SEC OGC Opinion No. 22-13; Re: Additional Paid In Capital

The Securities and Exchange Commission (“SEC”) in SEC OGC Opinion No. 22-13, dated 30 September 2022 (“Opinion”), discussed that by its nature, Additional Paid In Capital (“APIC”) forms part of the capital of a corporation and thus falls within the purview of the Trust Fund Doctrine. 

The Opinion is addressed to CommVerge Philippines, a company registered with the SEC on 09 July 1999 with an authorized capital stock (“ACS”) of ten million (Php10M) divided into 100,000 shares at a par value of Php100.00 each. CommVerge Solutions Holdings (Asia) Inc. (“CommVerge Holdings”), a company registered in the British Virgin Islands, is CommVerge Philippines’ parent company. 

CommVerge Philippines incurred a cumulative deficit of Two Hundred Twenty Million Pesos (Php220M) from 1999 to 2001. CommVerge Holdings helped CommVerge Philippines by making advances in the amount of Two Hundred Thirty Six Million Pesos (Php236M) (“advances”). On 29 May 2002, the ACS of CommVerge Philippines was increased to Two Hundred Thirty Six Million Pesos (Php236M). CommVerge Philippines then converted the advances equivalent to Php236M. 

By 2006, CommVerge Philippines continued to suffer operating losses and incurred an annual deficit up to Four Hundred Twenty-One Million Pesos (Php421M). By 2007, CommVerge Holdings made additional advances in the amount of One Hundred Forty-Nine Million Six Hundred Thousand (Php149.6M). 

CommVerge Philippines applied for equity restructuring and creation of APIC to partially wipe out the existing deficit as of financial year 2007. When the application was approved, the Php149.6M advances from CommVerge Holdings was converted to APIC. By 31 December 2018, CommVerge Philippines has paid out the advances which accumulated to about Php157M to CommVerge Holdings. CommVerge Philippines intends to return to CommVerge Holdings the Php149.6M advances that was converted to APIC provided it can do so legally and without violating the Trust Fund Doctrine. 

Nature of APIC

APIC is any contribution of stockholders over the par value of shares. APIC is also considered as a premium paid over the par value of shares. A stockholder is allowed by the SEC to infuse cash or property to be treated as APIC or premium. 

Under SEC Resolution No. 94, series of 2006, corporations, at their option, are allowed to apply for SEC approval of the creation of APIC, subject to payment of filing fees. The approval of SEC is mandatory when the consideration involved is other than cash. When the purpose for the creation of APIC is for equity restructuring, the approval of the SEC is mandatory regardless of whether the consideration is cash or not. 

Moreover, pursuant to SEC Memorandum Circular No. 11, series of 2008, APIC shall neither be declared as dividend nor shall it be reclassified to absorb deficiency except though an organizational restructuring duly approved by the SEC. 

Thus, there are no specific rules and regulations issued by the SEC on the nullification of APIC, and its subsequent conversion into subscribed capital. However, based on the previous Opinions issued, conversion of APIC involves the observance of the Trust Fund Doctrine.

Trust Fund Doctrine

As held in the case of Enano-Bote v. Alvarez, the trust fund doctrine enunciates a rule that a property of a corporation is a trust fund for the payment of creditors, but such property can be called a trust fund only by way of analogy or metaphor. As between the corporation itself and its creditors, it is a simple debtor, and as between its creditors and stockholders, its assets are in equity a fund for the payment of its debts. 

Further, in the case of Philippine Trust Co. v. Rivera the Supreme Court clarified that the Trust Fund Doctrine is not limited to reaching the stockholder’s unpaid subscription. The scope of the doctrine when the corporation is insolvent encompass not only the capital stock, but also other property and assets generally regarded in equity as a trust fund for the payment of corporate debts. 

Capital

Capital is a composition of the trust fund. In National Telecommunications Commission (“NTC”) v. Honorable Court of Appeals, the Court held that the capital subscribed is the total amount of the capital that persons, subscribers or shareholders, have agreed to take and pay for, which need not necessarily be, and can be more than, the par value of the shares. It is the amount that the corporation receives, inclusive of the premiums, if any, in consideration of the original issuance of the shares. The trust fund doctrine considers this subscribed capital as a trust fund for the payment of the debts of the corporation, to which the creditors may look for satisfaction. Until the liquidation of the corporation, no part of the subscribed capital may be returned or released to the stockholder, except in the redemption of redeemable shares, without violating this principle. 

Equity

Under the International Accounting Standards Board’s Framework, equity is the residual interest in the entity’s assets after deducting all its liabilities. Equity includes the entity’s issued ordinary shares, and options and warrants held by external parties to purchase those shares. There are many types of share capital, including ordinary shares, preferred shares, non-voting shares, participating shares and redeemable shares. The price of share capital is recorded at the amount that a corporation received in consideration for the issuance of shares, plus share premium or APIC, if any.

In sum, subsequently infused APIC forms part of the equity emanating from the original subscription agreement. APIC, as a premium, forms part of the capital of a corporation and therefore falls within the purview of the Trust Fund Doctrine. 

In Ong Yong, et al. v. David S. Tiu, et al., the Court held that the Trust Fund Doctrine is the underlying principle in the procedure for the distribution of capital assets, which is allowed only in (1) amendment of the articles of incorporation to reduce the ACS, (2) purchase of redeemable shares by the corporation, regardless of the existence of unrestricted retained earnings, and (3) dissolution and eventual liquidation of the corporation. The Court reiterated this in Philip Turner, et al. v. Lorenzo Shipping Corporation where it held that there can be no distribution of assets among the stockholders without first paying corporate debts. 

Having determined that APIC is covered by the Trust Fund Doctrine, the SEC discussed the proposed actions of CommVerge Philippines: 

1. Nullification of APIC and its subsequent conversion into subscribed capital will violate the Trust Fund Doctrine 
   
   When a corporate Trust Fund will be used for purposes other than those enumerated in Ong Yong, it will effectively result in the unauthorized distribution of the corporate Trust Fund, thereby violating the Trust Fund Doctrine.
   
   In the NTC case, it is clear that, until the liquidation of the corporation, no part of the subscribed capital may be returned or released to the stockholder without violating this principle. The corporate creditors, therefore, should have the first claim on the trust fund of the corporation and the stockholders have no rights to it, until all the creditors are satisfied.

2. Whether it is permitted to execute a reverse stock split to cover deficit in the amount of subscribed capital following the increase in par value
   
   Reverse stock split is the opposite of stock split and described as the pro rata combination of all the outstanding shares of a specified class into smaller number shares of that class by an amendment to articles stating the effect on outstanding shares. It may be required to increase the market value per share of a corporation’s shares or to restructure other outstanding debt or equity instruments issued by the corporation or it may be used to eliminate certain small minority stockholders. A stock split or reverse stock split, readjusts corporation’s capital structure. Either can therefore, be used as part of a recapitalization of a corporation. In a reverse stock split, the outstanding shares are transformed into a smaller number of outstanding shares and the effect is disguised unless the par or nominal value of the shares is changed as part of the transaction. In the absence of some feature not associated with the typical stock split (such as an option to receive cash rather than shares or a split or reverse split which does not result in proportionate change in the shareholdings of all holders of the same class or series) the receipt of shares as a result does not result in taxable income to either the stockholder or the corporation. 
   
   A share split refers to issuing ordinary shares to existing shareholders for no additional consideration. The number of ordinary shares outstanding is increased without an increase in resources. On the other hand, reverse split or consolidation of ordinary shares reduces the number of ordinary shares without a corresponding reduction in resources.
   
   As such, a reverse stock split will not create an APIC because the amount of the subscribed and paid-up capital will remain the same, considering that this will merely be a decrease in number of shares but with proportionate increase in par value. Hence, to undergo a reverse stock split will not result to decrease of deficit. 

3. Whether a reverse stock split will result to an increase in ACS and whether the same would be considered “original issuance” of stocks and thus subject to documentary stamp taxes
   
   Since there will be no changes in the balance of the Share Capital/Capital Stock after a reverse stock split, an increase or decrease in capital would not be possible as it simply increases the par value and decreases the number of shares proportionately. A reverse stock split will not result to an increase of ACS.