TITLE XII CLOSE CORPORATION

Sec. 96. Definition and applicability of Title

A close corporation is defined as "one whose articles of incorporation provide" that:

(a) All of 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);

(b) All of the issued stock of all classes shall be subject to one or more specified restrictions on
transfer permitted by Title XII of the Corporation Code; and

(c) The corporation shall not list in any stock exchange or make any public offering of any of its
stock of any class.

However, Section 96 has a proviso that notwithstanding the presence of all three (3) requisites in the
articles of incorporation, "a corporation shall be deemed not a close corporation when at least two-thirds
(2/3) of its voting stock or voting rights is owned or controlled by another corporation which is not a close
corporation."

The following cannot be a close corporation:

(1) Corporations declared to be vested with Public interest

(2) Insurance corporation
(3) Public utilities
(4) Educational institutions
(5) Bank
(6) Oil companies
(7) Mining companies
(8) Stock exchange

Villanueva is of position of the existing problem with the statutory definition. The objective test
of "what is provided in the articles of incorporation," which can be defeated by the test of "actual
disposition of shares of stock," gives rise to instability and downright confusion.

Close corporations are treated more as exceptional cases, while publicly-held corporations are the
general rule. Title XII of the Corporation Code which governs close corporations consists of relatively
few sections (Sections 96-105); in fact, the last paragraph of Section 96 provides that "the provisions of
other Titles of the Code shall apply suppletorily to close corporations except insofar as this Title
otherwise provides."

A closed corporation should be considered as a distinct type of business organization embodying

the best features of a partnership and a corporation. The separate personality, limited liability and right of
succession are all features of a corporate entity which the law upholds. The feature of delectus personae,
general management by all partners of business affairs are attractive features of a partnership which the
law guarantees and supervise.

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Characteristics of Close Corporation

(1) Stockholders may act as directors w/o need of election and thus are liable as directors;
(2) Quorum may be greater than mere majority;
(3) Transfer of stocks to others which would increase the number of stockholders to more than
maximum is invalid;
(4) Corporate acts may be binding even without a formal board meeting, if the stockholders had
knowledge or ratified the informal action of the others;
(5) Preemptive right extends to all stock issues;
(6) Deadlocks in board may be settled by the SEC, on written petition by any stockholder
(7) The right of appraisal may be exercised for any reason.

DE FACTO CLOSE CORPORATIONS

Definition & Nature

A de facto close corporation is a close corporation which does not with the Objective Test under
Section 96. A practical example is when actual business conditions would prevent stock-holders from
complying with the 20-stockholder limit or the transfer restriction attributes of close corporations, whilst
maintaining the close identity of stock ownership and active management.

Towards Statutory Recognition

Authors are of the opinion that jurisprudence would uphold the Objective Test in determining the
nature of the corporation, regardless of the actual practice. It is opined likewise that non-compliance with
the requirements on the Articles of Incorporation should not automatically merit declassification of the
corporation, but rather, administrative enforcement to ensure compliance with the requisites, under pain
of penalty under Section 144.

In the cases of Dulay v. CA (1993) and Naguiat v. NLRC (1997), the rulings tended to overlook
the formal requisites of a close corporation under Section 96. It is then possible that the coverage of a
close corporation may expand beyond the definition provided under the Code, and that principles
appertaining solely to close corporations may also be expanded to apply even to non-close corporations.

Nevertheless, in 1998, in San Juan Structural and Steel Fabricators, Inc. v. Court of
Appeals, the Court looked into the requisites under Section 96 to determine whether to consider a
corporation a close corporation, and thereby would allow the enforcement of corporate liability upon its
corporate officers

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;

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 (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 AND RESTRICTION IN THE TRANSFER OF SHARES

The restriction on the transferability of shares of stock in a close corporation is limited to what in
general parlance is called a right of first refusal. The right of first refusal is a control scheme essential to
a close corporation which allows the existing stockholders the power to maintain the character of delectus
personae and thereby prevent an outsider from coming into and interfering with the affairs of the
corporation.

Nevertheless, this right can be waived because under Section 98, if upon the expiration of said
period, the existing shareholder or corporation fails to exercise the option to purchase, the transferring
shareholder may sell his shares to any third person.

PROVISIONS FOR GREATER QUORUM OR VOTING REQUIREMENTS

Similar to ordinary corporations, close corporations are given by the Corporation Code,
particularly under Section 97 (3), the prerogative to provide in its articles of incorporation or in its by-
laws for greater quorum or voting requirements in meetings of stockholders or directors. Aside from the
quorum and voting requirement, the following provisions of the Corporation Code which generally apply
to ordinary corporations are likewise applicable to close corporations:

1. Section 7 which allows the classification and restriction of shares of stock including the
deprivation of voting rights;
2. Section 24 which reiterates the exercise by minority stockholders of the power of cumulative
voting;
3. Section 44 which expressly recognizes the power of a corporation to enter into management
contracts and provides for the procedure in the exercise of such power;
4. Section 58 which lays down the requirements for proxies; and
5. Section 59 which provides the requirements of voting trusts.

Close corporations are given authority to allow super-majority for quorum so that the
stockholders may have a greater say in the affairs of the corporation. Since in a close corporation setting,
participation in management may be agreed to be a manner by which corporation profits shall be

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distributed, the parties are allowed leeway by which minority shareholders are given a say by requiring
super-majority requirements for corporate acts.

Sec. 98. Validity of restrictions on transfer of shares

Restrictions on the right to transfer shares must appear

(a) Articles of Incorporation;

(b) By-laws; and
(c) Certificate of stock

Otherwise they shall not be binding on any purchaser 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.

CASE: Rural Bank of Salinas v. CA (1992)

A corporation, either by its board of director, its bylaws, or the act of its officers,
cannot create restriction in stock transfers, because restrictions in the traffic of stock must have
their source in legislative enactment or its charter, as the corporation itself cannot create such
impediment. The right of first refusal, therefore, should be available even to de facto close
corporations provided that same is delineated in the articles of incorporation and indicated in
the certificate of stock (to give notice to third parties) and is reasonable in its operation as not
to amount to a deprivation of a stockholders right to ultimately dispose of his shareholdings.

The right-of-first-refusal feature in a closed corporation setting is meant to provide a

default feature which need not be the subject of costly bargaining procedures

Other Restrictions:

Any transfer should not result in exceeding the maximum number of SHs
Prohibition on public offering
Qualifications for SH

Sec. 99. Effects of issuance or transfer of stock in breach of qualifying conditions. -

1. If stock of a close corporation is issued or transferred to any person who is not entitled under any
provision of the articles of incorporation to be 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.

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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, and if the issuance or transfer of stock to any person would cause the
stock to be held by more than 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 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 applicable if the transfer of stock, though contrary to
subsections (1), (2) of (3), has been consented to by all the stockholders of the close corporation, or 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.

Section 100. Agreements by Stockholders

1. Pre-incorporation agreements by and among stockholders shall survive the incorporation of the
corporation and shall continue to be valid and binding if such be their intent and to the extent that such
agreements are not inconsistent with the articles of incorporation

2. An agreement between two or more stockholders, if in writing and signed by the parties thereto, would
be valid and binding:

a. Even when it provides that in exercising any voting rights, the shares held by them shall be
voted as therein provided, or as they may agree, or as determined in accordance with a procedure
agreed upon by them.

b. Even though relating to any phase of the corporate affairs and even if the effect is to make
them partners among themselves.

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 c. Even if it relates to the conduct of the business and affairs of the corporation as to restrict or
interfere with the discretion or powers of the board of directors. Provided, that such agreement
shall impose on the parties-stockholders the liabilities for managerial acts imposed by the Code
on directors.

3. To the extent that the stockholders are actively engaged in the management or operation of the business
and affairs of a close corporation, the stockholders shall be held to strict fiduciary duties to each other and
among themselves.

Agreements among stockholders even for ordinary corporations essentially fall under the realm of
contracts and are governed by the Law on Contracts provided in our Civil Code. Under Article 1306 of
the Civil Code contracting parties may establish such stipulation, clauses, terms and conditions as they
may deem convenient provided they are not contrary to laws, morals, customs, public order and public
policy.

By way of illustration, in the case of Lambert vs. Fox, an agreement whereby the plaintiff and the
defendant being both stockholders of the corporation agreed not to dispose of any portion of their
shareholdings within the period of one year without previous written consent of the other party, with
penalty clause of P1,000 in case of violation, was held by the supreme court as valid.

On the other hand, agreement among stockholders of ordinary corporation (including de facto close
corporation) that relates to the conduct of the business and affairs of the corporation as to restrict or
interfere with the discretion of powers of the board would be invalid because of the restrictive provisions
of Section 23 and 27 of the Corporation Code.

Section 101. When Board Meeting is Unnecessary or Improperly Held

Section 101 of the Corporation Code states that, unless the by-laws provide otherwise, any action
by the directors of a close corporation under the following circumstances shall be valid despite the
absence of a board meeting:

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.

Under the second circumstance, ratification cannot take place where the action taken at a meeting
held without proper call or notice is beyond the corporate powers of the corporation.

If a directors meeting is held without proper call or notice, an action taken therein within the
corporate power is deemed ratified by a director who failed to attend, unless he promptly files his written
objection with the secretary of the corporation after having knowledge thereof.

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Section 102. Preemptive Right

Pre-emptive right under Ordinary Corporation vs Closed Corporation

Pre-preemptive in ordinary corporations, stockholders are given the preferential right to the issuance of
shares of stock (increase and new issuances) in proportion to their current shareholding, subject to certain
exceptions provided by Sec. 39, and as may be limited to by the Articles of Incorporations.

The pre-emptive right in closed corporations is essentially the same, although statutorily, is a little
broader than that of ordinary corporations. The exceptions provided in section 39, namely on those
issuances on required minimum stock ownership by the public, those issued in good faith with the
approval of stockholders, whether for the acquisition of property for corporate purposes, or for the
payment of standing debts, do not apply to closed corporations. This is because the provisions on closed
corporations expressly excludes these issuances as exceptions to the rule, unlike Sec. 39 which provides
for their exclusion. The right even applies regardless of the classes of shares issued. Voting, non-voting.
Preferred or common, treasury or fresh-issuances.

Section 103. Amendment of the Articles of Incorporation

Any amendment to the articles of incorporation which seeks to delete or remove any provision required
by this Title to be contained in the articles of incorporation or to reduce a quorum or voting
requirement stated in said articles of incorporation shall not be valid or effective unless approved by the
affirmative vote of at least two-thirds (2/3) of the outstanding capital stock, whether with or without
voting rights, or of such greater proportion of shares as may be specifically provided in the articles of
incorporation for amending, deleting or removing any of the aforesaid provisions, at a meeting duly called
for the purpose.

Section 104. Deadlocks

There is Deadlock when the directors or stockholders are so divided respecting the management
of the corporations business and affairs that the votes required for any corporate action cannot be
obtained with the consequence that the business and affairs of the corporation can no longer be conducted
to the advantage of the stockholders generally.

There is Deadlock not only in cases where the votes of two contending groups are equal but also
in cases where the required vote cannot be obtained because of division in the corporation.

What are the remedies of a stockholder in case of a Deadlock?

The SEC, upon written petition by a stockholder, shall have the Power to Arbitrate the dispute, In
the exercise of such power, The Commission shall have Authority to make such Order as it deems
appropriate, including and order:

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 1. Cancelling or altering any provision contained in the Articles of Incorporation or By-laws or any
stockholders agreement.
2. Cancelling, altering or enjoining any resolution or act of the Corporation, its Board of Directors,
stockholders or officers.
3. Directing or Prohibiting any act of the Corporation, its Board of Directors, stockholder, officers
or any person party to the action.
4. Requiring the purchase at their fair value of shares of any stockholder, either by the corporation
regardless of availability of Unrestricted Retained Earnings in its books, or by the Other
Stockholders.
5. Appointing of a Provisional Director.
6. Dissolving a Corporation or
7. Granting such other relief as the circumstances may warrant.

Who may be a Provisional Director?

A Provisional Director shall be an impartial person who is neither a stockholder nor a creditor of
the corporation or the subsidiary or affiliate of the corporation and whose further qualifications, if any,
may be determined by the Commission. A provisional Director is not a receiver of the corporation and he
does not have the title and powers of a custodian or receiver.

A Provisional Director shall have the rights and powers of a duly elected director of a corporation
including the right to notice of and vote in the Meetings of Directors, until such time as he shall be
removed by Order of the Commission or by all the stockholders. His compensation shall be determined
by Agreement between him and the corporation subject to the approval of the commission, which may fix
his compensation in the absence of agreement or in the event of disagreement between the Provisional
Director and the Corporation.

Differences between Sections 104 and 105 of the Corporation Code

Section 104 Section 105

Power of the corporation to compel purchase of his shares
Only in deadlock situation For any reason
Directed against the corporation or any Against the corporation only
stockholder
Even without unrestricted retained earnings; not When the corporation has sufficient assets in its
subject to any formula books to cover debts and liabilities exclusive of
capital stock
Power to Dissolve
SEC SEC
Compelling dissolution - deadlock When any of the acts of the directors, officers,
those in control of the corporation is illegal or
fraudulent, dishonest or oppressive, or unfairly
prejudicial to the corporation or any of the
stockholders Or whenever corporate assets are
being misapplied or wasted

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