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Law on Business Organizations What is meant by “Business organizations”?

Types of Business Organizations There is now a proliferation of business organizations with their own form and substance, advantages and disadvantages and pertinent rules. If a person wants to engage in business, he must resolve the threshold problem of choosing the form of business organization that he will use in his undertaking. His lawyer will be confronted with a situation where he will present alternative business forms and recommend what vehicle best suits his client. The basic types of business organizations that are available in the country are the following: 1. Sole Proprietorship  This is a form of business organization with only one proprietary owner; a single individual conducts business under his own name or under a business name. A “Business Name” refers to any name that is different from the true name of an individual which is used or signed in connection with his/her business which must be registered with the Bureau of Trade Regulation and Consumer Protection of the DTI. The sole proprietor manages and exercises complete control over the conduct of his business. Only his or his agent’s acts may bind the business. He is the only one to share in the profits. The individual proprietor is the only one who is personally liable for business debts.  It is the oldest, simplest, and most prevalent form of business organization. With the increasing complexity of everyday life came more specialists/proprietors. As the business of these specialists/proprietors became more complex so did the form of the business enterprise.  It is neither a creature of statute nor a contract; hence, the reportorial requirements imposed on corporations and registered partnerships do not apply to sole proprietorship. It involves none of the complexity or expense required of business associations such as corporations and partnership. The law only requires its proprietor owner to secure licenses, permits, register its business name, and pay taxes to the national government. 2. Partnership  There is a partnership when two or more persons bind themselves to contribute money, property, or industry to a common fund, with the intention of dividing the profits among themselves. (Art. 1767, NCC) We will discuss more on this after we finish corporations. Partnership will form part of your midterm examination (ME). Before the ME, you must master the basic distinctions between Corporations and Partnerships because I will be asking about that in the exam. 3. Joint Accounts (Sociedad de Cuentas en Participacion)  It is present when there is an arrangement whereby merchants may interest themselves in the transaction of other merchants, contributing thereto the amount of capital they may agree upon, and participating in the favorable and unfavorable results thereof in the proportion that they may determine. Give example and explain further. 4. Joint Venture

 It is an association of persons or companies jointly undertaking some commercial enterprise; generally all contribute assets and share risks.  It is an organization formed for some temporary purpose. Give example and explain further. 5. Cooperatives  It is an autonomous and duly registered association of persons, with a common bond of interest, who have voluntarily joined together to achieve their social, economic, and cultural needs and aspirations by making equitable contributions to the capital required, patronizing their products and services and accepting a fair share of the risks and benefits of the undertaking in accordance with universally accepted cooperative principles.  The governing law is R.A. 9520 otherwise known as “The Philippine Cooperative Code of 2008”. Give example and explain further. 6. Syndicate  A group of people who come together to work for a common aim.  It is an unincorporated business association that is often encountered among insurance companies who may be underwriting a large risk or banks that are lending a huge amount. Syndication is therefore the practice of dividing investment risk between several persons in order to minimize individual risk. For example, banks may extend credit to one borrower up to maximum legal amount under the law. But there may be times when a credit facility exceeds the lending limit of one bank which is very risky. What if borrower cannot pay? Then, the bank may go bankrupt. So how do banks resolve this or minimize the risk? In such case, the lead lender(BPI) may sell participating interests in the loan to other lenders (Metrobank and Security Bank) or may arrange a syndicated credit facility. In this syndicated loan, each lender is a member of the syndicate and a party to the loan documents. The borrower has a direct contractual relationship with each member of the lending syndicate. 7. Corporations  Its separate personality and the limited liability of its components make a corporation the most desirable business organization for many businessmen.  Business corporations have five core characteristics, namely: (a) Legal personality; (b) Limited liability; (c) Transferability of shares; (d) Delegated Management under a board structure ; and (e) Investor ownership. Discuss each briefly! These core characteristics respond to the exigencies of the large modern business enterprise and are therefore uniquely attractive for organizing productive activities. We will touch on these core characteristics as we go on with our discussion. While there are 7 types of business organizations available in the Philippines, for this particular subject however we will only focus on corporations and partnerships. The law on partnerships will be tackled after your preliminary examinations (PE).

BATAS PAMBANSA BLG. 68

Section 1. Title of the Code. This code shall be known as “The Corporation Code of the Philippines Brief history. The first general law on corporations in the Philippines was the Corporation Law, Act No. 1459, which was passed by the Philippine Commission in 1906 and took effect and took effect on April 1, 1906. Act No. 1459 was practically a codification of the American law on corporations. B.P Blg. 68 otherwise known as “The Corporation Code of the Philippines” repealed Act No. 1459 in 1980. The Corporation Code (CC) took effect on May 1, 1980.  The Corporation Code applies to all corporations already in existence at the time the Code took effect. (See Sec. 148, CC) Section 148 of the CC provides that all corporations lawfully existing and doing business in the Philippines on the date of the effectively of the Code and thereafter authorized, licensed or registered by the SEC, shall be deemed to have been authorized, licensed or registered under the provisions of the Code, subject to the terms and conditions of its license, and shall be governed by the provisions thereof. For example, see page 31 of Aquino’s book, second paragraph.  It is consistent with the mandate under Section 16, Article XIII of the Constitution for Congress to prescribe all the criteria for the “formation, organization, or regulation” of private corporations in a general law applicable to all without discrimination. The Corporation Code of the Philippines and the general law that it repealed provide for the formation and organization of corporations, define their powers, fix the duties of directors and other officers thereof, declare the rights and liabilities of shareholders and members and prescribe conditions under which corporations may transact business. In other words, the CC is to lay down rules and regulations of the organization corporations with a view to the protection of public interest.

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There are several group of persons that are affected by corporate laws. They are mainly the stockholders, directors and officers and creditors. Ano nga ba ang epekto ng CC sa mga grupong ito? Corporate law seeks to regulate both the relations between the groups and within the groups. It regulates the “mechanisms by which people join, or leave, one of these groups as well as their rights and duties once they have joined a group.  It promotes the economic and social development of the country through the development of the corporate vehicle as a means of doing business in the Philippines. The CC makes it possible for business to prosper and this would spread the benefits of prosperity among all the people, especially the employees of the corporations and associations which may be organized under the aegis of the Corporation Code. For example, the CC provides for separate corporate personality and limited liability rule which will encourage people to invest. When there are investments, it helps the economy, it produces jobs, unemployment rate decreases, so people have food to eat, the government collects more taxes, everybody is happy! Right?

 GENERAL RULE: The Corporation Code is the primary law that should be applied in the regulation of corporations. EXCEPTION: (1) The New Central Bank Act and the General Banking Law regulate specifically banks and other financial institutions. (2) The Insurance Code of the Philippines applies to insurance corporations. In these cases, the Corporation Code applies suppletorily. In other words class, certain facets or aspects of the organization and regulation of certain companies are governed by special laws (e.g. NCBA, GBL, and IC). The special laws governing those corporations apply primarily while the CC apply suppletorily. Other applicable laws and rules that apply to corporations are R.A. 8799 otherwise known as the Securities Regulation Code , the Foreign Investment Act of 1997 and some provisions of the New Civil Code which you all will be familiar of if and when you decide to take law, save for the Sec. Reg. Code which is part of our syllabus. SECTION 2. Corporation defined. 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.  The following attributes can be derived from the definition of corporation under Section 2: (1) It is an artificial being; (2) It is created by operation of law; (3) It has the right of succession; and (4) It has the powers, attributes and properties expressly authorized by law or incident to its existence.  A CORPORATION AS AN ARTIFICIAL BEING  The basic postulate in corporation law is that “a corporation is an artificial being created by operation of law.” It owes its life to the State and its birth is purely dependent on the State’s will. A corporation is an artificial being, invisible, intangible, and existing only in contemplation of law.1 A corporation is not in fact and in reality a person, but the law treats it as though it were a person by process of fiction, or by regarding it as an artificial person distinct and separate from its individual stockholders. It owes its existence to law. It is an artificial person created by law for certain specific purposes, the extent of whose existence, powers and liberties is fixed by its charter.2 A corporation as known to Philippine jurisprudence is a creature without any existence until it has received the imprimatur of the State acting according to law. It is logically inconceivable therefore that it will have rights and privileges of a higher priority than that of its creator. More than that, it cannot legitimately refuse to yield obedience to acts of its State organs, certainly not excluding the judiciary, whenever called upon to do so. 3  A CORPORATION AS A CREATION OF LAW OR CREATED BY OPERATION OF LAW  A corporation is granted by the State the right to exist by virtue of a primary franchise.

1

Tayag v. Benguet Consolidated, Inc.,G.R. No. 23145, November 29, 1968

2

Fletcher

3

Supra note 1.

A franchise is a special privilege conferred by governmental authority, and which does not belong to citizens of the country generally as a matter of common right.  For practical purposes, franchises, so far as relating to corporations, are divisible into: (1) Corporate or general franchise; and (2) Special or secondary franchises. A. The corporate or general franchise also known as the primary franchise of a corporation, that is, the right to exist as such, is vested in the individuals who compose the corporation and not in the corporation itself, and it cannot be conveyed in the absence of legislative authority to do so. B. The special or secondary franchise of a corporation is vested in the corporation and may ordinarily be conveyed or mortgaged under a general power granted to a corporation to dispose of its property. It pertains to certain rights and privileges conferred upon existing corporations, such as the right to use the streets of a municipality to lay pipes of tracks, erect poles or string wires. It refers to any of those franchises of a corporation other than its right or franchise to be a corporation, which is the primary franchise. Secondary franchises of a corporation for services performed may, under some of the authorities, be transferred in connection with an assignment of the tangible property of the corporation, when that property can be fully enjoyed by the grantee only by an exercise of such secondary franchise. EXAMPLE: The right to operate a messenger and express delivery service, by virtue of a legislative enactment, is admittedly a secondary franchise (R.A. No. 3260, entitled "An Act granting the JRS Business Corporation a franchise to conduct a messenger and express service)" and, as such, under our corporation law, is subject to levy and sale on execution together and including all the property necessary for the enjoyment thereof. The law, however, indicates the procedure under which the same (secondary franchise and the properties necessary for its enjoyment) may be sold under execution. Said franchise can be sold under execution, when such sale is especially decreed and ordered in the judgment and it becomes effective only when the sale is confirmed by the Court after due notice. 4 What does this tell us? If individuals elect a set of officers after which they merely folded their arms and exerted no further effort to effectuate the necessary registration, no juridical personality as a corporation shall be bestowed on the group. Such group of individuals would only be considered an association or at most a partnership. The right to be and to act as a corporation is not a natural or civil right of any person; such right as well as the right to enjoy the immunities and privileges resulting from incorporation constitutes a franchise and a corporation, therefore cannot be created except by or under a special authority from the state. 5 May a private corporation be created by special law? Article XII, Section 16 of the 1987 Constitution provides that Congress shall not, except by general law, provide for the formation, organization, or regulation of private corporations. Government owned and controlled corporations (GOCC) may be created or established by special charters in the interest of the common good and subject to the test of economic viability. A private corporation may be created only under the Corporation Code. Only public corporations may be created under a special law. The Constitution recognizes two classes of corporations: (1) The first refer to private corporations created under a general law. 4 5

JRS Express v. Imperial Insurance Inc., G.R. No. L-19891, July 31, 1964 Recreation and Amusement Association of the Philippines v. The City of Manila, et.al., G.R. No. L-7992, February 22, 1957

(2) The second refers to GOCCS created by special charters. Congress cannot enact a law creating a private corporation (PC) with a special charter. Such legislation would be unconstitutional. Private corporations may exist only under a general. The constitution authorizes Congress to create GOCCs through special charters. Since PC cannot have special charters, it follows that Congress can create corporations with special charters only if such corporations are government owned or controlled. What is a GOCC? A GOCC is a stock or non-stock corporation whether performing governmental or proprietary functions, which is directly chartered by a special law or if organized under the general corporation law is owned or controlled by the government directly or indirectly through a parent corporation or subsidiary corporation, to the extent of at least a majority of its outstanding capital stock or of its outstanding voting capital stock. By definition, three attributes thus make an entity a GOCC: (1) Its organization as stock or non-stock corporation; (2) The public character of its function; and (3) Governmental ownership over the same. Possession of all three attributes is necessary to deem an entity a GOCC. Hence, organization as a non-stock corporation and the mere performance of functions with a public character or aspect are not by themselves sufficient to consider an entity a GOCC; a corporation must also be, if not more importantly owned by the government. The government owns a stock or non-stock corporation if it has controlling interest in a corporation. In a stock corporation, the controlling interest of the government is assured by its ownership of at least 51% of the corporate capital stock. In a non-stock corporation, jurisprudence teaches that the controlling interest of the government is affirmed when “at least majority of the members are government officials holding such membership by appointment or designation” or there is otherwise “substantial participation of the government in the selection” of the corporation’s governing board. We’ll stop our discussion on GOCCs here besides our focus is on PCs. Going back to the topic on franchises, just to summarize… A corporation is therefore created by operation of law when it is granted a franchise either through a special law or it is organized under a general law. The general law under which a corporation can be organized in the Philippines is the Corporation Code.  RIGHT OF SUCCESSION OR PERPETUAL SUCCESSION This refers to the continuous existence which enables a corporation to manage its affairs, and hold property without the necessity of perpetual conveyances, for purposes of transmitting it. By reason of this quality, this ideal and artificial person remains, in its legal entity and personality, the same, though frequent changes may be made of its members. 6 Thus, a corporation continues to exist even if there is a change in those who compose it. Death of a shareholder or transfer of his shares will not affect the continued existence of a corporation. However, perpetual succession does not imply corporate immortality but rather a continuity of existence irrespective of that of its components. The term of a corporation is 50 years, subject to further extension of its term under Section 11 of the Corporation Code. 6

Black’s Law Dictionary, 6th Edition (1990), p. 1141.

Two important doctrines in Corporation Law (1) Doctrine of Separate Personality A corporation has a personality separate and distinct from its members. It has a personality separate and distinct from the persons composing it as well as from that of any other entity to which it may be related.7 This separate juridical personality is recognized under the NCC because its Article 44 specifies corporations as among those considered as juridical persons with juridical personality, separate and distinct from that of each shareholder or member. The NCC provides that the personality of juridical entities begins as soon as they have been constituted according to law.8 Article 45 of the New Civil Code provides that private corporations are regulated by laws of general application on the subject. On the other hand, Article 46 provides that juridical persons may acquire and possess property of all kinds as well as incur obligations and bring civil or criminal actions in conformity with laws and regulations of their organization.

DOCTRINE OF SEPARATE PERSONALITY

SEPARATE PROPERTIES SEPARATE OBLIGATIONS

Separate Properties. Because of the separate personality of the corporation, the properties of the corporation are not the properties of the stockholders, members or officers. Properties registered in the name of the corporation are owned by it as an entity separate and distinct from those who compose it. A stockholder cannot sell, transfer, mortgage or encumber the properties of the corporation without proper authority because such can be performed by the corporation only through officers or agents duly authorized for the purpose by corporate by laws or by specific acts of the board of directors (BOD). Similarly, a stockholder cannot use any such property to pay for his personal debts. In the same manner, properties of the shareholders, members, or officers of the corporation are not properties of the corporation. What is the Nature of Stockholders’ Interest in Corporate Properties? The interest of each stockholder consists in the properties of the corporation is indirect, contingent, and inchoate. 9 The interest of the shareholder on a particular property becomes actual, direct and existing only upon liquidation of the assets of the corporation and the same property is assigned to the shareholder concerned. The interest of each stockholder consists in the right to a proportionate part of the profits whenever dividends are declared by the corporation, during its existence, under its charter, and to a like proportion of the property remaining, upon the termination or dissolution of the corporation, after payment of its debts.10 Properties registered in the name of the corporation are owned by it as an entity separate and distinct from its members. While shares of stock constitute personal property, they do not represent property of the corporation. The corporation has property of its own which consists chiefly of real estate. A share of stock only typifies an aliquot part of the corporation’s property, or the right to share in its proceeds to that extent when distributed according to law and equity, but its holder is not the owner of any part of the capital of the corporation. Nor is he entitled to the possession of any definite portion of its property or assets. Indeed, the stockholders of a corporation are not co-owners of its (corporation’s) assets. The shareholders do not own pro-indiviso shares in the assets and therefore, they cannot mortgage or 7

Secosa, et.al. v. Heirs of Erwin Suarez Francisco, G.R. No. 160039, January 29,2004. Article 44 (2), New Civil Code. 9 Asia’s Emerging Dragon Corporation v. DOTC, 549 SCRA 44 (2008). 10 Fisher v. Trinidad, cited in Mobilia Products Inc. v. Umezawa 8

convey the same except in their capacity as directors, collectively with the other directors, or as duly authorized officers of the corporation. 11 Separate Obligations. The obligations of the corporation are not the obligations of its shareholders and members and officers and vice versa. The rule is that the directors and officers are not personally liable for obligations of the corporation. “The obligations incurred by the corporate officers, or other persons acting as corporate agents, are the direct accountabilities of the corporation they represent, and not theirs. However, personal liability may be incurred by directors and officers in certain cases. In these cases, the liability of the directors and officers is solidary with the corporation. Thus, directors and officers are solidarily liable: I. When directors and trustees, or in appropriate cases, the officers of the corporation: a. Vote for or assent to patently unlawful acts of the corporation; b. Act in bad faith or with gross negligence in directing the affairs of the corporation; c. Are guilty of conflicts of interest to the prejudice of corporation, its stockholders or members, and other persons; II.

When a director has consented to the issuance of watered stocks or who, having knowledge thereof, did not forthwith file with the corporate secretary his written objection thereto

III.

When the director, trustee, or officer has contractually agreed or stipulated to hold himself personally and solidarily liable with the corporation; and

IV.

When a director, trustee or officer is made, by specific provisions of law, personally liable for his corporate actions.

What is the underlying reason they are made liable? Directors and in certain cases officers owe obedience, diligence, and loyalty to the corporation. Neither are stockholders or officers liable for the contractual obligations of the corporation. Even majority shareholders are not liable for corporate obligations.12 However, there are instances when the officers or stockholders voluntarily make themselves personally liable. For instance, they can act as surety or make themselves solidarily liable by signing a surety agreement or make themselves solidarily liable by signing the appropriate surety agreement or affixing their joint and solidary signature. The corporation cannot likewise be made to answer for their personal obligations of the stockholders, members, directors or officers.

DOCTRINE OF SEPARATE PERSONALITY

SEPARATE PROPERTIES SEPARATE OBLIGATIONS

LIMITED LIABILITY RULE

LIMITED LIABILITY RULE. One feature that makes corporations more advantageous to investors compared to partnerships and single proprietorships is the Limited Liability Rule. Under this rule, “a stockholder is personally liable for the financial obligations of the corporation to the extent of his unpaid subscription.” While stockholders are generally not liable, the stockholders may be liable if they have not fully paid the subscription price. (2) DOCTRINE OF PIERCING THE VEIL OF CORPORATE FICTION. Basic in corporate law is the principle that a corporation has a separate personality distinct from its stockholders and from other corporations to which it may be connected. It is a fiction created by law 11 12

Mobilia Products Inc. v. Umezawa Construction & Development Corporation of the Philippines v. Cuenca, G.R. No. 163981, August 12, 20015, 466 SCRA 714,727

with the intent that it should be treated as true.13 However, under the doctrine of piercing the veil of corporate entity, the corporation’s separate juridical personality may be disregarded when there is an abuse of the corporate form. FOR EXAMPLE, corporate personality may be disregarded when the corporate identity is used to defeat public convenience, justify wrong, protect fraud, or defend crime. Also, where the corporation is a mere alter ego or business conduit of a person, or where the corporation is so organized and controlled and its affairs are so conducted as to make it merely an instrumentality, agency, conduit or adjunct of another corporation, then its distinct personality may be ignored. In these circumstances, the courts will treat the corporation as a mere aggrupation of persons and the liability will directly attach to them. The legal fiction of a separate personality in those cited instances, for reasons of public policy and in the interest of justice, will be justifiably set aside. The doctrine may be applied in at least three basic areas with which the law covers and isolates the corporation from any other legal entity to which it may be related: (a) Where public convenience may be defeated, as when the corporate fiction is used as vehicle for the evasion of an existing obligation; (b) Fraud cases or when the corporate entity is used to justify a wrong, protect fraud, or defend a crime; Example. There was a security guard who used to work for a dissolved corporation. After the dissolution, the guard was transferred to a new corporation. When the guard retired, the time that he worked for the dissolved corporation was not included in the length of service that was used for the purpose of determining his retirement pay. The Supreme Court ruled that the attempt to make the two security agencies as separate entities, when in reality they were one, was a devise to defeat the law. The veil of corporate fiction was disregarded because the same was used to perpetrate injustice or as a vehicle to evade obligations. (c) Alter ego cases, where a corporation is merely a farce since it is a mere alter ego or business conduit of a person, or where the corporation is so organized and controlled and its affairs are so conducted as to make it merely an instrumentality, agency, conduit, or adjunct of another corporation.

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1 Fletcher 77