Chapter XIII – Dividends/Purchase by Corporations of
Shares
Sec 43
— Sec 43: power of the corporation to declare dividends—-only the board
may declare dividends and only out of unrestricted retained earnings,
payable in cash, property, or stock to SHs of OCS
— Most important rights of a SH:
o Right to vote
o Right to proportional share of the corporate assets upon liquidation
o Right to share in the corporate profits
— Concept of Dividend
o 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 SHs
on demand or at fixed time.
o It is payment to the SHs as a return upon their investment
o All SHs of the same class share in it is proportion to the respective
amounts of stock which they hold
— Defn of Dividend: portion of corporate profits which is set aside for
distribution to the SHs in proportion to their subscription to the capital
stock of the corporation
— Power of the corporation to declare a dividend only out of unrestricted
retained earnings on the basis of outstanding capital stock held by SHs
Form of Dividends
Cash, property, or stock dividend
— Cash: most common form
o May be declared by the board under a formal resolution and does
not require the approval or ratification of the SHs
o Amount to be received by SH as his share of the dividends would
depend on the amount of stock held by him, regardless of whether
or not he has paid his full subscription
 But if shares become delinquent, any cash dividends due will
first be applied to the amount of the delinquency (if stock
dividends, he cannot get them until he has fully paid his
subscription)
 Cash dividends due on delinquent stock shall first be applied
to the unpaid balance on the subscription plus costs and
expenses
o Revocable before the announcement to the SHs of the declaration of
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dividends; as soon as cash dividends are publicly declared, SHs
have the right to their pro rata shares
o No par shares: must be fully paid to be considered as issued
 Thus holders of no par shares not fully paid are not
entitled to dividends
— Property: SEC rules
— Stock: distribution to the SHs of the company’s own stock
o 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
o It is actually two (2) things:
 A dividend, and…
 … the enforced use of dividend money to purchase
additional shares of stock at par
o stock dividends require:
 board resolution
 ratification of SHs representing 2/3 OCS
o Villanueva: stock dividends, unlike cash or property dividends,
may be declared out of premium surplus or paid-in capital
o Corporate profits are transferred to capital stock and shares
representing the increase in capitalization are distributed
o Stock dividends cannot be declared without first increasing the
capital stock, unless there are still unissued shares
o Although number of shares increase, their investment and
proportional interest remain the same
o Cannot be issued ifo persons not SHs
— Liquidating dividends: form part of the capital, and cannot be
declared from the unrestricted retained earnings
Nielson & Co v Lepanto Consolidated Mining Co. F: MR filed by
Lepanto Corp which involves an agreement subsequently extended, as to the
compensation of Nielson (a promoter?) which provides that he is entitled to receive
10% of any dividends declared and paid by Lepanto.
Nielson is not a SH of the corporation. During the extension period the corporation
declared dividends worth P3M. SC ruled that Nielson was entitled to the 10% of the
dividends paid and declared and Lepanto was ordered to issue and deliver to
Nielson shares of stocks as well as fruits or dividends accruing to the same. Lepanto
contends that payment to Nielson of stock dividends as compensation violates the
Corporation Law.
I: W/n the corporation can be compelled to issue and deliver to Nielson shares of
stock and the fruits thereof
H: Under the Code stock dividends cannot be issued to a person who is not a SH in
payment of services rendered. Nielson cannot be paid in shares of stock which form
part of the stock dividends of Lepanto.
The understanding between Lepanto and Nielson was simply to make the cash value of
the stock dividends as the basis for determining the amount of compensation that
should be paid to Nielson.
R: Consideration for shares of stock: (1) cash; (2) property; (3) undistributed profits.
A corporation may legally issue shares of stock in consideration of services rendered by
a person not a SH, or in payment of indebtedness, which is equivalent to issuing a stock
in exchange for cash. But a share of stock thus issued should be part of the original
capital stock of the corporation, or part of the stocks issued when the increase in
capitalization was properly authorized. In other words, it is the shares that are
originally issued by the corporation and forming the part of capital that can be
exchanged for cash or services rendered, or property—if the corporation has original
shares of stock unsold or unsubscribed, either coming from the original capitalization
or from the increased capitalization—these may be issued to a person already a SH.
But a share of stock coming from stock dividends cannot be issued to one who is not a
SH of a corporation.
A stock dividend is any dividend payable in shares of stock of the corporation declaring
or authorizing it—a distribution of shares among SHs, as dividends. It is actually 2
things: (1) a dividend; (2) the enforced use of dividend money to purchase additional
shares at par. When a corporation issues stock dividends, it shows that the
corporation’s accumulated profits have been capitalized instead of distributed to the
SHS or retained as surplus. Far from being a realization of profits, it tends rather to
postpone said realization, in that the fund represented by the new stock has been
transferred from the surplus to the assets and are thus no longer available for actual
distribution. It really adds nothing to the interest of each SH; the proportional interest
remains the same. It is the civil fruits of the original investment, and to the owners of
the shares go the fruits.
Although Lepanto says that the value of the dividends declared should be the basis for
determining the amount of compensation due to Nielson, it does not mean that the
compensation should be taken from the amount actually declared as cash dividends to
be distributed to the SHs. Otherwise there would be a dilution of the dividend that
corresponds to each share of stock held by the SHs.
Decision modified….Nielson to get P300,000 in cash, as equivalent to 10% of
thew value of the 3M stock dividend.
Source of Dividends
— Source: unrestricted retained earnings
— Def’n of unrestricted retained earnings: the undistributed earnings
of the corporation which have not been allocated for any managerial,
contractual, or legal purposes and which are free for distribution to the
SHs as dividends
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— (property or cash)
 Any and all items included in retained earnings—income
of all types, prior period adjustments, net income, special
distribution to SHs—can be declared as dividends, unless
restricted
 All other items not falling within the term “retained
earnings” are necessarily included in “capital” and are
unavailable for dividend declaration—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 assets, etc
o Difference between the total present value of its assets after
deducting losses and liabilities and the amount of its capital stock
o Balance of net worth or net assets after deducting the value of
the corporation’s outstanding stock
o Refer to the undistributed earnings or profits realized by the
corporation from its business
o If not reserved or not set aside by the board for some corporate
purpose or for some other legal or contractual purpose, such
retained earnings are unrestricted
o There must be an actual bona fide surplus to justify declaration of
dividends
— Def’n of retained earnings: the net accumulated earnings of the
corporation out of transactions with individuals or firms outside of the
corporation; sometimes referred to as earned surplus. Includes:
o earnings from sales of goods and services of the corporation in
the ordinary course of business
o earnings from sale of corporate property other than stock trade
o does not include premium on par value stock
 where par value shares are issued and SHs pay a
premium therefor over par, a paid-in surplus results.
 RP law does not allow paid-in surplus to be declared as
dividends either as cash or property, because 43 requires
dividends be paid out of unrestricted retained earnings
 Paid-in surplus is considered paid-in capital
o does not include treasury stock—considered as contractions or
expansions of paid-up capital
o does not include donations
— Sec 6: consideration for no-par value stock must be treated as capital
and is not available for distribution as dividends
o This is because SHs intended that the consideration for no par
value shares shall constitute the basic business fund of the
corporation to be permanently devoted to the corporate business
 o Retained earnings = Assets – (Liabilities + Legal capital)
— If subscribed shares have not been fully paid, the unpaid portion is a
receivable and is an asset of the corporation
o Any excess would be surplus or earnings for dividend declarations
o Net assets(+unpaid portion of subscribed shares) – total par value of
subscribed shares = earnings =dividends
— If watered stock exists, subscriber would be liable for the difference
between what he paid and the par value
o This liability of the SH is a receivable of the corporation
o Net assets (+receivable from SH) - total par value of subscribed
shares = earnings = dividends
o expectancy).
— Board has discretion to appropriate retained earnings for designated
purposes
— Agreements with creditors may also provide for restrictions on dividends
distributions
Berks Broadcasting v Craumer. F: Craumer et al together with one Landis (4
people), are the incorporators and directors of the Berks Broadcasting Company. The
books indicate that the stock is fully paid (auth. Capital stock = $100K) , through cash
($5K each) and the fixing of a value of $80K upon an asset denominated “Franchise and
Promotion Expense.”
A year later, this was written off and in its place were substituted 1) $50K as an amount
“Due on Unpaid Stock Subscriptions” -- (each SH paid $4.2K reducing the item to
$23,300. Then it was cancelled altogether and was replaced w/ the entry “Goodwill
and Promo Expense) and 2) “write-ups” or increases in the valuation of fixed assets
over and above depreciation costs, totaling $30K.
Balance sheet showed assets in excess (“surplus”) of liabilities iao $2,545.94. However,
the existence of that alleged surplus depended on the inclusion of the assets of the
write-ups of $26K; otherwise, there would be a deficiency to the extent of almost $24K.
Directors sold their stock, and declared a series of dividends totaling $13K based on the
earnings of the company of 12K+ plus the “surplus.”
The corporation, now under the control of new SHs, sued the directors to recover the
$13K which was allegedly unlawfully declared and paid out as dividends.
H: GR: Capital of a corporation must not be impaired in any manner
Exception: impairments involuntarily made through losses resulting from business
operations. It is illegal to declare and pay dividends from other than a surplus
consisting of an excess in the value of the assets over the aggregate of the liabilities and
the capital stock. The object of this prohibition is to afford a margin of protection for
creditors in view of the limited liability of the SHs, and to protect the interest of the SHs
themselves by preserving the capital so that the purposes of the corporation will be
carried out.
The surplus must be a bona fide and not an artificial or fictitious one; it must be
founded upon actual earnings or profits and not be dependent for its existence upon a
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theoretical estimate of an appreciation in the value of the company’s assets. Such
appraisals and conjectural valuations cannot be considered for the purpose of
dividends because are subject to market fluctuations, and are merely anticipatory of
future profits, and may never be actually realized as an asset of the company.
It is thus clear that since the “write-ups” of $26,000 represented an unrealized
appreciation in the value of the fixed assets, their inclusion in determining the
existence of a surplus from which dividends might be declared was unlawful, and
since when eliminated there would be not a surplus, but a deficiency in capital.
---Sir: so long as the assets (even if they appreciate in value) are not yet disposed,
dividends cannot be declared based on the appreciated value (because it is still an
CAMPOS: Since our Corpo Code allows dividends only out of unrestricted
retained earnings, an increase in the value of existing assets cannot be a source of
even a stock dividend.
Lich v US Rubber. F: Lich is a holder of 300 non-cumulative PS of United States
Rubber Company. She seeks to enjoin payment of a dividend on common stock
declared.
During 3 fiscal years (1935-37), the corporation experienced a deficit of close to
$24M, $17M and $10M for each of the 3 years, and a corresponding impairment of
capital. In each of these years, the annual net earnings were applied to the deficit,
and no dividends were declared.
The company underwent a reconstruction of its capital structure. It issued, in lieu of
no-par value CS, CS of par value $10. In the next 3 years the deficit was reduced and
cancelled and net profts were made available for dividends for non-cumulative PS,
but not common shares.
The company then declared a dividend, from the net profits for the current year and
from no other fund, on both PS and CS. In the deficit years, the company
maintained adequate reserves, which remain intact even when dividends were
declared. Lich contends that the preference of PS holders as to dividends extends
not only to the current year, but to the prior deficit years, and dividends cannot be
paid out to CS holders until dividends are paid to PS on the years in question and
the arrearages must be paid in full.
H: the doctrine of the Cast Iron Pipe Cases, based on sound equitable principles, is a
departure from the GR that holders of non-cumulative preferred stock lose with the
close of the fiscal year all rights in the undistributed net profits of that year. It
preserves to the holders of the non-cumulative PS their right in the undivided net
profits withheld from them and retained in the business, but otherwise available for
the payment of dividends. The right to earned dividends is not extinguished upon
the mere passing of the fiscal year. The doctrine, however, cannot be extended by
implication beyond its clear intendment.
It may be generally stated that as to the payment of dividends the holders of PS are
in no better position than the holders of CS except as to priority of payment.
Dividends on PS are not payable absolutely and unconditionally, but only out of the
sources designated by law.
The payment of dividends on non-cumulative PS is further circumscribed by the
certificate of incorporation and stock certificate; dividends on such stock are payable
only out of net profits and for the years in which the same were earned.
Thus the right of non-cumulative PS is conditional upon: (1) accrual of net profits (2)
retention of the same in the business. If there are no net profits, the deficiency is not
chargeable against the net profits of succeeding years. The test of applicability is W/N
there were in the years in which dividends were not declared, net profits available for
the lawful declaration and payment of dividends, but withheld from non-cumulative PS
and retained in the business. Net profits connotes clear pecuniary gain remaining after
deducting from gross earnings the expenses incurred. It is not synonymous with annual
net earnings, which may be productive of net profits, or reductive of the deficit.
In this case there were in 1935-37 no net profits to which the inchoate right to dividends
could have attached. There was a substantial deficit in each of the three years which
greatly exceeded the annual net earnings of the corresponding year. It is manifest
therefore that the annual net earnings of each year resulted, not in a profit, but in a
reduction of the deficit.
There was no source from which dividends could be paid out lawfully; the payment of
dividends under such circumstance would have been unlawful. The corporation is
charged with the duty of maintaining the integrity of the capital, on the faith of which
credit was extended, as a trust fund for the security of creditors.
When a man buys stock instead of bonds, he takes a greater risk in the business. No one
suggests that he has a right to the dividends if there are no net earnings. But the
investment presupposes that the business is to go on, and therefore even if there are net
earnings, the holder of stock is entitled to have a dividend declared only out of such part
of them as can be applied to the dividends consistently with a wise administration of a
going concern. If the annual net earnings of a corporation are justifiable applied to
legitimate corporate purposes, such as payment of debts, reduction of deficits, and
restoration of impaired capital, the right of non-cumulative preferred SHs to the
payments of dividends is lost. The payment of dividends from annual net earnings,
when the liabilities of a corporation exceed the assets, would be in derogation of the
rights of creditors. The payment of dividends under such circumstances, while debts
accrue, would be contrary to sound business practice.
Dividend Declaration discretionary with Board
— GR: The decision to declare dividends are matters addressed to the
business judgment of the board
o The fact that profits have accrued does not necessarily impose upon
the directors the duty to declare them as dividends
o Courts have no power to compel them to make the distribution of
dividends in the absence of BF or fraud or clear abuse of discretion
o Unless tainted with BF, fraud, or gross negligence, courts will not
interfere, and SHs will be bound
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 If for expansion of business, SH cannot complain
 If board capitalizes profits instead of distributing them
(i.e. issues stock dividends), requires approval of at least
2/3 OCS
o But the board cannot abuse their discretion and accumulate
profits unreasonably
o Remedy of SH: file an action in court to compel payment of
dividends
 Burden of proof lies with the SH
 Mandamus is not a proper remedy since the SH has no
individual interest in the profits of a corporation until and
unless a dividend is declared
Retention of excess profits
— 43: stock corporations are prohibited from retaining surplus profits in
excess of 100% of their paid-in capital stock
— Exceptions:
o When justified by corporation expansion projects approved by the
board
o When corporation is prohibited under any loan agreement with
any financial institution or creditor and without the latter’s
consent
o When such retention is necessary under special circumstances
Keough v St Paul Milk. F: Action to compel corporation to declare a cash
dividend, on the ground that those in charge of the corporate affairs (the Ryans) are
wrongfully and needlessly withholding profits available for cash dividends and
conspiring to retain them for their benefit and to the prejudice of the majority. The
business, assets, liabilities of the partnership were exchanged for 597 shares of the
St Paul Milk Co. The 597 shares represent the only stock issued until the stock
dividend. By amendment, the authorized capital was increased to $300K. A 6-to-1
stock dividend was declared and the amount necessary to cover the issued shares
was transferred from the surplus account to the capital account. When the
corporation paid out its first dividend, a total of $169,470 was distributed to SHs or
about a 335% return. There were no mortgages or liens or any other substantial
indebtedness. Sales are predominantly cash basis. Fixed assets were in good
condition. Wages were paid. The corporation had investments in bonds, CS in a
wholly-owned subsidiary, but the merchandise inventory was small. TC held that a
liberal and reasonable capitalization and surplus was the sum equal to the original
outstanding stock plus 2/3 of the accumulated surplus, and that all sums in excess
were unreasonable and constituted a violation of the fiduciary relation. Keough et al
claims that the capitalization in 1936 by the Ryans of a large percentage of the
accumulated surplus without reason or necessity other than to keep it within the
corporation under the dominating control of the Ryans. The Ryans contend that the
capitalization was for avoiding possible federal taxes upon undistributed surplus. TC
found that the capitalization was to strengthen control of the Ryans over the
corporation and surplus to prevent a distribution of earnings.

Issue: WON corp can be compelled to declare dividends.
H: In this case, YES> The determination of w/n to declare a dividend is essentially a
matter of internal management. It is primarily for the corporate directors in their sound
discretion to decide, and judicial review may be secured when abuses contravening the
SHs rights manifest themselves. A court will not compel a dividend unless the directors
act fraudulently, unjustly, or unreasonably so as to impair the rights of the complaining
SHs to their just proportion of the corporate profit. Generally the mere fact that a large
corporate surplus exists is not enough to warrant equitable intervention. Ultimately the
test is an examination of the GF and reasonableness of the policy of retaining that
which is otherwise available for dividends.
The corporation did not have a reasonable need for the large surplus accumulated and
held as bonds or other easily liquidated assets. Inventory was small, cash turnover was
liquid, no substantial obligations, no expansion program, accounts for depreciation
were set up—in short, the surplus was easily available for dividends, if the directors so
elected to do so. The large surplus existed at the time the Ryans were receiving salaries
in excess of their worth and draining from the corporation money otherwise available
for dividends. The capitalization of the surplus did not serve a corporate need; it was
referable only to the desires and purposes of those in control to keep it under their
control and subject to their machinations.
Furthermore, fraudulent expense items and other anomalies point to the intent of the
directors. Generally directors are proper parties to determine whether a divided shall be
in cash of stock, and a court will not interfere with the exercise of their discretion; but
where it appears that the object was to primarily benefit those in whom the discretion
rests, equitable powers can be called into operation. Directors and officers of the
corporation owe SHs the active duty of honesty and GF in the transaction of the
business and in their dealings. While it is true that the court cannot ordinarily compel a
corporation to declare a dividend at the suit of a minority SH, yet where dividends are
withheld for an unlawful purpose—to deprive a SH of his rights—he may have the aid of
equity for adequate protection.
A stock dividend really takes nothing from the property of the corporation, and adds
nothing to the interest of the SHs. Its property is not diminished, and their interests are
not increased. Where profits clearly warrant payment would be proper, the SHs cannot
be cut off by a stock dividend when it purpose is wrongfully to keep the profits of the
business with the control of those dominating the affairs so as to be available to them.
Such action is oppressive and evinces BF sufficient to justify equitable intervention.
Dodge v Ford Motor Co. F: Action by John Dodge, a minority SH, against the
Ford Motor Company to compel the declarations of dividends.
--TC granted motion and ordered the payment of dividends.
-- At this time, Ford Motor Co had just concluded its most prosperous year of
operations. Demand for Ford cars continued. It could make and market 500,000 cars.
Sales of parts and repairs increase. It had assets of more than $132M, COH $54M,
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surplus of $112M.
-- Liabilities continue the corporation as a semi-eleemosynary institution, and not
as a business concern. Henry Ford himself testified that the company he built had
made too much money, had too large profits, and that a sharing of profits with the
public, by reducing the prices. It expected a profit upwards of $60M. Ford’s
defense was that its policy was to reduce the selling price of Ford cars while
improving their quality, with the goal of producing 1M cars per year.
There was a general plan for expansion of the productive capacity of the business.
Management decided not to reduce in the meantime the price, but to maintain the
same and accumulate a large enough surplus to pay for the proposed expansion of
plant and equipment. There was a large daily, weekly, monthly, receipt of cash. The
output was practically continuous and within a few days, turned into cash.
-- Dodge et al contend that the plan was to the selling price of cars should be
attained. Ford argues that although a manufacturing corporation cannot engage in
humanitarian works as its principal business, the fact that it is organized for profit
does not prevent the existence of implied powers to carry on with humanitarian
motives such as charity as are incidental to the main business of the corporation.
H: the plan does not call for and is not intended to produce immediately a more
profitable business but a less profitable one, with the apparent immediate effect to
diminish the value of shares and return to SHs. There is no doubt that certain
sentiments, philantrophic and altruistic, creditable to Ford, had largely influenced
the policy to be pursued by the company. There is an obvious difference between an
incidental humanitarian expenditure of corporate funds for the employees, and a
general purpose and plan to benefit all mankind at the expense of others. There
should be no confusion of the duties Mr Ford conceives as owed to the general
public and the duties which in law he and his directors owe to the protesting
minority SHs. A business corporation is organized for the benefit and profit of the
SHs. The powers of directors are to be exercise to that end. Discretion of directors is
to be exercised in the means to attain that end, and does not include the end itself,
through the reduction of profits or nondistribution thereof. It is not within the
lawful powers of the board to shape and conduct the affairs of a corporation for the
incidental benefit of SHs and for the primary purpose of benefiting others.
The Court however did not interfere in the proposed expansion of the business of
Ford Motor. It is recognized that plans must often be made for a long future, for
expected competition, for continuing as well as an immediately profitable venture.
The experience of FMC is evidence of capable management of its affairs. But it
noted that the company took from the public money required for its plan but that
the considerable salaries of Mr Ford were not diminished.
--It is true that a considerable cash balance must be at all times carried by such a
concern. But, cash is coming in and output immediately converted into cash… So, it
would appear that, accepting and approving the plan of the directors, it was their
duty to distribute a very large sum of money to stockholders.
Preference as to Dividends (SEE CHAP XI—FINANCING)

— AOI may provide for stocks with preferences in the distribution of
dividends
o Voting
o Non-voting
 Cumulative
 Non-cumulative
Burk v Ottawa Gas & Electric Co. F: Suit by preferred SHs of Ottawa Gas,
demanding an accounting of all property and assets and declare and payment of
dividends. Burk claims that earnings of the business were such that the directors owed
them an imperative duty to declare a dividend.
--Ottawa Gas maintain that the corporate has been unable to declare a dividend because
its funds were exhausted by expenditures which it was obliged to make, which was for
the extensions of the company’s plant. TC ruled the extensions necessary and for the
betterment of the plant and its patrons.
H: Reversed and remanded to TC. Under the certificate of PS, the conditions which the
holder may demand a dividend depend on the precise terms of the contract upon which
it is issued.
The fair interpretation of the contract between the corporation and the PS holder is
that if in any year net profits are earned, a dividend is to be declared. To hold that the
board has a discretion to declare or not a dividend when it has funds it can use is to
hold that one of the parties to a contract has the option to pay something to the other or
not, at its own election since, if the dividend is not declare, the benefits of accumulated
profits are practically lost to these SHs. Such a construction should be avoided.
The directors owe a positive duty to pay a dividend to the PS whenever in any year there
were net profits available. Inasmuch as the only possible source of profit to the
preferred SH from his investment is the distribution of earnings in the year in which
they accrue, he has the right to insist that an accounting be taken annually, and that the
surplus of one year, available for a dividend, shall not be carried over to meet a possible
deficiency of the next.
The holder of PS, is however not generally a creditor until a dividend is declared, but if
a dividend ought to have been declared in a certain year to such SHs, they should be
regarded as creditors to such extent from such time or times. The company’s contract
with the PS is not to pay him at all events the amount of 6% of the net profits, but to
declare a dividend on that basis. The obligation of the corporation to pay dividends on
the PS out of the yearly net profits is subordinate to whatever obligation it owes to the
public. Therefore if it was necessary for the corporation to use the surplus in any year to
make extension to which patrons were entitled, a dividend for that year would have
been excused.
When Right to Dividends Vests; Rights of Transferee
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— Right vests as soon as the dividends have been lawfully declared by
the board; from that time on, it becomes a debt owing by the
corporation to each SH and no revocation can be made
— Whenever such dividend is declared, or the declaration of dividends
is made, the corporation becomes a debtor and the right of the SH to
distribution, unless a record date is specified, becomes fixed by the
declaration.
o The amount due to a SH belongs to him and it cannot without his
consent be reverted to the surplus account of the corporation
— Whoever owns or is the SH-of-record of the stocks at the time of
declaration also own the dividends
o GR: Subsequent transfer would not carry with it the right to
dividends
McLaran v. Crescent Planning Mill Co. F: McLaran is the administrator of
the estate of Humber, owner of 57 paid-up shares of stock of the Crescent Planning
Mill Co. and director of the company as well as President. The company declared a
dividend of 6%, divided into 4 payments of 1/1/2% each. No other action taken to
set apart a fund out of which to pay the dividend although the company was solvent
and had adequate surplus. Nonetheless the officers proceeded to pay Humber and
other SHs the 1st installment of the dividend. The next installment was not paid, the
board having discovered an error in the financial statements of the company such
that its assets were overstated by $6000. The board then voted to rescind and recall
the order paying out the dividends and defer the payment indefinitely. The company
was still perfectly solvent and had amply funds to pay the dividend. Humber
demanded payment of his dividend but was refused on account of the recent action
by the board. The corporation contends that there was no declaration because the
board failed to set aside funds for the purpose, and that by virtue of the resolution
its former action was rescinded and the payouts were recalled and put on hold.
I: W/n the mere declaration of a dividend by a solvent corporation creates a debt in
favor of the SH
I: W/n the corporation, having declared a dividend and paid one installment, turn
around and rescind installments yet unpaid
H: Case concerns the declaration of a cash dividend by a solvent corporation
possessed of ample undivided profits and surplus. The corporation contends that a
resolution declaring a dividend is not sufficient to create a dividend or create a debt
from the corporation in the absence of further action in setting apart a fund for the
purpose. The court held that if the declaration of the dividend is fairly and properly
made, out of profits existing at the time it was declared, the relation of debtor and
creditor is thereby established between the corporation and the SHs for the payment
of the dividend to the SH. The declaration of dividends operates as a severance
thereof from the stock in the general mass of the corporate property, and raises an
implied promise on the part of the corporation to pay the SH the amount of the
dividend. Action on the part of the corporation in setting aside the fund for the
specific purpose constitutes such moneys as a trust fund in the hands of the
corporation for the use of the SHs and in the event of bankruptcy of the corporation, the
SHs are not required to go in pro rata with the general creditors for such unpaid
dividends, but may proceed as against a trustee on account of such trust fund. Mere
declaration of the dividend, without more, by competent authority under proper
circumstances, creates a debt against the corporation ifo the SHs the same way as any
other general creditor of the concern. The setting apart of a fund thereafter, passes one
step further toward securing the payment of the debt to the SH.
Thus the mere declaration of the dividend itself, without the setting aside of the fund,
creates a debt, and the act of declaring a dividend from the stock and corpus of the
corporate property is ipso facto, in and of itself, the setting apart, setting aside and
segregating such dividends and it creates an immediate right of the SH to demand and
recover the same when due.
Liability for Illegal Dividends
1. Directors
— GR: not liable personally
— Exception: BF, negligence, willful violation of the law
— If liable: liable to corporation and creditors upon insolvency
31
2. SHs
— GR: in the absence of an express provision of law, an innocent
SH is not liable to return the dividends received by him out of
capital, unless the corporation was insolvent at the time of
payment
— SHs who received wrongfully or illegally declared dividends can
be held liable to refund them to the corporation or its creditors
o Why? In receiving the dividends, they do not act in a
corporate capacity and is not a ratificatory act of the SHs
Steinberg v Velasco: In determining the legality of declared dividends, the
existence of unrestricted retained earnings alone cannot be the test. The
existence of “surplus profits” alone does not suffice; the corporation should
have an actual bona fide surplus from which the dividends could be paid,
and the payment in full at the time would not affect the financial condition of
the corporation
Remedy in case of illegal distribution of dividends: directors in BF may be
held solidarily liable for the reimbursement of the amount declared as
dividend
Purchase by corporation of its own shares
7
Sec 41: expressly empowers the corporation to acquire its own shares for
a legitimate corporate purpose, provided it has unrestricted retained
earnings to cover the shares to be purchased.
o So long as the acquisition of shares does not exceed the
unrestricted retained earnings, the corporate creditors are
deemed protected
o Equivalent to subjecting dividend declaration to the extent of
unrestricted retained earnings
o Acquired shares by the corporation become treasury shares
Corporate purposes:
— To eliminate fractional shares
— To collect or compromise an indebtedness to the corporation arising
out of an unpaid subscription, in a delinquency sale, and to purchase
delinquent shares sold
— To pay dissenting or withdrawing SHs entitled to payment (appraisal
right)
1. Limitations on power: proper purposes and existence of
surplus
— A corporation has the power to purchase its own stocks,
provided…
o … that payment is made out of surplus profits, i.e.
unrestricted retained earnings, and…
o … it is for a legitimate purpose…
o … subject to appraisal right of SH under 81
— shares reacquired by the corporation become treasury
shares, which may be declared as property dividends to be
issued out of retained earnings previously used to support
their acquisition, provided that the amount of the retained
earnings has not be impaired by losses
— reasons for purchase of own shares:
o deadlocks in close corporations (no need for unrestricted
retained earnings)
o SHs may want to keep the corporation close and prevent
unwelcome strangers
o Corporation may want to exercise contractual right to
redeem PS or bonds, regardless of URE (Sec 8)
Sec 41
2. Remedies in case of improper purchase
— As to creditors: those prejudiced by the repurchase by an
insolvent corporation can recover against the selling SHs by
recovering the consideration paid
o Directors can be personally liable for approving the
repurchase in BF or with negligence (Sec 31)
— As to SHs: it reduces what is due them as dividends
o Repurchase can be discriminatory to the other SHs
o Shift in voting control
o Remedy: right of action against the directors under Sec 31

Dividends: cash—director’s approval sufficient;

stock/property—2/3 approval OCS
GR: only those who contributed are entitled to
dividends;
contributions become part of corporate assets; no
declaration of dividends, still corporate property
GR: dividend declaration discretionary with the board
(23)
Why? Unrestricted retained earnings are owned by the
corporation
Cash v stock/property dividend; willing to risk a stock
dividend (more often than not, stock prices drop when
stock dividends are declared)
Unrestricted retained earnings represent fruits of the
investment money; corporation doesn’t need the
money.
As anPrior to declaration,
investor, verify
I am entitled if any
to return!
retained
Services earnings
rendered can beform part
used asof the
consideration for
assets of the corporation
subscription
GR:paid
If 100% disposition of corporate
up capital, assets= But it does
declare dividends!
authority
not mean of the
that the board
capital stock is fully-paid up (could
Reasonable
only be 25%) exercise of judgment=
board may opt not
43: limitations—needs ofto declare contractual
company,
Remedy
obligation of SH: mandamus
(ex IPO)
Burden
but need not of proof:w/
comply SH43;
to other
proveways to do it…
… butcorporate
corporation does
hasnot
to need
contendit with an opposing
SH Declaration of dividends: once
cash: declared,
just boardSH does not
approval obtain shares
required
stock:ofdeferring
ordinarydividends;
creditor plowed back as corporate
Cash:cannot
funds; resultsyet
in recovery
be enjoyed of investment
and possibility that it
SHnever
can need benotrealized
wait for dissolution…
… but does
property: samenotasguarantee
stock divs;that
riskitthat
will be
it could be 0%
paid
book value
non-cash: SH conformity must be secured
why? Deferring payment of cash prolongs
exposure to risk of SHs dividends
8
stock dividends: plowed back into
corporation