Bea

b. Watered stocks
i. Definition
- Watered stocks are shares issued as fully paid when in truth no consideration is
paid in any form; or the consideration received is known to be less than the par
value or issued value of the shares. Watered stocks can either be par or no par
value shares. 

These also include stocks:

 Issued without consideration (Bonus Share);
 Issued as fully paid when the corporation has received less sum of money than
its par or issued value (Discounted Shares);
 Issued for consideration other than actual cash (property or service), the fair
valuation of which is less than its par or issued value;
 Issued as stock dividends when there are no sufficient retained earnings or
surplus to justify it.

And take note that the solidary liability of the directors emanates from the
fiduciary character of the position of director or corporate officer.

So for example:

When the par value shares or the issued value of no par value shares is 100 pesos
and only 80 pesos is paid to the corporation but the share is issued as fully paid,
the share is considered “water fictitiously paid up” to the extent of 20 pesos,
which is the difference between the consideration paid and the par value or
issued value of the share taken. In such case, the subscriber is liable for the
difference of 20 pesos.

The issue itself is not void, but the agreement that the shares shall be paid for less
than its par or issued value is illegal and void and cannot be enforced.

Issue of watered stocks is prohibited as

Section 64 prohibits the issuance of watered stocks to protect persons who may
acquire stock and the creditors of the corporation particularly those who may
become such on the faith of its outstanding capital stock being fully paid. The
prohibition secures equality among subscribers and prevents discriminations
against those who have paid in full the par or issued value of their shares.
These are effects of issue of water stock

First as the corporation, the issuance of watered stock is not merely ultra vires
but it is illegal per se as it is a violation of Section 62.

Second as the creditors, the law makes no distinction between those who became
such prior and subsequent to the issuance of watered stocks. The liability whether
or not the creditors have relied on an over-valuation of corporate capital

And lastly as the Securities and Exchange Commission, whether or not an issuance
would amount to an issue of watered stock is well within its authority to inquire
into in view of its power and duty to enforce all laws affecting corporations.

ii. Liability of directors for watered stocks

Sec. 64 states that a director or officer of a corporation who:

(a) consents to the issuance of stocks for a consideration less than its par or
issued value:
(b) consents to the issuance of stocks for the consideration other than cash,
valued in excess of its fair value; or
(c) having knowledge of the insufficient consideration, does not file written
objection with the corporate secretary, shall be liable to the corporation or its
creditors, solidarily with the stockholder concerned for the difference between
the value receive at the time of issuance of the stock and the par or issued value
of the same.

The liability of the consenting director or officer for the “water” in the stock is
solidary with the stockholder concerned. This means either of them can be held
liable for the whole amount of the difference. Note that the fair value of the stock
is determined at the time of its issuance so that the subsequent increase in the
value of the property given as consideration will not eliminate the “water” in the
stock and relieve the director or officer and stockholder from liability.

The directors will be held liable when:

1. Willfully and knowingly voting for and Assenting to patently unlawful acts of
the corporation. (Sec. 31)
2. Gross negligence or bad faith in directing the affairs of the corporation. (Sec.
31)
3. Acquiring any personal or pecuniary Interest in conflict of duty. (Sec. 31)
4. Acting without authority or in excess of authority or are motivated by ill‐will,
malice or bad faith, which gives rise to consequent damages. (Lim vs. NLRC, G.R.
No. 80685. March 16, 1989)
5. Consenting to the issuance of Watered stocks, or, having knowledge thereof,
failing to file objections with the secretary. (Sec. 65)

When will the director or officer is liable for a criminal offense?

A director or officer liable for a criminal offense when a law requires a

corporation to do a particular act, failure of which on the part of the responsible
officer to do so constitutes an offense, the responsible officer is criminally liable
therefore. The reason is that a corporation can act through its officers and agents
and where the business itself involves a violation of law all who participate in it
are liable. While the corporation may be fined for such criminal offense if the law
so provides, only the responsible corporate officer can be imprisoned. (People vs.
Tan Boon Kon, 1930) However, a director or officer can be held liable for a
criminal offense only when there is a specific provision of law making a particular
officer liable because being a corporate officer by itself is not enough to hold him
criminally liable. 

iii. Trust fund doctrine for liability for watered stocks

Where the corporation issues watered stock and thereby assumes an ostensible
capitalization in excess of its real assets, the transaction necessarily involves the
misleading of subsequent creditors; and a constructive fraud upon creditors,
whether done with that purpose actually in mind or not. Hence, it is held that
recovery may be had by a creditor in such case, even though the corporation itself
has no cause of action against the stockholders. The creditors’ right of action to
compel the making good of the representation as to the corporation’s capital is
based on fraud, and the trust fund doctrine is only another way of expressing the
same underlying idea. 

The doctrine serves as basis for holding such stockholders and officers liable for
watered stocks under which all corporate creditors would have legal basis to
recover against stockholder and guilty officers. The trust fund doctrine on
watered stock prevails. It is established doctrine subscriptions to the capital of a
corporation constitute a fund to which creditors have a right to look for
satisfaction of their claims and that the assignee in insolvency can maintain an
action upon any unpaid stock subscription in order to realize assets for the
payment of its debts. A corporation has no power to release an original subscriber
to its capital stock from the obligation of paying for his shares, without valuable
consideration for such release and as against creditors a reduction of the capital
stock and can take place only in the manner an under the conditions prescribed
by the statute or the charter or the articles of incorporation. Moreover, strict
compliance with the statutory regulations is necessary.

Payment of balance of subscription

Sec. 66 of the RCC provides that subject to the provisions of the subscription
contract, the board of directors may, at any time, declare due and payable to the
corporation unpaid subscription and may collect the same or such percentage
thereof, in either case, with accrued interest, if any, as it may dem necessary.

Payment of unpaid subscription or any percentage thereof, together with any

interest accrued, shall be made on the date specified in the subscription contract
or on the date stated in the call made by the board. Failure to pay on such date
shall render the entire balance due and payable and shall make the stockholder
liable for interest at the legal rate on such balance, unless a different interest at
the legal rate on such balance, unless a different interest rate is provided in the
subscription contract. The interest shall be computed from the date specified,
until full payment of the subscription. If no payment is made within thirty (30)
days from the said sate, all stocks covered by the subscription shall thereupon
become delinquent and shall be subject to sale as hereinafter provided, unless
the board of directors orders otherwise.

GR: The unpaid subscriptions are not due and payable until a call is made by the
corporation for payment.

XPN: 1. when the corporation has become insolvent 2. if the contract of

subscription provides the date or dates when payment is due
1. Non‐resident foreign subscribers required to pay their subscription in full upon
incorporation must pay in full their subscriptions unless their unpaid subscriptions
are guaranteed by a surety bond or by an assumption by a resident stockholder
through an affidavit of liability.
2. In case of no‐par value shares, they are deemed fully paid and non‐assessable

The balance of the subscription should be paid:  

1. On the date specified in the subscription contract, without need of demand or
call, or
2. If no date of payment has been specified, on the date specified on the call
made by the BOD; or within 30 days from the date of call (grace period is granted 
  3. When insolvency supervenes upon a corporation and the court assumes
jurisdiction to wind it up, all unpaid subscriptions become payable on demand,
and are at once recoverable, without necessity of any prior call.

Unpaid balance can accrue interest, if so required by the by‐laws and at the rate
of interest fixed in the by‐laws. If no rate of interest is fixed in the by‐laws, such
rate shall be deemed to be the legal rate. (Sec. 66) The above interest is different
from the interest contemplated by Sec. 67. The said unpaid balance will only
accrue interest, by way of penalty, on the date specified in the contract of
subscription or on the date stated in the call made by the board.   Note: Interest
contemplated in Sec. 66 is pertains to moratory interest which is the interest on
account of delay, while Sec. 67 speaks of compensatory interest which is the
internet on account of subscription in an installment basis.

There’s an effect if fail to pay the subscription on the date it is due shall render
the entire balance due and payable and shall make the shareholder liable for
interest at the legal rate on such balance, unless a different rate of interest is
provided in the by‐laws.

Call by board of directors

The stockholders concerned are given notice of the Resolution by the corporation
either personally or by registered mail. Publication of the notice of call is not
required unless the by-laws provide otherwise. Notice is likewise not necessary if
the contract of subscription stipulates a specific date when any unpaid portion is
due and payable.

A call is a declaration officially made by a corporation usually expressed in the

form of resolution of the board of directors requiring the payment of all or certain
prescribed portion of a subscriber’s stock subscription.
The board of directors may declare due and payable unpaid subscriptions. This
power of the directors is no longer absolute as it can be limited by the
subscription contract such that the directors may not disregard the amount to be
paid and the period for payment fixed in the subscription contract and make a call
earlier.
The board of directors may make a call anytime only where no date is specified in
the contract of subscription, otherwise the balance shall be payable on a date or
dates and fixed in the contract without need of call.

These are the requisites of a valid call

First it must be made in the manner prescribed by law second it must be made by
the board of directors and lastly it must operate uniformly upon all share holders.

Notice requirement

The stockholders concerned are given notice of the Resolution by the corporation
either personally or by registered mail. Publication of the notice of call is not
required unless the by-laws provide otherwise. Notice is likewise not necessary if
the contract of subscription stipulates a specific date when any unpaid portion is
due and payable.

The necessity for call depends upon the provisions of the subscription contract.
Call is necessary when required by the contract, or when no time is fixed for
payment. When call is necessary, notice must be given to the stockholder
concerned. A call without notice to the subscriber is practically no call at all. The
notice is regarded as a condition precedent to the right recovery. It must,
therefore be alleged and proved to maintain an action for the call. The right to
notice of call, however may be waived by the subscriber. When the corporation
becomes insolent the payment of stock subscription may be enforced without the
necessity of a prior call. Also, no call is necessary when the subscription is payable
not upon call or demand by the directors but immediately or on a specified day or
on before a specified day or when it is payable in installments at specified time.