36.2 Corporations: Capital Stock, Shares, and Subscriptions

Corporations: Capital Stock, Shares, and Subscriptions

Capital structure protects creditors and defines stockholders' rights. This section covers capital stock concepts and the trust fund doctrine, classes of shares (including founders', redeemable, and treasury shares), watered stock, subscriptions and the consideration for shares, and delinquency sales.

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1. Capital Stock Concepts & The Trust Fund Doctrine

Capital Stock Fundamentals

• Authorized Capital Stock (ACS): The maximum amount of capital fixed in the Articles of Incorporation that a corporation is legally authorized to issue, divided into shares of par value or expressed as a number of no-par value shares.
• Subscribed Capital: The portion of authorized capital stock that investors have contractually agreed to take up and pay for, whether fully paid or partially paid.
• Paid-up / Paid-in Capital: The actual amount of cash, property, or converted debt received by the corporation from subscribers in satisfaction of their stock subscriptions.
• Legal Capital (Stated Capital): The aggregate par value of all issued and subscribed par value shares, plus the total consideration received for all issued and subscribed no-par value shares. Under Philippine law, legal capital is strictly protected and cannot be impaired.

The Trust Fund Doctrine

The Trust Fund Doctrine is a foundational principle of Philippine corporate law providing that the capital stock, subscriptions, and other assets of a corporation constitute a trust fund dedicated primarily to the payment of corporate debts and the protection of corporate creditors.

                               Applications of the Trust Fund Doctrine
                                                  │
     ┌────────────────────────────┬───────────────┴───────────────┬────────────────────────────┐
     ▼                            ▼                               ▼                            ▼
Prohibition on Dividends     No Release of Unpaid            No Unlawful Share            Creditors' Priority
Out of Capital               Subscriptions                   Reacquisition                Over Stockholders
(Dividends payable only      (Corporation cannot forgive     (Own shares reacquired       (In liquidation, creditors
 from Unrestricted           unpaid balances without         only from Unrestricted       must be paid in full
 Retained Earnings)          creditor consent)               Retained Earnings)           before any equity return)

Under this doctrine:

1. Dividends may be declared and paid exclusively out of unrestricted retained earnings; paying dividends out of capital constitutes illegal capital impairment;
2. The corporation cannot gratuitously release or forgive a subscriber from paying their unpaid subscription balance without unanimous stockholder consent and adequate creditor protection;
3. The corporation cannot repurchase its own shares unless it has unrestricted retained earnings in its books (except for redeemable shares);
4. Upon dissolution, creditors must be fully satisfied before any corporate property or residual assets may be distributed to stockholders.

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2. Classes of Shares & Special Share Characteristics

Under Section 6 of RA 11232, corporations may issue various classes of shares with such rights, privileges, or restrictions as stated in the Articles of Incorporation:

Comparison of Share Classes

Preferred Shares: Dividend Classifications

• Cumulative vs Non-Cumulative: In cumulative preferred shares, if dividends are omitted or undeclared in any given year, the unpaid dividends accumulate in arrears and must be paid in full in subsequent years before any dividend can be distributed to common stockholders. In non-cumulative shares, undeclared dividends are forfeited.
• Participating vs Non-Participating: In participating preferred shares, after the preferred stockholders receive their stipulated preference rate and common stockholders receive an equivalent rate, preferred stockholders participate pro-rata with common stockholders in any remaining surplus profits. Non-participating shares receive only their fixed preference rate.

Watered Stock (Section 64)

Watered stock refers to shares issued by a corporation as fully paid up when in fact the corporation received consideration less than the par or issued value of the shares.

• Occurs when shares are issued: (1) For cash less than par or issued value; (2) For property, labor, or services valued in excess of their fair market value; or (3) As stock dividends when there are insufficient unrestricted retained earnings to justify the capitalization.
• Statutory Liability (Section 64): Any director or officer of a corporation who consents to the issuance of watered stock, or who, having knowledge thereof, fails to file a written objection with the corporate secretary, is jointly and severally (solidarily) liable with the stockholder concerned to the corporation and its creditors for the difference between the fair value received and the par or issued value of the shares.

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3. Subscriptions, Consideration, and Delinquency

Subscription Contracts

A subscription contract is any contract for the acquisition of unissued stock in an existing corporation or a corporation still to be formed.

• Pre-Incorporation Subscriptions (Section 60): A subscription entered into before corporate formation is irrevocable for a period of at least six (6) months from the date of subscription, unless: (1) all other subscribers consent to the revocation, or (2) the incorporation fails to materialize within said period or within a longer period agreed upon.

  Absolute Statutory Bar: No pre-incorporation subscription may be revoked after the submission of the Articles of Incorporation to the SEC (Section 60).

• Valid Consideration for Stock (Section 61): Shares may be issued only for: (1) actual cash; (2) property actually received and necessary for corporate purposes; (3) labor or services actually rendered to the corporation; (4) previously incurred corporate debt; (5) amounts transferred from unrestricted retained earnings to stated capital (stock dividends); or (6) outstanding shares exchanged in a reclassification. Promissory notes and future services are strictly prohibited from serving as valid consideration for stock.

Delinquency and Delinquency Sales (Sections 66 to 70)

When a subscriber fails to pay an unpaid subscription balance upon the call of the board or on the date specified in the contract:

                                    The Delinquency Process
                                               │
     ┌─────────────────────────────────────────┼─────────────────────────────────────────┐
     ▼                                         ▼                                         ▼
Call by Board of Directors            30-Day Grace Period                  Delinquency Sale at Auction
(Board passes resolution              (If unpaid 30 days after             (Sold to the HIGHEST BIDDER
 declaring unpaid subscriptions       due date, shares become              who pays full claim for the
 due and payable on date)             delinquent automatically)            SMALLEST fraction of shares)

Legal Effects of Delinquency (Section 70)

From the moment shares become delinquent:

1. The shares lose the right to vote or be represented at any stockholders' meeting;
2. The holder is disqualified from being elected or seated as a director;
3. Cash dividends are not paid to the delinquent stockholder, but are applied directly to unpaid balances, interest, and expenses;
4. Stock dividends are withheld until the unpaid subscription balance is paid in full.

The Delinquency Auction and "Highest Bidder" Defined

Under Section 67, at the public auction of delinquent shares, the highest bidder is legally defined as:

"The person offering to pay the full amount of the balance on the subscription together with accrued interest, costs of advertisement, and expenses of sale, for the SMALLEST NUMBER OR FRACTION OF SHARES."

If the highest bidder takes only a fraction of the shares, the remaining shares are issued to the original subscriber as fully paid. If no bidder appears, the corporation may bid in the shares using unrestricted retained earnings, and the shares become treasury shares.

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4. Worked Problem: Delinquency Sale and Identification of the Highest Bidder

Problem: Oscar subscribed to 10,000 shares of common stock of Beta Industrial Corp with a par value of PHP 100 per share (total subscription PHP 1,000,000). Oscar paid PHP 400,000 upon subscription. The Board of Directors made a call for the remaining balance of PHP 600,000. Oscar defaulted, and the shares became delinquent. Beta Industrial scheduled a delinquency sale. The total claim against Oscar consists of: unpaid subscription of PHP 600,000, accrued interest of PHP 36,000, and advertising and auction costs of PHP 14,000 (Total Claim = PHP 650,000).

At the public auction, the following bids were submitted:

• Bidder 1: Offers to pay PHP 650,000 for 7,500 shares;
• Bidder 2: Offers to pay PHP 650,000 for 6,200 shares;
• Bidder 3: Offers to pay PHP 600,000 for 5,000 shares;
• Bidder 4: Offers to pay PHP 650,000 for 8,000 shares.

Who is the winning "highest bidder" under Section 67 of the Revised Corporation Code, and how are the 10,000 shares distributed?

Analysis and Solution:

1. Statutory Definition under Section 67: The "highest bidder" is the person offering to pay the full amount of the claim (balance + interest + costs = PHP 650,000) for the smallest number or fraction of shares.
2. Evaluating the Bids:
   • Bidder 3 offered only PHP 600,000, failing to cover the full claim of PHP 650,000. Bidder 3 is disqualified.
   • Bidders 1, 2, and 4 all offer to pay the full claim of PHP 650,000.
   • Comparing the shares demanded: Bidder 4 demands 8,000 shares; Bidder 1 demands 7,500 shares; Bidder 2 demands 6,200 shares.
3. Conclusion: Bidder 2 is the winning highest bidder because they offered the full PHP 650,000 claim for the smallest fraction of shares (6,200 shares).
4. Distribution of Shares:
   • Bidder 2 receives 6,200 fully paid shares.
   • Oscar (the original subscriber) receives the remaining 3,800 shares ($10{,}000 - 6{,}200$) issued as fully paid up, because the entire subscription debt was extinguished by Bidder 2's payment.