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MODULE 1

Different Ways of Doing Business

There are essentially three ways of doing business thru a (1) sole proprietorship; (2)
partnership, and (3) corporation. While we will be concentrating on the third model, it is
likewise basically necessary to first understand what the two other models.

SOLE PROPRIETORSHIP

Sole (single) proprietorship means that you own and run the business. You may of
course hire employees to help you but the risks and profits are all yours. A lot of big
corporations started out this way.

You may register your business with the Department of Trade and Industry (DTI) as a
sole proprietorship. It will be registered as, for example, Mr. A, doing business under the
name and style of A Enterprises. You will also need to register your business with the
municipality, the SSS, and the BIR, just like any enterprise. The advantage of a sole
proprietorship is that you do not have to deal with anyone as a business partner.

There is, however, the disadvantage of unlimited liability. Essentially, if the business
becomes bankrupt your creditor can go after your personal assets to pay for business debts.

Also, for taxation purposes, your income from your business will be collated with
your income from your other sources, including from your employment. This is not
necessarily a bad thing. It all depends on whether there is a tax advantage in collating your
various incomes and expenses.

GENERAL PARTNERSHIP

Once the sole proprietorship starts growing and there is now the need for additional
capital and additional help running the business, a party may opt to go for a general
partnership. This party and at least one other person, can form a general partnership by
filing the Articles of Partnership with the Securities and Exchange Commission (SEC).

The rules on partnership are covered under the Book on Partnerships in the Civil
Code. The Civil Code defines a partnership as follows: “By the contract of partnership, two
or more persons bind themselves to contribute money, property and industry to a common
fund with the intention of dividing the profits among themselves.” One important thing to
remember is that the Civil Code provisions (in most instances) only come in when you and
your partners have not agreed on a particular matter.

Of course, if one of the partners can prove that there was a specific agreement, then
that agreement will prevail over the law. Such agreement normally should be in the Articles
of Partnership, but may also be in a separate document. The advantage of incorporating the
agreement in the Articles of Partnership, which is submitted and approved by the Securities
and Exchange Commission is that your agreement is now in a public document and will be
binding on third parties (other than the partners themselves.)
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In a General Partnership, there is still the problem of unlimited liability. In case the
business goes bankrupt, the creditors can go after the personal assets of any or all of the
partners. Even if a partner only has a 10% stake in the partnership, but the creditors know
that you are the one with the most money, they can go against your personal assets for the
entire partnership debt.

One other major difference between a partnership and a corporation is that in a

partnership, as a rule, all partners are agents of the firm. If you want to give the
management to only one or some of the partners, you have to specify it in the Articles of
Partnership. Otherwise, it will not be binding upon third persons who have no knowledge of
that fact. (In a limited partnership, the rule only applies to the general partners. The limited
partners cannot manage.)

In a corporation, on the other hand, the stockholder cannot involve himself in the
management of the corporation. The corporation acts through its board. The board in turn
elects the set of officers who actually manage the corporation on a day to day basis.

LIMITED PARTNERSHIP

The limited partner, however, is shielded from liability, to creditors, only to the
extent of his contributions (paid or promised.) Of course, he should not participate in the
management of the partnership. If he does, he loses his protection, and becomes liable just
like the other general partners.

As a final note on partnerships. A defective corporation DOES NOT become an

unregistered partnership. It may be a de facto corporation, under certain circumstances.

The third way of doing business is through the corporation.

SEPARATE JURIDICAL PERSONALITY

The Corporation Code defines a corporation as an artificial being created by

operation of law, having the right of succession and the powers, attributes and properties
expressly authorized by law or incident to its existence. The foregoing definition provides
for the attributes of a corporation, namely:

a. It is an artificial being.

b. It is created by operation of law.

c. It has the right of succession.

d. It has only the powers, attributes and properties expressly authorized by law or
incidental to its existence.

The Civil Code reinforces this by saying that the law grants corporation a separate
juridical personality separate and distinct from its stockholders. The Civil Code further
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states that corporations, as such, may acquire property, enter into contracts, and file (and
defend) civil and criminal cases.

Stated simply, the law artificially confers upon a legal fiction, the attributes and
rights of a natural person, except of course those attributes that are inherently human.

A corporation may therefore do the following:

1. Buy/sell properties of all kinds

2. Sue and be sued, civil and criminal
3. Enter into contracts.

These rights may be restricted by the corporations own Articles of Incorporation and
By-Laws or by other laws.)

CORPORATION AS AN ARTIFICIAL BEING OR PERSON

There are two kinds of persons under the law: natural persons or human beings, and
artificial persons. A corporation falls under the second kind. A corporation is a juridical
entity with a legal personality separate and distinct from the people comprising it whether
stockholders (or members in the case of non-stock corporation) and which juridical
personality commences upon the issuance of the certificate of incorporation by the
Securities and Exchange Commission (SEC).

CONSEQUENCES OF A SEPARATE JURIDICAL PERSONALITY

As a juridical entity, a corporation is separated by law by a dividing line from its

stockholders (or members, in case of non-stock corporations). The consequences of such
separate juridical personality, include the following, thus –

1) The debts of the corporation are not the debts of its stockholders, nor are the
debts of the stockholders the debts of the corporation.

2) The stockholders are not the owners of the assets of the corporation but have
only an indirect interest therein.

3) In connection with corporate property or affairs, stockholders cannot maintain

actions in their own name and they have no right to recover possession of
property belonging to the corporation or to recover damages for injury therein.

4) In taxation, the income of the corporation is not the income of the stockholders
who may still be required to pay taxes on the dividends they may derive from
such income.

DOCTRINE OF PIERCING THE VEIL OF CORPORATE ENTITY

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The separate personality of a corporation is intended to protect its stockholders

from liability for corporate acts. Nonetheless, in order to promote justice and prevent
inequity, the courts will not hesitate to pierce the corporate veil, (i.e. the cloak or shield that
keeps separate the respective liabilities of the corporation and its stockholders), if such
separate personality is used to defeat public convenience, justify a wrong, protect fraud or
defend crime or where a corporation serves as a mere alter ego or conduit of a person or an
instrumentality, agency or adjunct of another corporation or where the corporate fiction is
used to evade contracts and obligations., or confuse legitimate legal or judicial issues. The
doctrine may apply to corporations as well as natural persons involved with the corporation.
(Reynoso vs. CA, 345 SCRA 315; R. F. Sugay & Co. vs. Reyes, 120 Phil. 1497).

The primary consequence of piercing the veil is to hold the stockholders directly
liable for corporate acts or obligations. Where the separate personality of the corporation is
disregarded, the corporation will be treated merely as an association of persons and the
stockholders or members will be considered as the corporation, i.e. liability will attach
personally or directly to the officers and stockholders. (Yao, Sr.. vs. People, G.R. No. 168306,
June 19, 2007). In order, however, that the separate personality of the corporation may be
disregarded, the wrongdoing must be clearly established. In the absence of any malice or
bad faith, a stockholder or an officer of a corporation cannot be made personally liable for
corporate liabilities. Mere ownership by a single stockholder of all or nearly all of the capital
stock of the corporation is not a sufficient reason to disregard the fiction of separate
corporate personality. Nor will the fact that the corporate name bears the name of such
stockholder be a sufficient basis to pierce the corporate veil. (See Land Bank of the
Philippines vs. CA, G.R. No. 127181, September 4, 2001).

In Sarona vs. National Labor Relations Commission, January 18, 2012, the Supreme
Court summarized the application of the doctrine of piercing the corporate veil only in three
areas: (1) defeat of public convenience as when the corporate fiction is used as a vehicle for
the evasion of existing obligation; (2) fraud cases or when the corporate entity is used to
justify a wrong, protect fraud, or defend a crime; and (3) alter ego cases, where a
corporation is merely a farce since it is a mere alter ego or business conduit of a person, or
where the corporation is so organized and controlled and its affairs are so conducted as to
make it merely an instrumentality, agency, conduit or adjunct of another corporation.

Roberto C. Sicam and Agencia de R. C. Sicam, Inc. vs.

Lulu Jorge and Cesar Jorge; G.R. No. 159617; August 8, 2007

Facts: Lulu Jorge pawned several pieces of jewelry with Agencia de R.C. Sicam to
secure a loan in the total amount of P59,500.00 on different dates from September to
October 1987. The pawnshop receipts issued to Lulu Jorge bear the words “Agencia de R. C.
Sicam,” thus indicating that the pawnshop was owned by Roberto C. Sicam. On October 19,
1987, two armed mem entered the pawnshop and took whatever cash and jewelry that
were found in the pawnshop vault. On being informed of the loss of the jewelry, Lulu V.
Jorge requested Roberto Sicam to prepare the pawned jewelry for withdrawal but the
former failed to return the jewelry. Thus, Lulu Jorge and her husband Cesar filed a
complaint against Sicam seeking, among other reliefs, indemnification for the loss of the
pawned jewelry. In his answer, Sicam alleged, among other defenses, that he was not the
real-party-in-interest, as the pawnshop was incorporated on April 20, 1987, or about four
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months before the incident and that being so, he was not liable as the corporation had a
separate personality of its own.

Issue: Whether or not the corporate veil may be pierced.

Held: Yes, the veil of corporate fiction may be pierced when made as a shield to
perpetrate fraud and/or confuse legitimate issues. The theory of corporate entity was not
meant to promote unfair objectives or otherwise shield them. The pawnshop receipts issued
to Lulu Jorge all bear the words “Agencia de R. C. Sicam,” notwithstanding that the
pawnshop was allegedly incorporated in April 1987. The receipts issued after such alleged
incorporation were still in the name of “Agencia de R. C. Sicam,” thus inevitably misleading,
or at the very least, creating the wrong impression to the Spouses Jorge and the public as
well, that the pawnshop was owned solely by Sicam and not by a corporation. Even
Sicam’s counsel, in his letter of October 15, 1987 addressed to the Central Bank, expressly
referred to Sicam as the proprietor of the pawnshop notwithstanding the alleged
incorporation in April 1987. All the evidence thus justifies piercing of the veil of corporate
fiction.

POWER TO SUE

A corporation can sue to recover payment or to claim damages or to insist on

compliance with a contract it has entered into. The filing a case must be duly authorized by
the board of directors. In the same token, a suit can only be compromised or settled with
the approval of the board of directors.

The corporation must sue using its corporate name. This might sound obvious, but
in one case, a lawyer for the corporation filed a suit using the acronym of the corporation
(not the SEC registered name). The case was dismissed. On the other hand, the Supreme
Court was lenient when the mistake was made by the complainants against the corporation,
who being farm laborers, mistook the name of the Hacienda as the corporate name.

While a corporation itself cannot sue for moral damages per se (mental anxiety,
sleepless nights, tension) nor can it sue to recover moral damages suffered by its president,
it can sue for damages resulting from besmirched reputation. Technically, the suit is less of
a case for moral damages but more of a case involving the recovery for lost corporate
goodwill.

There is an interesting case wherein the majority of the board of directors agreed to
settle and receive only half of the amount of the bounced check that was issued to the
corporation. One of the directors/stockholders disagreed with the rest of the board and
sued the issuer of the check for violation of the bouncing check law. The Court said that
only the corporation, through its board of directors had the authority to file the suit.

What the stockholder should have done if he believed that there was breach of
director’s fiduciary obligation is to file a derivative suit against the directors to recover the
difference. In a derivative suit, you must be able to establish that you are not simply suing
to enforce your right (that is not available to other stockholders) but you are suing on
behalf of the corporation. (Technically/procedurally, however, a derivative suit is NOT a
class suit on behalf of the stockholders.)
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There are, however, certain pre-requisites to the filing of a derivative suit. He must
first exhaust internal corporate remedies, i.e., he must first complain to the board and the
management and no action was taken by the board. Also, he must be a stockholder at the
time: (a) the alleged anomaly was done; (b) of the filing of the case; and, (c) all throughout
the duration of the case. In case he sells all his shares and ceases to be a stockholder at
anytime, the case will be dismissed. The buyer of the shares cannot continue or file a new
case.

FREE TRANSFERABILITY OF SHARES

What are the other advantages (as compared with a partnership) of doing business
through the corporate form?

For one, the shares in the corporation (as a general rule) are freely transferable.
Your equity in the partnership is not. In a partnership, a partner may transfer his interest to
another person, but that person becomes merely an assignee. He has limited rights as an
assignee. He can get his shares in the profits (and assets upon liquidation). He cannot
however participate in the management. An assignee can only become a partner if the
other partners agree to accept him as a partner. Remember, that the major difference
between a partnership and a corporation is the partnership concept of DELECTUS
PERSONARUM. Stated simply, you choose who you want to be partners with.

In the case of ordinary corporations, as a general rule, you may transfer your shares
to anyone and that person becomes a stockholder. There are certain rules on when a
transferee becomes a stockholder and there are certain procedures on effecting the
transfer. Also, there are various contractual restrictions that the parties might agree to,
such as right of first refusal, first options, etc.

PARTNERSHIP VS. CORPORATE DISSOLUTION

One other advantage of a corporation over a partnership is that in partnerships,

death, retirement, insanity, civil interdiction or insolvency of a partner DISSOLVES a
partnership. This dissolution has certain legal consequences, such as continuity of the
business, liquidation, etc. In a corporation, on the other hand, these events occurring to a
stockholder, will not result in the dissolution of the corporation.,

Thus, in terms of duration of existence, a partnership will continue to exist until it is

dissolved under the circumstances above. In case of a corporation, the SEC grants a
maximum period of 50 years. You can extend this period several times, provided it is done
before actual expiration. Also, you cannot extend the term earlier than 5 years prior to the
termination date. There are however, exceptions, such as when you had entered into a long
term agreement and your creditors require you to extend earlier the 5 years prior.

WHAT ABOUT TAX ADVANTAGES

As far as the BIR is concerned, corporations and partnerships (whether registered or

not) are treated the same. You pay a corporate income tax of 35% or 2% of your gross
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income (Minimum Corporate Income Tax) whichever is higher. Anything accumulated in

excess of 100% of the capital stock is considered improperly accumulated.

If the corporation has improperly accumulated earnings, the BIR will impose a tax of
10% of the amount improperly accumulated. This is essentially to force the corporation to
distribute to its stockholders the corporate earnings which it does not need to pay off loans
or for future expansions.

The board of directors (not the stockholders) however may “restrict” certain
retained earnings. Essentially, the board will pass a board resolution stating that a certain
portion of its previous year’s earnings will not be available for distribution as dividends to
the stockholder as said amounts are need to pay off maturing loans or for future expansions
of the company. The corporation must inform the SEC and the reason given must be
supported by proof.

On the stockholder’s side there is a tax on the cash or property dividend given by a
domestic corporation to an individual. The tax rate is dependent on the
stockholder/taxpayer’s tax bracket.

Stock dividends are not taxed upon distribution. But once the stockholder sells the
stocks, it becomes likewise taxable.

COMMENCEMENT OF LEGAL EXISTENCE

As a general rule, partnerships are created by agreement of the parties and

therefore, the separate legal existence starts from the time the parties agree to form a
partnership. However, in most instances, partnerships now need to be registered as such
with the SEC.

Corporations, on the other hand, are in essence, grants of privileges by the State.
Thus the legal personality of a corporation does not start from the time the incorporators
sign the Articles of Incorporation but from the time the SEC approves the Articles of
Incorporation and issues a Certificate of Incorporation.

NATIONALITY OF CORPORATIONS AND PARTNERSHIPS

There is a difference between corporations and partnerships on the matter of

nationality. A partnership is a national of the country where the partnership agreement is
entered into. However, this is no longer significant as almost all partnerships are required
to be registered by the SEC. Thus, the firm is a national of the country where it is registered.

In the case of corporations, since it is the state that grants the privilege, the
corporation is a national of the country where it is incorporated.

We must distinguish between the nationality of the CORPORATION ITSELF and the
nationality of the owners of the corporation.
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Even if the stockholders are foreigners (in instances when the constitution and the
laws allow 100% foreign ownership) if it is registered in the SEC of the Philippines, then it is
a domestic-registered corporation. Its nationality is Filipino. Conversely, even if the
corporation is owned by Filipinos but is registered in another country, say the Bahamas,
then it is NOT a Filipino corporation.

There are certain laws that restrict ownership to Filipinos. This will be discussed
under the grandfather rule and control test when we get to foreign corporations.

CONSTITUTIONAL RIGHTS OF A CORPORATION

A corporation likewise enjoys certain constitutional rights.

EQUAL PROTECTION CLAUSE. A corporation can claim its constitutional right that a
particular law should apply equally to all persons similarly situated.

RIGHT AGAINST UNREASONABLE SEARCHES AND SEIZURES. A corporation can object

to the unlawful seizure of its documents. However, this right must be asserted by the
corporation through its board of directors. A mere stockholder cannot invoke this right on
behalf of the corporation (unless, of course, he has been duly authorized by the board).

DUE PROCESS. A corporation may invoke the right to due process. If only the
individual stockholders were impleaded and not the corporation, no judgment can be
rendered against the corporation as it has not had the opportunity to defend itself. Again,
this right must be invoked by the corporation, through its board of directors, and not by a
mere stockholder (unless, of course, he has been duly authorized by the board).

A corporation, however, cannot invoke the right against self-incrimination. A

corporation cannot be held liable for a crime, but the corporate veil may be pierced to hold
the erring officers liable.