SEC-OGC Opinion No. 21-10: Redemption and Retirement of Preferred Shares; Reduction of Capital Stock

Mehitabel Incorporated (“Mehitabel”) sought the opinion of the Securities and Exchange Commission (“SEC”) on whether it can redeem its preferred shares even without unrestricted retained earnings. 

It also presented the following minor issues:

1. Whether it is allowed to raise funds for the purpose of redeeming the preferred shares; 
2. Whether interim Financial Statements (“FS”) are sufficient proof to provide interim balances after infusion of cash; and 
3. Whether Mehitabel can retire the preferred shares after redemption and remove the same from the treasury through the amendment of its Articles of Incorporation (“AOI”). 

Redemption of Preferred Shares

The SEC opined that Mehitabel may purchase its redeemable shares from the holders thereof upon the expiration of a fixed period, as provided in its AOI and the certificates of stock representing the shares, regardless of the existence of unrestricted retained earnings in its books. However, the corporation must still have sufficient assets in its books to cover debts and liabilities inclusive of the capital stock.

Section 40 of the Revised Corporation Code (“RCC”) provides that a corporation can redeem, repurchase, or reacquire its own shares provided it has unrestricted retained earnings. As an exception, under Section 8, redeemable shares may be repurchased upon the expiration of a fixed period, regardless of the existence of unrestricted retained earnings. This exception is subject to the terms and conditions stated in the AOI of the corporation, the certificate of stock representing the shares, and the rules and regulations issued by the SEC. The general rule and exception are also provided for in Sections 3 and 5 of the Rules Governing Redeemable and Treasury Shares. Further limitation to the exception is found in the case of Republic v. Agana, as quoted:

“However, while redeemable shares may be redeemed regardless of the existence of unrestricted retained earnings, this is subject to the condition that the corporation has, after such redemption, assets in its books to cover debts and liabilities inclusive of capital stock. Redemption, therefore, may not be made where the corporation is insolvent or if such redemption will cause insolvency or inability of the corporation to meet its debt as they mature.”

Raising funds; Interim FS as Sufficient Proof

On the matter of raising funds for the purpose of redeeming shares, the SEC advised that it cannot, as a matter of policy, render an opinion on matters which require the determination of factual issues or those involving the exercise of business judgment. The issue of whether Mehitabel is allowed to raise funds for the purpose of redeeming shares is one such matter.

The SEC also advised that while an interim FS is sufficient proof to provide interim balances after infusion of cash, the same must be audited. Only an audited interim FS can provide reasonable basis for obtaining high, but not absolute, level of assurance to users that the FS are not materially misstated. 

Retirement of Preferred Shares 

Under Section 9 of the RCC, redeemable shares so redeemed by a corporation shall become part of that corporation’s treasury shares. Meanwhile, Section 3 of the Rules Governing Redeemable and Treasury Shares provide that, redeemable shares that are reacquired shall be considered retired and no longer issuable, unless otherwise provided in the AOI of the corporation. 

In this case, the amended AOI of Mehitabel is silent on the “reissuable” nature of its redeemable preferred shares. As such, upon reacquisition, the same are considered retired and may no longer be issued. Finally, for the corresponding treasury shares to be eliminated, the SEC advised that Mehitabel should file an application for decrease of authorized capital stock.