Corporation Law: The Revised Corporation Code of the Philippines - Sec 7, 8 and 9 (September 11, 2023)

THE REVISED CORPORATION CODE  OF THE PHILIPPINES  

Republic Act No. 11232 

TITLE I - GENERAL PROVISIONS 

Definitions and Classifications 

SEC. 7. Founders’ Shares. – Founders’ shares may be given certain rights and privileges not enjoyed by the owners of other stocks. Where the exclusive right to vote and be voted for in the election of directors is granted, it must be for a limited period not to exceed five (5) years from the date of incorporation: Provided, That such exclusive right shall not be allowed if its exercise will violate Commonwealth Act No. 108, otherwise known as the “Anti-Dummy Law”; Republic Act No. 7042, otherwise known as the “Foreign Investments Act of 1991”; and other pertinent laws. 

1. Rationale

• Founders' shares are shares that are given to those who helped organize the corporation. 
• This may be a form of reward to the "founders."
• Founder shares can be either common shares or preferred shares, depending on the preferences of the founders and investors.

2. Approval of the SEC

• The special rights granted to founders' shares are subject to the approval of the SEC.
• The approval of the SEC was inserted by the lawmakers to prevent abuse.

3. Nature of Five-Year Limit

• The five-year limitation imposed refers only to the exclusive right to vote and be voted for in the election of directors, a right normally enjoyed by holders of common shares, the class of shares which are supposed to have complete voting rights. 
• After the expiration of the five-year period, founders' shares shall have equal rights with the holders of common shares.

4.  Conditions

The exclusive right shall not be allowed if its exercise will violate:

• Anti-Dummy Law
• Foreign Investments Act
• Other pertinent laws

5. Anti-Dummy Law

• This was created to spell out how Filipinos are punished when they participate in evading the nationalization laws. 
• The Anti-Dummy Law also prohibits foreigners from intervening in the management, operation, administration, or control of any nationalized activity.

6. Foreign Investments Act

• The implementing rules of the Foreign Investment Act categorically said, “the control test shall be applied” when determining certain financial privileges for the Philippine National.
• The SEC explained that, based on the control test, further inquiry on the ownership of shareholders in “investing and investee corporations shall be dispensed with once it is clearly established that the participating corporations are 60% owned by Filipino citizens.”
• Non-Philippine nationals may own up to one hundred percent (100%) of domestic market enterprises unless foreign ownership therein is prohibited or limited by the Constitution and existing law or the Foreign Investment Negative List under Sec. 8 hereof.

SEC. 8. Redeemable Shares. – Redeemable shares may be issued by the corporation when expressly provided in the articles of incorporation. They are shares which may be purchased by the corporation from the holders of such shares 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 stated in the articles of incorporation and the certificate of stock representing the shares, subject to rules and regulations issued by the Commission. 

1. Redeemable Shares

• They are shares which may be purchased by the corporation from the holders of such shares 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 stated in the articles of incorporation and the certificate of stock representing the shares, subject to rules and regulations issued by the Commission. 
• Redeemable shares are shares of stocks issued by a corporation which said corporation can purchase or take up from their holders as expressly provided for in the articles of incorporation and certificates of stock representing said shares.
• Redeemable shares are usually preferred shares. 
• Section 8 provides formal requirements for redeemable shares. The obligation to redeem must be indicated in the Articles of Incorporation and the Certificates of Stock.
• The issuance of redeemable shares may be likened to temporary borrowings that enable a corporation to adjust its capital structure to meet varying conditions.

2. Rationale

• The redemption feature of shares was envisaged to effectively eliminate the market volatility risks on the side of the share owners. 
• There are clear advantages and benefits that inure to the redeemable preferred share owners who, on one hand, prefer a stable dividend yield on their investments and, on the other hand, want security from the uncertainty of market forces over which they do not have control.
• The presence of redeemable shares will also facilitate the raising of badly needed capital by the corporation but at the same time would not deceive creditors.

3. Unrestricted Retained Earnings Not Required

• Payment may come from capital
• Unrestricted retained earnings means the amount of accumulated profits and gains realized out of the normal and continuous operations of the company after deducting therefrom distributions of stockholders and transfers to capital stock or other accounts, and which is: 

1. not appropriated by its Board of Directors for corporate expansion projects or programs;
2. not covered by a restriction for dividend declaration under a loan agreement; and
3. not required to be retained under special circumstances obtaining in the corporation such as when there is a need for a special reserve for probable contingencies.

• Redemption, may not be made where the corporation is insolvent or if such redemption will cause insolvency or inability of the corporation to meet its debts as they mature. 
  

4. Mandatory Redemption

• This means that redemption must be made within a certain period.
• Compulsory or obligatory redeemable share is one that requires the issuing corporation to redeem or repurchase its preferred shares at a fixed date or at the option of the holder thereby giving the shareholder the right to the return of their investment.
• Mandatory redemption is not against public policy. 
• Anybody who acquires mandatory redeemable shares is forewarned that the redeemable shares may be purchased out of capital.
• All corporations which have issued redeemable shares with mandatory redemption features are required to set up and maintain a “sinking fund”

Sinking Fund 

• Fund set up by the corporation where cash is gradually set aside in order to accumulate the amount necessary to meet the redemption price of redeemable shares at specified dates in the future.
• It shall be deposited with a trustee bank and is not supposed to be invested in risky or speculative ventures.

5. Effect of Redemption

• Redemption is repurchase or reacquisition of stock by a corporation which issued the stock in exchange for property, whether or not the acquired share is cancelled, retired, or held in the treasury. 
• Essentially, the corporation gets back some of its stock, distributes cash or property to the shareholder in payment of stock and continues in business as before.
• When the redeemable shares are reacquired, the same shall be considered retired and no longer issuable unless otherwise provided for in the Articles of Incorporation.
• The redeemed shares shall be considered deduction to equity if there is no provision in the Articles of Incorporation that provides that the same shares are not retired. 
• In a sense, redemption is a repurchase of the shares for cancellation.
• The redeemed shares will not be considered retired and will become treasury shares if the Articles of Incorporation expressly provides that once redeemed, the redeemable shares shall be classified as treasury shares
• If the redeemable shares are considered retired, the authorized capital stock of the corporation is in effect reduced by the corresponding number of shares because the redeemed shares can no longer be re-issued. The Articles of Incorporation must be amended accordingly.

6. Tax Consequence

• For tax purposes, there are cases when redemption of shares (which were previously issued as stock dividends) is considered a scheme to circumvent the tax consequence of cash dividends. 
• There are cases when redemption is used as a veil for the constructive distribution of cash dividends.
• In those cases, the amounts received by the shareholder will be treated as cash dividend because the proceeds of redemption in such a case are additional wealth; they are not merely returns of capital but gains thereon.

7. Other Limitations

• Redeemable shares are also usually preferred shares, which by their terms are redeemable at a fixed date, or at the option of either issuing corporation, or the stockholder, or both at a certain redemption price. 
• Redemption by the corporation of its stock is, in a sense, a repurchase of it for cancellation. 
• Both the RCCP and the Corporation Code allow redemption of shares even if there are no unrestricted retained earnings on the books of the corporation. 
• This provision in effect qualifies the general rule that the corporation cannot purchase its own shares except out of current retained earning.

Problems:
Q: On September 15, 2013, XYZ Corporation issued to Paterno 800 preferred shares with the following terms: 

 "The Preferred Shares shall have the following rights, preferences, qualifications, and limitations, to wit: 

'l. The right to receive a quarterly dividend of One Per Centum (1%), cumulative and participating; 

2. These shares may be redeemed, by drawing of lots, at any time after two (2) years from date of issue, at the option of the Corporation; x x x." 

Today, Paterno sues XYZ Corporation for specific performance, for the payment of dividends on, and to compel the redemption of, the preferred shares, under the terms and conditions provided in the stock certificates. Will the suit proper? Explain.

A: NO. The suit will not prosper. The fact that Paterno holds preferred shares does not give him the right to compel XYZ Corporation to pay dividends. It is still within the business judgment of the Board of Directors to declare dividends and the judgment of the Board is always subject to the requirement that there must be unrestricted retained earnings. Holders of preferred shares are not creditors and dividends are not interest that is due. 

Paterno cannot likewise compel the corporation to redeem the shares because the express terms of the stipulation is to the effect that the shares "may be redeemed" after two (2) years thereby indicating that the redemption is not mandatory. Even if Paterno is holding mandatory redeemable shares, it is subject to the requirement that enough assets are left to cover debts and liabilities. In other words, there should be no effect on creditors.

SEC. 9. Treasury shares. – Treasury shares are shares of stock which have been issued and fully paid for, but subsequently reacquired by the issuing corporation through purchase, redemption, donation, or some other lawful means. Such shares may again be disposed of for a reasonable price fixed by the board of directors.

1. Treasury Shares

• Shares of stock that have been issued and fully paid for, but subsequently reacquired by the issuing corporation by purchase, redemption, and donation or through some other lawful means. 
• Treasury shares are issued shares but being in the treasury, they do not have the status of outstanding shares
• However, they still represent paid-for-interest in the property of the corporation.
• Treasury shares are currently owned by the corporation and not its shareholders. 
• As an owner of the treasury shares, the corporation may opt to retire, sell or distribute the treasury shares as property dividends. 
• Treasury shares are previously issued shares and they do not revert to unissued shares once they become part of the properties of the corporation. 
• This is so because the amount paid for the acquisition of treasury shares does not represent a return of capital to the stockholders but an investment out of retained earnings on salable property known as treasury shares.

2. Stages in the Life of Treasury Shares

• First Stage
• How treasury shares are created
• Can be created not only through redemption but also through other modes of acquisition like purchase, donation and the like 
• Second Stage
• The rights enjoyed by the corporation as the holder of treasury shares are restricted 
• No voting right and right to dividends
• Third Stage
• Disposition of treasury shares
• The discretion of the Board of Directors to fix reasonable terms and conditions through which treasury shares may cease to exist as such treasury shares.
• Board of Directors may provide for a reasonable price for the transfer of treasury shares

3. Limitations

Treasury shares, not having been retired by the corporation reacquiring it, are subject to the following rules:

1. They may be sold again as long as the corporation holds them as treasury shares.
2. Treasury shares cannot participate in dividends because dividends cannot be declared by the corporation to itself.
3. Treasury shares cannot be represented during stockholder's meetings for otherwise equal distribution of voting powers among stockholders will be effectively lost and the directors will be able to perpetuate their control of the corporation. 
4. The amount of unrestricted retained earnings equivalent to the cost of treasury shares being held shall be restricted from being declared and issued as dividends. The dividend restriction on retained earnings on account of treasury shares being held shall be lifted only after the treasury shares causing the restriction are reissued.

4. Nature and Effects

• A treasury share may be common or preferred share.
• Treasury shares may be used for a variety of corporate purposes, such as for a stock bonus plan for management and employees or for acquiring another company.
• It may be held indefinitely, resold or retired. 
• While held in the company's treasury, the stock earns no dividends and cannot vote in stockholders' meetings.
• Treasury shares are different from the authorized but unissued share. 
• Treasury shares do not reduce the number of issued shares or the amount of stated capital and their "sale" does not increase the number of issued shares or amount of stated capital. 
• The corporation has the option to retire the treasury shares.
•  Retirement of treasury shares shall be effected by decreasing the capital stock of the corporation in accordance with Section 38 of the Corporation Code (now Section 37 of the RCCP) for the purpose of eliminating the treasury shares. 
• Treasury shares may be declared as property dividend to be issued out of the retained earnings previously used to support their acquisition provided that the amount of the retained earnings has not been subsequently impaired by losses. 
• Any declaration and issuance of treasury shares as property dividend shall be disclosed and properly designated as property dividend in the books ·of the corporation and its financial statements.
• Inasmuch as treasury shares are not considered as outstanding capital stock, the corporation is not entitled to any right or privilege of a shareholder. 
• The reason is that when a corporation re-acquires its own shares, it does not become a subscriber thereof.
• The Board of Directors is empowered to re-issue the treasury shares. 
• The approval of the stockholders for the re-issuance of treasury shares is not necessary but the same is subject to the pre-emptive rights of shareholders.