptions to a

corporation cannot be offset against a money claim of an employee against the
employer. (Apodaca v. NLRC, 172 SCRA 442)

· Interest on all unpaid subscriptions shall be at the rate of interest

fixed in the by-laws. If there is none, it shall be the legal rate. (Sec. 66)

How Payment of Shares Enforced

HOW ARE UNPAID SUBSCRIPTIONS COLLECTED?

(1) Call for payment as necessary, i.e. the BOD declares the unpaid
subscriptions due and payable (Sec. 67);

(2) Delinquency sale (Sec. 68; to be discussed in the next section)

(3) Court action for collection (Sec. 70)

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

WHAT ARE THE RIGHTS OF UNPAID SHARES?

Holders of subscribed shares not fully paid which are not delinquent shall have all
the rights of a stockholder. (Sec. 72)

Effect of delinquency

WHAT IS DELINQUENT STOCK? (Sec. 67)

Stock that remains unpaid 30 days after the date specified in the subscription
contract or the date stated in the call made by the Board.

WHAT ARE THE EFFECTS OF DELINQUENCY?

1. The holder thereof loses all his rights as a stockholder except only the
rights to dividends;

2. Dividends will not be paid to the stockholder but will be applied to the
unpaid balance of his subscription plus costs and expenses. Also, stock dividends
will be withheld until full payment is made.

3. Such stockholder cannot vote at the election of directors or at any

meeting on any matter proper for stockholder action.

4. Stockholder cannot be counted as part of the required quorum.

5. Stockholder cannot be voted for as director of the corporation.

WHAT IS THE PROCEDURE FOR THE CONDUCT OF A DELINQUENCY SALE? (Sec. 68)

(1) Issuance of Board resolution

The BOD issues a resolution ordering the sale of delinquent stock, specifically
stating the amount due on each subscription plus all accrued interest, and the
date, time and place of the sale.

Note: The sale shall not be less than 30 days nor more than 60 days from the date
the stocks become delinquent.

(2) Notice of sale and publication

Notice of the date of delinquency sale and a copy of the resolution is sent to
every delinquent stockholder either personally or by registered mail. The notice
is likewise published once a week for 2 consecutive weeks in a newspaper of general
circulation in the province or city where the principal office of the corporation
is located.

(3) Sale at public auction

If the delinquent stockholder fails to pay the corporation on or before the date
specified for the delinquency sale, the delinquent stock is sold at public auction
to such bidder who shall offer to pay the full amount of the balance on the
subscription together with accrued interest, costs of advertisement and expenses of
sale, for the smallest number of shares or fraction of a share.
(4) Transfer and issuance of certificate of stock

The stock so purchased is transferred to such purchaser in the books of the

corporation and a certificate of stock covering such shares is issued.

If there is no bidder at the public auction who offers to pay the full amount of
the balance on the subscription and its attendant costs, the corporation may bid
for the shares, and the total amount due shall be credited as paid in full in the
books of the corporation. Title to all the shares of stock covered by the
subscription shall be vested in the corporation as treasury shares and may be
disposed of by said corporation in accordance with the Code.

Note that this is subject to the restrictions imposed by the Code on corporations
as regards the acquisition of their own shares. (See the discussion under
Dividends and Purchase by Corporation of its Own Shares.)

CAN A DELINQUENCY SALE BE QUESTIONED? (Sec. 69)

Yes. This is done by filing a complaint within 6 months from the date of sale, and
paying or tendering to the party holding the stock the sum for which said stock was
sold, with interest at the legal rate from the date of sale. No action to recover
delinquent stock sold can be sustained upon the ground of irregularity or defect in
the notice of sale, or in the sale itself of the delinquent stock unless these
requirements are complied with.
Lost or Destroyed Certificate

WHAT IS THE PROCEDURE FOR THE ISSUANCE OF NEW CERTIFICATES TO REPLACE THOSE STOLEN,
LOST OR DESTROYED? (Sec. 73)

(1) File an affidavit in triplicate with the corporation. The affidavit must
state the following:
(a) Circumstances as to how the certificates were SLD;
(b) Number of shares represented; and
(c) Serial number of the certificate
(d) Name of issuing corporation

(2) The corporation will publish notice after the affidavit and other information
and evidence have been verified with the books of the corporation, (Note however
that this is not mandatory. The corporation has the discretion to decide whether
to publish or not.)

The notice will contain the following information:

(a) Name of the corporation

(b) Name of the registered owner;
(c) Serial number of the certificate;
(d) Number of shares represented by the certificate;
(e) Effect of expiration of 1 year period from publication and failure to
present contest within that period.

(3) SLD certificate is removed from the books if after one year from date of last
publication, no contest is presented.

NOTE: One-year period will not be required if the applicant files a bond good for
1 year.

(4) The corporation will then issue new certificates.

However, if a contest has been presented to the corporation, or if an action is

pending court regarding the ownership of the SLD certificate, the issuance of the
new certificate shall be suspended until the final decision by the court.
NOTE: Should corporation issue new certificates without the conditions being
fulfilled and a third party proves that he is the rightful owner of the shares, the
corporation may be held liable to the latter EVEN IF it acted in good faith.

NOTE: Even if the above procedure was followed, if there was fraud, bad faith, or
negligence on the part of the corporation and its officers, the corporation may be
held liable.

TRANSFER OF SHARES

HOW ARE SHARES OF STOCK TRANSFERRED?

By delivery of the certificate/s indorsed by the owner or his attorney-in-fact or

other person legally authorized to make the transfer. (Sec. 63)
 WHAT ARE THE REQUISITES FOR A VALID TRANSFER?

(1) Delivery;

(2) Indorsement by the owner or his attorney-in-fact or other persons legally

authorized to make the transfer

à Indorsement of the certificate of stock is a mandatory requirement of law for an

effective transfer of a certificate of stock. (Razon v. CA, 207 SCRA 234)

(3) Recording of the transfer in the books of the corporation (so as to make
the transfer valid as against third parties)

à Until registration is accomplished, the transfer, though valid between the

parties, cannot be effective as against the corporation. Thus, the unrecorded
transferee cannot enjoy the status of a SH: he cannot vote nor be voted for, and
he will not be entitled to dividends.

No registration of transfer of unpaid shares

No shares of stock against which the corporation holds any unpaid claim
shall be transferable in the books of the corporation. (Sec. 63)

Remedy if registration refused

The proper remedy is a petition for a writ of mandamus to compel the corporation to
record the transfer or issue a new certificate in favor of the transferee, as the
case may be. The writ will be granted provided it is shown that he transferee has
no other plain, speedy and adequate remedy and that there are no unpaid claims
against the stocks whose transfer is sought to be recorded. It must be noted that
unless the latter fact is alleged, mandamus will be denied due to failure to state
a cause of action. (Campos & Campos)

Restrictions on Transfer; Close Corporations

General rule: Shares of stock are freely transferable, without restriction.

Exception: In close corporations, restrictions may be placed on the transfer

of shares. Such restrictions must appear in the AOI and in the by-laws, as well as
in the certificate of stock. Otherwise, the restriction shall not be binding on
any purchaser thereof in good faith.

The restrictions imposed shall be no more onerous than

granting the existing stockholders or the corporation the option to purchase the
shares of the transferring stockholder with such reasonable terms, conditions or
period stated therein. If this option is not exercised upon the expiration of the
period, the transferring stockholder may sell his shares to any third person.
(Sec. 98)

WHAT IS THE EFFECT OF ISSUANCE OR TRANSFER OF STOCK IN BREACH OF THE RESTRICTIONS?

The corporation may, at its option, refuse to register the transfer of

stock in the name of the transferee. (Sec. 99.4) However, this shall not be
applicable if the transfer, though otherwise contrary to subsections (1), (2) and
(3) of Sec. 99, has been consented to by all the stockholders of the close
corporation, or if the close corporation has amended its AOI in accordance with
Title XII of the Code.

For his part, the transferee may rescind the transfer or recover from
the transferor under any applicable warranty, whether express or implied.

UNAUTHORIZED TRANSFERS

Certificates indorsed in blank; when quasi-negotiable

A possessor, even without authority, may transfer good title to a bona fide
purchaser if:

· the real owner endorses the certificate in blank

· the conveyance is for purposes other than transfer
· that relying on the stock certificate, the purchaser believes the
possessor to be the owner thereof or has authority to transfer the same.

This proceeds from the theory of quasi-negotiability which provides that in

endorsing a certificate in blank, the real owner clothes the possessor with
apparent authority, thus, estopping him later from asserting his rights over the
shares of stock against a bona fide purchaser.

Quasi-negotiability does not apply in cases where the real owner:

a. did not entrust the certificate to anyone; and

b. is not otherwise guilty of estoppel

For example, in case the transfer is made by a finder or a thief.

Forged Transfers

A corporation does not incur any misrepresentation in the issuance of a certificate

made pursuant to a forged transfer. It can always recall from the person the
certificate issued, for cancellation.

In case where the certificate so issued comes into the hands of a bona fide
purchaser for value from the original purchaser, the corporation is estopped from
denying its liability. It must recognize both the original and the new certificate.
But if recognition results to an over-issuance of shares, only the original
certificate may be recognized, without prejudice to the right of the bona fide
purchaser to sue the corporation for damages.

Collateral Transfers

Shares of stock are personal property. Thus, they can either be pledged or
mortgaged. However, such pledge or mortgage cannot have any legal effect if it is
registered only in the corporate books.
Where a certificate is delivered to the creditor as a security, the contract is
considered a pledge, and the Civil Code will apply.

If the certificate of stock is not delivered to the creditor, it must be registered

in the registry of deeds of the province where the principal office of the
corporation is located, and in case where the domicile of the stockholder is in a
different province, then registration must also be made there.

In a situation where, the chattel mortgage having been registered, the stock
certificate was not delivered to the creditor but transferred to a bona fide
purchaser for value, it is the rule that the bona fide purchaser for value is bound
by the registration in the chattel mortgage registry. It is said that such a rule
tends to impair the commercial value of stock certificates.

CHUA GUAN VS. SAMAHANG MAGSASAKA (62 Phil. 473; 1935)

To guarantee payment of a debt, Co mortgaged his shares of Samahang Magsasaka stock

to Chiu. The said mortgage was duly registered in the City of Manila. Chiu later
assigned his rights in the mortgage to Guan who soon foreclosed the same after Co
failed to pay. Guan won in the public bidding. He requested the corporation that
new certificates be issued in his name. The corporation refused because apparently
prior to Guan’s demand, several attachments against the shares covered by the
certificates had been recorded in its books.

Did the chattel mortgage in the registry of deeds of Manila gave constructive
notice to the attaching creditors?

The Chattel Mortgage Law provides two ways of executing a valid chattel mortgage:
1) the possession of mortgaged property is delivered and retained by the mortgagee;
and, 2) without delivery, the mortgage is recorded in the register of deeds. But if
chattel mortgage of shares may be made validly, the next question then becomes:
where should such mortgage be properly registered?

It is the general rule that the situs of shares is the domicile of the owner. It is
also generally held that for the purpose of execution, attachment, and garnishment,
it is the domicile of the corporation that is decisive. Going by these principles,
it is deemed reasonable that chattel mortgage of shares be registered both at the
owner’s domicile and in the province where the corporation has its principal
office. It should be understood that the property mortgaged is not the certificate
but the participation and share of the owner in the assets of the corporation.

It is recognized that this method of hypothecating shares of stock in a chattel

mortgage is rather tedious and cumbersome. But the remedy lies in the legislature.

Note: The provision of the Chattel Mortgage Law (Act No. 1508) providing for
delivery of mortgaged property to the mortgagee as a mode of constituting a chattel
mortgage is no longer valid in view of the Civil Code provision defining such as a
pledge.

NON-TRANSFERABILITY
IN NON-STOCK CORPORATIONS

Although shares of stock are as a rule freely transferable, membership in a non-

stock corporation is personal and non-transferable, unless the articles of
incorporation or by-laws provide otherwise. The court may not strip him of his
membership without cause. (Sec. 90)

DIVIDENDS AND PURCHASE BY CORPORATION OF ITS OWN SHARES

Form of Dividends

IN WHAT FORMS CAN DIVIDENDS BE ISSUED?

1. Cash

2. Property

· scrip - certificate issued to SHs instead of cash dividends which

entitles them to a certain amount in the future

3. Stock dividends

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

DIFFERENTIATE BETWEEN CASH DIVIDENDS AND STOCK DIVIDENDS.

Cash Dividend Stock Dividend

Voting requirements for issuance

Board of Directors
Board of Directors + 2/3 OCS

Effect on delinquent stock

Shall be applied to the unpaid balance on the subscription plus costs and expenses.

Shall be withheld from the delinquent stockholder until his unpaid subscription is
fully paid.

Can this be issued by Executive Committee?

No. (Sec. 35)
No, since this requires SH approval. (Sec. 35)

FROM WHERE CAN DIVIDENDS BE SOURCED?

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

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

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

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

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

· transactions involving treasury stocks which are considered expansions

and contractions of paid-in capital;

· donations as additional paid- in capital;

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

element

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

Restrictions on dividend distribution include:

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

· Agreements with creditors, bondholders and preferred SHs requiring

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

· SEC-imposed restrictions pursuant to law, like those imposed on banks and

insurance companies;

· Restriction on the retained earnings equivalent to the cost of treasury

shares held by the corporation, which is lifted only after such shares are reissued
or retired (Sec. 195, PD 612)

SOME RULES ON DIVIDEND DECLARATION:

1. BOD has discretion whether or not to declare dividends and in what form.

Exception: Stock dividends, in which case a 2/3 vote of OCS is necessary.

However, such discretion cannot be abused and the BOD cannot accumulate surplus
profits unreasonably on the excuse that it is needed for expansion or reserves.

2. BOD should declare dividends when surplus profits of the corporation exceed
100% of the corporation's paid-in capital stock.

Exceptions:

(a) When justified by definite corporate expansion projects or programs

approved by the Board;

(b) When creditors prohibit dividend declaration without their consent as a

condition for the loan, and such consent has not yet been secured;

(c) When retention is necessary under special circumstances obtaining in the

corporation, e.g. when there is a need for special reserve for probable
contingencies. (Sec. 43)

4. The corporation may be subjected to additional tax when it fails to declare

dividends, thereby unreasonably accumulating profits. (See Sec. 25, NIRC)

5. The dividends received are based on stock held whether or not paid.
However, if the stocks are delinquent, the amount will first be applied to the
payment of the delinquency plus costs and expenses; stock dividends will not be
given to a delinquent SH.

When Right to Dividends Vests; Rights of Transferee

WHEN DOES THE RIGHT TO DIVIDENDS VEST?

As soon as the BoD has declared dividends. From this time, it becomes a
debt owed by the corporation, and therefore can no longer be revoked (McLaran v.
Crescent Planning).

EXCEPTION: If the declaration has not yet been announced or

communicated to the stockholders.

NOTE: When no dividends are declared for 3 consecutive years, preferred SHs are
given the right to vote for directors until dividends are declared.

NOTE: The extent of the SH’s share in the dividends will depend on the capital
contribution; NOT the number of shares he has.

Liability for Illegal Dividends

WHAT ARE ILLEGAL DIVIDENDS?

Illegal dividends are dividends declared in violation of law.

WHAT ARE THE EFFECTS OF THE ILLEGAL DECLARATION OF DIVIDENDS?

(1) If the directors acted wilfully, or with negligence or in bad faith, they
will be liable to the corporation. If the corporation has become insolvent, they
are liable to the corporation's creditors for the amount of dividends based out of
capital. (Based on Sec. 31)

(2) If the directors cannot be held liable because they acted with due
diligence and in good faith, in the absence of an express provision of law, an
innocent stockholder is not liable to return the dividends received by him out of
capital, unless the corporation was insolvent at the time of payment. (Majority
view; Campos)

Purchase by Corporation of its own shares

WHAT ARE THE REQUISITES FOR ACQUISITION BY THE CORPORATION OF ITS OWN SHARES?
(Sec. 41)

1. unrestricted retained earnings to cover the shares to be acquired;

2. legitimate corporate purpose

FOR WHAT PURPOSES CAN A CORPORATION ACQUIRE ITS OWN SHARES? (Sec. 41)

1. To eliminate fractional shares arising out of stock dividends;

2. To collect or compromise an indebtedness to the corporation, arising out

of unpaid subscription, in a delinquency sale, and to purchase delinquent shares
sold during said sale;
3. To pay dissenting or withdrawing stockholders entitled to payment for
their shares under the Corporation Code (Appraisal Right).

Appraisal Right (Sec. 81)

WHAT IS THE APPRAISAL RIGHT?

The appraisal right refers to the right of a stockholder who dissented and
voted against a proposed fundamental corporate action to get out of the corporation
by demanding payment of the fair value of his shares.

IN WHAT INSTANCES CAN THE APPRAISAL RIGHT BE EXERCISED?

The Corporation Code lists 4 instances:

(1) In case any amendment to the AOI has the effect of changing or restricting
the rights of any SH or class of shares, or of authorizing preferences in any
respect superior to those of outstanding shares of any class, or of extending or
shortening the term of corporate existence (Sec. 81);

(2) In case of sale, lease, exchange, transfer, mortgage, pledge or other

disposition of all or substantially all of the corporate property and assets as
provided in this Code (Sec. 81; Sec. 40);

(3) In case of merger or consolidation (Sec. 81);

(4) In case the corporation invests its funds in any other corporation or
business or for any purpose other than the primary purpose for which it was
organized (Sec. 42)
WHAT ARE THE REQUISITES FOR THE EXERCISE OF THE APPRAISAL RIGHT? (Sec. 82)

(1) SH must have voted against he proposed corporate action;

(2) Written demand on the corporation for payment of the fair value of his
shares;
(3) Such demand must have been made within 30 days after the date on which the
vote was taken;
(4) Surrender of the stock certificate/s representing his shares;
(5) Unrestricted retained earnings in the books of the corporation to cover
such payment.

WHAT IS THE EFFECT OF DEMAND FOR PAYMENT IN ACCORDANCE WITH THE APPRAISAL RIGHT?
(Sec. 83)

All rights accruing to the shares, including voting and dividend rights, are
suspended in accordance with the Corporation Code, except for the right of the SH
to receive payment of the fair value thereof.

Such suspension shall be from the time of demand until either:

(1) abandonment of the corporate action involved; or

(2) the purchase of the said shares by the corporation.

However, if said dissenting SH is not paid the value of his shares within
30 days after the award, his voting and dividend rights shall immediately be
restored.

WHAT ARE THE DUTIES OF THE DISSENTING STOCKHOLDER IN RELATION TO THE EXERCISE OF
THE APPRAISAL RIGHT?

The dissenting SH must submit the certificates of stock representing

his shares to the corporation for notation thereon that such shares are dissenting
shares within 10 days after demanding payment for his shares. Failure to do so
shall, at the option of the corporation, terminate his rights under Title X of the
Corporation Code. (Sec. 86)

WHAT ARE THE EFFECTS OF TRANSFER OF THE CERTIFICATES BEARING THE NOTATION THAT THEY
REPRESENT DISSENTING SHARES?

If the certificates are consequently cancelled, the rights of the

transferor as a dissenting SH cease and the transferee has all the rights of a
regular stockholder. All dividend contributions which would have accrued on the
shares will be paid to the transferee. (Sec. 86)

AMENDMENTS OF CHARTER

The charter of a private corporation consists of its articles of incorporation as

well as the Corporation Code and such other law under which it is organized.

Amendment by Legislature
Subject to the limitation that no accrued rights or liabilities be impaired, the
legislature has the power to make changes in existing corporations through an
amendment to the Corporation Code.

Amendment by Stockholders

One of the powers expressly granted by law to all corporations is the power to
amend its articles of incorporation. This, in effect, is a grant of power to
owners of 2/3 of the outstanding stocks to change the basic agreement between the
corporation and its stockholders, making such change binding on all the
stockholders, subject only to the right of appraisal, if proper.

WHAT ARE THE LIMITATIONS ON THE POWER TO AMEND?

PURPOSE: must be legitimate

VOTE: 2/3 of OCS / membership

(1) The appraisal right must be recognized in case the amendment

has the effect of changing rights of any stockholder or class of shares, or of
authorizing preferences in any respect superior to those of outstanding shares of
any class, or extending or shortening the term of corporate existence.

(2) Extension of corporate term cannot exceed 50 yrs. in any one

instance

(3) A copy of the amended articles should be filed with the SEC,
and with the proper governmental agencies, as appropriate (e.g., in the case of
banks, public utilities, etc.)

(4) Original and amended articles should contain all matters

required by law to be set out in said articles.

(5) An amendment to increase/decrease capital stock as well as to

extend/shorten corporate term cannot be made under Sec. 16, but must be made under
Sec. 37-38, respectively, both of which require a meeting; and

(6) Amendment must be in the form prescribed by the Code

ON WHAT GROUNDS CAN THE SEC DISAPPROVE THE PROPOSED AMENDMENTS?

The same grounds as for the disapproval of the original articles (Sec. 17):

· Not substantially in accordance with the form prescribed by the Code;

· Purpose(s) patently unconstitutional, illegal, immoral, or contrary to

government rules and regulations;

· Treasurer’s Affidavit concerning amount of capital stock subscribed/paid

is false;
· Required percentage of ownership of capital stock to be owned by citizens
of the Phils. has not been complied with as required by the Constitution or
existing laws;

· Absence of a favorable recommendation from the appropriate government

agency.

Amendment changing stockholder’s rights

The law expressly allows amendments which would change or restrict existing rights
of stockholders or any class of shares. (Sec. 81)

Effectivity of amendment

Amendments take effect only from the approval by the SEC. However, such approval
or rejection must be made within six months of filing of amendment; otherwise it
shall take effect even w/o such approval (as of the date of filing), unless cause
of delay is attributable to the corporation. (Sec. 16)

Special amendments

Increase of capital stock

After the authorized capital stock has been fully subscribed and the corporation
needs to increase its capital, it will have to amend its articles to increase its
capital stock. A corporation does not have the implied power to increase capital
stock; such a power can only be granted by law.
The power to increase or decrease capital stock must be exercised in accordance
with the provisions of Sec. 38 of the Code.

Reduction of capital stock

Reduction of capital stock is not allowed if it will prejudice the rights of

corporate creditors.

Change in corporate term

The Code allows a corporation not only to extend but also to shorten its term of
existence. As in the case of increase/decrease of capital stock, change must be
approved at a members’/stockholders’ meeting by 2/3 of the members/outstanding
capital stock.

Amendments in close corporations

To recall, the provisions required to be contained in the AOI of a close

corporation:

(1) All issued stock of all classes should be held by not more than 20;
(2) All issued stock shall be subject to one or more specified restrictions on
transfer permitted by law;
(3) Corporation should not be listed in the stock exchange or make any public
offering of its stock.
If any of these are deleted, then the corporation will cease to be a close
corporation and will lose the special privileges of such corporations. Thereafter,
it will be governed by the general provisions of the Code. Since such amendment
involves a change in the nature of the corporation, even non-voting stocks are
given a voice in the decision. A stockholders’ meeting is required and a 2/3 vote
must approve the amendment, unless otherwise provided by the articles of
incorporation.

DISSOLUTION

Modes of Dissolution

HOW MAY A CORPORATION BE DISSOLVED?

(1) Failure to organize and commence business (Sec. 22);

(2) Cessation of business for 5 years (Continuous inoperation; Sec. 22);

(3) Expiration of original, extended, or shortened term;

(4) Voluntary dissolution (Sec. 118-119);

(a) Where no creditors are affected (Sec. 118)

This is effected by majority vote of the BOD and a 2/3 vote of the OCS or members.
(Note the special notice requirements.) The copy of the resolution authorizing the
dissolution shall be certified by a majority of the BOD and countersigned by the
secretary of the corporation. THE SEC shall thereupon issue the certificate of
dissolution.

(b) Where creditors are affected (Sec. 119)

(1) Filing of petition for dissolution with SEC

A petition for dissolution must be filed with the SEC after having been signed by a
majority of the BOD, verified by the president or secretary or one of the
directors, and resolved upon by the affirmative vote of 2/3 of the OCS or members.
The petition must set forth all claims and demands against the corporation, and the
fact that the dissolution was approved by the SHs with the requisite 2/3 vote.

(2) Fixing of date by SEC for filing of objections to petition

If the petition is sufficient in form and substance, the SEC shall fix a date on or
before which objections thereto may be filed by any person.

Date: not less than 30 days nor more than 60 days after the
entry of the order

(3) Publication of order

Before the date fixed by the SEC, the SEC order shall be published and posted
accordingly.

Newspaper: Once a week for 3 weeks in a newspaper of general circulation

published in the municipality or city where the corporation's principal office is
situated, or there be no such newspaper, in a newspaper of general circulation in
the Philippines

Posting: For 3 consecutive weeks in 3 public places in the city or

municipality where the corporation's principal office is situated

(4) Hearing of the petition for dissolution

Upon 5 days notice, given after the date on which the right to file objections to
the order has expired, the SEC shall proceed to hear the petition and try any issue
made by the objections filed.

If no objection is sufficient, and the material allegations are true,

the SEC shall render judgment dissolving the corporation and directing such
disposition of its assets as justice requires.

Note: The SEC may appoint a receiver to collect such

assets and pay the debts of the corporation.

(3) Involuntary dissolution (Sec. 121):

(a) Revocation of Certificate of Registration by SEC (Sec. 121)

A corporation may be dissolved by the SEC upon filing of a verified complaint and
after proper notice and hearing on grounds provided by existing laws, rules and
regulations.

(b) Quo Warranto proceedings (See Sec. 5b, PD 902-A and Rule 66, Rules of
Court. Previously, the SEC had exclusive jurisdiction over quo warranto
proceedings involving corporation. Under the Securities Regulation Code or RA
8799, however, the jurisdiction of the SEC over all cases enumerated under Sec. 5
of PD 902-A have been transferred to the Regional Trial Courts.

The grounds for involuntary dissolution of a corporation under quo warranto

proceedings are:

(1) When the corporation has offended against a provision of an act for its
creation or renewal;

(2) When it has forfeited its privileges and franchises by non-user;

(3) When it has committed or omitted an act which amounts to a surrender of its
corporate rights, privileges or franchises;

(4) When it misused a right, privilege or franchise conferred upon it by law,

or when it has exercised a right, privilege or franchise in contravention of law

(PNB v. CFI, 209 SCRA 294; 1992)

(4) Shortening of corporate term (Sec. 120)

NOTE: The simplest and most expedient way of effecting dissolution

is by shortening the corporate term and waiting for such
term
to expire.

Dissolution of close corporations

In close corporations, any stockholder may, by written petition to the SEC, compel
the dissolution of such corporation when:

(1) Any of the acts of the directors, officers, or those in control

of the corporation is:

· Illegal;
· Fraudulent;
· Dishonest;
· Oppressive or unfairly prejudicial to the corporation
or any other SH;

(2) Corporate assets are being misapplied or wasted. (Sec. 105)

Effects of Dissolution

WHAT ARE THE EFFECTS OF DISSOLUTION?

· Corporation ceases to be a juridical person and consequently can no

longer continue transacting its business.

· Corporate existence continues for 3 years following dissolution for the

ff. purposes only:

(a) winding up of affairs; and

(b) liquidation of corporate assets.

· Corporation can no longer continue its business, except for winding up.

· Corporation CANNOT even be a de facto corporation.

· Corporate existence may be subject to COLLATERAL attack.

NOTE that the subsequent dissolution of a corporation may not remove or impair any
right or remedy in favor of or against, nor any liability incurred by, any
corporation, its stockholders, members, directors, trustees or officers. (Sec.
145)

Loss of juridical personality

Executory contracts

The prevailing view is that executory contracts are not extinguished by

dissolution. Sec. 145 of the Code states that "No right or remedy in favor of or
against any corporation….nor any liability incurred……shall be removed or impaired
either by the subsequent dissolution of said corp. or by any subsequent amendment
or repeal of this Code or of any part thereof."

Liquidation

WHAT IS LIQUIDATION? (Sec. 122)

Liquidation, or winding up, refers to the collection of all assets of the

corporation, payment of all its creditors, and the distribution of the remaining
assets, if any, among the stockholders thereof in accordance with their contracts,
or if there be no special contract, on the basis of their respective interests.

WHAT ARE THE METHODS OF LIQUIDATING A CORPORATION? AND WHO MAY UNDERTAKE THE
LIQUIDATION OF A CORPORATION?

1. Liquidation by the corporation itself through its board of directors

Although there is no express provision authorizing this method, neither is there

any provision in the Code prohibiting it.

2. Conveyance of all corporate assets to trustees who will take charge of

liquidation.

If this method is used, the 3-year limitation will not apply provided the
designation of the trustees is made within said period. There is no time limit
within which the trustee must finish liquidation, and he may sue and be sued as
such even beyond the 3-year period unless the trusteeship is limited in its
duration by the deed of trust. (See Nat'l Abaca Corp. v. Pore, supra)

3. Liquidation is conducted by the receiver who may be appointed by the SEC

upon its decreeing the dissolution of the corp.

As with the previous method, the three-year rule shall not apply. However, the
mere appointment of a receiver, without anything more, does not result in the
dissolution of the corporation nor bar it from the exercise of its corporation
rights.

FOR HOW LONG MAY THE LIQUIDATION OF A CORPORATION BE UNDERTAKEN?

Generally, a corporation may be continued as a body corporate for the

purpose of liquidation for 3 years after the time when it would have so dissolved.
(Sec. 122) However, it was held in the case of Clemente v. CA (supra) that if the
3-year period has expired without a trustee or receiver having been expressly
designated by the corporation itself within that period, the BOD itself may be
permitted to so continue as "trustees" by legal implication to complete the
corporate liquidation.

WHAT CAN AND SHOULD BE DONE DURING THE PERIOD OF LIQUIDATION?

(Sec. 122)

(1) Collection of corporate assets and property;

(2) Conveyance of all corporate property to trustees for the benefit of

SHs, members, creditors, and other persons in interest;

(3) Payment of corporation's debts and liabilities;

(4) Distribution of assets and property

Distribution of assets after payment of debts

GENERAL RULE: No corporation shall distribute any of its assets or

property except upon lawful dissolution and after payment of all its debts and
liabilities. (Sec. 122)

EXCEPTION: In cases of decrease of capital stock, and as otherwise

allowed by the Corporation Code

WHAT HAPPENS IF AN ASSET CANNOT BE DISTRIBUTED TO THE PERSON ENTITLED TO IT?

Any asset distributable to any creditor or stockholder or member who is

unknown or cannot be found shall be escheated to the city or municipality where
such assets are located. (Sec. 122)

Distribution of assets of non-stock corporations

WHAT ARE THE RULES FOR DISTRIBUTION OF ASSETS OF NON-STOCK CORPORATIONS? (Sec. 94-
95)

(1) All liabilities and obligations of the corporation shall be paid,

satisfied, and discharged, or adequate provision shall be made therefor.

(2) Assets held by the corporation upon a condition requiring return,

transfer or conveyance, and which condition occurs by reason of the dissolution,
shall be returned, transferred or conveyed in accordance with such requirements.

(3) Assets received and held by the corporation subject to limitations

permitting their use only for charitable, religious, benevolent, education or
similar purposes, but not subject to condition (2) above, shall be transferred or
conveyed to one or more corporations, societies or organization engaged in
activities in the Philippines substantially similar to those of the dissolving
corp. according to a plan of distribution adopted pursuant to Sec. 95 of the Code.

(4) Assets other than those mentioned in preceding paragraphs shall be

distributed in accordance with the AOI or by-laws.

(5) In any other case, assets may be distributed to such persons,

societies, organizations or corporations, whether or not organized for profit, as
may be specified in a plan of distribution adopted pursuant to Sec. 95.
* The plan of distribution of assets may be adopted by a majority vote of the
Board of trustees and approval of 2/3 of the members having voting rights present
or represented by proxy at the meeting during which said plan is adopted.

It must be noted that the plan of distribution of assets must not be inconsistent
with the provisions of Title XI of the Code.

CORPORATE COMBINATIONS

Techniques to achieve corporate combinations

WHAT ARE THE TECHNIQUES TO ACHIEVE A CORPORATE COMBINATION?

(1) Merger (A + B = A)

(2) Consolidation (A + B = C)

(3) Sale of substantially all corporate assets and purchase thereof by another
corporation;

(4) Acquisition of all / substantially all of the stock of one corporation from
its SHs in exchange for the stock of the acquiring corporation

Merger or Consolidation

WHAT IS THE PROCEDURE FOR MERGER OR CONSOLIDATION?

(1) Board of Directors of the constituent corporations must prepare and approve
a plan of merger or consolidation.

(2) 2/3 vote of OCS of the constituent corporations.

(3) Execution of the Articles of Merger/Consolidation, to be signed by the

Pres/VP and certified by the secretary / assistant secretary.

(4) Submission to the SEC for approval.

WHAT ARE THE EFFECTS OF MERGER OR CONSOLIDATION? (Sec. 80)

(1) The constituent corporation shall become a single corporation:

If merger: the surviving corporation designated in the plan of

merger

If consolidation: the consolidated corporation designated in the plan of

Consolidation.

(2) The separate existence of the constituent corporations shall cease, except
that of the surviving or consolidated corporation.
(3) The surviving or consolidated corporation shall possess all rights,
privileges, immunities and powers and shall be subject to all the duties and
liabilities of a corporation organized under the Corporation Code.

(4) The surviving or consolidated corporation shall thereupon and thereafter

possess all the rights, privileges, immunities and franchises of each of the
constituent corporations;

(5) All property (real or personal) and all receivables due on whatever account
(including subscriptions to shares and other choses in action), and all and every
other interest of, or belong to, or due to each constituent corporation, shall be
deemed transferred and vested in such surviving or consolidated corporation without
further act or deed.

(6) The surviving or consolidated corporation shall be responsible and liable

for all the liabilities and obligations of each of the constituent corporations in
the same manner as if such surviving or consolidated corporation had itself
incurred such liabilities or obligations; and any pending claim, action or
proceeding brought by or against any of such constituent corporations may be
prosecuted by or against the surviving or consolidated corporation. (Note: The
merger or consolidation does not impair the rights of creditors or liens upon the
property of any such constituent corporations.)

WHAT ARE THE RULES GOVERNING MERGER OR CONSOLIDATION INVOLVING A FOREIGN

CORPORATION LICENSED IN THE PHILIPPINES? (Sec. 132)

· A foreign corporation authorized to transact business in the Philippines

may merge or consolidate with any domestic corporation if such is permitted under
Philippine law and by the law of its incorporation.

· The requirements on merger or consolidation as provided in the

Corporation Code must be complied with.

· Whenever a foreign corporation authorized to transact business in the

Philippines is a party to a merger or consolidation in its home country or state,
such foreign corporation shall file a copy of the articles or merger or
consolidation with the SEC and the appropriate government agencies within 60 days
after such merger or consolidation becomes effective. Such copy of the articles
must be duly authenticated by the proper officials of the country or state under
the laws of which merger or consolidation was effected.

If the absorbed corporation in such a merger / consolidation happens to be the

foreign corporation doing business in the Philippines, it shall file a petition for
withdrawal of its license in accordance with Sec. 136.

Sale of substantially all corporate assets

WHEN IS A SALE OR OTHER DISPOSITION DEEMED TO COVER SUBSTANTIALLY ALL THE CORPORATE
PROPERTY AND ASSETS?

If by the sale the corporation would be rendered incapable of continuing the

business or accomplishing the purpose for which it was incorporated. (Sec. 40)
WHAT ARE THE REQUIREMENTS? (Sec. 40)

(1) Majority vote of BOD + 2/3 vote of OCS or members at a meeting duly called
for the purpose;

(2) Compliance with the laws on illegal combinations and monopolies

Note, however, that after such approval by the SHs, the BOD may
nevertheless, in its discretion, abandon such sale or other disposition without
further action or approval by the SHs. This, of course, is subject to the rights
of third parties under any contract relating thereto.

WHEN IS SH APPROVAL NOT NECESSARY FOR THE ABOVE DISPOSITION?

(1) If the disposition is necessary in the usual and regular course of business;
or

(2) If the proceeds of the disposition be appropriated for the conduct of its
remaining business (Sec. 40)

IS THE APPRAISAL RIGHT AVAILABLE TO DISSENTING STOCKHOLDERS?

Yes. However, it must be stressed that this right is generally

available only to dissenting stockholders of the selling corporation, not the
purchasing corporation. (It can be argued, though, that in instances wherein the
purchase constitutes an investment in a purpose other than its primary purpose,
stockholders' approval of such investment is necessary, and anyone who objects
thereto will have the appraisal right under Sec. 42.)

Exchange of stocks

In this method, all or substantially all the stockholders of the "acquired"

corporation are made stockholders of the acquiring corporation. With the exchange,
the acquired corporation becomes a subsidiary of the acquiring corporation.
Although this method does not combine the 2 businesses under a single corporation
as in merger and sale of assets, from the point of view of the acquiring (parent)
corporation, there is hardly any difference between owing the acquired
corporation's business directly and operating it through a controlled subsidiary.
In fact, the parent corporation would have the power to buy all the subsidiary's
assets and dissolve it, achieving the same result as in the other methods of
combination. (Campos & Campos)

FOREIGN CORPORATIONS

WHAT IS A FOREIGN CORPORATION? (Sec. 123)

A corporation formed and organized under laws other than those of the
Philippines, regardless of the citizenship of the incorporators and stockholders.
Such corporation must have been organized and must operate in a country which
allows Filipino citizens and corporations to do business there.

In times of war: For purposes of security of the state, the

citizenship of the controlling stockholders determines the corporation’s
nationality.

IN WHAT WAYS CAN A FOREIGN CORPORATION DO BUSINESS IN THE PHILS.?

(1) Wholly-owned subsidiary; or

(2) Branch office; or

(3) Joint venture with a local partner.

Permitted areas of investment

100% EQUITY: Mass media, except recording

The practice of a profession (law,
medicine, etc.)
Operation of rural banks
Cooperatives
Private security agencies
Small-scale mining
Utilization of marine resources
Ownership, operation, and management of cockpits;
Manufacture, repair, stockpiling of nuclear, biological, chemical,
and radiological weapons;

Note: Retail trade is no longer required to be 100% Filipino-owned on account

of the Retail Trade Liberalization Act.

75%-25% EQUITY: Inter-island shipping (R.A. 1937, Sec. 8)

Private recruitment
Contracts for construction and repair of locally-funded public
works

Except: Public works that would fall under the Build-

Operate-Transfer Law, as well as those that are foreign-funded

70%-30% EQUITY: Advertising

60%-40% EQUITY: Other industries.

WHAT IS THE SO-CALLED "GRANDFATHER RULE"?

Where a domestic corporation which has both Philippine and foreign stockholders is
an investor in another domestic corporation which has also both Philippine and
foreign stockholders, the so-called "grandfather rule" is used to determine whether
or not the latter corporation is qualified to engage in a partially nationalized
business, i.e. by determining the extent of Philippine equity therein.

Under present SEC rules, if the percentage of Filipino ownership in the first
corporation is at least 60%, then said corporation will be considered as a
Philippine national and all of its investment in the second corporation would be
treated as Filipino equity. On the other hand, if the Philippine equity in the
first corporation is less than 60%, then only the number of shares corresponding to
such percentage shall be counted as of Philippine nationality. (See SEC Rule
promulgated on 28 Feb. 1967, cited in Opinion # 18, Series of 1989, Department of
Justice, dated 19 January 1989.)

NOTE: The reader would be well-advised to cross-reference this

definition of the "grandfather rule" with a trusted commentary.

Legal Requirements Prior to Transaction of Business

Documentary Requirements (Sec. 125)

(1) BOI certificate

The BOI certificate is issued upon a finding of the Board of Investments that the
business operations of the foreign corp. will contribute to the sound and balanced
development of the national economy on a self-sustaining basis. (See Omnibus
Investments Code, Sec. 48-49)

NOTE: Applications, if not acted upon within 10 days from official acceptance
thereof, shall be considered automatically approved! (Art. 53, Omnibus Investments
Code)

(2) SEC license to do business (Sec. 125)

· Application under oath setting forth the information specified in Sec.

125;

· Additional information as may be necessary or appropriate to enable the

SEC to determine whether the corporation is entitled to a license to transact
business in the Philippines, and to determine and assess the fees payable;

· Duly executed certificate under oath by authorized official/s of the

jurisdiction of the company's incorporation, attesting to the fact that the laws of
the country of the applicant allow Filipino citizens and corporations to do
business therein, and that the applicant is an existing corporation in good
standing;

· Statement under oath of the president or any other person authorized by

the corporation showing that the applicant is solvent and in good financial
condition, and setting forth the assets and liabilities of the corporation within 1
year immediately prior to the application.

(3) Certificate from appropriate government agency

NOTE: Certain sectors such as banking, insurance, etc. require prior approval
from the government agencies concerned. (Sec. 17)

Deposit requirement (Sec. 126)

Within 60 days after the issuance of the license, the licensee shall deposit with
the SEC securities with an actual market value of at least P 100,000.00. These
securities are for the benefit of present and future creditors, and shall consist
of any of the following:

· Bonds or other evidence of indebtedness of the Government or its

instrumentalities, etc.;
· Shares of stock in "registered enterprises" as defined in R.A. 5186;
· Shares of stock in domestic corporations registered in the stock
exchange;
· Shares of stock in domestic insurance companies and banks.

Once the licensee ceases to do business in the Philippines, these deposited

securities shall be returned, upon the licensee's application and proof to the
satisfaction of the SEC that the licensee has no liability to Philippine residents
or the Philippine government.

Note: Foreign banking and insurance corporations are the exceptions to this
requirement.

Designation of a resident agent (Sec. 128)

The designation of a resident agent is a condition precedent to the

issuance of the license to transact business in the Philippines.

WHO: A resident of the Philippines.

PURPOSE: To be served any summons and other legal processes which may be
served in all actions or other legal proceedings against such corporation. Service
upon such resident shall be admitted and held as valid as if served upon the duly
authorized officers of the foreign corporation at its home office.

Laws applicable to foreign corporations

Foreign corporations lawfully doing business in the Philippines are

bound by all laws, rules and regulations applicable to domestic corporations of the
same class.

Exceptions: (1) As regards the creation, formation, organization or dissolution

of the corporation;
(2) As regards the fixing of relations, liabilities, responsibilities, or
duties of stockholders, members, or officers or corporations to each other or to
the corporation (Sec. 129)

Effects of Failure to Secure SEC License

WHAT ARE THE EFFECTS OF FAILURE TO SECURE A LICENSE?

(1) The corporation will not be permitted to maintain agency in the Philippines;

(2) The corporation will be subject to penalties and fines;

(3) The corporation will not be permitted to maintain or intervene in any action
before Philippine courts or administrative agencies; it can be SUED.

What Constitutes Transacting Business

WHAT IS CONSIDERED AS NOT DOING BUSINESS, AND THEREFORE NOT SUBJECT TO THE
LICENSING REQUIREMENT?

· Mere investment as a shareholder and the exercise of the rights as such

investor;

· Having a nominee director or officer represent the foreign investors’

interests;

· Appointing a representative or distributor in the Philippines who

transacts business in his own name and for his own account

Example: Rustan’s exclusive distributorship of Lacoste t-shirts

· Publication of a general advertisement;

NOTE: Under the Code of Commerce, the publication of an ad is prima

facie evidence (or at least creates a presumption) of doing business in the
Philippines.

· Maintaining stock of goods for processing by another entity in the

Philippines;

· Consignment of equipment to be used in processing products for export;

· Collecting information in the Philippines;

· Performing services incidental to an isolated contract of sale

Example: Installing machinery sold by a foreign corporation to a Philippine buyer

WHAT IS THE TEST OF DOING BUSINESS IN THE PHILIPPINES?

Whether or not there is continuity of transactions which are in pursuance of

the normal business of the corporation. (Metholatum v. Mangaliman)

How Courts Acquire Jurisdiction over Foreign Corporations

As a rule, jurisdiction over a foreign corporation is acquired by the courts

through service of summons on its resident agent.

If there is no assigned resident agent, the government official designated by

law can receive the summons on their behalf and transmit the same to them by
registered mail within 10 days. This will complete the service of the summons.
Summons can also be served on any of the corporation's officers or agents within
the Philippines. (See Sec. 128; Rule 14, Sec. 12, Rules of Court. Note that while
Sec. 128 presupposes that the foreign corporation has a license, Rule 14 does not
make such an assumption.)

Note that if there is a designated agent, summons served upon the government
official is not deemed a valid process.

v Johnlo Trading case holds that the service on the attorney of an FC who was
also charged with the duty of settling claims against it is valid since no other
agent was duly appointed.

v Service on Officers or Agents of an foreign corporation’s domestic

subsidiary will only vest jurisdiction if there is sufficient ground to disregard
the separate personalities.

GENERAL CORPORATION OF THE PHILIPPINES VS UNION INSURANCE (87 Phil. 313; 1950)

General Corporation and Mayon investment sued Union Insurance and Firemen’s Fund
Insurance (FFI) for the payment of 12 marine insurance policies. The summons was
served on Union which was then acting as FFI’s settling agent in the country. At
that time, it was not yet registered and authorized to transact business in the
Philippines.

Issue: Did the trial court acquire valid jurisdiction over FFI?

Yes. The service of summons for FFI on its settling agent was legal and gave the
court jurisdiction upon FFI. Section 14, Rule 7 of ROC embraces Union in the
phrase, “or agents within the Philippines”. The law does not make distinctions as
to corporations with or without authority to do business in the Philippines. The
test is whether a foreign corporation was actually doing business here. Otherwise,
a foreign corporation doing business illegally because of its refusal or neglect to
obtain the corresponding authority to do business may successfully though unfairly
plead such neglect or illegal act so as to avoid service and thereby impugn the
jurisdiction of the courts.

Withdrawal of Foreign Corporation

(Sec. 136)

HOW: By filing a petition for withdrawal of license

REQUISITES FOR ISSUANCE OF CERTIFICATE OF WITHDRAWAL:

(1) All claims which have accrued in the Philippines have been paid,
compromised and settled;

(2) All taxes, imposts, assessments, and penalties, if any, lawfully due to the
Philippine Government or any of its agencies or political subdivisions have been
paid; and

(3) The petition for withdrawal of license has been published once a week for 3
consecutive weeks in a newspaper of general circulation in the Philippines.

Revocation and Suspension of License

(Sec. 134)
WHAT ARE THE GROUNDS FOR REVOCATION OR SUSPENSION OF A LICENSE OF A FOREIGN
CORPORATION?

(1) Failure to file its annual report or pay any fees as required by the
Corporation Code;

(2) Failure to appoint and maintain a resident agent in the Philippines as

required;

(3) Failure, after change of resident agent or of his address, to submit to

the SEC a statement of such change;

(4) Failure to submit to the SEC an authenticated copy of any amendment to

its AOI or by-laws or of any articles of merger or consolidation within the time
prescribed by the Code;

(5) A misrepresentation of any material matter in any application, report,

affidavit or other document submitted by such corporation pursuant to Title XV;

(6) Failure to pay any and all taxes, imposts, assessments or penalties, if
any, lawfully due to the Philippine government or any of its agencies or political
subdivisions;

(7) Transacting business in the Philippines outside of the purpose/s for

which such corporation is authorized under its license;

(8) Transacting business in the Philippine as agent of or acting for and in

behalf of any foreign corporation or entity not duly licensed to do business in the
Philippines; or

(9) Any other ground as would render it unfit to transact business in the
Philippines.

SPECIAL AND MISCELLANEOUS PROVISIONS

Educational corporations
(Sec. 106-108)

· Educational corporations other than government-run institutions are

governed first by special laws, second, by the special provisions of the
Corporation Code, and lastly, by the general provisions of the Corporation Code.
(Sec. 106)

· At least 60% of the authorized capital stock of educational corporations

must be owned by Filipino citizens, and Congress may require increased Filipino
equity participation therein. (With the exception of educational institutions
established by religious groups and mission boards, which are not subject to this
equity requirement.) However, control and administration of educational
institutions must be vested exclusively in citizens of the Philippines. (Art. XIV,
Sec. 4 (2), 1987 Constitution) This means that no alien may be elected as a member
of the BOD nor appointed as Principal or officer thereof.

· Once a school, college or university has been granted government

recognition by the DECS, it must incorporate within 90 days from the date of such
recognition, unless it is expressly exempt by DECS for special reasons. (Act 2706,
Sec. 5) In addition, it must file a copy of its AOI and by-laws with the DECS.
Without the favorable recommendation of the DECS Secretary, the SEC will not accept
or approve such articles. (Sec. 107, Corporation Code)

Religious corporations
(Sec. 109-116)

Religious corporations are governed by Title XIII, Chapter II of the

Corporation Code and by the general provisions of the Code on non-stock
corporations insofar as they may be applicable. (Sec. 109)

Corporation sole (Sec. 110-115)

A corporation sole is an incorporated office, composed of a single

individual who may be a bishop, priest, minister or presiding officer of a
religious sect, denomination or church. Its purpose is to administer and manage as
trustee the property and affairs of such religious sect, denomination or church,
within the territorial jurisdiction of such office. (Sec. 110; Sec. 111 (3))

In case of death, resignation, transfer or removal of the person in

office, his successor replaces him and continues the corporation sole. The
property is not owned but is merely administered by the corporation sole, and
ownership pertains to the church or congregation he represents. On the other hand,
he is the person authorized by law as the administrator thereof and the court may
take judicial notice of such fact and of the fact that the parish priests have no
control over such property.

In determining whether the constitutional provision requiring 60%

Filipino capital for corporation ownership of private agricultural lands, the
Supreme Court has held that it is the nationality of the constituents of the
diocese, and not the nationality of the actual incumbent of the office, which must
be taken into consideration. Thus, where at least 60% of the constituents are
Filipinos, land may be registered in the name of the corporation sole, although the
holder of the office is an alien. This ruling is based on the fact that the
corporation sole is not the owner but merely the administrator of the property, and
that he holds it in trust for the faithful of the diocese concerned. (See Gana v.
Roman Catholic Archbishop of Manila, 43 O.G. No. 8, 3225; 1947)

Religious societies (Sec. 116)

In contrast to a corporation sole, religious societies are composed of

more than one person. The requirements for incorporation of such societies are set
forth in Sec. 116 of the Code.

Close Corporations
(Sec. 96-105)

WHAT ARE THE REQUISITES OF A CLOSE CORPORATION? (Sec. 96)

A close corporation, within the meaning of the Corporation Code, is one whose
articles of incorporation provide that:

(1) All the corporation's issued stock of all classes, exclusive of treasury
shares, shall be held of record by not more than a specified number of persons not
exceeding 20;

(2) All the issued stock of all classes shall be subject to one or more
specified restrictions on transfer permitted by Title XII of the Code; and

(3) The corporation shall not list in any stock exchange or make any public
offering of any of its stock of any class.

Notes:

· A narrow distribution of ownership does not, by itself, make a close

corporation. (San Juan Structural and Steel Fabricators v. CA, 296 SCRA 631)

· A corporation shall not be deemed a close corporation when at least 2/3

of its voting stock or voting rights is owned or controlled by another corporation
which is not a close corporation.

CAN A CORPORATION THAT IS NOT A CLOSE CORPORATION BE A STOCKHOLDER IN A CLOSE

CORPORATION?

YES, provided that said corporation owns less than 2/3 of voting stock or voting
rights.

WHAT ENTITIES MAY NOT BE ORGANIZED AS CLOSE CORPORATIONS? (Sec. 96)

· Mining
· Oil
· Stock Exchange
· Bank
· Insurance
· Public Utilities
· Educational Institutions
· Corporations declared vested with public interest

DISTINGUISH CLOSE CORPORATIONS FROM REGULAR CORPORATIONS.

Close Corporation "Regular" Corporation

No. of stockholders
Not more than 20 (Sec. 96)
No limit

Management
Can be managed by the stockholders (Sec. 97)
Managed by Board of Directors

Meetings
May be dispensed with (Sec. 101)

Actual meetings are required.

Quorum and Voting

Greater quorum and voting requirements allowed. (Sec. 97)

Pre-emptive right
Extends to all stock, including treasury shares (Sec. 102)
Does not extend to treasury shares.

Buy-back of shares
Must be > par value (Sec. 105)
May be < par value

Resolution of deadlocks
SEC has the power to arbitrate disputes in case of deadlocks, upon written petition
by any stockholder. (Sec. 104) This includes the power to appoint a provisional
director, as well as to dissolve the corporation.

Dissolution
May be petitioned by any stockholder whenever any of the acts of the directors or
officers or those in control of the corporation is illegal, fraudulent, dishonest,
oppressive or unfairly prejudicial to the corporation or any stockholder, or
whenever corporate assets are being misapplied or wasted. (Sec. 105)
Generally requires a 2/3 vote of the stockholders and a majority vote of the BOD.

(Note however that in case of involuntary dissolution under Sec. 121, a corporation
may be dissolved by the SEC upon filing of a verified complaint and after proper
notice and hearing.)

WHAT IS A PROVISIONAL DIRECTOR? (Sec. 104)

A provisional director is an impartial person who is neither a stockholder nor a

creditor of the corporation or of any subsidiary or affiliate of the corporation,
and whose qualifications, if any, may be determined by the SEC. He is not a
receiver of the corporation and does not have the title and powers of a custodian
or receiver. However, he has all the rights and powers of a duly-elected director
of the corporation, including the right to notice of and to vote at meetings of
directors, until such time as he shall be removed by order of the SEC or by all the
stockholders. (Sec. 104)

COMPARE APPRAISAL RIGHT AND WITHDRAWAL RIGHT IN CLOSE CORPORATIONS. (Sec. 105)

Withdrawal Right Appraisal Right

Type of corporation involved

Close corporation
"Regular" corporation

When availed of
For any reason (Sec. 105)
Only the grounds enumerated in Sec. 81 and Sec. 42

Fair value of shares

Must be > par or issued value (Sec. 105)
May be < par or issued value

Miscellaneous Provisions
(Sec. 137-149)

· The SEC has the power to issue rules and regulations reasonably necessary
to enable it to perform its duties under the Code, particularly in the prevention
of fraud and abuses on the part of the controlling stockholders, members,
directors, trustees or officers. (Sec. 143)

· Whenever the SEC conducts any examination of the operations, books and
records of any corporation, the results thereof must be kept strictly confidential,
unless the law requires them to be made public or where they are necessary evidence
before any court. (Sec. 142)

· All domestic and foreign corporations doing business in the Philippines

must submit an annual report to the SEC of its operations, with a financial
statement of its assets and liabilities and such other requirements as the SEC may
impose. (Sec. 141)

· No right or remedy in favor of or against, nor any liability incurred by,

any corporation, its stockholders, members, directors, trustees or officers, may be
removed or impaired by the subsequent dissolution of said corporation or by any
subsequent amendment or repeal of the Code. (Sec. 145)

· Violations of the Corporation Code not otherwise specifically penalized

therein are punishable by a fine of not less than P 1,000.00 but not more than P
10,000.00 or by imprisonment for not less than 30 days but not more than 5 years,
or both, in the discretion of the court. If the violation is committed by a
corporation, the same may be dissolved in appropriate proceedings before the SEC.
(Sec. 144)