SEC-OGC Opinion No. 22-01: Redemption of Preferred Shares

In this opinion, the Securities and Exchange Commission (“SEC”) provided guidance on the rules on the effect of redeemed preferred shares on unrestricted retained earnings.

The corporation in question has redeemable preferred shares in its outstanding capital stock and its articles of incorporation and certificates of stock provide for their redemption. However, it is their concern that upon redemption, the amount of retained earnings equivalent to the cost of said redeemable shares will be restricted pursuant to Section 4(1) of the SEC’s 1982 Rules Governing Redeemable and Treasury Shares (“1982 Rules”).

As a rule, under Section 40 of the Revised Corporation Code, a corporation cannot redeem, repurchase, or reacquire its own shares in the absence of unrestricted retained earnings. An exception to this rule can be found in Section 8 which provides that redeemable shares may be purchased by the corporation from the holders thereof, regardless of the existence of unrestricted retained earnings. Meanwhile, Section 5(5) of the 1982 Rules states that while redeemable shares may be redeemed despite the absence of unrestricted retained earnings, the corporation must still have, after such redemption, sufficient assets in its books to cover its debts and liabilities inclusive of capital stock. Redeemed preferred shares then become part of the corporation’s treasury shares. 

Under Section 4(1) of the 1982 Rules, “the amount of unrestricted retained earnings equivalent to the cost of the treasury shares being held, other than those acquired in accordance with the exceptions provided in Section 3(1) of these rules, shall be restricted from being declared and issued as dividends.” In other words, as opined in SEC-OGC Opinion No. 19-03, treasury shares are generally deducted from the unrestricted earnings to arrive at the ‘Retained Earnings Available for Dividend Declaration’. The earnings equivalent to the cost of treasury shares is not considered part of the earned surplus profits that may be distributed as dividends. As an exception to this rule, Section 3(1) provides that redeemed redeemable shares, although part of treasury shares, is not subtracted from the unrestricted retained earnings to determine the ‘Retained Earning Available for Dividend Declaration’. However, this exception will only apply subject to the rule that the corporation must still have sufficient assets in its books to cover debts and liabilities inclusive of capital stock, after redemption of the redeemable preferred shares.

As such, the SEC opined that the exception in Section 4(1) of the 1982 Rules, such that the cost of the treasury shares arising from the redemption of shares need not be deducted from the unrestricted retained earnings, will apply provided there are sufficient assets in the books of the corporation to cover its debts and liabilities inclusive of capital stock.