Sec. 31. Liability of directors, trustees or officers.

- Directors or trustees who willfully and knowingly

vote for or assent to patently unlawful acts of the corporation or who are guilty of gross negligence or bad
faith in directing the affairs of the corporation or acquire any personal or pecuniary interest in conflict
with their duty as such directors or trustees shall be liable jointly and severally for all damages resulting
therefrom suffered by the corporation, its stockholders or members and other persons.
When a director, trustee or officer attempts to acquire or acquires, in violation of his duty, any interest
adverse to the corporation in respect of any matter which has been reposed in him in confidence, as to
which equity imposes a disability upon him to deal in his own behalf, he shall be liable as a trustee for the
corporation and must account for the profits which otherwise would have accrued to the corporation.
Nature of directors’/trustees’ position
1. Agent or trustees for the corporation
The directors of a corporation are its agents. They also occupy a fiduciary relation to the
corporation. By numerous authorities they have been called “trustees”, with certain powers and
subject to certain duties in the management of its property, and each stockholder a cestui que trust
according to his interest and shares. In the performance of their official duties, they are under
obligations of trust and confidence to the corporation and its stockholders and must act in good
faith and for the interest of the corporation or its stockholders with due case and diligence and
within the scope of their authority.
2. Agents or trustees for the stockholders or members/creditors
So long as a purely private corporation remain solvent, its directors are agents or trustees for the
stockholders or members. But the moment such a corporation becomes insolvent, its directors are
trustees of all the creditors, whether they are members of the corporation or not, and must manage
its property and assets with strict regard to their interest and if they are themselves creditors while
the insolvent corporation is under their management, they will not be permitted to secure to
themselves by purchasing the corporate property or otherwise acquiring any personal advantage
over other creditors.
Cases when directors/trustees or officers liable for damages
GENERAL RULE:
Officers of a corporation are not personally liable for their official acts.
Exceptions: They exceeded their authority.
The veil of corporate fiction may be piereced, as follows:
1. He willfully and knowingly votes or assents to patently unlawful acts of the corporation.
2. He is guilty of gross negligence (not mere “want of ordinary prudence”) or bad faith in directing
the affairs of the corporation.
3. He acquires any personal or pecuniary interest in conflict with his duty as such director or trustee.

In the above instances, the erring board members or officers shall be held jointly and severally (or
solidarily) liable for all damages resulting therefrom suffered by the corporation, its stockholders or
members, or other persons.
Liability of directors/trustees or officers for bad faith or gross negligence
1. Directors or trustees are personally liable for any wrongful disposition of corporate assets and for any
loss or injury to the corporation arising from their gross negligence or unauthorized acts or violation of
their duties. But they are not liable for business losses incurred because of honest bad judgement not
amounting to bad faith or gross negligence.
2. Corporate directors and officers are solidarily liable with the corporation for the termination of
employment of employees if the termination is done with malice and bad faith.
Bad faith does not simply mean bad judgment or negligence; it imparts a dishonest purpose or some
moral obliquity and conscious doing of wrong. It means breach of known duty through some motive or
interest or ill-will; it partakes of the nature of fraud.” It is never presumed. In order to pierece the veil of
corporate fiction, for reasons of negligence by the director, trustee or officer in the conduct of the
transactions of the corporation, such negligence must be gross.
Liability of directors/trustees or officers for secret profits
They shall be held accountable for the profits which otherwise would have accrued to the corporation.
Private or secret profits obtained must be accounted for, even though the transaction on which they are
made is advantageous or is not harmful to the corporation, or even thought the director/trustee or
officer acted without intent to injure the corporation. The fact that the agreement whereby a person is
to receive a secret profit is made prior to the time he becomes an officer does not change the rule. And
the fact that the profits were derived from transactions ultra vires does not relieve the director/trustee
or officer from liability.
Sec. 32. Dealings of directors, trustees or officers with the corporation. - A contract of the corporation
with one or more of its directors or trustees or officers is voidable, at the option of such corporation,
unless all the following conditions are present:
1. That the presence of such director or trustee in the board meeting in which the contract was
approved was not necessary to constitute a quorum for such meeting;
2. That the vote of such director or trustee was nor necessary for the approval of the contract;
3. That the contract is fair and reasonable under the circumstances; and
4. That in case of an officer, the contract has been previously authorized by the board of directors.

Where any of the first two conditions set forth in the preceding paragraph is absent, in the case of a
contract with a director or trustee, such contract may be ratified by the vote of the stockholders
representing at least two-thirds (2/3) of the outstanding capital stock or of at least two-thirds (2/3) of the
members in a meeting called for the purpose: Provided, That full disclosure of the adverse interest of the
directors or trustees involved is made at such meeting: Provided, however, That the contract is fair and
reasonable under the circumstances.
Self-dealing directors/trustees or officers
GENERAL RULE:
A contract of a corporation with one or more of its directors/trustees or officers are voidable at the option
of the corporation. Reason: Being its agents and entrusted with the management of its affairs, the
directors or trustees and other officers of a corporation occupy a fiduciary relation towards it, and cannot
be allowed to contract with the corporation, directly or indirectly, or to sell property to it, or purchase
property from it, where they act both for the corporation and for themselves.
EXCEPTIONS: (Therefore valid)
1. All the conditions in Section 32 are present.
2. Not all conditions are present but the corporation (through the board) elects not to question the
validity of the contract without prejudice to the liability of the consenting directors or trustees for
damages under Section 31.
3. In the case of a contract with a director or trustee, only the third condition is present, i.e., the
contract is fair and reasonable under the circumstances, if the contract is ratified by the required vote
of the stockholders or members in a meeting called for the purpose, provided that full disclosure of the
adverse interest of the directors or trustees involved is made at such meeting.

Note: This section fails to specify whether the vote of the self-dealing director or trustee shall be counted
in the meeting for the ratification of the contract.

Watered Stocks
Sec. 65. Liability of directors for watered stocks. - Any director or officer of a corporation consenting
to the issuance of stocks for a consideration less than its par or issued value or for a consideration in any
form other than cash, valued in excess of its fair value, or who, having knowledge thereof, does not
forthwith express his objection in writing and file the same with the corporate secretary, shall be
solidarily, liable with the stockholder concerned to the corporation and its creditors for the difference
between the fair value received at the time of issuance of the stock and the par or issued value of the
same.
Watered stock defined
It is a stock issued not in exchange for its equivalent either in cash, property, share, stock dividends, or
services. It includes stock:
1. Issued without consideration (bonus share)
2. Issued as fully paid when the corporation has receive a lesser sum of money than its par or issued
value (discount share).
3. Issued for a consideration other than actual cash, such as property or services, the fair valuation of
which is less than its par or issued value.
4. Issued as stock dividend when there are no sufficient retained earnings or surplus to justify it.

Watered stock – shares issued for a consideration less than their par or issued price.
Issue of watered stock prohibited
Section 65 prohibits the issuance of watered stock to protect persons who may acquire stock and the
creditors of the corporation particularly those who may becomes such on the faith of its outstanding
capital stock being fully paid. The prohibition secures equality among subscribers and prevents
discrimination against those who have paid in full the par or issued value of their shares.
Basis or theory of liability
Where the corporation issues watered stock and thereby assumes an ostensible capitalization in excess of
its real assets, the transaction necessarily involves the misleading of subsequent creditors, and whether
done with the purpose actually in mind or not, is at least a constructive fraud upon creditors.
Prohibition refers to original issue
The prohibition to issue watered stock refers only to the original issue of stocks but not to a subsequent
transfer of such stocks by the corporation, for then it would no longer be an “issue” but a sale thereof.
(Hence, treasury shares may be sold for less than their par value provided it is reasonable.)
Liability for watered stock
Who can set up the inadequacy of the consideration for the issuance of stocks?
1. Creditors
2. Corporation itself.
3. Any dissenting stockholder, for an in behalf of the corporation in case the corporation refuses to claim
the difference not received.
Consenting director or officer – solidary with the participating stockholder.
NOTE: The FMV of the stock is determined at the time of its issuance. Subsequent increase in the FMV
of the property given as a consideration will not eliminate the “water” in the stock and relieve the director
or officer and stockholder from liability.
Liability of subscriber of watered stock – To contribute, if necessary, for the benefit of creditors to the
extent of the difference between the amount paid and the par or issued value of the shares. Liable also for
the purpose of adjusting the rights of the stockholders inter se.
NOTE:
- The holder of watered stock cannot escape liability by transferring the same to an irresponsible
person or to a bona fide purchaser.
- A creditor cannot recover against a holder of watered stock fraudulently represented as having
fully paid unless and until he has been actually injured.

Subsequent transferee – A transferee of stock in a corporation occupies the same position as his
transferor with respect to the right to complain an issue of watered stock, and is, therefore, estopped to
complain if his transferor was estopped. This is true notwithstanding the fact that he purchased the stock
in good faith an in ignorance of the fraudulent or unlawful issue.
Purchase without notice may maintain an action to recover damages sustained by him, either against:
1. The transferor, if he know of the character of the stock.
2. The directors or other officers who issued the same.
3. The corporation if it can be regarded as a party to the fraud.

Suit by the State

1. Quo warranto - When a corporation is guilty of ultra vires or illegal acts which constitute an injury to
or fraud upon the public or which will tend to injure or defraud the public, the State may institute quo
warranto proceedings to forfeit its charter for the misuse or abuse of its franchises.
2. Injunction - If a threatened act of a corporation will constitute a public nuisance, and prompt action is
necessary to prevent injury to the public therefrom, the Solicitor General may proceed for an injunction.
It is safe to say however that this principle does not authorize a suit by the Solicitor General to enjoin the
issue of watered stock. The State cannot maintain a suit to enjoin or cancel an issue of watered or
fictitious paid-up stock, where private rights only will be affected.

Sec. 20. De facto corporations. - The due incorporation of any corporation claiming in good faith to be a
corporation under this Code, and its right to exercise corporate powers, shall not be inquired into
collaterally in any private suit to which such corporation may be a party. Such inquiry may be made by
the Solicitor General in a quo warranto proceeding.
De jure corporation, defined –
A de jure corporation is one created in strict or substantial conformity with the mandatory statutory
requirements for incorporation and the right of which to exist as a corporation cannot be successfully
attacked or questioned by any party even in a direct proceeding for that purpose by the State.
De fact corporation, defined –
It is one which actually exists for all practical purposes as a corporation but which has no legal right to
corporate existence as against the State. It is one which has not complied with all the requirement
necessary to be a de jure corporation but has complied sufficiently to be accorded corporate status as
against third parties although not against the State.
Requisites of a de fact corporation
1. A valid law under which a corporation with powers assumed might be incorporated.
 In order that there can be a de facto corporation, there must be a law authorizing it to be a
corporation de jure for there cannot be a corporation de fact when there cannot be one de jure,
even though there may have been an assumption of corporate powers.
2. A bona fide attempt to organize a corporation under such law.
 When there has been no attempt in good faith to create a corporation de jure, there can be no de
facto corporation. Mere intent is not sufficient. In addition, there must be a bona fide attempt to
comply with the requirements of the law, which goes far enough to amount to “colorable
compliance” with the law.
 The defects which do not preclude the creation of a de facto corporations are those omissions
that may be considered as inadvertent or minor defects or errors which can be excused to prevent
injustice.
 Colorable compliance with the law –
o To constitute a corporation de fact, there must be, it is true, a colorable compliance with the
statute, but there need not be a substantial compliance. A substantial compliance makes the
body a corporation de jure.
 o There is no fixed rule on how far the proceedings must go or what steps are sufficient to
amount to this colorable compliance. It will depend on the situation and knowledge of the
parties.
3. Actual user or exercise in good faith of corporate powers conferred upon it by law.
 To create a corporation de fact, it is not sufficient to show the existence of a law under which a
corporation might be formed and an honest attempt to comply with the requirements thereof, but
it is also necessary to show an actual user or exercise of corporate powers or franchise.
 User contemplated – User consists in an enjoyment and exercise (although not rightful) of
such corporate franchises and powers as would be given by the law to an association if the
attempted organization had been perfected.
 Furthermore, it is essential that the corporation must act in good faith in claiming to be a
corporation and exercising corporate powers. Therefore, it after incorporation, the incorporators
discovered that they have not complied substantially with the law and still continued transacting
business as a corporation, without doing anything to correct the defect, the privilege of de facto
existence can no longer be invoked.

Stockholders of a de fact corporation enjoy exemption from personal liability for corporate obligations
as do stockholders of de jure corporations.

Basis of de facto doctrine

The recognition of de fact existence has been found necessary to promote the security of business
transactions and to eliminate quibbling over irregularities.
1. A third person dealing with a corporation will rarely be prejudiced if the company is recognized
as a corporation in spite of minor defects in its formation.
2. Seldom would it be just to allow a wrongdoer to quibble over such objections to escape liability
for wrongdoing.
3. It would be unjust to allow a claimant against a supposed company to assert the individual
liability of innocent passive investors on the ground of flaws in the formal steps of incorporation,
when they have attempted in good faith to comply with statutory requirements and the objecting
party is not prejudice.

Questioning validity of corporate existence

Assuming that a de facto corporation actually exists, its existence as a corporation cannot be
collaterally attached either by the State or by private individuals. The State must bring a direct
proceeding (quo warranto) against the corporation to oust it from the exercise of corporate powers
usurped by it and to have it dissolved.
Direct attack/collateral attack of corporate existence defined
Direct attack – It is one whereby the State, in a proceeding brought for that purpose, attacks the
existence of an association claiming to be a corporation. It can only be instituted by the government
through the Solicitor General by quo warranto proceedings.
Collateral attack – It one whereby corporate existence is questioned in some incidental
proceedings not provided by law for the express purpose of attacking the corporate existence.
Rule against collateral attack
 Rationale – The general rule against collateral attack upon corporate existence is based upon the ground
of public policy. Individual right is not invaded; it is the State’s right and authority which are
invaded and usurped. If the State, which alone grants the authority to incorporate, remains
silent, an individual would not be allowed and permitted to raise the inquiry.
When rule not applicable – The rule that collateral attack on the organic entity or existence of a
corporation will not be permitted does not apply, however, when the lack of right or the wrongdoing of
the corporation is in issue because in violation of public policy or of express or implied statutory
requirement, such as denial of its right to enforce contracts entered into without compliance with
prohibitions or express or implied statutory or public policy.
Thus, the defendant may question the personality of a foreign corporation transacting business in the
Philippines to maintain a suit on the ground that it is not duly licensed to do business in our country.
Where a corporation not even a de facto corporation
If failure to comply with conditions precedent prevents the coming into existence of any corporation
either de jure or de facto, then, on principle and in reason, the question may be raised collaterally as
well as directly, and by private individuals as well as by the State, unless there is something to operate
as an estoppels.
Capacity to sue or be sued – If a party is not either de jure or de facto, it has no legal capacity to sue
or be sued. And it follows that where the corporate existence of the plaintiff suing as a corporation is
defined, the burden is on it to prove its corporate existence either de jure or de facto, or at least to
show an estoppels on the part of the defendant to deny such existence.
Liability as partners – If neither a de jure nor a de facto corporation results, the incorporators should
be held liable as partners together with stockholders who subscribed to stocks knowing the failure of
the attemp ed incorporation of the business. It is the regular courts, not the SEC, that have jurisdiction
over disputes or controversies among them.
Proof of corporate existence
Proof of de jure existence – It must be made to appear that there is a valid law creating or authorizing
such a corporation, that there was a valid organization under it and a substantial compliance with all
conditions precedent.
Proof of de fact existence – If the question of corporate existence is raised collaterally, it is sufficient if
a de fact existence be shown. It is only necessary, in order to prove de factor corporate existence, to
show a law under which the alleged corporation might have been formed, a colorable bona fide
compliance with that law, and an assumption or user of corporate powers.
Proof of facts operating as an estoppel – Again, there are many cases in which a party may, by his
conduct, as by dealing with or holding out a body as a corporation, be estopped to deny its existence as a
corporate body. Here, it is not necessary to prove even a de fact corporate existence. All that is
necessary is to show the facts that will operate as an estoppels.
Where a person has contracted or dealt with an association as a corporation, proof of that fact alone is
prima facie evidence of the corporate existence of the body as against him, as in action by the alleged
corporation on a subscription to its stock.
Powers and liabilities of a de facto corporation
 So long as the State acquiesces in its existence and its exercise of corporate functions, it is under the
protection of the same law and governed by the same legal principles as de jure corporations, and may
legally do and perform every act and thing which the same entity could do or perform were it a de jure
corporation. As to all the world except the paramount authority under which it acts and from which it
receives its charter, it occupies the same position as though in all respects valid, and even as against the
State, except in direct proceedings to arrest its usurpation of power, its acts are to be treated as
efficacious.
Liability to taxation – A de facto corporation is subject to taxation in the same manner as though it
were a de jure corporation.
Binding effect of contracts – A transfer of property to or by a corporation de fact is valid and binding
against all persons except the State; bonds, deeds, and mortgage executed by such corporation are
valid, not only as against the corporation itself, but also as against anyone making a claim against its
assets, whether as a creditor directly of the corporation or as a creditor of its creditors or stockholders.
Protection against unauthorized acts – Whether a corporation is de fact or de jure, it is entitled to
protect itself from unauthorized acts.
Liabilities of officers and members of a de facto corporation
The officers and directors (or trustees) of a de facto corporation are subject to all the liabilities and
penalties attending to officers and directors duly chosen by a corporation de jure, including liability under
the criminal law, and their acts are biding when such acts would be within the power of such officers if
the corporation were one de jure.
Liability as partners to third persons – They cannot be held liable as partners by third persons who
deal with them in their supposed corporate capacity, merely on account of a technical defect in the
formation of the corporation. This is especially true where the stockholders had no knowledge of the
defects and had no intent to become partners and the ostensible corporation is apparent to third
persons. On the other hand, where an attempt to organize a corporation fails by omission of some
substantial step or proceeding required by the law, its members or stockholders are liable as partners.
Liability among themselves – When persons associate together and do business as a corporation and
the latter is defectively organized, their rights, duties, and liabilities, as between themselves, should be
determined and governed by the express or implied terms, conditions, and limitations contemplated by
their agreement.
Sec. 21. Corporation by estoppel. - All persons who assume to act as a corporation knowing it to be
without authority to do so shall be liable as general partners for all debts, liabilities and damages incurred
or arising as a result thereof: Provided, however, That when any such ostensible corporation is sued on
any transaction entered by it as a corporation or on any tort committed by it as such, it shall not be
allowed to use as a defense its lack of corporate personality. On who assumes an obligation to an
ostensible corporation as such, cannot resist performance thereof on the ground that there was in fact no
corporation.
Estoppel to deny corporate existence
An unincorporated association which represented itself to be a corporation, will be estopped from
denying its corporate capacity in a suit against it by a third person who relied in good faith on such
representation.
 Actually, an organization which has not complied with the conditions precedent to even de facto
existence is not, for any purpose, a corporation. Nevertheless, the incidents of a corporate existence
may exist as between the parties by virtue of an estoppels. Thus, besides corporation de jure and de
facto, there is sometimes a recognition of a third class known as corporation by estoppels, also
known as ostensible corporation.
It is generally conceded that corporations by estoppels are not based upon the same principles as a
corporations de facto. The doctrine of de facto corporation has nothing to do with the principle of
estoppels. A corporation de fact cannot be created by estoppels, the only effect of an estoppel being
to prevent the raising of the question as to the existence of a corporation.
Corporation by estoppel is founded on principles of equity and is designed to prevent injustice and
unfairness. It applies when persons assume to form a corporation and exercise corporate functions and
enter into business relations with third persons. Where there is no third person involved and the conflict
arises only among those assuming the form of a corporation who, therefore, know that it has not been
registered, there is no corporation by estoppel.
Corporation by estoppel without de facto existence
The doctrine seems to be that the estoppel prevails, notwithstanding that not all the 3 requisites necessary
to constitute as association of persons a de facto corporation are present. In other words, corporation by
estoppels may arise even if no de facto corporation exists.
A corporation by estoppels has no real existence in law. It is neither a de jure nor a de facto corporation. It
exists only between the persons who misrepresented their status and the parties who relied on the
misrepresentation. Its existence may be attacked by any third person except where the attacking party is
estopped to treat the entity other than as a corporation.
Illustration: A group of persons misrepresented themselves as X Co. when it is not to Y who recognized
it as such. On this representation, Y entered contract with them. On the other hand, without assuming to
act as a corporation, X Co. entered another contract with Z.

 X Co. is estopped from denying its existence as against Y but not against Z.

 Y is not allowed to question or challenge the validity of the organization or formation of X Co. in an
action by the latter against the former.

 If not all the associates participated or consented to the representation, as to them, the doctrine of
estoppel will not apply.
Estoppel of persons dealing with a corporation
Even if the ostensible corporation is proven to be legally non-existent, a party may be estopped from
denying its corporate existence.
The stockholder or members of a pretended or ostensible corporation who participated in holding it out as
a corporation are generally estopped or precluded to deny its existence against creditors for the purpose of
escaping liability for corporate debts or for unpaid part of a subscription to stock. A corporation which
continues its business instead of liquidating its affairs after the expiration of its corporate term, is a
corporation by estoppels for the purpose of being sued on its contracts, not a corporation de facto because
it no longer exists in fact and in law as a body corporate, except only for purposes of liquidating its
affairs.
So, also are the third persons who deal with such a corporation recognizing it as such and the pretended
corporation itself, estopped from denying its corporate existence and raising the defense of its lack of
corporate personality for the purpose of defeating a liability growing out of the contractual relation
between them and such entity or any tort committed by it as such or later taking advantage of their non-
compliance with the law, chiefly in cases where such persons have received the benefits of the contract.
In order for one to be estopped to deny the corporate existence of an organization, he must have
contracted or dealt with it as a corporation. Thus, if one deals with the members of a corporation as a
partnership, he is not estopped to show this fact or hold such individuals liable as partners. But one who is
induced to deal with an apparent corporation by fraud will not be estopped to deny the corporate
existence.
All persons not stockholders or members who assume to act as a corporation knowing it to be without
authority to do so shall be liable as general partners for all debts, liabilities, and damages incurred or
arising as a result thereof.
Persons liable as general partners
The Code makes liable as general partners “all persons who assume to act as a corporation,” and they
include persons who attempt, but fail, to from a corporation and who carry on business under the
corporate name. A de facto partnership among them is created.
Q: Are both active and inactive members of an unsuccessfully attempted corporation, neither de facto
nor de jure, liable as partners?
A: In a local case, the SC rules that while “stockholders” of a defectively incorporated association
become, in legal effect, partners inter se, such a relation does not necessarily exist, for ordinarily
persons cannot be made to assume the relations of partners, as between themselves, when their
purpose is that no partnership shall exist; it should be implied only when necessary to do justice
between the parties. Thus, one who takes no part except to subscribe for stock in a proposed
corporation which is never legally formed does not become a partner with other subscribers who
engage in business under the name of the pretended corporation, as to be liable as such in an action for
settlement of the alleged partnership and contribution