Power to acquire own

shares.

Section 41 expressly authorizes a stock corporation

to purchase or acquire its own shares subject to the
limitation that the acquisition is for a legitimate
corporate purpose or purposes and that there is
unrestricted retained earnings (see Sec. 43.) in its
books to cover the shares acquired.
(1) Elimination of fractional shares. A fractional
share is a share which is less than one (1) share.
Thus, if a stockholder own 250 shares and the
corporation declares 25% stock dividend, his total
shares will be 312 and 1/2 shares. Inasmuch as
fractional shares cannot be represented at corporate
meetings (No. 1.), the corporation may purchase the
same from the stockholders concerned or issue
fractional scrip certificates to such stockholders who
may negotiate for the sale thereof with other
stockholders also owning fractional shares so as to
convert them into full shares.
(2) Satisfaction of indebtedness to corporation. No.
2 of Section 41 does not authorize a corporation to
arbitrarily purchase the shares it issued to any of its
stockholders indebted to it, whether at the prevailing
market price or at par value for the purpose of
applying the proceeds thereof to the satisfaction of
its claim against them, and this is particularly true
where the consent of such stockholders has not been
secured. And even where their consent has been
secured, the corporation can buy their shares only if
the conditions for the purchase (infra.) are present.
(see SEC Opinion, Aug. 11, 1961.)
(3) Payment of shares of dissenting or withdrawing
stockholders. No. 3 of Section 41 refers to
instances when a dissenting stockholder is given
appraisal right (see Sec. 81.) and the right to
withdraw from the corporation as provided in Section
16 (Amendment of articles of incorporation), Section
37 (Power to extend or shorten corporate term),
Section 40 (Sale or other disposition of assets),
Section 42 (Power to invest corporate funds in
another corporation or business or for any other
purpose), Section 68 (Delinquency sale), Section 77
(Stockholders or members approval of plan of
merger or consolidation), and Section 105
(Withdrawal of stockholder or dissolution of [close]
corporation).
(4) Other cases. This power of the corporation to
acquire its own shares is not limited to the cases
enumerated in Section 41. Thus, it may also be
exercised under Section 9 (treasury shares). With
respect to redeemable shares, they may be
purchased by the corporation regardless of the
existence of unrestricted retained earnings in the
books of the corporation. (see Sec. 8.)
Conditions for the exercise of the power.

Briefly, a corporations right to purchase its shares

according to the weight of authority is subject to the
following limitations:
(1) That its capital is not thereby impaired;
(2) That it be for a legitimate and proper corporate
purpose;
(3) That there shall be unrestricted retained earnings
to purchase the same and its capital is not thereby
impaired;
(4) That the corporation acts in good faith and
without prejudice to the rights of creditors and
stockholders; and
(5) That the conditions of corporate affairs warrant it.
(SEC Opinion, Feb. 27, 1976.)
Sec. 41339

Trust fund doctrine.

Thus, if the aforementioned conditions are obtained,

a corporation may acquire the shares of alien
stockholders to comply with constitutional or legal
requirements prescribing the minimum percentage of
capital stock ownership of Filipino citizens in certain
corporations. (Ibid., see Sec. 12.)
This doctrine holds that the assets of the corporation
as represented by its capital stock are trust funds
to be maintained unimpaired and to be used to pay
corporate creditors in the sense that there can be no
distribution of such assets among the stockholders
without provision being first made for the payment of
corporate debts and that any such disposition of it is
a fraud on the creditors of the corporation and,
therefore, void.
(1) Corporation generally without power to purchase
its own shares. A corporation has no general
power to purchase its own shares of stock. This rule
is dictated by the necessity of protecting the
interests of existing creditors who might be adversely
affected by the stock purchase which, in effect, may
operate to reduce its capital stock to the extent of
the shares purchased without complying with the
formalities required by Section 38. The foregoing is in
consonance with the doctrine.
(2) Repayment to stockholders, a fraud on corporate
creditors. The purchase, in effect, constitutes a
fraud on corporate creditors as it amounts to
repayment to the stockholder of his proportionate
share from the corporate assets and hence, an
impairment of the capital available for the benefit
and protection of creditors who are preferred over
the stockholders in the distribution of corporate
assets. (see Sec. 122, last par.)
Note that under the doctrine, the corporation is not
prohibited to use its assets for purposes of its
business.

Power to invest funds

in other corporations
or for other purposes.

Power to declare
dividends.

By virtue of the provisions of Section 42, a

corporation may be organized with multiple lawful
purposes so long as the primary purpose is indicated
in the articles of incorporation. However, the
investment of its funds (includes any of its corporate
property) is limited to the primary purpose. In order
that it may invest its funds in any other corporation
or business or for any purpose other than the
primary purpose, compliance with the requirements
of Section 42 is necessary (see De la Rosa vs. MaoSugar Central Co., Inc., 27 SCRA 247.) and, of course,
subject to the prohibition against certain corporations
from having more than one purpose.
But a corporation may invest its funds in another
business which is incident or auxiliary to its primary
purpose as stated in its articles of incorporation
without the approval of the stockholders or members
as required under Section 42. In such case, a
dissenting stockholder shall have no appraisal right.
Sec. 42341
The board of directors of a stock corporation has the
power to declare dividends out of the unrestricted
retained earnings which shall be payable in cash, in
property, or in stock to all stockholders on the basis
of outstanding stock held by them.
(1) Stock dividends. In case of stock dividend, it
shall not be issued without the approval of
stockholders representing at least 2/3 of the capital
stock then outstanding at a regular meeting of the
corporation or at a special meeting duly called for the
purpose.
(2) Other dividends. A mere majority of
the quorum of the board of directors is sufficient to
declare other dividends. The board may declare
dividends other than stock without need of
stockholders approval. (Sec. 43)
The dividend is paid to the registered owner of stocks
as of a record date usually a date different from the
date of declaration. It is stated either at a given
percent or a fixed amount for each share. The record
date determines the time when the stockholders of
record shall be ascertained.
Concept of dividends.
A dividend is that part or portion of the profits of a
corporation set aside, declared and ordered by the
directors to be paid ratably to the stockholders on
demand or at a fixed time.
It is a payment to the stockholders of a corporation
as a return upon their investment. It is a
characteristic of a dividend that all stockholders of
the same class share in it in proportion to the

Classes of dividends.

respective amounts of stock which they hold. (13 Am.

Jur. 637-639.)
Dividends that may be declared by a corporation
may be classified as follows:
(1) Cash dividend or dividend payable in cash.
(a) Dividends on par value shares are made at a
stated percentage (e.g., 10%) of the par value
although they may also be paid as a fixed amount
per share.
(b) As to no par value shares, dividends are payable
in terms of so many pesos or centavos (e.g., P10.00,
P0.05) per share since there is no basis on which a
percentage can be stated.
(c) Dividends are usually paid in money;
(2) Property dividend or dividend distributed to the
stock-holders in the form of property, real or
personal, such as warehouse receipts, or shares of
stock of another corporation.
(a) A dividend payable in property is actually a cash
dividend. The stockholder can take the property, sell
it and realize the cash.
(b) A corporation may, therefore, pay declared cash
dividend in the form of a property provided the
distribution of the same is practicable, specifically
where the surplus is in that form (property) and is no
longer intended to be used in the operation of the
business;
(c) The property must form part of the surplus or
retained earnings of the corporation, otherwise it
cannot be declared as property dividends;
(3) Stock dividend or dividend payable on unissued
or increased or additional shares of the corporation
instead of in cash or in property.
(a) By this alternative to declaring dividends, the
corporation can retain earnings. The declaration
involves the issuance of new shares to be
distributed pro rata to the stockholders;
(b) A stock dividend may be declared to the extent of
the maximum number of shares authorized in the
articles of incorporation.
(4) Optional dividend or dividend which gives the
stockholder an option to receive cash or stock
dividend;
(5) Composite dividend or dividend which is partly in
cash and partly in stocks. Here, there is no option
involved;
(6) Scrip dividend or a writing or certificate issued to
a stockholder entitling him to the payment of money
or the like at some future time inasmuch as the
corporation at the time such dividends are declared
has profits not in cash, or has no sufficient cash, or
has the cash but wishes to reserve it for some
corporate purposes. It is in the form of a promissory
note or promise to pay and may be issued to bear
interest;

(7) Bond dividend or dividend distributed in bonds of

the corporation to the stockholders;
(8) Preferred dividend or dividend payable to one
class of stockholders in priority to be paid to another
class.
(9) Cumulative dividend or dividend payable at a
certain rate at statedtimes and if the stipulated
dividend is not paid in any dividend period, the
dividend in arrears must also be paid the following
period.
(10) Liquidating dividends which are actually
distributions of the assets of the corporation upon
dissolution or winding up of the same.
Dividends may also be participating or nonparticipating. (see Sec. 6.)
Dividends distinguished from profits
or earnings.
(1) A dividend, as applied to corporate stock, is that
portion of the profit or net earnings which the
corporation has set aside for ratable distribution
among the stockholders. Thus, dividends come from
profits, while profits are a source of dividends.

Dividends payable out

of unrestricted
retained earnings.

(2) Profits are not dividends until so declared or set

aside by the corporation. In the meantime, all profits
are a part of the assets of the corporation and do not
belong to the stockholders individually. (Ibid., 640.)
Under the law, dividends other than liquidating
dividends (which are not really dividends as they are
from capital) may be declared and paid out of the
unrestricted retained earnings of the
corporation. (Ibid.) A corporation cannot make a valid
contract to pay dividends other than from retained
earnings or profits and an agreement to pay such
dividends out of capital is unlawful and void.
The power of a corporation to acquire its own shares
is likewise subject to the condition that there be
unrestricted retained earnings in its books to cover
the shares to be purchased. (Sec. 41.)
Note: The Code, in Section 43, adopting the change
made in accounting terminology, substituted the
phrase unrestricted retained earnings, which may
be considered a more precise term, in place of
surplus profits arising from its business, in the
former law. However, the Code still speaks of
surplus profits in the second paragraph of Section
43 in fixing the maximum earnings which may be
retained by a corporation and in Section 3 in defining
stock corporations.
The Code deleted the phrase arising from its
business. It may be argued that the term

Unrestricted retained
earnings explained.

unrestricted retained earnings, as used in the

Code, refers to all the excess of assets of the
corporation over its liabilities including legal or stated
capital. Hence, it is not limited to accumulated net
profits of the corporation arising from its business
but may comprehend also other gains such as those
derived from the sale of fixed assets. But it does not
include the unrealized increase in value of fixed
assets. (infra.)
(1) The retained earnings of a corporation is the
difference between the total present value of its
assets after deducting losses and liabilities and the
amount of its capital stock. (see 11 Fletcher 1041.)
Capital stock, in this instance, should be understood
to refer to outstanding stock (see Sec. 137.) and not
the stated or nominal (authorized) capital stock.
Stated otherwise, the ordinary way of determining
whether a corporation has retained earnings or not is
to compute the value of all its assets and deduct
therefrom all of its liabilities including legal capital,
and thus ascertain whether the balance exceeds the
amount of its outstanding shares of capital stock.
This may be expressed in the following formula:
Retained earnings = Assets - (liabilities and capital)

Power to enter into

management contract.

The difference between the total assets and liabilities

of a corporation represents its net worth or net
assets or the stockholders equity consisting of the
capital invested and the retained earnings. Thus, the
retained earnings will be thebalance of the net worth
or net assets after deducting the value of the
corporations outstanding capital stock. They refer to
the accumulated undistributed earnings or profits
realized by a corporation arising from the transaction
of its business and the management of its affairs, out
of current and prior years.
Under Section 44, a corporation is expressly allowed
to enter into a management contract with another
corporation, which refers to any contract whereby a
corporation undertakes to manage or operate all or
substantially all of the business of another
corporation, whether such contracts are called
service contracts, operating agreements or
otherwise.
The following are the limitations for the exercise of
the power:
(1) The contract must be approved by a majority of
the quorum of the board of directors or trustees and
ratified by the prescribed vote of the stockholders or
members, as the case may be, of both the managing
and the managed corporations, at a meeting duly

called for the purpose; and

(2) The period of the contract must not be longer
than five (5) years for any one term except that
contracts which relate to the exploration,
development, exploitation or utilization of natural
resources may be entered into for such periods as
may be provided by pertinent laws or regulations.
In either of the two cases mentioned (par. 1.), the
management contract must be approved by the
stockholders of the managedcorporation owning at
least 2/3, not merely a majority, of the total
outstanding capital stock entitled to vote, or in case
the managed corporation is a non-stock corporation,
by at least 2/3, not merely a majority, of the
members.
ILLUSTRATIONS:
(1) Interlocking stockholders. If A, B, and C,
stockholders in both X Corporation and Y
Corporation, the managing and managed
corporations, respectively, own 35% of the total
outstanding capital stock entitled to vote of X
Corporation, the management contract must be
approved by the prescribed 2/3 vote of the stockholders of Y Corporation. The same vote shall apply
where A is the only stockholder in both corporations
and he owns more than 1/3 of the total outstanding
capital stock entitled to vote of X Corporation. Only a
majority vote is required if the more than 1/3 ownership of A, B and C, or of A refers to the outstanding
capital stock of Y Corporation, the managed
corporation.
(2) Interlocking directors. If A, B, C, D, and E
constitute the majority of the members of the board
of directors of X Corporation and also of Y
Corporation, the bigger 2/3 vote by the stockholders
of Y Corporation is necessary. This is a case of a
contract between two corporations with interlocking
directorates. (see Sec. 33.) The extent of the
shareholdings of A, B, C, D, and E in X Corporation is
immaterial.

Ultra vires and intra

vires acts explained.

In both illustrations, the management contract need

only be approved by the majority of the outstanding
capital stock of X Corporation, or in illustration No. 2,
of the members, in case X Corporation is a non-stock
corporation.
It is well-settled that a corporation is not restricted to
the exercise of powers expressly conferred upon it
but has the implied or incidental powers to do what is
reasonably necessary to carry out its express powers
and to accomplish the purposes for which it was

formed.
Sections 36(11) and 45 give express recognition to
these implied and incidental powers possessed by
private corporations.
According to the strict construction of the term,
an ultra vires act is one not within the express,
implied, and incidental powers of the corporation. It
is an act which is impliedly forbidden, because it is
not expressly or impliedly authorized or necessary or
incidental in the exercise of the powers so conferred.
Acts within the legitimate powers of a corporation are
calledintra vires.
ILLUSTRATION:

Ultra vires act

distinguished from
an illegal act.

A corporation was organized for the purpose of

engaging in the buying and selling of home
appliances. The act of buying and selling motor
vehicles would be ultra vires although it is itself lawful because it is outside the object for which the
corporation is created and, therefore, beyond its
powers.
The buying and selling of refrigerators would be intra
vires.
When properly used, an ultra vires act means simply
an act which is beyond the conferred powers of a
corporation or the purposes for which it is created.
(Republic vs. Acoje Mining Co., Inc., 7 SCRA 661
[1963].)
By itself, an ultra vires act is not necessarily illegal.
On the contrary, it may be lawful, moral and even
praiseworthy.

Ratification of ultra
vires acts.

An illegal corporate act, on the other hand, is an act

which is contrary to law, morals, good customs,
public order, or public policy (Art. 1306, Civil Code.)
and, therefore, per se illicit. (see Pirovano vs. de la
Rama, 96 Phil. 335 [1954].) The buying and selling of
contraband goods would not only be illegal but
alsoultra vires.
(1) Where the contract is illegal per se, it is wholly
void or inexistent. It cannot be ratified or validated.
(Art. 1409, Civil Code.)
(2) Where the contract is not illegal per se but merely
beyond the power of a corporation, the same is
merely voidable and may be enforced by
performance, ratification, or estoppel, or on equitable
ground. (Republic vs. Acoje Mining Co., Inc., supra.)
Effects of ultra vires acts which are not illegal.

The following rules are recognized:

(1) An ultra vires contract, as long as it is executory
on both sides, cannot be enforced by either party
thereto. It is in the public interest that corporations
do not transcend the powers granted to them and
their assets be not subjected to risks created by
forbidden acts;
(2) When an ultra vires contract has been fully
performed on both sides, neither party thereto can
lawfully set aside the same or to recover what has
been given. No public interest is involved here since
both parties have already received to their
advantage the benefits of the contract voluntarily
entered into; and
(3) When an ultra vires contract has been performed
on one side and the other has received benefits by
reason of such performance, recovery is permitted in
most courts on behalf of the former (7 Fletcher, 620.)
on the ground that it would be unjust to allow
retention of benefits by a party coupled with his
refusal to perform. Other courts hold the contract
unenforceable but require the party who has
received the benefits of performance to return what
he has received or failing to do that, to pay its reasonable value. (Ibid., 613.)
In any case, when a contract is not on its face
necessarily beyond the scope of the power of the
corporation by which it was made, it will, in the
absence of proof to the contrary, be presumed to be
valid. (Coleman vs. Rotel de France Co., 29 Phil. 323
[1915].) In other words, an act is presumed to be
within corporate powers unless clearly shown to be
otherwise.