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Trust Fund Doctrine

Assets: resources by companies

Sources of Assets:
1. liabilities
2. capital stocks
3. retained earnings

Assets = liabilities + Capital Stock + Retained Earnings

How is net income different from retained earnings?


Net income is usually for 1 year. Retained earnings start from the birth of the corporation

Where expenses exceed net income, the net is equal to net loss.

Deficit – net loss

Deficit means that the assets which have been taken by the owners have been increased.

The trust fund doctrine is for the benefit of the creditors against the corporation.

Creditors and stockholders are both lending money for the company.

Relationship of the creditors to the creditors – governed by the law on SecTrans

Law governs the relationship of the stockholders with the corporation – Corp Law
- On what level is it found? Intra-corporate level
- What primary law governs in this level?

Sub-levels of Extra-Corporate level


- coporation and creditors/debtors: Contract Law governs
- corporation and injured properties (quasi-delict): did not come from meeting of the minds
- corporation and its employees: Labor Law, contract of service

The trust fund doctrine is built by the courts. Clearest law on the matter: Sec 22 of the Corp Code

Who are the beneficiaries of the trust fund doctrine? Creditors

How are the stockholders disadvantaged? The assets of the corporation are treated as a trust for the
benefit of the creditors.

During the life of the corporation, what are the effects of TFD?

What are not covered by TFD? assets that represent the unrestricted retained earnings

Application of TFD:
1. When the assets which are returned to the stockholders are taken from CS, the status of such distribution
is void. Exception: when there is a proper reduction of the capital stock
2.
3.
4. when corporation insolvent
- insolvency: assets are not enough to cover for liabilities
- all assets are held by the Board for the benefit of the creditors
- upon dissolution, who’s first in line?
- Creditors
- Partners w/ respect to credit extension
- Partners w/ respect to income rights
- Partners w/ respect to the contribution

Subscription receivables become due and demandable despite what is stipulated about them
Is it lawful for a corporation to make donations? – Generally, donations are against the TFD, except when it
is reasonable

Why is it void? It takes away assets which are for the creditor or the stockholders

4 Qualities of the Corporation – which one of the 4 does TFD protect? Limited liability

They are liable only to eh extent of their investment (subscribed CS)


An individual, not a corporation, also enjoys limited liability - False

Unlimited liability – liable not just to the extent of his investment; businessand non-business assets are also
at stake

Limited liability actually furthers this doctrine

Is there statutory basis for limited liability? Sec 2 (juridical entity) of the Corp Code

Limited liability rule is a logical consequence of strong and juridical personality – True

Liability doctrine: relativity principle under contract law

Limited liability is the norm, unlimited liability is the aberration (deviation) – False
- limited liability/no liability is the aberration

Unlimited liability is where mortals dwell; limited liability is where magic happens 

Aberration hurts the creditors, it takes from the creditors what they could do

TFD: countervailing doctrine for the creditors

Why do creditors still deal with the corporation?


Because of the 4 qualities – makes them a better risk taker than a sole proprietor

Centralised management – makes the corporation different from the sole proprietor
Everything that goes in is reinvested

P500M (liabilities) = P200M (CS) 100M (retained earnings)

Scenario 1: They paid the 100M to the stockholders. It is void, must be returned
Scenario 2: Cash dividends (earnings of stockholders) were given from retained earnings – valid

Who has the right to the retained earnings? Creditors and stockholders

Why retain the CS when they don’t need it?

When the corporation makes money, the money is for the stockholders.
When the corporation loses money

What is the essence of an equity holder?


A person is entitled to a percentage of a gross income. Is he presumed to be a partner? No. Presumption
comes in when net profits are divided.

What is the difference between one who shares with the gross income and one who shares in the net
income? Latter bears the risk of ownership

What do you call the owners? Stockholders

Deficit – stockholders take it ‘in the chin’, how? When CS is wiped out, capital is worthless

Those who share in the gross income - no risk, no right to participate in the dividends, they should not be the
ones to absorb the dividends
Ong Yong vs Tiu
- casual breach is not a basis for recissin
- substantial breach
- division of property
Naked title – usufruct

Trust
Implied Trust

TFD is panoramic.

ARTICLES OF INCORPORATION

Articles – incorporators
- stockholdrs

Right to association – by buying shares of stock

Governs relationships between:


1. corporation and the State
2. stockholders and State
3. corporation and its stockholders

BY-LAWS

By-laws
– does not represent the relationship between the corporation and the State

The power to adapt by-laws is


- Is it incidental or expressly provided by law? Inherent
- AOI – must be expressly granted by law
- Why is it inherent? In every organization/association
- Part of the charter of corporation: primary franchise – to give the juridical person
- Exercise of legislative power
- plenary, except when creating private corporations
- Power to constitute/amend set of laws – because there is a group of persons already behind the
corporation (Gokongwei case)
TRUE. Why? Principle of necessity
- Inherent in character but expressed by practice because it is regulated by the Corp Code
- Manner by which by-laws are adopted:
1. upon corporation/as part of incorporation process
2. within 30 days before incorporation, upon resolution of Board of Directors
- no quorum (50% + 1) Ex. 15 stockholders: 8, being majority, must vote
- Adoption: affirmative vote by stockholders representing majority of outstanding capital stock, or majority of
members in non-stock corporation
- vote of 2/3 of outstanding stock capital -> articles of incorporation
- why does it require a higher number?
- majority of outstanding stock capital -> by-laws

Procedure of adopting by-laws


1. approval of board
2. ratification of stockholders
3. filing with SEC
4. approval of SEC, issuance of certificate

Period: 1 month/30 days from time of incorporation


SEC issuance: acts upon discretion

General Rule: By-laws are valid and binding upon issuance of SEC certificate
Exception: when the SEC, without fault of the corporation, had failed to act upon the process of certification
AOI
- contractual relationship between corporation and parties who deal with the corporation
- obligatory force

One who enters in a contract of loan is bound to know the terms/provision of AOI – TRUE
- AOI is a public document, represents the contractual relationship: element of consent
- corporation + third party: w/n it can give consent
- ability of the corporation to bind itself
- goes into the consent of the party you are dealing with
- cannot be immune to the corporation’s acts: doctrine of limited power
- by-laws: public document, but not binding on people who deal with the corporation
WHY?

19 January 2011

DIRECTORS, TRUSTEES, OFFICERS

Corporate governance – centralized management

Fiduciary – arises not because the law says so but because of their relationship

Vacancy – should be filled by stockholders

Power to Remove: vested in stockholders


- can only be removed by majority of member of the board
- Sec. 28, exception: director representing the minority
How is it determined that he is director of the minority?

Compensation – outside of the by-laws, how can one legally receive compensation?
- granted by vote of majority of stockholders representing capital stock

Does the board owe fiduciary duties to the stockholders? YES. – power to remove, power to appoint
- relationship is fiduciary, therefore revocable
- appointment by election by the stockholders: revocable by removal (2/3 of outstanding capital stock)
- principal-agent relationship? NO
- not agents: principal should be the one to give power
- they have fiduciary duties but they are not mere agents of the stockholders because a director’s primary
purpose is the maximization of profits (sec 23, centralized management)

Duty of Obedience
- agent is supposed to act upon instruction of the principal, within scope of authority delegated to him
- sec 23: grants full power to directors to act for stockholders, Board shall prevail (business judgment
rule/centralized management)
- trustee-beneficiary relationship (Stockholders – beneficiaries)
- to exercise ownership for the benefit of the stockholder (sec 23)
- trustee – legal/title, beneficiary – beneficial title
- BOD do not owe the duty of obedience to stockholders

BOD duties:
- duty of loyalty
- duty to inform
- duty of obedience (owed to the corporation, not to the stockholders)
- duty of diligence

Not all powers are vested in the BOD (sec 23)

Unless otherwise provided in this Code, the corporate powers of all corporations formed under this
Code shall be exercised

Power of the Board – plenary unless otherwise provided


Good Corporate Governance principle
- all powers to discipline and to compensate are not with the Board
- they are accountable to the stockholders
- directors are elected annually by the stockholders in an annual stockholders meeting

Cumulative Voting vs Straight Voting


- mandatory when it comes to stock corporations?
- straight voting: for non-stock corporations?
- cumulative voting is allowed in non-stock corporations if it is provided in the by-laws?

Minority should be given representation in the BOD

Election of Directors
- annually he has to renew or prove again that he can do his duties
- to stand a chance to be reelected (good governance)
-

Representation of the Minority


- so that their voices will be heard

Qualifications & Disqualifications


- because of fiduciary relationship: qualifications to discharge duties

Qualifications:
1. must own at least one share in capital stocks in his name
- nominal? Nominal consideration – real consideration – nothing!
- Why is at least one share is required? – to avoid directors that are strangers
to the corporation
2. Majority of the directors/trustees organized under the Corp. Law must be residents
-
Disqualifications:
1. must not have been convicted by a crime of conviction within 5 years prior to election
2. has not committed any violation of the Corp. Code

Gokongwei Case
- qualifications and disqualifications provided in the law are minimal
- Board can provide more, governed by the by-laws
- by-laws are void if they are unreasonable or discriminatory
- must not be written in a simple board/civil court resolution or house rules, it must be in the articles of
incorporation, by-laws, law

Removal
- Removal may be with or without cause: Provided, That removal without cause may not be used to deprive
minority stockholders or members of the right of representation to which they may be entitled under Section
24 of the Code

D Hondt Remainder Table


- teaches how to maximize votes, to get extra seats in case the other party misbehave

Doctrines in Contract Law


Relativity
Incorporation
Autonomy
Mutuality
Obligatory Force

Obligations & Duties


Obligation – formal contract/promise/commitment, close ended
Duty – moral obligation, open ended

Duty of Obedience – preparatory and progressive


- bounded by sec 23 or 22
- obey the mandate of the law, the charter, or the by-laws
- strongest in level of relationship: juridical entity (limited powers)
- weakest in extra corporate level – the State doesn’t care

Principle under sec 2 of Corp Code implemented by sec 45


- creature of limited powers: can only act within expressly provided powers
- under the obligation to run those powers

If duty of obedience is violated, the contract is void. (first ultra vires act: outside powers of corporation)
Contracts of corporation that are void – ultra vires
First Ultra Vires – does the court favour it?

Duty of Loyalty
– any officer or director who acquires personal interest or pecuniary interest in conflict with his duties are
solidarily liable for damages to the corporation, its stockholders and its members
- level of relationship where it is weakest: intra corporate level
- corp has no concern if contract is entered in third party, corp is stranger to the contract (doctrine of
relativity)
- is duty of loyalty relevant in extra-corporate level? NO
- if director/officer violates his duty, the contract is valid as to agent, director/officer is liable solidarily to the
corp
Doctrine of corporate opportunity
- business opportunity: he is liable to give to the corporation all the earnings/profits (obligation), he absorbs
all the losses

Duty of Diligence (sec 31)


- they are liable solidarily if they vote to or consent to patently unlawful acts, or are guilty of gross
negligence or bad faith
- they owe the same duties to the stockholders under trustee-beneficiary relationship
- negligence is not enough, it must be GROSS. Why? Because??

Levels under Extra-corporate level


Contracts
Courts
Employer-employee relationship

Duty of diligence – 3 grounds: Is it cast in stone? NO. You can gather from jurisprudence, etc

Sec 31: liable as a trustee, he must account for the profits


- general provision for all
- non-ratifiable

Duty of Loyalty
Implied trust:
1. constructive
2.

Sec 34: only for directors, ratifiable

Difference: see p. 412

When breach has been committed, what will the director do? Return the profits.

Why does the law talk twice?


- When it comes to directors, they are not favored
- when it comes to officers and trustees, favored

Sec 23: all business conducted, all property, controlled and held by the Board
- all powers controlled by Board, they have discretion
- UNLESS otherwise provided: sec 34: ratification is an exception
- the board has discretion for ratification
Voting of the stockholders to remove from office: primary, not just ratificatory

Non-remunerative: no wages – directors BUT can be granted compensation (sec 30)


- Chairman, Vice-Chairman, Treasurer, Secretary – have wages

Trustees: non-remunerative, why? Because they volunteer to do good, not for money
Trustee: holder of property for a beneficiary, public good, charitable purposes
Directors/Trustees: can be elected, can be remunerated, can be removed by stockholders

Duty of obedience: does apply in the intra-corporate level (board)


- relationship of corp to the State
- its breach gives rise to personal liability of the director to the third party
- creates the duty on the part of the board to enter into contracts within their
expressed purposes

General rule: if contract is ultra vires, it is valid BUT the board


It cannot overcome public policy, third parties who entered into contracts with good faith need to be satisfied

Ultra Vires 3rd type: contract is void even if the public is involved
Freedom to contract, provided that it is not against law, public policy, etc
Intra-corporate in character

General rule: agents are not personally liable for the acts he did in the scope of his authority
- he is a stranger to the contract (relativity)
- EXCEPT: when he acts in bad faith, gross negligence and when he binds
himself to be personally liable.

FRAUD: malicious intent


BAD FAITH: almost in the level of fraud, moral obliquity

Personal liability attaches when he: (PBCWLP)


1. assents to patently unlawful acts
2. he acts in bad faith or gross negligence
3. conflict of interest resulting to damages
4. consent to issuance of watered stocks
5. agrees to hold himself personally and solidarily liable with the corp
6. provision makes him to answer personally for the act

Business Judgment Rule


1. corporate powers and business operations, etc are all subject to the discretion of the Board
2. courts will not interfere/cannot question as long as it was done in good faith, or there is no abuse of
discretion

It is within the discretion of the board of directors; a business is a risk, board is not expected to know
everything (not a guarantee of profitability)

Pardo De Tavera case:


Security of tenure clause (Consti): there must be cause for removal
- for civil service and employees
- NO EXCEPTIONS, not even highly technical, highly confidential positions
Under Corp Code:
- Exception is under Business judgment rule: hiring and removing/terminating are within the business
judgment
- officers should be within business judgment: they are so integrated with operations of the corporation
- why don’t officers enjoy security of tenure? The nature of their position is fiduciary, but there is no basis (it
is so because the SC says so)
- President: fiduciary bound
- In absence of by-laws, he cannot be terminated if there is a stipulation in the contract of a term
- officer is important because he is provided for in the by-laws; if he is not in the by-laws, he is not important
- note: Marcos: he came up with security of tenure
- Exception: by-law provides for a term, they signed an employment contract with a term
Nacpil v IBC:
Important: it should be in the by-laws that officers are created, to be under business judgment rule
If not in by-laws: Art 12, sec 5: power to appoint/create officer position
Power to appoint is different from power to terminate
When you draw power from sec 23, there is security of tenure

NON-STOCK CORPORATIONS

1. Ratio behind Non-Stock Corps:


- private sectors come into areas that require public service under non-stock non -profit scheme with
incentives
- gives
- Commutativeness: one element of a contract
- There are certain commodities that are beyond measurable value
- charitable institution
- services or resources: surely to be spent on what they are worth

2. Tests:
a. purpose: must be found in charter, eleemosynary purpose (charitable, educational, literary, etc)
b. prohibition on distribution of profits(sec 87 of Corp Code) – prohibition in articles and by-laws
- there is no profit, but there is compensation
- can not have a an objective that isn’t charitable or religious

- no business in profitable venture as main industry

Implications that there is ‘capital stock’


- statutory power to declare dividends: stock corporation has the expressed power to distribute dividends
- voting rights & cumulative voting – non-stock corp: straight voting (cannot be taken away by A&BL) (stock
corp: cumulative voting is a must)
- transfer of shares and rights (sec 89 and 90 of Corp Code)
- distribution of net assets and profits upon dissolution
- applicability of stock corporation provisions (sec 92 applies)
- good governance doesn’t apply to non-stock corps

MEMBERS OF NON-STOCK CORPORATIONS


1. membership purely personal, non-transferable (personal before proprietary; abuse of right)
2. juridical entities as members
3. nature of membership’s voting rights
- it is possible to take away voting rights
- qualifications are allowed
- you cannot just be arbitrary

TRUSTEES AND OFFICERS


Default rule: straight voting
- election
- meeting of trustees: anywhere

Specific Rules applicable to Non-Stock:


Aside from the articles and by-laws, does it bind members to adopt house rules? YES

Assesment of Membership Dues


Non-applicability of the Nationalization Laws
Finals tip: nationality requirements are only for stock corporations
Land cannot be owned by juridical persons who are not 60% Filipino
Continuation of Activities After Dissolution
Distribution of Assets of Non-Stock Corporations

Finals tip: is it lawful for a NSCorp to change it’s purpose? YES and NO. Yes to those who agreed and no
those who did not.
CONVERSION TO STOCK CORPORATION
You cannot just amend the AOI

FOUNDATIONS
Not different to NS Corps
Technical term that has been derived under derived laws
It has guidelines
- You cannot spend more than 25k
- upon dissolution, upon paying its liabilities, must be transferred to another charitable institutions
Charitable Contributors

Educational Corps
Religious Corps
- corporation sole
- acquisition of land
- acquisition and disposition of land
- all corps have a term except for religious corps

Cooperatives
Stock – dictated by profit
Non-stock – charitable
Cooperatives – self-help

Real source of power – from the members

STOCKS
Subscription agreement is a genus of sale
Bilateral, reciprocal contract, onerous

Watered Stocks – subscription agreement


Watered stocks – misrepresented, hides true value (ex. van worth 100k, sell it for 200k, then say it’s already
discounted)
Discounted stocks – no misrepresentation, no fraud

Sec 63 – intra-corporate
- covers encumbrance of shares

RIGHTS & OBLIGATIONS OF A STOCKHOLDER

Rights of Stockholders:
1. right to vote
2. right to dividends
3. pre-emptive right
4. right to issue of certificate of stock
5. right to transfer properties
6. right to file derivative suit

Net assets – upon dissolution, the fiduciary relationship between the corp & creditors arises
Main obligation of corporation to creditors: make sure they first liquidate

When does a stockholder attain the right to transfer? Upon subscription

Modes of transfer of shares:


1. execution of a public instrument
2. negotiation, transfer and assignment of evidence of the intangible (cert of stock)
3. enjoyment of the rights of ownership

Right to Dividends
- from capital stock
- system of declaration of unrestricted retained earnings: business judgment rule
- cash dividends: board resolution
- stock dividends: can be declared by the board but requires ratification of 2/3 of OCS – why?
Forms of Dividends:
Cash
Property
Stock

Reasonable Restrictions
1. reasonable as to period (30-120 days)
2. as to execution
3. as to process

Purpose – very important, period depends on this

Treasury shares – issued and fully paid for, but subsequently reacquired by the issuing corporation by
purchase, redemption, duration or through other lawful means

Proxy
- agent of stockholder
- contract/instrument (agency)
- essentially revocable

There are irrevocable agencies

Naked owner – legal, registered owner

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