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.

Doctrine of Piercing the Corporate Veil | General Principles | Corporations | BUSINESS ORGANIZATIONS

Doctrine of Piercing the Corporate Veil in the Philippines

The Doctrine of Piercing the Corporate Veil is a legal principle used by courts to disregard the separate legal personality of a corporation, holding the individuals behind the corporation liable for its actions or obligations. Normally, a corporation is treated as a separate entity, distinct from its shareholders, directors, or officers. This principle is enshrined in Section 2 of the Revised Corporation Code of the Philippines (R.A. No. 11232), which recognizes that a corporation, upon incorporation, acquires a juridical personality separate and distinct from the individuals who compose it.

However, under certain circumstances, this legal distinction may be disregarded. The court applies the Doctrine of Piercing the Corporate Veil to prevent the misuse of the corporate form to commit fraud, circumvent the law, or evade obligations. Below is a detailed examination of the doctrine as applied in Philippine law:

1. General Principles

The Doctrine of Piercing the Corporate Veil does not impair the general rule that a corporation has a distinct legal personality. The doctrine is applied cautiously and sparingly, in exceptional cases where the corporate personality is being used to defeat public convenience, justify a wrong, protect fraud, or defend crime.

When the veil is pierced, the acts and liabilities of a corporation are treated as those of its incorporators, officers, or directors, who are then personally liable for the corporation's obligations. The purpose of piercing the corporate veil is to prevent fraud or injustice.

2. When is the Doctrine Applied?

In Philippine jurisprudence, the courts will apply the Doctrine of Piercing the Corporate Veil in the following circumstances:

a. To Defeat Fraud

The doctrine is invoked when the corporate fiction is used as a shield for fraudulent or dishonest activities. A corporation's separate legal personality cannot be used to perpetuate fraud or mislead creditors. If it is proven that the corporation was formed or is being operated in bad faith, the courts will disregard its separate personality.

For example, in Francisco Motors Corporation v. CA (G.R. No. 100812, June 25, 1999), the Supreme Court pierced the corporate veil when a corporation was used to defraud creditors.

b. To Circumvent the Law

Courts will pierce the corporate veil when the corporate entity is used to evade legal obligations or liabilities, such as in situations where corporations are deliberately undercapitalized to avoid meeting legal obligations.

c. To Achieve Equity

In some cases, piercing the corporate veil is necessary to prevent injustice or unfairness. This can occur when a corporate entity is used to abuse its corporate shield, resulting in unjust outcomes for other parties.

In Santos v. NLRC (G.R. No. 115795, September 25, 1998), the Supreme Court ruled that the corporate veil can be pierced when necessary to prevent the injustice of hiding behind the corporation's separate personality.

d. To Prevent Evasion of Existing Obligations

If the corporation is used as a mere conduit to avoid an already existing obligation, courts may pierce the corporate veil. For example, when a corporation is created solely for the purpose of evading liability from creditors or other parties.

3. Tests for Piercing the Corporate Veil

The Philippine Supreme Court has articulated various tests for determining when the Doctrine of Piercing the Corporate Veil should apply:

a. Instrumentality or Alter-Ego Test

This test applies when the corporation is so controlled by another person or entity that it becomes a mere instrumentality, conduit, or alter ego of that person or entity. The controlling party exercises such control over the corporation that the corporation has no separate will of its own.

In Cebu Shipyard and Engineering Works, Inc. v. William Lines, Inc. (G.R. No. 132607, May 5, 1999), the Court applied this test, finding that the corporation was a mere instrumentality of its principal stockholder.

b. Fraud Test

The fraud test is used when the corporate entity is being used to perpetrate fraud or commit wrongful acts against third parties. This was seen in McLeod v. NLRC (G.R. No. 90535, August 29, 1991), where the Court held that corporate officers could not use the corporate entity as a means to perpetrate injustice.

c. Equity Test

This test focuses on the need to prevent injustice or inequitable outcomes. Courts will pierce the veil when the corporate entity is being used in a way that frustrates justice and equitable principles.

4. Elements for Application of the Doctrine

For a court to apply the Doctrine of Piercing the Corporate Veil, certain elements must be proven:

1. Control by the Shareholders or Directors: The corporation must be under the control or domination of a person or entity who misuses the corporate form.
2. Wrongful Conduct: The controlling person or entity must have engaged in wrongful conduct, fraud, or used the corporate fiction to evade obligations.
3. Injury or Unjust Loss: There must be a causal connection between the wrongful conduct and the injury suffered by the aggrieved party.

5. Case Law on Piercing the Corporate Veil

Several landmark cases illustrate how Philippine courts apply the Doctrine of Piercing the Corporate Veil:

a. Velarde v. Lopez, Inc. (G.R. No. 153886, January 14, 2004)

In this case, the Supreme Court pierced the corporate veil of a corporation to hold the individuals behind it liable for using the corporation to avoid legal obligations. The Court emphasized that the doctrine should only be applied in exceptional cases where the corporate fiction is being used as a vehicle for fraud or to defeat public convenience.

b. Traders Royal Bank v. Court of Appeals (G.R. No. 129552, December 1, 1997)

The Court held that piercing the corporate veil was justified where a corporation was used as a vehicle to evade payment of taxes or to avoid compliance with statutory obligations.

c. Reynoso, Jr. v. Court of Appeals (G.R. No. 116124, March 7, 2000)

Here, the Court pierced the corporate veil to hold the officers of the corporation personally liable for a tort committed by the corporation, finding that the corporate entity was merely a shield for personal wrongdoing.

6. Application in Taxation

In the context of taxation, the Doctrine of Piercing the Corporate Veil is used to prevent tax evasion. The Bureau of Internal Revenue (BIR) and the courts may disregard the corporate personality if the corporation is found to be an instrumentality to avoid paying taxes. For instance, if a corporation is established merely to reduce tax liability without a legitimate business purpose, the BIR may pierce the corporate veil to impose liability directly on the individuals behind the corporation.

7. Exceptions and Limitations

The doctrine is not applied lightly, and courts generally adhere to the principle that a corporation’s legal personality should be respected. The following are limitations to the doctrine:

• It cannot be applied to merely impose greater liability on corporate officers for business losses or legitimate business failure.
• The doctrine is inapplicable where there is no evidence of fraud or improper use of the corporate entity.

Conclusion

The Doctrine of Piercing the Corporate Veil serves as an important tool in Philippine law to ensure that corporations are not misused to perpetrate fraud, evade legal obligations, or frustrate justice. However, it is a remedy of last resort and is applied only in exceptional circumstances when the corporate fiction is abused. Courts use various tests such as the instrumentality or alter-ego test, the fraud test, and the equity test to determine when to pierce the corporate veil.

Doctrine of Separate Juridical Personality | General Principles | Corporations | BUSINESS ORGANIZATIONS

Doctrine of Separate Juridical Personality

The doctrine of separate juridical personality is a foundational principle in corporate law, which states that a corporation has its own legal personality, separate and distinct from its stockholders, members, directors, officers, and other stakeholders. In the Philippines, this principle is recognized under the Revised Corporation Code of the Philippines (Republic Act No. 11232), as well as various judicial decisions interpreting the law. Here, we will explore the nuances of this doctrine, its legal implications, and related concepts.

1. Concept and Legal Basis

The doctrine of separate juridical personality establishes that a corporation is an artificial being created by operation of law. As such, it has rights, duties, and obligations that are independent of the individuals who compose it. Section 2 of the Revised Corporation Code states:

“A corporation is an artificial being created by operation of law, having the right of succession and the powers, attributes, and properties expressly authorized by law or incident to its existence.”

Thus, a corporation enjoys legal personality separate from its incorporators or members. It can:

• Enter into contracts;
• Sue and be sued;
• Own and hold property in its own name;
• Incur liabilities and obligations;
• Engage in business activities within the scope of its corporate powers.

This principle is central to the protection of the shareholders’ interests and helps facilitate the efficient operation of businesses. The corporation itself, not the individuals behind it, is the legal entity responsible for its actions.

2. Consequences of Separate Juridical Personality

The doctrine brings about several legal consequences that distinguish a corporation from other business organizations, such as sole proprietorships or partnerships:

a. Limited Liability

One of the most significant benefits of this doctrine is the concept of limited liability. Since the corporation is a separate legal entity, the liabilities and obligations of the corporation are its own, and the personal assets of its shareholders are generally protected from the corporation's creditors. Shareholders' liability is typically limited to the amount of their unpaid subscriptions to the corporation.

For example, in the case of G.R. No. 191138, Heirs of Angel Juan v. Metropolitan Bank and Trust Co., the Supreme Court upheld the separate personality of a corporation and emphasized that shareholders cannot be held personally liable for the corporate debts, absent compelling circumstances like fraud.

b. Continuity of Existence

A corporation enjoys perpetual succession, meaning that its existence does not depend on the life or continued membership of its shareholders or officers. The death, incapacity, or withdrawal of stockholders does not affect the corporation’s existence. Section 11 of the Revised Corporation Code provides for perpetual existence unless the corporation's articles of incorporation specify a shorter term.

c. Capacity to Sue and Be Sued

A corporation can sue or be sued in its own name. The individuals behind the corporation are not the proper parties to bring or defend an action unless there are valid grounds for piercing the corporate veil.

d. Ownership of Assets

A corporation can own property in its own name. The properties of the corporation belong to the corporation itself and not to its stockholders. Likewise, stockholders have no legal or equitable title to the corporation's properties by virtue of their ownership of shares. The distinction between corporate assets and shareholders’ assets is clearly demarcated.

3. Exceptions: Piercing the Corporate Veil

While the doctrine of separate juridical personality is a fundamental principle, courts may disregard the corporate fiction under certain exceptional circumstances. This is known as piercing the corporate veil, which happens when the corporation is used for fraudulent, illegal, or unjust purposes. The courts will then treat the corporation and its stockholders as one entity, holding the stockholders personally liable for the corporation's obligations.

The Supreme Court has laid down several instances when the corporate veil may be pierced, including:

1. When the corporation is used to evade obligations – If a corporation is used as a mere instrumentality or alter ego of a dominant stockholder or parent company to commit fraud, courts may hold the shareholders personally liable.

2. When the corporation is used for fraudulent purposes – This involves instances where the corporation is formed or used to deceive creditors, evade taxes, or perpetrate fraud.

3. When the corporation is merely a conduit or dummy – In cases where the corporation is a mere front, sham, or cloak to shield the individuals behind it from liabilities, courts may pierce the veil.

Relevant Case: Kukan International Corporation v. Reyes (G.R. No. 182729)

In this case, the Supreme Court pierced the corporate veil because the corporation was used to commit fraud, leading to personal liability for the individuals who controlled the corporation. The Court emphasized that the separate personality of the corporation cannot be used as a tool to justify wrongdoings or perpetrate injustice.

4. Implications in Taxation

The separate juridical personality of a corporation has significant implications in taxation. A corporation is considered a separate taxable entity, distinct from its shareholders or owners. It is subject to various taxes, including:

• Corporate Income Tax: The corporation’s income is taxed at the corporate level.
• Value-Added Tax (VAT): If the corporation engages in the sale of goods or services, it may be liable for VAT.
• Other Taxes: Depending on the corporation’s activities, it may be liable for other taxes such as excise taxes, documentary stamp taxes, etc.

Under the doctrine, the corporation files its own tax returns and pays taxes on its income. The profits distributed to shareholders in the form of dividends are taxed again at the shareholder level, resulting in double taxation. This is a common feature of corporate taxation, although it is generally accepted as a consequence of the separate juridical personality of the corporation.

5. Corporate Acts and Corporate Officers

The doctrine also means that acts performed by the corporation are distinct from the acts of its officers. Corporate officers generally do not incur personal liability for acts performed within the scope of their duties for the corporation. However, personal liability may attach to corporate officers in cases of:

• Gross negligence;
• Fraud;
• Misrepresentation;
• Criminal acts; or
• Clear evidence of malice in corporate decisions.

Relevant Case: Francisco v. Mejia (G.R. No. 196253)

In this case, the Supreme Court clarified that officers who act within the scope of their authority cannot be held personally liable for the debts and obligations of the corporation, unless they act in bad faith or with gross negligence.

6. Doctrine of Separate Personality in Family-Owned Corporations

The principle of separate juridical personality also applies to family-owned or closely-held corporations. Even in cases where all the stockholders are members of a single family, the corporation maintains a distinct and separate personality from its shareholders. However, because control is often concentrated in a few hands in such corporations, the doctrine of piercing the corporate veil is more likely to be invoked when the corporation is used to defeat public convenience or perpetrate injustice.

Conclusion

The doctrine of separate juridical personality is a cornerstone of corporate law in the Philippines, ensuring that corporations are treated as independent entities with their own rights and responsibilities. This principle allows for the protection of shareholders from corporate liabilities and the efficient functioning of the corporate structure. However, courts will not hesitate to pierce the corporate veil when the corporate form is abused for improper purposes such as fraud, illegal acts, or to evade obligations. The doctrine’s application is essential for understanding both the legal and economic ramifications of corporate existence, particularly in matters of liability and taxation.

Grandfather Rule | Nationality of Corporations | General Principles | Corporations | BUSINESS ORGANIZATIONS

Nationality of Corporations: The Grandfather Rule

In the context of Philippine corporate law, determining the nationality of a corporation is critical in situations where the law imposes restrictions on foreign ownership, such as in land ownership, natural resources, public utilities, and certain industries like mass media and advertising. The Grandfather Rule is one of the methods used to determine the "true" nationality of a corporation, particularly in cases where ownership structures are complex and involve multiple layers of corporate entities.

I. Relevant Legal Provisions

1. 1987 Philippine Constitution

   • The Constitution provides specific limitations on foreign ownership in certain areas, such as:
     • Land ownership: Only Filipino citizens or corporations with at least 60% Filipino ownership may own land (Art. XII, Sec. 7).
     • Operation of public utilities: Only corporations that are at least 60% Filipino-owned may operate public utilities (Art. XII, Sec. 11).
     • Exploration, development, and utilization of natural resources: Limited to Filipino citizens or corporations with at least 60% Filipino equity (Art. XII, Sec. 2).

2. Foreign Investments Act of 1991 (RA 7042, as amended by RA 8179)

   • This law reiterates the restrictions on foreign ownership of certain industries and provides guidelines for determining corporate nationality.

3. Implementing Rules and Regulations (IRR) of the Foreign Investments Act

   • The IRR provides further details on how the nationality of a corporation should be determined, particularly through the application of the Control Test and the Grandfather Rule.

II. Control Test vs. Grandfather Rule

1. Control Test (Primary Rule)

   • Under the Control Test, a corporation is considered a Filipino corporation if at least 60% of its outstanding capital stock is owned by Filipino citizens. This is a straightforward test of equity ownership, and it is generally the rule used in most cases.

2. Grandfather Rule (Supplementary Test)

   • The Grandfather Rule is a more nuanced and detailed method of determining the true nationality of a corporation, especially in cases where ownership involves multiple layers of corporations, some of which may have foreign shareholders.
   • The rule "looks through" the corporate structure to determine the nationality of stockholders in each layer of ownership, ultimately determining how much of the corporation is truly Filipino-owned.

III. When is the Grandfather Rule Applied?

The Grandfather Rule is typically applied in the following cases:

1. Where the 60-40 ownership split is met only nominally but the control of the corporation appears to be in the hands of foreign interests. This is often referred to as the "doubtful" or "circumventive" ownership situation.
2. When a corporation’s capital is divided among several tiers of corporate entities, some of which are foreign, making the application of the straightforward Control Test insufficient or misleading.

IV. Mechanics of the Grandfather Rule

1. Tracing Ownership

   • The Grandfather Rule works by tracing the ownership of each shareholder to determine the ultimate ownership of the corporation.
   • In cases where a corporation (Corporation A) owns shares in another corporation (Corporation B), the Grandfather Rule looks at the shareholders of Corporation A to determine the true ownership of the shares held by Corporation A in Corporation B.

   Example:

   • Corporation A owns 60% of Corporation B, and Corporation A has a Filipino shareholder owning 50% of its stock and a foreign shareholder owning the remaining 50%.
   • Under the Grandfather Rule, only 30% of Corporation B would be considered Filipino-owned (i.e., 60% * 50% = 30%).

2. Layered Ownership

   • If there are multiple layers of ownership, the Grandfather Rule is applied recursively, meaning that each layer of ownership is examined until the nationality of the ultimate beneficial owners is ascertained.
   • This tracing ensures that the constitutional or statutory ownership requirements are not circumvented by layering corporations to conceal foreign control.

V. Jurisprudence on the Grandfather Rule

1. SEC Opinions and Rulings

   • The Securities and Exchange Commission (SEC) has issued several opinions clarifying the application of the Grandfather Rule.
   • In some cases, the SEC applies the Grandfather Rule directly, while in others, it has opted for the Control Test as the default rule, reserving the Grandfather Rule for situations where foreign control is suspected.

2. Land Bank of the Philippines v. CA (G.R. No. 127181, October 6, 2000)

   • In this case, the Supreme Court ruled that when determining corporate nationality, the Control Test should be the primary method, and the Grandfather Rule should be applied only as a supplementary rule.
   • The Court emphasized that the Grandfather Rule should be used when there is a need to "pierce the veil of corporate fiction" to reveal the true nationality of the controlling stockholders.

3. SEC Opinions on Tiered Ownership

   • In SEC rulings where multi-tiered corporate ownership is present, the Grandfather Rule has been applied to prevent foreigners from indirectly gaining control over corporations that are constitutionally reserved for Filipino citizens or corporations.

VI. Application of the Grandfather Rule: Key Considerations

1. Purpose of the Grandfather Rule

   • The Grandfather Rule is used to prevent foreign nationals from circumventing the Constitution and other laws restricting foreign ownership in certain industries. It ensures that ownership and control rest truly with Filipino citizens, even if the corporate structure appears to comply nominally with the 60-40 rule.

2. Interpretation by Regulatory Bodies

   • The application of the Grandfather Rule depends largely on the discretion of regulatory bodies like the SEC. If there is a reasonable suspicion that the foreign equity exceeds the allowable limit, the SEC may invoke the Grandfather Rule to determine the actual ownership.

3. Incorporation of the Grandfather Rule in the SEC Rules

   • The SEC has adopted the Grandfather Rule in cases where the Control Test alone may lead to an incorrect determination of nationality, particularly in the context of land ownership, public utilities, and other areas with strict foreign ownership limits.

VII. Conclusion

The Grandfather Rule serves as an important safeguard in determining the nationality of corporations in the Philippines, particularly in areas where the Constitution and laws restrict foreign ownership. While the Control Test is the primary method for determining corporate nationality, the Grandfather Rule acts as a supplementary rule, ensuring that ownership and control truly reflect the intent of the law. The rule prevents foreign nationals from using layered corporate structures to circumvent restrictions on foreign participation in key industries, thereby protecting the interests of Filipino citizens and upholding the country's constitutional mandates.

The Grandfather Rule's application requires careful scrutiny of corporate structures and ownership, and regulatory bodies such as the SEC are entrusted with the task of applying the rule when necessary to ensure compliance with the law.

Control Test | Nationality of Corporations | General Principles | Corporations | BUSINESS ORGANIZATIONS

Nationality of Corporations: Control Test

1. Constitutional and Statutory Framework

The nationality of corporations is a critical concept in Philippine law, particularly due to the constitutional and statutory restrictions on the ownership and operation of certain businesses and properties by foreign entities. The Constitution of the Philippines limits foreign participation in various sectors such as land ownership, natural resources, public utilities, educational institutions, and mass media.

Constitutional Provisions:

• Article XII, Section 2 of the 1987 Philippine Constitution provides that the exploration, development, and utilization of natural resources shall be under the full control and supervision of the State and that foreign ownership should not exceed 40%.
• Article XII, Section 11 states that no franchise, certificate, or authorization for the operation of a public utility shall be granted except to citizens of the Philippines or corporations where at least 60% of the capital is owned by Filipino citizens.

The statutory provisions on nationality requirements can be found in various laws like the Foreign Investments Act (RA 7042) and Republic Act No. 8179 amending the Foreign Investments Act, which specifies that businesses wholly or partially owned by foreign entities are restricted from engaging in activities that fall under the Philippine Constitution’s Foreign Investment Negative List (FINL).

2. The "Control Test" – Doctrine Overview

In determining the nationality of a corporation for purposes of compliance with the Constitution and other laws restricting foreign ownership, Philippine jurisprudence has adopted the Control Test (also referred to as the "Grandfather Rule" when used in certain contexts).

Under the Control Test, the nationality of a corporation is determined by the nationality of the stockholders who control the corporation. The test emphasizes the actual control of the corporation, and not merely the formal legal structure. The basic tenet of this rule is that the corporation's citizenship is aligned with that of the controlling shareholders.

The Supreme Court of the Philippines, in several cases, has expounded upon this principle, emphasizing that it is the actual control that should dictate whether the corporation is Filipino or foreign.

Landmark Case: Narra Nickel Mining v. Redmont Consolidated Mines (G.R. No. 195580, April 21, 2014)

One of the key cases that reinforced the application of the Control Test is Narra Nickel Mining and Development Corp. v. Redmont Consolidated Mines Corp. This case involved a dispute over the nationality of a mining corporation engaged in the extraction of natural resources, an activity reserved exclusively for Filipino citizens or corporations that are at least 60% Filipino-owned.

In this case, the Supreme Court ruled that the Control Test takes precedence over the Grandfather Rule in determining the nationality of a corporation. The Court rejected the argument that foreign shareholders holding minority ownership could exercise control through indirect means. Instead, it emphasized that control refers to both the ownership and management of the corporation.

The Control Test looks at the corporate governance structure, including the composition of the board of directors and the officers of the corporation. Even if a corporation is formally compliant with the 60-40 rule on the face of stock ownership, it can still be deemed foreign if it can be shown that foreign nationals exercise control over the corporation through voting power or influence over decision-making processes.

3. The Grandfather Rule vs. Control Test

While the Control Test is the prevailing doctrine, there are instances when the Grandfather Rule (or the "piercing the veil of corporate fiction" rule) is invoked to supplement or further clarify the nationality determination.

Grandfather Rule Defined

The Grandfather Rule involves tracing the nationality of shareholders through layers of ownership. If a Filipino-owned corporation is in turn owned by another corporation, which has foreign shareholders, the rule requires looking beyond the nominal ownership to the underlying layers to determine whether the foreign shareholders ultimately control the company.

For example, a corporation may appear to be 60% Filipino-owned, but the Grandfather Rule would trace the ownership of the 60% Filipino shareholders. If these Filipino shareholders are found to be mere dummies for foreign nationals, the corporation will be treated as foreign.

Control Test vs. Grandfather Rule in Practice

• The Control Test is generally the preferred method in determining the nationality of a corporation. It simplifies the determination by focusing on effective control at the operational level, which is often evidenced by who controls the corporate board and decision-making power.
• The Grandfather Rule is invoked when there is suspicion that the formal application of the Control Test is being circumvented through layers of corporate ownership to mask the true identity of the shareholders or ultimate control.

The Supreme Court has clarified that the Grandfather Rule is not automatically applied but is instead used to pierce the veil of corporate fiction when there is sufficient evidence of corporate structuring meant to evade nationality restrictions.

4. Key Considerations in Applying the Control Test

When determining control, the following factors are generally considered:

• Ownership of voting shares: A simple majority of 60% of the capital stock is owned by Filipino citizens.
• Management and decision-making: The composition of the board of directors and corporate officers (president, treasurer, etc.) must be predominantly Filipino to align with the ownership structure.
• Corporate control and influence: Even if 60% of the capital stock is Filipino-owned, foreign nationals cannot exercise controlling influence over the corporation's policies and operations.

5. Practical Implications for Corporations

Corporations that engage in activities subject to nationality restrictions must ensure that they comply with the Control Test and constitutional requirements. This involves:

• Structuring ownership to ensure compliance with the 60-40 rule.
• Ensuring that control at the level of the board of directors and key officers is exercised by Filipinos.
• Being prepared for potential challenges invoking the Grandfather Rule if foreign nationals are suspected of circumventing nationality restrictions through complex ownership structures.

6. Conclusion

The Control Test is the dominant method for determining the nationality of a corporation under Philippine law. It emphasizes actual control over nominal ownership and is used to ensure compliance with constitutional restrictions on foreign participation in certain sectors. While the Grandfather Rule can be applied to supplement this test, its application is more limited and is generally invoked only when there is suspicion of evasion of the nationality restrictions. Corporations must carefully structure both ownership and management to align with the requirements and avoid potential legal issues.

Nationality of Corporations | General Principles | Corporations | BUSINESS ORGANIZATIONS

Nationality of Corporations: General Principles Under Philippine Law

The nationality of a corporation is a significant legal consideration in the Philippines, particularly because of the various constitutional and statutory restrictions on foreign ownership and participation in specific sectors of the economy. Determining whether a corporation is considered "Filipino" or "foreign" is critical for compliance with the Philippine Constitution, the Foreign Investments Act (FIA), and other regulatory laws. Below is an in-depth and meticulous explanation of the relevant principles surrounding the nationality of corporations in the Philippines.

I. Constitutional and Statutory Framework

1. Constitutional Restrictions on Foreign Ownership The 1987 Philippine Constitution limits foreign ownership in certain areas of investment. Among the most significant provisions are:

   • Public Utilities: Article XII, Section 11 of the Constitution limits foreign equity participation in public utilities to a maximum of 40%, meaning that at least 60% of the capital must be owned by Filipino citizens or Filipino corporations.
   • Natural Resources: Under Article XII, Section 2 of the Constitution, foreign ownership in corporations engaged in the exploration, development, and utilization of natural resources is limited to 40%.
   • Media: Article XVI, Section 11 mandates that ownership and management of mass media be wholly owned by Filipino citizens or Filipino-controlled corporations (100% Filipino ownership).
   • Land Ownership: Only Filipino citizens or corporations at least 60% owned by Filipinos may own private land in the Philippines (Article XII, Section 7).

2. Foreign Investments Act of 1991 (RA 7042 as amended by RA 8179) The Foreign Investments Act (FIA) defines restrictions on foreign equity in certain sectors through the Foreign Investment Negative List (FINL). Certain industries are restricted to full Filipino ownership, while others are subject to a maximum foreign equity cap (usually 40%).

II. Control Test and Grandfather Rule

The nationality of a corporation in the Philippines is generally determined by the application of two primary legal doctrines: the Control Test and the Grandfather Rule.

1. Control Test The Control Test is the primary rule used to determine the nationality of a corporation. This test evaluates the ownership of shares with voting rights and control over the corporation. If at least 60% of the outstanding capital stock entitled to vote is owned by Filipino citizens or Filipino-controlled corporations, the corporation is considered a Filipino corporation.

   • Example: If Corporation A has a total of 100 shares, 60 of which are owned by Filipino citizens, the corporation is considered Filipino, regardless of the foreign ownership of the remaining 40 shares.

   The Control Test is favored because it promotes simplicity in determining corporate nationality, focusing on the controlling interest in the corporation. The test was affirmed by the Philippine Supreme Court in the landmark case Narvacan v. Court of Appeals (G.R. No. 93605, May 18, 1993), where the Court emphasized the importance of "beneficial control" rather than just the formal ownership of shares.

2. Grandfather Rule The Grandfather Rule is an alternative method used when there is a need to look beyond the superficial ownership of shares. This rule traces the ultimate ownership of shares to the individual level to determine whether foreign interests hold actual control over a corporation. It is applied where there is a "doubt" about the real nationality of a corporation, especially when there are layers of corporate ownership involved.

   • Mechanics: The Grandfather Rule operates by "piercing the veil" of corporate structures and examining the actual beneficial ownership of shares. If a corporation's shareholders include other corporations, and those corporations are partly foreign-owned, the foreign ownership of these corporations is traced to the individual stockholders to determine the actual foreign interest.

   • Example: If a Filipino corporation (Corp B) owns 60% of another corporation (Corp C), but Corp B is 50% foreign-owned, the Grandfather Rule traces Corp B's foreign equity to Corp C. Corp C would be considered only 30% Filipino-owned (60% × 50%), which would disqualify it from being considered a Filipino corporation if the Grandfather Rule were applied.

3. Supreme Court Jurisprudence on the Control Test and Grandfather Rule The leading case that clarifies the relationship between the Control Test and the Grandfather Rule is Gamboa v. Teves (G.R. No. 176579, October 9, 2012). In this case, the Supreme Court ruled that the Control Test should be the primary standard for determining the nationality of a corporation. However, when there is doubt about the true nationality or when ownership is diluted through layers of intermediate corporate ownership, the Grandfather Rule may be applied.

   The Supreme Court further explained that for corporations engaged in constitutionally restricted activities (e.g., utilities), the 60-40 Filipino-foreign equity structure must reflect "full beneficial ownership and control" by Filipinos. Merely holding shares nominally in favor of foreigners would not satisfy the requirements of the Constitution.

III. Layered Corporate Ownership and the Application of Nationality Tests

The complexity of corporate structures often necessitates a careful application of both the Control Test and the Grandfather Rule. The application becomes particularly intricate in situations where corporations own shares in other corporations, creating layers of ownership.

• First Layer of Ownership: The Control Test is first applied to assess whether at least 60% of the outstanding voting shares in the first corporation are owned by Filipino citizens or Filipino-controlled corporations.
• Second Layer of Ownership: When a corporation is owned by another corporation, the Grandfather Rule may be triggered to determine the true beneficial ownership. The rule traces through layers of ownership to ensure that the Filipino majority requirement is not undermined through complex corporate structuring or nominal ownership.

IV. Special Cases and Considerations

1. Dummy Corporations The use of "dummy corporations" to evade nationality restrictions is prohibited under Philippine law. Dummy arrangements involve Filipino citizens nominally holding shares for the benefit of foreign investors. Such arrangements may be voided, and parties involved may be subject to penalties under the Anti-Dummy Law (Commonwealth Act No. 108, as amended). Violations may result in imprisonment, fines, or the cancellation of licenses to operate.

2. Preferential Rights for Filipino Corporations Filipino corporations often enjoy preferential rights in sectors like public utilities, mining, and agriculture. For example, Filipino-owned corporations may participate in contracts with the government for the development of natural resources under the Mining Act of 1995 (RA 7942) or the Build-Operate-Transfer Law (RA 6957).

3. Foreign Corporations and Licensing Foreign corporations wishing to do business in the Philippines must obtain a license from the Securities and Exchange Commission (SEC). These corporations are generally prohibited from engaging in activities reserved for Filipino-owned corporations unless they comply with applicable foreign ownership limits.

V. Role of the Securities and Exchange Commission (SEC)

The Securities and Exchange Commission (SEC) plays a crucial role in determining corporate nationality. When corporations register with the SEC, they are required to disclose the ownership of shares to verify compliance with the nationality restrictions under the Constitution and applicable laws. The SEC may conduct investigations and audits of corporate records to ensure the proper application of the Control Test and Grandfather Rule.

In 2013, following the Gamboa ruling, the SEC issued Memorandum Circular No. 8, Series of 2013, which provides the guidelines for determining the nationality of corporations. The Circular codifies the procedures for applying the Control Test and, where necessary, the Grandfather Rule, especially for corporations engaged in constitutionally restricted industries.

VI. Conclusion

The nationality of a corporation in the Philippines is a vital consideration in ensuring compliance with constitutional and statutory limits on foreign ownership. The Control Test is the primary method used to determine nationality, focusing on ownership of voting shares. However, the Grandfather Rule may be applied in cases of doubt, particularly in complex corporate structures, to trace the actual beneficial ownership and control by foreign investors. Both rules are critical in safeguarding the constitutional mandate of promoting Filipino participation in strategic industries and ensuring that national assets remain under the control of Filipinos.

The consistent interpretation and enforcement of these principles by the Philippine Supreme Court and the Securities and Exchange Commission ensure the effective regulation of corporate ownership in the country.

Nature and Attributes | General Principles | Corporations | BUSINESS ORGANIZATIONS

I. Business Organizations: Corporations

A. Corporations

1. General Principles

a. Nature and Attributes of Corporations

In Philippine law, corporations are primarily governed by Republic Act No. 11232 or the Revised Corporation Code of the Philippines. Understanding the nature and attributes of corporations involves analyzing their key characteristics, which distinguish them from other business entities, such as partnerships or sole proprietorships.

1. Definition and Legal Personality

A corporation is an artificial being created by operation of law, having the right of succession and the powers, attributes, and properties expressly authorized by law or incident to its existence. This definition is derived from Section 2 of the Revised Corporation Code. As an artificial person, a corporation enjoys several rights and obligations akin to those of a natural person, though it only exists in contemplation of law and through the act of incorporation.

The key concept here is that a corporation is a legal entity separate and distinct from its shareholders, directors, and officers. This principle of separate legal personality allows the corporation to:

• Own property in its own name;
• Enter into contracts;
• Sue and be sued;
• Borrow and lend money;
• Pay taxes independently from its shareholders.

2. Limited Liability

One of the most important features of a corporation is limited liability. Under this principle, the liability of the shareholders is limited only to the extent of their capital contribution. They are generally not personally liable for the obligations and debts of the corporation. This protects personal assets from being seized to satisfy corporate debts, which is a key advantage of doing business in corporate form.

Exceptions to limited liability, however, exist under the doctrine of piercing the corporate veil. If the corporation is used for fraud, to defeat public convenience, or is merely an alter ego of its owners, the courts may disregard the separate personality of the corporation and hold its shareholders or directors personally liable.

3. Right of Succession

A corporation has perpetual existence, unless otherwise provided in its articles of incorporation or unless dissolved by law. This means that the corporation's existence is not affected by the death, incapacity, or withdrawal of any of its shareholders or directors. This attribute gives stability and continuity to the corporate entity, making it an attractive business vehicle.

With the enactment of the Revised Corporation Code, corporations are no longer limited to a 50-year term. Unless a specific term is stipulated in the articles of incorporation, corporations now enjoy perpetual existence by default.

4. Centralized Management

A corporation’s business and affairs are generally managed by a Board of Directors (or Trustees, in the case of non-stock corporations), which is elected by the shareholders. The Board has the duty to set the overall direction of the corporation and to make policy decisions.

The centralized nature of corporate management means that the shareholders do not directly manage the day-to-day operations of the corporation. Instead, they exercise control by voting for the Board of Directors during annual meetings. This separation of ownership and management is one of the defining characteristics of a corporation.

5. Transferability of Shares

Ownership in a corporation is represented by shares of stock. A key feature of shares in a corporation is their transferability. Shares can generally be sold or transferred without affecting the existence or operations of the corporation. The Revised Corporation Code, however, allows corporations to impose reasonable restrictions on share transfers, which may be stipulated in the bylaws or stockholders' agreements.

The ease of transferability of shares increases liquidity and makes the corporation an attractive option for investors. Stockholders are free to sell their shares without needing the consent of the other shareholders or the corporation, subject to applicable laws and regulations.

6. Capacity to Act and Enter into Contracts

A corporation, as a juridical entity, has the power to:

• Enter into contracts and obligations;
• Borrow or lend money;
• Issue bonds, debentures, and other securities;
• Purchase or hold real and personal property in its own name;
• Sell or otherwise dispose of property.

These powers must be exercised in accordance with the corporation’s purpose as stated in its articles of incorporation. Any act outside the corporation’s stated purpose is considered ultra vires, meaning it is beyond the powers of the corporation, and such acts may be void or unenforceable.

The Board of Directors exercises these powers, and acts within the scope of its authority to bind the corporation in transactions with third parties.

7. Capital Structure

The capital structure of a corporation consists of its authorized capital stock, subscribed capital, and paid-up capital:

• Authorized capital stock is the maximum amount of shares that a corporation is authorized to issue, as stated in its articles of incorporation.
• Subscribed capital refers to the portion of the authorized capital stock that investors or shareholders have agreed to buy.
• Paid-up capital is the actual amount that has been paid by the shareholders towards their subscriptions.

The corporation must follow strict formalities when raising capital and issuing shares, in compliance with both the Revised Corporation Code and the Securities Regulation Code, particularly for publicly-listed companies.

8. Doctrine of Corporate Opportunity

The doctrine of corporate opportunity provides that directors and officers must not take for themselves business opportunities that should belong to the corporation. They are under a fiduciary duty to act in the best interest of the corporation, and any breach of this duty may result in personal liability.

If a director or officer diverts a business opportunity that should have belonged to the corporation for personal gain, the corporation can recover the profits from the director, or it may compel the director to account for any benefit derived.

9. Corporate Powers

Under Section 35 of the Revised Corporation Code, a corporation has certain express powers, including:

• To sue and be sued in its corporate name;
• To adopt and use a corporate seal;
• To amend its articles of incorporation;
• To adopt bylaws and amend them;
• To make donations for public welfare or charitable purposes;
• To establish pension, retirement, and other employee benefit plans;
• To exercise powers conferred by law or necessary for carrying out its purposes.

10. Doctrine of Separate Juridical Personality

The doctrine of separate juridical personality allows the corporation to maintain its own identity separate from that of its shareholders. This separation means that the corporation can sue or be sued in its own name, own assets in its own right, and bear responsibility for its own liabilities. The shareholders are insulated from the direct consequences of corporate activities.

The piercing of the corporate veil, as mentioned earlier, is an exception to this doctrine, applied in cases where the corporation is being used to evade legal obligations, commit fraud, or to act as an alter ego of the shareholders.

Conclusion

Corporations under Philippine law are powerful business vehicles, endowed with attributes such as separate legal personality, limited liability, right of succession, and centralized management. The Revised Corporation Code of the Philippines has modernized corporate governance practices, enabling corporations to enjoy perpetual existence, have flexible capital structures, and encourage more inclusive business practices. At the same time, corporate officers and directors are held to high fiduciary standards, and the doctrine of piercing the corporate veil ensures that the corporate form is not abused for illegitimate purposes.

General Principles | Corporations | BUSINESS ORGANIZATIONS

MERCANTILE AND TAXATION LAWS

I. BUSINESS ORGANIZATIONS

A. Corporations

1. General Principles

A corporation is a juridical entity created by operation of law, endowed with a legal personality separate and distinct from its stockholders or members. In the Philippines, the main body of law governing corporations is the Revised Corporation Code of the Philippines (RCC), or Republic Act No. 11232, which was enacted in 2019 to update and replace the previous Corporation Code (Batas Pambansa Blg. 68). The RCC contains comprehensive provisions outlining the rights, powers, and obligations of corporations, their stockholders, directors, and officers.

The general principles of corporate law in the Philippines can be summarized as follows:

1. Separate Legal Personality

A corporation possesses a legal personality distinct from its stockholders, directors, or members. This principle allows the corporation to:

• Own property in its name.
• Sue and be sued as a separate entity.
• Incur liabilities and obligations independently from its shareholders.

This principle was affirmed in the case of Salomon v. Salomon & Co., Ltd., which laid the foundation for the doctrine of the separate corporate personality. This also means that the liabilities of the corporation are generally limited to its assets, and creditors cannot pursue personal assets of shareholders to satisfy corporate debts (the principle of limited liability).

2. Limited Liability

One of the core principles of corporations is the limited liability of stockholders. Stockholders are only liable to the extent of their subscribed shares. This protection is one of the key reasons for the popularity of corporations as a form of business organization. However, this principle is not absolute. In certain situations, courts may disregard the separate personality of a corporation and hold the stockholders or officers personally liable for corporate obligations under the doctrine of piercing the corporate veil. Instances when this can happen include:

• Fraud
• Evasion of obligations
• Abuse of the corporate form
• Alter ego theory (when the corporation is used as a mere instrumentality or alter ego of the controlling shareholder).

Case law: In Yamashita v. Danesen, the Supreme Court clarified that the corporate veil may be pierced only in exceptional circumstances.

3. Perpetual Succession

Under the RCC, corporations now enjoy perpetual existence by default unless the articles of incorporation provide otherwise. Previously, corporations were granted a maximum term of 50 years, renewable for successive periods.

This principle allows the corporation to continue existing beyond the lives of its shareholders or members, ensuring the longevity of business ventures and legal certainty in terms of succession.

4. Transferability of Shares

The shares of a corporation represent ownership interest and are freely transferable, subject to any restrictions imposed by law or the corporation’s articles of incorporation and bylaws. Transferability of shares enhances liquidity and makes investment in corporations more attractive. In closely held or family corporations, however, restrictions on the transfer of shares are common, such as right of first refusal provisions.

5. Centralized Management

Management of the corporation is vested in a board of directors or trustees. The board acts as the governing body and is responsible for policymaking and overseeing the overall operations of the corporation. The directors or trustees are elected by the stockholders or members.

• Directors (for stock corporations): Elected by stockholders, they must own at least one share of stock.
• Trustees (for non-stock corporations): Elected by members.

Directors and trustees must act in good faith and in the best interest of the corporation. Breach of their fiduciary duties, such as the duty of loyalty, duty of diligence, or conflict of interest rules, can result in personal liability.

6. Corporate Powers

A corporation has the powers and authority to conduct activities in line with its primary purpose as stated in the articles of incorporation. The general corporate powers include:

• The power to sue and be sued.
• The power to own, purchase, and sell real and personal property.
• The power to enter into contracts.
• The power to borrow money.
• The power to make bylaws.

The Revised Corporation Code has expanded these powers and now includes provisions for corporate social responsibility (CSR), which explicitly allows corporations to invest in activities for the benefit of society.

7. Capital Structure

The capital structure of a corporation is divided into:

• Authorized capital stock: The maximum number of shares the corporation is allowed to issue as provided in its articles of incorporation.
• Subscribed capital: The amount of capital that stockholders have agreed to take up and pay for.
• Paid-up capital: The portion of the subscribed capital that has been paid by the stockholders.

Corporate shares may be issued with or without par value, and certain shares may have specific rights and privileges, such as preferred shares.

8. Corporate Governance

Corporate governance refers to the framework of rules and practices by which the board of directors ensures accountability, fairness, and transparency in the corporation's relationship with its shareholders, management, and other stakeholders.

The Securities and Exchange Commission (SEC) requires corporations to comply with governance standards to protect minority shareholders, enhance board diversity, and promote long-term sustainability.

The Revised Corporation Code emphasizes:

• Minority protection through cumulative voting and other mechanisms.
• Board diversity to include independent directors.
• Enhanced provisions on corporate social responsibility.

9. Corporate Dissolution and Liquidation

Dissolution of a corporation may be voluntary or involuntary:

• Voluntary dissolution occurs through a resolution passed by a majority of the board and approved by two-thirds of the stockholders.
• Involuntary dissolution may be initiated by the SEC for reasons such as expiration of the corporate term (if not perpetual), failure to comply with statutory requirements, or insolvency.

Upon dissolution, the corporation enters the process of liquidation, wherein its assets are converted into cash to pay its creditors and the remaining balance distributed to the stockholders.

10. Taxation of Corporations

Corporations are subject to the following taxes under the Tax Code (National Internal Revenue Code of 1997, as amended):

• Corporate Income Tax: Domestic corporations are taxed on their worldwide income, while foreign corporations are taxed only on income derived from Philippine sources. The current corporate income tax rate under the CREATE Law (Republic Act No. 11534) is 25% for large corporations and 20% for small and medium enterprises (SMEs).
• Minimum Corporate Income Tax (MCIT): Imposed on corporations if their income tax due is lower than 2% of gross income, effective starting the fourth taxable year of operation.
• Withholding Tax: Corporations are required to withhold taxes on certain payments to individuals and businesses.
• Percentage Tax: Certain non-VAT-registered corporations are subject to percentage taxes.
• Documentary Stamp Tax (DST): Corporations are liable for DST on certain transactions, such as issuance of shares.

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Conclusion

Corporations in the Philippines are governed by the Revised Corporation Code, which lays down the principles of separate legal personality, limited liability, centralized management, and other essential aspects of corporate law. Corporate governance is also enhanced through stricter rules on board composition and minority shareholder protection. Corporate taxation remains a vital part of corporate responsibilities, with various taxes applicable to domestic and foreign corporations. Understanding these general principles is critical for establishing, operating, and managing corporations in the Philippines.

Corporations | BUSINESS ORGANIZATIONS

MERCANTILE AND TAXATION LAWS: BUSINESS ORGANIZATIONS – CORPORATIONS

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I. Overview of Corporations

A corporation is an artificial being created by operation of law, having the right of succession and the powers, attributes, and properties expressly authorized by law or incident to its existence. In the Philippines, corporations are governed by Republic Act No. 11232, known as the Revised Corporation Code of the Philippines, which took effect in 2019, amending Batas Pambansa Blg. 68 (Corporation Code of 1980). The law regulates the formation, operation, and dissolution of corporations, providing clear rules on corporate governance, shareholder rights, and corporate responsibilities.

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II. Nature and Characteristics of a Corporation

1. Artificial Being: A corporation exists independently of its members or shareholders. It is a legal entity separate from the people who compose it.

2. Created by Operation of Law: A corporation comes into existence only by compliance with the statutory requirements under the Revised Corporation Code, unlike partnerships or sole proprietorships that may be formed through contracts or agreements among parties.

3. Right of Succession: A corporation has perpetual existence unless its Articles of Incorporation provide otherwise. The death, incapacity, insolvency, or withdrawal of shareholders does not affect the continuity of the corporation’s legal existence.

4. Powers, Attributes, and Properties: A corporation has the powers conferred upon it by law or its articles of incorporation. These include the power to sue and be sued, acquire properties, enter into contracts, and carry out the purposes for which it was incorporated.

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III. Types of Corporations

1. Stock Corporations: These are corporations with capital stock divided into shares and authorized to distribute dividends to its shareholders. Stock corporations are profit-oriented and are required to issue stocks representing ownership.

2. Non-Stock Corporations: These corporations do not issue shares of stock and are organized primarily for purposes other than profit (e.g., charitable, educational, cultural, or similar purposes). Non-stock corporations return no portion of their income to members as dividends but use their income for the promotion of the corporation’s purposes.

3. Close Corporations: A close corporation is one whose ownership is restricted to a small group of people, usually family members or close associates. Shares cannot be transferred without first offering them to existing shareholders. Close corporations are exempt from certain formalities, such as the holding of an annual stockholders’ meeting.

4. One Person Corporations (OPCs): Under the Revised Corporation Code, the Philippines now allows One Person Corporations (OPC), which is a corporation with a single stockholder, typically an individual or a trust. This structure offers the benefits of limited liability without requiring multiple shareholders.

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IV. Incorporation Process

1. Articles of Incorporation: To incorporate, the incorporators must submit Articles of Incorporation to the Securities and Exchange Commission (SEC). The articles must contain:

   • Name of the corporation.
   • Purpose(s) for which the corporation is being formed.
   • Principal place of business.
   • Term of existence (either perpetual or fixed).
   • Number of directors (at least 2 but not more than 15 for stock corporations).
   • Names, nationalities, and addresses of the incorporators.
   • Authorized capital stock, number of shares, and par value (if any).

2. By-laws: After the incorporation, the corporation must adopt a set of by-laws that govern the internal management of the corporation, such as the schedule of meetings, roles of officers, quorum requirements, etc.

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V. Corporate Governance

1. Board of Directors: The corporate powers of a stock corporation are exercised by a Board of Directors. The directors must be shareholders and are elected by the stockholders. The Revised Corporation Code introduced reforms in corporate governance, such as the establishment of an Independent Director for certain corporations (e.g., publicly listed corporations).

2. Officers: Officers of the corporation, such as the president, treasurer, and corporate secretary, are appointed by the Board. The president must be a director, while the treasurer must be a shareholder.

3. Meetings:

   • Stockholders’ Meetings: Annual meetings must be held to elect directors and discuss corporate affairs. Stockholders may attend meetings in person or via remote communication.
   • Board Meetings: Directors hold regular or special meetings to make decisions on behalf of the corporation.

4. Corporate Books: Corporations are required to maintain certain books, such as the stock and transfer book and minutes book, recording essential corporate actions and resolutions.

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VI. Shareholders’ Rights

1. Right to Vote: Shareholders have the right to vote on corporate matters, primarily in the election of directors and major corporate decisions such as mergers, consolidations, and amendments to the Articles of Incorporation.

2. Right to Dividends: Stockholders are entitled to dividends when declared by the Board, subject to certain conditions, such as the availability of unrestricted retained earnings.

3. Pre-emptive Right: Existing stockholders have the right to purchase newly issued shares to maintain their proportional ownership in the corporation, unless waived in the Articles of Incorporation.

4. Right to Inspect Corporate Books: Shareholders may demand to inspect the corporation’s books and records at reasonable times, provided that the request is made in good faith and for a legitimate purpose.

5. Right to Information: The Revised Corporation Code provides for the right of shareholders to be informed of the corporate affairs, specifically during stockholders’ meetings.

6. Appraisal Right: Shareholders may demand the payment of the fair value of their shares if they dissent from certain corporate actions, such as mergers, consolidation, and amendment of articles that significantly alter their rights.

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VII. Corporate Taxation

1. Corporate Income Tax: Corporations are subject to the Regular Corporate Income Tax (RCIT) of 25% on taxable income (reduced from 30% by the CREATE Law effective in 2021). Small corporations with a taxable income not exceeding P5 million and with total assets not exceeding P100 million are subject to a lower rate of 20%.

2. Minimum Corporate Income Tax (MCIT): If a corporation’s regular income tax is less than 2% of its gross income, it is required to pay the MCIT. However, the MCIT rate was temporarily reduced to 1% for the period 2020 to 2023 under the CREATE Law.

3. Branch Profit Remittance Tax: Foreign corporations with branches in the Philippines are subject to a 15% tax on profits remitted to their head offices.

4. Final Taxes on Dividends: Dividends declared by domestic corporations are subject to a final tax rate of 10% for individuals and variable rates depending on the residence and applicable tax treaties for foreign stockholders.

5. Fringe Benefits Tax: Corporations are subject to a 35% fringe benefits tax on certain benefits granted to their employees, except for rank-and-file employees.

6. Withholding Tax Obligations: Corporations are required to withhold tax on certain payments, such as compensation paid to employees and payments to suppliers of goods and services.

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VIII. Dissolution and Liquidation

1. Voluntary Dissolution: Corporations may dissolve voluntarily by a majority vote of the Board of Directors and a vote of at least two-thirds (2/3) of the outstanding shares. The corporation must file a petition for dissolution with the SEC.

2. Involuntary Dissolution: A corporation may also be dissolved involuntarily through SEC action if it fails to comply with the requirements of law, such as failure to file required reports or engage in illegal activities.

3. Liquidation: Upon dissolution, the corporation enters into a liquidation process to settle its debts and distribute any remaining assets to the shareholders. A trustee may be appointed to oversee the liquidation process.

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IX. Corporate Rehabilitation

Corporations facing financial distress can file for corporate rehabilitation under the Financial Rehabilitation and Insolvency Act (FRIA), which allows companies to reorganize their affairs and continue operations while negotiating with creditors. Corporate rehabilitation aims to restore the corporation to a solvent state rather than winding it up.

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The Revised Corporation Code and related tax laws provide a robust framework for the creation, operation, and dissolution of corporations in the Philippines. Compliance with corporate governance standards, respect for shareholder rights, and proper handling of tax obligations are essential for ensuring that corporations remain in good legal standing.

Republic Act No. 11232 | BUSINESS ORGANIZATIONS

Republic Act No. 11232: Revised Corporation Code of the Philippines

Republic Act No. 11232, also known as the Revised Corporation Code of the Philippines, was signed into law on February 20, 2019. It replaced the Corporation Code of 1980 (Batas Pambansa Blg. 68) and aims to improve the ease of doing business in the country while providing greater protection and flexibility to corporations and stakeholders. The law provides a comprehensive framework for the formation, governance, and regulation of both domestic and foreign corporations in the Philippines.

Below is a detailed breakdown of the significant provisions and key aspects of RA 11232 as it relates to business organizations:

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I. CORPORATE FORMATION

1. One-Person Corporation (OPC)

   • Definition: A corporation with a single stockholder, a major innovation in RA 11232. Previously, a minimum of five incorporators was required.
   • Key Features:
     • Only natural persons, trust, or estate can form an OPC.
     • Banks, quasi-banks, pre-need, trust companies, insurance, public and publicly listed companies, and non-chartered government-owned and controlled corporations (GOCCs) cannot incorporate as OPCs.
     • An OPC is not required to have a Board of Directors, but a single stockholder acts as both the President and sole director.
   • Corporate Secretary and Treasurer: Although not required to have a Board, the OPC is required to appoint a Corporate Secretary and Treasurer, who may or may not be the sole shareholder.

2. Incorporators

   • The revised law reduced the minimum number of incorporators from 5 to any number, including 1.
   • All incorporators must be natural persons, except in certain instances involving partnerships or associations.

3. Perpetual Existence

   • Under the old code, corporations had a maximum lifespan of 50 years, unless extended.
   • RA 11232 grants corporations perpetual existence unless otherwise provided in the Articles of Incorporation. This is a significant change as it encourages long-term investments and stability.

4. Corporate Term and Renewal

   • Corporations formed under the old law with limited terms may now opt for renewal even after the expiration of their term, as long as they file the necessary application with the Securities and Exchange Commission (SEC).

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II. CORPORATE GOVERNANCE

1. Board of Directors and Officers

   • Qualifications:
     • Directors must own at least one share of stock in their own name.
     • At least majority of the directors must be residents of the Philippines.
     • The number of directors must be at least five (5) but no more than fifteen (15).

2. Independent Directors

   • Publicly-listed corporations and companies vested with public interest must have independent directors. RA 11232 mandates that at least 20% of the board must be composed of independent directors.
   • Independent directors are individuals who are not officers, employees, or substantial shareholders of the corporation or its related companies.

3. Corporate Officers

   • Mandatory officers include the President, Corporate Secretary, Treasurer, and Compliance Officer (for corporations vested with public interest).
   • The President must be a director of the corporation, while the Corporate Secretary must be a resident and citizen of the Philippines.

4. Quorum and Voting

   • A majority of the board constitutes a quorum, unless the articles of incorporation or bylaws provide otherwise.
   • Voting can now be done through remote communication, a provision modernized to reflect the global shift towards digital solutions.
   • Stockholders may also vote through remote communication or in absentia during meetings.

5. Fiduciary Duties

   • Directors and corporate officers have fiduciary duties to act in good faith and in the best interests of the corporation, including the duty of diligence, loyalty, and avoidance of conflicts of interest.

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III. CORPORATE OPERATIONS

1. Corporate Name

   • The corporate name must be distinguishable from other entities. The SEC has the authority to issue regulations on corporate names and resolve disputes.
   • Corporations must also include the word “Corporation,” “Incorporated,” or “OPC” (for One-Person Corporations) in their names.

2. Stockholders' Meetings

   • RA 11232 allows electronic meetings (e.g., via teleconferencing, videoconferencing, etc.), especially in exigent circumstances such as public health emergencies.
   • Written notices for meetings must be sent to stockholders at least 21 days before the date of the meeting unless otherwise provided.

3. Bylaws

   • A corporation’s bylaws must be adopted within one month after incorporation.
   • Amendments or new bylaws may be adopted with the approval of a majority of the board and two-thirds (2/3) of the stockholders.

4. Dividends

   • Dividends, whether cash or property, may be declared by the board of directors, but they are payable only out of unrestricted retained earnings.

5. Corporate Books

   • Corporations must keep accurate records of transactions, including minutes of meetings of directors and stockholders.

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IV. DISSOLUTION AND LIQUIDATION

1. Voluntary Dissolution

   • A corporation may voluntarily dissolve upon:
     • The vote of the majority of the board and two-thirds (2/3) of the outstanding shares.
     • Submission of the articles of dissolution to the SEC.

2. Involuntary Dissolution

   • SEC may dissolve a corporation in cases of fraud, failure to commence business within two years, or continuous non-operation for at least five years.

3. Liquidation

   • Upon dissolution, the corporation must settle its liabilities and distribute remaining assets to stockholders.
   • A corporation can assign liquidators or leave liquidation to the Board of Directors under supervision of the SEC.

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V. FOREIGN CORPORATIONS

1. License to Transact Business

   • Foreign corporations must secure a license to transact business in the Philippines from the SEC before engaging in any commercial activities.
   • A foreign corporation is required to file reports with the SEC, including financial statements.

2. Branch Offices and Representative Offices

   • Foreign corporations may establish branch offices, which carry out business activities in the Philippines and are subject to the same taxation as domestic corporations.
   • Representative offices, on the other hand, are not allowed to generate income within the Philippines and exist solely to act on behalf of the parent company.

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VI. TAXATION AND OTHER COMPLIANCE REQUIREMENTS

1. Corporate Income Tax

   • Domestic corporations are taxed on their worldwide income, while foreign corporations are taxed only on their Philippine-sourced income.
   • The corporate income tax rate was adjusted under the Corporate Recovery and Tax Incentives for Enterprises Act (CREATE) law, but RA 11232 provides the structure for corporate compliance.

2. SEC Reporting Requirements

   • Corporations must submit General Information Sheets (GIS) and Audited Financial Statements (AFS) annually to the SEC.
   • The revised code has simplified and streamlined compliance procedures to encourage transparency.

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VII. PENALTIES AND SANCTIONS

1. Corporate Liability

   • A corporation, its officers, and directors may be subject to fines, penalties, or suspension for non-compliance with the provisions of RA 11232.
   • Corporations found guilty of offenses, including failure to submit required reports or fraudulent acts, can be penalized by the SEC, which has been granted broad powers under the new law.

2. Criminal Liability

   • Directors and officers may face criminal liability for fraudulent acts committed in connection with the corporation's activities.

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VIII. INNOVATIONS AND MODERNIZATION

1. Emergency Board Powers

   • During emergencies (e.g., natural disasters, war, public health crises), RA 11232 allows the corporation to fill board vacancies temporarily, ensuring continued operations.

2. E-Governance

   • Provisions for the use of technology in governance, including remote communication for meetings and voting, are intended to modernize corporate operations and facilitate ease of doing business.

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CONCLUSION

Republic Act No. 11232, the Revised Corporation Code of the Philippines, has modernized corporate governance and compliance in the Philippines. It simplifies procedures for incorporation, strengthens corporate governance, and protects stakeholders, all while fostering a more business-friendly environment. Key innovations include the creation of One-Person Corporations, provisions for perpetual corporate existence, and greater use of digital technology. This legal framework aims to promote ease of doing business, transparency, and corporate accountability, making the Philippines more competitive on the global stage.

BUSINESS ORGANIZATIONS

I. BUSINESS ORGANIZATIONS UNDER PHILIPPINE LAW

Business organizations in the Philippines are primarily governed by the Revised Corporation Code of the Philippines (Republic Act No. 11232), the Civil Code of the Philippines, and other relevant special laws like the Partnership Law and Cooperative Code. These laws lay out the structures, formation, governance, and obligations of various business organizations.

A. Types of Business Organizations

1. Sole Proprietorship

   • A business owned and operated by a single individual.
   • The owner has unlimited liability, meaning personal assets can be used to pay off debts and liabilities of the business.
   • Formation: Requires registration with the Department of Trade and Industry (DTI), Bureau of Internal Revenue (BIR), and possibly the local government (for permits and licenses).
   • Taxation: Sole proprietors are subject to income tax under the National Internal Revenue Code (NIRC) and may also be required to pay value-added tax (VAT) if applicable.

2. Partnership

   • Governed by the Civil Code of the Philippines.
   • Formed by two or more persons who agree to contribute money, property, or industry to a common fund, with the intention of sharing profits.
   • Types:
     • General Partnership: Partners have unlimited liability.
     • Limited Partnership: At least one partner has unlimited liability, while the other(s) may have limited liability to the extent of their contribution.
   • Registration: Partnerships are registered with the Securities and Exchange Commission (SEC).
   • Taxation: Subject to a corporate income tax rate similar to corporations.

3. Corporation

   • Governed by the Revised Corporation Code.
   • A legal entity separate from its owners, formed by at least two incorporators.
   • Owners (shareholders) have limited liability; liability is limited to the extent of their capital contribution.
   • One-Person Corporation (OPC): A special type of corporation with only one incorporator (under the Revised Corporation Code).
   • Types:
     • Stock Corporation: Has shareholders and issues shares of stock.
     • Non-stock Corporation: No shares of stock; typically organized for charitable, educational, or religious purposes.
   • Registration: Corporations must register with the SEC.
   • Taxation: Corporations are subject to corporate income tax, and dividends distributed to shareholders are also taxed.

4. Cooperative

   • Governed by the Cooperative Code of the Philippines (Republic Act No. 9520).
   • An organization owned and operated by its members, with the purpose of mutual benefit.
   • Registration: Cooperatives are registered with the Cooperative Development Authority (CDA).
   • Taxation: Cooperatives enjoy tax exemptions under certain conditions, particularly if they meet the requirements of being a duly-registered cooperative engaged in non-profit activities.

B. Formation and Registration of Business Organizations

1. Sole Proprietorship

   • Register the business name with the DTI.
   • Obtain necessary permits and licenses from the local government unit (LGU).
   • Secure a Tax Identification Number (TIN) from the BIR.

2. Partnership

   • Draft and execute a Partnership Agreement.
   • Register the partnership with the SEC, providing details on the partners, contributions, and other required information.
   • Secure a TIN from the BIR.
   • Obtain business permits and licenses from the LGU.

3. Corporation

   • Prepare and file the Articles of Incorporation and By-laws with the SEC.
   • OPC: Submit the required documents for a One-Person Corporation if only one incorporator.
   • Obtain a TIN and comply with all registration requirements with the BIR and LGU.
   • Corporations are also required to comply with the Anti-Money Laundering Act (AMLA) rules, submit annual financial statements, and undergo audits.

4. Cooperative

   • Formulate a Cooperative Development Plan and Articles of Cooperation.
   • Register with the CDA.
   • Secure BIR registration for tax purposes, even though cooperatives enjoy certain exemptions.

C. Governance and Legal Requirements

1. Sole Proprietorship

   • Simple governance structure, with the owner having complete control over operations.
   • However, compliance with local and national laws (e.g., labor, environmental regulations) is still required.

2. Partnership

   • Governed by the Partnership Agreement and provisions of the Civil Code.
   • Each partner acts as an agent of the partnership, and all partners are liable for the actions of each other in the course of business.

3. Corporation

   • Governed by a Board of Directors elected by the shareholders.
   • The corporation must hold regular and special meetings in accordance with the By-laws.
   • One-Person Corporation (OPC): The sole incorporator serves as both director and officer, simplifying governance.
   • Compliance with SEC reporting requirements (Annual Financial Statements, General Information Sheet, etc.) is mandatory.

4. Cooperative

   • Managed by a Board of Directors elected by members.
   • Must follow the Cooperative Development Plan and adhere to CDA reporting requirements, which include annual reports and financial statements.

D. Taxation

1. Sole Proprietorship

   • Subject to individual income tax based on graduated tax rates under the TRAIN Law (Tax Reform for Acceleration and Inclusion), ranging from 20% to 35% for individuals.
   • VAT or Percentage Tax may apply depending on the business' gross sales or receipts.

2. Partnership

   • Partnerships are subject to corporate income tax at the rate of 25% (or 20% for smaller businesses with net taxable income not exceeding PHP 5 million and total assets not exceeding PHP 100 million).
   • Partners are taxed individually on their share of the profits.

3. Corporation

   • Corporations pay corporate income tax based on the revised Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act:
     • 25% for regular corporations.
     • 20% for corporations with net taxable income not exceeding PHP 5 million and total assets not exceeding PHP 100 million.
   • Dividends distributed to shareholders are subject to 10% final withholding tax for domestic corporations.

4. Cooperative

   • Cooperatives that meet the requirements under the Cooperative Code enjoy tax exemptions, particularly if their activities are directed towards mutual benefit and not for profit.
   • However, cooperatives engaging in commercial activities may be subject to tax on those operations.

E. Dissolution and Liquidation

1. Sole Proprietorship

   • The business ceases upon the death or decision of the owner.
   • Liquidation involves settling debts and distributing remaining assets to the owner.

2. Partnership

   • A partnership may be dissolved by:
     • Death, incapacity, or withdrawal of a partner.
     • Agreement of the partners.
     • Court decree.
   • Liquidation involves winding up the business, paying off creditors, and distributing remaining assets among partners.

3. Corporation

   • A corporation may be dissolved through:
     • Voluntary dissolution by majority vote of the board and approval of at least two-thirds of the shareholders.
     • Involuntary dissolution by the SEC for failure to comply with legal requirements.
     • Dissolution through expiration of the corporate term, though under the Revised Corporation Code, a corporation can now exist perpetually unless the Articles of Incorporation provide otherwise.
   • Liquidation involves paying off creditors and distributing assets to shareholders.

4. Cooperative

   • Dissolution of cooperatives follows the rules of the CDA and involves a vote of the members.
   • Liquidation must prioritize the satisfaction of liabilities before the distribution of any remaining assets to members.

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II. TAXATION LAWS APPLICABLE TO BUSINESS ORGANIZATIONS

Taxation in the Philippines is primarily governed by the National Internal Revenue Code (NIRC), as amended by various tax reform laws such as the TRAIN Law and the CREATE Act. The Bureau of Internal Revenue (BIR) is responsible for administering and enforcing tax laws.

A. General Types of Taxes

1. Income Tax

   • Applies to individuals, partnerships, and corporations.
   • Different tax rates apply based on the entity type (individual vs. corporate taxpayers).

2. Value-Added Tax (VAT)

   • A 12% tax imposed on the sale of goods, services, or properties.
   • Required for businesses with gross annual sales or receipts exceeding PHP 3 million.

3. Percentage Tax

   • A 3% tax imposed on businesses that do not meet the VAT threshold (gross sales below PHP 3 million).

4. Withholding Tax

   • Businesses are required to withhold taxes on certain income payments such as compensation, dividends, and professional fees.

5. Documentary Stamp Tax (DST)

   • A tax on certain documents, instruments, loan agreements, and transactions.

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The legal and tax framework for business organizations in the Philippines is comprehensive and evolving, with recent reforms streamlining processes and offering incentives. Compliance with corporate governance and taxation requirements is crucial to avoid legal and financial consequences.