Corporate Contract Law

CORPORATION
LAW REVIEWER (2013-2014)
ATTY. JOSE MARIA G. HOFILEA
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])
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).
Rizal Light & Ice Co., Inc. v. Public Service Comm., 25 SCRA 285
(1968).
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 Taboras
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)
CORPORATION LAW REVIEWER (2013-2014)

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 Taboras 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 dont
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 Appeals


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 cant 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 couldnt 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
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.

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 Alberts 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.

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. Hofilea 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)


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
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
Childrens 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. Intl Express
Travel v. Court of Appeals, 343 SCRA 674 (2000).

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
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 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 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




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)

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:
The requirement of unrestricted retained earnings to cover the

shares is based on the trust fund doctrine which means that the


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. Hofilea 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 corporations 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. Hofilea the creditors have no right to compel
the company to sell the unsubscribed shares it has left
of the authorized capital stock.
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 BMPIs 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 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.

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 These are earnings which is

not earmarked for any particular purpose.
Dividends come from the unrestricted retained earnings.

Otherwise, you will impair the capital of the corporation.
o Stock Dividend 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 liquidated cash
Distribution is decided upon by the Board of
Directors.
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. Its like reinvesting your dividends to the

corporation.
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

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 corporations 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 Tius contributed a building and two lots, while the Ongs
contributed P100M.

Two years later, the Tuis 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


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
corporations 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. Hofilea 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.
A company may do what it wills with its properties, but

creditors are protected.


Corporate Contract Law

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CORPORATION

LAW REVIEWER (2013-2014)

ATTY. JOSE MARIA G. HOFILEA