Zomer Development vs. International Exchange

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EN BANC

G.R. No. 207161, September 08, 2015

Y-I LEISURE PHILIPPINES, INC., YATS INTERNATIONAL LTD. AND Y-


I CLUBS AND RESORTS, INC., Petitioners, v. JAMES YU, Respondent.

DECISION

MENDOZA, J.:

The present case attempts to unravel whether the transfer of all or substantially all
the assets of a corporation under Section 40 of the Corporation Code carries with it
the assumption of corporate liabilities.

This is a petition for review on certiorari under Rule 45 of the Rules of Court


assailing the January 30, 2012 Decision1 and the April 29, 2013 Resolution2 of the
Court of Appeals (CA), in CA-G.R. CV No. 96036, which affirmed with
modification the August 31, 2010 Decision3 of the Regional Trial Court, Branch 81,
Quezon City (RTC).

The Facts

Mt. Arayat Development Co. Inc. (MADCI) was a real estate development
corporation, which was registered4 on February 7, 1996 before the Security and
Exchange Commission (SEC). On the other hand, respondent James Yu (Yu) was a
businessman, interested in purchasing golf and country club shares.

Sometime in 1997, MADCI offered for sale shares of a golf and country club
located in the vicinity of Mt. Arayat in Arayat, Pampanga, for the price of P550.00
per share. Relying on the representation of MADCI's brokers and sales agents, Yu
bought 500 golf and 150 country club shares for a total price of P650,000.00 which
he paid by installment with fourteen (14) Far East Bank and Trust Company
(FEBTC) checks.5cralawrednad

Upon full payment of the shares to MADCI, Yu visited the supposed site of the golf
and country club and discovered that it was non-existent. In a letter, dated February
5, 2000, Yu demanded from MADCI that his payment be returned to him.6 MADCI
Page 2 of 20

recognized that Yu had an investment of P650,000.00, but the latter had not yet
received any refund.7cralawrednad

On August 14, 2000, Yu filed with the RTC a complaint 8 for collection of sum of
money and damages with prayer for preliminary attachment against MADCI and its
president Rogelio Sangil (Sangil) to recover his payment for the purchase of golf
and country club shares. In his transactions with MADCI, Yu alleged that he dealt
with Sangil, who used MADCI's corporate personality to defraud him.

In his Answer,9 Sangil alleged that Yu dealt with MADCI as a juridical person and
that he did not benefit from the sale of shares. He added that the return of Yu's
money was no longer possible because its approval had been blocked by the new set
of officers of MADCI, which controlled the majority of its board of directors.

In its Answer,10 MADCI claimed that it was Sangil who defrauded Yu. It invoked
the Memorandum of Agreement11 (MOA), dated May 29, 1999, entered into by
MADCI, Sangil and petitioner Yats International Ltd. (YIL). Under the MOA,
Sangil undertook to redeem MADCI proprietary shares sold to third persons or
settle in full all their claims for refund of payments. 12 Thus, it was MADCI's
position that Sangil should be ultimately liable to refund the payment for shares
purchased.

After the pre-trial, Yu filed an Amended Complaint,13 wherein he also impleaded


YIL, Y-I Leisure Phils., Inc. (YILPI) and Y-I Club & Resorts, Inc. (YICRI).
According to Yu, he discovered in the Registry of Deeds of Pampanga that,
substantially, all the assets of MADCI, consisting of one hundred twenty (120)
hectares of land located in Magalang, Pampanga, were sold to YIL, YILPI and
YICRI. The transfer was done in fraud of MADCI's creditors, and without the
required approval of its stockholders and board of directors under Section 40 of the
Corporation Code. Yu also alleged that Sangil even filed a case in Pampanga which
assailed the said irregular transfers of lands.

In their Answer,14 YIL, YILPI and YICRI alleged that they only had an interest in
MADCI in 1999 when YIL bought some of its corporate shares pursuant to the
MOA. This occurred two (2) years after Yu bought his golf and country club shares
from MADCI. As a mere stockholder of MADCI, YIL could not be held
responsible for the liabilities of the corporation. As to the transfer of properties
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from MADCI to YILPI15 and subsequently to YICRI,16 they averred that it was not


undertaken to defraud MADCI's creditors and it was done in accordance with the
MOA. In fact, it was stipulated in the MOA that Sangil undertook to settle all
claims for refund of third parties.

During the trial, the MOA was presented before the RTC. It stated that Sangil
controlled 60% of the capital stock of MADCI, while the latter owned 120 hectares
of agricultural land in Magalang, Pampanga, the property intended for the
development of a golf course; that YIL was to subscribe to the remaining 40% of
the capital stock of MADCI for a consideration of P31,000,000.00; that YIL also
gave P500,000.00 to acquire the shares of minority stockholders; that as a condition
for YIL's subscription, MADCI and Sangil were obligated to obtain several
government permits, such as an environmental compliance certificate and land
conversion permit; that should MADCI and Sangil fail in their obligations, they
must return the amounts paid by YIL with interests; that if they would still fail to
return the same, YIL would be authorized to sell the 120 hectare land to satisfy their
obligation; and that, as an additional security, Sangil undertook to redeem all the
MADCI proprietary shares sold to third parties or to settle in full all their claims for
refund.

Sangil then testified that MADCI failed to develop the golf course because its
properties were taken over by YIL after he allegedly violated the MOA.17 The lands
of MADCI were eventually sold to YICRI for a consideration of P9.3 million,
which was definitely lower than their market price.18 Unfortunately, the case
assailing the transfers was dismissed by a trial court in Pampanga.19cralawrednad

The president and chief executive officer of YILPI and YICRI, and managing
director of YIL, Denny On Yat Wang (Wang), was presented as a witness by YIL.
He testified that YIL was an investment company engaged in the development of
real estates, projects, leisure, tourism, and related businesses.20 He explained that
YIL subscribed to. the shares of MADCI because it was interested in its golf course
development project in Pampanga.21 Thus, he signed the MOA on behalf of YIL
and he paid P31.5 million to subscribe to MADCI's shares, subject to the fulfilment
of Sangil's obligations.22cralawrednad

Wang further testified that the MOA stipulated that MADCI would execute a
special power of attorney in his favor, empowering him to sell the property of
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MADCI in case of default in the performance of obligations.23 Due to Sangil's


subsequent default, a deed of absolute sale over the lands of MADCI was
eventually executed in favor of YICRI, its designated company.24 Wang also stated
that, aside from its lands, MADCI had other assets in the form of loan advances of
its directors.25cralawredcralawrednad

The RTC Ruling

In its August 31, 2010 Decision, the RTC ruled that because MADCI did not deny
its contractual obligation with Yu, it must be liable for the return of his payments.
The trial court also ruled that Sangil should be solidarily liable with MADCI
because he used the latter as a mere alter ego or business conduit. The RTC was
convinced that Sangil had absolute control over the corporation and he started
selling golf and country club shares under the guise of MADCI even without
clearance from SEC.

The RTC, however, exonerated YIL, YILPI and YICRI from liability because they
were not part of the transactions between MADCI and Sangil, on one hand and Yu,
on the other hand. It opined that YIL, YILPI and YICRI even had the foresight of
protecting the creditors of MADCI when they made Sangil responsible for settling
the claims of refunds of thirds persons in the proprietary shares. The decretal
portion of the decision reads:ChanRoblesvirtualLawlibrary
WHEREFORE, premises considered, judgment is hereby rendered as
follows:ChanRoblesvirtualLawlibrary

1. Ordering defendants Mt. Arayat Development Corporation, Inc. and Rogelio


Sangil to pay plaintiff James Yu jointly and severally the amounts of P650,000.04
with 6% legal rate of interest from the filing of the amended complaint until full
payment and and P50,000.00 as attorney's fees.

2. Dismissing the instant case against defendant Y-I Leisure Philippines, Inc.,
YATS International Limited and Y-I Clubs and Resorts, Inc.; and

3. Dismissing the counterclaims of Y-I Leisure Philippines, Inc., YATS


International Limited and Y-I Clubs and Resorts, Inc.
Page 5 of 20

SO ORDERED.26

In two separate appeals, the parties elevated the case to the CA.

The CA Ruling

In its assailed Decision, dated January 30, 2012, the CA partly granted the appeals
and modified the RTC decision by holding YIL and its companies, YILPI and
YICRI, jointly and severally, liable for the satisfaction of Yu's claim.

The CA held that the sale of lands between MADCI and YIL must be upheld
because Yu failed to prove that it was simulated or that fraud was employed. This
did not mean, however, that YIL and its companies were free from any liability for
the payment of Yu's claim.

The CA explained that YIL, YILPI and YICRI could not escape liability by simply
invoking the provision in the MOA that Sangil undertook the responsibility of
paying all the creditors' claims for refund. The provision was, in effect, a novation
under Article 1293 of the Civil Code, specifically the substitution of debtors.
Considering that Yu, as creditor of MADCI, had no knowledge of the "change of
debtors," the MOA could not validly take effect against him. Accordingly, MADCI
remained to be a debtor of Yu.

Consequently, as the CA further held, the transfer of the entire assets of MADCI to
YICRI should not prejudice the transferor's creditors. Citing the case of Caltex
Philippines, Inc. v, PNOC Shipping and Transport Corporation27 (Caltex), the CA
ruled that the sale by MADCI of all its corporate assets to YIL and its
companies necessarily included the assumption of the its liabilities. Otherwise, the
assets were put beyond the reach of the creditors, like Yu. The CA stated that the
liability of YIL and its companies was determined not by their participation in the
sale of the golf and country club shares, but by the fact that they bought the entire
assets of MADCI and its creditors might not have other means of collecting the
amounts due to them, except by going after the assets sold.
Page 6 of 20

Anent Sangil's liability, the CA ruled that he could not use the separate corporate
personality of MADCI as a tool to evade his existing personal obligations under the
MOA. The dispositive portion of the decision reads:ChanRoblesvirtualLawlibrary
WHEREFORE, the appeals are PARTLY GRANTED. Accordingly, the assailed
Decision dated August 31, 2010 in Civil Case No. Q-oo-41579 of the RTC of
Quezon City, Branch 81, is hereby AFFIRMED WITH MODIFICATION, in that
defendants-appellees YIL, YILPI and YICRI are hereby held jointly and severally
liable with defendant-appellee MADCI and defendant-appellant Sangil for the
satisfaction of plaintiff-appellant Yu's claim.

In all other respects, the assailed decision stands.

SO ORDERED.28

YIL and its companies, YILPI and YICRI, moved for reconsideration, but their
motion was denied by the CA in its assailed Resolution, dated April 29,2013.

Hence, this petition.


ISSUE

WHETHER OR NOT THE COURT OF APPEALS ERRED IN RULING


THAT PETITIONERS YATS GROUP SHOULD BE HELD JOINTLY AND
SEVERALLY LIABLE TO RESPONDENT YU DESPITE THE ABSENCE
OF FRAUD IN THE SALE OF ASSETS AND BAD FAITH ON THE PART
OF PETITIONERS YATS GROUP.29

Petitioners YIL, YILPI and YICRI contend that the facts of Caltex are not on all
fours with the case at bench. In Caltex, there was an express stipulation of the
assumption of all the obligations of the judgment debtor. Here, there was no
stipulation whatsoever stating that the petitioners shall assume the payment of
MADCI's debts.

The petitioners also argue that fraud must exist to hold third parties liable. The sale
in this case was not in any way tainted by any of the "badges of fraud" cited in Oria
v. McMicking.30 The CA itself stated that the alleged simulation of the sale was not
established by respondent Yu. Moreover, Article 1383 of the Civil Code requires
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that the creditor must prove that he has no other legal remedy to satisfy his claim.
Such requirement must be followed whether by an action for rescission or action for
sum of money.

On September 20, 2013, respondent Yu filed his Comment. 31 He asserted that the
CA correctly applied Caltex in the present case as the lands sold to the petitioners
were the only assets of MADCI. After the sale, MADCI became incapable of
continuing its business, and its corporate existence has just remained to this day in a
virtual state of suspended animation. Thus, unless the creditors had agreed to the
sale of all the assets of the corporation and had accepted the purchasing corporation
as the new debtor, sufficient assets should have been reserved to pay their claims.

On June 19, 2014, the petitioners filed their Reply,32 reiterating their previous
argument that the element of fraud was required in order for a third party buyer to
be liable to the seller's creditors.

The Court's Ruling

The petition lacks merit.

To recapitulate, respondent Yu bought several golf and country club shares from
MADCI. Regrettably, the latter did not develop the supposed project. Yu then
demanded the return of his payment, but MADCI could not return it anymore
because all its assets had been transferred. Through the acts of YIL, MADCI sold
all its lands to YILPI and, subsequently to YICRI. Thus, Yu now claims that the
petitioners inherited the obligations of MADCI. On the other hand, the petitioners
counter that they did not assume such liabilities because the transfer of assets was
not committed in fraud of the MADCI's creditors.

Hence, the issue at hand presents a complex question of law - whether fraud must
exist in the transfer of all the corporate assets in order for the transferee to assume
the liabilities of the transferor. To resolve this issue, a review of the laws and
jurisprudence concerning corporate assumption of liabilities must be undertaken.
Page 8 of 20

Background on the corporate


assumption of liabilities

In the 1965 case of Nell v. Pacific Farms, Inc.,33 the Court first pronounced the rule
regarding the transfer of all the assets of one corporation to another (hereafter
referred to as the Nell Doctrine) as follows:ChanRoblesvirtualLawlibrary

Generally, where one corporation sells or otherwise transfers all of its assets to
another corporation, the latter is not liable for the debts and liabilities of the
transferor, except:

1. Where the purchaser expressly or impliedly agrees to assume such debts;


2. Where the transaction amounts to a consolidation or merger of the
corporations;
3. Where the purchasing corporation is merely a continuation of the selling
corporation; and
4. Where the transaction is entered into fraudulently in order to escape
liability for such debts.

The Nell Doctrine states the general rule that the transfer of all the assets of a
corporation to another shall not render the latter liable to the liabilities of the
transferor. If any of the above-cited exceptions are present, then the transferee
corporation shall assume the liabilities of the transferor.

Legal bases of the Nell Doctrine

An evaluation of our contract and corporation laws validates that the Nell Doctrine
is fully supported by Philippine statutes. The general rule expressed by the doctrine
reflects the principle of relativity under Article 131134 of the Civil Code. Contracts,
including the rights and obligations arising therefrom, are valid and binding only
between the contracting parties and their successors-in-interest. Thus, despite the
sale of all corporate assets, the transferee corporation cannot be prejudiced as it is
Page 9 of 20

not in privity with the contracts between the transferor corporation and its creditors.

The first exception under the Nell Doctrine, where the transferee corporation
expressly or impliedly agrees to assume the transferor's debts, is provided
under Article 204735 of the Civil Code. When a person binds himself solidarity with
the principal debtor, then a contract of suretyship is produced. Necessarily, the
corporation which expressly or impliedly agrees to assume the transferor's debts
shall be liable to the same.

The second exception under the doctrine, as to the merger and consolidation of
corporations, is well-established under Sections 76 to 80, Title X of the
Corporation Code. If the transfer of assets of one corporation to another amounts
to a merger or consolidation, then the transferee corporation must take over the
liabilities of the transferor.

Another exception of the doctrine, where the sale of all corporate assets is entered
into fraudulently to escape liability for transferor's debts, can be found
under Article 1388 of the Civil Code. It provides that whoever acquires in bad faith
the things alienated in fraud of creditors, shall indemnify the latter for damages
suffered. Thus, if there is fraud in the transfer of all the assets of the transferor
corporation, its creditors can hold the transferee liable.

The legal basis of the last in the four (4) exceptions to the Nell Doctrine, where the
purchasing corporation is merely a continuation of the selling corporation, is
challenging to determine. In his book, Philippine Corporate Law,36 Dean Cesar
Villanueva explained that this exception contemplates the "business-enterprise
transfer." In such transfer, the transferee corporation's interest goes beyond the
assets of the transferor's assets and its desires to acquire the latter's business
enterprise, including its goodwill.

In Villa Rev Transit, Inc. v. Ferrer, 37 the Court held that when one were to buy the
business of another as a going concern, he would usually wish to keep it going; he
would wish to get the location, the building, the stock in trade, and the customers.
He would wish to step into the seller's shoes and to enjoy the same business
relations with other men. He would be willing to pay much more if he could get the
"good will" of the business, meaning by this, the good will of the customers, that
Page 10 of 20

they may continue to tread the old footpath to his door and maintain with him the
business relations enjoyed by the seller.

In other words, in this last exception, the transferee purchases not only the assets of
the transferor, but also its business. As a result of the sale, the transferor is merely
left with its juridical existence, devoid of its industry and earning capacity.
Fittingly, the proper provision of law that is contemplated by this exception would
be Section 40 of the Corporation Code,38 which
provides:ChanRoblesvirtualLawlibrary

Sec. 40. Sale or other disposition of assets. - Subject to the provisions of existing
laws on illegal combinations and monopolies, a corporation may, by a majority vote
of its board of directors or trustees, sell, lease, exchange, mortgage, pledge or
otherwise dispose of all or substantially all of its property and assets, including
its goodwill, upon such terms and conditions and for such consideration, which
may be money, stocks, bonds or other instruments for the payment of money or
other property or consideration, as its board of directors or trustees may deem
expedient, when authorized by the vote of the stockholders representing at least
two-thirds (2/3) of the outstanding capital stock, or in case of non-stock
corporation, by the vote of at least two-thirds (2/3) of the members, in a
stockholder's or member's meeting duly called for the purpose. Written notice of the
proposed action and of the time and place of the meeting shall be addressed to each
stockholder or member at his place of residence as shown on the books of the
corporation and deposited to the addressee in the post office with postage prepaid,
or served personally: Provided, That any dissenting stockholder may exercise his
appraisal right under the conditions provided in this Code.

A sale or other disposition shall be deemed to cover substantially all the corporate
property and assets if thereby the corporation would be rendered incapable of
continuing the business or accomplishing the purpose for which it was
incorporated.

After such authorization or approval by the stockholders or members, the board of


directors or trustees may, nevertheless, in its discretion, abandon such sale, lease,
exchange, mortgage, pledge or other disposition of property and assets, subject to
Page 11 of 20

the rights of third parties under any contract relating thereto, without further action
or approval by the stockholders or members.

Nothing in this section is intended to restrict the power of any corporation, without
the authorization by the stockholders or members, to sell, lease, exchange,
mortgage, pledge or otherwise dispose of any of its property and assets if the same
is necessary in the usual and regular course of business of said corporation or if the
proceeds of the sale or other disposition of such property and assets be appropriated
for the conduct of its remaining business.

In non-stock corporations where there are no members with voting rights, the vote
of at least a majority of the trustees in office will be sufficient authorization for the
corporation to enter into any transaction authorized by this section.
[Emphases Supplied]

To reiterate, Section 40 refers to the sale, lease, exchange or disposition of all or


substantially all of the corporation's assets, including its goodwill.39 The sale under
this provision does not contemplate an ordinary sale of all corporate assets; the
transfer must be of such degree that the transferor corporation is rendered incapable
of continuing its business or its corporate purpose.40cralawrednad

Section 40 suitably reflects the business-enterprise transfer under the exception of


the Nell Doctrine because the purchasing or transferee corporation necessarily
continued the business of the selling or transferor corporation. Given that the
transferee corporation acquired not only the assets but also the business of the
transferor corporation, then the liabilities of the latter are inevitably assigned to the
former.

It must be clarified, however, that not every transfer of the entire corporate assets
would qualify under Section 40. It does not apply (1) if the sale of the entire
property and assets is necessary in the usual and regular course of business of
corporation, or (2) if the proceeds of the sale or other disposition of such property
and assets will be appropriated for the conduct of its remaining business. 41 Thus,
the litmus test to determine the applicability of Section 40 would be the capacity of
the corporation to continue its business after the sale of all or substantially all its
Page 12 of 20

assets.

Jurisprudential recognition of the


business-enterprise transfer

Jurisprudence has held that in a business-enterprise transfer, the transferee is liable


for the debts and liabilities of his transferor arising from the business enterprise
conveyed. Many of the application of the business-enterprise transfer have been
related by the Court to the application of the piercing doctrine. 42cralawrednad

In A.D. Santos, Inc. v. Vasquez,43 a taxi driver filed a suit for workmen's
compensation against the petitioner corporation therein. The latter's defense was
that the taxi driver's employer was Amador Santos, and not the corporation.
Initially, the taxi driver was employed by City Cab, a sole proprietary by Amador
Santos. The taxi business was, however, transferred to the petitioner. Applying the
piercing doctrine, the Court held that the petitioner must still be held liable due to
the transfer of the business and should not be allowed to confuse the legitimate
issues.

In Buan v. Alcantara,44 the Spouses Buan were the owners of Philippine Rabbit Bus
Lines. They died in a vehicular accident and the administrators of their estates were
appointed. The administrators then incorporated the Philippine Rabbit Bus Lines.
The issue raised was whether the liabilities of the estates of the spouses were
conveyed to the new corporation due to the transfer of the business. Utilizing the
alter-ego doctrine, the Court ruled in the affirmative and stated
that:ChanRoblesvirtualLawlibrary

As between the estate and the corporation, the intention of incorporation was to
make the corporation liable for past and pending obligations of the estate as the
transportation business itself was being transferred to and placed in the name of the
corporation. That liability on the part of the corporation, vis-a-vis the estate, should
continue to remain with it even after the percentage of the estate's shares of stock in
the corporation should be diluted.45

The Court, however, applied the business-enterprise transfer doctrine independent


of the piercing doctrine in other cases. In San Teodoro Development Enterprises v.
Page 13 of 20

SSS,46 the petitioner corporation therein attempted to avoid the compulsory


coverage of the Social Security Law by alleging that it was a distinct and separate
entity from its limited partnership predecessor, Chua Lam & Company, Ltd. The
Court, however, upheld the findings of the SSS that the entire business of the
previous partnership was transferred to the corporation ostensibly for a valuable
consideration. Hence, "[t]he juridical person owning and operating the business
remain the same even if its legal personality was changed."47cralawrednad

Similarly, in Laguna Trans. Co., Inc. v. SSS,48 the Court held that the transferee
corporation continued the same transportation business of the unregistered
partnership therein, using the same lines and equipment. There was, in effect, only a
change in the form of the organization of the entity engaged in the business of
transportation of passengers.

Perhaps the most telling jurisprudence which recognized the business-enterprise


transfer would be the assailed case of Caltex. In that case, under an agreement of
assumption of obligations, LUSTEVECO transferred, conveyed and assigned to
respondent PSTC all of its business, properties and assets pertaining to its tanker
and bulk business together with all the obligations, properties and
assets.49 Meanwhile, petitioner Caltex, Inc. obtained a judgment debt against
LUSTEVECO, and it sought to enforce the same against PSTC. The Court ruled
that PSTC was bound by its agreement with LUSTEVECO and the former assumed
all of the latter's obligations pertaining to such business.

More importantly, the Court held that, even without the agreement, PSTC was still
liable to Caltex, Inc. based on Section 40, as follows:ChanRoblesvirtualLawlibrary

While the Corporation Code allows the transfer of all or substantially all the
properties and assets of a corporation, the transfer should not prejudice the creditors
of the assignor. The only way the transfer can proceed without prejudice to the
creditors is to hold the assignee liable for the obligations of the assignor. The
acquisition by the assignee of all or substantially all of the assets of the assignor
necessarily includes the assumption of the assignor's liabilities, unless the
creditors who did not consent to the transfer choose to rescind the transfer on the
ground of fraud. To allow an assignor to transfer all its business, properties and
Page 14 of 20

assets without the consent of its creditors and without requiring the assignee to
assume the assignor's obligations will defraud the creditors. The assignment will
place the assignor's assets beyond the reach of its creditors.

Here, Caltex could not enforce the judgment debt against LUSTEVECO. The writ
of execution could not be satisfied because LUSTEVECO's remaining properties
had been foreclosed by lienholders. In addition, all of LUSTEVECO's business,
properties and assets pertaining to its tanker and bulk business had been assigned to
PSTC without the knowledge of its creditors. Caltex now has no other means of
enforcing the judgment debt except against PSTC.50cralawrednad
[Emphasis Supplied]

The Caltex case, thus, affirmed that the transfer of all or substantially all the proper
from one corporation to another under Section 40 necessarily entails the assumption
of the assignor's liabilities, notwithstanding the absence of any agreement on the
assumption of obligations. The transfer of all its business, properties and assets
without the consent of its creditors must certainly include the liabilities; or else, the
assignment will place the assignor's assets beyond the reach of its creditors. In order
to protect the creditors against unscrupulous conveyance of the entire corporate
assets, Caltex justifiably concluded that the transfer of assets of a corporation under
Section 40 must likewise carry with it the transfer of its liabilities.

Fraud is not an essential


consideration in a business-
enterprise transfer

Notably, an evaluation of the relevant jurisprudence reveals that fraud is not an


essential element for the application of the business-enterprise transfer.51 The
petitioners in this case, however, assert otherwise. They insist that under
the Caltex case, there was an assumption of liabilities because fraud existed on the
part of PSTC, as the transferee corporation.

The Court disagrees.

The exception of the Nell doctrine,52 which finds its legal basis under Section 40,
provides that the transferee corporation assumes the debts and liabilities of the
Page 15 of 20

transferor corporation because it is merely a continuation of the latter's business. A


cursory reading of the exception shows that it does not require the existence of
fraud against the creditors before it takes full force and effect. Indeed, under the
Nell Doctrine, the transferee corporation may inherit the liabilities of the transferor
despite the lack of fraud due to the continuity of the latter's business.

The purpose of the business-enterprise transfer is to protect the creditors of the


business by allowing them a remedy against the new owner of the assets and
business enterprise. Otherwise, creditors would be left "holding the bag," because
they may not be able to recover from the transferor who has "disappeared with the
loot," or against the transferee who can claim that he is a purchaser in good faith
and for value.53 Based on the foregoing, as the exception of the Nell doctrine relates
to the protection of the creditors of the transferor corporation, and does not depend
on any deceit committed by the transferee -corporation, then fraud is certainly not
an element of the business enterprise doctrine.

The Court also agrees with the CA, in its assailed April 29, 2013 resolution, that
there was no finding of fraud in the Caltex case; otherwise it should have been
clearly and categorically stated.54 The discussion in Caltex relative to fraud seems
more hypothetical than factual, thus:ChanRoblesvirtualLawlibrary

If PSTC refuses to honor its written commitment to assume the obligations of


LUSTEVECO, there will be a fraud on the creditors of LUSTEVECO. x x x To
allow PSTC now to welsh on its commitment is to sanction a fraud on
LUSTEVECO's creditors.55

Besides, the supposed fraud in Caltex referred to PSTC's refusal to pay


LUSTEVECO's creditors despite the agreement on assumption of the latter's
obligations. Again, the Court emphasizes in the said case, even without the
agreement, PSTC was still liable to Caltex, Inc. under Section 40, due to the
transfer of all or substantially all of the corporate assets. At best, transfers of all or
substantially all of the assets to a transferee corporation without the consent of the
transferor corporation's creditor gives rise to a presumption of fraud against the said
creditors.56cralawrednad

Applicability of the
Page 16 of 20

business-enterprise transfer
in the present case

Bearing in mind that fraud is not required to apply the business-enterprise transfer,
the next issue to be resolved is whether the petitioners indeed became a
continuation of MADCI's business. Synthesizing Section 40 and the previous
rulings of this Court, it is apparent that the business-enterprise transfer rule applies
when two requisites concur: (a) the transferor corporation sells all or substantially
all of its assets to another entity; and (b) the transferee corporation continues the
business of the transferor corporation. Both requisites are present in this case.

According to its articles of incorporation, the primary purpose of MADCI was "[t]o
acquire by purchase, lease, donation or otherwise, and to own, use, improve,
develop, subdivide, sell, mortgage, exchange, lease, develop and hold for
investment or otherwise, real estate of all kinds, whether improved, managed or
otherwise disposed of buildings, houses, apartment, and other structures of
whatever kind, together with their appurtenance."57 During the trial before the RTC,
Sangil testified that MADCI was a development company which acquired
properties in Magalang, Pampanga to be developed into a golf
course.58cralawrednad

The CA found that MADCI had an entire asset consisting of 120 hectares of land,
and that its sale to the petitioners rendered it incapable of continuing its intended
golf and country club business.59 The Court holds that such finding is fully
substantiated by the records of the case. The MOA itself stated that MADCI had
120 hectares of agricultural land in Magalang, Pampanga, for the development of a
golf course.60 MADCI had the right of ownership over these properties consisting of
97 land titles, except for the 27 titles previous delivered to YIL.61 The 120-hectare
land, however, was then sold to YILPI,62 and then transferred to
YICRI.63cralawrednad

Respondent Yu testified that he verified the landholdings of MADCI with the


Register of Deeds in Pamapanga and discovered that all its lands were transferred to
YICRI.64 Because the properties of MADCI were already conveyed, Yu had no
other way of collecting his refund.65cralawrednad

Sangil also testified that MADCI had no more properties left after the sale of the
Page 17 of 20

lands to the petitioners:ChanRoblesvirtualLawlibrary

Atty. Nuguid: And after the sale, it has no more properties?


Sangil: That's right, Sir.

Q: And the business of MADCI was to operate and build golf course?
A: That's right, Sir.

Q: And because of the sale of all these properties, MADCI was not able to build the
golf course?
A: Yes, Sir.

Q: And did not anymore operate as a corporation?


A: MADCI is still there but as far the development of the golf course, it was
taken over by Mr. Wang.66cralawrednad
[Emphasis Supplied]

As a witness for the petitioners, Wang testified that Y1L bought the shares of stock
of MADCI because it had some interest in the project involving the development of
a golf course. The petitioners then found that MADCI had landholdings in
Pampanga which it would be able to develop into a golf course.67 Hence, the
petitioners were fully aware of the nature of MADCFs business and its assets, but
they continued to acquire its lands through the designated company,
YICRI.68cralawrednad

Based on these factual findings, the Court is convinced that MADCI indeed had
assets consisting of 120 hectares of landholdings in Magalang, Pampanga, to be
developed into a golf course, pursuant to its primary purpose. Because of its alleged
violation of the MOA, however, MADCI was made to transfer all its assets to the
petitioners. No evidence existed that MADCI subsequently acquired other lands for
its development projects. Thus, MADCI, as a real estate development corporation,
was left without any property to develop eventually rendering it incapable of
continuing the business or accomplishing the purpose for which it was incorporated.

Section 40 must apply.


Page 18 of 20

Consequently, the transfer of the assets of MADCI to the petitioners should have
complied with the requirements under Section 40. Nonetheless, the present petition
is not concerned with the validity of the transfer; but the respondent's claim of
refund of his P650,000.00 payment for golf and country club shares. Both the CA
and the RTC ruled that MADCI and Sangil were liable.

On the question of whether the petitioners must also be held solidarily liable to Yu,
the Court answers in the affirmative.

While the Corporation Code allows the transfer of all or substantially all of the
assets of a corporation, the transfer should not prejudice the creditors of the
assignor corporation.69 Under the business-enterprise transfer, the petitioners have
consequently inherited the liabilities of MADCI because they acquired all the assets
of the latter corporation. The continuity of MADCI's land developments is now in
the hands of the petitioners, with all its assets and liabilities. There is absolutely no
certainty that Yu can still claim its refund from MADCI with the latter losing all its
assets. To allow an assignor to transfer all its business, properties and assets without
the consent of its creditors will place the assignor's assets beyond the reach of its
creditors. Thus, the only way for Yu to recover his money would be to assert his
claim against the petitioners as transferees of the assets.

The MOA cannot


prejudice respondent

The MOA, which contains a provision that Sangil undertook to redeem MADCI
proprietary shares sold to third persons or settle in full all their claims for refund of
payments, should not prejudice respondent Yu. The CA correctly ruled that such
provision constituted novation under Article 129370 of the Civil Code. When there
is a substitution of debtors, the creditor must consent to the same; otherwise, it shall
not in any way affect the creditor. In this case, it was established that Yu's consent
was not secured in the execution of the MOA. Thus, insofar as the respondent was
concerned, the debtor remained to be MADCI. And given that the assets and
business of MADCI have been transferred to the petitioners, then the latter shall be
liable.

Interestingly, the same issue on novation was tackled in the Caltex case and the
Page 19 of 20

Court resolved it in this wise:ChanRoblesvirtualLawlibrary

The Agreement, under Article 1291 of the Civil Code, is also a novation of
LUSTEVECO's obligations by substituting the person of the debtor. Under Article
1293 of the Civil Code, a novation which consists in substituting a new debtor in
place of the original debtor cannot be made without the consent of the
creditor. Here, since the Agreement novated the debt without the knowledge
and consent of Caltex, the Agreement cannot prejudice Caltex. Thus, the assets
that LUSTEVECO transferred to PSTC in consideration, among others, of the
novation, or the value of such assets, remain even in the hands of PSTC subject to
execution to satisfy the judgment claim of Caltex.71cralawrednad
[Emphasis Supplied]

Free and Harmless Clause

The petitioners, however, are not left without recourse as they can invoke the free
and harmless clause under the MOA. In business-enterprise transfer, it is possible
that the transferor and the transferee may enter into a contractual stipulation stating
that the transferee shall not be liable for any or all debts arising from the business
which were contracted prior to the time of transfer. Such stipulations are valid, but
only as to the transferor and the transferee. These stipulations, though, are not
binding on the creditors of the business enterprise who can still go after the
transferee for the enforcement of the liabilities.72cralawrednad

An example of a free and harmless clause can be observed in the case of PCI
Leasing v. UCPB.73 In that case, a claim for damages was filed against the petitioner
therein as the registered owner of the vehicle, even though it was the latter's lessee
that committed an infraction. The Court granted the claim against the petitioner
based on the registered-owner rule. Even so, the Court stated therein
that:ChanRoblesvirtualLawlibrary

xxx the Court believes that petitioner and other companies so situated are not
entirely left without recourse. They may resort to third-party complaints against
their lessees or whoever are the actual operators of their vehicles. In the case at bar,
there is, in fact, a provision in the lease contract between petitioner and SUGECO
Page 20 of 20

to the effect that the latter shall indemnify and hold the former free and harmless
from any "liabilities, damages, suits, claims or judgments" arising from the latter's
use of the motor vehicle. Whether petitioner would act against SUGECO based on
this provision is its own option.

In the present case, the MOA stated that Sangil undertook to redeem MADCI
proprietary shares sold to third persons or settle in full all their claims for refund of
payments. While this free and harmless clause cannot affect respondent as a
creditor, the petitioners may resort to this provision to recover damages in a third-
party complaint. Whether the petitioners would act against Sangil under this
provision is their own option.

WHEREFORE, the petition is DENIED. The January 30, 2012 Decision and the
April 29, 2013 Resolution of the Court of Appeals in CA-G.R. CV No. 96036 are
hereby AFFIRMED in toto.

SO ORDERED

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