Philippine Telegraph & Telephone Corporation

May 28, 1987 Philippine Telegraph & Telephone Corporation SCC Bldg.,106 Alvarado St. Makati, Metro Manila Attention : Simeon A . Miravete Sr . EVP Finance Gentlemen: This refers to your letter dated March 19, 1987 requesting opinion on the query posed therein. It appears therein that the above-named company amended its articles of incorporation on October 25, 1985 providing for P70 Million worth of Serial Cumulative Non-Convertible Redeemable Preferred Stocks. Said series of shares are redeemable not earlier than five (5) years from the date of issue. However, an earlier redemption is allowed upon mutual agreement of the issuer and the shareholder. You alleged that at the time the articles of incorporation was amended, the dividend interest yield in the local market was high. Generally, medium term capital funds were available for three years to five years. As a public utility company, your need for capital funds would normally be repayable over ten years or more. It was for these reasons that you structured the serial preferred shares to allow the corporation to accept redemption shorter than five years where it is difficult to get five-year capital fund. On the basis of the above explanation, you would like to assure prospective investors (Phil-Am, for one) that the corporation can issue preferred shares of the above series with a redemption period shorter than five years from date of issue. Likewise, you would like to confirm to existing holders of said series of preferred stock that the corporation has not violated the amended articles of incorporation on the issuance of said shares now outstanding and those to be issued out of the same series but which will be redeemed within a period shorter than five (5) years if such would be the best term to get capital fund. Hence, your present request. In connection therewith, Section 8 of the Corporation Code of the Philippines provides: " Redeemable shares may be issued by the corporation when expressly so provided in the articles of incorporation .They may be purchased or taken up by the corporation upon the expiration of a fixed period, regardless of the existence of unrestricted retained earnings in the books of the corporation, and upon such other terms and conditions as may be stated in the articles of incorporation, which ...terms and conditions must also be stated in the certificates of stock representing said shares." (emphasis supplied) Section (e) of Article 7 of the amended articles of incorporation of subject corporation provides, thus: (e) The redemption period of these preferred shares, for each particular series, shall be fixed by the Board of Directors which in no case shall be earlier than 5 years from date of issue; Provided, however, that such redemption period once fixed for a particular series at the time of issue may not be modified or altered while any preferred shares corresponding to the particular series remain issued and outstanding; Provided, further, that arrangements for early redemption of any outstanding preferred share prior to the fixed redemption period may be effected but upon terms and conditions mutually agreed upon between the corporation and the holder of the preferred share .(Emphasis supplied) It is clear from the aforecited provision of the amended articles of incorporation of subject corporation that the above-mentioned P70 million serial cumulative non-convertible redeemable preferred stock may be redeemed by the corporation within a period shorter than 5 years upon terms and conditions mutually agreed upon between the corporation and the holder of the preferred share where no preferred shares corresponding to the particular series remain issued and outstanding, or where the redemption period for such particular series has not been fixed by the board of directors. However, it is worth mentioning that as a rule, purchase or redemption of shares is subject to the general restriction in favor of priority of creditors and may not be made when a corporation is insolvent or if such purchase or redemption will cause insolvency or inability to meet debts and liabilities as they accrue .(SEC Opinion dated July 25, 1986, addressed to Pacific Cement Company, Inc.,citing Ballantine on Corp. sec. 263, p. 620 citing Mueller v. Kreantor & Co. Inc.,131 N.J. Eq. 475, 25A (2d) 874). llcd Section V (5) of the SEC Rules and Regulations Governing Redeemable and Treasury Shares (1982) implementing Section 8 of the Corporation Code provides, thus: "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." (emphasis supplied) Redemption of shares is, therefore, subject to the limitation quoted hereunder: "The obligation to redeem is at all times subject to the implied condition that it will not render the corporation insolvent in the sense that it would be unable to meet the debts as they mature in the usual course of business." (11 Fletcher, Cyc. Corps.,1971 Rev. Vol.,sec. 5310, p. 593, citing Kraft v. Rochambeau Holdings Co.,210 Md 325, 125 A 2d 287); "It has been held that such contracts for redemption of stock are subject to the implied limitation that they cannot be enforced if the effect is to render the corporation insolvent, or if there are other express limitations upon the right ." (Fletcher, Supra.,sec. 5310, p. 593, citing Cremmins Pierce Co. v. Kidder Peabody Acceptance Corp.,282 Mass 367, 185 NE 383, 387). "Before shares can be redeemed, three obligations must be overcome: (1) there must be no violation of the contract of those shareholders, (2) it must not constitute a preferential treatment of those shareholders, and (3) it must not prejudice creditors .(Agbayani, Commercial Laws of the Philippines, Vol. 3, 1984 ed.,p. 103, citing Stevens).For the protection of creditors, the most general limitation is that redemption shall not be paid out of capital but only from surplus (Agbayani, citing Rohrlick, 339 and Stevens, 439),but there is statutory authority that it can be made even out of capital provided that the assets remaining after redemption are equal to the corporate debts plus the amount of the capital stock item if the same is redeemed by the cancellation of the redeemed shares." (Agbayani, citing Stevens, 440). In the light of the foregoing, it clearly appears that the "trust fund doctrine" is strictly adhered to, 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 Corporations, (Sec. 264, p. 621). Subject corporation may, therefore, issue the above-mentioned series of shares redeemable within a period shorter than 5 years subject to the foregoing limitations. Please be advised accordingly. Very truly yours, (SGD.) ROSARIO N. LOPEZ Associate Commissioner