Corporation Code Review

8/12/2019 Corporation Code Review

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ATENEO LAW SCHOOL CORPORATION LAW2-D [DEAN VILLANUEVA]

L.T.J.F. 2ndSemester S.Y. 2012-2013

Sources: CLV Lectures

Villanueva, Cesar,Philippine Corporate Law, Manila: Rex Printing Company, 2010.

Ateneo Central Bar Operations, Commercial Law Reviewer, 2007.

CORPORATION LAW REVIEWER

I. CONCEPTS

4 Corporate Attributes1. Artificial Beingjuridical capacity to enter

into contracts and transactions

2. Creature of the lawcreated by operationof law

3. Strong Juridical Personalityhas right ofsuccession and a separate existence

4. Creature of Limited Powersonly haspowers as authorized by law (express,

implied and incidental)

Tri-Level Existence1. Aggregation of Assetsassets only level2. Business Enterprisebusiness only level3. Juridical Entitya creature of the law

Tri-Level Relationship

1. Juridical Entity Levelbetweencorporation and the State

2. Intra-corporate Levelbetweencorporation and its agents, officers, share

holders; between shareholders and thecorporate directors, officers; between the

shareholders3. Extra-corporate Levelbetween the

corporation and its employees, its creditors,

contracting parties and the dealing public

Characteristics of a Corporation vs. a Partnership

Corporation Partnership

Strong JuridicalPersonality

Weak JuridicalPersonality

Centralized Management Mutual Agency

Limited Liability of

Investors and Officers

Unlimited Liability of

Partners

Free Transferability of

Shares

Delectus Personae

II. NATURE AND ATTRIBUTES

Constitutional Guarantees

1. Due Process and Equal Protection2. Unreasonable Searches and Seizure

NOTES:Corporate officers who are searched intheir personal capacity cannot invoke the

corporation's Constitutional rights since the latter has

a separate personality from its officers.

A corporation has NO right against self-

incrimination since this is a moral right. A

corporation, being a creature of the law, has no

morals.

Corporate Criminal Liability

A corporation can only act through it sofficers and agents.

A crime committed in the name of thecorporation is actually committed by the

individuals who act for and in behalf of suchcorporation.

A corporation, having no corporal existence,cannot be imprisoned. It cannot have an

intent since it has no mind

Civil Liabilities Arising from Criminal Offenses

While corporate officers are held criminallyliable for the for violations of the terms of thetrust receipts, they cannot be held personally

liable for the amount covered where they

signed the contract in their official capacity

(Consolidated Bank and Trust Corp v CA,356 SCRA 671)

Debts incurred by corporate agents, acting intheir official capacity, are not theirs but thedirect liability of the corporation.

Exception: when the corporate agents andofficers contractually agree or stipulate their

personal liabilities.


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Anti-Money Laundering Act of 2001 (AMLA)

AMLA defines an Offender as any personwho commits such offenses.

If the corporation is the criminal offender, thepenalty applies to the responsible officers

The offending corporation can be cited as theaccused or defendant, but the penalty

imposed is the revocation or suspension of its

license or franchise

Entitlement to Moral Damages

General Rule:Corporations are not entitled to

recover moral damages, being a creature incapableof feeling and having no emotions or senses.

Exception: A juridical person may recover moraldamages in cases of libel, slander or any form of

defamation under Article 2219 of the Civil Code.

While the court may allow the grant of moral

damages to corporations, it is not automatically

granted since there is a need to prove actual damage

suffered (Crystal v BPI, 572 SCRA 697)

Nationality of Corporations

Tests of Nationality1. Place of Incorporation2. Control3. War-time Test4. Investment Test (Based on FIA 1991)5. Grandfather Rule

Place of Incorporationa corporation is a nationalof the country under whose laws it is organized. This

is the primary mandatory test in peace time.

NOTE:a corporation which is 100% Filipino-ownedbut incorporated abroad is a foreign corporation.

Control Testa corporation's nationality is/determined by the nationality of the majority of the

stockholders. Test is generally applied in

nationalized industries.

War-time Testa form of the Control Test. A

corporation is an enemy due to the fact that majority

of its shareholders are nationals of an enemy State.

Investment TestForeign Investment Act 1991:

Where at least 60% of the voting capital stock is

owned by Filipinos, then the corporation is aPhilippine national.

Grandfather RuleThe ownership of the investingcorporation is counted in calculating how much

capital is controlled by Filipino citizens. This test is

applied up to the 2ndlevel of corporate ownership.

Query:Is the Grandfather Rule only used whenthere is doubt as to the ownership of a corporation

and that the control test is still the default test?

There are conflicting Opinions in this case:

DOJ Opinion No. 18, s. 1989: the Grandfather

Rule will not applyin cases where the 60-40Filipino-alien equity ownership is not in doubt.

But the SEC-OGC Opinion No. 10-31 (09

December 2010) seemed to indicate a revival of theGrandfather Rule: that the control test must not be

applied in determining if a corporation satisfies the

Constitutions requirementsPhilippinecitizenship is being unduly attributed to foreign

individuals Thus, applying the control test

effectively circumvents the Constitutional mandate One must not stop until the citizenships of the

individual or natural stockholders of layer after

layer of investing corporations have been

established, the very essence of the Grandfather

Rule.

Illustration:

A 60% Filipino-owned corporation investing inanother corporation (principal) that is also 60%

Filipino-owned. Assume that the investing

corporation comprises of the entire 60% Filipino


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ownership in the principal corporation

Ownership and

Status

Grandfather

Rule Applied

No Grandfather

Rule AppliedInvesting Corp (%) Filipino: 60

Foreign: 40Filipino: 60Foreign: 40

Principal Corp (%) Investing: 60Foreign: 40

Investing: 60Foreign: 40

Filipino Ownershipof Investing Corp

Limited to60%

Considered 100%

Filipino Ownershipof Principal Corp

(0.6 x 0.6) =0.36 or 36%

(1 x 0.6) = 0.6 or60%

Status Disqualified Qualified

NOTES:

The term capital refers only to shares ofstockentitled to vote (common shares and preferred sharesentitled to vote) and NOT the total outstanding

capital stock (Gamboa v Teves, 652 SCRA 690)

Effective Control means outstanding capital stockentitled to vote, coupled with beneficial ownership

(Heirs of Gamboa v Teves, GR 176579, 09 Oct 2012)

Control of a corporation is not limited to voting

rights of stocks alone but is determined by equity

(right to vote + right to receive dividends)

SEC Memo Circular 8 (2013)

The SEC gave a new interpretation of the rule on

Filipino ownership which pretty much overturnedthe Gamboa v. TevesDoctrine

The required percentage of Filipino ownership shallbe applied to BOTH:

1. Total number of outstanding shares of stockentitled to vote -AND-

2. Total number of outstanding shares of stockwhether or not entitled to vote

NOTE:If a corporation is incorporated in the

Philippines, but its equity is 59% Filipino, it is a

Filipino Corporation (pursuant to the Place of

Incorporation Test) but is not qualified to engage in

nationalized industries.

Nationalized Industries of the 1987 Constitution

Industry Filipino Ownership (%)

Natural Resources 60

Public Utilities 60

Mass Media 100

Advertising 70

NOTE:For nationalized industries, a corporationmay be disqualified even if the voting shares are

controlled by Filipinos. This scenario is possiblewhen the corporation enters into a transaction

enumerated under Sec. 6 of the Corporation Code

where in all shares, including non-voting shares areentitled to vote. Such votes of the non-voting shareswill be counted in determining the ownership

requirements.

Mere ownership of the facilities of a public utility is

not prohibited for foreign corporations. What isprohibited is the operation of these facilities to

serve the public. What constitutes a public utility is

not their ownership but their use to serve the public.(Tatad v Garcia 243 SCRA 436)

NOTE:A corporation is unlimitedly liable in terms

of its own liability. The stockholders are limitedlyliable to the extent of their investment.

III. PIERCING THE VEIL DOCTRINE

A corporation's separate juridical personality is

disregarded and it is seen merely as an association of

persons when the corporation is used to commitfraud and other illegitimate purposes.

General Characteristics

Doctrine applies only when the business


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enterprise is threatened or compromised

Generally used only as a last resort (except infraud cases)cannot be invoked when other

remedies are available. Doctrine can only be invoked once an

operation or transaction has taken place

Doctrine cannot be invoked to resolveremedial issues (circumventing technicalities)

since it is a commercial doctrine

When the veil is pierced, the corporationdoes not lose its separate personality entirely

it only loses it for purposes of that

particular situation (Res Judicata Effect)3 Purposes of Piercing the Veil

1. Equity Cases2. Fraud Cases3. Alter Ego Cases

Equity Cases

A catch-all provision where no fraud oralter ego circumstances can be culled by the

Court to warrant piercing

When the piercing is necessary to achievejustice or equity

Cannot be invoked if no public policy isinvolved

Eg: When the corporate fiction was used toconfuse legitimate issues

Fraud Cases

When the corporate entity is used to commitfraud or justify a wrong

Mere fraud does not automatically lead tocorporate piercing but the fact that thecorporate personality is used as a tool to

commit fraud

Does not always relate to fraud or a crime.As long as a wrong is done, which may evenbe civil in nature (eg: Joint tort feasor)

Piercing need not be a last resort in fraudcases. (Can be availed of to prevent fraud)

Alter Ego Cases

A.K.A. Instrumentality Piercing Corporation is used as a mere agent, conduit

or instrumentality of another person. A disrespect of the separate juridical entity Uses the corporate fiction to defeat public

convenience

Does not necessarily do a wrong but itcreates public inconvenience

Eg: When a corporation is used for a purposeother than achieving a commercial end

IV. CORPORATE CONTRACT LAW

3 Levels of Corporate Contracts

1. Pre-incorporation Level2. Post-incorporation Level3. Dissolution and Liquidation Level

Pre-incorporation Level

Business Enterprise level of existence Promotersthose who organize the

corporation. They promote the business

venturenot the juridical entity.

Promoters are NOT agents. Pre-incorporation Subscription Agreements

a contract for the acquisition of unissued

stocks

Promoter's Contractscontracts entered intoin behalf of a corporation which is in theprocess of organization.

Both contracting parties are aware that thecorporation is still in the process of

registration

Such contracts are valid as to the promoterbut void as to the corporation yet to be

formed (for absence of consent)

Post-incorporation Level

Ratification is the key element in upholdingthe validity and enforceability of promoter's


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contracts

Promoter is personally liable in the event thecorporation is NOT duly organized

stockholders (people who purchased issuedstocks) are NOT liable.

Once a corporation comes into existence, theratification is a NEW contract, separate and

distinct from the promoters contract (RizalLight and Ice Co. v. Municipality of Morong,

Rizal, 25 SCRA 285)

Post-incorporation Pre-incorporation

At least one of the the

parties intended tocontract with a fullyformed corporation

There is knowledge of

both parties that acorporation is yet to beformed or exist

3 Types of Corporation in Post-incorporation Level1. De Jure CorporationImmaculate, perfect

and duly formed corporation.

2. De Facto CorporationA corporationexists but is defective.

3. Corporation by EstoppelThere is nocorporation but the people act as if there is

one

De Facto Corporation

Elements:1. Existence of a valid law under which

corporation may be incorporated

2. Attempt in good faith to incorporate orcolorable compliance with law

3. Assumption of corporate powers The alleged defect or inexistence of the

corporation cannot be raised collaterally in a

private suit and can only be pursued in adirect suit such as a quo warrantoproceeding

(Sec. 20 Corporation Code)

Such defect cannot be used as an excuse toset aside a transaction entered into in good

faith

Examples of defects:

Defects in the incorporation papers Failure to submit the by-laws on time Ineligibility of the incorporators Articles of incorporation or the certificate

of incorporation is defective orinsufficient in form

Corporation by Estoppel

Doctrine seeks to enforce a contract wherethe element of consent is lacking.

Considered a corporation with respect tothose who cannot deny its existence because

of some agreement or conduct on their part.

Applies when at least one party to a contractwas under the impression that the corporate

party was a duly incorporated entity

Persons who assume to act as a corporationknowing it to be without authority will beheld as general partners (unlimitedly liable)

Liabilities Under a Corporation by Estoppel

Party Involved Liable as a

Active investor with knowledge

that there is no authority

General Partner

(unlimitedly liable)Active investor without knowledgethat there is no authority

Limited Partner(limitedly liable)

Passive Investor in good faith No Liability

Comparative Summary

Characteristic De Facto By Estoppel

Existence in Law Yes None

Dealings on a

corporate basis

Not required Required

Effect of lack ofrequisites

Could be acorporation

by estoppel

Not acorporation

in any shape

Trust Fund Doctrine (TFD)

Purpose is to protect corporate creditors


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Capital of the corporation is held in trust infavor of the creditors

Subscriptions to the capital of a corporationconstitute the trust fund

Retained earnings (profits) are for the benefitof the stockholders and are NOT part of thetrust fund

Stockholders Creditors

As investors, their right is

to have a share of the

profits earned

Their right is to be paid

back what they have

loaned

Assumes the risk of

losses incurred by thecorporation in thebusiness venture

Entitled to be protected

for the credit theyextended to thecorporation

Claim is satisfied throughthe retained earnings

Claim is satisfiedthrough the trust fund

General Rule:Until the liquidation of the

corporation, no part of the subscribed capital may bereturned or released to the stockholder (PLDT vNTC, 539 SCRA 365)

Exceptions:Capital may be distributed in only three instances:

1. Amendment of the Articles of Incorporationto reduce the authorized capital stock

2. Purchase of redeemable shares by thecorporation

3. Dissolution & liquidation of the corporationConsequences of TFD

1. It is unlawful to return to the stockholders aportion of their investment2. Corporations cannot declare dividends out ofthe capital stock

3. TFD covers both paid up capital (paidsubscriptions) and subscription receivables(stocks yet to be paid). However, payments

for additional stocks (increase of capital

stock)prior to the approval of the SECare

NOT covered by the TFD

4. Funds of creditors are placed against thecorporation's equity and not its liabilities:

To protect the creditors from losses The equity absorbs the impact of losses

5. Upon dissolution, stockholders absorb thelosses; creditors get paid first.

Q:If an investor violates the subscription agreement,

can such agreement be rescinded?

A:No. Rescission of a subscription agreement will

result in the unauthorized distribution of capitalassets, which is a violation of the TFD. (Ong Yong vTiu, 401 SCRA 1)

V. ARTICLES OF INCORPORATION AND BY-

LAWS

Articles of Incorporation (AI)

Charter of a corporation upon approval by theSEC. Charter = AI + SEC certificate

Corporate existence commences upon theissuance of the certificate of incorporation

Source of stockholders' rights AI is a contract between:

The State and the Corporation Stockholders and the State Corporation and its stockholders

Contents of Articles of Incorporation

Name of corporation Purpose of corporation Place of principal office in the Philippines Term of existence (not exceeding 50 years) Incorporators:

Names Nationalities Residences


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Number of directors or trustees Directors and Trustees

Names Nationalities Residences

Amount of capital stock Name, residences and nationalities of

subscribers and amount subscribed by each

Other matters not inconsistent with lawGrounds for Disapproval of AI

Failure of substantial compliance with theprescribed form by law

Illegal or immoral purpose of corporation Treasurer's affidavit is false Failure to comply with the required

percentage of Filipino ownership innationalized industries

Treasurer's Affidavit

An additional requirement for the approval ofthe AI, which is a sworn statement certifying

that:

1. at least 25% of the total capital stock issubscribed

2. At least 25% of the subscribed capitalstock is paid in cash or property

3. Paid-up capital is not less than Php5,000By-Laws

Governs intra-corporate relationship Public documents Binding with the State; has obligatory force Only regulates rightsnot diminish them

Some provisions may appear on both AI andthe By-Laws

Some matters normally appearing on the By-Laws can appear solely on the AI

But matters that should appear on the AIcannot appear solely on the By-Laws

Matters Commonly Found in By-Laws

Time, place and manner of conductingmeetings

Required quorum in meetings and manner ofvoting

Qualifications, duties and compensation ofdirectors, officers and employees

Penalties for violation of by-laws Manner of election or appointment and term

of all officers, except directors and trustees

Other matters for conducting businessLimits of By-Laws

Cannot be contrary to law or charter Cannot be unreasonable Cannot discriminate

Amendments

Action Articles ofIncorporation

By-Laws Consent of

Vote of theBoard

AbsoluteMajority

AbsoluteMajority

Corporation

Ratification 2/3 OCS(outstanding

capital stock)

Majority ofOCS

(50%+1share)

Stockholders

Approval of SEC SEC State

Rationale of Ratification:

Every stockholder has the right to expect that the

corporation will act (use their investments) in

accordance with the Articles of Incorporation. In theeven that the corporation deviates or conducts the

business contrary to the AI, the stockholders must be

asked to give their consent.

Articles of Incorporation By-Laws

Governs relationship

between State and corp.

Intracorporate

relationship

Source of rights Regulates rights


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Amendment needsratification of 2/3 OCS

Amendment needsmajority of OCS

Power to amend cannotbe delegated to theBoard by stockholders

Power to amend may bedelegated bystockholders to Board

VI. CORPORATE POWERS & AUTHORITY

Types of Corporate Powers

1. Expressexpressly authorized by law, theArticles of Incorporation or Charter

2. Incidental or Inherentincidental to thecorporation's existence. Flow from the nature

of the corporation as a juridical person.3. Impliednecessary for the exercise of

express powers. Flow from the nature of the

underlying business enterprise.

Power Type of Power

Sue and be sued Express

Succession Express

Amend the AI Express

Adopt by-laws Express

Issue and sell stocks Express

Purchase, sell, mortgage,

convey property or assets

Implied

Borrow money or create

bonded indebtedness

Incidental

Increase or decreasecapital stock

Express

Extend corporate term Express

Shorten corporate term IncidentalInvest in another

corporation or business

Express

Declare dividends Express

Make donations Express

Enter into managementcontracts

Express

Corporate Acts Requiring 2/3 OCS Ratification

1. Extend or shorten corporate term2. Increase or decrease capital stock3. Incur or crate bonded indebtedness4. Sell, dispose, lease or encumber all or

substantially all of corporate assets5. Investing in another corporation or business

other than the primary purpose

6. Declare stock dividends7. Amend the Articles of Incorporation8. Delegate to the Board of Directors the power

to amend the By-Laws (not considered a

corporate act since no prior board resolutionis required)

9. Enter into a management contract (uponcertain instances)

Bonded Indebtedness

Ordinarily, the power to borrow money(debentures) falls within the business

judgment power of the board and would notrequire stockholder's ratification

But the issuance of bonds (evidence ofindebtedness for a period of at least 360 days

or more) will need SEC approval andstockholder's ratification

An exception to the rule that corporate poweris lodged in the Board of Directors

If SEC approval is not secured, the loancontracts are still valid but the corporation

may be penalized

Bonded Indebtedness DebenturesObligation is evidenced

by a bond

Based on general credit

of corporation

Secured by collateral Not secured by collateral

Ratification is required No ratification required

A public issue since the The public will not be


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bond (a negotiableinstrument) would be

circulated in the public

involved

Rationale of Ratification:

The corporation's earnings are diverted to paying ormaintaining the loan obligation. None of the

earnings,in the form of dividends, might be left to the

stockholders thus their consent is required.

Investing in Another Corporation

Purpose of the power to investto seek themaximum return for their investible funds.

When the investment is pursuant to thecorporation's secondary purpose, it shall

require the ratification of the stockholders

As long as the investment is for theaccomplishment of the primary purpose, theapproval of the stockholders shall not be

necessary.

Q:If a corporation wants to invest in another

corporation or business beyond its primary and

secondary purpose, can it do so provided that the

ratification of the stockholders is secured?

A:No. The Corporation Code limits the powers of

the corporation as to those provided in the Articles ofIncorporation, and the Code. Such ratification would

be limited to pursuing the secondary purpose only.

Rationale of Ratification:Stockholders have the right to expect that the

corporation will pursue only its primary purpose and

the stockholders have the right to evaluate and give

their consent in the event that corporate funds willbe diverted to pursue a secondary purpose.

Sale, Disposition or Encumbrance of Assets

Affects the business enterprise level and doesnot affect the corporation's relationship with

the State thus securing the State's consent is

not required

Any sale, disposition or encumbranceeffected without the appropriate ratification

renders such transactions void

General Rule:Stockholders have a proprietary or

beneficial interest on the business enterprise thus it is

necessary to secure their authorization when selling,

encumbering or disposing of corporate assets.

Exceptions:1. If such disposition is necessary in the usual

course of business of the corporation2. If the proceeds of the disposition of assets be

appropriated for the conduct of the remaining

business

Test of Substantial Disposition of Assets

If the corporation will be rendered incapable of:1. Continuing the business -OR-2. Accomplishing its purpose

Management Contracts

A contract whereby a corporation undertakesto manage or operate all or substantially all

of the business of another corporation

No management contract shall be enteredinto for a period longer than 5 years for any

one term

Covers not only management contractsbetween 2 corporations but also a contractbetween a corporation and an individual or a

partnership

Conditions Requiring Two-Thirds (2/3) Ratification1. Stockholders representing the same interest

of both the managing and managed

corporations own more than one-third (1/3)of the total OCS entitled to vote of themanaging corporation. -OR-

2. A majority of the board of directors of themanaging corporation also constitute themajority of the board of the managed

corporation.


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NOTE:If both of the conditions mentioned above

are absent, only a concurrence of the majority of the

outstanding capital stock is required.

Ultra Vires Doctrine

No corporation shall possess or exercise anycorporate powers except those conferred bythis Code or by its Articles of Incorporation

and those that are necessary or incidental to

the exercise of the powers so conferred.

An act of a corporation committed beyond itsauthority or those that are beyond the powers

provided by law or its charter is an Ultra

Vires Act. Ultra Vires Acts refer to contracts since a

corporation can only act by entering into

contracts through the resolution of its Board

of Directors

Types of Ultra Vires Acts (Contracts)1. Firstexecuted or committed outside the

powers of the corporation

2. Secondexecuted or committed within thepowers of the corporation but without

authority from the board of directors3. Thirdacts committed, which are duly

authorized but are illegal, contrary to morals

and public policy.

Status of Contracts and the Ultra Vires Act

Ultra Vires Act Contract Status

First Type Void as to the StateVoidable as to 3rdpersons

Second Type Unenforceable

Void as to the Corporation

Third Type Null and Void

First Type of Ultra Vires Act

A corporation has no capacity to give itsconsent since the acts committed are outside

its conferred powers.

Lack of capacity to give consent makes thecontract voidable.

Contract is void as to the State but voidableas to 3rdpersons (valid until annulled)

Rationale: On the extra-corporate level, thedealing public has the right to expect that the

contracts they enter into will be enforced.

This wins over the voidness of the contract asto the State because of the non-impairment of

contracts clause in the Constitution.

Second Type of Ultra Vires Act

Contracts made on behalf of the corporationby agents who have not been authorized bythe Board of Directors or without proper

ratification by the stockholders

A specie of unenforceable contracts underContract Law

Void as to the corporation as having enteredinto by an agent without its consent. Alsovoid for violating the Centralized

Management Doctrine

Third Type of Ultra Vires Act

Contracts and transactions which are enteredinto in the name of the corporation, but are

contrary to laws, morals or public policy

Void contracts even when acted through theauthority of the Board of Directors.

Ultra Vires Doctrine Piercing the Veil Doctrine

Corporate acts are

done without authority

or beyond the powers

granted by law.

There is a disrespect or

misuse of the separate

juridical entity as to

undermine public interest.

Types: First, Second,

Third Ultra Vires

Types: Fraud, Alter-ego,

Equity Piercing

Separate juridical

personality is never setaside.

Separate juridical

personality is set aside forthat particular situation.


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Issue is on the validityor status of the

contract entered into.

Issue is how the corporatefiction was used as a tool to

undermine public interest

Can be invokedanytime by the injured

party.

Cannot be invoked whenthere are other remedies

available (last resort).

VII. DIRECTORS, TRUSTEES AND OFFICERS

Centralized Management

All corporate powers shall be exercised byand all business shall be conducted through

the Board of Directors (Sec. 23)

An exercise of the police power of the State Splits ownership of the corporation between:

1. Board of Directors (Trustees)nakedtitle holder

2. Stockholders (Beneficiaries)beneficialtitle holder

Sec. 23 is a form of Express TrustBoard of Directors (BOD) as Trustees

Not an agent of the beneficiary Carries the face of owner and exercises

ownership BOD does not owe duty of obedience to the

stockholders

BOD are agents of the corporation but notagents of the stockholders

BOD can ignore resolutions of thestockholders because such resolutions aremerely advisory in nature

Default Rule in Commercial Law

Every power vested in a person can bedelegated and re-delegated

An agent can appoint a sub-agent An agent becomes liable for the acts of the

sub-agent

Officers Collectively called management

Sub-agents of the BOD as agents of thecorporation

Business Judgment Rule

The manner of enforcing Sec. 23 Questions of management are left solely to

the honest decision of the officers and the

directors of the corporation

The courts have no authority to review theboards management decisions or substitute

their own judgment

2 Levels:1. Transaction Level

Binding on the corporation provided thereis no bad faith, malice or fraud

Cannot be overturned by the shareholdersor the courts

Fraudulent transactions: still binding until annulled Merely voidable contracts Only vice of consent is involved

2. Accountability of the Board, Officers andEmployees

Agency rules apply If the loss is merely due to an error in

business judgment, not amounting to bad

faith, then the officers are not liable

General Rule:Directors and officersacting within such business judgmentcannot be held personally liable for theconsequences of such acts

Exceptions:officer is held liable when: the business judgment is for patently

unlawful acts

there is gross negligence or bad faith he acquires any interest in conflict

with his duty as a director or officer


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Doctrines on Corporate Acts

Estoppel or Ratification

Premised on a reliance in good faith by thedealing public

Precludes a corporation from denying thevalidity of the transaction entered into with a

third party who relied in good faith on the

authority of the former

A corporation's ratification of a contract andacceptance of the benefits made such contract

valid and binding

Ratification must come from the Board ofDirectors or an authorized representative,who has full knowledge of the contract or

transaction concerned Ratification cannot be made by the same

person who wrongfully assume the power tomake the contract

Laches or Stale Demands

The failure to assert a right for anunreasonable and unexplained length of time

Presumption that the party entitled to assertsuch right has abandoned it

Apparent Authority

General Rule:In the absence of authority from the

BOD, no person can validly bind a corporation

Exception:When corporation knowingly permits

one of its officers or agents to act within the scope of

apparent authority, it holds him out to the public aspossessing the power to do those acts

Exception to the Exception:Self-dealing contractsof directors and officerswhen one of the directors

enters into a contract with his own corporation.

A director cannot use the doctrine of apparentauthority to enforce the contract he entered with the

corporation because, as an agent, he cannot

prioritize his own interests over the interest of the

corporation. If the corporation wishes to rescind the

contract the contracting director must submit to the

wishes of the corporation, his principal

The corporation is estopped from denying theagent's authority

Burden of proof is on the corporation to showthat its corporate officer is not authorized

The apparent power of an agent is determinedby the acts of the principal (how thecorporation holds out the agent to the public)

and not by the acts of the agent

Party invoking apparent authority mustprove:

Acts of the purported officer or agentjustifying belief in the agency by the

principal corporation

Knowledge of the corporation on suchagency or authority

Reliance thereon by the corporationRationale for Doctrine:

Third person has little or no information as to whatoccurs in corporate meetings and he must rely upon

the external manifestations of corporate consent.

Principles of Good Corporate Governance1. SizeNot less than 5 members and not more

than 15 members

2. Term of Board of Directors1 year limit3. Qualification requirement to be a directora

registered stockholder of at least 1 share

4. Other qualifications must be stated in the By-Laws. Corporation Code is supplementary

5. Only the stockholders have the power toremove a member of the board. Disciplinary

measures provided in the by-laws exercised

by the board are void.

Hold -Over Period

A situation which arises when no successor iscleared due to valid and justifiable reasons

The incumbent holds over and constitutes tofunction until another officer is chosen and


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qualified.

Incumbent Board is defactobut functions as ade jureboard

Vacancies of directors through the expirationof term may not be filled by the Board

Any attempt to grant a person a permanentseat in the Board of Directors in unlawful

When no meeting or election is held, thestockholders may initiate or call for one by apetition filed in court

Removal and Discipline of Directors

Removal is by vote of stockholdersrepresenting two-thirds (2/3) of the

outstanding capital stock

Such removal must take place at a meetingcalled for such purpose

Called by the Corporate Secretary on order ofthe President or on the written demand of the

stockholders representing at least a majority

of the outstanding capital stock

The Board may initiate legal actions (filing acriminal case, recover damages, etc.) against

the erring director on behalf of the

corporation but the Board has no power to

suspend or remove a director on its own

Removal with causewhen a director hasviolated his duties of diligence, obedience

and loyalty (duties of an agent)

Fiduciary Duties of Directors

Duty of Obedience

Board shall direct the affairs of a corporationonly in accordance with the purpose forwhich it was organized

Directors should act in a manner and withinthe formalities prescribed by its charter or by

law

Duty of Diligence

Must not willfully and knowingly vote orassent to patently unlawful acts of the

corporation

Must not act in bad faith or with grossnegligence

Duty of Loyalty

A director shall prioritize the interests of theprincipal corporation over his own

Doctrine of Corporate Opportunity A person cannot be a director of a

corporation when he is also an owner or

officer of a competing corporation.

Prevents the creation of an opportunityfor the competitor to prejudice the

corporation's interests Self-Dealings (Sec. 32 Corporation Code)

A contract between the corporation withone or more of its directors or officers

Generally voidable at the option of thecorporation unless all conditions are

present:

1. Presence of such director was notnecessary to constitute quorum

2. Vote of director was not necessary forapproval of contract

3. Contract is fair and reasonable4. In case of a dealing officer, the

contact has been previously

authorized by the Board

When the 1stor 2ndconditions are absent,contract may be ratified by a vote of

stockholders representing 2/3 of the

outstanding capital stock:Providedfulldisclosure is of the interests is made

NOTE:Even if the Board has approvedthe contract, when it is unfair andunreasonable, the stockholders can stillbring a derivative suit.

Corporations with Interlocking Directors Contracts between corporations cannot be

invalidated simply because they have

interlocking directors


14/41






Exception: in cases of fraud or when thecontract is unfair and unreasonable

Stockholdings exceeding 20% of theoutstanding capital stock shall beconsidered substantial for purposes of

interlocking directors

Duty to Inform

Directors are trustees of the stockholders(beneficiary)

All property of the corporation are held bythe Board of Directors

The Board has the duty to submit auditedfinancial statements and corporate records

Stockholders have the right to inspect andcopy corporate records

Breach of Duties by the Board

Breach of Duty of Obedience

Gives rise to Ultra Vires of the 1stand 3rdtype But NOT the 2ndtype (where an act is

within the powers of the corporation but

committed without authority)

Because the Board has plenary powers It is impossible for the Board to commit acts

without proper authority since authority isvested in the Board in the first place

NOTE:Does not cover acts requiringstockholders' ratification since the Boardowes its duty of obedience to the corporation

and not to the stockholders.

Breach of Duty of Diligence

Covers both acts of malice and negligence

Degree of negligence must be gross toconstitute breach

Does not cover failures and injuries broughtby the risks of doing business (ex: losses)

Breach of Duty of Loyalty

The Corporation Code contemplates asituation where a director, trustee or officer

incurs profits which should have been for the

account of the corporation Sec. 31holds a director, trustee or officer,

in violation of this duty, liable as a trustee

(not as an agent)

Sec. 34provides for a forgiveness clausethrough a stockholders' ratification. However,this applies only to disloyal directors and not

trustees and officers.

Q:Why is a director, trustee or officer liable as atrustee and not as an agent under Sec. 31?

A:Because an implied trust arises. The director orofficer is considered a trustee of the profits,

wrongfully acquired, for the benefit of the

corporation.

Q:Why is the forgiveness clause in Sec. 34

limited only to directors and not trustees or officers?

A:The Board has plenary powers, under Sec. 23,

which includes the power to forgive its officers.

However, the Board has no power to discipline orforgive its directors. The power to forgive or grant

a waiver for the acts of the erring director rests

solely on the stockholders.

Trustees are not included for 2 reasons:

1. Trustees are only for non-stock corporations.There can be no stockholders to give theratification, under Sec. 34, if there are no

stocks to hold in the first place.

2. The provision contemplates a situation whereprofits are wrongfully acquired by a directorto the prejudice of the stockholders. Trustees

cannot do the same thing because in a non-

stock corporation, no part of the corporation'sincome is distributable as dividends to its

members (Sec. 87). The members of a non-

stock corporation cannot give their


15/41






ratification, in case a trustee wrongfully

acquires corporate profits, since they are not

entitled to the profits in the first place.

Corporate Officers

Sub-agents of the Board of Directors and ofthe corporation

Officers are also trustees of the stockholders Also considered as employees under Labor

Law, with the corporation as the employer

With delegated powers and functions fromthe Board

Election of Officers

Stock Corporationsolely by the Board Close Corporationmay be granted

directly to the stockholders

Non-stock Corporationby the membersOfficers and Employees

Officer Employee

Occupies an office createdby charter, by-laws or law

Occupies no office

Elected by directors or

stockholders

Employed by a

managing officer

Jurisdiction in case of

controversyRTC SpecialCommercial Courts

Jurisdiction in case

of controversy -NLRC

An agent of the Board.

Termination of agency can beat the sole will of the

principal (Board)

Has all the rights of

an employeeafforded by the

Labor Code

Pursuant to the Business Judgment Rule, it iswithin the prerogative of the Board to appointand remove officers and employees.

The Labor Code grants security of tenure toboth employees and officers. This applies to

corporations.

The Board has the prerogative to hire but noprerogative to fire.

Definition of Officers: Officers are those defined or given such

character by the Corporation Code or the

By-Laws. (Gurrea v Lezama, 103 Phil.

553). They are agents.

If not defined by the Code or the By-Laws, the officer is merely an employee,

thus protected by the security of tenure.

NOTE:When a by-law provision expressly grants

the Board of Directors the full power to create new

offices and to appoint officers thereto, any officecreated and any officer appointed pursuant to such

clause does notbecome a corporate officer but isan employee. This is to prevent the circumvention of

the security of tenure afforded by law to employees(Matling Industrial Corp v Coros, 633 SCRA 12)

Officers Defined by the Corporation Code

Officer Function Qualifications

President Highest executive office.

Presumed to have theauthority to bind thecorporation in the ordinary

pursuit of business.

Must be a

director

Secretary Custodian of corporaterecords; register validtransfer of stocks incorporate books

Must be aresident ANDcitizen of thePhilippines

Treasurer Receive, keep and disbursethe funds of the corporation

May or may notbe a director

Liabilities of Officers

General Rule:Corporate officers are not personally

liable for their official acts

Exception:When the officer exceeded his authority,

acted with bad faith or malice, or when he breached

his duties of obedience, loyalty or diligence.

Directors or trustees are solidarily liable when they:

1. Assent to patently unlawful acts


16/41






2. Are guilty of gross negligence or bad faith3. Acquire interest in conflict with their duties

as directors or trustees

VIII. STOCKHOLDERS AND MEMBERS

Nature of RightsBasic Rights of Stockholders:

1. Vote2. Receive dividends3. Receive distributions upon liquidation4. Inspect the books of the corporation Restrictions on the rights of stockholders are

valid only if provided for in the Articles ofIncorporationnot the By-Laws

Rights remain with the stockholders evenwhen shares have been sequestered

Rights of Members

Membership in a non-stock corporation ispersonal in character

Non-transferable unless the Articles ofIncorporation or By-laws provide otherwise

Members may be entirely denied of theirvoting rights even if it is on fundamental

matters

Pre-Emptive Right

General Rule: Stockholders shall be granted the

first option to subscribe to any opening of unissued

capital stock

Exceptions:1. When such right is denied by the AI2. When the law requires minimum stock

ownership by or offering to the public

3. Issued with the approval of 2/3 OCS inexchange for property needed for corporatepurposes

4. Issued with the approval of 2/3 OCS inpayment of previously contracted debt

Pre-Emptive Right Right of First Refusal

Common law right Contractual right

A personal right andcannot be waived

through a majority vote

of stockholders

Stipulation is optionalsince RFR is a creature of

Contract Law

Pertains to unissued

shares of stock

Pertains to issued shares

of stock

Exercised against the

corporation

Exercised against another

stockholder

Restrictions on Transfers of Shares

1. Right of First Refusalstockholder must firstoffer the shares to the corporation or toexisting stockholders before selling to thirdparties

2. Right of First Optionright to buy the sharesat a fixed price

3. Right of Prior Consenta stockholder maysell his shares only when he obtains the

consent of the Board of Directors or other

stockholders

4. Buy-Back Agreementwhen shares are givenor assigned to officers or employees, thecorporation shall be granted the right to buy

back the shares should said employees orofficers resign or be terminated.

5. Absolute Prohibition to Transfer Sharesselfexplanatory

Type of Restriction Status

Right of First Refusal Valid under reasonableterms and consideration

Right of First Option Valid under reasonableterms and consideration

Buy-Back Agreement Valid under reasonable

terms and consideration

Right of Prior Consent Void

Absolute Prohibition Void


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Right of First Refusal (RFR)

Such restriction in an agreement is valid andbinding upon the contracting stockholderseven if not provided for in the AI or by-laws

provided the terms are reasonable

RFR stipulation placed in the by-laws aloneis void since it is not the function of the by-laws to diminish stockholder's rights

RFR stipulation placed in the Articles ofIncorporation is valid

To bind third persons, RFR must be expresslystipulated in:

Articles of Incorporation By-Laws Certificate of Stock

Test of Reasonable Restraint1. Restriction has a beneficial purpose of

protecting the corporation and its

stockholders2. Length of time of the suspension or

restriction is reasonable

Right to Vote Inherent and incidental to the ownership of

stocks

Right to participate in the control andmanagement of the corporation

Even if a series of shares is classified as non-voting, such shares are still entitled to vote on

matters enumerated in Sec. 6 (Amendments,

mergers, dissolution, etc.)

Sequestered shares does not entitle thegovernment to exercise acts of ownership

the registered owners of such shares stillexercise acts of dominion over them

Shares of stock owned jointly by 2 or morepersonsconsent of all co-owners are

necessary to be entitled to vote

Voting by Proxy

An agency relationship Right to issue a proxy cannot be denied in

stock corporations

Such right may be denied entirely when itcomes to non-stock corporations

Requisites for Valid Proxy

1. Must be in writing2. Signed by stockholder3. Filed with the Corporate Secretary before the

scheduled meeting

General Rule:Written authority from the principalstockholder is necessary for the proxy to act on his

behalf.

Exception:Executors, administrators and legal

representatives appointed by the court may vote on

behalf of the stockholders without need of anywritten proxy.

Voting Trust Agreements (VTA)

Stockholder becomes the beneficial owner(right to receive dividends)

Voting Trustee is the legal title owner (rightto vote)

Fiduciary but not revocable because thetrustee is essentially an owner of the legaltitle (thus trustee is qualified to be a director)

But stockholders who are defrauded by theirtrustees have a right to revoke the trust

Can be considered as a real contract sincethere is delivery of the legal title

Notarization of VTAa means of tradition(delivery)

General Rule:Parties can enter into a VTA for aperiod not exceeding 5 years at any one time

Exception:VTA required in a loan agreement mayexceed 5 years but shall automatically expire upon

full payment of loan


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Requisites for Valid VTA

1. In writing and notarized2. Must specify the terms and conditions3. Certified copy of such agreement is filed with

the corporation and the SEC

Proxy Voting Trust Agreement

An agency relationship A contractual relationship

Only needs to be inwriting to be enforceable

In writing, notarized andfiled with the SEC

Revocable since it is

only a mere agencyrelationship

Irrevocable because of the

binding contractualrelationship

Proxy has no otherrights not specifically

granted by the principal

Trustor may confer upontrustee other rights (not

limited to voting rights)

No right to inspectcorporate books

Trustee is entitled to theright to inspect

Proxy cannot exerciseappraisal right unless

granted by the principal

Trustee can exerciseappraisal right, subject to

his trust obligations

Right to Inspect Corporate Records

Shareholders, members, directors andtrustees of record and their respective agentscan inspect the records of the corporation

upon demand

Demand must be accompanied with astatement of the purpose of inspection

Proving or alleging fraud or mismanagementis not necessary to exercise right to inspect

Corporation may refuse the demand toinspect when:

the demand was made at an unreasonabletime of day

the person demanding is not a member,stockholder, trustee or director of record

the purpose of the inspection is improper.But the burden of proof lies with thecorporation

the records (such as the minutes ofmeetings) have not been written up and

approved by the directors

the person demanding has used forillegitimate purposes previously

examined records

If inspection is denied, the proper remedy ismandamus

For financial statements, corporation shallfurnish to the person demanding such copies

within 10 days from receipt of written request

Right to inspect extends to the records ofcontrolled subsidiaries of the parent

corporation

Criminal Liability

The stockholder or member who waswrongfully denied his right of inspection

may bring a criminal suit against the

offending director or trustee

Elements of the penal provision (Ang-Abayav. Ang):

1. A person with the right to inspect hasmade a prior demand in writing for a

copy of the records2. The officer or agent of the corporation

refused to allow such inspection

3. If refusal is made pursuant to a resolutionor order of the Board, the liability shall be

imposed on the directors or trustees who

voted for such refusal4. When the allegation, that the demand is

for an illegitimate purpose, is raised as a

defense, the contrary must be proved

Appraisal Right Right of a stockholder to demand payment of

the fair value of his shares after dissenting

from a proposed corporate action

Such corporate action involves a fundamentalchange in the corporate setting or where there

is a radical change in the contractual


19/41






relationship (rebus sic stantibus)

Not a common law right but a statutory right Such right is personal in nature and can only

be waived individually. Purely applicable to stock corporations Equivalent to a repurchase of shares

contrary to the Trust Fund Doctrine

Needs unrestricted retained earnings for thecorporation to buy back the shares

Applicable Situations

1. Amendment of the Articles of Incorporationwhich has the effect of changing or

restricting stockholders rights

2. Extending (NOT shortening) the corporateterm

3. Sale, lease or disposition of all orsubstantially all of the corporate assets

4. Investment in a non-primary business orpurpose

5. Merger or consolidationQ:Why resort to exercising the right of appraisalwhen a stockholder can simply sell his shares underthe doctrine of Free Transferability of Shares?

A:Because the 5 situations mentioned above destroythe market or the marketabilty of the shares and the

dissenting stockholders will dispose the shares at agreat loss.

NOTE:The amendments to the AI must result inchanging or restricting the rights of the stockholder.

Mere amendment of the AI in order to change the

corporation's name does not entitle the stockholder toexercise his appraisal right.

How Right is Exercised1. Stockholder has voted against the proposed

corporate action

2. Submits a written demand for payment of thefair value of his shares within 30 days after

the date on which the vote was taken3. If the proposed corporate action is

implemented, the corporation shall pay the

dissenting stockholder the fair value upon

surrender of the stock certificates

NOTE:Failure to submit a written demand within

the 30-day period is deemed a waiver of the

appraisal right

Effects of Exercising Appraisal Right

All rights (voting and dividend rights)accruing to such shares shall be suspended

The only right not suspended is the right toreceive payment for the fair value of the

shares

Dividends accrue but cannot be claimed If the dissenting stockholder is not paid

within 30 days after the award, his voting anddividend rights shall be restored (by

operation of law)

Cost and expenses of appraisal shall be borneby the corporation

If the fair value ascertained by the appraisersis approximately the same as the price the

corporation may have offered to pay, the cost

is borne by the shareholder

Derivative Suits

A common law right to sue for and in behalfof the corporation (NOT for the stockholders)

A suit instituted primarily for the benefit ofthe stockholders is not a derivative suit

A suit by a shareholder to enforce a corporatecause of action (Chua v. CA)

It is a conditionsine qua nonthat thecorporation is formally impleaded as a partyto the action or else it cannot amount to a

derivative suit

A remedy that may be resorted to wheneverthe corporate officials refuse to sue or are theones being sued

Some acts that may be remedied byderivative suit:

Where the Board of Directors wastes or


20/41






dissipates corporate funds

Mismanagement of the Board

Performance of ultra viresacts When intra-corporate remedy is

unavailing or futile

Exception to the Business Judgment Rule

Right to bring a derivative suit is anexception to the business judgment rule

Derivative suit comes into play whenever theBoard is not in a position to validly exercise

business judgment (eg: when the Board is the

author of the wrongdoing)

But not all actions against third partiesautomatically entitle the stockholder to bring

a derivative suitdetermination still with the

Board as an exercise of business judgment

Requisites to Bring Suit

1. Plaintiff is a stockholder or member at thetime of the questioned act or transaction

2. Exhaustion of intra-corporate remedies3. Reliefs sought pertain to the corporation4. No appraisal rights are available for the acts

complained of5. Suit is not a harassment or nuisance suit

NOTE:Not every suit filed in behalf of a

corporation is a derivative suit (eg: civil case arising

out of a criminal complaint)

General Rule:Exhaustion of intra-corporate

remedies is a requisite in filing a derivative suit.

Exception:It is not required when it is futile (eg:

when the Board itself is guilty of the acts committedagainst the corporation)

General Rule:Plaintiff must be a stockholder or

member at the time of the injurious act or transaction

Exception:A transferee (who was not a stockholder

at the time of the questioned act) may bring a

derivative suit when the covered transactions

continue and are injurious to him.

Exceptions to the Exception:1. When the transferor failed to institute the

derivative suit when he had the chance to doso, he becomes estopped. Transferee is also

estopped.

2. When the transferor himself was part of thefraud against the corporation

IX. SHARES OF STOCK

Types of Shares of Stock1. Common shareshave complete voting

rights but normally is not given preference in

the distribution of dividends

2. Preferred shareshave preference in thedistribution of assets and dividends. May or

may not be given voting rights

3. Redeemable sharesa class of shares whichmay be purchased by the corporation upon an

expiration of a fixed period. Such shares may

only be issued if expressly provided in the AI

4. Treasury sharesshares phave been issuedand fully paid for but subsequentlyreacquired by the issuing corporation.Despite the reacquisition, such treasury

shares are not part of the corporate assets.5. Founder's sharesMay be given exclusive

voting rights, which must not exceed 5 years

from date of approval by the SEC. Must be

specifically classified in the AI.

6. Authorized Capital StockNumber ofstocks a corporation is allowed to issue to the

dealing public. It is the sum total of both theissued and unissued shares of stock.

7. Outstanding Capital Stockportion of theAuthorized Capital Stock actually issued,

whether or not fully or partially paid, except

Treasury Shares.

8. Paid-up Capitalportion of the OCS which


21/41






have been paid by the stockholders9. Subscription Receivablesportion of which

is yet to be paid on the subscriptions

Nature of Shares of Stock

Units of ownership of the corporation issuedin exchange for cash, property or any other

consideration

An intangible personal property of thestockholder

Issued for the purpose of raising capital Shares of stock do not represent assets or

property of the corporation

Modes of Dealings

Dealing Transaction Between Contract Involved

Original Issuing corporation and

subscribing stockholder

Subscription

Agreement

Subsequent Original stockholder as

seller and buyer of shares

Sale, assignment,

mortgage, attachment

Modes of Constructive Delivery

1. Execution of a public document2. Transfer of titles, certificates or other

evidence of the incorporeal right

3. Use and enjoyment of the buyer of the rightswith the knowledge and consent of the sellingstockholder

Rights of Corporation Over Shares

A corporation has no proprietary claim (noright to vote or receive dividends) on the

shares it issues or redeems

But the following rights are granted: Call for the payment of unpaid

subscription Impose interest on the unpaid

subscriptions

Refuse to issue certificates of stock forsubscriptions not fully paid

Refuse to register the sale or assignment

of any share where subscription is not

fully paid

Refuse to recognize a sale or assignmentof shares which have not been dulyregistered in the corporate books

Original Dealings

There can be a subscription over unissued shares inthe following instances:

1. Original issuance of the Authorized CapitalStock at the time of incorporation

2. Issuing a portion of the Capital Stockpreviously unissued

3. Increase in the Authorized Capital StockSubscription

Underlying contractsubscription agreement Subscription contract/agreement covers the

acquisition of unissued shares (meeting of theminds of the corporation and the subscriber

as to the number and value of the shares)

Any condition imposed on the subscriptioncontract which undermines the ultimateobligation of the subscriber to pay is void.

It is not treated as a sale between thecorporation and subscriber

There is no such thing as a void subscriptionagreement; what may be void is theconsideration (eg: future services)

Subscription contract would constitute itselfthe tradition(mode of delivery) of the shares

It is subscription and not the payment of suchsubscription that vests:

stockholder's rights to the subscriber subscriber with ownership over the shares

General Rule:A subscriber, upon issuance legallyowns the shares and has rights over them even if

they are not fully paid for.

Exception:A subscriber may be deprived of his

rights when he is declared as a delinquent


22/41






stockholder.

NOTE:Since the subscription agreement is not a

specie of sale, it is not governed by Contract Law orthe Law on Sales. Thus it cannot be a subject of

rescission or waiver by the corporation-creditor (and

since it will also violate the trust Fund Doctrine). Anexception to the general rule of irrevocability is

provided for by Section 61 but is limited to

corporations yet to be formed:

A subscription for shares of stock of a corporation

still to be formed shall be irrevocable for a period of

at least 6 months from the date of subscription,

except:

a. When all the other subscribers consent to the

revocation; orb. Unless the incorporation fails to materialize

within said period or a longer period stipulated in

the subscription contract

However, no pre-incorporation subscription may be

revoked after the submission (not approval by) of the

articles of incorporation to the SEC.

Consideration for Issuance of Shares

Valid Considerations (any one or a combination of):1. Actual cash paid to the corporation2. Property actually received by the corporation

which is necessary or convenient for its use.Fair valuation of the property is subject to the

approval by the SEC

3. Labor or services actually rendered to thecorporation (NOT future services)

4. Previously incurred indebtedness by thecorporation

5. Amounts transferred from unrestrictedretained earnings to stated capital (eg:retained earnings converted into stock

dividends)

6. Outstanding shares exchanged for stocks inthe event of reclassification (eg: exchange of

common shares for preferred shares)

Query:Section 62 of the Corporation Code

expressly prohibits the acceptance of promissorynotes as consideration for subscription. However,

SEC rulings state that receivables may be legally

accepted as property consideration. But aren't

receivables essentially promissory notes and theterms only differ depending on who holds theinstrument? In the hands of a debtor, it is a

promissory note, while in the hands of a creditor

(the corporation), it is a receivable.

To answer this question, some accounting terms

must first be defined:

Accounts Receivablesrefers to negotiable

instruments (promissory notes, bills of exchange,

etc.) paid for goods sold or services rendered in lieuof cash. It reflects the profit-making activity of a

business enterprise. Treated as assets.

Subscription Receivablesrefers to the unpaid

portions of subscriptions. It reflects the capital-

raising activity of the corporation. Not treated as

assets.

What the Corporation Code prohibits is not the kind

of consideration the corporation receives inexchange for the subscription but rather it is how

such consideration is recorded in the accounting

books.

If a promissory note is recorded under accounts

receivablesit erroneously increases the assets of the

corporation. It gives the wrong impression to

creditors that the corporation is earning profits,when in fact it never sold goods or rendered

services. After all, the purpose of issuing stocks is

to raise capital and not generate profits.

If such promissory notes are recorded as accounts

receivables, then they will be treated as assets and


23/41






will be subject to the various modes ofextinguishment such as waiver, and rescission,

which will be violative of the Trust Fund Doctrine.

The prohibition in the Corporation Code wants to

ensure that such promissory notes and other

negotiable instruments received are properly

recorded to reflect the capital-raising activity of thecorporation. It is not treated as an asset thus it isbeyond the realm of the modes of extinguishment

under Contract Law.

A corporation may receive promissory notes or

other negotiable instruments provided such

promissory note or instrument arose from the profit-making activity of the subscriber.

Watered Stocks

When stocks are issued and deemed fullypaid but the underlying consideration has lessvalue or it is less than the stock's par value

Fraud is not an element to make directors andofficers liable

It is enough that such director or officerconsented to such issuance or had knowledgethereof and failed to express his objection in

writing and file it with the corporate secretary

The stockholder concerned is solidarily liablewith the director or officer to the corporationand its creditors

They will be liable for the difference betweenthe fair value and the par value of the stock

Unpaid Subscriptions

Insolvency or dissolution of a corporationdoes NOT release an original subscriber fromthe liability of paying for his unpaid shares.

When insolvency supervenes a corporation,unpaid stock subscriptions becomes payable

on demand

The assignee in the insolvency can maintainan action upon any unpaid subscription in

order to pay for corporate debts

In a subscription agreement, one cannot denythe obligation to pay even when the

corporation becomes insolvent

General Rule:A call (board resolution and notice to

stockholder) is necessary to make subscriber liable

for unpaid subscriptions.

Exceptions:1. When the subscription is payable on a

specified day on the contract2. When the corporation becomes insolvent,

unpaid subscription becomes due and

demandable

Delinquent Shares

If no payment is made within 30 days fromthe due date specified in the subscriptioncontract or from the date stated in the call of

the Board, stocks become delinquent

Effects: Delinquent stock shall not be voted for

and is not entitled to vote

Disqualification to exercise any of thestockholder's rights, except the right todividends

Cash dividends received shall be appliedfirst to the unpaid balance

Stock dividends are withheld until theunpaid balance is fully paid

Delinquency saledate of sale shall not beless than 30 days nor more than 60 days from

the date the stocks become delinquent

Notice of salesent to every delinquentstockholder and shall be published once a

week for 2 consecutive weeks in a newspaper

of general circulation

Highest bidder is one who shall pay for thesmallest number of fraction of a share:


24/41






Full amount of the balance on thesubscription

Interest

Cost of advertisement and sale Should there be no bidder, the corporation

may bid and the shares shall be converted to

Treasury Shares

Questioning the Sale: No action can be sustained on the ground

of irregularity in the notice or sale unless

such party pays or tenders the price of the

sale including interest from date of sale

Action must be commenced within 6months from date of sale

Highest Bidder - Illustration

Available shares for bid: 500 shares

Bid Price (Php) Number of Shares Fraction (Price per share)

500,000 100 500,000/100 = 5,000

500,000 50 500,000/50 = 10,000

500,000 1 500,000 (highest bidder)

The person who bid for 1 share is the highest bidder.

The remaining 499 shares are returned to the

delinquent stockholder

Certificate of Shares of Stock

Merely evidence of the issuance of shares ofstock

A stockholder may own shares of stockwithout possessing a stock certificate

What matters is that such stockholder isrecorded in the transfer books of the

corporation Certificate is not necessary to confer upon the

shareholder full ownership of the shares

When certificates are issued and incirculation, it means that the stocks are fully

paid

Q:May a corporation issue certificates of stock even

if the price is not fully paid for?

A:Yes. But the officers will be solidarily liable withthe stockholder concerned for watered stocks.

Quasi-Negotiable Character

There is no such thing as a holder in duecourse (unlike in Negotiable Instruments

Law)

Quasi-negotiability protects the stockholder-ownerin the event that the certificates arelost through fraud or stolen, their investments

in the corporation will not be undermined

Requirements for a valid transfer of stock:1. Delivery of certificate2. Certificate is indorsed by the owner3. Transfer is recorded in the books of

the corporation

Absent the third requirement, the transfer isvalid only between the parties but void as to

the corporation

Recording the transfer makes it valid andbinding against third persons, including thecorporation

Right to Issuance of Certificate

A subscriber is entitled to the issuance ofcertificate of stock only upon full payment of

the subscription

Remedies available to stockholders of recordif corporation refuses to issue certificate:

1. Specific performance2. Damages3. Mandamus

NOTE:The remedy of mandamus(or any of theother remedies) is not available to a third person who

has bought registered shares of a selling stockholdereven when they are fully paid for. Such buyer must

first establish his rightful purchase by clear evidence

before the corporation may be compelled to issuenew certificates in the buyer's name.


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Street Certificates

Certificate of stock endorsed in blank Behaves like a negotiable instrument except

there can be no holder in due course

Street certificate can be transferred from oneowner to another

Risk in the transfer falls on the owner Mere blank indorsement of the certificate of

stock by itself does not indicate the right ofthe holder to have the stocks transferred

(recorded in the corporate books) in his name

Express instructions from the registeredowner or a power of attorney is required tocompel the corporation to register the transfer

of shares

General Rule:Certificates of stock are quasi-negotiablea holder in good faith and for value is

not protected from the invalidity of the transaction

(still subject to defenses).

Exception:When the owner was guilty of

negligence that directly contributed to the loss, the

holder is entitled to demand from the issuing

corporation, the transfer of stocks into his name.(Santamaria v. HSBC, 89 Phil. 780).

Subsequent Dealings

For shares held in trustapproval of thebeneficial owners is necessary for the validity

of the transfer

When Subscriptions are not Fully Paid:o General Rule:Corporation may

refuse to acknowledge and register

such assignment

Sale of unpaid shares (SEC Opinion):o Sale of a portion of shares not fully

paidcannot transfer such portion of

the subscription since the subscriptioncontract is indivisible.

o Sale of entire shares not fully paidentire subscription may be transferred

to a single transfereeprovidedthe

consent of the corporation is secured.

Involuntary Dealings A mortgage or pledge of shares that involves

outright assignment or delivery and

indorsement of the certificates would

constitute a valid mortgage even withoutregistration with the register of deeds (RD).

Outside the physical delivery of thecertificates, a mortgage over the shares would

be valid and binding on third parties onlyupon registration of the mortgage in the

register of deeds.

Writ of attachment or execution would bevalid and binding on the shares (includingthird parties) upon proper service of the writ

to the proper corporate officer.

First in time is priority in right (eg: mortgageduly constituted and registered in the RDahead of the registration of the sale in the

corporate books is preferred over the latter)

Transaction Requirement for Validity

Pledge orMortgage

No delivery of certificates:Registration in the register of deeds isessential for validity and notice to the

worldWith delivery of certificates:There is

already completion of process thusregistration is not necessary

Sale orAssignment

Mere indorsement and delivery ofcertificates only binds the parties.

Registration in the stock and transfer

book is essential for validity and

notice to the world.

Levy or

Attachment

Upon proper delivery of the writ to the

proper corporate officer

NOTE:For a chattel mortgage of shares (without

physical delivery of certificates), double registration


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is required (at the mortgagor's residence and where

the chattel is located) exceptwhen the residence and

chattel are located in the same place.

X. CORPORATE ACQUISITIONS, MERGERS

& CONSOLIDATIONS

Acquisitions and Transfers

General Rule:The purchaser does not become

liable for the debts and liabilities of the transferringcorporation

Exceptions:1. When purchaser expressly or impliedly

agrees to assume the liabilities2. When purchaser acted in collusion with the

transferring corporation to defraud the

creditors3. When purchaser merely continues the

business of the transferring corporation

4. When transaction amounts to a merger orconsolidation

3 Levels of Acquisitions and Transfers

Transfer Object of Transfer

Assets-Only Only tangible properties

Business Enterprise The profit-earning capacity

Equity Controlling shareholdings

NOTE:Mere purchase of shares of stock for what

they are is an assets-only acquisition. But when themotive of the purchase is the ability to control the

corporation, it is an equity acquisition (eg: buying

2/3 of the outstanding capital stock).

Liability Rules

Transfer Transferee's Liability Rationale

Assets-

Only

Not liable unless

assumed

No contractual privity

between buyer and creditors

Business

Enterprise

Liable for debts of

the business

Common Law Lien

Equity Not liable unless Doctrine of separate

assumed juridical personality

Assets-Only Transfer

General Rule:Transferee is not liable for the debtsof the transferor

Exceptions:1. When the transfer is in violation of the Bulk

Sales Law (in fraud of creditors), the buyer is

not entitled to the goods purchased since suchtransaction is rendered void.

2. Corporate Dissolutionthe succeedingcorporation is liable for the debts of the

dissolved corporation to the extent of the fair

value of the assets assumed.

Business Enterprise Transfer

Primary interest of buyer is the earningcapacity of the business

The enterprise comprises of the assets,goodwill, list of clientele, suppliers,

employees, etc.

Transferee assumes the liabilities of theenterprise

Common law lienform of protection to thecreditors by allowing recovery of debts to thetransferee

Business enterprise transfers requiring 2/3ratificatory vote:

o Sale of all or substantially all theassets of the corporation (Sec. 40)

o Management contracts where acorporation operates all or

substantially all of the business ofanother corporation (Sec. 44)

If the transferor and transferee enter into aFree and Harmless clause (transferee does

not assume the liabilities of the business)such contractual stipulation is valid only

between them and not to the creditors.

Equity Transfer


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Buyer takes ownership of the business bypurchasing the controlling shareholdings of

the corporate owner

Must be substantial as to give transfereecontrol of the corporation

Mere transfer of shares is not an equitytransfer

Transferee is not liable to the debts of thetransferor or the corporationhe is liableonly to the extent of his investment.

Merger and Consolidation

Mergerunion where one or morecorporations are absorbed by the surviving

corporation

Consolidationunion of two or moreexisting corporations to form a new

corporation

There is transfer of both the businessenterprise and the juridical entity

New corporation assumes ipso juretheliabilities of the dissolved corporation

Procedure

1. A plan of merger or consolidation approvedby the majority of the Board

2. Ratificatory vote of 2/3 outstanding capitalstock

3. Exercise of appraisal right by any dissentingstockholder

4. Any amendments must be approved by amajority of the Board and ratified by 2/3OCS

5. Execution of the Articles of Merger orConsolidation

6. Submission of the financial statements to theSEC (long form audit report for insolventcorporations)

7. Approval by the SECEffects of Merger or Consolidation

Corporation Code Review

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Transcript of Corporation Code Review