ANGELES P. BALINGHASAY, RENATO M. BERNABE, ALODIA L. DEL ROSARIO, CATALINA T. FUNTILA, TERESITA L. GAYANILO, RUSTICO A. JIMENEZ, ARCELI P. JO, ESMERALDA D. MEDINA, CECILIA S. MO…

Balinghasay versus Medical Center Parañaque

The Case

This is a derivative suit brought by minority stockholders and the corporation itself against a group of directors who, while sitting on the board, entered into a contract with themselves. The Medical Center Parañaque, Incorporated sued its own directors over a memorandum of agreement for the operation of an ultrasound unit, asking that the agreement be annulled and that the directors account for the profits they took. The case matters because it gathers in one place the rules every bar candidate must know on quorum and majority in board meetings, on the voidable contract between a corporation and its directors under Section 32 of the Corporation Code, on the liability of directors who acquire an interest adverse to the corporation under Section 31, on the business judgment rule, and on the derivative suit as a remedy.

Procedural History

The stockholders and the corporation filed an amended complaint for injunction, accounting and damages before the Regional Trial Court of Parañaque City, Branch 258. The trial court dismissed the complaint. It held that the corporation had impliedly ratified the agreement by accepting benefits, that estoppel had set in because the corporation slept on its rights for almost four years, that the sharing arrangement was fair and reasonable, and that under the business judgment rule the court could not control the discretion of the board exercised in good faith.

The stockholders and the corporation elevated the matter to the Court of Appeals. The appellate court reversed and set aside the trial court's decision, declared the memorandum of agreement invalid, ordered the eight director-investors to account fully to the corporation for all profits from the ultrasound contract, and awarded two hundred thousand pesos in attorney's fees. It denied moral and exemplary damages. The Court of Appeals then denied the directors' motion for reconsideration.

The directors came to the Supreme Court by petition for review on certiorari under Rule 45, raising errors of law on the business judgment rule, on the circumstances surrounding the agreement, and on the award of attorney's fees.

Facts

The Medical Center Parañaque, Incorporated, organized in 1977, operates a hospital in Sucat, Parañaque City. Before 1997, its laboratory, physical therapy, pulmonary and ultrasound services were provided by independent concessionaires. When the concessions expired in 1997, the corporation decided to provide these services itself, except ultrasound. The board awarded the operation of the ultrasound unit to a group of investors composed mostly of obstetrics and gynecology doctors, nine of whom were themselves members of the board. The group bought a Hitachi ultrasound machine for eight hundred fifty thousand pesos and operated it, though without a written contract at first.

At the board meeting of August 14, 1998, twelve directors were present and seven of them belonged to the ultrasound investors; the board made a counter-offer rather than approving a contract. At the meeting of February 5, 1999, twelve directors attended and eight were ultrasound investors. A memorandum of agreement was then signed by the corporation's president, Bernabe, and by Oblepias for the investors. Under it, gross income less the sonologists' professional fees was divided sixty percent to the investors and forty percent to the corporation, shifting to fifty-five and forty-five beginning April 1, 1999, with ownership of the machine eventually transferring to the corporation.

A stockholder, Flores, wrote the corporation's counsel in October 1999 challenging the agreement as prejudicial, and in February 2000 manifested to the board that the agreement was illegal and could not be validly ratified. The derivative suit followed in 2001. The corporation's balance sheets for 1996 to 2000 showed cash and cash equivalents far exceeding the price of the machine, and the investors earned a net share of more than four million pesos from 1997 to 2001.

Issues

• Whether or not the Court of Appeals erred in disregarding the circumstances under which the memorandum of agreement was conceived and implemented.
• Whether or not the Court of Appeals erred in failing to consider that the agreement was an informal arrangement meant to address an urgent hospital necessity.
• Whether or not the Court of Appeals erred in not applying the business judgment rule.
• Whether or not the Court of Appeals erred in assessing two hundred thousand pesos in attorney's fees against the director-investors.

Applicable Provisions

Section 31 of the Corporation Code provides:

If a director, trustee or officer shall willfully and knowingly vote for or assent to any patently unlawful act of the corporation, or if he is guilty of gross negligence or bad faith in directing the affairs of the corporation, or acquires any personal or pecuniary interest in conflict with his duty as such director, trustee or officer, or shall consent to the issuance of watered stocks or who, having knowledge thereof, shall not forthwith file with the corporate secretary his written objection thereto, he shall be liable as such director, trustee or officer for all damages resulting therefrom suffered by the corporation, its stockholders or members and other persons.

This is the provision under which the stockholders sued, and it makes a director who acquires a personal interest in conflict with his duty liable for all damages suffered by the corporation.

Section 32 of the Corporation Code provides:

A contract between the corporation and one or more of its directors or trustees or between the corporation and another corporation or partnership in which one or more of its directors or trustees are also directors or trustees or have a substantial interest shall be voidable at the option of the corporation, whether or not the contract is fair and reasonable under the circumstances.

This is the provision the directors invoked, claiming the agreement was merely voidable and had been ratified, and it is the provision the Court construes on the requirements of ratification.

Article 22 of the New Civil Code provides:

Every person who through an act of performance by another, or any other means, acquires or comes into possession of something at the expense of the latter without just or legal ground, shall return the same to him.

This is the provision the Court uses to prevent unjust enrichment, allowing the investors to keep the machine they paid for while returning the income that should have gone to the corporation.

Ruling

On the first and second issues, the Court held that the petition raised mere questions of fact, not questions of law, and that no exceptional ground existed to re-evaluate the evidence. The circumstances and the urgent hospital necessity the directors invoked were admittedly never offered in evidence at the trial, so their truth or falsity was never tested. The Court of Appeals therefore could not be faulted for ruling against them on evidence showing that there was no quorum at the board meetings of August 14, 1998 and February 5, 1999, that the agreement was never ratified by two-thirds of the outstanding capital stock, and that the corporation had ample funds to buy the machine itself.

On the third issue, the Court held that the business judgment rule did not shield the directors. The rule bars courts from intruding into business judgments made in good faith, but here the directors who approved the agreement held an adverse interest, did not inhibit themselves from deliberating and voting, and did not promptly disclose the matter to the stockholders, who were asked to ratify only in the annual meetings from 2000 to 2003. The Court of Appeals' finding of invalidity was amply supported by evidence and jurisprudence.

On the fourth issue, the Court upheld the award of attorney's fees. The unjustified acts of the directors compelled the stockholders to litigate, and the appellate court had laid down in the body of its decision the factual and legal basis for the award, as the rule requires.

The Court, however, modified the judgment to prevent unjust enrichment. Since the investors had pooled their own money to buy the machine, they should retain ownership of it, to be used or disposed of independently of the corporation, while accounting for the income the corporation should have earned.

Doctrine

A contract between a corporation and one or more of its directors is voidable at the option of the corporation, whether or not it is fair and reasonable. Ratification requires the vote of two-thirds of the outstanding capital stock in a meeting called for the purpose, with full disclosure of the directors' interest. Absent such ratification, the contract remains voidable and may be annulled.

A director who acquires a personal or pecuniary interest in conflict with his duty is liable as a trustee for the corporation and must account for all profits that otherwise would have accrued to it. He must not only refrain from voting; he must disclose the conflict promptly to the stockholders.

The business judgment rule protects only judgments exercised in good faith in the interest of the corporation. It does not shield a board whose members dealt with themselves at the corporation's expense.

In a derivative suit, the corporation is the real party in interest and the suing stockholder is only a nominal party. It may be brought when the officials refuse to sue, when demand would be futile because they are the ones to be sued, or because they control the corporation.

On procedure, a petition for review on certiorari under Rule 45 is an appeal on pure questions of law, and factual questions are not reviewed absent exceptional circumstances. Defenses not offered in evidence at trial cannot be considered on appeal.

Disposition

The petition was denied; the Court of Appeals' decision and resolution were affirmed but modified, directing the eight director-investors to fully account for and return to the corporation all income it should have earned from the ultrasound operations from 1997 onward, while allowing the investors to retain ownership of the equipment.

Remember This

Memorize this line: a director who acquires an interest adverse to the corporation is liable as a trustee and must account for the profits, and a self-dealing contract is voidable unless ratified by two-thirds of the outstanding capital stock with full disclosure. Examiners use this case on the business judgment rule, on quorum and majority in board meetings, and on the derivative suit as a remedy for minority stockholders.