Trust Fund Doctrine | General Principles | Corporations | BUSINESS ORGANIZATIONS

Trust Fund Doctrine in Corporations (Philippine Law)

The Trust Fund Doctrine is a fundamental principle in corporate law that safeguards the interests of corporate creditors by ensuring that the capital of a corporation is preserved for the payment of its debts and liabilities. Under Philippine law, this doctrine holds that the capital stock, property, and assets of a corporation constitute a "trust fund" for the benefit of creditors. Consequently, corporate capital cannot be distributed to shareholders or stockholders except under specific conditions allowed by law, such as upon lawful dissolution and liquidation of the corporation.

This doctrine arises from the idea that when a corporation raises funds by issuing shares of stock to investors, the capital raised is held in trust for creditors, rather than simply belonging to shareholders. This ensures the protection of third parties dealing with the corporation, particularly creditors who extend credit based on the financial standing of the corporation. The Trust Fund Doctrine imposes certain restrictions on how the corporate capital can be utilized.

Key Elements and Applications of the Trust Fund Doctrine

1. Capital as a Trust Fund for Creditors:

   • Under the Trust Fund Doctrine, the capital stock of a corporation cannot be returned to shareholders or dissipated through unauthorized distributions as long as the corporation has outstanding obligations to creditors.
   • Any actions that impair the corporation’s capital base to the detriment of creditors, such as unauthorized stock buybacks, unwarranted dividends, or reductions in capital stock without due legal process, may be deemed void or subject to reversal.

2. Restrictions on Distribution of Corporate Assets:

   • Dividends: The declaration and payment of dividends to stockholders are subject to legal limitations under Philippine law. Dividends can only be declared from the corporation's "unrestricted retained earnings" and not from the paid-in capital. This ensures that the paid-in capital remains intact to satisfy creditor claims.
   • Buyback of Shares (Stock Redemption): When a corporation redeems its own shares, it must ensure that it does so from surplus or profits and not from its capital stock. A corporation cannot use its capital for the redemption of shares if doing so would prejudice creditors.
   • Return of Capital to Stockholders: The capital invested by stockholders may only be returned in a lawful process of dissolution and liquidation, and even then, only after all corporate debts and liabilities have been paid or provided for.

3. Statutory and Jurisprudential Basis:

   • The Trust Fund Doctrine is enshrined in Philippine corporate laws, particularly under the Revised Corporation Code of the Philippines (Republic Act No. 11232). The law emphasizes the preservation of corporate assets for creditor protection.
   • Several cases decided by the Supreme Court of the Philippines have affirmed the application of the Trust Fund Doctrine, particularly in situations where creditors seek to recover from a corporation that has unlawfully distributed its capital to shareholders. These cases have reinforced that corporate capital serves as a guarantee or trust fund for creditors.

4. Capital Stock as Defined by Law:

   • Capital stock refers to the total amount of stock subscribed and paid by stockholders. The Revised Corporation Code defines the various components of corporate capital, including:
     • Authorized Capital Stock: The total value of stock that a corporation is authorized to issue.
     • Subscribed Capital: The portion of the authorized capital stock that stockholders have committed to pay.
     • Paid-in Capital: The amount that has already been paid by stockholders for their subscriptions.

   Only surplus or net income, as defined by generally accepted accounting principles and subject to statutory adjustments, may be used for dividends or share redemptions, ensuring that the capital stock remains available for creditor claims.

5. Application in Corporate Dissolution:

   • When a corporation undergoes dissolution, the Trust Fund Doctrine continues to protect the creditors. The corporation’s remaining assets, after liquidation of liabilities, may only be distributed to shareholders after all debts have been satisfied. In the event of insolvency, creditors have first priority over the distribution of corporate assets.
   • Under the process of liquidation, the board of directors or a liquidator appointed by the court will ensure that the trust fund principle is observed, protecting creditors' interests.

6. Liability of Directors and Stockholders:

   • Directors, officers, or shareholders who violate the Trust Fund Doctrine by unlawfully declaring dividends, returning capital to stockholders, or otherwise dissipating the capital stock of the corporation may be held liable to creditors for the full amount of any unauthorized distribution.
   • Creditors may pursue corporate officers or shareholders who receive distributions in violation of the doctrine under the theory that such actions constitute a form of fraud, as the corporate capital should have been preserved for creditor satisfaction.

7. Reduction of Capital Stock:

   • A corporation may legally reduce its capital stock in certain instances, but this must follow the procedures laid out in the Revised Corporation Code (Sec. 38). Such reductions typically require approval by the board of directors, the vote of shareholders, and compliance with creditors’ rights, which may include creditor notifications and rights to object.
   • If the reduction in capital stock results in a release of funds to shareholders, creditors may intervene if such a reduction impairs their ability to recover debts owed by the corporation.

8. Exceptions to the Doctrine:

   • The Trust Fund Doctrine does not apply to earnings or surplus profits. Corporations are free to distribute these to shareholders in the form of dividends, provided that the distribution does not affect the capital stock.
   • Additionally, in cases where the law permits certain corporate reorganizations or restructuring, the Trust Fund Doctrine may allow some flexibility, as long as creditors' rights are safeguarded.

Conclusion

The Trust Fund Doctrine in Philippine corporate law is a key mechanism for ensuring that the financial resources of a corporation are preserved for the protection of its creditors. The doctrine prevents corporate capital from being depleted through unlawful distributions to stockholders, thereby serving as a buffer for corporate liabilities. This ensures that, even in cases of corporate failure, creditors can recover debts before any distribution of remaining assets to shareholders. The doctrine is supported by statutory law, the Revised Corporation Code, and jurisprudence, which collectively reinforce the fiduciary responsibility of corporate officers to uphold the capital integrity of corporations.

Any attempt to disregard the Trust Fund Doctrine can lead to personal liability for corporate directors and stockholders, highlighting the importance of adhering to this fundamental principle in corporate governance.