1.2 Common and Preferred Shares

1.2 Common and Preferred Shares

Under Section 6 of Republic Act No. 11232 (The Revised Corporation Code of the Philippines), corporate issuers are granted broad statutory authority to classify their capital stock into distinct share classes. These classes may carry varying rights, voting privileges, dividend preferences, and statutory restrictions, provided each classification is explicitly set forth in the Articles of Incorporation (AOI).

A fundamental mandate of Section 6 is that there must always be a class of shares with complete voting rights. No corporation can disenfranchise all its equity; common shares typically serve as this voting foundation.

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Common Shares: The Core Equity Interest

Common shares represent the basic residual ownership interest in a Philippine corporation. Common stockholders assume the ultimate business risk: they have no guaranteed dividend payout and stand last in line during corporate liquidation.

Essential Rights of Common Stockholders

1. Voting Power: Common stockholders possess full voting rights on all corporate matters submitted to a shareholder vote. In director elections, Philippine law guarantees cumulative voting (Section 23), allowing a stockholder to multiply their shares by the number of director seats to be elected and concentrate all votes on a single candidate or distribute them among multiple candidates.
2. Residual Dividend Claim: Common shareholders participate in corporate profits only after debt service, operating expenses, and preferred dividend preferences have been satisfied.
3. Preemptive Right: Common stockholders hold an inherent statutory right under Section 38 to subscribe to new share issuances to protect against dilution.
4. Liquidation Claim: Upon corporate dissolution, common stockholders receive the remaining assets only after all creditors, bondholders, and preferred shareholders have been paid in full.

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Preferred Shares: Preferences and Mechanics

Preferred shares are equity securities designed to provide investors with debt-like income priority while maintaining equity status. Under Section 6, preferred shares may be given preference in the distribution of dividends, the distribution of corporate assets upon liquidation, or any other preference not contrary to law.

Preferred Dividend Classifications

Preferred shares typically carry a fixed dividend rate stated either as a percentage of par value (e.g., 6% preferred on ₱100 par = ₱6.00 annual dividend) or as a fixed peso amount per share. Preferred dividends are divided into several operational structures:

Preferred Dividend Classifications
  ├── Arrears Accumulation:
  │     ├── Cumulative Preferred (Passed dividends accumulate as arrears)
  │     └── Non-Cumulative Preferred (Passed dividends are forfeited)
  └── Excess Sharing:
        ├── Participating Preferred (Shares in surplus profits beyond fixed coupon)
        └── Non-Participating Preferred (Receives only the stated fixed dividend)

1. Cumulative vs. Non-Cumulative

• Cumulative Preferred: If the board does not declare dividends in a given year (e.g., due to insufficient earnings or capital reinvestment), the unpaid dividend accumulates as a dividend in arrears. The corporation must fully settle all accumulated arrears to cumulative preferred shareholders before declaring or paying any dividend to common stockholders. Note: Dividends in arrears are not corporate debts until formally declared by the board.
• Non-Cumulative Preferred: If dividends are passed in any fiscal year, the preferred stockholder permanently forfeits the right to receive that year's payout. The corporation only needs to pay the current year's dividend to preferred holders before paying common dividends.

2. Participating vs. Non-Participating

• Participating Preferred: After the preferred shareholder receives their fixed dividend and the common shareholder receives an equivalent dividend percentage, participating preferred shares share pro-rata with common stock in any remaining distributable profits.
• Non-Participating Preferred: The preferred stockholder receives strictly their stated fixed dividend rate and nothing more, regardless of how extraordinarily profitable the corporation becomes. In the Philippines, preferred shares are presumed non-participating unless participation is explicitly granted in the AOI.

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The Eight Fundamental Acts Where "Non-Voting" Shares Vote

While Section 6 allows a corporation to classify preferred or redeemable shares as "non-voting," Philippine corporate law does not permit complete disenfranchisement.

Under Section 6, Paragraph 6 of the RCCP, holders of non-voting shares shall nevertheless be entitled to vote on the following eight (8) fundamental corporate actions:

1. Amendment of the Articles of Incorporation (including any extension or shortening of the corporate term).
2. Adoption and amendment of bylaws.
3. Sale, lease, exchange, mortgage, pledge, or other disposition of all or substantially all of the corporate property and assets.
4. Incurring, creating, or increasing bonded indebtedness.
5. Increase or decrease of authorized capital stock.
6. Merger or consolidation of the corporation with another corporation or corporations.
7. Investment of corporate funds in another corporation or business outside the primary purpose.
8. Dissolution of the corporation.

Non-Voting Shares Statutory Voting Rights (Sec 6)
  ├── Charter Governance: AOI Amendments | Bylaw Changes | Dissolution
  ├── Major Asset Moves: Sale of Substantially All Assets | Mergers & Consolidations
  └── Capital Structure: Increasing Bonded Debt | Increasing/Decreasing ACS | Outside Investments

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Redeemable Shares (Section 8)

Under Section 8 of the RCCP, redeemable shares are shares issued by a corporation that may be purchased or taken up by the corporation upon the expiration of a fixed period, regardless of the existence of unrestricted retained earnings in the corporate books.

Key Legal Properties

1. The URE Exemption: Regular share buybacks under Section 40 strictly require unrestricted retained earnings. In stark contrast, redeemable shares can be repurchased even if the corporation has zero or negative retained earnings, provided the corporation has sufficient assets in its books to cover all debts and liabilities inclusive of capital stock (the solvency rule).
2. Mandatory vs. Optional: Redemption may be at the option of the corporation (callable), at the option of the holder (puttable), or mandatory upon a specified maturity date.
3. Retirement of Shares: Once redeemed, redeemable shares are considered retired and cannot be reissued unless the AOI expressly permits their reissuance.

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Convertible Shares

Convertible shares (most commonly convertible preferred stock) give the holder the option to exchange their shares for a predetermined number of common shares.

• Conversion Ratio: Number of common shares received for each preferred share (e.g., a 1:4 ratio grants 4 common shares per preferred share).
• Conversion Price: The effective cost of common stock acquired through conversion (Par Value of Preferred / Conversion Ratio).
• Anti-Dilution Covenants: Charters typically include anti-dilution clauses that adjust the conversion ratio automatically if the corporation executes a stock split or stock dividend on its common shares.

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Founder's Shares (Section 7)

Under Section 7 of the RCCP, founder's shares are shares classified in the AOI that grant the original founders or promoters specific rights and privileges not enjoyed by other stockholders.

The Strict 5-Year Rule

Founder's shares may be granted the exclusive right to vote and be voted for in the election of directors. However, Section 7 imposes an absolute statutory cap:

$\text{Maximum Period of Exclusive Voting Rights} = 5 \text{ Years from SEC Approval}$

• The 5-year clock begins on the exact date the SEC approves the corporation's Articles of Incorporation.
• Once the 5-year period expires, the exclusive voting privilege terminates automatically by operation of law, and the shares revert to standard voting rights.
• Foreign Equity Restrictions: Founder's shares cannot be structured to circumvent foreign equity ceilings under the Philippine Constitution, the Anti-Dummy Law (Commonwealth Act No. 108), or the Foreign Investments Act (RA 7042).

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Treasury Shares (Section 9)

Under Section 9 of the RCCP, treasury shares are shares that have been lawfully issued and fully paid for, but subsequently reacquired by the issuing corporation through purchase, redemption, donation, or forfeiture.

Essential Legal Constraints on Treasury Shares

• No Voting Power: Treasury shares cannot be voted at shareholder meetings and cannot be counted toward establishing a quorum or a voting majority.
• No Dividend Entitlement: A corporation cannot pay dividends to itself; treasury shares receive neither cash nor stock dividends.
• Not Outstanding Equity: Treasury shares are issued shares, but they are not outstanding shares.
• Source of Acquisition (Section 40): A corporation can only repurchase its own shares to hold in treasury if it possesses sufficient unrestricted retained earnings (URE) to cover the purchase price.
• Reissuance Below Par: When reissuing treasury shares, the board of directors may sell them for any fair market price, even below original par value. Because the par value was already fully paid upon original issuance, selling treasury shares below par does not create watered stock (Section 64).

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Comparative Matrix: Share Classes and Key Legal Attributes

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Practical Exam Traps and Regulatory Pitfalls

• Trap 1: Assuming Non-Voting Preferred Shares Can Never Vote. Exam candidates frequently pick options stating that non-voting preferred shares have zero voice in corporate governance. Always remember the eight fundamental statutory matters where they must vote.
• Trap 2: Paying Dividends on Treasury Shares. If a scenario involves a corporation distributing a 10% stock dividend, the candidate must calculate the distribution based on outstanding shares only, excluding any treasury shares.
• Trap 3: The Redeemable Shares Retained Earnings Trap. Questions frequently ask if an insolvent corporation can redeem its redeemable shares if it has retained earnings, or if a solvent corporation without retained earnings can redeem them. The rule is simple: Retained earnings are not required, but corporate solvency (sufficient assets to cover debts) is mandatory.
• Trap 4: Founder's Exclusivity Renewal. The 5-year exclusivity limit for electing directors cannot be extended or renewed by charter amendment after incorporation. Once 5 years elapse, the exclusivity dies.