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Cesar L. Villanueva

M. A. P. Insights

Power to discipline and to remove directors is vested, not with the board, but with the stockholders

Section 28 of the Corporation Code (CC) provides in essence that the power to remove a director is not within the business judgment power of the Board of Directors (BOD), but is vested only with the stockholders representing at least two-thirds (2/3) of the outstanding capital stock of the corporation; and that in fact, when it comes to the removal of a director elected through minority cumulative voting, such removal by the stockholders can only be for cause.

This principle is reaffirmed in Section 29 of the CC which empowers the Board that continues to have quorum to fill up any vacancy that has occurred “other than by removal by the stockholders,” which confirms that the power to elect, remove and replace a Director lies within the legal prerogative of the stockholders, not the Board. Therefore, what is at present a cornerstone corporate governance (CG) principle under the CC is that the removal or suspension of a director does not fall within the legal competence of the Board; and that in fact by-law provisions granting such power to the Board would be void under the principle embodied in Section 47 of the CC that provisions of the by-laws cannot contravene statutory provisions.

If the power to remove a member of the Board rests solely in the hands of the stockholders, and that the Board has no power to remove any of their members even for cause, then it is logical to conclude that the power to discipline directors does not also fall within the business judgment of the BOD. Again, this principle is drawn from policy under the CC that it is good governance practice that every director of a corporation remains accountable directly to the stockholders, who have the power to remove him.




This position is bolstered by comparison of the parallel provisions of Section 31 and Section 34 of the CC, which both cover the obligation to return to the corporation the profits earned from violating the duty of loyalty. Section 34, which applies solely to directors of stock corporations who violate their duty of loyalty, provides that “[w]here a director, by virtue of his office, acquires for himself a business opportunity which should belong to the corporation, thereby obtaining profits to the prejudice of such corporation, he must account to the latter for all such profits by refunding the same, unless his act has been ratified by a vote of the stockholders owning or representing at least two-thirds (2/3) of the outstanding capital stock.”

When a director of a stock corporation has breached his duty of loyalty, he has no option but to refund the profits obtained from the business opportunity taken from the corporation, and the power to forgive him is not within the business judgment of the rest of the members of the BOD. Only the stockholders, by a vote of at least two-thirds (2/3) of the outstanding capital stock, have the power to forgive him and allow him to keep the fruits of his misdeed. This is in stark contrast to the provisions of Section 31 which is the general provision that applies to the breach of the duty of loyalty of directors, trustees and officers, which provides for a similar forfeiture of the profits earned, but does not prevent the exercise by the BOD of the use of its business judgment under Section 23 of the CC to formally adopt a resolution allowing the culprit trustee or officer to keep the fruits of his misdeed.

DIRECTORS ARE NOT GENERALLY ENTITLED TO REMUNERATIONS
Although the BOD is granted under Section 23 of the CC with near plenary corporate powers, legal title to all corporate assets, and directly constituted as the managers of the corporate enterprise, it is not expected that the directors assume their position as though they were employees of the corporation: they are not generally entitled to remuneration for their services, and do not enjoy security of tenure. The general rule under the CC is that members of the BOD are not entitled to compensation for their services, thus:

Sec. 30. Compensation of directors. — In the absence of any provision in the by-laws fixing their compensation, the directors shall not receive any compensation, as such directors, except for reasonable per diems; Provided, however, That any such compensation (other than per diems) may be granted to directors by vote of the stockholders representing at least a majority of the outstanding capital stock at a regular or special stockholders’ meeting. In no case, shall the total yearly compensation of directors, as such directors, exceed ten (10%) percent of the net income before income tax of the corporation during the preceding year. (n)

The rule that “A director’s service is generally non-compensable” under Section 30 of the CC is not aligned with the general rule in Commercial Law — a genre to which the CC belongs — that the services rendered by representatives of the business interests of others — agents and trustees — are presumed to be compensable, unless otherwise expressly agreed to be gratuitous. In the Law on Agency under the Civil Code, Article 1875 has adopted the commercial law rule that “Agency is presumed to be for compensation, unless there is proof to the contrary.” In the Law on Trusts, the general rule is that the services of the trustee are deemed compensable.

There is no doubt that Section 30 of the CC regulates a conflict-of-interest situation in the position of the Board vis-à-vis the finances of the corporation — it seeks to ensure that Boards are never in a situation where they can exercise the business judgment to grant themselves any form of compensation by the simple expedient of exercising their business judgment. Such practice may be deemed to violate directors’ duty of loyalty. Section 30 also fortifies the CG principle of accountability, i.e., that the directors are accountable only to the stockholders, who alone have the power to grant them compensation in the absence of any provisions in the company’s by-laws.

There are two theories put out to explain the prevailing principle under Section 30 that “directors serve without compensation, unless so provided in the by-laws,” thus:

The first theory is that membership in the BOD is considered under the CC to be essentially an honorary or gratuitous position, and that individuals who accept their nominations to the BOD do so out of a sense of quasi-public duty and in public recognition of their integrity and competence to serve the best interest of the investing public. While such theory may apply for non-stock corporations, and may have some merits for publicly-held companies which are imbued with public interests, they have no meaning to other forms of corporations which are set out for profits. It must be noted that Section 30 of the CC establishes a rule for all types of corporations, not just publicly-held companies.

Such an underlying rationale for Section 30 does not encourage a system of “professional directors,” who can devote full-time and resources in serving a number of companies as directors, and be well-satisfied that they would receive from their being directors “as such” reasonable compensation to lead a dignified life and provide well for their families’ needs in accordance with their stature in society. As the saying goes, if you only pay peanuts then you get monkeys to fill up your Board.

The second theory is that since directors must also be registered stockholders of the company to be qualified to be elected, and to retain their seats in the Board, then the compensation for their services must be in the form of being able to participate in the maximization of the profits of the company. This rationale has in fact been confirmed by the Supreme Court in Western Institute of Technology, Inc. v. Salas, where it declared that:

There is no argument that directors or trustees, as the case may be, are not entitled to salary or other compensation when they perform nothing more than the usual and ordinary duties of their office. This rule is founded upon a presumption that directors/trustees render service gratuitously, and that the return upon their shares adequately furnishes the motives for service, without compensation….This proscription, however, against granting compensation to directors/trustees of a corporation is not a sweeping rule. Worthy to note is the clear phraseology of Section 30…[t]he phrase as such directors is not without significance for it delimits the scope of the prohibition to compensation given to them for services performed purely in their capacity as directors or trustees. The unambiguous implication is that members of the board may receive compensation, in addition to reasonable per diems, when they render services to the corporation in a capacity other than as directors/trustees….

The rationale put forth under Western Institute of Technology supports the Shareholder Theory that the primary duty of the BOD, who must all be shareholders of the company, is to maximize the profits of the corporation for the sole benefit of its shareholders who alone are entitled to receive them by way of dividends. Such theory does not promote the CG reforms to focus the primary fiduciary obligation of the Board and Management of publicly-held companies under the aegis of the Stakeholder Theory.

Under both theories, the only “return” that directors can expect for their services “as such,” aside from public recognition, is to be given “reasonable” per diems, which have been defined “an allowance of so much every day for living expenses, usually while traveling in connection with work,” as expenses to cover attendance at meetings. In other words, directors can be expected to be “compensated” only for the actual time they attend a board meeting, and it is not within their compensable responsibility to be involved with corporate matters, outside of actual board meetings. Outside of stockholders’ generosity, and absence of any compensation provisions in by-laws, directors cannot expect to be paid for the merits of their services, and should expect nothing for serving above beyond the call of duty. And even when they are granted legally compensation for their services, the same is thoroughly controlled by law not to exceed ten percent (10%) of the net income before income tax.

The basic tenor of Section 30 therefore is that directors serve as fiduciaries of the corporation and stockholders, and they serve out of a sense of trust and honor; they are not expected to earn their livelihood from corporate affairs. Even the use of the term “as such” (twice in Section 30) seems to invite directors, if they wish to be well-compensated from their involvement in corporate affairs, to become corporate officers or assume any other additional role, such as a consultant for specific aspects of the corporate operations.

What can be drawn up from our discussions is that the language of, and the underlying rationale supporting, Section 30 of the CC has become antediluvian in flavor, and antithetical to the CG principles sweeping the corporate world. It probably is high-time to effect a formal change in the language of Section 30 of the CC that is consistent with CG reforms of empowering the BODs of publicly-held companies the power to set compensation for themselves and Management, but always subject to confirmation by the stockholders.

RATIONALE BEHIND THE LACK OF BOARD POWER TO DISCIPLINE, REMOVE OR EVEN COMPENSATE ITS MEMBERS
The rationale behind the “CG” policy of the CC in not granting the BOD the power to compensate and remove, much less to discipline, suspend or expel, any of its members, and in fact placing such powers solely with the stockholders, may be summarized as follows:

(a) Such policy adheres to the principle that each member of the Board is accountable to the entire body of stockholders and not to one another, and therefore they may, within all board proceedings and transactions, individually exercise their business discretion entirely for the benefit of the stockholders, without fear from a backlash of the controlling majority;

(b) The one-year limit on the terms of directors, and the submission of their election to the stockholders annually, as well as the power of the stockholders to remove them during their term, are considered the main avenue for demanding director’s responsibility and accountability;

(c) Giving the Board the power to remove or discipline one of their members would likely undermine the minority representation in the Board, since it can lead to situations where the majority members of the Board would use their collective power to ease out minority members;

(d) If a director could be removed or disciplined by the Board, then it would probably make him susceptible to influence by the wishes of the powers-that-be in the Board; but by being immune from internal Board pressures and discipline, a director can go against the wishes of the majority when his business judgment tells him to do so without fear of being sanctioned; and

(e) More importantly, since the BOD is the business manager of the company vested with business discretion, the policy ensures that high-level discussions, negotiation, bargaining and compromise, and not the threat of sanctions from the majority, become the basis upon which business consensus and decisions are arrived at.

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).

cvillanueva@vgslaw.com

map@map.org.ph

http://map.org.ph