Re : Appraisal Right of Preferred Shares

February 13, 2004 SEC OPINION NO. 09-04 Re : Appraisal Right of Preferred Shares Atty. Marcelo T. Dy Corporate Secretary Rizal Commercial Banking Corporation Makati City S i r : This refers to your letter dated 21 October 2003 requesting opinion whether Philip and Elnora Turner may exercise their appraisal right under Section 81 (1) of the Corporation Code despite the fact that they voted against the Amendment of the Articles of Incorporation allowing redemption of its outstanding preferred shares before five (5) years. You mentioned that in a special stockholders' meeting of RCBC held last 30 October 2000, particularly on the removal of "super majority voting requirement" in the amended articles of incorporation and by-laws, Spouses Turner, as common stockholders, voted against the said amendments and availed of their appraisal right as dissenting stockholders. On 12 September 2003, another amendment was approved in a stockholders' meeting allowing the redemption of the outstanding preferred shares before five (5) years. The said amendment reads in part: "Preferred shares shall be redeemable in five (5) years from the date of issue or earlier at the option of the Bank subject to prior approval of the Bangko Sentral ng Pilipinas and the shares to be redeemed are replaced with at least an equivalent amount of newly paid-in shares so that the total paid-in capital stock of the Bank is maintained at the same level immediately prior to redemption or are replaced with at least an equivalent amount in Tier 2 capital as qualifying a capital of the Bank. " Again during this 12 September 2003 special stockholders' meeting, the Turners dissented on the amendment and manifested their intention to exercise their appraisal rights. Hence, this query. Pertinent to the issue is Section 81 of the Corporation Code which provides: " Instances of appraisal right . Any stockholder of a corporation shall have the right to dissent and demand payment of the fair value of his shares in the following instances: 1. In case any amendment to the articles of incorporation has the effect of changing or restricting the rights of any stockholder or class of shares, or of authorizing preferences in any respect superior to those of outstanding shares of any class, or of extending or shortening the term of corporate existence;" xxx xxx xxx On the other hand, Art. 7 of your Articles of Incorporation states in part: aTADcH xxx xxx xxx "Preferred shares shall be redeemable in five (5) years from the date of issue subject to prior approval of the Bangko Sentral ng Pilipinas and the shares to be redeemed are replaced with at least an equivalent amount of newly paid-in shares so that the total paid-in capital stock of the Bank is maintained at the same level immediately prior to redemption." xxx xxx xxx It is your view that the afore-quoted amendment of the Articles which will result in the earlier redemption of the preferred shares and their replacement by capital notes cannot be said to have adversely affected the rights of Philip and Elena Turner as common stockholders. We do not agree. Should there be redemption of preferred shares and the same will be replaced by Capital Notes, holders of preferred shares will be transformed into creditors of the corporation. It is a general rule that a corporation cannot give preferred shareholders a claim for dividends or for a return of investment equal or superior to the right of creditors to payment of their claims. 1 Such arrangement, unless authorized by the statute, is deemed contrary to the policy of the corporation law. 2 The shareholders, both common and preferred, are risk-takers who are required to invest capital in the business and who can look only to what is left after creditors are fully provided for. Thus, in the absence of a clear statute, the claims of shareholders cannot be secured by a lien on the corporate assets. 3 Anent your claim that " the replacement of Capital Note are strictly speaking not the newly paid-in shares mentioned in the above-quoted provision of RCBCs Articles of Incorporation, they have the same purpose of maintaining the levels of capital required by BSP ," the same cannot be sustained being contrary to what is stated. Moreover, redemption of preferred shares frequently involves a reduction of legal capital, although not necessarily so, as preferred shares may be redeemed out of surplus. If redeemable shares are acquired from surplus, the surplus should be reduced. The purchase by a corporation of its own shares is objectionable from the standpoint of creditors when the purchase price is paid out of capital, that is, if corporate assets are paid out below the limit fixed by the legal capital. If shares are acquired by purchase and payment is made out of a surplus of assets over liabilities, including legal capital, creditors have no cause for complaint. 4 The newly paid-in shares and Capital Notes may be in pursuance of the same purpose/s but are of different nature. Newly paid-in shares refer to the amount paid for the subscription of stock in a corporation including the amount paid in excess of par value, net of treasury stock. 5 On the other hand, Capital Notes are debt instruments. In case of liquidation proceedings, creditors have superior rights than shareholders. Hence, in case capital notes will be used to maintain the levels of capital required by BSP, there is a substantial or fundamental effect on the rights of the common stockholders. Consequently, the latter may exercise their appraisal rights under Section 81 (1) of the Corporation Code. Very truly yours, (SGD.) VERNETTE G. UMALI-PACO General Counsel Footnotes 1. Ballantine on Corporations (Revised Edition, 1946) p. 503. 2. Ibid. 3. Ibid. 4. Villanueva, Cesar L.,Philippine Corporation Law, p. 546. 5. Lopez, Rosario N.,Vol. 1, p. 105.