Nielson & Co. Inc. vs. Lepanto Consolidated Mining Co.

[GR L-21601, 28 December 1968]

En Banc, Zaldivar (J): 6 concur, 4 took no part
Facts: [GR L-21601, 17 December 1966; Zaldivar (J): 6 concur, 2 took no part] An operating agreement was executed before World War
II (on 30 January 1937) between Nielson & Co. Inc. and the Lepanto Consolidated Mining Co. whereby the former operated and managed
the mining properties owned by the latter for a management fee of P2,500.00 a month and a 10% participation in the net profits resulting
from the operation of the mining properties, for a period of 5 years. In 1940, a dispute arose regarding the computation of the 10% share
of Nielson in the profits. The Board of Directors of Lepanto, realizing that the mechanics of the contract was unfair to Nielson, authorized
its President to enter into an agreement with Nielson modifying the pertinent provision of the contract effective 1 January 1940 in such a
way that Nielson shall receive (1) 10% of the dividends declared and paid, when and as paid, during the period of the contract and at the
end of each year, (2) 10% of any depletion reserve that may be set up, and (3) 10% of any amount expended during the year out of surplus
earnings for capital account. In the latter part of 1941, the parties agreed to renew the contract for another period of 5 years, but in the
meantime, the Pacific War broke out in December 1941. In January 1942 operation of the mining properties was disrupted on account of
the war. In February 1942, the mill, power plant, supplies on hand, equipment, concentrates on hand and mines, were destroyed upon
orders of the United States Army, to prevent their utilization by the invading Japanese Army. The Japanese forces thereafter occupied the
mining properties, operated the mines during the continuance of the war, and who were ousted from the mining properties only in August
1945. After the mining properties were liberated from the Japanese forces, LEPANTO took possession thereof and embarked in rebuilding
and reconstructing the mines and mill; setting up new organization; clearing the mill site; repairing the mines; erecting staff quarters and
bodegas and repairing existing structures; installing new machinery and equipment; repairing roads and maintaining the same; salvaging
equipment and storing the same within the bodegas; doing police work necessary to take care of the materials and equipment recovered;
repairing and renewing the water system; and retimbering. The rehabilitation and reconstruction of the mine and mill was not completed
until 1948. On 26 June 1948 the mines resumed operation under the exclusive management of LEPANTO. Shortly after the mines were
liberated from the Japanese invaders in 1945, a disagreement arose between NIELSON and LEPANTO over the status of the operating
contract which as renewed expired in 1947. Under the terms thereof, the management contract shall remain in suspense in case fortuitous
event or force majeure, such as war or civil commotion, adversely affects the work of mining and milling. On 6 February 1958,
NIELSON brought an action against LEPANTO before the Court of First Instance of Manila to recover certain sums of money
representing damages allegedly suffered by the former in view of the refusal of the latter to comply with the terms of a management
contract entered into between them on 30 January 1937, including attorney's fees and costs. LEPANTO in its answer denied the material
allegations of the complaint and set up certain special defenses, among them, prescription and laches, as bars against the institution of the
action. After trial, the court a quo rendered a decision dismissing the complaint with costs. The court stated that it did not find sufficient
evidence to establish LEPANTO's counterclaim and so it likewise dismissed the same. NIELSON appealed. The Supreme Court reversed
the decision of the trial court and enter in lieu thereof another, ordering Lepanto to pay Nielson (1) 10% share of cash dividends of
December, 1941 in the amount of P17,500.00, with legal interest thereon from the date of the filing of the complaint; (2) management fee
for January, 1942 in the amount of P2,500.00, with legal interest thereon from the date of the filing of the complaint; (3) management fees
for the sixty-month period of extension of the management contract, amounting to P150,000.00, with legal interest from the date of the
filing of the complaint; (4) 10% share in the cash dividends during the period of extension of the management contract, amounting to
P1,400,000.00, with legal interest thereon from the date of the filing of the complaint; (5) 10% of the depletion reserve set up during the
period of extension, amounting to P53,928.88, with legal interest thereon from the date of the filing of the complaint; (6) 10% of the
expenses for capital account during the period of extension, amounting to P694,364.76, with legal interest thereon from the date of the
filing of the complaint; (7) to issue and deliver to Nielson and Co. Inc. shares of stock of Lepanto Consolidated Mining Co. at par value
equivalent to the total of Nielson's 10% share in the stock dividends declared on November 28, 1949 and August 22, 1950, together with
all cash and stock dividends, if any, as may have been declared and issued subsequent to November 28, 1949 and August 22, 1950, as
fruits that accrued to said shares; provided that if sufficient shares of stock of Lepanto's are not available to satisfy this judgment, Lepanto
shall pay Nielson an amount in cash equivalent to the market value of said shares at the time of default, that is, all shares of stock that
should have been delivered to Nielson before the filing of the complaint must be paid at their market value as of the date of the filing of
the complaint; and all shares, if any, that should have been delivered after the filing of the complaint at the market value of the shares at
the time Lepanto disposed of all its available shares, for it is only then that Lepanto placed itself in condition of not being able to perform
its obligation; (8) the sum of P50,000.00 as attorney's fees; and (9) the costs.
Lepanto seeks the reconsideration of the decision rendered on 17 December 1966.
Issue: Whether the management contract is a contract of agency or a contract of lease of services.
Held: Article 1709 of the Old Civil Code, defining contract of agency, provides that "By the contract of agency, one person binds himself
to render some service or do something for the account or at the request of another." Article 1544, defining contract of lease of service,
provides that "In a lease of work or services, one of the parties binds himself to make or construct something or to render a service to the
other for a price certain." In both agency and lease of services one of the parties binds himself to render some service to the other party.
Agency, however, is distinguished from lease of work or services in that the basis of agency is representation, while in the lease of work
or services the basis is employment. The lessor of services does not represent his employer, while the agent represents his principal.
Further, agency is a preparatory contract, as agency "does not stop with the agency because the purpose is to enter into other contracts."
The most characteristic feature of an agency relationship is the agent's power to bring about business relations between his principal and
third persons. "The agent is destined to execute juridical acts (creation, modification or extinction of relations with third parties). Lease of
services contemplate only material (non-juridical) acts." Herein, the principal and paramount undertaking of Nielson under the
management contract was the operation and development of the mine and the operation of the mill. All the other undertakings mentioned
in the contract are necessary or incidental to the principal undertaking — these other undertakings being dependent upon the work on the
development of the mine and the operation of the mill. In the performance of this principal undertaking Nielson was not in any way
executing juridical acts for Lepanto, destined to create, modify or extinguish business relations between Lepanto and third persons. In
other words, in performing its principal undertaking Nielson was not acting as an agent of Lepanto, in the sense that the term agent is
interpreted under the law of agency, but as one who was performing material acts for an employer, for a compensation. It is true that the
management contract provides that Nielson would also act as purchasing agent of supplies and enter into contracts regarding the sale of
mineral, but the contract also provides that Nielson could not make any purchase, or sell the minerals, without the prior approval of
Lepanto. It is clear, therefore, that even in these cases Nielson could not execute juridical acts which would bind Lepanto without first
securing the approval of Lepanto. Nielson, then, was to act only as an intermediary, not as an agent. Further, from the statements in the
annual report for 1936, and from the provision of paragraph XI of the Management contract, that the employment by Lepanto of Nielson
to operate and manage its mines was principally in consideration of the know-how and technical services that Nielson offered Lepanto.
The contract thus entered into pursuant to the offer made by Nielson and accepted by Lepanto was a "detailed operating contract". It was
not a contract of agency. Nowhere in the record is it shown that Lepanto considered Nielson as its agent and that Lepanto terminated the
management contract because it had lost its trust and confidence in Nielson.
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Case Digest on NIELSON & CO. INC. V. LEPANTO CONSOLIDATED MINING CO.
Facts: Pursuant to an agreement in a management contract regarding the compensation of Nielson, Lepanto Consolidated will pay
Nielson 10% of any dividends declared and paid. Lepanto declared stock dividends worth one million in 1949 and two million in 1950.
This was during the period covered by an extension in the management contract. Nielson sued for his share in the stock dividends. The
Supreme Court declared that Nielson was entitled to receive 10% of the stock dividends declared or shares of stock worth 300T. In this
motion for reconsideration, Lepanto maintains that the court erred in such order because it is a violation of the Corporation Law, Section
16.
Issue: Whether or not a corporation can issue stock dividends to a person who is not a stockholder in payment of services rendered.
Decision: The Supreme Court ruled that Nielson is not entitled to a share in the stock dividends since he is not a stockholder. However,
he must still be paid his 10% fee using as the basis for computation the cash value of the stock dividends declared.
Important Points on the Case of Nielson:
Effects of the Inclusion of a Non-stockholder as a Stock Dividend Beneficiary
1. It deprives a stockholder of his right share in the corporate profits.
2. The proportion of a stockholder’s interest changes radically to his or her detriment.
3. The non-stockholder benefits without assuming the same risks as those born by a stockholder.
Source of Dividends
General Rule: No Stock dividend may be declared, except out of unrestricted retained earnings.
Retained Earnings – the net accumulated earnings of the corporation out transactions with individuals or firms outside of the corporation.
Retained earnings include earnings from the sale of goods or services in the ordinary course of its business, as well as earnings from the
sale of corporate property other than its stock in trade, at a price higher than cost.
Implicit from the term retained earnings is the limitation that a corporation has no power to declare dividends unless its legal or stated
capital is maintained.
Retained earnings do not include transactions involving treasury stock, since the purchase and sale of such stock are regarded as
contractions and expansions or paid-in capital. Neither do they include donations which are also considered as additional paid-in capital.
Where the value of existing assets has increased and a are appraisal is made, the increase is merely an unrealized capital element and
therefore does not constitute earnings from which dividends, whether in cash or stock, may be declared.
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 stockholders as dividends.

Could any stockholder, at his pleasure, pull-out the machines and equipment, following the sale
of his shares to a third party?

NO. The property of a corporation is not the property of its stockholders or members. Under the trust fund

doctrine, thecapital stock, property, and other assets of a corporation are regarded as equity in trust for the

payment of corporatecreditors which are preferred over the stockholders in the distribution of corporate

assets. The distribution of corporateassets and property cannot be made to depend on the whims and

caprices of the stockholders, officers, or directors ofthe corporation unless the indispensable conditions and
procedures for the protection of corporate creditors arefollowed. (YAMAMOTO vs. NISHINO LEATHER

INDUSTRIES, G.R. No. 150283, 16 April 2008)