As a rule, contracts are valid and binding only between and among the parties and their successors-in-interest. This reflects the principle of relativity of contracts, which Art. 1311 of the Civil Code articulates, thus:
“Art. 1311. Contracts take effect only between the parties, their assigns and heirs, except in case where the rights and obligations arising from the contract are not transmissible by their nature, or by stipulation or by provision of law. The heir is not liable beyond the value of the property he received from the decedent.”
Generally, then, any person who is not a party to the contract is not bound by the contractual stipulations. He or she neither acquires rights nor assumes obligations arising from that contract.
This principle holds true not only as regards natural persons, but also with respect to juridical entities like corporations.
Following this rule, when a corporation transfers all, or substantially all, its assets to another corporation, the transferee corporation is not charged with the burden of assuming the liabilities of the transferor corporation. The transferee corporation has nothing to do with the contracts previously entered by the transferor corporation.
There are instances, however, where the transferee corporation may be held answerable for the liabilities of the transferor corporation. One of such instances is when the transferee corporation is merely a continuation of the transferor corporation (Nell v. Pacific Farms, Inc; G.R. No. L-20850).
When is the transferee corporation merely a continuation of the transferor corporation?
The case of Y-I LEISURE PHILIPPINES, INC., YATS INTERNATIONAL LTD. AND Y-I CLUBS AND RESORTS, INC., Petitioners, v. JAMES YU, Respondent (G.R. No. 207161 – September 8, 2015) is instructive.
James Yu (YU) purchased on installment certain golf and country club shares from Mt. Arayat Development Co. Inc. (MADCI), a real estate development corporation.
YU, however, discovered later that MADCI failed to develop the supposed project. YU demanded for the return of his money.
Unfortunately, during the intervening time, sometime between the time YU purchased the shares and the time he made the demand, MADCI entered into a Memorandum of Agreement (MOA) with Yats International Ltd. (YIL).
The relevant provisions of the MOA included the following terms:
⇛ MADCI and, its president, Roberto Sangil (SANGIL) undertook to return the amounts paid by YIL with interests in case they would fail in their obligations;
⇛ Should they fail to return the amounts, YIL would be authorized to sell the 120 hectare land (comprising the entire assets of MADCI) to satisfy their obligation.
It appeared that MADCI and SANGIL failed to perform their obligations. All its assets (the 120-hectare land) was eventually sold to YIL, Y-I Leisure Phils., Inc. (YILPI) and Y-I Club & Resorts, Inc. (YICRI).
YU filed a complaint for collection of sum of money and damages, with prayer for preliminary attachment, against MADCI and SANGIL. The complaint was later amended to implead YIL, YILPI, and YICRI as party-defendants.
WERE YIL, YILPI, and YICRI liable?
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.
The Supreme Court held YIL, YILPI, and YICRI solidarily liable with MADCI and SANGIL under the 3rd exception laid down in the case of Edward J. Nell Company v. Pacific Farms, Inc., that is, the purchasing corporation is a mere continuation of the selling corporation.
Citing Villanueva, Philippine Corporate Law, 2010 ed., the Supreme Court pointed out that this exception contemplates the ‘business-enterprise transfer’. This transfer involves more than acquisition of assets. The purchasing (transferee) corporation acquires also the business of the selling (transferor) corporation, including its goodwill, as a going concern.
In the words of the Supreme Court, “as a result of the sale, the transferor is merely left with its juridical existence, devoid of its industry and earning capacity”.
This situation refers to Section 40 of the Corporation Code where a corporation sells, leases, exchanges, mortgages, pledges or otherwise disposes of all or substantially all of its property and assets, including its goodwill, for which reason it is rendered incapable of continuing the business or accomplishing the purpose for which it was incorporated.
The Supreme Court elucidated, thus:
“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.
The Supreme Court made reference to its decision in the case of CALTEX (PHILIPPINES), INC., Petitioner, vs. PNOC SHIPPING AND TRANSPORT CORPORATION, Respondent [G.R. No. 150711 – August 10, 2006], and reiterated:
“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 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.”
IS FRAUD REQUIRED FOR THIS EXCEPTION TO APPLY?
It is clear from the wordings of the exception that fraud is not required.
Fraud is not an element of the business enterprise doctrine…
“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. 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”, declared the Supreme Court.
For the exception to apply, only 2 requisites need to be satisfied.
- The transferor corporation sells all or substantially all of its assets to another entity; and
- The transferee corporation continues the business of the transferor corporation.
MADCI sold all its assets to YIL and its companies, YILPI and YICRI, hereby MADCI was rendered incapable to continue its business.
YIL, an investment company engaged in the development of real estates, projects, leisure, tourism, and related business, subscribed to the shares of MADCI because it was interested in its (MADCI) golf course development project.
Hence, both requisites were present in the case.
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