CORPORATE FINANCE IN RELATION TO FOREIGN INVESTMENT ACT

AND THE ROLE OF THE SECURITIES AND EXCHANGE COMMISSION

Outline:
Corporate Finance
Quasi-debt / Quasi-capital
Contractual covenants
Consequences
Capital Structure
Ownership restrictions
Doing Business in the Philippines
Why must a foreign corporation secure license from SEC?
Doing business without a license
Remedy
Merger / Inversion / Amendments
Merger or consolidation
Corporate Finance
The Securities and Exchange Commission
To issue rules and regulations
Corporate Finance
One of the features of doing business through a corporate form is its ability to
retain and goal resources from a great number of persons having different
and at times conflicting interest, and at the same time comply with both legal
and contractual restrictions imposed on the business.
These persons are the various sources of corporate finance, which may be
broadly classified as follows:
a. Trade suppliers, with regard to their claims for unpaid goods or
services supplied to the corporation, payable for a certain period of
time;
b. Corporate lenders and other financial institutions;
c. Shareholders, which may be further classified into controllers, minority
shareholders and even the investing public.
The shareholders
contribute to corporate finance not only in the form of their paid or
subscribed capital but also in the form of retained earnings or the socalled internally generated financing.
Creditors, in general, and as opposed to shareholders, provide credit to the
corporation under the condition that payment of their credit is relatively
assured, and therefore they are exposed to minimal risk. On the other hand,
shareholders do not have such assurance. They are the first to bear the
losses of the business. Consequently, creditors who assume less risk are
normally provided limited share in the success or profit of the business, while

the shareholders who assume greater risk one entitled to residual profit of the
business. Simply stated, the principle is: less risk, less shore in the profit,
more risk, more shore in the profit.
Corporate finance can be structured where a corporate funder may initially
assume the sale of a creditor with limited return or share in profit at a time
when the business is still risky, but with the option to take the role of a
shareholder with a bigger share in the profit when the business has become
stable and/or more profitable. This is the case of debt instruments, with
convertible into equity feature.
The Constitution or special law may restrict the type of ownership of certain
corporations. The restriction emanates from limitation of enjoyment of profits
from a particular activity to a certain type of shareholders, or on how the
business should be run or who should run the business, taking into account
national security and other policy considerations, or both. In such a case, the
restricted persons may only assume the role of creditor and, up to a certain
extent, the role of shareholder. The Corporation Code recognizes a
corporation may xxx classify its shares for the purpose of insuring compliance
with constitutional or legal requirements. (Sec. 6) Up to extent permissible,
political and economic rights may be treated differently. The law may
prescribe a certain debt to equity ration. Senior lender may also impose a
similar requirement and demand the senior character of their claim shall
always be preserved vis--vis the other funders. Taxation may provide
different treatment for debt and capital. There can be other variations, which
corporate finance may address, with proper structuring of both credit and
equity.
Quasi-debt / Quasi-capital
There are cases when the instrument is in the form of capital but in substance
(the whole or part of it) a debt, or vice versa, in form or debt but in substance
a capital. The former may be referred to as quasi-debt, while the latter quasicapital.
A corporation may issue a quasi-debt when it is prohibited on restricted from
further issuing debt instruments, either by existing creditors (vice loan
covenants) (requiring certain debt to equity ratio, or that their security shall
remain unimpaired or always superior and should not share such security with
other creditors, except those with statutory superior credits like the
government) or by law such as debt to equity ratio. The corporate funder in
turn requires that although its claim will be subordinate to that of existing
creditors, it require less exposure from risk than ordinary shareholders. The
return or share in the profit is structured in a way that it is higher than secured
creditors but lower than ordinary shareholders. An example of this type of
security is a non-voting, cumulative non-participating preference as to
dividends and as to assets, in case of liquidation. The sale of preference
shall take into character the degree of risk assumed by its holder vis--vis
ordinary creditors and shareholders. The share in profit is legally treated as

dividends (i.e., not deductible as expense) and not as interest for tax
purposes. The instrument may also give the holder to have a full character of
the ordinary creditors or shareholders by providing a convertibility feature, i.e.,
convertible into debt or land, or into common stock. This convertibility feature
may further enhance the issue price of the share, i.e., a higher issue price
(although the preference rate is only based on par value and not an issue
price) if convertible as of a certain state upon happening of a certain triggering
events or conditions at the option of the holder. In this manner, the holder
may enjoy the preference but with lower share in profit compared to ordinary
shareholder when the business is not yet stable, and a higher share in profit
by converting into common stock when the business has become stable and
more profitable. The trigger is typically in the form of certain financial ratios
(e.g., return on equity, etc.)
There may be a variation, where the holder need not convert into common
shares in order to share with them a higher profit, at the same time enjoying
the above preference. The share may instead be made participating. In this
case, the portion of the par value above the par value or ordinary issue price
of common share will be regarded as quasi-debt for purposes of computing
the appropriate return, while the amount equal to par value or issue price of
common shares will be regarded as equity portion. In any case, the holder
still maintains preference as to assets upon liquidation, making it more
secured compared to common shareholders but less secured compared to
ordinary creditors.
There may be a further balancing of return vis--vis the participation
character of the instrument. The instrument may instead be made noncumulative, rather than cumulative. In this sense, the instrument slightly
veers away from the debt character of the instrument since there is no
effective servicing of the instrument. The holder becomes a risk taker, in
exchange for the opportunity to share the residual profit with common
shareholders.
The participation as to asset feature may be removed in order to fully share
the risk with ordinary common shareholders. Its attractiveness may be
enhanced if the share becomes voting, as it assumes the same level of risk
as that of common shareholders. This in turn has to take into account the
requirements of law and/or existing contractual covenants as to restrictions on
economic and/or political rights of certain set of shareholders.
A corporation may issue a quasi-capital when law or contractual covenants to
issue shares of stock restrict it. This is made possible by virtue of the
convertibility feature of the instrument, especially when the same is solely at
the option of the holder. In practice, whenever a corporation issues this type
of instrument, the SEC requires the corporation to have unissued shares
allocated for instrument holders upon exercise of the convertibility option.
This may how a dilutive effect on equity interest of existing shareholders,
regulated by Sec. 37.

Holders of this type of instrument may also be given a security over the entire
assets of the corporation or a particular business of the corporation, such that
its issuance is tantamount to the sale of all or substantially all of corporate
assets, regulation by Section 40.
It should be noted Section 39 denies pre-emptive right when shares to be
issued in good faith with the approval of the stockholders representing twothirds (2/3) of the outstanding capital stock, in xxx payment of a previously
contracted debt. Such shareholder approval may be given in advance at the
time of issuance of a debt instrument.
Section 40, on the other hand, requires a similar level of corporate approval
when the corporation effectively sells by way of xxx mortgage, pledge or
otherwise dispose of all of its property and assets, including the goodwill,
upon such terms and conditions and for such consideration, which may be
money, stocks, bonds or other instruments for the payment of money or other
property or consideration. Thus, Section 38 also requires a similar level of
corporate approval when a corporation issues bonds, having a convertible
into equity feature (with a dilutive effect) implicating Section 39, and/or
secured by all or substantially of corporate assets tantamount to a sale in the
form of mortgage or pledge implicating Section 40.
For purposes of Section 40, the sale or creating a security over a certain
business of the corporation may constitute to cover substantially all the
corporate property and assets of the corporation.
The quasi-capital character of an instrument is sometimes used to circumvent
constitutional legal or regulatory restrictions (e.g., under the constitution,
NIRC, SRC, PCA, GBL, FRIA). In this case, its terms are not set out in the
AOI or Bylaws, but typically in contractual documents between or among
controlling shareholders, or controlling shareholders on the one hand and
third party investors.
Contractual covenants
The debt instrument, in some cases, is coupled with some contractual
covenants with controlling shareholders. Such covenants are not binding to
the corporation and the public, but in a small corporation operating as a quasiclose corporation may meet the purposes of the debt holder. This is similar to
shareholders agreement binding to shareholders of a quasi-close
corporation.
The shareholders may undertake to vote in a manner required by debt
holders, either in the form of a proxy (having a character of agency coupled
with interest), a pooling agreement (especially in a case where the debt
holder is also a shareholder) or a voting trust, in accordance with Section 59.
In the case of a voting trust specifically required as a condition in a loan
agreement, said voting trust may be for a period exceeding five (5) years but
shall automatically expire upon full payment of the loan. (Sec. 59) There

may also be a put, call, tag-along, drag-along, especially when the debt
holder is also a shareholder. These contractual covenants may establish
control over the entity, when backed up by substantial liquidated damages in
case of breach, or when the controlling or some of shareholders are
effectively agents or trustees of debt and/or equity holders. Thus, for
consolidation under Section 7 of the FRIA, control shall refer to the power
xxx to direct or govern the financial and operating policies of an enterprise so
as to obtain benefits from its activities. Control is presumed to exist when
(one) owns, directly or indirectly through subsidiaries or affiliates, more than
one-half (1/2) of the voting power of an enterprise unless, in exceptional
circumstances, it can clearly be demonstrated that such ownership does not
constitute control. Control also exists even when the (parent) owns one-half
(1/2) or less of the voting power of an enterprise when there is power:
(1) Over more than one-half (1/2) of the voting rights by virtue of an
agreement with investors;
(2) To direct or govern the financial and operating policies of the enterprise
under a statute or an agreement;
(3) To appoint or remove the majority of the members of the board of
directors or equivalent governing body; or
(4) To cost the majority votes at meetings of the board or equivalent
governing body.
(Sec. 4, f, in relation to Sec. 7). This has similar provision under Sec. 25
of the PCA.
The law speaks of majority of voting rights since the same is required to elect
the members of the Board (under Section 24 of the Corporation Code).
Unfortunately, the same contractual covenants are also used to circumvent
the constitution, legal and in certain cases regulatory restrictions. Specifically,
under the SRC, the law requires reports by five per centum (5%) holders of
equity securities, (SRC, Sec. 18) to warn the public of the so-called
beachhead acquisition. The holder of security is required to disclose,
among others, (c) the number of shares of such security which are
beneficially owned, and the number of shares concerning which there is a
right to acquire, directly or indirectly, by: (i) such person, and (ii) each
associate of such person xxx; and (d) information as to any contracts,
arrangements, or understanding with any person with respect to any
securities of the issues including but not limited to transfer, joint ventures,
loan or option agreements, puts or calls, guarantees or division of losses or
profits, or proxies naming the persons with whom such contracts,
arrangements or understanding have been entered into, and giving the details
thereof. (SRC, Sec. 18.1) The same guide may also be used for purposes of
tender offer requirements (under Section 19.1 as group of persons acting in
concert) and regulation of profit swings (under Section 23.1 as direct or
indirect beneficial owner). The same is true under Sec. 25 of PCA.

A similar rule may also be applied for purposes of nationalization laws.

On the other hand, for tax purposes, specifically on the deductibility of interest
between related parties, the law only uses value of the outstanding stock
(NIRC, Sec. 36B, in relation to Sec. 34 B, 2, b), and on imposition of
improperly accumulated earnings tax (Sec. 29) and of IPO tax (Sec. 127, B),
the law uses the special rule.
Consequences
As a rule contractual stipulations, agency and trust stipulations (Civil Code,
Art. 1306 in relation to Art. 1409, par. 1) are void. Hence, as between or
among contraction parties, the same may not be enforced. Certain provisions
of the Corporation Code explicitly exclude arrangements resulting in illegal
combinations and monopolies. (Secs. 40 and 59)
Special laws also impose penalties for circumvention of their provisions (e.g.,
NIRC, PCA, Anti-Dummy Law, SRC, etc.)
Capital Structure
The objectives of corporate funds may be achieved through contractual
stipulations on structure of corporations, or issuances of the instruments.
The Corporation Code provides the fundamental equality of shares. Except
as otherwise provided in the articles of incorporation and stated in the
certificate of stock, each share shall be equal in all respects to every other
share. The shares of stock of stock corporations may be divided into classes
or series of shares, or both, any of which classes or series of shares may
have such rights, privileges or restrictions as may be stated in the articles of
incorporation. Provided, that no share may be deprived of voting rights
except those classified and issued as preferred or redeemable shares,
unless otherwise provided in (the) Code. (Sec. 6)
The series or classes of shares can compartmentalize corporate funders.
There can also be further compartmentalize by creating a SPV, or SPVs,
which can mirror similar structures of the issuer, depending on the needs of
the corporation and corporate funders. Such SPV or SPVs, or series of
SPVs, will be permitted for any lawful purpose or purposes, (Sec. 10), and
not for circumvention of restrictions or conditions prescribed by special laws,
as discussed above.
Ownership restrictions
The economic and political (or voting) rights of shareholders may be varied,
and they need not be in symmetry. The proper capital structure should meet
the purpose or purposes of the law that it seeks to address. Further, the
substance and not the form should be considered. Thus, quasi-debt or quasicapital shall be characterized as debt or equity, depending on the terms of

issuances. Secret stipulations or those not reflected in the articles of

incorporation or by-laws will not necessarily make the capital structure noncompliant, but must be assessed as to their effect vis--vis the purpose or
purposes of the law.
Such purpose or purposes may in turn be ascertained using the rules of
statutory construction, using intrinsic and/or extrinsic aids, as proper under
the circumstances.
The ownership restrictions may be characterized under the constitution, as
follows:
a. Exploration, development and utilization of natural resources (A XII,
Sec. 1), including land ownership (A XII, Sec. 7)
b. Restriction when dictated by national interest (A XII, Sec. 10)
c. Operation of a public utility (A XII, Sec. 11)
d. Educational institutions (A XII, Sec. 4)
e. Ownership and management of mass media (A XVI, Sec. 11 (i))
f. Advertising (A XVI, Sec. 11 (2))
In cases of partly nationalized activities, the participation of foreign investors
in the governing body of entities in such (industry) shall be limited to their
appropriate share in the capital thereof, and all the executions and managing
officers of such entities must be citizens of the Philippines. (A XVII, Sec. 11)
The Supreme Court has discussed the interpretation of the ownership
requirement under the constitution for public utilities in the Gamboa case.
Narra Nickel case, in turn, affirmed the application of the control test, as the
main rule, and the strict rule or the grandfather test when circumstances
create doubt in the capital structure of the corporation engaged in a partly
nationalized activities.
The Foreign Investment Act (FIA) adopts the control test, provided a
corporation organized under the laws of the Philippines of which at least sixty
percent (60%) of the capital stock outstanding and entitled to vote is owned
and held by citizens of the Philippines. If the equity interest of Filipino is
below such threshold, the Philippine nationality of such entity will only be
measured up to the extent of the percentage of ownership by Filipino citizens.
This is the strict rule or the grandfather test. On the other hand, if the entity is
formed and organized under foreign law, such entity following the
incorporation test will only be regarded as Philippine national if registered as
doing business in the Philippines under the Corporation Code of which one
hundred percent (100%) of the capital stock outstanding and entitled to vote is
wholly owned by Filipinos. (FIA, Sec. 3)
Is it still necessary for the Constitution to be amended to attract foreign
investors despite the openings made and incentives given to foreign
corporations?

Doing Business in the Philippines

How do we treat foreign corporation, which maintains websites accessible in
the Philippines which makes transaction and earns income here over the
internet but has no physical store or registration here in the Philippines?
Foreign investors may conduct business in the Philippines, in general, either
by forming a subsidiary or opening a branch office. The former is an entity
separate and distinct from the investor entity, while the latter is an extension
of the corporate personality of such investors entity. Under the Corporation
Code, the former is referred to as an ordinary corporation, while the latter as a
foreign corporation. Under the NIRC, the former is referred to as a domestic
corporation (which being a separate juridical entity is subject to tax with
respect to its income from within and outside of the Philippines), while the
latter is a Resident Foreign Corporation, (which being a mere branch of a
foreign entity is only subject to tax with respect to its income from within the
Philippines).
An entity formed, organized or existing under foreign laws, as a rule, will not
have legal personality in the Philippines. Foreign laws cannot have legal
effect in the Philippines, being issuance of one country whose force generally
is only confined within the territory.
However, by virtue of international county, other countries (e.g., Philippines)
may recognize such laws of another (e.g., law forming a legal entity).
The Corporation Code provides the basic framework when foreign entities
may open a branch office in the Philippines. The law requires reciprocity from
the home country of the foreign entity (Sec. 123) and for the SEC to ensure
adequate protection of persons dealing with such foreign entity in the
Philippines. Thus, before the SEC may recognize such foreign entity and
permit it (with issuance of license) to do business in the Philippines, the law
requires the following:
a. Proof that the laws of the country or state of the applicant (foreign
corporation) allow Filipino citizens and corporations to do business
therein, and that the applicant is an existing corporation in good
standing. (Sec. 125)
b. Attestation by the foreign entitys duly authorized representative on and
corresponding proof of its solvency and the part it is in sound financial
condition (Sec. 125)
c. The basic information, relating to the entity, including the specific
purpose or purposes which the corporation intends to pursue in the
transaction of the business in the Philippines. Provided, that said
purpose or purposes are those specifically stated in the certificate of
authority issued by the appropriate government agency, and the

place in the Philippines where the corporation intends to operate.

(Sec. 125)
d. The name and address of its resident agent authorized to accept
summons and process in all legal proceedings and pending the
establishment of a local notice, all notices affecting the corporation.
(Sec. 125) (see also Secs. 127-128)
e. A deposit or bond for the benefit of present and future creditors of the
licenses in the Philippines. (Sec. 126) See also Secs. 134 to 136.
If the Securities and Exchange Commission is satisfied that the applicant has
complied with all the requirements of the (Corporation Code) and other
special laws, rules and regulations, the Commission shall issue a license to
the applicant to transact business in the Philippines for the purpose or
purposes specified in such license. Upon issuance of the license, such
foreign corporation may commence to transact business in the Philippines
and continue to do so for as long as it retains it authority to act as a
corporation under the laws of the country or state of incorporation, unless
such license is sooner surrendered, revoked, suspended or annulled. (Sec.
126)
Such foreign corporation shall be bound by all laws, rules and regulations
applicable to domestic corporations of the same class, except such only as
provided for the creation, formation, organization or dissolution of corporation
or those which fix the relations, liabilities, responsibilities, or duties of
stockholders, members or officers of corporations to each other as to the
corporation. (Sec. 159) Effectively, the corporation law of the country where
the foreign corporation is formed shall apply.
Why must a foreign corporation secure license from SEC?
A foreign corporation shall have the right to transact business in the
Philippine after it shall have obtained a license to transact business in this
country. (Sec. 123) Without such license, it cannot do business in the
Philippines.
In general, an activity done for profit and with regularity constitutes doing
business. In the context of a foreign corporation, the activity in the
Philippines must be pursuant to its registered purpose or purposes in its home
country. A single transaction may still be regarded as an element of a
business activity if it is in pursuant of such purpose or purposes. In contrast,
an isolated transaction undertaken as an incident to a business done abroad
does not constitute doing business. Thus, the elements of substance and
continuity should always be ascertained if a foreign entitys activity constitute
doing business in the Philippines.
Without such license, the foreign corporation may not transact with
government and avail of its services. For example, it may not import goods

under its name, register with BIR as a Resident Foreign Corporation (which
may claim deductions from Philippine income, unlike Non-resident foreign
corporation which is subject to tax at its gross income without benefit of
deductions), secure a business permit from a specific local government unit
which has jurisdiction over the place where it will operate, or sponsor its
officers and employees to secure a work visa from the Bureau of Immigration,
or avail of Philippine courts to protect its interest. (See Sec. 133) Further, the
SEC may issue cease and desist order and the concerned local government
unit, in the absence of a business permit, may close down its business.
Without such license or permit, the activity of a foreign entity will not be
regulated and therefore can be pernicious to persons with whom the entity
transacts business. It may not avail of the benefits of laws, rules, and
regulations that may be availed of by domestic corporations of the same
class. (Sec. 129) It may not register property under its name.
Will maintaining a website require the issuance of license if the foreign
corporation has no physical store or office here in the Philippines and all
transactions are made online?
Doing business without a license
Section 133 provides no foreign corporation transacting business in the
Philippines without a license, or its successors or assigns, shall be permitted
to maintain or intervene in any action, suit or proceeding in any court or
administrative agency of the Philippines; but such corporation may be send or
proceeded against before Philippine courts or administrative tribunals on any
valid cause of action recognized under Philippine laws. Resort to court or
administrative agency is a hallmark of free enterprise. The absence of this
remedy is a great disincentive to a foreign corporation, necessitating a license
of it seeks to do business (or discussed) in the Philippines.
While a foreign corporation doing business in the Philippine without a license
may not sue, it can be sued by, entities or persons in Philippine courts or
administrative agencies exercising quasi-judicial function. Thus, if the foreign
corporation has unpaid claims to its clients or customers for goods or
services, it cannot institute legal action to collect such claims. The client and
customers in turn may sue the foreign corporation for breach of warranties or
defects in goods or services. The foreign corporation may not file a counter
claim against such clients and customers since it is not only prevented from
maintaining but also prohibited from interviewing in court or administrative
action. Counterclaim is a form of court intervention.
These has been an issue whether stipulation for arbitration, preferably with a
venue abroad, may circumvent or avoid the effects of not securing license to
do business. It should be noted on arbitral award, if not voluntarily complied
with by the losing party requires an enforcement of judgment, which is a form
of court action. Hence, the foreign corporation, if it wins in arbitration, may
not enforce such judgment or award.

If a foreign corporation does business without a license and a Philippine

person seeks to sue such foreign corporation, the Rules of Court provide a
procedure how such entity may do so and for the court to acquire jurisdiction
over the person of such foreign corporation. On the other hand, if a foreign
corporation files a court action, the Philippine entity may move to dismiss the
action for the foreign corporations lack of cause of action (Rule 16) i.e., the
foreign corporation has no legal right ought to be protected by Philippine law.
(Rule 3)
How about those corporations which has an online store or website which is
accessible over the internet.? Will they still be considered doing business in
the Philippines if they are for instance earning income from Filipinos without
license?
Remedy
Jurisprudence has recognized that a foreign corporations purported lack of
course of action may be cured if it can establish that it has subsequently
secured a license from the SEC. Such subsequent registration does not cure
any infraction brought about by prior non-registration, for example, the liability
for Philippine taxes unpaid relating to its previous transactions.
Merger / Inversion / Amendments
The law requires a foreign corporation to report to SEC any amendment to its
articles of incorporation or by-laws, similar to the procedure prescribed to
domestic corporations. (Sec. 130) Nevertheless, its filing shall not of itself
enlarge or alter the purpose or purposes for which such corporation is
authorized to transact business in the Philippines. (Sec. 130) The foreign
must secure an amended license for such purpose. (Sec. 131)
A foreign corporation authorized to transact business in the Philippines may
merge or consolidate with any domestic corporation or corporations if such is
permitted under Philippine laws and by the laws of its incorporation. If the
absorbed corporation is the foreign corporation doing business in the
Philippines, the latter shall at the same time file a petition for withdrawal of its
license. (Sec. 132)
The SEC has issued a ruling to the effect there is no Philippine law at the
moment, which permits such merger or consolidation referred to in Section
132. This is a policy issue since the Corporation Code under Title IX on
merger and consolidation can be interpreted either way.
The merger between a foreign and a domestic corporation is a made to
implement the so-called corporate inversion, which is a technique to change
the head office of a corporation from one country to another, without
relocating and still maintaining its operations in the former. This is used to
avoid the high taxation regions in the main country of origin. At present, this
is not done since a domestic corporation and a resident foreign corporation

(i.e., formerly a domestic corporation but after the corporate inversion has
changed its head office and has become a foreign corporation authorized to
transact business in the Philippines) is similarly taxed. The only difference is
that the resident foreign corporation (after the corporation inversion) is not
anymore subject to Philippine tax with respect to its operations abroad. On
the other hand, a foreign corporation will unlikely do the reverse (i.e., a foreign
corporation incorporating its worldwide operation into a domestic corporation)
since a domestic corporation is subject to its income from worldwide
operations, and with a classical tax regime (where there is a first-level
corporate income tax and second-level dividend tax) is not attractive, unless
the tax regime will be changed and tax rates lowered.
Merger or consolidation
Section 80 provides the effects of merger or consolidation.
In a merger, the constituent corporations shall become a single corporation
which xxx shall be the swimming corporation designated in the plan of
merger. The separate existence of the constituent corporations shall cease,
except that of the surviving xxx corporation. (Sec. 80, pars. 1 & 2)
In a consolidation, the constituent corporation shall become a single
corporation which xxx shall be the consolidated corporation designated in the
plan of consolidation. the separate existence of the constituent corporations
shall cease except that of xxx the consolidated corporation. (Sec. 80, pars. 1
& 2)
The merger or consolidation may be broken down into several steps rolled
into one with a single consequence, as described above, and with effects as
described in Section 80. These steps may be described as follows:
a. The share-for-share exchange between the acquiring entity (i.e., the
surviving or consolidated entity, as the case may be) and the
shareholders of the acquired entity or entities (i.e., the constituent
entity or entities);
b. The effective dissolution of the acquired entity or entities where: all of
the rights, privileges, immunities and franchises of each of the
constituent corporations; and all property, real or personal, and all
receivables due on whatever account, including subscriptions to shares
and other chores in action, and all and every other interest of, or
belonging to or due to each constituent corporation, shall be deemed
transferred to and vested in the (acquiring entity) without further act or
deed; and the (acquiring entity) shall be responsible and liable for all
the liabilities and obligations of each of the constituent corporations in
the same manner as if such (acquiring entity) 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 (acquiring entity). The rights of creditors

or liens upon the property of any of such constituent corporations shall

not be impaired by such merger or consolidation. (sec. 80)
In the case of a merger, the same may be upstream or downstream. In an
upstream merger, the acquiring entity following the first step is described
above is the temporary parent entity. In a downstream merger, the
acquiring entity is the temporary subsidiary.
The merger may also be used to acquire an entity, following the so-called
triangular merger approach. This is done by creating a subsidiary by the
acquiring entity, where such subsidiary will in turn do a partly cash and partly
share swap with the shareholders of the acquired entity. The share swap
should enable the subsidiary of the acquiring entity to gain control of the
acquired entity. The cash settlement is caused through the stock exchange,
so the tax only involves a lower stock transaction tax, rather than the higher
capital gains tax. The triangular merger may either be forward triangular
merger or reverse triangular merger. The movement of the assets and
liabilities may or may not be subject to tax, following the provisions or
corporation reorganization under the Tax Code.
The SEC regulates these types of transactions. If, upon investigation, the
Securities and Exchange Commission has reason to believe that the
proposed merger or consolidation is contrary to or consistent with the
provisions of (the Corporation Code) or existing laws, it shall set a hearing to
give the corporations concerned the opportunity to be heard. (Sec. 79)
Corporate Finance
One of the difference between a business partnership and an ordinary
corporation is the ability of the business owner to transfer his equity interest to
another without disrupting the operations that goes with the corresponding
diminution of assets if the withdrawing business owner mere instead to put his
equity to the business. The latter situation is the case in business
partnership. This type of affiliation right gives the business owner the
opportunity to realize some economic benefit from the business, in full or in
part.
Under the law, the Board is generally mandated to declare dividends when its
unrestricted retained earnings exceed the corporations paid-in capital. (Sec.
43) In effect, the retained earnings equal to the paid in capital can be used in
operations without compulsion for the board to declare the same as
dividends. However, that extra amount does not serve as trust fund for the
benefit of the creditors. The same may be declared as dividends at any time
at the discretion of the Board. It is up to the creditors to require such an
amount to be restricted or appropriated as condition for their extension of
credit to the corporation, and is a form of self help on their part to protect
their interest.

The Board on the other hand, may also retain the excess retained earnings
for corporate buyers for declaring the same as stock dividends. Since the
shareholders would have ordinarily received such amount as cash dividends,
the law requires shareholders ratification (Sec. 43) for the declaration as
stock dividends.
The shareholder, with increased number of shares arising from stock
dividends, may retain his equity interest by not selling such additional shares.
He may also get to realize economic benefit from the declaration of stock
dividends by selling the additional shares, except that he will reduce his equity
interest in the corporation. In effect, the corporation declared cash dividends
to the shareholders and at the same time issued shares (normally requiring
shareholders ratification pursuant to Section 35) where:
a. The shareholder exercised their pre-emptive right by using the cash
dividend to pay for additional issuance of shares, (Sec. 39) to maintain
their equity interest (which is similar to a stock dividend scenario where
the shareholders have decided to keep additional shares); or
b. The shareholders did not exercise their pre-emptive right allowing
another person/s to pay for such shares (equivalent to cash dividends)
with the corresponding diminution of equity interest on the part of the
existing shareholders (which is similar to a stock dividend scenario
where the shareholders have decided to sell additional shares).
It is for this reason the law generally provides for similar treatment in taxation
when the tax rate on cash or property dividends and tax rate on the sale of
shares are the same, i.e., at 10% while the law does not impose a tax on
stock dividends unless by virtue of the same, there has been a subsequent
change in equity interest (NIRC, Sec. 73)
The above scenarios illustrate how retained earnings can be utilized as a form
of internal corporate finance.
It should be noted while cash dividends and capital gains are generally
created similarly for taxation purposes, the law provides a purported lower tax
when shares are listed and traded through a stock exchange. The 10%
capital gains tax is based on net capital gain, while .5% stock transactions tax
is based on gross selling price, and not on the net capital gains. Hence, the
effective tax on the part of selling shareholder could either be higher
(especially when he sells even when at a loss or with very minimal capital
gain) or lower (in a scenario where he has a huge capital gain). This tax
regime is a policy matter to encourage corporations to list in the exchange,
the public from investing in listed companies.
Equity financing is regarded as a cheap form of financing since the same
does not require periodic servicing in terms of dividends. However, when
credit is cheap and the business is profitable, such that the ROI is higher than
interest, equity financing is sparingly made.

The Securities and Exchange Commission

The SEC is the lead agency administering corporate laws, i.e.,
a. for the creation,
corporations;

formation,

organization,

or

dissolution

of

b. those, which fix the relations, liabilities, responsibilities, or duties of

stockholders, members, or officers of corporations to each other or to
the corporation. (Sec. 123)
The above illustrates the three (3) relationships governed by the Corporation
Code, i.e., with the government (par. a), among the corporate actors, and the
corporate actors on the one hand, and the corporation as a separate juridical
entity, on the other hand (par. b)
The SEC likewise regulates the selling or offering for sale or distribution of
securities as a form of corporate financing from the public (i.e., twenty or
more persons). The sale of securities by an issuer to fewer than twenty (20)
persons in the Philippines during any twelve-month period is exempt from
SEC registration requirement. (Secs. 10, 8) It also regulates the market
participants.
The SECs powers are primarily provided in the SEC Reorganization Act (PD
902-A), as amended by the SRC. Special laws provide supplemental powers,
and the Corporation Code. (SRC, Sec. 5)
To pass upon, refuse or deny the application for registration of any
corporation, partnership or associate. A private corporation may be formed
for any lawful purpose or purposes. (Sec. 10) Its establishment,
organization or operation (must) be consistent with the declared national
economic policies. (PD 902-A, par. h) See also Sec. 140. Its equation must
not be prejudicial or cause damage to public to suspend or revoke the
franchise or certificate of registration of corporations, partnerships, or
associations (par. 1) enumerates some of the grounds when the SEC may
exercise this power, including those provided under the Corporation Code and
other special laws. (See also Sections 134 and 144).
Under the Corporation Code, the SEC may order the dissolution of a close
corporation in case of deadlock (Sec. 104) or upon petition of a withdrawing
shareholder. Its involuntary dissolution on account of insolvency may be
decreed by a regular court, and not the SEC (FRIA). The SEC may also
decree dissolution in case of violation of Code (Sec. 144) To impose fines
and/or penalties for violation of laws it implements, their pertinent rules and
regulations, its orders, decisions and/or rulings.
Section 144 provides penalties for violations of any of the provisions of the
Corporation Code. However, these penalties it appears may be imposed by
the courts, and not by the SEC. PD 902-A, Section (F) is deemed to have
repealed it by specifically granting to impose such fines and penalties.

However, the SEC may not impose the penalty of imprisonment, as the same
is specifically vested in courts, under the Constitution.
Similar penalties may be imposed for violations of its rules and regulations
(issued pursuant to Sec. 145) and orders, decisions and rulings.
To issue rules and regulations
The SEC is specifically vested with the authority to promulgate rules and
regulations reasonably necessary to enable it to perform its duties (under the
Corporation Code), particularly in the prevention of fraud and abuses on the
part of the controlling stockholders, members, directors, trustees or officers.
(Sec. 143)
Under Section 141, corporations are mandated to submit annual reports of
their operations, together with their audited financial statements. Failure to
comply with such reports will merit fines and/or lead to revocation or
suspension of their franchise (PD 902-A, Sec. 6 (i)(6), Sec. 6 (f))
But it seems like the Securities and Exchange Commission is not doing a lot
of work.