Trust Fund Doctrine

The trust fund doctrine enunciates a –

xxx rule that the property of a corporation is a trust fund for the payment of creditors, but such
property can be called a trust fund ‘only by way of analogy or metaphor.’ As between the
corporation itself and its creditors it is a simple debtor, and as between its creditors and
stockholders its assets are in equity a fund for the payment of its debts.

It is established doctrine that subscriptions to the capital of a corporation constitute a fund to

which creditors have a right to look for satisfaction of their claims and that the assignee in
insolvency can maintain an action upon any unpaid stock subscription in order to realize assets for
the payment of its debts. (Velasco vs. Poizat, 37 Phil., 802) xxx

The trust fund doctrine is not limited to reaching the stockholder’s unpaid subscriptions. The scope
of the doctrine when the corporation is insolvent encompasses not only the capital stock, but also
other property and assets generally regarded in equity as a trust fund for the payment of corporate
debts. All assets and property belonging to the corporation held in trust for the benefit of creditors
that were distributed or in the possession of the stockholders, regardless of full payment of their
subscriptions, may be reached by the creditor in satisfaction of its claim.

Also, under the trust fund doctrine,a corporation has no legal capacity to release an original
subscriber to its capital stock from the obligation of paying for his shares, in whole or in
part, without a valuable consideration, or fraudulently, to the prejudice of creditors. The creditor is
allowed to maintain an action upon any unpaid subscriptions and thereby steps into the shoes of
the corporation for the satisfaction of its debt. To make out a prima facie case in a suit against
stockholders of an insolvent corporation to compel them to contribute to the payment of its debts
by making good unpaid balances upon their subscriptions, it is only necessary to establish that the
stockholders have not in good faith paid the par value of the stocks of the corporation.

REFERENCE: Halley v. Printwell, GR No. 15749

Investment of Corporate Funds - Section 41

SEC. 41. Power to Invest Corporate Funds in Another Corporation or Business or for Any
Other Purpose. – Subject to the provisions of this Code, a private corporation may invest its funds
in any other corporation, business, or for any purpose other than the primary purpose for which it
was organized, when approved by a majority of the board of directors or trustees and ratified by
the stockholders representing at least two-thirds (2/3) of the outstanding capital stock, or by at
least two thirds (2/3) of the members in the case of nonstock corporations, at a meeting duly called
for the purpose. Notice of the proposed investment and the time and place of the meeting shall be
addressed to each stockholder or member at the place of residence as shown in the books of the
corporation and deposited to the addressee in the post office with postage prepaid, served
personally, or sent electronically in accordance with the rules and regulations of the Commission
on the use of electronic data message, when allowed by the bylaws or done with the consent of the
stockholders: Provided, That any dissenting stockholder shall have appraisal right as provided in
this Code: Provided, however, That where the investment by the corporation is reasonably
necessary to accomplish its primary purpose as stated in the articles of incorporation, the approval
of the stockholders or members shall not be necessary.

Rule:

Pursuing Primary Purpose

 Where the investment by the corporation is reasonably necessary to accomplish its primary
purpose as stated in its AOI, the approval of the stockholders or members shall not be necessary.

 Requires only the approval of the Board.

Corporation as Incorporator

 Sec. 41 does not distinguish between an investment by a corporation in another existing

corporation and an investment as an incorporator in a new corporation to be formed.

 Implication: investment by a corporation as an incorporator would be subject to Board

approval only, no need for members’ or stockholders’ ratification IF the same is reasonably
necessary to accomplish its primary purpose.

 Sec. 5, SEC Memorandum Circular No. 16, Series of 2019 provides:

 SEC-registered domestic corporation or association is made an incorporator - its investment

in the new corporation must be approved by a majority if the board of directors or trustees
and ratified by the stockholders representing at least 2/3 of the outstanding capital stock
(stock corporation) or at least 2/3 of the members (non-stock corporation), at a meeting duly
called for the purpose.

 The requirement does not provide for any exception.

 Implication: even if the investment in the new corporation is reasonably necessary to

accomplish the investor’s primary purpose, ratification by the stockholders or members is
required.

Pursuing Secondary Purpose

Requirements:

1. There must be approval by a majority of the BOD/BOT;

2. the approval of the board must be ratified by the stockholders representing at least 2/3 of the OCS,
or by at least 2/3 of the members in the case of non-stock corporations, at a stockholders’ or
members’ meeting duly called for the purpose; and

3. In calling the stockholders’ meeting, notice of the proposed investment and the time and place of
the meeting shall be addressed to each stockholder or member at his/her/its place of residence as
shown in the books of the corporation and deposited to the addressee in the post office with postage
prepaid, or served personally, or sent electronically in accordance with SEC rules and regulations on
the use of the electronic data message when allowed by the by-laws or done with the consent of the
stockholders.
Appraisal Right

- granted because the stockholder will be exposed to a line of business that is not being pursued when
he invested in the company; his investment will be exposed to additional risks which was not
contemplated when he made the investment.

Investment

 Includes not only investment of money but also investment of property of the corporation.

- At times when a property is not necessary to its business, it may employ the property in a
business or for purpose which is not within the primary purpose in order to prevent the same
form being idle or unprofitable

Requirements (the corporation is allowed to lease its properties)

1. That the property is not presently used by the company and the leasing thereof is not made
on a regular basis;

2. That by leasing the property, it will make it productive instead of allowing them to remain
idle;

3. That there are no express restrictions in the AOI or By-laws;

4. That the leasing is not used as a scheme to prejudice corporate creditors or result in the
infringement of the Trust Fund Doctrine; and

5. That there must be compliance with the requirements of Section 41.

Investment in Shares

 Sec. 41 does not cover passive investment.

- A corporation with idle funds may invest in shares for the purpose of generating income

Note: it is within the authority and business discretion of the BOD/BOT of the corporation to
determine whether or not the investment by the corporation through acquisition of shares in another
corporation is reasonably necessary to accomplish its primary purpose as stated in the AOI.

Investment in Notes

 A corporation can invest its idle funds in bonds.

 It can also invest in corporate notes issued by private corporations and GOCCs.

 Legal basis: Sec. 35 - empowers corporations to deal with real and personal properties
including securities and bonds of other corporations as the transaction of lawful business of
the corporation may reasonably and necessarily require.

 Sec. 41 should be complied with if the investment is not pursuant to the primary purpose of
the corporation.
 SEC. 42. Power to Declare Dividends. – The board of directors of a stock corporation may
declare dividends out of the unrestricted retained earnings which shall be payable in cash, property,
or in stock to all stockholders on the basis of outstanding stock held by them: Provided, That any
cash dividends due on delinquent stock shall first be applied to the unpaid balance on the
subscription plus costs and expenses, while stock dividends shall be withheld from the delinquent
stockholders until their unpaid subscription is fully paid: Provided, further, That no stock dividend
shall be issued without the approval of stockholders representing at least two-thirds (2/3) of the
outstanding capital stock at a regular or special meeting duly called for the purpose.

Stock corporations are prohibited from retaining surplus profits in excess of one hundred
percent (100%) of their paid-in capital stock, except: (a) when justified by definite corporate
expansion projects or programs approved by the board of directors; or (b) when the corporation is
prohibited under any loan agreement with financial institutions or creditors, whether local or
foreign, from declaring dividends without their consent, and such consent has not yet been secured;
or (c) when it can be clearly shown that such retention is necessary under special circumstances
obtaining in the corporation, such as when there is need for special reserve for probable
contingencies.

BOD has the discretion to declare dividends.

Decision of the board alone is necessary to declare cash or property dividends.

Stock dividends - the decision of the board is subject to the approval of the stockholders representing
2/3 of the OCS.

Note: If the board does not want to declare stock dividends, then the stockholders cannot compel the
board to do so. The board’s discretion is maintained even if the dividends to be declared are stock
dividends.

 XPN: If the declaration of stock dividends requires increase of the authorized capital stock -
approval by the SEC of the increase of the authorized capital stock is necessary.

Requirements for dividend declaration:

1. Unrestricted retained earnings;

2. Resolution of the board; and

3. If stock dividends are declared, there must be a resolution of the Board with the concurrence of 2/3
of the OCS.

Property Dividends- are those that are paid in property instead of cash where the surplus is in that
form and it is practicable to do so distribute them among the shareholders.

 SEC rules: the property to be distributed as dividends shall consist only of property which is
no longer intended to be used in the operation of the business of the corporation and which
are practicable to be distributed as dividends.
  The issuance of property dividends shall not result in an inequitable distribution of property
to the stockholders in terms of the book of values and market values, if any, of the property
distributed.

 Where: some stockholders will receive cash and the other will receive property,

Rule: the prevailing market value of the property, as agreed upon by the stockholders
shall be considered in determining the equitable distribution of the total dividends.

Stock Dividends

 The earnings are distributed to the stockholders in the form of shares of stock.

 It involves the conversion of surplus or undivided profits into capital.

 Reasons for the declaration of stock dividends:

1. The corporation simply desires a larger permanent capitalization;

2. The market price may have increased above a desirable trading range and stock dividend will
generally reduce the per share market value of the company’s stocks;

3. The corporation may wish to have more stockholders (who might then buy its products) and
expects to eventually increase their number by increasing the number of shares outstanding. Some of
the stockholders receiving the stock dividend are likely to sell the shares to other persons; and

4. Stock dividends may be used to satisfy stockholders’ demands for cash dividends when the
corporation may not be willing to pay cash dividends but have enough money unrestricted retained
earnings.

Nature of stock dividends:

Dividends, regardless of the form there are declared, that is, cash, property or stocks, are valued at
the amount of the declared dividend taken from the unrestricted retained earning of a corporation.
Thus, the value of the declaration in the case of stock dividend is the actual value of the original
issuance of said stocks.

In the case of stock dividends, it is the amount that the corporation transfers from its surplus profit
account to its capital account or it is the amount that the corporation receives in consideration of the
original issuance of the shares.

Note: When the dividend is distributed, it ceases to be a property of the corporation as the entire or
portion of its unrestricted retained earnings is distributed pro rata to corporate shareholders.

When stock dividends are distributed, the amount declared ceased to belong to the corporation but is
distributed among the shareholders.

 Effect: the unrestricted retained earnings of the corporation are diminished by the amount of
the declared dividend while the stockholders’ equity is increased.

recap: declaration of dividends is discretionary upon the board

Note: Dividends are payable only when there are profits earned by the corporation and as a general
rule, even if there are existing profits, the BODs has the discretion to determine WON dividends are
declared.

XPN: Stock corporations are prohibited from retaining surplus profits in excess of 100% of their
paid-in capital. Thus, in such case, declaration of dividends is no longer purely discretionary on the
Board.

XPN to the XPN: Even if the retained surplus profits are in excess of 100% of the paid-in capital, the
Board may still refuse to declare dividends based on any of the following grounds:

1. It is justified by definite corporate expansion projects or programs approved by the Board; or

2. The corporation is prohibited under any loan agreement with any financial institutions or creditors,
whether local or foreign, from declaring dividends without their consent, and such consent has not
yet been secured; or

3. It can be clearly shown that such retention is necessary under special circumstances obtaining in
the corporation, such as when there is need for special reserve for probable contingencies.

SEC Memorandum Circular No. 11, Series of 2009 - Guidelines on the Determination of
Retained Earnings Available for Dividend Declaration:

Retained earnings

 The accumulated profits realized out of normal and continuous operations of the business
after deducting therefrom distributions to stockholders and transfers to capital stock or other
accounts.

 It shall be the amount as shown in the financial statements audited by the company’s
independent auditor.

 If applicable, such amount shall refer to the retained earnings of the parent company but not
the consolidated financial statements.

Unrestricted retained earnings

The amount of accumulated profits and gains realized out of normal and continuous operations of the
business after deducting therefrom distributions to stockholders and transfers to capital stock or other
accounts, and which is (1) Not appropriated by its BODs for corporate expansion projects or
programs; (2) Not covered by a restriction for dividend declaration under a loan agreement; and (3)
Not required to be retained under special circumstances obtaining in the corporation such as when
there is a need for a special reserve for probable contingencies.

Outstanding capital stock

Total shares of stock issued to subscribers or stockholders, whether or not fully or partially paid (As
long as there is a binding subscription agreement), except treasury shares.

Board – Board of Directors

Dividend – corporate profits allocated, lawfully declared and ordered by the directors to be paid to
the stockholders on demand or at a fixed time.

Delinquent subscription – subscription that has been declared by the Board as such after the
subscriber failed to settle the same after a period of 30 days from the date the subscription became
due as specified in the contact of subscription or in the call made by the board of directors.

Paid-in capital – the amount of outstanding capital and additional paid-in capital or premium paid
over the par value of shares.

GR: Dividends cannot be declared out of capital.

XPN: with respect to “wasting assets corporations” which are corporations solely or principally
engaged in the exploitation of wasting assets. They are allowed to distribute the net proceeds derived
from exploitation of their holdings such as mines, oil wells, patents and leaseholds, without
allowance or deduction or depletion.

GR: Trust fund doctrine is violated of dividends are declared out of capital.

XPNs:

1. Liquidating dividends and;

2. Dividends from investments in Wasting Assets Corporation.

Note: the cost of the treasury shares acquired from the redemption of redeemable shares is not
deducted and forms part of the retained earnings available for dividend declaration.

Paid-in surplus cannot be declared as dividends because they are part of capital.

 It is the difference between the par value and the issued value or selling price of the shares

 Not considered profits earned in the conduct of the business of the corporation

 Also called “premium”

 Additional Paid-In Capital (APIC) cannot be used for dividend declaration; it involves the
infusion of cash and property by a stockholder whenever no additional shares are issued in
consideration thereof.

 GR: Paid-in surplus cannot be declared as dividends. No dividend declaration if there is

a reduction surplus.

 XPNs:

1. That they be declared only as stock dividends and not as cash dividends;

2. No creditor is prejudiced; and

3. There is no resulting impairment of capital after declaration of dividends.

NOTE: THE XPNS FOR BOTH REDUCTION SURPLUS AND PAID-IN SURPLUS ARE NO
LONGER ACCEPTABLE UNDER THE PRESENT RULES PROVIDED IN SEC
MEMORANDUM CIRCULAR NO. 11, SERIES OF 2009.

Revaluation Surplus - occurs when there is an increase in the value of assets.

They are by nature subject to fluctuations.

GR: they cannot be declared as dividends because they cannot be considered earnings of the
corporation.

XPN: conditions:
1. The company has sufficient income from the operations from which the depreciation on the
appraisal increase is charged;

2. The company has no deficit at the time the depreciation on the reappraisal increase was charged to
operations; and

3. Such depreciation on the appraisal increase previously charged to operations is not erased or
impaired by subsequent losses, otherwise, only that portion not impaired by subsequent losses is
available for dividends.

Gain from sale of real property - available for dividend declaration because they part of retained
earnings.

XPN: corporations cannot distribute gains from sale of real property as dividends if the remaining
assets after distribution are less than the amount of legal or stated capital and liabilities.

Treasury shares - cannot be declared as stock dividends or cash dividends because they are not
considered part of earned or surplus profits.

Interim income:

GR: There can be no dividend declaration for profits in a fiscal year that has not yet expired.

XPN: conditions:

1. The amount of dividends involved would not be impaired by losses during the remaining period of
the year;

2. The projected income for the remaining period shall be submitted to the SEC; and

3. Should the company sustain losses during the remaining perios, the dividends should be refunded.

Who is entitled?

Stockholders are entitled to dividends pro rata based on the total number of shares. ONLY THE
STOCKHOLDERS AT THE TIME OF DECLARATION ARE ENTITLED TO DIVIDENDS.

Dividends are declared before the transfer of shares belong to the transferor, and dividends decalred
after the transfer belong to the transferee.
Record date is the future date specified in the resolution declaring dividend that the dividend shall be
payable to those who are stockholders of record on such specified future date or as of the date of the
meeting declaring said dividends.

Even unpaid subscribers are entitled to dividends.

Limitation: Sec. 42 - any cash dividends shall first be applied to the unpaid balance on the
subscription plus cost and expenses, while stock dividends shall be withheld from the delinquent
shareholder until his unpaid subscription is fully paid.

The right of the stockholders to be paid dividends accrues as soon as the declaration is made.

Effect: the corporation becomes their (stockholders’) debtor for their respective shares in the
dividends

The amount to be declared as dividends depends upon the amount of the unrestricted retained
earnings.

The dividends shall be declared pro rata, unless there are preferred shares that are entitled to a fixed
percentage.

Reportorial requirements

- right to dividend accrues even without the approval of the SEC.

Reportorial reqs:

1. Certification, under oath, by the corporate secretary, of the Board resolution declaring the
cash dividends;

2. Audited financial statements as of the last fiscal year, stamped received by the SEC and the
BIR;

3. Interim audited financial statements used as the basis for such declaration (to be submitted
also if the basis is other than item 2);

4. Project income statement for the remaining period certified by the company accountant;

5. Reconciliation of retained earnings available for dividend declaration certified by an

independent auditor.

Stock dividend declaration:

1. Certification, under oath, by the corporate secretary, of the declaration of stock dividends by
majority of the directors and the stockholders representing at least 2/3 of the OCS;

2. Audited financial statements as of the last fiscal year, stamped received by the SEC and the BIR;

3. Interim audited financial statements used as the basis for such declaration (to be submitted also if
the basis is other than item 2);
4. Project income statement for the remaining period;

5. Reconciliation of retained earnings available for dividend declaration certified by an independent

auditor.

6. Analysis of Capital Structure, signed under oath by the treasurer.

Property Dividend Declaration:

1. Certification, under oath, by the corporate secretary, of the Board resolution declaring the property
dividends;

2. List of stockholders and the allocation of the property dividends, as certified by the corporate
secretary;

3. Audited financial statements as of the last fiscal year, stamped received by the SEC and the BIR;

4. Detailed schedule of the property account appearing in the audited financial statements;

5. Certification by the president that the property is no longer needed in the operation of the
company.