Corporation Law: The Revised Corporation Code of the Philippines - Sec 40

 THE REVISED CORPORATION CODE  OF THE PHILIPPINES

Republic Act No. 11232 

TITLE IV -  POWERS OF CORPORATIONS

Section 40. Power to Acquire Own Shares.

Provided, That the corporation has unrestricted retained earnings in its books to cover the shares to be purchased or acquired, a stock corporation shall have the power to purchased or acquired, a stock corporation shall have the power to purchase or acquire its own shares for a legitimate corporate purpose or purposes, including the following cases:

(a) To eliminate fractional shares arising out of stock dividends;

(b) To collect or compromise an indebtedness to the corporation, arising out of unpaid subscription, in a delinquency sale, and to purchase delinquent shares sold during said sale; and

(c) To pay dissenting or withdrawing stockholders entitled to payment for their shares under the provisions of this Code.

1. Requirements for acquisition.

• In this jurisdiction, Section 40 of the RCCP authorizes corporations to acquire their own shares, provided that: 
• the acquisition is for a legitimate corporate purpose or purposes, and 
• the corporation has unrestricted retained earnings in its books to cover the shares to be purchased or acquired. 
• The SEC adopted the following enumeration of requirements for the exercise of the power to acquire the corporation's own shares: 
1. The capital is not impaired; 
2. A legitimate and proper corporate purpose or objective is advanced;
3. The corporate affairs warrant it;
4. The transaction is designed and carried out in good faith;
5. There is no intention and there is no resulting undue advantage to favored stockholders at the expense of the remainder;
6. The creditors are not prejudiced; 
7. The corporation acts in good faith and without prejudice to the rights of creditors and stockholders; and
8. There must be unrestricted retained earnings to purchase the shares.

• Section 40 of the RCCP provides a non-exclusive list of examples of cases when the corporation can acquire its own shares. 
•  The RCCP considers the three purposes mentioned therein as legitimate corporate purposes. Acquisition by the corporation of its own share is allowed for other legitimate purposes in addition to the three purposes expressly provided for. 
• However, it is still necessary under any of these legitimate purposes that there are unrestricted retained earnings. 
• The three legitimate purposes expressly provided for under the RCCP are:
1. To eliminate fractional shares arising out of stock dividends;
2. To collect or compromise an indebtedness to the corporation, arising out of unpaid subscription, in a delinquency sale, and to purchase delinquent shares sold during said sale; and
3. To pay dissenting or withdrawing stockholders entitled to payment for their shares under the provisions of the Code.
• The power of the corporation to acquire its own shares is applicable even if the mode of acquisition is through donation. 
• However, the sponsor of the then Corporation Code believed that unrestricted retained earnings would no longer be necessary if the acquisition is through donation. 

2. Rationale. 

• The general rule is that in the absence of statutory authority, the corporation cannot acquire its own shares. 
• The investments of the shareholders are generally locked-in until the liquidation. The view that a corporation cannot buy its own stocks unless there is an express grant of such power is based on the following reasons: 

1. the corporation cannot increase or diminish its capital without the sanction of the legislature;
2. the transaction is a fraud upon creditors; and
3. it is foreign to the purposes for which the corporation is created. 

• There is also the view that purchase of shares can be considered a violation of the Trust Fund Doctrine because the portion of the capital is taken to the prejudice of the creditors. 
• The limit on the purchase of the corporation's own shares springs from the necessity of imposing safeguards against the depletion by a corporation of its assets and the impairment of its capital needed for the protection of creditors. 
• The fear of allowing the exercise of such express power was expressed in this wise: "no verbiage can disguise the fact that a purchase by a corporation of shares in itself really amounts to a reduction of the company's assets, and that the shares purchased do, in fact remain extinguished, at least until the reissue has taken place. The fact that the transaction may not necessarily be injurious to any person is not sufficient reason for supporting it. It is contrary to the fundamental agreement of the shareholders and is condemned by the plainest dictates of sound policy. To allow the directors to exercise such power would be a frightful source of unfairness, mismanagement, and corruption. It is for these reasons that a shareholder cannot be allowed to withdraw from a corporation with his proportionate amount of capital, either by a release and cancellation before the shares have been paid up or by a purchase of the shares with the company's funds."

3. Express Power.

• The power to acquire its own shares is now an express power. However, in order to avoid the dangers that accompany the exercise of this express power, the SEC has always imposed the following conditions on its exercise: 

1. the capital of the corporation must not be impaired; 
2. a legitimate and proper corporate objective is advanced;
3. the condition of corporate affairs warrants it; and 
4. the transaction is designed and carried out in good faith.

PROBLEMS:

A corporation executed a promissory note binding itself to pay its President/Director, who had tendered his resignation, a certain sum in payment of the latter's shares and interests in the company. The corporation defaulted in paying the full amount so that said former President filed suit for collection of the balance before the SEC. 

Under what condition is a stock corporation empowered to acquire it's own shares?

Stock corporation may only acquire its own shares if the following conditions are complied with:

1. The capital of the corporation must not be impaired; 
2. A legitimate and proper corporate objective is advanced;
3. The condition of corporate affairs warrants it; and 
4. The transaction is designed and carried out in good faith. Also, the corporation should have unrestricted retained earnings in its books to cover the shares to be purchased. 

Is the arrangement between the corporation and its President covered by the Trust Fund Doctrine? Explain your answer briefly. 

Yes, the arrangement between the corporation and its President is covered by the Trust Fund Doctrine. The corporation cannot return what was paid by a stockholder for his shares because the subscribed capital is held in trust by the corporation for its creditors. (1992 Bar)

One of the stockholders of VM Corporation is OP Corporation. VM Corporation has been advancing money to OP Corporation to answer for its commitments. OP Corporation is now offering its shares in VM Corporation to pay its advances. Can the VM Corporation acquire its own shares which are in the name of OP Corporation by way of dacion en pago despite the presence of negative retained earnings in its books?

No under the given circumstances VM Corporation cannot acquire its own shares. Section 40 of the RCCP requires the existence of unrestricted retained earnings before a corporat10n can acquire its own shares. The case does not fall under any of the exceptions to the rule that unrestricted retained earnings is required. In addition, the de-recognition of receivables without receiving any cash from the debtor would further aggravate the liquidity position of the company. If the acquisition is allowed, the corresponding recognition of treasury shares would further increase the amount of negative equity of the company. (SEC SGC Opinion No. 09-11 dated May 8, 2009)