SEC-OGC Opinion No. 22-03: Preferred Shares; Rural Banks

The Securities and Exchange Commission (“Commission”) in SEC-OGC Opinion No. 22-03 (“Opinion”) confirmed that the distribution of dividends and liquidation made on the basis of the par value is not inconsistent with Section 42 of the Revised Corporation Code (“RCC”), and that the provisions of the Anti-Dummy Law will not apply to rural banks in relation to the Rural Bank Act of 1992.

The subject of the Opinion is X Rural Bank, a banking corporation duly organized under Philippine laws and licensed by the Bangko Sentral ng Pilipinas (“BSP”) as a rural bank. X Rural Bank proposed amendments to its Articles of Incorporation (“AOI”) which would result to its shares being 37.46% foreign-owned and 62.54% Filipino-owned. Moreover, in the proposed features, rights and restrictions of the shares, the distribution of dividends and liquidated value or a similar value shall be made in proportion to the par value of each share regardless of its classification. Each preferred share shall have preference in dividends and liquidation as may be fixed and approved by the board of directors, including the determination of the rate and manner of distribution of dividends. 

Distribution of dividends on the basis of par value

Under Paragraph 6 of Section 6 of the RCC, preferred shares of stock are given preference in the distribution of dividends, provided that preferred shares of stock may be issued only with a stated par value. The board of directors, where authorized in the articles of incorporation, may fix the terms and conditions of preferred shares of stock. 

Section 42 of the RCC provides that stockholders participation in the declaration of dividends shall be based on the outstanding capital stock held by them. In this regard, Section 173 of the RCC defines outstanding capital stock as the total shares of stock issued under binding subscription contracts to subscribers or stockholders, whether fully or partially paid, except treasury shares. Thus, the Commission has opined that the stockholder’s participation in dividends is based on the total subscription and not on the amount paid on account thereof. 

The Commission cited SEC Opinion addressed to Mr. Mitsuhiro Otsuki, dated July 16, 1996, where it was explained that dividends shall be declared on the basis of the number of shares held by the stockholders, not on the amount paid in consideration thereof. Likewise, in SEC Opinion No. 45-03 addressed to Atty. Maria Zarah R. Villanueva dated September 24, 2003, the Commission opined that it is legally valid to declare dividends in favor of preferred cumulative shareholders at the rate of 10% par value. 

Considering that giving the board of directors a blanket authority to fix the terms and conditions of preferred shares might result to an abuse of such authority, the Commission does not allow the same unless certain features, guidelines, or standards to be followed in the issuance of preferred shares are spelled out in the AOI.

Thus, the Commission opined that the new capital structure of X Rural Bank which gives preferred shares preference in dividends based on the par value of such shares is allowed under Section 42, in relation to Section 6 of the RCC. However, the board of directors should not be given a blanket authority in the determination of the terms and conditions in the issuance of preferred shares, unless guidelines or standards to be followed in the issuance of preferred shares are clearly spelled out in the AOI. Moreover, since the corporation is a bank, the dividend rate shall be subject to the rules and regulations of the BSP. 

Distribution of the liquidated value of preferred shares on the basis of par value

Section 6 of the RCC also provides that preferred shares of stock may be given preference in the distribution of corporate assets in case of liquidation provided that they may be issued only with a stated par value. The Commission cited SEC Opinion addressed to Col. Daniel V. dela Cruz dated April 11, 1980 where it opined that preferences granted to preferred shares may refer to the distribution of assets upon dissolution to the extent of the par value of the preferred shares together with the accrued dividends thereof. Similarly, in SEC Opinion addressed to Rolando A. Olegario dated December 14, 1981, the Commission affirmed the privileges granted to preferred shareholders of Volcano Lakeview Resort, Inc. whereby in case of liquidation, the said shareholders shall be paid based on the par value or ratably in so far as the assets of the corporation will permit, together with the accrued unpaid dividends. 

Thus, the liquidated value of preferred shares of X Rural Bank may be distributed based on the par value, provided that the terms and conditions in the distribution shall be clearly spelled out in its AOI which must be approved by the Commission, and subject to the rules and regulations of the BSP on liquidation of banks. 

The proposed capital structure of X Rural Bank vis-à-vis foreign equity threshold under the Rural Bank Act of 1992

Section 4 of the Rural Bank Act of 1992 (R.A. No. 7353) was amended by R.A. No. 10574 which allows foreign citizens to own, acquire or purchase up to sixty percent (60%) of voting stocks in a rural bank. 

Subsection X126.1. of the Manual of Regulations for Banks particularly provides for the guidelines with respect to the limits of stockholdings, such that, for rural banks, non-Filipino citizens, excluding foreign banks, may each or in the aggregate, own, acquire or purchase, up to sixty percent (60%) of the voting stocks in a rural bank. The percentage of foreign-owned stock in a bank shall be determined by the citizenship of the individual or corporate stockholders in that bank. 

Relative thereto, the Commission issued Memorandum Circular No. 8, s. 2013 or the Guidelines on Compliance with the Filipino-Foreign Ownership Requirements Prescribed in the Constitution and/or Laws which provides for the two-tiered test in determining nationality requirements. Paragraph 2 of Section2 thereof states that corporations covered by special laws which provide citizenship requirements shall comply with the provisions of said law.

Since all shares issued by X Rural Bank are granted voting rights, the same shall be considered to be in the same footing and shall be used in computing the Filipino-Foreign equity. From the total of 17,749,995 shares of X Rural Bank, 62.54% of which is owned by Filipinos, it is therefore compliant with the Rural Bank Act of 1992. However, being a bank, X Rural Bank is also subject to the regulation and supervision of the BSP. 

The proposed capital structure of the X Rural Bank X Vis-à-vis Anti-Dummy Law

The Department of Justice (“DOJ”) stated in its Opinion No. 016, series of 2004 dated January 26, 2004, that the very essence of the Anti-Dummy Law was to limit a certain economic activity, or the exercise or enjoyment of a certain right, franchise, privilege, property or business only to Filipino citizens, or to corporations or associations at least sixty percent (60%) of the capital of which is Filipino owned. 

In its Opinion No. 054, Series of 2010, dated November 23, 2010, the DOJ opined that the Financing Company Act of 1998 (RA No. 8556) effectively removed the limitation imposed under Section 6 of the Financing Company Act (RA No. 5980), the original law, such that up to sixty percent (60%) of the voting stock of financing companies may now be owned by foreign nationals. Hence, the amendment may be construed to have taken out financing companies from the coverage of Section 2-A of the Anti-Dummy Law. 

By the same logic, the Commission opined that rural banks are likewise deemed to have been taken out of the coverage of Section 2-A of the Anti-Dummy Law. This is consistent with DOJ Opinion No. 016 which stated that in light of the subsequent passage of several amendatory laws, which allowed foreign banks to own 100% or 60% of voting stock of a domestic bank, certain banking activities involving the entry and operation foreign banks into the Philippine banking system may now be deemed to have been taken out of the coverage of the Anti-Dummy Law.