CORPORATION LAW

RESEARCH PAPER

CORPORATIONS ON PARTNERSHIPS

Submitted by:

CIANO, CHARITY D.

Submitted to:

ATTY. JULIE BINALDO-VELASCO

 Romeo is a director of the Platinum Corporation and Wick Corporation.
He owns a 1% outstanding capital of Platinum Corporation and 40,000
stocks of Wick Corporation. The two corporation would like to be partners
to have a substantial income. The contract was presented to both the BOD
of both corporations. How would be the contract valid?

INTERLOCKING DIRECTORS1
Contracts entered into by the corporation with an interlocking director are
valid per se, where a director who concurrently sit in the Board of Directors (BOD)
of different corporations who is a party to the contract with other Corporation.
However, when the interlocking director becomes a self-dealing director, the
contract entered into is VOIDABLE.
When the interest in one corporation is nominal while the interest in the
other corporation is substantial, the interlocking director is a self-dealing Director
in so far as the corporation where he has nominal interest is concerned. If the
interest in one corporation is 20% and less of the voting stock, it is nominal. If the
interest in one corporation is more than 20% (substantial interest as to power and
influence), it is considered substantial. When an interlocking director becomes a
self- dealing director, apply the tests under Section 322. If the conditions of Section

1
Section 33 of the Corporation Code, Contracts between corporations with interlocking directors. - Except in cases
of fraud, and provided the contract is fair and reasonable under the circumstances, a contract between two or
more corporations having interlocking directors shall not be invalidated on that ground alone: Provided, That if the
interest of the interlocking director in one corporation is substantial and his interest in the other corporation or
corporations is merely nominal, he shall be subject to the provisions of the preceding section insofar as the latter
corporation or corporations are concerned. Stockholdings exceeding twenty (20%) percent of the outstanding
capital stock shall be considered substantial for purposes of interlocking directors. (n)
2
Section 32. Dealings of directors, trustees or officers with the corporation. - A contract of the corporation with
one or more of its directors or trustees or officers is voidable, at the option of such corporation, unless all the
following conditions are present: 1. That the presence of such director or trustee in the board meeting in which the
contract was approved was not necessary to constitute a quorum for such meeting; 2. That the vote of such
director or trustee was not necessary for the approval of the contract; 3. That the contract is fair and reasonable
under the circumstances; and 4. That in case of an officer, the contract has been previously authorized by the
board of directors. Where any of the first two conditions set forth in the preceding paragraph is absent, in the case
of a contract with a director or trustee, such contract may be ratified by the vote of the stockholders representing
at least two-thirds (2/3) of the outstanding capital stock or of at least two-thirds (2/3) of the members in a meeting
called for the purpose: Provided, That full disclosure of the adverse interest of the directors or trustees involved is
made at such meeting: Provided, however, That the contract is fair and reasonable under the circumstances.
32 are not met, the contract is annullable at the option of the corporation where he
has nominal interest.3
INTERLOCKING DIRECTORSHIP IN A MANAGEMENT CONTRACT
The management contract must be approved by 2/3 of the outstanding
capital stock of the managed corporation. This is to prevent conflict of interest in
the Doctrine of Corporate Opportunity. This happens when a director or officer
of a corporation takes advantage or seizes a business opportunity rightfully
belonging to the corporation for his own benefit or advantage. The purpose of
which is to prevent a director or officer from competing with their own
corporation.

JOHN GOKONGWEI, JR. vs. SECURITIES AND EXCHANGE

COMMISSION4

In this case, John Gokongwei Jr., as stockholder of San Miguel Corporation, filed
with the SEC a petition for "declaration of nullity of amended by-laws,
cancellation of certificate of filing of amended by-laws, injunction and damages
with prayer for a preliminary injunction" against the majority of the members of
the Board of Directors and San Miguel Corporation as an unwilling petitioner.
Gokongwei alleged that the Board amended the bylaws of the corporation,
prescribing additional qualifications for its directors, that no person shall qualify
or be eligible for nomination if he is engaged in any business which competes with
that of the Corporation. The board based their authority to do so on a resolution of
the stockholders. It was contended that according to section 22 of the Corporation
Law and Article VIII of the by-laws of the corporation, the power to amend,
modify, repeal or adopt new by-laws may be delegated to the Board of Directors
only by the affirmative vote of stockholders representing not less than 2/3 of the
subscribed and paid up capital stock of the corporation, which 2/3should have been
computed on the basis of the capitalization at the time of the amendment. Since the
amendment was based on 1961authorization, Gokongwei contended that the Board
acted without authority and in usurpation of the power of the stockholders.
Gokongwei claimed that prior to the questioned amendment, he had all the

3
Rapacon Bar Review Notes on Corporation Law p. 24
4
G.R. No. L-45911, April 11, 1979
qualifications to be a director of the corporation, being a substantial stockholder
thereof; that as a stockholder, Gokongwei had acquired rights inherent in stock
ownership, such as the rights to vote and to be voted upon in the election of
directors; and that in amending the by-laws, Soriano, et. al. purposely provided for
Gokongwei's disqualification and deprived him of his vested right as afore-
mentioned, hence the amended by-laws are null and void. As additional causes of
action, it was alleged that corporations have no inherent power to disqualify a
stockholder from being elected as a director and, therefore, the questioned act is
ultra vires and void. The Supreme Court declared that By-laws which prohibit a
director of a corporation from serving at the same time as a director of a competing
Corporation have been upheld as valid and reasonable. It was held that there is a
real danger for the corporation to allow the director of a competing corporation to
seat in the board of a rival Corporation because the director can assess confidential
proprietary information with respect to the business of the corporation and
therefore, may be held liable under Section 34 of the Corporation Code. The
argument for prohibiting competing corporations from sharing even one director is
that the interlock permits the coordination of policies between nominally
independent firms to an extent that competition between them may be completely
eliminated. Indeed, if a director, for example, is to be faithful to both corporations,
some accommodation may result. Suppose X is a director of both Corporation A
and Corporation B. X could hardly vote for a policy by A that would injure B
without violating his duty of loyalty to B; at the same time he could hardly abstain
from voting without depriving A of his best judgment. If the firms really do
compete in the sense of vying for economic advantage at the expense of the
other there can hardly be any reason for an interlock between competitors other
than the suppression of competition.5

REMEDY AGAINST AN INTERLOCKING DIRECTOR

1. All profits obtained by the disloyal director from the competing business
shall inure to the corporation because those profits should have belonged to
the corporation.

5
Travers, Interlock in Corporate Management and the Anti-Trust Law, 46 L. Rev., 819, 840 [1968]
 2. File an action to forfeit all those profit even if the disloyal director used
his own money or funds to finances the disloyal business.

3. If the competing business was set up by the disloyal director using

corporate funds, properties and asset, the entire business must be
appropriated and not only the profits.6

RATIFICATION OF THE ACTS OF THE INTERLOCKING DIRECTOR

The disloyal director may retain and keep the profits if his act was ratified
by 2/3 of the Outstanding Capital Stock.

CONTRACTS BETWEEN CORPORATIONS WITH INTERLOCKING

DIRECTORS7

(1) Section 33 recognizes as valid a contract between two or more

corporations which have interlocking directors, that is, one, some,
or all of the directors in one corporation is/are also
director/directors in another corporation as long as there is no
fraud and the contract is fair and reasonable under the
circumstances. However, if the interest of the interlocking
director in one corporation is substantial, that is, his
stockholdings exceed 20% of the outstanding capital stock and in
the other merely nominal, that is, his stockholdings do not exceed
20%, the rules of Section 32 on self-dealing directors shall apply
insofar as the latter corporation is concerned.

(2) Section 32 pertains to transactions between corporations with

interlocking directors resulting in the prejudice to one of the
corporations. It does not apply where the corporation allegedly
prejudiced is a third party, not one of the corporations with
interlocking directors.8

6
Rapacon Bar Review Notes on Corporation Law p. 24
7
THE CORPORATION CODE OF THE PHILIPPINES
ANNOTATED By HECTOR S. DE LEON
8
Development Bank of the Phils, vs. Court of Appeals, 363 SCRA 307 [2001]
EVILS OF INTERLOCKING DIRECTORATES
No absolute prohibition of interlocking directorates. Be it noted that
under Section 33, contracts between corporations having directors in common are
not rendered void or voidable on that ground alone. Transactions between such
corporations should be "subjected to close judicial scrutiny to determine the
absence or presence of fraud or unfairness." For example, where the circumstances
show that the transaction would be of great advantage to one corporation at the
expense of the other, especially where, in addition to this, the personal interests of
the directors or any of them would be enhanced at the expense of the stockholders,
the transaction is voidable by the stockholders within a reasonable time after
discovery of the fraud.9 An individual may be a stockholder in different
corporations and it is not unusual to find a director or corporate officer occupying
the same position in another corporation not only because he has investments
therein but also because his services may have been proven to be valuable.
However, while such situation is allowable, dealings of interlocking directors are
subject to Sections 31, 33, and 34.10

CONCLUSION
The contract between the two corporations with interlocking director would
be valid even if the interest of Romeo in one corporation is 20% and less of the
voting stock (nominal) and the interest in the other corporation is more than 20%
(substantial) as long as the contract is fair and reasonable under the circumstances
and there is no fraud involved in the transaction. Section 33 of the Corporation
expressly stated that this kind of contract is not void per se, but merely voidable in
cases of fraud and when the inter-locking director becomes a self-dealing director
where he uses such transaction to his own advantage and personal interests.
According to the facts of this case, the partnership entered by the two corporations
is for the purpose of having a substantial income for both of them, therefore, if the
contract entered is for the great advantage of both of the corporation without
prejudicing their rights and obligations, the contract would be valid.

9
19 Am. Jur. 2d 714.
10
SEC Opinion, May 4,1994
 Supposing their appears to be an issue regarding Romeo being the director
of both of the corporations, a remedy would be to remove Romeo from one of the
corporations as a director to avoid fraud, assessment of confidential proprietary
information with respect to the business of the corporation, and other effects which
would greatly cause disadvantage to the other corporation and also to avoid
damages that may be suffered by any of the corporations. Under the case SEC v.
Gokongwei, although directors of a private corporation are not regarded as
trustees, their character is that of a fiduciary insofar as the corporation and the
stockholders as a body are concerned. As agents entrusted with the management of
the corporation for the collective benefit of the stockholders, "they occupy a
fiduciary relation, and the relation is one of trust." It springs from the fact that
directors have the control and guidance of corporate affairs and property, and
hence, the property interests of the stockholders. Equity recognizes that
stockholders are the proprietors of the corporate interests and are ultimately the
only beneficiaries thereof." A director is a fiduciary. Their powers are powers in
trust. He cannot manipulate the affairs of his corporation to their detriment. He
cannot by the intervention of a corporate entity violate the ancient precept against
serving two masters. He cannot utilize his inside information and strategic position
for his own preferment. He cannot violate rules of fair play by doing indirectly
through the corporation what he could not do so directly. He cannot use his power
for his personal advantage and to the detriment of the stockholders and creditors no
matter how absolute in terms that power may be and no matter how meticulous he
is to satisfy technical requirements. For that power is at all times subject to the
equitable limitation that it may not be exercised for the aggrandizement,
preference, or advantage of the fiduciary to the exclusion or detriment of the
cestuis. The doctrine of "corporate opportunity" is precisely a recognition by the
courts that the fiduciary standards could not be upheld where the fiduciary was
acting for two entities with competing interests. This doctrine rests fundamentally
on the unfairness, in particular circumstances, of an officer or director taking
advantage of an opportunity for his own personal profit when the interest of the
corporation justly calls for protection.