RAMON DE LA RAMA, FRANCISCO ROD­RIGUEZ, HORTENCIA SALAS, PAZ SALAS AND PATRIA SALAS, HEIR OF MAGDALENA SALAS, AS STOCKHOLDERS ON THEIR OWN BEHALF AND FOR THE BENEFIT OF THE MA-A…

Ma-ao Sugar Central versus De la Rama

The Case

This is the story of four minority stockholders who sued their own corporation and its controlling director. Ramon de la Rama, Francisco Rodriguez, Hortencia Salas, Paz Salas, and Patria Salas, heir of Magdalena Salas, brought a representative or derivative suit in the name and for the benefit of the Ma-ao Sugar Central Company against that company, its director J. Amado Araneta, and three other directors. They complained of self-dealing, irregular loans, unauthorized investments, gross mismanagement, and asked for an accounting, for damages, for dissolution, and for receivership. The case matters because it is the classic Philippine teaching case on the derivative suit: who may bring it, what wrongs belong to the stockholder and what wrongs belong only to him as a planter or outsider, and how the Corporation Law treats a corporation that invests its funds in another corporation.

Procedural History

The suit was commenced in October 1953 in the Court of First Instance of Manila. After trial, the lower court rendered judgment dismissing the petition for dissolution but condemning J. Amado Araneta to pay the corporation 46,270 pesos with eight percent interest from the filing of the complaint. It also made permanent the injunction restraining the company from granting loans or advances to its officers and from investing in companies whose purpose is not connected with the sugar central business. Both sides appealed directly to the Supreme Court. The plaintiffs assigned four errors, and the defendants assigned two. The Supreme Court reviewed the whole record and decided both appeals in one decision.

Facts

The complaint covered the period from November 1946 to October 1952 and stated five causes of action: illegal and ultra vires acts consisting of self-dealing, irregular loans, and unauthorized investments; gross mismanagement; forfeiture of corporate rights warranting dissolution; damages and attorney's fees; and receivership. The defendants answered that the complaint was premature, that the plaintiffs had not made an earnest effort to exhaust their remedies within the corporation, and that no actual loss had been suffered. They also counterclaimed for damages, saying the complaint was malicious and its language abusive and insulting.

After trial, the lower court found a series of corporate irregularities which the defendants did not question on appeal. No stockholders' meetings were held in 1947, 1950, and 1951. Untrue entries were made in the books. There were illegal investments in Mabuhay Printing and Acoje Mining, made without the requisite authority of two-thirds of the stockholders. There were unauthorized loans to J. Amado Araneta totaling 132,082 pesos, in violation of a by-law prohibiting any director from borrowing money from the corporation. And corporate funds were diverted to affiliated companies without the approval of the board of directors.

The lower court nevertheless refused dissolution. It found that insolvency was not shown, that the discriminatory acts against planters were grievances of the plaintiffs as planters and not as stockholders, and that the culpable acts proved were not enough to secure a dissolution. It ordered only the correction of the abuses proved. Both parties then appealed.

Issues

• Whether or not the investment of corporate funds in the Philippine Fiber Processing Company violated Section 17 and one-half of the Corporation Law, it appearing that no stockholders' resolution approved the investment by the affirmative vote of stockholders holding at least two-thirds of the voting power.
• Whether or not the Ma-ao Sugar Central Company was insolvent.
• Whether or not the alleged discriminatory acts committed against the planters constituted mismanagement that could be raised in a derivative suit.
• Whether or not the culpable acts proved were sufficient ground for the dissolution of the corporation.
• Whether or not J. Amado Araneta was liable to pay the corporation 46,270 pesos with eight percent interest.
• Whether or not the plaintiffs were liable to the defendants for damages on the counterclaim.

Applicable Provisions

Section 17 and one-half of the Corporation Law provides:

No corporation organized under this act shall invest its funds in any other corporation or business, or for any purpose other than the main purpose for which it was organized, unless its board of directors has been so authorized in a resolution by the affirmative vote of stockholders holding shares in the corporation entitling them to exercise at least two-thirds of the voting power on such proposal at a stockholders meeting called for the purpose.

This is the provision the plaintiffs invoke, and the Court must decide whether the investment in the Philippine Fiber Processing Company required a two-thirds stockholders' vote.

Section 13, paragraph 10 of the Corporation Law provides:

Except as in this section otherwise provided, and in order to accomplish its purpose as stated in the articles of incorporation, to acquire, hold, mortgage, pledge or dispose of shares, bonds, securities and other evidences of indebtedness of any domestic or foreign corporation.

This is the provision the defendants invoke, and the Court must reconcile it with Section 17 and one-half.

Section 13, paragraph 9 of the Corporation Law provides:

To enter into any obligation or contract essential to the proper administration of its corporate affairs or necessary for the proper transaction of the business or accomplishment of the purpose for which the corporation was organized.

This power, read with the tenth paragraph, supports the acquisition of shares when it is done in pursuance of the corporate purpose.

The by-laws of the corporation, Section 3, Article 7, provide:

The Directors shall not in any case borrow money from the Company.

This is the by-law violated by the personal loans to J. Amado Araneta, and it grounds his liability to return the amount.

Ruling

On the first issue, the Court held that the investment in the Philippine Fiber Processing Company did not violate Section 17 and one-half. The Court reconciled the two provisions through the teaching of Professor Sulpicio Guevara: when the purchase of shares of another corporation is done in pursuance of the corporate purpose, it does not need the approval of the stockholders; but when the purchase is done solely for investment, the vote of approval of the stockholders is necessary. Because the Philippine Fiber Processing Company manufactured sugar bags, its business was important to the sugar central and aided it in its purpose, so the investment was in pursuance of the corporate purpose. The Court noted, however, that the investment was made without previous board authority and was only ratified afterwards, which it treated as an indication of the manner in which corporate business was being transacted.

On the second issue, the Court held that insolvency was not shown. It quoted the rule that the mere impairment of capital stock does not establish insolvency, and that an excess of liabilities over assets does not establish insolvency when other assets are available. The company had continued as a going concern for almost seven years after the suit was filed without apparently getting worse.

On the third issue, the Court held that the discriminatory acts against the planters were not a proper subject of a derivative suit. At most they constituted a cause of action of the individual planters, not of the stockholders as stockholders.

On the fourth issue, the Court held that the acts of mismanagement proved did not justify dissolution. It quoted the rule that relief by dissolution will be awarded only where no other adequate remedy is available, and is not available where the rights of the stockholders can be protected in some other way. The Court would order only the correction of the abuses proved.

On the fifth issue, the Court upheld the liability of J. Amado Araneta. The personal loans violated the by-law, and the supposed payment of the 46,270 peso balance was nothing more than a transfer of the item from his personal account to the loans receivable account, which the Court considered a juggling of the books. The loans were also without interest, and the later board resolution imposing eight percent could not bind the borrower.

On the sixth issue, the Court upheld the dismissal of the counterclaim. It found no bad faith on the part of the plaintiffs and nothing essentially libelous in the complaint, since allegations in a pleading, where relevant, are privileged even though they may not be clearly proved afterwards.

Doctrine

A stockholder's derivative suit is a representative action brought in the name and for the benefit of the corporation. It reaches only wrongs done to the corporation, and it cannot be used to litigate grievances that belong to the stockholder in some other capacity, such as a planter dealing with the central.

Under Section 17 and one-half of the Corporation Law, a corporation may invest its funds in another corporation or business only when its board of directors has been authorized by the affirmative vote of stockholders holding at least two-thirds of the voting power. But when the acquisition of shares of another corporation is in pursuance of the corporate purpose, the stockholders' approval is not necessary; the approval is required only when the purchase is made solely for investment. This is the reconciliation of Section 17 and one-half with Section 13, paragraph 10.

Dissolution is an extreme remedy. It will be granted only where no other adequate remedy is available and where the rights of the stockholders cannot be protected in some other way. Mere impairment of capital, or an excess of liabilities over assets, does not by itself establish insolvency.

A director who borrows from the corporation in violation of a by-law is liable to return the amount, and a book entry transferring the debt from a personal account to a loans receivable account is not payment.

Disposition

The Supreme Court affirmed the judgment of the lower court in all respects, upholding the liability of J. Amado Araneta to the corporation and the dismissal of the petition for dissolution and of the counterclaim.

Remember This

The one line to memorize: a derivative suit reaches only wrongs done to the corporation, and an investment in another corporation in pursuance of the corporate purpose needs no two-thirds stockholders' vote. Examiners use this case to test the distinction between a stockholder's derivative suit and an individual suit, and to test the reconciliation of Section 17 and one-half with Section 13 of the Corporation Law.