A. DEF Corporation has retained surplus profits in excess of 100% of its paid-in capital stock. However, it is unable to declare dividends, because it had entered into a loan agreement with a certain creditor wherein the declaration of dividends is not allowed without the consent of such creditor. If DEF Corporation cannot obtain this consent, will it be justified in not declaring dividends to its stockholders? Explain. (3%)
B. What is “watered stock” and what is the legal consequence of the issuance of such stock? (3%)
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Yes, DEF Corporation is justified in not declaring dividends. Watered stock is stock issued below par or fair value, making consenting officers solidarily liable for the difference. Under Section 42 of the Revised Corporation Code, corporations
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Quick check
Under Section 42 of the Revised Corporation Code, when is a corporation justified in retaining surplus profits exceeding 100% of paid-in capital?
Section 42 explicitly permits retaining surplus profits beyond 100% of paid-in capital when restricted under a loan agreement without creditor consent.
What constitutes 'watered stock' under Section 64 of the Revised Corporation Code of the Philippines?
Watered stock is stock issued for consideration below par value or for non-cash property valued above fair value.
What is the statutory legal consequence imposed on corporate directors who consent to the issuance of watered stock?
Section 64 imposes solidary liability on consenting directors for the difference between fair value received and par value.
Under Section 42, which corporate body possesses the primary authority to declare dividends out of unrestricted retained earnings?
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Which primary statute governs corporate dividend declarations, surplus retention rules, and watered stock liabilities in the Philippines?
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1. Surplus Profit Retention
Under Section 42 of the Revised Corporation Code of the Philippines (Republic Act Number 11232), stock corporations are prohibited from retaining surplus profits in excess of one hundred percent of their paid-in capital stock. However, a statutory exception applies when the corporation is prohibited from declaring dividends under a loan agreement with any financial institution or creditor without securing prior creditor consent. Where the corporation attempts in good faith but fails to obtain the requisite creditor consent, retaining the surplus profits beyond the one hundred percent limit is legally justified and fully compliant with corporate law.
2. Watered Stock Nature
Under Section 64 of the Revised Corporation Code (Republic Act Number 11232), watered stock is defined as stock issued by a corporation for a consideration less than its par or issued value, or for a consideration in any form other than cash valued in excess of its fair value. The issuance of watered stock violates the trust fund doctrine and breaches corporate capital integrity, as it misrepresents the actual capital resources available to protect corporate creditors and shareholders.
3. Watered Stock Liabilities
Under Section 64 of the Revised Corporation Code, any director or officer of a corporation who consents to the issuance of watered stock, or who having knowledge thereof fails to file a written objection with the corporate secretary, is rendered solidarily liable with the stockholder concerned to the corporation and its creditors for the difference between the fair value received and the par or issued value of the shares.