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61 F. Supp.

905 (1945)


No. 3618.

District Court, E. D. Pennsylvania.

July 20, 1945.

*906 Robert J. Bulkley, of Washington, D. C., and James F. Masterson and Simon
Pearl, both of Philadelphia, Pa., for plaintiff.

Albert Ward, R. Sturgis Ingersoll, and John Dickinson, all of Philadelphia, Pa., for

KALODNER, District Judge.

This secondary, or derivative action was brought by Otis & Co., a stockholder in the
Pennsylvania Railroad Co., against that Company, its officers and directors, and the
Pennsylvania, Ohio and Detroit Railroad Co., and certain of its officers and directors.
The latter is a wholly-owned subsidiary of the Pennsylvania Railroad. The matter is
presently before the Court on a motion for summary judgment for consideration on the
merits. Previously this Court determined an adjective issue in the instant case, and in
the opinion, filed November 1, 1944, 57 F. Supp. 680, briefly described the interests and
status of the parties. The statement therein is sufficient to suggest that the broad
question involved is whether the individual defendants are liable for alleged *907 losses
suffered by the Pennsylvania R. R. Co. arising out of the issuance and sale of over
$28,000,000 in bonds by the Pennsylvania, Ohio and Detroit R. R. Co., which
guaranteed the bonds.

The motion raises a preliminary question as to whether there now exists any genuine
issue concerning a material fact, excepting, of course, amount of damages. Federal
Rules of Civil Procedure, rule 56(c), 28 U.S.C.A. following section 723c. In addition to
the pleadings, there are on record, admissions, affidavits, counter-affidavits, and certain
exhibits, one of which is a transcript of proceedings before the Interstate Commerce
Commission when the bond issue here in controversy was submitted for approval.
Careful examination discloses no material issue of fact remaining with the exception of
damages; the plaintiff conceded this at the oral argument (Transcript, page 101).

The Court has before it all the facts which a formal trial would produce and since this
cause came on to be heard without a jury, and there is no substantial conflict
concerning the evidentiary facts, but only as to the inferences to be drawn therefrom,
this is a proper case for summary judgment. Fox v. Johnson & Wimsatt, Inc., 1942, 75
U.S.App.D.C. 211, 127 F.2d 729, 736, 737; see Toebelman v. Missouri-Kansas Pipe
Line Co., 3 Cir., 1942, 130 F.2d 1016.
Approaching the main interests of this case, it is appropriate at this point, because of
certain unusual characteristics, to set out the essential facts.

The Pennsylvania R. R. Co. (hereinafter referred to as P. R. R.) directly or indirectly

owns all of the capital stock of the Pennsylvania, Ohio & Detroit R. R. Co. (hereinafter
referred to as P. O. & D.) In the Spring of 1943, the latter company had outstanding a
total of $28,483,000 "Series A" bonds, maturing April 1, 1977, bearing interest at the
rate of 4½%, payable semi-annually, and redeemable on any interest payment date
subsequent to April 1, 1932, at 102.5 upon 60 days' notice. This bond issue was
guaranteed, both as to principal and interest, by P. R. R.

The possibility of refinancing this series of bonds had been under consideration by Mr.
Clement, president of P. R. R., and Mr. Pabst, vice president in charge of finance of P.
R. R. and president of P. O. & D., for approximately a year prior to June, 1943. During
the latter part of April, 1943, the bond market became so favorable to refinancing that
Clement directed Pabst to contact Kuhn, Loeb & Co. to determine whether it was
possible to sell at a price not less than par, a new issue of P. O. & D. bonds, guaranteed
by P. R. R., in the same amount as the Series A bonds but bearing interest not
exceeding 3¾%. The negotiations with Kuhn, Loeb & Co. continued through May and
part of June, the parties reaching an understanding, not legally binding, on the
afternoon of June 22, 1943. On the following day the directors of P. O. & D. approved a
resolution authorizing the sale of the new Series D 3¾% bonds, at the "best obtainable
price," and the directors of P. R. R. approved a resolution authorizing a guarantee
agreement. On the same day, June 23, 1943, the bonds were sold to Kuhn, Loeb and
Co. at par and accrued interest from July 1, 1943, to date of settlement, subject to
approval by the Interstate Commerce Commission.

It is not necessary here to set out in full the terms and conditions of the planned Series
D issue; a complete discussion appears in the Interstate Commerce Commission's
report, 1943, 254 I.C.C. 473. However, it may be said that the bonds were to mature
July 1, 1968, and were to be redeemable as a whole only, except for the purposes of
the sinking fund, upon 60 days' notice on any interest bearing date to January 1, 1959,
at 105 and accrued interest, and thereafter at a premium. A sinking fund provision, not
contained in the original Series A bond issue, specified that Series D bonds could be
called at 103 and accrued interest, to and including July 1, 1956, and thereafter at a
premium. The bonds were offered to the public at 101.75, a spread of 1.75. The last day
for settlement under the contract was July 31, 1943, since the purchase price must have
been received prior to the first publication of notice of redemption of the Series A bonds,
on August 2, 1943, the redemption being effective upon such publication. According to
the undisputed calculations and the Interstate Commerce Report, the refinancing would
result in a net saving of $7,583,664.70, plus an estimated tax saving of $1,500,000.

On June 22, 1943, before the action by the directors and before the contract of sale to
Kuhn, Loeb & Co. was executed, a Mr. Claflin, representing Halsey, Stuart & Co., Inc.,
visited Pabst in an effort to learn *908 whether there might be a refinancing of the P. O.
& D. bonds, but Pabst declined to give any information and, in response to another
question, stated that he did not think it was likely Halsey Stuart & Co. would have an
opportunity to bid if there were a refunding. On June 23, 1943, Halsey, Stuart & Co. and
Otis & Co. by telegrams to Clement and other directors of P. R. R. requested an
opportunity to submit a competitive bid for the P. O. & D. bonds. The defendants assert
that the telegram was not received until June 24th and on that day Clement telegraphed
a reply to Otis & Co., acknowledging the joint telegram and advising that the "railroad
has transacted the business referred to in a very satisfactory way, and in what is
considered the best interests of the railroad." Subsequently, on June 28, 1943, Halsey,
Stuart & Co. and Otis & Co., in a telegram addressed to Pabst and Clement, criticised a
25-year bond issue and offered to guarantee a price of 101, at a competitive bidding
sale, for 3¾% 35-year bonds. Copies of the telegram were sent to the Interstate
Commerce Commission. No reply was made by Pabst or Clement. Finally, on July 9,
1943, Halsey, Stuart & Co. and Otis & Co. sent a letter to Pabst offering to guarantee a
minimum bid of 102 at a competitive bidding sale for the Series D bonds, subject to
adjustment of call prices, or a minimum bid of 101 at a competitive sale for 34 or 35
year bonds; it invited a conference on desirable changes in terms and conditions and
stated that the offer would be kept open until July 19. The letter further advised that
copies were being sent to P. R. R., to its directors, and to the Interstate Commerce

Application to the Interstate Commerce Commission for approval of the Series D bonds
was made by P. R. R. and P. O. & D. on June 25, 1943. Otis & Co., a stockholder of P.
R. R., was granted leave to intervene, but such leave was denied Halsey, Stuart & Co.
The issues presented to the Commission are briefly summarized in the Commission's
report, 254 I.C.C. 473 at page 477:

"The intervener contends that this application is one where the conditions are such as to
make competitive bidding imperative and asks that we so decide, while the applicants
insist that a refunding issue is peculiarly inappropriate for competitive bidding, because
the publicity incident to that method of sale would disrupt the market for the bonds to be
called and refunded before definite arrangements for the refunding could be
consummated. The applicants argue that the question is whether the proposals
contained in the pending application are such as show that sufficient savings will result
therefrom, while the intervener contends that the application should be denied because
savings would be greater if a higher price had been received for the bonds, and that the
failure of the Pennsylvania to consult with more than one banker was a disservice to the

A majority of the Commissioners were not convinced that the applicants received the
best possible price and felt that because of negotiations with only one investment house
the applicants failed to explore the possibility of effecting greater savings, such as
through the issue of serial bonds. However, they determined that competitive bidding
was not appropriate, but could find no reason why more than one investment house
should not have been consulted. They also found that the transaction with Kuhn, Loeb &
Co. was "the result of arms-length dealing," and that the offers submitted by "a rival
investment company" were made on the spur of the moment and without adequate
consideration; therefore, because of the debt reduction provisions and because the sale
would result in a saving of approximately 9 million dollars which might not be realized if
approval were withheld, it was determined to approve the sale at a price not less than
100¼, considering the spread of 1¾ to be too great. This price was considered just and
reasonable. One Commissioner dissented. 1943, 254 I.C.C. 473.

The gist of the complaint is that the individual defendants failed and refused to exercise
ordinary care and judgment in the sale of the Series D bonds. The individual
defendants, it is alleged, kept secret the bond issue and refused to deal with any
investment house other than Kuhn, Loeb & Co. Furthermore, it is charged that as a
result of failing to "shop around," a half million dollars was lost, and another half million
dollars was lost in failing to put the issue to competitive bidding. In addition, it is also
asserted that certain of the directors were influenced because of their position as
directors of several institutions which had made agreements with Kuhn, Loeb & Co. to
purchase and/or sell part of the bond issue.

*909 In reply, the defendants contend that the transaction was an honest exercise of
judgment, that the procedure followed was similar to that generally pursued by railroads,
and that it was particularly desirable here. Adverse interests on the part of certain
directors is denied.

The defendants, however, go further and invoke what amounts to the doctrine of res
adjudicata; as they stated it: "The jurisdiction of this Court is excluded in the present
case by the fact that the same issues were presented to and decided by the Interstate
Commerce Commission, under its statutory authority, with the same objecting
stockholder before it, and the Commission's order of approval, not having been
subjected to judicial review in the manner provided therefore by statute, has become
judicially unassailable and not subject to collateral attack in this proceeding." It should
be pointed out that the plaintiff does not attack the validity of the Commission's
determination, nor does it seek to have the order set aside. In fact the plaintiff cites the
Commission's opinions, both majority and minority, as supporting its contentions.

As to the defendants' res adjudicata defense, it may be noted at once that that theory
was rejected by the United States Supreme Court in the case of Pittsburgh & W. Va. Ry.
Co. v. United States, 1930, 281 U.S. 479, 50 S. Ct. 378, 74 L. Ed. 980. There, a
minority stockholder intervened in a Commission proceeding involving the establishing
of a union passenger station at Cleveland, and alleged, inter alia, that the contracts by
the Wheeling & Lake Erie Ry. Co. were made in violation of the law of Ohio, the
Wheeling directors did not give Wheeling the benefit f unbiased judgment, Wheeling the
benefit of unbiased judgment, adequate and not the best obtainable. 281 and the price
for Wheeling's site was intransaction and the stockholder sought an injunction under the
Urgent Deficiencies Act, 1913, 38 Stat. 220, 28 U.S.C.A. § 47. On direct review, the
Supreme Court said, 281 U.S. at page 488, 50 S.Ct. at page 381, 74 L.Ed. 980:

"Second. The prayer that the contemplated action of the Wheeling should be enjoined
because its directors hold office illegally, are faithless to their trust, are acting in
violation of the rights of stockholders under the Ohio law, and, hence, that the Wheeling
could not legally exercise the authority granted to it by the Commission, was not
properly joined in this suit and is not subject to review in this Court on a direct appeal.
An application for such relief may not be included in a bill under the Urgent Deficiencies
Act to set aside an order of the Interstate Commerce Commission. (Citing cases). It is
neither ancillary to nor dependent upon the judgment as to the order. Relief of that
character may be had only in a suit invoking the plenary equity jurisdiction of the District
Court. Such a suit would be heard in ordinary course by a single judge; and it would be
appealable only to the Circuit Court of Appeals." (Emphasis supplied.)

The Supreme Court thereupon dismissed that part of the bill without prejudice. See
also, New York Central Securities Corporation v. United States, 1932, 287 U.S. 12, 28,
29, 53 S. Ct. 45, 77 L. Ed. 138, the final decision in a series of actions beginning with
Cleveland, C., C. & St. L. Ry. Co. v. Jackson, 6 Cir., 1927, 22 F.2d 509, on which the
defendants rest heavily. Since an intervening minority stockholder is not, in an injunction
proceeding, entitled to judicial review under the Urgent Deficiencies Act on questions
such as breach of fiduciary duty, and since such questions are not "ancillary to nor
dependent upon the judgment as to the order," it follows that the plaintiff here has
properly sought to enforce its rights in this action, and that the proceedings before the
Interstate Commerce Commission are not res adjudicata. See, Casey v. Woodruff,
Sup., 1944, 49 N.Y.S.2d 625, 640-642.

The Commission, under the statutory authority here involved, Act Feb. 28, 1920, 41
Stat. 494, 49 U.S.C.A. § 20a,[1] does not determine private rights. In Casey v. Woodruff,
supra, a case strikingly similar to the present controversy, Justice Shientag, in a well
considered and authoritative opinion, stated, 49 N.Y.S.2d at page 642:

"In formulating plans for the issuance and sale of the securities of a railroad,
the *910 board of directors necessarily must consider the public interest because the
railroad is engaged in public service. Obviously, it would be futile to propose a security
issue which the Commission would be bound to disapprove as not `compatible with
public interest' or with the proper performance by it of service to the public. § 20a. To
summarize what has been said on this point, it is clear that in determining that the
proposed issue of Series D bonds was improvident and unwise the Commission,
whether its action was based wholly or in part on the public interests, did substitute its
own judgment for that of the directors. It did not, however, purport to pass upon the
personal liability of the directors for alleged breach of fiduciary duty, nor did it have the
slightest basis of jurisdiction for that purpose."[2]

So much then as to the defendants' theory of res adjudicata. It is further urged on behalf
of the defendants that under the circumstances the instant action is tantamount to a
complaint that it was an abuse of discretion for the defendants to have followed the
judgment and order of the Commission. However, the "order" here referred to was not
mandatory, but permissive, in that the Commission merely authorized the sale. While it
may be true that the public and private interests overlapped and that the latter were
considered in some degree by the Commission, it is readily apparent from a reading of
its report that it recognized different standards were applicable depending upon whether
the interest of the public or of the private shareholder was involved. There may, indeed,
be a real difference between what is required in the public interest and what is
necessary to satisfy stockholders, and although the Commission authorized the sale,
that does not foreclose possible liability of the officers and directors for negligent breach
of their fiduciary duty.[3]

Coming now to the final question, that is, whether the officers and directors are guilty of
negligent mismanagement, it should be noted that of the fifteen individual defendants,
twelve are officers and/or directors of P. R. R. and three are directors of P. O. & D.; of
the fifteen, four are officers and/or directors of P. R. R. and P. O. & D. This fact is
noteworthy because P. R. R. is a Pennsylvania corporation while P. O. & D. is
incorporated in the States of Ohio and Michigan. Since the allegations of the complaint
deal solely with the internal affairs of the two corporations, the liability of the respective
officers and directors must be determined under the corporation laws of the states
wherein the associations were organized.

In Pennsylvania, the relation of officers and directors to the corporation is stated in the
Business Corporations Law 1933, P.L. 364, art. IV, § 408, 15 P.S. § 2852 408, as

"Officers and directors shall be deemed to stand in a fiduciary relation to the

corporation, and shall discharge the duties of their respective positions in good faith and
with that diligence, care and skill which ordinarily prudent men would exercise under
similar circumstances in their personal business affairs."

The state of the prior law, and the extent to which this statute changes it is
uncertain,[4] but the test of liability can hardly be different from that applied in Hunt v.
Aufderheide, 1938, 330 Pa. 362, 366, 199 A. 345, 347, where, in applying the law prior
to the statute, it was stated that:

"`The directors of a corporation are required to exercise reasonable and

ordinary *911 care, skill, and diligence in conducting its business, and the failure to
observe this standard of care imposes liability on a defaulting director,' Fell v. Pitts, 263
Pa. 314, 319, 106 Pa. 574, 575; that is, the care, skill and diligence which the ordinary
prudent man would exercise in similar circumstances." (Emphasis supplied.)

And see, South Penn Collieries Co. v. Sproul, 3 Cir., 1931, 52 F.2d 557, 561.

The statutory rule is not unlike that long in use in New York. See 3 Fletcher, Cyclopedia
of the Law of Corporations (1931) Sec. 1037; Hun v. Cary, 82 N.Y. 65, 37 Am.Rep. 546;
Casey v. Woodruff, supra. In the latter case, the plaintiff sought to recover, on the
ground of negligence, expenditures made by officers and directors preparatory to
floating a bond issue, for which permission was denied by the Interstate Commerce
Commission. In disposing of the case under the New York Law, the concept familiarly
known as the "business judgment rule"[5] was applied by the court, 49 N.Y.S.2d at page

"The question is frequently asked, how does the operation of the so-called `business
judgment rule' tie in with the concept of negligence? There is no conflict between the
two. When the courts say that they will not interfere in matters of business judgment, it
is presupposed that judgment reasonable diligence has in fact been exercised. A
director cannot close his eyes to what is going on about him in the conduct of the
business of the corporation and have it said that he is exercising business judgment.
Courts have properly decided to give directors a wide latitude in the management of the
affairs of a corporation provided always that judgment, and that means an honest,
unbiased judgment, is reasonably exercised by them."

In view of the Pennsylvania statute it seems that the application of this theory is
warranted in the instant case.

In any event, it is well settled that what constitutes negligence depends upon the
circumstances of the case, South Penn Collieries v. Sproul, supra; that the court will not
interfere with the internal management of corporations, and therefore will not substitute
its judgment for that of the officers and directors, Bowman v. Gum, Inc., 1937, 327 Pa.
403, 193 A. 271; and, what is a rule of reason, that negligence must be determined as
of the time of the transaction. It is also clearly established that mistakes or errors in the
exercise of honest business judgment do not subject the officers and directors to liability
for negligence in the discharge of their appointed duties. The rule was succinctly stated
by Justice Shientag in Casey v. Woodruff, supra, 49 N.Y.S.2d at page 642:

"The directors are entrusted with the management of the affairs of the railroad. If in the
course of management they arrive at a decision for which there is a reasonable basis,
and they acted in good faith, as the result of their independent judgment, and
uninfluenced by any consideration other than what they honestly believe to be for the
best interests of the railroad, it is not the function of the court to say that it would have
acted differently and to charge the directors for any loss or expenditures incurred."

On the matter of good faith, it seems to me there can be no doubt that the officers and
directors of both P. R. R. and P. O. & D. acted honestly, in good faith, and sought to
exercise their judgment for the best interests of the respective railroads. There is no
contention here that fraud was present; indeed, the allegations in the complaint contain
only a faint suggestion of bad faith, calling to the attention of the court that the officers
and directors were influenced because of their position as directors or officers of several
companies which had made purchase and sale agreements with Kuhn, Loeb & Co.
However, it clearly appears in the record of the I.C.C. proceedings that Kuhn, Loeb &
Co. had not made known to Pabst who were to be the underwriters and sales agents for
the particular bond issue. Moreover, in their affidavits these men disaffirm that they had
anything to do with such agreements either directly or indirectly, or that they discussed
railroad matters with their other interests. With respect to Colonel Mellon and the Mellon
Securities Corporation, plaintiff has brought to the court's attention certain penal
statutes, but this court cannot concern itself with those statutes except insofar as they
declare the public policy. Nevertheless, there is no doubt, and the plaintiff admits, that
Col. Mellon, although a director of P. R. R. was absent in the armed services and had
nothing whatever to do with *912 this transaction; he did not take part in any phase of it,
nor was he present at the board meetings, when the matter was considered, nor did he
vote. Aside from his mandatory absence, it is evident nothing more could be done to
relieve Col. Mellon of all implications of bad faith. The Interstate Commerce
Commission reached a like conclusion on this matter.

Applying the principles stated, I find no negligence on the part of the officers and

Parenthetically it may be stated that with respect to those defendants who are directors
of P. O. & D., the standard of care, skill and diligence in Ohio and Michigan is no greater
than that by which I have tested the liability of the officers and directors of P. R. R. See
Goff v. Emde, 1928, 32 Ohio App. 216, 167 N.E. 699, citing 3 Thompson, Corporations
(3rd ed.) Sec. 1520; 3 Fletcher, Cyclopedia (1931) Sec. 1037 n. 64.

It was the duty of the officers, in the course of business, to be on the alert for an
opportunity for refunding an outstanding bond obligation in a manner which would result
in a saving to their business, and there is no question that the management of the
defendant corporations did seize an opportune time for the refunding operation.
Clement, the president, and Pabst, the vice president in charge of finance and corporate
relations, were obviously well acquainted with the finances of the railroad. They had in
mind the refunding plan for approximately a year prior to its consummation; they
acquainted themselves with market conditions, and surveyed the situation with respect
to P. R. R. and other bonds which bore some resemblance to that which they proposed
to issue. On the basis of their knowledge and investigation Clement concluded they
could market the $28,000,000 issue of 3¾% bonds at par, and he directed Pabst to
negotiate with Kuhn, Loeb & Co. As a result of arms-length dealing, Clement obtained
what was considered the "best obtainable price." At the P. R. R. and P. O. & D. board
meetings of June 23, 1943, full disclosure of the facts was made, and the directors,
experienced men in the field of finance and business, acting on the basis of their own
knowledge and on the recommendations of the officers, authorized the sale and
guarantee. Although the P. R. R. board authorized the guarantee of a bond issue, the
terms and conditions of which were to be settled by the P. O. & D. board, and the P. O.
& D. board authorized a sale at the "best obtainable price," it is evident that they were
aware of the tentative agreement which Pabst and Clement had made with Kuhn, Loeb
and Co.

The plaintiff contends that this is not a case of error in business judgment, but rather it is
a case where there was no satisfactory collection of data or information on which
judgment could have been exercised. Furthermore, plaintiff asserts, the only proper way
to determine the actual "best obtainable price" was to obtain offers from more than one
investment house; this could be done by "shopping around," or better, by submitting the
issue to competitive bids. In support of this contention, plaintiff cites the admission of
the defendants that the bond issue involved was actually a "test" of the bond market,
since no large bond issue had been marketed for some time previously.

That recourse was not had to competitive bidding does not, of itself, afford a basis of
liability. Casey v. Woodruff, supra. It is highly significant that the Interstate Commerce
Commission refused to require competitive bidding, although plaintiff earnestly urged it
to do so. I have already set out at length, in my opinion of November 1, 1944, 57 F.
Supp. 680, at page 682, the view of the Commission and its justification of the refusal of
the defendants to require competitive bidding; it is only necessary to repeat my
summation, "The manner in which the defendant corporations floated the bond issue
has been in use * * * almost since `Iron Horse Days' it is apparently a matter of
corporate policy pursued by railroads generally." That the Commission later passed a
regulation requiring competitive bidding[6] does not aid the plaintiff, for the Commission
also found that competitive bidding was not appropriate because of the possible effect
on the market of the bonds to be called and refunded. 254 I.C.C. 473, 479. On this, I
may accept the opinion of the Commission as an expert department of the government.

The defendants unquestionably had the right to negotiate privately with Kuhn, Loeb &
Co. Although there is no charge of bad faith, or conspiracy, it seems clear that in
choosing that firm, the defendants *913 were following another custom in railroad
history. See In re Competitive Bidding, 1944, 257 I.C.C. 129, 153, 156. Kuhn, Loeb &
Co. have long been "the" banking house to P. R. R.[7] In dealing with Kuhn, Loeb & Co.
the defendants were dealing with a firm in which they had the confidence of years of
satisfactory banking relations and which was well acquainted with their financial
situation, structure and requirements. Although the Commission felt no special advice
was necessary, the record of the Commission's proceedings reveals that from time to
time Kuhn, Loeb & Co. did advise the railroad company as to their estimate of the
market, what it might absorb, the trend, and the terms of bonds and similar matters.
Again, the finding of the Commission on this matter may be considered determinative,
254 I.C.C. at page 481:

"2. There is no suggestion in the record that the Pennsylvania, with an investment of
over 3 billion dollars, is under any obligation to any banker; rather, the proposed
transaction is the result of arms-length dealing between competent parties in which
negotiations covering a considerable period culminated in a mutually satisfactory
purchase and sale at a price confirmed by applicants' boards of directors composed of
able businessmen."

It may also be noted that in dealing with Kuhn, Loeb & Co., defendants were not
contracting with another firm in which they were interested, nor did the directorates or
managerial positions interlock. There is no contention that fraud existed and fraudulent
acts will not be presumed. Casey v. Woodruff, supra, 49 N.Y.S.2d at page 645.

As to the plaintiff's contention that the Commission was not convinced that the best
obtainable price was received by the railroads, it is indeed difficult to determine in what
way the Commission construed the words "best obtainable price". However, it is at once
evident that the Commission substituted its judgment for that of the directors' in
increasing the price, and while this may be done by that body, see Casey v. Woodruff,
supra, 49 N.Y.S.2d at page 641, it is well settled that the courts will not similarly engage
themselves. On the matter of the spread, at the hearings before the Commission there
was submitted a tabulation showing an average spread of 1.2841 in four transactions
where the bond issue was submitted to competitive bidding. Nevertheless, it appears
that in one of the four instances the spread was as high as 1.9423. It can hardly be
concluded that a spread of 1.75 even suggests negligence, especially where, as here,
leeway must have been allowed for the risk in undertaking a large issue which "broke
the ice" in the bond market. Insofar as the fact that the bonds were favorably received is
concerned, it is clearly true that the monetary situation and the condition of the market
are not exactly foretellable. Failure to foresee what at best is uncertain does not
constitute negligence or mismanagement: what the market would absorb and the terms
and conditions that would meet with greatest success were, at the time the issue
involved here was planned, at most a matter of judgment; now they are fact. If the
defendants used their honest business judgment, as I am convinced they did, they
cannot be liable for failing to accurately foretell the welcome the market would give their
efforts. I am of the opinion no more was required of the individual defendants.

In summary then I find that the bond issue was adequately deliberated and planned,
properly negotiated and executed; there was no lack of good faith, no motivation of
personal gain or profit; and there was no lack of diligence, skill or care in selling the
issue at the price approved by the Commission, and which resulted in a saving of
approximately $9,000,000 to the corporations. The various directors were aware of the
proposed transaction and its course of conduct; copies of telegrams and letters from
Halsey, Stuart & Co., and Otis & Co. were sent to them; in any event they had a right to
rely on the information supplied by, and the good faith judgment of, those in whose
hands the conduct of the everyday affairs of the corporation was placed.

For the reasons stated, the defendants' motion for summary judgment is granted.


[1] Subdivision (2) of this section provides that the Commission shall make an order
authorizing, inter alia, assumption of obligations, only if it finds that such assumption,
"(a) is for some lawful object within its corporate purposes, and compatible with the
public interest, which is necessary * * * for or consistent with the proper performance by
the carrier of service to the public as a common carrier, and which will not impair its
ability to perform that service, and (b) is reasonably necessary and appropriate for such
purpose." In New York Central Securities Corporation v. United States, supra, the
Supreme Court determined, 287 U.S. at page 27, 53 S.Ct. at page 49, 77 L. Ed. 138,
that "lawful object within its corporate purposes" does not refer to state limitations upon
corporate purposes, but rather to the general field of corporate purposes.

[2] Berg v. Cincinnati, N. & C. Ry. Co., D.C.E.D.Ky., 1944, 56 F. Supp. 842, 848, is not
[3] See Atchison, T. & S. F. Ry. Co. v. Scarlett, 1937, 300 U.S. 471, 57 S. Ct. 541, 81 L.
Ed. 748. Defendant was not liable under the Safety Appliance Act, 45 U.S. C.A. §§ 11,
12, where it had complied with the pertinent Interstate Commerce Commission
regulation, but the fact that there was compliance did not necessarily constitute a
defense to an action for negligence.

[4] See 2 Segal, Pennsylvania Banking and Building and Loan Law (1941) Sec. 518.
See also Swentzel v. Penn Bank, 1892, 147 Pa. 140, 23 A. 405, 415, 15 L.R.A. 305, 30
Am.St.Rep. 718; Allen v. Roydhouse, D.C.E.D.Pa., 1916, 232 F. 1010. At least by
including in the statute the phrase "in their personal business affairs" it would seem the
distinction drawn in the latter case between the ordinary individual and the ordinary
director was eliminated.

[5] See Carson, Current Phases of Derivative Actions, (1942) 40 Mich.L.Rev. 1125;
Carson, Further Phases of Derivative Actions, (1944) 29 Corn.L.Q. 431.

[6] 9 F.R. 7205 Appendix, June 29, 1944.

[7] See Hearings before the Committee on Interstate Commerce, pursuant to S.R. 71
(74th Cong.), Part 18, page 7687 (1937-38).

G.R. No. L-15092 May 18, 1962

ALFREDO MONTELIBANO, ET AL., plaintiffs-appellants,

BACOLOD-MURCIA MILLING CO., INC., defendant-appellee.

Tañada, Teehankee and Carreon for plaintiffs-appellants.

Hilado and Hilado for defendant-appellee.

REYES, J.B.L., J.:

Appeal on points of law from a judgment of the Court of First Instance of Occidental Negros, in its
Civil Case No. 2603, dismissing plaintiff's complaint that sought to compel the defendant Milling
Company to increase plaintiff's share in the sugar produced from their cane, from 60% to 62.33%,
starting from the 1951-1952 crop year. 1äw phï1.ñët

It is undisputed that plaintiffs-appellants, Alfredo Montelibano, Alejandro Montelibano, and the

Limited co-partnership Gonzaga and Company, had been and are sugar planters adhered to the
defendant-appellee's sugar central mill under identical milling contracts. Originally executed in 1919,
said contracts were stipulated to be in force for 30 years starting with the 1920-21 crop, and
provided that the resulting product should be divided in the ratio of 45% for the mill and 55% for the
planters. Sometime in 1936, it was proposed to execute amended milling contracts, increasing the
planters' share to 60% of the manufactured sugar and resulting molasses, besides other
concessions, but extending the operation of the milling contract from the original 30 years to 45
years. To this effect, a printed Amended Milling Contract form was drawn up. On August 20, 1936,
the Board of Directors of the appellee Bacolod-Murcia Milling Co., Inc., adopted a resolution (Acts
No. 11, Acuerdo No. 1) granting further concessions to the planters over and above those contained
in the printed Amended Milling Contract. The bone of contention is paragraph 9 of this resolution,
that reads as follows:

ACTA No. 11
AGOSTO 20, 1936

xxx xxx xxx

Acuerdo No. 1. — Previa mocion debidamente secundada, la Junta en consideracion

a una peticion de los plantadores hecha por un comite nombrado por los mismos,
acuerda enmendar el contrato de molienda enmendado medientelas siguentes:

xxx xxx xxx

9.a Que si durante la vigencia de este contrato de Molienda Enmendado,

lascentrales azucareras, de Negros Occidental, cuya produccion anual de azucar
centrifugado sea mas de una tercera parte de la produccion total de todas
lascentrales azucareras de Negros Occidental, concedieren a sus plantadores
mejores condiciones que la estipuladas en el presente contrato, entonces esas
mejores condiciones se concederan y por el presente se entenderan concedidas a
los platadores que hayan otorgado este Contrato de Molienda Enmendado.

Appellants signed and executed the printed Amended Milling Contract on September 10, 1936, but a
copy of the resolution of August 10, 1936, signed by the Central's General Manager, was not
attached to the printed contract until April 17, 1937; with the notation —

Las enmiendas arriba transcritas forman parte del contrato de molienda enmendado,
otorgado por — y la Bacolod-Murcia Milling Co., Inc.

In 1953, the appellants initiated the present action, contending that three Negros sugar centrals (La
Carlota, Binalbagan-Isabela and San Carlos), with a total annual production exceeding one-third of
the production of all the sugar central mills in the province, had already granted increased
participation (of 62.5%) to their planters, and that under paragraph 9 of the resolution of August 20,
1936, heretofore quoted, the appellee had become obligated to grant similar concessions to the
plaintiffs (appellants herein). The appellee Bacolod-Murcia Milling Co., inc., resisted the claim, and
defended by urging that the stipulations contained in the resolution were made without
consideration; that the resolution in question was, therefore, null and void ab initio, being in effect a
donation that was ultra viresand beyond the powers of the corporate directors to adopt.

After trial, the court below rendered judgment upholding the stand of the defendant Milling company,
and dismissed the complaint. Thereupon, plaintiffs duly appealed to this Court.

We agree with appellants that the appealed decisions can not stand. It must be remembered that the
controverted resolution was adopted by appellee corporation as a supplement to, or further
amendment of, the proposed milling contract, and that it was approved on August 20, 1936, twenty-
one days prior to the signing by appellants on September 10, of the Amended Milling Contract itself;
so that when the Milling Contract was executed, the concessions granted by the disputed resolution
had been already incorporated into its terms. No reason appears of record why, in the face of such
concessions, the appellants should reject them or consider them as separate and apart from the
main amended milling contract, specially taking into account that appellant Alfredo Montelibano was,
at the time, the President of the Planters Association (Exhibit 4, p. 11) that had agitated for the
concessions embodied in the resolution of August 20, 1936. That the resolution formed an integral
part of the amended milling contract, signed on September 10, and not a separate bargain, is further
shown by the fact that a copy of the resolution was simply attached to the printed contract without
special negotiations or agreement between the parties.

It follows from the foregoing that the terms embodied in the resolution of August 20, 1936 were
supported by the same causa or consideration underlying the main amended milling contract; i.e.,
the promises and obligations undertaken thereunder by the planters, and, particularly, the extension
of its operative period for an additional 15 years over and beyond the 30 years stipulated in the
original contract. Hence, the conclusion of the court below that the resolution constituted gratuitous
concessions not supported by any consideration is legally untenable.

All disquisition concerning donations and the lack of power of the directors of the respondent sugar
milling company to make a gift to the planters would be relevant if the resolution in question had
embodied a separate agreement after the appellants had already bound themselves to the terms of
the printed milling contract. But this was not the case. When the resolution was adopted and the
additional concessions were made by the company, the appellants were not yet obligated by the
terms of the printed contract, since they admittedly did not sign it until twenty-one days later, on
September 10, 1936. Before that date, the printed form was no more than a proposal that either
party could modify at its pleasure, and the appellee actually modified it by adopting the resolution in
question. So that by September 10, 1936 defendant corporation already understood that the printed
terms were not controlling, save as modified by its resolution of August 20, 1936; and we are
satisfied that such was also the understanding of appellants herein, and that the minds of the parties
met upon that basis. Otherwise there would have been no consent or "meeting of the minds", and no
binding contract at all. But the conduct of the parties indicates that they assumed, and they do not
now deny, that the signing of the contract on September 10, 1936, did give rise to a binding
agreement. That agreement had to exist on the basis of the printed terms as modified by the
resolution of August 20, 1936, or not at all. Since there is no rational explanation for the company's
assenting to the further concessions asked by the planters before the contracts were signed, except
as further inducement for the planters to agree to the extension of the contract period, to allow the
company now to retract such concessions would be to sanction a fraud upon the planters who relied
on such additional stipulations.

The same considerations apply to the "void innovation" theory of appellees. There can be no
novation unless two distinct and successive binding contracts take place, with the later designed to
replace the preceding convention. Modifications introduced before a bargain becomes obligatory can
in no sense constitute novation in law.

Stress is placed on the fact that the text of the Resolution of August 20, 1936 was not attached to
the printed contract until April 17, 1937. But, except in the case of statutory forms or solemn
agreements (and it is not claimed that this is one), it is the assent and concurrence (the "meeting of
the minds") of the parties, and not the setting down of its terms, that constitutes a binding contract.
And the fact that the addendum is only signed by the General Manager of the milling company
emphasizes that the addition was made solely in order that the memorial of the terms of the
agreement should be full and complete.

Much is made of the circumstance that the report submitted by the Board of Directors of the appellee
company in November 19, 1936 (Exhibit 4) only made mention of 90%, the planters having agreed
to the 60-40 sharing of the sugar set forth in the printed "amended milling contracts", and did not
make any reference at all to the terms of the resolution of August 20, 1936. But a reading of this
report shows that it was not intended to inventory all the details of the amended contract; numerous
provisions of the printed terms are alao glossed over. The Directors of the appellee Milling Company
had no reason at the time to call attention to the provisions of the resolution in question, since it
contained mostly modifications in detail of the printed terms, and the only major change was
paragraph 9 heretofore quoted; but when the report was made, that paragraph was not yet in effect,
since it was conditioned on other centrals granting better concessions to their planters, and that did
not happen until after 1950. There was no reason in 1936 to emphasize a concession that was not
yet, and might never be, in effective operation.

There can be no doubt that the directors of the appellee company had authority to modify the
proposed terms of the Amended Milling Contract for the purpose of making its terms more
acceptable to the other contracting parties. The rule is that —

It is a question, therefore, in each case of the logical relation of the act to the corporate
purpose expressed in the charter. If that act is one which is lawful in itself, and not otherwise
prohibited, is done for the purpose of serving corporate ends, and is reasonably tributary to
the promotion of those ends, in a substantial, and not in a remote and fanciful sense, it may
fairly be considered within charter powers. The test to be applied is whether the act in
question is in direct and immediate furtherance of the corporation's business, fairly incident
to the express powers and reasonably necessary to their exercise. If so, the corporation has
the power to do it; otherwise, not. (Fletcher Cyc. Corp., Vol. 6, Rev. Ed. 1950, pp. 266-268)

As the resolution in question was passed in good faith by the board of directors, it is valid and
binding, and whether or not it will cause losses or decrease the profits of the central, the court has
no authority to review them.

They hold such office charged with the duty to act for the corporation according to their best
judgment, and in so doing they cannot be controlled in the reasonable exercise and
performance of such duty. Whether the business of a corporation should be operated at a
loss during depression, or close down at a smaller loss, is a purely business and economic
problem to be determined by the directors of the corporation and not by the court. It is a well-
known rule of law that questions of policy or of management are left solely to the honest
decision of officers and directors of a corporation, and the court is without authority to
substitute its judgment of the board of directors; the board is the business manager of the
corporation, and so long as it acts in good faith its orders are not reviewable by the courts.
(Fletcher on Corporations, Vol. 2, p. 390).

And it appearing undisputed in this appeal that sugar centrals of La Carlota, Hawaiian Philippines,
San Carlos and Binalbagan (which produce over one-third of the entire annual sugar production in
Occidental Negros) have granted progressively increasing participations to their adhered planter at
an average rate of

62.333% for the 1951-52 crop year;

64.2% for 1952-53;

64.3% for 1953-54;

64.5% for 1954-55; and

63.5% for 1955-56,

the appellee Bacolod-Murcia Milling Company is, under the terms of its Resolution of August 20,
1936, duty bound to grant similar increases to plaintiffs-appellants herein.
WHEREFORE, the decision under appeal is reversed and set aside; and judgment is decreed
sentencing the defendant-appellee to pay plaintiffs-appellants the differential or increase of
participation in the milled sugar in accordance with paragraph 9 of the appellee Resolution of August
20, 1936, over and in addition to the 60% expressed in the printed Amended Milling Contract, or the
value thereof when due, as follows:

0,333% to appellants Montelibano for the 1951-1952 crop year, said appellants having
received an additional 2% corresponding to said year in October, 1953;

2.333% to appellant Gonzaga & Co., for the 1951-1952 crop year; and to all appellants
thereafter —
4.2% for the 1952-1953 crop year;
4.3% for the 1953-1954 crop year;
4.5% for the 1954-1955 crop year;
3.5% for the 1955-1956 crop year;

with interest at the legal rate on the value of such differential during the time they were withheld; and
the right is reserved to plaintiffs-appellants to sue for such additional increases as they may be
entitled to for the crop years subsequent to those herein adjudged.

Costs against appellee, Bacolod-Murcia Milling Co.

Padilla, Bautista Angelo, Labrador, Concepcion, Barrera, Paredes and Dizon, JJ., concur.

[G.R. No. 125469. October 27, 1997]


INC., respondents.


The Securities and Exchange Commission is the government agency,

under the direct general supervision of the Office of the President,[1] with the
immense task of enforcing the Revised Securities Act, and all other duties
assigned to it by pertinent laws. Among its inumerable functions, and one of
the most important, is the supervision of all corporations, partnerships or
associations, who are grantees or primary franchise and/or a license or permit
issued by the government to operate in the Philippines.[2] Just how far this
regulatory authority extends, particularly, with regard to the Petitioner
Philippine Stock Exchange, Inc. is the issue in the case at bar.
In this Petition for Review of Certiorari, petitioner assails the resolution of
the respondent Court of Appeals, dated June 27, 1996, which affirmed the
decision of the Securities and Exchange Commission ordering the petitioner
Philippine Stock Exchange, Inc. to allow the private respondent Puerto Azul
Land, Inc. to be listed in its stock market, thus paving the way for the public
offering of PALIs shares.
The facts of the case are undisputed, and are hereby restated in sum.
The Puerto Azul Land, Inc. (PALI), a domestic real estate corporation, had
sought to offer its shares to the public in order to raise funds allegedly to
develop its properties and pay its loans with several banking institutions. In
January, 1995, PALI was issued a Permit to Sell its shares to the public by the
Securities and Exchange Commission (SEC). To facilitate the trading of its
shares among investors, PALI sought to course the trading of its shares
through the Philippine Stock Exchange, Inc. (PSE), for which purpose it filed
with the said stock exchange an application to list its shares, with supporting
documents attached.
On February 8, 1996, the Listing Committee of the PSE, upon a perusal of
PALIs application, recommended to the PSEs Board of Governors the
approval of PALIs listing application.
On February 14, 1996, before it could act upon PALIs application, the
Board of Governors of PSE received a letter from the heirs of Ferdinand E.
Marcos, claiming that the late President Marcos was the legal and beneficial
owner of certain properties forming part of the Puerto Azul Beach Hotel and
Resort Complex which PALI claims to be among its assets and that the
Ternate Development Corporation, which is among the stockholders of PALI,
likewise appears to have been held and continue to be held in trust by one
Rebecco Panlilio for then President Marcos and now, effectively for his estate,
and requested PALIs application to be deferred. PALI was requested to
comment upon the said letter.
PALIs answer stated that the properties forming part of Puerto Azul Beach
Hotel and Resort Complex were not claimed by PALI as its assets. On the
contrary, the resort is actually owned by Fantasia Filipina Resort, Inc. and the
Puerto Azul Country Club, entities distinct from PALI. Furthermore, the
Ternate Development Corporation owns only 1.20% of PALI. The Marcoses
responded that their claim is not confined to the facilities forming part of the
Puerto Azul Hotel and Resort Complex, thereby implying that they are also
asserting legal and beneficial ownership of other properties titled under the
name of PALI.
On February 20, 1996, the PSE wrote Chairman Magtanggol Gunigundo
of the Presidential Commission on Good Government (PCGG) requesting for
comments on the letter of the PALI and the Marcoses. On March 4, 1996, the
PSE was informed that the Marcoses received a Temporary Restraining Order
on the same date, enjoining the Marcoses from, among others, further
impeding, obstructing, delaying or interfering in any manner by or any means
with the consideration, processing and approval by the PSE of the initial public
offering of PALI. The TRO was issued by Judge Martin S. Villarama,
Executive Judge of the RTC of Pasig City in Civil Case No. 65561, pending in
Branch 69 thereof.
In its regular meeting held on March 27, 1996, the Board of Governors of
the PSE reached its decision to reject PALIs application, citing the existence
of serious claims, issues and circumstances surrounding PALIs ownership
over its assets that adversely affect the suitability of listing PALIs shares in the
stock exchange.
On April 11, 1996, PALI wrote a letter to the SEC addressed to the then
Acting Chairman, Perfecto R. Yasay, Jr., bringing to the SECs attention the
action taken by the PSE in the application of PALI for the listing of its shares
with the PSE, and requesting that the SEC, in the exercise of its supervisory
and regulatory powers over stock exchanges under Section 6(j) of P.D. No.
902-A, review the PSEs action on PALIs listing application and institute such
measures as are just and proper and under the circumstances.
On the same date, or on April 11, 1996, the SEC wrote to the PSE,
attaching thereto the letter of PALI and directing the PSE to file its comments
thereto within five days from its receipt and for its authorized representative to
appear for an inquiry on the matter. On April 22, 1996, the PSE submitted a
letter to the SEC containing its comments to the April 11, 1996 letter of PALI.
On April 24, 1996, the SEC rendered its Order, reversing the PSEs
decision. The dispositive portion of the said order reads:

WHEREFORE, premises considered, and invoking the Commissioners authority and

jurisdiction under Section 3 of the Revised Securities Act, in conjunction with Section
3, 6(j) and 6(m) of the Presidential Decree No. 902-A, the decision of the Board of
Governors of the Philippine Stock Exchange denying the listing of shares of Puerto
Azul Land, Inc., is hereby set aside, and the PSE is hereby ordered to immediately
cause the listing of the PALI shares in the Exchange, without prejudice to its authority
to require PALI to disclose such other material information it deems necessary for the
protection of the investing public.

This Order shall take effect immediately.


PSE filed a motion for reconsideration of the said order on April 29, 1996,
which was, however denied by the Commission in its May 9, 1996 Order
which states:

WHEREFORE, premises considered, the Commission finds no compelling reason to

consider its order dated April 24, 1996, and in the light of recent developments on the
adverse claim against the PALI properties, PSE should require PALI to submit full
disclosure of material facts and information to protect the investing public. In this
regard, PALI is hereby ordered to amend its registration statements filed with the
Commission to incorporate the full disclosure of these material facts and information.

Dissatisfied with this ruling, the PSE filed with the Court of Appeals on
May 17, 1996 a Petition for Review (with application for Writ of Preliminary
Injunction and Temporary Restraining Order), assailing the above mentioned
orders of the SEC, submitting the following as errors of the SEC:

On June 4, 1996, PALI filed its Comment to the Petition for Review and
subsequently, a Comment and Motion to Dismiss. On June 10, 1996, PSE
filed its Reply to Comment and Opposition to Motion to Dismiss.
On June 27, 1996, the Court of Appeals promulgated its Resolution
dismissing the PSEs Petition for Review. Hence, this Petition by the PSE.
The appellate court had ruled that the SEC had both jurisdiction and
authority to look into the decision of the petitioner PSE, pursuant to Section
3[3] of the Revised Securities Act in relation to Section 6(j) and 6(m)[4] of P.D.
No. 902-A, and Section 38(b)[5] of the Revised Securities Act, and for the
purpose of ensuring fair administration of the exchange. Both as a corporation
and as a stock exchange, the petitioner is subject to public respondents
jurisdiction, regulation and control. Accepting the argument that the public
respondent has the authority merely to supervise or regulate, would amount to
serious consequences, considering that the petitioner is a stock exchange
whose business is impressed with public interest. Abuse is not remote if the
public respondent is left without any system of control. If the securities act
vested the public respondent with jurisdiction and control over all corporations;
the power to authorize the establishment of stock exchanges; the right to
supervise and regulate the same; and the power to alter and supplement rules
of the exchange in the listing or delisting of securities, then the law certainly
granted to the public respondent the plenary authority over the petitioner; and
the power of review necessarily comes within its authority.
All in all, the court held that PALI complied with all the requirements for
public listing, affirming the SECs ruling to the effect that:

x x x the Philippine Stock Exchange has acted in an arbitrary and abusive manner in
disapproving the application of PALI for listing of its shares in the face of the
following considerations:

1. PALI has clearly and admittedly complied with the Listing Rules and full
disclosure requirements of the Exchange;

2. In applying its clear and reasonable standards on the suitability for listing of shares,
PSE has failed to justify why it acted differently on the application of PALI, as
compared to the IPOs of other companies similarly that were allowed listing in the

3. It appears that the claims and issues on the title to PALIs properties were even less
serious than the claims against the assets of the other companies in that, the assertions
of the Marcoses that they are owners of the disputed properties were not substantiated
enough to overcome the strength of a title to properties issued under the Torrens
System as evidence of ownership thereof;

4. No action has been filed in any court of competent jurisdiction seeking to nullify
PALIs ownership over the disputed properties, neither has the government instituted
recovery proceedings against these properties. Yet the import of PSEs decision in
denying PALIs application is that it would be PALI, not the Marcoses, that must go to
court to prove the legality of its ownership on these properties before its shares can be
In addition, the argument that the PALI properties belong to the
Military/Naval Reservation does not inspire belief. The point is, the PALI
properties are now titled. A property losses its public character the moment it
is covered by a title. As a matter of fact, the titles have long been settled by a
final judgment; and the final decree having been registered, they can no
longer be re-opened considering that the one year period has already
passed. Lastly, the determination of what standard to apply in allowing PALIs
application for listing, whether the discretion method or the system of public
disclosure adhered to by the SEC, should be addressed to the Securities
Commission, it being the government agency that exercises both supervisory
and regulatory authority over all corporations.
On August 15, 1996, the PSE, after it was granted an extension, filed an
instant Petition for Review on Certiorari, taking exception to the rulings of the
SEC and the Court of Appeals. Respondent PALI filed its Comment to the
petition on October 17, 1996. On the same date, the PCGG filed a Motion for
Leave to file a Petition for Intervention. This was followed up by the PCGGs
Petition for Intervention on October 21, 1996. A supplemental Comment was
filed by PALI on October 25, 1997. The Office of the Solicitor General,
representing the SEC and the Court of Appeals, likewise filed its Comment on
December 26, 1996. In answer to the PCGGs motion for leave to file petition
for intervention, PALI filed its Comment thereto on January 17, 1997, whereas
the PSE filed its own Comment on January 20, 1997.
On February 25, 1996, the PSE filed its Consolidated Reply to the
comments of respondent PALI (October 17, 1996) and the Solicitor General
(December 26, 1996). On may 16, 1997, PALI filed its Rejoinder to the said
consolidated reply of PSE.
PSE submits that the Court of Appeals erred in ruling that the SEC had
authority to order the PSE to list the shares of PALI in the stock
exchange. Under presidential decree No. 902-A, the powers of the SEC over
stock exchanges are more limited as compared to its authority over ordinary
corporations. In connection with this, the powers of the SEC over stock
exchanges under the Revised Securities Act are specifically enumerated, and
these do not include the power to reverse the decisions of the stock
exchange. Authorities are in abundance even in the United States, from which
the countrys security policies are patterned, to the effect of giving the
Securities Commission less control over stock exchanges, which in turn are
given more lee-way in making the decision whether or not to allow
corporations to offer their stock to the public through the stock exchange. This
is in accord with the business judgment rule whereby the SEC and the courts
are barred from intruding into business judgments of corporations, when the
same are made in good faith. The said rule precludes the reversal of the
decision of the PSE to deny PALIs listing application, absent a showing a bad
faith on the part of the PSE. Under the listing rule of the PSE, to which PALI
had previously agreed to comply, the PSE retains the discretion to accept or
reject applications for listing. Thus, even if an issuer has complied with the
PSE listing rules and requirements, PSE retains the discretion to accept or
reject the issuers listing application if the PSE determines that the listing shall
not serve the interests of the investing public.
Moreover, PSE argues that the SEC has no jurisdiction over sequestered
corporations, nor with corporations whose properties are under
sequestration. A reading of Republic of the Philippines vs. Sandiganbayan,
G.R. No. 105205, 240 SCRA 376, would reveal that the properties of PALI,
which were derived from the Ternate Development Corporation (TDC) and the
Monte del Sol Development Corporation (MSDC), are under sequestration by
the PCGG, and the subject of forfeiture proceedings in the
Sandiganbayan. This ruling of the Court is the law of the case between the
Republic and the TDC and MSDC. It categorically declares that the assets of
these corporations were sequestered by the PCGG on March 10, 1986 and
April 4, 1988.
It is, likewise, intimidated that the Court of Appeals sanction that PALIs
ownership over its properties can no longer be questioned, since certificates
of title have been issued to PALI and more than one year has since lapsed, is
erroneous and ignores well settled jurisprudence on land titles. That a
certificate of title issued under the Torrens System is a conclusive evidence of
ownership is not an absolute rule and admits certain exceptions. It is
fundamental that forest lands or military reservations are non-alienable. Thus,
when a title covers a forest reserve or a government reservation, such title is
PSE, likewise, assails the SECs and the Court of Appeals reliance on the
alleged policy of full disclosure to uphold the listing of the PALIs shares with
the PSE, in the absence of a clear mandate for the effectivity of such policy.
As it is, the case records reveal the truth that PALI did not comply with the
listing rules and disclosure requirements. In fact, PALIs documents supporting
its application contained misrepresentations and misleading statements, and
concealed material information. The matter of sequestration of PALIs
properties and the fact that the same form part of military/naval/forest
reservations were not reflected in PALIs application.
It is undeniable that the petitioner PSE is not an ordinary corporation, in
that although it is clothed with the marking of a corporate entity, its functions
as the primary channel through which the vessels of capital trade ply. The
PSEs relevance to the continued operation and filtration of the securities
transactions in the country gives it a distinct color of importance such that
government intervention in its affairs becomes justified, if not necessary.
Indeed, as the only operational stock exchange in the country today, the PSE
enjoys a monopoly of securities transactions, and as such, it yields an
immense influence upon the countrys economy.
Due to this special nature of stock exchanges, the countrys lawmakers
has seen it wise to give special treatment to the administration and regulation
of stock exchanges.[6]
These provisions, read together with the general grant of jurisdiction, and
right of supervision and control over all corporations under Sec. 3 of P.D. 902-
A, give the SEC the special mandate to be vigilant in the supervision of the
affairs of stock exchanges so that the interests of the investing public may be
fully safeguarded.
Section 3 of Presidential Decree 902-A, standing alone, is enough
authority to uphold the SECs challenged control authority over the petitioner
PSE even as it provides that the Commission shall have absolute jurisdiction,
supervision, and control over all corporations, partnerships or associations,
who are the grantees of primary franchises and/or a license or permit issued
by the government to operate in the Philippines The SECs regulatory authority
over private corporations encompasses a wide margin of areas, touching
nearly all of a corporations concerns. This authority springs from the fact that
a corporation owes its existence to the concession of its corporate franchise
from the state.
The SECs power to look into the subject ruling of the PSE, therefore, may
be implied from or be considered as necessary or incidental to the carrying
out of the SECs express power to insure fair dealing in securities traded upon
a stock exchange or to ensure the fair administration of such exchange.[7] It is,
likewise, observed that the principal function of the SEC is the supervision and
control over corporations, partnerships and associations with the end in view
that investment in these entities may be encouraged and protected, and their
activities pursued for the promotion of economic development.[8]
Thus, it was in the alleged exercise of this authority that the SEC reversed
the decision of the PSE to deny the application for listing in the stock
exchange of the private respondent PALI. The SECs action was affirmed by
the Court of Appeals.
We affirm that the SEC is the entity with the primary say as to whether or
not securities, including shares of stock of a corporation, may be traded or not
in the stock exchange. This is in line with the SECs mission to ensure proper
compliance with the laws, such as the Revised Securities Act and to regulate
the sale and disposition of securities in the country.[9] As the appellate court

Paramount policy also supports the authority of the public respondent to review
petitioners denial of the listing. Being a stock exchange, the petitioner performs a
function that is vital to the national economy, as the business is affected with public
interest. As a matter of fact, it has often been said that the economy moves on the
basis of the rise and fall of stocks being traded. By its economic power, the petitioner
certainly can dictate which and how many users are allowed to sell securities thru the
facilities of a stock exchange, if allowed to interpret its own rules liberally as it may
please. Petitioner can either allow or deny the entry to the market of securities. To
repeat, the monopoly, unless accompanied by control, becomes subject to abuse;
hence, considering public interest, then it should be subject to government regulation.

The role of the SEC in our national economy cannot be minimized. The
legislature, through the Revised Securities Act, Presidential Decree No. 902-
A, and other pertinent laws, has entrusted to it the serious responsibility of
enforcing all laws affecting corporations and other forms of associations not
otherwise vested in some other government office.[10]
This is not to say, however, that the PSEs management prerogatives are
under the absolute control of the SEC. The PSE is, after all, a corporation
authorized by its corporate franchise to engage in its proposed and duly
approved business. One of the PSEs main concerns, as such, is still the
generation of profit for its stockholders. Moreover, the PSE has all the rights
pertaining to corporations, including the right to sue and be sued, to hold
property in its own name, to enter (or not to enter) into contracts with third
persons, and to perform all other legal acts within its allocated express or
implied powers.
A corporation is but an association of individuals, allowed to transact
under an assumed corporate name, and with a distinct legal personality. In
organizing itself as a collective body, it waives no constitutional immunities
and perquisites appropriate to such body.[11] As to its corporate and
management decisions, therefore, the state will generally not interfere with the
same. Questions of policy and of management are left to the honest decision
of the officers and directors of a corporation, and the courts are without
authority to substitute their judgment for the judgment of the board of
directors. The board is the business manager of the corporation, and so long
as it acts in good faith, its orders are not reviewable by the courts.[12]
Thus, notwithstanding the regulatory power of the SEC over the PSE, and
the resultant authority to reverse the PSEs decision in matters of application
for listing in the market, the SEC may exercise such power only if the PSEs
judgment is attended by bad faith. In board of Liquidators vs. Kalaw,[13] it was
held that bad faith does not simply connote bad judgment or negligence. It
imports a dishonest purpose or some moral obliquity and conscious doing of
wrong. It means a breach of a known duty through some motive or interest of
ill will, partaking of the nature of fraud.
In reaching its decision to deny the application for listing of PALI, the PSE
considered important facts, which in the general scheme, brings to serious
question the qualification of PALI to sell its shares to the public through the
stock exchange. During the time for receiving objections to the application, the
PSE heard from the representative of the late President Ferdinand E. Marcos
and his family who claim the properties of the private respondent to be part of
the Marcos estate. In time, the PCGG confirmed this claim. In fact, an order of
sequestration has been issued covering the properties of PALI, and suit for
reconveyance to the state has been filed in the Sandiganbayan Court. How
the properties were effectively transferred, despite the sequestration order,
from the TDC and MSDC to Rebecco Panlilio, and to the private respondent
PALI, in only a short span of time, are not yet explained to the Court, but it is
clear that such circumstances give rise to serious doubt as to the integrity of
PALI as a stock issuer. The petitioner was in the right when it refused
application of PALI, for a contrary ruling was not to the best interest of the
general public. The purpose of the Revised Securities Act, after all, is to give
adequate and effective protection to the investing public against fraudulent
representations, or false promises, and the imposition of worthless
It is to be observed that the U.S. Securities Act emphasized its avowed
protection to acts detrimental to legitimate business, thus:

The Securities Act, often referred to as the truth in securities Act, was designed not
only to provide investors with adequate information upon which to base their
decisions to buy and sell securities, but also to protect legitimate business seeking to
obtain capital through honest presentation against competition form crooked
promoters and to prevent fraud in the sale of securities. (Tenth Annual Report, U.S.
Securities and Exchange Commission, p. 14).
As has been pointed out, the effects of such an act are chiefly (1) prevention of
excesses and fraudulent transactions, merely by requirement of that details be
revealed; (2) placing the market during the early stages of the offering of a security a
body of information, which operating indirectly through investment services and
expert investors, will tend to produce a more accurate appraisal of a security. x x
x. Thus, the Commission may refuse to permit a registration statement to become
effective if it appears on its face to be incomplete or inaccurate in any material
respect, and empower the Commission to issue a stop order suspending the
effectiveness of any registration statement which is found to include any untrue
statement of a material fact or to omit to state any material fact required to be stated
therein or necessary to make the statements therein not misleading. (Idem).

Also, as the primary market for securities, the PSE has established its
name and goodwill, and it has the right to protect such goodwill by maintaining
a reasonable standard of propriety in the entities who choose to transact
through its facilities. It was reasonable for PSE, therefore, to exercise its
judgment in the manner it deems appropriate for its business identity, as long
as no rights are trampled upon, and public welfare is safeguarded.
In this connection, it is proper to observe that the concept of government
absolutism in a thing of the past, and should remain so.
The observation that the title of PALI over its properties is absolute and
can no longer be assailed is of no moment. At this juncture, there is the claim
that the properties were owned by the TDC and MSDC and were transferred
in violation of sequestration orders, to Rebecco Panlilio and later on to PALI,
besides the claim of the Marcoses that such properties belong to Marcos
estate, and were held only in trust by Rebecco Panlilio. It is also alleged by
the petitioner that these properties belong to naval and forest reserves, and
therefore beyond private dominion. If any of these claims is established to be
true, the certificates of title over the subject properties now held by PALI may
be disregarded, as it is an established rule that a registration of a certificate of
title does not confer ownership over the properties described therein to the
person named as owner.The inscription in the registry, to be effective, must
be made in good faith. The defense of indefeasibility of a Torrens Title does
not extend to a transferee who takes the certificate of title with notice of a flaw.
In any case, for the purpose of determining whether PSE acted correctly in
refusing the application of PALI, the true ownership of the properties of PALI
need not be determined as an absolute fact. What is material is that the
uncertainty of the properties ownership and alienability exists, and this puts to
question the qualification of PALIs public offering. In sum, the Court finds that
the SEC had acted arbitrarily in arrogating unto itself the discretion of
approving the application for listing in the PSE of the private respondent PALI,
since this is a matter addressed to the sound discretion of the PSE, a
corporate entity, whose business judgments are respected in the absence of
bad faith.
The question as to what policy is, or should be relied upon in approving
the registration and sale of securities in the SEC is not for the Court to
determine, but is left to the sound discretion of the Securities and Exchange
Commission. In mandating the SEC to administer the Revised Securities Act,
and in performing its other functions under pertinent laws, the Revised
Securities Act, under Section 3 thereof, gives the SEC the power to
promulgate such rules and regulations as it may consider appropriate in the
public interest for the enforcement of the said laws. The second paragraph of
Section 4 of the said law, on the other hand, provides that no security, unless
exempt by law, shall be issued, endorsed, sold, transferred or in any other
manner conveyed to the public, unless registered in accordance with the rules
and regulations that shall be promulgated in the public interest and for the
protection of investors by the Commission. Presidential Decree No. 902-A, on
the other hand, provides that the SEC, as regulatory agency, has supervision
and control over all corporations and over the securities market as a whole,
and as such, is given ample authority in determining appropriate
policies. Pursuant to this regulatory authority, the SEC has manifested that it
has adopted the policy of full material disclosure where all companies, listed
or applying for listing, are required to divulge truthfully and accurately, all
material information about themselves and the securities they sell, for the
protection of the investing public, and under pain of administrative, criminal
and civil sanctions. In connection with this, a fact is deemed material if it tends
to induce or otherwise effect the sale or purchase of its securities.[15] While the
employment of this policy is recognized and sanctioned by laws, nonetheless,
the Revised Securities Act sets substantial and procedural standards which a
proposed issuer of securities must satisfy.[16] Pertinently, Section 9 of the
Revised Securities Act sets forth the possible Grounds for the Rejection of the
registration of a security:

- - The Commission may reject a registration statement and refuse to issue a permit to
sell the securities included in such registration statement if it finds that - -

(1) The registration statement is on its face incomplete or inaccurate in any material
respect or includes any untrue statement of a material fact or omits to state a material
facts required to be stated therein or necessary to make the statements therein not
misleading; or
(2) The issuer or registrant - -

(i) is not solvent or not is sound financial condition;

(ii) has violated or has not complied with the provisions of this Act, or the rules
promulgated pursuant thereto, or any order of the Commission;

(iii) has failed to comply with any of the applicable requirements and conditions that
the Commission may, in the public interest and for the protection of investors, impose
before the security can be registered;

(iv) had been engaged or is engaged or is about to engaged in fraudulent transactions;

(v) is in any was dishonest of is not of good repute; or

(vi) does not conduct its business in accordance with law or is engaged in a business
that is illegal or contrary or government rules and regulations.

(3) The enterprise or the business of the issuer is not shown to be sound or to be based
on sound business principles;

(4) An officer, member of the board of directors, or principal stockholder of the issuer
is disqualified to such officer, director or principal stockholder; or

(5) The issuer or registrant has not shown to the satisfaction of the Commission that
the sale of its security would not work to the prejudice to the public interest or as a
fraud upon the purchaser or investors. (Emphasis Ours)

A reading of the foregoing grounds reveals the intention of the lawmakers

to make the registration and issuance of securities dependent, to a certain
extent, on the merits of the securities themselves, and of the issuer, to be
determined by the Securities and Exchange Commission. This measure was
meant to protect the interest of the investing public against fraudulent and
worthless securities, and the SEC is mandated by law to safeguard these
interests, following the policies and rules therefore provided. The absolute
reliance on the full disclosure method in the registration of securities is,
therefore, untenable. At it is, the Court finds that the private respondent PALI,
on at least two points (nos. 1 and 5) has failed to support the propriety of the
issue of its shares with unfailing clarity, thereby lending support to the
conclusion that the PSE acted correctly in refusing the listing of PALI in its
stock exchange. This does not discount the effectivity of whatever method the
SEC, in the exercise of its vested authority, chooses in setting the standard for
public offerings of corporations wishing to do so. However, the SEC must
recognize and implement the mandate of the law, particularly the Revised
Securities Act, the provisions of which cannot be amended or supplanted my
mere administrative issuance.
In resum, the Court finds that the PSE has acted with justified
circumspection, discounting, therefore, any imputation of arbitrariness and
whimsical animation on its part. Its action in refusing to allow the listing of
PALI in the stock exchange is justified by the law and by the circumstances
attendant to this case.
ACCORDINGLY, in view of the foregoing considerations, the Court hereby
GRANTS the Petition for Review on Certiorari. The decisions of the Court of
Appeals and the Securities and Exchage Commission dated July 27, 1996
and April 24, 1996, respectively, are hereby REVERSED and SET ASIDE,
and a new Judgment is hereby ENTERED, affirming the decision of the
Philippine Stock Exchange to deny the application for listing of the private
respondent Puerto Azul Land, Inc.
Regalado (Chairman) and Puno, JJ., concur.
Mendoza, J., in the result.
G.R. No. L-30460 March 12, 1929

C. H. STEINBERG, as Receiver of the Sibuguey Trading Company, Incorporated, plaintiff-

GREGORIO VELASCO, ET AL., defendants-appellees.

Frank H. Young for appellant.

Pablo Lorenzo and Delfin Joven for appellees.


Plaintiff is the receiver of the Sibuguey Trading Company, a domestic corporation. The defendants
are residents of the Philippine Islands.

It is alleged that the defendants, Gregorio Velasco, as president, Felix del Castillo, as vice-president,
Andres L. Navallo, as secretary-treasurer, and Rufino Manuel, as director of Trading Company, at a
meeting of the board of directors held on July 24, 1922, approved and authorized various lawful
purchases already made of a large portion of the capital stock of the company from its various
stockholders, thereby diverting its funds to the injury, damage and in fraud of the creditors of the
corporation. That pursuant to such resolution and on March 31, 1922, the corporation purchased
from the defendant S. R. Ganzon 100 shares of its capital stock of the par value of P10, and on June
29, 1922, it purchased from the defendant Felix D. Mendaros 100 shares of the par value of P10,
and on July 16, 1922, it purchased from the defendant Felix D. Mendaros 100 shares of the par
value of P10, each, and on April 5, 1922, it purchased from the defendant Dionisio Saavedra 10
shares of the same par value, and on June 29, 1922, it purchased from the defendant Valentin
Matias 20 shares of like value. That the total amount of the capital stock unlawfully purchased was
P3,300. That at the time of such purchase, the corporation had accounts payable amounting to
P13,807.50, most of which were unpaid at the time petition for the dissolution of the corporation was
financial condition, in contemplation of an insolvency and dissolution.

As a second cause of action, plaintiff alleges that on July 24, 1922, the officers and directors of the
corporation approved a resolution for the payment of P3,000 as dividends to its stockholders, which
was wrongfully done and in bad faith, and to the injury and fraud of its creditors. That at the time the
petition for the dissolution of the corporation was presented it had accounts payable in the sum of
P9,241.19, "and practically worthless accounts receivable."

Plaintiff prays judgment for the sum of P3,300 from the defendants Gregorio Velasco, Felix del
Castillo, Andres L. Navallo and Rufino Manuel, personally as members of the Board of Directors, or
for the recovery from the defendants S. R. Ganzon, of the sum of P1,000, from the defendant Felix
D. Mendaros, P2,000, and from the defendant Dionisio Saavedra, P100, and under his second
cause of action, he prays judgment for the sum of P3,000, with legal interest against the board of
directors, and costs.

For answer the defendants Felix del Castillo, Rufino Manuel, S. R. Ganzon, Dionisio Saavedra and
Valentin Matias made a general and specific denial.

In his amended answer, the defendant Gregorio Velasco admits paragraphs, 1, 2 and 3 of each
cause of action of the complaint, and that the shares mentioned in paragraph 4 of the first cause of
action were purchased, but alleges that they were purchased by virtue of a resolution of the board of
directors of the corporation "when the business of the company was going on very well." That the
defendant is one of the principal shareholders, and that about the same time, he purchase other
shares for his own account, because he thought they would bring profits. As to the second cause of
action, he admits that the dividends described in paragraph 4 of the complaint were distributed, but
alleges that such distribution was authorized by the board of directors, "and that the amount
represented by said dividends really constitutes a surplus profit of the corporation," and as
counterclaim, he asks for judgment against the receiver for P12,512.47 for and on account of his
negligence in failing to collect the accounts.

Although duly served, the defendant Mendaros did not appear or answer. The defendant Navallo
was not served, and the case against him was dismissed.

April 30, 1928, the case was tried and submitted on a stipulation of facts, based upon which the
lower court dismissed plaintiff's complaint, and rendered judgment for the defendants, with costs
against the plaintiff, and absolved him from the cross-complaint of the defendant Velasco, and on
appeal, the plaintiff assigns the following errors:

1. In holding that the Sibuguey Trading Company, Incorporated, could legally purchase its
own stock.

2. In holding that the Board of Directors of the said Corporation could legally declared a
dividend of P3,000, July 24, 1922.

It is stipulated that on July 24, 1922, the directors of the corporation approved the purchase of stocks
as follows:

One hundred shares from S. R. Ganzon for P1,000;

One hundred shares from Felix D. Mendaros at the same price; which purchase was made on June
29, 1922; another

One hundred shares from Felix D. Mendaros at the same price on July 16, 1922;

Ten shares from Dionisio Saavedra at the same price on June 29, 1922.

That during such times, the defendant Gregorio Velasco purchased 13 shares for the corporation for
P130; Felix del Castillo — 42 shares for P420; Andres Navallo — 15 shares for P150; and the
defendant Mendaros — 10 shares for P100. That during the time these various purchases were
made, the total amount of subscribed and paid up capital stock of the corporation was P10,030, out
of the authorized capital stock 2,000 shares of the par value of P10 each.

Paragraph 4 of the stipulation also recites:

Be it also admitted as a fact that the time of the said purchases there was a surplus profit of
the corporation above-named of P3,314.72.

Paragraph 5 is as follows:

That at the time of the repeatedly mentioned various purchases of the said capital stock were
made, the said corporation had Accounts Payable in the total amount of P13,807.50 as
shown by the statement of the corporation, dated June 30, 1922, and the Accounts
Receivable in the sum of P19,126.02 according to the books, and that the intention of the
Board of Directors was to resell the stocks purchased by the corporations at a sum above
par for each stock, this expectation being justified by the then satisfactory and sound
financial condition of the business of the corporation.

It is also stipulated that on September 11, 1923, when the petition for the dissolution of the
corporation was presented to the court, according to a statement made June 30, 1923, it has
accounts payable aggregating P9,41.19, and accounts receivable for P12,512.47.

Paragraph 7 of the stipulation recites:

That the same defendants, mentioned in paragraph 2 of this stipulation of facts and in the
same capacity, on the same date of July 24, 1922, and at the said meeting of the said Board
of Directors, approved and authorized by resolution the payment of dividends to its
stockholders, in the sum of three thousand pesos (P3,000), Philippine currency, which
payments were made at different dates, between September 30, 1922, and May 12, 1923,
both dates inclusive, at a time when the corporation had accounts less in amount than the
accounts receivable, which resolution was based upon the balance sheet made as June 30,
1922, said balance sheet showing that the corporation had a surplus of P1,069.41, and a
profit on the same date of P2,656.08, or a total surplus amount of P3,725.49, and a reserve
fund of P2,889.23 for bad and doubtful accounts and depreciation of equipment, thereby
leaving a balance of P3,314.72 of net surplus profit after paying this dividend.
It is also stipulated at a meeting of the board of directors held on July 24, 1922, as follows:

6. The president and manager submitted to the Board of Directors his statement and balance
sheet for the first semester ending June 30, 1922 and recommended that P3,000 — out of
the surplus account be set aside for dividends payable, and that payments be made in
installments so as not to effect the financial condition of the corporation. That stockholders
having outstanding account with the corporation should settle first their accounts before
payments of their dividends could be made. Mr. Castillo moved that the statement and
balance sheet be approved as submitted, and also the recommendations of the president.
Seconded by Mr. Manuel. Approved.

Paragraph 8 of the stipulation is as follows:

That according to the balance sheet of the corporation, dated June 30, 1923, it had accounts
receivable in the sum of P12,512.47, due from various contractor and laborers of the
National Coal Company, and also employees of the herein corporation, which the herein
receiver, after his appointment on February 28, 1924, although he made due efforts by
personally visiting the location of the corporation, and of National Coal Company, at its
offices, at Malangas, Mindanao, and by writing numerous letters of demand to the debtors of
the corporation, in order to collect these accounts receivable, he was unable to do so as
most of them were without goods or property, and he could not file any suit against them that
might have any property, for the reason that he had no funds on hand with which to pay the
filing and sheriff fees to Malangas, and other places of their residences.

From all of which, it appears that on June 30, 1922, the board of directors of the corporation
authorized the purchase of, purchased and paid for, 330 shares of the capital stock of the
corporation at the agreed price of P3,300, and that at the time the purchase was made, the
corporation was indebted in the sum of P13,807.50, and that according to its books, it had accounts
receivable in the sum of P19,126.02. That on September 11, 1923, when the petition was filed for its
dissolution upon the ground that it was insolvent, its accounts payable amounted to P9,241.19, and
its accounts receivable P12,512.47, or an apparent asset of P3,271.28 over and above its liabilities.
But it will be noted that there is no stipulation or finding of facts as to what was the actual cash value
of its accounts receivable. Neither is there any stipulation that those accounts or any part of them
ever have been or will be collected, and it does appear that after his appointment on February 28,
1924, the receiver made a diligent effort to collect them, and that he was unable to do so, and it also
appears from the minutes of the board of directors that the president and manager "recommended
that P3,000 — out of the surplus account to be set aside for dividends payable, and that payments
be made in installments so as not to effect the financial condition of the corporation."

If in truth and in fact the corporation had an actual bona fide surplus of P3,000 over and above all of
its debt and liabilities, the payment of the P3,000 in dividends would not in the least impair the
financial condition of the corporation or prejudice the interests of its creditors.

It is very apparent that on June 24, 1922, the board of directors acted on assumption that, because it
appeared from the books of the corporation that it had accounts receivable of the face value of
P19,126.02, therefore it had a surplus over and above its debts and liabilities. But as stated there is
no stipulation as to the actual cash value of those accounts, and it does appear from the stipulation
that on February 28, 1924, P12,512.47 of those accounts had but little, if any, value, and it must be
conceded that, in the purchase of its own stock to the amount of P3,300 and in declaring the
dividends to the amount of P3,000, the real assets of the corporation were diminished P6,300. It also
appears from paragraph 4 of the stipulation that the corporation had a "surplus profit" of P3,314.72
only. It is further stipulated that the dividends should "be made in installments so as not to effect
financial condition of the corporation." In other words, that the corporation did not then have an
actual bona fide surplus from which the dividends could be paid, and that the payment of them in full
at the time would "affect the financial condition of the corporation."

It is, indeed, peculiar that the action of the board in purchasing the stock from the corporation and in
declaring the dividends on the stock was all done at the same meeting of the board of directors, and
it appears in those minutes that the both Ganzon and Mendaros were formerly directors and
resigned before the board approved the purchase and declared the dividends, and that out of the
whole 330 shares purchased, Ganzon, sold 100 and Mendaros 200, or a total of 300 shares out of
the 330, which were purchased by the corporation, and for which it paid P3,300. In other words, that
the directors were permitted to resign so that they could sell their stock to the corporation. As stated,
the authorized capital stock was P20,000 divided into 2,000 shares of the par value of P10 each,
which only P10,030 was subscribed and paid. Deducting the P3,300 paid for the purchase of the
stock, there would be left P7,000 of paid up stock, from which deduct P3,000 paid in dividends, there
would be left P4,000 only. In this situation and upon this state of facts, it is very apparent that the
directors did not act in good faith or that they were grossly ignorant of their duties.

Upon each of those points, the rule is well stated in Ruling Case Law, vol. 7, p. 473, section 454
where it is said:

General Duty to Exercise Reasonable Care. — The directors of a corporation are bound to
care for its property and manage its affairs in good faith, and for a violation of these duties
resulting in waste of its assets or injury to the property they are liable to account the same as
other trustees. Are there can be no doubt that if they do acts clearly beyond their power,
whereby loss ensues to the corporation, or dispose of its property or pay away its money
without authority, they will be required to make good the loss out of their private estates. This
is the rule where the disposition made of money or property of the corporation is one either
not within the lawful power of the corporation, or, if within the authority of the particular officer
or officers.

And section 458 which says:

Want of Knowledge, Skill, or Competency. — It has been said that directors are not liable for
losses resulting to the corporation from want of knowledge on their part; or for mistake of
judgment, provided they were honest, and provided they are fairly within the scope of the
powers and discretion confided to the managing body. But the acceptance of the office of a
director of a corporation implies a competent knowledge of the duties assumed, and
directors cannot excuse imprudence on the ground of their ignorance or inexperience; and if
they commit an error of judgment through mere recklessness or want of ordinary prudence or
skill, they may be held liable for the consequences. Like a mandatory, to whom he has been
likened, a director is bound not only to exercise proper care and diligence, but ordinary skill
and judgment. As he is bound to exercise ordinary skill and judgment, he cannot set up that
he did not possess them.

Creditors of a corporation have the right to assume that so long as there are outstanding debts and
liabilities, the board of directors will not use the assets of the corporation to purchase its own stock,
and that it will not declare dividends to stockholders when the corporation is insolvent.

The amount involved in this case is not large, but the legal principles are important, and we have
given them the consideration which they deserve.
The judgment of the lower court is reversed, and (a), as to the first cause of action, one will be
entered for the plaintiff and against the defendant S. R. Ganzon for the sum of P1,000, with legal
interest from the 10th of February, 1926, and against the defendant Felix D. Medaros for P2,000,
with like interests, and against the defendant Dionisio Saavedra for P100, with like interest, and
against each of them for costs, each on their primary liability as purchasers of stock, and (b) against
the defendants Gregorio Velasco, Felix del Castillo and Rufino Manuel, personally, as members of
the board of directors of the Sibuguey Trading Company, Incorporated, as secondarily liable for the
whole amount of such stock sold and purchased as above stated, and on the second cause of
action, judgment will be entered (c) for the plaintiff and jointly and severally against the defendants
Gregorio Velasco, Felix del Castillo and Rufino Manuel, personally, as members of the board of
directors of the Sibuguey Trading Company, Incorporated, for P3,000, with interest thereon from
February 10, 1926, at the rate of 6 per cent per annum, and costs. So ordered.

Johnson, Street, Malcolm, Ostrand, Romualdez and Villa-Real, JJ., concur.

Barnes v. Andrews
United States District Court for the Southern District of New
298 F. 614 (1924)

Liberty Starters Corporation (Liberty) was a New York corporation that
manufactured airplanes and starters for Ford Motor Company. Charles Andrews
(defendant), a corporate director of Liberty, took office as a director of Liberty in
October 1919 and resigned in June 1920, serving for less than a year. Liberty
continued business until 1921, when Earl Barnes (plaintiff) was appointed as
receiver and sold Liberty’s assets for a small profit. Barnes brought a suit in
equity against Andrews, alleging that Andrews did not give proper attention to his
duties as corporate director of Liberty. Specifically, Barnes alleged that Andrews
did not pay attention to Liberty’s waste in the spending and the incompetence of
certain employees. During Andrews’s time at Liberty, there had only been two
meetings for the corporate directors. Andrews attended one meeting, but missed
the other meeting because his mother died. Andrews had remained informed
about Liberty by speaking with Maynard, who was Liberty’s president and
Andrew’s personal friend, but did not ask specific questions about Liberty and
instead relied on the information that Maynard gave him. A decree was entered
for Andrews, and the suit came before the federal district court on a final hearing
on the bill in equity.

Rule of Law

OTT, Judge.

This case was remanded by us on the former appeal to enable plaintiff to

amend his petition so as to show certain facts which he claimed to have
in his possession. The nature of the suit was set out in our former
opinion. See 16 So.2d 132. Without again restating the allegations made
in the original petition or setting out in detail the allegations made by
plaintiff in his supplemental petition filed after the case was remanded, it
is sufficient to say that he claims to recover from the three defendants
the surtax which he was compelled to pay as his pro rata part of the
surtax assessed against the S. D. Pool Realty Company by the Federal
Government on account of the failure of the corporation to distribute its
earnings for 1938 before the end of that year. The allegations of his
petitions may be summarized as follows:

The said Pool Company was a holding corporation consisting of plaintiff

and his brother, S.D. Pool, together with his three sisters, Mrs. Farrell,
Mrs. D'Aquin and Mrs. Jarreau, each owning 20 per cent of the stock of
the Company; the three defendants, Stephen D. Pool, Mrs. Farrell and
Mrs. D'Aquin, as directors and officers of the corporation, were guilty of
negligence, ineptness and deceit, and conspired to oust plaintiff and his
sister, Mrs. Jarreau, and take control of the corporation for their own
advantage; because of the various acts on the part of said S.D. Pool,
concurred in by the other two defendants, the dividends due the said
corporation by the Times Picayune Publishing Company during the year
1938, amounting to the sum of $4200, were not received and distributed
during that year, by reason of which the corporation was assessed with
and required to pay a surtax on its undistributed profits for that year
under the Revenue Act of 1938, 26 U.S.C.A. Int.Rev.Acts, p. 1001 et
seq., which assessment was made against the stockholders after the
liquidation of the corporation, and plaintiff, as a stockholder, was forced
to pay his pro rata part of said tax, which amount so paid by him he now
seeks to recover from the three defendants.
In their answer the defendants admit that each of the stockholders of the
Pool Company was required to pay a surtax for the corporation because
of the failure to distribute the earnings of the Company in 1938, but they
deny that they were guilty of any negligence or wrong doing which
caused this tax to be assessed against the stockholders of the Company.
They allege that plaintiff was a director and secretary of the corporation
in 1938, and his acts caused the Times Picayune to withhold the
dividends during 1938, and the various letters written by plaintiff and by
S.D. Pool to the Times Picayune are referred to in the answer, as well as
the letters from the Times Picayune and its attorneys giving its reason
for withholding the dividends. They admit that they were directors of the
corporation in January, 1939, and so advised the Times Picayune, and
asked for and received the dividends due the Company in January, 1939.
They allege that they employed a certified public accountant and an
attorney to handle the tax matters and the legal affairs of the Company
and took their advice and acted in good faith in all matters pertaining to
the affairs of the corporation.

The trial judge dismissed plaintiff's suit, and he has appealed.

The acts of the defendants on which the plaintiff seeks to hold them
liable for the surtax which he had to pay as a stockholder of the Pool
corporation may be divided into what was done in 1938 and what was
done or not done by them after they were elected directors in January,

The charter of the corporation provided for the election of a board of

three directors in January of each year. At the stockholders meeting in
January, 1938, at which it appears all the stockholders were present, all
five of the stockholders were elected as directors, notwithstanding the
charter provided for only three directors. Plaintiff was elected secretary
of the corporation. Soon after this meeting, it seems that friction arose
among the stockholders, particularly between plaintiff and his brother,
S.D. Pool.
The domicile of the corporation was fixed in the charter at 2341
Esplanade Avenue, New Orleans, which seems to have been the home of
the parents of the stockholders. Some time in the early part of 1938,
Robert E. Pool suggested that the business of the corporation be
transacted by him as secretary at his home in Ventress, Louisiana, but
the three defendants, in a letter addressed to plaintiff on February 15,
1938, objected to the books of the corporation being carried to Ventress,
and insisted that these books be kept and all business of the corporation
be transacted at its domicile in New Orleans. Shortly after this
controversy arose, plaintiff demanded that S.D. Pool resign as vice
president and director of the corporation, which the latter refused to do.

On April 16, 1938, plaintiff, in his capacity as secretary of the S. D. Pool

Realty Company, wrote the Times Picayune requesting that it send all
future dividends, reports, notices, etc. to him as secretary of the
corporation at Ventress, Louisiana, to which the Times Picayune replied
that the domicile of the corporation was at 2341 Esplanade Avenue,
New Orleans, and "under the law we are obliged to send
communications to that address". On June 22, 1938, S.D. Pool, acting in
his capacity as vice president and acting president, wrote the Times
Picayune to ignore the request of plaintiff as secretary to have all
notices, etc., sent to his address at Ventress, as his action was not
authorized by the board of directors, and requested that all
communications to the Company be sent to the address of its domicile.
On June 30, 1938, the attorneys for the Times Picayune, to whom the
matter had been referred, wrote to plaintiff that, in view of the dispute
between plaintiff and his brother, the Times Picayune was advised to
hold the check representing the dividend payable July 1st and not to
deliver same until the matter had been settled between the parties or by
judgment of court.

Matters rocked along in this unsettled state with the controversy

continued and the dividend checks still held up by the Times Picayune
when, on December 9, 1938, S.D. Pool, acting as vice president, sent a
notice to plaintiff to be present at the annual stockholders meeting to be
held at the domicile of the Company on January 3, 1939. And on
December 30, 1938, S.D. Pool, as vice president, wrote the Times
Picayune the letter which we quoted in our former opinion, referring to
the conflicting instructions given in regard to the address to which the
dividends should be sent, and requesting the Times Picayune to hold all
dividend checks until further instructions after the stockholders meeting
which had been called to be held on January 3rd following.

Under these circumstances, no dividend checks were sent out to the Pool
Company during the year 1938.

It will be seen from what is said above that the dividend checks were not
received from the Times Picayune because of the advice of its attorneys
not to send out the checks until the affairs of the company had been
straightened out. Mr. Nicholson, President of the Times Picayune
Publishing Company, testified that it was on the advice of its attorneys
that the dividends were withheld and not because of the letter written by
S.D. Pool on Dec. 30, 1938. The dividends would not have been
received by the Pool Company in 1938 had S.D. Pool not written this
letter. It was the dispute among the directors and stockholders that
caused the dividends to be held up and as plaintiff was a director and
secretary of the Pool Company in 1938, it was as much his duty to see
that the dividends due the Company were received and distributed as it
was the duty of the other directors. Plaintiff made no effort to have the
controversy settled, and so far as the record shows, he was as much the
cause of the unhappy condition in the Company as was any of the other

On this second appeal, plaintiff puts considerable stress on his

contention that the defendants as directors of the Pool Company after
January, 1939, had until March 15th of that year in which to distribute
the 1938 dividends and avoid the surtax; that they admit receiving the
dividends from the Times Picayune in January, 1939, and he contends
they were negligent in failing to perform their duties as directors in that
they failed to distribute these dividends before March 15, 1939, as they
could have done under Section 405(c) of the Revenue Act of 1938, 26
U.S.C.A. Int.Rev.Acts, page 1133, and thereby avoided the surtax levy
against the corporation.

[1, 2] We do not deem it necessary to pass on the doubtful question of

whether or not, under the above Section of the Revenue Act of 1938, the
Pool Company could have distributed the dividends received from the
Times Picayune at any time before March 15, 1939, and avoided the
surtax assessment. The law on this point is very complicated and
involved. The defendants as directors were only required to exercise
reasonable care and diligence and act in good faith and with that
judgment and discretion which ordinarily prudent men exercise under
similar circumstances. They employed a certified public accountant to
make the income tax returns of the Company for 1938 and also had the
advice of an attorney in connection with its legal affairs. The defendants
did not know that these dividends had to be distributed before March 15,
1939 (if this could have been done), in order to avoid the surtax. They
had a right to rely on the advice and suggestion of the public accountant
and the attorney whom they had employed to look after these legal and
technical matters.

While the plaintiff claims that he knew that these dividends had to be
distributed before March 15, 1939, in order to avoid the surtax, yet he
admits that he never advised any of the defendants of this fact,
notwithstanding he was a stockholder and had as much at stake as any of
the defendants. It was to the interest of all the stockholders to avoid
paying this surtax, and it is hardly conceivable that the defendants would
have refused to distribute these dividends had they been advised or had
known that a failure to do so would subject them as well as plaintiff to
this loss.

Finding no error in the judgment appealed from, the same is hereby

affirmed at the cost of plaintiff.


MR. PRESIDING JUSTICE HUFFMAN delivered the opinion of the

This is an action against appellees to recover for an alleged wilful

conversion of grain belonging to appellant, and has to do with liabillity
of corporate directors for corporate torts or acts of subordinate officers.
Appellees were directors in a farmers co-operative grain company,
which operated an elevator under the corporate name of Steward Co-
operative Grain Company. The management, supervision and conduct of
the elevator business was in charge of Claude V. Herrmann, who was
also a defendant in this suit. Appellees denied the conversion, alleging
they had no knowledge of any arrangements by appellant with the
manager of the elevator for the storing of oats, and had no knowledge of
the action of the said Herrmann with respect to such oats. The case was
heard by the court. Judgment was entered for plaintiff appellant against
Claude V. Herrmann, for the amount claimed. Judgment was also
entered in favor of defendant directors, and plaintiff brings this appeal.

It appears that in July 1939, appellant entered into what is termed a lease
agreement with the Steward Co-operative Grain Company, a
corporation, by and through its manager Herrmann, whereby appellant,
for the sum of One Dollar and one half the net profits, became the lessee
of certain bins in the elevator for storage of grain. It is charged in the
complaint that appellant had 12,000 bushels of oats stored in the bins,
pursuant to the above agreement, that the elevator company shipped and
sold 9,081 bushels of such oats without the knowledge or consent of
appellant, and failed to account for the proceeds thereof. It also alleged
that the market value of such oats was $2,724.06.

It appears the appellees had no knowledge of the agreement made by

Herrmann with appellant, or that he had stored in the elevator any grain
belonging to appellant. Herrmann sold the oats in question during the
month of August 1939. The grain corporation was in financial straits. It
had a loan with a St. Louis bank. It appears that some time during the
month of September, an effort was made to bring about a reorganization
of the corporation, which effort was unsuccessful and the corporation
was later liquidated.

It is charged by appellant that appellee directors and the manager of the

elevator, Herrmann, wilfully and maliciously caused appellant's oats to
be taken from the bins it had under lease, sold on the market, and no
remittance made therefor. The evidence failed to show any knowledge
on the part of appellees concerning the transaction in question. Appellant
urges that appellees are liable upon their common law liability; that it
was their legal duty to exercise such supervision as might be required of
them in order that they know and have knowledge of what the agent of
the corporation was doing in connection with the corporate business, and
that because of their neglect of their duties in this respect, they are liable.
Appellant also urges as a ground of liability against appellees that they,
as directors of the corporation, by resolution made in September 1939,
ordered and directed the manager Herrmann, to sell all grain on hands.
However, the evidence discloses that the oats in question were sold in
the previous month of August.

Appellees urge they are not liable for the torts of the corporation merely
because they are directors, but that they are liable only for such torts in
which they participated, or of which they had knowledge, authorized or
directed. In this respect, they refer to C. J. S., vol. 19, p. 271 (Corp. —
Torts, par. 845, et seq.).

Appellant insists that circumstances may arise where directors by their

negligent inattention to business may render themselves liable for the
wrongful acts of subordinate officers. And it may be considered that
directors, although authorized and justified in committing the details of
the conduct of the corporate business to subordinate officers, are not
thereby justified in withdrawing their supervision and control of
corporate affairs. They cannot thus divest themselves of the duty of
general supervision and control by committing this duty to a subordinate
officer. However, of necessity, it becomes proper that they entrust to
subordinate and executive officers the discretionary powers which
usually and ordinarily appertain to the immediate management of the
particular business. Nothing appears in this case to indicate that
appellees did not exercise care and prudence in their selection of the
agent Herrmann. Neither does it appear that they sought to divest
themselves of a general supervision of the conduct of the business.
Further, nothing appears to indicate that they had any knowledge of, or
had acquiesced in a continuous or repeated course of conduct on the part
of Herrmann such as committed in the present instance. Courts will treat
directors with more leniency with respect to a single isolated act of fraud
on the part of a subordinate officer or agent, than where the practice
appears to have been so habitually and openly committed as to have
been easily detected upon proper supervision. We do not consider the
directors to be personally liable under the evidence in this case. Here we
find a single act secreted by the subordinate officer from the directors,
with the contract locked up by him without their knowledge of its
existence, and no corporate record to come before them reflecting such
transaction. Under such circumstances, it can hardly be said that
appellees in the exercise of ordinary and reasonable supervision could
have detected the wrongdoing of their subordinate officer.

The question of liability of a director in a corporation for the acts or

omissions of officers or agents, other than codirectors, admits of various
conditions. Ordinarily, where such director can be held liable for the acts
of subordinate officers, he must participate therein, be guilty of lack of
ordinary and reasonable supervision, or be guilty of lack of ordinary care
in the selection of such officer. The duties of a general manager of a
corporation are usually more extensive than those of a mere director.

The question often arises respecting the liability of a director for a tort
committed by a corporation. Liability in such instance on the part of the
director is generally considered to rest upon the question whether he
actively participated in the wrongdoing, and it seems impossible to lay
down any governing rule further than that the test is to be whether the
director authorized or participated in the alleged wrongful act. The mere
fact that a person is a director in a corporation does not necessarily
render him liable for the torts of the corporation or its agents. In other
words, directors are not to be held liable for the negligence of the
corporation merely because of their official relation to it. And the
general rule would seem to be that he must participate in the wrongful
act, or have such knowledge thereof as to give rise to liability. The
foregoing observations, of course, are made in consideration of the
circumstance that the director denies knowledge and participation, and
hence excludes any theory of authorization or direction. The rule as
announced in 19 C. J. S. 271, is supported in Fletcher — Corp. (vol. 4,
par. 2536, p. 3772, ch. 42, on directors, officers and agents and
participation in tort as essential to liability). Also see 13 Am. Jur. p.
1018, sec. 1086, et seq. This rule has recently been announced in the
case of Kulesza v. Chicago Daily News, Inc., 311 Ill. App. 117, 126,
where it is stated that to render an officer of a corporation liable for the
negligence of the corporation, he must be a participant in the wrongful
act. Further reference in support of the foregoing rule in other
jurisdictions, may be had from the West Reporter System, where
numerous cases will be found. (See Digest System — Corporations —
key number 306.)

Motion of appellees to tax cost of additional abstract to appellant,

granted, and same ordered so taxed.

The judgment of the trial court is affirmed.

Judgment affirmed.
United States Supreme Court
No. 155
Argued: Decided: March 1, 1920
[251 U.S. 524, 525] Messrs. Frank N. Nay and William A. Kneeland, both of Boston, Mass., for receiver.

Messrs. Robert G. Dodge and Robert M. Morse, both of Boston, Mass., for Dresser.

[251 U.S. 524, 526] Messrs. Clarence Alfred Bunker and Albert E. Pillsbury, both of Boston, Mass., for
Bunker and Hardy.

Mr. Albert E. Pillsbury, of Boston, Mass., for Dean and others.

Mr. Justice HOLMES delivered the opinion of the Court.

This is a bill in equity brought by the receiver of a national bank to charge its former president and
directors with the loss of a great part of its assets through the thefts of an employe of the bank while they
were in power. The case was sent to a master who found for the defendants; but the District Court entered
a decree against all of them. 229 Fed. 772. The Circuit Court of Appeals reversed this decree, dismissed
the bill as against all except the administrator of Edwin Dresser, the president, cut down the amount with
which he was charged1 and refused to add interest from the date of the decree of the District Court.
Dresser v. Bates, 250 Fed. 525, 162 C. C. A. 541. Dresser's administrator and the receiver both appeal, the
latter contending that the decree of the District Court should be affirmed with interest and costs.

The bank was a little bank at Cambridge with a capital of $100,000 and average deposits of somewhere
about $300,000. It had a cashier, a bookkeeper, a teller and a messenger. Before and during the time of
the losses Dresser was its president and executive officer, a large stockholder, with an inactive deposit of
from $35,000 to $50,000. From July, 1903, to the end, Frank L. Earl was cashier. Coleman, who made
the trouble, entered the service of the bank as messenger in September, 1903. In January, 1904, he was
promoted to be bookkeeper, being then not quite eighteen but having studied bookkeeping. In the
previous August an auditor employed on the retirement of a cashier had reported that the daily balance
book was very much behind, that it was impossible to [251 U.S. 524, 527] prove the deposits, and that a
competent bookkeeper should be employed upon the work immediately. Coleman kept the deposit ledger
and this was the work that fell into his hands. There was no cage in the bank, and in 1904 and 1905 there
were some small shortages in the accounts of three successive tellers that were not accounted for, and the
last of them, Cutting, was asked by Dresser to resign on that ground. Before doing so he told Dresser that
someone had taken the money and that if he might be allowed to stay he would set a trap and catch the
man, but Dresser did not care to do that and thought that there was nothing wrong. From Cutting's
resignation on October 7, 1905, Coleman acted as paying and receiving teller, in addition to his other duty,
until November, 1907. During this time there were no shortages disclosed in the teller's accounts. In May,
1906, Coleman took $2,000 cash from th vaults of the bank, but restored it the next morning. In
November of the same year he began the thefts that come into question here. Perhaps in the beginning he
took the money directly. But as he ceased to have charge of the cash in November, 1907, he invented
another way. Having a small account at the bank, he would draw checks for the amount he wanted,
exchange checks with a Boston broker, get cash for the broker's check, and, when his own check came to
the bank through the clearing house, would abstract it from the envelope, enter the others on his book and
conceal the difference by a charge to some other account or a false addition in the column of drafts or
deposits in the depositors' ledger. He handed to the cashier only the slip from the clearing house that
showed the totals. The cashier paid whatever appeared to be due and thus Coleman's checks were
honored. So far as Coleman thought it necessary, in view of the absolute trust in him on the part of all
concerned, he took care that his balances should agree with those in the cashier's book. [251 U.S. 524,
528] By May 1, 1907, Coleman had abstracted $17,000, concealing the fact by false additions in the
column of total checks, and false balances in the deposit ledger. Then for the moment a safer concealment
was effected by charging the whole to Dresser's account. Coleman adopted this method when a bank
examiner was expected. Of course when the fraud was disguised by overcharging a depositor it could not
be discovered except by calling in the passbooks, or taking all the deposit slips and comparing them with
the depositors's ledger in detail. By November, 1907, the amount taken by Coleman was $30,100, and the
charge on Dresser's account was $20,000. In 1908 the sum was raised from $33,000 to $49,671. In 1909
Coleman's activity began to increase. In January he took $6,829.26; in March, $10, 833.73; in June, his
previous stealings amounting to $83,390.94, he took $ 5,152.06; in July, $18,050; in August, $6,250; in
September, $17,350; in October, $47,277.08; in November, $51,847; in December, $46,956.44; in
January, 1910, $27,395.53; in February, $6,473.97; making a total of $310, 143.02, when the bank closed
on February 21, 1910. As a result of this the amount of the monthly deposits seemed to decline noticeably
and the directors considered the matter in September, but concluded that the falling off was due in part to
the springing up of rivals, whose deposits were increasing, but was parallel to a similar decrease in New
York. An examination by a bank examiner in December, 1909, disclosed nothing wrong to him.

In this connection it should be mentioned that in the previous semi- annual examinations by national
bank examiners nothing was discovered pointing to malfeasance. The cashier was honest and everybody
believed that they could rely upon him, although in fact he relied too much upon Coleman, who also was
unsuspected by all. If Earl had opened the envelopes from the clearing house, and had seen the checks, or
had examined the deposit [251 U.S. 524, 529] ledger with any care he would have found out what was
going on. The scrutiny of anyone accustomed to such details would have discovered the false additions
and other indicia of fraud that were on the face of the book. But it may be doubted whether anything less
than a continuous pursuit of the figures through pages would have done so except by a lucky chance.

The question of the liability of the directors in this case is the question whether they neglected their duty
by accepting the cashier's statement of liabilities and failing to inspect the depositors' ledger. The
statements of assets always were correct. A bylaw that had been allowed to become obsolete or nearly so is
invoked as establishing their own standard of conduct. By that a committee was to be appointed every six
months 'to examine into the affairs of the bank, to count its cash, and compare its assets and liabilities
with the balances on the general ledger, for the purpose of ascertaining whether or not the books re
correctly kept, and the condition of the bank in a sound and solvent condition.' Of course liabilities as well
as assets must be known to know the condition and, as this case shows, peculations may be concealed as
well by a false understatement of liabilities as by a false show of assets. But the former is not the direction
in which fraud would have been looked for, especially on the part of one who at the time of his principal
abstractions was not in contact with the funds. A debtor hardly expects to have his liability understated.
Some animals must have given at least one exhibition of dangerous propensities before the owner can be
held. This fraud was a novelty in the way of swindling a bank so far as the knowledge of any experience
had reached Cambridge before 1910. We are not prepared to reverse the finding of the master and the
Circuit Court of Appeals that the directors should not be held answerable for taking the cashier's
statement of liabilities to be as correct as the [251 U.S. 524, 530] statement of assets always was. If he had
not been negligent without their knowledge it would have been. Their confidence seemed warranted by
the semiannual examinations by the Government examiner and they were encouraged in their belief that
all was well by the president, whose responsibility, as executive officer; interest, as large stockholder and
depositor; and knowledge, from long daily presence in the bank, were greater than theirs. They were not
bound by virtue of the office gratuitously assumed by them to call in the pass books and compare them
with the ledger, and until the event showed the possibility they hardly could have seen that their failure to
look at the ledger opened a way to fraud. See Briggs v. Spaulding, 141 U.S. 132 , 11 Sup. Ct. 924; Warner v.
Penoyer, 91 Fed. 587, 33 C. C. A. 222, 44 L. R. A. 761. We are not laying down general principles, however,
but confine our decision to the circumstances of the particular case.

The position of the president is different. Practically he was the master of the situation. He was daily at
the bank for hours, he had the deposit ledger in his hands at times and might have had it at any time. He
had had hints and warnings in addition to those that we have mentioned, warnings that should not be
magnified unduly, but still that taken with the auditor's report of 1903, the unexplained shortages, the
suggestion of the teller, Cutting, in 1905, and the final seeming rapid decline in deposits, would have
induced scrutiny but for an invincible repose upon the status quo. In 1908 one Fillmore learned that a
package containing $ 150 left with the bank for safe keeping was not to be found, told Dresser of the loss,
wrote to him that he could not conclude that the package had been destroyed or removed by someone
connected with the bank, and in later conversation said that it was evident that there was a thief in the
bank. He added that he would advise the president to look after Coleman, that he believed he was living at
a pretty fast pace, and that he [251 U.S. 524, 531] had pretty good authority for thinking that he was
supporting a woman. In the same year or the year before, Coleman, whose pay was never more than
twelve dollars a week, set up an automobile, as was known to Dresser and commented on unfavorably, to
him. There was also some evidence of notice to Dresser that Coleman was dealing in copper stocks. In
1909 came the great and inadequately explained seeming shrinkage in the deposits. No doubt plausible
explanations of his conduct came from Coleman and the notice as to speculations may have been slight,
but taking the whole story of the relations of the parties, we are not ready to say that the two courts below
erred in finding that Dresser had been put upon his guard. However little the warnings may have pointed
to the specific facts, had they been accepted they would have led to an examination of the depositors'
ledger, a discovery of past and a prevention of future thefts.

We do not perceive any ground for applyi g to this case the limitations of liability ex contractu adverted to
in Globe Refining Co. v. Landa Cotton Oil Co., 190 U.S. 540 , 23 Sup. Ct. 754. In accepting the presidency
Dresser must be taken to have contemplated responsibility for losses to the bank, whatever they were, if
chargeable to his fault. Those that happened were chargeable to his fault, after he had warnings that
should have led to steps that would have made fraud impossible, even though the precise form that the
fraud would take hardly could have been foreseen. We accept with hesitation the date of December 1,
1908, as the beginning of Dresser's liability, but think it reasonable that interest should be charged against
his estate upon the sum found by the Circuit Court of Appeals to be due. It is a question of discretion, not
of right, Lincoln v. Claflin, 7 Wall. 132; Drumm-Flato Commission Co. v. Edmission, 208 U.S. 534, 539 ,
28 S. Sup. Ct. 367; but to the extent that the decree of the District Court was affirmed, Kneeland v.
American Loan & Trust Co., 138 U.S. 509 , 11 Sup. Ct. 426; De La Rama [251 U.S. 524, 532] v. De La
Rama, 241 U.S. 154, 159 , 36 S. Sup. Ct. 518, Ann. Cas. 1917C, 411, it seems to us just upon all the
circumstances that it should run until the receiver interposed a delay by his appeal to this Court. The
Scotland, 118 U.S. 507, 520 , 6 S. Sup. Ct. 1174. Upon this as upon the other points our decision is
confined to the specific facts.

Decree modified by charging the estate of Dresser with interest from February 1, 1916, to June 1, 1918,
upon the sum found to be due, and affirmed.

Mr. Justice McKENNA and Mr. Justice PITNEY dissent, upon the ground that not only the administrator
of the president of the bank but the other directors ought to be held liable to the extent to which they were
held by the District Court. 229 Fed. 772.

Mr. Justice VAN DEVANTER and Mr. Justice BRANDEIS took no part in the decision.

G.R. No. L-14441 December 17, 1966

PEDRO R. PALTING, petitioner,



This is a petition for review of the order of August 29, 1958, later supplemented and amplified by
another dated September 9, 1958, of the Securities and Exchange Commission denying the
opposition to, and instead, granting the registration, and licensing the sale in the Philippines, of
5,000,000 shares of the capital stock of the respondent-appellee San Jose Petroleum, Inc. (hereafter
referred to as SAN JOSE PETROLEUM), a corporation organized and existing in the Republic of

On September 7, 1956, SAN JOSE PETROLEUM filed with the Philippine Securities and Exchange
Commission a sworn registration statement, for the registration and licensing for sale in the
Philippines Voting Trust Certificates representing 2,000,000 shares of its capital stock of a par value
of $0.35 a share, at P1.00 per share. It was alleged that the entire proceeds of the sale of said
securities will be devoted or used exclusively to finance the operations of San Jose Oil Company,
Inc. (a domestic mining corporation hereafter to be referred to as SAN JOSE OIL) which has 14
petroleum exploration concessions covering an area of a little less than 1,000,000 hectares, located
in the provinces of Pangasinan, Tarlac, Nueva Ecija, La Union, Iloilo, Cotabato, Davao and Agusan.
It was the express condition of the sale that every purchaser of the securities shall not receive a
stock certificate, but a registered or bearer-voting-trust certificate from the voting trustees named
therein James L. Buckley and Austin G.E. Taylor, the first residing in Connecticut, U.S.A., and the
second in New York City. While this application for registration was pending consideration by the
Securities and Exchange Commission, SAN JOSE PETROLEUM filed an amended Statement on
June 20, 1958, for registration of the sale in the Philippines of its shares of capital stock, which was
increased from 2,000,000 to 5,000,000, at a reduced offering price of from P1.00 to P0.70 per share.
At this time the par value of the shares has also been reduced from $.35 to $.01 per share.1
Pedro R. Palting and others, allegedly prospective investors in the shares of SAN JOSE
PETROLEUM, filed with the Securities and Exchange Commission an opposition to registration and
licensing of the securities on the grounds that (1) the tie-up between the issuer, SAN JOSE
PETROLEUM, a Panamanian corporation and SAN JOSE OIL, a domestic corporation, violates the
Constitution of the Philippines, the Corporation Law and the Petroleum Act of 1949; (2) the issuer
has not been licensed to transact business in the Philippines; (3) the sale of the shares of the issuer
is fraudulent, and works or tends to work a fraud upon Philippine purchasers; and (4) the issuer as
an enterprise, as well as its business, is based upon unsound business principles. Answering the
foregoing opposition of Palting, et al., the registrant SAN JOSE PETROLEUM claimed that it was a
"business enterprise" enjoying parity rights under the Ordinance appended to the Constitution, which
parity right, with respect to mineral resources in the Philippines, may be exercised, pursuant to the
Laurel-Langley Agreement, only through the medium of a corporation organized under the laws of
the Philippines. Thus, registrant which is allegedly qualified to exercise rights under the Parity
Amendment, had to do so through the medium of a domestic corporation, which is the SAN JOSE
OIL. It refused the contention that the Corporation Law was being violated, by alleging that Section
13 thereof applies only to foreign corporations doing business in the Philippines, and registrant was
not doing business here. The mere fact that it was a holding company of SAN JOSE OIL and that
registrant undertook the financing of and giving technical assistance to said corporation did not
constitute transaction of business in the Philippines. Registrant also denied that the offering for sale
in the Philippines of its shares of capital stock was fraudulent or would work or tend to work fraud on
the investors. On August 29, 1958, and on September 9, 1958 the Securities and Exchange
Commissioner issued the orders object of the present appeal.

The issues raised by the parties in this appeal are as follows:

1. Whether or not petitioner Pedro R. Palting, as a "prospective investor" in respondent's

securities, has personality to file the present petition for review of the order of the Securities
and Exchange Commission;

2. Whether or not the issue raised herein is already moot and academic;

3. Whether or not the "tie-up" between the respondent SAN JOSE PETROLEUM, a foreign
corporation, and SAN JOSE OIL COMPANY, INC., a domestic mining corporation, is
violative of the Constitution, the Laurel-Langley Agreement, the Petroleum Act of 1949, and
the Corporation Law; and

4. Whether or not the sale of respondent's securities is fraudulent, or would work or tend to
work fraud to purchasers of such securities in the Philippines.

1. In answer to the notice and order of the Securities and Exchange Commissioner, published in 2
newspapers of general circulation in the Philippines, for "any person who is opposed" to the petition
for registration and licensing of respondent's securities, to file his opposition in 7 days, herein
petitioner so filed an opposition. And, the Commissioner, having denied his opposition and instead,
directed the registration of the securities to be offered for sale, oppositor Palting instituted the
present proceeding for review of said order.

Respondent raises the question of the personality of petitioner to bring this appeal, contending that
as a mere "prospective investor", he is not an "Aggrieved" or "interested" person who may properly
maintain the suit. Citing a 1931 ruling of Utah State Supreme Court2 it is claimed that the phrase
"party aggrieved" used in the Securities Act3and the Rules of Court4 as having the right to appeal
should refer only to issuers, dealers and salesmen of securities.
It is true that in the cited case, it was ruled that the phrase "person aggrieved" is that party
"aggrieved by the judgment or decree where it operates on his rights of property or bears directly
upon his interest", that the word "aggrieved" refers to "a substantial grievance, a denial of some
personal property right or the imposition upon a party of a burden or obligation." But a careful
reading of the case would show that the appeal therein was dismissed because the court held that
an order of registration was not final and therefore not appealable. The foregoing pronouncement
relied upon by herein respondent was made in construing the provision regarding an order of
revocation which the court held was the one appealable. And since the law provides that in revoking
the registration of any security, only the issuer and every registered dealer of the security are
notified, excluding any person or group of persons having no such interest in the securities, said
court concluded that the phrase "interested person" refers only to issuers, dealers or salesmen of

We cannot consider the foregoing ruling by the Utah State Court as controlling on the issue in this
case. Our Securities Act in Section 7(c) thereof, requires the publication and notice of the
registration statement. Pursuant thereto, the Securities and Exchange Commissioner caused the
publication of an order in part reading as follows:

. . . Any person who is opposed with this petition must file his written opposition with this
Commission within said period (2 weeks). . . .

In other words, as construed by the administrative office entrusted with the enforcement of the
Securities Act, any person (who may not be "aggrieved" or "interested" within the legal acceptation
of the word) is allowed or permitted to file an opposition to the registration of securities for sale in the
Philippines. And this is in consonance with the generally accepted principle that Blue Sky Laws are
enacted to protect investors and prospective purchasers and to prevent fraud and preclude the sale
of securities which are in fact worthless or worth substantially less than the asking price. It is for this
purpose that herein petitioner duly filed his opposition giving grounds therefor. Respondent SAN
JOSE PETROLEUM was required to reply to the opposition. Subsequently both the petition and the
opposition were set for hearing during which the petitioner was allowed to actively participate and did
so by cross-examining the respondent's witnesses and filing his memorandum in support of his
opposition. He therefore to all intents and purposes became a party to the proceedings. And under
the New Rules of Court,5 such a party can appeal from a final order, ruling or decision of the
Securities and Exchange Commission. This new Rule eliminating the word "aggrieved" appearing in
the old Rule, being procedural in nature,6 and in view of the express provision of Rule 144 that the
new rules made effective on January 1, 1964 shall govern not only cases brought after they took
effect but all further proceedings in cases then pending, except to the extent that in the opinion of the
Court their application would not be feasible or would work injustice, in which event the former
procedure shall apply, we hold that the present appeal is properly within the appellate jurisdiction of
this Court.

The order allowing the registration and sale of respondent's securities is clearly a final order that is
appealable. The mere fact that such authority may be later suspended or revoked, depending on
future developments, does not give it the character of an interlocutory or provisional ruling. And the
fact that seven days after the publication of the order, the securities are deemed registered (Sec. 7,
Com. Act 83, as amended), points to the finality of the order. Rights and obligations necessarily arise
therefrom if not reviewed on appeal.

Our position on this procedural matter — that the order is appealable and the appeal taken here is
proper — is strengthened by the intervention of the Solicitor General, under Section 23 of Rule 3 of
the Rules of Court, as the constitutional issues herein presented affect the validity of Section 13 of
the Corporation Law, which, according to the respondent, conflicts with the Parity Ordinance and the
Laurel-Langley Agreement recognizing, it is claimed, its right to exploit our petroleum resources
notwithstanding said provisions of the Corporation Law.

2. Respondent likewise contends that since the order of Registration/Licensing dated September 9,
1958 took effect 30 days from September 3, 1958, and since no stay order has been issued by the
Supreme Court, respondent's shares became registered and licensed under the law as of October 3,
1958. Consequently, it is asserted, the present appeal has become academic. Frankly we are
unable to follow respondent's argumentation. First it claims that the order of August 29 and that of
September 9, 1958 are not final orders and therefor are not appealable. Then when these orders,
according to its theory became final and were implemented, it argues that the orders can no longer
be appealed as the question of registration and licensing became moot and academic.

But the fact is that because of the authority to sell, the securities are, in all probabilities, still being
traded in the open market. Consequently the issue is much alive as to whether respondent's
securities should continue to be the subject of sale. The purpose of the inquiry on this matter is not
fully served just because the securities had passed out of the hands of the issuer and its dealers.
Obviously, so long as the securities are outstanding and are placed in the channels of trade and
commerce, members of the investing public are entitled to have the question of the worth or legality
of the securities resolved one way or another.

But more fundamental than this consideration, we agree with the late Senator Claro M. Recto, who
appeared as amicus curiae in this case, that while apparently the immediate issue in this appeal is
the right of respondent SAN JOSE PETROLEUM to dispose of and sell its securities to the Filipino
public, the real and ultimate controversy here would actually call for the construction of the
constitutional provisions governing the disposition, utilization, exploitation and development of our
natural resources. And certainly this is neither moot nor academic.

3. We now come to the meat of the controversy — the "tie-up" between SAN JOSE OIL on the one
hand, and the respondent SAN JOSE PETROLEUM and its associates, on the other. The
relationship of these corporations involved or affected in this case is admitted and established
through the papers and documents which are parts of the records: SAN JOSE OIL, is a domestic
mining corporation, 90% of the outstanding capital stock of which is owned by respondent SAN
JOSE PETROLEUM, a foreign (Panamanian) corporation, the majority interest of which is owned by
OIL INVESTMENTS, Inc., another foreign (Panamanian) company. This latter corporation in turn is
COMPANY, C.A., both organized and existing under the laws of Venezuela. As of September 30,
1956, there were 9,976 stockholders of PANCOASTAL PETROLEUM found in 49 American states
and U.S. territories, holding 3,476,988 shares of stock; whereas, as of November 30, 1956,
PANTEPEC OIL COMPANY was said to have 3,077,916 shares held by 12,373 stockholders
scattered in 49 American state. In the two lists of stockholders, there is no indication of the
citizenship of these stockholders,7 or of the total number of authorized stocks of each corporation, for
the purpose of determining the corresponding percentage of these listed stockholders in relation to
the respective capital stock of said corporation.

Petitioner, as well as the amicus curiae and the Solicitor General8 contend that the relationship
between herein respondent SAN JOSE PETROLEUM and its subsidiary, SAN JOSE OIL, violates
the Petroleum Law of 1949, the Philippine Constitution, and Section 13 of the Corporation Law,
which inhibits a mining corporation from acquiring an interest in another mining corporation. It is
respondent's theory, on the other hand, that far from violating the Constitution; such relationship
between the two corporations is in accordance with the Laurel-Langley Agreement which
implemented the Ordinance Appended to the Constitution, and that Section 13 of the Corporation
Law is not applicable because respondent is not licensed to do business, as it is not doing business,
in the Philippines.

Article XIII, Section 1 of the Philippine Constitution provides:

SEC. 1. All agricultural, timber, and mineral lands of the public domain, waters, minerals,
coal, petroleum, and other mineral oils, all forces of potential energy, and other natural
resources of the Philippines belong to the State, and their disposition, exploitation,
development, or utilization shall be limited to citizens of the Philippines, or to corporations or
associations at least sixty per centum of the capital of which is owned by such citizens,
subject to any existing right, grant, lease or concession at the time of the inauguration of this
Government established under this Constitution. . . . (Emphasis supplied)

In the 1946 Ordinance Appended to the Constitution, this right (to utilize and exploit our natural
resources) was extended to citizens of the United States, thus:

Notwithstanding the provisions of section one, Article Thirteen, and section eight, Article
Fourteen, of the foregoing Constitution, during the effectivity of the Executive Agreement
entered into by the President of the Philippines with the President of the United States on the
fourth of July, nineteen hundred and forty-six, pursuant to the provisions of Commonwealth
Act Numbered Seven hundred and thirty-three, but in no case to extend beyond the third of
July, nineteen hundred and seventy-four, the disposition, exploitation, development, and
utilization of all agricultural, timber, and mineral lands of the public domain, waters, minerals,
coal, petroleum, and other mineral oils, all forces of potential energy, and other natural
resources of the Philippines, and the operation of public utilities shall, if open to any person,
be open to citizens of the United States, and to all forms of business enterprises owned or
controlled, directly or indirectly, by citizens of the United States in the same manner as to,
and under the same conditions imposed upon, citizens of the Philippines or corporations or
associations owned or controlled by citizens of the Philippines (Emphasis supplied.)

In the 1954 Revised Trade Agreement concluded between the United States and the Philippines,
also known as the Laurel-Langley Agreement, embodied in Republic Act 1355, the following
provisions appear:


1. The disposition, exploitation, development and utilization of all agricultural, timber, and
mineral lands of the public domain, waters, minerals, coal, petroleum and other mineral oils,
all forces and sources of potential energy, and other natural resources of either Party, and
the operation of public utilities, shall, if open to any person, be open to citizens of the other
Party and to all forms of business enterprise owned or controlled, directly or indirectly, by
citizens of such other Party in the same manner as to and under the same conditions
imposed upon citizens or corporations or associations owned or controlled by citizens of the
Party granting the right.

2. The rights provided for in Paragraph 1 may be exercised, . . . in the case of citizens of the
United States, with respect to natural resources in the public domain in the Philippines, only
through the medium of a corporation organized under the laws of the Philippines and at least
60% of the capital stock of which is owned or controlled by citizens of the United States. . . .

3. The United States of America reserves the rights of the several States of the United States
to limit the extent to which citizens or corporations or associations owned or controlled by
citizens of the Philippines may engage in the activities specified in this Article. The Republic
of the Philippines reserves the power to deny any of the rights specified in this Article to
citizens of the United States who are citizens of States, or to corporations or associations at
least 60% of whose capital stock or capital is owned or controlled by citizens of States, which
deny like rights to citizens of the Philippines, or to corporations or associations which are
owned or controlled by citizens of the Philippines. . . . (Emphasis supplied.)

Re-stated, the privilege to utilize, exploit, and develop the natural resources of this country was
granted, by Article XIII of the Constitution, to Filipino citizens or to corporations or associations 60%
of the capital of which is owned by such citizens. With the Parity Amendment to the Constitution, the
same right was extended to citizens of the United States and business enterprises owned or
controlled directly or indirectly, by citizens of the United States.

There could be no serious doubt as to the meaning of the word "citizens" used in the aforementioned
provisions of the Constitution. The right was granted to 2 types of persons: natural persons (Filipino
or American citizens) and juridical persons (corporations 60% of which capital is owned by Filipinos
and business enterprises owned or controlled directly or indirectly, by citizens of the United States).
In American law, "citizen" has been defined as "one who, under the constitution and laws of the
United States, has a right to vote for representatives in congress and other public officers, and who
is qualified to fill offices in the gift of the people. (1 Bouvier's Law Dictionary, p. 490.) A citizen is —

One of the sovereign people. A constituent member of the sovereignty, synonymous with the
people." (Scott v. Sandford, 19 Ho. [U.S.] 404, 15 L. Ed. 691.)

A member of the civil state entitled to all its privileges. (Cooley, Const. Lim. 77. See U.S. v.
Cruikshank 92 U.S. 542, 23 L. Ed. 588; Minor v. Happersett 21 Wall. [U.S.] 162, 22 L. Ed.

These concepts clarified, is herein respondent SAN JOSE PETROLEUM an American business
enterprise entitled to parity rights in the Philippines? The answer must be in the negative, for the
following reasons:

Firstly — It is not owned or controlled directly by citizens of the United States, because it is owned
and controlled by a corporation, the OIL INVESTMENTS, another foreign (Panamanian) corporation.

Secondly — Neither can it be said that it is indirectly owned and controlled by American citizens
through the OIL INVESTMENTS, for this latter corporation is in turn owned and controlled, not by
citizens of the United States, but still by two foreign (Venezuelan) corporations, the PANTEPEC OIL

Thirdly — Although it is claimed that these two last corporations are owned and controlled
respectively by 12,373 and 9,979 stockholders residing in the different American states, there is no
showing in the certification furnished by respondent that the stockholders of PANCOASTAL or those
of them holding the controlling stock, are citizens of the United States.

Fourthly — Granting that these individual stockholders are American citizens, it is yet necessary to
establish that the different states of which they are citizens, allow Filipino citizens or corporations or
associations owned or controlled by Filipino citizens, to engage in the exploitation, etc. of the natural
resources of these states (see paragraph 3, Article VI of the Laurel-Langley Agreement, supra).
Respondent has presented no proof to this effect.
Fifthly — But even if the requirements mentioned in the two immediately preceding paragraphs are
satisfied, nevertheless to hold that the set-up disclosed in this case, with a long chain of intervening
foreign corporations, comes within the purview of the Parity Amendment regarding business
enterprises indirectly owned or controlled by citizens of the United States, is to unduly stretch and
strain the language and intent of the law. For, to what extent must the word "indirectly" be carried?
Must we trace the ownership or control of these various corporations ad infinitum for the purpose of
determining whether the American ownership-control-requirement is satisfied? Add to this the
admitted fact that the shares of stock of the PANTEPEC and PANCOASTAL which are allegedly
owned or controlled directly by citizens of the United States, are traded in the stock exchange in
New York, and you have a situation where it becomes a practical impossibility to determine at any
given time, the citizenship of the controlling stock required by the law. In the circumstances, we have
to hold that the respondent SAN JOSE PETROLEUM, as presently constituted, is not a business
enterprise that is authorized to exercise the parity privileges under the Parity Ordinance, the Laurel-
Langley Agreement and the Petroleum Law. Its tie-up with SAN JOSE OIL is, consequently, illegal.

What, then, would be the Status of SAN JOSE OIL, about 90% of whose stock is owned by SAN
JOSE PETROLEUM? This is a query which we need not resolve in this case as SAN JOSE OIL is
not a party and it is not necessary to do so to dispose of the present controversy. But it is a matter
that probably the Solicitor General would want to look into.

There is another issue which has been discussed extensively by the parties. This is whether or not
an American mining corporation may lawfully "be in anywise interested in any other corporation
(domestic or foreign) organized for the purpose of engaging in agriculture or in mining," in the
Philippines or whether an American citizen owning stock in more than one corporation organized for
the purpose of engaging in agriculture or in mining, may own more than 15% of the capital stock
then outstanding and entitled to vote, of each of such corporations, in view of the express prohibition
contained in Section 13 of the Philippine Corporation Law. The petitioner in this case contends that
the provisions of the Corporation Law must be applied to American citizens and business enterprise
otherwise entitled to exercise the parity privileges, because both the Laurel-Langley Agreement (Art.
VI, par. 1) and the Petroleum Act of 1948 (Art. 31), specifically provide that the enjoyment by them of
the same rights and obligations granted under the provisions of both laws shall be "in the same
manner as to, and under the same conditions imposed upon, citizens of the Philippines or
corporations or associations owned or controlled by citizens of the Philippines." The petitioner further
contends that, as the enjoyment of the privilege of exploiting mineral resources in the Philippines by
Filipino citizens or corporations owned or controlled by citizens of the Philippines (which corporation
must necessarily be organized under the Corporation Law), is made subject to the limitations
provided in Section 13 of the Corporation Law, so necessarily the exercise of the parity rights by
citizens of the United States or business enterprise owned or controlled, directly or indirectly, by
citizens of the United States, must equally be subject to the same limitations contained in the
aforesaid Section 13 of the Corporation Law.

In view of the conclusions we have already arrived at, we deem it not indispensable for us to pass
upon this legal question, especially taking into account the statement of the respondent (SAN JOSE
PETROLEUM) that it is essentially a holding company, and as found by the Securities and
Exchange Commissioner, its principal activity is limited to the financing and giving technical
assistance to SAN JOSE OIL.

4. Respondent SAN JOSE PETROLEUM, whose shares of stock were allowed registration for sale
in the Philippines, was incorporated under the laws of Panama in April, 1956 with an authorized
capital stock of $500,000.00, American currency, divided into 50,000,000 shares at par value of
$0.01 per share. By virtue of a 3-party Agreement of June 14, 1956, respondent was supposed to
have received from OIL INVESTMENTS 8,000,000 shares of the capital stock of SAN JOSE OIL (at
par value of $0.01 per share), plus a note for $250,000.00 due in 6 months, for which respondent
issued in favor of OIL INVESTMENTS 16,000,000 shares of its capital stock, at $0.01 per share or
with a value of $160,000.00, plus a note for $230,297.97 maturing in 2 years at 6% per annum
interest,9 and the assumption of payment of the unpaid price of 7,500,000 (of the 8,000,000 shares

On June 27, 1956, the capitalization of SAN JOSE PETROLEUM was increased from $500,000.00
to $17,500,000.00 by increasing the par value of the same 50,000,000 shares, from $0.01 to $0.35.
Without any additional consideration, the 16,000,000 shares of $0.01 previously issued to OIL
INVESTMENTS with a total value of $160,000.00 were changed with 16,000,000 shares of the
recapitalized stock at $0.35 per share, or valued at $5,600,000.00. And, to make it appear that cash
was received for these re-issued 16,000,000 shares, the board of directors of respondent
corporation placed a valuation of $5,900,000.00 on the 8,000,000 shares of SAN JOSE OIL (still
having par value of $0.10 per share) which were received from OIL INVESTMENTS as part-
consideration for the 16,000,000 shares at $0.01 per share.

In the Balance Sheet of respondent, dated July 12, 1956, from the $5,900,000.00, supposedly the
value of the 8,000,000 shares of SAN JOSE OIL, the sum of $5,100,000.00 was deducted,
corresponding to the alleged difference between the "value" of the said shares and the subscription
price thereof which is $800,000.00 (at $0.10 per share). From this $800,000.00, the subscription
price of the SAN JOSE OIL shares, the amount of $319,702.03 was deducted, as allegedly unpaid
subscription price, thereby giving a difference of $480,297.97, which was placed as the amount
allegedly paid in on the subscription price of the 8,000,000 SAN JOSE OIL shares. Then, by adding
thereto the note receivable from OIL INVESTMENTS, for $250,000.00 (part-consideration for the
16,000,000 SAN JOSE PETROLEUM shares), and the sum of $6,516.21, as deferred expenses,
SAN JOSE PETROLEUM appeared to have assets in the sum of $736,814.18.

These figures are highly questionable. Take the item $5,900,000.00 the valuation placed on the
8,000,000 shares of SAN JOSE OIL. There appears no basis for such valuation other than belief by
the board of directors of respondent that "should San Jose Oil Company be granted the bulk of the
concessions applied for upon reasonable terms, that it would have a reasonable value of
approximately $10,000,000." 10 Then, of this amount, the subscription price of $800,000.00 was
deducted and called it "difference between the (above) valuation and the subscription price for the
8,000,000 shares." Of this $800,000.00 subscription price, they deducted the sum of $480,297.97
and the difference was placed as the unpaid portion of the subscription price. In other words, it was
made to appear that they paid in $480,297.97 for the 8,000,000 shares of SAN JOSE OIL. This
amount ($480,297.97) was supposedly that $250,000.00 paid by OIL INVESMENTS for 7,500,000
shares of SAN JOSE OIL, embodied in the June 14 Agreement, and a sum of $230,297.97 the
amount expended or advanced by OIL INVESTMENTS to SAN JOSE OIL. And yet, there is still an
item among respondent's liabilities, for $230,297.97 appearing as note payable to Oil Investments,
maturing in two (2) years at six percent (6%) per annum. 11 As far as it appears from the records, for
the 16,000,000 shares at $0.35 per share issued to OIL INVESTMENTS, respondent SAN JOSE
PETROLEUM received from OIL INVESTMENTS only the note for $250,000.00 plus the 8,000,000
shares of SAN JOSE OIL, with par value of $0.10 per share or a total of $1,050,000.00 — the only
assets of the corporation. In other words, respondent actually lost $4,550,000.00, which was
received by OIL INVESTMENTS.

But this is not all. Some of the provisions of the Articles of Incorporation of respondent SAN JOSE
PETROLEUM are noteworthy; viz:

(1) the directors of the Company need not be shareholders;

(2) that in the meetings of the board of directors, any director may be represented and may
vote through a proxy who also need not be a director or stockholder; and

(3) that no contract or transaction between the corporation and any other association or
partnership will be affected, except in case of fraud, by the fact that any of the directors or
officers of the corporation is interested in, or is a director or officer of, such other association
or partnership, and that no such contract or transaction of the corporation with any other
person or persons, firm, association or partnership shall be affected by the fact that any
director or officer of the corporation is a party to or has an interest in, such contract or
transaction, or has in anyway connected with such other person or persons, firm, association
or partnership; and finally, that all and any of the persons who may become director or officer
of the corporation shall be relieved from all responsibility for which they may otherwise be
liable by reason of any contract entered into with the corporation, whether it be for his benefit
or for the benefit of any other person, firm, association or partnership in which he may be

These provisions are in direct opposition to our corporation law and corporate practices in this
country. These provisions alone would outlaw any corporation locally organized or doing business in
this jurisdiction. Consider the unique and unusual provision that no contract or transaction between
the company and any other association or corporation shall be affected except in case of fraud, by
the fact that any of the directors or officers of the company may be interested in or are directors or
officers of such other association or corporation; and that none of such contracts or transactions of
this company with any person or persons, firms, associations or corporations shall be affected by the
fact that any director or officer of this company is a party to or has an interest in such contract or
transaction or has any connection with such person or persons, firms associations or corporations;
and that any and all persons who may become directors or officers of this company are hereby
relieved of all responsibility which they would otherwise incur by reason of any contract entered into
which this company either for their own benefit, or for the benefit of any person, firm, association or
corporation in which they may be interested.

The impact of these provisions upon the traditional judiciary relationship between the directors and
the stockholders of a corporation is too obvious to escape notice by those who are called upon to
protect the interest of investors. The directors and officers of the company can do anything, short of
actual fraud, with the affairs of the corporation even to benefit themselves directly or other persons
or entities in which they are interested, and with immunity because of the advance condonation or
relief from responsibility by reason of such acts. This and the other provision which authorizes the
election of non-stockholders as directors, completely disassociate the stockholders from the
government and management of the business in which they have invested.

To cap it all on April 17, 1957, admittedly to assure continuity of the management and stability of
SAN JOSE PETROLEUM, OIL INVESTMENTS, as holder of the only subscribed stock of the former
corporation and acting "on behalf of all future holders of voting trust certificates," entered into a
voting trust agreement12 with James L. Buckley and Austin E. Taylor, whereby said Trustees were
given authority to vote the shares represented by the outstanding trust certificates (including those
that may henceforth be issued) in the following manner:

(a) At all elections of directors, the Trustees will designate a suitable proxy or proxies to vote
for the election of directors designated by the Trustees in their own discretion, having in mind
the best interests of the holders of the voting trust certificates, it being understood that any
and all of the Trustees shall be eligible for election as directors;
(b) On any proposition for removal of a director, the Trustees shall designate a suitable proxy
or proxies to vote for or against such proposition as the Trustees in their own discretion may
determine, having in mind the best interest of the holders of the voting trust certificates;

(c) With respect to all other matters arising at any meeting of stockholders, the Trustees will
instruct such proxy or proxies attending such meetings to vote the shares of stock held by
the Trustees in accordance with the written instructions of each holder of voting trust
certificates. (Emphasis supplied.)

It was also therein provided that the said Agreement shall be binding upon the parties thereto, their
successors, and upon all holders of voting trust certificates.

And these are the voting trust certificates that are offered to investors as authorized by Security and
Exchange Commissioner. It can not be doubted that the sale of respondent's securities would, to say
the least, work or tend to work fraud to Philippine investors.

FOR ALL THE FOREGOING CONSIDERATIONS, the motion of respondent to dismiss this appeal,
is denied and the orders of the Securities and Exchange Commissioner, allowing the registration of
Respondent's securities and licensing their sale in the Philippines are hereby set aside. The case is
remanded to the Securities and Exchange Commission for appropriate action in consonance with
this decision. With costs. Let a copy of this decision be furnished the Solicitor General for whatever
action he may deem advisable to take in the premises. So ordered.

Concepcion, C.J., Reyes, J.B.L., Dizon, Regala, Makalintal, Bengzon, J.P., Zaldivar and Sanchez,
JJ., concur.

Castro, J., took no part.

G.R. No. 6217 December 26, 1911

CHARLES W. MEAD, plaintiff-appellant,


Haussermann, Cohn & Fisher and A. D. Gibbs for plaintiff.

James J. Peterson and O'Brien & DeWitt for defendant McCullough.


This action was originally brought by Charles W. Mead against Edwin C. McCullough, Thomas L.
Hartigan, Frank E. Green, and Frederick H. Hilbert. Mead has died since the commencement of the
action and the case is now going forward in the name of his administrator as plaintiff.

The complaint contains three causes of action, which are substantially as follows: The first, for
salary; the second, for profits; and the third, for the value of the personal effects alleged to have
been left Mead and sold by the defendants.
A joint and several judgment was rendered by default against each and all of the defendants for the
sum of $3,450.61 gold. The defendant McCullough alone having made application to have this
judgment set aside, the court granted this motion, vacating the judgment as to him only, the
judgment as to the other three defendants remaining undisturbed. 1aw phi 1.net

At the new trial, which took place some two or three years later and after the death of Mead, the
judgment was rendered upon merits, dismissing the case as to the first and second causes of action
and for the sum of $1,200 gold in the plaintiff's favor on the third cause of action. From this judgment
both parties appealed and have presented separate bills of exceptions. No appeal was taken by the
defendant McCullough from the ruling of the court denying a recovery on his cross complaint.

On March 15, 1902, the plaintiff (Mead will be referred to as the plaintiff in this opinion unless it is
otherwise stated) and the defendant organized the "Philippine Engineering and Construction
Company," the incorporators being the only stockholders and also the directors of said company,
with general ordinary powers. Each of the stockholders paid into the company $2,000 mexican
currency in cash, with the exception of Mead, who turned over to the company personal property in
lieu of cash.

Shortly after the organization, the directors held a meeting and elected the plaintiff as general
manager. The plaintiff held this position with the company for nine months, when he resigned to
accept the position of engineer of the Canton and Shanghai Railway Company. Under the
organization the company began business about April 1, 102. itc-alf

The contract and work undertaken by the company during the management of Mead were the
wrecking contract with the Navy Department at Cavite for the raising of the Spanish ships sunk by
Admiral Dewey; the contract for the construction of certain warehouses for the quartermaster
department; the construction of a wharf at Fort McKinley for the Government; The supervision of the
construction of the Pacific Oriental Trading Company's warehouse; and some other odd jobs not
specifically set out in the record.

Shortly after the plaintiff left the Philippine Islands for China, the other directors, the defendants in
this case, held a meeting on December 24, 1903, for the purpose of discussing the condition of the
company at that time and determining what course to pursue. They did on that date enter into the
following contract with the defendant McCullough, to wit: 1awphil.net

For value received, this contract and all the rights and interests of the Philippine Engineering
and construction Company in the same are hereby assigned to E. C. McCullough of Manila,
P. I.

(Sgd.) E. C. McCULLOUGH,
President, Philippine Engineering and
Construction Company.

(Sgd.) F. E. GREEN, Treasurer.

(Sgd.) THOMAS L. HARTIGAN, Secretary.

The contract reffered to in the foregoing document was known as the wrecking contract with the
naval authorities.

On the 28th of the same month, McCullough executed and signed the following instrumental:
For value received, and having the above assignment from my associates in the Philippine
Engineering and Construction Company, I hereby transfer my right, title, and interest in the
within contract, with the exception of one sixth, which I hereby retain, to R. W. Brown, H. D.
C. Jones, John T. Macleod, and T. H. Twentyman.

The assignees of the wrecking contract, including McCullough, formed was not known as the "Manila
Salvage Association." This association paid to McCullough $15,000 Mexican Currency cash for the
assignment of said contract. In addition to this payment, McCullough retained a one-sixth interest in
the new company or association.

The plaintiff insists that he was received as general manager of the first company a salary which was
not to be less than $3,500 gold (which amount he was receiving as city engineer at the time of the
corporation of the company), plus 20 per cent of the net profits which might be derived from the
business; while McCullough contends that the plaintiff was to receive only his necessary expenses
unless the company made a profit, when he could receive $3,500 per year and 20 per cent of the
profits. The contract entered into between the board of directors and the plaintiffs as to the latter's
salary was a verbal one. The plaintiff testified that this contract was unconditional and that his salary,
which was fixed at $3,500 gold, was not dependent upon the success of the company, but that his
share of the profits was to necessarily depend upon the net income. On the other hand, McCullough,
Green and Hilbert testify that the salary of the plaintiff was to be determined according to whether or
not the company was successful in its operations; that if the company made gains, he was to receive
$3,5000 gold, and a percentage, but that if the company did not make any profits, he was to receive
only his necessary living expenses.

It is strongly urged that the plaintiff would not have accepted the management of the company upon
such conditions, as he was receiving from the city of Manila a salary of $3,500 gold. This argument
is not only answered by the positive and direct testimony of three of the defendants, but also by the
circumstances under which this company was organized and principal object, which was the raising
of the Spanish ships. The plaintiff put no money into the organization, the defendants put but little:
just sufficient to get the work of raising the wrecks under way. This venture was a risky one. All the
members of the company realized that they were undertaking a most difficult and expensive project.
If they were successful, handsome profits would be realized; while if they were unsuccessful, all the
expenses for the hiring of machinery, launches, and labor would be a total loss. The plaintiff was in
complete charge and control of this work and was to receive, according to the great preponderance
of the evidence, in case the company made no profits, sufficient amount to cover his expenses,
which included his room, board, transportation, etc. The defendants were to furnish money out of
their own private funds to meet these expenses, as the original $8,000 Mexican currency was soon
exhausted in the work thus undertaken. So the contract entered into between the directors and the
plaintiff as to the latter's salary was a contingent one.

It is admitted that the plaintiff received $1.500 gold for his services, and whether he is entitled to
receive an additional amount depends upon the result of the second cause of action.

The second cause of action is more difficult to determine. On this point counsel for the plaintiff has
filed a very able and exhaustive brief, dealing principally with the facts.

It is urged that the net profits accruing to the company after the completion of all the contracts
(except the salvage contract) made before the plaintiff resigned as manager and up to the time the
salvage contract was transferred to McCullough and from him to the new company, amounted to
$5,628.37 gold. This conclusion is reached, according to the memorandum of counsel for the plaintiff
which appears on pages 38 and 39 of the record, in the following manner:
Profits from the construction of warehouses for the $6,962.54

Profits from the construction of the wall at Fort 500.00

Profits from the inspection of the construction of 1,000.00
the P. O. T. warehouse
Profits obtained from the projects (according to 1,000.00
Mead's calculations)

Total 9,462.54

In this same memorandum, the expense for the operation of the company during Mead's
management, consisting of rents, the hire of one muchacho, the publication of various notices, the
salary of an engineer for four months, and plaintiff's salary for nine months, amounts to $3,834.17
gold. This amount, deducted from the sum total of profits, leaves $5,628.37 gold.

Counsel for the plaintiff, in order to show conclusively as they assert that the company, after paying
all expenses and indebtedness, had a considerable balance to its credit, calls attention to Exhibit K.
This balance reads as follows:

Abstract copy of ledger No. 3, folios 276-277. Philippine Engineering and Construction

Then follow the debits and credits, with a balance in favor of the company of $10,728.44 Mexican
currency. This account purports to cover the period from July 1, 1902, to April 1, 1903. Ledger No. 3,
above mentioned, is that the defendant McCullough and not one of the books of the company.

It was this exhibit that the lower court based its conclusion when it found that on January 25, 1903,
after making the transfer of the salvage contract to McCullough, the company was in debt $2,278.30
gold. The balance of $10,728.44 Mexican currency deducted from the $16,439.40 Mexican currency
(McCullough's losses in the Manila Salvage Association) leaves $2,278.30 United States currency at
the then existing rate of exchange. In Exhibit K, McCullough charged himself with the $15,000
Mexican currency which he received from his associates in the new company, but did not credit
himself with the $16,439.40 Mexican currency, losses in said company, for the reason that on April
1, 1903, said losses had not occurred. It must be borne in mind that Exhibit K is an abstract from a

The defendant McCullough, in order to show in detail his transactions with the old company,
presented Exhibits 1 and 2. These accounts read as follows:

Detailed account of the receipts and disbursements of E. C. McCullough and the Philippine
Engineering and Construction Company.

Then follow the debits ad credits. These two accounts cover the period from March 5 1902, to June
9, 1905. According to Exhibit No. 1, the old company was indebted to McCullough in the sum of
$14,918.75 Mexican currency, and according to Exhibit No. 2 he indebtedness amounted to
$6,358.15 Mexican currency. The debits and credits in these two exhibits are exactly the me with the
following exceptions; I Exhibit No. 1, McCullough credits himself with the $10,000 Mexican currency
(the amount borrowed from the bank and deposited with the admiral as a guarantee for the faithful
performance of the salvage contract); while in Exhibit No. 2 he credits himself with this $10,000 and
at he same time charges himself with this amount. In the same exhibit (No. 2) he credits himself with
$16,439.40 Mexican currency, his losses in the new company, received from said company.
Eliminating entirely from these two exhibits the $10,000 Mexican currency, the $15,000 Mexican
currency, and the $16,39.40 Mexican currency, the balance shown in McCullough's favor is exactly
the same in both exhibits. This balance amounts to $4,918.75 Mexian currency.

According to McCullough's accounts in Exhibits 1 and 2 the profits derived from the construction of
the Government warehouse amounted to $4,005.02 gold, while the plaintiff contends that these
profits amounted to $6,962.54 gold. The plaintiff, during his management of the old company, made
a contract with the Government for the construction of these are house and commenced work. After
he resigned and left for China, McCullough took charge of and completed the said warehouse.
McCullough gives a complete, detailed statements of express for the completion of this work,
showing the dates, to whom paid, and for what purpose. He also gives the various amounts he
received from the Government with the amounts of the receipt of the same. On the first examination,
McCullough testified that the total amount received from the Government for the construction of
these warehouse was $1,123 gold. The case was suspended for the purpose of examination the
records of the Auditor and the quater master, to determine the exact amount paid for this work. As a
result of this examination, the vouchers show an additional amount of about $5,000 gold, paid in
checks. These checks show that the same were endorsed by the plaintiff and collected by him from
the Hongkong and Shanghai Banking Corporation. This money was not handled by McCullough and
as it was collected by the plaintiff, it must be presumed, in the absence of proof, that it was
disbursed by him. McCullough did not charge himself with the $2,5000 gold, alleged to have been
profits from the construction of the wall at Fort McKinley, the inspection of the construction of the P.
O. T. warehouse, and other projects. This work was done under the management of the plaintiff and
it is not shown that the profits from these contracts ever reached the ands of McCullough.
McCullough was not the treasurer of the company at that time. The other items which the plaintiff
insist that McCullough had no right to credit himself with are the following:

Date To whom paid. Amount (Mex. currency).

Jan. 30, 1903 Green $2,000.00

Feb. 2, 1903 McCullough 1,300.00
Feb. 2, 1903 Green 1,027.92
Feb. 19, 1905 P. O. T. Co. note 2,236.80
May 23, 1905 Hilbert 1,856.02

June 9, 1905 Hartigan 1,225.00

McCullough says that these amounts represents cash borrowed from the evidence parties to carry
on the operations of the old company while it was trying to raise the sunken vessels. There is no
proof to the contrary, and McCullough's testimony on this point is strongly corroborated by the fact
that the work done by the company in attempting to raise theses vessels was it first undertaking. The
company had made no profits while tat work was going on under the management of the plaintiff, but
its expenses greatly exceeded that of the original $8,000 Mexican currency. It was necessary to
borrow money to continue that work. These amounts, having been borrowed, were outstanding
debts when McCullough took charge for the purpose of completing the warehouses and winding up
the business of the old company. These amounts do not represent payments or refunds of the
original capital. McCullough did not credit himself with any amount for his services for supervising
the completion of the warehouses, nor for liquidating or winding up the company's affairs. We think
that the amount of $4,918.75 Mexican currency, balance in McCullough's favor up to this point,
represents a fair, equitable, and just settlement.

So far we have referred to the Philippine Engineering and Construction Company as the "company,"
without any attempt to define its legal status.

The plaintiff and defendants organized this company with a capital stock of $100,000 Mexican
currency, each paying in on the organization $2,000 Mexican currency. The remainder, $9,000,
according to the articles of agreement, were to be offered to the public in shares of $100 Mexican
currency, each. The names of all the organizers appear in the articles of agreement, which articles
were duly inscribed in the commercial register. The purpose for which this organization was affected
were to engage in general engineering and construction work, and operating under the name of the
"Philippine Engineering and Construction Company." during its active existence, it engaged in the
business of attempting to rise the sunken Spanish fleet, constructing under contract warehouses and
a wharf for the United States Government, supervising the construction of a warehouse for a private
firm, and some assay work. It was, therefore, an industrial civil partnership, as distinguished from a
commercial one; a civil partnership in the mercantile form, an anonymous partnership legally
constituted in the city of Manila.

The articles of agreement appeared in a public document and were duly inscribed in the commercial
register. To the extent of this inscription the corporation partook of the form of a mercantile one and
as such must e governed by articles 151 to 174 of the Code of Commerce, in so far as these
provisions are not in conflict with the Civil Code (art. 1670, Civil Code); but the direct and principal
law applicable is the Civil Code. Those provisions of the Code of Commerce are applicable

This partnership or stock company (sociedad anonima) upon the execution of the public instrument
in which is articles of agreement appear, and the contribution of funds and personal property,
became a juridicial person — an artificial being, invisible, intangible and existing only in
contemplation of law — with the power to hold, buy, and ell property, and to use and be sued — a
corporation — not a general copartnership nor a limited copartnership. (Arts. 37, 38,1656 of the Civil
Code; Compania Agricola de Ultimar vs. Reyes et al., 4 Phil. Rep., 2; and Chief Justice Marshall's
definition of a corporation, 17 U. S., 518.)

The inscribing of its articles of agreement in the commercial register was not necessary to make it a
juridicial person — a corporation. Such inscription only operated to show that it partook of the form of
a commercial corporation. (Compania Agricola de Ultimar vs. Reyes et al., supra.)

Did a majority of the stockholders, who were at the same time a majority of the directors of this
corporation, have the power under the law and its articles of agreement, to sell or transfer to one of
its members the assets of said corporation?

In the first article of the statutes of incorporation it is stated tat by virtue of a public document the
organizers, whose names are given in full, agreed to form a sociedad anonima. Article II provides
that the organizers should be the directors an administrators until the second general meeting, and
until their successors were duly elected and installed. The third provides that the sociedad should
run for ninety-nine years from the date of the execution of its articles of agreement. Article IV sets
forth the object or purpose of the organization. Article V makes the capital $100,000 Mexican
currency, divided into one thousand shares at $100 Mexican currency each. Article VI provides that
each shareholder should be considered as a coowner in the assets of the company and entitled to
participate in the profits in proportion to the amount of his stock. Article VII fixed the time of holding
general meetings and the manner of calling special meetings of the stockholders. Article VIII
provides that the board of directors shall be elected annually. Article IX provides for the filing of
vacancies in the board of directors. Article X provides that "the board of directors shall elect the
officers of the sociedad and have under is charge the administration of the said sociedad." Article XI:
"In all the questions with reference to the administration of the affairs of the sociedad, it shall be
necessary to secure the unanimous vote of the board of directors, and at least three of said board
must be provides that all of the stock, except that which was divided among the organizers should
remain in the treasury subject to the disposition of the board of directors. Article XIII reads: "In all the
meetings of the stockholders, a majority vote of the stockholders present shall be necessary to
determine any question discussed." The fourteenth articles authorizes the board of directors to adopt
such rules and regulations for the government of the sociedad as it should deem proper, which were
not in conflict with its statutes.

When the sale or transfer heretofore mentioned took place, there were present four directors, all of
whom gave their consent to that sale or transfer. The plaintiff was then about and his express
consent to make this transfer or sale was not obtained. He was, before leaving, one of the directors
in this corporation, and although he had resigned as manager, he had not resigned as a director. He
accepted the position of engineer of the Canton and Shanghai Railway Company, knowing that his
duties as such engineer would require his whole time and attention and prevent his returning to the
Philippine Islands for at least a year or more. The new position which he accepted in China was
incompatible with his position as director in the Philippine Engineering and Construction Company, a
corporation whose sphere of operations was limited to the Philippine Islands. These facts are
sufficient to constitute an abandoning or vacating of hid position as director in said corporation. (10
Cyc., 741.) Consequently, the transfer or sale of the corporation's assets to one of its members was
made by the unanimous consent of all the directors in the corporation at that time.

There were only five stockholders in this corporation at any time, four of whom were the directors
who made the sale, and the other the plaintiff, who was absent in China when the said sale took
place. The sale was, therefore, made by the unanimous consent of four-fifths of all the stockholders.
Under the articles of incorporation, the stockholders and directors had general ordinary powers.
There is nothing in said articles which expressly prohibits the sale or transfer of the corporate
property to one of the stockholders of said corporation.

Is there anything in the law which prohibits such a sale or transfer? To determine this question, it is
necessary to examine, first, the provisions of the Civil Code, and second, those provisions (art. 151
to 174) of the Code o ] Commerce.

Articles 1700 to 1708 of the Civil Code deal with the manner of dissolving a corporation. There is
nothing in these articles which expressly or impliedly prohibits the sale of corporate property to one
of its members, nor a dissolution of a corporation in this manner. Neither is there anything in articles
151 to 174 of the Code of Commerce which prohibits the dissolution of a corporation by such sale or

The articles of incorporation must include:

xxx xxx xxx

The submission to the vote of the majority of the meeting of members, duly called and held,
of such matters as may properly be brought before the same. (No. 10, art. 151, Code of
Article XIII of the corporation's statutes expressly provides that "in all the meetings of the
stockholders, a majority vote of the stockholders present shall be necessary to determine any
question discussed."

The sale or transfer to one of its members was a matter which a majority of the stockholders could
very properly consider. But it i said that if the acts and resolutions of a majority of the stockholders in
a corporation are binding in every case upon the minority, the minority would be completely wiped
out and their rights would be wholly at the mercy of the abuses of the majority.

Generally speaking, the voice of a majority of the stockholders is the law of the corporation, but there
are exceptions to this rule. There must necessarily be a limit upon the power of the majority. Without
such a limit the will of the majority would be absolute and irresistible and might easily degenerate
into an arbitrary tyranny. The reason for these limitations is that in every contract of partnership (and
a corporation can be something fundamental and unalterable which is beyond the power of the
majority of the stockholders, and which constitutes the rule controlling their actions. this rule which
must be observed is to be found in the essential compacts of such partnership, which gave served
as a basis upon which the members have united, and without which it is not probable that they would
have entered not the corporation. Notwithstanding these limitations upon the power of the majority of
the stockholders, their (the majority's) resolutions, when passed in good faith and for a just cause,
deserve careful consideration and are generally binding upon the minority.

Eixala, in his work entitled "Instituciones del Derecho Mercantil de España," speaking of sociedades
anonimas, says:

The resolutions of the boards passed by a majority vote are valid . . . and authority for
passing such resolutions is unlimited, provided that the original contract is not broken by
them, the partnership funds not devoted to foreign purposes, or the partnerships
transformed, or changes made which are against public policy or which infringe upon the
rights of third persons.

The supreme court of Spain, in its decision dated June 30, 1888, said:

In order to be valid and binding upon dissenting members, it s an indispensable requisite that
resolutions passed by a general meeting of stockholders conform absolutely to the contracts
and conditions of the articles of the association, which are to be strictly construed.

That resolutions passed within certain limitations by a majority of the stockholders of a corporation
are binding upon the minority, is therefore recognized by the Spanish authorities.

Power of private corporation to alienate property. — This power of absolute alienability of

corporate property applies especially to private corporations that are established solely for
the purpose of trade or manufacturing and in which he public has no direct interest. While
this power is spoken of as belonging to the corporation it must be observed that the
authorities point out that the trustees or directors of a corporation do not possess the power
to dispose of the corporate property so as to virtually end the existence of the corporation
and prevent it from carrying on the business for which it was incorporated. (Thompson on
Corporation, second edition, sec. 2416, and cases cited thereunder.)

Power to dispose of all property. — Where there are no creditors, and no stockholder
objects, a corporation, as against all other persons but the state, may sell and dispose of all
its property. The state in its sovereign capacity may question the power of the corporation to
do so, but with these exceptions such as a sale is void. A rule of general application is that a
corporation of a purely private business character, one which owes no special duty to the
public, and is not given the right of eminent domain, where exigencies of its business require
it or when the circumstances are such that it can no longer continue the business with profit,
may sell and dispose of all its property, pay its debts, divide the remaining assets and wind
up the affairs of the corporation. (Id., sec. 2417.)

When directors or officers may dispose of all the property. — It is within the dominion of the
managing officers and agents of the corporation to dispose of all the corporate property
under certain circumstances; and this may be done without reference to the assent or
authority of the stockholders. This disposition of the property may be temporarily by lease, or
permanently by absolute conveyance. But it can only be done in the course of the corporate
business and for the furtherance of the purposes of the incorporation. The board of directors
possess this power when the corporation becomes involved and by reason of its
embarrassed or insolvent condition is unable either to pay its debts or to secure capital and
funds for the further prosecution of its enterprise, and especially where creditors are pressing
their claims and demands and are threatening to or have instituted actions to enforce their
claims. This power of the directors to alienate the property is conceded where it is regarded
as of imperative necessity. (If., sec. 2418, and case cited.)

When majority stockholder may dispose of all corporate property. — Another rule that
permits a majority of the stockholders to dispose of all the corporate property and wind up
the business, is where the corporation has became insolvent, and the disposition of the
property is necessary to pay the debt; or where from any cause the business is a failure, and
the best interest of the corporation and all the stockholders require it, then the majority have
clearly the power to dispose of all the property even as against the protests of a minority. It
would be a harsh rule that could permit one stockholder, or any minority of the stockholders,
to hold the majority to their investment where the continuation of the business would be at a
loss and where there was no prospect or hope that the enterprise could be made profitable.
The rule as stated by some courts is that the majority stockholders may dispose of the
property when just cause exists; and this just cause is usually defined to be the
unprofitableness of the business and where its continuation would be ruinous to the
corporation and against the interest of stockholders. (Id., sec. 2424, and cases cited.)

Nothing is better settled in the law of corporations than the doctrine that a corporation has
the same capacity and power as a natural person to dispose of the convey its property, real
or personal, provided it does not do so for a purpose which is foreign to the objects for which
it was created, and provided, further, it violates no charter or statutory restriction, on rule of
law based upon public policy. . . .This power need not be expressly conferred upon a
corporation by its charter. It is implied as an incident to its ownership of property, unless
there is some clear restriction in this charter or in some statute. (Clark and Marshall's Private
Corporations, sec. 152, and cases cited.)

A purely private business corporation, like a manufacturing or trading company, which is not
given the right of eminent domain, and which owes no special duties to the public, may
certainly sell and convey absolutely the whole of its property, when the exigencies of its
business require it to do so, or when the circumstances are such that it can no longer
profitably continue its business, provided the transaction is not in fraud of the rights of
creditors, or in violation of charter or statutory restrictions. And, by the weight of authority,
this may be done a majority of the stockholders against the dissent of the minority. (Id., sec.
160, and cases cited.)
The above citations are taken from the works of the most eminent writers on corporation law. The
citation of cases in support of the rules herein announced are too numerous to insert.

From these authorities it appears to be well settled, first, that a private corporation, which owes no
special duty to the public and which has not been given the right of eminent domain, has the
absolute right and power as against the whole world except the state, to sell and dispose of all of its
property; second, that the board of directors, has the power, without referrence to the assent or
authority of the stockholders, when the corporation is in failing circumstances or insolvent or when it
can no longer continue the business with profit, and when it is regarded as an imperative necessity;
third, that a majority of the stockholders or directors, even against the protest of the minority, have
this power where, from any cause, the business is a failure and the best interest of the corporation
and all the stockholders require it.

May officer or directors of the corporation purchase the corporate property? The authorities are not
uniform on this question, but on the general proposition whether a director or an officer may deal
with the corporation, we think the weight of authority is that he may. (Merrick vs. Peru Coal Co., 61
Ill., 472; Harts et al. vs. Brown et al., 77 Ill., 226; Twin-Lick Oil Company vs. Marbury, 91 U.S., 587;
Whitwell vs, Warner, 20 Vt., 425; Smith vs. Lansing, 22 N.Y., 520; City of St. Loius vs. Alexander, 23
Mo., 483; Beach et al vs. Miller, 130 Ill., 162.)

While a corporation remains solvent, we can see no reason why a director or officer, by the authority
of a majority of the stockholders or board of managers, may not deal with the corporation, loan it
money or buy property from it, in like manner as a stranger. So long as a purely private corporation
remains solvent, its directors are agents or trustees for the stockholders. They owe no duties or
obligations to others. But the moment such a corporation becomes insolvent, its directors are
trustees of all the creditors, whether they are members of the corporation or not, and must manage
its property and assets with strict regard to their interest; and if they are themselves creditors while
the insolvent corporation is under their management, they will not be permitted to secure to
themselves by purchasing the corporate property or otherwise any personal advantage over the
other creditors. Nevertheless, a director or officer may in good faith and for an adequate
consideration purchase from a majority of the directors or stockholders the property even of an
insolvent corporation, and a sale thus made to him is valid and binding upon the minority. (Beach et
al. vs. Miller, supra; Twin-Lick Oil Company vs. Marbury, supra; Drury vs. Cross, 7 Wall., 299;
Curran vs. State of Arkansas, 15 How., 304; Richards vs. New Hamphshire Insurance Company, 43
N. H., 263; Morawetz on Corporations (first edition), sec. 579; Haywood vs. Lincoln Lumber
Company et al., 64 Wis., 639; Port vs. Russels, 36 Ind., 60; Lippincott vs. Shaw Carriage Company,
21 Fed. Rep., 577.)

In the case of the Twin-Lick Oil Company vs. Marbury, supra, the complaint was a corporation
organized under the laws of West Virginia, engaged in the business of raising and selling petroleum.
It became very much embarrased and a note was given secured by a deed of trust, conveying all the
property rights, and franchise of the corporation to William Thomas to secure the payment of said
note, with the usual power of sale in default of payment. The property was sold under the deed of
trust; was bought in by defendant's agent for his benefit, and conveyed to him the same year. The
defendant was at the time of these transactions a stockholder and director in the company. At the
time the defendant's money became due there was no apparent possibility of the corporation's
paying it at any time. The corporation was then insolvent. The property was sold by the trustee and
bough in by the defendant at a fair and open sale and at a reasonable price. The sale and purchase
was the only mode left to the defendant to make his money. The court said:

That a director of a joint-stock corporation occupies one of those fiduciary relations where his
dealings with the subject-matter of his trust or agency, and with the beneficiary or party
whose interest is confided to his care, is viewed with jealousy by the courts, and may be set
aside on slight grounds, is a doctrine founded on the soundest morality, and which has
received the clearest recognition in this court and others. (Koehler vs. Iron., 2 Black, 715;
Drury vs. Cross, 7 Wall., 299; R.R. Co. vs. Magnay, 25 Beav., 586; Cumberland Co vs.
Sherman, 30 Barb., 553; Hoffman S. Coal Co. vs. Cumberland Co., 16 Md., 456.) The
general doctrine, however, in regard to contracts of this class, is, not that they are absolutely
void, but that they are voidable at the election of the party whose interest has been so
represented by the party claiming under it. We say, this is the general rule; for there may be
cases where such contracts would be void ab initio; as when an agent to sell buys of himself,
and by his power of attorney conveys to himself that which he was authorized to sell. but
even here, acts which amount t a ratification by the principal may validate the sale.

The present case is not one of that class. While it is true that the defendant, a s a director of
the corporation, was bound by all those rules of conscientious fairness which courts of equity
have imposed as the guides for dealing in such cases, it can not be maintained that any rule
forbids one director among several from loaning money to the corporation when the money is
needed, and the transaction is open, and otherwise free from blame. No adjudged case has
gone so far as this. Such a doctrine, while it would afford little protection to the corporation
against actual fraud or oppression, would deprive it of the air of those most interested in
giving aid judiciously, and best qualified to judge of the necessity of that aid, and of the
extent to which it may safely be given.

There are in such a transaction three distinct parties whose interest is affected by it; namely,
the lender, the corporation, and the stockholders of the corporation.

The directors are the officers or agents of the corporation, and represent the interests of the
abstract legal entity, and of those who own the shares of its stock. One of the objects of
creating a corporation by law is to enable it to make contracts; and these contracts may be
made with its stockholders as well as with others. In some classes of corporations, as in
mutual insurance companies, the main object of the act of the incorporation is to enable the
company to make contracts which its stockholders, or with persons who become
stockholders by the very act of making the contract of insurance. It is very true, that as a
stockholder, in making a contract of any kind with the corporation of which he is a member, is
in some sense dealing with a creature of which he is a part, and holds a common interest
with the other stockholders, who, with him, constitute the whole of that artificial entity, he is
properly held to a larger measure of candor and good faith than if he were not a stockholder.
So, when the lender is a director, charged, with others, with the control and management of
the affairs of the corporation, representing in this regard the aggregated interest of all the
stockholders, his obligation, if he becomes a party to a contract with the company, to candor
and fair dealing, is increased in the precise degree that his representative character has
given him power and control derived from the confidence reposed in him by the stockholders
who appointed him their agent. If he should be a sole director, or one of a smaller number
vested with certain powers, this obligation would be still stronger, and his acts subject to
more severe scrutiny, and their validity determined by more rigid principles of morality, and
freedom from motives of selfishness. All this falls far short, however, of holding that no such
contract can be made which will be valid; . . . .

In the case of Hancock vs. Holbrook et al. (40 La. Ann., 53), the court said:

As a strictly legal question, the right of a board of directors of a corporation to apply it

property to the payment of its debts, and the right of the majority of stockholders present at a
meeting called for the purpose to ratify such action and to dissolve the corporation, can not
be questioned.

But were such action is taken at the instance, and through the influence of the president of
the corporation, and were the debt to which the property is applied is one for which he is
himself primarily liable, and specially where he subsequently acquires, in his personal right,
the proerty thus disposed of, such circumstances undoubtedly subject his acts to severe
scrutiny, and oblige him to establish that he acted with the utmost candor and fair-dealing for
the interest of the corporation, and without taint of selfish motive.

The sale or transfer of the corporate property in the case at bar was made by three directors who
were at the same time a majority of stockholders. If a majority of the stockholders have a clear and a
better right to sell the corporate property than a majority of the directors, then it can be said that a
majority of the stockholders made this sale or transfer to the defendant McCullough.

What were the circumstances under which said sale was made? The corporation had been going
from bad to worse. The work of trying to raise the sunken Spanish fleet had been for several months
abandoned. The corporation under the management of the plaintiff had entirely failed in this
undertaking. It had broken its contract with the naval authorities and the $10,000 Mexican currency
deposited had been confiscated. It had no money. It was considerably in debt. It was a losing
concern and a financial failure. To continue its operation meant more losses. Success was
impossible. The corporation was civilly dead and had passed into the limbo of utter insolvency. The
majority of the stockholders or directors sold the assets of this corporation, thereby relieving
themselves and the plaintiff of all responsibility. This was only the wise and sensible thing for them to
do. They acted in perfectly good faith and for the best interests of all the stockholders. "It would be a
harsh rule that would permit one stockholder, or any minority of stockholders to hold a majority to
their investment where a continuation of the business would be at a loss and where there was no
prospect or hope that the enterprise would be profitable."

The above sets forth the condition of this insolvent corporation when the defendant McCullough
proposed to the majority of stockholders to take over the assets and assume all responsibility for the
payment of the debts and the completion of the warehouses which had been undertaken. The assets
consisted of office furniture of a value of less than P400, the uncompleted contract for the
construction of the Government warehouses, and the wrecking contract. The liabilities amounted to
at least $19,645.74 Mexican currency. $9,645.74 Mexican currency of this amount represented
borrowed money, and $10,000 Mexican currency was the deposit with the naval authorities which
had been confiscated and which was due the bank. McCullough's profits on the warehouse contract
amounted to almost enough to the pay the amounts which the corporation had borrowed from its
members. The wrecking contract which had been broken was of no value to the corporation for the
reason that the naval authorities absolutely refused to have anything further to do with the Philippine
Engineering and Construction Company. They the naval authorities) had declined to consider the
petition of the corporation for an extension in which to raise the Spanish fleet, and had also refused
to reconsider their action in confiscating the deposit. They did agree, however, that if the defendant
McCullough would organize a new association, that they would give the new concern an extension
of time and would reconsider the question of forfeiture of the amount deposited. Under these
circumstances and conditions, McCullough organized the Manila Salvage Company, sold five-sixth
of this wrecking contract to the new company for $15,000 Mexican currency and retained one-sixth
as his share of the stock in the new concern. The Manila Salvage company paid to the bank the
$10,000 Mexican currency which had been borrowed to deposit with the naval authorities, and
began operations. All of the $10,000 Mexican currency so deposited was refund to the new company
except P2,000. The new association failed and McCullough, by reason of this failure, lost over
$16,000 Mexican currency. These facts show that McCullough acted in good faith in purchasing the
old corporation's assets, and that he certainly paid for the same a valuable consideration.
But cancel for the plaintiff say: "The board of directors possessed only ordinary powers of
administration (Article X of the Articles of incorporation), which in no manner empowered it either to
transfer or to authorize the transfer of the assets of the company to McCullough (art. 1773, Civil
Code; decisions of the supreme court of Spain of April 2, 1862, and July 8, 1903)."

Article X of the articles of incorporation above referred to provides that the board of directors shall
elect the officers of the corporation and "have under its charge the administration of the said
corporation." Articles XI reads: "In all the questions with reference to the administration of the affairs
of the corporation, it shall be necessary to secure the unanimous vote of the board of directors, and
at least three of said board must be present in order to constitute a legal meeting." It will be noted
that article X statute a legal meeting." It will be noted that Article X placed the administration of the
affairs of the corporation in the hands of the board of directors. If Article XI had been omitted, it is
clear that under the rules which govern business of that character, and in view of the fact that before
the plaintiff left this country and abandoned his office as director, there were only five directors in the
corporation, then three would have been sufficient to constitute a quorum and could perform all the
duties and exercise all the powers conferred upon the board under this article. It would not have
been necessary to obtain the consent of all three of such members which constituted the quorum in
order that a solution affecting the administration of the corporation should be binding, as two votes
— a majority of the quorum — would have been sufficient for this purpose. (Buell vs. Buckingham &
Co., 16 Iowa, 284; 2 Kent. Com., 293; Cahill vs. Kalamazoo Mutual Insurance Company, 2 Doug.
(Mich.), 124; Sargent vs. Webster, 13 Met., 497; In re Insurance Company, 22 Wend., 591; Ex
parte Wilcox, 7 Cow., 402; id., 527, note a.)

It might appear on first examination that the organizers of this corporation when they asserted the
first part of Article XI intended that no resolution affecting the administration of the affairs should be
binding upon the corporation unless the unanimous consent of the entire board was first obtained;
but the reading of the last part of this same article shows clearly that the said organizers had no
such intention, for they said: "At least three of said board must be present in order to constitute a
legal meeting." Now, if three constitute a legal meeting, three were sufficient to transact business,
three constituted the quorum, and, under the above-cited authorities, two of the three would be
sufficient to pass binding resolutions relating to the administration of the corporation.

If the clause "have under in charge and administer the affairs of the corporation" refers to the
ordinary business transactions of the corporation and does not include the power to sell the
corporate property and to dissolve the corporation when it becomes insolvent — a change we admit
organic and fundamental — then the majority of the stockholders in whom the ultimate and
controlling power lies must surely have the power to do so.

Article 1713 of the Civil Code reads:

An agency stated in general terms only includes acts of administration.

In order to compromise, alienate, mortgage, or execute any other act of strict ownership an
express commission is required.

This article appears in title 9, chapter 1 of the Civil Code, which deals with the character, form, and
kind of agency. Now, were the positions of Hilbert, Green, Hartigan, and McCullough that the agents
within the meaning of the article above quoted when the assets of the corporation were transferred
or sold to McCullough? If so, it would appear from said article that in order to make the sale valid, an
express commission would be required. This provision of law is based upon the broad principles of
sound reason and public policy. There is a manifest impropriety in allowing the same person to act
as the agent of the seller and to become himself the buyer. In such cases, there arises so often a
conflict between duty and interest. "The wise policy of the law put the sting of a disability into the
temptation, as a defensive weapon against the strength of the danger which lies in the situation."

Hilbert, Green, and Hartigan were not only all creditors at the time the sale or transfer of the assets
of the insolvent corporation was made, but they were also directors and stockholders. In addition to
being a creditor, McCullough sustained the corporation the double relation of a stockholder and
president. The plaintiff was only a stockholder. He would have been a creditor to the extent of his
unpaid salary if the corporation had been a profitable instead of a losing concern.

But as we have said when the sale or transfer under consideration took place, there were three
directors present, and all voted in favor of making this sale. It was not necessary for the president,
McCullough, to vote. There was a quorum without him: a quorum of the directors, and at the same
time a majority of the stockholders.

A corporation is essential a partnership, except in form. "The directors are the trustees or managing
partners, and the stockholders are the cestui que trust and have a joint interest in all the property
and effects of the corporation." (Per Walworth, Ch., in Robinson vs. Smith, 3 Paige, 222, 232;
5 idem, 607; Slee vs. Bloom, 19 Johns., 479; Hoyt vs. Thompson, 1 Seld., 320.)

The Philippine Engineering and Construction Company was an artificial person, owning its property
and necessarily acting by its agents; and these agents were the directors. McCullough was then an
agent or a trustee, and the stockholders the principal. Or say (as corporation was insolvent) that he
was an agent or trustee and the creditors were the beneficiaries. This being the true relation, then
the rules of the law (art. 1713 of the Civil Code) applicable to sales and purchases by agents and
trustees would not apply to the purchase in question for the reason that there was a quorum without
McCullough, and for the further reason that an officer or director of a corporation, being an agent of
an artificial person and having a joint interest in the corporate property, is not such an agent as that
treated of in article 1713 of the Civil Code.

Again, McCullough did not represent the corporation in this transaction. It was represented by a
quorum of the board of directors, who were at the same time a majority of the stockholders.
Ordinarily, McCullough's duties as president were to preside at the meetings, rule on questions of
order, vote in case of a tie, etc. He could not have voted in this transaction because there was no tie.

The acts of Hilbert, Green, Hartigan, and McCullough in this transaction, in view of the relations
which they bore to the corporation, are subject to the most severe scrutiny. They are obliged to
establish that they acted with the utmost candor and fair dealing for the interest of the corporation,
and without taint motives. We have subjected their conduct to this test, and, under the evidence, we
believe it has safely emerged from the ordeal.

Transaction which only accomplish justice, which are done in good faith and operate legal
injury to no one, lack the characteristics of fraud and are not to be upset because the
relations of the parties give rise to suspicions which are fully cleared away. (Hancock vs.
Holbrook, supra.)

We therefore conclude that the sale or transfer made by the quorum of the board of directors — a
majority of the stockholders — is valid and binding upon the majority-the plaintiff. This conclusion is
not in violation of the articles of incorporation of the Philippine Engineering and Construction
Company. Nor do we here announce a doctrine contrary to that announced by the supreme court of
Spain in its decisions dated April 2, 1862, and July 8, 1903.
As to the third cause of action, it is insisted: First, that the court erred in holding the defendant
McCullough responsible for the personal effects of the plaintiff; and second, that the court erred in
finding that the effects left by the plaintiff were worth P2,400.

As we have said, the plaintiff was the manager of the Philippine Engineering Company from April 1,
1902, up to January 1, 1903. Sometimes during the previous month of December he resigned to
accept a position in China, but did not leave Manila until about January 20. He remained in Manila
about twenty days after he severed his connection with the company. He lived in rooms in the same
building which was rented by the company and were the company had its offices. When he started
for China he left his personal effects in those rooms, having turned the same over to one Paulsen.
Testifying on this point the plaintiff said:

Q. To whom did you turn over these personal effects on leaving here? — A. To Mr. Paulsen.

Q. Have you demanded payment of this sum [referring to the value of his personal effects]?
— A. On leaving for China I gave Mr. Haussermann power of attorney to represent me in this
case and demand payment.

Q. Please state whether or not you have an inventory of these effects. — A. I had an
inventory which was in my possession but it was lost when the company took all of the books
and carried them away from the office.

Q. Can you give a list or a partial list of your effect? — A. I remember some of the items.
There was a complete bedroom set, two marble tables, one glass bookcase, chairs, all of the
household effects I used when I was living in the Botanical Garden as city engineer, one
theodolite, which I bought after commencing work with the company.

Q. How much do you estimate to be the total reasonable value of these effects? — A. The
total would not be less than $1,200 gold.

Counsel for the plaintiff, on page 56 of their brief, say:

Mr. McCullough, in his testimony (pp. 39 and 40) admits full knowledge of and participation in
the removal and sale of the effects and states that he took the proceeds and considered
them part of the assets of the company. He further admits that Mr. Haussermann made a
demand for the proceeds of Mr. Mead's personal effects (p. 44).

McCullough's testimony, referred by the counsel, is as follows:

Q. At the time Mr. Mead left for China, in the building where the office was and in the office,
there were left some of the personal effects of Mr. Mead. What do you know about these
effects, a list of which is Exhibit B? — A. Nothing appearing in this Exhibit B was never
delivered to the Philippine Engineering and Construction Company, according to my list.

Q. Do you know what became of these effects? — A. No, sir. I have no idea. I never saw
them. I never heard these effects talked about. I only heard something said about certain
effects which Mr. Mead had in his living room.

Q. Do you know what became of the bed of Mr. Mead? — A. I know there were effects, such
as a bed, washstand, chairs, table, and other things, which are used in a living room, and
that they were in Mr. Mead's room. These effects were sent to the warehouse of the Pacific
Oriental Trading Company, together with the office furniture. We had to vacate the building
where the offices were and we had to take out everything therein. These things were
deposited in the warehouse of the Pacific Oriental Trading Company and were finally sold by
that company and the money turned over to me.

Q. How much? — A. P49.97.

Q. What did you do with this money? — A. I took it and considered it part of the assets of the
company. All of the other effects of the office were sold at the same time and brought

Q. Did Mr. Mead leave anyone in charge of his effects when he left Manila? — A. I think he
left Paulsen in charge, but Paulsen did not take these effects, so when we vacated the office
we had to move them.

Q. Did Paulsen continue occupying the living room where these effects were and did he use
these effects? — A. I do not know because I was in the office for three months before we

Q. Don't you know that it is a fact that Mr. Haussermann, as representative of Mr. Mead,
demanded of you and the company the payment of the salary which was due Mr. Mead and
the value of his personal effects? — A. Yes, sir.

As to the value of these personal effects, Hartigan, testifying as witness for the defendant, said:

I think the personal effects were sold for P50. His personal effects consisted of ordinary
articles, such as a person would use who had to be going from one place to another all the
time, as Mr. Mead. I know that all those effects were sold for less than P100, if I am not

The foregoing is the material testimony with reference to the defendant McCullough's responsibility
and the value of the personal effects of the plaintiff.

McCullough was a member of the company and was responsible as such for the rents where the
offices were located. The company had no further use for the building after the plaintiff resigned. The
vacating of the building was the proper thing to do. The office furniture was removed and stored in a
place where it cost nothing for rents. When Hilbert, member of the company, went to the office to
remove the company's office furniture, he found no one in charge of the plaintiff's personal effects.
He took them and stored them in the same place and later sold them, together with the office
furniture, and turned the entire amount over to defendant McCullough.

Paulsen, in whose charge Mead left his effects, apparently took no interest in caring for them. Was
the company to leave Mead's personal effects in that building and take the chances of having to
continue to pay rents, solely on account of the plaintiff's property remaining there? The company had
reason to believe that it would have to continue paying these rents, as they had rented the building
and authorized the plaintiff to occupy rooms therein.

The plaintiff knew when he left for China that he would be away a long time. He had accepted a
position of importance, and which he knew would require his personal attention. He did not gather up
his personal effects, but left them in the room in charge of Paulsen. Paulsen took no interest in
caring for them, but apparently left these effects to take care of them selves. The plaintiff did not
even carry with him an inventory of these effects, but attempted on the trial to give a list of them and
did give a partial list of the things he left in his room; but it is not shown that all this things were there
when Herbert removed the office furniture and some of the plaintiff's effects. The fact that the plaintiff
remained in Manila some twenty days after resigning and never cared for his own effects but left
them in the possession of an irresponsible person, shows extreme negligence on his part. He
exhibited a reckless indifference to the consequences of leaving his effects in the lease premises.
The law imposes on every person the duty of using ordinary care against injury or damages. What
constitutes ordinary care depends upon the circumstances of each particular case and the danger
reasonably to be apprehended.

McCullough did not have anything personally to do with these effects at any time. He only accepted
the money which Herbert turned over to him. He, personally, did not contribute in any way
whatsoever to the loss of the property, neither did he as a member of the corporation do so.

The plaintiff gave an estimate of the value of the effects which he left in his rooms and placed this
value at P2,400. He did not give a complete list of the effects so left, neither did he give the value of
a single item separately. The plaintiff's testimony is so indefinite and uncertain that i t is impossible to
determine with any degree of certainty just what these personal effects consisted of and their values,
especially when we take into consideration the significant fact that these effects were abondoned by
Paulsen. On the other hand, w have before us the positive testimony of Hilbert as to the amount
received for the plaintiff's personal effects, the testimony of Hartigan that the same were sold for less
than P100, and the testimony of McCullough as to the amount turned over to him by Herbert.

So we conclude that the great preponderance of evidence as to the value of these effects is in the
favor of the contention of the defendant. Their value therefore be fixed at P49.97.

For these reasons the judgment appealed from as to the first and second causes of action is hereby
affirmed. Judgment appealed from as to the third cause of action is reduced to P49.97, without

Arellano, C.J., Torres, Mapa, Carson and Moreland, JJ., concur.

48 F. Supp. 465 (1943)


District Court, S. D. New York.

January 11, 1943.

*466 A. Joseph Geist, of New York City (George E. Netter, Karl Leibel, and Mortimer A.
Shapiro, all of New York City, of counsel), for plaintiff.

Szold & Brandwen, of New York City (Robert Szold and Charles J. Tanenbaum, both of
New York City, of counsel), for intervening plaintiff Rosalie J. Leventritt.

Bijur & Herts, of New York City (Harry Bijur and Harold Herts, both of New York City, of
counsel), for intervening plaintiff Frederick W. Scholem.
Harper & Matthews, of New York City (Albert C. Rothwell and Cornelius D. Crowley, Jr.,
both of New York City, of counsel), for defendant, Sperry Corporation.

Humes, Buck, Smith & Stowell, of New York City, for defendant George N. Armsby.

Chadbourne, Hunt, Jaeckel & Brown, of New York City (Ralph P. Buell and William H.
Hall, both of New York City, of counsel), for defendants Standard Capital Co. and J.
Cheever Cowdin.

George Z. Medalie and Louis Haimoff, both of New York City, for defendants Thomas A.
Morgan and others.

Skutch, Meyer & Burton, of New York City (Ira Skutch and Harold Schwarzberg, both of
New York City, of counsel), for defendant Edward Allen Pierce.

DeBevoise, Stevenson, Plimpton & Page, of New York City (E. W. DeBevoise, of New
York City, of counsel), for defendant Alexander B. Royce.

Sullivan & Cromwell, of New York City (Inzer B. Wyatt, of New York City, of counsel), for
defendant J. Russell Forgan and others.

RIFKIND, District Judge.

The action is a derivative stockholders' suit brought by minority stockholders of the

Sperry Corporation against directors of that corporation and others.

The evidence establishes conclusively that in the Spring of 1936, a controversy,

attended by considerable bitterness, developed between the Sperry Corporation on the
one side and Cowdin and Standard Capital Company on the other. The Sperry
Corporation demanded of Cowdin and Standard Capital Company $193,000 which the
latter had received from Field Glore and Company as a 50% participation in the profits
realized by Field Glore and Company out of an agreement between the Sperry
Corporation and Field Glore and Company which Cowdin had negotiated on behalf of
Sperry Corporation at a time when Cowdin was a director and employee of the Sperry
Corporation and president and *467 principal stockholder of Standard Capital Company.

In this controversy there was a central issue of fact: Had Cowdin made a sufficient
disclosure of his arrangement with Field Glore and Company at the meeting of the
Sperry board of directors which authorized the agreement with Field Glore. That issue
has now been tried and I have resolved it against Cowdin. In the Spring of 1936, it had
not yet been tried; and no one could then prophesy with certainty how such an issue
would be resolved. In any event, the dispute led to negotiations which were fruitful in
producing a settlement agreement. In accordance with its terms Cowdin and Standard
Capital paid Sperry $101,407.05 and received from Sperry a release of its claim.
At least as against Cowdin and Standard Capital, plaintiffs cannot prevail until they first
succeed in striking down this release. To accomplish this, they have two avenues of
attack, of which one is to challenge the bona fides of the settlement. This alone fails
them, however, for I find the transaction was attended, on the part of the directors, by
good faith, sound business judgment and prudent solicitude for the welfare of the
corporation. The mere fact that this was a transaction between the corporation and one
of its directors does not avail to rob the release of its effectiveness. This principle would
be true whether the applicable law was that of New York, where the transaction
occurred, or that of Delaware, where the Sperry Corporation was incorporated.
Crawford v. Mexican Petroleum Co., 2 Cir., 1942, 130 F.2d 359.

To the extent that Munson v. Syracuse, G. & C. R. Co., 1886, 103 N.Y. 58, 8 N.E. 855,
may be said to impose a more rigid standard, it yields to the more moderate view
expressed by both prevailing and dissenting opinions in Everett v. Phillips, 1942, 288
N.Y. 227, 43 N.E.2d 18.

The second avenue of attack open to plaintiffs raises questions not so readily
answered. Plaintiffs challenge the release, asserting in substance that it is not the act or
deed of the corporation, its execution and delivery never having been validly authorized
by the board of directors. The issue thus tendered requires analysis of the proceedings
taken at two meetings of Sperry's board of directors: the meeting of June 30, 1936, at
which the settlement was authorized and the meeting of July 28, 1936, at which it was
approved or ratified.

The board consisted of eight members and the by-laws specified that a majority
constituted a quorum. At the June 30th meeting the following directors were present:
Morgan, Sanderson, Pierce, Royce, Doe and Cowdin. Cowdin retired from the meeting
before the consideration of the settlement. Only five directors remained and if anyone of
them was ineligible to be counted towards a quorum, no quorum was present.

Plaintiffs deny the disinterestedness of all the directors on the ground that all were
subject to liability for negligently entering into the Field Glore contract. Since I have
found that no negligence attended the making of that contract this argument of
necessity fails.

More specifically, plaintiffs assert the ineligibility of Morgan and Sanderson, the former
on the ground that he was, at the time, a stockholder of Standard Capital, and the latter
on the ground that his wife was at the time a stockholder of the same corporation. Since
the disqualification of Morgan alone would suffice to invalidate the proceedings taken at
the meeting, consideration of Sanderson's status may be deferred.

At the time of the meeting, Morgan was the owner of 50 shares of common and 50
shares of preferred of the stock of Standard Capital for which he had paid $5,050.
Standard Capital had outstanding at the time 10,555 shares of common stock and 4750
shares of preferred stock. The charter of Sperry contained not only the usual provisions
authorizing transactions in which a director is personally interested but a provision
specifically addressed to the present problem: "Any director whose interest in any such
contract or transaction arises solely by reason of the fact that he is a stockholder, officer
or creditor of such other company * * * shall not be deemed interested in such contract
or other transaction under any of the provisions of this paragraph, nor shall any such
contract or transaction be void or voidable, nor shall any director be liable to account
because of such interest nor need such interest be disclosed". Moreover this quoted
language is preceded by the sentence, "Directors so interested may be counted when
present at meetings of the Board of Directors or of such Committee for the purpose of
determining the *468 existence of a quorum". The charter, therefore, not only declares
that Morgan might be counted towards a quorum if interested but also that mere stock
ownership does not make him an interested director. If this charter provision is valid,
then Morgan, and a fortiori Sanderson, could properly be counted towards a quorum.

The Delaware Corporation Law provides that "The Certificate of Incorporation may also
contain any provision which the incorporators may choose to insert for the management
of the business and for the conduct of the affairs of the corporation, and any provision
creating, defining, limiting and regulating the powers of the corporation, the directors
and the stockholders * * * provided, such provisions are not contrary to the laws of this
State". Section 5, subdivision 8, Delaware Revised Code, Section 2037.

The statute law of Delaware contains no express prohibition of the provision in question.
However, it would unduly narrow the scope of the proviso if the word "laws" were
confined to statute law. See State ex rel. Cochran v. Penn-Beaver Oil Co., 1926, 4
W.W.Harr. 81, 34 Del. 81, 143 A. 257.

Extensive search by counsel and court has failed to reveal any precedent directly in
point. While a number of cases have considered the eligibility of an interested director to
be counted towards a quorum, in none of them was the court confronted by such a
provision as is here under review. Generally, the authorities are divided as to whether a
director's interest renders him ineligible for quorum purposes. Opposed to eligibility are:
Butts v. Wood, 1867, 37 N.Y. 317; In re Lone Star Shipbuilding Co., 2 Cir., 1925, 6 F.2d
192, 195; See Sturndorf v. Samurai Co., 1910, Sup., 121 N.Y.S. 217; Enright v.
Heckscher, 2 Cir., 1917, 240 F. 863; In re Webster Loose Leaf Filing Co., D.C.N.J.
1916, 240 F. 779; Wishon-Watson Co. v. Commissioner of Internal Revenue, 9 Cir.,
1933, 66 F.2d 52; Sacajawea Lumber & Shingle Co. v. Skookum Lumber Co., 1921,
116 Wash. 75, 198 P. 1112.

In favor of eligibility are: Gumaer v. Cripple Creek Tunnel T. & M. Co., 1907, 40 Colo. 1,
90 P. 81, 13 Ann.Cas. 781, 122 Am.St.Rep. 1024; Buell v. Buckingham, 1864, 16 Iowa
284, 85 Am.Dec. 516.

In the Enright case, supra, the Court of Appeals of this Circuit recognized this division of
opinion and said [240 F. 872]: "A director, whose interest in a matter disqualifies him
from voting upon a resolution concerning it, cannot, according to the better opinion, be
counted for the purpose of ascertaining whether a quorum was present when the vote is
It should be noted that in that case the interested director was not present at the
challenged meeting and that the court's comment on the quorum rule was not
necessary to its decision.

The Delaware courts have not yet expressed themselves on the question of eligibility for
a quorum. However, in Italo-Petroleum Corporation v. Hannigan, 1940, 1 Terry 534, 40
Del. 534, 14 A.2d 401, the court declared that the vote of an interested director could
not be counted to make a majority of the board. That, too, was dictum since the court
found that the facts if proved would establish a void, not a voidable, transaction [1]. Such
a transaction could not withstand attack regardless of the character of the board.

Reference may properly be had, too, to cases where the question of quorum was not
considered despite the manifest absence of a quorum if the governing rule is that an
interested director is ineligible for quorum purposes. One such case is Everett v.
Phillips, 1942, 288 N.Y. 227, 43 N.E.2d 18. No disinterested quorum could possibly
have been assembled in that case. The court, however, did not dispose of the issues on
that simple ground. It did not mention the question. Instead, it examined into the good
faith of the transaction and refused to upset it in the absence of proof of mala fides.
Furthermore, the court construed the charter of the corporation [2] for *469 whose benefit
the suit was brought, as authorizing interested directors to act; and not only failed to find
in such a provision anything repugnant to public policy but, on the contrary, used that
provision to buttress its conclusions. See, also, Spiegel v. Beacon Participations, Inc.,
1937, 297 Mass. 398, 8 N.E.2d 895; Crawford v. Mexican Petroleum Co., supra.

The function of this Court is not to determine whether in its judgment the challenged
provision of the Sperry charter violates some general public policy but whether
Delaware regards its public policy violated by such a provision.

When we consider that there is at least some authority which recognizes an interested
director's eligibility for quorum purposes even in the absence of charter provisions
expressly sanctioning such eligibility; (though it is the minority view and not the "better
opinion"); that the Delaware courts have so far failed to condemn such a provision; that
the New York courts have apparently sanctioned such a provision, then it seems to me
a federal court should not assume that Delaware forbids stockholders to contract to
make the rule sanctioned by the minority view prevail in the internal government of their
corporation. Plaintiffs have, therefore, failed to establish the invalidity of the clause in
question and the proceedings taken at the meeting of June 30th must be deemed to be
the valid act of the corporation.

At the meeting of July 28, 1936, the following directors were present and voted to
approve and ratify the settlement: Doe, Hopkins, Morgan, Pierce, Royce and
Sanderson. The following were present but refrained from voting: Cowdin, Armsby. If
the conclusion with respect to the meeting of June 30th is correct, then there was
clearly a proper quorum at this meeting. But even if a different result were reached
concerning the earlier meeting, the meeting of July 28th would nevertheless stand
unless Sanderson were deemed disqualified by reason of his wife's stock ownership in
Standard Capital. The evidence does not suggest that Sanderson was the beneficial
owner of his wife's stock. No one testified that Sanderson held the stock in his wife's
name or that it was bought with Sanderson's funds. It appears that Sanderson's only
connection with his wife's investment in the stock was that, at Cowdin's invitation, he
suggested the stock to his wife. Sanderson's conduct, when he learned of the payment
by Field Glore to Standard Capital, was prompt, vigorous and unequivocal in favor of
Sperry. The evidence does not support the contention that he was an interested

It has been suggested that Royce was an interested director because he expected
compensation for his services as attorney in negotiating and arranging the settlement
and that Doe was likewise interested because he was an employee of the corporation
and participant in a bonus plan under which his compensation was subject to the
determination of his fellow directors. If such circumstances disqualify a director the
personnel of a great many, if not most, American corporations would have to be
reconstituted. That would not necessarily be calamitous. However, the widespread
practice of having corporate attorneys and employees on boards of directors does
indicate a fairly universal acceptance by the bar of the proposition that such
relationships do not disqualify.

It follows that the release given by the corporation to Cowdin and Standard Capital is
valid and that the claim has been properly and completely discharged.

Fortunately it is no longer necessary to cite authority for the proposition that Cowdin's
conduct constituted a breach of fiduciary duty, was wrongful and actionable. It is not to
the discredit of the defendant directors that they did not wait for the prod of minority
stockholders but vigorously asserted the corporation's claim against their fellow director
and obtained a settlement which, in view of the difficult issue of fact and the uncertainty
attending all litigation, is fair.

The other aspects of the case require no elaboration. They are disposed of in the court's
findings of fact and conclusions of law.

The complaint is dismissed.


[1] The words "void" and "voidable," used in describing corporate transactions have led
to some confusion because of the different meanings assigned to them in varying
contexts. In minority stockholders' suits these words are useful abbreviations when
employed to distinguish between transactions which can be validated by less than all
the stockholders and transactions which cannot. In the case at bar, plaintiffs have
conceded that the transaction could have been ratified and approved by a majority vote
of the stockholders.
[2] I have been unable to find in the quoted provisions of the charter the authority which
the court of appeals mentioned.