The Corporation Code contains its own set of “corporate governance (CG) principles,” which can be summarized into the following general statements:
a. The size and composition of the Board of Directors can only be based on provisions contained in the Articles of Incorporation or the By-Laws.
b. Other than in those cases specifically provided by law, any qualification or disqualification pertaining to the members of the Board of Directors shall be valid only when expressly provided in the articles or by-laws.
c. Boards of Directors have no power by mere exercise of their Business Judgment, to provide for their own qualifications and disqualifications.
d. Outside of specific statutory empowerment, the power to elect, compensate, discipline, and remove any member of the Board of Directors is vested with the stockholders.
Board composition must be of optimum size
Section 14(6) of the Corporation Code expressly requires to be contained in the articles of incorporation of every corporation a provision that “The number of directors or trustees shall not be less than five (5) nor more than fifteen (15).” This statutory directive ensures that the size of the Board of any stock and for-profit corporation is one that is within “optimum range,” so as not to be so small to be ineffective, but not too large to be unwieldy and inefficient. You can evaluate the importance of the CG principle that “the Board must be of optimum size” when you compare the provisions of the Corporation Code with respect to non-stock corporations that are allowed to have board sizes of more than fifteen (15) members.
That the Board of Directors for stock corporations should be within the optimum size of not less than five (5) and not more than fifteen (15) members is a statutory mandate which cannot be overcome even by contrary provisions in the articles of incorporation and/or the by-laws of any stock corporation, much less by formal resolutions of the Board of Directors. It constitutes part of what is considered to be “good governance principle” under the Corporation Code.
Manner of election, qualifications and disqualifications of the Directors must be set out in the by-laws; not within the board’s business judgment
Section 47(5) of the Corporation Code provides that, “Subject to the provisions of the Constitution, this Code, other special laws, and the articles of incorporation, a private corporation may provide in its by- laws for … [t]he qualifications, duties and compensation of directors or trustees, officers and employees.” In turn, Section 47(7) allows to be provided in the by-laws “[t]he manner of election or appointment and the term of office of all officers other than directors or trustees.” Taken together, the two sections of the Corporation Code cover the principle that the manner of election, qualifications and disqualifications of the members of the Board of Directors can be legally provided only, outside of statutory provisions, in the by-laws of the corporation. Therefore, a key CG principle embodied with the provisions of the Corporation Code is that it is not within the business judgment power of the Board to provide for the composition, manner of election, qualifications or disqualification, outside of what is provided for by law, and the by-laws of the corporation.
Sections 23, 24, and 27 of the Corporation Code provide for the manner of election, term of office, and for the minimum statutory qualifications and disqualifications of directors, as follows:
(a) Members of the Board of Directors of a stock corporation shall “be elected from among the holders of stocks…who shall hold office for one (1) year and until their successors are elected and qualified”;
(b) Members of the Board of Directors of every stock corporation are to be elected through cumulative voting;
(c) Every director must own at least one (1) share of the capital stock of the corporation of which he is a director, which share shall stand in his name on the books of the corporation;
(d) Any director who ceases to be the owner of at least one (1) share of the capital stock of the corporation of which he is a director shall thereby cease to be a director; and
(e) No person convicted by final judgment of an offense punishable by imprisonment for a period of exceeding six (6) years, or a violation of this Code, committed within five (5) years prior to the date of his election or appointment, shall qualify as a director of any corporation.
The CG principle of accountability that is embodied in the statutory requirement of an annual election of the members of the Board of Directors of stock corporations is best explained by the Supreme Court in its decision in Valle Verde Country Club, Inc. v. Africa, which held —
The underlying policy of the Corporation Code is that the business and affairs of a corporation must be governed by a board of directors whose members have stood for election, and who have actually been elected by the stockholders, on an annual basis. Only in that way can the directors’ continued accountability to the shareholders, and the legitimacy of their decisions that bind the corporation’s stockholders, be assured. The shareholder vote is critical to the theory that legitimizes the exercise of power by the directors or officers over properties that they do not own.
It is therefore contrary to the good governance principles under the Corporation Code to have permanent directors in the Board. In Grace Christian High School v. Court of Appeals, our Supreme Court held that a by-law provision or company practice of giving a stockholder a permanent seat in the Board would be against the provisions of the Corporation Code which requires members of the board of corporations to be elected on an annual basis. Therefore, any provision in the articles of incorporation or by-laws which offends against policies found in the Corporation Code would be rendered unlawful and void by our courts. The importance of the annual voting of the members of the Board of Directors can be appreciated when compared with the provisions of the Corporation Code with respect to non-stock corporations that allow them by-law provisions to have staggered terms of three years.
Cumulative voting, which is a mandatory system of voting for directors in all stock corporations, ensures that minority stockholders have a reasonable chance of electing their nominees into the Board. It embodies the “CG principle” that the Board of Directors of every stock corporation, although it speaks and decides through the vote of the majority of its members, should have varied representation that allows the airing of the concerns and interests of the minority stockholders. The mandatory cumulative voting system in the election of the members of the Boards of Directors of companies under the Corporation Code therefore adheres to the current CG principle of “equitable treatment of shareholders.” Again, you can appreciate the centrality of the cumulative voting in the governance system for stock corporations, when compared to the provisions of the Corporation Code with respect to non-stock corporation where the default rule is straight voting for the members of the Board of Trustees.
The Corporation Code provisions on the manner of election, the qualifications and disqualifications for members of the Board of Directors ensure that only qualified persons occupy what is clearly a position of trust, and therefore adhere to the CG principle of competence. In Gokongwei, Jr. v. Securities and Exchange Commission, our Supreme Court recognized the principle that it is in the by-laws that the corporation may provide for additional qualifications and disqualifications for directors other than those found in statutory law, such as the power given under the then Section 21 of the Corporation Law (now Section 47 of the Corporation Code), thus:
In this jurisdiction, under section 21 of the Corporation Law, a corporation may prescribe in its by-laws “the qualifications, duties and compensation of directors, officers and employees….” This must necessarily refer to a qualification in addition to that specified by section 30 of the Corporation Law, which provides that “every director must own in his right at least one share of the capital stock of the stock corporation of which he is a director….Section 21 of the Corporation Law expressly gives the power to the corporation to provide in its by-laws for the qualification of directors and is “highly prudent and in conformity with good practice.”
Section 16 of the Corporation Code provides that any amendment to the provisions of the articles of incorporation would be valid and effective only upon a resolution by the majority of the Board of Directors and ratified by at least two-thirds (2/3) of the outstanding capital stock, with the amendments to be thereafter approved by the SEC. In turn, Section 48 provides that any amendment of the by-laws would be valid and effective only upon a resolution by the majority of the Board of Directors and ratified by at least a majority of the outstanding capital stock. In essence, outside of statutory provisions on the matter, the composition of the Board of Directors and the qualifications and disqualifications of its members are governed by existing provisions in the articles of incorporation and by-laws, and cannot be changed simply by a formal resolution of the Board of Directors in the exercise of their business judgment.
It is therefore part of good governance paradigm under the Corporation Code that the composition, manner of election, the qualifications and disqualifications, and the compensation of members of the Board of Directors should be clear and transparent to current and future stockholders, and founded upon firm and stable bases (i.e., statutory rules, articles and by-laws provisions), and upon which nomination and election processes can be pursued. The Corporation Code seems to consider as “bad CG” that the Board would have the power to provide on its own business discretion, even by formal board resolutions, for its composition, to adopt additional qualifications and disqualifications, or even to provide for themselves remunerations.
The Corporation Code therefore embodies a bias against giving Boards of Directors the power to influence on who may sit on the board at any given time, by merely adopting resolutions that would qualify only their chosen candidates, or even to adopt new norms of disqualification that would ease out members who are opposed to their views. To tolerate such state of matters would allow the incumbent majority of the Board to wield greater influence on other members, and the threat of being “disqualified” out of the board, would such minority directors fall under the influence of the majority. Such state of things would be contrary to the public policy behind the cumulative voting system for stock corporations. It would also be contrary to what seems to be the current “CG policy” under the Corporation Code, that directors as individually elected members of the Board must be totally accountable only to the corporation and the stockholders, and not to the Board as the possessor of all corporate powers under the doctrine of centralized management.
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).