Key Takeaway: The Supreme Court Upholds the Legality of Capital Stock Reduction Under Specific Conditions

Metroplex Berhad and Paxell Investment Limited v. Sinophil Corporation, et al., G.R. No. 208281, June 28, 2021

Imagine you’re a shareholder in a company that decides to reduce its capital stock. Suddenly, the value of your investment is at stake, and you’re left wondering about your rights and the legality of such a move. This scenario played out in the case of Metroplex Berhad and Paxell Investment Limited against Sinophil Corporation, a dispute that reached the Philippine Supreme Court. At its core, the case questioned the legality of a corporation’s decision to decrease its capital stock and the procedural steps required to ensure such actions are valid under Philippine law.

The crux of the case involved Metroplex and Paxell, foreign investors, challenging the reduction of Sinophil’s capital stock, which they believed was done selectively and without proper notice. The Supreme Court’s decision in this case sheds light on the legal framework governing capital stock reduction and the rights of shareholders, offering crucial guidance for corporations and investors alike.

Legal Context: Understanding Capital Stock Reduction Under Philippine Law

In the Philippines, the reduction of a corporation’s capital stock is governed by Section 38 of the Corporation Code. This section outlines the procedural requirements that a corporation must follow to legally decrease its capital stock. It mandates that such a reduction must be approved by a majority vote of the board of directors and a two-thirds vote of the outstanding capital stock at a stockholders’ meeting specifically called for this purpose.

The term “capital stock” refers to the total amount of shares a corporation is authorized to issue. Reducing this can be a strategic move for a company, often used to eliminate accumulated losses or to return capital to shareholders. However, it can also lead to disputes among shareholders, particularly if they feel their rights are being infringed upon.

Section 38 of the Corporation Code states: “No corporation shall increase or decrease its capital stock…unless approved by a majority vote of the board of directors, and at a stockholder’s meeting duly called for the purpose, two-thirds (2/3) of the outstanding capital stock shall favor the increase or diminution of the capital stock…” This provision ensures that shareholders have a say in significant corporate decisions that may affect their investments.

For instance, consider a company facing financial difficulties. It might decide to reduce its capital stock to streamline its financial structure. If the company follows the legal requirements, such as providing written notice to all shareholders and obtaining the necessary votes, the reduction would be legally valid. However, if it fails to adhere to these procedures, shareholders like Metroplex and Paxell could challenge the action in court.

Case Breakdown: The Journey of Metroplex and Paxell’s Challenge

Metroplex Berhad and Paxell Investment Limited, both foreign corporations, entered into a Share Swap Agreement with Sinophil Corporation in 1998. Under this agreement, Metroplex and Paxell transferred shares in another company in exchange for a significant stake in Sinophil. However, in 2001, Sinophil and another corporation, Belle Corporation, executed an Unwinding Agreement with Metroplex and Paxell, rescinding the original swap.

Following the unwinding, Sinophil’s shareholders voted to reduce the company’s authorized capital stock in 2002, 2005, and 2007. These reductions were approved by the Securities and Exchange Commission (SEC), leading Metroplex and Paxell to file a petition for review, arguing that the reductions were selective and violated their rights.

The case progressed through the SEC and the Court of Appeals (CA), both of which upheld the reductions as valid. The Supreme Court, in its decision, affirmed the lower courts’ rulings, emphasizing that Sinophil had complied with the requirements of Section 38 of the Corporation Code.

The Supreme Court’s reasoning included the following key points:

• “We reject petitioners’ contentions as they do not even cite any particular rule wherein notice and hearing is required before approval for the increase or decrease in the capital stock is granted or denied.”
• “Under Section 38 of the Corporation Code, such decrease only requires the approval of a majority of the board of directors and, at a stockholder’s meeting duly called for the purpose, two-thirds (2/3) vote of the outstanding capital stock.”
• “The SEC’s function here is purely administrative in nature,” focusing on ensuring compliance with formal requirements rather than interpreting contractual rights among shareholders.

The procedural journey involved several steps, including the submission of documents to the SEC, such as certificates of decrease, director’s certificates, and audited financial statements, as well as the holding of stockholders’ meetings to vote on the reductions.

Practical Implications: Navigating Future Capital Stock Reductions

The Supreme Court’s decision in this case provides clear guidance for corporations considering reducing their capital stock. Companies must strictly adhere to the requirements of Section 38 of the Corporation Code, including providing written notice to all shareholders and obtaining the necessary votes.

For shareholders, particularly minority ones, this ruling underscores the importance of actively participating in corporate governance. They should attend stockholders’ meetings and vote on significant decisions like capital stock reductions to protect their interests.

Key Lessons:

• Corporations must follow the legal requirements under Section 38 to ensure the validity of capital stock reductions.
• Shareholders have the right to be informed and to vote on such decisions, emphasizing the need for active participation in corporate governance.
• The SEC’s role is limited to verifying compliance with formal requirements, not adjudicating contractual disputes among shareholders.

Frequently Asked Questions

What is capital stock reduction?

Capital stock reduction is a corporate action where a company decreases its authorized shares, often to eliminate losses or return capital to shareholders.

What are the legal requirements for reducing capital stock in the Philippines?

A corporation must obtain a majority vote from its board of directors and a two-thirds vote from its shareholders at a meeting specifically called for this purpose. Written notice must be provided to all shareholders.

Can shareholders challenge a capital stock reduction?

Yes, shareholders can challenge a reduction if they believe it violates legal requirements or their rights. They can file a petition with the SEC or seek judicial review.

What role does the SEC play in capital stock reduction?

The SEC’s role is to ensure that the corporation has complied with the formal requirements of Section 38 of the Corporation Code. It does not adjudicate disputes among shareholders.

How can minority shareholders protect their interests in such cases?

Minority shareholders should actively participate in stockholders’ meetings, vote on significant decisions, and seek legal advice if they believe their rights are being violated.

ASG Law specializes in corporate governance and shareholder rights. Contact us or email hello@asglawpartners.com to schedule a consultation.