SEC-OGC Opinion No. 24-35, Re: Appropriation of Retained Earnings for Contingencies;

Odfjell Philippines, Inc. (“OPI”) is a corporation duly organized and existing under Philippine laws primarily engaged in the business of recruitment and placement of seafarers for overseas employment. OPI is solidarily liable with its principal/employer for any and all claims arising out of an employer-employee relationship or by virtue of any law or contract involving Filipino workers for overseas deployment, including claims for damages. OPI is also solidarily liable with its principal for civil liabilities for any violation of the Social Security System (“SSS”) Act of 2018. Thus, OPI sought clarity on whether these liabilities warranted the retention of its surplus profits in excess of one hundred (100%) of its paid-in capital limit, as outlined in Section 42 of the Revised Corporation Code (“RCC”). 

Financial Overview

Based on OPI’s 2018 Audited Financial Statement:

• Paid-up capital is Five Million Pesos (Php5,000,000.00) 
• Unappropriated retained earnings are at Seventeen Million Seven Hundred Seventy-Eight Thousand Eight Hundred Nine Pesos (Php17,778, 809)
• As of 30 April 2019, total medical and disability expenses for twenty-five (25) seafarers is estimated at Five Hundred Fifty-One Thousand and Eighty-Six Dollars (US$551,086).
  • One Hundred Fifty-Eight Thousand Four Hundred Thirty-Six Dollars (US$158,436) for medical treatment
  • Three Hundred Ninety-Two Thousand Six Hundred Fifty Dollars (US$392,650) for disability benefits

Moreover, because the SSS Employer Contribution has increased, OPI must spend an additional Four Hundred Thirty-Six Thousand Pesos (Php436,000.00) per month or Five Million Two Hundred Thousand Pesos (Php5,200,000.00) annually.

The key issue is the appropriate treatment of unappropriated retained earnings considering OPI’s liabilities, such as seafarer claims and increased SSS contributions.

Retained Earnings Under the RCC

Section 42 of the RCC limits the discretion of the board to retain earnings for general corporate purposes by providing three exceptions to the prohibition on retention of surplus profits:

(a) when justified by corporation expansion projects or programs approved by the board of directors; or

(b) when the corporation is prohibited by any loan agreement with financial institutions or creditors, whether local or foreign, from declaring dividends without their consent, and such consent has not yet been secured; or

(c) when it can be clearly shown that such retention is necessary under special circumstances obtaining in the corporation, such as when there is need for special reserve for probable contingencies.

A corporation may invoke exceptions under Section 42 of the RCC for retaining surplus profits in excess of one hundred percent (100%) of paid-in capital only when the elements or conditions are strictly complied with. 

To invoke Section 42 (c), the following must exist:

1. There must be contingency or contingent liability;
   According to Philippine Accounting Standards (“PAS”) 37, contingent liability refers to
   1. A possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity or
   2. A present obligation that arises from past events but is not recognized because 
      1. it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or 
      2. the amount of obligation cannot be measured with sufficient reliability.
         
2. The contingent liability must be probable, not merely possible; and
   Possible means “capable of existing or happening; feasible” while probable means “likely to happen, to exist or be true” or in accounting rules “more likely to occur than not.” Thus, Section 42 (c) refers to contingencies that are more likely to occur than merely possible ones.
   
3. Special circumstances obtaining in the corporation must be considered in determining the necessity for such retention.
   The following, among others, must be considered:
   1. Nature of the event or circumstance is “special”, uncommon or rare in the normal operating course of business which the company has no control
   2. The outflow of resources is “probable”; and
   3. A reliable estimate cannot be made.

Applicability to OPI’s Liabilities

1. Liability, potential or otherwise, for seafarer claims on medical/hospitalization expenses, sickness allowance, death and disability benefits
   While there is contingency, the probability of the same happening or not happening is likely unexpected or uncertain – e.g., the outcome of the cases is generally hard to predict. The contingency is even described in the query as “possible.” Additionally, special circumstances in the corporation negate the absolute necessity to retain funds – e.g., a bond to answer for claims of Overseas Filipino Workers and the practice in the industry to cover claims by insurance.
   
2. SSS Employer Contribution Increases: 
   The increase is mandated by law, over which OPI has no control, and applies to all private companies. In short, there is no longer a contingent liability as an expense. It is a normal expense that should be settled in the ordinary course of business operations.

Implications for OPI

Section 42 (c) under the RCC cannot be availed of to retain earnings for liability, potential or otherwise, for seafarer claims on medical/hospitalization expenses, sickness allowance, death, and disability benefits and increase in SSS employer contribution of OPI. Further, OPI’s unappropriated retained earnings of Seventeen Million Seven Hundred Seventy-Eight Thousand Eight Hundred Nine Pesos (Php 17,778,809.00) should only be retained to the extent justified under Section 42 of the RCC. 

Takeaway and Conclusion

The retention of surplus profits beyond the threshold is strictly limited to instances where contingencies are probable and justified by special circumstances that are uncommon or rare in the normal operating course of business, which the company has no control of. Compliance ensures not only adherence to legal standards but also the prudent management of corporate resources.