By The Manila Times on March 18, 2021.

The recently enacted Revised Corporation Code of the Philippines (RCCP) was meant to further ease doing business in the country and increase its competitiveness. But because of the significant economic downturns brought about by the Covid-19 pandemic, several companies and institutions have decided to halt operations and close shop altogether.

Corporations going through economic and financial troubles might contemplate the distribution of its capital assets and properties to individual shareholders in order to support their families amid the pandemic. Corporations might also contemplate rescinding subscription contracts for shares of stock in favor of shareholders for the same reason.

Since corporations are composed of shareholders, with each having an inchoate share in corporate assets and property, many people might assume that a corporation can freely dispose or distribute its capital assets and properties to shareholders upon the mere approval of the board and their fellow shareholders. But according to the trust fund doctrine, such forms of disposition are not allowed.

The trust fund doctrine provides that the capital stock, property and other assets of a corporation are regarded as equity in trust for the payment of corporate creditors (Philip Turner v. Lorenzo Shipping Corporation, G.R. 157479, 2010). It also provides that subscriptions to the capital stock of a corporation constitute a fund to which creditors have a right to look for the satisfaction of their claims (Boman Environmental Development Corporation v. Court of Appeals, G.R. 77860, 1988).

The Supreme Court has established that corporate creditors are preferred over stockholders in the distribution of corporate assets (Turner v. Lorenzo Shipping Corporation, G.R. 157479, 2010). It is the prevailing doctrine in US courts that the capital stock is a trust fund to be used particularly for the security of creditors, who presumably deal with it on the credit of the capital stock (Garcia v. Lim Chu Sing, G.R. L-39427, 193, citing 14 Corpus Juris, p. 383, sec. 505).

This doctrine is the underlying principle in distributing capital assets, as embodied in the Corporation Code (now the RCCP), which only allows it in three instances: amendment of the articles of incorporation to reduce the authorized capital stock; purchase of redeemable shares by the corporation, regardless of the existence of unrestricted retained earnings; and dissolution and eventual liquidation of the corporation.

The doctrine is also articulated in Section 40 on the power of a corporation to acquire its own shares, and in Section 139 of the RCCP on the prohibition against the distribution of corporate assets and property unless the stringent requirements for that purpose are complied with (Ong Yong v. Tiu, G.R. 144629, 2003).

The Supreme Court further expounded the doctrine’s objective in Ong Yong v. Tiu: “The distribution of corporate assets and property cannot be made to depend on the whims and caprices of the stockholders, officers or directors of the corporation, or even, for that matter, on the earnest desire of the court a quo ‘to prevent further squabbles and future litigations’ unless the indispensable conditions and procedures for the protection of corporate creditors are followed. Otherwise, the ‘corporate peace’ laudably hoped for by the court will remain nothing but a dream because this time, it will be the creditors’ turn to engage in ‘squabbles and litigations’ should the court order an unlawful distribution in blatant disregard of the Trust Fund Doctrine.”

The principle laid out by the doctrine clearly prohibits the corporation from distributing its capital assets and properties to its stockholders ahead of its corporate creditors. There can be no distribution of assets among stockholders without paying the creditors first, and for this reason any disposition of corporate funds to the prejudice of creditors is null and void (Boman Environmental Development Corporation v. Court of Appeals, G.R. 77860, 1988).

The primary reason there are stringent requirements and limited instances on the disposition of corporate assets and property is to protect the interests of corporate creditors in settling their unpaid claims due from the corporation and by maintaining corporate peace. It must be emphasized that the capital stock, property and other assets of the corporation are regarded as equity in trust for the payment of the creditors, and not property to be disposed pursuant to the will of the corporation’s directors and stockholders. (CIR v. Court of Appeals, G.R. 108576, 1999).

It is established that there are only three instances where the distribution of corporate capital assets is allowed in the RCCP. Aggrieved corporate creditors may file a complaint with the Securities and Exchange Commission regarding corporations violating the principle laid out by the doctrine. Erring corporations can be held administratively liable under Section 158 of the RCCP, which imposes penalties ranging from a fine of up to P2 million and issuance of a cease-and-desist order to the suspension or revocation of the certificate of incorporation and/or the dissolution of the corporation and forfeiture of its assets.

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