Corporate combinations: A closer look at the rules governing mergers and acquisitions

Prior to the enactment of the Corporation Code in 1980, corporations did not have the express power to merge or consolidate. Nevertheless, this lack of express statutory authority did not deter corporations from concluding de facto mergers or consolidations that enjoyed not only considerable popular support but also explicit judicial recognition. Indeed, the Supreme Court acknowledged that a virtual corporate combination may be achieved by employing the existing provisions of the general corporation law: first, the absorbed corporation sells all of its corporate assets to the absorbing corporation; second, the absorbed corporation dissolves itself by shortening its duration; finally, the absorbing corporation amends its articles of incorporation, if necessary, to accommodate the incidents and effects of the corporate combination.

The principal advantage of a statutory merger or consolidation over its de facto counterpart is that it effects the desired corporate combination in one fell swoop (i.e., assets, liabilities and all other business tangibles and intangibles are transferred to the surviving corporation, or consolidated in the new corporation, by following a single procedure).

However, in different circumstances, this particular procedure may constitute an obstacle to the desired corporate combination. In a rapid takeover effort, for example, severe time constraints may make it extremely difficult for a widely held corporation to obtain the required stockholder approval of the statutory merger or consolidation in time to close the deal, and the de facto merger or consolidation route becomes the efficient and expedient alternative to effect the intended takeover.

The following discussion describes, in summary fashion, the procedure for the execution of statutory mergers and consolidations, and, in addition, briefly outlines transactions that are structured initially as acquisitions but are ultimately intended to be mergers or consolidations.

STATUTORY MERGERS & CONSOLIDATIONS: undefined Although mergers and consolidations are two distinct types of corporate combination (a merger being a union whereby one or more existing corporations are absorbed by another corporation that survives and continues the combined business, while a consolidation is the union of two or more existing corporations to form a new one), the Corporation Code prescribes the same procedure for both. Thus, in either case, the constituent corporations formulate a plan of merger or consolidation, obtain the necessary corporate approvals and any necessary governmental endorsements, execute the articles of merger or consolidation, and then submit them to the Philippine Securities and Exchange Commission (SEC) for approval.

The merger or consolidation of banks, trust companies, insurance companies, public utilities, educational institutions and other corporations governed by special laws must have the favourable recommendation of the appropriate government agency before any application for approval is filed with the SEC. After the SEC is satisfied that the merger or consolidation is not inconsistent with the Corporation Code and existing laws, it issues a certificate of merger or consolidation, at which point the merger or consolidation becomes effective.

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

Any claim, action or proceeding pending by or against each such constituent corporation may be prosecuted by or against the surviving or consolidated corporation. It should be noted that the rights of the creditors of each constituent corporation are not impaired by the merger or consolidation.

DE FACTO MERGERS & CONSOLIDATIONS: To achieve a corporate combination, it is not always necessary to resort to statutory merger or consolidation. In fact, an asset or stock purchase may be combined with other arrangements to achieve the effect of a merger or consolidation (i.e., the transfer of the property and business of one corporation to another in exchange for securities issued by the latter to the stockholders of the former).

The more common procedure begins with a purchase by the acquiring corporation of all the assets of the acquired corporation using shares of the former’s capital stock as payment. Simultaneously with, or after, the completion of the purchase, the acquiring corporation assumes the payment of all the liabilities of the acquired corporation. Thereafter, the latter is dissolved and its remaining property (i.e., the shares of the acquiring corporation received as payment in the asset purchase) is distributed to its stockholders as liquidating dividend.

At the conclusion of the exercise (and except in respect of the tax consequences), the same legal results as in a statutory merger are achieved: the separate existence of one corporation is extinguished, its assets and business are transferred to another corporation, and its stockholders are transformed into stockholders of the latter corporation.

If an asset purchase is not ideal, an alternative is for the combining corporations to conclude a stock purchase. The acquiring corporation may purchase all the outstanding shares of stock of the acquired corporation from the latter’s existing stockholders in exchange for the acquiring corporation’s own shares of stock, making all the stockholders of the acquired corporation stockholders likewise of the acquiring corporation. Once the exchange is complete, the acquired corporation becomes the subsidiary of the acquiring corporation. Thereafter, the acquiring corporation can proceed to purchase all the assets of the acquired corporation and then to dissolve the latter, achieving basically the same result as in a statutory merger.

Regardless of the method pursued, however, the principal difference between a de facto and a statutory merger or consolidation lies in the assumption by the acquiring corporation (surviving or consolidated corporation) of the liabilities of the acquired corporation (constituent corporation[s]).

In a statutory merger or consolidation, the assumption of liabilities occurs ipso jure (by operation of law) when the merger or consolidation takes effect; in a de facto merger or consolidation, the acquiring corporation must still perform a positive act demonstrating its voluntary and express assumption of the liabilities and obligations of the acquired corporation.

As a corollary to this, in a statutory merger or consolidation, the assumption of liabilities generally takes place notwithstanding any objection by the acquired corporation’s creditors; in a de facto merger or consolidation, creditors of the acquired corporation are legally entitled to contest and to object to the assumption of liabilities, and to challenge the transaction as a fraudulent conveyance unless sufficient assets are reserved for the payment of the debts due to them.

EFFECTS ON STOCKHOLDERS & CREDITORS: Under the law, stockholders who object to a corporate action which effects a major change in their contract of investment are granted an appraisal right whereby they are permitted to withdraw their investment from the corporation and demand payment for the fair value of their shares. Subject to certain conditions, this appraisal right is available to all stockholders who oppose corporate acquisitions, mergers or consolidations. Within 30 days after the date on which the vote was taken that approved the corporate combination, a dissenting stockholder may serve upon the corporation in question a written demand for the payment of the fair value of his or her shares. Ten days after the date of this written demand, any such stockholder must surrender his or her stock certificates to the corporation for notation that they represent dissenting shares.

If the acquisition, merger or consolidation is implemented, the corporation must then pay to the stockholder the fair value of the stockholder’s shares as of the day prior to the date on which the stockholder vote was taken, excluding any appreciation or depreciation in anticipation of such acquisition, merger or consolidation.

On the other hand, notwithstanding that all the conditions required by law are complied with, the corporation is not required to make any payment in respect of an exercise of the appraisal right where it does not have sufficient unrestricted retained earnings in its books to cover such payment (i.e., there must be sufficient net corporate assets to pay creditors and to cover the par or issued value of the remaining shares).

As third parties to any proposed acquisition, merger or consolidation, the creditors of a corporation have no statutorily granted power to oppose the implementation of the transaction. On the other hand, the law recognises that creditors have valid proprietary interests that should be protected in the execution of corporate combinations.

Thus, in an asset purchase where all or substantially all of the assets of one corporation are sold to another, the selling corporation is directed to notify all its creditors of the proposed purchase, and to apply the purchase price received therefrom to the pro rata payment of their bona fide claims.

In a merger or consolidation, the surviving or consolidated corporation is obliged to assume the obligations and liabilities of the constituent corporations immediately upon the merger or consolidation’s taking effect. It is only in a stock purchase transaction that creditors do not receive any specific statutory protection because neither the existence nor the properties of the corporation concerned is affected by such transaction.

ACQUISITIONS: Corporate acquisitions generally take one or a combination of two forms: an asset purchase or a stock purchase.

Depending upon the financial and business considerations driving the acquisition, a corporation may decide to purchase only the specific assets of another corporation, or the entirety of its ongoing business, including all assets and liabilities.

On the other hand, a corporation may also acquire another corporation by purchasing a majority (or a greater percentage) of the latter’s outstanding capital stock from its existing stockholders. In this case, the acquisition occurs not at the enterprise level (because the acquired corporation retains, and remains the owner of, its property and business), but rather at the equity level as it is the ownership of the acquired corporation that has changed.

ASSET PURCHASE: Generally, the transfer of assets from one corporation to another is accomplished simply by the execution of the appropriate deed of sale or similar instrument, with such transfer and execution having been previously authorised and approved by the respective board of directors and stockholders, as necessary, of the selling and the purchasing corporations. Ownership of the assets may be transferred to the purchaser upon execution of the relevant sale document, The sale by a corporation of all or substantially all of its assets requires the affirmative vote of a majority of its board of directors, and of stockholders representing at least two-thirds of its outstanding capital stock. A sale is deemed to cover substantially all of a corporation’s property and assets if the corporation is thereby rendered incapable of continuing the business or accomplishing the purpose for which it was incorporated.

Any other sale, including the disposition of corporate property and assets in the usual and regular course of business, will not require stockholder authorisation and may proceed with only the requisite board approval.

BULK SALES: In addition to obtaining corporate approvals, a corporation selling all or substantially all of its corporate assets must comply with the notification and other requirements imposed by the law on “bulk sales”.

A bulk sale is defined as any sale, transfer, mortgage or assignment of the following: (i) A stock of goods, wares, merchandise, provisions or materials otherwise than in the ordinary course of business of the seller, mortgagor, transferor or assignor; (ii) All or substantially all of the business or trade hitherto conducted by the seller, mortgagor, transferor or assignor; or (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 from all its creditors, it must: (a) Deliver to the purchaser a sworn written statement of the names and addresses of all its creditors and the amounts due and owing, or to become due and owing, to each before it receives from said purchaser any part of the purchase price, or any promissory note, memorandum or other evidence therefor; (b) Make a full and detailed inventory of the stock of goods, wares, merchandise, provisions or materials 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 the price, terms and conditions of the bulk sale, at least 10 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 creditors against the fraud that may result when a business person secretly sells in bulk all or substantially all of his or her stock of goods. It should be noted that the general scheme of the law is to declare a bulk sale presumptively fraudulent and void as to the creditors of the seller, unless the above formalities are observed. Unlike the seller, the purchaser of all or substantially all of the assets of a corporation usually needs to obtain only corporate approvals. Under the law, the purchase is deemed to constitute an investment of corporate funds, which, in the following cases, requires the approval of a majority of the board of 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 corporation; and (b) Where the purchase is not authorised by any stated purpose, whether primary or secondary, of the purchasing corporation; in which case the articles of incorporation must be amended to authorise the purchase (such amendment requiring the approval of at least a majority of the directors of the purchasing corporation and of stockholders representing at least two-thirds of its outstanding capital stock). Only where the purchase is reasonably necessary to accomplish the primary purpose of the purchasing corporation will board approval be sufficient, and stockholder approval will not be required.

The principle is that stockholders have a right to decide how their funds are to be invested. Since their investment presumes that the corporation will confine its efforts to the achievement of its primary purpose, any action unrelated to the same must have their prior approval. Further, if the purchase is not related to any corporate purpose, the articles of incorporation must be amended to accommodate the same. The law permits a corporation to purchase real and personal property only “as the transaction of the lawful business of [said] corporation may reasonably and necessarily require”.

As between the contracting parties, the execution of a deed of sale is generally sufficient to transfer to the purchaser all of the seller’s rights, title and interests in and to the property covered thereby. However, some types of property call for compliance with certain formalities in order to make the transfer effective against third parties. These formalities are especially relevant in transactions involving the purchase of various types of properties, rights and interests, the transfer of some of which may be subject to specific legal requirements. For instance, the sale of motor vehicles must be registered with the Land Transportation Office, and the sale of land must 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 implemented through a simpler procedure. Although ordinarily effected through the execution of a stock purchase agreement, under the law, transfers of shares may in fact be accomplished by mere delivery to the purchaser of the relevant stock certificates duly endorsed by the seller. Such a transfer of shares is valid and binding between the seller and the purchaser, and, provided it is recorded in the books of the corporation, against third parties as well. Aside from this recording process, no other registration, notification or similar requirement need be complied with in order to make the transfer effective.

On the other hand, it should be noted that a stock purchase involving shares listed with the PSE and effected through the PSE follows a distinct procedure for the transfer of shares. Listed shares are bought and sold on the trading floor of the PSE on an order basis, where orders are generally prioritised first by price, then by time. Cross transactions (i.e., a sale transaction where the same broker has a buying and a selling order from two different clients at the same price and for the same issue) constitute the only exception to this rule, and enjoy priority over previously entered orders, provided that certain conditions imposed by the PSE are met.

The same rules on corporate approvals for the purchaser in an asset purchase apply to the purchaser in a stock purchase. If the stock purchase is reasonably necessary for the accomplishment of the primary purpose of the purchasing corporation, only board approval is required. In any other case, the affirmative vote of stockholders representing at least two-thirds of the outstanding capital stock of the 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 incorporation of the purchasing corporation, the articles must first be amended to include such authority.

If the seller in a stock purchase is an individual, he or she need not obtain any approval other than for the sale of his or her shares of stock. On the other hand, if the seller is a corporation, it must have been previously and validly authorised by its board to sell the shares. As a rule, no stockholder action is required for a corporate seller, provided only that the sale of the shares is reasonably and necessarily required in the transaction of the business of the corporation.

In addition to the corporate approvals of the seller and the purchaser, depending upon the circumstances attending the particular transaction, the consent of third parties to the stock purchase may have to be obtained. For example, where share transfer restrictions (such as a right of first refusal) are triggered by the sale of shares, the consent of the party or parties in whose favour the transfer restrictions were intended must be obtained. This consent effectively waives the operation of the transfer restriction and is important in a transaction that has been precisely structured to result in the acquisition of a majority of the shares in a corporation, where an offer (and possible sale) to any other person of the specific shares which are the subject of the stock purchase can defeat the purpose and intent of the purchaser. It should be noted that the rights of first refusal, in particular, have been unequivocally upheld by the SEC as valid and enforceable. Hence, any seller of shares subject to such a transfer restriction must either comply with its dictates or obtain the necessary waiver and consent. In case a stock purchase involves the transfer of a foreign investment, the registration with the Bangko Sentral ng Pilipinas may be similarly transferred to the purchaser to enable said purchaser to avail itself of the foreign exchange privileges pertaining to such registered investment. OBG would like to thank SyCip Salazar Hernandez & Gatmaitan for their contribution to THE REPORT Philippines 2014.