6. Corporate Contract Law

CORPORATION LAW REVIEWER (2013-‐2014)

ATTY. JOSE MARIA G. HOFILEÑA

CORPORATE CONTRACT LAW I. Pre-‐Incorporation Contracts A. Who Are Promoters? •

“Promoter” is 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. (Section 3.10, Securities Regulation Code [R.A. 8799])

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It is necessary to identify the promoters because it fills the gap between the intention to create the corporation, and its actual birth. o In the normal scheme of things, should the promoter be liable for contracts? NO. Because when the corporation is born, all contracts are transferred to it. o However, where the company was not formed, then the liability of the promoters become significant.

B. Nature of Pre-‐incorporation Agreements (Sections 60 and 61) Section 60. Subscription contract. Any contract for the acquisition of unissued stock in an existing corporation or a corporation still to be formed shall be deemed a subscription within the meaning of this Title, notwithstanding the fact that the parties refer to it as a purchase or some other contract. (n) Section 61. Pre-‐incorporation subscription. 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: Provided, That no pre-‐ incorporation subscription may be revoked after the submission of the articles of incorporation to the Securities and Exchange Commission. (n) C. Theories on Liabilities for Promoter's Contracts: •

Cagayan Fishing Dev. Co., Inc. v. Teodoro Sandiko, 65 Phil. 223 (1937).

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Rizal Light & Ice Co., Inc. v. Public Service Comm., 25 SCRA 285 (1968).

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Caram, Jr. v. CA, 151 SCRA 372 (1987).

Cagayan Fishing Dev. Co., Inc. v. Teodoro Sandiko Facts: Manuel Tabora owns 4 parcels of land covered by three mortgages which it sold to Cagayan Fisheries Dev. Co. Inc. at a time when it was still in the process of incorporation for a consideration of P1 and under the condition that the company would pay Tabora’s indebtedness to PNB. 5 months later, Cagayan was incorporated, but the mortgage loan was not paid. Subsequently the land was sold to Sandiko under the name of the corporation with the same conditions. Sandiko failed to comply with his obligation so Cagayan filed an action praying that the judgment be rendered. Issue: Whether or not Sandiko is liable to Cagayan.

NOTES BY RACHELLE ANNE GUTIERREZ (UPDATED APRIL 3, 2014)



Held: NO. The transfer to Cagayan was null because at the time it was effected, Cagayan was non-‐existent. If Cagayan could not and did not acquire the 4 parcels of land, it follows that it had no right to sell them to Sandiko. A corporation, until organized, has no being, franchise or

Securities and Exchange Commission just before the Certificate of Public Convenience was granted to it. Rizal Light contended that Morong Electric did not have a corporate personality at the time it was granted a franchise by the Municipality and as such was not even a de facto corporation.

faculties. Nor do those engaged in bringing it into being have any power to bind it by contract, unless so authorized by the charter. Manuel Tabora, his wife and others, as mere promoters of a corporation on the other hand. The lands remain inscribed in Tabora’s name. Sandiko always regarded Tabora as the owner of the lands. He dealt with the latter directly. The President of Cagayan only intervened to sign the contract in behalf of Cagayan. Even PNB always treated Tabora as the

Issue: Whether or not Morong Electric could validly be granted a franchise and apply for a Certificate of Public Convenience even when it did not yet have a separate corporate legal personality at those times Held: YES. Morong Electric might not yet have a corporate personality at those times but ultimately, it was granted its certificate of incorporation

owner of the lands. Doctrine: These promoters could not have acted as agent 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. However, this does not mean that acts of promoters can never be ratified by the corporation when it is subsequently organized.

by the SEC and it accepted its franchise according to the terms and conditions. In effect, the doctrine of ratification was applied in favor of Morong Electric. Doctrine: “The fact that a company is not completely incorporated at the time the grant is made to it does not affect the validity of the grant. But such grant cannot take effect until the corporation is organized.”

There are exceptions

American courts generally hold that contracts made by the promoters of a corporation on its behalf may be adopted, accepted, or ratified by the corporation when organized. General Rule: For corporations that are not yet incorporated, they don’t have capacity to act yet.

Rizal Light & Ice Co., Inc. v. Public Service Comm. Facts: Rizal Light and Ice has been distributing electricity in the Morong, Rizal Area since 1949 when it was awarded a Certificate of Public Convenience by the Public Service Commission. In 1962, Morong Electric Company was granted a franchise to operate an electric service in the Municipality of Morong, and it applied for a Certificate of Public Convenience. Its Certificate of Incorporation was granted by the

Caram, Jr. v. CA Facts: The Carams are challenging the validity of the Court of Appeal’s




decision ordering them to pay jointly and severally with Filipinas Orient Airways and with Barretto and Garcia plaintiff Arellano for his services which helped in the incorporation of Filipinas Orient Airways. The Carams claim that they were not the ones who requested the services of Arellano, and were merely financiers of the airways. As such they cannot be held personally liable. Issue: Whether or not the Carams are also and personally liable for such expenses and, if so, to what extent. Held: NO. After a perusal of the decision of the CA, the SC found that the Carams were not really involved in the initial steps that finally led to the incorporation of the Filipinas Orient Airways. It was Barretto and Garcia who handled the preparation of the project study. The said study being then subsequently presented to the Carams to induce the latter in investing to the proposed airlines. The Carams were merely among the financiers who were persuaded by the strength of the project study to invest in the proposed airline. Furthermore, there was no showing that the Filipinas Orient Airways was a fictitious corporation and did not have a separate juridical personality, to be able to justify making the Carams, as principal stockholders thereof, responsible for its obligations. Doctrine: II. De Facto Corporation (Section 20) Section 20. De facto corporations. The due incorporation of any corporation claiming in good faith to be a corporation under this Code, and its right to exercise corporate

powers, shall not be inquired into collaterally in any private suit to which such corporation may be a party. Such inquiry may be made by the Solicitor General in a quo warranto proceeding. •

A de facto corporation is one that has not yet been certified as existing by the SEC, but who believes in good faith that it has authority and power to operate as a corporation. o You can’t claim to be in good faith if there is no certificate of incorporation since you know that it is only upon the issuance of the certificate by the SEC that the corporation is given juridical personality.

A. Elements: Arnold Hall v. Piccio, 86 Phil. 634 (1950). Arnold Hall v. Piccio Facts: Arnold and Bradley Hall (petitioners) and Fred and Emma Brown, Chapman, and Abella (respondents) signed and acknowledged the articles of incorporation of the Far Eastern Lumber and Commercial Co., Inc. Attached to the articles of incorporation was an affidavit of the treasurer stating that about 23k of the stocks were subscribed and fully paid with properties transferred to the corporation. Pending action of the SEC concerning the articles, the respondents filed a case against petitioners where they claimed that FELC was an unregistered partnership and now they wished to dissolve it due to dissension among members. The Halls filed a case, claiming that the court had no jurisdiction to decree the dissolution of the company, because it being a de facto corporation, dissolution may only be ordered




in a quo warranto proceeding before the Solicitor General and that the respondents, having signed the articles of incorporation, are estopped from denying that it is a corporation. Issue: Whether or not the court had jurisdiction to decree the

III. Corporation by Estoppel Doctrine (Section 21; Salvatierra v. Garlitos, 103 Phil. 757 [1958]; Albert v. University Publishing Co., 13 SCRA 84 [1965]; Asia Banking Corp. v. Standard Products, 46 Phil. 145 [1924]; Madrigal Shipping Co., v. Ogilvie, 55 O.G. No. 35, p. 7331)

dissolution Held: YES. The parties very well know that the SEC has not issued the certificate of corporation. Thus, they couldn’t claim in good faith to be a corporation. In this case, there is no de facto corporation immune from collateral attack. Besides, this corporation is not a party to this case. The case is a litigation between stockholders, for the purpose of obtaining

Section 21. Corporation by estoppel. 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

dissolution. Even 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. Doctrine: Personality of a corporation begins to exist only from the moment such certificate is issued. Immunity from collateral attack is granted to corporations “claiming in good faith to be a corporation”

lack of corporate personality. 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.

under the Corporation Law. When both parties are aware that a corporation has not been duly organized, then the corporation by estoppel doctrine does not apply.

1. 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(2) 2. Both parties must recognize the corporate party even when one does not exist. At least one party to the contract was under the impression that the other corporate party was a duly incorporated entity. It can only apply when a certificate is issued

A. Elements of the Doctrine Corporation by Estoppel

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By its failure to submit its by-‐laws on time, the AIIBP may be considered a de facto corporation whose right to exercise corporate powers may not be inquired into collaterally in any private suit to which such corporations may be a party. Sawadjaan v. Court of Appeals, 459 SCRA 516 (2005).


but where, for lack of the other criteria, the de facto corporation doctrine cannot apply. Arnold Hall v. Piccio, 86 Phil. 634 (1950).



Salvatierra v. Garlitos Facts: Manuela Salvatierra entered into a contract of lease with Philippine Fibers Producers Corp. (represented by its President

out of such transaction. Doctrine 1: A registered corporation has a juridical personality separate and distinct from its component members or stockholders and officers and conversely, a stockholder or member cannot be held personally

Refuerzo) over a parcel of land in Leyte owned by the former. Barely a year after the lease, Salvatierra filed for damages, accounting and rescission; she averred that the corporation violated the provisions in the contract. The Court rendered a judgment in favour of Salvatierra, and moved to subject parcels of land owned by Refuerzo to attachment because the corporation had no properties in its name. Refuerzo filed a motion claiming that the decision rendered was null and void with

liable for any financial obligation of the corporation in excess of his unpaid subscription. But this rule is understood to refer merely to registered corporations and cannot be made applicable to the liability of members of an unincorporated association.

respect to him, there being no allegation in the complaint pointing to his personal liability. His defense was that for while it was stated in the complaint that he was a signatory to the lease contract, he did so in his capacity as president of the corporation. Issue 1: Whether or not Refuerzo, in his personal capacity, can be held liable for corporate debts.

applicable in this case. Held 2: NO. The doctrine of corporation by estoppel does not apply in this case because fraud was part of the 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

Held 1: YES. A person who acts as an agent without authority or without a principal is himself regarded as the principal; a person acting or purporting to act on behalf of a corporation which has no valid existence assumes such obligations and comes personally liable for contracts entered into. Refuerzo, as president of the unregistered corporation Phil. Fibers, was the agent of a non-‐existent principal, his liability cannot be limited or restricted to that imposed upon corporate

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. Doctrine 2: While as a general rule a person who has contracted or dealt with an association in such a way as to recognize its existence as a

shareholders. In acting on behalf of a corporation which he knew to be unregistered, he assumed the risk of reaping the consequential arising

Issue 2: Whether or not the doctrine of corporation by estoppel is

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.




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Agency Doctrine: Making the agent of an inexistent principal liable on the contract entered upon.1 o This agency doctrine applies only where there is fraud or misrepresentation on the part of one of the contract parties. The doctrine of corporation by estoppel has not application to a situation where both parties to the contract acted in the honest belief that a contracting corporate entity did exist. o It is in such no-‐fraud or no-‐misrepresentation cases that Salvatierra v. Garlitos 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. Albert v. University Publishing Co.

Facts: UP Co. through Jose Aruego, its President, entered into a contract with Mariano Albert for the exclusive right to publish his revised Commentaries on the Revised Penal Code. Because of UP Co.’s failure to pay its installments to Albert, the latter sued UP Co. alleging that it was a corporation duly organized and existing under the laws of the Philippines. UP Co. also admitted to Albert’s allegation of its corporate existence as well as to the execution and terms of the contract. Albert won the case, and thereafter petitioned for a writ of execution against Aruego as the real defendant because it was recently discovered that

there is no such entity as University Publishing Co., Inc. The SEC records show that UP Co. was never registered either as a corporation or partnership. Aruego claimed he is not a party to the case. Issue: Whether or not the judgment may be executed against Jose M. Aruego, supposed President of University Publishing Co., Inc., as the real defendant. Held: YES. On account of the non-‐registration UP Co. cannot be considered a corporation, not even a corporation de facto. It has therefore no personality separate from Jose M. Aruego; it cannot be sued independently. It is patently clear that Jose M. Aruego, acting as representative of a non-‐existent principal, was the real party to the contract sued upon, reaping the benefits resulting from it. Responsibility under the judgment falls on him since partial payments of the consideration were made by him, he violated its terms, which precipitated the previous suit in question. NOTE: Doctrine of corporation by estoppel did not apply to this case. Doctrine: In a suit against a corporation with no valid existence, the person who had and exercised the rights to control the proceedings, to make defense, to adduce and to cross-‐examine witnesses, and to appeal from a decision, is the real defendant, and the enforcement of a judgment against the corporation upon him is substantial observance of due process of law. •

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Villanueva, C. L., & Villanueva-‐Tiansay, T. S. (2013). Philippine Corporate Law. (2013 ed.). Manila, Philippines: Rex Book Store.


Albert therefore offers us the "philosophical bridge" between the two doctrines:



o o

First. That a corporation can be deemed to exist when in fact none may exist, in order to validate a contract; and 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.1

Asia Banking Corp. v. Standard Products Facts: Standard Products, Co., Inc. was indebted to Asia Banking Corporation and secured its indebtedness through a promissory note. Upon demand for the balance due, Standard failed to pay. Hence an action was brought by Asia Banking Corporation, which it won. But, Standard Products, Inc. contended that Asia Banking Corp failed to prove affirmatively the corporate existence of the parties, and the appellant insists that under these circumstances the court erred in finding that the parties were corporations with juridical personality and assigns same as reversible error.

corporate existence. Under these circumstances it was unnecessary for the plaintiff to present other evidence of the corporate existence of either of the parties. Doctrine: 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 cause 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. NOTE: Atty. Hofileña à The doctrines in three cases were laid down before the Corporate Code. As such, these doctrines were embodied in the Section 21 of the Corporation Code. B. Nature of Doctrine •

Issue: Whether or not respondent Standard Products is estopped from denying the corporate existence of the plaintiff Asia Banking Corp. Held: YES. The defendant having recognized the corporate existence of the plaintiff by making a promissory note in its favor and making partial payments on the same is therefore estopped to deny said plaintiff's corporate existence. It is, of course, also estopped from denying its own

third person is involved in the conflict, there is no corporation by estoppel. A failed consolidation therefore cannot result in a consolidated corporation by estoppel. Lozano v. De Los Santos, 274 SCRA 452 (1997) •

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Founded on principles of equity and designed to prevent injustice and unfairness, the doctrine applies when persons assume to form a corporation and exercise corporate functions and enter into business relations with third persons. Where no

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.1 o A party cannot challenge the personality of the plaintiff as a duly organized corporation after having acknowledged same when entering into the contract with the plaintiff as such corporation for the

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transportation of its merchandise. Ohta Dev. Co. v. Steamship Pompey, 49 Phil. 117 (1926).2 A person who accepts employment in an unincorporated charitable association is estopped from alleging its lack of juridical personality. Christian Children’s Fund v. NLRC, 174 SCRA 681 (1989).

The doctrine has evolved in Corporate Law primarily as a rule to promote the integrity of commercial contracts; the basic role of the 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.3 o

One who deals with an unincorporated association which is not duly incorporated is not estopped to deny its corporate existence when his purpose is not to avoid liability, but precisely to enforce the contract against the action for the purported corporation. Int’l Express Travel v. Court of Appeals, 343 SCRA 674 (2000).

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Villanueva, C. L., & Villanueva-‐Tiansay, T. S. (2013). Philippine Corporate Law. (2013 ed.). Manila, Philippines: Rex Book Store. 2 The same principle applied in Compania Agricole de Ultramar v. Reyes, 4 Phil. 1 (1911), but that case pertained to a commercial partnership which required registration in the registry under the terms of the Code of Commerce). 3 Villanueva, C. L., & Villanueva-‐Tiansay, T. S. (2013). Philippine Corporate Law. (2013 ed.). Manila, Philippines: Rex Book Store.

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Under the law on estoppel including that under Section 21 of Corporation Code, those acting on behalf of an ostensible corporation and those benefited by it, knowing it to be without valid existence, are held liable as general partners. Lim Tong Lim v. Philippine Fishing Gear Industries, Inc., 317 SCRA 728 (1999).

Lim Tong Lim v. Philippine Fishing Gear Industries, Inc. Facts: Chua and Yao, on behalf of Ocean Quest Fishing Corp., entered into a contract for the purchase of fishing nets from respondent-‐PFGI. They claimed that they were engaged in a business with petitioner-‐Lim who was not a signatory of the agreement. However, the buyers failed to pay for their purchases; hence, PFGI filed a collection suit against Chua, Yao and Lim with a prayer for a writ of preliminary attachment. The trial court ruled that a partnership existed among the Lim, Chua and Yao and held them jointly liable to pay PFGI based on the testimonies of witnesses presented and the Compromise Agreement executed by the three. Lim claims that he should not be held liable for the purchase price since he was not part of the negotiations with respondent-‐PFGI. Issue: Whether or not under the doctrine of corporation by estoppel, liability can be imputed only to Chua and Yao and not to Lim. Held: NO. Unquestionably, petitioner benefited from the use of the nets found inside F/B Lourdes, the boat that has earlier been proven to be an asset of the partnership. Although it was never legally formed for unknown reasons, this fact alone does not preclude the liabilities of the three as contracting parties in representation of it. Technically, it is true that petitioner did not directly act on behalf of the corporation.




thereof. People v. Garcia, 271 SCRA 621 (1997); People v. Pineda, G.R. No. 117010, 18 April 1997 (unpub). 2. 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

However, having reaped the benefits of the contract entered into by persons with whom he previously had an existing relationship, he is deemed to be part of said association and is covered by the scope of the doctrine of corporation by estoppel. Doctrine: 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.

enforcement of the contract.2 o 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 o Limited Partner liability à One who acts for a purported corporation not knowing that it had no authority to do

C. Two Levels: (i) With “Fraud;” and (ii) Without “Fraud” 1. 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.1 o General Partners à 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 venture. o When the incorporators represent themselves to be officers of the corporation which was never duly

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

registered with SEC, and engage in the name of the purported corporation in illegal recruitment, they are estopped from claiming that they are not liable as corporate officers under Section 25 of 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,

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. 3. 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

liabilities and damages incurred or arising as a result



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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

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 creditors of a corporation 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,

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.1 Lim Tong Lim v. Philippine Fishing Gear Industries, Inc., 317 SCRA 728 (1999).

any disposition of corporate funds to the prejudice of creditors is null and void. Boman Environmental Dev. Corp. v. CA, 167 SCRA 540 (1988).

IV. TRUST FUND DOCTRINE A. Commercial/Common Law Premise: Equity versus Debts; Preference of Creditors over Equity Holders (Art. 2236, Civil Code)

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other assets of the corporation are regarded as equity in trust for the payment of the corporate creditors. Comm. of Internal Revenue v. Court of Appeals, 301 SCRA 152 (1999). B. Nature and Coverage of the Trust Fund Doctrine: •

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• The requirement of unrestricted retained earnings to cover the shares is based on the trust fund doctrine which means that the

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The subscriptions to the capital stock 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. Phil. Trust Co. v. Rivera, 44 Phil. 469 (1923).

CIVIL CODE Article 2236. The debtor is liable with all his property, present and future, for the fulfillment of his obligations, subject to the exemptions provided by law. (1911a) •

Under the trust fund doctrine, the capital stock, property and

Atty. Hofileña à a shareholder cannot be compelled to pay more than what they subscribed to in order to address the debts of the corporation.

Even when the foreclosure on the corporate assets was wrongfully done, stockholders 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. APT v. Court of Appeals, 300 SCRA 579 (1998). •

The “trust fund” doctrine considers the subscribed capital stock as a trust fund for the payment of the debts of the corporation, to which the creditors may look for satisfaction. Until the liquidation of the corporation, no part of the subscribed capital stock may be turned over or released to the stockholder (except in the redemption of the redeemable shares) without violating this principle. Thus dividends must never impair the subscribed capital stock; subscription commitments cannot be condoned or remitted; nor can the corporation buy its own shares using the subscribed capital as the consideration therefore. NTC v. Court of Appeals, 311 SCRA 508 (1999). o Atty. Hofileña à the creditors have no right to compel the company to sell the unsubscribed shares it has left of the authorized capital stock.

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We clarify that the trust fund doctrine is not limited to reaching the stockholders’ unpaid subscriptions. The scope of the doctrine when the corporation is insolvent encompasses not only the capital stock, but also other property and assets generally regarded in equity as a trust fund for the payment of corporate debts. All assets and property belonging to the corporation held in trust for the benefit of creditors that were distributed or in the possession of the stockholders, regardless of full payment of their subscriptions may be reached by the creditors in satisfaction of its claim. Halley v. Printwell, Inc. 649 SCRA 116 (2011), citing VILLANUEVA, PHILIPPINE CORPORATE LAW (2001), p. 558.

Halley v. Printwell, Inc. Facts: BMPI (Business Media Philippines Inc.) is a corporation under the control of its stockholders, including Donnina Halley. In the course of its business, BMPI commissioned PRINTWELL to print Philippines, Inc. (a magazine published and distributed by BMPI). BMPI placed several orders amounting to P316,000 but was only able to pay P25,000. PRINTWELL sued BMPI for collection of the unpaid balance and later on impleaded BMPI’s original stockholders and incorporators to recover on their unpaid subscriptions. Issue: Whether or not a stockholder (Halley in this case) who was in active management of the business of the corporation and still has unpaid subscriptions should be made liable for the debts of the corporation by piercing the veil of corporate fiction Held: YES. Such stockholder should be made liable up to the extent of her unpaid subscription. It was found that at the time the obligation was incurred, BMPI was under the control of its stockholders who know fully well that the corporation was not in a position to pay its account (thinly capitalized). And, that the stockholders personally benefited from the operations of the corporation even though they never paid their subscriptions in full. Doctrine: TRUST FUND DOCTRINE. Under which corporate debtors might look to the unpaid subscriptions for the satisfaction of unpaid corporate debts. Subscriptions to the capital of a corporation constitutes a trust fund for the payment of the creditors (by mere analogy) In reality, corporation is a simple debtor. The creditor is




allowed to maintain an action upon any unpaid subscriptions and thereby steps into the shoes of the corporation for the satisfaction of its debt. The trust fund doctrine is not limited to reaching the stockholder’s unpaid subscriptions. The scope of the doctrine when the corporation is insolvent encompasses not only the capital stock but also other

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property and assets generally regarded in equity as a trust fund for the payment of corporate debts. C. To Purchase Own Shares (Sections 8, 41, 43 and 122, last paragraph) Section 8. Redeemable shares. 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 other terms and conditions as may be stated in the articles of incorporation, which terms and conditions must also be stated in the certificate of stock representing said shares. •

Unrestricted Retained Earnings à These are earnings which is not earmarked for any particular purpose.

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Dividends come from the unrestricted retained earnings. Otherwise, you will impair the capital of the corporation. o Stock Dividend à instead of giving you cash dividend to which you are entitled to, you will be given a stock as

Decision to issue stock dividends is made by 2/3 of the stockholders and majority of the Board. Cash Dividend à liquidated cash § Distribution is decided upon by the Board of Directors. §

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Redeemable shares need to be classified from the beginning that they are redeemable. o This is the exception to the general rule that you need URE in order to buy-‐back shares.

Section 41. Power to acquire own shares. A stock corporation shall have the power to purchase or acquire its own shares for a legitimate corporate purpose or purposes, including but not limited to the following cases: Provided, That the corporation has unrestricted retained earnings in its books to cover the shares to be purchased or acquired: 1. To eliminate fractional shares arising out of stock dividends; 2. 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 3. To pay dissenting or withdrawing stockholders entitled to payment for their shares under the provisions of this Code. (n)

equivalent. It’s like reinvesting your dividends to the corporation.

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The URE is also what the corporation can use to buy-‐back its shares from its stockholders.




Section 43. Power to declare dividends. The board of directors of a stock corporation may declare dividends 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: Provided, That any cash dividends

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

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: Provided, further, That 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. (16a)

was established. At any time during said three (3) years, the 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

Stock corporations are prohibited from retaining surplus profits in excess of one hundred (100%) percent of their paid-‐in capital stock, except: (1) when justified by definite corporate expansion projects or programs approved by the board of directors; or (2) when the corporation is prohibited under any loan agreement with any financial institution or creditor, whether local or foreign, from declaring

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. Upon the winding up of the corporate affairs, any asset distributable to any creditor or stockholder or member who is unknown or cannot

dividends without its/his consent, and such consent has not yet been secured; or (3) 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. (n)

be found shall be escheated to the city or municipality where such assets are located. Except 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. (77a, 89a, 16a)

Section 122. Corporate 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


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Under common law, there were originally conflicting views on whether a corporation had the power to purchase its own



stocks. Only a few American jurisdictions adopted the strict English rule forbidding a corporation from purchasing its own shares. In some American states where the English rule used to be adopted, statutes granting authority to purchase out of surplus funds were enacted, while in others, shares might be purchased even out of capital provided the rights of creditors were not prejudiced. The reason underlying the limitation of share purchases sprang from the necessity of imposing safeguards against the depletion by a corporation of its assets and against the impairment of its capital needed for the protection of creditors. Turner v. Lorenzo Shipping Corp., 636 SCRA 13 (2010). D. Rescission of Subscription Agreement •

The violation of terms embodied in a subscription agreement, with are personal commitments, do not constitute legal ground to rescind the subscription agreement since such would violate the Trust Fund Doctrine and the procedures for the valid distribution of assets and property under the Corporation Code. “In the instant case, the rescission of the Pre-‐Subscription Agreement will effectively result in the unauthorized distribution of the capital assets and property of the corporation, thereby violating the Trust Fund Doctrine and the Corporation Code, since the rescission of a subscription agreement is not one of the instances when distribution of capital assets and property of the corporation is allowed.” Distribution of corporate assets among the stockholders cannot even be resorted to achieve “corporate peace.” Ong Yong v. Tiu, 401 SCRA 1 (2003).

Ong Yong v. Tiu Facts: The Tiu family members are the owners of First Landlink Asia Development Corporation (FLADC). One of the corporation’s projects is the construction of Masagana Citimall in Pasay City. However, due to financial difficulties (they were indebted to PNB for P190 million), the Tius feared that the construction would not be finished. So to prevent the foreclosure of the mortgage on the two lots where the mall was being built, they invited the Ongs to invest in FLADC. The two parties entered into a Presubscription Agreement whereby each of them would hold 1,000,000 shares each and be entitled to nominate certain officers. The Tiu’s contributed a building and two lots, while the Ongs contributed P100M. Two years later, the Tui’s filed for rescission of the Presubscription Agremement because the Ongs refused to issue them their shares of stock and from assuming positions of VP and Treasurer to which they were entitled to nominate. The Ongs contended that they could not issue the new shares to the Tius because the latter did not pay the capital gains tax and the documentary stamp tax of the lots. And because of this, the SEC would not approve the valuation of the property contribution of the Tius. The Court of Appeals ordered liquidation of FLADC to enforce rescission of the contract. Issue: Whether or not the liquidation of FLADC violated the Trust Fund Doctrine Held: YES. In this case, the rescission would certainly be a violation of


CORPORATION LAW REVIEWER (2013-‐2014) the doctrine and also of the Corporation Code because the rescission would result in the unauthorized distribution of the assets of the corporation. Rescission based on a breach in the terms of a subscription agreement is not one of the instances when distribution of a corporation’s assets and property is allowed (Section 122). It would not only be unlawful but it would also be prejudicial to the corporate creditors who enjoy absolute priority of payment over any individual stockholder. Doctrine: This doctrine enunciates that subscriptions to the capital stock of a corporation constitute a fund to which the creditors have a right to look for the satisfaction of their claims. This doctrine is the underlying principle in the procedure for the distribution of capital assets, embodied in the Corporation Code, which allows the distribution of corporate capital only in three instances: (1) amendment of the Articles of Incorporation to reduce the authorized capital stock, (2) purchase of redeemable shares by the corporation, regardless of the existence of unrestricted retained earnings, and (3) dissolution and eventual liquidation of the corporation. NOTE: Atty. Hofileña à To release a person from his obligation to pay his subscribed shares is offensive to the Trust Fund Doctrine. •

Trust Fund Doctrine applies to all properties of the company, and not limited to simply the unpaid subscriptions.

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A company may do what it wills with its properties, but creditors are protected.



6. Corporate Contract Law

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