The board of directors of a stock corporation may declare dividends
out of the unrestricted retained earnings which shall be payable in cash, in property, or in stock to all stockholders on the basis of outstanding stock held by them: Provided, That any cash dividends due on delinquent stock shall first be applied to the unpaid balance on the subscription plus costs and expenses, while stock dividends shall be withheld from the delinquent stockholder until his unpaid subscription is fully paid: Provided, further, That no stock dividend shall be issued without the approval of stockholders representing not less than two-thirds (2/3) of the outstanding capital stock at a regular or special meeting duly called for the purpose. (16a)
Stock corporations are prohibited from retaining surplus profits in excess of one hundred (100%) percent of their paid-in capital stock, except: (1) when justified by definite corporate expansion projects or programs approved by the board of directors; or (2) when the corporation is prohibited under any loan agreement with any financial institution or creditor, whether local or foreign, from declaring dividends without its/his consent, and such consent has not yet been secured; or (3) when it can be clearly shown that such retention is necessary under special circumstances obtaining in the corporation, such as when there is need for special reserve for probable contingencies. (n)
A stock corporation exists to make profit and to distribute a portion of the profits to its stockholders.
A dividend is that part or portion of the profits of a corporation set aside, declared and order by the directors to be paid ratably to the stockholders on demand or at a fixed time. It is a payment to the stockholders of a corporation as a return upon their investment. It is a characteristic of a dividend that all stockholders of the same class share in it in proportion to the respective amounts of stock which they hold.
Stock dividend is the amount that the corporation transfers from its surplus profit account to its capital account. It is the same amount that can loosely be termed as the ―trust fund‖ of the corporation. NTC v. CA, 311 SCRA 508 (1999).
The power granted to stockholders to demand from the Board the declaration of dividends under Section 43 is one for the few instances under the Code where the stockholders themselves exercise a primary power, instead of the usual
ratificatory vote on action taken primarily by the board of directors. (Page 260 of CLV’s Textbook)
Dividends payable out of unrestricted retained earnings. Under the law, dividends other than liquidating dividends (which are not really dividends as they are from caoital) may be declared and paid out ―the unrestricted retained earnings‖ of the corporation.
The capital or capital stock which may not be impaired or depleted by the dividends is not the entire net assets of the corporation; rather, it is the legal capital of the corporation in the strict sense, referring to that portion of the net assets directly or indirectly contributed by the stockholders as consideration for the stocks issued to them upon the basis of their par or issued value.
Jack’s Lecture
Most common types; cash, property, stock dividends. Only the board approval is needed to declare cash dividends but the corporation must have retained earnings. Now when the corporation declares cash dividends and it has no retained earnings this is illegal and SH must return what they received and in fact directors will be made liable.
You have that Philbanking Corporation case before which became bankrupt because it kept declaring dividends at the time it was incurring losses and the justification: ―Eh you see we have always been declaring dividends regularly and if we stop now there might be a bank run.‖ Well you tell me now, katwiran ba yan ng taong matino? They attacked the CB for closing Philbanking.
Assuming it has retained earnings, once cash dividends have been declared they cannot be revoked because you can use that to manipulate the price. For example they declare that 25% cash dividend so the price moves up. The directors sell their shares then they revoke the declaration so the price goes down they buy back the shares.
In the case of property dividends you only need board approval but in the case of stock dividends you need the approval of the stockholders. Now, a stock dividend has no taxable consequence because it is the same pie but you are slicing it into more pieces.
For instance, here is somebody whose shares represent 10% of the net worth of the corp. The corp declared a 100% stock dividend. What will happen? He will still own 10 % of the net worth of the corporation. The book value of his original share plus his stock dividend will be the same. It is only when he sells and makes a profit will there be a taxable consequence. And because of that even if a stock dividend has been declared it can still be revoked because it’s the same pie only your slicing it in more pieces so even if you declare it you can revoke as long as the stock certificates have not yet been distributed.
The SEC has said that paid-in surplus cannot be declared as dividends whether stock or cash. For instance, here is a corp that made a public offering. The par value of the shares is 10 pesos per share but they offer to the public for 16 pesos so the buyers will be paying 6 pesos more. Now, that paid in surplus cannot be declared as a stock or cash dividend because according to the SEC you can only declare dividends from earnings from operations. That paid in surplus was not from operations
Itong si Agbayani sabi it cannot be declared but the SEC said it can be declared, subject to certain qualifications. One of the tricks for window dressing the financial statement is when the value of the corp is negative you have your real property re- appraised.
Now, the appraisal will increase the value of the property and that wipes out your negative value that’s why normally your external auditor will put a footnote in your financial statement for several years indicating that there has been a re- evaluation. Now, according to Agbayani it cannot be declared but the SEC says it can be declared subject to certain conditions. The property must be subject to depreciation so if it is land you cannot declare a dividend. It must be subject to depreciation and then you charge depreciation allowance and you have retained earnings then you can declare that as dividends.
1. Treasury shares, if they are declared, should be considered property, not stock dividends. Now the law provides (taken from a decree issued before) that if the surplus profits exceed 100% of the paid-in capital, you must declare dividends whether cash or stock otherwise you will be fined by the SEC. That is one of the rackets of SGV. ―O, mataas na yung retained earnings nyo, lagpas ng 100% mumultahan kayo ng SEC, you have to declare dividends.‖ So at the end of the year in your financial statement wala na yan and of course because of that, they will have to prepare a long-form report kasi hindi na kasali sa fiscal year and siyempre
tatagain ka for the long-form report.\ Justified by definite corporate expansion projects approved by the board. For instance you get a franchise from abroad there will be a development schedule. For instance they will tell you to open so many outlets within 5 years so when Dunkin Donuts first opened they were required to open 5 outlets within 5 years so the company was not declaring any dividends. Whatever retained earnings they were accruing were being used to put up other outlets. We have this client who owned a heavy mix (?) plant and said that the present plant cannot cope with our volume of business. We have to put up a bigger plant so they purchased a parcel of land in the CALABARZON and they will need 100 million to put up the new plant so they are not declaring any dividends. But it has to be definite in fact, the SEC will ask for copies of the Board Resolution showing the definite expansion plans. The Board Resolution is sufficient of course, you can’t be showing the same resolution for 5 years in a row. Kung hindi gumagalaw yung financial statement or hindi gumagalaw yung assets, ano ba yan? In this case, the SEC must look in. Like this fellow Henry Ng of Unimart, he doesn’t declare dividends and he’s always saying ―expansion‖ I don’t know how he’s getting away with it!
2. If the corporation is prohibited by a loan agreement from declaring dividends without the consent of the creditors or when the consent has not been obtained. Well, usually if it’s a big loan the creditor will require that as a condition and they will make sure the corp has enough funds to pay 3. Special circumstances there is a need to build up reserves
for contingencies (ex. There is a strike and the union filed a case for unfair labor practice because many employees were terminated so they said if we lose we will be made to pay backwages and that will amount to a hefty amount so we better start building reserves
Now the dividends will be given to the Stockholder (SH) of record. If the SH sells his shares but the transfer has not been recorded in the books of the corporation, it goes to the seller but he will have to deliver that to the buyer. That is between him and the buyer because remember it is the books that are controlling. Usually when the corporation declares a dividend it will say ―resolve that the corporation declare a cash div of 25% on Feb 25 to SH of record as of Feb 15 2002 and for this purpose the books of the corporation be closed at the end of business hours on Feb 15 and will be open again at 8:00 am of Feb 26 2002‖.
(i) Cash
Dividend payable in cash
As soon as cash dividends are publicly declared, the stockholders have the right to their pro rata shares.
It is the declaration of the dividends which creates both the dividends itself and the right of the stockholders to demand and receive it. (Page 406, De Leon, 2006 citing SEC Opinion, October 9, 1992)
Can be declared by mere Board resolution from unrestricted earnings. (Page 246 of CLV’s CLR, 2007)
Revocable before announcement to the shareholders. (Page 836 of CLV’s CLR, 2007)
Catindig Class Notes
Q: IN 2006, X Corp has URE of 100T. The amount is not enough to cover cash dividends to all SHs. Here, no declaration of dividends during the 1st quarter. Only in June, the corp acquired 4 M. So
4M+100T income in URE. Could the corp declare a cash dividend of 3.1 M.
A: No. 3.1 M is stil part of capital or it is not yet par of URE. To issue cash dividends of 3.1M might violate the trust fund doctrine.
(ii) Stock
It is dividend payable in unissued or increased or additional shares of the corporation instead of in cash or in property out of the unrestricted retained earnings of the corporation. A stock dividend may be declared only to the extent of the maximum number of shares authorized in the articles of incorporation.
Declaration may be revoked prior to actual issuance. (Page 836 of CLV’s CLR, 2007)
Catindig Class Notes Q: What are dividends?
A: It refers to return of investment. It is what a SH would want their Board to declare.
Q: if a corp has treasury shares, can it decide to give the shares to SHs?
A: Yep, it could be property dividends being assets of a corporation. (Si Ina yata nagrecit nito)
(iii) Property
It is dividend distributed to the stockholders in the form of property, real or personal, such as warehouse receipts, or shares of stock of another corporation.
(iv) Interim
Catindig Class Notes
Q: Is this your first time to hear “interim” What do you mean by interim? A: It means “temporary” di ba. Declaration of interim dividends is not prohibited by law.
(v) Record Date
Record date is fixed by the board of directors for determination of stockholders entitled to vote; if it does not do so, such date shall be the date of the notice of meeting. (Page 484 of De Leon, 2006)
There is no hard and fast rule describing the interval of time between the date of the declaration of dividends, the date of record of stockholders entitled thereto, and the date of payment, the same being left to the sound and judicious discretion of the directors. (SEC Opinion, April 11, 1962)
It is customary for the directors to fix the time for payment of a dividend. But a corporation cannot discriminate among the shareholders as to the time of payment of dividends.
If no time is fixed by the resolution declaring a dividend, it is payable on demand, and if the resolution declares that it shall be payable at such time as the board of directors may direct and the board fixes no time, the law implies that it shall be paid within a reasonable time.
Catindig Class Notes
Record date must be a current or prospective date, never a past date. Q: Why not a past date for record date?
A: Because of the problem of asymmetric information. In sales of stock, price is the primary consideration. And price is determined by information. If record date is ante-dated, the seller might be prejudiced because in setting the price it did not consider the benefit of dividends. (vi) Limitation on retention of surplus profits
Stock corporations are prohibited from retaining surplus profits in excess of 100% of their paid-in capital stock except when justified by any of the reasons mentioned. (Section 43(2)) Of the requirement which is mandatory is violated, the corporation may be compelled by the SEC to declare dividends to its stockholders.
The prohibition on retention of profits provided in Section 43 is applicable to all stock corporations.
There may be some question as to whether or not the retention of profits is justified by the ―reasonable needs of the business‖. Suffice it to say that the policy of the law to encourage and force the distribution of dividends curtails the discretionary power of directors to retain corporate earnings.
Section 29 of the Tax Code imposes a 10% surtax on corporations improperly accumulating profits or surplus, in addition to other income taxes imposed on corporations. The purpose is to prevent individual taxpayer from avoiding the progressive rates of income tax by employing the corporate form for the accumulation of taxable income. (Page 397, De Leon, 2006)
Note: No dividends can be declared out of capital, except liquidating dividends distributed at dissolution. (Section 122)
Note: Dividends (whether cash or stock) can be declared only out of the unrestricted retained earnings, although stock dividends may be issued out of premium surplus (since in the latter case, it is nothing but a book-entry procedure). (Page 837 of CLV’s CLR, 2007)
Catindig Class Notes
Q: How does a corporation prove that the exceptions apply to them as regards retained profits in excess of 100%?
A: BoD issues a RESOLUTION approving corporation expansion (for example). BoD creates a reserve. Excerpts of MINUTES of the Board Resolution may be shown to the SEC.
Q: What are those legal provisions as regards retention of surplus profits?
A:
(1) Section 43