(Third of five parts)
Section 130 of the Revised Corporation Code (RCC) sets out three rules governing the liability of the Single Stockholders, thus:
1.) Burden of Proof to Show the One Person Corporation (OPC) Was Adequately Financed: The Single Shareholder may claim limited liability only when he has discharged the burden of “affirmatively showing that the corporation was adequately financed.”
2.) Burden of Proof to Show OPC Is Independent of Stockholders’ Personal Property: Where the Single Stockholder cannot prove that the property of the OPC “is independent of the stockholder’s personal [i.e., non-invested] property, the stockholder shall be jointly and severally liable for the debts and other liabilities” of the OPC;
3.) Invoking the Piercing Doctrine: “The principles of piercing the corporate veil applies with equal force to One Person Corporations as with other corporations.”
a. Discharging the Burden of Affirmatively Showing that the OPC “Was Adequately Financed.” — The use under the first paragraph of Section 130 of the term “was adequately financed” in the past tense is clearly indicative that it refers to the state of finances of the OPC in the past prior to the (present) time when a debt of the OPC is sought to be enforced against the Single Stockholder.
There are only two past events to reasonably reckon when the OPC was adequately financed: (i) at the time of incorporation; or (ii) at of the constitution of the debt or liability of the OPC which is sought to be enforced against the Single Stockholder. Pursuant to the discussions on Item b. below, it is reasonable to conclude that the burden of affirmatively showing that the OPC “was adequately financed” refers to the point of incorporation.
The implication under the first paragraph of Section 130 is that it is the obligation of every Single Stockholder in incorporating the business/property into an OPC, that the entity itself is “adequately financed.”
What is the legal commercial meaning of “adequately financed”? How will the Single Stockholder comply with obligation at the time of incorporation, that the OPC is “adequately financed”? It should be noted that the first paragraph of Section 130 uses the term “adequately financed” instead of the term “adequately capitalized,” which would be a more appropriate term directly pointing to an affirmative obligation on the part of equity holders in a business enterprise. The terms have different legal implications.
It is a given in the commercial world, that the pursuit of any business enterprise essentially involves risks, thus:
(i) Equity-holders put their money into the enterprise knowingly taking on the risk that no income may be realized on the venture, and worse, that their investment would entirely be dissipated, especially when the venture becomes insolvent.
If the insolvent business venture was pursued through the medium of sole proprietorship or a partnership, the equity-holders remain liable to the extent of their non-invested properties to the venture creditors and other debtors. This is the application of the doctrine of unlimited liability that pervades in the media of sole proprietorships and partnerships.
On the other hand, if the insolvent business venture were pursued through the medium of the corporation, equity-holders are bound to the legal rule that all corporate assets and properties shall be distributed to the creditors of the corporation leaving them nothing to claim; but they are assured that, in the absence of fraud, their non-invested properties cannot be pursued by the creditors of the corporation. This is the legal commercial principle embodied under the doctrine of limited liability that is promised under the corporate setting.
(ii) Lenders and other creditors extend money/credit to the venture and impose rates of interests that would best cover the evaluated risks in extending credit to the venture, including the risk that they may not recover all principals and accrued interests, if the business enterprise becomes insolvent. Lenders and other creditors extend credit to the business venture knowing fully well that its operations have not been wholly-capitalized by the equity holders, that is the reason why they are seeking loans and other creditors from the lenders.
If the insolvent business venture was pursued through the medium of sole proprietorship or a partnership, the lenders and other creditors of the business venture have the legal right to pursue the non-invested properties of the equity-holders, which are not exempt from execution; and if the separate properties of the equity-holders are insufficient, such creditors and other lenders would be left holding the bag.
If the insolvent business venture was pursued through the corporate medium, the lenders and other creditors assume the risk that in the event of insolvency, they cannot recover from the non-invested properties of the stockholders. In other words, lenders and other creditors of the corporation, absent fraud on the part of the stockholders, are bound to the limited liability rule when they extend credit to a corporate debtor.
In the corporate setting, outside of fraud on the part of the equity-holders, the determination of whether the business venture is “adequately financed” is not only the undertaking of the equity-holders (in the exercise of their business judgment as owners of the business), but also of the lenders and other creditors (in the exercise of creditor prudence in running their own businesses). In the event the business venture becomes insolvent, everybody suffers, equity-holders lose all their investments, lenders and other creditors lose the value of the credits to the extent not covered by the assets and properties of the venture.
In the regular course of business therefore, stockholders and their agents (Board of Directors and officers) do not guarantee to the lenders and other creditors of the corporation that it is adequately financed, for it is precisely the very issue of “viability of the business venture” that is supposed to be determined by the lenders and other creditors in deciding whether or not to take the risk of extending loans and other credits to the corporation.
Therefore, the “burden of affirmatively showing that the corporation was adequately financed” under the first paragraph of Section 130 actually makes the OPC a more unattractive corporate medium for equity ventures when compared to the close corporation and the ordinary non-stock corporation where there is no such burden to discharge for the stockholders to be able to avail of the doctrine of limited liability.
b. “Adequately Capitalized” Vis-à-vis the Piercing Doctrine of “Under-capitalization.” — Jurisprudence has began to recognize that the “undercapitalization” of a corporation as a sub-specie of the piercing doctrine.
In McConnel v. Court of Appeals, 1 SCRA 722, 726 (1961), the Supreme Court, in applying the piercing doctrine to make the stockholders personally liable for a corporate debt, took special notice of the fact that “The corporation itself had no visible assets, as correctly found by the trial court, except perhaps the toll house, the wire fence around the lot and the signs thereof. It was for this reason that the judgment against it could not be fully satisfied.” McConnel seemed to imply that the incorporation of an entity without reasonable assets to support the undertaking or venture for which it is organized constitute a fraud against the corporate creditors, thus:
“The facts thus found cannot be varied by us, and conclusively show that the corporation is a mere instrumentality of the individual stockholders, hence the latter must individually answer for the corporate obligations. While the mere ownership of all or nearly all of the capital stock of a corporation [does not make it] a mere business conduit of the stockholder, that conclusion is amply justified where it is shown, as the case before us, that the operation of the corporation were so merged with those of the stockholders as to be practically indistinguishable from them. To hold the latter liable for the corporation’s obligation is not to ignore the corporation’s separate entity, but merely to apply the established principle that such entity can not be invoked or used for purposes that could not have been intended by the law that created that separate personality.”
In Gabionza v. Court of Appeals, 565 SCRA 38, 51-52 (2008), where the Supreme Court made the directors and stockholders of the corporation personally liable on the basis on inadequate capitalization:
“…The DoJ (Department of Justice)Resolution explicitly identified the false pretense, fraudulent act or fraudulent means perpetrated upon the [investing] petitioners. It narrated that petitions were made to believe that ASBHI had the financial capacity to repay the loans it enticed petitioners to extend, despite the fact… [of the]… deficient capitalization of ASBHI… evinced by its articles of incorporation, the treasurer’s affidavit… audited financial statements… and general information sheets… all of which petitioners attached to their respective affidavits.
x x x
Private respondents argue before this Court that the true capitalization of ASBHI has always been a matter of public record, reflected as it is in several documents which could be obtained by the petitioners from the SEC. We are not convinced. The material misrepresentations have been made by the agents or employees of ASBHI to petitioners, to the effect that the corporation was structurally sound and financially able to undertake the series of loan transactions that induced petitioners to enter into. Even if ASBHI’s lack of financial and structural integrity is verifiable from the articles of incorporation or other publicly available SEC records, it does not follow that the crime of estafa through deceit would be beyond commission when precisely there are bending representation would be able to meet its obligations. Moreover, respondents’ argument assumes that there is legal obligation on the part of petitioners to undertake an investigation of ASBHI before agreeing to provide the loans. There is no such obligation. It is unfair to expect a person to procure every available public record concerning an applicant for credit to satisfy himself of the latter’s financial standing. At least, that is not the way an average person takes care of his concerns.”
In other words, the doctrine of “inadequate capitalization” should only be applied in favor of corporate creditors who are not in a position to determine whether the corporation is adequately capitalized to operate sustainably to answer for its debts and liabilities. This doctrine certainly cannot apply to favor banking institutions who are mandated under the law to exercise utmost diligence in the pursuit of their industry which is vested with public interests.
It is our position that the manner by which the courts shall implement the meaning of the “burden to affirmatively show that the OPC was adequately financed,” under the first paragraph of Section 130 should follow the doctrine under “undercapitalized business venture.” Otherwise, the OPC becomes a truly unattractive corporate medium for businessmen, especially the targeted MSME businessmen, many of whom do not really have adequate resources.
The article reflects the personal opinion of the author and does not reflect the official stand of the Management Association of the Philippines or the MAP
Cesar L. Villanueva is Chair of the MAP Corporate Governance Committee, the Founding Partner of the Villanueva Gabionza & Dy Law Offices, and the former Chair of the Governance Commission for GOCCs (GCG).