National Exchange Co., Inc. vs. I. B. Dexter

A stipulation in a stock subscription agreement that the subscription price is payable only from dividends declared on the shares is illegal and void, and does not relieve the subscriber from personal liability for the unpaid balance, because it violates the statutory prohibition against issuing stock except in exchange for actual cash or property equal to the par value, and constitutes a fraud upon other stockholders and creditors.

During the American colonial period in the Philippines, corporate franchises were granted subject to statutory restrictions aimed at ensuring adequate capitalization and protecting creditors. Section 74 of the Philippine Bill of 1902 (Organic Act) and later Section 28 of the Jones Law (Autonomy Act of 1916) prohibited corporations from issuing stock or bonds except in exchange for actual cash or property at a fair valuation equal to the par value of the securities issued. This policy was incorporated into the Corporation Law (Act No. 1459) to prevent watered stock and ensure equality among stockholders in their liability to the corporation.

• On August 10, 1919, defendant I. B. Dexter signed a written subscription for 300 shares of the capital stock of C. S. Salmon & Co.
• The subscription agreement contained a stipulation stating: "payable from the first dividends declared on any and all shares of said company owned by me at the time dividends are declared, until the full amount of this subscription has been paid."
• In January 1920, the sum of P15,000 was paid on the subscription, derived from dividends declared by the company and supplemented by personal funds of the subscriber.
• No further dividends were declared by the corporation, and no additional payments were made by Dexter, leaving an unpaid balance of P15,000.
• Plaintiff National Exchange Co., Inc. is the assignee (through the Philippine National Bank) of C. S. Salmon & Co., and brought suit to recover the unpaid balance with interest.
• The trial court held that the stipulation regarding payment from dividends was invalid and rendered judgment for the plaintiff.

• The plaintiff-appellee argued that the stipulation making payment dependent solely on dividends was invalid and unenforceable under the Corporation Law, and that the defendant remained personally liable for the unpaid balance of the subscription regardless of whether dividends were declared.

• The defendant-appellant contended that corporations possess the general power to accept subscriptions upon special terms not prohibited by positive law or contrary to public policy, citing Fletcher's Cyclopedia.
• The appellant relied on Bank vs. Cook (125 Iowa, 111) to argue that a collateral agreement making a subscription collectible only from dividends is valid as between the parties and constitutes a complete defense to a suit on the subscription.

• Procedural Issues:
  • N/A
• Substantive Issues:
  • Whether a stipulation in a stock subscription providing that payment shall be made only from dividends declared on the shares relieves the subscriber from personal liability for the unpaid balance.

• Procedural:
  • N/A
• Substantive:
  • The Supreme Court affirmed the trial court's judgment, holding that the stipulation is illegal and void, and that the defendant is personally liable for the unpaid balance of P15,000.
  • The Court ruled that Section 16 of Act No. 1459 (the Corporation Law), implementing Section 74 of the Organic Act of 1902 and Section 28 of the Autonomy Act of 1916, prohibits the issuance of stock except for actual cash or property equal to par value.
  • A stipulation making payment contingent solely on dividends allows for the possibility that no payment will ever be made, which discriminates in favor of the particular subscriber and violates the statutory requirement of absolute equality among stockholders regarding liability on subscriptions.
  • Such stipulations constitute a fraud upon other stockholders and creditors because they lessen the capital of the company and impair the security of creditors.
  • The Court distinguished Bank vs. Cook, noting that it merely held such promises admissible as evidence of fraud and failure of consideration, not that they were valid defenses.
  • The law makes no distinction between shares subscribed before and after incorporation regarding the liability to pay full value; all subscribers are bound to pay the full par value in cash or its equivalent.

• Watered Stock Doctrine — Prohibits the issuance of shares without receiving actual cash or property equal to the par value thereof. The Court applied this doctrine to invalidate the dividend-contingent payment stipulation because it permitted the issuance of stock without ensuring receipt of actual value, potentially watering down the capital and defrauding creditors and other stockholders.
• Equality of Stockholders — Requires that all stockholders bear equal liability for the payment of their subscriptions. The Court held that any stipulation relieving a particular subscriber from the obligation to pay the full par value constitutes illegal discrimination against other stockholders who paid full value.
• Statutory Prohibition on Inadequate Consideration — Under Section 16 of Act No. 1459, corporations cannot issue stock except for actual cash paid or property actually received at fair valuation equal to par value. The Court interpreted this provision strictly to prevent any agreement that might result in stock being issued for less than par value.

• "If it is unlawful to issue stock otherwise than as stated it is self-evident that a stipulation such as that now under consideration, in a stock subscription, is illegal, for this stipulation obligates the subscriber to pay nothing for the shares except as dividends may accrue upon the stock."
• "Conditions attached to subscriptions, which, if valid, lessen the capital of the company, are a fraud upon the grantor of the franchise, and upon those who may become creditors of the corporation, and upon unconditional stockholders."
• "The general doctrine of corporation law is... that an agreement between a corporation and a particular subscriber, by which the subscription is not to be payable, or is to be payable in part only... is illegal and void as in fraud of other stockholders or creditors, or both."

• Putnam vs. New Albany, etc. Railroad Co. (21 Law. ed., 361) — Cited for the rule that conditions attached to subscriptions which lessen the capital of the company constitute a fraud upon the grantor of the franchise, creditors, and unconditional stockholders.
• Bank vs. Cook (125 Iowa, 111) — Distinguished by the Court; the appellant relied on this case to support the validity of dividend-dependent payment stipulations, but the Court clarified that the decision merely held such promises admissible as evidence of fraud and failure of consideration, rather than establishing their validity as a defense.

• Section 74, Organic Act of July 1, 1902 (Philippine Bill) — Prohibited the issuance of stock or bonds except in exchange for actual cash or for property at a fair valuation equal to the par value of the stock or bonds issued. Cited as the statutory basis ensuring absolute equality among stockholders.
• Section 28, Autonomy Act of August 29, 1916 (Jones Law) — Substantially reproduced the prohibition from Section 74 of the Organic Act regarding the issuance of stock only for actual cash or equivalent property value.
• Section 16, Act No. 1459 (The Corporation Law), as amended by Act No. 2792 — Provided that "no corporation shall issue stock or bonds except in exchange for actual cash paid to the corporation or for property actually received by it at a fair valuation equal to the par value of the stock or bonds so issued." The Court relied on this provision to invalidate the subject stipulation.