Poll automation and the Corporation Law – a bar review note

The brouhaha surrounding the contract negotiations between Comelec and the winning bidders of the automated elections project (Smartmatic and TIM, as a proposed joint venture) raises  questions re the Corporation Code and related jurisprudence.

The facts as reported in the newspapers are as follows. Smartmatic is a foreign corporation, while TIM is a Filipino corporation. Together they proposed to form a joint venture to computerize the 2010 elections, with TIM having a 60% stake as required by law. At the time of the bid award, the joint venture corporation does not yet exist, and the rules allow for a certain period for Comelec and the joint venture to sign a contract. In the meantime, TIM decides not to proceed with the joint venture, citing “irreconcilable differences” with Smartmatic.

At a Senate hearing, public officials insist that the proposed joint venture be liable for “failure” of elections if, for example, the machines they later provide do not operate as promised. Such liability may prove to be very expensive depending on how the damages are assessed, and views were expressed that the contract between the Comelec and the joint venture should not allow for a cap in the form of “liquidated damages.”

It is submitted that the “problems” of the poll automation award could have been avoided if the Comelec had set up a rule that no bid would be entertained from “consortium” bidders unless they had already properly incorporated themselves as joint ventures and provided evidence of their capital adequacy.

The following is a review of the legal rules that may apply to the matter.

Can TIM be held liable for the potential liquidated damages of Smartmatic-TIM?
The obvious answer is yes, but only if TIM signs the joint venture contract with Smartmatic.

What liability does TIM have prior to the incorporation of the Smartmatic-TIM joint venture?
Its liability is that of a promoter of a new corporation, which is the joint venture. A promoter is a person who takes initiative or part of the founding and organizing the business of a corporate issuer. Exception to this definition: a securities underwriter. Revised Securities Act, Sec. 2. A promoter is also one who brings together persons interested in an enterprise, aids in procuring subscriptions (of stock), and sets in motion the machinery which leads to the formation of a corporation. Armstrong v Sun Printing (NY case, as cited in Campos, Vol. 1, 54).

What is the liability of a promoter if the intended corporation is not formed?
The promoter is liable for his pre-incorporation acts and assumes the risk that he may not be reimbursed or relieved of liability in the event that the corporation is not formed. This conclusion seems inevitable from the presumptive rule, held in Wells v Fay and Egan (Georgia case, 1915, cited by Campos, 259). In Wells, it was held that if one contracts as an agent, when in fact he has no principal, he will be personally liable.

What if the liability is one that can attach only to the proposed corporation, such as for acts the corporation, when formed, might later commit?
It is submitted that the liability cannot attach. When a promoter/incorporator refuses to proceed with the incorporation because the proposed corporation would enter into a contract under which the promoter would become co-liable (as a principal officer of the corporation, for example; or as a managing partner if the proposed corporation is a joint venture), the situation is similar to a breach of promise to marry, which is generally not actionable. The promoter is liable for “preparatory” costs (of negotiation, etc.) but not for liabilities that are contingent on the formation of the corporation. After all, the promoter as a potential co-venturer has not yet signed the joint venture agreement.

But can one be liable for negotiating “in bad faith”?
Yes. This is a business tort question that is also covered by Arts. 19 and 20 of the Civil Code. Art. 19 states that “every person must, in the exercise of his rights and in the performance of his duties, act with justice, give everyone his due, and observe honesty and good faith.” Art. 20 provides that the person who violates Art. 19 is liable for damages. Art. 20 states: Every person who, contrary to law, willfully or negligently causes damage to another shall indemnify the latter for the same. Of course, the plaintiff must prove the bad faith (of the defendant), causation, and the extent of harm to himself in order to recover from the defendant. Although there is no recorded case of such a successful suit in the Philippines, a case cited in torts textbooks is Tuttle v Buck (Minnesota, 1909) where a wealthy banker established a barber shop and employed his influence to attract the customers of the plaintiff’s barber shop. The Court held for the plaintiff. Related to this question is the situation where fraud is perpetrated to induce another into a contract. Here, the remedy is to annul the contract (Civil Code Arts. 1330 and 1338) and to recover on damages. But if the result of an attempted fraud is a non-contract, it is submitted that it is difficult to prove causation or damage. After all, the “aggrieved” or “innocent” party was smart enough not to sign!

Can a corporation be a partner?
Generally, no, because the partnership would bind the corporation and it is public policy that only a corporation’s board of directors should have the power to bind the corporation. However, an exception is made when corporations form joint ventures because one of the requirements of a valid joint venture is that the corporate partners must be managing partners and they thereby become solidarily liable for the obligations of the partnership.

What is a joint venture?
It is an association of two or more persons to carry out a single business enterprise for profit. It is included in the concept of “particular partnership” in Art. 1783 of the Civil Code. The joint venture is a form of partnership governed by the law of partnerships, which would then include the features of separate juridical personality (of the joint venture), mutual agency among the co-venturers, and unlimited liability. Aurbach v Sanitary Wares, 1989.

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