Federal Insurance Company, Inc.

November 3, 1986 Federal Insurance Company, Inc. Zuellig Bldg., Buendia Avenue Makati, Metro Manila Attention : Mr . Alvaro M . Simbulan Legal and Claims Manager Sir : This has reference to your letter dated August 13, 1986 requesting for the opinion of this Commission on the queries posed therein. LibLex The facts as presented in your letter appear as follows: Sometime in May 1983, Anscor Capital and Investment Corporation (ANSCOR) offered to sell to you preferred shares issue of Meralco, which has the following dividend features: 1. The shares shall provide cumulative dividend at the rate of 18.0% per annum payable on or before the 15th of the month following dividend declaration. 2. The first dividend payment covering the period from issue date to March 31, 1984 shall be made on or before April 15, 1984. Subsequent dividend will be declared quarterly thereafter and paid within 15 days hence. On June 27, 1983, you bought for the sum of P1,000,000.00 from Meralco, through Anscor, 100,000 shares of Meralco's Preferred Series "C" Stock. You were issued stock certificates evidencing ownership over the shares of stock with the aforequoted features indicated at the back of said certificates. During the years 1984 and 1985 Meralco paid your dividends. With respect to your quarterly dividends from 1986, however, Meralco sent you a letter dated April 8, 1986 advising that due to legal and financial constraints it will be unable to declare dividends to holder of shares of its capital stock. It also appears that in your letter dated June 3, 1986, you questioned the non-payment of your quarterly dividends since you contended that they are guaranteed by Meralco. You likewise questioned Meralco's citation of its alleged loan agreements with four syndicates of foreign banks which came to your knowledge for the first time only when you received Meralco's letter of April 3, 1986. In reply to your letter, Meralco countered that it is in the nature of dividends that they become payable only if the Board of Directors makes a declaration of such dividends; that there is no actionable liability of the company issuing the preferred share to declare dividends thereon when the financial condition of the company does not warrant such a declaration; and that payment of dividend can never, by its very nature, be guaranteed. Later on, you found out that Meralco was allowed to increase its capitalization by issuing preferred shares of stock in lieu of foreign borrowings where interest expenses it had to pay had increased by 60%. On the basis of the foregoing facts, you now seek our opinion on the following queries. 1. In the light of the decision of the Board of Energy, Annex F thereof, whereby Meralco, in order to raise needed funds, was authorized to issue and sell to the public preferred shares instead of resorting to foreign borrowings which has become too expensive, is not the issuance of preferred shares in legal effect a form of borrowing from the buyers of said preferred shares such that payment of dividends on the due dates, as stated in the written General Terms and Conditions, Annex A thereof, and as printed at the back of the Stock Certificate, Annex B thereof, guaranteed by Meralco? 2. Is not Meralco guilty of non-disclosure of material facts to investors when at the time of the offering of the preferred shares it did not inform prospective investors of legal constraints contained in its Loan Agreements with foreign banks which are material to the payment of dividends? 3. By paying dividends on the due dates in 1984 and 1985, is not Meralco now estopped from invoking the alleged legal and financial constraints which were already existing in 1984 and 1985? Relative to your first query, please be informed that the issuance of preferred shares is not a form of loan to the corporation from the holders of the preferred shares, thus, guaranteeing the payment of dividends. Neither is a holder of preferred stock or considered as a creditor of the corporation. The following rulings are appropriate: "The general rule is that a holder of preferred stock, even though the preferred dividend is guaranteed, is not regarded as a creditor of the corporation, and entitled as such to share with the creditors in the distribution of the assets. He is, like the holders of the common stock, merely a stockholder but with the difference, that he is entitled to priority of payments out of the assets which remain after all debts are paid, the holders of the common stock sharing in such assets as are left." (Fletcher's Vol. 11, p. 853 citing Hazel Atlas Glass Co. v. Van Dyke & Reeves, Inc. 8 F. (2d) 710, 710). cdll "Preferred stockholders are shareholders in the corporation, with all the rights and liabilities of stockholders, and are not creditors of the corporation unless made by such valid provision in their contract, except in a limited and peculiar sense in some degree assimilating that relation, as your dissolution and the fact that the dividends are in terms, guaranteed, does not make them creditors." (Fletcher's, Vol. 11, p. 848, citing Warren v. King 108 U.S. 389, 27L. Ed. 769, 2 Sup. Ct. 789, Aff'g. 2 Fed. 36). Anent your second query, it is opined that there is no obligation on the part of Meralco to disclose facts to investors as your contract does not obligate it to do so. Furthermore, stockholders, whether preferred or common, are like ordinary investors who take risks in investing in business or purchasing shares in a corporation. A preferred stockholder signifies his purpose to participate in the venture of carrying on the business for which the company was incorporated, and his willingness to share in the profits and losses of the enterprise." (Best v. Oklahoma Mill Co. 124 Okla. 135 Pac. 1005 cited in Fletcher's Vol. 11, p. 831). Insofar as your third query is concerned, there can be no doubt that Meralco is not estopped from invoking legal and financial constraints although they were already existing in 1984 and 1985. It must be noted that "the holders of preferred stock are entitled only when there are profits out of which dividends may be declared . . . . Accordingly, notwithstanding the language or terms of the certificate guaranteeing dividend on preferred stock, it will be construed to be a guaranty of payment only in the event that dividends are earned because a corporation can only pay dividends out of profits. That is, the guaranty merely means that the holders of the stocks are entitled to the specified dividends when there are profits to pay them and not otherwise. . . . ." Such a guarantee, may, however, have the possible effect of making right to the dividends cumulative, that is, making the profits of one year make up for the deficiencies of the preceding year. (Fletcher's Vol. 12, p. 178). Likewise, it is worthy to note that the General Terms and Conditions of the contract itself protect you since it is provided therein that the rate of such dividends increases from 18% to 20% per annum computed from the day following the date of the immediately preceding dividend payment, should subsequent quarterly dividend payments not be made on or before the quarterly dividend payment dates. Since said share is cumulative, it also follows that you are entitled to payment of all the arrears. Please be advised accordingly. LexLib Very truly yours, (SGD.) JULIO A. SULIT, JR. Chairman