Perez, Olan, Lazo, Trinidad, Palabrica & Associates

April 29, 1987 Perez, Olan, Lazo, Trinidad, Palabrica & Associates 11th Floor, PLDT Bldg. Makati Ave.,Metro Manila Gentlemen: This relates to your letter, dated April 21, 1987, requesting the opinion of this Commission on the following queries in relation to Section 38 of the Corporation Code, to wit: whether the term "bonded indebtedness" refers to secured indebtedness only or whether it covers all forms of indebtedness whether secured or unsecured. are debentures which are unsecured and merely debt instruments covered by the term "bonded indebtedness." llcd Section 38 of the Corporation Code provides thus: "No corporation shall increase or decrease its capital stock or incur, create or increase any bonded indebtedness unless approved by a majority vote of the board of directors and, at a stockholders' meeting duly called for the purpose, two-thirds (2/3) of the outstanding capital stock shall favor the increase or diminution of the capital stock, or the incurring, creating or increasing of any bonded indebtedness. ...." One way of classifying debt securities is according to whether the principal amount loaned to the issuer is secured by a mortgage on the real or personal property of the debtor. (6A Fletcher, Cyc. Corp.,1981 Rev. Vol.,Sec. 2635).Debts secured by real property are usually referred to as bonds, while debts secured by the issuer's personal property are commonly referred to as collateral trust bonds. (Fletcher, sec. 2638, 2643)." A bond is a long-term debt security supported by a mortgage on corporate property ." (Fletcher, sec.,2635).The normal distinction between a corporate " bond " and a corporate "debenture" or "note" is that the former is usually secured by a mortgage ,while the latter usually is not. (5A Words and Phrases, p. 128 citing Fine v. H. Klein, Inc.,77 A 2d. 295, 298. 10 N.J. Supra 295). A comparison of Section 38 of the Corporation Code of the Philippines with Section 359 of the Civil Code of California shows that our law on the subject of creation and increase of "bonded indebtedness" is an adaptation of the law of California. Unfortunately, neither the statutory law of that state nor its judicial decisions afford any guidance as to the meaning of the term "bonded indebtedness." The only decision bearing upon the question which has been rendered by the California court up to the time is one articulated in Underhill v . Santa Barbara Land & Building & Improvement Co . ,93 Cal . 300, 307 ,which holds that a non-negotiable note issued by a corporation, although secured by mortgage, does not constitute a "bonded indebtedness" and therefore does not require the consent of shareholders. (cited in Fischer, the Philippine Law of Stock Corporation, sec. 313, par. 180).The two principal elements of distinction are time element and division of the whole debt into like aliquot part units of round denominations, represented by negotiable certificate of indebtedness, generally called "bonds",the purpose being to enable the corporation to make use of the borrowed money for a long period of years, to obtain it from a large number of people, and to facilitate the transfer of the certificate of indebtedness from hand to hand during the term of collective obligations. Such bond issues are usually secured by the transfer to a trustee of a specific property to secure the payment of debt .The effect of the creation and issuance of such obligation is a borrowing from the general public. Hence, whenever the corporation adopts this method of borrowing funds, the resulting obligations constitute "bonded indebtedness" subject to the statutory provision of the corporation law as to increase or creation. (Fischer, Supra., par. 180). Considering the foregoing, the Commission opines that "bonded indebtedness" refers to negotiable corporate bonds which are secured by mortgage on corporate property. Anent your second query, please be advised that "debentures" are serial obligations or "notes" representing indebtedness but not ordinarily secured by any specific mortgage, lien or pledge of security. (Ballantine on Corporations, sec. 210, p. 496). "They are usually issued under an indenture, in which a trust company agrees to supervise the execution of the covenants of the debtor for the benefit of all the holders." (Kesoler v. General Cable Corp., 92 Cal. App. 3d, 531, 155 Cal. Rptr. 94, cited in 6A Fletcher, Cyc. Corp., sec. 2649.1). Debentures are issued on the basis of the general credit of the corporation, and since debentures are not secured by collaterals, they are not bonded indebtedness in the true sense, and will not, therefore, require approval of the stockholders although it is a good corporate policy to require it. (Campos, Campos, Corporation Code, "Comments, Notes and Selected Cases, 1981 ed., pp. 673) Please be advised accordingly. Very truly yours, (SGD.) JULIO A. SULIT, JR. Chairman