Atty. Helen C. De Leon-Manzano

June 8, 1995 Atty. Helen C. De Leon-Manzano Tanjuatco, Sta. Maria, Tanjuatco 3rd Flr. Equitable Bank Bldg. 381 Sen. Gil Puyat Ave.,Makati, M.M. M a d a m : This refers to your letter of May 29, 1995 requesting confirmation of your opinion on the issues raised therein. llcd As stated, your client intends to purchase some of the outstanding shares of L.J. Philippine Institute, Inc. However, there appears to be a problem as the shareholders of the Company previously executed a Shareholders Agreement which contains provisions restricting the manner in which the shares of stock may be transferred. These restrictive provisions, however, are not provided for in the Articles of Incorporation or By-laws of the Company. Also, the Shareholders Agreement embodies certain provisions which are either contrary to law or to the Company's Articles of Incorporation or By-laws. On the basis of the foregoing facts, you would like to request confirmation of the following opinions: 1. That the restrictive provisions on the transfer of shares of stock as contained in the Shareholders Agreement are not legally effective because such restrictions are not provided for in the Company's Articles of Incorporation and By-laws; 2. That provisions of the Shareholders Agreement which are either contrary to law or to the Company's Articles of Incorporation or By-laws are not valid and therefore, not legally binding. "Shares of stock in a corporation are personal property, and it is well-settled that the owner has an absolute and inherent right, as an incident of his ownership, to sell and transfer the same at will, except insofar as the right may be restricted by the charter of the corporation, or the general law ,or by a valid by-law or by a valid agreement between him and the corporation ,provided the transfer is in good faith, and to a person capable of assuming the obligations of a stockholder. In the absence of such restrictions, a bonafide transfer does not require the consent of the corporation, and cannot be prevented by it or by its officers." ( SEC Opinion dated July 22, 1965 citing 12 Fletcher Sec. 5452 and reiterated in subsequent SEC Opinions) The transferable nature of ownership of shares of stock is expressly recognized under the Corporation Code of the Philippines which provides: "SECTION 63. Certificate of stock and transfer of shares . ....Shares of stock so issued are personal property and may be transferred by delivery of the certificate or certificates indorsed by the owner of his attorney-in-fact or other person legally authorized to make the transfer. ..." (Emphasis provided) Thus, the Commission had occasions to render opinions that as personal property, the facility of transferring them must not be unduly hampered by imposing restrictions as would amount to restraint on free alienation of property. In order to legally effect restrictions on the transfer of shares of stock, such restrictions must be reasonable and must be provided for in the Articles of Incorporation and stock certificates .This, however, does not mean that restrictions cannot be provided for in a separate contract, other than in the articles of incorporation. Restrictions on transfer of shares are essentially contractual in nature, and hence, may be embodied in a Shareholders Agreement. Thus, it was held that a restriction on the alienation of stock made between all the stockholders of a corporation may be enforced, if reasonable ,even though it is not contained in the certificate of incorporation or the by-laws. (12 Fletcher Sec. 5461.4, citing several authorities) According to the weight of authority, an agreement between a stockholder and the corporation giving the latter an option to purchase his shares before offering them to others is valid between the parties and as against transferees with notice .Although it may render the agreement unenforceable against purchasers without notice ,the mere absence of notice of the restrictions on the stock certificate will not affect the enforceability of the agreement against the parties themselves .(12 Fletcher Sec. 5461.6 citing several authorities) Accordingly, restrictions on the power to transfer shares of stock imposed in a Shareholders Agreement may be binding upon the stockholders who are parties thereto, since they are chargeable with notice, unless palpably unreasonable under the circumstances. The underlying test as to whether the restriction is valid and enforceable is whether the restriction is sufficiently reasonable as to justify the restriction overriding the general policy against restraint on alienation of personal property. Restrictions shall not be more onerous than granting the existing stockholders or the corporation the option to purchase the shares of the transferring stockholder with such reasonable terms, conditions or period stated therein. Reasonable option period may range from 30 to 60 days or even more, depending on the circumstances surrounding the case. After the option period has expired the stockholder is free to sell his shares of stock to anyone. A restriction clause is not valid and enforceable if it absolutely prohibits the sale or transfer of stock without the consent of the existing stockholders ,as this would violate the general law on free alienability of shares of stock. Relative to the second issue, it is well-settled that By-laws are defined as private laws of the corporation and such self-imposed private laws have, when valid, substantially the same force and effect as laws of the corporation as have the provisions of its charter in so far as the corporation and the persons within it are concerned. They are in effect written into the charter and in this sense, they become part of the fundamental law of the corporation. The corporation, and its directors and officers are bound by and must comply with them .(8 Fletcher, Sec. 4197) Likewise, the charter or articles of incorporation 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 of the Philippine Commercial laws, Vol. 4, citing Government vs. Manila Railroad Co., G.R. No. 30646, January 30, 1929, 52 Phil. 699) As such, the stockholders are duty bound to follow and observe the provisions thereof . Moreover, the Civil Code provides: "ARTICLE 5. Acts executed against the provisions of mandatory or prohibiting laws shall be void ,except when the law itself authorizes their validity." (Emphasis provided) "ARTICLE 1306. The contracting parties may establish such stipulations, clauses and conditions as they may deem convenient provided they are not contrary to law ,morals, good customs, public order or public policy." (Emphasis provided) Thus, for a shareholders agreement to be valid and enforceable, the same must not be contrary to law, articles of incorporation and by-laws of the corporation. cdll Very truly yours, (SGD.) FE ELOISA C. GLORIA Associate Commissioner