Opinion No. 19-20 Re: Redemption of Preferred Shares; Subscribed Capital Stock.

Securities and Exchange Commission RepublIc of the Phillppines Department of Finance

OFFICE OF THE GENERAL COUNSEL

27 May 2019

Shares; Subscribed Capital Stock SEC-0GC 0pinion No. 19-20 Re: Redemption of Preferred

Wack-Wack, Mandaluyong City 2/F, Highway 54 PIaza 986 Stanford St., EDSA QUADRIVER ENERGY CORPORATION

Attention: Atty. Roland G. Rosales

Dear Atty. Rosales:

opinion on the redemption of preferred shares. This refers to your letter dated 27 November 2017, requesting for an

million four hundred seventy-six thousand pesos (Php 1,012,476,000.00) and reclassified its shares into common and redeemable preferred shares. viable sources of power. Quadriver was registered with this Commission in engaged in the business of building, constructing, generating, operating, and maintaining power plants which produce energy derived from coal, fossil, fuel, geothermal, natural gas, biomass, solar, wind, hydroelectric, and other 2011. In 2016, Quadriver decreased its capital stock to one billion twelve Your letter states that Quadriver Energy Corporation ("Quadriver") is

hundred ninety (2,358,690) preferred shares issued to Sta. Clara Group, Inc. sole subscriber to the preferred shares, and that the Company intends to redeem and retire two million three hundred fifty-eight thousand six The letter likewise states that Sta. Clara Group, Inc. is currently the

In connection to this, the issues are:

2. Whether Quadriver's redemption of the preferred shares will not 1. Whether Quadriver can redeem the preferred shares even without result to insolvency; and retained earnings and without violating existing laws as well as the trust fund doctrine;

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3. Whether the redemption of the preferred shares will not result to a

reduction of the subscribed capital stock of Quadriver.

Code (Code) provides: With regard to the first query, Section 40 of the Revised Corporatior

. shall have the power to purchase or acquire its own shares for a corporation has unrestricted retained earnings in its:books to cover the shares to be purchased or acquired, a stock corporation legitimate corporate purpose or purposes, including the following cases: xxx"1 {Emphasis supplied) "Section:40. Power to acquire own shares. -Provided, That the

the payment of corporate creditors."2 The rationale is that a corporation's property and other assets of a corporation are regarded as equity in trust for creditors are preferred over the stockholders.3 shares is based on the trust fund doctrine which means that the capital stock, "The requirement "of unrestricted retained earnings to cover the

said shares xxx"4 Hence,: the existence of unrestricted retained earnings is repurchase or reacquire its own shares, of whatever class, unless it has an adequate amount of unrestricted retained earnings to support the cost of the required before a corporation can redeem its shares. Treasury Shares (the "1982 Rules") states that: "No corporation shall redeem, Moreover, Section 3(1) of the SEC Rules Governing Redeemable and

redeemable shares of the corporation or pursuant to the conversion right of 1982 .Rules is that: "When the shares are reacquired in the redemption of expressly provided for in its articles of incorporation and certificates of stock representing said shares of the corporation, xxx"5 This is based on Section 8 of convertible shares of the corporation, in accordance with the provision the Code which'provides: However, an exception to the general rule stated in Section 3(1) of the

fixed period, regardless'of the existence of unrestricted retained by: the corporation when expressly provided.in the articles of incorporation. They are shares which may be purchased by the corporation from the holders of such shares upon.the expiration of a earnings in the books of the corporation, and upon such other terms "Section 8.. Redeemable shares. - Redeemable shares may be issued

1 Republic Act. No. 11232, An Act Providing for the Revised Corporation Code of the Philippines (exact 2 Boman v. C.A., 249 Phil. 495-505 (1988). 4 SEC Rules Governing.Redeemable and Treasury Shares, 5 3(1) (1982) S id. S 3(1)(a reproduction of Section 41 of The Corporation Code of the Philippines, Batas Pambansa Blg. 68) 3

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and conditions stated in the articles of incorporation and the certificate of stock representing said shares,, subject to the rules and regulations issued by the Commission."6

In addition, Section 5(5) of the 1982 Rules states that "redeemable shares may be redeemed, regardless of the existence of unrestricted retained earnings, provided that the corporation has, after such redemption, sufficient assets in its books to cover debts and liabilities inclusive of capital stock."7

In short, although the general rule is that there must be unrestricted retained earnings before a corporation can redeem, repurchase, or reacquire its own shares, the exception is when the shares to be redeemed are redeemable as provided in the articles.of incorporation and certificates of stock of the corporation. But to redeem'said shares, there must be sufficient assets to cover the debts: and liabilities of the corporation, as discussed hereunder.

Asito your second query, please be advised that as a matter of policy, the Commission refrains from rendering opinion on matters which require determination of factual issues.8 Considering that the matter of insolvency require determination of factual issues, the Commission shall refrain from categorically answering the same.

However, for purposes of information only, the following may be imparted.

The right to redeem shares is subject: to the: condition that the redemption .would not render the corporation insolvent, and that the corporation has sufficient funds to satisfy its debts and liabilities. While a corporation, under its articles of incorporation, is allowed to redeem, this is still subject to applicable and existing laws, terms and conditions, and must also.not be in violation of the trust fund doctrine.9

The Supreme Court had already ruled that "while redeemable shares may. be redeemed regardless of the existence of unrestricted retained

redemption, assets in its books to cover debts and liabilities inclusive of earnings, this is subject to the condition that the corporation has, after such capital stock.. Redemption,therefore,' may not be made where the

6 The Revised Corporation Code of the Philippines (exact reproduction of Section 8 of The Corporation Code of the Philippines, Batas Pambansa Blg. 68) 7 SEC Rules Governing'Redeemable and Treasury Shares, 5 5(5) (1982) 8 Section 5.8, SEC Memorandum Circular No. 15, series of 2003 SEC Opinion dated 25 June 1991'addressed to Mr. Jess G. Tabora

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corporation is: insolvent or if such redemption will cause insolvency or inability of the corporation to meet its debts as they mature."1o

Moreover, for the protection of the stockholders, the 1982 Rules provide that a corporation that has issued redeemable shares shall set up and maintain a sinking fund to be deposited with a trustee bank which shall not be invested in risky and speculative ventures.11 A sinking fund refers to a fund set up by a corporation where cash is gradually set aside in order to accumulate the amount necessary to meet the redemption price of redeemable shares at specified dates in the future.12

With regard to your third query, Section 9 of the Code states that "treasury shares are shares of stock which have been issued and fully paid for, but subsequently reacquired by the issuing corporation through purchase, redemption, donation or some other lawful means."13 Section 3 of the 1982 Rules is likewise instructive:

XX

2. Treasury shares do not revert to the unissued shares of the corporation but are regarded as property acquired by the corporation which may be reissued or sold by the corporation at a

in the case of redeemable shares reacquired, the same shall be considered retired and no longer issuable; unless otherwise price to be fixed by the Board of Directors; provided, however, that

provided in the Articles of Incorporation.

xxx" (Emphasis ours)

Simply stated, where the articles of incorporation is silent on the reissuable nature of issued redeemable preferred shares, the same shall be considered retired and can no longer be reissued once they are redeemed. 14 However, while they are considered as retired, the same remains in treasury until removed from their treasury status by decreasing the authorized capital stock of the corporation in accordance with Section 38 of the Code. 15

Based on the foregoing, the redeemable shares once redeemed become part of the treasury shares of the corporation. To summarize, there One is non-reissuable, as when the articles of incorporation is silent on the are two types of treasury shares out of the redemption of preferred shares

10 Republic v. Agana, 336 Phil. 1-14 (1997} 12 SEC Rules, supra Note 7 Section 2d. 14 Section 3 [2], SEC Rules Governing Redeemable and Treasury Shares 11 SEC Rules, supra Note 7 Section 5.4 13 CORPORATION CODE, 5 9. 15 Section 4 [2], SEC Rules Governing Redeermable and Treasury Shares

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retired, and therefore, will not decrease the capital stock of the corporation. reissuable nature of the redeemable preferred shares: The same will be considered retired and can.no longer be reissued. The retirement of treasury shares of this nature have the effect of decreasing the capital stock of the corporation. The second is reissuable, when the articles of incorporation so provide. Treasury shares of this nature are considered reissuable, not

on the reissuable nature of its redeemable preferred shares. Accordingly, once. they are redeemed, the same shall be considered retired and are no longer reissuable.. In turn, the retirement .of the treasury shares decreasing the capital stock of the Company. corresponding to the: redeemed preferred shares have the effect of In the case of Quadriver, its amended articles of incorporation is silent

which has been identified as for informational purpose only is rendered based solely on the facts disclosed in the query and relevant solely to the particular issues raised therein and shall not be used in the nature of a standing rule binding upon the courts, or upon the Commission in other cases of similar or dissimilar circumstances.16 If upon investigation, it will be disclosed that the facts relied upon are different, this opinion shall be rendered null and void. It shall be understood that the foregoing opinion except that part

Please be guided accordingly.

CAMIYMCORREA : General Counsel

15 SeC Memorandum Circular 2003-15 No. 7.