CONTROL AND MANAGEMENT

Allocation of Power and Control

Q: What are the three levels of corporate control/power?

Board of directors or trustees- responsible for corporate policies and the general
management of the business and affairs of the corporation.

Officers- execute the policies laid down by the board.

Stockholders or members- have residual power over fundamental corporate changes like
amendments of articles of incorporation.

Who Exercises Corporate Powers

Board of directors or trustees

Q: What are the powers of the BOD?

The BOD is responsible for corporate policies and the general management of the
business affairs of the corporation. (See Citibank v Chua)

(a) Authority (Sec. 24)

(b) Requirements

(i) Qualifying share (Sec. 24)

(ii) Residence (Sec. 24)

(iii) Nationality

(iv) Disqualifications (Sec. 27)

- conviction by final judgment of offense punishable > 6 yrs. prison
- violation of Corporation code within 5 years prior to date of election or
appointment

(c) How elected (Sec. 24)

The formula for determining the number of shares needed to elect a given number of directors is as
follows:

X = Y x N1 +1
N+1

X = being the number of shares needed to elect a given number of directors

Y = being the total number of shares present or represented at the meeting
N1 = being the number of directors desired to be elected
N = being the total number of directors to be elected
(d) How removed (Sec. 28)

By a vote of the SHs holding or representing at least 2/3 of the outstanding capital stock, or by
a vote of at least 2/3 of the members entitled to vote, provided that such removal takes place at
either a regular meeting of the corporation or at a special meeting called for the purpose. In both
cases, there must be previous notice to the SHs / members of the intention to propose such
removal at the meeting.

Removal may be with or without cause. However, removal without cause may not be used to
deprive minority SHs or members of the right of representation to which they may be entitled
under Sec. 24 of the Code.

(e) How vacancy filled (Sec. 29)

If vacancy due to removal Must be filled by the SHs in a regular or special meeting
or expiration of term: called for that purpose.

If "vacancy" due to increase Only by means of an election at a regular or special SHs

in number of directors meeting duly called for the purpose, or in the
same or trustees: meeting authorizing the increase of
directors or trustees
if so stated in the notice of the meeting.

All other vacancies: May be filled by the vote of at least a majority of the
remaining directors or trustees, if still constituting a
quorum.

Note: Directors or trustees so elected to fill vacancies shall be elected only for the unexpired
term of their predecessors in office.

(f) How compensated (Sec. 30)

If provided in by-laws: That compensation stated in the by-laws.

If not provided in by-laws: Directors shall not receive any compensation other than
reasonable per diems, as directors. However, compensation
other than per diems may be granted to directors by a majority
vote of the SHs at a regular or special stockholders' meeting.

Note: In no case shall the total yearly compensation of directors, as such directors, exceed 10%
of the net income before income tax of the corporation during the preceding year.

(g) Matters requiring Board of Directors' action

(h) Liability (See subsequent discussion under Duties of Directors and Controlling
Stockholders.)

(i) In general (Sec. 31)

(ii) Business judgment rule

(iii) Dealings with the corporation (Sec. 32)

(iv) Contracts between corporations with interlocking directors (Sec. 33)

 (v) Disloyalty (Sec. 34)

(vi) Watered stocks (Sec. 65)

(i) Executive Committee (Sec. 35)

See subsequent discussion under Board Committees.

RAMIREZ VS. ORIENTALIST CO AND FERNANDEZ (38 Phil. 634; 1918)

In this case, the board of directors, before the financial inability of the corporation to
proceed with the project was revealed, had already recognized the contracts as being in existence
and had proceed with the necessary steps to utilize the films. The subsequent action by the
stockholders in not ratifying the contract must be ignored. The functions of the stockholders are
limited of nature. The theory of a corporation is that the stockholders may have all the profits but
shall return over the complete management of the enterprise to their representatives and agents,
called directors. Accordingly, there is little for the stockholders to do beyond electing directors,
making by-laws, and exercising certain other special powers defined by law. In conformity with
this idea, it is settled that contracts between a corporation and a third person must be made by
directors and not stockholders.

LOPEZ VS. ERICTA (45 SCRA 539; 1972)

In this case, the Board of Regents of the University of the Philippines terminated the ad
interim appointment of Dr. Blanco as Dean of the College of Education by not acting on the
matter. In the transcript of the meeting which was latter agreed to be deleted, it was found out
that the BOR, consisting of 12 members, voted 5 in favor of Dr. Blanco's appointment 3 voted
against, and 4 abstained.

The core of the issue is WON the 4 abstentions will be counted in favor of Dr. Blanco's
appointment or against it. The SC held that such abstentions be counted as negative vote
considering that those who abstained, 3 of which members of the Screening Committee,
intended to reject Dr. Blanco's appointment.

ZACHARY VS. MILLIN (294 Mic. 622; 1940)

The issue in this case is regarding the validity of the director's meeting at the company's
laboratory on December 8, 1937 wherein Zachary was removed as president of the company.
Zachary that he was not notified of the meeting thus, the action was void. On the other hand, the
defendants contend that the notice requirement was waived by Zachary's presence at the meeting.

The SC held that the validity of the meeting was not affected by the failure to give notice
as required by the by-laws, provided that the parties were personally present. Since all the parties
were present at the meeting of December 8, and understood that the meeting was to be a
directors' meeting, then the action taken is final and may not be voided by any informality in
connection with its being called.
PNB VS. CA (83 SCRA 238; 1978)

The action was brought by the mortgagor (Tapnio) against PNB for damages in
connection with the failure of the latter's board of directors to act expeditiously on the proposed
lease of the former's sugar quota to one Tuazon.

The Supreme Court held that while the PNB has the ultimate authority to approve or
disapprove the proposed lease since the quota was mortgaged to PNB, the latter certainly cannot
escape liability for observing, for the protection of the interest of the private respondents, that
degree of care, precaution and vigilance which the circumstances justly demand in approving or
disapproving the lease of the said sugar quota.

Corporate officers and agents

(a) Minimum set of officers and their qualifications (Sec. 25)

The minimum set of officers are:

(1) president (who shall be a director);

(2) secretary (who shall be a resident and Filipino citizen); and
(3) treasurer (who may or may not be a director)

The by-laws, however, may provide for other officers.

Any 2 or more positions may be held concurrently by the same person, except that no
one shall act as (a) president and secretary, or (b) president and treasurer at the same time.

(b) Disqualifications (Sec. 27)

- Conviction by final judgment of an offense punishable by imprisonment > 6 yrs.

- Violation of Corporation Code committed within 6 yrs. prior to the date of election or
appointment

(c) Liability in general (Sec. 31)

See discussion under Duties of Directors and Controlling Stockholders. .

(d) Dealings with the corporation (Sec. 32)

- Generally voidable (See discussion under Duties of Directors and Controlling

Stockholders)

What is the doctrine of apparent authority?

The doctrine of apparent authority provides that a corporation will be

liable to innocent third persons for the acts of its agent where the representation
was made by the agent in the course of business and acting within his/her
general scope of authority even though, in the particular case, the agent is
 secretly abusing his authority and attempting to perpetrate a fraud upon his/her
principal or some other person for his/her own ultimate benefit.

FIRST PHILIPPINE INTERNATIONAL BANK & RIVERA v. CA (January 24, 1996)

The authority of a corporate officer in dealing with third persons may be actual or
apparent. The doctrine of "apparent authority," with special reference to banks, was laid out
inPrudential Bank v. CA (223 SCRA 350) where it was held that:

A bank is liable for the wrongful acts of its officers done in the
interest of the bank or in the course of dealings of the officers in
their representative capacity but not for acts outside the scope of
their authority. A bank holding out its officers and agents as
worthy of confidence will not be permitted to profit by the frauds
they may thus be enabled to perpetrate in the apparent scope of
their employment; nor will it be permitted to shrink from its
responsibility for such frauds, even though no benefit may accrue
to the bank therefrom.

Accordingly, a bank is liable to innocent third persons where the representation is made
in the course of its business by its agent acting within the general scope of his authority even
though, in the particular case, the agent is secretly abusing his authority and attempting to
perpetrate a fraud upon his principal or some other person for his own ultimate benefit.
Application of these principles is especially necessary because banks have a fiduciary
relationship with the public and their stability depends on the confidence of the people in their
honesty and efficiency. Such faith will be eroded where banks do not exercise strict care in the
selection and supervision of its employees, resulting in prejudice to their depositors.

YU CHUCK V. KONG LI PO (46 Phil. 608; 1924)

The power to bind a corporation by contract lies with its board of directors or trustees.
Such power may be expressly or impliedly be delegated to other officers and agents of the
corporation. It is also well settled that except where the authority of employing servants or
agents is expressly vested in the board, officers or agents who have general control and
management of the corporation's business, or at least a specific part thereof, may bind the
corporation by the employment of such agents and employees as are usual and necessary in the
conduct of such business. Those contracts of employment should be reasonable. Case at bar:
contract of employment in the printing business was too long and onerous to the business (3-year
employment; shall receive salary even if corp. is insolvent).

THE BOARD OF LIQUIDATORS V. HEIRS OF MAXIMO KALAW (20 SCRA 987; 1967)

Kalaw was a corporate officer entrusted with general management and control of
NACOCO. He had implied authority to make any contract or do any act which is necessary for
the conduct of the business. He may, without authority from the board, perform acts of ordinary
nature for as long as these redound to the interest of the corporation. Particularly, he contracted
forward sales with business entities. Long before some of these contracts were disputed, he
contracted by himself alone, without board approval. All of the members of the board knew
about this practice and have entrusted fully such decisions with Kalaw. He was never questioned
nor reprimanded nor prevented from this practice. In fact, the board itself, through its acts and
by acquiescence, have laid aside the by-law requirement of prior board approval. Thus, it cannot
now declare that these contracts (failures) are not binding on NACOCO.

ZAMBOANGA TRANSPO V. BACHRACH MOTORS (52 Phil. 244; 1928)

A chattel mortgage, although not approved by the board of directors as stipulated in the
by-laws, shall still be valid and binding when the corporation, through the board, tacitly
approved and ratified it. The following acts of the board constitute implied ratification:

1. Erquiaga is one of the largest stockholder, and was the all-in-one officer (he was the
President, GM, Attorney, Auditor, etc.)

2. Two other directors approved his actions and expressed satisfaction with the advantages
obtained by him in securing the chattel mortgage.

3. The corporation took advantage of the benefits of the chattel mortgage. There were even
partial payments made with the knowledge of the three directors.

ACUNA V. BATAC PRODUCERS COOPERATIVE MARKETING ASSOCIATION (20

SCRA 526; 1967)

Acuna entered into an agreement with Verano, manager of PROCOMA, in which the
former would be constituted as the latter's agent in Manila. Acuna diligently went about his
business and even used personal funds for the benefit of the corporation. During the face-to-face
meeting with the board, Acuna was assured that there need not be any board approval for his
constitution as agent for it would only be a mere formality. Later on, the board disapproved the
agency and did not pay him. The SC ruled that the agreement was valid due to the ratification of
the corp. proven by these acts:

1. He was assured by the board that no board approval was necessary.

2. He delivered P 20,000, performed his work with the knowledge of the board.
3. Due to acquiescence, the board cannot disown or disapprove the contract.

Board Committees
The By-laws of the corporation may create an executive committee, composed of
not less than 3 members of the Board, to be appointed by the Board. The executive
committee may act, by majority vote of all its members, on such specific matters within
the competence of the board, as may be delegated to it in either (1) the By-laws, or (2) on
a majority vote of the board.
 However, the following acts may never be delegated to an executive committee:

(1) approval of any action for which shareholders' approval is also required;
(2) the filling of vacancies in the board (refer to Sec. 29);
(3) the amendment or repeal of by-laws or the adoption of new by-laws;
(4) the amendment or repeal of any resolution of the board which by its
express terms is not so amendable or repealable; and
(5) a distribution of cash dividends to the shareholders.

HAYES V. CANADA, ATLANTIC AND PLANT S.S CO., LTD. (181 F. 289; 1910)

In this case, the Executive Committee:

a) removed the Treasurer and appointed a new one

b) fixed the annual salary of the members of the Executive Committee
c) amended the by-laws by giving the President the sole authority to call a stockholder's
meeting and a board of directors meeting
d) amended the composition of the ExeCom by limiting it to just 2 persons.

Was these actions valid?

No, because the Executive Commmittee usurped the powers vested in the board and the
stockholders. If their actions was valid, it would put the corp. in a situation wherein only two
men, acting in their own pecuniary interests, would have absorbed the powers of the entire
corporation. "Full powers" should be interpreted only in the ordinary conduct of business and
not total abdication of board and stockholders' powers to the ExeCom. "FULL POWERS" does
not mean unlimited or absolute power.

Stockholders or Members

In the following basic changes in the corporation, although action is usually initiated by the board
of directors or trustees, their decision is not final, and approval of the stockholders or members would be
necessary:

(1) Amendment of articles of incorporation;

(2) Increase and decrease of capital stock;
(3) Incurring, creating or increasing bonded indebtedness;
(4) Sale, lease, mortgage or other disposition of substantially all corporate assets;
(5) Investment of funds in another business or corporation or for a purpose other than
the primary purpose for which the corporation was organized;
(6) Adoption, amendment and repeal of by-laws;
(7) Merger and consolidation;
(8) Dissolution of corporation

In all of these cases, even non-voting stocks, or non-voting members, as the case may be, will be
entitled to vote. (Sec. 6)
BOARD OF DIRECTORS AND ELECTION COMMITTEE OF SMB VS. TAN (105 Phil.
426; 1959)

Meeting was invalid for lack of notice. By-laws provide for a 5-day notice before
meeting. March 26 posting not enough for March 28 election.

JOHNSTON VS. JOHNSTON (61 O.G. No. 39, 6160; 1965)

As a general rule, a quorum at a stockholders' meeting, once reached, cannot be nullified

by a subsequent walkout.

However, the proceedings can be nullified if the walkout was for a reasonable and
justifiable cause. In this case, F. Logan Johnston, who owned and/or represented more than 50%
of the corporation's outstanding shares, was prohibited from voting the shares of the Silos family
(which he had validly purchased) and of the minor children of Albert S. Johnston (of whom he
was guardian) on the ground that such shares must first be registered in the names of the wards,
thereby prompting the walkout. The Court of Appeals held that the walkout was neither
unreasonable nor unjustifiable. It noted however that there was no formal declaration of a
quorum before the withdrawal from the meeting by F. Logan Johnston.

PONCE VS. ENCARNACION (94 Phil. 81; 1953)

Upon good cause, such as a Chairman of the Board failing to call a meeting, either by his
absence or neglect, the Court may grant a stockholder the authority to call such a meeting.

DETECTIVE AND PROTECTIVE BUREAU VS. CLORIBEL (26 SCRA 225; 1968)

The Corporation Law says that every director must own at least one (1) share of the
capital stock of the corporation.

GOKONGWEI VS. SEC (89 SCRA 336; 1979)

 Section 21 of the Corporation Law provides that a corporation may prescribe in its by-
laws the qualifications, duties, and compensation of its directors.

 A stockholder has no vested right to be elected director for he impliedly contracts that the
will of the majority shall govern.

 Amended by-laws are valid for the corporation has its inherent right to protect itself.

ROXAS V. DELA ROSA (49 Phil. 609; 1926)

 Under the Law, directors can only be removed from office by a vote of the stockholders
representing 2/3 of subscribed capital stock, while vacancies can be filled by a mere majority.

A director cannot be removed by a mere majority by disguising it as filling a vacancy.

ANGELES V. SANTOS (64 Phil. 697; 1937)

Court may appoint a receiver when corporate remedy is unavailable when board of
directors perform acts harmful to the corporation.

Generally, stockholders cannot sue on behalf of the corporation. The exception is when
the defendants are in complete control of the corporation.

CAMPBELL V. LEOW’S INC. (134 A. 2d 852; 1957)

The stockholders have an implied power to remove a director for cause. Even when there
is cumulative voting, stockholders can still remove directors for cause.

DELA RAMA V. MA-AO SUGAR CENTRAL CO, INC. (27 SCRA 247; 1969)

A corporation may use its funds to invest in another corporation without the approval of
the stockholders if done in pursuance of a corporate purpose. However, if it is purely for
investment, the vote of the stockholders is necessary.

VOTING

Pledgors, mortgagors, executors, receivers, and administrators (Sec. 55)

- Pledgors or mortgagors have the right to attend and vote at stockholders' meetings.

Exception: If the pledgee or mortgagee is expressly given by the pledgor or

mortgagor such right in writing which is recorded on the
appropriate corporate books.

- Executors, administrators, receivers and other legal representatives duly appointed

by the court may attend and vote in behalf of the stockholders or members without
need of any written proxy.

Joint owners of stock (Sec. 56)

- Generally, consent of all co-owners shall be necessary.

Treasury shares (Sec. 57)

- Treasury shares have no voting right for as long as such shares remain in the
Treasury.
Proxies (Sec. 58)

- Proxies must be in writing, signed by the stockholder/member, filed before the

scheduled meeting with the corporate secretary.

- Unless otherwise provided in the proxy, it shall be valid only for the meeting for
which it is intended. No proxy shall be valid and effective for a period longer than five
(5) years at any one time.

- Voting trusts may be voted by proxy unless the agreement provides otherwise.
(Sec. 59)

- It must be noted however that directors or trustees cannot vote by proxy at board
meetings. (Sec. 25)

- Note that in Sec. 89, non-stock corporations are permitted to waive the right to use
proxies via their AOI or by-laws.

Voting trust (Sec. 59)

- Voting trusts must be in writing, notarized, specifying the terms and conditions
thereof, certified copy filed with SEC. Failure to comply with this requirement renders
the agreement ineffective and unenforceable.

- As a general rule, voting trusts are valid for a period not exceeding 5 years at any
one time, and automatically expire at the end of the agreed period unless expressly
renewed.
However, in the case of a voting trust specifically required as a condition in a
loan agreement, said voting trust may exceed 5 years but shall automatically
expire upon payment of the loan.

- Voting trusts may be voted by proxy unless the agreement provides otherwise.
(Sec. 59)

Pooling agreement

- Pooling agreements refer to agreements between 2 or more SHs to vote their

shares the same way. They are different from voting trust agreements in that they do
not involve a transfer of stocks but are merely private agreements between 2 or more
SHs to vote in the same way.

- Sec. 100, par. 2 of the Corporation Code provides for pooling and voting
agreements in close corporations. Although there is no equivalent provision for
widely-held corporations, Justice and Prof. Campos are of the opinion that SHs of
widely-held corporations should not be precluded from entering into voting
agreements if these are otherwise valid and are not intended to commit any wrong or
fraud on the other SHs that are not parties to the agreement.

Non-voting shares (Sec. 6)

- Preferred or redeemable shares.

 ITF shares

And/or shares (Sec. 56)

- Any one of the joint owners can vote said shares or appoint a proxy thereof.

Devices Affecting Control

Proxy Device

Sec 58. Proxies. – Stockholders and members may vote in person or by proxy in all meetings of
stockholders or members. Proxies shall be in writing, signed by the stockholder or member and
filed before the scheduled meeting with the corporate secretary. Unless otherwise provided in the
proxy, it shall be valid only for the meeting for which it is intended. No proxy shall be valid and
effective for a period longer than five (5) years at any one time.

Character: agency relationship; revocable at will (by express revocation, by attending the
meeting) and by death, except when coupled with interest or is a security.

IN RE GIANT PORTLAND CEMENT CO. (21 A.2d 697; 1941)

Even if stocks are sold, the stockholder of record remains the owner of the stocks and has
the voting right until the by-law requiring recording of transfer in the transfer book is complied
with. Thus, a proxy given by the stockholder of record even if he has already sold the share/s of
stock remains effective.

STATE EX REL EVERETT TRUST V PACIFIC WAXED PAPER, (159 A.L.R. 297; 1945)

The general rule is that a proxy is revocable even though by its express terms it is
irrevocable. The exceptions are: (a) when authority is coupled with interest; (b) where authority
is given as part of a security and is necessary to effectuate such a security. It is coupled with
interest when there is interest in the share themselves (such as a right of first refusal in case of
sale) and the rights inherent in the shares (such as voting rights; capacity to obtain majority).

DUFFY V LOFT (17 Del. Ch. 376, 152 A. 849; 1930)

Where a stockholder’s meeting was validly convened, the proxies must be deemed
present even if the proxies were not presented, provided: (a) their existence is established; (b) the
agents were so designated to attend and act in SH’s behalf; (c) the agents were present in the
meeting.

Q: Is it valid for the corporation to pay the expenses for proxy solicitation?
 A: In the case of Rosenfeld v. Fairchild Engine and Airplane Corp. (128 N.E. 2d 291;
1955), it was held that in a contest over policy (as opposed to a purely personal power
contest), corporate directors have the right to make reasonable and proper expenditures,
subject to the scrutiny of the courts when duly challenged, from the corporate treasury for
the purpose of persuading the SHs of the correctness of their position and soliciting their
support for policies which the directors believe, in all good faith, are in the best interests
of the corporation. The SHs, moreover, have the right to reimburse successful
contestants for the reasonable and bona fide expenses incurred by them in any such
policy contest, subject to like court scrutiny.
However, where it is established that such monies have been spent for personal
power, individual gain or private advantage, and not in the belief that such expenditures
are in the best interest of the stockholders and the corporation, or where the fairness and
reasonableness of the amounts allegedly expended are duly and successfully
challenged, the courts will not hesitate to disallow them.

ROSENFELD V. FAIRCHILD (128 N.E. 2d 291; 1955)

In a contest over policy, as compared to a purely personal power contest, corporate

directors have the right to make reasonable and proper expenditures. Reason: in these days of
giant corporations with vast numbers of SH’s, if directors are not allowed to authorize reasonable
expenses in soliciting proxies, corporate business may be hampered by difficulty in procuring
quorum; or corporations may be at the mercy of persons seeking to wrest control for their
purposes if the directors may not freely answer their challenge. But corp expense may be
disallowed by courts where money was shown to have been spent for personal power, individual
gain or private advantage, or where fairness and reasonableness of amount spent has been
successfully challenged.

Voting Trust

A Voting Trust Agreement (VTA) is an agreement whereby the real ownership of the shares is
separated from the voting rights, the usual aim being to insure the retention of incumbent directors and
remove from the stockholders the power to change the management for the duration of the trust.

Advantages

 Accumulates power. Small shareholders are given the chance to have a representation in the
BOD or at least a spokesperson during stockholders’ meetings.
 Continuity of management.
 More effective than proxies because it is irrevocable.
 Ensures that the required number of stockholders is met thereby facilitating smooth corporate
operations.

Disadvantages

 Stockholders give up rights (voting and naked title)

 Susceptible to abuse
 Not used in widely held corporations

Rights given up by the shareholder in a VTA in exchange for the fiduciary obligation of
the trustee:
  Voting rights
 Proprietary rights/naked title/legal ownership
 Incidental rights such as to attend meetings, to be elected, to receive dividends)

Rights retained by the shareholder

 Beneficial or equitable ownership

 Right to revoke VTA in case of breach by trustee
 Regain full ownership after the lapse of the period
 Right to an accounting by the trustee after the period of the VTA

How is a voting trust created?

(1) A VTA is prepared in writing, notarized, and filed with the corporation and SEC.

(2) The certificates of stock covered by the VTA are cancelled and new ones (voting trust
certificates) are issued in the name of the trustee/s stating that they are issued pursuant to
the VTA.

(3) The transfer is noted in the books of the corporation.

(4) The trustee/s execute and deliver to transferors the voting trust certificates. (Note that these
certificates shall be transferable in the same manner and with the same effect as certificates
of stock.)

(5) At the end of the period of the VTA (or the full payment of the loan to which the VTA is made
a condition, as the case may be), in the absence of any express renewal, the voting trust
certificates as well as the certificates of stock in the name of the trustee/s shall be deemed
cancelled and new certificates of stock shall be reissued in the name of the transferors.

EVERETT V. ASIA BANKING (49 Phil. 512; 1926)

This case illustrates how VTA can give rise to effective control and how it can be abused.
Original stockholders can set aside the VTA when their rights are trampled upon by the trustee.

MACKIN, ET AL. V. NICOLLET HOTEL (25 F. 2d 783; 1928)

Invalidating circumstances of a VTA are:

 Want of consideration
 Voting power not coupled with interest
 Fraud
 Illegal or improper purpose

NIDC V. AQUINO (163 SCRA 153; 1988)

 A VTA transfers only voting or other rights pertaining to the shares subject of the
agreement, or control over the stock. Stockholders of a corp. that lost all its assets through
foreclosures cannot go after those properties. PNB-NIDC acquired those properties not as
trustees but as creditors.

Pooling and voting agreements

What are the advantages/disadvantages of a pooling agreement?

Advantages:

1. there is a commitment to agree to a certain manner of voting

2. minority stockholders are able to control the corpo

Disadvantages:

1. possibility of disagreement thus the need for an arbitration clause

2. there is no compelling reason for stockholders to act together

What rights does a shareholder give up/ retain with a pooling agreement?

Shareholders retain their right to vote because the parties are not constituted as agents.
However, the will of the parties may not be carried out due to non-compliance with the
pooling agreement.

RINGLING v. RINGLING (29 Del. Ch. 318, 49 A. 2d 603; 1946)

Generally, agreements and combinations to vote stock or control corporate fiction &
policy are valid if they seek without fraud to accomplish only what parties might do as
stockholders and do not attempt it by illegal proxies, trusts or other means in contravention of
statutes or law.

BUCK RETAIL STORE v. HARKERT (62 N.W. 2d 288; 1954)

Stockholders’ control agreements are valid where it is for the benefit of corporation
where it works no fraud upon creditors or other stockholders and where it violates no statute or
recognized public policy.

MCQUADE v. STONEHAM (189 N.E. 234; 1934)

An agreement among stockholders to divest directors of their power to discharge an

unfaithful employee is illegal as against public policy. Stockholders may not by agreement
among themselves control the directors in the exercise of the judgment vested in them by virtue
of their office to elect officers and fix salaries.

CLARK v. DODGE (199 N.E. 641; 1936)

 If the enforcement of a particular contract damages nobody-not even the public, there is
no reason for holding it illegal. Test is WON it causes damage to the corporation and
stockholders.

Cumulative voting (see sec. 24)

Methods of Voting

1. Straight voting: If A has 100 shares and there are 5 directors to be elected, he shall
multiply 100 by five (equals 500) and distribute equally among the five
candidates without preference

2. Cumulative voting: If A has 100 shares and there are 5 directors to be elected, he shall
(one candidate) multiply 100 by five (equals 500) and he can vote the 500 for only one
candidate.

3. Cumulative voting: If A has 100 shares, there are 5 directors to be elected, and he only
(multiple candidates) wants to vote for two nominees, he can divide 500 votes between the
two, giving each one 250 votes.

How to compute votes needed to get a director elected by cumulative voting:

1. Frey’s formula (minimum no. of votes to elect one director)

X= # of shares required
Y= # of outstanding votes
Z= # of directors to be elected

X = _ Y__ + 1
Z+1

2. Baker & Cary’s formula (minimum no. of votes needed to elect multiple directors)

X= # of shares required
Y= # of shares represented at meeting
D= # of directors the minority wants to elect
D’= total # of directors to be elected

X= Y x D + 1
D' + 1

NOTES

 Levels playing field or at least ensures that the minority can elect at least one representative
to the board of directors (BOD)

 Cannot of itself give the minority control of corporate affairs, but may affect and limit the
extent of the majority’s control
  By-laws cannot provide against cumulative voting since this right is mandated by law in
Section 24.

Classification of shares (see sec. 6)

Type of shares

1. Common: share with right to vote

2. Preferred: share has preference over dividends and distribution of assets upon liquidation;
right to vote may be restricted (Sec. 6)

3. Redeemable: share is purchased or taken up by the corporation upon the expiration of a fixed
period (Sec. 8); right to vote may be restricted (Sec. 6)

NOTES

 Stock can also be both preferred and redeemable.

 Even though the right to vote of preferred and redeemable shares may be restricted, owners
of these shares can still vote on certain matter provided for in Sec. 6.

 SEC requires that where no dividends are declared for three consecutive years, in spite of
available profits, preferred stocks will be given the right to vote until dividends are declared.

GOTTSCHALK V. AVALON REALTY (23 N.W. 2d 606; 1946)

 Provision granting right to vote to preferred stock previously prohibited from voting,
constitutes diminution of the voting power of common stock.
 Provision in the articles of incorporation granting holders of preferred stock right to vote in
case of default in payment of dividends after July 1, 1951 was construed as denial by
necessary implication of the right to vote even prior to July 1, 1951.

Restriction on transfer of shares

 Peculiar to close corporations.

 Most common restriction: granting first option to the other stockholders and/or the
corporation to acquire the shares of a stockholder who wishes to sell them.

 Restrictions on shares of stock must conform to the requirements in Sec. 98

 This gives to the corporation and/or to its current management the power to prevent the
transfer of shares to persons who they may see as having interests adverse to theirs.
Prescribing qualifications for directors; founder’s shares

Directors (See Sec. 23, 27, 47)

 As long as the qualifications imposed are reasonable and not meant to unjustly or unfairly
deprive the minority of their rightful representation in the BOD, such provisions are within the
power of the majority to provide in the by-laws.

 According to Gokongwei vs. SEC, aside from prescribing qualifications, by-laws can also provide
for the disqualification of anyone in direct competition with the corporation.

Founder’s shares

See Sec. 7 for definition

 Exception to the rule in sec. 6 that non-voting shares shall be limited to preferred and
redeemable shares

 If founder’s shares enjoy the right to vote, this privilege is limited to 5 years upon SEC’s
approval, so as to prevent the perpetual disqualification of other stockholders.

Management contracts (sec. 44)

 Contract to manage the day-to-day affairs of the corporation in accordance with the policies laid
down by the board of the managed corporation.

 BOD can and usually delegate many of its functions but it can’t abdicate its responsibility to act
as a governing body by giving absolute power to officers or others, by way of a management
contract or otherwise. It must retain its control over such officers so that it may recall the
delegation of power whenever the interests of the corporation are seriously prejudiced thereby.

SHERMAN & ELLIS VS. INDIANA MUTUAL CASUALTY (41 F. 2d 588; 1930)

Although corporations may, for a limited period, delegate to a stranger certain duties
usually performed by the officers, there are duties, the performance of which may not be
indefinitely delegated to outsiders.

UNUSUAL VOTING AND QUORUM REQUIREMENTS (Sec. 25, 97 [for close

corporations])

 Increases veto power of the minority in some cases.

  In exchange for the numerical majority in the BOD, minority can ask for a stronger veto
power in major corporate decisions.

BENITENDI VS. KENTON HOTEL (60 N.E. 2d 829; 1945)

 A requirement that there shall be no election of directors at all unless every single vote be
cast for the same nominees, is in direct opposition to the statutory rule that the receipt of
plurality of the votes entitles a nominee to election. (See Sec. 24)

 Requiring unanimity before the BOD can take action on any corporate matter makes it
impossible for the directors to act on any matter at all. In all acts done by the corporation, the
major number must bind the lesser, or else differences could never be determined nor settled.

 The State has decreed that every stock corporation must have a representative government,
with voting conducted conformably to the statutes, and the power of decision lodged in
certain fractions, always more than half, of the stock. This whole concept is destroyed when
the stockholders, by agreement, by-law or certificates of corporation provides for unanimous
action, giving the minority an absolute, permanent and all-inclusive power of veto.

 The requirement of unanimous vote to amend by-laws is valid. Once proper by-laws have
been adopted, the matter of amending them is no concern of the State.

Device Favorable To: Limitations

Cumulative voting MINORITY: assures them of Can’t give minority control of

representation on the board corp. affairs

Classification of shares MINORITY: so long as they hold Preferred and redeemable stock
more common stock as opposed can still vote on certain matters
to the majority who holds more as provided in Sec. 6 or as may
preferred stock be provided by the corp.

Restriction on transfer of MAJORITY: they can choose See Sec. 98

shares whether to keep or release
*applicable only to close shares and they can prevent
opposition from acquiring shares
corporations

Prescribing qualifications MAJORITY: they’re the ones who Qualifications must be

for directors; founder’s can prescribe the qualifications in reasonable and do not deprive
shares the by-laws minority of representation on the
board

Management contracts MAJORITY: allows them to  Cannot exceed five years

delegate certain functions and  BOD must retain control
duties without losing control over over corp. policies
the corporation
  BOD must have power to
recall contract

Unusual voting and quorum MINORITY: gives them stronger Subject to the limitations in Sec.
requirements veto power in certain corp. affairs 103.

MEETINGS

Meetings of Directors / Trustees

KINDS: Meetings of the Board of Directors or Trustees may be either regular or

special. (Sec. 49)

REGULAR: Held monthly, unless otherwise provided in the by-laws.

(Sec. 53)

SPECIAL: At any time upon call of the president or as provided in the by-
laws.

NOTICE: Must be sent at least 1 day prior to the scheduled meeting, unless
otherwise provided by the by-laws.

Note: Notice may be waived expressly or impliedly. (Sec. 53)

WHERE: Anywhere in or outside the Philippines, unless the by-laws provide

otherwise.

QUORUM: Generally, a majority of the number of directors or trustees as fixed in

the articles of incorporation shall constitute a quorum for the transaction
of corporate business. (Sec. 25)

Exceptions:

(1) If the AOI or by-laws provide for a greater majority;

(2) If the meeting is for the election of officers, which
requires the vote of a majority of all the members of the
Board

WHO PRESIDES: The president, unless the by-laws provide otherwise. (Sec. 54)

Meetings of Stockholders / Members

KINDS: Meetings of stockholders or members may be either regular or special.

(Sec. 49)

REGULAR: Held annually on a date fixed in the by-laws. If no date is fixed,

on any date in April of every year as determined by the Board of
Directors or trustees.

Notice: Written, and sent to all stockholders or members of record at

least 2 weeks prior to the meeting, unless a different period is
required by the by-laws.
 SPECIAL: At any time deemed necessary or as provided in the by-laws.

Notice: Written, and sent to all stockholders or members of record at

least 1 week prior to the meeting, unless otherwise provided in
the by-laws.

Note: Notice of any meeting may be waived expressly or

impliedly by any SH or member. (Sec. 50)

WHERE: In the city of municipality where the principal office of the corporation is
located, and if practicable in the principal office of the corporation. Metro
Manila is considered a city or municipality. (Sec. 51)

QUORUM: Generally, a quorum shall consist of the stockholders representing a

majority of the outstanding capital stock, or a majority of the members.

Exception: If otherwise provided for in the Code or in the

by-laws.

WHO PRESIDES: The president, unless the by-laws provide otherwise. (Sec. 54)

WHAT IS THE EFFECT IF A STOCKHOLDER'S MEETING IS IMPROPERLY

HELD OR CALLED?

Generally, the proceedings had and/or any business transacted shall be

void. However, the proceedings and/or transacted business may still be deemed
valid if:

(1) Such proceedings or business are within the powers or authority of

the corporation; and

(2) All the stockholders or members of the corporation were present or

duly represented at the meeting. (Sec. 51)

DUTIES OF DIRECTORS AND CONTROLLING STOCKHOLDERS

Duties and Liabilities of Directors

WHAT IS THE 3-FOLD DUTY THAT DIRECTORS OWE TO THE CORPORATION?

(1) Diligence
(2) Loyalty
(3) Obedience

Obedience - directors must act only within corporate powers and are liable for
damages if they acted beyond their powers unless in good faith. Assuming that they
acted within their powers, liability may still arise if they have not observed due
diligence or have been disloyal to the corporation.
 WHEN DOES LIABILITY ON THE PART OF DIRECTORS, TRUSTEES OR OFFICERS
ARISE?

In general, liability of directors, trustees or officers arises when they either:

(1) willfully and knowingly vote for or assent to patently unlawful acts of the
corporation; or
(2) are guilty of gross negligence of bad faith in directing the affairs of the
corporation; or
(3) acquire any personal or pecuniary interest in conflict with their duty as such
directors or trustees.

In such cases, the directors or trustees shall be liable jointly and severally for all
damages resulting therefrom suffered by the corporation, its stockholders or members
and other persons.

When a director, trustee or officer attempts to acquire or acquires, in violation of

his duty, any interest adverse to the corporation in respect of any matter which has been
reposed in him in confidence, as to which equity imposes a disability upon him to deal in
his own behalf, he shall be liable as a trustee for the corporation and must account for the
profits which would otherwise have accrued to the corporation. (Sec. 31)

In addition to this general liability, the Corporation Code provides for specific rules
to govern the following situations:

(1) Self-dealing directors (Sec. 32)

(2) Contracts between interlocking directors (Sec. 33)
(3) Disloyalty to the corporation (Sec. 34)
(4) Watered stocks (Sec. 65)

Duty of Diligence: Business Judgment Rule.

WHAT IS THE BUSINESS JUDGMENT RULE?

As a general rule, directors and trustees of the corporation cannot be held liable
for mistakes or errors in the exercise of their business judgment, provided they have
acted in good faith and with due care and prudence. Contracts intra vires entered into by
the board of directors are binding upon the corporation, and the courts will not interfere
unless such contracts are so unconscionable and oppressive as to amount to a wanton
destruction of the rights of the minority.

However, if due to the fault or negligence of the directors the assets of the
corporation are wasted or lost, each of them may be held responsible for any amount of
loss which may have been proximately caused by his wrongful acts or omissions. Where
there exists gross negligence or fraud in the management of the corporation, the
directors, besides being liable for damages, may be removed by the stockholders in
accordance with Sec. 28 of the Code. (Campos & Campos)

GENERAL RULE: Contracts intra vires entered into by BoD are binding upon the
corporation and courts will not interfere.

EXCEPTION: When such contracts are so unconscionable and oppressive as

to amount to a wanton destruction of the rights of the minority.
 WHAT KIND OF DILIGENCE IS EXPECTED OF DIRECTORS?

Directors are expected to manage the corporation with reasonable diligence, care
and prudence, i.e. the degree of care and diligence which men prompted by self-interest
generally exercise in their own affairs. Thus, they can be held liable not only
for willful dishonesty but also for negligence.
Although they are not expected to interfere with the day-to-day administrative details
of the business of the corporation, they should keep themselves sufficiently informed
about the general condition of the business.

WHAT FACTORS SHOULD BE CONSIDERED IN DETERMINING WHETHER

REASONABLE DILIGENCE HAS BEEN EXERCISED?

The nature of the business, as well as the particular circumstances of each case.
The court should look at the facts as they exist at the time of their occurrence, not aided
or enlightened by those which subsequently took place. (Litwin v. Allen)

OTIS AND CO. VS PENNSYLVANIA RAILROAD CO. (155 F. 2d 522; 1946)

If in the course of management, the directors arrive at a decision for which there is a
reasonable basis and they acted in good faith, as a result of their independent judgment, and
uninfluenced by any consideration other than what they honestly believe to be for the best
interest of the railroad, it is not the function of the court to say that it would have acted
differently and to charge the directors for any loss or expenditures incurred.

In the present case, the bond issue was adequately deliberated and planned, properly
negotiated and executed; there was no lack of good faith; no motivation of personal gain or
profit; there was no lack of diligence, skill or care in selling the issue at the price approved by the
Commission and which resulted in a saving of approximately $9M to the corporation.

MONTELIBANO VS. BACOLOD-MURCIA MILLING CO. (5 SCRA 36; 1962)

The Bacolod-Murcia Milling Co. adopted a resolution which granted to its sugar planters
an increase in their share in the net profits in the event that the sugar centrals of Negros
Occidental should have a total annual production exceeding one-third of the production of all
sugar central mills in the province. Later, the company amended its existing milling contract
with its sugar planters, incorporating such resolution. The company, upon demand, refused to
comply with the contract, stating that the stipulations in the resolution were made without
consideration and that such resolution was, therefore, null and void ab initio, being in effect a
donation that was ultra vires and beyond the powers of the corporate directors to adopt. This is
an action by the sugar planters to enforce the contract.

The terms embodied in the resolution were supported by the same cause and
consideration underlying the main amended milling contract; i.e., the premises and obligations
undertaken thereunder by the planters, and particularly, the extension of its operative period for
an additional 15 years over and beyond the thirty years stipulated in the contract.
 As the resolution in question was passed in good faith by the board of directors, it is valid
and binding, and whether or not it will cause losses or decrease the profits of the central, the
court has no authority to review them. They hold such office charged with the duty to act for the
corporation according to their best judgment, and in so doing, they cannot be controlled in the
reasonable exercise and performance of such duty. It is a well-known rule of law that questions
of policy or of management are left solely to the honest decision of officers and directors of a
corporation, and the court is without authority to substitute its judgment of the board of directors;
the board is the business manager of the corporation, and so long as it acts in good faith, its
orders are not reviewable by the courts.

LITWIN (ROSEMARIN ET. AL., INTERVENORS) VS. ALLEN ET. AL.

(25 N.Y.S. 2d 667; 1940)

FACTS: Alleghany Corp. bought terminals in Kansas City and St. Joseph. It needed to
raise money to pay the balance of the purchase price but could not directly borrow money due to
a borrowing limitation in its charter. Thus, it sold Missouri Pacific bonds to J.P. Morgan and Co.
worth $IOM. J.P. Morgan, in turn, sold $3M worth of the bonds to Guaranty Trust Company.
Under the contract, the seller was given an option to repurchase at same price within six months.

HELD: Option given to seller is invalid. It is against public policy for a bank to sell
securities and buy them back at the same price; similarly, it is against public policy for the bank
to buy securities and give the seller the option to buy them back at the same price because the
bank incurs the entire risk of loss with no possibility of gain other than the interest derived from
the securities during the period that the bank holds them. Here, if the market price of the
securities rise, the holder of the repurchase option would exercise it to recover the securities at a
lower price at which he sold them. If the market price falls, the seller holding the option would
not exercise it and the bank would sustain the loss.

Directors are not in a position of trustees of an express trust who, regardless of good
faith, are personally liable. In this case, the directors are liable for the transaction because the
entire arrangement was improvident, risky, unusual and unnecessary so as to be contrary to
fundamental conceptions of prudent banking practice. Yet, the advice of counsel was not
sought. Absent a showing of exercise of good faith, the directors are thus liable.

WALKER VS. MAN, ET. AL. (253 N.Y.S. 458; 1931)

FACTS: Frederick Southack and Alwyn Ball loaned Avram $20T evidenced by a
promissory note executed by Avram and endorsed by Lacey. The loan was not authorized by
any meeting of the board of directors and was not for the benefit of the corporation. The note
was dishonored but defendant-directors did not protest the note for non-payment; thus, Lacey,
the indorser who was financially capable of meeting the obligation, was subsequently
discharged.

HELD: Directors are charged not with misfeasance, but with non-feasance, not only with
doing wrongful acts and committing waste, but with acquiescing and confirming the wrong
doing of others, and with doing nothing to retrieve the waste. Directors have the duty to attempt
to prevent wrongdoing by their co-directors, and if wrong is committed, to rectify it. If the
defendant knew that an unauthorized loan was made and did not take steps to salvage the loan,
he is chargeable with negligence and is accountable for his conduct.

STEINBERG VS. VELASCO (52 Phil. 953; 1929)

FACTS: The board of directors of Sibuguey Trading Company authorized the purchase of
330 shares of stock of the corporation and declared payment of P3T as dividends to
stockholders. The directors from whom 300 of the stocks were bought resigned before the board
approved the purchase and declared the dividends. At the time of purchase of stocks and
declaration of dividends, the corporation had accounts payable amounting to P9,241 and
accounts receivable amounting to P12,512, but the receiver who made diligent efforts to collect
the amounts receivable was unable to do so.

It has been alleged that the payment of cash dividends to the stockholders was wrongfully
done and in bad faith, and to the injury and fraud of the creditors of the corporation. The
directors are sought to be made personally liable in their capacity as directors.

HELD: Creditors of a corporation have the right to assume that so long as there are
outstanding debts and liabilities, the BOD will not use the assets of the corporation to buy its
own stock, and will not declare dividends to stockholders when the corporation is insolvent.

In this case, it was found that the corporation did not have an actual bona fide surplus
from which dividends could be paid. Moreover, the Court noted that the Board of Directors
purchased the stock from the corporation and declared the dividends on the stock at the same
Board meeting, and that the directors were permitted to resign so that they could sell their stock
to the corporation. Given all of this, it was apparent that the directors did not act in good faith or
were grossly ignorant of their duties. Either way, they are liable for their actions which affected
the financial condition of the corporation and prejudiced creditors.

BARNES V. ANDREWS (298 F. 614; 1924)

A complaint was filed against a corporate director for failing to give adequate attention
(he relied solely on the President’s updates on the status of the corp) to the affairs of a
corporation which suffered depletion of funds.

The director was not liable. The court said that despite being guilty of misprision in his
office, still the plaintiff must clearly show that the performance of the director’s duties would
have avoided the losses. When a business fails from general mismanagement, business
incapacity, or bad judgment, it is difficult to conjecture that a single director could turn the
company around, or how much dollars he could have saved had he acted properly.

FOSTER V. BOWEN (41 N.E. 2d 181; 1942)

 Cushing, a director and in charge of leasing a roller skating rink of the corp, leased the
same to himself. Minority stockholders filed suit against Bowen, the corporation's President, to
recover for company losses arising out of an alleged breach of fiduciary duty.

Bowen was held to be not liable because: (1) Cushing's acts were not actually dishonest
or fraudulent; (2) Cushing performed personal work such as keeping the facility in repair which
redounded to the benefit of the company and even increased its income; (3) Bowen did not
profit personally through Cushing's lease; and (4) the issue of the possible illegality of the lease
was put before the Board of Directors, but the Board did not act on it but instead moved on to the
next item on the agenda. Absent any bad faith on Bowen's part, and a showing that it was a
reasonable exercise of judgment to take no action on the lease agreement at the time it was
entered into, Bowen was not liable.

LOWELL HOIT & CO. V. DETIG (50 N.E. 2d 602; 1943)

Lowell Hoit filed action against directors of a cooperative grain company for an alleged
willful conversion by the manager of grain stored in the company facility. The court said that the
directors were not personally liable. There was no evidence that the directors had knowledge of
the transaction between the manager and Lowell Hoit.

The court will treat directors with leniency with respect to a single act of fraud on the part
of a subordinate officer/agent. But directors could be held liable if the act of fraud was habitual
and openly committed as to have been easily detected upon proper supervision. To hold directors
liable, he must have participated in the fraudulent act; or have been guilty of lack of ordinary and
reasonable supervision; or guilty of lack of ordinary care in the selection of the officer/agent.

BATES V. DRESSER (40 S.Ct.247; 1920)

Coleman, an employee of the bank, was able to divert bank finances for his benefit,
resulting in huge losses to the bank. The receiver sued the president and the other directors for
the loss.

The court said that the directors were not answerable as they relied in good faith on the
cashier’s statement of assets and liabilities found correct by the government examiner, and were
also encouraged by the attitude of the president that all was well (the president had a sizable
deposit in the bank). But the president is liable. He was at the bank daily; had direct control of
records; and had knowledge of incidents that ordinarily would have induced scrutiny.

The self-dealing director

WHAT IS A SELF-DEALING DIRECTOR? (Sec. 32)

A self-dealing director is one who enters into a contract with the corporation of
which he is a director.
 WHAT IS THE NATURE OF CONTRACTS ENTERED INTO BY SELF-DEALING
DIRECTORS?

Voidable at the option of the corporation, whether or not it suffered damages. It

is possible that the self-dealing director may have the greatest interest in its welfare
and may be willing to deal with it upon reasonable terms.

However, such contract may be upheld by the corporation if all of the following
conditions are present:

(1) The presence of the self-dealing director or trustee in the board meeting for
which the contract was approved was not necessary to constitute a quorum
for such meeting;

(2) The vote of such self-dealing director or trustee was not necessary for the
approval of the contract;

(3) The contract is fair and reasonable under the circumstances;

(4) In the case of an officer, the contract has been previously authorized by the
Board of Directors.

In the event that either of or both conditions (1) and (2) are absent (i.e., the
presence of the director/trustee was necessary for a quorum and/or his vote was
necessary for the approval of the contract), the contract may be ratified by a 2/3 vote of
the OCS or all of the members, in a meeting called for the purpose. Full disclosure of the
adverse interest of the directors or trustees involved must be made at such meeting.

DOCTRINE: A director of a corporation holds a position of trust and as such, he owes

a duty of loyalty to his corporation. In case his interests conflict with those of the
corporation, he cannot sacrifice the latter to his own advantage and benefit. As corporate
managers, directors are committed to seek the maximum amount of profits for the
corporation. This trust relationship "is not a matter of statutory or technical law. It springs
from the fact that directors have the control and guidance of corporate affairs and
property and hence of the property interests of the stockholders." (Prime White Cement
Corp. v. IAC, 220 SCRA 103; 1993)

PALTING V. SAN JOSE PETROLEUM (Dec. 17, 1966)

The articles of inc. of respondent included a provision that relieves any director of all
responsibility for which he may otherwise be liable by reason of any contract entered into with
the corp., whether it be for his benefit or for the benefit of any other person, firm, association or
partnership in which he may be interested, except in case of fraud.

SC: This is in direct contravention of the Corp Law, of the traditional fiduciary relationship
between directors and the SH. The implication is that they can do anything short of fraud, even
to their benefit, and with immunity.

Note: This case was decided in 1966 under the Corporation Law, which had no
provisions on self-dealing directors.

MEAD V. MCCULLOUGH (21 Phil. 95; 1911)

Issue: validity of sale of corp. property and assets to the directors who approved the same.

Gen Rule: When purely private corporations remain solvent, its directors are agents or trustees
for the SH.

Exception: when the corp. becomes insolvent, its directors are trustees of all the creditors,
whether they are members of the corp. or not, and must manage its property and assets with strict
regard to their interest; and if they are themselves creditors while the insolvent corp is under their
management, they will not be permitted to secure to themselves by purchasing the corp property
or otherwise any personal advantage over the other creditors.

Exception to Exception: A director or officer may in good faith and or an adequate

consideration purchase from a majority of the directors or SH the property even of an
insolvent corp, and a sale thus made to him is valid and binding upon the minority.

In the case at bar, the sale was held to be valid and binding. Company was losing. 4
directors present during meeting all voted for the sale. They likewise constitute majority of SH.
Contract was found to be fair and reasonable.

PRIME WHITE CEMENT CORP. V. IAC (220 SCRA 103; 1993)

Prime White Cement Corp. (through the President and Chairman of the Board) and
Alejandro Te, a director and auditor of the corporation, entered into a dealership agreement
whereby Te was obligated to act as the corporation's exclusive dealer and/or distributor of its
cement products in the entire Mindanao area for 5 years. Among the conditions in the dealership
agreement were that the corporation would sell to and supply Te with 20,000 bags of white
cement per month, and that Te would purchase the cement from the corporation at a price of P
9.70 per bag.

Relying on the conditions contained in the dealership agreement, Te entered into written
agreements with several hardware stores which would enable him to sell his allocation of 20,000
bags per month. However, the Board of Directors subsequently imposed new conditions,
including the condition that only 8,000 bags of cement would be delivered per month. Te made
several demands on the corporation to comply with the dealership agreement. However, when
the corporation refused to comply with the same, Te was constrained to cancel his agreements
with the hardware stores. Notwithstanding the dealership agreement with Te, the corporation
entered into an exclusive dealership agreement with a certain Napoleon Co for marketing of
corporation's products in Mindanao. The lower court held that Prime White was liable to Te for
actual and moral damages for having been in breach of the agreement which had been validly
entered into.

On appeal, the Supreme Court held that the dealership agreement is not valid and
enforceable, for not having been fair and reasonable: the agreement protected Te from any
market increases in the price of cement, to the prejudice of the corporation. The dealership
agreement was an attempt on the part of Te to enrich himself at the expense of the corporation.
Absent any showing that the stockholders had ratified the dealership agreement or that they were
fully aware of its provisions, the contract was not valid and Te could not be allowed to reap the
fruits of his disloyalty.

Using inside information

USE OF INSIDE INFORMATION: Do directors and officers of a company owe any
duty at all to stockholders in relation to transactions whereby the officers and
directors buy for themselves shares of stock from the stockholders?

MINORITY RULE: YES. Directors and officers have an obligation to

the stockholders individually as well as collectively.

MAJORITY RULE: NO. Directors and officers owe no fiduciary duty at

all to stockholders, but may deal with them at arm’s
length. No duty of disclosure of facts known to
the director or officer exists. Nondisclosure
cannot constitute constructive fraud.

SPECIAL FACTS DOCTRINE: IT DEPENDS. Where special circumstances

or facts are present which make in inequitable to
withhold information from the stockholder, the duty
to disclose arises, and concealment is fraud.

In the case of Gokongwei v. SEC (89 SCRA 336; 1979), the Supreme Court,
quoting from the US case of Pepper v. Litton (308 U.S. 295-313; 1939) stated that a
director cannot, "by the intervention of a corporate entity violate the ancient precept
against serving two masters … He cannot utilize his inside information and his
strategic position for his own preferment. He cannot violate rules of fair play by doing
indirectly through the corporation what he could not do directly. He cannot use his
power for his personal advantage and to the detriment of the stockholders and
creditors no matter how absolute in terms that power may be and no matter how
meticulous he is to satisfy technical requirements. For that power is at all times
subject to the equitable limitation that it may not be exercised for the
aggrandizement, preference, or advantage of the fiduciary to the exclusion or
detriment of the cestuis."

Seizing Corporate Opportunity (Sec. 34)

If a director acquires for himself, by virtue of his office, a business opportunity

which should belong to the corporation, thereby obtaining profits to the prejudice of the
corporation, he must account to the corporation for all such profits by refunding the
same. However, if his act was ratified by 2/3 stockholders' vote, he need not refund said
profits. This provision applies even though the director may have risked his own funds in
the venture.

Note: This provision is to be distinguished from Sec. 32 on contracts of self-dealing

directors: contracts of self-dealing directors are voidable at the option of the
corporation even if it has not suffered any injury; on the other hand, Sec. 34
applies only if the corporation has been prejudiced by the contract.
SINGER VS. CARLISLE (27 N.Y.S. 2d 190; 1941)

In this case, it was held that the general allegations in the complaint of conspiracy of the
directors to obtain corporate opportunity were deficient. The complaint should state specific
transactions.

Directorship in 2 competing corporations does not in and of itself constitute a wrong. It

is only when a business opportunity arises which places the director in a position of serving two
masters, and when, dominated by one, he neglects his duty to the other, that a wrong has been
done.

IRVING TRUST CO. VS. DEUTSCH (79 L. Ed. 1243; 1935)

Fiduciary duty applies even if the corporation is unable to enter into transactions itself.

LITWIN V ALLEN (25 N.Y.S. 2d 667; 1940)

In this case, it was held that the common stock purchased by the defendants wasn’t a
business opportunity for the corporation. Having fulfilled their duty to the corporation in
accordance with their best judgment, the defendant directors were not precluded from a
transaction for their own account and risk.

Interlocking directors
WHAT IS AN INTERLOCKING DIRECTOR?

An interlocking director is one who occupies a position in 2 companies dealing

with each other.

WHAT IS THE RULE ON CONTRACTS INVOLVING INTERLOCKING DIRECTORS?

Except in cases of fraud, and provided the contract is fair and reasonable under
the circumstances, a contract between 2 or more corporations having interlocking
directors shall not be invalidated on that ground alone. This practice is tolerated by the
Courts because such an arrangement oftentimes presents definite advantages to the
corporations involved.
However, if the interest of the interlocking director in one corporation is
substantial (i.e., stockholdings exceed20% of the OCS) and his interest in the other
corporation or corporations is merely nominal, he shall be subject to the conditions stated
in Sec. 32, i.e., for the contract not to be voidable, the following conditions must be
present:
 (1) The presence of the self-dealing director or trustee in the board
meeting for which the contract was approved was not necessary to
constitute a quorum for such meeting;
(2) The vote of such self-dealing director or trustee was not necessary
for the approval of the contract;
(3) The contract is fair and reasonable under the circumstances;
(4) In the case of an officer, the contract has been previously authorized
by the Board of Directors.

In the event that either of or both conditions (1) and (2) are absent (i.e., the
presence of the director/trustee was necessary for a quorum and/or his vote was
necessary for the approval of the contract), the contract may be ratified by a 2/3 vote of
the OCS or all of the members, in a meeting called for the purpose. Full disclosure of the
adverse interest of the directors or trustees involved must be made at such meeting.

Note: The Investment House Law prohibits a director or officer of an investment

house to be concurrently a director or officer of a bank, except as otherwise
authorized by the Monetary Board. In no event can a person be authorized to be
concurrently an officer of an investment house and of a bank except where the
majority or all of the equity of the former is owned by the bank. (P.D. 129, Sec. 6,
as amended)
The Insurance Code likewise prohibits a person from being a director
and/or officer of an insurance company and an adjustment company. (Sec. 187)

GLOBE WOOLEN CO. V. UTICA GAS & ELECTRIC (121 N.E. 378; 1918)

Maynard, president and chief stockholder of Globe but nominal SH in Utica Gas,
obtained a cheap, 10-year contract for Utica to supply power. Maynard did not vote during the
meeting for the approval of the contract.

Can Globe seek to enforce contract? The Supreme Court held that Globe could not
enforce the contract and that said contract was voidable at the election of Utica. It was found
that based on the facts of the case, the contract was clearly one-sided. Maynard, although he did
not vote, exerted a dominating influence to obtain the contract from beginning to end.

The director-trustee has a constant duty not to seek harsh advantage in violation of his
trust.

Watered stocks (Sec. 65)

Any director or officer of the corporation:

(1) consenting to the issuance of stocks for a consideration less than its par
or issued value or for a consideration in any form other than cash, valued
in excess of its fair value, or
(2) who, having knowledge thereof, does not forthwith express his objection
in writing and file the same with the corporation secretary

shall be solidarily liable with the stockholders concerned to the corporation and its
creditors for the difference between the fair value received at the time of the issuance of
the stock and the par or issued value of the same.
Fixing compensation of directors and officers

GENERAL RULE: Directors as such are not entitled to compensation for

performing services ordinarily attached to their office.

EXCEPTIONS: (1) If the articles of incorporation or the by-laws expressly

so provide;
(2) If a contract is expressly made in advance.

WHO FIXES THE COMPENSATION? The stockholders only (majority of the OCS)

EXCEPTION: Per diems, which can be fixed by the directors themselves

APPLICABILITY OF COMPENSATION: Only to future and NOT past services.

MAXIMUM AMOUNT ALLOWED BY LAW: Total yearly income of the directors

shall not exceed 10% of the net income before income tax of the
corporation during the preceding year (Sec. 30)

GOV'T OF THE PHILIPPINES VS. EL HOGAR FILIPINO (50 Phil. 399; 1927)

The compensation provided in sec. 92 of the by-laws of El Hogar Filipino which

stipulated that 5% of the net profit shown by the annual balance sheet shall be distributed to the
directors in proportion to the attendance at board meetings is valid. The Corporation Law does
not prescribe the rate of compensation for the directors of a corporation. The power to fix it , if
any is left to the corporation to be determined in its by-laws. In the case at bar, the provision in
question even resulted in extraordinarily good attendance.

BARRETO VS. LA PREVISORA FILIPINA

This action was brought by the directors of defendant corporation to recover 1% from
each of the plaintiffs of the profits of the corporation for 1929 pursuant to a by-law provision
which grants the directors the right to receive a life gratuity or pension in such amount for the
corporation.

The SC held that the by-law provision is not valid. Such provision is ultra vires for a
mutual loan and building association to make. It is not merely a provision for the compensation
of directors. The authority conferred upon corporations refers only to providing compensation
for the future services of directors, officers, and employees after the adoption of the by-law in
relation thereto. The by-law can't be held to authorize the giving of continuous compensation to
particular directors after their employment has terminated for past services rendered gratuitously
by them to the corporation.

CENTRAL COOPERATIVE EXCHANGE INC VS. TIBE (33 SCRA 596; 1970)
 The questioned resolutions which appropriated the funds of the corporation for different
expenses of the directors are contrary to the by-laws of the corporation; thus they are not within
the board's power to enact. Sec. 8 of the by-laws explicitly reserved to the stockholders the
power to determine the compensation of members of the board and they did restrict such
compensation to actual transportation expenses plus an additional P30 per diems and actual
expenses while waiting. Hence, all other expenses are excluded. Even without the express
reservation, directors presumptively serve without pay and in the absence of any agreement in
relation thereto, no claim can be asserted therefore.

FOGELSON VS. AMERICAN WOOLEN CO. (170 F. 2d. 660; 1948)

A retirement plan which provides a very large pension to an officer who has served to
within one year of the retirement age without any expectation of receiving a pension would seem
analogous to a gift or bonus. The size of such bonus may raise a justifiable inquiry as to whether
it amounts to wasting of the corporate property. The disparity also between the president's
pension plan and that of even the nearest of the other officers and employees may also be
inquired upon by the courts.

KERBS VS. CALIFORNIA EASTERN AIRWAYS (90 A. 2d 652; 1952)

This is an appeal filed to enjoin the California Eastern Airways from putting into effect a
stock option plan and a profit-sharing plan. The SC held that the stock option plan was deficient
as it was not reasonably created to insure that the corporation would receive contemplated
benefits. A validity of a stock option plan depends upon the existence of consideration and the
inclusion of circumstances which may insure that the consideration would pass to the
corporation. The options provided may be exercised in toto immediately upon their issuance
within a 6 month period after the termination of employment. In short, such plan did not insure
that any optionee would remain with the corporation.

With regard to the profit-sharing plan, it was held valid because it was reasonable and
was ratified by the stockholders pending the action.

Close Corporations

Sec. 97 provides that the AOI of a close corp. may specify that it shall be managed by the
stockholders rather than the BoD. So long as this provision continues in effect:

 No stockholder’s meeting need be called to elect directors;

 Generally, stockholders deemed to be directors for purposes of this Code, unless the context
clearly requires otherwise;

 Stockholders shall be subject to all liabilities of directors. The AOI may likewise provide that
all officers or employees or that specified officers or employees shall be elected or appointed
by the stockholders instead of by the BoD.
Further, Sec. 100 provides that for stockholders managing corp. affairs:

 They shall be personally liable for corporate torts (unlike ordinary directors liable only upon
finding of negligence)

 If however there is reasonable adequate liability insurance, injured party has no right of
action v. stockholders-managers

Duty of Controlling Interest

A SH/director is still entitled to vote in a stockholder’s meeting even if his interest is adverse to a
corporation. But a stockholder able to control a corp. is still subject to the duty of good faith to the corp.
and the minority.

Persons with management control of corporation hold it in behalf of SHs and can not regard such
as their own personal property to dispose at their whim.

The ff. acts are legal:

 Transfer of managerial control through BoD resignation & seriatim election of successors if
concomitant with the sale and actual transfer of majority interest or that which constitutes
voting control;

 Disposal by controlling SH of his stock at any time & at such price he chooses

The ff. are illegal:

 Selling corp. office or management control by itself, that is NOT accompanied by stocks or
stocks are insufficient to carry voting control;

 Transferring office to persons who are known or should be known as intending to raid the
corporate treasury or otherwise improperly benefit themselves at the expense of the corp.
(Insuranshares Corp. V. Northern Fiscal);

 Receiving a bonus or premium specifically in consideration of their agreement to resign &

install the nominees of the purchaser of their stock, above and beyond the price premium
normally attributable to the control stock being sold;

INSURANSHARES CORP. V. NORTHERN FISCAL CORP. (35 F. Supp. 22; 1940)

The corp. is suing its former directors to recover damages as a result of the sale of its
control to a group (corporate raiders) who proceeded to rob it of most of its assets mainly
marketable securities.

Are previous directors who sold corp. control liable? Yes, they are under duty not to sell
to raiders.
 Owners of corp. control are liable if under the circumstances, the proposed transfer are
such as to awaken a suspicion or put a prudent man on his guard. As in this case, control was
bought for so much aside from being warned of selling to parties they knew little about, and also
from fair notice that such outsiders indeed intended to raid the corp.

Duty to Creditors

General rule: Corporate creditors can run after the corp. itself only, and not the directors for
mismanagement of a solvent corp.

If corp. becomes insolvent, directors are deemed trustees of the creditors and should therefore
manage its assets with due consideration to the creditor’s interest.

If directors are also creditors themselves, they are prohibited from gaining undue advantage over
other creditors.

Personal Liability of Directors

In what instances does personal liability of a corporate director, trustee or officer

validly attach together with corporate liability?

When the director / trustee / officer:

I. (1) assents to a patently unlawful act of the corporation;

(2) is in bad faith or gross negligence in directing the affairs of the corporation;
(3) creates a conflict of interest, resulting in damages to the corporation, its
stockholders or other persons

II. Consents to the issuance of watered stocks, or who, having knowledge thereof,
does not forthwith file with the corporate secretary his written objection thereto;

III. Agrees to hold himself personally and solidarily liable with the corporation;

IV. Is made, by a specific provision of law, to personally answer for his corporate
action.

(Tramat Mercantile v. CA, 238 SCRA 14)

UICHICO v. NLRC (G.R. No. 121434, June 2, 1997)

In labor cases, particularly, corporate directors and officers are solidarily liable with the
corporation for the termination of employment of corporate employees done with malice or in
bad faith.
 In the instant case, there was a showing of bad faith: the Board Resolution retrenching
the respondents on the feigned ground of serious business losses had no basis apart from an
unsigned and unaudited Profit and Loss Statement which had no evidentiary value whatsoever.