Pascual vs. Orozco, et al

A stockholder who was not a stockholder at the time of the transactions complained of, or whose shares had not devolved upon him by operation of law, cannot maintain a derivative suit for those prior corporate acts, unless the transactions continue and are injurious to him or affect him especially and specifically; and where a cause of action is divisible, a demurrer must be confined to the defective part.

Banco Español-Filipino was a banking corporation constituted by royal decree in 1854, later extended and modified by royal decree of July 14, 1897, and by Act No. 1790 of the Philippine Commission. Its reformed charter provided in article 30 that directors receive ten per cent and the board of government five per cent of net profits, with the remaining eighty-five per cent belonging to shareholders, and in article 31 that dividends are declared each semestre and stockholders meet annually in February. Candido Pascual was a stockholder of the bank; Eugenio del Saz Orozco and others were directors or members of the board of government. The dispute concerned the bank’s internal governance and the right of a stockholder to sue on its behalf.

Candido Pascual was a stockholder of Banco Español-Filipino. Eugenio del Saz Orozco and others were directors and members of the board of government of the bank. The bank’s reformed charter, article 30, provided that after deducting administration expenses and the legal reserve, ten per cent of profits went to the directors and five per cent to the board of government, while eighty-five per cent belonged to the shareholders; article 31 provided that dividends were declared each semestre and that stockholders met annually in February.

In his amended complaint, Pascual sued in his own right as a stockholder, for the benefit of the bank and all other stockholders. The first cause of action alleged that during 1903, 1904, 1905, and 1907, the defendants, without the knowledge, consent, or acquiescence of the stockholders, deducted their respective compensation from the gross income instead of from the net profits of the bank, thereby defrauding the bank and its stockholders of approximately P20,000 per annum. It further alleged that demands had been made but the defendants refused to refund the sums; that the defendants constituted a majority of the present board of directors, who alone could authorize an action against them in the name of the corporation; and that before filing suit the plaintiff exhausted every remedy within the banking corporation.

The second cause of action alleged that the defendants’ immediate predecessors in office during 1899, 1900, 1901, and 1902 committed the same illegality as to their compensation. It alleged that in the four years immediately following 1902, the defendants were the only officials or representatives of the bank who could and should investigate and take action regarding the sums fraudulently appropriated by their predecessors; that they were the only persons interested in the bank who knew of the fraudulent appropriation; that they wholly neglected to take any action or inform the stockholders; that due demand had been made; that the bank itself could not bring an action in its own name because the defendants were a majority; and that no remedy remained within the corporation. The third cause of action was not before the Supreme Court because the demurrer to it was overruled.

The complaint alleged that Pascual became a stockholder on November 13, 1903, although the opinion elsewhere refers to September 1903. The lower court sustained the demurrer to the first and second causes of action on the ground that in actions of this character the plaintiff must aver that he was the owner of stock in the corporation at the time of the occurrences complained of, or that the stock had since devolved upon him by operation of law. The Supreme Court noted that under article 31 dividends were declared twice a year and the first semestre began January 1; that stockholders meeting in February could vote on all business of the year irrespective of when they became stockholders; and that Pascual was a stockholder during all the time for which recovery was sought in the first cause except the first six months of 1903. The Court also observed that the plaintiff was not a stockholder during any of the time in question in the second cause of action.

• Failure to State a Cause of Action: Petitioner assigned as error that the lower court erred in sustaining the demurrer to the first and second causes of action because the facts alleged constitute a cause of action and the remedy sought is the only one available.
• Stock-Ownership Requirement as Procedural: Petitioner argued that the doctrine in Hawes vs. Oakland and Dimpfel vs. Ohio, etc., R.R. Co. was merely a rule of practice designed to prevent collusive suits in federal court, and that if it were substantive law, it was wrong on principle and should be disregarded.
• Defrauded Corporation’s Property Right: Petitioner contended that because the corporation was defrauded of its property, the corporation had a right of recovery that inured to the benefit of creditors, so subsequent creditors or purchasers could reach the property.

• Lack of Legal Capacity: Respondent demurred on the ground that plaintiff lacked legal capacity to sue.
• Failure to State a Cause of Action: Respondent demurred on the ground that the complaint failed to state facts constituting a cause of action.
• Defect of Parties Plaintiff: Respondent demurred on the ground of defect of parties plaintiff.
• Uncertainty: Respondent demurred on the ground of uncertainty.

• Stockholder’s Derivative Suit: Whether a stockholder may maintain a suit for and on behalf of the corporation where the corporation is under the control of the alleged wrongdoers and unable to sue.
• First Cause of Action – Sufficiency: Whether the lower court erred in sustaining the demurrer to the first cause of action on the ground that the complaint failed to state facts constituting a cause of action.
• Divisibility of the First Cause of Action: Whether a demurrer should be sustained as to the whole first cause of action when the time for which recovery is sought is divisible and the plaintiff was a stockholder during only part of that time.
• Second Cause of Action – Prior Transactions: Whether a stockholder may maintain a derivative suit for transactions that occurred before he acquired his shares.

• Stockholder’s Derivative Suit: Yes. A stockholder may maintain a suit for and on behalf of the corporation where the corporation is controlled by the guilty parties and unable or unwilling to sue; the corporation is the real party in interest.
• First Cause of Action – Sufficiency: Yes. The demurrer to the first cause of action should not have been sustained as to the whole; the facts alleged and the plaintiff’s stock ownership for most of the period made the cause sufficient in part.
• Divisibility of the First Cause of Action: Yes. Where a single count is divisible and only part is defective, the demurrer must be confined to the defective part; a general demurrer is overruled if a good cause of action appears in one averment.
• Second Cause of Action – Prior Transactions: No. A stockholder who was not a stockholder at the time of the transactions complained of cannot maintain a derivative suit for those prior acts, unless the transactions continue and are injurious to him or affect him especially and specifically.

• Stockholder’s Derivative Suit: The Court reviewed the origin and history of a stockholder’s right to sue on behalf of a corporation. A corporation is an artificial being and a collective name for the corporators; the real party in interest in such suits is the corporation, not the stockholder. A stockholder has no title, legal or equitable, to corporate property; his rights are sui generis, generally consisting of the right to a certificate, to vote, to receive proportionate profits, and to participate in distribution upon dissolution. The right of individual stockholders to sue for and on behalf of the corporation was initially denied but is now recognized. Where directors commit a breach of trust by fraud, ultra vires acts, or negligence, and the corporation is unable or unwilling to sue, a single stockholder may sue on behalf of himself and other stockholders for the benefit of the corporation. Plaintiff, as a stockholder, had the right to maintain suit for the bank, but the extent of that right depended on when, how, and for what purpose he acquired his shares. The bank’s quasi-public character did not affect the result.

• First Cause of Action – Sufficiency: Article 31 of the bank’s charter provided that dividends shall be declared each semestre and that stockholders meet once a year in February. All who were stockholders at that meeting had the right to vote on all business proceedings of the year, irrespective of when they became stockholders, and were entitled to dividends earned by their stock during the year not already declared and paid. Plaintiff had the right to participate in the general meeting on February 3, 1904. Dividends were declared twice a year, and the first semestre began January 1. If plaintiff was not entitled to the first semestre of 1903, he was entitled to the second semestre. He was therefore a stockholder during all the time for which he sought recovery in the first cause of action except the first six months of 1903. If the defendants had taken their salaries for 1903 at the close of that year or at any time after September 13, plaintiff would have had an interest and could have questioned the legality of their right to take such salary because his dividends would be directly affected.

• Divisibility of the First Cause of Action: Section 90 of the Code of Civil Procedure provided that if a complaint contains more than one cause of action, each distinct cause of action must be set forth in a separate paragraph containing all the facts constituting the particular cause of action. The Court applied the related pleading rule that where matter in a single count is divisible in its nature, the demurrer should be confined to those parts which are defective; the same general rule that applies to different counts applies to divisible matter in the same count constituting different causes of action. Where one count containing distinct averments discloses a good cause of action in one of such averments, a general demurrer will be overruled. The first cause of action was divisible in its nature. Conceding that it was demurrable as to the first six months of 1903, the demurrer should not have been sustained as to the whole cause.

• Second Cause of Action – Prior Transactions: Plaintiff was not a stockholder during any of the time in question in the second cause of action, which concerned the acts of defendants’ predecessors during 1899, 1900, 1901, and 1902. On whether a stockholder may maintain such a suit for acts occurring before he acquired his shares, the authorities did not agree. Hawes vs. Oakland held that a stockholder must show that he exhausted all means within the corporation to obtain redress and must allege that he was a shareholder at the time of the transaction complained of, or that the shares had devolved on him by operation of law, and that the suit was not collusive. The 94th Equity Rule later embodied the procedural part of that decision. Dimpfel vs. Ohio, etc., R.R. Co. was similar. The doctrine was announced in Hawes before the Equity Rule, so the requirement of stock ownership at the time of the transaction was substantive law, not merely a rule of practice. The rule requiring the averment was procedural, but the existence of the facts was necessary to give rise to the right of action. Sound reason and good authority sustain the rule that a purchaser of stock cannot complain of the prior acts and management of the corporation. The Court cited Home Fire Ins. Co. vs. Baker, Alexander vs. Searcy, and United Electric Securities Co. vs. Louisiana Electric Light Co. It modified the rule in Parsons vs. Joseph by holding that the disability attaches to the transferee who bought with or without notice, because shares of stock are not negotiable and the sale cannot pass greater rights than those possessed by the vendor. Plaintiff was not injured or affected by the transactions in the second cause before he acquired his shares; his vendor could have complained but did not. The discretion to sue or acquiesce is incapable of transfer. If plaintiff was defrauded in the purchase of the shares, he should sue his vendor. Subsequent creditors have no better right than subsequent purchasers to question a previous transaction in which the debtor’s property was obtained by fraud and which the debtor acquiesced in. Thus, a stockholder who was not such at the time of the transactions complained of, or whose shares had not devolved upon him by operation of law, cannot maintain suits of this character unless the transactions continue and are injurious to the stockholder, or affect him especially and specifically in some other way. The demurrer to the second cause of action was properly sustained.

• Stockholder’s Derivative Suit — A stockholder may sue in his own name for and on behalf of the corporation where the directors or guilty parties control the corporation and the corporation is unable or unwilling to institute suit. The corporation is the real party in interest, and the stockholder has no title, legal or equitable, to corporate property; his rights are sui generis. The Court applied this doctrine to recognize that plaintiff, as a stockholder, could maintain suit for the bank, but limited the extent of that right by when and how he acquired his shares.

• Ownership of Stock at the Time of the Transaction — As a matter of substantive law, a stockholder who was not a stockholder at the time of the transactions complained of, or whose shares had not devolved upon him by operation of law, cannot maintain a derivative suit for those prior corporate acts, unless the transactions continue and are injurious to the stockholder or affect him especially and specifically. The Court applied this to the second cause of action, which involved acts of defendants’ predecessors before plaintiff acquired his shares.

• Divisibility of a Cause of Action and Demurrer — Where a single count is divisible in its nature and only part is defective, a demurrer should be confined to the defective parts. A general demurrer will be overruled if one count containing distinct averments discloses a good cause of action in one of such averments. The Court applied this to the first cause of action, which covered several years, only the first six months of 1903 being defective as to plaintiff’s stock ownership.

• Non-Negotiability of Shares of Stock — Shares of stock are not negotiable, and a sale cannot pass greater rights than those possessed by the vendor. The disability of the transferor attaches to the transferee who bought with or without notice. The Court used this to reject plaintiff’s claim to sue for his vendor’s prior cause of action.

• Corporation as an Artificial Being — A corporation is an artificial being, intangible, and existing only in contemplation of law; it is a collective name for the corporators or members who compose the incorporated association. The Court used this to explain that the corporation, not the stockholder, is the real party in interest in a derivative suit.

• "A corporation is an artificial being, invinsible, intangible, and existing only in contemplation of law." — This defines the corporation as an artificial entity and supports the Court’s conclusion that the corporation, not the stockholder, is the real party in interest in a derivative suit.
• "The right of individual stockholders to maintain suits for and on behalf of the corporation was denied until within a comparatively short time, but his right is now no longer doubted." — This recognizes the stockholder’s derivative suit as an established remedy where the corporation is unable or unwilling to sue.
• "Where the matter in a single count is divisible in its nature, the demurrer should be confined to those parts which are defective, as the same general rule which applies to different counts applies also to divisible matter in the same count constituting different causes of action; and where one count, containing distinct averments, discloses a good cause of action in one of such averments, as when several breaches are assigned, some well and others ill, a general demurrer will be overruled." — This states the controlling procedural rule that allowed the first cause of action to survive in part despite the defective first six months of 1903.
• "So it seems to be settled by the Supreme Court of the United States, as a matter of substantive law, that a stockholder in a corporation who was not such at the time of the transactions complained of, or whose shares had not devolved upon him since by operation of law, can not maintain suits of this character, unless such transactions continue and are injurious to the stockholder, or affect him especially and specifically in some other way." — This is the canonical formulation of the substantive rule barring the second cause of action.

• Hawes vs. Oakland, 14 Otto [104 U.S.], 450, 456 — The Court treated this as establishing, as substantive law, that a stockholder must have owned stock at the time of the transaction complained of and must have exhausted intracorporate remedies; the doctrine predated the 94th Equity Rule.
• Dimpfel vs. Ohio, etc., R.R. Co., 110 U.S., 212; 28 Law Ed., 121, 122 — Cited as similar to Hawes; the bill failed because it did not show ownership at the time of the transactions and did not show exhaustion of remedies.
• Dodge vs. Woolsey, 18 How. (U.S.), 331 — Leading case recognizing that a stockholder may sue in equity on behalf of the corporation where directors breach trust and the corporation is unable or unwilling to sue.
• Foss vs. Harbottle — Leading English case; the stockholder’s suit against directors was dismissed because the complainant failed to prove the corporation was under the control of the guilty parties and unable to sue, but the court intimated such a suit might be entertained.
• Home Fire Ins. Co. vs. Baker, 60 L.R.A., 927, 933 — Cited for the rule that a purchaser of stock cannot complain of prior acts and management of the corporation.
• Alexander vs. Searcy, 81 Ga., 536 — Cited for the weight of authority that a person who did not own stock at the time of the transactions complained of cannot bring suit to have them declared illegal.
• United Electric Securities Co. vs. Louisiana Electric Light Co., 68 Fed., 673 — Cited for the principle that a purchaser of stock is not allowed to attack acts and management prior to acquiring his stock.
• Parsons vs. Joseph, 92 Ala., 403 — Discussed and modified: the Court held that the disability attaches to a transferee who bought with or without notice, because shares are not negotiable and the sale cannot pass greater rights than the vendor possessed.
• Clark vs. American Coal Co., 86 Iowa, 436 — Cited for the non-negotiability of shares and the rule that a sale cannot pass greater rights than those possessed by the vendor.
• Graham vs. La Crosse and Milwaukee R.R. Co., 102 U.S., 148 — Quoted with approval for the principle that a subsequent purchaser cannot assume a remedy waived or released by the party defrauded.
• Trustees of Dartmouth College vs. Woodward, 4 Wheat., 636 — Cited for the definition of a corporation as an artificial being.
• People ex rel. Winchester vs. Coleman, 133 N.Y. Appls., 279 — Cited for the description of a corporation as an artificial person.

• Article 30, Banco Español-Filipino Reformed Charter or Statutes — Provided that after deducting administration expenses and the legal reserve, ten per cent of profits went to the directors and five per cent to the board of government, with eighty-five per cent belonging to the shareholders. The first cause of action alleged that defendants deducted compensation from gross income instead of net profits, contrary to this provision.
• Article 31, Banco Español-Filipino Charter — Provided that dividends be declared each semestre and that stockholders meet yearly in February. The Court used it to determine that plaintiff was a stockholder for the second semestre of 1903 and thus for most of the period covered by the first cause of action.
• Section 90, Code of Civil Procedure — Required that if a complaint contains more than one cause of action, each distinct cause must be set forth in a separate paragraph. The Court applied the related pleading rule that a demurrer to divisible matter in a single count should be confined to the defective parts.
• 94th Equity Rule, U.S. Supreme Court, adopted January 23, 1883 — Required a stockholder’s bill to allege that plaintiff was a shareholder at the time of the transaction complained of, or that shares devolved by operation of law, and that the suit was not collusive; it also required efforts to secure corporate action. The Court characterized it as a rule of pleading, not the source of the substantive requirement.
• Act No. 1790 of the Philippine Commission — Extended and modified the bank’s royal decree and formed part of the bank’s charter history.
• Royal Decree of July 14, 1897 — Extended and modified the original grant of the bank’s charter.

Justices Arellano, C.J., Torres, Mapa, and Johnson concurred. Justice Carson concurred in part and dissented in part; Justice Moreland concurred with Justice Carson’s separate opinion.

• Carson, J. — Concurred in the result of overruling the demurrer to the first cause of action but dissented from the portion sustaining the demurrer to the second cause of action. The text states: “I concur in the foregoing opinion in so far as it overrules the demurrer but dissent in so far as it sustains the same in part.”
• Moreland, J. — Concurred with Justice Carson’s separate opinion. No independent reasoning is stated in the text.