CLOSE CORPORATION

What are the requisites of a close corporation?

1. All the corporation's issued stock of all classes, exclusive of treasury shares, shall be
held of record by not more than a specified number of persons, not exceeding twenty
(20);
2. All the issued stock of all classes shall be subject to one or more specified restrictions
on transfer permitted by this Title; and
3. The corporation shall not list in any stock exchange or make any public offering of
any of its stock of any class.

May any type of corporation, be organized as such close corporation?

No, the 3 qualifying conditions must be present

What if 2/3 of the outstanding capital stock is owned by another corporation which is
also a close corporation, will it be a close corporation?
No, it will only be a close corporation if 2/3 of the voting stocks of a close corporation is also
owned by a close corporation. Stated otherwise, even if another corporation owns or controls
2/3 of the voting stocks of a close corporation, the latter may still be considered as such close
corporation if the corporation owning or controlling the shares is also a close corporation.
(Sec. 96, first par.)

What kind of corporations cannot be a close corporation? (Sec. 96, second par.)
1. Mining or oil companies,
2. Stock exchange
3. Banks and insurance companies,
4. Public utilities
5. Educational institutions
6. Corporations vested with public interest

Is there is right of classification of directors in a stock corporation?

No, there is none.

Is there is right of classification of directors in a close corporation?

Yes, there is.

For Sec. 97:

Par. 1:
Class A - incorporators
Class B - relatives (3rd degree)
Class C - close business associates

Before a holder of an A share may offer his share to others, he must first offer it to the same
holders of A share.

Par. 2: 5-man member board

1k Class A 1 rep.
500 Class B 1 rep. 3 directors for each class of share
200 Class C 1 rep.
How will each class has its representative?
Cumulative voting within each class

Class A = 5k votes (1k shares x 5 directors)

Class B = 2, 500 votes (500 shares x 5 directors)
Class C = 1k votes (200 shares x 5 directors)

How many members can be elected to the Board for each class?
Class A - 3 members (5k votes ÷ 3 candidates)
Class B - 2 members (2, 500 votes ÷ 2 candidates)
Class C - no seat (only 5 directors are needed; both Class A and B already have 5 candidates)

Par. 3:
Stockholders/members meeting - instead of majority outstanding capital stock or majority of
the members, it may be stipulated that 3/4 is needed to have a quorum
Directors/trustees meeting - instead of majority of the members of the Board as fixed in the
articles of incorporation, it may be stipulated that majority of the members of Board present
in the meeting is needed to have a quorum

NOTE:
After classification, it must be followed by qualification then restriction

Restriction, to be valid:
1. Ordinary stock corporation
a. Articles of incorporation; and
b. Certificate of stocks
2. Close corporation
c. Articles of incorporation;
a. Certificate of stocks; and
b. By-laws

What happens if the transfer of shares is in violation of the qualifying conditions

provided for in the articles of incorporation, stock certificate and by-laws?

A1 has 200 shares. He wants to transfer his shares. Pursuant to restrictions and transfers of
shares, he first offered them to the existing A shareholders but to no avail. He then offers the
same to the corporation. The corporation is not in the position to acquire the shares. And,
pursuant to the conditions of restrictions and transfers, he now transfers his shares to X and Y
at 100 shares each. But X and Y are not qualified as stockholders of class A shares. They are
not incorporators nor relatives of A shareholders to the same degree provided for in the
articles of incorporation. Prior to such transfer, there are 20 stockholders. Upon transfer to X
and Y, there would have already been 21 stockholders.

May the transferee of the share of stock, if it violates the qualifying condition as
provided in the articles of incorporation, stock certificate and by-laws, has the same
right, power and privilege to compel the corporation that the transfer be recorded in
their name in the same manner as the transferee of the shares of stocks in ordinary
stock corporation may have?
No, they will not have the same right, power and privilege because Sec. 99 says "the
corporation may, at its option, refuse to register the transfer of stock in the name of the
transferee" (par. 4). It is optional; it not ministerial.

This is the rule in close corporation despite the ruling in Rural Bank of Salinas v. CA that the
right of the transferee to have the transfer recorded in his name in the books of the
corporation is an inherent right flowing from his stock ownership and if it is denied without
good cause, it may be compelled to do so by mandamus. The duty of the secretary to record
transfer is ministerial.

What happens now if it cannot be recorded in the books of the corporation?

The transferees (X and Y) may rescind the transaction (Sec. 99, last par.)

What is the remedy of A1?

He may compel the close corporation to purchase his shares at their fair value for any reason
provided that the corporation has sufficient assets to cover its debts and liabilities exclusive
of capital (Sec. 105)

What if there are already 20 stockholders and they want to add 2 more, may the
corporation be compelled to records the transfer?
In ordinary stock corporations, they may compel by mandamus. In close corporations, they
may not be compelled because it breaches the qualifying conditions. The corporation has the
option to refuse or not (Sec. 99[4]).

Since they cannot be compelled, may they admit?

Yes, provided all the stockholders consented or, instead of consenting, they decide to amend
their articles of incorporation (Sec. 99[5]). It will have to amend the articles of incorporation
to accommodate other purchasers of share. However, it will cease to be a close corporation if
it amends and becomes in excess of 20.

What if the other stockholders object to register? What will be the remedy of the
transferee?
His remedy is rescission. The effect of rescission is mutual restitution (Sec. 99, last par.).

How about the stockholder, what is his recourse?

He may compel the close corporation to purchase his shares at their fair value for any reason,
provided the corporation has sufficient assets in its books to cover the debts and liabilities
exclusive of capital.

NOTE:
In a close corporation, there is a withdrawing stockholder, unlike in an ordinary stockholder
where there is none, they may only do so in the exercise of appraisal rights.
What are the requirements before an act of a close corporation becomes valid even
without a meeting? (Sec. 101)
1. Before or after such action is taken, written consent thereto is signed by all the
directors; or
2. All the stockholders have actual or implied knowledge of the action and make no
prompt objection thereto in writing; or
3. The directors are accustomed to take informal action with the express or implied
acquiescence of all the stockholders; or
 4. All the directors have express or implied knowledge of the action in question and
none of them makes prompt objection thereto in writing.

In case of deadlocks, what is the remedy?

Any stockholder may write a petition the SEC (now the proper forum) to arbitrate the dispute
(Sec. 104)

What are the powers of SEC (now the proper forum) thereafter in the management of
the corporation?
1. Cancelling or altering any provision contained in the articles of incorporation, by-
laws, or any stockholder's agreement;
2. Cancelling, altering or enjoining any resolution or act of the corporation or its board
of directors, stockholders, or officers;
3. Directing or prohibiting any act of the corporation or its board of directors,
stockholders, officers, or other persons party to the action;
4. Requiring the purchase at their fair value of shares of any stockholder, either by the
corporation regardless of the availability of unrestricted retained earnings in its books,
or by the other stockholders;
5. Appointing a provisional director;
6. Dissolving the corporation; and
7. Granting such other relief as the circumstances may warrant.

REMINDERS:
1. Even if 100 % is owned by one person it will not be considered a close corporation
without the 3 requirements of Sec. 96
2. Other officers may be directly appointed and hired by the stockholders instead of the
Board of Directors
3. If it is not denied in the articles of incorporation or any amended thereto, the pre-
emptive rights in a close corporation is absolute because there is no public offering in
a close corporation, otherwise it will not be considered as close corporation
4. Powers of the SEC in intra-corporate concerns has been transferred to the special
commercial courts (proper forum) - original and exclusive jurisdiction
5. Dishonesty is a ground for dissolution of a close corporation
6. Family corporations are not automatically close corporations; the 3 qualifying
conditions must be present.

CLOSE CORPORATION ORDINARY STOCK

CORPORATION
Number of Cannot exceed 15 Unlimited
stockholders
Number of directors May be more than 15 to the Maximum of 15
extent that all stockholders can
be deemed directors
Restriction on shares Subject to certain restrictions Generally No restriction
of stock
Prohibition on shares Shares of stock are prohibited No prohibition
of stock from being listed in the stock
exchange or offered for sale to
the public
Liability on corporate Those active in management are Directors are liable only if they
torts personally liable unless the
corporation has obtained an
adequate liability insurance
Meeting requirement Directors can validly act even
without a meeting
Management by Agreements between
stockholders stockholders regarding the
operations of the business can
validly be made
Cumulative voting May be restricted to the extent
that directors may be classified
into one or more classes and to
be voted solely by a particular
class of stock
Election of officers The articles of incorporation
may provide that all officers
shall be elected or appointed by
the stockholders
Quorum and voting It may provide for greater
requirements quorum and voting
requirements in meetings of
stockholders and directors
Restriction on transfer Should be indicated in:
of shares of stock a. articles of incorporation
b. stock certificate
c. by-laws
Pre-emptive right Broader because it includes all
issued without exception
Return of investment A stockholder may withdraw
and compel the corporation to
purchase his shares for any
reason with the limitation only
that the corporation has
sufficient assets to cover its
liabilities exclusive of capital
stock
Interference Proper forum may interfere in
case of deadlocks even if the
directors/stockholders are acting
in good faith
Dissolution Any stockholder may petition
the SEC for corporate
dissolution on grounds among
other provided for in Sec. 105
have acted negligently or
fraudulently
Directors must act as a body at a
duly constituted meeting
Not valid and binding since
stockholders' agreement cannot
limit the discretion of the Board
to manage corporate affairs
No classification and no
restriction
Officers are elected by the
Board
The articles of incorporation or
by-laws may provide for greater
quorum and voting
requirements in directors'
meeting except those for
stockholders' meeting which
cannot be altered
Should be indicated in:
a. articles of incorporation
b. stock certificate
May be denied under Sec. 39
Unless he sells his shares, a
stockholder cannot get back his
investment nor compel the
corporation to buy his shares
except in the exercise of his
appraisal right
Courts may not interfere in the
business judgment of the
directors/stockholders
Only on the grounds provided in
the Code and PD 902-A, as
amended
TRUE OR FALSE:
1. A corporation is a close corporation if 2/3 of voting rights is owned by another
corporation.
2. A corporation must at all times have unrestricted retained earnings

ANSWER:
1. False, it will only be a close corporation if 2/3 of the voting stocks of a close
corporation is also owned by a close corporation.
2. False, (a) in case of redemption of redeemable share where the corporation may also
require its shares regardless of the existence of unrestricted retained earnings as
provided for in Sec. 8; and (b) in case of stockholder's right to compel a close
corporation to purchase his share, for any reason, under Sec. 105, when the
corporation has sufficient assets in its books to cover its debts and liabilities exclusive
of capital stock.

Explain:
1. The right of a stockholder to compel the corporation to pay the value of his shares is
broader in a close corporation in a close corporation than in an ordinary stock
corporation.
2. In cases of deadlock in a close corporation the courts can interfere in the management
of the corporate affairs.

ANSWERS:
1. Under Section 105 of the Corporation Code, a stockholder of a close corporation,
may, for any reason compel the corporation to purchase his shares at their fair value,
which shall not be less than their pair or issued value, with the limitation only that the
corporation has sufficient assets to cover its liabilities exclusive of capital stock. In an
ordinary stock corporation, unless a stockholder sells his shares, a stockholder cannot
get back his investment nor compel the corporation to buy his shares expect in the
exercise of his appraisal right under Section 81 of the Corporation Code.
2. Under Section 104 of the Corporation Code, the SEC is granted a wide discretion in
respect to the management of a close corporation in the event of a deadlock. This
jurisdiction of the SEC has been transferred to the regular courts under RA 8799 or
the Securities and Regulation Code.

Enumeration:
Grounds for involuntary dissolution provided for in the Code.

ANSWER:
a. Violation of any provision of the Code (Sec. 144);
b. In case of deadlock in a close corporation (Sec. 105);
c. In a close corporation, any acts of directors, officers or those in control of the
corporation which is illegal or fraudulent or dishonest or oppressive or unfairly
prejudicial to the corporation or any stockholder or whenever corporate assets are
being misapplied or wasted (supra.)

Objectives:
Distinguish close corporation from ordinary stock corporation:

ANSWER: (see table)