Legal Basis to Declare Cash Dividends in Corporations
One of the ways in which stockholders’ profit from their investments in a corporation is through dividend declarations. The power of corporations to declare dividends is implicit in its nature. Dividends which a corporation may declare take on two (2) forms, cash, and stock dividends. The process in making the dividend declaration varies for either type, but is governed by one provision of Republic Act No. 11232 also known as the Revised Corporation Code of the Philippines. Section 42 of the Revised Corporation Code states:
Section 42. Power to Declare Dividends. – The board of directors of a stock corporation may declare dividends out of the unrestricted retained earnings which shall be payable in cash, property, or in stock to all stockholders on the basis of outstanding stock held by them: Provided, That any cash dividends due on delinquent stock shall be first be applied to the unpaid balance on the subscription plus costs and expenses, while stock holders until their unpaid subscription is fully paid: Provided, further, That no stock dividend shall be issued without the approval of stockholders representing at least two-thirds (2/3)of the outstanding capital stock at a regular or special meeting duly called for the purpose.
Stock corporations are prohibited from restraining surplus profits in excess of one hundred percent (100%} of their paid-in capital stock, except: (a) when justified by the definite corporate expansion projects or programs approved by the board of directors; or (b) when the corporation is prohibited under 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.
Clearly, the declaration of dividends, either in cash or in stock, cannot be done without complying with certain mandatory steps and submission of documents. The steps below outline the process for declaration of cash dividends for corporations.
Steps to Declare Cash Dividends in Corporations
STEP 1: DETERMINE IF THE CORPORATION HAS SURPLUS PROFITS OR UNRESTRICTED RETAINED EARNINGS.
What is the concept of unrestricted retained earnings?
Under SEC Memorandum Circular No. 11, Series of 2002, this pertains to the amount of accumulated profits and gains realized out of the normal and continuous operations of the company after deducting therefrom distributions to stockholders and transfers to capital stock or other accounts, and which is: (1) not appropriated by its Board of Directors for corporate expansion projects or programs; (2) not covered by a restriction for dividend declaration under a loan agreement; and (3) not required to be retained under special circumstance obtaining in the corporation such as when there is a need for a special reserve for probable contingencies.
STEP 2: THE CORPORATE SECRETARY SHALL SEND NOTICE TO ALL THE BOARD OF DIRECTORS SPECIFYING THE TIME, PLACE, AND DATE OF THE MEETING FOR THE APPROVAL OF DECLARATION OF CASH DIVIDENDS.
Form of Notice to the Board of Directors
The Articles of Incorporation and By-Laws of the corporation should outline how the notice should be sent, in what form, and in what manner. For example, if the By-Laws of the corporation states that the notices of the regular or special meetings should be communicated by the corporate secretary to each director personally, then this requirement should be complied with strictly. If the By-Laws allow for other modes of communicating the notice, for example, by telephone, telex, telegram, or by written or oral message, then these too should be sufficient.
Suggested Form of Notice to the Board of Directors
The notice should be in writing in order to ensure that the action taken by the Board of Directors during the meeting will not be questioned by any Director by simply claiming that he/she was not notified of the meeting.
The notice in writing shall serve as a proof that all the members of the Board of Directors were notified.
Effect of absence of notice to the Board of Directors
As a general rule, the action taken by the Board of Directors during the meeting is illegal for lack of notice. This, notwithstanding, as held by the Supreme Court in the case of Lopez Realty Inc. vs. Florentina Fontecha, et al., G.R. No. 76801, 11 August 1995, the action of the Board of Directors may be ratified either expressly, by the action of the directors in subsequent legal meeting, or impliedly, by the corporation’s subsequent course of conduct. However, to follow the exception rather than the rule would be to tread into dangerous territory, especially where there is internal conflict in the corporation.
What is the effect of the presence of all the members of the Board of Directors during the meeting despite the lack of notice?
If the meeting is not questioned by any director and all the members of the Board of Directors participated in the meeting, the requirement of notice is deemed waived.
STEP 3: A QUOROM MUST BE PRESENT. THE CORPORATE SECRETARY MUST DETERMINE THE EXISTENCE OF A QUORUM DURING THE MEETING.
What constitutes a quorum?
Quorum is the majority of the number of directors as fixed in the Articles of Incorporation of the corporation.
STEP 4: MAJORITY VOTE OF THE BOARD OF DIRECTORS IS NECESSARY TO APPROVE THE DECLARATION OF CASH DIVIDENDS.
STEP 5: A REPORT PREPARED USING SEC FORM 17-C IS REQUIRED TO BE FILED WITHIN FIVE (5) DAYS AFTER THE DECLARATION OF DIVIDENDS.
STEP 6: SUBMIT COMPLETE DOCUMENTARY REQUIREMENTS TO THE SEC.
The following are the documents to be submitted to the SEC:
i. Notarized Secretary’s Certificate certifying the resolution of the Board of Directors in relation to the declaration of cash dividends.
ii. Interim unaudited financial statements certified by the Finance Officer (if the basis of determining the sufficiency of retained earnings is other than end of fiscal year)
iii. Audited Financial Statements as of the last fiscal year stamped received by the BIR and SEC.
iv. Reconciliation of retained earnings, if applicable. The reconciliation shall be based on the guidelines issued by the Securities and Exchange Commission. Reconciliation of retained earnings is required for the following cases:
a. Listed companies, corporations with securities under the Securities and Exchange Commission, and public companies;
b. Not listed companies, corporations with securities under the Securities and Exchange Commission but the amount of unrestricted retained earnings per company’s audited financial statements is in excess of 100% of its paid-in capital as of balance sheet. The company shall in this case attach in its financial statements a reconciliation of retained earnings as prescribed under SEC Memorandum Circular No. 11 series of 2008. If the adjusted retained earnings still exceed the company’s paid-in capital, there must be a description in its financial statements of the company’s concrete plan to comply with Section 42 of the Revised Corporation Code; or
c. The company applies for approval by the Commission of its proposed cash and/or property dividends or for confirmation of stock dividends. As one of the supporting documents to the application or request for confirmation, the latest audited financial statements shall be accompanied by a Reconciliation of retained earnings.
v. Notarized Secretary’s Certificate that the corporation is not involved in any pending intra-corporate controversy or dispute.
vi. Notarized Secretary’s Certificate, certifying the resolution of the Board resolution as to the reversal of appropriated retained to unappropriated retained earnings, if applicable.
vii. Compliance Monitoring Division (CMD) Clearance and/or clearance from other Department of the SEC and/or other government agencies.
STEP 7: UPON APPROVAL BY THE SEC, THE CASH DIVIDEND SHALL BE APPLIED AGAINST THE UNPAID SUBSCRIPTION PRICE THEN THE BALANCE SHALL BE DISTRIBUTED TO THE STOCKHOLDERS, AS PROVIDED UNDER SECTION 42 OF THE REVISED CORPORATION CODE.
These are the steps which must be complied with before cash dividends are declared by a corporation.
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