Right of first refusal and transfer of property to a corporation

A right of first refusal is a contractual right typically granted by the owner of an asset or property, allowing the recipient to match or decline an offer to purchase the asset or property after other offers have been made.

The Right of First Refusal may be found in the Articles of Incorporation and By-Laws of Corporations binding shareholders to the condition that should they decide to sell their shares they must allow the other non-selling shareholders the right or option to purchase their shares of stock. Some condominium corporation projects also contain this provision where existing owners must offer their units to other unit owners before selling to third parties.

At times, it can also be found in Contracts of Lease where the Lessee is given the right to purchase the property by matching other offers to buy the property from the Lessor-Owner.

When a lease contract contains a right of first refusal, the lessor is under a legal duty to the lessee not to sell to anybody until after he has made an offer to sell to the latter under the same terms and the lessee has chosen not to avail of the right to purchase the property.

A party to a contract cannot unilaterally withdraw a right of first refusal that stands upon valuable consideration. The grant of a right of first refusal that is contained in a contract of lease is deemed founded on a consideration as it forms part of the entire lease contract and is part of the consideration for the lease. (Osmena III v. PSLAM, et al., GR 212686, September 28, 2015)

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In Delpher Trades Corporation, et al. v Hydro Pipes Philippines, Inc., (GR L-69359, January 26, 1988) such a Right of First Refusal was included in a contract of lease for a parcel of land and this is what led to the dispute between the landowner-lessor and its lessee. Here the lessee sought to exercise the Right of First Refusal to purchase the leased property after discovering that the owner transferred the leased property to their family corporation.

Delfin Pacheco and his sister Pelagia Pacheco were the owners of a 27,169 square meter property in Bulacan which they leased to Hydro Pipes Philippines, Inc. (Hydro). The contract of lease provided that should the owner-lessors decide to sell the property, during and after the term of the lease, they shall first offer to sell it to the lessee who shall have the priority to buy the property under the same conditions of sale.

During the lease period, Delfin and Pelagia formed a corporation, Delpher Trades Corporation (Delpher) and they transferred the leased property to Delpher by executing a deed of exchange in favor of Delpher conveying the property in Bulacan and another property in Valenzuela to the corporation in exchange for 2,500 shares of stock in the corporation valued at PhP1.5 million. The other members of the Pacheco family owned the remaining 2,000 shares of stock in Delpher representing 45% of the capital stock of the company.

Upon discovering that the property they were leasing had been transferred to Delpher at a rate of PhP14 per square meter—significantly lower than the market value of PhP300 per square meter—Hydro, the lessee, filed a complaint with the Court. They sought to enforce their Right of First Refusal as stipulated in the Contract of Lease, nullify the transfer of the property to Delpher, and requested permission to purchase the Bulacan property at the same rate of PhP14 per square meter.

The trial court and appeals court ruled in favor of the Hydro and ordered the lessor landowner to sell the property to HYDRO for php14 per square meter.

The Supreme Court reversed this decision on the following grounds.

1. Delfin and Pelagia received no-par value shares for the property and, as such, continued to own an aliquot part (a part of the whole) of the assets of the corporation.

The Supreme Court noted that it was significant that Delfin and Pelagia received no-par value shares in Delpher in exchange for their properties. It explained that no-par value shares do not purport to represent any stated proportionate interest in the capital stock measured by value, but only a part of the whole number of such shares of the corporation. Moreover, because the shares were no-par, there was no attempt to state the true or current market value of the real estate transferred to the corporation.

2. Delfin and Pelagia owned 2,500 no-par shares of stock representing 55% of the equity capital of Delpher while the remaining 45% belonged to the same family group, the Pachecos.

3. Delpher was considered as a business conduit of the Pachecos and what they really did was to invest their properties and change the nature of their ownership from unincorporated to incorporated form by organizing Delpher to take control of their properties and at the same time save on inheritance taxes.

4. The Court declared that there is nothing wrong or objectionable about “estate planning” scheme resorted to by the Pachecos.

In sum, the Supreme Court declared that “Deed of Exchange” of property among Delfin, Pelagai and Delpher was not considered as a contract of sale. There was no transfer of actual ownership interests by the Pachecos to a third party and they merely changed their ownership from one form to another. The ownership remained in the same hands.

Based on the foregoing, the Supreme Court ruled that Hydro did not have any basis for its claim to be entitled to purchase the property on the ground of the Right of First Refusal contained in the contract of lease.

Before ending, it is noteworthy to point out some questions that may arise. Would the Supreme Court have ruled in the same way if Delpher’s shares of stock were par value shares instead of no-par value shares ?

Moreover, would Hydro be able to validly claim and enforce its Right of First Refusal if in the future, Delpher sells the property to third parties or if Delfin and Pelagia were to lose controlling interest in the family corporation, Delpher.

(The author, Atty. John Philip C. Siao, is a practicing lawyer and founding Partner of Tiongco Siao Bello & Associates Law Offices, an Arbitrator of the Construction Industry Arbitration Commission of the Philippines, and teaches law at the De La Salle University Tañada-Diokno School of Law. He may be contacted at [email protected]. The views expressed in this article belong to the author alone.)