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Corporate directors and officers may be bound by arbitration agreements entered into by the corporation of which they are directors.

In Lanuza, Jr., et al. v. BF Corporation, et al.,[1] the Supreme Court’s Second Division, in a decision penned by Justice Marvic MVF Leonen, held that “corporate representatives may be compelled to submit to arbitration proceedings pursuant to a contract entered into by the corporation they represent if there are allegations of bad faith or malice in their acts representing the corporation.” Companies doing business in the Philippines, and their directors and officers, should be aware of and keep the Lanuza decision in mind when entering into contracts with arbitration clauses, for purposes of risk assessment and management.

The Lanuza ruling

BF Corporation (BF) agreed to construct a mall and a multilevel parking structure. The agreement contained an arbitration clause. BF completed the construction but alleged non-payment by the project owner.

BF filed a collection case with the trial court against the project owner and the latter’s directors, alleging that they misrepresented that the project owner had funds to comply with its payment obligations and that non-payment was due to delayed processing of BF’s progress billings. BF impleaded the directors, claiming that they were in bad faith in directing the company’s (i.e., the project owner’s) affairs and should be held jointly and severally liable with the project owner. Upon motion of the directors, the case was eventually referred to arbitration.

During the pendency of the arbitration, the directors sought relief from the trial court seeking to be excluded from the arbitration for being non-parties to the arbitration agreement. The trial court ruled against the directors and held that “they were interested parties who must also be served with a demand for arbitration to give them the opportunity to ventilate their side of the controversy, safeguard their interest and fend off their respective positions.”[2] The Court of Appeals, on appeal, upheld the trial court’s ruling, and this issue eventually reached the Supreme Court – giving rise to the present decision.

While the issue was pending with the Supreme Court, the arbitral tribunal issued an award dismissing BF’s claim (against both the project owner and the directors), which rendered the proceedings before the Supreme Court moot. The Supreme Court, nevertheless, proceeded to resolve the issue raised by the directors “to clarify important matters for guidance”.[3]

The Supreme Court held that the directors may be compelled to submit to the arbitration proceedings in accordance with the arbitration agreement between the project owner and BF “in order to determine if the distinction between [the project owner’s] personality and [the directors’] personalities should be disregarded.” While the Court expressly recognized the parties’ autonomy to determine how their disputes should be resolved and the principle that an arbitration clause shall not apply to persons who were neither parties to the contract nor assignees of previous parties, it ruled that there are instances when the distinction between personalities of directors, officers and representatives, and of the corporation, are disregarded, known as piercing the veil of corporate fiction.[4]

When the veil of corporate fiction is pierced, corporate representatives are treated as the corporation itself and are held liable for corporate acts. The Court added that when there are allegations of bad faith or malice against corporate directors or representatives, it becomes the duty of the courts or tribunals to determine if these persons and the corporation should be treated as one. Thus, the courts or tribunals must first determine whether circumstances exist to warrant the courts or tribunals disregarding the distinction between the corporation and the persons representing it.

The Court ruled that when directors, as in this case, are impleaded in a case against a corporation, alleging malice or bad faith on their part in directing the affairs of the corporation, complainants are effectively alleging that the directors and the corporation are not acting as separate entities and that the contracts executed by the corporation (including the arbitration agreement) are contracts executed by the directors themselves.

Legal implications

Although the decision was rendered in respect of a moot issue and, thus, its binding effect as a precedent is unclear,[5] the legal implications of the decision are nevertheless potentially significant.

First, Lanuza holds that the issue of whether the veil of corporation fiction should be pierced is an arbitrable issue. The ruling is significant as it allows an arbitral tribunal to make a determination as to who the real parties to the arbitration agreement are. This is consistent with the principle of Kompetenz-Kompetenz, expressly adopted by Philippine law,[6] which gives an arbitral tribunal the power to resolve the issue of whether it has jurisdiction. As emphasized in Lanuza, “when there are allegations of bad faith or malice against corporate directors or representatives, it becomes the duty of courts or tribunals to determine if these persons should be treated as one” and, if so, whether the directors and representatives should be treated as the “corporation itself and should be held liable for corporate acts”. Notably, by express provision of the Philippine Corporation Code, when corporate directors or officers are guilty of bad faith or gross negligence, they may be held jointly and severally liable with the corporation but are not necessarily treated as the corporation itself.[7]

Second, the Lanuza decision seems to suggest that a court or tribunal dealing with a “piercing” issue should determine, as a preliminary issue, whether circumstances exist to warrant the courts or tribunals disregarding the distinction between the corporation and the persons representing it. Notably, under existing rules, the question of the jurisdiction of the tribunal may be resolved either as a preliminary issue or together with the award on the merits.[8] There are situations where it is more advisable to consider and resolve the issue of jurisdiction together with the merits of the dispute, such as when the issue of jurisdiction is intricately connected with the issues on the merits.[9] In such situations, the directors and officers of the corporation may have to participate throughout the entire arbitration process.

Third, Lanuza applies the concept of “piercing of the corporate veil” to bind corporate directors and officers to an arbitration agreement entered into by the their corporation. The concept of “piercing” has been used to bring in persons who had not signed the corporation’s arbitration agreement into an arbitration proceeding, through the “group of companies”[10] and “alter ego”[11] doctrines. The concept of “piercing” is well-entrenched in the Philippine legal system, like many other jurisdictions,[12] and is normally relied on by a claimant for purposes of impleading and/or holding a stockholder[13] or an affiliate/parent[14] liable for the obligations of a corporation. The Philippine Supreme Court, however, has applied the concept to hold corporate officers liable with the corporation that they represent.[15] In one case, the court applied the concept of “piercing” in discussing the liability of a corporate officer under the Corporation Code.[16] In Lanuza, the Court goes further to rule that corporate representatives may be bound by an arbitration agreement entered into by the corporation which they represent, if the circumstances authorize the application of the principle of “piercing”.

Practical implications

Prior to Lanuza, the liability of corporate directors and officers was generally determined in regular court proceedings. As a general rule, directors and officers may not be considered to have waived their day in court by signing an agreement containing an arbitration clause on behalf of a corporation.

Under Lanuza, corporate directors and officers may now be impleaded in arbitration proceedings involving the corporation which they represent on the theory that if they acted in bad faith in directing the affairs of the corporation, they and the corporation they represent should be considered as the same entity.

A practical effect of Lanuza is to allow companies (and its directors and officers) to avoid the expense of having to deal with parallel arbitration and court proceedings in respect of the same issues. Lanuza imposes on the tribunal the duty to determine whether the directors and officers should be considered to be the real parties to the arbitration agreement (applying the principle of piercing of the veil of corporate fiction). If the court determines that the requirements for “piercing” are present, it may proceed to take jurisdiction over the directors and officers. If not, the arbitral tribunal will have no jurisdiction over the directors and officers and should dismiss the claim as against them. Between a court which has no jurisdiction over the main claim against the corporation (by reason of the arbitration clause) and the tribunal which does, the tribunal may be in a better position to resolve this issue.

 

By Ramon Quisumbing, Donemark Calimon, and Grace Ann Lazaro (Quisumbing Torres in the Philippines, a member firm of Baker & McKenzie International)

 

[1] G.R. No. 174938, 1 October 2014.

[2] Under Republic Act 876 or the Arbitration Law (which currently applies only to domestic arbitrations), the jurisdiction to determine whether a person should be excluded from the arbitration proceeding is with the trial court.

[3] Citing Salonga v. Paño, 219 Phil. 402, 430 (1985) [Per J. Gutierrez, Jr., En Banc]; Angel v. Inopiquez, 251 Phil. 131, 136 (1989) [Per J. Bidin, Third Division]; Chavez v. Public Estates Authority, 433 Phil. 506, 522 (2002) [Per J. Carpio, En Banc]; Alliance for Rural and Agrarian Reconstruction, Inc. v. COMELEC, G.R. No. 192803, December 10, 2013, 712 SCRA 54, 75-76 [Per J. Leonen, En Banc].

[4] According to the Court, “piercing the veil of corporate fiction is warranted when “[the separate personality of a corporation] is used as a means to perpetrate fraud or an illegal act, or as a vehicle for the evasion of an existing obligation, the circumvention of statutes, or to confuse legitimate issues.”

[5] The Supreme Court has previously recognized the binding effect of rulings on issues which had become moot in certain exceptional circumstances, as follows: “first, there is a grave violation of the Constitution; second, the exceptional character of the situation and the paramount public interest is involved; third, when the constitutional issue raised requires formulation of controlling principles to guide the bench, the bar, and the public; and fourth, the case is capable of repetition yet evading review” (Kulayan v. Tan, G.R. No. 187298, 3 July 2012).

[6] Rule 2.2 and 2.4, A.M. No. 07-11-08-SC, 1 September 2009.

[7] Batas Pambansa Blg. 68, Section 31.

[8] Rule 3.20, A.M. No. 07-11-08-SC, 1 September 2009.

[9] Methanex v. United States (Partial Award on Jurisdiction, 7 Aug. 2002) and Glamis Gold v. United States (UNCITRAL/NAFTA).

[10] Dow Chemical Group v. Isover- Saint- Gobain (ICC Case No. 4131, 1982) (cited in Yaraslau Kryvoi, Piercing the corporate veil in international arbitration, 2011).

[11] Carte Blanche (Singapore) Pte. Ltd. v. Diners Club International, Inc., No. 1135, Docket 92-9125 , 19 August 1993.

[12] For example in the recent case of Petrodel Resources Ltd v Prest ([2013] UKSC 34), the English Supreme Court recognized the court’s distinct but limited power to pierce corporate veil although the Court did not exercise such power given the facts and circumstances of the case. In Taiwan, its legislative Yuan recently amended Article 154 of Taiwan’s Company Act to bring the law in line “ in line with the norms for corporate veil piercing in other jurisdictions such as the United States, the U.K., and Germany” (see http://www.winklerpartners.com/?p=3708). The United States Supreme Court has long recognized the propriety of “piercing” “when the notion of legal entity is used to defeat public convenience, justify wrong, protect fraud, or defend crime” (United States v. Milwaukee Refrigerator Transit Co. 142 F. 247, 255 (C.C.E.D. Wis. 1905 as cited in Thompson, Piercing the Corporate Veil: An Empirical Study, 1991).

[13] Saphir v. Neustadt, 177 Conn. 191, 3 April 1979.

[14] WH Smith PLC v. Benages & Associates, Inc., 2010 WL 5348724 (Fla. 3d DCA, 29 December 2010) and Craig v. lake Abestos of Quebec, 843 F.2d 145, 31 March 1988).

[15] See Mendoza and Yotoko vs. Banco Real Dev. Bank, 470 SCRA 86 (2005). In this case, the corporate officers mortgaged the corporation’s properties to guarantee a loan obtained from a bank and later relocated the mortgaged properties to another business establishment owned and operated by a new corporation. The Supreme Court held the officers personally liable on the corporate loan, stating that the corporate veil “would be lifted when the corporation is used by any of them as a cloak or cover for fraud or illegality or injustice.”

[16] See Heirs of Fe Tan Uy v. International Exchange Bank, G.R. No. 166282, 13 February 2013. In this case, the Court absolved petitioner, in his capacity as corporate officer, from liability, stating: “[n]onetheless, these shortcomings of Uy are not sufficient to justify the piercing of the corporate veil which requires that the negligence of the officer must be so gross that it could amount to bad faith and must be established by clear and convincing evidence.”

 

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