35.3 Corporations: Board of Directors, Officers, and Fiduciary Duties

Corporations: Board of Directors, Officers, and Fiduciary Duties

The board of directors (or trustees) exercises the corporate powers, conducts the business, and controls the property of the corporation (Section 22). This section covers the board's qualifications and disqualifications, independent directors, election by cumulative voting, removal and vacancies, corporate officers and committees, fiduciary duties, self-dealing and interlocking directors, and the corporate opportunity doctrine.

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1. The Board of Directors: Authority, Qualifications & Disqualifications

Management Authority under Section 22

Section 22 of RA 11232 establishes the core governance principle:

"Unless otherwise provided in this Code, the board of directors or trustees shall exercise the corporate powers, conduct all business, and control all properties of the corporation."

Individual stockholders cannot bind the corporation, nor can individual directors act unilaterally on corporate matters. Corporate acts must be authorized by the board functioning collegially as a body in a duly constituted meeting.

The Business Judgment Rule

Under the Business Judgment Rule, questions of policy or management are left solely to the honest decision of the board of directors. Courts will not interfere with, overturn, or substitute their judgment for the business decisions of directors acting in good faith and with reasonable diligence. Directors cannot be held personally liable for corporate business losses, debts, or errors of commercial judgment.

                             Exceptions to the Business Judgment Rule
                                 (Personal Liability under Section 30)
                                                 │
     ┌───────────────────────────┬───────────────┴───────────────┬───────────────────────────┐
     ▼                           ▼                               ▼                           ▼
Willful and Knowing       Gross Negligence or            Patently Unlawful              Conflict of Interest
Assent to Patently        Bad Faith in Directing         Acts in Contravention          (Self-dealing, secret
Unlawful Corporate Acts   the Affairs of Corporation     of Law or Charter              commissions, disloyalty)

Under Section 30, directors or trustees who willfully and knowingly vote for or assent to patently unlawful acts of the corporation, or who are guilty of gross negligence or bad faith in directing corporate affairs, or acquire any personal or pecuniary interest in conflict with their duty, are jointly and severally (solidarily) liable for all resulting damages suffered by the corporation, its stockholders, or third persons.

Qualifications of Directors (Section 22)

1. Stock Ownership: Every director of a stock corporation must own at least one (1) share of capital stock of the corporation in their own right. If a director disposes of all their shares, they automatically cease to be a director.
2. Natural Person: Directors must be natural persons of legal age.
3. Residency Modernization: Under RA 11232, the historical requirement that a majority of the board of directors must be residents of the Philippines has been repealed. Board members may reside anywhere, unless a special law governing nationalized or regulated industries provides otherwise.
4. Independent Directors: Corporations vested with public interest must have independent directors constituting at least twenty percent (20%) of their board. Under Section 22, public interest corporations include:
   • Publicly listed companies whose securities are traded on an organized exchange;
   • Public companies with assets of at least PHP 50,000,000 and having 200 or more holders each holding at least 100 shares of equity;
   • Banks, quasi-banks, trust entities, pawnshops, and non-stock savings and loan associations;
   • Insurance companies, pre-need firms, and public utilities.

Disqualifications under Section 26

A person is disqualified from being elected or seated as a director, trustee, or officer of any corporation if, within five (5) years prior to election or appointment, the person was:

1. Convicted by final judgment of an offense punishable by imprisonment for a period exceeding six (6) years;
2. Convicted by final judgment for violating the Revised Corporation Code;
3. Convicted by final judgment for violating the Securities Regulation Code (RA 8799);
4. Found administratively liable for any offense involving fraudulent acts; or
5. Declared by a foreign court or equivalent foreign regulatory authority for acts, violations, or misconduct similar to the above.

Under Section 26, the SEC has explicit authority to order the immediate removal of a disqualified director, trustee, or officer, motu proprio or upon a verified complaint, after due notice and hearing.

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2. Election, Removal, and Filling of Board Vacancies

Election Mechanics and Cumulative Voting (Section 23)

• Quorum: The election of directors requires the presence, in person or by proxy, of the owners of a majority of the outstanding capital stock entitled to vote.
• Voting Methods:
  • Stock Corporations: Cumulative voting is a mandatory statutory right that cannot be restricted or denied in the Articles of Incorporation or Bylaws.
  • Non-Stock Corporations: Straight voting applies (one vote per candidate up to the number of vacancies), unless cumulative voting is expressly authorized in the articles or bylaws.

The Cumulative Voting Formulas

Each stockholder holding voting stock is entitled to a total number of votes computed as:

$\text{Total Votes} = \text{Number of Voting Shares Held} \times \text{Number of Directors to be Elected}$

The stockholder may concentrate all their votes on a single candidate (plump voting) or distribute them among as many candidates as they see fit.

To determine the minimum number of voting shares required to guarantee the election of a desired number of directors ($d$), CPALE problems apply the cumulative voting formula:

$\text{Minimum Shares Required} = \left\lfloor \frac{d \times S}{D + 1} \right\rfloor + 1$

Where:

• $d = \text{number of directors desired to be elected}$
• $S = \text{total number of voting shares present or represented at the election}$
• $D = \text{total number of director seats to be filled}$

Removal of Directors (Section 27)

• Voting Threshold: Any director or trustee may be removed from office by a vote of stockholders holding or representing at least two-thirds (2/3) of the outstanding capital stock (or 2/3 of members in non-stock entities) at a regular or special meeting called for that purpose.
• Cause vs No Cause: Removal may be with or without cause. However, removal without cause may NOT be used to deprive minority stockholders of board representation to which they are entitled under cumulative voting.

Filling Board Vacancies (Section 28)

                                  Filling Vacancies in the Board (Section 28)
                                                      │
         ┌────────────────────────────────────────────┴────────────────────────────────────────────┐
         ▼                                                                                         ▼
Must be Filled by STOCKHOLDERS                                                            May be Filled by REMAINING DIRECTORS
(Special election called for the purpose)                                                 (If still constituting a QUORUM)
• Expiration of term                                                                      • Death
• Removal by stockholders                                                                 • Resignation
• Increase in the number of board seats                                                   • Disqualification
• Abandonment / total failure of election                                                 • Other causes (except removal, expiration, or size increase)

The Emergency Board Rule (Section 28): When a vacancy prevents the remaining directors from constituting a quorum and emergency action is urgently required to prevent grave, substantial, and irreparable loss or damage to the corporation, the remaining directors may temporarily appoint an emergency director from among the officers of the corporation by unanimous vote. The emergency director acts strictly to address the emergency, and their authority ceases upon election of a permanent replacement by the stockholders.

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3. Corporate Officers & Board Committees

Statutory Corporate Officers (Section 24)

Immediately following their election, the directors must organize and elect the corporate officers. The following matrix details statutory qualifications and incompatibility rules:

CPALE Rule on Dual Offices: The positions of Corporate Secretary and Corporate Treasurer may be held by the same person, provided that person is a resident Filipino citizen and does not hold the Presidency.

Executive Committee (Section 34)

If authorized by the bylaws, the board may create an Executive Committee composed of at least three (3) members of the board. The committee may act on such specific matters within the competence of the board as are delegated to it in the bylaws or by a majority board resolution.

Statutory Exceptions (Matters the Executive Committee CANNOT Act Upon):

1. Approval of any action for which stockholder approval is also required under the code;
2. Filling of vacancies in the board of directors;
3. Amendment or repeal of bylaws or the adoption of new bylaws;
4. Amendment or repeal of any resolution of the board which by its express terms is not amendable or repealable;
5. Distribution of cash, property, or stock dividends to stockholders.

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4. Fiduciary Duties and Conflict-of-Interest Transactions

Directors occupy a fiduciary relation of trust and confidence. Philippine corporate jurisprudence organizes their obligations into the Triad of Fiduciary Duties:

                                The Triad of Fiduciary Duties
                                              │
     ┌────────────────────────────────────────┼────────────────────────────────────────┐
     ▼                                        ▼                                        ▼
Duty of Obedience                        Duty of Diligence                        Duty of Loyalty
(Act strictly within powers conferred    (Exercise care of an ordinarily          (Subordinate personal interest
 by law, charter, and corporate bylaws)   prudent person in personal affairs)      to the unselfish welfare of firm)

Self-Dealing Directors (Section 31)

A self-dealing contract occurs when a corporation enters into a contract with one or more of its own directors, trustees, officers, or their spouses and relatives within the fourth civil degree of consanguinity or affinity.

• General Rule: A self-dealing contract is VOIDABLE at the option of the corporation.
• Exceptions (Contract is Valid and Unassailable if ALL Concur):
  1. The presence of such director in the board meeting approving the contract was not necessary to constitute a quorum;
  2. The vote of such director was not necessary for the approval of the contract;
  3. The contract is fair and reasonable under the circumstances;
  4. In corporations vested with public interest, material contracts are approved by at least a majority of the independent directors voting on the contract; and
  5. In case of an officer, the contract has been previously authorized by the board of directors.

Stockholder Ratification of Self-Dealing Contracts

Where any of the first three conditions is absent (for example, the director's presence was needed for quorum or the director's vote was needed for approval), the contract with a director may be ratified by the vote of stockholders representing at least two-thirds (2/3) of the outstanding capital stock (or 2/3 of members in non-stock entities) in a meeting called for that purpose, provided that full disclosure of the adverse interest is made and the contract is fair and reasonable.

Interlocking Directors (Section 32)

An interlocking directorship occurs when two independent corporations have one or more directors in common.

• General Rule: Contracts between corporations with interlocking directors are VALID, provided there is no fraud and the contract is fair and reasonable under the circumstances.
• Substantial Interest Exception: If the interlocking director's interest in one corporation is substantial (stockholding exceeding twenty percent [20%] of the outstanding capital stock) and their interest in the other corporation is merely nominal, the contract is governed by the rules on self-dealing directors (Section 31) with respect to the corporation where the director holds a nominal interest.

Corporate Opportunity Doctrine (Section 33)

Under Section 33, where a director acquires for themselves a business opportunity which should belong to the corporation, thereby obtaining profits to the expense of the corporation, the director must account for and refund to the corporation all such profits, unless the act has been ratified by a vote of stockholders owning or representing at least two-thirds (2/3) of the outstanding capital stock.

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5. Worked Problem: Cumulative Voting to Elect Minority Directors

Problem: Vanguard Mining Corp has 120,000 outstanding voting common shares. An upcoming election will fill seven (7) seats on the Board of Directors. A minority coalition of stockholders holds 32,000 shares and seeks to maximize their board representation. The majority bloc holds the remaining 88,000 shares and refuses to allocate any votes to the minority.

1. How many total votes can the minority coalition cast?
2. What is the maximum number of directors the minority coalition can guarantee electing through strategic cumulative voting?

Analysis and Computation:

1. Total Votes Castable by Minority:

$$\begin{aligned} \text{Total Minority Votes} &= \text{Shares Held} \times \text{Number of Director Seats} \\ &= 32{,}000 \times 7 = 224{,}000 \text{ votes} \end{aligned}$$

1. Minimum Shares Required Formula:

$\text{Minimum Shares} = \left\lfloor \frac{d \times S}{D + 1} \right\rfloor + 1$

Where $S = 120{,}000$, $D = 7$, and $D + 1 = 8$.

• To elect $d = 1$ director:

$\left\lfloor \frac{1 \times 120{,}000}{8} \right\rfloor + 1 = 15{,}000 + 1 = 15{,}001 \text{ shares}$

• To elect $d = 2$ directors:

$\left\lfloor \frac{2 \times 120{,}000}{8} \right\rfloor + 1 = 30{,}000 + 1 = 30{,}001 \text{ shares}$

• To elect $d = 3$ directors:

$\left\lfloor \frac{3 \times 120{,}000}{8} \right\rfloor + 1 = 45{,}000 + 1 = 45{,}001 \text{ shares}$

1. Conclusion: Because the minority holds 32,000 shares, they exceed the 30,001 share threshold but fall short of 45,001 shares. Therefore, the minority coalition can guarantee the election of exactly two (2) directors by concentrating their 224,000 votes equally on two candidates (112,000 votes each), which the majority (with $88{,}000 \times 7 = 616{,}000$ votes) cannot defeat across more than five candidates.

6. Worked Problem: Self-Dealing Director Contract and Voidability

Problem: Solid Rock Construction Inc. has a five-member Board of Directors consisting of Directors A, B, C, D, and E. Director A owns a heavy equipment leasing firm. At a meeting where Directors A, B, and C were present (constituting a quorum of 3), the board considered a contract to lease specialized excavators from Director A's firm for PHP 18,000,000 per year. Directors A and B voted to approve the contract, while Director C voted against it. The lease rate was commercially reasonable and fair. Later, stockholders discovered the contract and demanded its cancellation, while Director A argued the contract was valid because it was fair and approved by a majority of the quorum. Is the contract valid, voidable, or void?

Analysis and Solution:

1. Statutory Standard under Section 31: A contract between a corporation and its director is voidable unless: (a) the director's presence was not necessary for a quorum; (b) the director's vote was not necessary for approval; and (c) the contract is fair and reasonable.
2. Quorum and Voting Analysis:
   • Quorum required: 3 directors. Without Director A, only 2 directors (B and C) were present, which falls below a quorum.
   • Vote required: Majority of quorum (2 votes). Without Director A's affirmative vote, only Director B voted in favor, meaning the contract received only 1 vote from disinterested directors.
3. Conclusion: Because Director A's presence was indispensable for a quorum and their vote was necessary for approval, the contract is VOIDABLE at the option of Solid Rock Construction Inc., notwithstanding that the rental rate was commercially fair. To validate the contract, it must be submitted to the stockholders and ratified by at least two-thirds (2/3) of the outstanding capital stock after full disclosure under Section 31.