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Legal FrameworkLaying out the procedures for mergers & consolidationsConditions for stockholder appraisal rights explainedOptions for combining include asset & stock purchases“Bulk sale” rules apply to firms selling all of their assets

LEGAL FRAMEWORK OVERVIEW

Prior to 1980, corporations did not have the express power to merge

Prior to the enactment of the Corporation Code in1980, corporations did not have the express powerto merge or consolidate. Nevertheless, this lack ofexpress statutory authority did not deter corpora-tions from concluding de facto mergers or consoli-dations that enjoyed not only considerable popularsupport but also explicit judicial recognition. Indeed,the Supreme Court acknowledged that a virtual cor-porate combination may be achieved by employingthe existing provisions of the general corporation law:first, the absorbed corporation sells all of its corpo-rate assets to the absorbing corporation; second, theabsorbed corporation dissolves itself by shorteningits duration; finally, the absorbing corporation amendsits articles of incorporation, if necessary, to accom-modate the incidents and effects of the corporatecombination.

The principal advantage of a statutory merger orconsolidation over its de facto counterpart is thatit effects the desired corporate combination in onefell swoop (i.e., assets, liabilities and all other busi-ness tangibles and intangibles are transferred to thesurviving corporation, or consolidated in the new cor-poration, by following a single procedure).

However, in different circumstances, this partic-ular procedure may constitute an obstacle to thedesired corporate combination. In a rapid takeovereffort, for example, severe time constraints maymake it extremely difficult for a widely held corpo-ration to obtain the required stockholder approvalof the statutory merger or consolidation in time toclose the deal, and the de facto merger or consoli-dation route becomes the efficient and expedientalternative to effect the intended takeover.

The following discussion describes, in summaryfashion, the procedure for the execution of statu-tory mergers and consolidations, and, in addition,briefly outlines transactions that are structured initially as acquisitions but are ultimately intendedto be mergers or consolidations.

STATUTORY MERGERS & CONSOLIDATIONS:Although mergers and consolidations are two dis-tinct types of corporate combination (a merger beinga union whereby one or more existing corporationsare absorbed by another corporation that survivesand continues the combined business, while a con-solidation is the union of two or more existing cor-porations to form a new one), the Corporation Codeprescribes the same procedure for both. Thus, ineither case, the constituent corporations formulatea plan of merger or consolidation, obtain the nec-essary corporate approvals and any necessary gov-ernmental endorsements, execute the articles ofmerger or consolidation, and then submit them tothe Philippine Securities and Exchange Commission(SEC) for approval.

The merger or consolidation of banks, trust com-panies, insurance companies, public utilities, educa-tional institutions and other corporations governedby special laws must have the favourable recom-mendation of the appropriate government agencybefore any application for approval is filed with theSEC. After the SEC is satisfied that the merger or con-solidation is not inconsistent with the CorporationCode and existing laws, it issues a certificate ofmerger or consolidation, at which point the merg-er or consolidation becomes effective.

Upon the effectiveness of the merger or consol-idation, the separate existence of the constituent corporations (except the surviving corporation inthe case of a merger) ceases by operation of law.The constituent corporations become a single cor-poration which (in a merger) is the surviving corpo-ration or (in a consolidation) the consolidated corporation. Without further act or deed, the sur-viving or consolidated corporation possesses all the rights, privileges, immunities, franchises, prop-erty and every other interest of the constituent corporations, and becomes responsible and liable for all of the latter’s liabilities and obligations.

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Corporate combinationsA closer look at the rules governing mergers and acquisitions

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LEGAL FRAMEWORK OVERVIEW

Any claim, action or proceeding pending by oragainst each such constituent corporation may beprosecuted by or against the surviving or consoli-dated corporation. It should be noted that the rightsof the creditors of each constituent corporation arenot impaired by the merger or consolidation.DE FACTO MERGERS & CONSOLIDATIONS: Toachieve a corporate combination, it is not alwaysnecessary to resort to statutory merger or consoli-dation. In fact, an asset or stock purchase may becombined with other arrangements to achieve theeffect of a merger or consolidation (i.e., the trans-fer of the property and business of one corporationto another in exchange for securities issued by thelatter to the stockholders of the former).

The more common procedure begins with a pur-chase by the acquiring corporation of all the assetsof the acquired corporation using shares of the for-mer’s capital stock as payment. Simultaneously with,or after, the completion of the purchase, the acquir-ing corporation assumes the payment of all the lia-bilities of the acquired corporation. Thereafter, thelatter is dissolved and its remaining property (i.e., theshares of the acquiring corporation received as pay-ment in the asset purchase) is distributed to itsstockholders as liquidating dividend.

At the conclusion of the exercise (and except inrespect of the tax consequences), the same legalresults as in a statutory merger are achieved: the sep-arate existence of one corporation is extinguished,its assets and business are transferred to anothercorporation, and its stockholders are transformed intostockholders of the latter corporation.

If an asset purchase is not ideal, an alternative isfor the combining corporations to conclude a stockpurchase. The acquiring corporation may purchaseall the outstanding shares of stock of the acquiredcorporation from the latter’s existing stockholdersin exchange for the acquiring corporation’s ownshares of stock, making all the stockholders of theacquired corporation stockholders likewise of the

acquiring corporation. Once the exchange is com-plete, the acquired corporation becomes the sub-sidiary of the acquiring corporation. Thereafter, theacquiring corporation can proceed to purchase allthe assets of the acquired corporation and then todissolve the latter, achieving basically the same resultas in a statutory merger.

Regardless of the method pursued, however, theprincipal difference between a de facto and a statu-tory merger or consolidation lies in the assumptionby the acquiring corporation (surviving or consoli-dated corporation) of the liabilities of the acquiredcorporation (constituent corporation[s]).

In a statutory merger or consolidation, the assump-tion of liabilities occurs ipso jure (by operation of law)when the merger or consolidation takes effect; in ade facto merger or consolidation, the acquiring cor-poration must still perform a positive act demonstrat-ing its voluntary and express assumption of the lia-bilities and obligations of the acquired corporation.

As a corollary to this, in a statutory merger or con-solidation, the assumption of liabilities generallytakes place notwithstanding any objection by theacquired corporation’s creditors; in a de facto merg-er or consolidation, creditors of the acquired cor-poration are legally entitled to contest and to objectto the assumption of liabilities, and to challenge thetransaction as a fraudulent conveyance unless suf-ficient assets are reserved for the payment of thedebts due to them.EFFECTS ON STOCKHOLDERS & CREDITORS: Underthe law, stockholders who object to a corporateaction which effects a major change in their con-tract of investment are granted an appraisal rightwhereby they are permitted to withdraw their invest-ment from the corporation and demand payment forthe fair value of their shares. Subject to certain con-ditions, this appraisal right is available to all stock-holders who oppose corporate acquisitions, merg-ers or consolidations. Within 30 days after the date

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THE REPORT Philippines 2014

An asset or stock purchase may be combined with other arrangements to achieve a merger or consolidation

Stockholders who object to a merger have an appraisal right

LEGAL FRAMEWORK OVERVIEW

on which the vote was taken that approved the cor-porate combination, a dissenting stockholder mayserve upon the corporation in question a writtendemand for the payment of the fair value of his orher shares. Ten days after the date of this writtendemand, any such stockholder must surrender hisor her stock certificates to the corporation for nota-tion that they represent dissenting shares.

If the acquisition, merger or consolidation is imple-mented, the corporation must then pay to the stock-holder the fair value of the stockholder’s shares asof the day prior to the date on which the stockhold-er vote was taken, excluding any appreciation ordepreciation in anticipation of such acquisition,merger or consolidation.

On the other hand, notwithstanding that all theconditions required by law are complied with, thecorporation is not required to make any payment inrespect of an exercise of the appraisal right whereit does not have sufficient unrestricted retainedearnings in its books to cover such payment (i.e.,there must be sufficient net corporate assets to paycreditors and to cover the par or issued value of theremaining shares).

As third parties to any proposed acquisition, merg-er or consolidation, the creditors of a corporationhave no statutorily granted power to oppose theimplementation of the transaction. On the otherhand, the law recognises that creditors have validproprietary interests that should be protected in theexecution of corporate combinations.

Thus, in an asset purchase where all or substan-tially all of the assets of one corporation are sold toanother, the selling corporation is directed to noti-fy all its creditors of the proposed purchase, and toapply the purchase price received therefrom to thepro rata payment of their bona fide claims.

In a merger or consolidation, the surviving or con-solidated corporation is obliged to assume the obli-gations and liabilities of the constituent corporations

immediately upon the merger or consolidation’s tak-ing effect. It is only in a stock purchase transactionthat creditors do not receive any specific statutoryprotection because neither the existence nor theproperties of the corporation concerned is affect-ed by such transaction. ACQUISITIONS: Corporate acquisitions generallytake one or a combination of two forms: an assetpurchase or a stock purchase.

Depending upon the financial and business con-siderations driving the acquisition, a corporationmay decide to purchase only the specific assets ofanother corporation, or the entirety of its ongoingbusiness, including all assets and liabilities.

On the other hand, a corporation may also acquireanother corporation by purchasing a majority (or agreater percentage) of the latter’s outstanding cap-ital stock from its existing stockholders. In this case,the acquisition occurs not at the enterprise level(because the acquired corporation retains, andremains the owner of, its property and business), butrather at the equity level as it is the ownership ofthe acquired corporation that has changed.ASSET PURCHASE: Generally, the transfer of assetsfrom one corporation to another is accomplished sim-ply by the execution of the appropriate deed of saleor similar instrument, with such transfer and exe-cution having been previously authorised andapproved by the respective board of directors andstockholders, as necessary, of the selling and the pur-chasing corporations. Ownership of the assets maybe transferred to the purchaser upon execution ofthe relevant sale document,

The sale by a corporation of all or substantially allof its assets requires the affirmative vote of a major-ity of its board of directors, and of stockholders rep-resenting at least two-thirds of its outstanding cap-ital stock. A sale is deemed to cover substantially allof a corporation’s property and assets if the corpo-ration is thereby rendered incapable of continuingthe business or accomplishing the purpose for whichit was incorporated.

Any other sale, including the disposition of cor-porate property and assets in the usual and regularcourse of business, will not require stockholderauthorisation and may proceed with only the requi-site board approval.BULK SALES: In addition to obtaining corporateapprovals, a corporation selling all or substantiallyall of its corporate assets must comply with the noti-fication and other requirements imposed by the lawon “bulk sales”.

A bulk sale is defined as any sale, transfer, mort-gage or assignment of the following:

(i) A stock of goods, wares, merchandise, provi-sions or materials otherwise than in the ordinary course of business of the seller, mortgagor, trans-feror or assignor; (ii) All or substantially all of the business or tradehitherto conducted by the seller, mortgagor, trans-feror or assignor; or

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A corporation may decide to purchase only specific assets of another, or the entirety of its ongoing business

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LEGAL FRAMEWORK OVERVIEW

(iii) All or substantially all of the fixtures and equipment used in and about the business of the seller, mortgagor, transferor or assignor.

Unless the seller can produce written waivers fromall its creditors, it must:

(a) Deliver to the purchaser a sworn written state-ment of the names and addresses of all its cred-itors and the amounts due and owing, or to become due and owing, to each before it receives from saidpurchaser any part of the purchase price, or any promissory note, memorandum or other evidencetherefor; (b) Make a full and detailed inventory of the stock of goods, wares, merchandise, provisions or mate-rials sold in bulk at least 10 days before the sale, showing, insofar as is possible, the quantity and cost to the seller of each such article sold; (c) Notify every creditor appearing in the verified statement mentioned in clause (a) above of theprice, terms and conditions of the bulk sale, at least10 days before the actual transfer; and (d) Apply the price received from the bulk sale to the pro rata payment of the bona fide claims of all its creditors.

These measures are designed to protect creditorsagainst the fraud that may result when a businessperson secretly sells in bulk all or substantially all ofhis or her stock of goods.

It should be noted that the general scheme of thelaw is to declare a bulk sale presumptively fraudu-lent and void as to the creditors of the seller, unlessthe above formalities are observed.

Unlike the seller, the purchaser of all or substan-tially all of the assets of a corporation usually needsto obtain only corporate approvals. Under the law, the purchase is deemed to constitute an invest-ment of corporate funds, which, in the following cases, requires the approval of a majority of the boardof directors of the purchasing corporation and the ratification of stockholders representing at least two thirds of its outstanding capital stock:

(a) Where the purchase is for any purpose other than the primary purpose of the purchasing cor-poration; and (b) Where the purchase is not authorised by any stated purpose, whether primary or secondary, of the purchasing corporation; in which case the arti-cles of incorporation must be amended to author-ise the purchase (such amendment requiring theapproval of at least a majority of the directors ofthe purchasing corporation and of stockholders representing at least two-thirds of its outstand-ing capital stock).

Only where the purchase is reasonably necessary toaccomplish the primary purpose of the purchasingcorporation will board approval be sufficient, andstockholder approval will not be required.

The principle is that stockholders have a right todecide how their funds are to be invested. Sincetheir investment presumes that the corporation willconfine its efforts to the achievement of its primarypurpose, any action unrelated to the same must havetheir prior approval. Further, if the purchase is notrelated to any corporate purpose, the articles ofincorporation must be amended to accommodate thesame. The law permits a corporation to purchasereal and personal property only “as the transactionof the lawful business of [said] corporation may rea-sonably and necessarily require”.

As between the contracting parties, the executionof a deed of sale is generally sufficient to transferto the purchaser all of the seller’s rights, title andinterests in and to the property covered thereby.However, some types of property call for compli-ance with certain formalities in order to make thetransfer effective against third parties. These formal-ities are especially relevant in transactions involv-ing the purchase of various types of properties, rightsand interests, the transfer of some of which may besubject to specific legal requirements. For instance,the sale of motor vehicles must be registered with

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THE REPORT Philippines 2014

In a statutory merger, the assumption of liabilities occurs ipso jure when the merger takes effect

To sell all of its assets a firm requires board and stockholder approval

OBG would like to thank SyCip Salazar Hernandez & Gatmaitanfor their contribution to THE REPORT Philippines 2014.

LEGAL FRAMEWORK OVERVIEW

the Land Transportation Office, and the sale of landmust be registered with the register of deeds.STOCK PURCHASE: In contrast, stock purchases(executed outside the Philippine Stock Exchange[PSE]) require fewer approvals and may be imple-mented through a simpler procedure. Although ordi-narily effected through the execution of a stock pur-chase agreement, under the law, transfers of sharesmay in fact be accomplished by mere delivery to thepurchaser of the relevant stock certificates dulyendorsed by the seller. Such a transfer of shares isvalid and binding between the seller and the pur-chaser, and, provided it is recorded in the books ofthe corporation, against third parties as well. Asidefrom this recording process, no other registration,notification or similar requirement need be com-plied with in order to make the transfer effective.

On the other hand, it should be noted that a stockpurchase involving shares listed with the PSE andeffected through the PSE follows a distinct proce-dure for the transfer of shares. Listed shares arebought and sold on the trading floor of the PSE onan order basis, where orders are generally priori-tised first by price, then by time. Cross transactions(i.e., a sale transaction where the same broker hasa buying and a selling order from two different clientsat the same price and for the same issue) consti-tute the only exception to this rule, and enjoy prior-ity over previously entered orders, provided that cer-tain conditions imposed by the PSE are met.

The same rules on corporate approvals for thepurchaser in an asset purchase apply to the pur-chaser in a stock purchase. If the stock purchase isreasonably necessary for the accomplishment ofthe primary purpose of the purchasing corporation,only board approval is required. In any other case,the affirmative vote of stockholders representing atleast two-thirds of the outstanding capital stock ofthe purchasing corporation must also be obtained.In addition, if the stock purchase is not authorised

at all by the purpose clauses of the articles of incor-poration of the purchasing corporation, the articlesmust first be amended to include such authority.

If the seller in a stock purchase is an individual, heor she need not obtain any approval other than forthe sale of his or her shares of stock. On the otherhand, if the seller is a corporation, it must have beenpreviously and validly authorised by its board to sellthe shares. As a rule, no stockholder action is requiredfor a corporate seller, provided only that the sale ofthe shares is reasonably and necessarily required inthe transaction of the business of the corporation.

In addition to the corporate approvals of the sell-er and the purchaser, depending upon the circum-stances attending the particular transaction, theconsent of third parties to the stock purchase mayhave to be obtained. For example, where share trans-fer restrictions (such as a right of first refusal) aretriggered by the sale of shares, the consent of theparty or parties in whose favour the transfer restric-tions were intended must be obtained. This consenteffectively waives the operation of the transferrestriction and is important in a transaction that hasbeen precisely structured to result in the acquisitionof a majority of the shares in a corporation, wherean offer (and possible sale) to any other person ofthe specific shares which are the subject of the stockpurchase can defeat the purpose and intent of thepurchaser. It should be noted that the rights of firstrefusal, in particular, have been unequivocally upheldby the SEC as valid and enforceable. Hence, any sell-er of shares subject to such a transfer restriction musteither comply with its dictates or obtain the neces-sary waiver and consent. In case a stock purchaseinvolves the transfer of a foreign investment, the reg-istration with the Bangko Sentral ng Pilipinas maybe similarly transferred to the purchaser to enablesaid purchaser to avail itself of the foreign exchangeprivileges pertaining to such registered investment.

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A corporation selling all of its assets must comply with the the requirements of the law on “bulk sales”

Stock purchases executed outside of the PSE require fewer approvals

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LEGAL FRAMEWORK INTERVIEW

Rafael A Morales, Managing Partner, SyCip Salazar Hernandez &Gatmaitan

What immediate reforms in the judicial systemwould address congestion in the courts andaccessibility to litigants?MORALES: Congestion in the judiciary system wouldbe solved by filling up vacancies in the lower courts,upgrading court facilities, and enforcing the dead-lines for the disposition of pending cases. Filing feesshould be reduced to make the courts more acces-sible and affordable to litigants.

How can the region approach the harmonisa-tion of legal systems in anticipation of the forth-coming ASEAN integration?MORALES: The harmonisation of legal systems onthe whole is a long shot. However, the harmonisa-tion of laws is feasible, particularly those dealingwith commerce and trade. In fact, one can see stepsmade in this direction in the region, although theyare not necessarily driven by ASEAN integration. Forinstance, anti-money laundering laws are fundamen-tally shaped by the recommendations of the Finan-cial Action Task Force on Anti-Money Laundering.

What judicial initiatives should be prioritised tostrengthen political stability and anti-corrup-tion measures in the country?MORALES: In respect of political stability, the Con-stitution of the Philippines has, in fact, expanded thepower of judicial review. It is now the duty of theSupreme Court to determine whether or not therehas been a grave abuse of discretion on the part ofany branch or instrumentality of government and,if there has been, to rectify the situation. If this pow-er is judiciously exercised by the Supreme Court,political stability on the whole will be strengthened.On anti-corruption, the Supreme Court should con-tinue its drive to rid the judiciary of corruption. Here,it is necessary for us to raise substantially the com-pensation of judges in order to enhance their inde-pendence and make them immune to corruption.

How can judicial reform boost the attractivenessof the country for local and foreign investors?MORALES: Local and foreign investors all want pre-dictability and consistency in the judicial process. Theywant a judge to follow and observe precedents inthe course of settling their disputes, as well as aSupreme Court that is not above the law. To be sure,the attractiveness of the country to investors will beenhanced if these qualities and values are institu-tionalised in and by the judiciary.

To what extent does the push for transparencyand corporate governance affect legal expedi-ency and business sector confidence?MORALES: There is no question that businessmenand investors want transparency and good gover-nance firmly in place in the country. The executiveand legislative branches are always faulted for theirlack of political will to move in this direction. It is hightime that we ask the third branch of government,led by the Supreme Court, to demonstrate the judi-cial will to put its own house in order and restore,once and for all, transparency and accountability inthe judiciary. Certainly, good governance is for everyinstitution or organisation.

What are the primary obstacles generated bylack of funding allocated within the nationalbudget to the judiciary?MORALES: Lack of funding affects the quality andindependence of the judiciary. Indeed, the thirdbranch of the government deserves a respectableshare of the national budget. As it is, the salaries ofjudges in the Philippines pale in comparison to theircounterparts in the region. In the absence of a sig-nificant upward adjustment in the compensationpackage of judges, the judiciary will continue to havedifficulty in attracting good applicants to its ranks.So long as our judges are not financially stable, the independence of the judiciary is not guaranteed.

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Remaining judiciousOBG talks to Rafael A Morales, Managing Partner, SyCip SalazarHernandez & Gatmaitan

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