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Close Corporations

Chapter 15
Definition
Definition
Sec. 96. Definition and applicability of Title. - A close corporation, within the meaning of this Code, is one
whose articles of incorporation provide that: (1) All the corporations 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. Notwithstanding the foregoing, a corporation shall not be
deemed a close corporation when at least two-thirds () of its voting stock or voting rights is owned or
controlled by another corporation which is not a close corporation within the meaning Code.

Any corporation may be incorporated as a close corporation, except mining or oil companies, stock
exchanges, banks, insurance companies, public utilities, educational institutions and corporations
declared to be vested with public interest in accordance with the provisions of this Code.

The provisions of this Title shall primarily govern close corporations: Provided, That the provisions of other
Titles of this Code shall apply suppletorily except insofar as this Title otherwise provides.
Definition
The ultimate effect of the special provisions of the law on close corporations is to furnish another form of
business organization - a de facto corporation with a corporate shell. It is referred to sometimes as a
hybrid of both the corporate and partnership forms, an incorporated partnership or corporation de jure
but a de facto partnership.

This is because a close corporation may partake the nature of a partnership in that the stockholders
thereof take an active role in the management of the corporate affairs either as directors, officers or even
perhaps as partners in management which is akin to the partnership form of business. This, in fact, is the
main distinction between a close corporation and the ordinary stock corporation where, in the latter, the
stockholders have hardly a voice in management except perhaps to elect the directors.

Despite this, the stockholders who are active in management still enjoy limited liability to the extent of their
subscription in so far as corporate obligations are concerned. It will be noted, however, that under no. 5
Sec. 100 of the Code, they are made personally liable for corporate torts unless they have obtained a
reasonably adequate insurance liability.
Close Corporations
Close Corporations
Close corporations must contain the three provisions required to be indicated in
the AOI as provided by Sec. 96. Absent any of the provisions required by the said
section, the corporation, will not, for all legal intents and purposes, be considered
as a close corporation and would thus not be governed by Title XII of the Code,
but by the general provisions governing ordinary corporation. A corporation does
not become a close corporation because man and his wife owns 99.86% of the
capital stock (San Juan Structural Steel vs. CA). The qualifying conditions
required by law must be complied with.
owned by another corporation
owned by another corporation
Even if another corporation owns or controls of the voting stocks of a close
corporation, the latter may still be considered as such close corporation if the
corporation or controlling shares is also a close corporation.
Business with public interest
Business with public interest
Business with public interest may not be formed as a close corporation under the
second paragraph of Sec. 95. Sec. 140 of the Code lays down a similar policy
authorizing NEDA to recommend to the legislature the setting of maximum limits to
family or group ownership of stock in corporations vested with public interest, and
the determination of whether or not it should be vested with public interest within
its domain.
Permissive provisions
Sec. 97. Articles of incorporation. - The articles of incorporation of a close corporation may provide:

1. For a classification of shares or rights and the qualifications for owning or holding the same and restrictions
on their transfers as may be stated therein, subject to the provisions of the following section;
2. For a classification of directors into one or more classes, each of whom may be voted for and elected solely
by a particular class of stock; and
3. For a greater quorum or voting requirements in meetings of stockholders or directors than those provided in
this Code.

The articles of incorporation of a close corporation may provide that the business of the corporation shall be
managed by the stockholders of the corporation rather than by a board of directors. So long as this provision
continues in effect:

1. No meeting of stockholders need be called to elect directors;


2. Unless the context clearly requires otherwise, the stockholders of the corporation shall be deemed to be
directors for the purpose of applying the provisions of this Code; and
3. The stockholders of the corporation shall be subject to all liabilities of directors.

The articles of incorporation may likewise provide that all officers or employees or that specified officers or
employees shall be elected or appointed by the stockholders, instead of by the board of directors.
Classification of shares
Classification of shares
Under no. 1 of the previous slide, the close corporation may classify its shares into
different classes to be held of record only by the specified persons. Example:
Classes A, B and C. Class A is to be held only by the incorporators; Class B by
their relatives within the third civil degree of consanguinity or affinity; Class C by
their close business associates.
Classification of Directors
Classification of directors
Under no. 2, a close corporation may provide for a classification of directors into one or more class, each
of whom may be voted for and elected solely by a particular class of stock.

Example: 1,000 class A shares; 500 class B shares; and 200 class C shares. The AOI may provide that
each class shall have a representation in the BOD regardless of the number of shares within each class.
So, if the close corporation has 5 directors, then the AOI may allocate 3 directors for Class A shares, 1 for
B and 1 for C. Within each class, cumulative voting may also be exercised by the stockholders of such
class to elect their representative in the board. But to the extent that each class can elect its own directors
regardless of the number of shares in such class, cumulative voting may, in effect be restricted. This is so
because there is no provision for a classification of directors, then Class A stockholders, b cumulating
their votes (5x1000) will have 5,000 votes and can elect 3 directors with 1,666 votes each. Class B
shares, having 2,500 votes can vote 2 members and Class C shares having only 1,000 votes cannot be
guaranteed to any seat in the board.
Quorum and voting requirement
Quorum and voting requirement
A close corporation may provide for a greater quorum or voting requirement under
no. 3. Although the AOI or By-laws of other stock corporations may provide for
greater quorum and voting requirements in directors meeting as provided in Sec.
25 of the Code, those for stockholders meeting, unlike in a close corporation, may
not be altered or increased. This provisions in effect, increases the veto power of
the minority stockholders.
Direct management by stockholders
Direct management by stockholders
The AOI of the close corporation may provide that the corporation shall be managed by the stockholders
rather than by the BOD. If such be the case, the stockholders are deemed directors and are subject to all
the rights and liabilities of a director. However, their liability would be more extensive in that they are
personally liable for torts unless, again, the corporation has obtained reasonably adequate liability
insurance. As distinguished from the ordinary stock corporation, directors hereof are liable for corporate
torts only if they have been negligent or acted fraudulently in the performance of their functions. As to
what is reasonably adequate liability insurance would vary depending on the facts and circumstances of
the case.

In order that the provisions allowing a close corporation to do away with a BOD may be effective, the
same must contain the continuing provisions required in par. 2 of Sec. 97:

1. No meeting of stockholders need be called to elect directors;


2. Unless the context clearly requires otherwise, the stockholders of the corporation shall be deemed
to be directors for the purpose of applying the provisions of this Code; and
3. The stockholders of the corporation shall be subject to all liabilities of directors.
Election of officers
Election of officers
Sec. 97 likewise allows the AOI of a close corporation to provide that all officers or
employees shall be elected or appointed by the stockholders of the BOD.
Effect of breach of qualifying conditions
Effect of breach of qualifying conditions
Sec. 98. Validity of restrictions on transfer of shares. - Restrictions on the right to
transfer shares must appear in the articles of incorporation and in the by-laws as
well as in the certificate of stock; otherwise, the same shall not be binding on any
purchaser thereof in good faith. Said restrictions shall not be more onerous than
granting the existing stockholders or the corporation the option to purchase the
shares of the transferring stockholder with such reasonable terms, conditions or
period stated therein. If upon the expiration of said period, the existing
stockholders or the corporation fails to exercise the option to purchase, the
transferring stockholder may sell his shares to any third person.
Effect of breach of qualifying conditions
The restriction must be indicated not only in the AOI and the stock certificates but
also in the by-laws. The restrictions, however, shall not be more onerous than
granting existing stockholders or the corporation the option to purchase the shares
of the selling or transferring stockholder within reasonable terms, conditions and
period. If, after the expiration of the period, the existing stockholders or the
corporation fails to exercise the option the stockholder concerned may transfer his
shares to any third person subject to the provisions, however, of Sec. 99:
Sec. 99. Effects of issuance or transfer of stock in breach of qualifying conditions.
1. If the stock of a close corporation is issued or transferred to any person who is not entitled under any provisions of the articles
of incorporation to e a holder of record of its stock, and if the certificate for such stock conspicuously shows the qualifications
of the persons entitled to be holders of record thereof, such person is conclusively presumed to have notice of the fact of his
ineligibility to be a stockholder.
2. If the articles of incorporation of a close corporation states the number of persons, not exceeding twenty (20), who are entitled
to be holders of record of its stock, and if the certificate for such stock conspicuously states such number of persons, the
person to whom such stock is issued or transferred is conclusively presumed to have notice of this fact.
3. If a stock certificate of any close corporation conspicuously shows a restriction on transfer of stock of the corporation the
transferee of the stock is conclusively presumed to have notice of the fact that he has acquired stock in violation of the
restriction, if such acquisition violates the restriction.
4. Whenever any person to whom stock of a close close corporation has been issued or transferred has, or is conclusively
presumed under this section to have, notice either (a) that he is a person not eligible to be a holder of stock of the corporation,
or (b) that transfer of stock to him would cause the stock of the corporation to be held by more than the number of persons
permitted by its articles of incorporation to hold stock of the corporation, or (c) that the transfer of stock is in violation of a
restriction on transfer of stock, the corporation may, at its option, refuse to register the transfer of stock in the name of the
transferee.
5. The provisions of subsection (4) shall not be applicable if the transfer of stock, though contrary to subsections (1), (2) or (3),
has been consented to by all the stockholders of the close corporation, of if the close corporation has amended its articles of
incorporation in accordance with this Title.
6. The term transfer as used in this section is not limited to a transfer for value.
7. The provisions of this section shall not impair any right which the transferee may have to rescind the transfer or to recover
under any applicable warranty, express or implied.
Sale of shares
Sale of shares
Apparently, a selling stockholder may not be able to transfer his shares if to do so
would violate the qualifying conditions indicated in the AOI unless of course, all the
stockholder consents to the transfer or the AOI is amended (no. 5 above).
Stockholder
Stockholder
Stockholder concerned is not, however, left without any recourse as he may
compel the close corporation to purchase his shares at their fair value for any
reason subject only to the condition laid down in Sec. 105.
Transferee
Transferee
Transferee may rescind the transaction or to recover from the transferor under any
applicable warranty, express or implied.