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Case digest · Business judgment rule; bad faith of directors
Board of Liquidators vs. Heirs of Maximo M. Kalaw
Four typhoons turned a government corporation’s copra contracts into heavy losses. The board approved the contracts anyway, and the corporation sued its general manager and directors.
Facts
1946–1947
The National Coconut Corporation (NACOCO), a government corporation, traded copra by forward sales, selling it before it was in hand. For the fiscal year ending June 30, 1947, its general manager and board chairman, Maximo M. Kalaw, signed some 60 such contracts without prior board approval, and NACOCO reaped a gross profit of P3,631,181.48. The board voted him a special bonus.
July–October 1947
Kalaw signed nine more contracts, for the delivery of 16,500 tons of copra.
October–December 1947
Four typhoons struck the Philippines: one in October, two in November and one in December. Copra production fell, prices spiralled and warehouses were destroyed.
December 22, 1947
When it became clear the contracts would be unprofitable, Kalaw made a full disclosure to the board and apprised it of the impending heavy losses.
January 30, 1948
The board, with Kalaw, Juan Bocar, Casimiro Garcia and Leonor Moll in attendance, unanimously approved the contracts. NACOCO delivered less than half of the copra, and its settlements with the buyers summed up to P1,343,274.52.
February 1949
NACOCO sued Kalaw and directors Bocar, Garcia and Moll to recover the P1,343,274.52, charging the board with “bad faith and/or breach of trust” in approving the contracts. NACOCO was abolished in 1950, and the Board of Liquidators took its place. Kalaw died in March 1955, before trial, and his heirs were substituted. The trial court dismissed the complaint, and the government appealed directly to the Supreme Court.
Issue
Were Kalaw and the NACOCO directors personally liable for the P1,343,274.52 in settlements because the board approved copra contracts it knew would cause heavy losses?
Ruling
No. The Court held that the directors were not liable and affirmed the dismissal of the complaint.
By its practice of letting Kalaw sign such contracts without prior approval, the board had set aside the by-law requirement, so the contracts were valid corporate acts; in any event, the board ratified them on January 30, 1948. All the government had on its side was that the board knew the contracts would cause heavy losses, and that is not bad faith. It was not even suggested that the directors acted for personal reasons or to pocket money. The losses came from the typhoons, which also hit private traders, and the Court agreed with the trial court that this was damnum absque injuria, damage without a legal wrong. The Court found Kalaw clear of bad faith, and held that the good faith of Kalaw and the other directors decided the case. (The quotations follow the official Philippine Reports, 127 Phil. 399, 425. The LawPhil transcription reads “the coming of unpredictable typhoons”; the official report has no “of.”)
“Of course, Kalaw could not have been an insurer of profits. He could not be expected to predict the coming unpredictable typhoons.”
Doctrine
Bad faith is not the same as a bad business decision. Adopting the words of a U.S. court (Spiegel vs. Beacon Participations, 8 N.E. (2d) 895, 907), the Court said that “bad faith does not simply connote bad judgment or negligence; it imports a dishonest purpose or some moral obliquity and conscious doing of wrong; it means breach of a known duty thru some motive or interest or ill will; it partakes of the nature of fraud.” A board that approves a contract in good faith, knowing it will lose money, does not act in bad faith.
Compare: liable
In Virata vs. Ng Wee, G.R. Nos. 220926, 221058, 221109, 221135 and 221218, July 5, 2017, the directors of an investment house who ignored obvious warning signs were held liable: “Neither can the business judgment rule apply herein for it is elementary in corporation law that the doctrine admits of exceptions: bad faith being one of them, gross negligence, another.”
Bar tip
A loss is not proof of bad faith. Directors who approve a contract in good faith, even knowing it will lose money, are not personally liable. Look for a dishonest purpose, a personal interest or ill will.
Hear it explained
Business Judgment Rule, Podcast Ep. 6, at 3:34
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This digest is general legal information for education, not legal advice, and it is not a substitute for reading the decision. Quoted passages are taken word for word from the full text.