THE SUPREME COURT OF THE
FEDERATED STATES OF MICRONESIA
Cite as Mid-Pac v. Senda,
4 FSM Intrm. 376 (Pohnpei 1990)

[4 FSM Intrm. 376]

MID-PAC CONSTRUCTION CO., INC.,
for Benefits of Creditors of Civil Action No. 1988-095,
Plaintiffs,

vs.

AMBROS T. SENDA,
Defendant.

CIVIL ACTION NO. 1988-099

OPINION

Before Edward C. King
Chief Justice
December 14, 1990

APPEARANCES:
For the Plaintiffs:        Daniel J. Berman
                                     Attorney-at-Law
                                     P.O. Box 1491
                                     Kolonia, Pohnpei  FM   96941

For the Defendant:     Maketo Robert
                                     Attorney-at-Law
                                     P.O. Box 979
                                      Kolonia, Pohnpei  FM   96941

[4 FSM Intrm. 377]

HEADNOTES
Constitutional Law - Interpretation; Corporations
     Power to regulate the incorporation and operation of corporations falls within the constitutional power of the national government to regulate foreign and interstate commerce.  Mid-Pac v. Senda, 4 FSM Intrm. 376, 380 (Pon. 1990).

Constitutional Law - Interpretation; Transition of Authority
     The Corporations, Partnership and Agency regulations were adopted pursuant to, and affect the reach of, the Trust Territory statute regulating corporations and, since those statutory provisions are part of FSM national law by virtue of the transition clause of the FSM Constitution, the regulations too must retain their effect until they are amended or repealed pursuant to FSM law.  Mid-Pac v. Senda, 4 FSM Intrm. 376, 381 (Pon. 1990).

Corporations; Separation of Powers
     The determination of whether stockholders and directors should be protected at the expense of the general public and the employees of the corporation is, at the bottom, a policy choice of the kind that legislatures are better equipped than courts to make.  Mid-Pac v. Senda, 4 FSM Intrm. 376, 385 (Pon. 1990).

Corporations - Liability
     The C.P.A. regulations mandate that corporate directors and incorporators will be held liable for the corporation's debts if the corporation engages in business without meeting the minimum capital requirements.  Mid-Pac v. Senda, 4 FSM Intrm. 376, 385 (Pon. 1990).

Corporations - Liability; Equity; Remedies
     The estoppel doctrine, which is applied when justice demands intervention on behalf of a person misled by the conduct of the person estopped, is not available as a defense to a board member of a corporation where the board member knowingly misled regulatory officials and creditors of the corporation.  Mid-Pac v. Senda, 4 FSM Intrm. 376, 385 (Pon. 1990).

Corporations - Liability; Equity; Remedies
     The de facto doctrine, which is employed by courts to treat a business as a corporation even though it has not met all legal requirements for incorporation, is of no relevance to the regulatory prohibition against the corporation engaging in business until the corporation meets minimum capital requirements.  Mid-Pac v. Senda, 4 FSM Intrm. 376, 385 (Pon. 1990).

*    *    *    *

COURT'S OPINION
EDWARD C. KING, Chief Justice:
     This case requires a determination as to the rights of creditors of a corporation against an incorporator and director of the corporation which was

[4 FSM Intrm. 378]

originally organized under the laws of the Trust Territory of the Pacific Islands and has engaged in business as a corporation, first under the laws of the Trust Territory and now under the national laws of the Federated States of Micronesia, without fulfilling the conditions specified by law to permit a corporation to engage in business.

I.  Factual Background
     Plaintiffs, all of whom are judgment creditors in Civil Action No. 1988-099 against Mid-Pac Construction Co., Inc., an insolvent corporation, have brought this action against Ambros T. Senda, who was listed in publicly filed documents as one of the incorporators and directors of Mid-Pac when it was incorporated under the laws of the Trust Territory of the Pacific Islands in 1978.

     The evidence establishes that Mid-Pac initiated its business operations without paying in the required capital, and without the stock subscriptions, specified as conditions which must be fulfilled before a corporation may engage in business.

     The creditors also assert, and Mr. Senda concedes, that on November 14, 1978, under oath, he knowingly signed a false stock affidavit as the Secretary and Treasurer of Mid-Pac.  This affidavit, which falsely stated that the conditions for engaging in business as a corporation had been met by Mid-Pac, was filed with the Trust Territory Registrar of Corporations in order to obtain a corporate charter for Mid-Pac.

     Plaintiffs now contend that because Mid-Pac never met the requirements for doing business as a corporation, Mr. Senda, as an incorporator and director, is jointly liable for Mid-Pac's debts.  In the current context of the Federated States of Micronesia, this seems an extremely harsh penalty to impose on incorporators and directors of a defectively organized corporation.  Therefore the Court has carefully considered whether such a severe result is mandated by the law. However, for the reasons set forth in this opinion, the Court has concluded that no lesser alternative is available and that Mr. Senda must be held jointly liable, along with Mid-Pac, for all of Mid-Pac's unpaid debts.

II.  Legal Analysis
A.  General Principles
     As a general proposition, business activities are treated merely as an extension of the person engaging in them.  In the eyes of the law, and normally as a practical matter, no distinction is made between the money of the business and that of its owner.  Both are solely the property of the owner, to be done with as the owner pleases.  If the business activities are profitable, the proprietor thrives and becomes wealthy.

     The converse is also true.  As owner of all the property and cash of the business, the proprietor is personally liable for all of its debts.  If the

[4 FSM Intrm. 379]

business activities prove to be unprofitable the loss is a personal one to the proprietor and extends to the entire loss sustained by the business operations. Even after the business is terminated the former owners remain personally liable for all unpaid debts of the business.  This is true regardless of whether the owner is a sole proprietor, or whether several persons have pooled their funds and have engaged in business as a partnership.

     Some very capable people who might otherwise wish to enter into business activities may be discouraged from doing so by such unlimited financial risk.1 The Federated States of Micronesia, like many other nations, has recognized that encouragement of investment and business activities is in the national interest. This recognition has led the Federated States of Micronesia, as well as most other nations, to authorize legal structures whereby investors may pool their funds and limit the amount each will put at risk to engage in the particular business venture.

     Of course, if entrepreneurs were permitted to insulate themselves from all risk by conducting business activities through a separate entity without committing any funds at all to the enterprise, the result could be harmful to the climate for economic development.  The entrepreneur could lay claim to any profits that might be generated while throwing the risk of loss onto employees of the company, those who provide loans or supply credit, and any other persons who rely in any way upon future payments or performance by the business.  Many prudent people might refuse to work for, or do business with, such a separate entity.

     Thus, use of an insulated business entity typically is regulated by law with some care.  In exchange for giving entrepreneurs the opportunity to engage in business while limiting their investment and risk, governments normally impose by law various conditions designed to protect those who might enter into a financial or business relationship with the insulated business entity.

     The principal form of insulated business entity authorized by law in most nations is the corporation.  The legal requirements imposed upon corporations typically are intended to assure that at least a minimum amount of capital is paid in and committed to the enterprise before the corporation may begin doing business.  In addition, most, if not all, jurisdictions require that the organizers, or incorporators, of the corporation, file with regulatory officials some basic information about the corporation.  Potential creditors and the public in general then have access to this basic information concerning the corporation's financial structure and other characteristics for use in determining whether to transact business with the corporation.

[4 FSM Intrm. 380]

B.  Corporations in the FSM - Preliminary Issues
     The national statutory and regulatory scheme of the Federated States of Micronesia is in many ways typical of the general pattern that has already been described.  Yet, several significant aspects call for preliminary consideration before we proceed to the specifics of this case.

     First, in contrast with the regulatory scheme for corporations in the United States, the incorporation of Mid-Pac and most other currently existing corporations within the Federated States of Micronesia has been authorized by a statute administered by national, rather than state, officials.  The Court has considered the possibility that the United States practice, whereby states control the regulation of corporations, is constitutionally required in the Federated States of Micronesia, so that the regulations being relied upon in this case would be outside the powers available to the national government.  However, it seems clear that the power to regulate incorporation and operation of corporations reasonably may be seen as falling within the constitutional power of the national government to regulate foreign and interstate commerce.  FSM Const. art. IX, 2(g).2
 
     Another unusual aspect of the national law concerning corporations within the Federated States of Micronesia is the brevity and lack of detail in the statute,3 and the substantial reliance upon administrative regulations.  This is in contrast to most jurisdictions where the provisions concerning incorporation and regulation of corporations are almost exclusively statutory.  However no party raises any question as to the propriety of this primarily regulatory scheme and the Court perceives no reason why the government may be precluded from regulating corporations primarily pursuant to administrative regulations rather than by statute.

     As a final "preliminary" matter, the Court has also considered whether the

[4 FSM Intrm. 381]

regulations at the time of Mid-Pac's incorporation had been properly adopted, and whether they may still be applied to Mid-Pac up to the present time.

     The regulations covering corporations, partnerships and associations, now part of the Federated States of Micronesia regulations, were originally adopted by the Trust Territory Registrar of Corporations, and approved by the Attorney General and High Commissioner of the Trust Territory of the Pacific Islands. They became effective on July 15, 1974.  See I FSM Regs. 5, Corporations, Partnerships, and Associations (hereafter C.P.A. Regs).  The Trust Territory Code gave the Trust Territory Registrar of Corporations power, upon approval of the Attorney General, to prescribe "such rules and regulations as are deemed advisable to administer and carry into effect the provisions" of Title 37 of the Code.  37 TTC 52 (1980). Nobody contends, nor is there any reason to believe, that promulgation of these regulations was beyond the rulemaking powers of the Trust Territory officials who adopted them.

     The remaining preliminary question is whether the regulations became part of the body of the Federated States of Micronesia law along with their accompanying statute when the FSM came into existence.

     The Constitution's transition clause says, "A statute of the Trust Territory of the Pacific Islands continues in effect except to the extent that it is inconsistent with this Constitution or is amended, or repealed."  FSM Const. art. XV, 1.  The Constitutional Convention's Committee on General Provisions proposed the clause as "necessary in order to provide a smooth and orderly transition from the old to the new."  SCREP No. 28, II J. of Micro. Con. Con. 808.  The purpose, "to provide continued validity of existing laws," derives from the underlying principle that "a new Constitution ought to bring with it no greater changes than are necessary to effectuate its terms."  SCREP No. 28, supra, at 808.  This Court has read the clause as calling for interpretations which will avoid "gaps in the law" and "unanticipated results."  FSM v. Oliver, 3 FSM Intrm. 469, 477 n.9 (Pon. 1988).

     In this vein, the Court has held that the transition clause requires that a Trust Territory statute with an established meaning when the FSM Constitution went into effect be given the same breadth now until it is amended or repealed.  Oliver, 3 FSM Intrm. at 478.

     Applying these principles, it is apparent that regulations, adopted pursuant to, and affecting the reach of, a statute which is part of FSM national law by virtue of the transition clause, must retain their previous effect until the regulations are amended or repealed pursuant to FSM law.  Any other conclusion would be contrary to the underlying principle and goals of the transition clause, producing unnecessary gaps in the law and unanticipated results.

     The Court therefore concludes that the C.P.A. Regs remain in effect today

[4 FSM Intrm. 382]

as part of the law of the Federated States of Micronesia.4
 
C.  Application to Mid-Pac
     Having concluded that the C.P.A. Regs were in effect when Mid-Pac was incorporated and remain effective today, we now proceed to consider the impact of those regulations upon the rights of the parties in this litigation.

     The first sentence of part 2.7 of the C.P.A. Regs establishes certain capital requirements which must be met before a corporation may engage in business:

     Capital Necessary to Engage in Business; Liability of Directors:  No corporation for profit shall upon the incorporation thereof  engage in business in the Territory until three-fourths of its authorized capital stock has been subscribed for nor until ten percent of its authorized capital stock has been paid in by the acquisition of cash or by the acquisition of property of a value equal to ten percent of the authorized capital stock nor until the affidavit or affidavits required by subpart 2.5 of chapter 1, have been filed, provided that in no case shall any corporation for profit upon the incorporation thereof engage in business in the Territory until not less than $1,000 of its authorized capital stock has been paid in by the acquisition of cash or by the acquisition of property of a net value of not less than $1,000.

[4 FSM Intrm. 383]

     Thus, of the corporation's authorized capital stock, at least three-fourths must be subscribed and at least ten percent paid in, before the corporation may engage in business.

     As already noted, minimum capital requirements are designed primarily to protect those who might do business with the corporation.  It follows that potential creditors should be provided with some method of verifying that the minimum capital requirements have been met.  In the Federated States of Micronesia, the primary method is to assure public access to this and other key information about the corporation through a requirement that an affidavit, containing specified information and signed by the president, secretary and treasurer of the corporation, be filed with the Registrar of Corporations.  C.P.A. Regs, pt. 2.5. These minimums must be met, and the affidavit filed, before the corporation may engage in business.  Id. pt. 2.7.

     An affidavit was signed and acknowledged under oath by Herman P. Semes, as President, and Mr. Senda, as Secretary and Treasurer of Mid-Pac.  The affidavit represented that there had been full compliance with the part 2.7 requirements shown above.  Herman P. Semes, Hatler Gallen, and Ambros T. Senda were each said to have subscribed to 25,000 shares of the corporation's 100,000 authorized shares of $1 par value stock.  According to the affidavit, each had agreed to pay a subscription price of $1 per share.  It appeared then that the corporation had met the requirement that three-fourths of the authorized stock must be subscribed.

     Mid-Pac's minimum paid-in capital requirement of $10,000, that is, ten percent of its authorized capital of $100,000, was certified as having been met by payments of $5,100 each by Herman P. Semes and Hatler Gallen and of $1,000 by Ambros Senda.

     This stock affidavit was filed with the Trust Territory Registrar of Corporations on November 20, 1978.  The corporate charter therefore was issued on that day. It now has been established that all of the statements in the stock affidavit were false.

     This lawsuit originally was initiated by the Mid-Pac creditors to require Mr. Senda to pay the $25,000 subscription price for the shares referred to in the stock affidavit.  In response, he asserted that he in fact never did subscribe for any shares of the corporation stock and never did pay any amount of money into the company, but had merely signed the affidavit as an accommodation to his cousins, Herman Semes and Hatler Gallen.  Thereupon, the Mid-Pac creditors amended their complaint to assert that Mid-Pac had engaged in business in violation of the C.P.A. Regs and that Mr. Senda, as a director and incorporator of Mid-Pac, is jointly liable for the Mid-Pac debts.
 
     The case proceeded to trial under that theory.  Based upon the evidence adduced, it appears that no amount at all had been paid in before Mid-Pac began its business operations and that none of the organizers had committed themselves to buy any Mid-Pac stock.  Mid-Pac's business operations have now led to the company's insolvency.  Substantial judgments awarded to creditors

[4 FSM Intrm. 384]

of Mid-Pac remain unpaid.

     The Court finds that Mid-Pac Construction Co. did engage in business: (1) before three-fourths of its authorized capital stock had been subscribed; (2) before ten percent of its authorized capital stock had been paid in;  (3) before $1,000.00 of its capital stock had been paid in; (4) and without filing an affidavit which complied with subpart 2.5 of the C.P.A. Regs.  Each failure was a violation of part 2.7 of the regulations.

     The regulations leave no apparent discretion in the Court as to the effect of these violations.  The second and final sentence of part 2.7 says:

     In case of any violation of this section by any corporation, the incorporators and the directors thereof at the time the corporation commences to engage in business shall in their individual and private capacities be jointly and severally liable to the corporation and the stockholders and creditors thereof in the event of its bankruptcy or insolvency or in the event of its dissolution for any loss suffered by the corporation or its stockholders or creditors.

C.P.A. Regs., pt. 2.7.

     The corporation's charter lists Mr. Senda as an incorporator and a director of the company when Mid-Pac commenced its business operations.  Thus, the requirements of part 2.7 of the regulations are fully met.  The regulations mandate that the defendant be held "jointly and severally" liable to the creditors of Mid-Pac.

     Despite the clarity of this language, the Court has considered whether any diminution of Mr. Senda's liability might be permissible.

     In particular, the Court notes the view of the Pohnpei Supreme Court that it would be "premature and non-productive" to rely upon commingling of corporate and personal assets by corporate officials and stockholders as a ground for holding those persons liable for the debts of their corporation.
 
Koike v. Ponape Rock Products, Inc., 3 FSM Intrm. 57, 70 (Pon. S. Ct. Tr. 1986).

     The Koike court felt that protection of such persons against liability for corporate debts is appropriate in Pohnpei because "knowledge of business law is lacking" here and it is "the custom of property holdings in Pohnpei" for "family incorporated enterprises" to "intermingle the family's personal affairs with its incorporated business affairs."  Id.

     That holding of the Pohnpei Supreme Court in Koike seems quite reasonable in the context of that tort case.  However, we must remember that the question of liability for corporate debts is a two-edged machete.  To the extent we decide to protect stockholders and directors against corporate

[4 FSM Intrm. 385]

liabilities, we expose the general public, and especially employees and creditors of the corporation, to greater risk of loss.

     The determination of which persons to protect, stockholders and directors or the general public, is at the bottom a policy choice of the kind that legislatures are better equipped than courts to make.  See In re Cantero, 3 FSM Intrm. 481, 484 (Pon. 1988); Semens v. Continental Airlines, Inc. (II), 2 FSM Intrm. 200, 207 (Pon. 1986).

     In the case of a failure to meet minimum capital requirements, the policy determination has been made by regulatory officials and the Court is deprived of discretion.  In this context, the regulations mandate protection for creditors, not corporate directors and incorporators, and the reasoning of the court in Koike is foreclosed to this Court.

     Courts in other jurisdictions also have occasionally been reluctant to impose liability upon organizers for inadvertent or good faith failure to comply fully with the conditions precedent to organization of a corporation.  One doctrine employed to avoid excessively harsh results has been estoppel.  Under this doctrine, persons who have recognized the corporate existence of a business association by dealing with it as a corporation may be prevented from denying the legality of its incorporation.

     The other court-established doctrine which has been employed to soften the blow of ineffective incorporation is the de facto doctrine.  This may apply where there are: (1) the existence of a law authorizing incorporations; (2) an effort in good faith to incorporate under the existing law; and (3) actual exercise of corporate powers.  Mr. Senda asks that this de facto doctrine be applied in this case.

     Neither the de facto doctrine nor estoppel is applicable to the facts here before the Court.  The de facto doctrine is employed by courts to treat a business as a corporation even though it has not met all legal requirements for incorporation.  In this case, Mid-Pac received its charter and indisputably was a corporation.  The de facto doctrine is of no relevance to the regulatory prohibition against the corporation engaging in business until the corporation meets minimum capital requirements.

     Estoppel is applied when justice demands intervention on behalf of a person misled by the conduct of the person estopped.  Etpison v. Perman, 1 FSM Intrm. 405, 417 (Pon. 1984).  However, the doctrine may be used only to assist a person who has acted in good faith and who is favored by the equities.  One may sympathize with Mr. Senda's wish to accommodate the request of his cousins. This however does not erase the fact that he knowingly signed a false stock affidavit in order to mislead regulatory officials and creditors of Mid-Pac.  This is not good faith conduct and the estoppel doctrine is unavailable.

     Finally, and dispositively, the clear language of part 2.7 of the regulations prevents the exercise of judicial discretion and prohibits the

[4 FSM Intrm. 386]

Court from applying any of the softening or saving doctrines explored in this opinion.

III.  Conclusion
     Cases previously decided by this Court have established the long-standing insolvency of Mid-Pac Construction Co. as a result of its business activities. Previous judgments of this Court have held Mid-Pac Construction Co. liable to various creditors in an aggregate amount of $222,073.36.  A judgment shall be issued declaring that the defendant, Ambros T. Senda, is jointly and severally liable under those judgments.

     SO ORDERED the 14th day of December 1990.

*    *    *    *
 
Footnotes:
 
1.  The risk that unsuccessful business persons may be exposed to financial ruin is particularly great in the Federated States of Micronesia, since there is no bankruptcy law here.  An overwhelmed debtor may not obtain a general discharge of liabilities through bankruptcy proceedings, but may look for protection only to laws providing personal exemptions from attachment and execution.  6 F.S.M.C. 1415.
 
2.  This is not to suggest that it would be unconstitutional for the states to exercise such regulatory power over corporations.  There has been no effort by the national Congress to preempt this field.  Indeed, national legislation now specifically permits a State to establish its own process of incorporation and authorizes the President, upon application by a state, to "transfer the function of incorporation to the State for any corporate matter not within the exclusive authority of the National Government."  36 F.S.M.C. 206 (1987 Supp.).
 
3.  Most of the statutory provisions concerning corporations, partnerships and associations, now set out in Title 36 of the FSM Code, are drawn directly from the former Trust Territory Code.  Compare 36 F.S.M.C. 101-206 with 37 TTC 1-54 (1980).  Upon initiation of constitutional self-government by the Federated States of Micronesia in 1979, the former Trust Territory provisions became law of the Federated States of Micronesia pursuant to the transition clause of the Constitution.  FSM Const. art. XV, 1; see also FSM v. Oliver, 3 FSM Intrm. 469 (Pon. 1988).  Soon thereafter a few changes in style and nomenclature were made by the FSM Congress, Pub. L. No. 1-135 (1st Cong. 4th Reg. Sess. 1980), but the basic statutory and regulatory scheme remains almost identical with that established by Trust Territory officials.
 
4.  "The case before us must be considered in the light of our whole experience and not merely in that of what was said [fifteen] years ago."  paraphrasing Missouri v. Holland, 252 U.S. 416, 40 S. Ct. 382, 64 L. Ed. 641 (1920)(Holmes, J.).  Since the transition clause was intended to "provide a smooth and orderly transition from the old to the new", SCREP No. 28 at 808, and to protect the new governments against gaps in the law and unanticipated results, it is quite pertinent that those assigned responsibility within the national government for implementing the law have assumed the continued viability of Trust Territory regulations which have not been amended or repealed by affirmative action of the FSM Congress or administrative authorities.
 
      For example, the C.P.A. Regs have been reproduced and included in a loose-leaf binder distributed by the Office of the FSM Attorney General as regulations of the Federated States of Micronesia.  The binder also includes, immediately after the C.P.A. Regs, a memo issued by President Tosiwo Nakayama, dated January 5, 1987, delegating various powers under these regulations to the Secretary of Resources and Development.
 
      See also FSM Att'y Gen. Op. 1980-9, concluding that the Trust Territory regulations pertaining to taxation and finance remain in effect and binding upon the FSM Director of Finance until such time as they might be amended or repealed.