Barretto vs. La Previsora Filipina

A by-law provision of a mutual building and loan association granting a life gratuity or pension to particular directors for past services gratuitously rendered is ultra vires and void, being beyond the lawful powers of such associations, inconsistent with the principles of strict mutuality and equality of benefits and obligations among members, and lacking the essential elements of a contract, including mutual consent and valid consideration.

The plaintiffs were directors of La Previsora Filipina, a mutual building and loan association organized under the Corporation Law, from its incorporation until March 1929. Mutual building and loan associations are special corporations founded upon principles of strict mutuality and equality of benefits and obligations among their members, and they stand in a trust relation to their contributors with respect to the funds contributed. The Corporation Law expressly authorizes such associations to adopt by-laws for their government, but section 20 of that Act limits such authority to by-laws not inconsistent with the provisions of the law.

Alberto Barretto, Jose de Amusategui, and Jose Barretto had been directors of La Previsora Filipina, a mutual building and loan association, from its incorporation up to March 1929. At a general meeting of the stockholders on February 23, 1929, the corporation adopted an amendment to its by-laws, designated Article 68-A, which granted to eight named individuals, including the three plaintiffs, a sum equal to one percent (1%) of all the net profits of the corporation for the year or years in which they ceased to be directors, in consideration of the valuable services they had gratuitously rendered to the society for several years. The provision stated that this special remuneration would subsist while the director lived and would cease during any time he again became a director, and it declared itself to constitute a formal contract between the society and each of the named directors that could not be modified or amended except by mutual agreement of the parties.

The plaintiffs brought an action to recover 1% of the net profits of the corporation for 1929, which amounted to P50,727.53, from which each plaintiff's share would be P507.02½. The case was set for trial on July 30, 1930. After the presentation of the plaintiffs' evidence, counsel for the defendant informed the court that they desired to present a motion to dismiss the complaint on the ground that the plaintiffs had not shown a cause of action, and requested time to file the motion in writing with a supporting memorandum. The court granted this request, and on August 2, 1930, the defendant presented a written motion to dismiss, with the reservation of the right to offer defendant's evidence in support of its special defenses and counterclaim in the event the motion was denied.

On August 29, 1930, the trial court denied the motion to dismiss, holding that the plaintiffs' evidence showed a cause of action and constituted sufficient legal reason to require the defendant to present its evidence, setting the case for continuation of the hearing on September 22, 1930. On September 2, 1930, the plaintiffs petitioned the court to declare that the defendant had no right to present evidence and that judgment be entered according to the prayer of the complaint. On September 11, 1930, without setting aside its former order giving the defendant the right to present its evidence, the court rendered its decision holding that the defendant, by presenting its motion to dismiss, had impliedly waived its right to present its evidence, and rendered judgment in favor of each plaintiff for P505.25 with legal interest from May 2, 1930, with costs. The defendant's motion for reconsideration was denied on October 7, 1930, and its motion for a new trial was denied on October 18, 1930.

• Validity of By-law as Compensation: The appellees contended that Article 68-A was merely a provision for the compensation of directors, which is not only consistent with but expressly authorized by section 21 of the Corporation Law.
• Reliance on Precedent: The appellees cited the cases of El Hogar Filipino vs. Rafferty (37 Phil., 995) and Government of the Philippine Islands vs. El Hogar Filipino (50 Phil., 399) as authority for sustaining the validity of the by-law in question.

• Lack of Cause of Action: The appellant argued that the plaintiffs had not shown a cause of action against the defendant, as the by-law provision upon which the action was based did not create any legal obligation on the part of the corporation to pay a life gratuity or pension out of its net profits.
• Ultra Vires Nature of the By-law: The appellant maintained that the by-law provision was clearly beyond the lawful powers of a mutual building and loan association, being inconsistent with and subversive of the legislative scheme governing such associations.
• Waiver of Right to Present Evidence: The appellant contended that the trial court erred in holding that the defendant, by presenting its motion to dismiss, had impliedly waived its right to present its evidence, and that the decision was contrary to law and the weight of evidence.

• Validity of the By-law: Whether Article 68-A of the amended by-laws of the defendant corporation, granting a life gratuity or pension to former directors for past gratuitous services, created a legal obligation enforceable against the corporation.
• Contractual Validity: Whether the by-law provision constituted a valid contract between the corporation and the plaintiffs, possessing the essential elements of consent, object, and consideration.
• Ultra Vires Doctrine: Whether the by-law provision was beyond the lawful powers of a mutual building and loan association and therefore ultra vires and void.

• Validity of the By-law: No. Article 68-A of the amended by-laws did not, under the law as applied to its express provisions, create any legal obligation on the part of the corporation to pay a life gratuity or pension out of its net profits, as such a provision must be regarded as clearly beyond the lawful powers of a mutual building and loan association.
• Contractual Validity: No. The by-law could not be held to establish a contractual relation between the parties because the essential elements of a contract were lacking — there was no mutual consent, as the plaintiffs objected to and voted against the provision, and there was no valid consideration, as it was an attempt to give compensation for past services gratuitously rendered.
• Ultra Vires Doctrine: Yes. The provision was ultra vires, being entirely foreign to the government of the defendant corporation, inconsistent with and subversive of the legislative scheme governing building and loan associations, and contrary to the spirit of the law.

• Validity of the By-law: Section 20 of the Corporation Law, as construed in Fleischer vs. Botica Nolasco Co. (47 Phil., 583), expressly limits the authority of corporations to adopt by-laws to those not inconsistent with the provisions of the law. The authority conferred by section 21 refers only to providing compensation for the future services of directors, officers, and employees after the adoption of the by-law, and cannot be held to authorize the giving of continuous compensation to particular directors after their employment has terminated for past services rendered gratuitously. To permit such a transaction would create an obligation unknown to the law and countenance a misapplication of the funds of the defendant building and loan association to the prejudice of the substantial rights of its shareholders.

• Contractual Validity: Contracts between a corporation and third persons must be made by or under the authority of its board of directors, not by its stockholders; the action of stockholders in such matters is only advisory and not binding on the corporation, as held in Ramirez vs. Orientalist Co. and Fernandez (38 Phil., 634). There could not be a contract without mutual consent, and the plaintiffs did not consent to the provisions of the by-law but, on the contrary, objected to and voted against it. Furthermore, the by-law showed on its face that there was no valid consideration for the supposed obligation, as it was clearly an attempt to give in the future to certain directors compensation for past services gratuitously rendered, which is without consideration and imposes no obligation enforceable by action at law.

• Ultra Vires Doctrine: Building and loan associations are peculiar and special corporations founded upon principles of strict mutuality and equality of benefits and obligations. The trend of more recent decisions is that any contract made or by-law provision adopted by such an association in contravention of the statute is ultra vires and void. Such associations stand in a trust relation to the contributors in respect to the funds contributed, with an implied contract that they shall not divert their funds or powers to purposes other than those for which they were created. The fundamental law of building and loan associations is that all members must participate equally in the profits and bear the losses in the same proportion, and any diversion of their funds to purposes not authorized by the law of their creation is violative of the principles of mutuality between the members. The cases of El Hogar Filipino vs. Rafferty and Government of the Philippine Islands vs. El Hogar Filipino cited by the appellees were clearly distinguishable, as the causes of action were not of the same nature and the facts were entirely different.

• Ultra Vires Acts of Building and Loan Associations — Any contract made or by-law provision adopted by a building and loan association in contravention of the statute is ultra vires and void. Building and loan associations are founded upon principles of strict mutuality and equality of benefits and obligations, and any diversion of their funds to purposes not authorized by the law of their creation is violative of the principles of mutuality between the members. The Court applied this doctrine to hold that a by-law granting a life gratuity to former directors for past gratuitous services was entirely foreign to the government of the corporation, inconsistent with and subversive of the legislative scheme governing such associations, and contrary to the spirit of the law.

• Authority to Adopt By-laws — Section 20 of the Corporation Law limits the authority of corporations to adopt by-laws to those not inconsistent with the provisions of the law. The authority conferred by section 21 to provide compensation for directors refers only to providing compensation for future services after the adoption of the by-law, and cannot authorize the giving of continuous compensation to particular directors after their employment has terminated for past services rendered gratuitously.

• Contracts Must Be Made by the Board of Directors — Contracts between a corporation and third persons must be made by or under the authority of its board of directors and not by its stockholders. The action of stockholders in such matters is only advisory and not in any wise binding on the corporation. There could not be a contract without mutual consent, and a by-law provision to which the purported beneficiaries objected and voted against cannot establish a contractual relation.

• Consideration Requirement — A by-law provision attempting to give in the future to certain directors compensation for past services gratuitously rendered to the corporation is without consideration and imposes no obligation on the corporation which can be enforced by action at law.

• "A by-law provision of this nature must be regarded as clearly beyond the lawful powers of a mutual building and loan association, such as the defendant corporation." — This passage states the core holding that the by-law granting a life gratuity to former directors was ultra vires for a mutual building and loan association.

• "To permit the transaction involved in this case would be to create an obligation unknown to the law, and to countenance a misapplication of the funds of the defendant building and loan association to the prejudice of the substantial right of its shareholders." — This excerpt articulates the policy rationale for invalidating the by-law, emphasizing the protection of shareholders' rights against unauthorized diversions of corporate funds.

• "Strict mutuality and equality of benefits and obligations must be kept the groundwork and basis of these associations, and if they are not so founded they are not truly building and loan associations, entitled to the protection given such associations by the statute." — This quotation from McCauley vs. Building and Saving Assn. is adopted by the Court as the canonical formulation of the fundamental principle governing building and loan associations.

• "There could not be a contract without mutual consent, and it appears that the plaintiffs did not consent to the provisions of the by-law in question, but, on the contrary, they objected to and voted against it in the stockholders' meeting in which it was adopted." — This passage explains why the by-law failed to establish a contractual relation, emphasizing the absence of mutual consent as an essential element of a contract.

• Fleischer vs. Botica Nolasco Co., 47 Phil., 583 — Controlling precedent construing section 20 of the Corporation Law as limiting the authority to adopt by-laws to those not inconsistent with the provisions of the law; relied upon to establish that the by-law in question exceeded corporate powers.
• Ramirez vs. Orientalist Co. and Fernandez, 38 Phil., 634 — Followed for the proposition that contracts between a corporation and third persons must be made by or under the authority of its board of directors and not by its stockholders, whose action is only advisory.
• Bertche vs. Equitable Loan etc. Association, 147 Mo., 343; 71 A. S. R., 571 — Cited as authority for the principle that any diversion of building and loan association funds to purposes not authorized by law is violative of the principles of mutuality between members.
• McCauley vs. Building and Saving Assn., 97 Tenn., 421; 56 A. S. R., 813 — Cited for the canonical statement that strict mutuality and equality of benefits and obligations must be the groundwork and basis of building and loan associations.
• El Hogar Filipino vs. Rafferty, 37 Phil., 995 — Distinguished; the Court found this case clearly distinguishable from the present action, as the causes of action were not of the same nature and the facts were entirely different.
• Government of the Philippine Islands vs. El Hogar Filipino, 50 Phil., 399 — Distinguished on the same grounds as El Hogar Filipino vs. Rafferty.

• Section 20, Corporation Law — Limits the authority of corporations to adopt by-laws to those not inconsistent with the provisions of the law; construed in Fleischer vs. Botica Nolasco Co. and applied to invalidate the by-law provision as inconsistent with the legislative scheme governing building and loan associations.
• Section 21, Corporation Law — Authorizes corporations to provide compensation for directors, officers, and employees; construed by the Court as referring only to compensation for future services after adoption of the by-law, not to continuous compensation for past gratuitous services.

Avanceña, C.J., Street, Malcolm, Villamor, Villa-Real, Abad Santos, Hull, Vickers, Imperial, and Butte, JJ., concurred.