Sycip, Gorres, Velayo & Co.

January 23, 1985 Sycip, Gorres, Velayo & Co. P. O. Box 589, Manila 2800 Attention : F . G . Tagao Tax Division Gentlemen: This relates to your letter dated January 14, 1985, requesting the opinion of this Commission on the queries posed therein. It appears that General Credit Corporation is the rehabilitated Commercial Credit Corporation. The queries posed affecting said corporation is whether the corporation can redeem its preferred shares given the following conditions: a. The redemption is to be made before the redemption period; b. The preferred shares shall be redeemed at lower than par value; c. Absence of retained earnings; d. Redemption is approved by 2/3 votes of the common shareholders and that such redemption will not prejudice the interest of the minority shareholders. Article Seventh of the Amended Articles of Incorporation of General Credit Corporation (formerly: Commercial Credit Corporation) is quoted herein as follows: "That the capital stock of said corporation is FORTY MILLION (P40,000,000.00) PESOS, and said capital stock is divided into THREE HUNDRED THOUSAND (300,000) common shares and ONE HUNDRED THOUSAND (100,000) preferred shares of stock, both with a par value of ONE HUNDRED (P100.00) PESOS each. The preferred stock shall not have the right to vote but is entitled to an annual dividend of ten (10%) percent, payable semi-annually out of the net profits before any dividend is declared upon the common stock of this company. Should the net profits in any year be insufficient to pay such preferred dividend, either in whole or in part, any unpaid portion thereof shall become a charge against the future net profits of the company, and shall be paid in full out of such net profit before any dividends are paid upon the common stock; but the preferred stock shall not participate with the holders of common shares in the surplus profits after the amount of the stipulated preferred dividend has been and shall be redeemable at the option of the company at any time five (5) years after their issuance upon payment of any dividend still due and three (3%) percent premium above par value ." (emphasis supplied) Most modern statutes expressly authorize the issuance of redeemable stock when provided for in the articles of incorporation which must specify the power and details of its exercise (11 Fletcher, Cyc. Corps., 1971 Rev. Vol., sec. 5309 at 581). "Provisions in articles relating to the retirement of preferred stock is in effect a contract between the issuing corporation and the preferred stockholders." (Fletcher, Supra, sec. 5309 at 585, citing Franzen v. Fred Rueping Leather Co., 255 Wis. 265, 38 NW2d 517. Emphasis ours). " The right, when it exists can only be exercised in conformity with the terms of the contract , and in the manner, if any, prescribed by the statute (Fletcher, Supra, at 582, citing Fox v. Johnson & Wimsatt, Inc. 127 F2d 729. Emphasis supplied). Thus, "strict compliance with statutory or contractual provisions of redemption is essential". (Fletcher, Supra., sec. 5309, citing State v. Miller-Wohl Co., 3 Terry (43 Del) 73, 28 A2d 148). The board of directors cannot redeem shares of preferred stock upon any basis other than the corporate authority pursuant to which the preferred stock was issued and accepted by the preferred stockholders. (Fletcher, Supra, at 586, citing Hendricks v. Mill Engineering Supply Co., 68 Wash. 2d 490, 413 P2d 811). LexLib Moreover, it has been held that "provisions in certificate of incorporation fixing the time for the company's option to redeem preferred stock must be conformed to in order to effect a legal redemption". (Fletcher, Supra., sec. 5309 at 585). Neither may holders of founders shares by resolution authorizing the directors to redeem preferred stock at a price less than that fixed by the provisions of the certificate of incorporation, compels preferred stockholders to accept such payment. (People v. Imbrie & Co., 126 Misc. 457, 214 NYS 53, as cited in Fletcher, Supra, sec. 5309). It has to be stressed that "the charter of the corporation, whether it is created by special act or formed under a general corporation law, is a contract (1) between the state and the corporation; (2) between the corporation and the stockholders; and (3) between the stockholders and the state. (Martin, Commentaries and Jurisprudence on the Philippine Commercial Laws, Vol. 4, 1981 ed., p. 78, citing Government v. Manila Railroad Co., G.R. No. 30646, January 30, 1929 52 Phil. 699). All the terms of the preferred shares contract must be set forth in the certificate of incorporation and cannot be added to or changed by the by-laws, stock certificates or corporate resolutions. (Ballantine on Corporation, citing Geshill v. Glady's Balls Oil Co., 16 Del Ch. 289, 146 Atl. 337). In view of the foregoing, it is opined that General Credit Corporation cannot redeem its preferred shares before the redemption period as fixed in the articles of incorporation, nor may it redeem the same at a discount price in contravention of the provision of the corporate charter. However, should the corporation find the same necessary so as to improve its financial position, it is suggested that the company amends its articles of incorporation by changing the redemption features of its preferred shares. As to the redemption of preferred shares in the absence of retained earnings, quoted hereunder is the provision of Section V, par. 5 of SEC Rules Governing Redeemable Shares, to wit: "Redeemable shares may be redeemed regardless of the existence of unrestricted retained earnings, provided that the corporation has, after such redemption, sufficient assets in its books to cover debts and liabilities inclusive of capital stock." Redemption may not be made when a corporation is insolvent of if such redemption would cause insolvency or inability of the corporation to meet its debts as they mature. (11 Fletcher, Cyc. Corps., sec. 5309 at 581). Such limitation is based on the principle that "corporate assets are a trust fund for creditors to the extent that creditors are entitled to payment before any distribution of capital to shareholders". (Ballantine on Corporation, sec. 264 at 621). cdll Finally, please be informed that "the board of directors of corporation could exercise the right to redeem preferred stock of corporation without formal authorization by stockholders where such stock was by its charter, subject to redemption". (11 Fletcher, Cyc. Corp., sec. 5309, citing Brown v. Eastern States Corp., 86 F. Supp. 887, Aff'd. 181 F2d 26). However, where exercise of redemption right would modify the contract as expressed in the articles of incorporation, the same may not be lawfully exercised notwithstanding approval of 2/3 of the common shareholders for reasons hereinbefore stated. Please be guided accordingly. LibLex Very truly yours, (SGD.) MANUEL G. ABELLO Chairman