Corporation Law: The Revised Corporation Code of the Philippines - Sec 32

 THE REVISED CORPORATION CODE  OF THE PHILIPPINES

Republic Act No. 11232 

TITLE III -  BOARD OF DIRECTORS/TRUSTEES AND OFFICE

Section 32. Contracts Between Corporations with Interlocking Directors.

Except in cases of fraud, and provided the contract is fair and reasonable under the circumstances a contract between two (2) or more corporations having interlocking directors shall not be invalidated on that ground alone: Provided, That if the interest of the interlocking director in one (1) corporation is substantial and the interest in the other corporation or corporations is merely nominal, the contract shall be subject to the provisions of the preceding section insofar as the latter corporation or corporations are concerned.

Stockholding exceeding twenty percent (20%) of the outstanding capital stock shall be considered substantial for purposes of interlocking directors.

1. Effect of Interlocking Directorship. 

• Interlocking directorship by itself is not prohibited under the Corporation Code and the RCCP. 
• However, the By-Laws may contain provisions that disallow interlocking directorship in certain cases. 
• A contract between two or more corporations having interlocking directors shall not be invalidated on that ground alone, except in case of fraud or where the contract is not fair and reasonable.
• Nevertheless, when directors of a corporation "are on both sides of transaction, they are required to demonstrate utmost good faith and most scrupulous inherent fairness of bargain. The requirement of fairness is unflinching in its demand that where one stands on both sides of transaction, he has burden of establishing its entire fairness, sufficient to pass test of careful scrutiny by courts. There is no dilution of this obligation where one holds dual or multiple directorships, as in a parent-subsidiary context. Thus, individuals who act in a dual capacity as directors of two corporations, one of whom is parent and the other subsidiary, owe the same duty of good management to both corporations, and in the absence of an independent negotiating structure, or the directors' total abstention from any participation in the matter, this duty is to be exercised in light of what is best for both companies."

2. Meaning of Interlocking Directorship.

• There is interlocking directorship when one (or some or all) of the directors in one corporation is (or are) also a director(s) in another corporation. 
• The interest of the interlocking director in the corporation is:
• substantial = if his stockholdings exceed 20% of the outstanding capital stock. 
• nominal = if his equity is 20% or less of the outstanding capital stock.

3. Effect on Contracts. 

• If the interest of the interlocking director in one of the corporations is nominal and substantial in the other, a contract between the two corporations shall be voidable at the instance of the corporation where the interlocking director has nominal interest, unless the following conditions are present, in which case the contract will be considered valid:
1. The presence of the interlocking director in the Board meeting (of the corporation where his interest is merely nominal) in which the contract was approved was not necessary to constitute a quorum for such meeting;
2. The vote of such director was not necessary for the approval of the contract; and
3. The contract is fair and reasonable under the circumstances.
• The contract is valid if the interests of the interlocking director in the corporations involved are both substantial (stockholdings exceed 20% of outstanding capital stock), or are both nominal. 
• This is consistent with the rule that contracts between two or more corporations having interlocking directors shall not be invalidated on that ground alone. 
• The exception under Section 32 is when the contract is fraudulent or not fair and reasonable; the contract is voidable at the option of the corporation that is the victim of fraud or unfairness or unreasonableness. 
• The contract may also be annulled under the grounds provided in the New Civil Code for voidable contracts, which include fraud. 

4. Ratification. 

• Contracts between corporations with interlocking directors must always meet the third condition cited above, that is, said contracts must be fair and reasonable under the circumstances. 
• If the contract is fair and reasonable, the absence of either the first or second condition makes the contract voidable and capable of ratification.
• In the absence of any of the first two requirements, the contract can be ratified by the vote of the stockholders representing at least 2/3 of the outstanding capital stock (or at least 2/3 of the members) in a meeting called for the purpose so long as the following requisites are present: 
1. There must be full disclosure of the adverse interest of the directors/trustees involved at such meeting; and
2. The contract must be fair and reasonable under the circumstances.

5. Effect of Prejudice to Third Party. 

• Section 32 of the RCCP (previously, Section 33 of the Corporation Code), which provides for rules regarding transactions between corporations with interlocking directors, applies if the contract results in prejudice to one of the corporations. 
• This rule does not apply if the corporation allegedly prejudiced is a third party, not one of the corporations with inter locking directors

Problem:

Chito Santos is a director of both Platinum Corporation (PLATINUM) and Kwik Silver Corporation (KWIK). He owns one percent of the outstanding capital stock of PLATINUM and 40% of KWIK. PLATINUM plans to enter into a contract with KWIK that will make both companies earn very substantial profits. The contract is presented at the respective board meetings of Platinum and KWIK. 

a) In order that the contract will not be voidable, what conditions will have to be complied with? Explain. 

The contract will not be voidable if at the meeting of the Board of Directors of Platinum to approve the contract:

1. the presence of Chito Santos as director is not necessary to constitute a quorum for such meeting; 
2. his vote is not necessary for the approval of the contract; and 
3.  the contract is fair and reasonable under the circumstances. 

b) If these conditions are not met, how may this contract be ratified? 

If the condition relating to quorum and required number of votes are not met, the contract may be ratified by the vote of stockholders of Platinum representing 2/3 of the outstanding capital stock in a meeting called for the purpose. The contract may be ratified if the following conditions are present:

1. there is no fraud involved;
2. the contract is fair and reasonable under the circumstances; and
3. there is full disclosure of the adverse interest of Chito Santos at the stockholders' meeting of Platinum in which the contract is ratified. (1995 Bar)