Corporation Law: The Revised Corporation Code of the Philippines - Sec 38

  THE REVISED CORPORATION CODE  OF THE PHILIPPINES

Republic Act No. 11232 

TITLE IV -  POWERS OF CORPORATIONS

Section 37.  Power to Deny Preemptive Right. 

All stockholders of a stock corporation shall enjoy preemptive right to subscribe to all issues or disposition of shares of any class, in proportion to their respective shareholdings, unless such right is denied by the articles of incorporation or an amendment thereto: Provided, That such preemptive right shall not extend to shares issued in compliance with laws requiring stock offerings or minimum stock ownership by the public; or to shares issued in good faith with the approval of the stockholders representing two-thirds (2/3) of the outstanding capital stock in exchange for property needed for corporate purposes or in payment of previously contracted debt.

1. Power to Deny Preemptive Right. 
  • Preemptive right is the right of shareholders to subscribe to all issues or disposition of shares of any class in proportion to their shareholdings
  • Preemptive right is also defined as the right granted to the stockholders to have the first option to subscribe to any issuance or disposition of shares from the capital stock in proportion to the stockholdings of the shareholders.
1.01 Rationale. 
  • The foundation or underlying basis of this right is to maintain the relative and proportionate voting strength and control of existing shareholders. 
  • It is aimed to maintain the existing ratio of the:
    • shareholder's interest and 
    • voting power in the corporation
      • "The right is based on the principle that a shareholder, in subscribing to share of stock does so under the understanding that his equity is fixed by the relation which the number of shares which he subscribes bears to the total authorized capital stock, issued or unissued, subscribed or unsubscribed, at the time of subscription, as shown by the company's articles of incorporation, and should not, therefore, be diluted by the issuance of additional shares that effect his right to vote, to dividends, and to the distribution of assets upon liquidation, without first giving him the opportunity to subscribe to such shares in proportion to his shareholdings."
  • All stockholders whose names appear in the stock and transfer book at the time of the meeting approving the issuance of shares are entitled to preemptive right. 
  • Stockholders must be given a reasonable time within which to exercise their preemptive right. Upon the expiration of said period, any stockholder who has not exercised such right will be deemed to have waived it.
2. Issues or Disposition.
  • The preemptive right covers all issues and disposition
  • This includes:
    • issuance of the unsubscribed shares that are part of the original capital stock;
    • the increase of capital stock;
    • the corporation decides to dispose of its treasury shares
  • The broad phrase in Section 38 of the RCCP, "all issues or disposition of shares of any class," is construed to include:
    • new shares issued in pursuance of an increase of capital stock
    • shares from the unissued portion of the capital stock
    • treasury shares
  • Section 38 does not distinguish between newly issued shares and previously unsubscribed shares, hence, the preemptive right is available to existing shareholders with respect to unsubscribed but previously issued shares.
  • Benito v. Securities and Exchange Commission (1983):
    • If the shares are offered and are not subscribed or purchased by shareholders and later the shares are being offered again, there is no preemptive right with respect to the latter offer of shares. 
    • The theory is that when a corporation at its inception offers its first shares, it is presumed to have offered all those that it is authorized to issue. 
    • A subscriber is deemed to have taken his shares knowing they form a definite proportionate part of the whole number of authorized shares. When the shares left unsubscribed are later re-offered, he cannot therefore claim a dilution of interest. 
  • SEC-OGC Opinion No. 11-41 dated October 5, 2011
    • This rule is no longer controlling under Section 39 of the Corporation Code (now Section 38 of the RCCP) because the same provision  covers all issues and disposition of shares. The factual background in Benito took place under the old Corporation Law where preemptive right is not expressly provided.
  • The preemptive right is not available when shares are issued in exchange for shares in another corporation if the same is the result of a merger to which the corporations are parties. 
3. Waiver. 
  • A stockholder who neither desires nor intends to buy any of the stocks being offered may waive such right. 
  • In such event, the shares may be offered to any interested persons acceptable to the corporation. 
  • The right to waive preemptive right is a personal right; hence, the stockholders concerned should give such waiver individually or he can authorize somebody to execute the same for and in his behalf by way of a special power of attorney.
4. Transfer. 
  • The right to subscribe to new issues and disposition may be transferred by the shareholder. 
  • Unless there is an express restriction in the Articles of Incorporation, the preemptive right is transferable. 
5. When Not Available. 
  • Preemptive right is not available in the following instances even if there is an issuance or disposition of shares:
    1. When the right is denied in the Articles of Incorporation
    2. When shares are issued in compliance with laws requiring stock offerings or minimum stock ownership by the public; and
    3. When shares are issued in good faith with the approval of the stockholders representing 2/3 of the outstanding capital stock, in exchange for property needed for corporate purposes or in payment of a previously contracted debt. 
6. Denial and Restriction.  
  • Preemptive right may be restricted or denied under the Articles of Incorporation, and subject to certain exceptions and limitations. 
  • It should be noted in this connection that even if the preemptive right does not exist, either because the issue comes within the exceptions in Section 38 or because it is denied or limited in the Articles of Incorporation, an issue may still be objectionable if the directors acted in breach of trust and their primary purpose is:
    • to perpetuate or shift control of the corporation, or 
    • to 'free out' the minority interest
6.01. Not Against Public Policy. 
  • The power to deny preemptive right is not contrary to public policy. 
  • It was explained that "there is no inequity, there is no unfairness because a shareholder who feels that he does not desire to invest because he does not have the right of pre-emption simply should not invest. On the other hand, he must remember that perhaps because he is denied the right of pre-emption, he is given certain preferences on other matters, most likely the holder of the shares will be a holder of the preferred shares; perhaps not only preferred shares but a preferred cumulative, participating or convertible shares. In other words, he is given all the privilege except the right of pre-emption .. . such a shareholder would be very happy to have those shares under certain circumstances."

PROBLEMS:
"X" Realty, Inc., a corporation engaged in the subdivision business, has an authorized capital of P800,000.00, all of which has been fully subscribed. At a special meeting of the board of directors, the majority vote decided on the basis of the recommendation of its Executive Committee, that the corporation purchase a five-hectare property offered to it because it was ideal for its subdivision business, the price offered was lower than the prevailing market price and John Roque, the owner of the property, was willing to accept P200,000.00 worth of shares of the corporation in exchange of, or as payment for his property. No cash was involved in the transaction. Thus, the board approved a resolution increasing the authorized capital stock from P800,000.00 to Pl,000,000.00, stipulating that the additional P200,000.00 worth of shares be issued in exchange for the five-hectare property and that the existing stockholders would have no pre-emptive right to subscribe to the additional shares as the same were being issued to pay for the property. Was the action of the Board of Directors correct?
Yes, the action of the Board of Directors was correct but it is still not sufficient. Section 38 of the Revised Corporation Code requires that the resolution of the Board of Directors be approved by 2/3 of the outstanding capital stock, and further to be approved by the Securities and Exchange Commission with respect to the valuation of the property under Section 61 of the RCCP. No approval of the stockholders and the SEC has been obtained. No preemptive right is available if the stockholders' approval is obtained because Section 38 of the RCCP provides that there is no pre-emptive right with respect "to shares issued in good faith with the approval of the stockholders representing two-thirds (2/3) of the outstanding capital stock, in exchange for property needed for corporate purposes or in payment of a previously contracted debt" (1982 Bar). 

X Corporation is in need of land on which to construct an additional factory to be used in the expansion of its business. Jose Cruz owns a piece of land in Taytay, Rizal, which is ideal for the purpose, and the corporation offers to buy it at a fair price. Jose is willing to part with the land on condition that he is paid in shares of stocks of the corporation. The Board of Directors decided to accept the terms of Jose, but since the authorized capital stock of the corporation has been fully subscribed, it proposed to increase the capital stock so that it can consummate the sale of the land. The proposal, including the purchase of Jose's land in exchange for the new shares, was submitted to the stockholders in a meeting called for that purpose. Pedro Reyes who has 100 shares in the corporation, alleging that he and all other stockholders have a pre-emptive right to the new shares, insists that the corporation issue to him his proportionate quota of the new shares that he offers to buy in cash. Holders of 80% of the outstanding capital stock are in favor of the proposal to increase the capital stock, including the exchange of Jose's land for new shares of stock. Is Pedro Reyes within his rights in claiming a pre-emptive right? Explain.
No. Pedro Reyes was not well within his right to claim pre-emptive right. Section 38 of the Revised Corporation Code provides that all stockholders shall enjoy the pre-emptive right to subscribe to all issues of shares in proportion to their respective shareholdings. However, Section 38 provides that such pre-emptive right does not exist when shares are issued in exchange for property needed for corporate purposes, provided stockholders representing 2/3 of the subscribed capital stock approve of such issuance. Therefore, since more than 2/3 of the outstanding capital stock favored the proposal, Pedro Reyes cannot insist on the pre-emptive right. (1983 Bar)

XYZ Corporation has an authorized capital stock of Pl00,000.00, divided into 10,000 shares, each with a par value of Pl0.00. The subscribed capital stock is P50,000.00 or 5,000 shares. At the time of incorporation, S subscribed to 1,000 shares or Pl0,000.00. In need of additional funds, XYZ Corporation proposes to offer the unsubscribed 5,000 shares to new stock holders at P15.00 per share or an aggregate amount of P75,000.00. Explain whether or not S has the right to subscribe to any of the 5,000 shares, and if so, at what price.
S has a right to subscribe to 1,000 shares. Section 38 of the Revised Corporation Code provides that "all stockholders of a stock corporation shall enjoy pre-emptive right to subscribe to all issues or disposition of shares of any class, in proportion to their respective shareholdings" subject to several exceptions which are not applicable in this case. (1984 Bar)

ABC Corporation has an authorized capital stock of One Million pesos divided into 50,000 common shares and 50,000 preferred shares. At its inception, the Corporation offered for subscription all the common shares. However, only 40,000 shares were subscribed. Recently, the directors thought of raising additional capital and decided to offer to the public all the authorized shares of the Corporation at their market value. Would Mr. X a stockholder holding 4,000 shares, have pre-emptive rights to the remaining 10,000 shares? 
Yes. Mr. X has pre-emptive right to the remaining 10,000 shares. All stockholders of a stock corporation shall enjoy pre-emptive rights to subscribe to all issues or disposition of shares of any class, in proportion to their respective shareholdings. (1999 Bar

Note: An alternative answer may be given based on the case of Datu Benito v. SEC. There will be no pre-emptive right if the shares were not taken when originally offered. However, there is also an opinion to the effect that the said case is no longer controlling under the Corporation Code. 

Suppose that "X" Corporation has already issued the 1,000 originally authorized shares of the corporation so that it's Board of Directors and stockholders wish to increase its authorized capital stock. After complying with the requirements of the law on increase of capital stock, "X" issued an additional 1,000 shares of the same value. 

a. Assume that stockholder "A" presently holds 200 out of the 1,000 original shares. Would "A" have a pre-emptive right to 200 of the new issue of 1,000 shares? Why?
Yes, "A" would have a pre-emptive right to 200 of the new issue of 1000 shares. "A" is a stockholder of record holding 200 shares in "X" Corporation. Section 39 of the Corporation Code (now Section 38 of the RCCP) provides that each stockholder has the pre-emptive right to all issues of shares made by the corporation in proportion to the number of shares he holds on record in the corporation.

b. When should stockholder "A" exercise the pre-emptive right?
The pre-emptive right may be exercised within the time prescribed by the Board. Pre-emptive right must be exercised in accordance with the Articles of Incorporation or the By-Laws. When the Articles of Incorporation and the By-Laws are silent, the Board may fix a reasonable time within which the stockholders may exercise the right. (2001 Bar)

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