A Brown Energy Resources and Development, Inc. v. Company Registration and Monitoring Department

August 2, 2022 SEC EN BANC CASE NO. 04-15-370 A BROWN ENERGY RESOURCES AND DEVELOPMENT, INC. and NAKEEN CORP. , petitioners-appellant , vs. COMPANY REGISTRATION AND MONITORING DEPARTMENT, rep. by DIR. FERDINAND B. SALES , respondent-appellee . DECISION Before this Commission is the Memorandum on Appeal dated 8 April 2015 ("the Appeal") filed by Petitioners-Appellants A Brown Energy and Resources Development, Inc. ("ABERDI") and Nakeen Corp. ("NAKEEN") on 13 April 2015, assailing the Order of Respondent-Appellee Company Registration and Monitoring Department ("CRMD") dated 11 February 2015 denying Petitioners-Appellants' application for the approval of the revised plan of merger between ABERDI and NAKEEN. THE PARTIES Petitioner-Appellant ABERDI is a corporation duly organized and existing by virtue of the laws of the Republic of the Philippines. It owns all of the capital stocks of NAKEEN. Petitioner-Appellant NAKEEN is a corporation duly organized and existing by virtue of the laws of the Republic of the Philippines. It is a wholly owned subsidiary of ABERDI. Respondent-Appellee CRMD is one of the operating departments of the Securities and Exchange Commission ("Commission") tasked to, among others, process and act upon applications for amendments of articles of incorporation/articles of partnership, by-laws, mergers, consolidations, and other corporate actions involving reorganization that require prior approval of the Commission. RELEVANT FACTS On 2 April 2012, ABERDI and NAKEEN approved a Plan of Merger (the "Merger") with the former as the surviving corporation and the latter as the absorbed corporation. The Merger provides, among others, that the net assets of NAKEEN which will be transferred to ABERDI shall be treated as additional paid-in capital, considering that NAKEEN is a wholly-owned subsidiary of ABERDI. On the basis thereof, NAKEEN agreed that ABERDI will not issue shares of stock for the net assets that it will be transferring to ABERDI. On 12 July 2012, ABERDI filed an application for the approval of the Merger which will effect the transfer of the assets and liabilities of NAKEEN to ABERDI without issuance of any shares to NAKEEN in so far as the said assets are concerned. However, pending the approval of the Merger, the Bureau of Internal Revenue (BIR) issued BIR Ruling No. 508-2012 1 which considered upstream mergers between a parent company and its subsidiary where no shares will be issued as not tax free because the same partakes of a donation made by the latter to the former. On 30 August 2012, the Merger was approved by the Commission, with ABERDI as the surviving corporation and NAKEEN as the absorbed corporation. In order to comply with BIR Ruling No. 508-2012 and effect a tax-free merger, ABERDI and NAKEEN filed on 24 July 2013, a new application seeking the Commission's approval to amend the Merger (the "Amended Merger"), specifically with the inclusion of the following terms: 1. Issuance by ABERDI of 7,945,151 shares to itself, as the sole stockholder of NAKEEN, in exchange for the net assets of the latter as of 31 December 2012; and 2. The proposed Amended Merger shall take effect on the first day of the month succeeding the month of approval of the Amended Merger by the Commission. On 1 April 2014, the Office of the General Accountant ("OGA") of the Commission made the following findings on the proposed Amended Merger, to wit: 1. There is no pro-forma computation showing the impact on the net assets; and 2. Since the proposed restatement would have to be audited, the concurrence of the company's external auditor on the proposed adjustment vis--vis PFRS compliance is required. On 12 September 2014, the External Auditor of ABERDI submitted the company's computation and related pro-forma adjustments reflecting the effects of the merger in the statement of financial position of the company as of 31 December 2012. Thereafter, in its Memorandum dated 23 January 2015, the OGA rendered its evaluation on the compliance of ABERDI as follows: 1. The requirements per OGA's Memorandum dated 1 April 2014, specifically the submission of the company's external auditor's concurrence on the proposed adjustments vis--vis PFRS compliance, had not been complied with; and 2. ABERDI's proposed recognition of treasury shares amounting to P7,945,151 despite a deficit amounting to P96,402,421.00 was referred back to CRMD for appropriate action considering that the same involves a legal issue. Based on the above evaluation of OGA, CRMD issued an Order dated 11 February 2015 (the "Order") denying the application of Petitioners-Appellants on the ground that ABERDI failed to comply with the legal requirements, and that its recognition of treasury shares constitutes a violation of Section 41 of the Corporation Code (the "Code"). In its Letter-Request for Clarification and/or Reconsideration of SEC CRMD Case No. 13-469 dated 23 March 2015, Petitioners-Appellants, through counsel, sought the reconsideration of CRMD's Order alleging that: 1. Petitioners-Appellants' external auditor actually submitted the required concurrence on the proposed adjustments vis--vis PFRS compliance requirements; and 2. The issuance of shares of stock by ABERDI, the surviving corporation, in exchange for the net assets of NAKEEN, to itself, as the stockholder of NAKEEN, the absorbed corporation, does not violate Section 41 of the Corporation Code. Anent the 2nd ground raised by Petitioners-Appellants, they argued that the requirement on the existence of retained earnings for the repurchase of shares under Section 41 of the Corporation Code does not apply if the shares of stock are not treasury shares within the purview of Section 9 of the Code. They submit that the shares which ABERDI will issue to NAKEEN should not be considered as treasury shares because it will not he issued to a different holder and that the same will not be reacquired by the issuing corporation. Finally, Petitioners-Appellants argue that the trust fund doctrine is upheld in the above transaction considering that ABERDI will be acquiring the net assets of NAKEEN, thereby benefiting ABERDI's creditors. In its Letter dated 27 March 2015, the CRMD advised Petitioners-Appellants that their remedy is to file an appeal with the Commission En Banc pursuant to the 2006 SEC Rules of Procedure. On 13 April 2015, Petitioners-Appellants filed their Notice of Appeal and Memorandum on Appeal both dated 8 April 2015. On 20 April 2015, CRMD filed its Reply to Petitioners-Appellants' Memorandum on Appeal adopting the same position it has taken which was based on the findings of OGA. ISSUE The sole issue presented to this Commission is whether CRMD was correct in denying the Amended Merger of Petitioners-Appellants on the ground that it was allegedly violative of Section 41 of the Code. DISCUSSION Under the proposed Amended Merger of Petitioners-Appellants, ABERDI will issue 7,945,151 shares to NAKEEN which is equivalent to, and as consideration for the latter's net assets as of 31 December 2012, and any excess of the said net worth will be treated and booked as additional paid-in capital in the books of ABERDI. The foregoing was resorted to by Petitioners-Appellants to secure for themselves a tax-exemption considering that the BIR Ruling treated the original Merger sans the issuance of shares as partaking of the nature of a donation made by a subsidiary to its parent company, hence, not tax-exempt. 2 The foregoing was, however, considered by the CRMD as violative of Section 41 of the Corporation Code, and thus resolved to deny the same. Arguing that CRMD committed reversible error, Petitioners-Appellants maintained and posited that ABERDI's issuance of shares under the Amended Merger does not violate Section 41 of the Corporation Code, because it will not be purchasing its own shares, rather, it will be issuing the shares directly to itself in its capacity as the sole stockholder of NAKEEN, considering that such shares are being issued in exchange for the net assets of NAKEEN. 3 The Commission finds the arguments of Petitioners-Appellants and the CRMD to be bereft of merit. As regards the argument of Petitioners-Appellants, it should be emphasized at the outset that the Commission has already approved and rendered the Merger effective 4 on 30 August 2012, with ABERDI as the surviving corporation and NAKEEN as the absorbed corporation. In relation to the properties of the constituent corporations vis--vis the surviving corporation, Section 80 (4) of the Corporation Code provides for the legal effects of the Merger, to wit: " Section 80. Effects of merger or consolidation. The merger or consolidation shall have the following effects: xxx xxx xxx 4. The surviving or the consolidated corporation shall thereupon and thereafter possess all the rights, privileges, immunities and franchises of each of the constituent corporations; and all property, real or personal, and all receivables due on whatever account , including subscriptions to shares and other choses in action, and all and every other interest of, or belonging to, or due to each constituent corporation, shall be deemed transferred to and vested in such surviving or consolidated corporation without further act or deed ; x x x (Emphasis supplied) In Commissioner of Internal Revenue v. Pilipinas Shell Petroleum Corp. , 5 the Supreme Court held that in a merger, the acquisition by the surviving corporation of the rights, privileges, powers, and liabilities of the merged corporations are automatic, thus: "It should be emphasized that in the instant case, the transfer of SPPC's real property to respondent was pursuant to their approved plan of merger. In a merger of two existing corporations, one of the corporations survives and continues the business, while the other is dissolved, and all its rights, properties, and liabilities are acquired by the surviving corporation. Although there is a dissolution of the absorbed or merged corporations, there is no winding up of their affairs or liquidation of their assets because the surviving corporation automatically acquires all their rights, privileges, and powers, as well as their liabilities . Here, SPPC ceased to have any legal personality and respondent PSPC stepped into everything that was SPPC's, pursuant to the law and the terms of their Plan of Merger." (Emphasis supplied) In a similar manner, the Supreme Court affirmed in Commissioner of Internal Revenue v. La Tondea Distillers, Inc. , 6 that transfer to the surviving corporation of all the properties of each constituent corporation automatic and takes effect ipso jure , to wit: " In a merger, the real properties are not deemed "sold" to the surviving corporation and the latter could not be considered as "purchaser" of realty since the real properties subject of the merger were merely absorbed by the surviving corporation by operation of law and these properties are deemed without further act or deed . Therefore, the transfer of real properties to the surviving corporation in pursuance of a merger is not subject to documentary stamp tax. As stated at the outset, documentary stamp tax is imposed only on all conveyances, deeds, instruments or writing where realty sold shall be conveyed to a purchaser or purchasers. The transfer of SPPC's real property to respondent was neither a sale nor was it a conveyance of real property for a consideration contracted to be paid as contemplated under Section 196 of the Tax Code. Hence, Section 196 of the Tax Code is inapplicable and respondent is not liable for documentary stamp tax." (Emphasis supplied) Applying the foregoing legal precepts to the instant case, the proposed term in the Amended Merger where ABERDI will issue 7,945,151 shares to itself, as the sole stockholder of NAKEEN, in exchange for the net assets of the latter as of 31 December 2012, cannot be sustained as the same is not sanctioned by law and jurisprudence. Upon the approval and effectivity of the Merger on 30 August 2012, ALL the assets of NAKEEN were automatically transferred by operation of law to ABERDI. Thus, the issuance by ABERDI of 7,945,151 shares to itself is no longer necessary. Allowing ABDERDI to do otherwise will sanction not only a violation of Section 80 of the Corporation Code, but also of Section 62 7 thereof considering that ABERDI will be issuing watered stocks, or shares having a value that is less than par, or no value at all. More importantly, the legal effect of merger on the separate juridical personalities of the constituent corporations provided in Section 80 (2) of the Corporation Code, is crucial and impactful in the resolution of the issue in this case, to wit: " Section 80. Effects of merger or consolidation. The merger or consolidation shall have the following effects: xxx xxx xxx 2. The separate existence of the constituent corporations shall cease, except that of the surviving or the consolidated corporation ; x x x (Emphasis supplied) Under the afore-quoted provision, upon the approval of the Merger by the Commission, through the CRMD, on 30 August 2012, the separate existence of the constituent corporations effectively ceased, and only ABERDI survived. Hence, while the Amended Merger was approved by ABERDI and NAKEEN on 20 August 2012, the filing thereof on 24 July 2013 effectively prevented the Commission from acting on the same on the ground that with the approval of the Merger on 30 August 2012, only ABERDI was legally existing, being the surviving corporation. Consequently, the cessation of the separate existence of the constituent corporations rendered it legally impossible for them to file the Amended Merger. From the perspective of the Commission, there was no Amended Merger to speak of and recognize because the corporations applying for its approval have ceased to exist when the Merger was approved on 30 August 2012. Going now to the assailed Order, the records show that the CRMD denied the Amended Merger of Petitioners-Appellants on the basis of a finding that the latter incurred deficits based on its 2012 AFS. The CRMD maintained that ABERDI's proposal to issue 7,945,151 shares to itself sans unrestricted retained earnings, which the CRMD considered as treasury shares, will violate Section 41 of the Corporation. Petitioners-Appellants, however, assailed CRMD's ruling for its alleged complete disregard of the statutory definition of treasury shares under Section 9 of the Corporation Code. The Commission does not agree with CRMD. Section 41 of the Code categorically provides: "Sec. 41. Power to acquire own shares. A stock corporation shall have the power to purchase or acquire its own shares for a legitimate corporate purpose or purposes, including but not limited to the following cases: Provided , That the corporation has unrestricted retained earnings in its books to covert the shares to be purchased or acquired: x x x" (Emphasis ours) In the case of Philip Turner, et al. vs. Lorenzo Shipping Corporations , 8 the Supreme Court emphasized that the requirement of unrestricted retained earnings is based on the trust fund doctrine which considers capital stock, property, and other assets of a corporation, as equity in trust for the payment of corporate creditors, who are assured by law that corporate assets will not be used to purchase its own stock as longs as it has outstanding obligations, to wit: "The trust fund doctrine backstops the requirement of unrestricted retained earnings to fund the payment of the shares of stocks of the withdrawing stockholders. Under the doctrine, the capital stock, property, and other assets of a corporation are regarded as equity in trust for the payment of corporate creditors, who are preferred in the distribution of corporate assets. The creditors of a corporation have the right to assume that the board of directors will not use the assets of the corporation to purchase its own stock for as long as the corporation has outstanding debts and liabilities. There can be no distribution of assets among the stockholders without first paying corporate debts. Thus, any disposition of corporate funds and assets to the prejudice of creditors is null and void." Meanwhile, Section 9 of the Corporation Code defines treasury shares, to wit: "Sec. 9. Treasury shares. Treasury shares are shares of stock which have been issued and fully paid for but subsequently reacquired by the issuing corporation by purchase, redemption, donation or through some other lawful means. Such shares may again be disposed of for a reasonable price fixed by the board of directors." In the case of San Miguel Corp. v. Sandiganbayan , 9 the Supreme Court explained the nature and characteristics of a treasury share, to wit: "Although authorities may differ on the exact legal and accounting status of the so-called 'treasury shares,' they are more or less in agreement that treasury shares are stocks issued and fully paid for and re-acquired by the corporation either by purchase, donation, forfeiture or other means. Treasury shares are therefore issued shares , but being in the treasury they do not have the status of outstanding shares . Consequently, although a treasury share, not having been retired by the corporation re-acquiring it, may be re-issued or sold again, such share, as long as it is held by the corporation as a treasury share, participates neither in dividends, because dividends cannot be declared by the corporation to itself, nor in the meetings of the corporation as voting stock, for otherwise equal distribution of voting powers among stockholders will be effectively lost and the directors will be able to perpetuate their control of the corporation, though it still foregoing essential features of a treasury stock are lacking in the questioned shares." (Emphasis ours) On the basis of the foregoing, it is not difficult to discern and identify that the flaw in the position/ruling of the CRMD rests in its failure to consider that treasury shares are essentially issued and fully paid shares, as correctly pointed out by Petitioners-Appellants. Statutorily, therefore, shares which have not yet been issued by a corporation can never become treasury shares. In the instant case, the 7,945,151 shares that ABERDI was intending to issue to itself under the proposed Amended Merger are unissued shares. These shares will never become treasury shares. Necessarily, Section 41 of the Corporation Code which requires, sine qua non , the presence of unrestricted retained earnings for a corporation to validly acquire its own shares is not applicable. Accordingly, while this Commission sustains the denial of the Amended Merger, the legal basis for such denial is not due to ABERDI's failure to comply with Section 41 of the Corporation Code, but because under Section 80 thereof, ABERDI cannot possibly issue shares to itself considering that it already automatically acquired all the assets of NAKEEN by operation of law, after the Merger was approved. More importantly, under Section 80 (2) of the Corporation Code, Appellants ceased to have a legal personality to file the Amended Plan of Merger after the Merger was approved because their separate existence ceased by operation of law. WHEREFORE , premises considered, the Memorandum on Appeal is hereby DENIED for lack of merit. SO ORDERED. Makati City, Philippines. (SGD.) EMILIO B. AQUINO Chairperson (SGD.) JAVEY PAUL D. FRANCISCO Commissioner (SGD.) KELVIN LESTER K. LEE Commissioner (SGD.) KARLO S. BELLO Commissioner (SGD.) MCJILL BRYANT T. FERNANDEZ Commissioner Footnotes 1. August 3, 2012. 2. See Annex "C" (BIR Ruling No. 508-12 dated 3 August 2012) to the Appeal. 3. See Par. 24 (page 5) of the Appeal. 4. Section 79 of the Corporation Code for the effectivity of merger or consolidation, to wit: "The articles of merger or of consolidation, signed and certified as herein above required, shall be submitted to the Securities and Exchange Commission in quadruplicate for its approval: Provided. That in the case of merger or consolidation of banks or banking institutions, building and loan associations, trust companies, insurance companies, public utilities, educational institutions and other special corporations governed by special laws, the favorable recommendation of the appropriate government agency shall first be obtained. If the Commission is satisfied that the merger or consolidation of the corporations concerned is not inconsistent with the provisions of this Code and existing laws, it shall issue a certificate of merger or of consolidation, at which time the merger or consolidation shall be effective ." (Emphasis supplied) 5. G.R. No. 192398, [September 29, 2014], 744 PHIL. 313-332. 6. G.R. No. 175188, [July 15, 2015], 764 PHIL. 42-53. 7. " Section 62. Consideration for stocks . Stocks shall not be issued for a consideration less than the par or issued price thereat. x x x" 8. G.R. No. 157479, 24 November 2010. 9. G.R. Nos. 104637-38 & 109797, September 14, 2000.