CHAPTER 1

INTRODUCTION

Use of the Term "Corporate Law"

Proper Treatment of the Corporation Code

——

USE OF TERM "CORPORATE LAW"

The reference to the whole body of laws, principles and doctrines
covering private corporations in the Philippines is referred to in this book
as "Corporate Law" in order not to confuse the use of such term with the
official name of the old Corporation Law, or Act No. 1459. 1

PROPER TREATMENT OF THE CORPORATION CODE2

Philippine Corporate Law comes from the common law system of
the United States. Although we have a Corporation Code that provides for
statutory principles, Philippine Corporate Law is essentially, and continues
to be, the product of commercial developments. Necessarily, the statutory
corporate provisions and principles are essentially representations of a
time when such principles were governing, or at best, the general
controlling influence, but by no means can be taken to indicate future
developments. Much of the development in Corporate Law can be
expected to happen in jurisprudential rules that apply and adopt corporate
principles into the changing concepts and mechanism of the commercial
world.
The Corporation Code should therefore be seen as suggesting
dated principles and practices in Corporate Law, but the real toss and
tussle, and the boiling pot for current and future Corporate Law
developments necessarily would be in commercial practices, which would
be reflected in issues and controversies put forth before the judicial
system, and some of which would be synthesized into jurisprudential law.
Once in a while of course, Congress comes up with pieces of legislation
meant to supplement or amend existing Corporate Law doctrines or rules;

1
Enacted on 1 March 1906 by the Philippine Commission, and took effect on 1 April
1906. Section 1 of Act No. 1459 specifically provides that “The short title of this Act shall
be ‘The Corporation Law.’”
2
A more detailed discussion of this approach is found in Chapter 20 on Legal
Theory of Philippine Corporate Law.
but often such legislative enactments are meant to officially incorporate
already existing commercial practices into statutory language.
The study of Philippine Corporate Law, and the interpretation and
application of the various provisions of the Corporation Code and other
suppletory statutory provisions in Philippine jurisdiction, should therefore
take their approach on what the Philippine Supreme Court held in a
leading case:3 that "Corporation Law must be given a reasonable not an
unduly harsh, interpretation which does not hamper the development of
trade relations and which fosters more friendly commercial intercourse
among countries. The objectives . . . are even more relevant today when
we view commercial relations in terms of a world economy, when the
tendency is to re-examine the political boundaries separating one nation
from another insofar as they define business requirements or restrict
marketing conditions."4

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CORP. MANUSCRIPT\01-INTRODUCTION\11-22-2002

3
Home Insurance Co. v. Eastern Shippine Lines, 123 SCRA 434 (1983).
4
Ibid, at p. 435.
 CHAPTER 2

BRIEF HISTORY OF
PHILIPPINE CORPORATE LAW

Historical Background of Philippine Corporate Law

Sociedades Anónimas
Cuentas En Participacion
The Old Corporation Law
The Corporation Code

——

HISTORICAL BACKGROUND OF PHILIPPINE CORPORATE LAW

1. Sociedades Anónimas
Prior to the arrival of the American occupying forces in the Philippine
scene, the only existing business vehicle under the Spanish colonial
administration similar to the Anglo-Saxon corporations were the sociedades
anónimas. The sociedades anónimas were introduced in Philippine jurisdiction
on 1 December 1888 with the extension to Philippine territorial application of
Articles 151 to 159 of the Spanish Code of Commerce.
Although there were similarities, such as the features of limited liability and
centralized management granted to such juridical entity, the sociedad anónima
did not exactly correspond to the notion of the corporation in English and
American law. That was particularly true with respect to matters concerning the
organization of the enterprise, the distribution of dividends, and those in which
equity intervenes for the benefit of creditors.
A sociedad anónima was considered a commercial partnership, a sort of a
corporation, “where upon the execution of the public instrument in which its
articles of agreement appear, and the contribution of funds and personal
property, becomes a juridical person—an artificial being, invisible, intangible, and
existing only in contemplation of law—with power to hold, buy, and sell property,
and to sue and be sued—a corporation—not a general copartnership nor a
limited copartnership . . . The inscribing of its articles of agreement in the
commercial register was not necessary to make it a juridical person—a
corporation. Such inscription only operated to show that it partook of the form of
a commercial corporation.”1

1
Mead v. McCullough, 21 Phil. 95,106 (1911).
 The introduction in late 1888 of the sociedades anónimas as commercial
medium of doing business did not prosper under Philippine setting, since by
1898, the American occupation had began. The American authorities lost no time
introducing into the Philippine legal system various aspects of the common law
system, especially in commercial and procedural matters, to enhance
commercial activities between the new colony and the United States.
Harden v. Benguet Consolidated Mining Co.,2 gave a vivid description on
the background on the enactment of The Corporation Law into Philippine
jurisdiction:

When the Philippine Islands passed to the sovereignty of

the United States, the attention of the Philippine Commission
was early drawn to the fact that there is no entity in Spanish
law exactly corresponding to the notion of the corporation in
English and American law; and in the Philippine Bill, approved
July 1, 1902, the Congress of the United States inserted
certain provisions, under the head of Franchise, which were
intended to control the lawmaking power in the Philippine
Islands in the matter of granting of franchises, privileges and
concessions. . . .
Under the guidance of this and certain other provisions
thus enacted by Congress, the Philippine Commission entered
upon the enactment of a general law authorizing the creation
of corporations in the Philippine Islands. This rather elaborate
piece of legislation is embodied in what is called our
Corporation Law (Act No. 1459 of the Philippine Commission).
The evident purpose of the commission was to introduce the
American corporation into the Philippine Islands as the
standard commercial entity and to hasten the day when the
sociedad anónima of the Spanish law would be obsolete. That
statute is a sort of codification of American corporate law.3

Under Section 75 of the then Corporation Law, any sociedad anónima

existing at the time of the passage of the Law was authorized at its option to
either continue doing business as such entity or to transform and be organized
under and by virtue of the provisions of the Corporation Law. In the event that it
elected to transform and re-organize under the provisions of the Corporation
Law, it was provided that the entity shall transfer all corporate interests to the
new corporation. If a stock corporation, it was authorized to issue its shares of
stock at par to the stockholders or members of the old corporation according to
their interests. The election to transform or to retain status quo was to be made
within a reasonable time from the effectivity of the Corporation Law.4

2
58 Phil. 141 (1933).
3
Ibid, at p. 145-146.
4
Benguet Consolidated Mining Co., v. Pineda, 98 Phil. 711 (1956).
 Under Section 191 of the then Corporation Law, sociedades anónimas
which did not opt to reform and organize under the Corporation Law, shall
continue to be governed by the laws that were in force prior to the passage of the
Corporation Law, particularly the provisions of the Code of Commerce on
sociedades anónimas, "in relation to their organization and method of transacting
business and to the rights of members thereof as between themselves."
Philippine jurisprudence recognized the difference between a corporation
and a sociedad anónima and did not interchange the two. In Phil. Products Co.
v. Primateria Society Anonyme Pour Le Commerce Exterieur,5 the Supreme
Court refused to apply the provisions of then Section 68 of the Corporation Law
requiring "foreign corporations" to obtain a license to do business in the
Philippines to an entity that was deemed to be a sociedad anónima.
Today, the sociedad anónima constitutes nothing more than an historical
relic under Philippine Corporate Law since no new entity can be organized and
registered as a sociedad anónima under existing laws.

2. Cuentas en Participacion
Early on, Philippine jurisprudence recognized the concept or set-up of
cuentas en participacion. Bourns v. Carman,6 described a cuentas en
participacion as a sort of an accidental partnership constituted in such a manner
that its existence was only known to those who had an interest in the same, there
being no mutual agreement between the partners, and without a corporate name
indicating to the public in some way that there were other people besides the one
who ostensibly managed and conducted the business, governed under Article
239 of the Code of Commerce.
Those who contract with the person under whose name the business of
such accidental partnership of cuentas en participacion is conducted, shall have
only a right of action against such person and not against the other persons
interested in the venture, and the latter, on the other hand, did not have any right
of action against third person who contracted with the manager unless such
manager formally transfers his right to them.7

3. The Old Corporation Law

The Corporation Law, or Act No. 1459, which was in fact the first
corporate statute in Philippine jurisdiction, became effective on 1 April 1906. It
had various piece-meal amendments during its 74-year history. It rapidly became
antiquated and not adopted to the changing times.

4. The Corporation Code

5
15 SCRA 301 (1965).
6
7 Phil. 117 (1906).
7
Ibid, at p. 120.
 The present Corporation Code, or Batas Pambansa Blg. 68, became
effective on 1 May 1980. It adopted various corporate doctrines previously
enunciated by the Supreme Court under the old Corporation Law. It clarified the
obligations of corporate directors and officers, expressed in statutory language
established principles and doctrines, and provided for a chapter on close
corporations.
The Code was enacted "to establish a new concept of business
corporations so that they are not merely entities established for private gain but
effective partners of the National Government in spreading the benefits of
capitalism for the social and economic development of the nation."8

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CORP. MANUSCRIPT\02-HISTORY OF CORPORATE LAW \\11-22-2002

8
Explanatory Note to Cabinet Bill No. 3, which became the basis for the Corporation Code
enacted by the then Interim Batasang Pambansa, and which took effect on 1 May 1980.
 CHAPTER 3

NATURE, ATTRIBUTES, AND

CLASSIFICATIONS OF CORPORATIONS

Analyzing Statutory Definition of Corporation

Theories on Formation of a Corporation
Theory of Concession
Theory of Enterprise Entity
TRI-LEVEL EXISTENCE IN CORPORATE SETTING
Corporation as a Creature of the Law
Constitutional Provision
Civil Code Provision
Franchises of Corporations
Attributes of Corporation
Artificial Being
Creature of Law
Right of Succession
Creature of Enumerated Powers, Attributes and Properties
Advantages of Corporate Form
Strong Legal Personality
Limited Liability to Investors
Free Transferability of Units of Investment
Centralized Management
Advantages over Unregistered Associations
Disadvantages of Corporate Form
Complicated and Costly Formation and Maintenance
Lack of Personal Element
Abuse of Corporate Management
Limited Liability Hits Innocent Victims
Double Taxation
Comparing the Corporation with Other Business Media
Sole Proprietorships
Partnerships
Does a Defective Incorporation Process Result Into a Partnership?
Business Trusts
Joint Ventures
Cooperatives
ENTITLEMENT OF CORPORATION TO CONSTITUTIONAL GUARANTEES
Liability of Corporations for Torts
Criminal Liability of Corporations
Entitlement to Moral Damages
NATIONALITY OF CORPORATIONS
Exploitation of Natural Resources
Owning and Operating Public Utilities
Mass Media
Advertising Industry
 War-time Test
Investment Test and Grandfather Rule
Policy of the Corporation Code on Control Test
CLASSIFICATIONS OF CORPORATIONS
In Relation to the State:
Public and Private Corporations
Distinctions Between Public and Private Corporations
Quasi-Public Corporations
As to Place of Incorporation:
Domestic Corporations
Foreign Corporations
As to Legal Status:
Corporation De Jure
Corporation De Facto
Corporation by Estoppel
Corporation by Prescription
As to Existence of Shares of Stock:
Stock Corporations
Non-Stock Corporations
As to Relationship of Management and Control
Holding Company
Affiliate Company
Parent and Subsidiary Companies

——

ANALYZING THE STATUTORY DEFINITION OF THE CORPORATION1

. . . A corporation is an artificial being created by

operation of law, having the right of succession and the
powers, attributes and properties expressly authorized by law
or incident to its existence.2

The corporate entity is a medium, one of many available to businessmen,

by which commercial activities can efficiently be undertaken. Although under
Section 2 of the Corporation Code, a corporation is a juridical entity with a
personality separate and distinct from the members or stockholders that
compose it, in reality a corporation is but a fiction extended by law to investors,
managers and businessmen by which to conduct their affairs in the business
world.

1
This portion is taken from the introduction of the published article entitled "Corporate
Contract Law: Unifying Theme on Theories Relating to Promoter's Contracts, De Facto
Corporations, Corporations by Estoppel, Articles of Incorporation, By-Laws, and Ultra Vires Acts,"
37 ATENEO L.J. 1 (No. 2, June 1994).
2
Sec. 2, Corporation Code.
 The present statutory definition of the corporation is essentially a narrow
and antiquated view of the corporate vehicle. It looks at only one aspect—the
relationship between the corporation and the State—of the otherwise
multifaceted relationships that a corporation would have in the business
environment. The statutory definition views the corporation merely as a creature
of the law, when actually juridical personality is merely one aspect of corporate
existence. The corporate setting embodies contractual relationships of varying
degrees, and consequently, principles of Contract Law, Agency Law, and even
Labor Law, tend to be enmeshed into Corporate Law principles. The resulting
interactions between principles of Corporate Law and other legal disciplines have
continued to create tension and sometimes hybrid legal products, that animate
the Philippine legal system.

THEORIES ON FORMATION A CORPORATION

Two basic theories have evolved on the formation of a corporation and its
capacity to act in the commercial world.

1. Theory of Concession
Tayag v. Benguet Consolidated, Inc.,3 characterized a corporation as an
artificial being, created by operation of law. . . "It owes its life to the state, its birth
being purely dependent on its will."
Tayag expressly denied the application of the genossenschaft theory
enunciated by Friedmann4 which treated a corporation as "the reality of the group
as a social and legal entity, independent of state recognition and concession." 5 It
held that a corporation is "a creature without any existence until it has received
the imprimatur of the state acting according to law," and that "[i]t is logically
inconceivable therefore that it will have rights and privileges of a higher priority
than that of its creator. . . [and] cannot legitimately refuse to yield obedience to
acts of its state organs, certainly not excluding the judiciary whenever called
upon to do so."6
Ang Pue & Co. v. Secretary of Commerce and Industry,7 would hold that to
"organize a corporation or a partnership that could claim a juridical personality of
its own and transact business as such, is not a matter of absolute right but a
privilege which may be enjoyed only under such terms as the State may deem
necessary to impose."
Torres v. Court of Appeals,8 in invalidating the act of the principal
stockholder of a family corporation in canceling stock certificates and issuing new
3
26 SCRA 242, 252 (1968)
4
LEGAL THEORY, pp. 164-168 (1947); also Holdsworth, English Corporation Law, 31 YALE
L.J. 382 (1922).
5
26 SCRA 242, 253.
6
Ibid.
7
5 SCRA 645, 647 (1962).
8
278 SCRA 793 (1997).
once and not coursing the same through the Corporate Secretary, held that “[a]ll
corporations, big or small, must abide by the provisions of the Corporation Code.
Being a simple family corporation is not an exemption. Such corporations cannot
have rules and practices other than those established by law.”
Under the theory of concession, although fiction cannot be created unless
there is an enterprise or group upon whom it may be conferred, and in spite of
the underlying contract among the persons wanting to form the corporation, the
grant is only by virtue of a primary franchise given by the State. It is within the
power of the State whether to grant it or not. The theory of concession is also the
underlying basis for the ultra vires doctrine.
The theory of concession, therefore, looks at a corporation simply as a
creature of the State, completely within the control of the latter. This is the theory
covered by Section 2 of the Corporation Code as it defines a corporation.

2. Theory of Enterprise Entity

Under the enterprise theory, the entity commonly known as "corporate
entity" takes its being from the reality of the underlying enterprise, formed or in
formation; that the state's approval of the corporate form sets up a prima facie
case that the assets, liabilities and operations of the corporation are those of the
enterprise. But that where the corporate entity is defective, or otherwise
challenged, its existence, extent and consequences may be determined by the
actual existence and operations of the underlying enterprise, which by these very
qualities and operations acquires an entity of its own, recognized by law. 9
The enterprise theory is meant to cover the situations where the courts
have either: (a) erected corporate personality which the state had not granted; or
(b) disregarded corporate personality where the state had granted it; both for the
purpose of giving legal effect to factual relationships set up between an economic
entity and an outsider.10 As the exponent of the theory had written, "The
corporation is emerging as an enterprise bounded by economics, rather than as
an artificial juridical personality bounded by forms of words in a charter, minute
books, and books of account."11
The theory draws is vitality from the fact that it is not legal fiction alone that
creates a corporate entity. Any State grant must presuppose the existence of
consent or common venture among those who will form the corporation. Although
it is within the power of the State to give such grant or to deny it, the corporate
fiction cannot be created unless there is an enterprise or group upon whom it
would be conferred. But once granted, and the entity acquires juridical
personality, it does not mean that the group, as distinguished from the juridical
entity, becomes a creature of the State, but actually becomes a creature of its
own volition and maintains either singly or collectively their inherent rights under

9
Berle, The Theory of Enterprise, 47 COL. L. REV. No. 3 (April, 1947).
10
Ibid, at 345.
11
Ibid.
the law, which may tend to project to their business dealings done through the
corporation.
Although generally the enterprise entity theory has to a great extent been
discarded in American corporate literature, its basic flaw may not pertain to
Philippine setting because we have in our jurisdiction a different principle on
juridical personality. While under American common law, a partnership does not
have a personality separate and distinct from the partners, under Philippine civil
law tradition, although a partnership is inherently a contractual relationship, the
Civil Code grants to it a personality separate and distinct from the partners.12
Therefore, other than a general code provision granting it a juridical personality,
the partnership personality becomes a reality by two or more persons deciding to
contribute money, property or industry to a common fund with the intention of
dividing the profits among themselves without need of a grant of specific
authority by the state.
To a great extent, once a corporate entity comes into being it has certain
rights almost independent of the whims of its creator. Even though the
corporation is a creature of the State, the underlying relationship is still
composed of moral individuals who are not at all creatures of the State. For
example, the State would not destroy the group nor the business, without
observing the due process clause of the Constitution. In Bache & Co. (Phil.), Inc.
v. Ruiz,13 the Court held that a corporation is entitled to immunity against
unreasonable searches and seizures. It recognized that "[a] corporation is, after
all, but an association of individuals under an assumed name and with a distinct
legal entity. In organizing itself as a collective body it waives no constitutional
immunities appropriate for such body. Its property cannot be taken without
compensation. It can only be proceeded against by due process of law, and is
protected against unlawful discrimination."
In Philippine Stock Exchange, Inc. v. Court of Appeals,14 the Court
recognized that “[a] corporation is but an association of individuals, allowed to
transact under an assumed corporate name, and with a distinct legal personality
[and that in] organizing itself as a collective body, it waives no constitutional
immunities and perquisites appropriate to such a body.” The Court held that
although the Securities and Exchange Commission (SEC), under the Revised
Securities Act, Pres. Decree 902-A, and other pertinent laws, has been entrusted
the serious responsibility of enforcing all laws affecting corporations and other
forms of associations not otherwise vested in some other government office,
nevertheless, the SEC did not have absolute control on the management
prerogatives of the Board of Directors of the Philippine Stock Exchange (PSE),
12
Art. 1768 of the Civil Code provides: “The partnership has a juridical personality separate
and distinct from that of each of the partners,” even in case of failure to comply with the
requirements of the law on registration. In contrast there now provision in the Corporation Code
that expressly provides a juridical personality of a corporation “separate and distinct from that of
each of the stockholders or members” that compose it. See also Campos Rueda & Co. v. Pacific
Commercial Co., 44 Phil. 916 (1922).
13
37 SCRA 823 (1971).
14
281 SCRA 232, 88 SCAD 589 (1997).
since the “PSE is, after all, a corporation authorized by its corporate franchise to
engage in its proposed and duly approved business.”
The enterprise theory therefore hinges itself on the fact that there can be
no corporate existence without persons to compose it; there can be no
association without associates.15 The separate juridical existence granted to a
corporation is mere legal fiction, and therefore whenever necessary for the
interests of the public or for the protection or enforcement of the rights of the
members, courts will disregard the legal fiction and operate upon both the
corporation and the persons composing it.
The recognition of the organizational existence of a groups of individuals
extant any State grant or recognition is now more recognized in the case of
unincorporated associations. On matters involving affairs of an unincorporated
association, such as election contests for officers of civic clubs, the courts
generally will not interfere in the ruling of its policy-making body.16 If the State
would consider binding among the associates in an unincorporated associations
their acts and actuations, then the more so in a duly incorporated association,
which has a juridical personality.
To a great extent, this underlying relationship between and among
individuals as the root of every corporate setting is recognized and reinforced by
the Corporation Code itself that requires that no corporation can be organized
unless formed by "[a]ny number of natural persons not less than five (5) but not
more than fifteen (15), all of legal age and a majority of whom are residents of
the Philippines."17

TRI-LEVEL EXISTENCE IN CORPORATE SETTING

In considering developments in Corporate Law, there are in the corporate
setting three (3) “levels of existence,” thus:
First, the corporation as a juridical entity or a juridical fiction, which views
the relationship between the State and the corporation.
Second, the corporate setting provides for contractual relationships on
four (4) sub-levels, namely:

(a) Between the corporation and its agents or representatives to

act in the real world, such as its directors and its officers,
governed suppletorily by the Law on Agency;
(b) Between the corporation and its shareholders or members;
(c) Between and among the shareholders in a common venture;
and

15
Arnold v. Willets & Patterson, Ltd. 45 Phil. 634 (1923).
16
Lions Club International v. Amores, 121 SCRA 621 (1983).
17
Sec. 10, Corporation Code.
 (d) Between the corporation and third parties or "outsiders",
which is essentially governed by Contract Law; and Labor
Law when it comes to relationship with officers and
employees.

Third, the corporation becomes in its operation a business economic unit,

a business enterprise, or what is called in Accounting as a "going concern."18
Being well-aware of the tri-level existence in the corporate setting provides
a better way to explain the varying and interweaving doctrines prevailing in
Corporate Law. Although the Supreme Court would declare that there is a need
"to put an end to the fiction that corporations are people,"19 nevertheless it would
make the corporation liable for torts,20 or sooner pierce the veil of corporate
fiction and make the individual members of the corporation answerable for
corporate liabilities, when even without doing so, no obstacles are thrown in the
way of obtaining justice.21
In practice the piercing of the veil of corporate fiction is achieved only by
looking at the corporation as an aggregation of individuals doing business; thus,
the Supreme Court looks at the underlying association of individuals in a
corporate setting. "Corporations are composed of natural persons and the legal
fiction of a separate corporate personality is not a shield for the commission of
injustice and inequity."22 In the first case23 where the Philippine Supreme Court
applied the piercing doctrine, it had to concede the underlying association of
individuals in a corporate setting:

The proposition that a corporation has an existence

separate and distinct from its membership has its
limitations. It must be noted that this separate existence is
for particular purposes. It must also be remembered that
there can be no corporate existence without persons to
compose it; there can be no association without
associates.24

18
VALIX & PERALTA, FINANCIAL ACCOUNTING (Vol. One), 1976 ed., pp. 13 and 18.
19
Luzon Brokerage Co., Inc. v. Maritime Building Co., Inc., 86 SCRA 305 (1978).
20
Philippine National Bank v. Court of Appeals, 83 SCRA 237 (1978)
21
See more exhaustive discussions in Chapter 4 on Corporate Juridical Personality and
Doctrine of Piercing the Veil of Corporate Fiction.
22
Tan Boon Bee & Co., Inc. v. Jarencio, 163 SCRA 205 (1988).
23
Arnold v. Willits & Patterson, Ltd., 44 Phil. 634 (1923).
24
Ibid, at p. 644, quoting THOMPSON ON CORPORATIONS, 2d ed. Vol. I, Sec. 10.
CORPORATION AS A CREATURE OF THE LAW
1. Constitutional Provisions
The power to create corporations is one of the attributes of sovereignty. 25
The exercise of the power is legislative in character, and that Legislature may,
subject to the restrictions of the Constitution, create a particular corporation by
direct act, or make provisions, by general law, for the organization of
corporations by natural persons upon compliance with the prescribed
conditions.26
Under the Constitution,27 Congress cannot, except by general law, provide
for the formation, organization, or regulation of private corporations. The same
constitutional provisions allows government-owned or -controlled corporations to
be created or established by special charters in the interests of the common
good and subject to the test of economic viability. Consequently, it has been held
that a private corporation created pursuant to a special law is a nullity, and such
special law is unconstitutional for being violative of the Constitution.28
The constitutional provision taking away from Congress the power to grant
specific franchises to private corporations comes from a history of corruption
when such power was exercised by Legislatures in common law jurisdiction,
where only the rich and powerful could obtain such franchises, and therefore be
able to have monopolies of certain endeavors.
In Philippine jurisdiction, the Corporation Code is the general law under
which private corporations are organized pursuant to the mandates of the
Constitution.29

2. Civil Code Provisions

Under Article 44 of the Civil Code of the Philippines, other than the State
and its political subdivisions, and other corporations, institutions and entities for
public interest or purpose, the law recognizes corporations, partnerships and
associations for private interest or purpose to which are granted “a juridical
personality, separate and distinct from that of each shareholder, partner or
member.”
Under Article 45 of the same Code, the juridical persons organized as
public corporations are governed by the laws creating or recognizing them, while
private corporations are regulated by laws of general application on the subject.
Partnerships and associations for private interests or purpose are governed by
the provisions of the Civil Code concerning partnerships.
25
McCullough v. Maryland, 4 Wheat. 316, 4 L.Ed. 579.
26
FISHER, THE PHILIPPINE LAW ON STOCK CORPORATIONS, (1929 Ed.), p. 3.
27
Sec. 16, Art. XII of the 1987 Constitution.
28
NDC v. Phil. Veterans Bank, 192 SCRA 257 (1990).
29
Likewise it is the Corporation Code that is the central statutory component of the "laws of
general application" referred to under Art. 45 of the Civil Code which provides: "Private
corporations are regulated by laws of general application on the subject."
 3. Franchises of Corporations
J.R.S. Business Corp. v. Imperial Insurance, Inc.,30 recognized the
differences between the primary franchise and secondary franchise of a
corporation. "For practical purposes, franchises, so far as relating to
corporations, are divisible into (a) corporate or general franchises; and (b) special
or secondary franchises. The former is the franchise to exist as a corporation,
while the latter are certain rights and privileges conferred upon existing
corporations, such as the right to use the streets of a municipality to lay pipes or
tracks, erect poles or string wires . . . The primary franchise of a corporation, that
is, the right to exist as such, is vested in the individuals who compose the
corporation and not in the corporation itself and cannot be conveyed in the
absence of a legislative authority so to do. But the special or secondary
franchises of a corporation are vested in the corporation and may ordinarily be
conveyed or mortgaged under a general power granted to a corporation to
dispose of its property, except such special or secondary franchises as are
charged with a public use."31

ATTRIBUTES OF THE CORPORATION

From the statutory definition of a corporation, the following four basic
attributes are often ascribed to the corporate entity:
1. Artificial Being
It is the fiction of law which creates the "person" of the corporation. By
operation of law, it becomes a being with the attributes of an individual with full
capacity to enter into contractual relations. It is a legal or juridical person with a
personality separate and distinct from its individual members.
As was held in Vazquez v. Borja,32 "[i]t is well known that a corporation is
an artificial being invested by law with a personality of its own, separate and
distinct from that of its stockholders and from that of its officers who manage and
run its affairs. The mere fact that its personality is owing to a legal fiction and that
it necessarily has to act thru its agents, does not make the latter personally liable
on a contract duly entered into, or for an act lawfully performed by them, for and
in its behalf. The legal fiction by which the personality of a corporation is created
is a practical reality and necessity. Without it, no corporate entities may exist and
no corporate business may be transacted."33

2. Creature of the Law

The juridical existence of a corporation is dependent on the consent or
grant of the sovereign. From a strict legal point of view, a corporation cannot

30
11 SCRA 634 (1964).
31
Ibid, p. 638, quoting from Gulf Refining Co. v. Cleveland Trust Co., 108 So., 158.
32
74 Phil. 560 (1944).
33
Ibid, at pp. 566-567.
come into being by mere consent of the parties; there must be a law granting it,
and once granted form the primary franchise of the corporation.
There must first be an underlying contract among the individuals forming
the corporation upon which the state grant may be conferred. Therefore, you
have an inter-play of State grant and contractual relations between the parties.
Which principle has precedence in resolving conflict would depend upon the
public interest or issue to be resolved. This issue is discussed more in details in
Chapter IV, on Corporate Contract Law.

3. Right of Succession
The corporation has the capacity for continuous existence despite the
death or replacement of its shareholders or members, for it has a personality
separate and distinct from those who compose it. The strong legal personality of
the corporation is an attribute that has made it most attractive to businessmen
when compared to other media.

4. Creature of Enumerated Powers,

Attributes and Properties
Under the classic concession theory, once a corporation has been granted
juridical personality by the State, it is allowed and can legally exercise only such
powers granted by the law for its creation, as opposed to a natural person, who
has the ability to exercise any power and enter into any business activity and the
only limitation would be that an individual has no right to enter into an act or
transaction that is contrary to law, morals and public policy. In other words,
Section 2 of the Corporation Code which provides that a corporation as “having
the . . . powers, attributes and properties expressly authorized by law or incident
to its existence,” defines every corporation to be a creature of limited powers.
This is the old and narrow view of the corporation as a creature of the law.

ADVANTAGES OF CORPORATE FORM

1. Strong Legal Personality
The corporation has a legal capacity to act and contract as a distinct unit
in its own name; and it has continuity of existence. As distinguished from a
partnership, it has a strong legal personality having a separate and distinct
personality from the members composing it, unaffected by the death, resignation,
insolvency of any of its stockholders or members. Its credit-worthiness and the
certainty of long-term contractual dealings with a stable person, are strengthened
by such continuity of existence.
In addition, a corporation's creation, organization, management and
dissolution are standardized as they are governed by a general incorporation
law, and therefore, the commercial practice and jurisprudential law governing
corporations tend to be more established and reliable when compared to other
media of doing business. Likewise, the constitution of the Securities and
Exchange Commission as the administrative agency granted quasi-judicial power
over controversies and issues governing corporations and corporate matters, has
allowed a more efficient system focused on the special field and consistent
stream of decisions on Corporate Law coming from a single agency.
With the enactment of the Securities Regulation Code,34 which has
transferred all corporate cases and issues to the jurisdiction of the regular courts,
the tradition of allowing a specialized forum to handle corporate matters and
issues has been retained since under the Administrative Memorandum No. 00-
11-03-SC35 of the Supreme Court, only designated Regional Trial Court branches
in each regional district in the country, whose presiding judges are well-versed in
corporate and commercial development, are granted exclusive jurisdiction to
hear and decide on corporate cases under Section 5 of Pres. Decree 902-A.

2. Limited Liability to Investors

The Supreme Court has defined the limited liability feature of corporate
entities as follows:

One of the advantages of a corporate form of business

organization is the limitation of an investor‟s liability to the
amount of the investment. This feature flows from the legal
theory that a corporate entity is separate and distinct from its
stockholders. However, the statutorily granted privilege of a
corporate veil may be used only for legitimate purposes. On
equitable considerations, the veil can be disregarded when it is
utilized as a shield to commit fraud, illegality or inequity; defeat
public convenience; confuse legitimate issues; or serve as a
mere alter ego or business conduit of a person or an
instrumentality, agency or adjunct of another corporation.36

The liability of investors in a corporation is limited to their shares as

distinguished from partnerships where even if the assets of the partnership are
already exhausted, creditors can still go after the individual properties of the
partners. In a partnership, an investor can lose everything he owns even when
not intended for the venture,37 while this is not the case in corporations.

34
Subsec. 5.2 of Republic Act No. 8799.
35
Dated 21 November 2000.
36
San Juan Structural and Steel Fabricators, Inc. v. Court of Appeals, 296 SCRA 631, 645,
99 SCAD 281, 298 (1998).
37
Art. 1816 of the Civil Code provides that “All partners are liable pro rata with all their
properties and after partnership assets have been exhausted, for all partnership debts.
Art. 1817 provides that “Any stipulation against personal liability of partners for partnership
debts is void, except as among them.”
Art. 1824, provides that “All partners are liable solidarily with the partnership for everything
chargeable to the partnership when caused by the wrongful act or omission of any partner acting
 Of course, through contractual stipulations, there are many ways to go
around the limited liability feature of a corporation and to make major
shareholders still liable for more than their actual or promised investments in the
corporation. For example in case of bank loans, bankers sometimes demand
additional security or may require that in addition corporate officers make
themselves also personally liable for the corporate debt.
The advantage of the corporate setting is the default rule of limited liability
affords a more efficient means to encouraging investments in the venture, and
additional economic cost is spent only when parties attempt to go around the
limited liability feature. A corporation and its stockholders may therefore choose
whether or not to concede the advantage or protection of limited liability, while in
a partnership, there is already an implied contract that if the partnership's assets
are insufficient, the partners separate properties would be liable.

3. Free Transferability of Units of Investment

In a corporate setting, as a general rule, the shares of stocks can be
transferred without the consent of the other stockholders. This would assure
investors of a ready mechanism to dispose of their investments when their
personal or financial situation may require it, and therefore places more liquidity
in the corporate setting and would better encourage investors to do channel their
investments through corporate vehicles.
However, the system of free transferability of the units of investments in
the corporate setting presumes a well-developed market for shares of stocks.
Clark opines that the corporate vehicle flourishes best in a society where the
distribution of wealth, although by no means equal, is not extremely lopsided, so
that large amounts of money capital needed to launch and sustain large business
enterprises must be collected and aggregated into usable pools. Business must
solicit investors on a mass scale, not merely by private negotiations with a
handful of very rich people.38

4. Centralized Management
A corporation's management is centralized in the board of directors.
Shareholders are not agents of the corporation, nor can they bind the
corporations, unlike in a partnership setting, where each partner may bind the
partnership,39 even without the knowledge of the other partners. Therefore, in its
legal relationship, a corporation presents a more stable and efficient system of
governance and dealings with third parties, since management prerogatives are
centralized in its board of directors. By imposition of law, and except in

in the ordinary course of business of the partnership or with authority from the other partners and
for partner‟s act or misapplication of properties.”
38
CLARK, CORPORATE LAW, (Little Brown and Company, 1986 ed.), p. 3.
39
In the absence of contractual stipulation, all partners shall be considered agents and
whatever any one of them may do alone shall bind the partnership. Arts. 1803(1) and 1818, Civil
Code.
particularly designated instances, stockholders are bound by the management
decisions and transactions of the board of directors of the corporation, whether
they like it or not.

5. Advantages Over Unregistered Associations

A corporation established in accordance with the Corporation Code has
benefits or advantages over that of an unregistered association. These
advantages are: It enjoys perpetual succession under its corporate name and in
an artificial form; it has the capacity to take and grant property, and contract
obligations; it can sue and be sued in its corporate name as a juridical person; it
has the capacity to receive and enjoy common grants of privileges and
immunities; and its stockholders or members have generally no personal liability
beyond the value of their shares.40 The advantages of the corporation over
unregistered association is subject to the rules pertaining to the corporation by
estoppel doctrine.41
Article 1775 of the Civil Code provides that associations and societies,
whose articles are kept secret among the members, and wherein any one of the
members may contract in his own name with third persons, shall have no juridical
personality, and shall be governed by the provisions relating to co-ownership.

DISADVANTAGES OF CORPORATE FORM

1. Complicated and Costly Formation and Maintenance
The corporation is relatively complicated in formation and management.
When compared to other media like the single proprietorship or the partnership,
the corporation entails relatively high cost of formation and operation. There is a
greater degree of governmental control and supervision than in other forms of
business organization.

2. Lack of Personal Element

There is ordinarily lack of personal element in view of the transferability of
shares, and the vesting of management powers in the board of directors who
may be professional managers. This has spawned corporate irresponsibility.

3. Abuse of Corporate Management

In large corporations, management and control are separated from
ownership; there is a severance of control and ownership. Control is vested in
the board of directors. The stockholder's voting rights have become theoretical
particularly in large corporations because of the use of the proxies and
widespread ownership. In a practical sense therefore, investors have very little
voice over the conduct of business of the corporation.
40
SEC Opinion, 26 June 1989, XIII SEC QUARTERLY BULLETIN, 19-20 (No. 3, Sept. 1989)
41
See Chapter 5 on Corporate Contract Law.
 4. Limited Liability Hits Innocent Victims
The limited liability feature of the corporation has often been abused by
business in order to avoid having to provide adequate protection and
compensation for victims of the business ventures they undertake. Also the
limited liability feature has tended to increase transaction cost by the parties
being forced to enter into contractual schemes skirting the limited liability features
of the corporation when it is a party to a transaction.

5. Double Taxation
The corporation has traditionally been subjected to heavier taxation than
other forms of business organizations; the profits of the corporation which are
already subjected to corporate income tax when declared and distributed as
dividends to the stockholders are again subjected to further income tax.
With the trust of Government to encourage both local and foreign
investments in the country, and to entice the use of the corporation as the vehicle
for such investments, many of the previous tax laws that tended to make
corporate vehicles expensive have been abolished. Except for dividends
declared by domestic corporation in favor of foreign corporation,42 dividends
received by individuals from corporation,43 as well as inter-corporate dividends
between domestic corporations,44 were subject to zero rate of income taxation.
There had also been an abolition of the personal holding companies tax and tax
on unreasonably accumulated surplus of corporations.45
However, with the passage of the Tax Reform Act of 1997, beginning
1998, there has been imposed the following tax burdens on the means of doing
business through the medium of the corporation:

(a) Re-imposition of final tax on cash and property dividends

received by individuals from domestic corporations;46
(b) Imposition of minimum corporate income tax at 2% of gross
income on the fourth taxable year from commencement of
business operations, when the minimum income tax is
greater than the regular corporate income tax;47 and
(c) Re-imposition of improperly accumulated earnings tax at the
rate of 10% of the defined improperly accumulated taxable
income.48

42
Sec. 25(a) and (b), National Internal Revenue Code of 1977.
43
Sec. 21, National Internal Revenue Code of 1977.
44
Sec. 24, National Internal Revenue Code of 1977.
45
Executive Order No. 37 (1986).
46
Sec. 24(B)(2), National Internal Revenue Code of 1997.
47
Sec. 27(E), National Internal Revenue Code of 1997.
48
Sec. 29, National Internal Revenue Code of 1997.
COMPARING THE CORPORATION WITH
OTHER MEDIA OF BUSINESS ENDEAVORS
1. Sole Proprietorships
Sole proprietorships are less saddled with the many requirements and
regulations which corporations are often subjected to by law. The owner is in
command of his whole business and he stands to lose as much as he puts in and
even more to the extent of all his personal holdings.
This is in contrast to a corporation where control belongs to the board of
directors, and there is limited liability on the part of the shareholders.
Consequently, sole proprietorships work well only for carrying-on simple or
small business endeavors, and do not function well in cases of large enterprises
which require huge capital investments and specialized management skills.

2. Partnerships49
Article 1768 of the Civil Code provides that the partnership has a juridical
personality separate and distinct from that of each of the partners, even in case
of failure to comply with the registrations requirements of the Code.50
The most important distinction between the corporation and the
partnership are their legal capacities. A corporation has a stronger legal
personality, enabling it to continue despite the death, insolvency or withdrawal of
any of its stockholders or members. In a partnership, the withdrawal, death or
insolvency of any partner would automatically bring about the dissolution of the
partnership.51
Limited liability is a main feature in a corporate setting, whereas partners
are liable personally for partnership debts not only to what they have invested in
the partnership but even as to their other properties.52
Generally, every partner is an agent of the partnership53 and by his sole
act, he can bind the partnership,54 whereas in a corporation, only the board of
directors or its agents can bind the corporation.

a. Does a Defective Incorporation Process

Result into a Partnership?
The clear distinctions between the corporation and partnership can best
be illustrated by discussing the issue of whether a defective incorporation would
at least result into a partnership.

49
Please see capsule on Philippine Partnership Law, Appendix A.
50
See Art. 1772, first paragraph, Civil Code.
51
Arts. 1828 and 1830, Civil Code.
52
Arts. 1816, 1817, 1824, and 1839, Civil Code.
53
Arts. 1803(1), 1818, and 1819, Civil Code.
54
Arts. 1822 and 1823, Civil Code.
 When five or more persons come together to contribute money or property
to a venture with the intention of receiving profits therefrom and intending to form
a corporation, but because of certain defects no corporation is formed under the
law, do we then consider at the very least, that a partnership with a separate
juridical personality has been created? The author believes that the answer
would be in the negative, based on two grounds:
First, both corporate and partnership relationship are fundamentally
contractual relationship created by the co-venturers who consent to come
together under said relationship. If the parties had intended to create an
association in the form of a corporation, a partnership cannot be created in its
stead since such is not within their intent, and therefore does not constitute a part
of their consent to the contractual relationship.
Second, the important differences between the corporation and the
partnership cannot lead one to the conclusion that in the absence of the first, the
contracting parties would have gone along with the latter. Limited liability,
centralized management and easy transferability of the units of ownership in a
corporation are by themselves strong factors for parties' intention to be bound in
the corporate relationship, and one cannot presume that if these features are not
met that they would in the alternative wish to be covered by a partnership
relationship, which has generally would involve unlimited liability, mutual agency
among the partners, and the delectus personarum feature.
It is the legal principle that when parties come together and all the
elements of a particular contract are present, although the parties may have
nominated it otherwise, the law will impose such contractual relationship upon
them. In other words, the contract or relationship is what the law says it is, not
how the parties wish to call it. Therefore, when five or more persons come
together to contribute money or property to a common venture or fund with the
intention of dividing the profits among themselves, the parties may wish to call it
otherwise; however, under the definition of the Article 1767 of the Civil Code, it
would still be a partnership, even if the parties had intended a corporation but did
not materialize because of certain registration deficiencies.
Nevertheless, such principle cannot apply, since the essence of what
constitutes the contractual relationship of partnership under Article 1767 is the
coming "together" or what is known in partnership law as "delectus personarum"
and not just the joint venture. The essence of partnership is the personal
relationship, i.e., that each would-be partner goes into the venture precisely
because he wants the other co-venturers, and no other persons, to be with him in
the venture. A venturer who seeks to enter into a corporate relationship perhaps
does not even care about the personality of the other co-venturers, and fully
aware that he himself and others have the ability to transfer their investments to
outsiders.
On the other hand, there seems to be indications of contrary view to the
above. Under Section 21 of the Corporation Code, when parties act and pretend
to be a corporation, when in fact none exist, the law would impute to them a
juridical personality to validate the contract under the corporation by estoppel
doctrine; however, it would treat the parties as partners since it expressly makes
them liable as "general partners."
Under such contrary view, the main issue would be the priority between
the personal creditors of the "partners" in a corporation by estoppel doctrine, and
the "corporate" creditors of the corporation by estoppel, as to the assets invested
into the venture. The author would presume that it would have to be the
corporate creditors that would have priority over the “corporate” assets as this
seems to be the moving spirit of the corporation by estoppel doctrine.
This position of the author has been partially justified by the discussions of
the Supreme Court in Pioneer Insurance & Surety Corp. v. Court of Appeals,55
when it resolved the issue of "What legal rules govern the relationship among co-
investors whose agreements was to do business through the corporate vehicle
but who failed to incorporate the entity in which they had chosen to invest?" 56
Quoting from American jurisprudence, the Supreme Court in Pioneer
Insurance held that there has been the position that as among themselves the
rights of the stockholders in a defectively incorporated association should be
governed by the supposed charter and the laws of the state relating thereto and
not by the rules governing partners,57 nevertheless it has been held that
“ordinarily persons who attempt, but fail, to form a corporation and who carry on
business under the corporate name occupy the position of partners inter se,58
and their rights as members of the company to the property acquired by the
company will be recognized.”59
Notwithstanding the foregoing, the Supreme Court took the position that
such partnership relationship does not exist, "for ordinarily persons cannot be
made to assume the relation of partners, as between themselves, when their
purpose is that no partnership shall exist . . . and it should be implied only when
necessary to do justice between the parties; thus, one who takes no part except
to subscribe for stock in a proposed corporation which is never legally formed
does not become a partner with other subscribers who engage in business under
the name of the pretended corporation, so as to be liable as such in an action for
settlement of the alleged partnership and contributions. . . A partnership relation
between certain stockholders and other stockholders, who were also directors,
will not be implied in the absence of an agreement, so as to make the former
liable to contribute for payment of debts illegally contracted by the latter.60 Nor will
it make the investor to a would-be corporation liable for losses sustained from its

55
175 SCRA 668 (1989).
56
Ibid, at p. 681.
57
Quoting from CORPUS JURIS SECUNDUM which cited Cannon v. Brush Electric Co., 54 A.
121, 96 Md. 446, 94 Am. S.R. 584.
58
Ibid, citing Lynch v. Perryman, 119 P. 229, 29 Okl. 615, Ann. Cas. 1913 A. 1065.
59
Ibid, citing Smith v. Schoodoc Pond Packing Co., 84 A, 268m 109 Me. 555; Whipple v.
Parker, 29 Mich 369.
60
Ibid, at p.683, quoting from CORPUS JURIS SECUNDUM, Vol. 68, p. 464.
operations under a partnership inter se theory.”61 The key elements in resolving
the issue seem to have been in Pioneer Insurance those of intent and
participation in business activities.
The doctrinal pronouncement is Pioneer Insurance can be summarized as
follows: When parties come together intending to form a corporation, but no
corporation is formed due to some legal cause, then:

(a) Parties who had intended to participate or actually

participated in the business affairs of the proposed
corporation would be considered as partners under a de
facto partnership, and would be liable as such in an action
for settlement of partnership obligations; whereas,
(b) Parties who took no part except to subscribed for stock in a
proposed corporation, do not become partners with other
subscribers who engaged in business under the name of the
pretended corporation, and are not liable for action for
settlement of the alleged partnership contribution.

The doctrinal pronouncements in Pioneer Insurance are consistent with

the distinctions between an investor in partnership venture, where there is a clear
intent to participate in the management of the partnership business and for which
limited liability is not afforded by law; and an investor in a corporation, where
under the principal of centralized management, there is no intent to participate in
the corporate operations, and for which limited liability is afforded by law.

3. Business Trusts
As compared to a corporation, a business trust is simply a deed of trust
which is easier and less expensive to constitute for it is not bound by any legal
requirements like the former. It does not have a separate juridical personality,
and is mainly governed by contractual doctrines and the common law principles
on trust. Trust relationship is centered upon properties, and which places naked
titled in the trustee, and beneficial title in the beneficiary.

4. Joint Ventures62
The Supreme Court has held that the legal concept of a joint venture is of
common law origin, and has no precise legal definition. Under Philippine law, a
joint venture is a form of partnership and should thus be governed by the law of
partnerships,63 which would then include the features of separate juridical
personality, mutual agency among the co-venturers, and unlimited liability.

61
Ibid, at p. 685.
62
For a more comprehensive discussion on joint ventures, see Appendix C on Philippine
Law on Joint Ventures.
63
Aubach v. Sanitary Wares Mfg. Corp., 189 SCRA 130 (1989). In that case the Supreme
Court held also: "It has been held that while generally a corporation cannot enter into a
 The element of a joint ventures, being basically those of the partnership,
has been affirmed in Kilosbayan, Inc. v. Guingona, Jr.:64

Joint venture is defined as an association of persons or

companies jointly undertaking some commercial enterprise;
generally all contribute assets and share risks. It requires a
community of interest in the performance of the subject matter,
a right to direct and govern the policy in connection therewith,
and duty, which may be altered by agreement to share both in
profit and losses. the acts of working together in a joint
project.65

5. Cooperatives66
A cooperative is a duly registered association of persons, with a common
bond of interest, who have voluntarily joined together to achieve lawful common
social or economic end, making equitable contributions to the capital required
and accepting a fair share of the risks and benefits of the undertaking in
accordance with universally accepted cooperative principles.67
A cooperative, like an ordinary corporation, has a juridical personality
separate and distinct from its members, and has limited liability feature. 68
Unlike an ordinary corporation, cooperatives are governed by principles of
democratic control where the members in primary cooperatives shall have equal
voting rights on a one-member-one-vote principle;69 where the board of directors
manages the affairs of the cooperative, but it is the general assembly of full
membership that exercises all the rights and performs all of the obligations of the
cooperative;70 and are under the supervision and control of the Cooperative
Development of Authority71 and not the SEC.
Unlike an ordinary stock corporation which is organized for profit, and a
non-stock corporation which can be organized for any eleemosynary purpose
and no part of the net income is to be distributed to the officers and members
thereof, the primary objective of every cooperative is self-help: "to provide goods

partnership contract, it may however engage in a joint venture with others. Some features of a
joint venture agreement, carried out in the form of a corporation, are that a minority group is given
a specified number of seats in the board of directors, i.e., three directors in a board of nine
directors; the minority group is entitled to designate a member of the executive committee and his
vote is required for certain transactions; the quorum is required for amendment of the articles and
by-laws is more than the number specified in the law, i.e. 75 % of outstanding shares of stock."
64
232 SCRA 110, 143 (1994).
65
Ibid, citing BLACK‟S LAW DICTIONARY, Sixth ed., at p. 839.
66
More detailed discussions on legal requirements covering cooperatives are found in
Chapter 17 on Non-Stock Corporations and Foundations.
67
Art. 3, Cooperative Development Authority Act (R.A. 6938)
68
Arts. 12 and 30, ibid.
69
Art. 4(2), ibid.
70
Arts. 5(3) and 34, ibid.
71
The Cooperative Development Authority Act (R.A. 6939).
and services to its members and thus enable them to attain increased income
and savings, investments, productivity, and purchasing power and promote
among them equitable distribution of net surplus through maximum utilization of
economies of scale, cost-sharing and risk-sharing without conducting the affairs
of the cooperative for eleemosynary or charitable purposes."72
The Law on cooperatives declares it a policy of the State to foster the
creation and growth of cooperatives as a practical vehicle for promoting self-
reliance and harnessing people power towards the attainment of economic
development and social justice.73

ENTITLEMENT OF THE CORPORATION TO

CONSTITUTIONAL GUARANTEES
A corporation enjoys constitutional rights and, generally, it enjoys the
same protection that the law grants to individuals.
A corporation is entitled to due process and the equal protection of the law
and protection against unreasonable search and seizure. In Smith, Bell & Co. v.
Natividad,74 a domestic corporation with the majority of its shareholdings held by
British subjects, sought to have a law reserving registration of vessels for
coastwide shipping only to domestic corporations wholly owned by Filipinos or
American citizens as violation of the due process and equal protection clauses.
Although denying the stand of the domestic corporation, the Supreme Court
acknowledged that corporate entities do have a right to claim protection under
such constitutional rights, thus -

The guarantees of the Fourteenth Amendment and so of

the first paragraph of the Philippine Bill of Rights, are universal
in their application to all persons within the territorial
jurisdiction, without regard to any differences of race, color, or
nationality. The word "person" includes aliens . . . Private
corporations, likewise, are "persons" within the scope of the
guaranties in so far as their property is concerned. . .75

Stonehill v. Diokno,76 recognized that corporations are protected by the

constitutional guarantee against unreasonable searches and seizures. However,
the Court ruled that the officers of a corporation from which documents, papers
and things were seized have no cause of action to assail the legality of the
seizures, regardless of the amount of shares of stock or of the interest of each of
them in said corporation, and whatever the offices they hold therein may be,
because the corporation has a personality separate and distinct from those of

72
Art. 7, The Cooperative Code of the Philippines (R.A. 6938).
73
Art. 2, ibid.
74
40 Phil. 136 (1919).
75
Ibid, at p. 144.
76
20 SCRA 383 (1967).
said officers. It held that the legality of a seizure can be contested only by the
party whose rights have been impaired thereby; and the objection to an unlawful
search is purely personal and cannot be availed of by third parties, such as
officers of the corporation who interpose it for their personal interests.
In Bache & Co. (Phil.), Inc. v. Ruiz,77 the Court held that a corporation is
entitled to immunity against unreasonable searches and seizures. "A corporation
is, after all, but an association of individuals under an assumed name and with a
distinct legal entity. In organizing itself as a collective body it waives no
constitutional immunities appropriate for such body. Its property cannot be taken
without compensation. It can only be proceeded against by due process of law,
and is protected, under the 14th Amendment, against unlawful discrimination."78
In the same case, however, the Court denied that corporations have a
right to claim protection on the constitutional right against self-incrimination. By
applying American doctrine, the Court held that the privilege against self
incrimination "is a personal one, applying only to natural individuals," 79 and a
corporation may be compelled to submit to the visitorial powers of the State even
if this result in disclosure of criminal acts of the corporation.80
In Bataan Shipyard & Engineering Co., Inc. v. PCGG,81 the Court held that
the right against self-incrimination has no application to juridical persons: "While
an individual may lawfully refuse to answer incriminating questions unless
protected by an immunity statute, it does not follow that a corporation, vested
with special privileges and franchises, may refuse to show its hand when
charged with an abuse of such privilege."82
The denial of the right against self-incrimination is extensively quoted in
Bataan Shipyard from Wilson v. United States:83

The corporation is a creature of the state. It is presumed

to be incorporated for the benefit of the public. It receives
certain special privileges and franchises, and holds them
subject to the laws of the state and the limitations of its
charter. Its power are limited by law. It can make no contract
not authorized by its charter. Its right to act as a corporation
are only preserved to it so long as it obeys the laws of its
creation. There is a reserve right in the legislature to
investigate its contracts and find out whether it has exceeded
its powers. It would be a strange anomaly to hold that a state,
having chartered a corporation to make use of certain
franchises, could not, in the exercise of sovereignty, inquire

77
37 SCRA 823 (1971).
78
Ibid, at p. 837, quoting from Hale v. Henkel, 201 U.S. 43, 50 L.Ed. 652.
79
United States v. White, 322 U.S. 694, 698 (1944).
80
Hale v. Henkel, 201 U.S. 43 (1906); Wilson v. United States, 221 U.S. 361 (1911). See
also BERNAS, CONSTITUTIONAL RIGHTS & DUTIES (Vol. I, 1974 ed.) pp. 299-300.
81
150 SCRA 181 (1987).
82
Ibid, at p. 234, quoting from Hal v. Henkel, 201 U.S. 43.
83
55 L.Ed. 771,780.
 how these franchises had been employed, and whether they
had been abused, and demand the production of the corporate
books and papers for that purpose. The defense amounts to
this, that an officer of the corporation which is charged with a
criminal violation of the statute may plead the criminality of
such corporation as a refusal to produce its books. To state
this proposition is to answer it. While an individual may lawfully
refuse to answer incriminating questions unless protected by
an immunity statute, it does not follow that a corporation,
vested with special privileges, and franchise may refuse to
show its hand when charged with an abuse of such privileges.

It would seem that when it comes to the constitutional rights of due

process, equal protection of law, and protection against unreasonable searches
and seizures, the Supreme Court would be willing to view the corporation merely
as a vehicle, by which individuals transact their businesses and therefore, by
using such medium, they are deemed not to have waived their constitutional
rights. After all, as discussed in other chapters of this book, jurisprudence has
tended to recognize the underlying enterprise beneath the corporation fiction, or
at least the aggregation of individuals that make-up any corporate setting. And
yet, when it comes to the constitutional right against self-incrimination, the
Supreme Court would rely upon old American doctrine which views the
corporation as a mere creature of the law and with separate juridical personality
apart from its stockholders or members.
The difference in the Court's stance may lie in the fact, that the right
against self-incrimination does not really result in physical intrusion into the
premises of the corporation, because it would require only that the corporation,
through its agents, produce records and books before the courts. The denial of
the right against self-incrimination from corporations does not really invite state
authorities into the premises or physical privacy of the stockholders or members
who compose the corporation; but would deny acting individuals the right to
abuse the corporate medium as a means to do folly.
On the other hand, to deny the due process rights or right against
unreasonable searches and seizures to corporations would actually be to invite
state authorities to physically intrude into corporate premises, and therefore also
intrude into the personal and business privacy of the stockholders or members
who compose it. Perhaps that is the basis for the difference in stance by the
Supreme Court between two sets of constitutional rights with respect to
corporations.
Another view is that the constitutional guarantees of due process, equal
protection clause and against unreasonable searches and seizures are all meant
to curb the abuse that the State and its representatives may employ upon the
citizenry, including the modes upon which they conduct their lives and
businesses. On the other hand, the constitutional protection against self-
incrimination is not meant to prevent an actual State abuse but to avoid
pressuring the individual from having to tell a lie. "The main purpose of the
provision . . . is to prohibit compulsory oral examination of prisoners before the
trial, or upon trial, for the purpose of extorting unwilling confessions or
declarations implicating them in the commission of a crime."84 A corporation owes
full allegiance and subject to the unrestricted jurisdiction of the courts of the State
under which it has been organized.85 Likewise, it has no soul that can be damned
by a lie.

LIABILITY OF CORPORATIONS FOR TORTS

Philippine National Bank v. Court of Appeals,86 set out clearly the nature of
the liability of a corporation for the tortuous acts of its directors or officers. In that
case, it was shown that the Philippine National Bank, through the
unreasonableness of its board of directors in refusing to timely approved the
lease of sugar quota allocation mortgaged with the bank, caused a borrower to
lose the lease income it was to earn therefrom, which lease proceeds were more
than enough to fully pay the loan obligation of the borrower with the bank. The
lower court found the bank, through the unreasonable intransigence of its
directors, as being guilty of torts under Article 19 of the Civil Code which
mandates that every person "must in the exercise of his rights and in the
performance of his duties, act with justice, give everyone his due, and observe
honesty and good faith."
In affirming the liability of the bank for the tortuous act of its board, the
Supreme Court held that a corporation is civilly liable in the same manner as
natural persons for torts, because "generally speaking, the rules governing the
liability of a principal or master for a tort committed by an agent or servant are the
same whether the principal or master be a natural person or a corporation, and
whether the servant or agent be a natural person or artificial person. All of the
authorities agree that a principal or master is liable for every tort which he
expressly directs or authorizes, and this is just as true of a corporation as of a
natural person. A corporation is liable, therefore, whenever a tortuous act is
committed by an officer or agent under express direction or authority from the
stockholders or members acting as a body, or, generally, from the directors as
the governing body."87
It seems clear from the ruling in Philippine National Bank that not every
tortuous act committed by an officer can be ascribed to the corporation as its
liability, for it is reasonable to presume that in the granting of authority by the
corporation to its agent, such a grant did not include a direction to commit
tortuous acts against third parties. Only when the corporation has expressly
directed the commission of such tortuous act, would the damages resulting
therefrom be ascribable to the corporation. And such a direction by the
corporation, is manifested either by its board adopting a resolution to such effect,

84
U.S. v. Tan Teng, 23 Phil. 145, 152 (1912).
85
Tayag v. Benguet Consolidated, Inc., 26 SCRA 242, 248 (1968).
86
83 SCRA 237 (1978).
87
Ibid, at p. 247, citing 10 FLETCHER CYCLOPEDIA CORPORATION, 1970 ed., pp. 266-267.
as in the Philippine National Bank case, or having taken advantage of such an
tortuous act the corporation, through its board, expressly or impliedly ratifies such
an act or is estopped from impugning such an act.
Since the board of directors of a corporation is the embodiment of the very
power and prerogatives of a corporation, the act of the board in directing or
undertaking a tortuous act is necessarily that of the corporation. In short, the act
of the board is essentially that of the corporation, and therefore corporate assets
cannot escape enforcement of the claims for damages of the tort victim. The tort
liability of the corporation is without prejudice to a derivative suit being filed by
the stockholders to recover from the responsible board members and officers the
damages suffered by the corporation.
Sergio F. Naguiat v. NLRC,88 although admitting that “[o]ur jurisprudence
is wanting as to the definite scope of „corporate tort‟,” nevertheless sought to
encompass corporate tort to “consists in the violation of a right given or the
omission of a duty imposed by law . . , tort is a breach of a legal duty.” In that
case, for failure of the corporate employer to grant separation pay to employees
in case of closure or cessation of operations of establishments or undertaking not
due to serious business losses or financial reverses as mandated in Article 283
of the Labor Code, the Court held the corporate employer liable for tort, including
its stockholder who was actively engaged in the management or operation of the
business.

CRIMINAL LIABILITY OF CORPORATIONS

In the early case of West Coast Life Ins. Co. v. Hurd,89 while the Court
admitted that there are various penal laws in the Philippines which corporations
as such may violate, there are no provisions in the law relating to the practice
and procedure in criminal actions whereby a corporation may be proceeded
against criminally and brought into court.
In West Coast Life the Court held that in many American cases cited
which show that corporations have been proceeded against criminally by
indictment and otherwise, and have been punished as malefactors by the courts,
"in those cases, the statute, by express words or by necessary intendment,
included corporations within the persons who could offend against the criminal
laws; and the legislature, at the same time established a procedure applicable to
corporations. No case has been cited to us where a corporation has been
proceeded against under a criminal statute where the court did not exercise its
common law powers or where there was not in force a special procedure
applicable to corporations."90
The Court also took cognizance of the fact that when it comes to criminal
jurisdiction, our courts "have no common law jurisdiction or powers," and being

88
269 SCRA 564, 80 SCAD 502 (1997).
89
27 Phil. 401 (1914).
90
Ibid, at p. 407-408.
creatures of statute have only those powers conferred upon them by statute,
which would naturally come from Spanish and not from common law sources.
The Court went on to say -

It is undoubted that, under the Spanish criminal law and

procedure, a corporation could not have been proceeded
against criminally, as such, if such an entity as a corporation in
fact existed under the Spanish law, and as such it could not
have committed a crime in which a willful purpose or a
malicious intent was required. Criminal actions would have
been restricted or limited, under that system, to the officials of
such corporation and never would have been directed against
the corporation itself. This was the rule with relation to
associations or combination of persons approaching, more or
less, the corporation as it is now understood, and it would
undoubtedly have been the rule with corporations. From this
source, then, the courts derive no authority to bring
corporations before them in criminal actions, nor to issue
processes for that purpose.91

Later, in People v. Concepcion,92 the Court held that when a criminal

statute forbids the corporation itself from doing an act, the prohibition extends to
the board of directors, and to each director separately and individually.
In People v. Tan Boon Kong,93 the Court laid down the principle that "a
corporation can act only through its officers and agents, and where the business
itself involves a violation of the law, the correct rule is that all who participate in it
are liable."94
In Tan Boon Kong the trial court dismissed an information filed against the
general manager of a corporation for violation of the requirement under the
provisions of the then Administrative Code, for corporations to make and file true
returns of their receipts and sales on the ground that the offense charged must
be regarded as committed by the corporation and not by its officials or agents.
The trial court recognized and applied the separate juridical personality of the
corporation in the application of the criminal statute for acts done for and in
behalf of the corporation. On appeal the Supreme Court brushed aside the
defense of separate juridical personality of a corporation by an officer who seeks
to avoid criminal liability arising from a violation of the law for transactions done
in behalf of the corporation. The Court's reasoning was in line with the piercing
doctrine that the veil of corporate fiction cannot be used to avoid the penalty
imposable for committing a criminal offense.
Essentially, therefore, in the field of Criminal Law, the Court refuses to
apply the fiction of corporate entity to shield the individual actors in the criminal
91
Ibid.
92
44 Phil. 129 (1922).
93
54 Phil. 607 (1930).
94
Ibid, at p. 609.
act, even when they do the criminal act for or in behalf of the corporation they
represent. The doctrinal pronouncement in Tan Boon Kong is essential to social
order; otherwise, criminals can hide behind the cloak of corporate fiction, and
with impunity violate the laws of the land with no adverse consequences to their
persons and personal fortunes.
The other reason why a corporation cannot be held liable for a crime is the
difficulty, if not impossibility, of imposing the penal sanction, i.e., imprisonment, to
a being that has no corporal existence, and which cannot therefore be thrown in
jail. Although there are instances where the law also imposes fine as a penalty,
and the same can be imposed against a corporation, such a theory would
undermine the criminal law system of a country, since bad guys would then with
impunity, commit crimes to further business objectives, if the dire consequences
would only be fines, especially so when the whole venture still would be
profitable even when the fines are paid.
Also, a crime cannot be imputed to a corporation, being a mere artificial
being without a mind, since the criminal intent as an essential ingredient of a
crime would be missing. Thus, by way of obiter, the Court would say matter-of-
factly in Times, Inc v. Reyes,95 that no criminal action can lie against an accused
who is a corporation because of the lack of the essential element of malice.
In Sia v. People,96 the Court made a clear distinction when a corporate
officer can be held personally criminally liable for acts done in behalf of the
corporation. In that case, the President of the corporation had, on behalf of the
corporation, entered into a trust receipt arrangement for the corporation with the
bank. When the corporation failed to turn over the merchandise covered by the
receipt or the proceeds from the sale thereof, a crime of estafa punishable under
the Revised Penal Code was filed against the President.
Although the President acted in behalf of the corporation, the Supreme
Court held that under the circumstances it cannot be held liable for the crime.
The Court held that the principle in Tan Boon Kong holding the responsible
officer personally liable for crimes committed by the corporation applies only in a
situation where "the corporation was directly required by law to do an act in a
given manner, and the same law makes the person who fails to perform the act
in the prescribed manner expressly liable criminally."97 The Court went on to
say—

The performance of the act is an obligation directly

imposed by the law on the corporation. Since it is a
responsible officer or officers of the corporation who actually
perform the act for the corporation, they must of necessity be

95
39 SCRA 303 (1971).
96
121 SCRA 655 (1983).
97
Ibid, at p. 662. For example, under Section 1 (2) of Pres. Decree 772, if the offense of
squatting is committed by a corporation or an association, the penalty imposed by law shall be
meted out on the president, director, manager or managing partners of the corporation or
association who shall be liable thereon.
 the ones to assume the criminal liability; otherwise this liability
as created by the law would be illusory, and the deterrent
effect of the law, negated.98

At the time of Sia, Pres. Decree 115 had not been enacted making it
expressly a case of estafa for violating the terms of the trust receipts and
imposing expressly the criminal liability upon the responsible officer, directors,
officers, employees or other officials of a corporation. Since at the time of Sia the
act alleged to be a crime was not in the performance of an act directly ordained
by the law to performed by the corporation, and that the crime imputed would
only arise based on the intent and the agreement of the parties to the trust
receipt, and not by the direct provision of law, then "[t]he intention of the parties,
therefore, is a factor determinant whether a crime was committed or whether a
civil obligation alone [was] intended by the parties."99
The Court then held in the absence of an express provision of law making
the President liable for the criminal offense committed by the corporation, the
existence of a criminal liability on his part may not be said to be beyond any
doubt, as is the quantum of evidence required in criminal cases. "In all criminal
prosecutions, the existence of criminal liability for which the accused is made
answerable must be clear and certain. The maxim that all doubts must be
resolved in favor of the accused is always of compelling force in the prosecution
of offenses."100
Although before Sia, the Court had convicted an individual liable for estafa
under a trust receipt transaction in Samo v. People,101 it held that it was
inapplicable since in that case the individual was shown to be acting for his own
behalf and not in behalf of a corporation. The Court held in Sia that it "has thus
far not ruled on the criminal liability of an officer of a corporation signing in behalf
of said corporation a trust receipt of the same nature as that involved herein." 102
Such pronouncement of the Court would mean that when an officer does
an act for and in behalf of the corporation, his intent would not be ascribed to him
in his personal capacity, but should be ascribed as the intent of the corporation
as it pertains to the transaction. This would amount to respecting the separate
juridical personality of a corporation, even in criminal cases, so that the intent
and motivation of corporate officers acting for in behalf of the corporation would
be ascribable to the corporation as corporate offenses, and the responsible
officer liable for the criminal act as the "personification" of the corporation in the
real world.
Such an implied conclusion can be drawn-out from the concurring opinion
of then Justice Teehankee in Sia when he ruled that —

98
Ibid.
99
Ibid, at p. 663.
100
Ibid.
101
5 SCRA 354 (1962).
102
Samo v. People, 5 SCRA 354, 663.
 . . . Petitioner personally cannot be charged and
convicted for the crime of estafa for failure of the corporation
(MEMAP) represented by him as president and general
manager to pay . . .
All these acts were corporate acts with the accused duly
representing the corporation as its president and general
manager: the application for bank financing, the deposit (which
was from corporate funds, and not a deposit made by the
petitioner, as wrongly alleged in the information), the receipt of
the steel sheets, then manufactured into finished products
(which could not technically be done under the terms of the
trust receipt required by the bank, under which the very sheets
were supposed to be sold by the corporation) and the non-
payment of the credit extended by the bank. There is not the
slightest evidence nor intimation that these corporate acts
were unauthorized or that petitioner personally had committed
any fraud or deceit in connection therewith or that he had
personally been responsible for or benefited from the
corporation's failure to pay the bank the balance due under the
trust receipt.103

It seems that the deceit or fraud employed by an officer to further a

corporate transactions cannot be ascribed as his personal deceit. This position is
untenable, for every agent, even in the pursuit of the business of his principal,
would be personally liable for the deceit or fraud which he chose voluntarily as an
individual to do when he could have avoided it.
If we pursue the doctrine in Sia that a corporate officer can only be held
personally liable for the crime committed by or in behalf of a corporation only in
cases when "the corporation was directly required by law to do an act in a given
manner, and the same law makes the person who fails to perform the act in the
prescribed manner expressly liable criminally," and in all other cases, such acting
officer cannot be held personally liable for the crime committed on behalf of the
corporation, since there is a refusal to disregard the separate entity of the
corporation, then what the trial court held in Sia would apply to a great body of
criminal acts done by bad guys through the corporate scheme —

A corporation is an artificial person, an abstract being. If

the defense theory is followed unscrupulously legions would
form corporations to commit swindle right and left where
nobody could be convicted, for it would be futile and ridiculous
to convict an abstract being that can not be pinched and
confined in jail like a natural, living person, hence the result of
the defense theory would be hopeless chose in business and
finance. It is completely untenable.104

103
121 SCRA 655, 668.
104
Ibid, at p. 662.
 Finally, the Supreme Court clarified in Cometa v. Court of Appeals,105 that
although a criminal case can only be filed against the officers of a corporation
and not against the corporation itself, it does not follow that the corporation
cannot be a real-party-in-interest for the purpose of bringing a civil action for
malicious prosecution for the damages incurred by the corporation for the
criminal proceedings brought against its officer.

ENTITLEMENT TO MORAL DAMAGES

In an early case,106 the Supreme Court held that since a corporation is an
artificial person, and cannot experience physical sufferings, mental anguish,
fright, serious anxiety, wounded feelings, moral shock or social humiliation, there
would be no basis to grant its recovery of moral damages. However, the Court
noted by way of obiter in that same case that "[a] corporation may have a good
reputation which, if besmirched, may also be a ground for the award of moral
damages."107
Nevertheless, in recent decisions, the Supreme Court held that even when
the corporation's reputation and goodwill have been prejudiced, "there can be no
award for moral damages under Article 2217 and succeeding articles of Section
1 of Chapter 3 of Title XVIII of the Civil Code in favor of a corporation."108
Although in Asset Privatization Trust v. Court of Appeals,109 the Supreme
Court seemed again to have gone back to the original doctrine that “[u]nder
Article 2217 of the Civil Code, moral damages include besmirched reputation
which a corporation may possibly suffer,” nevertheless the Court set the record
straight in ABS-CBN Broadcasting Corp. v. Court of Appeals,110 that corporations
are not entitled to recover any form of moral damages, thus:

Moral damages are in the category of an award designed

to compensate the claimant for actual injury suffered and not
to impose a penalty on the wrongdoer. The award is not meant
to enrich the complainant at the expense of the defendant, but
to enable the injured party to obtain means, diversion, or
amusements that will serve to obviate the moral suffering he
has undergone. It is aimed at the restoration, within the limits
of the possible, of the spiritual status quo ante, and should be
proportionate to the suffering inflicted. . . The award of moral
damages cannot be granted in favor of a corporation because,
being an artificial person and having existence only in legal

105
301 SCRA 459, 102 SCAD 360 (1999).
106
Mambulao Lumber Co. v. Philippine National Bank, 22 SCRA 359 (1968). See also
People v. Manero, 218 SCRA 85 (1993).
107
Ibid, at p. 380.
108
Prime White Cement Corp. v. Intermediate Appellate Court, 220 SCRA 103, 113-114
(1993); also Solid Homes, Inc. v. Court of Appeals, 275 SCRA 267, 84 SCAD 366 (1997).
109
300 SCRA 579, 101 SCAD 1028 (1998).
110
301 SCRA 589, 102 SCAD 459 (1999).
 contemplation, it has no feelings, no emotions, no senses. It
cannot, therefore, experience physical suffering and mental
anguish, which can be experienced only by one having a
nervous system. The statement in People v. Manero [218
SCRA 85 (1993)] and Mambulao Lumber Co. v. PNB [130
Phil. 366 (1968)], that a corporation may recover moral
damages if it “has a good reputation that is debased, resulting
in social humiliation” is an obiter dictum. . . The possible basis
of recover of a corporation would be under Articles 19, 20 and
21 of the Civil Code, but which requires a clear proof of malice
or bad faith.

NATIONALITY OF CORPORATIONS
The nationality of a corporation "serves as a legal basis for subjecting the
enterprise or its activities to the laws, the economic and fiscal powers, and the
various social and financial policies, of the state to which it is supposed to
belong."111
In Philippine jurisdiction, the principal doctrine on the test of nationality of
a corporate entity is the place of incorporation test: that a corporation is a
national of the country under whose laws is has been organized and registered.
This is embodied in Section 123 of the Corporation Code which provides that "a
foreign corporations is one formed, organized or existing under any laws other
than those of the Philippines and whose laws allow Filipino citizens and
corporations to do business in its own country or state."
The other test of nationality is the control test, under which the nationality
of a corporation is determined by the nationality of the majority of the
stockholders on whom control is vested.
Nationality is only one basis by which a state controls the affairs of the
corporation. The place of principal business test is also applied to determine
whether a state has jurisdiction over the existence and legal character of a
corporation, its capacity or powers, internal organization, capital structure, the
rights and liabilities of directors, officers, and shareholders towards each other
and to creditors and third persons.112 Under that test, the corporation is a
"national" or subject to the jurisdiction of the place where its principal office or
center of management (siege social) is located.
Although the place of incorporation test is the primary test of nationality of
corporations in the Philippines, in the following cases, in addition to the place of
incorporation test, the control test is also applied:

1. Exploitation of Natural Resources

111
SALONGA, PRIVATE INTERNATIONAL LAW (1979 ed.), p. 338.
112
SALONGA, ibid, at pp. 348-350.
 Section 2, Article XII of the Constitution provides that "[a]ll lands of the
public domain, waters, minerals, coal, petroleum, and other mineral oils, all
forces of potential and other natural resources are owned by the State. . . The
State may directly undertake such activities, or it may enter into co-production,
joint venture, or production sharing agreements with Filipino citizens, or
corporations or associations at least sixty per centum of whose capital is owned
by such citizens."113
The policy of the State to ensure that the exploitation of natural resources
or the pursuit of activities deemed to be of public or national interest are in the
control of Filipinos.
In addition, the section authorizes the President to enter into agreements
with foreign-owned corporations involving either technical or financial assistance
for large-scale exploration, development, and utilization of minerals, petroleum,
and other mineral oils according to general terms and conditions provided by law,
based on real contributions to the economic growth and general welfare of the
country. However, the President shall notify the Congress of very contract
entered into within 30 days from its execution.
Even if the corporation is a creature of the State, which can be controlled,
there was a need to further safeguard the exploitation of our natural resources. If
a creature of the Philippine law does not assure the Legislature of its control,
then a creature created by another state must necessarily be disqualified.
Allegiance, by virtue of nationality of said corporation, is owed to the State which
created it.
The constitutional provision114 on limiting the exploitation of natural
resources to corporations at least 60% of the capital stock is owned by Filipino
citizens, does not contain the place of incorporation test. But it must necessarily
be presumed that the control test provided in the Constitution would pertain only
to domestic corporations; and that necessarily a foreign corporation even though
controlled by Filipino citizens would not be qualified to exploit our natural
resources.
The constitutional provision does not distinguish between voting shares
and non-voting shares. So that, even if the voting shares are controlled by
Filipinos, if the total shareholdings of the company (both voting and non-voting)
does not meet the minimum 60% Filipino ownership requirement of the
Constitution, such corporation would still not be qualified to engage in activities
that seek to exploit our natural resources. The broadness of the constitutional
language by not distinguishing voting from non-voting shares seems to square
with Section 6 of the Corporation Code, where in eight fundamental corporate
restructuring or transactions, all shares, including non-voting shares, would be
entitled to vote. Therefore, in those eight case enumerated in Section 6, even
foreigners who hold non-voting shares would be entitled to vote.

113
Emphasis supplied.
114
Sec. 2, Art. XII, 1987 Constitution.
 Register of Deeds of Rizal v. Ung Sui Si Temple 115 laid down the principle
"that the purpose of the sixty per centum requirement is obviously to ensure that
corporations or associations allowed to acquire agricultural land or to exploit
natural resources shall be controlled by Filipinos; and that the spirit of the
Constitution demands that in the absence of capital stock, the controlling
membership should be composed of Filipino citizens."116 In that case, the Court
disqualified a non-incorporated religious organization, whose trustees and whose
members were Chinese nationals, from acquiring by donation a piece of land.
In Roman Catholic Administrator of Davao, Inc. v. The LRC and the
Register of Deeds of Davao,117 held that a corporation sole would have no
nationality at all to disqualify it from owning land in the Philippines even though
its only corporator was a Canadian citizen.
Studying the history of the Roman Catholic Apostolic Church in the
Philippines, the Court held that —

. . . Under the circumstances of the present case, it is

safe to state that even before the establishment of the
Philippine Commonwealth and of the Republic of the
Philippines, every corporation sole then organized and
registered by express provision of law the necessary power
and qualification to purchase in its name private lands located
in the territory in which it exercised its functions or ministry and
for which it was created, independently of the nationality of its
incumbent unique and single member and head, the bishop of
the diocese. It can be also maintained without fear of being
gainsaid that the Roman Catholic Apostolic Church in the
Philippines has no nationality and that the framers of the
Constitution did not have in mind the religious corporation sole
when they provided that 60 per centum of the capital thereof
be owned by Filipino citizens.118

The Court classified a corporation sole as a special form of corporation

usually associated with the clergy designed to facilitate the exercise of the
functions of ownership of the church which was regarded as property owner. It is
created not only to administer the temporalities of the church or religious society
where the corporator belongs, but also to hold and transmit the same to his
successor in said office.
But the Court went on to say, that even if nationality is ascribed to a
corporation sole, the nationality of the constituents of the diocese, and not the
nationality of the actual incumbent of the parish, must be taken into
consideration, because the corporation sole ordinarily holds the property in trust

115
97 Phil. 58 (1955).
116
Ibid, at p. 61.
117
102 Phil. 597 (1957).
118
Ibid, at p. 612.
for the benefit of the Roman Catholic faithful of their respective locality or
diocese.
The reasoning of the majority decision in Roman Catholic Administrator
has serious flaws. As observed by Justice J.B.L. Reyes in his dissenting opinion,
"[i]n requiring corporations or associations to have 60% of their capital owned by
Filipino citizens, the constitution manifestly disregarded the corporate fiction, i.e.,
the juridical personality of such corporations or associations. It went behind the
corporate entity and looked at the natural persons that composed it, and
demanded that a clear majority in interest (60%) should be Filipino." 119 He
observed the doctrine in Ung Siu Si Temple, that if the association had no
capital, its controlling membership must be composed of Filipinos "[b]ecause
ownership divorced from control is not true ownership."120
Since under the rules governing corporation sole, the members of the
religious association cannot overrule or override the decisions of the sole
corporator, then it would be wrong to conclude that the control of the corporation
sole would be in the members of the religious association.
What the Court held in Roman Catholic Administrator as "the unhappy
freak of English law" has certainly now become a freak in Philippine Corporate
Law.

2. Owning and Operating Public Utilities

Section 11, Art. XII of the Constitution provides that "[n]o franchise,
certificate, or any other form of authorization for the operation of a public utility
shall be granted except to citizens of the Philippines or to corporations or
associations organized under the laws of the Philippines at least sixty per centum
of whose capital is owned by such citizens, nor shall such franchise, certificate,
or authorization be exclusive in character or for a longer period than fifty years. . .
The State shall encourage equity participation in public utilities by the general
public. The participation of foreign investors in the governing body of any public
utility enterprise shall be limited to their proportionate share in its capital, and all
the executive and managing officers of such corporation or association must be
citizens of the Philippines."
Unlike the provisions on the exploitation of natural resources, the
aforequoted provisions expressly includes the place of incorporation test and
requires that only domestic corporations with at least 60% of the capital stock
owned by Filipinos may own and operate public utilities in the Philippines.
In People v. Quasha,121 the Court held that the Constitution does not
prohibit the mere formation of a public utility corporation without the required
proportion of Filipino capital. What it does prohibit is the granting of a franchise or
other form of authorization for the operation of a public utility to a corporation

119
Ibid, at p. 636.
120
Ibid, at p.637.
121
93 Phil. 333 (1953).
already in existence but without the requisite proportion of Filipino capital.
Quasha therefore draws the distinction between the primary franchise of a
corporate entity by virtue of which it is constituted as a body politic endowed with
separate juridical personality, and the secondary franchise that it may receive
during its life for the exercise of a privilege granted by law, such as the operation
of a public utility.
The ruling in Quasha can be pointed to as the basis to show that the
constitutional provision122 prohibiting Congress, except by general law, to provide
for the formation, organization, or regulation of private corporations, really serves
no useful benefit, since all that it covers is the primary franchise, which merely
constitutes the corporation into a juridical entity. It is the secondary franchise by
which the corporation may be granted special privileges, licenses or benefits not
enjoyed by other corporations, where the real abuse may be committed. And yet,
there is no doubt that under the Constitution, Congress has the power to directly
grant secondary franchises to private corporations.
The Quasha doctrine was reiterated in Tatad v. Garcia, Jr.,123 which held
that although the Constitution requires in no uncertain terms that a franchise for
the operation of a public utility can be granted only to corporations at least 60%
of the capital of which is owned by Filipinos; however, "it does not require a
franchise before one can own the facilities needed to operate a public utility so
long as it does not operate them to serve the public. In law, there is a clear
distinction between the „operation‟ of a public utility and the ownership of the
facilities and equipment used to serve the public."124 Therefore, the Court held
that in a railway system, while a foreign corporation may own the rail tracks,
rolling stocks like the coaches, rail stations, terminals and the power plant, and
although a franchise is needed to operate these facilities to serve the public, they
do not by themselves constitute a public utility. "What constitutes a public utility is
not their ownership but their use to serve the public."125 The Court held that in
law, there is a clear distinction between the "operation" of a public utility and the
"ownership" of the facilities and equipment used to serve the public.126

3. Mass Media
Under Section 11, Article XVI of the 1987 Constitution, the ownership of
mass media shall be limited to citizens of the Philippines, or to corporations,
cooperatives or associations, wholly-owned and managed by such citizens. Mass
media includes radio, television, and printed media and does not include

122
Sec. 16, Art. XII, 1987 Constitution.
123
243 SCRA 436, 60 SCAD 480 (1995).
124
Ibid, at pp. 452-453.
125
Ibid, at pp. 453, citing Iloilo Ice & Cold Storage Co. v. Public Service Board, 44 Phil. 551
(1923).
126
Ibid, at pp. 452-453, citing Iloilo Ice & Cold Storage Co. v. Public Service Board, 44 Phil.
551, 557-558 (1923).
commercial telecommunications, which are considered as public utilities, nor the
advertising industry.127
The term "mass media" shall mean the gathering, transmission of news,
information, messages, signals, and forms of written, oral and all visual
communication and shall embrace the print medium, radio, television, films,
movies, advertising in all its phases, and their business managerial.128 The
distinctive features of any mass media undertaking is the dissemination of
information and ideas to the public, or a portion thereof.129 It is divided into the
print media and the broadcast media; the broadcast media includes radio and
television broadcasting in all their aspects and all other cinematographic or radio
promotion and advertising.130 The term covers any medium of communication, a
newspaper, radio, motion pictures, or television, designed to reach the masses
and that tends to set the standards, ideals and aims of the masses. 131 The term
has also been opined to include cable television.132
Although the constitutional provision governing mass media does not
expressly include the place of incorporation test, the same shall be deemed
included under the same principle governing exploitation of natural resources. In
fact, the ancillary control test for mass medium under the Constitution is actually
more stringent than in other defined areas, since it requires not only 100%
Filipino ownership of the capital stock of the corporation, but also 100%-Filipino
management of the entity.

4. Advertising Industry
Section 11, Art. XVI of the 1987 Constitution provides that the advertising
industry is impressed with public interest, and shall be regulated by law for the
protection of consumers and the promotion of the general welfare.
Only Filipino citizens or corporations or associations at least seventy
percent (70%) of the capital of which is owned by such citizens shall be allowed
to engage in the advertising industry. It also provides that the participation of
127
BERNAS, THE CONSTITUTIONS OF THE REPUBLIC OF THE PHILPPINES—A COMMENTARY
(1988 ed.), p. 563; Chapter 1, Rules and Regulations for Mass Media in the Philippines.
128
Pres. Decree 36, as amended by Pres. Decrees 191 and 197.
129
DOJ Opinion No. 120, series of 1982.
130
Section 2, Pres. Decree 576; SEC Opinion, 24 March 1983, addressed to Justice Manuel
Lazaro.
131
DOJ Opinion 163, s. 1973; SEC Opinion dated 15 July 1991, XXV SEC Q UARTERLY
BULLETIN, 31 (No. 4, Dec. 1991).
132
The National Telecommunications Commission (NTC), which regulates and supervises
the cable television industry in the Philippines under Section 2 of Executive Order No. 436, s.
1997, has provided under NTC Memorandum Circular No. 8-9-95, under item 920(a) thereof
provides that “Cable TV operations shall be governed by E.O. No. 205, s. 1987. If CATV
operators offer public telecommunications services, they shall be treated just like a public
telecommunications entity.” Under DOJ Opinion No. 95, series of 1999, the Secretary of Justice,
taking its cue from Allied Broadcasting, Inc. v. Federal Communications Commission, 435 F. 2d
70, considered CATV as “a form of mass media which must, therefore, be owned and managed
by Filipino citizens, or corporations, cooperatives or associations, wholly-owned and managed by
Filipino citizens pursuant to the mandate of the Constitution.”
foreign investors in the governing body of the entities in such industry shall be
limited to their proportionate share in the capital thereof, and all the executive
and managing officers of such entities must be citizens of the Philippines.

5. War-Time Test
In Filipinas Compañia de Seguros v. Christern,133 the Court held that in
times of war, the nationality of a private corporation is determined by the
character or citizenship of its controlling stockholders. The Court considered the
juridical entity an enemy based on the fact that the "majority of the stockholders
of the respondent corporation were German subjects." It ruled that the control
test was applicable only in war-time. It refused the sole application of the place of
incorporation test during war-time to determine the nationality of an enemy
corporation.
The war-time test enunciated by Filipinas Compañia has since been
adhered to in subsequent decisions of the Court.134

6. Investment Test and Grandfather Rule

The "grandfather rule" is the method by which the percentage of Filipino
equity in a corporation engaged in nationalized and/or partly nationalized areas
of activities, provided for under the Constitution and other nationalization laws, is
computed, in cases where corporate shareholders are present in the situation, by
attributing the nationality of the second or even subsequent tier of ownership to
determine the nationality of the corporate shareholder.
In recognizing and applying the grandfather rule, the SEC has adopted the
formula of the Secretary of Justice135 to the effect that:

Shares belonging to corporations or partnerships at least

60% of the capital of which is owned by Filipino citizens shall
be considered as of Philippine nationality, but if the percentage
of Filipino ownership in the corporation or partnership is less
than 60% only the number of shares corresponding to such
percentage shall be counted as of Philippine nationality. . .136

It must be stressed however, that the afore-quoted SEC rule applies only
for purposes of resolving issues on investments. The SEC was quick to add:
133
89 Phil. 54 (1951).
134
Davis Winship v. Philippine Trust Co., 90 Phil. 744 (1952).
135
DOJ Opinion No. 18, s. 1989.
136
SEC Opinion, 23 November 1993, XXVIII SEC QUARTERLY BULLETIN 39 (No. 1, March
1994); SEC Opinion, 14 April 1993, XXVII SEC QUARTERLY BULLETIN 29 (No. 3, Sept. 1993); SEC
Opinion, 23 March 1993, XXVII SEC QUARTERLY BULLETIN 15 (No. 3, Sept. 1993); SEC Opinion, 6
August 1991, SEC QUARTERLY BULLETIN 44 (No. 4, Dec. 1991); SEC Opinion, 30 May 1990, XXIV
SEC QUARTERLY BULLETIN 52 (No. 3, Sept. 1990); SEC Opinion, 14 December 1989, XXIV SEC
QUARTERLY BULLETIN 7 (No. 2, June 1990); SEC Opinion, 6 November 1989, XXIV S EC
QUARTERLY BULLETIN 56 (No. 1, March 1990.
"However, while a corporation with 60% Filipino and 40% Foreign equity
ownership is considered a Philippine national for purposes of investment, it is not
qualified to invest in or enter into a joint venture agreement with corporations or
partnerships, the capital or ownership of which under the constitution or other
special laws are limited to Filipino citizens only." 137 A joint venture arrangement
would mean that such corporation has become a partner and is deemed then to
be acting or involving itself in the operations of a nationalized activity by the acts
of the local partners by virtue of the principle of mutual agency applicable to
partnerships.
Under Section 3(a) of the Foreign Investment Act of 1991, the term
"Philippine national" as it refers to a corporate entity shall mean a corporation
organized under the laws of the Philippines of which at least sixty percent (60%)
of the capital stock outstanding and entitled to vote is owned and held by citizens
of the Philippines. However, it provides that where a corporation and its non-
Filipino stockholders own stocks in a SEC-registered enterprise, at least sixty
percent (60%) of the capital stock outstanding and entitled to vote of both
corporations must be owned and held by citizens of the Philippines and at least
sixty percent (60%) of the members of the Board of Directors of both
corporations must be citizens of the Philippines, in order that the corporation
shall be considered a Philippine national. The law therefore, limits the test to
voting shares, but however, makes it more stringent when it comes to actual
control by making a double 60% rule requirement as to both holding and held
company, as well as their board of directors.
How many levels should grandfather rule be applied? In the early case of
Palting v. San Jose Petroleum Inc.,138 the Supreme Court refused the registration
and sale into the Philippines of securities of a Panamanian registered company
the proceeds of which were to be exclusively used to finance the oil exploration
efforts of a domestic corporation, which was owned 90% by the Panamanian
company. The Panamanian company sought authority to issue the securities on
the basis of the parity rights under the Laurel-Langley Agreement.
It was the contention of the Panamanian company that since its majority
shareholdings are owned by another Panamanian company, which in turn was
owned 100% by two (2) Venezuelan companies whose shares were being traded
in the stock exchanges in the United States, then it was qualified to exercise the
privileges granted under the Laurel-Langley agreement.
In refusing to apply the long chain of ownership source to find control to be
with American citizens in the United States who have bought the shares of the
two (2) Venezuelan companies, the Court held that "with a long chain of
intervening foreign corporations . . . 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

137
SEC Opinion, 14 December 1989, XXIV SEC QUARTERLY BULLETIN 7 (No. 2, June 1990).
138
18 SCRA 924 (1966).
for the purpose of determining whether the American ownership-control-
requirement is satisfied?"139
In short, the message of Palting is that the application of the grandfather
rule to determine the nationality of the ultimate controller of a subject corporation
cannot go beyond the level of what is reasonable. The further away the level of
ownership from the subject corporation, the less can one practically associate
control of the subject corporation.
In a 1977 internal memorandum issued by the SEC applying the
grandfather rule, it suggested that the rule be applied on two (2) levels of
corporate relations for publicly-held corporations or where the shares are traded
in the stock exchanges; and to apply the rule on three (3) levels for closely held
corporations or the shares of which are not traded in the stock exchange. On the
other hand, under Central Bank Circular No. 1171,140 the Monetary Board in
applying the grandfather rule in corporate ownership in banking institutions
directed application up to the fourth level or fourth tier of corporate ownership.
Aside from the General Banking Law of 2000 which expressly provides for
the application of the grandfather rule,141 the Investment Houses Law also applies
the rule.142

7. Policy of the Corporation Code on Control Test

Section 140 of the Corporation Code, which allows the imposition of the
control test, provides that the National Economic and Development Authority
(NEDA) shall from time to time, make a determination of whether the corporate
vehicle has been used by any corporation or by business or industry to frustrate
the provisions thereof or of applicable laws, and shall submit to Congress,
whenever deemed necessary, a report of its findings, including recommendations
for their prevention or correction.
However, Section 140 takes into consideration the policy of the State for
economic development and integration of the Philippine economy in the
competitive world economy. Under Section 140 it is provided that in
recommending to Congress corporations, business or industries to be declared
vested with a public interest and in formulating proposals for limitations on stock
ownership, the NEDA shall consider the type and nature of industry, the size of
the enterprise, the economies of scale, the geographic location, the extent of
Filipino ownership, the labor intensity of the activity, the export potential, as well
139
Ibid, at p. 937.
140
Issued in 1988.
141
Sec. 11, Rep. Act No. 8791: “The citizenship of the controlling stockholders of the
corporation shall be the basis of computing the percentage irrespective of the place of
incorporation."
142
Sec. 5, Pres. Decree 129 (1973), as amended by Rep. Act No. 8366: "In determining the
percentage of foreign-owned voting stocks in Investment Houses, the basis for the computation
shall be citizenship of each stockholder, and, with respect to corporate owners of voting stock, the
citizenship of the individual owners of the voting stock in the corporation holding shares in that
Investment House."
as other factors which are germane to the rationalization and promotion of
business and industry.
The section authorizes the setting by Congress of maximum limits for
stockholdings in corporations declared by it to be vested with a public interest,
belonging to individuals or groups of individuals related to each other by
consanguinity or affinity or by close business interests, or whenever it is
necessary to achieve national objectives, prevent, monopolies or combinations in
restraint of trade, or to implement national economic policies declared in laws,
rules and regulations designed to promote the general welfare and foster
economic development.
There are writers who have taken the position of considering the control
test and principal place of business test, under specified conditions, as equally
prominent and independent of the place of incorporation test, even under
Philippine jurisdiction.143 This author does not agree with such position. Under
Philippine jurisdiction, the primary test is always the place of incorporation test,
since we adhere to the doctrine that a corporation is a creature of the State under
whose it has been created. A corporation organized under the laws of a foreign
country, irrespective of the nationality of the persons who control it, is necessarily
a foreign corporation. The control test, and the principal place of business test
(siege social), are merely adjunct tests, when the place of incorporation test
indicates that the subject corporation is organized under Philippine laws.
The issue of double nationality or multiple nationality which other authors
have alluded to would arise because of different nationality tests employed by
various jurisdictions, is not an important consideration under Philippine setting.
As in the case of double nationality for individuals, as held by prominent authors
in Conflict of Laws, the Philippine authority will always consider the person from
the point of view of Philippine doctrine and treat it as Philippine national if it falls
squarely within the test.144
All issues relating to double taxation, standing to sue in local forum, etc.,
do not really relate to nationality issues, but are a function of jurisdiction, as it
pertains to the concept of "doing business". For indeed, even if a British
corporation is wholly owned by Filipinos, but does not engage in a single
transaction in Philippine soil, the determination of its nationality under Philippine
law would be utterly irrelevant since there is no conflict to resolve under
Philippine law which would require a resolution of such issue. In addition, even
when a clearly recognized Philippine corporation, owned 100% by Filipino citizen
does business in a foreign country, it would nevertheless be subject to taxation or
jurisdiction of the courts and agencies of such foreign country, irrespective of the
nationality issue.

143
See Vasquez, Nationality of Juridical Persons: Evaluation and Departure, 60 PHIL. L.J.
292 (1985).
144
SALONGA, PRIVATE INTERNATIONAL LAW, (U.P. Law Center, 1979 ed.), pp. 136-137.
PARAS, PHILIPPINE CONFLICT OF LAWS, (Rex Book Store, 1979 ed.), pp. 108-109.
CLASSIFICATIONS OF CORPORATIONS
For purely academic purposes, certain classes of corporations will be
discussed hereunder. However, for a better philosophical approach on certain
classifications other chapters of this book should be referred to.
The substantial issues relating to de facto corporations and the
corporation by estoppel doctrine are discussed in Chapter 5 on Corporate
Contract Law. The underlying doctrine on non-stock corporations, as
distinguished from stock corporations, is thoroughly discussed in Chapter 16 on
Non-Stock Corporations and Foundations. The substantial aspect of doing
business in the Philippines of foreign corporations, as distinguished from
domestic corporation, is discussed in Chapter 17 on Foreign Corporations and
the Concept of Doing Business.

IN RELATION TO THE STATE

1. Public and Private Corporations
Section 3 of the old Corporation Law distinguished between public and
private corporations, and defined public corporations as "those formed or
organized for the government of a portion of the State." On the other hand, the
same section defined private corporations as those formed for some private
purpose, benefit, aim, or end.
Public corporations are those created for political purposes connected with
the public good in the administration of the civil government. Public corporations
therefore are essentially municipal corporation, or those formed and organized by
the State for government, such as the baranggay, municipality, city and the
province. In essence, a public corporation, being a mini-state, possesses all
three great powers of government: police power, power of eminent domain, and
power of taxation.
Municipal corporations, with respect to its governmental functions, i.e.,
political subdivisions created by the legislature for the convenient administration
of the government, or some aspect of the government, of the inhabitants of a
defined district, remain entirely subject to the legislative control. They are
organized for the purpose of serving the communal welfare of the inhabitants of a
town or a city.
Municipal corporations are incorporated to continue the existence and the
legal status of the town or city without regard to the coming and going people
who inhabit it. They are not operated for profit, and the operating expenses are
levied against the members through the process of taxation.
A municipal corporation possesses a two-fold character: (a) public or
governmental character, in which it acts as agent of the state and exercises, by
delegation a part of the sovereignty of the state; (b) a private, corporate or
proprietary character, in which it acts as a private or business corporation, and
stands for the community in the administration of its local affairs wholly beyond
the sphere of public purposes for which its governmental powers are conferred.
In their governmental character, the municipal corporations are possessed
of and can exercise the so-called police power of the state, by delegation of the
legislature. They may levy taxes for certain purposes under limitations imposed
by the law making body.
In their proprietary character, municipal corporations are empowered to
mortgage their property under certain limitations. They can sue and be sued,
enter into contracts and may be held liable for damages for torts committed by
them in the exercise of their corporate functions as distinguished from public and
governmental functions.
Private corporations are divided into stock corporations and non-stock
corporations. Corporations which have a capital stock divided into shares and are
authorized to distribute to the holders of such shares dividends or allotments of
the surplus profit on the basis of the shares held are stock corporations. All other
private corporations are non-stock corporations. Private corporations may be
classified according to their purposes: (a) the business corporation, or the profit-
seeking corporations, (b) religious corporations, (b) eleemosynary corporations
or those organized for charitable, scientific or vocational corporations.

2. Distinctions Between Public and Private Corporations

What distinguishes a public corporation from a private corporation owned
by the government is not ownership of the controlling interest.
In National Coal Co. v. Collector of Internal Revenue,145 National Coal Co.
was created by Act 2705 for the purpose of developing the coal industry, with the
Government owning almost all of the shareholdings of the company. The
company was created with the general powers of a corporation and such other
powers as may be necessary to enable it to prosecute the business of the
development. The Legislature subsequently passed a law providing for the
leasing and development of coal lands and exempted the same from specific
taxes. On that basis, National Coal Co. took possession of coal lands belonging
to the government, and began to extract coal. The Collector levied against the
company specific tax coal extracted from coal land. National Coal Co. claimed
exemption from specific taxes stating that it is the owner of the land from which it
has mined the coal in question, being a government corporation.
The Court held that National Coal Co. is a private corporation. The mere
fact that the government happens to be a majority stockholder does not make a
corporation a public corporation. The Court took into consideration that the law
creating the National Coal Co. expressly made the company subject to all the
provisions of the then Corporation Law. As a private corporation, it had no
greater rights, powers, or privileges than any other corporation which might be
organized for the same purpose under corporation law. It was not certainly the
145
46 Phil. 583 (1924).
intention of the legislature to give it a right or privilege over other legitimate
private corporation. Even if the majority stockholder is the government or that the
charter was a direct grant by legislature or it was not incorporated for public
welfare, such matters did not make the National Coal Co. a public corporation—it
is still a private corporation especially the act creating it, made the company
subject to the provisions of the Corporation Law.
Therefore, National Coal shows that the mere fact that the government
happens to be a majority stockholder of a corporation with its own charter, does
not make it a public corporation, especially when its charter provides that it is
subject to all the provisions of the Corporation Law. It can therefore have no
greater rights, powers or privileges than any other corporation which might be
organized for the same purpose under the Corporation Code.
Sometimes the distinction between public corporation and a private
corporation is based on the corporation's creation. Usually a public corporation is
created by its charter whereas a private corporation is created under a general
incorporation law, which today is the Corporation Code. However, while this is a
general norm, many private corporations are granted special charters by the
Legislature, because they constitute government-owned or -controlled
corporations, but still cannot be considered as public corporations.
In Cervantes v. Auditor General,146 NAFCO was created under
Commonwealth Act 332, with its controlling stock owned by the Government and
the power of appointing its directors vested in the President of the Philippines.
However, it was expressly made subject to the provisions of the Corporation Law
insofar as they were compatible with the provisions of its charter. The Manager of
NAFCO questioned the denial by the Auditor General of his claims for quarters
allowance granted in a resolution of its board of directors.
The Court held that there could be no question that the NAFCO is a
private corporation controlled by the government, and subject to the provisions of
law which subjected it to the supervision and control of the Control Committee
which had the power to pass upon the program of activities and yearly budget of
expenditures approved by its board of directors.
Based upon the cases above, there are two types of private corporations:
(a) those organized for private ends and (b) those government-owned or
controlled corporation organized with their own charters. Therefore, it is possible
for a government controlled or owned corporations to have private holdings (e.g.
PNB before it was privatized) and a private corporation to have government
holdings.
However, it is not the public purpose alone, or the fact of complete or
controlling ownership by the State of its capital, or the fact that it has a charter
under a special law, that distinguishes a public corporation from a private
corporation. Thus, certain corporations, wholly-owned by the Government,
having a public purpose, and organized under their own charter would still

146
91 Phil. 359 (1952).
continue to be private corporations, such as the National Development
Corporation, the Philippine National Railways, etc.

3. Quasi-Public Corporations
There is a group of corporations that seem to be a cross between private
corporations and public corporations, and they are classified as quasi-public
corporations. These usually cover school districts, water districts, and the like.
Marilao Water Consumers Association, Inc. v. Intermediate Appellate
147
Court, held that water districts organized under Pres. Decree 198, although
considered as quasi-public corporations and authorized to exercise the powers,
rights and privileges given to private corporations under existing laws, are
entirely distinct from corporations organized under the Corporation Code, and not
within the jurisdiction of the SEC.
PNOC-Energy Development Corp. v. Leogardo,148 PNOC-Eneregy
Development Corp. v. NLRC,149 and Davao City Water District v. Civil Service
Commission,150 held that the doctrine that employees of government-owned and
controlled corporations, whether created by special law or formed as subsidiaries
under the general corporation law are governed by the Civil Service Law and not
by the Labor Code, has been supplanted by the 1987 Constitution. The present
doctrine is that: The test in determining whether a government-owned or
controlled corporation is subject to the Civil Service Law is the manner of its
creation, such that government corporations created by special charter are
subject to its provisions while those incorporated under the general corporation
law are not within the coverage, and therefore are governed by the Labor Code.
Boy Scouts of the Philippines v. NLRC,151 held that although Boy Scouts of
the Philippines does not receive any monetary or financial subsidy from the
Government, and that its funds and assets are not considered government in
nature and not subject to audit by the Commission of Audit, the fact that it
received a special charter from the government, that its governing board are
appointed by the Government, and that its purpose are of public character, for
they pertain to the educational, civic and social development of the youth which
constitute a very substantial and important part of the nation, it is not a public
corporation in the same sense that municipal corporation or local governments
are public corporation since its does not govern a portion of the state, but it also
does not have proprietary functions in the same sense that the functions or
activities of government-owned or -controlled corporations such as the National
Development Company or the National Steel Corporation, is may still be
considered as such, or under the 1987 Administrative Code as an instrumentality

147
201 SCRA 437 (1991).
148
175 SCRA 26 (1989).
149
201 SCRA 487 (1991).
150
201 SCRA 593 (1991).
151
196 SCRA 176 (1991).
of the Government. Therefore, the employees are subject to the Civil Service
Law.
Under Rep. Act 7656, which required government-owned or controlled
corporations to declare dividends to the National Government, the term
"government-owned or controlled corporations" has been specifically defined as
"corporations organized as a stock or non-stock corporation vested with functions
relating to public needs, whether governmental or proprietary in nature, and
owned by the Government directly or through its instrumentalities either wholly
or, where applicable as in the case of stock corporations, to the extent of at least
fifty-one percent (51%) of its capital stock." The term also includes financial
institutions, owned or controlled by the National Government, "but shall exclude
acquired asset corporations."

AS TO PLACE OF INCORPORATION
1. Domestic Corporations
A domestic corporation is one incorporated under laws of the Philippines.
Under Section 123 of the Corporation Code, "a foreign corporation is one formed,
organized or existing under any laws other than those of the Philippines and
whose laws allow Filipino citizens and corporations to do business in its own
country or State. It shall have the right to business in the Philippines after it shall
have obtained a license to transact business in the country in accordance with
this code and a certificate of authority from the appropriate government agency."

2. Foreign Corporations
A foreign corporation may be licensed by the SEC to do business in the
Philippines only under the principle of reciprocity, after securing a certificate of
authority from the Board of Investments under Executive Order 226, or the
Omnibus Investments Code, and after complying with the conditions for issuance
of the license on application forms, structural organizations and capitalization.
The objectives of the statutory provisions prescribing conditions under
which foreign corporations are permitted to do business in a state other than that
of their creation:

(a) To place them on an equality with domestic corporations;

(b) To subject them to inspection so that their condition may be
known; and
(c) To protect the residents of the state doing business with them
by subjecting them to the courts of the state.
 In case of war, for reasons of national security, in addition to the
incorporation test embodied in Section 123 of the Corporation Code, the "control
test" is applied to determine the nationality of a corporation.152
A foreign corporation can have no legal existence beyond the bounds of
the state or sovereignty by which it is created. It exist only in contemplation of law
and by the force of law, and where that law ceases to operate, the corporation
can have no existence. This principle however, does not prevent a corporation
from acting in another state or country with the latter's express or implied
consent.
The state, in extending to foreign corporations the privilege of doing
business, may impose such privilege with whatever conditions and restrictions it
deems fit to impose.153

AS TO LEGAL STATUS
1. De Jure Corporation
A corporation has de jure existence if there is a full or substantial
compliance with the requirements of an existing law permitting organization of
such corporation as by proper articles of incorporation duly executed and filed.
Generally, its juridical personality is not subject to attack in the courts from any
source.
If a corporation is a de jure corporation, its due incorporation cannot be
successfully attacked even in a quo warranto proceeding by the State. Therefore
if such proceeding is brought against a corporation and the State has a prima
facie case, the corporation must show that it is a de jure corporation.

2. Corporation De Facto
A corporation has de facto existence where there is a bona fide attempt to
incorporate, colorable compliance with the statute and user of corporate powers.
Under Section 20 of the Corporation Code, the "due incorporation of any
corporation claiming in good faith to be a corporation . . . and its right to exercise
corporate powers, shall not be inquired into collaterally in any private suit ot
which such corporation may be a party." Such inquiry may be made by the
Solicitor General in a quo warranto proceeding.154
The doctrine grew out of the necessity to promote the security of business
transactions and to eliminate quibbling over irregularities. It would be a rare case
where a third persons dealing with a corporation is prejudiced by its recognition

152
Filipinas Compania de Seguros v. Christern, Huenefeld & Co., Inc., 89 Phil. 54 (1951);
Davis Winship v. Philippine Trust Co., 90 Phil. 744 (1952); Haw Pia v. China Banking Corp., 80
Phil. 604 (1948).
153
See discussions on doing business in Chapter 17 on Non- Stock Corporations and
Foundations.
154
Ibid.
as a separate entity despite some minor defects in its incorporation. It would be
unfair to allow a claimant against the alleged corporation to insist on the
individual liability of innocent investors merely because of some minor flaws in its
incorporation.
A more thorough discussion of the de facto corporation doctrine is
provided for in Chapter 5 on Corporate Contract Law.

3. Corporation by Estoppel
Although an entity may not be a corporation de jure or de facto, a
particular person or party may, by estoppel or admission, be precluded from
denying its corporate existence. A group of persons may assume to do business
as a corporation without having gone far enough to give a de facto existence to
the entity.
Under certain circumstances and for certain purposes, either the group or
third persons contracting with the purported corporation may be estopped to
deny its corporate status.
Under Section 21 of the Corporation Code, "[a]ll persons who assume to
act as a corporation knowing it to be without authority to do so shall be liable as
general partners for all debts, liabilities and damages incurred or arising as a
result thereof; Provided, however, That when any such ostensible corporation is
sued on any transaction entered by it as a corporation or on any tort committed
by it as such, it shall not be allowed to use as a defense its lack of corporate
personality.”
In addition, the same section provides that "[o]ne who assumes an
obligation to an ostensible corporation as such, cannot resist performance
thereof on the ground that there was in fact no corporation."
The corporation by estoppel doctrine is founded on procedural
convenience, avoidance of inquiries into irrelevant formalities, and fairness to all
parties concerned.
The corporation by estoppel doctrine is properly discussed in Chapter 5 on
Corporate Contract Law.

4. Corporation by Prescription
The Roman Catholic Church is a corporation by prescription, with
acknowledged juridical personality inasmuch as it is an institution which
"antedated by almost a thousand years any other personality in Europe, and
which existed „when Grecian eloquence still flourished in Antioch and when idols
were still worshipped in the temple of Mecca.‟"155

155
Barlin v. Ramirez, 7 Phil. 41 (1906).
AS TO EXISTENCE OF SHARES OF STOCKS
1. Stock Corporations
Corporations which have a capital stock divided into shares and are
authorized to distribute to the holders dividends. If not authorized by the by-laws
to distribute the dividends, but it is a stock corporation, can a corporation
distribute dividends to its shareholders? The answer seems to be in the
affirmative, since one of the expressed powers granted to stock corporations
under Section 43 of the Corporation Code is the power to declared dividends.

2. Non-Stock Corporations
Section 87 of the Corporation Code provides that a non-stock corporation
is one where on part of its income is distributable as dividends. Under the Code,
a non-stock corporation is one where no part of its income is distributable as
dividends to its members, trustees or officers, subject to the provisions on
dissolution, provided that any profit which a non stock corporation may obtain as
an incident to its operations shall, whenever necessary or proper be used for the
furtherance of the purpose or purposes for which the corporation was organized,
subject or the provisions of this title.
This provisions governing stock corporations, when pertinent shall be
applicable to non-stock corporations, except as may be covered by specific
provisions of this title.
Section 88 provides that non-stock corporations may be formed or
organized for charitable, religious, educational professional, cultural, recreational,
fraternal, literary, scientific, social, civic service, or similar purposes, like trade,
industry, agriculture and like chambers, or any combination thereof, subject to
the special provisions of this title governing particular classes of non stock
corporations.
In Collector of Internal Revenue v. Club Filipino,156 the Club Filipino was a
civic organization created for recreational purposes, and neither in the articles of
incorporation nor in the by-laws was there a provision relative to dividends and
their distribution, although it is covenanted that upon its dissolution, the club's
remaining assets, after paying debts, shall be donated to a charitable institution.
Whatever profits the club had were used to defray its overhead expenses and to
improve its golf course. The issue is whether or not the club is liable to pay
business taxes. The Court found that the plain and ordinary meaning of business
is restricted to activities or affairs where profit is the purpose. Having found that
the club was organized to help develop and cultivate sports; that whatever profit
it derives are actually used to defray its over head expenses, it stands to reason
that the club is not engaged in the business of an operation of a bar and
restaurant.

156
5 SCRA 321 (1962).
 It would seem therefore that for a stock corporation to exist, two requisites
must be complied with: (a) a capital stock divided into shares; and (b) authority to
distribute dividends. However, it is to be noted that nowhere in its articles or by
laws could be found an authority for the distribution of its dividends or surplus
profits.
There is no authorization to declare dividends and this authorization can
only be found either in the articles, the by-law or the resolutions.
Thus, every time there is an express authorization in either the articles of
incorporation or by-laws of a corporation to declare dividends, it is undoubtedly a
stock corporation. When there is no express prohibition not to distribute
dividends, it would seem that the corporation is a non-stock corporation. And like
the Club Filipino case, where there is no express authorization, no express
prohibition, and practice of the corporation shows that it has never declared
dividends in the past and the purpose of the corporation is eleemosynary, it is a
non-stock corporation.

AS TO RELATIONSHIP OF MANAGEMENT AND CONTROL

1. Holding Company
A "holding company" is one that "controls another as a subsidiary or
affiliate by the power to elect its management. . . a holding company is one
which holds stocks in other companies for purposes of control rather than for
mere investment.157

2. Affiliate Company
An affiliate is a company which is subject to common control of a mother
or holding company and operated as part of a system. 158 An "affiliate" is defined
by SEC as a person that directly or indirectly, through one or more
intermediaries, controls or is controlled by, or is under common control with, the
person specified, through the ownership of voting shares, by contract, or
otherwise.159

3. Parent and Subsidiary Companies

When a corporation has a controlling financial interest in one or more
corporations, the one having control is known as the "parent company" and the
others are known as the "subsidiary companies." A "subsidiary" of a specified

157
SEC Opinion, 30 September 1986, XX SEC QUARTERLY BULLETIN (Nos. 3 & 4, Sept. &
Dec, 1986), p. 308, quoting from BALLANTINE LAW ON CORPORATIONS.
158
Ibid.
159
Rule 1-2, SEC Rules on Form and Content of Financial Statements Required to Filed by
Corporations Whose Shares of Stock are Sold Or Offered for Sale to the Public. (1973).
person is an affiliate controlled by such person, directly or indirectly, through one
or more intermediaries.160
When it comes to listed companies, the SEC Rules on Form and Content
of Financial Statements161 require consolidated financial statements to be filed
combining the operations of both the parent and the subsidiary companies.
The SEC Rules define the term "control" as the possession, directly or
indirectly, of the power to direct or cause the direction of the management and
policies of the corporation, either through the ownership of its voting shares or by
the existence of a contract or by any other lawful means. In general, the SEC
rules provide that any corporation owning 20% of the outstanding voting shares
of another shall be presumed to be in control of the other.162
Other factors shall also be considered, other than the control factor, thus:

(a) When the shares of stock of one of the companies are

traded-in the stock exchanges or over-the-counter
markets; or
(b) When one of the companies is a banking institution,
financing company, investment house or investment
company;
(c) When one of the companies is issuing commercial papers
or other securities registered with the SEC as required
under the Revised Securities Act; or
(d) When the total liabilities of one of the companies is more
than P10 Million or when the total liabilities of the group is
more than P50 Million at the beginning of the most
recently completed fiscal year.

The submission of the consolidation financial statements to the SEC in

compliance with its rules, however, does not exempt the constituent corporations
from filing also their individual financial statements.
The following may be excluded from consolidations:

(a) When the control thereon by the parent company is likely

to be temporary as, for example when the subsidiary must
be disposed of under a court order or will be abandoned if
certain likely adverse contingencies materialize;
(b) When control does not rest with the majority owners as,
for instance, when the subsidiary is formally placed under
receivership, or operates under foreign exchange

160
Ibid.
161
Issued under SEC Circular No. 2, Series of 1973.
162
Rule 1-2, SEC Rules on Form and Content of Financial Statements Required to Filed by
Corporations Whose Shares of Stock are Sold Or Offered for Sale to the Public (1973).
 restrictions, controls or other governmentally imposed
uncertainties so severe that they cast significant doubt on
the parent's ability to control the subsidiary.

The financial statements of a non-subsidiary is also required to be

consolidated with those of another group of parent and subsidiary companies
provided that the group owns more than 50% of the equity capital of the non-
subsidiary even if the majority of the shares owned are non-voting, or provided
that the group has the power to control the operations of the non-subsidiary by
statute or agreement irrespective of the equity ownership involved. 163

—oOo—

CORP. MANUSCRIPT\03-NATURE & ATTRIBUTES OF CORPORATIONS\07-29-2002

163
See also Sandiego, Director, Examiners and Appraisers Dept., SEC, Accounting Times
(1st Quarter, 1993).
 CHAPTER 4

CORPORATE JURIDICAL PERSONALITY

AND DOCTRINE OF PIERCING THE VEIL
OF CORPORATE FICTION1

Introduction
Main Doctrine of Separate Juridical Personality
Application of Piercing Doctrine
Nature and Consequences of Piercing Doctrine
Piercing Application Has Only Has Res Judicata Effect
Piercing Application is to Prevent Fraud or Wrong and Not Available
for Other Purposes
“Victim” Standing
Piercing Application is Essentially of Judicial Prerogative
Piercing Application Must Be Shown to Be Necessary and With
Factual Basis
Classification of the Piercing Cases
Fraud Cases
Piercing Doctrine Cannot Be Employed to Commit Fraud
Corporate Fiction Must Be Employed to Commit Fraud
Tax Evasion Cases
Alter-ego Elements in Fraud Piercing Cases
Evasion of Lawful Obligations
Liability of Officers
Rules in Labor Cases
Probative Factors
In Summary
Alter Ego Cases
Manner of Operating the Corporate Enterprise
Tax Avoidance Cases
Under-Capitalization
Forum-Shopping
Parent-Subsidiary Relationship
Affiliated Companies
Transfer of Business Enterprise
Disturbing Developments Adopting the Umali Doctrine
In Summary

1
This chapter is based on the article entitled Restatement of the Doctrine of Piercing the
Veil of Corporate Fiction, published in 37 ATENEO L.J. 19 (No. 2, June, 1993).
Equity Cases
Piercing Doctrine and Due Process Clause
Corporations in Sequestration Issues
Final Observations

——

INTRODUCTION
The aim of this chapter is to emphasize the complementary relationship of
the piercing doctrine to the main doctrine that a corporation has a juridical
personality separate and distinct from the stockholders or members who
compose it.
Looking at the number of decisions rendered by the Supreme Court where
it has pierced the veil of corporate fiction, compared with the handful of decisions
by which it has refused to apply the piercing doctrine and instead affirmed the
main doctrine of separate juridical personality, may give one the impression that
the main doctrine has lost some of its vitality, and that the piercing doctrine has
grown lush and vital.
It is always comforting to note, however, especially for businessmen for
whom the corporate entity has undoubtedly become the most popular medium to
pursue business endeavors, that the viability and vitality of a doctrine is to be
tested not by the times it has been challenged and overcome in court decisions,
but by the usefulness and frequency of its employment in the market place. The
enormity of the number of Supreme Court decisions applying the piercing
doctrine without hitch does not even begin to show the thousands and thousands
of daily transactions negotiated and completed employing the main doctrine of
separate corporate entity.
When dealing with piercing cases, it is always important to consider that
the aim which is, or at least should be, sought to be achieved by the Court is not
to use the piercing doctrine as a ram to break down the ramparts of the main
doctrine of separate juridical personality, but more properly for the ancillary
piercing doctrine to act as a regulating valve by which to preserve the powerful
engine that is the main doctrine of separate juridical personality.
It is important therefore to consider that the vitality of the main doctrine of
separate juridical personality is essential in preserving and promoting the
corporation as an entity by which the business community can continue to
harness capital resources and undertake either risky or large-scale enterprises;
and that the development of the piercing doctrine should not act in competition
with, but rather to complement and make more vital, the main doctrine of
separate juridical personality.
MAIN DOCTRINE OF SEPARATE JURIDICAL PERSONALITY
Since its 1906 introduction in the Philippines,2 the corporation has been
defined3 as "an artificial being created by operation of law, having the right of
succession and the powers, attributes and properties expressly authorized by
law or incident to its existence." The definition is the basis of the primary doctrine
that a corporation being a juridical person has a personality separate and distinct
from the stockholders or members who compose it.4
In one case, the Supreme Court has summarized the primary doctrine to
be that a corporation is a juridical entity with legal personality separate and
distinct from those acting for and in its behalf and, in general, from the people
comprising it; and that obligations incurred by the corporation, acting through its
directors, officers and employees are its sole liabilities.5 In another case, it held
that “[a] corporation is an entity separate and distinct from its stockholders.
While not in fact and in reality to a person the law treats the corporation as
thought it were a person by process of fiction or by regarding it as an artificial
person distinct and separate from its individual stockholders.”6
The granting to the corporate entity of a strong separate juridical
personality has been considered as the attribute or privilege most characteristic
of the corporations.7 Unlike the cumbersome juridical personality of its nearest
rival today, the partnership, the separate juridical personality of the corporation,
has features that has made it most attractive to businessmen: right of
succession, limited liability, centralized management, and generally free-
transferability of shares of stock. In addition, the strong separate juridical
personality of the corporation facilitates and preserves the "going concern value"
of the underlying business enterprise, saves on transaction costs, and prevents
disruption of that value because of investors who withdrawal or who are
deceased. Therefore, an undermining of the separate juridical personality of the
corporation, such as the abusive application of the piercing doctrine, necessarily
dilutes any or all of these attributes.
The stability of the main doctrine of separate juridical personality is
inextricably linked with the attractiveness of the corporation as an efficient
medium by which businessmen can pursue business enterprises. The
undermining of the main doctrine would also compel businessmen to have to
enter into inefficient and costly contractual relations to fill the gaps created by a
flawed main doctrine.

2
Act No. 1459 passed by the then Philippine Commission, known as “The Corporation Law.”
3
Sec. 2, Act No. 1459, and Sec. 2, Batas Pambansa Blg. 25.
4
When studying Corporate Law, there is little direct consciousness that the doctrine of
separate juridical personality also finds basis from Article 44 of the Civil Code which recognizes as
juridical persons “[c]orporations, partnership and associations for private interests or purposes to
which the law grants a juridical personality, separate and distinct from that of each shareholder,
partner or member.”
5
Santos v. NLRC, 69 SCAD 390, 254 SCRA 673, 96 SCAD 561 (1996).
6
Remo, Jr. v. Intermediate Appellate Court, 172 SCRA 405, 408 (1989).
7
BALLANTINE, Sec. 287.
 The Supreme Court has not been wanting in paying lip service to the main
doctrine of separate juridical personality, especially in recent years, when it
seems, at every turn, a proposition to pierce the veil of corporate fiction has
become a knee-jerk reaction in most litigations involving corporate parties.
However, the Court has not really taken a clear and direct path on the main
doctrine vis-a-vis the piercing doctrine.
In Stockholders of F. Guanzon and Sons, Inc. v. Register of Deeds of
Manila,8 the distribution of the corporate properties to the stockholders was
deemed not in the nature of a partition among co-owners, but rather a disposition
by the corporation to the stockholders, as opposite parties to a contract. It held
that "[a] corporation is a juridical person distinct from the members composing it
[and that] [p]roperties registered in the name of the corporation are owned by it
as an entity separate and distinct from its members. While shares of stock
constitute the personal property, they do not represent property of the
corporation. . . A share of stock only typifies an aliquot part of the corporation's
property, or the right to share in its proceeds to that extent when distributed
according to law and equity, but its holder is not the owner of any part of the
capital of the corporation, nor is he entitled to the possession of any definite
portion of its property or assets. The stockholder is not a co-owner or tenant in
common of the corporate property."9
Manila Gas Corp. v. Collector of Internal Revenue,10 held that the tax
exemptions granted to a corporation do not pertain to its corporate stockholders
due to their separate corporate personalities: "A corporation has a personality
distinct from that of its stockholders, enabling the taxing power to reach the latter
when they receive dividends from the corporation. It must be considered as
settled in this jurisdiction that dividends of a domestic corporation which are paid
and delivered in cash to foreign corporations as stockholders are subject to the
payment of the income tax, the exemption clause to the charter [of the domestic
corporation] notwithstanding."11
Likewise, attempts by stockholders to intervene in suits against their
corporations have been struck down in Magsaysay-Labrador v. Court of
Appeals,12 on the basic premise that a party may intervene under remedial
provisions if the stockholder has a legal interest in the matter in litigation; but that
stockholders' right in corporate property is purely inchoate and will not entitle
them to intervene in a litigation involving corporate property.
Magsaysay-Labrador held that a majority stockholder's interest in
corporate property, "if it exists at all, . . . is indirect, contingent, remote,
conjectural, consequential and collateral. At the very least, their interest is purely
inchoate, or in sheer expectancy of a right in the management of the corporation
and to share in the profits thereof and in the properties and assets thereof on
8
6 SCRA 373 (1962).
9
Ibid, at 375-376.
10
62 Phil. 895 (1936).
11
Ibid, at p. 898.
12
180 SCRA 266 (1989).
dissolution, after payment of the corporate debts and obligations." 13 It also held
that while a share of stock represents a proportionate or aliquot interest in the
property of the corporation "it does not vest the owner thereof with any legal right
or title to any of the property, his interest in the corporate property being
equitable or beneficial in nature. Shareholders are in no legal sense the owners
of corporate property, which is owned by the corporation as a distinct legal
person."14
In Saw v. Court of Appeals15 the Court refused the petition for intervention
filed by the stockholders in a collection case covering the loans of the
corporation on the ground that the interest of shareholders in corporate property
is purely inchoate; and this purely inchoate interest will not entitle them to
intervene in a litigation involving corporate property.16 And vice-versa, in Sulo ng
Bayan v. Araneta, Inc.17 where an attempt by a non-stock and non-profit
corporation organized for the benefit of its members to bring a suit in behalf of its
members for the recovery of certain parcels of land owned by the members was
not allowed by the Court.
In the same manner, in Asset Privatization Trust v. Court of Appeals,18 the
Court held that even when there was wrongful foreclosure on the assets of the
corporation, the stockholders would have no standing to recover for themselves
moral damages; otherwise, it would amount to the appropriation by, and the
distribution to, such stockholders of part of the corporation’s assets before the
dissolution of the corporation and the liquidation of its debts and liabilities.
In Traders Royal Bank v. Court of Appeals,19 an action sought to make
officers and stockholders liable for corporate debts on the basis of such
relationship alone was turned down by the Court: "The corporate debt or credit is
not the debt or credit of the stockholder nor is the stockholder's debt or credit
that of the corporation."20
Cruz v. Dalisay,21 held that the mere fact that one is president of the
corporation does not render the property he owns or possesses the property of

13
Magsaysay-Labrador v. Court of Appeals, 180 SCRA 266, 271 (1989).
14
Ibid, at pp. 271-272, citing BALLANTINE 288-289; Pascual v. Del Sanz Orozco, 19 Phil. 82,
86 (1911).
15
195 SCRA 740 (1991).
16
Ibid, at pp. 744-745.
17
72 SCRA 347 (1976).
18
300 SCRA 579, 617, 101 SCAD 1028 (1998).
19
177 SCRA 789 (1989): The mere fact that an individual bound himself as surety for a
corporations obligations does not vest the SEC exclusive jurisdiction over said individuals or over
the latter's person or property in a rehabilitation and receivership proceedings pending with the
SEC over the corporate entity. Traders Royal Bank v. Court of Appeals, 177 SCRA 788, 792
(1989).
20
177 SCRA 789, 792.
21
152 SCRA 487 (1987).
the corporation, since the president, as an individual, and the corporation are
separate entities.22
In National Power Corp. v. Court of Appeals,23 the Court held that the
finding in the trial court’s judgment of solidary liability among the corporation and
its officers and directors would patently be baseless when the decision contains
no allegation, finding or conclusion regarding particular acts committed by said
officers and members of the board of directors that show them to have been
individually guilty of unmistakable malice, bad faith, or ill-motive in their personal
dealings with third parties. The Court emphasized that when corporate officers
and directors are sued merely as nominal parties in their official capacities as
such, they cannot be held liable personally for the judgment rendered against the
corporation.
24
In Sebreño v. Court of Appeals, the mere showing that three
corporations had one common director sitting the boards of all the corporations,
without further allegation and proof that one or another of the three (3)
corporations concededly related companies used the other two (2) as mere alter
egos or that the corporate affairs of the other two (2) were administered and
managed for the benefit of one, did not authorize piercing their separate juridical
personalities.
In the same manner, in CKH Industrial and Development Corp. v. Court of
Appeals,25 the Court held that the interests of payees in promissory notes cannot
be off-set against the obligations between the corporations to which they are
stockholders in the absence of any allegation, much less, even a scintilla of
substantiation, that the parties interests in the corporation are so considerable as
to merit a declaration of unity of their civil personalities.
In Good Earth Emporium, Inc. v. Court of Appeals,26 the Court, in refusing
to allow execution of a corporate judgment debt against the officer, held that
being an officer or stockholder of a corporation does not by itself make one's
property also of the corporation, and vice-versa, for they are separate entities,
and that shareholders are in no legal sense the owners of corporate property
which is owned by the corporation as a distinct legal person.27
In Development Bank of Philippines v. NLRC,28 the Court held that
ownership of a majority of capital stock and the fact that a majority of directors of
a corporation are the directors of another corporation created no employer-
employee relationship, nor did it make the controlling stockholder liable for
employees' claim of the subject corporation.

22
Ibid, at p. 486. See also Sulong Bayan, Inc. v. Araneta, Inc., 72 SCRA 347, 354-355
(1976).
23
273 SCRA 419, 83 SCAD 360 (1997).
24
222 SCRA 466 (1993).
25
272 SCRA 333, 82 SCAD 509 (1997).
26
194 SCRA 544 (1991).
27
Ibid, at p. 550, citing Traders Royal Bank v. Court of Appeals, 152 SCRA 482 (1989) and
Cruz v. Dalisay, 152 SCRA 482 (1989).
28
186 SCRA 841 (1990).
 Earlier, Liddell & Co. v. Collector of Internal Revenue,29 expressed the
principle that mere ownership by a single stockholder or by another corporation
of all or nearly all capital stocks of the corporation is not by itself sufficient
ground for disregarding the separate corporate personality. 30 Likewise, Umali v.
Court of Appeals,31 held that the mere fact that the businesses of two or more
corporations are interrelated is not a justification for disregarding their separate
personalities, absent sufficient showing that the corporate entity was purposely
used as a shield to defraud creditors and third persons of their rights. 32
The Supreme Court has therefore consistently held that substantial
ownership in the capital stock of a corporation entitling the shareholder a
significant vote in the corporate affairs allows them no standing or claims
pertaining to corporate affairs;33 nor does substantial identity of the incorporators
of two corporation necessarily imply fraud.34 It is now a well-established doctrine
that mere ownership by a single stockholder or by another corporation of all or
nearly all of the capital stock of a corporation is not of itself sufficient ground for
disregarding the separate corporate personality.35

APPLICATION OF PIERCING DOCTRINE

The main doctrine of separate juridical personality is to be tempered by
the supporting doctrine of piercing the veil of corporate fiction. Since both
theories were transported to Philippine jurisdiction as part and parcel of the
implantation of American Corporation Law, the source of the piercing doctrine is
also common law. But the magical words by which the piercing doctrine has
come to be known36 found their origins in the case of United States v. Milwaukee
Refrigerator Transit Co.:37

If any general rule can be laid down, in the present state

of authority, it is that a corporation will be looked upon as a
legal entity as a general rule, and until sufficient reason to the
contrary appears; but, when the notion of legal entity is used
to defeat public convenience, justify wrong, protect fraud, or

29
2 SCRA 632, 640 (1961)
30
See also Palay, Inc. v. Clave, 124 SCRA 638 (1983); Pabalan v. NLRC, 184 SCRA 495
(1990).
31
189 SCRA 529, 543 (1990).
32
Ibid, at p. 543. Also Diatagon Labor Federation v. Ople, 101 SCRA 534 (1980).
33
PNB v. Phil Neg. Oil Co., 49 Phil. 857, 853, and 862 (1927); Liddel v. Court of Industrial
Relations, 93 Phil. 160 (1961); Pabalan v. NLRC, 184 SCRA 495 (1990).
34
Tantoco v. Kaisahan ng Mga Manggagawa sa La Campana, 106 Phil. 199 (1959); Del
Rosario v. NLRC, 187 SCRA 777 (1990); North Davao Mining Corp. v. NLRC, 254 SCRA 721, 69
SCAD 430 (1996).
35
Asionics Philippines, Inc. v. NLRC, 290 SCRA 164, 94 SCAD 351 (1998).
36
So commonplace has the incantation been that even the Philippine Supreme Court when
it says the mantra, does not even cite the case of United States v. Milwaukee Refrigerator Transit
Co., 142 Fed. 247 (1905).
37
142 Fed. 247 (1905).
 defend crime, the law will regard the corporation as an
association of persons.38

A more expansive declaration of the piercing doctrine has been given by

the Philippine Supreme Court as follows:

When the fiction is used as a means of perpetrating a

fraud or an illegal act or as a vehicle for the evasion of an
existing obligation, the circumvention of statutes, the
achievement or perfection of a monopoly or generally the
perpetration of knavery or crime, the veil with which the law
covers and isolates the corporation from the members or
stockholders who compose it will be lifted to allow for its
39
consideration merely as an aggregation of individuals.

The main treatment of the piercing doctrine to both corporate practitioners

and their clients has always been how to prevent its being applied by the courts
to their particular situation and avoid the dire consequences of piercing, which is
mainly holding the associates in the venture personally liable for corporate
obligations. Therefore, the discussions below study the main features of each of
the three general classes of piercing cases, so that in actual practice counsel
and their clients would know how to properly structure their transactions to avoid
inviting the "ire" of the courts.

NATURE AND CONSEQUENCES OF PIERCING DOCTRINE

1. Piercing Application Has Only Res Judicata Effect
Umali v. Court of Appeals,40 has held that when the piercing doctrine is
applied in a case, the consequences would be that the members or stockholders
of the corporation will be considered as the corporation, that is, liability will attach
directly to the officers and stockholders.41
The application of the piercing doctrine is not a contravention of the
principle that the corporate personality of a corporation cannot be collaterally
attacked. Koppel (Phil.), Inc. v. Yatco,42 held that when the piercing doctrine is
applied against a corporation in a particular case, the court does "not deny legal
personality . . . for any and all purposes." 43 The application of the piercing
doctrine is therefore within the ambit of the principle of res adjudicata that binds

38
at 255.
39
San Juan Structural and Steel Fabricators, Inc. v. Court of Appeals, 296 SCRA 631, 645,
99 SCAD 281 (1998); First Philippine International Bank v. Court of Appeals, 252 SCRA 259, 67
SCAD 196 (1996).
40
189 SCRA 529 (1990).
41
Umali v. Court of Appeals, 189 SCRA 529 (1990).
42
77 Phil. 496 (1946).
43
Ibid, at pp. 504-505.
only the parties to the case only to the matters actually resolved therein. Even
when a corporation's legal personality had been pierced in case, it was held in
Tantongco v. Kaisahan ng mga Mangagawa sa La Campana and CIR,44 that
such corporation still possessed such separate juridical personality in any other
case, or with respect to other issues.

2. Piercing Application Is to Prevent Fraud or

Wrong and Not Available for Other Purposes
Since the piercing doctrine was fashioned to prevent fraud, or injustice, it
would have no application in situations where no fraud or injustice would be
prevented by the application of such doctrine, as to make officers and
stockholders liable for corporate debts. Thus in Umali, the Court refused the plea
to pierce the veil of corporate fiction to achieve a remedy of declaring void the
foreclosure proceedings on the ground that "the legal corporate entity is
disregarded only if it is sought to hold the officers and stockholders directly liable
for a corporate debt or obligation. In the instant case, petitioners do not seek to
impose a claim against the individual members of the three corporations
involved; on the contrary, it is these corporations which desire to enforce an
alleged right against the petitioners."45
In Boyer-Roxas v. Court of Appeals46 the Court held that since piercing is
used only when the corporation is used "as a cloak or cover for fraud or illegality,
or to work injustice, or where necessary to achieve equity or when necessary for
the protection of creditor," then it cannot be resorted to merely to establish a right
or interest, and in that case the Court did not allow piercing when it was
employed to justify under a theory of co-ownership the continued use and
possession by stockholders of corporate properties.
Likewise, in Union Bank of the Philippines v. Court of Appeals,47 the Court
held that the piercing doctrine cannot be availed of in order to dislodge from the
jurisdiction of the SEC the petition for suspension of payments filed under
Section 5(e) of Pres. Decree 902-A,48 on the ground that the petitioning
individuals should be treated as the real petitioners to the exclusion of the
petitioning corporate debtor. The Court further held: “The doctrine of piercing the
veil of corporate fiction heavily relied upon by the petitioner is entirely misplaced,
as said doctrine only applies when such corporate fiction is used to defeat public
convenience, justify wrong, protect fraud or defend crime.”

a. “Victim” Standing

44
106 Phil. 199 (1959).
45
Ibid, at p. 543.
46
211 SCRA 470 (1992).
47
290 SCRA 198, 94 SCAD 381 (1998).
48
Subsection 5.2 of the Securities Regulation Code has transferred corporate rehabilitation
cases to the jurisdiction of regular courts.
 In Traders Royal Bank v. Court of Appeals,49 the Court held that the
piercing doctrine is an equitable remedy, “and may be awarded only in cases
when the corporate fiction is used to defeat public convenience, justify wrong,
protect fraud or defend crime or where a corporation is a mere alter ego or
business conduit of a person.” It could not be employed by a corporation to be
able to complete its claims against another corporation, and cannot therefore be
employed by the claimant who does not interpose to be the victim of any wrong
or fraud. The Court further held:

Piercing the veil of corporate entity requires the court to

see through the protective shroud which exempts its
stockholders from liability that ordinarily, they could be subject
to, or distinguishes one corporation from a seemingly separate
one, were it not for the existing corporate fiction. But to do
this, the court must be sure that the corporate fiction was
misused, to such an extent that injustice, fraud or crime was
committed upon another, disregarding, thus, his, her, or its
rights. It is the protection of the interests of innocent third
persons dealings with the corporate entity which the law aims
to protect by this doctrine.

3. Piercing Application is Essentially

of Judicial Prerogative
Cruz v. Dalisay,50 held that piercing of the veil of corporate fiction is a
judicial remedy not available to a sheriff. In Cruz, the executing sheriff when it
could not locate properties of the corporation to enforce a judgment debt, chose
to pierce the veil of corporate fiction and levied on the properties of the president
who was also the majority stockholder of the corporation. The Court overruled
such actuation because the sheriff had usurped "a power belonging to the court."
The pronouncement in Cruz however is not consistent with previous
decisions of the Court where administrative application of the piercing doctrine,
such as by the Bureau of Internal Revenue to uphold tax assessments, 51 have
been upheld. Properly considered, therefore, the more appropriate application of
Cruz would be that the administrative determination of the facts upon which the
piercing doctrine is to be applied is subject to judicial or quasi-judicial review, as
the case may be.

49
269 SCRA 601, 80 SCAD 12 (1997).
50
192 SCRA 487, 486 (1987)
51
Koppel (Philippines, Inc. v. Yatco, 77 Phil. 496 (1946); Yutivo Sons Hardware v. Court of
Tax Appeals, 1 SCRA 160 (1961); Liddell & co. v. Collector of Internal Revenue, 2 SCRA 632
(1961); Commissioner of Internal Revenue v. Norton and Harrison, 11 SCRA 714 (1964); Marvel
Building v. David, 94 Phil. 376 (1954).
 4. Piercing Application Must be Shown to
Be Necessary and With Factual Basis
Luxuria Homes, Inc. v. Court of Appeals,52 reiterated the ruling that to
disregard the separate juridical personality of a corporation, the wrongdoing must
be clearly and convincingly established, and that it cannot be presumed. In that
case, the Supreme Court refused to pierce the veil of corporate fiction and held
that the organization of the corporation at the time when the relationship
between the landowner and the developer were still cordial cannot be used as a
basis to hold the corporation liable later on for the obligations of the landowner to
the developer under the mere allegation that the corporation is being used to
evade the performance of obligation by one of its major stockholders.
In Laguio v. NLRC,53 the Court held that mere substantial identity of the
incorporators of two corporations does not necessarily imply fraud, nor warrant
the piercing of the veil of corporate fiction, and that in the absence of clear and
convincing evidence to show that the corporate personalities were used to
perpetuate fraud, or circumvent the law, the corporations are to be rightly treated
as distinct and separate from each other.

CLASSIFICATION OF PIERCING CASES

A review of the piercing cases decided by the Supreme Court would point
out their classification into three (3) major areas:54

(a) When the corporate entity is used to commit fraud or to

justify a wrong, or to defend a crime ("fraud cases");
(b) When the corporate entity is used to defeat public
convenience, or a mere farce, since the corporation is
merely the alter ego, business conduit or instrumentality of a
person or another entity ("alter ego cases"); and
(c) When the piercing the corporate fiction is necessary to
achieve justice or equity ("equity cases").

The main distinction between the fraud cases of piercing from the mere
alter ego cases of piercing is that in the former there is always an element of
malice or evil motive, while in the latter case, even in the absence of an evil
motive, piercing would be allowed. However, it is also true that when the
corporate entity is used to commit a wrong or to achieve fraud, although
52
302 SCRA 315, 102 SCAD 892 (1999).
53
262 SCRA 715, 75 SCAD 92 (1996).
54
Azcuna in his article The Doctrine of Piercing the Veil of Corporate Fiction: A Review and
Analysis of Philippine Supreme Court Decision from Willets to Ramirez, 18 ATENEO L.J. 9 (Vol. I),
groups them only into two classes: (1) when the corporate entity is used to promote fraud,
injustice, illegality of wrong; and (2) the corporate entity is a mere alter ego, business, conduit,
branch or agency of a person, natural or another corporation. (at p. 34). However, Umali v. Court
of Appeals, 189 SCRA 529 (1990), has impliedly recognized three (3) groupings (at p. 542).
necessarily you may also achieve an alter ego scenario, the same would
primarily fall within fraud cases.
The third category of equity cases has mainly become the "dumping
ground," or perhaps the "added flourish" of the Court, when it had to apply the
piercing doctrine but could find it convenient to do so because no evil had been
sought to be achieved, but at the same time the corporate juridical personality of
the subject corporation cannot be respected in order to achieve justice.
The three (3) cases of piercing may appear together as in R.F. Sugay v.
Reyes,55 where an attempt by the corporation to avoid liability by distancing itself
from the acts of the its President, Mr. Romulo F. Sugay, alleging that he acted as
agent for another corporation was brushed aside by the Court when it held that
"the dual roles of Romulo F. Sugay should not be allowed to confuse the facts
relating to employer-employee relationship . . . [i]t being a legal truism that when
the veil of corporate fiction is made as a shield to perpetrate a fraud and/or
confuse legitimate issues (here, the relation of employer-employee), the same
should be pierced. Verily, the R.F. Sugay & Co., Inc. is a business conduit of
R.F. Sugay."56

FRAUD CASES
1. Piercing Doctrine Cannot
Be Employed to Commit Fraud
Gregorio Araneta, Inc. v. Tuason de Paterno and Vidal,57 held that the
piercing doctrine is employed to prevent the commission of fraud and cannot be
employed to perpetuate a fraud. In that case, Tuason sold lots to G. Araneta Inc.
Subsequently, the corporation filed a case against Tuason to compel delivery of
clean title to said lots. Tuason claimed that the sale was made to her agent, Jose
Araneta, president of the buying corporation, and therefore the corporate fiction
should be disregarded, the sale being not valid as it was made to an agent of the
seller.58
The Court ruled that corporate fiction will not be disregarded because the
corporate entity was not used to perpetuate fraud nor circumvent the law and the
disregard of the technicality would pave the way for the evasion of a legitimate
and binding commitment, especially since Tuason was fully aware of the position
of Mr. Araneta in the corporation at the time of sale.
2. Corporate Fiction Must

55
12 SCRA 700 (1964).
56
Ibid, at p. 705.
57
91 Phil. 786 (1952).
58
Under Article 1491 of the Civil Code, a purchase by an agent of the property of the
principal is void.
 Be Employed to Commit Fraud
Since the piercing doctrine is meant to prevent the commission of fraud; it
has no application to allow persons or entities to gain advantages. 59 In addition,
the application of the piercing doctrine is a remedy of last resort and will not be
applied, even in case of fraud, if other remedies are available to the parties.
In Umali v. Court of Appeals,60 the Court refused to apply the piercing
doctrine since the petitioners were "merely seeking the declaration of the nullity
of the foreclosure sale, which relief may be obtained without having to disregard
the aforesaid corporate fiction attaching to respondent corporations, [especially
since] petitioners failed to establish by clear and convincing evidence that private
respondents were purposely formed and operated, and thereafter transacted
with petitioners, with the sole intention of defrauding the latter." 61
3. Tax Evasion Case
In Commissioner of Internal Revenue v. Norton and Harrison62 where the
parent corporation owned all the outstanding stocks of the subsidiary
corporation, and financed all the operations of the subsidiary, and treated the
subsidiary's employees as its own; where the officers of both corporations were
located in the same compound; where the board of the subsidiary was
constituted in such a way to enable the parent to actually direct and manage
subsidiary's affairs by making the same officers of the board for both
corporations; and where the fiction of corporate entity was being used as a shield
for tax evasion by making it appear that the original sale was made by the parent
corporation to the subsidiary corporation in order to gain tax advantage, the
Court did not hesitate to pierce the veil of corporate fiction and treat as void the
sales between the corporations.
Since Norton and Harrison is a fraud case, you begin to wonder why there
was a need to show that the subsidiary corporation was being used as an
instrumentality or conduit of the parent corporation, since even in the absence of
such evidence, piercing to prevent fraud (i.e., tax evasion) would have been
warranted.
4. Alter-ego Elements
in Fraud Piercing Cases

59
In Burnett Commissioner v. Clarke, 287 US 410, 53 S.Ct. 207, 77 L.Ed. 397, the United
States Supreme Court refused to allow a taxpayer to use the piercing doctrine to gain a tax
advantage. In that case, Clarke indorsed his notes for a corporation of which he was majority
stockholder. He sustained losses by virtue of such endorsement. Such losses could not be
deducted on his income tax returns, because first, it did not result from any operation of any trade
or business regularly carried on by a taxpayer and, more importantly, because a corporation and
its stockholders are generally to be treated as separate entities, and only under exceptional
circumstances can the difference be disregarded.
60
189 SCRA 529 (1990).
61
189 SCRA 529, 543 (1990).
62
11 SCRA 714 (1954).
 Fraud case need not necessarily be accompanied by alter ego elements
to make the fraud case stick, because fraud is a matter of proof, and often it is a
state of the mind being founded on malice. In order to establish the state of mind
of the stockholders or officers to make them liable for corporate debts, or as in
the case of Norton and Harrison, in order to consider two separate entities as
one and the same, there may be an imperative need to detail the circumstances
which show that the corporate fiction is being used consciously as a means to
commit a fraud. In short, the alter ego circumstances may be needed to prove
the malicious intent of the parties.
In NAMARCO v. Associated Finance Co.,63 it was held that where a
stockholder, who has absolute control over the business and affairs of the
corporation, entered into a contract with another corporation through fraud and
false representations, such stockholder shall be liable jointly and severally with
his co-defendant corporation even when the contract sued upon was entered
into on behalf of the corporation.
Namarco demonstrates when a fraud case overlaps an alter ego case, as
held by the Court: "We feel perfectly justified in ‘piercing the veil of corporation
fiction’ and in holding Sycip personally liable, jointly and severally with his co-
defendant, for the sums of money adjudged in favor of the appellant. It is settled
law in this and other jurisdictions that when the corporation is the mere alter ego
of person, the corporate fiction may be disregarded; the same being true when
the corporation is controlled, and its affairs are so conducted as to make it
merely an instrumentality, agency or conduit of another." 64
Other than having entered in the name of a corporation a fraudulent
contract, which normally the board of directors would never have approved of,
there is no finding in Namarco of a consistent practice of Sycip using the
corporation as an alter ego. Therefore, in fraud cases, the alter ego concept
pertains to employing the corporation even for a single transaction, to do evil,
unlike in pure alter ego cases, where the courts go into findings of systematic
disregard and disrespect of the separate juridical person of the corporation.

5. Evasion of Lawful Obligations

In Palacio v. Fely Transportation Co.,65 where it was found that an
incorporator's main purpose in forming the corporation was to evade his
subsidiary civil liability resulting from the conviction of his driver, the corporation
was made liable for such subsidiary liability by denial of the plea that it had a
separate juridical personality and could not be held liable for the personal
liabilities of its stockholder. The Court took into consideration as part of the
attempt to do fraud that the only property of the corporation was the jeep owned
by the main stockholder involved in the accident.

63
19 SCRA 962 (1967).
64
Ibid, at p. 965.
65
5 SCRA 1011 (1962).
 In Villa Rey Transit, Inc. v. Ferrer,66 the Court held that when the fiction of
legal entity is "urged as a means of perpetrating a fraud or an illegal act or as a
vehicle for the evasion of an existing obligation, the circumvention of statutes,
the achievement or perfection of a monopoly or generally the perpetration of
knavery or a crime, the veil with which the law covers and isolates the
corporation from the members or stockholders who compose it will be lifted to
allow for its consideration merely as an aggregation of individuals."67 In that
case, the Court pierced the veil of corporate fiction to enforce a non-competition
clause entered into by its controlling stockholder in his personal capacity.

6. Liability of Officers
The general rule is laid down in Palay, Inc. v. Clave,68 that unless
"sufficient proof exists on record" that an officer (in that decision, a President and
controlling stockholder) has "used the corporation to defraud private respondent"
he cannot be made personally liable "just because he `appears to be the
controlling stockholder.'"69 "Mere ownership by a single stockholder or by
another corporation of all or nearly all of the capital stock of a corporation is not
of itself sufficient ground for disregarding the separate corporate personality." 70
Even in the early case of Mindanao Motor Line, Inc. v. Court of Industrial
Relations,71 dealing on claims for backwages, the Court had ruled that the
resident manager and general manager of the corporation cannot be made
solidarily responsible with the corporation for the payment of backwages, when it
is clear from the records that they were merely agents who acted within the
scope of their corporate positions, and there was no showing that they had acted
negligently or in bad faith.72 "It is a well-known principle of law that an agent who
acts in behalf of a disclosed principal within the scope of his authority cannot be
held liable to third persons."73
Pabalan v. NLRC,74 held that "[t]he settled rule is that the corporation is
vested by law with a personality separate and distinct from the persons
composing it, including its officers as well as from that of any other entity to
which it may be related . . . [and an officer] acting in good faith within the scope
of his authority . . . cannot be held personally liable for damages."75
Pabalan refused to hold the officers of the corporation personally liable for
corporate obligations on employees' wages, since "[i]n this particular case

66
25 SCRA 845 (1968).
67
Ibid, at pp. 857-858.
68
124 SCRA 638 (1983).
69
Ibid, at pp. 648-649.
70
Ibid, at p. 649.
71
6 SCRA 710 (1962).
72
Ibid, at pp. 714-715.
73
Ibid, at p. 715, citing Art. 1897 of the Civil Code, Banque Generale Belge v. Walter Bull &
Co., 84 Phil. 164 (1949).
74
184 SCRA 495 (1990).
75
Ibid, at p. 499.
complainants did not allege or show that petitioners, as officers of the
corporation deliberately and maliciously designed to evade the financial
obligation of the corporation to its employees, or used the transfer of the
employees as a means to perpetrate an illegal act or as a vehicle for evasion of
existing obligation, the circumvention of statutes, or to confuse the legitimate
issues."76
In R.F. Sugay v. Reyes77 an attempt by the corporation to avoid liability by
distancing itself from the acts of the its President was struck down, with the Court
holding that a corporation may not distance itself from the acts of a senior officer:
"the dual roles of Romulo F. Sugay should not be allowed to confuse the facts." 78
To the same effect is the ruling in Paradise Sauna Massage Corporation v. Ng,79
where it was held that an officer-stockholder who is a party signing in behalf of
the corporation to a fraudulent contract cannot claim the benefit of separate
juridical entity: "Thus, being a party to a simulated contract of management,
petitioner Uy cannot be permitted to escape liability under the said contract by
using the corporate entity theory. This is one instance when the veil of corporate
entity has to be pierced to avoid injustice and inequity." 80

7. Rules in Labor Cases

In the field of labor, however, the rule on the liability of corporate officers
for corporate obligations to employees seems to have taken two different strains.
In A.C. Ransom Labor Union-CCLU v. NLRC,81 the Court in interpreting
the Labor Code held that since a corporate employer is an artificial person, it
must have an officer who can be presumed to be the employer, being the
"person acting in the interest of (the) employer" as provided in the Labor Code.
Therefore, A.C. Ransom held that "the responsible officer of the employer
corporation can be held personally, not to say even criminally, liable for non-
payment of backwages; and that in the absence of definite proof as to the
identity of an officer or officers of the corporation directly liable for failure to pay
backwages, the responsible officer is the president of the corporation jointly and
severally with other presidents of the same corporation."
In effect, A.C. Ransom would hold a corporate officer liable for corporate
obligations by the mere fact that he is the highest officer even when there is no
proof that he acted in the particular matter for the corporation.
In Del Rosario v. NLRC,82 the Court (stating that the doctrine in A.C.
Ransom inapplicable without further explanation) refused to allow a writ of
execution to be applied against the properties of officers and stockholders for a

76
Ibid, at p. 500.
77
12 SCRA 700 (1964).
78
Ibid, at p. 705.
79
181 SCRA 719 (1990).
80
Ibid, at p. 729.
81
142 SCRA 269 (1986).
82
187 SCRA 777 (1990).
judgment rendered against the corporation which was later found without assets
on the ground that "[b]ut for the separate juridical personality of a corporation to
be disregarded, the wrongdoing must be clearly and convincingly established. It
cannot be presumed." In addition, it was held that "[t]he distinguishing marks of
fraud were therefore clearly apparent in A.C. Ransom. A new corporation was
created, owned by the same family, engaging in the same business and
operating in the same compound." In short, Del Rosario re-affirmed the original
doctrine before A.C. Ransom pronouncement that in order for a corporate officer
or stockholder to be held liable for corporate debts it must clearly be shown that
he had participated in the fraudulent or unlawful act.
The principle was reinforced in Western Agro Industrial Corporation v.
Court of Appeals,83 which held that a corporate officer cannot be held personally
liable for a corporate debt simply because he had executed the contract for and
in behalf of the corporation. It held that when a corporate officer acts in behalf of
a corporation pursuant to his authority, it is "a corporate act for which only the
corporation should be made liable for any obligations arising from them." 84
Two months after Del Rosario, the Court in Maglutac v. NLRC,85 held a
corporate officer liable for the claims against the corporation, relying upon the
A.C. Ransom ruling but only with respect to the doctrine that the responsible
officer of a corporation who had a hand in illegally dismissing an employee
should be held personally liable for the corporate obligations arising from such
act.
In Rustan Pulp & Paper Mills, Inc. v. IAC,86 the Court reiterated the
principle that the President and Manager of a corporation who entered into and
signed a contract in his official capacity, cannot be made liable thereunder in his
individual capacity in the absence of stipulation to that effect due to the
personality of the corporation being separate and distinct from the person
composing it.87

8. Probative Factors
The Supreme Court in Concept Builders, Inc. v. NLRC,88 summarized the
probative factors that are considered when the corporate mask may be lifted and
the corporate veil may be pierced, when a corporation is but the alter ego of a
person or of another corporation:

(a) Stock ownership by one or common ownership of both

corporations;

83
188 SCRA 709 (1990).
84
Ibid, at p. 718.
85
189 SCRA 767 (1990).
86
214 SCRA 665, 672 (1992).
87
Ibid, at p. 672, citing Banque Generale Belge v. Walter Bull and Co., Inc., 84 Phil. 164
(1949).
88
257 SCRA 149, 70 SCAD 764 (1996).
 (b) Identity of directors and officers;
(c) The manner of keeping corporate books and records; and
(d) Methods of conducting the business.

The Court held that the "conditions under which the juridical entity may be
disregarded vary according to the peculiar facts and circumstances of each case.
No hard and fast rule can be accurately laid down, but certainly, there are some
probative factors of identity that will justify the application of the doctrine of
piercing the corporate veil."
The Court in Concept Builders adopted the following tests in determining
the applicability of the doctrine of piercing the veil of corporate fiction:

1. Control, not mere majority of complete stock control, but

complete denomination, not only of finances but of policy
and business practice in respect to the transaction attacked
so that the corporate entity as to this transaction had at the
time to separate mind, will or existence of its own;
2. Such control must have been used by the defendant to
commit fraud or wrong, to perpetuate the violation of
statutory or other positive legal duty, or dishonest and
unjust act in contravention of plaintiff's legal rights; and
3. The aforesaid control and breach of duty must proximately
cause the injury or unjust loss complained of.
The absence of any of these elements prevents
“piercing the corporate veil.” In applying the “instrumentality”
or “alter ego” doctrine, the courts are concerned with reality
and not form, with how the corporation operated and the
individual defendant's relationship to that operation. 89

Obviously, from the foregoing, the inclusion of the element of fraud to be

existing in each case, while incorporating the alter-ego test, applies only in fraud
cases.

9. In Summary
From all the foregoing, what clearly comes out as the guiding rule is that
piercing is allowed in fraud cases only when the following elements are present:

(a) There must have been fraud or an evil motive in the affected
transaction, and the mere proof of control of the corporation
by itself would not authorize piercing;

89
Ibid.
 (b) The main action should seek for the enforcement of
pecuniary claims pertaining to the corporation against
corporate officers or stockholders, or vice-versa;
(c) The corporate entity has been used in the perpetration of the
fraud or in the justification of wrong, or to escape personal
liability.

Fraud cases requiring the application of piercing doctrine should therefore

be properly perceived as viewing the corporate entity from outside--from the
position of those in the business community who have to deal with corporations
on the other side of the bargaining table. If shady businessmen can hide behind
the fortress of the separate juridical personality, then it would make dealings with
corporations more tentative since the outside party must demand additional
assurances (such as joint and solidary undertaking by key officers and
stockholders on corporate liabilities) from the players behind the corporate
facade.
Piercing in fraud cases therefore is an assurance to the dealing public that
in cases of mischief by the actors behind the corporation, the piercing doctrine
allows them remedy against the very actors themselves. This safety hatch in fact
makes the corporate entity attractive not only for the businessmen who employ it,
but also on the part of the parties who have to contract with such corporate
entities.
In addition, a basic public policy abounds in fraud cases similar to the
doctrine of why in criminal corporate acts it is the actor behind the corporation
and not the corporate entity that is liable for the criminal prosecution. Without the
fraud cases of piercing, then the corporate entity would become a shield behind
which unscrupulous businessmen can hide and perhaps even become
dangerously aggressive in undertaking duplicitous deals because they would
never have to be personally liable for their fraudulent or unlawful acts. To
maintain the separate juridical personality under such circumstances would
therefore encourage fraudulent activities within society, and instead of making
the corporation an attractive medium, the dastardly deals by which it would be
exploited absent the piercing doctrine, would in fact put corporate entities at the
periphery or perhaps even in the underworld of business dealings.

ALTER EGO CASES

1. Manner of Operating the Corporate Enterprise
The first Philippine case to apply the piercing doctrine was actually Arnold
v. Willets and Patterson, Ltd.,90 and it was clearly an alter ego case.91 In that

90
44 Phil. 634 (1923).
91
The Court found that "There is no claim or pretense that there was any fraud or collusion
between plaintiff and Willits, and it is very apparent that Exhibit B was to the mutual interests of
both parties." - Ibid, at p. 643
case the creditors' committee of the corporation opposed the payment of
compensation due to the plaintiff Arnold under a contract-letter signed by Willits,
the controlling stockholder, without board approval. The signing president was
the controlling stockholder of the corporation. The Court held the validity of
contract and "[a]lthough the plaintiff was the president of the local corporation,
the testimony is conclusive that both of them were what is known as a one man
corporation, and Willits, as the owner of all the stocks, was the force and
dominant power which controlled them."92The Court expressed the language of
piercing doctrine when applied to alter ego cases, as follows: "Where the stock
of a corporation is owned by one person whereby the corporation functions only
for the benefit of such individual owner, the corporation and the individual should
be deemed the same."93
In La Campana Coffee Factory v. Kaisahan ng Manggagawa,94 Tan Tong
and his family owned and controlled two corporations, one engaged in the sale of
coffee and the other in starch. Both corporations had one office, one
management and one payroll; and the laborers of both corporations were
interchangeable. The 60 members of the labor association in the coffee and
starch factories demanded for higher wages addressed to "La Campana Starch
and Coffee Factory." La Campana Coffee Factory sought dismissal of the
petition on the ground that the starch and coffee factory are two distinct juridical
persons. The Court disregarded the fiction of corporate existence and treated the
two companies as one.
It should be noted that cases like La Campana Coffee Factory, where the
issue was the jurisdiction of the Court of Industrial Relations to hear the matter,
show that unlike in fraud cases where there must be a pecuniary claim as
enunciated in Umali, in alter ego cases no such pecuniary claim need be
involved to allow the courts to apply the piercing doctrine.
In Ramirez Telephone Corp. v. Bank of America95 Ramirez had unpaid
rents due Herbosa. The latter sought to garnish Ramirez's bank account, but no
such personal account existed, and only an account in the name of Ramirez
Telephone Company could be found and was garnished. The Court held that the
corporate bank account could be garnished despite the fact that Ramirez himself
leased Herbosa's premises because: although Ramirez was the tenant, the
company in truth occupied the premises; Ramirez paid the rents with checks of
the telephone company; and 75% of the shares of the company belonged to
Ramirez and his wife.
In Madrigal Shipping v. Oglivie,96 the crew members of "SS Bridge"
brought an action against Madrigal Shipping Company for recovery of unpaid
salaries. However, it seemed that Madrigal & Co. was the registered owner of
92
Ibid, at p. 641.
93
Ibid, at p. 645, quoting from U.S. Gypsum Co. vs. Mackay Wall Plaster Co., 199 Pac.,
249.
94
93 Phil. 160 (1953).
95
29 SCRA 191 (1969).
96
SUPREME COURT ADVANCED DECISION, October, 1958 issue; 55 O.G. No. 35, p. 7331.
such vessel. The Court held that granting that it was not the Madrigal Shipping
Co. that owned the vessel but actually Madrigal & Co., a corporation with a
juridical personality distinct from the former, yet as the former was the subsidiary
of the latter, and as found by the facts that it was a business conduit for the
latter, the fiction of corporate existence may be disregarded to make the former
liable for the claims.
Sibagat Timber Corp. v. Garcia,97 held that "where it appears that two
business enterprises are owned, conducted, and controlled by the same parties,
both law and equity will, when necessary to protect the rights of third persons,
disregard the legal fiction that two corporations are distinct entities, and treat
them as identical."
2. Tax Avoidance Cases
In Marvel Building v. David,98 where corporate properties were sought to
be sold by the BIR in order to enforce payment of the tax liabilities of its
stockholder, Castro. It was found that Castro and ten others incorporated Marvel
Building Corporation. The BIR assessed against Castro war profit taxes for
properties formerly in the name of Castro but which were later transferred to the
corporation. It seemed that the ten other incorporators were mere dummies. The
Court upheld the BIR finding that the corporation was a mere alter ego of the
Castro as it appeared that she had enormous profits and accordingly had the
motive to set up such a title-holding shield; that duplicate stock certificates had
been issued to various purported stockholders lacking the means to pay their
alleged subscriptions and no receipts issued for subscriptions paid; that no
stockholder's or director's meeting was held; that the books of account treated
everything as belonging to and controlled by Castro. Although it would seem that
Marvel should be classified as a fraud case (evasion of taxes), this would not
seem to be so under that case.
In Yutivo Sons Hardware v. Court of Tax Appeals99 Yutivo Sons and
Hardware Co. imported cars and trucks, which it sold to Southern Motors Inc.
Sales taxes were paid by Yutivo on this first sale. Southern Motors sold the
vehicles to the public. The Collector of Internal Revenue sought to impose sales
tax not on the basis of Yutivo's sales to Southern Motors but on Southern Motor's
higher sales to the public. To this the Court agreed. Although it found that
Southern Motors was not organized to perpetuate fraud; however, Southern
Motors was indeed actually owned and controlled by Yutivo as to make it a mere
subsidiary or branch of the latter. Yutivo, through common officers and directors
exercised full control over Southern Motor's cash funds, policies, expenditures
and obligations.
In Liddell & Co. v. Collector of Internal Revenue,100 Liddell & Co was
engaged in importing and retailing cars and trucks. Frank Liddell owned 98% of

97
216 SCRA 470 (1992).
98
94 Phil. 376 (1954).
99
1 SCRA 160 (1961).
100
2 SCRA 632 (1961).
its stocks. Later Liddell Motors Inc. was organized to do for retailing for Liddell &
Co. Frank's wife owned almost all its stocks. Since then, Liddell & Co. paid sales
tax on the basis of its sales to Liddell Motors. But the Collector of Internal
Revenue considered the sales by Liddell Motors to the public as the basis for the
original sales tax. The Court, agreeing with the Collector, held that Frank owned
both corporations as his wife could not have had the money to pay her
subscriptions. Such fact alone though not sufficient to warrant piercing, but under
the proven facts of the case, Liddell Motors was the medium created by Liddell &
Co. to reduce its tax liability. A taxpayer has the legal right to decrease, by
means which the law permits, the amount of what otherwise would be his taxes
or altogether avoid them; but a dummy corporation serving no business
purposes other than as a blind, will be disregarded.
Yutivo and Liddell (and therefore Marvel) are alter ego cases and not
fraud cases although the clear intention of parties was to minimize taxes and the
Court clearly decreed that no imposition of surcharge by virtue of fraud was
imposable by the BIR. The Court held in a language sweet to the ears of
businessmen and tax lawyers that "the legal right of a taxpayer to decrease the
amount of what otherwise would be his taxes, or altogether avoid them, by
means which the law permits, cannot be doubted . . . [and] a taxpayer may gain
advantage of doing business thru a corporation if he pleases, but the revenue
officers in proper cases, may disregard the separate corporate entity where it
serves but as a shield for tax evasion and treat the person who actually may take
the benefits of the transactions as the person accordingly taxable."101
Therefore, no less than the Court has stated that the use of the corporate
entity to gain a vantage (such as minimization of taxation) is not by itself a
fraudulent scheme. The corporate entity is there for both businessmen and
lawyers to tinker with, to gain every advantage available under the law, and that
alone is not a reprehensible act.
3. Under-Capitalization
In McConnel v. Court of Appeals,102 a forcible entry case, the corporation
was ordered to pay damages, but such corporation was later found without
enough assets, so the defendant went after the properties of the stockholders.
The Court decided for piercing, holding the stockholders liable for the deficiency.
Although it held that mere ownership of all and nearly all of the stocks does not
make a corporation a business conduit of the stockholders, but in that case, the
operation of the corporation was so merged with those of the stockholders as to
be practically indistinguishable. Furthermore, they had the same office, the funds
were held by the stockholders, and the corporation had no visible assets.
One cannot be sure whether McConnel is clearly an alter ego case or a
fraud case of piercing, since the Court had cited and fused together the
Milwaukee chant on piercing in fraud cases together with the alter ego formula.
No fraud seems to have been intimated in the decision since it based its
101
Ibid, at p. 641, citing Gregory v. Helvering, 293 U.S. 465, 7 L.Ed. 596, 599, 55 S.Ct.
102
1 SCRA 722 (1961).
conclusion more on the findings of the lower court that "[t]he evidence clearly
shows that these persons completely dominated and controlled the corporation
and that the functions of the corporation were solely for their benefits."103
However, it is in McConnel where the Court took special notice of the fact
that "[t]he corporation itself had no visible assets, as correctly found by the trial
court, except perhaps the toll house, the wire fence around the lot and the signs
thereof. It was for this reason that the judgment against it could not be fully
satisfied."104 Does McConnel imply that the incorporation of an entity without
reasonable assets to support the undertaking or venture for which it is organized
constitute a fraud against the corporate creditors? From the language in
McConnel, it would not seem so, since after noting the lack of visible assets of
the corporation, the Court held:

The facts thus found can not be varied by us, and

conclusively show that the corporation is a mere
instrumentality of the individual stockholders, hence the latter
must individually answer for the corporate obligations. While
the mere ownership of all or nearly all of the capital stock of a
corporation [does not make it] a mere business conduit of the
stockholder, that conclusion is amply justified where it is show,
as the case before us, that the operation of the corporation
were so merged with those of the stockholders as to be
practically indistinguishable from them. To hold the latter liable
for the corporation's obligation is not to ignore the
corporation's separate entity, but merely to apply the
established principle that such entity can not be invoked or
used for purposes that could not have been intended by the
105
law that created that separate personality.

Under-capitalizing a corporate enterprise (as distinguished from siphoning

off corporate assets) is therefore a species of alter ego cases, especially so
when it is never considered prudent business practice for ventures to shoulder all
the capital needed for the venture when credit therefor is available. Indeed
leveraging is an accepted, and often idealized, business practice. More
importantly, most corporate creditors extend credit to the corporation after having
studied the financial statements of the corporation, and the allegation of under-
capitalization would have been apparent from such financial statements.
Corporate creditors therefore extend credit fully aware of the risk involved in
case of under-capitalization, and the element of fraud generally does not attain
by that fact alone.106

103
Ibid, at 725.
104
Ibid, at 726.
105
Ibid, at p. 726.
106
"In one line of cases [in the United States], the fact that the sole owner of stock in a
corporation has embarked the concern in large operations with no adequate capital or assets to
support such operations, is held to justify the conclusion that this insufficently outfitted entity did
 4. Forum-Shopping
A recent area where the piercing doctrine has been applied is in attempts
to go around the remedial law provisions against forum shopping. In First
Philippine International Bank v. Court of Appeals,107 the Court held that "[i]n
addition to the many cases where the corporate fiction has been disregarded, we
now add the instant case, and declare herewith that the corporation veil cannot
be used to shield an otherwise blatant violation of the prohibition against forum-
shopping. Shareholders, whether suing as the majority in direct actions or as the
minority in a derivative suit, cannot be allowed to trifle with court processes,
particularly where, as in this case, the corporation itself has not been remiss in
vigorously prosecuting or defending corporate causes and in using and applying
remedies available to it. To rule otherwise would be to encourage corporate
litigants to use their shareholders as fronts to circumvent the stringent rules
against forum shopping."

5. Parent-Subsidiary Relationship
The alter ego doctrine has had an uneven application in the area of
parent-subsidiary relationship. We start with the premise laid down in Liddell &
Co., Inc. v. Collector of Internal Revenue:108

It is of course accepted that the mere fact that one or

more corporations are owned and controlled by a single
stockholder is not of itself sufficient ground for disregarding
separate corporate entities. Authorities support the rule that it
is lawful to obtain a corporation charter, even when a single
substantial stockholder, to engage in a specific activity, and
such activity may co-exist with other private activities of the
stockholder. If the corporation is a substantial one, conducted
lawfully and without fraud on another, its separate identity is to
109
be respected.

Although ownership of the controlling capital stock of the corporation by

itself would not authorize piercing, however, when existing together with other
factors, the courts have given much weight to such control feature to pierce.

not really conduct a separate enterprise, and the parent corporation is held liable for its
obligations. Some of these cases . . . suggest that to preserve the independence of an enterprise
which is needed to support the continuance of separate legal personality, the stockholder must
provide the entity with separate assets sufficient to give it at least a reasonable business chance
to carry out its asserted function. In these . . . the court's rulings construct a new entity, this time
out of spare parts distributed among component corporation. . ." Berle, The Theory of Enterprise
Entity, 47 COL. L. REV. No. 3, 343, 345.
107
252 SCRA 259, 67 SCAD 196 (1996).
108
2 SCRA 632 (1961).
109
Ibid, at p. 640.
 In Koppel (Phil.), Inc. v. Yatco,110 the Supreme Court held that virtual
control of the shareholdings of a corporation would lead to certain legal
conclusions. The Court could not overlook the fact that in the practical working of
corporate organizations of the class to which the two entities belonged, the
holder or holders of the controlling part of the capital stock of the corporation,
particularly where the control is determined by the virtual ownership of the totality
of the shares, dominate not only the selection of the board of directors but, more
often than not, also the action of that board.
The Court was wont to conclude that "[a]pplying this to the instant case,
we can not conceive how the Philippine corporation could effectively go against
the policies, decisions, and desires of the American corporation . . . Neither can
we conceive how the Philippine corporation could avoid following the directions
of the American corporation in every other transaction where the had both to
intervene, in view of the fact that the American corporation held 99.5 per cent of
111
the capital stock of the Philippine corporation. . ." We seem to draw from
Koppel the principle that control of the shareholdings of the corporation
necessarily means by itself control of the operations of the corporation.
Fortunately, the pronouncements in Koppel should not constitute
precedents in alter ego cases simply because Koppel actually involved a fraud
case of piercing, and there were in fact numerous findings in the decision where
the subsidiary corporation was made an instrumentality of the parent
corporation.112
The afore-quoted Liddell pronouncements have been re-affirmed in
Development Bank of the Philippines v. NLRC,113 where although DBP was the
majority stockholder of Philippine Smelters Corporation (PSC), and that majority
of the latter's board members came from DBP, and DBP was the mortgagee to
practically all the latter's properties, still the Court refused to pierce the veil of
corporate fiction to make DBP liable for the claims of the employees of PSC.
"We do not believe that these circumstances are sufficient indicia of the
existence of an employer-employee relationship as would confer jurisdiction over
the case of the labor arbiter." To the same effect is the earlier ruling in Diatagon
Labor Federation v. Ople.114
However, in Philippine Veterans Investment Development Corporation v.
Court of Appeals115 things took a different turn.116 In that case, PHIVIDEC sold
110
77 Phil. 497 (1946).
111
Ibid, at pp. 508-509.
112
The subsidiary corporation bore the expenses of the parent company; used its own
inventory to cover orders from the parent company; answered for the drafts of the parent
company; had key officers residing in the United States; and employed simple booking entries for
credits due from the parent company.
113
186 SCRA 841 (1990).
114
101 SCRA 534 (1980).
115
181 SCRA 669 (1990).
116
The author is always apprehensive of Supreme Court decisions that seek to oversimplify
things, as Justice Cruz enunciated in his opening statement in Philippine Veterans Investment
Development Corporation: "The concept of piercing the veil of corporate fiction is a mystique to
its controlling equity interests in PRI to PHILSUCOM, with a stipulation that
PHIVIDEC shall hold PHILSUCOM free and harmless against all liabilities of
PRI. PHILSUCOM subsequently formed the Panay Railways, Inc. to operate the
railway assets acquired from PHIVIDEC. Borres, a prior creditor of PRI sued
both PRI and Panay Railways, and the latter in turn filed a third-party complaints
against PHIVIDEC.
In the judgment, PHIVIDEC was held liable with PRI on the claims of
Borres. PHIVIDEC contended that it could not be held liable for the debts of PRI
since they are entirely distinct and separate corporations although the latter was
its subsidiary; that the transfer of shares of stock of PRI to PHILSUCOM did not
divest PRI of its juridical personality or of its capacity to direct its own affairs and
conduct its own business under the control of its own board of directors; and that
by the same token it PRI was answerable for its own obligations, which cannot
be passed on to PHIVIDEC.
Aside from the fact that PHIVIDEC agreed expressly to hold PHILSUCOM
(and also consequently the latter's subsidiary PRI which filed the third-party
complaint against PHIVIDEC) free and harmless against claims arising before
the transfer of PRI, the Court held for the piercing of the corporate fiction on the
following principle:

Where it appears that two business enterprises are

owned, conducted and controlled by the same parties, both
law and equity will, when necessary to protect the rights of
third persons, disregard the legal fiction that two corporations
are distinct entities, and treat them as identical.117

The factual basis used by the Court in order to enforce the above-quoted
doctrine is the finding of the trial court that "PHIVIDEC's act of selling PRI to
PHILSUCOM shows that PHIVIDEC had complete control of PRI's business."118
Perhaps there were other considerations in the lower court's findings showing
that indeed PHIVIDEC had complete control over PRI, but they certainly were
not mentioned in the Court's decision.
It is therefore unfortunate, and perhaps even tragic, that to allow a
piercing under the alter ego doctrine, the Court would use the sale by a parent
company of its shareholdings in a subsidiary to demonstrate complete control
over the subsidiary. The result of such a doctrine would be that in cases of
"equity transfers" as discussed below, contrary to the ruling in Edward J. Nell
Company v. Pacific Farms, Inc.,119 the applicable rule would be that the
transferor is always liable for the corporate liabilities of the corporation whose

many people, especially the layman. But it is not as esoteric as all that as this case will
demonstrate." at p. 670.
117
Ibid, at p. 673, citing Jabney v. Belmont Country Club Properties, Inc. 279 Pac. 829.
118
Ibid, at p. 674.
119
15 SCRA 415 (1965).
shares are transferred in complete derogation of the main doctrine of separate
juridical personality.
Logically, a stockholder has always complete and almost absolute control
over the share of stocks he holds in a corporation. But that does not necessarily
mean that he has actual complete control over the affairs and transactions of the
corporation. Perhaps the Court forgot its own pronouncements that shares of
stock in a corporation do not mean any interest in corporate properties as held in
Stockholders of F. Guanzon and Sons, Inc. v. Register of Deeds of Manila,120
Magsaysay-Labrador v. Court of Appeals,121 Saw v. Court of Appeals,122 and
Sulo ng Bayan, Inc. v. Araneta, Inc.123
More in point is the ruling in Remo, Jr. v. Intermediate Appellate Court,124
where the Court held: “The mere fact that a stockholder sells his shares of stock
in the corporation during the pendency of a collection case against the
corporation, does not make such stockholder personally liable for the corporate
debt, since the disposing stockholder has no personal obligation to the creditor,
and it is the inherent right of the stockholder to dispose of his shares of stock
anytime he so desires.”125

6. Affiliated Companies
In Guatson International Travel and Tours, Inc. v. NLRC,126 the other
affiliated corporations were also made liable by the NLRC for the separation pay
and backwages for which a corporate-employer was held liable. In contesting the
inclusion of the other corporations to the liability, on the ground that they were
separate and distinct legal personalities, the Court took the following proven
facts into consideration in piercing the veil of corporate fiction: the three
companies were owned by one family, such that majority of the officers of the
companies are the same; the companies are located in one building and use the
same messengerial service; the terminated employee was not paid separation
fee when he was absorbed by the other affiliate company, nor was he made to
resign from the first corporation.
In Azcor Manufacturing, Inc. v. NLRC,127 the Supreme Court delineated
the effect of applying the piercing doctrine to affiliated companies, when by the

120
6 SCRA 373 (1962).
121
180 SCRA 266 (1989).
122
195 SCRA 740 (1991).
123
72 SCRA 347 (1976).
124
172 SCRA 405, 413-414 (1989).
125
Ibid, at p. 14. The Court further held therein: “Even when the corporation is guilty in a
fraudulent transaction, a stockholder cannot be made personally liable for the resulting corporate
debt, when no evidence shows that the particular stockholder had any part or participation in the
perpetuation of the fraudulent transaction. Fraud must be established by clear and convincing
evidence. If at all, it is the principal character on whom fault should be attributed, the President,
who should be held personally liable, and not every stockholder.”
126
230 SCRA 815, 49 SCAD 329 (1994).
127
303 SCRA 26, 103 SCAD 293 (1999).
act of the managements of the two companies, its employees are placed at a
disadvantage, thus:

The doctrine that a corporation is a legal entity or a

person in law distinct from the persons composing it is merely
a legal fiction for purposes of convenience and to subserve
the ends of justice. This fiction cannot be extended to a point
beyond its reason and policy. Where, as in this case, the
corporation fiction was used as a means to perpetrate a social
injustice or as a vehicle to evade obligations or confuse the
legitimate issues, it would be discarded and the two (2)
corporations would be merged as one, the first being merely
considered as the instrumentality, agency conduit or adjunct of
the other. In this case, because of the actions of management
of the two corporation, there was much confusion as to the
proper employment of the claimant.

Tomas Lao Construction v. NLRC,128 held that where it appears that three
business enterprises are owned, conducted and controlled by the same parties,
both law and equity will, when necessary to protect the rights of third persons,
disregard the legal fiction that the corporations are distinct entities and treat them
as identical. In that case the three corporations were informally referred to as the
“Lao Group of Companies,” all of which were engaged in the construction of
public roads and bridges, and they entered into joint venture agreements among
each other to undertake their projects either simultaneously or successively so
that, whenever necessary, they would lease tools and equipment to one another,
each one would also allow the utilization of their employees by the other two.
Those proven facts where found proper bases for piercing the veil of corporate
fiction as to workers’ claims.

7. Transfer of Business Enterprise

There is a species of alter ego cases which deserves separate
discussions. Often a business enterprise, apart from the juridical personality
under which is operates, has a "separate being" of its own. This species of alter
ego cases is discussed in Chapter 13, as part of Corporate Acquisitions and
Transfers, Mergers and Consolidations.

8. Disturbing Developments Adopting the Umali Doctrine

Under fraud cases, Umali129 held that piercing the veil of corporate fiction
is available only if it is sought to hold the officers and stockholders directly liable
for a corporate debt or obligation.

128
278 SCRA 716, 86 SCAD 746 (1997).
129
189 SCRA 529, 542 (199).
 The doctrine in Umali, which is a fraud case, seems to have been derived
from the doctrine in Diatagon Labor Federation v. Ople,130 where the Court
struck down the holding of the Director of Labor Relations treating two
corporations as single bargaining unit for "because the two companies are
indubitably distinct entities with separate juridical personalities" despite clear
showing close relationship between them, which in many other cases decided by
the Court would have been enough basis to pierce.131 We can only surmise that
such holding of refusal to pierce was because the issue involved was not money
or damage claims, nor did it seek to hold any corporate officer or stockholder
liable, but merely "whether two companies should be regarded as a single
collective bargaining unit."132
Lately, in the case of Indophil Textile Mill Workers Union v. Calica,133
although it was shown that two corporations business are related, that some of
the employees of the two corporations are interchanged, and that the physical
plants, offices and facilities are situated in the same compound, were not
considered sufficient bases to pierce the veil of corporate fiction in order to treat
the two corporations as one bargaining unit. In coming to this conclusion, the
Court relied upon not only Diatagon Labor Federation, but also the doctrine in
Umali that "the legal corporate entity is disregarded only if it is sought to hold the
officers and stockholders directly liable for a corporate debt or obligation."
However, Umali is a fraud case and the doctrine enunciated there finds
rationale support because piercing in fraud cases is resorted to enforce liability
on the persons employing fraud. But both Diatagon Labor Federation and
Indophil Textile Mill are merely alter ego cases and the requirement that a
monetary claim should be interposed should not have been made applicable,
especially in the light of other alter ego cases decided by the Court applying the
piercing doctrine even when the issue involved merely one on jurisdiction.134

9. In Summary
From all the foregoing there seem to be four (4) policy bases for piercing
the veil of corporate fiction in alter ego cases:
Firstly, even when the controlling stockholder or managing officer intends
consciously to do no evil, the use of the corporation as an alter ego, and in some
cases as the private checkbook of the controlling stockholder, is in direct
violation of the central principle in Corporation Law of treating the corporation as
a separate juridical entity from its members and stockholders. Consequently,
those whose acts and actuations directly violate this central doctrine, make
130
101 SCRA 535 (1980).
131
The employees were formerly employees of one of the corporations transferred to the
other; even after the transfer, the affected employees continued to use the pay envelopes and
identification cards of their former employer; the two companies had common management and
represented by the same lawyers.
132
101 SCRA 535.
133
205 SCRA 697 (1992).
134
La Campana Coffee Factory v. Kaisahan ng Maggagawa, 93 Phil. 160 (1953).
themselves personally liable for having themselves cast away the protective
characteristic of limited liability of the separate juridical personality.
Secondly, and more importantly, by not respecting the separate juridical
personality of the corporation, others who deal with the corporation are not also
expected to be bound by the separate juridical personality of the corporation,
and may treat the interests of both the controlling stockholder or officer and the
corporation as the same.
This finds rational justification from the fact that the lack of respect for the
separate affairs of the corporation, makes its difficult for the public to monitor
exactly what properties and funds pertain to the corporation and those that
pertain separately to the stockholders or officers; and that to allow such random
interchange of assets and funds would probably lead to the defraudation of the
creditors who deal with the corporation. Although no actual fraud is committed,
unless the alter ego cases are upheld, then it is up to the dealing public to
carefully keep tab or close accounting of what assets do pertain to the
corporation.
Such a situation would increase overseeing transaction costs to those
who deal with corporate entities if the burden is placed on their shoulders, and in
fact would make the corporate entity a less attractive medium to transact with.
Therefore the application of the piercing doctrine to alter ego cases provides for
a more efficient policy because it throws the burden to the person or persons
who are in the best position to account properly and treat arms-length corporate
properties and affairs.
Thirdly, piercing in alter ego cases may prevail even when no monetary
claims are sought to be enforced against the stockholders or officers of the
corporation. Note must be taken of the disturbing developments in Diatagon
Labor Federation and Indophil Textile adopting the Umali doctrine in fraud cases
to alter ego cases.
Fourthly, when the underlying business enterprise does not really change
and only the medium by which that business enterprise is changed, then there
would be occasion to pierce the veil of corporate fiction to allow the business
creditors to recover from whoever has actual control of the business enterprise.
However, this aspect is more property discussed in Chapter 13.

EQUITY CASES
Equity cases applying the piercing doctrine are what are termed the
"dumping ground", where no fraud or alter ego circumstances can be culled by
the Court to warrant piercing. The main features of equity cases is the need to
render justice in the situation at hand or to brush aside merely technical
defenses. Often, equity cases of piercing appear in combination with other types
of piercing.
 In Telephone Engineering and Service Co., Inc. v. Workmen's
Compensation Commission135 the veil of corporate fiction was not allowed to be
availed of, and piercing was allowed when the corporate fiction was made as a
scheme to confuse the legitimate issues, such when the defense of separate
juridical personality is interposed for the first time on appeal.
In Emilio Cano Enterprises v. Court of Industrial Relations136 where a suit
for reinstatement was filed against the corporate officers in such capacities, but
which did not include the corporation, the judgment debt was sought to be
enforced against the corporate assets. Although Emilio Cano Enterprises is
essentially an alter ego case, the Court had occasion to apply the rationale for
equity cases of piercing, thus:

. . . Verily, the order against them [the corporate

officers] is in effect against the corporation. No benefit can be
attained if this case were to be remanded to the court a quo
merely in response to a technical substitution of parties for
such would only cause an unwarranted delay that would work
to Honorata's prejudice. This is contrary to the spirit of the law
which enjoins a speedy adjudication of labor cases
disregarding as much as possible the technicalities of the
procedure. We, therefore, find unmeritorious the relief herein
prayed for.137

In A.D. Santos v. Vasquez,138 a suit for workmen's compensation was filed

by taxi driver Vasquez against AD Santos, Inc. Vasquez testified that Amador
Santos was his employer. AD Santos Inc., contended that Amador is the one
liable. The Court held that AD Santos Inc., is liable. Indeed, Amador was at one
time, the sole owner and operator of the taxi business that employed Vasquez,
which was later transferred to AD Santos Inc. But such testimony should not be
allowed to confuse the facts relating to employer-employee relationship, for when
the veil of corporate fiction to "confuse legitimate issues," the same should be
pierced.

PIERCING DOCTRINE AND DUE PROCESS CLAUSE

The established doctrine in Philippine jurisprudence is that a person not
impleaded in the case cannot be bound by the decision rendered therein, since
no individual or entity shall be affected by a proceeding to which he is a
stranger.139

135
104 SCRA 354 (1981).
136
13 SCRA 291 (1965).
137
Ibid, at p. 293.
138
22 SCRA 1156 (1968).
139
Church Assistance Program v. Sibulo, (21 March 1989); Filamer Christian Institute v.
Court of Appeals, 190 SCRA 485,192 (1990).
 Often the piercing doctrine is sought to be applied against the controlling
stockholders or officers after a judgment debt against the corporation cannot be
enforced because the corporation is found to be without sufficient assets. It has
been rightly argued in several cases, that to enforce a writ of execution to satisfy
a judgment rendered against the corporation on the separate assets of the
stockholders or officers would be in violation of the due process clause in cases
where such stockholders or officers where not even summoned as parties to the
case brought against the corporation.
In McConnel v. Court of Appeals,140 when the judgment debt could not be
satisfied from corporate assets, an entirely new case was filed by the judgment
creditor against both the corporation and the controlling stockholders, and
pleaded therein the application of the piercing doctrine to make the stockholders
liable for the judgment debt of the corporation.
In Emilio Cano Enterprises v. Court of Industrial Relations,141 a suit for
reinstatement was filed against Emilio Cano and Rodolfo Cano in their capacities
as officers of Emilio Cano Enterprises. Inc., which did not include the corporation
as defendant. The Court rendered judgment against the two, for reinstatement
due to the fact that the stockholders belong to a single family. A writ of execution
of the judgment debt was issued directed against the properties of the
corporation, instead of those of the properties of the respondents officers. The
Court denied the action to quash the writ of execution on the ground that the
judgment sought to be enforced was not rendered against the corporation which
is a juridical personality separate and distinct from its officers. The Court held
that a factor that should not be overlooked is that the officers where sued, not in
their private capacities, but as officers of the corporation, and "[h]aving been
sued officially their connection with the case must be deemed to be impressed
with the representation of the corporation." 142 A corporation is a fiction, it can
only act through its officers, so there would be no denial of due process in this
case even if the corporation was not made a party defendant.
In NAMARCO v. Associated Finance co., Inc.143 where corporate liability
was sought to be enforced against the President who fraudulently entered into a
contract in the name of the corporation, the piercing of the veil of corporate
fiction was sought with the President being already made a defendant at the
onset together with the corporation.
In Jacinto v. Court of Appeals,144 it was held that the piercing doctrine may
be applied by the courts even when the complaint does not seek its
enforcement, so long as evidence is adduced during trial as the basis for its
application can be had. In other words, there must be evidential basis for
application of the piercing doctrine during the trial on the merits.

140
1 SCRA 723 (1961).
141
13 SCRA 291 (1965).
142
Ibid, at p. 292.
143
19 SCRA 962 (1967).
144
198 SCRA 211 (1991).
 In Arcilla v. Court of Appeals145 a judgment rendered against a person "in
his capacity as President" of the corporation was enforceable against the assets
of such officer when the decision itself found that he merely used the corporation
as his alter ego or as his business conduit.
Again, in Labor Law the doctrine takes a different twist when invoking the
piercing doctrine to make stockholders and officers liable for corporate debts at
the point of execution.
This issue was raised in A.C. Ransom Labor Union-CCLU v. NLRC,146
where corporate officers were sought to be made personally liable for a judgment
for backwages rendered against the corporation. In allowing judgment to be
executed against officers who were not parties to the case filed against the
corporation, the Court relied upon the provisions of the Labor Code that defined
the liable "employer" to "include any person acting in the interest of an employer,
directly or indirectly."147 The Court held:

. . . Since RANSOM is an artificial person, it must have

an officer who can be presumed to be the employer, being the
`person acting in the interest of (the employer' RANSOM. The
corporation, only in the technical sense, is the employer.
The responsible officer of an employer corporation can
be held personally, not to say even criminally, liable for a non-
payment of back wages. That is the policy of the law. . .148
The reasoning on this issue in A.C. Ransom still fails to
answer how a party, even when he is indicated by statutory
language to be responsible for an act, can be held liable when
he has not even been given his day in court under the due
process clause. The doctrine was reiterated in Villanueva v.
149
Adre.
The A.C. Ransom doctrine actually contradicted the
earlier ruling in Sunio v. National Labor Relations
Commission,150 where it was held that:
It is basic that a corporation is invested by law with a
personality separate and distinct from those of the persons
composing it as well as from that of any other entity to which it
may be related. Mere ownership by a single stockholder or by
another corporation of all or nearly all of the capital stock of a
corporation is not of itself sufficient ground for disregarding
the separate corporate personality.

145
215 SCRA 120 (1992).
146
142 SCRA 269 (1986).
147
Ibid, at p. 273, citing Article 212(c) of the Labor Code.
148
Ibid, at pp. 273-274. The A.C. Ransom doctrine was reiterated in Gudez v. NLRC, 183
SCRA 644 (1990); Maglutac v. NLRC, 189 SCRA 767 (1990); and Chua v. NLRC, 182 SCRA 353
(1990).
149
172 SCRA 876 (1989).
150
127 SCRA 390 (1984).
 However, the later case of Lim v. National Labor
Relations Commission151 clarified that the A.C. Ransom
doctrine applies only when the corporation no longer exists:
The case of Ransom v. NLRC is not in point because
there the debtor corporation actually ceased operations after
the decision of the Court of Industrial Relations was
promulgated against it, making it necessary to enforce it
against its former president. Sweet Lines is still existing and
able to satisfy the judgment in favor of the private
respondent.152

But even the broad application of the A.C. Ransom doctrine was refused
subsequently unless fraud is shown on the part of the officer sought to be made
153
personally liable. That is the reason why subsequently Del Rosario v. NLRC,
refused to apply A.C. Ransom pronouncement and denied enforcement of a writ
of execution against the officers for an unsatisfied judgment against the
corporation because it found that "[i]n the case before us, not only has there
been a failure to establish fraud, but it has also not been shown that petitioner is
the corporate office responsible for private respondent's predicament." 154 In
other words, to warrant application of piercing to make a corporate officer or
stockholder liable for the corporate debts or obligations, evidence must be shown
that such officer or stockholder was responsible for the corporate act, and that
stage can only come during the hearing on the merits.
Subsequently, De Guzman v. NLRC,155 further clarified the A.C. Ransom
doctrine not to be applicable to all types of officers, such as the general
manager, even if he is the highest ranking officer, when such officers is neither a
stockholder or a member of the board of directors.
In Western Agro Industrial Corporation v. Court of Appeals,156 where the
corporate officer was sued with the corporation to enforce a corporate obligation,
the Court refused to apply the piercing doctrine to make the corporate officer
liable for the corporate obligation since "[i]n this case there is no showing that
[the corporate officer] was not authorized by the corporation to enter into
purchase contracts . . . [and] [m]oreover, the respondent corporation has not
shown any circumstances which would necessitate the piercing of the corporate
veil so as to make [the corporate officer] personally liable for the obligations
incurred by the petitioner."157 Therefore, if in a clear case were a corporate
officer or stockholder is made a party jointly with the corporation to enforce
corporate debts and obligation, such corporate officer or stockholder cannot be
made personally liable without evidence adduced to warrant the piercing such as

151
171 SCRA 328 (1989).
152
Ibid, at p. 335.
153
187 SCRA 777 (1990).
154
Ibid, at p. 782.
155
211 SCRA 723 (1992).
156
188 SCRA 709 (1990).
157
Ibid, at p. 718.
fraud, then the more they cannot be belatedly made personally liable for a
corporate judgment debt at the point of execution for indeed the tribunal is at that
point without further jurisdiction to receive evidence on the merits.
This very issue was raised in Pabalan v. NLRC,158 where the corporate
officers sought to be made personally liable for a judgment rendered against the
corporation argued that no jurisdiction was acquired over them "as they have not
been served with summons and thus they were deprived of due process." 159 In
addressing this issue, the Court held:

The Court finds these grounds to be devoid of merit. As

the record shows while originally it was PIF which was
impleaded as respondent before the labor arbiter, petitioners
also appeared in their behalf through counsel. Thereafter
when the supplemental position paper was filed by
complainants, petitioners were impleaded as respondents to
which they filed an opposition inasmuch as they filed their own
supplemental position papers. They were therefore properly
served with summons and they were not deprived of due
160
process.

In other words, when confronted with the issue of due process, the Court
would consider it a legitimate and serious issue and would determine, as it did in
Pabalan, whether such constitutional guarantee has been violated.
Lately, in EPG Construction Company, Inc. v. Court of Appeals161 it was
reiterated that where it is not shown that the President of a corporation "had
acted maliciously or in bad faith" and there is no evidence adduce to show why
he should be made liable with the corporation for the latter's obligation, such
officer may not be made personally liable for corporate contracts entered in his
official capacity.

CORPORATIONS IN SEQUESTRATION ISSUES

In The PCGG Sequestration Cases,162 the Supreme Court has held that
the corporations which have been used as the instruments for acquisition, or as
being depositaries of products, of ill-gotten wealth, need not be impleaded as
separate parties to cases filed with the Sandiganbayan, and would still be proper
subject of sequestration.
The Court observed that such corporations "were organized so that they
could be used for improper, illegal and anomalous availment of financial or other
advantage; or were formed or being operated or manipulated by public officers

158
184 SCRA 495 (1990).
159
Ibid, at p. 498.
160
Ibid, at pp. 498-499.
161
210 SCRA 230 (1992).
162
240 SCRA 376 (1995).
sub rosa, or by private individuals, with the use of public funds or property or
assets otherwise illegally acquired, or in breach of public trust or violation of
fiduciary duty; or in the case of existing firms, that their stock had been
purchased by or for public officers and their relatives, friends and associates,
with the use of public funds or illegally acquired money, or in violation of law or
fiduciary duty, etc. Elsewise stated, following the classic pattern of a money-
laundering operation, they were either sham, ‘shell’ or ‘dummy’ corporations
serving as fraudulent devises or conduits for private gain of public officers and
employees; or companies from which stock has been acquired, or firms into
which capital had been infused, or shares of stock purchased, with the use of
illegally acquired assets, and which therefore constituted the res: the thing or
object treated of in the action."163
With respect to corporation organized with ill-gotten wealth, the Court held
that the corporations themselves are not guilty of misappropriation, fraud or other
illicit conduct—in other words, the companies themselves are the object or things
involved in the action, the res thereof—there is not need to implied them either.
"Indeed, their impleading is not proper on the strength along of their having been
formed with ill-gotten funds, absent any other particular wrongdoing on their part.
The judgment may simply be directed against the shares of stock shown to have
been issued in consideration of ill-gotten wealth."164

FINAL OBSERVATIONS
Of the three (3) types of piercing cases, it would seem therefore that the
most restricted ones are the fraud piercing cases since the Supreme Court has
required that allegations of fraud must clearly be proven to make a stockholder
or officer liable for corporate debts and that piercing is available only when there
is a claim for recovery against such stockholders or officers.
The alter ego cases of the piercing tend to have wider leeway in their
applications and even without intending to do malice or just by being practical in
costing by taking shortcuts such as housing together under closely inter-related
operations two or more corporate businesses, the controlling stockholders or
officers may find themselves liable personally for corporate debts.
The most unwieldy class are the equity cases, when often in a fit of
laziness, the courts may just tend to pierce and not carefully go through the facts
of the case to rely on other doctrines to do justice. Fortunately, the equity cases
often are resorted to as additional grounds (supportive roles) in fraud and alter
ego cases; however, the tendency to abuse is there.
But all three types of piercing have an underlying theme that often does
not draw the proper attention to which it is entitled to: In all of the piercing cases
discussed, the effect of piercing has always been to make the active or
intervening stockholder or officer liable for corporate debts and obligations.
163
Ibid, at p. 465.
164
Ibid, at pp. 465-466.
Therefore, what is clear, especially for publicly-listed companies, is that the main
doctrine of separate juridical personality, and all its ancillary attributes, including
limited liability, remain firm and formidable to mere passive investors in a
corporation.
This proves the point that the corporate entity is meant primarily to attract
investors to place their money in the hands of professional managers (a
divorcement of ownership from control) and that most corporate doctrines were
intended for such a set-up. Close supervision of one's investment should be
more compatible with other forms of media such as partnership and sole
proprietorship. In fact, the Corporation Code has given a special type of vehicle
for investors who wish to actively manage their investments: the close
corporations, which have been termed as incorporated partnership and for which
intervening stockholders are made personally liable for corporate debts and
obligations.165

—oOo—

CORPLAW .DIR\CORPMAN.DIR\04-PIERCING DOCTRINE\07-29-2002

165
See Sec. 100, Corporation Code. Please see Chapter 16 on Close Corporations.
 CHAPTER 5

CORPORATE CONTRACT LAW1

UNIFYING THEME ON THEORIES RELATING TO
PROMOTERS' CONTRACTS, DE FACTO CORPORATIONS,
CORPORATION BY ESTOPPEL, ARTICLES OF INCORPORATION,
BY-LAWS, AND ULTRA VIRES ACTS

Merging Principles of Corporate Law and Contract Law

Pre-Incorporation Stages: Promoter's Contract
Who is a Promoter?
Pre-incorporation Subscription Agreements
Other Promoter’s Contracts
CONTRACTS OF DEFECTIVELY-FORMED OR NON-EXISTENT
CORPORATIONS
De Facto Corporations
Rationale of Doctrine
Various Scopes of De Facto Corporation Doctrine
Requisites for De Facto Status
Valid Statute Under Which Organized
Colorable Compliance with Law
User of Corporate Powers
Continued Good Faith
Corporation by Estoppel Doctrine
Rationale of Doctrine
Historical Development of Doctrine
Current Status of Doctrine
Cases Outside De Facto Corporation and Corporation by Estoppel Doctrines
ARTICLES OF INCORPORATION AND BY-LAWS
Articles of Incorporation
By-Laws
Non-Bonding Effects of By-Laws for “Outsiders”
ULTRA VIRES DOCTRINE
Types of Ultra Vires Cases
Test to Determine Ultra Vires of First Type
Policies Supervening in Ultra Vires Issues
Distinguishing from Acts Which Are Per Se Illegal
Doctrine of Estoppel or Ratification
Illegal Acts
Acts or Contracts in Behalf of Corporation by Unauthorized Persons
Premise on Corporate Power
Doctrine of Apparent Authority
“Timely-Repudiation” Ruling
De Facto Corporate Officers

1
The chapter is an updated and revised version of the article with the same title published
in 37 ATENEO L.J. 1 (No. 2, June 1994).
 Corporate Dealings with Directors and Officers
Comparison with Principles in Unenforceable Contracts
FINAL OBSERVATIONS

————

MERGING PRINCIPLES OF CORPORATE LAW AND CONTRACT LAW

Corporations are expressly empowered to deal with third parties and enter
into valid and binding contracts with them. We have in the relationship of
corporations with third parties a merging of the legal disciplines of Contract Law
and Corporate Law. In such a merging of disciplines, there is often created a
conflict between policies and social values put forth by each of the disciplines.
In Contract Law, for a contract to be valid and binding, three essential
requisites must concur: (a) consent of the contracting parties; (b) subject matter
of the contract; and (c) cause or consideration.2
The essential requisite of consent requires two parties who are legally
capacitated by law to bind and be bound by obligations, and also should not
represent the same interests. Article 1305 of the Civil Code defines a contract as
"a meeting of minds between two persons whereby one binds himself, with
respect to the other, to give something or to render some service." In addition,
Article 1305 of the same Code provides that a "contract must bind both
contracting parties; its validity or compliance cannot be left to the will of one of
them." The very form of the consent has requisites, laid down in Article 1319 of
the Civil Code, which requires two parties not representing the same interests,
thus: "Consent is manifested by the meeting of the offer and the acceptance
upon the thing and the cause which are to constitute the contract."
Although the corporate entity is a juridical person, being a legal fiction it
cannot act in the world except through its duly authorized officers or
representatives. There is therefore the issue in Corporate Law which impinges on
the Law on Contracts on what happens to contracts entered into where the
corporation either has not been legally constituted, or has been defectively
constituted. Also, there are issues as to contracts involving duly constituted
corporations, but which were entered into by officers who either were not duly
authorized, or who exceeded the scope of their authorities.
When a corporation has not been constituted by law, there is as yet no
juridical person which can validly enter into a contract. Contract Law would
consider a contract entered into in behalf of a non-existent corporation as a void
contract for lack of the essential requisite of consent being given by two
contracting parties. However, in the Corporate Law, such contracts could have
binding effects depending on the prevailing circumstances.
In addition, a distinction has to be drawn between a situation where such a
contract is entered into with the parties knowing fully well that a corporation does
not yet legally exist, and the other situation where at least one of the parties is

2
Art. 1318, Civil Code of the Philippines.
unaware that a corporation has not been duly constituted. The first situation
refers to what the author would generically term as promoter's contracts or pre-
incorporation contracts. The second situation is what is termed as contracts
entered into with a defectively formed corporation, which would include the de
facto corporations and the corporations by estoppel.

PRE-INCORPORATION STAGES: PROMOTER'S CONTRACT

1. Who is a Promoter?
It is not the Corporation Code, but rather the Securities Regulation Code3
that defines a promoter to be “a person who, acting alone or with others, takes
initiative in founding and organizing the business or enterprise of the issuer and
receives consideration therefor.”4
Promoters, as the visionaries or trailblazers in founding a corporate
enterprise, are certainly not in the same category as carpetbaggers. Their
activities are deemed beneficial to society and therefore are regulated by law. No
formal recognition is accorded to promoter's contracts in the Corporation Code,
except under Sections 60 and 61 thereof, on pre-incorporation subscriptions.

2. Pre-incorporation Subscription Agreement

Under Section 60 any contract for the acquisition of unissued stock in an
existing or a corporation still to be formed shall be deemed a subscription within
the meaning of the Corporation Code, notwithstanding the fact that the parties
refer to it as a purchase or some other contract.
Under Section 61, a subscription for shares of stock of a corporation still to
be formed shall be irrevocable for a period of at least six (6) months from the
date of subscription, unless all of the other subscribers consent to the revocation,
or unless the incorporation of said corporation fails to materialize within said
period or within a longer period as may be stipulated in the contract of
subscription. However, no pre-incorporation subscription may be revoked after
the submission of the articles of incorporation to the SEC.
Sections 60 and 61 have effectively adopted in our jurisdiction a fused
version of both the "contract theory" and the "offer theory" in defining the nature
of pre-incorporation subscription agreements.
The offer theory construes subscription agreement as only continuing
offers to proposed corporations, which offer does not ripen into a contract until
accepted by the corporation when organized.5 The obvious result of the offer

3
Rep. Act No. 8799 (May, 2000).
4
Sec. 3.10, ibid.
5
Navarro, Two Points of Reform of Philippine Corporate Law, 27 PHIL. L.J. 669 (1952). "The
„offer' theory is worked out from the law of contracts. The analogy, however, fails for while in
ordinary contracts, there are both offerors and offerees, in our case the contemplated corporation
has not yet come into existence. To consider the offer as continuing and, therefore, as if made at
the time the corporation comes into existence is a twisting of the facts, for it is not so made in
fact. Neither may analogy be drawn between the contemplated corporation and a conceived child
for no one ever imagines contracting with it, except, perhaps, giving a gift to it, which does not
theory is that it allows withdrawal of subscriber at least before the corporation
comes into existence and accepts the offer.
Under the contract theory, a subscription agreement among several
persons to take shares in a proposed corporation becomes a binding contract
and is irrevocable from the time of subscription, unless cancelled by all the
parties before acceptance by the corporation.
It can be seen therefore that Sections 60 and 61 have fused the essential
features of both theories in their provisions. A subscription contract is essentially
a contract between the corporation and the subscribing person. The essence of
the stock subscription is an agreement to take and pay for original unissued
shares of a corporation, formed or to be formed.6
In the case of a pre-incorporation subscription agreement, Contract Law
would consider the subscription contract void, because one of the parties of the
contract, the corporation, does not exist. Yet Sections 60 and 61, as special
provisions in the Corporation Code, override the general provisions of Contract
Law, and mandate that pre-incorporation contracts are valid and enforceable. In
fact, Section 61 goes to the extent of saying that pre-incorporation subscription
agreements are irrevocable for a period of six (6) months from the date of
subscription. Under one point of view, there is no necessity under Section 61 for
the corporation to accept the subscription agreements, and it seems to bind the
corporation upon formation, as much as it binds the subscriber.
However, under another point of view, the provisions under Section 61 of
the Corporation Code making irrevocable pre-incorporation subscription
agreements pertains to the subscriber and between the subscribers among
themselves, and does not and cannot pertain to the corporation, because legally
speaking irrevocability (which the said section strictly covers prior to the fact of
incorporation of the corporation) cannot apply to a party who during that period
does not yet exist.
In addition, a pre-incorporation agreement is a type of promoter's contract,
and the prevailing theories in the Philippine jurisdiction (i.e., the contract theory
and the offer theory) are consistent with the fact that a promoter's contract is not
necessarily binding on the corporation once it is formed or organized and may be
refused by the corporation once formed. The only time when the corporation is
bound by a promoter's contract is when it has at the time of its constitution
received benefits from the contract. This appears to be the more logical and
forceful view.
Subscription agreements are "special contracts" in the sense that they go
beyond what we would term as ordinary contracts. Although subscription
agreements are contracts between the subscriber and the corporation, they are

come within the purview of contract law. It is not any good to consider the subscriptions as made
with an agent of the proposed corporation, for then there would be an agent for a principal that
does not exist. Again, if we grant the legal possibility of there being an agent of a non-existing
principal, this destroys the theory, as the subscription becomes perfected contract between two
able parties." Ibid, at p. 671.
6
Delpher Trades Corp. v. Intermediate Appellate Court, 157 SCRA 349, 353-354 [1988],
quoting Rohrlich 243, cited in AGBAYANI, COMMENTARIES AND JURISPRUDENCE ON THE
COMMERCIALS LAWS OF THE PHILIPPINES, Vol. III, 1980 ed., at p. 430.
at the same time deemed to be contracts among the stockholders of the
corporation. Such a "special relationship" among the subscribers of a corporation
can be sustained only if we look beyond the pale of the corporate fiction and see
that actually, beneath the corporate shell, is an association of warm-bodied
persons who decided to band together in the corporation in pursuit of a business.
This is clear from the fact that under Section 61, a pre-incorporation agreement is
generally irrevocable within the stipulated 6 month period "unless all of the other
subscribers consent to the revocation."

3. Other Promoter’s Contracts

Other than the subscription agreements which in the pre-incorporation
stage are essential in the process of founding a corporation, there are other
contracts that may have to be entered into in founding the "business of the
corporation." These are contracts entered into in the name of the intended
corporation by the promoters or organizers of the corporation. An example of
this type of contract, are deeds of assignment entered into by subscribers who
transfer their property holdings to the corporation as payment for their paid-up
capital subscription, under the provisions for tax-free exchanges of property of
the National Internal Revenue Code.7 The validity of such contracts, and their
binding power over the corporation, are notions that come to us as common law
doctrine; Contract Law would consider such promoter's contracts void.
In Cagayan Fishing Development Co., Inc. v. Teodoro Sandiko,8 four
parcels of land were sold to a corporation in the process of incorporation, under
specific terms whereby the outstanding mortgage loan on the properties would
have to be fully paid by the corporation. Later, the corporation was incorporated,
but the mortgage loan was not paid. However, the corporation sold the parcels of
land to Sandiko with the condition that the latter would shoulder the mortgage
debts. When Sandiko failed to comply with his obligation, the corporation filed a
recovery suit. In dismissing the case, the trial court held the contract to be void
since it was entered into with a corporation that had no corporate existence at
that time the properties were transferred to it. The Court upheld the dismissal of
the case holding:

That a corporation should have a full and complete

organization and existence as an entity before it can enter into
any kind of contract or transact any business, would seem to
be self-evident. . . . A corporation, until organized, has no
being, franchises, or faculties. Nor do those engaged in
bringing it into being have any power to bind it by contract,
unless so authorized by the charter. Until organized as
authorized by the charter there is not a corporation, nor does it
possess franchises or faculties for it or others to exercise, until
it acquires a complete existence.9

7
Sec. 30(C), National Internal Revenue Code of 1997.
8
65 Phil. 223 (1937).
9
Ibid, at pp. 227-228, quoting Gent v. Manufacturers and Merchants' Mutual Insurance
Company, 107 Ill. 652, 658.
 But more importantly, while the Court conceded that there are
circumstances where "the acts of promoters of a corporation [may] be ratified by
the corporation if and when subsequently organized . . . but under the peculiar
facts and circumstances of the present case we decline to extend the doctrine of
ratification which would result in the commission of injustice or fraud to the
candid and unwary."10 The Court elaborated thus:

Boiled down to its naked reality, the contract here

(Exhibit A) was entered into not only between Manuel Tabora
and a non-existent corporation but between Manuel Tabora as
owner of four parcels of land on the one hand and the same
Manuel Tabora, his wife and others, as mere promoters of a
corporation on the other hand. For reasons that are self-
evident, these promoters could not have acted as agents for a
projected corporation since that which had no legal existence
could have no agent. A corporation, until organized, has no life
and therefore no faculties. It is, as it were, a child in ventre sa
mere.11

It would seem that the ratio in Cagayan Fishing is that ratification is the
key element in upholding the validity and enforceability of promoter's contracts.
Without ratification by a corporation after its due incorporation, a contract entered
into in behalf of a corporation yet to be organized or still in the process of
incorporation is void as against the corporation. In Cagayan Fishing the Court
found significant, the fact that the deals involving the properties were treated not
as corporate assets but as the personal assets of the Taboras; as well as the fact
that the titles of the parcels of land were not even registered in the name of the
corporation: "In fact, to this day, the lands remain inscribed in Tabora's name.
The defendant always regarded Tabora as the owner of the lands. He dealt with
Tabora directly. Jose Ventura, president of the plaintiff corporation, intervened
only to sign the contract, Exhibit B, in behalf of the plaintiff. Even the Philippine
National Bank, mortgagee of the four parcels of land, always treated Tabora as
the owner of the same." These all pointed to a lack of a bona fide ratification of
the deed of sale of the properties in favor of the corporation.
In Rizal Light & Ice Co., v. Municipality of Morong, Rizal,12 a franchise
awarded in favor of a corporation was sought to be annulled on the ground that
at the time the application was filed, the corporation was then only in the process
of incorporation. In dismissing the action, the Court held that although a franchise
may be treated as a contract, the eventual incorporation of the applicant
corporation after the grant of the franchise, "and its acceptance of the franchise
as shown by its action in prosecuting the application filed with the Commission
for the approval of said franchise, not only perfected a contract between the
respondent municipality and Morong Electric but cured the deficiency pointed out
by the petitioner in the application of Morong Electric."13

10
Ibid, at pp. 227-228, citing FLETCHER CYC. OF CORP., Perm. Ed., 1931, Vol. I, Secs. 207 et
seq.
11
Ibid, at p. 228.
12
25 SCRA 285 (1968).
13
Ibid, at p. 305.
 The Court also clarified in Rizal Light that in deciding Cagayan Fishing
"this Court did not say in that case that the rule is absolute and that under no
circumstances may the acts of promoters of a corporation be ratified or accepted
by the corporation if and when subsequently organized. Of course, there are
exceptions. It will be noted that American courts generally hold that a contract
made by the promoters of a corporation on its behalf may be adopted, accepted
or ratified by the corporation when organized."14
In Caram, Jr. v. Court of Appeals,15 the Court stated that it would not
resolve the issue of whether it is the promoters or the corporation itself that shall
be responsible for the expenses incurred in connection with such organization.
Nevertheless it ruled that investors who were not the "moving spirit" behind the
organization of the corporation, but who were merely convinced to invest in the
proposed corporate venture on the basis of the feasibility study undertaken, are
not liable personally with the corporation for the cost of such feasibility study.
"The most that can be said is that they benefited from such services, but that
surely is no justification to hold them personally liable therefor. Otherwise, all the
other stockholders of the corporation, including those who came in later, and
regardless of the amount of their shareholdings, would be equally and personally
liable also with the petitioners for the claims of the private respondents."16
Although Justice Cruz in Caram, Jr. stated at the onset that "[f]or purposes
of resolving this case before us, it is not necessary to determine whether it is the
promoters of the proposed corporation, or the corporation itself after its
organization, that shall be responsible for the expenses incurred in connection
with such organization," the issue was in fact resolved in Caram, Jr. since the
Court took pains to point out that the majority investing incorporators were not
included in the definition of "promoter":

The above finding bolsters the conclusion that the

petitioners were not involved in the initial stages of the
organization of the airline, which were being directed by
Barreto as the main promoter. It was he who was putting all
the pieces together, so to speak. The petitioners were merely
among the financiers whose interest was to be invited and who
were in fact persuaded, on the strength of the project study, to
invest in the proposed airline.17

If indeed, the question of whether or not one is a promoter is irrelevant in

determining one's liability for the pre-organization expenses, then it would have
been unnecessary in Caram, Jr. to determine that the majority investing
incorporators were not promoters in order to absolve them from any liability on
the pre-organizational expenses.
What is of further significance in Caram, Jr. is the finding of the Court that
since there was no representation that the corporation was fictitious, there was
14
Ibid, at p. 306, citing FLETCHER CYC. OF CORP., Perm. Ed., Vol. I, Chap. 9, Sec. 207, p.
681.
15
151 SCRA 372 (1987).
16
Ibid, at p. 375.
17
Ibid, at p. 375.
no justification to hold the stockholders thereof personally liable. This is a
doctrine that has an effect similar to the doctrine of corporation by estoppel, thus:

Significantly, there was no showing that the Filipinas

Orient Airways was a fictitious corporation and did not have a
separate juridical personality, to justify making the petitioners,
as principal stockholders thereof, responsible for its
obligations. As a bona fide corporation, the Filipinas Orient
Airways should alone be liable for its corporate acts as duly
authorized by its officers and directors.18

CONTRACTS OF DEFECTIVELY-FORMED
OR NON-EXISTENT CORPORATIONS
1. De Facto Corporation
a. Rationale of Doctrine
It should be borne in mind that the de facto doctrine is not limited in its
application to Corporate Law; it is also a well-developed concept in the Law on
Public Corporations and the Law on Public Officers. The common feature of the
de facto doctrine in those legal fields, is that it prevents any party from raising the
defect of authority as a means to avoid fulfillment of a contract or a transaction
entered into in good faith.
Tayko v. Capistrano,19 which discussed the policy of the doctrine as
applied to public officers, held that "[t]he principle is one founded in policy and
convenience, for the right of one claiming a title or interest under or through the
proceedings of an officer having an apparent authority to act would be safe, if it
were necessary in every case to examine the legality of the title of such officer up
to its original source, and the title or interest of such person were held to be
invalidated by some accidental defect or flaw in the appointment, election or
qualification of such officer, or in the rights of those from whom his appointment
or election emanated; nor could the supremacy of the laws be maintained, or
their execution enforced, if the acts of the judge having a colorable, but not a
legal title, were to be deemed invalid."20
The de facto doctrine's essence is to protect the sanctity of dealings by the
public with persons or entities whose authority emanates from the State, to allow
the public to take such authority at face value, provided nothing is clearly shown
to be defective in such authority. Even if it should be proven that such authority
was indeed defective, such defect cannot be used as an excuse to set aside a
relationship or transaction entered into in good faith.
In the field of Corporate Law, the de facto corporation doctrine is meant to
protect the enforceability of corporate dealings and contracts, to allow the public
to take at reasonable face value the authority of the corporation to enter into valid

18
Ibid, at p. 375.
19
53 Phil. 866 (1928). See also Gamboa v. Court of Appeals, 108 SCRA 1 (1981).
20
Ibid , at p. 873.
and binding contracts, thereby providing a healthy system by which to encourage
the public to deal with corporate entities. The de facto corporation doctrine is
therefore meant to apply to the level of existence that pertains to the relationship
of the corporation with the dealing public; and is not meant to govern nor be
applicable to other levels of existence, such as those pertaining to intra-corporate
relationships.

b. Various Scope of De Facto Corporation Doctrine

The main sequences of the de facto corporation doctrine are as follows:

(a) The enterprise contracts with an outsider, who later brings

action against the enterprise as though it were a corporation,
and the enterprise is held liable in corporate form;
(b) The enterprise contracts with an outsider, and subsequently
brings actions in corporate form against the outsider, the
outsider is held liable to the enterprise;
(c) The enterprise contracts with an outsider, and the outsider
brings action against the component individuals, they are
absolved from liability and the outsider held to his remedy
against the enterprise only; or
(d) The enterprise contracts with an outsider, and the
component individuals seek to hold the outsider liable on his
contract, where logically the individuals are not allowed to
recover, recovery must be by the enterprise.21

c. Requisites for De Facto Status

Under American jurisprudence, for the de facto corporation doctrine to
apply, the following requisites must concur:

(a) The existence of a valid law under which it may be

incorporated;
(b) An attempt in good faith to incorporate, or “colorable
compliance” with provisions on incorporation; and
(c) Assumption by the enterprise of corporate powers.

In Hall v. Piccio,22 a corporation was organized from an unregistered

partnership among several individuals. Immediately after the execution of the
articles of incorporation, the corporation proceeded to do business with the
adoption of by-laws and the election of its officers. The articles of incorporation
were forwarded to the SEC for registration. But before the issuance of the
corresponding certificate of incorporation, some of the incorporators filed an
action in court to have the unregistered partnership dissolved, and included as
defendants some of the officers of the partnership. The defendants filed a motion
to dismiss on the ground that the court had no jurisdiction over the dissolution of
21
Berle, The Theory of Enterprise Entity, 47 COL. L. REV. (No. 3), 343, 345.
22
86 Phil. 603 (1950).
the company. Since it was a de facto corporation, they argued, dissolution
thereof could only be ordered in a quo warranto proceeding; and since the
plaintiffs signed the articles of incorporation, they were now estopped from
claiming that it is not a corporation but only a partnership.
The Court held that since the certificate of incorporation had not been
issued by the SEC, then the de facto corporation doctrine did not apply. None of
the incorporation directors could claim in good faith to be a corporation, being
fully aware of the non-issuance of the certificate of incorporation. Likewise, since
the suit was not one where the corporation itself was made a party, but was
merely a litigation between stockholders of the alleged corporation for the
purpose of obtaining its dissolution, "[e]ven the existence of a de jure corporation
may be terminated in a private suit for its dissolution between stockholders,
without the intervention of the state."23
In spite of the rulings therein, Piccio cannot be taken to have changed the
parameters of the de facto corporation doctrine.
Firstly, Piccio cannot be taken to be doctrinal when it comes to the de
facto doctrine simply because the suit therein involved really intra-corporate
disputes; the de facto doctrine applies to contracts and transactions made by or
on behalf of the corporation with “outsiders” and has no application in intra-
corporate disputes.
If one where to look closely at the ruling, then the real value of Piccio
would be that de facto doctrine and the corporation by estoppel doctrine have no
applications to issues and controversies that deal on the level of those that fall
within the intra-corporate level. This much has been confirmed in the recent
case of Lozano v. De los Santos,24 where the Supreme Court held that
“Corporation by estoppel is founded on principles of equity and is designed to
prevent injustice and unfairness. It applies when persons assume to form a
corporation and exercise corporate functions and enter into business relations
with third persons. Where there is no third person involved and the conflict arises
only among those assuming the form of a corporation, who therefore know that it
has not been registered, there is no corporation by estoppel.”
Secondly, since good faith is the underlying element of the de facto
doctrine, Piccio actually made it the essential test of the existence of such good
faith, that the parties to a corporate entity, i.e., the incorporators, must have been
aware of the issuance of the certificate of incorporation by the SEC for such good
faith to exist. Since ignorance of the law excuses no one from compliance
therewith, and since Section 11 of the then Corporation Law specifically provided
that corporate existence begins "only from the moment such certificate is issued,"
there was no instance in which incorporators and the public dealing with
corporations could pretend to be in good faith. They were duty-bound to
ascertain that such a certificate had in fact been issued. More would be said of
the Piccio doctrine hereunder.

d. Valid Statute Under Which Organized

23
Ibid, at p. 606.
24
274 SCRA 452 (1997).
 The valid statute under which most private corporations are organized
today would be the Corporation Code, which therefore supplies the first element
of what would constitute a de facto corporation existing in Philippine jurisdiction.
Can there be a de facto corporation organized under an enabling statute
that is an unconstitutional? Following the "orthodox view" that "an
unconstitutional act, whether legislative or executive, is not a law, confers no
rights, imposes no dues, and affords no protection,"25 the enabling statute being
unconstitutional would be absolutely void, and no corporation organized under it
can achieve the status of being de facto corporation. Therefore, the prevailing
view is that an unconstitutional enabling law has the same effect as though there
is no law under which to organize, and even if the associates organize in good
faith in reliance upon it, the resulting association cannot claim to be a de facto
corporation.
There is, however, the "qualified view" that the "actual existence of a
statute prior to such a determination [of unconstitutionality], is an operative fact
and may have consequences which cannot always be erased by a new judicial
declaration."26 Under that theory, a corporation defectively organized under the
law before it was declared unconstitutional can claim to be a de facto corporation
(presuming that other requisites are present), since it was organized under color
of law, that the statute is presumptively constitutional until it has been judicially
declared to be invalid, and that until it is so declared, men have a right to act and
contract under such presumption. Consequently, the acts and contracts of such a
defectively formed corporation, before the enabling law under which is was
organized is declared unconstitutional, cannot be avoided as against the
interests of the public, or of third persons who have invested or acted in good
faith in reliance upon their validity, by any ex post-facto declaration or decision
that the law under which they act was void.
After declaration of the invalidity or unconstitutionality of the enabling
statute, any corporation organized under it can no longer claim the status of
being a de facto corporation, since at that point the element of good faith would
no longer exist.
Hence, a distinction should be made when dealing with a corporation that
has been organized under an enabling law that has been declared
unconstitutional. If the constitutionality of the statute is raised for the first time in
an action wherein it is sought to prevent the future incurring of rights and
obligations, it will be proper to permit collateral attack; where the constitutionality
of the statute is raised for the first time in litigation seeking enforcement of
contracts or transaction which have been fully or partially consummated,
collateral attack on the juridical personality of the corporation should not be
permitted, since the corporation should be treated as a de facto corporation.
Courts have, however, through jurisprudence, arrived at the same result
as that upheld by such minority opinion, holding that a corporation organized
under a statute subsequently declared unconstitutional may nevertheless be

25
Fernandez v. Cuerva, 21 SCRA 1095, 1106 (1967).
26
Ibid. Also De Agbayani v. Philippine National Bank, 36 SCRA 429 (1971).
considered a corporation by estoppel, where there have been previous dealing
between the parties on a corporate basis.

e. Colorable Compliance with Law

The general principle is that while substantial compliance is not
necessary, colorable compliance with the requirements of the law must be
shown. When there has been no attempt in good faith to create a corporation de
jure, there can be no de facto corporation. Any other rule might well open the
door to fraud upon the public. Mere intent is not sufficient. In addition, there must
be a bona fide attempt to comply with the requirements of the law. The outward
manifestation of the existence of a corporate being is therefore necessary as the
basis upon which the dealing public may be led to believe that they are dealing
with a juridical person.
Some defects that would preclude the creation of even a de facto
corporation are the absence of articles of incorporation, the failure of filing the
articles of incorporation with the SEC, and the lack of certificate of incorporation
from the SEC.
In Philippine jurisdiction, the filing of articles of incorporation and the
issuance of the certificate of incorporation may therefore be considered as
essential for the existence of a de facto corporation.27
Some defects that do not preclude the creation of a de facto corporation
are as follows:

(a) Defects in the incorporation papers - the articles of

incorporation fail to state all the matters required by the
Corporation Code to be stated, or state some of them
incorrectly;
(b) Corporate name - the name of the corporation closely
resembles that of a pre-existing corporation that it will tend to
deceive the public;
(c) Ineligibility of incorporators - the incorporators or a certain
number of them are not residents of the Philippines;28 or
(d) Defects in the execution of incorporation papers, the
acknowledgment of the articles of incorporation, or certificate
of incorporation is insufficient or defective in form, or it was
acknowledged before the wrong office.

f. User of Corporate Powers

Taking subscriptions to and issuing shares of stocks, electing members
and directors, adopting by-laws in connection with buying a lot and constructing
and leasing a building upon it, are sufficient acts of user of corporate power to
constitute a corporation de facto.

27
Hall v. Piccio, 86 Phil. 603 (1950).
28
SEC Opinion, 17 January 1985, SEC ANNUAL OPINIONS 1985, at p. 9.
 "Organization" as used in reference to corporations, has a well-understood
meaning, which is the election of officers, providing for the subscription and
payment of the capital stock, the adoption of by-laws, and such other steps as
are necessary to endow the legal entity with the capacity to transact the
legitimate business for which it was created. Under a statute providing that, until
articles of incorporation should be recorded, the corporation should transact no
business except its own organization, it is held that the term "organization"
means simply the process of forming and arranging into suitable disposition the
parties who are to act together in, and defining the objects of, the compound
body, and that this process, even when complete in all its parts, does not confer
a franchise either valid or defective, but, on the contrary, it is only the act of the
individuals, and something else must be done to secure the corporate
franchise.29

g. Continued Good Faith

In Hall v. Piccio,30 the Court denied the ground that the corporation was a
de facto corporation and its existence could not be attacked collaterally: that the
incorporating group had not obtained the certificate or incorporation, and
consequently, the incorporating group could not claim in good faith, to be a
corporation. The Court held that under our statute, it is the issuance of the
certificate of incorporation by the SEC which calls a corporation into being.
If despite such a substantial defect there is nevertheless the issuance of a
certificate of incorporation by the SEC, and the incorporators knew of such defect
at the time of issuance, would the situation still call for the application of the de
facto corporation doctrine? Also, if there was good faith at the time of
incorporation which would have brought about the creation of a de facto
corporation with the issuance of the SEC certificate, but later on the directors and
officers of the corporation came to know of such defect, would the corporation
then lose it standing as a de facto corporation?
Section 20 of the Corporation Code which uses the language "any
corporation claiming in good faith," in defining a de facto corporation, and
applying Piccio ruling that the issuance of the certificate of incorporation by the
SEC is the minimum requirement by which such good faith may exist, then the
proper position that can be taken in the two issues raised would be that such
issuance of the SEC certificate would raise the corporation to the level of being a
de facto corporation and therefore, "its right to exercise corporate powers, shall
not be inquired into collaterally in any private suit to which such corporation may
be a party."31
This position is bolstered by the fact that under Section 6(l) of Pres.
Decree No. 902-A, in defining the powers of the SEC, grants as one of the basis
by which the SEC may suspend or revoke "after proper notice and hearing," the
franchise or certificate of registration of corporations when there has been "fraud
in procuring its certificate of registration." In other words, even the SEC has to go
through a quasi-judicial process before it can revoke the certificate of a

29
Benguet Consolidated Mining Co. v. Pineda, 98 Phil. 711, 720 (1956).
30
86 Phil. 603 (1950).
31
Sec. 20, Corporation Code.
corporation which has used fraud in the process of its incorporation, clearly
indicating that prior to such revocation, the corporation has all the powers and
attributes of a corporation de facto.
In addition, to allow the collateral attack on the personality of a corporation
because of existing defects known to the corporation and its board would
circumvent the very rationale of the de facto doctrine which seeks to prevent any
party from raising the defect of authority as a means to avoid fulfillment of a
contract or a transaction entered into.
On the other hand, in a suit between and among the parties who knew
that there was a defect in the incorporation of the corporation, there certainly is
no good faith on their part and in their case, the de facto doctrine cannot be
availed of in order to further their fraud.

2. Corporation by Estoppel Doctrine

The corporation by estoppel doctrine presents a clear exception to the
general treatment of unregistered associations.32

a. Rationale of Doctrine
Estoppel is essentially a common law principle, and has been the source
of many rules which seek to work out justice or equity between the parties, on the
theory that an admission or representation is rendered conclusive upon the
person making it, and cannot be denied or disproved as against the person
relying thereon.33 The doctrine of estoppel has its origins in equity, and is based
on moral right and natural justice,34 and is designed to prevent injustice and
unfairness.35 The doctrine therefore permeates and goes beyond Corporate Law
considerations.
The doctrine is meant to hold contractual parties to their representations
or expectations at the time the contract was perfected; and it does not allow
parties to draw on a basic defect—lack of one contracting party—to avoid the
enforcement of the contract. The doctrine has evolved in Corporate Law primarily
as a rule to promote the integrity of commercial contracts; the basic role of the
32
In an opinion rendered by the SEC, it characterized the advantages of a corporation from
an unregistered corporation: "A corporation is a legal entity deriving its existence from a
franchise, whereas, as association in the narrow sense of the term is a creature of contract
without legal personality separate and distinct from the individuals composing it. An unregistered
association cannot sue and be sued; it cannot enter into contracts in the name of the association
and neither can it acquire properties under its common name. Contracts entered into in its behalf
make the persons signing or executing them liable to the other contracting party. It is not
competent to act or appoint agents or confer upon another authority to act on its behalf, and
those who act or purpose to act as its representatives or agents do so at their own risk. It is only
when the association is incorporated under the Corporation Code that it acquires juridical
personality, distinct and separate from its stockholders or members. Such incorporation enables
the association to exercise the powers which its charter and the Corporation Code grant to said
association." SEC Opinion, 22 August 1989, XXIV S EC QUARTERLY BULLETIN 2 (No. 1, March
1990).
33
Report of the Code Commission, p. 59, Introduction to Title IV of the Civil Code on
Estoppel.
34
Mirasol v. Municipality of Tabaco, 43 Phil. 610 (1922).
35
Lozano v. De los Santos, 274 SCRA 452, 83 SCAD 898 (1997).
doctrine of corporation by estoppel is to promote the public's underlying faith in
contracts drawn with corporate entities, rather than to promote corporate
principles. For this reason, the doctrine as it has evolved in Section 21 seems
convoluted from a strict Corporate Law point of view; or at least, the basic
elements of the doctrine as expressed in Section 21 seem to be contradictory or
antithetical.
A review of jurisprudential history up to the adoption of Section 21 clearly
show that an uneven path had to be followed by our courts in applying the
original versions of the doctrine. Section 21 had to cut through the logical maze
to practically dictate a solution long sought by the courts, which they had been
unable to logically reach through accepted legal principles of those times.

b. Historical Development of Doctrine

The case of Asia Banking Corporation v. Standard Products Co.,36
reiterated the estoppel principle upheld by the earlier decisions of the Supreme
Court in Behn, Meyer & Co. v. Rosatzin,37 and Chamber of Commerce v. Pua Te
Ching.38 In Asia Banking a collection suit was brought by the bank on a
promissory note issued in behalf of the corporate borrower. At the trial, the bank
failed to prove affirmatively the corporate existence of the parties, and so the
defendant corporate borrower insisted on appeal that the judgment rendered
against it was wrong.
In brushing aside the contention of the corporate borrower, the Court held
that the "general rule is that in the absence of fraud a person who has contracted
or otherwise dealt with an association in such a way as to recognize and in effect
admit its legal existence as a corporate body is thereby estopped to deny its
corporate existence in any action leading out of or involving such contract or
dealing, unless its existence is attacked for causes which have arisen since
making the contract or other dealing relied on as an estoppel and this applies to
foreign as well as to domestic corporations."39
In Asia Banking, the defendant corporate borrower, having recognized the
corporate existence of the plaintiff by making a promissory note in its favor and
making partial payments on the same, was estopped to deny plaintiff's corporate
existence, and also from denying its own corporate existence; evidence to
establish such facts was thus unnecessary.
Asia Banking affirmed the first element of the corporation by estoppel
doctrine now found in the second paragraph of Section 21: "One who assumes
an obligation to an ostensible corporation as such, cannot resist performance
thereof on the ground that there was in fact no corporation." At the time of Asia
Banking, it was the only element of the doctrine. The effect of the estoppel is to
prevent the declaration of nullity of a contract on the ground that one of the
parties thereto, a purported corporate entity, does not in fact exist.

36
46 Phil. 144 (1924).
37
5 Phil. 660 (1906).
38
14 Phil. 222 (1909).
39
Ibid, at p. 145 citing 14 C.J. 227 and Chinese Chamber of Commerce v. Pua Te Ching, 14
Phil. 222 (1909).
 However, if one were to examine further this element of the doctrine, one
would see that to uphold the validity of a contract, both parties thereto must
recognize the corporate party even when one does not exist. Consequently, the
recognition of a corporate entity which in fact did not exist, in order to uphold the
validity of the contract, would lead to the application of the doctrine that once a
corporate entity exists, then it has a personality separate and distinct from the
stockholders or members who compose it. The separate juridical personality
doctrine requires that officers and stockholders acting for the corporation cannot
be held personally liable for corporate debts and liabilities. The conclusion is that
the persons who purport to act for a non-existent corporation would be held to
the existence of such corporate entity, and logically the corporate contract cannot
be enforced against them because of the separate juridical personality that is a
consequence of the recognition of the corporation.
This was the logical wall that faced the courts with the application of the
then version of the corporation by estoppel doctrine, as amply demonstrated in
Hall v. Piccio40 previously discussed above. The Supreme Court found in Piccio
that all parties to the contract were aware that the certificate of incorporation had
not yet been issued. The Court also held that the parties knew, or ought to have
known, that the personality of a corporation begins to exist only from the moment
such certificate is issued. Since "nobody was led to believe anything to his
prejudice or damage, the principle of estoppel does not apply [and] [o]bviously
this is not an instance requiring the enforcement of contract with the corporation
through the rule of estoppel."
The implication in Piccio is that the corporation by estoppel doctrine
applies only when at least one party to a contract was under the impression that
the other, corporate party was a duly incorporated entity. When both parties, as
in Piccio, are aware that a corporation has not been duly organized, then the
corporation by estoppel doctrine does not apply. Piccio therefore establishes one
of the elements of the doctrine: that at least one of the contracting parties was
under the impression or belief that the corporate entity party to the contract was
duly incorporated.
But if we were to take Piccio to its logical conclusion then it would
practically mean that the doctrine of corporation by estoppel will never apply,
since under Piccio all parties, whether incorporating stockholders or third-parties,
are mandated by law to be aware that corporate existence begins only upon the
issuance of the certificate of incorporation by the SEC.41 And since the issuance
or non-issuance of a certificate of incorporation is a matter of public record, even
third parties are charged with constructive knowledge of the fact of such non-
issuance. In fact, it would seem to be an obligation of one who deals with a
corporate entity to know whether such certificate has been issued, since this is
easily verifiable with the SEC.
If such a certificate is indeed issued but there is a defect in the
incorporation process of a contracting corporate entity, pursuant to Piccio, the
doctrine of de facto corporation would come into play. However, if no such
certificate of incorporation has been issued, then even the corporation by
40
86 Phil. 603 (1950).
41
Sec. 19, Corporation Code.
estoppel doctrine would be inapplicable, because both the associates in the
purported corporation and the other party to the contract cannot plead ignorance
of the fact that no corporation existed, since they are chargeable with the
knowledge of the non-issuance.
One conclusion that may be drawn from all this is that, following Piccio,
the corporation by estoppel doctrine cannot apply when no certificate has been
issued. It can only apply when a certificate is issued but where, for lack of the
other criteria, the de facto corporation doctrine cannot apply. This does not seem
to be a good doctrine. What we can reasonably draw as a conclusion from Piccio
is that the non-issuance of a certificate of incorporation affects the good faith only
of the corporate insiders, mainly the incorporating stockholders or members. The
lack of the certificate does not prevent the application of the estoppel doctrine to
a third party who entered into a contract with the purported corporation, believing
it to be duly incorporated.
As was pointed earlier, it was wrong for Piccio to have discussed the
applicability of the corporation by estoppel doctrine in a suit between and among
corporate insiders. As was said much later on in Lozano v. De los Santos,42 the
doctrine applies when persons assume to form a corporation and exercise
corporate functions and enter into business relations with third persons, and
therefore has no application “[w]here there is no third person involved and the
conflict arises only among those assuming the form of a corporation.”
Nevertheless, Piccio is clear in stating the proposition that in a purported-
corporation setting, when the de facto corporation doctrine cannot be applied, it
does not necessarily mean that the corporation by estoppel doctrine becomes
the applicable doctrine.
Subsequently in Vda. de Salvatierra v. Hon. Garlitos,43 the Court added a
new twist. Salvatierra, as owner of a piece of land, entered into a contract of
lease with a corporation allegedly "duly organized and existing under the laws of
the Philippines," represented by its president. When the obligations imposed
under the contract of lease on the corporate lessee were not complied with,
Salvatierra brought an action for accounting, rescission and damages. Judgment
was rendered against the corporation. When a writ of execution was sought to be
enforced, no properties in the name of the corporation could be located, and
consequently properties registered in the name of its president were levied upon.
The president sought to have the levy against his properties lifted, since he was
not even a party to the case against the corporation. On the other hand,
Salvatierra showed that the case was brought against the corporation in the
belief that it was duly incorporated, and that he found out only after judgment that
it had not been duly registered with the SEC.
Under those proven facts, the Supreme Court held the president
personally liable on the contract entered into on behalf of the purported
corporation. In resolving the case, the Court in Salvatierra refused to apply the
corporation by estoppel doctrine:

42
274 SCRA 452, 83 SCAD 898 (1997).
43
103 Phil. 757 (1958).
 . . . While as a general rule a person who has contracted
or dealt with a corporate body is estopped from denying the
same in an action arising out of such transaction or dealing . . .
yet this doctrine may not be held to be applicable where fraud
takes a part in the said transaction. In the instant case, on
plaintiff's charge that she was unaware of the fact that the
Philippine Fibers Producers Co., Inc. had no juridical
personality, defendant Refuerzo gave no confirmation or
denial and the circumstances surrounding the execution of the
contract lead to the inescapable conclusion that plaintiff
Manuela T. Vda. de Salvatierra was really made to believe that
such corporation was duly organized in accordance with law.44

Clearly, Salvatierra recognized then the logical effect of the estoppel

doctrine, that once a non-existent corporation is recognized to exist as a
corporate entity capable of executing a valid and binding contract, then it has a
separate personality, and its obligations under the contract cannot be ascribed to
its agents. Salvatierra thus reasoned out —

There can be no question that a corporation when

registered has a juridical personality separate and distinct from
its component members or stockholders and officers such that
a corporation cannot be held liable for the personal
indebtedness of a stockholder even if he should be its
president . . . and conversely, a stockholder or member cannot
be held personally liable for any financial obligation by the
corporation in excess of his unpaid subscription. But the rule is
understood to refer merely to registered corporations and
cannot be made applicable to liability of members of an
unincorporated association. The reason behind this doctrine is
obvious--since an organization which before the law is non-
existent has no personality and would be incompetent to act
and appropriate for itself the powers and attribute of a
corporation as provided by law; it cannot create agents or
confer authority on another to act in its behalf; thus, those who
act or purport to act as its representatives or agents do so
without authority and at their own risk. And as it is an
elementary principle of law that a person who acts as agent
without authority or without a principal is himself regarded as
the principal, possessed of all the rights and subjects to all the
liabilities of a principal, a person acting or purporting to act on
behalf a corporation which has no valid existence assumes
such privileges and obligations and becomes personally liable
for contracts entered into for other acts performed as such
agent. . .45

In Salvatierra the Court, having problems with the logical repercussions of

the corporation by estoppel doctrine as it stood at that time, refused to apply it.
Instead it relied upon a principle of the Law on Agency: that an agent who enters
44
Ibid, at p. 763.
45
Ibid.
into a contract outside of his authority or for a non-existent principal is deemed to
be the principal in the said contract. In other words, using the agency principle,
Salvatierra was able to prevent the frustration of enforcement of a contract on the
mere ground that one contracting party is missing.
What is intriguing about Salvatierra is that although it refused to apply the
estoppel doctrine, the principle it used to make individuals personally liable for
the contract has been adopted under Section 21, as an integral part of the
corporation by estoppel doctrine: "All persons who assume to act as a
corporation knowing it to be without authority to do so shall be liable as general
partners for all debts, liabilities and damages incurred or arising as a result
thereof."
There is, therefore, contradiction in Section 21: While the heart of the
estoppel doctrine lies in recognizing a corporation as party to a contract where
none in fact exists; there is also embodied in Section 21, the legal consequence
that actors are made personally liable for contracts entered into in behalf of the
corporation.
The question then is why was there a need to merge both Asia Banking
and Salvatierra rulings in the corporation by estoppel doctrine under Section 21?
There seemed to be more expedience in just adopting Salvatierra's agency
doctrine by itself, since it accomplishes both objectives without illogical results,
namely, (a) it validates the contract in question by supplying the missing
contracting party in the person of the agent (i.e., acting officer of the purported
corporation); and (b) it makes the perpetrator of the misrepresentation personally
liable for the contract.
Later, Albert v. University Publishing Co., Inc.,46 gave new input to the then
version of the estoppel doctrine. Albert sued the University Publishing Co., Inc.
for his share in the publication of a book under a contract entered into by the
parties, with the corporation being represented in the contract by its president,
Jose M. Aruego. Judgment was rendered in favor of Albert against the
corporation. When judgment was sought to be enforced against the corporation,
it was discovered that it had never been registered with the SEC. The judgment
was then sought to be enforced against Aruego in his personal capacity. Aruego
raised the point that the contract was not a personal contract but one with a
juridical entity. The Court ruled -

. . . Precisely, however, on account of the non-

registration it cannot be considered a corporation, not even a
corporation de facto (Hall vs. Piccio, 86 Phil. 603). It has
therefore no personality separate from Jose M. Aruego; it
cannot be sued independently."47

However, the Court also rejected application of the corporation by

estoppel doctrine to resolve the issue:

46
13 SCRA 84 (1965).
47
Ibid, at pp. 86-87l.
 The corporation-by-estoppel doctrine has not been
invoked. At any rate, the same is inapplicable here. Aruego
represented a non-existent entity and induced not only the
plaintiff but even the court to believe in such a representation.
He signed the contract as “President” of “University Publishing
Co., Inc.,” stating that this was a “corporation duly organized
and existing under the laws of the Philippines,” and obviously
misled plaintiff (Mariano A. Albert) into believing the same.
One who has induced another to act upon his willful
misrepresentation that a corporation was duly organized and
existing under the law, cannot thereafter set up against his
victim the principle of corporation by estoppel (Salvatierra [sic]
vs. Garlitos, 56 O.G. 3069).48

However, in Albert, the Court discussed how the then version of the
estoppel doctrine could be applied to hold the actors behind the purported
corporation, personally liable for the contract, at the same time that corporate
liability was upheld:

Even with regard to corporations duly organized and

existing under the law, we have in many a case pierced the
veil of corporate fiction to administer the ends of justice. And in
Salvatiera (sic) vs. Garlitos, supra, p. 3073, we ruled: `A
person acting or purporting to act on behalf of a corporation
which has no valid existence assumes such privileges and
obligations and becomes personally liable for contracts
entered into or for other acts performed as such agent. . . .49

The implication of Albert is clear: even with the then version of the
estoppel doctrine, we could uphold the validity and enforceability of a contract by
upholding the fiction of the contracting corporation's existence, (although in fact it
cannot exist); but nonetheless, under the piercing doctrine, we can pierce the veil
of the recognized corporate party and make the actors liable personally for the
obligations arising from the contract.
Although Albert itself refused to apply the estoppel doctrine, it was such a
thesis that eventually found itself embodied as the corporation by estoppel
doctrine in Section 21. Albert therefore offers us the "philosophical bridge"
between the two doctrines: the first, that a corporation can be deemed to exist
when in fact none may exist, in order to validate a contract; and the second, that
although the veil of corporate fiction is set up, it will be pierced to enforce the
contract, to hold the actors behind such misrepresentation liable for the
obligations arising from such contract.
The remaining issue is why we need to adopt such a crisscrossing
estoppel doctrine at all under Section 21, when Salvatierra's agency doctrine—
that of making the agent of an inexistent principal liable on the contract—already
achieves with clearer logic the same ends sought to be achieved by Section 21?

48
Ibid, at p. 87, emphasis supplied.
49
Ibid, at pp. 87-88.
 The reason is that Salvatierra is sufficient only when there is fraud or
misrepresentation on the part of one of the contracting parties. It has no
application to a situation where both parties to the contract acted in the honest
belief that a contracting corporate entity did exist. In such a case, Salvatierra
cannot apply, since only an agent who knew that his purported principal did not
exist can be held personally liable. In a no-fraud or no-misrepresentation case,
since the "agent" cannot be held as principal to the contract to validate it, there is
an issue as to the validity and enforceability a contract where a contracting party
is missing.
It is in such no-fraud or no-misrepresentation cases that Salvatierra is
clearly inadequate. This is where the present statutory version of the corporation
by estoppel doctrine applies, since its applicability does not require fault or
conscious misrepresentation.

c. Current Status of Doctrine

Section 21 of the Corporation Code now contains the statutory parameters
of the "corporation by estoppel" doctrine, which provides that all persons who
assume to act as a corporation knowing it to be without authority to do so shall
be liable as general partners for all debts, liabilities and damages incurred or
arising as a result thereof, provided, however, that when any such ostensible
corporation is sued on any transaction entered by it as a corporation or on any
tort committed by it as such, it shall not be allowed to use as a defense its lack of
corporate personality.
In addition, the section also provides that one who assumes an obligation
to an ostensible corporation as such, cannot resist performance thereof on the
ground that there was in fact no corporation.
Section 21, as a fusion of the strict estoppel doctrine and the Albert
rationale for piercing, amply covers both fraud and no-fraud cases. When fraud
or misrepresentation occurs with the perfection of the contract with a purported
corporation, then section makes the actor personally liable on the contract as a
general partner. On the other hand, when no fraud or misrepresentation occurs,
although it does not make persons acting for the purported corporation liable
personally, it would prevent both sides from raising the non-existence of the
corporation as a means to avoid enforcement of the contract.
In no-fraud or no-misrepresentation cases, the estoppel doctrine under
Section 21 would create a corporation when none exists to uphold the validity
and enforceability of the contract, but ultimately does it not make the persons
acting for the purported corporation liable? If so, how can enforcement be made
effectively on a contract against a corporation that does not exist? On these
issues the special wording of Section 21 seems to provide an answer.
Section 21 uses the word "liable as general partners" instead of "liable
personally," in defining the liability of persons who assume to act as a corporation
knowing it to be without authority to do so. Had Section 21 used the words "liable
personally," then the clear implication would be that persons who act for a
purported corporation without knowing it to be without authority to do so would
not be personally liable for the debts, liabilities and damages incurred or arising
from the contract.
 For example, in People v. Garcia,50 the Court held that an individual
cannot avoid his liabilities to the public as an incorporator of a corporation whose
incorporation was not consummated, when he held himself out to the public as
officer of the corporation and received money from applicants who availed of
their services, thus: “Such individual is estopped from claiming that he is not
liable as corporate officers for illegal recruitment under the corporation by
estoppel doctrine under Section 25 of the Corporation Code which provides that
all persons who assume to act as a corporation knowing it to be without authority
to do so shall be liable as general partners for all the debts, liabilities and
damages incurred or arising as a result thereof.”
By using the term "general partners", the implication under Section 21 is
that one who knows a corporation not to exist would be liable not only with what
he purported to invest in the venture, but he could be held liable to all his
properties, even those not actually invested or promised to be invested in the
purported corporate venture. Therefore, one who acts for a purported corporation
not knowing that it had no authority to do so would be liable, by way of
distinction, only as a limited partner; that is, he would be liable only to the extent
of his investment or promised investment in the purported corporate venture. In a
no-fraud or no-misrepresentation case, the persons acting in good faith for the
purported corporation would still be personally liable, but only to the extent of
their actual or promised investment in the corporate venture. This logically ties in
with the limited liability feature of a purported corporation given legal recognition
in the estoppel doctrine.
Nevertheless, Lim Tong Lim v. Philippine Fishing Gear Industries, Inc.,51
the Supreme Court held that it is not only those who actually participated in the
contract or transactions that can be held as general partner, but also that “the
liability for a contract entered into on behalf of an unincorporated association or
ostensible corporation may lie in a person who may not have directly transacted
on its behalf, but reaped benefits from that contract,” thus:

In such case, all those who benefit from the transaction

made by the ostensible corporation, despite knowledge of its
legal defects, may be held liable for contracts they impliedly
assented to or took advantage of. . . Clearly, under the law on
estoppel, those acting on behalf of a corporation and those
benefited by it, knowing it to be without valid existence, are
held liable as general partners.

This latest ruling of the Supreme Court in Lim is in stark contract to its
rulings in Pioneer Insurance v. Court of Appeals,52 where the liabilities of parties
to a corporate venture was sought to be determined when it was shown that the
corporation intended to be formed was never duly incorporated. The Court held
in that case that:

50
271 SCRA 621, 88 SCAD 898 (1997).
51
317 SCRA 728 (1999).
52
175 SCRA 668 (1989).
 While it has been held that as between themselves the
rights of the stockholders in a defectively incorporated
association should be governed by the supposed charter and
the laws of the state relating thereto and not by the rule
governing partners . . . it is ordinarily held that persons who
attempt, but fail, to form a corporation and who carry on
business under the corporate name occupy the position of
partners inter se. . . Thus, where persons associate
themselves together under articles to purchase property to
carry on a business, and their organization is so defective as
to come short of creating a corporation within the statute, they
become in legal effect partners inter se, and their rights as
members of the company to the property acquired by the
company will be recognized. . . However, such a relation does
not necessarily exist, for ordinarily persons cannot be made to
assume the relation of partners, as between themselves, when
their purpose is that no partnership shall exist. . ., and it should
be implied only when necessary to do justice between the
parties; thus, one who take no part except to subscribe for
stock in a proposed corporation which is never legally formed
does not become a partner with other subscribers who engage
in the business under the name of the pretended corporation,
so as to be liable as such in an action for settlement of the
alleged partnership and contribution. . . A partnership relation
between certain stockholders and other stockholders, who
were also directors, will not be implied in the absence of an
agreement, so as to make the former liable to contribute for
payment of debts illegally contracted by the latter. . . 53

The resulting doctrine would therefore be that when there was clear
intention to form a partnership venture through a corporate vehicle, which
essentially means that the partners had intended to be active participants in the
business of the corporation, then even those who did not directly participate in
the contract or transaction being sued upon, but benefited therefrom may be held
liable as general partners under the corporation by estoppel doctrine. On the
other hand, when the investors intended only to invest in a corporate venture with
no intention of participating in its corporate affairs, and the corporation was not
formed, no partnership relation is deemed established by the failure to
incorporate, and such investors cannot even be held liable for the contracts and
transaction sued upon even when such contracts and transactions were entered
into by the corporate actors in the name of an ostensible corporation.
It should be borne in mind that Section 21 is merely a "freeze-frame" of
Congress‟ appreciation of the doctrine as it stood at the time of the adoption of
the Corporation Code. However, the doctrine itself existed even prior to attaining
statutory definition, and is based on the common law principle of estoppel.
Therefore, despite the language of Section 21, it should be expected that since
the corporation by estoppel doctrine is meant to be used to render justice, it will
continue to evolve and to be developed by judicial and quasi-judicial bodies to

53
Ibid, at pp. 682-683.
make it an optimum means of rendering justice, or achieving equitable solutions
to issues involving the use of the corporate medium.

3. Cases Outside De Facto Corporation

and Corporation by Estoppel Doctrines
As discussed previously, there are instances when the de facto doctrine
cannot be applied because of the lack of one of its requisites. There are also
cases where the corporation by estoppel doctrine cannot be applied, such as
when both parties knew that the corporate party to the contract does not exist.
Obviously, even the old version of the estoppel doctrine in Asia Banking is not
applicable, since there is no element of misrepresentation in such cases. What
then is the applicable doctrine?
A possible solution would be application of the pari delicto doctrine.54 In
such a case, we hark back to Piccio which applied pari delicto where both the de
facto corporation and the estoppel doctrines could not be applied. However, it is
not clear in Piccio how exactly the pari delicto doctrine was applicable; rather, the
ruling expounded more on the lack of cause of action than on the in pari delicto
doctrine.
A further difficulty is that, both Articles 1411 and 1412 of the Civil Code on
pari delicto cover only situations when there is outright "illegality of the cause or
object of the contract." They do not apply in the cases under consideration,
where there is no illegality in the cause or object of the contract, but where one of
the requisites of a valid contract is missing: consent from an existing party. In
addition, the pari delicto doctrine does not square with the intention of the parties
of entering into a contract, which intention is not in itself illegal. If we were to look
at the contractual motivation of the parties who used a non-existent corporation,
evidently they expected to be bound by their contract, and the more appropriate
doctrine to apply would be a derivative of the unenforceable contract doctrine.
Under Article 1403 of the Civil Code, unless ratified, a contract is
unenforceable when it has been "entered into in the name of another person by
one who has been given no authority or legal representation, or who has acted
beyond his powers." Clearly, for the cases under consideration, the actor for the
purported corporate party is without authority from a principal. Nevertheless the
contract can be enforced because of clear "ratification" on the part of the other
party, who entered into the contract knowing fully well that the other party had no
authority to act for the purported corporate party, and with both of them believing
that the contract would be enforceable as between them anyway.
This solution finds rational support in Salvatierra; but unlike Salvatierra
which applies only the representing party doctrine, the proposed solution applies
to both parties to the contract who knew that the corporate party did not exist.
Therefore, to paraphrase Salvatierra,55 since a non-existent organization
has no personality, and is incompetent to act and appropriate for itself the

54
Articles 1411 and 1412 of the Civil Code provide that neither contracting parties may
recover what he has given by virtue of the contract, or demand the performance of the other's
undertaking.
55
103 Phil. 757, at pp. 763-764.
powers and attributes of a corporation; it cannot create agents or confer authority
on another to act in its behalf. In contracts entered into for such purported
corporations, where both parties knew that no such corporation existed, the
actors enter the contract without authority and at their own risk. An elementary
principle in law is then applied: when actors to a contract act or allow others to
act as agents without authority or without a principal, the law considers such
agents as principals, possessed of all the rights and subject to all the liabilities of
a principal. Such agents may be considered by all the actors to have assumed
the privileges and obligations of the purported principal corporation, and become
personally liable for contracts entered into, or for other acts performed, by them
as such agents.

ARTICLES OF INCORPORATION AND BY-LAWS

1. Articles of Incorporation
The articles of incorporation is a basic contract document in Corporate
Law, defining the charter of the corporation. Early on, Government of the P.I. v.
Manila Railroad Co.,56 characterized the charter of the corporation as a contract
between the corporation and the State, and stated that "the state and the grantee
of a charter are equally bound by its provisions."57 It described the charter of the
corporation as a contract between three parties:

(a) Between the State and the corporation;

(b) Between the stockholders and the State; and
(c) Between the corporation and its stockholders.58

The reverence of the law, and of the courts, the binding effect of the
provisions of the articles of incorporation on the parties thereto is such that
amendments thereto can be made by one party only with the consent of the other
parties under the strict provisions of the Corporation Code,59 but also, the
contents thereof as mandated by law60 and are treated with strictness. Thus, the
use of a corporate name other than that provided for in the articles was not
allowed in Red Line Trans. Co. v. Rural Transit Co.,61 which stated that the
incorporators "constitute a body politic and corporate under the name stated in
the certificate" and that a corporation has the power "of succession by its
corporate name" and by "that name alone is it authorized to transact business."62

2. By-Laws
56
52 Phil. 699 (1929).
57
Ibid, at p. 702.
58
Ibid, at p. 703.
59
Sec. 16, Corporation Code.
60
Sec. 14, Corporation Code.
61
60 Phil. 549 (1934).
62
Ibid, at pp. 554-555. Parenthetically, though, the Supreme Court has stated in Republic
Planters Bank v. Court of Appeals, 216 SCRA 738 (1992), that a change in the corporate name
when approved by the SEC does not make a new corporation, and has no effect on the identity of
the corporation, or on its property, rights, or liabilities.
 By-laws, unlike the articles of incorporation, are meant to be an intramural
document, to govern the relationship between and among the members of a
corporate family. As held in Rural Bank of Salinas v. Court of Appeals,63 "[b]y-
laws are intended merely for the protection of the corporation, and prescribe
regulation, not restrictions." Thus, Rural Bank of Salinas held that restrictions
affecting the assignment or transfer of shares cannot validly be provided for in
the corporation's by-laws, and any such provisions in the by-laws are void.64
The rule, therefore, is that although the power of the corporation to adopt
by-laws is an inherent right, by-law provisions cannot contravene the law.65 The
validity or reasonableness of a by-law provision is a question of law, and in such
cases the issue to be resolved would be whether a by-law provision conflicts with
a provision of law, or with the charter of the corporation; or is in the legal sense
unreasonable and therefore unlawful.66
On the basis of their nature and their functions one may therefore
conclude that provisions of the articles of incorporation prevail over by-law
provisions. This seems however to be a sweeping statement, because of the
consequences that such a notion would have on the dealings of corporations with
third parties: since the articles of incorporation define the powers and purposes
of the corporation as it deals with the world, they would therefore bind a third
person dealing with the corporation, whether or not such person was aware of
the provisions of the articles of incorporation.
On the other hand, since by-law provisions are intramural in nature and
are not meant to bind parties outside the corporate family, it stands to reason that
the public dealing with the corporation is not supposed to be interested in the
provisions of the corporation's by-laws, and therefore should not be bound
thereby. This seems to be the principle followed in ultra vires cases decided by
the Supreme Court, especially as ultra vires goes into the power and authority of
corporate officers.
However, the case of Peña v. Court of Appeals,67 seems to negate this
proposition on the non-binding character of by-laws on third parties. In that case,
the Supreme Court ruled that the "by-laws of a corporation are its own private
laws which substantially have the same effect as the laws of the corporation.
They are in effect, written into the charter. In this sense they become part of the
fundamental law of the corporation with which the corporation and its directors
and officers must comply."68
Peña would then elevate by-law provisions to the level of provisions of the
articles of incorporation, and give them the same binding effect over third parties
63
210 SCRA 510 (1992).
64
This doctrine should be understood to mean that restrictions on transfers provided in the
by-laws contrary to law cannot have legal effect. It is possible to provide in the by-laws
procedures on the transfer of shares, provided they are consistent with law. Nava v. Peers
Marketing Corporation, 74 SCRA 65 (1976), has earlier held that a corporation can include in its
by-laws rules, not inconsistent with law, governing the transfer of its shares of stock. See further
discussions on the matter in Chapter 10.
65
Government of the Philippine Islands v. El Hogar Filipino, 50 Phil. 399 (1927).
66
Gokongwei v. SEC, 89 SCRA 336, 361-362 (1979).
67
193 SCRA 717 (1991).
68
Ibid, at p. 729, citing 8 FLETCHER CYC. CORP., Perm. Ed., pp. 750 -751.
dealing with the corporation. This conclusion is inevitable from Peña, which was
a suit between corporate "outsiders", with the highest bidder in a public auction of
corporate property on the one hand, and the buyer of the right of redemption of
the corporation on the other.
In that case, the Supreme Court held as void, the board resolution selling
the corporation's right to redeem the property, as well as the subsequent sale
thereof, because the resolution was adopted in a manner contrary to the
procedure outlined in the corporation's by-laws for special meetings.
On the other hand, in Board of Liquidators v. Heirs of Maximo Kalaw,69 the
Court held that it is possible for an express provision of the by-law to be violated
and the board may, in certain corporate actions, bind the corporation in spite of
the fact that it is contrary to the by-law provision. It held that there are two ways
by which corporate actions may come about through the corporation's board of
directors, either the board may empower or authorize the act or contract, or it can
be ratificatory act on the part of the board. As long as there is a corporate
approval through the board of directors, whether implied or express, it is valid to
bind the corporation.
In Yao Ka Sin Trading v. Court of Appeals,70 the Court in nullifying a
cement supply contract entered into by the President and Chairman of the
cement manufacturing company, but without prior board resolution, made
expressly binding on the purchaser the provisions of the company's by-laws
which provided that board resolution is required, although the President may be
the one to execute the resulting contract for the company. However, it should be
noted that in Yao Ka Sin Trading that before the contract could be implemented,
the board did pass a resolution expressly repudiating the same.
Post-Peña decisions of the Supreme Court clearly reiterate the non-
binding effects of by-laws to third parties who deal with the corporation without
specific knowledge of applicable by-law provisions.

a. Non-Binding Effects of By-Laws to “Outsiders”

In China Banking Corp. v. Court of Appeals,71 a pledge of shares of stock
was duly registered with the corporation, which sent out a letter acknowledging
the pledge. Later on, due to non-payment of the secured loan, the shares were
sold at public-auction, with the pledgee being the highest bidder. The corporation
refused to register the notice of sale in its books, and in fact declared the share
as being delinquent for non-payment of monthly dues and proceeded with
delinquency sale, all pursuant to the terms and conditions set forth in the
corporation‟s by-laws. In insisting on its prior claim on the share, the corporation
relies upon the provision of its by-laws which provides for the delinquency sale,
and held the provision to be binding upon the pledgee.
The Court in China Banking held that in order that by-law provisions can
be binding upon third parties, such third-parties must have acquired knowledge
of the pertinent by-laws at the time the transaction or agreement between said

69
20 SCRA 987 (1967).
70
209 SCRA 763, 81 SCAD 184 (1992).
71
270 SCRA 503, 85 SCAD 846 (1997).
third party and the shareholders was entered into, in this case, at the time the
pledge agreement was executed. In that case, the Court held that the corporation
could have easily informed pledgee of its by-laws when it sent notice formally
recognizing pledgee of its shares registered in the name of a stockholder of
record. The corporation‟s belated notice of said by-laws at the time of foreclosure
did not suffice to overturn the rights of the pledgee. The Court reiterated the
principle on the binding effects of by-laws as to third parties, thus:

By-laws signify the rules and regulations or private laws

enacted by the corporation to regulate, govern and control its
own actions, affairs and concerns and its stockholders or
members and directors and officers with relation thereto and
among themselves in their relation to it. In other words, by-
laws are the relatively permanent and continuing rules of
action adopted by the corporation for its own government and
that of the individuals composing it and having the directions,
management and control of its affairs, in whole or in part, in
the management and control of its affairs and activities (9
Fletcher 4166, 1982 ed.)
The purpose of a by-law is to regulate the conduct and
define the duties of the members towards the corporation and
among themselves. They are self-imposed and, although
adopted pursuant to statutory authority, have no status as
public law. (Ibid.)
Therefore, it is the generally accepted rule that third
persons are not bound by by-laws, except when they have
knowledge of the provisions either actually or constructively.

In PMI Colleges v. NLRC,72 the corporation sought to avoid liability under

a contract of service which was not signed by the Chairman of the Board as
clearly mandated under the corporation‟s by-laws. The Court held that such
contract cannot be held as invalid just because the signatory thereon was not the
Chairman of the Board which allegedly violated the corporation‟s by-laws, “[s]ince
by-laws operate merely as internal rules among the stockholders, they cannot
affect or prejudice third persons who deal with the corporation, unless they have
knowledge of the same.”
Be that as it may, the "limiting" effect of provisions of the articles of
incorporation and by-laws on corporate contracts with the public, has been
tempered by the Supreme Court by the manner is has applied the ultra vires
doctrine.

ULTRA VIRES DOCTRINE

Section 45 of the Corporation Code, embodies in statutory form the ultra
vires doctrine as it provides that no corporation "shall possess or exercise any
corporate powers except those conferred by this Code or by its articles of
incorporation and except such as are necessary or incidental to the exercise of
72
277 SCRA 462 (1997).
the powers so conferred." During the early history of Philippine Corporate Law, it
was the accepted notion that any contract made or by-law provision adopted by a
corporation in contravention of law were ultra vires and void.73 The ultra vires
doctrine is based on two corporate principles.
Firstly, the ultra vires doctrine stems in part from the principle that a
corporation is a creature of the law, and has only such powers and privileges as
are granted by the State. Since the corporation is considered a legal creature,
the doctrine finds it hard to accommodate the notion that a corporation can be
more than just an entity of limited capacities and powers, and could hold powers
or privileges not emanating from the State. In other words, the ultra vires doctrine
is really a product of the theory of concession, which is expressed in the
Corporation Code's antediluvian definition of a corporation in Section 2. One can
see why much of the vigor of the ultra vires doctrine has since dissipated.
Secondly, the ultra vires doctrine upholds the duty of trust and obedience
owed by the corporation's directors and officers to the stockholders or members.
Such duty of obedience dictates that the corporation engage only in transactions
to which the stockholders and members bind themselves, by way of the
provisions of the purpose clause of the articles of incorporation. In addition, the
duties of corporate directors and officers must necessarily include an obligation
not to enter into transactions which violate the law.
The ultra vires doctrine may be viewed as the creature of an earlier time,
when society was unfamiliar with the corporate vehicle as a means of doing
business. Suspicious of the mischief such a medium made possible, society
decided it was prudent that it be controlled and regulated as much as possible.
Today the corporate entity has become commonplace, and doctrines and
mechanisms abound by which the State and society temper the corporation's
self-serving and profit-motivated nature to promote social and business welfare.
Currently, the attitude is to give business much more freedom to deal with the
world through the corporate medium.
As jurisprudential history has shown, the strict application of the principle
of ultra vires has undermined corporate contracts and commercial transactions.
As a consequence, courts have had the tendency to tone down the application of
the ultra vires doctrine when it begins to undermine public trust and confidence in
corporate contracts.

1. Types of Ultra-Vires Cases

There are three (3) types of ultra vires acts, namely:
(a) Acts done beyond the powers of the corporation as provided
for in the law or its articles of incorporation;
(b) Acts or contracts entered into in behalf of the corporation by
persons who have no corporate authority; and
(c) Acts or contracts which are per se illegal as being contrary to
law;

73
Baretto v. La Previsora Filipina, 57 Phil. 649 (1932).
 2. Test to Determine Ultra Vires of the First Type
Montelibano v. Bacolod-Murcia Milling Co., Inc.,74 clarified the extent of the
application of the ultra vires doctrine. At issue was the validity and binding effect
on the corporation of an amended milling contract that granted favorable terms to
planters. Although the amended milling contracts were approved by the board of
directors, it was interposed for the corporation that the resolution was null and
void ab initio, being in effect a donation that was ultra vires, beyond the powers
of the corporate directors to adopt. The Supreme Court upheld the authority of
the board acting for the corporation to modify the terms of the amended milling
contract for the purpose of making its terms more acceptable to the other
contracting parties. It gave the formula for determining the applicability of the
ultra vires doctrine:

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.75

The test uses the rather stringent terms "direct and immediate" only with
reference to the business of the corporation; whereas, it uses the rather liberal
terms of "fairly incident" and "reasonably necessary" with reference to powers of
the corporation.
When the business of a corporation is used as the reference point, much
latitude is given to the corporation to enter into various contracts as long as they
have a logical relation to the pursuit of such business. Thus, in one early case,76
the Supreme Court upheld a purpose clause in the articles of incorporation which
allowed the corporation to engage in what were rather broadly worded activity as
"mercantile purposes." The Court construed that as allowing the corporation to
"engage in such incidental business as may be necessary and advisable to give
effect to, and aid in, the successful operation and conduct of the principal
business."77
On the other hand, when the purpose clause of a corporation's articles of
incorporation has unwittingly used limiting words, such as describing its business
as "transportation by water," the Court will hold the corporation to such limited
business and will refuse to construe the same to allow the corporation to engage

74
5 SCRA 36 (1962).
75
Ibid, at p. 42 quoting 6 FLETCHER CYC. CORP. Rev. Ed. 1950, pp 266-268. Emphasis
supplied.
76
Uy Siuliong v. Director of Commerce and Industry, 40 Phil. 541 (1919).
77
Ibid, at p. 544.
in the land transportation business.78 In such instances, the corporation has no
one but itself (and perhaps its legal counsel who prepared the articles of
incorporation) to blame for tying its own hands.
Another example would be the sale of land owned by the corporation. In
San Juan Structural and Steel Fabricators, Inc. v. Court of Appeals,79 the Court
held that a corporation whose primary purpose is to market, distribute, export and
import merchandise, the sale of land is not within the actual or apparent authority
of the corporation acting through its officers, much less when acting through the
treasurer. The Court also pointed out that Articles 1874 and 1878 of the Civil
Code require that when land is sold through an agent, the agent‟s authority must
be in writing, otherwise the sale is void.
Another example would be the obtaining of loans by the corporation.
China Banking Corp. v. Court of Appeals,80 held that the power to borrow money
is one of those cases where even a special power of attorney is required under
Art. 1878 of the Civil Code, and therefore there is invariably a need of an
enabling act of the corporation to be approved by its board of directors. The
Court held that the argument that the obtaining of loan was in accordance with
the ordinary course of business usages and practices of the corporation was
devoid of merit because the prevailing practice in the corporation was to explicitly
authorize an officer to contract loans in behalf of the corporation.

a. Policies Supervening in Ultra Vires Issues

As the Montelibano test showed, the attitude of courts towards corporate
acts and contracts which are not per se illegal or prohibited, is quite liberal. This
is because of two public policies, one in the realm of Contract Law, the other in
the realm of Corporate Law.
Firstly, if contracts of corporations could be set aside by the mere showing
that they do not fall within the language of the purpose clause of the articles of
incorporation, then the public dealing with corporations would be wary of entering
into contracts with corporate entities. If they must deal at all with corporate
entities, they would be forced to engage upon costly and time-consuming
verification and contractual safeguards (such as making the officers and
stockholders jointly and severally liable on the contract) to ensure that they would
at least get relief in case the issue of ultra vires comes in.
More importantly, setting aside the corporate contract on the ground that
the corporation has no express authority, would contravene the expectations of
both parties, who entered into the contract expecting to be bound. As the Court
has aptly stated in a case, "[t]he defense of ultra vires rests on violation of trust or
duty toward stockholders, and should not be entertained where its allowance will
do greater wrong to innocent parties dealing with corporation."81
Secondly, the trend has been to move away from holding corporate acts
and contracts as ultra vires, because of the philosophy underlying the "business

78
Luneta Motor Company v. A.D. Santos, Inc., 5 SCRA 809 (1962).
79
296 SCRA 631, 645, 99 SCAD 281 (1998).
80
270 SCRA 503, 81 SCAD 184 (1997).
81
Republic v. Acoje Mining Co., Inc., 3 SCRA 361 (1963).
judgment rule." The business judgment rule states that courts will not sit in
judgment to substitute their business judgment for that of the directors; and that
as much as possible, directors, in the exercise of their business judgment, should
be given leeway to adopt corporate policies and to engage in transactions as
they deem best for the corporation, and the same cannot be claimed to be
beyond their powers or ultra vires.
Montelibano itself said that "[a]s 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."82 The Court added that "[i]t is a well-known rule of law that
questions of policy or 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 [for that] 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."83
Furthermore, the demands of business are such that it is impossible to
anticipate all possible contingencies at the time the articles of incorporation are
drawn. In the face of unreasonably strict application of ultra vires principles, there
would be a need for corporations to continually amend or revise charters simply
to keep abreast with the various aspects of the very businesses they were meant
to engage in.

b. Distinguishing From Acts Which Are Per Se Illegal

Montelibano indicates clearly that there is a difference in treatment
between an ultra vires act which is per se illegal, and one that is not. Obviously,
an act that is per se illegal or prohibited by law cannot be given much latitude
and is generally void. On the other hand, an act or contract of a corporation
which is not per se illegal or prohibited by law is subjected to a test to determine
whether it is intra vires or ultra vires.
The distinctions between acts and contracts which are illegal per se, and
those which are not, as to their legal effects, have been recognized in Pirovano v.
De la Rama Steamship Co.84 In that case the Supreme Court held that "illegal
acts" of a corporation contemplate the doing of an act which is contrary to law,
morals, or public order, or contravenes some rules of public policy or public duty,
and are, like similar transactions between individuals, void. Such acts or
contracts cannot serve as basis of a court action, nor acquire validity by
performance, ratification, or estoppel. On the other hand, ultra vires acts or those
which are not illegal and void ab initio but are within the scope of the articles of
incorporation, are merely voidable and may become binding and enforceable
when ratified by stockholders.
Pirovano held that the ratification by stockholders of an ultra vires act
which is not illegal, cures the infirmity of the corporate act, and makes it perfectly
valid and enforceable, specially so if it is not merely executory but executed and
consummated, and no creditors are prejudiced.
82
Ibid, at p. 42.
83
Ibid, quoting from 2 FLETCHER ON CORPORATIONS, p. 390.
84
96 Phil. 335 (1954).
 The latitude with which the courts tend to treat as intra vires, corporate
acts and contracts that do not squarely fall within the wordings of the purpose
clause of the corporate charter, has permeated Supreme Court decisions down
through the years. Thus, the Court has held that when a corporation by its
charter has the power to issue bonds, then it is deemed also to have the implied
power to guarantee them in order to place them upon the market under better,
more advantageous conditions, and thereby secure the profit derived from their
sale;85 it has construed the word "deal" in the charter to be broad enough to
include any manner of disposition, including donation of money not immediately
required by the corporation;86 it has validated a board resolution making the
corporation a guarantor for its designated postmaster for funds received by the
latter to service the mails of corporate employees;87 it has held that the charter
authority to write-off loans and advances includes the power to waive penalty
charges on past due loans, which are of a lesser category.88
Significantly, the Corporation Code in Section 36, expressly grants certain
powers to corporations. These powers were previously the subject of great
controversy, and much literature have been written on the subject powers, such
as the power of the corporation to make reasonable donations,89 and to establish
pension, retirement and other plans for the benefit of directors, trustees, officers
and employees.

c. Doctrine of Estoppel or Ratification

Even when a particular corporate transaction does not pass the lenient
Montelibano test and is held ultra vires, the transaction would nevertheless be
held binding on the corporation under the estoppel doctrine. Carlos v. Mindoro
Sugar Co.,90 laid down the following presumption:

When a contract is not on its face necessarily beyond the

scope of the power of the corporation by which it was made, it
will, in the absence of proof to the contrary, be presumed to be
valid. Corporations are presumed to contract within their
powers. The doctrine of ultra vires, when invoked for or
against a corporation, should not be allowed to prevail where it
would defeat the ends of justice or work a legal wrong.91

Carlos explained the law's attitude towards the ultra vires doctrine: "The
defense is by some courts regarded as an ungracious and odious one, to be
sustained only where the most persuasive considerations of public policy are
involved, and there are numerous decisions and dicta to the effect that the plea

85
Carlos v. Mindoro Sugar Co., 57 Phil. 343 (1932).
86
Pirovano v. De la Rama Steamship Co., 96 Phil. 335 (1954).
87
Republic v. Acoje Mining Co., Inc., 3 SCRA 361 (1963).
88
Land Bank of the Philippines v. Commission on Audit, 190 SCRA 154 (1990).
89
See Pirovano v. De la Rama Steamship Co., 96 Phil. 335 (1954), where the Supreme
Court had to go through several hair-splitting distinctions to validate a donation given by the
corporation to the minor children of its late president who was to a large extent responsible for the
rapid and very successful development and expansion of the activities of the corporation.
90
57 Phil. 343 (1932).
91
Ibid, at p. 353, quoting from Coleman v. Hotel de France Co., 29 Phil. 323 (1915).
should not as a general rule prevail whether interposed for or against the
corporation, where it will not advance justice but on the contrary will accomplish a
legal wrong."92
Carlos pointed out that the great weight of authority is to the effect that,
where a transaction is merely ultra vires and not malum in se or malum
prohibitum, although it may be made a basis for forfeiture of the corporate charter
or dissolution of the corporation, such transaction is, if performed by one party,
not void as between the parties, and an action may be brought directly upon the
transaction and relief had according to its terms.93
Therefore, even in the case of ultra vires acts which are not per se illegal,
a corporation cannot be heard to complain that it is not liable for the acts of its
board, because of estoppel by representation. In Republic v. Acoje Mining Co.,
Inc.,94 the Court, in making a distinction between ultra vires acts and illegal acts,
held:

. . . The term ultra vires should be distinguished from an

illegal act for the former is merely voidable which may be
enforced by performance, ratification, or estoppel, while the
latter is void and cannot be validated. It being merely voidable,
an ultra vires act can be enforced or validated if there are
equitable grounds for taking such action. Here it is fair that the
resolution be upheld at least on the ground of estoppel.95

People’s Aircargo and Warehousing Co., Inc. v. Court of Appeals,96 held

that even when the contract entered into in behalf of the corporation is outside
the usual powers of the corporate officer, the corporation‟s ratification of the
contract and acceptance of the benefits arising therefrom have made such
contract binding upon the corporation; and that the enforceability of contracts
made under Article 1403(2) of the Civil Code, where there has been no authority
by the principal, is ratified “by acceptance of benefits under them” under Article
1405 of the Civil Code.
The ratification that would bind the corporation would have to come from the
board of directors or a properly authorized representative. Thus, in Aguenza v.
Metropolitan Bank and Trust Co.,97 the Supreme Court held that when the
counsel representing the corporation in a collection suit admits on behalf of the
corporation that the latter admitted culpability for personal loans obtained by its
corporate officers, such admission cannot be given legal effect to the detriment of
the corporation, since the admission made in the answer by the counsel for the
corporation was “without any enabling act or attendant ratification of corporate
act,” as would authorize or even ratify such admission. In the absence of such
ratification or authority, such admission does not bind the corporation. The Court
further held:
92
Ibid, at p. 352.
93
Ibid, at p. 352, citing 14-A CORPUS JURIS, pp. 319-320.
94
3 SCRA 361 (1963).
95
Ibid, at p. 365.
96
297 SCRA 170, 185, 99 SCAD 482 (1998).
97
271 SCRA 1, 81 SCAD 397 (1997).
 Also, the letter issued by the corporate officers who
obtained the loan “as indicating the corporate liability of the
corporation,” cannot also serve to make the corporation liable.
The documents and admissions cannot have the effect of a
ratification of an unauthorized act. Ratification can never be
made on the part of the corporation by the same persons who
wrongfully assume the power to make the contract, but the
ratification must be by the officers as governing body having
authority to make such contract.

3. Illegal Acts
Curiously enough, even when confronted with what was obviously an
illegal act or a contract contrary to law, the Supreme Court has tended to uphold
the result of the contract with respect to the contracting parties, which contract
should have been void ab initio.
In Harden v. Benguet Consolidated Mining Co.,98 the mining company,
Benguet Consolidated Mining Company, in violation of the express prohibitions of
the then Corporation Law, held shares of stock in another mining corporation, the
Balatoc Mining Company. The shareholders of the Balatoc Mining Company filed
an action against Benguet Mining Company to annul the certificates of stock
issued in favor of the latter, and to recover money collected by the latter from the
arrangements.
In upholding the dismissal of the complaint by the trial court, the Court
noted that, although the contract between the two mining companies was illegal
for contravening the Corporation Law, the statutory provision in question was
adopted by the legislature with the intention that public policy should be
controlling in the granting of mining rights. The Court said that the violation of the
prohibition is of such a nature that it can be proceeded upon only by way of a
criminal prosecution, or by action of quo warranto, which can be maintained only
the State.
The Court observed that, insofar are the parties were concerned, no civil
wrong had been committed between them, and if public wrong had been
committed, then the directors of Balatoc Mining Company and the plaintiff
Harden himself, were the active inducers of the commission of that wrong. But
more importantly, the Court observed:

. . . The contract, supposing it to have been unlawful in

fact, has been performed on both sides, by the building of the
Balatoc plant by the Benguet Company and the delivery to the
latter of the certificate of 600,000 shares of the Balatoc
Company. There is no possibility of really undoing what has
been done. Nobody would suggest the demolition of the mill.
The Balatoc Company is secure in the possession of that
improvement, and talk about putting the parties in statu quo
ante by restoring the consideration with interest, while the
Balatoc Company remains in possession of what is obtained
98
58 Phil. 140 (1933).
 by the use of that money, does not quite meet the case. Also,
to mulct the Benguet Company in many millions of dollars in
favor of individuals who have not the slightest equitable right to
that money is a proposition to which no court can give a ready
assent.99

The lesson from Harden therefore is that, even where corporate contracts
are illegal per se, when only public or government policy is at stake and no
private wrong is committed, the courts will leave the parties as they are, in
accordance with their original contractual expectations.

4. Acts or Contracts in Behalf of

Corporation by Unauthorized Persons

a. Premise of Corporate Power

As a general rule, only the acts of corporate officers within the scope of
their authority are binding on the corporation; but when these officers exceed
their authority, their actions cannot bind the corporation, unless it has ratified
such acts or is estopped from disclaiming them.100 The officer acting without
proper authority cannot by his act be the basis upon which to bind the
corporation of ratification, nor can third-parties rely upon such unauthorized act to
bind the corporation to ratification.101
The primary rule therefore under the corporate set-up is that in the
absence of an authority from the board of directors, no person, not even the
officers of the corporation, can validly bind the corporation.102
In one case, the Court has said that a corporation is a juridical person,
separate and distinct from its stockholders and members, having powers,
attributes and properties expressly authorized by law or incident to its existence;
being a juridical entity, a corporation may act through its board of directors, which
exercises almost all corporate powers, lays down all corporate business policies
and is responsible for the efficiency of management, as provided in Section 23 of
the Corporation Code.103
While a corporation may appoint agents to enter into a contract in its
behalf, the agent should not exceed his authority. 104 Consequently, persons who
deal with corporate agents within circumstances showing that the agents are
acting in excess of corporate authority, may not hold the corporation liable.105
In another case, the Court held that indubitably, a corporation may act
only through its board of directors or, when authorized either by its by-laws or by
99
Ibid, at pp. 149-150.
100
San Juan Structural and Steel Fabricators, Inc. v. Court of Appeals, 296 SCRA 631, 645,
99 SCAD 281 (1998).
101
Ibid.
102
Premium Marble Resources v. Court of Appeals, 264 SCRA 11, 76 SCAD 9 (1996).
103
People’s Aircargo and Warehousing Co., Inc. v. Court of Appeals, 297 SCRA 170, 182,
99 SCAD 482 (1998).
104
Assets Privatization Trust v. Court of Appeals, 300 SCRA 579, 101 SCAD 1028 (1998).
105
Traders Royal Bank v. Court of Appeals, 269 SCRA 601, 80 SCAD 12 (1997); also Art.
1883, Civil Code.
its board resolution, through its officers or agents in the normal course of
business.106
When it comes therefore to other corporate officers who purport to act in
favor of the corporation, their dealings with third persons may be actual or
apparent, for which the corporation as the principal is liable for the obligations
contracted by its agent. Nevertheless, the agent's apparent representation yields
to the principal's true representation and the contract is considered as entered
into between the principal and the third person.107

b. Doctrine of Apparent Authority

The doctrine of apparent authority has evolved in consideration of the third
type of ultra vires acts, but which has had an uneven development.
In seems settled now from Supreme Court rulings that if a corporation
knowingly permits one of its officers, or any other agent, to act within the scope
of an apparent authority, it holds him out to the public possessing the power to so
do those acts; and thus, the corporation will, as against anyone who has in good
faith dealt with it through such agent, be estopped from denying the agent‟s
authority.108
The Court has also held that apparent authority is derived not merely from
practice, since its existence may be ascertained through: (a) the general manner
in which the corporation holds out an officer or agent as having the power to act
or, in other words, the apparent authority to act in general, with which it clothes
him; or (b) the acquiescence in his acts of a particular nature, with actual or
constructive knowledge thereof, whether within or beyond the scope of his
ordinary powers.109 Necessarily, the application of the doctrine of apparent
authority requires presentation of evidence of similar acts executed either in its
favor or in favor of other parties. It is not the quantity of similar acts which
establishes apparent authority, but the vesting of a corporate officer with the
power to bind the corporation.110
Earlier, Ramirez v. Orientalist Co.,111 adopted the principle that when an
action is brought against a corporation upon an alleged contract, if the
corporation desires to set up the defense that the contract was executed by one
not authorized as its agent, it must plead such fact.112 The Court held -

A corporation can not avail itself of the defense that it

had no power to enter into the obligation to enforce which the
suit is brought, unless it pleads that defense. This principle

106
San Juan Structural and Steel Fabricators, Inc. v. Court of Appeals, 296 SCRA 631, 645,
99 SCAD 281, 294 (1998).
107
First Philippine International Bank v. Court of Appeals, 252 SCRA 259, 67 SCAD 196
(1996).
108
People’s Aircargo and Warehousing Co., Inc. v. Court of Appeals, 297 SCRA 170, 184-
185, 99 SCAD 482, 497-498 (1998).
109
People’s Aircargo and Warehousing Co., Inc. v. Court of Appeals, 297 SCRA 170, 183-
184, 99 SCAD 482 (1998).
110
Ibid.
111
38 Phil. 634 (1918).
112
Ibid, at p. 644.
 applies equally where the defendant intends to challenge the
power of its officer or agent to execute in its behalf the contract
upon which the action is brought and where it intends to
defend on the ground of a total want of power in the
corporation to make such a contract.113

In Ramirez the corporation was sought to be held liable on film distribution

contracts entered into in its name by its director-treasurer. Although the
corporation did not deny under oath the contracts pleaded in the complaint, it
alleged that its officer did not have authority to sign the contracts for the
corporation. In brushing aside such a defense, the Court discussed the rationale
for the doctrine of apparent authority granted to corporate officers sufficient to
bind the corporation that "[i]n dealing with corporations the public at large is
bound to rely to a large extent upon outward appearances. If a man is found
acting for a corporation with the external indicia of authority, any person, not
having notice of want of authority, may usually rely upon those appearances; and
if it be found that the directors had permitted the agent to exercise that authority
and thereby held him out as a person competent to bind the corporation, or had
acquiesced in a contract and retained the benefit supposed to have been
conferred by it, the corporation will be bound, notwithstanding the actual authority
may never have been granted."114
Ramirez further held that the public is not supposed nor required to know
the transactions which happen around the table where the corporate board of
directors or the stockholders are from time to time convoked, and that whether a
particular officer actually possesses the authority which he assumes to exercise
is frequently known to very few, and the proof usually is not readily accessible to
the stranger who deals with the corporation on the faith of the ostensible
authority exercised by some of the corporate officers.115 It is therefore
reasonable, in a case where an officer of a corporation has made a contract in its
name, that the corporation should be required, if it denies his authority, to state
such defense in its answer, since by that means the plaintiff is apprised of the
fact that the agent's authority is contested; and he is given an opportunity to
adduce evidence showing either that the authority existed or that the contract
was ratified and approved.116
In Philippine National Bank v. Court of Appeals,117 a bank was held bound
by the acts of its branch manager, since the Court considered well-settled the
rule that if a private corporation intentionally or negligently clothes its officers or
agents with apparent power to perform acts for it, the corporation will be
estopped to deny that such apparent authority is real as to innocent third parties
dealing in good faith with such officers or agents.118

113
Ibid, at p. 644 quoting THOMPSON ON CORPORATIONS, 1st ed., Vol. 6, Sec. 7631.
114
Ibid, at pp. 645-646.
115
Ibid.
116
Ibid.
117
94 SCRA 357 (1979).
118
The principle was reiterated in The authority of a corporate officer in dealing with third
persons may be actual or apparent. . . the principal is liable for the obligations contracted by the
agent. The agent's apparent representation yields to the principal's true representation and the
contract is considered as entered into between the principal and the third person First Philippine
 In Francisco v. Government Service Insurance System119 at issue was the
binding effect of an acceptance telegram sent by the general manager of the
corporation, which contained provisions contrary to the terms approved by the
board of directors, covering the terms of settlement of an obligation. In upholding
the binding effect of the acceptance telegram on the corporation the Court held:

. . . Assuming this to be true, how was appellee to know

it? Corporate transactions would speedily come to a standstill
were every person dealing with a corporation held duty-bound
to disbelieve every act of its responsible officer, no matter how
regular they should appear on their faces . . .120

Francisco held that if a corporation intentionally or negligently clothes its

officers or agents with apparent power to perform acts for it, the corporation will
be estopped to deny that such apparent authority is real, as to innocent third
persons dealing in good faith with such officers or agents.121 Since a corporation
cannot see, or know, anything except through its officers, then knowledge of
facts acquired or possessed by an officer or agent of a corporation in the course
of his employment, and in relation to matters within the scope of his authority, is
notice to the corporation, whether he communicates such knowledge or not.122
Francisco also explained why the public generally cannot be required to
look beyond the officers acting for a corporation:

A very large part of the business of the country is carried

on by corporations. It certainly is not the practice of persons
dealing with officers or agents who assume to act for such
entities to insist on being shown the resolution of the board of
directors authorizing the particular officer or agent to transact
the particular business which he assumes to conduct. A
person who knows that the officer or agent of the corporation
habitually transacts certain kinds of business for such
corporation under circumstances which necessarily shows
knowledge on the part of those charged with conduct of the
corporate business assumes, as he has the right to assume,
that such agent or officer is acting within the scope of his
authority.123

International Bank v. Court of Appeals, 252 SCRA 259, 67 SCAD 196 (1996), where the Supreme
Court held that "[t]he authority of a corporate officer in dealing with third persons may be actual or
apparent. . . the principal is liable for the obligations contracted by the agent. The agent's
apparent representation yields to the principal's true representation and the contract is
considered as entered into between the principal and the third person."
119
7 SCRA 577 (1963).
120
Ibid, at p. 583.
121
Ibid, at p. 584.
122
Ibid, at pp. 584-585 quoting BALLANTINE, LAW ON CORPORATIONS, Sec. 112.
123
Ibid, at pp. 583-584 quoting from Curtis Land & Loan Co. v. Interior Land Co., 137 Wis.
341, 118 N.W. 853, 129 Am. St.Rep. 1068; as cited in 2 FLETCHER'S ENCYCLOPEDIA, PRIV. CORP.,
Perm. Ed., at p. 263,
 In Areola v. Court of Appeals,124 the corporate insurer was held liable for
damages for cancellation the insurance policy of the insured for alleged failure to
pay the premium, when in fact the premium had been paid to the branch
manager who failed to remit them to the head office. The Court held that a
corporation acts solely through its employees, and the latter's acts are
considered as its own for which it can be held to account.
In People’s Aircargo v. Court of Appeals,125 the Court held the corporation
liable to a second contract of service that was entered into by the President
without prior board authorization, when the facts showed that a first contract of
service was paid by the corporation when it was entered into by the President
also without prior board authorization. The Court held that when the first contract
was consummated and paid with full knowledge of the board of directors, it
clothed the President with power to bind the corporation and consequently the
contractor cannot be faulted for believing that President‟s conformity to the
second contract was also binding on the Company. The Court also held that by
having accepted the benefits from the services of contractor for the second
contract, the corporation is estopped from denying the enforceability of the
second contract.
The Court in People’s Aircargo also recognized the peculiar position of the
President with respect to corporate operations, that inasmuch as a the President
is often given general supervision and control over corporate operations, the
strict rule that said officer has no inherent power to act for the corporation is
slowly giving way to the realization that such officer has certain limited powers in
transactions of the usual and ordinary business of the corporation, thus:

In the absence of a charter or bylaw provision to the

contrary, the president is presumed to have the authority to act
within the domain of the general objectives of the corporation‟s
business and within the scope of his or her usual duties.
Hence, it has been ruled in other jurisdiction that the president
of the corporation possesses the power to enter into a contract
for the corporation, when the “conduct on the part of both the
president and the corporation [shows] that he had been in the
habit of acting in similar matters on behalf of the company and
that the company had authorized him so to act and had
recognized, approved and ratified his former and similar
actions.” Furthermore, a party dealing with the president of a
corporation is entitled to assume that he has the authority to
enter, on behalf of the corporation, into contracts that are
within the scope of the powers of said corporation and that do
not violate any statute or rule on public policy.126

c. “Timely-Repudiation” Ruling

124
236 SCRA 643, 55 SCAD 478 (1994).
125
297 SCRA 170, 99 SCAD 478 (1998).
126
Ibid, at p. 186.
 On the other hand, the recent case of Yao Ka Sin Trading v. Court of
Appeals127 presents what seems to be a reversal of the Ramirez doctrine. Yao Ka
Sin invalidated a contract to supply cement entered into by a cement company by
Mr. Maglana, its President and Chairman of the board of directors. Aside from
the fact that the by-laws of the cement company did not give the President the
authority to enter into contracts without prior board approval, the Court held that
application of the doctrine of apparent authority is the burden of the outsider
dealing with a corporation to show: "It was incumbent upon the petitioner to prove
that indeed the private respondent had clothed Mr. Maglana with apparent power
to executive Exhibit `A' or any similar contract. This could have been easily done
by evidence of similar acts executed either in its favor or in favor of other parties.
Petitioner miserably failed to do that." Upon the other hand, private respondent's
evidence overwhelmingly shows that no contract can be signed by the president
without first being approved by the Board of Directors."128
More importantly, in Yao Ka Sin, within a number of days (23 days) from
the execution of the President of the unauthorized contract, the board of directors
of the cement company passed a resolution repudiating the contract and given
due notice thereof to the other party when the contract was still as the executory
stage. In other words, there was no omission or misconduct on the part of the
board in Yao Ka Sin for the doctrine of estoppel or ratification to come in.
Although one would first get the impression that Yao Ka Sin may have
reversed the Ramirez doctrine, by shifting the burden in the doctrine of apparent
authority from the corporation to the other contracting party, but taken in its
entirety, Yao Ka Sin did not reverse the Ramirez doctrine, but rather completed
the cycle.
Yao Ka Sin did not repudiate the Ramirez doctrine that if the corporation
desires to set up the defense that the contract was executed by one not
authorized as its agent, it must plead and prove such fact; so that the burden is
initially on the shoulders of the corporation. However, the facts as they reach the
Supreme Court in Yao Ka Sin shows that indeed the cement company had
already discharged such burden by showing by clear evidence that its President
was not so authorized. Yao Ka Sin therefore holds, that once the corporation has
discharged its obligation under the Ramirez doctrine that acting officer was not in
fact authorized, then the burden of proof now shifts to the contracting party to
show that indeed by previous acts and actuations the acting officer had been
clothed by the corporation with apparent authority for the public to have taken
such authority at face value.
Vicente v. Geraldez,129 declared non-binding on the corporation, a
compromise agreement entered into by counsel without a prior special power of
attorney having been granted by the corporation. The Supreme Court refused to
apply the doctrine of estoppel or ratification even when it was shown that the
administrative manager had signed the compromise or had pursued an act
pursuant to the compromise agreement under the ruling that, it is only the board
of directors of the corporation that has the power to ratify a previously

127
209 SCRA 763 (1992).
128
Ibid, at p. 784.
129
52 SCRA 210 (1973).
unauthorized corporate act. The Court held that "ratification can never be made
`on the part of the corporation by the same persons who wrongfully assume the
power to make the contract, but the ratification must be by the officer or
governing body having authority to make such contract and, as we have seen,
must be with full knowledge.'"130
Vicente is not really a radical departure since it involved power to
compromise in suits, which is governed by particular provisions of the Rules of
Court, and therefore, it cannot be expected that proceedings on compromise,
especially involving a corporate party, would be pursued on the basis of apparent
authority. The Court held "the Rules require for attorneys to compromise the
litigation of their clients, a special authority. And while the same does not state
that the special authority be in writing the court has every reason to expect that, if
not in writing, the same be duly established by evidence other than the self-
serving assertion of counsel himself that such authority was verbally given
him."131
Crisologo-Jose v. Court of Appeals,132 held that accommodation contracts
on negotiable instruments executed in behalf of the corporation would not bind
the corporation without previous board authorization.133 The issuance or
indorsement of negotiable instruments in the name of a corporation without
consideration and for the accommodation of another was deemed to be ultra
vires, and the person who takes the instrument with knowledge of the
accommodation nature thereof cannot recover against a corporation which is
only an accommodation party.134
Crisologo-Jose stands as one of the few contemporary cases where the
Court has upheld the defense of ultra vires as validly exempting liability on the
part of the corporation for a contract entered into its name by an unauthorized
officer. In that case, the payee of the check issued by the corporation as an
accommodation party, was fully aware that the corporation was not receiving any
benefit from the transaction and that the issuance of the check was not for the
benefit of the corporation, and was therefore fully aware that the corporate
signatories to the check had not been duly authorized by the board of directors.
Therefore, the principles of ratification by acceptance of benefits or the doctrine
of apparent authority, nor the principle of estoppel espoused by the Court to
undermine the defense of ultra vires were inapplicable to favor the payee as
against the corporation since in his case estoppel could not apply being fully
aware of the lack of authority. It is unfortunate that Crisologo-Jose did not clearly
point out in this clear manner the reason why the ultra vires doctrine prevailed in
that instance when normally it is brushed aside by the courts.
Mendezona v. Phil. Sugar Estates Dev. Co.,135 had long before ruled that
the declarations of an individual director relating to the affairs of the corporation,
but not made in the course of, or connected with, the performance of the
130
Ibid, at p. 229, quoting from 2 FLETCHER, CYCLOPEDIA CORPORATIONS, 1067-1069, (1969
Rev. Volume).
131
Ibid, at p. 225.
132
177 SCRA 594 (1989)
133
Ibid, citing Oppenheim v. Simon Reigel Cigar Co., 90 N.Y.S. 355, cited in 11 C.J.S. 309.
134
Ibid, at p. 599, citing 11 C.J.S. 309, 14A C.J. 732.
135
41 Phil. 475, 491-492 (1921), citing 2 THOMPSON, par. 1073 and 1408.
authorized duties of such director, are held not biding on the corporation. False
statements made by a single director, for the purpose of defrauding the creditors
of the corporation, including the corporation itself, could not affect or bind it. The
general rule is that officers of corporations acting within the scope of their
authority may bind the corporation in the same way and to the same extent as if
they were the agents of natural persons, unless the charter or by-laws, otherwise
provide. They cannot, in general, bind the corporation by acts in excess of the
authority with which they are clothed unless such acts are ratified.
From the foregoing, it would seen that in the realm of contract
enforcement, the ultra vires doctrine has found very little application. It has
become more of a technical defense raised by or against the corporation, which
courts have readily brushed aside. However, the ultra vires doctrine still stands
as a principle of Corporate Law, and it reigns supreme in a purely intramural
corporate setting. In cases where the protagonists remain within the corporate
setting, or when the contract with an outsider is still executory as not to have
caused yet damage to the latter, the doctrine has been applied by courts with
vigor, for indeed it goes into the root of corporate relationship.

d. De Facto Corporate Officers

In a opinion,136 the SEC has applied the doctrine of de facto officers in the
Law on Public Officers to corporate officers. The SEC opined that the principle on
de facto officers may be applied insofar as third parties dealing with the
corporations.137 It defined a corporate officer as a de facto officer where he acts
as such, under color of an election or appointment, but fails being a de jure
officer by some irregularity or failure to qualify as required by law.138
In applying the doctrine to purported corporate officers, the SEC held:
"The doctrine of the validity of the acts of officers de facto rest on public policy
and justice. The official dealings of directors de facto with third persons are
sustained as rightful and valid on ground of continuous acquiescence by the
corporation, and suffering them to hold themselves out as having such authority;
thereby inducing others to deal with them in such capacity. It would be
impracticable for third persons to deal with corporations at all, if each one must
investigate the legality of the title of each corporation officers as a condition
precedent to a business transaction."139
One would notice from the reasoning of the SEC that it is really applying
the jurisprudential doctrine on apparent authority.

8. Corporate Dealings with Directors and Officers

Prime White Cement Corp. v. Intermediate Appellate Court,140 recognized
the self-dealing contracts of directors and officers constitute a strong exception to
the doctrine of apparent authority. In that case, a director entered into a
136
SEC Opinion, 27 September 1993, XXVIII SEC QUARTERLY BULLETIN 14 (No. 1, March
1994).
137
Ibid.
138
Ibid.
139
Ibid.
140
220 SCRA 103 (1993).
Dealership Agreement with the corporation, signed by its chairman and
president, for the corporation to supply 20,000 bags of white cement per month
for five years at a fixed price of P9.70 per bag. Subsequently, the Board refused
to abide by the contract unless new conditions are accepted providing for new
price formula. The dealing director sued for specific performance on the contract.
The Court held that under both the Corporation Law then and the present
Corporation Code, the doctrine is that all corporate powers shall be exercised by
the board of directors, except as otherwise provided by law. It then summarized
the prevailing rules applicable when a corporate act or contract is entered into
without prior board authority: "Although is cannot completely abdicate its power
and responsibility to act for the juridical entity, the Board may expressly delegate
specific powers to its President or any of its officers. In the absence of such
express delegation, a contract entered into by its President, on behalf of the
corporation, may still bind the corporation if the board should ratify the same
expressly or impliedly. Implied ratification may take various forms--like silence or
acquiescence; by acts showing approval or adoption of the contract; or by
acceptance and retention of the benefits flowing therefrom. Furthermore, even in
the absence of express or implied authority by ratification, the President as such
may, as a general rule, bind the corporation by a contract in the ordinary course
of business, provided the same is reasonable under the circumstances. These
rules are basic, but are all general and thus quite flexible. They apply where the
President or other officer, purportedly acting for the corporation, is dealing with a
third person, i.e., a person outside the corporation."141
The Court held that "[t]he situation is quite different where a director or
officer is dealing with his own corporation," and held:

A director of a corporation holds a position of trust and

as such, he owes a duty of loyalty to his corporation. In case
his interests conflict with those of the corporation, he cannot
sacrifice the latter to his own advantage and benefit. As
corporate managers, directors are committed to seek the
maximum amount of profits for the corporation. This trust
relationship "is not a matter of statutory or technical law. It
springs from the fact that directors have the control and
guidance of corporate affairs and property and hence of the
property interest of stockholders.142

Prime White Cement held that a director holds a position of trust and as
such, he owes a duty of loyalty to his corporation, and his contracts with the
corporation must always be at reasonable terms, otherwise the contract is void
or voidable at the option of the corporation. The Court found that the terms of the
Dealership Agreement were unreasonable for the corporation and that the
unfairness in the contract was a basis which renders a contract entered into by
the President, without authority from the board of directors, void or voidable,
although it may have been in the ordinary course of business.

141
Ibid, at p. 110.
142
Ibid.
 9. Comparison With Uneforceable Contract Principles
The principles applied by the Supreme Court in deciding issues pertaining
to the ultra vires acts or contracts, other than the third type which are violative of
the law or public policy, is similar to principles of Contract Law on unenforceable
contracts.
Unenforceable contracts under Philippine jurisdiction cannot be sued upon
or enforced, unless ratified, but once ratified, they have the effect of valid
contracts.143
Under Article 1403 of the Civil Code of the Philippines, unless they are
ratified, contracts entered into by "in the name of another person by one who has
given no authority or legal representation, or who has acted beyond his powers"
are deem to be unenforceable. Under Philippine jurisprudence, uneforceable
contracts are valid but cannot be enforced or effected, unless there has been
ratification, in which case the contract become valid and enforceable contracts. In
addition, unenforceable contracts, once ratified validates them from the
inception.144 Also, unenforceable contracts cannot be assailed by third persons.145
In addition, the principle of unenforceability of such contracts is deemed waived
when such contracts have been partially or fully executed by one of the parties
thereto.
In the case of the two (2) types of ultra vires contracts, i.e., those entered
into beyond the powers or purpose of the corporation, and those entered into by
unauthorized corporate officers or representatives, such contracts are similarly
located to unenforceable contracts entered into on behalf of the corporation, by
representatives who were not authorized by the corporation or acted beyond the
authorized powers granted to them. Consequently, the treatment of such ultra
vires contracts should be the same as those of similar unenforceable contracts.
This seems to be the path that has been followed by the Supreme Court as it has
applied principles pertaining to unenforceable contracts to such types of ultra
vires contracts, including the principles of estoppel and ratification, including the
fact that it has refused to disturbed contracts that have been executed, which is
equivalent to ratification.

FINAL OBSERVATIONS
What is clear from all the foregoing discussions is that in the field of
commercial transactions as they involve corporate entities, the principles of
Corporate Law are made to harmonize with other disciplines in order to sustain
the validity of contracts and transactions entered into by corporations with the
dealing public, in accordance with legitimate contractual and business
expectations that the corporations would be bound thereby, without the need of
costly and protracted verification as to the powers and authority of such
corporations, and the persons who act in their behalf. Rarely will the courts apply
pure corporate doctrines on their own merits, and courts will not apply them at all

143
PARAS, CIVIL CODE OF THE PHILIPPINES ANNOTATED (Vol. IV, 1994 ed.), at p. 766.
144
Art. 1407, Civil Code of the Philippines.
145
Art. 1408, Civil Code of the Philippines.
when their application would promote injustice and permit parties to skirt
contractual obligations they clearly assumed when the contracts were drawn.
Even in the case of acts or contracts of corporations which are illegal per
se, the State has often declined to fuse public interests with private affairs.
Courts have refused to invalidate the effects of such contracts on the parties in
order to enforce the State's interests, where the contract has created private
wrongs. The State will then seek its own cause against the erring corporation,
usually in a quo warranto proceeding to have the corporation's charter declared
forfeited.

—oOo—

CORPLAW \CORPMAN.DIR\CORPORATE CONTRACT LAW\10 JAN 2003

 CHAPTER 6

ARTICLES OF INCORPORATION

Contractual Significance of Articles of Incorporation

Registration of Articles of Incorporation
Examination and Approval/Disapproval by SEC
Special Rules for Banks
Grounds for Disapproval of Articles of Incorporation
Contents of Articles of Incorporation
Treasurer's Affidavit
Other Documentary Requirements
Corporate Name
Guidelines on Corporate Names
Change of Corporate Name
Purpose Clause
Investment in Non-Primary Purpose Activities
Rule on Interpretation of Purpose Clauses
Principal Place of Business
Residence of Corporation
Service of Process Upon a Corporation
Corporate Term
Commencement of Corporate Existence
Incorporating Stockholders or Members
Capital Structure at Registration
Subscription and Paid-up Requirements
Issuance of Par Value Shares of Stock
Amendments to Articles of Incorporation

——

CONTRACTUAL SIGNIFICANCE OF ARTICLES OF INCORPORATION

The contractual significance of the articles of incorporation in Corporate
Law is discussed in Chapter 5 on Corporate Contract Law, which looks at its
significance as the basic contract document in Corporate Law, defining the
charter of the corporation, and the contractual relationships between the State
and the corporation, the stockholders and the State, and between the
corporation and its stockholders.1
The reverence which both the law and the courts have accorded to the
articles of incorporation as the basic corporate contract is manifested by the

1
Government of the P.I. v. Manila Railroad Co., 52 Phil. 699 (1929).
 2

strict rules to be followed in its registration and the manner by which any portion
thereof may be amended. Nevertheless, it is pointed out in the discussions in
that chapter that the limiting effects of provisions of the articles of incorporation
on corporate contracts with the public, has been tempered by the Supreme
Court by the manner is has applied the ultra vires doctrine.
The purpose of the present chapter is really to discuss more the
mechanical features of adopting and amending the articles of incorporation and
to look into its basic provisions.

REGISTRATION OF ARTICLES OF INCORPORATION

The articles of incorporation do not become binding as the charter of the
corporation unless they has been filed with and registered by the SEC. 2
In the case of articles of incorporation of special types of corporations,
such as banks, public utilities, insurance companies, etc., they will not be
registered by the SEC unless said articles are accompanied by a favorable
recommendation from the appropriate agencies supervising such special types
of corporations, to the effect that the articles are in accordance with the law.

1. Examination and Approval/Disapproval by SEC

Upon filing of the articles of incorporation, the SEC will examine whether
the provisions thereof are in accordance with law. If the articles of incorporation
are not in conformity with law, SEC shall give the incorporators reasonable time
within which correct or modify the objectionable portions.3
After examination, upon satisfaction of all legal requirements, SEC issues
the certificate of incorporation. Only then shall the corporation have a personality
separate and distinct from its stockholders or members. However, the approval
of the articles of incorporation and issuance of the certificate of registration does
not preclude the SEC, if it later finds that the incorporators were guilty of fraud in
procuring the certificate of incorporation, from revoking the same subject to
proper hearing.
Pres. Decree 902-A gives the SEC, after consultation with the Board of
Investments (BOI), National Economic Development Administration (NEDA), or
other appropriate government agencies, the power to refuse or deny application
for registration of any corporation, if its establishment, organization or operation
will not be consistent with the declared national economic policies.4
The implication under Pres. Decree 902-A is that the SEC may look
beyond the terms of the articles of incorporation, and may refuse registration
although the articles of incorporation may contain lawful purposes, if other

2
Sec. 14, Corporation Code
3
Sec. 17, Corporation Code.
4
Sec. 6(k), Pres. Decree 902-A.
 3

circumstances show that the applicant's establishment or operation may run

counter to the nation's economic policies.

2. Special Rule for Banks

Section 14 of the General Banking Law of 20005 expressly provides that
the SEC shall not register the articles of incorporation of any bank, or any
amendment thereto, unless accompanied by a certificate of authority issued by
the Monetary Board, under its seal. Such certificate shall not be issued unless
the Monetary Board is satisfied from the evidence submitted to it that: (a) All
requirements of existing laws and regulations to engage in the business for
which the applicant is proposed to be incorporated have been complied with; (b)
The public interest and economic conditions, both general and local, justify the
authorization; and (c) The amount of capital, the financing, organization,
direction and administration, as well as the integrity and responsibility of the
organizers and administrators, reasonably assure the safety of deposits and the
public interest.
In addition, Section 81 of the Law provides expressly that the SEC shall
not register the articles unless accompanied by a certificate of authority issued
by the Bangko Sentral ng Pilipinas (BSP).

3. Grounds for Disapproval of

Articles of Incorporation
Under Section 17 of the Corporation Code, the SEC may reject the
articles of incorporation or disapprove any amendment thereto if the same is not
in compliance with the requirements of the Code, provided that the SEC shall
give the incorporators reasonable time within which to correct or modify the
objectionable portions of the articles or amendment.
The following are grounds for such rejection or disapproval by the SEC of
the articles of incorporation:

(a) The articles of incorporation or any amendment

thereto is not substantially in accordance with the
form prescribed by law;
(b) The purpose or purposes of the corporation are
patently unconstitutional, illegal, immoral, or
contrary to government rules and regulations;
(c) The Treasurer's Affidavit concerning the amount
of capital stock subscribed and/or paid is false;
(d) The percentage of ownership of the capital stock
to be owned by citizens of the Philippines has not

5
Rep. Act 8791.
 4

been complied with as required by existing laws

or the Constitution.

CONTENTS OF ARTICLES OF INCORPORATION

Section 14 of the Corporation Code provides that all corporations
organized thereunder shall file with the SEC articles of incorporation in any of
the official languages, duly signed and acknowledged by all the incorporators,
containing substantially the following matters:

(a) Name of the corporation;

(b) Purpose clauses, and should distinguish the
primary purpose from the secondary purposes,
should the corporation have more than one
purpose; a non-stock corporation shall not include
a purpose which would change or contradict its
nature;
(c) Place of principal office within the Philippines;
(d) Term of existence;
(e) Names, nationalities and residences of the
incorporators;
(f) Number of directors or trustees (between 5 to 15);
(g) Names, nationalities and residences of the
persons who shall act as directors or trustees until
the first regular directors or trustees are duly
elected and qualified; and
(h) If stock corporation, amount of authorized capital
stock, number of shares, par value or no par value
shares, original subscribers, amounts subscribed
and paid by each.

The basic contents of the articles of incorporation are considered by law

to be so important and jurisdictional that Section 15 of the Corporation Code
provides for the basic form of articles of incorporation.

1. Treasurer's Affidavit
The SEC shall not accept articles of incorporation of a stock corporation
unless accompanied by a sworn statement by the Treasurer that at least twenty-
five percent (25%) of the total capital stock authorized is subscribed and at least
twenty-five percent (25%) of such have been fully paid in cash or property—fair
valuation of which is equal to at least twenty-five percent (25%) of the said
subscription. Such paid-up capital shall be no less than P5,000.00.
 5

The twenty-five percent (25%) subscription requirement under Section 38

of the Corporation Code refers to the total subscription and not to individual
subscription and regardless of the class of shares.6

2. Other Documentary Requirements

SEC Guidelines require that a bank certificate covering the deposit of the
paid-up capital, in accordance with a prescribed form under oath by a
responsible official of the bank, must accompany the incorporation papers.7
In addition, a letter of authority authorizing the SEC to examine not only
the bank deposit but also the corporations books of accounts and supporting
records to determine the existence and utilization of the paid-up capital stock
must also be submitted. The letter of authority shall be binding upon the
corporation even if there is a change of corporate officers.8
Even when evidence is presented that the payments effected for the paid-
up capital of a corporation were actually borrowed from the certifying bank, the
SEC held that the bank would have no authority to demand payment from the
corporation for the loans given to the individual incorporators. The SEC held that
a corporation has a personally separate and distinct from that of each of the
stockholders, and for that matter the property belonging to a corporation cannot
be attached or held answerable for the debts of the stockholders thereof, and
that the stockholders are liable personally for their own obligations. The SEC
held:

Otherwise stated, the debt of a stockholder is not the

debt of the corporation of which he is a stockholder; and
conversely, the debt of the corporation is not the debt of the its
stockholders. The loan agreement between the borrowers and
the creditor bank is a private contract between them of which
the proposed corporation is not a party. The moment the
borrowed money was contributed as payment to subscriptions
and upon incorporation, the ownership thereof is transferred to
the new corporation. Accordingly, upon the issuance by the
SEC of the certificate of incorporation, the corporation, being
then the owner of the funds, can already withdraw and
disburse the same for the operation of its business; and the
borrower stockholders cannot, as a matter of right, demand for
the return of the funds invested to answer their liability to the
creditor Bank nor can they demand that the corporation to pay
their debts.9

6
SEC Opinion, 18 April 1995, XXIX SEC QUARTERLY BULLETIN 41 (No. 3, Sept. 1995).
7
Sec. 1, SEC GUIDELINES FOR THE VERIFICATIONS OF THE PAID-UP CAPITAL (CASH) OF
CORPORATIONS (1976).
8
Sec. 2, ibid.
9
SEC Opinion, 8 October 1993, XXVIII SEC QUARTERLY BULLETIN 24 (No. 1, March 1994),
citing Wise Co., Inc. v. Man Sung Lung, 69 Phil. 308 (1940).
 6

The SEC also requires that incorporators are required to submit a written
undertaking to change their partnership or corporate name in case there is
another person, firm or entity with a prior right to the use of the said name or one
similar to it.10

CORPORATE NAME
The incorporators "constitute a body politic and corporate under the name
stated in the certificate."11 A corporation has the power "of succession by its
corporate name."12 The name of a corporation is therefore essential to its
existence; it cannot change its name except in the manner provided by the
statute; by that name alone is it authorized to transact business;13 and it is by
that name that a corporation can sue and be sued, and perform all other legal
acts.
Since the corporate name is the main practical means of identifying
corporation from its members or stockholders, and other entities, the
Corporation Code does not allow a corporation to adopt a name identical or
deceptively or confusingly similar or to any other name already protected by law
or which is patently deceptive, confusing or contrary to existing laws.14
In Red Line Trans. v. Rural Transit,15 it was held that a corporation may
use another name as a business or brand name, but a corporation cannot use
another corporation's name because it will only confuse the public. The name of
the corporation is essential to its existence.
In Laureano Investment and Development Corp. v. Court of Appeals,16it
was held that a corporation has no right to intervene in a suit using a name other
than its registered name, and if the corporation legally and truly wanted to
intervene, it should have used its corporate name as the law requires and not
another name which it had not registered.
Nevertheless, the Supreme Court has held that there would be no denial
of due process when a corporation is sued and judgment is rendered against it

10
SEC GUIDELINES IN THE APPROVAL OF CORPORATE AND PARTNERSHIP NAMES (1977).
11
Section 19, Corporation Code.
12
Ibid.
13
Red Line Transportation Co v. Rural Transit Co., 60 Phil. 549 (1934).
14
Sec. 18, Corporation Code.
For as long as the corporation is still existing, regardless of whether or not it is in
operation, its corporate name cannot again be used by any other group. This is clear from the
provision of Section 18 of the Corporation Code which provides that no corporate name may be
allowed by the SEC that is identical or deceptively or confusingly similar to that of “any existing
corporation.” SEC Opinion, 21 September 1993, XXVIII SEC QUARTERLY BULLETIN 7 (No. 1,
March 1994).
15
60 Phil. 549 (1934).
16
272 SCRA 253 (1997).
 7

under its unregistered trade name, holding that “[a] corporation may be sued
under the name by which it makes itself known to its workers.17

1. Guidelines on Corporate Names

The SEC Revised Guidelines18 provides for the following policies on the
use of corporate names aimed at safeguarding public interest and avoiding
future conflicts, thus:

1. The corporate name shall contain the word “Corporation” or its

abbreviation “Corp.” or “Incorporated”, or “Inc.”.
The partnership name shall contain the word “Company”
or “Co.”. For limited partnership, the word “Limited” or “Ltd.”
shall be included. In case of professional partnership, the word
“Company” need not be used.
2. Terms descriptive of a business in the name shall he indicative
of the primary purpose. If there are two (2) descriptive terms,
the first shall refer to the primary purpose and the second shall
refer to one of the secondary purposes.
3. The name shall not be identical, misleading or confusingly
similar to one already registered by another corporation or
partnership with the Commission or a sole proprietorship
registered with the Department of Trade and Industry (DTI).
If the proposed name is similar to the name of a
registered firm, the proposed name must contain at least one
distinctive word different from the name of the company
already registered.
4. Business or tradename of any firm which is different from its
corporate or partnership name shall be indicated in the. articles
of Incorporation or partnership of said firm.
5. Tradename or trademark duly registered with the Intellectual
Property Office (IPO) can not be used as part of a corporate or
partnership name without the consent of the owner of such
tradename or trademark.
6. lf the name or surname of a person is used as part of a
corporate or partnership name, the consent of said person or
his heirs must be submitted except if that person is a
stockholder, member, partner or a declared national hero. If

17
Pison-Arceo Agricultrual and Development Corp. v. NLRC, 87 SCAD 175, 279 SCRA
312 (1997).
18
SEC Memorandum No. 14, Series of 2000 (24 October 2000).
 8

such person can not be identified or non-existent, an

explanation for the use of such name shall be required.
7. The meaning of initials in the name shall be disclosed in writing
by the registrant.
8. Name containing a term descriptive of a business different from
the business of a registered company whose name also bears
similar term(s) used by the former may be allowed.
9. The name should not be patently deceptive, confusing or
contrary to existing laws.
10. The name which contains a word identical to a word in a
registered name shall not be allowed if such word is coined or
already appropriated by a registered firm, regardless of the
number of the different words in the proposed name, unless
there is consent from the registered firm or this firm is one of
the stockholders or partners of the entity to be registered.
11. The name of an internationally known foreign corporation or
one similar to it may not be used by a domestic corporation
without the consent of the former.
12. The term “Philippines” when used as part of the name of a
subsidiary corporation of a foreign corporation shall be in
parenthesis: i.e. “(Philippines)” or “(Phil.)”.
13. The foIlowing words shall not he used as part of a corporate or
partnership names:
(a) As provided by special laws:
(i) “Finance”, “Financing” or “Finance and Investment”
by corporations or partnerships not engaged in the
financing business (R.A. 5980, as amended)
(ii) “Engineer”, “Engineering” or “Architects” as part of
the corporate name (R.A. 546 and R.A; 1582)
(iii)“Bank”, “Banking”, “Banker”, “Building and Loan
Association”, “Savings and Loan Association”, “Trust
Corporation”, “Trust Company” or words of similar
import by corporations or associations not engaged
in banking business,. (R.A. 337, as amended)
(iv) “United Nations” in full or abbreviated form can not
be part of a corporate or partnership name (R.A. 266)
(v) “Bonded” for corporations or partnerships with
unlicensed warehouse (RA 245)
 9

(b) As a matter of policy:

(i) “Investment(s)” by corporations or partnerships not
organized as investment house, investment company
or a holding company.
(ii) “National” by all stock corporations arid partnership.
(iii)“Asean”, “Calabarzon” and “Philippines 2000”.
14. The name of a dissolved firm shall not be allowed to be used
by other firms within three (3) years after the approval of the
dissolution of the corporation by the Commission, unless
allowed by the last stockholders representing at least majority
of the outstanding capital stock of the dissolved firm.
15. Registrant corporations or partnership shall submit a letter
undertaking to change their corporate or partnership name in
case another person or firm has acquired a prior right to the
use of the said firm name or the same is deceptively or
confusingly similar to one already registered unless this
undertaking is already included as one of the provisions of the
articles of incorporation or partnership of the registrant.

2. Change of Corporate Name

Although a corporation has the power to change its name by following the
procedure laid down by law, the change of name of a corporation does not result
in its dissolution. Philippine First Insurance Co. v. Hartigan,19 held that the
changing of the name of a corporation is no more than creation of a corporation
than the changing of the name of a natural person is the begetting of a natural
person. The act, in both cases, would seem to be what the language which we
use to designate it imports—a change of name and not a change of being.
The amendment of the corporate name in the articles of incorporation and
its approval by the SEC no longer requires another amendment to the old
corporate names appearing in the by-laws of the corporation.20

PURPOSE CLAUSE
The significance of the purpose clause in the articles of incorporation is
that it confers, as well as limits, the powers which a corporation may exercise.
The purpose clause must specify which is the corporation's primary purpose and

19
34 SCRA 252 (1970).
20
SEC Opinion, 2 October 1986, XX SEC QUARTERLY BULLETIN 40 (Nos. 3 & 4, Sept. &
Dec., 1986).
 10

which are the secondary purpose. The secondary purpose or purposes need not
be related to the main purpose.
Some of the other reasons for indicating purpose in the charter of the
corporation are so that:

(a) Prospective investors shall know the kind of

business the corporation deals with;

(b) Management shall know the limits of its actions;

(c) A third-party can know whether his dealing with

the corporation are with corporate functions and
powers.

The indication of the primary purpose of the corporation is necessary for

the administrative supervision and monitoring of the State, as it can determine
which particular agency shall have jurisdiction over the operations of the
corporation.
In Uy Suiliong v. Director of Commerce,21 it was held that statements of
primary purpose is to protect shareholders so they will know the main path of
business of the corporation and they may file derivative suits if corporation
deviate from the primary purpose.
The purpose of a corporation must be lawful. If patently illegal, the articles
of incorporation shall be rejected by the SEC. If purpose stated in the articles of
incorporation is lawful, SEC cannot ask for other purpose other than those
stated, hence mandamus will lie to compel SEC to issue certificate of
incorporation, unless under declared policies, the SEC may need to regulate
certain lawful purposes or activities in consonance with declared national
economic policies.22
In Palting v. San Jose Petroleum, Inc.,23 the Supreme Court considered
the provisions in the articles of incorporation of a corporate entity that allowed
the directors and officers immunity from any claims against the corporation even
in cases of self-dealings, as being against Philippine corporate policies:

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

21
40 Phil. 541 (1919).
22
Sec. 6(k)7, Pres. Decree 90-2A.
23
18 SCRA 924 (1966).
 11

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, association or corporation 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 corporation; 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.24

The Court held that the impact of the questioned provisions of the articles
of incorporation upon the traditional fiduciary relationship between the directors
and the stockholders of a corporation would be too obvious to escape notice by
those who are called upon to protect the interest of investors. The Court found
that the provisions would authorize the directors and officers of the company to
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.
Asuncion v. De Yriarte,25 held that when on the face of the articles of
incorporation presented for registration it is shown that it is organized for a
purpose contrary to law or public policy, the same may be denied outright
registration. In Asuncion where the purpose in the articles of incorporation
sought to take possession and control of municipal property within a barrio and
administer the same exclusively for the benefit of the residents of the barrio, said
articles of incorporation showed the object of the incorporation to be unlawful in
that it sought to deprive the municipality in which the barrio was situated of its
property and its citizens of the right of enjoying the same and would, if permitted,
disrupt and destroy the government of the municipalities of the State and
abrogate the laws relating to the formation and government of municipalities.
The articles were denied outright registration.
Asuncion held also that although the duties of the official concerned
happened to be ministerial, it does not necessarily follow that he may not, in the
administration of his office, determine question of law. It is his duty to determine
whether the objects of the corporation as expressed in the articles of
incorporation are lawful pursuant to the then Corporation Law. And just because
the articles of incorporation are perfect in form, it does not mean that the division
of the archives must accept and register them and issue the corresponding

24
Ibid, at pp. 942-943.
25
28 Phil. 67 (1914).
 12

certificate of incorporation no matter as what the corporation's purpose is. It is

not only the right but also the duty of the appropriate government agency to
determine the lawfulness of the objects and purpose of the corporation before it
issues a certificate of incorporation.

1. Investment in Non-Primary Purpose Activities

Under Section 42 of the Corporation Code, a private corporation may
invest its funds in any other corporation or business or for any purposes other
than the primary purpose for which it was organized, when approved by a
majority of the board of directors or trustees and ratified by the stockholders
represented at least two-thirds (2/3) of the outstanding capital stock, or by at
least two-thirds (2/3) of the members in case of non-stock corporations, at a
stockholder's of members‟ meeting duly called for the purpose.
Written notice of the proposed investment and the time and place of the
meeting shall be addressed to each stockholder or member at his place of
residence as shown on the books of the corporation and deposited to the
addressee in the post office with postage prepaid, or served personally;
however, any dissenting stockholders shall have appraisal right.26
Also, where the investment by the corporation is reasonably necessary to
accomplish its primary purposes as stated in the articles of incorporation, the
approval of the stockholders on members shall not be necessary.27

2. Rule of Interpretation of Purpose Clauses

The SEC has ruled that the rules governing the construction of charters of
corporations are, for the most part, the same as those which govern the
construction and interpretation of statutes, contracts and other written
instruments.28
The SEC held that it is a general rule that when the charter of a
corporation confers certain enumerated powers on the corporation, it is to be
construed as including incidental powers reasonably necessary to the proper
exercise of the enumerated powers and as excluding all other non-enumerated
powers; and that if the powers are expressly enumerated in details “such
specification by implication excludes all other powers or rights, except such
incidental or subordinate rights and powers as may be necessary to an exercise
of the powers and rights expressly given.”29 The specification of certain powers
operates as a limitation on such objects as are embodied therein and is an
implied prohibition of the exercise of other instinct powers.30 Furthermore,
express powers cannot be enlarged by implication; thus, it was held that the
26
Sec. 42, Corporation Code.
27
Ibid.
28
SEC Opinion, 26 January 1994, XXVIII SEC QUARTERLY BULLETIN 46 (No. 2, June 1994),
citing 7A FLETCHER, Sec. 3640, and 6 FLETCHER CYC. CORP., Sec. 2483.
29
Ibid.
30
Ibid.
 13

general language of a charter following a recitation of specific power is

construed and confined within the limitations of the specific power named.31

PRINCIPAL PLACE OF BUSINESS

The principal place of business of a corporation must be indicated in its
articles of incorporation. Although the corporation may hold office in a place
other the place indicated in the articles of incorporation, for jurisdictional
purpose, the place indicated in the articles of incorporation is binding.

1. Residence of Corporation
Article 51 of the Civil Code provides that "when the law creating or
recognizing them, or any other provision does not fix the domicile of juridical
persons, the same shall be understood to be the place where their legal
representation is established or where they exercise their principal functions."
Clavecilla Radio System v. Antillon,32 held that the residence of a
corporation is the place where its principal office is established; it can be sued in
that place, not in the place where its branch office is located.
A corporation in a metaphysical sense is a resident of the place where its
principal office is located as stated in the articles of incorporation and cannot be
allowed to file a personal action in a place other than that place.33
Sy v. Tyson Enterprises, Inc.,34 held that the residence of the President
for purposes of venue and service of summons is not the residence of the
corporation because a corporation has a personality separate and distinct from
that of its officers and stockholders.
For purposes of venue in intra-corporate suits, under Section 1, Rule 1 of
the Interim Rules of Procedure for Intra-corporate Controversies, when the
articles of incorporation indicate that the principal place of business is “Metro
Manila,” as allowed under Section 51 of the Corporation Code, then the action
must be filed in the city or municipality where the head office is actually located.

2. Service of Process Upon a Corporation

Under Section 11, Rule 14 of the 1997 Rules of Civil Procedure of the
Philippines, if the defendant in a suit is a corporation organized under the laws
of the Philippines, service may be made on the President, general manager,
secretary, treasurer, or in-house counsel.

31
Ibid.
32
19 SCRA 379 (1967).
33
Young Auto Supply Co v. Court of Appeals, 223 SCRA 670, 42 SCAD 673 (1993).
34
119 SCRA 367 (1982).
 14

In one case35, the Supreme Court noted that the rationale of all rules for
service of process on corporation is that service must be made on a
representative so integrated with the corporation sued as to make it a priori
supposable that he will realize his responsibilities and know what he should do
with any legal papers served on him. It then held that service of summons upon
the assistant general manager has served the purpose of the law.

CORPORATE TERM
Section 11 of the Corporation Code provides that a corporation shall exist
for a period not exceeding fifty (50) years from the date of incorporation unless
sooner dissolved or unless said period is extended.
The corporate term, as originally stated in the articles of incorporation,
may be extended for period not exceeding fifty (50) years in any single instance
by an amendment in the articles of incorporation, provided that no extension can
be made earlier than five (5) years prior to the original or subsequent expiry date
unless there are justifiable reasons for an earlier extension.36
The corporation may virtually have a perpetual lifespan renewable every
fifty years. The limit of a fifty-year term emphasizes the contractual nature of the
corporation: people would be discourage to invest if it lasted forever;
management would theoretically be more honest—a renewal of the corporate
term would be a vote of confidence by the stockholders or members.
Benguet Consolidated Mining Co. v. Pineda,37 discussed the importance
of the corporate term as it is co-terminous with its possession of an independent
legal personality, distinct from that of its component members: "The State and
its officers also have an obvious interest in the term of life of associations, since
the conferment of juridical capacity upon them during such period is a privilege
that is derived from statute. . . And the State is naturally interest that this
privilege be enjoyed only under the conditions and not beyond the period that it
sees fit to grant; and, particularly, that it be not abused in fraud and to the
detriment of other parties; and for this reason it has been ruled that „the
limitation (of corporate existence) to a definite period is an exercise of control in
the interest of the public.‟"38

1. Commencement of Corporate Existence

Section 19 of the Corporation Code provides that a private corporation
commences to have corporate existence and juridical personality and is deemed
incorporated from the date the SEC issues a certificate of incorporation under its
official seal; and thereupon the incorporators, stockholders or members and
their successors shall constitute a body politic and corporate under the name

35
Villa Rey Transit, Inc. v. Far East Motor Corp., 81 SCRA 298 (1978).
36
Sec. 11, Corporation Code.
37
98 Phil. 711 (1956).
38
Ibid, at p. 719, citing Smith v. Eastwood Wire Manufacturing Co., 43 Atl. 568.
 15

stated in the articles of incorporation for the period of the time mentioned
therein, unless said period is extended or the corporation is sooner dissolved in
accordance with law.

INCORPORATING STOCKHOLDERS OR MEMBERS

Section 10 of the Corporation Code provides that any number of natural
persons not less than five (5) but not more fifteen (15), all of legal age and
majority of whom are residents of the Philippines, may form a private corporation
for any lawful purpose.
Only natural persons can be incorporators. However, the law does not
preclude corporations and partnership from becoming stockholders or members
as long as they are not incorporators.39 The issue has been raised before on
what is the need for legislating that incorporators must be natural persons, and it
was held then that:40

From this premise, it was easy to give vitality to the

ancestral abhorrence of corporations. Judges could not
imagine why a corporation which “has no soul to be
damned, and no body to be kicked” should be empowered
to incorporate other corporation. The strongest statement
of this fear is found in Schwab v. Potter Co. [194 N.Y. 409,
416] as follows: “‟Artificial persons,‟ without brain or body,
existing only on paper through legislative command and
incapable of thought or action except through natural
persons, can not create other ‟artificial persons,‟ and those,
others still, until the line is so extended and the capital
stock so duplicated and reduplicated, as to result in
confusion and fraud.' The logic is unassailable once the
premise is accepted. The “fiction" theory of corporate
personality invades this area of the law. This is hardly the
occasion to discuss a subject that has engaged the
attention of scholars and philosophers for many centuries
now. It is sufficient at this time to remark that the judges
have done a good job of confusing the means with the
ends. The problem of business life are better solved by
pragmatism or empiricism than by slavish loyalty to
concept formulations. Once we are cognizant that behind
the premise was the policy of inhibiting corporations, now
gone or nearly so, we shall no longer hesitate to substitute

39
Government of the Philippine Islands v. El Hogar Filipino, 50 Phil. 399, 460-461 (1929).
40
Navarro, Two Points of Reform of Philippine Corporation Law, 35 PHIL. L. J. 598. "Not
much light is shed by writers and court decisions on the policy of the doctrine as stated in the
beginning. Historically, if credence be given to Kyd, the spectacle of one corporation being inside
another would be nothing new." (at p. 682).
 16

a different premise and thus arrive at a contrary

conclusion.41

The same author posited that the power to hold stock in other
corporations was not conferred or implied under the old practice. The holding
company was impossible. It was against this background that courts also held
that corporations could not themselves be incorporators. And although
corporations are now generally empowered by general laws to own stocks in
other corporations, we still carry to this day a relic of the past. The principle we
are discussing, thus, draws support exclusively from the "fiction" theory of
corporate personality.42 The same author further said:

. . . Besides, the use of dummy incorporators is quite

general, for the law attaches little or no importance to
incorporators. Their function is extremely ceremonial. As
Fletcher says: "Corporators are mere instruments of the
law for purposes of preliminary organization. The moment
that is accomplished, the amount required as capital is
paid in, the necessary certificate signed, and the charter
granted, they are functi officio, or, more accurately, they
may then become stockholders. They exist before
stockholders come in, corporators cease to be."43

In practice, the SEC would allow the incorporation of a corporation which

would have as original stockholder in the articles of incorporation, as long as the
minimum number of individual incorporators appear. In one opinion, the SEC
has posited that both domestic and foreign corporations, if allowed by their
charters, may be initial subscribers to the capital stock of a corporation, but their
subscription will not be considered in the computation of the 25% requirement
for incorporation.44 The SEC also requires that the subscription of corporations
to the capital stock of a corporation in the process of incorporation be fully paid
due to their limited liability capacity;45 but after incorporation, corporations may
subscribe without having to fully pay their subscription under the premise that
the risk of insolvency no longer exist at that point.46
The Corporation Code maintains the requirement that at least five (5)
individuals must be incorporators of a corporation for perhaps a more practical
reason. Our jurisdiction recognizes the existence of promoter's contracts, or
contracts entered into on behalf of a corporation still in the process of
organization. Indeed, transactions may already be pursued with the parties

41
Ibid, at p. 683.
42
Ibid, at p. 684.
43
Ibid.
44
SEC Opinion, 23 May 1967, SEC FOLIO 1960-1976, at p. 284; Also, SEC Opinion, 14
November 1978.
45
SEC Opinion, 23 May 1967, SEC FOLIO 1960-1976, at p. 284.
46
SEC Opinion, 29 June 1976, SEC FOLIO 1960-1976, at p. 936.
 17

aware that the corporation is still under registration proceedings. If anything

goes wrong with the incorporation process, and there may have been liabilities
created at the time of incorporation, then the existence of five individual
incorporators allows the public or injured party to run after the persons who
cannot hide behind a corporate fiction or who can avail of limited liability
features. In addition, there must still indeed be individuals, who can be held
criminally liable, for acts done relating to incorporation process. Such remedies
would be unavailing or would be meaningless if the incorporators are
themselves juridical entities.
If only two incorporators are residents of the Philippines a corporation still
exists—a de facto corporation provided that at least five (5) incorporators must
sign the articles of incorporation.47 This however does not prevent the existence
of the so-called one-man corporation, where business is actually owned by one
individual, it is still possible for him to incorporate by giving nominal ownership of
only one share of stock to each of 4 other persons—this is not necessarily
illegal. There is no general requirement of Philippine citizenship only a majority
of the incorporators must be residents of the Philippines. However, there are
some areas of business and industry wherein ownership is reserved, wholly or
partially to Filipinos, e.g., public utilities (60%), retail trade (100%), exploitation
of natural resources (60%), advertising industry (70%), and mass media (100%).
An incorporator will always retain his status as the incorporator of the
corporation because such status is acquired by the mere fact of being one of the
persons who originally composed the corporation. He may cease to be a
stockholder or a member, he may lose all his rights and interest in the
corporation, but he will always be known as the incorporator. The articles of
incorporation cannot therefore be amended to delete the name of an
incorporator and substitute it with that of another, the latter not being an
incorporator.48

CAPITAL STRUCTURE AT REGISTRATION

The articles of incorporation must state the amount of its authorized
capital stock and the number of shares into which it is divided. Under Section 12
of the Corporation Code, stock corporation incorporated shall not be required to
have any minimum authorized capital stock except as otherwise specifically
provided for by special law, and provided that the paid-up capital cannot be
lower than P5,000.00.
In normal practice, SEC will not allow a corporation to be organized with
P5,000 minimum paid-up capital because it is too thinly capitalized. More likely
SEC would require a higher paid-up amount for incorporation. SEC can do this
because as an administrative body it can make rules.

47
SEC Opinion, 11 October 1971, SEC FOLIO 1960-1976, at p. 495.
48
SEC Opinion, 7 January 1974, VIII SEC QUARTERLY BULLETIN 21 ( No. I, Jan. 1974).
 18

Maximum capitalization is required to be indicated to protect the

stockholders—limits the issuance of the capital stock and extent of voting power
or capacity of a stockholder. The limitation of the maximum capitalization of the
corporation is also important in delineating the pre-emptive rights of
stockholders to future issuances of shares of stock.
The right of incorporation must not be confused with the ability of
operation. Our law, as amended, is not concerned with how much capital a
business corporation should have in its possession before it could lawfully
operate, except in certain kinds of private corporations like banks and insurance
companies. As held by one author, "except in corporations which directly affect
public interest, our law merely requires that 20% "of the entire number" of the
authorized shares must be subscribed and 25% of the subscription paid . . . But
certainly, the law could not require beforehand how much capital a private
corporation should have for its business, because this problem properly belongs
to the business judgment of those in charge of the management. . . Anyway, the
Corporation Law (Section 19) expressly provides that if an incorporated
corporation fails to organize itself and commence the operation of its business
within two years from the date of incorporation, then its corporate powers shall
cease. it is evidence therefore that the law is not particular about the minimum
amount of capital which every incorporated corporation must have for purposes
of operation. It merely fixes the minimum number of authorized shares to be
subscribed and paid for purposes of incorporation. That the general
incorporation law does not intend to fix the minimum amount of capital for
operational purposes is quite understandable, because this problem belongs
exclusively to the business judgment of the incorporators and the directors. . ."49

SUBSCRIPTION AND PAID-UP REQUIREMENTS

Section 13 of the Corporation Code provides that at least twenty-five
percent (25%) of the authorized capital stock as stated in the articles of
incorporation must be subscribed at the time of incorporation, and at least
twenty-five percent (25%) of the total subscription must be paid upon
subscription, the balance to be payable on a date or dates fixed in the contract
of subscription without need of call, or in the absence of a fixed date or dates,
upon call by the board of directors, provided that in no case shall the paid-up
capital be less than P5,000.00.
"Capital Stock" is the amount fixed in the articles of corporation procured
to be subscribed and paid-in. It is settled that shares issued in excess of the
authorized capital stocks are void.

49
Guevarra, The Right of Incorporation Under Philippine Incorporation Law, 33 PHIL. L.J.
349 (1958).
 19

"Outstanding Capital Stock" is the total shares of stock issued to

subscribers or stockholders, whether or not fully or partially paid (as long as
there is a binding subscription agreement), except treasury shares.50
"Subscribed Capital Stock" is that portion of the capital stock subscribed
(i.e., procured to be paid) whether or not fully paid.
"Subscription" is the mutual agreement of the corporation and subscriber
to take and pay for the stock a corporation.
According to one author,51 the weight of authority in the United States
supports the view that the purpose of the legislature in requiring a certain
percentage of the authorized capital stock to be subscribed before incorporation
is to give assurance to the public that may deal with the new corporation that it is
actually able to operate and undertake to do business and to meet obligations
as they arise from the start of its operation.
In a leading case in the Supreme Court of the United States, Burke v.
52
Smith, it was held that the purpose of such a requisition is, that the state may
be assured of the successful prosecution of the work, and that creditors of the
company may have, to the extent, at least, of the required subscription, the
means of obtaining satisfaction for their claims.
It was posited that it should be the policy of the law not to unduly restrict
the incorporation of business corporations; as long as the purpose is lawful, the
right to engage in legitimate business should not be unduly restrained. "It is not
within the contemplation of the general incorporation law to discourage
incorporation of business corporations with small capital. Fraud is not
necessarily associated with small capital. On the contrary, it is in big, moneyed
corporation where fraud could easily be committed through the adoption of
various corporate devices. In the absence of fraud in the incorporation of a
corporation, every legitimate business enterprise should be allowed to flourish to
promote the economic salvation of the country. Unless the law clearly and
unequivocably provides otherwise, and unless public policy clearly dictates to
the contrary, incorporation should be the rule rather than the exception."53

1. Issuance of Par Value Shares of Stock

"Par Value Share" is one in the certificate of stock of which appears an
amount in pesos as the nominal value of shares. Such par value must be stated
in the articles of incorporation and par share cannot be issued at less than such
par value, which can be changed only by an amendment of the articles of
incorporation.

50
Sec. 137, Corporation Code.
51
Guevarra, The Right of Incorporation under the Philippine Incorporation Law, 33 PHIL.
L.J. 349,350 (1958), quoting from SEC Order, dated 2 January 1958.
52
16 Wall., U.S. 390, 21 L. Ed. 361 (1873).
53
Guevarra, The Right of Incorporation Under the Philippine Incorporation Law, 33 PHIL.
L.J. 349, 357 (1958).
 20

If no par value shares will be issued by the corporation, such fact must be
stated in the articles, and the consideration of their issuance cannot be less than
the issued value, which in turn cannot be less than five pesos for each.
The consideration for which no-par value shares may be issued is
referred to as its "issued value," may be fixed in any of three ways:

(a) By the articles of incorporation;54

(b) By the board of directors when so authorized by
said articles or by the by-laws;55 or
(c) By the stockholders representing at least a
majority of the outstanding capital stock.56

Some corporations cannot issue no-par value shares: banks, public

utilities, insurance companies, building and loan associations.57 The reason
behind such a prohibition is there are certain businesses or activities vested with
public interests and proper accountability is served if nominal amounts are
assigned to their shares which would be the basis of their capital structure.

AMENDMENTS TO ARTICLES OF INCORPORATION

Section 16 of the Corporation Code provides that unless otherwise
prescribed by the Code or by special laws, and for legitimate purposes, any
provision or matter stated in the articles of incorporation may be amended by a
majority vote of the board of directors or trustees and the vote or written sent of
the stockholders representing at least two-thirds (2/3) of the outstanding capital
stock, without prejudice to the appraisal right of dissenting stockholders in
accordance with the provisions of this Code, or the vote or written assent of at
least two-thirds (2/3) of the members if it be a non-stock corporation.
The original and amended articles together shall contain all provisions
required by law to be set out in the articles of incorporation. Such articles, as
amended, shall be indicated by underscoring the change or changes made, and
a copy thereof duly certified under oath by the corporate secretary and a
majority of the directors or trustees stating the fact that said amendment or
amendments have been duly approved by the required vote of stockholders or
members, shall be submitted to the SEC.58
The amendments shall take effect upon their approval by the SEC, or in
case the SEC fails to act on the application, within six months from the date of
filing for a cause not attributable to the corporation.59

54
Sec. 62, Corporation Code.
55
Ibid.
56
Ibid.
57
Sec. 6, Corporation Code.
58
Sec. 16, Corporation Code.
59
Ibid.
 21

—oOo—

CORPORATION LAW\CORPMAN.DIR\07-29-2002
 CHAPTER 7

BY-LAWS

Legal Basis of Power to Adopt By-Laws

Contractual Significance of By-Laws
Requisites of Valid By-Laws
By-Law Provisions Cannot Contravene Law
By-Law Provisions Cannot Contravene the Charter
By-Law Provisions Must Be Reasonable and Cannot Discriminate
Procedure Adoption of By-Laws
Rule on By-Laws of Banks
Basic Contents of By-Laws
Matters Usually Found in By-Laws
Other Matter that May Be Included in By-Laws
Matters that May Be Found in Articles of Incorporation and By-Laws
Matters that Cannot Be Provided for in By-Laws
Amendments to By-Laws
Hierarchical Value of By-Laws

——

LEGAL BASIS OF POWER TO ADOPT BY-LAWS

Gokongwei, Jr. v. Securities and Exchange Commission,1 discussed the
existing theory on the power of a corporation to adopt and amend by-laws, which
is considered an inherent power of every corporation, thus:

It is recognized by all authorities that every corporation

has the inherent power to adopt by-laws "for its internal
government, and to regulate the conduct and prescribe the
rights and duties of its members towards itself and among
themselves in reference to the management of its affairs." At
common law, the rule was "that the power to make and adopt
by-laws was inherent in every corporation as one of its
necessary and inseparable legal incidents.” And it is settled
throughout the United States that in the absence of positive
legislative provisions limiting it, every private corporation has
this inherent power as one of its necessary and inseparable
legal incidents, independent of any specific enabling provision
in its charter or in general law, such power of self-government

1
89 SCRA 336 (1979).
 being essential to enable the corporation to accomplish the
purpose of its creation.2

CONTRACTUAL SIGNIFICANCE OF BY-LAWS

The contractual significance of by-laws in Corporate Law is discussed in
Chapter 5 on Corporate Contract Law, the provisions of which, unlike the articles
of incorporation, are meant to govern merely the internal affairs of the
corporation, and the relationship between and among the members of a
corporate family. Essentially, by-laws are intended merely for the protection of
the corporation, and prescribe regulation, not restrictions; they are always subject
to the charter of the corporation."3
One point of view is that since by-laws operate merely as internal rules
among the stockholders and corporate officers, they cannot affect nor prejudice
third persons who deal in good faith with the corporation, unless they have
knowledge of the same; and that strangers are not bound to know the by-laws of
a corporation which are merely provisions for the government of a corporation
and notice of them will not be presumed.
Under such theory, since by-law provisions are intramural in nature and
are not meant to bind parties outside the corporate family, it stands to reason that
the public dealing with the corporation is not supposed to be interested in the
provisions of the corporation's by-laws, and therefore should not be bound
thereby.
This was the doctrine implicitly applied by the Supreme Court in Fleischer
v. Botica Nolasco Co.,4 In that case Gonzales was the original owner of the 5
shares of stock of the Botica Nolasco, Inc., which he indorsed and delivered said
shares to plaintiff Henry Fleischer, in consideration of a large sum of money
owed by Gonzales to Fleischer. The secretary-treasurer of said corporation,
offered to buy from Henry Fleischer, on behalf of the corporation, said shares of
stock, at their par value of P100 a share, for P500 by virtue of article 12 of the by-
laws of Botica Nolasco, Inc., giving said corporation the preferential right to buy
from Gonzales said shares.
The plaintiff Fleischer refused to sell to the defendant and requested
corporate secretary to register said shares in his name, but the request was
refused by the corporate secretary contending that it would be in contravention of
the by-laws.

2
Ibid, at p. 365, citing McKee & Company v. First National Bank of San Diego, 265 F.Supp.
1 (1967), citing Olincy v. Merle Norman Cosmetics, Inc., 200 Cal. App. 20, 260, 19 Cal. Reptr.
387 (1962); and FLETCHER, CYCLOPEDIA CORPORATIONS.
3
Rural Bank of Salinas v. Court of Appeals, 210 SCRA 510 (1992), quoting from THOMSON
ON CORPORATIONS, Sec. 137.
4
47 Phil. 583 (1925).
 The Court declared void the by-law provision which granted to the
stockholders a right of first refusal over shares sought to be disposed by other
stockholders. In voting down the by-law provision, the Court relied upon the
provision of then Section 35 of the Corporation Law that provided that "shares of
stock so issued are personal property and may be transferred by delivery of the
certificate indorsed by the owners or his attorney in fact or other person legally
authorized to make the transfer." Under the doctrine that a corporation can adopt
by-law provisions only insofar as their are not inconsistent with any existing law,
the right of first refusal was deemed void. In supporting this contention, the Court
relied upon American rulings that "The power to enact by-laws restraining the
sale and transfer of stock must be found in the governing statute or the charter."
A careful review of the Court's reasoning in Fleischer shows an intent to
put by-laws in their proper hierarchical place, i.e., that it is not the function of by-
laws to take away or abridge the substantial rights of stockholders. However, the
same reasoning recognized that the same may be done either pursuant to a
statutory provision or in the articles of incorporation. This doctrine has remained
consistent with the provisions of Section 6 of the Corporation Code that requires
that any privilege or restriction pertaining to shares of stock should be found in
the articles of incorporation.
In addition, Fleischer seems to support the opinion that by-law provisions
are essentially intramural covenants and do not bind a dealing member of the
public, who had no knowledge of their provisions, thus:

And moreover, the by-law now in question cannot

have any effect on the appellee. He had no knowledge of
such by-law when the shares were assigned to him. He
obtained them in good faith and for a valuable
consideration. He was not a privy to the contract created
by said by-law between the shareholder Manual Gonzalez
and the Botica Nolasco, Inc. Said by-law cannot operate to
defeat his rights as a purchaser.5

However, as discussed previously, the decision in Peña v. Court of

Appeals,6 seems to negate this proposition on the non-binding character of by-
laws on third parties. In that case, the Supreme Court ruled that the "by-laws of a
corporation are its own private laws which substantially have the same effect as
the laws of the corporation. They are in effect, written into the charter. In this
sense they become part of the fundamental law of the corporation with which the
corporation and its directors and officers must comply," 7 and made binding upon
litigating parties who were not within the corporate family.
Loyola Grand Villas Homeowners (South) Association, Inc. v. Court of

5
Ibid, at p. 592.
6
193 SCRA 717 (1991).
7
Ibid, at p. 729, citing 8 FLETCHER CYC. CORP., Perm. Ed., pp. 750 - 751.
Appeals,8 holds that by-laws may be necessary for the “government” of the
corporation by they nevertheless are subordinate to the articles of incorporation,
as well as to the Corporation Code and related statutes. It acknowledged that
there are in fact cases where by-laws are unnecessary to corporate existence or
to the valid exercise of corporate powers. Thus —

As the “rules and regulations or private laws enacted by

the corporation to regulate, govern and control its own actions,
affairs and concerns and its stockholders or members and
directors and officers with relation thereto and among
themselves in their relation to it,” (8 FLETCHER
CYCLOPEDIA OF THE LAW OF PRIVATE CORPORATIONS,
at p. 633) by-laws are indispensable to corporation in this
jurisdiction. Although they may not be essential to corporate
birth but certainly, these are required by law for an orderly
governance and management of corporation. Nonetheless,
failure to file them within the period required by law by no
means tolls the automatic dissolution of a corporation.

Like in the immediately preceding chapter covering articles of

incorporation, the purpose of the present chapter is really to discuss more the
mechanical features of adopting and amending the by-laws of a corporation, and
to look into their basic provisions.

REQUISITES OF VALID BY-LAWS

The adoption and validity of by-law provisions are subject to well-defined
doctrines.

1. By-Law Provisions Cannot Contravene Law

Although the power of the corporation to adopt by-laws is an inherent
right, and it exist even without the law expressly granting such power,
nevertheless, Section 36 of the Corporation Code expressly enumerates as one
of the powers of a corporation, the power to adopt by-laws "not contrary to law,
morals or public policy." Jurisprudence has long before established that by-law
provisions cannot contravene the law.9
The corporation being a creature of the law, its by-law provisions cannot
prevail over legal provisions and the lawful court orders and processes. In Tayag
v. Benguet Consolidated, Inc.,10 the Supreme Court refused to apply the
provision of the by-laws of a domestic corporation on the issuance and
replacement of lost certificates of stock to overturn an order of a court of law for

8
276 SCRA 681, 85 SCAD 420 (1997).
9
Government of the Philippine Islands v. El Hogar Filipino, 50 Phil. 399 (1927).
10
26 SCRA 242, 248 (1968).
the corporation to issue new certificates of stock in lieu of those which were
physically outside of Philippine jurisdiction.
By way of illustration, in Government of Philippine Islands. v. El Hogar
Filipino,11 the by-laws provided that the board of directors of the association, by
the vote of an absolute majority of its members, is empowered to cancel shares
and to return to the owner thereof the balance of resulting from the liquidation
thereof whenever, by the reason of their conduct, or for any other motive, the
continuation as members of the owner of such share is not desirable." The Court
held that the by-law provision was a patent nullity, since "it is in direct conflict with
the latter part of Section 187 of the Corporation Law, which expressly declares
that the board of directors shall not have the power to force the surrender and
withdrawal of unmatured stock except in case of liquidation of the corporation or
forfeiture of the stock for delinquency."
In another case,12 a provision sought to be included in the by-laws
granting to a stockholder a permanent representation in the board of directors of
the corporation was held to be contrary to the provisions of the Corporation Code
requiring all members of the board to be elected by the stockholders or
members. The Court held that even when the members of the association may
have formally adopted the provision, their action would be of no avail because no
provision of the by-laws can be adopted if it is contrary to law.13
Reiterating the Fleischer ruling, in Thomson v. Court of Appeals,14 the
Court held that the authority granted to a corporation to regulate the transfer of its
stock does not empower the corporation to restrict the right of a stockholder to
transfer his shares, but merely authorizes the adoption of regulations as to the
formalities and procedure to be followed in effecting transfer.

2. By-Law Provisions Cannot Contravene the Charter

Under Section 47 of the Corporation Code, even specified provisions of
the by-laws are "subject to the provisions of the Constitution, this Code, other
special laws, and the articles of incorporation." That would mean that any
provision in the articles of incorporation to the contrary would supersede the
similar provision in the by-laws of a corporation. In other words, any provision in
the by-laws which contravenes the provision in the articles of incorporation must
give way to the article provision, even when the nature of the subject matter is
something that would normally find it provided in the by-laws rather than in the
articles of incorporation.

3. By-Laws Must Be Reasonable

and Cannot Discriminate

11
50 Phil. 399 (1927).
12
Grace Christian High School v. Court of Appeals, 281 SCRA 133, 88 SCAD 281 (1997).
13
Ibid.
14
298 SCRA 280, 100 SCAD 415 (1998).
 The validity or reasonableness of a by-law provision is a question of law,
and in such case the issue to be resolved would be whether a by-law provision
conflicts with a provision of law, or with the charter of the corporation; or is in the
legal sense unreasonable and therefore unlawful.15
This rule is subject to the limitation that "where the reasonableness of a
by-law is a mere matter of judgment, and one upon which reasonable minds
must necessarily differ, a court would not be warranted in substituting its
judgment instead of the judgment of those who are authorized to make by-laws
and who have exercised their authority."16
It should be noted that early on, the Supreme Court held that the
circumstance that one of the provisions contained in the by-laws of a corporation
is invalid as conflicting with the express provision of law is not a misdemeanor on
the part of the corporation for which the corporation can be penalized by the
forfeiture of its charter; the proper remedy is to render such offending provision
invalid and of no force and effect.17

PROCEDURE FOR ADOPTION OF BY-LAWS

Under Section 46 of the Corporation Code, every corporation must, within
one month after receipt of official notice of the issuance of its certificate of
incorporation by the SEC, adopt a code of by-laws for its government not
inconsistent with the Code.
Loyola Grand Villas Homeowner (South) Association, Inc. v. Court of
Appeals,18 holds that Section 46 of the Corporation Code, which provides that the
corporation “must” adopt a set of by-laws within one (1) month after receipt of
notice of the issuance of the certificate of incorporation by the SEC, reveals the
legislative intent to attach a directory, and not mandatory, meaning for the word
“must” in the first sentence thereof, since the second paragraph of the section
allows the filing of the by-laws even prior to incorporation. It necessarily follows
that failure to file the by-laws within that period does not imply “demise” of the
corporation, but merely constitutes a ground by which the SEC may seek
forfeiture of the franchise of the corporation as provided in Pres. Decree 902-A.
By-laws may also be adopted and filed prior to incorporation; in such case,
such by-laws shall be approved and signed by all the incorporators and
submitted to the SEC, together with the articles of incorporation.
For the adoption of by-laws, the affirmative vote of stockholders
representing at least a majority of the outstanding capital stock, or at least a
majority of the members in the case of non-stock corporations, shall be
necessary.19

15
Gokongwei v. Securities and Exchange Commission, 89 SCRA 336, 361-362 (1979).
16
Ibid, at pp. 361-362, citing People ex rel. Wildi v. Ittner, 165 Ill. App. 360, 367 (1911).
17
Government of the Philippine Islands v. El Hogar Filipino, 50 Phil. 399 (1927).
18
276 SCRA 681, 88 SCAD 420 (1997).
19
Sec. 46, Corporation Code.
 The by-laws shall be signed by the stockholders or members voting for
them and shall be kept in the principal office of the corporation, subject to the
inspection of the stockholders or members during office hours. A copy thereof,
duly certified to by a majority of the directors or trustees and countersigned by
the secretary of the corporation, shall be filed with the SEC which shall be
attached to the original articles of incorporation.20
In all cases, by-laws shall be effective only upon the issuance of the SEC
of a certification that the by-laws are not inconsistent with the Corporation
Code.21
The SEC shall not accept for filing the by-laws or any amendment thereto
of any bank, banking institution, building and loan association, trust company,
insurance company, public utility, educational institution, or other special
corporations governed by special laws, unless accompanied by a certificate of
the appropriate government agency to the effect that such by-laws or
amendments are in accordance with law. 22
The failure to adopt and file the by-laws do not automatically operate to
dissolve a corporation, but is considered a ground by which the SEC may seek
the corporation's dissolution.23 Under Section 6(l)(5) of Pres. Decree 902-A, the
SEC may suspend or revoke, after proper notice and hearing, the franchise or
certificate of registration of a corporation for its failure to file by-laws within the
period required by law.

RULE ON BY-LAWS OF BANKS

Under the General Banking Law of 2000, the SEC shall not register the
by-laws of any bank, or any amendment thereto, unless accompanied by a
certificate of authority from the BSP.24

BASIC CONTENTS OF BY-LAWS

1. Matters Usually Found in By-Laws
The following matters are the basic contents of by-laws as enumerated
under Section 47 of the Corporation Code:
(a) Time, place and manner of calling and conducting regular
and special meetings of directors or trustees; places for
meetings of directors or trustees may be outside the
Philippines if it so provided in the by-laws.

20
Ibid.
21
Ibid.
22
Ibid.
23
Chung Ka Bio v. Intermediate Appellate Court, 163 SCRA 534 (1988).
24
Sec. 14, Rep. Act 8791.
 (b) Time and manner of calling and conducting regular and
special meetings of the stockholders or members;25
(c) Required quorum in meetings of stockholders and the
manner of voting;
(d) Form for proxies of stockholders and members and manner
of voting;
(e) Qualifications, duties and compensation of
directors/trustees, officers, and employees;
(f) Time for holding annual election of directors or trustees,
mode and manner of giving notice thereto;
(g) Manner of election or appointment and the term of office of
all officers except directors or trustees;
(h) Penalties for violation of by-laws;
(i) Manner of issuing stock certificate; and
(j) Such other matters necessary for the proper means of
corporate business and affairs.

Although any and all the foregoing matters go into internal matters of the
corporation and rightly belong to the by-laws, the express provision of Section 7
of the Corporation Code implies, that if any of the above-enumerated matters are
also governed by the articles of incorporation, then the latter's provision shall
prevail.

2. Other Matters that May Be Included in By-Laws

Other matters which under the Corporation Code may be provided for in
the by-laws are as follows:

(a) Designation of time when voting rights may be exercised by

stockholders of record;26
(b) Providing for additional officers for the corporation;27
(c) Provisions for the compensation of the directors;28
(d) Creation of an executive committee;29

25
Under Sec. 51 of the Corporation Code, the place for meeting of stockholders or
members of a corporation can only be in the city of municipality where the principal office of the
corporation is located and if practicable in the principal office of the corporation. However, Metro
Manila is to be considered a city or municipality. Any provision in the by-laws changing such
place shall be illegal.
26
Sec. 24, Corporation Code.
27
Sec. 25. ibid.
28
Sec. 30. ibid.
 (e) Date of the annual meeting or provisions of special meetings
of the stockholders or members of the corporation;30
(f) Quorum on meetings of stockholders or members of the
corporation;31
(g) Providing for the presiding officer at meetings of the directors
or trustees, as well as of the stockholders or members;32
(h) Procedure for issuance of certificates of shares of stock;33
(i) Providing for interest on unpaid subscriptions;34
(j) Entries to be made in the stock and transfer book;35 and
(k) Providing for meetings of the members in a non-stock
corporation outside of the principal office of the
corporation.36

3. Matters That May Be Found in Articles

of Incorporation and By-Laws
In addition, the Corporation Code expressly allows certain matters to be
provided for either in the articles of incorporation or the by-laws of the
corporation, thus:

(a) Providing for cumulative voting in non-stock corporations;37

(b) Providing for a higher quorum requirement for a valid board
meeting;38
(c) Limiting, broadening or denial of the right to vote, including
voting by proxy, for members in non-stock corporations;39
(d) Transferability of membership in a non-stock corporations;40
(e) Termination of membership in non-stock corporations;41
(f) Manner of election and term of office of trustees and officers
in non-stock corporations;42

29
Sec. 35. ibid.
30
Secs. 50 and 53. ibid.
31
Sec. 52. ibid.
32
Sec. 54. ibid.
33
Sec. 63. ibid.
34
Sec. 66. ibid.
35
Sec. 74. ibid.
36
Sec. 93. ibid.
37
Sec. 24. ibid.
38
Sec. 25. ibid.
39
Sec. 89. ibid.
40
Sec. 90. ibid.
41
Sec. 91. ibid.
42
Sec. 92. ibid.
 (g) Manner of distribution of assets in non-stock corporations
upon dissolution;43 and
(h) Providing for staggered board in educational institutions;44

In a close corporation, restrictions on the right to transfer shares must

appear both in the articles of incorporation and in the by-laws, as well as in the
certificate of stock; otherwise, the restriction shall not be binding on any
purchaser thereof in good faith.45
It would seem from Peña v. Court of Appeals,46 that when the Code allows
certain matters to be provided for in either the articles of incorporation or by-laws,
then in the absence of conflict between the two documents, the enforceability of
such matters whether it be in the articles or by-law would be the same.
In Peña at issue was the provision in the by-laws which governed quorum
in special meeting of the board of directors. The Court held: "Under Section 25 of
the Corporation Code of the Philippines, the articles of incorporation or by-laws of
the corporation may fix a greater number than the majority of the number of
board members to constitute the quorum necessary for the valid transaction of
business. Any number less than the number provided in the articles or by-laws
therein cannot constitute a quorum and any act therein would not bind the
corporation; all that the attending directors could do is to adjourn."47

4. Matters That Cannot Be Provided for in By-Laws

On the other hand, under the provisions of the Corporation Code, the
following matters must be provided for in the articles of incorporation, and
consequently cannot be governed by the corporation's by-laws:

(a) Classification of shares of stock and preferences granted to

preferred shares;48
(b) Provisions on founder's shares;49
(c) Providing for redeemable shares;50
(d) Provisions on the purposes of the corporation;51
(e) Providing for the corporate term of existence;52
(f) Capitalization of stock corporations;53

43
Sec. 94. ibid.
44
Sec. 108. ibid.
45
Sec. 98. ibid.
46
193 SCRA 717 (1991).
47
Ibid, at p. 729, citing BALLANTINE, p. 130.
48
Sec. 6, Corporation Code.
49
Sec. 7, ibid.
50
Sec. 8, ibid.
51
Secs. 14, 15, 36(11) and 45, ibid.
52
Secs. 11, 14 and 37, ibid.
 (g) Corporate name;54 and
(h) Denial of pre-emptive rights;55

AMENDMENTS TO BY-LAWS
Under Section 48 of the Corporation Code, the board of directors or
trustees, by a majority vote thereof, and the owners of at least a majority of the
outstanding capital stock, or at least a majority of the members of a non-stock
corporation, at a regular or special meeting duly called for the purpose, may
amend or repeal any by-laws or adopt new by-laws.
The owner of two-thirds (2/3) of the outstanding capital stock, or two-thirds
(2/3) of the members in a non-stock corporation, may delegate to the board of
directors of trustees the power to amend or repeal any by-laws or adopt new by-
laws; provided, that any power delegated to the board of directors or trustees to
amend or repeal any by-laws or adopt new by-laws shall be considered revoked
when ever stockholders owning or representing a majority of the outstanding
capital stock or a majority of the members in non-stock corporation, shall so vote
at a regular or special meeting.56
Whenever any amendment or new by-laws are adopted, such amendment
or new by-laws shall be attached to the original by-laws in the office of the
corporation, and a copy thereof, duly certified under oath by the corporate
secretary and a majority of directors and trustees, shall be filed with the SEC the
same to be attached to the original articles of incorporation and original by-laws.
The amended or new by-laws shall only be effective upon the issuance by
the SEC of a certification that the same are not inconsistent with this Code.
The Supreme Court has held that the amendment of a by-law provision to
undermine the right to security of tenure of a regular employee of the corporation
cannot be allowed. In Salafranca v. Philamlife (Pamplona) Village Homeowners
Association, Inc.,57 it held:

Admittedly, the right to amend the by-laws lies solely in

the discretion of the employer, this being in the exercise of
management prerogative or business judgment. However this
right, extensive as it may be, cannot impair the obligation of
existing contracts or rights. . . A contrary interpretation would
no find justification in the laws or the Constitution. If we were
to rule otherwise, it would enable an employer to remove any
employee from his employment by the simple expediency of

53
Secs. 13 and 14, ibid..
54
Secs. 14 and 18, ibid..
55
Sec. 39, ibid..
56
Sec. 48, Corporation Code.
57
300 SCRA 469, 479 (1998).
 amending its by-laws and providing that his/her position shall
cease to exist upon the occurrence of a specified event.

HIERARCHICAL VALUE OF BY-LAWS

Although by-laws constitute the law binding on the corporation,
nevertheless it has its proper hierarchical place. Even when the by-laws provide
for a contrary rule from orders of a court, the court order will prevail. The Court
has held that "it would be a legal absurdity to impart to such a provision
conclusiveness and finality. Assuming that a contrariety exists between the
above by-law and the command of a court decree, the latter is to be followed. It
is understandable, as Cardozo pointed out, that the Constitution overrides a
statute, to which, however, the judiciary must yield deference, when appropriately
invoked and deemed applicable. It would be most highly unorthodox, however, if
a corporate by-law would be accorded such a high estate in the jural order that a
court must not only take not of it but yield to its alleged controlling force."58

—oOo—

CORP. MANUSCRIPT\07-BY-LAWS\07-29-2002

58
Tayag v. Benguet Consolidated, Inc., 26 SCRA 242, 252 (1968).
 CHAPTER 8

CORPORATE POWERS AND AUTHORITY

Underlying Theory on Corporate Powers
Effects of Underlying Contractual Theory on Exercise of Corporate Powers
Corporate Powers and Capacity
Express Powers
Incidental Powers
Implied or Necessary Powers
Application of Ultra Vires Doctrine to Powers of Corporation
Power to Extend or Shorten Corporate Term
Appraisal Rights Issues
Nature of Power
Need to Amend Articles of Incorporation
Power to Increase or Decrease Capital Stock
Nature of Power
Appraisal Right Issues
No Appraisal Right in Increase of Capital Stock
No Appraisal Right in Decrease of Capital Stock
Implied Policy under Section 38
Effectivity of Increase of Capital Stock
Special Rules on Listed Shares
Power to Incur, Create, or Increase Bonded Indebtedness
Nature of a Bond
Requirements of Corporation Code
Particular Requirements of SEC
Nature of the Power
Power to Sell, Lease, Dispose or Encumber Assets
Nature of Power
Nature of Transactions Covered
Transactions Not Covered by Ratificatory Vote Requirement
Sale or Disposition of All Corporate Assets or Property
Sale or Disposition of Substantially All Corporate Assets or Property
Bulk Sales Law
Consequences of Contracts Entered Into Without Requisites Stockholders' Approval
Appraisal Right
Power to Purchase Own Shares
When Power May Be Exercised
Need for Unrestricted Retained Earnings
Rationale Behind Rule
Redeemable Shares
Power to Invest Corporate Funds in Another Corporation or Business
Rationale of Rule
Coverage of “Funds” under Section 38
Investment that Should Be Considered Within Primary Purpose
Investments Outside of Secondary Purposes
Consequences of Non-Obtaining of Ratificatory Vote
Power to Declare Dividends
Retention of Surplus Profits
Report to SEC
Restrictions on Banks
Power to Enter into Management Contract
Coverage of “Management Contract”
Ratification Requirements When There Is Common Control
of Involved Corporations
Rationale for Ratification Requirements
On Part of Managed Company
On Part of Managing Company
Cases Not Covered by Section 44
Power to Make Donations
Power to Provide Gratuities to Employees
Power to Enter Into Partnership
Jurisprudential Rule
SEC Rules
Reportorial Requirements When Exercising Specific Powers

——

This chapter will discuss the underlying theories and characterizations of

corporate powers in general, and discussions of the mechanical or procedural
aspects of particular powers granted to or exercised by a corporation. Many of
the particular powers discussed herein are also covered in other chapters of the
book as they are relevant to particular topics or issues discussed therein.

UNDERLYING THEORY ON CORPORATE POWERS

Under the Corporation Code, the underlying doctrine on corporate powers
and capacity is covered by the theory of concession, which looks at a corporation
simply as a mere creature of, and completely within the control, of the State.
Section 2 of the Code defines a corporation as only having "the powers,
attributes and properties expressly authorized by law or incident to its existence."
The treatment of the corporation as a creature of limited and expressed
powers is also covered under the ultra vires doctrine, now expressly covered
under Section 45 of the Code which provides that “[n]o corporation . . . shall
possess or exercise any corporate powers except those conferred by this Code
or by its articles of incorporation and except such as are necessary or incidental
to the exercise of the powers so conferred.”
Under the ultra-vires doctrine, a corporation has only three (3) types of
powers which result in intra vires contracts or transactions: express, implied, or
incidental powers. Strictly speaking, any contract or transaction of the corporation
that does not fall into any of these powers, is ultra vires.1

1
See more in-depth discussions of the ultra vires doctrine in Chapter 5, Corporate Contract
Law.
EFFECTS OF UNDERLYING CONTRACTUAL THEORY
ON EXERCISE OF CORPORATE POWERS
The primary rule under Section 23 of the Corporation Code is that "unless
otherwise provided in" the Corporation Code, all corporate powers shall be
exercised, and all corporate business shall be conducted, by the board of
directors of the corporation. The source of power of the board of directors is
therefore primary, and is not a delegated power from the stockholders or
members of the corporation.
Nevertheless, there are specified instances in the Corporation Code,
where the particular exercise of power of the corporation by the board, in order to
be binding and effective, requires the consent or ratification of the stockholders
or members, and on the part of the State. When the consent of all members of
the corporate relationships, i.e., the corporation acting through its board, the
stockholders or members, and the State, is required to be obtained in order to
validate or give legal effect to a corporate power, that shows that in each of those
specified instances, the underlying contractual relationship is being amended or
altered, and therefore, the approval or consent of all the parties concerned must
be obtained.
The principle of corporate power being primarily vested in the board of a
corporation is therefore circumscribed by the greater doctrine of the underlying
corporate contractual relationship between and among the members of a
particular corporate family, in line with the principle in Contract Law, that a party
to a contract cannot relieve himself from the contractual terms and conditions,
much less amend or alter them, without the consent or approval of the other
party or parties.
In the case of the group of stockholders or members, as constituting a
"party" to the contractual corporate relationship, there is a need to determine how
their consent or dissent on a particular amendment or alteration of the tenets of
the relationship, is deemed to be expressed, since they constitute of several
individuals. As a “party-group”, their consent or dissent is recognized either by
their majority vote or qualified two-thirds (2/3) vote, as the case may be, and their
decisions generally affect even those who did not vote for, or voted against, the
wishes of the majority. However, even between and among the stockholders or
members, although for efficiency of running of corporate affairs the "rule of the
majority" has been adopted, the Code still recognizes in certain instances that
one who does not agree with the decision of the majority and whose contractual
expectations has either been frustrated or altered by the decision of the majority,
should be given the right not to have to stay within confines of the corporate
contractual relationship and is granted an option to withdraw from such
relationship, by the exercise of appraisal right.

CORPORATE POWERS AND CAPACITY

1. Express Powers
 Article 46 of the Civil Code of the Philippines provides that "[j]uridical
persons may acquire and possess property of all kinds, as well as incur
obligations and bring civil or criminal actions, in conformity with the laws and
regulations of their organization."
Section 36 of the Corporation Code expressly enumerates ten (10) powers
which corporations may exercise, namely:

(a) To sue and be sued in its corporate name;

(b) Power of succession by its corporate name for the period of
time stated in the articles of incorporation and the certificate
of incorporation;
(c) To adopt and use a corporate seal;
(d) To amend its articles of incorporation;
(e) To adopt by-laws, not contrary to law, morals, or public
policy, and to amend or repeal the same;
(f) In case of stock corporations, to issue or sell stocks to
subscribers and to sell treasury stocks; and to admit
members to the corporation if it be a non-stock corporation;
(g) To purchase, receive, take or grant, hold, convey, sell, lease,
pledge, mortgage and otherwise deal with such real and
personal property, including securities and bonds of other
corporations, as the transaction of the lawful business of the
corporation may reasonably and necessarily require;
(h) To enter into merger or consolidation with other
corporations;
(i) To make reasonable donations, including those for the public
welfare or for hospital, charitable, cultural, scientific, civic, or
similar purposes; provided that no corporation, domestic or
foreign, shall give donations in aid of any political party or
candidate or for purposes of partisan political activity; and
(j) To establish pension, retirement, and other plans for the
benefit of its directors, trustees, officers and employees.

The enumerated powers under Section 36 therefore are express powers

of corporations organized under the Corporation Code. Some of the powers
expressly granted under the section are considered to be inherent or incidental
powers, which means that even when not granted under the law expressly, such
incidental powers are deemed to be within the capacity of corporate entities,
such as the power to adopt and amend a set of by-laws.2

2
Gokongwei v. Securities and Exchange Commission, 89 SCRA 337 (1979).
 There are other express powers granted to corporations in other sections
of the Corporation Code. In addition to the express powers granted under the
Code, a corporation's other express powers are those provided for in its articles
of incorporation, as recognized under Section 45 of the Code.
The sources of express powers of a corporation are therefore those
provided for by law and those enumerated in its charter.
The Supreme Court has held that even in the exercise of express powers
of the corporation, in the absence of an authority from the board of directors, no
person, not even the officers of the corporation, can validly bind the corporation.
In one case, the Court has ruled that in the absence of any board resolution
authorizing the filing of a suit for the corporation, then any suit filed on behalf of
the corporation should be dismissed; the power of the corporation to sue and be
sued in any court is lodged with the board of directors that exercises its corporate
powers.3 The SEC has opined that investments of a corporation in another
corporation in the form of shares of stock constitute part of the assets or property
of the investor corporation, and cannot be legally disposed of by mere
endorsement of the President, since the such shares fall within disposition of
properties being part of the management powers of the board of directors. 4
It has also been held that as a rule, a corporation exercises its powers,
including the power to enter into contracts, through its board of directors; and that
while a corporation may appoint agents to enter into a contract in its behalf, the
agent should not exceed his authority.5

2. Incidental Powers
Incidental powers of the corporation, in addition to its express powers, are
recognized also under Section 2 of the Corporation Code which defines a
corporation as having "the powers, attributes and properties expressly authorized
by law or incident to its existence."
Powers incident to corporate existence are those that attach to a
corporation at the moment of its creation without regard to its express powers or
particular primary purpose, and may be said to be inherent in it as a legal entity
or a legal organization. These powers include the power to sue and be sued, to
grant and receive, in the corporate name; the power to purchase, hold, and
convey real and personal property for such purposes as are within the objects of
its creation; the power to have a corporate seal; the power to adopt and amend
by-laws for its government; and the power, in the proper cases, to disenfranchise
or remove members.
Powers that go into the very nature and extent of a corporation's juridical
entity cannot be presumed to be incidental or inherent powers. The juridical entity

3
Premium Marble Resources v. Court of Appeals, 264 SCRA 11, 76 SCAD 9 (1996); Bitong
v. Court of Appeals, 292 SCRA 503 (1998).
4
SEC Opinion, dated 21 August 1995, XXX SEC QUARTERLY BULLETIN 12 (No. 1, June
1996).
5
Assets Privatization Trust v. Court of Appeals, 300 SCRA 579, 101 SCAD 1028 (1998).
of a corporation is State-granted and cannot be altered or amended without State
authority. For example, the right of succession is not inherent or incidental power
of a corporation and does not exist by the fact that a corporation is granted a
juridical entity. The argument is that when the State grants to an aggregation of
individuals a separate juridical entity, such grant is specific and does not extend
to others not originally part of the group without a further grant by the State of the
power of succession. This is best demonstrated in the case of the partnership,
where, although a separate juridical entity is granted by law into the venture, no
power of succession is presumed to exist when a member of the group dies,
resigns or withdraws from the venture. In any event the power of succession is
expressly granted to corporations under Section 36 of the Corporation Code.
Another example would be the power to merge or consolidate with another
corporate entity. Such power cannot be implied to exist outside of State-grant
merely from the fact that a corporation has been granted juridical entity.
Corporations cannot, without State authorization, vary the composition of those
to whom it grants a juridical entities by merger or consolidation.

3. Implied or Necessary Powers

Section 36(11) of the Corporation Code provides that a corporation has
the power and capacity "[t]o exercise such other powers as may be essential or
necessary to carry out its purpose or purposes as stated in its articles of
incorporation." The sub-paragraph covers what are called the implied or
necessary powers of corporate entities, which exist as a necessary consequence
of the exercise of the express powers of the corporation or the pursuit of its
purposes as provided for in the articles of incorporation. The rule may thus be
stated that the management of a corporation, in absence of express restrictions,
has discretionary authority to enter into contracts or transactions which may be
deemed reasonably necessary or incidental to its business purposes.
To illustrate, the SEC has opined that a non-realty corporation has the
implied power to lease-out idle real property, ratiocinating that when the business
of the corporation is such as to render it necessary for it to own a certain kind of
property, and at times such property is not necessary to its business, it may
employ the property in a business or for a purpose which is not strictly within the
objects of its creation, in order to prevent the same from remaining idle and
unprofitable, provided it does not engage continually in such collateral
enterprise.6

4. Application of Ultra Vires Doctrine

to Powers of Corporation7
Montelibano v. Bacolod-Murcia Milling Co., Inc.,8 clarified the extent of the
application of the ultra vires doctrine on the implied or necessary powers of a
6
SEC OPINION, 9 NOVEMBER 1994, XXIX SEC QUARTERLY BULLETIN 2 (NO. 2, JUNE 1995),
CITING 16 FLECTHER SEC. 2535.
7
See Chapter 5 on Corporate Contract Law on more detailed discussions on ultra-vires
contracts.
corporation. At issue was the validity and binding effect on the corporation of an
amended milling contract that granted favorable terms to planters. Although the
favorable terms sought to be included in the amended milling contracts were
approved by the board of directors, it was interposed for the corporation that the
resolution was null and void ab initio, being in effect a donation since no
consideration was received for the favorable terms extended, and therefore was
ultra vires, beyond the powers of the corporate directors to adopt.
The Supreme Court upheld the authority of the board acting for the
corporation to modify the terms of the amended milling contract for the purpose
of making its terms more acceptable to the other contracting parties. It gave the
formula for determining the applicability of the ultra vires doctrine:

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.9

The test uses the rather stringent terms "direct and immediate" only with
reference to the business of the corporation; whereas, it uses the rather liberal
terms of "fairly incident" and "reasonably necessary" with reference to powers of
the corporation.
When the business of a corporation is used as the reference point, much
latitude is given to the corporation to enter into various contracts as long as they
have a logical relation to the pursuit of such business. In one early case, 10 the
Court upheld a purpose clause in the articles of incorporation which allowed the
corporation to engage in what were rather broadly worded activity as "mercantile
purposes." The Court construed that as meaning to "engage in such incidental
business as may be necessary and advisable to give effect to, and aid in, the
successful operation and conduct of the principal business."11
On the other hand, when the purpose clause of a corporation's articles of
incorporation has unwittingly used limiting words, such as describing its business
as "transportation by water," the Court will hold the corporation to such limited

8
5 SCRA 36 (1962).
9
Ibid, at p. 42 quoting 6 FLETCHER CYC. CORP., Rev. Ed. 1950, pp 266-268. Emphasis
supplied.
10
Uy Siuliong v. Director of Commerce and Industry, 40 Phil. 541 (1919).
11
Ibid, at p. 544.
business and will refuse to construe the same to allow the corporation to engage
in the land transportation business.12
As the Montelibano test showed, the attitude of courts towards corporate
acts and contracts which are not per se illegal or prohibited, is quite liberal. That
is because of two public policies, one in the realm of Contract Law, the other in
the realm of Corporate Law. The policies involving the ultra vires doctrine are
thoroughly discussed in Chapter 5 on Corporate Contract Law.

POWER TO EXTEND OR SHORTEN CORPORATE TERM

Under Section 37 of the Corporation Code, a private corporation may
extend or shorten its term of existence when approved by a majority vote of the
board of directors or trustees, and ratified at a meeting by the stockholders
representing at least two-thirds (2/3) of the outstanding capital stock or by at
least two-thirds (2/3) of the members in the case of non-stock corporations.
Written notice of the proposed action and of the time and place of the
meeting shall be addressed to each stockholder or member at his place of
residence as shown on the books of the corporation and deposited to the
addressee in the post office with postage prepaid, or served personally. 13

1. Appraisal Rights Issues

In case of extension of corporate term, any dissenting stockholder may
exercise his appraisal right to have his shares bought back at fair value by the
corporation.14 Nevertheless, under Section 81 of the Code, the appraisal right is
also available to a dissenting stockholder even when it covers the shortening of
the term of corporate existence.
The exercise of appraisal rights rightly belongs to a case of extension of
corporate term because extension actually novates the corporate contract with
each shareholder, which now seeks to extend the corporate relationship beyond
the original term provided for in the articles of incorporation.
The appraisal right should not be triggered when it comes to shortening of
corporate life, because there is really no violation of the original contractual intent
since, say if the dissenting stockholder had invested into the venture for say 50-
year corporate term, then he is presumed to be in it for a lesser period of time.
Therefore, the inclusion of the case of shortening of corporate life under Section
81 should not prevail over the specific provision under Section 37.

2. Nature of Power

12
Luneta Motor Company v. A.D. Santos, Inc., 5 SCRA 809 (1962).
13
Sec. 37, Corporation Code.
14
Ibid.
 The power to extend corporate life is not a inherent power of a
corporation, since the corporate term is not only a matter that constitutes an
integral clause of the articles of incorporation, but also the State in granting
juridical personality to a corporation is presumed to have granted only for the
period of time provided in the corporation's charter.
On the other hand, the power to shorten corporate life, although an item
that would cover an amendment of the articles of incorporation, is for practical
purposes, an inherent right on the part of the corporation, since the decision to
shorten the business life of a business endeavor should really be addressed to
the business decision of the business venturers. Although the State would have
to approve formally the shortening of the original corporate term of a corporation,
for all practical purposes, the State really compels the underlying enterprise to go
on when the co-venturers have decided to cease operations. This goes into the
aspect of dissolution, as in fact Section 120 of the Corporation Code now
expressly recognizes shortening of corporate life as a means of dissolving the
corporation.

3. Need to Amend Articles of Incorporation

In addition, aside from the procedural requirements provided under
Section 37 on the extension or shortening of corporate life, the exercise of either
such power affects the clause in the articles of incorporation providing for the
original corporate term of the entity, and therefore would involve the application
of the process of amending the articles of incorporation as provided in Section 16
of the Corporation Code.

POWER TO INCREASE OR DECREASE CAPITAL STOCK

Under Section 38 of the Corporation Code, no corporation shall increase
or decrease its capital stock unless approved by a majority vote of the board of
directors, and at a stockholders' meeting duly called for the purpose, approved by
stockholders owning or representing at least two-thirds (2/3) of the outstanding
capital stock.
Written notice of the proposed increase or diminution of the capital stock
must be addressed to each stockholder at his place of residence as shown on
the books of the corporation and deposited to the addressee in the post office
with postage prepaid, or served personally.15
A certificate in duplicate must signed by a majority of the directors of the
corporation and counter signed by setting forth;

(a) That the requirements of law on increasing or decreasing

capital stock have been complied with;

15
Sec. 38, Corporation Code.
 (b) The amount of the increase or diminution of the capital
stock;
(c) If an increase of the capital stock, the amount of capital stock
or number of shares of no-par stock thereof actually
subscribed, the names, nationalities and residences of the
persons subscribing, the amount of capital stock or number
of shares of no-par stock subscribed by each, and the
amount paid by each on his subscription in cash or property,
or the amount of capital stock or number of shares of no-par
stock allotted to each stockholder if such increase is for the
purpose of making effective stock dividend therefor
authorized;
(d) The actual indebtedness of the corporation on the day of the
meeting;
(e) The amount of stock represented at the meeting; and
(f) The vote authorizing the increase or diminution of the capital
stock, or the incurring, creating or increase of any bonded
indebtedness.16

Any increase or decrease in the capital stock shall require prior approval
of the SEC. The SEC shall not accept for filing any certificate of increase of
capital stock unless accompanied by the sworn statement of the treasurer of the
corporation showing that at least twenty-five percent (25%) of such increased
capital stock has been subscribed and that least twenty-five percent (25%) of the
amount subscribed has been paid either in actual cash to the corporation or that
there has been transferred to the corporation property the valuation of which is
equal to twenty-five percent (25%) of the subscription.17
More importantly, the section expressly provides that no decrease of the
capital stock shall be approved by the SEC, if its effect shall prejudice the rights
of the corporate creditors.18
From and after approval by the SEC and the issuance its certificate of
filing, the capital stock shall stand increased or decreased as the certificate of
filing may declare.19

1. Nature of Power
The power to increase or decrease capital stock is not an inherent power
of the corporation, not only because it touches upon an item expressly required
to be provided for in the articles of incorporation, but also the capital stock of a
corporation is governed by common law doctrines, such as the trust fund

16
Ibid.
17
Ibid.
18
Ibid.
19
Ibid.
doctrine, and pre-emptive rights. Therefore, in increasing or decreasing the
capital stock of the corporation, the corporation must not only comply with the
provisions of Section 38, but also with the provisions of Section 16 of the Code
governing the amendment of the articles of incorporation.
The formal procedures provided for in Section 38 clearly show that an
increase or decrease of the capital stock amends the underlying contractual
relationships between and among the members of the corporate family; which is
the reason for requiring the contractual parties to give their consent before the
exercise of such power can be validly implemented.

2. Appraisal Rights Issues

a. No Appraisal Right in Increase of Capital Stock

In the case of stockholders, an increase of the authorized capital stock
actually has the potential effect of diluting his proportionate interest in the
corporation. Even with the existence of the pre-emptive right to all stockholders in
case of increase of authorized capital stock (including those who dissented to the
measure), there is no guaranty that any stockholder can preserve his
proportional interests in the corporation since he might not have the personal
financial resources to exercise his pre-emptive right to the increase. And yet in
the case of dissenting stockholders, no right of appraisal is granted to them either
under Section 38 or Section 81 of the Code. The non-granting of appraisal right
to dissenting stockholders in case of increase of capital stock may be rationalized
on two (2) grounds.
Firstly, the increase is capital stock does not prevent any stockholder,
including a dissenting stockholder from opting out of the contractual relationship
by simply selling his shares in the corporation to any interested buyer. This is the
true with shares of publicly listed corporations; however, this is more theoretical
when it comes to shares of non-listed corporations, where there may be no
market for the shares to allow a dissenting stockholder to withdraw from the
corporate relationship.
On the other hand, the exercise of appraisal right when available affords
the dissenting stockholder to obtain the reasonable value of his shares. In
addition, if feature of free-transferability of shares of stock is the basis for not
granting the appraisal right in this case, then the appraisal right should not be
granted also in all other cases provided for in Section 81 of the Code, since also
in those cases, the dissenting stockholder theoretically has a way of getting-out
of the corporate set-up by selling his shares.
Secondly, the grant of appraisal right in case of increase of capital stock
would defeat the very purpose for which the power is exercised, i.e., to raise
funds for the operation or even survival of the corporate business. The reason
why a corporation would undertake to increase its capital stock is to raise the
working capital of the corporation, and if dissenting stockholders were granted
the appraisal right, then it would in fact dilute the attempted increase, since the
corporation would have to pay-out the fair value of the shares of the dissenting
stockholders. This seems to be the more rationale basis for the non-granting of
appraisal right in case of increase of capital stock.

b. No Appraisal Right in Decrease of Capital Stock

The decrease of the capital stock of a corporation should not trigger the
exercise of the appraisal right for precisely, the decrease of capital stock would
result in returning part of the investments of the stockholders, including those
stockholders who dissented.

c. Implied Policy under Section 38

The policy embodied in Section 38 of the Corporation Code therefore,
although it recognizes that an increase in authorized capital stock redefines the
contractual relations in the corporate setting as it requires the approval of
stockholders owning or representing two-thirds (2/3) of the outstanding capital
stock, does not include the appraisal right on the part of the dissenting
stockholders, in the sense that every stockholder should come into the corporate
setting fully aware that the expediencies of corporate life may require that
eventually the corporation may need to increase capitalization to fund its
operations or expansions, and needs to look primarily into its equity investors to
fund the same.

3. Effectivity of Increase in Capital Stock

Prior to SEC approval of the increase in the authorized capital stock of the
corporation, and despite the board resolution approving the increase in capital
stock, and the receipt of payment on the future issues of the shares from the
increased capital stock, such funds do not constitute part of the capital stock of
the corporation until approval of the increase by the SEC.
In Central Textile Mills, Inc. v. National Wages and Productivity
Commission,20 the Supreme Court held that: "These payments cannot as yet be
deemed part of the [corporation's] paid-up capital, technically speaking, because
its capital stock has not yet been legally increased. . . Such payments constitute
deposits on future subscriptions, money which the corporation will hold in trust for
the subscribers until it files a petition to increase its capitalization and a certificate
of filing of increase of capital stock is approved and issued by the SEC."

4. Special Rules on Listed Shares

The SEC Rules in the case of corporations whose securities are listed in
the stock exchange or registered under the then Revised Securities Act (now
covered by the Securities Regulation Code), is that no announcement of an offer
of rights to acquire share or to issue stock dividends to stockholders shall be
made after an increase of capital stock without a definite fixed date for the
exercise of such right or issuance of stock dividends. The rule is meant to avoid
20
260 SCRA 368, 73 SCAD 109 (1996).
delays in the issuance of rights or distribution of stock dividends after an increase
of capital stock.21

POWER TO INCUR, CREATE OR INCREASE BONDED INDEBTEDNESS

1. Nature of a Bond
The SEC Interim Guidelines for the Registration of Bonds22 define a
"bond" as a security "representing denominated units of indebtedness issued by
a corporation to raise money or capital obliging the issuer to pay the maturity
value at the end of a specified period which should be not less than 360 days,
and where applicable, payment of interest on stipulated dates." It also expressly
provides that bonds "secured by mortgage on specific corporate property shall be
created under Section 38 of the Corporation Code prior to registration" with the
SEC.
In one opinion,23 the SEC has limited the term "bonded indebtedness" to
cover only indebtedness of the corporation which are secured by mortgage on
real or personal property, as distinguished from "debentures" which are
unsecured corporate indebtedness. Debentures are issued on the basis of the
general credit of the corporation and are not secured by collaterals, and therefore
do not constitute bonded indebtedness and will not require approval of the
stockholders.24

2. Requirements of Corporation Code

Under Section 38 of the Corporation Code, no corporation shall incur,
create or increase any bonded indebtedness unless approved by a majority vote
of the board of directors, and at a stockholders' meeting duly called for the
purpose, two-thirds (2/3) of the outstanding capital stock shall favor the incurring,
creating or increasing of any bonded indebtedness. Non-stock corporations may
incur or create bonded indebtedness, or increase the same, with the approval by
a majority vote of the board of trustees and of at least two-thirds (2/3) of the
members in a meeting duly called for the purpose.25
Written notice of the proposed incurring, creating, or increasing of any
bonded indebtedness is to be considered, must be addressed to each
stockholder at his place of residence as shown on the books of the corporation
and deposited to the addressee in the post office with postage prepaid, or served
personally.26

21
Sec. 1, Rules Requiring Definite Dates for the Exercise of Pre-Emptive or Other Rights or
For the Issuance of Stock Dividends (1973).
22
XXII SEC QUARTERLY BULLETIN 92-96 (No. 1, March 1988).
23
SEC Opinion, 29 April 1987, XXI SEC QUARTERLY BULLETIN 21-22 (No. 3, Sept. 1987).
See also SEC Opinion, 6 April 1990, XXIV SEC QUARTERLY BULLETIN 28-29 (No. 3, Sept. 1990).
24
Ibid.
25
Sec. 38, Corporation Code.
26
Ibid.
 Any incurring, creating or increasing of bonded indebtedness shall require
prior approval of the SEC. The same requirements for registration with the SEC
for the increase or decrease of capital stock practically applies to the exercise by
the corporation of the power to incur, create or increase bonded indebtedness.
The SEC is expressly granted authority to determine the sufficiency of the terms
thereof.

3. Particular Requirements of SEC

Under the SEC Interim Guidelines, an application for the registration and
issuance of bonds can only be filed by the issuing corporation which has a
minimum net worth of P25.0 Million at the time of the filing of the application, and
must have been in operation for three (3) years. In addition, it must fulfill the
financial ratios mandated by the SEC in the Interim Guidelines.
Among the supporting documents specified by the SEC in the Interim
Guidelines, an issuing corporation must execute and submit a Trust Indenture
with a trustee bank and an Underwriting Agreement, together with the printed
prospectus and titles covering the securities for the bonded indebtedness.

4. Nature of Power
The power to incur or create liabilities is an inherent power on the part of
business corporations, since it is presumed that they would need to incur or
create liabilities as part of the normal operations of the business and the pursuit
of the purpose of the corporation. Such power is also part of the express powers
granted to all corporations organized under the Corporation Code, under Section
36 thereof.
Ordinarily, the incurring, creating or increasing of indebtedness really does
not go into or amend the corporate contractual relationship between and among
the members of the corporate family. However, when it comes to bonded
indebtedness, Section 38 imposes the same procedural requisites as the
increase or decrease of capital stock, since they create special burdens on the
corporation, such as the need to provide for a sinking fund to answer for the
maturity value of the bonds and the creation of first liens of important assets of
the corporation. Usually bonded indebtedness involve very large amounts and
the burdens created on the operations of the corporation usually covers a long
period of time.
The rationale for the rather strict requirements under the Code for the
incurring, creating or increasing of bonded indebtedness is to ensure that not
only the board of directors alone can bind the corporation to such burdensome
affairs, but that the qualified concurrence of the stockholders or members should
be obtained.
Note also that no appraisal right is granted to dissenting stockholders
when the corporation either validly incurs, creates or increases bonded
indebtedness since, the granting of such appraisal right under such
circumstances would drain the corporation of financial resources contrary to the
purpose for which the power is exercise to raise funds for corporate affairs. Also,
the incurring, creation or increasing of bonded indebtedness does not really go
into the original intent or corporate relationship of the stockholders or members
with the corporation. Even when such indebtedness is not bonded under the
principles of the trust fund doctrine, corporate creditors have priority over the
assets of the corporation; therefore, adding the feature of being a bonded
indebtedness did not really take anything from the position of the stockholders or
members that they would have had if the indebtedness were not a bonded
indebtedness.

POWER TO SELL, DISPOSE, LEASE OR ENCUMBER OF ASSETS

Under Section 40 of the Corporation Code, subject to the provisions of
existing laws on illegal combinations and monopolies, a corporation may, by a
majority vote of its board of directors or trustees, sell, lease, exchange,
mortgage, pledge or otherwise dispose "of all or substantially all of its property
and assets," including its goodwill, upon such terms and conditions and for such
consideration, which may be money, stocks, bonds or other instruments for the
payment of money or other property or consideration, as its board of directors or
trustees may deem expedient, when authorized by the vote of the stockholders
representing at least two-thirds (2/3) of the outstanding capital stock, or in case
of non-stock corporation, by the vote of at least to two-thirds (2/3) of the
members, in a stockholders' or members' meeting duly called for the purpose.
In non-stock corporations were there are no members with voting rights,
the vote of at least a majority of the trustees in office will be sufficient
authorization for the corporation to enter into any such transaction.
Written notice of the proposed action and of the time and place of the
meeting shall be addressed to each stockholder or member at his place of
residence as shown on the books of the corporation and deposited to the
addressee in the post office with postage prepaid, or served personally.27

1. Nature of Power
The exercise of the power to sell or dispose of all or substantially all of the
assets of the corporation is deem to undermine the contractual relationship of
two members of the corporate relationship, namely, the corporation acting
through its board on one hand, and the group of stockholders, on the other hand.
The exercise of such power does not really affect the relationship of the
corporation with the State, since it not only goes into the exercise of the business
judgment of the board of what best to do with the affairs of the corporation, but
more so since a corporation in such instance does not really lose its juridical
entity.
In other words, the exercise of such a power really affects the business
enterprise level of corporate set-up, an area much left by the State to the
27
Sec. 40, Corporation Code.
judgment of the managers, and does not in any way affect or alter the juridical
entity granted by the State. Consequently, nowhere is the consent of the State
required or referred to under Section 40 when the corporation sells or disposes of
all or substantially all of its assets.

2. Nature of Transactions Covered

The sale, disposition or encumbrance of all or substantially all of the
assets of the corporation does not render it empty, since the corporation is still
left with assets received in exchange, albeit cash or other forms of assets, and
neither does it change its primary purpose indicated in its articles of
incorporation. Section 40 specifically enumerates transactions which are onerous
contracts, as contrasted from gratuitous contracts, and therefore in each
instance, the corporation always receives something of equal value to what has
been sold, disposed or encumbered.
Theoretically, there is no change in the basic relationship between the
corporation and the stockholders, other than as if the corporation were again at
the starting point of it business life. The reason why a stockholders' ratification is
required when the board sells, disposes or encumbers all or substantially all of
the corporate assets is that it recognizes the stockholders right to the nature and
status of the corporate business, as well as future developments proceeding
therefrom, when they put their investments into the corporation. When the
corporation, through its board, attempts to alter or dispose of such level, even
when the corporation ends up with the same value covering the cash or other
form of consideration received for the sale or disposition, it must get the
confirmation of the stockholders.
One way of looking at it is that, since stockholders through their
investments directly suffer the risks of business failure for the current business of
the corporation, they deserve also all the profits and benefits that are likely to
proceed from such business, and the Board before it abandons such business,
must as a matter of fairness and equity get the conformity of the stockholders.

3. Transactions Not Covered by

Ratificatory Vote Requirement
Section 40 expressly provides that nothing therein is intended to restrict
the power of any corporation, without the authorization by the stockholders or
members, to sell, lease, exchange, mortgage, pledge or otherwise dispose of any
of its property and assets in any of the following circumstances:

(a) If it is necessary in the usual and regular course of

business of such corporation; or
(b) If the proceeds of the sale or other disposition of
such property and assets be appropriated for the
conduct of its remaining business.
 Under any of the two conditions, a sale, lease, exchange, mortgage,
pledge or disposition of property or asset is deemed to be within the business
judgment of the board of directors, and would not require stockholders' or
members' ratification.
It is important to consider that Section 40 does not deal with the primary
or secondary purposes of the corporation as provided for in its articles of
incorporation. The tests provided therein have to do with the "business
enterprise" of the corporation.
By way of illustration therefore, if a corporation decides to sell all of its
present business which is a losing venture, and with the proceeds still intends to
set-up anew and pursue the same business, the sale or disposition is still subject
to ratification by the stockholders or members, simply because such a
transaction is by its very nature an unusual or extraordinary transaction, which
requires stockholders' or members' approval. On an ordinary basis, business are
not sold entirely in order to start anew.
This position is bolstered by the use under Section 40 of the qualifying
phrases "in the usual and regular course of business of such corporation" and
"for the conduct of its remaining business."
To illustrate, Lopez Realty v. Fontecha,28 held that providing gratuity pay
for its employees is one of the express powers of a corporation under the
Corporation Code, and cannot be considered to be ultra vires to avoid any
liability arising from the issuance of resolution granting such gratuity pay. It held
that such resolution did not also require the ratification of the stockholders under
Section 40 of the Code Corporation because such provision is applicable to the
sale, lease, exchange or disposition of all or substantially all of the corporation's
assets, including its goodwill.

4. Sale or Disposition of All Corporate Assets or Property

The determination of a sale, disposition or encumbrance "of all" of the
corporate property or assets is a quantitative test, which when covered would
require the necessary stockholders' or members' approval.
Such a sale, disposition or encumbrance cannot be covered by the
exemption provided in Section 40 where no stockholders' or members' approval
is necessary because the sale of all of the assets or property of a business can
never be "in the usual and regular course of business of such corporation," nor
can it be argued that the proceeds of the sale or other disposition of such
property and assets be appropriated for the conduct of its remaining business,
since the sale or disposition of "all" assets or property means there is no
remaining business to conduct.

5. Sale or Disposition of Substantially All

the Corporate Assets or Property

28
247 SCRA 183, 192, 63 SCAD 494, 503 (1995).
 Section 40 likewise provides for a formula where the ratificatory vote of
stockholders or members is required in the sale, lease, mortgage, pledge or
disposition of "substantially all" of the property or assets by the corporation: A
sale or other disposition shall be deemed to cover substantially all the corporate
property and assets if thereby the corporation would be rendered incapable of:

(a) Continuing the business; or

(b) Accomplishing the purpose for which it was
incorporated.

Note that the foregoing formula is applicable only when determining

whether the sale or disposition is "substantially all of the corporate property and
assets," and has no application when the sale or disposition is "of all . . . of its
property and assets."
The test on whether a sale, disposition or encumbrance is substantial is a
qualitative, rather than a quantitative, test. This means that sale of one piece of
machinery, if it is essential in the continuation of the business, amounts to sale of
substantially all assets. Sale of several parcels of land, on the other hand, if not
disruptive of the corporation's business, is not a substantial sale of all corporation
assets. In the former, approval of qualified majority of the outstanding capital
stock is needed; in the latter, a mere board resolution would be sufficient.
However, unlike in the other tests provided under Section 40 which limit
themselves to the "business" of the corporation, the formula for sale or
disposition of "substantially all" corporate assets or property includes a test of
whether it would render the corporation incapable of accomplishing the "purpose
for which it was incorporated." The purpose of a corporation is found in its articles
of incorporation.
This particular test presents difficulties, since the sale of all or substantially
all of the assets or property of a corporation does not affect the purpose clause in
the articles of incorporation, and since the disposition in each case is onerous,
the corporation is always entitled to receive proceeds from the transaction by
which it is always in a position to start anew and pursue its corporate purpose
delineated in its articles of incorporation. The only time when this is clear is when
the purpose clause of the business is conditioned upon the corporation having a
valuable formula without which the purpose can no longer be practically
achieved. Strictly speaking therefore, a sale or disposition of substantially all of
the corporate asset or property, which by its nature always allows the corporation
to pursue its purpose, would never require stockholders' or members' approval.
Such a position would make the formula absurd. Therefore, the test is one of
practicality in being able to pursue the primary purpose of the corporation.
Since the formula of a sale or disposition of "substantially all" of the
corporate assets or property is a qualitative test, then it should stand to reason
that the test that the transaction renders the corporation incapable of pursuing its
purpose would be qualified by the intent of the corporation: if the intention is not
only to abandon the particular business but also to desist from pursuing the
purpose for which the corporation is registered, then even if financially the
corporation is still in a position to pursue its corporate purpose, the transaction is
covered by the need to get the ratificatory vote of the stockholders or members.
In addition, any disposition of corporate asset or property, even if it does not
involve all such corporate assets or property, which is not in the usual course of
business of the corporate, would be within the covered transactions under
Section 40 which would require stockholders' or members' approval, even when
practically the corporation as an entity is still capable of pursuing its charter
purpose.
Finally, the disposition of a line of business or department of the
corporation, when it does not prevent the corporation from pursuing the main
business for which it is organized would not seem to be covered by the
requirement under Section 40 requiring stockholders or members' ratificatory
vote.29

6. Bulk Sales Law

Aside from the requirements under Section 40, the sale of all or
substantially all of the corporate assets or property may require compliance with
the Bulk Sales Law,30 when the transaction falls within the classification of the
Law as "sale in bulk" and would require the seller to execute a sworn statement
listing the corporate creditors and the amount and nature of their claims, giving of
notice of the sale, and applying the proceeds of the sale proportionately to the
payment of the listed obligations.
Under the Bulk Sales Law, failure to comply with its requirements renders
the transaction void and fraudulent, irrespective of the intentions of the parties to
the transaction.31

7. Consequences of Contracts Entered Into

Without the Requisite Stockholders' Approval
Section 40 does not provide for the legal consequence to contracts or
transactions entered into by the corporation, through its board, without obtaining
the ratificatory votes of the stockholders or members.
What the section provides is that even when such ratification of the
stockholders or members is acquired, the board of directors or trustees may,
nevertheless, in its discretion, abandon such sale, lease, exchange, mortgage,

29
In one opinion, the SEC held that the disposition by the Forbes Park Association, Inc. of
its water system to MWSS, did not require the ratificatory vote of its members "on the assumption
that the water system constitutes merely a part of the assets of Forbes Park Association, Inc.,
such that the assignment thereof in favor of MWSS for such other property or consideration as
the board of directors may deem expedient will not render the Association incapable of continuing
the business or accomplishing the purpose for which it was incorporated." XXI SEC QUARTERLY
BULLETIN 6-7 (No. 1, March 1987).
30
Act No. 3952, as amended by Rep. Act No. 111.
31
For a more substantive discussions on the applicability of the Bulk Sales Law, see
Chapter 16, VILLANUEVA, LAW ON SALES, Rex Book Store, (1998 ed.).
pledge or other disposition of property and assets, subject to the rights of third
parties under any contract relating thereto, without further action or approval by
the stockholders or members.
Therefore, the entering into the sale, disposition or encumbrance of all or
substantially all of the assets of the corporation should be treated as being within
the governing doctrine of ultra vires contracts of the third type (i.e., those entered
into by unauthorized officers or representatives of the corporation) and should be
construed and disposed under the doctrine prevailing on such ultra vires
contracts.
Peña v. Court of Appeals,32 seems to indicate that the sale of the only asset
of the corporation made by the board without the appropriate stockholders’s
approval would render the contract void. Subsequently, in Islamic Directorate of
the Philippines v. Court of Appeals,33 the Supreme Court confirmed that the sale
by the board of trustees of the only property of the corporation without
compliance with the provisions of Section 40 of the Corporation Code requiring
the ratification of members representing at least two-thirds (2/3) of the
membership, would make the sale null and void.

8. Appraisal Right
Any dissenting stockholder may exercise his appraisal right in case of sale
of all or substantially all of the corporate assets or property. Unlike in the case of
shortening of corporate life which actually triggers a dissolution of the corporation
and return of the residual value of the corporation, if any, to the stockholders, the
sale or disposition of all or substantially all of the assets of the corporation does
not necessarily lead to dissolution. The exercise therefore of appraisal right
should be accorded to dissenting stockholders in such instance, otherwise, they
continue to be locked into a venture which no longer pursues, or is able to
pursue, the original purpose or objective for which dissenting investors made
their investments.
The appraisal right is accorded to dissenting stockholders as a matter of
equity and fairness since they should be allowed to plough their investments into
ventures they feel they could get a better return rather than with a corporation
that is no longer capable of pursuing the business.

POWER TO PURCHASE OWN SHARES

Under Section 41 of the Corporation Code, a stock corporation has the
power to purchase or acquire its own shares for a legitimate corporate purpose
or purposes, provided it has unrestricted retained earnings in its books to cover
the shares to be purchased. Shares of a corporation once purchased or acquired
by it become treasury shares.

32
193 SCRA 717, 730 (1991).
33
272 SCRA 454, 82 SCAD 618 (1997).
 1. When Power May Be Exercised
By way of illustration, the section enumerates the following as legitimate
corporation purposes for a stock corporation purchasing its own shares:

(a) To eliminate fractional shares arising out of stock dividends;

(b) To collect or compromise an indebtedness to the
corporation, arising out of unpaid subscription, in a
delinquency sale, and to purchase delinquent shares sold
during said sale; and
(c) To pay dissenting or withdrawing stockholders entitled to
payment for their shares in the exercise of their appraisal
rights.

The enumeration is by no means exclusive since other purposes, which

have legitimate business objectives, are acceptable to justify a stock corporation
purchasing or acquiring its own shares. Another reason why the corporation may
seek to increase its treasury shares is to decrease the cost of doing business,
especially where there are cumulative preferred shares, by decreasing the
amount of dividends which will have to be paid in the future. The whole
procedure is favored during depression as a contraction device.34

2. Need For Unrestricted Retained Earnings

Section 41 requires that the corporation must have unrestricted retained
earnings in its books to cover the shares to be purchased or acquired. The
reason for this limitation is that the repurchase of shares, like the distribution of
dividends, is a method of distribution or withdrawal of assets, and may be subject
to abuse. In fact, Steinberg v. Velasco,35 held that the creditors of a corporation
have the right to assume that so long as there are debts and liabilities, the board
of directors of the corporation will not use its assets to purchase its own stock or
to declare dividends to its stockholders when the corporation is insolvent.
Therefore a specific provision to expressly empower a corporation to
acquire its own shares was provided for in the Corporation Code because of the
conflicting issues on such power, involving the trust fund doctrine and abuse of
corporate management.

3. Rationale Behind the Rule

One writer,36 has observed that the policy of the law as to protection of
capital is not consistently carried out and that many abuses are made possible by
the unrestricted use of such a power; such power has been branded as a fruitful
source of unfairness, mismanagement and corruption, while others see through

34
Salonga, The Purchase by a Corporation of Its Own Shares, 27 PHIL. L.J. 686-687 (1952).
35
52 Phil. 953 (1929).
36
Salonga, The Purchase by a Corporation of Its Own Shares, 27 PHIL. L.J. 686-687 (1952).
the use of such power a method for secret withdrawal and distribution of the
current assets of the corporation which may be needed in the business, or a
means of speculating with corporate funds.
He also observed that treasury stock may also be availed of to perpetuate
control of the enterprise without the expensive requisite of a majority of voting
stock. Since treasury stock cannot be voted, by using corporate funds to
purchase the majority shares and retire it from the voting arena, what was before
a minority in the controlling group can be converted into a majority and their
control may thereby be continued indefinitely.37
A detailed discussion of the power as it applies under the trust fund
doctrine is found in Chapter 12, Capital Structures of Corporations.

4. Redeemable Shares
Under Section 8 of the Corporation Code, in the case of redeemable
shares, the same may be acquired or redeemed by the corporation even without
existence of unrestricted retained earnings. The redemption of redeemable
shares in the absence of unrestricted retained earnings does not prejudice
corporate creditors.
Redeemable shares can only be provided when they are so classified and
they are indicated as such in the articles of incorporation. When the corporate
creditors decide to extend credit to the corporation, they would or should know
for a fact that the corporation has issued redeemable shares.

POWER TO INVEST CORPORATE FUNDS IN ANOTHER

CORPORATION OR BUSINESS
Under Section 42 of the Corporation Code, a corporation may invest its
fund in any other corporation or business or for any purpose other than the
primary purpose for which it was organized when approved by a majority of the
board of directors or trustees and ratified by the stockholders representing at
least two-thirds (2/3) of the outstanding capital stock, or by at least two-thirds
(2/3) of the members in the case of non-stock corporations, at a stockholders' or
members' meeting duly called for the purpose.
Written notice of the proposed investment and the time and place of the
meeting shall be addressed to each stockholder or member at his place of
residence as shown on the books of the corporation and deposited to the
addressee in the post office with postage prepaid, or served personally. 38

1. Rationale of Rule

37
Salonga, ibid at pp. 686, 689.
38
Sec. 43, Corporation Code.
 When a corporation, through its board, invests funds in another
corporation or business other than pursuant to its primary purpose, even if it
seeks to pursue a secondary purpose provided for in the articles of incorporation,
the ratification of the stockholder or members under Section 42 is still required. In
other words, whenever the corporation seeks to engage into a secondary
purpose allowed under its articles of incorporation, although intra vires, it must
seek the approval of the stockholders or members of the corporation.
The law therefore presumes rather strongly that when stockholders invest,
or members join, a corporation, it is with the primary expectation that the
corporation, through its board, will only pursue the primary purpose indicated in
the articles of incorporation, and if the board feels that it is propitious to pursue a
secondary purpose, then it would do so only if the stockholders or members have
had a chance to evaluate and decide upon such diversion of corporate funds
from the primary business of the corporation.

2. Coverage of “Funds” under Section 42

The SEC has ruled that the term “funds” under Section 42 includes any
corporate property to be used in the furtherance of the business, and
consequently when property is devoted in any business other that pursuit of the
primary purpose for which the corporation was incorporated, it would need the
ratificatory vote of two-thirds (2/3) of the outstanding capital stock of the
corporation.39

3. Investments that Should Be Considered

Within Primary Purpose
Section 42 expressly provides that where the investment by the
corporation is reasonably necessary to accomplish its primary purpose as stated
in the articles of incorporation, the approval of the stockholders or members shall
not be necessary, since the matter lies clearly within the business discretion or
judgment of the board of directors of the corporation.
There are certain investments of the corporation that would be deemed
consistent with the primary purpose by virtue of the essence of the corporation as
a business enterprise.
All corporations, whatever may be their primary purposes, are deemed to
have the power to invest corporate funds in another corporation or business, as a
means of obtaining the best returns of their investible funds. For example, when
a corporation has investible cash that it does not need in its operations, say
P500,000.00, then the board, as prudent businessmen, must ensure that the
amount is placed in the best form of investment to allow the corporation the
ability to liquidate easily when it needs it in its operation, but in the meantime
allows the best returns to the corporation.

39
XXIX SEC QUARTERLY BULLETIN 2 (No. 2, June 1995).
 Therefore, any corporation, whatever its primary purpose, has a choice of
placing such fund either in a savings or time deposit account, or in money market
placements, or treasury bills, or even in shares of stocks of other corporations
which are traded in the stock exchange. The exercise of such business judgment
on the part of the board in consistent with the primary purpose, since it is
expected even from the stockholders to believe, that it is within the ordinary
business discretion of the board to place the corporation's investible fund in the
form of investment that would yield the best possible return to the corporation,
and would not require the ratification of the stockholder or members each time.
For example, a fishing company, through its board, should be allowed to place
say its investible fund of P100,000.00 in PLDT or San Miguel commercial papers
or even perhaps their shares, if they offer the best return at that point in time for
the corporation, without need of obtaining stockholders' approval; much less
should such investments trigger any appraisal right on the part of dissenting
stockholders.

4. Investments Outside of Secondary Purposes

Investments by the corporation in a business or activity within the
secondary purposes of the corporation, are definitely covered by Section 42
which requires the ratificatory vote of stockholders or members to be valid.
The issue then would follow that since Section 42 requires the
stockholders' or members' ratificatory vote for investments "other than the
primary purpose for which it was organized," and does not expressly limit such
investment to any other purpose provided for in the corporation's articles, would
the corporation then be legally allowed to invest in another corporation or
business beyond its primary purpose and secondary purposes provided that
ratificatory vote of its stockholders or members can be obtained?
If one where to limit the review to the wordings of Section 42, the answer
would seem to be in the affirmative. However, the terms of Section 42 are
deemed to be circumscribed by the provisions of Sections 36 and 45 of the
Corporation Code. Section 36, after enumerating express powers of
corporations, provides an all-encompassing clause that a corporation may
exercise such other powers as may be essential or necessary to carry out its
purpose or purposes "as stated in its articles of incorporation." Section 45
provides expressly that no corporation shall possess or exercise any corporate
power except those conferred by the Corporation Code, or by its articles of
incorporation. Under such terms, the ratificatory vote of stockholders or members
to legally allow a corporation to invest funds outside of its primary purpose (and
those which are necessary or incidental to the exercise of such purpose), would
be limited to pursuing the secondary purposes of the corporation.

5. Consequences of Non-Obtaining of Ratificatory Vote

Section 42 does not indicate the legal consequences on contracts and
transactions entered into in violation of its provision. The non-obtaining of the
ratificatory vote of the stockholders or members under Section 42 of the Code
should be construed to be within the realm of ultra vires contracts of the third
type, having been entered into by representatives of the corporation not duly
authorized.

POWER TO DECLARE DIVIDENDS

Under Section 43 of the Corporation Code, the Board of Directors of a
stock corporation may declare dividends out of the restricted retained earnings
which shall be payable in cash, in property, or in stock to all stockholders on the
basis of outstanding capital stock held by them. However, any cash dividends
due on delinquent stock shall be first be applied to the unpaid balance on the
subscription, plus costs and expenses, while stock dividends shall be withheld
from the delinquent stockholder until his unpaid subscription is fully paid.
No stock dividend shall be issued without the approval of stockholders
representing not less than two-thirds (2/3) of the outstanding capital stock at a
regular or special meeting duly called for the purpose.40
Dividends may be distributed only to stockholders of the corporation
declaring the dividend. In Nielson & Co., Inc. v. Lepanto Consolidated Mining
Co.,41 Lepanto contended that the payment to Nielson of stock dividends as
compensation for its services under their management contract is a violation of
the then Corporation Law and that it was not, and it could not be, the intention of
the parties that the services of Nielson should be paid in shares of stock taken
out of stock dividends declared by Lepanto. The Court held that stock dividends
cannot be issued to a person who is not a stockholder in payment of services
rendered. The remedy was to have Lepanto pay for the value of the shares of
stock.

1. Retention of Surplus Profits

Section 43 prohibits stock corporations from retaining surplus profits in
excess of one-hundred percent (100%) of their paid-up capital stock,42 except in
the following situations:

(a) When justified by definite corporate expansion projects or

programs approved by the board of directors;43

40
Sec. 43, Corporation Code.
41
26 SCRA 540 (1968).
42
Even under the old Corporation Law, the SEC had issued the Rules Governing the
Distribution of Excess Profits of Corporations (1973), which provides that "All corporations which
have surplus profits in excess of necessary requirements for capital expansion and reserves shall
declare and distribute the excess profits as dividends to stockholders.” (Sec. 1)
43
SEC RULES GOVERNING THE DISTRIBUTION OF EXCESS PROFITS OF CORPORATIONS provides
that the amounts appropriated for such purpose shall be segregated from the free surplus; and
that upon completion of the expansion program, the reserve established shall be declared as
stock dividends.
 (b) When the corporation is prohibited under any loan
agreement with any financial institution or creditor, whether
local or foreign, from declaring dividends without its/his
consent, and such consent has not yet been secured; or
(c) When it can be clearly shown that such retention is
necessary under special circumstances obtaining in the
corporation, such as when there is need for special reserve
for probable contingencies.44

Under the SEC Rules Governing the Distribution of Excess Profits of

Corporations, where the financial statements of the corporation show surplus
profits in excess of 100% of paid-up capital, it shall explain by footnotes why the
same has not been declared as dividends; if the explanation is not satisfactory,
the SEC shall direct the corporation to distribute the excess as dividends.45
The power granted to stockholders to demand from the Board the
declaration of dividends under Section 43 is one of the few instances under the
Code where the stockholders themselves exercise a primary power, instead of
the usual ratificatory vote on actions taken primarily by the board of directors.

2. Report to SEC
Any declaration of dividends, whether cash or stock, shall be reported to
the SEC within fifteen (15) days from the date of declaration. For corporations
whose shares or securities are listed in the stock exchange or registered and
licensed under the Revised Securities Act (now the Securities Regulation Code),
the report shall be filed with the SEC before or simultaneously with the release or
publication of the notice of declaration of dividends to stockholders.46

3. Restrictions on Banks
Under Section 57 of the General Banking Law of 2000,47 no bank or quasi-
bank shall declare dividends greater than its accumulated net profits then on
hand deducting therefrom its losses and bad debts. Neither shall the bank or
quasi-bank declare dividends, if at the time of declaration:

(a) Its clearing account with the Bangko Sentral is overdrawn;

(b) It is deficient in the required liquidity floor for government
deposits for five (5) or more consecutive days;
(c) It does not comply with the liquidity standards/ratios
44
SEC RULES GOVERNING THE DISTRIBUTION OF EXCESS PROFITS OF CORPORATIONS includes
as justification for non-declaration of dividends when the same is consistent with policy or
requirements of a government office.
45
Sec. 2 thereof.
46
Sec. 3, SEC RULES GOVERNING THE DISTRIBUTION OF EXCESS PROFITS OF CORPORATIONS
(1973)
47
Rep. Act 8791.
 prescribed by the Bangko Sentral for purposes of
determining funds available for dividend declaration; or
(d) It has committed a major violation as may be determined by
the Bangko Sentral.

POWER TO ENTER INTO MANAGEMENT CONTRACT

Section 44 of the Corporation Code provides that no corporation shall
conclude a management contract with another corporation, unless such contract
shall have been approved by the board of directors and by stockholders owning
at least the majority of the outstanding capital stock, or by at least a majority of
the members in the case of a non-stock corporation, of both the managing and
the managed corporation, at a meeting duly called for the purpose.
No management contract shall be entered into for a period longer than five
(5) years for any one term.48

1. Coverage of “Management Contract”

The rules apply to any contract whereby a corporation undertakes to
manage or operate all or substantially all of the business of another corporation,
whether such contracts are called service contracts, operating agreements, or
otherwise.49 However, such service contracts or operating agreements which
relate to the exploration, development, exploitation or utilization of natural
resources may be entered into for such periods as may be provided by the
pertinent laws or regulations.50

2. Ratification Requirements When There

Is Common Control of Involved Corporations
Section 44 provides a special ratification rule, where:

(a) a stockholder or stockholders representing the same interest

of both the managing and the managed corporations own or
control more than one-third (1/3) of the total outstanding
capital stock entitled to vote of the managing corporation; or
(b) where a majority of the members of the board of directors of
the managing corporation also constitute a majority of the
members of the board of directors of the managed
corporation;

then the management contract must be approved by the stockholders of the

managed corporation owning at least two-thirds (2/3) of the total outstanding
48
Sec. 44, Corporation Code.
49
Sec. 44, Corporation Code.
50
Ibid.
capital stock entitled to vote, or by at least two-thirds (2/3) of the members in the
case of a non-stock corporation.

3. Rationale for Ratification Requirements

a. On Part of Managed Corporation
The rationale for the ratificatory requirement under Section 44 of the
managed corporation is that such a management contract is a deviation from the
principle under Section 23 that the corporate affairs shall be managed by the
board of directors, and thereby a departure from such an arrangement would
require the approval of the stockholders under the principle that it would vary the
contractual corporate arrangements, by allowing basically an outsider to involve
itself in the management of corporate affairs.

b. On Part of Managing Corporation

On the other hand, the rationale for ratificatory measures on the part of the
managing corporation is that the management arrangement is a deviation from
the principle also that the board of directors in the managing corporation
assumed office with the understanding that they would devote their time and
resources for the affairs of the corporation, and the entering into the
management contract whereby the board, as the direct agents of the managing
corporation, would be devoting their time and resources towards the operations
of another corporation, would be a deviation from such a contractual relationship,
and thereby would require the confirmation of the stockholders of the managing
corporation.
Under these principles, the ratificatory procedure should not therefore be
applicable to a corporation that is organized primarily as a management
company, and its entering into a management contract is clearly within the
primary purpose of the corporation and in accordance with the contractual
understanding with the stockholders of such managing corporation.

4. Cases Not Covered by Section 44

It would seem from the express language of Section 44, that when it
comes to a management contract entered into by the managed corporation under
the definition of Section 44, not with another corporation but with a partnership or
an individual, the same would not be covered by and thereby need not comply
with the ratificatory requirements of Section 44.
This is easier explained on the side of the managing person, since being a
principal himself, it need not get the confirmation of anybody to start managing
the affairs of the managed corporation. To a great extent, this also explains the
rationale for the ratificatory requirements under Section 44 for the managing
corporation: since the management contract will be entered into by an agent, i.e.,
the board of directors who are really only agents of the managing corporation,
there is a need to get to the bottom of the principal (i.e., managing corporation)
by getting a confirmation of the management contract from the owners of the
principal, that is, the stockholders.
It is more difficult to explain why when a corporation enters into a
management contract with an individual, the ratificatory requirements under
Section 44 are not applicable, other than saying that Section 44 has failed to
provide or cover such situation.
Perhaps, the lack or non-coverage by Section 44 of such a situation when
the board of the managed corporation transfers the management thereof to an
individual can best be glimpsed by the fact that it is not mandated under Section
23 of the Code, which grant to the board corporate powers, that the board must
always exercise such corporate powers directly, In other words, the board has
power and authority to appoint an agent or representative to discharge the
powers of the board, and this is best exemplified by the appointment of the
officers and the management to run the day-to-day affairs of the corporation.
Such officers are merely agents of the board of directors, and their act is still the
act of their principal source of corporate power, the board. Under such a setting,
it cannot be argued that the board has in fact and in law abandoned the
management of the corporation to others.
In the same vein, when the board therefore appoints, through a
management contract, an outsider to manage the affairs of the corporation, such
outsider really discharges his duties as an agent and under the control of the
board. On the other hand, when the manager under the management contract is
a corporation, a special ratificatory procedure is required since the board of the
managing corporation is not actually turning over the affairs of the corporation to
the direct party thereto, the managing corporation, since the latter is only a
fiction, and the contract is actually to be done and executed by the representative
thereof, which is the board of directors of the managing corporation, who in turn
would probably have to assign the greater part of management to officers who
will run the day-to-day affairs of the corporation. Therefore, the performance and
execution of a management contract by a corporation with another corporation is
actually a multi-tiered affair, and actually done by people who have no direct
contractual relationship with the managed corporation (unlike in a management
contract with an individual where the manager himself has a direct contractual
relationship and obligation to the managed corporation). Such a long-winded
affair therefore would need the special ratificatory feature mandated under
Section 44 of the Code.
To a great extent, this argument of underlying ownership and control of
the managing corporation is recognized under Section 44 which requires a two-
thirds (2/3) ratificatory act when the stockholders of the managing corporation
own more than one-third (1/3) of the outstanding capital stock of the managed
corporation, and there is great tendency for conflict of interests to come in, to the
detriment of the managed corporation.
POWER TO MAKE DONATIONS
Section 36(9) of the Corporation Code authorizes corporations to "make
reasonable donations, including those for the public welfare or for hospital,
charitable, cultural, scientific, civic, or similar purposes; provided that no
corporation, domestic or foreign, shall give donations in aid of any political party
or candidate or for purposes of partisan political activity. The power to make
donations is circumscribed by the necessity that such donations must be
"reasonable".
The grant to corporations in general under the Corporation Code of the
express power to make reasonable donations has done away with the old issue
on whether such gratuitous exercise contravened the essential nature of for-profit
corporations and would constitute ultra vires acts.

POWER TO GRANT GRATUITIES TO EMPLOYEES

Under Section 36(10) of the Corporation Code, a corporation has
expressed power to establish pension, retirement, and other plans for the
benefits of its directors, trustees, officers and employees.
In Lopez Realty v. Fontecha,51 the Supreme Court held that providing
gratuity pay for its employees is one of the express powers of a corporation
under the Corporation Code, and cannot be considered to be ultra vires to avoid
any liability arising from the issuance of resolution granting such gratuity pay.
Such resolution does not also require the ratification of the stockholders under
Section 40 of the Code Corporation because such provision is applicable to the
sale, lease, exchange or disposition of all or substantially all of the corporation's
assets, including its goodwill.
The grant to corporations in general of the express power to establish
pension, retirement and other plans for employees has rendered moot the old
issue on whether it was consistent with the for-profit nature for a corporation,
through its board of directors, to extend gratuities to employees which would be
effective after they have ceased employment with the corporation, and would
therefore constitute an act of donation. 52

POWER TO ENTER INTO PARTNERSHIP

The prevailing rule in the United States is that "unless it is expressly
authorized by statute or charter, a corporation cannot ordinarily enter into
partnerships with other corporations or with individuals, for, in entering into a
partnership, the identity of the corporation is lost or merged with that of another
and the direction of the affairs is placed in other hands than those provided by

51
247 SCRA 183, 192 (1995).
52
See the rationalization that had to be resorted to before the Corporation Code in Pirovano
v. De la Rama Steamship, Inc., 96 Phil. 335 (1954).
law of its creation. . . A corporation can act only through its duly authorized
officers and agents and is not bound by the acts of anyone else, while in a
partnership each member binds the firm when acting within the scope of the
partnership."53
The doctrine is grounded on the theory that the stockholders of a
corporation are entitled, in the absence of any notice to the contrary in the
articles of incorporation, to assume that their directors will conduct the corporate
business without sharing that duty and responsibility with others.54

1. Jurisprudential Rule
Tuason v. Bolaños,55 recognized at that time in Philippine jurisdiction the
doctrine in Anglo-American jurisprudence that "a corporation has no power to
enter into a partnership."56 Nevertheless, Tuason recognized that a corporation
may validly enter into a joint venture agreement, "where the nature of that
venture is in line with the business authorized by its charter."57
A joint venture is essentially a partnership arrangement, although of a
special type, since it pertains to a particular project or undertaking.58 Although
Tuason does not elaborate on why a corporation may become a co-venturer or
partner in a joint venture arrangement, it would seem that the policy behind the
prohibition on why a corporation cannot be made a partner do not apply in a joint
venture arrangement. Being for a particular project or undertaking, when the
board of directors of a corporation evaluate the risks and responsibilities
involved, they can more or less exercise their own business judgment is
determining the extent by which the corporation would be involved in the project
and the likely liabilities to be incurred. Unlike in an ordinarily partnership
arrangement which may expose the corporation to any and various liabilities and
risks which cannot be evaluated and anticipated by the board, the situation
therefore in a joint venture arrangement, allows the board to fully bind the
corporation to matters essentially within the boards business appreciation and
anticipation.
It is clear therefore that what makes a project or undertaking a "joint
venture" to authorize a corporation to be a co-venturer therein is not the name or
nomenclature given to the undertaking, but the very nature and essence of the
undertaking that limits it to a particular project which allows the board of directors
of the participating corporation to properly evaluate all the consequences and
likely liabilities to which the corporation would be held liable for.
53
FLETCHER CYC. CORPORATIONS (Perm. Ed.) 2520.
54
BAUTISTA, TREATISE ON PHILIPPINE PARTNERSHIP LAW (1978 Ed.), at p. 9.
55
95 Phil. 106 (1954).
56
Ibid, at p. 109.
57
Ibid, quoting from Wyoming-Indiana Oil Gas Co. v. Weston, 80 A.L.R., 1043, citing
FLETCHER CYC. OF CORP., Sec. 1082.
58
BAUTISTA, supra, at p. 50. In Torres v. Court of Appeals, 278 SCRA 793, 86 SCAD 812
(1997), the Supreme Court held unequivocally that a joint venture agreement for the development
and sale of a subdivision project would constitute a partnership pursuant to the elements thereof
under Article 1767 of the Civil Code that defines when a partnership exists.
 2. SEC Rules
The SEC, in a number of opinions, has recognized the general rule that a
corporation cannot enter into a contract of partnership with an individual or
another corporation on the premise that it would be bound by the acts of the
persons who are not its duly appointed and authorized agents and officers, which
is inconsistent with the policy of the law that the corporation shall manage its own
affairs separately and exclusively.59
However, the SEC has on special occasions allowed exceptions to the
general rule when the following conditions are complied with:

(a) The authority to enter into a partnership relation is expressly

conferred by the charter or the articles of incorporation of the
corporation, and the nature of the business venture to be
undertaken by the partnership is in line with the business
authorized by the charter or articles of incorporation of the
corporation involved;60
(b) The agreement on the articles of partnership must provide
that all the partners shall manage the partnership, and the
articles of partnership must stipulate that all the partners
shall be jointly and severally liable for all the obligations of
the partnership.61

The second condition set by the SEC would have the effect of allowing a
corporation to enter as a general partner in general partnership, which would still
have contravened the doctrine of making the corporation unlimitedly liable for the
acts of the other partners who are not its authorized officers or agents. This
interpretation of the second condition was confirmed by the SEC in 1994, to
mean that a partnership of corporations should be organized as a "general
partnership" wherein all the partners are "general partners so that all corporate
partners shall take part in the management and thus be jointly and severally
liable with the other partners."62
The rationale given by the SEC for the second condition was that if the
corporation is allowed to be a limited partner only, there is no assurance that the
corporate partner shall participate in management of the partnership which may
create a situation wherein the corporation may not be bound by the acts of the
partnership in the event that, as a limited partner, the corporation chooses not to
participate in the management.63

59
SEC Opinion, 22 December 1966, SEC FOLIO 1960-1976, at p. 278; citing 13 Am. Jr.
Sec. 823 (1938); 6 FLETCHER CYC. CORP., Perm. Ed. Rev. Repl. 1950, at p. 2520.
60
SEC Opinion, 29 February 1980.
61
Ibid.
62
SEC Opinion, dated 23 February 1994, XXVII SEC QUARTERLY BULLETIN 18 (No. 3, Sept.
1994).
63
Ibid.
 However, in 1995, the SEC reversed such interpretation and practically
dropped the second requirement, when it admitted the following reasoning for
allowing a corporation to invest in a limited partnership, thus:

1. Just as a corporate investor has the power to make passive

investments in other corporations by purchasing stock, a
corporate investor should also be allowed to make passive
investments in partnerships as a limited partner, who would then
not be bound beyond the amount of its investment by the acts of
the other partners who are not its duly appointed and authorized
agents and officers. Hence, the very reason why as a general rule,
a corporation cannot enter into a contract of partnership, as stated
in the 1966 SEC opinion, would no longer be present, as the
corporation, which is merely a limited partner, will now be
protected from the unlimited liability of the other partners who are
not agents or officers of the corporation;
2. Section 42 of the Corporation Code which permits a corporation to
invest its funds in another corporation or business, does not
require that the investing corporation be involved in the
management of the investee corporation with a view to protect its
investment therein. By entering into a contract of limited
partnership, a corporation would continue to manage its own
corporate affairs while validly abstaining from participation in the
management of the entity in which it has invested. Accordingly, as
there is generally no threat that a corporate limited partner would
be solidarily liable with the partnership, there would be no reason
for requiring a corporate partner to actually manage the
partnership, if it makes the business decision no to do so and opts
to become a limited partner; and
3. The SEC policy that a corporation cannot enter into a limited
partnership, is an offshoot of the outdated view in the U.S., that,
as a general rule, corporations could not form a partnership; that
corporations cannot become limited partners, is based on an
assumption which is no longer current. Jurisprudence and
common commercial practice in the U.S., indicate that
corporations are not barred from acting as limited partners.
Current American laws support the position that a corporation can
enter into a contract of limited partnership. For example, the
Revised Uniform Limited Partnership Act of 1976 (as amended in
1985), specifically confirms, that corporations may act as limited
partners. Almost all states in the U.S. have adopted limited
partnership laws which provide, in the same manner as the
Revised Uniform Limited Partnership Act, that corporations may
act as limited partners. This indicates that many other jurisdictions
simply follow the broad language of the Revised Model Business
Corporations Act which suggests that corporations may act as
limited partners and in no event prohibits that activity. These
statutes reaffirm what is indicated by the commercial practice in
the U.S., that corporations can act as limited partners. The
proliferation of statutes reversing the doctrine forbidding
 corporations to become partners is proof of the unsoundness of
and dissatisfaction with such doctrine.64

In that opinion, the SEC conceded on the points raised by confirming that
"inasmuch as there is no existing Philippine law that expressly prohibits a
corporation from becoming a limited partner in a partnership, the Commission is
inclined to adopt your view on the matter,"65 provided that the power to enter into
a partnership is provided for in the corporation's charter.
The SEC went on to say: "We agree with your statements that a
reconsideration of the present policy of the Commission on the matter is timely in
order to permit the Philippine commercial environment to maintain its pace in
terms of legal infrastructure with similar developments in the international arena
with a view to encouraging and facilitating greater domestic and foreign
investments in Philippine business enterprise."66

REPORTORIAL REQUIREMENTS WHEN

EXERCISING SPECIFIC POWERS
In order to apprise the general public and the government of the operation
status of corporations, as well as of the trends and actual business climate of the
country, the SEC issued the Rules Requiring Statement of Reasons for Change
in the Corporate Charter or Cessation of Business, and Filing of Corresponding
Resolution Authorizing Same.67
Under the Rules when a corporation—

(a) Increases or decreases its capital stock;

(b) Changes its line of business;
(c) Creates bonded indebtedness;
(d) Merges or consolidated with other corporations;
(e) Extends or shortens its term of existence;
(f) Increases or decreases the number of its directors;
(g) Ceases business operations; or
(h) Dissolves;

it must in its application with the SEC state the reasons or causes for said action
in the resolution of the stockholders or board of directors approving the same,
which resolution must be signed and attested by the president and secretary of
the corporation.

64
SEC Opinion, 17 August 1995, XXX SEC QUARTERLY BULLETIN 8-9 (No. 1, June 1996).
65
Ibid.
66
Ibid.
67
November, 1971.
 The Rules also provide that when a corporation invests funds in any other
corporation or business or for any purpose other than the main purpose for which
the corporation is organized pursuant, it shall file with the SEC a copy of the
resolution adopted by the affirmative vote of the stockholders holding at least
two-thirds (2/3) of the voting power authorizing the board of directors to invest in
another corporation or business.

—oOo—

CORPORATION LAW\CORP. MANUSCRIPT\08-CORPORATE POWERS\02-07-2003

 CHAPTER 9

DIRECTORS, TRUSTEES,
AND OFFICERS

Nature of Power and Authority of Board

Rationale of “Centralized Management”
Primary Objective of Board
Source of Power of Board
Theory of Original Power
Theory of Delegated Power
Peculiar Agency Role of Board
The Business Judgment Rule
Theoretical Basis of the Rule
Coverage of Rule
Requirement that the Board Must Act as a Body
Executive Committee
Qualifications and Disqualification of Directors and Trustees
Qualifications
Rule on Corporate Stockholders
Rule on Board of Directors of Banks
Disqualifications
Additional Qualifications and Disqualifications
Election of Board of Directors
Cumulative Voting
Classic Formula
Glasser Itiretative Procedure
D’Hondt Remainders Table
Election of Board of Trustees
Non-Permanency of Seat in Board
Alien Membership in Board of Directors
Vacancy in Board
Report on Election of Directors, Trustees and Officers
Term of Office; Hold-over Principle
Meetings of Directors and Trustees
Kinds of Meetings
Requisites for a Valid Board Meeting
Modes of Attendance of Board Members
Attendance by Stockholders of Board Meetings
Compensation of Directors and Officers
CORPORATE OFFICERS
Theory on Power of Board to Delegate Authority to Corporate Officers
Two Levels of Discussions on Corporate Officership
Theory on Power of Board to Appoint/Terminate Corporate Officers
Two Disciplines Diverging in Corporate Officership Issue
Election or Appointment of Officers
 President
Corporate Secretary
Corporate Treasurer
Corporate “Agents” for Service of Summons Upon Corporation
Common Law Nature of Duties and Obligations of Directors, Trustees and Officers
General Rule on the Duties and Liabilities of Directors, Trustees and Officers
Duty of Obedience
Duty of Diligence
Duty of Loyalty; Corporate Opportunity Doctrine
Dealings of Directors, Trustees or Officers with Corporation
Contracts Between Corporations with Interlocking Directors
Liability of Officers
General Rule on Liability of Corporate Officers
Different Strain in Labor Law
Duty of Directors to Corporate Creditors
ELECTION AND REMOVAL OF DIRECTORS, TRUSTEES AND OFFICERS
Removal of Directors and Trustees
What Constitutes “Cause”
Rationale of RTC Jurisdiction Over Matters Covering Officers
Who Are "Officers" and "Managers" Within the Jurisdiction of RTC?
Positions Created Pursuant to Enabling By-law Provisions
Branching Officership Test
Stockholder-Officer Combination
"Extent" by Which Regular Courts Can Adjudicate under Section 5(c)?
RTC Jurisdiction Even on Damages
Procedural Rules on Suits Brought
Addressing Constitutional Issue

——

This chapter covers the discussions on the power and authority, duties
and functions, and the obligations of directors, trustees, officers and other
representatives of corporations. Discussions on the binding effect of acts and
contracts entered into in behalf of corporations by unauthorized officers or
representatives are covered in the third type of ultra vires acts found in Chapter 5
on Corporate Contract Law.

NATURE OF POWER AND AUTHORITY OF BOARD

Section 23 of the Corporation Code clearly states that, unless otherwise
provided in the Code, the powers of a corporation formed shall be exercised, all
business conducted, and all property of such corporation controlled and held, by
the board of directors or trustees to be elected from among the holders of stocks,
or where there are no stocks, from among the members of the corporation, who
shall hold office for one (1) year until their successors are elected and qualified.
 The Supreme Court has characterized the power of the board of directors
as follows:

Under the Corporation Code, unless otherwise provided

by said Code, corporate powers, such as the power to enter
into contracts, are exercised by the Board of Directors.
However, the Board may delegate such powers to either an
executive committee or officials or contracted managers. The
delegation, except for the executive committee, must be for
specific purposes. The delegation to officers makes the latter
agents of the corporation; accordingly, the general rules of
agency as to the binding effects of their acts would apply. For
such officers to be deemed fully clothed by the corporation to
exercise a power of the Board, the latter must specially
authorize them to do so.1

In another case,2 the Court was emphatic in saying that in the absence of
an authority from the board of directors, no person, not even the officers of the
corporation, can validly bind the corporation. It held that in the absence of any
board resolution authorizing the filing of a suit for the corporation, then any suit
filed on behalf of the corporation should be dismissed, since the power of the
corporation to sue and be sued in any court is lodged with the board of directors
that exercises its corporate powers.3

1. Rationale of “Centalized Management”

One of the advantageous features of the corporation is that it acts in the
business world through a centralized management, which promotes efficiency
and prevents confusions arising from diffused corporate powers. Investors and
creditors of the corporation, as well as those who deal with it, can rely upon the
law-directed fact that the corporation shall be bound only through its board of
directors or Trustees, or representatives duly authorized by the board. In any
organizational set-up, the congruence of authority and responsibility in the same
person, committee, or board always promotes efficiency. This is the rationale for
the business judgment rule.
The Board of a corporation has sole authority to determine policy and
conduct the ordinary business of the corporation within the scope of its charter.
As long as the board acts honestly and the contract does not defraud or abuse
the rights of the minority, the courts will not interfere in their judgments and
transactions. The minority members of the board and the minority stockholders
cannot come to court upon allegations of want of judgment or lack of efficiency
on the part of the majority and change the course of the administration of
corporate affairs.

1
ABS-CBN Broadcasting Corporation v. Court of Appeals, 301 SCRA 572 (1999).
2
Premium Marble Resources v. Court of Appeals, 264 SCRA 11, 76 SCAD 9 (1996).
3
Ibid.
 Corporate elections furnish one of the primary remedies for internal
dissentions, as the majority must rule so long as it keeps within the powers
conferred by the corporate charter. The common law principles on duties of
obedience, diligence and loyalty, which have been incorporated as specific
provisions in the Corporation Code, provide for the other corporate features to
prevent abuse on the part of the corporate managers.

2. Primary Objective for Board

Although no specific clause is found in the Corporation Code directly on
the matter, the Supreme Court has held that the primary obligation of the
directors of a corporation is "to seek the maximum amount of profits for the
corporation," and characterized the position as a "position of trust" and that in
case a director‟s interests conflict with those of the corporation, he cannot
sacrifice the latter to his own advantage and benefit.4 The fiduciary or trust
relationship "is not a matter of statutory or technical law. It springs from the fact
that directors have the control and guidance of corporate affairs and property and
hence of the property interest of the stockholders."5

SOURCE OF POWER OF BOARD

There are two theories on the source of power of the board: the theory of
original power and the theory of delegated power.

1. Theory of Original Power

Under the theory of original power, the source of power of the board
comes directly from the law,6 and that the board is originally and directly granted
corporate power as the embodiment of the corporation. This theory has no
democratic notions, but actually is more akin to the principles of autocracy. It
recognizes that one of the attractive features of the corporate vehicle for the
efficient and economical management of corporate affairs is promoted by
centralization of control in a small group of decision-makers, which is the board
of directors or Trustees.
The theory finds support in Section 23 of the Corporation Code which
clearly vests corporate powers in the board, and only limits such power in narrow
situations when "otherwise provided in the Code."
Ramirez v. The Orientalist Co.,7 held that "[b]oth upon principle and
authority it is clear that any action or resolution of the stockholders on corporate
matters should be ignored. The functions of the stockholders of a corporation, it
must be remembered, are of limited nature. The theory of a corporation is that

4
Prime White Cement Corp. v. Intermediate Appellate Court, 220 SCRA 103, 110 (1993).
5
Ibid, quoting from Gokongwei v. Securities and Exchange Commission, 89 SCRA 336
(1979).
6
Sec. 23, Corporation Code.
7
38 Phil. 634 (1918).
the stockholders may have all the profits but shall turn over the complete
management of the enterprise to their representatives and agents, called
directors. Accordingly there is little for the stockholders to do beyond electing
directors, making by-laws, and exercising certain other special powers defined by
law. In conformity with this idea it is settled that contracts between a corporation
and third persons must be made by the directors and not by the stockholders.
The corporation, in such matters, is represented by the former and not by the
latter.8 This conclusion is entirely accordant with the provisions of section 28 of
our Corporation Law [now Section 23 of the Corporation Code]."9

2. Theory of Delegated Power

Under the theory of delegated power, the authority exercised by the Board
is viewed as derived or delegated authority, delegated to them by stockholders or
members of the corporation. Under such theory, the source of primary theory can
override the decisions of its delegates. Such theory promotes the notion of
"democracy" in the corporate set-up, where the real source of power are the
stockholders or members, and the representatives thereof would be the board. It
is also consistent with notions in Property Laws that recognizes that as a general
rule the owners exercises ultimate power and disposition over the subject matter
to which he holds title.
Under this view, a corporation has a personality separate and distinct from
the individuals that compose it, but the fact remains that it cannot act without the
medium of human beings. The corporate powers should belong to the
stockholders or members who form the corporation, and who contribute the
corporate assets. The stockholders or members are the real owners of the
corporation, and to them the corporate powers must belong, and that the board
of directors or Trustees merely act as their agents or representatives.
Angeles v. Santos,10 upholds the theory that the power of the board of
directors emanates from the stockholders or members of the corporation. In that
case the Court held that: "The board of directors of a corporation is a creation of
the stockholders and controls and directs the affairs of the corporation by
delegation of the stockholders. But the board of directors, or majority thereof, in
drawing themselves the powers of the corporation, occupies a position of
trusteeship in relation to the minority of the stock in the sense that the board
should exercise good faith, care and diligence in the administration of the affairs
of the corporation and should protect not only the affairs of the majority but also
those of the minority of the stock. Where a majority of the board of directors
wastes or dissipates the funds of the corporation or fraudulently disposes of its
properties, or performs ultra vires acts, the court, in the exercise of its equity
jurisdiction, and upon showing that intracorporate remedy is unavailing, will
entertain a suit filed by the minority members of the board of directors, for and in
behalf of the corporation, to prevent waste and dissipation and the commission of
8
Citing COOK ON CORPORATION, Sixth Ed., Secs. 708 and 709.
9
Supra, at p. 654.
10
64 Phil. 697, 706 (1937).
a illegal acts and otherwise redress the injuries of the minority stockholders
against the wrong-doings of the majority."
Angeles therefore recognizes that the source of the common law rights of
stockholders and members to bring a derivative suit on behalf of the corporation
is based on the recognition that the powers of the board is delegated to them by
the stockholders or members.

PECULIAR AGENCY ROLE OF THE BOARD

Under Section 23 of the Corporation Code, the board is the main agency
by which all corporate powers and authority are exercised, and strictly speaking
any other officer appointed to represent the corporation, is a mere appointee of
the board.
In a manner of speaking, the board acts as an agent of the corporation,
and is bound by the rules applying to agency relationship. In an ordinary agency
relationship, the principal has the right to preempt the agent in matters relating to
the agency, to countermand the decision of the agent, and even to terminate at
will the agency relationship.
In the corporate setting, although the board is an agent of the corporation,
since the principal is a mere juridical concept, it realistically is not in a position to
countermand the decisions of its agent, the board. In fact, unlike in an ordinary
principal-agent relationship, the corporate principal does not really have its own
mind to allow it to decide matters for itself. Under Section 23, the mind of the
corporation is principally its own agent, the board. Therefore, the determination of
the board is practically and legally the determination of the principal corporation
itself.
This line of discussion brings us therefore to the logical cross-road that
provides that although legally the board is the agent of the principal corporation,
since the principal does not have real existence or a mind of its own to make
decisions, the board is by its own exercise of business judgment, the very
principal speaking and acting in the commercial world. In a manner of speaking,
the board stands both as an agent of the corporation, and the very
personification of the corporation in the commercial and legal world, and
practically stands almost as the principal for corporate powers and affairs, and
that the officers and representatives that it appoints are its own agents.
The danger of abuses being committed under such peculiar principal-
agent relationship has under common law lead to institution of the remedy of
derivative suit to be placed in the hands of stockholders and members as a
means to check negligence, fraud and abuses by the board.

THE BUSINESS JUDGMENT RULE

The corporate principle recognizing corporate power and competence to
be lodged primarily with the board of directors is embodied in the "business
judgment rule." A resolution or transaction pursued within the corporate powers
and business operations of the corporation, and passed in good faith by the
board of directors, is valid and binding, and generally the courts have no
authority to review the same or substitute their own judgment, even when the
exercise of such power may cause losses to the corporation or decrease the
profits of a department.
Montelibano v. Bacolod-Murcia Milling Co., Inc.,11 had earlier established
the principle that when a resolution is “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," 12
adding that "[i]t is a well-known rule of law that questions of policy or
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 [for that]
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." 13
Gamboa v. Victoriano,14 held that courts cannot supplant the discretion of
the board on administrative matters as to which they have legitimate power of
action, and contracts which are intra vires entered into by the board are binding
upon the corporation and courts will not interfere unless such contracts are so
unconscionable and oppressive as to amount to a wanton destruction of rights of
the minority.
One author15 has discussed how the laissez faire doctrine has influenced
the development of business judgment rule in Corporate Law:

This legal concept of a private corporation must have

been based on the nineteenth century economic doctrine of
laissez faire. So, the early decisions of the courts, influenced
by this doctrine, held that a business corporation exists solely
for the benefit of those who had invested their capital in it.
Thus, in the case of Dodge v. Ford Motor Co. [204 Mich. 507,
170 N.W. 684 (1919)], Mr. Ford, desiring to plow back the
profits of the business to the corporation to enable him to sell
cheaper cars for the benefit of the buying public, decided not
to make further declaration of cash dividends. The minority
stockholders complained, claiming that Mr. Ford had no
business of making business for the benefit of strangers. The
court sustained the contention of the minority stockholders,
holding that:
"Under a legal system based on private
ownership and freedom of contract, he (Mr. Ford) has
no duty to conduct his business to any extent for the

11
5 SCRA 36 (1962).
12
Ibid, at p. 42.
13
Ibid, quoting from 2 FLETCHER ON CORP., at p. 390.
14
90 SCRA 40 (1979).
15
Guevarra, The Social Function of Private Corporations, 34 PHIL. L.J. 464, 466 (1959).
 benefit of strangers; he conducts it solely for his own
private gain and never to those with whom he deals
only the duty of carrying out such bargains as he may
make with them. . .
“A business corporation is organized and carried
on primarily for the benefit of the stockholders, and that
the directors cannot conduct the affairs of a corporation
for the merely incidental benefit of shareholders and for
the primary purpose of benefiting others."

1. Theoretical Basis of Rule

Fletcher has summed up the business judgment rule as an integral part of
the role of the board of directors: "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 the corporation should be operated at a loss during
depression, or closed down at a smaller loss, is a purely business and economic
problem, to be determined by the directors of a corporation and not by the courts.
It is a well-known rule of law that questions of policy or of management are left
solely to the honest decisions of officers and directors of a corporation, and the
other 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 its acts in
good faith its orders are not reviewable by the courts."16
Philippine Stock Exchange, Inc. v. Court of Appeals,17 also seems to
establish another theoretical basis for the business judgment rule based on the
recognition of the corporation merely as an association of individuals who
thereby do not give up through the medium of the corporation their management
prerogatives on business matters, thus:

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 a body. As to its corporate management
decision, 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 its acts in good faith, its orders are not reviewable by the
courts.

16
2 FLETCHER ON CORP., at p. 390.
17
281 SCRA 232, 88 SCAD 589 (1997).
 In Philippine Stock Exchange, the Supreme Court upheld the management
prerogatives of the Board of Directors of the Philippine Stock Exchange as
against the control of the SEC, through the reiteration of the business judgment
rule, thus:

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 reviewable by the courts.
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 SEC‟s 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. . .
In reaching the decision to deny the application of listing
of PALI, the PSE considered important facts, which, in the
general scheme, bring to serious question the qualification of
PALI to sell it shares to the public through the stock exchange.
PSE 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 ventures.
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 chose to transact through its
facilities. It was reasonable for the 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.

2. Coverage of Rule
From the foregoing, it can be seen that the business judgment rule
actually has two (2) applications, namely:

(a) Resolutions and transactions entered into by the Board of

Directors within the powers of the corporation cannot be
reversed by the courts not even on the behest of the
stockholders of the corporation; and
 (b) Directors and officers acting within such business judgment
cannot be held personally liable for the consequences of
such acts.

Courts and other administrative bodies having jurisdiction over

corporations generally would not interfere in the judgment or business decisions
of the board, nor will they substitute their wisdom for that of the board. Under
Section 23, the contract of the State with the corporation, its investors and the
public at large who must deal with the corporation, is that the "corporate powers"
are vested in the board, and generally courts or other government agencies
would not overturn nor interfere with the judgment and decisions of the board.
Courts and other tribunals are wont to override the business judgment of the
board mainly because, courts are not in the business of business, and the laissez
faire rule or the free enterprise system prevailing in our social and economic set-
up dictates that it is better for the State and its organs to leave business to the
businessmen; especially so, when courts are ill-equipped to make business
decisions; and more importantly, the social contract in the corporate family to
decide the course of the corporate business has been vested in the board and
not with the courts.
The business judgment rule is not only a substantial rule of law, but also a
rule on evidence. Whenever any action is brought to question the validity of a
board resolution or corporate transaction approved by the board, the general rule
is once it has been entered into by the board by virtue of the exercise of its
judgment, and it will be presumed to be valid.
The other branch of the business judgment rule is that corporate officers
cannot be held personally liable for corporate debts or obligations incurred in the
exercise of the business judgment. However, when directors or trustees violate
their duties, the can be held personally liable, thus:

(a) When the director willfully and knowingly vote for patently
unlawful acts of the corporation;18
(b) When he is guilty of gross negligence or bad faith in directing
the affairs of the corporation;19 and
(c) When he acquires any personal or pecuniary interest in
conflict with his duty as such directors.20

Likewise, the above-enumerated exceptions when directors, trustees and

corporate officers may be held personally liable for corporate acts, provide also
the three (3) instances when courts are authorized to supplant the decision of the
board, which is deemed to be biased and may prove detrimental to the
corporation.

18
Sec. 31, Corporation Code.
19
Ibid.
20
Secs. 31 and 34, Corporation Code.
 Philippine Stock Exchange defined the meaning and coverage of “bad
faith” on the part of the board of directors of a corporation as to warrant an
exemption from the business judgment rule, thus: “bad faith does not simply
connote bad judgment or negligence, but „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.‟”

REQUIREMENT THAT BOARD MUST ACT AS A BODY

Under Section 25 of the Corporation Code, "a majority of the number of
directors or trustees as fixed by the articles of incorporation shall constitute a
quorum for the transaction of the corporate business, and every decision of at
least a majority of the directors or trustees present at a meeting at which there is
a quorum shall be valid as a corporate act."
The grant of corporate power is to the board as a body, and not to the
individual members thereof, and that the corporation can be bound only by the
collective act of the board. The rationale for this rule is the public policy, that it
makes better management practice for the board to sit down, to discuss
corporate affairs, and decide on the basis of their consensus.21
It must be noted however, that the principle that the corporation can be
bound only by the collective act or will of the board sets only the general rule. As
will be seen, a corporation can be bound even by the act of its officers, but
always because of the act or default of the board.
In Lopez Realty v. Fontecha,22 the Supreme Court held that the general
rule is that a corporation, through its board of directors, should act in the manner
and within the formalities, if any, prescribed by its charter or by the general law.
Thus, directors must act as a body in a meeting called pursuant to the law or the
corporation's by-laws, otherwise, any action taken therein may be questioned by
any objecting director or shareholder. However, it pointed out that nevertheless
jurisprudence provides that an action of the board of directors during a meeting,
which was illegal for lack of notice, may be ratified either expressly, by the action
of the directors in subsequent legal meeting, or impliedly, by the corporation's
subsequent course of conduct.
In Ramirez v. The Orientalist Co.,23 the director-treasurer of the
corporation entered into transactions for the leases of films without prior board
authorization. Although the articles of incorporation of the company authorized it
to manufacture, buy, or otherwise obtain all accessories necessary for
conducting the business of maintaining and conducting theaters, the Court

21
The SEC has opined that directors and trustees can only exercise their power as a board,
not individually. They shall meet and counsel each other and any determination affecting the
corporation shall be arrived at only after consultation at a meeting of the board attended by at
least a quorum. SEC Opinion, 10 March 1972, SEC FOLIO 1960-1976, at p. 526.
22
247 SCRA 183, 63 SCAD 494 (1995).
23
38 Phil. 634 (1918).
nevertheless held that a treasurer has no independent authority to bind the
corporation by signing its name to the documents; and that under then Section
28 of the Corporation Law (now Section 23 of the Corporation Code) all
corporate powers shall be exercised and all corporate business conducted by the
board of directors. The by-laws of the corporation even provided that the power
to make contracts shall be vested in the board of directors. Although the by-laws
provided that the president shall have the power, and it shall be his duty, to sign
contracts, the Court nevertheless construed this provision to refer to the formality
of reducing to proper form the contracts which are authorized by the board and is
not intended to confer an independent power to make contracts binding on the
corporation.
Nonetheless, the Court held that the fact that the power to make corporate
contracts is vested in the board of directors does not signify that a formal vote of
the board must always be taken before contractual liability can be fixed upon a
corporation; for the board can create liability, like an individual, by other means
than by a formal expression of its will.24 The Court held that when the corporation
acts through its officers, certain things are presumed, and by virtue of business
and commercial customs, the officer is presumed to have power, and that he acts
with the board's authority. "The authority of the subordinate agent of a
corporation often depends upon the course of dealings which the company or its
directors have sanctioned. It may be established sometimes without reference to
official record of the proceedings of the board, by proof of the usage which the
company had permitted to grow up in the business, and of the acquiescence of
the board charged with the duty of supervising and controlling the company's
business."25
The implication is clear from Ramirez in reference to outsiders dealing
with the corporation, that not all corporate actions need formal board approval.
The board need not come together and act as a body to perform a corporate act.
In many cases no act is required of the members of the board in order to bind the
corporation; the fact that they know of a particular corporate transaction or
contract, and they stayed silent about it, or worse, they allowed the corporation to
gain by the transaction or contract, would already bind the corporation.
Ramirez also discussed the principal in procedural law as it pertained to
corporations, that when an actionable document is used as the basis in a suit
against the corporation, it becomes incumbent upon the corporation, if it desires
to question the authority of the purported agent who signed the document, to
deny the due execution of said contract under oath. The failure of a corporation
to deny the genuineness and due execution of an actionable document would be
an admission not only of the signature of the corporate officer therein, but also of
his authority to make the contract in behalf of the corporation, and of the power of

24
Ibid, at pp. 648-649.
25
Ibid, at pp. 649-650 quoting from Robert Gair Co. v. Columbia Rice Packing Co., 124 La.,
194.
the corporation to enter into such contract.26 Ramirez rationale for the doctrine
was as follows:

In dealing with corporations the public at large is bound

to rely to a large extent upon outward appearances. If a man is
found acting for a corporation with the external indicia of
authority, any person, not having notice of want of authority,
may usually rely upon those appearances; and if it be found
that the directors had permitted the agent to exercise that
authority and thereby held him out as an person competent to
bind the corporation, or had acquiesced in a contract and
retained the benefit supposed to have been conferred by it, the
corporation will be bound, notwithstanding the actual authority
may never have been granted. The public is not supposed nor
required to know the transaction which happen around the
table where the corporate board of directors or the
stockholders are from time to time convoked. Whether a
particular officer actually possesses the authority which he
assumes to exercise is frequently known to very few, and the
proof of it usually is not readily accessible to the stranger who
deals with the corporation on the faith of the ostensible
authority exercised by some of the corporate officers. It is
therefore reasonable, in a case where an officer of a
corporation has made a contract in its name, that the
corporation should be required, if it denies his authority, to
state such defense in its answer. By this means the plaintiff is
apprised of the fact that the agent's authority is contested; and
he is given an opportunity to adduce evidence showing either
that the authority existed or that the contract was ratified or
approved.27

Ramirez held that "[t]he integrity of commercial transactions can only be

maintained by holding the corporation strictly to the liability fixed upon it by its
agents in accordance with law. . . As already observed, it is familiar doctrine that
if a corporation knowingly permits one of its officers, or any other agent, to do
acts within the scope of an apparent authority, and thus holds him out to the
public as possessing power to do those acts, the corporation will, as against any
one who has in good faith dealt with the corporation through such agent, be
estopped from denying his authority; and where it is said `if the corporation
permits' this means the same as `if the thing is permitted by the directing power
of the corporation.'"28
Board of Liquidators v. Heirs of Maximo Kalaw,29 held that it is possible for
an express provision of the by-law to be violated and the board may, in certain
corporate actions, bind the corporation in spite of the fact that it is contrary to the
26
Ibid, at pp. 641-642.
27
Ibid, at pp. 645-646.
28
Ibid, at pp. 654-655.
29
20 SCRA 987 (1967).
by-law provision. It held that there are two ways by which corporate actions may
come about through the corporation's board of directors, either the board may
empower or authorize the act or contract, or it can be ratificatory act on the part
of the board. As long as there is a corporate approval through the board of
directors, whether implied or express, it is valid to bind the corporation.
Acuña v. Batac Producers Corporative Marketing Association,30 held that
between the act of the board as a body in beforehand affirming, although
informally, to the other party the perfection of a contract, on one hand, and a
subsequent express resolution formally taken at the board meeting which
resolution then proceeds to "disapprove and/or rescind" the said contract, the
former must prevail. The Court held that "[t]here is abundant authority in support
of the proposition that the ratification may be express or implied, and that implied
ratification may take diverse forms, such as by silence or acquiescence; by acts
showing approval or adoption of the contract; or by acceptance and retention of
benefits flowing therefrom."31

EXECUTIVE COMMITTEE
Under Section 35 of the Corporation Code, the by-laws of a corporation
may create an executive committee, composed of not less than three (3)
members of the board, to be appointed by the board. The executive committee
may act, by majority vote of all its members, on such specific matters within the
competence of the board, as may be delegated to it in the by-laws or on a
majority vote of the board, except with respect to:

(a) Approval of any action for which shareholders' approval is

also required;
(b) The filing of vacancies in the board;
(c) The amendment or repeal of by-laws or the adoption of new
by-laws;
(d) The amendment or repeal of any resolution of the board
which by its express terms is not so amendable or
repealable; and
(e) Distribution of cash dividends to the shareholders.

The executive committee can do any act because the power of the board
to delegate certain specific acts is unlimited. However, by the language of
Section 35 of the Corporation Code, ultimate power must remain with the board
of directors, and it would be against corporate principle to empower the executive
committee with authority that the board itself cannot countermand.

30
20 SCRA 526 (1967).
31
Ibid, at p. 533.
 Nothing in the Corporation Code prevents the creation of an executive
committee by board resolution, even in the absence of an enabling clause in the
by-laws. The creation of such executive committee would be in line with full
authority of the board to appoint agents and delegates. But taking the cue from
Section 35 of the Code, such executive committee, its composition and powers,
would be subject to the same limitations provided for by the Code, since the
board by mere resolution cannot create an executive committee that will have
greater powers than one sanctioned by law.
The SEC, however, in an opinion held that by virtue of Section 35 of the
Corporation Code, an executive committee can only be created by virtue of a
provision in the by-laws and that in the absence of such by-law provision, the
board of directors cannot simply create or appoint an executive committee to
perform some of its functions.32

QUALIFICATIONS AND DISQUALIFICATIONS OF DIRECTORS AND TRUSTEES

1. Qualifications
Every director must own at least one (1) share of the capital stock of the
corporation of which he is a director, which share shall stand in his name on the
books of the corporation. No person shall be elected as trustee unless he is a
member of the corporation.33
Any director who ceases to be the owner of at least one (1) share of the
stock of the corporation of which he is a director shall thereby cease to be a
director. Trustees of non-stock corporations must be members thereof. A majority
of the directors or trustees of all corporations organized under this Code must be
residents of the Philippines.
The fact that a director is only holding the share as a nominee of another
person does no disqualify him as a director. What the law requires is that he has
legal title to the share. Under the old Corporation Law it was required that every
director must own "in his own right" at least one share of the capital stock of the
corporation. Under the present Section 23 of the Corporation Code, it requires
only that the share of a director "shall stand in his name on the books of the
corporation."
Lee v. Court of Appeals,34 held that under the old law, "the eligibility of a
director, strictly speaking, cannot be adversely affected by the simple act of such
director being a party to a voting trust agreement inasmuch as he remains owner
(although beneficial or equitable only) of the shares subject of the voting trust
agreement pursuant to which a transfer of the stockholder's shares in favor of the

32
SEC Opinion, dated 27 September 1993, XXVIII SEC QUARTERLY BULLETIN 12 (No. 1,
March 1994).
33
Sec. 92, Corporation Code.
34
205 SCRA 752 (1992).
trustee is required. . . No disqualification arises by virtue of the phrase `in his own
right' provided under the old Corporation Code (sic)."35
Lee therefore concluded that with the omission of the phrase "in his own
right" under the present Corporation Code, the election of trustees and other
persons who in fact are not the beneficial owners of the shares registered in their
names on the books of the corporation becomes formally legalized and therefore,
is a clear indication that in order to be eligible as a director, what is material is the
legal title to, not the beneficial ownership of, the stock as appearing on the books
of the corporation.36
Lee held that the disposition by a director of all of the shares in the
corporation, through a voting trust agreement, had the legal effect of him ceasing
to be a director of the corporation and creating a vacancy in the board, since as a
consequence of the execution of the voting trust agreement, such director
ceased to own at least one share standing in his name in the books of the
corporation.

a. Rule on Corporate Stockholders

In cases of corporate stockholders or corporate members of a corporation,
such entities cannot be qualified to be elected as such to the board of the
corporation. A corporation cannot act by itself but only through its officers and
agents, and as such a corporation cannot attend personally board meetings of
the corporation wherein it is elected as a director, but only through representative
or a proxy, which would contravene the established rule that a director may not
be represented by a proxy at a meeting of the board.37 In addition such corporate
stockholders or members of the corporation cannot also designate an individual
representative to be voted into the board of the corporation since the
representative would not be a stockholder of record nor a member himself, which
is a minimum requirement to be qualified to be voted into the board of the
corporation.38
Therefore, in the case of corporate stockholders or corporate members,
their representation in the board can be achieved by making their individual
representatives trustees of the shares or membership, which would then make
them stockholders or members of record, and thereby qualified to be elected to
the board, but at the same time maintaining legal responsibility of trustees to the
corporate stockholder or members.

b. Rules on Board of Directors of Banks and Listed Companies

35
Ibid, at p. 761.
36
Ibid, citing 2 FLETCHER, CYCLOPEDIA OF THE LAW OF PRIVATE CORPORATIONS, sec. 300, p.
92 (1969), citing People v. Lihme, 269 Ill. 351, 109 N.E. 1051.
37
Sec. 26, Corporation Code.
38
See SEC Opinion, 2 June 1986, XX SEC QUARTERLY BULLETIN (Nos. 1 & 2, March &
June, 1986); SEC Opinion, 16 July 1985, SEC ANNUAL OPINIONS 1985, at p. 125; SEC Opinion,
26 June 1969, SEC FOLIO 1960-1976, at p. 381.
 The board of directors of a bank shall have at least two (2) “independent
directors,” which shall be persons other than an officer or employee of the bank,
its subsidiaries or affiliates or related interests.39
Listed and public companies and those with registered securities shall
have at least two (2) independent directors or they shall constitute at least twenty
percent (20%) of such board, whichever is lesser, which shall mean a person
other than an officer or employee of the corporation, its parent or subsidiaries, or
any other individual having a relationship with the corporation, which would
interfere with the exercise of independent judgment in carrying out the
responsibilities of a director.40

2. Disqualifications
A directors must not have been convicted of an offense punishable by
imprisonment of exceeding six (6) years or has not committed any violation of
Corporation Code within five (5) years prior to his election.41
Under Section 19 of the General Banking Law of 2000, except for rural
banks, no appointive or elective public official, whether full-time or part-time shall
at the same time serve as officer of any private bank, save in cases where such
service is incident to financial assistance provided by the government or a
government-owned or controlled corporation to the bank or unless otherwise
provided under existing laws.

3. Additional Qualifications and Disqualifications

The by-laws of the corporation can provide other qualifications and
disqualifications in addition to those provided in the Corporation Code.
Gokongwei v. Securities and Exchange Commission,42 held that a
stockholder has no vested right to be elected to the Board of Directors. The Court
held that any person "who buys stock in a corporation does so with the
knowledge that its affairs are dominated by a majority of the stockholders and
that he impliedly contracts that the will of the majority shall govern in all matters
within the limits of the act if incorporation and lawfully enacted by-laws and not
forbidden by law." To this extent, therefore, the stockholder may be considered to
have "parted with his personal right or privilege to regulate the disposition of his
property which he has invested in the capital stock of the corporation and
surrendered it to the will of the majority or his fellow incorporators. It can not
therefore be justly said that the contract, express or implied, between the
corporation and the stockholders is infringed by any act of the corporation which
is authorized by a majority.43

39
Sec. 15, The General Banking Law of 2000 (RA 8791).
40
Sec. 38, The Securities Regulation Code (RA 8799).
41
Sec. 27, Corporation Code.
42
89 SCRA 336 (1979).
43
Ibid.
ELECTION OF BOARD OF DIRECTORS
Under Section 24 of the Corporation Code, at all elections of directors or
trustees, there must be present, either in person or by representatives authorized
to act by written proxy, the owners of the majority of the outstanding capital
stock, or if there be no capital stock, a majority of the members entitled to vote.
The election must be by ballot if requested by any voting stockholder
entitled to vote shall have the right to vote in person or by proxy the number of
shares of stock standing, at the time fixed in the by-laws, in his own name on the
stock books of the corporation, or where the by-laws are silent, at the time of the
election. No delinquent stock shall be voted.
Any meeting of the stockholders or members called for an election may
adjourn from day to day or from time to time but not sine die or indefinitely if, for
any reason, no election is held, or if there are no present or represented by
proxy, at the meeting, the owners of a majority of the outstanding capital stock, or
if there be no capital stock, a majority of the members entitled to vote.

CUMULATIVE VOTING
Section 24 of the Corporation Code expressly provides for cumulative
voting in the election of the directors of stock corporations. The provisions for
cumulative voting are mandatory.
Under that section, at all elections of directors, a stockholder may vote
such number of shares for as many persons as there are directors to be elected
or he may cumulate said shares and give one candidate as many votes as the
number of directors to be elected multiplied by the number of his shares shall
equal, or he may distribute them on the same principle among as many
candidates as he shall see fit, provided that the total number of votes cast by him
shall not exceed the number of shares owned by him as shown in the books of
the corporation multiplied by the whole numbers of directors to be elected.
Cumulative voting therefore is a voting procedure wherein a stockholder is
allowed to concentrate his votes and give one candidate as many votes as the
number of directors to be elected multiplied by the number of his shares shall
equal. The policy of cumulative voting is to allow minority stockholders the
capacity to be able to elect representatives to the board of directors.44 No
exception is provided for in Section 24 so that the articles may not provide for
restriction or suppression of the principle of cumulative voting in stock
corporations.
In contrast to cumulative voting, which allows for an opportunity for
minority representation in the board, straight voting allows a simple majority of
the shareholders to elect the entire board of directors leaving the minority

44
Glazer, Glazer, & Grofman, Cumulative Voting In Corporate Elections: Introducing
Strategy into the Equation, 35 S. CAROLINA L. REV. 295 (1934).
shareholders unrepresented. Under straight voting, each shareholder simply
votes the number of shares he owns for each director nominated.
Cumulative voting is reckoned to be equitable since it allows stockholders
the opportunity for representation on the board of directors in proportion to their
holdings. Such minority representation is believed not to interfere with the
principle of majority rule since the number of directors elected by each group will
vary with its proportion of ownership. It is also believed that minority interests
have a voice on the board since stockholders and management often have
different goals. Finally, it is believed that since corporate and securities laws
generally create a balance of power in favor of insiders and controlling interest,
some counterveilling power in the hands of outside minority interest is
desirable.45
On the other hand, the system of cumulative voting has been criticized by
other sectors because in tends to partisan representation in the board, which is
inconsistent with the notion that a director properly represents all interest groups
in the corporate setting. It is said to breed disharmony in the board which
dissipates the energies of management and leads to an atmosphere of
uncertainty at the top level. Often, cumulative voting is used by persons who are
motivated by narrow, selfish interests.46

1. Classic Formula
The formula that has become popular in many corporate literature
applying the cumulative voting system is credited to Cole,47 which is as follows:

S x D1
S1 = ______ + 1
D+1
Where,
S1 = Number of shares owned by some shareholders or group
of shareholders [Bloc I]
S = Total number of shares voting at the meeting
D1 = Number of directors Bloc I desires to elect
D = Total number of directors to be elected at the meeting

In cases where S1 includes a fractional term (e.g., 51/4), Cole provides

that S1 should be taken to be the largest whole number, less than that given by
the formula (e.g., 5).48

45
Williams, Cumulative Voting, 33 HARV. BUS. REV., May-June 1955, at 108, 111.
46
Ibid. See also Glazer, Glazer, & Geofman, Cumulative Voting in Corporate Elections:
Introducing Strategy into the Equation, supra.
47
Cole, Legal and Mathematical Aspects of Cumulative Voting, 2 S.C.L.Q. 225 (1954).
 For example, Mr. Cruz owns 66 shares of stock of ABC Corp. If there are
5 directors to be chosen, Mr. Cruz is entitled to 330 votes obtained by multiplying
66 by 5. Mr. Cruz is at liberty to distribute any or all of the votes he is entitled to
cast among any of the candidates.
In a situation where ABC Corporation has 100 outstanding capital stock,
using the Cole Formula, Mr. Cruz would be assured to electing 4 members
thereof computed as follows:

500 x D1
330 = ________ + 1
5+1

500 x D1
330 - 1 = ________
6

6 x (330-1) = 500 x D1

1,974
________ = D1
500

D1 = 2.9 or 4

In a seminal paper collaborated into by an economist, a lawyer and a

political science professor,49 the group was able to show that the Cole Formula
suffers from three basic flaws: (a) It occasionally yields erroneous results in
situations involving only two competing blocs of shareholders; (b) The formula
addresses only the question of how many directors a bloc can be assured of
electing, and ignores the possibility that a bloc's optimal strategy may be to vote
for more candidates than it is certain of electing; and (c) The formula may yield
erroneous results in situations involving more than two competing blocs of
shareholders.50

2. Glasser Itiretative Procedure

Another formula was also discussed in the article called the Glasser
Formula, which applied the game theoretic notions to cumulative voting.51

48
Ibid at 230.
49
Glazer, Glazer and Geofman, Cumulative Voting in Corporate Elections: Introducing
Strategy into the Equation, 35 S. CAROLINA L. REV. 295 (1984).
50
Ibid, at p. 299.
51
Glasser, Game Theory and Cumulative Voting, 5 Mgmt. Sci. 151 (1959).
 D x S1 D x S11
Integer _______ is greater than Integer __________
D1 D + 1 - D1

The Glasser Formula which uses the iterative procedure illustrates an

important feature of cumulative voting: the number of directors a bloc can be
certain of electing depends not only upon the proportion of total shares which its
owns, but also upon the absolute number of shares it owns.52 Nevertheless,
although the Glasser Formula yielded more accurate results than the Cole
Formula in determining the assured number of directors that a group can elect, it
still did not define the optimum manner of voting.

3. D'Hondt Remainders Table53

The formula "offers a simple method for determining the number of
candidates for whom a bloc should vote."54 The D'Hondt Remainders Table is
constructed by dividing the number of votes each bloc can cast by the integers 1
through D (i.e., the total number of directors to be elected), which will indicate the
number of shares controlled and the number of candidates for whom votes are
cast.55
"D'Hondt Remainders Table is first used to determine the number of
directors each block is certain of electing. The largest entries in the table are
circled, indicating D, the number of directors to be elected."56
Using the same ABC Corp. illustration above, with Mr. Cruz being Bloc I,
the D'Hondt Remainders Table should appear as follows:57

1 2 3 4 5
1/2
Bloc I 330 165 110 82 66
2/3 1/2
Bloc II 170 85 56 42 34

52
Glazer, Glazer and Geofman, supra, at p. 302. "The discrepancy should remind corporate
management and its counsel that the absolute number of shares to be issued to each
shareholders group as well as the relative proportional interests of each such group are important
in planning a corporation's shareholders structure." at p. 303.
53
B. Grofman, A Review of Macro-Election Systems, German Political Yearbook (R.
Wildenmann ed. 1975); Balinski and Young, Stability, Coalitions, and Schisms in Proportional
Representation Systems, 72 Am. Pl. Sci. Rev. 848 (1978).
54
Ibid, at p. 305.
55
Ibid.
56
Ibid, at pp. 305-306.
57
Ibid, at p. 305.
 The article goes on to say: "The smallest circle entry in the top row
appears in column 3, whi ch means that Row 1 can guarantee itself three seats.
The smallest circled entry in the bottom row appears in column 2, indicating that
Bloc II can guarantee itself two seats. Each bloc should always nominate at least
the number of candidates it is certain in electing. . . In this case, however, Bloc I
can safely nominate more than three candidates. That is, the fourth entry in the
top row, 82½ , is larger than the first uncircled entry in the bottom row, 56-2/3.
Hence, Bloc I can safely nominate four candidates. But should Bloc I nominate
more than four candidates? Yes. The fifth entry in the top row, 66, is greater
than the first uncircled number in the bottom row. Therefore, Bloc I should
nominate five candidates, the same result obtained earlier through a somewhat
different line of reasoning. If Bloc I divides its votes for two candidates, Bloc I will
still elect three candidates since Bloc II will exhaust its votes on its two
candidates. If Bloc II divides its votes among three candidates instead of two,
Bloc I will elect all five of its candidates since Bloc I can give 66 votes to each of
its five while Bloc II can only give 56-2/3 votes to its three candidates. Bloc I
cannot lose and may achieve a significant gain. . . Generally, a bloc can safely
vote for a directors if the at entry in that bloc's row in the table is greater than the
first uncircled entry in the competing bloc's row."58
In a three-cornered battle, the article gives the following illustrative table:59

1 2 3 4 5
2/3
Bloc I 200 100 66 50 40

1/2 2/3 1/4

Bloc II 125 62 41 31 25

1/2 1/2 1/4

Bloc III 125 62 41 31 5

The article compares the accuracy of the D'Hondt Remainder Table with
the Cole Formula, thus: "Consider the following election. There are three blocs, I,
II, and III. The blocs shareholdings are SI = 40, SII = 25, SIII = 25, so that S = 90
and D the number of directors to be elected) 5. According to Cole's formula, the
maximum number of seats Bloc I is certain of winning in two.

As long as Bloc II and III do not join forces to vote for the
same candidates, Bloc I can elect more candidates by dividing
its votes among three candidates, giving each one (5)(40)/3 =
662/3 votes. Since this number is less than 662/3 (the number
of votes cast for each of Bloc I's three candidates). Bloc I is as

58
Ibid.
59
Ibid, at p. 307.
 assured of filing three seats, rather than two, contrary to the
outcome given by Cole's formula. . .
Once again the D'Hondt Reminders Table gives the
correct answer. Table 2 is generated by dividing the number of
votes which can be cast by Blocs I, II, and III (i.e. 200,125, and
125) by the integers 1 through D (i.e, 1 through 5). Again, the
five largest entries in the table are circled. This process
indicates that Bloc I is guaranteed of electing three directors if
each of the blocs votes for a different set of candidates.
Similarly, Blocs II and III are assured of electing one director
each.
As stated previously, the D'Hondt Reminders Table
indicates the number of directors a bloc is certain of electing
as well as the number of directors for whom it should vote.
The number in the fourth column of the top row, 50, is smaller
than the largest of the uncircled entries in the other rows,
621/2. Thus, Bloc I should not vote for four directors.
Similarly, the number in the fifth column of the top row, 40, is
less than the largest of the circled entries in the other rows,
125, so that Bloc 1 should not vote for five directors. Instead, it
should spread its votes evenly among three candidates, the
number it is certain of electing. Following the same procedure
for Bloc II, the first uncircled entry in the middle row, 621/2 is
not greater than the largest uncircled entry in the other rows,
621/2 Bloc II and III should vote therefore for one candidates.60

ELECTION OF BOARD OF TRUSTEES

Non-stock or special corporations may, through their articles of
incorporation or their by-laws, designate their governing boards by any name
than as “Board of Trustees.”61
Under Section 92 of the Corporation Code, unless otherwise provided in
the articles of incorporation or the by-laws, the board of trustees of non-stock
corporations, which may be more than fifteen (15) in number as may be fixed in
their articles of incorporation or by-laws, shall, as soon as organized, so classify
themselves that the term of office of one-third (1/3) of their number shall expire
every year; and subsequent elections of trustees shall be held annually and
trustees so elected shall have a term of three (3) years. Trustees thereafter
elected to fill vacancies occurring before the expiration of a particular term shall
hold office only for unexpired period.
Under Section 24 of the Corporation Code, "unless otherwise provided in
the articles of incorporation, or in the by-laws," members of corporations which
have no capital stock may cast as many votes as there are trustees to be elected

60
Ibid, at pp. 35-36.
61
Sec. 138, Corporation Code.
but may not cast more than one vote for one candidate. Candidates receiving the
highest number of votes shall be declared elected.
In non-stock corporations, the default rule in the election of trustees is
straight voting. Unlike the mandatory rule for cumulative voting for stock
corporations, in non-stock corporations, it is possible to provide for other types of
voting in either the articles of incorporation or the by-laws of the corporation.

NON-PERMANENCY OF SEAT IN BOARD

The Supreme Court has already held unlawful any attempt to grant to any
person a permanent seat in the board of a corporation, thus:” Any provision in the
by-laws or the practice of the corporation giving a stockholder a permanent seat
in the Board of Directors of the corporation would be against the provision of
Sections 28 and 29 of the Corporation Code which requires member of the board
of corporations to be elected. In addition, Section 23 of the Corporation Code
which provides for the powers of the Board of Directors or Trustees expressly
requires them “to be elected from among the holders of stock, or where there is
no stock, from among the members of the corporation.”62

ALIEN MEMBERSHIP IN BOARD OF DIRECTORS

Commonwealth Act No. 108, otherwise known as the Anti-Dummy Law,
penalizes the intervention of aliens in the management, operation, administration
or control of a nationalized enterprise or activity. Nevertheless, Pres. Decree 715
has settled the issue of alien membership in the board of directors of nationalized
enterprises, when it provided that "election of aliens as members of the board of
directors of governing body of corporations or associations engaging in partially
nationalized activity shall be allowed in proportion to their allowable participation
or share in the capital of such entities."
Under Section 15 of the General Banking Law of 2000, non-Filipino
citizens may become members of the board of directors of a bank to the extent of
the foreign participation in the equity of said bank.

VACANCY IN BOARD
Under Section 29 of the Corporation Code, any vacancy occurring in the
board of directors or trustees other than by removal by the stockholders or
members or by expiration of term, may be filled by the vote of at least a majority
of the remaining directors or trustees, if still constituting a quorum; otherwise,
said vacancies must be filled by the stockholders in a regular or special meeting
called for that purpose. A director or trustee so elected to fill a vacancy shall be
elected only for the unexpired term of his predecessor in office.

62
Grace Christian High School v. Court of Appeals, 281 SCRA 133, 88 SCAD 499 (1997).
 Any position in the board to be filled by reason of an increase in the
number of directors or trustees shall be filled only by an election at a regular or at
a special meeting of stockholders or members duly called for the purpose, or in
the same meeting authorizing the increase of directors or trustees if so stated in
the notice of the meeting.63
Therefore, vacancies in the board other than by removal or expiration of
term may be filled by the vote of majority of remaining directors or trustees, if
there is quorum; if there is no quorum, it may be filled by stockholders or
members in a regular or special meeting called for that purpose.
Vacancy by reason of an increase in members of the board can be filled-
up only by election of the stockholders or members of the corporation.

REPORT ON ELECTION OF DIRECTORS, TRUSTEES AND OFFICERS

Under Section 26 of the Corporation Code, within thirty (30) days after the
election of the directors, trustees and officers of the corporation, the secretary, or
any other officer of the corporation, shall submit to the SEC, the names,
nationalities and residences of the directors, trustees and officers elected. Should
a director, trustee or officer or officers die, resign or in any manner cease to hold
office, his heirs in case of his death, the secretary, or any other officer of the
corporation, or the director, trustee or officer himself, shall immediately report
such fact to the SEC.
The provisions of Section 26 of the Corporation Code are deemed to be
mandatory and jurisdictional. And the determination of who are the legal directors
and officers of the corporation is conditioned upon the reports submitted to the
SEC pursuant to said section.
In Premium Marble Resources v. Court of Appeals,64 the Supreme Court
confirmed that "[b]y the express mandate of the Corporation Code (Section 26),
all corporations duly organized pursuant thereto are required to submit within the
period therein stated (30 days) to the SEC the names, nationalities and
residences of the directors, trustees and officers elected." In that case, the Court
explained the importance of the requirement of the law: "Evidently the objective
sought to be achieved by Section 26 is to give the public information, under
sanction of oath of responsible officers, of the nature of business, financial
condition and operational status of the company together with information on its
key officers or managers so that those dealing with it and those who intend to do
business with it may know or have the means of knowing facts concerning the
corporations financial resources and business responsibility."
Premium Marble Resources held that only the directors and officers of the
corporation whose name appears in the report submitted to the SEC are deemed

63
Sec. 39, Corporation Code.
64
264 SCRA 11, 76 SCAD 9 (1996).
legally constituted to bind the corporation in bringing of any suit in behalf of the
corporation.

TERM OF OFFICE; HOLD-OVER PRINCIPLE

The term of office of the members of the board in a stock corporation shall
be one (1) year and until their successors are elected and qualified.65
In the event no new board is elected and qualified after the original one-
year term of the board of directors, then under the hold-over principle, the
existing board, if still constituting a quorum, is still a legitimate board with full
authority to bind the corporation.66
Ponce v. Encarnacion,67 held that where no meeting is called by the board
for the stockholders to elect a new set of directors, one may be called by the
stockholders by a petition filed in the courts and the remedy for calling a
stockholders' meeting is similar to a preliminary injunction--it is possible for the
courts to set it as an ex-parte hearing for granting it and there is no denial of due
process.

MEETINGS OF DIRECTORS OR TRUSTEES

1. Kinds of Meeting
There are two types of meeting of the board: the regular meeting, which
are held by the board monthly, unless the by-laws provide otherwise; and the
special meetings, those held by the board at any time upon the call of the
president, or as provided in the by-laws. Special meetings may be held at any
time upon call be held anywhere in and outside the Philippines, unless the by-law
provide otherwise.68
The president shall preside at all meetings of the board.69
The quorum in the meeting of the board shall be the presence of a
majority of the number of directors as fixed in the articles of incorporation.70
The required vote to pass a resolution shall be a majority vote of the
directors present at such meeting where quorum is achieved.71

65
Sec. 23, Corporation Code.
66
The Corporation Code does not require the taking of an oath of office to qualify the
elected directors and officers. Election alone does not make the person elected, a director but
there must be an acceptance, either express or implied, although he is rebuttably presumed to
accept upon notification, or enters upon the duties of an office after his election or appointment.
SEC Opinion, 21 January 1986, XX SEC QUARTERLY BULLETIN (Nos. 1 & 2, March & June, 1986).
67
94 Phil. 81 (1953).
68
Sec. 54, Corporation Code.
69
Ibid.
70
Ibid.
71
Ibid.
 In the election of officers, however, the vote of the majority of all the
members of the board is necessary.72

2. Requisites for a Valid Board Meeting

The following therefore are the requisites of a valid board meeting:

(a) Meeting of the directors or trustees duly assembled as a

board, at the place, time and manner provided in the by-
laws;
(b) Presence of the required quorum; and
(c) Decision of the majority of the quorum or, in other cases, a
majority of the entire board.

On account of their responsibility to the corporation, directors or trustees

cannot validly act by proxy.73 They must attend meetings of the board and act in
person and as a body. Each director or trustee is required by law to exercise his
personal judgment and he cannot delegate his powers or assign his duties.
In case of abstention during a board meeting on a vote taken on any
issue, the general rule is that an abstention is counted in favor of the issue that
won the majority vote; since by their act of abstention, the abstaining directors
are deem to abide by the rule of the majority.74

3. Mode of Attendance of Board Members

A director or trustee cannot attend nor be represented in a board meeting
by proxy. Since the board is the governing body of the corporation upon whom all
corporate powers are vested by law, each elected member are supposed to
exercise their judgment and discretion in running the affairs of the corporation.
The each have been elected by the stockholders or members on the basis of
their personal qualifications and capabilities with full expectations that they would
discharge their duties and functions personally.75
SEC Memorandum Circular No. 15, series of 2001, pursuant to the terms
of the Code of Commerce, embodies the guidelines for the conduct of
teleconferencing and videoconferencing (i.e., conferences or meetings through
electronic medium or telecommunications where the participants who are not
physically present are located at different local or international places) of board of
directors, providing for safeguards to ensure the integrity of the meeting, the

72
Ibid.
73
Sec. 26, Corporation Code; SEC Opinion, 22 May 1998, XXXII SEC QUARTERLY BULLETIN
13 (No. 1, June 1998).
74
Lopez v. Ericta, 45 SCRA 539 (1972).
75
See SEC Opinion, 7 February 1994,XXVIII SEC QUARTERLY BULLETIN 4 (No. 3, March
1994).
proper recording of the minutes thereof and the safekeeping of the electronic
recording mechanism as part of the records of the corporation.76

4. Attendance by Stockholders of Board Meetings

The SEC has opined that the Corporation Code does not confer upon any
stockholder the right to attend board meeting and that the allowance of
stockholders to attend board meeting is upon the discretion of the board itself.77

COMPENSATION OF DIRECTORS AND OFFICERS

Under Section 30 of the Corporation Code, in the absence of any
provision in the by-laws fixing their compensation, the directors shall not receive
any compensation, as each directors, except for reasonable per diems. 78
However, the section also provides that such compensation, other than per
diems, may be granted to directors by the vote of the stockholders representing
at least a majority of the outstanding capital stock at a regular or special
stockholders' meeting.
In no case shall the total yearly compensation of directors, as such
directors, exceed ten percent (10%) of the net income before income tax of the
corporation during the preceding year.79
When it comes to officers, no specific prohibition is found in the
Corporation Code. In Rogers v. Hill,80 there appeared a provision in the by-laws
of the corporation, which set a formula has been set by which to determine other
than the per diem, the compensation of directors. The compensation is usually
tied up with a certain percentage of the net income. For example 1% of net
income is reasonable enough. But in multi-million corporations like San Miguel,
even the 1% of net income as salary of the directors will go by the millions
already. Therefore, when the amount becomes huge and unreasonable, at that
point the courts may go in and in fact suspend the enforcement of the by-law
provision. What does this mean? The general rule is that the courts of law will
not meddle into business determination, one of which is the salary scale of
people. Except when it comes to the area of compensation of directors. The
courts have and will continue to come in on this area. If they find that the
compensation is unreasonable, then the courts will invalidate or render
unenforceable such a determination.
76
Likewise, Section 15 of the General Banking Law of 2000 provides that the meeting of the
board of directors of banks may be conducted through modern technologies such as, but not
limited to, teleconferencing and videoconferencing.
77
SEC Opinion, 21 January 1992, XXVI SEC QUARTERLY BULLETIN 6 (No. 2, June 1992).
78
The SEC has opined that nothing in the Corporation Code authorizes the corporation to
pay stockholders or members per diem for attendance in meetings, and that Section 47 of the
Code provides compensation to directors and trustees to the exclusion of stockholders and
members since the latter do not render service but attend meetings in the exercise of their
personal rights. SEC Opinion, 30 June 1971, SEC FOLIO 1960-1976, at p. 477.
79
Sec. 30, Corporation Code.
80
289 U.S. 582.
 Generally, dividends and compensation policies represent areas of
conflicts-of-interests. In cases where there is a danger of conflict situation, and
the Board will be in a position to choose between their personal interests and
those of the corporation, and other persons, namely the corporate creditors, it
grants courts jurisdiction to intervene in the exercise of judicial powers, in order
to make sure that the members of the board will not abuse the powers granted to
them. Conflicts-of-interests situations are clearly an exception to the business
judgment rule.
The law therefore draws a clear distinction between the functions of
directors and trustees, on the one hand, and the officers on the other hand. In
Western Institute of Technology, Inc. v. Salas,81 the Court held that “[d]irectors
and trustees are not entitled to salary or other compensation when they perform
nothing more than the usual and ordinary duties of their office, founded on the
presumption that directors and trustees render service gratuitously, and that the
return upon their shares adequately furnishes the motives for service, without
compensation.”82 It held that under Section 30 of the Corporation Code, there are
two (2) ways by which members of the board can be granted compensation apart
from reasonable per diems: (a) when there is a provision in the by-laws fixing
their compensation; and (b) when the stockholders representing a majority of the
outstanding capital stock at a regular or special meeting agree to give them
compensation, and concluded that “[f]rom the language of Section 30, it may also
be deduced that members of the board may also receive compensation, when
they render services to the corporation in a capacity other than as directors or
trustees of the corporation.”
The Court then held in Western Institute of Technology that position of
being Chairman and Vice-Chairman, like that of Treasurer and Secretary, were
considered by the officers as not mere directorship position, but officership
position that would entitle the occupants to compensation. Likewise, the limitation
placed under Section 30 of the Corporation Code that directors cannot receive
compensation exceeding 10% of the net income of the corporation, would not
apply to the compensation given to such positions since it is being given in their
capacity as officers of the corporation and not as board members.

CORPORATE OFFICERS
1. Theory on the Power of Board to Delegate its
Authority to Corporate Officers
Although Section 23 of the Corporation Code provides that the power and
the responsibility to decide whether the corporation should enter into a contract
that will bind the corporation is lodged in the Board, nevertheless, just as a
natural person may authorize another to do certain acts for and on his behalf, the
81
278 SCRA 216, 86 SCAD 315 (1997).
82
Ibid, at 223, citing AGBAYANI, COMMENTARIES AND JURISPRUDENCE ON THE COMMERCIAL
LAWS OF THE PHILIPPINES, Vol. 3, 1988 ed., p. 259.
board of directors may validly delegate some of its functions and powers to
officers, committees or agents.83 The authority of such individuals to bind the
corporation is generally derived from law, corporate by-laws, and authorizations
from the board, either expressly or impliedly by habit, custom or acquiescence in
the general course of business.84
Consequently, the general principles of agency govern the relation
between the corporation and its officers or agents, subject to the articles of
incorporation, by-laws, or relevant provisions of law. The Supreme Court has
therefore held: “A corporate officer or agent may represent and bind the
corporation in transactions with third persons to the extent that the authority to do
so has been conferred upon him, and this includes powers which have been
intentionally conferred, and also such powers as, in the usual course of the
particular business, are incidental to, or may be implied from, the powers
intentionally conferred, powers added by custom and usage, as usually
pertaining to the particular officer or agent, and such apparent powers as the
corporation has caused persons dealing with the officer or agent to believe that it
has conferred.”85

2. Two Levels of Discussions of Corporate Officership

In Corporate Law, there are two levels of discussions when it comes to the
coverage of "corporate officers". The first level, relates to the power of the board
of directors to hire and terminate officers in the exercise of business judgment, as
contrasted from non-officers who are protected by the security of tenure policy
under Labor Law, a policy embodied in the Constitution. As will be discussed
hereunder, the test of "officers" under first level is based on an arbitrary formula,
and does not necessarily go into the nature or importance of the position held;
and that the nature of the office is not essential in determining such type of
"officership."
The second level of determination of who are corporate officers deals on
the distinction of corporate officers from non-officers to determine who are bound
by the duties of loyalty and diligence. Under Section 31 of the Corporation Code,
both directors and officers are jointly and severally liable for assenting to patently
unlawful acts of the corporation or who are guilty of gross negligence or bad faith
in directing the affairs of the corporation or acquire any personal or pecuniary
interest in conflict with their duty as such directors or officers. Non-officers
therefore are not generally imposed any duty of loyalty or diligence. The
differentiation of such "officers" from non-officers must necessarily lie on the
nature of the office held by them.

83
People’s Aircargo and Warehousing Co., Inc. v. Court of Appeals, 297 SCRA 170, 182,
99 SCAD 482, 495 (1998).
84
Ibid.
85
San Juan Structural and Steel Fabricators, Inc. v. Court of Appeals, 296 SCRA 631, 645,
99 SCAD 281, 294 (1998); also BA Finance Corporation v. Court of Appeals, 211 SCRA 112
(1992).
 3. Theory on Power of Board to Appointment/
Terminate Corporate Officers
Officers of the corporation are within the business judgment of the board
of directors to terminate in the absence of a specific period of employments
provided in their contracts or in the by-laws. It has been held by the Supreme
Court that “[a] corporate officer‟s dismissal is always a corporate act, or an intra-
corporate controversy, and the nature is not altered by the reason or wisdom with
which the Board of Directors may have in taking such action.86
In Mita Pardo de Tavera v. Philippine Tuberculosis Society, Inc.,87 it was
held that since the letter of appointment as Executive Secretary to the Board of
the officer did not contain a fixed term, the implication is that appointee held an
appointment at the pleasure of the appointing power, which in essence was
temporary in nature, and co-extensive with the desire of the board of directors.
When the board opted to replace the incumbent, technically there was no
removal but only an expiration of the term and in an expiration of term, there is
no need of prior notice, due hearing or sufficient grounds before the incumbent
can be separated from office.
The ruling in De Tavera case was founded on the fact that the disputed
position of Executive Secretary was also provided for in the Code of By-Laws of
the Philippine Tuberculosis Society, Inc.

a. Two Disciplines Diverging in Corporate

Officership Issues
In strict corporate sense, the terms of corporate officers is co-terminous
with that of the board. It can even be said that corporate officers serve at the
pleasure of the board. This is a fundamental doctrine in Corporate Law because
the ability of the board to hire and terminate officers lies at the very heart of the
operations of the corporation; it is part of the exercise of the business judgment
of the board.
On the other, under Labor Laws, corporate officers are also looked upon
as employees, and the corporation as the employer. Consequently, the protective
policies of the Labor Code, as well as the Constitution (e.g., due process and
security of tenure) are also made to apply to corporate officers.
It is the divergence of policies and principles in Corporate Law and Labor
Law that creates jurisprudential tension, and has spun several clarificatory
doctrines on the matter.

86
Tabang v. NLRC, 266 SCRA 462, 78 SCAD 174 (1997); Fortune Cement Corporation v.
NLRC, 193 SCRA 258 (1991). Tabang also held: “An „office‟ is created by the charter of the
corporation and the officer is elected by the directors or stockholders (2 Fletcher Cyc. Corp. Ch.
II, Sec. 266). On the other hand, an “employee” usually occupies no office and generally is
employed not by action of the directors or stockholders but by the managing officer of the
corporation who also determines the compensation to be paid to such employee.”
87
112 SCRA 243 (1982).
 The issue of who are corporate officers was essential in determining who
had proper jurisdiction in cases involving officers, whether it was the SEC under
Section 5 of Pres. Decree 902-A or the NLRC. Pursuant to Section 5.2 of the
Securities Regulation Code,88 the quasi-judicial jurisdiction of the SEC under
Section 5 of the Decree has been transferred to the Regional Trial Courts (RTC).
The issue therefore as to who are properly the officers of a corporation would still
be relevant as to determining whether it is the RTC or the NLRC which would
have proper jurisdiction over cases involving the appointment and termination of
corporate officers.

4. Election or Appointment of Officers

Under Section 25 of the Corporation Code, immediately after their
election, the directors of a corporation must formally organize by the election of a
president, who shall be a director, a treasurer who may or may not be a director,
a secretary who shall be a resident and citizen of the Philippines, and such other
officers as may be provided for in the by-laws. Any two or more positions may be
held concurrently by the same person, except that no one shall act as president
and secretary or as president and treasurer at the same time.
The reason for the prohibition of the President also occupying the position
of treasurer or secretary at the same time is to prevent an abuse of power and
discretion, and to provide a system of check and balance between such sensitive
positions. It is not hard to imagine the temptations allayed to a President, if he
could certify unauthorized expenditures, if he is also treasurer, or to issue a
Secretary's Certificate over power or authority over which the board had not
granted him.
The directors or trustees and officers to be elected shall perform the duties
enjoined on them by law and the by-laws of the corporation.
In a stock corporation, the appointment of an officer is solely within the
power of the board of directors. In a non-stock corporation, unless otherwise
provided for in the articles of incorporation or the by-laws, officers of a non-stock
corporation may be elected by the members.89

5. President
People’s Aircargo and Warehousing Co., Inc. v. Court of Appeals,90
discussed the nature of the position of the President and the powers vested in
him by reason of such position, thus:

Inasmuch as a corporate president is often given general

supervision and control over corporate operations, the strict
rule that said officer has no inherent power to act for the

88
Rep. Act No. 8799.
89
Sec. 92, Corporation Code.
90
297 SCRA 170, 99 SCAD 482 (1998).
 corporation is slowly giving way to the realization that such
officer has certain limited powers in transactions of the usual
and ordinary business of the corporation. In the absence of a
charter or bylaw provision to the contrary, the president is
presumed to have the authority to act within the domain of the
general objectives of the corporation‟s business and within the
scope of his or her usual duties. Hence, it has been ruled in
other jurisdiction that the president of the corporation
possesses the power to enter into a contract for the
corporation, when the “conduct on the part of both the
president and the corporation [shows] that he had been in the
habit of acting in similar matters on behalf of the company and
that the company had authorized him so to act and had
recognized, approved and ratified his former and similar
actions. Furthermore, a party dealing with the president of a
corporation is entitled to assume that he has the authority to
enter, on behalf of the corporation, into contracts that are
within the scope of the powers of said corporation and that do
not violate any statute or rule on public policy.91

6. Corporate Secretary
Torres, Jr. v. Court of Appeals,92 had held that in the absence of
provisions to the contrary, the corporate secretary is the custodian of corporate
records—he keeps the stock and transfer book and makes proper and necessary
entries therein. It is the duty and obligation of the corporate secretary to register
valid transfers of stock in the books of the corporation; and in the event he
refuses to comply with such duty, the transferor-stockholder may rightfully bring
suit to compel performance.
When a Secretary‟s Certificate is regular on its face, it can be relied upon
by a third party who does not have to investigate the truths of the facts contained
in such certification; otherwise business transactions of corporations would
become tortuously slow and unnecessarily hampered.93

7. Corporate Treasurer
A corporate treasurer‟s function have generally been described as “to
receive and keeps funds of the corporation, and to disburse them in accordance
with the authority given him by the board or the properly authorized officers.”
Unless duly authorized, a treasurer, whose power are limited, cannot bind
the corporation in a sale of its assets. Selling is obviously foreign to a corporate
treasurer‟s function. When the corporation categorically denies ever having
authorized its treasurer to sell the subject parcel of land, the buyer had the

91
Ibid, at pp. 185-186.
92
278 SCRA 793, 86 SCAD 812 (1997).
93
Esguerra v. Court of Appeals, 267 SCRA 380, 78 SCAD 741 (1997).
burden of proving that the treasurer was in fact authorized to represent and bind
the allegedly selling corporation in the transaction. And failing to discharge such
burden, and failing to show any provision of the articles of incorporation, bylaws
or board resolution to prove that the treasurer possessed such power, the sale is
void and not binding on the alleged selling corporation.94

8. Corporate “Agents” for Purposes of Service

of Summons upon Corporation
The Supreme Court in Pabon v. NLRC,95 also discussed the extent of
coverage of the term “corporate agents,” relying upon the Black‟s Law Dictionary
which defines an “agent” as “a business representative, whose function is to
bring about, modify, affect, accept performance of, or terminate contractual
obligations between principal and third persons.” To this extent, an “agent” may
also be shown to represent his principal in some one or more of his relations to
others, even though he may not have the power to enter into contracts. The rules
on service of process make service on “agent” sufficient. It does not in any way
distinguish whether the “agent” be general or special, but is complied with even
by a service upon an agent having limited authority to represent his principal. As
such, it does not necessarily connote an officer of the corporation. However,
though this may include employees other than officers of a corporation, this does
not include employees whose duties are not so integrated to the business that
their absence or presence will not toll the entire operation of the business.
Pabon held that for purposes of determining proper service of summons to
a corporation in a quasi-judicial proceeding before the NLRC, a bookkeeper can
be considered as an agent of the corporation within the purview of the Rules of
Court. The rationale of all rules with respect to service of process on a
corporation is that such service must be made to an agent or a representative so
integrated with the corporation sued as to make it a priori supposable that he will
realize his responsibilities and know what he should do with any legal papers
served on him. The bookkeeper‟s task is one under consideration that his regular
recording of the corporation‟s “business accounts” and “essential facts about the
transactions of a business or enterprise” safeguards the corporation from
possible fraud being committed adverse to its own corporate interest.
Section 11, Rule 14 of the 1997 Rules of Civil Procedure has now
removed “agent” from those enumerated officers authorized to receive summons
for a corporate defendant. Consequently, the case-law on the matter may no
longer apply.
E.B. Villarosa & Partners Co., Ltd. v. Benito,96 has clearly reversed the
previous rulings on service of summons to “agents” of the corporate defendant.
Consequently, the following doctrines no longer apply: service of summons upon

94
San Juan Structural and Steel Fabricators, Inc. v. Court of Appeals, 296 SCRA 631, 645,
99 SCAD 281, 295 (1998).
95
296 SCRA 7, 98 SCAD 665 (1998).
96
312 SCRA 65, 71-72 (1999).
a construction project manager;97 a corporation‟s assistant manager;98 ordinary
clerk of a corporation;99 private secretary of corporate executives;100 retained
counsel;101 officials who had charge or control of the operations of the
corporation, like the assistant general manager;102 or the corporation‟s Chief
Finance and Administrative Officer.103

COMMON LAW NATURE OF DUTIES OF

DIRECTORS, TRUSTEES AND OFFICERS
In Philippine setting, the three-fold duties of directors, trustees and officers
are the duty of obedience, duty of diligence, and the duty of loyalty.
The present Corporation Code contains specific provisions governing the
duties and liabilities of directors, trustees and officers of the corporation, under
Sections 31, 32, 33 and 34. Those sections are new in the Code, and have no
counterpart in the old Corporation Law. Nevertheless, even under the old
Corporation Law, the three-fold duties of directors, trustees and officers were
well-recognized.
Palting v. San Jose Petroleum, Inc.,104 considered provisions in the by-
laws of a corporation seeking to have its securities registered and distributed in
the Philippines. The Supreme Court held:

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. Considering
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
associations or corporation; and that none of such contracts or
transactions of this company with any person or persons,
firms, associations or corporation 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
97
Kanlaon Construction Enterprises Co., Inc. v. NLRC, 279 SCRA 337 (1997).
98
Gesulgon v. NLRC, 219 SCRA 561 (1993).
99
Golden Country Farms, Inc. v. Sanvar Development Corporation, 214 SCRA 295 (1992);
G & G Trading Corporation v. Court of Appeals, 158 SCRA 466 (1988).
100
Summit Trading and Development Corporation v. Avendaño, 135 SCRA 397 (1985).
101
Republic v. Ker & Co., Ltd., 18 SCRA 207 (1966).
102
Villa Rey Transit, Inc. v. Far East Motor Corp., 81 SCRA 298 (1978).
103
Far Corporation v. Francisco, 146 SCRA 197 (1986). See also Filoil Marketing Corp. vs.
Marine Development Corp. of the Philippines, 177 SCRA 86 (1982).
104
18 SCRA 924 (1966).
 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.105

In that case the Court held: "The impact of these provisions upon the
traditional fiduciary 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 and 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 provisions which
authorized the election of non-stockholders as directors, completely disassociate
the stockholders from the government and management of the business in which
they have invested."106
Prime White Cement Corp. v. Intermediate Appellate Court,107 also
recognized that the fiduciary obligations of the directors and trustees of a
corporation, as they are now set out in the Corporation Code, merely incorporate
well-settled principles in Corporate Law.108
It is clear therefore that the duties and obligations of directors, trustees
and officers of the corporation have their bases in common law, derived from the
nature and relationships created in the corporate setting and the fiduciary nature
of the positions held by such persons. Therefore, the attempt under the
Corporation Code to define in statutory form the nature of the duties and
obligations of directors, trustees and officers can only be construed as an attempt
to cover most of the such situations, but cannot be considered as to exclude
other forms of violations of such duties as to be outside of corporate sanction.
For example, the violation of the duty of loyalty found in Sections 33 and
34 of the Corporation Code where a conflict of interest is present either in direct
dealings of an officer with the corporation or in dealings between corporations
having interlocking directors. In a situation where there would still be conflict of
interests that may work injustice to a corporation by a director or trustee who is in
a conflict situation, but that the circumstances do not squarely fall within the
coverage of Sections 33 and 34 of the Corporation Code, nevertheless a cause
of action would still arise in favor of the corporation to annul such a contract
entered into its name.

105
Ibid, at pp. 942-943.
106
Ibid.
107
220 SCRA 103 (1993).
108
Ibid, at p. 112.
GENERAL RULE ON DUTIES AND LIABILITIES OF
DIRECTORS, TRUSTEES AND OFFICERS
The general rule is that members of the board and officers of a corporation
who purport to act for and in behalf of the corporation, keep within the lawful
scope of their authority in so acting, and act in good faith, do not become liable,
whether civilly or otherwise, for the consequences of their acts. Those acts, when
they are such a nature and are done under such circumstances, are properly
attributed to the corporation alone and no personal liability is incurred by such
officers and Board members.109
Even in a situation where a contract was entered into with the corporation
and it specified that it was signed in consideration of the President of the
corporation and that if the latter should cease to be the manager of the
corporation that the contract would terminate, did not make the President liable
personally under the contract since the Supreme Court considered it as
"elementary that a corporation has a personality separate and distinct from the
persons composing it," and nothing in the contract provided that the President
would be bound in his personal capacity.110
A corporate officer cannot be held personally liable for a corporate debt
simply because he had executed the contract for and in behalf of the corporation.
It held that when a corporate officer acts in behalf of a corporation pursuant to his
authority, is "a corporate act for which only the corporation should be made liable
for any obligations arising from them."111
The President and General Manager of a corporation who entered into
and signed a contract in his official capacity cannot be made liable thereunder in
his individual capacity in the absence of stipulation to that effect due to the
personality of the corporation being separate and distinct from the persons
composing it.112
The proper appreciation of the director's role and function would require
that although a director may have been voted into office by a block of
shareholders, it is the director's duty to vote according to his own independent
judgment and his own conscience as to what is in the best interests of the
corporation.113

DUTY OF OBEDIENCE
Since the Corporation Code still adheres to the ultra vires doctrine,114 then
the Board of Directors or Trustees of a corporation are bound to observe the duty

109
Benguet Electric Cooperative, Inc. v. NLRC, 209 SCRA 55, 63 (1992).
110
Banque Generale Belge v. Walter Bull & Co., Inc., 84 Phil. 164, 167 (1949).
111
Western Agro Industrial Corporation v. Court of Appeals, 188 SCRA 709 (1990).
112
Rustan Pulp & Paper Mills, Inc. v. IAC, 214 SCRA 665 (1992), citing Banque Generale
Belge v. Walter Bull and Co., 84 Phil. 164 (1949).
113
San Miguel Corp. v. Kahn, 176 SCRA 447, 463 (1989).
114
Sec. 45, Corporation Code.
of obedience, which means that they will direct the affairs of the corporation only
in accordance with the purposes for which it was organized. Section 26 of the
Corporation Code expressly provides that “directors or trustees and officers to be
elected shall perform the duties enjoined on them by law and by the by-laws of
the corporation.”
As one author has said: "Although the corporate powers of private
corporations organized under the Corporation Law are exercised and controlled
by a board of directors, yet these powers of the board are necessarily limited,
because all the limitations imposed by law on private corporation are necessarily
imposed also on the board of directors who act in behalf of the corporation. In
other words, what is ultra vires or beyond the power on the part of the
corporation must also be ultra vires or beyond the power on the part of its board
of directors."115

DUTY OF DILIGENCE
Under Section 31 of the Corporation Code, directors or trustees who
willfully and knowingly vote for or assent to patently unlawful acts of the
corporation or who are guilty of gross negligence or bad faith in directing the
affairs of the corporation, shall be liable jointly and severally for all damages
resulting therefrom suffered by the corporation, its stockholders or members and
other persons.
The liability of guilty directors shall be jointly and severally; the solidary
obligation is availabe not only to the corporation but also to stockholders and
others who might suffer from such wrongful act.
The liability is such that a director need to have voted for in order to be
liable, but mere assent to a wrongful act or contract would make him liable.
Therefore, when an unlawful act or contract is for decision of the board, it is not
enough that the director abstains from voting; i is important to cast a negative
vote and allow such to be placed of record in order to escape liability.
Benguet Electric Cooperative, Inc. v. NLRC,116 held that Section 31 of the
Corporation Code applies even to government-owned and -controlled
corporations, pursuant to the provisions of Section 4 of the Code that renders the
provisions of the Corporation Code applicable in a supplementary manner to all
corporations, including those with special or individual charters so long as those
provisions are not inconsistent with such charters.
Benguet Electric Cooperative also held "[t]he dismissal of an officer or
employee in bad faith, without lawful cause and without procedural due process,
is an act that is contract legem. It cannot be supposed that members of the
boards of directors derive any authority to violate the express mandates of law or
the clear legal rights of their officers and employees by simply purporting to act

115
Guevarra, The Social Function of Private Corporations, 34 PHIL. L.J. 464, 465 (1959).
116
Guevarra, The Social Function of Private Corporations, 34 PHIL. L.J. 464, 465 (1959).
for the corporation they control."117 In addition, it held that the corporation would
then have a right to be reimbursed from the board of directors for any amounts
that the corporation is adjudged to have to pay to a third party claimant by reason
of the unlawful decision of the board of directors. "Such right of reimbursement is
essential if the innocent members [of the corporation] are not to be penalized for
the acts of respondent Board members which were both done in bad faith and
ultra vires. The liability-generating acts here are the personal and individual acts
of respondents Board members, and are not properly attributed to [the
corporation] itself."118
When it comes to the acts and contracts of the board of directors and
officers of the corporation, Board of Liquidators v. Kalaw,119 defined the meaning
and coverage of "bad faith," thus:

Rightfully had it been said 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 breach of a known duty thru some motive or
interest or ill will; it partakes of the nature of fraud. Applying
this precept to the given facts herein, we find that there was no
"dishonest purpose," or "some moral obliquity," or "conscious
doing of wrong," or "breach of a known duty," or "some motive
or interest or ill will:” that "partakes of the nature of fraud.”
Nor was it even intimated here that the NACOCO
directors acted for personal reasons, or to serve their own
private interests, or to pocket money at the expense of the
corporation. We have had occasion to affirm that bad faith
contemplates a "state of mind affirmatively operating with
future design or with some motive of self-interest or ill will or
for ulterior purpose,"120 . . ."Upon a close examination of the
reported cases although there are many dicta no easily
reconcilable, yet I have found no judgment or decree which
has held directors to account, except when they have
themselves been personally guilty of some fraud on the
corporation, or have known and connived at some fraud in
others, or where such fraud might have been prevented had
they given ordinary attention to their duties. . ."121 Plaintiff did
not even dare charge its defendant-directors with any of these
malevolent acts.122

117
Ibid, at p. 66.
118
Ibid.
119
20 SCRA 986, 1006-1007 (1967)
120
Citing Air France v. Carascoso, 18 SCRA 155 (1966).
121
Briggs v. Spaulding, 141 U.S. 132, 148-149, 35 L.Ed. 662, 669, quotes with approval
from Judge Sherwood in Sperings Appl., 71 Pa. 11.
122
Ibid.
 The general rule however that mere ownership of majority of the shares of
stock in a corporation, or mere officership itself does not make one personally
liable:

It is well known that a corporation is an artificial being

invested by law with a personality of its own, separate and
distinct from that of its stockholders and from that of its officers
who manage and rum its affairs. The mere fact that its
personality is owing to a legal fiction and that it necessarily has
to act through its agents, does not make the latter personally
liable on a contract duly entered into, or for an act lawfully
performed, by them for and in its behalf. The legal fiction by
which the personality of a corporation is created is a practical
reality and necessity. Without it no corporate entities may exist
and no corporate business may be transacted. Such legal
fiction may be disregarded only when an attempt is made to
use it as a cloak to hide an unlawful or fraudulent purpose. No
such thing has been alleged or proven in this case. It has not
been alleged nor even intimated that Vazquez personally
benefitted by the contract of sale in question and that he is
merely invoking the legal fiction to avoid personal liability.
Neither is it contended that he entered into said contract for
the corporation in bad faith and with intent to defraud the
plaintiff. We find no legal and factual basis upon which to hold
him liable on the contract either principally or subsidiarily.
. . . The fact that the corporation, acting through
Vazquez as its manager, was guilty of negligence in the
fulfillment of the contract, did not make Vazquez principally or
even subsidiarily liable for such negligence. Since it was the
corporation's contract, its nonfulfillment, whether due to
negligence or fault or to any other cause, made the
corporation and not its agent liable.123

Even under the old Corporation Law, which unlike the present Corporation
Code, did not have specific provisions governing the liabilities of directors,
trustees, or officers, nevertheless the duties of diligence and loyalty were clearly
recognized to exist.
An example of violation of the duty of diligence covering a conflict-of-
interests situation is found in Steinberg v. Velasco.124 In that case, the directors
of the corporation were held personally liable for causing the corporation to
purchase their own shares of stock and declaring dividends, which because of
the failure to take into consideration of worthless receivables, worked to the
detriment of the creditors. The Supreme Court held that the directors did not act
with diligence in taking the word of their chairman and not making an informed

123
Vazquez v. Borja, 74 Phil. 560, 566-568 (1944).
124
52 Phil. 953 (1929).
decision based on the facts then available to them and on not relying on other
documents available to them.

DUTY OF LOYALTY; CORPORATE OPPORTUNITY DOCTRINE

Under Section 31 of the Corporation Code, directors or trustees who
acquire any personal or pecuniary interest in conflict with their duty as such
directors or trustees shall be liable jointly and severally for all damages resulting
therefrom suffered by the corporation, its stockholders or members and other
persons.
When a director, trustee or officer attempts to acquire or acquires, in
violation of his duty, any interest adverse to the corporation in respect of any
matter which has been reposed in him in confidence, as to which equity imposes
a liability upon him to deal in his own behalf, he shall be liable as a trustee for the
corporation and must account for the profits which otherwise would have accrued
to the corporation.
On the other hand, under Section 34, where a director, by virtue of his
office, acquires for himself a business opportunity which should belong to the
corporation, thereby obtaining profits which should belong to the corporation, he
must "account to the latter for all such profits by refunding the same, unless his
act has been ratified by a vote of the "stockholders" owning or representing at
least two-thirds (2/3) of the outstanding capital stock. This provision shall be
applicable, notwithstanding the fact that the director risked his own funds in the
venture.
The differences between the second paragraph of Section 31 and Section
34 are therefore as follows:

(a) While they both cover the same subject matter which is
business opportunity but they concern different personalities;
Section 34 is only applicable to directors and not to officers,
while Section 31, is applicable to directors, trustees and
officers;
(b) Section 34 allows a ratification of a transaction by a self-
dealing director by the vote of stockholders representing
two-thirds (2/3) of the outstanding capital stock; Section 31
does not cover ratification, and even if 99% of the
stockholders affirm the transactions, the remaining minority
shareholders can still oppose such a self-dealing transaction
and file a derivative suit for and in behalf of the corporation.

Why is it that the self-dealing transaction entered into by a director can be

ratified while that entered by an officer cannot be ratified?
One theory that has been offered is that directors and trustees are the
direct elected representatives of the stockholders or members. Under the theory
of delegated power, directors and trustees are responsible directly to the
stockholders and members. Consequently, when they breach their duty of
obedience, power has been granted to their principle to waive any cause of
action on their delegates.
On the other hand, officers are not generally elected by the stockholders
or members, but actually appointed by the board. Therefore, the board as mere
delegates of the stockholders and members, cannot waive the officer's
misfeasance.
The other theory is that officers are mandated to have a greater degree of
loyalty to the corporation than the directors since officers spend more time with
the affairs of the corporation, getting salary from the corporation and working day
to day for the corporation; whereas directors usually meet only once a month and
have other business aside from their being directors. Therefore, the closeness to
corporate operations and secrets imposes upon corporate officers a higher
degree of liability in case of breach of the duty of loyalty to which the law does
not grant a reprieve, not even by way of ratification by the stockholders or
members.
In a situation where violation of the duty of loyalty on the part of the
majority stockholder who also acted as officer of the corporation warranted his
removal or seeking dissolution on the part of the minority stockholder, the Court
in Chase v. Buencamino, Sr.,125 held: "The removal of a stockholder (in this case
a majority stockholder) from the management of the corporation and/or the
dissolution of a corporation in a suit filed by a minority stockholder is a drastic
measure. It should be resorted to only when the necessity is clear which is not
the situation in the case at bar."
The Court approved the mechanism provided by the trial court whereby
instead of the appointment of a receiver, the minority stockholder was given a
veto right, appealable to the court, on all decisions of management.
Chase also characterized the obligation of the officer who violates his duty
of loyalty to reimburse the corporation for profits earned based on the principles
of trust: "He willingly benefited therefrom, that was a fraud upon Amparts and on
the broad of principle of agency and trust, 1455, 1891, New Civil Code, he should
surrender thereon, his gains."

DEALINGS OF DIRECTORS, TRUSTEES

OR OFFICERS WITH CORPORATION
Under Section 35 of the Corporation Code, a contract of the corporation
with one or more of its directors or trustees or officers is voidable at the option of
such corporation, unless all the following conditions are present that:

125
136 SCRA 365, 385 (1983).
 (a) The presence of such director or trustee in the board
meeting in which the contract was approved was not
necessary to constitute a quorum for such meeting;
(b) The vote of such director or trustee was not necessary for
the approval of the contract;
(c) The contract is fair and reasonable under the circumstances;
and
(d) In the case of an officer, the contract with the officer has
been previously authorized by the board of directors.

Where any of the first two conditions set forth in the preceding paragraph
is absent, in the case of a contract with a director or trustee, such contract may
be ratified by the vote of the stockholders representing at least two-thirds (2/3) of
the outstanding capital stock, or of two-thirds (2/3) of the members, as the case
may be, in a meeting called for the purpose. However, in order that such
ratificatory vote would be valid, it is required that there be full disclosure of the
adverse interest of the directors or trustees involved is made.
In Mead v. McCullough,126 it was held that while a corporation remains
solvent, there is no 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."127
Mead held that where a director in a corporation accepts a position in
which his duties are incompatible with those as such director it is presumed that
he has abandoned his office as director of the corporation.
Prime White Cement Corp. v. Intermediate Appellate Court,128 recognizing
that the provisions of Section 31 of the Corporation Code on self-dealing merely
incorporated well-established principles in Corporate Law, applied the procedure
required therein for determining the validity of a contract entered into by the
corporation with its director.
126
21 Phil. 95 (1911).
127
Ibid, at pp. 113-114.
128
220 SCRA 103 (1993).
 The facts in that case showed that a director entered into a Dealership
Agreement with the corporation, signed by its chairman and president, for the
corporation to supply 20,000 bags of white cement per month for five years at a
fixed price of P9.70 per bag. Subsequently, the Board refused to abide by the
contract unless new conditions are accepted providing for new price formula. The
dealing director sued for specific performance on the contract. The Court held
that although the general rule when it comes to President entering into a contract
for the corporation is that when the contract is in the ordinary course of business,
provided the same is reasonable under the circumstances, the contract binds the
corporation, nevertheless the rule does not apply when the contract is entered
into with a director or officer of the corporation itself. A director holds a position of
trust and as such, he owes a duty of loyalty to his corporation, and his contracts
with the corporation must always be at reasonable terms, otherwise the contract
is void or voidable at the option of the corporation.
The Court found that the terms of the Dealership Agreement were
unreasonable for the corporation. It held that the dealing director was a
businessman himself and must have known, or at least must be presumed to
know, that at that time, prices of commodities in general, and white cement in
particular, were not stable and were expected to rise. "At the time of the contract,
petitioner corporation had not even commenced the manufacture of white
cement, the reason why delivery was not to begin until 14 months later. . . no
provision was made in the `dealership agreement' to allow for an increase in
price mutually acceptable to the parties." It held that the unfairness in the
contract is also a basis which renders a contract entered into by the President,
without authority from the Board of Directors, void or voidable, although it may
have been in the ordinary course of business. Finally, it noted that there was no
showing that the stockholders had ratified the agreement or that they were fully
aware of its provisions.

CONTRACTS BETWEEN CORPORATIONS

WITH INTERLOCKING DIRECTORS
Under Section 33 of the Corporation, except in cases of fraud, and
provided the contract is fair and reasonable under the circumstances, a contract
between two or more corporations having interlocking directors shall not be
invalidated on that ground alone. However, if the interest of the interlocking
directors in one corporation or corporations is merely nominal, he shall be subject
to the same ratificatory vote required from stockholders and members, as in the
case of dealings of directors, trustees and officers with their corporation.
Stockholdings exceeding twenty percent (20%) of the outstanding capital
stock shall be considered substantial for purpose of interlocking directors.
LIABILITY OF OFFICERS129
1. General Rule on Liability of Officers
The general rule is laid down in Palay, Inc. v. Clave,130 that unless
"sufficient proof exists on record" that an officer (in that case, a President and
controlling stockholder) has "used the corporation to defraud private respondent"
he cannot be made personally liable "just because he „appears to be the
controlling stockholder.'"131 "Mere ownership by a single stockholder or by
another corporation of all or nearly all of the capital stock of a corporation is not
of itself sufficient ground for disregarding the separate corporate personality."132
Pabalan v. NLRC,133 held that "[t]he settled rule is that the corporation is
vested by law with a personality separate and distinct from the persons
composing it, including its officers as well as from that of any other entity to which
it may be related . . . [and an officer] acting in good faith within the scope of his
authority . . . cannot be held personally liable for damages."134
Pabalan refused to hold the officers of the corporation personally liable for
corporate obligations on employees' wages, since "[i]n this particular case
complainants did not allege or show that petitioners, as officers of the corporation
deliberately and maliciously designed to evade the financial obligation of the
corporation to its employees, or used the transfer of the employees as a means
to perpetrate an illegal act or as a vehicle for evasion of existing obligation, the
circumvention of statutes, or to confuse the legitimate issues."135
In R.F. Sugay v. Reyes,136 an attempt by the corporation to avoid liability
by distancing itself from the acts of the its President was struck down with the
Court holding that a corporation may not distance itself from the acts of a senior
officer: "the dual roles of Romulo F. Sugay should not be allowed to confuse the
facts."137
To the same effect is the ruling in Paradise Sauna Massage Corporation
v. Ng,138 where it was held that an officer-stockholder who is a party signing in
behalf of the corporation to a fraudulent contract cannot claim the benefit of
separate juridical entity: "Thus, being a party to a simulated contract of
management, petitioner Uy cannot be permitted to escape liability under the said

129
This section originally appeared as part of the article Restatement of the Doctrine of
Piercing the Veil of Corporate Fiction, published in 37 ATENEO L. J. 19 (Number 2, June, 1993).
130
124 SCRA 638 (1983).
131
Ibid, at pp. 648-649.
132
Ibid, at p. 649.
133
184 SCRA 495 (1990).
134
Ibid, at p. 499.
135
Ibid, at p. 500.
136
12 SCRA 700 (1964).
137
Ibid, at p. 705.
138
181 SCRA 719 (1990).
contract by using the corporate entity theory. This is one instance when the veil
of corporate entity has to be pierced to avoid injustice and inequity." 139
Tramat Mercantile, Inc. v. Court of Appeals,140 holds that personal liability
of a corporate director, trustee or officer along (although not necessarily) with the
corporation may so validly attach, as a rule, only when:

(a) He assents (i) to a patently unlawful act of the corporation, or

(ii) for bad faith or gross negligence in directing its affairs, or
(iii) for conflict of interest, resulting in damages to the
corporation, its stockholders or other persons (Section 31,
Corporation Code);
(b) He consents to the issuance of watered stocks or who,
having knowledge thereof, does not forthwith file with the
corporate secretary his written objection thereto (Section 65,
Corporation Code);
(c) He agrees to hold himself personally and solidarily liable with
the corporation (De Asis & Co., Inc. v. Court of Appeals, 136
SCRA 599 [1985]);
(d) He is made, by a specific provision of law, to personally
answer for his corporate action (Exemplified in Section 144,
Corporation Code; also Section 13, Pres. Decree No. 115, or
the Trust Receipts Law).141

In addition, jurisprudence has also held that the officer of the corporation
can be held solidarily liable with the corporation for simulated or fraudulent
contracts entered into in behalf of the corporation.142
National Power Corp. v. Court of Appeals,143 held that the finding of
solidarily liable among the corporation and its officers and members of the Board
of Directors would be patently baseless when the decision of the trial court
contains no such allegation, finding or conclusion regarding particular acts
committed by said officers and directors that show them to have individually
guilty of unmistakable malice, bad faith, or ill-motive in their personal dealings
with an entity which dealt with their corporation; and that in fact it was only in the
dispositive portion of the decision of the trial court that solidary liability as such
was first mentioned. It also ruled that when the corporate officers and directors
are sued merely as nominal parties in their official capacities as such, by that
reason alone they cannot be made personally liable for the judgment against the
corporation.

139
Ibid, at p. 729.
140
238 SCRA 14, 56 SCAD 450 (1994).
141
The listing was reiterated in Santos v. NLRC, 254 SCRA 673, 682, 69 SCAD 390, 398
(1996); Uichico v. NLRC, 273 SCRA 35, 83 SCAD 31 (1997).
142
Paradise Sauna v. Ng, 181 SCRA 719 (1990).
143
273 SCRA 419 (1997).
 2. Different Strain in Labor Law
In the field of labor, however, liability of corporate officers for corporate
obligations to employees seems to have taken two different strains.
In A.C. Ransom Labor Union-CCLU v. NLRC,144 the Court in interpreting
the Labor Code held that since a corporate employer is an artificial person, it
must have an officer who can be presumed to be the employer, being the
"person acting in the interest of (the) employer" as provided in the Labor Code. 145
Therefore, A.C. Ransom held that "the responsible officer of the employer
corporation can be held personally, not to say even criminally, liable for non-
payment of backwages; and that in the absence of definite proof as to the identity
of an officer or officers of the corporation directly liable for failure to pay
backwages, the responsible officer is the president of the corporation jointly and
severally with other presidents of the same corporation."
In effect, A.C. Ransom would hold a corporate officer liable for corporate
obligations by the mere fact that he is the highest officer even when there is no
proof that he acted in the particular matter for the corporation.
Later, in Chua v. NLRC,146 the vice-president of the company was made
personally liable also for being the highest and most ranking official of the
corporation next to the President who was dismissed, for the latter's claim for
unpaid wages.
In Del Rosario v. NLRC,147 the Court (stating that the doctrine in A.C.
Ransom inapplicable without further explanation) refused to allow a writ of
execution against the properties of officers and stockholders for a judgment
rendered against the corporation which was later found without assets on the
ground that "[b]ut for the separate juridical personality of a corporation to be
disregarded, the wrongdoing must be clearly and convincingly established. It
cannot be presumed." In addition, it was held that "[t]he distinguishing marks of
fraud were therefore clearly apparent in A.C. Ransom. A new corporation was
created, owned by the same family, engaging in the same business and
operating in the same compound."
In short, Del Rosario re-affirmed the original doctrine before A.C. Ransom
pronouncement that in order for a corporate officer or stockholder to be held
liable for corporate debts it must clearly be shown that he had participated in the
fraudulent or unlawful act.
The principle was reinforced in Western Agro Industrial Corporation v.
Court of Appeals,148 which held that a corporate officer cannot be held personally
liable for a corporate debt simply because he had executed the contract for and
144
142 SCRA 269 (1986).
145
The decision interpreted the meaning of the word "employer" from Art. 212(c) of the
Labor Code, which provided: "(c) `Employer' includes any person acting in the interest of an
employer, directly or indirectly. . ." Ibid, at p. 273.
146
182 SCRA 353 (1990).
147
187 SCRA 777 (1990).
148
188 SCRA 709 (1990).
in behalf of the corporation. It held that when a corporate officer acts in behalf of
a corporation pursuant to his authority, is "a corporate act for which only the
corporation should be made liable for any obligations arising from them."149
Two months after Del Rosario, the Court in Maglutac v. NLRC,150 held a
corporate officer liable for the claims against the corporation, relying upon the
A.C. Ransom ruling but only with respect to the doctrine that the responsible
officer of a corporation who had a hand in illegally dismissing an employee
should be held personally liable for the corporate obligations arising from such
act.
Prior to A.C. Ransom, the ruling of the Supreme Court in Garcia v.
NLRC,151 is that personal liability of corporate officers to dismissed employees
depends on whether such officer acted with evident malice and bad faith, and
when no evidence is adduced to show any of these circumstances, even the
acting officer dismissing the employees cannot be held personally liable. This
ruling was reiterated recently in Seaborne Carriers Corporation v. NLRC.152
Recently in Santos v. NLRC,153 clarified that Article 289 of the Labor
Code154 cannot be applied to hold the President of the corporation liable
personally because the provisions refers only to the imposition of penalties under
the Code." It held that when the termination of an officer is due , collectively, to
the need to further mtigiation of losses, the onset of the rainy season, the
insurgency problem in the area and the lack of funds to further support the
mining operations of the corporation, then the provision of Article 289 do not
apply.
The Court held that that the A.C. Ransom and Chua cases, which involved
holding the President and Vice-President, respectively, liable personally in the
absence of clear identification of the officer directly responsble for failure to pay
backwages, applied only because in both cases involved family-owned
corporations and rightfully applied the doctrined of piercing the veil of corporation
fiction.155 The Court upheld the basic rule enunciated in Sunio that "It is basic that
a corporation is invested by law with a personality separate and distinct from
those of the persons composing it as well as from that of any other legal entity to
which it may be related. Mere ownership by a single stockholder or by another
corporation of all or nealry all of the capital stock of a corporation is not of itself

149
Ibid, at p. 718.
150
189 SCRA 767 (1990).
151
153 SCRA 639 (1987).
152
237 SCRA 343, 55 SCAD 842 (1994).
153
254 SCRA 673, 69 SCAD 390 (1996).
154
Art. 289 of the Labor Code reads: "ART. 289. Who are liable when committed by other
than natural person.--If the offense is committed by a corporation, trust, firm, partnership,
association or any other entity, the penalty shall be imposed upon the guilty officer or officers of
such corporation, trust, firm, partnership, association or entity."
155
254 SCRA 673, 683-684.
sufficient ground for isregarding the separate corporate personality," and that
"the Sunio doctrine still prevails."156
Reahs Corporation v. NLRC,157 reviewed the A.C. Ransom doctrine of
imposing solidarily liability on the highest officers of the corporation for judgment
on labor claims rendered against the corporation pursuant to Article 283 of the
Labor Code, and reviewed its application in subsequent cases of Maglutac,
Chua, Gudez and Pabalan. It reiterated the main doctrine of separate personality
of a corporation which should remain as the guiding rule in determining corporate
liability to its employees, and that at the very least, to justify solidary liability,
“there must be an allegation or showing that the officers of the corporation
deliberately or maliciously designed to evade the financial obligation of the
corporation to its employees,” or a showing that the officers indiscriminately
stopped its business to perpetuate an illegal act, as a vehicle for the evasion of
existing obligations, in circumvention of statutes, and to confuse legitimate
issues.
In Reahs the Supreme Court held that while there was no sufficient
evidence to conclude that the officers have indiscriminately stopped the entity‟s
business, at the same time, they have opted to abstain from presenting sufficent
evidence to establish the serious and adverse financial condition of the company.
The Court held:

This uncaring attitude on the part of the officers of

Reahs‟ gives credence to the supposition that they simply
ignored the side of the workers who, more or less, were only
demanding what is due them in accordance with law. In fine,
these officers were conscious that they corporation was
violating labor standard provisions but they did not act to
correct these violations; instead, they abruptly closed
business. Neither did they offer separation pay to the
employees as they conveniently resorted to a lame excuse
that they suffered serious business losses, knowing fully well
that they had no substantial proof in their hands to prove such
losses.

A review of the recent decisions of the Supreme Court clearly indicates that
the highest court of the land still has not figured out yet which doctrine it shall
uphold in Labor Laws.
Gudez v. NLRC,158 held that the President of a corporation that has closed
its business even upon the order of the Philippine Constabulary which
necessitated the termination of the employees was made jointly and solidary
liable for the termination benefits due to the separated employees, the Court
holding: “Thus, where the employer corporation is no longer existing and unable

156
Ibid, at pp. 684-685.
157
271 SCRA 247, 81 SCAD 634 (1997).
158
183 SCRA 644 (1990).
to satisfy the judgment in favor of the employee, the officers should be held liable
for acting on behalf of the corporation.”
Similarly in Carmelcraft Corporation v. NLRC,159 the Court rejected the
contention of the officer that she cannot be held personally liable for the labor
claims of employees of the corporate employer since it "is a distinct and separate
entity with a legal personality of its own . . . [and she] was only an agent of the
company carrying out the decisions of its board of directors.” The Court affirmed
the joint and soidary liable of the officer with the corporate employer especially
when it was found that she was “in fact and legal effect the corporation, being not
only its president and general manager but also its owner.”
In Valderrama v. NLRC,160 the Court reiterated that since a “corporation
can only act through its officers and agents . . . that any decision against the
company can be enforced against the officers in their personal capacities should
the corporation fail to satisfy the judgment against it . . . where the employer
corporation is no longer existing and unable to satisfy the judgment in favor of the
employee, the officer should be held liable for acting on behalf of the
corporation.”
AHS/Philippines v. Court of Appeals,161 held that corporate officers are not
personally liable for money claims of discharged employees unless they acted
with evident malice and bad faith in terminating their employment.
Uichico v. NLRC,162 held that in labor cases, particularly, corporate
directors and officers are solidarily liable with the corporation for the termination
of employment of corporate employees done with malice or in bad faith. In that
case, it is undisputed that the corporate officers have a direct hand in the illegal
dismissal of the employees. They were the one, who as high-ranking officers and
directors of the corporation, signed the Board Resolution retrenching the
employees on the feigned ground of serious business losses that had no basis
apart from an unsigned and unaudited Profit and Loss Statement which, to
repeat, had no evidentiary value whatsoever. This is indicating of bad faith on the
part of the corporate officers for which they can be held jointly and severally
liable with the Corporation for all the money claims of the illegally terminated
employees.
In Asionics Philippines, Inc. v. NLRC,163 the Court reiterated that when
there is nothing on record to indicate that the President and the majority
stockholder of a corporation acted in bad faith or with malice in carrying out the
retrenchment program of the company, he cannot be held solidarily and
personally liable with the corporation.

159
186 SCRA 393 (1990).
160
256 SCRA 466, 70 SCAD 382 (1996).
161
257 SCRA 319, 71 SCAD 99 (1996).
162
273 SCRA 35, 83 SCAD 31 (1997).
163
290 SCRA 164, 94 SCAD 351 (1998).
 Brent Hospital, Inc. v. NLRC,164 held that a corporation, being a juridical
entity, may act only through its directors, officers and employees and obligations
incurred by them, acting as corporate agents, are not theirs but the direct
accountabilities of the corporation they represent.
In Nicario v. NLRC,165 the Supreme Court held that the manager of a
corporation are not personally liable for their official acts unless it is shown that
they have exceeded their authority. There is nothing on record to show that the
manager deliberately and maliciously evaded the corporation‟s financial
obligation to the employee; hence, there appearing to be no evidence on record
that the manager acted maliciously or deliberately in the non-payment of benefits
to the employee, the manager cannot be held jointly and severally liable with the
corporate employers. A reading of the decision in Nicario would show that there
was a determination of whether the corporate employer had no assets with which
to pay the claims of the employee.
Nevertheless, in Restuarante Las Conchas v. Llego,166 the Supreme Court
had apparently returned to the A.C. Ransom principle that “[a]lthough as a rule,
the officers and members of a corporation are not personally liable for acts done
in the performance of their duties, this rule admits of exceptions, one of which is
when the employer corporation is no longer existing and is unable to satisfy the
judgment in favor of the employee, the officers should be held liable for acting on
behalf of the corporation.” In that case, the restaurant business had to be closed
down because possession of the premises had been lost through an adverse
decision in an ejectment case. The Court held: “In the present case, the
employees can no longer claim their separation benefits and 13th month pay from
the corporation because it had already ceased operation. To require them to do
so would render illusory the separation and 13tj month pay awarded to them by
the NLRC. Their only recourse is to satisfy their claim from the officers of the
corporation who were, in effect, acting in behalf of the corporation.”

DUTY OF DIRECTORS TO CREDITORS

There is no express duty of directors or trustees to the corporate creditors
under principles of Corporate Law. The relationship of corporate creditors with
the corporation is one based mainly on Contract Law.
However, it has been established that upon insolvency of the corporation,
the board of directors of a corporation are duty bound to hold the assets of the
corporation primarily first for the payment of the corporation's liabilities.
Under Section 65 of the Corporation Code, any director or officer of a
corporation consenting to the issuance of stocks for a consideration less than its
par or issued value or for a consideration in any form other than cash, valued in
excess of its fair value, or who, having knowledge thereof, does not forthwith

164
292 SCRA 304, 96 SCAD 34 (1998).
165
295 SCRA 619, 98 SCAD 545 (1998).
166
314 SCRA 24 (1999).
express his objection in writing and file the same with the corporate secretary,
shall be solidarily liable with the stockholder concerned to the corporation and its
creditors for the difference between the fair value received at the time of
issuance of the stock and the par or issued value of the same.

REMOVAL OF DIRECTORS, TRUSTEES AND OFFICERS167

1. Removal of Directors and Trustees
Under Section 28 of the Corporation Code, any director or trustee of a
corporation may be removed from office by a vote of the stockholders holding or
representing two-thirds (2/3) of the outstanding capital stock, or if the corporation
be a non-stock corporation, by a vote of two-thirds (2/3) of the members entitled
to vote: Provided, That such removal shall take place either at a regular meeting
of the corporation or at a special meeting called for the purpose of removal of
directors or trustees, or any of them, must be called by the secretary on order of
the president or on the written demand of the stockholders representing or
holding at least a majority of the outstanding capital stock, or, if it be a non-stock
corporation, on the written demand of a majority of the members by any
stockholder or member of the corporation signing the demand.
Notice of the time and place of such meeting, as well as of the intention to
propose such removal, must be given by publication or by written notice as
prescribed in the Corporation Code.168
The vacancy resulting from removal may be filled by election at the same
meeting without further notice, or at any regular or at any special meeting called
for the purpose, after giving notice as prescribed in the Code.169 Removal may be
with or without cause; however, removal without cause cannot be used to deprive
minority stockholders or members of the right of representation to which they
may be entitled under Section 24 of the Corporation Code requiring cumulative
voting.
The general rule therefore is that any director may be removed from office
by a vote of the stockholders holding or representing two-thirds (2/3) of the
outstanding capital stock. When removal is for cause, the two-thirds (2/3) vote is
the minimum requirement to remove a director.
When removal is without cause, the two-thirds (2/3) vote is also enough to
remove a director. The exception is that when the director is elected by the

167
This section is based on a section taken from the article Jurisprudential Analyses of SEC
Jurisdiction in Intra-Corporate Disputes, and Investments Devices and Schemes, the original
version of which was published in T HE LAWYERS REVIEW , Vol. VI, (No. 10, Oct. 1992). The article
had been updated and included as Appendix to the 1998 edition of the book. The Appendix no
longer appears in this edition of the book due to the removal of quasi-judicial powers of the SEC
under Section 5.2 of the Securities Regulation Code.
168
Sec. 28, Corporation Code.
169
Ibid.
minority through cumulative voting, he may not be removed without cause even if
there is two-thirds (2/3) vote.

a. What Constitutes "Cause"?

The law does not define the "cause" that can be a legal basis for removal
of a member of the Board. What is clear is that "for cause" goes into the three
duties of a director and officer—loyalty, obedience and diligence. Whenever
these three duties are violated, certainly they will constitute sufficient "cause" for
removal.
When the Corporation Code says that a certain action has to be done
either by the board or stockholders, and it says that notice has to be given, it is
more than directory, it is mandatory. So that in the removal of members of the
Board, it cannot be done in any meeting whether special or regular. It can only be
done in a meeting where previously notice has been given and such notice must
specify that one of the things that will be discussed is the removal of director.
Even if it is within the competence of those who attend the meetings, the
resolution for the removal of director would not be voidable, it will be void, in spite
of the compliance of the two-thirds (2/3) required by law.170

2. Rationale of RTC Jurisdiction over Matters Covering Officers

Under the original version of Section 5(c) of Pres. Decree 902-A, the SEC,
and not the NLRC, would have proper jurisdiction to hear matters relating to
appointment of corporate officers. As held in Fortune Cement Corp. v. NLRC,171
"a corporate officer's dismissal is always a corporate act and/or intra-corporate
controversy and that nature is not altered by the reason or wisdom which the
Board of Directors may have in taking such action."172
Section 5(c) of Pres. Decree 902-A granted original and exclusive
jurisdiction to the SEC on "election or appointments of directors, trustees, officers
or managers of such corporations". However, Section 5.2, Chapter II of the
Securities Code173 transferred the jurisdiction over all cases under Section 5 from
the SEC to the Regional Trial Courts (RTC), which includes issues involving the
election and appointments of directors, trustees, and officers.
Nevertheless, the rulings of the Supreme Court under Section 5(c) of
Pres. Decree 902-A, as they pertained to SEC jurisdiction, would still be
applicable in cases of similar nature that now fall within the jurisdiction of the
RTC because the issue on conflicting jurisdiction with the NLRCwould still
prevail.
170
Roxas v. de la Rosa, 49 Phil. 609 (1926). Curiously in that case the Supreme Court held
that because only a majority called the meeting for removal of the director, they cannot still
successfully oust a director since 2/3 vote is required. This is erroneous. Even if a majority is
needed to call a meeting, it does not mean that only the majority will attend. The majority may, in
that meeting, gather the required two-thirds (2/3) vote in order to successfully oust a director.
171
193 SCRA 258 (1991).
172
Also Lozon v. NLRC, 240 SCRA 1 (1995).
173
Rep. Act No. 8799.
 There are basically two (2) controversies arising from the application of
Section 5(c) as to the SEC, and now with the RTC:

(a) The issue of who are deemed to be "officers" and

"managers" within the jurisdiction of the RTC vis-à-vis the
jurisdiction of NLRC with respect to officers-employees of
corporate employers;
(b) Even when the controversy is within the original and
exclusive jurisdiction of the RTC, what is the "extent" by
which the power of the regular courts can adjudicate,
especially as to matters pertaining to backwages and
remunerations, which are inherently labor laws issues not
within the competence of trial judges.

3. Who Are "Officers" and "Managers"

Within the Jurisdiction of RTC?
In the case of Gurrea v. Lezama,174 it was held by the Supreme Court that
the term "corporate officer" refers only to officers of a corporation who are given
that character either by the then Corporation Law, or by the corporation's by-
laws.
The SEC itself in its opinions has held that even when the intention of the
board of a corporation is to make the "General Financial Secretary" an officer
thereof, he cannot be classified as such where the by-laws of the corporation
discloses that the position is not one of the offices provided therein.175 In another
opinion, the SEC has held that if the by-laws enumerate the officers to be elected
by the board, the provision is conclusive, and the board is without power to
create new offices without amending the by-laws.176
Under Section 25 of the Corporation Code, the President, Secretary and
Treasurer are specifically mentioned as officers of the corporation. In addition the
same section provides that the board of directors may elect "such other officers
as may be provided for in the by-laws." The Code therefore has continued the
principle that corporate officers shall include in addition only such positions as
are provided for in the by-laws of the corporation.
In interpreting SEC (now the RTC) jurisdiction under Section 5(c) of Pres.
Decree 902-A, the Supreme Court has also narrowed its coverage following the
foregoing formula of determining who are corporate officers.
In the case of Mita Pardo de Tavera v. Philippine Tuberculosis Society,
Inc.,177 it was held that since the letter of appointment Pardo de Tavera as
Executive Secretary to the Board did not contain a fixed term, the implication is

174
103 Phil. 553 (1958).
175
SEC Opinion, 15 May 1969, SEC FOLIO 1960-1976, at p. 377.
176
SEC Opinion, 19 October 1971, SEC FOLIO 1960-1976, at p. 498.
177
112 SCRA 243 (1982).
that appointee held an appointment at the pleasure of the appointing power and
was in essence temporary in nature, co-extensive with the desire of the Board of
Directors. When the Board opted to replace the incumbent, technically there is no
removal but only an expiration of the term and there is no need of prior notice,
due hearing or sufficient grounds before the incumbent can be separated from
office. The Supreme Court took note in Tavera that the disputed position of
Executive Secretary was also provided for in the Code of By-Laws of the
Philippine Tuberculosis Society, Inc.
In PSBA v. Leaño,178 the Court, in holding that the SEC (now RTC) has
jurisdiction over the ouster of the Executive Vice-President, took note that said
position was provided for in the corporate by-laws.
However, it is interesting to note that in PSBA, Justice Melencio-Herrera
concluded her ratiocination with the cryptic denouement: "The matter of whom to
elect is a prerogative that belongs to the Board, and involves the exercise of
deliberate choice and the faculty of discriminative selection. Generally speaking,
the relationship of a person to a corporation, whether as officer or as agent or
employee, is not determined by the nature of the services performed, but by the
incidents of the relationship as they actually exist."179
The ponente cited the American case of Bruce v. Travelers Ins. Co.,180
which reiterated the doctrine in common law jurisdiction that the distinction
between an agent or employee and an officer is not determined by the nature of
the work performed, but by the nature of the relationship of the particular
individual to the corporation:

. . . One distinction between officers and agents or

employees of a corporation lies in the manner of their creation.
An Office is created usually by the charter or by-laws of the
corporation, while an agency or employment is created usually
by the officers. A further distinction may thus be drawn
between an officer and an employee of a private corporation in
that the latter is subordinate to the officers and under their
control and direction . . . It is clear that the two terms officers
and agents are by no means interchangeable. . .181

The evolving test of the Supreme Court in determining who are corporate
officers therefore follows closely the American doctrine on the matter.
So also in the case of Dy v. NLRC,182 where the board of directors ousted
by non-election the bank manager, the Supreme Court took note that the position
is an elective position provided for in the by-laws of the corporation.

178
127 SCRA 778, 781 (1984).
179
Ibid, at p. 783; emphasis supplied.
180
266 F2d 781.
181
266 F2d 781, at pp. 784-785.
182
145 SCRA 211 (1986),
 Espino v. NLRC,183 reiterated the ruling that the SEC (now the RTC) and
not the NLRC "has original and exclusive jurisdiction over cases involving the
removal from employment of corporate officers." In that case, in controversy was
the position of Executive Vice President-Chief Operating Officer of the Philippine
Airlines, which position was provided for in the by-laws of the airline company.
Pearson & George, (S.E. Asia), Inc. v. NLRC,184 held that "[a]ny question
relating or incident to the election of the new Board of Directors, the non-
reelection of Llorente as a Director, his loss of the position of Managing Director,
or the abolition of the said office are intra-corporate matters. Disputes arising
therefrom are intra-corporate disputes which, if unresolved within the corporate
structure of the [corporation], may be resolved in an appropriate action only by
the SEC [now the RCT] pursuant to its authority under paragraph (c) and (d),
Section 5 of P.D. No. 902-A."185
The Court also held that the reliance on LEP International Philippines, Inc.
v. NLRC, was misplaced since what was challenged in that case was not the
jurisdiction of the SEC (now the RTC) but its act of upholding the validity of the
dismissal of LEP's Chief Executive, who was not a stockholder, much less a
director, of LEP but was merely a managerial employee of the said company.186
The foregoing rulings are still relevant in determining the proper
jurisdiction of the RTC over disputes involving officers and directors under
Section 5(c) of Pres. Decree 902-A.

4. Positions Created Pursuant to Enabling By-Law Provisions

What has not clearly been ruled upon by the Supreme Court is a situation
where the position is created by board resolution pursuant to an enabling
provision in the by-laws of the corporation.
An example would be the obiter in Tabang v. NLRC,187 where the
Supreme Court held:

The president, vice-president, secretary and treasurer

are commonly regarded as the principal or executive officers
of a corporation, and modern corporation statutes usually
designate them as the officers of the corporation. However,
other offices are sometimes created by the charter or by-laws
of a corporation, or the board of directors may be empowered

183
240 SCRA 52, 58 SCAD 46 (1995).
184
253 SCRA 136, 67 SCAD 698 (1996).
185
Ibid, at pp. 142-143.
186
Ibid, at p. 145.
187
266 SCRA 462 (1997).
 under the by-laws of a corporation to create additional offices
as may be necessary.188

The ruling with respect to the clause “and such other officers” was obiter
because the position in controversy was that of Medical Director which was
specifically provided for in the quoted by-law provision, thus “[t]o appoint a
Medical Director, Comptroller/Administrator, Chiefs of Services and such other
officers as it may deem necessary and prescribe their powers and duties.” On the
basis of the quoted by-law provision, the Court held that “such specifically
designated positions should be considered „corporate officers‟ position, and the
determination of the rights and the concomitant liability arising from any ouster
from such positions, would be intra-corporate controversy subject to the
jurisdiction of the SEC,” which now falls within the jurisdiction of the RCT.
Section 25 of the Corporation Code defines a position to be an officer
position “as may be provided for in the by-laws,” and seems to imply that an
officership position becomes such only when the by-laws so provide for them,
and would rule out creation of the position by virtue of a by-law enabling
provision. This position seems sensible because an enabling provision in the by-
law does not really create a power that was not with the Board of Directors; even
without such enabling by-law provision, the Board of any corporation is always
considered to have the power to appoint “officers” as part of the corporate
powers under Section 23 of the Corporation Code, and therefore, when any such
position is created it would be an “employee” position that would be governed by
the provisions of the Labor Code.
The employment of an enabling clause in the by-laws to create an “officer”
position could also lead to absurd ends where by simply providing for such
clause in the by-laws of the corporation, the Board of Directors are able to
periodically and by means of a resolution to “create and appoint” officers to any
position in the organization, who would not be protected by the security tenure
clause.
Ongkingco v. NLRC,189 held that the dismissal or non-appointment of a
corporate officer is clearly an intra-corporate matter and jurisdiction properly
belonged to the SEC (now the RTC). Section 5(c) of Pres. Decree 902-A
expressly covers both election and appointment of corporate directors, trustees,
officers and managers, and that jurisdiction pertains to the SEC (now the RTC)
even if the complaint by a corporate officer includes money claims since such
claims are actually part of the perquisites of his position, and therefore interlinked
with his relations with the corporation.

188
Tabang v. NLRC, 266 SCRA 462 (1997), citing SEC Opinion, 25 March 1983; J.
CAMPOS, JR., THE CORPORATION CODE, COMMENTS, NOTES AND SELECTED CASES, Vol. I, 383-384.
189
270 SCRA 613, 81 SCAD 252 (1997).
 5. Branching the Officership Test
In Dy v. NLRC,190 where the board of directors ousted by non-election the
bank manager, the Supreme Court took note that the position is an elective
position provided for in the by-laws of the corporation. However, the Supreme
Court in sustaining that the SEC (now the RTC) had jurisdiction over the
controversy held that:

. . . The question of remuneration, involving as it does, a

person who is not a mere employee but a stockholder and
officer, an integral part, it might be said, of the corporation, is
not a simple labor problem but a matter that comes within the
area of corporate affairs and management, and is in fact a
corporate controversy in contemplation of the Corporation
Code.191

The aforequoted portion of the decision in Dy seems to imply that if the

controversy in intertwined with management matters by persons who have
special relations to the corporation, such as being a stockholder, the controversy
is essentially corporate, by virtue of Section 3 or Section 5(b) on intra-corporate
disputes. This therefore seems to create two (2) branches of SEC (now the RTC)
jurisdiction when it comes to corporate officers. The first are those who are
strictly "officers" because their positions are provided for either by law or in the
by-laws of the corporation. Any controversy arising from such relationship is now
within the original and exclusive jurisdiction of the regular courts by virtue of
Section 5(c) of Pres. Decree 902-A in relation to Section 5.2 of the Securities
Regulation Code.
The other corporate "officers" whose positions are not provided for in the
by-laws, who therefore are strictly mere employees of the corporation, when they
are at the same time stockholders or members of the corporation, and seem to
occupy such employment positions by virtue of such relationship to the
corporation, the controversies arising therefrom are within the jurisdiction of the
SEC by virtue of the expanded coverage of Section 5(b) in Union Glass. In both
instances, the emphasis of the Supreme Court has always been that the
controversies involved primarily a corporate matter, with the right and power of a
board to terminate corporate officers.
In Gregorio Araneta University Foundation v. Teodoro,192 although the
respondent interposed illegal dismissal and sought recovery of separation pay,
retirement benefits and other monetary claims with the NLRC arising from the
"non-extension" of his appointment as Vice President and concurrently, as
Treasurer of the corporation, the Court denied the contention of the petitioning
corporation that jurisdiction over the case should be with the SEC (now the RTC)
since respondent was undoubtedly a corporate officer. In denying the petitioner's
190
145 SCRA 211 (1986).
191
Ibid, at p. 222.
192
167 SCRA 79 (1988).
contention, and distinguishing it from PSBA and Dy, the Court held that the
complaint was filed by the respondent with the NLRC not questioning the validity
of the board of directors' meetings wherein the corporate officers involved were
not reelected, resulting in the termination of their services. Therefore, no issue
which was intra-corporate in nature was necessary to be resolved which would
necessitate the vesting of the controversy with the jurisdiction of the SEC, now
the RTC.
The SEC then, and now the RTC, rather than the NLRC, should have
jurisdiction to hear matters relating to appointment and removal of corporate
officers. As held in Fortune Cement Corp. v. NLRC,193 "a corporate officer's
dismissal is always a corporate act and/or intra-corporate controversy and that
nature is not altered by the reason or wisdom which the Board of Directors may
have in taking such action."194

6. Stockholder-Officer Combination
A special relationship has been placed upon officers of the corporation
being stockholders at the same time to vest jurisdiction over an illegal dismissal
suit with the SEC, now a matter falling within the jurisdiction of the RTC.
In Paguio v. NLRC,195 the Supreme Court put much weight on relationship
of being stockholders of the corporation and at the same time being officers. It
held that the NLRC has no jurisdiction over case where the petitioners are
stockholders and officers of respondent corporation. "They filed a complaint
against private respondent for illegal dismissal. Such being the case, it is the
Securities and Exchange Commission (SEC) that has jurisdiction over the case
as will be expansively discussed hereinafter. It is no hindrance to SEC's
jurisdiction that a person raises in his complaint the issues that he was illegally
dismissed and asks for remuneration where, as in this case, complainant is not a
mere employee but a stockholder and officer of the corporation."196

7. "Extent" by Which Regular Courts Can

Adjudicate Under Section 5(c)
In resolving SEC (now RTC) jurisdiction, over intra-corporate
controversies under Section 5(b), the Supreme Court in Union Glass & Container
Corporation v. Securities and Exchange Commission,197 was careful to point out
that when the enumerated intra-corporate relationships were not present as to
some parties, then the issues pertaining to such corporate outsiders must be
brought to, and resolved by, the regular courts since the same did not involve
corporate matters and are therefore within the competence of regular courts to
decide upon. The issue no longer applies today, since regular courts may

193
193 SCRA 258 (1991).
194
Also Lozon v. NLRC, 240 SCRA 1 (1995); Espino v. NLRC, 240 SCRA 52 (1995).
195
253 SCRA 166, 67 SCAD 337 (1996).
196
Ibid, at pp. 171.
197
126 SCRA 31 (1983).
exercise proper jurisdiction over any party, even when he does not fall within the
intra-corporate relationship.
In PSBA v. Leaño,198 Tan, who was one of the principal stockholders of
PSBA, was also elected director and the Executive Vice-President enjoying
salaries and allowances. The PSBA board at its regular meeting declared all
corporate positions vacant, except those of the President and Chairman, and at
the same time elected a new set of officers, with Tan not being re-elected as
Executive Vice-President. Tan filed with the NLRC a complaint for illegal
dismissal, with prayer for full payment of backwages and without loss of other
benefits. In upholding the jurisdiction of the SEC (now the RTC) on the ground
that the matter was essentially intra-corporate controversy, and ordering the
dismissal of the case pending with the NLRC, the Supreme Court impliedly held
that even as to issues pertaining to backwages and employments benefits, the
same would be within the power of the SEC to rule upon, as part and parcel of
the main controversy of whether the corporation, through its board directors, had
authority to remove Tan from his corporate office.
In Dy v. NLRC,199 Vailoces who was a manager of the corporate rural
bank, as well as director and stockholder thereof, was, by board resolution of a
newly constituted board, removed as bank manager. Vailoces filed an action for
illegal dismissal with the labor arbiter, with prayer for damages. A judgment was
rendered by the labor arbiter declaring that Vailoces was illegally dismissed and
ordering the petitioners to pay salary differentials, cost of living allowances, back
wages from date of dismissal up to the date of reinstatement. The judgment was
affirmed by the NLRC. On petition to the Supreme Court, the Court found that the
controversy came under Section 5(c) and was within the original and exclusive
jurisdiction of the SEC, and thereupon annulled and declared void the awards of
the arbiter. In ruling so, the Court held:

. . . It is of no moment that Vailoces, in his amended

complaint, seeks other relief (sic) which would seemingly fall
under the jurisdiction of the Labor Arbiter, because a closer
look at these--underpayment of salary and non-payment of
living allowance--shows that they are actually part of the
perquisites of his elective position, hence, intimately linked
with his relations with the corporation. The question of
remuneration, involving as it does, a person who is not a mere
employee but a stockholder and officer, an integral part, it
might be said, of the corporation, is not a simple labor problem
but a matter that comes within the area of corporate affairs
and management, and is in fact a corporate controversy in
contemplation of the Corporation Code.200

198
127 SCRA 778 (1984)
199
145 SCRA 211 (1986).
200
Ibid, at p. 222.
 So also in Cagayan de Oro Coliseum, Inc. v. Office of the MOLE,201 the
Supreme Court, in determining which agency had jurisdiction over a case filed by
the President for non-payment of wages and other benefits, the ruling in Dy was
affirmed:

Although the reliefs sought by Chaves appear to fall

under the jurisdiction of the labor arbiter as they are claims for
unpaid salaries and other remunerations for services
rendered, a close scrutiny thereof shows that said claims are
actually part of the perquisites of his position in, and therefore
interlinked with his relations with the corporation. . .202

The Dy doctrine therefore compelled the SEC, now the RTC, to be

competent not only in the field of corporate and securities law, but also in the
field of labor laws, but this was unavoidable in cases covered by Section 5(c),
where the complaining officer or manager should win his claims against the
corporation and/or the board of directors for unlawful removal from office. For this
task, the SEC was ill-equipped to do, and there seems to be no real advantage
attained nor any efficient system installed by compelling SEC, now the RTC, to
attain such competence in the specialized field of Labor Laws.
While it would seem that the Supreme Court would allow the SEC to
assume jurisdiction over the main intra-corporate controversy, together with the
issue of damages and employment benefits, it does not allow NLRC to decide on
matters inherently corporate in nature, even when the main controversy is within
the jurisdiction of the said agency.
In Apodaca v. NLRC,203 the Court set aside the judgment of the NLRC
which held that a stockholder who fails to pay his unpaid subscription on call
becomes a debtor of the corporation and that the set-off of said obligation against
the wages and other benefits due to him. The stockholder was also President
and General Manager of the corporation but resigned prior to filing a case with
the labor arbiter for the payment of his unpaid wages, his cost of living allowance,
the balance of his representation expenses and his bonus compensation. No
intra-corporate dispute related to his former positions as an officer of the
corporation since he resigned therefrom voluntarily.
Although the main controversy was within the jurisdiction of the NLRC, the
Court held that "the NLRC had no jurisdiction to determine such intra-corporate
dispute between the stockholder and the corporation as in the matter of unpaid
subscription. This controversy was deemed to be within the exclusive jurisdiction
of the Securities and Exchange Commission."204

201
192 SCRA 315 (1990).
202
Ibid, at p. 319. The Dy doctrine was also affirmed in Fortune Cement Corporation v.
NLRC, 193 SCRA 258 (1991).
203
172 SCRA 442 (1989).
204
Ibid, at p. 445.
 Lately, Lozon v. NLRC,205 reiterated Dy when it held that the renumeration
being asserted by an officer of a corportion is "not a simple labor problem but a
matter that comes within the area of corporate affairs and managment, and is in
fact, a corporate controversy in contemplation of the Corporation Code."

8. RTC Jurisdiction Even on Damages

Recently, in Andaya v. Abadia,206 where the main issue was the removal
of the President and General Manager of a savings association, even the claims
for damages arising from alleged violation of the provisions of the Civil Code on
human relations, would not exclude the case from the jurisdiction of the SEC,
"considering that his rights thereto either depends on, or is inextricably linked
with, the resolution of the corporate controversies." 207 The Court held that the
allegations of violations of the provisions of the Civil Code on human relations do
not necessarily call for the application of the provisions of the Civil Code in place
of the association's by-laws. The Court further held that the determination of the
rights of the petitioner arising from the alleged illegal convening of the meeting of
the association's board of directors and his subsequent ouster from corporate
offices as a result of the voting for the reorganization of management are
obviously intra-corporate controversies, within the competence of the SEC (now
the RTC) to decide upon.
The ruling in Andaya was also reiterated in Lozon, where the Court held
that "indeed, controversies within the purview of Section 5 of P.D. No. 902-A
must not be so constricted as to deny to the SEC [now the RTC] the sound
exercise of its expertise and competence in resolving all closely related aspects
of such corporate disputes."
The issue of SEC competence on matters of damages is now moot, since
RTC have appropriate competence to determine issues of damages.

9. Procedural Rules on Suits Brought

The specific rules governing suits “election contests in stock and non-
stock corporations” are now provided for under Rule 6 of the Interim Rules of
Procedure Governing Intra-Corporate Controversies.
An “election contest” refers to any controversy or dispute involving title or
claim to any elective office in a stock or non-stock corporation, the validation of
proxies, the manner and validity of elections, and the qualifications candidates,
including the proclamation of winners, to the office of director, trustee or other
officer directly elected by the stockholders in a close corporation or by members
of a non-stock corporation where the articles of incorporation or by-laws so
provide.208

205
240 SCRA 1, 58 SCAD 1 (1995).
206
228 SCRA 705, 46 SCAD 1036 (1993).
207
Ibid, at p. 712.
208
Sec. 2, Rule 6, Interim Rules.
 The complaint in an election contest must be filed within fifteen (15) days
from the date of the election if the by-laws of the corporation do not provide for a
procedure of resolution of the controversy, or within fifteen (15) days from the
resolution of the controversy by the corporation as provided in its by-laws.209 In
addition, it is required that the plaintiff should have exhausted all intra-corporate
remedies in election cases as provided for in the by-laws of the corporation.210
Election contest suits are summary in nature, with the trial courts
mandated within two (2) days from the filing of the complaint, upon a
consideration of the allegations thereof, to dismiss the complaint outright if it is
not sufficient in form and substance, or, if it is sufficient, order the issuance of
summons which shall be served, together with a copy of the complaint, on the
defendant within two (2) days from its issuance;211 and the defendant having a
period of ten (10) days within which to file an answer. 212 The parties are
mandated to attach to their pleadings the affidavits of witnesses, documentary
and other evidence in support thereof.213 The courts are required to render a
decision based on the pleadings, affidavits and documentary and other evidence
within fifteen (15) days from receipt of the last pleading, or from the date of the
last hearing as the case may be;214 and the decisions are immediately
executory.215

10. Addressing the Constitutional Issue

The business judgment doctrine that it is within the legal competence of
the Board of Directors to terminate at the exercise of their discretion corporate
officers literally runs contrary to the security of tenure clause embodied in Article
279 of the Labor Code, and more importantly, would be contrary to the provisions
of Sec. 3(2), Article XIII of the 1987 Constitution, which provides:

. . . The State shall afford full protection to labor, local

and overseas, organized and unorganized, and promote
full employment and equality of employment opportunities
to all.
It shall guarantee the rights of all workers to security
of tenure, humane conditions of work, and a living wage.
They shall also participate in policy and decision-making
processes affecting their rights and benefits as may be
provided by law.216

209
Sec. 3(1), Rule 6, Interim Rules.
210
Sec. 3(2), Rule 6, Interim Rules.
211
Sec. 3, Rule 6, Interim Rules.
212
Sec. 5, Rule 6, Interim Rules.
213
Sec. 6, Rule 6, Interim Rules.
214
Sec. 9, Rule 6, Interim Rules.
215
Sec. 4, Rule 1, Interim Rules.
216
Emphasis supplied.
 The constitutional language on the right of “all workers” to security of
tenure provides for no exception. The Labor Code and case-law on the matter
clearly recognize two (2) levels of “employees,” the managerial and supervisory
employees and the rank-and-file employees,217 both of which are recognized to
enjoy security of tenure afforded to all workers.218
The close proximity of the powers and functions of managerial employees
to the business endeavors and management powers necessarily has given rise
to varying treatment as contrasted to rank-and-file employees. For example, by
law managerial employees are prohibited from joining, assisting, or forming any
labor union,219 and can be removed for loss of confidence provided there is
substantial proof and observance of due process.220
And yet the standing jurisprudential ruling when it comes to corporate
officers, although Labor Law would clearly consider them as employees enjoying
security of tenure, is that they enjoy no such security of tenure and their
incumbency is within the business judgment discretion of the board of directors
or trustees. The only conclusion that can be drawn from this is that in spite of the
clear language of the Constitution which provides for no exception, corporate
officers do not enjoy the constitutional guarantee to security of tenure, which can
be justified on the following grounds:
Firstly, the prerogative of management to hire and fire all employees was
the original prevailing doctrine that encompassed all employees of a business
enterprise; and the notion of security of tenure of employees was considered
contrary to the rights of ownership.221 In fact, the absolute right of management to
hire and fire employees was then still the prevailing doctrine at the time Gurrea v.
Lezama222 was decided, which was actually the first reported decision in
corporate law on the matter.
When the security of tenure clause did appear in the 1973 Constitution, it
was merely a declaration of principle that “The State shall assure the rights of
workers to self-organization, collectively bargaining and security of tenure,” which
found statutory implementation under the Labor Code. But even then the
interpretation of the statutory rule on security of tenure under the Labor Code

217
Art. 212(m), Labor Code of the Philippines. Managerial employees are defined as those
who are vested with the power and prerogatives to lay down and execute management policies to
hire, transfer, suspend, lay off, recall, discharge, assign or discipline employees; while
supervisory employees are those who, in the interest of the employer, effectively recommend
such managerial actions if the exercise of such actions is merely routine or clerical in naturebut
requires the use of independent judgment. All other employees who do not fall within the
managerial or supervisory levels are considered rank-and-file employees.
218
Dosch v. NLRC, 123 SCRA 296 (1983); De Leon v. NLRC, 100 SCRA 691 (1980);
Maglutac v. NLRC, 189 SCRA 767 (1990); Estiva v. NLRC, 225 SCRA 170 (1993).
219
Art. 245, Labor Code of the Philippines.
220
Estiva v. NLRC, 225 SCRA 170 (1993).
221
Gutierrez v. Bachrach Motor Co., Inc., 105 Phil. 9 (1959); Amador Capiral v. Manila
Electric Company Co., Inc., 9 SCRA 804 (1963).
222
103 Phil. 553 (1958).
exempted expressly under case-law corporate officers whose term of office were
deemed to be within the business judgment of the Board of Directors or Trustees.
Therefore, when the 1987 Constitution elevated the security of tenure
clause from mere declaration of principles to self-enforcing provisions, it must be
understood that the constitutional precept embodied the same nuances that
pertained to it and interpreted by the Supreme Court under the 1973 Constitution,
which includes an exemption therefrom of corporate officers.
Secondly, the non-coverage of corporate officers from the security of
tenure clause under the Constitution is now well-established principle by
numerous decisions upholding such doctrine under aegis of the 1987
Constitution223 in the face of contemporary decisions of the same Supreme Court
likewise confirming that “security of tenure covers all employees or workers
including managerial employees”224
Thirdly, the decisions of the Supreme Court upholding the business
judgment prerogatives of the board of directors on the termination of corporate
officers clearly would recognize that the essential legal relationship prevailing is
that of Agency, that corporate officers essentially are appointed as agents of the
corporation, and necessarily since trust imbues is such relationship, they are
essentially revocable. This is in stark contrast to the security of tenure clause
where the relationship sought to be governed is that essentially of employer-
employee, and seeks to safeguard the right to livelihood.
Finally, just as the security of tenure clause under the civil service system
provides for exemption for positions that are policy-determining, highly
confidential or highly technical employees,225 the Supreme Court has now began
to fashion similar exemptions applicable to the security of tenure clause for
private employees.
The only problem with such analogy is that under the civil service system,
the nature, duties and functions of the position are critical in determining whether
such office is not within the coverage of the security of tenure clause;226 whereas,
in the case of corporate officers, the Supreme Court has employed the
peremptory test under Gurrea (i.e., that only those officers who are declared
such under the law or provided for in the by-laws are within Board‟s business
judgment prerogative to terminate at its discretion) and has in fact held in
Philippine School of Business Administration that “the relationship of a person to
a corporation, whether as officer or as agent or employee, is not determined by
the nature of the services performed, but by the incidents of the relationship as
they actually exist."227

223
Ongkingco v. NLRC, 270 SCRA 612, 81 SCAD 252 (1997); Tabang v. NLRC, 266 SCRA
464, 78 SCAD 174 (1987).
224
Maglutac v. NLRC, 189 SCRA 767 (1990)
225
Sec. 2(3), Art. IX-B, 1987 Constitution.
226
Laurel v. Civil Service Commission, 203 SCRA 195 (1991).
227
Ibid, at p. 783; emphasis supplied.
 There is no decision yet rendered by the Supreme Court where the
constitutional issue has clearly been put at issue, and it should be expected that
once the constitutional issue is pushed further before the Supreme Court‟s
determination, rulings would be issued to the effect that the nature of the position
of an officer should also be determinative of whether it should be exempted from
the coverage of the security of tenure clause.

—oOo—

CORP. MANUSCRIPT\09-DIRECTORS & OFFICERS\08-02-2002

 CHAPTER 10

SHARES OF STOCK,
SUBSCRIPTION AGREEMENTS,
AND CERTIFICATES OF STOCK

Nature of Shares of Stock

Rights of Corporation with Respect to Shares of Stock
SUBSCRIPTION AGREEMENTS: Root of the Standing of Stockholders
When Shares Deemed Subscribed
Subscription Agreements under the Statute of Frauds
Characteristics of Subscription Agreements
Pre-Incorporation Subscription Agreements
Consideration for Issuance of Shares
Cash and Promissory Notes for Subscription
Property Consideration
Debts and Service as Consideration
Set-off of Corporation's Indebtedness
Unrestricted Retained Earnings or Existing Capital as Consideration
Consequences of Unlawful Consideration
Watered Stocks
Releases from Subscription Obligations
Payment of Balance of Subscription
Call on Unpaid Subscriptions
Nature of the Call
When Call Not Necessary
Delinquency Sale
Who Is the Highest Bidder?
Questioning the Delinquency Sale
Other Remedies Still Available to Corporation
Effects of Delinquency
Prescription on Demand for the Payment of Subscription
CERTIFICATE OF STOCK
Rights to Issuance of Certificate of Stock
Special Rules for Uncertificated Shares
Nature of Certificate of Stock
Probative Value of Certificate of Stock
Issuance of Certificate of Stock
Negotiation of Certificate of Stock
Forged and Illegal Transfers of Certificates
Lost or Destroyed Certificates of Stock
SPECIAL RULES FOR REGISTRED OR LISTED SHARES
Rule on Uncertificated Shares
Binding Effect on Shares Transactions
Evidentiary Value of Clearing Agency Record
Pledging Security or Interest Therein
Issuer’s Responsibility for Wrongful Transfer to
Registered Clearing Agency
Power of SEC to Issue Rules Covering Shares
STOCK AND TRANSFER BOOK
Where Kept
Who May Be Transfer Agent
Who May Make Proper Entries
Registration with the SEC
BIR Certification to Effect Transfer of Shares of Stock
Probative Value of Stock and Transfer Book
Trust Relations on Shares of Stock
TRANSFER, SALE AND ASSIGNMENT OF SHARES
When Shares Are Not Fully Paid
Sale of Portion of Not Fully-Paid Shares
Sale of Entire Not Fully-Paid Shares
When Shares Are Fully Paid
Non-Exclusivity of Section 63 on Modes of Registration
Remedy if Registration of Transfer Refused
Prescription on Cause of Action
Claims for Damages
INVOLUNTARY DEALINGS WITH SHARES
Pledge, Mortgage and Other Encumbrances
When Shares Not Covered by Certificates
When Shares Covered by Certificates
Mortgage Contracts Versus Attachments and Levies
Attaching or Levying Creditors Versus Other Creditors
Voluntary Buyer/Assignee Versus Attaching Creditors
Summary of Current Doctrinal Rules on Shares of Stock

——

NATURE OF SHARES OF STOCK

Shares of stock in a corporation constitute personal property of the
stockholder, which he can contract with as in any other form of property, like
assignment by way of disposition, or pledge by way of encumbrance. Shares of
stock therefore are properties and have intrinsic pecuniary value to the
stockholders.
Shares of stock, however, do not represent proprietary rights of
stockholders to the assets or properties of the corporation. Although shares of
stock represent aliquot parts of the corporation's capital, or the right to share in
the proceeds when the remaining assets of the corporation are distributed
according to law and equity, its holders do not own any part of the assets
represented by the capital of the corporation; nor are the stockholders entitled to
the possession of any definite portion of the corporation's assets or properties. 1
Shares of stock do not legally represent a proprietary claim of co-ownership or
tenancy-in-common in the assets and properties of the corporation.2
The Supreme Court in Magsaysay-Labrador v. Court of Appeals,3 has
characterized a stockholder's interest in corporate contracts, transactions and
properties, "if it exists at all, . . . is indirect, contingent, remote, conjectural,
consequential and collateral. At the very least, their interest is purely inchoate, or
in sheer expectancy of a right in the management of the corporation and to share
in the profits thereof and in the properties and assets thereof on dissolution, after
payment of the corporate debts and obligations."4

RIGHTS OF CORPORATION WITH RESPECT TO SHARES

The corporation has the following powers and rights with respect to the
shares of stock already issued to stockholders, thus:

(a) Subject to any contrary stipulation in the subscription

agreement, to call for the payment of the unpaid
subscription, together with interest accrued, if any, on the
date specified in the contract of subscription or on the date
stated in the call made by the board;5
(b) To impose interest on the unpaid subscriptions from the date
of subscription, if so required by, and at the rate of interest
fixed in, the by-laws;6
(c) To refuse to issue to the subscriber the certificates of stock
covering shares where the subscription has not been fully
paid;7
(d) To refuse to recognize and register the sale or assignment of
any share where the subscription has not been fully paid; 8
and

1
Boyer-Roxas v. Court of Appeals, 211 SCRA 470 (1992).
2
Magsaysay-Labrador v. Court of Appeals, 180 SCRA 266, 271-272 (1989); Stockholders
of F. Guanzon and Sons, Inc. v. Register of Deeds of Manila, 6 SCRA 373 (1962); Pascual v. Del
Sanz Orozco, 19 Phil. 82, 86 (1911).
3
180 SCRA 266, 271 (1989).
4
Ibid, at p. 271.
5
Sec. 67, Corporation Code.
6
Sec. 66, Corporation Code.
7
Sec. 64, Corporation Code. The SEC has opined that a subscription is one, entire and
indivisible whole contract. It cannot be divided into portions to allow the stockholder to be entitled
to a certificate of stock until he has remitted the full payment of his subscription together with
interests and expenses. SEC Opinion, 12 November 1993, XXVIII SEC QUARTERLY BULLETIN 36
(No. 1, March 1994).
8
Sec. 63, Corporation Code.
 (e) To refuse to recognize a sale or assignment of shares of
stock which have not been duly registered in the stock and
transfer book.9

On the other hand, the corporation does not have power on its own
volition to:

(a) Demand for the repurchase of its shares of stock unless the
shares are classified as redeemable shares in the articles of
incorporation;10
(b) Refuse to pay to the stockholders dividends declared on
shares which have not been declared delinquent to apply
them to the payment of the unpaid subscription;11 and
(c) Bid delinquent shares, and thereby to obtain for itself profit,
for a value greater than the balance due on the unpaid
subscription, plus accrued interest, costs of advertisement
and expenses of sale.12

It has also been ruled that the unpaid subscription of a stockholder which
has not become due by call through a formal board resolution cannot be off-
setted against a money claim of the employee-stockholder against the employer-
corporation; or even when a proper call has been made, such off-setting would
still not be authorized as being violative of the prohibition against unauthorized
deductions under the Labor Code.13

SUBSCRIPTION AGREEMENT:
ROOT OF THE STANDING OF STOCKHOLDERS
The subscription agreement underpins the relationship between the
stockholder and the corporation. The subscription agreement therefore is a
special contract in Corporate Law; although it is governed by the Law on
Contracts, specifically as a species of sale contracts, a subscription agreement
has special features that go beyond such discipline, and delve into the very heart
of Corporate Law.
Section 72 of the Corporation Code provides expressly that "[h]olders of
subscribed shares not fully paid which are not delinquent shall have all the rights
of a stockholders." Clearly therefore, it is subscription to shares of stock that
creates the legal relationship between the stockholder and the corporation; it is

9
Sec. 63, Corporation Code; Price v. Martin, 58 Phil. 707 (1933).
10
Sec. 8, Corporation Code.
11
Sec. 71, Corporation Code.
12
Sec. 68, Corporation Code.
13
Apocada v. NLRC, 172 SCRA 442, 445-446 (1989).
subscription, and not the payment of such subscription, that grants to the
stockholder the statutory and common rights granted to stockholders.14

1. When Shares Deemed Subscribed

The critical issue therefore would be the determination of when a
subscriber is deemed to have subscribed to shares of stock as to constitute him
a stockholder of the corporation, entitled to the rights pertaining thereto.
There seems little doubt that a subscription contract is akin to a sale of
shares of stock. In fact, prior to the provision of Section 60 of the Corporation
Code which expressly provides that “[a]ny contract for the acquisition of unissued
stock . . . shall be deemed a subscription . . . notwithstanding the fact that the
parties refer to its as a purchase or some other contract,” it was recognized that
the sale of unissued shares of stock may be treated wholly as a sale of shares
governed by the Law on Sales.15 Consequently, a subscription agreement has
also the same characteristics of a sale of shares of stock, namely, that it is
nominate, bilateral, consensual, onerous and commutative.
One may also conclude that like the species sale, a subscription
agreement is not a mode of transferring ownership but constitute merely a title at
the point of perfection; and therefore, tradition or delivery is still required to make
the subscriber the owner of the shares. A closer look into the provisions of the
Corporation Code and case-law would indicate otherwise.
The full payment of the subscription value and/or the issuance of the
covering certificates are not important ingredients for transfer of ownership over
the subscribed shares. This rule is obvious from the provision of Section 72 of
the Corporation Code, which provides that “[h]olders of subscribed shares not
fully paid which are not delinquent shall have all the rights of a stockholders.” In
one case,16 the Supreme Court held that the entire shareholdings of a
stockholder, even when he has not fully paid for them, belong in ownership to
him with legal authority to sell or mortgage them validly.
Furthermore, as far as the corporation is concerned, the registration of the
subscription in the stock and transfer book is not also essential to constitute
subscription and issuance of the shares, since Section 63 of the Corporation
Code, which is the controlling provision on registration in the stock and transfer
books, is meant to govern the binding effects of sale and dispositions of shares
as far as third parties are concerned.
Therefore, a subscription agreement exists upon the meeting of the minds
of the corporation and the subscriber as to the number and subscription value of
shares. And since a subscription agreement shall exist upon meeting of the
minds, i.e., consent, it would necessarily mean that the covered shares have
therefore been issued by the corporation at that point in time, since subscription

14
Fua Cun v. Summers, 44 Phil. 705 (1923).
15
Bayla v. Silang Traffic Co., Inc., 73 Phil. 557 (1942).
16
Fua Cun v. Summers, 44 Phil 705 (1923).
and issuance as to a particular share of stock happen exactly at same point in
time, being merely opposite sides of the same coin.
What can be drawn from the provisions of Sections 60, 63, and 72 is that
the entering into any contract for the acquisition of unissued stock, which shall be
deemed as subscription agreement, would constitute itself the tradition by which
the subscriber becomes a stockholder of the corporation, and through which he
becomes the owners of the shares of stock subscribed and exercise acts of
ownership, subject to the limiting provisions under the Corporation Code, such as
the lien which the corporation has over not fully paid shares under the second
paragraph of Section 63. In other words, unlike the species sale, which
constitutes merely a title and not a mode by which ownership of the subject
matter is transferred, a subscription agreement constitutes the very mode by
which the covered shares are thereby issued and then owned by the subscriber.

2. Subscription Agreement under the Statute of Frauds

Whether a subscription agreement would be subject to the provisions of
the Statute of Frauds, since it is considered a species of sale, is one that also
requires delving into.
Nowhere in the Corporation Code is it required that a subscription
agreement should be in writing in order to be valid, and essentially, being a
consensual contract, it is binding on both the corporation and the subscriber
upon meeting of the minds. This is in stark contrast to the requirements under
Sections 58 and 59 of the Corporation Code specifically requiring that proxies
and voting trust agreements must be reduced in writing to be enforceable.
The issue boils down therefore to whether a valid subscription agreement
may be enforced when it has not been reduced in writing. The settlement of this
issue bears much significance on the enforceability of subscription agreements,
vis-à-vis the protection afforded under the trust fund doctrine to corporate
creditors.
It is the position of the writer, that subscription agreements are not
covered by the Statute of Frauds, and the corporation has a right to enforce and
collect, and to adduce oral evidence, upon an oral subscription agreement, on
the following grounds:

(a) The special treatment accorded to subscription agreements

under Corporate Law requires that subscription agreements,
even when they have been entered into orally, should be
allowed to be proved and enforced by oral evidence, in order
to fully protect corporate creditors under the trust fund
doctrine; and
(b) Even if subscription agreements are covered by the Statute
of Frauds, but by their nature which upon consent would
make the subscriber a stockholder and owner of the covered
shares, which would constitute partial execution, they are
 deemed to be exempted from the prohibition against the
presenting of oral evidence to prove and enforce them.

3. Characteristics of Subscription Agreements

There can be a subscription only with reference to shares of stock which
have never been issued, in the following cases:

(a) The original issuance from authorized capital stock at the

time of incorporation;
(b) The opening, during the life of the corporation, of the portion
of the original authorized capital stock previously unissued;
or
(c) The increase of authorized capital stock achieved through a
formal amendment of the articles of incorporation and
registration thereof with the SEC.

Any transaction covering issued shares of stock is not a subscription

agreement, and therefore is governed by the Law on Sales on assignment. 17
Under Section 60 of the Corporation Code, any contract for the acquisition
of unissued stock in an existing corporation or a corporation still to be formed
shall be deemed a subscription agreement, notwithstanding the fact that the
parties refer to it as a purchase or some other contract. The Corporation Code
has therefore eliminated the distinctions between the subscription contract for
shares governed primarily by Corporate Law principles, and a purchase
agreement covering unissued shares, which was governed primarily by the Law
of Sales. The distinctions between the two types of contracts were important
under the old Corporation Law, and in fact caused much confusion.
In Salmon, Dexter & Co. v. Unson,18 the Supreme Court relieved the
subscriber of his obligation under a "Subscription for Capital Stock" when the
corporation increased the authorized capital stock without his consent. The Court
held that "[a]fter incorporation, one may become a shareholder by subscription,
or by purchasing stock directly from the corporation, or from individual owners
thereof. A distinction is drawn by authorities between a subscription and a sale of
shares by it. Whether a particular contract is a subscription or a sale of stock is a
matter of construction, and depends upon its terms and the intention of the
parties."19
In Salmon, the Court took into consideration the clear intention in the
contract that the subscription constituted a definite portion of the then existing
authorized capital stock, and that the increase in the capital stock had amended

17
See Chapter XIV of the author’s book LAW ON SALES (Rex Book Store, 1998 ed.), on the
characteristics of assignment of intangibles, like shares of stock, as a species of sale.
18
47 Phil. 649 (1925).
19
Ibid, at p. 652.
the situation which was not within the contemplation of the subscriber, and which
allowed him to rescind the agreement. It therefore looked at the arrangement as
a sale of unissued shares of stock.
In Bayla v. Silang Traffic Co., Inc.,20 the petitioner bought shares of stock
from the corporation on installment basis. The title of the contract was
"Agreement for Installment Sale of Shares." Since the corporation had become
insolvent, there was a call on the subscription, and the issue was whether the
contract was a subscription contract which rendered the obligation demandable
upon insolvency of the corporation, or a purchase agreement, which would grant
the purchaser the legal authority to rescind the contract by reason of insolvency
of the seller-corporation.
Bayla held that the nature of a contract covering unissued shares made
after its incorporation, the contract was either a subscription contract or a
purchase of stock, depending upon the terms of the agreement and the
intentions of the parties. It held that a subscription is a mutual agreement among
the subscribers to take and pay for the stock of a corporation, and therefore it
was not possible to withdraw from such an agreement without the consent of the
other subscribers, and even if the corporation should become insolvent because
of the enforcement of the trust fund doctrine. In contrast, the Court recognized
that a "purchase" of shares of stock is an independent agreement between the
individual and the corporation to buy shares of stock from it at a stipulated price,
and the insolvency of the corporation makes it incapable of complying with its
obligation, which grants to the purchaser the right to rescind the agreement.
Bayla, which was decided under the Corporation Law, laid down the
distinctions between a subscription contract and a purchase agreement as
follows:

(a) In a purchase contract, the promise to issue the shares and

the promise to pay the price are considered to create
dependent and concurrent duties and payment is a condition
to the right to a certificate for shares and the status of a
shareholder; whereas, under the subscription agreement,
the subscriber becomes a stockholder even if he has not
paid his subscription;
(b) The purchaser is not a debtor, and according to some
courts, the measure of liability of the purchaser if he defaults,
is in damages for the difference between the contract price
and the market value of the shares; whereas, in subscription
agreement, the unpaid subscription is a debt of the
subscriber;
(c) Bankruptcy or insolvency of the corporation will terminate its
claim against the purchaser on the theory that it can no
longer perform its side of an executory contract by delivery
20
73 Phil. 557 (1942).
 of a valid certificate and that the consideration has failed;
whereas, in subscription, insolvency of the corporation
makes the unpaid subscription immediately due and
demandable;
(d) The provisions of the Corporation Law regarding calls for
unpaid subscriptions and assessment of stock (Secs. 37 to
50) did not apply to a purchase of stock; and
(e) The rule that the corporation has no legal capacity to release
an original subscriber to its capital stock from the obligation
to pay for his shares is inapplicable to a contract of purchase
of shares.

Since the distinctions between a subscription agreement and purchase of

stock led to various frauds being committed against stockholders and creditors of
the corporation, Section 60 of the Corporation Code removed such distinctions
and now provides that all agreements pertaining to the purchase of unissued
shares of stock of a corporation would be considered as subscription agreements
and governed by the principles of Corporate Law.
With Section 60 of the Code, the protection to corporate creditors has
been strengthened so that any and all transactions relating to the issuance of
shares of stock is a subscription agreement for which, in case of insolvency, the
corporate creditors may enforce even against one denominated as a purchaser.
Consequently, all doctrines pertaining to subscription agreements stand as the
surviving principles governing all contracts covering unissued shares of the
authorized capital stock of the corporation.
By way of illustration, let us take the situation where a subscriber enters
into a subscription agreement with a corporation covering unissued shares of
stock. It was stipulated in the subscription agreement that the subscriber's right to
be treated as a stockholder and to enjoy the rights of a stockholder would only
commence upon the full payment of the subscription.
Under the old Corporation Law, and based on an unreported case
supposedly decided by the Supreme Court,21 the stipulation, suspending the
effectivity of the issuance as well as the rights of the stockholder, was considered
valid and binding on both parties, thus:

. . .Contracts of subscription to the capital stock of a

corporation, like other contracts, are the sources of obligations
which have the force of law between the contracting parties.
These obligations may be either pure or conditional. The
conditions attached to an obligation may be either suspensive

21
The citation at 64 Phil. 1053-1054 referred to an unpublished decision Lusk v. Stevens,
G.R. No. 45473, 13 March 1937. However, Lusk v. Stevens, G.R. No. 45325, 27 February 1937,
appears as a published decision in 64 Phil. 154 and does not discuss any Corporate Law
principle at all.
 or resolutory. . . In conditional obligations, the acquisition of
rights as well as the extinction or loss of those already
acquired, shall depend upon the event constituting the
condition. . . That the acceptance by the company of S's offer
to subscribe was made under a suspensive condition, and
does not confer on the latter the rights of a stockholder until
the condition is fulfilled. To hold otherwise would be to brand
the contract with illegality and render it ineffective, a result
which should be avoided. . . The doctrine enunciated by the
courts that by the act of incorporation, without more, the
original subscribers became members of the corporation,
entitled to all the rights and privileges of membership,
including the right to vote, does not apply to subscriptions to
stock on a condition precedent. Such subscription do not
render the subscriber stockholders until the condition is
performed."22

The aforequoted ruling in the unpublished decision must be deemed to

cover a purchase contract covering unissued shares, since it was decided under
the old Corporation Law where by stipulation or clear intention the parties may
have their contract governed by the Law on Sales, and therefore constitutes a
purchase agreement rather than a subscription agreement. The stipulation
suspending any rights to the subscriber until full payment clear reveals the
intention of the parties to be governed by a purchase agreement.
The same agreement when entered under the Corporation Code would
nevertheless be governed by Corporate Law principles, and will not be treated as
a sale of shares of stock. Therefore, in spite of such stipulation on suspension,
and since the shares have not been declared delinquent, strictly speaking the
subscriber has become a stockholder of the corporation, entitled to all the rights
of a stockholder. Except when the circumstances of the case shows the
imperative to apply the principle of estoppel, such stipulation in the subscription
agreement would be void because it goes into the ability or liability of the
subscriber to pay the subscription. Jurisprudence dictates that any condition
imposed on the obligation to pay the subscription in a subscription contract is
void. If the condition is void as to the corporation, then equally it is void as to the
subscriber, without affecting the validity of the subscription agreement. Under the
Corporation Code, in a subscription agreement, it is only delinquency duly
declared, that would deprive the subscriber the rights of a stockholder.
That is not to say that terms, stipulations and conditions may not be
agreed upon in a subscription agreement. Such varying terms, stipulations and
conditions are valid and effective between the parties for so long only as they do
not undermine the ultimate obligation of the subscriber to pay the subscription in
order to protect the claims of corporate creditors.

22
At 64 Phil. 1053-1054 (1937).
 3. Pre-Incorporation Subscription Agreements
Under the old Corporation Law, while generally there was no issue as to
the binding effect of subscription to shares of stock after incorporation, there
were several conflicting positions as to the binding effect of such subscription
before incorporation.23
As to subscriptions to shares before incorporation, there was the "offer"
theory which construed subscriptions as only continuing offers to the proposed
corporation which do not ripen into contracts until accepted by the corporation
when organized. Under such theory, the subscribers are allowed to withdraw
their subscription at any time before the corporation comes into existence and
accepts the offer.24 A subscriber can thus speculate without financial risk to
himself, such that if there is over-subscription, he can take his shares and sell
them at a premium; otherwise, he withdraws from the situation before the
corporation accepts the subscription.25
Under the "contract theory," followed only in a few jurisdiction in the United
States, a subscription agreement among several persons to take shares in a
proposed corporation becomes a binding contract and is irrevocable from the
time of subscription unless cancelled by all the parties before acceptance by the
corporation.26 The difficulty of the theory is the legal standing of the corporation
formed to enforce the subscription agreements, not being the direct party thereto.
It was posited under such theory that the right of the corporation to enforce the
subscription agreement is sustained under the theory that the corporation was a
third party beneficiary under an agreement pour autrui.27 One drawback of the
contract theory, which prevents a subscriber from withdrawing from the
arrangement, was that if the corporation is not organized within a reasonable
time, the subscriber is tied up for a long time to a project which, may not come
through, which would be detrimental to the economic welfare of society.28

23
Navarro, Two Points of Reform of Philippine Corporate Law, 25 PHIL. L.J. 598. "The `offer'
theory is worked out from the law of contracts. The analogy, however, fails for while in ordinary
contracts there are both offerors and offerees, in our case the contemplated corporation has not
yet come into existence. To consider the offer as continuing and, therefore, as if made at the time
the corporation comes into existence is a twisting of the facts, for it is not so made in fact. Neither
may analogy be drawn between the contemplated corporation and a conceived child for no one
ever imagines contracting with it, except, perhaps, giving a gift to it, which does not come within
the purview of contract law. It is not any good to consider the subscriptions as made with an
agent of the proposed corporation, for then there would be an agent for a principal that does not
exist. Again, if we grant the legal possibility of there being an agent of a non-existing principal,
this destroys the theory, as the subscriptions become perfected contracts between two able
parties. The Bryant case indicated, though holding otherwise, that there must be an offeree, for
the formative subscription is a mere „nudum pactum’ — a promisor without a promisee; a
contractor without a contractee. In fact every element of a binding contract is wanting." (at p.
671).
24
Ibid, at p. 670.
25
Ibid.
26
Ibid, at p. 673.
27
Ibid, at p. 674
28
Ibid, at p. 676.
 It was observed that under the old Corporation Law the two theories
supporting pre-incorporation agreements were "vain justifications of varying
policies" and although "both seek to extend their roots into contract law," they
were not even remote relations of the latter.29 Thus, it was held that "[t]he law
developed by courts on formative subscriptions is peculiar to corporate law and is
quite apart from the law of contracts."30
There was also the issue on the binding effect of subscriptions appearing
in the articles of incorporation. Although there was consensus that subscriptions
appearing in the articles of incorporation, when such subscriptions are required
by statute as preliminary to incorporation, are binding and irrevocable from the
time the articles are drawn, it was observed that the same pertain only to
subscribers who signed the articles of incorporation.31
Section 61 of the Corporation Code has now provided a statutory basis for
the theories covering the binding effects of pre-incorporation agreements to
shares of stock. It provides that a subscription for shares of stock of a corporation
still to be formed shall be irrevocable for a period of at least six (6) months from
the date of subscription, except:

(a) When all of the other subscribers consent to the revocation;

or
(b) Unless the incorporation of said corporation fails to
materialize within said period or within a longer period as
may be stipulated in the contract of subscription.

However, no pre-incorporation subscription may be revoked after the

submission of the articles of incorporation to the SEC. Section 61 has therefore
placed a limit to the period under which a subscriber is bound by his pre-
incorporation agreement, which was the main objection to the "contract theory
under the old Corporation Law.
From the rules laid down under Section 61 of the Corporation Code, one
can clearly gleam the special nature of a pre-incorporation subscription, which
fused together the best features of both the "offer" and "contract" theories. It
recognized that the subscription agreement is a contract between the subscriber
and the corporation. Although the corporation is still non-existent since it is still in
the process of incorporation, it is still bound, under the pre-incorporation

29
Ibid, at p. 676.
30
Ibid.
31
Ibid, at pp. 676-677, citing Hughes v. Antietam Mfg. Co. (1871) 34 Md. 316; Lake Ontario,
A. & N.Y.R. Co. v. Mason (1857) 16 N.Y. 451; Johnson v. The Wabash & Mt. Vernon Plank-Road
Co., (1861) 16 Ind. 389; Jones v. Milton & R. Turn. Co., (1856) 7 Ind. 547; Poughkeepsie & S. P.
Pl. Road Co. v. Griffin, (1861) 24 N.Y. 150; Sodus Bay & C.R. Co. v. Hamlin, (1881) 24 Hun
(N.Y.) 390; Seacoast Packing Co. v. Long, 116 S.C. 406; Louiville & B.R.R. Co. v. Elliot, 101 N.Y.
Supp. 328; Anderson v. The Newcastle and Richmond Railroad Co. (1859) 12 Ind. 376; Rehbein
v. Rahr, (1901) Wis. 136; Campbell v.Rayen (1913) 176 Mich. 208.
agreement. The pre-incorporation agreement is replaced by the promoter's
contract, although this is merely an expectancy.
It also recognizes the contractual relationship among all the subscribers.
Whether it is a pre-incorporation agreement or an ordinary subscription
agreement, a subscription is essentially an agreement among the stockholders.
This is the second relationship and the reason why it is provided in Section 61
that a subscriber can only withdraw from the contract or agreement when there is
consent of all subscribers. Under this concept, a subscription agreement is in a
sense a contract among the several subscribers, and no one of the subscribers
can thus withdraw from the contract without the consent of all the others and
thereby diminish, without the universal consent of all the others, the common
fund in which all have acquired an interest.32
One of the implications of considering the subscription contract to be one
entered into among stockholders is that it is beyond the powers of the board of
directors to release the subscribers since the consent of all subscribers is
necessary.33 And even if the all the subscribers would approve the release of a
particular subscriber it is still not possible if the creditors would be prejudiced,
under the trust fund doctrine.

CONSIDERATION FOR ISSUANCE OF SHARES

Since the capital stock of a corporation constitutes the area or basis upon
which the trust fund doctrine operates, the law ensures that the consideration
received (which becomes part of the assets of the corporation) would have
proper value to support the capital stock.
Under Section 62 of the Corporation Code, stocks shall not be issued for a
consideration less than the par or issued price thereof.34 Consideration for the
issuance of stock may be any, or a combination of any two or more, of the
following:

(a) Actual cash paid to the corporation;

(b) Property, tangible or intangible, actually received by the
corporation and necessary or convenient for its use and
lawful purposes at a fair valuation equal to the par or issued
value of the stock issued;
(c) Labor performed for or services actually rendered to the
corporation;
(e) Previously incurred indebtedness by the corporation;
32
SEC Opinion, 30 Oct. 1989, SEC QUARTERLY BULLETIN 50-52 (1 March 1990).
33
Velasco v. Poizat, 37 Phil. 802 (1918)
34
Under Sec. 62 the issued price of no-par value shares may be fixed in the articles of
incorporation or by the board of directors pursuant to authority conferred upon it by the articles of
incorporation or the by-laws, or in the absence thereof by the stockholders at a meeting duly
called for the purpose representing at least a majority of the outstanding capital stock.
 (f) Amounts transferred from unrestricted retained earnings to
stated capital; and
(g) Outstanding shares exchanged for stocks in the event of
reclassification or conversion.

Where the consideration is other than actual cash, or consists of intangible

property such as patents or copyrights, the valuation thereof shall initially be
determined by the incorporators or the board of directors, subject to approval by
the SEC.35
The same consideration as provided for shares of stock, insofar as they
may be applicable, may be used for the issuance of bonds by the corporation.36
Under Section 65 of the Corporation Code, any director or officer of a
corporation consenting to the issuance of stocks for a consideration less than its
par or issued value or for a consideration in any form other than cash, valued in
excess of its fair value, or who, having knowledge thereof, does not forthwith
express his objection in writing and file the same with the stockholder concerned
to the corporation and its creditors for the difference between the fair value
received at the time of issuance of the stock and the par or issued value of the
same.

1. Cash and Promissory Notes for Subscription

Section 62 of the Code expressly provides that shares of stock shall not
be issued in exchange for promissory notes or future services.
It should be noted that Section 62 covers the element of "consideration" in
a subscription agreement, as part of the meeting of the minds of the party to
constitute a valid and binding contract between the corporation and the
subscriber. In spite of the wordings of Section 62 of cash “actually paid to the
corporation,” it is not required that there be actual payment of the cash
consideration in order to make the subscription agreement valid and binding.
Indeed, a subscription agreement is a consensual contract, perfect, valid and
binding upon the meeting of the minds of the parties on the subject matter (the
shares subscribed) and the consideration.
Therefore, even though the consideration agreed upon between the
corporation and the subscriber may be "cash", the non-payment of the
consideration does not render the contract invalid or void, for indeed the unpaid
subscription constitutes "subscription receivable" in the books of the corporation.
Only when there is a call by the board, or when under the terms of the
subscription agreement payment is due, is the stockholder legally required to pay
actual cash to the corporation, and failure to do so would subject the shares to
being declared delinquent and leading to the suspension of the rights of a
stockholder.

35
Sec. 62, Corporation Code.
36
Ibid.
 The better issue to be resolved is why on the books of the corporation
"subscription receivable" (an obligation to pay cash in the future) is valid
consideration under a subscription contract, and yet Section 62 expressly
prohibits promissory notes (or for that matter the creation of "accounts
receivable") to be accepted as consideration for subscription of shares of stock,
when both "notes receivable" and "accounts receivable" may constitute
essentially the same undertaking by the same subscriber to pay cash in the
future, just like "subscription receivable."
The prohibition under Section 62 may be based on two factors: firstly, on
the underlying difference in legal consequences between "notes receivable" or
“accounts receivable” on one hand, and "subscription receivable," on the other
hand; and, secondly, the philosophical basis that underlies the trust fund
doctrine, that the capital stock of a corporation, especially the paid-up portion
thereof, should be backed-up by assets which have their own intrinsic value other
than the promise of a person to pay in the future. In fact, when property other
than cash is paid for subscription, their proper valuation must be proved before
the SEC to ensure that shares are not issued in exchange of properties which do
not have value equal to the par or issued values of such shares.
If a note receivable is accepted as payment for subscription of shares of
stock, the face value of the note would appear as an addition to the assets of the
corporation's balance sheet, without corresponding deduction on the capital stock
of the equity portion. Consequently, creditors who examine the financial
statements of such corporation would be led to believe on face value alone that
the entire paid-up capital stock of the corporation has been paid in cash or
property that has intrinsic value that is not dependent upon the fulfillment of the
promise or credit standing of a person. One should also appreciate the notion
that notes or accounts receivable arising from dealings with third parties tend to
have better valuation since they are the product of arms-length transactions, than
notes or accounts receivable received from an insider, where conflicts-of-
interests situation may lead to compromising the valuation or event he collection
efforts, to the detriment of the corporation and consequently, the corporate
creditors.
On the other hand, subscription receivables are correctly treated not as
assets of the corporation, and are reflected properly in the balance sheet of the
corporation as deductions from stockholder's equity and the difference shows
only a net amount of the stockholder's equity which is backed-up by assets
actually received by the corporation (such as cash or property) which have
values that do not depend on the credit standing of another person. In short, the
presentation of subscription receivable in the corporation's balance sheet clearly
informs the creditors of the actual net amount of capital stock which is truly
backed-up by realizable assets.

2. Property Consideration
 The property which a corporation may accept in exchange for its stock
must be of a kind which the corporation may lawfully acquire and hold in carrying
out the purposes of its incorporation, and which is necessary or proper for it to
own in carrying on its business.37 It cannot lawfully issue stock for property which
its charter does not authorize it to acquire, or for property acquired for an
unauthorized purpose.
For example, real property may be accepted as payment on subscription
to the capital stock only when the same can be used in the business of the
corporation, as in real estate development, subdivision, agro-industrial business,
and the like, as well as for the establishment of offices.
The property must be of substantial nature, having a pecuniary value
capable of being ascertained, and must be something real and tangible as
distinguished from something constructive or speculative; and it must be of such
character that it can be delivered to the corporation, instead of being merely
communicated to its officers or employees. It must also be such as is capable of
being applied to the payment of debts and of distribution among the
stockholders.
The SEC has ruled that property, such as financial instruments and
receivables, may be legally accepted as capital contributions, subject to the
following conditions:

(a) Actually received by the corporation;

(b) Necessary or convenient for the corporation‟s use and lawful
purpose; and
(c) At a fair valuation equal to the par value of the stock issued
to be approved by the SEC.38

Receivables may be accepted by the corporation as valid payment for

subscription, being considered as property consideration, and not as cash
payments. Consequently, the SEC has ruled that such receivables shall be
subject to verification by the SEC of their existence and collectibility; and since
non-payment of the stocks may still be possible in the event that the creditors of
the parent company fail to pay their obligations, the shares to be issued in
consideration thereof shall be held in escrow until the actual payment of the
amount.39

3. Debts and Service as Consideration

A corporation is allowed to receive as payment for its stocks not only
money and property but also labor performed for or services actually rendered to

37
Sec. 62, Corporation Code.
38
SEC Opinion, 25 January 1995, XXIX SEC QUARTERLY BULLETIN 36 (No. 2, June 1995)
39
SEC Opinion, 17 December 1993, XXVIII SEC QUARTERLY BULLETIN 17 (No. 2, June
1994); SEC Opinion, 25 January 1995, XXIX SEC QUARTERLY BULLETIN 36 (No.2, June 1995).
the corporation provided the transaction is in good faith and no fraud is
perpetrated upon other stockholders. Compensation payable for services actually
rendered to the corporation is credit which is property and whose value is
ascertainable.
An agreement to issue stock for services to be rendered in the future is
void under Section 62 of the Corporation Code, and the corporation should not
be estopped to deny that the services constituted payment of the stock
subscription even though it has received the benefit thereof.
Although a previously incurred debt is valid consideration for subscription,
future services would are not allowed as consideration for subscription because
the value of such service to the corporation in exchange for shares of stock
would again depend on the future performance of the subscriber of the service
offered, and there would be a tendency to short-change the corporation. In the
case of a previously incurred debt, their valuation would have been established
at arms-length prior to even negotiating on the subscription agreement, and they
would more often represent the true value of services which the corporation has
received.
In an opinion,40 the SEC ruled that movie star contracts cannot be
accepted as payment for subscription inasmuch as the services of movie stars
under such contracts are not yet considered as actually rendered/received as
their services will still be performed in the future.

4. Set-off of Corporation's Indebtedness

In the case of setting-off of corporate debts against subscription liabilities,
the same psychology applies in the situation under Section 62 which allows
previously incurred debt as proper consideration for the subscription of shares of
stock. Such previously incurred debt (which may either be an accounts payable
or notes payable of the corporation) would be converted to capital and it is likely
that having been established at arms-length, they represent the true value to the
corporation. Another way of looking at it is that since previously incurred
obligations of the corporation exists in its books, the corporation would have had
to pay the same in cash to its creditor, and in turn the same cash is paid back by
such creditor to the corporation for subscription of shares.

5. Unrestricted Retained Earnings or

Existing Capital as Consideration
Under Section 62 of the Code, consideration constituting "amounts
transferred from unrestricted retained earnings to stated capital," and
"outstanding shares exchanged for stocks in the event of reclassification or
conversion," are merely booking entries. The amounts transferred from
unrestricted retained earnings to stated capital covers the declaration of stock
dividends, which has the effect of "capitalizing" unrestricted retained earnings.

40
SEC Opinion, 6 November 1995, XXX SEC QUARTERLY BULLETIN 2 (No. 2, Dec. 1996).
 Stock dividends are in the nature of shares of stock, where the
consideration is the amount of unrestricted retained earnings converted into
equity in the corporation‟s books.41
Declaration of stock dividends should be distinguished from
reclassification or conversion of shares which do not really affect the integrity of
capital stock which has been paid-up previously but only changes its composition
or manner of classification.

6. Consequences of Unlawful Consideration

Aside from enumerating under Section 62 the allowable considerations for
subscriptions on shares of stock, the same section provides clearly that “shares
of stock shall not be issued in exchange for promissory notes or future services.”
What happens therefore when, in spite of the clear injunction under Section 62,
the corporation enters into a subscription agreement that covers a disallowed
consideration. It would not be in consonance with the trust fund doctrine, nor to
the best interests of the corporation and its creditors, to consider such
subscription contract as void. The reasonable interpretation is that the
subscription contract would be valid and binding on both the corporation and the
subscriber, but that the provision on such unlawful consideration is deemed void,
such that the subscription agreement would be construed to be for cash and the
unpaid amount be treated as part of subscription receivables.
In addition, the entering into such an unlawful consideration clause under
the subscription agreement would subject the board of directors and participating
officers to the same liabilities provided for under Section 65 of the Corporation
Code for watered stocks.

WATERED STOCK
In giving added "teeth" to Section 62 which governs what considerations a
corporation may accept for the issuance of shares of stock, the Code makes
directors and officers liable for watered stocks under Section 65, thus: "Any
director, or officer of a corporation consenting to the issuance of stocks for a
consideration less than its par or issued value or for a consideration in any form
other than cash, valued in excess of its fair value, or who, having knowledge
thereof, does not forthwith express his objection in writing and file the same with
the corporate secretary, shall be solidarily liable with the stockholder concerned
to the corporation and its creditors for the difference between the fair value
received at the time of issuance of the stock and the par or issued value of the
same."
Sections 62 and 65 are substantial adoptions of the relevant portions of
Sections 5 and 16 of the old Corporation Law, and include in the enumerations
other items which, although not enumerated under the old Corporation Law, were

41
Lincoln Philippine Life v. Court of Appeals, 293 SCRA 92, 96 SCAD 542 (1998).
nevertheless generally accepted as valid consideration for issuance of stock,
such as previously incurred debts and services already rendered.
Shares issued as fully paid when in truth the consideration received is
known to be less than the par value or issued value of the shares are called
"watered stock". The term sometimes is used to include "bonus shares" under an
agreement that nothing shall be paid to the corporation for them, and "discount
shares" issued at a discount under an agreement to pay less than the par value
in money.
Stock watering is prohibited because of the injuries caused to:

(a) The corporation, which is deprived of needed capital and the

opportunity to market its securities to its own advantage,
thus hurting its business prospects and financial
responsibility;
(b) Existing and future shareholders, who are also injured by the
dilution of the proportionate interests in the corporation and
who pay full value for their shares;
(c) Present and future creditors, who are injured as the
corporation is deprived of the assets or capital required by
law to be contributed by all shareholders as substitute for
individual liability for corporate debts; and
(d) Persons who deal with it or purchase its securities who are
deceived because stock watering is invariable accompanied
with misleading corporate accounts and financial statements,
particularly by an overstatement of the value of assets
received for the shares to cover up a capital deficit resulting
from overvaluation and underpayment of purported capital
contributions.42

Basically, three (3) theories have been advanced as basis for holding
stockholders and officers liable for watered stocks.
Firstly, under the "subscription contract theory," which holds that the
subscription contract is the source and measure of the duty of a subscriber to
pay for his shares; if the contract releases him from further liability, the subscriber
ceases to be liable.43
The subscription contract theory is unacceptable in our jurisdiction
because of the peremptory language of then Section 16 of the Corporation Law,
and now Sections 62 and 65 of the Corporation Code.
Secondly, under the "fraud theory" previously discussed, which holds a
shareholder liable for watered stock on the basis of tort or misrepresentation.
According to the theory, the wrong done to the creditor is fraud or deceit in falsely
42
BALLANTINE, 794.
43
BALLANTINE, 802.
representing that the par value has been paid or agreed to be paid in full. Under
this theory, subsequent creditor without notice is presumed to have been
deceived by this misrepresentation; but prior creditors with notice are not
protected. This was the ruling in Hospes v. Northwestern Manufacture & Car
Co.,44 even as it rejected the trust fund doctrine:

The phrase that the capital of a corporation constitute a

trust fund for the benefit of creditors is misleading. Corporate
property is not held in trust, in any proper sense of the term. A
trust implies two estate or interests - one equitable and one
legal; one person, as trustee, holding the legal title, while
another, as the cestui que trust, has the beneficial interest.
Absolute control and power of disposition are inconsistent with
the idea of a trust. The capital of a corporation is its property. It
has the whole beneficial interest in it, as well as the legal title.
It may use the income and profits of it, the same as a natural
person. It is a trustee for its creditors in the same sense and to
the same extent as a natural person, but no further . . . It
certainly cannot require the invention of any new doctrine in
order to enforce so familiar a rule of equity. It is the
misrepresentation of fact in stating the amount of capital to be
greater than it really is that is the true basis of the liability of
the stockholder in such cases; and it follows that it is only
those creditors who have relied, or who can fairly be presumed
to have relied, upon the professed amount of capital, in whose
favor the law will recognize and enforce an equity against the
holders of (bonus) stock.45

Thirdly, under the trust fund doctrine, under which all corporate creditors
would have legal basis to recover against stockholders and guilty officers.
Despite the views of foreign authors that the fraud theory is the prevailing
46
view, it would seem that in Philippines jurisdiction, the trust fund doctrine on
watered stock prevails. In Philippine Trust Corp. v. Rivera,47 the Supreme Court
held -

It is established doctrine that subscriptions to the capital

of a corporation constitute a fund to which creditors have a
right to look for satisfaction of their claims and that the
assignee in insolvency can maintain an action upon any
unpaid stock subscription in order to realize assets for the
payment of its debts. . .A corporation has no power to release
an original subscriber to its capital stock form the obligation of
paying for his shares, without a valuable consideration for

44
48 Minn. 174, 50 NW 117.
45
Ibid.
46
BALLANTINE, 806; THOMPSON, 3429.
47
44 Phil. 469 (1923).
 such release; and as against creditors a reduction of the
capital stock and take place only in the manner and under the
conditions prescribed by the statute or the charter or the
articles of incorporation. Moreover, strict compliance with the
statutory regulations is necessary.48

Likewise, under Section 65 of the Corporation Code, no distinction is

made as to creditors whether they become such prior to or subsequent to the
issuance of the watered stock and fraud is not made an element. In any event,
Section 65 is by itself sufficient basis to hold a stockholder liable to any corporate
creditor without need to resorting to any of the discussed theories.
The legal standing of corporate creditors against guilty stockholders and
officers for watered stock is clear in a situation when the corporation is insolvent
since then all corporate assets would be held for the satisfaction of the claims of
the creditors, before any distribution is made to the stockholders. But when the
corporation is still a "going concern" and the watering of the stock does not
actually render it insolvent, does Section 65 actually grant corporate creditors the
legal standing to bring at that point a suit against the involved stockholder and
the guilty officers?
In the payment of property for subscribed shares, Section 62 of the
Corporation Code provides that "the valuation thereof shall initially be determined
incorporators or the board of directors subject to approval by the Securities and
Exchange Commission." In actual practice the watering of stock is not supposed
to happen because property consideration for subscription is always evaluated
by the SEC which often conducts an examination of the involved properties and
appraisal reports are submitted to establish the fair value of such properties.
When the SEC approves the valuation it may be difficult to sustain an assertion
later on that there has been watering of the shares.

RELEASES FROM SUBSCRIPTION OBLIGATIONS

The accepted rule in Philippine jurisdiction is that a corporation can
release a subscriber from liability on the subscription, in whole or in part, only
with the express or implied consent of all of the shareholders, and only when
there is no prejudice to corporate creditors.49
Lingayen Gulf Electric Power Company, Inc. v. Baltazar,50 held that "a
valid and binding subscription for stock of a corporation cannot be cancelled so
as to release the subscriber from liability thereon without the consent of all the
stockholders." It allowed certain exceptions to the rule: in the case of "bona fide
compromise, or to set off a debt due from the corporation, a release, supported

48
Ibid, citing Velasco vs. Poizat, 37 Phil. 802 and 14 C.J., 498, 620.
49
SALONGA, supra, p. 497; AGBAYANI, COMMERCIAL LAW oF THE PHILIPPINES, Vol. 3, 1984
ed., pp. 454-455.
50
93 Phil. 404 (1953). See also Phil. Trust Co. v. Rivera, 44 Phil. 469 (1923), and Nava v.
Peers Marketing Corp., 74 SCRA 65 (1976).
by consideration, [which] will be effectual as against dissenting stockholders and
subsequent and existing creditors." Note, however, that the exceptions
mentioned in Lingayen Gulf really do not constitute a gratuitous release since a
valuable consideration is actually received by the corporation, such as
cancellation of corporate debt. Even under Section 62 of the Corporation Code a
bona fide debt is sufficient consideration for the issuance of a share.
In the United States there is the view that a pre-incorporation subscription
merely constitutes a continuing offer since the corporation still to be formed has
yet not legal existence, and therefore the pre-incorporation subscription may be
revoked anytime prior to legal incorporation.51
Section 61 of the Corporation Code has rejected that view and in effect
adopts the other view that pre-incorporation contract is a binding contract among
the subscriber and no party may revoke the contract without the consent of the
other. The section provides that a subscription for shares of stock of a
corporation still to be formed shall be irrevocable for a period of at least six (6)
months from the date of subscription, unless all of the other subscribers consent
to the revocation, or unless the incorporation of said corporation fails to
materialize within the 6-month period or within a longer period as may be
stipulated in the contract of subscription. However, it provides that no pre-
incorporation subscription may be revoked after the submission of the articles of
incorporation to the SEC.
In Philippine Trust Co. v. Rivera,52 Rivera subscribed to 450 shares of
stock in the corporation. The corporation later became insolvent, and Philippine
Trust Company became its assignee in bankruptcy. PhilTrust instituted an action
to recover the stock subscription of Rivera who claimed that his failure to pay
was due to the fact that the company's capital was reduced by 50% during
stockholder's meeting prior insolvency and that such reduction released him from
payment of the unpaid subscription.
The Supreme Court ruled that the resolution releasing the stockholder's
from their obligation to pay the 50% of their subscriptions was an attempted
withdrawal of so much capital from the fund upon which the company's creditors
were entitled ultimately to rely on and having been effected without compliance
with the statutory requirements, was wholly ineffectual. The Court held that
subscription to the capital of a corporation constitute a fund to which creditors
have a right to look for satisfaction of their claims and that the assignee in
insolvency can maintain an action upon any unpaid stock subscription in order to
realize assets for the payment of its debts. The Court added:

A corporation has no power to release an original

subscriber to its capital stock from the obligation of paying for
his shares, without a valuable consideration for such release;
and as against creditors a reduction of the capital stock can

51
Collines v. Morgan Grain Co., 16 F. 2d 253; BALLANTINE, 444; FLETCHER, 91-94.
52
44 Phil 469 (1923).
 take place only in the manner and under the conditions
prescribed by the statute or the charter or the articles of
incorporation. Moreover, strict compliance with the statutory
regulations is necessary.53

The Court observed that subscriptions payable can be cancelled if there is

a reduction in capital stock, (a) which is possible of done with the consent of the
creditors, or (b) if they will not be prejudiced by such move, in which case their
consent is not necessary.
Miranda v. Tarlac Rice Mill Co.,54 held that Section 38 of the Corporation
Law provided that "the board of directors of every corporation may at any time
declare due and payable to the corporation unpaid subscription to the capital
stock and may collect the same with interest accrued thereon or such percentage
of said unpaid subscriptions as it may deem necessary . . . this power of the
directors is absolute and cannot be limited by the subscription contract, but this
does not mean that the directors may not rely on the subscription contract if they
see fit to do so."55
The Court also held that the facts that the corporation had ceased to do
business and that the other stockholders have not been required to pay for their
shares in accordance with their subscription agreement, did not justify the
corporation to return to the plaintiff the amount paid previously by a particular
stockholder. "If the directors have failed to perform their duty with respect to the
other stockholders, the law provides a remedy therefor."56
In that case, Miranda subscribed for 100 shares of stock of a corporation
still to be organized, to be paid according to a schedule. Thereafter, Miranda
mortgaged in lieu of cash for the same corporation a parcel of land, in order for
the latter's capital to increase, with the officers of said corporation as his
attorneys-in-fact. However, the corporation borrowed from one Tablante
P10,000 secured by a mortgage on the same parcel of land originally belonging
to Miranda. At the time of the constitution of the mortgage to Tablante, Miranda
had only a balance of P3,000 on his subscription payable.
The Court viewed that it was the intention of the parties that the property
should be mortgaged immediately for a sum not to exceed P10,000 not only for
the purpose of paying the subscription agreement of Miranda, but also for
increasing the capital of the corporation, in order to carry out the purposes for
which it was to be organized. Miranda even repaid to Tablante the amount which
the officers of the corporation had borrowed.
It is important to make a distinction between dates specified to make
payment that is made in a subscription contract and a simple subscription

53
Ibid, at pp. 470-471, citing 14 C.J., 498, 620.
54
57 Phil 619 (1932).
55
Ibid, at p. 627, quoting from FISHER, THE PHILIPPINE LAW ON STOCK CORPORATIONS, at p.
97.
56
Ibid, at p. 628.
contract. In the first case, payments to the subscription must be made on said
dates, without need of a call; and non-compliance with said date can be
converted to a delinquency status. However, in the second case, a call is
necessary in order for delinquency to set in. In Miranda's case, he was to make
payment to his subscriptions based on a schedule embodied in the subscription
contract.
In Velasco v. Poizat,57 Poizat was a stockholder of the Philippine Chemical
Product Co. from the inception of the enterprise; fifteen (15) of those shares
subscribed by Poizat and the other 15 shares subscribed by Infante, were not
fully paid. The board of directors adopted two resolutions, the first to make good
by new subscriptions in proportion to their respective holdings the 15 shares of
Infante which have been surrendered by Infante; the other was to require Poizat
to pay the amount of his subscription upon the 15 shares and should Poizat
refuse to pay, the company would undertake judicial collection proceedings.
When the company went into voluntary insolvency, the assignee, Velasco, filed a
complaint against Poizat seeking to recover his deficiency. Poizat contended that
the call of the board of directors was not made pursuant to the requirements of
the Corporation Law and that the action was instituted before the expiration of
the 30 days specified in the Section 38 of the old Corporation Law.
The Court held that Poizat continued to be liable on his subscription.
When insolvency supervenes upon a corporation and the court assumes
jurisdiction to wind it up, unpaid stock subscriptions become payable on demand,
and are at once recoverable in an action instituted by the assignee in insolvency.
In Philippine National Bank v. Bitulok Sawmill, Inc.,58 Pres. Roxas
organized the Philippine Distributing Agency for the purpose of insuring the
steady supply of lumber to enable the war sufferers to rehabilitate their
devastated homes. The President convinced the lumber produces to form a
lumber cooperative and to pool their resources together. Roxas promised and
agreed to finance the agency by making the government invest P9.00 for every
peso the members would invest. Relying on the assurance, Bitulok and several
others subscribed to the stocks of Phil. Distributing Agency. The Legislature was
not able to appropriate the counterpart fund to be put up by the government,
hence, Pres. Roxas instructed PNB to grant the Phil. Distributing Agency. The
loan was not paid, as a consequence, PNB filed a suit their subscriptions to the
Phil. Distributing Agency. May PNB collect the balance on the subscription in
spite of the conditions attached thereto which were not fulfilled.
The Court held that it is a well-settled principle that with all the vast
powers lodged in the President, he is still devoid of the prerogative of suspending
the operation of any statute or any of its terms. The power of suspending the
laws is lodged with the Legislature, which has indicated that the obligation for the
payment of subscription by the defendants shall be governed by the Corporation
Law. The President could not suspend the effectivity of the Corporation Law;

57
37 Phil 802 (1918).
58
23 SCRA 1366 (1968).
therefore, the defendants remain liable to the balance of their subscription.
The Philippine National Bank case gives the essence of a subscription
contract. It is indeed a species of the Law on Contracts, but the principles in
Corporate Law prevail. One of the principles in Corporate Law is that when one
enters into a subscription agreement, one cannot deny the obligation to pay,
even when the corporation becomes insolvent.
When one enters into a subscription agreement, the principles of
Corporate Law become part and parcel of the contract. The cases therefore hold
that any contradiction to modify the condition of the obligation to pay is
essentially void. It does not avoid the subscription agreement, but avoids the
condition. The obligation to pay then becomes a purely simple obligation.

PAYMENT OF BALANCE OF SUBSCRIPTION

Under Section 66 of the Corporation Code, subscribers for stock shall pay
to the corporation interest on all unpaid subscriptions from the date of
subscription, if so required by, and at the rate of interest fixed in, the by-laws. If
no rate of interest is fixed in the by-laws, such rate shall be deemed to be the
legal rate.
Under Section 67, subject to the provisions of the contract of subscription,
the board of directors of any stock corporation may at any time declare due and
payable to the corporation unpaid subscriptions to the capital stock and may
collect the same or such percentage thereof, in either case with accrued interest,
if any, as it may deem necessary.
Payment of any unpaid subscription or any percentage thereof, together
with the interest accrued, if any shall be made on the date specified in the
contract of subscription or on the date stated in the call made by the board.
Failure to pay on such date shall render the entire balance due and payable and
shall make the stockholder liable for interest at the legal rate on such balance,
unless a different rate of interest is provided in the by-laws, computed from such
date until full payment.
If within 30 days from the said date no payment is made, all stocks
covered by said subscription shall thereupon become delinquent and shall be
subject to sale as hereinafter provided, unless the board of directors orders
otherwise.

CALL ON UNPAID SUBSCRIPTIONS

1. Nature of the Call
The word “call” is capable of three meanings, namely: (a) it may mean the
resolution of the board of directors for the payment of unpaid subscriptions; (b)
notification of such resolution made on the stockholders; or (c) the time when
subscriptions become payable.59
A call is usually expressed in the form of a resolution adopted by the
board of directors, specifying the proportion of the unpaid subscription which it is
desired to call in and the time or times when it is to be payable. The entire
amount of the unpaid subscription may be called at once or it may be made
payable by installments, at stated intervals, or by successive calls.
A resolution to make a call prospectively is good; that is, a resolution
providing that a call made on a specified day in the future.60 Under such
circumstance, the date so specified is the date of the call, although the resolution
also provides for payment in installments at a still later date.61 What would be
critical is the date of payment and not the date of the resolution approving the
same.62
A call must be uniform with respect to all holders of the class of shares on
which it is made who have already paid an equal amount on their shares, and as
a general rule it must not exceed the balance remaining unpaid on their shares.

2. When Call Not Necessary

There are two (2) instances when call is not necessary to make the
subscriber liable for payment of the unpaid subscription:
(a) When, under the terms of the subscription contract,
subscription is payable, not upon call, but immediately, or on
a specified day, or when it is payable in installments at
specified times; and

(b) If the corporation becomes insolvent, which makes the

liability on the unpaid subscription due and demandable
regardless of any stipulation to the contrary in the
subscription agreement.
Lingayen Gulf Electric Power Co. v. Baltazar,63 held that the provisions of
the old Corporation Law on notice of call and delinquency sale proceedings are
mandatory in nature and must strictly be complied with; when not complied with,
the call would be unlawful and ineffective. The Court further held that "the reason
for the mandatory provision is not only to assure notice to all subscribers, but
also to assure equality and uniformity in the assessment on stockholders."64

59
SEC Opinion, 31 August 1995, XXX SEC QUARTERLY BULLETIN 25 (No. 1, June 1996).
60
SEC Opinion, 31 August 1995, XXX SEC QUARTERLY BULLETIN 25 (No. 1, June 1996).
61
Ibid.
62
Ibid.
63
93 Phil. 404 (1953).
64
Ibid, at p. 409, citing 14 C.J. 639.
 Lingayen Gulf, as in the case of Velasco v. Poizat,65 also distinguished the
requirements when the corporation becomes insolvent, in which case all unpaid
stock subscriptions become payable on demand and are immediately
recoverable in an action instituted by the assignee. However, citing foreign
sources, Lingayen Gulf seems to recognize, by way of exception, when a
subscriber may be released from his subscription: "In particular circumstances,
as where it is given pursuant to a bona fide compromise, or to set off a debt due
from the corporation, a release, supported by consideration, will be effectual as
against dissenting stockholders and subsequent and existing creditors."66 Note
that even in such "exceptions" the release is for valuable consideration.
The release according to Lingayen Gulf, must have the consent of all
other stockholders since "[a] contract of subscription is, at least in the sense
which creates an estoppel, a contract among the several subscribers. For this
reason none of the subscribers can withdraw from the contract without the
consent of all the others, and thereby diminish, without the universal consent, the
common fund in which all have acquired an interest."67
In summary, Lingayen Gulf held: "In conclusion we hold that under the
Corporation Law, notice of call for payment for unpaid subscribed stock must be
published, except when the corporation is insolvent, in which case, payment is
immediately demandable. We also rule that release from such payment must be
made by all the stockholders."68
Edward A. Keller & Co., Ltd. v. COB Group Marketing, Inc.,69 affirmed that
the "stockholder is personally liable for the financial obligations of a corporation
to the extent of his unpaid subscription,"70 even when the corporation itself, which
was the main creditor for the obligation, was not shown to be insolvent. This
presumes that the liability of stockholders for unpaid subscription to corporate
obligations is direct and they can be sued in their personal capacity with the
corporation even when the latter is still very much solvent.
Velasco v. Poizat,71 held that "the Corporation Law clearly recognizes that
a stock subscription is a subsisting liability from the time the subscription is
made, since it requires the subscriber to pay interest quarterly from that date
unless he is relieved from such a liability by the by-laws of the corporation. The
subscriber is as much bound to pay the amount of the shares subscribed by him
as he would be to pay any other debt, and the right of the company to demand
payment is no less incontestable."

65
37 Phil. 805 (1918).
66
Ibid, at p. 411, quoting from 18 CJS 874.
67
Ibid, at pp. 411-412, quoting 2 THOMPSON ON CORPORATIONS, p. 194.
68
Ibid, at p. 413.
69
141 SCRA 86 (1986).
70
Ibid, citing Vda. de Salvatierra v. Garlitos, 103 Phil. 757, 763 (1958).
71
37 Phil. 802 (1918).
DELINQUENCY SALE
Under Section 68, the board of directors may, by resolution, order the sale
of delinquent stock and shall specifically state the amount due on each
subscription, plus all accrued interest, and the date, time and place, of the sale
which shall not be less than thirty (30) days, nor more than sixty (60) days from
the date the stocks become delinquent.
Notice of said sale, with a copy of the resolution, shall be sent to every
delinquent stockholder either personally or by registered mail. The notice shall
furthermore be published once a week for two (2) consecutive weeks in a
newspaper of general circulation in the province or city where the principal office
of the corporation is located.
Under Section 67 of the Corporation Code, it is specifically provided that
the unpaid subscription “shall be made on the date specified in the contract of
subscription or on the date stated in the call made by the board . . . If within thirty
(30) days from the said date no payment is made, all stocks covered by said
subscription shall thereupon become delinquent.” The SEC has ruled that the
use of the word “shall” shows that a prior call or board resolution demand
payment is not necessary if a specific date of payment is specified in the
subscription contract; and neither is there a need of a formal declaration of the
board for an unpaid subscription to become delinquent in the event of failure to
pay the unpaid subscription within the prescribed 30 day period from the date
specified in the subscription contract.72

1. Who Is the Highest Bidder?

Unless the delinquent stockholder pays to the corporation, on or before
the date specified for the sale of the delinquent stock, the balance due on his
subscription, plus accrued interest, costs of advertisement and expenses of sale,
or unless the board of directors otherwise orders, said delinquent stock shall be
sold at public auction to such bidder who shall offer to pay the full amount of the
balance on the subscription together with accrued interest, costs of
advertisement and expenses of sale, for the smallest number of shares or
fraction of a share. The stock so purchased shall be transferred to such
purchaser in the books of the corporation and a certificate for such stock shall be
issued in his favor. The remaining shares, if any, shall be credited in favor of the
delinquent stockholder who shall likewise be entitled to the issuance of a
certificate of stock covering such shares.
Should there be no bidder at the public auction who offers to pay the full
amount of the balance on the subscription together with accrued interest, costs of
advertisement and expenses of sale, for the smallest number of shares or
fractions of a share, the corporation may bid for the same, and the total amount
due shall be credited as paid in full in the books of the corporation. Title to all the
shares of stock covered by the subscription shall be vested in the corporation as

72
SEC Opinion, 13 March 1998, XXXII SEC QUARTERLY BULLETIN 3 (No. 1, June 1998).
treasury shares and may be disposed of by said corporation as the case of other
treasury shares.
Remaining shares go to the delinquent stockholder for the simple reason
that Section 68 protects the delinquent stockholder himself. Corporations are not
supposed to make money out of the sale.

2. Questioning the Delinquency Sale

Section 69 of the Corporation Code provides that no action to recover
delinquent stock sold can be sustained upon the ground of irregularity or defect
in the notice of sale, or in the sale itself of the delinquent stock, unless the party
holding the stock the sum for which the same was sold, with interest from the
date of sale at the legal rate; and no such action shall be maintained unless it is
commenced by the filing of a complaint within six (6) months from the date of
sale.

3. Other Remedies Still Available to Corporation

Under Section 70, nothing in the Code's provisions on delinquency sale
prevents the corporation from collecting by action in a court of proper jurisdiction
the amount due on any unpaid subscription, with accrued interest, costs and
expenses.
In De Silva v. Aboitiz,73 De Silva subscribed for 650 shares of stock. He
has paid only 200 shares. Subsequently, the Board of said corporation declared,
by resolution, the unpaid subscription to be due and demandable; and non-
payment of which on the date fixed would amount to a sale of said shares. De
Silva questioned said authority of the Board, as the corporation's by-laws
provided that the Board may deduct an amount from the net profit to be applied
to unpaid subscriptions. He contended that the Board cannot prescribe another
manner of collecting unpaid subscriptions when one has already been provided
in the by-laws.
The Court ruled that the Board of Directors has absolute discretion to
choose which remedy it deems proper in order to collect on the unpaid
subscriptions. If it does not which to make use of the authority given to it in the
by-law, it still has two other remedies. It may put up the unpaid stock for sale as
provided in Sections 38 to 48 of the Corporation Law or by action in court.

4. Effects of Delinquency
Under Section 71, no delinquent stock shall be voted for or be entitled to
vote or to representation at any stockholder's meeting, nor shall the holder
thereof be entitled to any rights of a stockholder except the right to dividends in
accordance with the provisions of this Code, until and unless he pays the amount

73
44 Phil 755 (1923).
due on his subscription with accrued interest and the costs and expenses of
advertisement, if any.
Delinquency is achieved in either one of two ways:

(a) Failure to pay the subscription on the date mentioned in the

call; or
(b) Failure to pay the subscription on the date specified on the
contract of subscription.

Once a stock has become delinquent, it has the following effects on its
holder:

(a) It disqualifies the stockholder to be voted for or be entitled to

vote or to representation at any stockholder's meeting;
(b) It disqualifies the stockholder to exercise any rights of a
stockholder except the right to dividends, until and unless he
pays the amount due on his subscription with accrued
interest and the costs and expenses of advertisement, if any.

The holders of delinquent shares shall not be entitled to notice of the

regular or special meeting of the stockholders, nor shall the shares be included in
the determination of a quorum for shareholdings‟ meetings.74 The only right
remaining to a delinquent stockholder is the right to receive dividends under
Section 71 of the Corporation Code, but the cash dividend due shall first be
applied to the unpaid balance, while stock dividend shall be withheld until the
unpaid balance is fully paid.75 In effect, the stockholder‟s right to dividend is even
restricted.76

5. Prescription on Demand for the

Payment of Subscription
In Garcia v. Suarez,77 the Supreme Court discussed the prescriptive
period for the enforcement of a subscription agreement.
In that case, Suarez subscribed to sixteen shares of stock of the
corporation, but paid only the value of four shares. Garcia was subsequently
appointed by the court a receiver of the corporation and ordered the collection of
all credits of the corporation, payments of its debts and disposal of its assets.
When Garcia made a demand on Suarez to pay the balance of his subscription,
Suarez refused, claiming that the corporation's right to demand has already
prescribed since ten years had lapsed from the date of his subscription. He also

74
SEC Opinion, 13 March 1998, XXXII SEC QUARTERLY BULLETIN 3 (No. 1, June 1998).
75
Ibid.
76
Ibid.
77
67 Phil 441 (1939).
claimed that he was released from such obligation by the president of the
corporation.
The Court ruled that the action has not prescribed, since the period begins
to run from the time payment becomes demandable, which in the case of
subscription of shares begins to run only from the time the board of directors
declares that balance are due and demandable. The prescriptive period does not
begin to run from the date of the subscription. The Court held: "Of course, the
obligation to pay arises from the date of the subscription, but the coming into
being of an obligation should not be confused with the time when it becomes
demandable."78 Moreover, a corporation or its officers have no legal capacity to
release a subscriber to its capital stock from the obligation to pay for his shares,
and any agreement to this effect is invalid.

CERTIFICATE OF STOCK
1. Rights to Issuance of Certificate of Stock
Under Section 63 of the Corporation Code, the capital of the stock
corporation shall be divided into shares for which certificates signed by the
president or vice-president, countersigned by the secretary or assistant
secretary, and sealed with the seal of the corporation shall be issued in
accordance with the by-laws. Shares of stock so issued are personal property
and may be transferred by delivery of the certificate or certificates indorsed by
the owner or his attorney-in-fact or other person legally authorized to make the
transfer.
Under Section 64 of the Corporation Code, no certificate of stock shall be
issued to a subscriber until the full amount of his subscription together with
interest and expenses (in case of delinquent shares), if any is due, has been
paid. A subscriber must first totally pay his subscription before a certificate of
stock covering shares subscribed and paid for could be issued to him. But an
unpaid subscription (not declared delinquent) can be voted upon in corporate
meetings. Such delinquent shares are also entitled to dividends, subject to the
rules set forth in Section 43 of the Corporation Code on delinquent shares.
The purpose of the prohibition is to prevent the partial disposition of a
subscription which is not fully paid, because if it is permitted, and the subscriber
subsequently becomes delinquent in the payment of his subscription, the
corporation may not be able to sell as many of his subscribed shares as would
be necessary to cover the total amount due from him, which is authorized under
Section 68 of the Corporation Code.
Before the rule under Section 64 was established under the Corporation
Code, the Supreme Court in Baltazar v. Lingayen Gulf Electric Power Co. Inc.,79
had occasion to rule upon the old corporate practice that covered procedure of a

78
Ibid, at p. 444.
79
14 SCRA 522 (1965).
corporation in issuing certificates of stock to its individual subscribers for unpaid
shares of stock. In order to maintain their control of the corporations, defendant,
who constituted a majority of the holdover board of directors passed a resolution
prohibiting unpaid shares of stock from voting.
This resolution was held invalid by the trial court, which ruled that if the
entire subscribed shares of stock were not paid, the paid shares of stock may not
be deprived of the right to vote. The Supreme Court held that since it was the
practice and procedure of the corporation to issue certificates of stock to its
individual subscribers, it may not take away the right to vote granted by such
certificates. Also, unless prohibited by its by-laws, certificates of stock may be
issued for less than the number of the shares subscribed for provided the par
value of each of the stocks represented by each of the certificates has been paid.
The provisions under Section 64 do not actually prohibit the same results
in Baltazar, but actually operates as a legal basis on the part of the corporation,
through its board of directors and officers, to refuse any claim by a subscriber to
issue certificate of stock covering the extent of shares that have been paid-up
while leaving the remaining balance unpaid. But nothing is Section 64 prohibits
the corporation from "dividing" the subscription of a subscriber by considering
portion thereof as fully paid and issuing a corresponding certificate over the paid-
up shares. But pursuant to Section 64, such option is only granted to the
corporation.
In the absence of provisions in the by-laws to the contrary, a corporation
may apply payments made by subscribers on account of their subscriptions
either as:

(a) Full payment for the corresponding number of shares, the

par value of which is covered by such payment; or
(b) Payment pro-rata to each and all the entire number of
shares subscribed for.

Obviously, the two alternatives cannot be availed of by the corporation at

the same time. Once an alternative is chosen, it must be applied uniformly to all
stockholders similarly situated, and therefore, it cannot be changed without the
consent of all stockholders who might be affected.

a. Special Rules for Uncertificated Shares

Under Section 43.2 of the Securities Regulation Code,80 the SEC may, by
specific rule or regulation, allow corporations to provide in their articles of
incorporation and by-laws for the use of uncertificated securities.
“Uncertificated security” is defined as security evidenced by electronic or
similar records.81

80
Rep. Act 8799 (May, 2000).
81
Sec. 3.14, The Securities Regulation Code (R.A. 8799).
 2. Nature of Certificates of Stock
De los Santos v. Republic,82 held that in Philippine jurisprudence, a
certificate of stock is not a negotiable instrument, but is regarded as quasi-
negotiable in the sense that it may be transferred by endorsement, coupled with
delivery, but it is not negotiable because the holder thereof takes it without
prejudice to such rights or defenses as the registered owners or transferor's
creditor may have under the law, except insofar as such rights or defenses are
subject to the limitations imposed by the principles governing estoppel.
De los Santos based its ruling on the fact that under Section 35 of the
Corporation Law (now Section 63 of the Corporation Code), a sale of shares of
stock, even when coupled with endorsement and delivery of the covering stock
certificates, “shall not be valid, except as between the parties,” until it is “entered
and noted upon the books of the corporation,” and that such sale is “absolutely
void” and, hence, as good as non-existent,” as far as third parties and the
corporation is concerned.83
Tan v. Securities and Exchange Commission,84 discussed the nature and
function of certificate of stock: "A certificate of stock is not necessary to render
one a stockholder in a corporation. Nevertheless, a certificate of stock is the
paper representative or tangible evidence of the stock itself and of the various
interests therein. The certificate is not stock in the corporation but is merely
evidence of the holder's interest and status in the corporation, his ownership of
the share represented thereby, but is not in law the equivalent of such ownership.
It expresses the contract between the corporation and the stockholder, but it is
not essential to the existence of a share in stock or the creation of the relation of
shareholder to the corporation."85
Tan held that the lack of endorsement of a certificate of stock which had
been previously delivered to the corporation by the registered stockholder for
cancellation (and eventually returned to the stockholder for his endorsement)
would not prevent the corporation from cancelling in the books of the corporation
of such certificate and issuance of a new certificate in favor of the new owner of
the shares.
The statement in Tan that the certificate of stock does not represent
ownership of the shares covered therein should be understood in the light that
Tan essentially involved issues between intra-corporate members, namely the
corporation and the stockholder. The detailed provisions under the Corporation
Code on the issuance, registration and treatment of certificates of stock is meant
to protect the quasi-negotiable nature of the certificate of stock and its
acceptance in the world of commerce.
The SEC has aptly ruled that a person may own shares of corporate stock
without possessing a stock certificate which after all is merely an evidence of
82
96 Phil. 577 (1955).
83
Ibid, at p. 599.
84
206 SCRA 740 (1992).
85
Ibid, at pp. 749-750, citing 13 Am.Jr.2d 769.
ownership of the stock; and that for as long as the subscriber to the stock is duly
recorded in the stock and transfer book of the corporation as the owner, he is
considered a stockholder or record and is entitled to all the rights of a
stockholder.86

3. Probative Value of Certificate of Stock

The certificate of stock itself once issued is a continuing affirmation or
representation that the stock described therein is valid and genuine and is at
least prima facie evidence that it was legally issued in the absence of evidence to
the contrary; however, this presumption may be rebutted.87

4. Issuance of Certificate of Stock

A formal certificate of stock could not be considered issued in
contemplation of law unless signed by the president or vice-president and
countersigned by the secretary or assistance secretary.88
The issuance or delivery of the certificate of stock is not necessary to
constitute the subscriber a stockholder of the corporation; however, delivery is
generally, an essential element of the issuance of the certificate of stock itself. 89
There is no issuance of the certificate where it is never detached from the
certificate book although the blanks therein are properly filled up, if the person
whose name is inserted therein has no control over the books of the
corporation.90
Curiously though, in one case,91 the Supreme Court held that the share of
stock is deemed not issued where the certificate made out in the name of the
subscriber is never delivered to him but is retained by the corporation as security
for notes given by him for the unpaid portion of his subscription; and this has
been held to be true even though the subscriber votes the stock and though
dividends are declared on it which are credited on the notes.
While the issuance of a stock certificate is not a condition precedent to
render one a stockholder, under Section 63 of the Corporation Code every
stockholder has a right to have a proper certificate issued to him by the
corporation upon demand, as soon as he has complied with the conditions under
Section 64 of the Corporation Code which requires full payment of the
subscription.92
The SEC has opined that the remedies available to a stockholder if a
corporation wrongfully refuses to issue a certificate of stock are as follows:
86
SEC Opinion, 6 January 1999, XXXIII SEC QUARTERLY BULLETIN 44 (No. 1, June, 1999).
87
Bitong v. Court of Appeals, 292 SCRA 304, 96 SCAD 205 (1998).
88
Bitong v. Court of Appeals, 292 SCRA 503, 96 SCAD 205 (1998).
89
Tuazon v. La Previsora Filipina, 67 Phil. 36 (1938), quoting from 11 FLETCHER CYC.
CORP., at 324-325.
90
Ibid.
91
Ibid.
92
SEC Opinion, 6 January 1999, XXXIII SEC QUARTERLY BULLETIN 44 (No. 2, June, 1999).
 (a) To file a suit for specific performance of an express or
implied contract;
(b) To file for an alternative relief by way of damages where
specific performance cannot be granted;
(c) To file a petition for mandamus to compel the issuance of the
certificate where the conditions, facts and circumstances of
the particular case bring it within the legal rules which govern
the granting of the writ; or
(d) To rescind the contract of subscription if the corporation
wrongfully refuses to deliver a certificate, and sue to recover
back what has been paid.93

5. Negotiation of Certificate of Stock

Since certificates of stock are quasi-negotiable in nature, the normal mode
of dealing with such certificates is by the process of endorsement and delivery. It
must be noted that “endorsement and delivery” of certificates of stock may be for
any of the three (3) purposes:

(a) For sale or assignment of the shares;

(b) Pursuant to a trust or nominee arrangement; or
(c) By way of pledge or encumbrance of the shares.

Endorsement is an essential ingredient in dealing with certificates of stock,

and generally cannot be dispensed with. For example, the SEC has opined that
the articles of incorporation of a stock corporation cannot provide for a bearer
certificate without the need for the endorsement of the registered owner thereof,
since Section 63 of the Corporation Code clearly requires the endorsement of the
certificate of stock by the owner or duly authorized persons in transferring
ownership of the shares of stock.94
As discussed below, the legal effects and consequences of endorsement
and delivery for each of each of the three instances would be different.
In Bitong v. Court of Appeals,95 the Supreme Court held that the rule is
that the endorsement of the certificate of stock by the owner, his attorney-in-fact,
or any other person legally authorized to make the transfer shall be sufficient to
effect the transfer of shares only if the same is coupled with delivery; and that the
delivery of the stock certificate duly endorsed by the owner is the operative act of
transfer of shares from the lawful owner to the new transferee. It specifically
enumerated the following requirements for the valid transfer of stocks:

93
SEC Opinion, 8 January 1987, XXI SEC QUARTERLY BULLETIN 1 (No. 1, March 1987); SEC
Opinion, 9 June 1988, XXII SEC QUARTERLY BULLETIN 18 (Nos. 3, Sep. 1988).
94
SEC Opinion, 1 September 1995, XXX SEC QUARTERLY BULLETIN 27 (No. 1, June 1996).
95
292 SCRA 503, 96 SCAD 205 (1998).
 (a) There must be delivery of the stock certificate;
(b) The certificate must be endorsed by the owner or his
attorney-in-fact or other persons legally authorized to make
the transfer; and
(c) To be valid against third parties, the transfer must be
recorded in the books of the corporation.

Even Bitong therefore recognized that registration of the transfer of the

share in the stock and transfer books is necessary to complete the process of
negotiation of the certificate of stocks.

6. Forged and Illegal Transfers of Certificates

The doctrine that emerges from decisions of the Supreme Court with
respect to unauthorized or forged transfer of certificates of stock emphasizes the
fact that since certificates of stock are only quasi-negotiable, they do not afford
the same protection to a holder in good faith and for value who receives them in
the course of their being negotiated, and that the ownership of the true owner
would be preferred. The only exception to such rule is when the circumstances
showed that the true owner was guilty of negligence is causing the loss.
Early on, De los Santos v. Republic,96 held that since certificates of stock
are not negotiable instruments, a transferee under a forged assignment acquires
not title which can be asserted against the true owner, unless the true owner‟s
own negligence has been such as to create an estoppel against him. The rule
therefore would be that the doctrine that a bona fide purchaser of shares under a
forged or unauthorized transfer acquires no title as against the true owner does
not apply where the circusmtances are such as to estop the latter from asserting
his title.”97
Subsequently, Santamaria v. Hongkong and Shanghai Banking Corp.,98
held that a bona fide pledgee or transferee of a stock from the apparent owner is
not chargeable with knowledge of the limitations placed on said certificates by
the real owner, or of any secret agreement relating to the use which might be
made of the stock by the holder.
It further held that when a stock certificate is endorsed in blank it
constitute what is termed as "street certificate", so that upon its face, the holder is
entitled to demand its transfer into his name from the issuing corporation. Such
certificate is deemed quasi-negotiable, and as such the transferee thereof is
justified in believing that it belongs to the holder and transferor.
In that case, Mrs. Josefa Santamaria bought 10,000 shares of stock of a
mining corporation. The certificates were made out in the name of a brokerage
firm, duly indorsed in blank and delivered to Mrs. Santamaria for valuable

96
96 Phil. 577 (1955).
97
Ibid, quoting from 12 FLETCHER CYC. CORP., at 521-534).
98
89 Phil. 780 (1951).
consideration. She delivered it to R.J. Campos and Co., another brokerage firm,
to comply with the latter's requirement that she deposit something on account if
she wanted to buy shares of another mining corporation. Campos thereafter
delivered to a bank the said certificate duly indorsed to said bank pursuant to a
letter of hypothecation executed by Campos in favor of said bank. The said
certificate was delivered to the bank in the ordinary course of business, together
with many other securities, and the time it was delivered the bank had no
knowledge that the shares represented by the certificate belonged to Mrs.
Santamaria for it was in the for of a street certificate transferable by mere
delivery.
The Court held that she could not recover the certificates since she could
have asked the corporation that issued it to cancel it and issue another in lieu
thereof in her name. Her negligence was the immediate cause of the damage,
since the certificate was endorsed by her to constitute as a street certificate.
Upon its face, the holder was entitled to demand its transfer to his name from the
issuing corporation. The bank is not obligated to look beyond the certificate to
ascertain the ownership of the stock at the time he received it from Campos, it
having been given pursuant to a letter of hypothecation.
Of recent vintage is the ruling in Neugene Marketing, Inc. v. Court of
Appeals,99 where the Supreme Court held that when the certificates of stock
have been endorsed in blank for purposes of showing the nominee relations, the
eventual delivery and registration of the shares in violation of the trust
relationship and after their having been stolen, would be void, even when such
transfers have been registered in the stock and transfer book.
The proven facts in Neugene Marketing indicated that the registered
owners of the stock certificate had endorse them in blank for custody and
safekeeping of the beneficial owners thereof, who kept them in a family vault, but
where subsequently stolen. No negligence was found to have actuated the acts
of the registered owners. In addition, the proper corporate officers of the
corporation were aware of the blank endorsement of the certificates and
therefore were adjudged to have acted in bad faith in assigning the certificates to
other parties and in recording the transfers in the stock and transfer book.
The Court therefore held that since the certificates were endorsed in blank
and delivered for safekeeping and not in the process of negotiation, it was
essential that the beneficial owners must give their approval for the transfer of
the certificates that the beneficial owners for such transfers to be valid and
effective. Finally, the Court ruled in Neugene Marketing that the lack of
consideration for the transfers also made such transfers void and inexistent.

7. Lost or Destroyed Certificates

99
303 SCRA 295, 103 SCAD 526 (1999).
 Under Section 73, the following procedure shall be followed for the
issuance by a corporation of new certificate(s) of stock in lieu of those which
have been lost, stolen or destroyed:
The registered owner of certificate(s) of stock in a corporation or his legal
representative shall file with the corporation an affidavit in triplicate setting forth, if
possible, the circumstances as to how the certificate(s) were lost, stolen or
destroyed, the number of shares represented by each certificate, the serial
number(s) of the certificate(s) and the name of the corporation which issued the
same. He shall also submit such other information and evidence which he may
deem necessary.
After verifying the affidavit and other information and evidence with the
books of the corporation, said corporation shall publish a notice in a newspaper
of general circulation published in the place where the corporation has its
principal office, once a week for three (3) consecutive weeks at the expense of
the registered owner of the certificate(s) of stock which have been lost, stolen or
destroyed.
The notice shall state the name of said corporation, the name of the
registered owner and the serial number(s) of said certificate(s) and the number of
shares represented by such certificate(s), and that after the expiration of one (1)
year from the date publication, if no contest has been presented to said
corporation regarding said certificate(s) of stock, the right to make shall such
contest shall be barred and said corporation shall cancel in its books the
certificate(s) of stock which have been lost, stolen or destroyed and issue in lieu
thereof new certificate(s) of stock, unless the registered owner files a bond or
other security in lieu thereof as may be required, running for period of one (1)
year for a sum and in such form and with such sureties as may be satisfactory to
the board of directors, in which case a new certificate may be issued even before
the expiration of one (1) year period provided therein.
If a contest has been presented to said corporation or if an action is
pending in court regarding the ownership of said certificate(s) of stock which
have been lost, stolen or destroyed, the issuance of the new certificate(s) of
stock in lieu thereof shall be suspended until the final decision by the court
regarding the ownership of said certificate(s) of stock which have been lost,
stolen or destroyed.
Except in case of fraud, bad faith, or negligence on the part of the
corporation and its officers, no action may be brought against any corporation
which shall have issued certificate(s) of stock in lieu of those lost, stolen or
destroyed pursuant to the procedure above described.
Section 73 seeks to avoid duplication of certificates to the detriment of the
rightful owner. It is without prejudice to any court action over the lost certificates
of stock.
 In an opinion,100 the SEC held that the requirements under Section 73 of
the Corporation Code are not mandatory, thus:

While Section 73 of the Corporation Code appears to be

mandatory, the same admits of exceptions, such that a
corporation may voluntarily issue a new certificate in lieu of the
original certificate of stock which has been lost without
complying with the requirements under Section 73 of the
Corporation Code, provided that the corporation is certain as
to the real owner of the shares to whom the new certificate
shall be issued. . . . It would be an internal matter for the
corporation to find measures in ascertaining who are the real
owners of stock for purposes of liquidation. It is well-settled
that unless proven otherwise, the “stock and transfer book” of
the corporation I the best evidence to establish stock
ownership.”

A corporation may actually not heed the procedure under Section 73 of

the Corporation Code in accordance with the SEC Opinion, but by doing so, it
cannot avail of the “free and harmless” clause provided in said section, that
“Except in case of fraud, bad faith, or negligence on the part of the corporation
and its officers, no action may be brought against any corporation which shall
have issued certificate(s) of stock in lieu of those lost, stolen or destroyed” and
open itself to claims for damages.

SPECIAL RULES ON REGISTERED OR LISTED SHARES

1. Rule on Uncertificated Shares
Notwithstanding Section 63 of the Corporation Code, under Section 43.1
of the Securities Regulation Code, a corporation whose shares of stock are
registered pursuant to the Code or listed on a stock exchange may:

100
SEC Opinions, 28 January 1999 XXXIII SEC QUARTERLY BULLETIN 50 (No. 1, June 1999).
According to the SEC, foreign jurisprudence is replete with authorities to the effect that a
corporation may voluntarily issue a new certificate of stock in place of an original certificate which
has been lost or destroyed and it can be compelled to issue a new certificate without any
indemnity where upon the facts, it is reasonably certain that the original certificate will not
reappear, as where there is a clear proof that the original had been destroyed, or that it had been
lost or stolen, not having an assignment by the owner, or where the certificate was lost by the
corporation itself by carelessness, or if the corporation was otherwise protected, for in such a
case the corporation could not incur any liability by reason of the original certificate. While Section
73 of the Corporation Code appears to be mandatory, the same admits exceptions, such that a
corporation may voluntarily issue a new certificate n lieu of the original certificate of stock which
has been lost without complying with the requirements under Section 73 of the Corporation Code,
provided that the corporation is certain as to the real owner o the shares to whom the new
certificate shall be issued. SEC Opinion, 28 January 1999, XXXIII SEC QUARTERLY BULLETIN 50
(No. 1, June 1999).
 (a) If so resolved by its Board of Directors and agreed by a
shareholder, issue shares to, or record the transfer of some
or all of its shares into the name of said shareholders,
investors or, securities intermediary in the form of
uncertificated securities;
(b) The use of uncertificated securities shall be without prejudice
to the rights of the securities intermediary subsequently to
require the corporation to issue a certificate in respect of any
shares recorded in its name; and
(c) If so provided in its articles of incorporation and by-laws,
issue all of the shares of a particular class in the form of
uncertificated securities and subject to a condition that
investors may not require the corporation to issue a
certificate in respect of any shares recorded in their name.

2. Binding Effect on Shares Transactions

Under Section 43.3 of the Code, transfers of securities, including an
uncertificated securities, may be validly made and consummated in any of the
following manners:

(a) By appropriate book-entries in the securities accounts

maintained by securities intermediaries;
(b) In the stock and transfer book held by the corporation or the
stock transfer agent and such bookkeeping entries shall be
binding on the parties to the transfer.

A transfer made pursuant to the foregoing has the effect of the delivery of
a security in bearer form or duly indorsed in blank representing the quantity or
amount of security or right transferred, including the unrestricted negotiability of
that security by reason of such delivery.101
However, transfer of uncertificated shares shall only be valid, so far as the
corporation is concerned, when a transfer is recorded in the books of the
corporation so as to show the names of the parties to the transfer and the
number of shares transferred.102

3. Evidentiary Value of Clearing Agency Record

The official records and book entries of a clearing agency shall constitute
the best evidence of such transactions between clearing agency and its
participants and members, without prejudice to the right of participants‟ or
members‟ clients to prove their rights, title and entitlement with respect to the

101
Sec. 43.3, The Securities Regulation Code.
102
Ibid.
book-entry security holdings of the participants or members held on behalf of the
clients.103 However, the corporation shall not be bound by the foregoing
transactions unless the corporate secretary is duly notified in such manner as the
SEC may provide.104

4. Pledging a Security or Interest Therein.

In addition to other methods recognized by law, a pledge of, or release of
a pledge of, a security, including an uncertificated security, is properly constituted
and the instrument proving the right pledged shall be considered delivered to the
creditor under Articles 2093 and 2095 of the Civil Code if a securities
intermediary indicates by book-entry that such security has been credited to a
specially designated pledge account in favor of the pledgee.105
Such pledge has the effect of the delivery of a security in bearer form or
duly indorsed in blank representing the quantity or amount of such security or
right pledged.106
In the case of a registered clearing agency, the procedures by which, and
the exact time at which, such book-entries are created shall be governed by the
registered clearing agency‟s rules.107 However, the corporation shall not be bound
by the foregoing transactions unless the corporate secretary is duly notified in
such manner as the SEC may provide. 108
The foregoing rules are limited only to registered or listed shares of stock.

5. Issuer’s Responsibility for Wrongful

Transfer to Registered Clearing Agency
The registration of a transfer of a share into the name of and by a
registered clearing agency or its nominee shall be final and conclusive unless the
clearing agency had notice of an adverse claim before the registration was made;
but this shall be without prejudice to any rights which the claimant may have
against the issuer for wrongful registration in such circumstances.109

6. Power of Sec on Issuing Rules Covering Shares

Section 47 of the Securities Regulation Code lays down the powers of the
SEC with issuing rules on ownership issues pertaining to securities, including
shares of stock. The SEC “is authorized, having due regard to the public interest
and the protection of investors, to promulgate rules and regulations which:”

103
Sec. 44, The Securities Regulation Code.
104
Ibid.
105
Sec. 45, The Securities Regulation Code.
106
Ibid.
107
Ibid.
108
Ibid.
109
Sec. 46, The Securities Regulation Code.
 (a) Validate the transfer of securities by book-entries rather than
the delivery of physical certificates;110
(b) Establish when a person acquires a security or an interest
therein and when delivery of a security to a purchaser
occurs;111
(c) Establish which records constitute the best evidence of a
person‟s interests in a security and the effect of any errors in
electronic records of ownership; 112
(d) Codify the rights of investors who choose to hold their
securities indirectly through a registered clearing agency
and/or other securities intermediaries; 113
(e) Codify the duties of securities intermediaries (including
clearing agencies) who hold securities on behalf of
investors;114 and
(f) Give first priority to any claims of a registered clearing
agency against a participant arising from a failure by the
participant to meet its obligations under the clearing
agency‟s rules in respect of the clearing and settlement of
transactions in securities, in a dissolution of the participant,
and any such rules and regulations shall bind the issuers of
the securities, investors in the securities, any third parties
with interests in the securities, and the creditors of a
participant of a registered clearing agency. 115

STOCK AND TRANSFER BOOK

Under Section 74 of the Corporation Code, a stock corporation must keep
a book to be known as the "stock and transfer book," in which must be kept a
record of:

(a) All stocks in the names of the stockholders alphabetically

arranged;
(b) The installment paid and unpaid on all stock for which
subscription has been made, and the date of payment of any
installment;
(c) A statement of every alienation, sale or transfer of stock
made; and

110
Sec. 47.1, Ibid.
111
Sec. 47.2, ibid.
112
Sec. 47.3, ibid.
113
Sec. 47.4, ibid.
114
Sec. 47.5, ibid.
115
Sec. 47.6, ibid.
 (d) Such other entries as the by-laws may prescribe.

1. Where Kept
The stock and transfer book shall be kept in the principal office of the
corporation or in the office of its stock transfer agent and shall be open for
inspection to any director or stockholder of the corporation at reasonable hours
on business days.116

2. Who May Be Transfer Agent

No stock transfer agent or one engaged principally in the business of
registering transfer of stocks in behalf of a stock corporation shall be allowed to
operate in the Philippines unless he secures a license from the SEC and pays a
free as may be fixed by the SEC, which shall be renewed annually. 117 However, a
stock corporation is not precluded from performing or making transfer of its own
stocks, in which case all the rules and regulations imposed on stock transfer
agents, except the payment of a license fee herein provided, shall be
applicable.118

3. Who May Make Proper Entries

In Torres, Jr. v. Court of Appeals,119 the Supreme Court held that entries
made on the stock and transfer book by any person other than the corporate
secretary, such as those made by the President and Chairman, cannot be given
any valid effect.
Torres held that a stockholder who transfers shares of stock has no
authority to effect their entries in the stock and transfer book of the corporation,
even when the corporate secretary happens to be at odds with such stockholder,
and even when such stockholder happen to be in possession of the book. It is
the corporate secretary‟s duty and obligation to register valid transfers of stock
and if said corporate officer refuses to comply, the transferor-stockholder may
rightfully bring suit to compel performance; but he cannot effect such transfers in
the corporate books by himself, since he cannot take the law in his own hands.
Such entries would then be void.

4. Registration with SEC

The SEC Rules Requiring the Maintenance of Stock and Transfer Book,120
require that all stock corporations must set-up and register their stock and
transfer book with the SEC within thirty (30) days from receipt of their certificate
of incorporation.

116
Sec. 74, Corporation Code.
117
Ibid.
118
Ibid.
119
278 SCRA 793, 86 SCAD 812 (1997).
120
XX SEC QUARTERLY BULLETIN 125 (Nos. 3 & 4, Sept. & Dec 1986).
 5. BIR Certification to Effect Transfer of Shares
Under Section 97 of the 1997 National Internal Revenue Code, the
corporate secretary is not authorized to effect transfer of shares to any new
owner in the books of a corporation, unless accompanied by a certification from
the Commissioner of Internal Revenue that the taxes, either estate tax, donor's
tax, have been paid.

6. Probative Value of Stock and Transfer Book

The Supreme Court held in Bitong v. Court of Appeals,121 that the books
and records of a corporation, which include even the stock and transfer book, are
generally admissible in evidence in favor of or against the corporation and its
members to prove the corporate acts, its financial status and other matters
including one‟s status as a stockholder. They are ordinarily the best evidence of
corporate acts and proceedings. However, the books and records of a
corporation are not conclusive even against the corporation but prima facie
evidence only. Parol evidence may be admitted to supply omissions in the
records, explain ambiguities, or show what transpired where no records were
kept, or in some cases where such records were contradicted. The effect of
entries in the books of the corporation which purport to be regular records of the
proceedings of its board of directors or stockholders can be destroyed by
testimony of a more conclusive character than mere suspicion that there was an
irregularity in the manner in which the books were kept.
Bitong reiterated the principle that the foregoing considerations are
founded on the basic principle that stock issued without authority and in violation
of law is void and confers no right on the person to whom it is issued and
subjects him to no liabilities; and that where there is an inherent lack of power in
the corporation to issue the stock, neither the corporation nor the person to
whom the stock is issued is estopped to question its validity since an estoppel
cannot operate to create stock which under the law cannot have existence.
The SEC has opined that corporate books and records are merely private
books and records, and as such, they are subject to the general rule of evidence
which are commonly applicable to documentary evidence, thus:

. . . As held in the number of cases, the general rule is

that such original books and records, if they are in existence
and can be produced, are prima facie evidence of the matters
recorded therein . . . However, it is not to be implied from the
foregoing that original books and records are the exclusive
evidence of the matters and things which ordinarily are or
should be written therein since parol or other extraneous
evidences are admissible in many situations. . . Thus, while
the stock and transfer books are commonly said to be
evidences of stock ownership, extrinsic evidence of mattes

121
Bitong v. Court of Appeals, 292 SCRA 304, 96 SCAD 205 (1998).
 which are or should be recorded in the corporate books and
records may be admitted where the original corporate records
are lost, mislaid or destroyed, or are otherwise inaccessible.
Proper foundation proof explaining the failure to produce the
original books and records must first be laid for the
introduction of other evidences. Such secondary evidence,
ordinarily consists of copies of the records, either certified or
sworn to, or parol testimony.122

TRUST RELATIONS ON SHARES OF STOCK

Philippine Corporate Law recognizes that trust relationship may be
created involving shares of stock of a corporation. For example, in determining
who would be qualified to act as incorporators in the process of incorporation of a
corporation, Section 10 of the Corporation Code provides that “[e]ach of the
incorporators of a stock corporation must own or be a subscriber to at least one
(1) share of the capital stock of the corporation.” Another example would be
Section 23 of the Code which requires that “[e]very director must own at least
one (1) share of the capital stock of the corporation of which he is a director,
which share shall stand in his name on the books of the corporation.”
The Supreme Court has acknowledged that nominal ownership in shares
is all that is required under Section 23 even when it is shown that the registered
stockholder is only a nominee or trustee for another person. 123 Section 59 of the
Code recognizes the validity of voting trust arrangements and provides for the
solemnities.
Outside of special laws which limit certain business or activities to
Filipinos, nominee and trustee arrangements covering shares of stock do not
violate any public policy. Nevertheless, nominee and trusts arrangements
involving shares of stock must still comply with the applicable legal registration
and formalities.
In Bitong v. Court of Appeals,124 the Supreme Court held that even when it
has been shown that the registered owner of shares of stock holds the share in
trust for the benefit of the principal, it is necessary nevertheless that the trustee
must still endorse the stock certificate to validate the cancellation of her share
and to have the transfer recorded in the books of the corporation in favor of the
principal or another trustee.

122
SEC Opinion, 12 January 1994, XXVIII SEC QUARTERLY BULLETIN 33 (No. 2, June 1994),
citing I5 FLETCHER CYC. CORP., 1976 rev. vol., Sec. 2196 at p. 643; FLETCHER Sec. 2196, at p.
644; and FLETCHER, Sec. 2197, at p. 648.
123
Tan v. SEC, 206 SCRA 740 (1992).
The SEC has opined that the certificates of stock for fully paid shares may be issued
directly to the nominee provided it is with the subscriber‟s instructions. SEC Opinion, 14 January
1994, XXVIII SEC QUARTERLY BULLETIN 39 (No. 2, June 1994).
124
292 SCRA 304, 96 SCAD 205 (1998).
 In Neugene Marketing, Inc. v. Court of Appeals, 125 the Court held that
when the certificates of stock have been endorsed in blank for purposes of
showing the nominee relations, the eventual delivery and registration of the
shares in violation of the trust relationship and after their having been stolen,
would be void, even when such transfers have been registered in the stock and
transfer book.
The Court also held in Neugene Marketing that the approval of the
beneficial owners of the shares held in trust is necessary for the validity and
effectivity of the transfer of the stock certificates. Likewise it was also held that
the lack of consideration for the transfer would make such transfers void and
inexistent.

TRANSFER, SALE AND ASSIGNMENT OF SHARES

One of the fundamental rights of a stockholder is his right to sell or
transfer his shares of stock. The free-transferability of the units of ownership in a
corporate setting is one of the attractive features of the corporation. Rulings of
the Supreme Court on the matter center around this doctrine. Therefore, the
authority granted to a corporation to regulate the transfer of its stock does not
empower the corporation to restrict the right of a stockholder to transfer his
shares, but merely authorizes the adoption of regulations as to the formalities
and procedure to be followed in effecting transfer.126
It is well-settled that shares of stock in a corporation are personal property
and the owner thereof has an inherent right, as an incident of his ownership, to
transfer the same at will, as indicated clearly in Section 63 of the Corporation
Code, and as such, the facility of transferring them must not be duly hampered
by imposing restrictions as would amount to restraint on free alienation of
property.127 The SEC has, however, as a matter of policy, allowed reasonable
restrictions on the transfer of shares in the articles of incorporation if the
restrictions comply with the provisions of Section 93 of the Corporation Code,
namely, that the restriction must appear in the articles of incorporation, by-laws
and the certificates of stock, and that said restrictions shall not be more onerous
than granting the existing stockholders or the corporation the option to purchase
the shares of the transferring stockholder with such reasonable terms, conditions
or period stated therein.128

1. When Shares Are Not Fully Paid

125
303 SCRA 295, 103 SCAD 526 (1999).
126
Thomson v. Court of Appeals, 298 SCRA 280, 100 SCAD 415 (1998).
127
SEC Opinion, 8 August 1995, XXX SEC QUARTERLY BULLETIN 21 (No. 1, June 1996);
SEC Opinion, 20 February 1995, XXIX SEC QUARTERLY BULLETIN 4 (No. 3, Sept. 1995); SEC
Opinion, 13 January 1994, XXVIII SEC QUARTERLY BULLETIN 37 (No. 2, June 1994); SEC Opinion,
13 Oct. 1964, SEC FOLIO 1960-1976, at p. 217.
128
Ibid.
 Under Section 63 of the Corporation Code, no shares of stock against
which the corporation holds any unpaid claim shall be transferable in the books
of the corporation. Therefore, a corporation may refuse to acknowledge and
register a sale or assignment of shares which are not fully paid, and may
continue to hold the original subscriber liable on the payment of the subscription.
However, China Banking Corp. v. Court of Appeals,129 has reiterated the
principle that Section 63 of the Corporation Code which provides that “no share
of stock against which the corporation holds any unpaid claim shall be
transferable in the books of the corporation” cannot be utilized by the corporation
to refuse to recognize ownership over pledged shares purchased at public
auction. The term “unpaid claims” refers to “any unpaid claims arising from
unpaid subscription, and not to any indebtedness which a subscriber or
stockholder may owe the corporation arising from any other transactions.
Obligations arising from unpaid monthly dues do not fall within the coverage of
Section 63.”

a. Sale of Portion of Not Fully-Paid Shares

The SEC has opined on several occasions that a stockholder who has not
paid the full amount of his subscription cannot transfer part of his subscription in
view of the indivisible nature of a subscription contract.130 The reason behind the
principle of disallowing transfer of not fully paid subscription to several transferee
is that it would be difficult to determine whether or not the partial payments made
should be applied as full payment for the corresponding number of shares which
can only be covered by such payment or as proportional payment to each and all
of the entire number of subscribed shares, and it would be difficult to determine
the unpaid balance to be assumed by each transferee.131

b. Sale of Entire Not Fully-Paid Shares

On the other hand, the SEC has opined that the entire subscription,
although not yet fully paid, may be transferred to a single transferee, who as a
result of the transfer must assume the unpaid balance. It is necessary, however,
to secure the consent of the corporation since the transfer of subscription rights
and obligations contemplates a novation of contract which under Article 1293 of
the Civil Code cannot be made without the consent of the creditor.132
Consequently, the contract of sale or assignment between the original
subscriber and his transferee, although binding between them, cannot be forced
upon the corporation, when it covers not fully paid shares. This principle is in

129
270 SCRA 503 (1997).
130
SEC Opinion, 9 October 1995, XXX SEC QUARTERLY BULLETIN 48 (No. 1, June 1996);
SEC Opinion, 3 June 1994, XXVIII SEC QUARTERLY BULLETIN 24 (No. 4, Dec. 1994); SEC
Opinion, 8 March 1990, XXIV SEC QUARTERLY BULLETIN 9 (No. 3, Sept. 1990).
131
Ibid.
132
SEC Opinion, 9 October 1995, XXX SEC QUARTERLY BULLETIN 48 (No. 1, June 1996);
SEC Opinion, 3 June 1994, XXVIII SEC QUARTERLY BULLETIN 24 (No. 4, Dec. 1994); SEC
Opinion, 17 September 1990, XXV SEC QUARTERLY BULLETIN 17 (No. 1, March 1991).
consonance with the principle in Contract Law that the substitution of the party of
the obligor can be made only with the express consent of the obligee, the
corporation being considered the obligee in a subscription contract.

2. When Shares Are Fully Paid

Section 63 of the Corporation Code provides that shares of stock so
issued with covering certificate of stock are personal property and may be
transferred by delivery of the certificate or certificates indorsed by the owner or
his attorney-in-fact or other person legally authorized to make the transfer.
Nevertheless, the same section provides that no transfer, shall be valid,
except as between the parties, until the transfer is recorded in the books of the
corporation showing the names of the parties to the transaction, the date of the
transfer, the number of the certificate or certificates and the number of shares
transferred.
Uson v. Diosomito,133 laid down the rule in our jurisdiction that under the
language of Section 63 of the Corporation Code (which was then Section 35 of
the Corporation Law), the failure to register a sale or transfer in the stock and
transfer book of the corporation would render the sale invalid and not binding to
all persons, including attaching creditors of the seller, thus:

We think that the true meaning of the language is, and

the obvious intention of the legislature in using it was, that all
transfers of shares not so entered are invalid as to attaching or
executing creditors of the assignors, as well as to the
corporation and to subsequent purchasers in good faith, and,
indeed, as to all persons interested in the shares, except the
parties to such transfers. All transfers not so entered on the
books of the corporation are absolutely void; not because they
are without notice or fraudulent in law or in fact, but because
they are made so void by statute.134

In Uson, the Supreme Court resolved the issue of whether a bona fide
transfer of shares of a corporation, not registered or noted on the books of the
corporation, would be valid as against a subsequent lawful attachment of said
shares, regardless of whether the attaching creditor had actual notice of said
transfer or not. The Court held that transfer would be void.
The Court, through Mr. Justice Butte, held that the language of the then
Corporation Law was plain to the effect that the right of the owner of the shares
of stock of a corporation to transfer the same by delivery of the certificate,
whether it be regarded as a statutory or common right, was limited and restricted
by the express provision that "no transfer, however, shall be valid, except, as

133
61 Phil. 535 (1935).
134
Ibid, at p. 540, quoting from In re Murphy, 51 Wis., 519; 8 N.W., 419. Emphasis supplied.
between the parties, until the transfer is entered and noted upon the books of the
corporation."
Recently, in Garcia v. Jomouad,135 the Court reiterated and affirmed the
ruling in Uson, holding that “the transfer of the subject certificate . . . was not
valid as to the . . . judgment creditors, as the same still stood in the name of . . .
the judgment debtor, at the time of the levy on execution.” The Court also held
that the entry in the minutes of the meeting of the Club‟s board of directors noting
the resignation of the seller as proprietary member did not constitute compliance
with Section 63 of the Corporation Code, because said provision strictly requires
the recording of the transfer in the books of the corporation, and not elsewhere,
to be valid as against third parties.
The rationale for the Uson doctrine was explained in Escano v. Filipinas
Mining Corporation,136where the Supreme Court enumerated the following
reasons for holding registration of a sale or disposition of shares of stock valid
only when registered in the stock and transfer book of the corporation, thus:

(a) To enable the corporation to know at all times who its actual
stockholders are, because mutual rights and obligations
exist between the corporation and its stockholders;
(b) To afford to the corporation an opportunity to object or refuse
its consent to the transfer in case it has any claim against
the stock sought to be transferred, or for any other valid
reason; and
(c) To avoid fictitious or fraudulent transfers.

In Escano, Escano obtained judgment in his favor against Salvosa, who

was ordered to deliver to the former his escrow shares in the Filipinas Mining
Corporation. A writ of garnishment was issued. However, before such judgment
was rendered, Salvosa sold his escrow shares to Bengzon and then from
Bengzon to Standard Investment of the Philippines. These transfers were not
recorded. But Standard did manage to have it recorded in the books of Filipinas
Mining Corporation three years after the writ of garnishment was issued. Later
Filipinas Mining issued the shares to Standard. The issue resolved by the
Supreme Court was whether the issuance of the new certificates was valid as
against the attaching creditor.
The Court held that the requirements of registration applies to shares in
escrow, and saw no valid reason for treating unissued shares held in escrow
differently from issued shares insofar as their sale and transfer is concerned.
Escano held that the same doctrine applied also to unissued shares held
in escrow. But in so holding Escano seems to have authorized the recording in

135
323 SCRA 424 (2000).
136
74 Phil. 711 (1944).
the stock and transfer book of transactions pertaining to shares over which no
certificate of stock has been issued by the corporation, thus:

. . . But we see no valid reason for treating unissued

shares held in escrow differently from issued shares insofar as
their sale and transfer is concerned. In both cases the
corporation is entitled to know who the actual owners of the
shares are, and to object to the transfer upon any valid
ground. Likewise, in both cases the possibility of fictitious or
fraudulent transfers exists. The only reason advanced by the
appellant for exempting the transfer of unissued shares from
recording is that in case of unissued shares there is no
certificate number to be recorded. But that is a mere detail
which does not affect the reason behind the rule. The lack of
such detail does not make it impossible to record the transfer
upon the books of the corporation so as to show the names of
the parties to the transaction, the date of the transfer, and the
number of shares transferred, which are the most essential
data. . .137

Bitong v. Court of Appeals,138 reiterated the requisites under Section 63 of

the Corporation Code which envisions a formal certificate of stock which can be
issued only upon compliance with certain requisites, thus:

First, the certificate must be signed by the president or

vice-president, countersigned by the secretary or assistant
secretary, and sealed with the seal of the corporation. A mere
typewritten statement advising a stockholder of the extent of
his ownership is a corporation without qualification and/or
authentication cannot be considered as a formal certificate of
stock;
Second, delivery of the certificate is an essential element
of its issuance. Hence, there is no issuance of a stock
certificate where it is never detached from the stock books
although blanks therein are properly filled up if the person
whose name is inserted therein has no control over the books
of the company;
Third, the par value, as to par value shares, or the full
subscription as to no par value shares, must first be fully paid;
and
Fourth, the original certificate must be surrendered
where the person requesting the issuance of a certificate is a
139
transferee from a stockholder.

137
Ibid.
138
292 SCRA 304, 96 SCAD 205 (1998).
 3. Non-Exclusivity of Section 63 on Modes of Registration
Strictly speaking, Section 63 governs only the sale or assignment of
shares of stock, and specifically covered by a stock certificates. The use of the
word "may" in the section indicates that the endorsement and delivery of the
certificate and the registration of the transfer in the book of the corporation is only
one of the modes recognized by law by which to legally and effectively sale and
assign shares of stock that would be binding not only upon the contracting
parties, but also to the corporation and its officers and third parties who will deal
with the covered shares.
Embassy Farms, Inc. v. Court of Appeals,140 held that "[f]or an effective
transfer of shares of stock the mode and manner of transfer as prescribed by law
must be followed. . . As provided under Section 63 of . . . the Corporation Code
of the Philippines, shares of stock may be transferred by delivery to the
transferee of the certificate property indorsed. Title may be vested in the
transferee by the delivery of the duly indorsed certificate of stock."141
Tan v. Securities and Exchange Commission,142 held that delivery of the
certificate of stock in not essential in order to effect the transfer thereof in the
books of the corporation, "where is appears that the persons sought to be held as
stockholders are officers of the corporation, and have the custody of the stock
book."143 However, Tan should be viewed from the essence that the ruling was
issued involving intra-corporate parties, the corporation and the stockholder.
Tan also held that the mode of endorsement and delivery of certificate
provided for in Section 63 of the Corporation Code, is only one of the modes
recognized by the provision because of the use of the term "may" 144 and
considered the fact that when the parties to the sale, including the officers of the
corporation, have undertaken actions to recognized the sale of the shares, such
as the issuance of replacement certificate in the name of the transferee and the
registration thereof in the stock and transfer book, with full knowledge of the
transferor, the same should be recognized as a valid mode of sale of the covered
shares that binds not only the parties to the sale, but also the corporation, its
officers, and third parties who will deal with the shares, especially when the
transfer has been reported to the SEC, and the transferee had been exercising
rights of ownership over the covered shares.
But whatever may have been the mode of effecting the sale or assignment
of shares of stock, Magsaysay-Labrador v. Court of Appeals,145 holds that the
sale or assignment must be registered in the stock and transfer book of the
corporation in order to be binding on third parties. In that case, the Court held

139
Ibid; reformatted to enumerative format.
140
188 SCRA 492 (1990).
141
Ibid, at p. 498.
142
206 SCRA 740, 749 (1992).
143
Ibid, quoting from Tuazon v. La Previsora Filipina, 67 Phil. 36 (1938).
144
Ibid, at p. 748, citing Chua v. Samahang Magsasaka, 62 Phil 472 (1935).
145
180 SCRA 266 (1989).
that a transferee cannot claim a right to intervene as a stockholder in corporate
issue on the strength of the transfer of shares allegedly executed by a registered
stockholder. The transfer must be registered in the books of the corporation to
affect third persons and also the corporation. This principle was reiterated in
Bitong v. Court of Appeals.146
On the other hand, Razon v. Intermediate Appellate Court,147 held that
oral testimony to show that one is the principal or beneficial owners of shares of
stocks for which he has allowed a certificate of stock to be issued in the name of
his alleged nominee will not be sufficient basis to claim rightful ownership over
the shares of stock. The Court held that "[f]rom the point of view of the
corporation . . . the petitioner who claims ownership over the questioned shares
of stock must show that the same were transferred to him by proving that all the
requirements for the effective transfer of shares of stock in accordance with the
corporation's by laws, if any, were followed or in accordance with the provisions
of law. . . The petitioner failed in both instances. . . In the absence of the
corporation's by-laws or rules governing effective transfer of shares of stock, the
provisions of the Corporation Law are made applicable to the instant case. The
law is clear that in order for a transfer of stock certificate to be effective, the
certificate must be properly indorsed and that title to such certificate of stock is
vested in the transferee by the delivery of the duly indorsed certificate of
stock."148

4. Remedy If Registration of Transfer Refused

Hager v. Bryan,149 discussed the remedy available to shareholder whose
transfer of share is refused by the corporation. In that case, the Bryan-Landon
Company was the registered owner of shares of stock in the Visayan Electric
Company. Later it indorsed its certificates of stock to Hager. Hager brought his
certificates to the Visayan Electric Company to transfer upon the company's
books the stocks under his name. The company secretary refused. Hager files a
case for mandamus to compel the registration.
The Supreme Court found that the remedy of mandamus unavailable
under the facts of the case. There are two possible cases before the secretary
may be compelled to make the recording in the stock and transfer book; either
there are express instructions by the registered owner to make such transfer to
the indorsee, or there is a power of attorney authorizing such transfer.
In other words, the mere blank indorsement of the certificate of stock by
itself does not clearly and unequivocable indicate that the registered owner‟s
wish to have the certificate cancelled and a new one issued in the name of the
holder. Endorsement, aside from being part of negotiation, may also be
employed to effect other transactions, such as the act of pledging the shares

146
292 SCRA 304 (1998).
147
207 SCRA 234 (1992).
148
Ibid, at pp. 240-241.
149
19 Phil. 138 (1911).
where there is no intention to part with the title thereto but merely to guaranty the
payment of a loan.
Thus, today we have at the back of certificates of stock the following
inscription, and signed by the registered shareholder in the certificate:

For value received I hereby assign the within named

shares to ________ and appoint ___________ my attorney to
make the transfer on the books of the company.

5. Prescription on Cause of Action

In one case,150 it was held that a stipulation on the stock certificate that the
assignment thereof would not be binding on the corporation unless such
assignment is registered in the books of the club as required under the by-laws,
which does not provide when the registration should be made, would mean that
the cause of action and the determination of the prescription period would begin
only upon demand for registration is made and not at the time of the assignment
of the certificate.

6. Claims for Damages

In case of publicly listed shares, in case of refusal of the corporation to
issue new certificates of stock, the claim for damages pertaining to the value that
the shares could have sold at the stock market is considered speculative damage
and cannot be recovered. The Court held in Batong Buhay Gold Mines v. Court
of Appeals,151 that "[i]t is easy to say now that had private respondent gained
legal title to the shares, it could have sold the same and reaped a profit . . . but it
could not do so because of petitioner's refusal to transfer the stocks in the
former's name at the time demand was made, but then it is also true that human
nature, being what it is, private respondent's officials could also have refused to
sell and instead wait for expected further increases in value."

INVOLUNTARY DEALINGS WITH SHARES

1. Pledge, Mortgage and Other Encumbrances
The right of a stockholder to pledge, mortgage or otherwise encumber his
shares is recognized under Section 55 of the Corporation Code, which regulates
the manner of voting on pledged or mortgaged shares.

150
Won v. Wack Wack Golf & Country Club, 104 Phil. 466 (1958)
151
147 SCRA 4, 8 (1987).
 The SEC recognizes the well-settled principle that shares of stock in a
corporation are personal property and the owner thereof has an inherent right, as
an incident of his ownership, to transfer the same at will, which would include the
power to encumber said shares.152
The SEC has, however, as a matter of policy, allowed reasonable
restrictions on the right of shareholders to encumber their shares if the
restrictions comply with the provisions of Article 93 of the Corporation Code,
namely, that the restriction must appear in the articles of incorporation, by-laws
and the certificates of stock, and that said restrictions shall not be more onerous
than granting the existing stockholders or the corporation the option to purchase
the shares of the transferring stockholder with such reasonable terms, conditions
or period stated therein.153
Therefore, if the restriction on the right to pledge or mortgage shares of
stock absolutely prohibits the stockholders from pledging or mortgaging their
shares without the consent of the board of directors, it would be violative of the
statutory right of the stockholders to encumber shares of stock as allowed in
Section 55 of the Corporation Code.154
However, when the restriction merely allows the corporation or existing
stockholders to accept the offer within the option period, and thereafter, if no one
accepts the offer, the stockholder is free to pledge or mortgage his shares in
favor of any third party, such provision is reasonable, valid and binding. 155

a. When Shares Not Covered by Certificates

Fua Cun v. Summers,156 discussed the applicable rule in case the
mortgage of shares of stock are not covered by certificates of stock.
In that case, Chua Soco subscribed for 500 shares of China Bank, and
paid only half of the subscription price, and was issued a receipt, stating therein
the total number shares. Chua then executed a promissory note in favor of Fua
Cun, securing it with a chattel mortgage on the shares subscribed by him, and
assigning the receipt. Notice of the assignment and the chattel mortgage was
given by Fua Cun to China Bank. Subsequently Chua's interest in the 500 shares
were attached by the same bank as Chua failed to pay a previously contracted
debt. Fua Cun claims ownership over 250 shares by virtue of the payment of the
payment of the amount equivalent to them by Chua and the mortgage thereof to
Fua Cun. The bank argued that the mortgage over the shares was not allowed by
the nature thereof.
The Supreme Court held that chattel mortgages on shares of stock are
valid as between the parties, and that they could be enforced even as against
third parties with notice. "There can be no doubt that an equity in shares of stock

152
SEC Opinion, 8 August 1995, XXX SEC QUARTERLY BULLETIN 21 (No. 1, June 1996).
153
Ibid.
154
Ibid.
155
Ibid.
156
44 Phil 705 (1923).
may be assigned and that the assignment is valid as between the parties and as
to persons to whom notice is brought home."157
Nevertheless, the Court admitted to the difficulty in pinning down notice of
a chattel mortgage over shares of stock on third parties: "an equity in shares of
stock is of such an intangible character that it is somewhat difficult to see how it
can be treated as a chattel and mortgaged will furnish constructive notice to third
parties."158 The Court observed:

These certificates of stock are in the pockets of the

owner, and go with him where he may happen to locate, as
choses in action, or evidence of his right, without any means
on the part of those with whom he proposes to deal on the
faith of such a security of ascertaining whether or not this
stock is in pledge or mortgaged to others. He finds the name
of the owner on the books of the company as a subscriber of
paid-up stock . . . with the certificates in his possession, pays
for these certificates their full value, and has the transfer to
him made on the books of the company, thereby obtaining a
perfect title. What other inquiry is he to make, so as to make
his investment certain and secure? Where is he to look, in
order to ascertain whether or not this stock has been
mortgaged? The chief office of the company may be at one
place to-day and at another tomorrow. The owner may have
no fixed or permanent abode, and with his notes inn one
pocket and his certificates of stock in the other--the one
evidencing the extent of his interest in the stock of the
corporation, the other his right to money owing him by his
debtor, we are asked to say that the mortgage is effectual as
to the one and inoperative as to the other.159

However, the Court is Fua Cun did not have to answer such an issue,
since the facts of the case clearly showed that the bank had been given prior
notice of the chattel mortgage over the shares by the mortgagee before bank
enforced any lien on the shares. The Court noted that prior lien existed in favor of
the bank because "[a]t common law a corporation has no lien upon the shares of
stockholders for any indebtedness to the corporation."160
It should be noted however that a limited lien has been placed in favor of
the corporation under Section 63 of the Corporation Code that provides that "No
shares of stock against which the corporation holds an unpaid claim shall be
transferable in the books of the corporation." However, the same is not a lien for
the claims of the corporation against the stockholder on contractual obligations,
and certainly does not cover encumbrances since the statutory language only

157
Ibid, at pp. 709-710.
158
Ibid, at pp. 708-709).
159
at p. 709, quoting from Spalding v. Paine's Adm'r., 81 Ky. 416.
160
Ibid.
covers "transfers". It merely authorizes the corporation not to recognize any sale
or assignment of shares over which the subscription has not been fully paid and
to hold the original subscriber liable for the payment of the subscription.
In addition, the Court held that Fua Cun's right did not only cover half of
the shares paid, but actually the entire numbers of shares subscribed even
though only half of the subscription had only been paid by Chua. "The plaintiff's
rights consist in an equity in five hundred shares and upon payment of the unpaid
portion of the subscription price he becomes entitled to the issuance of a
certificate for said five hundred shares in his favor."161 This supports the issue
that it is subscription, and not payment of the subscription, that determines the
right and standing of a stockholder in the corporation and the equity interest he
has, and that generally an obligation to pay subscription is not a divisible
obligation.
Therefore, under Section 72 of the Corporation Code, holders of
subscribed shares not fully paid which are not delinquent shall have all the rights
of a stockholder. The paid-up portion is only essential and affects the right of a
stockholder in the event of a call and delinquency proceedings.

b. When Shares Covered by Stock Certificate

Monserrat v. Ceron,162 is an example of a case where the shares of stock
encumbered were covered by certificates of stock.
In that case the registered owner of shares endorsed and delivered the
stock certificate of shares under the terms of a Deed of Transfer conveying to the
transferee the usufruct over the shares with express prohibition under the deed
"from selling, mortgaging, encumbering, alienating or otherwise exercising any
act implying absolute ownership of all or any of the shares in question, the
transferor having reserved for himself and his heirs the right to vote derived from
said shares of stock and to recover ownership thereof at the termination of the
usufruct." A new certificate was issued in the name of the transferee, and the
deed was noted in the stock and transfer book of the corporation.
Subsequently, the transferee, in violation of the prohibition in the deed,
mortgaged the shares of stock, without informing the mortgagee of the terms of
the deed. When the mortgagee thereupon sought to enforce the mortgage on the
shares, the transferor invoked the provisions of the deed as binding upon the
mortgagee of the shares.
The Court, in reaching its conclusion, relied upon the provision of the
Corporation Law (now Section 63 of the Corporation Code), and noted that the
provisions "do not require any entry except of transfers of shares of stock in order
that such transfers may be valid as against third person." In other words, the
Court was of the position that the provisions of Section 63 holding as valid a
transaction involving shares of stock only as between the parties thereto and void

161
Ibid, at p. 710.
162
58 Phil. 469 (1933).
as to the other can only refer to "transfers" or dispositions and not to
encumbrances or security arrangements involving shares of stock.
The Court therefore held that "the chattel mortgage is not the transfer
referred to in [Section 63 of the Corporation Code], which transfer should be
entered and noted upon the books of the corporation in order to be valid, and
which, as has already been said, means the absolute and unconditional
conveyance of the title and ownership of a share of stock."163 In short, Monserrat
held that when it comes to mortgages and other encumbrances covering shares
of stock "which are not a complete and absolute alienation of the dominion and
ownership thereof, its entry and notation upon the books of the corporation is not
necessary requisite to its validity."164
Monserrat clearly implies that a notation in the stock and transfer book
covering transfer of ownership or dominion over shares, binds the world even
when no actual notice thereof is obtained by third parties dealing with the share,
and that notation of such disposition or transfer must be made in the stock and
transfer book, not only for notice, but also validity of the transition. Whereas,
when it comes to encumbrances on shares of stock, not only is the notation
thereof in the stock and transfer book not necessary for its validity, but the
notation thereof in the stock and transfer book would not even bind the world or
third parties dealing with the shares without actual knowledge.
Parenthetically, the ratiocination in Monserrat using the language of
Section 63 could lead to the absurd conclusion that if annotation of an
encumbrance in the stock and transfer book is not necessary for its validity, then
annotation of a disposition of shares of stock is necessary in the stock and
transfer book for the validity of such disposition. That would mean that
registration in the stock and transfer book is the fourth requisite for the validity of
a disposition of shares (aside from consent, cause and consideration). So that if
an assignment of shares of stock is not annotated in the stock and transfer book,
it is valid as to the parties, and void as to everybody else. That means also, that
actual knowledge of a third person of such a disposition means nothing since the
same is void anyway, and until the fourth requisite is complied with, i.e.,
registration in the stock and transfer book, actual knowledge would not validate
the disposition.
Such an implication cannot be reasonably inferred from the reasoning in
Monserrat, since Fua Cun itself has said that "[t]here can be no doubt that an
equity in shares of stock may be assigned and that the assignment is valid as
between the parties and as to persons to whom notice is brought home."165
In Chua Guan v. Samahang Magsasaka, Inc.,166 the registered owner
mortgaged the shares, and the mortgagee not only registered the mortgage with
the registry of deeds, but also in the books of the corporation. When the

163
Ibid, at p. 474.
164
Ibid, at p. 474.
165
Ibid, at p. 710.
166
62 Phil. 472 (1935),
mortgagee foreclosed on the mortgage, the officers of the corporation refused to
issue new certificates in the name of the mortgagee as the winning bidder thereof
in the auction sale, on the ground that before the mortgagee made his demand
upon the corporation, writs of attachments had been served upon and registered
in the books of the corporation against the mortgagor, which the mortgagee
refused to have annotated in the new certificate to be issued to him.
To resolve the issue of whether the mortgage took priority over the writs of
attachment, the Court had to determine whether the registration of the chattel
mortgage in the registry of chattel mortgages in the office of the register of deeds
was equivalent to constructive notice to the attaching creditors.
The Court first settled the issue by affirming the Monserrat doctrine that
"the registration of the said chattel mortgage in the office of the corporation was
not necessary and had no legal effect."167 It also held that the annotation of such
mortgage on the certificate does not also produce legal effect.
Taking its cue from the Chattel Mortgage Law,168 the Court held:

The practical application of the Chattel Mortgage Law on

shares of stock of a corporation presents considerable
difficulty and we have obtained little aid from the decisions of
other jurisdictions because that form of mortgage is ill suited to
the hypothecation of shares of stock and has been rarely used
elsewhere. In fact, it has been doubted whether shares of
stock in a corporation are chattels in the sense in which that
word is used in chattel mortgage statutes.169

In deciding where such registration should be made, the Court held:

It is common but not accurate generalization that the

situs of shares of stock is at the domicile of the owner. The
term situs is not one of fixed or invariable meaning or usage.
Nor should we lose sight of the difference between the situs of
the shares and the situs of the certificates of shares. The situs
of shares of stock for some purposes may be at the domicile of
the owners and for others at the domicile of the corporation;
and even elsewhere. . . It is a general rule that for purposes of
execution, attachment and garnishment, it is not the domicile
of the owner of a certificate but the domicile of the corporation
which is decisive.170

167
Ibid, at p. 477.
168
Act No. 1508, as amended.
169
Ibid, at p. 478.
170
Ibid, at p. 480, quoting 11 FLETCHER CYC. PRIVATE CORP.,par. 5106. Cf. sections 430 and
450, Code of Civil Procedure.
 The Court then held that "considering the ownership of shares in a
corporation as property distinct from the certificates which are merely the
evidence of such ownership, it seems to us a reasonable construction . . . to hold
that the property in the shares may be deemed to be situated in the province in
which the corporation has its principal office or place of business. If this province
is also the province of the owner's domicile, a single registration is sufficient. If
not, the chattel mortgage should be registered both at the owner's domicile and
in the province where the corporation has its principal office or place of business.
In this sense the property mortgaged is not the certificate but the participation
and share of the owner in the assets of the corporation."171
The requirements do not seem practical. If a contract more onerous than
encumbrance, such as the assignment of shares, could validly be annotated in
the stock and transfer book to affect the whole world, why not provide the same
requirement for a contract less invasive as a mortgage. The law should be
interpreted, if not amended, to read that both encumbrances and transfer of
shares should be valid only as against the parties and void as against third
persons unless annotated in the stock and transfer book.
Chua Guan also held that although under Section 63 the surrender of
certificate is necessary to effect the transfer of shares, nevertheless, the "use of
the verb „may‟ does not exclude the possibility that a transfer may be made in
different manner." That means that the execution of a deed of assignment can be
a valid mode of transferring title covering shares of stock.
However, the broad statement in Chua Guan was modified in the later
case of Nava v. Peers Marketing Corporation.172 In Nava, Po subscribed 80
shares of stock of the corporation of which only 20 shares were unpaid by him,
leaving to the corporation an unpaid claim of P6,000 as the balance due on his
subscription. The 20 shares were not covered by any stock certificate. He
subsequently transferred the 20 shares to Nava. Nava asked the corporation to
enter in its book his name as the owner of the 20 shares. When the corporation
refused, Nava brought an action for mandamus.
The Court held that the transfer made by Po to Nava is not the "alienation,
sale, or transfer of stock" that is supposed to be recorded in the stock and
transfer book, as contemplated in Section 52 of the Corporation Law (now
Section 63 of the Corporation Code). "As a rule, the shares which may be
alienated are those which are covered by certificates of stock as governed by
Section 35 of the Corporation Law." Moreover, the Court noted that "the
corporation has a claim on the said shares for the unpaid balance of Po's
subscription. A stock subscription is a subsisting liability from the time the
subscription is made. The subscriber is as much bound to pay his subscription as
he would be to pay any other debt. The right of the corporation to demand
payment is no less incontestable."173 Hence, under the facts of the case, the

171
Ibid, at pp. 480-481.
172
74 SCRA 65 (1976).
173
Ibid, at p. 69.
Court held that there was no clear duty on the part of the officers of the
corporation to register the twenty shares in Nava's name, and therefore no cause
of action for mandamus.
The Court also took into consideration the assertion of Nava that in the
case of Baltazar v. Lingayen Gulf Electric Power Co.,174 he should be issued a
certificate of stock to the portion of the shares already paid for. The Court said
that the doctrine of Baltazar only applies if indeed a certificate of stock had been
issued by the corporation. "As already stressed, in this case no stock certificate
was issued to Po. Without the stock certificate, which is the evidence of
ownership of corporate stock, the assignment of corporate shares is effective
only between the parties to the transaction."175 and that "the delivery of the stock
certificate, which represents the shares to be alienated, is essential for the
protection of both the corporation and its stockholders."176
Bachrach Motor Co. v. Lacson Ledesma,177 held that a mortgage or
pledge over shares of stock is governed also by the principle in the Civil Code
that in order to be effective as against third persons, evidence of its date must
appear in a public instrument; however, this principle has been modified by the
Chattel Mortgage Law in the sense that a contract of pledge and that of chattel
mortgage, to be effective as against third persons, need not appear in public
instruments provided that thing pledged or mortgaged be delivered or placed in
the possession of the creditor. Consequently, it held that the pledge of shares of
stock covered by a certificate is valid and binds third parties, when certificate of
stock has been endorsed and delivered to the creditor, notwithstanding the fact
that the contract does not appear in a public instrument. In sustaining such
doctrine, the Court held:

Certificates of stock or of stock dividends, under the

Corporation Law, are quasi-negotiable instruments in the
sense that they may be given in pledge or mortgage to secure
an obligation . . . In view, however, of the fact that the
certificates of stock, while not negotiable in the sense of the
law merchant, like bills and notes, are so framed and dealt
with as to be transferable, when properly indorsed, by mere
delivery, and as they frequently convey, by estoppel against
the corporation or against prior holders, as good a title to the
transferee as if they were negotiable, and, inasmuch as a
large commercial use is made of such certificates as collateral
security, and it is to the public interest that such use should be
simplified and facilitated by placing them as nearly as possible
on the plane of commercial paper, they are often spoken of
and treated as quasi negotiable, that is, as having some of the
attributes and partaking of the character of negotiable

174
14 SCRA 522 (1965).
175
Supra, at p. 71, citing Davis v. Wachter, 140 So. 361.
176
Ibid, at p. 71, citing Samllwood v. Moretti, 128 So. 2d 628.
177
64 Phil. 681 (1937).
 instruments, in passing from hand to hand, especially where
they are accompanied by an assignment and power of
attorney, executed in blank, to transfer them to anyone who
may obtain possession as holders, even though such
assignment and power are under seal.178

It should be noted that both Chua Guan and Bachrach Motors covered the
issue on what type of registration would constitute valid constructive knowledge
to third parties on encumbrances covering shares of stock. Both cases covered
shares of stock for which certificates of stock have been issued. Chuan Guan
held that to be binding on third parties, the encumbrance must be registered with
the registry of deeds of the place of principal office of the corporation and
residence of the mortgagor; whereas Bachrach Motors held that no such
registration is necessary to bind third parties when the certificate of stock
evidencing the shares mortgaged or pledged is endorsed and delivered to the
mortgagee.
Perhaps in finding our way through the conflict, it is important to note that
in Chua Guan, it was the corporation itself that refused to recognize the
mortgage over shares, where previously attachments thereon had been served
upon the corporation. On the other hand, Bachrach Motors involved a suit
between the creditors of the registered stockholder and the mortgagee of the
shares. However, it would seem from the language of Chua Guan, that it meant
to confront the issue that if registration were the mode to bind third parties, what
type of registration would that be. Thus, Chua Guan held:

Section 4 of Act No. 1508 provides for two ways for

executing a valid chattel mortgage which shall be effective
against third persons. First, the possession of the property
mortgaged must be delivered to and retained by the
mortgagee; and, second, without such delivery the mortgage
must be recorded in the proper office or offices of the register
or registers of deeds. If a chattel mortgage of shares of stock
of a corporation may validly be made without the delivery of
possession of the property to the mortgagee and the mere
registration of the mortgage is sufficient to give constructive
notice to third parties, we are confronted with the question as
to the proper place of registration of such a mortgage."179

Therefore, it would be safe to conclude that in encumbrances over shares

of stock, Bachrach Motors tells us that delivery of the shares, by endorsement
and delivery of the certificate of stocks covering them by the mortgagor to the
mortgagor, would be valid and would itself create constructive knowledge binding

178
Ibid, at pp. 695-696, quoting from 14 C.J., 665, sec. 1034; South Bend First Nat. Bank v.
Lanier, 20 Law. Ed., 172; Weniger v. Success Min. Co., 227 Fed 548; Scott v. Pequonnock Nat.
Bank, 15 Fed. 494.
179
Ibid, at p. 479.
on third parties. Whereas, in the absence of such delivery, then Chua Guan tells
us that double registration with the proper registers of deeds should be complied
with to make the encumbrance binding on third parties.
Lately, the Supreme Court reiterated in Lim Tay v. Court of Appeals,180 the
doctrine that when shares of stocks are pledged by means of endorsement in
blank and delivery of the covering certificates to secure a mortgage loan, the
pledgee does not become the owner of the shares simply by the failure of the
registered stockholder to pay his loan. Consequently, without proper foreclosure,
the lender cannot demand that the shares be registered in his name, since a
contract of pledge of shares does not make the pledgee the owners of the shares
pledged.

2. Mortgage Contracts Versus Attachments and Levies

Under Section 7(c) of Rule 57 of the 1997 Rules of Civil Procedure of the
Philippines, shares of stock or an interest in stock or shares of any corporation
shall be attached "by leaving with the president or managing agent thereof, a
copy of the writ, and a notice stating that the stock or interest of the party against
whom the attachment is issued is attached in pursuance of such writ."
The case of Chua Guan v. Samahang Magsasaka, Inc.,181 would provide
a good starting basis of the discussions on trying to evolve the doctrinal rules
governing conflicting claims over shares of stock in a corporation brought about
by voluntary and involuntary dealings or processes, in that case between the
foreclosing mortgagee and attaching creditors covering the same shares of stock
in a corporation.
The facts in Chua Guan indicate clearly that, Co Toco who was the
registered owner of 5,894 shares, covered by nine (9) certificates of stock,
mortgaged such shares to Chua Chiu to guarantee a debt, with the certificates of
stock being delivered with the mortgage to the mortgagee. Since Co Toco was a
resident of Manila, the mortgage was duly registered in the office of the Register
of Deeds of Manila in June 1931, and with the corporation in September 1931.
Subsequently, Chua Chiu assigned all his rights in the mortgage to Chua
Guan which assignment was registered in the Register of Deeds of Manila in
December, 1931 and with the corporation in January, 1932. When Co Toco
defaulted in the payment of his debt, Chua Guan foreclosed on the mortgage and
delivered the certificates of stock and copies of the mortgage and assignment to
the Manila sheriff to be sold at public auction. At the auction sale in December,
1932, Chua Guan was the highest bidder and a certificate of sale was issued by
the sheriff in his favor.
In February, 1933, when Chua Guan tendered the certificates of stock for
cancellation and issuance of new certificates in his name, the corporation refused
to comply unless the new certificates are issued subject to the nine (9)

180
293 SCRA 634 (1998).
181
62 Phil. 472 (1935).
attachments received by the corporation and noted on its records before the
corporation received notice from the mortgagee Chua Chiu of the mortgage of
the 5,894 shares in June, 1931.
In its decision, the Supreme Court noted that "[n]o question is raised as to
the validity of the said mortgage or of said writs of attachment and the sole
question presented for decision is whether the said mortgage takes priority over
the said writs of attachment."182 In addition, the Court noted that "[i]t is not
alleged that the said attaching creditors had actual notice of the said mortgage
and the question therefore narrows itself down to this: Did the registration of said
chattel mortgage in the registry of chattel mortgages in the office of the register of
deeds of Manila . . . give constructive notice to the said attaching creditors?"183
In resolving the issue against Chua Guan, the Court noted in passing that
"the registration of the said chattel mortgage in the office of the corporation was
not necessary and had no legal effect . . . [and that the] long mooted question as
to whether or not shares of a corporation could be hypothecated by placing a
chattel mortgage on the certificate representing such shares we now regard as
settled by the case of Monserrat vs. Ceron. . ."184
Looking at the provisions of the Chattel Mortgage Law185 the Supreme
Court noted that there are generally two ways of executing a valid chattel
mortgage "which shall be effective against third persons. First, the possession of
the property mortgaged must be delivered to and retained by the mortgagee;
and, second, without such delivery the mortgage must be recorded in the proper
office or offices of the register or registers of deeds."186 When possession of the
property cannot be delivered to the mortgagee, the Court noted the provisions of
the Law which required that if the property is situated in a different province from
that in which the mortgagor resides, the mortgage shall be recorded in the office
of the register of deeds, of both the province in which the mortgagor resides and
that in which the property is situated.
The Court then in Chua Guan laid down the rule of double registration
when it comes to chattel mortgage involving shares of stock in a corporation:

[C]onsidering that the ownership of shares in a

corporation as property distinct from the certificates which are
merely the evidence of such ownership, it seems to us a
reasonable construction of section 4 of Act No. 1508 to hold
that the property in the shares may be deemed to be situated
in the province in which the corporation has its principal office
or place of business. If this province is also the province of the
owner's domicile, a single registration is sufficient. If not, the
chattel mortgage should be registered both at the owner's

182
Ibid, at p. 477.
183
Ibid.
184
Ibid.
185
Sec. 4, Act No. 1508.
186
Supra, at p. 479.
 domicile and in the province where the corporation has its
principal office or place of business. In this sense the property
mortgage is not the certificate but the participation and share
of the owner in the assets of the corporation.187

In arriving at this specific mode of registration of a chattel mortgage

covering shares of stock, the Supreme Court discussed the difficulty in dealing
with shares of stock, even when evidenced by a certificate of stock. It noted that
the "certificates of stock are in the pockets of the owner, and go with him where
he may happen to locate, as choses in action, or evidence of his right, without
any means on the part of those with whom he proposes to deal on the faith of
such a security of ascertaining whether or not this stock is in pledge or
mortgaged to others."188
The Court also noted that if registration of the chattel mortgage of shares
of stock in the province of the owner's domicile should be sufficient, those who
lend on such security would be confronted with the practical difficulty of being
compelled not only to search the records of every province in which the
mortgagor might have been domiciled but also every province in which a chattel
mortgage by any former owner of such shares might be registered. The Court
held:

We cannot think that it was the intention of the legislature

to put this almost prohibitive impediment upon the
hypothecation of shares of stock in view of the great volume of
business that is done on the faith of the pledge of shares of
stock as collateral."189 The Court noting that "[n]or should we
lose sight of the difference between the situs of the shares and
the situs of the certificates of stock,"190 added that additional
registration in the domicile of the corporation was required
since "[i]t is a general rule that for purposes of execution,
attachment and garnishment, it is not the domicile of the owner
of a certificate but the domicile of the corporation which is
decisive.191

Consequently, the Court in Chua Guan held that since the chattel
mortgage in favor of Chua Guan, although registered in the stock and transfer
book, but was not registered in the register of deeds in the principal place of
business of the corporation, then the attaching creditors are entitled to priority
over the defectively registered mortgage of Chua Guan.192

187
Ibid, at pp. 480-481.
188
Ibid, at p. 478.
189
Ibid, at p. 480.
190
Ibid.
191
Ibid, citing FLETCHER, CYC. ON THE LAW OF PRIVATE CORP., par. 5106.
192
Ibid, at p. 482.
 3. Attaching or Levying Creditors Versus Other Creditors
Subsequently, in the unreported case of Samahang Magsasaka, Inc. v.
Chua Guan,193 the summary report indicated the salient facts to be that in the
decision of the trial court it was held that "Gonzalo Chua Guan is the legal owner
of the 5,894 shares of stock in question and has a better right to said shares than
each and every one of the attaching creditors."
The summary reported that the Supreme Court reversed the decision of
the lower court holding that the rights of the attaching creditors to the 5,894
shares of stock in Samahang Magsasaka, Inc. enjoy priority over the rights of
Chua Guan since "as between the two appellants the right of the first enjoys
priority over the second, it having been registered ahead on the books of the
corporation." The holding would still be consistent with the facts as reported in
the earlier Chua Guan case where the Supreme Court noted that first eight of the
nine (9) attachments were received by the corporation and noted on its records
before the corporation received notice from the mortgagee Chua Chiu of the
mortgage of the 5,894 shares in June, 1931.
Placing priority in the registration in the stock and transfer book as the
determining factor seems to be a good rule-of-thumb since the only objective
basis by which third parties who deal with the shares of stock of a judgment
debtor would be to verify the stock and transfer book to determine whether he is
still the rightful owner. Since attachments and levy are involuntary dealings on
the shares of stock of the registered stockholder, who may himself be unaware of
their application over his shares, it is only correct to make the registration in the
stock and transfer book the final arbiter as to priority among several attaching
creditors and even as to buyers or assignees of the shares sold or assigned by
the seller in good faith being unaware of the application of a writ of attachment or
levy upon his shares.
Earlier, in Chua Guan, the Supreme Court had recognized the situation
that shares standing in the name of the debtor in the books of the corporation will
be liable to seizure by attachment or levy on execution at the instance of other
creditors even when the debtor had previously sold or assigned the shares to a
third party and indorsed and delivered the covering stock certificates. 194

4. Voluntary Buyer/Assignee Versus Attaching Creditors

It is rather unfortunate that in a case involving a buyer of the shares of
stock and the attaching creditors of the registered owner of the same shares of
stock, the later Chua Guan ruling was rejected by the Supreme Court in the
subsequent case of Chemphil Export & Import Corp. v. Court of Appeals.195
In Chemphil, a consortium of banks obtained from the trial court a writ of
preliminary attachment against Garcia to answer for their claims on the surety

193
96 Phil. 974 (1955).
194
62 Phil. 472, 481.
195
251 SCRA 257, 66 SCAD 557 (1995).
agreement executed by Garcia. In July 1985, the writ was enforced against
Garcia's shares of stock with Chemphil which were garnished, but the writ was
not annotated in Chemphil's stock and transfer book. When the judgment was on
appeal with the Court of Appeals, a compromise agreement was entered into.
Subsequently, Garcia sold his Chemphil shares which ultimately were
assigned to CEIC. In June 1989, the shares were registered and recorded in the
corporate books of Chemphil in CEIC's name and the corresponding stock
certificates were issued to it.
Meanwhile, because of Garcia's failure to comply with the compromise
judgment, in July 1989, the consortium filed a motion for execution and among
the properties levied were Garcia's shares in Chemphil previously garnished. The
consortium became the highest bidder of the Chemphil shares at public auction.
On motion of the consortium, the trial court issued an order directing the
corporate secretary of Chemphil to enter in its stock and transfer books the
sheriff's certificate of sale, to cancel the certificates of stock of "Garcia and all
those which may have subsequently been issued in replacement and/or in
substitution thereof," and to issue new certificates of stock in the name of the
banks in the consortium.
CEIC filed a motion to intervene seeking the recall of the order on the
grounds that it is the rightful owner of the disputed shares, having bought them
from Garcia. The consortium filed their opposition alleging that their attachment
lien over the disputed shares of stocks must prevail over the private sale in favor
of the CEIC considering that said shares of stock were garnished in the
consortium's favor as early as July 1985.
In ruling for CEIC, the trial court, among other things found that CEIC
acquired the shares without knowledge of the previous attachment in favor of the
consortium since it was not annotated in the stock and transfer books of
Chemphil. It also cited the unreported case of Samahang Magsasaka, Inc. v.
Chua Guan,196 where it was held that "as between two (2) attaching creditors, the
one whose claims was first registered on the books of the corporation enjoy
priority."197 It ruled that "a levy on the shares of corporate stock to be valid and
binding on third persons, the notice of attachment or garnishment must be
registered and annotated in the stock and transfer books of the corporation."
The Court of Appeals overturned the decision of the lower court on the
ground that under Section 7(d), Rule 56 of the Rules of Court, a notice of
garnishment is duly served by the sheriff on the President of Chemphil, and this
would be binding on third parties.
On appeal, the Supreme Court sustained the decision of the Court of
Appeals that found that to be valid and binding on third parties, no law requires
that an attachment of shares of stock be recorded in the stock and transfer book
of the corporation.

196
96 Phil. 974 (1955)
197
251 SCRA 257, 270, 366 SCAD 557, 580 (1995).
 In addition, the Supreme Court held that the rule laid down in Samahang
Magsasaka, Inc. v. Chua Guan did not have application in the case since CEIC
was not an attaching creditor.198 It added also that "[n]owhere in the said decision
was it categorically stated that annotation of the attachment in the corporate
books is mandatory for its validity for the purpose of giving notice to third
persons."199
The Court held that attachment of shares of stock are not included in the
term "transfer" as provided in Section 63 of the Corporation Code, since only
absolute transfers of shares of stock are required to be recorded in the
corporation's stock and transfer book in order to have "force and effect as against
third persons,"200 since an attachment does not constitute an absolute
conveyance of property but is primarily used as a means "to seize the debtor's
property in order to secure the debt or claim of the creditor in the event that a
judgment is rendered."201
Therefore, according to the Supreme Court since the claim of CEIC over
the Chemphil shares was based on the Deed of Sale, it is a settled rule that a
purchaser of attached property acquires it subject to an attachment legally and
validly levied thereon.202
The difficulty with the Chemphil doctrine on attachment is that although
granting that the attachment of shares of stock by service of the writ on the
proper corporate officer is valid, the doctrine would make it binding on any third
party who deals with the shares even when he purchases the shares in good
faith and for value, i.e., without notice of the attachment. Under the Chemphil
ruling, in order for a would-be buyer to determine the whether the registered
stockholder still has the rightful ownership of the shares registered in the stock
and transfer book in his name, the would-be buyer would still necessarily have to
determine from the proper corporate officers whether the subject shares have
been previously garnished or attached which process have not yet been
registered, and according to the doctrine need not be registered, in the stock and
transfer book of the corporation. The public dealing with shares of stock do not
therefore have the unbiased stock and transfer book to rely upon, but actually
must rely upon the fortitude, and perhaps even honesty of corporate officers.
In a contest therefore between a buyer in good faith and the attaching
creditor over the shares of stock of the seller-judgment debtor, the buyer in good
faith cannot rely alone on what appears in the stock and transfer book and the
fact that the covering certificates have been duly endorsed and delivered to him
by the registered owner thereof, since his rights would be defeated by a
judgment creditor who has been able to previously serve a writ on the proper
corporate officer although nothing at all is indicated in the stock and transfer
book.
198
Ibid, at p. 281.
199
Ibid, at p. 285.
200
Ibid, at pp. 283-284.
201
Ibid.
202
Ibid, at p. 285.
 The effect of the Chemphil doctrine is to dilute the quasi-negotiable
character of the certificate of stock. The proper solution should be the same as
that provided for in the case of negotiable documents of title under Article 1519 of
the Civil Code which provides that when the document of title issued is
negotiable in character, the goods covered thereby "cannot be attached by
garnishment or otherwise or be levied under an execution unless the document
be first surrendered to the bailee or its negotiations enjoined." In the same
manner where the shares of stock are covered by a certificate of stock, in order
to protect the public who takes the certificate of stock in the form of a quasi-
negotiable instrument, then there should not be allowed an attachment or levy of
the underlying shares unless the certificate is also attached or levied upon or its
negotiation enjoined; and the simplest manner by which this can be done is to
require that the attachment or levy must first be annotated in the stock and
transfer book in order to be valid and binding as against third parties.

SUMMARY OF CURRENT DOCTRINAL RULINGS

ON SHARES OF STOCK
If we analyze the doctrinal rules laid down by the Supreme Court in the
various decisions is has rendered covering dealings with shares of stock, we can
draw up the following summary:

(a) A mortgage or pledge of shares of stock that would involve

the outright assignment or delivery and indorsement of the
certificates of stock to the pledgee or mortgagee would
constitute a valid mortgage even without registration with the
register of deeds, but it would always be subject to prior
attachment or levy of the shares duly effected pursuant to
the Rules of Court by the judgment creditors of the
registered stockholder;
(b) Outside of physical transfer of delivery of the certificates of
stock, a chattel mortgage over the shares of stock, whether
or not covered certificates of stock, would be valid and
binding on third parties only if the mortgage was registered
with the register of deeds or registers of deeds, as the case
may be, of the province or city where the mortgagor has his
domicile and where the corporation has its principal place of
business;
(c) A writ of attachment/execution against the shares of stock of
the judgment debtor would be valid and binding on the
shares and against third parties, the moment there is proper
service of the writ to the proper officer of the corporation
pursuant to Section 7(d), Rule 57 of the Rules of Court;
(d) In any of the three (3) cases above, the pledge, mortgage,
attachment or levy of the shares of stock would thereupon
 be valid and binding on the entire world upon their
constitution or completion of process; no registration of the
pledge, mortgage, attachment or levy in the stock and
transfer book of the corporation is required either to make
any of them valid or binding; and their registration in the
stock and transfer book would have no legal effect at all and
such registration does not produce the effect of notice to
third parties;
(e) As between two contending judgment creditor, it would seem
that the first to have the writ served upon the proper officer
of the corporation would be preferred;
(f) As between contending pledgee/mortgagee and an attaching
creditor, if the registration requirement for the pledge or
mortgage happened first in point of time prior to service of
the writ to the proper corporate officer, the pledge or
mortgage shall be preferred; whereas, if the service of the
writ to the proper court officer happened ahead of the
registration of the pledge or mortgage, then the attaching
creditor would be preferred;
(g) As between a pledge/mortgage duly constituted (even when
not registered in the stock and transfer book) and the buyer
or assignee of the shares, if the pledge or mortgage was
constituted and registered ahead of the registration of the
sale or assignment in the stock and transfer book (even
when the sale or assignment was perfected and
consummated ahead of the pledge or mortgage) the pledge
or mortgage would still be preferred because the registration
of the sale or assignment in the stock and transfer book is a
necessary ingredient to make the sale or assignment binding
on third parties, including the pledgee/mortgagee;
(h) As between an attaching/levying creditor where there has
been proper service of the writ to the proper corporate officer
(even when not registered in the stock and transfer book)
and the buyer or assignee of the shares, if writ was properly
served upon the corporate officer ahead of the registration of
the sale or assignment in the stock and transfer book (even
when the sale or assignment was perfected and
consummated ahead of the service of the writ) the
attachment/levy would still be preferred because the
registration of the sale/assignment in the stock and transfer
book is a necessary ingredient to make the sale or
assignment binding on third parties, including on attaching/
levying creditor.
 In effect, by the strict application of Section 63 of the Corporation Code to
cover only the sale, assignment or absolute disposition of shares of stock, the
Supreme Court has placed a bias against voluntary sales, assignments or
dispositions of shares of stock vis-à-vis pledges, mortgages, attachment or levy
thereof. To be valid and binding on third parties, the voluntary sale, assignment
or disposition of the shares requires the essential element of registration in the
stock and transfer book; otherwise the sale, assignment or disposition is
considered void as to third parties, even when they have actual notice. Whereas,
when it comes to pledge, mortgage, encumbrance, attachment or levy of shares,
registration thereof in the stock and transfer book is not essential either for
validity or as a species of notifying third parties.
Consequently, a buyer or assignee would always have to declare the
contract to the entire world by registration in the stock and transfer book in order
to be valid, whereas all others who deal with the same shares can complete their
priority claim in private outside of the stock and transfer book unknown to the rest
of the world who may want to voluntarily deal with the shares but would be in no
position to ever be fully assured on whether there is no lien completed against
the shares.
We would have therefore the clearly inequitable situation where the
attaching or levying creditors using the stock and transfer book as the conclusive
basis by which to enforce the writ against shares still standing in the name of the
judgment debtor (although he has sold the shares to another person), whereas a
buyer in good faith and for value who actually registers his purchase in the stock
and transfer book at the time when nothing was annotated therein of any lien,
would be precluded from using the stock and transfer book as his conclusive
basis to determine the clean title of his registered seller as a basis for securing
his title to the shares of stock.
In the same manner a pledgee or mortgagee who registers his pledge or
mortgage in the register of deeds may rely upon the stock and transfer book as
the conclusive basis by which to determine the validity and priority of the pledge
or mortgage of the shares still standing in the name of the pledgor and
mortgagor, and yet a buyer in good faith and for value, and even to whom the
clean certificate of stock have been duly endorsed and delivered, and who
actually registers his purchase in the stock and transfer book at the time when
they stood clean in the name of the registered seller, is precluded from using the
stock and transfer book as his conclusive basis to determine the clean title of his
registered seller as the basis for securing his title to the shares of stock.
In these cases, the registration requirements under stock and transfer
books, instead of becoming the basis by which title to shares of stock can clearly
and conclusively be voluntarily sold and bought, and the basis for assurance and
protection to the investing public, has been transformed into the very stumbling
block to achieving the ideal situation by which shares of stock can voluntarily be
dealt with, accompanied with a reasonable assurance of the clean title thereto.
 Making registration in the stock and transfer book as the mandatory
means by which dealings with shares of stock can be valid and effective as
against both the corporation and third parties would make the procedure simple
and easier to verify. After all as the Supreme Court said in Chua Guan "Loans
upon stock securities should be facilitated in order to foster economic
development. The transfer by endorsement and delivery of a certificate with the
intention to pledge the shares covered thereby should be sufficient to give legal
effect to that intention and to consummate the juristic act without necessity of
registration."203

—oOo—-

CORP. MANUSCRIPT/10-SHARES OF STOCK/07-29-2002

203
Chua Guan v. Samahang Magsasaka, Inc., supra, at p. 482.
 CHAPTER 11

RIGHTS AND OBLIGATIONS OF

STOCKHOLDERS AND MEMBERS

Philosophy on Rights of Stockholders and Members

Rights of Stockholders
Rights of Members
PRE-EMPTIVE RIGHTS
Subscription Deposits Not Within Pre-emptive Rights
Exceptions to Pre-emptive Rights
Distinguished from Right of First Refusal
Extent of Coverage of the Pre-emptive Rights
RIGHT OF FIRST REFUSAL AND OTHER RESTRICTIONS ON
TRANSFER OF SHARES
Types of Restrictions on Shares
Jurisprudential Rules o Rights of First Refusal
Contractual Stipulations
Restrictions in By-Laws
Restrictions in Charter
Restrictions Must Be Indicated in Stock Certificates
Underlying Doctrine on Restrictions on Shares
Non-competition Clause
RIGHT TO VOTE
Varying the Voting Rights
Voting Rights of Members
Party Entitled to Vote
Voting on Joint Ownership
Pledgor, Mortgagors and Administrators
Treasury Shares
Election of Directors and Trustees
Amendment of Articles of Incorporation
Investment in Another Business or Corporation
Merger and Consolidation
Increase and Decrease of Capital Stock
Incurring or Creating Bonded Indebtedness
Adoption, Amendment and Repeal of By-Laws
Declaration of Stock Dividends
Management Contracts
Fixing of Consideration of No-par Value Shares
AGREEMENTS AFFECTING VOTING RIGHTS
Proxies
Nature of Proxy Relationship
Requisites for Valid Proxy
Period of Effectivity of Proxy
Who May Be Appointed Proxy
 Voting Trust Agreements
Nature of Voting Trust Agreement
Requisite of Valid Voting Trust Agreement
Differences Between Proxy and Voting Trust Agreement
Pre-termination of Voting Trust Agreement
Voting Trust Agreement as Part of Loan Arrangement
Pooling Agreements and Other Shareholders' Agreement
Hierarchy of Enforceability
STOCKHOLDERS' OR MEMBERS' MEETINGS
Calls and Types of Meeting
Place and Time of Meeting
Who Can Call a Meeting
Quorum
Minutes of Meeting
RIGHT TO INSPECT/EXAMINE CORPORATE RECORDS
Basis of Right to Inspect
Specified Records Subject to Inspection
Right to Financial Statements
Annual Report of Corporations
Summary of Corporate Obligation to Report
Manner of Availing of Right to Inspect
Who May Exercise Right to Inspect
Nature and Scope of Right to Inspect
Summary of Doctrinal Rulings on Right to Inspect
Purposes of Inspection
Remedies If Inspection Denied
Mandamus
Damages
Criminal Suit
Procedural Rules on Suits Brought
Who May Be Held Liable
Defenses Available to Director, Trustee or Officer Held Liable
Right to Inspect Covers Controlled Subsidiaries
APPRAISAL RIGHT
Nature of the Appraisal Right
Who Is Entitled to Exercise
Instances When Right May be Exercised
How Right Exercised
Effect of Demand for Payment
Notation on Certificates; Right of Transferee
How Payment of Fair Value Effected
Existence of Unrestricted Retained Earnings
When Right to Payment Ceases
Party Who Bears Cost of Appraisal
Denial of Appraisal Right
Statutory Attitude Towards Appraisal Right
Emerging Significance of Existence of Appraisal Rights
DERIVATIVE SUITS
Definition
Requisites for Filing of Derivative Suit
Proper Party to Bring Derivative Suit
 Requirements under SEC Rules
Exhaustion of Intra-Corporate Remedies
Laches by Inaction of Directors
Grounds for Derivative Suit
Wastage and Diversion of Corporate Funds
Violation of the Laws
Nature of Reliefs Prayed for
Appointment of Receiver
Proper Forum for Derivative Suit
Business Judgment Rule
Withdrawal of Stockholder or Demand for Dissolution in Close
Corporations
Right to Proportionate Share of Remaining Assets Upon Dissolution

——

This chapter discusses the various rights and obligations of stockholders

and members. The right to the issuance of certificates of stock, and the right to
transfer shares, are properly discussed in Chapter 10 on Shares of Stocks,
Subscription Agreements, and Certificates of Stock; and the right to dividends is
discussed in Chapter 12 on Capital Structure of Corporations.

PHILOSOPHY ON RIGHTS OF STOCKHOLDERS AND MEMBERS

1. Rights of Stockholders
The Corporation Code, as it views the stockholders of a stock corporation
as a group of investors, provides for two complementing philosophical
approaches to the treatment of stockholders under relevant corporate contractual
relationship:

(a)The default rule is that all stockholders have equal rights and
obligations, expressed in the last paragraph of Section 6 that
provides: “each share shall be equal in all respects to every
other share.”
(b) When preferences or restrictions are made to apply to a
class of shares, then such preferences on restrictions shall
exists and be valid only when the particular form and
procedure mandated by the Code, which under the same
section provides that it be “provided in the articles of
incorporation and stated in the certificate of stock.”

Section 6 provides in clear terms that although the default rule is that all
shareholders have equal rights and obligations, nevertheless, when authorized
by the articles of incorporation, the board of directors, may fix the terms and
conditions of preferred shares of stock or any series thereof, or to classify its
shares for the purpose of insuring compliance with constitutional or legal
requirements;1 however, such terms and conditions shall be effective upon filing
of a certificate thereof with the SEC.2
Cojuangco Jr. v. Roxas,3 recognized the important rights of stockholders,
which continue to remain with the stockholders even when the shares have been
sequestered, to be the following: (a) the right to vote; (b) the right to receive
dividends; (c) the right to receive distributions upon liquidation of the corporation;
and (d) the right to inspect the books of the corporation. Such rights pertain to all
stockholders without the need for any express or enabling provision in the
articles of incorporation, or the by-laws.
Other rights to which stockholders are entitled to, such as the right to
transfer or dispose of his fully paid shares of stock and the right to file derivative
suit, also underscore the proprietary nature of the shares as medium of
investments on the part of stockholders, a purely business relationship not
focused on any personality relationship, as consistent to the "for profit" nature of
stock corporations, and consistent with the corporate feature of presenting to the
commercial world “freely-transferable units of ownership.”

2. Rights of Members
On the other hand, the eleemosynary nature of non-stock corporations
define the characteristic of membership therein as being essentially personal in
nature and therefore not generally transferable.
Section 89 of the Corporation Code specifically provides that the right of
members of any class or classes to vote “may be limited, broadened or denied to
the extent specified in the articles of incorporation or the by-laws” of a non-stock
corporation.
The SEC has opined that the rule in Section 6 allowing non-voting shares
to vote on specified fundamental matters does not apply to non-voting members
of a non-stock corporation; that insofar as members of a non-stock corporation,
the applicable provision is not Section 6 but Section 89 of the Code, which
specifically provides that members may be denied entirely their voting rights in
the articles of incorporation or by-laws of the corporation.4
Section 89 also provides that the right of members to vote by proxy may
be denied under the articles of incorporation or by-laws of a non-stock
corporation.5

1
Sec. 6, Corporation Code.
2
Ibid.
3
195 SCRA 797 (1991).
4
SEC Opinion, 4 September 1995, XXX SEC QUARTERLY BULLETIN 29 (No. 1, June 1996).
5
See also SEC Opinion, 20 September 1994, XXIX SEC QUARTERLY BULLETIN 20 (No.1,
March 1995).
 Under Section 90 of the Code, membership in a non-stock corporation and
all rights arising therefrom are personal and non-transferable, unless the articles
of incorporation or the by-laws otherwise provide.
Under Section 91 of the Code, membership shall be terminated in the
manner and for the causes provided in the articles of incorporation or the by-
laws. Termination of membership shall have the effect of extinguishing all rights
of a member in the corporation or in its property, unless otherwise provided in the
articles of incorporation or the by-laws.

PRE-EMPTIVE RIGHT
Section 39 of the Corporation Code provides that all stockholders of a
stock corporation shall enjoy pre-emptive rights to subscribe to “all issues or
disposition” of shares of any class, in proportion to their respective
shareholdings.
Pre-emptive right refers to the common law right granted to the
stockholders of a corporation to be granted the first option to subscribe to any
opening of the unissued capital stock, or to any increase of the authorized capital
stock, of the corporation.
The recognition of the pre-emptive right is intended to protect both the
proprietary and voting rights of a stockholder in a corporation. The proportionate
interests of a stockholder in a corporation determines his proportionate power to
vote in corporate affairs when the law gives the stockholders a right to affirm or
deny board actions. The proportionate interest of the stockholder to the
outstanding capital stock also determines his proportionate share in the
dividends declared by the corporation, as well as his proportionate right to the
remaining assets of the corporation upon dissolution of the corporation. 6

1. Subscription Deposits Not Within Pre-emptive Rights

The SEC has ruled that in determining the proportionate right of the
stockholders to subscribed to a proposed increase of capital stock, subscription
deposits are excluded. “Deposits for additional subscriptions” are payments
received for future issuance of stock which may or may not materialize. While
deposits of this nature may be allowed for balance sheet presentation as part of
the stockholders equity account, the same cannot be considered as part of the
capital of the corporation until shares are actually issued in consideration thereof.

2. Exceptions to Pre-emptive Rights

Section 39 provides the only exceptions to the exercise of the pre-emptive
rights of stockholders, thus:

6
SEC Opinion, 11 August 1997, XXXII SEC QUARTERLY BULLETIN 15 (No. 2, Dec. 1997);
SEC EAD Memo, dated 29 July 1997.
 (a) When such right is denied by the articles of incorporation or
an amendment thereto;
(b) Stockholders have no pre-emptive rights to the issuance of
shares from the capital stock of the corporation:

(i) On shares to be issued in compliance with laws

requiring stock offerings or minimum stock
ownership by the public;
(ii) To shares to be issued in good faith with the
approval of the stockholders representing two-
thirds (2/3) of the outstanding capital stock, in
exchange for property needed for corporate
purposes; or
(iii) To shares to be issued in good faith with the
approval of the stockholders representing
two-thirds (2/3) of the outstanding capital
stock, in payment of previously contracted
debt.

The pre-emptive rights of stockholders in a corporation are not statutory

rights, but are common law rights, and exist even when no specific grant or
recognition of such right is provided for in statutory law. The right need not even
be provided in the corporation's articles of incorporation or by-laws. In fact, under
Section 39, the only manner by which the pre-emptive rights of stockholders in a
stock corporation can be denied, amended or altered is through specific
provisions in the articles of incorporation.
The SEC has ruled that a majority vote of stockholders waiving the pre-
emptive right in a meeting called for the purpose would not be valid and binding
on the individual stockholders since the pre-emptive right is a personal right of a
stockholder, and accordingly, the waiver should be given individually by the
stockholders concerned or he may authorize somebody to execute the same for
and in his behalf by way of a special power of attorney.7
When a shareholder has effectively waived the exercise of his pre-emptive
right to an issuance of shares, it is not necessary that said shares should again
be offered on a pro-rata basis to the stockholders who took advantage of their
right of pre-emption. The SEC has ruled that as long as they exercise their pre-
emptive rights, their relative and proportionate voting strength in the corporation
will not be affected adversely, and the waived shares may be offered to non-
stockholders of record on a first come first serve basis without violating the pre-
emptive rights of the stockholders.8 However, the SEC considers it a sound
7
SEC Opinion, 6 Dec. 1994, XXIX SEC QUARTERLY BULLETIN 10 (No. 2, June 1995); SEC
Opinion, 12 Dec. 1994, XXIX SEC QUARTERLY BULLETIN 14 (No.2, June 1995); SEC Opinion, 1
October 1981.
8
SEC Opinion, 16 Dec. 1994, XXIX SEC QUARTERLY BULLETIN 10 (No.2, June 1995); SEC
Opinion, 23 March 1998, XXXII SEC QUARTERLY BULLETIN 6 (No. 1, June 1998).SEC Opinion, 24
corporate practice to offer always the remaining shares to interested
stockholders of record whenever practical and feasible before offering them to
third parties.9

3. Distinguished from Right of First Refusal

Pre-emptive right is a common law right and may be exercised by
stockholders even when no provision is granted in the law. The right of first
refusal arises only by virtue of contractual stipulations, in which case the right is
construed strictly against the right of persons to dispose of or deal with their
property. The right of first refusal may also be provided for in specified statutory
provisions, such as that provided for in Section 98 of the Code on close
corporations. Unlike pre-emptive right which pertains to stockholder by common
law and does not require any statutory enabling provision, the right of first
refusal, if not provided for by law or by the articles of incorporation, does not exist
at all.
Pre-emptive right pertains to that portion of the authorized capital stock
that has not been subscribed, i.e., unissued shares that are offered for
subscription; whereas, a right of first refusal pertains to shares already issued.
Pre-emptive right therefore is a right claimed against the corporation on unissued
shares of its capital stock; while right of first refusal is a right exercisable against
another stockholder of the corporation on his shares of stock.

4. Extent of Coverage of Pre-emptive Rights

The generally accepted rule under the old Corporation Law was that the
pre-emptive rights of existing stockholders of the corporation pertain only in
cases of increase of the authorized capital stock,10 and that such right do not
obtain to existing unsubscribed portion of the authorized capital stock. Under the
old doctrine therefore, the board of directors have the power to open for
subscription to non-stockholders the unsubscribed portion of the authorized
capital stock.
Datu Tagoranao Benito v. Securities and Exchange Commission,11 which
decided the issue under the terms of the old Corporation Law, explained the
rationale of the old doctrine. It held that when a corporation at its inception offers
its shares, it is presumed to have offered all those which it is authorized to issue.

Sept. 1974, SEC FOLIO 1960-1976, at p. 733.

9
Ibid.
10
Under Section 39 of the Corporation Code it is clearly implied that the grant of pre-
emptive right to existing stockholders is made mandatory to an increase of the authorized capital
stock, unless such preemptive right is denied under the articles of incorporation or the issuance of
shares falls under any of the exceptions provided therein. The foundation or underlying basis of
this right is to maintain the proportionate voting strength and control of existing stockholders, that
is, the existing ration of their interest and voting power in the corporation. SEC Opinion, 7
December 1993, XXVIII SEC QUARTERLY BULLETIN 9 (No. 2, June 1994).
11
123 SCRA 722 (1983). Dee v. SEC, 199 SCRA 238 (1991), which reiterated the doctrine
of Benito was decided on factual issues under the old Corporation Law.
An original subscriber is deemed to have taken his shares knowing that they form
a definite proportionate part of the whole number of authorized shares. When the
shares left unsubscribed are later offered, he cannot therefore claim a dilution of
interest.
Under the current provision Section 39 of the Corporation Code, the pre-
emptive right of stockholders is recognized to exist to "all issues or disposition of
shares of any class." The use of the terms "issues or disposition" clearly provides
that the pre-emptive right should now be available even to issues from the
existing unsubscribed portion of the authorized capital stock when the board
decides to open them for subscription, and even to re-issuance or sale of
treasury shares of the corporation.
In one opinion,12 the SEC noted that the wordings of Section 39 of the
Corporation Code would include the disposition of treasury shares to be covered
by the pre-emptive rights of stockholders, thus:

The broad phrase "all issues or disposition of shares of

any class" in the above provision is construed to include not
only new shares issued in pursuance of an increase of capital
stock or from the unissued shares which form part of the
authorized capital stock, but also covers "treasury shares."
Treasury shares would come under the term "disposition".
Likewise, considering that it is not included among the
exceptions enumerated therein, where pre-emptive right shall
not extend, the intention is to include it in is application.13

RIGHTS OF FIRST REFUSAL AND OTHER

RESTRICTIONS ON TRANSFERS OF SHARES
1. Types of Restrictions on Shares
In corporate practice, there are various types of restrictions that may be
placed upon the transfer or assignment of shares of stock.
The more common one is the "right of first refusal," which would provide
that a stockholder who may wish to sell or assign his shares must first offer the
shares to the corporation or to the other existing stockholders of the corporation,
under terms and considerations which are reasonable, and only when the
corporation or the other stockholders do not or fail to exercise their option, is the
offering stockholder at liberty to dispose of his shares to third parties.
A "right of first option" grants to the corporation the right to buy the shares
at a fixed price, and would be valid if the terms and consideration are reasonable.

12
SEC Opinion, 14 January 1993, XXVII SEC QUARTERLY BULLETIN 16 (No. 2, June 1993).
13
Ibid, at p. 18.
 A "right of prior consent" provision would require that any stockholder who
may wish to sell, assign or dispose of his shares in the corporation may do so
only when he obtains the consent of the board of directors or other stockholders
of the corporation. Such stipulations are void since they unduly restrain the
exercise of the stockholder of his proprietary interest in the shares, as illustrated
in a situation where a stockholder cannot dispose of his shares because of failure
to obtain such consent.
A "buy-back agreement" exists in situations when shares are given or
assigned to officers or employees under the condition that should they resign or
be terminated from employment, the corporation shall be granted the right to buy-
back the shares. Such stipulations are valid so long as the terms and the
consideration are reasonable.
An absolute prohibition to transfer shares, even when contained in the
articles of incorporation, would be void since it would violate the provision of
Section 63 of the Corporation Code which treats of shares of stock as personal
property of which the stockholder has the inherent right to dispose as incident of
his ownership.14

2. Jurisprudential Rules on Rights of First Refusal

a. Contractual Stipulations
Lambert v. Fox,15 held valid an agreement entered into between the two
majority stockholders of a corporation whereby they mutually agreed not to sell,
transfer, or otherwise dispose of any part of their shareholdings till after one year
from the date of the agreement.
Under the facts of Lambert, in 1911, the firm John R. Edgar and Company
found itself in such a financial condition that its creditors, including the defendant
and the plaintiff, agreed to take over the business, incorporate it and accept stock
therein in payment of their respective credits. The plaintiff and the defendant,
being the two largest stockholders of the new corporation, entered into an
agreement that neither of them would "sell, transfer, or otherwise dispose of any
of their present holdings of stock in said John R. Edgar and Company, Inc., till
after one year from the date thereof." They further agreed that the party violating
such agreement would pay P1,000 to the other party as liquidated damages in
breach of contract.
In upholding the agreement, Lambert held that the stipulation was not
illegal nor in restraint of trade and offends no public policy. "The suspension of
the power to sell has a beneficial purpose, results in the protection of the
corporation as well as of the individual parties to the contract, and is reasonable
as to the length of time of the suspension." But in so holding, Lambert made it
clear that the doctrine did not mean to cover the suspension of "the right of

14
SEC Opinion, 20 February 1995, XXIX SEC QUARTERLY BULLETIN 4 (No. 3, Sept. 1995).
15
26 Phil. 588 (1914).
alienation of stock, limiting ourselves to the statement that the suspension in this
particular case is legal and valid."
Although the SEC may render the shareholder agreement imposing
restrictions on transfer of shares uneforceable against third-party purchasers
without notice, restriction on the power to transfer shares of stock in a
shareholder‟s agreement, even if not provided for in the articles of incorporation
or by-laws, was held to be binding upon the stockholders who are parties thereto
since they are chargeable with notice, unless palpably unreasonable under the
circumstances as to justify the restriction overriding the general policy against
restraint on alienation of personal property.16

b. Restriction in By-Laws
In Fleischer v. Botica Nolasco Co.,17 Manuel Gonzales was the original
owner of the 5 shares of stock of the Botica Nolasco, Inc., which he indorsed and
delivered said shares to plaintiff Henry Fleischer, in consideration of a large sum
of money owed by Gonzales to Fleischer. The secretary-treasurer of said
corporation, offered to buy from Henry Fleischer, on behalf of the corporation,
said shares of stock, at their par value of P100 a share, for P500 by virtue of
article 12 of the by-laws giving said corporation the preferential right to buy from
Gonzales said shares.
The plaintiff Fleischer refused to sell to the defendant and requested
corporate secretary to register said shares in his name, but the request was
refused by the corporate secretary contending that it would be in contravention of
the by-laws.
The Supreme Court declared void the by-law provision which granted to
the stockholders a right of first refusal over shares sought to be disposed by
other stockholders. In voting down the by-law provision, the Court relied upon the
provision of then Section 35 of the Corporation Law that provided that "shares of
stock so issued are personal property and may be transferred by delivery of the
certificate indorsed by the owners or his attorney in fact or other person legally
authorized to make the transfer." Under the doctrine that a corporation can adopt
by-law provisions only insofar as they are not inconsistent with any existing law,
the right of first refusal was deemed void. In supporting this contention, the Court
relied upon American rulings that "[t]he power to enact by-laws restraining the
sale and transfer of stock must be found in the governing statute or the charter."
A careful review of the Court's reasoning in Fleischer shows it was not the
ruling to declare void provisions on rights of first refusal per se, but more properly
the ruling was meant to put by-laws in their proper hierarchical value, that is, it is
not the function of by-laws to take away or abridge the substantial rights of
stockholders. In fact, the ruling recognized that the same may be done either
pursuant to a legal provision or in the articles of incorporation. This doctrine has
remained consistent with the provisions of Section 6 of the Corporation Code that

16
SEC Opinion, 8 June 1995, XXIX SEC QUARTERLY BULLETIN 32 (No. 4, Dec. 1995)
17
47 Phil. 583 (1925).
requires that any privilege or restriction pertaining to shares of stock should be
found in the articles of incorporation.
In addition Fleischer seems to support the opinion that by-law provisions
are essentially intramural covenants and do not bind the public, thus:

And moreover, the by-law now in question cannot have

any effect on the appellee. He had no knowledge of such by-
law when the shares were assigned to him. He obtained them
in good faith and for a valuable consideration. He was not a
privy to the contract created by said by-law between the
shareholder Manual Gonzalez and the Botica Nolasco, Inc.
Said by-law cannot operate to defeat his rights as a
purchaser.18

However, in Padgett v. Babcock & Templeton, Inc.,19 the Court held that
the indication on the face of the stock certificate that it is "nontransferable" alone
does not compel the corporation to buy back the shares from the stockholder,
and held that "in the absence of a similar contractual obligation and of a legal
provision applicable thereto, it is logical to conclude that it would be unjust and
unreasonable to compel the said defendants to comply with a non-existent or
imaginary obligation."20
The Fleischer ruling was reiterated in Rural Bank of Salinas v. Court of
Appeals,21 where the Court held that the only limitation imposed by Section 63 of
the Corporation Code is when the corporation holds any unpaid claim against the
shares intended to be transferred, and that “[a] corporation, either by its board, its
by-laws, or the act of its officers, cannot create restrictions in stock transfers,
because „xxx Restrictions in the traffic of stock must have their source in
legislative enactment, as the corporation itself cannot create such impediment.
By-laws are intended merely for the protection of the corporation, and prescribe
relation, not restriction; they are always subject to the charter of the corporation.‟”

c. Restrictions in the Charter

Once the right of first refusal is properly provided for in the articles of
incorporation of the corporation, it becomes a property right in favor of the
stockholders. As held in Presidential Commission on Good Government v.
Securities and Exchange Commission,22 the right of first refusal is primarily an
attribute of ownership, and the waiver thereof is also an act of ownership and

18
Ibid, at p. 592.
19
59 Phil. 232 (1933).
20
Ibid, at 235.
21
210 SCRA 510 (1992).
22
G.R. No. 82188, 30 June 1988 [unreported].
belongs only to the stockholders of the corporation, who then would have the
sole authority to waive it.23
The SEC, as a matter of policy, allows restrictions on transfer of shares in
the articles of incorporation if the same is necessary and convenient to the
attainment of the objective for which the company was incorporated, unless
palpably unreasonable under the circumstances.24 The underlying test as to
whether the restriction are valid and enforceable is whether the restriction is
sufficiently reasonable as to justify the restriction overriding the general policy
against restraint on alienation of personal property. 25 The SEC has ruled that the
period of one month is deemed reasonably sufficient for the existing stockholder
of corporation within which to signify their desire to buy the shares of stock being
offered for sale by any stockholder before the same may be offered to third
parties. 26

d. Restrictions Must Be Indicated in Stock

Considering that shares of stock burdened with restrictions on
transferability may fall into the hands of innocent purchasers, the SEC as a
matter of policy, requires that restrictions on transfer shares must be printed in
the stock certificate.27

3. Underlying Doctrine in Restriction on Transfer of Shares

Issues involving rights of first refusals and other restriction over ownership
interests in shares of stock seem to be tied up with the public policy against
“restraint of trade,” commonly treated in “non-competition clause” provisions in
contractual relations. The rulings of the Supreme Court in evaluating the validity
of rights of first refusal implies that shares of stock in a corporation are
considered species of trade and occupation through the participation in the
business enterprise of the corporate entity.
This was recognized in Villa Rey Transit, Inc. v. Ferrer,28 where the Court
acknowledged that when one buys the business of another as a going concern,
“he usually wishes to keep it going; he wishes to get the location, the building,
the stock in trade, and the customers. He wishes to step into the seller's shoes

23
The SEC has ruled that the transfer of naked ownership in shares of stock to qualify the
nominee merely to be voted into the board of directors of the corporation is not a violation of the
provisions in the charter granting to the corporation or other stockholders the right of first refusal,
provided that the transfer contains a description that the nominees hold the stocks merely as
trustees thereof. SEC Opinion, 12 February 1985, 1985 SEC ANNUAL OPINIONS 33; SEC Opinion,
21 May 1986, XX SEC QUARTERLY BULLETIN 83 (Nos. 1 & 2, March and June, 1986).
24
SEC Opinion, 20 February 1995, XXIX SEC QUARTERLY BULLETIN 4 (No. 3, September
1995).
25
Ibid.
26
Ibid.
27
SEC Opinion, 2 May 1995, XXIX SEC QUARTERLY BULLETIN 2 (No. 4, Dec. 1995); SEC
Opinion, 13 January 1994, XXVIII SEC QUARTERLY BULLETIN 37 (No. 2, June 1994); SEC
Opinion, 13 October 1964, SEC FOLIO 1960-1976, at p. 217.
28
25 SCRA 845 (1968), quoting from CORBIN ON CONTRACTS, Vol. 6, Sec. 1385, p. 483.
and to enjoy the same business relations with other men. He is willing to pay
much more if he can get the „good will‟ of the business, meaning by this the good
will of the customers, that they may continue to tread the old footpath to his door
and maintain with him the business relations enjoyed by the seller. . . In order to
be well assured of this, he obtains and pays for the seller's promise not to reopen
business in competition with the business sold." The Court went on to say in Villa
Rey Transit:

The law concerning contracts which tend to restrain

business or trade has gone through a long series of changes
from time to time with the changing conditions of trade and
commerce. With trifling exceptions, said changes have been a
continuous development of a general rule. The early cases
show plainly a disposition to avoid and annul all contracts
which prohibited or restrained any one from using a lawful
trade “at any time or at any place,” as being against the benefit
of the state. Later, however, the rule became well established
that if the restraint was limited to “a certain time” and within “a
certain place,” such contracts were valid and not “against the
benefit of the state.” Later cases, and we thing the rule is now
well established, have held that a contract in restraint of trade
is valid providing there is a limitation upon either time or place.
A contract, however, which restrains a man from entering into
business or trade without either limitation as to time or place,
will be held invalid. . .
The public welfare of course must always be considered
and if it be not involved and the restrained upon one party is
not greater than protection to the other requires, contracts like
the one we are discussing will be sustained. The general
tendency, we believe, of modern authority, is to make the test
whether the restraint is reasonably necessary for the
protection of the contracting parties. If the contract is
reasonably necessary to protect the interest of the parties, it
will be upheld.29

Consequently, when provisions of first refusal involving shares of stock

appear in the proper form, i.e., as a private contractual commitment as in the
case Lambert, or as provisions in the articles of incorporation as mandated in
Fleischer and Rural Bank of Salinas, the Supreme Court would inevitable turn it
attention to determining whether the substantive terms of the right of first refusal
are valid in accordance with the policy against restraint of trade.

29
Ibid, citing Del Castillo v. Richmond, 45 Phil. 679, 683 (1924), citing Anchor Electric Co. v.
Hawkes, 171 Mass. 101; Alger v. Tacher, 19 Pickering (Mass.) 51; Taylor v. Blanchard, 13 Allen
(Mass.) 370; Lurking Rule Co., v. Fringeli, 57 Ohio State 596; Fowle v. Park, 131 U.S. 88, 97;
Diamond Match Co. v. Reeber, 106 N.Y. 473; National Benefit Co., v. Union Hospital Co., 45
Minn. 272; Swigert & Howard v. Tilden, 121 Iowa 650; Ollendorf v. Abrahamson, 38 Phil. 585
(1918).
 The jurisprudential history of “restraint of trade” doctrine in the Philippines
looks at the “intrinsic reasonableness” of any provision tending to restrain a
person from engaging trade or calling, and that such restrictions may be upheld
when not contrary to the public welfare and not greater than is necessary to
afford a fair and reasonable protection to the party in whose favor it is imposed, 30
and such reasonableness seem to apply whenever the restraint or prohibition is
limited in both time and place.31
In Lambert, the Supreme Court found the provision in the contract
between the parties imposing a penalty for one disposing of his shares within the
prohibited one-year period to comply with the twin test of reasonable restraint: (a)
"has a beneficial purpose, results in the protection of the corporation as well as of
the individual parties to the contract;” and (b) “reasonable as to the length of time
of the suspension." In fact, the provision in Lambert did not declare the
disposition of shares void or annullable, but merely subjected the violating party
to penalty for breach of the prohibition.
The doctrinal thrust under Section 63 of the Corporation Code is that
shares of stock are personal property of the stockholder and should be within his
power to dispose, and which would be consistent with the one of the
advantageous features of the corporate medium promoted under Corporate Law
of "free transferability of the units of ownership.” Consequently, the
“reasonableness” of any provision restraining the disposition by a shareholder of
his shares in the corporation would be tested or whether such provision in effect
would undermine his ability to eventually be able to dispose of such shares.
Consequently, a stipulation prohibiting a stockholder from disposing of his
shareholder, even when found in the articles of incorporation, would be void
because directly divest the ability of the stockholder to dispose of his shares.
Likewise, a provision that invalidates a sale or disposition of shares of stock
without the consent of the corporation and/or the other stockholders would be
void, since by their withdrawal of such consent, a stockholder would be forced to
maintain his shareholdings in the corporation.
A right of first refusal that grants to the corporation or the other
stockholder the first option to purchase the shares of a disposing stockholder is
in principle valid because it does not in effect prevent the disposing stockholder
from eventually being able to dispose of the shares, and it generally should not
matter to him that the eventual buyer would be the corporation or another
stockholder. However, when the term or period upon which the option may be
30
Ollendorf v. Abrahamson, 38 Phil. 585 (1918): “In the course of time this opinion was
abandoned and the American and English courts adopted the doctrine that where the restraint
was unlimited as to both time and space it was void, but that agreements limited as to time but
unlimited as to space, or limited as to space but unlimited as to time were valid. In recent years
there has been a tendency on the part of the courts of England and America to discard these
fixed rules and to decide each case according to its peculiar circumstances, and make the validity
of the restraint depend upon its reasonableness. If the restraint is no greater than is reasonably
necessary for the protection of the party in whose favor it is imposed it is upheld, but if it goes
beyond this it is declared void.” at p. 591.
31
Del Castillo v. Richmond, 45 Phil. 679 (1924).
exercised by the corporation or stockholder is unreasonable, as for example
when the option can be exercised within an extended period of more than one
year before the disposing stockholder could sell his shares to a third party, then it
becomes unreasonable restraint of trade. An unduly long period of time of
restraint, or when the terms unduly complicate and burden the disposing
stockholder who may have a ready and willing third-party buyer, would make
such provisions not comply with the reasonableness requirement mandated by
jurisprudence.
The SEC has given the parameters on what constitutes reasonable
restrictions, thus: 32

(a) The restrictions shall not be more onerous than granting the
existing stockholders or the corporation the option to
purchase the shares of the transferring stockholder with
such reasonable terms, conditions or period stated therein;
(b) A restriction clause is no valid and enforceable if it absolutely
prohibits the sale or transfer of stock without the consent of
the existing stockholders, as this would violate the general
law on free alienability of shares of stock;
(c) Reasonable option period may range from 30 to 60 days or
even more, depending on the circumstances surrounding the
case; and
(d) After the option period has expired the stockholder is free to
sell his shares of stock to anyone.

4. Non-Competition Clause
The SEC has opined that a non-competition clause may be properly
provided for as a condition for being a stockholder in the articles of incorporation
or by-laws of the corporation.33
The SEC ruled that such disqualification provision is a valid and
reasonable exercise of corporate authority since a corporation, under the
principle of self-preservation, has the inherent right to preserve and protect itself
by excluding competitors or hostile interests.34 The provision is made obviously
to prevent a stockholder from creating an opportunity to take advantage of the
information which he may have acquired as such to promote his individual
interest to the prejudice of the corporation and other stockholders.35 The
stockholders have a fiduciary relation with their corporation for the collective
benefit of the stockholders.36 Any person who intends to buy sock in a

32
SEC Opinion, 8 June 1995, XXIX SEC QUARTERLY BULLETIN 32 (No. 4, Dec. 1995).
33
SEC Opinion, 12 August 1998, XXXIII SEC QUARTERLY BULLETIN 14 (No. 1, June, 1999).
34
Ibid.
35
Ibid.
36
Ibid.
corporation does so with the knowledge that its affairs are governed by the
articles of incorporation and by-laws; and with such knowledge, the stockholder
may be considered to have consented to the disqualification to engage in the
same line of business and thus, it cannot be said that the stockholder‟s right is
infringed. 37

RIGHT TO VOTE
1. Varying the Voting Rights
Under Section 6 of the Corporation Code, no share may be deprived of
voting rights except those classified and issued as "preferred" or "redeemable"
shares. In addition, there shall always be a class or series of shares which have
complete voting rights.38 The creation of a class of shares with multiple voting
rights appears to be effective where the purpose is to unequally distribute voting
power so as to confer larger participation in management on a shareholder or
class of shareholders.39
Where the articles of incorporation provide for non-voting shares in the
cases allowed by the Corporation Code, the holders of such shares shall
nevertheless be entitled to vote on the following matters;

(a) Amendment of the articles of incorporation;

(b) Adoption and amendment for the by-laws;
(c) Sale, lease, exchange, mortgage, pledge, or other dis-
position of all or substantially all of the corporate property;
(d) Incurring, creating, or increasing bonded indebtedness;
(e) Increase or decrease of capital stock;
(f) Merger or consolidation of the corporation with another
corporation or other corporations;
(g) Investment of corporate funds in another corporation or
business in accordance with this code; and
(h) Dissolution of the corporation.40

Except in the above cases, the vote necessary to approve a particular

corporate act as provided in the Corporation Code shall be deemed to refer only
to stocks with right to vote.41

37
Ibid.
38
Sec. 6, Corporation Code.
39
Ferrer, Varying a Shareholder's Statutory Participation in Management by the Use of Non-
Statutory Devices, 9 ATENEO L.J. 10 (1959)
40
Sec. 6, Corporation Code.
41
Ibid.
 Under Section 137 of the Corporation Code, the term "outstanding capital
stock" means "the total shares of stock issued to subscribers or stockholders,
whether or not fully or partially paid (as long as there is a binding subscription
agreement), except treasury shares." Although Section 137 in defining
"outstanding capital stock" expressly excludes only treasury shares, it is not
meant to cover non-voting shares whenever it is used in relation to voting
requirements because of the qualification under Section 6.

2. Voting Rights for Members

In a non-stock corporation, Section 89 of the Corporation Code provides
that the right of the member of any class to vote may be limited, broadened or
denied to the extent specified in the articles of incorporation or the by-laws.
Unless so limited, broadened or denied, each member regardless of class shall
be entitled to one vote. Unlike in the case of stock corporation where the right to
vote by proxy cannot be taken away, in a non-stock corporation the right of a
member to vote by proxy may be taken away by provisions in the articles of
incorporation or in the by-laws.42
Unless otherwise provided in the articles of incorporation or in the by-laws,
members of a non-stock corporation may cast as many votes as there are
trustees to be elected but may not cast more than one vote for one candidate.
Candidates receiving the highest number of votes shall be declared elected.43
Voting by mail or other similar means by members of non-stock
corporations may be authorized by the by-laws of non-stock corporations and
under such conditions which may be prescribed by the SEC.44
Cumulative voting for trustees may be provided for in the by-laws of a non-
stock corporation.45 In the absence of provisions allowing for cumulative voting in
a non-stock corporation, the members can only vote under the straight voting
system.

3. Party Entitled to Vote

Price v. Martin,46 held that until challenged in a proper proceeding, a
stockholder of record has a right to participate and vote in any meeting of the
stockholders of the corporation, and in the absence of fraud, the action of the
stockholders at that meeting cannot be collaterally attacked on account of such
participation. A person who has purchased stock and who desires to be
recognized as a stockholder, for the purpose of voting, must secure such a
standing by having the transfer recorded upon the books of the corporation; and

42
Sec. 89, Corporation Code.
43
Ibid. Also Sec. 24, Corporation Code.
44
Ibid.
45
Sec. 24, Corporation Code.
46
58 Phil 707 (1933).
if the transfer is not duly made upon request he has, as his remedy, to compel it
to be made.47
The sequestration of shares does not entitle the government to exercise
acts of ownership over the shares; consequently, even sequestered shares may
be voted upon by the registered stockholder of record.48
The SEC has also opined that it would be illegal for a corporation adopt a
rule that a stockholder who fails to attend the meeting or appoint a proxy is
deemed to have appointed the Chairman of the meeting as his proxy, since
Section 58 of the Corporation Code clearly provides that a proxy to be valid must
be in writing and signed by the stockholder.49
Since the appointment of proxy is purely personal, and the right to vote is
inseparable from the right of ownership of stock without the owner‟s consent, and
therefore a proxy to vote stock, to be valid, must have been given by the person
who is the legal owner of the stock and entitled to vote the same at the time it is
to be voted.50

4. Voting on Joint Ownership

Under Section 56 of the Corporation Code, in case of shares of stock
owned jointly by two (2) or more persons, in order to vote the same, the consent
of all the co-owners shall be necessary, unless there is a written proxy signed by
all the co-owners, authorizing one or some of them or any other person to vote
such share or shares. However, when the shares are owned in an "and/or"
capacity by the holders thereof, any of the joint owners can vote said shares or
appoint a proxy therefore.
When a certificate of stock is issued with the conjunctive “and/or” placed
between the names of the parties who are co-owners of said shares, it is
understood that the shares covered by the certificate may be transferred upon
the endorsement of both or either of the stockholders and the right to vote the
shares may also be exercised by both or any of them.51

5. Pledgors, Mortgagors and Administrators

Under Section 55 of the Corporation Code, in case of pledged or
mortgaged shares in stock corporations, the pledgor or mortgagor shall have the
right to attend and vote at meetings of stockholders, unless the pledgee or
mortgagee is expressly given such right in writing which is recorded on the
appropriate corporate books by the pledgor or mortgagor.

47
Ibid.
48
Cojuangco Jr. v. Roxas, 195 SCRA 797 (1991).
49
SEC Opinion, 3 December 1993, XXVIII SEC QUARTERLY BULLETIN 5 (No. 2, June 1994).
50
Ibid.
51
SEC Opinion, 9 May 1995, XXIX SEC QUARTERLY BULLETIN 12 (No. 4, Dec. 1995).
 Executors, administrators, receivers, and other legal representatives duly
appointed by the court may attend and vote in behalf of the stockholders or
members without need of any written proxy. 52 In spite of what may be provided
for in the by-laws on a non-stock corporation on the suspension of voting rights of
a deceased member, it would seem that under Section 55 the power to vote on
the membership is by operation of law transferred to the administrator of the
estate of the deceased member.
The SEC has opined that based on the said section of the Code, an
administrator of a deceased member may vote on corporate matters and
therefore, should be counted in determining the requisite vote approving a
corporate act.53
The SEC has also opined that generally restrictions on the right of
shareholders to pledge or mortgage their shares would be unlawful.54 The SEC
has, however, as a matter of policy, allowed reasonable restrictions on the
transfer of shares in the articles of incorporation if the restrictions comply with the
provisions of Article 93 of the Corporation Code, namely, that the restriction must
appear in the articles of incorporation, by-laws and the certificates of stock, and
that said restrictions shall not be more onerous than granting the existing
stockholders or the corporation the option to purchase the shares of the
transferring stockholder with such reasonable terms, conditions or period stated
therein.55
Therefore, if the restriction on the right to pledge or mortgage shares of
stock absolutely prohibits the stockholders from pledging or mortgaging their
shares without the consent of the board of directors, it would be violative of the
statutory right of the stockholders to encumber shares of stock as allowed in
Section 55 of the Corporation Code.56 However, when the restriction merely
allows the corporation or existing stockholders to accept the offer within the
option period, and thereafter, if no one accepts the offer, the stockholder is free
to pledge or mortgage his shares in favor of any third party, such provision is
reasonable, valid and binding.57

6. Treasury Shares
Under Section 57 of the Corporation Code, treasury shares shall have no
voting rights as long as such stock remains in the treasury. The philosophy
behind the prohibition is that to give voting rights to treasury shares could enable
the directors to prolong their stay in office against the wishes of the holders of the
majority of the stock.

52
Sec. 55, Corporation Code.
53
SEC Opinion, 3 March 1986, XX SEC QUARTERLY BULLETIN (Nos. 1 & 2, March & June,
1986).
54
SEC Opinion, 8 August 1995, XXX SEC QUARTERLY BULLETIN 21 (No. 1, June 1996).
55
Ibid.
56
Ibid.
57
Ibid.
 In case of resale or reissue, treasury shares regain whatever voting rights
and dividends to which they were originally entitled in the hands of the third-party
buyer.

7. Election of Directors and Trustees

Under Section 24 of the Corporation Code, at all elections of directors or
trustees, there must be present, either in person or by representative authorized
to act by written proxy, the owners of the majority of the outstanding capital
stock, or if there be no capital stock, a majority of the members entitled to vote.
The election must be by ballot if requested by any voting stockholder or member.
In stock corporations, every stockholder entitled to vote shall have the
right to vote in person or by proxy the number of shares of stock standing, at the
time fixed in the by-laws, in his own name on the stock book of the corporation,
or where the by-laws are silent, at the time of the election.58 No delinquent stock
shall be voted.59
Any meeting of the stockholders or members called for an election may
adjourn from day to day or from time to time but not sine die or indefinitely, if for
any reason, no election is held, or if there are not present or represented by
proxy, at the meeting, the owners of the majority of the outstanding capital stock,
if there be no capital stock, a majority of the members entitled to vote.60

8. Amendment of Articles of Incorporation

Under Section 16 of the Corporation Code, unless otherwise prescribed by
the Code itself, or by special law, and for legitimate purposes, any provision or
matter stated in the articles of incorporation may be amended by a majority vote
of the board of directors or trustees, and the vote or written assent of the
stockholders representing at least two-thirds (2/3) of the outstanding capital stock
without prejudice to the appraisal right of dissenting stockholders when granted
by the Code, or the vote or written assent of two-thirds (2/3) of the members if it
be a non-stock corporation.

9. Investment in Another Business or Corporation

Under Section 42 of the Corporation Code, a corporation may invest its
funds in any other corporation or business or for any purpose than the primary
purpose for which it was organized when approved by a majority of the board of
directors or trustees and ratified by the stockholders representing at least two-
thirds (2/3) of the outstanding capital stock, or by at least two-thirds (2/3) of the
members in the case of non-stock corporations, at a stockholders meeting duly
called for the purpose.

58
Sec. 24, Corporation Code.
59
Ibid.
60
Ibid.
 However, where the investment by the corporation is reasonably
necessary to accomplish its primary purpose as stated in the articles of
incorporation, the approval of the stockholders or members shall not be
necessary.61
Written notice of the proposed investment and the time and place of the
meeting shall be addressed to each stockholder or member at his place of
residence as shown on the books of the corporation and deposited to the
addressee in the post office with postage pre-paid or served personally.62

10. Merger and Consolidation

Under Section 77 of the Corporation Code, upon approval by majority vote
of each of the board of directors or trustees of the constituent corporations of the
plan or merger or consolidation, the same shall be submitted for approval by the
stockholders or members, of each of such corporations at separate corporate
meetings dully called for the purpose. Notice of such meetings shall be given to
all stockholders or members of the respective corporations, at least two (2)
weeks prior to the date of the meeting, either personally or by registered mail.
The notice shall state the purpose of the meeting and shall include a copy
or a summary of the plan of merger or consolidation as the case may be. The
affirmative vote of the stockholders representing at least two-thirds (2/3) of the
outstanding capital stock in case of stock corporation, or at least two-thirds (2/3)
of the members in case of non-stock corporations, shall be necessary for the
approval of such plan.63
Any dissenting stockholder in stock corporations may exercise his
appraisal right in accordance with the provisions of the Corporation Code;
provided, that if after the approval by the stockholder of such plan, the board of
directors should decide to abandon the plan, the appraisal shall be
extinguished.64
Any amendment to the plan of the merger or consolidation may be made,
provide such amendment is approved by a majority vote of the respective boards
of directors or trustees of all the constituent corporations and ratified by the
affirmative vote of stockholders representing at least two-thirds (2/3) of the
outstanding capital stock or two-thirds (2/3) of the members of each of the
constituent corporations. Such plan, together with any amendment, shall be
considered as the agreement of merger or consolidation.65

11. Increase and Decrease of Capital Stock

61
Sec. 42, Corporation Code.
62
Ibid.
63
Sec. 77, Corporation Code.
64
Ibid.
65
Ibid.
 Under Section 38 of the Corporation, no corporation shall increase or
decrease its capital stock, unless approved by a majority vote of the board of
directors and at a stockholders' meeting duly called for the purpose, two-thirds
(2/3) of the outstanding capital stock shall favor the increase or diminution of the
capital stock.
Written notice of the proposed increase or diminution of the capital stock is
to be considered, must be addressed to each stockholder at his place of
residence as shown on the books of the corporation and deposited to the
addressee in the post office, with postage pre-paid, or served personally.

12. Incurring or Creating Bonded Indebtedness

Under the same Section 38, no stock corporations may incur or create
bonded indebtedness, or increase the same, with the approval by a majority of
the board of trustees and of at least two-thirds (2/3) of the members in a meeting
duly called for the purpose.

13. Adoption, Amendment and Repeal of By-Laws

Under Section 48 of the Corporation Code, the board of directors or
trustees, by majority vote thereof, and the owners of at least a majority of the
members of a non-stock corporation, at a regular or special meeting duly called
for the purpose, may amend or repeal any by-laws or adopt new by-laws.
The owners of two-thirds (2/3) of the outstanding capital stock or two-
thirds (2/3) of the members of a non stock corporation may delegate to the board
of directors or trustees to amend or repeal any by-laws and adopt new by-laws.
However, any power delegated to the board of directors or trustees to amend or
repeal any by-laws or adopt new by-laws shall be considered as revoked
whenever stockholder owning or representing a majority of the outstanding
capital stock or a majority of the members in non-stock corporations, shall so
vote at a regular or special meeting.

14. Declaration of Stock Dividends

Section 43 of the Corporation Code provides that no stock dividend shall
be issued without the approval of stockholder representing not less than two-
thirds (2/3) of the outstanding capital stock at a regular or special meeting duly
called for the purpose.

15. Management Contracts

Under Section 44 of the Corporation Code, no corporation shall conclude
a management contract with another corporation unless such contract shall have
been approved by the board of directors and by shareholders owning at least a
majority of the outstanding capital stock, or by at least a majority of the members
in case of a non-stock corporation, of both the managing and the managed
corporation, at a meeting duly called for the purpose, provided that:
 (a) Where a stockholder or stockholders representing the same
interest of both the managing and the managed corporations
own or control more than one-fourth (1/4) of the total
outstanding capital stock entitled to vote of the managing
corporation; or
(b) Where a majority of the members of the board of directors of
the managing corporation also constitute a majority of the
members of the board of directors of the managed
corporation, then the management contract must be
approved by the shareholders of he managed corporation
owning at least two-thirds (2/3) of the total outstanding
capital stock entitled to vote, or by at least two-thirds (2/3) of
the members in the case of non-stock corporation.

16. Fixing of Consideration of No-par Value Shares

Under Section 62 of the Corporation Code, the issued price of no-par
value shares may be fixed in the articles of incorporation or the by-laws, or in the
absence thereof, by the shareholders at a meeting duly called for the purpose
representing at least a majority of the outstanding capital stock.

AGREEMENTS AFFECTING VOTING RIGHTS

1. Proxies66
Under Section 58 of the Corporation Code, stockholders and members
may vote in person or by proxy in all meetings of stockholders or members.

a. Nature of Proxy Relationship

A proxy is a special form of agency and governed by the Law on Agency.
Consequently, being a strictly fiduciary relation, a proxy is essentially revocable
in nature; and any attempt or stipulation to render it irrevocably would be to no
avail. Generally, proxies, even those with irrevocable terms, have always been
considered as revocable, unless coupled with an interest, and their revocation
may be by formal notice, orally, or by conduct as by the appearance of the
stockholder or member giving the proxy, or the issuance of a subsequent proxy,
or the sale of shares.
As a rare exception, a proxy coupled-with-interest may be rendered non-
revocable where the proxy has parted with value or incurred liability at the
stockholder's request, the essence being that the exercise of the proxy as the
means of reimbursement or indemnity. Therefore, it is not the giving of onerous
consideration that make a proxy coupled-with-interest, but that the proxy is an

66
You may wish to refer to the right-up of rules affecting proxies in Appendix D on Proxy
Rules and Appreciation.
integral part of the security by which a loan or indebtedness is to be paid or
liquidated.
The SEC has appropriately observed that a person acting as proxy for a
stockholder is in the eyes of the law, the latter‟s agent and as such, a mere
fiduciary who has the duty of acting in strict accord with requirements of a
fiduciary relation; and that accordingly, the proxy holder must act in accordance
with the instructions given to him/her by the stockholder and any violation of such
fiduciary duty shall be governed by the pertinent laws on Agency, not by the
Corporation Code.67

b. Requisites for Valid Proxy

In order to be valid and enforceable, a proxy must comply with the
following requisites: 68

(a) The proxy shall in writing;69

(b) Signed by the stockholder70 or member; and
(c) Filed before the scheduled meeting with the corporate
secretary.71

The SEC has opined that if the by-laws of the association do not prescribe
a particular form for proxy, the imposition of a particular form by the corporation
would be void, and the members may use other forms of proxies as long as they
are executed in accordance with Section 58 of the Corporation Code, which
provides that proxies shall be in writing, signed by the stockholder or member
and filed before the schedule meeting with the corporate secretary. 72
For purposes of determining quorum and entitlement to vote or to
participate in stockholders meeting, the proxy must be filed/registered with the
corporate secretary prior to the stockholders meeting, and unless filed in
accordance with the provisions of the Corporation Code or the by-laws, the proxy
holder is not entitled to any right.73
Finally, when the by-laws of a corporation are silent on the time of
submission of proxies, the corporation cannot fix the deadline, since it is clear
under Section 58 that when no deadline or period of filing/submission of the
proxies is provided for in the by-laws, then proxies may be filed anytime before
the scheduled meeting.74

c. Period of Effectivity of Proxy

67
SEC Opinion, 15 July 197, XXXII SEC QUARTERLY BULLETIN 4 (No. 2, Dec. 1997).
68
Sec. 58, Corporation Code.
69
Sec. 20.2, The Securities Regulation Code [RA 8799].
70
Ibid.
71
Ibid.
72
SEC Opinion, 14 June 1995, XXIX SEC QUARTERLY BULLETIN 36 (No. 4, Dec. 1995).
73
SEC Opinion, 15 July 197, XXXII SEC QUARTERLY BULLETIN 4 (No. 2, Dec. 1997).
74
SEC Opinion, 4 September 1995, XXX SEC QUARTERLY BULLETIN 29 (No. 1, June 1996).
 Unless otherwise provided in the proxy, it shall be valid only for the
meeting for which it is intended. No proxy shall be valid and effective for a period
longer than five (5) years at any one time.75

e. Who May be Appointed Proxy

Section 58 of the Corporation Code imposes no limitation as to the
persons who may be appointed as proxy and by-law provisions restricting the
right of a stockholder to appoint a proxy would be void.
However, in the case of non-stock corporation, Section 89 of the
Corporation Code the articles of incorporation or by-laws may restrict the right of
a member to vote by proxy. The SEC has opined that under Section 89 the right
of members to vote by proxy may be denied entirely by appropriate provisions in
the articles of incorporation or by-laws of a non-stock corporation.76

2. Voting Trust Agreements

a. Nature of Voting Trust Agreement
The voting trust device involving the complete surrender by the
shareholder of his voting rights to a trustee or trustees, appears to have been
effective in the rehabilitation of insolvent corporations, as well as in irrevocably
committing groups of shareholders to the continuation of fixed business
policies.77
Under a voting trust arrangement, a stockholder of a stock corporation
parts with the voting power only but retains the beneficial ownership of the stock.
A voting trustee is only a share owner vested with colorable and fictitious title for
the sole purpose of voting upon stocks that he does not own. Consequently, the
transferring stockholder, although he has ceased to be a stockholder of record,
retains the right of inspection of corporate books which he can exercise
concurrently with the voting trustee.
By its very nature, a voting trust agreement results in the separation of the
voting rights of a stockholder from his other rights such as the right to receive
dividends, the right to inspect the books of the corporation, the right to sell certain
interests in the assets of the corporation and other rights to which a stockholder
may be entitled until the liquidation of the corporation.78

b. Requisites of Valid Voting Trust Agreement

Under Section 59 of the Corporation Code, one or more stockholders of a
stock corporation may create a voting trust for the purpose of conferring upon a
75
Sec. 58, Corporation Code. Also provided for under Sec. 20.3 of the Securities Regulation
Code [RA 8799].
76
SEC Opinion, 20 September 1994, XXIX SEC QUARTERLY BULLETIN 20 (No.1, March
1995).
77
Ferrer, Varying a Shareholder's Statutory Participation in Management by the Use of Non-
Statutory Devices, 9 ATENEO L.J. 10 (1959).
78
Lee v. Court of Appeals, 205 SCRA 752,758 (1992).
trustee or trustees the right to vote and other rights pertaining to the shares for a
period not exceeding five (5) years at any one time. In the case of a voting trust
specifically required as a condition in a loan agreement, said voting trust may be
for a period exceeding five (5) years but shall automatically expire upon full
payment of the loan.
A voting trust agreement shall be ineffective and unenforceable unless:

(a) It is in writing and notarized, and shall specify the terms and
conditions thereof; and
(b) A certified copy of such agreement shall be filed with the
corporation and with the SEC.79

The certificate or certificates of stock covered by the voting trust

agreement shall be cancelled and new ones shall be issued in the name of the
trustee or trustees stating that they are issued pursuant to said agreement. In the
books of the corporation, it shall be noted that the transfer in the name of the
trustee or trustees is made pursuant to said voting trust agreement. The trustee
or trustees shall execute and deliver transferor voting trust certificates, which
shall be transferable in the same manner and with the same effect as certificates
of stock.80
The voting trust agreement filed with the corporation shall be subject to
examination by any stockholder of the corporation in the same manner as any
other corporate book or record, provided that both the transferor and the trustee
or trustees may exercise the right. Any other stockholder may transfer his shares
to the same trustee or trustees upon the terms and conditions stated in the voting
trust agreement, and thereupon shall be bound by all the provision of said
agreement.81
No voting agreement shall be entered into for the purpose of
circumventing the law against monopolies and illegal combinations in restraint of
trade or used for purposes of fraud.82
Unless expressly renewed, all rights granted in voting trust agreement
shall automatically expire at the end of the agreed period, and the voting trust
certificates as well as the certificates of stock in the name of the trustee or
trustees shall thereby be deemed cancelled and new certificates of stock shall be
reissued in the name of the transferor.83
The voting trustee or trustees may vote by proxy unless the agreement
provides otherwise.84

79
Sec. 59, Corporation Code.
80
Ibid.
81
Ibid.
82
Ibid.
83
Ibid.
84
Ibid.
 The trustee is the legal title holder or owner of the shares so transferred
under the agreement. He is, therefore, qualified to be a director.

c. Differences Between Proxy and Voting Trust Agreement

Lee v. Court of Appeals,85 gave the following criteria "to distinguish a
voting trust agreement from proxies and other voting pools and agreements:"

(a) The voting rights of the stock are separated from the other
attributes of ownership;
(b) The voting rights granted are intended to be irrevocable for a
definite period of time; and
(c) The principal purpose of the grant voting rights is to acquire
voting control of the corporation.86

Lee also recognized that a voting trust agreement may confer upon a
trustee not only the stockholder's voting rights but also other rights pertaining to
his shares as long as the voting trust agreement is not entered for the purpose of
circumventing the law against monopolies and illegal combination in restraint of
trade or used for purposes of fraud:87

Thus, the traditional concept of a voting trust agreement

primarily intended to single out a stockholder's right to vote
from his other rights as such and made irrevocable for a
limited duration may in practice become a legal device
whereby a transfer of the stockholder's share is effected
subject to the specific provision of the voting trust agreement.
The execution of a voting trust agreement, therefore, may
create a dichotomy between the equitable or beneficial
ownership of the corporate shares of a stockholder, on the one
hand, and the legal title thereto on the other hand.88

The other differences between a voting trust agreement and a proxy are
as follows:

(a) Proxy is essentially an agency relationship based on

personal qualifications and preferences, and therefore,
essentially revocable; whereas, a voting trust agreement is a
contractual relationship based on the Law of Trust, and exist
by virtue of a property relationship, and is not revocable,
although it may be lawfully terminated based on breach of
trustf

85
205 SCRA 752 (1992).
86
Ibid, citing 5 FLETCHER CYC. LAW ON PRIVATE CORP., Sec. 2075 (1976), at p. 331.
87
Ibid, at p. 758, citing Sec. 59, Corporation Code.
88
Ibid, at pp. 758-759.
 (b) Both the proxy and the voting trust agreement are fiduciary
in nature. A voting trust agreement is not revocable because
the parties are bound by the contractual relationship created.
A proxy is, however, generally revocable unless coupled with
an interest. This feature of irrevocability provides for stability
in the voting trust relationship.
(c) A proxy can only act the specified stockholders' or members'
meeting (if the proxy is not continuing in nature), while a
trustee is not limited to any particular meeting.
(d) The proxy has no right to receive dividends; whereas, a
trustee will receive the dividends declared on the shares
held in trust, but with obligation to dispose of them for the
benefit of the beneficial owner
(e) The proxy does not have the right to inspect and such right
was not granted under the proxy; whereas, in a voting trust
arrangement, trustee is the person entitled to exercise the
right to inspect.
(f) The proxy does not have the appraisal right; in a voting trust
arrangement, it is the trustee, as the naked owner of the
shares, who will exercise the appraisal right, but subject to
his trust obligations with the beneficial owner.

d. Pre-termination of Voting Trust Agreement

In Everett v. The Asia Banking Corporation,89 the controlling stockholders
of the corporation executed voting trust in favor of Asia Banking in order to
facilitate the business between the two and for protection of all parties from
outside creditors. When the trustee bank abused its powers in the management
of the affairs of the corporation, the controlling stockholders brought suit to
terminate the voting trust arrangement. The Supreme Court in effect recognized
the right of transferring stockholders even under the old Corporation Law to set
aside the trust agreement when their rights are trampled upon by trustee.
The Corporation Code now provides that no voting trust be used for the
purposes of fraud.90 Even under the general principles of law, stockholders who
are defrauded by their trustees have a right to revoke the trust and recover
damages from such trustee.

e. Voting Trust Agreement as Part of Loan Arrangement

Section 59 of the Corporation Code implicitly recognizes that voting trust
agreements are entered into as part of loan arrangement of the corporation with
a banking institution. The section provides that although as a strict rule voting
trust agreements cannot exceed five (5) years, "in the case of a voting trust
89
49 Phil. 512 (1926).
90
Sec. 59, Corporation Code.
specifically required as a condition in a loan agreement, said voting trust may be
for a period exceeding five (5) years but shall automatically expire upon full
payment of the loan."
Section 59 envisions a situation where a corporation obtains a loan from a
bank, but as a condition of the loan, the majority stockholders also would be
required to execute voting trust agreement over their shares in the corporation to
ensure that the lending institution would have a controlling interests in corporate
votes to be taken that may affect the ability of the borrowing corporation to pay
the loan. The voting trust therefore constitute further security to the lending
institution, although it is not the corporation which executes the same since it is
not the owner of the shares, but the stockholders of the corporation.
It is very difficult to imagine that the proviso in Section 59 on loan
arrangement would only cover a loan arrangement entered into by the
stockholder himself with a banking institution, since a pledge or mortgage of the
shares would be the better contract. Usually, when the loan taken with a lending
institution is the personal loan of a stockholder, aside from the encumbrance of
the share, the lending institution would have very little interests in the operations
of the corporation as to require a voting trust to participate in management, since
the corporation nor its assets can be held liable for the loan.
The voting trust arrangement as part of the loan arrangement of a
corporation with a lending institution was the situation covered in National
Investment and Development Corp. v. Aquino.91 In that case, a part of the
conditions mandated in the Financial Agreement entered into by the borrowing
corporation with the Philippine National Bank (PNB) and the National Investment
and Development Corp. (NIDC), a voting trust agreement was executed over
sixty percent (60%) of the outstanding and paid up capital stock of the borrowing
corporation. The execution of the voting trust also facilitated implementation of
the condition in the Financing Agreement that allowed PNB-NIDC to appoint
members in the seven-man board of the corporation, and the appointment of a
comptroller by PNB-NIDC to supervise the financial management of the
corporation.
During the term of the voting trust, the corporation defaulted in the loan
which resulted in the foreclosure and sale of its oil mills with PNB-NIDC ending
as the highest bidders thereof. Upon termination of the voting trust, the
corporation sought to have PNB-NIDC account for all the assets and oil mills of
the corporation under the theory that PNB-NIDC acquired them as trustees for
the corporation.
The Supreme Court held that what the corporation should have done was
to annul the foreclosures, and cannot interpose its claim to the oil mills on the
basis of the voting trust agreement. The Court held:

91
163 SCRA 153 (1988).
 It is clear that what was assigned to NIDC was the power
to vote the shares of stock of the stockholders of Batjak,
representing 60% of Batjak's outstanding shares, and who are
the signatories to the agreement. The power entrusted to
NIDC also included the authority to execute any agreement or
document that may be necessary to express the consent or
assent to any matter, by the stockholders. Nowhere in the said
provisions or in any other part of the Voting Trust Agreement is
mention made of any transfer or assignment to NIDC of
Batjak's assets, operations, and management. NIDC was
constituted as trustee only of the voting rights of 60% of the
paid-up and outstanding shares of stock in Batjak. . The
acquisition by PNB-NIDC of the properties in question was not
made or effected under the capacity of a trustee but as a
foreclosing creditor for the purpose of recovering on a just and
valid obligation of Batjak.92

The Supreme Court therefore failed to appreciate the fact that the voting
trust was obtained from the shareholders of the borrowing corporation precisely
to allow PNB-NIDC to have management and undertake control in the operations
of the borrowing corporation. Although National Investment Development Corp.
would hold that "a voting trust transfers only voting or other rights pertaining to
the shares subject of the agreement, or control over the stock," 93 it failed to
appreciate that the voting trust arrangement was part and parcel of the loan
arrangement of the borrowing corporation, and therefore must be construed not
by its technical set-up (as a contract basically on the shares between the
transferring stockholders and the lending institution) but actually as a means by
which the lending institution obtains control over the management or operation of
the borrowing corporation during the loan period.
Therefore, when it decided National Investment and Development Corp.
the Supreme Court was not ready to import into Philippine jurisprudence the
concept of "lender's liability" by which a lender becomes liable as trustee for the
operations and management of the company to which it had extended loans by
reason of its allowed itself to be involved in the management and operations of
the borrowing corporation.94

3. Pooling Agreement and other Stockholders' Agreement

Under Section 100(2) of the Corporation Code, although it falls in the Title
covering Close Corporations, an agreement between two or more stockholders, if
in writing and signed by the parties thereto, may provide that in exercising any
92
Ibid, at p. 173-174.
93
Ibid, at p. 173.
94
See Villanueva, The Fiduciary Duties of Directors and Officers Representing the Creditor
Pursuant to a Loan Workout Arrangement: Parameters Under Philippine Corporate Setting, 35
ATENEO L.J. (No. 1, Feb. 1991). Poblador, The Tort of Bad Faith Breach as an Emerging Theory
of Lender Liability: Exploring Philippine Analogues of the California and Montana Doctrines, LXIII
PHIL. L.J. (March 1989).
voting rights, the shares held by them shall be voted therein provided, or as they
may agree, or as determined in accordance with a procedure agreed upon by
them.
Pooling or voting agreements are agreements by which two or more
stockholders agree that their shares shall be voted as a unit. They are usually
concerned with the election of directors to gain control of the management. In
such agreements, the parties thereto remain the legal owners of theirs stocks
with the right to vote them, although contractually they each have bound
themselves to vote in accordance with the decision of the majority in the pool.
Since a pooling agreement covers personal obligations to do (as
contrasted from real obligation to give), then although the terms thereof are valid
and binding as contractual commitments, they cannot be enforced by an action
for specific performance based on the public policy against involuntary
servitudes. Therefore, enforcement of pooling agreements are made by imposing
hefty liquidated damages provisions for non-compliances with the terms thereof.

4. Hierarchy of Enforceability
The voting trust agreement is the most effective of the arrangement, being
based on the law on trust, the relationship cannot be arbitrarily terminated except
for proper cause provided by law. Proxy, being based on the Law on Agency, can
be terminated at will by the principal, even when the contrary is provided for in
the proxy agreement. On the other hand, although the pooling agreement is
based on Contract Law, since it covers an obligation to do, specific performance
is not an available remedy.

STOCKHOLDERS' OR MEMBERS' MEETINGS

1. Calls and Types of Meeting
Under Section 49 of the Corporation Code, meetings of directors, trustees,
stockholders, or members may be regular or special.
Under Section 50 thereof, regular meetings of stockholders of members
shall be held annually on a date fixed in the by-laws, or if not so fixed, on any
date in April of every year as determined by the board of directors or trustees.
Written notice of regular meetings shall be sent to all stockholders or members of
record at least two (2) week prior to the meeting, unless a different period is
required by the by-laws.
Special meetings of stockholders or members shall be held at any time
deemed necessary or as provided in the by-laws; provided that at least one (1)
week written notice shall be sent to all stockholders or members, unless
otherwise provided in the by-laws.95

95
Sec. 50, Corporation Code.
 Notice of any meeting may be waived, expressly or impliedly, by any
stockholder or member.96

2. Place and Time of Meeting

Under Section 51 of the Corporation Code, stockholders or members
meetings, whether regular or special, shall be held in the city or municipality
where the principal office of the corporation is located, and if practicable, in the
principal office of the corporation. However, the same section provides that Metro
Manila shall, for the purposes of this section, be considered a city or municipality.
Notice of the meetings shall be in writing and the time and place thereof stated
therein.
The SEC has ruled that the rule under Section 51 of the Corporation Code
expressly providing that stockholders meetings shall be held in the city or
municipality where the principal office of the corporation is located is mandatory,
and only admits of one exception, which is that such meeting shall be valid even
if not held in the proper place when “all the stockholders or members of the
corporation are present or duly represented at the meeting.” 97 Failure to comply
with the mandatory provisions of Section 51 would render the meeting illegal.98
The SEC has also ruled that postponement of the annual stockholders'
meeting may be allowed for justifiable and meritorious reasons provided however
that the same be held within a reasonable time from the date it has been
postponed and that proper notice of the change of the date is given to all
stockholders of record.99
All proceedings had and any business transacted at any meeting of the
stockholders or members, if within the powers or authority of the corporation,
shall be valid even if the meeting be improperly held or called, provided all the
stockholders or members of the corporation are present or duly represented at
the meeting.100
For non-stock corporations, under Section 93 of the Corporation, the by-
laws may provide that the members of a non-stock corporation may hold their
96
Ibid.
97
SEC Opinion, 7 April 1998, XXXII SEC QUARTERLY BULLETIN 10 (No. 1, June 1998).
98
Ibid.
99
SEC Opinion, 17 April 1986, XX SEC QUARTERLY BULLETIN Nos. 1 & 2 (March & June
1986).
As a general rule, where the date of the annual meeting of the corporation is fixed in the by-
laws, the same cannot be postponed. But this rule, however, admits of exceptions as where the
annual meeting cannot be held for some justifiable and valid reasons, provided that the
postponement of the annual meeting be for a reasonable time and provided that proper notice
shall be sent to all stockholders of the corporation in the manner prescribed by the corporate by-
laws. In addition, under the Amended SEC Rules Requiring the Filing of Information Sheets by
Domestic Corporations, if for any justifiable reason, the annual meeting has to be postponed, the
company should notify the SEC in writing of such postponement with ten (10) days from date of
such postponement. SEC Opinion 29 April 1999, XXXIII SEC QUARTERLY BULLETIN 61 (No. 1,
June 1999); SEC Opinion, 8 March 1995, XXIX SEC QUARTERLY BULLETIN 9 (No. 3, Sept. 1995).
100
Sec. 51, Corporation Code.
regular or special meetings at any place even outside the place where the
principal office is located within the Philippines; provided that proper notice is
sent to all members indicating the date, time, and place of meeting.

3. Who Can Call a Meeting

The person or persons designated in the by-laws to have authority to call
stockholders' or members' meeting. In the absence of such provision in the by-
laws, the meeting may be called by a director or trustee or by an officer entrusted
with the management of the corporation unless otherwise provided by law.
Whenever for any cause, there is no person authorized to call a meeting,
the SEC, under a petition of a stockholder or member, and on the showing of
good cause therefore, may issue an order to the petitioning stockholder or
member directing him to call a meeting of the corporation by giving proper notice
required by the Corporation Code or by the by-laws. The petitioning stockholder
or member shall preside thereat until at least a majority of the stockholders or
members present have chosen one of their number as presiding officer. 101
Pursuant to the powers granted to the SEC under Section 50 of the
Corporation Code, and Section 6(f) of Pres. Decree 902-A, the SEC has opined
that when there is no person authorized to call a meeting or in the event the
person authorized in the by-laws to call a meeting fails or refuses to call for a
meeting, any interested stockholder may petition the SEC to authorize him to call
a meeting, or compel the officers of the corporation to call a meeting.102

4. Quorum
Under Section 52 of the Corporation Code, unless otherwise provided for
in the Code itself or in the by-laws, a quorum shall consist of the stockholders
representing a majority of the outstanding capital stock or a majority of the
members in the case of non-stock corporations.
In those cases in which the law determines the number of shareholders or
members whose concurring votes are necessary to make their action binding on
the corporation, no less than such number is necessary to constitute a quorum at
a meeting called to transact such business. In such cases, the by-laws may
provide for a greater quorum.
In other cases, the by-laws may provide for the holding of meetings with
the presence of any number of stockholders or members, even less than a
majority, provided that there are at least two. It is customary however, to provide
in the by-laws that the presence of the registered holders of a majority of the
outstanding shares is necessary to constitute a quorum, but that a smaller
number may meet and adjourn to a later date, and that at such adjourned
meeting, the shareholders attending shall constitute a quorum.

101
Sec. 50, Corporation Code.
102
SEC Opinion, 17 June 1998, XXXII SEC QUARTERLY BULLETIN 6 (No. 2, Dec. 1998).
 The SEC has opined that where a corporation encounters several
unsuccessful attempts or it it would be impossible for the corporation to get the
required quorum of the stockholders/members necessary to transact business, it
may, pursuant to the provisions of Pres. Decree 902-A, petition the SEC for the
appointment of a management committee to undertake the management
thereof.103

5. Minutes of Meeting
Under Section 74 of the Corporation Code, the corporation shall, at its
principal office, keep and carefully preserve a record of all minutes of all
meetings of stockholders or members, in which it shall be set forth in detail the
time and place of holding the meeting; how authorized; the notice given; whether
the meeting was regular or special; if special, its object those present and
absent; and every act done or ordered done at the meeting.
Upon the demand of any director, trustee, shareholder or member, the
time when any director, trustee, shareholder or member entered or left the
meeting must be noted in the minutes; and on a similar demand, the yeas and
nays must be taken on any motion or proposition, and a record thereof carefully
made. The protest of any director, trustee, shareholder or member or any action
or proposed action must be recorded in full on his demand.104
Without the signature of the secretary of the meeting, an alleged minutes
taken at that meeting has no probative value nor credibility.105

RIGHT TO INSPECT/EXAMINE CORPORATE RECORDS

1. Basis of Right to Inspect
The rights pertaining to a stockholder or member as such would be of little
value if he did not have access to information on corporate affairs. His right to
participate in management through the exercise of his voting powers, would be
useless if he had no means of gaining information upon which he could render
informed and intelligent judgment. Moreover, it would be highly difficult for a
stockholder or member to protect his own individual rights from the actions of
those in power if he could not compel management to open the books and
records for his inspection. Hence, the right to information is founded on his
beneficial interest through ownership of shares or membership, and granted by
common law for the purpose of protecting his individual interests.
Gokongwei, Jr. v. Securities and Exchange Commission, 106 held that "The
stockholder's right of inspection of the corporation's books and records is based
upon their (sic) ownership of the assets and property of the corporation. It is,

103
SEC Opinion, 10 July 1998, XXXII SEC QUARTERLY BULLETIN 10 (No. 2, Dec. 1998).
104
Sec. 74, Corporation Code.
105
SEC Opinion, 30 June 1971.
106
89 SCRA 336 (1979).
therefore, an incident of ownership of the corporate property, whether this
ownership or interest be termed an equitable ownership, a beneficial ownership,
or a quasi-ownership. This right is predicated upon the necessity of self-
protection.”107
Africa v. PCGG,108 and Republic v. Sandiganbayan,109 upheld the principle
that the right of the registered stockholder to inspect or examine corporate
records and to obtain excerpts thereof is not affected by the fact that the shares
have been sequestered, since sequestration by itself does not severe ownership
over the shares of the registered stockholder.

2. Specified Records Subject to Inspection

Under Section 74 of the Corporation Code, every corporation shall, at its
principal office, keep and carefully preserve a record of all business transactions,
and minutes of all meetings of stockholders or members, or of the board of
directors or trustees, in which shall be set forth in detail the time and place of
holding the meeting, how authorized, the notice given, whether the meeting was
regular or special, if special its object, those present and absent, and every act
done or ordered done at the meeting.
Upon the demand of any director, trustee, stockholder or member entered
or left the meeting must be noted in the minutes; and on a similar demand, the
yeas and nays must be on any motion taken or proposition, and record thereof
carefully made.110 The protest of any director, trustee, stockholder or member
any action or proposed action must be recorded in full on his demand.111
The section is worded in broad language, for "record of all business
transactions" covers practically all matters of import in a profit-seeking
corporation. The corporation is in duty bound to expose its records and book for
inspection by the shareholders, but it is not always bound to show all of them
under all circumstances.
W.G. Philpotts v. Phil. Manufacturing Company,112 also recognized that
there are some things which a corporation may undoubtedly keep secret,
notwithstanding the right of inspection given by law to the shareholder. For
instance, where a corporation, engaged in the business of manufacture, has
acquired a formula or process not generally known, which has proved by utility to
it in the manufacture of its products, a stockholder would not have access to such
formula.

a. Right to Financial Statements

107
Ibid, at pp. 384-385.
108
205 SCRA 39 (1992).
109
199 SCRA 39 (1991).
110
Sec. 74, Corporation Code.
111
Ibid.
112
40 Phil. 471 (1919).
 Within ten (10) days from receipt of a written request of any stockholder or
member, the corporation shall furnish to him its most recent financial statement,
which shall include a balance sheet as of the end of the last taxable year and a
profit or loss statement for said taxable year, showing in reasonable detail its
assets and liabilities and the result of its operations.113
At the regular meeting of shareholders or members, the board of directors
or trustees shall present to such shareholders or members a financial report of
the operations of the corporation for the preceding year, which shall include
financial statements, duly signed and certified by an independent certified public
accountant.114
However, if the paid-up capital of the corporation is less than P50,000, the
financial statements may be certified under oath by the treasurer or any
responsible officer of the corporation.115

b. Annual Report of Corporations

Under Section 141 of the Corporation Code, every corporation, domestic
or foreign, lawfully doing business in the Philippine shall submit to the SEC within
the periods it prescribes, an annual report of its operations, together with a
financial statement of its assets and liabilities, certified by any independent CPA
in appropriate cases, covering the preceding fiscal year and such other
requirements as the SEC may require.

c. Summary of Corporate Obligation to Report

In summary, the books and records which are legally required to be
prepared, maintained or kept by the corporation are as follows:

(a) Books that record all business transactions of the

corporation which shall include contracts, memoranda,
journals, ledgers, etc.;
(b) Minutes book for meetings of stockholders or members;
(c) Minutes book for meetings of the board of directors or
trustees;
(d) Stock and transfer book;
(e) Annual financial statements;116
(f) Annual report to the SEC;117 and

113
Sec. 75, Corporation Code.
114
Ibid.
115
Ibid.
116
Sec. 141, Corporation Code.
117
Under SEC rules, within thirty (30) calendar days following the date of the annual
stockholders' or members' meeting, and organizational meeting of the board, the corporation is
supposed to fill-up and submit to the SEC the General Information Sheet which includes the
names, nationality and residence of corporate officers, directors or trustees, the capital structure
 (g) Report of election of directors, trustees and officers within
thirty (30) days after such election.118

3. Manner of Availing of Right to Inspect

Section 74 of the Corporation Code provides that the records of all
business transactions of the corporation and the minutes of any meeting shall be
open to the inspection of any director, trustee, stockholder or member of the
corporation at reasonable hours on business days and he may demand, in
writing, for a copy of excerpts from said records or minutes, at his expense.
The statute gives the shareholder or member the right to inspect the
records and books of the corporation "at reasonable hours." The corporation
cannot unreasonably restrict his right, on this matter, nor shorten the period upon
which the right to inspect may be availed of by a stockholder.
In Pardo v. Hercules Lumber Co.,119 the corporate secretary refused to
permit petitioner or his agent to inspect the records and business transactions of
the company at times desired by the petitioner. The basis of the refusal was the
provision in the company's by-laws which declared that every stockholder may
examine the books of the company and other documents pertaining to the same
upon the days which the board of directors shall annually fix.
The Court held that the resolution of the board of directors of a corporation
limiting the rights of stockholders to inspect its records to a period of ten (10)
days shortly prior to the annual stockholders meeting is an unreasonable
restriction given by Section 51 of the Corporation Law, which declares that the
right to inspection can be exercised "at reasonable hours." This was interpreted
to mean that the right of inspection may be exercised at reasonable hours on
business days throughout the year, and not merely during an arbitrary period of a
few days chosen by the directors.

4. Who May Exercise Right to Inspect

Only shareholders, members, directors and trustees of record can inspect
the records of the corporation. They can, of course, avail of this right in person or
by representative.
W.G. Philpotts v. Phil. Manufacturing Corp.,120 declared that a stockholder
has the right to exercise his right of inspection of corporate records either in
person or by some authorized agent or attorney, to inspect and examine records
of the corporation, in conformity with the general rule that what a man may do in
person he may do through another.

of the corporation, it earnings for the year, its existing retained earnings, and investments of
corporate funds.
118
Sec. 26, Corporation Code.
119
47 Phil 964 (1924).
120
40 Phil 471 (1919).
 The right may be regarded as personal, in the sense that only
stockholders may enjoy it; but the inspection and examination may be made by
another. Otherwise, it would be unavailing in many instances. The stockholders
may be aided by experts and counsel, so as to make the inspection valuable to
them.

5. Nature and Scope of Right to Inspect

Gokongwei, Jr. v. Securities and Exchange Commission, 121 has held that
"where the right [to inspect] is granted by statute to the stockholder, it is given to
him as such and must be exercised by him with respect to his interest as a
stockholder and for some purpose germane thereto or in the interest of the
corporation. In other words, the inspection has to be germane to the petitioner's
interest as a stockholder, and has to be proper and lawful in character and not
inimical to the interest of the corporation."122
At common law, stockholders had a right to inspect the corporate records
at reasonable hours. The statute explicitly recognizes this important right and
provides that the records of all business transactions of the corporation and
minutes of any meeting "shall be open to the inspection of any director, member
or stockholder of the corporation at reasonable hours.” The same right exists with
reference to stock and transfer books.
The general rule outlined under Section 74 of the Corporation Code is that
a stockholder has a right to inspect the books and papers of the corporation at
reasonable hours without need of showing any act of mismanagement,
defraudation, or such cause as would render the examination proper.
However, the same section does not consider the exercise of the right to
inspect to be absolute and it may be denied. The corporation may show, and it
seems that it has the burden of proof, that the purpose of the stockholder is
improper, by way of defense. This in line with the rule laid down by Gokongwei,
Jr. v. Securities and Exchange Commission,123 that the "weight of judicial opinion
appears to be, that on application for mandamus to enforce the right, it is proper
for the court to inquire into and consider the stockholder's good faith and his
purpose and motives in seeking inspection . . . But the `impropriety of purpose
such as will defeat enforcement must be set up [by] the corporation defensively if
the Court is to take cognizance of it as a qualification. In other words, the specific
provisions take from the stockholder the burden of showing propriety of purpose
and place upon the corporation the burden of showing impropriety of purpose or
motive."124
In Veraguth v. Isabela Lumber Company,125 the Court held that directors
of a corporation have the unqualified right to inspect the books and records of the

121
89 SCRA 336 (1979).
122
Ibid, at pp. 384-385.
123
89 SCRA 336 (1989).
124
Ibid, at p. 384.
125
57 Phil 266 (1932).
corporation at all reasonable times. Pretexts may not be put forward by the
officers of a corporation to keep a director or stockholders from inspecting the
books and minutes of the corporation, and the right of inspection cannot be
denied on the grounds that the director or stockholders is on unfriendly terms
with the officers of the corporation whose records are sought to be inspected.
Nevertheless, the Court also held that a director or stockholders has no absolute
right to secure certified copies of the minutes of a corporation until these minutes
have been written up and approved by the directors.
The proviso in Section 74 of the Corporation Code makes the prevailing
rule now to be that the motive of the stockholder in requesting to inspect the
corporate records material. Africa v. PCGG,126 clearly interprets Section 74 of the
Corporation Code as to have placed the right of inspections to be subject to three
limitations:

(a) The right of inspection should be exercised at reasonable

hours on business days;
(b) The person demanding the right to examine and copy
excerpts from the corporate records and minutes has not
improperly used any information secured through any
previous examination of the records of such corporation; and
(c) The demand is made in good faith or for a legitimate
purpose.

In fact, Gonzales v. Philippine National Bank,127 in contrasting the present

language of Section 74 of the Corporation Code to that of Section 51 of the old
Corporation Law, held that while the present provision seemingly enlarges the
right of inspection, "the new Code has prescribed limitations to the same. It is
now expressly required as a condition for such examination that the one
requesting it must not have been guilty of using improperly any information
secured through a prior examination, and that the person asking for such
examination must be `acting in good faith and for a legitimate purpose in making
his demand.'" The Court held that the "unqualified provision on the right of
inspection previously contained in Section 51 [of the Corporation Law] no longer
holds true under the provisions of the present law."
Gonzalez also held that it is the stockholder seeking to exercise the right
of inspection to set forth the reasons and the purposes for which he desires such
inspection. In that case, the purpose of the stockholder in seeking inspection of
corporate records of the bank to arm himself with materials which he can use
against the respondent bank for acts done by the latter when the petitioner was a
total stranger to the same, were not deemed proper motives.

126
205 SCRA 39, 41 (1992). The Supreme Court held that even the stockholders of
sequestered shares is not deprived of his proprietary right to inspect corporate records.
127
122 SCRA 489 (1983).
 Finally, Republic v. Sandiganbayan,128 held that "[w]hile it may be true that
the right to inspections granted by Section 74 of the Corporation Code is not
absolute, as when the stockholder is not acting in good faith and for a legitimate
purpose . . . or when the demand is purely speculative or merely to satisfy
curiosity . . . [it is still with the corporate officers] to discharge the burden of proof
to show that the private respondent's action in seeking examination of the
corporate records was moved by unlawful or ill-motivated designs which could
appropriately call for a judicial protection against the exercise of such right. Save
for its unsubstantiated allegations, petitioner could offer no proof, nay, not even a
scintilla of evidence that respondent . . . was motivated by bad faith; that the
demand was for an illegitimate purpose or that the demand was impelled by
speculation or idle curiosity. . ."129
Republic therefore reiterated the principle set in Gokongwei that "the
impropriety of purpose such as will defeat enforcement must be set up (by) the
corporation defensively if the Court is to take cognizance of it as a
qualification."130

a. Summary of Doctrinal Rulings on Right to Inspect

The right to inspect by a stockholder, member, director or trustee is
subject to the following doctrinal rulings:

(a) The demand for inspection should cover only reasonable

hours on business days;
(b) The stockholder, member, director or trustees demanding
the exercise of the right is one who has not improperly used
any information secured through any previous examination
of the records of the corporation or any other corporation;
(c) The demand must be accompanied with statement of the
purpose of the inspection, which must show good faith or
legitimate purpose; and
(d) If the corporation or its officers contest such purpose or
contend that there is evil motive behind the inspection, the
burden of proof is with the corporation or such officer to
show the same.

In an opinion,131 the SEC has succinctly summarized the legal basis and
the extent of the right to inspect:

128
199 SCRA 39 (1991).
129
Ibid, at p. 47.
130
199 SCRA 39 (1991); Gokongwei, Jr. v. Securities and Exchange Commission, 89
SCRA 336 (1979).
131
SEC Opinion, 14 September 1998, XXXIII SEC QUARTERLY BULLETIN 23 (No. 1, June,
1999).
 The right of the stockholders to inspect the corporate
books and records is based on the principle that a stockholder
has the right to be fully informed as to the status and condition
o the corporation, the manner its affairs are conducted and
how its capital to which they have contributed is employed or
managed. Said right may be exercised either by himself or by
any proper representative or attorney-in-fact, who may be an
accountant or a lawyer or any other person who can help the
stockholder understand and interpret the corporate records,
and either with or without the attendance of the stockholder.
The right to inspect is not absolute and the corporation may
show in defense that the stockholder is acting from wrongful
motives, since the exercise of the right to inspect should be for
a legitimate purpose, which means that it must be germane to
the interest of the stockholder as such, as where the purpose
is to find out the actual financial condition of the corporation
and how his investment is being used. Likewise, the purpose
should not be contrary to the interest of the corporation nor
should it be made merely to gratify a stockholder‟s curiosity.

6. Purposes for Inspection

The propriety or impropriety of the demand should be determined by
balancing the individual interest of the demanding shareholder against the
interest of the corporation as a whole and all the other shareholders among the
interest that would ordinarily be held proper are:

(a) To ascertain whether the corporation is being

mismanaged;
(b) To ascertain the financial condition of the
corporation;
(c) To ascertain the value of shares of stocks for sale
or investment;
(d) To obtain a mailing list of shareholders to solicit
proxies or influence voting, in anticipation of
shareholders' meeting.

Purposes which may warrant denial of the right of inspection, because the
purpose is improper, are as follows:

(a) To obtain information as to business secrets or to assist a

reveal business secrets;
(b) To secure business "prospects" or investment of advertising
lists, as where the shareholder seeks the list of shareholder
for the purpose of selling it to an advertising agency;
 (c) To find technical defects in corporate transactions in order to
bring "nuisance" or "strike suits" for purpose of blackmail or
extortion;
(d) To obtain information intended to be published so as to
embarrass the company business, depress the value of its
assets, and cause loss to stockholders; or where the
purpose is to create demoralization and dissension among
the shareholders and by depressing the value of shares, be
able to deal with them profitably, at their expense.

7. Remedies If Inspection Denied

a. Mandamus
Where the corporation has not established the impropriety of the
shareholder's request to inspect the records of the corporation, but the
corporation still refuses to allow the shareholder, member, director or trustee the
right to inspect, the right may be enforced by mandamus.

b. Damages
The stockholder or member who was wrongfully denied such right may
also file, in the same action, for damages against the director, trustee,
shareholder or member who denied him the right.

c. Criminal Suit
The stockholder or member who was wrongfully denied his right of
inspection may also bring criminal suit against the offending officer punishable
under Section 144 of the Corporation Code.
Under Section 74 of the Corporation Code, any officer or agent of the
corporation who shall refuse to allow any director, trustee, stockholder or
member of the corporation to examine and copy excerpts from its records or
minutes, in accordance with the provision of this Code, shall be liable to such
director, trustee stockholder or member for damages, and in addition, shall be
guilty of an offense which shall be punishable under Section 144 of the
Corporation Code. If such refusal is pursuant to a resolution or order of the board
of directors or trustees, the liability under this section for such action shall be
imposed upon the directors or trustees who voted for such refusal.

d. Procedural Rules on Suits Brought

The specific rules governing suits covering the inspection of corporate
books and records are now provided under Rule 7 of the Interim Rules of
Procedure Governing Intra-Corporate Controversies.
The suits involving the rights of stockholders or members to inspect the
books and records and/or be furnished with financial statements of a corporation
are summary in nature, with the trial courts mandated within two (2) days from
the filing of the complaint, upon a consideration of the allegations thereof, to
dismiss the complaint outright if it is not sufficient in form and substance, or, if it
is sufficient, order the issuance of summons which shall be served, together with
a copy of the complaint, on the defendant within two (2) days from its issuance;
and the defendant having a period of ten (10) days within which to file an answer.
The parties are mandated to attach to their pleadings, the affidavits of witnesses,
documentary and other evidence in support thereof. The courts are required to
render a decision based on the pleadings, affidavits and documentary and other
evidence within fifteen (15) days from receipt of the last pleading; and the
decisions are immediately executory.

8. Who May Be Held Liable

The corporate officer who has in his custody the books and paper sought
to be inspected, and refuses to allow inspection. If the refusal is pursuant to a
resolution or order of the board of directors or trustees, then the directors or
trustees who voted for such refusal shall be held liable

9. Defenses Available to Director,

Trustee or Officer Held Liable
The following defenses are expressly recognized under Section 74 as
defenses available to a director, trustee or officer for refusing to allow a
stockholder or member to exercise his right to inspect corporate records:

(a) The person demanding to examine has improperly used any

information secured through any prior examination of the
records or minutes of such corporation or for any other
corporation; or
(b) The one requesting to inspect was not taking in good faith or
for a legitimate purpose in making his demand.

10. Right to Inspect Covers Controlled Subsidiaries

In Gokongwei, Jr. v. Securities and Exchange Commission, 132 the
petitioner, a major shareholder of San Miguel Corporation (SMC), sought to
exercise his right to inspect the books and records of SMC International, a
foreign subsidiary wholly owned and controlled by SMC. Since the petitioner was
not a stockholder of record of the subsidiary, he was denied his request for
inspection of books of the subsidiary corporation.
The Supreme Court upheld the right of the petitioner to be allowed to
examine the records of the subsidiary company. It held that the shareholder's
right of inspection of the corporation's books and records is based upon their
ownership of the assets and properties of the corporation. It is therefore an

132
89 SCRA 336 (1979).
incident of ownership of the corporate property, whether his ownership or interest
be termed an equitable ownership, a beneficial ownership or a quasi-ownership.
The Court took into consideration the fact that the foreign subsidiary is
wholly-owned by SMC and therefore, under its control, it would be more in
accord with equity, good faith and fair dealing to construe the statutory right of
petitioner as shareholder to inspect the books and records of the corporation as
extending to books and records of such wholly-owned subsidiary which are in
SMC's control.

APPRAISAL RIGHT
1. Nature of Appraisal Right
Appraisal right refers to a stockholder‟s right to demand payment of the
fair value of his shares, after dissenting from a proposed corporate action
involving a fundamental change in the corporate setting, in the specific cases
provided for in the Corporation Code.
The appraisal right is given to a stockholder in a particular situation where
there has been a radical change in the contractual relationship presumably
agreed upon between the stockholder and the corporation, a change which the
dissenting stockholder could not have reasonably anticipated may happen at the
time he invested into, or created his contractual relationship with, the corporation.

2. Who Is Entitled to the Exercise

A prejudiced stockholder may exercise such right. A prejudiced
stockholder is one who dissented in the meeting where the proposal or proposed
amendment was approved. The stockholder must have voted against the
corporation transaction in order to avail of the appraisal right. Mere silence or
abstention does not entitle such stockholder to the exercise of the right.

3. Instances When Right is Exercisable

Sections 37, 42 and 81 of the Corporation Code enumerate the instances
when a stockholder may exercise his appraisal right, thus:

(a) In case any amendment to the articles of incorporation has

the effect of changing or restricting the rights of any
stockholder or class of shares, or of authorizing preferences
in any respect superior to those of outstanding shares of any
class;
(b) In case of extending or shortening the term of corporate
existence;
(c) In case of sale, lease, exchange, transfer, mortgage, pledge
or other disposition of all or substantially all of the corporate
property and assets;
 (d) In case the corporation decides to invest its funds in another
corporation or business outside of its primary purpose; and
(e) In case of merger or consolidation.

Although Section 81 expressly allows the exercise of appraisal right even

in case of shortening of corporate term, nevertheless, Section 37, governing the
extension or shortening of corporate life, provides for appraisal right only "in case
of extension of corporate term."

4. How Right Exercised

The appraisal right may be exercised by any stockholder who shall have
voted against the proposed corporate action, by making a written demand on the
corporation within thirty (30) days after the date on which the vote was taken for
payment of the fair value of his shares.133 The failure to make the demand within
such period shall be deemed a waiver of the right.134

5. Effect of Demand for Payment

From the time of demand for payment of the fair value of stockholder's
shares, until either the abandonment of the corporate action involved or the
purchase of the said shares by the corporation, all rights accruing to such shares,
including voting and dividend rights, shall be suspended, except the right of such
stockholder to receive payment of the fair value thereof. If the dissenting
stockholder is not paid the value of his shares within thirty (30) days after the
award, his voting and dividend rights shall immediately be restored.135

6. Notation on Certificates; Right of Transferee

Within ten (10) days after demanding payment for his shares, a dissenting
stockholder shall submit the certificate(s) of stock representing his shares to the
corporation for notation thereon that such shares are dissenting shares. Reason
for the surrender of the certificate so that it may be marked by the corporation as
a dissenting stock. His failure to do so shall, at the option of the corporation,
terminate his appraisal right.136
If shares represented by the certificates bearing such notation are
transferred, and the certificates consequently cancelled, the rights of the
transferor as a dissenting stockholder shall cease and the transferee shall have
all the rights of a regular stockholder; and all dividend distributions which would
have accrued on such shares shall be paid to the transferee.137

133
Sec. 82, Corporation Code.
134
Ibid.
135
Sec. 83, Corporation Code.
136
Sec. 86, Corporation Code.
137
Ibid.
 7. How Payment of Fair Value Effected
If the proposed corporate action is implemented or effected, the
corporation shall pay to such stockholder, upon the surrender of the certificates
of stock representing his shares, the fair value thereof as of the day prior to the
date on which the vote was taken, excluding any appreciation or depreciation in
anticipation of such corporate action.138 The formula is given to prevent
speculation in view of the pending action; because of certain action that will be
taken, it is possible that others dissent in order to gain an advantage where the
majority took a risk.
If within a period of sixty (60) days from the date the corporate action was
approved by the stockholders, the withdrawing stockholder and the corporation
cannot agree on the fair value of the shares, it shall be determined and appraised
by three (3) disinterested persons, one of whom shall be named by the
stockholder, another by the corporation, and the third by the two thus chosen. 139
The law does not say for how long or within what period the board of appraisers
may determine the price of the shares.
The findings of the majority of the appraisers shall be final, and their
award shall be paid by the corporation within thirty (30) days after such award is
made.140
Upon payment by the corporation of the agreed or awarded price, the
stockholder shall forthwith transfer his shares to the corporation.141

8. Existence of Unrestricted Retained Earnings

No payment shall be made to any dissenting stockholder unless the
corporation has unrestricted retained earnings in its books to cover payment.142
The lack of unrestricted retained earnings in the books of the corporation
is not enumerated as one of the grounds when the right ceases. However, in
case payment cannot be made because the corporation has no available
unrestricted retained earnings in its books, then the provisions of Section 83 of
the Corporation Code would come into play "[t]hat if the dissenting stockholder is
not paid the value of his shares within 30 days after the award, his voting and
dividend rights shall immediately be restored.”

9. When Right to Payment Ceases

No demand for payment by way of exercise of appraisal right may be
withdrawn unless the corporation consents thereto.143

138
Sec. 82, Corporation Code.
139
Ibid.
140
Ibid.
141
Ibid.
142
Ibid.
143
Sec. 84, Corporation Code.
 In the following cases, even when such demand has been made, it can be
withdrawn by the dissenting stockholder:

(a) If such demand for payment is withdrawn with the consent of

the corporation;
(b) If the proposed corporate action is abandoned, or rescinded
by the corporation;
(c) If the proposed corporate action is disapproved by the SEC
where such approval is necessary;
(d) If the SEC determines that such shareholder is not entitled to
appraisal right.

In cases where the exercise of the appraisal right is withdrawn or deemed

withdrawn, then the right of said shareholder to be paid the fair value of his
shares shall cease, his status as a shareholder shall thereupon be restored, and
all dividend distributions which would have accrued on his shares, shall be paid
to him.144

10. Party Who Bears Cost of Appraisal

The costs and expenses of appraisal shall be borne by the corporation,
unless the fair value ascertained by the appraisers is approximately the same as
the price which the corporation may have offered to pay the shareholder, in
which case they shall be borne by the latter. In the case of an action to recover
such fair value, all costs and expenses shall be assessed against the
corporation, unless the refusal of the shareholder to receive payment was
unjustified.145

11. Denial of Appraisal Right

May the right be denied in the articles of incorporation? Is a contractual
stipulation in the articles of incorporation waiving the appraisal right void?
Rights granted by law can be waived individually, unless such waiver
would contravene public policy. Therefore, when it is waived without the
dissenting stockholder's consent, such as when it is defeated by provisions in the
articles of incorporation, then it will be violative of public policy. But when an
individual, who is already a stockholder, who is not constrained to waive because
he is already a stockholder enters into a contract knowingly, intelligently waiving
his appraisal right, such waiver is not void.
An article or by-law provision may be void because it goes against public
policy. If anybody becomes a part of the corporation, in fact, he is forced to
accept the article or by-law provisions as they are. But when he is already a

144
Ibid.
145
Sec. 85, Corporation Code.
member of the corporation, he need not waive, because there is really no
compulsion for him to waive except for valuable consideration.

12. Statutory Attitude Towards Appraisal Right

From its applicable provisions, it would seem that the Corporation Code
looks with certain disfavor on the exercise of the appraisal right. In the
procedures given by the Code on the exercise of the right, certain positive steps
must be taken by the dissenting stockholder along the way, otherwise he loses
his right. In addition, even when the dissenting stockholder has complied with all
the steps required of him by the Code, there must be available unrestricted
retained earnings for even his right of payment to be granted.
For example, where the corporation decides to embark upon a venture,
where prior to the amendment of the articles of incorporation, there was only one
class of shares, say common stocks, then in order for the corporation to attract
financing or working capital where common stocks may not be able compete
effectively with other forms investments such as Treasury bills, then the
corporation may find it necessary to create preferred shareholdings. In order to
create preferred stocks, it must amend the articles of incorporation, which can be
achieved only with the ratification of stockholders owning or representing two-
thirds (2/3) of the outstanding capital stock. If say one-third (1/3) of the
outstanding capital stock dissent, and by dissenting, the dissenting shareholders
will exercise their appraisal rights, the corporation would them have to pay for the
value of the shares of the dissenting shareholders. The corporation would find
itself in worse financial position.
The treatment of the appraisal right can be appreciated from the fact that
the exercise thereof has the direct effect of diverting resources from corporate
coffers and may have serious financial implications on the operations or even
survival of the corporation. Such bias against the appraisal right may be
appreciated from the fact that since the essence of shares of stock in their free-
transferability, then the appropriate remedy of a dissenting stockholder would be
to dispose of his shareholdings in the corporation.

13. Emerging Significance of Existence of Appraisal Rights

Under Section 1, Rule 1 of the Interim Rules of Procedure Governing
Intra-Corporate Controversies, made effective by the Supreme Court on 1 April
2001, the “[a]vailability of appraisal rights for the act or acts complained of,” shall
be considered by the courts in determining whether a suit is a nuisance or
harassment suit.”
The exercise of the right of appraisal in cases when it is granted by
statutory provisions in considered under procedural law as the main remedy
available to dissenting stockholders, rather than bringing suits to enjoin corporate
acts approved by the required majority vote of stockholders.
DERIVATIVE SUITS
The legal standing of stockholders to bring derivative suits for and in
behalf of their corporation, is not a civil law right; in fact, the Corporation Code
contains no provision recognizing or regulating the filing of derivative suits. It is a
common law right of stockholders and members; it exists by virtue of Philippine
jurisprudence adopted from Anglo-American jurisprudence.
Angeles v. Santos,146 discussed the common law basis of the right of a
stockholder to bring a derivative suit on behalf of the corporation, thus:

The board of directors of a corporation is a creation of

the stockholders and controls and directs the affairs of the
corporation by delegation of the stockholders. But the board of
directors, or majority thereof, in drawing themselves the
powers of the corporation, occupies a position of trusteeship in
relation to the minority of the stock in the sense that the board
should exercise good faith, care and diligence in the
administration of the affairs of the corporation and should
protect not only the affairs of the majority but also those of the
minority of the stock. Where a majority of the board of
directors wastes or dissipates the funds of the corporation or
fraudulently disposes of its properties, or performs ultra vires
acts, the courts, in the exercise of its equity jurisdiction, and
upon showing that intra-corporate remedy is unavailing, will
entertain a suit filed by the minority members of the board of
directors, for and in behalf of the corporation, to prevent waste
and dissipation and the commission of a illegal acts and
otherwise redress the injuries of the minority stockholders
against the wrongdoings of the majority.147

In another case, 148 it was held that an individual stockholder is permitted

to institute a derivative suit on behalf of the corporation wherein he helds stock in
order to protect or vindicate corporate rights, whenever the officials of the
corporation refuse to sue, or are the ones to be sued or hold control of the
corporation. In such actions, the suing stockholder is regarded as a nominal
party, with the corporation as the real party in interest.
Lately, in Bitong v. Court of Appeals,149 the Supreme Court summarized
the nature and basis of the right of stockholders to bring a derivative suit on
behalf of the corporation, thus:

It is well settled in this jurisdiction that where corporate

directors are guilty of a breach of trust, not of mere error of

146
64 Phil. 697 (1937).
147
Ibid, at p. 706.
148
First Philippine International Bank v. Court of Appeals, 252 SCRA 259, 67 SCAD 196
(1996).
149
292 SCRA 503, 96 SCAD 205 (1998).
 judgment or abuse of discretion, and intracorporate remedy is
futile or useless, a stockholder may institute a suit in behalf of
himself and other stockholders and for the benefit of the
corporation, to bring about a redress of the wrong inflicted
directly upon the corporation and indirectly upon the
stockholders. The stockholder‟s right to institute a derivative
suit is not based on any express provision of the Corporation
Code but is impliedly recognized when the law makes
corporate directors or officers liable for damages suffered by
the corporation and its stockholders for violation of their
fiduciary duties.
Hence, a stockholder may sue for mismanagement,
waste or dissipation or corporate assets because of a special
injury to him for which he is otherwise without redress. In
effect, the suit is an action for specific performance of an
obligation owed by the corporation to the stockholders to
assist its rights of action when the corporation has been put in
default by the wrongful refusal of the directors or management
to make suitable measure for its protection.
The basis of a stockholder‟s suit is always one in equity,
However, it cannot prosper without first complying with the
legal requisites for its institution. The most important of these
is the bona fide ownership by a stockholder of a tock in his
own right at the time of the transaction complained of which
invests him with standing to institute a derivative action for the
benefit of the corporation.

1. Definition
A derivative suit is one which is instituted by a shareholder or a member of
a corporation, for and in behalf of the corporation for its protection from acts
committed by directors, trustees, corporate officers, and even third persons.
Western Institute of Technology, Inc. v. Salas,150 held that “[a] derivative
suit is an action brought by minority shareholders in the name of the corporation
to redress wrongs committed against the corporation, for which the directors
refuse to sue. It is a remedy designed by equity and has been the principal
defense of the minority shareholders against abuses by the majority.”

2. Requisites For Filing of Derivative Suit

San Miguel Corp. v. Kahn,151 discussed and put together the requisites for
a proper derivative suit, which requisites used to be scattered in various
decisions of the Supreme Court, thus:

150
278 SCRA 216, 86 SCAD 315 (1997).
151
176 SCRA 447 (1989).
 (a) The party bringing suit should be a shareholder as of the
time of the act or transaction complained of, and at the time
of the filing of the suit, the number of his shares not being
material;152
(b) The party has tried to exhaust intra-corporate remedies, i.e.,
has made a demand on the board of directors for the
appropriate relief, but the latter has failed to refused to heed
his plea;153 and
(c) The cause of action actually devolves on the corporation, the
wrongdoing or harm having been, or being caused to the
corporation and not to the particular stockholder bringing the
suit.154

3. Proper Party to Bring Derivative Suit

San Miguel Corp., in discussing the first requisite, held that the "bona fide
ownership by a stockholder of stock in his own right suffices to invest him with
standing to bring a derivative action for the benefit of the corporation. The
number of his shares is immaterial since he is not suing in his own behalf, or for
the protection or vindication of his own particular right, or the redress of a wrong
committed against him, individually, but in behalf and for the benefit of the
corporation."155
Unfortunately, in laying down the first requisite of proper party, San Miguel
included the qualification "the party bringing suit should be a shareholder as of
the time of the act or transaction complained of." This therefore includes the
ruling in Pascual v. Orozco,156 that the relator in a derivative suit must have been
a stockholder of the corporation both at the time the cause of action took place
and at the time of suit.
In Pascual a minority stockholder of a corporation brought a suit for and in
behalf of the corporation against the board of directors. The articles of
incorporation provided that the compensation of the directors comprises a certain
percentage of the net income of the corporation. But the directors, instead of
determining the compensation from the net income, used as basis the gross
income which resulted in losses to the corporation. But petitioner's cause of
action covered the period when he was not yet a stockholder of the corporation.
The Supreme Court held that a stockholder of a corporation who was not
such at the time when alleged objectionable transaction took place, or whose
shares of stocks have not since devolved upon him by operation of law, cannot

152
Citing Pascual Orozco, 19 Phil. 82; Republic v. Cuaderno, 19 SCRA 671.
153
Citing Everett v. Asia Banking Corporation, 49 Phil. 512 (1926); Angeles v. Santos, 64
Phil. 697 (1937).
154
Citing Evangelista v. Santos, 86 Phil. 387 (1950).
155
176 SCRA 463.
156
19 Phil 83 (1911).
maintain suits of this character, unless such transactions continue and are
injurious to such stockholder or affect him especially or specifically in some other
way.
A close reading of Pascual would clearly show that the rationale for the
rule was that there is in the in the United States jurisdiction, two sets of court
system—the federal judicial system and the state judicial systems. In order to
prevent forum shopping, the rule in the United States is such that when a
derivative suit is brought it is essential that the relator should have been a
stockholder both at the time the act complained of occurred and at the time the
derivative suit is filed. The prevailing rule then was that a shareholder who was
one at the time of the institution of the action may bring a derivative suit. It was
then quite easy and in fact possible to bring a suit out of state court and bring it to
federal court by just making sure that you transfer a share to someone outside of
the state. If the suit is filed in California, what can be done is transfer one share
to a resident of Florida to grant federal courts jurisdiction. In order to correct this
collusion, the requisite was imposed that the relator must be a shareholder at the
time the cause of action accrued.
The ruling is Pascual needs to be critically reviewed and perhaps set-
aside altogether. There seems to be little basis under Philippine laws to require
that relator was a stockholder only at the time of the institution of the action but
not at the time the cause of action accrued when it is the corporation that is really
the interested party. The main consideration in Pascual of forum-shopping holds
no merit under Philippine jurisdiction which does not have separate federal-states
sets of judicial system.
The ruling in Pascual, however provided that "[a] stockholder in a
corporation who was not such at the time when alleged objectionable
transactions took place, or whose shares of stock have not since devolved upon
him, by operation of law, cannot maintain suits of this character, unless such
transaction continue and are injurious to such stockholder or affect him especially
or specifically in some other way."157 Therefore, a person who was not a
stockholder at the time the cause of action accrued may bring a derivative suit
when the covered transactions continue and are injurious to such shareholder or
affect him especially or specifically in some other way. However, such
stockholder may not institute the derivative suit:

(a) If the transferor, when he had the chance or right to

constitute the derivative suit when he was still the
shareholder, did not do so, then his transferee cannot
institute the derivative suit himself. If the transferor is
estopped, then the transferee must also be estopped; or
(b) It is possible that the transferor himself, was part of the fraud
against the corporation, therefore, you cannot expect him to

157
Ibid, at p. 99.
 bring an action for and in behalf of the corporation, then the
transferee cannot also institute the derivative suit.

Nevertheless, even such reasoning should not prevail if we consider that

the main purpose of the derivative suit is to protect the interest of the corporation.
An individual shareholder may institute a derivative suit behalf of the corporation,
wherein he holds stock, in order to protect or vindicate corporate rights whenever
the officials of the corporation refuse to sue, or are the ones to be sued or hold
control of the corporation. In such actions, the suing shareholder is regarded as a
nominal party, with the corporation as the real party in interest.

a. Requirements under Interim Rules

Under Section 1, Rule 8 of the Interim Rules of Procedure for Intra-
Corporate Controversies,158 no derivative action or claim shall be brought by a
stockholder or member in the name of the corporation unless the following
requisites are complied with:

(a) The plaintiff was a stockholder or member at the time the

questioned act or transaction subject of the action occurred,
as well as at the time the action was filed, and “remains as
such during the pendency of the action;”
(b) The plaintiff exerted all reasonable efforts, and alleges with
particularity in the complaint, to exhaust all remedies
available under the articles of incorporation, by-laws, laws or
rules governing the corporation to obtain the relief he
desires;

(c) No appraisal rights are available for the act or acts

complained of; and

(d) The suit is not a nuisance or harassment suit.

As will be noticed from the Interim Rules, they not only maintain the
jurisprudential requirements for “standing” of the relator, but require specifically
that during the pendency of the suit, the relator maintains his shareholdings in
the corporation, which does not conform to the procedural rule that jurisdiction of
the tribunal is determined by the alleged facts at the time of the filing of the
petition or complaint.
In addition, the Interim Rules provide that a derivative action shall not be
discontinued, compromised or settled without the approval of the court, which
shall determine that the interests of the stockholders or members, will be
substantially affected by the discontinuance, compromise or settlement, and that

158
Formally adopted by the Supreme Court in February 2001, pursuant to the transfer of the
quasi-judicial powers of the SEC to the RTC under the Securities Regulation Code.
the court may direct that notice be given, by publication or otherwise, to the
stockholders or members whose interests it determines will be so affected.
The Interim Rules seem to presume that a derivative action is for the
benefit of the stockholders or members of the corporation, when jurisprudence
has ruled that a derivative action is essentially for the benefit of the corporation
as a separate juridical entity.

4. Exhaustion of Intra-corporate Remedies

The general rule is that a derivative suit can only be filed when there has
been a showing of exhaustion of intra-corporate remedies. Exhaustion of intra-
corporate remedy is not only a procedural rule but also a substantive rule. In
order for the petition to be complete and proper, this must be alleged specifically.
The exception to the requirement of exhaustion of intra-corporate
remedies is when exhaustion would be futile or useless because the board itself
would not bring the suit for the reason that they are also guilty or part of the fraud
committed against the corporation.
In Republic Bank v. Cuaderno,159 the petitioner brought a derivative suit in
behalf of the corporation against the officers and the board of directors. The
complaint alleged that the directors approved a resolution granting excessive
compensation to officers of the corporation. The suit was filed in order to prevent
dissipation of the corporate funds for the payment of the salary of said officers.
The board of directors claimed that the action cannot prosper for failure to
compel the board of directors to file a suit for and in behalf of the corporation.
The Court held that such a suit need not be authorized by the corporation
where its objective is to nullify the action taken by its manager and the board of
directors, in which case any demand for intra-corporate remedy would be futile.

a. Laches by Inaction of Directors

Where the corporation is virtually immobilized from commencing suit
against its directors such as when the board of directors, under the by-laws of the
corporation, had the control of the affairs of the corporation, laches does not
begin to attach against the corporation until the directors cease to be such.160

5. Grounds for Derivative Suit

In one case,161 the Supreme Court held that for a derivative suit to
prosper, it is required that the minority shareholder who is suing for and on behalf
of the corporation must allege in his complaint before the proper forum that he is
suing on a derivative cause of action on behalf of the corporation and all other
shareholders similarly situated who wish to join.

159
19 SCRA 671 (1967).
160
Central Cooperative Exchange, Inc. v. Tibe, Sr., 33 SCRA 593,598 (1970).
161
Western Institute of Technology, Inc. v. Salas, 278 SCRA 216, 86 SCAD 315 (1997).
 a. Wastage and Diversion of Corporate Funds
It may be considered a wastage or diversion of corporate funds to hire
officers and appoint directors whose main purpose is to shield the chairman from
criminal prosecution.
Republic v. Cuaderno,162 held that a "stockholder in a banking corporation
has a right to maintain a suit for and on behalf of the corporation, but the extent
of such right depends upon when and for what purpose he acquired the shares of
stock of which he is the owner."

. . . There is no denying that the facts thus pleaded in the

complaint constitute a cause of action for the bank: if the
questioned appointment were made solely to protect Roman
from criminal prosecution, by a Board composed by Roman's
creatures and nominees, then the moneys disbursed in favor
of Cuaderno and Dizon, would be an unlawful wastage or
diversion of corporate funds, since the Republic Bank would
have no interest in shielding Roman and the directors in
approving the appointments would be committing a breach of
trust; the Bank, therefore, could sue to nullify the
appointments, enjoin disbursement of its funds to pay them,
and recover those paid out for the purpose, as prayed for in
the complaint in this case.163

b. Violation of Laws
Reyes v. Tan,164 also gave a valid basis the violation of laws allowed by
the board as basis for a derivative suit. The Court held that where the director of
the corporation permitted the fraudulent transaction to go unpunished by allowing
the importation of finished textile instead of raw cotton for the textile mill, and
nothing appears to have been done to remove the erring purchasing managers,
the appointment of receiver may have been thought of by the court so that the
dollar allocation for raw material may be reviewed and the textile mill placed on
an operating basis, because it is possible that a receiver in which the Central
Bank may have confidence is appointed, the dollar allocation for raw material
may be restored.

6. Nature of the Reliefs Prayed For

The action must be brought for the benefit of the corporation. In
Evangelista v. Santos,165 the plaintiffs were minority stockholders, who brought a
derivative suit against the principal officer for damages resulting from the
mismanagement of corporate affairs and misuse of corporate assets. The

162
19 SCRA 671 (1967).
163
Ibid, at p. 677.
164
3 SCRA 198 (1961).
165
86 Phil 387 (1950).
complaint prayed for judgment requiring defendant, among others, to pay
plaintiffs the value of their respective participation in said assets on the basis of
the value of the stocks held by each of them.
The Court held that the suit would not prosper. The stockholders brought
the action not for the benefit of the corporation but for their own benefit since they
asked that the defendant make good the losses occasioned by his
mismanagement and pay them the value of their respective participation in the
corporate assets on the basis of their respective holdings. The Court held that
the relief sought could not be done until all corporate debts, if there be any, are
paid and the existence the corporation terminated by the limitation of its charter
or by lawful dissolution.
Since it is the corporation which is the real party in interest, then the reliefs
prayed for must be for the benefit or interest of the corporation. When the reliefs
prayed for do not pertain to the corporation, then it is an improper derivative suit.

7. Appointment of Receiver
Chase v. CFI of Manila,166 held that in addition to the right to file a
derivative suit, a shareholder, in order to ensure that during the pendency of the
derivative suit, the corporation is ran properly, he can also ask for the
appointment of a receiver to take management away from the board and instead
place it in the hands of a receiver. The power of the court to appoint a receiver in
a derivative suit was reiterated in Reyes v. Tan.167
The Chase doctrine now finds statutory implementation in Pres. Decree
902-A which grants the SEC the power to appoint on its own or by petition a
receiver or a management committee as ancillary to the exercise of exclusive
jurisdiction over corporations.

8. Proper Forum for Derivative Suit

The proper forum for a derivative suit used to be with SEC under Section
5(b) of Pres. Decree 902-A;168 however, pursuant to Section 5.2 of the Securities
Regulation Code169 all intra-corporate disputes under Section 5 of Pres. Decree
902-A have been transferred to the jurisdiction of the Regional Trial Courts
(RTC).

9. Business Judgment Rule

If the corporation suffers losses by virtue of a corporate act, or a negligent
act, is it the duty of the director to bring an action to recover damages? Must
every wrong done or inflicted upon the corporation be always righted? If the
board of directors fail to take the remedies in order to correct a wrong done to the
166
18 SCRA 602 (1966).
167
3 SCRA 198 (1961).
168
Western Institute of Technology, Inc. v. Salas, 278 SCRA 216, 86 SCAD 315 (1997).
169
Rep. Act 8799 (2000).
corporation, then have they done wrong? All of the issues raised by this
questions go into the determination of the extent of the business judgment rule,
as if affects the right to bring derivative suit.
Sometimes in may be better for the corporation not to seek relief for a
wrong done to it. Since the primary duty of the directors is to increase the net
asset value of the corporation, by deriving profits, certain remedies may actually
cost the corporation more in terms of future profits. Therefore, when wrong is
committed against the corporation, whether to bring a suit for the corporation or
not primarily lies within the discretion and exercise of business judgment of the
board. And consequently, when the board has in the exercise of its business
judgment, decided in good faith that it will not pursue remedies on behalf of the
corporation, then the use of the derivative suit mechanism by the stockholder
would be improper.
It is only when the board itself has the be author of the wrong being done
or having been done to the corporation, where business judgment consideration
are not applicable since in such a conflict situation it can hardly be expected that
the board or its culprit members would be in a position to exercise proper
business judgment to protect the interest of the corporation. In such situation, not
even the exhaustion of intra-corporate remedy is necessary for a stockholder to
bring a derivative suit in behalf of the corporation.
But when the cause of action is against third parties, or against some of
the members of the board, but there remains enough disinterested members for
the board to validly act as a body, the determination on whether to take corporate
action is essentially still within the board of the corporation in the exercise of its
business judgment.
In instances under American jurisprudence, even when all or majority of
the directors were guilty of fraud, they may still prevent a derivative suit, by
invoking the play of proper business judgment under the circumstance. This may
be done by forming a committee to investigate the matters complained of and
give recommendation whether to sue or not. The formation of an independent
committee is a valid exercise of business judgment; and since an independent
committee would be in a position to exercise business judgment, then the filing of
a derivative suit would under such circumstances be improper. At the very least,
there is as yet at that point no exhaustion of intra-corporate remedies, which is a
requirement for the valid filing of a derivative suit.
As a general rule, the findings of the committee binds the corporation. But
in the end, it will always be the court to determine whether the findings are sound
and valid. So even if almost always, the members of the committee owe a
certain allegiance to the appointing board, it is still the court which will determine
the validity of the findings of the committee.
Thus, in Republic Bank v. Cuaderno,170 the issue was raised that the
relators mainly controvert the right to question the appointment and selection of

170
19 SCRA 671, 676 (1967).
defendants Cuaderno and Dizon, which they contend to be the result of
corporate acts with which plaintiff, as stockholder, cannot interfere. The Supreme
Court held that "[n]ormally, this is correct, but Philippine jurisprudence is settled
that an individual stockholder is permitted to institute a derivative or
representative suit on behalf of the corporation wherein he holds stock in order to
protect or vindicate corporate rights, whenever the official of the corporate refuse
to sue, or are the ones to be sued or hold the control of the corporation."
In Reyes v. Tan,171 the complaint was filed by stockholders to appoint a
receiver and recover damages against the directors of the corporation for the
resulting loss of foreign exchange allocation of the corporation due to failure of
the directors to take proper action against the defrauding corporate officer to
violation of Central Bank regulations on importation of textile raw materials. The
Court held that "[i]t is not denied by petitioner that the allocation of dollars to the
corporation for the importation of raw materials was suspended. In the eyes of
the court below, as well in our own, the importation of textiles instead of raw
materials, as well as the failure of the board of directors to take action against
those directly responsible for the misuse of dollar allocations constitute fraud, or
consent thereto on the part of the directors. Therefore, a breach of trust was
committed which justified the derivative suit by a minority stockholder on behalf
of the corporation."172
But in addition in Reyes it was argued that the management has been
changed and the new management has not been afforded a chance to show
what it can do. The Court held: "The supposed new management, alleged as a
ground for the reversal of the order of the court below appointing a receiver, is
not in itself a ground of objection to the appointment of a receiver. The parties
found to be guilty of the fraud, as a cause of which receivership proceeded were
instituted, were the Board of Directors, which took no action to stop the
anomalies being perpetrated by the management. But it appears that
management must have acted directly under orders of the Board of Directors.
The appointment of a new management, therefore, would not remedy the
anomalous situation in which the corporation is found, because such situation
was not due to the management alone but principally because of the direction of
the Board of Directors."173
In Pascual v. Del Saz Orozco,174 the Court held that although the counsel
has not been actually authorized by the board of directors to appear for and in
behalf of the respondent corporation, the fact that counsel is the secretary-
treasurer of the respondent corporation and a member of the board, and that the
other members of the board, the president and his wife, who should normally
initiate the action to protect the corporate properties and interests are the ones to
be adversely affected thereby, a single stockholder under such circumstance
may sue in behalf of the corporation. The ruling was reiterated in Republic v. Phil.

171
3 SCRA 198 (1961).
172
Ibid, at p. 202.
173
at 204-205.
174
19 Phil. 82 (1911).
Resources Dev. Corp.,175 where it was held that counsel as stockholder and
director of the respondent corporation may sue in its behalf and file the
complaint-in-intervention in the proper court.

10. Nuisance Suits

Under Section 1, Rule 8 of the Interim Rules of Procedure Governing
Intra-Corporate Controversies, one of the conditions for filing a derivative suit is
that the “suit is not a nuisance or harassment suit;” otherwise, the court is
authorized to “forthwith dismiss the case.”
Under Section 1(b)(4), Rule 1 of the said Interim Rules, the availability of
appraisal right for the act or acts complained of is an important factor in intra-
corporate suits for the courts to determine whether the suit is a nuisance suit or
one brought for harassment.

WITHDRAWAL OF STOCKHOLDER OR DEMAND FOR DISSOLUTION IN

CLOSE CORPORATIONS
In addition and without prejudice to the other rights and remedies available
to a stockholder, any stockholder of a close corporation may, for any reason,
compel the said corporation to purchase his shares at their fair value, which shall
not be less than their par or issued value, when the corporation has sufficient
assets in its books to cover its debts and liabilities exclusive of capital stock.
However, any shareholder of a close corporation may, by written petition
to the SEC, compel the dissolution of such corporation whenever any of the acts
of the directors, officers of those in control of the corporation is illegal, or
fraudulent, or dishonest, or oppressive or unfairly prejudicial to the corporation or
any stockholder, or whenever corporate assets are being misapplied or wasted.

RIGHT TO PROPORTIONATE SHARE OF

REMAINING ASSETS UPON DISSOLUTION
Under Section 122 of the Corporation Code, except by decrease of capital
stock, and as otherwise allowed in the Code (such as redemption of redeemable
shares provided under Section 8 thereof, and instances when the corporation is
allowed to buy back its shares under Section 41 of the Code), "no corporation
shall distribute any of its assets or property except upon lawful dissolution and
after payment of all its debts and liabilities."
Upon the dissolution of the corporation, after all its obligations have been
settled, the remaining assets are to be distributed among the stockholders or
members in proportion to their shareholdings or interests, in the absence of any
provision to the contrary.

175
102 Phil. 960, 967 (1958).
 —oOo—

CORP. MANUSCRIPT\11-STOCKHOLDERS & MEMBERS\07-30-2002

 CHAPTER 12

CAPITAL STRUCTURES
OF CORPORATIONS

Principles Contrasting Equity Investments from Corporate Debts

Nature of Share from Point of View of the Corporation
Power to Issue Shares
Limitations on Power to Issue Shares
CAPITAL STOCK
CLASSIFICATIONS OF SHARES
Policies on Classifications of Shares
Commons Shares
Preferred Shares
Cumulative and Non-Cumulative Preferred Shares
Entitlement to Preference
Participating and Non-Participating Preferred Shares
Redeemable Shares
Taxability of Redemption of Stock Dividends
Founders' Shares
Which Are Founders’ Shares
Effect When Exclusivity Period Expires
No Par Value Shares
Treasury Shares
Hybrid of Securities
TRUST FUND DOCTRINE
Historical Background
Application of the Doctrine in Philippine Setting
Fraud Theory
Coverage of Trust Fund Doctrine
Concept of “Capital Stock”
Observations
DIVIDENDS
Concepts of Surplus Profits and Retained Earnings
Unrestricted Retained Earnings
Treatment of Paid-In Surplus
Consideration Received for No- Par Value Shares
Discretion of Board to Declare Dividends
Retention of Excess Profits
SEC Rules Governing the Distribution of Excess Profits
Concept of Dividends
Dividends Distinguished from Profits
Cash and Stock Dividends
Property Dividends
Liability of Illegally Received Dividends
Dividend Declarations for Government Corporations
Liquidating Dividends
Acquisition by Corporation of Its Own Shares
QUASI-REORGANIZATION AND OTHER SPECIAL RULES ON SHARES OF STOCK
Use of Reappraisal Value of Assets
Reduction of Capital Stock
Debt-to-Equity Conversions
Special Treatments on Shares
Warrants
Stock Options
Stock Splits
Stock Consolidations
Stock Reclassification and Exchange

——

PRINCIPLES CONTRASTING EQUITY INVESTMENTS

FROM CORPORATE DEBTS
Equity investments and debt contracts are the two basic sources by which
a corporation is able to finance its operations, other than from operational or
transactional income. The choice between equity sourcing and debt sourcing of
working funds represents to the corporation the "cost burden" it has to carry in its
operations.
On the side of the would-be investor to the corporate enterprise, whether
he places the amount as an equity investment or a debt extension would depend
not only on the difference in returns offered between the two types of
"involvement" but also the risks and consequences that each relationship entails.
Although, both equity investments and debt placements in a corporation can be
viewed as investment schemes by which the investor expects a return,
nevertheless, the motivation or impetus involved in each case is different.
Firstly, one who makes an equity placement in a corporation expects that
his returns shall be tied-up with the success or loss of the operations of the
corporation. Therefore, he places his investment ready and willing to take a risk
with management's style of operating the affairs of the corporation. In one case,
the Supreme Court held that “[s]hareholders, both common and preferred, are
considered risk takers who invest capital in the business and who can look only
to what is left after corporate debts and liabilities are fully paid.”1
Since the return of the equity investor is intricately woven into the
business affairs of the corporation, then reciprocally he is given a voice or a say
in management in the sense that he would be entitled to participate in the
election of the board of directors, and also to cast votes on certain corporate
structural matters in those instances enumerated by law when stockholders have
a ratificatory vote on management action. His interests in the operations of the

1
Republic Planters Bank v. Agana, 269 SCRA 1, 80 SCAD 1 (1997).
corporation is also reflected in the retained earnings component of the
stockholders‟ equity and from which he could expect to receive dividends.
For the corporation, the advantage of equity investment is the absence of
"carrying cost," since the corporate enterprise is not bound to pay any return on
the investment unless there are profits, and even then, the board of directors is
generally granted business discretion to determine when to declare such return
in the form of dividends. The corporate enterprise also has the flexibility of
declaring dividends in the form of stock dividend which does not drain the
finances of the enterprise, and yet allows the stockholders to "cash-in" on the
stock dividends by selling them in the open market.
Secondly, an equity investment in a corporate enterprise is generally non-
withdrawable for so long as the corporation has not been dissolved. This assures
the corporate enterprise and its managers that they will have such resources at
their disposal so long as the corporate enterprise remains a going concern.
On the other hand, a person who extends a loan or debt to the
corporation, only looks at the financial condition and operations of the corporation
as a means of gauging the ability of the corporation to pay-back the loan at the
specified period. But a creditor puts no stake on the operations of the
corporation, and therefore, the contractual obligation of the corporate enterprise
to pay the stipulated return (interest) remains even when the operations are
incurring losses. Since the relationship is essentially contractual in a loan
placement with a corporation, the investor has every right to demand the
payment of the placement upon its maturity.
Consequently, the expected return between the two types of investment
would be different. In a loan placement in a corporation, since the investor places
no stake in the results of the operations, he can only demand the stipulated fixed
return of his investment even if by the use of the borrowed funds, the enterprise
is able to reap huge profits. In the case of an equity investor, since he has placed
his stake in the results of operations, he generally participates in all income
earned by the venture.
The SEC has opined that the object of a corporation is to earn money for
the stockholders, and that when a corporation earns profit over and above the
amount of its capital, the stockholders are entitled to have a share in such profit
in proportion to their shareholdings and the fund being set apart for this purpose
is called dividend.2
Thirdly, the difference in legal expectations between a debt investor and
an equity investor, also dictates the legal preference in payment from corporate
properties of the first as compared to the latter. Since a debt investor places no
stake in the corporate operations and his rights are based on contract, then the
corporate venture must in case of insolvency, devote and prefer all corporate
assets towards the payment of its creditors. On the other hand, since the equity

2
SEC Opinion, 5 October 1994, XXIX SEC QUARTERLY BULLETIN 22 (No.1, March 1995),
citing 11 FLETCHER Sec. 5318.
investors clearly undertook to place their investment to the risk of the venture,
they can only receive a return of their investment only from the remaining assets
of the venture, if any, after the payment of all liabilities to creditors.

NATURE OF SHARE FROM POINT OF VIEW

OF THE CORPORATION
While shares of stock constitute personal property to the stockholder, they
do not represent property or claims on the assets of the corporation. A share of
stock only typifies an aliquot part of the corporation's property, or the contingent
right to share in its proceeds to that extent when distributed according to law and
equity, but its holder it not the owner of any part of the capital of the corporation;
nor is he entitled to the possession of any definite portion of its property or
assets, and the stockholder cannot be treated as a co-owner or tenant in
common of the corporate property.3

POWER TO ISSUE SHARES

Stock corporations have the express and inherent power to issue or sell
stocks.4 The power to issue shares of stock in a corporation is lodged in the
board of directors and no stockholders meeting is required to consider it because
additional issuances of shares of stocks does not need approval of the
stockholders,5 since the power to approve the opening for subscription and
issuance of shares from the unissued authorized capital stock is not expressly
granted to the stockholders by any provision of he Corporation Code, but the
same is subject to the pre-emptive right under Section 39 of the Corporation
Code.6 It is only necessary that appropriate resolution of the board of directors
approving the issuance be secured, and that the necessary application be filed
with the SEC to exempt the additional issuances from the registration
requirements under the Securities Regulation Code.
The word "issue" as used in Section 62, refers to original issue, that is,
when the stock first passes from the corporation to the interest of the
stockholder.

LIMITATIONS ON POWER TO ISSUE SHARES

Shares of stock cannot be issued for a consideration less than the par or
issued price thereof,7 except treasury shares so long as the price is reasonable.8

3
Stockholders of F. Guanzon and Sons, Inc. v. Register of Deeds of Manila, 6 SCRA 373
(1962).
4
Sec. 36, Corporation Code.
5
Dee v. Securities and Exchange Commission, 199 SCRA 238 (1991).
6
SEC Opinion, 12 January 1995, XXIX SEC QUARTERLY BULLETIN 28 (No.2, June 1995).
7
Sec. 62, Corporation Code.
8
Sec. 9, Corporation Code.
 Shares of stock cannot be issued in exchange for promissory notes or
future services.9 It would seem that the negotiable instruments other than the
promissory note such as checks can be used in payment of stocks but they shall
produce the effect of payment only when they have been cashed, or when
through the fault of the creditor, they have been impaired.10
When the consideration is other than actual cash, or consists of intangible
property, the value thereof shall be initially determined by the incorporators or the
board of directors, subject to the approval by the SEC.11

CAPITAL STOCK
The term "capital stock" or "outstanding capital stock" is defined under
Section 137 of the Corporation Code to mean "the total shares of stock issued to
subscribers or stockholders, whether or not fully or partially paid (as long as there
is a binding subscription agreement), except treasury shares."
The SEC has ruled that the term “capital stock” or “authorized capital
stock” is the amount fixed in the articles of incorporation to be subscribed and
paid by the stockholders of the corporation. When shares are subscribed out of
the authorized capital stock, that portion of the paid-in capital arising from the
subscriptions becomes the legal capital of the corporation which cannot be
returned to the stockholders in any form during the lifetime of the corporation
unless otherwise allowed by law.12
The definition of capital stock clearly shows that its composed of two
items, namely: (a) the portion which have been paid by the stockholders,
represented by the account "Paid-up Capital"; and (b) the portion which is to be
paid on the subscriptions, represented by the account "Subscription
Receivables."
In one case,13 the Supreme Court has defined “paid-up capital” as “that
portion of the authorized capital stock which has been both subscribed and paid;”
and clarified that “not all funds or assets received by the corporation [from
stockholders] can be considered paid-up capital, for this term has a technical
signification in Corporation Law, [which requires that such] must form part of the
authorized capital stock of the corporation, subscribed and then actually paid up.”
Consequently, any amount paid to the corporation which is in payment for future
subscriptions to anticipated increases in the authorized capital stock is not

9
Sec. 62, Corporation Code.
10
Art. 1249, Civil Code.
11
Sec. 59, Corporation Code.
12
SEC Opinion, 11 August 1997, XXXII SEC QUARTERLY BULLETIN 15 (No. 2, Dec. 1997).
13
MSCI-NACUSIP Local Chapter v. National Wages and Productivity Commission, 269
SCRA 173, 80 SCAD 155 (1997).
deemed to be part of capital stock until the corporation's capital is actually
increased with the approval of the SEC.14
In defining the relationship between the corporation and its stockholders,
the capital stock represents the legal and proportional standing of the
stockholders with respect to the corporation and corporate matters, such as their
rights to vote and to receive dividends.
In financial terms, the capital stock of the corporation as reflected in the
financial statement of the corporation, represents the financial or proprietary
claim of the stockholders to the net assets of the corporation upon dissolution. In
addition, the capital stock represents the totality of the portion of the corporation's
assets and receivables which are covered by the trust fund doctrine and provide
for the amount of assets and receivables of the corporation which are deemed
protected for the benefit of the corporate creditors and from which the corporation
cannot declare any dividends.
In one case,15 the Supreme Court held that the capital stock of a
corporation represents the interest and is the property of stockholders in the
corporation, who can only be deprived thereof in the manner provided by law,
and therefore cannot be levied nor attached to enforce a judgment debt of the
corporation.
The capital stock of a corporation cannot be subject to levy by corporate
creditors as to allow them to operate the affairs of the corporation. The capital
stock of the corporation represents the interest and is the property of
stockholders in the corporation, who can only be deprived thereof in the manner
provided by law.16

CLASSIFICATION OF SHARES
1. Policies on Classification of Shares
The Corporation Code provides three (3) basic policies on share
classification.
Firstly, it expressly recognizes the freedom and power of a corporation to
classify shares. Under Section 6 of the Corporation Code, the shares of stock of
stock corporations may be divided into classes or series of shares, or both, any
of which classes or series of shares may have rights, privileges, or restrictions as
may be stated in the articles of incorporation. However, no share may be

14
Central Textile Mills, Inc. v. National Wages and Productivity Commission, 260 SCRA368
(1996).
15
J.R.S. Business Corp. v. Imperial Insurance, Inc., 11 SCRA 634, 639 (1964), citing
Therebee v. Baker, 35 N.E. Eq. [8 Stew.] 501, 505; In re Wells' Estate, 144 N.W. 174, 177, Wis.
294, cited in 6 W ORDS AND PHRASES, 109.
16
Ibid.
deprived of voting rights except those classified and issued as "preferred" or
"redeemable " shares, unless otherwise provided in the Corporation Code.17
Any or all of the shares or series of shares may have a par value or have
no par value as may be provided for in the articles of incorporation.18 However,
banks, trust companies, insurance companies, public utilities, and building and
loan associations shall not be permitted to issue no-par value shares of stock.19
A corporation may furthermore classify its shares for the purpose of
insuring compliance with constitutional or legal requirements.20
Secondly, the Code expressly adopts the presumption of equality of the
rights and features of shares when nothing is expressly provided to the contrary.
Under Section 6, "Except as otherwise provided in the articles of incorporation
and stated in the certificate of stock, each share shall be equal in all respects to
every other share." In other words, although a corporation has the power to
classify its shares of stock, provide for preferences and other conditions, when
nothing has been provided for in the articles of incorporation, no presumption
should exist to distinguish one share from another.
In one case,21 the Supreme Court has held that: “Both common and
preferred shares are part of the corporation‟s capital stock. Both stockholders are
no different from ordinary investors who take on the same investment risks.
Preferred and common shareholders participate in the same venture, willing to
share in the profits and losses of the enterprise. Moreover, under the doctrine of
equality of shares—all stocks issued by the corporation are presumed equal with
the same privileges and liabilities, provided that the Articles of Incorporation is
silent on such differences.”
The SEC has ruled that the mere classification of shares into preferred
shares does not necessarily deprive them of voting rights. In the absence of any
restrictions in the articles of incorporation or by-laws of the corporation, preferred
shares would be voting shares having the same rights as common shares, since
under Section 6 of the Corporation Code, all shares shall equal rights except
when otherwise provided in the articles of incorporation and state in the
certificate of stock. Consequently, where the articles of incorporation and the
certificates of stock are silent on the matter of voting rights, all issued shares,
regardless of their class nomenclature, shall be considered to have equal voting
rights.22

17
The SEC opined that common shares classified as “C” shares cannot validly be denied
votings rights even under the articles of incorporation, since under Section 6 of the Corporation
Code, only preferred shares may be denied voting rights. Even the mandatory feature of
assigning the voting rights of such class “C” shares to a trustee would be a virtual denial of such
voting rights and therefore illegal. SEC Opinion, 15 July 197, XXXII SEC QUARTERLY BULLETIN 5
(No. 2, Dec. 1997).
18
Sec. 6, Corporation Code.
19
Ibid.
20
Ibid.
21
Commissioner of Internal Revenue v. Court of Appeals, 301 SCRA 152 (1999).
22
SEC Opinion, 16 July 1996, XXX SEC QUARTERLY BULLETIN 22 (No. 2, Dec. 1996).
 Thirdly, the Code provides for voting rights for all types of shares on
matters it considers as fundamental measures. Under Section 6, there shall
always be a class or series of shares which have complete voting rights. Where
the articles of incorporation provide for non-voting shares, the holders of such
shares shall nevertheless be entitled to vote on the following matters:

(a) Amendment to the articles of incorporation;

(b) Adoption and amendment of by-laws;
(c) Sale, lease, exchange, mortgage, pledge or other disposition
of all or substantially all of the corporate property;
(d) Incurring, creating or increasing bonded indebtedness;
(e) Increase or decrease of capital stock;
(f) Merger of consolidation of the corporation with another
corporation or other corporations;
(g) Investment of corporate funds in another corporation or
business in accordance with this Code; and
(h) Dissolution of the corporation.

Except in the foregoing cases, the vote necessary to approve a particular

corporate act covers only to stocks with voting rights.

2. Common Shares
Corporations are generally authorized by statute to issue two or more
classes of stock, which may vary with respect to their rights to dividends, their
voting rights, and their right to share in the assets of the corporation on
liquidation. The most common classification of stock is into common and
preferred shares.
Common stock do not have any special contract rights or preferences.
Frequently it is the only class of stock outstanding. It generally represents the
greatest proportion of the corporation's capital structure and bears the greatest
risk of loss in the event of failure of the enterprise. Bearing the risk of loss, along
with participation in corporation assets after all claims are paid, management of
the corporation, and participation in profits are the foremost elements of common
shares.
In one case, the Supreme Court has defined a common stock to represent
“the residual ownership interest in the corporation. . . a basic class of stock
ordinarily and usually issued without extraordinary rights or privileges and entitles
the shareholder to a pro rata division of profits.”23

3. Preferred Shares

23
Commissioner of Internal Revenue v. Court of Appeals, 301 SCRA 152 (1999).
 A preferred share of stock is one “which entitles the holder thereof to
certain preferences over the holders of common stock . . . designed to induce
persons to subscribe for shares of a corporation.”24 Although preferred shares
may take a multiplicity of forms, the most common forms may be classified into
two: (a) preferred shares as to assets; and (b) preferred shares as to dividends.25
Preferred shares as to assets gives the holder thereof preference in the
distribution of the assets of the corporation in case of liquidation. Preferred
shares as to dividends give the holder the right to receive dividends on said
shares to the extent agreed upon before any dividends at all are paid to the
holders of common stock.26
The contractual rights and preferences of an issue of preferred stock must
be provided for in the articles of incorporation. Under Section 6 of the
Corporation Code, preferred shares issued by any corporation may be given
preference in the distribution of the assets of the corporation in case of liquidation
and in the distribution of dividends, or such other preferences as may be stated
in the articles of incorporation which are not violative of the provisions of the
Corporation Code.
Preferred shares of stock may be issued only with a stated par value. 27
The board of directors, where authorized in the articles of incorporation, may fix
the terms and conditions of preferred shares of stock or any series thereof.28
Under the policy of the Corporation Code that does not grant benefits to a
share unless expressly provided for in the articles of incorporation, the naming of
shares as "preferred" without indicating what preferential rights they are
accorded, would not give such preferred shares any right in addition to those
enjoyed by common shares.
But even when preferred shares are granted special rights and
preferences that distinguish preferred from common stocks, both represent a
contribution to the capital of the corporation. A preferred stock is no more a debt
than common stock, and until a dividend is declared the holder of preferred
shares is not a creditor of the corporation. Furthermore, the rights of preferred
shareholders are subordinate to the rights of all of the creditors of the
corporation.

a. Cumulative and Non-cumulative Preferred Shares

Cumulative preferred shares entitle the holders thereof to payment not
only of current dividends but also of back dividends not previously paid, when
and if dividends are declared, to the extent agreed upon, before holders of

24
Republic Planters Bank v. Agana, 269 SCRA 1, 80 SCAD 1 (1997).
25
Ibid.
26
Republic Planters Bank v. Agana, 269 SCRA 1, 80 SCAD 1 (1997).
27
Sec. 6, Corporation Code.
28
Ibid. “Preferred stocks are those which entitle the shareholder to some priority on
dividends and asset distribution.” Commissioner of Internal Revenue v. Court of Appeals, 301
SCRA 152 (1999).
common shares are paid. The fundamental characteristic of cumulative stock is
that if the preferred dividend is not paid in full in any year, whether or not earned,
the deficiency must be made up before any dividend may be paid on the
common stock.
Non-cumulative preferred shares entitle the holders merely to the payment
of current dividends that are paid, to the extent agreed upon before the holders of
common shares are paid.
Prior to the adoption of the rule in Section 6 of the Corporation Code that
no preference or other right can be presumed to exist in favor of any share
unless clearly provided for in the articles of incorporation, there was
jurisprudence and general commercial acceptance that in the absence of any
stipulation, preferred shares are deemed to be cumulative.29

b. Entitlement to Preferences
The preference lawfully granted to preferred shares must be interpreted
and construed in accordance with applicable Corporate Law doctrines, and
cannot be deemed absolute.
For example, in one case,30 the Supreme Court has held that although the
certificates of stock granted the stockholder the right to receive quarterly
dividends of 1%, cumulative and participating, the stockholders did not become
entitled to the payment thereof as a matter of right without necessity of a prior
declaration of dividends. The Court held: “Both Sec. 16 of the Corporation Law
and Sec. 43 of the present Corporation Code prohibit the issuance of any stock
dividend without the approval of stockholders, representing not less than two-
thirds (2/3) of the outstanding capital stock at a regular or special meeting duly
called for the purpose. These provisions underscore the fact that payment of
dividends to a stockholder is not a matter of right but a matter of consensus.
Furthermore, „interest bearing stocks,‟ on which the corporation agrees
absolutely to pay interest before dividends are paid to the common stockholders,
is legal only when construed as requiring payment of interest as dividends from
net earnings or surplus only.”31
In spite of the specific preferences granted to preferred shares, there is no
guaranty, that the share will receive any dividends, or that the preferred
shareholders will have preference to corporate assets greater than the corporate
creditors, thus:

Similarly, the present Corporation Code provides that the

board of directors of a stock corporation may declare
dividends only out of unrestricted retained earnings. The

29
Fidelity Trust Co. v. Leigh Valley R. Co., 215 Pa. 610, 64 A. 829; Hazel Atlas Glass Co. v.
Van Dyke & Reeves, Inc., 8 F.2d 716; Bank of America Nat'l. Trust & Savings Assn. v. West End
Chemical Co., 100 P.2d 318).
30
Republic Planters Bank v. Agana, 269 SCRA 1, 80 SCAD 1 (1997).
31
Ibid.
 Code, in Section 43, adopting the change made in accounting
terminology, substituted the phrase “unrestricted retained
earnings,” which may be a more precise term, in place of
“surplus profits arising from its business” in the former law.
Thus, the declaration of dividends is dependent upon the
availability of surplus profit or unrestricted retained earnings,
as the case may be. Preferences granted to preferred
stockholders, moreover, do not give them a lien upon the
property of the corporation nor make them creditors of the
corporation, the right of the former being always subordinate to
the latter. Dividends are thus payable only when there are
profits earned by the corporation and as a general rule, even if
there are existing profits, the board of directors has the
discretion to determine whether or not dividends are to be
declared. Shareholders, both common and preferred, are
considered risk takers who invest capital in the business and
who can look only to what is left after corporate debts and
liabilities are fully paid.32

c. Participating and Non-Participating Preferred Shares

Participating preferred shares that entitle the holders to participate with the
holders of common shares in the retained earnings after the amount of stipulated
dividend has been paid to the preferred shares.
Non-participating preferred shares are those that entitle holders of
preferred shares only to the stipulated preferred dividends and no more.
The nature and extent of participation on a specified basis with the
common stock must be stated in the articles of incorporation.

4. Redeemable Shares
Section 8 of the Corporation Code provides that redeemable shares may
be issued by the corporation when expressly so provided in the articles of
incorporation. They may be purchased or taken up by the corporation upon the
expiration of a fixed period, regardless of the existence of unrestricted retained
earnings in the books of the corporation, and upon such terms and conditions as
may be stated in the articles of incorporation, which terms and condition must
also be stated in the certificates of stock representing said shares.33
It has been held that when the certificates of stock recognizes redemption,
but the option to do so is clearly vested in the corporation, the redemption is
clearly the type known as “optional” and rest entirely with the corporation and the
stockholder is without right to either compel or refuse the redemption of its
stock.34

32
Republic Planters Bank v. Agana, 269 SCRA 1, 80 SCAD 1 (1997).
33
Sec. 8, Corporation Code.
34
Republic Planters Bank v. Agana, 269 SCRA 1, 80 SCAD 1 (1997).
 “Redemption” has been defined as the “repurchase, a reacquisition of
stock by a corporation which issued the stock in exchange for property, whether
or not the acquired stock is cancelled, retired or held in the treasury [and that]
[e]ssentially, the corporation gets back some of its stock, distributes cash or
property to the shareholder in payment for the stock, and continues in business
as before.35
The SEC Rules Governing Redeemable and Treasury Shares,36 expressly
define "redeemable shares" as shares of stock issued by a corporation which the
corporation can purchase or take up from their holders as expressly provided for
in its articles of incorporation and certificates of stock representing said shares.
The Rules provide that all corporations which have issued redeemable
shares with mandatory redemption features are required to set up and maintain a
sinking fund, which shall be deposited with a trustee bank and not be invested in
risky or speculative ventures. The Rules also provide that redeemable shares
may be redeemed, regardless of the existence of unrestricted retained earnings,
"provided that the corporation has, after such redemption, sufficient assets in its
books to cover debts and liabilities inclusive of capital stock."
In addition, the SEC Rules provide that redeemable shares reacquired
shall be considered retired and no longer issuable, unless otherwise provided in
the articles of incorporation of the redeeming corporation.
In various ways, the SEC Rules seek to safeguard corporate creditors, as
by requiring full payment of subscriptions and preventing any return to
shareholders out of capital, if claims of creditors would be impaired.
Consequently, a purchase by a corporation of its own shares is objectionable
from the standpoint of creditors when the purchase price is paid out of capital,
that is, if corporate assets are paid out below the limit fixed by the legal capital. If
shares are acquired by purchase and payment is made out of a surplus of assets
over liabilities, including the legal capital, creditors have no cause for complaint.
The express provisions of Section 8 which allows redemption "regardless
of the existence of unrestricted retained earnings" would now constitute a clear
exception to the trust fund doctrine. Under Section 8, redeemable shares may be
issued by the corporation when expressly so provided in the articles of
incorporation. They may be purchased be purchased or taken up by the
corporation upon the expiration of a fixed period, regardless of the existence of
unrestricted retained earnings in the books of the corporation, and upon such
other terms and conditions stated in the articles of incorporation, which terms and
conditions must also be stated in the certificate of stock representing said shares.
Nevertheless, the consistency of policy of protecting corporate creditors is
still there in the sense that creditors will not be misled since it is required that the
redemption feature must be stated both in the articles of incorporation and the
certificates of stock.
35
Commissioner of Internal Revenue v. Court of Appeals, 301 SCRA 152 (1999).
36
Issued by the SEC on 26 April 1982. See SEC Rules and Regulations (1986 ed.), at p.
256.
 These issues have been dealt with particularity in Republic Planters Bank
v. Agana,37 thus:

Redeemable shares are shares usually preferred, which

by their terms are redeemable at a fixed date, or at the option
of either issuing corporation, or the stockholder, or both at a
certain redemption price. A redemption by the corporation of
its stock is, in a sense, a repurchase of it for cancellation. The
present Code allows redemption of shares even if there are no
unrestricted retained earnings on the books of the corporation.
This is a new provision which in effect qualifies the general
rule that the corporation cannot purchase its own shares
except out of current retained earnings. However, while
redeemable shares may be redeemed regardless of the
existence of unrestricted retained earnings, this is subject to
the condition that the corporation has, after such redemption,
assets in its books to cover debts and liabilities inclusive of
capital stock. Redemption, therefore, may not be made where
the corporation is insolvent or if such redemption will cause
insolvency or inability of the corporation to meet its debts as
they mature.38

a. Taxability of Redemption of Stock Dividends

The Supreme Court has held that “[w]hen the corporation redeems shares
coming from those issued upon establishment of the corporation or from initial
capital investment, the redemption to their concurrent value of acquisition would
not be subject to tax, because that would constitute merely a return of
investment. On the other hand, if the redemption is from previously declared
stock dividends, the proceeds of the redemption constitute additional wealth, for
it is no longer merely a return of capital but a gain thereon, and subject to tax.” 39
The Court recognized that the redemption of stock dividends previously
issued is used in commercial practice as a veil for the constructive distribution of
cash dividends, and therefore subject to income tax.

5. Founders' Shares
Section 7 of the Corporation Code, provides that founders' shares
“classified as such in the articles of incorporation” may be given certain rights
and privileges not enjoyed by the owners of other stocks, provided that where the
exclusive right to vote and be voted for in the election of directors is granted, it
must be for a limited period not to exceed 5 years subject to the approval of the
SEC. The five-year period shall commence from the date of the aforesaid
approval by the SEC.

37
269 SCRA 1, 80 SCAD 1 (1997).
38
Emphasis supplied.
39
Commissioner of Internal Revenue v. Court of Appeals, 301 SCRA 152 (1999).
 a. Which Are Founders’ Share?
Perhaps the most obvious feature of founders‟ share is that they are
issued basically to the founders or initial organizers of the corporation, but
nothing in the language of Section 7 expressly so provides. In fact, under Section
7 the classification of founders‟ share may be interpreted to be based on two
aspects: (a) nomenclature; or (b) certain exclusive rights granted to such shares.
The issue therefore is whether founders‟ shares are such because they
have been classified and have been given the nomenclature of “founders‟ share”
under the articles of incorporation. This does not seem to be within the spirit of
Section 6 of the Corporation Code that in effect provides that it is not
nomenclature that gives rights and preference to shares of stock.
Consequently, we must presume that what makes shares as founders‟
shares would be that they are given the exclusive rights not given to other
stockholders, and specially the right to vote and be voted for in the election of
directors. The existence of founders‟ shares must necessarily include the fact
that there are other shares that do not enjoy such rights, and would necessarily
include the existence of common shares, which ordinarily would have the right to
vote and be voted into the board of directors. That would have to be the rationale
basis for the restriction provided in Section 7 that such exclusive rights shall not
exceed five (5) years and subject to the approval of the SEC.
It would then also be reasonable to conclude that a class of shares, even
when not given the nomenclature of “founders‟ share”, would necessarily fall
within the provision of Section 7 (and therefore be classified as founders‟ share)
whenever such class of shares are given the exclusive right to vote and be voted
for in the election of directors, and necessarily such exclusive rights shall have a
limited period of five (5) years.

b. Effect When Exclusivity Period Expires

The SEC has opined that upon the expiration of the period within which
the founders‟ shares can exercise their exclusive right to vote and be voted for in
the election of directors, such exclusive right would only be transferred to
common shareholders who are supposed to exercise such right had there been
no founders share. Other classes of shares, such as preferred shares, are not
affected.40

6. No Par Value Shares

Under Section 6 of the Corporation Code, shares of stock issued without
par value shall be deemed fully paid and no-assessable and the holder of such
shares shall not be liable to the corporation or to its creditors in respect thereto.
Shares without par value may not be issued for a consideration less than the
value of P5.00 per share and that the entire consideration received by the
40
SEC Opinion, 10 August 1995, XXX SEC QUARTERLY BULLETIN 5 (No. 1, June 1996); SEC
Opinion, 27 September 1989, XXIV SEC QUARTERLY BULLETIN 23 (No. 1, March 1990).
corporation for its no-par value shares be treated as capital and shall not be
available for distribution as dividends.
In one case, the Supreme Court characterized no-par value shares thus:
"[a] no-par value share does not purport to represent any stated proportionate
interest in the capital stock measured by value, but only an aliquot part of the
whole number of such shares of the issuing corporation. The holder of no-par
shares may see from the certificate itself that he is only an aliquot sharer in the
assets of the corporation. But this character of proportionate interest is not
hidden beneath a false appearance of a given sum of in money, as in the case of
par value shares. The capital stock of a corporation issuing only no-par value
shares is not set forth by a stated amount of money, but instead is expressed to
be divided into a stated number of shares, such as 1,0000 shares. This indicates
that a shareholder of 100 such shares is an aliquot sharer in the assets of the
corporation, no matter what value they may have, to the extent of 100/1,000 or
1/10. Thus, by removing the par value of shares, the attention of persons
interested in the financial condition of a corporation is focused upon the value of
assets and the amount of its debts."41

7. Treasury Shares
Section 9 of the Corporation Code provides that treasury shares are
shares of stock which have been issued and fully paid for, but subsequently
reacquired by the issuing corporation by purchase, redemption, donation, or
through some other lawful means. Such shares may again be disposed of for a
reasonable price fixed by the board of directors.
Treasury shares are therefore shares that a corporation acquires after it
has issued them.
The SEC has opined that treasury shares have no effect on the stated
capital of the corporation unless and until they are cancelled or retired, in which
event the stated capital is reduced by the amount then representing the shares. 42
Treasury shares must be distinguished from the authorized but unissued shares:
the acquisition of treasury shares does not reduce the number of issued shares
or the amount of stated capital and their sale does not increase the number of
issues shares or the amount of the stated capital.43
A corporation may sell treasury shares for any amount the board of
directors determines, even if the shares have a par value that is more than the
sale price. Treasury shares do not have voting rights nor pre-emptive rights. In
addition, no dividends are paid on treasury shares.

41
Delpher Trades Corp. v. Intermediate Appellate Court, 157 SCRA 349, 353-354 [1988],
quoting directly from AGBAYANI, COMMENTARIES AND JURISPRUDENCE ON THE COMMERCIAL LAWS OF
THE PHILIPPINES, Vol. III, 1980 Ed., p. 107).
42
SEC Opinion, 18 March 1987, SEC QUARTERLY BULLETIN (No. 1, March 1987), at pp. 19-
20.
43
Ibid.
 In Commissioner of Internal Revenue v. Manning,44 the Supreme Court
discussed the various features of treasury shares, as follows:

(a) Although authorities differ on the exact legal and accounting

statues of so-called “treasury share,” they are more or less in
agreement that treasury shares are stocks issued and fully
paid for and re-acquired by the corporation either by
purchase, donation, forfeiture or other means;
(b) Treasury shares are therefore issued shares, but being in
the treasury, they do not have the status of outstanding
shares;
(c) Consequently, although a treasury share, not having been
retired by the corporation re-acquiring it, may be re-issued or
sold again, such share, as long as it is held by the
corporation as a treasury share, participates neither in
dividends, because dividends cannot be declared by the
corporation to itself, nor in the meetings of the corporation as
voting stock, for otherwise equal distribution of voting powers
among stockholders will be effectively lost and the directors
will be able to perpetuate their control of the corporation,
though it still represents a paid-for interest in the property of
the corporation.45

The SEC Rules Governing Redeemable and Treasury Shares provide that
treasury shares do not revert to the unissued shares of the corporation but are
regarded as property acquired by the corporation which may be reissued or sold
by the corporation at a price to be fixed by the Board of Directors.
The amount of unrestricted retained earnings equivalent to the cost of the
treasury shares being held shall be restricted from being declared and issued as
dividends. The dividend restriction on retained earnings on account of the
treasury shares shall be lifted only after the treasury shares causing the
restriction are reissued or retired. The retirement of treasury shares shall be
effected by decreasing the capital stock of the corporation in accordance with
Section 38 of the Corporation Code for the purpose of eliminating treasury
shares.46
Treasury shares shall have no voting rights as long as such shares remain
in treasury.47
Treasury shares may be declared as property dividend to be issued out of
the retained earnings previously used to support their acquisition, provided that
the amount of the said retained earnings has not been subsequently impaired by

44
66 SCRA 14 (1975).
45
Ibid, at pp. 23-24.
46
Sec. 4(2), Sec Rules Governing Redeemable and Treasury Shares (1982).
47
Sec. 5(2), Ibid.
losses.48 Any declaration and issuance of treasury shares as property dividend
shall be disclosed and properly designated as property dividend in the books of
the corporation and in its financial statements.49
Rule on Treasury Shares for Banks — No bank shall purchase or
acquire shares of its own capital stock or accept its own shares as a security for
a loan, except when authorized by the Monetary Board; and in every case the
stock so purchase or acquired shall, within six (6) months from the time of its
purchase or acquisition, be sold or disposed of at a public or private sale.50

8. Hybrid Securities
Two of the principal sources of capital formation in corporations involve
debt and equity investment securities. The sale of equity securities provides an
initial and often continuing source of corporate funds.
"Equity securities" represent an ownership interest in the corporation and
include both common and preferred stock. In addition, corporations finance
much of their continued operations through debt securities.
"Debt securities," or bonds, do not represent an ownership interest in the
corporation but rather create a debtor-creditor relationship between the
corporation and the bondholder.
Debt securities have the advantageous of allowing a return to the investor
whether or not the corporation has unrestricted retained earnings. Interest paid
on the debt securities are deductible to the corporation for income tax purposes.
Equity securities payments, being dividends are not tax deductible to the
corporation. However, equity securities usually grant a voting right to the holder,
allowing participation in certain management aspects of the corporation. Also,
under present tax legislation, dividends are subject to zero rate of income tax;
whereas, interest paid on debt securities are generally taxable to the holder
thereof.
In the early case of Government v. Philippine Sugar Estates Co.,51 the
Supreme Court, in determining whether the arrangement between two
corporations was a contract of partnership or a loan arrangement,52 noted the
following features in the contract in ruling that it is partnership (i.e., equity)
arrangement:

48
Sec. 5(3), Ibid.
49
Ibid.
50
Sec. 10, The General Banking Law of 2000 [RA 8791].
51
38 Phil. 15 (1918).
52
The issue arose from an alleged violation of then Section 13 of the old Corporation Law
which provided that no corporation shall be authorized to conduct the business of buying and
selling real estate or be permitted to hold or own real estate except such as may reasonably
necessary to enable it to carry out the purposes for which it has been created; however, the
section authorized a corporation to loan funds upon real estate, security, and purchase of real
estate when necessary for the collection of loans, but it shall dispose of real estate so obtained
within five years after receiving the title.
 (a) There was no period fixed in the contract for the repayment
of the money, except that the first return from sale of the
land was to be devoted to the payment of the capital, and
there was no date fixed for such payment;
(b) The entire amount of the "credit" was not to be turned over
at once but was to be used by the "borrowing" company as it
was needed;
(c) The return on the capital was not by a fixed rate of interest
but 25% of the profits earned by the "borrowing" company in
"todos los negocios;"
(d) The "lending" company agreed to pay 25% of all general
expenditures true and necessary that the "borrowing"
company must make for the development of its business;
(e) The consent of the "lending" company was necessary when
the "borrowing" company desired to sell the land at below an
agreed market price, but was not required if the selling price
was over the benchmark figure; and
(f) The "lending" company acted as treasurer of the entire
enterprise.

The foregoing terms and conditions of the contract between the two
corporations indicated to the Court that although denominated as a loan
agreement, the arrangement between the companies was actually one of
partnership, with the amount "loaned" constituting actual equity investment in the
venture.
The Court held: "It is difficult to understand how this contract can be
considered a loan. There was no date fixed for the return of the money and there
was no fixed return to be made for the use of the money. The return was
dependent solely upon the profits of the business. It is possible for the defendant
to receive a return from the business even after all of the `capital' has been
returned. The „capital‟ was to be returned as soon as the land was sold and
apparently . . there were to be no profits until this „capital‟ was returned. The
defendant was not to receive anything for the use of said sum until after the
capital had been fully repaid, which is not consistent with the idea of loan. It is not
impossible to provide that the capital be repaid first but the usual method is to
pay the interest first. . ."53
The other practical consideration for investors in choosing between equity
or loan investments in a corporation boils down to tax considerations: the
interests returns on loans or credit investments are taxable to the lending

53
Ibid, at p. 24.
company, whereas dividend returns on equity investments are subject to zero
rate of income tax.54

TRUST FUND DOCTRINE55

Corporate borrowings, aside from direct equity investments, often
constitute the largest source of financing for large undertakings in modern
settings. It is a business truism that opportunity should be taken of making profits
out of the money of others through leveraging. The important function of debt
financing in the commercial world has spawn devices to encourage creditors to
lend to corporate debtors with an assurance of adequate protection against
rapacious directors and officers, who may or may not connive with stockholders.
The "trust fund doctrine" is a corporate theory developed in the United
States which seeks to protect the interest of corporate creditors, and is deemed
to have been implanted in our jurisdiction with the adoption of the Corporation
Law patterned after American corporate statutes, and carried over by
jurisprudential rulings under the aegis of the present Corporation Code.
This section discusses what facets of the American doctrine has been
adopted under Philippine jurisdiction.

1. Historical Background
The trust fund doctrine is a judicial invention credited to Justice Story,
which he first enunciated in the 1824 decision in Wood v. Drummer.56 A suit in
equity was brought by creditors of banking corporation to hold the stockholders of
such corporation personally liable, it appearing that the greater part of the capital
of the corporation had been distributed to the stockholders as dividends, thereby
rendering the bank insolvent and leaving the creditors unpaid. Justice Story
announced the doctrine as follows:

It appears to me very clear upon general principles, as

well as the legislative intention, that the capital stock of banks
is to be deemed a pledge or trust fund for the payment of the
debts contracted by the bank. The public, as well as the
legislature, have always supposed this to be a fund
appropriated for such purpose. The individual stockholders are
not liable for the debts of the bank in their private capacities.
The charter relieves them from personal responsibility and
54
Under the 1997 National Internal Revenue Code, although dividends received by a
domestic corporation from another domestic corporation are exempt from income tax (Sec.
27[D][4]), beginning 1 January 1998, dividends declared from profits earned from that date to
individuals are subject to a final tax of 10% (Sec. 24[B][2]).
55
The original version of this section appeared as an article in XXXI A TENEO L.J. (No.1,
Feb. 1987). Certain topics in the original article, such as discussions on the nature of the
subscription agreements, watered stocks and repurchase of shares have been properly
discussed under their own headings in this chapter.
56
Mason 308, Fed. Cas. No. 17, 944.
 substitutes the capital stock in its stead. Credit is universally
given to this fund by the public, as the only means of
repayments. During the existence of the corporation it is the
sole property of the corporation, and can be applied only
according to its charter, that is, as a fund for the payment of its
debts, upon the security of which it may discount and circulate
notes. Why, otherwise, is any capital stock required by our
charters? If the stock may, the next day after it is paid in, be
withdrawn by the stockholders without payment of the debts of
the corporation, why is its amount so studiously provided for,
and its payment by the stockholders so diligently required? To
me this point appears so plain upon principles of law, as well
as common sense, that I cannot be brought into any doubt,
that the charters of our banks make the capital stock a trust
fund for the payment of all the debts of the corporation. The bill
holders and other creditors have the first claims upon it, and
the stockholders have no rights, until all the other creditors are
satisfied. They have the full benefit of all the profits made by
the establishment, and cannot take any portion of the fund,
until all the other claims on it are extinguished. Their rights are
not to the capital stock, but to the residuum after all demands
on it are paid. . . If I am right in this point, the principal difficulty
in the cause is overcome. If the capital stock is a trust fund,
then it may be followed by the creditors into the hands of any
persons, having notice of the trust attaching to it. As to the
stockholders themselves, there can be no pretense to say,
that, both in law and fact, they are not affected with the most
ample notice. The doctrine of following trust funds into the
hands of any persons, who are not innocent purchasers, or do
not otherwise possess superior equities, has been long
established.57

In adopting the rule, the U.S. Supreme Court held: "Though it be a

doctrine of modern date, we think it now well established that the capital stock of
the corporation, especially its unpaid subscription, is a trust fund for the benefit of
the general creditors of the corporation. And when we consider the rapid
development of corporations as instrumentalities of the commercial and business
world in the last few years, with the corresponding necessity of adapting legal
principles to the new and varying exigencies of this business, it is no solid
objection to such a principle that it is modern, for the occasion for it could no
sooner have arisen."58
Over the years the doctrine received close scrutiny by state supreme
courts and the U.S. Supreme Court itself, with the controversy centering on the
proposition as to whether or not the capital stock of a corporation is a trust fund

57
As reported in FLETCHER, 7370.
58
New Albany v. Burke, 11 Wall. (U.S.) 96, 20 L. ed. 155; Burke v. Smith, 16 Wall. (U.S.)
390, 21 L. Ed. 361; Sawyer v. Hoag, 17 Wall. (U.S.) 610, 21 L. Ed. 731; Sangor v. Upton, 91 U.S.
56, 23 L. Ed. 220.
for the benefit of creditors. Thus, in invoking the doctrine it was contended that a
corporation debtor does not stand on the same footing as an individual debtor;
that while the latter has supreme dominion over his own property, a corporation
is a mere trustee, holding its property for the benefits of its stockholders and
creditors, and that if it fails to pursue its rights against third persons, whether
arising out of fraud or otherwise, it is a breach of trust, and corporate creditors
may come into equity to compel an enforcement of the corporate duty.59
To such a legal position the U.S. Supreme Court held:

A corporation is a distinct entity. Its affairs are

necessarily managed by officers and agents, it is true, but, in
law, it is as distinct a being as an individual is, and is entitled
to hold property (if not contrary to its charter) as absolutely as
an individual can hold it, . . . When a corporation becomes
insolvent, it is so far civilly dead that its property may be
administered as a trust fund for the benefit of its stockholders
and creditors. A court of equity, at the instance of the proper
parties, will then make those funds trust funds, which, in other
circumstances, are as much the absolute property of the
corporation as any man's property is his. We see no reason
why the disposal by a corporation of any of its property should
be questioned by subsequent creditors of the corporation any
more than a like disposal by an individual of his property
should be so. The same principle of law apply to each.60

The U.S. Supreme Court held in clearer language in another case: "When
a corporation is solvent, the theory that its capital stock is a trust fund upon which
there is any lien for the payment of its debts has in fact very little foundation. No
general creditor has any lien upon the fund under such circumstances, and the
right of the corporation to deal with its property is absolute so long as it does not
violate its charter or the law applicable to such corporation."61
It is generally accepted that the proper scope of the trust fund doctrine is
that the capital stock of a corporation, as well as all its other property and assets
are generally regarded in equity as a trust fund for the payment of corporate
debts, the creditors of the corporation have the right to priority payment over any
stockholder thereof.62 However, this broad definition that encompasses all
"property and assets" is more accurately applicable to corporation that is
insolvent.

2. Application of Doctrine in Philippine Setting

59
Cf. Graham v. La Crosse & R. Co., 102 U.S. 148, 26 L. Ed. 106.
60
Ibid.
61
McDonald v. Williams, 174 U.S. 397, 43 L. Ed. 1022, 19 Sup. Ct. 743.
62
Chicago Rock Island & Pac. R.R. Co. v. Howard, 7 Wall 392, 19 L. ed. 117; Sawyer v.
Hoag, 17 Wall. 610, 21 L. ed. 731; Pullman v. Upton, 96 U.S. 328, 24 L. ed. 818.
 An examination of the various cases on the matter has shown that the
trust fund doctrine usually applies in four cases:

(a) Where the corporation has distributed its capital among the
stockholders without providing for the payment of creditors;
(b) Where it had released the subscribers to the capital stock
from their subscriptions;
(c) Where it has transferred the corporate property in fraud of its
creditors; and
(d) Where the corporation is insolvent.63

The doctrine itself has to a great extent been marginalized in the United
States, mainly because of its misleading name; nevertheless, in Philippine
jurisdiction, our own Supreme Court seems to accept the doctrine as a given.
The definition that has been much adhered to in Philippine jurisdiction is
one given by Fletcher: "The capital stock of a corporation, or the assets of an
insolvent corporation representing its capital, is a trust fund for the benefit of the
company's creditors."64
Our Supreme Court had formally adopted the principle of the doctrine in
Philippine Trust Co. v. Rivera,65 when it held that: "It is established doctrine that
subscriptions to the capital of a corporation constitute a fund to which the
creditors have a right to look for satisfaction of their claims and that the assignee
in insolvency can maintain an action upon any unpaid stock subscription in order
to realize assets for the payment of its debts."
Garcia v. Lim Chu Sing,66 held that "Stockholders, as such, are not
creditors of the corporation.67 It is the prevailing doctrine of the American courts,
repeatedly asserted in the broadest terms that the capital stock of a corporation
is a trust fund to be used more particularly for the security of creditors of the
corporation, who presumably deal with it on the credit of its capital stock.”68
Under the Corporation Code the Supreme Court in Boman Environmental
Dev't. Corp. v. Court of Appeals,69 reaffirmed the application of the doctrine in our
jurisdiction when it held that -

The requirement of unrestricted retained earnings to

cover the shares is based on the trust fund doctrine which
means that the capital stock, property and other assets of a
corporation are regarded as equity in trust for the payment of
corporate creditors. The reason is that creditor of a corporation
63
THOMPSON, 3427.
64
FLETCHER, 7369.
65
44 Phil. 469, 470 (1923). Reiterated in Lumanlan v. Cura, 59 Phil. 746, 749 (1934).
66
59 Phil. 562 (1934).
67
Ibid, citing 14 CORPUS JURIS, p. 848, sec. 1289
68
Ibid, citing 14 CORPUS JURIS, p. 383, sec. 505.
69
167 SCRA 540 (1988).
 are preferred over the stockholders in the distribution of
corporate assets. There can be no distribution of assets
among the stockholders without first paying corporate
creditors. Hence, any disposition of corporate funds to the
prejudice of creditors is null and void.70

It is unfortunate that Boman Environmental Dev't. would "redefine" the

doctrine in such inelegant, if not inaccurate, language. It is not accurate to state,
as it was stated in the decision, that "capital stock, property and other assets of a
corporation" are regarded as equity in trust for the payment of the corporate
creditors. Only the assets of the corporation to the extent that they represent the
capital stock are regarded to be in trust for the benefit of the corporate creditors.
It is also not accurate to state that "There can be no distribution of assets
among stockholders without first paying corporate creditors." For indeed, it is
valid under the Corporation Code, for the corporation, through its board of
directors, to declare dividends and pay out its assets to the extent of the
dividends declared, to its stockholders even when there are outstanding
corporate obligations, so long as the payment of dividends is from unrestricted
retained earnings.
The only time when the broad and bold language of Boman Environmental
Dev't. would be accurate is when the corporation is insolvent. In such a case,
since the assets of the corporation are not even enough to pay for its liabilities,
obviously there is nothing to be given to the stockholders. In an insolvent
situation, since creditors are preferred over the stockholders, it would then be
right to say that there can be no distribution of assets among the stockholders
without first paying corporate creditors.
Only recently, in Commissioner of Internal Revenue v. Court of Appeals,71
the Court reiterated that “[u]nder the trust fund doctrine, the capital stock,
property and other assets of the corporation are regarded as equity in trust for
the payment of the corporate creditors. “
The clearest injunction in our jurisdiction upholding the principles of the
doctrine would be Section 122 of the Corporation Code governing dissolution of
corporations and their liquidation when it provides that "[e]xcept by decrease of
capital stock and as otherwise allowed by this Code, no corporation shall
distribute any of its assets or property except upon lawful dissolution and after
payment of all its debts and liabilities."
Finally, the SEC Rules Governing Redeemable and Treasury Shares
(1982), expressly adopts the doctrine as follows: "The outstanding capital stock
of a corporation, including unpaid subscriptions, shall constitute a trust fund held
by the corporation for the benefit of its creditors which shall not be returned to the
stockholders by repurchase of shares or otherwise, except in the manner as
provided for under the Corporation Code and these rules."

70
Ibid, at p. 548.
71
301 SCRA 152 (1999).
 3. Fraud Theory
Due to the difficulties met with the terminology and application of the trust
fund doctrine, there have been advocates of the position that most issues relating
to capital stock or corporate assets and as to unpaid subscriptions properly
belong to the question of fraud rather than trust fund.72 Under this theory, the
actionable wrong is the fraud or misrepresentation by directors, officers, or
stockholders in falsely representing that the capital stock has been fully paid or
covered by binding subscription contracts. Consequently, only creditors who may
have been defrauded are entitled to relief; creditors who had notice are not
protected.
This varies with the principle under the trust fund doctrine that seeks to
protect all corporate creditors.

4. Coverage of Trust Fund Doctrine

In our jurisdiction we have adopted by statutory provisions the two
precursors of the trust fund doctrine, namely, the capital impairment rule and the
profit rule. Under these corollary rules, a fixed capital must be preserved for
protecting the claims of creditors so that dividend distributions to stockholders
should be limited to profits earned or accumulated by the corporation. Impliedly
therefore, for a solvent corporation, the trust fund doctrine encompasses only the
capital stock of the corporation.

a. Concept of "Capital Stock"

The protective reach of the trust fund doctrine, when the corporation is not
in a state of insolvency, would be only up to the extent of the "capital stock" of
the corporation. In other words, since retained earnings, although part of
stockholders' equity, do not constitute part of "capital stock," it is not covered by
the doctrine, and the corporation is at liberty to declare and pay out assets to the
stockholders by way of dividends up to the extent of its unrestricted retained
earnings.
Section 137 of the Corporation Code defines "outstanding capital stock" to
mean total shares of stock issued to subscribers, or stockholders, whether or not
fully or partially paid (as long as there is a binding subscription agreement),
except treasury shares."
The SEC has defined the term “capital stock” or “authorized capital stock”
is the amount fixed in the articles of incorporation to be subscribed and paid by
the stockholders of the corporation. When shares are subscribed out of the
authorized capital stock, that portion of the paid-in capital arising from the
subscriptions becomes the legal capital of the corporation which cannot be
returned to the stockholders in any form during the lifetime of the corporation
unless otherwise allowed by law.73

72
THOMPSON, 3429.
73
SEC Opinion, 11 August 1997, XXXII SEC QUARTERLY BULLETIN 15 (No. 2, Dec. 1997).
 In Accounting, "capital stock" is deemed to cover only "legal capital." In the
case of par value stock, capital stock or legal capital is represented by the
aggregate par value of all shares issued and subscribed.74 If the par value shares
are sold at a premium, the excess is not treated as legal capital; but it can only
be declared as stock dividends and not any other form of dividends.75 Since stock
dividends has a manner of capitalizing the portion of the retained earnings or
excess of paid-in capital, then rightly it can be concluded that subscription in
excess of par value in the case of par stock, is within the ambit of the trust fund
doctrine.
In case of no-par value stock, the legal capital is the total consideration
received for the shares of stock. Under Section 6 of the Corporation Code, the
entire consideration received from no-par shares shall be treated as capital, and
shall not be available for distribution as dividends. In such case, there is no issue
as to the proper coverage of the "capital stock" as encompassing every
consideration paid, or promised to be paid, for subscription of shares in a
corporation.
In relation to the trust fund doctrine, the Supreme Court held in Central
Textile Mills, Inc. v. National Wages and Productivity Commission,76 that funds
received by the corporation to cover subscription payment on increase in
authorized capital stock prior to approval thereof of the SEC would not be
covered within the ambits of the trust fund doctrine. The Court held: "As a trust
fund, this money is still withdrawable by any of the subscribers at any time before
the issuance of the corresponding shares of stock, unless there is a pre-
subscription agreement to the contrary. . . Consequently, if a certificate of
increase has not yet been issued by the SEC, the subscribers to the
unauthorized issuance are not to be deemed as stockholders possessed of such
legal rights to vote and dividends."

5. Observations
An examination of the relevant provisions of the Corporation Code shows
that to a great extent the trust fund doctrine has been engrafted and sometimes
strengthened in our jurisdiction. In few instances, such as on redeemable shares
and in allowing a corporation to purchase its own shares, the doctrine has been
relaxed, if not discarded, in response to legitimate needs of corporate entities to
respond to business imperatives. But generally, the need to preserve the capital
stock of the corporation as fund "to which creditors may look upon for the
satisfaction of their claim" has been preserved.
And although there have been much criticism against the doctrine, there
are some who may find solace in what was said in Witt v. Nelson,77 that the

74
VALIX AND PERALTA, FINANCIAL ACCOUNTING (1981 Ed.), Vol. Two, p. 404 .
75
Ibid.
76
260 SCRA368, 73 SCAD 109 (1996).
77
169 S.W. 381.
"theory is not obsolete, and will not become obsolete anywhere until honesty
shall become obsolete."

DIVIDENDS
The concept of the trust fund doctrine is acknowledged and its scope
clearly delineated, in the power of the corporation to declare dividends, as
defined under Section 43 of the Corporation Code.
Section 43 of the Corporation Code, which governs the power of a
corporation to declare dividends, provides that the board of directors of a stock
corporation may declare dividends only out of the unrestricted retained earnings
which shall be payable in cash, in property, or in stock to all stockholders on the
basis of outstanding stock held by them.78

1. Concepts of Surplus Profits and Retained Earnings

Section 43 of the Corporation Code now expressly provides that dividends
can only be declared out of unrestricted "retained earnings."
The relevant provision of Section 16 of the old Corporation Law from
which Section 43 above was adopted read as follows:

No corporation shall make or declare any dividend

except from the surplus profit arising from its business, or
divide or distribute its capital stock or property other than
actual profits among its members or stockholders until after
the payment of its debts and the termination of its existence by
limitation or lawful dissolution.

Prior to the enactment of the Corporation Code, there was extreme

difficulty in interpreting the phrase "surplus profit arising from the business" used
under the old Corporation Law. Controversies raged on whether the provision
authorized declaration of dividends out of current profits although the
accumulated losses over the years have impaired the capital; on whether
dividends could be declared only from profits "realized in normal business
operations" or whether it would include any kind of surplus not falling under the
category of "capital".

78
While it is normal corporate practice to declared dividends after the end of the fiscal year
when the company could definitely determine whether it made profits and the amount thereof, in
its opinions, the SEC has allowed the declaration of dividends from current accumulated net
earnings of the company earned during an interim period, provided the company has sufficient
retained earnings for the purpose which will not be impaired by losses, whether or expected or
not, during the remaining period of the fiscal year. SEC Opinion, dated 22 October 1974, SEC
FOLIO 1960-1976, at p. 746; SEC Opinion, 15 January 1986, XX SEC QUARTERLY BULLETIN 1 & 2
(March & June, 1986).
 There was also issue on what is covered by the phrase "capital stock or
property," and whether it covered the authorized capital stock, which the
maximum number of shares that a corporation may issue without amending its
articles of incorporation; or whether it covered the outstanding stock, which
covers the shares actually subscribed and issued to stockholders.
Salonga, in his treatise,79 discussed the controversy in this manner:

Another interesting question is presented regarding the

referential use of the phrase, "surplus profits arising form its
business." Is this confined to profits realized in normal
business operations, or should it also include any kind of
surplus not falling under the category of "capital"? In fine, is
the phrase narrowed down to earned surplus, or should it
include any kind of capital surplus? It may be worth pointing
out that in 1825, when the New York parent of the present
dividend provision found in our statute was drafted, the
problem of capital surplus was not contemplated. The New
York legislature did not seem to recognize that there might be
another fund available for dividends. Today, the distinction
between earned surplus and other forms of surplus is
acknowledged. In the United States, for example, several
statutes, such as those of California and Michigan, carefully
confine the fund for dividend distribution to earned surplus,
thus ruling out the possibility of a corporation paying dividends
out of donated assets or funds, paid-in surplus arising from
issuance of no-par stock, premium on par value shares,
revaluation surplus created through write-ups of the assets,
and reduction surplus arising from reduction of the capital.
There is no decided case as yet in the Philippines which
may be cited to settle this particular point, at there is much to
be said in favor of the view that, as a general proposition, any
kind of surplus should be considered available for dividends.
This interpretation follows from the very essence and meaning
of balance sheet surplus, i.e., the excess property of a
corporation, however acquired, over and above its debts and
the stated capital reserved to protect the creditors. It is of
course entirely possible for our courts to disregard past
construction of American courts of statutes modelled upon the
New York dividend law of 1825, and hold that the earned
surplus test should prevail. The provision of Section 16 is
ambiguous enough to permit such a holding.

The present language of Section 43 has avoided the controversy by

dropping the use of the terms "surplus profits" and "capital stock or property" and
instead mandates that dividends shall be declared only "out of the unrestricted
retained earnings."

79
SALONGA, PHILIPPINE LAW ON PRIVATE CORPORATIONS, 1968 ed., pp. 524-525.
 In Accounting, the term "retained earnings" is a technical term that has a
definite coverage. It represents the cumulative balance of periodic net income
dividend distributions, prior period adjustments [on prior year's net income, and
special distributions to stockholders resulting from capital adjustments [quasi-
reorganization];"80 it represents "the accumulated net income of a corporation
from the date of incorporation (or from the date of the latest date when a deficit
was eliminated in quasi-organization), after deducting therefrom distribution to
stockholders and transfers to capital stock or other accounts."81 In simple terms,
retained earnings represents the accumulation of net profits of the corporation
over the years and likewise losses sustained, as well as deductions made upon
previous dividends declared; if the accumulation resulted in a net loss over the
years, it is called a "deficit."
"Restricted" or "appropriated" retained earnings is that portion of the
retained earnings specifically earmarked or "set-aside" for specific purpose such
as to meet contingent liabilities, or planned expansion of facilities. Restriction of
retained earnings is but a memorandum notation in the books of accounts as a
reminder that the amount restricted should not be declared anymore as
dividends. "Unrestricted" or "unappropriated" retained earnings represents that
portion which is free and can be declared or dividends to stockholders.82
With the use of the term "unrestricted retained earnings" under the
Corporation Code, many of the old issues have been laid to rest in that:

(a) Any and all items included in retained earnings (i.e., income
of all types, prior period adjustments net income, special
distribution to stockholders resulting from [quasi-
reorganization] can be declared as dividends, unless
restricted);
(b) All other items not falling within the term "retained earnings"
are necessarily included in "capital" and are unavailable for
dividend declaration (e.g., donated assets or funds, paid-in
surplus arising from issuance of no-par stock, premium paid
on par value shares, revaluation surplus created to write-ups
of the assets).

It should be noted that when the corporation incurs a deficit (i.e., negative
retained earnings), the operations have actually "eaten-up" into the capital stock
and there is actually a capital impairment. Even if the corporation manages to
make profits in succeeding years, no dividends can be declared until the deficit is
"wiped-out" and the retainer earnings shows a positive amount.

80
VALIX & PERALTA, FINANCIAL ACCOUNTING, Vol. Two, p. 492.
81
Bulletin on Accounting Principles No. 10, dated November, 1975, issued by the Philippine
Institute of Certified Public Accountants (PICPA).
82
VALIX & PERALTA, supra.
 The decision in the case of Steinberg v. Velasco,83 indicates that in
determining the legality of declared dividends, the existence of unrestricted
retained earnings alone cannot be the test. In that case, the board of directors
passed and implemented a resolution authorizing the purchase of a substantial
portion of the shares of stockholders and the declaration of dividends of
P3,000.00. At the time of the adoption of the resolution, the corporation had a
"surplus profit" of P3,314.72 and had as assets (accounts receivables) that far
exceeded its liabilities. It turned out that the assets were practically worthless.
The evidence indicated that the directors in adopting the resolution were either
acting in bad faith or with the use of ordinary care could have determined the
non-existence of "surplus profit".
In holding the directors solidarily liable to corporate creditors to the extent
of the dividends paid-out, the Court held that the existence a "surplus profit"
alone does not suffice but that the corporation should "have an actual bona fide
surplus from which the dividends could be paid, and that the payment of them in
full at that time would not affect the financial condition of the corporation."
As applied to Section 43 of the Corporation Code, Steinberg is a clear
indication that only dividends declared from a bona fide unrestricted retained
earnings is legally permissible. Thus, although a corporation's balance sheet
provides for an unrestricted retained earnings, if the figure does not register the
true value of the assets (such as when worthless assets have not been written-
off), dividends declared on that basis would be illegal.
Steinberg also indicates the remedy available in case of illegal distribution
of dividends: that directors who are in bad faith or are grossly ignorant of their
duties shall be held solidarily liable for the reimbursement of the amount declared
as dividend.

a. Unrestricted Retained Earnings

The retained earnings of a corporation is the difference between the total
present value of its assets after deducting losses and liabilities and the amount of
its capital stock. The ordinary way of determining whether a corporation has
retained earnings or not is to compute the value of all its assets and deduct
therefrom all of its liabilities, including legal capital, and thus ascertain whether
the balance exceeds the amount of its outstanding shares of capital stock, thus:

RETAINED EARNINGS = ASSETS - (LIABILITIES AND LEGAL CAPITAL)

The difference between the total assets and liabilities of a corporation

represents its net worth or net assets or the stockholders' equity consisting of the
capital invested and the retained earnings.
The retained earnings will be the balance of the net worth or net assets
after deducting the value of the corporation's outstanding capital stock. They

83
52 Phil. 953 (1929).
refer to the accumulated undistributed earnings or profits realized by the
corporation arising from the transaction of its business and the management of
its affairs, out of current and prior years.
Such retained earnings or portion thereof are said to be unrestricted and
therefore free for dividend distribution to stockholders, if they have not been
reserved or set aside by the board of directors for some corporate purpose or for
some other purpose in accordance with legal or contractual requirements.
To justify the declaration of dividends, there must be an actual bona fide
surplus or profits or earnings over and above all debts and liabilities of the
corporation. Hence, earnings of the corporation which have dividends may be
paid.
Dividends may not be declared so long as a deficit exists, whether
resulting from its operations of preceding years, or the present. It does not
likewise include increases in value of fixed assets, nor borrowed funds.

2. Treatment of Paid-In Surplus

Where par value shares are issued by a corporation and a premium is
paid by the subscriber over the par, a paid-in surplus results and recorded as
such in the books of the corporation. Although in other states their laws give the
right to pay dividends on common shares as well as preferred out of paid-in
surplus, while in other jurisdictions the paid-in surplus is restricted to be paid out
to preferred shares with disclosure of the source of the recipients of the
dividends,84 Philippine jurisdiction does not allow paid-in surplus to be declared
as dividends, either as cash or property, in view of the provision of Section 43 of
the Corporation Code which requires that dividends be paid out of "unrestricted
retained earnings."
The SEC holds that "unrestricted retained earnings" as defined under the
generally accepted accounting principles is understood to mean "the
accumulated profits realized out of normal and continuous operations of the
business after deducting therefrom distribution of stockholders and transfer to
capital stock or other accounts85 . . . Retained earnings include earnings from
sales of goods or services of the corporation in the ordinary course of its
business, as well as the earnings from sale of corporate property other than its
stock in trade, at a price higher than its cost. However, they do not include
premium on par stock, i.e., the difference between the part value and the higher
price for which the stock is sold by the corporation since this is regarded as paid-
in capital."86

84
SEC Opinion, 23 September 1986, XX SEC QUARTERLY BULLETIN (Nos. 3 & 4, Sept. &
Dec., 1986), citing BALLANTINE ON CORPORATION, pp. 539-540.
85
Ibid, quoting from the Minutes of the 31st meeting of the Committee on Revision of Laws
and Codes and Constitutional Amendments at the VIP Lounger at Room "A", Batasan Complex,
Quezon City, Metro Manila on 10 March 1980.
86
Ibid, citing CAMPOS AND LOPEZ-CAMPOS, COMMENTS, NOTES AND SELECTED CASES,
CORPORATION CODE, pp. 771-772.
 a. Consideration Received for No-Par Value Shares
Section 6 of the Corporation Code provides that in case of no-par value
shares, "the entire consideration received by the corporation for its no-par value
shares shall be treated as capital and shall not be available for distribution as
dividends." In case of no-par value shares, the entire consideration (including
paid-in surplus) received from the same shall be treated as capital and shall not
be available for distribution as dividends. The theory is that the stockholders
intended that all such consideration shall constitute the basic business fund of
the corporation to be permanently devoted in the prosecution of the corporate
business.

3. Discretion of Board to Declare Dividends

The general rule has always been that the declaration of dividends is
essentially within the business judgment of the board of directors of a stock
corporation. The fact that profits have accrued in the prosecution of the corporate
business does not necessarily impose upon the directors the duty to declare
them as dividends. If in their business judgment, they reasonably determine that
the profits should be kept in the business, generally the courts have no power to
compel them to make the distribution in the absence of bad faith or clear abuse
of discretion.
Stockholders may sue the directors to compel them to declare and pay a
dividend if they unreasonably accumulate profits of the corporation but they have
the burden of proving the justification of declaring dividends. Mandamus is not a
proper remedy in this case since a stockholder has no individual interest in the
profits of a corporation until a dividend has been declared.

a. Retention of Excess Profits

Under Section 43 of the Corporation Code, it is now expressly provided
that stock corporations are prohibited from retaining surplus profits in excess of
100% of their paid-in capital stock, except in the following cases:

(a) When justified by definite corporation expansion projects or

programs approved by the board of directors;
(b) When the corporation is prohibited under any loan
agreement with any financial institution or creditor, whether
local or foreign from declaring dividends without its/his
consent, and such consent has not yet been secured; or
(c) When it can be clearly shown that such retention is
necessary under special circumstances obtaining in the
corporation, such as when there is a need for special
reserve for probable contingencies.

Section 43 of the Corporation Code therefore now expressly grants a

cause of action for stockholders to compel the board of directors to declare
dividends; but the exceptions expressly provided in the section actually grants a
lot of leeway for the board of directors to be able to retain funds within the
corporate coffers, such as by adopting formally expansion plans for the corporate
enterprise.

b. SEC Rules Governing the Distribution of Excess Profits

The SEC Amended Rules Governing the Distribution of Excess Profits of
Corporation,87 provide that all domestic stock corporations which have surplus
profits in excess of necessary requirements for capital expansion and reserves
shall declare and distribute the excess profits as dividends to stockholders,
pursuant to the provisions of Section 43 of the Corporation Code which prohibits
the corporation from retaining surplus profits in excess of 100% of its paid-up
capital, except in the instances enumerated therein.
The SEC Amended Rules provide that the SEC would consider it sufficient
justification for non-distribution of dividends when such is consistent with the
policy or requirement of a government office like the Bangko Sentral, Insurance
Commission, Board of Transportation, Board of Investments, etc., including the
policy of the SEC regarding the restriction on declaration of dividends where
there are treasury shares held by a corporation to cover the costs of said shares,
until the same are re-issued or retired.
Any appropriation of surplus profit, i.e., restriction of retained earnings,
can be done by the corporation only upon prior approval of the board of directors
and such appropriation and justification therefor shall be duly disclosed in notes
to the corporation's financial statements.
A corporation that fails or neglects to: (a) declare dividends to its
stockholders; (b) disclose any appropriations/reserve approved by the board of
directors; or (c) disclose the justification for non-distribution of dividends; may be
imposed a penalty of 1/10 of 1% of the excess amount over the paid-in capital
but in no case less than P200.00 nor more than P10,000.00 for that given fiscal
year, or be punished by suspension or revocation of the license or permit to sell
securities issued to the corporation.

4. Concept of Dividends
A stock corporation exists to make a profit and to distribute a portion of the
profits to its stockholders. A dividend is that portion of the profits of a corporation
set aside, declared and ordered by the directors to be paid ratably to the
stockholders on demand or at fixed time. It is payment to the stockholders of a
corporation as a return upon their investment. It is a characteristic of a dividend
that all stockholders of the same class share in it is proportion to the respective
amounts of stock which they hold. The term dividend indicates that there must be
a surplus or profits to be divided. However, the word has also been used to

87
XXIX SEC QUARTERLY BULLETIN 104 (No. 3, Sept. 1995).
describe distributions made to stockholders on liquidation of the corporation and
to distribution of assets upon a reduction of the capital stock.

a. Dividends Distinguished from Profits

Profits cover a larger meaning than dividends and include benefits of any
kind, the excess of value over cost, acquisition beyond expenditures, gain or
advance.
A dividend, as applied to corporate stock, is that portion of the profits or
net earnings which the corporation has set aside for ratable distribution among
the stockholders. Dividends come from the profits. Profits are not dividends until
so declared or set aside by the corporation.

b. Cash and Stock Dividends

A cash dividend may be declared by the board of directors under a formal
and does not require the approval or ratification of the stockholders. On the other
hand, stock dividends, which requires the prior resolution of the board of
directors, may be validly declared only with the approval of stockholders
representing not less than two-thirds (2/3) of the outstanding capital stock at a
regular or special meeting duly called for the purpose.
Stock dividends are in the nature of shares of stock, the consideration for
which is the amount of unrestricted retained earnings converted into equity in the
corporation‟s books. “A stock dividend of a corporation is a dividend paid in
shares of stock instead of cash, and is properly only out of surplus profits. So, a
stock dividend is actually two things: (1) a dividend and (2) the enforced used of
the dividend money to purchase additional shares of stock at par.”88
Although all forms of dividends (whether cash or stock) can be declared
only out of unrestricted retained earnings, stock dividend may be issued out of
premium surplus. No stock dividends can be issued to non-stockholders even for
services rendered.89
Any cash dividends due on delinquent stock shall first be applied to the
unpaid balance on the subscription plus costs and expenses, while stock
dividends shall be withheld from the delinquent stockholder until his unpaid
subscription is fully paid.
Cash dividends are revocable before announcement to the shareholders;
as soon as cash dividends are publicly declared, the stockholders have the right
to their pro rata shares. In the absence of a record date, the dividend belongs to
the stockholder at the time of declaration. When such declaration is made, the
corporation becomes a debtor and the right of the shareholder to distribution,
unless a record date is specified, becomes fixed by the declaration. When a cash
dividend is duly declared, the amount due to the stockholder belongs to him and

88
Lincoln Philippine Life v. Court of Appeals, 293 SCRA 92, 96 SCAD 542 (1998).
89
Nielson v. Co. vs. Lepanto Consolidated, 26 SCRA 540 (1968).
it cannot without his consent be reverted to the surplus account of the
corporation.
Stock dividend declarations may be revoked prior to actual issuance
thereof. In the case of scrip dividend declaration, they are, just like stock
dividends, revocable before actual issuance.
No dividends can be declared out of capital except liquidating dividends
and the so-called "dividends" from investment in a wasting asset corporation.

c. Property Dividends
The SEC Rules Regulating the Issuance of Property Dividends,90 provide
for the following guidelines for all stock corporations which declare property
dividends:

(a) Within thirty (30) days from declaration thereof, a notice

must be sent by the corporation showing the nature of
property declared as dividends, their individual book values
and market values, if any, and the manner in which such
property are distributed to the stockholders;
(b) The property declared as dividends should no longer be
intended to be used in the operation of the business of the
corporation and which should be practicable to be distributed
as dividends;
(c) The issuance of property dividends shall not result to an
inequitable distribution of property to the stockholders in
terms of the book values and market values, if any, of the
property distributed;
(d) Where distribution is made where some of the stockholders
will receive cash and the others will receive property, the
prevailing market value of the property, as agreed upon by
the stockholders shall be considered in determining the
equitable distribution of the total dividends;
(e) No dividends in the form of land shall be issued to a foreign
individual or entity not qualified to hold land; and
(f) No actual distribution of property dividends shall be made
without the approval of the SEC.

5. Liabilities for Illegally Received Dividends

In case dividends are wrongfully or illegally declared and paid, the
stockholders who received them can be held liable to refund them to the
corporation or its creditors. It is immaterial to consider that the dividends were

90
XXVI SEC QUARTERLY BULLETIN 115 (No. 3, Sept. 1992).
mistakenly paid out. Since they do not act in a corporate capacity in receiving
the dividends, they do not thereby ratify the illegal act of the board as to preclude
a subsequent recovery.
If the directors acted in good faith, and without negligence, they are not
liable to the corporation or to the creditors for declaring and paying dividends
when they should not have done so, and thereby diminishing the capital stock.
But if they have been guilty of fraudulent breach of trust, or of gross negligence,
in paying dividends when they had no right to pay them, they are personally
liable to creditors.

6. Dividend Declarations for Government Corporations

Under Rep. Act No. 7656 (1993) all government-owned or -controlled
corporations shall declare and remit at least 50% of their annual net earnings as
cash, stock or property dividends to the National Government. Exempted from
this requirement are government-owned or -controlled corporations created or
organized by law to administer real or personal properties or funds held in trust
for the use and benefit of its members, such as the GSIS, Home Development
Mutual Fund, the ECC, the OWWA and the Philippine Medicare Commission.
It is interesting to note that Rep. Act 7656 defines "government-owned or -
controlled corporations" as to corporations organized as a stock or non-stock
corporation vested with functions relating to public needs, whether governmental
or proprietary in nature, and owned by the Government directly or through its
instrumentalities either wholly or where applicable as in the case of stock
corporations, to the extent of at least 51% of its capital stock.
Exempted from such definition are "acquired asset corporations" which
refers to corporations:

(a) Which are under private ownership, the voting or outstanding

shares of which were conveyed to the Government or to a
government agency, instrumentality or corporation in
satisfaction of debts whether by foreclosure or otherwise, or
duly acquired by the Government through final judgment in a
sequestration proceeding; or
(b) Which is a subsidiary of a government corporation organized
exclusively to own and manage, or lease, or operate specific
physical assets acquired by a government financial
institution in satisfaction of debts incurred therewith, and
which in any case by law or by enunciated policy is required
to be disposed of to private ownership within a specified
period of time.

7. Liquidating Dividends
 Under the law, dividends other than liquidating dividends (which form part
of the capital) may be declared and paid out of the unrestricted retained earnings
of the corporation. A corporation cannot make a valid contract to pay dividends
other than from retained earnings or profits and an agreement to pay such
dividends out of capital is unlawful and void. The power of the corporation to
acquire its own share is likewise subject to the condition that there be
unrestricted retained earnings in its books to cover the shares to be purchased.
The reason for the rule is that the capital stock of the corporation is a trust
fund for the security of the creditors and cannot be distributed to their prejudice to
the stockholders as dividends, the creditors being precluded from holding the
stockholders personally liable for their claims.
For purposes of the general rule, the capital or capital stock which may not
be impaired or depleted by dividends is not the entire net assets of the
corporation; rather it is the legal capital of the corporation in the strict sense,
referring to that portion of the net assets directly or indirectly contributed by the
stockholders as consideration for the stocks issued to them upon the basis of
their par or issued value.

ACQUISITION BY CORPORATION OF ITS OWN SHARES

Section 41 of the Corporation Code expressly empowers a corporation to
acquire its own share "for a legitimate corporate purpose or purposes" with the
limitation that "the corporation has unrestricted retained earnings in its book to
cover the shares to be purchased or acquired." It gives as illustrations of what
constitutes legitimate corporate purpose the following cases:

(a) To eliminate fractional shares arising out of stock dividends;

(b) To collect or compromise an indebtedness to the
corporation, arising out of unpaid subscription, in a
delinquency sale, and to purchase delinquent shares sold
during said sale; and
(c) To pay dissenting or withdrawing stockholders entitled to
payment for their shares under the provisions of this Code.

Section 41 has no direct counterpart provision in the Corporation Law,

except that its paragraph 3 (item [c] above) is carry-over, albeit broader, of the
three (3) instances in the Corporation Law when a corporation was allowed to
purchase its own shares to satisfy the appraisal right of dissenting stockholders,
thus:

(a) In order to acquire the shares of a dissenter from a corporate

resolution "to invest its funds in any other corporation or
 business, or for any purpose other than the main purpose for
which it was organized."91
(b) In order to acquire the shares of a dissenter from an
amendment of the articles of incorporation which adversely
affects the value of his shares.92
(c) In order to acquire the shares of a dissenter from a
resolution to sell substantially all the corporate assets.93

Under the old Corporation Law, the exercise of the appraisal right was
subject to the following condition: “A stockholder shall not be entitled to payment
for his shares under the provisions of this section unless the value of the
corporate assets which would remain after such payment would be at least equal
to or aggregate of its debts, liabilities and the aggregate value and/or issued of
the remaining subscribed capital stock.” On the other hand, Section 82 of the
Corporation Code on the exercise of appraisal right provides in part "[t]hat no
payment shall be made to any dissenting stockholder unless the corporation has
unrestricted retained earnings."
The effect of the change in phraseology under Section 82 of the
Corporation Code may be best explained by way of illustration, taking a
corporation which has the following financial condition:

ASSETS LIABILTILIES & STOCKHOLDER EQUITY

Cash P1,000,000 Liabilities P 500,000
Other Assets 3,000,000 Capital Stock 3,000,000
_________ Retained Earnings 500,000
Total P4,000,000 Total P4,000,000

Under the old Corporation Law, in the exercise of appraisal right, the most
that a corporation could purchase on the shares of dissenting stockholders is
P1,000,000 (or 1/3 of the capital stock, since the two-thirds (2/3) would have
voted for the corporate transaction to be valid). Mathematically, there would be
no legal obstacle to paying to the extent of P1,000,000 to dissenting stockholders
since the net result of the payment would always be that the remaining assets
would always be equal to the total amounts of liabilities and the remaining capital
stock. This can be appreciated from the fact that for every peso of capital stock
reduced due to purchase, there is a corresponding decrease of an equivalent
peso on the assets used as payment; thus, the equality of both sides of the
balance sheet is always maintained.

91
Sec. 17-1/2, Act No. 1459.
92
Sec. 18, Act No. 1459.
93
Sec. 28-1/2, Act No. 1459.
 This observation would not apply of course if we construe that when the
old Corporation Law used the term "value" for the remaining assets, it referred
their fair market value or realizable value. But this is unlikely the intention since
for the covered transactions the corporation is still to function as a "going
concern" and therefore the assets continue to be valued at their book value.
Using the same illustration above, under the Corporation Code, the most
that the corporation can be obliged to pay to dissenting stockholders (whose
shares may amount to as high as P1,000,000) is only P500,000 since that is only
the extent of the unrestricted retained earnings. In effect, the Corporation Code
offers a more stringent formula before it allows a corporation to buy-out a
dissenting stockholders in instances allowed by law.
Under the old Corporation Law, it would seem that the accepted view was
that a corporation generally has no power to purchase its own shares and
reduced the stated capital, and this was expressed in Steinberg v. Velasco:94

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.95

In Boman Environmental Dev't., the Supreme Court, in construing a suit

brought by a withdrawing stockholder against the corporation to enforce payment
of the balance due on promissory note issued by the corporation, found that said
promissory note was issued as consideration for the surrender of his shares of
stock and interest in the corporation. Under such circumstances, the Court did
not consider the claim as a simple monetary claim based on a promissory note,
but really a purchase by the corporation of its own shares and must be construed
in accordance with the requirement of Section 41 of the Corporation Code, on the
existence of unrestricted retained earnings.96
The Court held that the provisions of the Corporation Code, including
Section 41, "should be deemed written into the agreement between the
corporation and the stockholder even if there is no express reference to them in
the promissory note."
Section 41 of the Corporation Code is an adoption of the American
doctrine that a corporation should be allowed to purchase its own shares for
legitimate corporate purposes provided it does not prejudice the corporate
creditors. Such legitimate purpose should include a move by the corporation to
exclude interested purchasers of its stock who represent an antagonistic interest,
or to comply with its contractual commitment in financing contracts. It is
perceived that so long the acquisition of shares does not exceed the unrestricted

94
52 Phil. 953 (1929).
95
Ibid, at p. 961.
96
167 SCRA 540 (1988). See Note 13.
retained earnings, the corporate creditors are deemed protected. This is also an
implied acknowledgment that the trust fund doctrine applies only to the
subscribed capital stock as distinguished from the retained earnings.
Allowing a corporation to purchase its own shares to the extent of its
unrestricted retained earnings has been viewed as equivalent to subjecting
dividend declaration to the extent of unrestricted retained earnings. 97 It has been
insisted that the purchase of a corporation's own share should be always from its
own surplus.98 But requiring the existence of unrestricted retained earnings does
not directly achieve such an end and it is not comparable to the situation of
declaring dividends.
Dividends when declared and paid-out are charged directly against
retained earnings as is the standard accounting procedure. On the other hand,
when a corporation acquires its own shares (which thereby become treasury
shares), the amount of acquisition is charged to the account "Treasury Shares"
which is not directly deducted from the retained earnings, but is presented
normally as a deduction from the total stockholders' equity (the sum total of
capital stock and retained earnings).99 Therefore, in order to preserve legal
capital, the retained earnings is usually appropriated or restricted to the extent of
the cost of the treasury stock, and the same cannot be declared as dividends
until the treasury stock is subsequently resold.100 To that extent therefore the
safeguards under the trust fund doctrine are met.
The difficulty comes with the disposition or resale of the treasury stock.
Whatever the method of accounting adopted by the corporation on treasury
shares,101 any "loss" in the disposition of treasury shares later on is first charged
to capital stock, and only when the capital stock or premium on capital stock is
not enough to cover the "loss" will the amount be charged to retained earnings. 102
In other words, although no dividends may be declared from restricted retained
earnings cover the shares reacquired by the corporation as treasury shares (and
thereby effectively prevents the declaration of dividends that will eat-up into the
legal capital), nevertheless, the disposition of treasury shares would effectively
reduce first the capital stock portion, rather than the retained earnings portion.
To illustrate, in a corporation that has a capital stock of P1,000,000 and
retained earnings of P500,000, legally it can acquire its shares for legitimate
purpose up to the extent of P500,000. The results would be:
97
CAMPOS AND LOPEZ-CAMPOS, CORPORATION CODE, 1981 ed., p. 804; AGBAYANI, supra, pp.
341-343.
98
BALLANTINE, 605.
99
Par. 6, Statement of Financial Accounting Standards No. 18 (SFAS No. 18 September
1987); VALIX & PERALTA, FINANCIAL ACCOUNTING, Vol. Two, 1981 ed., pp. 458-459.
100
VALIX & PERALTA, FINANCIAL ACCOUNTING, Vol. Two, 1981 ed., pp. 458-459.
101
Under the "cost method," the treasury stock is recorded at cost, regardless of whether
the cost is more or less than the original issue price of the stock. Under the "retirement method,"
the cost of acquisition of the treasury stock is charged firs to the par value or original issuance
cost, and any difference is charged first to capital stock, the premium on paid-in capital stock, and
lastly to retained earnings. See VALIX & PERALTA, supra, at pp. 460-462.
102
VALIX & PERALTA, supra, at pp. 460-464.
 BEFORE SHARE ACQUISITION AFTER SHARE ACQUISITION
Capital Stock P1,000,000 Capital Stock P1,000,000
Less: Treasury Shares 500,000
Net Capital Stock P 500,000
Retained Earnings 500,000 Retained Earnings 500,000
Stockholders' Equity P1,500,000 Stockholders‟ Equity P1,000,000

Even after the acquisition of the shares, there is still available retained
earnings of P500,000 because acquisition of shares is charged against Capital
Stock, and not against retained earnings. Strictly speaking, nothing prevents the
corporation from thereafter declaring cash dividends because of the availability of
retained earnings should be deemed restricted to the extent of the value of the
shares acquired by the corporation. If the retirement of shares is permanent for
all intents and purposes the affected portion of the retained earnings has been
"capitalized".
The accounting treatment for the purchase by the corporation of its own
shares should be as stated by Prof. Nemmers that "Purchases as to be restricted
to earned surplus and are to be cumulatively shown as charged to that account
on the balance sheet. Gains from purchases upon resale should be credited to
capital surplus and losses charged to earned surplus."103

QUASI-REORGANIZATION AND OTHER

SPECIAL RULES ON SHARES OF STOCK
The SEC has held that the reasons for inducing a reorganization are not in
every case the same, but for the most part, they are to be found in the wake of
financial condition of the particular corporation, aimed to generally put the
corporation upon a sound financial basis, and to enable it to take care of its
obligations, thereby, avoiding liquidation or bankruptcy.104
"Quasi-reorganization" is not a term used nor referred to in the
Corporation Code since it is more an accounting concept basically covering two
(2) methods:

(a) Through the use of the reappraisal surplus of a corporation's

assets to wipe-out the deficit or negative retained
earnings;105 and

103
Purchase by a Corporation of Its Owns Shares, 1942 W IS. L. REV. 161, 188.
104
SEC Opinion, 18 June 1986, XX SEC QUARTERLY BULLETIN (Nos. 1 & 2, March and
June, 1986), citing 15 FLETCHER, 1961 Rev. Vol., secs. 7201.
105
SEC Opinion, 14 Sept. 1998, XXXII SEC QUARTERLY BULLETIN 21 (No. 1, June, 1999).
 (b) By the reduction of a corporation's capital stock through the
formal filing of an application for amendment of its articles of
incorporation with the SEC.106

1. Use of Reappraisal Value of Assets

For quasi-reorganization intended to use reappraisal surplus on the
corporation's assets to wipe-out the deficit of the corporation, the SEC has issued
the Guidelines for Quasi-Reorganization,107 which provides the following basic
tenets:

(a) Only companies which are financially in distress, may be

allowed to undergo quasi-reorganization;
(b) The company must have substantial increment in the market
value of its fixed assets as appraised by a reputable licensed
appraiser which is adequate to absorb its accumulated past
losses;
(c) The appraisal increment to be considered in the plan shall be
limited to real properties, permanently installed fixed assets,
and other machineries and equipment directly needed and
actually used in the operations of the company;
(d) The appraisal increment of fixed assets undergoing repair or
will require repair before the same can be put into productive
use shall not be included in the appraisal of assets for
purposes of quasi-reorganization;
(e) The company shall present a project study on its future
operations to support its quasi-reorganization;
(f) The remaining appraisal surplus set up in the books of the
company after the deficit shall have been offset will not be
used to wipe out losses that my be incurred in the future
without the prior approval of the SEC;
(g) For purposes of dividend declaration, the retained earnings
of the company shall be restricted to the extent of the deficit
wiped out and not recovered by accumulated depreciation
on appraisal increment by the appraisal surplus; and
(h) After the quasi-reorganization of the company has been
effected and approved by the SEC, the company shall
disclose in all its financial statement for a minimum period of
three (3) years the mechanics, purpose and effect of such

106
Ibid.
107
See SEC RULES AND REGULATIONS (1986 ed.), at p. 246; SEC Opinion, 18 August 1994,
XXIX SEC QUARTERLY BULLETIN 7 (No.1, March 1995).
 quasi-reorganization on the financial condition of the
company.

2. Reduction of Capital Stock

Section 38 of the Corporation Code allows reduction of capital stock
pursuant to the procedure mandated therein for the protection of corporate
creditors. It expressly provides that "no decrease of the capital stock shall be
approved by the Commission, if its effect shall prejudice the rights of corporate
creditors." There are instances in a corporate life, that the corporation should be
allowed to reduce its capital stock.
The existence of a capital deficit will usually prevent the distribution of
dividends and the reduction of legal capital may be used to wipe out the deficit
and permit the resumption of dividend payments from earnings either on
common or preferred shares. Otherwise, earnings must be used to repair the
deficit.
If the capital invested in the business proves to be more than is needed for
carrying on the business, a reduction of the legal capital may be used to create a
reduction or capital surplus. This may be distributed to the shareholders by way
of liquidating dividends, subject to certain limitations for the protection of creditors
and preferred shareholders.

3. Debt-to-Equity Conversions
Other that the two (2) commons forms of quasi-reorganization discussed
above, a corporation may negotiate with its creditors for authority to convert their
claims against the corporation into equity. In situations where there is greater
likelihood that the creditors would be able to recover their exposures to the
corporation by allowing it to be unburdened with the interests and other charges
of liability accounts, the creditors may be willing to change their status to being
equity holders of the corporation.
The long-term view of such creditors would be that the continued
operation of the corporate debtor would best preserve the value of their claims,
and that other than future receipt of dividends declared once the corporation
becomes financially viable again, they would anticipate the market value of their
equity holdings as a means to recoup their exposure in the future.
Under this scheme, the corporation may convert existing liabilities into
equity accounts which the consent of the corporate creditors. Sometimes debts
and liabilities are converted into capital surplus or additional paid-in capital and
then later on by using the same account to wipe out or reduce the deficit of the
corporation.
SPECIAL TREATMENTS RELATING TO SHARES
1. Warrants
Under the SEC Amended Rules Governing Warrants,108 a "warrant" is
defined as "a type of security which entitles the holder the right to subscribe to,
the unissued capital stock of a corporation or to purchase issued shares in the
future, evidenced by a Warrant Certificate, whether detachable or not, which may
be sold or offered for sale to the public but does not apply to a right granted
under an Option Plan duly approved by the [SEC] for the benefit of employees,
officers and/or directors of the issuing corporation."109
The SEC Amended Rules now recognize two (2) types of Issuers of
warrants, namely:110

(a) A duly registered domestic corporation which issues or

proposes to issue Subscription Warrants; or
(b) A person or a group of persons who issue(s) or propose(s)
to issue Covered Warrants.

The Rules allow for two (2) types of warrants, namely:111

(a) "Subscription Warrant" which entitles the holder thereof the

right to subscribe to a pre-determined number of shares out
of the unissued capital stock of the Issuer;
(c) "Covered Warrant" which entitles the holder thereof the right
to purchase from the Issuer a pre-determined number of
existing shares.

The SEC Amended Rules define a “warrant certificate” as the certificate

representing the right to a warrant “which may be detachable or not,” duly issued
by the Issuer to the warrantholder.112 There are therefore two (2) types of warrant
certificates, namely:

(a) “Detachable warrant” which may be sold, transferred or

assigned to any person by the warrantholder separate from,
and independent of, the corresponding Beneficiary
Securities;113 and

108
XXVIII SEC QUARTERLY BULLETIN 78 (No. 2, June 1994).
109
Sec. 1(1), ibid.
110
Sec. 1(11), ibid.
111
Sec. 1(2), ibid.
112
Sec. 1(3), ibid.
113
Sec. 1(8), ibid. In case of detachable warrants, the Covered Warrant Certificate must
state on its face that the Covered Warrant does NOT represent shares of stock, but a mere right
to purchase an indicated class or type of stock owned by the Issuer under the terms and
condition stated therein. Sec. 7, ibid.
 (b) ”Non-detachable warrant” which cannot be sold, transferred
or assigned to any person by the warrantholder separate
from, or independent of the Beneficiary Securities.114

Warrantholders may exercise their right granted under a warrant within the
period approved by the SEC which shall not be less than one (1) year, nor more
than five (5) years from the date of the issue of the warrants.115
The exercise price for the warrants shall be the price per share at which
the Issuer is required to sell the Underlying Shares, upon the exercise of the
rights granted in the warrant, which shall be at a price fixed at the time of
application for registratio of the warrant or computed using the stated formula
approved by the SEC.116 The exercise price must be paid in full upon exercise,
and shall not be less than the par value of the Underlying Shares, or not less that
P5.00 per share, if the Underlying Shares are withou par value.117
All warrants authorized for issuance by the SEC shall be transferable
without need of approval from the SEC.118
An Issuer of warrants must provide for a Warrants Registry Book
maintained by the warrants registrar independent of the Issuer.119 Any sale,
transfer, or assignment of a warrant must be duly recorded in the Warrants
Registry Book, and unless recorded in therein, the transfer of warrants shall not
be binding on the Issuer.120

2. Stock Options
The SEC has issued the Rules Governing the Grants of Stock Options,
which defines a stock option as "a privilege granted to a party to subscribe to a
certain portion of the unissued capital stock of a corporation within a specified
period and under the terms and conditions of the grant, exercisable by the
grantee at any time within the period granted."121
The Rules provide that no corporation shall grant any stock option unless
approval by the SEC is first obtained.122 Aside from a formal board resolution
authorizing the grant of the option, the Rules require that the application with
SEC should contain a detailed statement as to the plan or scheme by which the
option shall be exercised.
No exercise of the right of the option shall be valid unless accompanied by
the payment of not less than 40% of the total price of the shares so purchased,

114
Secs. 1(9) and 12, ibid.
115
Sec. 1(12), ibid.
116
Sec. 11(13), Ibid.
117
Sec. 10, ibid.
118
Sec. 12, Ibid.
119
Sec. 11, ibid.
120
Sec. 12, ibid.
121
Sec. 1, Rules Governing the Grants of Stock Options (1977).
122
Ibid.
which payment shall be properly receipted for by the corporate treasurer, except
where the grantee is an employee or officer who is not a director of the
corporation in which case only 25% of the total price shall be required, or allow a
planned payroll deduction scheme.123 If the option shall be for compensation or
payment of services already rendered, then the initial payment shall not be
required.124
The Rules also provide for the following guidelines:

(a) Stock options may be granted on the basis of proportionate

interests of stockholders in the capital stock;
(b) Stock options granted to employees or officers who are not
members of the board may also be allowed after a review of
the scheme since it would be in consonance with the policy
of the government to widen corporate base and to distribute
corporate profits wider and more equitably;
(c) Stock options granted to non-stockholders may be granted
only upon showing that the board has been duly authorized
to grant same by its charter or by a resolution of the
stockholders owning at least two-thirds (2/3) of the
outstanding capital stock of the corporation, both voting and
non-voting;
(d) Options granted to directors, managing groups and
corporate officers must be approved in a stockholders'
meeting by stockholders owning at least two-thirds (2/3) of
all the outstanding capital stock, voting or non-voting;
(e) The options must be exercised within a period of three (3)
years from the approval thereof by the SEC, or upon
extension thereof duly approved by the SEC; and
(f) No transfer of the right to an option shall be made without the
approval of the SEC.125

The Rules anticipates circumvention thereof through favorable

subscriptions which really are stock options. Therefore the Rules provide that
when a person has been allowed to subscribe to so many shares as would make
him a stockholder to at least 5% of the total subscribed capital stock of the
corporation at a price below the current market price, even when the subscription
is above par, such subscription shall be considered and treated as stock option
and the subscriber must be required to tender payment thereof to the corporation
of at least 75% of the total price of the subscription.126

123
Sec. 2(g), Rules Governing the Grants of Stock Options (1997).
124
Ibid.
125
Sec. 3, ibid.
126
Sec. 6, ibid.
 Such subscriptions shall not also be transferable until full payment
thereof.127 If the shares are to be disposed of or sold, the price should not be
lower than par or less than 80% of the market price at the time of the exercise, or
if there is no transaction at the time of exercise, then the last asked price
whichever is higher; provided that if the shares are not listed, the 80% referred to
shall be based on book value.128

3. Stock Splits
In a stock split, each of the issued and outstanding shares is simply
broken up into a greater number of shares, each representing a proportionately
smaller interest in the corporation. The usual purpose of a stock split is to lower
the price per share to a more marketable price and thus increase the number of
the potential shareholders. They encourage investment.
Under Accounting Standards, when the number of additional shares
issued as a stock dividend is so great that it has, or may reasonably be expected
to have, the effect of materially reducing the share market value, the transaction
partakes of the nature of a stock split.129 An issuance of additional shares of 20%
or more of the number of previously outstanding shares is regarded as a stock
split.130

4. Stock Consolidations
On the other hand, in stock consolidations, new shares are issued in
replacement of old shares with a higher par or issued value, without affecting the
total value of the issued shares. Stock consolidations are resorted to make each
share have a higher par or issued value and thereby make them more expensive
in acquiring and to bring the stock within higher end of the market.

5. Stock Reclassification and Exchange

“Reclassification” of shares does not always bring any substantial
alteration in the subscriber‟s proportional interest, while an “exchange” would
effect “a shifting of the balance of stock features like priority in dividend
declarations or absence of voting rights.”131
Generally, neither the reclassification nor exchange of shares per se
would yield income for tax purposes.132 The mere exchange of shares, without
more, produces no realized income to the stockholder because it would involve
only a modification of the stockholder‟s rights and privileges—which is not a flow
of wealth for tax purposes, since the issue of taxable dividend may arise only

127
Ibid.
128
Ibid.
129
Statement of Financial Accounting Standards No. 18, par. 10.
130
Ibid.
131
Commissioner of Internal Revenue v. Court of Appeals, 301 SCRA 152 (1999).
132
Ibid.
once a subscriber disposes of his entire interests and not when there is still
maintenance of proprietary interest. 133

—oOo—

CORP. MANUSCRIPT\12-CAPITAL STRUCTURE\07-30-2002

133
Ibid.
 CHAPTER 13

CORPORATE ACQUISITIONS,
MERGERS & CONSOLIDATIONS

TYPES OF ACQUISTIONS AND TRANSFERS

"Assets-Only" Level
"Business-Enterprise" Level
"Equity" Level
General Rules on Liability Transfers
ASSETS-ONLY TRANSFER
Rationale for Non-Assumption of Liabilities
Coverage of Bulk Sales Law
Special Rule in Corporate Dissolution
Voluntary Assumption of Liabilities
BUSINESS-ENTERPRISE TRANSFERS
Nature of Business Enterprise
Statement of Doctrine
Application of Doctrine
Rationale of Doctrine in Business Enterprise Transfers
Free and Harmless Clause
Business-Enterprise Doctrine as an Aspect of Piercing Doctrine
EQUITY TRANSFERS
Rationale of Doctrine
Application of the Doctrine
MERGERS AND CONSOLIDATIONS
Power to Merge or Consolidate
Comparison of Merger and Consolidation
Procedures in Merger or Consolidation
Plan of Merger or Consolidation
Stockholders' or Members' Approval
Right of Appraisal of Dissenting Stockholders
Amendment of Plan of Merger or Consolidation
Articles of Merger or Consolidation
Submission of Financial Statements Requirements
Approval by SEC
Effects of Merger or Consolidation
Salient Advantages of Mergers and Consolidations
Contrary Ruling for BOI Incentives
De Facto Mergers or Consolidation
Recognition of De Facto Mergers
De Facto Mergers under the Corporation Code
Statutory Provisions Applicable to De Facto Mergers
SPIN-OFFS
EFFECTS OF TRANSFERS ON EMPLOYEES
Assets-Only Transfers
Business-Enterprise Transfers
Employees Have No Equity Claim against the Business Enterprise
Piercing Doctrine Application
The Need for a Clear “Break” in Operations
Equity Transfers
Mergers and Consolidations
Spin-offs

——

TYPES OF ACQUISITIONS AND TRANSFERS

In considering the acquisition or transfer of corporate business, the
scheme or mode of acquisition or transfer can best be fashioned only if the
contracting parties understand the three (3) levels by which the acquisition or
transfer may be effected: the "assets-only" level, the "business-enterprise" level,
and the "equity" level.

1. "Assets-Only" Level
In the "assets-only" acquisition, the purchaser is only interested in the
"raw" assets and properties of the business, perhaps to be used to establish his
own business enterprise or to be used for his on-going business enterprise. In
such an acquisition, the purchaser is not interested in the entity of the corporate
owner of the assets, nor of the goodwill and other factors relating to the business
itself.
In other instances, the purchaser is interested only in purchasing the
assets to ensure that he would not be embroiled in issues relating to the liabilities
and other contractual commitments of the business enterprise or those pertaining
to the transferor.

2. "Business-Enterprise" Level
In the "business-enterprise" level, the purchaser's interest goes beyond
the assets or properties of the business enterprise. The purchaser‟s primary
interest is essentially to obtain the “earning capability” of the venture. However,
the purchaser in such is not interested in obtaining the juridical entity that owns
the business enterprise, and therefore purchases directly the business from the
corporate entity.
As will be shown in the discussions hereunder, the essence of the
"business-enterprise" transfer is that the effect is that the transferee merely
continues the same business of the transferor.
 3. "Equity" Level
The "equity" level constitutes looking at the entirety of the business
enterprise as it is owned and operated by the corporation. The purchaser takes
control and ownership of the business by purchasing the shareholdings of the
corporate owner. The control of the business enterprise is therefore indirect,
since the corporate owner remains the direct owner of the business, and what
the purchaser has actually purchased is the ability to elect the members of the
board of the corporation who run the business.

4. General Rules on Liability Transfers

In Corporate Law, different legal consequences result from acquisitions
and transfers of the business enterprise, depending on the mode of acquisition or
transfer that is employed in each case.
Edward J. Nell Company v. Pacific Farms, Inc.,1 holds that generally,
where one corporation sells or otherwise transfers all of its assets to another
corporation, the transferee is not liable for the debts and liabilities of the
transferor, except:

(a) Where the purchaser expressly or impliedly agrees to

assume such debts;
(b) Where the transaction is entered into fraudulently in order to
escape liability for such debts;
(c) Where the purchasing corporation is merely a continuation of
the selling corporation; and
(d) Where the transaction amounts to a consolidation or merger
of the corporation.2

Properly evaluating the pronouncements in Edward J. Nell insofar as they

involve transfers of business concerns, the following rules apply to the
enforceability of liabilities against the transferee regardless of the separate
juridical personality of the transferor and transferee:

(a) In a pure assets-only transfer, the transferee is not liable

for the debts and liabilities of the transferor, except where
the transferee expressly or impliedly agrees to assume
such debts or when there was fraud;
(b) In a transfer of the business enterprise, the transferee is
liable for the debts and liabilities of the transferor; and

1
15 SCRA 415 (1965).
2
Ibid, at p. 417. The enumeration has been re-arranged to follow the pattern of the
discussions in this chapter.
 (c) In an equity transfer, the transferee is not liable for the
debts and liabilities of the transferor, except where the
transferee expressly or impliedly agrees to assume such
debts.

ASSETS-ONLY TRANSFERS
1. Rationale for Non-Assumption of Liability
In an assets-only transfer, the transferee is not liable for the debts and
liabilities of the transferor, except where the transferee expressly or impliedly
agrees to assume such debts.
In an assets-only transfer it is logical that the transferee would not be
liable for the debts and liabilities of his transferor since there is no privity of
contract over the debt obligations between the transferee and the transferor's
creditors.
The modification of an obligation with the substitution of a new debtor,
would necessarily require not only the consent of the creditors, but also the
consent of the person who is sought to be substituted as the new debtor. The
Law on Contracts, particularly those pertaining to sale properly govern the
transfer of liabilities in an asset-only transfer.

2. Coverage of Bulk Sales Law

An assets-only transfer if constituting "bulk sale" under the Bulk Sales
Law,3 would affect the transferee in the sense that if the sale has not complied
with the requirements of the Law, the sale could be classified as fraudulent and
void, and therefore title of the transferee over the assets would be void, even if
he were a purchaser in good faith.4
The Bulk Sales Law imposes no direct obligation on the buyer, mortgagee,
transferee or assignee in bulk sale, even in case of failure to comply with the
requirements for bulk sales. Strictly speaking, therefore, since criminal provisions
are to be construed strictly in favor of the accused, a buyer in bulk sale cannot be
deemed to be subject to the criminal liability under the Law, although criminal
lawyers have often used the argument of the buyer being a principal by
indispensable cooperation to make such buyer criminally liable, if he was aware
of the fraudulent intent of the seller or conspired with the seller.5
This however does not mean that the buyer, mortgagee, transferee or
assignee in bulk sale is insulated from the civil effects of the Law, since non-

3
Act No. 3952, as amended by Rep. Act No. 111.
4
The Court of Appeals in People v. Wong, 50 O.G. 4867, has held that the Bulk Sales Law
applies only to merchandising business or establishments, and has no application to other forms
of activities such as in that case the sale of the equipment, tools and machineries of a foundry
shop.
5
See discussions in VILLANUEVA, LAW ON SALES (Rex Book Store, 1998 ed.), pp. 301-304.
compliance by the seller, mortgagor, transferor, or assignor of the obligations
mandated by the Law, whether or not known to the buyer, mortgagee, transferee
or assignee, would nevertheless render the transaction in specified instances
discussed above as "fraudulent and void." Consequently, such buyer,
mortgagee, transferee or assignee would find himself not entitled to the goods or
wares, or the business for which he had paid good money for. He may still find
himself at the end of a suit brought by the business creditors to recover what he
has obtained from a bulk sale, or even liable for damages for having conspired
with the seller, mortgagor, transferor or assignor to defraud the creditor.6

3. Special Rule in Corporate Dissolution

When another corporation takes over the assets of another corporation
which is dissolved, the succeeding corporation is liable for the claims against the
dissolved corporation to the extent of the fair value of the assets assumed.
Gonzales v. Sugar Regulatory Administration,7 held that “the termination
of the life of a juridical entity does not by itself imply the diminution of extinction of
rights demandable against such juridical entity,” among which would be the
priority claims of corporate creditors against corporate assets. Since the assets
“must respond for payment of the lawful obligations” of a dissolved corporation,
then it is required that the succeeding corporation would be liable for all such
lawful claims “to the extent of the fair value of assets actually taken over.”

4. Voluntary Assumption of Liabilities

The other instance in an assets-only transfer when the transferee
becomes liable for the obligations of the transferor is when by contract, express
or implied, the transferee voluntarily assumes such obligations of the transferor.

BUSINESS-ENTERPRISE TRANSFERS
1. Nature of Business-Enterprise
A business enterprise, apart from the juridical personality under which is
operates, has a "separate being" of its own. Properly speaking, a business
enterprise comprises more than just the properties of the business, but includes
a "concern" that covers the employees, the goodwill, list of clientele and
suppliers, etc., which give it value separate and distinct from its owners or the
juridical entity under which it operates. This is what is termed as the "economic
unit", "the enterprise", "the going concern", or the "financial unit", recognized in
other disciplines, such as Economics and Accounting.
In Accounting, although a business enterprise is carried on in the form of a
single proprietorship (and therefore has no separate juridical personality) it is

6
Ibid.
7
174 SCRA 377 (1989).
considered and accounted for as a separate accounting unit apart from the other
assets and businesses of the proprietor.
A business enterprise by itself is a "concern" that has a separate
economic or selling value from its owners' other assets; and that businessmen
evaluating whether to purchase such business enterprise do not only look at the
properties of the business, but many other intangibles that really have no definite
monetary value, except when expressed as goodwill, 8 and assigned a value
under principles in Accounting, such as the moral and technical competence of
the employees and middle-management, the list of its valued clientele, location of
the business, etc. Although, jurisprudence refuses to recognize a separate
existence of the business enterprise apart from the juridical personality which the
State grants in corporations,9 and partnerships,10 such separate existence of the
business enterprise does exist and is recognized in the business world.
Villa Rey Transit, Inc. v. Ferrer,11 recognized that when purchaser buys
the business of another as a going concern, he usually wishes to keep it going;
he wishes to get the location, the building, the stock in trade, and the customers;
he wishes to step into the seller's shoes and to enjoy the same business relations
with other men. The buyer "is willing to pay much more if he can get the „good
will‟ of the business, meaning by this the good will of the customers, that they
may continue to tread the old footpath to his door and maintain with him the
business relations enjoyed by the seller."12

2. Statement of Doctrine
Jurisprudence has held that in a business-enterprise transfer, the
transferee is liable for the debts and liabilities of his transferor.
The purpose of the jurisprudential doctrine is to protect the creditors of the
business by allowing them a remedy against the new controller or owner of the
business enterprise. Otherwise, creditors would be left "holding the bag," since
they may not be able to recover from the transferor who has "disappeared with
the loot," nor against the transferee who can claim that he is a purchaser in good
faith and for value.

8
"Recent cases have enlarged the concept of goodwill over the behavioristic resort of old
customers to the old place of business. It is now recognized that „It may include in addition to
those factors all that goes with a business in excess of its mere capital and physical value, such
as reputation for promptness, fidelity, integrity, politeness, business sagacity and commercial skill
in the conduct of its affairs, solicitude for the welfare of customers and other tangible elements
which contribute to successful commercial venture.‟" Villa Rey Transit, Inc. v. Ferrer, 25 SCRA
845 (1968), footnote no. 35 at pp. 859-860, quoting from W ILLISTON ON CONTRACTS, Vol. 5, p.
4592.)
9
Tayag v. Benguet Consolidated Inc., 26 SCRA 242 (1968). It rejected the genossenchaft
theory of Friedman that would recognize the corporate entity as "the reality of the group as a
social and legal entity independent of state recognition and concession."
10
Ang Pue & Co. v. Sec. of Commerce and Industry, 5 SCRA 645 (1962). The formation of
a corporate entity or a partnership is not a matter of right, but rather of a privilege.
11
25 SCRA 845 (1968).
12
Ibid, quoting from CORBIN ON CONTRACTS, Vol. 6, Sec. 1385, p. 483.
 3. Application of Doctrine
Many of the applications of the business-transfer transfer doctrine seem to
be related by the Supreme Court to the application of the piercing doctrine, so as
to raise the issue of whether the business-transfer transfer doctrine is merely a
sub-classification of the piercing doctrine. It will be noted that in the various
decisions on the matter, the Court has never considered fraud as an essential
ingredient for the application of the business-enterprise transfer doctrine.
In Rivera v. Litam & Company, Inc.,13 a new corporation was organized
which provided in its articles of incorporation that it was taking over the assets
and properties of a corporation that was dissolved. It turned out that the old
corporation was part of a fraudulent scheme to exclude from the estate of a
deceased stockholder the shares held in the old corporation. The Court ruled that
since the new corporation acquired the assets and properties of the old
corporation, it was bound to assume also the obligations and liabilities as
provided for in the articles of incorporation.14
In A.D. Santos v. Vasquez,15 a judgment in suit for workmen's
compensation was filed against the corporate taxi cab company. Despite the
testimony of the claimant that he was employed not by the taxi cab company, but
rather by the majority stockholder in the latter's personal capacity, the Court
nevertheless upheld the judgment against the taxi cab company observing that
although in truth the majority stockholder operated the business under a sole
proprietorship scheme, it was subsequently transferred to the taxi cab company.
However, in this case, the Court also applied the doctrines of piercing the veil of
corporate fiction.
In Buan v. Alcantara,16 the Court held that a new corporation taking over
all of the mortgaged assets of an old corporation in exchange for all the old
corporation's capital stock and continuing to operate the business formerly
operated by the old corporation is an alter ego of the old corporation so as to be
liable to pay the obligations of the old corporation, notwithstanding that the old
corporation retained titled to the mortgaged assets. Similarly, where the
administrator of the estate of a decedent incorporated the assets of the estate
into a corporation and continued the business of the latter, the administrator and
the corporation so formed are alter egos, each in respect to the other, so that the
administrator would still be liable for the obligations of the corporation, just as the
corporation would be liable for the debts of the administrator.
In Quimson v. Alaminor Cooperative Marekting Assn., Inc.,17 and
Detective & Protective Bureau, Inc. v. United Employees' Welfare Assn.,18 the
Court took note of the general rule, that a corporation is not liable on or for

13
4 SCRA 1072 (1962).
14
Ibid, at p. 1084.
15
22 SCRA 1158 (1968).
16
127 SCRA 834 (1984).
17
73 Phil. 342 (1941).
18
98 Phil. 582 (1956).
contracts or debts of a pre-existing partnership because the two entities are
distinct and separate, unless the corporation has expressly or impliedly and on
sufficient consideration adopted or assumed the same. However, the Court held
that when it goes down to the level of the enterprises between the two sets of
entities, such as where a corporation has been formed by the members of a
partnership subsequent to the incurring of debts, the former partnership being the
only members of the corporation and the assets of the partnership have been
transferred to the corporation for the continuation of the business, in exchange
for stock and without other consideration, the corporation thereby assumes the
partnership debts and is prima facie liable therefor, since the legal entity of the
corporation and the partners may be disregarded and the members of the
partnership may be said to have simply put on a new coat.
In Cagayan Valley Enterprises, Inc. v. Court of Appeals,19 it was held that
when a single proprietorship is registered as a corporation, the corporation is
managed by the owner of the single proprietorship and is engaged in the same
line of business and in the same place as that of the latter, it can be said that the
corporation is a continuation of the single proprietorship and may be held liable
for the latter's act, said circumstances justifying piercing the veil of corporate
entity.
Nevertheless, in many other decisions of the Supreme Court on the
matter, it has applied the business-enterprise transfer doctrine without reference
to, and independent from, the piercing doctrine.
In San Teodoro Development Enterprises, Inc. v. Social Security
System,20 although the business enterprise was originally held under a
partnership scheme and latter the business was transferred to a corporation, the
business enterprise was deemed to have been in operation for the required two-
year period as to come under the coverage of the SSS Law, thus:

On the strength of the foregoing facts, the Social

Security Commission found that the dissolution of the
partnership and the organization of the corporation were
effected in such sequence as to insure the smooth and orderly
transfer of the business from the partnership to the corporation
without interruption in the function of the business; that the
entire business of the partnership, including the materials and
equipment used in connection therewith, were transferred to
the corporation ostensibly for a valuable consideration; and
that even the name of the corporation was the same as the
tradename of the partnership, and apparently their employees
are also the same. All these, the Commission said, coupled
with the fact that four out of the five members of the
partnership do not only own the controlling stock of the
corporation but also hold positions having to do with the
management and control of the corporation, indicates in a
19
179 SCRA 218 (1989).
20
8 SCRA 96 (1963).
 conclusive manner that there was merely a change in the
juridical personality of the entity operating the business, so
that it may be said that the substance of the juridical person
owning and operating the business remain the same if its legal
personality has changed.21

Although there was no fraud intended, San Teodoro held that the
possibility of fraud allowed the application of the piercing doctrine.
To the same effect is Laguna Trans. Co., Inc. v. Social Security System,22
where the Court held that "[t]he corporation continued the same transportation
business of the unregistered partnership, using the same lines and equipment.
There was, in effect, only a change in the form of the organization of the entity
engaged in the business of transportation of passengers."23 It further held that
"[w]hile it is true that a corporation once formed is conferred a juridical personality
separate and distinct from the persons composing it, it is but a legal fiction
introduced for purposes of convenience and to subserve the ends of justice. The
concept cannot be extended to a point beyond its reasons and policy, and when
invoked in support of an end subversive of this policy, will be disregarded by the
courts."24
The doctrine of Laguna Transportation therefore is that where a
corporation is formed by, and consisted of members of a partnership whose
business and property was conveyed and transferred to the corporation for the
purpose of continuing its business, in payment for which corporate capital stock
was issued, such corporation is presumed to have assumed partnership debts,
and is prima facie liable therefor.
Oromeca Lumber Company, Inc. v. Social Security Commission,25 held
that where the business of a partnership is merely absorbed and continued by a
corporation, the corporation must be deemed to be engaged in business from the
time the partnership it had succeeded started it business and activities.

4. Rationale of Doctrine in Business Enterprise Transfers

The doctrine in business-enterprise transfers recognizes the reality in the
business world that although no formal mortgage contract is executed, creditors
and suppliers extend credit to the business enterprise because they see the
business's earning capacity and assets as a "security" to the undertaking that
they will eventually be paid back.26 The doctrine therefore puts the burden on the

21
Ibid, at pp. 99-100.
22
107 Phil. 833 (1960).
23
Ibid, at p. 837.
24
Ibid, at p. 837, citing 13 AM.JUR. 160.
25
4 SCRA 1188 (1962).
26
It would be instructive to see the judicial attitude to the extension of credit as underpinning
a clear intention to establish a long-term business. On the issue of whether a foreign corporation
intended to engage in business in the Philippines, in Eriks Pte. Ltd. v. Court of Appeals, 267
SCRA 567 (1997), the Supreme Court found that the extension of credit terms to be indicative of
shoulder of the person who is in the best position to protect himself, namely the
transferee, by obtaining certain guarantees and protection from his transferor.
The doctrine also finds support in the Bulk Sales Law, 27 which declares as
void and fraudulent the bulk sale of all or substantially all of the business
enterprise without applying the purchase proceeds to the pro-rata payment of
bona fide claims of the creditors of the business enterprise.

5. Free and Harmless Clause

In business-enterprise transfers, it is possible that the transferor and the
transferee may enter into a contractual stipulation stating either that the
transferee shall not be liable for any or all debts arising from the business which
were contracted or accrued prior to the time of transfer. Another form of
stipulation would be for the transferor to hold the transferee free and harmless
against all claims arising from the business transferred which accrued prior to the
time of transfers.
Such stipulations or conditions of sale are valid and binding, but only as to
the transferor and the transferee, and their respective successors-in-interest.
Such stipulations or conditions are non-binding on the creditors of the business
enterprise who can still go after the transferee for the enforcement of the
liabilities of the business enterprise even those accrued prior to the transfer.
The jurisprudential doctrine on business-enterprise transfers has evolved
for the protection of business creditors, therefore neither the transferor nor the
transferee can "waive" or "modify" such right or cause of action of the creditors
without the latter's consent. Likewise, the free-and-harmless stipulation between
the transferor and the transferee is a private contract and cannot bind non-
contracting parties, such as the business creditors.

EQUITY TRANSFERS
1. Rationale of Doctrine
In an equity transfers, the transferee is not liable for the debts and
liabilities of the transferor, except where the transferee expressly or impliedly
agreed to assume such debts.
The logic of the doctrine in equity transfer finds support in the main
doctrine of separate juridical personality, that by purchasing the shares in a

intent to do business in the Philippines for an indefinite period, thus: "More than the sheer number
of transactions entered into, a clear and unmistakable intention on the part of petitioner to
continue the body of its business in the Philippines is more than apparent. . . Further, its grant
and extension of 90-day credit terms to private respondent for every purchase made, unarguably
shows an intention to continue transaction with private respondent, since in the usual course of
commercial transactions, credit is extended only to customers in good standing or to those on
whom there is an intention to maintain long-term relationship.”
27
Act 3952, as amended by Rep. Act No. 111.
corporation that owns a business, the stockholder does not by that reason alone
become the owner directly of the business assets and does not become
personally liable for the debts and liabilities of the business.
In addition, the buyer of the controlling shares of stock in a corporation
may take advantage of the “limited liability” feature that is part of such corporate
set-up.

2. Application of the Doctrine

In Edward J. Nell, the creditor sought to make the transferee corporation
liable for the corporate obligations on the ground that it was a mere alter ego of
the corporation purchased "because [the transferee corporation] had purchased
all or substantially all of the shares of stock, as well as the real and personal
properties of the [subject corporation]." The Court held that since "there is neither
proof nor allegation that [transferee-corporation] expressly or impliedly agreed to
assume the debt [of the subject corporation] or that the sale of either the shares
of stock or the assets of [the subject corporation] to the appellee has been
entered into fraudulently, in order to escape liability for the debt of the [subject
corporation]," there was no basis to hold the transferee-corporation liable for the
debts and liabilities of the subject corporation.
In Philippine Veterans Investment Development Corporation v. Court of
Appeals,28 PHIVIDEC was held liable for the obligations of its subsidiary (the
shareholdings of which it had sold to PHILSUCOM) mainly because it executed
an agreement to hold PHILSUCOM free and harmless against claims arising
before the transfer, and also because of the Court's claim that piercing of the veil
was appropriate in that case.
The general rule therefore is that in an equity transfer, the transferee does
not become personally liable for the obligations of the corporate enterprise under
the main doctrine of separate juridical personality, unless either the transferee by
contract assumes such obligations, or there is basis for piercing the veil of
corporate fiction
In North Davao Mining Corp. v. NLRC,29 involved was the claim for
separation pay by employees of the North Davao Mining Corporation. The
shareholdings in the company were among the assets transferred by PNB to the
national government, and that by virtue of Proclamation No. 50 (8 December
1986), the Asset Privatization Trust was constituted trustee of the government
assets. The Solicitor General in his Comment filed with the Supreme Court
challenged the assertion of the corporation that it was no longer in a position to
pay the benefits on the ground that the national government remains solvent and
in financial position to do so.
The Supreme Court held that even when the national government owned
or controlled 81.8% of the common stock and 100% of the preferred stock of the

28
181 SCRA 669 (1990).
29
254 SCRA 721, 69 SCAD 430 (1996).
corporation, it remains only a stockholder thereof, and under existing laws and
prevailing jurisprudence, a stockholder as a rule is not directly, individually and/or
personally liable for the indebtedness of the corporation. The obligation of the
corporation cannot be considered the obligation of the national government,
hence, whether the latter be solvent or not is not material. "The respondent have
not shown that this case constitutes one of the instances where the corporate veil
may be pierced. From another angle, the national government is not the
employer of private respondent and his co-complainants, so there is no reason to
expect any kind of bailout by the national government under existing law and
jurisprudence.”

MERGERS AND CONSOLIDATIONS

1. Power to Merge or Consolidate
Since merger or consolidation affects the juridical personalities of the
participating corporations, neither merger nor consolidation is deemed to be
within the inherent powers of corporations, and the power to merge or
consolidate must be expressly granted by law. Unlike under the old Corporation
Law which contained no express provisions on merger or consolidation, now
Section 76 of the Corporation Code expressly authorizes two or more
corporations to merge into a single corporation which shall be one of the
constituent corporations or to consolidate into a new single corporation which
shall be the consolidated corporation.

2. Comparison of Merger and Consolidation

Consolidation is the union of two or more existing corporations to form a
new corporation called the consolidated corporation. It is a combination by
agreement between two or more corporations by which their rights, franchises,
privileges and properties are united and become those of a single, new
corporation, composed generally, although not necessarily, of the stockholders of
the original corporations.
Merger, on the other hand, is a union whereby one or more existing
corporations are absorbed by another corporation which survives and continues
the combined business.
The parties to a merger or consolidation are called constituent
corporations. In consolidation, all the constituent corporations are dissolved and
absorbed by the new consolidated enterprise. In merger, all constituent
corporations, except the surviving corporation, are dissolved.
In both cases, there is no liquidation of the assets of the dissolved
corporations, and the surviving or consolidated corporation assumes ipso jure the
liabilities of the dissolved corporations, regardless of whether the creditors have
consented or not to such merger or consolidation.30

3. Procedures in Merger or Consolidation

a. Plan of Merger or Consolidation
Section 76 of the Corporation Code, expressly empowers the board of
directors or trustees of each corporation, party to the merger or consolidation, to
approve a plan of merger or consolidation setting forth the following:

(a) The names of the constituent corporations proposing to

merge or consolidate;
(b) The terms of the merger or consolidation and the mode of
carrying the same into effect;
(c) A statement of the changes, if any, in the articles of
incorporation of the surviving corporation in case of merger;
and, with respect to the consolidated corporation in case of
consolidation, all the statements required to be set forth in
the articles of incorporation organized under the Corporation
Code; and
(d) Such other provisions with respect to the proposed merger
or consolidation as are deemed necessary or desirable.

b. Stockholders' or Members' Approval

Upon approval by majority vote of each of the board of directors or
trustees of the constituent corporations of the plan of merger or consolidation, the
same shall be submitted for approval by the stockholders or members of each of
such corporations at separate corporate meetings duly called for the purpose.
Notice of such meetings shall be given to all stockholders or members of
the respective corporations, at least two (2) weeks prior to the date of the
meetings, either personally or by registered mail. Said notice shall state the
purpose of the meeting and shall include a copy or a summary of the plan of
merger or consolidation, as the case may be.
The affirmative vote of stockholders representing at least two-thirds (2/3)
of the outstanding capital stock of each corporation in the case of stock
corporations, or at least two-thirds (2/3) of the members in the case of non-stock
corporations, shall necessary for the approval of such plan.31
In a non-stock corporation, the SEC has opined that the vote for the
approval of merger cannot be made by mail or similar means. While Section 89
of the Corporation Code, members of a non-stock corporation may be allowed to
30
Sec. 80, Corporation Code.
31
Sec. 77, Corporation Code.
vote by mail or other similar means, the same should be treated as a general
provision for non-stock corporation applicable only in the absence of a specific
provision in the Corporation Code on a particular subject matter; nevertheless
Section 77 of the Corporation Code specifically provides for the procedure in
approving merger agreements applicable to both stock and non-stock
corporations, and being a specific provision, it should be treated as an exception
to Section 89.32

c. Right of Appraisal of Dissenting Stockholders

Any dissenting stockholder in stock corporations may exercise his
appraisal right, provided that if after the approval by the stockholders of such
plan, the board of directors should decide to abandon the plan, the appraisal right
shall be extinguished.33

d. Amendment of Plan of Merger or Consolidation

Any amendment to the plan of merger or consolidation may be made,
provided such amendment is approved by majority vote of the respective boards
of directors or trustees of all the constituent corporations and ratified by the
affirmative vote of stockholders representing at least two-thirds (2/3) of the
outstanding capital stock, or of two-thirds (2/3) of the members, of each of the
constituent corporations.34
Such plan, together with any amendment, shall be considered as the
agreement of merger or consolidation.35

e. Articles of Merger or Consolidation

After the approval by the stockholders or members of the merger or
consolidation, articles of merger or articles of consolidation shall be executed by
each of the constituent corporations, to be signed by the president or vice-
president and certified by the secretary or assistant secretary of each corporation
setting forth:

(a) The plan of the merger or the plan of consolidation;

(b) As to stock corporations, the number of shares outstanding,
or in the case of non-stock corporations, the number of
members; and
(c) As to each corporation, the number of shares or members
voting for and against such plan, respectively.36

32
SEC Opinion, 4 August 1998, XXXII SEC QUARTERLY BULLETIN 14 (No. 2, Dec. 1998);
SEC Opinion, 10 September 1993, XXVIII SEC QUARTERLY BULLETIN 5 (No. 1, March 1994); SEC
Opinion, 25 March 1981.
33
Ibid.
34
Sec. 77, Corporation Code.
35
Ibid.
 f. Submission of Financial Statements Requirements
Under current SEC rules, the applying constituent corporations are
required to submit their respective financial statements which serve as the basis
of fixing the shares to be issued in favor of the merged corporation vis-a-vis the
net assets to be absorbed by the surviving corporation as of a specific date. The
date is important because it indicates the values of said assets as of that date. In
fact, it is required that the articles of merger or consolidation should be filed not
more than 120 days from the date of the long form audit report for each of the
constituent corporations.

g. Approval by SEC
The articles of merger or consolidation, signed and certified as required by
law, shall be submitted to the SEC in quadruplicate for its approval.37
In the case of merger or consolidation of banks or banking institutions,
building and loan associations, trust companies, insurance companies, public
utilities, educational institutions, and other special corporations governed by
special laws, the favorable recommendation of the appropriate government
agency shall first be obtained.38
Where the SEC is satisfied that the merger or consolidation of the
constituent corporations is not inconsistent with the provisions of the Corporation
Code and existing laws, it shall issue a certificate of merger or consolidation, as
the case may be, at which time and merger or consolidation shall be effective. 39
If, upon investigation, the SEC has reason to believe that the proposed
merger or consolidation is contrary to or inconsistent with provisions of existing
laws, it shall set a hearing to give the corporations concerned the opportunity to
be heard.40 Written notice of the date, time and place of said hearing shall be
given to each constituent corporation at least two (2) weeks before said
hearing.41 The SEC shall decide based on the results of the hearing.42
The Supreme Court has held that a merger does not become effective
upon the mere agreement of the constituent corporations, and that the procedure
prescribed under the Corporation Code would clearly show that the the merger
shall be effective only upon the issuance by the SEC of a certificate of merger. 43
The effectivity date of the merger is crucial for determining when the merged or
absorbed corporation ceases to exist; and when its rights, privileges, properties
as well as liabilities pass on to the surviving corporation.44

36
Art. 78, Corporation Code.
37
Sec. 79, Corporation Code.
38
Ibid.
39
Ibid.
40
Ibid.
41
Ibid.
42
Ibid.
43
Associated Bank v. Court of Appeals, 291 SCRA 511, 95 SCAD 372 (1998).
44
Ibid.
 4. Effects of Merger or Consolidation
Section 80 of the Corporation Code provides for the following legal effects
of a merger or consolidation:

(a) The constituent corporations shall become a single

corporation which, in case of merger, shall be the surviving
corporation designated in the plan of merger; and, in case of
consolidation, shall be the consolidated corporation
designated in the plan of consolidation;
(b) The separate existence of the constituent corporations shall
cease, except that of the surviving or the consolidated
corporation;
(c) The surviving or the consolidated corporation shall
thereupon and thereafter possess all the rights, privileges,
immunities and franchise of each of the constituent
corporations;
(d) All property, real or personal, and all receivables due on
what ever choses in action, and all the every other interest
of, or belonging to, or due to each constituent corporation,
shall be taken and deemed to be transferred to and vested in
such surviving or consolidated corporation without further act
or deed;
(e) The surviving or consolidated corporation shall be
responsible and liable for all the liabilities and obligations of
each of the constituent corporations in the same manner as
if such surviving or consolidated corporation had itself
incurred such liabilities or obligations;
(f) Any claim, action or proceeding pending by or against any of
such constituent corporations may be prosecuted by or
against the surviving or consolidated corporation, as the
case may be; and
(g) Neither the rights of creditors nor any lien upon the property
of any of each constituent corporation shall be impaired by
such merger or consolidation.

The legal effect of either merger or consolidation is not to disturb the legal
continuity of the underlying "business enterprises" of each of the constituent
corporations. Associated Bank v. Court of Appeals,45 described what would be
the effect of merger on the constituent corporations:

45
291 SCRA 511, 95 SCAD 372 (1998).
 Ordinarily, in the merger of two or more existing
corporations, one of the combining corporations survives and
continues the combined business, while the rest are dissolved
and all their rights, properties and liabilities are acquired by the
surviving corporation. Although there is a dissolution of the
absorbed corporations, there is no winding up of their affairs or
liquidation of their assets, because the surviving corporation
automatically acquires all their rights, privileges and powers,
as well as their liabilities. . . The effectivity date of the merger
is crucial for determining when the merged or absorbed
corporation ceases to exist; and when its rights, privileges,
properties as well as liabilities pass on to the surviving
corporation.

a. Salient Advantages of Mergers and Consolidation

The process of merger or consolidation, unlike the regular transfer and
acquisition processes, are able to achieve a “continuous” flow of the juridical
personalities and business enterprises of the constituent corporation, and under
the clear rules under Section 80, there no legal “break” in such juridical
personalities and business enterprises as they end up combined in the surviving
or consolidated corporation. In essence, the surviving or consolidated corporation
cannot even be treated as the “transferee” of the constituent corporation, and
that for all intents and purposes, the surviving or consolidated corporation is
every bit the exactly the same, although combined, entity as each of the
constituent corporations.
This salient feature of every merger or consolidation therefore allows
corporate planners to achieve certain ends not available to other forms of
transfers and acquisitions. An example would be contractual or statutory
prohibitions on transfers, which do not expressly cover mergers or
consolidations, would allow the surviving or consolidated corporation to
automatically assume the same role as the constituent corporation covered by
such prohibition, and the merger or consolidation cannot be deemed a violation
of the non-transfer clause.
Another important area where merger or consolidation play an important
role is in the field of taxation. Transfers of assets or business enterprise, or even
the transfer of controlling shareholdings, are generally subject to taxable gains
tax. Under Section 40(C)(2)(a) of the 1997 National Internal Revenue Code, no
gain or loss shall be recognized if in pursuance of a plan of merger or
consolidation:

(a) A corporation, which is a party to a merger or consolidation,

exchanges property solely for the stock in a corporation
which is a party to the merger or consolidation;
(b) A shareholder exchanges stock in a corporation which is a
party to the merger or consolidation solely for the stock of
 another corporation also a party to the merger or
consolidation; or
(c) A security holder of a corporation which is a party to the
merger or consolidation exchanges his securities in such
corporation solely for stock or securities in another
corporation which is a party to the merger or consolidation.]

b. Contrary Ruling for BOI Incentives

Although Section 80(3) of the Corporation clearly provides that the
surviving or consolidated corporation shall possess all the rights, privileges,
immunities and powers of the constituent, nevertheless, in the field of BOI
incentives, particularly in the case of net operating loss carry over, the Supreme
Court in Paper Industries Corp. of the Philippines v. Court of Appeals,46 refused
to apply the legal effect of merger as to grant to the surviving corporation the
rights and incentives available to one of the constituent corporation.
In that case the Paper Industries Corporation of the Philippines (PICOP)
entered into a merger with Rustan Pulp and Paper Mills, Inc. (RPPM), both
companies being registered with the BOI as preferred pioneer enterprise. It was
shown that one of the considerations for the merger was the attraction to PICOP
of the accumulated losses of RPPM of P81.0 Million, to offset against the income
of PICOP from its operations using the incentives provided for under Section 7 of
R.A. No. 5186 on net operating loss carry over. When the merger became official
with PICOP as the surviving corporation, PICOP wanted to avail of the
accumulated losses of RPPM as the surviving corporation.
The Court held that PICOP could note use the accumulated losses of
RPPM to offset against its operating income even though both enterprises are
BOI registered. It held that in Philippine jurisdiction, the ordinary rule--that is, the
rule applicable in respect of corporations not registered with the BOI as a
preferred pioneer enterprise—is that net operating losses cannot be carried over.
Under our Tax Code losses may be deducted from gross income only if such
losses were actually sustained in the same year that they are deducted or
charged off. The Court held:

Thus it is that R.A. No. 5186 introduced the carry-over of

net operating losses as a very special inventive to be granted
only to registered pioneer enterprises and only with respect to
their registered operations. The statutory purpose here may be
seen to be the encouragement of the establishment and
continued operation of pioneer industries by allowing the
registered enterprise to accumulate its operating losses which
may be expected during the early years of the enterprise and
to permit the enterprise to offset such losses against income
earned by it in later years after successful establishment and
regular operations. To promote its economic development

46
250 SCRA 243, 66 SCAD 53 (1995).
 goals, the Republic foregoes or defers taxing the income of the
pioneer enterprise until after that enterprise has recovered or
offset its earlier losses. The statutory purpose can be served
only if the accumulated operating losses are carried over and
charged off against income subsequently earned and
accumulated by the same enterprise engaged in the same
registered operations.47

5. De Facto Mergers or Consolidations

a. Recognition of De Facto Mergers

De facto mergers and consolidations are recognized in Philippine
jurisdiction, especially under the old Corporation Law which, unlike the present
Corporation Code, did not have specific provisions to effect statutory mergers
and consolidations.
In Reyes v. Blouse,48 the Court laid down the statutory process by which a
merger could be pursued under the old Corporation Law:

. . . the fact that the intent of the resolution of the Board

of Directors is not to dissolve the company but merely to
transfer its assets to a new corporation in exchange for its
corporate stock is clearly deducible from the provision that the
company will not be dissolved but will continue existing until its
stockholders decide to dissolve the same. This comes
squarely within the purview of Section 28 1/2 of the
Corporation Law which provides, among others, that a
corporation may sell, exchange, lease, or otherwise dispose of
all of its property and assets, including its goodwill, upon such
terms and conditions as its Board of Directors may deem
expedient when authorized by the affirmative vote of the
shareholders holding at least 2/3 of the voting power. The
phrase "or otherwise dispose of" is a very broad and in a
sense covers a merger or consolidation.49

b. De Facto Merger under the Corporation Code

Under the Corporation Code therefore, a de facto merger can be pursued
by one corporation acquiring all or substantially all of the properties of another
corporation in exchange of shares of stock of the acquiring corporation. The
acquiring corporation would end-up with the business enterprise of the target
corporation; whereas, the target corporation would end up with basically its only
remaining assets being the shares of stock of the acquiring corporation.

47
Ibid.
48
91 Phil. 305 (1952).
49
Ibid, at 309.
 The separate juridical personalities of the constituent corporations would
remain, and consequently, the successorship provisions of Section 80 of the
Corporation Code would not come into play. However, the jurisprudential rules on
the successorship of liabilities under business-enterprise transfers would apply,
such that the acquiring corporation would then be liable for the liabilities
pertaining to the business enterprise it has acquired.
In order to temper the effects of the successorship issues on liabilities, a
modification may be introduced whereby the acquiring corporation first organizes
a subsidiary, which would be the medium that will acquire the business
enterprise of the target corporation and therefore the liabilities pertaining thereto
would be directly enforceable against the subsidiary and not against the
acquiring mother corporation.

c. Statutory Provisions Applicable to De Facto Mergers

For the acquiring corporation, a direct de facto merger would not
necessarily involve the provisions of Section 42 of the Corporation Code on
investment of funds for non-primary purpose, especially when the business
enterprise acquired is in line with the primary purpose of the acquiring
corporation, but more so since the shares of stock used as consideration for the
acquisition do not really involve the use of corporate funds, but actually involve
capital account transactions. Consequently, a de facto merger may be achieved
by the Board of Directors of the acquiring corporation without having to trigger
the two-thirds (2/3) ratificatory vote of the stockholders or members.
For the target corporation, the sale or disposition of all or substantially all
of the assets would trigger application of the provisions Section 40 of the
Corporation Code, and consequently, would require the two-thirds (2/3)
ratificatory vote of the outstanding capital stock or membership, as the case may
be; but may likewise trigger the exercise of the appraisal rights of dissenting
stockholders.
If eventually, the target corporation would dissolve itself in order to effect
distribution of the shares consideration coming from the acquiring corporation,
there might not be a need for the exercise of the appraisal rights by the
dissenting stockholders. However, it is also possible to avoid the triggering of the
appraisal rights by structuring the de facto merger where the target corporation
first spin-off of the assets to a wholly owned subsidiary, and it is the subsidiary
that would eventually transfer the assets to the acquiring corporation. Since the
target corporation would be the only stockholder of the subsidiary, it will not
dissent to the transfer of assets and would not thereby trigger the appraisal rights
issue.

SPIN-OFFS
A spin-off has the opposite effect of merger or consolidation, whereby a
department, division or portions of the corporate business enterprise is sold-off or
assigned into a new corporation that will arise by the process which may
constitute it into a subsidiary of the original corporation.
American literature describes "a spin-off to exist when a parent
corporation organizes a subsidiary, to which is transferred part of parent's assets
in exchange for all of capital stock of subsidiary and stock of subsidiary is
transferred to parent's shareholders without surrender of their stock in parent."50
It is also described as one "where part of assets of corporation is transferred to a
new corporation and stock of transferee is distributed to shareholders of
transferor without surrender by them of stock in the transferor."51
Unlike in merger or consolidation where the Corporation Code has
provided for specific procedures and voting requirements to accomplish the
same, spin-offs are not regulated specifically under the Code. The nearest
provision of the Code by which spin-offs may be governed would be Section 40
which provides that in the sale, lease, exchange, mortgage, pledge or other
disposition of all or substantially all of the corporations property or assets
"whereby the corporation would be rendered incapable of continuing the
business," would require the majority vote of the board of directors or trustees,
and ratified by the vote of stockholders representing at least two-thirds (2/3) of
the outstanding capital stock, or two-thirds (2/3) of the entire membership, as the
case may be.

EFFECTS OF TRANSFERS ON EMPLOYEES

In Labor Law, the resulting rules on transfers and acquisitions differ from
the conventional wisdom given by the Supreme Court in other areas or discipline.

1. Assets-Only Transfers
In an asset-only transfer, the transferee is not bound to retain the
employees of the transferor, since the former does not really step into the shoes
of the latter. In addition, the transferee is not liable for any of the claims against
the transferor, even if the sale of the business assets of the transferor should
result in the shutting down of the transferor's operations and the laying-off of the
transferor's employees.
The issue of “whether or not the purchaser of the assets of an employer
corporation can be considered a successor employer of the latter‟s employees”
was directly raised in Sundowner Development Corp. v. Drilon.52 In that case, the
Mabuhay Hotel, Inc. which was leasing the hotel premises it was operating, by
way of amicable settlement in an ejectment case, surrendered the premises to
the lessor and sold its assets to the new lessee, the Sundowner Development
Corporation. The employees of Mabuhay Hotel subsequently sought labor rights
against Sundowner Development Corporation, and the Secretary of Labor

50
BLACK'S LAW DICTIONARY, p. 1256 (1979).
51
Ibid.
52
180 SCRA 14, 15 (1989).
directed the latter to absorb the old employees of Mabuhay Hotel which had
completely ceased operations. The Court overturned the ruling of the Secretary,
and laid down the principle involved in assets-only transfers, thus:

The rule that unless expressly assumed, labor contracts

such as employment contracts and collective bargaining
agreements are not enforceable against a transferee of an
enterprise, labor contracts being in personam, thus binding
only between the parties. A labor contract merely creates an
action in personam and does not create any real right which
should be respected by third parties. This conclusion draws its
force from the right of an employer to select his employees
and to decide when to engage them as protected under our
Constitution, and the same can only be restricted by law
through the exercise of the police power.
As a general rule, there is no law requiring a bona fide
purchaser of assets of an on-going concern to absorb in its
employ the employees of the latter.
However, although the purchaser of the assets or
enterprise is not legally bound to absorb in its employ the
employees of the seller of such assets or enterprise, the
parties are liable to the employees if the transaction between
the parties is colored or clothed with bad faith.

Although it should be properly considered a business-enterprise transfer

case, Yu v. NLRC53 nevertheless recognized that when a transferee purchases
only the assets of the transferor, the transferee cannot be held liable for the labor
claims and obligation for reinstatement adjudged against the transferor, thus:

Another factor to consider is that TDI as a corporation or

its shares of stock were not purchased by Twin Ace. The
buyer limited itself to purchasing most of the assets,
equipment, and machinery of TDI. Thus, Twin Ace or Tanduay
Distillers did not take over the corporate personality of TDI
although the manufacture the same product as the same plant
with the same equipment and machinery. Obviously, the trade
name “Tanduay” went with the sale because the new firm does
business as Tanduay Distillers and its main product of rum is
sold as Tanduay Rum. There is no showing, however, that TDI
itself absorbed by Twin Ace or that it ceased to exist as a
separate corporation.

Earlier, in MDII Supervisors and Confidential Employees Association v.

Presidential Assistant on Legal Affairs,54 where a corporation engaged in the

53
245 SCRA 134, 61 SCAD 881 (1995).
54
79 SCRA 40 (1977).
manufacture of dairy products, sold the plant and part of its assets to another
company, the Court held that the buyer of the assets cannot be held liable for the
labor claims interposed against the corporate-seller, thus: “There is no law
requiring that the purchaser of MDII‟s assets should absorb its employees. As
there is no such law, the most that the NLRC could do, for reasons of public
policy and social justice, was to direct [the buyer] to give preference to the
qualified separated employees of MDII in the filling up of vacancies in the
facilities. . .”55

2. Business-Enterprise Transfers
Following the applicable general rule, in a business-enterprise transfer,
the transferee should be bound to retain the services of the employees of the
business that it has acquired, although it is not liable for the violations that the
transferor had committed in the past and for which the transferor remains solely
liable.
This legal flow of things in business-enterprise transfers was recognized
early on in Sunio v. NLRC,56 which involved the sale by two (2) sister
corporations of their ice plant to another corporation. The Court held that "the
sale of a business of a going concern does not ipso facto terminate the
employer-employee relations insofar as the successor-employer [the transferee]
is concerned, and that change of ownership or management of an establishment
or company is not one of the just causes provided by law for termination of
employment."57 Nevertheless, the Court took into consideration that the case did
not just involve a “simple change of ownership” since before the sale of the
business enterprise, the transferors-corporations had already terminated their
employees and the latter had voluntarily accepted the payment of their
termination pay.
In effect, the termination of employment by the transferor and payment of
all proper benefits prior to actual sale is recognized by Sunio as the proper
means to avoid a situation where the transferee shall then be bound to continue
with the employments of the employees of the assumed business enterprise.
Nevertheless, the ruling in MDII (which is as asset-only transfer decision)
began to be applied in business-enterprise transfer cases.
Central Azucarera del Danao v. Court of Appeals,58 had helped
unnecessarily to dramatically change the basic rule for labor claims in business-
enterprise transfers. The facts of the decision showed that Central Azucarera
sold substantially all of its business, a sugar mill, to Danao Development
Corporation (Dadeco). Although the contract of sale made no express mention of
the continued employment status of the old employees of Central Azucarera
upon the consequent change of its ownership and management, Dadeco hired
55
Ibid at p. 47.
56
127 SCRA 390 (1984).
57
Ibid, at p. 395.
58
137 SCRA 295 (1985).
the regular and permanent employees but in accordance with its own hiring and
selection policies.
Three employees were subsequently terminated during their employ with
Dadeco. Claims for termination pay were filed by employees against both
Dadeco and Central Azucarera. Central Azucarera interposed the defense that
even on claims covering the period prior to the transfer of the sugar mill to
Dadeco, it cannot be held liable since the claims should be interposed only
against Dadeco, who is deemed to have assumed such responsibility by taking
over all the assets of the business.
The decision raised the issue decisively: “The issue that arises then is,
whether or not a change of ownership or management of an establishment or
corporation by virtue of the sale or disposition of all or substantially all of its
properties and assets operates to insulate the selling corporation . . . from its
obligation to its employees.”59 The ruling means to primarily dispose of the issue
of liability of the transferor, but it also ruled upon the issue of whether Dadeco
could also be held liable for such claims.
The Supreme Court held that the change of ownership or management of
a business establishment or enterprise is not one of the just causes under the
law,60 and cannot be construed as synonymous with nor analogous to closing or
cessation of operation of an establishment or enterprise and therefore cannot
exempt the transferor from liability for separation pay. However, it recognized as
well-established the principle "that it is within the employer's legitimate sphere of
management control of the business to adopt economic policies to make some
changes or adjustments in their organization or operations that would insure
profit to itself or protect the investments of its stockholders. As in the exercise of
such management prerogative, the employer may merge or consolidate it
business with another, or sell or dispose all or substantially all of its assets and
properties which may bring about the dismissal or termination of its employees in
the process," provided it is done in good faith,61 and in which case it is not liable
for terminated employees to claim for termination pay.
On the other hand, the Court also held that the immediate transferee of
the business enterprise has no liability to the employees of the transferor to
continue employing them; nor is the transferee liable for past unfair labor
practices of the previous owner, except, when the liability therefor is assumed by
the new employer under the contract of sale, or when liability arises because of
the new owner's participation in thwarting or defeating the rights of the
employees.

59
Ibid at pp. 303-304.
60
The old Termination Pay Law, Rep. Act No. 1052.
61
Ibid, at pp. 304-305. See also Majestic & Republic Theaters Employees Association v.
Court of Industrial Relations, 4 SCRA 457 (1962); Fernando v. Angat Labor Union, 5 SCRA 248
(1962); H. Aronson v. Associated Labor Union, 40 SCRA 7 (1971); Philippine Land-Air-Sea Labor
Union (PLASLU) v. Sy Indong Company Rice and Corn Mill, 11 SCRA 277 (1964); Cruz v.
PAFLU, 42 SCRA 68 (1971).
 The Court held that "there is no law requiring that the purchaser should
absorb the employees of the selling company." 62 Since no arrangements were
made with Dadeco on the latter's hiring of the employees of the sugar mill, the
Court therefore considered the sale by Central Azucarera of its milling business,
not as a cessation of business, but one which effectively terminated employment
of its employees and for which it was liable for termination pay.
In San Felipe Neri School of Mandaluyong, Inc. v. NLRC,63 the entire
school premises was sold by the former corporate owners to a new entity, who
then began to rehire all of the employees and teachers of the old school. The
employees then sought to be paid separation pay on the basis of their having
been terminated from employment by the sale of the school to a new entity and
their being re-hired anew by the entity. They also sought to have the new owning
entity liable for such separation pay.
The Court characterized the transaction merely as equivalent to only a
sale of assets: “It is not disputed that San Felipe Neri School of Mandaluyong,
Inc. sold its properties and assets to RCAM . . . but RCAM did not buy the school
nor assumed its liabilities. Immediately thereafter, RCAM, as the transferee-
purchaser, continued the operation of the school, but applied for a new permit to
operate the same. . . In short, there was a change of ownership or management
of the school properties and assets.”64 In holding the original owner liable, the
Court held:

Change of ownership or management of an

establishment or company, however, is not one of the just
causes provided by law for the termination of employment . . .
There can be no controversy, however, for it is a principle well-
recognized, that it is within the employer‟s legitimate sphere of
management control of the business to adopt economic
policies or make some changes or adjustments in their
organization or operation that would insure profit to itself or
protect the investment of its stockholders. As in the exercise of
such management prerogative, the employer may merge or
consolidate its business with another, or sell or dispose all or
substantially all of its assets and properties which may bring
about the dismissal or termination of its employees in the
process. Such dismissal or termination should not, however,
be interpreted in such a manner as to insulate the employer or
selling corporation (petitioner school) from its obligation to its
employees, particularly the payment of separation pay. Such
situation is not envisioned in the law. It strikes at the very
concept of social justice. . .”

62
Ibid, at p. 305, citing MDDII Supervisors & Confidential Employees Association (FFS) v.
Presidential Assistant on Legal Affairs, 79 SCRA 40 (1977).
63
201 SCRA 478 (1991).
64
Ibid at p. 484.
 In determining the liability of the transferee-RCAM, the Court took into
consideration the deed of sale which provided for no express stipulation
whatsoever relative to the continued employment by the transferee of the
employees and “[o]n the contrary, records show that RCAM expressly manifested
its unwillingness to absorb the . . . school‟s employees or to recognize their prior
service. . . And there is no law which requires the purchaser to absorb the
employees of the selling corporation.” In absolving the transferee-RCAM from
obligations to the employees, the San Felipe relied upon the rulings in MDII,
which essentially was an assets-only transfer, and of course Central Azucarera
del Danao.

a. Employees Have No Equity Claims

on the Business Enterprise
It seems clear from the Central Azucarera del Danao and San Felipe
rulings that, unlike the general rule in a business-enterprise transfer which makes
the transferee liable for the liabilities of the transferor arising from the business
enterprise pursuit, when it comes to labor claims the transferee is not obligated to
absorb the employment of the existing employees in the acquired business
enterprise, nor the outstanding claims against the transferor. The implication in
Central Azucarera del Danao is that the doctrinal basis by which creditors of a
business enterprise may rely upon the business enterprise to whomever it should
pass-on to as the security for the payment of their claims, has no application in
the field of employment, and that the employees's contractual relationship is
personal and only with the original employer-transferor.

b. Piercing Doctrine Application

This line of reasoning was reiterated in Yu v. NLRC.65 In that case a
favorable judgment was obtained by the retrenched employees against Tanduay
Distillery, Inc. (TDI) for unfair labor practice, illegal lay off, and separation
benefits. Subsequently, TDI sold its assets and product name to Twin Ace
Holdings, Inc. The officers of Twin Ace Holdings we impleaded as party
respondents, doing business under the name and style of "Tanduay Distillers."
The Court held that the original judgment of the NLRC was final and
executory and was only against TDI. The decision could not be amended to
include the officers of Twin Ace because of the fundamental rule that a final and
executory decision cannot be amended or corrected,66 no longer subject to
change, revision, amendment, or reversal,67 and the court loses jurisdiction over
it, except to order its execution.68

65
245 SCRA 134, 61 SCAD 881 (1995).
66
Citing First Integrated Bonding and Insurance Company, Inc. v. Hernando, 199 SCRA
796 (1991).
67
Citing Miranda v. Court of Appeals, 71 SCRA 295 (1976).
68
Citing PY Eng Chong v. Herrera, 70 SCRA 130 (1976).
 The Court also held that the use by Twin Ace of similar sounding or almost
identical business name of TDI was an obvious device to capitalize on the
goodwill which the name has built over the years; but that by itself did not make
the Twin Ace liable for the debts and obligations of the TDI to its employees,
thus:

Another factor to consider is that TDI as a corporation or

its shares of stock were not purchased by Twin Ace. The
buyer limited itself to purchasing most of the assets,
equipment, and machinery of TDI. Thus, Twin Ace or Tanduay
Distillers did not take over the corporate personality of TDI
although the manufacture the same product as the same plant
with the same equipment and machinery. Obviously, the trade
name “Tanduay” went with the sale because the new firm does
business as Tanduay Distillers and its main product of rum is
sold as Tanduay Rum. There is no showing, however, that TDI
itself absorbed by Twin Ace or that it ceased to exist as a
separate corporation. In point of fact TDI is now herein a party
respondent represented by its own counsel.69

The Court further held that "[r]espondent-employees have not presented

any proof as to communality of ownership and management to support their
contention that the two companies are one firm or closely related. The doctrine of
piercing the veil of corporate entity applies when the corporate fiction is used to
defeat public convenience, justify wrong, protect fraud, or defend crime or where
a corporation is the mere alter ego or business conduit of a person." 70 There was
no evidence to show communality of ownership and management to support the
contention that the two corporations are one firm or closely related, then there is
no basis to pierce their separate juridical personalities.
Another factor considered was that TDI as a corporation or its shares of
stock were not purchased by Twin Ace. The buyer limited itself to purchasing
most of the assets, equipment, and machinery of TDI. Thus, Twin Ace or
Tanduay Distillers did not take over the corporate personality of TDI although
they manufacture the same product at the same plant with the same equipment
and machinery. Obviously, the trade name "Tanduay" went with the sale because
the new firm does business as Tanduay Distillers and its main product of rum is
sold as Tanduay Rum. There was no showing, however, that TDI itself was
absorbed by Twin Ace or that it ceased to exist as a separate corporation.
Yu deemed it important that there must be a continuity of the identity of
the owners in the business. It distinguished its ruling from previous rulings of the
Supreme Court. Thus, it held that in La Campana Coffee Factory, Inc. v.
Kaisahan ng Mangagawa sa La Campana (KKM),71 that "La Campana Coffee

69
245 SCRA 134, 144. citing Diatagon Labor Federation Local 110 of the ULGWP v. Ople,
101 SCRA 534 (1980) and Palay, Inc. v. Clave, 124 SCRA 638 (1983).
70
Ibid, at p. 145, citing Indophil Textile Mill Workers Union v. Calica, 205 SCRA 697 (1992).
71
93 Phil. 160 (1953).
Factory, Inc. and La Campana Gaugau Packing were substantially owned by the
same person. They had one office, one management, and a single payroll for
both businesses. The laborers of the gaugau factory and the coffee factory were
also interchangeable, the workers in one factory worked also in the other
factory."
It compared also its ruling with the results in Clarapols v. Court of
Industrial Relations,72 where it held "the Clarapols Steel and Nail Plant, which
was ordered to pay its workers backwages, ceased operations on June 30, 1956
and was succeeded on the very next day, July 1, 1956, by the Clarapols Steel
Corporation. Both corporations were substantially owned and controlled by the
same person and there was not break or cessation in operations. Moreover, all
the assets of the steel and nail plant were transferred to the new corporation.”
Yu therefore seems to clarify that in the field of Labor Law doctrine of
business-enterprise transfer as to make the transferee liable for the business
obligations of the transferor is really a species of piercing doctrine and would
require a certain degree of continuity of the same business by the same owners
using the corporate fiction as a shield, and that the transferor has ceased to exist
and operate on its own.

c. The Need for a Clear “Break”

in Operations
The Yu ruling is in stark contrast to the ruling in Pepsi-Cola Bottling Co. v.
NLRC,73 which applied the principle applicable to business-enterprise transfer,
without having to rely upon the piercing doctrine. Involved in that case were the
claims for reinstatement of dismissed officers against the then Pepsi Cola
Distributor (PCD), which had ceased to operate because of business losses,
against an entirely different corporate entity, Pepsi-Cola Products Philippines,
Inc. (PCPPI), which subsequently acquired the franchise to sell Pepsi-Cola
products in the Philippines. In holding the new corporation liable for the
obligations of the old PCD, the Court held:

Pepsi-Cola Distributors of the Philippines may have

ceased business operations and Pepsi-Cola Products
Philippines Inc. may be a new company but it does not
necessarily follow that no one may now be held liable for
illegal acts committed by the earlier firm. The complaint was
filed when PCD was still in existence. Pepsi-Cola never
stopped doing business in the Philippines. The same soft
drinks products sold in 1988 when the complaint was initiated
continue to be sold now. The sale of products, purchases of
materials, payment of obligations, and other business acts did

72
65 SCRA 613 (1975).
73
210 SCRA 277 (1992). Reiterated in Pepsi-Cola Distributors of the Philippines, Inc. v.
NLRC, 247 SCRA 386, 63 SCAD 684 (1995), and also in Corral v. NLRC, 258 SCRA 704, 72
SCAD 171 (1996).
 not stop at the time PCD bowed out and PCPPI came into
being. There is no evidence presented showing that PCPPI, as
the new entity or purchasing company is free from any
liabilities incurred by the former corporation.

Pepsi-Cola Bottling Co. therefore reiterated the doctrine that when the
business enterprise is sold or transferred even to an entirely new entity, the
transferee is deemed to assume liabilities of the business enterprise, and the
burden of proof is with the transferee to show his non-liability.
What may have convinced it to rule as it did in Pepsi-Cola Bottling Co.
was the Court‟s finding that in the surety bond put to cover the appeal, both PCD
and PCPPI bound themselves to answer the monetary awards of the private
respondent in case of an adverse decision of the appeal, which clearly implied
that PCPPI as a result of the transfer of the franchise bound itself to answer for
the liability of PCD to its employees.
In Avon Dale Garments, Inc. v. NLRC,74 the dismissed employees
demanded that in the computation of their separation pay the period during which
the latter were employed by Avon Dale Shirt Factory should be included against
its successor-in-interests Avon Dale Garments, Inc. Although an articles of
dissolution was filed by the Avon Dale Shirt Factory with the SEC, the Supreme
Court held that the mere filing thereof without more is not enough to support the
conclusion that actual dissolution of an entity in fact took place. It therefore held
that the prevailing circumstances was that the Avon Dale Garments, Inc. is not
distinct from its predecessor Avon Dale Shirt Factory, but in fact merely
continued the operations of the latter under the same owners, the same business
venture, at same address, and even continued to hire same employees. "Thus,
conformably with established jurisprudence, the two entities cannot be deemed
as separate and distinct where there is a showing that one is merely the
continuation of the other."75
The lesson in Avon Dale Garments is therefore that for a new enterprise to
take over the business concerns of the other as not to make the new owners or
business entity liable for the labor claims against the predecessor-in-interests,
there must be a formal and substantial termination and break from the operations
of the predecessor as to constitute the transferee a separate business entity.

3. Equity Transfers
In an equity transfer, since the only result of the transaction is a change in
the ownership or control of the corporate employer, the employees remain with
the corporate employer in exactly the same manner as before the equity transfer,
and therefore the purchaser does not assume any personal liability to the
employees.

74
246 SCRA 733, 63 SCAD 268 (1995).
75
Ibid, at p. 737, citing Cagayan Valley Enterprises, Inc. v. Court of Appeals, 179 SCRA 218
(1989).
 For example, in Development Bank of the Philippines v. NLRC,76 the
Supreme Court held that the fact that instead of foreclosing on the mortgaged
assets, DBP converted its loans to equity making it the controlling stockholder of
a bank, and although the majority of the members of the board of directors of the
bank were designated by DBP, the same did not make DBP an employer of the
bank employees, nor did it make DBP liable for the wage claims of the bank's
employees. The clear implication is that in equity transfers, the corporate-
employer remains liable for its employment contracts and the claims that may
arise therefrom.
Unfortunately, in Manlimos v. NLRC,77 the Supreme Court, through then
Justice Davide, went to the extreme case of applying to an equity purchase the
business-enterprise transfer doctrine of Central Azucarera del Danao. It was
obvious that Manlimos did not appreciate the difference between an equity
transfer and a business-enterprise transfer.
In Manlimos, the complete ownership and management of Super
Mahogany Plywood Corporation, a domestic corporation engaged in plywood
manufacturing, were taken over by a new group of investors who bought the
controlling shareholdings thereof. The employees of the corporation were
informed of such change of ownership, who continued to work for the "new
owner" and were considered terminated, with their conformity, up to a short
period and at the end of which they received separation pay, 13th month pay and
other benefits. Later, the separated employees sought reinstatement on the
ground that their termination was illegal since they remained regular employees
of the corporation regardless of the change of management.
The Court, in upholding the separation of some of the employees who
were not re-hired, held that a change of ownership in a business concern is not
proscribed by law,78 relying upon the rulings in Sunio and Central Azucarera del
Danao, both of which were business-enterprise transfer cases. The Court held in
Manlimos: "Where such transfer of ownership is in good faith, the transferee is
under no legal duty to absorb the transferor's employees as there is no law
compelling such absorption. The most that the transferee may do, for reasons of
public policy and social justice, is to give preference to the qualified separated
employees in the filling of vacancies in the facilities of the purchaser."79 The
ruling cited two other cases as the basis for such ruling, namely MDII
Supervisors and Confidential Employees Association v. Presidential Assistant on
Legal Affairs,80 which involved essentially an asset-only transfer, and San Felipe
Neri School of Mandaluyong, Inc. v. NLRC,81 which involved a business-
enterprise transfer.

76
186 SCRA 841 (1990).
77
242 SCRA 145, 59 SCAD 445 (1995).
78
Ibid, citing Sunio v. NLRC, 127 SCRA 390 (1984).
79
Ibid.
80
79 SCRA 40 (1977).
81
201 SCRA 478 (1991).
 The logic of the reasoning in Manlimos is flawed, since with the change of
majority ownership of a corporation, the relationship of employer-employee in the
business does not change, and the corporate-employer, which has a juridical
personality separate and distinct from the new set of stockholders, remains the
same employer to the employees of the business.
Robledo v. NLRC,82 would make the successor enterprise liable for the
debts of the previous enterprise on the basis of piercing doctrine scenario. In that
case, the BASEC corporation was organized to be engaged in operating security
agency, having as one of its incorporators Bacani, who also had at that time a
security agency operated as a single proprietorship. Later, Bacani closed down
his operations and terminated his employees. His terminated employees sought
to hold the BASEC corporation liable for unpaid overtime and legal holiday pays,
contending that Bacani intentionally closed his operations to allow expansion of
the business through BASEC. They contended that the Bacani family merely
continued the operation of the business by creating BASEC in order to avoid the
obligations of the former, contending that Bacani became an incorporator of
BASEC together with his wife and daughter.
The Court held that the doctrine of piercing the veil of corporate entity is
used whenever a court finds that the corporate fiction is being used to defeat
public convenience, justify wrong, protect fraud, or defend crime, or to confuse
legitimate issues, or that a corporation is the mere alter ego or business conduit
of a person or where the corporation is so organized and controlled and its affairs
are so conducted as to make it merely an instrumentality, agency, conduit or
adjunct of another corporation.83 The Court refused to make BASEC liable for the
claims of the terminated employees since the facts showed that BASEC already
existed prior to closure of Bacani of his operations; that Bacani was merely one
of the five incorporators with the lease number of shares in BASEC; and there
was no showing that the assets of the single proprietorship were even transferred
to BASEC.

4. Mergers and Consolidations

In mergers and consolidation, because of the specific provisions of
Section 80 of the Corporation Code which mandates that the surviving or
consolidated corporation must necessarily assume all the liabilities of the
constituent corporations, it would be logical to expect that the contractual rights
of employees and the existing collective bargaining agreement, if any, would
have to be absorbed by the surviving or consolidated corporation. Again,
however, the rulings of the Supreme Court run against the natural grain.
In National Union Bank Employees v. Lazaro,84 the Supreme Court
recognized the legal effects of Section 80 of the Corporation Code that the
surviving corporation in a merger would be considered as the successor

82
238 SCRA 52, 56 SCAD 485 (1994).
83
Ibid, at p. 57.
84
156 SCRA 123 (1988).
employer with respect to the claims of employees of the constituent corporation,
even with respect to CBA deadlock situations which existed right before the
merger of the companies.
The ruling of the Court in Filipinas Port Services, Inc. v. NLRC,85 that the
employees of a predecessor-constituent corporation cannot avail of their
previous tenure when determining their termination benefits with the surviving
corporation in the merger, is in direct opposition to the subsequent ruling in
Filipinas Port Services, Inc. v. NLRC,86 that the employees have a right to their
retirement benefits computed from the time worked with the predecessor-
constituent corporations, saying there was no break in the employer-employee
relationship.
In First General Marketing Corp. v. NLRC,87 the Court ruled that because
of the specific provision in the merger document expressly provide that the
surviving corporation would assume all the benefits derived from the existing
CBA, then the contractual stipulation was binding. But the ruling was more an
application of contract law principles.

5. Spin-off
In San Miguel Corp. Employees Union-PTGWO v. Confessor,88262 SCRA
81 (1996), where San Miguel Corp. spun-off its Magnolia ice cream division to a
new Magnolia Corporation, and the feeds and livestock division into the San
Miguel Feeds, Inc., the Supreme Court held that spin-offs were done for valid
business cause and in good faith, and therefore valid spin-offs. The Court denied
the SMC union‟s petition to include the employees in the spun-off divisions to be
within the SMC bargaining unit, and held that the employees in the new
corporations constitute new bargaining units. MSCve cnlude 8it

—oOo—

CORP. MANUSCRIPT\13-ACQUISITIONS & MERGER.DOC\07-30-2002

85
177 SCRA 203 (1989).
86
200 SCRA 773 (1991).
87
223 SCRA 337, 42 SCAD 349 (1993).
88
262 SCRA 81, 74 SCAD 465 (1996).
 CHAPTER 14

SUSPENSION OF PAYMENTS,
REHABILITATION, AND INSOLVENCY
PROCEEDINGS

SUSPENSION OF PAYMENTS
Under Insolvency Law
Under Pres. Decree 902-A
Laws Applicable to Corporate Suspension of Payments
Two Types of Suspension of Payments Proceedings
CORPORATE REHABILITATION
Basis of RTC Power to Undertake Corporate Rehabilitation
Nature and Purpose of Corporate Rehabilitation
Rules on Rehabilitation
Appointment of Management Committee/Rehabilitation Receiver
Power of RTC to Appoint a Management Committee
Legal Effect of Appointment of Management Committee/Rehabilitation Receiver;
the Automatic Stay
Rationale of Automatic Stay on Existing Suits and Causes of Action
Meaning of "Claims"
Creditors Covered by Automatic Stay
Suspension of Employees’ Claims
Jurisdiction Over Non-Corporate Debtor
Powers of the Management Committee/Rehabilitation Receiver
Approval of Rehabilitation Plan; Cram Down Power of RTC
POWER TO LIQUIDATE CORPORATIONS
INSOLVENCY PROCEEDINGS
Governing Law and Jurisdiction
Voluntary Insolvency
Filing of Petition
Effect of Order of Insolvency
Appointment of Assignee
Effect of Appointment of Assignee
Function of Assignee
Involuntary Insolvency
Filing of Petition
Qualifications of Petitioning Creditors
Standing Foreign Corporate Creditors to Petition
Acts of Insolvency
Effects of Order of Insolvency and Appointment of Receiver
Procedure
General Effect of Corporate Insolvency Proceedings
 ——

SUSPENSION OF PAYMENTS
UNDER INSOLVENCY LAW
As far as corporations are concerned, the Insolvency Law 1 provides that a
corporation "possessing sufficient property to cover all [its] debts . . . but foresees
the impossibility of meeting them when they respectively fall due, may petition
that [it] be declared in the state of suspension of payments by the court."2
The following procedure, requirements and legal consequences are
provided for in the Law:

1. The Petition shall be filed in court, annexing:

(a) An inventory of corporate assets;

(b) Schedule of corporate liabilities; and

(c) Proposed agreement requested of the creditors;3

2. The court shall then issue an order (with the requisite

publication thereof):
(a) Calling a meeting of creditors; and
(b) Containing an absolute injunction:
(i) Forbidding the corporation during the
proceedings from disposing in any manner
its property, except in the ordinary
operations of the business; and
(ii) From making any payments outside of the
necessary or legitimate expenses of the
business;4
3. As to the unsecured creditors:
(i) Any execution pending shall not be consolidated
with the proceedings, but shall be suspended
before sale of property is made thereunder,
provided that the debtor makes a request therefor
1
Act No. 1956, as amended.
2
Sec. 2, The Insolvency Law.
3
Ibid.
4
Sec. 3, Ibid.
 to the court where the proceedings for suspension
of payments are pending;5
(ii) They cannot sue or institute suit to collect their
claims during the suspensions of payment
proceedings;6
4. For secured creditors, no such suspension of proceedings
can be obtained;7
5. The suspension order shall lapse after three (3) months have
passed without the proposed agreement being accepted by
the creditors or when it is denied;
6. Only creditors included in the annexed schedule shall be
cited to appear and take part in the meeting;8
7. The presence of creditors representing at least three-fifths
(3/5) of the liabilities of the corporation shall be necessary for
the valid holding of meeting;9
8. To obtain a majority vote it is necessary that two-thirds (2/3)
of the creditors voting shall unite upon the same proposition,
and the claims represented by said majority vote total to at
least three-fifths (3/5) of the liabilities of the corporation;10
9. The proposed agreement shall be deemed rejected if the
number of creditors required for holding a meeting does not
attend thereat, or the two majorities required for approval
thereof is not obtained, even if the negative vote itself does
not receive such majorities;11
10. The following are not bound by any agreement determined
upon at the creditors‘ meeting, but if they should join the
voting they shall be bound in the same manner as are the
other creditors:12
(i) Persons having claims for personal labor,
maintenance, incurred within sixty (60) days
immediately preceding the filing of the petition;
and
(ii) Persons having legal or contractual mortgages;13

5
Sec. 6, Ibid.
6
Sec. 6, ibid.
7
Ibid.
8
Sec. 5, Ibid.
9
Sec. 8, ibid.
10
Sec. 8(e)(1), Ibid.
11
Sec. 10, ibid.
12
Ibid.
13
Sec. 9, ibid.
 11. If the decision of the meeting be negative, or if no decision is
had in default of such number of majorities, the proceedings
shall be deemed terminated without recourse, and the
parties concerned shall be at liberty to enforce the rights
which may correspond to them;14
12. If the proposed agreement is validly approved, and in spite of
opposition thereto heard by the court, the court shall issue
an order directing the agreement to be made effective and
binding on all creditors included in the schedule and properly
summoned, but not upon secured creditors and those who
have employment claims against the corporation;15 and
13. If the corporation fails wholly or in part to perform the
approved agreement, all the rights which the creditors had
against the corporation before the agreement shall revest to
them, and the corporation may be made subject to
insolvency proceedings.16

UNDER PRES. DECREE 902-A

Originally, under Pres. Decree 902-A, corporate suspension of payments
and rehabilitation proceedings were within the original and exclusive jurisdiction
of the SEC; now such proceedings are within the jurisdiction of the Regional Trial
Courts (RTC).
Section 5(d) of Pres. Decree 902-A, pursuant to Section 5.2 of the
Securities Regulation Code,17 provides for the exclusive jurisdiction of the RTC
over petitions of corporations "to be declared in a state of suspension of
payments in cases where the corporation . . . possesses property to cover all of
its debts but foresees the impossibility of meeting them when they respectively
fall due or in cases where the corporation . . . has no sufficient assets to cover its
liabilities, but is under the management committee created pursuant to this
Decree."
The rule was that in an ordinary proceeding for the suspension of
payments of a petitioning corporation which has enough assets to meet its
liabilities, the provisions of the Insolvency Law on the matter would still apply,
except to the extent that the procedural rules are amended or supplemented by
proper rules issued by the SEC (now the Supreme Court). However, although the
provisions of the Insolvency Law should apply to ordinary proceedings for
suspension of payments involving corporations, the same are not mandatory in
the sense that because of the broad powers granted to the SEC (now the RTC)
under Pres. Decree 902-A, the RTC may choose to appoint a management
14
Sec. 11, ibid.
15
Ibid.
16
Sec. 13, ibid.
17
Rep. Act No. 8799 (2000).
committee or rehabilitation receiver that will operate and be bound not by the
terms of the Insolvency Law, but in accordance with the broad powers granted to
them by the Decree.

1. Laws Applicable to Corporate Suspension

of Payments Proceedings
The Insolvency Law provides clear rules and procedural requirements
which ought to be binding on the RTC even under the terms of Pres. Decree 902-
A. Since the Decree primarily sought to provide for the organizational structure,
jurisdiction and powers of the SEC, therefore, to the extent not otherwise
amended under the terms of Pres. Decree 902-A, the terms and provisions of the
Insolvency Law were binding on SEC, and continue to be binding on the RTC, in
simple suspension of payments and insolvency proceedings. This principle was
recognized in Ching v. Land Bank of the Philippines,18 when it held that:

The SEC, like any other administrative body, is a tribunal

of limited jurisdiction and as such, could wield only such
powers as are specifically granted to it by its enabling statute.
Its jurisdiction should be interpreted in strictissimi juris.19

More importantly, in resolving the issue on whether Section 6 of Pres.

Decree 902-A is deemed to have repealed the provisions of the Insolvency Law,
Ching held that:

A well-recognized rule in statutory construction is that

repeals by implication are not favored and will not be so
declared unless it be manifest that the legislature so intended.
When statutes are in pari materia they should be construed
together. In construing them the old statutes relating to the
same subject matter should be compared with the new
provisions and if possible by reasonable construction, both
should be construed that effect may be given to every
provision of each.20

The implication and conclusion are clear, that since Pres. Decree 902-A
has not expressly repealed the provisions of the Insolvency Law as they apply to
corporations and other juridical entities, they must be construed as still binding
on the SEC, now the RTC, on suspension of payments and insolvency
proceedings validly filed, insofar as they have not been amended or supplanted
by specific provisions of the Decree.

2. Two Types of Corporate Suspension of

Payments Proceedings

18
201 SCRA 190 (1991).
19
Ibid, at p. 198.
20
Ibid, at p. 202.
 A comparison of the Insolvency Law and the relevant provisions of Pres.
Decree 902-A, as they have been interpreted by the Supreme Court, would
reveal the basic differences between the two (2) types of suspension of
payments proceedings involving corporate debtors:

(a) Under the Insolvency Law, the suspensive effect of the order
issued pursuant to the petition does not cover secured
creditors, while the suspensive effect under Pres. Decree
902-A upon appointment of the management
committee/rehabilitation receiver, would cover all corporate
creditors, both secured and unsecured;
(b) Under the Insolvency Law, in the absence of any agreement
among the corporate creditors, the automatic stay would
expire after three (3) months; under Pres. Decree 902-A, the
automatic stay has no time limit and prevails for so long as
the corporate debtor is under a management
committee/rehabilitation receiver and there is no directive to
liquidate its assets;
(c) The final agreement on the manner of payment of the
obligations of the corporate debtor is subject to the qualifying
majority votes required under the Insolvency Law; while
under Pres. Decree 902-A, the management
committee/rehabilitation receiver is granted sufficient powers
to take such measures as are necessary to bring back to
financial health the distressed company without need to
obtain creditors‘ approval.

The Interim Rules of Procedure on Corporate Rehabilitation (2000) do not

recognize corporate suspension of payments proceedings under Pres. Decree
902-A, and impliedly recognize only proceedings under the Insolvency Law.

CORPORATE REHABILITATION
BASIS OF RTC POWER TO UNDERTAKE
CORPORATE REHABILITATION
Under the declared government policy of encouraging investments and
more active participation in the affairs of private corporations and enterprises
through which desirable activities may be pursued for the promotion of economic
development and to promote a wider and more meaningful equitable distribution
of wealth, creating therefore a need to have an agency to be invested with ample
powers to protect such investment and the public,21 the powers and jurisdiction of
the SEC and its organization were enhanced and streamlined under Pres.

21
First Whereas clause of Pres. Decree 902-A.
Decree 902-A. The SEC under the Decree was granted powers to pursue the
management or rehabilitation of private corporations through the appointment of
a management committee or a rehabilitation receiver.
Pursuant to the terms of Section 5.2 of the Securities Regulation Code,
such jurisdiction over corporate rehabilitation proceedings has been transferred
to the RTC, which should therefore continue to act under such mandate.

NATURE AND PURPOSE OF CORPORATE REHABILITATION

One author22 has defined corporate rehabilitation as a process "to try to
conserve and administer [the corporation's] assets in the hope that it may
eventually be able to return from financial stress to solvency. It contemplates of
the continuation of corporate life and activities so that it may be able to return to
its former condition of successful operations and financial stability."
The Supreme Court has held that "[r]ehabilitation contemplates a
continuance of corporate life and activities in an effort to restore and reinstate the
corporation to its former position of successful operation and solvency." 23
Likewise, the Court has held that ―the rehabilitation of a financially
distressed corporation benefits its employees, creditors, stockholders and, in a
larger sense, the general public. And in considering whether to rehabilitate or not,
the SEC gives preference to the interest of creditors, including employees. The
reason is that shareholders can recover their investments only upon liquidation of
the corporation, and only if there are assets remaining after all corporate
creditors are paid.‖24

RULES ON REHABILITATION
As of the writing of this chapter, the Supreme Court had approved the
Interim Rules of Procedure on Corporate Rehabilitation (2000), which were
based primarily on the provisions of the SEC Rules on Corporate Recovery.
The rehabilitation proceedings are mandated under the Interim Rules to
be in rem, summary and non-adversarial in nature.25 The orders issued by the
RTC in such proceedings are immediately executory.26
The Interim Rules provide for the following basic steps for rehabilitation:

1. Filing of the verified Petition with the appropriate RTC27 by:

22
Balgos, Corporate Rehabilitation: Should Secured Creditors Queue?, 8 PHIL. L. GAZ. 1
(Nos. 6-7), citing BLACK'S LAW DICTIONARY, p. 1451.
23
Ruby Industrial Corp. v. Court of Appeals, 284 SCRA 445, 90 SCAD 407 (1998).
24
Rubberworld (Phils.), Inc. v. NLRC, 305 SCRA 721, 105 SCAD 485 (1999).
25
Sec. 1, Rule 3, Interim Rules of Procedure on Corporate Rehabilitation.
26
Sec. 5, Rule 3, ibid.
27
Sec. 4-1, Interim Rules of Procedure on Corporate Rehabilitation.
 (a) Corporate debtor which foresees the impossibility of meeting
its debts when they respectively fall due; or

(b) Creditor(s) holding at least 25% of the debtor‘s total liabilities;

2. The following shall be annexed to the Petition:28
(a) Audited financial statements at end of its last fiscal year;
(b) Interim financial statements;
(c) Schedule of Debts and Liabilities;
(d) Inventory of Assets;
(e) Rehabilitation Plan;
(f) Schedule of Payments and disposition of assets effected within
three (3) months preceding filing of Petition;
(g) Schedule of Cash Flow for the last three (3) months;
(h) Statement of Possible Claim;
(i) Affidavit of General Financial Condition;
(j) At least three (3) nominees for rehabilitation receiver;
(k) Certificate under oath that directors and stockholders have
irrevocably approved/consented to all actions/matters
necessary under the rehabilitation plan.29
3. The Rehabilitation Plan shall include:
(a) Desired business assets or goals and the duration and
coverage of the rehabilitation;
(b) Terms and conditions of such rehabilitation, including manner
of implementation, giving due regard to the interest of secured
creditors;
(c) Material financial commitments to support the rehabilitation
plan;
(d) Means for execution of rehabilitation plan, which may include
debt-to-equity conversion, restructuring of debts, dacion en
pago, sale of assets or of controlling interests;
(e) Liquidation analysis that estimates the proportion of the claims
that the creditors, and shareholders would receive if the
debtors‘ properties were liquidated; and
(f) Such other relevant information to enable a reasonable
investor to make an informed decision on the feasibility of the
rehabilitation plan.

28
Sec. 2, Rule 4, ibid.
29
Only a rehabilitation plan and list of nominees to position of rehabilitation receiver need to
be annexed to the Petition when filed by creditors. Sec. 4, Rule 4, ibid.
 4. Issuance of the stay order30 not later than five (5) days from
the filing of the Petition which, among others, shall:
(a) Appoint a rehabilitation receiver for the petitioning
corporate debtor;
(b) Stay all actions for claims against the debtor, which
shall cover both secured and unsecured creditors or
claimants;31
(c) Set an initial hearing for the Petition; and
(d) Direct the creditors and other interested parties to file
their verified commend on or opposition to the Petition
not later than ten (10) days before the initial hearing
and putting them on notice that their failure to do so
would bar them from participating in the proceedings;
5. Publication of the stay order in a newspaper of general
circulation in the Philippines once a week for two (2)
consecutive weeks,32 which makes the proceeding in rem in
nature;33
6. Initial hearing on the Petition not earlier than forty-five (45)
days but not laterthan sixty (60) days from the filing of the
Petition;34
7. Referral of rehabilitation plan to rehabilitation receiver who
shall submit his recommendation thereon to the RTC not
later than ninety (90) days from the initial hearing;35
8. Meetings between corporate debtor and/or rehabilitation
receiver with the creditors and other interested parties, which
should take place before the final revision of the plan prior to
its final submission to the RTC for approval;36
9. Modification or revision by the debtor of the rehabilitation plan
in the light of the comments, opposition or discussions with
the rehabilitation receiver, creditors and other interested
parties;37

30
Sec. 4-6, ibid.
31
The stay order covers both secured and unsecured creditors, in line with the principle of
―equality is equity‖ doctrine in rehabilitation proceedings since allowing the secured creditors to
enforce their liens may hinder or prevent the rescue of the corporate debtor. See B.F. Homes,
Inc. v. Court of Appeals, 190 SCRA 262 (1990); Alemar’s Sibal & Sons, Inc. v. Elbinias, 186
SCRA 94 (1990); and Bank of the Philippine Islands v. Court of Appeals, 229 SCRA 223 (1994).
32
Sec. 6, Rule 4, ibid.
33
Sec. 1, Rule 3, ibid.
34
Sec. 6, Rule 4, ibid.
35
Sec. 9, Rule 4, ibid.
36
Sec. 21, Rule 4, ibid.
37
Sec. 22, Rule 4, ibid.
 10. Submission of a final rehabilitation plan to the RTC for
approval;38
11. The Petition shall be dismissed (which results into the
automatic lifting of the stay order unless otherwise ordered
by the RTC) if no rehabilitation plan is approved by the RTC
after one-hundred-eighty (180) days from the date of the
initial hearing;39
12. Approval or disapproval of the rehabilitation plan by the RTC:
(a) If approved, implementation of the plan and
modifications in the course thereof if necessary to meet
the desired business targets;40 or
(b) If not approved, the Petition shall be dismissed.41

APPOINTMENT OF MANAGEMENT COMMITTEE/

REHABILITATION RECEIVER
1. Power to Appoint Management Committee
under Pres. Decree 920-A
Under Section 6 (c) and (d) of Pres. Decree 902-A, in order to effectively
exercise its jurisdiction, the SEC (now the RTC) is empowered:
(a) To appoint one or more receivers of the property, real or
personal, which is the subject of action pending before the
RTC in accordance with the pertinent provisions of the Rules
of Court;
(b) In appropriate cases, appoint a rehabilitation receiver of
corporations not supervised or regulated by other
government agencies who shall have, in addition to the
powers of a regular receiver under the provisions of the
Rules of Court, such functions and powers as provided in the
Decree; and
(c) Upon petition or motu proprio, to appoint a management
committee, board, or body to undertake the management of
corporations not supervised or regulated by other
government agencies in appropriate cases when there is
imminent danger of dissipation, loss, wastage or destruction
of assets or other properties or paralyzation of business
operations of such corporations which may be prejudicial to

38
Sec. 22, Rule 4, ibid.
39
Sec. 11, Rule 4, ibid.
40
Sec. 26, Rule 4, ibid.
41
Sec. 11, Rule 4, ibid.
 the interest of minority stockholders, parties-litigants or the
general public.

The powers granted to the SEC under Section 6 of the Decree are
"intended to effectively exercise such jurisdiction" enumerated under Section 5 of
the Decree. The enumerated jurisdictions do not only cover proceedings for
suspension of payments, but also in intra-corporate disputes, fraud scheme
proceedings, and election of officers and directors.42 Consequently, such powers
are also vested with the RTC‘s in the exercise of their jurisdiction under Section 5
of Pres. Decree 902-A.
The Interim Rules of Procedure on Corporate Rehabilitation (2000) do not
contain any provisions for the appointment of a Management Committee, and in
effect only recognize the appointment of a Rehabilitation Receiver. The
Rehabilitation Receiver under the Interim Rules, ―shall not take over the
management and control of the debtor but shall closely oversee and monitor the
operations of the debtor during the pendency of the proceedings, and for this
purpose shall have the powers, duties and functions of a receiver under
Presidential Decree No. 902-A, as amended, and the Rules of Court.43
Subsequently, however, the Supreme Court issued the Interim Rules of
Procedure Governing Intra-Corporate Controversies, which under Rule 9
recognizes that ―as an incident to any of the cases filed under this Rules or the
Interim Rules on Corporate Rehabilitation, a party may apply for the appointment
of a management committee for the corporation.‖ Under the Interim Rules, the
management committee would have the extensive powers under Sec. 6 of Pres.
Decree 902-A.

2. Legal Effect of Appointment of Management Committee/

Rehabilitation Receiver; the Automatic Stay
The Decree provides that "upon appointment of a management
committee, rehabilitation receiver, board or body, . . . all actions for claims
against the corporation . . . under management or receivership pending before
any court, tribunal, board or body shall be suspended accordingly,"44 which is
known in American bankruptcy parlance as the "automatic stay."
The Decree does not provide for any duration of the automatic stay, and
therefore is deemed to apply during the entire period that the corporate debtor is
under the management committee or the rehabilitation receiver.45 In one case,46
the Supreme Court held that Pres. Decree 902-A itself does not provide for the
duration of the automatic stay; hence, the suspensive effect has no time limit and
remains in force as long as reasonably necessary to accomplish the purpose of
the SEC order.
42
See Ching v. Land Bank of the Philippines, 201 SCRA 190, 201-202 (1991).
43
Sec. 14, Rule 4, ibid.
44
Sec. 6(c), Pres. Decree No. 902-A.
45
See BF Homes, Inc. v. Court of Appeals, 190 SCRA 262, 268 (1990).
46
Rubberworld (Phils.), Inc. v. NLRC, 305 SCRA 721, 105 SCAD 485 (1999).
 In the original decision in Rizal Commercial Banking Corporation v.
Intermediate Appellate Court, 47 the Supreme Court had ruled that the suspensive
effect, such as the prohibition against foreclosure, "attaches as soon as a petition
for rehabilitation is filed. Were it otherwise, what is to prevent the petitioner from
delaying the creation of the Management Committee and in the meantime
dissipate all its assets. The sooner the SEC takes over and imposes a freeze on
all the assets, the better for all concerned."
In resolving a motion for reconsideration of the original decision, RCBC,
the Supreme Court in its ruling on 9 December 1999, reversed its position and
ruled that the automatic stay would be effective only upon the appointment of a
management committee or a rehabilitation receiver on the basis of the clear
language of Pres. Decree 902-A.
The Supreme Court‘s reconsideration of its original ruling in RCBC was in
line with its ruling in Barotac Sugar Mills, Inc. v. Court of Appeals,48 where it was
held that the appointment of a management committee or rehabilitation receiver
may only take place after the filing with the SEC of an appropriate petition for
suspension of payments. The conclusion is inevitable that pursuant to Section
6(c), taken together with Sections 5(c) and (d), a court action is ipso jure
suspended only upon the appointment of a management committee or a
rehabilitation receiver.
Under Sec. 11, Rule 4 of the Interim Rules, the stay order shall be
effective from the date of its issuance until the dismissal of the Petition or the
termination of the rehabilitation proceedings; and unless an extension is granted
by the RTC on the basis of ―convincing and compelling evidence that the debtor
may successfully be rehabilitated,‖ the Petition shall be dismissed if no
rehabilitation plan is approved by the RTC upon the lapse of one-hundred eighty
(180) days from date of initial hearing.

a. Rationale of Automatic Stay on Existing Suits

and Causes of Action
Finasia Investments and Finance Corp v. Court of Appeals,49 gave the
rationale for the automatic stay provided for under Section 6(c) of Pres. Decree
902-A, thus:

. . . The cause of action therein does not consist of

demand for a payment of debt or enforcement of pecuniary
liability. It has nothing to do with the purpose of Section 6(c) of
P.D. 902-A, as amended, which is to prevent a creditor from
obtaining an advantage or preference over another with
respect to action against corporations . . . under management
or receivership and to protect and preserve the rights of party

47
213 SCRA 830, 838 (1992).
48
275 SCRA 497, 84 SCAD 560 (1997).
49
237 SCRA 446, 56 SCAD 67 (1994).
 litigants as well as the interest of the investing public or
creditors. . .50

The suspension of all actions under Pres. Decree 902-A ―is intended to
give enough breathing space for the management committee or rehabilitation
receiver to make the business viable again, without having to divert attention and
resources to litigations in various fora.‖51

b. Meaning of "Claims"
Finasia also has held that the "claims" covered by Section 6(c) of the
Decree "refers to debts or demands of a pecuniary nature. It means ‗the
assertion of a right to have money paid. It is used in a special proceedings like
those before administrative court, on insolvency.‘"52 Therefore, in spite of the
appointment of a rehabilitation receiver for a corporation under Pres. Decree
902-A, an action against a corporation seeking the nullification of the corporate
documents cannot be suspended by reason thereof, since the civil action does
not present a monetary claim against the corporation.

The Interim Rules of Procedure on Corporate Rehabilitation of the

Supreme Court now define ―claim‖ to include ―all claims or demands of whatever
nature or character against a debtor or its property, whether for money or
otherwise."53 The rule effectively reverses the Finasia ruling.

c. Creditors Covered by Automatic Stay

Unlike the provisions in the Insolvency Law which exempts secured
creditors from the suspensive effect of the order issued by the court in an
ordinary suspension of payments proceedings, the provisions of Pres. Decree
902-A, when it comes to the appointment of a management committee or a
rehabilitation receiver, do not contain an exemption for secured creditors from the
suspensive effect provided in the Decree.
Originally, in the early case of Philippine Commercial Bank v. Court of
Appeals,54 the Supreme Court, relying on jurisprudential rule pre-Pres. Decree
902-A, held that the SEC's order for suspension of payments of a corporation, as
well as for all actions of claims against the corporation, could only be applied to
claims of unsecured creditors and that "[s]uch orders can not extend to creditors

50
Ibid, at p. 451.
51
Rubberworld (Phils.), Inc. v. NLRC, 305 SCRA 721, 105 SCAD 485 (1999).
52
Ibid, at p. 450. The Court also quoted the definition of BLACK'S LAW LEGAL DICTIONARY
(5th ed.) of "claim": "Right to payment, whether or not such right is reduced to judgment,
liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal,
equitable, secured, or unsecured; or right to an equitable remedy for breach of performance if
such breach gives rise to a right to payment, whether or not such right to an equitable remedy is
reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured,
unsecured." at p. 224.
53
Sec. 1, Rule 2.
54
172 SCRA 436 (1989).
holding a mortgage, pledge or any lien on the property unless they give up the
property, security or lien in favor of all the creditors."55
The PCIB ruling was abrogated in several subsequent decisions of the
Supreme Court,56 interpreting the proper coverage of the automatic stay upon the
SEC's appointment of a management committee or rehabilitation receiver, ruling
that whenever a distressed corporation has asked the SEC for rehabilitation and
suspension of payments, preferred creditors may no longer assert such
preference, but shall stand on equal footing with other creditors.
Alemar's Sibal & Sons, Inc. v. Elbinias,57 held that during rehabilitation
receivership, the assets are held in trust for the equal benefit of all creditors to
preclude one from obtaining an advantage or preference over another by the
expediency of attachment, execution or otherwise. The Court held:

. . . For what would prevent an alert creditor, upon

learning of the receivership, from rushing posthaste to the
courts to secure judgments for the satisfaction of its claims to
the prejudice of the less alert creditors.
As between creditors, the key phrase is "equality is
equity." When a corporation threatened by bankruptcy is taken
over by a receiver, all the creditors should stand on an equal
footing. Not anyone of them should be given any preference
by paying one or some of them ahead of the others. This is
precisely the reason for the suspension of all pending claims
against the corporation under receivership. Instead of creditor
vexing the courts with suits against the distressed firm, they
are directed to file their claims with the receiver who is a duly
appointed officer of the SEC.58

BF Homes, Inc. v. Court of Appeals,59 also explained that the reason for
suspending actions for claims against a corporation is to enable the management
committee or rehabilitation receiver to effectively exercise its/his powers free
from any judicial or extra-judicial interference that might unduly hinder the
"rescue" of the debtor company.60
Bank of the Philippine Islands v. Court of Appeals,61 held that even
foreclosure of mortgage shall be disallowed so as not to prejudice other creditors
or cause discrimination among them. If foreclosure is undertaken despite the fact

55
Ibid, at p. 440, citing Chartered Bank v. Imperial and National Bank, 48 Phil. 931.
56
Alemar's Sibal & Sons v. Elbinias, 186 SCRA 945 (1990); BF Homes, Inc. v. Court of
Appeals, 190 SCRA 262 (1990); Araneta v. Court of Appeals, 211 SCRA 390 (1992); Rizal
Commercial Banking Corp. v. Intermediate Appellate Court, 213 SCRA 830 (1992); and State
Investment House, Inc. v. Court of Appeals, G.R. No. 123240, 5 Feburary 1996 (unrep.).
57
186 SCRA 94 (1990).
58
Ibid, at pp. 99-100.
59
190 SCRA 262 (1990).
60
Ibid, at p. 269.
61
229 SCRA 223, 47 SCAD 186 (1994).
that a petition for rehabilitation has been filed, the certificate of sale shall not be
delivered pending rehabilitation. If that has already been done, no transfer
certificate of title shall likewise be effected within the period of rehabilitation. The
Court held that the rationale behind Pres. Decree 902-A, is to effect a feasible
and viable rehabilitation, which cannot be achieve if one creditor is preferred over
the others.62
Ruby Industrial Corp. v. Court of Appeals,63 held that when a distressed
company is placed under rehabilitation, the appointment of a management
committee follows to avoid collusion between the previous management and
creditors it might favor, to the prejudice of the other creditors: "All assets of a
corporation under rehabilitation receivership are held in trust for the equal benefit
of all creditors to preclude one from obtaining an advantage or preference over
another by the expediency of attachment, execution or otherwise. As between
the creditors, the key phrase is equality in equity. Once the corporation
threatened by bankruptcy is taken over by a receiver, all the creditors ought to
stand in equal footing. Not any one of them should be paid ahead of the others.
This is precisely the reason for suspending all pending claims against the
corporation under receivership."
In Rubberworld (Phils.), Inc. v. NLRC,64 the Court held that the credit
preferences provided for by law, particularly the preferential rights of workers and
employees under Article 10 of the Labor Code, were no longer applied in
rehabilitation proceedings, thus: ―The preferential right of workers and employees
under Article 110 of the Labor Code may be invoked only upon the institution of
insolvency or judicial liquidation proceedings. Indeed, it is well-settled that ‗a
declaration of bankruptcy or a judicial liquidation must be present before
preferences over various money claims may be enforced.‗ But debtors resort to
preferences of credit – giving preferred creditors the right to have their claims
paid ahead of those of other claimants – only when their assets are insufficient to
pay their debts fully. The purpose of rehabilitation proceedings is precisely to
enable the company to gain a new lease on life and thereby allow creditors to be
paid their claims from its earnings. In insolvency proceedings, on the other hand,
the company stops operating, and the claims of creditors are satisfied from the
assets of the insolvent corporation.‖
In the earlier version of this work, the author had opined:

Although the ruling in Philippine Commercial

International Bank v. Court of Appeals,65 that suspension of
actions provided for under Pres. Decree No. 902-A covers all
corporate creditors, whether secured or non-secured, has
been abrogated by the Supreme Court, nevertheless, PCIB is

62
Rizal Commercial Banking Corp. v. Intermediate Appellate Court, 213 SCRA 830, 838;
State Investment House, Inc. v. Court of Appeals, G.R. No. 123240, 5 February 1996.
63
284 SCRA 445, 90 SCAD 407 (1998).
64
305 SCRA 721, 105 SCAD 485 (1999).
65
172 SCRA 436 (1989).
 still relevant when it decreed that "We take judicial notice of
the fact that the SEC order for the dissolution and liquidation of
Philfinance has already been upheld by this Court . . . In view
of this development, it appears that the Rehabilitation Receiver
has no more right to enjoin the auction sale since its prayer for
injunctive relief was based on the order for suspension of
payments."66
Clearly when rehabilitation is no longer pursued in the
case of a corporate debtor, the suspensive effect provided for
by Pres. Decree No. 902-A upon the appointment of the
management committee or rehabilitation receiver, ceased to
have any further hold, and the corporate creditors are then at
liberty to pursue their claims in different fora against the
corporate debtor.

The author‘s position has sinced been validated by the Supreme Court in
the 9 December 1999 resolution in Rizal Commercial Banking Corporation,67
where it held:

It behooves the Court, therefore, to settle the issue in

this present rsolution once and for all, and for the guidance of
the Bench and the Bar, the following rules of thumb shall are
(sic) laid down:
1. All claims against corporations, partnerships, or
associations that are pending before any court, tribunal, or
board, without distinction as to whether or not a creditors is
secured or unsecured, shall be suspended effective upon the
appointment of a management committee, rehabilitation
receiver, board, or body in accordance with the provisions of
Presidential Decree No. 902-A.
2. Secured creditors retain their preference over
unsecured creditors, but enforcement of such preference is
equally suspended upon the appointment of a management
committee, rehabilitation receiver, board, or body. In the event
that the assets of the corporation, partnership, or association
are finally liquidated, however, secured and preferred credits
under the applicable provisions of the Civil Code will definitely
have preference over unsecured ones.
In other words, once a management committee,
rehabilitation receiver, board or body is appointed pursuant to
P.D. 902-A, all actions for claims against a distressed
corporation pending before any court, tribunal board or body
shall be suspended accordingly.

66
Ibid, at p. 441.
67
G.R. No. 74851, 9 December 1999.
 This suspension shall not prejudice or render ineffective
the status of a secured creditor as compared to a totally
unsecured creditor. P.D. 902-A does not state anything to this
effect. What it merely provides is that all actions for claims
against the corporation, partnership or association shall be
suspended. This should give the receiver a chance to
rehabilitate the corporation if there should still be a possibility
for doing so. (This will be in consonance with Alemar’s, BF
Homes, Aranaz and RCBC insofar as enforcing liens by
preferred creditors are concerned.)
However, in the event that rehabilitation is no longer
feasible and claims against the distressed corporation would
eventually have to be settled, the secured creditors shall enjoy
preference over the unsecured creditors (still maintaining PCIB
ruling), subject only to the provisions of the Civil Code on
Concurrence and Preferences of Credit (our ruling in State
Investment House, Inc. vs. Court of Appeals, 277 SCRA 209
[1997]).

d. Suspension of Employees’ Claims

In Rubberworld (Phils.), Inc. v. NLRC,68 the Court held that upon the
appointment of a management committee, rehabilitation receiver, board or body
pursuant to Pres. Decree 902-A, all actions for claims against corporations,
partnerships or associations under management or receivership pending before
any court, tribunal, board or body shall be suspended accordingly, and ―[a]mong
the actions suspended are those for money claims before labor tribunals, like the
National Labor Relations Commission (NLRC) and the labor arbiters.‖

e. Jurisdiction Over Non-Corporate Debtor

Traders Royal Bank v. Court of Appeals,69 has held that in spite of the
appointment of a rehabilitation receiver by the SEC over a corporate debtor, it
would still have no jurisdiction over an individual and his assets, when such
individual is jointly and severally liable with the corporate debtor even on certain
obligations, and even when such individual included himself as co-petitioner with
the corporation debtor in filing the petition with the SEC. Consequently, such
individual cannot take advantage of the suspensive effect of the appointment by
the SEC of a rehabilitation receiver for the corporation, and his creditors can
commence and maintain an action against such individual even during the
pendency of the rehabilitation proceedings as to the corporate debtor. In that
case, the Supreme Court held:

Although Ching was impleaded in SEC Case No. 250, as

co-petitioner of PBM, the SEC could no assume jurisdiction

68
305 SCRA 721, 105 SCAD 485 (1999).
69
177 SCRA 788 (1989).
 over his person or properties. The Securities and Exchange
Commission was empowered, as rehabilitation receiver, to
take custody and control of the assets and properties of PBM
only, for the SEC has jurisdiction over the corporations only
not over private individuals, except stockholders in an intra-
corporate dispute (Sec. 5, P.D. 902-A and Sec. 2 of P.D.
1758). Being a nominal party in SEC Case No. 2250, Ching's
properties were not included in the rehabilitation receivership
that the SEC constituted to take custody of PBM's assets.
Therefore, the petitioner bank was not barred from filing a suit
against Ching, as surety for PBM. An anomalous situation
would arise if individual sureties for debtor corporations may
escape liability by simply co-filing with the corporation a
petitioner for suspension of payments in the SEC whose
jurisdiction is limited only to corporations and their corporate
assets.70

70
Ibid, at p. 791-792.
 Union Bank of the Philippines v. Court of Appeals,71 held that the inclusion
of an individual petitioner in a suspension of payments/rehabilitation proceedings
filed with the SEC in behalf of the corporate petitioner, does not justify a prayer
for the dismissal of the entire petition because of the inclusion of the wrong party-
petitioner. What the SEC can do is to dismiss the petition insofar as it pertains to
the individual petitioner under the rules pertaining to misjoinder of parties.
Modern Paper Products, Inc. v. Court of Appeals,72 held that the petition
for suspension of payment filed for the corporate petitioner should be dismissed
insofar as it included spouses-petitioners on the ground that SEC had no right to
assume jurisdiction over individual petitioners, and could not include them in the
order of suspension of payments. The Court did not accept the argument of the
spouses-petitioners that the claims against them, the payments of which they
sought to have suspended through their petitioner before the SEC, were not
personal in nature because such claims were incurred by them in their capacity
as officers of the corporate petitioner and while acting for and in behalf of the
corporation, thus: ―To subscribe to such theory that they had acted for and in
behalf of the corporate petitioner when they executed the suretyship agreements
would result in an absurd situation wherein the corporation, acting through its
officers, would actually be acting as surety for itself.‖
The issue on jurisdiction over non-corporate debtor has now been
rendered moot since regular courts, while exercising jurisdiction under Sec. 5 of
Pres. Decree 902-A, would still have jurisdiction over non-corporate debtors
under their general jurisdiction powers under the Rules of Court.

POWERS OF MANAGEMENT COMMITTEE/

REHABILITATION RECEIVER
Section 6(d) of the Decree enumerates the powers and functions of the
management committee or rehabilitation receiver to be as follows:

(a) To take custody of, and control over, all the existing assets and
property of such entities under management;
(b) To evaluate the existing assets and liabilities, earnings and
operations of such corporations, partnerships or other
associations;
(c) To determine the best way to salvage and protect the interest of
the investors and creditors;
(d) To study, review and evaluate the feasibility of continuing
operations and structure and rehabilitate such entities if
determined to be feasible by the SEC (now the RTC);

71
290 SCRA 198, 94 SCAD 381 (1998).
72
286 SCRA 749, 92 SCAD 58 (1998).
 (e) To report and be responsible to the SEC ( now the RTC) until
dissolved by the SEC (now the RTC); and
(f) May overrule or revoke the actions of the previous management
and board of directors of the entity or entities under the
management notwithstanding any provision of law, articles of
incorporation or by-laws to the contrary.

The management committee, or rehabilitation receiver, board or body,

shall not be subject to any action, claim or demand for, or in connection with, any
act done or omitted to be done by it in good faith in the exercise of its functions,
or in connection with the exercise of its powers conferred by the Decree.73
As discussed previously, the Interim Rules have taken-away the power of
the Rehabilitation Receiver to take control and management of the corporate
debtor, his role basically is to ―closely oversee and monitor the operations of the
debtor during the pendency of the proceedings.‖74
Nevertheless, under the Interim Rules of Procedure on Intra-Corporate
Controversies, the management committee may be appointed by the RTC in
corporate rehabilitation proceedings with powers as extensive as those provided
under Sec. 6 of Pres. Decree 902-A.

APPROVAL OF REHABILITATION PLAN;

CRAM-DOWN POWER OF RTC
The Interim Rules expressly empower the RTC to approve a rehabilitation
plan ―even over the opposition of creditors holding a majority of the total liabilities
of the debtor if, in its judgment, the rehabilitation of the debtor is feasible and the
opposition of the creditors is manifestly unreasonable.‖75

In determining whether or not the opposition of the auditors is manifestly

unreasonable, the RTC shall consider the following

(a) The plan would likely provide the objecting class of creditors
with compensation greater than that which they would have
received if the assets of the debtor were sold by a liquidator with
a three (3) month period;

(b) The shareholders lose at least their controlling interest as a

result of the plan; and

(c) The Rehabilitation Receiver has recommended approval of the

plan.76

73
Last paragraph of Sec. 6(d), Pres. Decree 902-A.
74
Sec. 14, Rule 4, Interim Rules.
75
Sec. 23, Rule 4, Interim Rules.
76
Ibid.
 Under the Interim Rules, the approval of the rehabilitation plan by the RTC
shall result in the following:

(a) The rehabilitation plan shall be binding upon the corporate

debtor and all persons who may be affected by it, including the
creditors, whether or not such persons have participated in the
proceedings or opposed the plan or whether or not their claims
have been scheduled;

(b) The corporate debtor shall comply with and take all actions
necessary to carry out, the provisions of the plan;

(c) Payments shall be made to the creditors in accordance with the

provisions of the plan;

(d) Contracts and other arrangements between the debtor and its
creditors shall be interpreted as continuing to apply to the extent
that they do not conflict with the provisions of the plan; and

(e) Any compromises on amounts or rescheduling of timing of

payments by the debtor shall be binding on creditors regardless
of whether or not the plan is successfully implemented.77

On motion or motu proprio, within ninety (90) days from the approval of
the RCT may revoke the approval thereof on the ground that the same was
secured through fraud.78

An approved rehabilitation plan may, on motion, be altered or modified if,

in the judgment of the RTC, such alteration or modification is necessary to
achieve the desired targets or goals set forth therein.79

Whether the ―cram-down‖ power of the RTC to impose the terms of the
rehabilitation plan against opposing secured creditors, which would effectively
novate their security arrangements or specific corporate property, would
withstand constitutional attack on the basis of violation of the due process and
non-impairment of contract clauses of the Constitution remains to be seen.80

POWER TO LIQUIDATE CORPORATIONS

Under Section 6(d), the SEC may, on the basis of the findings and
recommendation of the management committee, or rehabilitation receiver, board
of body, or in its own findings, determine that the continuance in business or

77
Sec. 24, Rule 4, ibid.
78
Sec. 25, Rule 4, ibid.
79
Sec. 26, Rule 4, ibid.
80
You may wish to see author‘s position on such constitutional issues in REVISITING THE
PHILIPPINE LAW ON CORPORATE REHABILITATION, XLII ATENEO L. J.(No. 2, May 1999).
such corporation or entity would not be feasible or profitable nor work to the best
interest of the stockholders, parties-litigants, creditors, or the general public, and
order the dissolution of such corporation or entity and its remaining assets
liquidated accordingly.
Such power to liquidated an insolvent corporation should now be deemed
vested with the regular courts in the exercise of their jurisdiction under Section 5
of Pres. Decree 902-A.

INSOLVENCY PROCEEDINGS
GOVERNING LAW AND JURISDICTION
Corporate insolvency proceedings, whether voluntary or involuntary,
should not fall within the jurisdiction of the SEC under Pres. Decree 902-A (which
makes no reference to insolvency at all), but with the regular courts under the
provisions of the Insolvency Law. Ching v. Land Bank of the Philippines,81 held:

Under Act 1956, otherwise known as the Insolvency

Law, jurisdiction over proceedings for suspension of
payments, voluntary and involuntary insolvency is exclusively
vested in the regular courts. However, P.D. No. 1758 issued in
1981 added to the exclusive and original jurisdiction of the
SEC, defined and delineated in Section 5 of P.D. 902-A, . . .
Petitioners of corporations . . . to be declared in the state of
suspension of payments . . .82

Ching refused the proposition that Section 5(d) effectively repealed the
Insolvency Law as to transfer and confer upon the SEC jurisdiction theretofore
enjoyed by the regular courts over proceedings for voluntary and involuntary
insolvency.83 It held that ―Section 5(d) of Pres. Decree 902-A should be
construed as vesting upon the SEC original and exclusive jurisdiction only over
petitions to be declared in a state of suspension of payments, which may either
be: (a) a simple petition for suspension of payments based on the provisions of
the Insolvency Law, or (b) a similar petition accompanied by a prayer for the
creation/appointment of a management committee and/or rehabilitation receiver
based on the provisions of 902-A. Said provision cannot be stretched to include
petitions for insolvency."84
Ching therefore laid down the following permutations covering a financially
distressed corporation:85

81
201 SCRA 190 (1991).
82
Ibid, at pp. 197-198.
83
Ibid, at p. 198.
84
Ibid, at pp. 198-199.
85
Ibid, at p. 199.
 (a) Where the petition filed is one for declaration of a state of
suspension of payments due to a recognition of the
inability to pay one's debts and liabilities, and where the
petitioning corporation either:
(i) has sufficient property to cover all its debts but
foresees the impossibility of meeting them when
they fall due (solvent but illiquid); or
(ii) has no sufficient property (insolvent) but is under
the management of a rehabilitation receiver or a
management committee,
the applicable law is P.D. No. 902-A pursuant to section 5
of par. (d) thereof;
(b) Where the petitioning corporation has no sufficient assets
to cover its liabilities and is not under rehabilitation receiver
or management committee created under P.D. No. 902-A
and does not seek merely to have the payments of its
debts suspended, but seeks a declaration of insolvency, as
in this case, the applicable law is Act 1956 on voluntary
insolvency, specifically section 14 thereof.

Nevertheless, Ching also held that although strictly a petition for

declaration of insolvency of private corporation is still with the regular courts
which have exclusive and original jurisdiction, the SEC possessed ample power
under Pres. Decree 902-A to declare a corporation insolvent as an incident of
and in continuation of its already acquired jurisdiction over petitioners to be
declared in the state of suspension of payments in the two (2) cases provided in
Section 5(d) of the Decree.
The provisions of the Insolvency Law therefore still govern the procedure
when a corporate debtor seeks to pursue voluntary insolvency proceedings, or
when creditors seek involuntary insolvency proceedings against a corporate
debtor.

VOLUNTARY INSOLVENCY
1. Filing of Petition
Under the Law, a corporate debtor suffering from absolute insolvency
whose liabilities exceed One Thousand Pesos (P1,000.00),86 may file a petition
for voluntary insolvency, through an officer authorized by the board of directors,87
with the RTC of the province or city where the petitioning corporation has resided
for six (6) months next preceding the filing of the petition.88

86
Sec. 14, The Insolvency Law.
87
Sec. 52, ibid.
88
Sec. 14, ibid.
 The petition is to be accompanied by a verified schedule and inventory in
the same manner as in a petition for suspension of payments.89
Upon the filing of the petition and its accompanying documents, the RTC
shall issue an order declaring the petitioner insolvent, and directing the sheriff to
take possession of, and safely keep, until the appointment of the receiver or
assignee, all the corporate documents, properties, estate, and effects of the
petitioning corporation.90

2. Effect of Order of Insolvency

The order of declaration of insolvency shall include an order forbidding the
payment of any debts due to the petitioning corporation, the delivery of any
property belonging to the corporation, and the transfer of any such property by
the petitioning corporation.91
Upon the granting of the order of declaration of insolvency, and an
application for a stay of proceedings, all civil proceedings pending against the
petitioning corporation shall be suspended.92

3. Appointment of Assignee
The RTC order shall also contain a call for the creditors to convene for the
purpose of electing an assignee.93 The assignee is elected by a double majority
of the creditors who have proved their claims.94 If no assignee is elected or
qualified, the RTC has power to appoint an assignee.95
The clerk of court then assigns and conveys to the assignee all the
property of the debtor not exempt from execution.96 The assignee requires title to
such property, which title shall relate back to the date of filing of the petition.97
Pursuant thereto, the sheriff shall deliver to the assignee all the property of the
debtor under his possession and safe-keeping.

4. Effect of Appointment of Assignee

The assignment of the debtor's estate effectuates the dissolution of any
attachment levied within one month next preceding the commencement of the
insolvency proceedings.98 The assignment shall also serve to vacate and set

89
Ibid.
90
Sec. 18, ibid.
91
Ibid.
92
Unson and Lacson v. Abeto, 47 Phil. 42, 44 (1924).
93
Sec. 18, The Insolvency Law.
94
Sec. 30, ibid.
95
Sec. 31, ibid.
96
Sec. 32, ibid.
97
Ibid.
98
Sec. 32, Ibid.
aside any judgment entered in any action commenced within thirty days
immediately prior to the commencement of insolvency proceedings.99

5. Functions of Assignee
The main responsibility of the assignee is to convert all of the assets of the
corporate debtor into cash,100 and that three (3) months after his appointment, or
earlier when the RTC so directs, he shall render an account of the corporate
debtor's estate at a hearing called for by the court.101 At the hearing, the RTC will
determine the rights of claimants to participate and may order a payments to
corporate creditors whose claims have been proven and allowed.102 Further
accounts and dividends shall be made as often as occasion requires until such
time as the final account is rendered.103

INVOLUNTARY INSOLVENCY
1. Filing of Petition
A petition for involuntary insolvency may be filed by three (3) or more
creditors against the corporation,104 who feel that their interests should be
protected against acts of insolvency such as absconding from the country,
absence with an intent to defraud creditors, etc., being done by the corporate
debtor.
However, the literal interpretation of Section 52 of the Law would seem to
imply that the petition of only one creditor of the corporation would be sufficient to
effect an involuntary insolvency thereof: "this Act shall apply to corporations . . .
upon a creditor's petition made and presented in the manner provided in respect
to debtors, like proceedings shall be had and taken as are provided in the case of
debtors." One author has opined that whether one or three creditors should file
the petition for involuntary insolvency of a corporation is not a settled rule.105

99
Sec. 32, ibid.
100
Sec. 39, ibid.
101
Sec. 43, ibid.
102
Ibid.
103
Ibid.
104
Sec. 20, ibid.
105
PEREZ, THE INSURANCE CODE AND INSOLVENCY LAW (University Book Supply, Inc., 1976
ed.), at p. 406.
 2. Qualifications of Petitioning Creditors
The petitioning creditors must be residents of the Philippines, whose
credits accrued in the Philippines, the aggregate amount of which credits is not
less than One Thousand Pesos (P1,000.00), and that none of the creditors has
become a creditor by assignment within thirty (30) days prior to the filing of said
petition.106

3. Standing Foreign Corporate Creditors to Petition

State Investment House, Inc. v. Citibank, N.A.,107 held that a foreign
corporation which shows that it is a resident of the Philippines has legal standing
to petition for the involuntary insolvency of a corporate debtor. The Court held:
"The [Insolvency Law] plainly grants to a juridical person, whether it be a bank or
not or it be a foreign or domestic corporation, as to natural persons as well, such
a power to petition for the adjudication of bankruptcy of any person, natural or
juridical, provided that it is a resident corporation and joins at least two other
residents in presenting the petition for the Bankruptcy Court."108

4. Acts of Insolvency
Under the Insolvency Law, "acts of insolvency" on the part of the debtor
which would warrant the filing of a petition for involuntary insolvency by creditors
include the following:109

(a) Intention to depart or departure from the Philippines to

defraud creditor;
(b) Absence from the Philippines to defraud creditors;
(c) Concealment of debtor to avoid legal process;
(d) Concealment or removal of corporate property to avoid legal
process;
(e) Confession of judgment in favor of any creditor to defraud
other creditors;
(f) Allowing default judgment in favor of a creditor to defraud
other creditors;
(g) Allowing corporate property to be taken under legal process
in preference of a particular creditor to defraud other
creditors;
(h) Conveyance, assignment or transfer of property to defraud
creditors;

106
Ibid.
107
203 SCRA 9 (1991).
108
Ibid, at p. 22.
109
See Sec. 20, The Insolvency Law.
 (i) Conveyance, assignment or transfer of property in
contemplation of insolvency;
(j) Default of a merchant or tradesman to pay current obligations
for a period of thirty (30) days;
(k) Failure to pay money on deposit or received in a fiduciary
capacity for a period of thirty (30) days after demand; and
(l) Insufficiency of property to satisfy an execution against the
debtor.

When it comes to a corporate debtor, "departure" from the Philippines

should include measures taken by the corporate to exclude local courts from
having jurisdiction over its "person".

5. Effects of Order of Insolvency and Appointment of Receiver

The effects of the order of declaration of insolvency and the appointment
of the receiver are the same as those discussed above in the case of voluntary
insolvency.
Radiola-Toshiba Philippines, Inc. v. Intermediate Appellate Court,110 held
that under Section 32 of the Insolvency Law it is clear that the attachments
dissolved are those levied within one (1) months next preceding the
commencement of the insolvency proceedings and judgments vacated and set
aside are judgments entered in any action, including judgment entered by default
or consent of the debtor, where the action was filed within thirty (30) days
immediately prior to the commencement of the insolvency proceedings.111 In
short, there is a cut off period—one (1) months in attachment cases and thirty
(30) days in judgments entered in actions commenced prior to the insolvency
proceedings.112
Section 79 on the other hand, provides for the right of the plaintiff if the
attachment is not dissolved before the commencement of the proceedings in
insolvency, or is dissolved by an undertaking given by the defendant, if the claim
upon which the attachment suit was commenced is proved against the estate of
the debtor. It does not conflict with Section 32.113

6. Procedure
The same rules for involuntary insolvency proceedings apply to voluntary
insolvency proceedings, except as follows:
(a) The petition is filed with the RTC of the province or city in which
corporate debtor has its principal place of business,114 which
shall be accompanied by a bond to answer for all costs,
110
199 SCRA 373 (1991).
111
Ibid, at p. 379-380.
112
Ibid.
113
Ibid.
 expenses, attorney's fees and damages incurred by the debtor
in the event that the petition is dismissed or withdrawn by the
petitioners, or if the debtor shall not be declared an insolvent.115
(b) A hearing is conducted for the purpose of affording the
corporate debtor the opportunity to show cause why it should
not be declared insolvent.116
(c) When the circumstances warrant, the RTC shall adjudge the
debtor insolvent,117 and a meeting is called for the creditors to
elect an assignee.118
(d) The assets of the corporate debtor are conveyed to the
assignee, who shall liquidate them into cash and pay the debts
of the corporate debtor.119

GENERAL EFFECT OF CORPORATE INSOLVENCY PROCEEDINGS

While an individual debtor who is in a state of absolute insolvency may
resort to declaration of insolvency in order to obtain a discharge from his
liabilities, no such discharge in available to corporate debtors under the
Insolvency Law.120
The no-discharge rule when it comes to corporate debtors may be
supported by two reasonings. First, a corporate entity, being merely a medium for
doing business, it would be more convenient for the individuals behind the
corporate entity to simply proceed with forming a new corporation to undertake
another venture and would then not be saddled by the liabilities of the insolvent
corporation. Second, the lack of discharge would be superfluous with respect to
the stockholders since they would be protected from corporate liabilities under
the limited liability principle that would apply to them.

—oOo—

CORP. MANUSCRIPT\14-SUSPENSION OF PAYMENTS & REHABILITATION\07-30-2002

114
Sec. 20, The Insolvency Law.
115
Ibid.
116
Sec. 23, ibid.
117
Sec. 24, ibid.
118
Sec. 30, ibid.
119
Sec, 33, ibid.
120
Sec. 52 of The Insolvency Law expressly provides that "Whenever any corporation is
declared insolvent, its property and assets shall be distributed to the creditors; but no discharge
shall be granted to any corporation."
 CHAPTER 15

CORPORATE DISSOLUTIONS AND

LIQUIDATIONS

No Vested Rights to Corporate Fiction

Nature of Dissolution
Methods of Dissolution
Voluntarily Dissolution Where No Creditors Affected
Voluntary Dissolution Where Creditors Affected
Dissolution by Shortening Corporate Term
Dissolution by Expiration of Corporate Term
Involuntary Dissolution
Grounds for Involuntary Dissolution
When Corporation Deemed “Organized”
When Corporation Deemed to “Commence Business”
Procedure for Involuntary Dissolution
Under Old Rules of Court
Under Pres. Decree 902-A
Particular SEC Rules on Suspension/Revocation of Certificate of Registration
Right of Minority Stockholders to Demand Dissolution
Jurisprudential Attitude Towards Involuntary Dissolutions
Obtaining of Tax Clearance
NATURE OF CORPORATE LIQUIDATION
Methods of Liquidations
Liquidation Through Board of Directors or Trustees
Liquidation Through a Trustee
Liquidation Through a Receiver
Disposition of Pending Claims Against Dissolved Corporation
General Rule on Abatement
Proceeding Against the Officers/Stockholders Possessing Corporate Assets
Continuing Suits Against Counsel of Record as Trustee
Effects of Dissolution and Liquidation
No Authority to Enter Into New Business
Summary on Dissolution and Liquidation Proceedings
REINCORPORATION
Applicable Legal Provisions
Extension of Corporate Life During Period of Dissolution
Distinctions Between Extension of Corporate Life, Revival and Reincorporation
Process of Reincorporating
Rights of Opposing Creditors
Rights of Dissenting Stockholders
 ——

NO VESTED RIGHTS TO CORPORATE FICTION

The Supreme Court has held that no person who asserts a claim against a
juridical entity can claim any constitutional right to the perpetual existence of
such entity, thus:

Juridical persons, whether incorporated or not, whether

owned by the government or the private sector, may come to
an end at one time or another for a variety of reasons, e.g., the
fulfillment or the abandonment of the business purposes for
which a corporation was set up. Thus, the Corporation Code
provides for termination of corporate life, the dissolution of the
corporation, the winding up of its operations, the liquidation of
its assets, the payment of its obligations and distribution of any
residual assets to its stockholders.1

However, the Court emphasized that the termination of the life of a

juridical entity does not by itself imply the diminution or extinction of rights
demandable against a juridical entity. Consequently, when the assets of a
dissolved entity are taken over by another entity, the successor entity must be
held liable for the obligations of the dissolved entity pertaining to the assets so
assumed, “to the extent of the fair value of assets actually taken over.”2

NATURE OF DISSOLUTION
Dissolution of a corporation signifies the extinguishment of its franchise
and the termination of its corporate existence for business purpose. The mere
fact that the corporation has ceased to do business does not necessarily
constitute a dissolution, if it is still solvent and has not gone into liquidation.
The dissolution of a corporation may either be de jure or de facto. A de
jure dissolution is one adjudged and determined by administrative or judicial
sentence, or brought about by an act of the sovereign power, or which results
from the expiration of the charter period of corporate life. A de facto dissolution is
one which takes place in substance and in fact when the corporation by reason
of insolvency, cessation of business, or suspension of all its operations, as the
case may be, goes into liquidation, still retaining its primary franchise to be a
corporation. This is actually a dissolution only of the "business enterprise," while
leaving intact the juridical entity.

1
Gonzales v. Sugar Regulatory Administration, 174 SCRA 377 (1989).
2
Ibid, at pp. 385-386.
METHODS OF DISSOLUTION
A corporation formed or organized under the Corporation Code may be
dissolved either voluntarily or involuntarily. 3 There are three modes of voluntary
dissolution:

(a) Where no creditors are affected by the dissolution, by an

administrative application for dissolution filed with the SEC;4
(b) Where creditors are affected by dissolution, by a formal
petition for dissolution filed with the SEC, with due notice,
and hearing to be duly conducted;5 and
(c) Shortening of corporate term by the amendment of the
articles of incorporation.6

Another mode of "voluntary" dissolution would be allowing the expiration

of the corporate term as provided in the articles of incorporation of the
corporation.

VOLUNTARILY DISSOLUTION WHERE NO CREDITORS AFFECTED

When no creditors are involved, only a SEC application for dissolution is
required. The process is equivalent to the application for the amendment of the
articles of incorporation, except that in addition, publication of the notice of
dissolution must also be complied with.
Under Section 118 of the Corporation Code, in case the dissolution of a
corporation does not prejudice the rights of any creditor having a claim against
such corporation, then dissolution may be effected by complying with the
following procedural requirements:

(a) Majority vote of the board of directors or trustees adopting a

resolution for the dissolution of the corporation;
(b) Sending of notices to each stockholder or member either by
registered mail or by special delivery, of the time, place and
object of the meeting calling for the approval of the
dissolution of the corporation, at least thirty (30) days prior to
said meeting;
(c) Publication of the such notice of meeting for three (3)
consecutive weeks in a newspaper published in the place
where the principal office of said corporation is located, and
if none, in a newspaper of general circulation in the
Philippines; and
3
Sec. 117, Corporation Code.
4
Sec. 118, Corporation Code.
5
Sec. 119, Corporation Code.
6
Sec. 120, Corporation Code.
 (d) The resolution duly adopted by the affirmative vote of the
stockholders owning at least two-thirds (2/3) of the
outstanding capital stock, or of at least two-thirds (2/3) of the
members, at meeting held on the call of the directors or
trustees.

A copy of the resolution authorizing the dissolution shall be certified by a

majority of the board of directors or trustees and countersigned by the secretary
of the corporation and filed with the SEC.7 The SEC shall thereupon issue the
certificate of dissolution.8
The SEC will not deny an application for dissolution when there are no
creditors involved because of the constitutional prohibition against involuntary
servitude or the constitutional guarantee of association, and the right to refuse to
continue an association. Since other than the stockholders or members of the
corporation, no third parties are involved, the State, through the SEC, will
generally grant the request for the dissolution of the corporation.

VOLUNTARY DISSOLUTION WHERE CREDITORS AFFECTED

If there are creditors involved, there is a need to file a formal petition for
dissolution with the SEC. The proceedings are quasi-judicial in nature and
conducted to ensure that the rights of the creditors are fully protected. In such
proceedings, the SEC is not mandated to dissolve the corporation, especially
when it would be detrimental to the interests of the creditors, who may wish to
rehabilitate the operations of the corporation to ensure that it would be able to
pay-off all of its debts. This authority of the SEC is also provided for in Pres.
Decree 902-A.9
Under Section 119 of the Corporation Code, where the dissolution may
prejudice the rights of any creditor, the following procedure shall be complied
with:
(a) A petition for dissolution of a corporation shall be filed with
the SEC, signed by a majority of its board of directors or
trustees or other officers having the management of its
affairs, verified by its president or secretary or one of its
directors or trustees, and shall set forth all claims and
demands against it, and that its dissolution was resolved
upon by the affirmative vote of the stockholders representing
at least two-thirds (2/3) of the outstanding capital stock or by
at least two-thirds (2/3) of the members, at a meeting of its
stockholders or members called for that purpose.10

7
Ibid.
8
Ibid.
9
Please see discussions on corporate rehabilitation in Chapter 14, Suspension of
Payments, Rehabilitation and Insolvency Proceedings.
10
Sec. 119, Corporation Code.
 (b) If the petition is sufficient in form and substance, the SEC, by
an order reciting the purpose of the petition, shall fix a date
on or before which objections thereto may be filed by any
person, which date shall not be less than thirty (30) days nor
more than sixty (60) days after the entry of the order.11
(c) Before such date, a copy of the order shall be published at
least once a week for three (3) consecutive weeks in a
newspaper of general circulation published in the
municipality or city where the principal office of the
corporation is situated, or if there be no such newspaper,
then in a newspaper of general circulation of the Philippines,
and a similar copy shall be posted for three (3) consecutive
weeks in three (3) public places in such municipality or city. 12
(d) Upon five (5) days' notice, given after the date on which the
right to file objections as fixed in the order has expired, the
SEC shall proceed to hear the petition and try any issue
made by objections filed; and if no such objection is
sufficient, and the material allegations of the petition are
true, it shall render judgment dissolving the corporation and
directing such disposition of its assets as justice requires,
and may appoint a receiver to collect such assets and pay
the debts of the corporation.

DISSOLUTION BY SHORTENING CORPORATE TERM

A voluntary dissolution may be effected by amending the articles of
incorporation to shorten the corporate term.13 Therefore, the procedure outlined
under the law for the amendment of the articles of incorporation should also be
complied with, and the application filed with the SEC.
Under its internal rules, the SEC would require the following:

(a) Notice of the dissolution of the corporation by shortening of

the corporate term be published in a newspaper of general
circulation for three (3) consecutive weeks;
(b) Listing of the corporate creditors, with their consent to the
shortening of the corporate term;
(c) Submission by the majority stockholders or principal officers
of the corporation of an undertaking under oath that they
shall personally answer for any outstanding obligations of
the corporation; and

11
Ibid.
12
Ibid.
13
Sec. 120, Corporation Code.
 (d) The latest audited financial statements of the corporation
which must not be earlier than the date of the stockholders'
or membership meeting approving the amendment to the
articles of incorporation, and a BIR clearance on the tax
liabilities of the corporation. 14

Upon approval of the amended articles of incorporation or the expiration of

the shortened term, as the case may be, the corporation shall be deemed
dissolved without any further proceedings, subject only to the provisions for
corporate liquidations.15

DISSOLUTION BY EXPIRATION OF CORPORATE TERM

When the corporate life of the corporation as stated in its articles of
incorporation is allowed to expire, without extension, then the corporation is
deemed dissolved by such expiration without need of further action on the part of
the corporation or the State.16
Alhambra Cigar and Cigarette Manufacturing Corp. v. Securities and
Exchange Commission,17 held that a corporation cannot extend its life by
amendment of its articles of incorporation to be effected during the three (3) year
statutory period for liquidation when its original term had already expired. The
three (3) year statutory period for corporate liquidation is not for the purpose of
continuing the business for which it was established, but strictly limited to
liquidation. The extension of corporate life of a corporation is deemed to
constitute new business and cannot be validly pursued during the liquidation
stage.
Under Section 11 of the Corporation Code, the corporate term as originally
stated in the articles of incorporation may be extended in any single instance by
an amendment of the articles of incorporation, but cannot be made earlier than
five (5) years prior to the original or subsequent expiry date.
The privilege of extension of corporate term is purely statutory and that all
statutory conditions precedent must be complied with in order that the extension
may be effectuated. Generally, these conditions must be complied with and the
steps necessary to effect the extension must be taken during the life of the
corporation, and before the expiration of its term of existence as originally fixed
by its charter or the general law, since as a rule, the corporation is ipso facto
dissolved as soon as its term expires.

14
SEC Opinion, 5 July 1979, the XIII SEC QUARTERLY BULLETIN 3 (No. 4, Oct. 1979).
15
Sec. 20, Corporation Code.
16
Sec. 11, Corporation Code; Philippine National Bank v. Court of First Instance of Rizal,
Pasig, Br. XXI, 209 SCRA 294 (1992).
17
24 SCRA 269 (1968).
INVOLUNTARY DISSOLUTION
A corporation may be dissolved by the SEC upon filing of a verified
complaint and after proper notice and hearing on grounds provided by existing
laws, rules and regulations.18

1. Grounds for Involuntary Dissolution

The grounds for involuntary dissolution of corporations are scattered in
various provisions of law and provided for in jurisprudence, namely:

(a) If the corporation does not formally organize and commence

the transaction of its business or the construction of its works
within two (2) years from the date of its incorporation, its
corporate power ceases and the corporation shall be
deemed dissolved;19
(b) If the corporation has commenced the transaction of its
business, but subsequently becomes continuously
inoperative for a period of at least five (5) years, 20 the same
shall be a ground for the suspension or revocation of its
corporate franchise or certificate of incorporation;21
(c) When the corporation fails to adopt and file a code of by-
laws in the manner provided for by law;22
(d) When the corporation has offended against a provision of a
law for its creation or renewal;23
(e) When it has committed or omitted an act which amounts to a
surrender of its corporate rights, privileges, or franchises;24
(f) When it has misused a right, privilege, or franchise conferred
upon it by law, or when it has exercised a right, privilege, or
franchise in contravention of law,25 such as commission by
the corporation of ultra vires or illegal acts;

18
Sec. 121, Corporation Code.
19
Sec. 22, Corporation Code.
20
Sec. 22, Corporation Code. Under Sec. 6(l)(4) of Pres. Decree 902-A, the SEC may
suspend, or revoke, after proper notice and hearing, the franchise or certificate of registration of
corporations for continuous inoperation for a period of at least five (5) years.
21
Under Sec. 2(b), Rule 66 of the Rules of Court, a ground for quo warranto proceedings
against a corporation exists when the corporation has forfeited its privileges and franchise by
non-user. The section has since been deleted under the new version of Rule 66 of the 1997
Rules of Civil Procedure.
22
Sec. 6(l)(5), Pres. Decree 902-A; Chung Ka Bio v. Intermediate Appellate Court, 163
SCRA 534 (1988).
23
Sec. 2(a), Rule 66, Rules of Court.
24
Sec. 2(c), Rule 66, Rules of Court.
25
Sec. 2(d), Rule 66, Rules of Court.
 (g) When on the basis of findings and recommendations of a
duly appointed management committee or rehabilitation
receiver, or based on the SEC's own findings, the
continuance of the business of the corporation would not be
feasible or profitable nor work to the best interest of the
stockholders, parties-litigants, creditors, or the general
public;26
(h) When the corporation is guilty of fraud in procuring its
certificate of registrations;27
(i) When the corporation is guilty of serious misrepresentation
as to what the corporation can do or is doing to the great
prejudice of or damage to the general public;28
(j) Refusal of the corporation to comply or defiance of any lawful
order of the SEC restraining commission of acts which would
amount to a grave violation of its franchise;29 and
(k) Failure of the corporation to file required reports in
appropriate forms as determined by the SEC within the
prescribed period.30

a. When Corporation Deemed “Organized”

Benguet Consolidated Mining Co. v. Pineda,31 held that the term to
"organize" when used in reference to a corporation, involves the election of
officers, providing for the subscription and payment of the capital stock, the
adoption of by-laws, and such other steps as are necessary to endow the legal
entity with the capacity to transact the legitimate business for which it was
created. The term "organization" relates to the systematization and orderly
arrangement of the internal and managerial affairs and organs of the corporation.
Under the SEC Rules on Suspension/Revocation of the Certificate of
Registration of Corporations,32 a corporation shall be considered as formally
organized if it has accomplished the following:

(a) Adoption of the by-laws and the filing and approval of the
same with and by the SEC in the event the same is not
adopted and filed simultaneously with the articles of
incorporation;
(b) Election of the board of directors or trustees and of the
officers;
26
Sec. 6(d), Pres. Decree 902-A.
27
Sec. 6(l)(1), Pres. Decree 902-A.
28
Sec. 6(l)(2), Pres. Decree 902-A.
29
Sec. 6(l)(3), Pres. Decree 902-A.
30
Sec. 6(l)(6), Pres. Decree 902-A.
31
98 Phil. 711, 720 (1956).
32
XXVIII SEC QUARTERLY BULLETIN 90 (No. 3, June 1994).
 (c) Establishment of the principal office;
(d) Providing for the subscription and payment of the capital
stock and the taking of such other steps as are necessary to
endow the legal entity with capacity to transact the legitimate
business for which it was created.

b. When Corporation Deemed to Have

“Commenced Business”
The same SEC Rules consider a corporation to have commenced the
transaction of its business when it has performed preparatory acts geared
towards the fulfillment of the purposes for which it was established such as but
not limited to the following:

(a) Entering into contracts or negotiations for lease or sale of

properties to be used as business or factory site;
(b) Making plans for and the construction of the factory;
(c) Taking steps to expedite the construction of the company's
working equipment.

2. Procedure for Involuntary Dissolution

a. Under Old Rules of Court
Under the old Rules of Court, the Solicitor General or a public prosecutor,
when directed by the President of the Philippines, or when upon complaint or
otherwise he has good reason to believe that any case specified under the law
exist to pursue quo warranto proceedings against the corporation for violation of
its franchise, must be the one to commence such action.33
The Solicitor General or public prosecutor may, with the permission of the
court in which the action is to be commenced, bring such an action at the request
and upon the relation of another person; but in such case the officer bringing it
may first require an indemnity for the expenses and costs of action to be given to
him by the person at whose request and upon whose relation the same is
brought.34
In addition, the Rules of Court provided that when it is found that a
corporation has, by an act done or omitted, surrendered, or forfeited its corporate
rights, privileges, and franchises, or has not used the same during the term of
five (5) years, judgment shall be entered that it be ousted and excluded
therefrom and that it be dissolved. When it is found that the corporation has
offended is a matter or manner which does not by law work as a surrender or

33
Sec. 2 and 3, Rule 66 of the old Rules of Court.
34
Sec. 4, Rule 66, Rules of Court.
forfeiture, judgment shall be rendered that it be ousted from the continuance of
such offense and the exercise of any power usurped by it.35
The provisions under the Rules of Court one forfeiture of franchise have
since been deleted under Rule 66 of the 1997 Rules of Civil Procedure on
recognition that the matter is governed by the provisions of Pres. Decree 902-A,
and within the original and exclusive jurisdiction of the SEC. Nevertheless, the
Interim Rules on Intra-Corporate Controversies do not also provide rules
governing involuntary dissolution of corporations, under the premise that such
proceedings do not fall with the corporate jurisdiction of the RTC.

b. Under Pres. Decree 902-A

Under Section 6 of the Decree, in order to effectively exercise its
jurisdiction over corporate entities, the SEC inter alia possesses the following
powers:

(a) To create and appoint a management committee, board, or

body upon petition or motu propio to undertake the
management of corporations, partnerships or other
associations not supervised or regulated by other
government agencies in appropriate cases wherein there is
imminent danger of dissipation, loss or wastage or
destruction of assets or other properties or paralyzation of
business operations or entities which may be prejudicial to
the interest of the minority stockholders, any of the party
litigants or the general public;
(b) To create or appoint a management committee, or board or
body to undertake the management of corporations,
partnerships or other associations supervised or regulated
by other government agencies such as banks and insurance
companies, upon request of the government agency
concerned.

The management committee or rehabilitation receiver, board or body shall

have the following powers:

(a) To take custody of, and control over, all existing assets and
properties of such entities under management; to evaluate
the existing assets and liabilities, earnings and operations of
such corporations, partnerships or other associations; to
determine the best way to salvage and protect the interest of
the investors and creditors; to study, review, and evaluate
the feasibility of continuing the operations and restructure

35
Sec. 12, Rule 66, Rules of Court.
 and rehabilitate such entities if determined to be feasible by
the SEC
(b) It shall report and be responsible to the SEC until dissolved
by order of the SEC; provided, however, that the submission
may, on the basis of the findings and recommendation of the
management committee, or rehabilitation receiver, board or
body, or on its own findings, determine that the continuance
in business of such corporation or entity would no be
feasible or profitable nor work to the best interest of the
stockholders, parties-litigants, creditors, or the general
public, order the dissolution of such corporation or entity and
its remaining assets liquidated accordingly.
(c) It may overrule or revoke the actions of the previous
management and board of directors of the entity or entitles
under management notwithstanding any provision of law,
articles of incorporation or by-laws to the contrary.
(d) It shall not be subject to any action, claim or demand for, or
in connection with, any act done or omitted to be done by it
in good faith in the exercise of its powers herein conferred.

It is not clear whether the SEC still has such powers with the transfer of its
quasi-judicial jurisdiction under Sec. 5 of Pres. Decree 902-A to the RTC
pursuant to Sec. 5.2 of the Securities Regulation Code.

3. Particular SEC Rules on Suspension/Revocation

of Certificate of Registration
The SEC Rules on Suspension/Revocation of the Certificate of
Registration of Corporations36 governs the following instances:

(a) Corporations which have failed to formally organize and

commence the transaction of their business or the
construction of their works within two (2) years from the date
of incorporation;
(b) Corporations which have been inoperative for a continuous
period of at least five (5) years;
(c) Corporation which have failed to file by-laws within the
prescribed period;
(d) Corporations which have failed to file/register for a period of
five (5) years their financial statements, general information
sheet, or stock and transfer book or membership book.

36
XXVIII SEC QUARTERLY BULLETIN 90 (No. 3, June 1994).
 In any of the foregoing instances, the SEC shall mail to the corporation
and the controlling stockholder a show-cause-order directing them to show cause
within thirty (30) days from receipt thereof why the certificate of registration shall
not be suspended or revoked.
A second show-cause-order shall be published in a newspaper of general
circulation, directing the corporation which failed to respond to the first order to
appear before the SEC at a hearing on the date, time and at the place stated in
the order.
If the corporation, through its officers/directors, shall not comply with the
directives for the submission of the required reports, or when the corporation fails
to appear, the SEC may issue the lesser sanction which is suspension which
shall immediately be executory. The corporation shall then have ninety (90) days
from receipt thereof within which to file a petition for reconsideration of the order.
After the lapse of the ninety (90) day period and no petition for reconsideration
has been filed, the order of revocation shall be issued which shall become final
and executory.
The SEC has opined that even under Section 22 of the Corporation Code,
there can be no automatic dissolution of a corporation after its incorporation has
been approved by the SEC. It shall continue to exist as a juridical entity
notwithstanding its non-operational status until its certificate of registration is
formally revoked by the SEC after due notice and hearing.37

RIGHT OF MINORITY STOCKHOLDERS TO DEMAND DISSOLUTION

Other than the exercise of the SEC of its power to dissolve a corporation
by reason of a petition filed with it pursuant to the powers granted under Pres.
Decree 902-A, minority stockholders do not have a common law right, much less
a statutory right to demand for dissolution of the corporation. This is based on the
principle that minority stockholders invest in the corporate vehicle fully aware that
the affairs of the corporation would be subject to the control of the majority
stockholders. Gokongwei v. Securities and Exchange Commission,38 held that
any person "who buys stock in a corporation does so with the knowledge that its
affairs are dominated by a majority of the stockholders and that he impliedly
contracts that the will of the majority shall govern in all matters within the limits of
the act if incorporation and lawfully enacted by-laws and not forbidden by law."39
There is however, a peculiar ruling rendered by the Supreme Court in
Financing Corporation of the Phil. v. Teodoro,40 which case originated from a civil
suit brought by the minority stockholders with the then Court of First Instance
against the corporation and its president and general manager, alleging gross

37
SEC Opinion, 4 May 1995, XXIX SEC QUARTERLY BULLETIN 4 (No. 4, Dec. 1995); SEC
Opinion, 22 May 1998, XXXII SEC QUARTERLY BULLETIN 12 (No. 1, June 1998).
38
89 SCRA 336 (1979).
39
Ibid, at p. 366.
40
93 Phil. 678 (1953).
mismanagement and fraudulent conduct of corporate affairs, and seeking that
the corporation be dissolved. The suit was opposed on the ground that it sought
dissolution of the corporation whereas according to law a suit for the dissolution
of a corporation can be brought and maintained only by the State through its
legal counsel, namely the Solicitor General, and that minority stockholders have
no personality to maintain the action for dissolution.
The Court held that although it is "[t]rue it is that the general rule is that
the minority stockholders of a corporation cannot sue and demand for its
dissolution. However, there are cases that hold that even minority stockholders
may ask for dissolution, this, under the theory that such minority members, if
unable to obtain redress and protection of their rights within the corporation, must
not and should not be left without redress and remedy."41 The Court went on to
say —

. . . We repeat that although as a rule, minority

stockholders of a corporation may not ask for its dissolution in
a private suit, and that such action should be brought by the
Government through its legal officer in a quo warranto case, at
their instance and request, there might be exceptional cases
wherein the intervention of the State, for one reason or
another, cannot be obtained, as when the State is not
interested because the complaint is strictly a matter between
the stockholders and does not involve, in the opinion of the
legal officer of the Government, any of the acts or omissions
warranting quo warranto proceedings, in which minority
stockholders are entitled to have such dissolution. When such
action or private suit is brought by them, the trial court has
jurisdiction and may or may not grant the prayer, depending
upon the facts and circumstances attending it.42

The doctrine of Financing Corporation has eventually became part of

Pres. Decree 902-A which grants to the SEC the power to decree the dissolution
of the corporation upon the appointment of a management committee or receiver
brought in a private suit filed by stockholders or officers on cases within the
jurisdiction of the SEC.
The "private interest" ruling of Financing Corporation also finds statutory
imprimatur in Title XII of the Corporation Code on close corporations, which
under Sections 104 and 105 in cases of deadlocks or illegal or fraudulent acts,
grant to a stockholder to seek for the dissolution of the corporation.

41
Ibid, at p. 680
42
Ibid, at p. 681.
JURISPRUDENTIAL ATTITUDE TOWARDS INVOLUNTARY DISSOLUTION
Republic v. Bisaya Land Transportation Co.,43 describes well the solicitous
attitude of the courts in remedying violations committed by corporations, before
resorting to the extreme punishment of forfeiture of franchise and dissolution. In
that case the Bisaya Land Transp. Co. (Bisaya) was engaged in the business of
land and water transportation. The Solicitor General filed a petition for quo
warranto for the dissolution of Bisaya alleging that it had violated and offended
the provisions of the Corporation Law and other statutes of the Philippines by
having committed acts amounting to a forfeiture of its franchise, rights, and
privileges and through various means misused and abused the terms of its
franchise, some of which were as follows: falsely reconstituted its articles of
incorporation by adding new purposes not originally included; acquiring public
lands and timber concessions; leasing of a pasture land; operating a general
merchandise store which is neither necessary for nor accomplishment of its
principal purpose; engaging in mining operations.
After a very careful and deliberate consideration of the evidence
presented by the Solicitor General came to the conclusion that the same did not
warrant a quo warranto that could justify to terminate corporate life, and that the
corporate acts or omissions complained of had not resulted in substantial injury
to the public. Hence the Solicitor General withdrew the quo warranto proceedings
filed against Bisaya.
The issue before the Supreme Court was whether the Solicitor General
vested with the full power to manage and control the State's litigation, which
includes the power to discontinue such litigation if and in his opinion this could be
done. The Court held that the general rule is that the Solicitor General may do so
with the approval of the court. The purpose of the motion for the dismissal of the
quo warranto is to take the State out of an unnecessary court litigation.
According to the Court, dissolution is a serious remedy granted to the
courts against offending corporations. Courts, as a general rule, should not resort
to dissolution when the prejudice is not a prejudice against the public or not an
outright abuse of, or violation of the corporate charter. Even if the prejudice is
public in nature, the remedy is to enjoin or correct the mistake. Only when it
cannot be remedied anymore then dissolution can come in.
Government v. El Hogar Filipino,44 held that the holding of real property by
a savings and loan association which it had previously foreclosed beyond the five
(5) year holding period allowed by law shall not be a ground for forfeiture of its
franchise, especially when the corporation was shown to have acted in good
faith. The Supreme Court held that the penalty of dissolution would be
excessively severe and fraught with consequence altogether disproportionate to
the offense committed.

43
81 SCRA 9 (1978).
44
50 Phil 399 (1927).
 In Government v. Phil. Sugar Estates Co.,45 the Court refused to order
right away the forfeiture of franchise by a corporation seriously offending its
charter, but first directed the ousting of the corporation from the unlawful act. In
that case, Philippine Sugar Estates Co. (PSEC) entered into a contract with the
Tayabas Land Company for the purpose of engaging in the business of
purchasing lands along the right of way of the Manila Railroad Company through
the province of Tayabas with a view of reselling the same to the Manila Railroad
Company. PSEC by its charter was authorized to engage in any mercantile or
industrial enterprise. For a period of eighteen (18) months it had misused its
corporate authority, franchises, and privileges and had assumed privileges and
franchises not granted. PSEC contended that the money given to Tayabas Land
Company was in a form of a loan.
The Court found that the purpose of the intervention of PSEC was for
profit, to enrich itself at the expense of the taxpayers. The franchise granted to
PSEC should be withdrawn and annulled and that it be disallowed to do and to
continue doing business in the Philippine Islands, unless it shall within a period of
six (6) months after final decision, liquidate, dissolve and separate absolutely in
every respect and in all of its relations with Tayabas Land Company.
On the other hand, in Republic v. Security Credit & Acceptance Corp.,46
the Court directed immediately the forfeiture of franchise of an offending
corporation, since damage to the public was imminent. In that case, the Security
Credit & Acceptance Corp. did not have authority to engage in banking
corporations as required by the General Banking Act. Security Credit
nevertheless received deposits from the public regularly. Such deposits were
treated in the Corporation's financial statements as conditional subscriptions to
capital stock. Out of the funds obtained from the public through the receipt of
deposits or the sale of securities, loans are made regularly to any person by
Security Credit. The legal counsel of the Central Bank of the Philippines (CB)
rendered an opinion stating that Security Credit was engaged in the business of
banking within the purview of R.A. No. 337. A resolution was passed by the CB
declaring that Security Credit should first comply with the provisions of R.A. No.
337. Notwithstanding the resolution passed by the CB, Security Credit still
continued the function and activities which had been declared to constitute illegal
banking operations.
The Court found the illegal transactions thus undertaken by Security
Credit warranted its dissolution. It was apparent from the fact proven that the
misuser of the corporate funds and franchise affects the essence of its business,
that it is willful and has been repeated 59,643 times and that its continuance
inflicts injury upon the public, owing to the number of persons affected.

45
38 Phil. 15 (1918).
46
19 SCRA 58 (1967).
OBTAINING OF TAX CLEARANCE
Under Section 52(C) of the NIRC of 1997, every corporation shall, within
thirty (30) days after the adoption of a resolution or plan for its dissolution, or for
the liquidation of the whole or any part of its capital stock, including corporations
which have been notified of possible involuntary dissolution by the SEC, or for its
reorganization, file the necessary return with the BIR, setting forth the terms of of
such resolution or plan; and that prior to the issuance of the SEC of the certificate
of dissolution or reorganization, such corporation must secure a certificate of tax
clearance from the BIR to be submitted to the SEC.
Under Section 2 of BIR-SEC Regulations No. 1, whenever a corporation
undergoes dissolution, whether voluntarily or involuntarily, a tax clearance must
be obtained from the Bureau of Internal Revenue, by filing with the Bureau an
income tax returns covering the income earned by them from the beginning of
the taxable year to the date of dissolution. The SEC is required to furnish the
Commissioner of Internal Revenue a copy of any order of involuntary dissolution
or suspension of the primary franchise or certificate of registration of a
corporation.47
The SEC shall issue the final order of dissolution only after a certificate of
tax clearance has been submitted by the dissolving corporation. However, in the
case of involuntary dissolution, the SEC may nevertheless proceed with the
dissolution if thirty (30) days after the receipt of the suspension order no tax
clearance has yet been issued.

NATURE OF CORPORATE LIQUIDATION

“Liquidation” is “the settlement of the affairs of a corporation [which]
consists of adjusting the debts and claims, that is, of collecting all that is due the
corporation, the settlement and adjustment of claims against it and the payment
of its just debts.”48
Liquidation is the process by which all the assets of the corporation are
converted into liquid assets (cash) in order to pay for all claims of corporate
creditors, and the remaining balance, if any, is to be distributed to the
stockholders or members of the corporation. A liquidation proceeding is a
proceeding in rem so that all other interested persons whether known to the
parties or not may be bound by such proceedings.49
Dissolution always precedes liquidation, and there is no legal basis to
proceed with liquidation without the corporation first having been dissolved. This
is in accordance with the principles of the trust fund doctrine as applied in

47
A corporation whose corporate powers cease and are deemed dissolved because it was
not formally organized and did not commence the transaction of its business within two (2) years
from its incorporation need not secure a certificate of tax clearance. BIR Ruling No. 242, 10
November 1986.
48
China Banking Ciorp. V. M. Michelin & Cie, 58 Phil. 261 (1933).
49
Chua v. NLRC, 190 SCRA 558 (1990).
Philippine jurisdiction. Therefore, Section 122 of the Corporation Code expressly
provides that "[e]xcept by decrease by decrease of capital stock and as
otherwise allowed by this Code, no corporation shall distribute any of its assets
or property except upon lawful dissolution and after payment of all its debts and
liabilities."

METHODS OF LIQUIDATION
In our jurisdiction, there are three (3) recognized methods of liquidation of
corporate affairs.

1. Liquidation Through Board of Directors or

Trustees
The Supreme Court has held that there can be no doubt that under
Sections 77 and 78 of the old Corporation Law (now Section 122 of the
Corporation Code), the Legislature intended to let the shareholders have the
control of the assets of the corporation upon dissolution in winding up its affairs,
thus:

The normal method of procedure is for the directors and

executive officers to have charge of the winding up operations,
though there is the alternative method of assigning the
property of the corporation to the trustees for the benefit of its
creditors and shareholders. While the appointment of a
receiver rests within the sound judicial discretion of the court,
such discretion must, however, always be exercised with
caution and governed by legal and equitable principles, the
violation of which will amount to its abuse, and in making such
appointment the court should take into consideration all the
facts and weigh the relative advantages and disadvantages of
appointing a receiver to wind up the corporate business.50

2. Liquidation Through a Trustee

Under Section 122 of the Corporation Code, at any time during the three
(3) years of liquidation, a corporation is authorized and empowered to convey all
of its property to trustees for the benefit of stockholders, members, creditors, and
other persons in interest. From and after any such conveyance by the
corporation of its property in trust, all interest which the corporation had in the
property terminates, the legal interest vests in the trustees, and the beneficial
interest in the stockholders, members, creditors or other persons in interest.
In such cases, the three (3) year limitation will not apply provided the
designation of the trustee is made within said period. Unless the trusteeship is

50
China Banking Ciorp. V. M. Michelin & Cie, 58 Phil. 261 (1933).
limited in its duration by the deed of trust, there is no time limit which the trustee
must finish the liquidation, and he may sue or be sued even beyond the three (3)
year period.
In Board of Liquidators v. Kalaw,51 the Court held that the placing of the
affairs and assets of the NACOCO in the hands of a Board of Liquidators upon
dissolution, did not terminate the power of the Board to continue with the
liquidation process of NACOCO even after the lapse of the three (3) year period,
because the Board of Liquidators became the trustees; the Board took the place
of the corporation after the expiration of its affairs. Since no time limit has been
tacked to the existence of the Board and its functions of closing the affairs of the
corporation, it was held that the Board can still cases pending even after the
three (3) year period.
Gelano v. Court of Appeals,52 would hold the term "trustee" under the
Corporation Code should be understood in its general concept which could
include the counsel to whom was entrusted in a pending case, the prosecution of
the suit filed by the corporation. The Court held:

The purpose in the transfer of the assets of the

corporation to a trustee upon its dissolution is more for the
protection of its creditor and stockholders. Debtors like the
petitioners herein may not take advantage of the failure of the
corporation to transfer its assets to a trustee, assuming it has
any to transfer which petitioner has failed to show, in the first
place. To sustain petitioner's contention would be to allow
them to enrich themselves at the expense of another, which all
enlightened legal systems condemn.53

Lately, in both Clemente v. Court of Appeals,54 and Reburiano v. Court of

Appeals,55 the Supreme Court extended the Gelano ruling to include the board of
directors of a dissolved corporation to validly constitute “trustees” to carry on the
liquidation process beyond the three-year period mandated under Section 122.

3. Liquidation Through a Receiver

In China Banking Corp. V. M. Michelin & Cie,56 the Supreme Court had
outlined the procedure of liquidation when a receiver has been appointed by
the courts for the dissolution of the corporation, thus:

The appointment of a receiver by the court to wind up the

affairs of the corporation upon petition for voluntary dissolution

51
20 SCRA 987 (1967).
52
103 SCRA 90 (1981).
53
Ibid, at p. 99.
54
242 SCRA 717, 723 (1995).
55
301 SCRA 342, 102 SCAD 285 (1999).
56
58 Phil. 261 (1933).
 does not empower the court to hear and pass on the claims of
the creditors of the corporation at first hand. . . all claims must
be presented for allowance to the receiver or trustee or other
proper persons during the winding up proceedings which in
this jurisdiction would be within the three years provided by
sections 77 and 78 of the Corporation Law as the term for the
corporate existence of the corporation, and if a claim is
disputed or unliquidated so that the receiver cannot safely
allow the same, it should be transferred to the proper court for
trial and allowance, and the amount so allowed then presented
to the receiver or trustee for payment. The rulings of the
receiver on the validity of claims submitted are subject to
review by the court appointing such receiver though no appeal
is taken to the latter‟s ruling.

A receiver in liquidation stands on a different legal basis from a trustee in

liquidation. A trusteeship is basically a contractual relationship governed by the
Law on Trust, and generally centered upon property, such that the trustee
assumes naked title to the property placed in trust. It is therefore a relationship
that can be created by a corporation through its Board of Directors, without need
of judicial authorization. The trustee in liquidation is not appointed by any court,
but he is actually a transferee who holds legal title to the corporate assets and he
is accountable under the terms of the trust agreement. The trustee's fiduciary
obligations are provided in the trust instrument and by applicable legal
provisions.
A receivership, is created by means of judicial or quasi-jucidial
appointment of the receiver. The receiver is actually an officer of the court and
must therefore be accountable to the court.
Under Section 6 of Pres. Decree 902-A, the SEC is empowered to create
or appoint a management committee, board, or body to undertake the
management of the corporation. Such management committee or rehabilitation
receiver, board or body shall have the power to take custody of, and control over,
all the existing assets and property of the corporation. The SEC may, on the
basis of the findings and recommendation of the management committee, or
rehabilitation receiver, board or body, or in its own findings, determine that the
continuance in business of such corporation would not be feasible or profitable
nor work to the best interest of the stockholders, parties-litigants, creditors, or the
general public, order the dissolution of such corporation and the liquidation of its
remaining assets.
Again, the three (3) year period does not apply in such mode of liquidation
because the corporation is substituted by the receiver who may sue or be sued.
Sumera v. Valencia,57 held that when a corporation is dissolved and the
liquidation of its assets is placed in the hands of a receiver or assignee, the
period of three (3) years as prescribed under the law for liquidation cannot be

57
67 Phil. 721 (1939).
made to apply, and the assignee may institute all actions leading to the
liquidation of the assets of the corporation even after the expiration of said three
(3) years.
When liquidation is done, either by a trustee or receiver, the corporate
personality is not important. For the next three (3) years after dissolution, there is
corporate personality to do business other that to pursue liquidation. After the
three (3) year period, there is no more corporate personality either in this two
cases (trustee or receiver), but even then it no longer matters, since from the
time the assets of the corporation are transferred to a trustee or receiver
pursuant to a liquidation all such assets are then held by and in the name of the
trustee or receiver who can lawfully proceed with liquidation even if the
corporation no longer exists, because he has title to the assets.

DISPOSITION OF PENDING CLAIMS AGAINST

DISSOLVED CORPORATION
1. General Rule on Abatement
National Abaca Corp. v. Pore,58 held that in the absence of statutory
provision to the contrary, pending actions by or against a corporation are abated
upon the expiration of the three (3) year period allowed by law for the liquidation
of its affairs.
The then Corporation Law contained no provision authorizing a
corporation, after three (3) years from the expiration of its lifetime, to continue in
its corporate name, actions instituted by it within said period of the three (3)
years. The Court noted that it is precisely for this reason that the Corporation
Law also authorized the corporation, "at any time during said three (3) years . . .
to convey all its property to trustees for the benefit of members, stockholders,
creditors, and others in interest" evidently for the purpose among others, of
enabling said trustees to prosecute and defend suits by or against the
corporation before the expiration of said period.

2. Procedures Against Officers/Stockholders

Possessing Corporate Assets
However, Tan Tiong Bio v. Commissioner,59 would imply that even after
the three (3) year period of liquidation, corporate creditors can still pursue their
claims against corporate assets against the officers or stockholders who have
taken over the properties of the corporation.
In Tan Tiong Bio, the Commissioner wrote the corporation that the
investigations made by the Bureau revealed that it was the corporation, not Dee
Hong Lue, who was asking for a refund, that had actually purchased the surplus
goods from Foreign Liquidation Commission and that the properties were

58
2 SCRA 989 (1961).
59
100 Phil. 86 (1956).
invoiced in the name of Dee, in trust for the corporation. The corporation was
therefore assessed a deficiency sales tax by the Collector. When the corporation
appealed the assessment to the Court of Tax Appeals, the Solicitor General
moved for dismissal of the appeal on the ground that the corporation no longer
had the capacity to sue because the three (3) year term of liquidation had
expired.
The Court held that the State cannot insist on making tax assessment
against a corporation that no longer exists and then turn around and oppose the
appeal questioning the legality of the assessment precisely on the ground that
the corporation is non-existent, and has no longer capacity to sue. The State
cannot adopt inconsistent stand and thereby deprive the officers and directors of
defunct corporation of the remedy to question the validity and correctness of the
assessment for which, if sustained, they would be held personally liable as
successors-in-interest to the corporate property.
The Court observed that it may be true that in so far as the corporation is
concerned, it no longer exists and therefore no suits can be maintained for and
against it. In case of taxes, the law specifically says that responsible corporate
officers shall be personally liable for deficiencies. When a corporation has
distributed its properties, those who received the properties are in fact liable for
corporate taxes. The answer therefore as what is the remedy of the corporate
creditors after the three (3) year period is to trace where the corporate assets
have gone, wherever they rested, be he a stockholder or a non-stockholder. The
cause of action is to file an action against that person who has a control of the
corporate assets.
To the same effect is the ruling in Republic v. Marsman Development
Company,60 where the Court held that while Section 77 of the Corporation Law
[now section 122 of the Corporation Code] provides for a three year period for
the continuation of the corporate existence of the corporation for purposes of
liquidation, there is nothing in said provision which bars an action for the recovery
of the debts of the corporation against the liquidator thereof, after the lapse of the
said three-year period: “It immaterial that the present action was filed after the
expiration of the three years . . . for at the very least, and assuming that judicial
enforcement of taxes may not be initiated after said three years despite the fact
that actual liquidation has not terminated and the one in charge thereof is still
holding the assets of the corporation, obviously for the benefit of all the creditors
thereof, the assessment aforementioned, made within the three years, definitely
established the Government as a creditor of the corporation for whom the
liquidator is supposed to hold assets of the corporation.”

3. Continuing Suit Against Counsel of

Record Considered as Trustee

60
44 SCRA 418 (1972).
 Gelano v. Court of Appeals,61 held that a corporation with a pending court
action may still continue prosecuting or defending the same even after the lapse
of the three (3) years of liquidation, and that the counsel of record can be
considered as the trustee in such case, with full authority to continue prosecuting
or defending the suit.
Finally, De Guzman v. NLRC,62 held that although a corporate officer,
such as a general manager, is not liable for corporate obligations, such as claims
for wages, and no suit against him can be filed for the account of a corporation in
liquidation; nevertheless, when such corporate officer obtains corporate property
to apply to his own claims, such corporate officer shall be liable to the extent
thereof to corporate liabilities, since knowing fully well that certain creditors had
similarly valid claims, he took advantage of his position as general manager, and
applied the corporation's assets in payment exclusively to his own claims.

EFFECTS OF DISSOLUTION AND LIQUIDATION

Every corporation whose charter expires by its own limitation or is
annulled by forfeiture or otherwise, or whose corporate existence for other
purposes is terminated in any other manner, shall nevertheless be continued as
a body corporate for three (3) years after the time when it would have been so
dissolved for the purpose of prosecuting and defending suits by or against it and
enabling it to settle and close its affairs, to dispose of and convey its property and
to distribute its assets, but not for the purpose of continuing the business for
which it was established.63
At any time during said three (3) years, the dissolved corporation is
authorized and empowered to convey all of its property to trustees for the benefit
of stockholders, members, creditors, and other persons in interest. From and
after any such conveyance by the corporation of its property in trust for the
benefit of its stockholders, members, creditors and others in interest, all interest
which the corporation has in the property terminates, the legal interest vests in
the trustees, and the beneficial interest in the stockholders, members, creditors
or other persons in interest.64
Upon winding up of the corporate affairs, any asset distributable to any
creditor or stockholder or member who is unknown or cannot be found shall be
escheated to the city or municipality where such assets are located.65
A corporation in the process of liquidation has no legal authority to engage
in any new business, even if the same is in accordance with the primary purpose
stated in its articles of incorporation. This is because upon dissolution, the
corporation in effect losses its franchise and no longer has legal personality to

61
103 SCRA 90 (1981).
62
211 SCRA 723 (1992).
63
Sec. 122, Corporation Code.
64
Ibid.
65
Ibid.
pursue its business; and the only remnants of its legal personality is that of
transacting its liquidation during the given three (3) year period.

1. No Authority to Enter into New Business

Buenaflor v. Camarines Sur Industry Corp.,66 therefore held that a
corporate grantee of a certificate of public convenience to operate an ice plant
cannot lawfully continue to sell ice after the expiration of its corporate life; and
neither can it apply for a new certificate for its is incapable of receiving a grant. At
the point of dissolution, the doctrines of corporation by estoppel or de facto
corporations are not made to apply to save the transaction.
One will see in Buenaflor the mandatory effects of dissolution. In fact, the
general rule is that there is no juridical personality after dissolution. If there is, it is
only juridical personality to serve but one purpose—for all transactions pertaining
to liquidation. Any matter entered into that is not for the purpose of liquidation will
be a void transaction because of the non-existence of the corporate party.

2. Summary on Dissolution
and Liquidations Proceedings
Recently, Clemente v. Court of Appeals,67 revisited the procedures of
dissolution and liquidation. In that case, the Supreme Court refused the petition
filed by alleged stockholders of a sociedad anonima for the declaration of the
corporate assets to pertain to them in the absence of showing any transfer or
disposition by the corporation in their favor. The Court said that in the absence of
a corporate liquidation, it is the corporation, not the stockholders, which can
assert, if at all, any title to the corporate assets. "If indeed, the sociedad has long
become defunct, it should behoove petitioners, or anyone else who may have
any interest in the corporation, to take appropriate measures before a proper
forum for a peremptory settlement of its affairs."68
The Court then proceeded to lay down the procedures and effects of
dissolution and liquidation of a corporation as provided for in Sections 117 to 122
of the Corporation Code, and existing jurisprudence, thus:

(a) The termination of the life of a juridical entity does not by

itself cause the extinction or diminution of the rights and
liabilities of such entity nor those of its owners and creditor;69
(b) The corporation continues to be a body corporate for three
(3) years after its dissolution for purposes of prosecuting and
defending suits by and against it and for enabling it to settle

66
108 Phil. 472 (1960).
67
242 SCRA 717 (1995).
68
Ibid, at p. 722.
69
See Gonzales v. Sugar Regulatory Administration, 174 SCRA 377 (1989).
 and close its affairs, culminating in the disposition and
distribution of its remaining assets;
(c) It may, during the three-year term, appoint a trustee or a
receiver who may act beyond that period;
(d) If the three-year extended life has expired without a trustee
or receiver having been expressly designated by the
corporation within that period, the board of directors or
trustees themselves, following the rationale of the Supreme
Court's decision in Gelano v. Court of Appeals70 may be
permitted to so continue as "trustees" by legal implication to
complete the corporate liquidation;
(e) Still in the absence of a board of directors or trustees, those
having any pecuniary interest in the assets, including not
only the shareholders but likewise the creditors of the
corporation, acting for and in its behalf, might make proper
representations with the SEC, which has primary and
sufficient broad jurisdiction in matters of this nature, for
working out a final settlement of the corporate concerns.

Reburiano v. Court of Appeals,71 reiterated the ruling of the Supreme

Court that seeks to allow the full liquidation of the corporate affairs even beyond
the three-year period provided for in the Code, and invoked in addition the
transitory provision of Section 145 of the Corporation Code, thus:

In Gelano case, the counsel of the dissolved corporation

was considered a trustee. In the later case of Clemente v.
Court of Appeals [242 SCRA 717 (1995)], we held that the
board of directors may be permitted to complete the corporate
liquidation by continuing as “trustees” by legal implication.
Under Section 145 of the Corporation Code, “No right of
remedy in favor or against any corporation . . . shall be
removed or impaired either by the subsequent dissolution of
said corporation or by any subsequent amendment or repeal
of this Code or of any part thereof.” This provision safeguards
the rights of a corporation which is dissolved pending litigation.

REINCORPORATION
This section discusses the legal feasibility of reincorporating a corporation
that has already reached the point of dissolution.

1. Applicable Legal Provisions

70
103 SCRA 90 (1981).
71
301 SCRA 342, 102 SCAD 285 (1999).
 Under Section 121 of the Corporation Code, a corporation may be
dissolved by the SEC upon filing of a verified complaint and after proper notice
and hearing on grounds provided by existing laws, rules and regulations.
Under Section 6(l), of Pres. Decree 902-A, the SEC has the power to
revoke the certificate of registration of a corporation when there is fraud in
procuring its certificate of registration.
The legal effectS of such revocation of the certificate of registration of a
corporation, as spelled-out in Section 122 of the Corporation Code, is that such
corporation "shall nevertheless be continued as a body corporate for three (3)
years after the time when it would have been so dissolved, for the purpose of
prosecuting and defending suits by or against it and enabling it to settle and
close its affairs, to dispose of and convey its property and to distribute its assets,
but not for the purpose of continuing the business for which it was established."
Section 122 provides that "[a]t any time during said three (3) years, said
corporation is authorized and empowered to convey all of its property to trustees
for the benefit of stockholders, members, creditors, and other persons in interest.
From and after any such conveyance by the corporation of its property in trust for
the benefit of its stockholders, members, creditors and others in interest, all
interest which the corporation had in the property terminates, the legal interest
vests in the trustees, and the beneficial interest in the stockholders, members,
creditors or other persons in interest."
In addition, Section 40 of the Corporation Code authorizes the board of
directors, upon ratification by stockholders holding two-thirds (2/3) of the
outstanding capital stock of a corporation, "to sell, lease, exchange, mortgage,
pledge, or otherwise dispose of all or substantially all of its property and assets,
including its goodwill, upon such terms and conditions and for such
consideration, which may be money, stocks, bonds or other instruments for the
payment of money or other property or consideration, as its board of directors . . .
may deem expedient."

2. Extension of Corporate Life During

Period of Dissolution
In the interpretation of Section 122 (as well as the old Section 77 of the old
Corporation Law), the Supreme Court has consistently taken the position that it
would be illegal for the corporation, when it has reached the stage of dissolution,
to seek to extend its corporate life, even with the amendment of the articles of
incorporation, because the same would constitute "new business" contrary to the
injunction of the law that upon dissolution the corporation cannot go into a
transaction "for the purpose of continuing the business for which it was
established."
In Philippine National Bank v. Court of First Instance of Rizal,72 the Court
held that when the period of corporate life expires, the corporation ceases to be a
72
209 SCRA 294 (1992).
body corporate for the purpose of continuing the business for which it was
organized. In Alhambra Cigar & Cigarette Manufacturing Company, Inc. v.
Securities & Exchange Commission,73 it was held that a corporation cannot
extend its life by amendment of its articles of incorporation effected during the
three-year statutory period for liquidation when its original term of existence had
already expired, as the same would constitute new business.

3. Distinctions Between Extension of

Corporate Life, Revival and Reincorporation
Fletcher recognizes the distinction between the extension of a charter and
the grant of a new one. "To renew a charter is to revive a charter which has
expired, or, in other words, „to give a new existence to one which has been
forfeited, or which has lost its vitality by lapse of time.‟ To „extend‟ a charter is „to
increase the time for the existence of one which would otherwise reach its limit at
an earlier period.‟ On the other hand, the renewal of a corporate charter by
extending the term of corporate life has been considered, in legal effect, as
amounting to the grant of a new charter so as to subject the corporation to the
laws in effect at the time of renewal."74 He further says:

Whether an act operates as a revival or a reincorporation

is a question of construction. A corporation chartered by
special law does not lose title to land held by it because an act
reincorporating it is not passed until after the expiration of the
period of existence fixed by its original charter. The
reinstatement of a repealed charter relates back to the date of
proclamation of the repealer and validates any corporate
action taken in the interim. Only the state can attack the
reinstatement of a forfeited charter.75

On the other hand, Fletcher holds that "[r]eincorporation consists in the

taking out of a new charter by a corporation in order to correct errors or defects in
the original incorporation, or to enlarge the power or limit the liabilities of the
corporation, or to lengthen or revive the corporate life. In a sense it is but an
amendment of the charter, and generally, under the statutes, there is no new
corporation but the company is the same as before the reincorporation.”
As has already been pointed out, under Philippine jurisprudence the
reincorporation of a corporation which has the legal effect of extended the old
corporate entity is not authorized when this is sought to be achieved after the
original term has expired.
73
24 SCRA 269 (1968).
74
8 FLETCHER CYCLOPEDIA CORPORATIONS, Perm. Ed., Sec. 4092. Fletcher also holds that
"[w]hether a charter creates a new corporation or merely continues the existence of an old one is
to be determined from its terms, construed in accordance with the legislative intent and the intent
of the corporators. Ordinarily neither an extension nor a revival creates a new corporation." Ibid,
Sec. 4093.
75
Ibid, Sec. 4108.
 4. Process of Reincorporating
While extension of corporate life of a corporation which has reached the
stage of dissolution, is not permitted, the Supreme Court has recognized that
"reincorporation" of an old corporation, is not prohibited, even when the old
corporation has reached the state of dissolution.
The decision in Chung Ka Bio v. Intermediate Appellate Court,76 covers
the case of Philippine Blooming Mills Company, Inc., the corporate term of which
under the original terms of its articles of incorporation was to expire on 19
January 1977. On 14 May 1977, the members of the board of directors executed
a deed of assignment of all of the accounts receivable, properties, obligations
and liabilities of the old PBM in favor of Chung Siong Pek in his capacity as
treasurer of the new PBM, "then in the process of reincorporation."77 On 14 June
1977, the new PBM was issued a certificate of incorporation by the SEC.
Some of the stockholders of the old PBM filed with the SEC a petition for
liquidation of both the old and the new PBM alleging that the former had become
legally non-existent for failure to extend its corporate life and that the latter had
likewise been ipso facto dissolved for non-use of the charter and continuous
failure to operate with 2 years from incorporation.
On the issue of whether the board of directors of an already dissolved
corporation does not have the inherent power, without the express consent of the
stockholders, to convey all its assets to a new corporation, the Supreme Court
held that since there is no proof that the two-thirds (2/3) vote was not given by
the stockholders, "there is the presumption of regularity which must operate in
favor of the private respondents, who insist that the proper authorization as
required by the Corporation Law was obtained at a meeting called for the
purpose."78 In addition, the Court held that had not the required ratificatory vote
of the stockholders been obtained, "the new PBM would not have been issued a
certificate of incorporation, which should also be presumed to have been done
regularly."79
In addition, the Court held that"[w]hile we agree that the board of directors
is not normally permitted to undertake any activity outside of the usual liquidation
of the business of the dissolved corporation, there is nothing to prevent the
stockholders from conveying their respective shareholdings toward the creation
of a new corporation to continue the business of the old. Winding up is to the sole
activity of a dissolved corporation that does not intend to incorporate anew. If it
does, however, it is not unlawful for the old board of directors to negotiate and
transfer the assets of the dissolved corporation to the new corporation intended
to be created as long as the stockholders have given their consent. This was not

76
163 SCRA 534 (1988).
77
Ibid, at p. 535.
78
Ibid, at p. 539. There is a presumption in favor of a corporation that all requirements of the
law have been complied with. U.S. v. Asensi, 34 Phil. 671 (1916).
79
Ibid, at p. 539.
prohibited by the Corporation [Law]. In fact, it was expressly allowed by Section
28-1/2."80
As the Court found in Chung Ka Bio, both Sections 77 and 28-1/2 of the
old Corporation Law "are now Sections 122 and 40, respectively, with
modifications, of the Corporation Code."81 Even under the provisions of the
present Corporation Code, nothing prohibits the old board of directors of a
dissolved corporation to negotiate and transfer the assets of the dissolved
corporation to the new corporation intended to be created as long as the
stockholders have given their consent, and such consent by stockholders is
expressly allowed in Section 40 of the said Code.

a. Rights of Opposing Creditors

Chung Ka Bio failed to address the issue as to the effectivity of
reincorporation against the existing creditors of the defunct corporation on the
assets thereof. Under the rules of dissolution, it is mandated that all assets of the
dissolved corporation must be applied first towards the payment of the existing
creditors of the dissolved corporation.

b. Rights of Dissenting Stockholders

Even when reincorporation would not prejudice existing creditors of the
defunct corporation, such as when the assets sought to be reincorporated
represent the net assets after the payment of all liabilities, Chung Ka Bio still
does not discuss the rights of dissenting stockholders who refused to have their
share in the net assets reincorporated into a new corporation. The finding that
two-thirds (2/3) of the stockholdings, or for that matter any greater vote of
conformity to the reincorporation cannot serve to bind the proprietary rights of
stockholders who vote against such decision.

—oOo—

CORP. MANUSCRIPT\ 15- DISSOLUTION\07-30-2002

80
Ibid, at p. 540.
81
Ibid, at p. 539.
 CHAPTER 16

CLOSE CORPORATIONS1

Introduction
General Concept of Corporation Code on Nature of Corporation
Concept of Close Corporation
Statutory Definition of Close Corporations
Problems with Statutory Definition
De Facto Close Corporations
Likely Jurisprudential Solutions
Need for a Close Corporation
Title XII on Close Corporations
Classification of Shares and Restriction of Transfer
Classification of Directors
Provisions for Greater Quorum or Voting Requirements
Stockholders as Corporate Managers
Agreements Among Stockholders
Board Meetings Unnecessary
Pre-emptive Rights
Deadlocks and Dissolution
Repurchase of Shares of Stock
Piercing the Veil of Corporate Fiction
Conclusion

——

INTRODUCTION
There has always been a wide consensus among Corporate Law
practitioners that if statistics are taken on existing corporate entities in the
Philippines, a vast majority would be what are termed as close corporations,
while the rest would be publicly-held corporations. The distinctions between a
close corporation and a publicly-held corporation not only has legal significance,
but more importantly, such distinctions were, and still continue to have, practical
repercussions in the enforcement of rights and obligations in the business world.
With the adoption of the Corporation Law2 in 1906, no conscious and definitive
attempt was made to establish different sets of rules to govern the affairs of close
corporations, and the same sets of rules for publicly-held corporations were
made to apply to close corporations.

1
The chapter is an expanded version of the article Philippine Close Corporations, originally
published in 32 ATENEO L. J. 1 (No. 2, March, 1988).
2
Act No. 1459.
 Yet even under the old Corporation Law, the features of the close
corporation were recognized, thus:

One salient feature of this type of corporation is that

ownership of its shares is limited either to the members of a
family or to a group of friends or business associates. Unlike
publicly-held corporations, where membership is open to
anyone willing to pay the price, in close corporations
membership is restricted and acceptance as a member often
becomes a matter of personal consideration. Another peculiar
feature of a close corporation is the identity between
ownership and management--the shareholders are themselves
the directors and officers. With these two features, one is
immediately reminded of a partnership with its element of
delectus personae and the authority of any of its general
partners to act for the partnership in the absence of a
designated manager.3

Nevertheless, the provisions of the Corporation Law applied more to

publicly-held corporations than to close corporations, and there was a bias
against close corporations, as though such entities, or those of similar nature,
were mutants of the "perfect corporate structure" that was sought to be made
prevalent in the Philippine setting.
As is often true in the business world, what judges, lawmakers and social
scientist may consider as ideal or desirable would invariably give way to the
necessary demands of commercial transactions. Investors wanted a business
vehicle that would incorporate the best features of a partnership and a
corporation. With the enactment of the Corporation Code in May, 1980, our
lawmakers have given formal statutory recognition to close corporations as a
valid medium of business enterprise. The acts pertaining to close corporations
which formerly were considered as "corporate malpractices" have now been
given legal acceptance under Title XII of the Corporation Code.4

GENERAL CONCEPT OF CORPORATION CODE

ON NATURE OF CORPORATION
The general impression one gets after reading through the provisions of
the Corporation Code is that close corporations are treated more as exceptional
cases, while publicly-held corporations are the general rule. Although the
3
Ferrer, Varying a Shareholder's Statutory Participation in Management by the Use of Non-
Statutory Devices, 9 ATENEO L.J. 10-11 (1959).
4
The concept of closely-held corporation was previously given statutory recognition under
the National Internal Revenue Code which subjected them to the 10% corporate development tax
on their taxable net income. The definition of "closely-held corporation" covered any corporation
at least 50% in value of the outstanding stock or at least 50% of the total combined voting power
of all classes of stock entitled to vote is owned directly or indirectly by or for not more than five
persons, natural or juridical. The tax was deleted by the Batasang Pambansa in March, 1983.
Philippine corporate setting has undergone significant changes, the bias against
close corporations remains.
The bulk of the provisions of the Corporation Code devotes itself to
general and specific rules more applicable to publicly-held corporations. Title XII
of the Corporation Code which governs close corporations consists of relatively
few sections (Sections 96-105); in fact, the last paragraph of Section 96 provides
that "the provisions of other Titles of [the] Code shall apply suppletorily [to close
corporations] except insofar as this Title otherwise provides."
As will be shown hereunder, such a statutory attitude has significance,
particularly with respect to the legislative intent to ascribe to an entity similar to a
close corporation the qualities and conditions of a publicly-held corporation.

CONCEPT OF CLOSE CORPORATION

Under American jurisprudence, close corporations are those in which the
major part of the persons to whom the powers have been granted, on the
happening of vacancies among them, have the right of themselves to appoint
others to fill such vacancies, without allowing to the stockholders in general any
vote or choice in the selection of such new officers;5 or where the business policy
and activities are entirely dominated for practical purposes by the majority stock
ownership of a family whose stock is not traded in any market and is very
infrequently sold.6
The SEC opined that the main distinction between close corporation from
other corporations is the identity of stock ownership and active management, i.e.,
all or most of the stockholders are active in the corporate business either as
directors, officers or other key men in management.7

1. Statutory Defintion of Close Corporation

Under Section 96 of the Corporation Code, a close corporation is defined
as "one whose articles of incorporation provide" that:

(a) All of the corporation's issued stock of all classes,

exclusive of treasury shares, shall be held of record by
not more than a specified number of persons, not
exceeding twenty (20);

5
McKim v. Odom, Md., 3 Bland, 407, 416
6
Brooks v. Willcuts, D.C. Minn., 9 F. Supp. 19, 20.
7
SEC Opinion, 7 February 1994, XXVIII SEC QUARTERLY BULLETIN 3 (No. 3, Sept. 1994):
"Where business associates belong to a small, closely-nit group, they usually prefer to keep the
organization exclusive and would not welcome strangers, since it is through their efforts and
managerial skill that they expect the business to grow and prosper, it is quite understandable why
they would not trust outsiders to hare whatever fortune, big or small, the the business may bring.”
 (b) All of the issued stock of all classes shall be subject to
one or more specified restrictions on transfer permitted
by Title XII of the Corporation Code; and
(c) The corporation shall not list in any stock exchange or
make any public offering of any of its stock of any class.

However, Section 96 has a proviso that notwithstanding the presence of

all three (3) requisites in the articles of incorporation, "a corporation shall be
deemed not a close corporation when at least two-thirds (2/3) of its voting stock
or voting rights is owned or controlled by another corporation which is not a close
corporation."

2. Problems with Statutory Definition

In the original version of the paper published on the subject matter, 8 the
author had observed that the definition of a close corporation under Section 96 of
the Corporation Code offers a serious stumbling block to the growth in the
Philippines jurisprudence of this type of business vehicle.
Firstly, by limiting the applicability of Title XII to corporations having all the
three (3) enumerated requisites, a significant portion of what otherwise would be
generally accepted close-corporations would not be covered by Title XII of the
Corporation Code, and instead would continue to be governed by the same
provisions applicable to publicly-held corporations. This would be true even in
case of corporations possessing two out of the three (3) enumerated requisites.
Secondly, by providing in Section 96 that all three (3) enumerated
requisites must by stated in the article of incorporation, it would seem that those
corporations possessing all the requisites in actual practice would not be covered
by the provisions of Title XII of the Corporation Code if their articles of
incorporations are silent on the matter.
Thirdly, even for corporations whose articles of incorporation provide for
all three (3) requisites such would cease to be governed by Title XII of the
Corporation Code (i.e., they would be governed by the provisions pertaining to
publicly-held corporations) if actual operations show that any one of the
requisites has been violated. Hence, in a situation where all three (3) requisites
are provided for in the articles of incorporation of a particular corporation, and
during its existence, the actual number of shareholders exceeds 20, opinion has
been expressed that such facts automatically disqualify the corporation from
being a close corporation.
This position seems to be bolstered by Section 96 which provides that
even if all three (3) requisites are provided for in the articles of incorporation, the
corporation ceases to be a close corporation "when at least two-thirds (2/3) of its
voting stock or voting rights is owned or controlled by another corporation which
is not a close corporation."

8
See note 1.
 The objective test of "what is provided in the articles of incorporation,"
which can be defeated by the test of "actual disposition of shares of stock," gives
rise to instability and downright confusion. A corporation may be a close
corporation today, not a close corporation tomorrow, and again is a close
corporation the next day, depending on how many stockholders hold its shares of
stock. What would be worse is the prospect that a group of stockholders can
determine whether or not to place corporate affairs within the ambit of Title XII of
the Corporation Code, by the simple expedient of having the shareholdings in a
close corporation exceed the maximum twenty (20) shareholders provided for in
Section 96.
Under Title XII of the Corporation Code, the legal status of being a close
corporation carries with it certain rights, obligations, special procedures and
rules, as well as legal advantages and disadvantages. It is difficult to imagine our
lawmakers having built on shaky foundation the legal concept of what would
constitute a close corporation.

3. De Facto Close Corporations

However, such position as then held recognized that such proffered
solution did not address the problem of what would be the legal disposition as to
the majority of close corporations which do not comply with the objective test
provided in Section 96 of the Corporation Code (hereinafter referred to as "de
facto close corporation").
To state that de facto close corporations can and should now comply with
the requisites as provided in Section 96 of the Corporation Code is too simplistic
an approach that is not in touch with business realities. Actual business
conditions may prevent them from complying strictly with the 20-stockholder limit
or to restrictions on transfer, and yet maintaining for all intents and purposes the
very close identity of stock ownership and active management. It may also
happen that a corporate venture can comply with all the requisites provided
under Section 96 of the Corporation Code, but business judgment dictates that it
must not do so because the business does not wish to be tied-up with all the
legal disadvantages and fluidity offered under Title XII of the Corporation Code.
Suppose a business group wishes to adopt some of the schemes allowed
under Title XII of the Corporation Code, will it be barred from doing so? And
would the group's action be considered a "malpractice" simply because it is not
pursued under the cloak of a close corporation defined under Section 96? What
would be the "legal concessions" that de facto close corporations may avail of
under the present law? What is the actual policy towards the de facto close
corporations that should guide Philippine tribunals?
 These are significant issues that have remained unanswered under the
Corporation Code.9 These were some of the issues raised in the original
published version of the paper.

4. Likely Jurisprudential Solutions

The original paper published by the author on the matter held then that in
case of dispute, jurisprudence would uphold the objective test in determining the
nature of the corporation, regardless of actual practice. It was proposed in the
original published version of the paper that the remedy in case of non-
compliance with any of the requisites provided in the articles of incorporation is
not the automatic declassification of the corporation but rather for administrative
enforcement to ensure that measures be taken by the corporation or its offices to
comply with the requisites under pain of penalty as provided in Section 144 of the
Corporation Code.10
In 1993, the Supreme Court in Manuel R. Dulay Enterprises v. Court of
Appeals,11 has made pronouncements on some of the points discussed above. In
that case, the corporation was described to have its controlling stockholders,
members of the Dulay family, to compose the board of directors and officers, with
nominal shares listed in the names of two other nominees, and which corporation
was the registered owner of the Dulay Apartments. The corporation, obtained
various loans for the construction of its hotel project, Dulay Continental Hotel,
and borrowed money from one of its directors, Virgilio Dulay, to continue the
project. As a result, Virgilio Dulay occupied one of the apartment units since 1973
while at the same time managing the Dulay Apartments.
In 1976, the corporation, through its President, sold the Dulay Apartments
under a sale with option to purchase within two years, to one Veloso, who
mortgaged the property in favor of one Torres, who eventually foreclosed on the
property and become the highest bidder at the auction sale. When the
redemption period expired, Torres sought to consolidate title, and filed an action
to recover possession of the property. The corporation filed an action against
9
It is not gratifying at all to know that nearly 30 years ago the issue on "malpractices"
relating to close corporations were raised by the late Judge Simeon N. Ferrer in his leading article
published in Vol. IX of the ATENEO LAW JOURNAL entitled Varying a Shareholder's Statutory
Participation in Management by the Use of Non-Statutory Devices. It is Possible Under Our
Corporation Statute? And yet even with the enactment of the Corporation Code, many of those
issues have remained unanswered as to de facto close corporations.
10
Under Sec. 144 it is provided that "Violations of any of the provisions of this Code or its
amendments not otherwise specifically penalized therein shall be punished by a fine of not less
than one thousand (P1,000.00) pesos but not more than ten thousand (P10,000.00) pesos or by
imprisonment for not less than thirty (30) days but not more than five (5) years, or both, in the
discretion of the court. If the violation is committed by a corporation, the same may, after notice
and hearing, be dissolved in appropriate proceedings before the Securities and Exchange
Commission: Provided, That such dissolution shall not preclude the institution of appropriate
action against the director, trustee or officer of the corporation responsible for said violation:
Provided, further, That nothing in this section shall be construed to repeal the other causes for
dissolution of a corporation provided in this Code.
11
225 SCRA 678, 44 SCAD 297 (1993).
Torres and Veloso for the cancellation of the sale at foreclosure on the ground
that the sale of the property to Veloso was done by the President without actual
board approval.
In upholding the validity and binding effect of the sale of the Dulay
Apartments on the corporation, the Court relied upon the provisions of Section
101 of the Corporation Code pertaining to close corporation, and held: "In the
instant case, petitioner corporation is classified as a close corporation and
consequently a board resolution to authorize the sale or mortgage of the subject
property is not necessary to bind the corporation for the action of its president. At
any rate, a corporate action taken at a board meeting without proper call or
notice in a close corporation is deemed ratified by the absent director unless the
latter promptly files his written objection with the secretary of the corporation after
having knowledge of the meeting which, in this case, petitioner Virgilio Dulay
failed to do." In addition, the Court used the doctrine of piercing the veil of
corporation fiction to bind the corporation for the acts of its President.
However, other than a description of the composition of the corporation,
nothing at all was indicated in the decision to show how the Court arrived at the
conclusion that the corporation was a close corporation. Neither was there any
attempt at all to square with the definition under Section 96 of the Corporation
Code.
The Dulay ruling, which tended to overlook the formal requisites of a close
corporation under Section 96, was reiterated in Sergio F. Naguiat v. NLRC,12
where the Supreme Court held personally and solidarily liable the President and
Vice-President of two corporations, under the findings that—

Both officers admitted that the two corporation were

“close family corporations” owned by the Naguiat family. The
two officers are liable solidarily with the Clark Field Taxis, Inc.
for employment compensation awarded to the employees of
Clark Field Taxis. Section 100, paragraph 5, (under Title XII on
Close Corporations) of the Corporation Code provides that to
the extent that the stockholders are actively engaged in the
management or operation of the business and affairs of the
close corporation, the stockholders shall be held to strict
fiduciary duties to each other and among themselves; said
stockholders shall be personally liable for corporate torts
unless the corporation has obtained reasonably adequate
liability insurance.

The Dulay and Sergio F. Naguiat rulings demonstrate a tendency that may
be followed in the future: (a) the coverage of "close corporation" may expand
beyond the definition provided for in the Corporation Code; or (b) principles
pertaining peculiarly to close corporations under Title XII of the Corporation Code
would be expanded to apply even to non-close corporation, i.e., de facto close

12
269 SCRA 564, 80 SCAD 502 (1997).
corporations, or even publicly-held corporations. At any rate, with the statutory
recognition of the strict close corporation, it can be anticipated that the Supreme
Court would by jurisprudence expand the doctrines into and recognize the de
facto close corporations.
Nevertheless, in 1998, in San Juan Structural and Steel Fabricators, Inc.
v. Court of Appeals,13 the Court looked into the requisites under Section 96 to
determine whether to consider a corporation a close corporation, and thereby
would allow the enforcement of corporate liability upon its corporate officers. In
San Juan the Court held just because the corporate treasurer and her husband
together owned 99.866% of the outstanding capital stock of the corporation “does
not justify a conclusion that it is a close corporation which can be bound by the
acts of its principal stockholder who need no specific authority, “ thus:

The determination of when a corporation is a close

corporation is determined by the requisites provided in Sec. 96
of the Corporation Code. In this case, the articles of
incorporation do not contain any provision stating that (1) the
number of stockholders shall not exceed 20, or (2) a
preemption of shares is restricted in favor of any stockholder
or of the corporation, or (3) listing its stocks in any stock
exchange or making a public offering of such stocks is
prohibited. The corporation does not become a close
corporation by the mere fact that the spouses owned 99.866%
of the capital stock. The mere ownership by a single
stockholder or by another corporation of all or nearly all of the
capital stock of a corporation is not of itself sufficient ground
for disregarding the separate corporate personalities. So, too,
a narrow distribution of ownership does not, by itself, make a
close corporation.14

The Court sought to distinguish its ruling in Dulay thus: “The principle in
Manuel R. Dulay Enteprises, Inc. v. Court of Appeals, 225 SCRA 678 (1993), do
not apply because in Dulay the sale of real property was contracted by the
president of a close corporation with the knowledge and acquiescence of its
board of directors.”

NEED FOR A CLOSE CORPORATION

A close corporation is essentially not simply a corporation; it is the
progeny of a marriage of convenience between the essence of a partnership and
that of a corporation. A close corporation should be considered a distinct type of
business organization embodying what businessmen perceive to be the best
features of a partnership and a corporation.

13
296 SCRA 631(1998).
14
Ibid, at p. 645.
 Under a free-market system, businessmen should be left a liberty to adopt
a business medium which they feel is best for the pursuit of their commercial
affairs, so long as the route chosen by them is not contrary to law, morals, public
policy and public order. The separate personality, limited liability and right of
succession are all features of a corporate entity which the law upholds and which
businessmen may avail of. The feature of delectus personae, general
management by all partners of business affairs are attractive features of a
partnership which the law guarantees and supervise. That businessmen take the
best features of a corporation and a partnership and combine them in a business
organization called the close corporation by itself cannot be considered
reprehensible or against any legal norm. Our lawmakers explicitly recognize the
acceptability of such a business scheme by giving formal recognition to close
corporations under Title XII of the Corporation Code.
When our Legislature, as policy determining body, enacted Title XII as
part of the Corporation Code, did they intend the same to be a recognition of the
reality that close corporations are here to stay and should be given legal and
judicial accommodation? On the other hand, by enacting Title XII of the
Corporation Code was it the intention that only the close corporation defined in
Section 96 thereof be given "living space", while all others would fall under the
broad category of publicly-held corporation?
A review of the deliberations of what was then Cabinet Bill No. 3 does not
really shed much light into the legislative intent, for indeed there was practically
no discussion on close corporations. Nevertheless, what was stated by the
sponsor of the bill, then Minister Estelito Mendoza, about close corporations is
worth noting:

. . . While a code, such as the proposed code now

before us, may appear essentially regulatory in nature, it does
not, and is not intended, to curb or stifle the use of the
corporate entity as a business organization. Rather, the
proposed code recognizes the value, and seeks to inspire
confidence in the value of the corporate vehicle in the
economic life of society.
There are those who see a “curse in bigness.” The
corporation code carries no inherent bias against “bigness.”
On the contrary, the code acknowledges the economic and
technological necessity of bigness in modern industry. It thus
seeks to assure that the corporate entity does not only survive
but becomes an attractive and effective vehicle for the
accumulation of capital and the production of goods. This is
not to suggest that corporations must of necessity be big.
What I emphasize is that, no provision in the code is designed
to impede growth: rather, growth is encouraged. But use of the
corporate entity by those groups who do not desire to be
public thereby providing for themselves more limited access to
 resources is not discouraged. A whole new title on close
corporations has in fact been included in the Code. . .15

TITLE XII ON CLOSE CORPORATIONS

We proceed to review specific grants under Title XII of the Corporation
Code to close corporations, and compare how much they have been
"recognized" previously under corporate jurisprudence and to discuss the
business rationale thereof. To the extent that such specific grants have been
recognized by the Supreme Court prior to the enactment of the Corporation Code
is itself a strong indication that they are available even to de facto close
corporations, and therefore even to publicly-held corporations.

1. Classification of Shares and Restriction of Transfer

Section 97(1) provides that the articles of incorporation of the close
corporations may provide for "a classification of shares or rights and the
qualification for owning or holding the same and restrictions on their transfers as
may be stated therein." In turn, Section 98 provides that restrictions on the right
to transfers shares must appear in the articles of incorporation, in the by-laws, as
well as in the certificate of stock . . . [and] shall not be more onerous than
granting the existing stockholders of the corporation the option to purchase the
shares of the transferring stockholder with such reasonable terms, conditions or
period stated therein."
The classification of shares or rights and qualification for owning or
holding the same is not a feature peculiar only to close corporations. Under
Section 6 of the Corporation Code, even publicly held corporations may have
their shares "divided into classes or series of shares, or both, any of which
classes or series of shares may have such rights, privileges or restrictions as
may be stated in the articles of incorporation."
The restriction on the transferability of shares of stock in a close
corporation is limited to what in general parlance is called a "right of first refusal;"
and from the wordings of Section 98, it would be the most onerous restriction
allowed. The right of first refusal is a control scheme essential to a close
corporation which allows the existing stockholders the power to maintain the
character of delectus personae and thereby prevent an outsider from coming
into and interfering with the affairs of the corporation. Section 98 thus formally
puts into statutory form the ruling in the leading American case of Barreto v. King,
et al.,16 thus:

As to public policy, we see nothing in the provisions

contrary to that, at least as between the plaintiff and the

15
Records of the Interim Batasan Pambansa, 5 November 1979, Vol. III, p. 1212.
16
63 NE 934.
 corporation. . . Furthermore, looking at the stock as property, it
might be said that as far as it appears and probably in fact, it
was called into existence with this restriction inherent in it, by
the consent of all concerned. . . Stock in a corporation is not
merely property. It also creates a personal relation analogous
otherwise than technically to a partnership. . . There seems to
be no greater objection to restraining the right of choosing
ones associates in a corporation than in a firm.17

In the 1925 case of Fleischer v. Botica Nolasco Co.18 a provision in the by-
laws of the corporation gave to the corporation a preferential right to buy the
shares of stockholders who wished to dispose of their shareholdings. In holding
that the provision in the by-laws was void, the Supreme Court held:

Section 13, paragraph 7 above-quoted empowers a

corporation to make by-laws not inconsistent with any existing
law, for the transferring of its stock. It follows from said
provision, that a by-law adopted by a corporation relating to
transfer of stock should be in harmony with the law on the
subject of transfer of stock. The law on the subject is found in
Section 35 of Act. No. 1459 above-quoted. Said section
specifically provides that the shares of stock “are personal
property and may be transferred by delivery of the certificate
indorsed by the owner, etc.” Said Section 35 defines the
nature, character and transferability of shares of stock. Under
said section they are personal property and may be
transferred as therein provided. Said section contemplates no
restriction as to whom they may transferred or sold. It does not
suggest that any discrimination may be created by the
corporation in favor or against a certain purchaser. The holder
of shares as owner of personal property, is at liberty, under
said section, to dispose of them in favor of whomsoever he
pleases, without any other limitation in this respect, than the
general provisions of law. Therefore, a stock corporation in
adopting a by-law governing transfer of shares of stock should
take into consideration the specific provision of Section 35 of
Act. No. 1459, and said by-law should be made to harmonize
with said provisions. It should not be inconsistent therewith.

Nevertheless, in arriving at such a ruling, the Court relied upon the

following authority which expressly allows such a restriction if authorized in the
charter of the corporation, thus:

The right of unrestrained transfer of shares inheres in the

very nature of a corporation, and courts will carefully scrutinize
any attempt to impose restrictions or limitations upon the right
17
Ibid.
18
47 Phil. 583 (1925).
 of stockholders to sell and assign their stock. The right to
impose any restraint in this respect must be conferred upon
the corporation either by the governing statute or by the
articles of corporation. It cannot be done by a by-law, without
statutory or charter authority. . .19
It follows from the foregoing that a corporation has no
power to prevent or to restrain transfers of its shares, unless
such power is expressly conferred in its charter or governing
statute. This conclusion follows from the further consideration
that by-laws or other regulations restraining such transfers,
unless derived from authority expressly granted by the
legislature, would be regarded as impositions in restraint of
trade.20

Moreover, the Court likewise relied on the non-binding effect of restrictions

on transferability existing only in the by-laws, thus:

And moreover, the by-law now in question cannot have

any effect on the appellee. He had no knowledge of such by-
law when the shares were assigned to him. He obtained them
in good faith and for a valuable consideration. He was not a
privy to the contract created by said by-law between the
shareholder Manuel Gonzalez and the Botica Nolasco, Inc.
Said by-law cannot operate to defeat his rights as a purchaser.
An authorized by-law forbidding a shareholder to sell his
shares without first offering them to the corporation for a
period of thirty days is not binding upon an assignee of the
stock as a personal contract, although his assignor knew of
the by-law and took part in its adoption. (10 Cyc., 579; Ireland
vs. Globe Mining Co., 21 R.I., 9.). . .
A by-law of a corporation which provides that transfer of
stock shall not be valid unless approved by the board of
directors, while it may be enforced as a reasonable regulation
for the protection of the corporation against worthless
stockholders, cannot be made available to defeat the rights of
third persons. (Framers' & Merchants' Bank of Linevill vs.
Wasson, 48 Lowa, 336.)

In the earlier case of Lambert v. Fox,21 the Court had already held valid an
agreement between shareholders not to dispose of the shareholdings in the
corporation for a designated reasonable period of time. The Court held that the
suspension of the power to sell had a beneficial purpose, resulted in the
protection of the corporation as well as of the individual parties to the contract,
and was reasonable as to length of time of suspension.
19
Ibid, quoting from 4 THOMPSON ON CORPORATIONS, Sec. 4334, pp. 818, 819.
20
Ibid, quoting from 10 CYC., p. 578.
21
26 Phil. 588 (1914).
 Lately, the doctrine was reiterated in Rural Bank of Salinas v. Court of
Appeals,22 which held that a corporation, either by its board of director, its by-
laws, or the act of its officers, cannot create restriction in stock transfers,
because restrictions in the traffic of stock must have their source in legislative
enactment or its charter, as the corporation itself cannot create such impediment.
The right of first refusal, therefore, should be available even to de facto
close corporations provided that same is delineated in the articles of
incorporation and indicated in the certificate of stock (to give notice to third
parties) and is reasonable in its operation as not to amount to a deprivation of a
stockholders right to ultimately dispose of his shareholdings.
The right-of-first-refusal feature in a close corporation setting is meant to
provide a default feature which need not be the subject of costly bargaining
procedures, where clearly the intention of the parties is to limit the management
of the underlying corporate enterprise only among the investors themselves,
much similar to the delecties personarum in a partnership. It is a feature that
insures to the other investors that they would not have within their midst a person
who might not have the requisite management trust that original investors came
together in the first place.

2. Classification of Directors
Section 97(2) of the Corporation Code provides that the articles of
incorporation of a close corporation may provide for "a classification of directors
into one or more classes, each of which may be voted for and elected solely by a
particular class of stock."
The power to classify the directors in ordinary corporations seems to be
denied under Section 24 of the Corporation Code which provides for the election
of directors in the following manner:

At all elections of directors of trustees, there must be

present, either in person or by representative authorized to act
by written proxy, the owners of a majority of the capital stock,
or if there be no capital stock, a majority of the members
entitled to vote. The election must be by ballot if requested by
any voting stockholder or member. In stock corporations,
every stockholder entitled to vote shall have the right to vote in
person or by proxy the number of shares of stock standing, at
the time fixed in the by-laws, in his own name on the stock
books of the corporation, or where the by-laws are silent, at
the time of the election; and said stockholder may vote such
number of shares for as many persons as there are directors
to be elected or he may cumulate said shares and give one
candidate as many votes as the number of directors to be
elected multiplied by the number of his shares shall equal, or
he may distribute them on the same principle among as many
22
210 SCRA 510 (1992).
 candidates as he shall see fit: Provided, That the total number
of votes cast by him shall not exceed the number of shares
owned by him as shown in the books of the corporation
multiplied by the whole number of directors to be elected . . .

The spirit of proportionate representation is admittedly inherent in publicly-

held corporations. But does the same spirit pervade in a de facto close
corporation?
The classification of directors provision in a close corporation setting
allows the group to parcel out among themselves various management aspects
in the corporate enterprises. The provision indicate an inherent closeness
between equity and management, especially when the scheme of profit
distribution is based not only on the equity holdings, but is also tied to
management performance, in the form of salaries, per dicus, and expensive
account privileges.

3. Provisions for Greater Quorum or Voting Requirements

Under Section 97(3) of the Corporation Code, a close corporations may
provide in its articles of incorporation "[f]or greater quorum or voting requirements
in meetings of stockholders or directors than those provided in this Code."
The same prerogative of higher quorum requirements for meetings of
stockholders and directors is also granted to ordinary corporations. Under
Section 25 of the Corporation Code, "Unless the articles of incorporation or the
by-laws provide for a greater majority, a majority of the number of directors or
trustees as fixed in the articles of incorporation shall constitute a quorum for the
transaction of corporate business." In addition, there are authors who, after a
careful review of the specific provisions of the Corporation Code on quorum and
voting requirements, hold that the Corporation Code merely lays down the
minimum limit and leaves it up to the corporation to raise such limits as business
may so require.23
Nevertheless, the Corporation Code has given formal recognition for
clarified control devices which essentially pertain to close corporations thus:

(a) Section 7 as previously discussed, allowed a classification

and restriction of shares of stock including the deprivation of
voting rights;
(b) Section 24 reiterates the exercise by minority stockholders of
the power of cumulative voting;
(c) Section 44 now expressly recognizes the power of a
corporation to enter into management contracts and
provides for the procedure in the exercise of such power;

23
Ferrer, supra.
 (d) Section 58 for the first time lays down the requirements for
proxies; and
(e) Section 59 provides the requirements of voting trusts.

The specific grant of authority to allow super-majority for quorum reflects

the Corporation Code’s policy that in a close-corporation setting, the property
rights are not only tied with dividend rights; that parties are able to employ the
corporate set-up to improve their management prerogatives by having a greater
say in the affairs of the corporation. Since in a close-corporation setting,
participation in management may be agreed to be a manner by which corporation
profits shall be distributed, therefore the parties are allowed leeway by which
minority shareholders are given a say by requiring super-majority requirements
for corporate acts.

4. Stockholders as Corporate Managers

Section 97 of the Corporation Code provides as follows: "The articles of
incorporation of a close corporation may provide that the business of the
corporation shall be managed by the stockholders of the corporation rather than
by a board of directors." In addition, it provides that so long as such provision
continues in effect:

(a) No meeting of stockholders need be called to elect directors;

(b) Unless the context clearly otherwise, the stockholders of the
corporation shall be deemed to be directors for purposes of
applying provisions of this Code; and
(c) The stockholders of the corporation shall be subject to all
liabilities of directors.

In addition, the section provides that "[t]he articles of incorporation may

likewise provide that all officers or employees or that specified officers, or
employees shall be elected or appointed by the stockholders, instead of by the
board of directors."
The feature of a close corporation whereby there is a merger of stock
ownership and active management is what significantly distinguished it from
other corporations. An ordinary corporation is managed and controlled by its
board of directors. This lies at the very heart of the nature of an ordinary
corporation. Under Section 23 of the Corporation Code, this corporate principle is
mandated when it provides that "[u]nless otherwise provided in this Code, the
corporate powers of all corporations formed under this Code shall exercised, all
business conducted and all property of such corporations controlled and held by
the board of directors or trustees to be elected among the holders of stocks, or
where there is no stock, from among the members of the corporation, who shall
hold office for no stock, from among the members of the corporation, who shall
hold office for one (1) year and until their successors are elected and qualified."
In addition, Section 25 of the Corporation Code mandates that it is the board of
directors who shall elect the president, treasurer, secretary and such other
officers as may be provided for in the by-laws.
In de facto close corporations even if there is an actual merger of stock
ownership and corporate management in the same group, if the acts are not
those of the board of directors, the act would be invalid because of the clear and
restrictive provision of Sections 23 and 27. In Barreto v. La Previsora Filipina,24
the Supreme Court held that "contracts between a corporation and third persons
must be made by or under the authority of its board of directors and not by its
stockholders," and that the action of its stockholders in such matters is only
advisory and is not binding on the corporation.25

5. Agreements Among Stockholders

Section 100 of the Corporation Code provides the following agreements
among stockholders to be valid, binding and enforceable:

(a) Agreements by and among stockholders executed before

the formation and organization of a close corporation, signed
by all stockholders, shall survive the incorporation of such
corporation and shall continue to be valid and binding
between and among such stockholders, if such be their
intent, to the extent that such agreements are not
inconsistent with the articles of incorporation, irrespective of
where the provisions of such agreements are contained,
except those required by the Title on closed corporation to
be embodied in said articles of incorporation.
(b) An agreement between two or more stockholders if in writing
and signed by the parties thereto, may provide that in
exercising any voting rights, the shares held by them shall
be voted as therein provided, or as they may agree, or as
determined in accordance with a procedure agreed upon by
them.
(c) No provision in any written agreements signed by the
stockholders, relating to any phase of the corporate affairs,
shall be invalidated as between the parties on the ground
that its effect is to make the them partners among
themselves.
(d) A written agreement among some or all of the stockholders
in a close corporation shall not invalidated on the ground that
it so related to the conduct of the business and affairs of the
corporation as to restrict or interfere with the discretion or
powers of the board of directors: Provided, That such
24
57 Phil. 649 (1932).
25
Also Ramirez v. Orientalist Co., 38 Phil. 634 (1918).
 agreements shall impose on the stockholders who are
parties thereto the liabilities for managerial acts imposed by
this Code on directors.

It seems from the wordings of Sec. 100 that in order to be enforceable,

agreements between stockholders must be in writing, thus giving a species of the
application of the Statute of Frauds in Corporate Law.
Agreements among shareholders even for ordinary corporations
essentially fall under the realm of Contract Law. Under Article 1306 of the Civil
Code contracting parties may establish such stipulation, clauses terms and
conditions as they may deem convenient provided they are not contrary to laws,
morals, customs, public order and public policy. By way of illustration, in the case
of Lambert v. Fox26 an agreement whereby the plaintiff and the defendant being
both stockholders of the corporation agreed not to dispose of any portion of their
shareholdings within a period of one year without previous written consent of the
other party, with a penalty clause of P1,000.00 in case of violation, was held by
the Supreme Court as valid.
On the other hand, an agreement among stockholders in an ordinary
corporation that relates to the conduct of the business affairs of the corporation
as to restrict or interfere with the discretion or powers of the board of directors
would be invalid because of the restrictive provisions of Sections 23 and 27 of the
Corporation Code.
In the realism of close corporation thereof, the law recognizes the ability of
parties to arrange their affairs by specific contract terms operating within the
corporate structure. Truly, in a close corporation setting, the sanctity of the
“corporate entity” is given less emphasize to allow the parties to primarily be
governed by the specific contracts they enter into at the time of “incorporating”
their enterprise.

6. Board Meetings Unnecessary

Section 101 of the Corporation Code provides that an action of the board
of directors of a close corporations shall be valid even if:

(a) Before or after such action is taken, written consent thereto

is signed by all directors; and
(b) All of the stockholders have actual or implied knowledge of
the action and make no prompt objection thereto in writing;
or
(c) The directors are accustomed to take informal action with the
express or implied acquiescence of all the stockholders, or

26
26 Phil. 588 (1914).
 (d) All the directors have express or implied knowledge of the
action in question and none of them makes prompt objection
thereto in writing.

For ordinary corporations, it is mandated under Section 25 of the

Corporation Code that every decision of the board of directors must be made by
"at least a majority of the directors or trustees present at a meeting at which there
is a quorum."
Settled jurisprudence relating to ultra vires doctrine even before the
enactment of the Corporation Code laid down the basic principle that an ordinary
corporation can be held liable even under the circumstances described under
Section 101 or even when the resolution of the board is not within the express
powers approved by the corporation.
In Republic of the Philippines v. Acoje Mining Company, Inc.27 the Court
laid down the principle that a corporation can be bound to a transaction when in
fact it has received the benefits therefrom even if the resolution of the board of
directors approving it was beyond the powers of the board.
In Ramirez v. Orientalist Co.,28 it was held that if a corporation knowingly
permits one of its officers, or any other agent, to do acts within the scope of an
apparent authority, and thus holds him out to the public as possessing power to
do those acts, the corporation will, as against any one who has in good faith dealt
with the corporation through such office, be estopped from denying the authority
even in the absence of a formal vote on the transaction by its board of directors.
In Acuña v. Batac Producer Cooperative Marketing Association,29 the
Courts established the principle that subsequent ratification by the board of
directors of transactions entered into on behalf of the Corporation cleanses the
same of all defects; and that ratification may take diverse forms, such as by
silence or acquiescence by the board; any act showing approval or adopting of
the contract; or by acceptance and retention by the board of benefits flowing
therefrom.

6. Pre-emptive Rights
Section 102 of the Corporation Code provides that the pre-emptive rights
of stockholders in close corporations shall extend to all stock to be issued,
including re-issuance of treasury shares, unless the articles of incorporation
provide otherwise.
This right is similar to that granted to stockholders of ordinary corporations
under Section 39. Said section grants a pre-emptive right to stockholders in
respect to all issues or dispositions of shares of any class, unless such right is

27
7 SCRA 361 (1963).
28
38 Phil. 634 (1917).
29
20 SCRA 526 (1967).
denied in the articles of incorporation. However, under Section 39, the pre-
emptive right is not applicable in the following instances:

(a) When shares are issued in compliance with laws requiring

stock offering or minimum stock ownership by the public;
and
(b) When shares are to be issued in good faith with the approval
of the stockholders representing two-thirds (2/3) of the
outstanding capital stock in exchange for property needed
for corporate purposes or in payment of a previously
contracted debt.

The non-inclusion in Section 102 of the above-enumerated exceptions is a

clear indication of their non-applicability to close corporations because of the
desire to preserve the characteristic of delectus personae in close corporations.

7. Deadlocks and Dissolution

Section 104 of the Corporation Code provides that notwithstanding any
contrary provision in the articles of incorporation or by-laws or any agreement of
the stockholders of a close corporation, if the directors or stockholders are so
divided respecting the management of the corporation's business and affairs that
the votes required for any corporate action cannot be obtained, with the
consequence that the business and affairs of the corporation can no longer be
conducted to the advantage of the stockholders generally, the SEC, upon written
petition by any stockholder, shall have the power to arbitrate the dispute. In the
exercise of such power, the SEC shall have authority to make such orders as it
deems appropriate, including an order:

(a) Canceling or altering any provision contained in the articles

of incorporation, by laws, or any stockholder's agreement;
(b) Canceling, altering or enjoining any resolution or other act of
the corporation or its board of directors, stockholders, or
officers;
(c) Directing or prohibiting any act of the corporation or its board
of directors, stockholders, officers, or other persons party to
the action;
(d) Requiring the purchase of their fair value of shares of any
stockholder, either by the corporation regardless of the
availability of unrestricted retained earnings in its books, or
by the other stockholders;
(e) Appointing a provisional director;
(f) Dissolving the corporation;
(g) Granting such other relief as the circumstances may warrant.
 A provisional director shall be an impartial person who is neither a
stockholder nor a creditor of the corporation or of any subsidiary or affiliate of the
corporation, and whose further qualifications, if any, may be determined by the
SEC. A provisional director is not a receiver of the corporation and does not have
the title and powers of a custodian or receiver. A provisional director shall have
all the rights and powers of a duly elected director of the corporation, including
the right to notice of and to vote at meetings of directors, until such time as he
shall be removed by order of the SEC or by all the stockholders. His
compensation shall be determined by agreement between him and the
corporation subject to approval of the SEC, which may fix his compensation in
the absence of agreement, or in the event of disagreement between the
provisional director and the corporation.
In addition, Section 105 of the Corporation Code provides that any
stockholder of a close corporation may, for any reason, compel the said
corporation to purchase his shares at their fair value, which shall not be less than
their par or issued value, when the corporation has sufficient assets in its books
to cover its debts and liabilities exclusive of capital stock.
Also, any stockholder of a close corporation may, by written petition to the
SEC, compel the dissolution of such corporation whenever any of the acts of the
directors, officers, or those in control of the corporation is illegal, or fraudulent, or
dishonest, or oppressive or unfairly prejudicial to the corporation or any
stockholder, or whenever corporate assets are being misapplied or wasted.
The above discussions are considered as one of the more unattractive
features of a close corporation since power is placed in hands of one or a few to
call upon the dissolution of the corporation. Such power to dissolve is practically
equivalent to the situation in a partnership where with or without reason any
partnership may seek the dissolution of the partnership.
To say that by adopting a de facto close corporation through non-
compliance with Section 69 of the Corporation Code one would free the
corporation from the "vicissitudes" of a close corporation is to ignore the vast
powers granted to the SEC under Pres. Decree 902-A, as amended.30 Said
regulatory agency has been granted the power under reasonable circumstances,
to dissolve a corporation, or to place it under management receivership, thus:

SEC. 6. In order to effectively exercise such jurisdiction,

the Commission shall possess the following powers:
a) To issue preliminary or permanent injunctions,
whether prohibitory or mandatory, in all cases in which it has
jurisdiction, and in which cases the pertinent provisions of the
Rules of Court shall apply;
b) To issue writs of attachment in cases in which it has
jurisdiction in order to preserve the rights of parties and in
30
Pres. Decree 902-A has been amended by Pres. Decrees 1653, 1758 and 1799, and by
the Securities Regulation Code (R.A. 8799).
 such cases the pertinent provision of the rules of Court shall
apply;
c) To appoint one or more receivers of the property, real
and personal, which is the subject of the action pending before
the Commission in accordance with the pertinent provisions of
the Rules of Court in such other cases whenever necessary in
order to preserve the rights of the parties-litigants and/or
protect the interest of the investing public and creditors;
Provided, however, That the Commission may, in appropriate
cases, appoint a rehabilitation receiver of corporations,
partnerships or other associations not supervised or regulated
by other government agencies who shall have, in addition to
the powers of a regular receiver under the provisions of the
Rules of Court, such functions and powers as are provided for
in the succeeding paragraph (d) hereof; Provided, further, that
the Commission may appoint a rehabilitation receiver of
corporations, partnerships or other associations supervised or
regulated by other government agencies, such as banks and
insurance companies, upon request of the government agency
concerned: Provided, finally, That upon appointment of a
management committee, rehabilitation receiver, board or body,
pursuant to this Decree, all actions for claims against
corporations, partnerships , or associations under
management or receivership pending before any court,
tribunal, board or body shall be suspended accordingly:
d) To create and appoint a management committee,
board, or body upon petition or motu proprio to undertake the
management of corporations, partnerships or other
associations not supervised or regulated by other government
agencies in appropriate cases when there is imminent danger
of dissipation, loss, wastage, or destruction of assets or other
properties or paralyzation of business operations of such
corporations or entities which may be pre-judicial to the
interest of minority stockholders, parties-litigants or the general
public; Provided, further, That the Commission may create to
appoint a management committee, board or body to undertake
the management of corporations, partnerships or other
associations supervised or regulated by other government
agencies, such as banks and insurance companies, upon
request of the government agency concerned. . .

The management committee or rehabilitation receiver, board or body

appointed by the SEC has the power to take custody of, and control over, all the
existing assets and property of such entities under management; to evaluate the
existing assets and liabilities, earnings and operations of such corporations,
partnerships or other associations, to determine the best way to salvage and
protect the interest of the investors and creditors; to study, review and evaluate
the feasibility of continuing operations and restructure and rehabilitate such
entities if determined to be feasible by the SEC. The Commission may, on the
basis of the findings and recommendation of the management committee or
rehabilitation receiver, board or body, or on its own findings, determine that the
continuance in business of such corporation or entity would not be feasible or
profitable nor work to the best interest of the stockholders, parties-litigants,
creditors, or the general public, order the dissolution of such corporation entity
and its remaining assets liquidated accordingly.
In addition, the law provides that the management committee or
rehabilitation receiver, board or body may overrule or revoke the actions of the
previous management and board of directors of the entity or entities under
management notwithstanding any provision of law, articles of incorporation or by-
laws to the contrary.
Section 6 of the Decree specifically grants to the SEC the power to
suspend, or revoke, after proper notice and hearing, the franchise or certificate of
registration of corporations, partnerships, or associations, upon any of the
grounds provided by law, including the following:

(a) Fraud in procuring its certificate of registration;

(b) Serious misrepresentation as to what the corporation can do
to the great prejudice of or damage to the general public;
and
(c) Refusal to comply or defiance of any lawful order of
Commission restraining commission of acts which would
amount to a grave violation of its franchise.

The “deadlock” provisions for close-corporation are meant to cover

situations where the original “management intent” of the parties no longer
functions properly, brought about by events that were likely not anticipated at the
time of incorporation. Often, deadlocks do happen in a corporate setting
because some members feel that the managing group has been able to corner
the profits of the enterprise by various schemes employed (e.g., unreasonable
high scheme, abuse of expense, accounts, etc.), and therefore the threat of
deadlock is a means afforded by the law as a means to rearranging the corporate
affairs in terms more equitable to all the parties.
Since a close-corporation setting does not allow a stockholder to “cash-in”
on his equity because there would exist no market for his shares (i.e., existence
of right of first refusal), then the “deadlock” provisions is an essential feature for
close-corporations, where the threat of dissolution or repurchase of shares,
provides a strong incentive for the controlling group to manage equitable or
otherwise face the likelihood that the enterprises would be folded up.
REPURCHASE OF SHARES OF STOCK
Section 3(3) of the SEC Rules Governing Redeemable and Treasury
Shares (1982), provides that in the case of close corporation, any stockholder
may, for any reason, compel the corporation to purchase his shares at a value
not less than their par or issued value, provided that the corporation has, after
the withdrawal of the stockholder, sufficient assets in its books to cover its debts
and liabilities exclusive of capital stock.
Nevertheless, even when the close corporation does not have the required
unrestricted retained earnings, Section 3(1) of the Rules allows the corporation to
repurchase or reacquire the shares when made pursuant to the order of the SEC
acting to arbitrate a deadlock as provided for under Section 104 of the
Corporation Code.

PIERCING THE VEIL OF CORPORATE FICTION

It is a well-settled doctrine that the separate personality of a corporation
may be disregarded under the doctrine of piercing the veil of corporate fiction
whenever the notion of corporate entity is used to defeat public convenience,
justify a wrong, protect fraud or defend crime. Nevertheless, a close reading of
the Philippine leading cases on this doctrine31 would also show that there would
be a piercing of the corporate veil whenever the controlling stockholders and
officers use the corporate fiction as a mere conduit or alter ego or when they do
not themselves conduct the corporate business affairs with full respect to the
separate personality of the corporation, as when they treat the assets and
transactions of the corporation as their own.
Undoubtedly, when a corporation, including a close corporation, is being
used to promote fraud, injustice, illegality or wrong, such circumstances would
always warrant a piercing of the veil of corporate fiction.
In alter-ego piercing cases, with the formal recognition of a close
corporation under Title XII of the Corporation Code, there can be no application
of the above doctrine to a close corporation as defined under Section 96 thereof,
when such a close corporation is intended merely as an alter ego or conduit of
the stockholders. Consequently, the corporate defenses of limited liability should
still be available to stockholders of such close corporations.

31
Ramirez Telephone Corp. v. Bank of America, 29 SCRA 191 (1969); NAMARCO v.
Associated Finance Co., 19 SCRA 962 (1967); Yutivo Sons Hardware Co. v. Court of Tax
Appeals, 1 SCRA 160 (1961); A.D. Santos v. Vasquez, 22 SCRA 1156 (1968); Liddell & Co., Inc.
v. Collector of Internal Revenue, 2 SCRA 632 (1961); Palacio v. Fely Transportation Co., 5 SCRA
1011 (1962); R.F. Sugay & Co. v. Reyes, 12 SCRA 700 (1964); Arnold v. Willits and Patterson,
44 Phil. 634 (1923); La Campana Coffee Factory v. Kaisahan Manggagawa sa La Campana, 93
Phil. 160 (1953); Emilio Cano Enterprises, Inc., v. C.I.R., 13 SCRA 291 (1965); Marvel Building
Corporation v. David, 94 Phil. 376 (1954); Laguna Transportation Co., Inc. v. SSS, 107 Phil. 83
(1960); McConnel v. Court of Appeals, 1 SCRA 722 (1961); San Teodoro Development
Enterprises, Inc. v. SSS, 8 SCRA 96 (1963); Koppel (Phil.) Inc. v. Yatco, 77 Phil. 496 (1946);
Commissioner of Internal Revenue v. Norton and Harrison Company, 11 SCRA 711 (1964).
 On the other hand, for the de facto corporations, they would be
susceptible to the application of the doctrine for being mere conduits or alter-
egos of their stockholders. This aspect may prove to be attraction for
incorporators to incorporate a close corporation under the provision of Section 96
of the Corporation Code.
However, it must be noted that in the case of Dulay, the Supreme Court
after classifying the corporation as a close corporation (actually a de facto close
corporation since it did not go through the requirements of Section 96),
nevertheless applied the piercing doctrine to make the corporation liable for the
contract entered into by its controlling stockholder and president without the
appropriate board resolution.

CONCLUSION
From the foregoing discussions, it can be drawn that although the
Corporation Code has not made formal recognition of, and laid down provisions
for, the de facto close corporations, by and large, such a de facto close
corporations may avail themselves of some advantages and grants much similar
to those afforded to de jure close corporations under Title XII of the Corporation
Code. Much has yet to be attained towards the full legal acceptance of close
corporations as distinct vehicles of business endeavors. But the most significant
step has been taken towards that direction with the recognition, albeit in a limited
scope, of the close corporation under the Corporation Code. The legal gap that
still remains certainly poses a worthy challenge to both Philippine corporate
practitioners and lawmakers to fill-up.

——oOo——

CORP. MANUSCRIPT\16-CLOSE CORPORATIONS\06-20-2000

 CHAPTER 17

NON-STOCK CORPORATIONS,
FOUNDATIONS AND COOPERATIVES
Essence of Non-Stock Corporation
Eleemosynary Purpose and Non-Distribution of Profits
Distribution of Net Assets and Profits upon Dissolution
Applicability of Stock Corporation Provisions
Theory on Non-Stock Corporations
Members in Non-Stock Corporations
Membership Purely Personal
Juridical Persons as Members of Non-Stock Corporation
Nature of Members’ Voting Right
Proxy Rules for Members
Effects of Delinquency in Membership
Manner of Voting
Place of Meeting
Trustees and Officers
Right and Manner of Voting in Non-Stock Corporations
Number and Election of Trustees
Juridical Persons as Members of Board of Trustees
Election of Officers
Specific Rules Applicable to Non-Stock Corporations
For-Profit Purpose in Articles of Incorporation
Power to Adopt Rules and Regulations
Assessment of Membership Dues
Non-Applicability of Rules on Subscription and Pre-emptive Rights
Rules on Increases in Capital Contributions
Selling of Raffle Tickets and Other Profit-Seeking Activities
Continuation of Activities After Dissolution
Distribution of Assets of Non-Stock Corporation
Conversion of Non-Stock Corporation to Stock Corporation
FOUNDATIONS
Foundations Not a Special Category under Corporation Code
Tax-Exempt Status
Charitable Contributions
Application by Foundations with BIR
Requirements on Donors to Foundations
BIR Reportorial Requirements
In Summary
CONDOMINIUM CORPORATIONS
Basis of Membership
Cutting-off of Utility Services
Express Provisions in By-laws
No Express Provisions in By-laws
Rules on Uniformity of Leasing-Out of Units
 Bingo and Other Fund-Raising Activities
EDUCATIONAL INSTITUTIONS
Incorporation
Pre-requisites to Incorporation
Conversion of Non-Stock Educational School to Stock Corporation
Board of Trustees
Benefits and Privileges of Educational Institutions
RELIGIOUS CORPORATIONS
Corporate Sole
Acquisition of Land
Articles of Incorporation
Submission of Articles of Incorporation
Acquisition and Alienation of Property
Filling-up of Vacancies
Dissolution
Religious Societies
Term of Existence of Religious Corporations
COOPERATIVES
Rationale for Cooperative System
Definition of "Cooperative"
Main Objective of Cooperative
Organization and Members of Cooperatives
Democratic Set-Up in Cooperative
Capital and Distribution of Net Surplus
Board of Directors
General Assembly
Other Features of Cooperatives

——

ESSENCE OF NON-STOCK CORPORATION

1. Eleemosynary Purpose and Non-Distribution of Profits
Title XI of the Corporation Code contains the governing provisions on non-
stock corporations, which it defines as "one where no part of its income is
distributable as dividends to its members, trustees, or officers . . . [and that] any
profit . . . [it] may obtain as an incident to its operation shall, whenever necessary
or proper, be used for the furtherance of the purpose or purposes for which the
corporation was organized."1
In particular, Section 88 thereof provides that non-stock corporation may
be formed or organized for charitable, religious, educational, professional,
cultural, recreation, fraternal, literary, scientific, social, civic service, or similar
purposes, like trade, industry, agriculture and like chambers, or any combination
thereof." In addition, Section 14(2) of the Corporation Code provides that in the

1
Sec. 87, Corporation Code.
articles of incorporation, "a non-stock corporation may not include a purpose
which would change or contradict its nature as such."
The definition and treatment of non-stock corporation under the
Corporation Code is quite interesting in that it clearly recognizes that a non-stock
and non-profit corporation may actually earn profits from its operations so long as
the profits are devoted for its eleemosynary purpose.
The SEC has ruled that the mere fact that a non-stock corporation may
earn profit does not make it a profit-making corporation where such profit or
income is used to carry out the purposes set forth in the articles of incorporation
and is not distributed to its incorporators, members, trustees or officers.2
Likewise, nowhere does the definition exclude the existence of stock in the
capital stock of the corporation from being qualified to be considered a non-stock
corporation. However, the non-existence of stocks in a non-stock corporation
would be well-implied from the fact that stocks are by express provision of law,
entitled to receive dividends,3 which would then contravene the primary character
of a non-stock corporation that does not allow the distribution of profits and
dividends to its members.
The essence of a non-stock corporation is therefore not the non-existence
of shares of stock to cover its capital, but its primary purpose should be
eleemosynary in nature, and there is a prohibition in its articles of incorporation
or by-laws that no part of the income or any form of dividend is distributable to
the members, officers and trustees of the corporation,4 even though the
corporation may earn profits from its operations.5

2. Distribution of Net Assets and Profits upon Dissolution

Although a non-stock corporation cannot distribute profits or dividends to
its members, officers and trustees during its corporate term, in the event of
dissolution, after the payment of all liabilities and return of assets received
subject to limitations permitting their use, the remaining assets may be
distributed to the members, or any class or classes of members, as provided for
in its articles of incorporation and by-laws; and in the absence of distribution rules
in the articles of incorporation and by-laws, the remaining assets may be
distributed to such persons, societies, organizations or corporations, whether or
not organized for profit, as may be specified in a plan of distribution as adopted
by the board of trustees and ratified by the members.6
Therefore, in a regular non-stock corporation it is possible for its net
assets, as well as the accumulated profits from its years of operations, to inure to

2
SEC Opinion, 13 November 1990, XXIV SEC QUARTERLY BULLETIN 63 (No. 1, March,
1990).
3
Sec. 43, Corporation Code.
4
Collector of Internal Revenue v. Club Filipino, Inc. de Cebu, 5 SCRA 321 (1962).
5
Collector of Internal Revenue v. University of the Visayas, 1 SCRA 669 (1961).
6
Secs. 94 and 95, Corporation Code.
the benefit of private individuals or entities for profit but only as a consequence of
dissolution.

3. Applicability of Stock Corporation Provisions

The provisions governing stock corporations, when pertinent, shall be
applicable to non-stock corporations, except as may be covered by specific
provisions of the Code pertaining to non-stock corporations.7
To illustrate, the SEC has opined8 that incorporators of a non-stock
corporation must be construed to be members thereof, on the ground that while
there is no explicit provision in the Corporation Code which requires that an
incorporator of a non-stock corporation must be a member of the corporation, the
requirement under Section 10 of the Code stating that incorporators or a stock
corporation must be stockholders thereof is also applicable to non-stock
corporation by virtue of Section 87 of the Code which provides that the provisions
governing stock corporations, when pertinent, shall be applicable to non-stock
corporations.

THEORY ON NON-STOCK CORPORATIONS

The best way to evaluate the institution of non-stock corporations in the
Philippines, is to look at the emerging theory on non-profit enterprises in the
United States9 from where our own provisions on non-stock corporations were
derived.
The accepted primary legal distinction between stock corporations and
non-profit corporations are the diverging rules on profit distribution. While all net
earnings and residual value of the business in a stock corporation can be
distributed to its stockholders, there is an expressed legal prohibition from
making such distributions in a non-stock corporation. The rationale for the use of
the non-profit form for eleemosynary endeavors, such as activities for charitable,
religious, scientific, educational, or similar activities, "lies in the chief function of
the non-distribution constraint, namely, that it helps to overcome contractual
failure in situations where such failure is quite likely to occur."10 In other words,
the non-profit corporation is employed in activities where there would be
difficulties in properly monitoring and quantifying the effectiveness and quality of
the services rendered, which in essence is covered by the concept of
"contractual failure."
"Contractual failure" is characterized by the inability of a buyer of services
to assure himself that he is getting what he intends to be contracting for; in more

7
Sec. 87 of the Corporation Code.
8
SEC Opinion, 12 May 1995, XXIX SEC QUARTERLY BULLETIN 16 (No. 4, Dec. 1995).
9
Hansmann, The Role of Nonprofit Enterprise, 89 YALE L.J. 835 (1980); Clark, Does the
Nonprofit Form Fit the Hospital Industry?, 93 HARV. L. REV. 1416 (1980); CLARK, CORPORATE LAW
(Little, Brown and Company, 1986 ed.), pp. 699-703.
10
CLARK, CORPORATE LAW (Little, Brown and Company, 1986 ed.), at pp. 699-700.
general terms, it denotes high monitoring and enforcement costs.11 The
prohibition in non-stock corporations against distribution of profits to its members
and officers "is supposed to be helpful in such situations because it gives the
buyer some reason to believe that those who appoint and control the actual
providers of service and goods will not have an incentive to take advantage of his
vulnerability as consumer."12
On the other hand, in a stock corporation, both the shareholders and the
officers, who control the provision of the service bought, have an incentive not
only to be as efficient as possible and thus to outperform competitors, but also to
take advantage of all market imperfections.
In case of an activity such as the delivery of tangible products, the product
itself is an objective gauge of whether the purchaser thereof is receiving equal
value for the amount he has paid therefore. On the other hand, in a enterprise
such as education, it is very difficult to monitor whether the services bargained
for have been properly and adequately delivered or performed, or whether the
providers thereof, in order to increase their profit margin, have in fact cut corners.
In the case of education therefore, it would be better to allow the pursuit thereof
in a non-stock enterprise, since the legal inability of the providers to gains
anything personal from the cutting of corners (since they cannot obtain profits
from the operations) would be more incentive for such providers to deliver the
quality services expected from them. And since there is disincentive for any
personal gains on the part of the providers, there is much less need on the part
of the purchaser of the services to having to spend more time and resources in
order to monitor the rendering of such services.
Under the American theory on non-profit enterprise, "[w]henever general
goals cannot be reduced or agreed upon to, operationally defined set of
particular objectives and results, it is obviously difficult or impossible to monitor
and assess performance of those who undertake to provide services aimed at
achieving the general goals. Accordingly, consumers may have a preference for
nonprofit service-delivery organizations."13
The American theory applies equally to Philippine setting, not only
because of the legal constraint for non-stock corporations in distributing any profit
to their members and officers, the directive towards devoting any profits earned
to the purpose for which the corporation is formed, but by limiting the purposes
for which non-stock corporations can be formed to eleemosynary purposes
(charitable, religious, educational, professional, cultural recreational, fraternal,
literary, scientific, social, civic service, or similar purposes, like trade, industry,
agriculture, and like chambers, or any combination thereof), which by nature
cannot be provided with objective verifiable indicators, and if carried on by a
profit corporation, would entail much monitoring costs.

11
CLARK, supra, at p. 700.
12
Ibid.
13
CLARK, supra, at p. 701.
MEMBERS OF NON-STOCK CORPORATIONS
1. Membership Purely Personal
Membership in a non-stock corporation, and all rights arising therefrom,
are personal and non-transferable, unless the articles of incorporation or the by-
laws provide otherwise.14
Membership shall be terminated in the manner and for the causes
provided in the articles of incorporation or the by-laws.15
Termination of membership shall have the effect of extinguishing all rights
of a member in the corporation or in its property, unless otherwise provided in the
articles of incorporation or the by-laws.16

2. Juridical Entities as Members of a

Non-Stock Corporation
The SEC has rendered an opinion that juridical persons may be members
of a non-stock corporation, provided that a provision for the classification of
members shall include duly designated or authorized representatives of juridical
persons as members of the corporation, for purposes of qualifying them as
incorporators.17

3. Nature of Members’ Voting Right

The right of the members of any class or classes to vote may be limited,
broadened or denied to the extent specified in the articles or incorporation or the
by-laws.18 Unless so limited, broadened or denied, each member, regardless of
class, shall be entitled to one vote,19 which is in contrast to the rule of cumulative
voting in stock corporations.
The SEC has opined20 that the rule in Section 6 of the Corporation Code
allowing non-voting shares to vote on specified fundamental applies only to stock
corporations, and does not apply to non-voting members of a non-stock
corporation. What applies to non-stock corporations is Section 89 of the
Corporation Code, which specifically provides that members may be denied
entirely their voting rights in the articles of incorporation or by-laws of the
corporation.

14
Sec. 90, Corporation Code.
15
Sec. 91, Corporation Code.
16
Ibid.
17
SEC Opinion, 16 April 191, citing 2 FLETCHER CYC. OF CORP., 1982 Rev. Vol., Sec. 300 at
93; SEC Opinion, 12 May 1995, XXIX SEC QUARTERLY BULLETIN 16 (No. 4, Dec. 1995).
18
Sec. 89, Corporation Code.
19
Ibid.
20
SEC Opinion, 4 September 1995, XXX SEC QUARTERLY BULLETIN 29 (No. 1, June 1996);
SEC Opinion, 30 August 1994, XXIX SEC QUARTERLY BULLETIN 13 (No.1, March 1995).
 4. Proxy Rules for Members
Unless otherwise provided by the articles of incorporation or the by-laws,
a member may vote by proxy.21
Proxy representation may be denied entirely in a non-stock corporation
provided it is done through appropriate provisions in the articles of incorporation
or the by-laws.22

5. Effects on Delinquency in Membership

Unlike for a stockholder in a stock corporation whereby delinquency of
stock automatically suspends his right to vote and be voted upon, 23 in a non-
stock corporation, under Section 89 of the Corporation Code, the suspension of a
delinquent member’s right to vote depends on whether or not such member is
disenfranchised under the articles of incorporation or by-laws of the corporation;
and in the absence of such specific provision, such member is still entitled to one
vote.24

6. Manner of Voting
Under Section 89 of the Corporation Code, voting by mail or other similar
means by members of non-stock corporations may be authorized by the by-laws
with the approval of, and under such conditions which may be prescribed by, the
SEC.
Nevertheless, the provisions of Section 89 should be treated as a general
provision for non-stock corporation applicable only in the absence of a specific
provision in the Corporation Code on a particular subject matter.25 Therefore, in
the case of mergers and consolidations, Section 77 of the Corporation Code
specifically provides for the procedure in approving merger agreements
applicable to both stock and non-stock corporations, which requires corporate
mergers to be approved by the stockholders or members at a meeting duly called
for the purpose. Being a specific provision, it should be treated as an exception
to Section 89.26

21
Ibid.
22
SEC Opinion, 20 September 1994, XXIX SEC QUARTERLY BULLETIN 20 (No.1, March
1995).
23
Sec. 71, Corporation Code.
24
SEC Opinion, 16 June 1998, XXXIII SEC QUARTERLY BULLETIN 4 (No. 1, June, 1999);
SEC Opinion, dated 17 August 1998, XXXIII SEC QUARTERLY BULLETIN 4 (No. 1, June, 1999).
25
SEC Opinion, 4 August 1998, XXXII SEC QUARTERLY BULLETIN 14 (No. 2, Dec. 1998);
SEC Opinion, 10 September 1993, XXVIII SEC QUARTERLY BULLETIN 5 (No. 1, March 1994); SEC
Opinion, 25 March 1981.
26
SEC Opinion, 4 August 1998, XXXII SEC QUARTERLY BULLETIN 14 (No. 2, Dec. 1998).
 The SEC has opined in several cases that where the law requires a duly
called meeting to carry out a corporate transaction, “constructive” or “electronic
presence” is not a substitute for actual presence.27

7. Place of Meetings
The by-laws may provide that the members of a non-stock corporation
may hold their regular or special meetings at any place even outside the place
where the principal office of the corporation is located, provided it is within the
Philippines and that proper notice is sent to all members indicating the date, time
and place of the meeting.28

TRUSTEES AND OFFICERS

1. Right and Manner of Voting in Non-Stock Corporations
In a non-stock corporation, the default rule for the election of trustees is
straight voting: "Unless otherwise provided in the articles of incorporation or in
the by-laws, members of corporations which have no capital stock may cast as
many votes as there are trustees to be elected but may not cast more than one
vote for one candidate."29
Cumulative voting can apply only in a non-stock corporation setting when
it is provided for in the articles of incorporation or the by-laws.
However, the language of Section 24 does not necessarily mean that in
the absence of stipulation in the articles or by-laws, there is no cumulative voting
in a non-stock corporation. It is true that a corporation which has capital stock
may by its nature (prohibition to distribute profits and eleemosynary purpose) be
a non-stock corporation according to jurisprudence. Nevertheless, although it
fulfills the twin requisites of non-stock and non-profit corporation, by virtue of the
fact that it is a corporation that has capital stock provided for in its articles of
incorporation, Section 24 provides that cumulative voting would apply.

2. Number and Election of Trustees

No person shall be elected as trustee unless he is a member of the
corporation.30
Unless otherwise provided in the articles of incorporation or the by-laws,
the board of trustees of non-stock corporations, which may be more than fifteen

27
SEC Opinion, 4 August 1998, XXXII SEC QUARTERLY BULLETIN 14 (No. 2, Dec. 1998);
SEC Opinion, 10 September 1993, XXVIII SEC QUARTERLY BULLETIN 5 (No. 1, March 1994); SEC
Opinion, 25 March 1981.
28
Sec. 93, Corporation Code. SEC Opinion, 24 September 1997, XXXII SEC QUARTERLY
BULLETIN 20 (No. 2, Dec. 1997).
29
Sec. 24, Corporation Code.
30
Sec. 92, Corporation Code.
(15) in number as may be fixed in their articles of incorporation or by-laws,31
shall, as soon as organized, so classify themselves that the term of office of one-
third (1/3) of their number shall expire every year; and subsequent elections of
trustees shall be held annually and trustees so elected shall have a term of three
(3) years. Trustees thereafter elected to fill vacancies occurring before the
expiration of a particular term shall hold office only for unexpired period.32

3. Juridical Persons as Members of Board of Trustees

The SEC has also rendered opinions to the effect that juridical persons
may become members of the Board of Trustees of a non-stock corporation. A
non-stock corporation whose membership is composed of juridical persons was
allowed to be registered, provided that a provision for the classification of
members shall include duly designated or authorized representatives of juridical
persons as members of the corporation, for purposes of qualifying them as
members of the Board of Directors, which shall be provided in the articles of
incorporation or by-laws.33
In the case of a condominium corporation where all the members thereof
are corporate members or juridical person, the SEC ruled that an officer or duly
authorized agent or trustee who has been designated by a corporate unit
owner/member or a condominium corporation as its representative for the
express purpose of qualifying him as director, may be eligible to be elected as
director; since to rule otherwise would create a situation when there would be no
Board of Directors.34

4. Election of Officers
It is usually the board of trustees that appoints the officers of a non-stock
corporation, similar to the rules under stock corporations. However, in a non-
stock corporation, unless otherwise provided for in the articles of incorporation or
the by-laws, officers of a non-stock corporation may be elected directly by the
members.35
If the officers in a non-stock corporation are directly elected by the
members, as allowed under Section 92 of the Corporation Code, the power to
remove them is vested directly in the members.36

31
Ibid.
32
Ibid.
33
SEC Opinion, 12 May 1995, XXIX SEC QUARTERLY BULLETIN 16 (No. 4, Dec. 1995).
34
SEC Opinion, 16 April 191, citing 2 FLETCHER CYC. OF CORP., 1982 Rev. Vol., Sec. 300 at
93.
35
Ibid.
36
SEC Opinion, 24 April 1995, XXIX SEC QUARTERLY BULLETIN 52 (No. 3, Sept. 1995).
SPECIFIC RULES APPLICABLE TO NON-STOCK CORPORATIONS
1. For Profit Purpose in Articles of Incorporation
Non-stock corporations by their nature are not empowered to engage in
business with the object of making income or profit, hence, it cannot include a
purpose in its articles of incorporation which would change or contradict its
nature as such. This is clear from the provision of Section 14 of the Corporation
Code which provides that “a non-stock corporation may not include a purpose
which would change or contradict its nature as such.”37

2. Power to Adopt Rules and Regulations

A non-stock corporation may adopt rules and regulations, provided they
are not contrary to the provisions of the by-laws, articles of incorporation and the
Corporation Code.38 While corporate by-laws are subject to the approval of the
SEC, rules and regulations of the corporation do not need SEC approval, unless
they involve matters where the law requires SEC approval.39

3. Assessment of Membership Dues

The SEC has opined40 that the board of directors of a non-stock
corporation may assess membership dues even when nothing has been provided
for in the articles of incorporation and by-laws. The general rule is that the
manner of assessing members must be in accordance with the provisions of the
by-laws. In the absence of such provisions, a corporation, through its Board of
Directors, may collect only reasonable membership dues and only for purposes
of accomplishing the purposes or objectives for which the corporation was
organized.

4. Non-applicability of Rules on
Subscriptions and Pre-emptive Rights
The SEC has rendered an opinion41 that the rules in the Corporation Code
on 25%-25% subscription and paid-up requirements, and pre-emptive rights, are
not applicable to non-stock corporations, even when they involve proprietary
membership in country clubs, since such rules pertain only to stock corporations
and have no application to non-stock corporations.

5. Rule on Increases in Capital Contributions

There is no need to file a formal application with the SEC to reflect an
increase in the contributed capital of a non-stock corporation, since Section 38 of
the Corporation Code, which provides for the requirements for an increase in the

37
SEC Opinion, 11 September 1995, XXX SEC QUARTERLY BULLETIN 36 (No. 1, June 1996).
38
39
SEC Opinion, 16 October 1995, XXX SEC QUARTERLY BULLETIN 55 (No. 1, March 1996).
Ibid.
40
SEC Opinion, 16 June 1995, XXIX SEC QUARTERLY BULLETIN 38 (No. 4, Dec. 1995).
authorized capital stock, is applicable only to stock corporations, and has no
application to non-stock corporations. For non-stock corporations, it is sufficient,
for purposes of updating the SEC records on the matter, that it is reflected in the
financial statements.42

6. Selling of Raffle Tickets and Other

Profit-Seeking Activities
The general rule is that a non-stock corporation is not empowered to
engage in business for profit. It may be allowed to engage in profitable business
only if it is necessary or essential to carry out the eleemosynary purposes for
which it was organized.43
When a non-stock corporation primarily organized to give reliefs to victims
of natural disaster sells and distributes raffle tickets, the same is subject to the
provisions of Act No. 4075, otherwise known as the Solicitation Permit Law, 44
and the Rules and Regulations of the Department of Social Welfare and
Development (DSWD) and Bureau Internal Revenue (BIR).45
In other cases,46 the SEC ruled that a non-stock and non-profit corporation
engage cannot engage in CATV System as the corporation’s countryside/rural
enterprise project. Under Section 87 of the Corporation Code, non-stock and
non-profit corporations are not empowered to venture on economic business
activities, except when they are incident to its purpose, then it may engage in
business activities which are reasonably necessary to carry out the purposes for
which the corporation was organized. Any such power which is reasonably
necessary to enable a corporation to carry out its express powers granted and
the purposes of its creation is to be deemed implied or incidental purpose.
However, activities merely convenient or useful are not implied if they are not
essential, having in view the nature and object of incorporation.

CONTINUATION OF ACTIVITIES AFTER DISSOLUTION

After its dissolution, a non-stock corporation is not prohibited from
continuing its operations. While a dissolved non-stock corporation is prohibited
from continuing its operation as a corporation, it may opt to continue to undertake
the purposes for which it was organized, but its status is only that of an ordinary
association without a juridical personality.47

41
SEC Opinion, 30 August 1994, XXIX SEC QUARTERLY BULLETIN 13 (No.1, March 1995).
42
SEC Opinion, 2 April 1998, XXXII SEC QUARTERLY BULLETIN 93 (No. 1, June 1998).
43
SEC Opinion, 7 September 1995, XXX SEC QUARTERLY BULLETIN 33 (No. 1, June 1996);
SEC Opinion, 19 September 1995, XXX SEC QUARTERLY BULLETIN 39 (No. 1, June 1996).
44
As amended by Pres. Decree 1564.
45
SEC Opinion, 20 January 1999, XXXIII SEC QUARTERLY BULLETIN 48 (No. 1, June 1999).
46
SEC Opinion, 16 December 1993, XXVIII SEC QUARTERLY BULLETIN 15 (No. 2, June
1994); SEC Opinion, 18 February 1993, XXVII SEC QUARTERLY BULLETIN 42 (No. 2, June 1993).
47
SEC Opinion, 25 September 1995, XXX SEC QUARTERLY BULLETIN 43 (No. 1, June 1996).
DISTRIBUTION OF ASSETS OF NON-STOCK CORPORATION
Under Section 94 of the Corporation Code, in case of dissolution of a non-
stock corporation, it assets shall be applied and distributed as follows:

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

satisfied and discharged, or adequate provisions shall be
made therefore;
(b) Assets held by the corporation upon a condition requiring
return, transfer, or conveyance, and which condition occurs
by reason of the dissolution, shall be returned, transferred or
conveyed in accordance with such requirements;
(c) Assets received and held by the corporation subject to
limitations permitting their use only for charitable, religious,
benevolent, education or similar purposes, but not held upon
a condition requiring return, transfer or conveyance by
reason of the dissolution, shall be transferred or conveyed to
one or more corporations, societies or organization engaged
in activities in the Philippines substantially similar to those of
the dissolving corporation pursuant to an adopted plan of
distribution;
(d) Assets other than those mentioned in the preceding
paragraphs, if any, shall be distributed in accordance with
the provisions of the articles of incorporation or the by-laws,
to the extent that the articles of incorporation or the by-laws
determine the distributive rights of members, or any class of
classes of members, or provide for distribution; and
(e) In any other case, assets may be distributed to such
persons, societies, organizations or corporations whether or
not organized for profit, as may be specified in an adopted
plan of distribution.

Even in the case of non-stock corporations, the Corporation Code

recognizes the legality of distributing the remaining assets of the corporation to
the members thereof or even to a profit corporation pursuant to an adopted plan
of distribution.
A plan providing for the distribution of assets, may be adopted by a non-
stock corporation in the process of dissolution by majority vote of its board of
trustees, who shall adopt a resolution recommending a plan of distribution and
directing the submission thereof to a vote at a regular or special meeting of
members having voting rights.48

48
Sec. 95, Corporation Code.
 Written notice setting forth the proposed plan of distribution or a summary
thereof, and the date, time and place of such meeting shall be given to each
member entitled to vote, within the time and in the manner provided in the
Corporation Code for the giving of notice of meetings to members.49
Such plan of distribution shall be adopted upon approval of at least two-
thirds (2/3) of the members having voting rights present or represented by proxy
at such meeting.50

CONVERSION OF NON-STOCK CORPORATION

TO STOCK CORPORATION
The SEC has ruled that while an existing stock corporation may be
converted into a non-stock corporation by mere amendment of its articles of
incorporation, an existing non-stock corporation cannot be converted into a stock
corporation by the simple process of amending its articles of incorporation.51 The
SEC based its position on Section 87 of the Corporation Code, which defines a
non-stock corporation as one "where no part of its income is distributable as
dividends to its members, trustees or officers." Consequently, the members of a
non-stock corporation are not entitled to any profit or income that may be
obtained out of the operation or activities or from other assets of the non-stock
corporation. The Commission opined, thus:

Until the corporation is dissolved and unless it is so

provided in the articles of incorporation or by-laws, the
members are not entitled to any beneficial or vested interest
over the assets of a non-stock corporation. In other words, a
non-stock, non-profit corporation only holds its funds in trust
for the carrying out of the objectives and purposes expressed
in its charter or articles of incorporation. The conversion of an
existing "non-stock non-profit" corporation into a "stock
corporation" without dissolving it first would be tantamount to
distribution of its assets or income to its members inasmuch as
after its conversion, the assets of the non-stock corporation
would now be treated as payment to the subscriptions of the
members who will now become the stockholders of the stock
corporation.52

49
Ibid.
50
Ibid.
51
SEC Opinion, 20 March 1995, XXIX SEC QUARTERLY BULLETIN 15 (No. 3-Sept. 1995);
SEC Opinion, 13 May 1992, XXVI SEC QUARTERLY BULLETIN 12 ( No. 3, Sept., 1992); SEC
Opinion, 10 December 1992, XXVII SEC QUARTERLY BULLETIN 6 (No. 2-June 1993); SEC Opinion,
24 February 1989, XXIII SEC QUARTERLY BULLETIN 2 (No. 2-June 1989); SEC Opinion, 19
September 1988, XXII SEC QUARTERLY BULLETIN 28 (No. 4, Dec. 1988).
52
SEC Opinion, 24 February 1989, SEC QUARTERLY BULLETIN (No. 2, June 1989); SEC
Opinion, 13 May 1992, XXVI SEC QUARTERLY BULLETIN 12 (No. 3, Sept. 1992).
 The SEC has held that for purposes of transformation, it is fundamental
that the non-stock corporation must be dissolved first under any of the methods
allowed by law and thereafter, the members may organize a stock corporation
directed to bring profits or pecuniary gains to themselves.53
The Corporation Code prohibits a non-stock corporation during its
corporate life from distributing any part of the profit or dividends to the members,
officers or trustees; and the remaining assets of the corporation can only be
distributed to the members only upon dissolution.54
The amendment of the articles of incorporation to convert the non-stock
corporation does not seek to dissolve the corporation but to change it nature to
stock corporation, the crediting of the member's equity to stockholders' equity
would constitute a distribution of the profits or dividends of the corporation to the
members which is prohibited by the Corporation Code. Whereas before the
corporate change the members only had membership which was essentially non-
transferable and from which no commercial value can be placed, the
transformation would put in the hands of the members-then-stockholders shares
of stock which are transferable in nature and for the value of the book value of
the assets of the corporation, which should not have been realizable by them
during the corporate term of the corporation.
Also, the change of the purpose clause to profit or mercantile venture
would violate Section 14(2) of the Corporation Code, which in enumerating the
contents of the articles of incorporation, clearly prohibits a non-stock corporation
in including in the purpose clause of its articles of incorporation any purpose
which would change or contradict its nature as such.

FOUNDATIONS
1. Foundations Not a Special Category
under Corporation Code
The Corporation Code contains no separate provisions, nor does it even
refer to "foundations" as separate types of corporations different from non-stock
corporations. Foundations are essentially non-stock corporations governed by
the same Title XI of the Code. What therefore makes foundations different from
regular non-stock corporations are the privileges granted to it by special laws,
essentially in the field of Taxation.

2. Tax-Exempt Status
Under Section 30 of the National Internal Revenue Code of 1997
("NIRC"), the following corporations, among others, are exempt from corporate
income taxation:

53
Ibid.
54
Secs. 94 and 95, Corporation Code.
 (a) Non-stock corporations or associations organized and
operated exclusively for religious, charitable, scientific,
athletic, or cultural purposes, or for the rehabilitation of
veterans, no part of its net income or asset shall belong to or
inure to the benefit of any member, organizer, officer or any
specific person;
(b) Business leagues, chamber of commerce, or board of trade,
not organized for profit and no part of the net income of
which inures to the benefit of any private stockholder or
individual;
(c) Civic league or organization not organized for profit but
operated exclusively for the promotion of social welfare;
(d) Non-stock and non-profit educational institution;

Therefore both a regular non-stock corporation and a foundation are tax-

exempt institution under Section 30 of the NIRC when they are organized for the
eleemosynary purposes specified therein and no profit inures to the benefit of
their members, officers and trustees. Nevertheless, the same section provides
that “the income of whatever kind and character of the foregoing organizations
from any of their properties, real or personal, or from any of their activities
conducted for profit, regardless of the disposition made of such income, shall be
subject to tax imposed under this Code."
Under Section 34(H)(2)(c) of the NIRC, the definition of foundation is
preceded by the qualifying term "non government organization" which means a
non-profit domestic corporation. This tax-exempt status of ordinary non-stock
corporations and foundations only pertain to income earned from pursuing their
eleemosynary purposes, and not to other profit-seeking venture outside of their
main purpose.
Under existing revenue regulations, in order for regular non-stock
corporations and foundations to establish their tax-exempt status, and thus be
relieved of the duty of filing income tax returns and paying income tax, it is
necessary that they file an affidavit with the Commissioner of Internal Revenue
showing the character of their organizations, the purpose for which they are
organized, their actual activities, the source of their income and the disposition
thereof, and whether or not any of the income is credited to surplus or inures or
may inure to the benefit of any private stockholder or individual.55 It has been
held, however, in Collector v. V.G. Sinco Educational Corporation,56 that the
formal requirements of Revenue Regulations No. 2 are not mandatory and that
an entity concerned may, in the absence of compliance with such requirements,
still show that it falls under the provisions of Section 26 of the NIRC.

55
Sec 24, Revenue Regulations No. 2.
56
100 Phil. 127 (1956).
 From the point of view of tax-exemption, foundations enjoy the same
privilege, and must undertake the same application process with the BIR to enjoy
such privilege, as with regular non-stock corporations.

3. Charitable Contributions
Under Section 34(H)(1) of the NIRC governing the computation of taxable
net income, taxpayers are allowed to deduct from their taxable gross income
contributions and gifts actually paid and made within the taxable year "to
domestic corporations or associations organized and operated exclusively for
religious, charitable, scientific, youth and sports development, cultural or
educational purposes or for the rehabilitation of veterans, or to social welfare
institutions, no part of the net income of which inures to the benefit of any private
stockholder or individual."
The extent by which a taxpayer may deduct from his taxable net income
the charitable contributions and gifts to regular non-stock corporations organized
for any of the purposes enumerated in Section 34(H)(1) is as follows:

(a) For individual taxpayer, 10% of his taxable net income

derived from business; and
(b) For corporate taxpayers, 5% of taxable net income derived
from business.

On the other hand, under Section 34(H)(2)(c) contributions and gifts made
to "foundations" or “nongovernment organization” may be deductible in full by the
taxpayer from his taxable gross income. It actually is Section 34(H)(2)(c), which
now refers to "foundations" as "accredited nongovernment organizations," and
defines and distinguishes them from other corporate entities, as follows:

(a) Non-profit domestic corporation, formed and organized

under Philippine laws;
(b) Organized and operated exclusively for scientific, research,
educational, character-building and youth and sports
development, health, social welfare, cultural or charitable
purposes, or a combination thereof, no part of the net
income of which inures to the benefit of any private
individual;
(c) Which, not later than the 15th day of the third month after the
close of the corporation's taxable year in which contributions
are received, makes utilization directly for the active conduct
of the activities constituting the purposes or function for
which it is organized and operated, unless an extended
period is granted by the Secretary of Finance in accordance
with the rules and regulations promulgated;
 (d) The level of administration expense of which, shall on an
annual basis, conform with the rules and regulations to be
prescribed by the Secretary of Finance but in no case to
exceed thirty percent (30%) of the total expenses; and
(e) The assets of which in the event of dissolution would be
distributed to another non-profit domestic corporation
organized for similar purpose or purposes or to the State for
public purpose, or would be distributed by a court to another
organization to be used in such manner as in the judgment
of said court shall best accomplish the general purpose for
which the dissolved organization was organized.

It will be noted therefore that a foundation or accredited nongovernment

organization is for practical purposes a creature fashioned under NIRC for
purposes of tax administration. The requirements laid-down by Section
34(H)(2)(c) put more stringent requirements on the foundation as compared to a
regular non-stock corporation, namely:

(a) The limitation of administration expenses to 30% of the

corporation's total expenses; and
(b) The strict form of distribution of the net assets of the
corporation in the event of dissolution to similar non-stock
corporations or to the State (whereas, it is legal for regular
non-stock corporation to distribute their net assets to the
members or event other entities organized for profit).

In exchange for such stringent requirements, donations, contributions and

gifts to foundations are totally deductible by the taxpayer from his tax gross
income, while those to regular non-stock corporation are subject to the 10%-5%
limitations for their deduction from the taxable gross income of a taxpayer.
Theoretically therefore, taxpayers would have greater motivations to donate and
contribute to foundations than to regular non-stock corporation because of the
greater tax benefits to them.
The direct benefit granted under Section 34(H)(2)(c) is to the contributing
or donating taxpayer and not to the foundation itself. Whether the entity is a
foundation or a regular non-stock corporation does not really matter since all
donations to them are equally tax-exempt. In fact, the foundation is at a greater
disadvantage as compared to a regular non-stock corporation, since a foundation
is subject to the 30% limitation on its administration expenses, whereas a regular
non-stock corporation is not saddled by such limitation. In addition, a foundation
is mandated with greater reportorial obligations to the BIR than the regular non-
stock corporation since it has to make not later than the 15th of the third month
after the close of its taxable year a detailed report.

4. Application by Foundations with the BIR

 For a foundation to qualify for full deduction, under BIR-NEDA Regulations
No. 1-81, as amended, it must file with the Government and Tax Exempt
Corporation Division of the BIR a sworn statement showing the character or the
organization, the purpose for which it is organized, its actual activities, the
sources of income and its disposition; and other facts relating to their operations
which are relevant to their qualification as donee institutions. Once the foundation
is qualified as a donee institution by the issuance of BIR Certificate of
Registration, it must issue certificates of donations in the form prescribed by the
BIR on every donation or gift it receives within thirty (30) days from receipt of the
donation.

5. Requirements on Donors to Foundations

Donors should give a notice for every donation worth over P1,000.00 to
the Commissioner of Internal Revenue within thirty (30) days after the receipt of
the certificate of donation attaching thereto a copy of the certificate issued to him
by the qualified donee institution. The notice of donation to the BIR is essentially
to qualify the donor to deduct the donation or contribution in full in his income tax
returns.

a. BIR Reportorial Requirements

A foundation, to maintain is status as a qualified donee institution, should
file not later than the 15th day of the fourth month after the close of its taxable
year, an annual information return,57 certified by an officer thereof, containing,
among other things, a list of the donations and income received during the year,
a list of the activities and/or project undertaken by the institution and the cost of
each undertaking indicating in particular where and how the donation has been
utilized and that no part of its net income inures to the benefit of any private
stockholder or individual.

6. In Summary
For purposes of Corporate Law, with respect to corporate powers and
capabilities, and rules on internal management and membership relations, there
are no distinctions between foundations and regular non-stock corporations, and
there is no advantage enjoyed in this realm by foundations over regular non-
stock corporations. In fact, a foundation would suffer a diminution of the extent of
power by which to distribute its net assets in the event of dissolution, as
compared to a regular non-stock corporation.
In the realm of income taxation, both a foundation and a non-stock
corporation can equally enjoy tax-exempt status.
When it comes to charitable contributions, a foundation is limited in the
manner by which it disburses the same by the 30% limitation on its administrative
expenses, whereas no such limitation applies to regular non-stock corporations.

57
BIR Form No. 1702-A.
In addition, both the donors to, and the management of, foundations are saddled
with reportorial requirements on donations given and received, as the case may
be. On the other hand, because donations to foundations which have qualified as
donee-institutions are deductible in full, there may be greater motivation from
benefactors to give to foundations rather than to a regular non-stock corporation.

CONDOMINIUM CORPORATIONS
1. Basis for Membership
The SEC has ruled58 that a buyer may not on the basis of the sale
contract, insist on being registered the owner of the unit and member of the
condominium corporation, since membership in a condominium corporation is
evidenced by a title issued upon full payment of the unit. Accordingly, only those
persons under whose names the condominium certificates of titles (CCTs) are
issued can be considered as the members of the condominium corporation.

2. Cutting-off of Utility Services

a. Express Provisions in By-Laws
The SEC has ruled59 that the by-laws of a condominium corporation may
provide authorization to cut-off utility services to the unit of a delinquent member,
pursuant to the provisions of Section 36(5) of the Corporation Code, which
expressly authorizes every corporation to adopt by-laws not contrary to law,
morals or public policy and to amend or repeal the same, and Section 47(10)
which vests upon a corporation much leeway and discretion in including
provisions therein which it may deem necessary for the proper and convenient
transaction of its corporate affairs, a condominium corporation can legally and
validly amend its by-laws and master deed to authorize its management to
disconnect utility services for condominium units whose owners/members fail to
timely remit and pay association dues, assessments for insurance and other
special assessments due from them.

b. No Express Provisions in By-Laws

In the absence of specific by-law authority, the SEC could not give a
categorical ruling on whether the board of directors enforce a board resolution
authorizing management to disconnect utility services for condominium units
whose owners/members fail to timely remit dues and other assessments.60
What the SEC did state was that since the Board of Directors is the
governing body o the corporation with whom the management of the corporate
affairs is vested under Section 23 of the Corporation Code, then it is for the

58
SEC Opinion, 10 January 1994, XXVIII SEC QUARTERLY BULLETIN 30 (No. 2, June 1994).
59
SEC Opinion, 22 June 1998, XXXIII SEC QUARTERLY BULLETIN 6 (No. 1, June, 1999).
60
SEC Opinion, 22 June 1998, XXXIII SEC QUARTERLY BULLETIN 6 (No. 1, June, 1999).
Board by virtue of its management power, to determine whether or not the such
enforcement can properly be regarded as an act of management of corporate
affairs and whether or not such form of sanction by mere Board resolution is
reasonably necessary under the circumstances to keep and maintain the
corporation. In the exercise of such prerogative, the Board should exercise best
care and god judgment solely in the interest of the corporation, and acts of the
Board done in good faith and in the exercise of an honest judgment are
presumed to be regular and valid.61

3. Rules on Uniformity of Leasing-Out of Units

A condominium corporation may not validly adopt a resolution or house
rule limiting and providing for uniformity in the leasing out of the units by the unit
owners, since any restriction as to the transfer, use, lien or encumbrance of
condominium units, to be valid, must be expressly provided in the enabling
master deed or the declaration of restrictions duly annotated in the certificate of
title and duly registered under the Land Registration Act.62

4. Bingo and Other Fund-Raising Activities

May a condominium corporation engage in fund-raising activities, such as
bingo socials, movie premiers, bazaars, raffles, etc., in order to augment the
corporate funds?
When specific fund-raising activity is not within the authorized purposes of the
condominium corporation under its articles of incorporation, then it has no
authority to undertake such activities. The articles of incorporation would have to
be amended to include such purposes and powers. Moreover, fund solicitation
from the public is subject to the provisions of Act No. 4075, otherwise known as
the Solicitation Permit Law, as amended by Pres. Decree 1564, and the Rules
and Regulations of the Department of Social Welfare and Development.63

EDUCATIONAL CORPORATIONS
1. Incorporation
Educational corporations shall be governed by special laws and by the
general provisions of the Corporation Code.64 The Education Act of 198265
provides for requirements on corporate structure of educational institutions.

2. Pre-requisites to Incorporation

61
Ibid.
62
SEC Opinion, 4 January 1994, XXVIII SEC QUARTERLY BULLETIN 27 (No. 2, June 1994).
63
SEC Opinion, 17 January 1995, XXIX SEC QUARTERLY BULLETIN 30 (No.2, June 1995);
SEC Opinion, 5 April 1995, XXIX SEC QUARTERLY BULLETIN 34 (No. 3, Sept. 1995).
64
Sec. 106, Corporation Code.
65
Batas Pambansa Blg. 232, and later amended by Republic Act 7798 (1994).
 The SEC shall not accept or approve the articles of incorporation and by-
laws of any educational institution, except upon favorable recommendation of the
Department of Education and Culture.66
Section 25 of the Education Act of 1982 provides that all schools shall be
established in accordance with law.
The establishment of new national schools and the conversion of existing
schools from elementary to national secondary schools or to tertiary schools shall
be by law.
Any private school proposed to be established must incorporate as a non-
stock educational corporation in accordance with the provisions of the
Corporation Code. The requirement may be waived in the case of family-
administered pre-school institutions. Likewise, pursuant to an amendment of
Section 25 under Republic Act 7798, private schools may be incorporated as
stock educational corporations in capital-intensive courses of study as
determined by the Department of Education, Culture and Sports (DECS), the
Commission on Higher Education (CHED), and the Department of Sciences and
Technology (DOST), as the case may be.
Under Section 4(2), Article XIV of the 1987 Constitution, educational
institutions, other than those established by religious group and mission boards,
shall be owned solely by citizens of the Philippines or corporations or association
at least sixty percent (60%) of the capital of which is owned by such citizens.
Congress may, however, require increased Filipino equity participation in all
educational institutions. The control and administration of all educational
institutions shall be vested in Filipino citizens.
In addition, it provides that no educational institution shall be established
exclusively for aliens and no group of aliens shall comprise more than one-third
(1/3) of the enrollment in any school. Those provisions however shall not apply to
schools established for foreign diplomatic personnel and their dependents and,
unless otherwise provided by law, for other foreign temporary residents.

3. Conversion of Non-Stock Educational

School to Stock Corporation
The SEC has ruled67 that a non-stock and non-profit educational
foundation cannot be converted into a stock corporation by the amendment of its
articles of incorporation, because it would be tantamount to distribution of the
corporate assets or income of the corporation to its members inasmuch as
thereafter they automatically become stockholders thereof. This scheme might
defraud the public who may have contributed donations, gifts, or grants to the
non-stock, non-profit corporation since after the conversion the donated

66
Sec. 107, Corporation Code.
67
SEC Opinion, 20 March 1995, XXIX SEC QUARTERLY BULLETIN 15 (No. 3, September
1995); SEC Opinion, 24 February 1989, XXIII SEC QUARTERLY BULLETIN (No. 2, June 1993).
corporate assets would in effect be treated as paid-in capital or subscription
payments of the stockholders.
The proper procedure would be to dissolve it first under any of the
methods specified in Title XIV of the Corporation Code so that the corporate
assets shall be liquidated in accordance with the distribution procedure for non-
stock corporations, and thereafter register it as a new stock corporation subject
to the requirements of the Department of Education, Culture and Sports.68

4. Board of Trustees
Trustees of educational institutions organized as non-stock corporation
shall not be less than (5) nor more than (15), provided, that the number of
trustees shall be in multiples of five (5),69 and may hold office for a term of five (5)
years.70 The number of directors for schools organized as stock corporations
may be any number between five (5) and fifteen (15),71 and shall hold office for
one year.72
The multiples of five (5) in the board of trustees in an educational
institution must be complied, since the provisions of Section 108 are mandatory
provision, otherwise, the Legislature would have provided for an exception to the
same.73
Unless otherwise provided in the articles of incorporation, or the by-laws,
the board of trustees of incorporated schools, colleges, or other institutions of
learning shall, as soon as organized, so classify themselves that the term of
office of one-fifth (1/5) of their number shall expire every year. Trustees
thereafter elected to fill vacancies, occurring before the expiration of term shall
hold office only for the unexpired period. Trustees elected thereafter to fill
vacancies caused by expiration of term shall hold office for five (5) years.74
A majority of the trustees shall constitute a quorum for the transaction of
business. The powers and authority of trustees shall be defined in the by-laws.75
For institutions organized as stock corporations, the number and term of
directors shall governed by the provisions on stock corporations.76

5. Benefits and Privileges of Educational Institutions

68
Ibid
69
Sec. 108, Corporation Code; Se. 108, Batas Pambansa Blg. 68.
70
Sec. 108, Batas Pambansa Blg. 68.
71
Sec. 10, Batas Pambansa Blg. 68.
72
Sec. 23, Batas Pambansa Blg. 68.
73
SEC Opinion, 17 November 1994, XXIX SEC QUARTERLY BULLETIN 5 (No.2, June 1995).
74
Ibid.
75
Ibid.
76
Ibid.
 All revenues and assets of non-stock, non-profit educational institutions
used actually, directly, and exclusively for educational purposes shall be exempt
from taxes and duties.77
Upon the dissolution or cessation of the corporate existence of an
educational institution, its assets shall be disposed of in the manner provided by
law.78
Proprietary educational institutions, including those cooperatively owned,
may likewise be entitled to such exemptions subject to the limitations provided by
law including restrictions on dividends and provisions for reinvestments.79
Subject to the conditions prescribed by law, all grants, endowments,
donations, or contributions used actually, directly, and exclusively for educational
purposes shall be exempt from tax.80

RELIGIOUS CORPORATIONS
Religious corporations may be incorporated by one or more persons. Such
corporations may be classified into corporations sole and religious societies.81
Religious corporations shall governed also by the general provisions on
non-stock corporations insofar as they may be applicable.82
The SEC has ruled that since the Corporation Code does not provide for
the term of a religious corporation, whether sole or aggregate, therefore a
religious corporation may exist in perpetuity.83

1. Corporation Sole
For the purpose of administering and managing, as trustee, affairs,
property and temporalities of any religious denomination, sect or church, a
corporation sole may be formed by the chief archbishop, bishop, priest, minister,
rabbi or other presiding elder of such religious denomination, sect or church.84

a. Acquisition of Land
In Roman Catholic Apostolic Adm. of Davao, Inv. v. Land Registration
Commission85 it was held that a corporation sole is a special form of corporation
usually associated with clergy designated to facilitate the exercise of the
functions of ownership of the church and to regulate the holding and transmission
of such temporalities to the successor of head of the religious sect. It therefore
77
Sec. 4(3), Art. XIV, 1987 Constitution.
78
Ibid.
79
Ibid.
80
Sec. 4(4), Art. XIV, 1987 Constitution.
81
Sec. 109, Corporation Code.
82
Ibid.
83
SEC Opinion, 10 December 1981, XVI SEC QUARTERLY BULLETIN 24 (No. 1, Jan. 1981).
84
Sec. 110, Corporation Code.
85
102 Phil. 596 (1957).
had no nationality. In addition, Roman Catholic held that even if a corporation
sole had a nationality, the same would be determined, not by the national of the
sole corporator, but by the nationality of the constituent of the religious members
constituting the sect. It was therefore, held that a corporation sole was not
disqualified under the constitutional provision providing that only Filipino citizens
or corporations of which at least sixty percent (60%) of the capital stock are
qualified to hold land in the Philippines.
In Director of Lands v. Intermediate Appellate Court,86 in reversing the
priorly adhered doctrine on the matter, held that alienable public land held by a
possessor, personally or through his predecessor-in-interest, openly,
continuously and exclusively for the prescribed statutory period of 30 years under
the Public Land Act is converted to private property by the mere lapse or
completion of said period, ipso jure. Consequently, the requirements of the Public
Land Act qualifying only individuals to acquire public land, cannot apply to
corporate entities who have acquired land by such prescription since the same
would then be private land, not covered by the Public Land Act. The doctrine was
reiterated in Republic v. Intermediate Appellate Court.87
The Director of Lands therefore overturned the previous doctrine that a
corporation sole is disqualified to acquire or hold alienable lands of the public
domain, because of the constitutional prohibition qualifying only individuals to
acquire land of the public domain and the provision under the Public Land Act
which applied only to Filipino citizens or natural persons in the cases of Republic
v. Villanueva,88 and Republic v. Iglesia Ni Cristo.89
The SEC has ruled that when a corporation sole is headed by a foreigner,
it may acquire land in the Philippines only when records are submitted showing
that the members of the Church or religious denomination represented by it
constitute at least 60% Filipinos. 90

b. Articles of Incorporation
Under Section 111 of the Corporation Code, in order to become a
corporation sole, the chief archbishop, bishop, priest, minister, rabbi or presiding
elder of any religious denomination, sect or church must file with the SEC articles
of incorporation setting forth the following:

(a) That he is the chief archbishop, bishop, priest, minister, rabbi

or presiding elder of his religious denomination, sect or
church and that he desires to become a corporation sole;

86
146 SCRA 510 (1986).
87
168 SCRA 165 (1988).
88
114 SCRA 875 (1982).
89
127SCRA 687 (1984).
90
SEC Opinion, 21 September 1993, XXVIII SEC QUARTERLY BULLETIN 11 (No. 1, March
1994); SEC Opinion, 8 August 1994, XXIX SEC QUARTERLY BULLETIN 2 (No. 1, March, 1995).
 (b) That the rules, regulations and discipline of his religious
denomination, sect or church are not inconsistent with his
becoming a corporation sole and do not forbid it;
(c) That as such chief archbishop, bishop, priest, minister, rabbi
or presiding elder, he is charged with the administration of
the temporalities and the management of the affairs, estate
and properties of his religious denomination. sect or church
within his territorial jurisdiction, describing such territorial
jurisdiction;

(d) The manner in which any vacancy occurring in the office of

chief archbishop, bishop, priest, minister, rabbi or presiding
elder is required to be filled, according to the rules,
regulations or discipline of the religious denomination, sect
or church to which he belongs; and
(e) The place where the principal office of the corporation sole is
to be established and located, which place must be within
the Philippines.

The articles of incorporation may include any other provision not contrary
to law for the regulation of the affairs of the corporation.

c. Submission of Articles of Incorporation

The articles of incorporation must be verified, before filing, by affidavit or
affirmation of the chief archbishop, bishop, priest, minister, rabbi or presiding
elder, as the case may be, and accompanied by a copy of the commission,
certificate of election or letter of appointment of such chef archbishop, bishop,
priest, minister, rabbi or presiding elder, duly certified to be correct by any notary
public.91
From and after the filing with the SEC of the said articles of incorporation,
verified by affidavit or affirmation, and accompanied by the documents mentioned
in the preceding paragraph, such chief archbishop, bishop, priest minister, rabbi
or presiding elder, as the case may be, shall become a corporation sole, and all
temporalities, estate and properties of the religious denomination, sect or church
theretofore administered or managed by him as such chief archbishop, bishop,
priest rabbi or other presiding elder shall be held in trust by him as a corporation
sole, for the use, purpose, behalf and sole benefit of his religious denomination,
sect or church, including hospitals, schools, colleges, orphan asylums,
parsonages and cemeteries thereof.92

d. Acquisition and Alienation of Property

91
Sec. 112, Corporation Code.
92
Ibid.
 Any corporation sole may purchase and hold real estate and personal
property for its church, charitable, benevolent or educational purposes, and may
receive bequests or gifts for such purposes.93
Such corporation may mortgage or sell real property held by it upon
obtaining an order for that purpose from the Regional Trial Court of the province
where the property is situated; but before the order is issued, proof must be
made to the satisfaction of the court that notice of the application for leave to
mortgage or sell has been given by publication or otherwise in such manner and
for such time as said court may have directed, and that it is to the interest of the
corporation that leave to mortgage or sell should be granted.94
The application for leave to mortgage or sell must be made by petition,
duly verified, by the chief archbishop, bishop, priest, minister, rabbi or presiding
elder acting as corporation sole, and may be opposed by any member of the
religious denomination, sect or church represented by the corporation sole. In
cases where the rules, regulations and discipline of the religious denomination,
sect or church, religious society or order concerned represented by such
corporation sole regulate the method of acquiring, holding selling and mortgaging
real estate and personal property, such rules, regulations and discipline shall
control, and the intervention of the courts shall not be necessary. 95

e. Filling-up of Vacancies
The successors in office of any chief archbishop, bishop, priest, minister,
rabbi, or presiding elder in a corporation sole shall become the corporation sole
on their accession to office; and shall be permitted to transact business as such
on the filing with the Securities and Exchange Commission of a copy of their
commission, certificate of election, or letters of appointment, duly certified by any
notary public.96
During any vacancy in the office of the chief archbishop, bishop, priest,
minister, rabbi, or presiding elder of any religious denomination, sect or church
represented by the corporation sole, the person or persons authorized and
empowered by the rules, regulations or discipline of the religious denomination,
sect or church represented by the corporation sole to administer the temporalities
and manage the affairs, estate and properties of the corporation sole during the
vacancy shall exercise all the powers and authority of the corporation sole during
such vacancy.97

f. Dissolution

93
Sec. 113, Corporation Code.
94
Ibid.
95
Ibid.
96
Sec. 114, Corporation Code.
97
Ibid.
 A corporation sole may be dissolved and its affairs settled voluntarily by
submitting to the SEC a verified declaration of dissolution.98 The declaration of
dissolution shall set forth:

(a) The name of the corporation;

(b) The reason for dissolution and winding up;
(c) The authorization for the dissolution of the corporation by the
particular religious denomination, sect or church;
(d) The names and addresses of the persons who are to
supervise the winding up of the affairs of the corporation.

Upon approval of such declaration of the dissolution by the SEC, the

corporation shall cease to carry on its operations except for the purpose of
winding up its affairs.99
In Cañete v. Court of Appeals,100 the Supreme Court held that in a
religious corporation, when the minority of the members have chosen to separate
themselves into a distinct body and refuse to recognize the authority of the
governing board, they can claim no rights to the property of the religious
corporation from the fact that they had previously been members thereof.

2. Religious Societies
Under Section 116 of the Corporation Code, any religious society or
religious order, or any diocese, synod, or district organization of any religious
denomination, sect, or church, unless forbidden by the constitution, rules,
regulations, or discipline of the religious denomination, sect or church of which it
is a part, or by competent authority, may, upon written consent and/or by an
affirmative vote at a meeting called for the purpose of two-thirds (2/3) of its
membership, incorporate for the administration of its temporalities or for the
management of its affairs, properties and estate by filing with the SEC, articles of
incorporation verified by the affidavit of the presiding elder, secretary, or clerk or
other member of such religious society or religious order, or diocese, synod, or
district organization of the religious denomination, sect, or church, setting forth
the following:

(a) That the religious society or religious order or diocese,

synod, or district organization is a religious organization of
some religious denomination, sect, or church;
(b) That two-thirds (2/3) of its membership have given their
written consent or have voted to incorporate at a duly
convened meeting of the body;

98
Sec. 115, Corporation Code.
99
Ibid.
100
171 SCRA 13, 20 (1989).
 (c) That the incorporation of the religious society or religious
order, or diocese, synod, or district organization desiring to
incorporate is not forbidden by competent authority or by the
constitution, rules, regulations or discipline of the religious
denomination, sect, or church of which it forms a part;
(d) That the religious society or religious order, or diocese,
synod, or district organization desires to incorporate for the
administration of its affairs, properties and estate;
(e) The place where the principal office of the corporation is to
be established and located, which place must be within the
Philippines; and
(f) The names, nationalities, and residences of the trustees,
elected by the religious society or religious order, or diocese,
synod, or district organization to serve for the first year or
such other period as may be prescribed by the laws of the
religious society or religious order, or the diocese, synod, or
district organization, the board of trustees to be not less than
five (5) nor more than fifteen (15).

3. Term of Existence of Religious Corporations

Since Sections 110 and 116 of the Corporation Code do not provide for a
term of existence of religious corporations, whether classified as corporation sole
or corporation aggregate, therefore, religious corporations may be allowed to
exist perpetually.101

COOPERATIVES
1. Rationale for Cooperative System
Cooperatives are species of non-stock corporation which are entirely
governed by a special law, The Cooperative Development Authority Act.102 Under
the Act, the State fosters the creation and growth of cooperatives "as a practical
vehicle for promoting self-reliance and harnessing people power towards the
attainment of economic development and social justice."103 The State "shall
encourage the private sector to undertake the actual formation and organization
of cooperatives and shall create an atmosphere that is conducive to the growth
and development of these cooperatives."104

101
SEC Opinion, 8 August 1997, XXXII SEC QUARTERLY BULLETIN 13 (No. 2, Dec. 1997);
SEC Opinion, 23 October 1995, XXX SEC QUARTERLY BULLETIN 59 (No. 1, March 1996).
102
Rep. Act 6939.
103
Art. 2, Rep. Act 6938.
104
Ibid.
 2. Definition of "Cooperatives"
A cooperative is a duly registered association of persons, with a common
bond of interest, who have voluntarily joined together to achieve a lawful
common social or economic end, making equitable contribution to the capital
required and accepting a fair share of the risks and benefits of the undertaking in
accordance with universally accepted cooperative principles.105

3. Main Objective of Cooperative

The primary objective of every cooperative is to provide goods and
services to its members and thus enable them to attain increased income and
savings, investments, productivity, and purchasing power and promote among
them equitable distribution of net surplus through maximum utilization of
economies of scale, cost-sharing and risk-sharing without, however, conducting
the affairs of the cooperative for eleemosynary or charitable purposes. 106
A cooperative shall provide maximum economic benefits to its members,
teach them efficient ways of doing things in a cooperative manner, and
propagate cooperative practices and new ideas in business and management
and allow the lower income groups to increase their ownership in the wealth of
this nation.107

4. Organization and Members of Cooperatives

The members in a cooperative can include person either natural or
juridical who, adhering to the principles of the cooperative have been admitted by
the cooperative as member.108
A primary cooperative may be organized and registered by at least fifteen
(15) persons109 for any or all of the following purposes:

(a) To encourage thrift and savings mobilization among the

members;
(b) To generate funds and extend credit to the members for
productive and provident purposes;
(c) To encourage among members systematic production and
marketing;
(d) To provide goods and services and other requirements to
the members;
(e) To develop expertise and skills among its members;

105
Art. 3, Rep. Act 6938.
106
Art. 7, Rep. Act 6938.
107
Ibid.
108
Art 5(1), ibid.
109
Art. 10, ibid.
 (f) To acquire lands and provide housing benefits for the
members;
(g) To insure against losses of the members;
(h) To promote and advance the economic, social and
educational status of the members;
(i) To establish, own, lease or operate cooperative banks,
cooperative wholesale and retail complexes, insurance and
agricultural or industrial processing enterprises, and public
markets;
(j) To coordinate and facilitate the activities of cooperatives; and
(k) To undertake any and all other activities for the effective and
efficient implementation of the Cooperative Code of the
Philippines.110

5. Democratic Set-Up in Cooperative

Cooperatives are defined as democratic organization, and their affairs are
to be administered by persons elected or appointed in a manner agreed upon by
the members. Members of a primary cooperative shall have equal voting rights
on a one-member-one-vote principle.111 Any voting agreement or other device to
evade the one-member-one-vote provision shall be void.112
No member of a primary cooperative shall be permitted to vote by proxy
unless provided for specifically in the by-laws of the cooperative; however,the by-
laws of a cooperative other than a primary cooperative may provide for voting by
proxy. Voting by proxy means allowing a delegate of a cooperative to represent
or vote in behalf of another delegate of the same cooperative.113
In case of secondary and tertiary cooperatives, such cooperatives shall
have voting rights as delegates of members-cooperative, but such cooperatives
shall have only five (5) votes.114 The votes cast by the delegates shall be
deemed as votes cast by the members thereof.115
Unless otherwise provided in the by-laws, a quorum shall consist of
twenty-five percent (25%) of all the members entitled to vote.116

6. Capital and Disposition of Net Surplus

110
Art. 6, Rep. Act 6938.
111
Art. 4, ibid.
112
Art. 36, ibid.
113
Art. 37, ibid.
114
Ibid.
115
Ibid.
116
Art. 36, ibid.
 Share capital in a cooperative shall receive a strictly limited rate of
interest.117 Net surplus arising out of the operations of a cooperative belongs to
its members and shall be equitably distributed for cooperative development,
common services, indivisible reserve fund, and for limited interest on capital
and/or patronage refund in the manner provided for in the Act and in the articles
of cooperation and by-laws.118

7. Board of Directors
The board of directors of the cooperative is the body entrusted with the
management of the affairs of the cooperative under its articles of cooperative and
by-laws.119 The board of directors of the cooperative shall direct and supervise
the business, manage the property of the cooperative and may, by resolution,
exercise all powers of the cooperative as are not reserved for the general
assembly under the Act and the by-laws.120
The conduct and management of the affairs of the cooperative shall be
vested in a board of directors which shall be composed of not less than five (5)
nor more than fifteen (15) members elected by the general assembly for a term
of two (2) years and shall hold office until their successors are duly elected and
qualified, or until duly removed; however, no director shall serve for more than
three (3) consecutive terms.121

8. General Assembly
The general assembly is composed of members who are entitled to vote
under the articles of cooperation and by-laws of the cooperative.122 It shall
constitute the highest policy-making body of the cooperative and shall exercise
such powers as are provided by law, those stated in the articles of cooperation
and the by-laws of the cooperative.123
Under the Act, the general assembly shall have the following exclusive
power which cannot be delegated:

(a) To determine and approve amendments to the articles of

cooperation and by-laws;
(b) To elect or appoint the members of the board of directors,
and to remove them for cause;
(c) To approve developmental plans of the cooperative; and

117
Art. 4(3), ibid.
118
Art. 4(4), ibid.
119
Art. 5(3), ibid.
120
Art. 39, ibid.
121
Art. 38, ibid.
122
Art. 33, ibid.
123
Ibid.
 (d) Such other matters requiring a two-thirds (2/3) vote of all the
members of the general assembly as provided in the Act.124

9. Other Features of Cooperatives

Like the ordinary corporation, a cooperative expressly has the feature of
limited liability;125 has an original term of 50 years, with a right to extend by an
amendment of the articles of incorporation;126 shall have juridical personality only
upon issuance of the certificate of registration by the Cooperative Development
Authority;127

——oOo——

CORP. MANUSCRIPT\17-NON-STOCK CORPORATIONS & FOUNDATIONS\08-02-2002

124
Art. 34, ibid.
125
Arts. 12 and 30, ibid.
126
Art. 13, ibid.
127
Art. 16, ibid.
 CHAPTER 18

FOREIGN CORPORATIONS AND THE

CONCEPT OF "DOING BUSINESS IN
THE PHILIPPINES"1
Nature of Corporate Creature
Definition of "Foreign Corporations"
Requisites for Obtaining License to Do Business in Philippines
Designation of Local Agent
Agreement on Service of Summons with SEC
Effect of Failure to Appoint or Maintain Agent
Oath on Reciprocity Compliance
Deposit of Securities
Effect of Being Issued License
Licensed Foreign Corporation Deemed Domesticated
Consequences of Not Obtaining a License to Do Business
On Standing to Sue and Be Sued
On the Validity of Contract
Conflicting Rulings of Supreme Court
Pari Delicto Ruling
Doctrine of Estoppel
Revoking Pari Delicto Ruling in Favor of Estoppel Doctrine
Problems with Estoppel Doctrine
Concept of "Doing Business" Under Foreign Investment Act of 1991
Statutory Definition of "Doing Business"
Ruling on Indentors and Brokers
Law on Regional or Area Headquarters
Jurisprudential Tests of "Doing Business"
Defining “Isolated Transactions”
Twin-Characterization Test
Essence of Intent to Pursue Continuity of Transactions
Extension of Credit as Essential Indication of Intent
The Contract Test
Evolving Role of Contract Test
Reinsurance Not Per Se Doing Business
Doctrine on Isolated Transactions
Special Rules Pertaining to Actions on Corporate Names, Tradenames and Trademarks
Transactions and Contracts with Agents, Brokers and Indentors
Foreign Corporations as Parties Defendants
Nexus of "Doing Business in the Philippines"
Valid Service of Summons Premised upon “Doing Business”
Service of Summons on Counsel
1
This chapter is based on the article entitled Philippine Doctrine of “Doing Business' for
Foreign Corporations,” published in two-part series in THE LAWYERS REVIEW, Part I - Vol. VII (No.
4, April, 1993), Part II - Vol. VII (No. 6, June, 1993).
 Designation of Local Agent Conclusive on Service of Summons
Allegations on “Doing Business” Merely Preliminary
Consent to Jurisdiction of Local Courts
The Facilities Management Strain
Applying the Control Test
The Signetics Clarification
Latest Word on the Matter
Contractual Stipulation on Venue
Procedural Rule on Pleading "Doing Business"
In Summary
Coverage
Isolated Transactions
Consequences
Domicile and Residence of Foreign Corporations
Resident Agent
Laws Applicable to Foreign Corporations
Amendment of Articles of Incorporation
Merger and Consolidation
Revocation of License to Do Business
Withdrawal of Foreign Corporations

——

NATURE OF CORPORATE CREATURE

A corporation is essentially a creature of the state under the laws of which
it has been granted its juridical personality; and strictly speaking, beyond the
territories of such creating state, a corporation has no legal existence, since the
powers of the creating laws do not extend beyond the territorial jurisdiction of the
state under which it is created.2 A foreign corporation is one which owes its
existence to the laws of another state, and generally, has no legal existence
within the state in which it is foreign.3
It is a fundamental rule of international jurisdiction that no state can by its
laws, and no court (which is only a creature of the state) can by its judgments or
decrees, directly bind or affect property or persons beyond the limits of that
state.4 However, under the doctrine of comity in international laws, "a corporation
created by the laws of one state is usually allowed to transact business in other
states and to sue in the courts of the forum."5
The legal standing of foreign corporations in the host state therefore is
founded on international law on the basis of consent,6 and the extent by which a
hosting state can enforce its laws and jurisdiction over corporations created by

2
Marshall-Wells Co. v. Henry W. Elser & Co., 46 Phil. 70, at p. 74 (1924).
3
Avon Insurance PLC v. Court of Appeals, 278 SCRA 312, 86 SCAD 401 (1997).
4
Times, Inc. v. Reyes, 39 SCRA 303 (1971), citing Perkins v. Dizon, 69 Phil. 186 (1939).
5
Ibid, citing Paul v. Virginia, 8 Wall. 168 (1869); Sioux Remedy Co. v. Cape and Cope, 235
U.S. 197 (1914); Cyclone Mining Co. v. Baker Light & Power Co., 165 Fed. 996 (1908).
6
SALONGA, PRIVATE INTERNATIONAL LAW, 1979 ed., p. 344.
other states has been the subject of jurisprudential rules and municipal
legislations, especially in the fields of taxation,7 foreign investments, and capacity
to obtain reliefs in local courts and administrative bodies.
Consent, as a requisite for jurisdiction over foreign corporations, is
founded on considerations of due process and fair play. As held in Pennoyer v.
Neff,8 the jurisdiction of courts to render judgment in personam is grounded on
their de facto power over the defendant's person. Therefore his presence within
the territorial jurisdiction of a court is prerequisite to its rendition of judgment
personally binding him. International Shoe Co. v. State of Washington9 expanded
the coverage by stating that due process requires only that in order to subject a
defendant to a judgment in personam, if he not be present within the territory of
the forum, he must have certain minimum contacts with it such that the
maintenance of the suit does not offend "traditional notions of fair play and
substantial justice."
International Shoe Co. held that "[s]ince the corporate personality is a
fiction, although a fiction intended to be acted upon as though it were a fact, it is
clear that unlike an individual its „presence‟ without, as well as within, the State of
its origin can be manifested only by activities carried on in its behalf by those who
are authorized to act for it. To say that a corporation is so „present‟ there as to
satisfy due process requirements . . . is to beg the question to be decided. For
the terms „present‟ or „presence‟ are merely used to symbolize those activities of
the corporation's agent with the State which courts will deem to be sufficient to
satisfy the demands of due process." Thus, it deemed that "presence" in a forum
state will not be doubted when the activities of the corporation there have not
only been continuous and systematic, but also give rise to liabilities sued on,
even though no consent to be sued or authorization to an agent to accept service
of process has been given.
A foreign corporation may be subjected to jurisdiction by reason of
consent, ownership of property within the State, or by reason of activities within
or having an effect within the state.10 For example, the filing of an action by a
foreign corporation before Philippine courts would mean that by voluntary
appearance, the local courts have actually obtained jurisdiction over the "person"
of the foreign corporation.11
Another basis by which a host state is deemed to have authority over a
foreign corporation is under the doctrine of "doing business" within the territorial
jurisdiction of the host state. It is an established doctrine that when a foreign
corporation undertakes business activities within the territorial jurisdiction of a
host state, then it ascribes to the host state standing to enforce its laws, rules

7
The chapter does not cover nor discuss the concept of "doing business" in the field of
taxation, as the subject is itself a technical matter that deserves a separate discussion.
8
95 U.S. 714, 733, 24 L.Ed. 565 (1877).
9
326 U.S. 310, 66 S.Ct. 154, 90 L.Ed. 95 (1945).
10
SALONGA, supra, citing Goodrich (Scoles), 136.
11
Communication Materials and Design, Inc. v. Court of Appeals, 260 SCRA 673, 73 SCAD
374 (1996).
and regulations. In the same manner, in order to regulate the basis by which a
foreign corporation seeks to do business and the manner by which it would seek
redress within the judicial and administrative authorities within the host state,
have given rise to the requirement that a license be obtained under the penalty
that failure to do so would not give it legal standing to sue in local courts and
administrative bodies exercising quasi-judicial powers.
On the other hand, when a foreign corporation's activities within the host
state do not fall within the concept of "doing business," the requirements of
obtaining a license to engage in business are generally not applicable to it, and it
would still have legal standing to sue in local courts and administrative agencies
to obtain relief.
In such an instance, the jurisdiction by local courts and administrative
bodies over a foreign corporation seeking relief would be the clear consent
manifested by the filing of the suit.
The Philippine Supreme Court has held that "the recognition of the legal
status of a foreign corporation is a matter affecting the policy of the forum, and
distinction drawn in our Corporation Law between the standing of a corporation
which does not engage in business in the Philippines and does not require a
license to sue, and a foreign corporation which engages in business in the
Philippines, and is required to obtain a license to sue, is an expression of that
policy."12 A state may therefore restrict the right of a foreign corporation to
engage in business within its limits, and to sue in its courts.13
Outside of consent, the concept of "doing business" therefore becomes
the crucial point to determine whether foreign corporations and multinational
enterprises have come within the territorial jurisdictions of the host countries and
consequently to determine to what extent they are bound to obtain licenses
within various host countries before they can sue with local courts and
administrative bodies.

DEFINITION OF "FOREIGN CORPORATIONS"

Section 123 of Corporation Code defines a "foreign corporation" as "one
formed, organized or existing under any laws other than those of the Philippines
and whose laws allow Filipino citizens and corporation to do business in its own
country or state." It is unfortunate that the present Philippine definition of foreign
corporation contains the policy of reciprocity as part of the definition, since it
leads to an absurd implication that corporate entities organized in countries that
do not grant reciprocity rights to Filipinos and Philippine entities are not "foreign
corporations." It is clear that despite the language of Section 123, all corporations
organized other than under Philippine laws are foreign corporations, irrespective
of the issue of reciprocity.

12
Mentholatum Co., Inc. v. Mangaliman, 72 Phil. 524, 530 (1941).
13
Marshall-Wells Co. v. Henry W. Elser & Co., 46 Phil. 70, 74.
 Although wrongly placed, the inclusion of the element of reciprocity in the
definition of foreign corporations emphasizes the Philippines' policy that unless
our own nationals are granted business access in a foreign state, then the
corporate entities of such foreign state would likewise not be granted legal
business access in Philippine territory. This is clear in the succeeding sentence
of Section 123 that provides that foreign corporations from state that grant
reciprocity rights to Philippine nationals "shall have the right to transact business
in the Philippines after it shall have obtained a license to transact business in this
country in accordance with this Code and a certificate of authority from the
appropriate government agency."

REQUISITES FOR OBTAINING LICENSE TO

DO BUSINESS IN THE PHILIPPINES
A foreign corporation shall be granted a license to transact business by
filing a verified application with the SEC setting forth specifically required data,
including certified copies of its articles of incorporation and by-laws.14

1. Designation of Local Agent

Among the things to be stated in the verified application are the name and
address of the foreign corporation's resident agent authorized to accept
summons and process in all legal proceedings and, pending the establishment of
a local office, all notices affecting the corporation.15 Obviously, this requirement
insures that proper jurisdiction may be obtained over a foreign corporation in the
event of suits and other proceedings.
A written power of attorney must be filed by the foreign corporation with
the SEC designating some person who must be a resident of the Philippines, on
whom any summons and other legal processes may be served in all actions or
other legal proceedings against such corporation, and consenting that service
upon such resident agent shall be admitted and held as valid as if served upon
the duly authorized officers of the foreign corporation at its home office.16

2. Agreement on Service of Summons with SEC

In consideration of its being granted a license to do business in the
Philippines, the foreign corporation shall execute and file with the SEC an
agreement or stipulation agreeing that if at any time said corporation shall cease
to transact business in the Philippines or shall be without any resident agent in
the Philippines on whom any summons or other legal processes may be served,
then in any action or proceeding arising out of any business or transaction which

14
Sec. 125, Corporation Code.
15
Ibid. Sec. 127 of the Corporation Code provides that the resident agent may either be an
individual residing in the Philippines who must be of good moral character and sound financial
standing or a domestic corporation lawfully transacting business in the Philippines.
16
Sec. 128, Corporation Code.
occurred in the Philippines, service of any summons or other legal process may
be made upon the SEC and that such service shall have the same force and
effect as if made upon the duly authorized officers of the foreign corporation at its
home office.17
Whenever such service of summons or other process shall be made upon
the SEC, it must, within ten (10) days thereafter, transmit by mail a copy of such
summons or other legal process to the corporation at its home or principal office.
The sending of such copy by the SEC shall be a necessary part of and shall
complete such service.18

3. Effect of Failure to Appoint or Maintain Agent

The failure to appoint and maintain a resident agent in the Philippines or
failure, after change of its resident agent or of his address, to submit to the SEC
a statement of such change, are grounds for revocation of a license granted to a
foreign corporation to do business.19

4. Oath on Reciprocity Compliance

Attached to the application shall also be a duly executed certificate under
oath by the authorized official or officials of the jurisdiction of incorporation,
attesting to the fact that the laws of the country or state of the applicant allow
Filipino citizens and corporations to do business therein.20

5. Deposit of Securities
Within sixty (60) days from issuance of the license to do business, such
foreign corporation shall deposit with the SEC, for the benefit of its present and
future creditors, Philippine securities21 in the actual market value of at least
P100,000.00, subject to further deposit of additional securities every six months
after each fiscal year equivalent in actual market value to two percent (2%) of the
amount by which the foreign corporation's gross income for that fiscal year
exceeds P5,000,000.00.
Furthermore, the SEC may require further securities in the event the
deposit has decreased by at least ten percent (10%) of the actual market value at
the time they were deposited.22

17
Ibid.
18
Ibid.
19
Sec. 134, Corporation Code.
20
Sec. 128, Corporation Code.
21
Sec. 126, Corporation Code enumerates them to consist of bonds or other evidence of
indebtedness of the Philippine Government, its political subdivisions and instrumentalities, or
government-owned or controlled corporations and entities, shares of stocks in "registered
enterprises," shares of stocks of listed domestic entities, or shares of stock in domestic insurance
companies and banks, or any combination of these kinds of securities -
22
Sec. 126, Corporation Code.
 6. Effects of Being Issued License
When a foreign corporation is issued the license to do business in the
Philippines, it may commence to transact its business in the Philippines and
continue to do so for as long as it retains its authority to act as a corporation
under the laws of the country or state of its incorporation, unless such license is
sooner surrendered, revoked, suspended, or annulled.23
The Corporation Code therefore takes pain to ensure that in allowing a
foreign corporation to engage in business activities in the Philippines, proper
safeguards are taken to allow obtaining jurisdiction over such foreign corporation
in case of suit and that proper securities are present within Philippine jurisdiction
to answer for a foreign corporation's obligations to locals. The Supreme Court
has held: "The purpose of the law is to subject the foreign corporation doing
business in the Philippines to the jurisdiction of our courts. It is not to prevent the
foreign corporation from performing single or isolated acts, but to bar it from
acquiring a domicile for the purpose of business without first taking steps
necessary to render it amenable to suits in the local courts."24
Such strict rules are necessary since a foreign corporation doing business
in the Philippines is bound by all laws, rules and regulations applicable to
domestic corporations of the same class, except for matters that go into creation,
formation, organization or dissolution of corporations or such as to fix relations,
liabilities, responsibilities or duties of stockholders, members, or officers of
corporation to each other or to the corporation, or simple intra-corporate
disputes.25

a. Licensed Foreign Corporation Deemed Domesticated

The harmony and balance sought to be achieved by our "doing business"
requirements for obtaining license are best exemplified by the fact that once a
foreign corporation has obtained a license to do business, then it is deemed
domesticated, and should be subject to no harsher rules that is required of
domestic corporations.
Such policy is exemplified in the case of Claude Neon Lights, Fed. Inc. v.
Phil. Adv. Corp.,26 where the Supreme Court refused the issuance of a writ of
attachment on properties in the Philippines of a foreign corporation licensed to do
business in the Philippines on the mere allegation that "it is not residing in the

23
Sec. 126, Corporation Code.
24
Eriks Pte. Ltd. v. Court of Appeals, 267 SCRA 567, 76 SCAD 70 (1997). The Court also
held in that case: "It was never the intent of the legislature to bar court access to a foreign
corporation or entity which happens to obtain an isolated order for business in the Philippines.
Neither, did it intend to shield debtors from their legitimate liabilities or obligations. But it cannot
allow foreign corporations or entities which conduct regular business any access to courts without
the fulfillment by such corporation of the necessary requisites to be subjected to our
government's regulation and authority. By securing a license, the foreign entity would be giving
assurance that it will abide by the decisions of our courts, even if adverse to it."
25
Sec. 129, Corporation Code.
26
57 Phil. 607 (1932).
Philippine Islands." The Court held that having regard for the reason of the law
allowing issuance of writs of attachments for the protection of creditors of a non-
resident, the same reason does not apply to a foreign corporation doing business
in the Philippines and licensed to do so by Philippine authority.
The Court held that unlike a natural person who does not reside in the
Philippines, such foreign corporation is required by law to appoint a resident
agent for service of process; must prove to the satisfaction of the Government
before it does business here, that it is solvent and in sound financial condition;
has had to pay license fee and its business subject at anytime to investigation by
the Government authorities; and that his right to continue do business is subject
to revocation by the Government; and books and papers subject to examination
at any time by the Government; and is bound by all laws, rules and regulations
applicable to domestic corporations; all designed to protect the creditors and the
public. The Court further held:

A natural person not residing in the Philippines can

evade service of summons and other legal processes, the
foreign corporation licensed to do business in Philippines
cannot. Corporations, as a rule, are less mobile than
individuals. This is specially true of foreign corporations that
are carrying on business by proper authority in [the
Philippines]. They possess, as a rule, great capital which is
seeking lucrative and more or less permanent investment in
young and developing countries like our Philippines.27

CONSEQUENCES OF NOT OBTAINING A LICENSE TO DO BUSINESS

1. On Standing to Sue and Be Sued
Section 133 of the Corporation Code provides that a foreign corporation
doing business in the Philippines without first obtaining the license to do
business:

(a) Shall not be permitted to maintain or intervene in any action,

suit or proceeding in any court or administrative agency of
the Philippines;
(b) But such foreign corporation may be sued or proceeded
against before Philippine courts or administrative tribunals
on any valid cause of action recognized under Philippine
laws.

In addition, Section 134 makes it a ground for revocation of license, when

a foreign corporation transacts business in the Philippines as agent of or acting

27
Ibid, at p. 612.
for and in behalf of any foreign corporation or entity not duly licensed to do
business in the Philippines.
It seems clearly implied from the languages of both Sections 133 and 134,
that the failure of a foreign corporation to obtain a license to do business when
one is required, does not affect the validity of the transactions of such foreign
corporation, but simply removes the legal standing of such foreign corporation to
sue. Although such foreign corporation may still be sued, the Corporation Code
fails to indicate that once sued, if such foreign corporation can interpose
counterclaims in the same suit.

2. On the Validity of Contract

Home Insurance Company v. Eastern Shipping Lines,28 established the
Philippine doctrine on the legal effect on the contract itself when a foreign
corporation engages in business in the Philippines without obtaining the required
license.
In that case, Home Insurance Company, a foreign corporation, which
admittedly had engaged in business in the Philippines, had issued the subject
insurance contracts in the Philippines without obtaining the necessary license.
Subsequently, it obtained the license before filing the cases for collection under
the insurance contracts. The lower court dismissed the complaint and declared
that pursuant to its understanding of the basic public policy reflected in the
Corporation Law, the insurance contracts executed before a license was secured
must be held null and void, and the subsequent procurement of the license did
not validate the contracts.
The Supreme Court, although it recognized there were conflicting schools
of thought both here and abroad which are divided on whether such contracts are
void or merely voidable, took its cue from the doctrine laid down in Marshall-
Wells Co. v. Elser29 that the doctrine under Section 69 of the then Corporation
Law "was to subject the foreign corporation doing business in the Philippines to
the jurisdiction of our courts . . . and not to prevent the foreign corporation from
performing single acts, but to prevent it from acquiring domicile for the purpose of
business without taking the necessary steps to render it amenable to suit in the
local courts."
In addition, the Court took into consideration the philosophy discussed in
General Corporation of the Philippines v. Union Insurance Society of Canton
Ltd.,30 that the fact of doing business in the Philippines, and not the non-obtaining
of the license, is the more crucial point:

The test is whether a foreign corporation was actually

doing business here. Otherwise, a foreign corporation illegally
doing business here because of its refusal or neglect to obtain
28
123 SCRA 424 (1983).
29
46 Phil. 70 (1924).
30
87 Phil. 313 (1950).
 the corresponding license and authority to do business may
successfully though unfairly plead such neglect or illegal act so
as to avoid service and thereby impugn the jurisdiction of the
local courts. It would indeed be anomalous and quite
prejudicial, even disastrous, to the citizens in this jurisdiction
who in all good faith and in the regular course of business
accept and pay for shipments of goods from America, relying
for their protection on duly executed foreign marine insurance
policies made payable in Manila and duly endorsed and
delivered to them, that when they go to court to enforce said
policies, the insurer who all along has been engaging in this
business of issuing similar marine policies, serenely pleads
immunity to local jurisdiction because of its refusal or neglect
to obtain the corresponding license to do business here
thereby compelling the consignee or purchasers of the goods
insured to go to America and sue in its courts for redress.

Home Insurance Company therefore held that contracts entered into by a

foreign corporation doing business in the Philippines without the requisite license
remain valid and enforceable and "[t]he requirement of registration affects only
the remedy,"31 and that "the lack of capacity at the time of the execution of the
contracts was cured by the subsequent registration."32
The Court also noted that under both Sections 68 and 69 of the old
Corporation Law (now Sections 133 and 144 of the Corporation Code), penal
sanctions are imposed for failure to comply with the registration requirements,
then "[t]he penal sanction for the violation and the denial of access to our courts
and administrative bodies are sufficient from the viewpoint of legislative policy." 33
The Home Insurance Company doctrine was reiterated in Eriks Pte. Ltd. v.
Court of Appeals,34 where the Supreme Court expressly held "subsequent
acquisition of the license will cure the lack of capacity at the time of the execution
of the contract."

CONFLICTING RULINGS OF SUPREME COURT

Based on the foregoing, it is therefore with serious doubt that we consider
the doctrinal pronouncements of the Supreme Court on the legal effects of non-
obtaining of the license when a foreign corporation engages in business in the
Philippines.

1. Pari Delicto Ruling

31
Supra, at p. 438.
32
Ibid, at p. 439.
33
Ibid. The feasibility of imposing the criminal penalty under Section 144 of the Corporation
Code against the officers of the foreign corporation seems of doubtful application. See
discussions on the matter in Chapter 19.
34
267 SCRA 567, 76 SCAD 70 (1997).
 In Top-Weld Manufacturing v. ECED, S.A.,35 a local company entered into
separate licensing and technical assistance agreements with two Swiss
corporations, by virtue of which the local company was constituted a licensee to
manufacture welding products under specifications, with raw materials to be
purchased from suppliers designated by the licensors. In addition, distributorship
agreements were entered into with another Panamanian company.
When the local company found out that the foreign entities were
negotiating with another group to replace it as their licensee and distributor, it
instituted an action seeking to enjoin the foreign corporations from negotiating
with third persons or from actually carrying out the transfer of their distributorship
and franchising rights, and from terminating the existing contracts. The local
company invoked the provisions of Section 4(9) of Rep. Act 5455, known as the
Foreign Business Regulation Act, which prohibited aliens or foreign firms from
terminating any franchise, licensing or other agreements that they have with a
resident of the Philippines except for violation thereof or other just cause and
upon payment of just compensation and reimbursement and other expenses
incurred by the licensee in developing a market for the products.
The Supreme Court held that although the foreign corporations did not
obtain the necessary license, it did not exempt them from BOI requirements
under the law for "[t]o accept this view would open the way for an interpretation
that by doing business in the country without first securing the required written
certificate from the Board of Investments, a foreign corporation may violate or
disregard the safeguards which the law, by its provisions, seeks to establish."36
However, the Court nevertheless decreed that the local company could not
invoke the provisions of Rep. Act 5455, thus:

As between the parties themselves, R.A. No. 5455 does

not declare as void or invalid the contracts entered into without
first securing a license or certificate to do business in the
Philippines. Neither does it appear to intend to prevent the
courts from enforcing contracts made in contravention of its
licensing provisions. There is no denying, though, that an
“illegal situation,” as the appellate court has put it, was created
when the parties voluntarily contracted without such license.
The parties are charged with knowledge of the existing
law at the time they enter into the contract and at the time it is
to become operative. . . In this case, the record shows that, at
least, petitioner had actual knowledge of the applicability of
R.A. No. 5455 at the time the contract was executed and at all
times thereafter. . . . The very purpose of the law was
circumvented and evaded when the petitioner entered into
said agreements despite the prohibition of R.A. No. 5455. The
parties in this case being equally guilty of violating R.A. No.
5455, they are in pari delicto, in which case it follows as a

35
138 SCRA 118 (1985).
36
Ibid, at p. 130.
 consequence that petitioner is not entitled to the relief prayed
for in this case.37

The result in Top-Weld Manufacturing would be that a contract or

transaction between a local and foreign corporation that would qualify the latter to
be doing business in the Philippines without obtaining the requisite license would
not be actionable at all in Philippine courts or administrative bodies. If the foreign
corporation brings an action on said contract or transaction, it will be dismissed
under Section 133 of the Corporation Code as a consequence of not obtaining
the license. On the other hand, if the local counterpart brings an action on the
contract, it would also be dismissed on grounds of pari delicto, under Top-Weld
which held that "the law will not aid either party to an illegal agreement. It leaves
the parties where it finds them."38
Although the Court acknowledged that "[a]s between the parties
themselves, R.A. No. 5455 does not declare as void or invalid the contracts
entered into without first securing a license or certificate to do business in the
Philippines," yet at the same time it would apply the pari delicto doctrine because
it would "not aid either party to an illegal agreement." The effect is to hold such a
contract void.
Such pronouncements in Top-Weld contravene the clear language in
Section 133 that "a foreign corporation doing business in the Philippines without
first obtaining the license to do business . . . may be sued or proceeded against
before Philippine courts or administrative tribunals on any valid cause of action
recognized under Philippine laws." Also, the pronouncements fail to consider the
crucial point that obtaining the license is a duty imposed upon the foreign
corporation doing business in the Philippines, not on the locals who deal with it,
and precisely it is a duty imposed on foreign corporations in order to protect the
locals.

2. Doctrine of Estoppel
In Merrill Lynch Futures, Inc. v. Court of Appeals,39 the Supreme Court
came out with a diametrically opposed ruling to the pari delicto principle of Top-
Weld Manufacturing.
In that case, Merrill Lynch Futures, Inc., through a domestic corporation,
was found to be engaging in business (commodity futures) in the Philippines
without obtaining the proper license. It brought a suit in Philippine courts to
enforce a claim against local investors. Although the Court found the foreign
corporation to have engaged in business in the Philippines without the requisite
license, it overturned the dismissal of the suit, on the ground that if the local
investors knew that the foreign corporation had no license to do business in the

37
Ibid, at p. 131. Emphasis supplied.
38
Ibid, at p. 131, citing Bough v. Cantiveros, 40 Phil. 210 (1919).
39
211 SCRA 824 (1992).
Philippines, then they are estopped from using the lack of license to avoid their
obligations, thus—

The rule is that a party is estopped to challenge the

personality of a corporation after having acknowledged the
same by entering into a contract with it. And the "doctrine of
estoppel to deny corporate existence applies to foreign as well
as to domestic corporations;" “one who has dealt with a
corporation of foreign origin as corporate entity is estopped to
deny its corporate existence and capacity." The principle "will
be applied to prevent a person contracting with a foreign
corporation from later taking advantage of its noncompliance
with the statutes, chiefly in cases where such person has
received the benefits of the contract . . .40

The Merrill Lynch doctrine of estoppel has been reiterated in National

Sugar Trading Corporation v. Court of Appeals.41 In that case a complaint for
specific performance and partial rescission of contract and damages was brought
by a foreign corporation against the National Sugar Trading Corporation
(NASUTRA) with the Regional Trial Court. Although the complaint alleged that
the foreign corporation was not engaged in business in the Philippines,
NASUTRA, after filing an answer, had moved to dismiss the complaint on the
ground that the foreign corporation was actually engaged in business in the
Philippines and had not obtained a license, and thereby has no standing to sue in
Philippine courts.
Although the issue brought before the Supreme Court was whether the
foreign corporation was engaged in business in the Philippines without a license,
and in fact the Court held that "[w]hether a foreign corporation is doing business
in the Philippine must be determined in the light of the peculiar circumstances of
each case . . . [and] is essentially a question of fact," nevertheless the resolution
of such issue was rendered irrelevant because the Court applied the Merrill
Lynch estoppel doctrine. It held -

Petitioners do not dispute private respondent's claim that

NASUTRA entered into the Contract of Purchase and Sale of
Sugar with the latter in 1980 . . . In fact, in its Motion to
Dismiss filed below, petitioner SRA admits the partial delivery
of the sugar and the issuance of SRA Resolution No. 68-87-A
recognizing payment and receipt by NASUTRA of the
purchase price for the said sugar, and NASUTRA's existing
obligation over the undelivered portion . . . Given these
preliminary facts and assuming that petitioner NASUTRA was
aware from the outset that private respondent had no license
to do business in this country, it would appear quite inequitable
40
Ibid, at p. 837. The "estoppel" doctrine was also reiterated in Georg Grotjahn GMBH &
Co. v. Isnani, 235 SCRA 216, 54 SCAD 289 (1994).
41
246 SCRA 465, 63 SCAD 31 (1995)
 for NASUTRA, a state-owned corporation, to evade payment
of an otherwise legitimate indebtedness due and owing to
private respondent upon the plea that the latter should have
obtained a license first before perfecting a contract with the
Philippine government.42

In addition, the Court took into serious consideration the fact that the
foreign corporation did not actually "sell sugar and derive income from the
Philippines," but actually bought sugar from the Philippine government and
allegedly paid for it in full. The theory therefore would seem that the activity to be
undertaken in the Philippines to be considered engaged in business is one that is
for profit-making activity and not one where the foreign corporation merely seeks
to enter into a purchase or acquisition transaction which by itself it does not
derive profit. The Court then went on to quote from Antam Consolidated, Inc. v.
Court of Appeals,43 which it deemed similar in facts and held that the doctrine of
lack of capacity to sue based on failure to acquire a local license is based on
considerations of sound public policy. The license requirement was imposed to
subject the foreign corporation doing business in the Philippines to the
jurisdiction of its courts and never intended to favor domestic corporation who
enter into solitary transactions with unwary foreign firms and then repudiate their
obligations simply because the latter are not licensed to do business in the
country.
The rulings of the Supreme Court would also imply that when a foreign
corporation doing business in the Philippines has not obtained the requisite
license is sued, then by the principle of estoppel, it may interpose the proper
counterclaims.

3. Revoking Pari-Delicto Ruling

in Favor of Estoppel Doctrine
Recently, the Top-Weld doctrine of pari delicto seems to have been
revoked in favor of the estoppel doctrine in Communication Materials and
Design, Inc. v. Court of Appeals,44 where the Supreme Court in applying directly
the Top-Weld doctrine found that the contract of a foreign corporation with a local
broker or agent as having highly restrictive terms and conditions as to constitute
the foreign corporation as doing business in the Philippines.
In that case, although the foreign corporation was held doing business in
the Philippines, the Court refused to allow the plea of the local company that not
having been licensed to do business in the Philippines, the foreign corporation
has no standing to sue. The Court, invoking the Merrill Lynch doctrine held:

42
Ibid, at pp. 469-470 citing Merrill Lynch Futures, Inc. v. Court of Appeals, 211 SCRA 824
(1992).
43
143 SCRA 288 (1986).
44
260 SCRA 673, 73 SCAD 374 (1996).
 A foreign corporation doing business in the Philippines
may sue in Philippine courts although not authorized to do
business here against a Philippine citizen or entity who had
contracted with and benefited by said corporation. To put it
another way, a party is estopped to challenge the personality
of a corporation after having acknowledged the same by
entering into a contract with it. And the doctrine of estoppel to
deny corporate existence applies to a foreign as well as to
domestic corporations. One who has dealt with a corporation
of foreign origin as a corporate entity is estopped to deny its
corporate existence and capacity. The principle will be applied
to prevent a person contracting with a foreign corporation from
later taking advantage of its noncompliance with the statutes
chiefly in cases where such person has received the benefits
of the contract.

The Court held that the doctrine of lack of capacity to sue based on the
failure to acquire a local license is based on considerations of sound public
policy. The license requirement was imposed to subject the foreign corporation
doing business in the Philippines to the jurisdiction of its courts. It was never
intended to favor domestic corporations who enter into solitary transactions with
unwary foreign firms and then repudiate their obligations simply because the
latter are not licensed to do business in this country.45

4. Problems with Estoppel Doctrine

The problem with the Merrill Lynch estoppel doctrine is that it basically
lacks one of the essential ingredients that constitutes the element of estoppel,
which is that by the action or representation of one party (i.e., the local entity or
individual), the other party (i.e., the foreign corporation), has been held to believe
that he would be entitled to relief on the contract entered into in the course of
doing business in the Philippines without a license. When a foreign entity
engages in business in the Philippines and fails to obtain the requisite license,
then the simple act of a local entering into a contract with such foreign
corporation cannot reasonably give rise to estoppel or the belief therefore on the
part of the foreign entity that he would be allowed to secure reliefs from local
courts since the provisions of Section 133 of the Corporation Code, which is
deemed to be part of such contract, prevents such belief from having a
reasonable basis.
The Merrill Lynch estoppel doctrine effectively removes the sanction
provided for by law on the failure of a foreign corporation to obtain a license
before it engages in business in the Philippines, and therefore there would be
less motive on the part of such foreign corporation to obtain the license since it
can always sue in Philippine courts.

45
Quoting from National Sugar Trading Corp. v. Court of Appeals, 246 SCRA 465, 63
SCAD 31 (1995).
 Eriks Pte. Ltd. v. Court of Appeals,46 has answered the issue that to
prevent a foreign corporation to sue on a contract would be unjust enrichment for
the local counterpart, albeit not in express reference to the estoppel doctrine. In
that case it was argued by the foreign corporation that its denial of access to
Philippine courts would afford unjust enrichment to the defendant. The Court
held: "a judgment denying a foreign corporation relief from our courts for failure to
obtain the requisite license to do business, should not be construed as an
attempt to foreclose the ultimate right to collect on an obligation. . . Res judicata
does not set in a case dismissed for lack of capacity to sue, because there has
been no determination on the merits. Moreover, this Court has ruled that
subsequent acquisition of the license will cure the lack of capacity at the time of
the execution of the contract."

CONCEPT OF "DOING BUSINESS" UNDER

FOREIGN INVESTMENT ACT OF 1991
The Foreign Investment Act of 199147 now governs foreign investments in
the Philippines that do not seek BOI incentives. The Act has repealed Book II of
the Omnibus Investments Code of 1987.48

1. Statutory Definition of "Doing Business"

Instead of defining a "foreign corporation," the Act refers to a "non-
Philippine national" as an entity not falling within the definition of "Philippine
National." A Philippine national means

a corporation organized under the laws of the Philippines

of which at least sixty percent (60%) of the capital stock
outstanding and entitled to vote is owned and held by citizens
of the Philippines . . . Provided, That where a corporation and
its non-Filipino stockholders own stocks in a SEC registered
enterprise, at least sixty percent (60%) of the capital stock
outstanding and entitled to vote of both corporations must be
owned and held by citizens of the Philippines and at least sixty
percent (60%) of the members of the Board of Directors of
both corporations must be citizens of the Philippines, in order
that the corporation shall be considered a Philippine national.49

Under the negative list concept of the Act, a non-Philippine national, upon
registration with the SEC, may do business in the Philippines or invest in a
domestic enterprise up to one hundred percent (100%) of its capital, unless

46
267 SCRA 567, 76 SCAD 70 (1997).
47
Rep. Act 7042.
48
Executive Order 226.
49
Sec. 3(a), Foreign Investment Act of 1991.
participation of non-Philippine nationals in the enterprise is prohibited or limited to
a smaller percentage by existing law and/or under the negative lists of the Act.50
Although the Act has removed the requirement of registration with the BOI
for foreign investors to do business in the Philippines outside the negative lists,
nevertheless it confirms the need for such foreign corporation, before engaging in
business in the Philippines, to register with, and obtain a license to do business
from, the SEC.
Under the Implementing Rules and Regulations issued by the Department
of Trade and Industry, a foreign corporation is defined as "one which is formed,
organized or existing under laws other than those of the Philippines."51
The Act defines "doing business" to include the following by express
enumeration:

(a) Soliciting orders, service contracts, opening offices,

whether called “liaison” offices or branches;
(b) Appointing representatives or distributors domiciled in the
Philippines or who in any calendar year stay in the
country for a period or periods totaling one hundred
eighty (180) days or more;
(c) Participating in the management, supervision or control of
any domestic business, firm, entity or corporation in the
Philippines; and
(d) Any other act or acts that imply a continuity of
commercial dealings or arrangements, and contemplate
to that extent the performance of acts or works, or the
exercise of some of the functions normally incident to,
and in progressive prosecution of, commercial gain or of
the purpose or object of the business organization.52

On the other hand, the Act makes clear that "doing business" does not
include the following acts and activities:

(a) Mere investment as a shareholder by a foreign entity in a

domestic corporation duly registered to do business,
and/or the exercise of rights as such investor;
(b) Having a nominee director or officer to represent its
interests in such corporation; and

50
Sec. 5, Foreign Investment Act of 1991.
51
Sec. 1(c), Implementing Rules and Regulations of FIA „91.
52
Sec. 3(d), Foreign Investment Act of 1991; emphasis supplied.
 (c) Appointing a representative or distributor domiciled in the
Philippines which transacts business in its own name and
for its own account.53

The DTI Implementing Rules and Regulations, in defining "doing

business," not only carry the same language as appearing in the Act, but also
includes the following items as not being included in the term "doing business":

(a) The publication of a general advertisement through any

print or broadcast media;
(b) Maintaining a stock of goods in the Philippines solely for
the purpose of having the same processed by another
entity in the Philippines;
(c) Consignment by a foreign entity of equipment with a local
company to be used in the processing of products for
export;
(d) Collecting information in the Philippines; and
(e) Performing services auxiliary to an existing isolated
contract of sale which are not on a continuing basis, such
as installing in the Philippines machinery it has
manufactured or exported to the Philippines, servicing
the same, training domestic workers to operate it, and
similar incidental services.54

A review of the enumerated instances of activities not constituting doing

business shows a common denominator that by themselves the activities do not
bring any direct receipts or profits to the foreign corporation. This would be
consistent with the ruling of the Supreme Court in National Sugar Trading
Corporation v. Court of Appeals,55 that activities within Philippine jurisdiction that
do not create earnings or profits to the foreign corporation do not constitute doing
business in the Philippines.
Such exceptions to the doing business concept are not found in the
statutory definition of doing business, and do not conform to the public policy
behind the requirement of getting a license, i.e., that foreign corporation are
prevented from conducting activities in the Philippine before steps are taken to
ensure that both the state and the locals would have a valid means of obtaining
jurisdiction over their persons (which is achieved by the process of obtaining a
license to do business). Thus, it has been held in Avon Insurance PLC v. Court
of Appeals, 56 thus:

53
Ibid.
54
Sec. 1(f), Implementing Rules and Regulations of FIA „91.
55
246 SCRA 465, 63 SCAD 31 (1995).
56
278 SCRA 312, 86 SCAD 401 (1997).
 The purpose of the law in requiring that foreign
corporations doing business in the country be licensed to do
so, it to subject the foreign corporations doing business in the
Philippines to the jurisdiction of the courts, otherwise, a foreign
corporation illegally doing business here because of its refusal
or neglect to obtain the required license and authority to do
business may successfully though unfairly plead such neglect
or illegal act so as to avoid service and thereby impugn the
jurisdiction of the local courts.
The same danger does not exist among foreign
corporations that are indubitably not doing business in the
Philippines. Indeed, if a foreign corporation does not do
business here, there would be no reason for it to be subject to
the State‟s regulation. As we observed, in so far as the State is
concerned, such foreign corporation has no legal existence.
Therefore, to subject such foreign corporation to the courts‟
jurisdiction would violate the essence of sovereignty.

2. Ruling on Indentors and Brokers

The Supreme Court in Top-Weld Manufacturing, Inc. v. ECED S.A.,57 has
ruled on operative function of exemption of a foreign corporation from obtaining a
license to do business under Section 1(f)(1) and 1(f)(2) of the Rules and
Regulations Implementing the Omnibus Investments Code of 1987, when it
transacts business through middlemen, acting in their own names, such as
indentors, commercial brokers or commercial merchants.
In Top-Weld, the licensing and representative agreements entered into by
the foreign corporation with locals were deemed to be "highly restrictive" in
nature as to reduce the locals to being mere conduits or extension of the foreign
corporation in the Philippines.
The Court held that the foreign corporations were doing business in the
Philippine because the disputed contracts with the locals were entered into to
carry out the purposes for which they were created, i.e., to manufacture and
market welding products and equipment. The terms and conditions of the
contracts as well as the conduct of the foreign corporations indicate that they
established within the Philippines a continuous business, and not merely one of a
temporary character.
The Court in Top-Weld did indicate that the foreign corporations could be
exempted from the requirements of Republic Act 5455 if the local company were
an independent entity which buys and distributes products not only of the foreign
corporation, but also of other manufactures or transacts business in its name and
for its account and not in the name or for the account of the foreign principal. It
held that a reading of the agreements between the foreign corporations and the

57
138 SCRA 118 (1985).
local company shows that they are highly restrict in nature, thus making the local
company a mere conduit or extension of the foreign corporations.
In spite of the provisions of the Act and the Implementing Rules and
Regulations, therefore, even when the local agents, brokers, or indentors of
foreign corporation transact sales in their own names, but the covering licensing
or representative agreements with foreign corporations contain highly restrictive
terms as to render the locals merely conduits or extensions of foreign
corporations, the latter would still be considered as "doing business" in the
Philippines.
The doctrine was reiterated in Communication Materials and Design, Inc.
v. Court of Appeals,58 which found the following provisions in the Master Service
Agreement of the foreign corporation with the local company as highly restrictive
as to make the latter merely a conduit or extension of the foreign company:

(a) It required the local technical representative to provide

the employees of the technical and service center with
the foreign corporation identification cards, and to
correspond only on the foreign corporation's letterhead;
(b) Local employees were instructed to answer telephone
using the foreign corporation's name, and all calls being
recorded and forwarded to the foreign company on a
weekly basis;
(c) The local company was obliged to provide the foreign
company with a monthly report detailing the failure and
repair of the products and to requisition materials and
components from the foreign corporation; and
(d) The agreement provided for a "no competing product"
clause.

LAW ON REGIONAL OR AREA HEADQUARTERS

The acts of a foreign corporation registered under Pres. Decree 218 as a
regional or area headquarter, which includes acting as supervision, coordination,
communications and coordination center for its home office's affiliates, the
naming of its local agent and employment of Philippine national are acts pursuant
to its primary purposes and functions as a regional/area headquarters for its
home office, and are deemed to be "doing business" in the country, as defined
under the Omnibus Investment Code of 1987, and would give it standing to sue
in Philippine courts even without a separate license to do business.59

58
260 SCRA 673, 73 SCAD 374 (1996).
59
Georg Grotjahn GMBH & Co. v. Isnani, 235 SCRA 216, 54 SCAD 289 (1994).
 Regional headquarters are not regulated nor licensed under Section 123
of the Corporation Code, but under Executive Order 226 (otherwise known as the
Omnibus Investment Code of 1987), and therefore do not need a separate
license from the SEC in order to operate as an area or regional headquarters in
the Philippines for a multinational company. No license is required since area or
regional headquarters are established only to supervise, coordinate and
communicate with their own affiliates, subsidiaries or branches in the Asia Pacific
region, and are not allowed to do business in the Philippines like the branch or
representative offices of foreign corporations licensed pursuant to the
Corporation Code.60
Republic Act 8756, which amended the Omnibus Investment Code, has
provided for the establishment within Philippine jurisdiction of “regional operating
headquarters,” which means “foreign entity which is allowed to derive income in
the Philippines by performing qualifying services to its affiliates, subsidiaries or
branches in the Philippines, in the Asia-Pacific Region and in other foreign
markets.” Once is has obtained the appropriate license as a regional operating
headquarters, it does not need to acquire a separate license to do business in
the Philippines.

JURISPRUDENTIAL TESTS OF "DOING BUSINESS"

1. Defining “Isolated Transactions”
Whether a foreign corporation needs to obtain a license, and fails to do so,
whether it should be denied legal standing to obtain remedies from local courts
and administrative agencies, depends therefore on the issue whether it will
engage in business in the Philippines. Not every activity undertaken in the
Philippines amounts to doing business as to require the foreign corporation to
obtain such license. The issue is exactly what "doing business" covers. No
definition is offered under the Corporation Code as to what constitutes doing
business.
Marshall-Wells Co. v. Henry W. Elser & Co.,61 was the earliest case
decided by the Supreme Court directly in point. In that case, an Oregon
corporation sued a domestic corporation in the then court of first instance of
Manila, to recover the unpaid balance on a bill on sale of goods. The complaint
was dismissed by the trial court on demurrer by the defendant since the
complaint did not show that the plaintiff, being a foreign corporation, had
complied with the legal requirement of foreign corporations obtaining the license
to do business.
Marshall-Wells then established the rule that obtaining of a license and the
effect of not obtaining such license only applied to foreign corporations doing
business in the Philippines; it had no application to foreign corporations not doing

60
SEC Letter reply to Atty. Cesar L. Villanueva, dated 31 January 1996.
61
46 Phi. 70 (1924).
business in the Philippine. In construing what is not included in the term "doing
business," Marshall-Wells did indicate that an "isolated" transaction would not
place a foreign corporation within the term "doing business."
The Supreme Court in Marshall-Wells discussed the rationale behind then
Section 69 of the Corporation Law (now Section 133 of the Corporation Code),
thus:

The object of the statute was to subject the foreign

corporation doing business in the Philippines to the jurisdiction
of its courts. The object of the statute was not to prevent the
foreign corporation from performing single act, but to prevent it
from acquiring a domicile for the purpose of business without
taking the steps necessary to render it amenable to suit in the
local courts. The implication of the law is that it was never the
purpose of the Legislature to exclude a foreign corporation
which happens to obtain an isolated order for business from
the Philippines, from securing redress in the Philippine courts,
and thus, in effect, to permit persons to avoid their contracts
made with such foreign corporations."62

Subsequently, the Court rendered a decision in Western Equipment and

Supply Co. v. Reyes,63 where from the stipulation of facts of the parties they had
agreed that the foreign corporation, "had never engaged in business in the
Philippine Islands." Under such an admitted fact it was easy for the Court to hold
that a foreign corporation which has never done any business in the Philippines
and which is unlicensed and unregistered to do business here, but is widely and
favorably known in the Philippines through the use therein of its products bearing
its corporate and trade name, has a legal right to maintain an action in the
Philippines to restrain the residents and inhabitants from organizing a corporation
bearing the same name as the foreign corporation.
Western Equipment did not define what constitutes "doing business" since
it was stipulated by the parties that the foreign corporation has done no business
in the Philippines. It supported the doctrine that foreign corporation can bring an
action in the Philippines to protect its reputation, corporate name and goodwill
which have been established through the natural development of its trade over a
long period of years, in the doing of which it does not seek to enforce any legal or
contract rights arising from, or growing out of, any business which it has
transacted in the Philippines.64

2. Twin Characterization Test

62
Ibid, at p. 75. Emphasis supplied.
63
51 Phil. 115 (1927).
64
Ibid, at p. 128.
 In 1941, the Supreme Court in Mentholatum Co., Inc. v. Mangaliman,65
began to fashion a jurisprudential test of what constitutes "doing business" in the
Philippines for foreign corporations. In that case, Mentholatum Company, an
American corporation, and its exclusive Philippine distributing agent, Philippine-
American Drug Company, instituted an action for infringement of trademark and
unfair competition against defendants Mangaliman. Mentholatum had in previous
years registered the trademark "Mentholatum" for its products consisting of
medicament and salve. The defendants Mangaliman had prepared a
medicament and salve named "Mentholiman" which they sold to the public
packed in containers of the same size, color and shape as "Mentholatum".
Although the trial court found for the plaintiffs, on appeal the Court of Appeals
reversed the decision, holding that the activities of Mentholatum were business
transactions in the Philippines, and that, by Section 69 of the Corporation Law, it
could not maintain any action.
In a petition for certiorari filed with the Supreme Court, the plaintiffs-
petitioners claimed that although Mentholatum may be covered by the provision
of then Section 69 of the Corporation Law on the effects of doing business
without a license, the complaint was also filed by Philippine-American Drug
Company, a domestic corporation, which had sufficient interest and standing to
maintain the complaint. In addition, it was shown that Mentholatum itself had not
sold any of its products in the Philippines, and it was Philippine-American Drug
Co., Inc. and fifteen other local entities which imported the products and sold
them locally.
It determining whether Mentholatum fell under the category of doing
business in the Philippines, which thereby required it to obtain a license to do
business, the Court held:

No general rule or governing principle can be laid down

as to what constitutes “doing” or “engaging in” or “transacting”
business. Indeed, each case must be judged in the light of its
peculiar environmental circumstances. The true test, however,
seems to be whether the foreign corporation is continuing a
body or substance of the business or enterprise for which it
was organized or whether it has substantially retired from it
and turned it over to another. . . The term implies a continuity
of commercial dealings and arrangements, and contemplates,
to that extent, the performance of acts or works or the exercise
of some of the functions normally incident to, and in
progressive prosecution of, the purpose and object of its
organization.66

65
72 Phil. 524 (1941).
66
Ibid, at pp. 528-529, citing Traction Cos. v. Collectors of Int. Revenue [C.C.A. Ohio] 223
F. 984, 987; Griffin v. Implement Dealer's Mut. Fire Ins. Co., 241 N.W. 75, 77; Pauline Oil & Gas
Co. v. Mutual Tank Line Co., 246 P. 851, 852, 118 Okl. 111; Automotive Material Co., v.
American Standard Metal Products Corp., 158 N.E. 698, 703, 327 Ill. 367). Emphasis supplied.
 In deciding that Mentholatum was indeed engaged in business in the
Philippines, the Supreme Court took cognizance of the allegation in the complaint
that clearly stated that the "Philippine-American Drug Co., Inc., is the exclusive
distributing agent in the Philippine Islands of the Mentholatum Co., Inc., in the
sale and distribution of its products known as the Mentholatum." The Court
therefore concluded that whatever transactions the Philippine-American Drug
Company had executed in view of the law, the Mentholatum did itself. The Court
held therefore that since Mentholatum is a foreign corporation doing business in
the Philippine without a license, it may not prosecute the action for violation of
trademark and unfair competition. In addition, neither may the Philippine-
American Drug Company maintain the action for the reason that the
distinguishing features of the agent being its representative character and
derivative authority, and could not, to the advantage of its principal, claim an
independent standing in court apart from Mentholatum.
What is significant in Mentholatum is its drawing of the two tests to
determine whether a foreign corporation is engaged in business in the
Philippines:
First, it considered as the "true test" of doing business in the Philippines
as to whether a foreign corporation is maintaining or continuing in the Philippines
"the body or substance of the business or enterprise for which it was organized
or whether is has substantially retired from it and turned it over to another."
Second, it defined "doing business" to necessarily imply "a continuity of
commercial dealings and arrangements, and contemplates, to that extent, the
performance of acts or works or the exercise of some of the functions normally
incident to, and in progressive prosecution of, the purpose and object of its
organization."
Taken together, the characterization by Mentholatum of "doing business"
in the Philippines covers transactions or series of transactions in pursuit of the
main business goals of the corporation, and done with intent to continue the
same in the Philippines. It re-affirmed the early characterization of Marshall-Wells
that an "isolated transaction" by a foreign corporation cannot qualify as "doing
business" since it lacks the element of continuity. Notice that the element of profit
results did not figure into the test.
Commissioner of Internal Revenue v. British Overseas Airways Corp.,67
held that when an international airline maintains a general sales agent in the
Philippines, which engaged in the selling and issuing of tickets, breaking down
the whole trip into series of trip—each trip in the series corresponding to a
different airline company, receiving the fare from the whole trip, and allocating to
the various airline companies on the basis of their participation in the services
rendered through the mode of interline settlement, then those activities constitute

67
149 SCRA 395 (1987).
doing business in the Philippines for which it could be held liable for income tax
liabilities as a resident foreign corporation under the Philippine Tax Code.68
Top-Weld Manufacturing, Inc. v. ECED, S.A.,69 summarized it well when it
held that:

There is no general rule or governing principle laid down

as to what constitutes "doing" or "engaging in" or "transacting"
business in the Philippines. Each case must be judged in the
light of its peculiar circumstances. (Mentholatum Co. v.
Mangaliman, 72 Phil. 524). Thus, a foreign corporation with a
settling agent in the Philippines which issues twelve marine
policies covering different shipments to the Philippines
(General Corporation of the Philippines v. Union Insurance
Society of Canton, Ltd. 87 Phil 313) and a foreign corporation
which had been collecting premiums on outstanding policies
(Manufacturing Life Insurance Co., v. Meer, 89 Phil. 351) were
regarded as doing business here. The acts of these
corporations should be distinguished from a single or isolated
business transaction or occasional, incidental and casual
transactions which do not come within the meaning of the law.
Where a single act or transaction, however, is not merely
incidental or casual but indicates the foreign corporation's
intention to do other business in the Philippines, said single act
or transaction constitutes "doing" or "engaging in" or
"transacting" business in the Philippines (Far East
International Import and Export Corporation v. Nankai Kogyo,
Co., 6 SCRA 725).

In Top-Weld Manufacturing the Court considered the foreign corporation

as doing business in the Philippines when it entered into the disputed contracts
which were in accordance with the purpose for which it was created, namely, to
manufacture and market welding products and equipment. The terms and
conditions of the contracts, as well as the conduct thereof, indicate the
establishment within the country of a continuous business, and not merely one of
a temporary character.

3. Essence of Intent to Pursue Continuity of Transactions

The lack of intent to pursue with continuity transactions in the Philippines
has been found crucial by the Supreme Court in determining whether the foreign
corporation is engaged in business in the Philippines.
Litton Mills, Inc. v. Court of Appeals,70 clearly held that it is not really the
fact that there is only a single act done that is material for determining whether a

68
Reiterated in Commissioner of Internal Revenue v. Japan Air Lines, Inc., 202 SCRA 450
(1991).
69
138 SCRA (1985).
70
256 SCRA 696, 75 SCAD 160 (1996).
corporation is engaged in business in the Philippines, since other circumstances
must be considered. Where a single act or transaction of a foreign corporation is
not merely incidental or casual but is of such character as distinctly to indicate a
purpose on the part of the foreign corporation to do other business in the state,
such act will be considered as constituting business.

4. Extension of Credit as Essential Indication of Intent

Eriks Pte. Ltd. v. Court of Appeals,71 found the extension of credit terms to
be indicative of intent to do business in the Philippines for an indefinite period,
thus: "More than the sheer number of transactions entered into, a clear and
unmistakable intention on the part of petitioner to continue the body of its
business in the Philippines is more than apparent. . . Further, its grant and
extension of 90-day credit terms to private respondent for every purchase made,
unarguably shows an intention to continue transaction with private respondent,
since in the usual course of commercial transactions, credit is extended only to
customers in good standing or to those on whom there is an intention to maintain
long-term relationship. . . What is determinative of “doing business” is not really
the number or the quantity of the transactions, but more importantly, the intention
of an entity to continue the body of its business in the country. The number and
quantity are merely evidence of such intention."
In the case of foreign movie companies who have registered intellectual
property rights over their movies in the Philippines, it was held that the
appointment of local lawyer to protect such rights for piracy is not deemed to be
doing business.72 The Court held: "We fail to see how exercising one's legal and
property rights and taking steps for the vigilant protection of said rights,
particularly the appointment of an attorney-in-fact, can be deemed by and of
themselves to be doing business here."73

5. The Contract Test

In 1955, in Pacific Vegetable Oil Corp. v. Singzon,74 the Supreme Court
began fashion what seemed like a second branch of judicial characterization of
what constitutes "doing business," which essentially is a contract test.
In that case, a suit was filed by a foreign corporation against the defendant
to recover damages suffered as a consequence of the failure of the defendant to
deliver copra which was ordered through a contract negotiated and perfected in
the United States, under "c.i.f. Pacific Coast" terms. The lower court dismissed
the complaint holding that plaintiff had no personality to institute the case
because at the time the case was filed the plaintiff had no license to do business
in the Philippines, and even it afterwards obtained such license, the belated act
did not have the effect of curing the defect that existed when the case was

71
267 SCRA 567, 76 SCAD 70 (1997).
72
Columbia Pictures, Inc. v. Court of Appeals, 261 SCRA 144, 73 SCAD 674 (1996).
73
Ibid.
74
Advanced Decisions Supreme Court, April 1955 Vol., p. 100-A.
instituted. On appeal, the Supreme Court held that the plaintiff was not doing
business in the Philippines under the contract, and there was no necessity for it
to obtain a license before it can maintain the suit.
In holding that the plaintiff foreign corporation was not doing business in
the Philippines by virtue of the contract covering copra to be processed and
delivered from the Philippines, the Supreme Court took cognizance of the fact
that the subject contract was entered into in the United States by the parties; that
payment of the price was to be made at San Francisco, California, through a
letter of credit to be opened at a bank thereat; and with respect to the delivery of
the copra, it was stipulated to be at "c.i.f., Pacific Coast" which meant that
delivery is to be made only at the port of destination since the seller (defendant)
obliged himself to take care of the freight until the goods have reached
destination. Thus, although it was found by the Supreme Court that the plaintiff
foreign corporation had also bought copra from other exporters in the Philippines,
it took note of the fact that those transactions were undertaken under similar
circumstances.
The Pacific Vegetable Oil doctrine does not consider the twin
characterization tests of Mentholatum of substance of the transactions pertaining
to the main business of the corporation and the continuity or intent to continue
such activities. It would seem that even if the twin characterization tests of
Mentholatum obtained in a case, under the Pacific Vegetable Oil doctrine, so
long as the perfection and consummation of a series of transactions are done
outside Philippine territorial jurisdiction, the same would not constitute doing
business in the Philippines, even if the products themselves should be
manufactured or processed in the Philippines by locals.
The implication of this doctrine is that if the salient points of a contract do
not find themselves in the Philippines, Philippine authorities have no business
subjecting the parties to local registration and licensing requirements.
The doctrine had a follow-up in Aetna Casualty & Surety Company v.
Pacific Star Line.75 In that case, a foreign insurance company, as subrogee of the
insured, instituted civil actions in the then court of first instance of Manila to
recover sums pertaining to damages on stolen cargo it insured, against local
companies which handled the goods. In their amended answers, the defendants
alleged that plaintiff is a foreign corporation not duly licensed to do business in
the Philippines and, therefore, without capacity to sue.
Upon stipulation of facts showing that plaintiff was not licensed to engage
in business in the Philippines, and that in fact it had filed thirteen (13) other civil
cases in the Philippines of similar nature, the trial court dismissed the complaint
ruling that although a foreign corporation may file a suit in the Philippines in
isolated cases, but where the plaintiff has been filing actions in the Philippines
not just in isolated instances, but in numerous cases and therefore has been
doing business in the country without obtaining a license.

75
80 SCRA 635 (1977).
 On appeal, the Supreme Court held that the foreign insurance company
was not doing business in the Philippines, and therefore was not prohibited from
maintaining a suit in Philippine courts. The Court found that the contract of
insurance was entered into in New York; that payment was made to the
consignee in its New York branch and that since the corporation "was merely
collecting a claim assigned to it by the consignee, it is not barred from filing the
instant case although it has not secured a license to transact insurance business
in the Philippines."76
Subsequently, in Universal Shipping Lines, Inc. v. Intermediate Appellate
77
Court, it was held that a foreign insurance company may sue in Philippine
courts upon the marine insurance policies issued by it abroad to cover
international-bound cargoes shipped by a Philippine carrier, even if it has no
license to do business in the Philippines, "for it is not the lack of the prescribed
license (to do business in the Philippines) but doing business without such
license, which bars a foreign corporation from access to our courts." 78 The
Supreme Court considered the activities as not doing business in the Philippines.
The Rules and Regulations implementing the Omnibus Investments Code
of 1987,79 expressly included in the definition of "doing business" the "soliciting of
orders, purchases (sales) or service contracts." In fact, it provided that "Concrete
and specific solicitations by a foreign firm or by an agent of such foreign firm, not
acting independently of the foreign firm, amounting to negotiations or fixing of the
terms and conditions of sales or service contracts, regardless of where the
contracts are actually reduced to writing, shall constitute doing business even if
the enterprise has no office or fixed place of business in the Philippines." In
addition, the Rules and Regulations expressly provided that "The arrangements
agreed upon as to manner, time and terms of delivery of the goods or the
transfer of title thereto is immaterial." Effectively therefore, the Board of
Investments, by the implementing Rules and Regulations, had attempted to
override the Pacific Vegetable doctrine.
The Implementing Rules and Regulations to the Foreign Investment Act of
1991, while retaining "soliciting orders" as doing business in the Philippines has
dropped entirely the explicit provisions seeking to override the Pacific Vegetable
doctrine. However, its retaining "soliciting orders" as constituting doing business
in the Philippines indicates a bias against the Pacific Vegetable doctrine.
In addition, the Supreme Court in Communication Materials and Design,
Inc. v. Court of Appeals,80 has held that "[i]n determining whether a corporation
does business in the Philippines, or not, aside from their activities within the
forum, reference may be made to the contractual agreements entered into by it
with other entities in the country." It referred to the case of Top-Weld

76
Ibid, at p. 644.
77
188 SCRA 170 (1990)
78
Ibid, at p. 173.
79
Executive Order 226.
80
260 SCRA 673, 73 SCAD 374 (1996).
Manufacturing, Inc. v. ECED S.A.,81 where the highly restrictive terms in the
License and Technical Agreement and the Distributor Agreement with locals
became the basis of treating the foreign corporations as doing business in the
country; and to the case of Merill Lynch Futures, Inc. v Court of Appeals,82 where
the futures contract entered into by the foreign corporation with locals weighed
heavily in the Court's ruling finding it engaging in business in the Philippines.

6. Evolving Role of Contract Test

As the contract test is evolving in Philippine jurisprudence, it seems to
provide a premise upon which the twin characterization test of Mentholatum
should be applied, requiring that the transactions or series of transactions that
should be the basis for determining whether a foreign corporation is transacting
business in the Philippines, would require that the salient features of such
contract must find their fulfillment within Philippine shores. This clearly was the
implication in the more recent case of Columbia Pictures, Inc. v. Court of
Appeals.83
In that case, the Court reviewed the general concept of doing business by
applying the twin characterization tests:

No general rule or governing principles can be laid down

as to what constitutes "doing" or "engaging in" or "transacting"
business. Each case must be judged in the light of its own
peculiar environmental circumstances. The true test, however,
seems to be whether the foreign corporation is continuing the
body or substance of the business or enterprise for which it
was organized whether it has substantially retired from it and
turned it over to another.
As a general proposition upon which many authorities
agree in principle, subject to such modifications as may be
necessary in view of the particular issue or of the terms of the
statute involved, it is recognized that a foreign corporation is
"doing," "transacting," "engaging in," or "carrying on" business
in the State when, and ordinarily only when, it has entered the
State by its agents and is there engaged in carrying on and
transacting through them some substantial part of its ordinary
or customary business, usually continuous in the sense that it
may be distinguished from merely casual, sporadic, or
occasional transitions and isolated acts.

The Court held that although Section 1(g) of the Implementing Rules and
Regulations of the Omnibus Investments Code lists among others the "soliciting
orders, purchases (sales) or service contracts, and the appointing of
representative or distributor who is domiciled in the Philippines," as constituting

81
138 SCRA 118 (1985).
82
211 SCRA 824 (1992).
83
261 SCRA 144, 73 SCAD 674 (1996).
doing business, the mere fact that foreign movie companies are copyright owners
or owners of exclusive distribution rights in the Philippines of motion pictures or
films did "not convert such ownership into an indicium of doing business which
would require them to obtain a license before they can sue upon a cause of
action in local courts, such as in this case seeking protection for the intellectual
properties."
The Court stressed that as a general rule, a foreign corporation will not be
regarded as doing business in the State simply because it enters into contracts
with residents of the State, where such contracts are consummated outside the
State. In fact, a view is taken that a foreign corporation is not doing business in
the State merely because sales of its products are made there or other business
furthering its interest is transacted there by an alleged agent, whether a
corporation or a natural person, whether such activities are not under the
direction and control of the foreign corporation but are engaged in by the alleged
agent as an independent business.
It is generally held that sales made to customers in the State by an
independent dealer who has purchased and obtained title from the corporation of
the products sold are not a doing of business by the corporation. Likewise, a
foreign corporation which sells its products to person styled "distributing agents"
in the State, for distribution by them, is not doing business in the State so as to
render it subject to service of process therein, where the contract with these
purchasers is that they shall buy exclusively from the foreign corporation such
goods as it manufactures and shall sell them at trade prices established by it."
As discussed hereunder, the contract test has also been applied as part of
the jurisprudential ruling subjecting the foreign corporation not doing business in
the Philippines to the jurisdiction of local courts on isolated contracts that have
been entered into or performed within Philippine territorial jurisdiction.84

7. Reinsurance Not Per Se Doing Business

Avon Insurance PLC v. Court of Appeals,85 held that the nature of the
reinsurance business cannot not necessarily mean that a foreign reinsurance
company can be deemed being engaged in business in the Philippines. The
Supreme Court recognized existence of authority to the effect that a reinsurance
company is not doing business in a certain state merely because the property or
lives which are insured by the original insurer company are located in that state,86
thus: “The reason for this is that a contract of reinsurance is generally a separate
and distinct arrangement for the original contract of insurance, whose contracted
risk is insured in the reinsurance agreement. Hence, the original insured has
generally no interests in the contract of reinsurance.”

84
Hyopsung Maritime Co., Ltd. v. Court of Appeals, 165 SCRA 258 (1988); Signetics
Corporation v. Court of Appeals, 225 SCRA 737, 44 SCAD 357 (1993).
85
278 SCRA 312 (1997).
86
Citing Moris Co. v. Scandinavia Ins. Co., 279 U.S. 405 (1929).
DOCTRINE ON ISOLATED TRANSACTIONS
The doctrine is that for isolated transactions, foreign corporation are not
required to obtain a license in order to obtain relief from local courts or agencies.
In one case,87 the Court held that the phrase "isolated transaction" has a
definite and fixed meaning, i.e., "a transaction or series of transactions set apart
from the common business of a foreign enterprise in the sense that there is no
intention to engage in a progressive pursuit of the purpose and object of the
business organization."
The Court held that it was never the intent of the legislature to bar court
access to a foreign corporation or entity which happens to obtain an isolated
order for business in the Philippines. "Neither, did it intend to shield debtors from
their legitimate liabilities or obligations. But it cannot allow foreign corporations or
entities which conduct regular business any access to courts without the
fulfillment by such corporation of the necessary requisites to be subjected to our
government's regulation and authority. By securing a license, the foreign entity
would be giving assurance that it will abide by the decisions of our courts, even if
adverse to it."88
In Eastboard Navigation, Ltd. v. Juan Ysmael and Co., Inc.,89 it was held
that when a foreign shipping company entered into a charter party arrangement
with a local company for a vessel to load cargo of scrap iron in the Philippines for
Buenos Aires, the transaction entered into in the Philippines was held not to
qualify it to be considered as being engaged in business, although on a previous
occasion its vessel was chartered by the National Rice and Corn Corporation to
carry rice cargo from abroad to the Philippines, since the two transactions were
not related. It was held therefore, that such foreign corporation had capacity to
sue in the Philippines even without a license.
In Antam Consolidated, Inc. v. Court of Appeals,90 the Supreme Court
sustained the lower court in not dismissing a complaint filed by a foreign
corporation on the basis of three contracts of purchase and sale of coconut oil
from local companies. The Court found that from the facts alone it could be
deduced that there was only one agreement between the petitioners and the
respondent and that was the delivery by the former of 500 long tons of crude
coconut oil to the latter, who in turn, must pay the corresponding price for the
same. The only reason why the respondent entered into the second and third
transactions with the petitioners was because it wanted to recover the loss it
sustained from the failure of the petitioners to deliver the crude coconut oil under
the first transaction and in order to give the latter a chance to make good on their
obligation. The Court discussed the policy behind the rule:

87
Ericks Pte. Ltd. v. Court of Appeals, 267 SCRA 567, 76 SCAD 70 (1997).
88
Ericks Pte. Ltd. v. Court of Appeals, 267 SCRA 567, 76 SCAD 70 (1997).
89
102 Phil. 1 (1957).
90
143 SCRA 288 (1986).
 The doctrine of lack of capacity to sue based on failure to
first acquire a local license is based on consideration of sound
public policy. It was never intended to favor domestic
corporations who enter into solitary transactions with unwary
foreign firms and then repudiate their obligations simply
because the latter are not licensed to do business in this
country.91

The auxiliary rule in Antam Consolidated is similar in principle to the

provision of Section 1(f)(8) of the Implementing Rules to the Foreign Investment
Act that does not consider as "doing business" the performance of services
auxiliary to an existing isolated contract of sale which are not on a continuing
basis.
The principle that a foreign corporation not engaged in business in the
Philippines may not be denied the right to file an action in Philippine courts for
isolated transactions has been reiterated in other cases, such as (a) one
involving the collision of two vessels at the harbor of Manila in Dampfschieffs
Rhederei Union v. La Campañia Transatlantica;92 (b) the loss of goods bound for
Hongkong but erroneously discharged in Manila in The Swedish East Asia Co.,
Ltd. v. Manila Port, Service;93 (c) infringement of trade name in General
Garments Corporation v. Director of Patents94 and Universal Rubber Products,
Inc. v. Court of Appeals;95 (d) the recovery of damages sustained by cargo
shipped to the Philippines in Bulakhidas v. Navarro;96 (e) the sale to the
government of road construction equipment and spare parts with no intent of
continuity of transaction in Gonzales v. Raquiza;97 and (f) the recovery on a
Hongkong judgment against a resident in Manila in Hang Lung Bank, Ltd. v.
Saulog.98
In Hang Lung Bank, Ltd. v. Saulog99 the Supreme Court added a particular
point in the rationale for the allowing foreign corporations not doing business in
the Philippines to sue in our courts: "Otherwise we will be hampering the growth
and development of business relations between Filipino citizens and foreign
nationals. Worse, we will be allowing the law to serve as a protective shield for
unscrupulous Filipino citizens who have business relationships abroad."100

91
Ibid, at p. 297.
92
8 Phil. 766 (1907).
93
25 SCRA 633 (1968).
94
41 SCRA 50 (1971).
95
130 SCRA 104 (1984).
96
142 SCRA 1 (1986).
97
180 SCRA 254 (1989).
98
201 SCRA 137 (1991).
99
201 SCRA 137 (1991).
100
Ibid, at p. 7145.
SPECIAL RULES PERTAINING TO ACTIONS ON
CORPORATE NAMES, TRADENAMES AND TRADEMARKS
Justice Moran rendered a dissenting opinion in Mentholatum that the
provisions of Section 69 of the Corporation Law do not apply to suits brought by
foreign corporations for infringement of trademarks and unfair competition, the
theory being that "the right to the use of the corporate name and trade name of a
foreign corporation is a property right, a right in rem, which it may assert and
protect in any of the courts of the world even in countries where it does not
personally transact any business," and that "trade mark does not acknowledge
any territorial boundaries but extends to every mark where the traders' goods
have become known and identified by the use of the mark."101
Although Western Equipment had previously held that the right to the use
of the corporate name and trade name of a foreign corporation is a property right,
a right in rem, which it may assert and protect in any of the courts of the world
even in countries where it does not personally transact any business, the same
ruling could not then apply in Mentholatum, since unlike in Western Equipment
where there was an expressed finding or stipulation that the foreign corporation
never engaged in business in the Philippines, in Mentholatum the foreign
corporation was found to have engaged in business in the Philippines without
obtaining the requisite license; therefore, by public policy expressed in Section
69 of the then Corporation Law, the Court declared In Mentholatum that it could
not sue in Philippine courts.
The remarks of Justice Moran in his dissenting opinion state only the
positive rule discussed in Western Equipment that when a foreign corporation
does not do business in the country, it needs no license to bring suit to enforce
its rights within the local courts. However, the remarks forget that the purpose of
then Section 69 of the Corporation Law was that when a foreign corporation
indeed does business in the Philippines without obtaining a license, there is a
public policy of prohibiting it from seeking any remedy from Philippine courts and
administrative bodies.
However, the matter as to trademarks and tradenames had become moot
with the adoption of Section 21-A102 of then Republic Act 166 (The Trademark
Law), which expressly provided that a foreign corporation, whether licensed to do
business or not in the Philippines, with a mark or tradename registered in the
Philippines, may bring an action before Philippine courts for infringement, unfair
competition, false designation of origin and false description, if the country of

101
at pp. 530-531.
102
Sec. 21-A states: "Any foreign corporation or juristic person to which a mark or
tradename has been registered or assigned under this Act may bring an action hereunder for
infringement, for unfair competition, or false designation of origin and false description, whether or
not it has been licensed to do business in the Philippines under Act numbered Fourteen Hundred
and Fifty-Nine, as amended, otherwise known as the Corporation Law, at the time it brings the
complaint; Provided, That the country of which the said foreign corporation or juristic person is a
citizen, or in which it is domiciled, by treaty, convention or law, grants a similar privilege to
corporate or juristic persons of the Philippines."
which the foreign corporation is a citizen, or in which it is domiciled, by treaty,
convention, or law, grants a similar privilege to corporations or juristic persons of
the Philippines.
In Leviton Industries v. Salvador103 the Supreme Court held that pursuant
to the terms of Section 21-A of Rep. Act 166, failure of a foreign corporation to
allege in its complaint two essential conditions, namely, that the trademark or
tradename has been registered with the Philippine Patent Office and that the
country of which the foreign corporation is a domiciliary grants similar privileges
to Philippine corporations, would be fatal to its cause of action and would subject
the complaint to dismissal.
Previously it was held in General Garments Corporation v. Director of
Patents,104 that when the action brought by a foreign corporation is not one under
Section 21-A, but rather under Section 17 of Rep. Act. 166 for the administrative
cancellation of the trademark which is alleged to have been infringed, then
registration of the trademark with the Philippine Patent Office would not be
necessary.
Subsequently, in La Chemise Lacoste, S.A. v. Fernandez, 105 it was held
that a foreign corporation not doing business in the Philippines, has personality to
commence criminal proceedings for violation of Article 189 of the Revised Penal
Code for unfair competition on the use of trademarks and tradenames, without
having to allege the qualifying circumstances under Section 21-A of Rep. Act
166. In that case, the Court also took judicial cognizance of the Philippine duties
and obligations under the Paris Convention for the Protection of Industrial
Property to assure the nationals of "countries of the Union" have an effective
protection against unfair competition in the same way that they are obliged to
similarly protect Filipino citizens and firms.
The current legislation is reflected in Converse Rubber Corporation v.
Universal Rubber Products, Inc.,106 which struck down the reasoning of the
Director of Patents when he concluded that a foreign corporation not licensed to
do business in the country is actually not doing business on its own in the
Philippines, and therefore has no name to protect in the forum. The Court held
that a foreign corporation has a right to maintain an action in the forum even if it
is not licensed to do business and is not actually doing business on its own
therein to protect its corporate and tradenames, since it is a property right in rem,
which it may assert to protect against all the world, in any of the courts of the
world—even in jurisdiction where it does not transact business—just the same as
it may protect its tangible property, real or personal, against trespass, or
conversion.107

103
114 SCRA 420 (1982).
104
41 SCRA 50 (1971).
105
129 SCRA 373 (1984).
106
147 SCRA 154 (1987).
107
Ibid, at pp. 164-165. This is a reiteration of the same doctrine held in Converse Rubber
Corporation v. Jacinto Rubber & Plastic Co., Inc., 97 SCRA 158 (1980) and Universal Rubber
Products, Inc. v. Court of Appeals., 130 SCRA 104 (1984). To the same effect were the rulings in
 Converse Rubber Corporation recognized that such ruling is in
consonance with the Convention of the Union of Paris for the Protection of
Industrial Property to which the Philippines became a party on 27 September
1965. Article 8 thereof provides that "A trade name shall be protected in all the
countries of the Union without the obligation of filing or registration, whether or
not it forms part of the trademark."108 The mandate of the Convention finds its
implementation in Section 37 of Rep. Act 166.
Nevertheless, the Supreme Court has also held that when a foreign
corporation seeks to obtain the extraordinary writ of preliminary injunction against
a local company alleged to be using its tradename, the fact that it is not engaged
in business in the Philippines would show that the matter should be decided on
the merits and that in the meantime no preliminary injunction should be granted
since, not being engaged in business in the Philippines, no grave or irreparable
damage can be shown to be caused in the writ of injunction is not issued.109
In 1997, the Intellectual Property Code was promulgated to consolidate all
laws relating to intellectual properties. Section 160 of the Code, which effectively
replaced Section 21-A of The Trademark Law, provides that “Any foreign national
or judicial person who meets the requirements of Section 3110 of this Act and
does not engage in business in the Philippines may bring a civil or administrative
action hereunder for opposition, cancellation, infringement, unfair competition, or
false designation of origin and false description, whether or not it is licensed to do
business in the Philippine under existing laws.”
The wordings of Section 160 do not seem to comprehend the thrust of
Section 21-A of The Trademark Law, and the new qualification that such foreign
corporation must not be engaged in business in the Philippines contradicts the
provision that dispenses with the need to obtain a license to do business in the
Philippines to qualify a foreign corporation to seek remedy under the Code. It can
therefore be reasonably anticipated that the courts will eventually interpret
Section 160 of the Code to have the same meaning and application as Section
21-A of The Trademark Law, which would qualify any foreign corporation, even
when doing business in the Philippines without appropriate license, to be able to
obtain remedies and reliefs under the Code.

Puma Sportschuhfabriken Rudolf Dassler, K.G. v. Intermediate Appellate Court, 158 SCRA 233
(1988) and Philips Export B.V. v. Court of Appeals, 206 SCRA 457 (1992).
108
Ibid, at p. 165.
109
Philip Morris, Inc. v. Court of Appeals, 224 SCRA 576, 43 SCAD 400 (1993).
110
Section 3 provides: “. . .Any person who is a national or who is domiciled or has a real
and effective industrial establishment in a country which is a party to any convention, treaty or
agreement relating to intellectual property rights or the repression of unfair competition, to which
the Philippines is also a party, or extends reciprocal rights to nationals of the Philippines by law,
shall be entitled to benefits to the extent necessary to give effect to any provision of such
convention, treaty or reciprocal law, in addition to the rights to which any owner of an intellectual
property right is otherwise entitled by this Act.”
TRANSACTIONS AND CONTRACTS WITH
AGENTS, BROKERS AND INDENTORS
In Mentholatum, it was held that the sale of the products of a foreign
corporation through a local company was equivalent to the foreign corporation
doing business in the Philippines, because the actions of the agent in the
Philippines pertain to its foreign principal, and thereby without obtaining a license
in the Philippines, both the foreign corporation and the agent have no capacity to
sue in Philippine courts.
La Chemise Lacoste, S.A. v. Fernandez,111 clarified that not every sale to
an exclusive agent in the Philippines by a foreign corporation would constitute
the latter as doing business in the Philippines. It held that the principle in
Mentholatum is applicable only when it is found that the local company or
representative is selling the foreign company's products in the latter's name or for
the latter's account. In that case, the marketing of the products of the French
company in the Philippines "is done through an exclusive distributor, Rustan
Commercial Corporation. The latter is an independent entity which buys and then
markets not only products of the petitioner but also many other products bearing
equally well-known and established trademarks and tradenames. In other words,
Rustan is not a mere agent or conduit of the petitioner."112
In addition, the Court in La Chemise Lacoste took cognizance of "the rules
and regulations promulgated by the Board of Investments pursuant to its rule-
making power under Presidential Decree 1789, otherwise known as the Omnibus
Investment Code," which define "doing business" as one which excludes "a
foreign firm which does business through middlemen acting on their own names,
such as indentors, commercial brokers or commission merchants . . . Appointing
[of] a representative or distributor who is domiciled in the Philippines [who] has
an independent status, i.e., it transacts business in its name and for its account,
and not in the name or for the account of a principal."113
In Schmid & Oberly, Inc. v. RJL Martinez Fishing Corp.114 a local fishing
company, RJL Martinez Fishing Corp. filed an action against Schmid & Oberly,
Inc. to recover the purchase prices of twelve (12) generators it had bought on the
theory that Schmid was the vendor of the generators, as such vendor, was liable
under its warranty against hidden defects. The generators were ordered by RJL
Martinez Fishing Corp. from Schmid & Oberly who arranged to have them
imported from abroad from Nagata Co. of Japan. Schmid & Oberly, Inc. by way
of defense allege that being merely indentor in the sale between Nagata Co., the
exporter and RJL Martinez, the importer, it was not liable on the contract, much
less for warranty for hidden defects.
The Court took cognizance of the fact that under the Rules and
Regulations to Implement Pres. Decree 1789 (the Omnibus Investment Code),
111
129 SCRA 373 (1984).
112
Ibid, at p. 383.
113
Ibid, at pp. 383-384.
114
166 SCRA 493 (1988).
"indentors' are defined together with "commercial brokers" and "commission
merchants": "A foreign firm which does business through the middlemen acting in
their own names, such as indentors, commercial brokers or commission
merchants, shall not be deemed doing business in the Philippines. But such
indentors, commercial brokers or commission merchants shall be the ones
deemed to be doing business in the Philippines."
The Court therefore recognized that foreign corporations who sell their
products in the Philippines through commercial brokers, commercial merchants
or indentors, are not deemed to be doing business in the Philippines, and are not
required to obtain a license to do business in the country: "Thus, the chief feature
of a commercial broker and a commercial merchant is that in effecting a sale,
they are merely intermediaries or middlemen, and act in a certain sense as the
agent of both parties to the transaction. . . It would appear that there are three
parties to an indent transaction, namely, the buyer, the indentor, and the supplier
who is usually a non-resident manufacturer residing in the country where the
goods are to be bought. . . An indentor may therefore be best described as one
who, for compensation, acts as a middlemen in bringing about a purchase and
sale of goods between a foreign supplier and a local purchaser."115
From the reasoning in Schmid & Oberly it is clear therefore that the sales
in an indent contract is between the local purchaser and the foreign seller, and
the indentor merely is an agent for both. That would mean that, had it not been
for the provisions of the Implementing Rules and Regulations to the Omnibus
Investment Code, the foreign corporation is indeed doing business in the
Philippines, and for which it needs to obtain the license.
It is with curiosity to note therefore why such a foreign corporation would
not be considered being engaged in business in the Philippines for in such a
case an important part of the contract (delivery of the subject matter) takes part
within Philippine territory under the contract theory of Pacific Vegetable.
Likewise, such transactions conform to the twin characterization enunciated in
Mentholatum.
In fact, the Supreme Court turned down the contention in Schmid & Oberly
to hold the local indentor liable for the penal provisions of the then Section 69 of
the Corporation Law:

Finally, the afore-quoted penal provision in the

Corporation Law finds no application to SCHMID and its
officers and employees relative to the transactions in the
instant case. What the law seeks to prevent, through said
provision, is the circumvention by foreign corporations of
licensing requirements through the device of employing local
representatives. An indentor, acting in his own name, is not,
however, covered by the above-quoted provision. In fact, the
provision of the Rules and Regulations implementing the
Omnibus Investment Code quoted above, which was copied

115
Ibid, at p. 502.
 from the Rules implementing Republic Act No. 5455,
recognizes the distinct role of an indentor, such that when a
foreign corporation does business through such indentor, the
foreign corporation is not deemed doing business in the
Philippines.116

In other words, had it not been for the implementing rule provision, a
foreign corporation selling its products in the Philippines would be doing business
here for indeed the contract is strictly between the foreign exporter and the local
buyer, with the indentor merely acting as agent for both. The implementing rules
has therefore afforded foreign corporations the route of "circumvention by foreign
corporations of licensing requirements through the device of employing local
[indentors]." Indeed, this is the logic of Schmid & Oberly since it expressly found
the indentor not to be liable on the warranty on hidden defects since it was not
considered the seller of the products. What is not explained in Schmid & Oberly,
though, is how the Supreme Court could accept that an administrative rule and
regulation provision can override clear statutory requirements for foreign
corporations engaging in business in the Philippines from obtaining a license. It is
a settled principle in our jurisdiction, that rules and regulations issued by
administrative agencies cannot amend the law or go beyond the limits of the law
which they seek to implement.117
Further, it is to be noted that the present applicable Implementing Rules
and Regulations of the Foreign Investment Act of 1991 have totally dropped the
provisions exempting from the definition of doing business transactions by
foreign corporations done through indentors, commercial brokers or commission
merchants. However, the rules and regulations have retained the provision
excluding from "doing business" the appointing of a representative or distributor
domiciled in the Philippines which transact business in the representative's or
distributor's own name and account.
Both the La Chemise Lacoste and the Schmid & Oberly rulings overlooked
the fact that although the sales made by middlemen, distributors or
representatives "in their own name or for their own accounts" in the Philippines
do not pertain to the foreign principals abroad, nevertheless the purchase and
importation by such middlemen, distributors or representatives of such products
from abroad undeniably constitute a body of transactions in the Philippines of
which their foreign principals are direct parties.
And yet in Wang Laboratories, Inc. v. Mendoza,118 the Supreme Court
treated differently a foreign corporation being represented in the Philippines by a
independent distributor. In that case, although the foreign corporation Wang
Laboratories, Inc. had an exclusive distributor in the Philippines, and a local firm
had entered into direct contract with the local distributor, the Supreme Court
refused allow the motion to dismiss filed by the foreign corporation on the ground
116
Ibid, at p. 505.
117
U.S. v. Barrias, 11 Phil. 327 (1908); Young v. Rafferty, 33 Phil. 276 (1916); Olsen v.
Aldenese, 43 Phil. 64 (1922) ; Santos v. Estenzo, 109 Phil. 419 (1960),
118
156 SCRA 44 (1987).
that not doing business in the Philippines, the court below had not obtained
jurisdiction over the person of the foreign corporation, by serving summons on its
local exclusive distributor. In finding that Wang Laboratories, Inc. was doing
business in the Philippines, the court took into consideration the appointment of
the local distributor as indicated of doing business, and various advertisements
showing the local company to be the representative of the foreign corporation
and that admission in the reply to the opposition to the motion to dismiss by the
foreign corporation that "it deals exclusively with [the local company] in the sale
of its products in the Philippines,"119 clearly indicating that the sales and deliveries
by foreign corporation to its distributor in the Philippines constitutes doing
business, regardless of whether the distributor sells the same products to the
public for its own account.
The subsequent case of Granger Associates v. Microwave Systems,
120
Inc., which did not expressly overrule La Chemise Lacoste and Schmid &
Oberly, offer us further insight.
In that case, Granger Associates, an American corporation with no license
to do business in the Philippines, entered into a series of agreements with the
local company, Microwave Systems, Inc., principally constituting the local
company as the licensee to manufacture and sell the licensor's products in the
Philippines, together with a loan extended to the licensee. An action was latter
on brought by Granger Associates against the local company to collect sums not
paid on the agreements. The local company invoked Section 133 of the
Corporation Code to dismiss the complaint on the ground that Granger
Associates, having done business in the Philippines without obtaining a license,
has no authority to maintain the suit. Granger Associates argued that the various
transactions with the local company "were mere facets of the basic agreement
licensing MSI to manufacture and sell Granger's products in the Philippines [and]
[a]ll subsequent agreements were merely auxiliary to the first contract and should
not be considered separate transactions coming within the concept of `doing
business in the Philippines.'"121
Although the Court found that many agreements entered into dealt on
other matters as to constitute doing business, the Court went on to hold that
"[e]ven if it be assumed for the sake of argument that the subject matter of the
first contract is of the same kind as that of the subsequent agreements, that fact
alone would not necessarily signify that all such agreements are merely auxiliary
to the first. As long as it can be shown that the parties entered into a series of
agreements, as in successive sales of the foreign company's regular products,
that company shall be deemed as doing business in the Philippines."122
The Court also found that Granger Associates saw to it that it was assured
of at least one seat in the board of directors of the local company, "without
prejudice to the right of Granger to request additional seats as its interest may
119
Ibid, at p. 51.
120
189 SCRA 631 (1990).
121
Ibid, at p. 635.
122
Ibid, at p. 637. Emphasis supplied.
require." The fact that it was directly involved in the business of the local
company was also manifested in another stipulation where Granger Associates
"acknowledged and confirmed" the transfer of a block of stocks from one
shareholder to another group of investors. Such approval was considered by the
Court as not normally given except by a stockholder enjoying substantial
participation in the management of the business of the company.123
Although the rules and regulations of the Board of Investments provide
that mere investment in a local company by a foreign corporation should not be
construed as doing business in the Philippines, however the Court in Granger
Associates found that the investment of the foreign company was quite
substantial, "enabling it to participate in the actual management and control of
MSI [and] it appointed a representative in the board of directors to protect its
interest, and this director was so influential that, at his request, the regular board
meeting was converted into an annual stockholder's meeting to take advantage
of his presence."124
Noteworthy are the statements of the Court that "At any rate, the
administrative regulation, which is intended only to supplement the law, cannot
prevail against the law itself as the court has interpreted it. It is axiomatic that the
delegate, in exercising the power to promulgate implementing regulations, cannot
contradict the law from which the regulations derive their very existence. The
courts, for their part, interpret the administrative regulations in harmony with the
law that authorized them in the first place and avoid as much as possible any
construction that would annul them as an invalid exercise of legislative power."125
On the argument that a foreign corporation must be shown to have dealt
with the public in general to be considered as transacting business in the
Philippines, the Court held that "it is the performance by a foreign corporation of
the acts for which it was created, regardless of volume of business, that
determines whether a foreign corporation needs a license or not."126
Finally, Granger Associates reiterated the rationale of the doctrine:

The purpose of the rule requiring foreign corporations to

secure a license to do business in the Philippines is to enable
us to exercise jurisdiction over them for the regulation of their
activities in this country. If a foreign corporation operates in the
Philippines without submitting to our laws, it is only just that it
no be allowed to invoke them in our courts when it should
need them later for its own protection. While foreign investors
are always welcome in this land to collaborate with use for our
mutual benefit, they must be prepared as an indispensable

123
Ibid, at p. 638.
124
Ibid, at p. 639.
125
Ibid, at pp. 639-640. Emphasis supplied.
126
Ibid, at p. 640, citing Tabios, Severino S., Fundamentals of Doing Business by a Foreign
Corporation in the Philippines, 142 SCRA 10.
 condition to respect and be bound by Philippine law in proper
cases, as in the one at bar.127

Granger Associates therefore does not consider it crucial that a foreign

corporation does not deal with, or sell directly to, the public by using a
middleman, a commercial broker, an indentor, or a distributor; rather, it considers
crucial "the performance by a foreign corporation of the acts for which it was
created, regardless of volume of business." By dealing with its products with local
brokers, indentors, or distributors, regardless of what the latter do with the
products subsequently, a foreign corporation is performing acts integral to its
purpose.
However, under the Foreign Investment Act of 1991, the policy of the
State (not by administrative fiat) has been declared on the matter when the law
itself provides that not included in the definition of "doing business" is the act of
"appointing a representative or distributor domiciled in the Philippines which
transacts business in its own name and for its own account."128
Taking the rationale of the ruling in Granger Associates, the following
exceptions to "doing business" provided for in the Implementing Rules and
Regulations to the Act are of doubtful validity and are beyond the language of the
Act itself:

(a) Maintaining stock of goods in the Philippines solely for the

purpose of having the same processed by another entity in
the Philippines; and
(b) Consignment by a foreign entity of equipment with a local
company to be used in the processing of products for export.

By way of obiter in Phil. Products Co. v. Primateria Societe Anonyme Pour

Le Commerce Exterieur: Primnaterial (Phil.), Inc.129 since the foreign corporation
therein was held liable for the judgment, it was held by the Supreme Court that
"[i]n the absence of express legislation," agents or representatives of foreign
corporations may be held personally liable for acts and contracts entered into in
behalf of such corporations only when "premised on the inability to sue the
principal or non-liability of such principal."130
Lately, Hanh v. Court of Appeals,131 held that when a foreign car company
has an agent or distributor in the Philippines, it will be considered doing business
in the country, and the trial court acquired jurisdiction over the foreign corporation
by virtue of the service of summons on the Department of Trade and Industry.
Otherwise, if the representative is not the agent of the foreign company but an
independent dealer, the foreign corporation is not considered doing business in

127
Ibid, at p. 642.
128
Sec. 3(d), Rep. Act No. 7042.
129
15 SCRA 301 (1965).
130
Ibid, at p. 306.
131
266 SCRA 537, 78 SCAD 20 (1997).
the Philippines within the meaning of the Foreign Investments Act of 1991 an the
Rules and Regulations implementing the Omnibus Investment Code of 1987, 132
and the trial court did not acquire jurisdiction over the foreign corporation.
The Court found the following allegations in the complaint to be sufficient
to show that the foreign corporation was doing business in the Philippines
through its local representative: the local representative took orders for the cars
and transmitted them to the foreign company; that the foreign company upon
receipt of the orders, fixed the downpayment and pricing charges, notified the
local representative of the scheduled production month for the orders, and
reconfirmed the orders by signing and returning to him the acceptance sheets; all
documents and invoice being in the forms of the foreign company; payment was
made by the buyer directly to the foreign company; title to the cars purchased
passed directly to the buyer and the local representative never paid for the
purchase price of the cars sold in the Philippines, and merely received
commissions.

FOREIGN CORPORATIONS AS PARTIES DEFENDANTS

Section 12, Rule 14 of the 1997 Rules of Civil Procedure133 provides for
the manner of service upon foreign corporations by allowing service of summons
to be made on “its resident agent designated in accordance with law for that
purpose, or, if there be no such agent, on the government official designated by
law to that effect, or on any of its officers or agents within the Philippines."
However, in order to obtain jurisdiction over a foreign corporation under
the section, it specifically provides that such foreign corporation must have
"transacted business in the Philippines." The phrase would only emphasize the
fact that as a matter of principle our laws take effect, and courts have jurisdiction
over, foreign corporations, in the absence of consent, on the nexus of their doing
business in the Philippines. Generally, our laws would have no binding effect on
foreign corporations who do not have "presence" in the Philippines, otherwise
any judgment rendered would be a violation of due process.
Hanh v. Court of Appeals,134 reiterated the rule that for purposes of having
summons served on a foreign corporation in accordance with Rule 14, Section
14 of the Rules of Court, it is sufficient that it be alleged in the complaint that the
foreign corporation is doing business in the Philippines. The court need not go
beyond the allegations of the complaint in order to determine whether it has
jurisdiction. A determination that the foreign corporation is doing business is only
tentative and is made only for the purpose of enabling the local court to acquire
jurisdiction over the foreign corporation through service of summons. Such
determination does not foreclose a contrary finding should evidence later show
that it is not transacting business in the country.

132
E.O. No. 226.
133
Replaced Section 14, Rule 14 of the Rules of Court.
134
266 SCRA 537, 78 SCAD 240 (1997).
 1. Nexus of "Doing Business in the Philippines"
Perkins v. Dizon,135 had clearly discussed the general principle when it
held that "when the defendant is a non-resident and refuses to appear voluntarily,
the court cannot acquire jurisdiction over his person even if the summons be
served by publication, for he is beyond the reach of judicial process. No tribunal
established in one State can extend its process beyond its territory so as to
subject to its decisions either persons or property located in another State . . .
and a personal judgment upon constructive or substituted service against a non-
resident who does not appear is wholly invalid."136
The basic premise as it applies to foreign corporation is laid down in
Times, Inc. v. Reyes,137 that "a fundamental rule of international jurisdiction [is]
that no state can by its laws, and no court which is only a creature of the state,
can by its judgments or decrees, directly bind or affect property or persons
beyond the limits of that state."138
In addition, Times, Inc. held that a foreign corporation may, by writ of
prohibition, seek relief against the wrongful assumption of jurisdiction by a trial
court which refuses to dismiss an action filed against said foreign corporation
where no proper jurisdiction has been obtained. "And a foreign corporation
seeking a writ of prohibition against further maintenance of a suit, on the ground
of want of jurisdiction, is not bound by the ruling of the court in which the suit was
brought, on a motion to quash service of summons, that it has jurisdiction."139
In Pacific Micronisian Line, Inc. v. Del Rosario,140 the then Workmen's
Compensation Commission sought to obtain jurisdiction over the foreign
corporation, Pacific Micronisian Line, by service of summons to its agent in the
Philippines. The foreign corporation filed a special appearance with the
Commission for the sole purpose of asking the dismissal of the claim on the
ground that the Commission had no jurisdiction over it because it is a foreign
corporation not domiciled in this country, it is not licensed to engage and is not
engaging in business therein, has no office in the Philippines, and is not
represented by any agent authorized to receive summons or any other judicial
process in its name and behalf.
In construing the proper service of summons for a foreign corporation
under the old Section 14, Rule 14 of the Rules of Court, the Court held that "in
order that services may be effected in the manner above stated, said section also
requires that the foreign corporation be one which is doing business in the
Philippines. This is a sine qua non requirement. This fact must first be
established in order that summons can be made and jurisdiction acquired. This is
not only clear in the rule but is reflected in a recent decision of this Court. We

135
69 Phil. 186 (1939).
136
Ibid, at p. 189.
137
39 SCRA 303 (1971).
138
Ibid, at p. 313, citing Perkins v. Dizon, 69 Phil. 186 (1939); 14 Am Jur. 418.
139
Ibid, at p. 315.
140
96 Phil. 23 (1954).
there said that `as long as a foreign private corporation does or engages in
business in this jurisdiction, it should and will be amenable to process and the
jurisdiction of local courts.'"141
Pacific Micronisian therefore recognized the doctrine that the law of a
state cannot become operative upon a foreign corporation until it comes within
the state to "do business."142
In that case, the Court did not consider as doing business the act of the
foreign corporation which is exclusively engaged in the business of carrying
goods and passengers by sea between Guam and the Trust Territories of the
Pacific Islands, in having a local agent in the Philippines secure the services of
an individual to act as cook and chief steward in one of the vessels. It was noted
that the foreign corporation had never sent its ships to the Philippines, nor has it
transported nor even solicited the transportation of passengers and cargoes to
and from the Philippines, nor does it have properties or office in the Philippines.
Since the act was considered an isolated one, incidental, or casual, and "not of a
character to indicate a purpose to engage in business" within the meaning of the
rule, then it follows that the agent in the Philippines who recruited the individual
cannot be authorized to receive service of summons.

a. Valid Service of Summons Premised

Upon “Doing Business”
General Corporation. of the Philippines v. Union Insurance Society. of
Canton, Ltd.,143 clearly stated that the provisions of Section 14, Rule 14 of the old
Rules of Court providing for the methods of service of summons employing the
phrase "doing business in the Philippines" makes no distinction as to whether
said business was being done or engaged in legally with the corresponding
authority and license of the Government, or perhaps, illegally, without the benefit
of any such authority or license. "As long as a foreign private corporation does or
engages in business in this jurisdiction, it should and will be amenable to process
and the jurisdiction of the local courts, this for the protection of the citizens, and
service upon any agent of said foreign corporation constitutes personal service
upon the corporation and accordingly judgment may be rendered against said
foreign corporation."144
General Corporation of the Philippines held that where a foreign insurance
corporation engages in regular marine insurance business here by issuing
marine insurance policies abroad to cover foreign shipments to the Philippines,
said policies being made payable in the Philippines, and said insurance company
appoints and keeps an agent in the Philippines to receive and settle claims
flowing from said policies, then said foreign corporation will be regarded as doing
business in the Philippines.
141
Ibid, at pp. 27-28, quoting also General Corporation of the Philippines v. Union Insurance
Society of Canton, Ltd.,49 Off. Gaz., 73, September 14, 1950.
142
Ibid, at p. 28, quoting THOMPSON ON CORPORATIONS, Vol. 8, 3rd Ed., pp. 843-844.
143
87 Phil. 313 (1950).
144
Ibid, at p. 318, citing FISHER, PHILIPPINE LAW OF STOCK CORPORATION, pp. 451, 456.
 Subsequently, in Salonga v. Warner Barnes & Co., Ltd.145 the Supreme
Court, without even discussing the issue of whether a foreign insurance was
engaged in business in the Philippines or not, held that under Section 14, Rule
14 of the Rules of Court, "if the defendant is a foreign corporation and it has not
designated an agent in the Philippines on whom service may be made in case of
litigation, such service may be made on any agent it may have in the Philippines .
. . [including] a settling agent who may serve the purpose."146

b. Service of Summons on Counsel

In Johnlo Trading Co. v. Flores,147 and Johnlo Trading Co. v. Zulueta,148
the Supreme Court held that when a foreign corporation does business in the
Philippines, and has entered into certain contracts through its counsel and
benefitted from such contracts, a suit in local courts against such foreign
corporation would justify the service of summons upon such counsel even when
said counsel has not been expressly authorized by the foreign corporation to
receive summons because "courts will not sanction a doctrine that a corporation
can deny the power of an agent when an advantage is to be obtained by such
denial, and share in the fruits of the contract when it is to its interest to consider
such contract binding."149 In those cases, it was found that the counsel had acted
in a representative capacity in and outside of court, "so much so that he
undertook to settle claims that had been filed against it."150
However, it should be noted that in Johnlo Trading Co. other than the
counsel, there was no other representative or officer of the foreign corporation in
the Philippines upon which summons could be served upon the foreign
corporation, thus:

Granting, however, for the sake of argument that Balcoff

merely acted as counsel for the petitioner, still we are of the
opinion that, upon the strength of the authorities we have
quoted above, the service made upon him of the summons
intended for the petitioner can be deemed sufficient in
contemplation of law, or within the meaning of Section 14,
Rule 7, of our Rules of Court, to bind his client Johnlo Trading
Company, upon the theory that, as the only person in the
Philippines charged with the duty of settling claims against it,
he must be presumed . . . to communicate to his client the
service made upon him of any process that may result in a
judgment and execution that may deprive it of its property, and
the probabilities are, under such circumstances, that the
corporation will be duly informed of the pendency of the suit.
And this is a very realistic interpretation of the law, for it goes

145
88 Phil. 125 (1951).
146
Ibid, at p. 134.
147
88 Phil. 741 (1951).
148
88 Phil. 750 (1951).
149
Ibid, at p. 753.
150
Ibid, at p. 746.
 on the assumption that men holding such relationship "will be
prompt to protect their own interest, and diligent in the
discharged (sic) of their duties to those who have reposed
confidence in them."151

In the absence of such special circumstance in Johnlo Trading Co. then

the general rule would apply that counsel has no authority merely by virtue of his
general employment as such, to waive or admit service for his client of original
process by which the court for the first time acquires jurisdiction of the client and
that service upon an attorney representing a foreign corporation in the collection
of other claims for which his service had not been engaged is invalid.152

c. Designating Local Agents Conclusive

on Service of Summons
In Poizat v. Morgan,153 the Supreme Court ruled that where a foreign
corporation has designated a person to receive service of summons in judicial
proceedings affecting the corporation, that designation is exclusive and service of
summons is without force and effect unless made on him.154

d. Allegations on “Dong Business” Merely Preliminary

Signetics Corporation v. Court of Appeals,155 clarified that the ruling of
Pacific Micronisian that doing business "must first be established in order that
summons can be made and jurisdiction acquired," does not require that evidence
must first be adduced to prove doing business before summons can be served
upon the foreign corporation. The Court held that the "fact of doing business
must the, in the first place, be established by appropriate allegations in the
complaint." Litton Mills, Inc. v. Court of Appeals,156 held that the trial court need
not go beyond the allegations in the complaint to determine whether or not a
defendant foreign corporation is doing business for the purpose of Section 14,
Rule 14 of the old Rules of Court.
Hyopsung Maritime Co., Ltd. v. Court of Appeals,157 reiterated that the sine
qua non requirement for service of summons and other legal processes or any
such agent or representative is that the foreign corporation is doing business in
the Philippines. It also ruled that the voluntary appearance as a mode of service
of summons which confers jurisdiction over the person of a foreign corporation
must be one that has been authorized by the foreign corporation.

151
Ibid, at p. 746.
152
Ibid, at pp. 743-744, quoting 5 AM. JUR. p. 313, and citing Taylor v. Granite State
Provident Association, 136 N.Y. 343, 32 N.E. 9922, 32 American St. Rep. 749 and Moore v.
Freeman's National Bank, 92 N.C. 590).
153
28 Phil. 597 (1914).
154
The doctrine was reiterated in H.B. Zachry Company International v. Court of Appeals,
232 SCRA 329, 51 SCAD 207 (1994).
155
225 SCRA 737, 44 SCAD 357 (1993).
156
256 SCRA 696, 75 SCAD 160 (1996).
157
165 SCRA 258 (1988).
 Lately, French Oil Mills Machinery Co., Inc. v. Court of Appeals,158 seems
to have declared the matter settled, thus:
When it is shown that a foreign corporation is doing
business in the Philippines, summons may be served on (a) its
resident agent designated in accordance with law; (b) if there
is no resident agent, the government official designated by law
to that effect; or (c) any of its officers or agent within the
Philippines. The mere allegation in the complaint that a local
company is the agent of the foreign corporation is not sufficient
to allow proper service to such alleged agent. Although there
is no requirement to first substantiate the allegation of agency,
yet it is necessary that there must be specific allegations in the
complaint that establishes the connection between the
principal foreign corporation and its alleged agent with respect
to the transaction in question. Nowhere in the case of
Signetics Corporation v. Court of Appeals, did the Court state
that if the “complaint alleges that defendant has an agent in
the Philippines, summons can validly be served thereto even
without prior evidence of the truth of such factual allegation; it
is only in the headnote of the reporter which is not part of the
decision.

2. Consent to Jurisdiction of Local Courts

Although doing business is the nexus by which local courts are granted
the right to obtain jurisdiction over the "person" of foreign corporation, consent
may also authorize local courts and administrative agencies to exercise
jurisdiction over foreign corporations even when they are not doing business in
the Philippines.
In Far East International Import and Export Corp. v. Nankai Kogyo Co.,
Ltd.159 a suit was filed against a Japanese corporation in Philippine courts for
specific performance, damages and issuance of a writ of injunction. The
Japanese company, by special appearance, filed a motion to dismiss the
complaint and dissolve the preliminary injunction on the ground that the court had
no jurisdiction over said foreign corporation and over the subject matter and
failure to state a cause of action. When the motion to dismiss was overruled on
the ground that it did not appear indubitable, an answer was filed and invoked
defenses and grounds for dismissal of the complaint other than lack of
jurisdiction. In deciding that proper jurisdiction was obtained over the defendant
foreign corporation, the Supreme Court held that when the defendant foreign
corporation filed an answer which invoked grounds other than lack of jurisdiction,
the act vested upon the trial court jurisdiction to take cognizance of the case.
The rule in Far East International therefore is that when a defendant
foreign corporation objects to the jurisdiction of the court, but at the same time it
alleges any non-jurisdictional grounds for dismissing the action, the court then
158
295 SCRA 462, 98 SCAD 407 (1998).
159
6 SCRA 725 (1962).
acquires jurisdiction over the person of the defendant. What was worse in Far
East International is that the defendant foreign corporation presented evidence
on the merits of the case.
This affirmed the ruling in General Corporation of the Philippines v. Union
Insurance Society of Canton, Ltd.,160 that the participation of counsel for a foreign
corporation in the trial process, including the cross-examination of witnesses,
agreement and objection to documentary evidence, and the introduction of
witnesses and documentary evidence would prevent the plea of lack of
jurisdiction over the person of such foreign corporation.161
In addition, Far East International discussed that the consequence of
doing business in the Philippines would render a foreign corporation subject to
jurisdiction of Philippine courts. It adopted the rule that a single act may bring the
corporation within the purview of the statute where it is an act of the ordinary
business of the corporation. In such a case, the single act or transaction is not
merely incidental or casual, but is of such character as distinctly to indicate a
purpose on the part of the foreign corporation to do other business in the state,
and to make the state a basis of operations for the conduct of a part of the
corporation's ordinary business.162 The test therefore embodies the second tier
of the Mentholatum tests that an act within the main purpose of the corporation
which shows an intent to continue the business in the Philippines, would
constitute doing business.
In Far East International it was shown that the defendant foreign
corporation had sent an officer in the Philippines to look into the operation of
mines, thereby revealing the desire to continue engaging in business in the
Philippine, after receiving the shipment of the scrap iron under consideration,
making the Philippines a base of operations.
In Avon Insurance PLC v. Court of Appeals,163 it was reiterated that the
appearance of a foreign corporation to a suit is precisely to question the
jurisdiction of the said tribunal over the person of the defendant, then such
appearance is not equivalent to service of summons, nor does it constitute an
acquiescence to the court‟s jurisdiction.

3. The Facilities Management Strain

Based on the foregoing discussions, it is with serious reservation that we
view the obiter in Facilities Management Corporation v. De la Osa,164 where
Justice Makasiar had stated with logical simplicity that "Indeed, if a foreign
corporation, not engaged in business in the Philippines, is not barred from
seeking redress from courts in the Philippines a fortiori, that same corporation

160
87 Phil. 313 (1950).
161
Ibid, at p. 321.
162
Ibid, at p. 734, citing 17 FLETCHER CYC. OF CORPORATIONS, sec. 8470, pp. 572-573.
163
278 SCRA 312, 327 (1997).
164
89 SCRA 131 (1979).
cannot claim exemption from being sued in Philippine courts for acts done
against a person or persons in the Philippines."165
The logic is flawed because although the first part of the obiter is correct,
the second part did not necessarily flow as a logical consequent of the first part.
Although a foreign corporation not doing business in the Philippines is beyond
the jurisdiction of our courts, nevertheless by filing a complaint in our courts, it
voluntarily surrenders jurisdiction over its "person" to the courts. But the reverse
does not necessarily follow. Since a foreign corporation is not doing business in
the Philippines, short of voluntary surrender to local jurisdiction, there can be no
legal basis by which our local processes may be served upon such corporation to
allow local courts to have jurisdiction over its "person" as a party defendant in a
case. In addition, the minimum requirement of "presence" as a notion of due
process is not present in such a situation.
After all, it was already held previously by the Supreme Court in Philippine
Columbian Enterprises Co. v. Lantin,166 that "actions by foreign corporations are
governed by rules different from those in actions against them."167 In that case,
when the trial court refused to rule on a motion to dismiss a complaint filed by a
Japanese corporation on the ground that the ground relief upon (that the plaintiff
was doing business in the Philippines without a license) did not appear
indubitable, the defendants refused such deferment and to file an answer since
the filing of a counterclaim would be recognizing the legal capacity of the plaintiff
corporation which they are precisely questioning.
In setting aside such argument, the Court held that "A counterclaim
partakes of the nature of a complaint and/or cause of action against the plaintiff,
so that if the petitioners-defendants should file a counterclaim, the private
respondent-plaintiff . . . would be a defendant thereto, in which case the said
foreign corporation would not be maintaining a suit and, consequently, Section
69 of the Corporation Law would not apply." Clearly, therefore, the restrictive
effects of Section 69 (now section 133) on failure to obtain the necessary license
to do business have no application at all when a foreign corporation is sued as a
defendant in Philippine courts.
Fortunately, the pronouncements of Justice Makasiar in Facilities
Management were merely obiter since the facts showed that the foreign
corporation in that case was engaged in business in the Philippines without
obtaining a license by the appointment of a liaison officer in the Philippines to
recruit personnel. The Court took cognizance of the rules and regulations of the
Board of Investments implementing Rep. Act No. 5455 enumerating the
appointment of liaison officers in the Philippines as indicative of doing business in
the country.

165
Ibid, at p. 139.
166
39 SCRA 376 (1971).
167
Ibid, at p. 385.
 Unfortunately, FBA Aircraft, S.A. v. Zosa,168 subsequently affirmed the
obiter in Facilities Management as its ratio decidendi in resolving the issue
raised. In that case, a complaint with prayer for issuance of a writ preliminary
attachment was filed against FBA Aircraft, Inc., a foreign corporation not
engaged in business in the Philippines. A writ of attachment was issued and
enforced against three aircrafts and engines in the Philippines. The complaint
was subsequently dismissed "for lack of jurisdiction over the persons of the
defendant and the writ of attachment dissolved." On the issue of whether a
foreign corporation can be sued in the Philippines on the basis of an isolated
transaction, the Supreme Court held on appeal, quoting from Facilities
Management, that "if a foreign corporation, not engaged in business in the
Philippines, is not barred from seeking redress from courts in the Philippines, a
fortiori, that same corporation cannot claim exemption from being sued in
Philippine courts for acts done against a person or persons in the Philippines." In
addition, the Court held that since the foreign corporation's properties have been
attached within the Philippines, extraterritorial service of summons clearly may
be effected under Rule 14, Section 17 of the Rules of Court.
The logical juxtaposition in Facilities Management cannot be the basis for
allowing suit against a foreign corporation not doing business in the Philippines,
for that would be a denial of due process. However, FBA Aircraft was correct in
its resolution since indeed a writ of attachment has been obtained in the
Philippines on properties of the foreign corporation, converting the action to one
in rem.
Later, in the case of Wang Laboratories, Inc. v. Mendoza,169 the Supreme
Court, relying upon the Facilities Management pronouncement, held in sweeping
terms that "the issue on the suability of foreign corporation whether or not doing
business in the Philippine has already been laid to rest. The Court has
categorically stated that although a foreign corporation is not doing business in
the Philippines, it may be sued for acts done against persons in the
Philippines."170 However, since the Court found in Wang Laboratories that the
defendant foreign corporation was indeed engaged in business in the Philippines
by having appointed an agent and installed its computer products in various
establishments in the Philippines, the pronouncement should be taken as obiter.
Recently in Royal Crown Internationale v. NLRC,171 the Court used the
Facilities Management obiter as though it were gospel truth. In that case, a
foreign corporation, through a local placement company, Royal Crown
Internationale, hired the services on a Filipino architectural draftsman for work in
Saudi Arabia. When the Filipino was terminated abroad, he brought a suit in the
Philippines against both the foreign corporation and the placement agency for
illegal termination. Service of summons upon the foreign corporation was served

168
110 SCRA 1 (1981).
169
156 SCRA 44 (1987).
170
Ibid, at pp. 52-53. Emphasis supplied.
171
178 SCRA 569 (1989).
by extra-territorial service under Section 17, Rule 14 of the Rules of Court. 172
From a judgment holding both the foreign corporation and the local placement
agency jointly and severally liable to the Filipino, a petition for certiorari was with
Supreme Court for nullification of such judgment on the ground, among others,
that it cannot be held liable solidarily with the foreign corporation since the NLRC
had not acquired jurisdiction over the latter through an extra-territorial service of
summons.
The Court held that "It is well-settled that service upon any agent of a
foreign corporation, whether or not engaged in business in the Philippines,
constitutes personal service upon that corporation, and accordingly, judgment
may be rendered against said foreign corporation,"173 citing Facilities
Management.
Therefore we have a situation where the doctrine that a foreign
corporation not doing business in the Philippines can be sued in Philippine courts
for an isolated contract entered into in the Philippines is found in three cases
(Facilities Management, FBA Aircraft and Wang Laboratories) where indeed the
doctrine was not at all essential for the Supreme Court to resolve the jurisdiction
over the foreign corporation since it was either truly engaged in business in the
Philippines or the action is an action in rem; and in one case (Royal Crown
Internationale) where the affected foreign corporation was not the one raising the
issue (for indeed it was not "present") but a co-defendant local company.
Lacking the nexus of "doing business" in the Philippines, and in the
absence of consent, a foreign corporation cannot be made a defendant in
Philippine courts in an action personam and judgment rendered against such
foreign corporation would be void.

a. Applying the Control Test

Hyopsung Maritime Co., Ltd. v. Court of Appeals,174 sought to qualify the
Facilities Management rule. In that case which involved the suit filed in local
courts against a foreign corporation, the Court mandated the principle that
service of summons under Section 14, Rule 14 of the old Rules of Court
"requires that the foreign corporation be one which is doing business in the
Philippines. This is sine qua non requirement. This fact must first be established
in order that summons can be made and jurisdiction acquired."175
The Court then provided that when the contract sued upon has entirely
been executed outside of Philippine jurisdiction, the rule in Facilities
Management is inapplicable, thus:

The present case must be distinguished from Facilities

Management Corp. vs. de la Osa which involved the non-
172
Now Sec. 15, Rule 14 o the 1997 Rules of Civil Procedure.
173
Ibid, at p. 577.
174
165 SCRA 258 (1988).
175
Ibid, at p. 263 quoting from Pacific Micronesian Line, Inc. v. del Rosario, 96 Phil. 23
(1954).
 payment by Facilities Management Corp (FMC in short), a
non-resident foreign corporation, of overtime compensation, as
well as swing shift and graveyard shift premiums to Leonardo
de la Osa, a Filipino, successively employed as painter,
houseboy, and cashier. Notably, de la Osa was hired in Manila
by the Filipino agent of FMC and the contract of employment
between him and FMC was originally executed and
subsequently renewed in Manila. . . On the other hand, the
present suit is for the recovery of damages based on a breach
of contract which appears to have been entirely entered into,
executed, and consummated in Korea. . . Simply put, the
petitioner is beyond the reach of our courts.176

Hyopsung Maritime would therefore include the "contract test" of Pacific

Vegetables as a requisite element for the application of the Facilities
Management rule, i.e., that for a foreign corporation not doing business in the
Philippines can be sued in local courts provided it is based on a contract or
transaction which would wholly or partially executed or fulfilled within Philippine
territory.
In 1990 in Marubeni Nederland B.V. v. Tensuan177 the Supreme Court took
a different approach. In that case, a suit was filed by a local against a Japanese
corporation, on the basis of the limited and special appearance filed by counsel
of the foreign corporation seeking dismissal of the complaint on the ground that
the court a quo had no jurisdiction over the person of the petitioner "since it is a
foreign corporation neither doing nor licensed to do business in the Philippines."
The Court then clearly laid the "pivotal" issue to be "whether or not petitioner
Marubeni Nederland B.V. can be considered as `doing business' in the
Philippines and therefore subject to the jurisdiction of our courts," implying the
minimum nexus to be "doing business" to allow our courts to have jurisdiction
over the person of the defendant foreign corporation.
In any event, the Court, relying on the provisions of rules and regulations
implementing Rep. Act 5455 which considered as "doing business" soliciting of
orders, purchases (sales) or service contracts in the Philippines, held Marubeni
Nederland B.V. to be doing business in the Philippines, and with or without a
license, was subject to the jurisdiction of local courts:

Even assuming for the sake of argument that Marubeni

Nederlands B.V. is a different and separate business entity
from Marubeni Japan and its Manila branch, in this particular
transaction, at least, Marubeni Nederland B.V. through the
foregoing acts, had effectively solicited “orders, purchases
(sales) or service contracts” as well as constituted Marubeni
Corporation, Tokyo, Japan and its Manila Branch as its
representative in the Philippines to transact business for its

176
Ibid, at pp. 263-264. Emphasis supplied.
177
190 SCRA 105 (1990).
 account as principal. These circumstances, taken singly or in
combination, constitute “doing business in the Philippines”
within the contemplation of the law.178

It is ironical that in 1990 in Marubeni Nederland B.V. the Supreme Court

was still struggling with the issue of whether the defendant foreign corporation
was "doing business in the Philippines" to warrant jurisdiction of the trial court
over the "person" of the defendant, when there existed already the Facilities
Management doctrine which allows court jurisdiction over foreign corporation
even not engaged in business in the Philippines on an isolated transaction done
in the Philippines.
The logic of Facilities Management doctrine is that although an isolated
transaction of a foreign corporation within Philippine jurisdiction does not amount
to doing business as to require it to obtain a license and to sue on such isolated
transaction, nevertheless, the entering by the foreign corporation of such isolated
transaction within the Philippines is taken as a consent to be subject to the
jurisdiction of Philippine courts. Therefore Facilities Management has reduced
the "nexus" by which Philippine agencies and courts are deemed to have
authority over foreign corporation from "doing business" to "engaging in an
isolated transaction" in the Philippines.

b. The Signetics Clarification

The argument has reached full circle recently in Signetics Corporation v.
Court of Appeals.179 In that case, an American corporation, Signetic Corporation,
through a wholly-owned subsidiary, entered into a lease contract over a piece of
land with a local company. In a case subsequently filed by a the local company
against the American corporation for damages arising from the lease contract
(there was a piercing of the veil of corporate fiction treating the local subsidiary
and the parent American company as one), Signetics filed, by way of special
appearance, a motion to dismiss the complaint on the ground of lack of
jurisdiction over its person. It invoked Section 14, Rule 14 of the Rules of Court
and the rule laid down in Pacific Micronisian Line, Inc. v. Del Rosario180 to the
effect that the fact of doing business in the Philippines should first be established
in order that summons could be validly made and jurisdiction acquired by the
court over a foreign corporation.
In affirming the denial of the motion to dismiss, the Supreme Court held
that the doctrine in Pacific Micronisian Line should be interpreted to mean the
fact of doing business must be established by appropriate allegations in the
complaint, and thereafter extraterritorial service of summons may be done
pursuant to the provisions of Section 17, Rule 14, of the Rules of Court.
In addition, the Court held that even if Signetics were not doing business
in the Philippines, under the Facilities Management doctrine "a foreign

178
Ibid, at p. 110.
179
225 SCRA 737, 44 SCAD 357 (1993).
180
96 Phil. 23 (1954).
corporation, although not engaged in business in the Philippines, may still look
up to our courts for relief; reciprocally, such corporation may likewise be `sued in
Philippine courts for acts done against a person or person in the Philippines."
The Court went on to say that Signetics right to question the jurisdiction of
the court over its person is now to be deemed a foreclosed matter since -

. . . If it is true, as Signetics claims, that its only

involvement in the Philippines was through a passive
investment in Sigfil, which it even later disposed of, and that
TEAM Pacific is not its agent, then it cannot really be said to
be doing business in the Philippines. It is a defense, however,
that requires the contravention of the allegations of the
complaint, as well as full ventilation, in effect, of the main
merits of the case, which should not thus be within the
province of a mere motion to dismiss. . .181

This was a curious proposition on the part of the Court, since by adopting
the Facilities Management doctrine, whether or not a foreign corporation is
engaged in business in the Philippines has now become legally irrelevant, and
the fact of not doing business in the Philippines is not a proper defense for a suit
brought in Philippine courts against a foreign corporation. The point that matters
with the full adoption of the Facilities Management doctrine is whether the
requirements of due process and fair play could be complied with against a
foreign corporation not doing business in the Philippines, i.e., whether the proper
process of obtaining jurisdiction over its "person" have been complied with.
This point at least was recognized in Signetics Corporation when the
Court went to stress that -

. . . provided that, in the latter case, it would not be

impossible for court processes to reach the foreign
corporation, a matter that can later be consequential in the
proper execution of judgment. Verily, a State may not exercise
jurisdiction in the absence of some good basis (and not
offensive to traditional notions of fair play and substantial
justice) for effectively exercising it, whether the proceedings
are in rem, quasi in rem or in personam.182

c. Latest Word on the Matter

Lately, in Avon Insurance PLC v. Court of Appeals,183 the Supreme Court
seems to have discounted the absolute suability rule of Facilities Management,
thus:

181
Ibid, at p. 746.
182
Ibid.
183
278 SCRA 312, 324, 86 SCAD 401, 412 (1997).
 In the alternative, private respondents submits that
foreign corporation not doing business in the Philippines are
not exempt from suits leveled against them in courts, citing the
case of Facilities Management Corporation vs. Leonardo Dela
Osa, et al.,. . . We are not persuaded by the position taken by
the private respondent. In Facilities Management case, the
principal issue presented was whether the petitioner had been
doing business in the Philippines, so that service of summons
upon its agent as under Section 14, Rule 14 of the Rules of
Court can be made in order that the Court of First Instance
could assume jurisdiction over it. The Court ruled that the
petitioner was doing business in the Philippines, and that by
serving summons upon its resident agent, the trial court had
effectively acquired jurisdiction. In that case, the court made
no prescription as the absolute suability of foreign corporations
not doing business in the country, but merely discounts the
absolute exemption of such foreign corporations from liabilities
particularly arising from acts done against a person or persons
in the Philippines.

4. Contractual Stipulation on Venue

When a contract between a local and a foreign corporation stipulates
venue to be within the proper courts in the Philippines, the Supreme Court has
recognized the same to be a consent to being sued in the Philippines even when
the foreign corporation does no business in the Philippines.
In Lingner & Fisher GMBH v. Intermediate Appellate Court,184 a stipulation
was provided for in the licensing agreement entered into between a foreign
corporation and a local company that read: "All legal settlements within the
compass of this AGREEMENT shall fall under the jurisdiction of Philippine
courts."185 In a suit brought against the foreign corporation, where summons was
served upon its local counsel, the Supreme Court held that no evidence as to
whether the foreign corporation was doing business in the Philippines was
necessary to be adduced to make it amenable to the jurisdiction of the trial court
since whether or not the foreign corporation is doing business in the Philippines
"will not matter because the parties had expressly stipulated in the AGREEMENT
that all controversies based on the AGREEMENT `shall fall under the jurisdiction
of Philippine courts.' In other words, there was a covenant on venue to the effect
that [the foreign corporation] can be sued by [the local company] before
Philippine Courts in regards to a controversy related to the AGREEMENT."186
Nevertheless, the Supreme Court found service of summons upon the
foreign corporation's counsel as improper, but directed that since there is no
evidence to show that the foreign corporation was engaged in business for the
case to come under Section 14, Rule 14 of the Rules of Court where doing
184
125 SCRA 522 (1983).
185
Ibid, at p. 524.
186
Ibid, at p. 527.
business "is a sine qua non requirement,"187 then service of summons can be
effected by extraterritorial service under Section 17, Rule 14, in relation to Rule 4
of the Rules of Court, "which recognizes the principle that venue can be agreed
upon by the parties."188
Lingner & Fisher GMBH therefore laid down the rule that "if a local plaintiff
and a foreign corporation have agreed on Philippine venue, summons by
publication can be made on the foreign corporation under the principle of liberal
construction of the rules to promote just determination of actions."189

PROCEDURAL RULE ON PLEADING "DOING BUSINESS"

Early on, in Spreckels v. Ward,190 which actually involved the application of
then Section 69 of the Corporation Law to a partnership considered as an
"unregistered foreign corporation," the Supreme Court held that the provisions of
Section 69 denying to unregistered foreign corporations the right to maintain suits
for the recovery of any debt, claim or demand, "do not impose on all plaintiff-
litigants the burden of establishing by affirmative proof that they are not
unregistered foreign corporations. The fact will not be presumed by the courts
without some evidence tending to establish its existence." 191 In other words, the
disqualification under Section 69 of the then Corporation Law was considered a
matter of defense with burden of proof on the part of the party raising it.
Marshall-Wells laid down the procedural doctrine that the noncompliance
of a foreign corporation doing business in the Philippines of the requirement for it
to obtain a license, may be pleaded as an affirmative defense; and the burden of
proof is on the party relying on such defense to show that the plaintiff is a foreign
corporation, that it is doing business in the Philippines, and that it has not
obtained the license as required by law.192
The then rule that lack of authority of a foreign corporation to sue in
Philippines courts for failure to obtain the license is a matter of affirmative
defense and should be established by evidence was subsequently reiterated in In
re Liquidation of the Mercantile Bank of China; The Fletcher American National
Bank of Indianapolis v. Ang Cheng Lian.193
The rule was reversed in Atlantic Mutual Ins. Co. v. Cebu Stevedoring Co.,
194
Inc., which now provides for the prevailing rule.
In that case, two foreign insurance corporations sued Cebu Stevedoring
Co., Inc. for recovery of sum of money by way of subrogation over the insurance

187
Ibid.
188
Ibid, at p. 528.
189
Ibid.
190
12 Phil. 414 (1909).
191
Ibid, at p. 419.
192
46 Phil. 70, 76 (1924).
193
65 Phil. 385 (1938).
194
17 SCRA 1037 (1966).
claims on a local insured company for losses sustained on cargoes handled by
the defendant. The trial court, on motion, dismissed the complaint for failing to
state that the plaintiffs were duly licensed foreign corporation to transact
business in the Philippines. On appeal, the plaintiffs contended that the
requirement for allegation of licensed being obtained is required only if the
plaintiff foreign corporation is engaged in business in the Philippines; but that if a
foreign corporation is not doing business in the Philippines, it is not barred from
seeking redress in Philippine courts in proper cases, as when it sues on an
isolated transaction.
However, although the Supreme Court sustained the principle upon which
the plaintiffs appealed the dismissal, it nevertheless upheld the dismissal since
the complaint filed with the lower court only alleged that the plaintiffs are foreign
corporation, without further indicating that they are exempt from the requisite of a
license because they are not engaged in business in the Philippines:

But merely to say that a foreign corporation not doing

business in the Philippines does not need a license in order to
sue in our court does not completely resolve the issue in the
present case. The proposition, as stated, refers to the right to
sue; the question here refers to pleading and procedure. It
should be noted that insofar as the allegations in the complaint
have a bearing on appellants' capacity to sue, all that is
averred is that they are both foreign corporations existing
under the laws of the United States. This averment conjures
two alternative possibilities: either they are engaged in
business in the Philippines or they are not so engaged. In the
first, they must have been duly licensed in order to maintain
this suit; if the second, if the transaction sued upon is singular
and isolated, no such license is required. In either case, the
qualifying circumstances is an essential part of the element of
plaintiffs' capacity to sue and must be affirmatively pleaded.195

Atlantic Mutual went on to say that where the law denies to a foreign
corporation the right to maintain suit unless it has previously complied with a
certain requirement, then such compliance, or the fact that the suing corporation
is exempt therefrom, becomes a necessary averment of the complaint. "These
are matters peculiarly within the knowledge of appellants alone, and it would be
unfair to impose upon appellee the burden of asserting and proving the contrary.
It is enough that foreign corporations are allowed by law to seek redress in our
courts under certain conditions: the interpretation of the law should not go so far
as to include, in effect, an inference that those conditions have been met from
the mere fact that the party suing is a foreign corporation."196
Commissioner of Customs v. K.M.K. Gani,197 held that "[t]he fact that a
foreign corporation is not doing business in the Philippines must be disclosed if it
195
Ibid, at p. 1040.
196
Ibid, at p. 1041.
197
182 SCRA 591 (1990).
desires to sue in Philippine courts under the `isolated transactions rule.' Without
this disclosure, the court may choose to deny it the right to sue." 198 In addition, it
stated that the "isolated transaction rule" applies only to foreign corporations, and
not a foreign partnership or a foreign "firm".
In any event, Rule 8, Section 4, of the 1997 Rules of Civil Procedure now
require that in case of foreign corporations, "facts showing the capacity of a party
to sue or be sued . . . must be averred."
New York Marine Managers, Inc. v. Court of Appeals,199 found occasion to
reiterate the rule. The Court therein found the complaint filed by the foreign
corporation to be fatally defective for failing to allege its duly authorized
representative or resident agent in [Philippine] jurisdiction. It ruled that the
signature of its counsel on the pleading was not enough: "The pleadings filed by
counsel . . . do not suffice. True, a lawyer is generally presumed to be properly
authorized to represent any cause in which he appears . . . But the presumption
is disputable. Where said authority has been challenged or attacked by the
adverse party the lawyer is required to show proof of such authority or
representation in order to bind his client. The requirement of the production of
authority is essential because the client will be bound by his acquiescence
resulting from his knowledge that he was being represented by said attorney." 200

IN SUMMARY
From all the foregoing, we can therefore summarize the current state of
the Philippines doctrine of "doing business" as it applies to foreign corporations:

1. Coverage
"Doing business" in the Philippines covers transactions or series of
transactions that have the twin-characterization of: (a) in pursuit of the main
business goals of the corporation; and (b) done with intent to continue the same
198
Ibid, at p. 596.
199
249 SCRA 416 (1995). "The issue on whether a foreign corporation can seek the aid of
Philippine courts for relief recoils to the basic question of whether it is doing business in the
Philippines or has merely entered into an isolated transaction. This Court has held in a long line
of cases that a foreign corporation not engaged in business in the Philippines may exercise the
right to file an action in Philippine courts for an isolated transaction. However . . . to say merely
that a foreign corporation to doing business in the Philippines does not need a license in order to
sue in our courts does not completely resolve the issue. When the allegation in the complaint
have a bearing on the plaintiff's capacity to sue and merely sate that the plaintiff is a foreign
corporation existing under the laws of the United States, such averment conjures two alternative
possibilities: either the corporation is engaged in business in the Philippines, or it is not so
engaged. In the first, the corporation must have been duly licensed in order to maintain the suit; in
the second, the transaction sued upon is singular and isolated, no such license is required. In
either case . . . [it] cannot be inferred from the mere fact that the party suing is a foreign
corporation. The qualifying circumstance being an essential part of the plaintiff's capacity to sue
must be affirmatively pleaded . . . Failing in this requirement, the complaint filed by the [foreign
corporation] with the trial court, it must be said, fails to show its legal capacity to sue." Ibid.
200
Ibid. Same ruling in Hahn v. Court of Appeals, 266 SCRA 537, 78 SCAD 240 (1997).
in the Philippines; and in fact a single transaction showing such twin
characterization would qualify as doing business.
Except that there is an isolated body of jurisprudence that holds that even
when such twin characterization is present in a series of transaction, when the
main features of the contract, of perfection or execution, payment and effects of
delivery are outside Philippine territorial jurisdiction, the same would not
constitute doing business in the Philippines.
However, the implementing rules of the BOI has tended to overcome such
an isolated transaction doctrine by including in the definition of "doing business"
the soliciting of orders in the Philippines.

2. Isolated Transaction Doctrine

A transaction (or even series of transactions) that do not fall within the
"doing business" definition is considered an "isolated transaction" not requiring
the obtaining of license to authorize a foreign corporation to bring suit in the
Philippine courts and administrative bodies to enforce the same or obtain relief.
While generally a foreign corporation not doing business in the Philippines
is beyond the jurisdiction of local courts and administrative bodies because of
lack of "presence" to satisfy the requirements of due process, there is a body of
jurisprudence that hold that an "isolated transaction" would constitute "presence"
to make a foreign corporation amenable to local jurisdiction.
Even when a foreign corporation is not engaged in business in the
Philippines and is sued in the Philippine courts, although it may by special
appearance object to the obtaining of jurisdiction over its person, nevertheless, if
it alleges any non-jurisdictional grounds for dismissing the action, or participates
in the trial proper and cross-examines witness, or presents its own witnesses, the
court then acquires jurisdiction over the person of the defendant.
Likewise, stipulating that venue of suits involving a contract would be in
the proper courts of the Philippines is considered "consent" to allow jurisdiction
over the person of the foreign corporation even when not doing business in the
Philippines.
The fact that a foreign corporation is not doing business in the Philippines
must be alleged if it desires to sue in Philippine courts under the "isolated
transactions rule." Without this disclosure, the court may choose to deny it the
right to sue.

3. Consequences
The consequences of failure of a foreign corporation to obtain a license
when it conducts business in the Philippines would be:

(a) To be denied access in Philippine courts and

administrative bodies to obtain relief on the contracts and
transactions it has entered into;
 (b) And yet to be amenable to suits on those contracts and
transactions it has entered into;
(c) But that the subsequent obtaining of a license prior to
filing of a suit would cure the defect and allow the foreign
corporation to sue in local courts and administrative
bodies on said contracts and transactions.
Unfortunately, the Supreme Court has employed the pari delicto doctrine
and likewise held the local counterparts without remedy also in case it enters into
a contract or transaction with a foreign corporation that does not obtain the
necessary license.
The Supreme Court has also applied to estoppel doctrine to authorized a
foreign corporation that has engaged in business in the Philippines without the
requisite license to bring a suit against the local counterpart to enforce on a
contract or transaction.
By way of leave-taking, we should remember the philosophical approach
of the Supreme Court in interpreting Section 69 of then Corporation Law, now
Section 133 of the Corporation Code, that they "must be given a reasonable, not
an unduly harsh, interpretation which does not hamper the development of trade
relations and which fosters friendly commercial intercourse among countries." 201
"The objectives enunciated in the 1924 decision [in Marshall-Wells Co. v. Elser]
are even more relevant today when we view commercial relations in terms of a
world economy, when the tendency is to re-examine the political boundaries
separating one nation from another insofar as they define the business
requirements or restrict marketing conditions."202

DOMICILE AND RESIDENCE OF FOREIGN CORPORATIONS

The domicile of a corporation belongs to the state where it was
incorporated, and in a strict technical sense, such domicile as a corporation may
have is single in its essence and a corporation can have only one domicile which
is the state of its creation.203
The residence of a corporation is necessarily where it exercises corporate
functions or the place where its business is done.204 A foreign corporation
licensed to do business in a state is a resident of any country where it maintains
an office or agent for transaction of its usual and customary business for venue
purposes; that a corporation may be domiciled in one state and resident in

201
Home Insurance Company v. Eastern Shipping Lines, 123 SCRA 424, 435 (1983).
202
Ibid, at p. 435.
203
Northwest Orient Airlines v. Court of Appeals, 241 SCRA 192, 58 SCAD 797 (1995).
204
State Investment House, Inc. v. Citibank, N.A., 203 SCRA 9 (1991); Northwest Orient
Airlines v. Court of Appeals, 241 SCRA 192, 58 SCAD 197 (1995).
another; its legal domicile is the state of its creations presents no impediment to
its residence in a real and practical sense in the state of its business activities. 205
Under our jurisprudence, pending extraterritorial service of summons to a
foreign corporation, an attachment of a foreign corporation's properties in the
Philippines may be maintained.206

RESIDENT AGENT
A resident agent may be either an individual residing in the Philippines,
must be of good moral character and of sound financial standing, or a domestic
corporation lawfully transacting business in the Philippines.207
The SEC shall require as a condition precedent to the issuance of the
license that the foreign corporation file a written power of attorney designating
some person who must be resident of the Philippines, on whom any summons
and other legal processes may be served in all actions or other legal proceedings
against such corporation, and consenting that service upon such resident agent
shall be admitted and held as valid as if served upon the duly authorized officers
of the foreign corporation at its home.208
Whenever such service of summons or other process is made upon the
SEC, it must, within ten (10) days thereafter, transmit by mail a copy of such
summons or other legal process to the corporation at its home or principal office.
The sending of such copy by the SEC is a necessary part of and shall complete
such service. All expenses incurred by the SEC for such service shall be paid in
advance by the party as whose instance the service is made. In case of a change
of address of the resident agent, it shall be his or its duty to immediately notify in
writing the SEC.209

LAWS APPLICABLE TO FOREIGN CORPORATIONS

Any foreign corporation lawfully doing business in the Philippines shall be
bound by all laws, rules and regulations applicable to domestic corporations of

205
Ibid.
206
FBA Aircraft v. Zosa, 110 SCRA 1 (1981).
207
Sec. 127, Corporation Code.
208
The specific wordings required under Sec. 128 reads: "The (name of foreign corporation)
does hereby stipulate and agree, in consideration of its being granted by the Securities and
Exchange Commission a license to transact business in the Philippines, that if at any time said
corporation shall cease to transact business in the Philippines, or shall be without any resident
agent in the Philippines, or shall be without any resident agent in the Philippines on whom any
summons or other legal processes may be served, then in any action or proceeding arising out of
any business or transaction which occurred in the Philippines, service of any summons or legal
process may be made upon the Securities and Exchange Commission and that such service shall
have the same force and effect as if made upon the duly-authorized officers of the corporation at
its home office."
209
Sec. 128, Corporation Code.
the same class, save and except such only provide for the creation, formation,
organization or dissolution of corporations or such as fix the relations, liabilities,
responsibilities, or duties of stockholders, members, or officers of corporations to
each other or to the corporation.210
An illustration of this principle can be found in Grey v. Insular Lumber
Co.211 In that case, the foreign corporation doing business in the Philippines was
organized under the laws of New York. According to the then Stock Corporation
Law of New York, only stockholders owning at least 3% of the shares of the
corporation may inspect the books and records of the corporation. Plaintiff Grey
held less than 3% of defendant corporation stockholdings. Grey invoked the
provision of Philippine laws which allowed stockholders owning less than 3% of
shares to inspect books and records of a corporation. The Supreme Court held
that intramural matters such as the qualification to inspect corporate records are
governed by the laws where the corporation was incorporated.

AMENDMENT OF ARTICLES OF INCORPORATION

Whenever the articles of incorporation or the by-laws of a foreign
corporation authorized to transact business in the Philippines are amended, such
foreign corporation shall, within sixty (60) days after such amendment becomes
effective, file with the SEC, and in the proper cases with the appropriate
government agency, a duly authenticated copy of the articles of incorporation or
by-laws, as amended, indicating clearly in capital letters or by underscoring the
change or changes made, duly certified by the authorized official or officials of
the country or state of incorporation.212
The filing thereof shall not itself enlarge or alter the purpose or purposes
for which such corporation is authorized to transact business in the Philippines.213

MERGER AND CONSOLIDATION

One or more foreign corporations authorized to transact business in the
Philippines may merge or consolidate with any domestic corporation or
corporations if such is permitted under Philippine laws and by the law of its
incorporation. However the requirements on merger or consolidation as provided
in the Corporation Code have to be complied with. 214
Whenever a foreign corporation authorized to transact business in the
Philippines shall be a party to a merger or consolidation in its home country or
state as permitted by the law of its incorporation, such foreign corporation shall,
within sixty (60) days after such merger or consolidation becomes effective, file
210
Sec. 129, Corporation Code.
211
67 Phil. 139 (1938).
212
Sec. 130, Corporation Code.
213
Ibid.
214
Sec. 132, Corporation Code.
with the SEC, and in proper cases with the appropriate government agency, a
copy of the articles of merger or consolidation duly authenticated by the proper
officials or officials of the country or state under the laws of which such merger or
consolidation was effected. If the absorbed corporation is the foreign corporation
doing business in the Philippine, the latter shall at the same time file a petition for
withdrawal of its license in accordance with this Title.215

REVOCATION OF LICENSE TO DO BUSINESS

The license of a foreign corporation may be revoked or suspended by the
SEC upon any of the following grounds:

(a) Failure to file its annual report or pay any fees as

required by the Code;
(b) Failure to appoint and maintain a resident agent in the
Philippines as required by this Title;
(c) Failure, after change of its resident agent or of his
address, to submit to the SEC a statement of such
change as required by the Code;
(d) Failure to submit to the SEC an authenticated copy of
any amendment to its articles of merger or consolidation
within the time prescribed by the Code;
(e) A misrepresentation of any material matter in any
application, report, affidavit or other document submitted
by such corporation pursuant to the Code;
(f) Failure to pay any and all taxes, impost, assessments or
penalties, if any, lawfully due to the Philippine
Government or any of its agencies or political
subdivisions;
(g) Transacting business in the Philippines outside of the
purpose or purposes for which such corporation is
authorized under its license;
(h) Transacting business in the Philippines as agent of or
acting for and in behalf of any foreign corporation or
entity not duly licensed to do business in the Philippines;
or
(i) Any other ground as would render it unfit to transact
business in the Philippines.216

215
Ibid.
216
Sec. 134, Corporation Code.
 Upon the revocation of any such license to transact business in the
Philippines, the SEC shall issue a corresponding certificate of revocation,
furnishing a copy thereof to the appropriate government agency in the proper
cases. The SEC shall also mail to the corporation at its registered office in the
Philippines a notice of such revocation accompanied by a copy of the certificate
of revocation.217

WITHDRAWAL OF FOREIGN CORPORATION

A foreign corporation licensed to transact business in the Philippines by
filing a petition for withdrawal of license. The petition for withdrawal or license
has been published once a week for three (3) consecutive weeks in a newspaper
of general circulation in the Philippines. However, the SEC will not issue the
certificate of withdrawal unless all claims which have accrued in the Philippines
have been paid, compromised or settled and all taxes, imposts, assessments
and penalties, if any, lawfully due to the Philippine Government or any of its
agencies or political subdivisions have been paid.218

——oOo——

CORP. MANUSCRIPT.DIR\18-FOREIGN CORPORATIONS\8-02-2002

217
Sec. 135, Corporation Code.
218
Sec. 136, Corporation Code.
 CHAPTER 19

SPECIAL PROVISIONS AND PENALTIES

SEC Power and Supervision

Confidential Nature of SEC Examination
Applicability of Code to Special Corporations
Applicability of New Requirements on Existing Corporations
Effect of Dissolution of the Corporation or Amendment or Repeal of the Corporation
Code
Repealing Clause of the Corporation Code
PENAL PROVISIONS OF THE CORPORATION CODE
Criminal Law Principles
Elements of the Criminal Offense under Section 144
Meaning of "Violation" Under Section 144
Section 190-1/7: Historical Background to Section 144
Contrary View
Absence of Malice or Defense of Good Faith

——

SEC POWER AND SUPERVISION

The Corporation Code provides that the SEC shall have the power and
authority to implement its provisions, to promulgate rules and regulations
reasonable necessary to enable it to perform its duties under the Code,
particularly in the prevention of fraud and abuses on the part of the controlling
stockholders, members, directors, trustees or officers.1
Under Section 141 of the Corporation Code, every corporation, domestic
or foreign, lawfully doing business in the Philippines, shall submit to the SEC an
annual report of its operations, together with a financial statement of its assets
and liabilities, certified by any independent certified public accountant in
appropriate cases, covering the preceding fiscal year and such other
requirements as the SEC may require. Such report shall be submitted within
such period as may be prescribed by the SEC.
Under present SEC Rules, the following are the reportorial requirements
of registered corporations:

1
Sec. 143, Corporation Code.
 (a) Registration and stamping of the stock and transfer book or
the membership book, within thirty (30) days from the date of
the issuance of the certificate of incorporation;

(b) Filing of the General Information Sheet within thirty (30) days
from the date of actual meeting of the stockholders or
membership meeting;
(c) The filing of two (2) copies of the financial statements duly
stamped "received" by the Bureau of Internal Revenue
(BIR), within 105 days after the end of the fiscal year as
specified in the by-laws;
(d) The filing of an Affidavit of Non-Operation or Board
Resolution or Affidavit of Cessation of Business Operations,
within one-hundred-five (105) days after the end of the fiscal
year as specified in the by-laws for corporations that have
ceased operations and no longer prepare financial
statements;
(e) Filing of the notice of postponement of annual meeting, at
least ten (10) days before the date of the annual meeting as
specified in the by-laws, in case the meeting cannot be held
as provided; and
(f) Filing of the Affidavit of Non-Holding of Annual Meeting,
together with the General Information Sheet, within thirty
(30) days before the date of the annual meeting as specified
in the by-laws in case of non-holding of the annual meeting.

CONFIDENTIAL NATURE OF SEC EXAMINATION

All interrogatories propounded by the SEC and answers thereto, as well
as the results of any examination made by the SEC or by any other official
authorized by law to make an examination of the operations, books and records
of any corporation, shall be kept strictly confidential, except insofar as the law
may require the same to be made public or where such interrogatories, answers
or results are necessary to be presented as evidence before any court.2

APPLICABILITY OF THE CODE TO SPECIAL CORPORATIONS

Corporations created by special laws or charters shall be governed
primarily by the provisions of the special law or charter creating them or

2
Sec. 142, Corporation Code.
applicable to them, supplemented by the provisions of the Corporation Code,
insofar as they are applicable.3

APPLICABILITY OF NEW REQUIREMENTS ON EXISTING CORPORATIONS

All corporations lawfully existing and doing business in the Philippines on
the date of the effectivity of the Corporation Code and theretofore authorized,
licensed or registered by the SEC, shall be deemed to have been authorized,
licensed or registered under the provisions of the Corporation Code, subject to
the terms and conditions of their license, and shall be governed by the provisions
of the Code.4 Where any such corporation is affected by the new requirements of
the Corporation Code, said corporation shall, unless otherwise provided, be
given a period of not more than two (2) years from the effectivity of the
Corporation Code within which to comply with the same.5

EFFECT OF DISSOLUTION OF THE CORPORATION OR

AMENDMENT OR REPEAL OF THE CORPORATION CODE
Section 145 of the Corporation Code provides for two important aspects:

(a) That established rights in favor of or remedies against the

corporation, its stockholders, members, directors, trustees,
or officers, are not affected by the amendment or repeal of
the Corporation Code; and
(b) Such established rights or remedies are also unaffected by
the dissolution of the corporation.

In spite of such provision, of course, the effects of dissolution as provided

by the Corporation Code and jurisprudence shall always prevail.
In Reburiano v. Court of Appeals,6 the Supreme Court employed the
language of Section 145 to rule that in spite of the lapse of the three (3) period
limitation for the liquidation of a corporation, nevertheless, there would still be
legal basis to pursue remedies for and its behalf since the section provides
clearly that “[n]o right of remedy in favor or against any corporation . . . shall be
removed or impaired either by the subsequent dissolution of said corporation.”

REPEALING CLAUSE OF THE CORPORATION CODE

The repealing clause in Section 146 of the Corporation Code does not
provide for a direct repeal of the old Corporation Law (Act No. 1459), but is rather
an implied repeal thereof, thus: "Except as expressly provided by this Code, all

3
Sec. 147, Corporation Code.
4
Sec. 148, Corporation Code.
5
Ibid.
6
301 SCRA 342, 102 SCAD 285 (1999).
laws or parts thereof inconsistent with any provision of this Code shall be
deemed repealed."
Since the Corporation Code is meant to cover the whole body of law on
Corporate Law, despite the implied repeal provisions of Section 146 thereof, the
old Corporation Law is deemed repealed in toto.
Also, the explanatory note to then Cabinet Bill No. 3 which became the
basis for the Code states that the "bill is intended to supplant the present
Corporation Law, Act No. 1459."
Certain provisions of the old Corporation Law are still quite instructive,
such as the definitional differences between public corporations and private
corporations.

PENAL PROVISIONS OF THE CORPORATION CODE7

Section 144, of the Corporation Code, provides that -

SEC. 144. Violations of the Code.--Violations of any of

the provisions of this Code or its amendments not otherwise
specifically penalized therein shall be punished by a fine of not
less than one thousand (P1,000.00) pesos but not more than
ten thousand (P10,000.00) pesos or by imprisonment for not
less than thirty (30) days but not more than five (5) years, or
both, in the discretion of the court. If the violation is committed
by a corporation, the same may, after notice and hearing, be
dissolved in appropriate proceedings before the Securities and
Exchange Commission; Provided, That such dissolution shall
not preclude the institution of appropriate action against the
director, trustee, or officer of the corporation responsible for
said violation: Provided, further, That nothing in this section
shall be construed to repeal the other causes for dissolution of
a corporation provided in this Code. (190-1/7a).

Under Section 27 of the Code, a person convicted by final judgment of a

violation of the Code committed within five (5) years prior to the date of his
election or appointment, shall not be qualified as a director, trustee or officer of
any corporation.
In-depth discussions on the proper interpretation and coverage of Section
144 of the Corporation Code is essential since it provides for criminal penalties
for violations of "any" of the provisions of the Corporation Code, and therefore
seems to over-criminalize the provisions of the Code. The broad language of
Section 144, unless properly applied, presents a codal land mine that could maim
or harm the actors in the corporate setting, or would tend to put at risk many of

7
This section was first published with the title "The Penal Provision Under Sec. 144 of the
Corporation Code," with THE LAWYERS REVIEW, Vol. X, No. 2, 29 February 1996.
the actuations and decisions of the directors, trustees, and corporate officers, as
to necessarily cramp the exercise of their business judgment.
Lately, practitioners have began to look at the seemingly all-
encompassing provisions of Section 144 to effectively obtain results on their
demands or claims against the corporation, by dangling a threat of criminal suit
against corporate directors and officers.

1. Criminal Law Principles

To effectively render a proper interpretation of the extent and reach of
Section 144, which is essentially a criminal law provision, it is necessary to view
the section in line with prevailing Philippine Criminal Law principles.
Although the Corporation Code was essentially derived from common law
jurisprudence and legislation from the United States, nevertheless, it has been
long held by Philippine Supreme Court that the so-called common law crimes
known in the United States and England as the body of principles, usages and
rules of action, which do not rest for their authority upon any express and positive
declaration of the will of the legislature, are not recognized in the Philippines. 8
Unless there be a particular provision in the penal code or special penal law that
defines and punishes the act, even if it be socially or morally wrong, no criminal
liability is incurred by its commission.9
We have therefore in Philippine jurisdiction one of the fundamental rules of
construction in Criminal Law, that penal laws are strictly construed against the
State and liberally in favor of the accused.10 Although it has also been held that
such construction rule may be invoked only where the law is ambiguous and
there is doubt as to its interpretation; where the law is clear and unambiguous,
there is no room for the application of the rule.11
Nevertheless, the Supreme Court has equally held that the rule of strict
construction of criminal law is subordinate to the rule of reasonable, sensible
construction, having in view the legislative purpose and intent, and given effect to
the same; the rule should not be unreasonably applied as to defeat the true intent
and meaning of the enactment found in the language actually used. 12 Penal
statutes shall not, by what may be thought their spirit and equity, be extended to
offenses other than those which are specifically and clearly described and
provided for since the law will not allow constructive offenses or arbitrary
punishments.13 This rule does not exclude the application of common sense to
the terms used in the law.14

8
U.S. v. Taylor, 28 Phil. 599, 604 (1914).
9
Ibid.
10
U.S. v. Abad Santos, 36 Phil. 243 (1917); People v. Yu Hai, 99 Phil. 725 (1956); People
v. Terrado, 125 SCRA 648 (1983).
11
People v. Gatchalian, 104 Phil. 664 (1958).
12
People v. Padilla and Von Arend, 71 Phil. 261 (1941).
13
People v. Abuyen, 52 Phil. 722, 726 (1929).
14
Ibid.
 2. Elements of the Criminal Offense Under Section 144
Looking at the language of Section 144, one can see that it seems all-
encompassive in nature as it imposes criminal liability for "Violations of any of the
provisions of this Code or its amendments not otherwise specifically penalized
therein." This is further bolstered by the fact that in addition, Section 144 does
not mean to cover other provisions of the Corporation Code which provides for
specific penalties (as Section 74 on violation of the right of inspection as
discussed hereunder) because is uses the phrase "not otherwise specifically
penalized therein."
It is difficult to construe Section 144 to mean that all non-compliance with
the provisions of the Corporation Code would be criminally punishable. For
example, under Section 26 of the Corporation Code, it is provided that within
thirty (30) days after the election of the directors, trustees and officers of the
corporation, the secretary, or any other officer of the corporation, shall submit to
the SEC, the names, nationalities and residences of the directors, trustees and
officers elected. If a corporate secretary fails to comply with this provision, would
he then be subject to a criminal penalty under Section 144?
Such a construction would seem too harsh, and effectively discourages
competent and well-meaning individuals from accepting positions within the
corporate setting. It would then make the corporation a very unattractive medium
for commerce.

3. Meaning of "Violation" Under Section 144

The proper and reasonable interpretation of Section 144 is to determine
what the term "violations" covers.
"Violation" means "Injury; infringement; breach of right, duty or law;" 15 the
action of breaking a law, rule, agreement, promise, or instruction.16
Therefore, the "violations" covered by Section 144 covers only those
provisions in the Corporation Code which are expressly mandatory in nature to
show the true intent of Legislature to impose a penal sanction for non-compliance
therewith.
For example, Section 15 of the Corporation Code provides for the form to
be followed in preparing and filing the articles of incorporation of a corporation.
Certainly, non-compliance therewith would not subject the incorporators to penal
sanction, although certainly that would be a "violation" of the provisions of the
Corporation Code in broad use of the term "violation". Especially so when the
Code itself under Section 17 gives the SEC authority to reject the articles of
incorporation or disapprove the same if it does not comply with the Code. In fact
that same section grants the incorporator a reasonable time "within which to
correct or modify the objectionable portions of the articles."

15
BLACK'S LAW DICTIONARY, 5th Ed.
16
W ORLD BOOK DICTIONARY, 1983 Ed., Doubleday & Company, Inc. Chicago Illinois.
 There are other provisions in the Corporation Code where it would seem
clear that civil sanction for damages is imposed rather than the criminal sanction
under Section 144 thereof. Under Section 31 thereof, a director or trustee who
willfully and knowingly votes for or assents to patently unlawful acts of the
corporation or who are guilty of gross negligence or bad faith in directing the
affairs of the corporation or acquire any personal or pecuniary interest in conflict
with their duty as such directors or trustees shall be liable jointly and severally for
all damages resulting therefrom suffered by the corporation, its stockholders or
members and other persons. Under Section 32, where a director, by virtue of his
office, acquires for himself a business opportunity which should belong to the
corporation, thereby obtaining profits to the prejudice of such corporation, he
must account to the corporation for all such profits by refunding the same.
Under Section 65, any director or officer of a corporation consenting to the
issuance of stocks for a consideration less than its par or issued value or for a
consideration in any form other than cash, valued in excess of its fair value, or
who, having knowledge thereof, does not forthwith express his objection in
writing and file the same with the corporate secretary, shall be solidarily liable
with the stockholder concerned to the corporation and its creditors for the
difference between the fair value received at the time of issuance of the stock
and the par or issued value of the same.
In all the foregoing instances, it would not be proper to subject erring
directors, trustees, or corporate officers to criminal penalty under Section 144
since the specific provisions themselves provide for the proper remedies in each
case. This is the proper and reasonable interpretation of the phrase in Section
144 "not otherwise specifically penalized therein" to mean that even when the
provisions seems to be mandatory and the violation thereof is a serious breach,
when the particular provision already provides for a specific penalty or sanction,
the penal sanction under Section 144 should not be made to apply.
There is a specific provision of the Corporation Code where the
Legislature has made it clear or apparent that it seeks to impose the penal
sanctions under Section 144 for non-compliance therewith. Under Section 74,
any officer or agent of the corporation who shall refuse to allow any director,
trustee, stockholder or member of the corporation to examine or copy excerpts
from its records and minutes, in accordance with the provisions of this Code
"shall be liable to such director, trustee, stockholder or member for damages, and
in addition, shall be guilty of an offense which shall be punishable under Section
144 of this Code."
Section 74 of the Corporation Code is therefore a clear example of the
intent of Legislature that when it seeks to impose the criminal sanction under
Section 144 for violation of the provision of the Code, then it uses clear words to
so indicate.
At present, only Section 74 of the Corporation Code refers to Section 144,
so that effectively only violation of the right of inspection under Section 74 are
criminally punishable under Section 144.
 In effect, the broad coverage of Section 144 is meaningless since it is
applicable only to Section 74 of the Code. If that is the legal effect, then it could
be argued that Legislature, when it enacted Section 144 of part of the
Corporation Code, had not intended it to be a practically useless provision since
the penal sanctions provided therein could have effectively been stated in
Section 74 if it is indeed the only violation applicable to said provision. However,
such a position fails to consider that indeed Section 144 was meant to be the
over-all penal sanction under the Code, if and when Legislature deems it
appropriate to impose a penal sanction for violation thereof not only based on the
current provisions of the Code, but also "its amendments" in the future.
It should also be noted that although a penal provision like Section 144 is
usual in special laws, nevertheless, the implementation dura lex, sed lex of such
penal provisions under most special laws is without controversy because the
subject thereof is limited and the acts covered therein are clearly defined. Such
position cannot be equated to Section 144, since the Corporation Code, indeed is
a "code" that necessary covers a broad subject and almost innumerable acts.

4. Section 190-1/7: Historical Background to Section 144

As indicated at the end of Section 144, it is an amended version of Section
190-1/7 of the old Corporation Law. A contrary view to the position taken in this
paper does not take into consideration that the present Section 144 of the
Corporation Code, is a carry-over of Section 190-1/7 of the old Corporation Law.
It should be recalled that when the then Corporation Law sought to impose a
criminal penalty on a prohibited act, the Law spelled it our clearly, thus:

(a) Under then Section 15 of the Law, it punished as an offense

by a fine of P20,000 employment of persons in slavery in a
corporation doing business in the Philippines or receiving
any grant, franchise or concession from the Philippine
Government;
(b) Under Section 19 of the Law, any corporation which fails to
report to the SEC any cessation or change of address, if
any, shall be subject to a fine of not less than P100 nor more
than P1,000;
(c) Under then Section 69 of the Law, any officer, or agent of the
corporation or any person transacting business or any
foreign corporation not having the license prescribed by law
shall be punished by imprisonment of not less than six (6)
months nor more than two (2) years or by a fine of not less
than P200 nor more than P1,000, or by both such
imprisonment and fine, in the discretion of the court.
 Subsequently, then Section 190-1/7 became the general sanction under
the then Corporation Law for violations of the above-enumerated offenses.17
Such offenses, considered to be archaic, have not been carried over into the
Corporation Code. Therefore, Section 144 should now be viewed not as a
contemporary enactment of Legislature as a "new" policy towards violation of the
any and all provisions of the Corporation Code, but really a relic or carry-over of
the old Corporation Law provision which therefore should be interpreted in the
same manner as then Section 190-1/7 of the Law, which also carried the phrase
"not otherwise penalized therein."
As originally enacted, the old Corporation Law18 did not contain any
appropriate clause directly penalizing the act of a corporation, or member of a
corporation for violation of certain prohibited acts under that law. The Philippine
Legislature undertook to remedy the situation in section 3 of Act No. 2792,
approved on 18 February 1919, providing for the original version of Section 190.
Government of the Philippine Islands v. El Hogar Filipino,19 held that the
section was not intended to make every casual violation of one of the
Corporation Law provisions ground for involuntary dissolution of the corporation
and that the court was entitled to exercise discretion in such matters. At the time
of El Hogar, the version of then Section 190 on the dissolution of corporate
violator was expressed in mandatory terms, thus:

SEC. 190. (A). Penalties.--The violation of any of the

provisions of this Act and its amendments not otherwise
penalized therein, shall be punished by a fine of nor more than
one thousand pesos, or by imprisonment for not more than
one thousand pesos, or by imprisonment for not more than five
years, or both, in the discretion of the court. If the violation is
committed by a corporation, the same shall, upon such
violation being proved, be dissolved quo warranto proceedings
instituted by the Attorney-General or by any provincial fiscal by
order of said Attorney-General . .

The Court held that although the section uses the word "shall" the
provision on dissolution should be interpreted to mean "may". It held another way
to put the same conclusion is to say that the expression "shall be dissolved by
quo warranto proceedings" means in effect, "may be dissolved by quo warranto
proceedings in the discretion of the court." The Court also held that "[t]he
proposition that the word `shall' may be construed as `may', when addressed by
the Legislature to the courts is well supported in jurisprudence."20
Nevertheless, El Hogar declared the section invalid for lack of adequate
title to the Act. Subsequently, the Philippine Legislature re-enacted substantially

17
SALONGA, PHILIPPINE LAW ON PRIVATE CORPORATIONS, p. 629 (1968 Ed.).
18
Act No. 1459.
19
50 Phil. 399 (1927).
20
Ibid, at p. 414, citing Becker v. Lebanon and M. St. Ry. Co., 188 Pa., 484.
the same penal provision in section 21 of Act No. 3518, under a title sufficiently
broad to comprehend the subject matter.
Harden v. Benguet Consolidated Mining Co,21 held that violation of the
provisions of the old Corporation Law prohibiting one mining corporation from
acquiring interest in another was held not to permit repudiation of the contract for
such interest, though it might subject the corporation to quo warranto or criminal
proceedings. What is important is the ruling in Harden is the pronouncement of
the Court that Section 190 "was adopted by the lawmakers with a sole view to
the public policy that should control in the granting of mining rights. Furthermore,
the penalties imposed in what is now section 190(A) of the Corporation Law for
the violation of the prohibition in question are of such nature that they can be
enforced only by a criminal prosecution or by an action of quo warranto. But
these proceedings can be maintained only by the Attorney-General in
representation of the Government."22
The implication in Harden is that, as dissolution of a corporation is a
matter addressed to the courts, and can be commenced only by the State,
through the Solicitor General, when enforcing a public policy, as distinguished
from answering a private wrong; so also criminal prosecutions under Section
144, as a derivative from the old Section 190 of the Corporation Law, can be
proceeded by the State only for violations of the provisions of the Corporation
Code that go into prohibitory provisions of the Code covering fundamental public
policy, and can only be commenced by the Solicitor General, and now the SEC,
in representation of the Government, and not upon the complaint of any ordinary
citizen.

5. Contrary View
It should be noted, however, that Guevarra, in his treatise on the old
Corporation Law23 took the contrary position that the Law "provides special
penalties for violations of some provisions of the Corporation Law and also a
general penalty for violations not specifically penalized therein."24
We must also take note of the obiter expressed in Home Insurance
Company v. Eastern Shipping Lines.25 In that case, Home Insurance Company, a
foreign corporation, which admittedly had engaged in business in the Philippines,
had issued insurance contracts in the Philippines without obtaining the necessary
license. Subsequently, it obtained the license before filing the cases for collection
under the insurance contracts. The lower court dismissed the complaint and
declared that pursuant to its understanding of the basic public policy reflected in
the Corporation Law, the insurance contracts executed before a license was

21
58 Phil. 141 (1933).
22
Ibid, at p. 149; emphasis supplied.
23
GUEVARRA, CORPORATION LAW (Phil. Jur. Series I), 1978 Ed., U.P. Law Center.
24
Ibid, at p. 250.
25
123 SCRA 424 (1983).
secured must be held null and void, and the subsequent procurement of the
license did not validate the contracts.
The Supreme Court, although it recognized there were conflicting schools
of thought both here and abroad which are divided on whether such contracts are
void or merely voidable, took its cue from the doctrine laid down in Marshall-
Wells Co. v. Elser,26 that the doctrine of then Section 69 of the old Corporation
Law "was to subject the foreign corporation doing business in the Philippines to
the jurisdiction of our courts . . . and not to prevent the foreign corporation from
performing single acts, but to prevents it from acquiring domicile for the purpose
of business without taking the necessary steps to render it amenable to suit in
the local courts."
However, although the issue of criminal sanction was not at issue, Justice
Gutierrez in Home Insurance held that Section 133 of the present Corporation
Code, which unlike its counterpart Section 69 of the Corporation Law provided
specifically for penal sanctions for foreign corporations engaging in business in
the Philippines without obtaining the requisite license, should be deemed to have
a penal sanction by virtue of Section 144 of the Corporation Code, thus:

Significantly, Batas Pambansa Blg. 68, the Corporation

Code of the Philippines has corrected the ambiguity caused by
the wording of Section 69 of the old Corporation Law. . .
The old Section 69 has been reworded in terms of non-
access to courts and administrative agencies in order to
maintain or intervene in any action or proceedings.
The prohibition against doing business without first
securing a license is now given penal sanction which is also
applicable to other violations of the Corporation Code under
the general provisions of Section 144 of the Code.
It is, therefore, not necessary to declare the contract null
and void even as against the erring foreign corporation. The
penal sanction for the violation and the denial of access to our
courts and administrative bodies are sufficient from the
viewpoint of legislative policy.27

Home Insurance in dealing with the scope and reach of Section 144, has
not only expressed an obiter, but more importantly has not looked into the
implications of such broad pronouncements on the basis of Criminal Law
principles, since such principles have not been raised, discussed nor focused
into appropriately in the rendering of the decision. When the appropriate case is
brought to the Supreme Court, and the proper factual basis and principles of
Criminal Law are discussed and detailed before the Court, we believe that the
Court will take a contrary position on ratio decidendi considerations. After all, it

26
46 Phil. 70 (1924).
27
Ibid, at pp. 438-439. Emphasis supplied.
was in Home Insurance where the Court itself expressed the position that "[t]he
Corporation Law must be given a reasonable, not an unduly harsh, interpretation
which does not hamper the development of trade relations." 28 Otherwise, Section
144, hangs like a damocles sword ready to chop off the neck of corporate
directors, trustees, and officers.

6. Absence of Malice or Defense of Good Faith

Even if one where to meet head-on the position that Section 144 was
meant by Legislature to encompass every violation of the provisions Corporation
Code, it would be extremely difficult to obtain a conviction under Section 144,
except for the specific violation under Section 74 of the Code. Not only must the
guilt of the accused be proven beyond reasonable doubt, but more so, since
violations of the Corporation Code are not mala prohibita, but constitute mala in
se, then the evil intent or malice of the accused is an essential element for a
crime punishable under Section 144. This is demonstrated by no less than
Section 74 which provides good faith as a defense: "That it shall be a defense to
any action under this section that the person demanding to examine and copy
excerpts from the corporation's records and minutes has improperly used any
information secured through any prior examination or the records or minutes of
such corporation or of any other corporation, or was not acting in good faith or for
a legitimate purpose in making his demand."
In cases, therefore, of prosecutions under Section 144, the director,
trustee or officer accused, could have more than enough legal basis to claim
good faith because of the varied interpretations and applications of the principles
of Corporate Law.
It should be recalled that Corporate Law is essentially a transplant of that
specific body of law coming from the common law jurisdiction of the various
states of the United States. The Corporation Code may have expressed in
statutory form many of the common law principles of Corporate Law, however
there are various interpretations of similar provisions in various codes. In
addition, there are various common law principles in Corporate Law that are
applicable in our jurisdiction that have not even found their way in the
Corporation Code, but which nevertheless are applied by our Supreme Court. A
prime example of this are the principles pertaining to derivative suits, which are
all found in decisions of the Supreme Court which have no direct statutory basis
in the Corporation Code.
Our own Supreme Court every now and then relies on discussions of
Fletcher to resolves issues in Corporate Law. In addition, there are varying, and
sometimes conflicting decisions on the same principle or statutory provision in
Corporate Law among the various courts in the United States. Finally, the often
fast development in our commercial transactions which have by practice allowed
previously outlawed practices to be accepted (such as rights of first refusal
practice, classification of the board seats, etc.) have often been recognized as
28
Ibid, at p. 435.
reasonable and lawful bases to validly animate board decisions or actions of
corporate officers.
There is therefore every leeway for the defense in a criminal suit based on
Section 144 of the Corporation Code, to show that the element of malice does
not pertain to an act or a transaction upon which the criminal imputation is based
upon.

—oOo—

CORP. MANUSCRIPT\19-MISECLLANYCORPMAN.DIR\8-02-2002
 CHAPTER 20

LEGAL THEORY OF PHILIPPINE

CORPORATE LAW

Characterization of Philippine Legal Setting

Nature of Philippine Corporate Law
Proper Role of Corporation Code
Role of Corporation in Business and Society
Corporate Social Responsibility
Role of Corporations in Philippine Society
The Impending Dominance of e-Commerce

——

This chapter appears at the end of the book, although psychologically, it

should be the first chapter as it talks of the philosophical background of
Philippine Corporate Law, and how the author feels the provisions of the
Corporation Code should be handled. But one would appreciate the points raised
in this chapter only after one has gone through some of the more substantial
theories discussed in the main chapters of the book, which discussions are the
foundation for the issues raised and discussed herein.

CHARACTERIZATION OF PHILIPPINE LEGAL SETTING

Like most developing countries, the Philippines faces the imperative need
to evolve a legal system that is logically and structurally coherent and responsive
to the complex needs of its society. This would require striking a balance
between anchoring laws on the sociological and cultural values of its people, and
the need to adapt such laws to international standards because of the
importance of foreign trade and international relations to its national
development.
The Philippines has a legal system which is a hybrid of Roman civil law
and Anglo-American common law (with the partial application of the Muslim legal
system to the Filipino Muslims of southern Philippines). The blending of two great
western legal systems during the American occupation is thought to have given
the Philippine legal system the characteristics of elasticity and progressiveness;
yet it engendered great confusion, with the fear that the blending had "resulted in
the evil birth of a phenomenal creature!"1
History demonstrates that the key to a nation's balanced development is
the ability to innovate and adapt legal systems to the changing needs of a
modern world, consistent with the cultural and social values of its people.
Consequently, the hybrid legal system, if properly developed, should allow
Philippine legal jurists, scholars, and practitioners greater flexibility to adapt the
best theories and innovations of the civil and common law traditions as
guideposts for Philippine society, both being undeniable heritage of the Nation's
past.2
When it comes to business and property rights, the relatively short legal
history of the Philippines, shows society seeking to strike a balance between the
free enterprise system and a paternalistic or socialist system. This ambivalent
stance finds its best manifestation in the various provisions of the Philippine
Constitution itself. Although the Constitution would protect property and life under
due process clause,3 and declare that -

. . . The State recognizes the indispensable role of the

private sector, encourages private enterprise, and provides
incentives to needed investments,4

it would nevertheless imbue with “social functions” property and enterprise

ownership, thus -

. . . The use of property bears a social function, and all

economic agents shall contribute to the common good,
individuals and private groups, including corporations,
cooperatives, and similar collective organizations, shall have
the right to own, establish, and operate economic enterprises,
subject to the duty of the State to promote distributive justice
and to intervene when the common good so demands.5

Philippine Corporate Law therefore must function and evolve within such
milieu.

1J.P. LAUREL, ASSERTIVE NATIONALISM 80 (1931).

2
"If we are to live and flourish an independent nation, we've got to find the roots, the firm
roots, of our cultural heritage. The question it seems, is what is to be included and what to be
excluded from this heritage." R. MANGLAPUS, FREEDOM, NATIONHOOD AND CULTURE, 2-3 (1959).
3
Sec. 1, Article III (Bill of Rights), Philippines Constitution.
4
Sec. 20, Art. II (Declaration of Principles and State Policies), Philippine Constitution.
5
Sec. 6, Art. XII (National Economy and Patrimony), Philippine Constitution.
NATURE OF PHILIPPINE CORPORATE LAW
Philippine Corporate Law is a direct transplant of American Corporate
Law;6 it is, therefore, inherently a product of the common law system. However,
unlike in the United States where common law prevails, Philippine Corporate Law
must operate within a hybrid legal system. Unfortunately, the underlying
philosophical bases of such a hybrid system have not been clearly fleshed out by
jurists and legal scholars. Sometimes there is an outright refusal to acknowledge
any integration.7
In De los Santos and Astraquillo v. Republic,8 where the issue was the
binding effect of transfers of shares of stock of corporations, the Supreme Court
in adhering closely to the language, or rather lack of provision in the then
Corporation Law held: "The failure of the Philippine government to incorporate its
provisions in our statute books, for a period of almost 45 years, is to our mind,
clear proof of the unwillingness of our legislative department to change the policy
set forth in section 35 of Act No. 1459. Needless to say, this fact negates our
authority--which is limited to the interpretation of the law, and its application, with
all its imperfections--to abandon what the dissenting opinion characterizes as the
„civil law standpoint,‟ and substitute, in lieu thereof, the commercial viewpoint, by
applying said section 5 of the Uniform Stock Transfer Act, although not a part of
the law of the land. Indeed, even in matters generally considered as falling within
„commercial territory,‟ the Roman Law concept has not given way in the
Philippine to the Common Law approach, except when there is explicit statutory
provision to the contrary.”
In West Coast Life Ins. Co. v. Hurd,9 the Supreme Court held that when it
comes to criminal jurisdiction involving corporations and corporate officers,
Philippine courts "have no common law jurisdiction or powers," and being
creatures of statute have only those powers conferred upon them by statute,
which would naturally come from Spanish and not from common law sources. On
other occasions, such integration is indeed recognized in the Philippine legal
system.10

6
Harden v. Benguet Consolidated Mining Co., 58 Phil. 141 1933, referred to the original
Corporation Law (Act No. 1459) "a sort of codification of American corporate law."
7
U.S. v. Cuna, 12 Phil. 241 (1908), held that "Neither English nor American common law is
in force in these island; nor are the doctrines derived therefrom binding upon our courts, save
only insofar as they are founded on sound principles applicable to local conditions, and are not in
conflict with existing law." (at p. 244)
8
96 Phil. 577 (1955)
9
27 Phil. 401 (1914).
10
Fua Cun v. Summers, 44 Phil. 704 (1923), demonstrate clearly the applicability of
common law doctrines even in the absence of statutory recognition. At the time of Fua Cun is was
not yet generally recognized that a valid mortgage could be constituted over shares of stock in a
corporation. The Court held "At common law a corporation has no lien upon the shares of
stockholders for any indebtedness to the corporation . . . and our attention has not been called to
any statute creating such a lien here." It would even seem from Fua Cun that common law
principles prevail in such common law subjects such as Corporate Law, unless suppressed by
statutory denials.
 It would be wrong for a Filipino jurist or legal practitioner to go to either
extreme, and to treat the Corporation Code as though it were either purely a
code in the civil law sense, or a purely common law product. The underlying
philosophy governing corporations, and its legal consequences within the hybrid
legal system, have been evaluated in the various chapters of this book. Hopefully
such a study would contribute to a better understanding of the basic
characteristics of the Philippine hybrid legal system.11

PROPER ROLE OF CORPORATION CODE

The existence of codes, which historically has been regarded as the
touchstone of the civil law system, no longer seems a crucial distinction with the
common law system. Nevertheless, codes are a strong manifestation of the
pronounced variance between the prevailing ideologies in the civil and common
law systems, as regards the sources of positive law and the proper role of
judges.12
In civil law tradition, codes still tend to be treated, not as complete, but as
self-sufficient, in the sense that they embody a comprehensive system of norms
to be applied to all cases arising within the areas they propose to cover;
interpretation is thought of as a process of "enlarging the code out of itself." 13 If
the text fails to supply an answer to a problem, no matter of what type, the judge
will fashion a solution derived from the code itself, from the relation of its part,
from its structure or from its general principles.14 In the Philippines, there is a
tendency to base all discussions of legal issues on statutory provisions.
In fairly recent times, codes have begun to be promulgated in common law
jurisdictions, but these do not create codified law in the same tradition as in the
civil law system. The common law codes are always interpreted against the
background of the common law; they are not meant to abolish that law, but,
rather, consolidate and restate it. Neither are they "designed to embody the
whole law of relations, rights and duties; except in those instances where their
language clearly and unequivocally discloses an intention to depart from, alter, or
abrogate the common law rule concerning a particular subject matter, a section

11
The author has previously published in the Philippine Law Journal an article dealing on
the theory of judicial precedents under the Philippine hybrid legal system: Comparative Study of
the Judicial Role and Its Effect on the Theory on Judicial Precedents in the Philippine Hybrid
Legal System, 65 PHIL. L. J. Vols. 1 & 2.
12
See JOHN HENRY MERRYMAN, THE CIVIL LAW TRADITION 26-27 (1985).
13
GLENDON, GORDON & OSAKWE, COMPARATIVE LEGAL TRADITIONS 126-128 (1982).
14
"This more or less tracks the method of exegesis where the judge is merely to apply the
text of the law as the conscious will of the legislator, or, where the text is obscure, to discover the
legislative intent, the legislative history of the text and the accepted doctrine at the time when the
law was adopted were first to be examined. If this research failed to reveal the legislative intent,
the judge is to find a solution by the application of logical processes to the written text, namely,
reasoning by analogy, reasoning a contrario, and, most important, reasoning by induction to find
the general rules, and by deduction, to apply the general rules to a particular case." Arthur von
Mehren, Book Review, 63 HARV. L. REV. 370, 371 (1949).
of the code purporting to embody a common law doctrine or rule will be
construed in the light of common law decisions on the same subject." 15 A fortiori,
where the code remains silent, it does not affect existing common law at all. 16
It has been observed that even in the United States, where the legal
system has been more innovative and flexible than in England, no matter how
numerous and important statutes have become, they are viewed with some
discomfort, because they are not the normal expression of legal rule. Statutory
rules are only truly assimilated into the American legal system once they have
been judicially interpreted and applied, and it is then possible to refer to the court
decisions applying them rather than to the legislative text themselves. "Enacted
law and regulations are traditionally thought of as complement or rectifications to
a pre-existing body of law—the Common law in stricto sensu."17
Nevertheless, the important differences still recognized to exist between
the two legal traditions are as follows:18 (a) In the civil law system, authoritative
starting points for legal reasoning normally take the form of legislation; while in
the common law system, reliance is largely on judicial decisions; and (b) in the
civil law system legal propositions are stated more abstractly and systematically
than in the common law system; the former also generally places greater value
than does the latter on coherence, structure, and high-level generalization.19
These distinctions result from the belief under the civil law tradition that
the sources of the law are primarily statutory, a belief however that is said to be
on the wane.20
If the Philippine were a purely civil law jurisdiction, then the philosophy
applicable to Philippine Corporate Law would be the general rule that law is a
"rule of conduct intimately linked to ideas of justice and morality;" and that the
task of formulating the law would pertain to a legal scholar who would be
absorbed more by the theoretical aspect and be less interested in their actual
administration and practical application.21

15
Ibid.
16
Ibid; see also DAVID, MAJOR LEGAL SYSTEMS IN THE W ORLD TODAY (1985) at p. 450.
17
DAVID, supra note, at p. 407-408.
18
VON MEHREN, LAW IN THE UNITED STATES, at p. 3. A third distinction is included in Prof. Von
Mehren's work: In the civil law system Roman influence was various and profound; while common
law system was little influenced by Roman law.
19
Although the "starting point" distinction is important, it is not by itself satisfactory, since it
does not tell us if from distinct starting points, the modes of legal reasoning traject to basically the
same resolution of achieving justice for the same legal problem. Both civil law and common law
systems, in their respective modes of legal reasonings, seek to achieve resulting justice in their
processes; nevertheless, the process that each employs varies, and, consequently, so may the
qualities of the results. The main distinctions between the legal minds in both systems are the
ideology and the legal attitude in the sources of the law and the limits pressed upon the use of
such sources.
20
Merryman points that the present civil law system recognizes three sources of law,
namely, statutes, regulations, and customs, with the listing traditionally thought to be exclusive
and arranged in the descending order of authority, and customs thought only to fill statutory gaps.
MERRYMAN, CIVIL LAW TRADITION, supra, at 22-23.
21
DAVID, supra, at 22.
 On the other hand, if we were to isolate and compartmentalize Philippine
Corporate Law as being wholly governed by the common law system, then the
Corporation Code and other companion statutes could be looked upon as a set
of legal rules meant to provide solutions to trials, rather than as a code of general
rules of conduct for the future. The Code would then be much less abstract than
the legal rules in civil law system.
However, in a hybrid legal system, the solution is not so simple. When a
legal system is installed in a given state, it tends to permeate the entirety of the
legal system. This results from the fact that the same legal actors act in most
branches of the law, be they private or public laws. In most national legal
systems, there may be a dominating set of legal traditions that is continually
influenced by legal developments from other jurisdictions. Even as the "foreign"
elements are imported into the prevailing system, how they metamorphose and
transform are in great part dictated by the system's underlying legal philosophy.
This is the situation found in the Philippine legal system.
It must be emphasized, therefore, that Philippine Corporate Law is a
transplant from United States common law; and though we have a Corporation
Code that provides for statutory principles, Philippine Corporate Law is
essentially the product of commercial developments. Much of this development
can be expected to take place by way of jurisprudential rules that try to apply and
adapt corporate principles to changing concepts and mechanisms within the
world of commerce. The statutory principles embodied in the Corporation Code
should therefore be considered as dated rules or legal expressions of approved
corporate practices, since they hark back to a time when such principles were the
prevailing view, or at least the general controlling influence. Unless the statutory
provisions so clearly state, such provisions are by no means be taken to restrict
and define future developments.
In other words, the high regard with which we hold the Civil Code cannot
also be accorded the Corporation Code. True, both sets of codes represent the
people's will, expressed through their Legislature, of the fields that they cover.
Nevertheless, the difference in their coverage also dictates the difference in
treatment of the two codes. The Civil Code is meant to regulate private relations
of members of civil society, determining their respective rights and obligations. 22
The reverence and respect we place upon the Civil Code is justified by the idea
that it embodies "timeless truths" since it goes into the very essence of man and
his relationships. Through different periods in time, the essence of man does not
change, and the basic relationships that result likewise do not change.
On the other hand, the Corporation Code is meant to be a collection of
rules governing only a particular medium of doing business in the Philippines, the
corporation, and which actually expresses in statutory form the accepted practice
as borne out by jurispruduential rules. Our Corporation Code therefore
constitutes an attempt by Legislature to reflect, at the time of its passage, some

22
TOLENTINO, CIVIL CODE OF THE PHILIPPINES, Vol. I, 1990 ed., p. 11.
of the prevailing accepted practices and customs of businessmen regarding the
corporate vehicle.
But commercial practices evolve, and so too must the commercial media
employed, as well as the legal principles and concepts applicable thereto.
Business dynamics are characterized by swift adaptation in the face of
technological, scientific, and social developments. To consider therefore the
Corporation Code as embodying eternal truths is folly; reverence to the
provisions of the Corporation Code should be upheld only insofar as it continues
to be relevant to the needs of business and commercial transactions.
Of course this is not to condone anarchic transgression of such provisions
of the Corporation Code as one considers no longer acceptable or practical.
Rather, it is the treatment of, and reverential attitude towards the Code, that must
be defined. Philippine Corporate Law must evolve a philosophy that allows both
flexibility and stability.

ROLE OF CORPORATION IN BUSINESS AND SOCIETY

The corporation as a medium of doing business evolved within the
western free market system. In the free market, the role of the public sector is to
produce "public goods," prevent and correct market failures, and redistribute
wealth. The private sector is supposed to do everything else. The traditional view
of Corporate Law is to focus problems on the "corporation and its decision
makers." The corporation and the doctrinal pronouncement related thereto are
therefore the products of business and technological impetus, and rarely the
other way around.
Clark opines that the corporate vehicle flourishes best in a society where
the distribution of wealth, although by no means equal, is not extremely lopsided,
so that large amounts of capital needed to launch and sustain large business
enterprises must be collected and aggregated into usable pools.23 Business must
solicit investors on a mass scale, and not merely negotiate privately with a
handful of very rich people.24 However, Philippine society does not yet enjoy an
acceptably even distribution of wealth, and so the role of the corporation may be
quite be different. Consequently, the corporation is used as the Government‟s
tool to redistribute wealth or to undertake activities that are geared towards the
public good. These are demonstrated by provisions of the Corporation Code on
non-stock corporations, and the supporting tax incentives for contributions and
donations to such eleemosynary entities; the passage of a specific statute
governing cooperatives; and clarifying the power of corporations, through their
boards, to make reasonable donations to charity and provide for employee
gratuities.
Consequently, while the idea of the corporation originally took roots in the
western free-market system, the corporate set-up in the Philippines rests on a
23
CLARK, CORPORATE LAW, (Little Brown and Company, 1986 ed.), p. 3.
24
Ibid.
very different foundation, with the Philippine Constitution espousing both free
market and socialist principles, with the State intervening into private properties
for the greater good.

CORPORATE SOCIAL RESPONSIBILITY

The role of the corporation in Philippine society depends on the social
philosophy ascribed to such a medium. In an important sense, this all depends
upon the social or moral orientation of the society upon which the business
medium has to operate.
There are three (3) views from which to judge the proper role of the
corporation in business and society, thus:

(a) From the viewpoint of the State treating the corporation as

its creature;
(b) From the viewpoint of businessmen and investors, who view
the corporation as the medium by which to pursue
commerce and to whom the bottom line is the maximization
of profits; and
(c) From the viewpoint of society, which realizes that
corporations consume resources, and for which reason it is
expected to bear some social responsibility or at least
behave as a good corporate citizen.

Which view has become the primary influence in our society's perception
of the corporation, necessarily dictates the molding of Philippine legal philosophy
towards the corporation.
It is believed by certain sectors of Philippine society that "private
enterprise must discharge its social responsibility towards society in a way which
befits its unique competence. It should involve itself more and more in social
development for the total well-being of the nation."25 It is believed that "[f]or an
Asian company, corporate social responsibility is part of a social contract with the
community [and that] [t]he company observes this unwritten covenant not out of
fear of being vulnerable to criticism or any untoward action, but because it does
business with an innate social conscience."26
One author holds that "the real and obvious truth about private
corporations is, that once they have voluntarily agreed to do business in a
community, they thereby become at once members of that community, with
duties and obligations which cannot be far different from the duties and

25
Statement of Commitment of the Philippine Business for Social Progress.
26
Soriano, Andres III, Beyond Being A Mere Contributor of Funds, BUSINESS W ORLD
PUBLICATION ON CORPORATE CITIZENSHIP (1993).
obligations ordinarily expected of members in an organized, progressive, and
progressing society."27
In an association such as the PHILIPPINE BUSINESS FOR SOCIAL PROGRESS,
the top corporations of the Philippines have pledged to set aside out of their
operating funds an amount for social development equivalent to one percent
(1%) of the each year's net profit before income taxes, of which twenty percent
(20%) shall be delivered to a common social development foundation, which will
manage and allocate it.28
Nowhere in the Corporation Code does it expressly say that profit
maximization is the primary role of the corporation, or the fundamental duty of the
board; but these are quite obvious from the basic set-up of the corporation, and
from provisions covering the same. The norm of profit maximization provides a
better monitoring mechanism, and encourages investors to invest in the
corporation.29 The fact that our Corporation Code provides a special chapter for
non-stock corporations does not itself mean that business corporations should be
without social conscience or social responsibility, just as the existence of priests,
nuns, and social workers in society should not preclude ordinary citizens from
making benevolent gestures. Likewise, even the business judgment rule will not
shield directors and officers from personal liability in engaging in activities that
are clearly geared towards profit maximization, when such would be immoral or
unlawful.
Yet the extent to which the notion of "corporate social responsibility"
actually shapes the legal philosophy behind Philippine Corporate Law is still an
open question. Philippine Corporate Law is meant to cover basically the main
norm that the corporation is a vehicle for businessmen and investors; however,
our corporate philosophy does suggest clearly that our business corporations
should have a social conscience. This is obvious from provisions now expressly
allowing the board of directors of corporations to "make reasonable donations,
including those for public welfare or for hospital, charitable, cultural scientific,
civic, or similar purposes."30

27
Guevarra, The Social Function of Private Corporations, 34 PHIL. L.J. 464 (1959). "So,
some men are beginning to realize that private corporations are not strictly private, that they do
not exist solely for their own benefit, but that they are deemed legitimate members of an organic
society in which they move about. They may freely do things, in spite of the legal limitations
surrounding a corporate entity, if such an act is intended and will directly benefit the community.
In other words, the doctrine of ultra vires does not apply, and should not be applied, to acts done
in favor of the public. Society is a living, growing organism, and its amelioration is a function of all
its members, whether natural or juridical." Ibid.
28
Ibid.
29
This is the view that Clark terms as "dualism" or "traditionalist view" which regards the
private and public sphere as having distinct functions that ought to be kept distinct. Therefore a
corporation's directors and officers have a fiduciary duty to maximize shareholder wealth, subject
to numerous duties to meet specific obligations to other groups affected by the corporation.
CLARK, ibid, at pp. 677-679.
30
Sec. 36(9), Corporation Code.
 Except for such isolated provisions, the Corporation Code has not gone
all-out in pushing corporations to assume social responsibility as an integral part
of their functions. In fact, it is other statutes, such as our tax laws, that encourage
corporations to undertake charitable work, where the legislature has sought to
imbue business corporations with a social conscience. This is because the
controlling mechanism in our jurisdiction is that corporate responsibility is better
addressed and monitored by making profit-maximization the core of our
corporate legal philosophy. Other relationships that have to do with corporations
are better served by other disciplines, such as labor laws, torts, criminal law, and
environmental laws.

ROLE OF CORPORATIONS IN PHILIPPINE SOCIETY

What is apparent from the various discussions in this book is that the
underlying legal philosophy of Philippine Corporate Law is that of dynamism in
the growth of the doctrinal bases upon which the corporate vehicle is to function:
that law is meant to grow and adapt itself not only from the statutory expression
of the State, but primarily also from case-law, which really constitutes the
workshop upon which many issues and innovations in Corporate Law would have
to be tested and applied. And it is case-law that emphasizes the commercial role
of the corporation, and the expediency and efficiency with which it can meet such
a role in our society.
Consequently, the Corporation Code, an inherently common law code,
must be interpreted against the background of the common law. It should not be
taken as replacing or even abolishing all rules and policies relating to Corporate
Law, but as consolidating and restating them. Neither should the provisions of
the Corporation Code be considered as having been designed to embody the
whole law of relations, rights and duties in a corporate setting; except in those
instances where its language clearly and unequivocally discloses an intention to
depart from, alter, or abrogate the common law rule concerning a particular
subject matter, a provision of the Code purporting to embody a common law
doctrine or rule should be construed in the light of decisions of the Supreme
Court on the same subject. Consequently, where the Corporation Code remains
silent on a particular issue or matter, it does not affect existing common law at all.
What these discussions indicate to scholars, jurists, and legal
practitioners, is that the provisions of the Corporation Code are not meant to be
the defining boundaries of the playing field of Philippine Corporate Law, but
merely constitute one of the guideposts; and that the playing field is large and
often-changing, and we must look with dynamism on changes upon which they
continue to improvise and innovate. The constant emphasis in various decisions
of the Supreme Court is that the corporate vehicle is only a means or medium
fashioned to allow members of society to enter into enterprise and to transact
businesses; a corporation is not an end in itself. Necessarily, the law governing
corporations must be guided by such an underlying philosophy that yields
necessarily to substance, rather than insisting on maintaining the form.
 This is best illustrated by decisions in the field of the ultra vires doctrine,
where in the realm of contract enforcement the ultra vires doctrine has met very
little success in enforcement, and has become more of a technical defense
raised by or against the corporation, but which courts have readily brushed aside.
Also, when a corporation has been defectively formed or has not been organized
as to endanger commercial transactions, the courts have tended to side-step
such a defect by various doctrines engrafted into the law, such as the de facto
corporation doctrine, or the corporation by estoppel doctrine. It is a pity that the
courts have to jiggle and juggle their way though the ultra vires doctrine in the
face of refusal of our legislators to update our legal provisions by making the
doctrine largely immaterial in our jurisdiction.
The courts have not equated the social responsibility of the corporation, if
it exists at all, to be as important as the business function thereof. In fact, aside
from certain specified allowances, such as expressly granting the right to give
charitable contribution, the duty accorded to corporate director and officers, is
essentially that of profit maximization.
What therefore is the Philippine legal philosophy—or for that matter, the
legal psychology—concerning Philippine Corporate Law? It is this: that a
corporation is more than a creature of the law, but essentially a creature of
commerce and business enterprise, granted by the State certain privileges to
allow it to achieve more efficiently its main function. Necessarily, the legal
practices and policies pertaining to the corporation must shift with the prevailing
and accepted business practices and development. The dynamics of business
development should prevail; and this can only be done through the dynamism of
jurisprudential rulings, when Legislature tends to lag behind economic and
technological developments.

THE IMPENDING DOMINANCE OF e-COMMERCE

The evolving philosophical approach to Philippine Corporate Law may well
be overtaken, by an impending deluge that would provide for a paradigm shift of
the most fundamental order, which could to a great extent make the corporation
as a business medium less important.
The main purpose of the corporate vehicle is to provide a legal medium by
which investments across the nation could be accumulated and handled by a
professional group of managers to undertake great ventures. Today, the
rounding-up of resources and investments across the land, and in fact across
international waters, is being achieved more and more by electronic commerce
through the facilities of the internet, thus giving rise to an e-commerce domain.
The evolving effect of e-commerce is to empower individuals to seek information
across the globe and to be able to reach any asset or resource by his own
individual engine of choice. e-Commerce has also allowed individuals and small
groups to be able to reach markets across national boundaries to offer their
goods or services without having to incur the high costs of a marketing network
presently employed by corporate enterprises.
 This “individual empowerment” that the internet has afforded to both
providers and users of goods and services, across international boundaries, and
with less government ability to regulate and interfere, would eventually
undermine the very role of corporations as the great organizers and providers for
goods and services. Investments would be flowing across world electronic
channels by the click of a mouse, and the attractiveness and effectiveness of e-
commerce making the role of corporate enterprises less pivotal in both national
and international scenes becomes more and more apparent by the
pervasiveness of such digital system.
The corporate enterprise has tended to work efficiently based on
hierarchical organization with the Board of Directors essentially being at the
pinnacle of the organization, with stockholders across the land being merely
passive investors. As it is becoming more apparent today, the global pace of
changes brought about by the digital system would make organizational
boundaries more fluid and community members will come from both inside and
outside the organization. The internet and other new communications technology
will be increasing productivity through organizations that would be more like
communities with flatenning structures rather than the traditional hierarchical
structures.31
Whereas the corporate entity was intended to build the confines of a
business walls and within those walls the enterprise could be organized and
operated effectively to intermingle commercially with the market, one writer has
observed that e-commerce actually must break down such walls, thus:

In the future, organizations will increasingly encourage

the formation of communities of interests that cross
organizational boundaries. Open Internet software will change
the whole communications paradigm. Organizations will tear
down walls and have a common intranet infrastructure running
across all of their systems. “Firewalls” will still be used to
protect proprietary information, but external networks, called
extranets, will be developed to reach out to people who are not
employees but are important stakeholders in the organization.
In a highly interconnected world, most new products and
services will not be developed in a vacuum. Customers and
suppliers, as members of communities of interest, will become
more involved in the product development and product
improvements process. The people who invest in the product,
build it, and use it all have one common interests—they want
the product to work! By creating a system where all key
stakeholders can efficiently provide ideas and feedback,
companies can greatly speed up and improve the
development process.

31
See the interesting write-up of James L. Barksdale, Communications Technology in
Dynamic Organizational Communities, in THE COMMUNITY OF THE FUTURE OF THE DRUCKER
FOUNDATION; Jossey-Bass Publishers, San Francisco, U.S.A., 1998 ed.
 The new technology is helping to bring about a whole
new attitude about how to communicate. Organizations of the
future will place a high priority on building communities of
interest that cross traditional boundaries of structure, system,
time, and space. Such community building can help in forging
the long-term relationships between people that provide the
needed stability for these organizations to prosper in a rapidly
changing world.32

It becomes imperative therefore that for Corporate Law to maintain its

relevance and importance in the commercial world, that it must continue to
evolve, and now perhaps must undergo a sort of paradigm shift to keep itself
relevant in the aftermath of the e-commerce revolution.

—oOo—

CORP. MANUSCRIPT\20-PHILIPPINE CORPORATE PHILOSOPHY\06-26-2000

32
Ibid, at p. 98.