Introduction

In the dynamic landscape of Philippine business, startups and small enterprises often face capital constraints, leading some to explore alternative compensation models such as offering equity to workers in lieu of or in addition to cash salaries. This practice, while common in tech hubs globally, raises significant legal questions when the company is unregistered. An unregistered company typically refers to a business entity that has not complied with the formal registration requirements under Philippine law, such as those mandated by the Securities and Exchange Commission (SEC) for corporations or the Department of Trade and Industry (DTI) for sole proprietorships and partnerships. This article comprehensively examines the legal framework governing such arrangements, the inherent risks involved, and the pathways to labor compliance, drawing on relevant statutes, jurisprudence, and regulatory guidelines to provide a thorough analysis.

Understanding Equity Compensation in the Philippine Context

Equity compensation involves granting employees or workers an ownership interest in the company, such as shares of stock, stock options, or partnership interests, as part of their remuneration. In registered corporations, this is often structured through employee stock ownership plans (ESOPs) or similar mechanisms. However, in an unregistered company, the concept becomes nebulous because the entity may lack the legal personality to issue valid equity instruments.

Under Philippine law, businesses can operate in various forms:

Sole Proprietorships: Owned by one individual, registered with the DTI. Equity here would essentially mean transferring ownership, which is not typical for compensation.
Partnerships: Governed by the Civil Code (Articles 1767-1867), requiring registration with the SEC for limited partnerships but not always for general ones. Offering equity might involve admitting workers as partners.
Corporations: Must be registered with the SEC under the Revised Corporation Code (Republic Act No. 11232). Unregistered entities cannot legally issue shares.

Paying workers with equity in an unregistered setup blurs the line between employment and ownership, potentially transforming workers into co-owners without the protections afforded by formal structures.

Relevant Legal Framework

Labor Laws and Compensation Requirements

The Philippine Labor Code (Presidential Decree No. 442, as amended) is the cornerstone of employment relations. Article 82 defines "wages" as remuneration for services rendered, payable in legal tender or facilities that meet specific criteria. Equity does not qualify as wages under this definition because it is not immediately convertible to cash and its value is speculative.

Minimum Wage and Benefits: Republic Act No. 6727 (Wage Rationalization Act) and regional wage orders mandate cash payments for minimum wages. Substituting equity for cash could violate these, exposing employers to backpay claims and penalties under Article 279 (security of tenure).
Non-Diminution of Benefits: Article 100 prohibits reducing existing benefits. If equity is offered as a supplement, it must not undermine statutory entitlements like 13th-month pay (Presidential Decree No. 851) or social security contributions (Republic Act No. 11199, Social Security Act of 2018).
Contractual Agreements: Employment contracts must comply with Article 1305 of the Civil Code, ensuring they are not contrary to law, morals, or public policy. Equity grants in unregistered companies may be deemed invalid if they circumvent labor protections.

Securities and Corporate Laws

The Securities Regulation Code (Republic Act No. 8799) regulates the issuance of securities, defined broadly to include shares, options, or investment contracts. Offering equity to workers could be seen as a securities offering, requiring SEC registration unless exempted.

Exemptions: Section 10 provides exemptions for issuances to fewer than 20 persons or to qualified buyers, but unregistered companies cannot avail of these as they lack corporate status.
Revised Corporation Code: Section 12 requires SEC registration for corporations to acquire juridical personality. An unregistered "company" operates as a de facto partnership or sole proprietorship, where equity issuance might trigger unintended tax or liability consequences.
Anti-Fraud Provisions: Even without registration, misrepresentations in equity offers could violate Section 26 of the SRC, leading to civil and criminal liabilities.

Tax Implications

The National Internal Revenue Code (Republic Act No. 8424, as amended) treats equity compensation as taxable income under Section 32(A). Workers receiving equity must report its fair market value as compensation income, subject to withholding tax (BIR Revenue Regulations No. 2-98).

For unregistered companies, failure to withhold and remit taxes could result in assessments, penalties, and interest under Section 248.
Equity grants may also attract documentary stamp tax (Section 174) if formalized in documents.

Other Regulatory Considerations

Intellectual Property: If workers contribute to IP, equity might complicate ownership under Republic Act No. 8293 (Intellectual Property Code).
Foreign Workers: Additional layers apply under the Alien Employment Permit system (Department of Labor and Employment Order No. 186-17).
Data Privacy: Equity arrangements involving personal data must comply with Republic Act No. 10173 (Data Privacy Act).

Legal Risks Associated with Equity Payments in Unregistered Companies

Risks to the Employer/Company

Invalidity of Equity Grants: Without registration, equity may be legally void. Workers could challenge the arrangement in court, claiming it as disguised wages, leading to orders for cash payment plus damages (e.g., Supreme Court case Azucena v. Potenciano, G.R. No. 140092).
Labor Disputes and Penalties: Violations of the Labor Code could result in complaints before the National Labor Relations Commission (NLRC). Penalties include fines up to PHP 100,000 per violation (DOLE Department Order No. 183-17) and potential criminal charges for willful non-payment of wages.
Securities Violations: Unauthorized issuance of equity could prompt SEC investigations, with fines ranging from PHP 50,000 to PHP 5,000,000 (SRC Section 54) and imprisonment up to 21 years.
Tax Liabilities: The Bureau of Internal Revenue (BIR) may reclassify equity as loans or advances, imposing deficiency taxes, surcharges (25-50%), and interest (20% per annum).
Personal Liability: Owners of unregistered companies face unlimited personal liability as sole proprietors or general partners (Civil Code Article 1816), exposing personal assets to worker claims.
Reputational and Operational Risks: Such practices may deter talent, invite audits, or complicate future registration or funding rounds.

Risks to Workers

Uncertain Value and Liquidity: Equity in an unregistered company is illiquid and may become worthless if the business fails, leaving workers without compensation.
Loss of Labor Protections: Accepting equity might inadvertently classify workers as partners, forfeiting employee rights like overtime pay (Labor Code Article 87) or termination protections (Article 294).
Tax Burdens: Workers could face immediate taxation on equity's deemed value, even if unrealized, without employer withholding.
Enforcement Challenges: Proving equity entitlements in court is difficult without formal documentation, potentially leading to protracted litigation.
Fraud Exposure: Unscrupulous employers might use equity promises to exploit workers, violating anti-trafficking laws (Republic Act No. 9208, as amended).

Broader Systemic Risks

Widespread adoption could undermine labor standards, prompting regulatory crackdowns. In jurisprudence, cases like Millares v. NLRC (G.R. No. 122827) emphasize that compensation must be fair and compliant, rejecting creative evasions.

Ensuring Labor Compliance: Best Practices and Alternatives

To mitigate risks, businesses should prioritize registration:

Register the Entity: Incorporate with the SEC for corporations or register partnerships appropriately. This enables legitimate ESOPs under SEC Memorandum Circular No. 9-2014.
Structure Equity Properly: Use written agreements detailing vesting schedules, valuation methods (e.g., book value or appraisal), and buy-back options. Comply with SRC exemptions if applicable.
Combine with Cash: Ensure equity supplements, not replaces, minimum wages and benefits. Conduct fair market valuations for tax purposes.
Seek Professional Advice: Consult lawyers for contract drafting and accountants for tax planning. Obtain DOLE clearances if needed.
Alternatives to Equity: Consider profit-sharing (allowed under Labor Code Article 97) or performance bonuses, which are cash-based and compliant.
Documentation and Transparency: Maintain records of all compensation, including equity grants, to defend against disputes.
Regular Audits: Periodically review arrangements for compliance with evolving laws, such as amendments from the CREATE Act (Republic Act No. 11534) affecting taxes.

For unregistered companies intent on equity, transitioning to registered status is essential. Temporary measures like deferred compensation agreements might bridge the gap but carry risks.

Conclusion

Paying workers with equity in an unregistered company in the Philippines is fraught with legal perils, from labor code violations and securities infractions to tax pitfalls and personal liabilities. While innovative compensation can foster alignment and growth, it must not compromise worker rights or regulatory mandates. Businesses are advised to formalize their structures and seek expert guidance to navigate this complex terrain. Ultimately, compliance not only averts risks but also builds sustainable enterprises that contribute to the Philippine economy. Policymakers may consider reforms to accommodate startup realities, but until then, caution remains paramount.