Valdes, Asuncion, Gomez and Associates

September 23, 1986 Valdes, Asuncion, Gomez and Associates c/o Atty. V. V. Asuncion, Jr. 3rd Floor, Cacho-Gonzales Building Cor. Trasierra & Aguirre Streets Legaspi Village, Makati Metro Manila Gentlemen: This refers to your letter dated June 17, 1986, requesting for reconsideration of the Commission's ruling that paid-in surplus cannot be declared as stock dividends. cdll The Commission, in an opinion dated October 18, 1983, ruled that paid-in surplus cannot be declared as dividends, the basis of which is Section 43 of the Corporation Code which provides that dividends can be declared only from the unrestricted retained earnings. The law provides, thus: "SECTION 43. Power to declare dividends . The board of Directors of stock corporations may declare dividends out of the unrestricted retained earnings which shall be payable in cash, in property, or in stock to all stockholders on the basis of outstanding stock held by them: ... It is evident from the aforecited provision that dividends must be declared and paid out of the unrestricted retained earnings of the corporation. However, you believe otherwise, and contend that: 1. Retained earnings include paid-in surplus You claim that the term "retained earnings" does not have any special definition in our corporation law and is often synonymously with "net profits" or "surplus profits". The word "surplus" itself represents the net assets of a corporation in excess of all liabilities, including its capital stock and is commonly classified into two: earned surplus and paid-in surplus. Earned surplus results from profitable operations of the company, and paid-in surplus arises from the sale or issuance of stock at more than par. Like retained earnings, the term "surplus profits" has no fixed meaning in our dividend law and different constructions may be given to it under varying circumstances. You contend the general view that where the property or assets of a corporation have accumulated in excess of its chartered capital and other liabilities, the excess may be regarded as constituting a surplus of profits, available for dividends. (Randall v. Bailey, 288, NY 280, 43 N.E. 2d. 43; George E. Warren Co. vs. US /6 F. Suppl. 587). Thus, for purposes of dividend declaration, you submit that the term "retained earnings" could not be limited to refer only to the accumulated profits realized out of the direct and normal operations of the corporation, but must also include earnings from its other transactions. cdll 2. Stock dividend is not capital distribution That the declaration of stock dividend out of paid-in surplus will not in any way impair the capital of the corporation as there is no actual distribution of the capital or assets of the corporation below the legal capital and the liabilities. Stock dividend takes nothing from the property of the corporation, and in no way depletes its assets. There is merely a conversion of surplus assets into capital of the corporation. Hence, this present request for a reconsideration of the ruling of the Commission that paid-in surplus cannot be declared as stock dividends. Relative thereto, the Commission comments as follows: I. On the 1st contention : Surplus values arise either from earnings or from other sources and are classified into (1) earned surplus, (2) paid-in or contributed surplus , (3) revaluation surplus, and (4) reduction surplus arising from the reduction of stated capital. Where par value shares are issued and a premium paid over par, a paid-in surplus results. In many states the law gives the right to pay dividends on common shares as well as preferred out of paid-in surplus; in other states earned surplus is the normal basis for common shares and the distribution of paid-in surplus is restricted to preferred shares with disclosure of the source of the recipients of the dividends. (Ballantine on Corporation pp. 539-540). In our jurisdiction "paid-in surplus" cannot be declared as dividend (either as cash or stock) in view of the following provision of the Corporation Code: "SECTION 43. Power to declare dividends . The Board of Directors of a stock corporation may declare dividends out of the unrestricted retained earnings which shall be payable in cash, in property or in stock to all stockholders on the basis of outstanding stocks held by them." ...(emphasis supplied) From the foregoing provision, it is evident that dividends must be declared and paid out of the unrestricted retained earnings of the corporation. The term "retained earnings" as defined under the generally accepted accounting principles is understood to mean " the accumulated profits realized out of normal and continuous operations of the business after deducting therefrom distribution of stockholders and transfers to capital stock or other accounts." (Minutes of the 31st meeting of the Committee on Revision of Laws and Codes and Constitutional Amendments at the VIP Lounge at Room "A",Batasan Complex, Quezon City, Metro Manila on March 10, 1980).Retained earnings include earnings from sales of goods or services of the corporation in the ordinary course of its business, as well as the earnings from sale of corporate property other than its stocks in trade, at a price higher than its cost. However, they do not include premium on par stock ,i. e. the difference between the par value and the higher price for which the stock is sold by the corporation since this is regarded as paid-in capital (Campos and Lopez-Campos, Comments, Notes and Selected Cases, Corporation C od e pp. 771-772). LexLib Likewise, it is to be noted that under Section 6 of the Corporation Code, the entire consideration paid for no-par stocks is considered as "capital", hence, the same cannot be declared as dividends. The law provides, thus: "SECTION 6. ... Provided, further, that the entire consideration received by the corporation for its no-par value shares shall be treated as capital and shall not be available for distribution as dividends . If the law provides that the entire consideration paid for no par value shares shall be treated as "capital" and shall not be available for distribution, we find no reason why the amount paid for stock in excess of the par value should not be treated as part of its capital. The term "paid-in capital" already connotes that it is part of the capital itself. Thus, it has been held that the entire proceeds of sales of a corporation of its own stock, even when sold for more than par value, are part of its capital stock ,and therefore cannot be considered as profits earned through the conduct of business out of which dividends may be paid. ( SEC Opinion dated August 10, 1973 citing Merchants Insurers Reporting Co. and Youtz (1918) 39 Cal. App. 226, 178, p. 540). Considering that "paid-in capital surplus" is considered as part of "capital" rather than as "retained earnings",the same cannot be declared either as stock or cash dividend. II. On the 2nd contention : Since paid-in capital surplus is considered as part of capital, it is not correct to say that the same can be transferred from surplus profits account to capital account since the account itself is already part of the capital account. If by allowing the declaration of stock dividend there is no personal gain on the part of the stockholders since the total equity interest of the stockholders in the corporation before and after the declaration of stock dividend remains the same and that no creditors will be affected considering that by so doing, the corporation will not part with cash or property, we find no legal basis or justification why we should change the status of paid-in surplus. As earlier mentioned, it is already part of the capital account which under the so-called "Trust fund doctrine" cannot be diminished for the protection of the creditors. If we would allow said transaction, there would be a possibility of abuse which may result in the deception of the public by an excessive revaluation of corporate assets from time to time. It is quite difficult to determine the new value of corporate assets and this will require a kind of careful review in order to assume that the new capital presented to the public is an accurate one. In the light of the foregoing, we regret to inform you that your request for reconsideration is hereby denied. llcd Please be advised accordingly. Very truly yours, (SGD.) JULIO A. SULIT, JR. Chairman