Mei

Duties of Directors and Officers

Smith v. Van Gorkom 488 A.2d 858 (Del. 1985)

Before HERRMANN, C.J., and MCNEILLY, HORSEY, MOORE and CHRISTIE, JJ., constituting the Court en banc. HORSEY, J. (for the majority): This appeal from the Court of Chancery involves a class action brought by shareholders of the defendant Trans Union Corporation (“Trans Union” or “the Company”), originally seeking rescission of a cash-out merger of Trans Union into the defendant New T Company (“New T”), a wholly-owned subsidiary of the defendant, Marmon Group, Inc. (“Marmon”). Alternate relief in the form of damages is sought against the defendant members of the Board of Directors of Trans Union, New T, and Jay A. Pritzker and Robert A. Pritzker, owners of Marmon. Following trial, the former Chancellor granted judgment for the defendant directors by unreported letter opinion dated July 6, 1982. Judgment was based on two findings: (1) that the Board of Directors had acted in an informed manner so as to be entitled to protection of the business judgment rule in approving the cash-out merger; and (2) that the shareholder vote approving the merger should not be set aside because the stockholders had been “fairly informed” by the Board of Directors before voting thereon. The plaintiffs appeal. Speaking for the majority of the Court, we conclude that both rulings of the Court of Chancery are clearly erroneous. Therefore, we reverse and direct that judgment be entered in favor of the plaintiffs and against the defendant directors for the fair value of the plaintiffs’ stockholdings in Trans Union, in accordance with Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983) We hold: (1) that the Board’s decision, reached September 20, 1980, to approve the proposed cash-out merger was not the product of an informed business judgment; (2) that the Board’s subsequent efforts to amend the Merger Agreement and take other curative action were ineffectual, both legally and factually; and (3) that the Board did not deal with complete candor with the stockholders by failing to disclose all material facts, which they knew or should have known, before securing the stockholders’ approval of the merger.

I.

The nature of this case requires a detailed factual statement. The following facts are essentially uncontradicted:

-A-

Trans Union was a publicly-traded, diversified holding company, the principal earnings of which were generated by its railcar leasing business. During the period here involved, the Company had a cash flow of hundreds of millions of dollars annually. However, the Company had difficulty in generating sufficient taxable income to offset increasingly large investment tax credits (ITCs). Accelerated depreciation deductions had decreased available taxable income against which to offset accumulating ITCs. The Company took these deductions, despite their

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effect on usable ITCs, because the rental price in the railcar leasing market had already impounded the purported tax savings. In the late 1970’s, together with other capital-intensive firms, Trans Union lobbied in Congress to have ITCs refundable in cash to firms which could not fully utilize the credit. During the summer of 1980, defendant Jerome W. Van Gorkom, Trans Union’s Chairman and Chief Executive Officer, testified and lobbied in Congress for refundability of ITCs and against further accelerated depreciation. By the end of August, Van Gorkom was convinced that Congress would neither accept the refundability concept nor curtail further accelerated depreciation. Beginning in the late 1960’s, and continuing through the 1970’s, Trans Union pursued a program of acquiring small companies in order to increase available taxable income. In July 1980, Trans Union Management prepared the annual revision of the Company’s Five Year Forecast. This report was presented to the Board of Directors at its July, 1980 meeting. The report projected an annual income growth of about 20%. The report also concluded that Trans Union would have about $195 million in spare cash between 1980 and 1985, “with the surplus growing rapidly from 1982 onward.” The report referred to the ITC situation as a “nagging problem” and, given that problem, the leasing company “would still appear to be constrained to a tax breakeven.” The report then listed four alternative uses of the projected 1982-1985 equity surplus: (1) stock repurchase; (2) dividend increases; (3) a major acquisition program; and (4) combinations of the above. The sale of Trans Union was not among the alternatives. The report emphasized that, despite the overall surplus, the operation of the Company would consume all available equity for the next several years, and concluded: “As a result, we have sufficient time to fully develop our course of action.”

-B- On August 27, 1980, Van Gorkom met with Senior Management of Trans Union. Van Gorkom reported on his lobbying efforts in Washington and his desire to find a solution to the tax credit problem more permanent than a continued program of acquisitions. Various alternatives were suggested and discussed preliminarily, including the sale of Trans Union to a company with a large amount of taxable income. Donald Romans, Chief Financial Officer of Trans Union, stated that his department had done a “very brief bit of work on the possibility of a leveraged buy-out.” This work had been prompted by a media article which Romans had seen regarding a leveraged buy-out by management. The work consisted of a “preliminary study” of the cash which could be generated by the Company if it participated in a leveraged buy-out. As Romans stated, this analysis “was very first and rough cut at seeing whether a cash flow would support what might be considered a high price for this type of transaction.” On September 5, at another Senior Management meeting which Van Gorkom attended, Romans again brought up the idea of a leveraged buy-out as a “possible strategic alternative” to the Company’s acquisition program. Romans and Bruce S. Chelberg, President and Chief Operating Officer of Trans Union, had been working on the matter in preparation for the meeting. According to Romans: They did not “come up” with a price for the Company. They merely “ran the numbers” at $50 a share and at $60 a share with the “rough form” of their cash figures at the time. Their “figures indicated that $50 would be very easy to do but $60 would be very difficult to do under those figures.” This work did not purport to establish a fair price for either the Company or 100% of the stock. It was intended to determine the cash flow needed to service the debt that would “probably” be incurred in a leveraged buy-out, based on “rough

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calculations” without “any benefit of experts to identify what the limits were to that, and so forth.” These computations were not considered extensive and no conclusion was reached. At this meeting, Van Gorkom stated that he would be willing to take $55 per share for his own 75,000 shares. He vetoed the suggestion of a leveraged buy-out by Management, however, as involving a potential conflict of interest for Management. Van Gorkom, a certified public accountant and lawyer, had been an officer of Trans Union for 24 years, its Chief Executive Officer for more than 17 years, and Chairman of its Board for 2 years. It is noteworthy in this connection that he was then approaching 65 years of age and mandatory retirement. For several days following the September 5 meeting, Van Gorkom pondered the idea of a sale. He had participated in many acquisitions as a manager and director of Trans Union and as a director of other companies. He was familiar with acquisition procedures, valuation methods, and negotiations; and he privately considered the pros and cons of whether Trans Union should seek a privately or publicly-held purchaser. Van Gorkom decided to meet with Jay A. Pritzker, a well-known corporate takeover specialist and a social acquaintance. However, rather than approaching Pritzker simply to determine his interest in acquiring Trans Union, Van Gorkom assembled a proposed per share price for sale of the Company and a financing structure by which to accomplish the sale. Van Gorkom did so without consulting either his Board or any members of Senior Management except one: Carl Peterson, Trans Union’s Controller. Telling Peterson that he wanted no other person on his staff to know what he was doing, but without telling him why, Van Gorkom directed Peterson to calculate the feasibility of a leveraged buy-out at an assumed price per share of $55. Apart from the Company’s historic stock market price,5 and Van Gorkom’s long association with Trans Union, the record is devoid of any competent evidence that $55 represented the per share intrinsic value of the Company. Having thus chosen the $55 figure, based solely on the availability of a leveraged buy-out, Van Gorkom multiplied the price per share by the number of shares outstanding to reach a total value of the Company of $690 million. Van Gorkom told Peterson to use this $690 million figure and to assume a $200 million equity contribution by the buyer. Based on these assumptions, Van Gorkom directed Peterson to determine whether the debt portion of the purchase price could be paid off in five years or less if financed by Trans Union’s cash flow as projected in the Five Year Forecast, and by the sale of certain weaker divisions identified in a study done for Trans Union by the Boston Consulting Group (“BCG study”). Peterson reported that, of the purchase price, approximately $50-80 million would remain outstanding after five years. Van Gorkom was disappointed, but decided to meet with Pritzker nevertheless. Van Gorkom arranged a meeting with Pritzker at the latter’s home on Saturday, September 13, 1980. Van Gorkom prefaced his presentation by stating to Pritzker: “Now as far as you are concerned, I can, I think, show how you can pay a substantial premium over the present stock price and pay off most of the loan in the first five years. * * * If you could pay $55 for this Company, here is a way in which I think it can be financed.” Van Gorkom then reviewed with Pritzker his calculations based upon his proposed price of $55 per share. Although Pritzker mentioned $50 as a more attractive figure, no other price

5 The common stock of Trans Union was traded on the New York Stock Exchange. Over the five year period from 1975 through 1979, Trans Union’s stock had traded within a range of a high of $39 1/2 and a low of $24 1/4 . Its high and low range for 1980 through September 19 (the last trading day before announcement of the merger) was $38 1/4 -$29 1/2 .

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was mentioned. However, Van Gorkom stated that to be sure that $55 was the best price obtainable, Trans Union should be free to accept any better offer. Pritzker demurred, stating that his organization would serve as a “stalking horse” for an “auction contest” only if Trans Union would permit Pritzker to buy 1,750,000 shares of Trans Union stock at market price which Pritzker could then sell to any higher bidder. After further discussion on this point, Pritzker told Van Gorkom that he would give him a more definite reaction soon. On Monday, September 15, Pritzker advised Van Gorkom that he was interested in the $55 cash-out merger proposal and requested more information on Trans Union. Van Gorkom agreed to meet privately with Pritzker, accompanied by Peterson, Chelberg, and Michael Carpenter, Trans Union’s consultant from the Boston Consulting Group. The meetings took place on September 16 and 17. Van Gorkom was “astounded that events were moving with such amazing rapidity.” On Thursday, September 18, Van Gorkom met again with Pritzker. At that time, Van Gorkom knew that Pritzker intended to make a cash-out merger offer at Van Gorkom’s proposed $55 per share. Pritzker instructed his attorney, a merger and acquisition specialist, to begin drafting merger documents. There was no further discussion of the $55 price. However, the number of shares of Trans Union’s treasury stock to be offered to Pritzker was negotiated down to one million shares; the price was set at $38--75 cents above the per share price at the close of the market on September 19. At this point, Pritzker insisted that the Trans Union Board act on his merger proposal within the next three days, stating to Van Gorkom: “We have to have a decision by no later than Sunday [evening, September 21] before the opening of the English stock exchange on Monday morning.” Pritzker’s lawyer was then instructed to draft the merger documents, to be reviewed by Van Gorkom’s lawyer, “sometimes with discussion and sometimes not, in the haste to get it finished.” On Friday, September 19, Van Gorkom, Chelberg, and Pritzker consulted with Trans Union’s lead bank regarding the financing of Pritzker’s purchase of Trans Union. The bank indicated that it could form a syndicate of banks that would finance the transaction. On the same day, Van Gorkom retained James Brennan, Esquire, to advise Trans Union on the legal aspects of the merger. Van Gorkom did not consult with William Browder, a Vice-President and director of Trans Union and former head of its legal department, or with William Moore, then the head of Trans Union’s legal staff. On Friday, September 19, Van Gorkom called a special meeting of the Trans Union Board for noon the following day. He also called a meeting of the Company’s Senior Management to convene at 11:00 a.m., prior to the meeting of the Board. No one, except Chelberg and Peterson, was told the purpose of the meetings. Van Gorkom did not invite Trans Union’s investment banker, Salomon Brothers or its Chicago-based partner, to attend. Of those present at the Senior Management meeting on September 20, only Chelberg and Peterson had prior knowledge of Pritzker’s offer. Van Gorkom disclosed the offer and described its terms, but he furnished no copies of the proposed Merger Agreement. Romans announced that his department had done a second study which showed that, for a leveraged buy-out, the price range for Trans Union stock was between $55 and $65 per share. Van Gorkom neither saw the study nor asked Romans to make it available for the Board meeting. Senior Management’s reaction to the Pritzker proposal was completely negative. No member of Management, except Chelberg and Peterson, supported the proposal. Romans

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objected to the price as being too low;6 he was critical of the timing and suggested that consideration should be given to the adverse tax consequences of an all-cash deal for low-basis shareholders; and he took the position that the agreement to sell Pritzker one million newly-issued shares at market price would inhibit other offers, as would the prohibitions against soliciting bids and furnishing inside information to other bidders. Romans argued that the Pritzker proposal was a “lock up” and amounted to “an agreed merger as opposed to an offer.” Nevertheless, Van Gorkom proceeded to the Board meeting as scheduled without further delay. Ten directors served on the Trans Union Board, five inside (defendants Bonser, O’Boyle, Browder, Chelberg, and Van Gorkom) and five outside (defendants Wallis, Johnson, Lanterman, Morgan and Reneker). All directors were present at the meeting, except O’Boyle who was ill. Of the outside directors, four were corporate chief executive officers and one was the former Dean of the University of Chicago Business School. None was an investment banker or trained financial analyst. All members of the Board were well informed about the Company and its operations as a going concern. They were familiar with the current financial condition of the Company, as well as operating and earnings projections reported in the recent Five Year Forecast. The Board generally received regular and detailed reports and was kept abreast of the accumulated investment tax credit and accelerated depreciation problem. Van Gorkom began the Special Meeting of the Board with a twenty-minute oral presentation. Copies of the proposed Merger Agreement were delivered too late for study before or during the meeting. He reviewed the Company’s ITC and depreciation problems and the efforts theretofore made to solve them. He discussed his initial meeting with Pritzker and his motivation in arranging that meeting. Van Gorkom did not disclose to the Board, however, the methodology by which he alone had arrived at the $55 figure, or the fact that he first proposed the $55 price in his negotiations with Pritzker. Van Gorkom outlined the terms of the Pritzker offer as follows: Pritzker would pay $55 in cash for all outstanding shares of Trans Union stock upon completion of which Trans Union would be merged into New T Company, a subsidiary wholly-owned by Pritzker and formed to implement the merger; for a period of 90 days, Trans Union could receive, but could not actively solicit, competing offers; the offer had to be acted on by the next evening, Sunday, September 21; Trans Union could only furnish to competing bidders published information, and not proprietary information; the offer was subject to Pritzker obtaining the necessary financing by October 10, 1980; if the financing contingency were met or waived by Pritzker, Trans Union was required to sell to Pritzker one million newly-issued shares of Trans Union at $38 per share. Van Gorkom took the position that putting Trans Union “up for auction” through a 90-day market test would validate a decision by the Board that $55 was a fair price. He told the Board that the “free market will have an opportunity to judge whether $55 is a fair price.” Van Gorkom framed the decision before the Board not as whether $55 per share was the highest price that could be obtained, but as whether the $55 price was a fair price that the stockholders should be given the opportunity to accept or reject. Attorney Brennan advised the members of the Board that they might be sued if they failed to accept the offer and that a fairness opinion was not required as a matter of law.

6 Van Gorkom asked Romans to express his opinion as to the $55 price. Romans stated that he “thought the price was too low in relation to what he could derive for the company in a cash sale, particularly one which enabled us to realize the values of certain subsidiaries and independent entities.”

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Romans attended the meeting as chief financial officer of the Company. He told the Board that he had not been involved in the negotiations with Pritzker and knew nothing about the merger proposal until the morning of the meeting; that his studies did not indicate either a fair price for the stock or a valuation of the Company; that he did not see his role as directly addressing the fairness issue; and that he and his people “were trying to search for ways to justify a price in connection with such a [leveraged buy-out] transaction, rather than to say what the shares are worth.” Romans testified: I told the Board that the study ran the numbers at 50 and 60, and then the subsequent study at 55 and 65, and that was not the same thing as saying that I have a valuation of the company at X dollars. But it was a way--a first step towards reaching that conclusion.

Romans told the Board that, in his opinion, $55 was “in the range of a fair price,” but “at the beginning of the range.” Chelberg, Trans Union’s President, supported Van Gorkom’s presentation and representations. He testified that he “participated to make sure that the Board members collectively were clear on the details of the agreement or offer from Pritzker;” that he “participated in the discussion with Mr. Brennan, inquiring of him about the necessity for valuation opinions in spite of the way in which this particular offer was couched;” and that he was otherwise actively involved in supporting the positions being taken by Van Gorkom before the Board about “the necessity to act immediately on this offer,” and about “the adequacy of the $55 and the question of how that would be tested.” The Board meeting of September 20 lasted about two hours. Based solely upon Van Gorkom’s oral presentation, Chelberg’s supporting representations, Romans’ oral statement, Brennan’s legal advice, and their knowledge of the market history of the Company’s stock, the directors approved the proposed Merger Agreement. However, the Board later claimed to have attached two conditions to its acceptance: (1) that Trans Union reserved the right to accept any better offer that was made during the market test period; and (2) that Trans Union could share its proprietary information with any other potential bidders. While the Board now claims to have reserved the right to accept any better offer received after the announcement of the Pritzker agreement (even though the minutes of the meeting do not reflect this), it is undisputed that the Board did not reserve the right to actively solicit alternate offers. The Merger Agreement was executed by Van Gorkom during the evening of September 20 at a formal social event that he hosted for the opening of the Chicago Lyric Opera. Neither he nor any other director read the agreement prior to its signing and delivery to Pritzker. On Monday, September 22, the Company issued a press release announcing that Trans Union had entered into a “definitive” Merger Agreement with an affiliate of the Marmon Group, Inc., a Pritzker holding company. Within 10 days of the public announcement, dissent among Senior Management over the merger had become widespread. Faced with threatened resignations of key officers, Van Gorkom met with Pritzker who agreed to several modifications of the Agreement. Pritzker was willing to do so provided that Van Gorkom could persuade the dissidents to remain on the Company payroll for at least six months after consummation of the merger. Van Gorkom reconvened the Board on October 8 and secured the directors’ approval of the proposed amendments--sight unseen. The Board also authorized the employment of Salomon Brothers, its investment banker, to solicit other offers for Trans Union during the proposed “market test” period.

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The next day, October 9, Trans Union issued a press release announcing: (1) that Pritzker had obtained “the financing commitments necessary to consummate” the merger with Trans Union; (2) that Pritzker had acquired one million shares of Trans Union common stock at $38 per share; (3) that Trans Union was now permitted to actively seek other offers and had retained Salomon Brothers for that purpose; and (4) that if a more favorable offer were not received before February 1, 1981, Trans Union’s shareholders would thereafter meet to vote on the Pritzker proposal. It was not until the following day, October 10, that the actual amendments to the Merger Agreement were prepared by Pritzker and delivered to Van Gorkom for execution. As will be seen, the amendments were considerably at variance with Van Gorkom’s representations of the amendments to the Board on October 8; and the amendments placed serious constraints on Trans Union’s ability to negotiate a better deal and withdraw from the Pritzker agreement. Nevertheless, Van Gorkom proceeded to execute what became the October 10 amendments to the Merger Agreement without conferring further with the Board members and apparently without comprehending the actual implications of the amendments. Salomon Brothers’ efforts over a three-month period from October 21 to January 21 produced only one serious suitor for Trans Union--General Electric Credit Corporation (“GE Credit”), a subsidiary of the General Electric Company. However, GE Credit was unwilling to make an offer for Trans Union unless Trans Union first rescinded its Merger Agreement with Pritzker. When Pritzker refused, GE Credit terminated further discussions with Trans Union in early January. In the meantime, in early December, the investment firm of Kohlberg, Kravis, Roberts & Co. (“KKR”), the only other concern to make a firm offer for Trans Union, withdrew its offer under circumstances hereinafter detailed. On December 19, this litigation was commenced and, within four weeks, the plaintiffs had deposed eight of the ten directors of Trans Union, including Van Gorkom, Chelberg and Romans, its Chief Financial Officer. On January 21, Management’s Proxy Statement for the February 10 shareholder meeting was mailed to Trans Union’s stockholders. On January 26, Trans Union’s Board met and, after a lengthy meeting, voted to proceed with the Pritzker merger. The Board also approved for mailing, “on or about January 27,” a Supplement to its Proxy Statement. The Supplement purportedly set forth all information relevant to the Pritzker Merger Agreement, which had not been divulged in the first Proxy Statement. On February 10, the stockholders of Trans Union approved the Pritzker merger proposal. Of the outstanding shares, 69.9% were voted in favor of the merger; 7.25% were voted against the merger; and 22.85% were not voted.

II. We turn to the issue of the application of the business judgment rule to the September 20 meeting of the Board. The Court of Chancery concluded from the evidence that the Board of Directors’ approval of the Pritzker merger proposal fell within the protection of the business judgment rule. The Court found that the Board had given sufficient time and attention to the transaction, since the directors had considered the Pritzker proposal on three different occasions, on September 20, and on October 8, 1980 and finally on January 26, 1981. On that basis, the Court reasoned that the Board had acquired, over the four-month period, sufficient information to reach an informed business judgment on the cash-out merger proposal. The Court ruled:

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... that given the market value of Trans Union’s stock, the business acumen of the members of the board of Trans Union, the substantial premium over market offered by the Pritzkers and the ultimate effect on the merger price provided by the prospect of other bids for the stock in question, that the board of directors of Trans Union did not act recklessly or improvidently in determining on a course of action which they believed to be in the best interest of the stockholders of Trans Union.

The Court of Chancery made but one finding; i.e., that the Board’s conduct over the entire period from September 20 through January 26, 1981 was not reckless or improvident, but informed. This ultimate conclusion was premised upon three subordinate findings, one explicit and two implied. The Court’s explicit finding was that Trans Union’s Board was “free to turn down the Pritzker proposal” not only on September 20 but also on October 8, 1980 and on January 26, 1981. The Court’s implied, subordinate findings were: (1) that no legally binding agreement was reached by the parties until January 26; and (2) that if a higher offer were to be forthcoming, the market test would have produced it, and Trans Union would have been contractually free to accept such higher offer. However, the Court offered no factual basis or legal support for any of these findings; and the record compels contrary conclusions. Under Delaware law, the business judgment rule is the offspring of the fundamental principle, codified in §141(a), that the business and affairs of a Delaware corporation are managed by or under its board of directors. In carrying out their managerial roles, directors are charged with an unyielding fiduciary duty to the corporation and its shareholders. The business judgment rule exists to protect and promote the full and free exercise of the managerial power granted to Delaware directors. The rule itself “is a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.” Aronson [v. Lewis, 473 A.2d 805 (Del. 1984)] at 812. Thus, the party attacking a board decision as uninformed must rebut the presumption that its business judgment was an informed one. Id. The determination of whether a business judgment is an informed one turns on whether the directors have informed themselves “prior to making a business decision, of all material information reasonably available to them.” Id. Under the business judgment rule there is no protection for directors who have made “an unintelligent or unadvised judgment.” Mitchell v. Highland-Western Glass, 167 A. 831, 833 (Del. Ch. 1933). A director’s duty to inform himself in preparation for a decision derives from the fiduciary capacity in which he serves the corporation and its stockholders. Since a director is vested with the responsibility for the management of the affairs of the corporation, he must execute that duty with the recognition that he acts on behalf of others. Such obligation does not tolerate faithlessness or self-dealing. But fulfillment of the fiduciary function requires more than the mere absence of bad faith or fraud. Representation of the financial interests of others imposes on a director an affirmative duty to protect those interests and to proceed with a critical eye in assessing information of the type and under the circumstances present here. Thus, a director’s duty to exercise an informed business judgment is in the nature of a duty of care, as distinguished from a duty of loyalty. Here, there were no allegations of fraud, bad faith, or self-dealing, or proof thereof. Hence, it is presumed that the directors reached their business judgment in good faith, and considerations of motive are irrelevant to the issue before us. The standard of care applicable to a director’s duty of care has also been recently restated by this Court. In Aronson, supra, we stated:

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While the Delaware cases use a variety of terms to describe the applicable standard of care, our analysis satisfies us that under the business judgment rule director liability is predicated upon concepts of gross negligence. (footnote omitted)

473 A.2d at 812. We again confirm that view. We think the concept of gross negligence is also the proper standard for determining whether a business judgment reached by a board of directors was an informed one. In the specific context of a proposed merger of domestic corporations, a director has a duty under §251(b), along with his fellow directors, to act in an informed and deliberate manner in determining whether to approve an agreement of merger before submitting the proposal to the stockholders. Certainly in the merger context, a director may not abdicate that duty by leaving to the shareholders alone the decision to approve or disapprove the agreement. Only an agreement of merger satisfying the requirements of §251(b) may be submitted to the shareholders under §251(c). It is against those standards that the conduct of the directors of Trans Union must be tested, as a matter of law and as a matter of fact, regarding their exercise of an informed business judgment in voting to approve the Pritzker merger proposal.

III. The issue of whether the directors reached an informed decision to “sell” the Company on September 20, 1980 must be determined only upon the basis of the information then reasonably available to the directors and relevant to their decision to accept the Pritzker merger proposal. This is not to say that the directors were precluded from altering their original plan of action, had they done so in an informed manner. What we do say is that the question of whether the directors reached an informed business judgment in agreeing to sell the Company, pursuant to the terms of the September 20 Agreement presents, in reality, two questions: (A) whether the directors reached an informed business judgment on September 20, 1980; and (B) if they did not, whether the directors’ actions taken subsequent to September 20 were adequate to cure any infirmity in their action taken on September 20. We first consider the directors’ September 20 action in terms of their reaching an informed business judgment.

-A- On the record before us, we must conclude that the Board of Directors did not reach an informed business judgment on September 20, 1980 in voting to “sell” the Company for $55 per share pursuant to the Pritzker cash-out merger proposal. Our reasons, in summary, are as follows: The directors (1) did not adequately inform themselves as to Van Gorkom’s role in forcing the “sale” of the Company and in establishing the per share purchase price; (2) were uninformed as to the intrinsic value of the Company; and (3) given these circumstances, at a minimum, were grossly negligent in approving the “sale” of the Company upon two hours’ consideration, without prior notice, and without the exigency of a crisis or emergency. As has been noted, the Board based its September 20 decision to approve the cash-out merger primarily on Van Gorkom’s representations. None of the directors, other than Van Gorkom and Chelberg, had any prior knowledge that the purpose of the meeting was to propose a cash-out merger of Trans Union. No members of Senior Management were present,

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other than Chelberg, Romans and Peterson; and the latter two had only learned of the proposed sale an hour earlier. Both general counsel Moore and former general counsel Browder attended the meeting, but were equally uninformed as to the purpose of the meeting and the documents to be acted upon. Without any documents before them concerning the proposed transaction, the members of the Board were required to rely entirely upon Van Gorkom’s 20-minute oral presentation of the proposal. No written summary of the terms of the merger was presented; the directors were given no documentation to support the adequacy of $55 price per share for sale of the Company; and the Board had before it nothing more than Van Gorkom’s statement of his understanding of the substance of an agreement which he admittedly had never read, nor which any member of the Board had ever seen. The defendants rely on the following factors to sustain the Trial Court’s finding that the Board’s decision was an informed one: (1) the magnitude of the premium or spread between the $55 Pritzker offering price and Trans Union’s current market price of $38 per share; (2) the amendment of the Agreement as submitted on September 20 to permit the Board to accept any better offer during the “market test” period; (3) the collective experience and expertise of the Board’s “inside” and “outside” directors;17 and (4) their reliance on Brennan’s legal advice that the directors might be sued if they rejected the Pritzker proposal. We discuss each of these grounds seriatim:

(1) A substantial premium may provide one reason to recommend a merger, but in the absence of other sound valuation information, the fact of a premium alone does not provide an adequate basis upon which to assess the fairness of an offering price. Here, the judgment reached as to the adequacy of the premium was based on a comparison between the historically depressed Trans Union market price and the amount of the Pritzker offer. Using market price as a basis for concluding that the premium adequately reflected the true value of the Company was a clearly faulty, indeed fallacious, premise, as the defendants’ own evidence demonstrates. The record is clear that before September 20, Van Gorkom and other members of Trans Union’s Board knew that the market had consistently undervalued the worth of Trans Union’s stock, despite steady increases in the Company’s operating income in the seven years preceding the merger. The Board related this occurrence in large part to Trans Union’s inability to use its ITCs as previously noted. Van Gorkom testified that he did not believe the market price accurately reflected Trans Union’s true worth; and several of the directors testified that, as a general rule, most chief executives think that the market undervalues their companies’ stock. Yet, on September 20, Trans Union’s Board apparently believed that the market stock price accurately reflected the value of the Company for the purpose of determining the adequacy of the premium for its sale. The parties do not dispute that a publicly-traded stock price is solely a measure of the value of a minority position and, thus, market price represents only the value of a single share. Nevertheless, on September 20, the Board assessed the adequacy of the premium over market, offered by Pritzker, solely by comparing it with Trans Union’s current and historical stock price.

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We reserve for discussion under Part III hereof, the defendants’ contention that their judgment, reached on September 20, if not then informed became informed by virtue of their “review” of the Agreement on October 8 and January 26.

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Indeed, as of September 20, the Board had no other information on which to base a determination of the intrinsic value of Trans Union as a going concern. As of September 20, the Board had made no evaluation of the Company designed to value the entire enterprise, nor had the Board ever previously considered selling the Company or consenting to a buy-out merger. Thus, the adequacy of a premium is indeterminate unless it is assessed in terms of other competent and sound valuation information that reflects the value of the particular business. Despite the foregoing facts and circumstances, there was no call by the Board, either on September 20 or thereafter, for any valuation study or documentation of the $55 price per share as a measure of the fair value of the Company in a cash-out context. It is undisputed that the major asset of Trans Union was its cash flow. Yet, at no time did the Board call for a valuation study taking into account that highly significant element of the Company’s assets. We do not imply that an outside valuation study is essential to support an informed business judgment; nor do we state that fairness opinions by independent investment bankers are required as a matter of law. Often insiders familiar with the business of a going concern are in a better position than are outsiders to gather relevant information; and under appropriate circumstances, such directors may be fully protected in relying in good faith upon the valuation reports of their management. Here, the record establishes that the Board did not request its Chief Financial Officer, Romans, to make any valuation study or review of the proposal to determine the adequacy of $55 per share for sale of the Company. On the record before us: The Board rested on Romans’ elicited response that the $55 figure was within a “fair price range” within the context of a leveraged buy-out. No director sought any further information from Romans. No director asked him why he put $55 at the bottom of his range. No director asked Romans for any details as to his study, the reason why it had been undertaken or its depth. No director asked to see the study; and no director asked Romans whether Trans Union’s finance department could do a fairness study within the remaining 36-hour period available under the Pritzker offer. Had the Board, or any member, made an inquiry of Romans, he presumably would have responded as he testified: that his calculations were rough and preliminary; and, that the study was not designed to determine the fair value of the Company, but rather to assess the feasibility of a leveraged buy-out financed by the Company’s projected cash flow, making certain assumptions as to the purchaser’s borrowing needs. Romans would have presumably also informed the Board of his view, and the widespread view of Senior Management, that the timing of the offer was wrong and the offer inadequate. The record also establishes that the Board accepted without scrutiny Van Gorkom’s representation as to the fairness of the $55 price per share for sale of the Company--a subject that the Board had never previously considered. The Board thereby failed to discover that Van Gorkom had suggested the $55 price to Pritzker and, most crucially, that Van Gorkom had arrived at the $55 figure based on calculations designed solely to determine the feasibility of a leveraged buy-out.19 No questions were raised either as to the tax implications of a cash-out merger or how the price for the one million share option granted Pritzker was calculated.

19

As of September 20 the directors did not know: that Van Gorkom had arrived at the $55 figure alone, and subjectively, as the figure to be used by Controller Peterson in creating a feasible structure for a leveraged buy-out by a prospective purchaser; that Van Gorkom had not sought advice, information or assistance from either inside or outside Trans Union directors as to the value of the Company as an entity or the fair price per share for 100% of its stock; that Van Gorkom had not consulted with the Company’s investment bankers or other financial analysts; that Van Gorkom had not consulted with or confided in any officer or director of the Company except Chelberg;

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None of the directors, Management or outside, were investment bankers or financial analysts. Yet the Board did not consider recessing the meeting until a later hour that day (or requesting an extension of Pritzker’s Sunday evening deadline) to give it time to elicit more information as to the sufficiency of the offer, either from inside Management (in particular Romans) or from Trans Union’s own investment banker, Salomon Brothers, whose Chicago specialist in merger and acquisitions was known to the Board and familiar with Trans Union’s affairs. Thus, the record compels the conclusion that on September 20 the Board lacked valuation information adequate to reach an informed business judgment as to the fairness of $55 per share for sale of the Company.

(2) This brings us to the post-September 20 “market test” upon which the defendants ultimately rely to confirm the reasonableness of their September 20 decision to accept the Pritzker proposal. In this connection, the directors present a two-part argument: (a) that by making a “market test” of Pritzker’s $55 per share offer a condition of their September 20 decision to accept his offer, they cannot be found to have acted impulsively or in an uninformed manner on September 20; and (b) that the adequacy of the $17 premium for sale of the Company was conclusively established over the following 90 to 120 days by the most reliable evidence available--the marketplace. Thus, the defendants impliedly contend that the “market test” eliminated the need for the Board to perform any other form of fairness test either on September 20, or thereafter. Again, the facts of record do not support the defendants’ argument. There is no evidence: (a) that the Merger Agreement was effectively amended to give the Board freedom to put Trans Union up for auction sale to the highest bidder; or (b) that a public auction was in fact permitted to occur. The minutes of the Board meeting make no reference to any of this. Indeed, the record compels the conclusion that the directors had no rational basis for expecting that a market test was attainable, given the terms of the Agreement as executed during the evening of September 20. [N]otwithstanding what several of the outside directors later claimed to have “thought” occurred at the meeting, the record compels the conclusion that Trans Union’s Board had no rational basis to conclude on September 20 or in the days immediately following, that the Board’s acceptance of Pritzker’s offer was conditioned on (1) a “market test” of the offer; and (2) the Board’s right to withdraw from the Pritzker Agreement and accept any higher offer received before the shareholder meeting.

(3) The directors’ unfounded reliance on both the premium and the market test as the basis for accepting the Pritzker proposal undermines the defendants’ remaining contention that the Board’s collective experience and sophistication was a sufficient basis for finding that it reached its September 20 decision with informed, reasonable deliberation.21

and that Van Gorkom had deliberately chosen to ignore the advice and opinion of the members of his Senior Management group regarding the adequacy of the $55 price.

21 Trans Union’s five “inside” directors had backgrounds in law and accounting, 116 years of collective employment

by the Company and 68 years of combined experience on its Board. Trans Union’s five “outside” directors included four chief executives of major corporations and an economist who was a former dean of a major school of

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(4)

Part of the defense is based on a claim that the directors relied on legal advice rendered at the September 20 meeting by James Brennan, Esquire, who was present at Van Gorkom’s request. Unfortunately, Brennan did not appear and testify at trial even though his firm participated in the defense of this action. There is no contemporaneous evidence of the advice given by Brennan on September 20, only the later deposition and trial testimony of certain directors as to their recollections or understanding of what was said at the meeting. Since counsel did not testify, and the advice attributed to Brennan is hearsay received by the Trial Court over the plaintiffs’ objections, we consider it only in the context of the directors’ present claims. In fairness to counsel, we make no findings that the advice attributed to him was in fact given. We focus solely on the efficacy of the defendants’ claims, made months and years later, in an effort to extricate themselves from liability. Several defendants testified that Brennan advised them that Delaware law did not require a fairness opinion or an outside valuation of the Company before the Board could act on the Pritzker proposal. If given, the advice was correct. However, that did not end the matter. Unless the directors had before them adequate information regarding the intrinsic value of the Company, upon which a proper exercise of business judgment could be made, mere advice of this type is meaningless; and, given this record of the defendants’ failures, it constitutes no defense here. We conclude that Trans Union’s Board was grossly negligent in that it failed to act with informed reasonable deliberation in agreeing to the Pritzker merger proposal on September 20; and we further conclude that the Trial Court erred as a matter of law in failing to address that question before determining whether the directors’ later conduct was sufficient to cure its initial error. A second claim is that counsel advised the Board it would be subject to lawsuits if it rejected the $55 per share offer. It is, of course, a fact of corporate life that today when faced with difficult or sensitive issues, directors often are subject to suit, irrespective of the decisions they make. However, counsel’s mere acknowledgement of this circumstance cannot be rationally translated into a justification for a board permitting itself to be stampeded into a patently unadvised act. While suit might result from the rejection of a merger or tender offer, Delaware law makes clear that a board acting within the ambit of the business judgment rule faces no ultimate liability. Thus, we cannot conclude that the mere threat of litigation, acknowledged by counsel, constitutes either legal advice or any valid basis upon which to pursue an uninformed course. Since we conclude that Brennan’s purported advice is of no consequence to the defense of this case, it is unnecessary for us to invoke the adverse inferences which may be attributable to one failing to appear at trial and testify.

business and chancellor of a university. The “outside” directors had 78 years of combined experience as chief executive officers of major corporations and 50 years of cumulative experience as directors of Trans Union. Thus, defendants argue that the Board was eminently qualified to reach an informed judgment on the proposed “sale” of Trans Union notwithstanding their lack of any advance notice of the proposal, the shortness of their deliberation, and their determination not to consult with their investment banker or to obtain a fairness opinion.

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-B- We now examine the Board’s post-September 20 conduct for the purpose of determining … whether it was informed and not grossly negligent.

(1) First, as to the Board meeting of October 8: Its purpose arose in the aftermath of the September 20 meeting: (1) the September 22 press release announcing that Trans Union “had entered into definitive agreements to merge with an affiliate of Marmon Group, Inc.;” and (2) Senior Management’s ensuing revolt. Trans Union’s press release stated: FOR IMMEDIATE RELEASE: CHICAGO, IL--Trans Union Corporation announced today that it had entered into definitive agreements to merge with an affiliate of The Marmon Group, Inc. in a transaction whereby Trans Union stockholders would receive $55 per share in cash for each Trans Union share held. The Marmon Group, Inc. is controlled by the Pritzker family of Chicago. The merger is subject to approval by the stockholders of Trans Union at a special meeting expected to be held sometime during December or early January. Until October 10, 1980, the purchaser has the right to terminate the merger if financing that is satisfactory to the purchaser has not been obtained, but after that date there is no such right. In a related transaction, Trans Union has agreed to sell to a designee of the purchaser one million newly-issued shares of Trans Union common stock at a cash price of $38 per share. Such shares will be issued only if the merger financing has been committed for no later than October 10, 1980, or if the purchaser elects to waive the merger financing condition. In addition, the New York Stock Exchange will be asked to approve the listing of the new shares pursuant to a listing application which Trans Union intends to file shortly. Completing of the transaction is also subject to the preparation of a definitive proxy statement and making various filings and obtaining the approvals or consents of government agencies.

The press release made no reference to provisions allegedly reserving to the Board the rights to perform a “market test” and to withdraw from the Pritzker Agreement if Trans Union received a better offer before the shareholder meeting. The defendants also concede that Trans Union never made a subsequent public announcement stating that it had in fact reserved the right to accept alternate offers, the Agreement notwithstanding. The public announcement of the Pritzker merger resulted in an “en masse” revolt of Trans Union’s Senior Management. The head of Trans Union’s tank car operations (its most profitable division) informed Van Gorkom that unless the merger were called off, fifteen key personnel would resign. Instead of reconvening the Board, Van Gorkom again privately met with Pritzker, informed him of the developments, and sought his advice. Pritzker then made the following suggestions for overcoming Management’s dissatisfaction: (1) that the Agreement be amended to permit Trans Union to solicit, as well as receive, higher offers; and (2) that the shareholder meeting be postponed from early January to February 10, 1981. In return, Pritzker asked Van Gorkom to obtain a commitment from Senior Management to remain at Trans Union for at least six months after the merger was consummated. Van Gorkom then advised Senior Management that the Agreement would be amended to give Trans Union the right to solicit competing offers through January, 1981, if they would

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agree to remain with Trans Union. Senior Management was temporarily mollified; and Van Gorkom then called a special meeting of Trans Union’s Board for October 8. Thus, the primary purpose of the October 8 Board meeting was to amend the Merger Agreement, in a manner agreeable to Pritzker, to permit Trans Union to conduct a “market test.” Van Gorkom understood that the proposed amendments were intended to give the Company an unfettered “right to openly solicit offers down through January 31.” Van Gorkom presumably so represented the amendments to Trans Union’s Board members on October 8. In a brief session, the directors approved Van Gorkom’s oral presentation of the substance of the proposed amendments, the terms of which were not reduced to writing until October 10. But rather than waiting to review the amendments, the Board again approved them sight unseen and adjourned, giving Van Gorkom authority to execute the papers when he received them. Thus, the Court of Chancery’s finding that the October 8 Board meeting was convened to reconsider the Pritzker “proposal” is clearly erroneous. The next day, October 9, and before the Agreement was amended, Pritzker moved swiftly to off-set the proposed market test amendment. First, Pritzker informed Trans Union that he had completed arrangements for financing its acquisition and that the parties were thereby mutually bound to a firm purchase and sale arrangement. Second, Pritzker announced the exercise of his option to purchase one million shares of Trans Union’s treasury stock at $38 per share--75 cents above the current market price. Trans Union’s Management responded the same day by issuing a press release announcing: (1) that all financing arrangements for Pritzker’s acquisition of Trans Union had been completed; and (2) Pritzker’s purchase of one million shares of Trans Union’s treasury stock at $38 per share. The next day, October 10, Pritzker delivered to Trans Union the proposed amendments to the September 20 Merger Agreement. Van Gorkom promptly proceeded to countersign all the instruments on behalf of Trans Union without reviewing the instruments to determine if they were consistent with the authority previously granted him by the Board. The amending documents were apparently not approved by Trans Union’s Board until a much later date, December 2. The record does not affirmatively establish that Trans Union’s directors ever read the October 10 amendments. In our view, the record compels the conclusion that the directors’ conduct on October 8 exhibited the same deficiencies as did their conduct on September 20. The Board permitted its Merger Agreement with Pritzker to be amended in a manner it had neither authorized nor intended. The Court of Chancery, in its decision, overlooked the significance of the October 8-10 events and their relevance to the sufficiency of the directors’ conduct. The Trial Court’s letter opinion ignores: the October 10 amendments; the manner of their adoption; the effect of the October 9 press release and the October 10 amendments on the feasibility of a market test; and the ultimate question as to the reasonableness of the directors’ reliance on a market test in recommending that the shareholders approve the Pritzker merger. We conclude that the Board acted in a grossly negligent manner on October 8; and that Van Gorkom’s representations on which the Board based its actions do not constitute “reports” under §141(e) on which the directors could reasonably have relied. Further, the amended Merger Agreement imposed on Trans Union’s acceptance of a third party offer conditions more onerous than those imposed on Trans Union’s acceptance of Pritzker’s offer on September 20. After October 10, Trans Union could accept from a third party a better offer only if it were incorporated in a definitive agreement between the parties, and not conditioned on financing or on any other contingency.

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The October 9 press release, coupled with the October 10 amendments, had the clear effect of locking Trans Union’s Board into the Pritzker Agreement. Pritzker had thereby foreclosed Trans Union’s Board from negotiating any better “definitive” agreement over the remaining eight weeks before Trans Union was required to clear the Proxy Statement submitting the Pritzker proposal to its shareholders.

(2) Next, as to the “curative” effects of the Board’s post-September 20 conduct, we review in more detail the reaction of Van Gorkom to the KKR proposal and the results of the Board-sponsored “market test.” The KKR proposal was the first and only offer received subsequent to the Pritzker Merger Agreement. The offer resulted primarily from the efforts of Romans and other senior officers to propose an alternative to Pritzker’s acquisition of Trans Union. In late September, Romans’ group contacted KKR about the possibility of a leveraged buy-out by all members of Management, except Van Gorkom. By early October, Henry R. Kravis of KKR gave Romans written notice of KKR’s “interest in making an offer to purchase 100%” of Trans Union’s common stock. Thereafter, and until early December, Romans’ group worked with KKR to develop a proposal. It did so with Van Gorkom’s knowledge and apparently grudging consent. On December 2, Kravis and Romans hand-delivered to Van Gorkom a formal letter-offer to purchase all of Trans Union’s assets and to assume all of its liabilities for an aggregate cash consideration equivalent to $60 per share. Van Gorkom’s reaction to the KKR proposal was completely negative; he did not view the offer as being firm because of its financing condition. It was pointed out, to no avail, that Pritzker’s offer had not only been similarly conditioned, but accepted on an expedited basis. Van Gorkom refused Kravis’ request that Trans Union issue a press release announcing KKR’s offer, on the ground that it might “chill” any other offer. Romans and Kravis left with the understanding that their proposal would be presented to Trans Union’s Board that afternoon. Within a matter of hours and shortly before the scheduled Board meeting, Kravis withdrew his letter-offer. He gave as his reason a sudden decision by the Chief Officer of Trans Union’s rail car leasing operation to withdraw from the KKR purchasing group. Van Gorkom had spoken to that officer about his participation in the KKR proposal immediately after his meeting with Romans and Kravis. However, Van Gorkom denied any responsibility for the officer’s change of mind. At the Board meeting later that afternoon, Van Gorkom did not inform the directors of the KKR proposal because he considered it “dead.” Van Gorkom did not contact KKR again until January 20, when faced with the realities of this lawsuit, he then attempted to reopen negotiations. KKR declined due to the imminence of the February 10 stockholder meeting. In the absence of any explicit finding by the Trial Court as to the reasonableness of Trans Union’s directors’ reliance on a market test and its feasibility, we may make our own findings based on the record. Our review of the record compels a finding that confirmation of the appropriateness of the Pritzker offer by an unfettered or free market test was virtually meaningless in the face of the terms and time limitations of Trans Union’s Merger Agreement with Pritzker as amended October 10, 1980.

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(3) Finally, we turn to the Board’s meeting of January 26, 1981. The defendant directors rely upon the action there taken to refute the contention that they did not reach an informed business judgment in approving the Pritzker merger. The defendants contend that the Trial Court correctly concluded that Trans Union’s directors were, in effect, as “free to turn down the Pritzker proposal” on January 26, as they were on September 20. The Board’s January 26 meeting was the first meeting following the filing of the plaintiffs’ suit in mid-December and the last meeting before the previously-noticed shareholder meeting of February 10. All ten members of the Board and three outside attorneys attended the meeting. At that meeting the following facts, among other aspects of the Merger Agreement, were discussed: (a) The fact that prior to September 20, 1980, no Board member or member of Senior Management, except Chelberg and Peterson, knew that Van Gorkom had discussed a possible merger with Pritzker; (b) The fact that the price of $55 per share had been suggested initially to Pritzker by Van Gorkom; (c) The fact that the Board had not sought an independent fairness opinion; (d) The fact that, at the September 20 Senior Management meeting, Romans and several members of Senior Management indicated both concern that the $55 per share price was inadequate and a belief that a higher price should and could be obtained; (e) The fact that Romans had advised the Board at its meeting on September 20, that he and his department had prepared a study which indicated that the Company had a value in the range of $55 to $65 per share, and that he could not advise the Board that the $55 per share offer made by Pritzker was unfair. [T]he defendants argue that whatever information the Board lacked to make a deliberate and informed judgment on September 20, or on October 8, was fully divulged to the entire Board on January 26. Hence, the argument goes, the Board’s vote on January 26 to again “approve” the Pritzker merger must be found to have been an informed and deliberate judgment. On the basis of this evidence, the defendants assert: (1) that the Trial Court was legally correct in widening the time frame for determining whether the defendants’ approval of the Pritzker merger represented an informed business judgment to include the entire four-month period during which the Board considered the matter from September 20 through January 26; and (2) that, given this extensive evidence of the Board’s further review and deliberations on January 26, this Court must affirm the Trial Court’s conclusion that the Board’s action was not reckless or improvident. We cannot agree. We find the Trial Court to have erred, both as a matter of fact and as a matter of law, in relying on the action on January 26 to bring the defendants’ conduct within the protection of the business judgment rule. [T]estimony and the Board Minutes of January 26 are remarkably consistent. Both clearly indicate recognition that the question of the alternative courses of action, available to the Board on January 26 with respect to the Pritzker merger, was a legal question, presenting to the Board (after its review of the full record developed through pre-trial discovery) three options: (1) to “continue to recommend” the Pritzker merger; (2) to “recommend that the stockholders vote against” the Pritzker merger; or (3) to take a noncommittal position on the merger and “simply leave the decision to [the] shareholders.”

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We must conclude from the foregoing that the Board was mistaken as a matter of law regarding its available courses of action on January 26, 1981. Options (2) and (3) were not viable or legally available to the Board under §251(b). The Board could not remain committed to the Pritzker merger and yet recommend that its stockholders vote it down; nor could it take a neutral position and delegate to the stockholders the unadvised decision as to whether to accept or reject the merger. Under §251(b), the Board had but two options: (1) to proceed with the merger and the stockholder meeting, with the Board’s recommendation of approval; or (2) to rescind its agreement with Pritzker, withdraw its approval of the merger, and notify its stockholders that the proposed shareholder meeting was cancelled. There is no evidence that the Board gave any consideration to these, its only legally viable alternative courses of action. But the second course of action would have clearly involved a substantial risk--that the Board would be faced with suit by Pritzker for breach of contract based on its September 20 agreement as amended October 10. As previously noted, under the terms of the October 10 amendment, the Board’s only ground for release from its agreement with Pritzker was its entry into a more favorable definitive agreement to sell the Company to a third party. Thus, in reality, the Board was not “free to turn down the Pritzker proposal” as the Trial Court found. Indeed, short of negotiating a better agreement with a third party, the Board’s only basis for release from the Pritzker Agreement without liability would have been to establish fundamental wrongdoing by Pritzker. Clearly, the Board was not “free” to withdraw from its agreement with Pritzker on January 26 by simply relying on its self-induced failure to have reached an informed business judgment at the time of its original agreement. Therefore, the Trial Court’s conclusion that the Board reached an informed business judgment on January 26 in determining whether to turn down the Pritzker “proposal” on that day cannot be sustained. The Court’s conclusion is not supported by the record; it is contrary to the provisions of §251(b) and basic principles of contract law; and it is not the product of a logical and deductive reasoning process. Upon the basis of the foregoing, we hold that the defendants’ post-September conduct did not cure the deficiencies of their September 20 conduct; and that, accordingly, the Trial Court erred in according to the defendants the benefits of the business judgment rule.

IV. Whether the directors of Trans Union should be treated as one or individually in terms of invoking the protection of the business judgment rule and the applicability of §141(c) are questions which were not originally addressed by the parties in their briefing of this case. This resulted in a supplemental briefing and a second rehearing en banc on two basic questions: (a) whether one or more of the directors were deprived of the protection of the business judgment rule by evidence of an absence of good faith; and (b) whether one or more of the outside directors were entitled to invoke the protection of §141(e) by evidence of a reasonable, good faith reliance on “reports,” including legal advice, rendered the Board by certain inside directors and the Board’s special counsel, Brennan. The parties’ response, including reargument, has led the majority of the Court to conclude: (1) that since all of the defendant directors, outside as well as inside, take a unified position, we are required to treat all of the directors as one as to whether they are entitled to the protection of the business judgment rule; and (2) that considerations of good faith, including the presumption that the directors acted in good faith, are irrelevant in determining the threshold issue of whether the directors as a Board exercised an informed business judgment. For the same reason, we must reject defense counsel’s ad hominem argument for

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affirmance: that reversal may result in a multi-million dollar class award against the defendants for having made an allegedly uninformed business judgment in a transaction not involving any personal gain, self-dealing or claim of bad faith.

V. The defendants ultimately rely on the stockholder vote of February 10 for exoneration. The defendants contend that the stockholders’ “overwhelming” vote approving the Pritzker Merger Agreement had the legal effect of curing any failure of the Board to reach an informed business judgment in its approval of the merger. The parties tacitly agree that a discovered failure of the Board to reach an informed business judgment in approving the merger constitutes a voidable, rather than a void, act. Hence, the merger can be sustained, notwithstanding the infirmity of the Board’s action, if its approval by majority vote of the shareholders is found to have been based on an informed electorate. The settled rule in Delaware is that “where a majority of fully informed stockholders ratify action of even interested directors, an attack on the ratified transaction normally must fail.” Gerlach v. Gillam, 139 A.2d 591, 593 (Del.Ch. 1958). The question of whether shareholders have been fully informed such that their vote can be said to ratify director action, “turns on the fairness and completeness of the proxy materials submitted by the management to the ... shareholders.” Michelson v. Duncan, supra at 220. In Lynch v. Vickers Energy Corp., supra, this Court held that corporate directors owe to their stockholders a fiduciary duty to disclose all facts germane to the transaction at issue in an atmosphere of complete candor. We defined “germane” in the tender offer context as all “information such as a reasonable stockholder would consider important in deciding whether to sell or retain stock.” Id. at 281. Applying this standard to the record before us, we find that Trans Union’s stockholders were not fully informed of all facts material to their vote on the Pritzker Merger and that the Trial Court’s ruling to the contrary is clearly erroneous. We list the material deficiencies in the proxy materials: (1) The fact that the Board had no reasonably adequate information indicative of the intrinsic value of the Company, other than a concededly depressed market price, was without question material to the shareholders voting on the merger. Accordingly, the Board’s lack of valuation information should have been disclosed. Instead, the directors cloaked the absence of such information in both the Proxy Statement and the Supplemental Proxy Statement. Through artful drafting, noticeably absent at the September 20 meeting, both documents create the impression that the Board knew the intrinsic worth of the Company. What the Board failed to disclose to its stockholders was that the Board had not made any study of the intrinsic or inherent worth of the Company; nor had the Board even discussed the inherent value of the Company prior to approving the merger on September 20, or at either of the subsequent meetings on October 8 or January 26. Neither in its Original Proxy Statement nor in its Supplemental Proxy did the Board disclose that it had no information before it, beyond the premium-over-market and the price/earnings ratio, on which to determine the fair value of the Company as a whole. (2) We find false and misleading the Board’s characterization of the Romans report in the Supplemental Proxy Statement.

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Nowhere does the Board disclose that Romans stated to the Board that his calculations were made in a “search for ways to justify a price in connection with” a leveraged buy-out transaction, “rather than to say what the shares are worth,” and that he stated to the Board that his conclusion thus arrived at “was not the same thing as saying that I have a valuation of the Company at X dollars.” Such information would have been material to a reasonable shareholder because it tended to invalidate the fairness of the merger price of $55. Furthermore, defendants again failed to disclose the absence of valuation information, but still made repeated reference to the “substantial premium.” (3) We find misleading the Board’s references to the “substantial” premium offered. The Board gave as their primary reason in support of the merger the “substantial premium” shareholders would receive. But the Board did not disclose its failure to assess the premium offered in terms of other relevant valuation techniques, thereby rendering questionable its determination as to the substantiality of the premium over an admittedly depressed stock market price. (4) We find the Board’s recital in the Supplemental Proxy of certain events preceding the September 20 meeting to be incomplete and misleading. It is beyond dispute that a reasonable stockholder would have considered material the fact that Van Gorkom not only suggested the $55 price to Pritzker, but also that he chose the figure because it made feasible a leveraged buy-out. The directors disclosed that Van Gorkom suggested the $55 price to Pritzker. Although by January 26, the directors knew the basis of the $55 figure, they did not disclose that Van Gorkom chose the $55 price because that figure would enable Pritzker to both finance the purchase of Trans Union through a leveraged buy-out and, within five years, substantially repay the loan out of the cash flow generated by the Company’s operations. (5) The Board’s Supplemental Proxy Statement, mailed on or after January 27, added significant new matter, material to the proposal to be voted on February 10, which was not contained in the Original Proxy Statement. Some of this new matter was information which had only been disclosed to the Board on January 26; much was information known or reasonably available before January 21 but not revealed in the Original Proxy Statement. Yet, the stockholders were not informed of these facts. Included in the “new” matter first disclosed in the Supplemental Proxy Statement were the following: (a) The fact that prior to September 20, 1980, no Board member or member of Senior Management, except Chelberg and Peterson, knew that Van Gorkom had discussed a possible merger with Pritzker; (b) The fact that the sale price of $55 per share had been suggested initially to Pritzker by Van Gorkom; (c) The fact that the Board had not sought an independent fairness opinion; (d) The fact that Romans and several members of Senior Management had indicated concern at the September 20 Senior Management meeting that the $55 per share price was inadequate and had stated that a higher price should and could be obtained; and (e) The fact that Romans had advised the Board at its meeting on September 20 that he and his department had prepared a study which indicated that the Company had a value in the range of $55 to $65 per share, and that he could not advise the Board that the $55 per share offer which Pritzker made was unfair. In this case, the Board’s ultimate disclosure as contained in the Supplemental Proxy Statement related either to information readily accessible to all of the directors if they had asked the right questions, or was information already at their disposal. In short, the

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information disclosed by the Supplemental Proxy Statement was information which the defendant directors knew or should have known at the time the first Proxy Statement was issued. The defendants simply failed in their original duty of knowing, sharing, and disclosing information that was material and reasonably available for their discovery. They compounded that failure by their continued lack of candor in the Supplemental Proxy Statement. While we need not decide the issue here, we are satisfied that, in an appropriate case, a completely candid but belated disclosure of information long known or readily available to a board could raise serious issues of inequitable conduct. The burden must fall on defendants who claim ratification based on shareholder vote to establish that the shareholder approval resulted from a fully informed electorate. On the record before us, it is clear that the Board failed to meet that burden. For the foregoing reasons, we conclude that the director defendants breached their fiduciary duty of candor by their failure to make true and correct disclosures of all information they had, or should have had, material to the transaction submitted for stockholder approval.

VI. To summarize: we hold that the directors of Trans Union breached their fiduciary duty to their stockholders (1) by their failure to inform themselves of all information reasonably available to them and relevant to their decision to recommend the Pritzker merger; and (2) by their failure to disclose all material information such as a reasonable stockholder would consider important in deciding whether to approve the Pritzker offer. We hold, therefore, that the Trial Court committed reversible error in applying the business judgment rule in favor of the director defendants in this case. On remand, the Court of Chancery shall conduct an evidentiary hearing to determine the fair value of the shares represented by the plaintiffs’ class, based on the intrinsic value of Trans Union on September 20, 1980. Thereafter, an award of damages may be entered to the extent that the fair value of Trans Union exceeds $55 per share. REVERSED and REMANDED for proceedings consistent herewith. MCNEILLY, J., dissenting: The majority opinion reads like an advocate’s closing address to a hostile jury. And I say that not lightly. Throughout the opinion great emphasis is directed only to the negative, with nothing more than lip service granted the positive aspects of this case. In my opinion Chancellor Marvel (retired) should have been affirmed. The Chancellor’s opinion was the product of well reasoned conclusions, based upon a sound deductive process, clearly supported by the evidence and entitled to deference in this appeal. Because of my diametrical opposition to all evidentiary conclusions of the majority, I respectfully dissent. The first and most important error made is the majority’s assessment of the directors’ knowledge of the affairs of Trans Union and their combined ability to act in this situation under the protection of the business judgment rule. Trans Union’s Board of Directors consisted of ten men, five of whom were “inside” directors and five of whom were “outside” directors. The “inside” directors were Van Gorkom, Chelberg, Bonser, William B. Browder, Senior Vice-President-Law, and Thomas P. O’Boyle, Senior Vice-President-Administration. At the time the merger was proposed the inside five directors had collectively been employed by the Company for 116 years and had 68 years of

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combined experience as directors. The “outside” directors were A.W. Wallis, William B. Johnson, Joseph B. Lanterman, Graham J. Morgan and Robert W. Reneker. With the exception of Wallis, these were all chief executive officers of Chicago based corporations that were at least as large as Trans Union. The five “outside” directors had 78 years of combined experience as chief executive officers, and 53 years cumulative service as Trans Union directors. The inside directors wear their badge of expertise in the corporate affairs of Trans Union on their sleeves. But what about the outsiders? Dr. Wallis is or was an economist and math statistician, a professor of economics at Yale University, dean of the graduate school of business at the University of Chicago, and Chancellor of the University of Rochester. Dr. Wallis had been on the Board of Trans Union since 1962. He also was on the Board of Bausch & Lomb, Kodak, Metropolitan Life Insurance Company, Standard Oil and others. William B. Johnson is a University of Pennsylvania law graduate, President of Railway Express until 1966, Chairman and Chief Executive of I.C. Industries Holding Company, and member of Trans Union’s Board since 1968. Joseph Lanterman, a Certified Public Accountant, is or was President and Chief Executive of American Steel, on the Board of International Harvester, Peoples Energy, Illinois Bell Telephone, Harris Bank and Trust Company, Kemper Insurance Company and a director of Trans Union for four years. Graham Morgan is achemist, was Chairman and Chief Executive Officer of U.S. Gypsum, and in the 17 and 18 years prior to the Trans Union transaction had been involved in 31 or 32 corporate takeovers. Robert Reneker attended University of Chicago and Harvard Business Schools. He was President and Chief Executive of Swift and Company, director of Trans Union since 1971, and member of the Boards of seven other corporations including U.S. Gypsum and the Chicago Tribune. Directors of this caliber are not ordinarily taken in by a “fast shuffle”. I submit they were not taken into this multi-million dollar corporate transaction without being fully informed and aware of the state of the art as it pertained to the entire corporate panoroma of Trans Union. True, even directors such as these, with their business acumen, interest and expertise, can go astray. I do not believe that to be the case here. These men knew Trans Union like the back of their hands and were more than well qualified to make on the spot informed business judgments concerning the affairs of Trans Union including a 100% sale of the corporation. Lest we forget, the corporate world of then and now operates on what is so aptly referred to as “the fast track”. These men were at the time an integral part of that world, all professional business men, not intellectual figureheads. I have no quarrel with the majority’s analysis of the business judgment rule. It is the application of that rule to these facts which is wrong. An overview of the entire record, rather than the limited view of bits and pieces which the majority has exploded like popcorn, convinces me that the directors made an informed business judgment which was buttressed by their test of the market. At the time of the September 20 meeting the 10 members of Trans Union’s Board of Directors were highly qualified and well informed about the affairs and prospects of Trans Union. These directors were acutely aware of the historical problems facing Trans Union which were caused by the tax laws. They had discussed these problems ad nauseam. In fact, within two months of the September 20 meeting the board had reviewed and discussed an outside study of the company done by The Boston Consulting Group and an internal five year forecast

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prepared by management. At the September 20 meeting Van Gorkom presented the Pritzker offer, and the board then heard from James Brennan, the company’s counsel in this matter, who discussed the legal documents. Following this, the Board directed that certain changes be made in the merger documents. These changes made it clear that the Board was free to accept a better offer than Pritzker’s if one was made. The above facts reveal that the Board did not act in a grossly negligent manner in informing themselves of the relevant and available facts before passing on the merger. To the contrary, this record reveals that the directors acted with the utmost care in informing themselves of the relevant and available facts before passing on the merger. The majority finds that Trans Union stockholders were not fully informed and that the directors breached their fiduciary duty of complete candor to the stockholders required by Lynch v. Vickers Energy Corp., 383 A.2d 278 (Del. 1978) [Lynch I], in that the proxy materials were deficient in five areas. Here again is exploitation of the negative by the majority without giving credit to the positive. To respond to the conclusions of the majority would merely be unnecessary prolonged argument. But briefly what did the proxy materials disclose? The proxy material informed the shareholders that projections were furnished to potential purchasers and such projections indicated that Trans Union’s net income might increase to approximately $153 million in 1985. That projection, what is almost three times the net income of $58,248,000 reported by Trans Union as its net income for December 31, 1979 confirmed the statement in the proxy materials that the “Board of Directors believes that, assuming reasonably favorable economic and financial conditions, the Company’s prospects for future earnings growth are excellent.” This material was certainly sufficient to place the Company’s stockholders on notice that there was a reasonable basis to believe that the prospects for future earnings growth were excellent, and that the value of their stock was more than the stock market value of their shares reflected. Overall, my review of the record leads me to conclude that the proxy materials adequately complied with Delaware law in informing the shareholders about the proposed transaction and the events surrounding it. ON MOTIONS FOR REARGUMENT Following this Court’s decision, Thomas P. O’Boyle, one of the director defendants, sought, and was granted, leave for change of counsel. Thereafter, the individual director defendants, other than O’Boyle, filed a motion for reargument and director O’Boyle, through newly-appearing counsel, then filed a separate motion for reargument. Plaintiffs have responded to the several motions and this matter has now been duly considered. The Court, through its majority, finds no merit to either motion and concludes that both motions should be denied. We are not persuaded that any errors of law or fact have been made that merit reargument. However, defendant O’Boyle’s motion requires comment. Although O’Boyle continues to adopt his fellow directors’ arguments, O’Boyle now asserts in the alternative that he has standing to take a position different from that of his fellow directors and that legal grounds exist for finding him not liable for the acts or omissions of his fellow directors. Specifically, O’Boyle makes a two-part argument: (1) that his undisputed absence due to illness from both the September 20 and the October 8 meetings of the directors of Trans Union entitles him to be relieved from personal liability for the failure of the other directors to exercise due care at

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those meetings; and (2) that his attendance and participation in the January 26, 1981 Board meeting does not alter this result given this Court’s precise findings of error committed at that meeting. We reject defendant O’Boyle’s new argument as to standing because not timely asserted. Our reasons are several. One, in connection with the supplemental briefing of this case in March, 1984, a special opportunity was afforded the individual defendants, including O’Boyle, to present any factual or legal reasons why each or any of them should be individually treated. Thereafter, at argument before the Court on June 11, 1984, the following colloquy took place between this Court and counsel for the individual defendants at the outset of counsel’s argument: COUNSEL: I’ll make the argument on behalf of the nine individual defendants against whom the plaintiffs seek more than $100,000,000 in damages. That is the ultimate issue in this case, whether or not nine honest, experienced businessmen should be subject to damages in a case where-- JUSTICE MOORE: Is there a distinction between Chelberg and Van Gorkom vis-a-vis the other defendants? COUNSEL: No, sir. JUSTICE MOORE: None whatsoever? COUNSEL: I think not.

Two, in this Court’s Opinion dated January 29, 1985, the Court relied on the individual defendants as having presented a unified defense. We stated: The parties’ response, including reargument, has led the majority of the Court to conclude: (1) that since all of the defendant directors, outside as well as inside, take a unified position, we are required to treat all of the directors as one as to whether they are entitled to the protection of the business judgment rule ...

Three, previously O’Boyle took the position that the Board’s action taken January 26, 1981--in which he fully participated--was determinative of virtually all issues. Now O’Boyle seeks to attribute no significance to his participation in the January 26 meeting. Nor does O’Boyle seek to explain his having given before the directors’ meeting of October 8, 1980 his “consent to the transaction of such business as may come before the meeting.” It is the view of the majority of the Court that O’Boyle’s change of position following this Court’s decision on the merits comes too late to be considered. He has clearly waived that right. The Motions for Reargument of all defendants are denied.

Smith vs. Gorkom

Synopsis of Rule of Law.

Under the business judgment rule, a business judgment is presumed to be an informedjudgment, but the judgment will not be shielded under the rule if the decision wasunadvised.

Facts

Trans Union had large investment tax credits (ITCs) coupled with accelerated depreciationdeductions with no offsetting taxable income. Their short term solution was to acquirecompanies that would offset the ITCs, but the Chief Financial Officer, Donald Romans,suggested that Trans Union should undergo a leveraged buyout to an entity that could offsetthe ITCs. The suggestion came without any substantial research, but Romans thought that a$50-60 share price (on stock currently valued at a high of $39 ½) would be acceptable. VanGorkom did not demonstrate any interest in the suggestion, but shortly thereafter pursuedthe idea with a takeover specialist, Jay Pritzker. With only Romans’ unresearched numbersat his disposal, Van Gorkom set up an agreement with Pritzker to sell Pritzker Trans Unionshares at $55 per share. Van Gorkom also agreed to sell Pritzker one million shares of TransUnion at $39 per share if Pritzker was outbid. Van Gorkom also agreed not to solicit otherbids and agreed not to provide proprietary information to other bidders. Van Gorkom onlyincluded a couple people in the negotiations with Pritzker, and most of the seniormanagement and the Board of Directors found out about the deal on the day they had to voteto approve the deal. Van Gorkom did not distribute any information at the voting, so theBoard had only the word of Van Gorkom, the word of the President of Trans Union (whowas privy to the earlier discussions with Pritzker), advice from an attorney who suggestedthat the Board might be sued if they voted against the merger, and vague advice fromRomans who told them that the $55 was in the beginning end of the range he calculated. VanGorkom did not disclose how he came to the $55 amount. On this advice, the Boardapproved the merger, and it was also later approved by shareholders.

Issue.

The issue is whether the business judgment by the Board to approve the merger was aninformed decision.

Held

The Delaware Supreme Court held the business judgment to be gross negligence, which isthe standard for determining whether the judgment was informed. The Board has a duty to

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give an informed decision on an important decision such as a merger and can not escape theresponsibility by claiming that the shareholders also approved the merger. The directors areprotected if they relied in good faith on reports submitted by officers, but there was no reportthat would qualify as a report under the statute. The directors can not rely upon the shareprice as it contrasted with the market value. And because the Board did not disclose a lackof valuation information to the shareholders, the Board breached their fiduciary duty todisclose all germane facts.

Additional:

Dissent. The dissent believed that the majority mischaracterized the ability of the directorsto act soundly on the information provided at the meeting wherein the merger vote tookplace. The credentials of the directors demonstrated that they gave an intelligent businessjudgment that should be shielded by the business judgment rule.

The court noted that a director’s duty to exercise an informed business judgment is a duty ofcare rather than a duty of loyalty. Therefore, the motive of the director can be irrelevant, sothere is no need to prove fraud, conflict of interests or dishonesty.

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Facts

The case involved a proposed leveraged buy-out merger of TransUnion by Marmon Groupwhich was controlled by Jay Pritzker. [1] Defendant Jerome W. Van Gorkom, who was theTransUnion's chairman and CEO, chose a proposed price of $55 without consultation withoutside financial experts. He only consulted with the company's CFO, and that consultationwas to determine a per share price that would work for a leveraged buyout. [1] Van Gorkomand the CFO did not determine an actual total value of the company. [1] The court washighly critical of this decision, writing that "the record is devoid of any competent evidencethat $55 represented the per share intrinsic value of the Company." The proposed mergerwas subject to Board approval. At the Board meeting, a number of items were not disclosed,including the problematic methodology that Van Gorkom used to arrive at the proposedprice. Also, previous objections by management were not discussed. The Board approvedthe proposal.

Held:

The Court found that the directors were grossly negligent, because they quickly approvedthe merger without substantial inquiry or any expert advice. For this reason, the board ofdirectors breached the duty of care that it owed to the corporation's shareholders. As such,the protection of the business judgment rule was unavailable. The Court stated,The ruleitself

"is a presumption that in making a business decision, the directors of a corporation acted onan informed basis, in good faith and in the honest belief that the action taken was in the bestinterests of the company." ... Thus, the party attacking a board decision as uninformed mustrebut the presumption that its business judgment was an informed one. ”

488 A.2d at 872. Furthermore, the court rejected defendant's argument that the substantialpremium paid over the market price indicated that it was a good deal. In so doing, the courtnoted the irony that the board stated that the decision to accept the offer was based on theirexpertise, while at the same time asserting that it was proper because the price offered was alarge premium above market value. The decision also clarified the directors' duty ofdisclosure, stating that corporate directors must disclose all facts germane to a transactionthat is subject to a shareholder vote.

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Republic of the Philippines SUPREME COURT Manila

EN BANC

G.R. No. L-15092 May 18, 1962

ALFREDO MONTELIBANO, ET AL., plaintiffs-appellants, vs. BACOLOD-MURCIAMILLING CO., INC., defendant-appellee.

Tañada, Teehankee and Carreon for plaintiffs-appellants. Hilado and Hilado for defendant-appellee.

REYES, J.B.L., J.:

Appeal on points of law from a judgment of the Court of First Instance of OccidentalNegros, in its Civil Case No. 2603, dismissing plaintiff's complaint that sought to compel thedefendant Milling Company to increase plaintiff's share in the sugar produced from theircane, from 60% to 62.33%, starting from the 1951-1952 crop year.1äwphï1.ñët

It is undisputed that plaintiffs-appellants, Alfredo Montelibano, Alejandro Montelibano, andthe Limited co-partnership Gonzaga and Company, had been and are sugar planters adheredto the defendant-appellee's sugar central mill under identical milling contracts. Originallyexecuted in 1919, said contracts were stipulated to be in force for 30 years starting with the1920-21 crop, and provided that the resulting product should be divided in the ratio of 45%for the mill and 55% for the planters. Sometime in 1936, it was proposed to executeamended milling contracts, increasing the planters' share to 60% of the manufactured sugarand resulting molasses, besides other concessions, but extending the operation of the millingcontract from the original 30 years to 45 years. To this effect, a printed Amended MillingContract form was drawn up. On August 20, 1936, the Board of Directors of the appelleeBacolod-Murcia Milling Co., Inc., adopted a resolution (Acts No. 11, Acuerdo No. 1)granting further concessions to the planters over and above those contained in the printedAmended Milling Contract. The bone of contention is paragraph 9 of this resolution, thatreads as follows:

ACTA No. 11 SESSION DE LA JUNTA DIRECTIVA AGOSTO 20, 1936

x x x x x x x x x

Acuerdo No. 1. — Previa mocion debidamente secundada, la Junta en consideracion a unapeticion de los plantadores hecha por un comite nombrado por los mismos, acuerdaenmendar el contrato de molienda enmendado medientelas siguentes:

x x x x x x x x x

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9.a Que si durante la vigencia de este contrato de Molienda Enmendado, lascentralesazucareras, de Negros Occidental, cuya produccion anual de azucar centrifugado sea mas deuna tercera parte de la produccion total de todas lascentrales azucareras de NegrosOccidental, concedieren a sus plantadores mejores condiciones que la estipuladas en elpresente contrato, entonces esas mejores condiciones se concederan y por el presente seentenderan concedidas a los platadores que hayan otorgado este Contrato de MoliendaEnmendado.

Appellants signed and executed the printed Amended Milling Contract on September 10,1936, but a copy of the resolution of August 10, 1936, signed by the Central's GeneralManager, was not attached to the printed contract until April 17, 1937; with the notation —

Las enmiendas arriba transcritas forman parte del contrato de molienda enmendado,otorgado por — y la Bacolod-Murcia Milling Co., Inc.

In 1953, the appellants initiated the present action, contending that three Negros sugarcentrals (La Carlota, Binalbagan-Isabela and San Carlos), with a total annual productionexceeding one-third of the production of all the sugar central mills in the province, hadalready granted increased participation (of 62.5%) to their planters, and that under paragraph9 of the resolution of August 20, 1936, heretofore quoted, the appellee had become obligatedto grant similar concessions to the plaintiffs (appellants herein). The appellee Bacolod-Murcia Milling Co., inc., resisted the claim, and defended by urging that the stipulationscontained in the resolution were made without consideration; that the resolution in questionwas, therefore, null and void ab initio, being in effect a donation that was ultra vires andbeyond the powers of the corporate directors to adopt.

After trial, the court below rendered judgment upholding the stand of the defendant Millingcompany, and dismissed the complaint. Thereupon, plaintiffs duly appealed to this Court.

We agree with appellants that the appealed decisions can not stand. It must be rememberedthat the controverted resolution was adopted by appellee corporation as a supplement to, orfurther amendment of, the proposed milling contract, and that it was approved on August 20,1936, twenty-one days prior to the signing by appellants on September 10, of the AmendedMilling Contract itself; so that when the Milling Contract was executed, the concessionsgranted by the disputed resolution had been already incorporated into its terms. No reasonappears of record why, in the face of such concessions, the appellants should reject them orconsider them as separate and apart from the main amended milling contract, speciallytaking into account that appellant Alfredo Montelibano was, at the time, the President of thePlanters Association (Exhibit 4, p. 11) that had agitated for the concessions embodied in theresolution of August 20, 1936. That the resolution formed an integral part of the amendedmilling contract, signed on September 10, and not a separate bargain, is further shown by thefact that a copy of the resolution was simply attached to the printed contract without specialnegotiations or agreement between the parties.

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It follows from the foregoing that the terms embodied in the resolution of August 20, 1936were supported by the same causa or consideration underlying the main amended millingcontract; i.e., the promises and obligations undertaken thereunder by the planters, and,particularly, the extension of its operative period for an additional 15 years over and beyondthe 30 years stipulated in the original contract. Hence, the conclusion of the court below thatthe resolution constituted gratuitous concessions not supported by any consideration islegally untenable.

All disquisition concerning donations and the lack of power of the directors of therespondent sugar milling company to make a gift to the planters would be relevant if theresolution in question had embodied a separate agreement after the appellants had alreadybound themselves to the terms of the printed milling contract. But this was not the case.When the resolution was adopted and the additional concessions were made by thecompany, the appellants were not yet obligated by the terms of the printed contract, sincethey admittedly did not sign it until twenty-one days later, on September 10, 1936. Beforethat date, the printed form was no more than a proposal that either party could modify at itspleasure, and the appellee actually modified it by adopting the resolution in question. So thatby September 10, 1936 defendant corporation already understood that the printed terms werenot controlling, save as modified by its resolution of August 20, 1936; and we are satisfiedthat such was also the understanding of appellants herein, and that the minds of the partiesmet upon that basis. Otherwise there would have been no consent or "meeting of the minds",and no binding contract at all. But the conduct of the parties indicates that they assumed, andthey do not now deny, that the signing of the contract on September 10, 1936, did give riseto a binding agreement. That agreement had to exist on the basis of the printed terms asmodified by the resolution of August 20, 1936, or not at all. Since there is no rationalexplanation for the company's assenting to the further concessions asked by the plantersbefore the contracts were signed, except as further inducement for the planters to agree tothe extension of the contract period, to allow the company now to retract such concessionswould be to sanction a fraud upon the planters who relied on such additional stipulations.

The same considerations apply to the "void innovation" theory of appellees. There can be nonovation unless two distinct and successive binding contracts take place, with the laterdesigned to replace the preceding convention. Modifications introduced before a bargainbecomes obligatory can in no sense constitute novation in law.

Stress is placed on the fact that the text of the Resolution of August 20, 1936 was notattached to the printed contract until April 17, 1937. But, except in the case of statutoryforms or solemn agreements (and it is not claimed that this is one), it is the assent andconcurrence (the "meeting of the minds") of the parties, and not the setting down of itsterms, that constitutes a binding contract. And the fact that the addendum is only signed bythe General Manager of the milling company emphasizes that the addition was made solelyin order that the memorial of the terms of the agreement should be full and complete.

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Much is made of the circumstance that the report submitted by the Board of Directors of theappellee company in November 19, 1936 (Exhibit 4) only made mention of 90%, theplanters having agreed to the 60-40 sharing of the sugar set forth in the printed "amendedmilling contracts", and did not make any reference at all to the terms of the resolution ofAugust 20, 1936. But a reading of this report shows that it was not intended to inventory allthe details of the amended contract; numerous provisions of the printed terms are alaoglossed over. The Directors of the appellee Milling Company had no reason at the time tocall attention to the provisions of the resolution in question, since it contained mostlymodifications in detail of the printed terms, and the only major change was paragraph 9heretofore quoted; but when the report was made, that paragraph was not yet in effect, sinceit was conditioned on other centrals granting better concessions to their planters, and that didnot happen until after 1950. There was no reason in 1936 to emphasize a concession thatwas not yet, and might never be, in effective operation.

There can be no doubt that the directors of the appellee company had authority to modify theproposed terms of the Amended Milling Contract for the purpose of making its terms moreacceptable to the other contracting parties. The rule is that —

It is a question, therefore, in each case of the logical relation of the act to the corporatepurpose expressed in the charter. If that act is one which is lawful in itself, and not otherwiseprohibited, is done for the purpose of serving corporate ends, and is reasonably tributary tothe promotion of those ends, in a substantial, and not in a remote and fanciful sense, it mayfairly be considered within charter powers. The test to be applied is whether the act inquestion is in direct and immediate furtherance of the corporation's business, fairly incidentto the express powers and reasonably necessary to their exercise. If so, the corporation hasthe power to do it; otherwise, not. (Fletcher Cyc. Corp., Vol. 6, Rev. Ed. 1950, pp. 266-268)

As the resolution in question was passed in good faith by the board of directors, it is validand binding, and whether or not it will cause losses or decrease the profits of the central, thecourt has no authority to review them.

They hold such office charged with the duty to act for the corporation according to their bestjudgment, and in so doing they cannot be controlled in the reasonable exercise andperformance of such duty. Whether the business of a corporation should be operated at a lossduring depression, or close down at a smaller loss, is a purely business and economicproblem to be determined by the directors of the corporation and not by the court. It is awell-known rule of law that questions of policy or of management are left solely to thehonest decision of officers and directors of a corporation, and the court is without authorityto substitute its judgment of the board of directors; the board is the business manager of thecorporation, and so long as it acts in good faith its orders are not reviewable by the courts.(Fletcher on Corporations, Vol. 2, p. 390).

And it appearing undisputed in this appeal that sugar centrals of La Carlota, Hawaiian

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Philippines, San Carlos and Binalbagan (which produce over one-third of the entire annualsugar production in Occidental Negros) have granted progressively increasing participationsto their adhered planter at an average rate of

62.333% for the 1951-52 crop year; 64.2% for 1952-53; 64.3% for 1953-54; 64.5% for1954-55; and 63.5% for 1955-56, the appellee Bacolod-Murcia Milling Company is, underthe terms of its Resolution of August 20, 1936, duty bound to grant similar increases toplaintiffs-appellants herein.

WHEREFORE, the decision under appeal is reversed and set aside; and judgment is decreedsentencing the defendant-appellee to pay plaintiffs-appellants the differential or increase ofparticipation in the milled sugar in accordance with paragraph 9 of the appellee Resolutionof August 20, 1936, over and in addition to the 60% expressed in the printed AmendedMilling Contract, or the value thereof when due, as follows:

0,333% to appellants Montelibano for the 1951-1952 crop year, said appellants havingreceived an additional 2% corresponding to said year in October, 1953;

2.333% to appellant Gonzaga & Co., for the 1951-1952 crop year; and to all appellantsthereafter — 4.2% for the 1952-1953 crop year; 4.3% for the 1953-1954 crop year; 4.5% forthe 1954-1955 crop year; 3.5% for the 1955-1956 crop year;

with interest at the legal rate on the value of such differential during the time they werewithheld; and the right is reserved to plaintiffs-appellants to sue for such additional increasesas they may be entitled to for the crop years subsequent to those herein adjudged.

Costs against appellee, Bacolod-Murcia Milling Co.

Padilla, Bautista Angelo, Labrador, Concepcion, Barrera, Paredes and Dizon, JJ., concur.

The Lawphil Project - Arellano Law Foundation

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Facts:

Plaintiffs-appellants, Alfredo Montelibano, Alejandro Montelibano, and the Limited co-partnership Gonzaga and Company, had been and are sugar planters adhered to thedefendant-appellee's sugar central mill under identical milling contracts.

The contracts were stipulated to be in force for 30 years and that the resulting productshould be divided in the ratio of 45% for the mill and 55% for the planters. It was laterproposed to execute amended milling contracts, increasing the planters' share to 60% of themanufactured sugar and resulting molasses, besides other concessions, but extending theoperation of the milling contract from the original 30 years to 45 years.

The Board of Directors of the appellee Bacolod-Murcia Milling Co., Inc., adopted aresolution granting further concessions to the planters over and above those contained in theprinted Amended Milling Contract. Appellants signed and executed the printed AmendedMilling Contract but a copy of the resolution was not attached to the printed contract.

In 1953, the appellants initiated the present action, contending that three Negros sugarcentrals had already granted increased participation to their planters, and that underparagraph 9 of the abovementioned resolution, the appellee had become obligated to grantsimilar concessions to the plaintiffs (appellants herein).

However, the appellee Bacolod-Murcia Milling Co., inc., resisted the claim, and defendedby urging that the stipulations contained in the resolution were made without consideration;that the resolution in question was, therefore, null and void ab initio, being in effect adonation that was ultra vires and beyond the powers of the corporate directors to adopt.

After trial, the court below rendered judgment upholding the stand of the defendant Millingcompany, and dismissed the complaint. Thereupon, plaintiffs duly appealed to this Court.

Issue: Whether or not the resolution is valid and binding between the corporation andplanters.

Held: The Supreme Court held in the affirmative. There can be no doubt that the directors ofthe appellee company had authority to modify the proposed terms of the Amended MillingContract for the purpose of making its terms more acceptable to the other contractingparties. The rule is that —

It is a question, therefore, in each case of the logical relation of the act to the corporatepurpose expressed in the charter. If that act is one which is lawful in itself, and not otherwiseprohibited, is done for the purpose of serving corporate ends, and is reasonably tributary tothe promotion of those ends, in a substantial, and not in a remote and fanciful sense, it mayfairly be considered within charter powers. The test to be applied is whether the act in

1

question is in direct and immediate furtherance of the corporation's business, fairly incidentto the express powers and reasonably necessary to their exercise. If so, the corporation hasthe power to do it; otherwise, not.

As the resolution in question was passed in good faith by the board of directors, it is validand binding, and whether or not it will cause losses or decrease the profits of the central, thecourt has no authority to review them.

It is a well-known rule of law that questions of policy or of management are left solely to thehonest decision of officers and directors of a corporation, and the court is without authorityto substitute its judgment of the board of directors; the board is the business manager of thecorporation, and so long as it acts in good faith its orders are not reviewable by the courts.Hence, the appellee Bacolod-Murcia Milling Company is, under the terms of its Resolution,duty bound to grant similar increases to plaintiffs-appellants herein.

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Today is Tuesday, March 17, 2015

Republic of the PhilippinesSUPREME COURT

Manila

EN BANC

G.R. No. L-18805 August 14, 1967

THE BOARD OF LIQUIDATORS1 representing THE GOVERNMENT OF THE REPUBLIC OF THE PHILIPPINES,plaintiff-appellant, vs.HEIRS OF MAXIMO M. KALAW,2 JUAN BOCAR, ESTATE OF THE DECEASED CASIMIRO GARCIA,3 andLEONOR MOLL, defendants-appellees.

Simeon M. Gopengco and Solicitor General for plaintiff-appellant.L. H. Hernandez, Emma Quisumbing, Fernando and Quisumbing, Jr.; Ponce Enrile, Siguion Reyna, Montecillo andBelo for defendants-appellees.

SANCHEZ, J.:

The National Coconut Corporation (NACOCO, for short) was chartered as a non-profit governmental organization onMay 7, 1940 by Commonwealth Act 518 avowedly for the protection, preservation and development of the coconutindustry in the Philippines. On August 1, 1946, NACOCO's charter was amended [Republic Act 5] to grant thatcorporation the express power "to buy, sell, barter, export, and in any other manner deal in, coconut, copra, anddessicated coconut, as well as their by-products, and to act as agent, broker or commission merchant of theproducers, dealers or merchants" thereof. The charter amendment was enacted to stabilize copra prices, to servecoconut producers by securing advantageous prices for them, to cut down to a minimum, if not altogether eliminate,the margin of middlemen, mostly aliens.4

General manager and board chairman was Maximo M. Kalaw; defendants Juan Bocar and Casimiro Garcia weremembers of the Board; defendant Leonor Moll became director only on December 22, 1947.

NACOCO, after the passage of Republic Act 5, embarked on copra trading activities. Amongst the scores ofcontracts executed by general manager Kalaw are the disputed contracts, for the delivery of copra, viz:

(a) July 30, 1947: Alexander Adamson & Co., for 2,000 long tons, $167.00: per ton, f. o. b., delivery: Augustand September, 1947. This contract was later assigned to Louis Dreyfus & Co. (Overseas) Ltd.

(b) August 14, 1947: Alexander Adamson & Co., for 2,000 long tons $145.00 per long ton, f.o.b., Philippineports, to be shipped: September-October, 1947. This contract was also assigned to Louis Dreyfus & Co.(Overseas) Ltd.

(c) August 22, 1947: Pacific Vegetable Co., for 3,000 tons, $137.50 per ton, delivery: September, 1947.

(d) September 5, 1947: Spencer Kellog & Sons, for 1,000 long tons, $160.00 per ton, c.i.f., Los Angeles,California, delivery: November, 1947.

(e) September 9, 1947: Franklin Baker Division of General Foods Corporation, for 1,500 long tons, $164,00per ton, c.i.f., New York, to be shipped in November, 1947.

(f) September 12, 1947: Louis Dreyfus & Co. (Overseas) Ltd., for 3,000 long tons, $154.00 per ton, f.o.b., 3Philippine ports, delivery: November, 1947.

(g) September 13, 1947: Juan Cojuangco, for 2,000 tons, $175.00 per ton, delivery: November andDecember, 1947. This contract was assigned to Pacific Vegetable Co.

(h) October 27, 1947: Fairwood & Co., for 1,000 tons, $210.00 per short ton, c.i.f., Pacific ports, delivery:December, 1947 and January, 1948. This contract was assigned to Pacific Vegetable Co.

(i) October 28, 1947: Fairwood & Co., for 1,000 tons, $210.00 per short ton, c.i.f., Pacific ports, delivery:January, 1948. This contract was assigned to Pacific Vegetable Co.

An unhappy chain of events conspired to deter NACOCO from fulfilling these contracts. Nature supervened. Fourdevastating typhoons visited the Philippines: the first in October, the second and third in November, and the fourth inDecember, 1947. Coconut trees throughout the country suffered extensive damage. Copra production decreased.Prices spiralled. Warehouses were destroyed. Cash requirements doubled. Deprivation of export facilities increasedthe time necessary to accumulate shiploads of copra. Quick turnovers became impossible, financing a problem.

When it became clear that the contracts would be unprofitable, Kalaw submitted them to the board for approval. Itwas not until December 22, 1947 when the membership was completed. Defendant Moll took her oath on that date.A meeting was then held. Kalaw made a full disclosure of the situation, apprised the board of the impending heavylosses. No action was taken on the contracts. Neither did the board vote thereon at the meeting of January 7, 1948following. Then, on January 11, 1948, President Roxas made a statement that the NACOCO head did his best toavert the losses, emphasized that government concerns faced the same risks that confronted private companies,that NACOCO was recouping its losses, and that Kalaw was to remain in his post. Not long thereafter, that is, onJanuary 30, 1948, the board met again with Kalaw, Bocar, Garcia and Moll in attendance. They unanimouslyapproved the contracts hereinbefore enumerated.

As was to be expected, NACOCO but partially performed the contracts, as follows:

Buyers Tons Delivered Undelivered

Pacific Vegetable Oil 2,386.45 4,613.55

Spencer Kellog None 1,000

Franklin Baker 1,000 500

Louis Dreyfus 800 2,200

Louis Dreyfus (Adamson contract of July 30, 1947) 1,150 850

Louis Dreyfus (Adamson Contract of August 14, 1947) 1,755 245

T O T A L S 7,091.45 9,408.55

The buyers threatened damage suits. Some of the claims were settled, viz: Pacific Vegetable Oil Co., in copradelivered by NACOCO, P539,000.00; Franklin Baker Corporation, P78,210.00; Spencer Kellog & Sons,P159,040.00.

But one buyer, Louis Dreyfus & Go. (Overseas) Ltd., did in fact sue before the Court of First Instance of Manila,upon claims as follows: For the undelivered copra under the July 30 contract (Civil Case 4459); P287,028.00; for thebalance on the August 14 contract (Civil Case 4398), P75,098.63; for that per the September 12 contract reduced tojudgment (Civil Case 4322, appealed to this Court in L-2829), P447,908.40. These cases culminated in an out-of-court amicable settlement when the Kalaw management was already out. The corporation thereunder paid DreyfusP567,024.52 representing 70% of the total claims. With particular reference to the Dreyfus claims, NACOCO put upthe defenses that: (1) the contracts were void because Louis Dreyfus & Co. (Overseas) Ltd. did not have license todo business here; and (2) failure to deliver was due to force majeure, the typhoons. To project the utter

unreasonableness of this compromise, we reproduce in haec verba this finding below:

x x x However, in similar cases brought by the same claimant [Louis Dreyfus & Co. (Overseas) Ltd.] againstSantiago Syjuco for non-delivery of copra also involving a claim of P345,654.68 wherein defendant set upsame defenses as above, plaintiff accepted a promise of P5,000.00 only (Exhs. 31 & 32 Heirs.) Following thesame proportion, the claim of Dreyfus against NACOCO should have been compromised for only P10,000.00,if at all. Now, why should defendants be held liable for the large sum paid as compromise by the Board ofLiquidators? This is just a sample to show how unjust it would be to hold defendants liable for the readinesswith which the Board of Liquidators disposed of the NACOCO funds, although there was much possibility ofsuccessfully resisting the claims, or at least settlement for nominal sums like what happened in the Syjucocase.5

All the settlements sum up to P1,343,274.52.

In this suit started in February, 1949, NACOCO seeks to recover the above sum of P1,343,274.52 from generalmanager and board chairman Maximo M. Kalaw, and directors Juan Bocar, Casimiro Garcia and Leonor Moll. Itcharges Kalaw with negligence under Article 1902 of the old Civil Code (now Article 2176, new Civil Code); anddefendant board members, including Kalaw, with bad faith and/or breach of trust for having approved the contracts.The fifth amended complaint, on which this case was tried, was filed on July 2, 1959. Defendants resisted the actionupon defenses hereinafter in this opinion to be discussed.

The lower court came out with a judgment dismissing the complaint without costs as well as defendants'counterclaims, except that plaintiff was ordered to pay the heirs of Maximo Kalaw the sum of P2,601.94 for unpaidsalaries and cash deposit due the deceased Kalaw from NACOCO.

Plaintiff appealed direct to this Court.

Plaintiff's brief did not, question the judgment on Kalaw's counterclaim for the sum of P2,601.94.

Right at the outset, two preliminary questions raised before, but adversely decided by, the court below, arrest ourattention. On appeal, defendants renew their bid. And this, upon established jurisprudence that an appellate courtmay base its decision of affirmance of the judgment below on a point or points ignored by the trial court or in whichsaid court was in error.6

1. First of the threshold questions is that advanced by defendants that plaintiff Board of Liquidators has lost its legalpersonality to continue with this suit.

Accepted in this jurisdiction are three methods by which a corporation may wind up its affairs: (1) under Section 3,Rule 104, of the Rules of Court [which superseded Section 66 of the Corporation Law]7 whereby, upon voluntarydissolution of a corporation, the court may direct "such disposition of its assets as justice requires, and may appointa receiver to collect such assets and pay the debts of the corporation;" (2) under Section 77 of the Corporation Law,whereby a corporation whose corporate existence is terminated, "shall nevertheless be continued as a bodycorporate for three years after the time when it would have been so dissolved, for the purpose of prosecuting anddefending suits by or against it and of enabling it gradually to settle and close its affairs, to dispose of and convey itsproperty and to divide its capital stock, but not for the purpose of continuing the business for which it wasestablished;" and (3) under Section 78 of the Corporation Law, by virtue of which the corporation, within the threeyear period just mentioned, "is authorized and empowered to convey all of its property to trustees for the benefit ofmembers, stockholders, creditors, and others interested."8

It is defendants' pose that their case comes within the coverage of the second method. They reason out that suitwas commenced in February, 1949; that by Executive Order 372, dated November 24, 1950, NACOCO, togetherwith other government-owned corporations, was abolished, and the Board of Liquidators was entrusted with thefunction of settling and closing its affairs; and that, since the three year period has elapsed, the Board of Liquidatorsmay not now continue with, and prosecute, the present case to its conclusion, because Executive Order 372provides in Section 1 thereof that —

Sec.1. The National Abaca and Other Fibers Corporation, the National Coconut Corporation, the National

Tobacco Corporation, the National Food Producer Corporation and the former enemy-owned or controlledcorporations or associations, . . . are hereby abolished. The said corporations shall be liquidated inaccordance with law, the provisions of this Order, and/or in such manner as the President of the Philippinesmay direct; Provided, however, That each of the said corporations shall nevertheless be continued as a bodycorporate for a period of three (3) years from the effective date of this Executive Order for the purpose ofprosecuting and defending suits by or against it and of enabling the Board of Liquidators gradually to settleand close its affairs, to dispose of and, convey its property in the manner hereinafter provided.

Citing Mr. Justice Fisher, defendants proceed to argue that even where it may be found impossible within the 3 yearperiod to reduce disputed claims to judgment, nonetheless, "suits by or against a corporation abate when it ceasesto be an entity capable of suing or being sued" (Fisher, The Philippine Law of Stock Corporations, pp. 390-391).Corpus Juris Secundum likewise is authority for the statement that "[t]he dissolution of a corporation ends itsexistence so that there must be statutory authority for prolongation of its life even for purposes of pending litigation"9and that suit "cannot be continued or revived; nor can a valid judgment be rendered therein, and a judgment, ifrendered, is not only erroneous, but void and subject to collateral attack." 10 So it is, that abatement of pendingactions follows as a matter of course upon the expiration of the legal period for liquidation, 11 unless the statutemerely requires a commencement of suit within the added time. 12 For, the court cannot extend the time alloted by

statute. 13

We, however, express the view that the executive order abolishing NACOCO and creating the Board of Liquidatorsshould be examined in context. The proviso in Section 1 of Executive Order 372, whereby the corporate existence ofNACOCO was continued for a period of three years from the effectivity of the order for "the purpose of prosecutingand defending suits by or against it and of enabling the Board of Liquidators gradually to settle and close its affairs,to dispose of and convey its property in the manner hereinafter provided", is to be read not as an isolated provisionbut in conjunction with the whole. So reading, it will be readily observed that no time limit has been tacked to theexistence of the Board of Liquidators and its function of closing the affairs of the various government ownedcorporations, including NACOCO.

By Section 2 of the executive order, while the boards of directors of the various corporations were abolished, theirpowers and functions and duties under existing laws were to be assumed and exercised by the Board of Liquidators.The President thought it best to do away with the boards of directors of the defunct corporations; at the same time,however, the President had chosen to see to it that the Board of Liquidators step into the vacuum. And nowhere inthe executive order was there any mention of the lifespan of the Board of Liquidators. A glance at the otherprovisions of the executive order buttresses our conclusion. Thus, liquidation by the Board of Liquidators may, undersection 1, proceed in accordance with law, the provisions of the executive order, "and/or in such manner as thePresident of the Philippines may direct." By Section 4, when any property, fund, or project is transferred to anygovernmental instrumentality "for administration or continuance of any project," the necessary funds therefor shallbe taken from the corresponding special fund created in Section 5. Section 5, in turn, talks of special fundsestablished from the "net proceeds of the liquidation" of the various corporations abolished. And by Section, 7, fiftyper centum of the fees collected from the copra standardization and inspection service shall accrue "to the specialfund created in section 5 hereof for the rehabilitation and development of the coconut industry." Implicit in all these,is that the term of life of the Board of Liquidators is without time limit. Contemporary history gives us the fact that theBoard of Liquidators still exists as an office with officials and numerous employees continuing the job of liquidationand prosecution of several court actions.

Not that our views on the power of the Board of Liquidators to proceed to the final determination of the present caseis without jurisprudential support. The first judicial test before this Court is National Abaca and Other FibersCorporation vs. Pore, L-16779, August 16, 1961. In that case, the corporation, already dissolved, commenced suitwithin the three-year extended period for liquidation. That suit was for recovery of money advanced to defendant forthe purchase of hemp in behalf of the corporation. She failed to account for that money. Defendant moved todismiss, questioned the corporation's capacity to sue. The lower court ordered plaintiff to include as co-partyplaintiff, The Board of Liquidators, to which the corporation's liquidation was entrusted by Executive Order 372.Plaintiff failed to effect inclusion. The lower court dismissed the suit. Plaintiff moved to reconsider. Ground:excusable negligence, in that its counsel prepared the amended complaint, as directed, and instructed the board'sincoming and outgoing correspondence clerk, Mrs. Receda Vda. de Ocampo, to mail the original thereof to the courtand a copy of the same to defendant's counsel. She mailed the copy to the latter but failed to send the original to the

court. This motion was rejected below. Plaintiff came to this Court on appeal. We there said that "the rule appears tobe well settled that, in the absence of statutory provision to the contrary, pending actions by or against a corporationare abated upon expiration of the period allowed by law for the liquidation of its affairs." We there said that "[o]urCorporation Law contains no provision authorizing a corporation, after three (3) years from the expiration of itslifetime, to continue in its corporate name actions instituted by it within said period of three (3) years." 14 However,these precepts notwithstanding, we, in effect, held in that case that the Board of Liquidators escapes from theoperation thereof for the reason that "[o]bviously, the complete loss of plaintiff's corporate existence after theexpiration of the period of three (3) years for the settlement of its affairs is what impelled the President to create aBoard of Liquidators, to continue the management of such matters as may then be pending." 15 We accordinglydirected the record of said case to be returned to the lower court, with instructions to admit plaintiff's amendedcomplaint to include, as party plaintiff, the Board of Liquidators.

Defendants' position is vulnerable to attack from another direction.

By Executive Order 372, the government, the sole stockholder, abolished NACOCO, and placed its assets in thehands of the Board of Liquidators. The Board of Liquidators thus became the trustee on behalf of the government. Itwas an express trust. The legal interest became vested in the trustee — the Board of Liquidators. The beneficialinterest remained with the sole stockholder — the government. At no time had the government withdrawn theproperty, or the authority to continue the present suit, from the Board of Liquidators. If for this reason alone, wecannot stay the hand of the Board of Liquidators from prosecuting this case to its final conclusion. 16 The provisionsof Section 78 of the Corporation Law — the third method of winding up corporate affairs — find application.

We, accordingly, rule that the Board of Liquidators has personality to proceed as: party-plaintiff in this case.

2. Defendants' second poser is that the action is unenforceable against the heirs of Kalaw.

Appellee heirs of Kalaw raised in their motion to dismiss, 17 which was overruled, and in their nineteenth specialdefense, that plaintiff's action is personal to the deceased Maximo M. Kalaw, and may not be deemed to havesurvived after his death.18 They say that the controlling statute is Section 5, Rule 87, of the 1940 Rules of Court.19

which provides that "[a]ll claims for money against the decedent, arising from contract, express or implied", must befiled in the estate proceedings of the deceased. We disagree.

The suit here revolves around the alleged negligent acts of Kalaw for having entered into the questioned contractswithout prior approval of the board of directors, to the damage and prejudice of plaintiff; and is against Kalaw andthe other directors for having subsequently approved the said contracts in bad faith and/or breach of trust." Clearlythen, the present case is not a mere action for the recovery of money nor a claim for money arising from contract.The suit involves alleged tortious acts. And the action is embraced in suits filed "to recover damages for an injury toperson or property, real or personal", which survive. 20

The leading expositor of the law on this point is Aguas vs. Llemos, L-18107, August 30, 1962. There, plaintiffssought to recover damages from defendant Llemos. The complaint averred that Llemos had served plaintiff byregistered mail with a copy of a petition for a writ of possession in Civil Case 4824 of the Court of First Instance atCatbalogan, Samar, with notice that the same would be submitted to the Samar court on February 23, 1960 at 8:00a.m.; that in view of the copy and notice served, plaintiffs proceeded to the said court of Samar from their residencein Manila accompanied by their lawyers, only to discover that no such petition had been filed; and that defendantLlemos maliciously failed to appear in court, so that plaintiffs' expenditure and trouble turned out to be in vain,causing them mental anguish and undue embarrassment. Defendant died before he could answer the complaint.Upon leave of court, plaintiffs amended their complaint to include the heirs of the deceased. The heirs moved todismiss. The court dismissed the complaint on the ground that the legal representative, and not the heirs, shouldhave been made the party defendant; and that, anyway, the action being for recovery of money, testate or intestateproceedings should be initiated and the claim filed therein. This Court, thru Mr. Justice Jose B. L. Reyes, theredeclared:

Plaintiffs argue with considerable cogency that contrasting the correlated provisions of the Rules of Court,those concerning claims that are barred if not filed in the estate settlement proceedings (Rule 87, sec. 5) andthose defining actions that survive and may be prosecuted against the executor or administrator (Rule 88,

sec. 1), it is apparent that actions for damages caused by tortious conduct of a defendant (as in the case atbar) survive the death of the latter. Under Rule 87, section 5, the actions that are abated by death are: (1)claims for funeral expenses and those for the last sickness of the decedent; (2) judgments for money; and (3)"all claims for money against the decedent, arising from contract express or implied." None of these includesthat of the plaintiffs-appellants; for it is not enough that the claim against the deceased party be for money, butit must arise from "contract express or implied", and these words (also used by the Rules in connection withattachments and derived from the common law) were construed in Leung Ben vs. O'Brien, 38 Phil. 182, 189-194,

"to include all purely personal obligations other than those which have their source in delict or tort."

Upon the other hand, Rule 88, section 1, enumerates actions that survive against a decedent's executors oradministrators, and they are: (1) actions to recover real and personal property from the estate; (2) actions toenforce a lien thereon; and (3) actions to recover damages for an injury to person or property. The presentsuit is one for damages under the last class, it having been held that "injury to property" is not limited toinjuries to specific property, but extends to other wrongs by which personal estate is injured or diminished(Baker vs. Crandall, 47 Am. Rep. 126; also 171 A.L.R., 1395). To maliciously cause a party to incurunnecessary expenses, as charged in this case, is certainly injury to that party's property (Javier vs. Araneta,L-4369, Aug. 31, 1953).

The ruling in the preceding case was hammered out of facts comparable to those of the present. No cogent reasonexists why we should break away from the views just expressed. And, the conclusion remains: Action against theKalaw heirs and, for the matter, against the Estate of Casimiro Garcia survives.

The preliminaries out of the way, we now go to the core of the controversy.

3. Plaintiff levelled a major attack on the lower court's holding that Kalaw justifiedly entered into the controvertedcontracts without the prior approval of the corporation's directorate. Plaintiff leans heavily on NACOCO's corporateby-laws. Article IV (b), Chapter III thereof, recites, as amongst the duties of the general manager, the obligation: "(b)To perform or execute on behalf of the Corporation upon prior approval of the Board, all contracts necessary andessential to the proper accomplishment for which the Corporation was organized."

Not of de minimis importance in a proper approach to the problem at hand, is the nature of a general manager'sposition in the corporate structure. A rule that has gained acceptance through the years is that a corporate officer"intrusted with the general management and control of its business, has implied authority to make any contract or doany other act which is necessary or appropriate to the conduct of the ordinary business of the corporation. 21 Assuch officer, "he may, without any special authority from the Board of Directors perform all acts of an ordinarynature, which by usage or necessity are incident to his office, and may bind the corporation by contracts in mattersarising in the usual course of business. 22

The problem, therefore, is whether the case at bar is to be taken out of the general concept of the powers of ageneral manager, given the cited provision of the NACOCO by-laws requiring prior directorate approval of NACOCOcontracts.

The peculiar nature of copra trading, at this point, deserves express articulation. Ordinary in this enterprise arecopra sales for future delivery. The movement of the market requires that sales agreements be entered into, eventhough the goods are not yet in the hands of the seller. Known in business parlance as forward sales, it isconcededly the practice of the trade. A certain amount of speculation is inherent in the undertaking. NACOCO wasmuch more conservative than the exporters with big capital. This short-selling was inevitable at the time in the lightof other factors such as availability of vessels, the quantity required before being accepted for loading, the laborneeded to prepare and sack the copra for market. To NACOCO, forward sales were a necessity. Copra could notstay long in its hands; it would lose weight, its value decrease. Above all, NACOCO's limited funds necessitated aquick turnover. Copra contracts then had to be executed on short notice — at times within twenty-four hours. To beappreciated then is the difficulty of calling a formal meeting of the board.

Such were the environmental circumstances when Kalaw went into copra trading.

Long before the disputed contracts came into being, Kalaw contracted — by himself alone as general manager —for forward sales of copra. For the fiscal year ending June 30, 1947, Kalaw signed some 60 such contracts for thesale of copra to divers parties. During that period, from those copra sales, NACOCO reaped a gross profit ofP3,631,181.48. So pleased was NACOCO's board of directors that, on December 5, 1946, in Kalaw's absence, itvoted to grant him a special bonus "in recognition of the signal achievement rendered by him in putting theCorporation's business on a self-sufficient basis within a few months after assuming office, despite numeroushandicaps and difficulties."

These previous contract it should be stressed, were signed by Kalaw without prior authority from the board. Saidcontracts were known all along to the board members. Nothing was said by them. The aforesaid contracts stand toprove one thing: Obviously, NACOCO board met the difficulties attendant to forward sales by leaving the adoption ofmeans to end, to the sound discretion of NACOCO's general manager Maximo M. Kalaw.

Liberally spread on the record are instances of contracts executed by NACOCO's general manager and submittedto the board after their consummation, not before. These agreements were not Kalaw's alone. One at least wasexecuted by a predecessor way back in 1940, soon after NACOCO was chartered. It was a contract of leaseexecuted on November 16, 1940 by the then general manager and board chairman, Maximo Rodriguez, and A.Soriano y Cia., for the lease of a space in Soriano Building On November 14, 1946, NACOCO, thru its generalmanager Kalaw, sold 3,000 tons of copra to the Food Ministry, London, thru Sebastian Palanca. On December 22,1947, when the controversy over the present contract cropped up, the board voted to approve a lease contractpreviously executed between Kalaw and Fidel Isberto and Ulpiana Isberto covering a warehouse of the latter. On thesame date, the board gave its nod to a contract for renewal of the services of Dr. Manuel L. Roxas. In fact, also onthat date, the board requested Kalaw to report for action all copra contracts signed by him "at the meetingimmediately following the signing of the contracts." This practice was observed in a later instance when, on January7, 1948, the board approved two previous contracts for the sale of 1,000 tons of copra each to a certain "SCAP" anda certain "GNAPO".

And more. On December 19, 1946, the board resolved to ratify the brokerage commission of 2% of Smith, Bell andCo., Ltd., in the sale of 4,300 long tons of copra to the French Government. Such ratification was necessarybecause, as stated by Kalaw in that same meeting, "under an existing resolution he is authorized to give abrokerage fee of only 1% on sales of copra made through brokers." On January 15, 1947, the brokerage feeagreements of 1-1/2% on three export contracts, and 2% on three others, for the sale of copra were approved by theboard with a proviso authorizing the general manager to pay a commission up to the amount of 1-1/2% "withoutfurther action by the Board." On February 5, 1947, the brokerage fee of 2% of J. Cojuangco & Co. on the sale of2,000 tons of copra was favorably acted upon by the board. On March 19, 1947, a 2% brokerage commission wassimilarly approved by the board for Pacific Trading Corporation on the sale of 2,000 tons of copra.

It is to be noted in the foregoing cases that only the brokerage fee agreements were passed upon by the board, not

the sales contracts themselves. And even those fee agreements were submitted only when the commissionexceeded the ceiling fixed by the board.

Knowledge by the board is also discernible from other recorded instances.1äwphï1.ñët

When the board met on May 10, 1947, the directors discussed the copra situation: There was a slow downwardtrend but belief was entertained that the nadir might have already been reached and an improvement in prices wasexpected. In view thereof, Kalaw informed the board that "he intends to wait until he has signed contracts to sellbefore starting to buy copra."23

In the board meeting of July 29, 1947, Kalaw reported on the copra price conditions then current: The copra marketappeared to have become fairly steady; it was not expected that copra prices would again rise very high as in theunprecedented boom during January-April, 1947; the prices seemed to oscillate between $140 to $150 per ton; aradical rise or decrease was not indicated by the trends. Kalaw continued to say that "the Corporation has beenclosing contracts for the sale of copra generally with a margin of P5.00 to P7.00 per hundred kilos." 24

We now lift the following excerpts from the minutes of that same board meeting of July 29, 1947:

521. In connection with the buying and selling of copra the Board inquired whether it is the practice of themanagement to close contracts of sale first before buying. The General Manager replied that this practice is

generally followed but that it is not always possible to do so for two reasons:

(1) The role of the Nacoco to stabilize the prices of copra requires that it should not cease buying even whenit does not have actual contracts of sale since the suspension of buying by the Nacoco will result inmiddlemen taking advantage of the temporary inactivity of the Corporation to lower the prices to the detrimentof the producers.

(2) The movement of the market is such that it may not be practical always to wait for the consummation ofcontracts of sale before beginning to buy copra.

The General Manager explained that in this connection a certain amount of speculation is unavoidable.However, he said that the Nacoco is much more conservative than the other big exporters in this respect.25

Settled jurisprudence has it that where similar acts have been approved by the directors as a matter of generalpractice, custom, and policy, the general manager may bind the company without formal authorization of the boardof directors. 26 In varying language, existence of such authority is established, by proof of the course of business,the usage and practices of the company and by the knowledge which the board of directors has, or must bepresumed to have, of acts and doings of its subordinates in and about the affairs of the corporation. 27 So also,

x x x authority to act for and bind a corporation may be presumed from acts of recognition in other instanceswhere the power was in fact exercised. 28

x x x Thus, when, in the usual course of business of a corporation, an officer has been allowed in his officialcapacity to manage its affairs, his authority to represent the corporation may be implied from the manner inwhich he has been permitted by the directors to manage its business.29

In the case at bar, the practice of the corporation has been to allow its general manager to negotiate and executecontracts in its copra trading activities for and in NACOCO's behalf without prior board approval. If the by-laws wereto be literally followed, the board should give its stamp of prior approval on all corporate contracts. But that boarditself, by its acts and through acquiescence, practically laid aside the by-law requirement of prior approval.

Under the given circumstances, the Kalaw contracts are valid corporate acts.

4. But if more were required, we need but turn to the board's ratification of the contracts in dispute on January 30,1948, though it is our (and the lower court's) belief that ratification here is nothing more than a mere formality.

Authorities, great in number, are one in the idea that "ratification by a corporation of an unauthorized act or contractby its officers or others relates back to the time of the act or contract ratified, and is equivalent to original authority;"and that " [t]he corporation and the other party to the transaction are in precisely the same position as if the act orcontract had been authorized at the time." 30 The language of one case is expressive: "The adoption or ratificationof a contract by a corporation is nothing more or less than the making of an original contract. The theory ofcorporate ratification is predicated on the right of a corporation to contract, and any ratification or adoption isequivalent to a grant of prior authority." 31

Indeed, our law pronounces that "[r]atification cleanses the contract from all its defects from the moment it wasconstituted." 32 By corporate confirmation, the contracts executed by Kalaw are thus purged of whatever vice ordefect they may have. 33

In sum, a case is here presented whereunder, even in the face of an express by-law requirement of prior approval,the law on corporations is not to be held so rigid and inflexible as to fail to recognize equitable considerations. And,the conclusion inevitably is that the embattled contracts remain valid.

5. It would be difficult, even with hostile eyes, to read the record in terms of "bad faith and/or breach of trust" in theboard's ratification of the contracts without prior approval of the board. For, in reality, all that we have on thegovernment's side of the scale is that the board knew that the contracts so confirmed would cause heavy losses.

As we have earlier expressed, Kalaw had authority to execute the contracts without need of prior approval.

Everybody, including Kalaw himself, thought so, and for a long time. Doubts were first thrown on the way only whenthe contracts turned out to be unprofitable for NACOCO.

Rightfully had it been said that bad faith does not simply connote bad judgment or negligence; it imports a dishonestpurpose or some moral obliquity and conscious doing of wrong; it means breach of a known duty thru some motiveor interest or ill will; it partakes of the nature of fraud.34 Applying this precept to the given facts herein, we find thatthere was no "dishonest purpose," or "some moral obliquity," or "conscious doing of wrong," or "breach of a knownduty," or "Some motive or interest or ill will" that "partakes of the nature of fraud."

Nor was it even intimated here that the NACOCO directors acted for personal reasons, or to serve their own privateinterests, or to pocket money at the expense of the corporation. 35 We have had occasion to affirm that bad faithcontemplates a "state of mind affirmatively operating with furtive design or with some motive of self-interest or ill willor for ulterior purposes." 36 Briggs vs. Spaulding, 141 U.S. 132, 148-149, 35 L. ed. 662, 669, quotes with approvalfrom Judge Sharswood (in Spering's App., 71 Pa. 11), the following: "Upon a close examination of all the reportedcases, although there are many dicta not easily reconcilable, yet I have found no judgment or decree which has helddirectors to account, except when they have themselves been personally guilty of some fraud on the corporation, orhave known and connived at some fraud in others, or where such fraud might have been prevented had they givenordinary attention to their duties. . . ." Plaintiff did not even dare charge its defendant-directors with any of thesemalevolent acts.

Obviously, the board thought that to jettison Kalaw's contracts would contravene basic dictates of fairness. They didnot think of raising their voice in protest against past contracts which brought in enormous profits to the corporation.By the same token, fair dealing disagrees with the idea that similar contracts, when unprofitable, should not meritthe same treatment. Profit or loss resulting from business ventures is no justification for turning one's back oncontracts entered into. The truth, then, of the matter is that — in the words of the trial court — the ratification of thecontracts was "an act of simple justice and fairness to the general manager and the best interest of the corporationwhose prestige would have been seriously impaired by a rejection by the board of those contracts which proveddisadvantageous." 37

The directors are not liable." 38

6. To what then may we trace the damage suffered by NACOCO.

The facts yield the answer. Four typhoons wreaked havoc then on our copra-producing regions. Result: Copraproduction was impaired, prices spiralled, warehouses destroyed. Quick turnovers could not be expected. NACOCOwas not alone in this misfortune. The record discloses that private traders, old, experienced, with bigger facilities,were not spared; also suffered tremendous losses. Roughly estimated, eleven principal trading concerns did runlosses to about P10,300,000.00. Plaintiff's witness Sisenando Barretto, head of the copra marketing department ofNACOCO, observed that from late 1947 to early 1948 "there were many who lost money in the trade." 39 NACOCOwas not immune from such usual business risk.

The typhoons were known to plaintiff. In fact, NACOCO resisted the suits filed by Louis Dreyfus & Co. by pleading inits answers force majeure as an affirmative defense and there vehemently asserted that "as a result of the saidtyphoons, extensive damage was caused to the coconut trees in the copra producing regions of the Philippines andaccording to estimates of competent authorities, it will take about one year until the coconut producing regions willbe able to produce their normal coconut yield and it will take some time until the price of copra will reach normallevels;" and that "it had never been the intention of the contracting parties in entering into the contract in questionthat, in the event of a sharp rise in the price of copra in the Philippine market produce by force majeure or by causedbeyond defendant's control, the defendant should buy the copra contracted for at exorbitant prices far beyond the

buying price of the plaintiff under the contract." 40

A high regard for formal judicial admissions made in court pleadings would suffice to deter us from permitting plaintiffto stray away therefrom, to charge now that the damage suffered was because of Kalaw's negligence, or for thatmatter, by reason of the board's ratification of the contracts. 41

Indeed, were it not for the typhoons, 42 NACOCO could have, with ease, met its contractual obligations. Stock

accessibility was no problem. NACOCO had 90 buying agencies spread throughout the islands. It could purchase2,000 tons of copra a day. The various contracts involved delivery of but 16,500 tons over a five-month period.Despite the typhoons, NACOCO was still able to deliver a little short of 50% of the tonnage required under thecontracts.

As the trial court correctly observed, this is a case of damnum absque injuria. Conjunction of damage and wrong ishere absent. There cannot be an actionable wrong if either one or the other is wanting. 43

7. On top of all these, is that no assertion is made and no proof is presented which would link Kalaw's acts —ratified by the board — to a matrix for defraudation of the government. Kalaw is clear of the stigma of bad faith.Plaintiff's corporate counsel 44 concedes that Kalaw all along thought that he had authority to enter into thecontracts, that he did so in the best interests of the corporation; that he entered into the contracts in pursuance of anoverall policy to stabilize prices, to free the producers from the clutches of the middlemen. The prices for whichNACOCO contracted in the disputed agreements, were at a level calculated to produce profits and higher than thoseprevailing in the local market. Plaintiff's witness, Barretto, categorically stated that "it would be foolish to think thatone would sign (a) contract when you are going to lose money" and that no contract was executed "at a price unsafefor the Nacoco." 45 Really, on the basis of prices then prevailing, NACOCO envisioned a profit of aroundP752,440.00. 46

Kalaw's acts were not the result of haphazard decisions either. Kalaw invariably consulted with NACOCO's ChiefBuyer, Sisenando Barretto, or the Assistant General Manager. The dailies and quotations from abroad wereguideposts to him.

Of course, Kalaw could not have been an insurer of profits. He could not be expected to predict the coming ofunpredictable typhoons. And even as typhoons supervened Kalaw was not remissed in his duty. He exerted effortsto stave off losses. He asked the Philippine National Bank to implement its commitment to extend a P400,000.00loan. The bank did not release the loan, not even the sum of P200,000.00, which, in October, 1947, was approvedby the bank's board of directors. In frustration, on December 12, 1947, Kalaw turned to the President, complainedabout the bank's short-sighted policy. In the end, nothing came out of the negotiations with the bank. NACOCOeventually faltered in its contractual obligations.

That Kalaw cannot be tagged with crassa negligentia or as much as simple negligence, would seem to be supportedby the fact that even as the contracts were being questioned in Congress and in the NACOCO board itself,President Roxas defended the actuations of Kalaw. On December 27, 1947, President Roxas expressed his desire"that the Board of Directors should reelect Hon. Maximo M. Kalaw as General Manager of the National CoconutCorporation." 47 And, on January 7, 1948, at a time when the contracts had already been openly disputed, theboard, at its regular meeting, appointed Maximo M. Kalaw as acting general manager of the corporation.

Well may we profit from the following passage from Montelibano vs. Bacolod-Murcia Milling Co., Inc., L-15092, May18, 1962:

"They (the directors) hold such office charged with the duty to act for the corporation according to their bestjudgment, and in so doing they cannot be controlled in the reasonable exercise and performance of such duty.Whether the business of a corporation should be operated at a loss during a business depression, or closed down ata smaller loss, is a purely business and economic problem to be determined by the directors of the corporation, andnot by the court. It is a well known rule of law that questions of policy of management are left solely to the honestdecision of officers and directors of a corporation, and the court is without authority to substitute its judgment for thejudgment of the board of directors; the board is the business manager of the corporation, and so long as it acts ingood faith its orders are not reviewable by the courts." (Fletcher on Corporations, Vol. 2, p. 390.) 48

Kalaw's good faith, and that of the other directors, clinch the case for defendants. 49

Viewed in the light of the entire record, the judgment under review must be, as it is hereby, affirmed.

Without costs. So ordered.

Reyes, J.B.L., Makalintal, Bengzon, J.P., Zaldivar, Castro and Angeles, JJ., concur.Fernando, J., took no part.Concepcion, C.J. and Dizon, J., are on leave.

Footnotes

1Original plaintiff, National Coconut Corporation, was dissolved on November 24, 1950 by the President'sExecutive Order 372, which created the Board of Liquidators. Hence, the substitution of party plaintiff.

2Defendant Maximo M. Kalaw died in March of 1955 before trial.

3Substituted for defendant Casimiro Garcia, deceased.

4Explanatory Note of House Bill 295, 1st Session, 2nd Congress, later Republic Act 5; Congressional Record,House of Representatives, July 22, 1946; Minutes of the NACOCO Directors' Meeting of July 2, 1946, Exh. 4-Heirs.

5R.A., p. 238; Emphasis supplied.

6Garcia Valdez vs. Tuason, 40 Phil. 943, 951-952; Lucero vs. Guzman, 45 Phil. 852, 879; Relative vs. Castro,76 Phil. 563, 567-568.

7III Agbayani, Corporation Law, 1964 ed., p. 1679.

8Government vs. Wise & Co., Ltd. (C.A.), 37 O.G. No. 26, pp. 545, 546.

910 C.J.S., p. 1503; emphasis supplied.

101 C.J.S., p. 141.

11Id., p. 143; 16 Fletcher, p. 901.

1216 Fletcher, p. 902.

13Service & Wright Lumber Co. vs. Sumpter Valley Ry. Co., 152 P. 262, 265.

14Citing Sumera vs. Valencia, 67 Phil. 721, 726-727.

15Emphasis ours.

16See: Section 3, Rule 3, Rules of Court.

17Record on Appeal, pp. 21-25.

18Id., p. 154.

19Now Section 5, Rule 86.

20Section 1, Rule 88 of the 1940 Rules of Court; now Section 1 Rule 87, Revised Rules of Court.

212 Fletcher Cyclopedia Corporations, p. 607. See: Yu Chuck vs. Kong Li Po, 46 Phil. 608, 614.

22Sparks vs. Dispatch Transfer Co., 15 S.W. 417, 419; Pacific Concrete Products Corporation vs. Dimmick,289 P. 2d 501, 504; Massachusetts Bonding & Ins. Co. vs. Transamerican Freight Lines, 281 N.W. 584, 588-589; Sealy Oil Mill & Mfg. Co. vs. Bishop Mfg. Co., 235 S.W. 850, 852.

23Emphasis supplied.

24Emphasis supplied.

25Emphasis supplied.

26Harris vs. H. C. Talton Wholesale Grocery Co., 123 So. 480.

27Van Denburgh vs. Tungsten Reef Mines Co., 67 P. (2d) 360, 361, citing First National Fin. Corp. vs. Five-ODrilling Co., 289 P. 844, 845.

28McIntosh vs. Dakota Trust Co., 204 N.W. 818. 824.

29Murphy vs. W. H. & F. W. Cane, 82 Atl. 854, 856. See Martin vs. Webb, 110 U.S. 7, 14-15, 28 L. ed. 49, 52.See also Victory Investment Corporation vs. Muskogee Electric T. CO., 150 F. 2d. 889, 893.

302 Fletcher, p. 858, citing cases.

31Kridelbaugh vs. Aldrehn Theatres Co., 191 N.W. 803, 804, citing cases; emphasis supplied.

32Article 1313, old Civil Code; now Article 1396, new Civil Code.

33Tagaytay Development Co. vs. Osorio, 69 Phil. 180, 184.

34Spiegel vs. Beacon Participations, 8 N.E. (2d) 895, 907, citing cases.

35See: 3 Fletcher, Sec. 850, pp. 162-165.

36Air France vs. Carrascoso, L-21438, September 28, 1966.

37R.A., pp. 234-235.

383 Fletcher, pp. 450-452, citing cases. Cf. Angeles vs. Santos, 64 Phil. 697, 707.

39Tr., p. 30, August 29, 1960.

40See Exhibit 29-Heirs, NACOCO's Second Amended Answer in Civil Case 4322, Court of First instance ofManila, entitled "Louis Dreyfus & Co. (Overseas) Limited, plaintiff vs. National Coconut Corporation,defendant."

41Section 2, Rule 129, Rules of Court; 20 Am. Jur., pp. 469-470.

42The time for delivery of copra under the July 30, 1947 contract was extended. Fifth Amended Complaint,R.A., P. 15. See also Exhibit 26- Heirs.

43Churchill and Tait vs. Rafferty 32 Phil. 580, 605; Ladrera vs Secretary of Agriculture and Natural Resources,L-13385, April 28, 1960.

44Memorandum of Government Corporate Counsel Marcial P. Lichauco dated February 9, 1949, addressedto the Secretary of Justice, 8 days after the original complaint herein was filed in court. R.A., pp. 69, 90-112.

45Tr., pp. 18, 29, August 29, 1960.

46See Exhibit 20-Heirs.

47Exhibit 25-Heirs.

48Emphasis supplied.493 Fletcher, pp. 450-452, supra.

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EN BANC

G.R. No. 6217 December 26, 1911

CHARLES W. MEAD, plaintiff-appellant, vs. E. C. McCULLOUGH, ET AL., and THEPHILIPPINE ENGINEERING AND CONSTRUCTION COMPANY, defendant-appellants.

Haussermann, Cohn & Fisher and A. D. Gibbs for plaintiff. James J. Peterson and O'Brien &DeWitt for defendant McCullough.

TRENT, J.:

This action was originally brought by Charles W. Mead against Edwin C. McCullough,Thomas L. Hartigan, Frank E. Green, and Frederick H. Hilbert. Mead has died since thecommencement of the action and the case is now going forward in the name of hisadministrator as plaintiff.

The complaint contains three causes of action, which are substantially as follows: The first,for salary; the second, for profits; and the third, for the value of the personal effects allegedto have been left Mead and sold by the defendants.

A joint and several judgment was rendered by default against each and all of the defendantsfor the sum of $3,450.61 gold. The defendant McCullough alone having made application tohave this judgment set aside, the court granted this motion, vacating the judgment as to himonly, the judgment as to the other three defendants remaining undisturbed.1awphi1.net

At the new trial, which took place some two or three years later and after the death of Mead,the judgment was rendered upon merits, dismissing the case as to the first and second causesof action and for the sum of $1,200 gold in the plaintiff's favor on the third cause of action.From this judgment both parties appealed and have presented separate bills of exceptions.No appeal was taken by the defendant McCullough from the ruling of the court denying arecovery on his cross complaint.

On March 15, 1902, the plaintiff (Mead will be referred to as the plaintiff in this opinionunless it is otherwise stated) and the defendant organized the "Philippine Engineering andConstruction Company," the incorporators being the only stockholders and also the directorsof said company, with general ordinary powers. Each of the stockholders paid into thecompany $2,000 mexican currency in cash, with the exception of Mead, who turned over tothe company personal property in lieu of cash.

Shortly after the organization, the directors held a meeting and elected the plaintiff asgeneral manager. The plaintiff held this position with the company for nine months, when heresigned to accept the position of engineer of the Canton and Shanghai Railway Company.

1

Under the organization the company began business about April 1, 102.itc-alf

The contract and work undertaken by the company during the management of Mead werethe wrecking contract with the Navy Department at Cavite for the raising of the Spanishships sunk by Admiral Dewey; the contract for the construction of certain warehouses forthe quartermaster department; the construction of a wharf at Fort McKinley for theGovernment; The supervision of the construction of the Pacific Oriental Trading Company'swarehouse; and some other odd jobs not specifically set out in the record.

Shortly after the plaintiff left the Philippine Islands for China, the other directors, thedefendants in this case, held a meeting on December 24, 1903, for the purpose of discussingthe condition of the company at that time and determining what course to pursue. They didon that date enter into the following contract with the defendant McCullough, towit:1awphil.net

For value received, this contract and all the rights and interests of the Philippine Engineeringand construction Company in the same are hereby assigned to E. C. McCullough of Manila,P. I.

(Sgd.) E. C. McCULLOUGH, President, Philippine Engineering and ConstructionCompany.

(Sgd.) F. E. GREEN, Treasurer. (Sgd.) THOMAS L. HARTIGAN, Secretary.

The contract reffered to in the foregoing document was known as the wrecking contract withthe naval authorities.

On the 28th of the same month, McCullough executed and signed the followinginstrumental:

For value received, and having the above assignment from my associates in the PhilippineEngineering and Construction Company, I hereby transfer my right, title, and interest in thewithin contract, with the exception of one sixth, which I hereby retain, to R. W. Brown, H.D. C. Jones, John T. Macleod, and T. H. Twentyman.

The assignees of the wrecking contract, including McCullough, formed was not known asthe "Manila Salvage Association." This association paid to McCullough $15,000 MexicanCurrency cash for the assignment of said contract. In addition to this payment, McCulloughretained a one-sixth interest in the new company or association.

The plaintiff insists that he was received as general manager of the first company a salarywhich was not to be less than $3,500 gold (which amount he was receiving as city engineerat the time of the corporation of the company), plus 20 per cent of the net profits whichmight be derived from the business; while McCullough contends that the plaintiff was to

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receive only his necessary expenses unless the company made a profit, when he couldreceive $3,500 per year and 20 per cent of the profits. The contract entered into between theboard of directors and the plaintiffs as to the latter's salary was a verbal one. The plaintifftestified that this contract was unconditional and that his salary, which was fixed at $3,500gold, was not dependent upon the success of the company, but that his share of the profitswas to necessarily depend upon the net income. On the other hand, McCullough, Green andHilbert testify that the salary of the plaintiff was to be determined according to whether ornot the company was successful in its operations; that if the company made gains, he was toreceive $3,5000 gold, and a percentage, but that if the company did not make any profits, hewas to receive only his necessary living expenses.

It is strongly urged that the plaintiff would not have accepted the management of thecompany upon such conditions, as he was receiving from the city of Manila a salary of$3,500 gold. This argument is not only answered by the positive and direct testimony ofthree of the defendants, but also by the circumstances under which this company wasorganized and principal object, which was the raising of the Spanish ships. The plaintiff putno money into the organization, the defendants put but little: just sufficient to get the workof raising the wrecks under way. This venture was a risky one. All the members of thecompany realized that they were undertaking a most difficult and expensive project. If theywere successful, handsome profits would be realized; while if they were unsuccessful, all theexpenses for the hiring of machinery, launches, and labor would be a total loss. The plaintiffwas in complete charge and control of this work and was to receive, according to the greatpreponderance of the evidence, in case the company made no profits, sufficient amount tocover his expenses, which included his room, board, transportation, etc. The defendantswere to furnish money out of their own private funds to meet these expenses, as the original$8,000 Mexican currency was soon exhausted in the work thus undertaken. So the contractentered into between the directors and the plaintiff as to the latter's salary was a contingentone.

It is admitted that the plaintiff received $1.500 gold for his services, and whether he isentitled to receive an additional amount depends upon the result of the second cause ofaction.

The second cause of action is more difficult to determine. On this point counsel for theplaintiff has filed a very able and exhaustive brief, dealing principally with the facts.

It is urged that the net profits accruing to the company after the completion of all thecontracts (except the salvage contract) made before the plaintiff resigned as manager and upto the time the salvage contract was transferred to McCullough and from him to the newcompany, amounted to $5,628.37 gold. This conclusion is reached, according to thememorandum of counsel for the plaintiff which appears on pages 38 and 39 of the record, inthe following manner:

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Profits from the construction of warehouses for the Government $6,962.54 Profits from theconstruction of the wall at Fort McKinley 500.00 Profits from the inspection of theconstruction of the P. O. T. warehouse 1,000.00 Profits obtained from the projects(according to Mead's calculations) 1,000.00 Total9,462.54

In this same memorandum, the expense for the operation of the company during Mead'smanagement, consisting of rents, the hire of one muchacho, the publication of variousnotices, the salary of an engineer for four months, and plaintiff's salary for nine months,amounts to $3,834.17 gold. This amount, deducted from the sum total of profits, leaves$5,628.37 gold.

Counsel for the plaintiff, in order to show conclusively as they assert that the company, afterpaying all expenses and indebtedness, had a considerable balance to its credit, calls attentionto Exhibit K. This balance reads as follows:

Abstract copy of ledger No. 3, folios 276-277. Philippine Engineering and ConstructionCompany.

Then follow the debits and credits, with a balance in favor of the company of $10,728.44Mexican currency. This account purports to cover the period from July 1, 1902, to April 1,1903. Ledger No. 3, above mentioned, is that the defendant McCullough and not one of thebooks of the company.

It was this exhibit that the lower court based its conclusion when it found that on January 25,1903, after making the transfer of the salvage contract to McCullough, the company was indebt $2,278.30 gold. The balance of $10,728.44 Mexican currency deducted from the$16,439.40 Mexican currency (McCullough's losses in the Manila Salvage Association)leaves $2,278.30 United States currency at the then existing rate of exchange. In Exhibit K,McCullough charged himself with the $15,000 Mexican currency which he received fromhis associates in the new company, but did not credit himself with the $16,439.40 Mexicancurrency, losses in said company, for the reason that on April 1, 1903, said losses had notoccurred. It must be borne in mind that Exhibit K is an abstract from a ledger.

The defendant McCullough, in order to show in detail his transactions with the old company,presented Exhibits 1 and 2. These accounts read as follows:

Detailed account of the receipts and disbursements of E. C. McCullough and the PhilippineEngineering and Construction Company.

Then follow the debits ad credits. These two accounts cover the period from March 5 1902,to June 9, 1905. According to Exhibit No. 1, the old company was indebted to McCulloughin the sum of $14,918.75 Mexican currency, and according to Exhibit No. 2 he indebtedness

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amounted to $6,358.15 Mexican currency. The debits and credits in these two exhibits areexactly the me with the following exceptions; I Exhibit No. 1, McCullough credits himselfwith the $10,000 Mexican currency (the amount borrowed from the bank and deposited withthe admiral as a guarantee for the faithful performance of the salvage contract); while inExhibit No. 2 he credits himself with this $10,000 and at he same time charges himself withthis amount. In the same exhibit (No. 2) he credits himself with $16,439.40 Mexicancurrency, his losses in the new company, received from said company. Eliminating entirelyfrom these two exhibits the $10,000 Mexican currency, the $15,000 Mexican currency, andthe $16,39.40 Mexican currency, the balance shown in McCullough's favor is exactly thesame in both exhibits. This balance amounts to $4,918.75 Mexian currency.

According to McCullough's accounts in Exhibits 1 and 2 the profits derived from theconstruction of the Government warehouse amounted to $4,005.02 gold, while the plaintiffcontends that these profits amounted to $6,962.54 gold. The plaintiff, during hismanagement of the old company, made a contract with the Government for the constructionof these are house and commenced work. After he resigned and left for China, McCulloughtook charge of and completed the said warehouse. McCullough gives a complete, detailedstatements of express for the completion of this work, showing the dates, to whom paid, andfor what purpose. He also gives the various amounts he received from the Government withthe amounts of the receipt of the same. On the first examination, McCullough testified thatthe total amount received from the Government for the construction of these warehouse was$1,123 gold. The case was suspended for the purpose of examination the records of theAuditor and the quater master, to determine the exact amount paid for this work. As a resultof this examination, the vouchers show an additional amount of about $5,000 gold, paid inchecks. These checks show that the same were endorsed by the plaintiff and collected byhim from the Hongkong and Shanghai Banking Corporation. This money was not handledby McCullough and as it was collected by the plaintiff, it must be presumed, in the absenceof proof, that it was disbursed by him. McCullough did not charge himself with the $2,5000gold, alleged to have been profits from the construction of the wall at Fort McKinley, theinspection of the construction of the P. O. T. warehouse, and other projects. This work wasdone under the management of the plaintiff and it is not shown that the profits from thesecontracts ever reached the ands of McCullough. McCullough was not the treasurer of thecompany at that time. The other items which the plaintiff insist that McCullough had noright to credit himself with are the following:

Date To whom paid. Amount (Mex. currency). Jan. 30, 1903 Green $2,000.00 Feb. 2, 1903McCullough 1,300.00 Feb. 2, 1903 Green 1,027.92 Feb. 19, 1905 P. O. T. Co. note 2,236.80May 23, 1905 Hilbert 1,856.02 June 9, 1905 Hartigan 1,225.00

McCullough says that these amounts represents cash borrowed from the evidence parties tocarry on the operations of the old company while it was trying to raise the sunken vessels.There is no proof to the contrary, and McCullough's testimony on this point is strongly

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corroborated by the fact that the work done by the company in attempting to raise thesesvessels was it first undertaking. The company had made no profits while tat work was goingon under the management of the plaintiff, but its expenses greatly exceeded that of theoriginal $8,000 Mexican currency. It was necessary to borrow money to continue that work.These amounts, having been borrowed, were outstanding debts when McCullough tookcharge for the purpose of completing the warehouses and winding up the business of the oldcompany. These amounts do not represent payments or refunds of the original capital.McCullough did not credit himself with any amount for his services for supervising thecompletion of the warehouses, nor for liquidating or winding up the company's affairs. Wethink that the amount of $4,918.75 Mexican currency, balance in McCullough's favor up tothis point, represents a fair, equitable, and just settlement.

So far we have referred to the Philippine Engineering and Construction Company as the"company," without any attempt to define its legal status.

The plaintiff and defendants organized this company with a capital stock of $100,000Mexican currency, each paying in on the organization $2,000 Mexican currency. Theremainder, $9,000, according to the articles of agreement, were to be offered to the public inshares of $100 Mexican currency, each. The names of all the organizers appear in thearticles of agreement, which articles were duly inscribed in the commercial register. Thepurpose for which this organization was affected were to engage in general engineering andconstruction work, and operating under the name of the "Philippine Engineering andConstruction Company." during its active existence, it engaged in the business of attemptingto rise the sunken Spanish fleet, constructing under contract warehouses and a wharf for theUnited States Government, supervising the construction of a warehouse for a private firm,and some assay work. It was, therefore, an industrial civil partnership, as distinguished froma commercial one; a civil partnership in the mercantile form, an anonymous partnershiplegally constituted in the city of Manila.

The articles of agreement appeared in a public document and were duly inscribed in thecommercial register. To the extent of this inscription the corporation partook of the form of amercantile one and as such must e governed by articles 151 to 174 of the Code ofCommerce, in so far as these provisions are not in conflict with the Civil Code (art. 1670,Civil Code); but the direct and principal law applicable is the Civil Code. Those provisionsof the Code of Commerce are applicable subsidiary.

This partnership or stock company (sociedad anonima) upon the execution of the publicinstrument in which is articles of agreement appear, and the contribution of funds andpersonal property, became a juridicial person — an artificial being, invisible, intangible andexisting only in contemplation of law — with the power to hold, buy, and ell property, andto use and be sued — a corporation — not a general copartnership nor a limitedcopartnership. (Arts. 37, 38,1656 of the Civil Code; Compania Agricola de Ultimar vs.

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Reyes et al., 4 Phil. Rep., 2; and Chief Justice Marshall's definition of a corporation, 17 U.S., 518.)

The inscribing of its articles of agreement in the commercial register was not necessary tomake it a juridicial person — a corporation. Such inscription only operated to show that itpartook of the form of a commercial corporation. (Compania Agricola de Ultimar vs. Reyeset al., supra.)

Did a majority of the stockholders, who were at the same time a majority of the directors ofthis corporation, have the power under the law and its articles of agreement, to sell ortransfer to one of its members the assets of said corporation?

In the first article of the statutes of incorporation it is stated tat by virtue of a publicdocument the organizers, whose names are given in full, agreed to form a sociedad anonima.Article II provides that the organizers should be the directors an administrators until thesecond general meeting, and until their successors were duly elected and installed. The thirdprovides that the sociedad should run for ninety-nine years from the date of the execution ofits articles of agreement. Article IV sets forth the object or purpose of the organization.Article V makes the capital $100,000 Mexican currency, divided into one thousand shares at$100 Mexican currency each. Article VI provides that each shareholder should beconsidered as a coowner in the assets of the company and entitled to participate in the profitsin proportion to the amount of his stock. Article VII fixed the time of holding generalmeetings and the manner of calling special meetings of the stockholders. Article VIIIprovides that the board of directors shall be elected annually. Article IX provides for thefiling of vacancies in the board of directors. Article X provides that "the board of directorsshall elect the officers of the sociedad and have under is charge the administration of the saidsociedad." Article XI: "In all the questions with reference to the administration of the affairsof the sociedad, it shall be necessary to secure the unanimous vote of the board of directors,and at least three of said board must be provides that all of the stock, except that which wasdivided among the organizers should remain in the treasury subject to the disposition of theboard of directors. Article XIII reads: "In all the meetings of the stockholders, a majorityvote of the stockholders present shall be necessary to determine any question discussed."The fourteenth articles authorizes the board of directors to adopt such rules and regulationsfor the government of the sociedad as it should deem proper, which were not in conflict withits statutes.

When the sale or transfer heretofore mentioned took place, there were present four directors,all of whom gave their consent to that sale or transfer. The plaintiff was then about and hisexpress consent to make this transfer or sale was not obtained. He was, before leaving, oneof the directors in this corporation, and although he had resigned as manager, he had notresigned as a director. He accepted the position of engineer of the Canton and ShanghaiRailway Company, knowing that his duties as such engineer would require his whole time

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and attention and prevent his returning to the Philippine Islands for at least a year or more.The new position which he accepted in China was incompatible with his position as directorin the Philippine Engineering and Construction Company, a corporation whose sphere ofoperations was limited to the Philippine Islands. These facts are sufficient to constitute anabandoning or vacating of hid position as director in said corporation. (10 Cyc., 741.)Consequently, the transfer or sale of the corporation's assets to one of its members was madeby the unanimous consent of all the directors in the corporation at that time.

There were only five stockholders in this corporation at any time, four of whom were thedirectors who made the sale, and the other the plaintiff, who was absent in China when thesaid sale took place. The sale was, therefore, made by the unanimous consent of four-fifthsof all the stockholders. Under the articles of incorporation, the stockholders and directorshad general ordinary powers. There is nothing in said articles which expressly prohibits thesale or transfer of the corporate property to one of the stockholders of said corporation.

Is there anything in the law which prohibits such a sale or transfer? To determine thisquestion, it is necessary to examine, first, the provisions of the Civil Code, and second, thoseprovisions (art. 151 to 174) of the Code o ] Commerce.

Articles 1700 to 1708 of the Civil Code deal with the manner of dissolving a corporation.There is nothing in these articles which expressly or impliedly prohibits the sale of corporateproperty to one of its members, nor a dissolution of a corporation in this manner. Neither isthere anything in articles 151 to 174 of the Code of Commerce which prohibits thedissolution of a corporation by such sale or transfer.

The articles of incorporation must include:

x x x x x x x x x

The submission to the vote of the majority of the meeting of members, duly called and held,of such matters as may properly be brought before the same. (No. 10, art. 151, Code ofCommerce.)

Article XIII of the corporation's statutes expressly provides that "in all the meetings of thestockholders, a majority vote of the stockholders present shall be necessary to determine anyquestion discussed."

The sale or transfer to one of its members was a matter which a majority of the stockholderscould very properly consider. But it i said that if the acts and resolutions of a majority of thestockholders in a corporation are binding in every case upon the minority, the minoritywould be completely wiped out and their rights would be wholly at the mercy of the abusesof the majority.

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Generally speaking, the voice of a majority of the stockholders is the law of the corporation,but there are exceptions to this rule. There must necessarily be a limit upon the power of themajority. Without such a limit the will of the majority would be absolute and irresistible andmight easily degenerate into an arbitrary tyranny. The reason for these limitations is that inevery contract of partnership (and a corporation can be something fundamental andunalterable which is beyond the power of the majority of the stockholders, and whichconstitutes the rule controlling their actions. this rule which must be observed is to be foundin the essential compacts of such partnership, which gave served as a basis upon which themembers have united, and without which it is not probable that they would have entered notthe corporation. Notwithstanding these limitations upon the power of the majority of thestockholders, their (the majority's) resolutions, when passed in good faith and for a justcause, deserve careful consideration and are generally binding upon the minority.

Eixala, in his work entitled "Instituciones del Derecho Mercantil de España," speaking ofsociedades anonimas, says:

The resolutions of the boards passed by a majority vote are valid . . . and authority forpassing such resolutions is unlimited, provided that the original contract is not broken bythem, the partnership funds not devoted to foreign purposes, or the partnerships transformed,or changes made which are against public policy or which infringe upon the rights of thirdpersons.

The supreme court of Spain, in its decision dated June 30, 1888, said:

In order to be valid and binding upon dissenting members, it s an indispensable requisite thatresolutions passed by a general meeting of stockholders conform absolutely to the contractsand conditions of the articles of the association, which are to be strictly construed.

That resolutions passed within certain limitations by a majority of the stockholders of acorporation are binding upon the minority, is therefore recognized by the Spanishauthorities.

Power of private corporation to alienate property. — This power of absolute alienability ofcorporate property applies especially to private corporations that are established solely forthe purpose of trade or manufacturing and in which he public has no direct interest. Whilethis power is spoken of as belonging to the corporation it must be observed that theauthorities point out that the trustees or directors of a corporation do not possess the powerto dispose of the corporate property so as to virtually end the existence of the corporationand prevent it from carrying on the business for which it was incorporated. (Thompson onCorporation, second edition, sec. 2416, and cases cited thereunder.)

Power to dispose of all property. — Where there are no creditors, and no stockholderobjects, a corporation, as against all other persons but the state, may sell and dispose of all

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its property. The state in its sovereign capacity may question the power of the corporation todo so, but with these exceptions such as a sale is void. A rule of general application is that acorporation of a purely private business character, one which owes no special duty to thepublic, and is not given the right of eminent domain, where exigencies of its business requireit or when the circumstances are such that it can no longer continue the business with profit,may sell and dispose of all its property, pay its debts, divide the remaining assets and windup the affairs of the corporation. (Id., sec. 2417.)

When directors or officers may dispose of all the property. — It is within the dominion ofthe managing officers and agents of the corporation to dispose of all the corporate propertyunder certain circumstances; and this may be done without reference to the assent orauthority of the stockholders. This disposition of the property may be temporarily by lease,or permanently by absolute conveyance. But it can only be done in the course of thecorporate business and for the furtherance of the purposes of the incorporation. The board ofdirectors possess this power when the corporation becomes involved and by reason of itsembarrassed or insolvent condition is unable either to pay its debts or to secure capital andfunds for the further prosecution of its enterprise, and especially where creditors are pressingtheir claims and demands and are threatening to or have instituted actions to enforce theirclaims. This power of the directors to alienate the property is conceded where it is regardedas of imperative necessity. (If., sec. 2418, and case cited.)

When majority stockholder may dispose of all corporate property. — Another rule thatpermits a majority of the stockholders to dispose of all the corporate property and wind upthe business, is where the corporation has became insolvent, and the disposition of theproperty is necessary to pay the debt; or where from any cause the business is a failure, andthe best interest of the corporation and all the stockholders require it, then the majority haveclearly the power to dispose of all the property even as against the protests of a minority. Itwould be a harsh rule that could permit one stockholder, or any minority of the stockholders,to hold the majority to their investment where the continuation of the business would be at aloss and where there was no prospect or hope that the enterprise could be made profitable.The rule as stated by some courts is that the majority stockholders may dispose of theproperty when just cause exists; and this just cause is usually defined to be theunprofitableness of the business and where its continuation would be ruinous to thecorporation and against the interest of stockholders. (Id., sec. 2424, and cases cited.)

Nothing is better settled in the law of corporations than the doctrine that a corporation hasthe same capacity and power as a natural person to dispose of the convey its property, real orpersonal, provided it does not do so for a purpose which is foreign to the objects for which itwas created, and provided, further, it violates no charter or statutory restriction, on rule oflaw based upon public policy. . . .This power need not be expressly conferred upon acorporation by its charter. It is implied as an incident to its ownership of property, unlessthere is some clear restriction in this charter or in some statute. (Clark and Marshall's Private

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Corporations, sec. 152, and cases cited.)

A purely private business corporation, like a manufacturing or trading company, which is notgiven the right of eminent domain, and which owes no special duties to the public, maycertainly sell and convey absolutely the whole of its property, when the exigencies of itsbusiness require it to do so, or when the circumstances are such that it can no longerprofitably continue its business, provided the transaction is not in fraud of the rights ofcreditors, or in violation of charter or statutory restrictions. And, by the weight of authority,this may be done a majority of the stockholders against the dissent of the minority. (Id., sec.160, and cases cited.)

The above citations are taken from the works of the most eminent writers on corporationlaw. The citation of cases in support of the rules herein announced are too numerous toinsert.

From these authorities it appears to be well settled, first, that a private corporation, whichowes no special duty to the public and which has not been given the right of eminentdomain, has the absolute right and power as against the whole world except the state, to selland dispose of all of its property; second, that the board of directors, has the power, withoutreferrence to the assent or authority of the stockholders, when the corporation is in failingcircumstances or insolvent or when it can no longer continue the business with profit, andwhen it is regarded as an imperative necessity; third, that a majority of the stockholders ordirectors, even against the protest of the minority, have this power where, from any cause,the business is a failure and the best interest of the corporation and all the stockholdersrequire it.

May officer or directors of the corporation purchase the corporate property? The authoritiesare not uniform on this question, but on the general proposition whether a director or anofficer may deal with the corporation, we think the weight of authority is that he may.(Merrick vs. Peru Coal Co., 61 Ill., 472; Harts et al. vs. Brown et al., 77 Ill., 226; Twin-LickOil Company vs. Marbury, 91 U.S., 587; Whitwell vs, Warner, 20 Vt., 425; Smith vs.Lansing, 22 N.Y., 520; City of St. Loius vs. Alexander, 23 Mo., 483; Beach et al vs. Miller,130 Ill., 162.)

While a corporation remains solvent, we can see no reason why a director or officer, by theauthority of a majority of the stockholders or board of managers, may not deal with thecorporation, loan it money or buy property from it, in like manner as a stranger. So long as apurely private corporation remains solvent, its directors are agents or trustees for thestockholders. They owe no duties or obligations to others. But the moment such acorporation becomes insolvent, its directors are trustees of all the creditors, whether they aremembers of the corporation or not, and must manage its property and assets with strictregard to their interest; and if they are themselves creditors while the insolvent corporationis under their management, they will not be permitted to secure to themselves by purchasing

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the corporate property or otherwise any personal advantage over the other creditors.Nevertheless, a director or officer may in good faith and for an adequate considerationpurchase from a majority of the directors or stockholders the property even of an insolventcorporation, and a sale thus made to him is valid and binding upon the minority. (Beach etal. vs. Miller, supra; Twin-Lick Oil Company vs. Marbury, supra; Drury vs. Cross, 7 Wall.,299; Curran vs. State of Arkansas, 15 How., 304; Richards vs. New Hamphshire InsuranceCompany, 43 N. H., 263; Morawetz on Corporations (first edition), sec. 579; Haywood vs.Lincoln Lumber Company et al., 64 Wis., 639; Port vs. Russels, 36 Ind., 60; Lippincott vs.Shaw Carriage Company, 21 Fed. Rep., 577.)

In the case of the Twin-Lick Oil Company vs. Marbury, supra, the complaint was acorporation organized under the laws of West Virginia, engaged in the business of raisingand selling petroleum. It became very much embarrased and a note was given secured by adeed of trust, conveying all the property rights, and franchise of the corporation to WilliamThomas to secure the payment of said note, with the usual power of sale in default ofpayment. The property was sold under the deed of trust; was bought in by defendant's agentfor his benefit, and conveyed to him the same year. The defendant was at the time of thesetransactions a stockholder and director in the company. At the time the defendant's moneybecame due there was no apparent possibility of the corporation's paying it at any time. Thecorporation was then insolvent. The property was sold by the trustee and bough in by thedefendant at a fair and open sale and at a reasonable price. The sale and purchase was theonly mode left to the defendant to make his money. The court said:

That a director of a joint-stock corporation occupies one of those fiduciary relations wherehis dealings with the subject-matter of his trust or agency, and with the beneficiary or partywhose interest is confided to his care, is viewed with jealousy by the courts, and may be setaside on slight grounds, is a doctrine founded on the soundest morality, and which hasreceived the clearest recognition in this court and others. (Koehler vs. Iron., 2 Black, 715;Drury vs. Cross, 7 Wall., 299; R.R. Co. vs. Magnay, 25 Beav., 586; Cumberland Co vs.Sherman, 30 Barb., 553; Hoffman S. Coal Co. vs. Cumberland Co., 16 Md., 456.) Thegeneral doctrine, however, in regard to contracts of this class, is, not that they are absolutelyvoid, but that they are voidable at the election of the party whose interest has been sorepresented by the party claiming under it. We say, this is the general rule; for there may becases where such contracts would be void ab initio; as when an agent to sell buys of himself,and by his power of attorney conveys to himself that which he was authorized to sell. buteven here, acts which amount t a ratification by the principal may validate the sale.

The present case is not one of that class. While it is true that the defendant, a s a director ofthe corporation, was bound by all those rules of conscientious fairness which courts ofequity have imposed as the guides for dealing in such cases, it can not be maintained thatany rule forbids one director among several from loaning money to the corporation when themoney is needed, and the transaction is open, and otherwise free from blame. No adjudged

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case has gone so far as this. Such a doctrine, while it would afford little protection to thecorporation against actual fraud or oppression, would deprive it of the air of those mostinterested in giving aid judiciously, and best qualified to judge of the necessity of that aid,and of the extent to which it may safely be given.

There are in such a transaction three distinct parties whose interest is affected by it; namely,the lender, the corporation, and the stockholders of the corporation.

The directors are the officers or agents of the corporation, and represent the interests of theabstract legal entity, and of those who own the shares of its stock. One of the objects ofcreating a corporation by law is to enable it to make contracts; and these contracts may bemade with its stockholders as well as with others. In some classes of corporations, as inmutual insurance companies, the main object of the act of the incorporation is to enable thecompany to make contracts which its stockholders, or with persons who becomestockholders by the very act of making the contract of insurance. It is very true, that as astockholder, in making a contract of any kind with the corporation of which he is a member,is in some sense dealing with a creature of which he is a part, and holds a common interestwith the other stockholders, who, with him, constitute the whole of that artificial entity, he isproperly held to a larger measure of candor and good faith than if he were not a stockholder.So, when the lender is a director, charged, with others, with the control and management ofthe affairs of the corporation, representing in this regard the aggregated interest of all thestockholders, his obligation, if he becomes a party to a contract with the company, to candorand fair dealing, is increased in the precise degree that his representative character has givenhim power and control derived from the confidence reposed in him by the stockholders whoappointed him their agent. If he should be a sole director, or one of a smaller number vestedwith certain powers, this obligation would be still stronger, and his acts subject to moresevere scrutiny, and their validity determined by more rigid principles of morality, andfreedom from motives of selfishness. All this falls far short, however, of holding that nosuch contract can be made which will be valid; . . . .

In the case of Hancock vs. Holbrook et al. (40 La. Ann., 53), the court said:

As a strictly legal question, the right of a board of directors of a corporation to apply itproperty to the payment of its debts, and the right of the majority of stockholders present at ameeting called for the purpose to ratify such action and to dissolve the corporation, can notbe questioned.

But were such action is taken at the instance, and through the influence of the president ofthe corporation, and were the debt to which the property is applied is one for which he ishimself primarily liable, and specially where he subsequently acquires, in his personal right,the proerty thus disposed of, such circumstances undoubtedly subject his acts to severescrutiny, and oblige him to establish that he acted with the utmost candor and fair-dealing forthe interest of the corporation, and without taint of selfish motive.

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The sale or transfer of the corporate property in the case at bar was made by three directorswho were at the same time a majority of stockholders. If a majority of the stockholders havea clear and a better right to sell the corporate property than a majority of the directors, then itcan be said that a majority of the stockholders made this sale or transfer to the defendantMcCullough.

What were the circumstances under which said sale was made? The corporation had beengoing from bad to worse. The work of trying to raise the sunken Spanish fleet had been forseveral months abandoned. The corporation under the management of the plaintiff hadentirely failed in this undertaking. It had broken its contract with the naval authorities andthe $10,000 Mexican currency deposited had been confiscated. It had no money. It wasconsiderably in debt. It was a losing concern and a financial failure. To continue itsoperation meant more losses. Success was impossible. The corporation was civilly dead andhad passed into the limbo of utter insolvency. The majority of the stockholders or directorssold the assets of this corporation, thereby relieving themselves and the plaintiff of allresponsibility. This was only the wise and sensible thing for them to do. They acted inperfectly good faith and for the best interests of all the stockholders. "It would be a harshrule that would permit one stockholder, or any minority of stockholders to hold a majority totheir investment where a continuation of the business would be at a loss and where there wasno prospect or hope that the enterprise would be profitable."

The above sets forth the condition of this insolvent corporation when the defendantMcCullough proposed to the majority of stockholders to take over the assets and assume allresponsibility for the payment of the debts and the completion of the warehouses which hadbeen undertaken. The assets consisted of office furniture of a value of less than P400, theuncompleted contract for the construction of the Government warehouses, and the wreckingcontract. The liabilities amounted to at least $19,645.74 Mexican currency. $9,645.74Mexican currency of this amount represented borrowed money, and $10,000 Mexicancurrency was the deposit with the naval authorities which had been confiscated and whichwas due the bank. McCullough's profits on the warehouse contract amounted to almostenough to the pay the amounts which the corporation had borrowed from its members. Thewrecking contract which had been broken was of no value to the corporation for the reasonthat the naval authorities absolutely refused to have anything further to do with thePhilippine Engineering and Construction Company. They the naval authorities) had declinedto consider the petition of the corporation for an extension in which to raise the Spanishfleet, and had also refused to reconsider their action in confiscating the deposit. They didagree, however, that if the defendant McCullough would organize a new association, thatthey would give the new concern an extension of time and would reconsider the question offorfeiture of the amount deposited. Under these circumstances and conditions, McCulloughorganized the Manila Salvage Company, sold five-sixth of this wrecking contract to the newcompany for $15,000 Mexican currency and retained one-sixth as his share of the stock inthe new concern. The Manila Salvage company paid to the bank the $10,000 Mexican

14

currency which had been borrowed to deposit with the naval authorities, and beganoperations. All of the $10,000 Mexican currency so deposited was refund to the newcompany except P2,000. The new association failed and McCullough, by reason of thisfailure, lost over $16,000 Mexican currency. These facts show that McCullough acted ingood faith in purchasing the old corporation's assets, and that he certainly paid for the samea valuable consideration.

But cancel for the plaintiff say: "The board of directors possessed only ordinary powers ofadministration (Article X of the Articles of incorporation), which in no manner empoweredit either to transfer or to authorize the transfer of the assets of the company to McCullough(art. 1773, Civil Code; decisions of the supreme court of Spain of April 2, 1862, and July 8,1903)."

Article X of the articles of incorporation above referred to provides that the board ofdirectors shall elect the officers of the corporation and "have under its charge theadministration of the said corporation." Articles XI reads: "In all the questions withreference to the administration of the affairs of the corporation, it shall be necessary tosecure the unanimous vote of the board of directors, and at least three of said board must bepresent in order to constitute a legal meeting." It will be noted that article X statute a legalmeeting." It will be noted that Article X placed the administration of the affairs of thecorporation in the hands of the board of directors. If Article XI had been omitted, it is clearthat under the rules which govern business of that character, and in view of the fact thatbefore the plaintiff left this country and abandoned his office as director, there were onlyfive directors in the corporation, then three would have been sufficient to constitute aquorum and could perform all the duties and exercise all the powers conferred upon theboard under this article. It would not have been necessary to obtain the consent of all threeof such members which constituted the quorum in order that a solution affecting theadministration of the corporation should be binding, as two votes — a majority of thequorum — would have been sufficient for this purpose. (Buell vs. Buckingham & Co., 16Iowa, 284; 2 Kent. Com., 293; Cahill vs. Kalamazoo Mutual Insurance Company, 2 Doug.(Mich.), 124; Sargent vs. Webster, 13 Met., 497; In re Insurance Company, 22 Wend., 591;Ex parte Wilcox, 7 Cow., 402; id., 527, note a.)

It might appear on first examination that the organizers of this corporation when theyasserted the first part of Article XI intended that no resolution affecting the administration ofthe affairs should be binding upon the corporation unless the unanimous consent of theentire board was first obtained; but the reading of the last part of this same article showsclearly that the said organizers had no such intention, for they said: "At least three of saidboard must be present in order to constitute a legal meeting." Now, if three constitute a legalmeeting, three were sufficient to transact business, three constituted the quorum, and, underthe above-cited authorities, two of the three would be sufficient to pass binding resolutionsrelating to the administration of the corporation.

15

If the clause "have under in charge and administer the affairs of the corporation" refers to theordinary business transactions of the corporation and does not include the power to sell thecorporate property and to dissolve the corporation when it becomes insolvent — a changewe admit organic and fundamental — then the majority of the stockholders in whom theultimate and controlling power lies must surely have the power to do so.

Article 1713 of the Civil Code reads:

An agency stated in general terms only includes acts of administration.

In order to compromise, alienate, mortgage, or execute any other act of strict ownership anexpress commission is required.

This article appears in title 9, chapter 1 of the Civil Code, which deals with the character,form, and kind of agency. Now, were the positions of Hilbert, Green, Hartigan, andMcCullough that the agents within the meaning of the article above quoted when the assetsof the corporation were transferred or sold to McCullough? If so, it would appear from saidarticle that in order to make the sale valid, an express commission would be required. Thisprovision of law is based upon the broad principles of sound reason and public policy. Thereis a manifest impropriety in allowing the same person to act as the agent of the seller and tobecome himself the buyer. In such cases, there arises so often a conflict between duty andinterest. "The wise policy of the law put the sting of a disability into the temptation, as adefensive weapon against the strength of the danger which lies in the situation."

Hilbert, Green, and Hartigan were not only all creditors at the time the sale or transfer of theassets of the insolvent corporation was made, but they were also directors and stockholders.In addition to being a creditor, McCullough sustained the corporation the double relation ofa stockholder and president. The plaintiff was only a stockholder. He would have been acreditor to the extent of his unpaid salary if the corporation had been a profitable instead of alosing concern.

But as we have said when the sale or transfer under consideration took place, there werethree directors present, and all voted in favor of making this sale. It was not necessary forthe president, McCullough, to vote. There was a quorum without him: a quorum of thedirectors, and at the same time a majority of the stockholders.

A corporation is essential a partnership, except in form. "The directors are the trustees ormanaging partners, and the stockholders are the cestui que trust and have a joint interest inall the property and effects of the corporation." (Per Walworth, Ch., in Robinson vs. Smith, 3Paige, 222, 232; 5 idem, 607; Slee vs. Bloom, 19 Johns., 479; Hoyt vs. Thompson, 1 Seld.,320.)

The Philippine Engineering and Construction Company was an artificial person, owning its

16

property and necessarily acting by its agents; and these agents were the directors.McCullough was then an agent or a trustee, and the stockholders the principal. Or say (ascorporation was insolvent) that he was an agent or trustee and the creditors were thebeneficiaries. This being the true relation, then the rules of the law (art. 1713 of the CivilCode) applicable to sales and purchases by agents and trustees would not apply to thepurchase in question for the reason that there was a quorum without McCullough, and forthe further reason that an officer or director of a corporation, being an agent of an artificialperson and having a joint interest in the corporate property, is not such an agent as thattreated of in article 1713 of the Civil Code.

Again, McCullough did not represent the corporation in this transaction. It was representedby a quorum of the board of directors, who were at the same time a majority of thestockholders. Ordinarily, McCullough's duties as president were to preside at the meetings,rule on questions of order, vote in case of a tie, etc. He could not have voted in thistransaction because there was no tie.

The acts of Hilbert, Green, Hartigan, and McCullough in this transaction, in view of therelations which they bore to the corporation, are subject to the most severe scrutiny. Theyare obliged to establish that they acted with the utmost candor and fair dealing for theinterest of the corporation, and without taint motives. We have subjected their conduct tothis test, and, under the evidence, we believe it has safely emerged from the ordeal.

Transaction which only accomplish justice, which are done in good faith and operate legalinjury to no one, lack the characteristics of fraud and are not to be upset because therelations of the parties give rise to suspicions which are fully cleared away. (Hancock vs.Holbrook, supra.)

We therefore conclude that the sale or transfer made by the quorum of the board of directors— a majority of the stockholders — is valid and binding upon the majority-the plaintiff.This conclusion is not in violation of the articles of incorporation of the PhilippineEngineering and Construction Company. Nor do we here announce a doctrine contrary tothat announced by the supreme court of Spain in its decisions dated April 2, 1862, and July8, 1903.

As to the third cause of action, it is insisted: First, that the court erred in holding thedefendant McCullough responsible for the personal effects of the plaintiff; and second, thatthe court erred in finding that the effects left by the plaintiff were worth P2,400.

As we have said, the plaintiff was the manager of the Philippine Engineering Company fromApril 1, 1902, up to January 1, 1903. Sometimes during the previous month of December heresigned to accept a position in China, but did not leave Manila until about January 20. Heremained in Manila about twenty days after he severed his connection with the company. Helived in rooms in the same building which was rented by the company and were the

17

company had its offices. When he started for China he left his personal effects in thoserooms, having turned the same over to one Paulsen. Testifying on this point the plaintiffsaid:

Q. To whom did you turn over these personal effects on leaving here? — A. To Mr. Paulsen.

Q. Have you demanded payment of this sum [referring to the value of his personal effects]?— A. On leaving for China I gave Mr. Haussermann power of attorney to represent me inthis case and demand payment.

Q. Please state whether or not you have an inventory of these effects. — A. I had aninventory which was in my possession but it was lost when the company took all of thebooks and carried them away from the office.

Q. Can you give a list or a partial list of your effect? — A. I remember some of the items.There was a complete bedroom set, two marble tables, one glass bookcase, chairs, all of thehousehold effects I used when I was living in the Botanical Garden as city engineer, onetheodolite, which I bought after commencing work with the company.

Q. How much do you estimate to be the total reasonable value of these effects? — A. Thetotal would not be less than $1,200 gold.

Counsel for the plaintiff, on page 56 of their brief, say:

Mr. McCullough, in his testimony (pp. 39 and 40) admits full knowledge of andparticipation in the removal and sale of the effects and states that he took the proceeds andconsidered them part of the assets of the company. He further admits that Mr. Haussermannmade a demand for the proceeds of Mr. Mead's personal effects (p. 44).

McCullough's testimony, referred by the counsel, is as follows:

Q. At the time Mr. Mead left for China, in the building where the office was and in theoffice, there were left some of the personal effects of Mr. Mead. What do you know aboutthese effects, a list of which is Exhibit B? — A. Nothing appearing in this Exhibit B wasnever delivered to the Philippine Engineering and Construction Company, according to mylist.

Q. Do you know what became of these effects? — A. No, sir. I have no idea. I never sawthem. I never heard these effects talked about. I only heard something said about certaineffects which Mr. Mead had in his living room.

Q. Do you know what became of the bed of Mr. Mead? — A. I know there were effects,such as a bed, washstand, chairs, table, and other things, which are used in a living room,and that they were in Mr. Mead's room. These effects were sent to the warehouse of the

18

Pacific Oriental Trading Company, together with the office furniture. We had to vacate thebuilding where the offices were and we had to take out everything therein. These thingswere deposited in the warehouse of the Pacific Oriental Trading Company and were finallysold by that company and the money turned over to me.

Q. How much? — A. P49.97.

Q. What did you do with this money? — A. I took it and considered it part of the assets ofthe company. All of the other effects of the office were sold at the same time and broughtP347.16.

Q. Did Mr. Mead leave anyone in charge of his effects when he left Manila? — A. I think heleft Paulsen in charge, but Paulsen did not take these effects, so when we vacated the officewe had to move them.

Q. Did Paulsen continue occupying the living room where these effects were and did he usethese effects? — A. I do not know because I was in the office for three months before wevacated.

Q. Don't you know that it is a fact that Mr. Haussermann, as representative of Mr. Mead,demanded of you and the company the payment of the salary which was due Mr. Mead andthe value of his personal effects? — A. Yes, sir.

As to the value of these personal effects, Hartigan, testifying as witness for the defendant,said:

I think the personal effects were sold for P50. His personal effects consisted of ordinaryarticles, such as a person would use who had to be going from one place to another all thetime, as Mr. Mead. I know that all those effects were sold for less than P100, if I am notmistaken.

The foregoing is the material testimony with reference to the defendant McCullough'sresponsibility and the value of the personal effects of the plaintiff.

McCullough was a member of the company and was responsible as such for the rents wherethe offices were located. The company had no further use for the building after the plaintiffresigned. The vacating of the building was the proper thing to do. The office furniture wasremoved and stored in a place where it cost nothing for rents. When Hilbert, member of thecompany, went to the office to remove the company's office furniture, he found no one incharge of the plaintiff's personal effects. He took them and stored them in the same placeand later sold them, together with the office furniture, and turned the entire amount over todefendant McCullough.

Paulsen, in whose charge Mead left his effects, apparently took no interest in caring for

19

them. Was the company to leave Mead's personal effects in that building and take thechances of having to continue to pay rents, solely on account of the plaintiff's propertyremaining there? The company had reason to believe that it would have to continue payingthese rents, as they had rented the building and authorized the plaintiff to occupy roomstherein.

The plaintiff knew when he left for China that he would be away a long time. He hadaccepted a position of importance, and which he knew would require his personal attention.He did not gather up his personal effects, but left them in the room in charge of Paulsen.Paulsen took no interest in caring for them, but apparently left these effects to take care ofthem selves. The plaintiff did not even carry with him an inventory of these effects, butattempted on the trial to give a list of them and did give a partial list of the things he left inhis room; but it is not shown that all this things were there when Herbert removed the officefurniture and some of the plaintiff's effects. The fact that the plaintiff remained in Manilasome twenty days after resigning and never cared for his own effects but left them in thepossession of an irresponsible person, shows extreme negligence on his part. He exhibited areckless indifference to the consequences of leaving his effects in the lease premises. Thelaw imposes on every person the duty of using ordinary care against injury or damages.What constitutes ordinary care depends upon the circumstances of each particular case andthe danger reasonably to be apprehended.

McCullough did not have anything personally to do with these effects at any time. He onlyaccepted the money which Herbert turned over to him. He, personally, did not contribute inany way whatsoever to the loss of the property, neither did he as a member of thecorporation do so.

The plaintiff gave an estimate of the value of the effects which he left in his rooms andplaced this value at P2,400. He did not give a complete list of the effects so left, neither didhe give the value of a single item separately. The plaintiff's testimony is so indefinite anduncertain that i t is impossible to determine with any degree of certainty just what thesepersonal effects consisted of and their values, especially when we take into consideration thesignificant fact that these effects were abondoned by Paulsen. On the other hand, w havebefore us the positive testimony of Hilbert as to the amount received for the plaintiff'spersonal effects, the testimony of Hartigan that the same were sold for less than P100, andthe testimony of McCullough as to the amount turned over to him by Herbert.

So we conclude that the great preponderance of evidence as to the value of these effects is inthe favor of the contention of the defendant. Their value therefore be fixed at P49.97.

For these reasons the judgment appealed from as to the first and second causes of action ishereby affirmed. Judgment appealed from as to the third cause of action is reduced toP49.97, without costs.

20

Arellano, C.J., Torres, Mapa, Carson and Moreland, JJ., concur.

21

MEAD v. McCULLOUGH

Charles Mead, Edwin McCullough and three others organized the corporation called ThePhilippine Engineering and Construction Company (PECC). The 4 organizers, exceptMead, contributed to the majority of the capital stock of PECC, the remaining shareswere offered to the public. Mead contributed some personal properties. Mead wasassigned as a manager but he resigned as such when he accepted an engineering job inChina. But even so, he remained as one of the five directors (the organizers).

At that time, PECC was already incurring losses. McCullough, the president, proposedthat he shall buy the assets of the corporation. The three other directors then voted infavor of this proposal hence the assets were transferred to McCullough. Mead learned ofthis and so he opposed it because the personal properties he contributed were alsotransferred to McCullough.

Mead also argued that under the articles of incorporation of PECC, the board of directorsonly have ordinary powers; that the authorization made by the three directors to allow thesale of company assets to McCullough constitutes an act of agency which is invalid atthat because no express commission was made, i.e., no power of attorney was made infavor of the directors. The requirement for a commission can be inferred from Article1713 of the Civil Code which provides:

An agency stated in general terms only includes acts of administration.

In order to compromise, alienate, mortgage, or execute any other act of strict ownershipan express commission is required. (Emphasis supplied).

Mead also insists that under their charter, no resolution affecting the administration of theaffairs of PECC should be binding upon the corporation unless the unanimous consent ofthe entire board was first obtained

ISSUE: Whether or not the three directors had the authority to allow the sale/transfer ofthe company assets to McCullough.

HELD:

Yes. Several factors have to be considered. First is the fact that Mead abandoned his postwhen he took the job offer to work in China. He knew for a fact that the nature of the joboffered is permanent. Second, a close reading of the articles of incorporation of PECC

shows that there is no such intention for unanimity when it comes to votes affectingmatters of administration. The only requirement is that “At least three of said board mustbe present in order to constitute a legal meeting.” Which was complied with when theother four directors were present when the decision to transfer the company assets wasmade.

Third is the fact that PECC was in a downhill situation. A corporation is essentially apartnership, except in form. “The directors are the trustees or managing partners, and thestockholders are the cestui que trust and have a joint interest in all the property andeffects of the corporation.” McCullough as a director himself and the president can beconsidered an agent but not the “agent” contemplated in Article 1713 of the Civil Code.Article 1713 deals with the broad aspect of agency and in ordinary cases but not in thecase of a corporation and its directors. In the case at bar, the more appropriate analogy isthat PECC, being a losing corporation, has its directors as the trustees. The trustees-directors hold the company assets in trust for the beneficiaries, which are the creditors.As trustees, they decided that it is beneficial to sell the company assets to McCullough toat least recover some cash equivalents in the winding up of the corporate affairs. Besides,there is no prohibition against the selling of company assets to one of its directors eitherfrom law or from PECC’s articles of incorporation.

SECOND DIVISION

G.R. No. L-68555 March 19, 1993

PRIME WHITE CEMENT CORPORATION, petitioner, vs. HONORABLEINTERMEDIATE APPELLATE COURT and ALEJANDRO TE, respondents.

De Jesus & Associates for petitioner.

Padlan, Sutton, Mendoza & Associates for private respondent.

CAMPOS, JR., J.:

Before Us is a Petition for Review on Certiorari filed by petitioner Prime White CementCorporation seeking the reversal of the decision * of the then Intermediate Appellate Court,the dispositive portion of which reads as follows:

WHEREFORE, in view of the foregoing, the judgment appealed from is hereby affirmed intoto. 1

The facts, as found by the trial court and as adopted by the respondent Court are herebyquoted, to wit:

On or about the 16th day of July, 1969, plaintiff and defendant corporation thru its President,Mr. Zosimo Falcon and Justo C. Trazo, as Chairman of the Board, entered into a dealershipagreement (Exhibit A) whereby said plaintiff was obligated to act as the exclusive dealerand/or distributor of the said defendant corporation of its cement products in the entireMindanao area for a term of five (5) years and proving (sic) among others that:

a. The corporation shall, commencing September, 1970, sell to and supply the plaintiff, asdealer with 20,000 bags (94 lbs/bag) of white cement per month;

b. The plaintiff shall pay the defendant corporation P9.70, Philippine Currency, per bag ofwhite cement, FOB Davao and Cagayan de Oro ports;

c. The plaintiff shall, every time the defendant corporation is ready to deliver the good, openwith any bank or banking institution a confirmed, unconditional, and irrevocable letter ofcredit in favor of the corporation and that upon certification by the boat captain on the bill oflading that the goods have been loaded on board the vessel bound for Davao the said bank orbanking institution shall release the corresponding amount as payment of the goods soshipped.

Right after the plaintiff entered into the aforesaid dealership agreement, he placed an

1

advertisement in a national, circulating newspaper the fact of his being the exclusive dealerof the defendant corporation's white cement products in Mindanao area, more particularly, inthe Manila Chronicle dated August 16, 1969 (Exhibits R and R-1) and was evencongratulated by his business associates, so much so, he was asked by some of hisbusinessmen friends and close associates if they can be his sub-dealer in the Mindanao area.

Relying heavily on the dealership agreement, plaintiff sometime in the months ofSeptember, October, and December, 1969, entered into a written agreement with severalhardware stores dealing in buying and selling white cement in the Cities of Davao andCagayan de Oro which would thus enable him to sell his allocation of 20,000 bags regularsupply of the said commodity, by September, 1970 (Exhibits O, O-1, O-2, P, P-1, P-2, Q, Q-1 and Q-2). After the plaintiff was assured by his supposed buyer that his allocation of20,000 bags of white cement can be disposed of, he informed the defendant corporation inhis letter dated August 18, 1970 that he is making the necessary preparation for the openingof the requisite letter of credit to cover the price of the due initial delivery for the month ofSeptember, 1970 (Exhibit B), looking forward to the defendant corporation's duty to complywith the dealership agreement. In reply to the aforesaid letter of the plaintiff, the defendantcorporation thru its corporate secretary, replied that the board of directors of the saiddefendant decided to impose the following conditions:

a. Delivery of white cement shall commence at the end of November, 1970;

b. Only 8,000 bags of white cement per month for only a period of three (3) months will bedelivered;

c. The price of white cement was priced at P13.30 per bag;

d. The price of white cement is subject to readjustment unilaterally on the part of thedefendant;

e. The place of delivery of white cement shall be Austurias (sic);

f. The letter of credit may be opened only with the Prudential Bank, Makati Branch;

g. Payment of white cement shall be made in advance and which payment shall be used bythe defendant as guaranty in the opening of a foreign letter of credit to cover costs andexpenses in the procurement of materials in the manufacture of white cement. (Exhibit C).

xxx xxx xxx

Several demands to comply with the dealership agreement (Exhibits D, E, G, I, R, L, and N)were made by the plaintiff to the defendant, however, defendant refused to comply with thesame, and plaintiff by force of circumstances was constrained to cancel his agreement forthe supply of white cement with third parties, which were concluded in anticipation of, and

2

pursuant to the said dealership agreement.

Notwithstanding that the dealership agreement between the plaintiff and defendant was inforce and subsisting, the defendant corporation, in violation of, and with evident intentionnot to be bound by the terms and conditions thereof, entered into an exclusive dealershipagreement with a certain Napoleon Co for the marketing of white cement in Mindanao(Exhibit T) hence, this suit. (Plaintiff's Record on Appeal, pp. 86-90). 2

After trial, the trial court adjudged the corporation liable to Alejandro Te in the amount ofP3,302,400.00 as actual damages, P100,000.00 as moral damages, and P10,000.00 as andfor attorney's fees and costs. The appellate court affirmed the said decision mainly on thefollowing basis, and We quote:

There is no dispute that when Zosimo R. Falcon and Justo B. Trazo signed the dealershipagreement Exhibit "A", they were the President and Chairman of the Board, respectively, ofdefendant-appellant corporation. Neither is the genuineness of the said agreement contested.As a matter of fact, it appears on the face of the contract itself that both officers were dulyauthorized to enter into the said agreement and signed the same for and in behalf of thecorporation. When they, therefore, entered into the said transaction they created theimpression that they were duly clothed with the authority to do so. It cannot now be said thatthe disputed agreement which possesses all the essential requisites of a valid contract wasnever intended to bind the corporation as this avoidance is barred by the principle ofestoppel. 3

In this petition for review, petitioner Prime White Cement Corporation made the followingassignment of errors. 4

I

THE DECISION AND RESOLUTION OF THE INTERMEDIATE APPELLATE COURTARE UNPRECEDENTED DEPARTURES FROM THE CODIFIED PRINCIPLE THATCORPORATE OFFICERS COULD ENTER INTO CONTRACTS IN BEHALF OF THECORPORATION ONLY WITH PRIOR APPROVAL OF THE BOARD OF DIRECTORS.

II

THE DECISION AND RESOLUTION OF THE INTERMEDIATE APPELLATE COURTARE CONTRARY TO THE ESTABLISHED JURISPRUDENCE, PRINCIPLE ANDRULE ON FIDUCIARY DUTY OF DIRECTORS AND OFFICERS OF THECORPORATION.

III

THE DECISION AND RESOLUTION OF THE INTERMEDIATE APPELLATE COURT

3

DISREGARDED THE PRINCIPLE AND JURISPRUDENCE, PRINCIPLE AND RULEON UNENFORCEABLE CONTRACTS AS PROVIDED IN ARTICLE 1317 OF THENEW CIVIL CODE.

IV

THE DECISION AND RESOLUTION OF THE INTERMEDIATE APPELLATE COURTDISREGARDED THE PRINCIPLE AND JURISPRUDENCE AS TO WHEN AWARD OFACTUAL AND MORAL DAMAGES IS PROPER.

V

IN NOT AWARDING PETITIONER'S CAUSE OF ACTION AS STATED IN ITSANSWER WITH SPECIAL AND AFFIRMATIVE DEFENSES WITH COUNTERCLAIMTHE INTERMEDIATE APPELLATE COURT HAS CLEARLY DEPARTED FROM THEACCEPTED USUAL, COURSE OF JUDICIAL PROCEEDINGS.

There is only one legal issue to be resolved by this Court: whether or not the "dealershipagreement" referred by the President and Chairman of the Board of petitioner corporation isa valid and enforceable contract. We do not agree with the conclusion of the respondentCourt that it is.

Under the Corporation Law, which was then in force at the time this case arose, 5 as well asunder the present Corporation Code, all corporate powers shall be exercised by the Board ofDirectors, except as otherwise provided by law. 6 Although it cannot completely abdicate itspower and responsibility to act for the juridical entity, the Board may expressly delegatespecific powers to its President or any of its officers. In the absence of such expressdelegation, a contract entered into by its President, on behalf of the corporation, may stillbind the corporation if the board should ratify the same expressly or impliedly. Impliedratification may take various forms — like silence or acquiescence; by acts showingapproval or adoption of the contract; or by acceptance and retention of benefits flowingtherefrom. 7 Furthermore, even in the absence of express or implied authority byratification, the President as such may, as a general rule, bind the corporation by a contractin the ordinary course of business, provided the same is reasonable under the circumstances.8 These rules are basic, but are all general and thus quite flexible. They apply where thePresident or other officer, purportedly acting for the corporation, is dealing with a thirdperson, i. e., a person outside the corporation.

The situation is quite different where a director or officer is dealing with his owncorporation. In the instant case respondent Te was not an ordinary stockholder; he was amember of the Board of Directors and Auditor of the corporation as well. He was what isoften referred to as a "self-dealing" director.

4

A director of a corporation holds a position of trust and as such, he owes a duty of loyalty tohis corporation. 9 In case his interests conflict with those of the corporation, he cannotsacrifice the latter to his own advantage and benefit. As corporate managers, directors arecommitted to seek the maximum amount of profits for the corporation. This trustrelationship "is not a matter of statutory or technical law. It springs from the fact thatdirectors have the control and guidance of corporate affairs and property and hence of theproperty interests of the stockholders." 10 In the case of Gokongwei v. Securities andExchange Commission, this Court quoted with favor from Pepper v. Litton, 11 thus:

. . . He cannot by the intervention of a corporate entity violate the ancient precept againstserving two masters. . . . He cannot utilize his inside information and his strategic positionfor his own preferment. He cannot violate rules of fair play by doing indirectly through thecorporation what he could not do directly. He cannot use his power for his personaladvantage and to the detriment of the stockholders and creditors no matter how absolute interms that power may be and no matter how meticulous he is to satisfy technicalrequirements. For that power is at all times subject to the equitable limitation that it may notbe exercised for the aggrandizement, preference, or advantage of the fiduciary to theexclusion or detriment of the cestuis. . . . .

On the other hand, a director's contract with his corporation is not in all instances void orvoidable. If the contract is fair and reasonable under the circumstances, it may be ratified bythe stockholders provided a full disclosure of his adverse interest is made. Section 32 of theCorporation Code provides, thus:

Sec. 32. Dealings of directors, trustees or officers with the corporation. — A contract of thecorporation with one or more of its directors or trustees or officers is voidable, at the optionof such corporation, unless all the following conditions are present:

1. That the presence of such director or trustee in the board meeting in which thecontract was approved was not necessary to constitute a quorum for such meeting;

2. That the vote of such director or trustee was not necessary for the approval of thecontract;

3. That the contract is fair and reasonable under the circumstances; and

4. That in the case of an officer, the contract with the officer has been previouslyauthorized by the Board of Directors.

Where any of the first two conditions set forth in the preceding paragraph is absent, in thecase of a contract with a director or trustee, such contract may be ratified by the vote of thestockholders representing at least two-thirds (2/3) of the outstanding capital stock or of two-thirds (2/3) of the members in a meeting called for the purpose: Provided, That full

5

disclosure of the adverse interest of the directors or trustees involved is made at suchmeeting: Provided, however, That the contract is fair and reasonable under thecircumstances.

Although the old Corporation Law which governs the instant case did not contain a similarprovision, yet the cited provision substantially incorporates well-settled principles incorporate law. 12

Granting arguendo that the "dealership agreement" involved here would be valid andenforceable if entered into with a person other than a director or officer of the corporation,the fact that the other party to the contract was a Director and Auditor of the petitionercorporation changes the whole situation. First of all, We believe that the contract was neitherfair nor reasonable. The "dealership agreement" entered into in July, 1969, was to sell andsupply to respondent Te 20,000 bags of white cement per month, for five years startingSeptember, 1970, at the fixed price of P9.70 per bag. Respondent Te is a businessmanhimself and must have known, or at least must be presumed to know, that at that time, pricesof commodities in general, and white cement in particular, were not stable and wereexpected to rise. At the time of the contract, petitioner corporation had not even commencedthe manufacture of white cement, the reason why delivery was not to begin until 14 monthslater. He must have known that within that period of six years, there would be a considerablerise in the price of white cement. In fact, respondent Te's own Memorandum shows that inSeptember, 1970, the price per bag was P14.50, and by the middle of 1975, it was alreadyP37.50 per bag. Despite this, no provision was made in the "dealership agreement" to allowfor an increase in price mutually acceptable to the parties. Instead, the price was pegged atP9.70 per bag for the whole five years of the contract. Fairness on his part as a director ofthe corporation from whom he was to buy the cement, would require such a provision. Infact, this unfairness in the contract is also a basis which renders a contract entered into bythe President, without authority from the Board of Directors, void or voidable, although itmay have been in the ordinary course of business. We believe that the fixed price of P9.70per bag for a period of five years was not fair and reasonable. Respondent Te, himself, whenhe subsequently entered into contracts to resell the cement to his "new dealers" Henry Wee13 and Gaudencio Galang 14 stipulated as follows:

The price of white cement shall be mutually determined by us but in no case shall the samebe less than P14.00 per bag (94 lbs).

The contract with Henry Wee was on September 15, 1969, and that with Gaudencio Galang,on October 13, 1967. A similar contract with Prudencio Lim was made on December 29,1969. 15 All of these contracts were entered into soon after his "dealership agreement" withpetitioner corporation, and in each one of them he protected himself from any increase in themarket price of white cement. Yet, except for the contract with Henry Wee, the contractswere for only two years from October, 1970. Why did he not protect the corporation in the

6

same manner when he entered into the "dealership agreement"? For that matter, why did thePresident and the Chairman of the Board not do so either? As director, specially since hewas the other party in interest, respondent Te's bounden duty was to act in such manner asnot to unduly prejudice the corporation. In the light of the circumstances of this case, it is toUs quite clear that he was guilty of disloyalty to the corporation; he was attempting in effect,to enrich himself at the expense of the corporation. There is no showing that thestockholders ratified the "dealership agreement" or that they were fully aware of itsprovisions. The contract was therefore not valid and this Court cannot allow him to reap thefruits of his disloyalty.

As a result of this action which has been proven to be without legal basis, petitionercorporation's reputation and goodwill have been prejudiced. However, there can be no awardfor moral damages under Article 2217 and succeeding articles on Section 1 of Chapter 3 ofTitle XVIII of the Civil Code in favor of a corporation.

In view of the foregoing, the Decision and Resolution of the Intermediate Appellate Courtdated March 30, 1984 and August 6, 1984, respectively, are hereby SET ASIDE. Privaterespondent Alejandro Te is hereby ordered to pay petitioner corporation the sum ofP20,000.00 for attorney's fees, plus the cost of suit and expenses of litigation.

SO ORDERED.

Narvasa, C.J., Padilla, Regalado and Nocon, JJ., concur.

7

PRIME WHITE CEMENT v. IAC

Corporation Code – Award of Moral Damages to Corporations – Self-Dealing Director

In July 1969, Zosimo Falcon and Justo Trazo entered into an agreement with Alejandro Tewhereby it was agreed that from 1970 to 1976, Te shall be the sole dealer of 20,000 bagsPrime White cement in Mindanao. Falcon was the president of Prime White CementCorporation (PWCC) and Trazo was a board member thereof. Te was likewise a boardmember of PWCC. It was agreed that the selling price for a bag of cement shall be P9.70.

Before the bags of cement can be delivered, Te already made known to the public that he isthe sole dealer of cements in Mindanao. Various hardwares then approached him to be hissub-dealers, hence, Te entered into various contracts with them. But then apparently, Falconand Trazo were not authorized by the Board of PWCC to enter into such contract.Nevertheless, the Board wished to retain the contract but they wanted some amendmentwhich includes the increase of the selling price per bag to P13.30 and the decrease of thetotal amount of cement bags from 20k to 8k only plus the contract shall only be effective fora period of three months and not

Te then sued PWCC for damages. PWCC filed a counterclaim and in said counterclaim, it isclaiming for moral damages the basis of which is the claim that Te’s filing of a civil caseagainst PWCC destroyed the company’s goodwill. The lower court ruled in favor Te.

ISSUE: Whether or not the ruling of the lower court is correct.

HELD: No. Te is what can be called as a self-dealing director – he deals business with thesame corporation in which he is a director. There is nothing wrong per se with that.However, Sec. 32 provides that:

SEC. 32. Dealings of directors, trustees or officers with the corporation. —- A contract ofthe corporation with one or more of its directors or trustees or officers is voidable, at theoption of such corporation, unless all the following conditions are present:

1. That the presence of such director or trustee in the board meeting in which thecontract was approved was not necessary to constitute a quorum for such meeting;

2. That the vote of such director or trustee was not necessary for the approval of thecontract;

3. That the contract is fair and reasonable under the circumstances; and

1

4. That in the case of an officer, the contract with the officer has been previouslyauthorized by the Board of Directors.

In this particular case, the Supreme Court focused on the fact that the contract betweenPWCC and Te through Falcon and Trazo was not reasonable. Hence, PWCC has all therights to void the contract and look for someone else, which it did. The contract isunreasonable because of the very low selling price. The Price at that time was at leastP13.00 per bag and the original contract only stipulates P9.70. Also, the original contractwas for 6 years and there’s no clause in the contract which protects PWCC from inflation.As a director, Te in this transaction should protect the corporation’s interest more than hispersonal interest. His failure to do so is disloyalty to the corporation.

Anent the issue of moral damages, there is no question that PWCC’s goodwill andreputation had been prejudiced due to the filing of this case. However, there can be no awardfor moral damages under Article 2217 of the Civil Code in favor of a corporation.

NOTE: In a later case, Coastal Pacific Trading, Inc. vs Southern Rolling Mills Co., Inc.(July 28, 2006), it was ruled that a corporation may be entitled to moral damages providedthat its good reputation was debased resulting in its humiliation in the business realm.

2

Mei

Fundamental Changes

THIRD DIVISION

[G.R. No. 142936. April 17, 2002]

PHILIPPINE NATIONAL BANK & NATIONAL SUGAR DEVELOPMENTCORPORATION, petitioners, vs. ANDRADA ELECTRIC & ENGINEERINGCOMPANY, respondent.

D E C I S I O NPANGANIBAN, J.:

Basic is the rule that a corporation has a legal personality distinct and separate from thepersons and entities owning it. The corporate veil may be lifted only if it has been used to shieldfraud, defend crime, justify a wrong, defeat public convenience, insulate bad faith or perpetuateinjustice. Thus, the mere fact that the Philippine National Bank (PNB) acquired ownership ormanagement of some assets of the Pampanga Sugar Mill (PASUMIL), which had earlier beenforeclosed and purchased at the resulting public auction by the Development Bank of thePhilippines (DBP), will not make PNB liable for the PASUMIL’s contractual debts to respondent.

Statement of the Case

Before us is a Petition for Review assailing the April 17, 2000 Decision[1] of the Court ofAppeals (CA) in CA-GR CV No. 57610. The decretal portion of the challenged Decision reads asfollows:

“WHEREFORE, the judgment appealed from is hereby AFFIRMED.”[2]

The Facts

The factual antecedents of the case are summarized by the Court of Appeals as follows:

“In its complaint, the plaintiff [herein respondent] alleged that it is a partnership duly organized, existing, andoperating under the laws of the Philippines, with office and principal place of business at Nos. 794-812 DelMonte [A]venue, Quezon City, while the defendant [herein petitioner] Philippine National Bank (hereinreferred to as PNB), is a semi-government corporation duly organized, existing and operating under the lawsof the Philippines, with office and principal place of business at Escolta Street, Sta. Cruz, Manila; whereas,the other defendant, the National Sugar Development Corporation (NASUDECO in brief), is also a semi-government corporation and the sugar arm of the PNB, with office and principal place of business at the 2nd

Floor, Sampaguita Building, Cubao, Quezon City; and the defendant Pampanga Sugar Mills (PASUMIL inshort), is a corporation organized, existing and operating under the 1975 laws of the Philippines, and had its

business office before 1975 at Del Carmen, Floridablanca, Pampanga; that the plaintiff is engaged in thebusiness of general construction for the repairs and/or construction of different kinds of machineries andbuildings; that on August 26, 1975, the defendant PNB acquired the assets of the defendant PASUMIL thatwere earlier foreclosed by the Development Bank of the Philippines (DBP) under LOI No. 311; that thedefendant PNB organized the defendant NASUDECO in September, 1975, to take ownership and possessionof the assets and ultimately to nationalize and consolidate its interest in other PNB controlled sugar mills;that prior to October 29, 1971, the defendant PASUMIL engaged the services of plaintiff for electricalrewinding and repair, most of which were partially paid by the defendant PASUMIL, leaving several unpaidaccounts with the plaintiff; that finally, on October 29, 1971, the plaintiff and the defendant PASUMILentered into a contract for the plaintiff to perform the following, to wit –

‘(a) Construction of one (1) power house building;

‘(b) Construction of three (3) reinforced concrete foundation for three (3) units 350 KWdiesel engine generating set[s];

‘(c) Construction of three (3) reinforced concrete foundation for the 5,000 KW and 1,250KW turbo generator sets;

‘(d) Complete overhauling and reconditioning tests sum for three (3) 350 KW dieselengine generating set[s];

‘(e) Installation of turbine and diesel generating sets including transformer, switchboard,electrical wirings and pipe provided those stated units are completely supplied withtheir accessories;

‘(f) Relocating of 2,400 V transmission line, demolition of all existing concretefoundation and drainage canals, excavation, and earth fillings – all for the total amountof P543,500.00 as evidenced by a contract, [a] xerox copy of which is hereto attachedas Annex ‘A’ and made an integral part of this complaint;’

that aside from the work contract mentioned-above, the defendant PASUMIL required the plaintiff to performextra work, and provide electrical equipment and spare parts, such as:

‘(a) Supply of electrical devices;

‘(b) Extra mechanical works;

‘(c) Extra fabrication works;

‘(d) Supply of materials and consumable items;

‘(e) Electrical shop repair;

‘(f) Supply of parts and related works for turbine generator;

‘(g) Supply of electrical equipment for machinery;

‘(h) Supply of diesel engine parts and other related works including fabrication of parts.’

that out of the total obligation of P777,263.80, the defendant PASUMIL had paid only P250,000.00, leavingan unpaid balance, as of June 27, 1973, amounting to P527,263.80, as shown in the Certification of the chiefaccountant of the PNB, a machine copy of which is appended as Annex ‘C’ of the complaint; that out of saidunpaid balance of P527,263.80, the defendant PASUMIL made a partial payment to the plaintiff ofP14,000.00, in broken amounts, covering the period from January 5, 1974 up to May 23, 1974, leaving anunpaid balance of P513,263.80; that the defendant PASUMIL and the defendant PNB, and now the defendantNASUDECO, failed and refused to pay the plaintiff their just, valid and demandable obligation; that thePresident of the NASUDECO is also the Vice-President of the PNB, and this official holds office at the 10th

Floor of the PNB, Escolta, Manila, and plaintiff besought this official to pay the outstanding obligation of thedefendant PASUMIL, inasmuch as the defendant PNB and NASUDECO now owned and possessed theassets of the defendant PASUMIL, and these defendants all benefited from the works, and the electrical, aswell as the engineering and repairs, performed by the plaintiff; that because of the failure and refusal of thedefendants to pay their just, valid, and demandable obligations, plaintiff suffered actual damages in the totalamount of P513,263.80; and that in order to recover these sums, the plaintiff was compelled to engage theprofessional services of counsel, to whom the plaintiff agreed to pay a sum equivalent to 25% of the amountof the obligation due by way of attorney’s fees. Accordingly, the plaintiff prayed that judgment be renderedagainst the defendants PNB, NASUDECO, and PASUMIL, jointly and severally to wit:

‘(1) Sentencing the defendants to pay the plaintiffs the sum of P513,263.80, with annual interest of 14%from the time the obligation falls due and demandable;

‘(2) Condemning the defendants to pay attorney’s fees amounting to 25% of the amount claim;

‘(3) Ordering the defendants to pay the costs of the suit.’

“The defendants PNB and NASUDECO filed a joint motion to dismiss the complaint chiefly on the groundthat the complaint failed to state sufficient allegations to establish a cause of action against both defendants,inasmuch as there is lack or want of privity of contract between the plaintiff and the two defendants, the PNBand NASUDECO, said defendants citing Article 1311 of the New Civil Code, and the case law ruling inSalonga v. Warner Barnes & Co., 88 Phil. 125; and Manila Port Service, et al. v. Court of Appeals, et al., 20SCRA 1214.

“The motion to dismiss was by the court a quo denied in its Order of November 27, 1980; in the same order,that court directed the defendants to file their answer to the complaint within 15 days.

“In their answer, the defendant NASUDECO reiterated the grounds of its motion to dismiss, to wit:

‘That the complaint does not state a sufficient cause of action against the defendant NASUDECO because:(a) NASUDECO is not x x x privy to the various electrical construction jobs being sued upon by the plaintiffunder the present complaint; (b) the taking over by NASUDECO of the assets of defendant PASUMIL wassolely for the purpose of reconditioning the sugar central of defendant PASUMIL pursuant to martial lawpowers of the President under the Constitution; (c) nothing in the LOI No. 189-A (as well as in LOI No. 311)authorized or commanded the PNB or its subsidiary corporation, the NASUDECO, to assume the corporateobligations of PASUMIL as that being involved in the present case; and, (d) all that was mentioned by thesaid letter of instruction insofar as the PASUMIL liabilities [were] concerned [was] for the PNB, or itssubsidiary corporation the NASUDECO, to make a study of, and submit [a] recommendation on theproblems concerning the same.’

“By way of counterclaim, the NASUDECO averred that by reason of the filing by the plaintiff of the presentsuit, which it [labeled] as unfounded or baseless, the defendant NASUDECO was constrained to litigate and

incur litigation expenses in the amount of P50,000.00, which plaintiff should be sentenced to pay. Accordingly, NASUDECO prayed that the complaint be dismissed and on its counterclaim, that the plaintiffbe condemned to pay P50,000.00 in concept of attorney’s fees as well as exemplary damages.

“In its answer, the defendant PNB likewise reiterated the grounds of its motion to dismiss, namely: (1) thecomplaint states no cause of action against the defendant PNB; (2) that PNB is not a party to the contractalleged in par. 6 of the complaint and that the alleged services rendered by the plaintiff to the defendantPASUMIL upon which plaintiff’s suit is erected, was rendered long before PNB took possession of the assetsof the defendant PASUMIL under LOI No. 189-A; (3) that the PNB take-over of the assets of the defendantPASUMIL under LOI 189-A was solely for the purpose of reconditioning the sugar central so that PASUMILmay resume its operations in time for the 1974-75 milling season, and that nothing in the said LOI No. 189-A, as well as in LOI No. 311, authorized or directed PNB to assume the corporate obligation/s of PASUMIL,let alone that for which the present action is brought; (4) that PNB’s management and operation under LOINo. 311 did not refer to any asset of PASUMIL which the PNB had to acquire and thereafter [manage], butonly to those which were foreclosed by the DBP and were in turn redeemed by the PNB from the DBP; (5)that conformably to LOI No. 311, on August 15, 1975, the PNB and the Development Bank of thePhilippines (DBP) entered into a ‘Redemption Agreement’ whereby DBP sold, transferred and conveyed infavor of the PNB, by way of redemption, all its (DBP) rights and interest in and over the foreclosed realand/or personal properties of PASUMIL, as shown in Annex ‘C’ which is made an integral part of theanswer; (6) that again, conformably with LOI No. 311, PNB pursuant to a Deed of Assignment datedOctober 21, 1975, conveyed, transferred, and assigned for valuable consideration, in favor of NASUDECO, adistinct and independent corporation, all its (PNB) rights and interest in and under the above ‘RedemptionAgreement.’ This is shown in Annex ‘D’ which is also made an integral part of the answer; [7] that as aconsequence of the said Deed of Assignment, PNB on October 21, 1975 ceased to managed and operate theabove-mentioned assets of PASUMIL, which function was now actually transferred to NASUDECO. Inother words, so asserted PNB, the complaint as to PNB, had become moot and academic because of theexecution of the said Deed of Assignment; [8] that moreover, LOI No. 311 did not authorize or direct PNB toassume the corporate obligations of PASUMIL, including the alleged obligation upon which this present suitwas brought; and [9] that, at most, what was granted to PNB in this respect was the authority to ‘make astudy of and submit recommendation on the problems concerning the claims of PASUMIL creditors,’ undersub-par. 5 LOI No. 311.

“In its counterclaim, the PNB averred that it was unnecessarily constrained to litigate and to incur expenses

in this case, hence it is entitled to claim attorney’s fees in the amount of at least P50,000.00. Accordingly,PNB prayed that the complaint be dismissed; and that on its counterclaim, that the plaintiff be sentenced topay defendant PNB the sum of P50,000.00 as attorney’s fees, aside from exemplary damages in such amountthat the court may seem just and equitable in the premises.

“Summons by publication was made via the Philippines Daily Express, a newspaper with editorial office at371 Bonifacio Drive, Port Area, Manila, against the defendant PASUMIL, which was thereafter declared indefault as shown in the August 7, 1981 Order issued by the Trial Court.

“After due proceedings, the Trial Court rendered judgment, the decretal portion of which reads:

‘WHEREFORE, judgment is hereby rendered in favor of plaintiff and against the defendant Corporation,Philippine National Bank (PNB) NATIONAL SUGAR DEVELOPMENT CORPORATION (NASUDECO)and PAMPANGA SUGAR MILLS (PASUMIL), ordering the latter to pay jointly and severally the formerthe following:

‘1. The sum of P513,623.80 plus interest thereon at the rate of 14% per annum as claimedfrom September 25, 1980 until fully paid;

‘2. The sum of P102,724.76 as attorney’s fees; and,

‘3. Costs.

‘SO ORDERED.

‘Manila, Philippines, September 4, 1986.

'(SGD) ERNESTO S. TENGCO‘Judge’”[3]

Ruling of the Court of Appeals

Affirming the trial court, the CA held that it was offensive to the basic tenets of justice andequity for a corporation to take over and operate the business of another corporation, whiledisavowing or repudiating any responsibility, obligation or liability arising therefrom.[4]

Hence, this Petition.[5]

Issues

In their Memorandum, petitioners raise the following errors for the Court’s consideration:

“I

The Court of Appeals gravely erred in law in holding the herein petitioners liable for the unpaidcorporate debts of PASUMIL, a corporation whose corporate existence has not been legally extinguishedor terminated, simply because of petitioners[’] take-over of the management and operation of PASUMILpursuant to the mandates of LOI No. 189-A, as amended by LOI No. 311.

“II

The Court of Appeals gravely erred in law in not applying [to] the case at bench the ruling enunciated inEdward J. Nell Co. v. Pacific Farms, 15 SCRA 415.”[6]

Succinctly put, the aforesaid errors boil down to the principal issue of whether PNB is liable forthe unpaid debts of PASUMIL to respondent.

This Court’s Ruling

The Petition is meritorious.

Main Issue:Liability for Corporate Debts

As a general rule, questions of fact may not be raised in a petition for review under Rule 45 ofthe Rules of Court.[7] To this rule, however, there are some exceptions enumerated in Fuentes v.Court of Appeals.[8] After a careful scrutiny of the records and the pleadings submitted by theparties, we find that the lower courts misappreciated the evidence presented.[9] Overlooked by theCA were certain relevant facts that would justify a conclusion different from that reached in theassailed Decision.[10]

Petitioners posit that they should not be held liable for the corporate debts of PASUMIL,because their takeover of the latter’s foreclosed assets did not make them assignees. On theother hand, respondent asserts that petitioners and PASUMIL should be treated as one entity and,as such, jointly and severally held liable for PASUMIL’s unpaid obligation.

As a rule, a corporation that purchases the assets of another will not be liable for the debts ofthe selling corporation, provided the former acted in good faith and paid adequate consideration forsuch assets, except when any of the following circumstances is present: (1) where the purchaserexpressly or impliedly agrees to assume the debts, (2) where the transaction amounts to aconsolidation or merger of the corporations, (3) where the purchasing corporation is merely acontinuation of the selling corporation, and (4) where the transaction is fraudulently entered into inorder to escape liability for those debts.[11]

Piercing the CorporateVeil Not Warranted

A corporation is an artificial being created by operation of law. It possesses the right ofsuccession and such powers, attributes, and properties expressly authorized by law or incident toits existence.[12] It has a personality separate and distinct from the persons composing it, as well asfrom any other legal entity to which it may be related.[13] This is basic.

Equally well-settled is the principle that the corporate mask may be removed or the corporateveil pierced when the corporation is just an alter ego of a person or of another corporation.[14] Forreasons of public policy and in the interest of justice, the corporate veil will justifiably be impaled[15]

only when it becomes a shield for fraud, illegality or inequity committed against third persons.[16]

Hence, any application of the doctrine of piercing the corporate veil should be done withcaution.[17] A court should be mindful of the milieu where it is to be applied.[18] It must be certainthat the corporate fiction was misused to such an extent that injustice, fraud, or crime wascommitted against another, in disregard of its rights.[19] The wrongdoing must be clearly andconvincingly established; it cannot be presumed.[20] Otherwise, an injustice that was neverunintended may result from an erroneous application.[21]

This Court has pierced the corporate veil to ward off a judgment credit,[22] to avoid inclusion ofcorporate assets as part of the estate of the decedent,[23] to escape liability arising from a debt,[24]

or to perpetuate fraud and/or confuse legitimate issues[25] either to promote or to shield unfairobjectives[26] or to cover up an otherwise blatant violation of the prohibition against forum-shopping.

[27] Only in these and similar instances may the veil be pierced and disregarded.[28]

The question of whether a corporation is a mere alter ego is one of fact.[29] Piercing the veil ofcorporate fiction may be allowed only if the following elements concur: (1) control -- not mere stockcontrol, but complete domination -- not only of finances, but of policy and business practice inrespect to the transaction attacked, must have been such that the corporate entity as to thistransaction had at the time no separate mind, will or existence of its own; (2) such control musthave been used by the defendant to commit a fraud or a wrong to perpetuate the violation of astatutory or other positive legal duty, or a dishonest and an unjust act in contravention of plaintiff’slegal right; and (3) the said control and breach of duty must have proximately caused the injury orunjust loss complained of.[30]

We believe that the absence of the foregoing elements in the present case precludes thepiercing of the corporate veil. First, other than the fact that petitioners acquired the assets ofPASUMIL, there is no showing that their control over it warrants the disregard of corporatepersonalities.[31] Second, there is no evidence that their juridical personality was used to commit afraud or to do a wrong; or that the separate corporate entity was farcically used as a mere alterego, business conduit or instrumentality of another entity or person.[32] Third, respondent was notdefrauded or injured when petitioners acquired the assets of PASUMIL.[33]

Being the party that asked for the piercing of the corporate veil, respondent had the burden ofpresenting clear and convincing evidence to justify the setting aside of the separate corporatepersonality rule.[34] However, it utterly failed to discharge this burden;[35] it failed to establish bycompetent evidence that petitioner’s separate corporate veil had been used to conceal fraud,

illegality or inequity.[36]

While we agree with respondent’s claim that the assets of the National Sugar DevelopmentCorporation (NASUDECO) can be easily traced to PASUMIL,[37] we are not convinced that thetransfer of the latter’s assets to petitioners was fraudulently entered into in order to escape liabilityfor its debt to respondent.[38]

A careful review of the records reveals that DBP foreclosed the mortgage executed byPASUMIL and acquired the assets as the highest bidder at the public auction conducted.[39] Thebank was justified in foreclosing the mortgage, because the PASUMIL account had incurredarrearages of more than 20 percent of the total outstanding obligation.[40] Thus, DBP had not only aright, but also a duty under the law to foreclose the subject properties.[41]

Pursuant to LOI No. 189-A[42] as amended by LOI No. 311,[43] PNB acquired PASUMIL’s assetsthat DBP had foreclosed and purchased in the normal course. Petitioner bank was likewise taskedto manage temporarily the operation of such assets either by itself or through a subsidiarycorporation.[44]

PNB, as the second mortgagee, redeemed from DBP the foreclosed PASUMIL assets pursuantto Section 6 of Act No. 3135.[45] These assets were later conveyed to PNB for a consideration, theterms of which were embodied in the Redemption Agreement.[46] PNB, as successor-in-interest,stepped into the shoes of DBP as PASUMIL’s creditor.[47] By way of a Deed of Assignment,[48] PNBthen transferred to NASUDECO all its rights under the Redemption Agreement.

In Development Bank of the Philippines v. Court of Appeals,[49] we had the occasion to resolvea similar issue. We ruled that PNB, DBP and their transferees were not liable for MarinduqueMining’s unpaid obligations to Remington Industrial Sales Corporation (Remington) after the twobanks had foreclosed the assets of Marinduque Mining. We likewise held that Remington failed todischarge its burden of proving bad faith on the part of Marinduque Mining to justify the piercing ofthe corporate veil.

In the instant case, the CA erred in affirming the trial court’s lifting of the corporate mask.[50]

The CA did not point to any fact evidencing bad faith on the part of PNB and its transferee.[51] Thecorporate fiction was not used to defeat public convenience, justify a wrong, protect fraud or defendcrime.[52] None of the foregoing exceptions was shown to exist in the present case.[53] On thecontrary, the lifting of the corporate veil would result in manifest injustice. This we cannot allow.

No Merger or Consolidation

Respondent further claims that petitioners should be held liable for the unpaid obligations ofPASUMIL by virtue of LOI Nos. 189-A and 311, which expressly authorized PASUMIL and PNB tomerge or consolidate. On the other hand, petitioners contend that their takeover of the operationsof PASUMIL did not involve any corporate merger or consolidation, because the latter had neverlost its separate identity as a corporation.

A consolidation is the union of two or more existing entities to form a new entity called theconsolidated corporation. A merger, on the other hand, is a union whereby one or more existingcorporations are absorbed by another corporation that survives and continues the combinedbusiness.[54]

The merger, however, does not become effective upon the mere agreement of the constituentcorporations.[55] Since a merger or consolidation involves fundamental changes in the corporation,as well as in the rights of stockholders and creditors, there must be an express provision of lawauthorizing them.[56] For a valid merger or consolidation, the approval by the Securities andExchange Commission (SEC) of the articles of merger or consolidation is required.[57] Thesearticles must likewise be duly approved by a majority of the respective stockholders of theconstituent corporations.[58]

In the case at bar, we hold that there is no merger or consolidation with respect to PASUMILand PNB. The procedure prescribed under Title IX of the Corporation Code[59] was not followed.

In fact, PASUMIL’s corporate existence, as correctly found by the CA, had not been legallyextinguished or terminated.[60] Further, prior to PNB’s acquisition of the foreclosed assets,PASUMIL had previously made partial payments to respondent for the former’s obligation in theamount of P777,263.80. As of June 27, 1973, PASUMIL had paid P250,000 to respondent and,from January 5, 1974 to May 23, 1974, another P14,000.

Neither did petitioner expressly or impliedly agree to assume the debt of PASUMIL torespondent.[61] LOI No. 11 explicitly provides that PNB shall study and submit recommendations onthe claims of PASUMIL’s creditors.[62] Clearly, the corporate separateness between PASUMIL andPNB remains, despite respondent’s insistence to the contrary.[63]

WHEREFORE, the Petition is hereby GRANTED and the assailed Decision SET ASIDE. Nopronouncement as to costs.

SO ORDERED.

Vitug, (Acting Chairman), Sandoval-Gutierrez, and Carpio, JJ., concur.Melo, (Chairman), J., Abroad, on official leave.

[1] Rollo, pp. 30-39. Penned by Justice Renato C. Dacudao, with the concurrence of Justices Quirino D. Abad Santos Jr.(Division chairman) and B. A. Adefuin de la Cruz (member).

[2] Assailed Decision, p. 11; rollo, p. 39.

[3] Ibid., pp. 1-7; ibid., pp. 30-35.

[4] Id., p. 9; id., p. 37.

[5] The case was deemed submitted for decision on February 12, 2001, upon this Court’s receipt of petitioners’Memorandum, signed by Atty. Salvador A. Luy. Respondent’s Memorandum, which was filed on February 9,2001, was signed by Atty. Renecio R. Espiritu.

[6] Petitioners’ Memorandum, pp. 7-8; rollo, pp. 73-74. Original in upper case and italicized.

[7] Cordial v. Miranda, 348 SCRA 158, December 14, 2000.

[8] 268 SCRA 703, February 26, 1997.

[9] Baricuatro Jr. v. Court of Appeals, 325 SCRA 137, February 9, 2000.

[10] Ibid.

[11] Jose C. Campos Jr. and Maria Clara Lopez-Campos, The Corporation Code: Comments, Notes and Selected Cases,Vol. 2, 1990 ed., p. 465, citing Edward J. Nell Company v. Pacific Farms, Inc., 15 SCRA 415, November 29, 1965;

West Texas Refining & Dev. Co. v. Comm. of Int. Rev., 68 F. 2d 77.

[12] §2, Corporation Code.

[13] Yu v. National Labor Relations Commission, 245 SCRA 134, June 16, 1995.

[14] Lim v. Court of Appeals, 323 SCRA 102, January 24, 2000.

[15] Francisco Motors Corporation v. Court of Appeals, 309 SCRA 72, June 25, 1999.

[16] San Juan Structural and Steel Fabricators, Inc. v. Court of Appeals, 296 SCRA 631, September 29, 1998.

[17] Reynoso IV v. Court of Appeals, 345 SCRA 335, November 22, 2000.

[18] Francisco Motors Corporation v. Court of Appeals, supra.

[19] Traders Royal Bank v. Court of Appeals, 269 SCRA 15, March 3, 1997.

[20] Matuguina Integrated Wood Products, Inc. v. Court of Appeals, 263 SCRA 491, October 24, 1996.

[21] Francisco Motors Corporation v. Court of Appeals, supra.

[22] Sibagat Timber Corp. v. Garcia, 216 SCRA 470, December 11, 1992.

[23] Cease v. Court of Appeals, 93 SCRA 483, October 18, 1979.

[24] Arcilla v. Court of Appeals, 215 SCRA 120, October 23, 1992.

[25] Jacinto v. Court of Appeals, 198 SCRA 211, June 6, 1991.

[26] Villanueva v. Adre, 172 SCRA 876, April 27, 1989

[27] First Philippine International Bank v. Court of Appeals, 252 SCRA 259, January 24, 1996.

[28] ARB Construction Co., Inc. v. Court of Appeals, 332 SCRA 427, May 31, 2000.

[29] Heirs of Ramon Durano Sr. v. Uy, 344 SCRA 238, October 24, 2000.

[30] Lim v. Court of Appeals, supra.

[31] Traders Royal Bank, v. Court of Appeals, supra.

[32] Umali v. Court of Appeals, 189 SCRA 529, September 13, 1990.

[33] Traders Royal Bank, v. Court of Appeals, supra.

[34] Republic v. Sandiganbayan, 346 SCRA 760, December 4, 2000.

[35] Lim v. Court of Appeals, supra.

[36] San Juan Structural and Steel Fabricators, Inc. v. Court of Appeals, supra.

[37] Respondent’s Memorandum, p. 6; rollo, p. 60.

[38] Edward J. Nell Company v. Pacific Farms Inc., supra, p. 417, per Concepcion, J.

[39] See Redemption Agreement, Annex “C”; records, p. 56.

[40] Presidential Decree No. 385 (The Law on Mandatory Foreclosure) provides:

“Section 1. It shall be mandatory for government financial institutions, after the lapse of sixty (60) days from theissuance of this Decree, to foreclose the collaterals and/or securities for any loan, credit, accommodation, and/orguarantees granted by them whenever the arrearages on such account, including accrued interest and othercharges, amount to at least twenty percent (20%) of the total outstanding obligations, including interest and othercharges, as appearing in the books of account and/or related records of the financial institution concerned. Thisshall be without prejudice to the exercise by the government financial institutions of such rights and/or remedies

available to them under their respective contracts with their debtors, including the right to foreclosure on loans,credits, accommodations and/or guarantees on which the arrearages are less than twenty percent (20%).”

[41] Development Bank of the Philippines v. Court of Appeals, supra.

[42] Annex “A”; records, p. 50.

[43] Annex “B”; ibid., p. 52.

[44] Ibid.; id., p. 53.

[45] This article provides:

“Sec. 6. In all cases in which an extrajudicial sale is made under the special power hereinbefore referred to, thedebtor, his successor in interest or any judicial creditor or judgment creditor of said debtor, or any person having alien on the property subsequent to the mortgage or deed of trust under which the property is sold, may redeemthe same at any time within the term of one year from and after the date of the sale; and such redemption shall begoverned by the provisions of sections four hundred and sixty-four to four hundred and sixty six, inclusive, of theCode of Civil Procedure (now Rule 39, Section 28 of the 1997 Revised Rules of Civil Procedure), in so far asthese are not inconsistent with the provisions of this Act.”

[46] See Redemption Agreement Annex “C”; records, p. 56.

[47] Litonjua v. L &R Corporation, 320 SCRA 405, December 9, 1999.

[48] Annex PNB-2; records, p. 61.

[49] GR No. 126200, August 16, 2001.

[50] Francisco Motors Corporation v. Court of Appeals, supra.

[51] Development Bank of the Philippines v. Court of Appeals, supra.

[52] Union Bank of the Philippines v. Court of Appeals, 290 SCRA 198, May 19, 1998.

[53] Vlason Enterprises Corporation v. Court of Appeals, 310 SCRA 26, July 6, 1999.

[54] Campos Jr. and Lopez-Campos, The Corporation Code: Comments, Notes and Selected Cases, supra, pp. 440-441.

[55] Associated Bank v. Court of Appeals, 291 SCRA 511, June 29, 1998.

[56] Campos Jr. and Lopez-Campos, The Corporation Code: Comments, Notes and Selected Cases, supra, p. 441.

[57] §79 Corporation Code.

[58] §77 Corporation Code.

[59] “Title IX – MERGER AND CONSOLIDATION

“SEC. 76. Plan of merger or consolidation. – Two or more corporations may merge into a singlecorporation which shall be one of the constituent corporations or may consolidate into a new single corporationwhich shall be the consolidated corporation.

“The board of directors or trustees of each corporation, party to the merger or consolidation, shall approvea plan of merger or consolidation setting forth the following:

‘1. The names of the corporations proposing to merge or consolidate, hereinafter referredto as the constituent corporations;

‘2. The terms of the merger or consolidation and the mode of carrying the same into effect;

‘3. A statement of the changes, if any, in the articles of incorporation of the survivingcorporation in case of merger; and, with respect to the consolidated corporation in case ofconsolidation, all the statements required to be set forth in the articles of incorporation for corporationsorganized under this Code; and

‘4. Such other provisions with respect to the proposed merger or consolidation as aredeemed necessary or desirable.’

“SEC. 77. Stockholders’ or members’ approval. – Upon approval by majority vote of each of the boardof directors or trustees of the constituent corporations of the plan of merger or consolidation, the same shall besubmitted for approval by the stockholders or members of each of such corporations at separate corporatemeetings duly called for the purpose. Notice of such meetings shall be given to all stockholders or members ofthe respective corporations, at least two (2) weeks prior to the date of the meeting, either personally or byregistered mail. Said notice shall state the purpose of the meeting and shall include a copy or a summary of theplan of merger or consolidation. The affirmative vote of stockholders representing at least two-thirds (2/3) of theoutstanding capital stock of each corporation in the case of stock corporations or at least two-thirds (2/3) of themembers in the case of non-stock corporations shall be necessary for the approval of such plan. Anydissenting stockholder in stock corporations may exercise his appraisal right in accordance with the Code:Provided, That if after the approval by the stockholders of such plan, the board of directors decides to abandonthe plan, the appraisal right shall be extinguished.

“Any amendment to the plan of merger or consolidation may be made, provided such amendment isapproved by majority vote of the respective boards of directors or trustees of all the constituent corporations andratified by the affirmative vote of stockholders representing at least two-thirds (2/3) of the outstanding capitalstock or of two thirds (2/3) of the members of each of the constituent corporations. Such plan, together with anyamendment, shall be considered as the agreement of merger or consolidation.

“SEC. 78. Articles of merger or consolidation. - After the approval by the stockholders or members asrequired by the preceding section, articles of merger or articles of consolidation shall be executed by each of theconstituent corporations, to be signed by the president or vice-president and certified by the secretary orassistant secretary of each corporation setting forth:

‘1. The plan of the merger or the plan of consolidation;

‘2. As to stock corporations, the number of shares outstanding, or in the case of non-stockcorporations, the number of members, and

‘3. As to each corporation, the number of shares or members voting for and against such plan,respectively.’

“SEC. 79. Effectivity of merger or consolidation. - The articles of merger or of consolidation, signed andcertified as herein above required, shall be submitted to the Securities and Exchange Commission inquadruplicate for its approval: Provided, That in the case of merger or consolidation of banks or bankinginstitutions, building and loan associations, trust companies, insurance companies, public utilities, educationalinstitutions and other special corporations governed by special laws, the favorable recommendation of theappropriate government agency shall first be obtained. If the Commission is satisfied that the merger orconsolidation of the corporations concerned is not inconsistent with the provisions of this Code and existinglaws, it shall issue a certificate of merger or of consolidation, at which time the merger or consolidation shall beeffective.

“If, upon investigation, the Securities and Exchange Commission has reason to believe that the proposedmerger or consolidation is contrary to or inconsistent with the provisions of this Code or existing laws, it shall seta hearing to give the corporations concerned the opportunity to be heard. Written notice of the date, time andplace of hearing shall be given to each constituent corporation at least two (2) weeks before said hearing. TheCommission shall thereafter proceed as provided in this Code.

“SEC. 80. Effects of merger or consolidation. - The merger or consolidation shall have the followingeffects:

‘1. The constituent corporations shall become a single corporation which, in case of merger, shallbe the surviving corporation designated in the plan of merger; and, in case of consolidation, shall bethe consolidated corporation designated in the plan of consolidation;

‘2. The separate existence of the constituent corporations shall cease, except that of thesurviving or the consolidated corporation;

‘3. The surviving or the consolidated corporation shall possess all the rights, privileges,immunities and powers and shall be subject to all the duties and liabilities of a corporation organizedunder this Code;

‘4. The surviving or the consolidated corporation shall thereupon and thereafter possess all therights, privileges, immunities and franchises of each of the constituent corporations; and all property,real or personal, and all receivables due on whatever account, including subscriptions to shares andother choses in action, and all and every other interest of, or belonging to, or due to each constituentcorporation, shall be deemed transferred to and vested in such surviving or consolidated corporationwithout further act or deed; and

‘5. The surviving or consolidated corporation shall be responsible and liable for all the liabilities and obligations of each ofthe constituent corporations in the same manner as if such surviving or consolidated corporation had itselfincurred such liabilities or obligations; and any pending claim, action or proceeding brought by or against any ofsuch constituent corporations may be prosecuted by or against the surviving or consolidated corporation. Theright of creditors or liens upon the property of any of such constituent corporations shall not be impaired by suchmerger or consolidation.’”

[60] Associated Bank v. Court of Appeals, supra.

[61] Edward J. Nell Company v. Pacific Farms, Inc., supra.

[62] Annex “B”; records, p. 53.

[63] Traders Royal Bank, v. Court of Appeals, supra.

PNB, NASUDECO vs. Andrada Electric and Engineering Company (2002)

Doctrine: Basic is the rule that a corporation has a legal personality distinct and separate from the persons and entities owning it. The corporate veil may be lifted only if it has been used to shield fraud, defend crime, justify a wrong, defeat public convenience, insulate bad faith or perpetuate injustice. Thus, the mere fact that the Philippine National Bank (PNB) acquired ownership or management of some assets of the Pampanga Sugar Mill (PASUMIL), which had earlier been foreclosed and purchased at the resulting public auction by the Development Bank of the Philippines (DBP), will not make PNB liable for the PASUMIL’s contractual debts to respondent.

Facts:

1. PASUMIL (Pampanga Sugar Mills) engaged the services of Andrada Electric for electrical rewinding, repair, the construction of a power house building, installation of turbines, transformers, among others. Most of the services were partially paid by PASUMIL, leaving several unpaid accounts.

2. On August 1975, PNB, a semi-government corporation, acquired the assets of PASUMIL—assets that were earlier foreclosed by the DBP.

3. On September 1975, PNB organized NASUDECO (National Sugar Development Corporation), under LOI No. 311 to take ownership and possession of the assets and ultimately, to nationalize and consolidate its interest in other PNB controlled sugar mills. NASUDECO is a semi-government corporation and the sugar arm of the PNB.

4. Andrada Electric alleges that PNB and NASUDECO should be liable for PASUMIL’s unpaid obligation amounting to 500K php, damages, and attorney’s fees, having owned and possessed the assets of PASUMIL.

Issue:Whether PNB and NASUDECO may be held liable for PASUMIL’s liability to Andrada Electric and Engineering Company.

Held: NO.

Basic is the rule that a corporation has a legal personality distinct and separate from the persons and entities owning it. The corporate veil may be lifted only if it has been used to shield fraud, defend crime, justify a wrong, defeat public convenience, insulate bad faith or perpetuate injustice.

Thus, the mere fact that the Philippine National Bank (PNB) acquired ownership or management of some assets of the Pampanga Sugar Mill (PASUMIL), which had earlier been foreclosed and purchased at the resulting public auction by the Development Bank of the Philippines (DBP), will not make PNB liable for the PASUMIL's contractual debts to Andrada Electric & Engineering Company (AEEC).

Piercing the veil of corporate fiction may be allowed only if the following elements concur: (1) control not mere stock control, but complete domination² not only of finances, but of policy and business practice in respect to the transaction attacked, must have been such that the corporate entity as to this transaction had at the time no separate mind, will or existence of its own; (2) such control must have been used by the defendant to commit a fraud or a wrong to perpetuate the violation of a statutory or other positive legal duty, or a dishonest and an unjust act in contravention of plaintiff's legal right; and (3) the said control and breach of duty must have proximately caused the injury or unjust loss complained of.

The absence of the foregoing elements in the present case precludes the piercing of the corporate veil.

First, other than the fact that PNB and NASUDECO acquired the assets of PASUMIL, there is no showing that their control over it warrants the disregard of corporate personalities. Second, there is no evidence that their juridical personality was used to commit a fraud or to do a wrong; or that the separate corporate entity was farcically used as a mere alter ego, business conduit or instrumentality of another entityor person. Third, AEEC was not defrauded or injured when PNB and NASUDECO acquired the assets of PASUMIL. Hence, although the assets of NASUDECO can be easily traced to PASUMIL, the transfer of the latter's assets to PNB and NASUDECO was not fraudulently entered into in order to escape liability for its debt to AEEC.

There was NO merger or consolidation with respect to PASUMIL and PNB.

Respondent further claims that petitioners should be held liable for the unpaid obligations of PASUMIL by virtue of LOI Nos. 189-A and 311, which expressly authorized PASUMIL and PNB to merge or consolidate (allegedly).

On the other hand, petitioners contend that their takeover of the operations of PASUMIL did not involve any corporate merger or consolidation, because the latter had never lost its separate identity as a corporation.

A consolidation is the union of two or more existing entities to form a new entity called the consolidated corporation. A merger, on the other hand, is a union whereby one or more existing corporations are absorbed by another corporation that survives and continues the combined business.

The merger, however, does not become effective upon the mere agreement of the constituent corporations. Since a merger or consolidation involves fundamental changes in the corporation, as well as in the rights of stockholders and creditors, there must be an express provision of law authorizing them.

For a valid merger or consolidation, the approval by the SEC of the articles of merger or consolidation is required. These articles must likewise be duly approved by a majority of the respective stockholders of the constituent corporations.

In the case at bar, there is no merger or consolidation with respect to PASUMIL and PNB. The procedure prescribed under Title IX of the Corporation Code was not followed.

In fact, PASUMIL’s corporate existence, as correctly found by the CA, had not been legally extinguished or terminated. Further, prior to PNB’s acquisition of the foreclosed assets, PASUMIL had previously made partial payments to respondent for the former’s obligation in the amount of P777,263.80. As of June 27, 1973, PASUMIL had paid P250,000 to respondent and, from January 5, 1974 to May 23, 1974, another P14,000.

Neither did petitioner expressly or impliedly agree to assume the debt of PASUMIL to respondent. LOI No. 11 explicitly provides that PNB shall study and submit recommendations on the claims of PASUMIL’s creditors. Clearly, the corporate separateness between PASUMIL and PNB remains, despite respondent’s insistence to the contrary.

FIRST DIVISION

[ G.R. No. 123793, June 29, 1998 ]

ASSOCIATED BANK, PETITIONER,

VS.

COURT OF APPEALS AND LORENZO SARMIENTO JR., RESPONDENTS.

DECISION

PANGANIBAN, J.:

In a merger, does the surviving corporation have a right to enforce a contract entered into bythe absorbed company subsequent to the date of the merger agreement, but prior to theissuance of a certificate of merger by the Securities and Exchange Commission?

The Case

This is a petition for review under Rule 45 of the Rules of Court seeking to set aside theDecision of the Court of Appeals in CA-GR CV No. 26465 promulgated on January 30,1996, which answered the above question in the negative. The challenged Decision reversedand set aside the October 17, 1986 Decision in Civil Case No. 85-32243, promulgated bythe Regional Trial Court of Manila, Branch 48, which disposed of the controversy in favor ofherein petitioner as follows:

“WHEREFORE, judgment is hereby rendered in favor of the plaintiff Associated Bank. Thedefendant Lorenzo Sarmiento, Jr. is ordered to pay plaintiff:

The amount of P4,689,413.63 with interest thereon at 14% per annum until fully paid;

The amount of P200,000.00 as and for attorney’s fees; and

The costs of suit.”

On the other hand, the Court of Appeals resolved the case in this wise:

“WHEREFORE, premises considered, the decision appealed from, dated October 17, 1986 isREVERSED and SET ASIDE and another judgment rendered DISMISSING plaintiff-appellee’scomplaint, docketed as Civil Case No. 85-32243. There is no pronouncement as to costs.”

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The Facts

The undisputed factual antecedents, as narrated by the trial court and adopted by publicrespondent, are as follows:

“x x x [O]n or about September 16, 1975 Associated Banking Corporation and Citizens Bankand Trust Company merged to form just one banking corporation known as AssociatedCitizens Bank, the surviving bank. On or about March 10, 1981, the Associated Citizens Bankchanged its corporate name to Associated Bank by virtue of the Amended Articles ofIncorporation. On September 7, 1977, the defendant executed in favor of Associated Bank apromissory note whereby the former undertook to pay the latter the sum of P2,500,000.00payable on or before March 6, 1978. As per said promissory note, the defendant agreed topay interest at 14% per annum, 3% per annum in the form of liquidated damages,compounded interests, and attorney’s fees, in case of litigation equivalent to 10% of theamount due. The defendant, to date, still owes plaintiff bank the amount of P2,250,000.00exclusive of interest and other charges. Despite repeated demands the defendant failed to paythe amount due.

xxx xxx xxx

x x x [T]he defendant denied all the pertinent allegations in the complaint and alleged asaffirmative and[/]or special defenses that the complaint states no valid cause of action; that theplaintiff is not the proper party in interest because the promissory note was executed in favorof Citizens Bank and Trust Company; that the promissory note does not accurately reflect thetrue intention and agreement of the parties; that terms and conditions of the promissory noteare onerous and must be construed against the creditor-payee bank; that several partialpayments made in the promissory note are not properly applied; that the present action ispremature; that as compulsory counterclaim the defendant prays for attorney’s fees, moraldamages and expenses of litigation.

On May 22, 1986, the defendant was declared as if in default for failure to appear at the Pre-Trial Conference despite due notice.

A Motion to Lift Order of Default and/or Reconsideration of Order dated May 22, 1986 wasfiled by defendant’s counsel which was denied by the Court in [an] order dated September 16,1986 and the plaintiff was allowed to present its evidence before the Court ex-parte onOctober 16, 1986.

At the hearing before the Court ex-parte, Esteban C. Ocampo testified that x x x he is anaccountant of the Loans and Discount Department of the plaintiff bank; that as such, hesupervises the accounting section of the bank, he counterchecks all the transactions thattranspired during the day and is responsible for all the accounts and records and other thingsthat may[ ]be assigned to the Loans and Discount Department; that he knows the [D]efendantLorenzo Sarmiento, Jr. because he has an outstanding loan with them as per their records;that Lorenzo Sarmiento, Jr. executed a promissory note No. TL-2649-77 dated September 7,

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1977 in the amount of P2,500,000.00 (Exhibit A); that Associated Banking Corporation and theCitizens Bank and Trust Company merged to form one banking corporation known as theAssociated Citizens Bank and is now known as Associated Bank by virtue of its AmendedArticles of Incorporation; that there were partial payments made but not full; that the defendanthas not paid his obligation as evidenced by the latest statement of account (Exh. B); that asper statement of account the outstanding obligation of the defendant is P5,689,413.63 lessP1,000,000.00 or P4,689,413.63 (Exh. B, B-1); that a demand letter dated June 6, 1985 wassent by the bank thru its counsel (Exh. C) which was received by the defendant on November12, 1985 (Exh. C, C-1, C-2, C-3); that the defendant paid only P1,000,000.00 which isreflected in the Exhibit C.”

Based on the evidence presented by petitioner, the trial court ordered Respondent Sarmientoto pay the bank his remaining balance plus interests and attorney’s fees. In his appeal,Sarmiento assigned to the trial court several errors, namely:

“I The [trial court] erred in denying appellant’s motion to dismiss appellee bank’s complaint onthe ground of lack of cause of action and for being barred by prescription and laches.

II The same lower court erred in admitting plaintiff-appellee bank’s amended complaint whiledefendant-appellant’s motion to dismiss appellee bank’s original complaint and using/availing[itself of] the new additional allegations as bases in denial of said appellant’s motion and in theinterpretation and application of the agreement of merger and Section 80 of BP Blg. 68,Corporation Code of the Philippines.

III The [trial court] erred and gravely abuse[d] its discretion in rendering the two as if in defaultorders dated May 22, 1986 and September 16, 1986 and in not reconsidering the same upontechnical grounds which in effect subvert the best primordial interest of substantial justice andequity.

IV The court a quo erred in issuing the orders dated May 22, 1986 and September 16, 1986declaring appellant as if in default due to non-appearance of appellant’s attending counselwho had resigned from the law firm and while the parties [were] negotiating for settlement ofthe case and after a one million peso payment had in fact been paid to appellee bank forappellant’s account at the start of such negotiation on February 18, 1986 as act of earnestdesire to settle the obligation in good faith by the interested parties.

V The lower court erred in according credence to appellee bank’s Exhibit B statement ofaccount which had been merely requested by its counsel during the trial and bearing date ofSeptember 30, 1986.

VI The lower court erred in accepting and giving credence to appellee bank’s 27-year-oldwitness Esteban C. Ocampo as of the date he testified on October 16, 1986, and therefore, hewas merely an eighteen-year-old minor when appellant supposedly incurred the foistedobligation under the subject PN No. TL-2649-77 dated September 7, 1977, Exhibit A ofappellee bank.

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VII The [trial court] erred in adopting appellee bank’s Exhibit B dated September 30, 1986 inits decision given in open court on October 17, 1986 which exacted eighteen percent (18%)per annum on the foisted principal amount of P2.5 million when the subject PN, Exhibit A,stipulated only fourteen percent (14%) per annum and which was actually prayed for inappellee bank’s original and amended complaints.

VIII The appealed decision of the lower court erred in not considering at all appellant’saffirmative defenses that (1) the subject PN No. TL-2649-77 for P2.5 million dated September7, 1977, is merely an accommodation pour autrui bereft of any actual consideration toappellant himself and (2) the subject PN is a contract of adhesion, hence, [it] needs [to] bestrictly construed against appellee bank -- assuming for granted that it has the right to enforceand seek collection thereof.

IX The lower court should have at least allowed appellant the opportunity to presentcountervailing evidence considering the huge amounts claimed by appellee bank (principalsum of P2.5 million which including accrued interests, penalties and cost of litigation totaledP4,689,413.63) and appellant’s affirmative defenses -- pursuant to substantial justice andequity.”

The appellate court, however, found no need to tackle all the assigned errors and limited itselfto the question of “whether [herein petitioner had] established or proven a cause of actionagainst [herein private respondent].” Accordingly, Respondent Court held that the AssociatedBank had no cause of action against Lorenzo Sarmiento Jr., since said bank was not privy tothe promissory note executed by Sarmiento in favor of Citizens Bank and Trust Company(CBTC). The court ruled that the earlier merger between the two banks could not have vestedAssociated Bank with any interest arising from the promissory note executed in favor of CBTCafter such merger.

Thus, as earlier stated, Respondent Court set aside the decision of the trial court anddismissed the complaint. Petitioner now comes to us for a reversal of this ruling.

Issues

In its petition, petitioner cites the following “reasons”:

“I The Court of Appeals erred in reversing the decision of the trial court and in declaring thatpetitioner has no cause of action against respondent over the promissory note.

II The Court of Appeals also erred in declaring that, since the promissory note was executed infavor of Citizens Bank and Trust Company two years after the merger between AssociatedBanking Corporation and Citizens Bank and Trust Company, respondent is not liable topetitioner because there is no privity of contract between respondent and Associated Bank.

III The Court of Appeals erred when it ruled that petitioner, despite the merger betweenpetitioner and Citizens Bank and Trust Company, is not a real party in interest insofar as the

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promissory note executed in favor of the merger.”

In a nutshell, the main issue is whether Associated Bank, the surviving corporation, mayenforce the promissory note made by private respondent in favor of CBTC, the absorbedcompany, after the merger agreement had been signed.

The Court’s Ruling

The petition is impressed with merit.

The Main Issue:

Associated Bank Assumed

All Rights of CBTC

Ordinarily, in the merger of two or more existing corporations, one of the combiningcorporations survives and continues the combined business, while the rest are dissolved andall their rights, properties and liabilities are acquired by the surviving corporation. Althoughthere is a dissolution of the absorbed corporations, there is no winding up of their affairs orliquidation of their assets, because the surviving corporation automatically acquires all theirrights, privileges and powers, as well as their liabilities.

The merger, however, does not become effective upon the mere agreement of the constituentcorporations. The procedure to be followed is prescribed under the Corporation Code.Section 79 of said Code requires the approval by the Securities and Exchange Commission(SEC) of the articles of merger which, in turn, must have been duly approved by a majority ofthe respective stockholders of the constituent corporations. The same provision further statesthat the merger shall be effective only upon the issuance by the SEC of a certificate of merger.The effectivity date of the merger is crucial for determining when the merged or absorbedcorporation ceases to exist; and when its rights, privileges, properties as well as liabilities passon to the surviving corporation.

Consistent with the aforementioned Section 79, the September 16, 1975 Agreement ofMerger, which Associated Banking Corporation (ABC) and Citizens Bank and TrustCompany (CBTC) entered into, provided that its effectivity “shall, for all intents and purposes,be the date when the necessary papers to carry out this [m]erger shall have been approved bythe Securities and Exchange Commission.” As to the transfer of the properties of CBTC toABC, the agreement provides:

“10. Upon effective date of the Merger, all rights, privileges, powers, immunities, franchises,assets and property of [CBTC], whether real, personal or mixed, and including [CBTC’s]goodwill and tradename, and all debts due to [CBTC] on whatever act, and all other things inaction belonging to [CBTC] as of the effective date of the [m]erger shall be vested in [ABC],the SURVIVING BANK, without need of further act or deed, unless by express requirements of

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law or of a government agency, any separate or specific deed of conveyance to legally effectthe transfer or assignment of any kind of property [or] asset is required, in which case suchdocument or deed shall be executed accordingly; and all property, rights, privileges, powers,immunities, franchises and all appointments, designations and nominations, and all otherrights and interests of [CBTC] as trustee, executor, administrator, registrar of stocks andbonds, guardian of estates, assignee, receiver, trustee of estates of persons mentally ill and inevery other fiduciary capacity, and all and every other interest of [CBTC] shall thereafter beeffectually the property of [ABC] as they were of [CBTC], and title to any real estate, whetherby deed or otherwise, vested in [CBTC] shall not revert or be in any way impaired by reasonthereof; provided, however, that all rights of creditors and all liens upon any property of [CBTC]shall be preserved and unimpaired and all debts, liabilities, obligations, duties andundertakings of [CBTC], whether contractual or otherwise, expressed or implied, actual orcontingent, shall henceforth attach to [ABC] which shall be responsible therefor and may beenforced against [ABC] to the same extent as if the same debts, liabilities, obligations, dutiesand undertakings have been originally incurred or contracted by [ABC], subject, however, to allrights, privileges, defenses, set-offs and counterclaims which [CBTC] has or might have andwhich shall pertain to [ABC].”

The records do not show when the SEC approved the merger. Private respondent’s theory isthat it took effect on the date of the execution of the agreement itself, which was September16, 1975. Private respondent contends that, since he issued the promissory note to CBTC onSeptember 7, 1977 -- two years after the merger agreement had been executed -- CBTCcould not have conveyed or transferred to petitioner its interest in the said note, which was notyet in existence at the time of the merger. Therefore, petitioner, the surviving bank, has noright to enforce the promissory note on private respondent; such right properly pertains only toCBTC.

Assuming that the effectivity date of the merger was the date of its execution, we still cannotagree that petitioner no longer has any interest in the promissory note. A closer perusal of themerger agreement leads to a different conclusion. The provision quoted earlier has this otherclause:

“Upon the effective date of the [m]erger, all references to [CBTC] in any deed, documents, orother papers of whatever kind or nature and wherever found shall be deemed for all intentsand purposes, references to [ABC], the SURVIVING BANK, as if such references were directreferences to [ABC]. x x x” (Underscoring supplied)

Thus, the fact that the promissory note was executed after the effectivity date of the mergerdoes not militate against petitioner. The agreement itself clearly provides that all contracts --irrespective of the date of execution -- entered into in the name of CBTC shall be understoodas pertaining to the surviving bank, herein petitioner. Since, in contrast to the earlieraforequoted provision, the latter clause no longer specifically refers only to contracts existingat the time of the merger, no distinction should be made. The clause must have beendeliberately included in the agreement in order to protect the interests of the combining banks;

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specifically, to avoid giving the merger agreement a farcical interpretation aimed at evadingfulfillment of a due obligation.

Thus, although the subject promissory note names CBTC as the payee, the reference toCBTC in the note shall be construed, under the very provisions of the merger agreement, as areference to petitioner bank, “as if such reference [was a] direct reference to” the latter “for allintents and purposes.”

No other construction can be given to the unequivocal stipulation. Being clear, plain and freeof ambiguity, the provision must be given its literal meaning and applied without aconvoluted interpretation. Verba legis non est recedendum.

In light of the foregoing, the Court holds that petitioner has a valid cause of action againstprivate respondent. Clearly, the failure of private respondent to honor his obligation under thepromissory note constitutes a violation of petitioner’s right to collect the proceeds of the loan itextended to the former.

Secondary Issues:

Prescription, Laches, Contract

Pour Autrui, Lack of Consideration

No Prescription or Laches

Private respondent’s claim that the action has prescribed, pursuant to Article 1149 of the CivilCode, is legally untenable. Petitioner’s suit for collection of a sum of money was based on awritten contract and prescribes after ten years from the time its right of action arose.Sarmiento’s obligation under the promissory note became due and demandable on March 6,1978. Petitioner’s complaint was instituted on August 22, 1985, before the lapse of the ten-year prescriptive period. Definitely, petitioner still had every right to commence suit against thepayor/obligor, the private respondent herein.

Neither is petitioner’s action barred by laches. The principle of laches is a creation of equity,which is applied not to penalize neglect or failure to assert a right within a reasonable time, butrather to avoid recognizing a right when to do so would result in a clearly inequitable situation

or in an injustice. To require private respondent to pay the remaining balance of hisloan is certainly not inequitable or unjust. What would be manifestly unjust and inequitable ishis contention that CBTC is the proper party to proceed against him despite the fact, which hehimself asserts, that CBTC’s corporate personality has been dissolved by virtue of its mergerwith petitioner. To hold that no payee/obligee exists and to let private respondent enjoy thefruits of his loan without liability is surely most unfair and unconscionable, amounting to unjustenrichment at the expense of petitioner. Besides, this Court has held that the doctrine oflaches is inapplicable where the claim was filed within the prescriptive period set forth underthe law.

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No Contract

Pour Autrui

Private respondent, while not denying that he executed the promissory note in the amount ofP2,500,000 in favor of CBTC, offers the alternative defense that said note was a contract pourautrui.

A stipulation pour autrui is one in favor of a third person who may demand its fulfillment,provided he communicated his acceptance to the obligor before its revocation. An incidentalbenefit or interest, which another person gains, is not sufficient. The contracting parties musthave clearly and deliberately conferred a favor upon a third person.

Florentino vs. Encarnacion Sr. enumerates the requisites for such contract: (1) thestipulation in favor of a third person must be a part of the contract, and not the contract itself;(2) the favorable stipulation should not be conditioned or compensated by any kind ofobligation; and (3) neither of the contracting parties bears the legal representation orauthorization of the third party. The “fairest test” in determining whether the third person’sinterest in a contract is a stipulation pour autrui or merely an incidental interest is to examinethe intention of the parties as disclosed by their contract.

We carefully and thoroughly perused the promissory note, but found no stipulation at all thatwould even resemble a provision in consideration of a third person. The instrument itself doesnot disclose the purpose of the loan contract. It merely lays down the terms of payment andthe penalties incurred for failure to pay upon maturity. It is patently devoid of any indicationthat a benefit or interest was thereby created in favor of a person other than the contractingparties. In fact, in no part of the instrument is there any mention of a third party at all. Exceptfor his barefaced statement, no evidence was proffered by private respondent to support hisargument. Accordingly, his contention cannot be sustained. At any rate, if indeed the loanactually benefited a third person who undertook to repay the bank, private respondent couldhave availed himself of the legal remedy of a third-party complaint. That he made no effortto implead such third person proves the hollowness of his arguments.

Consideration

Private respondent also claims that he received no consideration for the promissory note and,in support thereof, cites petitioner’s failure to submit any proof of his loan application and ofhis actual receipt of the amount loaned. These arguments deserve no merit. Res ipsa loquitur.The instrument, bearing the signature of private respondent, speaks for itself. RespondentSarmiento has not questioned the genuineness and due execution thereof. No further proof isnecessary to show that he undertook to pay P2,500,000, plus interest, to petitioner bank on orbefore March 6, 1978. This he failed to do, as testified to by petitioner’s accountant. The latterpresented before the trial court private respondent’s statement of account as of September30, 1986, showing an outstanding balance of P4,689,413.63 after deducting P1,000,000.00

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paid seven months earlier. Furthermore, such partial payment is equivalent to an expressacknowledgment of his obligation. Private respondent can no longer backtrack and deny hisliability to petitioner bank. “A person cannot accept and reject the same instrument.”

WHEREFORE, the petition is GRANTED. The assailed Decision is SET ASIDE and theDecision of RTC-Manila, Branch 48, in Civil Case No. 26465 is hereby REINSTATED.

SO ORDERED.

Davide Jr. (Chairman), Bellosillo, Vitug, and Quisumbing, JJ., concur.

Rollo, pp. 38-48.

Eighth Division, composed of JJ. Eduardo G. Montenegro, ponente; Jaime M. Lantin,chairman; and Jose C. de la Rama, concurring.

Penned by Judge Bonifacio A. Cacdac Jr.

RTC Decision, p. 2; records, p. 129.

Assailed Decision, p. 11; rollo, p. 48.

RTC Decision, pp. 1-2; assailed Decision, pp. 2-3; Petition for Review, pp. 1-4.

CA rollo, pp. 35-38. (Upper case in the original.)

This case was deemed submitted for decision upon receipt by this Court of privaterespondent’s Memorandum on October 10, 1997.

Petition, p. 5; rollo, p. 24. (Upper case in the original.)

Jose C. Campos Jr. and Maria Clara Lopez-Campos, The Corporation Code: Comments,Notes and Selected Cases, Vol. 2, 1990 ed., p. 441; § 80, Corporation Code.

Campos and Campos, ibid., p. 447.

Pertinent provisions of the Corporation Code read:

“SEC. 76. Plan of merger or consolidation. -- Two or more corporations may merge into asingle corporation which shall be one of the constituent corporations or may consolidate into anew single corporation which shall be the consolidated corporation.

The board of directors or trustees of each corporation, party to the merger of consolidation,shall approve a plan of merger or consolidation setting forth the following:

The names of the corporations proposing to merge or consolidate, hereinafter referred to asthe constituent corporations;

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The terms of the merger or consolidation and the mode of carrying the same into effect;

A statement of the changes, if any, in the articles of incorporation of the surviving corporationin case of merger; and, with respect to the consolidated corporation in case of consolidation,all the statements required to be set forth in the articles of incorporation for corporationsorganized under this Code; and

Such other provisions with respect to the proposed merger or consolidation as are deemednecessary or desirable.

SEC. 77. Stockholders’ or members’ approval. -- Upon approval by a majority vote of each ofthe board of directors or trustees of the constituent corporations of the plan of merger orconsolidation, the same shall be submitted for approval by the stockholders or members ofeach of such corporations at separate corporate meetings duly called for the purpose. Noticeof such meetings shall be given to all stockholders or members of the respective corporations,at least two (2) weeks prior to the date of the meeting, either personally or by registered mail.Said notice shall state the purpose of the meeting and shall include a copy or a summary ofthe plan of merger or consolidation, as the case may be. The affirmative vote of stockholdersrepresenting at least two-thirds (2/3) of the outstanding capital stock of each corporation incase of stock corporations or at least two thirds (2/3) of the members in case of non-stockcorporations, shall be necessary for the approval of such plan. Any dissenting stockholder instock corporations may exercise his appraisal right in accordance with the Code: Provided,That if after the approval by the stockholders of such plan, the board of directors shoulddecide to abandon the plan, the appraisal right shall be extinguished.

Any amendment to the plan of merger or consolidation may be made, provided suchamendment is approved by majority vote of the respective boards of directors or trustees of allthe constituent corporations and ratified by the affirmative vote of stockholders representing atleast two-thirds (2/3) of the outstanding capital stock or two-thirds (2/3) of the members ofeach of the constituent corporations. Such plan, together with any amendment, shall beconsidered as the agreement of merger or consolidation.

SEC. 78. Articles of merger or consolidation. -- After the approval by the stockholders ormembers as required by the preceding section, articles of merger or articles of consolidationshall be executed by each of the constituent corporations, to be signed by the president orvice-president and certified by the secretary or assistant secretary of each corporation settingforth: 1. The plan of the merger or the plan of consolidation; 2. As to stock corporations, thenumber of shares outstanding, or in the case of non-stock corporations, the number ofmembers; and 3. As to each corporation, the number of shares or members voting for andagainst such plan, respectively.

SEC. 79. Securities and Exchange Commission’s approval and effectivity of merger or

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consolidation. -- The articles of merger or of consolidation, signed and certified as hereinaboverequired, shall be submitted to the Securities and Exchange Commission in quadruplicate for

its approval: Provided, That in the case of merger or consolidation of banks or bankinginstitutions, building and loan associations, trust companies, insurance companies, publicutilities, educational institutions and other special corporations governed by special laws, thefavorable recommendation of the appropriate government agency shall first be obtained.Where the commission is satisfied that the merger or consolidation of the corporationsconcerned is not inconsistent with the provisions of this Code and existing laws, it shall issue acertificate of merger or of consolidation, as the case may be, at which time the merger orconsolidation shall be effective.

If, upon investigation, the Securities and Exchange Commission has reason to believe that theproposed merger or consolidation is contrary to or inconsistent with the provisions of this Codeor existing laws, it shall set a hearing to give the corporations concerned the opportunity to beheard. Written notice of the date, time and place of said hearing shall be given to eachconstituent corporations at least two (2) weeks before said hearing. The Commission shallthereafter proceed as provided in this Code.

SEC. 80. Effects of merger or consolidation. -- The merger or consolidation, as provided in thepreceding sections, shall have the following effects:

The constituent corporations shall become a single corporation which, in case of merger, shallbe the surviving corporation designated in the plan of merger; and, in case of consolidation,shall be the consolidated corporation designated in the plan of consolidation;

The separate existence of the constituent corporations shall cease, except that of the survivingor the consolidated corporation;

The surviving or the consolidated corporation shall possess all the rights, privileges,immunities and powers and shall be subject to all the duties and liabilities of a corporationorganized under this Code;

The surviving or the consolidated corporation shall thereupon and thereafter possess all therights, privileges, immunities and franchises of each of the constituent corporations; and allproperty, real or personal, and all receivables due on whatever account, includingsubscriptions to shares and other choses in action, and all and every other interest of, orbelonging to, or due to each constituent corporation, shall be taken and deemed to betransferred to and vested in such surviving or consolidated corporation without further act ordeed; and

The surviving or consolidated corporation shall be responsible and liable for all the liabilitiesand obligations of each of the constituent corporations in the same manner as if such survivingor consolidated corporation had itself incurred such liabilities or obligations; and any claim,

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action or proceeding pending by or against any of such constituent corporations may beprosecuted by or against the surviving or consolidated corporation, as the case may be. Therights of creditors or any lien upon the property of any of such constituent corporation shall not

be impaired by such merger or consolidation.”

Records, pp. 33-40.

No. 14, p. 8, Agreement of Merger; records, p. 40.

Agreement of Merger, pp. 5-6; records, pp. 37-38.

Ibid., pp. 6-7; records, pp. 38-39.

Art. 1370, Civil Code.

Ruben E. Agpalo, Statutory Construction, 1990 ed., p. 94.

Art. 1144, Civil Code.

Catholic Bishop of Balanga vs. Court of Appeals, 264 SCRA 181, 193, November 14, 1996.

Olizon vs. Court of Appeals, 236 SCRA 148, 157, September 1, 1994.

Chavez vs. Bonto-Perez, 242 SCRA 73, 80-81, March 1, 1995.

Art. 1311, par. 2, Civil Code.

79 SCRA 192, 201, September 30, 1977, per Guerrero, J.

Ibid., p. 202.

§ 11, Rule 6, Rules of Court.

Exh. “B”; records, p. 130.

Ducasse v. American Yellow Taxi Operators, Inc., 224 App. Div. 516, 231 NY Supp. 51(1928), citing Chipman v. Montgomery, 63 NY 211; in Campos and Campos, supra.

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ASSOCIATED BANK vs. CA and LORENZO SARMIENTO JR

G.R. No. 123793 June 29, 1998

FACTS: On or about September 16, 1975 Associated Banking Corporation and Citizens Bank and Trust Company merged to form just one banking corporation known as Associated Citizens Bank, the surviving bank. On or about March 10, 1981, the Associated Citizens Bank changed its corporate name to Associated Bank by virtue of the Amended Articles of Incorporation. On September 7, 1977, defendant LORENZO SARMIENTO JR., executed in favor of Associated Bank a promissory note whereby the former undertook to pay the latter the sum of P2,500,000.00 payable on or before March 6, 1978. As per said promissory note, the defendant agreed to pay interest at 14% per annum, 3% per annum in the form of liquidated damages, compounded interests, and attorney's fees, in case of litigation equivalent to 10% of the amount due. The defendant, to date, still owes plaintiff bank the amount of P2,250,000.00 exclusive of interest and other charges. Despite repeated demands the defendant failed to pay the amount due. However defendant denied all the allegations of petitioner and alleged as affirmative and/or special defenses, inter alia, that the complaint states no valid cause of action and the plaintiff is not the proper party in interest because the promissory note was executed in favor of Citizens Bank and Trust Company. On October 17, 1986, the RTC ordered Respondent Sarmiento to pay the bank his remaining balance plus interests and attorney's fees. On appeal, Respondent Court held that the Associated Bank had no cause of action against Lorenzo Sarmiento Jr., since said bank was not privy to the promissory note executed by Sarmiento in favor of Citizens Bank and Trust Company. The court ruled that the earlier merger between the two banks could not have vested Associated Bank with any interest arising from the promissory note executed in favor of CBTC after such merger. Hence the instant petition for review.

ISSUE: Whether or not Associated Bank, the surviving corporation, may enforce the promissory note made by private respondent in favor of CBTC, the absorbed company, after the merger agreement had been signed.

RULING: Ordinarily, in the merger of two or more existing corporations, one of the combining corporations survives and continues the combined business, while the rest are dissolved and all their rights, properties and liabilities are acquired by the surviving corporation. Although there is a dissolution of the absorbed corporations, there is no winding up of their affairs or liquidation of their assets, because the surviving corporation automatically acquires all their rights, privileges and powers, as well as their liabilities.

The merger, however, does not become effective upon the mere agreement of the constituent corporations. The procedure to be followed is prescribed under the Corporation Code. Section 79 of said Code requires the approval by the Securities and Exchange Commission of the articles of merger which, in turn, must have been duly approved by a majority of the respective stockholders of the constituent corporations. The same provision further states that the merger shall be effective only upon the issuance by the SEC of a certificate of merger. The effectivity date of the merger is crucial for determining when the merged or absorbed corporation ceases to exist; and when its rights, privileges, properties as well as liabilities pass on to the surviving corporation.

Assuming that the effectivity date of the merger was the date of its execution, we still cannot agree that petitioner no longer has any interest in the promissory note. A closer perusal of the merger agreement leads to a different conclusion. The provision of the merger agreement has this clause:

Upon the effective date of the merger, all references to [CBTC] in any deed, documents, or other papers of whatever kind or nature and wherever found shall be deemed for all intents and purposes, references to [ABC], the SURVIVING BANK, as if such references were direct references to [ABC]. . . (Emphasis supplied)

Thus, the fact that the promissory note was executed after the effectivity date of the merger does not militate against petitioner. The agreement itself clearly provides that all contracts — irrespective of the date of execution — entered into in the name of CBTC shall be understood as pertaining to the surviving bank, herein petitioner. Since, in contrast to the earlier aforequoted provision, the latter clause no longer specifically refers only to contracts existing at the time of the merger, no distinction should be made. The clause must have been deliberately included in the agreement in order to protect the interests of the combining banks; specifically, to avoid giving the merger agreement a farcical interpretation aimed at evading fulfillment of a due obligation.

Thus, although the subject promissory note names CBTC as the payee, the reference to CBTC in the note shall be construed, under the very provisions of the merger agreement, as a reference to petitioner bank, "as if such reference [was a] direct reference to" the latter "for all intents and purposes."

No other construction can be given to the unequivocal stipulation. Being clear, plain and free of ambiguity, the provision must be given its literalmeaning and applied without a convoluted interpretation. Verba lelegis non est recedendum.

In light of the foregoing, the Court holds that petitioner has a valid cause of action against private respondent. Clearly, the failure of private respondent to honor his obligation under the promissory note constitutes a violation of petitioner's right to collect the proceeds of the loan it extended to the former.

EN BANC

[ G.R. No. 97237, August 16, 1991 ]

FILIPINAS PORT SERVICES, INC., PETITIONER,

VS.

NATIONAL LABOR RELATIONS COMMISSION, PATERNO LIBOON, SEGUNDO AQUINO,JOVITO BULAY, DOMINGO NAVOA, DELFIN BERMEJO, CELEDONIO MANGUBAT,ALBERTO MAHINAY, SR., TEODULO SILAYA, SANTOS ARGUIDO, JUANITO LABANON,FLORENCIO MIRANTES, LUCIO BARRERA, VICENTE GILDORE, LEON FUENTES,CASIMIRO MAGSAYO, FERNANDO MORIENTE, MATIAS ORBITA, SR., FRANCISCOPARDILLO, ILDEFONSO JUMILLA AND JOSE CANTONJOS, RESPONDENTS.

DECISION

PARAS, J.:

This is a petition for clarification with prayer for preliminary injunction filed by Filipinas PortServices, Inc. (hereinafter referred to as Filport) seeking to clarify two conflicting decisionsrendered by this Court in cases involving identical or similar parties, facts and issues.

The antecedent facts of the case are as follows:

In view of the government policy which ordained that cargo handling operations should belimited to only one cargo handling operator-contractor for every port (under CustomsMemorandum Order 28075, later on superseded by General Ports Regulations of thePhilippine Ports Authority) the different stevedoring and arrastre corporations operating in thePort of Davao were integrated into a single dockhandlers corporation, known as the DavaoDockhandlers, Inc., which was registered with the Securities and Exchange Commission onJuly 13, 1976.

Due to the late receipt of its permit to operate at the Port of Davao from the Bureau ofCustoms, Davao Dockhandlers, Inc., which was subsequently renamed Filport, actuallystarted its operation on February 16, 1977.

As a result of the merger, Section 118, Article X of the General Guidelines on The Integrationof Stevedoring/Arrastre Services (PPA Administrative Order No. 13-77) mandated Filport todraw its personnel complements from the merging operators, as follows:

"Sec. 118. Absorption of labor - Subject to the provisions of the immediate preceding section,

and consistent with the actual operational requirements of the new management, all laborforce together with its necessary personnel complement, of the merging operators shall beabsorbed by the merged or integrated organization to constitute its labor force." (Emphasissupplied)

Thus, Filport's labor force was mostly taken from the integrating corporations, among them theprivate respondents.

On February 4, 1987, private respondent Paterno Liboon and 18 others filed a complaint withthe Department of Labor and Employment Regional Office in Davao City, alleging that theywere employees of Filport since 1955 through 1958 up to December 31, 1986 when theyretired; that they were paid retirement benefits computed from February 16, 1977 up toDecember 31, 1986 only; and that taking into consideration their continuous length of service,they are entitled to be paid retirement benefits differentials from the time they started workingwith the predecessors of Filport up to the time they were absorbed by the latter in 1977 (p. 15,Rollo).

Finding Filport a mere alter ego of the different integrating corporations, the Labor Arbiter heldFilport liable for retirement benefits due private respondents for services rendered prior toFebruary 16, 1977. Said decision was affirmed by the NLRC on appeal.

Filport filed a petition for certiorari with the Supreme Court docketed as G.R. No. 85704,claiming that it is an entirely new corporation with a separate juridical personality from theintegrating corporations; and that Filport is not a successor‑employer, liable for the obligationsof private respondents' previous employers, as shown clearly in the memorandum datedNovember 21, 1978 of PPA Assistant General Manager Maximo S. Dumlao, Jr., to wit:

"21 November 1978

"MEMORANDUM

"TO : The Officer-in-Charge

PMU Davao

"FROM : The ACM for Operations

"SUBJECT : Clarification of Sec. 116 of PPA Administrative Order No. 13-77 of NewOrganization 's Liability

"In reply to your telegram dated November 16, 1978, Sec. 116 of PPA Administrative Order#13-77 is hereby quoted for clarification:

"New Organization's Liability - The integrated cargo-handling organization shall be absolutely

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free from any liability or obligation of the merging operators who shall continue to beindividually liable for their respective liabilities or obligations, if any." (underscoring supplied) xx x

"The new organization's liability shall be the payment of salaries, benefits and all other moneydue the employee as a result of his employment, starting on the date of his service in thenewly integrated organization.

"In answer to your query, therefore, the absorption of an employee into a newly integratedorganization does not include the carry over of his length of service.

s/t MAXIMO S. DUMLAO, JR.

Asst. General Manager"

While G.R. No. 85704 was still pending decision by this Court, Josefino Silva, anotheremployee of Filport, instituted a suit against Filport and Damasticor (one of the defunctstevedoring firms) claiming for retirement benefits for services rendered prior to February 19,1977. The labor arbiter found for Josefino Silva and said decision was affirmed by the NLRC.

Filport filed a petition for certiorari with the Supreme Court docketed as G.R. No. 86026. OnAugust 31, 1989, this Court, through the First Division, rendered a decision, holding that:

"Petitioner (Filport) cannot be held liable for the payment of the retirement pay of privaterespondent (Josefino Silva) while in the employ of DAMASTICOR x x x who is heldresponsible for the same as the labor contract is in personam and cannot be passed on to thepetitioner." (Rollo, p. 7)

In so ruling, the First Division relied heavily on the case of Fernando v. Angat Labor Union (5SCRA 248) where it was held that unless expressly assumed, labor contracts are notenforceable against a transferee of an enterprise, labor contracts being in personam.

Per entry of judgment, the aforesaid decision became final and executory on November 24,1989 (p. 87, Rollo).

On September 3, 1990, however, this Court, through the Second Division, dismissed thepetition in G.R. No. 85704 "for failure to sufficiently show that the questioned judgment istainted with grave abuse of discretion."

Per entry of judgment, said resolution became final and executory on December 4, 1990 (p.108, Rollo).

Hence, the instant petition for clarification with prayer for preliminary injunction to enjoin therespondents from enforcing the decision in G.R. No. 85704 until further orders of this Court.

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We see no reason to disturb the findings of fact of the public respondent, supported as theyare by substantial evidence in the light of the well established principle that findings ofadministrative agencies which have acquired expertise because their jurisdiction is confined tospecific matters are generally accorded not only respect but at times even finality, and thatjudicial review by this Court on labor cases does not go so far as to evaluate the sufficiency ofthe evidence upon which the Labor Arbiter and the NLRC based their determinations but arelimited to issues of jurisdiction or grave abuse of discretion. (National Federation of LaborUnion v. Ople, 143 SCRA 129).

In the case filed by private respondent Paterno Liboon et al against Filport, the findings of theNLRC in its November 27, 1987 decision are categorical:

"In resolving the issues, the Labor Arbiter concludes as follows:

"The eventual incorporation of the arrastre/stevedoring firms and their subsequent registrationwith the Securities and Exchange Commission on July 13, 1975 brought to the fore theinterlocking ownership of the new corporation.

x x x x x x x x x

"Subsequent amendment of its Articles of Incorporation highlighted by the renaming of theDavao Dockhandlers, Inc. to Filipinas Port Services, Inc. did not diminish the fact that theownership and constituency of the new corporation are basically identical with the previousowners.

"It is, therefore, the considered view of this Office that respondent Filport being a mere alterego of the different merging companies has at the very least, the obligation not only to absorbinto its employ workers of the dissolved companies, but also to absorb the length of serviceearned by the absorbed employees from their former employers.

x x x x x x x x x

"We are in full accord with, and hereby sustain, the findings and conclusions of the LaborArbiter. Under the circumstances, respondent-appellant is a successor‑employer. As asuccessor entity, it is answerable to the lawful obligations of the predecessor employers,herein integrees. This Commission has so held under the principle of 'substitution' that thesuccessor firm is liable to (sic) the obligations of the predecessor employer, notwithstandingthe change in management or even personality, of the new contracting employer." (Lakas NgManggagawang Filipino [LAKAS] v. Tarlac Electrical Cooperative, Inc. et al., NLRC Case No.RB III-157-75, January 28, 1978, En Banc). x x x The Supreme Court earlier upheld the"Substitutionary" doctrine in the case of Benguet Consolidated, Inc. vs. BOI Employees &Workers Union, (G.R. L-24711, April 30, 1968, 23 SCRA 465). (pp. 35 & 37, Rollo)

Said findings were reiterated in the case filed by Josefino Silva against Filport where the

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NLRC, in its decision dated January 19, 1988, further ruled that:

"x x x As We have ruled in the similar case involving herein appellant, the latter is deemed asurvivor entity because it continued in an essentially unchanged manner the businessoperators of the predecessor arrastre and port service operators, hiring substantially the sameworkers, including herein appellee, of the integree predecessors, using substantially the samefacilities, with similar working conditions and line of business, and employing the samecorporate control, although under a new management and corporate personality." (G.R. No.86026, p. 35, Rollo)

Thus, granting that Filport had no contract whatsoever with the private respondents regardingthe services rendered by them prior to February 16, 1977, by the fact of the merger, asuccession of employment rights and obligations had occurred between Filport and the privaterespondents. The law enforced at the time of the merger was Section 3 of Act No. 2772 whichtook effect on March 6, 1918. Said law provides:

"Sec. 3. Upon the perfecting, as aforesaid, of a consolidation made in the manner hereinprovided, the several corporations parties thereto shall be deemed and taken as onecorporation, upon the terms and conditions set forth in said agreement; or, upon the perfectingof a merger, the corporation merged shall be deemed and taken as absorbed by the othercorporation and incorporated in it; and all and singular rights, privileges, and franchises ofeach of said corporations, and all property, real and personal, and all debts due on whateveraccount, belonging to each of such corporations, shall be taken and deemed as transferred toand vested in the new corporation formed by the consolidation, or in the surviving corporationin case of merger, without further act or deed; and the title to real estate, either by deed orotherwise, under the laws of the Philippine Islands vested in either corporation, shall not bedeemed in any way impaired by reason of this Act: Provided, however, That the rights ofcreditors and all liens upon the property of either of said corporations shall be preservedunimpaired; and all debts, liabilities, and duties of said corporations shall thenceforth attach tothe new corporation in case of a consolidation, or to the surviving corporation in case of amerger, and be enforced against said new corporation or surviving corporation as if said debts,liabilities, and duties had been incurred or contracted by it."

As earlier stated, it was mandated that Filport shall absorb all labor force and necessarypersonnel complement of the merging operators, thus, clearly indicating the intention tocontinue the employer-employee relationships of the individual companies with its employeesthrough Filport.

The alleged memorandum of the PPA Assistant General exonerating Filport from any liabilityarising from and as a result of the merger is contrary to public policy and is violative of theworkers' right to security of tenure. Said memorandum was issued in response to a query ofthe PMU Officer-in-Charge and was not even published nor made known to the workers whocame to know of its existence only at the hearing before the NLRC. (G.R. No. 86026, pp. 93-94, Rollo)

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The principle involved in the case cited by the First Division (Fernando v. Angat Labor Union[supra]) applies only when the transferee is an entirely new corporation with a distinctpersonality from the integrating firms and NOT where the transferee was found to be merelyan alter ego of the different merging firms, as in this case. Thus, Filport has the obligation notonly to absorb the workers of the dissolved companies but also to include the length of serviceearned by the absorbed employees with their former employers as well. To rule otherwisewould be manifestly less than fair, certainly, less than just and equitable.

Finally, to deny the private respondents the fruits of their labor corresponding to the time theyworked with their previous employers would render at naught the constitutional provisions onlabor protection. In interpreting the protection to labor and social justice provisions of theConstitution and the labor laws, and rules and regulations implementing the constitutionalmandate, the Supreme Court has always adopted the liberal approach which favors theexercise of labor rights. (Euro-Linea, Phils., Inc. v. NLRC, 156 SCRA 83).

WHEREFORE, the Resolution of the Second Division of this Court in G.R. No. 85704 datedSeptember 3, 1990 is hereby REITERATED.

SO ORDERED.

Fernan, C.J., Melencio-Herrera, Gutierrez, Jr., Cruz, Feliciano, Padilla, Bidin, Sarmiento,Griño-Aquino, Medialdea, Regalado, and Davide, Jr., JJ., concur.

Narvasa, and Gancayco, JJ., in the result.

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Notes:

Mei

Rehabilitation

FIRST DIVISION

[ G.R. No. 105364, June 28, 2001 ]

PHILIPPINE VETERANS BANK EMPLOYEES UNION-N.U.B.E. AND PERFECTO V.FERNANDEZ, PETITIONERS,

VS.

HONORABLE BENJAMIN VEGA, PRESIDING JUDGE OF BRANCH 39 OF THEREGIONAL TRIAL COURT OF MANILA, THE CENTRAL BANK OF THE PHILIPPINES ANDTHE LIQUIDATOR OF THE PHILIPPINE VETERANS BANK, RESPONDENTS

DECISION

KAPUNAN, J.:

May a liquidation court continue with liquidation proceedings of the Philippine Veterans Bank(PVB) when Congress had mandated its rehabilitation and reopening?

This is the sole issue raised in the instant Petition for Prohibition with Petition for PreliminaryInjunction and application for Ex Parte Temporary Restraining Order.

The antecedent facts of the case are as follows:

Sometime in 1985, the Central Bank of the Philippines (Central Bank, for brevity) filed withBranch 39 of the Regional Trial Court of Manila a Petition for Assistance in the Liquidation ofthe Philippine Veterans Bank, the same docketed as Case No. SP-32311. Thereafter, thePhilipppine Veterans Bank Employees Union-N.U.B.E., herein petitioner, represented bypetitioner Perfecto V. Fernandez, filed claims for accrued and unpaid employee wages andbenefits with said court in SP-32311.

After lengthy proceedings, partial payment of the sums due to the employees were made.However, due to the piecemeal hearings on the benefits, many remain unpaid.

On March 8, 1991, petitioners moved to disqualify the respondent judge from hearing theabove case on grounds of bias and hostility towards petitioners.

On January 2, 1992, the Congress enacted Republic Act No. 7169 providing for therehabilitation of the Philippine Veterans Bank.

Thereafter, petitioners filed with the labor tribunals their residual claims for benefits and forreinstatement upon reopening of the bank.

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Sometime in May 1992, the Central Bank issued a certificate of authority allowing the PVB toreopen.

Despite the legislative mandate for rehabilitation and reopening of PVB, respondent judgecontinued with the liquidation proceedings of the bank. Moreover, petitioners learned thatrespondents were set to order the payment and release of employee benefits upon motion ofanother lawyer, while petitioners' claims have been frozen to their prejudice.

Hence, the instant petition.

Petitioners argue that with the passage of R.A. 7169, the liquidation court became functusofficio, and no longer had the authority to continue with liquidation proceedings.

In a Resolution, dated June 8, 1992, the Supreme Court resolved to issue a TemporaryRestraining Order enjoining the trial court from further proceeding with the case.

On June 22, 1992, VOP Security & Detective Agency (VOPSDA) and its 162 security guardsfiled a Motion for Intervention with prayer that they be excluded from the operation of theTemporary Restraining Order issued by the Court. They alleged that they had filed a motionbefore Branch 39 of the RTC of Manila, in SP-No. 32311, praying that said court order PVB topay their backwages and salary differentials by authority of R.A. No 6727, Wage Orders No.NCR-01 and NCR-01-Ad and Wage Orders No. NCR-02 and NCR-02-A; and, that said court,in an Order dated June 5, 1992, approved therein movants' case and directed the bankliquidator or PVB itself to pay the backwages and differentials in accordance with thecomputation incorporated in the order. Said intervenors likewise manifested that there was anerror in the computation of the monetary benefits due them.

On August 18, 1992, petitioners, pursuant to the Resolution of this Court, dated July 6, 1992,filed their Comment opposing the Motion for Leave to File Intervention and for exclusion fromthe operation of the T.R.O. on the grounds that the movants have no legal interest in thesubject matter of the pending action; that allowing intervention would only cause delay in theproceedings; and that the motion to exclude the movants from the T.R.O. is without legal basisand would render moot the relief sought in the petition.

On September 3, 1992, the PVB filed a Petition-In-Intervention praying for the issuance of thewrits of certiorari and prohibition under Rule 65 of the Rules of Court in connection with theissuance by respondent judge of several orders involving acts of liquidation of PVB even afterthe effectivity of R.A. No. 7169. PVB further alleges that respondent judge clearly acted inexcess of or without jurisdiction when he issued the questioned orders.

We find for the petitioners.

Republic Act No. 7169 entitled "An Act To Rehabilitate The Philippine Veterans Bank CreatedUnder Republic Act No. 3518, Providing The Mechanisms Therefor, And For Other Purposes",which was signed into law by President Corazon C. Aquino on January 2, 1992 and which was

6

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published in the Official Gazette on February 24, 1992, provides in part for the reopening ofthe Philippine Veterans Bank together with all its branches within the period of three (3) yearsfrom the date of the reopening of the head office. The law likewise provides for the creationof a rehabilitation committee in order to facilitate the implementation of the provisions of thesame.

Pursuant to said R.A. No. 7169, the Rehabilitation Committee submitted the proposedRehabilitation Plan of the PVB to the Monetary Board for its approval. Meanwhile, PVB filed aMotion to Terminate Liquidation of Philippine Veterans Bank dated March 13, 1992 with therespondent judge praying that the liquidation proceedings be immediately terminated in viewof the passage of R.A. No. 7169.

On April 10, 1992, the Monetary Board issued Monetary Board Resolution No. 348 whichapproved the Rehabilitation Plan submitted by the Rehabilitaion Committee.

Thereafter, the Monetary Board issued a Certificate of Authority allowing PVB to reopen.

On June 3, 1992, the liquidator filed A Motion for the Termination of the LiquidationProceedings of the Philippine Veterans Bank with the respondent judge.

As stated above, the Court, in a Resolution dated June 8, 1992, issued a temporaryrestraining order in the instant case restraining respondent judge from further proceeding withthe liquidation of PVB.

On August 3, 1992, the Philippine Veterans Bank opened its doors to the public and startedregular banking operations.

Clearly, the enactment of Republic Act No. 7169, as well as the subsequent developments hasrendered the liquidation court functus officio. Consequently, respondent judge has beenstripped of the authority to issue orders involving acts of liquidation.

Liquidation, in corporation law, connotes a winding up or settling with creditors and debtors.It is the winding up of a corporation so that assets are distributed to those entitled to receivethem. It is the process of reducing assets to cash, discharging liabilities and dividing surplus orloss.

On the opposite end of the spectrum is rehabilitation which connotes a reopening orreorganization. Rehabilitation contemplates a continuance of corporate life and activities in aneffort to restore and reinstate the corporation to its former position of successful operation andsolvency.

It is crystal clear that the concept of liquidation is diametrically opposed or contrary to theconcept of rehabilitation, such that both cannot be undertaken at the same time. To allow theliquidation proceedings to continue would seriously hinder the rehabilitation of the subjectbank.

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Anent the claim of respondents Central Bank and Liquidator of PVB that R.A. No. 7169became effective only on March 10, 1992 or fifteen (15) days after its publication in the OfficialGazette; and, the contention of intervenors VOP Security, et. al. that the effectivity of said lawis conditioned on the approval of a rehabilitation plan by the Monetary Board, among others,the Court is of the view that both contentions are bereft of merit.

While as a rule, laws take effect after fifteen (15) days following the completion of theirpublication in the Official Gazette or in a newspaper of general circulation in the Philippines,the legislature has the authority to provide for exceptions, as indicated in the clause "unlessotherwise provided."

In the case at bar, Section 10 of R.A. No. 7169 provides:

Sec. 10. Effectivity. - This Act shall take effect upon its approval.

Hence, it is clear that the legislature intended to make the law effective immediately upon itsapproval. It is undisputed that R.A. No. 7169 was signed into law by President Corazon C.Aquino on January 2, 1992. Therefore, said law became effective on said date.

Assuming for the sake of argument that publication is necessary for the effectivity of R.A. No.7169, then it became legally effective on February 24, 1992, the date when the same waspublished in the Official Gazette, and not on March 10, 1992, as erroneously claimed byrespondents Central Bank and Liquidator.

WHEREFORE, in view of the foregoing, the instant petition is hereby GIVEN DUE COURSEand GRANTED. Respondent Judge is hereby PERMANENTLY ENJOINED from furtherproceeding with Civil Case No. SP- 32311.

SO ORDERED.

Davide, Jr., C.J., (Chairman), Puno, Pardo, and Ynares-Santiago, JJ., concur.

* This case was transferred to the ponente pursuant to the resolution in AM No. 00-9-03-SC.Re: Creation of Special Committee on Case Backlog dated February 27, 2001.

Rollo, p. 5.

Ibid.

Id.

Id., at 6.

Id.

1

2

3

4

5

Page 4

Id.

Sec. 5, Republic Act No. 7169, Official Gazette, February 24, 1992, p. 963.

Sec. 7, Ibid.

Wilson vs. Superior Court in and for Santa Clara County, 2 Cal.2d 632, 43 P.2d 286, 288.

Ruby Industrial Corporation vs. Court of Appeals, 284 SCRA 445 (1998).

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PHILIPPINE VETERANS BANK EMPLOYEESUNION-N.U.B.E. and PERFECTO V.FERNANDEZ, petitioners, vs. HONORABLEBENJAMIN VEGA, Presiding Judge of Branch 39 ofthe REGIONAL TRIAL COURT of Manila, theCENTRAL BANK OF THE PHILIPPINES and THELIQUIDATOR OF THE PHILIPPINE VETERANSBANK, respondents.

Perfecto V. Fernandez for petitioner.Carpio Villaraza & Cruz for petitioner-in-intervention.Augusto del Rosario for himself as intervenor.Bonifacio A. Tavera, Jr. for intervenor VOPSDA.Emma G. Salmani for respondents.

SYNOPSIS

During the pendency of Case No. SP-32311, a petition forassistance in the liquidation of the Philippine Veterans Bank(PVB). Republic Act No. 7169 providing for the rehabilitationof the bank, was passed into law. It was approved by thePresident on January 2, 1992 and published in the OfficialGazette on February 24, 1992. Meanwhile, PVB filed a motionto terminate liquidation proceedings with respondent judge inview of the passage of R.A. No. 7169. Another motion of thesame character was filed by the liquidator, but respondent judgecontinued with the proceedings. August 3, 1992, the PVBopened its doors to the public and started regular bankingoperations.The enactment of Republic Act No. 7169 has rendered theliquidation court functus officio and respondent judge has beenstripped of the authority to issue orders involving acts ofliquidation. Liquidation connotes a winding up or settling withthe creditors and debtors while rehabilitation connotes areopening or reorganization. Both are diametrically opposed toeach other, such that both cannot be undertaken at the sametime. D E C I S I O N

KAPUNAN, J p:

May a liquidation court continue with liquidation proceedings ofthe Philippine Veterans Bank (PVB) when Congress hadmandated its rehabilitation and reopening?This is the sole issue raised in the instant Petition for Prohibitionwith Petition for Preliminary Injunction and application for ExParte Temporary Restraining Order.The antecedent facts of the case are as follows:Sometime in 1985, the Central Bank of the Philippines (CentralBank, for brevity) filed with Branch 39 of the Regional TrialCourt of Manila a Petition for Assistance in the Liquidation ofthe Philippine Veterans Bank, the same docketed as Case No.SP-32311. Thereafter, the Philippine Veterans Bank EmployeesUnion-N.U.B.E., herein petitioner, represented by petitionerPerfecto V. Fernandez, filed claims for accrued and unpaidemployee wages and benefits with said court in SP-32311. 1After lengthy proceedings, partial payment of the sums due tothe employees were made. However, due to the piecemealhearings on the benefits, many remain unpaid. 2On March 8, 1991, petitioners moved to disqualify therespondent judge from hearing the above case on grounds ofbias and hostility towards petitioners. 3On January 2, 1992, the Congress enacted Republic Act No.7169 providing for the rehabilitation of the Philippine VeteransBank. 4Thereafter, petitioners filed with the labor tribunals their residualclaims for benefits and for reinstatement upon reopening of thebank. 5Sometime in May 1992, the Central Bank issued a certificate ofauthority allowing the PVB to reopen. 6Despite the legislative mandate for rehabilitation and reopeningof PVB, respondent judge continued with the liquidationproceedings of the bank. Moreover, petitioners learned thatrespondents were set to order the payment and release ofemployee benefits upon motion of another lawyer, whilepetitioners' claims have been frozen to their prejudice.Hence, the instant petition.Petitioners argue that with the passage of R.A. 7169, theliquidation court became functus officio, and no longer had theauthority to continue with liquidation proceedings.In a Resolution, dated June 8, 1992, the Supreme Court resolvedto issue a Temporary Restraining Order enjoining the trial court

from further proceeding with the case.On June 22, 1992, MOP Security & Detective Agency(VOPSDA) and its 162 security guards filed a Motion forIntervention with prayer that they be excluded from theoperation of the Temporary Restraining Order issued by theCourt. They alleged that they had filed a motion before Branch39 of the RTC of Manila, in SP-No. 32311, praying that saidcourt order PVB to pay their backwages and salary differentialsby authority of R.A. No 6727, Wage Orders No. NCR-01 andNCR-01-A and Wage Orders No. NCR-02 and NCR-02-A; and,that said court, in an Order dated June 5, 1992, approved thereinmovants' case and directed the bank liquidator or PVB itself topay the backwages and differentials in accordance with thecomputation incorporated in the order. Said intervenors likewisemanifested that there was an error in the computation of themonetary benefits due them. On August 18, 1992, petitioners, pursuant to the Resolution ofthis court, dated July 6, 1992, filed their Comment opposing theMotion for Leave to File Intervention and for exclusion from theoperation of the T.R.O. on the grounds that the movants have nolegal interest in the subject matter of the pending action; thatallowing intervention would only cause delay in theproceedings; and that the motion to exclude the movants fromthe T.R.O. is without legal basis and would render moot therelief sought in the petition.On September 3, 1992, the PVB filed a Petition-In-Interventionpraying for the issuance of the writs of certiorari and prohibitionunder Rule 65 of the Rules of Court in connection with theissuance by respondent judge of several orders involving acts ofliquidation of PVB even after the effectivity of R.A. No. 7169.PVB further alleges that respondent judge clearly acted inexcess of or without jurisdiction when he issued the questionedorders.We find for the petitioners.Republic Act No. 7169 entitled "An Act To Rehabilitate ThePhilippine Veterans Bank Created Under Republic Act No.3518, Providing The Mechanisms Therefor, And For OtherPurposes," which was signed into law by President Corazon C.Aquino on January 2, 1992 and which was published in theOfficial Gazette on February 24, 1992, provides in part for thereopening of the Philippine Veterans Bank together with all itsbranches within the period of three (3) years from the date of thereopening of the head office. 7 The law likewise provides for thecreation of a rehabilitation committee in order to facilitate the

implementation of the provisions of the same. 8Pursuant to said R.A. No. 7169, the Rehabilitation Committeesubmitted the proposed Rehabilitation Plan of the PVB to theMonetary Board for its approval. Meanwhile, PVB filed aMotion to Terminate Liquidation of Philippine Veterans Bankdated March 13, 1992 with the respondent judge praying that theliquidation proceedings be immediately terminated in view ofthe passage of R.A. No. 7169.On April 10, 1992, the Monetary Board issued Monetary BoardResolution No. 348 which approved the Rehabilitation Plansubmitted by the Rehabilitation Committee.Thereafter, the Monetary Board issued a Certificate of Authorityallowing PVB to reopen.On June 3, 1992, the liquidator filed A Motion for theTermination of the Liquidation Proceedings of the PhilippineVeterans Bank with the respondent judge.As stated above, the Court, in a Resolution dated June 8, 1992,issued a temporary restraining order in the instant caserestraining respondent judge from further proceeding with theliquidation of PVB.On August 3, 1992, the Philippine Veterans Bank opened itsdoors to the public and started regular banking operations.Clearly, the enactment of Republic Act No. 7169, as well as thesubsequent developments has rendered the liquidationcourt functus officio. Consequently, respondent judge has beenstripped of the authority to issue orders involving acts ofliquidation.Liquidation, in corporation law, connotes a winding up orsettling with creditors and debtors. 9 It is the winding up of acorporation so that assets are distributed to those entitled toreceive them. It is the process of reducing assets to cash,discharging liabilities and dividing surplus or loss. On the opposite end of the spectrum is rehabilitation whichconnotes a reopening or reorganization. Rehabilitationcontemplates a continuance of corporate life and activities in aneffort to restore and reinstate the corporation to its formerposition of successful operation and solvency. 10It is crystal clear that the concept of liquidation is diametricallyopposed or contrary to the concept of rehabilitation, such thatboth cannot be undertaken at the same time. To allow theliquidation proceedings to continue would seriously hinder therehabilitation of the subject bank.

Anent the claim of respondents Central Bank and Liquidator ofPVB that R.A. No. 7169 became effective only on March 10,1992 or fifteen (15) days after its publication in the OfficialGazette; and, the contention of intervenors VOP Security, et al.,that the effectivity of said law is conditioned on the approval ofa rehabilitation plan by the Monetary Board, among others, theCourt is of the view that both contentions are bereft of merit.While as a rule, laws take effect after fifteen (15) days followingthe completion of their publication in the Official Gazette or in anewspaper of general circulation in the Philippines, thelegislature has the authority to provide for exceptions, asindicated in the clause "unless otherwise provided."In the case at bar, Section 10 of R.A. No. 7169provides: CDAEHS

Sec. 10.Effectivity. — This Act shall take effect uponits approval.

Hence, it is clear that the legislature intended to make the laweffective immediately upon its approval. It is undisputed thatR.A. No. 7169 was signed into law by President Corazon C.Aquino on January 2, 1992. Therefore, said law becameeffective on said date.Assuming for the sake of argument that publication is necessaryfor the effectivity of R.A. No. 7169, then it became legallyeffective on February 24, 1992, the date when the same waspublished in the Official Gazette and not on March 10, 1992, aserroneously claimed by respondents Central Bank andLiquidator.WHEREFORE, in view of the foregoing, the instant petition ishereby GIVEN DUE COURSE and GRANTED. RespondentJudge is hereby PERMANENTLY ENJOINED from furtherproceeding with Civil Case No. SP- 32311.SO ORDERED.Davide, Jr., C.J., Puno, Pardo and Ynares-Santiago, JJ., concur.Footnotes1.Rollo, p. 52.Ibid.3.Id.4.Id., at 6.5.Id.6.Id.7.Sec. 5, Republic Act No. 7169, Official Gazette, February 24,

1992, p. 963.8.Sec. 7, Ibid.9.Wilson vs. Superior Court in and for Santa Clara County, 2

Cal. 2d 632, 43 P.2d 286, 288.10.Ruby Industrial Corporation vs. Court of Appeals, 284

SCRA 445 (1998). CASE DIGESTFacts: Sometime in 1985, the Central Bank of the Philippinesfiled with Branch 39 of the Regional Trial Court of Manila aPetition for Assistance in the Liquidation of the PhilippineVeterans Bank (Case SP-32311). Thereafter, the PhilippineVeterans Bank Employees Union-N.U.B.E. (PVBEU-NUBE),represented by Perfecto V. Fernandez, filed claims for accruedand unpaid employee wages and benefits with said court in SP-3231. After lengthy proceedings, partial payment of the sumsdue to the employees were made. However, due to the piecemealhearings on the benefits, many remain unpaid. On 8 March1991, petitioners moved to disqualify the Judge Benjamin Vega,Presiding Judge of Branch 39 of the Regional Trial Court ofManila, from hearing the above case on grounds of bias andhostility towards petitioners. On 2 January 1992, the Congressenacted Republic Act 7169 providing for the rehabilitation ofthe Philippine Veterans Bank. Thereafter, PVBEU-NUBE andFernandez filed with the labor tribunals their residual claims forbenefits and for reinstatement upon reopening of the bank.Republic Act 7169 entitled "An Act To Rehabilitate ThePhilippine Veterans Bank Created Under Republic Act 3518,Providing The Mechanisms Therefor, And For Other Purposes",which was signed into law by President Corazon C. Aquino on 2January 1992 and which was published in the Official Gazetteon 24 February 1992, provides in part for the reopening of thePhilippine Veterans Bank together with all its branches withinthe period of 3 years from the date of the reopening of the headoffice. The law likewise provides for the creation of arehabilitation committee in order to facilitate the implementationof the provisions of the same.

Pursuant to said RA 7169, the Rehabilitation Committeesubmitted the proposed Rehabilitation Plan of the PVB to theMonetary Board for its approval. Meanwhile, PVB filed aMotion to Terminate Liquidation of Philippine Veterans Bankdated 13 March 1992 with Judge Vega praying that theliquidation proceedings be immediately terminated in view ofthe passage of RA 7169. On 10 April 1992, the Monetary Board

issued Monetary Board Resolution 348 which approved the

Rehabilitation Plan submitted by the Rehabilitation Committee.Thereafter, the Monetary Board issued a Certificate of Authorityallowing PVB to reopen. Sometime in May 1992, the CentralBank issued a certificate of authority allowing the PVB toreopen. Despite the legislative mandate for rehabilitation andreopening of PVB, Judge Vega continued with the liquidationproceedings of the bank. Moreover, PVBEU-NUBE andFernandez learned that the Central Bank was set to order thepayment and release of employee benefits upon motion ofanother lawyer, while PVBEU-NUBE's and Fernandez's claimshave been frozen to their prejudice. On 3 June 1992, the liquidator filed A Motion for theTermination of the Liquidation Proceedings of the PhilippineVeterans Bank with Judge Vega. PVBEU-NUBE and Fernandez,on the other hand, filed the petition for Prohibition with Petitionfor Preliminary Injunction and application for Ex ParteTemporary Restraining Order. In a Resolution, dated 8 June1992, the Supreme Court resolved to issue a TemporaryRestraining Order enjoining the trial court from furtherproceeding with the case. On 22 June 1992, MOP Security &Detective Agency (VOPSDA) and its 162 security guards filed aMotion for Intervention with prayer that they be excluded fromthe operation of the Temporary Restraining Order issued by theCourt. On 3 August 1992, the Philippine Veterans Bank openedits doors to the public and started regular banking operations. Issue: Whether or not a liquidation court can continue withliquidation proceedings of the Philippine Veterans Bank (PVB)when Congress had mandated its rehabilitation and reopening. Ruling: Clearly, the enactment of Republic Act No. 7169, aswell as the subsequent developments has rendered theliquidation court functus officio. Consequently, respondentjudge has been stripped of the authority to issue orders involvingacts of liquidation. Liquidation, in corporation law, connotes awinding up or settling with creditors and debtors. It is thewinding up of a corporation so that assets are distributed tothose entitled to receive them. It is the process of reducing assetsto cash, discharging liabilities and dividing surplus or loss. Onthe opposite end of the spectrum is rehabilitation whichconnotes a reopening or reorganization. Rehabilitationcontemplates a continuance of corporate life and activities in aneffort to restore and reinstate the corporation to its former

position of successful operation and solvency. It is crystal clear

that the concept of liquidation is diametrically opposed orcontrary to the concept of rehabilitation, such that both cannotbe undertaken at the same time. To allow the liquidationproceedings to continue would seriously hinder therehabilitation of the subject bank.

FIRST DIVISION

[G.R. No. 146698. September 24, 2002]

PHILIPPINE AIRLINES, petitioner, vs. SPOUSES SADIC AND AISHAKURANGKING and SPOUSES ABDUL SAMAD T. DIANALAN ANDMORSHIDA L. DIANALAN, respondents.

D E C I S I O NVITUG, J.:

In April 1997, respondents, all Muslim Filipinos, returned to Manila from their pilgrimage to theHoly City of Mecca, Saudi Arabia, on board a Philippines Airlines (PAL) flight. Respondentsclaimed that they were unable to retrieve their checked-in luggages. On 05 January 1998,respondents filed a complaint with the Regional Trial Court (RTC) of Marawi City against PAL forbreach of contract resulting in damages due to negligence in the custody of the missing luggages.

On 02 March 1998, PAL filed its answer invoking, among its defenses, the limitations under theWarsaw Convention. On 19 June 1998, before the case could be heard on pre-trial, PAL, claimingto have suffered serious business losses due to the Asian economic crisis, followed by a massivestrike by its employees, filed a petition for the approval of a rehabilitation plan and the appointmentof a rehabilitation receiver before the Securities and Exchange Commission (SEC). On 23 June1998, the SEC issued an order granting the prayer for an appointment of a rehabilitation receiver,and it constituted a three-man panel to oversee PAL’s rehabilitation. On 25 September 1998, theSEC created a management committee conformably with Section 6(d) of Presidential Decree(“P.D.”) 902, as amended, declaring the suspension of all actions for money claims against PALpending before any court, tribunal, board or body. Thereupon, PAL moved for the suspension of theproceedings before the Marawi City RTC. On 11 January 1999, the trial court issued an orderdenying the motion for suspension of the proceedings on the ground that the claim of respondentswas only yet to be established. PAL’s motion for reconsideration was denied by the trial court.

PAL went to the Court of Appeals via a petition for certiorari. On 16 April 1999, the appellatecourt dismissed the petition for the failure of PAL to serve a copy of the petition on respondents.PAL moved for a reconsideration. In its resolution, dated 08 October 1999, the appellate courtdenied the motion but added that a second motion for reconsideration before the trial court couldstill be feasible inasmuch as the assailed orders of the trial court were merely interlocutory innature. Consonantly, PAL filed before the trial court a motion for leave to file a second motion forreconsideration. The trial court, however, denied leave of court to admit the second motion forreconsideration. Again, PAL filed a motion for reconsideration which sought reconsideration of thedenial of the prayed leave to file a second motion for reconsideration. In an order, dated 28December 2000, the trial court denied the motion.

On the thesis that there was no other plain, speedy and adequate remedy available to it, PALwent to this Court via a petition for review on certiorari under Rule 45 of the Rules of Court, raisingthe question of -

"Whether or not the proceedings before the trial court should have been suspended after the court wasinformed that a rehabilitation receiver was appointed over the petitioner by the Securities and ExchangeCommission under Section 6(c) of Presidential Decree No. 902-A.”[1]

In their comment to the petition, private respondents posited (a) that the instant petition underRule 45 would not lie, the assailed orders of the court a quo being merely interlocutory; (b) that PALwas already operational and thus claims and actions against it should no longer be suspended; (c)that the SEC, not the RTC, should have the prerogative to determine the necessity of suspendingthe proceedings; and (d) that the only claims or actions that could be suspended under P.D. 902-Awere those pending with the SEC.

While a petition for review on certiorari under Rule 45 would ordinarily be inappropriate toassail an interlocutory order, in the interest, however, of arresting the perpetuation of an apparenterror committed below that could only serve to unnecessarily burden the parties, the Court hasresolved to ignore the technical flaw and, also, to treat the petition, there being no other plain,speedy and adequate remedy, as a special civil action for certiorari. Not much, after all, can begained if the Court were to refrain from now making a pronouncement on an issue so basic as thatsubmitted by the parties.

On 15 December 2000, the Supreme Court, in A.M. No. 00-8-10-SC, adopted the InterimRules of Procedure on Corporate Rehabilitation and directed to be transferred from the SEC toRegional Trial Courts,[2] all petitions for rehabilitation filed by corporations, partnerships, andassociations under P.D. 902-A in accordance with the amendatory provisions of Republic Act No.8799. The rules require trial courts to issue, among other things, a stay order in the “enforcementof all claims, whether for money or otherwise, and whether such enforcement is by court action orotherwise,” against the corporation under rehabilitation, its guarantors and sureties not solidarilyliable with it. Specifically, Section 6, Rule 4, of the Interim Rules of Procedure On CorporateRehabilitation, provides:

“SEC. 6. Stay Order. - If the court finds the petition to be sufficient in form and substance, it shall, not laterthan five (5) days from the filing of the petition, issue an Order (a) appointing a Rehabilitation Receiver andfixing his bond; (b) staying enforcement of all claims, whether for money or otherwise and whether suchenforcement is by court action or otherwise, against the debtor, its guarantors and sureties not solidarilyliable with the debtor; (c) prohibiting the debtor from selling, encumbering, transferring, or disposing in anymanner any of its properties except in the ordinary course of business; (d) prohibiting the debtor frommaking any payment of its liabilities outstanding as at the date of filing of the petition; (e) prohibiting thedebtor’s suppliers of goods or services from withholding supply of goods and services in the ordinary courseof business for as long as the debtor makes payments for the services and goods supplied after the issuance ofthe stay order; (f) directing the payment in full of all administrative expenses incurred after the issuance ofthe stay order; (g) fixing the initial hearing on the petition not earlier than forty-five (45) days but not laterthan sixty (60) days from the filing thereof; (h) directing the petitioner to publish the Order in a newspaper ofgeneral circulation in the Philippines once a week for two (2) consecutive weeks; (I) directing all creditorsand all interested parties (including the Securities and Exchange Commission) to file and serve on the debtora verified comment on or opposition to the petition, with supporting affidavits and documents, not later thanten (10) days before the date of the initial hearing and putting them on notice that their failure to do so willbar them from participating in the proceedings; and (j) directing the creditors and interested parties to securefrom the court copies of the petition and its annexes within such time as to enable themselves to file theircomment on or opposition to the petition and to prepare for the initial hearing of the petition.”

The stay order is effective from the date of its issuance until the dismissal of the petition or thetermination of the rehabilitation proceedings.[3]

The interim rules must likewise be read and applied along with Section 6(c) of P.D. 902-A, asso amended, directing that upon the appointment of a management committee, rehabilitationreceiver, board or body pursuant to the decree, “all actions” for claims against the distressedcorporation “pending before any court, tribunal, board or body shall be suspended accordingly.”Paragraph (c) of Section 6 of the law reads:

“Section 6. In order to effectively exercise such jurisdiction, the Commission shall possess the followingpowers:

“xxx xxx xxx.

“c) To appoint one or more receivers of the property, real or personal, which is the subject of the actionpending before the Commission in accordance with the pertinent provisions of the Rules of Court in suchother cases whenever necessary in order to preserve the rights of the parties-litigants and/or protect theinterest of the investing public and creditors: x x x Provided, finally, That upon appointment of amanagement committee, the rehabilitation receiver, board or body, pursuant to this Decree, all actions forclaims against corporations, partnerships, or associations under management or receivership pending beforeany court, tribunal, board or body shall be suspended accordingly.”

A “claim” is said to be “a right to payment, whether or not It is reduced to judgment, liquidatedor unliquidated, fixed or contingent, matured or unmatured, disputed or undisputed, legal orequitable, and secured or unsecured.”[4] In Finasia Investments and Finance Corporation[5] thisCourt has defined the word “claim,” contemplated in Section 6(c) of P.D. 902-A, as referring todebts or demands of a pecuniary nature and the assertion of a right to have money paid as well.

Verily, the claim of private respondents against petitioner PAL is a money claim for the missingluggages, a financial demand, that the law requires to be suspended pending the rehabilitationproceedings.[6] In B.F. Homes, Inc. vs. Court of Appeals,[7] the Court has ratiocinated:

“x x x (T)he reason for suspending actions for claims against the corporation should not be difficult todiscover. it is not really to enable the management committee or the rehabilitation receiver to substitute thedefendant in any pending action against it before any court, tribunal, board or body. Obviously, the realjustification is to enable the management committee or rehabilitation receiver to effectively exercise its/hispowers free from any judicial or extra-judicial interference that might unduly hinder or prevent the ‘rescue’of the debtor company. To allow such other action to continue would only add to the burden of themanagement committee or rehabilitation receiver, whose time, effort and resources would be wasted indefending claims against the corporation instead of being directed toward its restructuring andrehabilitation.”[8]

WHEREFORE, the petition is GRANTED. The assailed orders of the Regional Trial Court,Branch 9, of Marawi City, are SET ASIDE. No costs.

SO ORDERED.

Davide, Jr., C.J., (Chairman), Ynares-Santiago, and Carpio, JJ., concur.

[1] Rollo, p. 12.

[2] SEC. 2. Applicability to Rehabilitation Cases Transferred from the Securities and Exchange Commission. - Cases forrehabilitation transferred from the Securities and Exchange Commission to the Regional Trial Courts pursuant to RepublicAct No. 8799, otherwise known as The Securities Regulation Code, shall likewise be governed by these Rules.

[3] SEC. 11. Period of the Stay Order. - The stay order shall be effective from the date of its issuance until the dismissal ofthe petition or the termination of the rehabilitation proceedings.

The petition shall be dismissed if no rehabilitation plan is approved by the court upon the lapse of one hundred eighty(180) days from date of the initial hearing. The court may grant an extension beyond this period only if it appears byconvincing and compelling evidence that the debtor may successfully be rehabilitated. In no Instance, however, shall theperiod for approving or disapproving a rehabilitation plan exceed eighteen (18) months from the date of filing of thepetition.

[4] Black’s Law Legal Dictionary, p. 224, 5th ed., as cited in the case of Finasia Investments and Finance Corp. vs. Courtof Appeals, 837 SCRA 446.

[5] 237 SCRA 446.

[6] Barotac Sugar Mills, Inc. vs. Court of Appeals, 275 SCRA 497; Rubberworld (Phils.) Inc. vs. NLRC, 305 SCRA 721,among others.

[7] 190 SCRA 262.

[8] At p. 269.

EN BANC

[G.R. No. 74851. December 9, 1999]

RIZAL COMMERCIAL BANKING CORPORATION, petitioner, vs.INTERMEDIATE APPELLATE COURT AND BF HOMES, INC., respondents.

R E S O L U T I O NMELO, J.:

On September 14, 1992, the Court passed upon the case at bar and rendered its decision, dismissing thepetition of Rizal Commercial Banking Corporation (RCBC), thereby affirming the decision of the Court ofAppeals which canceled the transfer certificate of title issued in favor of RCBC, and reinstating that ofrespondent BF Homes.

This will now resolve petitioner’s motion for reconsideration which, although filed in 1992 was notdeemed submitted for resolution until in late 1998. The delay was occasioned by exchange of pleadings, thesubmission of supplemental papers, withdrawal and change of lawyers, not to speak of the case having beenpassed from one departing to another retiring justice. It was not until May 3, 1999, when the case was re-raffled to herein ponente, but the record was given to him only sometime in the late October 1999.

By way of review, the pertinent facts as stated in our decision are reproduced herein, to wit:

On September 28, 1984, BF Homes filed a “Petition for Rehabilitation and for Declaration of Suspension ofPayments” (SEC Case No. 002693) with the Securities and Exchange Commission (SEC).

One of the creditors listed in its inventory of creditors and liabilities was RCBC.

On October 26, 1984, RCBC requested the Provincial Sheriff of Rizal to extra-judicially foreclose its realestate mortgage on some properties of BF Homes. A notice of extra-judicial foreclosure sale was issued bythe Sheriff on October 29, 1984, scheduled on November 29, 1984, copies furnished both BF Homes(mortgagor) and RCBC (mortgagee).

On motion of BF Homes, the SEC issued on November 28, 1984 in SEC Case No. 002693 a temporaryrestraining order (TRO), effective for 20 days, enjoining RCBC and the sheriff from proceeding with thepublic auction sale. The sale was rescheduled to January 29, 1985.

On January 25, 1985, the SEC ordered the issuance of a writ of preliminary injunction upon petitioner’sfiling of a bond. However, petitioner did not file a bond until January 29, 1985, the very day of the auctionsale, so no writ of preliminary injunction was issued by the SEC. Presumably, unaware of the filing of thebond, the sheriffs proceeded with the public auction sale on January 29, 1985, in which RCBC was thehighest bidder for the properties auctioned.

On February 5, 1985, BF Homes filed in the SEC a consolidated motion to annul the auction sale and to citeRCBC and the sheriff for contempt. RCBC opposed the motion.

Because of the proceedings in the SEC, the sheriff withheld the delivery to RCBC of a certificate of salecovering the auctioned properties.

On February 13, 1985, the SEC in Case No. 002693 belatedly issued a writ of preliminary injunctionstopping the auction sale which had been conducted by the sheriff two weeks earlier.

On March 13, 1985, despite SEC Case No. 002693, RCBC filed with the Regional Trial Court, Br. 140, Rizal(CC 10042) an action for mandamus against the provincial sheriff of Rizal and his deputy to compel them toexecute in its favor a certificate of sale of the auctioned properties.

In answer, the sheriffs alleged that they proceeded with the auction sale on January 29, 1985 because no writof preliminary injunction had been issued by SEC as of that date, but they informed the SEC that they wouldsuspend the issuance of a certificate of sale to RCBC.

On March 18, 1985, the SEC appointed a Management Committee for BF Homes.

On RCBC’s motion in the mandamus case, the trial court issued on May 8, 1985 a judgment on thepleadings, the dispositive portion of which states:

“WHEREFORE, petitioner’s ‘Motion for Judgment on the pleadings is granted and judgement is herebyrendered ordering respondents to execute and deliver to petitioner the Certificate of the Auction Sale ofJanuary 29, 1985, involving the properties sold therein, more particularly those described in Annex ‘C’ oftheir Answer.” (p. 87, Rollo.)

On June 4, 1985, B.F. Homes filed an original complaint with the IAC pursuant to Section 9 of B.P. 129praying for the annulment of the judgment, premised on the following:

“x x x: (1) even before RCBC asked the sheriff to extra-judicially foreclose its mortgage on petitioner’sproperties, the SEC had already assumed exclusive jurisdiction over those assets, and (2) that there wasextrinsic fraud in procuring the judgment because the petitioner was not impleaded as a party in themandamus case, respondent court did not acquire jurisdiction over it, and it was deprived of its right to beheard.” (CA Decision, p. 88, Rollo).

On April 8, 1986, the IAC rendered a decision, setting aside the decision of the trial court, dismissing themandamus case and suspending issuance to RCBC of new land titles, “until the resolution of case by SEC inCase No. 002693,” disposing as follows:

WHEREFORE, the judgment dated May 8, 1985 in Civil Case No. 10042 is hereby annulled and set asideand the case is hereby dismissed. In view of the admission of respondent Rizal Commercial BankingCorporation that the sheriff’s certificate of sale has been registered on BF Homes’ TCT’s . . . (here the TCTswere enumerated) the Register of Deeds for Pasay City is hereby ordered to suspend the issuance to themortgagee-purchaser, Rizal Commercial Banking Corporation, of the owner’s copies of the new land titlesreplacing them until the matter shall have been resolved by the Securities and Exchange Commission in SECCase No. 002693.”

(p. 257-260, Rollo; also pp. 832-834, 213 SCRA 830[1992]; Emphasis in the original.)

On June 18, 1986, RCBC appealed the decision of the then Intermediate Appellate Court (now, back toits old revered name, the Court of Appeals) to this Court, arguing that:

1. Petitioner did not commit extrinsic fraud in excluding private respondent as party defendant in SpecialCivil Case No. 10042 as private respondent was not indispensable party thereto, its participation not beingnecessary for the full resolution of the issues raised in said case.

2. SEC Case No. 2693 cannot be invoked to suspend Special Civil Case No. 10042, and for that matter, theextra-judicial foreclosure of the real estate mortgage in petitioner’s favor, as these do not constitute actionsagainst private respondent contemplated under Section 6(c) of Presidential Decree No. 902-A.

3. Even assuming arguendo that the extra-judicial sale constitute an action that may be suspended underSection 6(c) of Presidential Decree No. 902-A, the basis for the suspension thereof did not exist so as toadversely affect the validity and regularity thereof.

4. The Regional Trial court had jurisdiction to take cognizance of Special Civil Case No. 10042.

5. The Regional Trial court had jurisdiction over Special Civil Case No. 10042.”

(p. 5, Rollo.)

On November 12, 1986, the Court gave due course to the petition. During the pendency of the case,RCBC brought to the attention of the Court an order issued by the SEC on October 16, 1986 in CaseNo.002693, denying the consolidated Motion to Annul the Auction Sale and to cite RCBC and the Sheriff forContempt, and ruling as follows:

WHEREFORE, the petitioner’s “Consolidated Motion to Cite Sheriff and Rizal Commercial BankingCorporation for Contempt and to Annul Proceedings and Sale,” dated February 5, 1985, should be as is,hereby DENIED.

While we cannot direct the Register of Deeds to allow the consolidation of the titles subject of the OmnibusMotion dated September 18, 1986 filed by the Rizal Commercial banking Corporation, and therefore, deniessaid Motion, neither can this Commission restrain the said bank and the Register of Deeds from effecting thesaid consolidation.

SO ORDERED.

(p. 143, Rollo.)

By virtue of the aforesaid order, the Register of Deeds of Pasay City effected the transfer of title oversubject pieces of property to petitioner RCBC, and the issuance of new titles in its name. Thereafter, RCBCpresented a motion for the dismissal of the petition, theorizing that the issuance of said new transfercertificates of title in its name rendered the petition moot and academic.

In the decision sought to be reconsidered, a greatly divided Court (Justices Gutierrez, Nocon, and Meloconcurred with the ponente, Justice Medialdea; Chief Justice Narvasa, Justices Bidin, Regalado, andBellosillo concurred only in the result; while Justice Feliciano dissented and was joined by Justice Padilla,then Justice, now Chief Justice Davide, and Justice Romero; Justices Griño-Aquino and Campos took nopart) denied petitioner’s motion to dismiss, finding basis for nullifying and setting aside the TCTs in thename of RCBC. Ruling on the merits, the Court upheld the decision of the Intermediate Appellate Courtwhich dismissed the mandamus case filed by RCBC and suspended the issuance of new titles to RCBC. Setting aside RCBC’s acquisition of title and nullifying the TCTs issued to it, the Court held that:

. . . whenever a distressed corporation asks the SEC for rehabilitation and suspension of payments, preferredcreditors may no longer assert such preference, but . . . stand on equal footing with other creditors.Foreclosure shall be disallowed so as not to prejudice other creditors, or cause discrimination among them. If foreclosure is undertaken despite the fact that a petition for rehabilitation has been filed, the certificate ofsale shall not be delivered pending rehabilitation. Likewise, if this has also been done, no transfer of titleshall be effected also, within the period of rehabilitation. The rationale behind PD 902-A, as amended, is toeffect a feasible and viable rehabilitation. This cannot be achieved if one creditor is preferred over theothers.

In this connection, the prohibition against foreclosure attaches as soon as a petition for rehabilitation is filed. Were it otherwise, what is to prevent the petitioner from delaying the creation of a Management Committeeand in the meantime dissipate all its assets. The sooner the SEC takes over and imposes a freeze on all theassets, the better for all concerned.

(pp. 265-266, Rollo; also p. 838, 213 SCRA 830[1992].)

Then Justice Feliciano (joined by three other Justices), dissented and voted to grant the petition. Heopined that the SEC acted prematurely and without jurisdiction or legal authority in enjoining RCBC and thesheriff from proceeding with the public auction sale. The dissent maintain that Section 6 (c) of PresidentialDecree 902-A is clear and unequivocal that, claims against the corporations, partnerships, or associationsshall be suspended only upon the appointment of a management committee, rehabilitation receiver, board orbody. Thus, in the case under consideration, only upon the appointment of the Management Committee forBF Homes on March 18, 1985, should the suspension of actions for claims against BF Homes have takeneffect and not earlier.

In support of its motion for reconsideration, RCBC contends:

The restraining order and the writ of preliminary injunction issued by the Securities and ExchangeCommission enjoining the foreclosure sale of the properties of respondent BF Homes were issued without orin excess of its jurisdiction because it was violative of the clear provision of Presidential Decree No. 902-A,and are therefore null and void; and

Petitioner, being a mortgage creditor, is entitled to rely solely on its security and to refrain from joining theunsecured creditors in SEC Case No. 002693, the petition for rehabilitation filed by private respondent.

We find the motion for reconsideration meritorious.

The issue of whether or not preferred creditors of distressed corporations stand on equal footing with allother creditors gains relevance and materiality only upon the appointment of a management committee,rehabilitation receiver, board, or body. Insofar as petitioner RCBC is concerned, the provisions ofPresidential Decree No. 902-A are not yet applicable and it may still be allowed to assert its preferred statusbecause it foreclosed on the mortgage prior to the appointment of the management committee on March 18,1985. The Court, therefore, grants the motion for reconsideration on this score.

The law on the matter, Paragraph (c), Section 6 of Presidential Decree 902-A, provides:

Sec. 6. In order to effectively exercise such jurisdiction, the Commission shall possess the following powers:

c) To appoint one or more receivers of the property, real and personal, which is the subject of the actionpending before the Commission in accordance with the pertinent provisions of the Rules of Court in suchother cases whenever necessary to preserve the rights of the parties-litigants to and/or protect the interest ofthe investing public and creditors; Provided, however, that the Commission may, in appropriate cases,appoint a rehabilitation receiver of corporations, partnerships or other associations not supervised orregulated by other government agencies who shall have, in addition to the powers of a regular receiver underthe provisions of the Rules of Court, such functions and powers as are provided for in the succeedingparagraph (d) hereof: Provided, finally, That upon appointment of a management committee, rehabilitationreceiver, board or body, pursuant to this Decree, all actions for claims against corporations, partnerships orassociations under management or receivership pending before any court, tribunal, board or body shall besuspended accordingly. (As amended by PDs No. 1673, 1758 and by PD No. 1799. Emphasis supplied.)

It is thus adequately clear that suspension of claims against a corporation under rehabilitation is countedor figured up only upon the appointment of a management committee or a rehabilitation receiver. Theholding that suspension of actions for claims against a corporation under rehabilitation takes effect as soon asthe application or a petition for rehabilitation is filed with the SEC – may, to some, be more logical and wisebut unfortunately, such is incongruent with the clear language of the law. To insist on such ruling, no matterhow practical and noble, would be to encroach upon legislative prerogative to define the wisdom of the law–plainly judicial legislation.

It bears stressing that the first and fundamental duty of the Court is to apply the law. When the law isclear and free from any doubt or ambiguity, there is no room for construction or interpretation. As has beenour consistent ruling, where the law speaks in clear and categorical language, there is no occasion forinterpretation; there is only room for application (Cebu Portland Cement Co. vs. Municipality of Naga, 24SCRA 708 [1968]).

Where the law is clear and unambiguous, it must be taken to mean exactly what it says and the court has nochoice but to see to it that its mandate is obeyed (Chartered Bank Employees Association vs. Ople, 138SCRA 273 [1985]; Luzon Surety Co., Inc. vs. De Garcia, 30 SCRA 111 [1969]; Quijano vs. DevelopmentBank of the Philippines, 35 SCRA 270 [1970]).

Only when the law is ambiguous or of doubtful meaning may the court interpret or construe its trueintent. Ambiguity is a condition of admitting two or more meanings, of being understood in more than oneway, or of referring to two or more things at the same time. A statute is ambiguous if it is admissible of twoor more possible meanings, in which case, the Court is called upon to exercise one of its judicial functions,which is to interpret the law according to its true intent.

Furthermore, as relevantly pointed out in the dissenting opinion, a petition for rehabilitation does notalways result in the appointment of a receiver or the creation of a management committee. The SEC has toinitially determine whether such appointment is appropriate and necessary under the circumstances. UnderParagraph (d), Section 6 of Presidential Decree No. 902-A, certain situations must be shown to exist before amanagement committee may be created or appointed, such as;

1. when there is imminent danger of dissipation, loss, wastage or destruction of assets or other properties;or

2. when there is paralization of business operations of such corporations or entities which may beprejudicial to the interest of minority stockholders, parties-litigants or to the general public.

On the other hand, receivers may be appointed whenever:

1. necessary in order to preserve the rights of the parties-litigants; and/or

2. protect the interest of the investing public and creditors. (Section 6 (c), P.D. 902-A.)

These situations are rather serious in nature, requiring the appointment of a management committee or areceiver to preserve the existing assets and property of the corporation in order to protect the interests of itsinvestors and creditors. Thus, in such situations, suspension of actions for claims against a corporation asprovided in Paragraph (c) of Section 6, of Presidential Decree No. 902-A is necessary, and here we borrowthe words of the late Justice Medialdea, “so as not to render the SEC management Committee irrelevant andinutile and to give it unhampered ‘rescue efforts’ over the distressed firm” (Rollo, p. 265).

Otherwise, when such circumstances are not obtaining or when the SEC finds no such imminent dangerof losing the corporate assets, a management committee or rehabilitation receiver need not be appointed andsuspension of actions for claims may not be ordered by the SEC. When the SEC does not deem it necessaryto appoint a receiver or to create a management committee, it may be assumed, that there are sufficient assetsto sustain the rehabilitation plan and, that the creditors and investors are amply protected.

Petitioner additionally argues in its motion for reconsideration that, being a mortgage creditor, it isentitled to rely on its security and that it need not join the unsecured creditors in filing their claims before theSEC-appointed receiver. To support its position, petitioner cites the Court’s ruling in the case of PhilippineCommercial International Bank vs. Court of Appeals, (172 SCRA 436 [1989]) that an order of suspension ofpayments as well as actions for claims applies only to claims of unsecured creditors and cannot extend tocreditors holding a mortgage, pledge, or any lien on the property.

Ordinarily, the Court would refrain from discussing additional matters such as that presented in RCBC’ssecond ground, and would rather limit itself only to the relevant issues by which the controversy may besettled with finality.

In view, however, of the significance of such issue, and the conflicting decisions of this Court on thematter, coupled with the fact that our decision of September 14, 1992, if not clarified, might mislead theBench and the Bar, the Court resolved to discuss further.

It may be recalled that in the herein en banc majority opinion (pp. 256-275, Rollo, also published asRCBC vs. IAC, 213 SCRA 830 [1992]), we held that:

. . . whenever a distressed corporation asks the SEC for rehabilitation and suspension of payments, preferredcreditors may no longer assert such preference, but . . . stand on equal footing with other creditors.Foreclosure shall be disallowed so as not to prejudice other creditors, or cause discrimination among them. If foreclosure is undertaken despite the fact that a petition for rehabilitation has been filed, the certificate ofsale shall not be delivered pending rehabilitation. Likewise, if this has also been done, no transfer of title

shall be effected also, within the period of rehabilitation. The rationale behind PD 902-A, as amended, is toeffect a feasible and viable rehabilitation. This cannot be achieved if one creditor is preferred over theothers.

In this connection, the prohibition against foreclosure attaches as soon as a petition for rehabilitation isfiled. Were it otherwise, what is to prevent the petitioner from delaying the creation of a ManagementCommittee and in the meantime dissipate all its assets. The sooner the SEC takes over and imposes a freezeon all the assets, the better for all concerned.

(pp. 265-266, Rollo; also p. 838, 213 SCRA 830[1992]. Emphasis supplied.)

The foregoing majority opinion relied upon BF Homes, Inc. vs. Court of Appeals (190 SCRA 262 [1990]– per Cruz, J.: First Division) where it was held that “when a corporation threatened by bankruptcy is takenover by a receiver, all the creditors should stand on an equal footing. Not anyone of them should be givenpreference by paying one or some of them ahead of the others. This is precisely the reason for thesuspension of all pending claims against the corporation under receivership. Instead of creditors vexing thecourts with suits against the distressed firm, they are directed to file their claims with the receiver who is a

duly appointed officer of the SEC” (pp. 269-270; emphasis in the original). This ruling is a reiteration ofAlemar’s Sibal & Sons, Inc. vs. Hon. Jesus M. Elbinias (pp. 99-100;186 SCRA 94 [1990] – per Fernan, C.J.:Third Division).

Taking the lead from Alemar’s Sibal & Sons, the Court also applied this same ruling in Araneta vs. Courtof Appeals (211 SCRA 390 [1992] – per Nocon, J.: Second Division).

All the foregoing cases departed from the ruling of the Court in the much earlier case of PCIB vs. Courtof Appeals (172 SCRA 436 [1989] – per Medialdea, J.: First Division) where the Court categorically ruledthat:

SEC’s order for suspension of payments of Philfinance as well as for all actions of claims against Philfinancecould only be applied to claims of unsecured creditors. Such order can not extend to creditors holding amortgage, pledge or any lien on the property unless they give up the property, security or lien in favor of allthe creditors of Philfinance. . .

(p. 440. Emphasis supplied)

Thus, in BPI vs. Court of Appeals (229 SCRA 223 [1994] – per Bellosillo, J.: First Division) the Courtexplicitly stated that “. . . the doctrine in the PCIB Case has since been abrogated. In Alemar’s Sibal & Sonsv. Elbinias, BF Homes, Inc. v. Court of Appeals, Araneta v. Court of Appeals and RCBC v. Court of Appeals,we already ruled that whenever a distressed corporation asks SEC for rehabilitation and suspension ofpayments, preferred creditors may no longer assert such preference, but shall stand on equal footing withother creditors. . .” (pp. 227-228).

It may be stressed, however, that of all the cases cited by Justice Bellosillo in BPI, which abandoned theCourt’s ruling in PCIB, only the present case satisfies the constitutional requirement that “no doctrine orprinciple of law laid down by the court in a decision rendered en banc or in division may be modified orreversed except by the court sitting en banc” (Sec 4, Article VIII, 1987 Constitution). The rest were divisiondecisions.

It behooves the Court, therefore, to settle the issue in this present resolution once and for all, and for theguidance of the Bench and the Bar, the following rules of thumb shall are laid down:

1. All claims against corporations, partnerships, or associations that are pending before any court,tribunal, or board, without distinction as to whether or not a creditor is secured or unsecured, shall besuspended effective upon the appointment of a management committee, rehabilitation receiver, board, orbody in accordance with the provisions of Presidential Decree No. 902-A.

2. Secured creditors retain their preference over unsecured creditors, but enforcement of such preferenceis equally suspended upon the appointment of a management committee, rehabilitation receiver, board, orbody. In the event that the assets of the corporation, partnership, or association are finally liquidated,however, secured and preferred credits under the applicable provisions of the Civil Code will definitely havepreference over unsecured ones.

In other words, once a management committee, rehabilitation receiver, board or body is appointedpursuant to P.D. 902-A, all actions for claims against a distressed corporation pending before any court,tribunal, board or body shall be suspended accordingly.

This suspension shall not prejudice or render ineffective the status of a secured creditor as compared to atotally unsecured creditor. P.D. 902-A does not state anything to this effect. What it merely provides is thatall actions for claims against the corporation, partnership or association shall be suspended. This should

give the receiver a chance to rehabilitate the corporation if there should still be a possibility for doing so. (This will be in consonance with Alemar’s, BF Homes, Araneta, and RCBC insofar as enforcing liens bypreferred creditors are concerned.)

However, in the event that rehabilitation is no longer feasible and claims against the distressedcorporation would eventually have to be settled, the secured creditors shall enjoy preference over theunsecured creditors (still maintaining PCIB ruling), subject only to the provisions of the Civil Code onConcurrence and Preferences of Credit (our ruling in State Investment House, Inc. vs. Court of Appeals, 277SCRA 209 [1997]).

The majority ruling in our 1992 decision that preferred creditors of distressed corporations shall, in away, stand on equal footing with all other creditors, must be read and understood in the light of the foregoingrulings. All claims of both a secured or unsecured creditor, without distinction on this score, are suspendedonce a management committee is appointed. Secured creditors, in the meantime, shall not be allowed toassert such preference before the Securities and Exchange Commission. It may be stressed, however, that

this shall only take effect upon the appointment of a management committee, rehabilitation receiver, board,or body, as opined in the dissent.

In fine, the Court grants the motion for reconsideration for the cogent reason that suspension of actionsfor claims commences only from the time a management committee or receiver is appointed by the SEC. Petitioner RCBC, therefore, could have rightfully, as it did, move for the extrajudicial foreclosure of itsmortgage on October 26, 1984 because a management committee was not appointed by the SEC until March18, 1985.

WHEREFORE, petitioner’s motion for reconsideration is hereby GRANTED. The decision datedSeptember 14, 1992 is vacated, the decision of Intermediate Appellate Court in AC-G.R. No. SP-06313REVERSED and SET ASIDE, and the judgment of the Regional Trial Court National Capital JudicialRegion, Branch 140, in Civil Case No. 10042 REINSTATED.

SO ORDERED.

Davide, Jr., C.J., Bellosillo, Puno, Vitug, Kapunan, Mendoza, Quisumbing, Pardo, Buena, Gonzaga-Reyes, Ynares-Santiago, and De Leon, Jr., JJ., concur.

Panganiban, J., see separate opinion.Purisima, J., no part.

Rizal  Commercial  Banking  Corpora2on  vs.  Intermediate  Appellate  Court and BF Homes

G.R. No. 74851 (December 9, 1999)

Facts:

Petitioner RCBC is a mortgagor-creditor of the party respondent BF Homes. BF Homes, beinga distressed firm, filed before the Securities and Exchange Commission a Petition forRehabilitation and for Declaration of Suspension of Payments. Consequently, RCBC requestedthe sheriff of Rizal to levy on execution the properties of party respondent, and consequentlyobtained favorable judgment. RCBC being the highest bidder during the public auction is nowseeking for the transfer certificate of titles from the Register of Deeds issued in its name. It isworthy to note that it was on October 26, 1984 that RCBC obtained favor over the execution ofthe respondent’s properties, and it was only on March 18, 1985 that a Management Committeewas organized by the SEC for BF Homes.

Issue:

Whether or not the Court may depart from the words of the law which clearly provides that acreditor may levy execution on a firm’s properties when such execution precedes SEC’sorganization of a Management Committee to act as its receiver.

Held:

PD 209-A states that suspension of claims against a corporation under rehabilitation is countedor figured up only upon the appointment of a management committee or a rehabilitationreceiver. The holding that suspension of actions for claims against a corporation underrehabilitation takes effect as soon as the application or a petition for rehabilitation is filed withthe SEC — may, to some, be more logical and wise but unfortunately, such is incongruent withthe clear language of the law. Suspension of actions for claims commences only from the timea management committee or receiver is appointed by the SEC. Petitioner RCBC rightfullymoved for the extrajudicial foreclosure of its mortgage on October 26, 1984 because amanagement committee was not appointed by the SEC until March 18, 1985.

Reasoning:

No matter how practical and noble a reason would be, in order to depart from the words of thelaw stated in clear and unambiguous manner, would be to encroach upon legislativeprerogative to define the wisdom of the law. Such is plainly judicial legislation.

Policy:

Paragraph C Section 6 of PD 209-A states that upon appointment of a management committeerehabilitation receiver, board or body, pursuant to this Decree, all actions for claims againstcorporations, partnerships or associations under management or receivership, pending beforeany court, tribunal, board or body shall be suspended accordingly.

Mei

Notes:

Mei

Dissolution