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INTRODUCTION

MEANING AND SCOPE OF CREDIT TRANSACTIONS

Credit transactions include all transactions involving the purchase or loan of goods, services, or
money in the present with a promise to pay or deliver in the future.

TWO TYPES OF CREDIT TRANSACTIONS/ CONTRACTS OF SECURITY

1. Secured transactions or contracts of real security – supported by a collateral or an


encumbrance of property

2. Unsecured transactions or contracts of personal security – fulfillment by the debtor is


supported only by a promise to pay or the personal commitment of another

EXAMPLES OF CREDIT TRANSACTIONS

1. Bailment contracts
2. Contracts of guaranty and suretyship
3. Mortgage
4. Antichresis
5. Concurrence and preference of credits

MEANING OF SECURITY

Security (def). Something given, deposited, or serving as a means to ensure the fulfillment or
enforcement of an obligation or of protecting some interest in property.

KINDS OF SECURITY

1. Personal Security - when an individual becomes a surety or a guarantor

2. Property or Real Security – when a mortgage, pledge, antichresis, charge, or lien or


other device used to have property held, out of which the person to be made secure can be
compensated for loss.

BAILMENT

Bailment (def). The delivery of property of one person to another in trust for a specific purpose,
with a contract, that the trust shall be faithfully executed and the property returned or duly accounted
for when the special purpose is accomplished or kept until the bailor reclaims it.

To be legally enforceable, a bailment must contain all the elements of a valid contract, which are
consent, object, and cause or consideration. However, a bailment may also be created by operation
of law.

PARTIES IN BAILMENT

1. Bailor – the giver; the one who delivers the possession of the thing bailed
2. Bailee – the recipient; the one who receives the possession or custody of the thing delivered

KINDS OF BAILMENT

1. For the sole benefit of the bailor


Examples: gratuitous deposit and mandatum (bailment of goods where the bailee gratuitously
undertakes to do some act with respect to the property)

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Ex. My tito from the States makes padala a balikbayan box filled with spam through another
relative who’s flying to the Philippines on vacation. It only benefits my tito (the bailor). Or,
Helen deposits Polsci’s baby chair with the mysterious little guy who doesn’t smile in the bag
depository counter outside the lib. In this case, only Helen benefits (based on a true story).

2. For the sole benefit of the bailee


Examples: commodatum and gratuitous simple loan or mutuum
Ex. Xilca borrows my white blouse because she forgot to bring clothes to change from her
Pasay City Jail outfit. Only Xilca is benefited, not me. Or, Xilca borrows P10 from me without
interest.

3. For the benefit of both parties


Examples: deposit for a compensation, involuntary deposit, pledge, bailments for hire
Ex. Ansky pawns her huge diamond earrings at Villarica Pawnshop. The pawnshop gives
her P10,000 and a pawn ticket. Both parties benefit – Ansky gets fast cash, while the
pawnshop gets to keep the huge diamond earrings to make sure that Ansky pays, and in case
she doesn’t they can sell the earrings.

1 and 2 are gratuitous bailments. There is no consideration because they are considered more
as a favor by one party to the other. Bailments under number 3 are mutual-benefit bailments,
and they usually result from business transactions.

BAILMENT FOR HIRE

Bailment for hire arises when goods are left with the bailee for some use or service by him
always for some compensation.

KINDS OF BAILMENT FOR HIRE

1. Hire of things – goods are delivered for the temporary use of the hirer
2. Hire of service – goods are delivered for some work or labor upon it by the bailee
3. Hire for carriage of goods – goods are delivered either to a common carrier or to a private
person for the purpose of being carried from place to place
4. Hire of custody – goods are delivered for storage

I. LOAN

GENERAL PROVISIONS

Art. 1933. By the contract of loan, one of the parties delivers to another, either something not
consumable so that the latter may use the same for a certain time and return it, in which case the
contract is called a commodatum; or money or other consumable thing, upon condition that the
same amount of the same kind and quality shall be paid, in which case the contract is simply called
a loan or mutuum.

Commodatum is essentially gratuitous.

Simple loan may be gratuitous or with a stipulation to pay interest.

In commodatum the bailor retains the ownership of the thing loaned, while in simple loan, ownership
passes to the borrower.

Art. 1934. An accepted promise to deliver something by way of commodatum or simple loan is
binding upon the parties, but the commodatum or simple loan itself shall not be perfected until the
delivery of the object of the contract.

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ESSENTIAL ELEMENTS OF A CONTRACT IN THE CONTEXT OF A LOAN
Consent of the parties Borrower and Lender
Object Property
Cause or Consideration For the lender: right to demand the return of the
thing

For the borrower: acquisition of the thing

CHARACTERISTICS OF THE CONTRACT OF LOAN

1. A real contract – the delivery of the thing loaned is necessary for the perfection of the
contract

2. A unilateral contract – once the subject matter has been delivered, it creates obligations on
the part of only one of the parties (the borrower)

CAUSE OR CONSIDERATION IN A CONTRACT OF LOAN

1. As to the borrower: the acquisition of the thing


2. As to the lender: the right to demand its return or of its equivalent

KINDS OF LOAN

1. Commodatum – where the lender delivers to the borrower a non-consumable thing so that
the latter may use it for a certain time and return the identical thing

2. Simple loan or mutuum – where the lender delivers to the borrower money or other
consumable thing upon the condition that the latter shall pay the same amount of the
same kind and quality.

LOANS DISTINGUISHED FROM CREDIT

Credit means the ability of an individual to borrow money or things by virtue of the confidence or
trust reposed by a lender that he will pay what he may promise within a specified period.

Loan means the delivery by one party and the receipt by the other party of a given sum of
money or other consumable thing upon an agreement to repay the same amount of the same kind
and quality, with or without interest.

Õ The concession of a credit necessarily involves the granting of loans up to the limit of the amount
fixed in the credit.

As opposed to debt, credit is a debt considered from the creditor’s standpoint. It is that which is due
to any person.

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DISTINCTIONS BETWEEN COMMODATUM AND SIMPLE LOAN

COMMODATUM SIMPLE LOAN


SUBJECT MATTER Not consumable Money or other consumable
thing
OWNERSHIP Retained by the lender Transferred to the borrower
GRATUITOUS? Gratuitous Default rule is that it is
gratuitous BUT the parties may
stipulate interest, in which case,
it becomes onerous
PAYMENT BY BORROWER Borrower must return the same Borrower need only pay the
thing loaned same amt of the same kind and
quality
KIND OF PROPERTY Real or personal Personal only
PURPOSE Temporary use or possession Consumption
WHEN LENDER MAY DEMAND Lender may demand return of Lender may not demand return
the thing before the expiration of the thing before the lapse of
of the term in case of urgent the term agreed upon
need
LOSS OF THE THING Suffered by the lender (since he Suffered by the borrower even if
is the owner) through fortuitous event

Õ In commodatum, if you do not return the thing when it is due, you will be liable for estafa because
ownership of the property is not transferred to the borrower.

Õ In loan, the borrower who does not pay is not criminally liable for estafa. His liability is only a civil
liability for the breach of the obligation to pay. This is because in loan, ownership of the thing is
transferred to the borrower, so there is no unlawful taking of property belonging to another.

ACCEPTED PROMISE TO MAKE A FUTURE LOAN

Borrower goes to Lender and asks if he could borrow P10K at 6% interest per annum. Lender says
okay, I will lend you the money. This is an accepted promise to make a future loan. It is a
consensual contract and is binding upon the parties.

But is there a contract of loan at this point? No, because loan is a real contract and is perfected only
upon delivery of the thing.

FORM OF LOAN

There are no formal requisites for the validity of a contract of loan except if there is a stipulation for
the payment of interest. A stipulation for the payment of interest must be in writing.

CHAPTER 1 COMMODATUM

Art. 1935. The bailee in commodatum acquires the use of the thing loaned but not its fruits; if any
compensation is to be paid by him who acquires the use, the contract ceases to be a commodatum.

KINDS OF COMMODATUM

1. Ordinary commodatum
2. Precarium – one whereby the bailor may demand the thing loaned at will

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NATURE OF COMMODATUM

ÕCommodatum in simple terms is hiram – A agrees to lend his guard dog to his friend B for a week
for free. B is entitled to use the dog for this period. At the end of the week, B must return the dog to
A. If the dog gives birth while it is in the custody of B, the puppies (fruits) belong to A.

1. The bailee acquires the use of the thing but not its fruits, unless there is a stipulation to the
contrary.

2. It is essentially gratuitous.

3. The purpose of the contract is the temporary use of the thing loaned for a certain time.
(So if the bailee is not entitled to use the thing, it is not commodatum but it may be a
deposit.)

4. The subject matter is generally non-consumable real or personal property, though


consumable goods may also be the subject of commodatum if the purpose is not the
consumption of the object (ex. Display of a bottle of wine).

5. The lender need not be the owner of the thing loaned. It is enough that he has possessory
interest in the thing or right to use it which he may assert against the bailee and third persons
though not against the rightful owner. (Ex. A lessee may sublet the thing leased).

6. It is purely personal in character. The consequences of this are the following:

a. The death of either party extinguishes the contract unless there is a contrary
stipulation for the commodatum to subsist until the purpose is accomplished

b. The borrower cannot lend or lease the thing to a third person. However,
members of the borrower’s household may make use of the thing loaned except:

i. if there is a stipulation to the contrary; or


ii. if the nature of the thing forbids it.

7. The parties may stipulate that the borrower may use the fruits of the thing, but this must
only be incidental to the use of the thing itself (because if it is the main cause, the contract
may be one of usufruct).

OBLIGATIONS OF THE BORROWER

1. Liability for ordinary expenses – The borrower should defray the expenses for the use and
preservation of the thing loaned.

2. Liability for loss of the thing – The general rule is the borrower is not liable for loss or
damage due to a fortuitous event. The owner bears the loss. But in the following cases,
the borrower is liable for loss through a fortuitous event:

a. if he devotes the thing to a purpose different from that for which it was loaned (bad
faith) this is a breach of the tenor of the obligation

b. if he keeps it longer than the period stipulated or after the accomplishment of the use
for which the commodatum has been constituted (delay)

c. if the thing loaned has been delivered with appraisal of its value unless there is a
stipulation exempting the bailee from responsibility in case of a fortuitous event this
is equivalent to an assumption of risk;

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d. if he lends or leases the thing to a third person who is not a member of his
household also a breach of the tenor of the obligation;

e. if, being able to save either the thing borrowed or his own thing, he chose to save his
own (ingratitude).

3. Liability for deterioration of the thing - The borrower is not liable for the ordinary
deterioration or wear and tear of the thing that comes as a natural consequence of its use.
This is borne by the lender. Reason: Because the lender retains ownership so he should bear
the loss from ordinary deterioration. Also, because the purpose of commodatum is for the
borrower to use the thing. Deterioration is a natural result of such use.

4. Obligation to return the thing loaned – The borrower must return the thing as soon as the
period stipulated expires or the purpose has been accomplished. He cannot keep the thing as
security for anything that the lender may owe him, except for a claim for damages suffered
because of the flaws of the thing loaned.

So for example, Xilca earlier won a bet with Cayo, as a result of which, Cayo owes her a tuna
sandwich. Cayo loaned Alvin Ang’s Frisbee to Xilca for 10 days. At the end of the 10 days,
Xilca cannot refuse to return Alvin Ang’s frisbee to Cayo and hold it hostage until Cayo
delivers the sandwich. Why? Because Xilca’s obligation as a borrower is to return the thing
after the period expires, and she cannot keep it as a security for anything that Cayo may owe
her.

Or, Xilca borrows Kim Chong’s car for 10 days. While the car is in Xilca’s possession, a tire
explodes. Xilca has to buy a new tire for P3,000. At the end of the 10 days, Xilca refuses to
return the car unless Kim Chong pays her the P3,000. Can Xilca refuse to return? No. In this
case, Kim Chong owes Xilca P3,000 as an extraordinary expense for the preservation of the
thing. But even if Kim Chong owes Xilca money in connection with the thing that he loaned,
Xilca still cannot retain the car as security.

Exception: If the thing loaned has hidden defects and the borrower suffers damages as a
result of the hidden defect, the borrower can claim damages against the lender. Pending
payment of the damages by lender to borrower, borrower can keep the thing as a security.
(see discussion below)

5. Liability of two or more bailees – When there are two or more borrowers to whom a thing
is loaned in one contract, there liability is solidary.

OBLIGATIONS OF THE LENDER

1. Obligation to respect the duration of the loan – The lender cannot demand the return of
the thing until after the expiration of the period or after the accomplishment of the use for
which the commodatum was constituted. However, he may demand its return or temporary
use if he should have urgent need of the thing.

2. Precarium – Precarium is a kind of commodatum where the lender may demand the thing
at will. Precarium exists in the following cases:

a. If there is no stipulation as to the duration of the contract or to the use to which the
thing loaned should be devoted

b. If the use of the thing is merely tolerated by the lender

BUT, the lender may not demand the thing capriciously, arbitrarily, or whimsically, since this
would give rise to an action on the part of borrower for abuse of right under Articles 19, 20,
and 21.

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3. Right to demand return of thing for acts of ingratitude – If the borrower commits any of
the acts enumerated in Art. 765 of the Civil Code, the lender may demand the immediate
return of the thing from the borrower. (This applies to ordinary commodatum, since in
precarium the lender can demand at will, subject to the provisions against abuse of right)

4. Obligation to refund extraordinary expenses

a. Extraordinary expenses for the preservation of the thing – The lender should
refund the borrower the extraordinary expenses for the preservation of the thing,
provided that the borrower informs the lender before incurring the expense,
unless the need is so urgent that the lender cannot be notified without danger.

b. Extraordinary expenses arising from actual use of the thing – Extraordinary


expenses arising on the occasion of the actual use of the thing shall be borne by the
lender and borrower on a 50-50 basis, unless there is a contrary stipulation.

5. All other expenses are for the account of the borrower.

6. Liability for damages for known hidden flaws - Requisites: (F-HADD)

a. There is a flaw or defect in the thing loaned;


b. The flaw or defect is hidden
c. The lender is aware of the flaw
d. The lender does not advise the borrower of the flaw
e. The borrower suffers damages by reason of the flaw or defect

The lender is penalized for his failure to disclose a hidden flaw which causes damage because
he is in a position to prevent the damage from happening.

(HOT TIP) Example: Borrower borrows a 1970 Mitsubishi Lancer from Lender. Unfortunately,
Lender forgets to tell borrower that the car has a tendency to overheat after 10 minutes. So
Borrower drives, and after 10 minutes, the car stalls and overheats. Borrower opens the hood
and sees lots of steam. He opens the radiator cap to put water inside. Radiator water scalds
his face, and he suffers from burns. Can he claim damages from Lender and can he keep the
car as security?

No, because in this case, Buyer should have known. He was, at least, in a position to know
that the car just might be prone to overheating since it was old already. And when he opened
the hood and saw lots of steam, he should have known that if he opened the radiator, very hot
water would spray out. He should have taken precautions when he opened the hood or he
should have gone to a gas station or mechanic to have it fixed. But since he was negligent, he
has only himself to blame for the damage caused. The defect was not really hidden since
Borrower was in a position to know of it even if Lender did not inform him. Had he been more
careful, he would not have been scalded.

ABANDONMENT OF THING BY THE LENDER

Can the lender tell Borrower: I don’t want to pay for the extraordinary expenses and damages that I
owe you. Just keep the thing, and let’s forget about my obligation.

No. The lender cannot exempt himself from the payment of the expenses or damages by abandoning
the thing to the borrower. This is because the expenses and damages may exceed the value of the
thing loaned, and it would, therefore, be unfair to allow the lender to just abandon the thing instead of
paying for the expenses and damages.

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CHAPTER 2 SIMPLE LOAN OR MUTUUM

DEFINITION

Simple loan (def). A contract whereby one of the parties delivers to another money or other
consumable thing with the understanding that the same amount of the same kind and quality
shall be paid.

A simple loan involves the payment of the equivalent and not the identical thing because the
borrower acquires ownership of the thing loaned. The term “return” is not used since the
distinguishing character of the simple loan from commodatum is the consumption of the thing.

CONSIDERATION

What is the consideration in this kind of contract? The promise of the borrower to pay is the
consideration for the obligation of the lender to furnish the loan.

NO CRIMINAL LIABILITY FOR ESTAFA FOR FAILURE TO PAY

There is no criminal liability for failure to pay a simple loan because the borrower acquires ownership
of the thing.

FUNGIBLE AND CONSUMABLE THINGS

Fungible things (def). Those which are usually dealt with by number, weight, or measure, so that
any given unit or portion is treated as the equivalent of any other unit or portion. Those which may
be replaced by a thing of equal quality and quantity. (ex. Rice, oil, sugar). If it cannot be replaced
with an equivalent thing, then it is non-fungible.

Consumable things (def). Those which cannot be used without being consumed.

Õ Whether a thing is consumable or not depends upon its nature. Whether a thing is fungible or
not depends on the intention of the parties.

BARTER

Barter (def). A contract where one of the parties binds himself to give one thing in consideration of
the other’s promise to give another thing. (in short, exchange of property)

If one person agrees to transfer the ownership of non-fungible things to another with the
obligation on the part of the latter to give things of the same kind, quantity, and quality, the contract
is a contract of barter.

DISTINCTIONS BETWEEN MUTUUM, COMMODATUM, AND BARTER

MUTUUM COMMODATUM BARTER


SUBJECT MATTER Money or other fungible Non-fungible things Non-fungible things
things
OBLIGATION OF THE Return the equivalent Return the identical Return the equivalent
BORROWER thing borrowed
GRATUITOUS? May be gratuitous or Always gratuitous Onerous
onerous

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FORM OF PAYMENT

1. If the object is money – Payment must be made in the currency stipulated; otherwise it is
payable in the currency which is legal tender in the Philippines. According to Art. 1955, Art.
1250, is applicable in payments of loans. 1250 provides that in case of extraordinary inflation
or devaluation, the value of the currency at the time of the establishment of the
obligation (not at the time of payment) should be the basis for payment.

BUT JPSP thinks that this is rarely applied because it would create a bad precedent and would
wreak havoc on the economy. It would also shift the loss to the lender, which shouldn’t be the
case since the loan is primarily for the benefit of the borrower. So unless there’s a drastic
economic situation, we shouldn’t adjust the value of the currency. The obligation should be
paid based on the value of the currency at the time of payment.

Ex: In 2000, Borrower borrowed $1,000 from Lender at the peso-dollar exchange rate of P50-
$1, payable in 2004. In 2004, FPJ becomes President, and as a result, the rate becomes P60-
$1. If the parties had agreed that payment would be in dollars, Borrower still has to pay
$1,000. If the parties had agreed that payment would be in pesos, Borrower should pay at
the rate of P60 to a dollar, or P60,000. Why? You cannot apply 1250 and base the amount
due on the value of the currency in 2000 because the inflation is not so extraordinary as to
warrant the adjustment.

2. If the object is a fungible thing other than money – Borrower must pay lender another
thing of the same kind, quality, and quantity. In case it is impossible to do so, the borrower
shall pay its value at the time of the perfection of the loan.

Why does the law require that the value of the thing be based on its value at the time of the
perfection of the loan? There’s a historical explanation: the rule was created at a time when
there were still interest ceilings. Thus, the reason for requirement is to prevent circumvention
of the interest ceilings.

Even if there are no longer any interest ceilings, this rule is still applicable. So how do you opt
out of it? Stipulate! Put a stipulation that says that if it is impossible to pay a thing of the
same kind, quality, and quantity, borrower shall pay the market value of the thing at the time
of payment.

INTEREST

Requisites for Recovery of Interest:

1. The payment of interest must be expressly stipulated.


2. in writing
[3. And the interest must be lawful (but since there is no Usury Law anymore, then there is no
such thing as unlawful interest, so I don’t think this requisite is still included)]

There is no Usury Law anymore, but an interest rate may still be struck down for being
unconscionable. The test of an unconscionable interest rate is relative and there is a need to look at
the parity/disparity in the status of the parties and in their access to information during the
negotiations.

Stipulation of interest

1. The interest rate stipulated by the parties, not the legal rate of interest, is applicable.

2. Default rule: If the parties do not stipulate an interest rate, the legal rate for loans and
forbearances of money is 12%.

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For other sources of obligations, such as sale, and damages arising from injury to persons and
loss of property which do not involve a loan, the legal rate of interest is 6%.

3. Increases in interest must also be expressly stipulated.

4. It is only in contracts of loan, with or without security, that interest may be stipulated and
demanded.

5. Stipulation of interest must be mutually agreed upon by the parties and may not be
unilaterally increased by only one of the parties. This would violate consensuality and
mutuality of contract (PNB v. CA). But the parties can agree upon a formula for determining
the interest rate, over which neither party has control (ex: interest will be adjusted quarterly
at a rate of 3% plus the prevailing 91-day T-bill rate, etc.). But if the formula says “interest
will be based on T-bill rates and other interest-setting policies as the bank may determine,”
this is not valid.

Escalation Clause – A clause which authorizes the automatic increase in interest rate.

An escalation clause is valid when it is accompanied by a De-Escalation Clause. A de-escalation


clause is a clause which provides that the rate of interest agreed upon will also be automatically
reduced. There must be a specified formula for arriving at the adjusted interest rate, over which
neither party has any discretion.

When the borrower is liable for interest even without a stipulation:

1. Indemnity for damages – The debtor in delay is liable to pay legal interest as indemnity for
damages even without a stipulation for the payment of interest.

Where to base the rate of damages:


a. Rate in the penalty clause agreed upon by the parties
b. If there is no penalty clause, additional interest based on the regular interest rate of
the loan
c. If there is no regular interest, additional interest is equivalent to the legal interest rate
(12%)

Example: Lender lends P10K at 10% interest with penalty interest of 6%. On due date,
Borrower fails to pay. Borrower only pays a year after. How much should he pay?

Borrower should pay the principal + interest on the loan + penalty interest
= 10K + 10% of 10K + 6% of 10K
= 10K + 1K + .6K
= 11,600

Lender lends P10K at 10% interest. On due date, Borrower fails to pay. Borrower only pays a
year after. How much should he pay?

Borrower should pay 10K + 10% of 10K (interest on the loan) + 10% of 10K (penalty
interest)
= 10K + 1K + 1K
= 12,000
The penalty interest in this case is 10% since there is no penalty interest stipulated.
The additional interest is based on the regular interest of the loan.

Lender lends P10K, no interest. On due date, Borrower fails to pay. How much should
Borrower pay a year later?

Borrower should pay P10K + 12% of P10K = 11,200. The penalty interest is 12% since
there is no interest on the loan nor a penalty interest stipulated. The extra interest is based
on the legal rate of interest.

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2. Interest accruing from unpaid interest – Interest due shall earn interest from the time it
is judicially demanded although the obligation may be silent on this point (Art. 2212.)

If interest is payable in kind:

If interest is payable in kind, its value shall be appraised at the current price of the products or
goods at the time and place of payment.

Take note that you should not confuse this with the rule when the principal obligation consists of
goods other than money. If the principal obligation consists in the payment of goods and it is
impossible to deliver the goods, the borrower should pay the value of the thing at the time of the
constitution of the obligation.

But if interest is payable in kind, it should be appraised at its value at the time of payment.

General Rule: Accrued interest shall not earn interest


Exceptions:

1. When judicially demanded (Art. 2212)


2. Express stipulation – Also called compounding interest where the parties agree that
accrued interest shall be added to the principal and the resulting total amount shall earn
interest.
Õ A stipulation as to compounding interest must be in writing.

How does compounding interest work?

Lender lends P100,000 payable in 2 years at 10% interest compounded per annum.

At the end of the first year, how much is due? Principal plus 10% interest = 110,000.

On the second year, the 110,000 becomes the new principal amount and it is what will earn the 10%
interest. So at the end of the second year, how much is due?
110,000 + 10% of 110,000
= 110,000 + 11,000
= 121,000

In compounding interest, you add the unpaid interest to the principal. The resulting amount is your
new principal which will then earn interest again.

What if the borrower pays interest when there is no stipulation providing for it?

If the debtor pays unstipulated interest by mistake, he may recover, since this is a case of solutio
indebiti or undue payment.

But if the debtor voluntarily pays interest (either unstipulated or stipulated by not in writing) because
of some moral obligation, he cannot later recover. The obligation to return the interest is a natural
obligation.

II. GUARANTY AND SURETYSHIP

CHAPTER 1 NATURE AND EXTENT OF GUARANTY

Art. 2047. By guaranty a person, called the guarantor, binds himself to the creditor to fulfill the
obligation of the principal debtor in case the latter should fail to do so.

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If a person binds himself solidarily with the principal debtor, the provisions of Section 4, Chapter 3,
Title 1 of this Book shall be observed. In such case the contract is called a suretyship.

Guaranty (def.) A contract whereby the guarantor binds himself to the creditor to fulfill the
obligation of the principal debtor in case the latter should fail to do so.

In a contract of guaranty, the parties are the guarantor and the creditor.

Characteristics of the Contract of Guaranty (A-SC-U-D)

1. Accessory: It is dependent for its existence upon the principal obligation guaranteed by it.

2. Subsidiary and Conditional: It takes effect only when the principal debtor fails in his
obligation.

3. Unilateral:

a. It gives rise to obligations on the part of the guarantor in relation to the creditor and
not vice-versa. (Although after its fulfillment, the principal debtor should indemnify
the guarantor, but this obligation is only incidental)

b. It may be entered into even without the intervention of the principal debtor.

4. Distinct Person: It requires that the person of the guarantor must be distinct from the
person of the principal debtor (you cannot guaranty your own debt). However, in a real
guaranty, a person may guarantee his own obligation with his own properties.

Classification of Guaranty

1. In the broad sense:

a. personal: the guaranty is the credit given by the person who guarantees the
fulfillment of the principal obligation (guarantor)

b. real: the guaranty is property. If the guaranty is immovable property: real mortgage
or antichresis; If the guaranty is movable property: pledge or chatter mortgage

2. As to origin:

a. conventional: by agreement of the parties

b. legal: imposed by law

c. judicial: required by a court to guarantee the eventual right of one of the parties in a
case

3. As to consideration:

a. gratuitous: the guarantor does not receive anything for acting as guarantor

b. onerous: the guarantor receives valuable consideration for acting as guarantor

4. As to the person guaranteed:

a. single: constituted solely to guarantee or secure performance of the principal


obligation

Sheryl IID 2002 PAGE 12


b. double or sub-guaranty: constituted to secure fulfillment of a prior guaranty;
guarantees the obligation of a guarantor

5. As to scope and extent:

a. definite: limited to the principal obligation only or to a specific portion thereof

b. indefinite or simple: includes not only the principal obligation but also all its
accessories, including judicial costs.

Second Paragraph of Art. 2047: Suretyship

If a person binds himself solidarily with the principal debtor, it is a contract of suretyship. The
guarantor is called a surety. Suretyship is governed by Articles 1207 to 1222 of the Civil Code on
solidary obligations. Suretyship dispenses with certain legal requirements/conditions precedent for
proceeding against a guarantor.

What is the difference between passive solidarity (solidarity among debtors) and
suretyship?

Review of oblicon: According to Tolentino, the two are similar in the following ways:

1. A solidary debtor, like a surety, stands for some other person.

2. Both debtor and surety, after payment, may require that they be reimbursed.

The difference is that the lender cannot go after the surety right away. There has to be default on
the part of the principal debtor before the surety becomes liable. If it were mere solidarity among
debtors, the creditor can go after any of the solidary debtors on due date.

Nature of a Surety’s Undertaking

1. Contractual and Accessory BUT Direct: The contractual obligation of the surety is merely
an accessory or collateral to the obligation contracted by the principal. BUT, his liability to the
creditor is direct, primary, and absolute.

2. Liability is limited by the terms of the contract: The extent of a surety’s liability is
determined only by the terms of the contract and cannot be extended by implication.

3. Liability arises only if principal debtor is held liable: If the principal debtor and the
surety are held liable, their liability to pay the creditor would be solidary. But, the surety does
not incur liability unless and until the principal debtor is held liable.

a. A surety is bound by a judgment against the principal even though the party was not a
party to the proceedings.

b. The creditor may sue, separately or together, the principal debtor and the surety
(since they are solidarily bound).

c. Generally, a demand or notice of default is not required to fix the surety’s liability.

d. An accommodation party (one who signs an instrument as maker, drawer, acceptor, or


indorser without consideration and only for the purpose of lending his name) is, in
effect, a surety. He is thus liable to pay the holder of the instrument, subject to
reimbursement from the accommodated party.

Sheryl IID 2002 PAGE 13


Example: Tuks accommodates Shak so that he can obtain a loan from the bank. At
the bottom of the loan agreement, the following signatures appear:

(sgd) Tuks (sgd) Shak


Lino Chris Kapunan Sherwin Shakramy

Is Tuks a surety or a solidary debtor? According to JPSP, based on this document


above, Tuks is a solidary debtor. Remember the rule? I promise to pay signed by two
parties = solidary. To make sure that he’s merely a guarantor or surety, Tuks should
sign a separate guaranty agreement. Besides, a guaranty must be express. It is not
presumed.

e. A surety bond is void where there is no principal debtor.

4. Surety is not entitled to exhaustion: A surety is not entitled to the exhaustion of the
properties of the principal debtor since the surety assumes a solidary liability for the
fulfillment of the principal obligation.

5. The undertaking is to the CREDITOR, not to the principal debtor: The debtor cannot
claim that the surety breached its obligation to pay for the principal obligation because there
is no obligation as between the surety and the debtor. If the surety does not pay, the
principal debtor is still not relieved of his obligation.

Guaranty Distinguished from Suretyship:

GUARANTY SURETYSHIP
Guarantor promises to answer for the debt, Surety promises to answer for the debt, default or
default or miscarriage of the principal miscarriage of the principal (same)
Liability of the guarantor depends upon an Surety assumes liability as a regular party to
independent agreement to pay the obligation if the undertaking
the primary debtor fails to do so
The engagement of the guarantor is a collateral Surety is charged as an original promisor
undertaking
The guarantor is secondarily liable A surety is primarily liable

Õ MAIN DIFFERENCE: A surety undertakes to pay if the principal does not pay (insurer of the debt).
A guarantor binds himself to pay if the principal cannot pay (insurer of the solvency of the debtor).

Õ Since the obligation of the surety is to pay so long as the principal does not pay (even if he can;
even if he is solvent), the undertaking of the surety is more onerous than that of a guarantor who
pays only in the event that the principal is broke.

Illustration:

A borrows P10,000 from B, with C agreeing to be the surety. A refuses to pay B out of spite. In this
case, since C is a surety, B can immediately demand payment from C.

If, in this case, C is a guarantor instead, B would have to exhaust all the property of A before he can
collect from C. it is not enough that A refuses to pay even if he can; in order for C to be liable, A
would have to be unable to pay.

If you were a lender and the borrower offers as security either X as guarantor or a real
estate mortgage, which one would you choose?

Choose the mortgage. If you were the lender, a real estate mortgage is more advisable because you
can collect against the property. In a guaranty/surety, you would have to go against the guarantor or

Sheryl IID 2002 PAGE 14


surety – you would have to sue him, obtain judgment, and then execute judgment. This is subject to
a lot of delays. The guarantor or surety can stall your claim.

Art. 2048. A guaranty is gratuitous, unless there is a stipulation to the contrary.

GENERAL RULE: Guaranty is gratuitous.


EXCEPTION: Guaranty is onerous only if it is stipulated.

What is the cause/consideration of a contract of guaranty?

The cause of a contract of guaranty is the same cause which supports the principal obligation of
the principal debtor. There is no need for an independent consideration in order for the contract of
guaranty to be valid. The guarantor need not have a direct interest in the obligation nor receive any
benefit from it. It is enough that the principal obligation has consideration.

Art. 2049 A married woman may guarantee an obligation without the husband’s consent, but shall
not thereby bind the conjugal partnership, except in cases provided by law.

Art. 94 of the Family Code


The absolute community of property shall be liable for:

(3) Debts and obligations contracted by either spouse without the consent of the other to the extent
that the family may have been benefited.

A married woman who acts as guarantor without the consent of the husband binds only her separate
property unless the debt benefited the family.

There is no express prohibition against a married woman acting as guarantor for her husband.

Remember that now, in order to bind the absolute community, the consent of both spouses is needed.
If only the consent of one spouse is obtained, the absolute community will not be liable unless the
obligation redounded to the benefit of the community.

When the husband acts as a guarantor for another person without the consent of the wife, the
guaranty binds only the husband since the benefit really accrues to the principal debtor and not to the
husband or his family. The exception is if the husband is really engaged in the business of
guaranteeing obligations because in this case, his occupation or business is deemed to be undertaken
for the benefit of the family.

Art. 2050. If a guaranty is entered into without the knowledge or consent, or against the will of the
principal debtor, the provisions of articles 1236 and 1237 shall apply.

A contract of guaranty is between the guarantor and the creditor. It can be instituted without the
knowledge or even against the will of the debtor, since the purpose of the contract is to give the
creditor all the possible measures to secure payment.

However, if the contract of guaranty is entered into without the knowledge or consent or against the
will of the principal debtor, the effect is like payment by a 3rd person:

1. The guarantor can only recover insofar as the payment has been beneficial to the debtor.

2. The guarantor cannot compel the creditor to subrogate him in the creditor’s rights such as
those arising from a mortgage, guaranty or penalty.

If the guaranty was entered into with the consent of the principal debtor, the guarantor is subrogated
to all the rights which the creditor had against the debtor once he pays for the obligation.

Illustration:

Sheryl IID 2002 PAGE 15


A owes B P10,000. Without the knowledge of A, C guarantees the obligation. C pays A P10,000. C
tries to collect the P10,000 from A, but A tells him that he has already paid B 4,000.

In this case, C can only collect P6,000 from A since it was only the extent to which A was benefited
by his payment.

If the loan was secured by a mortgage, C cannot foreclose the mortgage if A does not pay him
because he is not subrogated to the rights of B.

Art. 2052. A guaranty cannot exist without a valid obligation.

Nevertheless, a guaranty may be constituted to guarantee the performance of a voidable or


unenforceable contract. It may also guarantee a natural obligation.

A guaranty is an accessory contract and cannot exist without a valid principal obligation. So if the
principal obligation is void, the guaranty is also void.

BUT, a guraranty may be constituted to guarantee the following defective contracts and natural
obligations:

1. Voidable: because the contract is binding unless it is annulled

2. Unenforceable: because an unenforceable contract is not void.

3. Natural obligations: even if the principal obligation is not civilly enforceable, the creditor may
still go after the guarantor

Art. 2053. A guaranty may also be given as security for future debts, the amount of which is not yet
known; there can be no claim against the guarantor until the debt is liquidated. A conditional
obligation may also be secured.

Continuing Guaranty (def) – A guaranty that is not limited to a single transaction but which
contemplates a future course of dealings, covering a series of transactions generally for an
indefinite time or until revoked.

A continuing guaranty is generally prospective in its operation and is intended to secure future
transactions (generally does not include past transactions).

Examples:

1. Common example given by JPSP is the credit line – The bank allows you to borrow up to
a certain ceiling, but there is no release of funds yet. If you have an obligation with a third
person and you default, the third person just needs to inform the bank, and the bank will
release the money. The money released will be considered as a loan from the bank to you.
The bank will allow the release of the money so long as it doesn’t exceed the ceiling.

2. To secure payment of any debt to be subsequently incurred – If the contract states that
the guaranty is to secure advances made “from time to time,” “now in force or hereafter
made,” or uses the words “any debt,” “any indebtedness,” “any sum,” “any
transaction,” the guaranty is a continuing guaranty.

3. To secure existing unliquidated debts – Future debts may also mean debts that already
exist but whose amount is still unknown.

Art. 2053 may be misleading because it says that a guaranty may be constituted to secure future
debts. The important thing to remember in the guaranty of future debts is that there must be an

Sheryl IID 2002 PAGE 16


existing obligation already that is being guaranteed. Because without that existing obligation, the
guaranty would be void. Guaranty is an accessory obligation, so it cannot exist without the principal.

Example: G guarantees the 10K loan that B owes L and any other indebtedness that B may
incur against L. This is a valid guaranty because there is already an existing obligation (the
10K loan).

G guarantees the loan that B and L will enter into tomorrow. This is not valid. Although it is
for a future debt, it is not valid under Article 2053 because there is no principal obligation yet.
There is nothing to guarantee.

Guaranty of Conditional Obligations

If the principal obligation is subject to a suspensive condition, the guarantor is liable only after the
fulfillment of the condition.

If it is subject to a resolutory condition, the happening of the condition extinguishes both the principal
obligation and the guaranty.

Art. 2054. A guarantor may bind himself for less, but not for more than the principal debtor, both as
regards the amount and the onerous nature of the conditions.

Should he have bound himself for more, his obligations shall be reduced to the limits of that of the
debtor.

Since the contract of guaranty is a subsidiary and accessory contract, the guarantor’s liability
cannot exceed that of the principal obligation. If the guarantor binds himself for more than the
liability of the principal debtor, his liability shall be reduced.

However, if the creditor sues the guarantor, the guarantor may be made to pay costs, attorney’s fees,
and penalties even if this will make his liability exceed that of the principal.

How do you opt out of this rule?

Example: G guaranteed B’s 100K obligation to L to the extent of 100K. As an extra


consideration for lending the money, L wants an additional 20K from guarantor (gravy,
according to JPSP). Since 2054 provides that the guarantor cannot bind himself for more than
the principal debtor, how do the parties opt out of the rule?

Guarantor and Lender should enter into a new and separate agreement. They should take
it out of the context of the guaranty and have a new agreement in which L would (kunwari)
perform some service for G in consideration of the additional 20K.

Art. 2055. A guaranty is not presumed; it must be express and cannot extend to more than what is
stipulated therein.

If it be simple or indefinite, it shall comprise not only the principal obligation, but also all its
accessories, including the judicial costs, provided with respect to the latter, that the guarantor shall
only be liable for those costs incurred after he has been judicially required to pay.

RULE: Guaranty is never presumed. It must be express.

Reason for the rule: Because a guarantor assumes an obligation to pay for another’s debt without
any benefit to himself. Thus, it has to be certain that he really intends to incur such an obligation and
that he proceeds with consciousness of what he is doing.

Form required for Guaranty

Guaranty must be IN WRITING

Sheryl IID 2002 PAGE 17


A contract of guaranty, to be enforceable, must be in writing because it falls under the Statute of
Frauds as a “special promise to answer for the debt, default or miscarriage of another.” De Leon
textbook says that surety is not covered by the Statute of Frauds. JPSP says that a surety is still
covered by the SOF since it is still a promise to answer for the default of another person. What is not
covered by the SOF is being a solidary co-debtor.

Construction of Guaranty

A guaranty is strictly construed against the creditor and in favor of the guarantor and is not to
be extended beyond its terms or specific limits. Doubts should be resolved in favor of the guarantor
or surety.

Õ Generally, a guarantor is liable only for the obligation of the debtor stipulated upon, and not to
obligations assumed PREVIOUS to the execution of the guaranty unless an intent to be so
liable is clearly indicated. (Prospective application of the guaranty)

However, this rule of construction is applicable only to an accommodation surety or one that is
gratuitous. It does not apply in cases where the surety is compensated with consideration. In such
cases, the agreement is interpreted against the surety company that prepared it.

Is a stipulation that says that the guaranty will subsist only until maturity of the obligation
valid?

Generally, no. Such a stipulation would defeat the purpose of a guaranty which is to answer for the
default of the principal debtor. If the guaranty is only up to the date of maturity, there is no way that
the guarantor can be liable since default comes only at maturity date.

But Cayo pointed out a situation in class where this might be possible and JPSP agreed: If the
lender asked for a guaranty precisely because there was a danger of the borrower absconding or
becoming insolvent prior to maturity date, then the guaranty is valid.

2nd Paragraph of Art. 2055: Extent of Guarantor’s Liability

1. Definite guaranty – The liability of the guarantor is limited to the principal debt, to the
exclusion of accessories.

2. Indefinite or simple guaranty – If the agreement does not specify that the liability of the
guarantor is limited to the principal obligation, it extends not only to the principal but also
to all its accessories.

This is because in entering into the agreement, the principal could have fixed the limits of
his responsibility solely to the principal. If he did not fix it, it is presumed that he wanted to
be bound not only to the principal but also to all its accessories.

GENERAL RULE: It is not necessary for the CREDITOR to expressly accept the contract of
guaranty since the contract is unilateral; only the guarantor binds himself to do something.

EXCEPTION:

If the guarantor merely offers to become a guaranty, it does not become a binding obligation unless
the creditor accepts and notice of acceptance is given to the guarantor.

On the other hand, if the guarantor makes a direct or unconditional promise of guaranty (and not
merely an offer), there is no need for acceptance and notice of such acceptance from the creditor.

Art. 2056. One who is obliged to furnish a guarantor shall present a person who possesses integrity,
capacity to bind himself, and sufficient property to answer for the obligation which he guarantees.

Sheryl IID 2002 PAGE 18


The guarantor shall be subject to the jurisdiction of the court of the place where this obligation is to
be complied with.

Art. 2057. If the guarantor should be convicted in first instance of a crime involving dishonesty or
should become insolvent, the creditor may demand another who has all the qualifications required in
the preceding article. The case is excepted where the creditor has required and stipulated that a
specified person should be the guarantor.

Ideally, the qualifications of a guarantor are the ff:

1. Integrity
2. Capacity to bind himself
3. Sufficient property to answer for the obligation which he guarantees

Õ But the creditor can waive these requirements.

Jurisdiction over the guarantor:

Jurisdiction over the guarantor belongs to the court where the principal obligation is to be fulfilled, in
accordance with the rule that accessory follows the principal.

Effect of Subsequent Loss of Qualifications

The qualifications need only to be present at the time of the perfection of the contract. The
subsequent loss of the qualifications would not extinguish the liability of the guarantor, nor will it
extinguish the contract of guaranty.

However, the creditor may demand another guarantor with the proper qualifications.

When may the creditor demand another guarantor?

1. In case the guarantor is convicted in the first instance of a crime involving dishonesty (since
he loses integrity)

2. In case the guarantor becomes insolvent (since he loses sufficient property to answer for the
obligation which he guarantees) there is no need for a judicial declaration of insolvency

What is the effect of the guarantor’s death on the guaranty?

The guaranty survives the death of the guarantor. The general rule is that a party’s contractual rights
and obligations are transmissible to his successors. The rules on guaranty do not expressly provide
that the guaranty is extinguished upon the death of the guarantor. Applying Art. 2057, the
supervening incapacity of the guarantor does not extinguish the guaranty but merely gives the
creditor the right to demand a replacement. But the creditor can waive this right and choose to hold
the guarantor to his bargain. If he so chooses, the creditor’s claim passes to the heirs of the deceased
guarantor.

When may the creditor NOT demand another guarantor?

Where the creditor has stipulated in the original agreement that a specified person should be the
guarantor, he is bound by the terms of the agreement and he cannot thereafter deviate from it.

CHAPTER 2 EFFECTS OF GUARANTY

Art. 2058. The guarantor cannot be compelled to pay the creditor unless the latter has exhausted all
the property of the debtor, and has resorted to all the legal remedies against the debtor.

Sheryl IID 2002 PAGE 19


The liability of the guarantor is only accessory and subsidiary. Thus, in order for the creditor to collect
from the guarantor, the ff. conditions must be fulfilled:

1. The creditor should have exhausted all the property of the debtor; and

2. The creditor has resorted to all legal remedies against the debtor (ex. Accion pauliana/
rescission of fraudulent alienations)

Can the creditor implead the guarantor as a co-defendant with the debtor?

No. Except in cases provided in 2059, Article 2062 says that creditor should proceed against the
principal debtor alone.

Art. 2059. This excussion shall not take place:

1. If the guarantor has expressly renounced it;

2. If he has bound himself solidarily with the debtor;

3. In case of insolvency of the debtor;

4. When he has absconded, or cannot be sued within the Philippines unless he has left a manager or
representative;

5. If it may be presumed that an execution on the property of the principal debtor would not result
in the satisfaction of the obligation.

GENERAL RULE: The guarantor is entitled to demand that the creditor first exhaust the properties of
the principal debtor before collecting from the guarantor.

EXCEPTIONS:

1. Under Art. 2059


2. If the guarantor does not comply with Art. 2060
3. If the guarantor is a judicial bondsman and sub-surety (Art. 2084)
4. Where a pledge or mortgage has been given by him as a special security.
5. If he fails to interpose it as a defense before judgment is rendered against him.

EXCEPTIONS UNDER ART. 2059 (RUSIA)

1. When the right is Renounced or waived.


• The waiver must be made in express terms.

2. When the liability assumed by the guarantor is Solidary.


• In this case, he becomes a surety with primary liability.

3. When the principal debtor is Insolvent.

What kind of insolvency? JPSP says it’s practical insolvency meaning assets are less than
liabilities, but it still depends on the situation.

Examples:

B borrows 100K from L guaranteed by G. B has 1M in assets which are all still with him and
1.5M in liabilities. B defaults. Can L collect from G right away?

No. In this case, G still has the benefit of excussion. Why? Because even if B is apparently
insolvent, since his liabilities exceed his assets, there is still no claim against these assets by
the other creditors. They can still be accessed by L, and L can still file an action for collection

Sheryl IID 2002 PAGE 20


of money against B. So in this case, even if B is insolvent on paper, his properties are still
with him, and he can still pay L. Therefore, G still should still have the benefit of excussion.

B borrows 100K from L guaranteed by G. On due date, B defaults and has zero assets but has
a 200K credit/receivable from X. Can L collect from G.

Still no. L must file an action for collection and an accion subrogatoria so that he can
exercise B’s right to collect the money from X. Only if these actions fail can L then collect
from G.

4. When the principal debtor Absconds or cannot be locally sued.

So even if the borrower has fled to the Bahamas, if he still has properties here, Lender must
sue against the property first before collecting from the guarantor.

5. When resort to all legal remedies would be a Useless formality.

• If exhausting the properties of the debtor would be useless since it would still not satisfy
the obligation, the guarantor cannot require the creditor to resort to these legal remedies
against the debtor anymore, since doing so would be a useless formality.
• In this case, it is not even necessary that the debtor is judicially declared insolvent or
bankrupt.

How does the lender get around this requirement? If the lender wants to be able to go against the
guarantor right away without having to go through excussion, he must get the guarantor to either sign
a waiver of the benefit of excussion or make him solidarily liable (a surety).

Example: B borrowed 100k guaranteed by G. B defaulted. Lender made a demand for


payment against G. G paid. Later, G found out that he had the benefit of excussion. He
demanded reimbursement from Lender. Can G recover?

G cannot recover. Payment constitutes a waiver of the benefit.

Art. 2060. In order that the guarantor may make use of the benefit of excussion, he must set it up
against the creditor upon the latter’s demand for payment from him, and point out to the creditor
available property of the debtor within Philippine territory sufficient to cover the amount of the debt.

Art. 2061. The guarantor having fulfilled all the conditions required in the preceding article, the
creditor who is negligent in exhausting the property pointed out shall suffer the loss, to the extent of
said property, for the insolvency of the debtor resulting from such negligence.

To collect from the guarantor, the creditor must make a prior demand for payment from the
guarantor.

1. When should the demand be made? The demand can only be made after judgment on the
debt.

2. How should it be made? The demand must be an actual demand. Joining the guarantor in
the suit against the principal is not the demand intended by law.

Additional Requisites in Order to Claim the Benefit of Excussion

Guarantor tells Lender “Exhaust Borrower’s property first before collecting from me.” Is this enough
for the Guarantor to claim the benefit of excussion?

No. In order to demand that the creditor exhaust the properties of the principal debtor, the guarantor
must:

Sheryl IID 2002 PAGE 21


1. Set up the benefit of excussion against the creditor upon demand for payment by the creditor
from him; and

2. Point out to the creditor available property of the debtor within Philippine territory
sufficient to cover the amount of debt. (Therefore, property located abroad or which is not
easily available is not included among those that the guarantor can point out to the creditor.)

Õ Once the guarantor has fulfilled the requisites for making use of the benefit of excussion, the
creditor has the duty to exhaust all the property of the debtor and to resort to all legal remedies
against the debtor. If he fails to do so, he shall suffer the loss to the extent of the value of the
property.

Art. 2062. In every action by the creditor, which must be against the principal debtor alone, except
in the cases mentioned in Article 2059, the former shall ask the court to notify the guarantor of the
action. The guarantor may appear so that he may, if he so desires, set up such defenses as are
granted him by law. The benefit of excussion mentioned in article 2058 shall always be unimpaired,
even if judgment should be rendered against the principal debtor and the guarantor in case of
appearance by the latter.

The creditor must sue the principal debtor alone. He cannot sue the guarantor with the principal or
the guarantor alone except in the cases mentioned in Art. 2059 where the guarantor loses the benefit
of excussion.

The guarantor must be notified so that he may appear and set up his defenses if he wants to.

If the guarantor appears, he is still given the benefit of exhaustion event after judgment is rendered
against the principal debtor.

If he does not appear, judgment is not binding on him. Lender must sue the guarantor to claim
against him.

So, collecting from the guarantor is really a two-step process. The purpose of the two-step process is
to allow the guarantor to make use of the benefit of excussion. The disadvantage is that there is a
time lag between the judgment against the principal debtor and the one against the guarantor, which
allows the guarantor to hide his assets in the meantime.

How to get around this two-step process: A bank guaranty or a letter of credit. In a bank guaranty, if
the debtor does not pay, the creditor need only inform the bank of the default and the bank releases
the money. It’s like a standing loan by the bank in favor of the debtor to answer for a debt in favor of
third persons, in case he is unable to pay.

Art. 2063. A compromise between the creditor and the principal debtor benefits the guarantor but
does not prejudice him. That which is entered into between the guarantor and the creditor benefits
but does not prejudice the principal debtor.

Reason: A compromise binds only the parties thereto and not third persons. Thus, it cannot prejudice
the guarantor or debtor who was not a party to the compromise.

Exception: If the compromise has a benefit in the nature of a stipulation in favor of a third person,
the compromise may bind that third person.

Example: D owes C 10K with G as guarantor.

D and C agree to reduce the debt to 8K. G’s liability is also reduced to 8K in case D does not pay,
since the compromise is beneficial to G.

Sheryl IID 2002 PAGE 22


Art. 2064. The guarantor of a guarantor shall enjoy the benefit of excussion both with respect to the
guarantor and to the principal debtor.

A sub-guarantor can demand the exhaustion of the properties both of the guarantor and of the
principal debtor before he pays the creditor.

Art. 2065. Should there be several guarantors of only one debtor and for the same debt, the
obligation to answer for the same is divided among all. The creditor cannot claim from the
guarantors except the shares which they are respectively bound to pay, unless solidarily has been
expressly stipulated.

The benefit of division among the co-guarantors ceases in the same cases and for the same reasons
as the benefit of excussion against the principal debtor.

When is there a benefit of division among several guarantors?

The following conditions must concur in order that several guarantors may claim the benefit of
division:

1. There should be several guarantors


2. Of only one debtor
3. For the same debt

In this case, the liability of the co-guarantors is joint. They are not liable to the creditor beyond
the shares which they are bound to pay.

Exceptions:

1.The co-guarantors cannot avail themselves of the benefit of division under the circumstances
enumerated in Art. 2059 (RUSIA).

2. If solidarity has been expressly stipulated.

Art. 2066. The guarantor who pays the debtor must be indemnified by the latter.

The indemnity comprises:

(1) The total amount of the debt;


(2) The legal interests thereon from the time the payment was made known to the creditor, even
though it did not earn interest for the creditor;
(3) The expenses incurred by the guarantor after having notified the debtor that payment had been
demanded of him;
(4) Damages, if they are due.

Once the guarantor pays the principal obligation, the principal debtor must pay him back consisting
of:

(TIED)

1. The Total amount of the debt – The guarantor has the right to demand reimbursement only
when he has actually paid the debt UNLESS there is a stipulation which gives him the right to
demand reimbursement as soon as he becomes liable even if he has not yet paid. The
guarantor cannot ask for more than what he has paid.

2. Interest – The guarantor is entitled to interest from the time notice of payment of the debt
was made known to the debtor. The notice is a demand upon the debtor to pay the
guarantor. If he delays, he is liable for damages in the form of interest. The guarantor can
collect interest even if the principal obligation was a loan without an interest. This is because

Sheryl IID 2002 PAGE 23


the right of the guarantor is independent of the principal obligation to the creditor. The basis
of the right is the delay of the debtor in reimbursing.

3. Expenses – This refers only to those expenses that the guarantor has to satisfy in accordance
with law as a consequence of the guaranty. This is limited to those expenses incurred by the
guarantor after having notified the debtor that payment has been demanded of him by the
creditor.

4. Damages – Guarantor is entitled to damages only if they are due.

Exceptions to the right to indemnity of the guarantor

1. Where the guaranty is constituted without the knowledge or against the will of the debtor, the
guarantor can only recover insofar as the payment had been beneficial to the debtor

2. Payment by a third person who does not intend to be reimbursed by the debtor is deemed to
be a donation, which requires the debtor’s consent. But the payment is valid with respect to
the creditor.

3. Waiver

Art. 2067. The guarantor who pays is subrogated by virtue thereof to all the rights which the
creditor had against the debtor.

If the guarantor has compromised with the creditor, he cannot demand of the debtor more than
what he has really paid.

When the guarantor pays, he becomes subrogated to the rights of the creditor against the debtor.
What happens really is just a change in creditor. The guarantor becomes the creditor, but the
obligation subsists in all other aspects. He may, for example, foreclose a mortgage in case of failure
of the debtor to reimburse him.

The right of subrogation is given to the guarantor so that he can enforce his right to indemnity/ to be
reimbursed.

It arises by operation of law upon payment by the guarantor. The creditor need not formally cede his
rights to the guarantor.

But the right of subrogation is given only to the guarantor if he has the right to be reimbursed. If, for
some reason, he has no right to be reimbursed, he cannot subrogate either.

Compromise

B owes lender P1M. Lender was a good friend of Guarantor and agreed that if G became liable, he
would only have to pay P500K. If B defaults and Guarantor pays P500K, he can only recover P500K
from B, not the original P1M.

Is there a situation where this rule would even be disadvantageous to the Debtor?

Yes. Let’s say there was no such rule. B owes L P1M. G, who was a compadre of L, brokered a
deal with L, in which they agreed that should G become liable, he would only pay P500K. Since
there’s no rule, G tells B about the deal with L. G tells B that if G pays the P500K, B should reimburse
him P600K. This would give B a savings of P400 K, while G earns P100K. Everyone will be happy.

But since there is a rule that says that G cannot ask for more than what he has actually paid, G has no
inducement, no incentive to broker that deal with his compadre L. Why would he go through the
trouble when in any case, he would be getting the same amount that he pays?

Sheryl IID 2002 PAGE 24


How do you get out of this situation? B should “hire” G as his agent to broker the deal with L. As
compensation for the service rendered by G, B will pay him P100K. So the agreement is taken out of
the context of the guaranty and everyone is happy.

Art. 2068. If the guarantor should pay without notifying the debtor, the latter may enforce against
him all the defenses which he could have set up against the creditor at the time the payment was
made.

Obligation of the guarantor before he pays the creditor

Before he pays the creditor, guarantor should first give notice to the principal debtor. If he does not
give notice, the debtor may enforce all the defenses which he could have set up against the creditor at
the time of payment.

Example: Debtor pays Creditor. But Creditor is sneaky and tells Guarantor that Debtor defaulted. So
Guarantor pays, without telling Debtor. Guarantor makes a demand for reimbursement from Debtor.
Is Debtor liable?

No. Debtor can invoke the fact of payment to the Creditor against Guarantor. Had Guarantor given
notice to Debtor, he would have known of the defenses that Debtor had against Creditor which would
have made him think twice about paying. Guarantor’s remedy here is against sneaky Creditor.

Art. 2069. If the debt was for a period and the guarantor paid it before it become due, he cannot
demand reimbursement of the debtor until the expiration of the period unless the payment has been
ratified by the debtor.

If the principal debt was one with a period, it becomes demandable only upon expiration of the period.
Guarantor is only liable if the debtor defaults, but there can be no default before the expiration of the
period. If the guarantor still pays before the expiration of the period, he must wait for the period to
expire before he can collect from the debtor.

Exception: Guarantor need not wait for the period if the debtor ratifies payment or consents to it.

Art. 2070. If the guarantor has paid without notifying the debtor, and the latter not being aware of
the payment, repeats the payment, the former has no remedy whatever against the debtor, but only
against the creditor. Nevertheless, in case of gratuitous guaranty, if the guarantor was prevented
by a fortuitous event from advising the debtor of the payment, and the creditor becomes insolvent,
the debtor shall reimburse the guarantor for the amount paid.

This is like the situation in 2068, only this time, the guarantor pays before the debtor pays. Even in
such a case, guarantor still cannot recover from debtor because he should have informed debtor of his
intention to pay. Had he informed debtor, debtor would not have paid. Guarantor will suffer the loss
of his failure to comply with his one and only obligation before paying which is to notify the debtor.

Exception: Guarantor may claim reimbursement from debtor if (requisites):

1. It is a gratuitous guaranty
2. The guarantor was prevented by a fortuitous event from informing the debtor of payment
3. Creditor becomes insolvent

Remember that the culprit here, aside from the guarantor who did not inform the debtor, is the
sneaky creditor who nonchalantly received payment twice. If he is solvent, the guarantor must collect
from him. But if he is insolvent and the three requisites above are present, the guarantor can
reimburse from the principal debtor.

Art. 2071. The guarantor, even before having paid, may proceed against the principal debtor:

(1) When he is sued for payment;

Sheryl IID 2002 PAGE 25


(2) In case of insolvency of the principal debtor;

(3) When the debtor has bound himself to relieve him from the guaranty within a specified period,
and this period has expired;

(4) When the debt has become demandable, by reason of the expiration of the period for payment;

(5) After the lapse of 10 years, when the principal obligation has no fixed period for its maturity
unless it be of such nature that it cannot be extinguished except within a period longer than 10
years;

(6) If there are reasonable grounds to fear that the principal debtor intends to abscond;

(7) If the principal debtor is in imminent danger of becoming insolvent.

In all these cases, the action of the guarantor is to obtain release from the guaranty, or to demand a
security that shall protect him from any proceedings by the creditor and from the danger of
insolvency of the debtor.

Under these 7 circumstances, the guarantor has these rights against the debtor BEFORE he makes
payment:

1. Right to be released if lender agrees


Release from the guaranty requires that the lender consent because the guaranty is actually
a contract between the lender and the guarantor

2. Right to demand a security

The purpose is to enable the guarantor to take measures to protect his interest in view of the
probability that debtor would default and he would be called upon to answer for the obligation.

Art. 2072. If one, at the request of another, becomes a guarantor for the debt of a third person who
is not present, the guarantor who satisfies the debt may sue either the person so requesting or the
debtor for reimbursement.

Art. 2073. When there are two or more guarantors of the same debtor and for the same debt, the
one among them who has paid may demand of each of the others the share which is proportionately
owing from him.

If any of the guarantors should be insolvent, his share shall be borne by the others, including the
payer, in the same proportion.

The provisions of this article shall not be applicable, unless the payment has been made in virtue of
a judicial demand or unless the principal debtor is insolvent.

This article applies only if there are two or more guarantors of the same debtor for the same debt and
one of them has paid:

1. by virtue of a judicial demand; or


2. when the principal debtor is insolvent.

The liability of the guarantors is joint. If one of them pays the entire obligation, he is entitled to be
reimbursed the amount of the shares of the other guarantors.

Example: A, B, C guaranty the 90K loan of X. A pays 90K. A can collect 30 K each from B and C.

Sheryl IID 2002 PAGE 26


But unlike in an ordinary joint obligation, if one of the guarantors is insolvent, the co-guarantors must
answer for his share. In this sense, the obligation behaves like a solidary obligation.

Example: A, B, C guaranty the 90K loan of X. A pays 90K. B becomes insolvent. A and C must
shoulder B’s share. So their liabilities become 45K each. A can collect 45 K from C.

Art. 2074. In the case of the preceding article, the co-guarantors may set up against the one who
paid, the same defenses which would have pertained to the principal debtor against the creditor, and
which are not purely personal to the debtor.

Example: A, B, C guaranty the obligation of X. A pays even if the obligation has prescribed already. A
demands reimbursement from B and C. Can they refuse to pay? Yes, they can invoke defenses
inherent in the obligation, such as prescription, against the co-guarantor who pays.

A, B, C guaranty the obligation of X who was a minor. A pays. Can B and C refuse to reimburse him
on the ground that X is a minor? No, because the defense is personal to X.

Art. 2075. A sub-guarantor, in case of the insolvency of the guarantor for whom he bound himself, is
responsible to the co-guarantors in the same terms as the guarantor.

A, B, C are guarantors of X. D is a guarantor of A. C pays the entire obligation. A becomes insolvent.


Can C reimburse from D? Yes, according to Art. 2075.

CHAPTER 3 EXTINGUISHMENT OF GUARANTY


Art. 2076. The obligation of the guarantor is extinguished at the same time as that of the debtor,
and for the same causes as all other obligations.

Because guaranty is an accessory and subsidiary contract, it is extinguished once the principal
obligation is extinguished.

But the extinguishment of the guaranty does not always carry with it the extinguishment of the
principal obligation.

Any agreement between the creditor and the principal debtor which essentially varies the terms of the
principal contract without the consent of the surety will release the surety from liability. This is
because the alteration would result in a novation of the principal contract which is consequently
extinguished and replaced with a new one. Since the old principal contract is extinguished, the
accessory contract of guaranty/surety is also extinguished.

When is an alteration material?

There must be a change which imposes a new obligation or added burden or which takes away some
obligation already imposed, changing the legal effect of the contract.

Examples:

1. Increase in the principal amount, regardless of the extent of the liability assumed by the
guarantor
2. Substitution of the principal debtor
3. Extension or shortening of the term of the principal debt

In these cases, the guaranty is extinguished altogether.

Decrease in the amount of the principal obligation: The guaranty subsists and is benefited by the
change since the guarantor cannot bind himself for more than the principal obligation.

Sheryl IID 2002 PAGE 27


Art. 2077. If the creditor voluntarily accepts immovable or other property in payment of the debt,
even if he should afterwards lose the same through eviction, the guarantor is released.

This is a case of dacion. Since dacion extinguishes the principal obligation, the accessory obligation is
also extinguished and is not revived even if the creditor is subsequently evicted from the property.

Art. 2078. A release made by the creditor in favor of one of the guarantors, without the consent of
the others, benefits all to the extent of the share of the guarantor to whom it has been granted.

A, B, C are guarantors of X for 90K. The creditor releases A without the consent of B and C. The
release should benefit B and C to the extent of 30K (A’s share). They shall be liable only for 60K or
30K each.

A, B, C are guarantors of X for 90K. The creditor releases A with the consent of B and C. Since B and
C consented to the release, their liability is still 90K or 45K each.

Art. 2079. An extension granted to the debtor by the creditor without the consent of the guarantor
extinguishes the guaranty. The mere failure on the part of the creditor to demand payment after
the debt has become due does not of itself constitute any extension of time referred to herein.

If the creditor grants the debtor an extension of time within which to comply with the principal
obligation, the guaranty is extinguished. This is because the principal debtor could become insolvent
during the extension period, and the guarantor would not be able to ask for reimbursement.

But if the guarantor consents or waives his right under this article in advance, the extension will not
extinguish the guaranty.

It is immaterial whether the guarantor suffers actual prejudice as a result of the extension. The
length of time of the extension is also immaterial. As long as the period is extended, the guaranty is
extinguished.

The extension must be based on a new agreement between the debtor and creditor. If the creditor
merely fails to make a demand on due date, it is not an extension.

Can the guarantor sue the creditor for his delay in making a demand, thereby lengthening the risk of
the insolvency of the principal debtor? No.

Art. 2080. The guarantors, even though they are solidary, are released from their obligation
whenever by some act of the creditor they cannot be subrogated to the rights, mortgages and
preference of the latter.

Art. 2081. The guarantor may set up against the creditor all the defenses which pertain to the
principal debtor and are inherent in the debt; but not those that are purely personal to the debtor.

Chapter 4 Legal and Judicial Bonds


The only important thing you have to remember about a legal bond is that it is a surety. Therefore
there is no benefit of excussion.

Sheryl IID 2002 PAGE 28


PLEDGE AND MORTGAGE

PROVISIONS COMMON TO PLEDGE AND MORTGAGE


Article 2085. The following requisites are essential to the contracts of pledge and mortgage:

(1)That they be constituted to secure the fulfillment of a principal obligation;


(2)That the pledgor or mortgagor be the absolute owner of the thing pledged or mortgaged;
(3)That the persons constituting the pledge or mortgage have the free disposal of their property
and in the absence thereof, that they be legally authorized for the purpose.
(4)Third persons who are not parties to the principal obligation may secure the latter by pledging or
mortgaging their own property.
Article 2086. The provisions of article 2052 are applicable to a pledge or mortgage.
[A guaranty cannot exist without a valid obligation. However, it may guarantee the performance of a
voidable or unenforceable contract or a natural obligation]
Article 2087. It is also of the essence of these contracts that when the principal obligation becomes
due, the things in which the pledge or mortgage consists may be alienated for the payment to the
creditor.
WHAT IS PLEDGE?
It is a contract by virtue of which the debtor delivers to the creditor or to a third person a movable
or a document involving incorporeal rights for the purpose of securing the fulfillment of a
principal obligation with the understanding that when the obligation is fulfilled, the thing delivered
shall be returned with all its fruits and accessions.

What are the kinds of pledge?


Pledge may be either:
1. Voluntary or conventional (created by agreement of the parties);
2. Legal (by operation of law).

What are the characteristics of pledge? [RAUS]


Pledge is:
1. Real, because it is perfected by delivery of the thing pledged.
2. Acessory, because it has no independent existence.
3. Unilateral, because it creates an obligation solely on the part of the creditor to return the
thing pledged upon fulfillment of the principal obligation.
4. Subsidiary, because the obligation of the creditor does not arise until fulfillment of the
principal obligation.

WHAT IS THE CONSIDERATION IN PLEDGE?


If the pledgor is also the debtor, the consideration is the principal contract.
If the pledgor is a third person, the cause it the compensation received or the liberality of the pledgor.

WHAT ARE THE DIFFERENCES BETWEEN PLEDGE AND MORTGAGE?


1. Mobility – pledge is constituted on movables; mortgage on immovables.
2. Delivery – pledge requires delivery for perfection; mortgage does not.

Cayo IID 2002 PAGE 29


3. Requisites to bind third person/s – pledge, to bind third persons must be in a public
instrument; mortgage, must be registered in the proper registry.

A LOAN IS SECURED BY BOTH A PLEDGE AND A GUARANTY. CAN THE CREDITOR REFUSE
PAYMENT BY THE GUARANTOR AND CHOOSE TO FORECLOSE IN ORDER TO SATISFY THE
DEBT?
No, payment by the guarantor cannot be refused.
WHAT ARE THE ESSENTIAL REQUISITES OF PLEDGE AND MORTGAGE? [PRADO]
1. Purpose - To secure fulfillment of principal obligation;
2. Real – There must be delivery of the thing.
3. Alienation – when the principal obligation becomes due and the debtor defaults, the thing
may be alienated to satisfy the former.
4. Disposal – Pledgor/mortgagor must have free disposal of the thing or capacity to dispose.
5. Ownership – Pledgor/mortgagor must be the absolute owner of the thing;

PURPOSE: To secure fulfillment of a principal obligation


WHAT IF THE THING PLEDGED/MORTGAGED IS SUBSEQUENTLY LOST; WHO BEARS THE
LOSS? IS THE PRINCIPAL OBLIGATION EXTINGUISHED?
The pledgor bears the loss. Remember that there hasn’t been transfer of ownership.
The principal obligation is of course not extinguished, the pledge/mortgage is only accessory.
However, the debtor must replace the thing or lose the benefit of the period.
Pledge/mortgage is a direct lien on the property. It is better than guarantee because the property
pledged can be sold upon default by the debtor, unlike in guaranty where several requirements have
to be complied with first.
PROBLEM: D TRANSFERS PROPERTY TO C AND AT THE SAME TIME EXECUTES AN
INDEMNITY AGREEMENT; OR D TRANSFERS PROPERTY TO C TO SECURE AN EXISTING
OBLIGATION. HOW WILL THE TRANSFER BE CHARACTERIZED?
Both transfers will be characterized as pledges.

REAL: There must be delivery of the thing to perfect the contract.


An agreement to pledge, when there is breach, gives rise to damages.

ALIENATION: When the principal obligation becomes due and the


debtor defaults, the thing may be alienated to satisfy the former.
DOES THE CREDITOR HAVE TO GO TO COURT TO ENFORCE THE PLEDGE OR MORTGAGE?
No, to require litigation would be to nullify the lien and defeat the purpose of the contract.

FREE DISPOSAL:

Cayo IID 2002 PAGE 30


WHAT DO “FREE DISPOSAL” AND “CAPACITY TO DISPOSE” OF THE PROPERTY MEAN?
Free disposal means that the property is not subject to any claim by a third person.
Capacity to dispose means that though the pledgor/mortgagor does not have free disposal, the third
person with a claim authorized him to dispose (tingin ko lang).

In case of corporations, the board should adopt a resolution to approve the pledge/mortgage. If what
is to be pledged or mortgaged constitutes all of the corporation’s assets, 2/3 of outstanding capital
stock must approve.

Rule on consent:
If pledgor/mortgagor is married, consent of spouse is needed; if agent, authorization of principal.

For married persons – how to wiggle out of a pledge or mortgage agreement:


Pledge or mortgage your conjugal property without your spouse’s signature. In case the property is
foreclosed, you can raise the defense that there was no consent (remember, half consent is no
consent!)
What if the pledge was constituted to secure an obligation of the family business, doesn’t this redound
to the benefit of the conjugal partnership?
No, JPSP said that the pledge of conjugal property con only be considered to redound to the benefit of
the partnership if the family business is constituting pledges.
If you are the pledgee/mortgagee, check if pledgor/mortgagor has authority to dispose of the
property.

Another example on free disposal or legal authority:


Ex. Pledgor corporation is placed under receivership. The corporation cannot pledge shares of stock
because pledge is a disposition requiring court approval.

OWNERSHIP:
CAN FUTURE PROPERTY BE PLEDGED?
No, it is essential that the pledgor be the absolute owner of the thing.
Note: It is the sale and not the registration in the LTO that transfers ownership of a vehicle.
Note: A co-owner can only pledge/mortgage his ideal share in the co-ownership.
Note: A mortgagor can rely on what is on the face of the Torrens title.

WHAT IS MEANT BY ABSOLUTE OWNERSHIP?


BOTH BENEFICIAL AND LEGAL TITLE must vested in the pledgor/mortgagor
Ex. Trustee is legal owner of shares of stock; trustor is beneficial owner: Neither can pledge the
shares.
Pledge/mortgage can’t be constituted without a principal obligation even if there is a subsequent
principal obligation. This is different from situation where the lender extends a credit line for 1M,
though borrower has not yet drawn, the credit line can still be secured via pledge/mortgage.
Ex. deed of assignment/absolute sale to secure fulfillment of obligation this is a mortgage or an
implied trust according to the SC.
The pledgor/mortgagor must be absolute owner of the thing or the property. The creditor may rely on
the title/stock certificate if there is no notice of defect in title.
However, failure of the pledgor to present the thing is a red flag that should put the pledgee on guard
as to the pledgor’s right to pledge the thing.

Cayo IID 2002 PAGE 31


Though the pledgor must own the thing and have free disposal of it, see the following problem
discussed in class:
Ex. On day 1, stocks are sold to X with the condition that the sale will be effective if X tops the bar.
On day 2, X pledges the stocks.
On day 3, the bar exam results come out, with X in the number one spot.
Is the pledge valid?
Yes, the pledge is valid. Remember Oblicon, conditional obligations? The effects of a conditional
obligation to give, when the condition happens, retroact to the date of the constitution of the
obligation. OWNERSHIP RETROACTS TO DAY 1.

In the above condition, what if the condition is resolutory?


As long as the pledge is registered in a public document, it is valid and binding as to third persons.
Ex: Day 1 - X receives from A shares of stock with the resolutory condition that they shall be returned
to A if X does not pass the bar.
Day 2 – X pledges the shares.
Day 3 – X fails the bar.
Is the pledge valid?
Yes. As long as the pledgee registered the pledge in a public instrument, such pledge is binding on A.
*But if you use the argument that the effects retroact, doesn’t that mean that when X pledged the
things, he wasn’t the owner? I suppose the public instrument is stronger than the legal fiction.
CAN THE CREDITOR IMMEDIATELY ACCEPT A PLEDGE FURNISHED BY A DEBTOR IF THE
PLEDGE BELONGS TO A THIRD PERSON?
No, the creditor cannot require on the word of the pledgor/mortgagor alone, he must exercise due
care and make sure the pledge/mortgage has given consent. This is especially true in the banking
industry, which is impressed with public interest.
WHAT IS THE CONSEQUENCE THEN IF THE CREDITOR DOES NOT VERIFY WITH THE
PLEDGOR/MORTGAGOR?
The pledge/mortgage is null and void. Article 599 gives the owner of a movable who has been
unlawfully deprived thereof the right to recover the same.

(1) Article 2088. The creditor cannot appropriate the things given by way of pledge or mortgage, or
dispose of them. Any stipulation to the contrary is null and void.
WHAT DOES THE CREDITOR WITH THE PLEDGE/MORTGAGE WHEN THE DEBTOR DEFAULTS?
The creditor can move for the sale of the thing pledged or mortgaged.
WHAT IF THE CREDITOR WANTS TO ACQUIRE THE THING?
He may purchase it at the public auction.
WHAT IF THERE IS A STIPULATION THAT THE CREDITOR WILL ACQUIRE THE THING UPON
DEFAULT?
The stipulation (pactum commissorium) is null and void.
WHAT ARE THE REQUISITES FOR PACTUM COMMISSORIUM TO EXIST?
1. There should be a pledge/mortgage;
2. There should be a stipulation for AUTOMATIC appropriation or the thing in case of default by
the debtor.
ARE THERE ANY EXCEPTIONS TO PACTUM COMMISSORIUM?

Cayo IID 2002 PAGE 32


Yes, Article 2112 provides that if the thing pledged or mortgaged is not sold in two public auctions,
the creditor may appropriate the same.
WHAT IS THE REASON FOR THE PROHIBITION?
The value of the thing pledged or mortgaged is usually more than the amount of the obligation.
WHAT HAPPENS TO THE CONTRACT OF PLEDGE/MORTGAGE IF THERE IS A STIPULATION OF
PACTUM COMMISSORIUM; IS IT VOID?
No, only the stipulation is void; the principal contract will subsist.
HOW CAN YOU OPT OUT OF THE PROHIBITION ON PACTO COMMISSORIO?
1. You can enter into another contract subsequent to the pledge/mortgage. The prohibition
applies only to stipulations made in the contract of pledge/mortgage.
2. The debtor can voluntarily cede the property to the creditor. This would in effect be a novation
of the pledge/mortgage.
3. There can be a stipulation where the debtor merely promises to sell; non-compliance would
give the creditor, not a right to the property, but an action for damages.
4. There can be a stipulation granting the creditor authority to take possession and not
ownership of the property upon foreclosure.

Examples on pactum commissorium:


Ex. X corporation pledges shares; the pledge agreement states that pledgee has authority to instruct
Corporate Secretary of X to transfer shares in name of pledgee in case of default. VALID?
NO. The execution of document transferring the shares is only a confirmation of the sale that was
already consummated automatically.
Ex. If the agreement is that, upon default, pledgee sells the things pledged at market price and
applies profits to the outstanding obligation. Valid?
Yes. There is no automatic transfer of ownership. In fact, the sale of the thing to satisfy the obligation
is the essence of pledge.
Ex. Upon default, pledgor conveys property to pledgee by dation; and for the purpose, pledgee is
attorney in fact of pledgor. Valid?
YES. It is not automatic; there is need for another agreement to be entered into.
Ex. Pledgee has the option to purchase the thing upon default at price certain. Valid?
Yes. There must be a subsequent sale; it is not automatic.
Remember, for PC to exist, the EFFECTIVE ACT IS DEFAULT, upon which, there is automatic transfer
of ownership.

Article 2089. A pledge or mortgage is indivisible, even though the debt may be divided among the
successors in interest of the debtor or of the creditor.
Therefore, the debtor’s heir who has paid a part of the debt cannot ask for the proportionate share of
extinguishment of the pledge or mortgage as long as the debt is not completely satisfied.
Neither can the creditor’s heir who has received his share of the debt return the pledge or cancel the
mortgage, to the prejudice of the other heirs who have not yet been paid.
From these provisions is excepted the case in which, there being several things given in mortgage or
pledge, each one of them guarantees only a determinate portion of credit.
The debtor, in this case, shall have the right to the extinguishment of the pledge or mortgage as the
portion of the debt for which each thing is specially answerable is satisfied.
Article 2090. The indivisibility of a pledge or mortgage is not affected by the fact that the debtors
are not solidarily liable.

Cayo IID 2002 PAGE 33


WHAT DO YOU MEAN PLEDGE/MORTGAGE IS INDIVISIBLE?
Ex: 1M Loan. It was secured by REM. The REM covered several (100) condominium units. In
accordance with the schedule, there was payment of 100K, can you ask release of corresponding
amount of units?
No release. Pledge is indivisible.
WHAT ARE THE EXCEPTIONS TO INDIVISIBILITY:
1. Where each one of several thing guarantees a determinate portion of credit.
Ex: If you have 100 mortgages securing corresponding portion of the loan, then when the
corresponding portion is paid, the corresponding pledge/mortgage is extinguished. All 100 mortgages
may be in the same document.
Or, if the parties agree to allow partial discharge of the pledge/mortgage. How? Cancel
pledge/mortgage and constitute a new pledge/mortgage.The downside is that you must again pay
doc. stamps and reg. fees, unlike in the document with 100 mortgages, where the fees are only paid
once.
2. If there was only partial release of the loan. CB v. CA. The bank only released a portion of the
loan; the court ordered a corresponding portion of the REM to be released.
3. Where there was failure of consideration. Creditor took over management but the business
failed.

Article 2091. The contract of pledge or mortgage may secure all kinds of obligations, be they pure
or subject to a suspensive or resolutory condition.
Pledge/mortgage may secure all sorts of valid, voidable, unenforceable obligations.
Article 2092. A promise to constitute a pledge or mortgage gives rise only to a personal action
between the contracting parties, without prejudice to the criminal responsibility incurred by him
who defrauds another, by offering in pledge or mortgage as unencumbered, things which he knew
were subject to some burden, or by misrepresenting himself to be the owner of the same.

PROVISIONS APPLICABLE ONLY TO PLEDGE

Article 2093. In addition to the requisites prescribed in article 2085, it is necessary, in order to
constitute the contract of pledge, that the thing pledged be placed in the possession of the
creditor, or of a third person by common agreement.
Remember. Pledge/mortgage are real contracts.
If you agree, but don’t deliver to the pledgee or a third person/s, there is no pledge but there is an
agreement to enter into a pledge.
Can delivery be made to the pledgor?
Yes, if he is acting as agent of pledgee or where the thing pledged is so unwieldy as to make delivery
impossible, constructive delivery is allowed.
What may be the objects of pledge?
Movables within the commerce of man.
Delivery may be the actual thing or a title (certificates of deposit, stocks).
Must be indorsed. Shares of stock not negotiable so no indorsement is required, however, for safety
reasons, the same may be required.

Article 2094. All movables which are within commerce may be pledged, provided they are
susceptible of possession.

Cayo IID 2002 PAGE 34


Article 2095. Incorporeal rights, evidenced by negotiable instruments, bills of lading, shares of
stock, bonds, warehouse receipts and similar documents may also be pledged. The instrument
proving the right pledged shall be delivered to the creditor, and if negotiable, must be indorsed.
Article 2096. A pledge shall not take effect against third persons if a description of the thing
pledged and the date of the pledge do not appear in a public instrument.

The problem here is: how do third persons check if the thing is pledged when the thing isn’t
represented by some sort of title which can be annotated?
They can’t but they should exercise diligence. Red flags would be failure or inability of debtor to show
the thing or the title to the thing.

No requirement as to form but to affect third persons, it must be in a public instrument (notarized
document).

Article 2097. With the consent of the pledgee, the thing pledged may be alienated by the pledgor or
owner, subject to the pledge.
The ownership of the thing pledged is transmitted to the vendee or transferee as soon as the pledgee
consents to the alienation, but the latter shall continue in possession.
Ex: pledgor pledges property to pledgee to secure a loan. Pledge is in a public instrument. Pledgor sell
property to third person/s without notice to pledgee – sale is valid but transfer of ownership is
suspended until pledgee consents.
Why would the pledgee want to be informed – administrative purposes; who gets property when
obligation is paid.

Article 2098. The contract of pledge gives a right to the creditor to retain the thing in his possession
or in that of a third person to whom it has been delivered, until the debt is paid.
Article 2099. The creditor shall take care of the thing pledged with the diligence of a good father of
a family; he has a right to the reimbursement of the expenses made for its preservation, and is
liable for its loss or deterioration, in conformity with the provisions of this Code.
Article 2100. The pledgee cannot deposit the thing pledged with a third person, unless there is a
stipulation authorizing him to do so.
The pledgee is responsible for the acts of his agents or employees with respect to the thing pledged.
Remedy of pledgor if pledgee deposits it with a third party without authority?
The pledgor may demand extrajudicial deposit of the thing under 2104 or deposit with a third
person/s in 2106.

If the pledgee deposits the thing with a third person without authorization, can the pledgor demand
resolution of the pledge agreement?
Yes. Substantial breach under 1191 gives the injured party the right to resolve the obligation. It can
be argued that the principal consideration was that the custodian be the pledgee; now if the creditor
transfers possession, it’s a principal breach.

Article 2101. The pledgor has the same responsibility as a bailor in commodatum in the case under
article 1951.
[The pledgor who, knowing the flaws of the thing pledged, does not advise the pledgee of the same,
shall be liable to the latter of the damages which he may suffer by reason thereof.]
Article 2102. If the pledge earns or produces fruits, income, dividends, or interests, the creditor
shall compensate what he receives with those which are owing him; but if none are owing him, or
insofar as the amount may exceed that which is due, he shall apply it to the principal. Unless there
is a stipulation to the contrary, the pledge shall extend to the interest and earnings of the right
pledged.

Cayo IID 2002 PAGE 35


In case of a pledge of animals, their offspring shall pertain to the pledgor or owner of animals
pledged, but shall be subject to the pledge, if there is no stipulation to the contrary.
The creditor who receives the fruits should apply them to whatever amount is owing (obligations due
and payable), if not due, the fruits just form part of the pledge.

If the period is for the benefit of the pledgee, even if the obligation is not due, he may compensate
against the interest or the principal, as the case may be.
Ex: Lender lends Borrower money, payable upon demand. To secure the loan, B pledges a goat. Here
the benefit of the period is for the creditor, L. L may then take the goat’s milk and offspring and
compensate against what is owing him even if the obligation is not yet due.

Article 2103. Unless the thing pledged is expropriated, the debtor continues to be the owner
thereof.
Nevertheless, the creditor may bring the actions which pertain to the owner of the thing pledged in
order to recover it from, or defend it against a third person.
If the thing is expropriated, the thing will continue with respect to the thing given. labo!

Article 2104. The creditor cannot use the thing pledged, without the authority of the owner, and if
he should do so, or should misuse the thing in any other way, the owner may ask that it be
judicially or extrajudicially deposited.
When the preservation of the thing pledged requires its use, it must be used by the creditor but only
for that purpose.

The creditor can only use the thing if he is authorized or its preservation requires use.
If he misuses it, the pledgor can demand extrajudicial deposit.

Article 2105. The debtor cannot ask for the return of the thing pledged against the will of the
creditor, unless and until he has paid the debt and its interest, with expenses in a proper case.
Article 2106. If through the negligence or willful act of the pledgee, the thing pledged is in danger of
being lost or impaired, the pledgor may require that it be deposited with a third person.
Though the pledgor cannot demand return of the thing unless the obligation is fulfilled, if the thing
pledged is in danger of being lost or impaired through the pledgee’s willful act or negligence, he may
require its deposit with a third person.

Article 2107. If there are reasonable grounds to fear the destruction or impairment of the thing
pledged, without the fault of the pledgee, the pledgor may demand the return of the thing, upon
offering another thing in pledge, provided the latter is of the same kind as the former and not of
inferior quality, and without prejudice to the right of the pledgee under the provisions of the
following article.
The pledgee is bound to advise the pledgor, without delay, of any danger to the thing pledged.
Article 2108. If, without the fault of the pledgee, there is danger of destruction, impairment, or
diminution in value of the thing pledged, he may cause the same to be sold at a public sale. The
proceeds of the auction shall be a security for the principal obligation in the same manner as the
thing originally pledged.
If the thing is in danger of diminution or destruction, without the pledgee’s fault, the pledgor may
demand its return, provided he replaces it with another of the same kind and quality.
Despite the pledgor’s right above, in the same situation, the pledgee may opt to sell the thing and
keep the proceeds; the pledgee’s right takes precedence over the pledgor’s. In this case, the proceeds
of the sale shall be security for the debt.
In 2108, upon due date, if the cash value is less than the principal obligation, the creditor can still
recover the balance from the debtor, unlike in foreclosure. this looks important.

Cayo IID 2002 PAGE 36


The pledgor can question the sale, alleging that he could have obtained a better price.

Article 2109. If the creditor is deceived on the substance or quality of the thing pledged, he may
either claim another thing in its stead, or demand immediate payment of the principal obligation.

This is an instance where the debtor loses the benefit of the period: If the debtor dupes the creditor
as to the quality of the thing, the creditor may demand immediate payment or delivery of another
security.

Article 2110. If the thing pledged is returned by the pledgee to the pledgor or owner, the pledge is
extinguished. ANY STIPULATION TO THE CONTRARY SHALL BE VOID.
If subsequent to the perfection of the pledge, the thing is in the possession of the pledgor or owner,
there is a prima facie presumption that the same has been returned by the pledgee. This
same presumption exists if the thing pledged is in the possession of a third person who has
received it from the pledgor or owner after the constitution of the pledge.
If after the perfection of the pledge, the property is in the possession of the pledgor, as owner, the
presumption is that it was returned and extinction of the pledge, UNLESS the owner holds it as agent
of the pledgee.

*Article 2111. A statement in writing by the pledgee that he renounces or abandons the pledge is
sufficient to extinguish the pledge. For this purpose, neither the acceptance by the pledgor or
owner, nor the return of the thing pledged is necessary, the pledgee becoming a depositary.
PROBLEM: TO SECURE HIS LOAN, BORROWER PLEDGED HIS CAR TO LENDER. OUT OF THE KINDNESS
OF HIS HEART, LENDER COMPOSED A LETTER RENOUNCING THE PLEDGE. HE USED THE CAR TO
DRIVE TO THE POST OFFICE AND MAILED THE LETTER.
WHILE DRIVING HOME, LENDER SPOTTED BORROWER WITH LENDER’S WIFE AND FELT VERY ANGRY
AND JEALOUS.
WHEN BORROWER RECEIVED THE LETTER, HE WENT TO LENDER’S HOUSE TO RECOVER THE CAR BUT
LENDER REFUSED AND TOLD BORROWER TO PISS OFF. CAN LENDER REFUSE TO RETURN THE CAR?
No. See Article 2111.

Article 2112. The creditor to whom the credit has not been satisfied in due time, may proceed
before a Notary Public to the sale of the thing pledged. This sale shall be made at a public auction,
and with notification to the debtor and the owner of the thing pledged in a proper case, stating the
amount for which the public sale is to be held.
If at the first auction the thing is not sold, a second one with the same formalities shall be held; and
if at the second auction there is no sale either, the creditor may appropriate the thing pledged. In
this case he shall be obliged to give an acquittance for his entire claim.
WHAT ARE THE FORMALITIES REQUIRED FOR THE NOTARIAL SALE?
(1) the debt is due and unpaid;
(2) the sale must be at a public auction;
(3) there must be notice to the pledgor and owner, stating the amount due; and
(4) the sale must be with the intervention of a notary public.

How is the public sale conducted?


Default rule: Proceed before a Notary Public and ask him to conduct a notarial sale. The notary
supervises the sale of the pledged property, drafts the rules and notifies the debtor and the owner.
Is there a period required for notification?

Cayo IID 2002 PAGE 37


No particular period is required by law. Notice can be given right before close of office the day
preceding the sale. Before that date, debtor already defaulted; he should have known a notarial sale
was forthcoming.
The reason, according to JPSP, is, if there were a period, the pledgor would be able to litigate and
obtain an injunction.

Can it be a private sale?


Ex: stocks pledged, listed on the PSE and just coursed through a broker. Yes – there is no express
prohibition. But see the de Leon book under Article 2112.

Exception to pactum commissorium if the thing is not sold after two sales, the creditor may
appropriate the thing and it shall be considered as full payment for the entire obligation.

Article 2113. At the public auction, the pledgor or owner may bid. He shall, moreover, have a better
right if he should offer the same terms as the highest bidder.
The pledgee may also bid, but his offer shall not be valid if he is the only bidder.
The pledgor is allowed to bid and all things being equal, his bid shall be preferred over that of others.
The law wants to conserve the property in the owner.
The pledgee may also bid, but his offer shall not be valid if he is the only bidder because the law
seeks to prevent fraud. Fraud is possible if the parties had stipulated that the debtor shall be allowed
to the excess and the creditor, who is bidding alone, bids low.

Article 2114. All bids at the public auction shall offer to pay the purchase price at once. If any other
bid is accepted, the pledgee is deemed to have been received the purchase price, as far as the
pledgor or owner is concerned.
Pledgee can waive cash requirement, but that is his lookout.

Article 2115. The sale of the thing pledged shall extinguish the principal obligation, whether or not
the proceeds of the sale are equal to the amount of the principal obligation, interest and expenses
in a proper case.
If the price of the sale is more than said amount, the debtor shall not be entitled to the excess,
unless it is otherwise agreed. If the price of the sale is less, neither shall the creditor be entitled to
recover the deficiency, notwithstanding any stipulation to the contrary.
The obligation is extinguished when the pledge is sold regardless of whether the proceeds are less or
more than the amount of the obligation. Unlike in a mortgage, there can be recovery of deficiency.
IN PLEDGE, YOU CAN STIPULATE THAT THE DEBTOR WILL BE ENTITLED TO THE EXCESS
BUT YOU CAN’T STIPULATE THAT THE CREDITOR WILL BE ALLOWED TO RECOVER
DEFICIENCY.
PROBLEM: IN THE PLEDGE AGREEMENT, THE PARTIES STIPULATED THAT, IN CASE OF NOTARIAL
SALE, THE PLEDGOR SHALL BE ENTITLED TO THE EXCESS AND THE PLEDGEE SHALL BE ENTITLED TO
RECOVER THE DEFICIENCY. ARE THE STIPULATIONS VALID?
The stipulation that the debtor shall be entitled to the excess is valid. The stipulation giving the
creditor the right to recover the deficiency is void. See Article 2115.

HOW DO YOU GUARD AGAINST THE SITUATION OF NOT BEING ABLE TO RECOVER THE DEFICIENCY
IF YOU ARE THE PLEDGEE?
Set a minimum bid (if this is actually allowed; JPSP says yes, book says no)
OR
Instead of selling the thing, just sue for the entire obligation.

Cayo IID 2002 PAGE 38


OR
Stipulate that if the value of the pledge goes under a certain amount, then the debtor shall be obliged
to pledge additional securities.
Ex: 1M obligation, 1.5M worth of stocks pledged; stipulate that if the value goes below 1.3M then the
debtor will be obliged to pledge additional securities.

Without such a stipulation, can Article 2108 have the same effect?
Ex: 1M obligation, 1.5M worth of stocks pledged. When the stocks go down top 1.4M, can you claim
that the value of the pledge is diminishing and then choose to sell the stocks for 1.4M, keeping the
profits as security, pursuant to 2108?
JPSP says: “Maybe but speculative.” Probably not if the change in price is just a day-to-day
fluctuation.

PROBLEM: 1M IS SECURED BY A 700K MORTGAGE AND A 900K PLEDGE. IF YOU ARE THE LENDER,
AND THE BORROWER DEFAULTS, WHICH SECURITY TO YOU GO AFTER FIRST?
Go against the REM first, then take the whole pledge and make $$$! In REM, unlike in pledge, the
debtor is entitled to the excess and the creditor is entitled to recover the deficiency, as a default rule.

Article 2116. After the public auction, the pledgee shall promptly advise the pledgor or owner of the
result thereof.

This is to allow the debtor to take reasonable steps if he suspects that the sale was not honest.

Article 2117. Any third person who has any right in or to the thing pledged may satisfy the principal
obligation as soon as the latter becomes due and demandable.
The creditor cannot refuse payment by a third person WITH AN INTEREST in the thing pledged.
Third party can be a buyer of the thing or someone with a junior lien.
Why would a third person with a junior lien want to pay the obligation? The property may be more
valuable than the obligation and he may want his lien to become senior.

Article 2118. If a credit which has been pledged becomes due before it is redeemed, the
pledgee may collect and receive the amount due. He shall apply the same to the payment of his
claim, and deliver the surplus, should there be any, to the pledgor.
Under this article, the thing pledged is a credit which has become due. The creditor can thus collect
the amount due and compensate, DELIVERING THE SURPLUS TO THE DEBTOR.

The pledgee has the duty to collect any due credits, in line with the ordinary diligence required of him.

Article 2119. If two or more things are pledged, the pledgee may choose which he will cause to be
sold, unless there is a stipulation to the contrary.
He may demand the sale of only as many of the things as are necessary for the payment of the debt.
PROBLEM: A 1.5M DEBT IS SECURED BY 2M WORTH OF SMC SHARES. IF YOU ARE THE PLEDGEE,
HOW WOULD YOU SELL?
Sell all. You are not required to sell by piece.
Pledgor can restrict only if there are two pledges securing the obligation.

Article 2120. If a third party secures an obligation by pledging his own movable property under the
provisions of article 2085 he shall have the same rights as a guarantor under articles 2066 to
2070, and articles 2077 to 2081.

Cayo IID 2002 PAGE 39


He is not prejudiced by any waiver of defense by the principal obligor.
The third party pledgor is entitled to:
1. Indemnity;
2. Subrogation;
3. Pledgor is released if creditor accepts property in payment of debt;
4. Release in favor of one pledgor benefits all;
5. Extension granted to debtor extinguishes pledge;
6. Pledgors are released from obligation if by some act of the creditor, there can be no
subrogation;
7. Pledgor may set up defenses inherent in the debt.

Article 2121. Pledges created by operation of law, such as those referred to in articles 546, 1731,
and 1994, are governed by the foregoing articles on the possession, care and sale of the thing as
well as on the termination of the pledge. However, after payment of the debt and expenses, the
remainder of the price of the sale shall be delivered to the obligor.
Article 2122. A thing under a pledge by operation of law may be sold only after demand of the
amount for which the thing is retained.
The public auction shall take place within one month after such demand. If, without just grounds,
the creditor does not cause the public sale to be held within such period, the debtor may require
the return of the thing.
In pledges by operation of law, the remainder of the sale price shall be delivered to the debtor.
The foregoing articles govern the following pledges by operation of law; BUT after sale, the excess, if
any, is returned to the pledgor:
• Possessor in good faith may retain the thing on which he spent for necessary expenses until
he is reimbursed.
• He who works on a movable may retain the same until paid for the work.
• Depositary may retain thing until paid for the deposit.
• Agent may retain objects of agency until reimbursed by principal.
• Laborer’s wages are considered a lien on goods manufactured or work done.
How about any deficiency? I think creditor will be entitled to recover because here, he did not
accept the pledge voluntarily and the reason for prohibiting recovery is absent (the reason being that
creditors should know not to lend more than what can be secured).

Article 2123. With regard to pawnshops and other establishments, which are engaged in making
loans secured by pledges, the special laws and regulations concerning them shall be observed,
and subsidiarily, the provisions of this Title.

Cayo IID 2002 PAGE 40


REAL MORTGAGE

Art. 2124. Only the following property may be the object of a contract of mortgage:

(1) Immovables;
(2) Alienable real rights in accordance with the laws, imposed upon immovables.

Nevertheless, movables may be the object of a chattel mortgage.

Mortgage (def). A real estate mortgage is a contract whereby the debtor secures to the creditor
the fulfillment of a principal obligation, specially subjecting to such security immovable property
or real rights over immovable property in case the principal obligation is not complied with at the
time stipulated.

What are the characteristics of the contract of mortgage?

Mortgage is a real, accessory, and subsidiary contract.

Who takes possession of the mortgaged property?

As a general rule, the mortgagor retains possession of the property mortgaged.

However, it is not an essential requisite of the contract of mortgage that the property remains in
the possession of the mortgagor. If the mortgagor delivers the property to the mortgagee, it
can still be a contract of mortgage, plus some other contract.

What is the consideration in a contract of mortgage?

Since mortgage is an accessory contract, the consideration is the same as that of the principal
contract.

What are the kinds of real mortgage?

1. Voluntary – Agreed to between the parties or constituted by the will of the owner of the
property

2. Legal – Required by law to be executed in favor of certain persons

3. Equitable – Lacks the proper formalities of mortgage but shows the intention of the
parties to make the property as a security for a debt.

What is the subject matter of real mortgage

1. Immovables
2. Alienable rights imposed upon immovables

Can you mortgage future property?

Future property CANNOT be the object of a contract of mortgage. One cannot constitute a
mortgage on “any other property he might have now and those he might acquire in the

Cayo IID 2002 PAGE 41


future.” Remember that one of the essential requisites of mortgage is that the mortgagor
should be the absolute owner of the thing mortgaged.

But a stipulation which says that the mortgage covers future improvements upon real property
already mortgaged is valid. This is because these future improvements are deemed included in
the real property by accession; they are not separate from the real property already subject of
the mortgage.

Art. 2125. In addition to the requisites stated in Article 2085, it is indispensable, in order that a
mortgage may be validly constituted, that the document in which it appears be recorded in the
Registry of Property. If the instrument is not recorded, the mortgage is nevertheless binding
between the parties.

The persons in whose favor the law establishes a mortgage have no other right than to
demand the execution and the recording of the document in which the mortgage is formalized.

Art. 1357. If the law requires a document or other special form, as in the acts and contracts
enumerated in the following article, the contracting parties may compel each other to observe
that form, once the contract has been perfected. This right may be exercised simultaneously
with the action upon the contract.

Art. 1358. The following must appear in a public document:

(1) Acts and contracts which have for their object the creation, transmission, modification, or
extinguishment of real rights over immovable property…

What are the requisites of real mortgage?

1. It must be constituted to secure a principal obligation.

2. The mortgagor must be the absolute owner of the thing mortgaged.

3. He must have free disposal of the thing or otherwise be authorized to do so.

4. When the principal obligation becomes due, the property mortgaged may be alienated
for the payment to the creditor.

5. To prejudice third persons, the mortgage must be recorded in the Registry of Property.

If the first four requisites are present, there is already a valid mortgage between the parties –
mortgagor and mortgagee.

But to affect third persons, there is a need to comply with the fifth requisite: The document of
mortgage must be recorded in the Registry of Property. This is because recording the
document in the Registry of Property serves as notice to 3rd persons. This is similar to the
requirement in pledge that the pledge be in a public document.

Can there be an oral mortgage?

Cayo IID 2002 PAGE 42


As between the parties, YES. As long as the four essential requisites above are present, there
is already a mortgage between the parties. It need not be in writing in order to be enforceable
since it is not covered by the Statute of Frauds.

But the oral mortgage is not binding against third persons. And the mortgagee cannot register
the mortgage in the Registry of Property if it is an oral mortgage. So his remedy is to invoke
Art. 1357 and 1358. 1357 provides that if there is already a valid contract, one party can
compel the other party to observe the proper form. In this case, since there is already a valid
mortgage between the parties, the mortgagee can compel the mortgagor to execute a public
document of mortgage, so that the mortgagee can then register it in the Registry of Property.

Remember that 1357 is only for convenience. Its purpose is to compel the mortgagor to
execute a public document, so that the mortgagee can register the mortgage. It does not
determine the validity or even the enforceability of the mortgage between the parties. Before
you can invoke it, there has to be a valid mortgage first.

Once the previously oral mortgage is in a public document and is subsequently registered in the
Registry of Property, it becomes binding on third persons.

Procedure: What happens when you enter into a contract of


mortgage?

Step 1: Execute the document of mortgage

Step 2: Go to a notary public, who will notarize the document.

Step 3: Pay the documentary stamp tax within the first five days of the succeeding month. The
doc
stamp tax is a percentage of the value of the property mortgaged.

Step 4: Go to the Office of the Register of Deeds and pay the registration fees. Before you pay
the
registration fees, the government will require you to update payment of realty taxes on
the property. After payment of the registration fees, the mortgage will be annotated on
the title.

Problem: Mortgagor mortgages a house and lot worth 500K to Mortgagee to secure a principal
obligation of “100K and any and all future indebtedness.” The mortgage is registered.
Meanwhile, Mortgagor owes another creditor, X, 500K. The total indebtedness of Mortgagor to
Mortgagee eventually reaches 500K. On due date, Mortgagor fails to pay both X and
Mortgagee. The house and lot is his only property. X is able to obtain a writ or attachment on
the house and lot. Who has a better right to the house and lot – X or mortgagee?

Mortgagee has a better right with respect only to 1/5 of the house and lot. This is because
the mortgage was registered only to the extent of 100K, and not to the “any and all future
debts.” Therefore, the mortgage is binding on third persons only with respect to the 100K debt,
or 1/5 of the house. X can argue on two grounds:

1. That Mortgagee paid doc stamp taxes based only on the 100K debt, not on the
succeeding 400K debt. So he even cheated the government of its revenues in this
case.

Cayo IID 2002 PAGE 43


2. Besides, at the time of the mortgage, the 400K debt was non-existent.

Therefore, X has a better right with respect to the 4/5 which was not registered.

How does mortgagee opt out of this problem?

1. He can do a credit line arrangement in which he will give the debtor a ceiling up to which
he can borrow. The mortgage deed will say that the principal obligation is 500K, but
debtor has the choice of asking for a release of funds below this ceiling. This way, the
mortgagee is sure that the entire 500K loan is registered. But this is costly, since the
doc stamp tax will be based on the ceiling and not on the actual amount released.

2. The better solution is that the mortgagee should execute and register a new document
each time he releases funds to the mortgagor/debtor.

What happens if the mortgage is void?

If for some reason, the mortgage is void, the principal obligation subsists. What is lost is only
the right of the creditor to foreclose the mortgage in order to satisfy the principal obligation.
Moreover, even if the mortgage itself is void, the mortgage deed remains as proof of the
principal obligation.

Art. 2126. The mortgage directly and immediately subjects the property upon which it is
imposed, whoever the possessor may be, to the fulfillment of the obligation for whose security
it was constituted.

In guaranty, the property of the guarantor is not subjected to a lien. The action of the creditor is
against the guarantor himself and not against his property. The creditor would still have to sue
the guarantor, obtain judgment, execute it, etc.

On the other hand, in mortgage, the property is subjected to a lien. It creates a real right which
is inseparable from the property mortgaged. It is enforceable against the whole world (provided
it is registered). Until the principal obligation is discharged, the mortgage follows the property
wherever it goes and subsists even if the ownership changes.

So if the mortgagor sells the mortgaged property, the property still remains subject to the
fulfillment of the obligation secured by it. All subsequent purchasers must respect the
mortgage, as long as it is registered, or even if it is not registered, if the purchaser knew that it
was mortgaged.

The mortgagee has a right to rely in good faith on what appears on the certificate of title of the
mortgagor. In the absence of anything to excite suspicion, he is under no obligation to look
beyond the certificate.

Does the mortgagor lose his title to the property mortgaged?

No. A mortgage does not involve a transfer, cession, or conveyance of property but only
constitutes a lien thereon. It does not extinguish the title of the debtor. The mortgagor/debtor
continues to be the owner. The only right of the mortgagee is to foreclose the mortgage and
sell the property to satisfy the obligation. The mortgagor’s default does not operate to vest in
the mortgagee the ownership of the encumbered property.

Cayo IID 2002 PAGE 44


Since the mortgagor retains ownership of the mortgaged property, he can even mortgage it
again to another mortgagor (junior lien/encumbrance).

Art. 2127. The mortgage extends to the natural accessions, to the improvements, growing
fruits, and rents or income not yet received when the obligation becomes due, and to the
amount of the indemnity granted or owing to the proprietor from the insurers of the property
mortgaged, or in virtue of expropriation for public use, with the declarations, amplifications
and limitations established by law, whether the estate remains in the possession of the
mortgagor, or it passes into the hands of a third person.

Future property, in themselves, cannot be the subject matter of mortgage. But, the future
improvements, accessions, and fruits of property already mortgaged are also covered by the
mortgage. This is because they are deemed to be part of the principal thing which was already
existing at the time of the constitution of the mortgage.

To exclude these things, there must be an express stipulation to that effect.

Examples:

1. The mortgage deed contains a provision that “all property taken in exchange or
replacement, as well as all buildings, machineries, and, equipment, and others that the
mortgagor may acquire, construct, install, attach, or use in its lumber concession shall
immediately become subject to the mortgage.”

This is a valid stipulation, especially where the property mortgaged is subject to


deterioration (such as machinery and equipment). The purpose of this stipulation is to
maintain the value of the property mortgaged.

2. JPSP example: In the mortgage deed, Mortgagor mortgages house and lot #1 and
another house and lot which he will acquire next month. The deed is registered. Is this
a valid mortgage?

Between mortgagor and mortgagee, the mortgage is valid with respect to both house
and lot #1 and #2. The remedy of the mortgagee, once mortgagor acquires the second
house and lot, is to compel the mortgagor to execute a public document evidencing the
mortgage of the 2nd house and lot and to register it, so that it would be binding on third
parties.

But, as against third parties, the mortgage is only valid with respect to the first house
and lot but not to the second house and lot, until the latter is registered.

What happens if the thing mortgaged is expropriated?

The security becomes the cash given by the government as indemnity. Upon default, the
mortgagee can apply the cash as payment for the obligation.

Art. 2128. The mortgage credit may be alienated or assigned to a third person, in whole or in
part, with the formalities required by law.

Cayo IID 2002 PAGE 45


The mortgage credit is a real right, and under property law, real rights over immovables are
also considered immovables in themselves. Thus, they may be alienated or assigned to third
persons, in whole or in part, by the mortgagee who is the owner of the right. The assignee may
then foreclose the mortgage in case of nonpayment of the principal obligation.

The alienation or assignment of the mortgage credit is valid even if it is not registered.
Registration is only necessary to affect third persons.

Art. 2129. The creditor may claim from a third person in possession of the mortgaged
property, the payment of the part of the credit secured by the property which said third person
possesses, in the terms and with the formalities which the law establishes.

Art. 2129 does not really apply to all third persons in possession of the property. It only applies
to those in possession of the mortgaged property in the concept of owner. If the possession
by a third person is only as lessee, the creditor may not collect the credit from that third person.

When a mortgagor alienates/sells the mortgaged property to a third person, the creditor may
demand from him the payment of the principal obligation. This is because the mortgage credit
is a real right, which follows the property wherever it goes, even if its ownership changes.
However, before the creditor can collect from the third person, he must have made a demand
on the debtor, and the latter should have failed to pay.

Example: A mortgaged his land worth P5M in favor of B to secure a debt of P6M. A sold the
land to C.

On due date, B should demand payment of the P6M from A. If A fails to pay, B may foreclose
the mortgage. B may also choose to collect P5M (not P6M) from C, which is the part of the
principal obligation secured by the property sold to C. C is not liable for the deficiency of P1M
in the absence of a contrary stipulation. If C pays B, C can go after A for reimbursement.

Art. 2130. A stipulation forbidding the owner from alienating the immovable mortgaged shall
be void.

A stipulation forbidding the owner from alienating the mortgaged property is void for being
contrary to public policy because it is an undue impediment or interference on the transmission
of property. However, if the mortgagor alienates the property, the transferee must respect the
mortgage because it is a real right.

A stipulation that requires the mortgagor to notify the mortgagee in writing before he sells the
property is VALID. This is not a prohibition but a mere regulation.

The mortgagee would want to regulate the disposition of the property by the mortgagor
because first, he would want to know the type of person from whom he might have to collect the
credit later on. Second, any disposition of the mortgaged property by the mortgagor is a red
flag that may indicate that the mortgagor/debtor may not be able to pay the debt later on
(Because why is he suddenly disposing of his property? Maybe he doesn’t have money
anymore.)

Art. 2131. The form, extent and consequences of a mortgage, both as to its constitution,
modification and extinguishment, and as to the other matters not included in this Chapter shall
be governed by the provisions of the Mortgage Law and of the Land Registration Law.

Cayo IID 2002 PAGE 46


FORECLOSURE

The essence of a mortgage is that upon default, the mortgagee can foreclose – he can sell the
property and apply the proceeds of the sale to the payment of the principal obligation.

What is foreclosure?

It is the remedy available to the mortgagee by which he subjects the mortgaged property to the
satisfaction of the obligation. It denotes the procedure adopted by the mortgagee to terminate
the rights of the mortgagor on the property and includes the sale itself.

How do you foreclose?

There are two types of foreclosure – judicial and extra-judicial foreclosure.

The default rule is judicial foreclosure. You can only do extra-judicial foreclosure if the
mortgage deed has a provision which gives the mortgagee the special power of attorney to sell
the mortgaged property in accordance with Act 3135.

But these are only default rules. The parties may also stipulate that the sale will be a private
sale.

Mortgage to a Foreigner – RA 133

Can you mortgage to a foreigner?

Yes, since foreigners are only prohibited from owning real property in the Philippines, not from
being mortgagees. The situation is governed by RA 133.

However, if the mortgagor defaults, the foreigner CANNOT foreclose extra-judicially. He can
only foreclose judicially. Moreover, he cannot bid or take part in any sale of the real
property in case of foreclosure.

Can the foreigner take possession of the property during the


mortgage?

Pursuant to the mortgage, the alien-mortgagee cannot take possession of the property during
the mortgage. But, he can possess it as lessee.

Can the foreigner take possession of the property upon default of the
mortgagor?

The foreigner can take possession of the mortgaged property upon default but only for the
purpose of foreclosure and receivership in accordance with the prescribed judicial procedures,
AND in no case exceeding five years.

When confronted with a foreclosure problem…

Cayo IID 2002 PAGE 47


First, check if there’s a stipulation saying that there will be a private sale. If there is such a
stipulation, the property can be sold at a private sale. If there is no such stipulation, then there
will be either judicial or extra-judicial foreclosure.

Second, look for the following tell-tale signs:

1. Is the mortgagee a foreigner? If it’s a foreigner, it’s automatically judicial foreclosure


(Act 133).

2. If the mortgagee is not a foreigner, look for a stipulation in the mortgage agreement
which gives the mortgagee the special power of attorney to carry out the extra-
judicial foreclosure in accordance with Act 3135. If you find this stipulation, it is an
extra-judicial foreclosure.

3. If there is no stipulation for extra-judicial foreclosure under Act 3135, it is a judicial


foreclosure governed by Rule 68 of the Rules of Court.

Third, if it’s an extra-judicial foreclosure, look at the parties. Who is foreclosing?

1. If it is a bank, the governing law is Act 3135, but there will be certain exceptions
applicable only to banking institutions, provided in Section 47 of the General Banking
Act.

2. If the mortgagee is not a bank, the extra-judicial foreclosure will be governed by Act
3135.

Fourth, now that you know whether it’s judicial or extra-judicial foreclosure, let’s go through
each of the processes…

JUDICIAL FORECLOSURE UNDER RULE 68, RULES OF COURT

STEP 1: The mortgagee should file a petition for judicial foreclosure in the court which has
jurisdiction over the area where the property is situated

STEP 2: The court will conduct a trial. If, after trial, the court finds merit in the petition, it will
render judgment ordering the mortgagor/debtor to pay the obligation within a period not less
than 90 nor more than 120 days from the finality of judgment.

STEP 3: Within this 90 to 120 day period, the mortgagor has the chance to pay the obligation to
prevent his property from being sold. This is called the EQUITY OF REDEMPTION PERIOD.

STEP 4: If mortgagor fails to pay within the 90-120 days given to him by the court,
the property shall be sold to the highest bidder at public auction to satisfy the
judgment.

STEP 5: There will be a judicial confirmation of the sale. After the confirmation of the
sale, the purchaser shall be entitled to the possession of the property, and all the
rights of the mortgagor with respect to the property are severed or terminated.

The equity of redemption period actually extends until the sale is confirmed. Even after
the lapse of the 90 to 120 day period, the mortgagor can still redeem the property,
so long as there has been no confirmation of the sale yet. Therefore, the equity of

Cayo IID 2002 PAGE 48


redemption can be considered as the right of the mortgagor to redeem the property
BEFORE the confirmation of the sale.

Õ IMPORTANT: After the confirmation of the sale, the mortgagor does not have a
right to redeem the property anymore. This is the general rule in judicial foreclosures
– there is no right of redemption after the sale is confirmed.

The exception to this rule is when the judicial foreclosure is done by a BANK. In
such a case, there is still a right of redemption within one year from the
registration of the sale.

STEP 6: The proceeds of the sale of the property will be disposed as follows:

1. First, the costs of the sale will be deducted from the price at which the
property was sold

2. The amount of the principal obligation and interest will be deducted

3. The junior encumbrances will be satisfied

4. Õ If there is still an excess, the excess will go back to the mortgagor. In mortgage,
the mortgagee DOES NOT get the excess (unlike in pledge).

Õ If there is a deficiency, the mortgagee can ask for a DEFICIENCY JUDGMENT


which can be imposed on other property of the mortgagor. This is unlike the
rule in pledge, where the pledgee cannot collect any deficiency. This is also
unlike the rule in extra-judicial foreclosure where the mortgagee must go to
court and file another action for the collection of the deficiency. In this case,
there is no need to file an action. The mortgagee just has to file a motion in
court for the deficiency judgment.

Why should you stay away from judicial foreclosure?

Judicial foreclosure is costly, since the parties would need to hire lawyers. Moreover, in judicial
foreclosure, the parties have very little control over the sale because there is court
intervention. Judicial foreclosure is also more susceptible to stalling/dilatory tactics by the
mortgagor, since he can file all sorts of motions in court to prevent the sale.

EXTRA-JUDICIAL FORECLOSURE UNDER ACT 3135

When is extra-judicial foreclosure proper?

There must be a provision in the mortgage giving the mortgagee the special power of attorney
to carry out the extra-judicial foreclosure under Act 3135.

Where should the sale be made?

The sale can only be made in the province where the property is situated. So if several
properties located in different provinces are mortgaged to secure one principal obligation, the
creditor must foreclose in each and every jurisdiction where the property is located.

Cayo IID 2002 PAGE 49


What is the procedure?

STEP 1: File a complaint for extra-judicial foreclosure with the


Executive Judge

STEP 2: Notice of the sale

There are two kinds of notices required:

1. Posting in at least 3 public places 20 days before the sale – usually in the Sheriff’s
office, the Assessor’s office, and the Register of Deeds.

2. Publication in a newspaper of general circulation, once a week for at least three


consecutive weeks if the value of the property exceeds P400

This need not be done within a span of 21 days. For example, you can publish on
August 30, which is a Friday, then on September 2, which is a Monday, and then on
September 9, which is also a Monday. In this case, publication for three consecutive
weeks is completed within 11 days.

The notice should contain the description of the property to be sold, date, time, and place of the
sale, and the principal obligation to be satisfied by the sale of the mortgaged property.

There is no need for personal notice to the mortgagor, unlike in a guaranty. This is because
the mortgagor, having defaulted in the principal obligation, should expect that a foreclosure is
forthcoming. This is because the mortgagor, having defaulted in the principal obligation,
should expect that a foreclosure is forthcoming. If you’re the mortgagee, you would want to
surprise the mortgagor so the he cannot employ dilatory tactics such as getting an injunction in
order to delay the foreclosure. If you’re nasty, you should publish it in Abante, which is a
newspaper of general circulation, but which nobody consults for the purpose of checking if their
mortgaged property is about to be foreclosed.

STEP 3: Public Auction

Time for conducting the public sale: Between 9 am to 4 pm

Manner of conducting the sale: The sale should be under the direction of the sheriff of the
province, the justice or auxiliary justice of the peace of the municipality, or of a notary public of
the municipality, who shall be compensated with FIVE PESOS for each day of actual work
performed (wow $$$).

Who may bid: Anyone may bid at the sale, unless there are exceptions stipulated in the
mortgage deed. Even the mortgagee/creditor may bid. And unlike in pledge, even if the
mortgagee/creditor is the sole bidder, the sale is still valid. This is because there is a right
to redeem in extra-judicial foreclosure. Therefore, the lower the price at which it is sold, the
better the chances of the mortgagor/debtor to redeem the property.

Can the parties stipulate a minimum price at which the property


shall be sold?

Cayo IID 2002 PAGE 50


No, because the property must be sold to the highest bidder. Parties cannot, by agreement,
contravene the law. However, this rule may not apply where the purchaser happens to be the
creditor or mortgagee himself. The mortgagor can argue that the stipulation should be binding
on the mortgagee on the principle of estoppel.

What is the effect of inadequacy of the price at which the property is


sold at auction?

If there is a right to redeem, inadequacy of price is not material because the debtor may
reacquire the property. It will even make it easier for him to redeem it if it is sold at a low price.

Mere inadequacy of price will not be sufficient to set aside the sale unless the price is so
inadequate as to shock the conscience.

What happens if there is an excess?

The excess should first be applied to satisfy the junior liens and encumbrances on the property.
If there is still an excess, it goes to the mortgagor.

What happens if there is a deficiency?

The mortgagee must go to court and file an action to collect the deficiency. He may file an
action for a deficiency judgment even during the period of redemption.

STEP 4: Possession of the Property

Upon foreclosure, if the mortgagor is in possession of the property, he will retain possession
during the redemption period (one year from the date of the sale).

However, if the winning bidder already wants possession of the property, he may file a petition
in court to gain possession. He must give a bond equivalent to the rent for the use of the
property for 12 months. The bond will answer for any loss to the mortgagor if it is later found
that he was not in default in the mortgage obligation or that the conduct of the sale violated Act
3135. Upon approval of the bond, the court will issue a writ of possession in favor of the
purchaser.

Õ Exception to this rule: If the party foreclosing is a BANK, Sec 47 of the General Banking
Law provides that the purchaser shall immediately have the right to take possession of the
property upon confirmation of the sale.

Remedy of the Mortgagor

If the winning bidder is able to obtain the writ of possession even before the expiration of the
one-year period, the mortgagor may petition that the sale be set aside and the writ of
possession be cancelled on the ground that he was not in default or that the sale was not made
in accordance with Act 3135. The petition must be filed within 30 days from the grant of the writ
of possession.

STEP 5: Redemption

Cayo IID 2002 PAGE 51


The debtor has the right to redeem the property sold within one year from the date of the
sale, reckoned from date of execution of the certificate of sale since it is only from that date
that the sale takes effect as a conveyance.

Õ Exception: If the mortgagee foreclosing is a BANK and the mortgagor is a JURIDICAL


PERSON, the juridical person shall have the right to redeem the property BEFORE the
registration of the certificate of sale but NOT EXCEEDING 90 DAYS FROM THE DATE OF
THE FORECLOSURE.

Õ What is the difference between the RIGHT OF REDEMPTION and EQUITY OF REDEMPTION?

The right of redemption is the right of the mortgagor to redeem the mortgaged
property within a certain period (in most cases, within 1 year) AFTER the sale of the
property in satisfaction of the mortgage debt. It is available to the mortgagor only
when the mortgage is foreclosed extrajudicially. It is not available in judicial
foreclosures, except when the mortgagee foreclosing is a bank.

On the other hand, equity of redemption is the right of the mortgagor in a judicial
foreclosure to pay the amount of his obligation BEFORE the confirmation of the sale of
the mortgaged property.

Who may redeem?

The debtor, his successors in interest, or any judicial creditor or judgment creditor
of the debtor, or any person having a junior encumbrance or lien on the property
may exercise the right of redemption.

Example: Mortgagor mortgaged a house and lot to A. Later, Mortgagor also


mortgaged it to B. A foreclosed the mortgage and bought the house and lot at the
auction. In this case, upon the sale of the property to A, the only right that B as
second mortgagee has is the right to redeem. He may exercise the right by paying
off the debt secured by the first mortgage. B’s exercise of Mortgagor’s equity of
redemption is equivalent to foreclosure of the junior mortgage.

How much should the one exercising the right of redemption pay?

The mortgagor (or whoever is redeeming the property) should pay the PURCHASE
PRICE of the property (not the amount of the original obligation anymore) plus
INTEREST OF 1% PER MONTH (this is according to De Leon, citing Rule 39 Section 28
of the Rules of Court. JPSP says interest is at 2% per month).

Õ Exception: If the mortgagee foreclosing is a BANK, under Sec 47 of the General


Banking Law, the mortgagor should pay the amount of the ORIGINAL OBLIGATION
(not the purchase price) plus INTEREST AT THE ORIGINAL RATE stipulated in the
mortgage contract plus all COSTS and expenses incurred by the bank from the sale
of the property.

What happens if the debtor/mortgagor fails to redeem the property within the prescribed
period?

If the debtor/mortgagor fails to redeem the property within the prescribed period, the purchaser
has the absolute right to a writ of possession. From then on, the mortgagor loses his right over
the property.

Cayo IID 2002 PAGE 52


Title to the property sold under a mortgage foreclosure remains with the mortgagor until the
expiration of the redemption period. The right of the purchaser at the foreclosure sale is merely
inchoate or contingent until after the period of redemption has expired without the right being
exercised. When the debtor/mortgagor fails to redeem within the period for redemption, the
purchaser’s right becomes final.

What is the effect of the timely exercise of the right of redemption?

If the debtor/mortgagor is able to exercise the right of redemption on time, he does not really
recover property since he does not lose ownership until after the expiration of the redemption
period. He merely frees it of the encumbrance created by the mortgage.

What happens if the mortgagor sells the property to a third person within the redemption
period?

The third person, in buying the property, is actually buying not the property itself but the right
to redeem the property and the right to possess it within the redemption period.

X mortgaged property to a Bank to secure a P1M loan at 17% interest. The mortgage was
foreclosed. At the sale, the property was sold to the Bank as the highest bidder for P800K.
The bank then sold the property to Y for P1.5M. If X wants to redeem the property, to
whom should he pay and how much?

X should pay to the Bank. He should pay only P1M - the amount of the principal obligation plus
interest at 17%, plus costs (Sec 47 General Banking Law: Remember, this is the exception to
the general rule that the mortgagor should pay the purchase price and 1% interest per month).
Y would then have a right to seek reimbursement from the Bank.

The right of redemption may be exercised by the mortgagee under the same terms, even if the
property is subsequently sold to a third party. A different rule would make it easy for the buyer
at the foreclosure sale to render the right of redemption nugatory simply by making a
conveyance of the property for an amount beyond the capacity of the mortgagor to pay.

Can the right of redemption be waived by the mortgagor in advance?

It depends if there is a fair exchange of value and information between the parties.

If the mortgagor is a farmer who mortgages his parcel of land and he waives the right to
redeem, he can later argue that the waiver was not valid for being contrary to the public policy
of preserving the property in the hands of the owner.

But if the mortgagor is a businessman who waives the right to redeem in exchange for lower
interest rates, this waiver is valid because there is a fair exchange of value.

SUMMARY OF EXCEPTIONS UNDER SECTION 47 OF THE GENERAL BANKING LAW


OF 2000

Cayo IID 2002 PAGE 53


When the party foreclosing the mortgage is a BANK, the same procedure as in judicial or extra-
judicial foreclosure, as the case may be, is followed. However, the following are the exceptions
to the general rules, applicable only to banks:

1. In judicial foreclosures, there is still a right to redeem

As a general rule, there is no right of redemption in judicial foreclosure. Upon


confirmation of the sale, the mortgagor cannot redeem the property anymore.

But if the mortgagor foreclosing judicially is a bank, the mortgagor shall have a right to
redeem within one year from the sale.

2. Redemption Price

In ordinary extra-judicial foreclosure, the redemption price is the purchase price plus
interest at 1% (or 2%?) per month.

In extra-judicial foreclosure by a bank, the redemption price consists of:

a. the amount of the mortgage obligation


b. plus the interest on the loan at the rate stipulated in the mortgage contract
c. plus costs of the sale incurred by the bank

3. Automatic Right of Possession

In ordinary extra-judicial foreclosure, the mortgagor retains possession of the


property within the redemption period. If the purchaser wishes to have possession
within the redemption period, he must file a petition for the issuance of a writ of
possession with a corresponding bond.

In extra-judicial foreclosure by a bank, the purchaser automatically has the right to take
possession after the confirmation of the sale.

4. Injunction

If anybody wants to enjoin the conduct of foreclosure proceedings instituted by a


bank, the petitioner must file a bond fixed by the court to satisfy whatever damage
the bank may suffer by the injunction.

There is no such provision in the case of ordinary extra-judicial foreclosure.

5. Period of Redemption for Juridical Persons

In ordinary extra-judicial foreclosure, the mortgagor may redeem the property after
it is sold within one year from the execution of the certificate of sale. There is no
distinction, whether the party redeeming is a natural or juridical person.

If the party foreclosing extrajudicially is a bank, the same rule as above is applicable
to natural persons. BUT, juridical persons may redeem the property subject only to
the following conditions:

a. it must be BEFORE the registration of the sale

Cayo IID 2002 PAGE 54


b. and, it must not be later than 90 days from the date of the sale

EFFECTS ON THE JUNIOR MORTGAGE

What happens if there was a second mortgage constituted on the property that was
foreclosed?

If the property was mortgaged a second time, the second mortgage is subordinate
to the first mortgage. The first mortgagor has the right to foreclose the mortgage
upon default by the debtor.

The following are the rights of a junior mortgagee:

1. If the first mortgagee forecloses judicially, before the sale is effected, the
junior mortgagee may exercise the equity of redemption vested in the
mortgagor. The junior mortgagee may satisfy the obligation of the
mortgagor to prevent the sale of the property.

What happens to the ownership of the property when the second mortgagee
exercises the right of redemption?

There are two interpretations – one under the Rules of Court and another
under the Civil Code.

When the second mortgagee exercises the equity of redemption by paying


the obligation of the mortgagor/debtor, the mortgagor/debtor has 60 days
to reimburse the second mortgagee what he paid. If the original debtor fails
to pay within this period, ownership will be consolidated in the second
mortgagee who paid. This interpretation is according to Section 28 Rule 39
of the Rules of Court.

But according to the Civil Code rules on payment (oblicon), the effect should
be like payment of an obligation by a third person, in which case, the second
mortgagee merely becomes subrogated in the right of the first mortgagee to
foreclose the mortgage.

2. When an extra-judicial sale is made, the junior mortgagee may exercise the
mortgagor’s right to redeem within one year from the sale. De Leon says
that he should pay the amount of the original obligation. JPSP says that the
junior mortgagee exercising the right to redeem should follow Act 3135 – he
should pay the price at which the property was sold.

3. If the property is sold for more than the amount of the obligation to the first
mortgagee, the excess should be applied to the payment of the obligation to
the second mortgagee.

But if there is no excess, the second mortgage is extinguished.

Õ If you’re the second mortgagee, you can also foreclose, not the property (since
you cannot do that because the right of the first mortgagee is superior), but the

Cayo IID 2002 PAGE 55


right of redemption instead. This is so that you would be the only one who can
exercise it when the proper time comes.

CHATTEL MORTGAGE

Art. 2140. By a chattel mortgage, personal property is recorded in the Chattel


Mortgage Register as a security for the performance of an obligation. If the
movable, instead of being recorded, is delivered to the creditor or a third person,
the contract is a pledge and not a chattel mortgage.

What is chattel mortgage?

Chattel mortgage is the contract by virtue of which personal property is recorded in


the Chattel Mortgage Register as a security for the performance of an obligation.

This definition under the Chattel Mortgage Law is no longer applicable. It is the
definition under Art. 2140 of the Civil Code that applies now.

What are the characteristics of the contract of chattel mortgage?

1. It is an accessory contract because it secures performance of a principal


obligation

2. It is a formal contract because it requires registration in the Chattel Mortgage


Register for its validity (but only against third persons)

3. It is a unilateral contract because it produces only obligations on the part of


the creditor to free the thing from the encumbrance on fulfillment of the
obligation.

What is the subject matter of chattel mortgage?

The subject matter of chattel mortgage is personal or movable property.

What are the requisites for a valid chattel mortgage?

1. It must be constituted to secure a principal obligation.

2. The mortgagor must be the absolute owner of the thing mortgaged.

3. He must have free disposal of the thing or otherwise be authorized to do so.

4. When the principal obligation becomes due, the property mortgaged may be alienated
for the payment to the creditor.

5. To prejudice third persons, the mortgage must be recorded in the Chattel Mortgage
Registry.

If the first four requisites are present, there is already a valid mortgage between the parties –
mortgagor and mortgagee.

Cayo IID 2002 PAGE 56


But to affect third persons, there is a need to comply with the fifth requisite: The document of
mortgage must be recorded in the Chattel Mortgage Registry. This is because recording the
document in the Chattel Mortgage Registry serves as notice to 3rd persons. This is similar to
the requirement in pledge that the pledge be in a public document and the requirement in Real
Estate Mortgage that it must be recorded in the Registry of Property.

Note that unlike in pledge, there is no need for actual delivery of the personal property to the
mortgagee.

DISTINCTIONS BETWEEN CHATTEL MORTGAGE AND PLEDGE

CHATTEL MORTGAGE PLEDGE


DELIVERY OF THE PERSONAL Not necessary Delivery is necessary for
PROPERTY validity of the pledge
REGISTRATION IN THE Necessary for validity of Not necessary; public
REGISTRY OF PROPERTY the chattel mortgage document is enough to
against third persons bind third persons
PROCEDURE FOR SALE Governed by Section 14 of Governed by Article 2112
the Chattel Mortgage Law of the Civil Code
RIGHT TO EXCESS OF Excess goes to the Excess goes to the
PROCEEDS OF SALE debtor/mortgagor pledgee/creditor unless
otherwise stipulated
RIGHT TO RECOVER Creditor/mortgagee can Creditor/pledgee is not
DEFICIENCY recover deficiency from entitled to recover any
the debtor/mortgagor, deficiency after the
except if covered by Recto property is sold,
Law notwithstanding any
contrary stipulation

Art. 2141. The provisions of this Code on pledge, insofar as they are not in
conflict with the Chattel Mortgage Law, shall be applicable to chattel mortgage.

THE CHATTEL MORTGAGE LAW

How do you constitute a chattel mortgage?

To constitute a chattel mortgage, the parties must register the personal property
mortgaged in the Chattel Mortgage Register as security for the performance of an
obligation. However, if the chattel mortgage is not registered, it is still valid and
binding as between the parties. The requirement of registration is not for validity
but only for binding third parties.

What is the effect of registration?

The registration of the chattel mortgage creates a real right or lien which follows
the personal property wherever it goes. Registration gives the mortgagee
symbolic possession.

Cayo IID 2002 PAGE 57


What is the form required for a chattel mortgage?

According to Sec. 5 of the Chattel Mortgage Law, the following form should be
sufficient:

FORM OF CHATTEL MORTGAGE AND AFFIDAVIT

This mortgage made this Fifth day of October 2002 by Sheryl


Tanquilut, a resident of municipality of Taytay, Province of Rizal Philippines,
mortgagor, to Anna del Castillo a resident of the municipality of Cainta,
Province of Rizal Philippines, mortgagee, witnesseth:

That the said mortgagor hereby conveys and mortgages to the said
mortgagee all of the following-described personal property situated in the
municipality of Taytay Province of Rizal, and now in the possession of said
mortgagor, to wit:

A PAIR OF SKY BLUE NIKE PRESTO SNEAKERS, SIZE 3XS

This mortgage is given as security for the payment to the said Anna
del Castillo, mortgagee, of the sum of fifty pesos, with interest thereon at
the rate of twenty-five per centum per annum due on 25 December 2002.

The conditions of this obligation are such that if the mortgagor, his
heirs, executors, or administrators shall well and truly perform the full
obligation above stated according to the terms thereof, then this obligation
shall be null and void.

Executed at the municipality of Taytay in the Province of Rizal this


Fifth day of October 2002.

Sgd. Sheryl Tanquilut


In the presence of:

Sgd. Xilca Alvarez


Sgd. Helen Arevalo

FORM OF OATH (affidavit of good faith)

[Tip: know the contents of an affidavit of good faith. JPSP might


ask us to make one in the exam. Lumabas sa past exam]

We severally swear that the foregoing mortgage is made for the purpose of
securing the obligation specified in the conditions thereof, and for no other purpose,
and that the same is a just and valid obligation, and one not entered into for the
purpose of fraud.

FORM OF CERTIFICATE OF OATH

In the Province of Rizal, personally appeared Sheryl Tanquilut, Xilca


Alvarez, and Helen Arevalo, the parties who signed the foregoing affidavit
and made oath to the truth thereof before me.

Cayo IID 2002 PAGE 58


Sgd. Bhoy-B
Notary public

Cayo IID 2002 PAGE 59


What happens if there is no affidavit of good faith?

The mortgage is still valid between the parties, but it will not bind third persons,
such as creditors and subsequent encumbrancers. If there is no affidavit of good
faith, the mortgage will not be preferred as against these third persons.

Can you constitute a chattel mortgage to secure a future obligation or “a current obligation
plus any and all obligations hereinafter contracted by the mortgagor in favor of the
mortgagee”?

No. You can only constitute a chattel mortgage to secure debts or obligations that
are existing at the time the mortgage is constituted. If it is constituted to secure
an obligation that is not yet existent, it is void. The affidavit of good faith executed
by the mortgagor states that the mortgage is constituted to secure the obligation
specified therein and for no other purpose.

What the parties should do is to execute a new document/ deed of chattel


mortgage to cover the newly contracted obligation.

Can you mortgage future property?

Section 7 of the Chattel Mortgage Law provides that as a general rule, you cannot
mortgage property that you do not own at the time of the constitution of the
mortgage. Therefore, you cannot mortgage future property.

But as an exception to this rule, the inventory of retail stores can be the subject of
chattel mortgage, even if technically, they may be acquired by the mortgagor after
the mortgage is constituted. This is because the after-acquired property is actually
in renewal or in replenishment of goods on hand when the mortgage was executed.
The SC came up with this exception in order not to hamper the circulation of capital
in the industry.

What happens when the mortgagor pays the obligation?

If the mortgagor pays the obligation, he gets a discharge from the mortgagee so
that he can then cancel the lien annotated on the title and in the Chattel Mortgage
Registry.

What happens when the mortgagor defaults on the obligation?

1. Right of Redemption

In case of default, the following persons may redeem the property before it
is sold, by paying the amount of the obligation plus costs and expenses
incurred from the breach:

a. the mortgagor
b. a subsequent mortgagee
c. a subsequent attaching creditor

If an attaching creditor redeems, he is subrogated to the rights of the


mortgagor. He can foreclose the mortgage.

Cayo IID 2002 PAGE 60


But once the property is sold at auction, there can be no redemption
anymore.

2. Right of Mortgagee to Possession

If the creditor/mortgagee wants to foreclose upon default, he has the


implied right to take the mortgaged property. If the debtor/mortgagor
refuses to surrender the property, the creditor should file an action for
replevin to take possession or for judicial foreclosure.

3. Foreclosure

The parties can stipulate for a private sale upon default.

If there is no stipulation, the applicable rule is Section 14 of the Chattel


Mortgage Law.

According to Section 14, the creditor/mortgagee can cause the property to


be sold at public auction thirty days after default. This is a minimum grace
period given to the mortgagor to redeem the property before it is sold at
auction. There is no maximum time period for holding the sale.

The procedure is the same as that for extra-judicial foreclosure of a real


estate mortgage, except for the notice requirements. In chattel mortgage,
the only notice requirement is posting at two or more public places in the
municipality and personal notice to the mortgagor and junior mortgagees at
least ten days before the date of the sale (no publication).

The proceeds of the sale will be applied as follows:

a. Costs and expenses of the sale


b. Payment of the obligation secured by the mortgage
c. Claims of persons holding subsequent mortgages in their order;
and
d. The balance, if any, shall be given to the mortgagor

Can the mortgagee recover any deficiency after the sale of the property?

Unlike in pledge, the creditor can still file an action for recovery of any
deficiency in case the proceeds of the sale do not satisfy the entire
obligation, unless the situation is covered by the Recto Law.

PROBLEMS ON REAL AND CHATTEL MORTGAGE

Mortgagor mortgaged property worth 120K to secure a 100K loan. Mortgagor defaulted.
Mortgagee foreclosed. The property was sold to X for 70K. Should mortgagor redeem the
property?

Yes, because he can sell it for more than 70K and realize more than the amount of
the principal obligation.

But if, in the example above, the mortgagor has creditors running after him for debts worth
300K, should he redeem?

Cayo IID 2002 PAGE 61


No, he should not redeem. If he redeems, he spends 70K in order to re-acquire
property, which he may thereafter lose again to his other creditors.

Borrower borrows P1M from Lender. Borrower executes a deed of assignment by way of
security over the shares of stock in favor of Lender in order to secure payment of the loan.
It is stipulated that upon payment of the loan by Borrower, Lender will re-convey the shares
of stock to Borrower. What is this arrangement?

This can either be a PLEDGE or an IMPLIED TRUST.

It’s not really a pledge because there is an absolute conveyance of ownership by


the supposed pledgor in favor of the pledgee. But the Supreme Court has treated
this in several cases as a pledge.

JPSP likes the implied trust theory better because there is a statutory basis. Art.
1454 of the Civil Code provides that if an absolute conveyance of property is made in
order to secure the performance of an obligation of the grantor toward the grantee, a
TRUST by virtue of law is established. If the fulfillment of the obligation is offered
by the grantor when it becomes due, he may demand the reconveyance of the
property to him.

If it’s a trust, there is no need to foreclose (actually, there’s no right to foreclose).

What happens if there’s default? Art. 1454 does not cover this situation, which is
probably why the Supreme Court has characterized this type of transaction as a
pledge instead. JPSP thinks that if there’s default, ownership will be consolidated
in the lender/trustee. But if the parties don’t want any problem, they should
stipulate the precise effect of default.

Borrower borrows P10M from Lender. Borrower offers the following securities to Lender:

(1) a GUARANTY by X who is worth P100M


(2) a PLEDGE of shares of stock worth P10M
(3) a REAL ESTATE MORTGAGE worth P15M

Which one should Lender choose?

It really depends on the circumstances, but here are the considerations:

1. If he chooses the pledge, it is easier to foreclose, and he can get the excess
in case the shares of stock are sold for more than P10M.

2. If he chooses the guaranty, it is good only if he is sure that the guarantor


will pay. If the guarantor is any of the following, persons, the guaranty
would be a good choice:

a. the Government – because it is never insolvent


b. a Bank – in the form of a bank guaranty through a letter of credit
c. Insurance Company – though in some cases, it is also hard to collect
from an insurance company (also, take note that they would be
governed, not by the Civil Code provisions on guaranty, but by the
Insurance Code).

Cayo IID 2002 PAGE 62


But the disadvantage of choosing the guaranty is that the guarantor who is
worth P100M can afford to hire good lawyers who can stall the Lender’s
claim.

3. In the case of the real estate mortgage, it depends on how easy it would be
to dispose of the property. If it’s property at a prime spot in Makati, this
might be a good choice since it can probably be sold at a good price right
away. But if it’s located in the boondocks, the Lender may have a very
difficult time selling it.

Borrower borrows P10M from Lender. The loan is secured by a guaranty by X, who is worth
P100M, a real estate mortgage worth P8M, and a pledge worth P8M. If Borrower defaults,
what is the best way for Lender to proceed?

1. Foreclose the real estate mortgage first. Then get a deficiency judgment for
the remaining P2M.

2. Then, foreclose the pledge because in pledge, he gets to keep the excess –
resulting in an upside of P6M.

3. The Guarantor is not yet an option since he has the benefit of excussion.
The Lender must first go through steps 1 and 2 and other remedies before
running after X.

Borrower borrows P10M from Lender. The loan is secured by a pledge worth P8M and a
guaranty by X. How should the Lender proceed in case of default by Borrower?

If Lender forecloses the pledge, he will have a deficiency of P2M, which he cannot
collect anymore. On the other hand, he cannot proceed against the guarantor
without foreclosing the pledge first.

So what should he do? He should sue Borrower in his capacity as debtor, not as a
pledgor, for collection of the debt. Then, he should attach the property pledged.
When judgment in his favor is rendered, he can then execute it against the
attached shares. The shares can be sold at an ordinary execution sale, not a
foreclosure sale. In this way, the shares will be taken out of the context of the
pledge, and any deficiency in the sale can still be recovered by the lender. After
the execution of the judgment on the shares, the Lender can then go after the
Guarantor for the deficiency.

ANTICHRESIS

Art. 2132. By the contract of antichresis the creditor acquires the right to receive the fruits of
an immovable of his debtor, with the obligation to apply them to the payment of the interest, if
owing, and thereafter to the principal of his credit.

What is antichresis?

Antichresis is a contract by which the creditor acquires the right to receive the fruits of an
immovable belonging to the debtor, with the obligation to apply them to the payment of the
interest, if owing, and thereafter to the principal of his credit.

Cayo IID 2002 PAGE 63


What are the characteristics of antichresis?

1. Accessory – It secures the performance of a principal obligation. Manresa, however,


believes that it is an independent contract.

2. Formal Contract – It must be in specified form to be valid (in writing).

Is delivery of the property to the creditor required?

Delivery is not required for the validity of the contract itself. BUT, it is required in order that the
creditor may receive the fruits.

Does antichresis apply to all of the fruits of the immovable concerned?

GENERAL RULE: The general rule is that the contract of antichresis covers ALL the fruits of
the encumbered property.

If the parties do not want all of the fruits to be subject to the antichresis, they must STIPULATE
otherwise.

Is it essential for the contract to have a stipulation for interest in order to have an accessory
contract of antichresis?

No. It is not essential to the contract of antichresis that the loan that it guarantees should have
interest. There is nothing in the law that says that antichresis can only guarantee interest-
bearing loans.

What are the differences between antichresis and real mortgage?

ANTICHRESIS REAL MORTGAGE


Property is delivered to the creditor Debtor usually retains possession of the
property
Creditor acquires only the right to receive the Creditor has no right to receive the fruits, but
fruits of the property; not a real right mortgage creates a real right over the property
which is enforceable against the world
General rule is that creditor must pay the Creditor has no obligation to pay taxes and
taxes and charges upon the estate; parties charges
must stipulate otherwise
Expressly stipulated that the creditor shall No obligation on the part of the mortgagee to
apply the fruits to the payment of interest, if apply the fruits to interest and principal
owing, and thereafter to the principal

Õ Antichresis and real mortgage are similar in that the subject matter is real property.

Õ Like pledge and mortgage, antichresis gives a real right if it is registered in the Registry of
Property.

Example: A borrowed P1M from B. To secure the loan, A delivered a parcel of land with
coconut trees to B, giving B the power to administer it and harvest the coconuts. What is
the nature of the contract?

Cayo IID 2002 PAGE 64


Answer: The contract is one of mortgage, not antichresis. In order for it to be a contract of
antichresis, it must be expressly agreed between creditor and debtor that the creditor, having
been given possession of the property, is to apply the fruits to the payment of interest, if owing,
and thereafter, to the principal.

Art. 2133. The actual market value of the fruits at the time of the application thereof to the
interest and principal shall be the measure of such application.

When it is time to apply the fruits to the payment of the interest or the principal, the creditor
must base the value of the fruits on their market value at the time of the application.

Example:

The property subject of the contract of antichresis has mango trees. In January, one kilo of
mangoes costs P50/kilo. But in May, when mangoes are in season, one kilo costs 25/kilo. If
interest is due in January, the creditor must apply the fruits to the payment of interest based on
the price of P50/kilo. If interest is due in May, he should compute at the price of P35/kilo.

Art. 2134. The amount of the principal and of the interest shall be specified in writing;
otherwise, the contract of antichresis shall be void.

Is there a form required for the contract of antichresis?

Yes. The contract must state the amount of the principal and the interest IN WRITING. If
this form is not followed, the contract of antichresis is VOID. The requirement that it be in
writing is necessary not merely to bind third persons but to make the contract valid.

But even if the antichresis is void, the principal obligation is still valid.

Art. 2135. The creditor, unless there is a stipulation to the contrary, is obliged to pay the taxes
and charges upon the estate.

He is also bound to bear the expenses necessary for its preservation and repair.

The sums spent for the purposes stated in this article shall be deducted from the fruits.

What are the obligations of the creditor under the contract of antichresis?

1. Pay the taxes and charges upon the estate –

If the creditor does not pay the taxes, he is required by law to pay indemnity for damages to
the debtor.

If the debtor pays the taxes on the property which the creditor should have paid, the amount
is to be applied to the payment of the debt. If the amount of taxes paid by the debtor is
enough to satisfy the principal obligation, then the loan and the antichresis are extinguished;
the creditor must return the property to the debtor.

What if the creditor does not want to pay the taxes and charges? They must so stipulate in
their agreement OR see the next article.

Cayo IID 2002 PAGE 65


2. Apply the fruits

The creditor must apply the fruits of the property to the payment of interest, if
owing, and thereafter to the principal.

Art. 2136. The debtor cannot reacquire the enjoyment of the immovable without first having
totally paid what he owes the creditor.

But the latter, in order to exempt himself from the obligations imposed upon him by the
preceding article, may always compel the debtor to enter again upon the enjoyment of the
property, except when there is a stipulation to the contrary.

When can the debtor get back the property subject of the antichresis?

The debtor can get it back only when he has totally paid the principal obligation. This is
because the property stands as a security for the payment of the principal obligation.

Is there an exception?

Yes. The exception to this rule is if the creditor does not want to pay the taxes and charges
upon the estate. In such a case, the creditor may compel the debtor to get the property back,
UNLESS there is a contrary stipulation (exception to the exception).

But this has the effect of extinguishing the contract of antichresis.

Art. 2137. The creditor does not acquire the ownership of the real estate for nonpayment of
the debt within the period agreed upon.

Every stipulation to the contrary shall be void. But the creditor may petition the court for
the payment of the debt or the sale of the real property. In this case, the Rules of Court on
the foreclosure of mortgages shall apply.

What happens when the debtor defaults on the principal obligation?

The creditor DOES NOT acquire ownership of the real estate. Any stipulation to the contrary
shall be void. This is because the contract of antichresis covers only the right to receive the
fruits from the estate, and not its ownership. Also, this is pactum commisorium, which is void.

The creditor has the following remedies in case of default:

1. Bring an action for specific performance.


2. Petition for the sale of the real property in judicial foreclosure proceedings under Rule
68 of the Rules of Court.

Can the parties stipulate on an extra-judicial foreclosure? Yes, in the same manner that
they are allowed in pledge and mortgage.

Can the creditor acquire the property given in antichresis by prescription?

No, and any stipulation to the contrary shall be void. In order to acquire property be
prescription, possession must be in the concept of owner. The antichretic creditor possesses
the property merely as a holder.

Cayo IID 2002 PAGE 66


Exception: Just like in a co-ownership, if the creditor repudiates the antichresis, he can acquire
the property by prescription.

Art. 2138. The contracting parties may stipulate that the interest upon the debt be
compensated with the fruits of the property which is the object of the antichresis, provided that
if the value of the fruits should exceed the amount of interest allowed by the laws against
usury, the excess shall be applied to the principal.

The creditor must first apply the fruits to the payment of the interest. If the value of the fruits
exceeds the value of the interest due, then the creditor should apply the excess to the principal.

The second part of this provision is no longer applicable, since there is no Usury Law anymore.

Art. 2139. The last paragraph of article 2085, and articles 2089 to 2091, are applicable to this
contract.

Other characteristics of Antichresis:

1. A third person, who is not a party to the principal contract, may offer his immovable
under the contract of antichresis to secure the debt of another. (2085)

2. The contract of antichresis is indivisible. (2089)

3. The indivisibility of the antichresis is not affected by the fact that the debtors are not
solidarily liable. (2090)

4. The contract of antichresis may secure all kinds of obligations – pure or conditional.
(2091)

CONCURRENCE AND PREFERENCE OF CREDITS

What is concurrence of credits?

Concurrence of credits implies the possession by two or more creditors of equal rights or
privileges over the same property or all of the property of a debtor.

What is preference of credit?

It is the right held by a creditor to be preferred in the payment of his claim out of the debtor’s
assets above others. In other words, it is the right to be paid first.

Nature and Effect of Preference

1. Exception to the general rule – Because, generally, you have to pay your creditors
when the debt becomes due. There should be no rules as to who should be paid first.
Preference applies only when there are two or more creditors with separate claims
against a debtor who has insufficient property. Since it is an exception to the general
rule, the law as to preferences is strictly construed.

Cayo IID 2002 PAGE 67


2. Does not create an interest in property – Preference simply creates a right to be paid
first from the proceeds of the sale of property of the debtor. It does not create a lien on
the property itself, but merely a preference in the application of the proceeds of the
property after it is sold.

3. The creditor does not have the right to TAKE the property or SELL it as against
another creditor – Preference is not a question as to who may take and sell property
belonging to the debtor. Preference applies after a sale, and it is a question of
application of the proceeds of the sale to satisfy the debt.

4. It must be asserted – If the right claimed is not asserted and maintained, it is lost. If
property has not been seized, it is open to seizure by another.

5. It must be maintained – Where a creditor released his levy, leaving the property in
possession of the debtor, thereby indicating that he did not intend to press his claim
further as to that specific property, he is deemed to have abandoned his claim of
preference.

When are the rules on preference of credits applicable?

The rules apply only where:

1. there are two or more creditors


2. with separate and distinct claims
3. against the same debtor
4. who has insufficient property.

There must be a proceeding such as an insolvency proceeding wherein the creditors can file
their claims. The right becomes significant only after the properties of the debtor have been
inventoried and liquidated, and the claims of the various creditors have been established.
Because before that, you have no way of knowing who the creditors are, and you have no
liquidated property out of which you can pay them.

What is the difference between preference of credit and a lien?

A preference applies only to claims which do not attach to specific properties. A lien, on the
other hand, creates a charge on a particular property.
Can a creditor whose credit is not yet due assert a right to preference?

No. The title on Concurrence and Preference of Credits refers only to credits which are already
due.

CHAPTER 1 GENERAL PROVISIONS

Art. 2236. The debtor is liable with all his property, present and future, for the fulfillment of his
obligations, subject to the exemptions provided by law.

General Rule: A debtor is liable with ALL his property, present and future, for the fulfillment of
his obligations.

Cayo IID 2002 PAGE 68


Exceptions: Exemptions provided by law, such as future support, the family home, property in
custodia legis, etc. See page 489-492 of De Leon for the list (not very important)

Art. 2237. Insolvency shall be governed by special laws insofar as they are not inconsistent
with this Code.

Art. 2238. So long as the conjugal partnership or absolute community subsists, its property
shall not be among the assets to be taken possession of by the assignee for the payment of
the insolvent debtor’s obligations, except insofar as the latter have redounded to the benefit of
the family. If it is the husband who is insolvent, the administration of the conjugal partnership
or absolute community may, by order of the court, be transferred to the wife or to a third
person other than the assignee.

If one of the spouses is insolvent, the assets of the CPG or AC do not pass to the assignee in
insolvency elected by the creditors or appointed by the court. The reason for this is that the
CPG or AC is distinct from the individual spouses. The exemption applies provided that:

1. The CPG or AC subsists; and


2. The obligations of the insolvent spouse have not redounded to the benefit of the
family.

The insolvency of the husband does not dissolve the CPG or AC.

Art. 2239. If there is property, other than that mentioned in the preceding article, owned by
two or more persons, one of whom is the insolvent debtor, his undivided share or interest
therein shall be among the assets to be taken possession of by the assignee for the payment
of the insolvent debtor’s obligation.

If there is a co-ownership (other than CPG or AC) and one of the co-owners becomes insolvent,
only his undivided share or interest in the property can be possessed by the assignee in
insolvency proceedings. Of course, the shares of the other co-owners cannot be taken
possession of by the assignee.

Art. 2240. Property held by the insolvent debtor as a trustee of an express or implied trust,
shall be excluded from the insolvency proceedings.

In a trust, the trustee is not the owner of the property, though he has legal title thereto. Since
he is not the absolute owner of the property held in trust, these properties should not be
included in insolvency proceedings.

CHAPTER 2 CLASSIFICATION OF CREDITS

The Civil Code classifies credits against a particular insolvent into three general categories:

1. special preferred credits listed in 2241 and 2242


2. ordinary preferred credits listed in 2244
3. common credits under 2245

Special Preferred Credits (2241 and 2242)

Cayo IID 2002 PAGE 69


The items in bold face are the important/relevant ones:

Art. 2241. With reference to specific movable property of the debtor, the following claims or
liens shall be preferred:

(1) Duties, taxes and fees due thereon to the State or any subdivision thereof;

(2) Claims arising from misappropriation, breach of trust, or malfeasance by public


officials committed in the performance of their duties, on the movables, money or
securities obtained by them;

(3) Claims for the unpaid price of movables sold, on said movables, so long as they
are in the possession of the debtor, up to the value of the same, and if the movable
has been resold by the debtor and the price is still unpaid, the lien may be enforced
on the price; this right is not lost by the immobilization of the thing by destination,
provided it has not lost its form, substance and identity; neither is the right lost by
the sale of the thing together with other property for a lump sum, when the price
thereof can be determined proportionally;

(4) Credits guaranteed with a pledge so long as the things pledged are in the hands
of the creditor, or those guaranteed by a chattel mortgage, upon the things
pledged or mortgaged, up to the value thereof;

(5) Credits for the making, repairs, safekeeping or preservation of personal property, on the
movable thus made, repaired, kept or possessed;

(6) Claims for laborers’ wages, on the goods manufactured or the work done;

(7) For expenses of salvage, upon the goods salvaged;

(8) Credits between the landlord and the tenant, arising from the contract of tenancy on
shares, on the share of each in the fruits or harvest;

(9) Credits for transportation, upon the goods carried, for the price of the contract and
incidental expenses, until their delivery and for thirty days thereafter;

(10) Credits for lodging and supplies usually furnished to travelers by hotel keepers, on the
movables belonging to the guest as long as such movables are in the hotel, but not for money
loaned to the guests;

(11) Credits for seeds and expenses for cultivation and harvest advanced to the debtor, upon
the fruits harvested;

(12) Credits for rent for one year, upon the personal property of the lessee existing on the
immovable leased and on the fruits of the same, but not on money or instruments of credit;

(13) Claims in favor of the depositor if the depositary has wrongfully sold the thing deposited,
upon the price of the sale.

Cayo IID 2002 PAGE 70


In the foregoing cases, if the movables to which the lien or preference attaches
have been wrongfully taken, the creditor may demand them from any possessor, within
thirty days from the unlawful seizure.

First, you must remember that, aside from item (1) on taxes imposed in connection with the
movable, 2141 does establish the order of priority among these claims. It just enumerates the
preferred claims with respect to specific movables.

With respect to the same specific movable or immovable, creditors merely concur. There is no
preference among them, except that the State always gets paid the taxes imposed on the
property first.

(1) Taxes

The tax must be due on the movable itself.

(2) Misappropriation, breach of trust, malfeasance of public officers

The acquisition must have been in the performance of official functions.

Also, the property must still be in the hands of the public official. If it is sold to a purchaser for value
and in good faith, there can be no more claim on the movable.

(4) Guaranteed with a pledge or chattel mortgage

To be a preferred credit:

If it’s a pledge, it must be in a public instrument.

If it’s a chattel mortgage, it must be registered in the chattel mortgage registry.

Last paragraph of 2241

If the movable is wrongfully taken, the preferred creditor may get it back within 30 days through
an accion subrogatoria, exercising the right of the debtor to recover property wrongfully taken
from him granted under Article 559.

Problem: The Debtor’s only property is a Jaguar worth P2.5M. His liabilities are:

a. to the Government: Income tax of P1M


Import duties on the car worth P1M

b. chattel mortgage on the car worth P2M

c. unpaid price of the car of P1M

d. P1M promissory note (notarized)

What are the preferred claims with respect to the Jaguar?

1. P1M import duties on the car


2. P2M chattel mortgage
3. P1M unpaid price

Cayo IID 2002 PAGE 71


These are the only preferred claims because they are the ones attached to the movable itself.
The income tax and the promissory note are not preferred because they are not attached to the
car.

How do you prioritize the preferred claims?

1. P1M import duties – the State is always the priority with respect to preferred claims
2. The chattel mortgagee and the unpaid seller will then proportionally share the P1.5M
left: P1M will go to the mortgagee and 500K will go to the unpaid seller.

Note, however, that taxes are not always preferred. For example, income tax is not preferred
with respect to the Jaguar. In order to be preferred, the tax must be imposed on the movable
itself.

Õ This has to be done in the context of insolvency proceedings.

Problem: Government official used public funds to acquire a Jaguar from a seller in good
faith. Government official becomes insolvent. The Government wants to recover the car. If
you’re government counsel, how should you proceed?

The textbook answer would be that the government can go after the car in insolvency
proceedings. It has a preferred claim over the car under par. (2) of 2241. But, the
disadvantage of this is that, unlike the government claim for tax credits, it is not prioritized over
other special preferred claims. The government would have to share with the other creditors
who likewise have a special preferred claim on the Jaguar, such as an unpaid seller.

The better alternative is to characterize it as an implied TRUST. When funds belonging to


another (in this case, the government) are used to purchase a movable under the name of
another person (the corrupt government official), there is an implied trust. The trustor is the
government, while the trustee is the government official. The trustor/government actually owns
the car. There is thus no need to go through the insolvency proceedings, since the Jaguar is
not among the properties of the insolvent debtor.

Under a trust agreement, X gave Investment House some money. Investment House placed
the money in a time deposit. Investment House issued promissory notes for its obligations
to other creditors.

If Investment House becomes insolvent, X can show that the money is not owned by
Investment House, so it should be excluded from the insolvency proceedings.

Art. 2242. With reference to specific immovable property and real rights of the debtor, the
following claims, mortgages and liens shall be preferred, and shall constitute an encumbrance
on the immovable or real right:

(1) Taxes due upon the land or building;

(2) For the unpaid price of real property sold, upon the immovable sold;

(3) Claims of laborers, masons, mechanics and other workmen, as well as of architects,
engineers and contractors, engaged in the construction, reconstruction or repair of buildings,
canals or other works, upon said buildings, canals, or other works;

Cayo IID 2002 PAGE 72


(4) Claims of furnishers of materials used in the construction, reconstruction or repair of
buildings, canals or other works, upon said buildings, canals or other works;

(5) Mortgage credits recorded in the Registry of Property upon the real estate
mortgaged;

(6) Expenses for the preservation or improvement of real property when the law authorizes
reimbursement upon the immovable preserved or improved;

(7) Credits annotated in the Registry of Property, in virtue of a judicial order, by


attachments or executions, upon the property affected, and only as to later credits;

(8) Claims of co-heir in the partition of an immovable among them, upon the real property thus
divided;

(9) Claims of donors of real property for pecuniary charges or other conditions imposed upon
the donee, upon the immovable donated;

(10) Credits of insurers, upon the property insured, for the insurance premium for two years.

(1) Taxes

Capital gains tax is NOT a preferred credit because it is really a tax on income and not on the
property itself.

This provision covers real property taxes.

(2) Unpaid Seller

There is no need to register the sale in order for the unpaid seller to have a preferred claim
against the immovable.

(5) Mortgage

The mortgage must be registered in the Registry of Property in order for the credit to be a
preferred claim against the immovable.

(7) Credits annotated in the Registry of Property in virtue of judicial order, attachment, or
execution

The credits must also be registered in order to be preferred.

The preference is only with respect to LATER CREDITS.

The credit is preferred only with respect to other attachments, not to other kinds of credit.
Therefore, this does not share equally with the other claims. It merely provides that a credit by
virtue of judicial order, attachment, or execution that is first registered in the Registry of
Property is preferred over other credits of the same nature, which are registered at a later date.

Unlike the other special preferred credits, these credits do not share
proportionately in the property upon which they are imposed. To determine the

Cayo IID 2002 PAGE 73


order of priority among several credits of this kind, their dates should be the basis.
The first one to be registered will be prioritized over the others.

Õ Again, 2242, is not an order of priority, with the exception of taxes imposed upon the
immovable, which is prioritized. 2242 is merely an enumeration.

Why isn’t there a provision for malfeasance or misfeasance with respect to immovables?

Corrupt public officials can easily hide movables, which is why it would be more difficult to
recover them. Hence, there is a provision giving the government preference with respect to
movables. But in the case of immovables, the corrupt public officials cannot really hide them.
The government can establish a preferred claim over them simply by attaching. (This is the
reason given by JPSP. For the reason of the Code Commission, ask Pelagio Cuison).

Problem: Debtor’s only assets are a house and lot worth P5M, a car worth P1M, and jewelry
worth 500K. Among Debtor’s liabilities are a real estate mortgage on the house and lot to
secure a loan worth P3M and a chattel mortgage on the car to secure a loan worth P500K.
Debtor has other obligations worth P6M. What are the preferred credits? How much free
property does Debtor have?

With respect to the house and lot, the real estate mortgage is preferred. With respect to the
car, the chattel mortgage is preferred.

To determine the value of the Debtor’s free property, pay off the preferred claims first:

House and Lot worth P5M – P3M REM obligation = P2M excess

Car worth P1M – 500K chattel mortgage obligation = 500K excess

The excess after the preferred claims have been satisfied will go to the free property of the
debtor:

Free property = Jewelry worth 500K + P2M excess from House and Lot + 500K excess from
car
= 500K + 2M + 500K
= 3M

The free property of Debtor is worth P3M. The other creditors for P6M will then line up for this
portion according to the order of priority established in Art. 2244 if they are ordinary preferred
credits and 2245 if they are common credits.

Problem: Realty Company entered into a contract to sell with X. Under the contract to sell,
X will sell the lot to Realty Company, and Realty Company will pay the price in installments.
Realty Company failed to pay the installments in full. The lot was used in a condominium
project. How can X collect from Realty Company, in case it becomes insolvent?

X should claim that he still owns the lot since the contract was merely a contract TO sell.
Therefore, the lot should not be included in the insolvency proceedings concerning Realty
Company. X can also claim that the condominium project on the lot cannot be included in the
insolvency proceedings either because it is an improvement on a lot owned by X, not by Realty
Company. This way, if Realty Company becomes insolvent, X does not have to line up and
compete with other creditors’ claims, because he can say that he is the owner of the property.

Cayo IID 2002 PAGE 74


Õ JPSP says that if you’re a creditor, you should avoid the preferred claim route because you
would rather not line up along with the other creditors. You should find a way to be the owner
of the thing that you’re after – such as, proving that it’s an implied trust or a contract to sell, etc.

Art. 2243. The claims or credits enumerated in the two preceding articles shall be considered
as mortgages or pledges of real or personal property, or liens within the purview of legal
provisions governing insolvency. Taxes mentioned in No. 1 article 2241, and No. 1, article
2242, shall first be satisfied.

2243 gives the rule that taxes due on the movable or on the immovable concerned should be
satisfied first. The rest of the special preferred claims share equal preference among
themselves.

Ordinary Preferred Credits (2244)

Art. 2244. With reference to other property, real and personal of the debtor, the following
claims or credits shall be preferred in the order named:

(1) Proper funeral expenses for the debtor, or children under his or her parental authority who
have no property of their own, when approved by the court;

(2) Credits for services rendered the insolvent by employees, laborers, or


household helpers for one year preceding the commencement of the proceedings in
insolvency;

(3) Expenses during the last illness of the debtor or his or her spouse and children under his
or her parental authority, if they have no property of their own;

(4) Compensation due the laborers or their dependents under laws providing for indemnity for
damages in case of labor accident, or illness resulting from the nature of the employment;

(5) Credits and advancements made to the debtor for support of himself or herself, and family,
during the last year preceding the insolvency;

(6) Support during the insolvency proceedings, and for three months thereafter;

(7) Fines and civil indemnification arising from a criminal offense;

(8) Legal expenses, and expenses incurred in the administration of the insolvent’s estate for
the common interest of the creditors, when properly authorized and approved by the court;

(9) Taxes and assessments due the national government other than those mentioned in
Articles 2241, No. 1, and 2242, No. 1;

(10) Taxes and assessments due any province, other than those referred to in Articles
2241, No. 1, and 2242, No. 1;

(11) Taxes and assessments due any city or municipality, other than those indicated in
Articles 2241, No. 1, and 2242, No. 1;

(12) Damages for death or personal injuries caused by a quasi-delict;

Cayo IID 2002 PAGE 75


(13) Gifts due to public and private institutions of charity or beneficence;

(14) Credits which, without special privilege, appear in (a) a public instrument; or (b) in a
final judgment, if they have been the subject of litigation. These credits shall have
preference among themselves in the order of priority of the dates of the instruments and
of the judgments respectively.

Once the special preferred claims under 2241 and 2242 have been satisfied, the property
remaining constitute the debtor’s free property. The debtor’s free property will then be used to
pay ordinary preferred claims in the order established in 2244. Unlike 2241 and 2242, 2244 is
not merely an enumeration; it establishes the order of priority. Also, unlike 2241 and 2242,
2244 does not establish a preference with respect to specific property of the debtor. The
preference is with respect to the mass of properties of the debtor remaining after the special
preferred claims have been satisfied.

Important Items

(2) Labor Claims

Art. 110 of the Labor Code has modified 2244 by moving labor claims to number (1), ahead of funeral
expenses. Labor claims are still not in the level of special preferred claims under 2241 and 2242. The
Labor Code merely moved it up to the top of the list of ordinary preferred claims. Also, Art. 110 of the
Labor Code has removed the one-year limitation.

(9), (10), (11) Taxes

Note that this is unlike special preferred claims where a tax is imposed upon a specific movable or
immovable property. Special preferred claims, as provided by 2243, enjoy first preference with
respect to the property upon which they are imposed.

Under 2244, on the other hand, taxes of other kinds are only ordinary preferred credits and are only
9th, 10th, and 11th priorities with respect to the free portion of the property of the debtor. Examples
are income tax, license fees, and capital gains tax. These are not imposed on specific property of the
debtor, so they are ordinary preferred claims, which can be collected against the debtor’s free
property.

Taxes owing the national government should be satisfied first, followed by the provincial government,
then the city or municipal government.

(14) Credits appearing in a public instrument or in a final judgment

This paragraph contains the rule of preference when you have several credits appearing in public
instruments or in a final judgment. To determine the order of preference among them, just consider
the date. First in time, priority in right, sabi nga ni CLV.

This does not include those registered credits which fall under 2241 and 2242, such as those arising
from a pledge or mortgage, or an attachment of specific real property.

Example:

The claims are as follows:

A notarized promissory note dated May 1, 2002.


A promissory note in a private document dated January 1, 2002.
A judgment for sum of money dated October 1, 2002.

Cayo IID 2002 PAGE 76


What is the order of priority?

1. Notarized promissory note dated May 1, 2002


2. Judgment dated October 1, 2002
3. Promissory note in a private document dated January 1, 2002

Common Credits

Art. 2245. Credits of any other kind or class, or by any other right or title not comprised in the four
preceding articles, shall enjoy no preference.

If it is not among those mentioned in 2241, 2242, and 2244, it is a common credit. Creditors with
common credits have to line up for the excess of the debtor’s property after claims under 2241, 2242,
and 2244 have been satisfied. There is no order of preference among common creditors; they share
whatever is left in proportion to their credit, regardless of date.

CHAPTER 3 ORDER OF PREFERENCE OF CREDITS

Art. 2246. Those credits which enjoy preference with respect to specific movables, exclude all others
to the extent of the value of the personal property to which the preference refers.

Art. 2247. If there are two or more credits with respect to the same specific movable property, they
shall be satisfied pro rata, after the payment of duties, taxes and fees due the State or any
subdivision thereof.

Art. 2248. Those credits which enjoy preference in relation to specific real property or real rights,
exclude all others to the extent of the value of the immovable or real right to which the preference
refers.

Art. 2249. If there are two or more credits with respect to the same specific real property or real
rights they shall be satisfied pro rata, after the payment of the taxes and assessments upon the
immovable property or real right.

Art. 2250. The excess, if any, after the payment of the credits which enjoy preference with respect
to specific property, real or personal, shall be added to the free property which the debtor may
have, for the payment of other credits.

Art. 2251. Those credits which do not enjoy any preference with respect to specific property and
those which enjoy preference, as to the amount paid, shall be satisfied according to the following
rules:

(1) In the order established in article 2244;

(2) Common credits referred to in article 2245 shall be paid pro rata regardless of dates.

APPLYING THE RULES


STEP 1: MAKE AN INVENTORY OF ASSETS

List down all the assets of the debtor.

Group these assets into two: the Preferred Group and the Free Property Group.

Those assets with special preferred claims under 2241 and 2242 imposed upon them belong to the
Preferred Group.

Cayo IID 2002 PAGE 77


Those without special preferred claims will constitute the debtor’s Free Property.

Remember to take out property held by the debtor only in the capacity of trustee. He may have legal
title to it, but the beneficial title and ownership actually belong to another person. Since the property
does not belong to the debtor, they should not be included in the proceedings. The same goes for
property of the AC of CPG, property held as lessee or usufructuary, etc.

STEP 2: GROUP THE CLAIMS

Make four groups – (1) special preferred credits on movables, (2) special preferred credits on
immovables, (3) ordinary preferred credits, and (4) common credits.

For the special preferred claims, look out for the following because they are the most common:

1. For movables:

a. import duties/other taxes imposed directly on the movable


b. an obligation secured by a pledge (in a public instrument) or a chattel mortgage
(registered)
c. claim of unpaid seller for the price of the movable

2. For immovables:

a. real estate taxes


b. an obligation secured by a real estate mortgage (registered)
c. claim of unpaid seller for the price of the immovable
d. credits annotated in the Registry of Property by attachment or execution upon the
immovable

Put the ordinary preferred claims under 2244 together. List them down according to the order under
2244, since 2244 already gives the order of preference. Remember, though, that labor claims are on
top. The most common are:

1. labor claims
2. taxes other than those imposed directly upon a movable or an immovable, such as income
taxes and license fees (In the following order: national government, provincial
government, city or municipal government).
3. credits in a final judgment or in a public document, such as notarized promissory notes

Put the other credits not falling under these three together. These are the common claims. The usual
example is a promissory note in a private instrument.

STEP 3: SATISFY THE SPECIAL PREFERRED CLAIMS

First: Take the value of the specific movable/immovable upon which the preferred claim is imposed.

Second: Pay the taxes due on the property.

Third: Pay the preferred claim of the creditor.

What if you have more than one preferred creditor over the same property?

Ex: The claims against a car are: import duties, chattel mortgage, and unpaid seller.

In this case, pay the taxes first. Since the mortgage creditor and the unpaid seller are both
special preferred creditors, they will share the balance proportionately. There will only be
proportionate sharing in case the value of the thing after payment of taxes is not enough to

Cayo IID 2002 PAGE 78


satisfy all of the special preferred claims against it. If the value of the thing is sufficient, then
all the special preferred claims must be paid in full.

Fourth: If, after paying the taxes and other special preferred claims, there is an excess, take the value
of the excess and add it to the debtor’s Free Property.

Fifth: If the value of the specific property is not enough to satisfy the taxes and other special preferred
claims, and there is a deficiency, follows these rules:

a. If the deficiency is in a credit arising from a pledge, real mortgage, or chattel mortgage,
put the deficiency in the ordinary preferred credits group. Why do we know right away
that it is an ordinary preferred credit? It is a credit in a public instrument, so it is an
ordinary preferred credit under (14) of 2244. You know it’s in a public instrument because
it was treated at first as a special preferred credit, and the requirement under 2241 and
2242 is that these transactions be registered (for real and chattel mortgage) or be in a
public document (for pledge).

b. If the deficiency is in a credit arising from a transaction that is not in a public document or
is not contained in a final judgment (ex: unrecorded sale), put the deficiency in the
common credits group.

STEP 4: UPDATE THE INVENTORY AND LIST OF CREDITS

After you have satisfied all of the special preferred claims, update the following:

1. The inventory of assets

You may have to add to the Free Property Group if, after satisfying the special preferred
claims, you have an excess. Make sure that you add the excess to the Free Property Group.

Add up the entire value of the Free Property Group because this is what you will use to settle
the ordinary preferred claims and the common claims.

2. The list of ordinary preferred claims

If there was a deficiency in satisfying the special preferred claims, the deficiency will be an
ordinary preferred credit if it is notarized or is contained in a final judgment.

3. The list of common claims

If there was a deficiency in satisfying the special preferred claims, the credit will be a common
credit if it is not notarized or contained in a final judgment.

STEP 5: SATISFY THE ORDINARY PREFERRED CLAIMS

List down all the ordinary preferred claims in the order in which they are listed in 2244. This is the
order of preference among them.

Most probably, there will be several credits in public instruments and final judgments. Arrange these
by date. Those falling on the same date will enjoy equal preference and will share the balance of the
free property proportionately.

STEP 6: SATISFY THE COMMON CLAIMS

Whatever is remaining of the debtor’s free property will be used to satisfy the common claims. Since
these will not be enough to cover the debtor’s remaining liabilities (he’s insolvent), the common
creditors will share the balance in proportion to the amount of their credit, regardless of the date.

Cayo IID 2002 PAGE 79


Most probably, JPSP will just ask us to list the order of preference of several credits. So my
suggestion is to make the lists mentioned above and just update the list of ordinary preferred claims
and common claims after satisfying the special preferred claims, in case there is an excess or
deficiency.

Examples:

On January 1, 2002, Debtor executes a promissory note for 500K in a private instrument.
On March 1, 2002, he executes a Real Estate Mortgage over his house and lot worth P3M to
secure a P5M loan. On the same date, he also executes a notarized promissory note for
P1M. On September 1, 2002, a creditor is able to obtain a favorable judgment against
Debtor for P100K. Debtor becomes insolvent. What is the order of priority of his creditors’
claims?

1. The mortgage credit should be satisfied first. But since it is for P5M and the house and lot is
only worth P3M, there will be a deficiency of P2M. The P2M will be an ordinary preferred
credit.

2. Next in priority are the notarized promissory note for P1M and the P2M deficiency on the
mortgage credit. They are both ordinary preferred credits under (14) of 2244. Since they
were executed on the same date, they enjoy the same order of preference and will share
proportionately in the free property of the Debtor.

3. The last to be satisfied will be the promissory note in a private instrument, which is a common
credit.

The debtor’s assets are a house and lot, a car, and cash. He is insolvent. His obligations
are as follows:

A real estate mortgage dated June 1, 2002


Chattel mortgage on the car dated March 1, 2002
Real property tax on the house and lot
Income tax
Import duty on the car
Unpaid seller of the lot, sold to him on March 1, 2002
License fee owing the city government for business of Debtor
Notarized promissory note dated March 1, 2002
Acknowledgment receipt of debt dated March 1, 2002
Judgment dated March 1, 2002, with attachment on house and lot dated January 1, 2002

What is the order of preference?

First, make the inventory:

Immovable Property with Special Preferred Claim

House and Lot

Movable Property with Special Preferred Claim

Car

Free Property

Cash

Second, group the credits:

Cayo IID 2002 PAGE 80


SPECIAL PREFERRED SPECIAL PREFERRED ORDINARY COMMON CLAIMS
CLAIMS OVER CLAIMS OVER PREFERRED CLAIMS
IMMOVABLE MOVABLE PROPERTY
PROPERTY
Real estate mortgage Import duty on the car Income tax Acknowledgment
dated June 1, 2002 receipt of debt dated
Chattel mortgage on License fee owing the March 1, 2002
Real property tax on the car dated March 1, city government for
the house and lot 2002 business of Debtor

Unpaid seller of the lot, Notarized promissory


sold on March 1, 2002 note dated March 1,
2002
Judgment dated March
1, 2002, with
attachment on house
dated January 1, 2002

Third, satisfy special preferred claims:

With respect to the House and Lot

1. Real property tax


2. The following will share proportionately the balance after the payment of the real property
tax:

a. Real estate mortgage creditor


b. Unpaid seller
c. Judgment dated March 1, 2002 with attachment on house and lot dated January 1,
2002

[Let’s assume that there was a deficiency in settling the claims of these three creditors]

With respect to the Car

1. Import duty
2. Chattel mortgage creditor

Fourth, update the list of credits:

ORDINARY PREFERRED CLAIMS COMMON CLAIMS


Income tax Acknowledgment receipt of debt dated March 1,
2002
License fee owing the city government for
business of Debtor

Notarized promissory note dated March 1, 2002

Add:

Deficiency in claim of
Real estate mortgage creditor dated June 1, 2002

Deficiency in claim of unpaid seller of the lot, sold


on March 1, 2002

Deficiency in claim from judgment dated March 1,


2002

Cayo IID 2002 PAGE 81


Fifth, pay the ordinary preferred claims out of free property in the following order:

1. Income tax

2. License fees

3. Proportionate sharing:
Notarized promissory note dated March 1, 2002
Unpaid seller’s deficiency, sale dated March 1, 2002
Deficiency in judgment credit, dated March 1, 2002

4. Deficiency in real estate mortgage, dated June 1, 2002

Sixth, pay the common claims out of free property

Acknowledgment receipt of debt

Cayo IID 2002 PAGE 82


INSOLVENCY LAW

What is insolvency?

It denotes the state of a person whose liabilities are more than his assets.

The Insolvency Law provides for three remedies:

1. Suspension of Payments
2. Petition for Voluntary Insolvency
3. Petition for Involuntary Insolvency

I. SUSPENSION OF PAYMENTS

What is suspension of payments?

Suspension of payments is the postponement, by court order, of the payment of debts of one who,
while possessing sufficient property to cover his debts, foresees the impossibility of meeting them
when they respectively fall due (solvent but not liquid).

What are the laws governing suspension of payments?

A debtor may file a petition for suspension of payments either under The Insolvency Law or PD
902-A.

SUSPENSION OF PAYMENTS UNDER PD 902-A

Who may file for suspension of payments under PD 902-A?

A corporation may file for suspension of payments under PD 902-A if it is either:

1. Solvent but not liquid; OR


2. Insolvent and under the management of a Rehabilitation Receiver or Management
Committee

A Rehabilitation Receiver or Management Committee is a group of persons appointed by the


court to take over the assets of the insolvent corporation in order to turn it around.

Õ A natural person cannot file for suspension of payments under PD 902-A,

Where do you file a petition for suspension of payments under PD


902-A?

You file the petition with the RTC (it used to be with the SEC, but the law was amended).

What are the advantages of filing a petition for suspension of


payments?

The advantages of filing a petition for suspension of payments are:

1. The debtor has continued access to the assets and resources of the corporation; and

Cayo IID 2002 PAGE 83


2. It gives the debtor leverage or a framework for negotiation (that is, if he files it under PD
902-A, not the Insolvency Law). The debtor can delay payment for as long as the court
allows, so it’s a good chance to bargain with creditors in the meantime.

Cayo IID 2002 PAGE 84


If you were the debtor corporation, what are the advantages of filing the petition for
suspension of payments under PD 902-A instead of under the Insolvency Law?

1. PD 902-A is more lenient than the Insolvency Law. Under the Insolvency Law, the
debtor must be solvent but not liquid. Under PD 902-A, even if the corporation is
insolvent, as long as it is under Rehabilitation Receiver or Management Committee, it
can file for suspension of payments.

2. Under the Insolvency Law, the creditors have a say on whether to grant the petition.
Under PD 902-A, only the court decides.

3. Under PD 902-A even secured creditors are covered by the suspension; there are no
exceptions. All claims are suspended. Under the Insolvency Law, secured creditors are
not covered by the suspension; they may foreclose upon default.

SUSPENSION OF PAYMENTS UNDER THE INSOLVENCY LAW (SECTIONS 2-13)

What are the requisites of the petition for suspension of payments


under the Insolvency Law?

The petition must be filed by a debtor:

1. possessing sufficient property to cover all his debts (SOLVENT)

2. foreseeing the impossibility of meeting them when they respectively fall due (NOT
LIQUID)

3. petitioning that he be declared in the state of suspension of payments.

The debtor may either be a natural or juridical person (Although, as mentioned already, if you’re
a corporation, it would be better to file the petition under PD 902-A, not under the Insolvency
Law).

The petition need not be verified.

What is the procedure for suspension of payments?

1. File a petition with the RTC where the debtor has resided for six months prior to the
filing of the petition.

The petition should be accompanied by a verified list of all of his creditors, debts and
liabilities, a statement of his assets and liabilities, and the proposed agreement that he
requests from his creditors.

2. The court will issue an order calling for the meeting of all creditors. The meeting should
take place not less than 2 weeks nor more than 8 weeks from the date of the order.

3. The order will be published and notice sent to all the creditors of the debtor.

Cayo IID 2002 PAGE 85


4. There will be a meeting of creditors in which they will decide whether to grant the
petition. Take note that the amount of the debt is not reduced. The debtor merely buys
more time to satisfy his obligations.

Quorum Requirement: To have a valid meeting, the creditors present must represent
at least 60% of the total liabilities of the debtor.

Ex: A has liabilities worth P10,000 as follows: creditor X: 3,000; creditor Y: 3,000, and
creditor Z: 4,000. If X and Y are present, there will be a quorum because they represent
6,000 or 60% of the total liabilities of A.

5. The creditors will approve the proposition of the debtor.

Majority required to approve the proposal: A double majority consisting in 2/3 of the
number of creditors voting, which 2/3 must represent at least 60% of the total liabilities
of the debtor.

Example: There are 99 creditors representing total liabilities worth P100K. What is the
majority required to approve any proposal?

The majority required is 66 creditors (2/3 of the number of creditors voting), who
must, in addition, represent at least P60K worth of liabilities.

What if the debtor owes one creditor a total of P60K, is his single vote a valid majority?

No. Because although he met the requirement of 60% of the liabilities, he does not
constitute 2/3 of the number of creditors voting. There must be a double majority.

6. Objections, if any, to the decision must be made within 10 days following the meeting.

7. Issuance of the order of the court directing that the agreement be carried out in case the
decision is declared valid, or when no objection to said decision has been presented.

What are the effects of filing of the petition?

1. No disposition of his property may be made by the debtor except those made in the
ordinary course of business;

2. No payments may be made by the debtor except those made in the ordinary course of
business;

3. Upon request to the court, all pending executions against the debtor shall be suspended
except execution against property especially mortgaged.

Why is it in the interest of the debtor to refrain from making any disposition or payment
other than those in the ordinary course of business?

Dispositions or payments made which are not in the ordinary course of business may indicate
that the debtor connived with a creditor into voting in favor of the suspension of payments by
buying his vote. Also, this shows that the debtor is liquid after all, and therefore, does not need
to be placed in a state of suspension of payments.

Cayo IID 2002 PAGE 86


Are all of the creditors of the debtor affected by the filing of the
petition?

Only those creditors included in the schedules filed by the debtor will be called upon to take part
in the meeting. Hence, those who did not appear because they were not informed of the
proceedings will not be affected. The debtor is obliged to disclose all of his creditors in the
petition. The disclosure shall be verified or confirmed under oath.

Which creditors are not affected by the order of suspension of


payments?

Aside from those creditors to whom notice was not given, the following creditors are also not
covered by the suspension:

1. Persons having claims for personal labor, maintenance, expense of last illness and
funeral of the wife or children of the debtor incurred in the 60 days immediately
preceding the filing of the petition; and

2. Persons having legal or contractual mortgages. They can foreclose upon default in
spite of the suspension of payment.

(But take note that this does not apply if the petition was filed under PD 902-A, in which
case, ALL creditors are covered by the suspension of payments. This rule applies only
when the petition is filed under the Insolvency Law.)

What are the grounds for questioning the decision of the meeting?

1. Procedural defects in the calling and holding of the meeting, and the deliberations
conducted, which caused prejudice to the rights of the creditors;

2. Fraudulent connivance between a creditor and the debtor for the creditor to vote in
favor of the proposed agreement;

If there is proof that the debtor somehow bribed the creditor or bought his vote, the
decision of the meeting can be set aside. However, it is legal to give OTHER incentives
to the creditor, such as higher interest rates. These are not bribes but merely incentives
to induce them to vote in favor of suspension.

3. Fraudulent conveyance of claims by a creditor for the purpose of obtaining a majority.

Ex: There are 99 creditors with claims worth P100K total. 1 creditor represents 60K
worth of credits, while the other 98 creditors represent a total of 40K. The one creditor
is in favor of suspension of payments, while the other 98 are against it. How will this
one creditor manipulate the situation in order to approve the petition?

He has already complied with the 60% requirement. His problem is the 2/3 of the
creditors requirement, since he only represents 1/99 of the creditors. What he can do is
to assign some of his credits to 200 other people. That way, they will represent 201/299
of the creditors, with a total claim of 60K. This is enough to meet the double majority
requirement. BUT, this is a ground for questioning the decision of the meeting.

Cayo IID 2002 PAGE 87


II. VOLUNTARY INSOLVENCY

What is the concept of voluntary insolvency?

An insolvent debtor whose liabilities exceed P1,000 may apply to be discharged from his debts
and liabilities by filing a petition for voluntary insolvency in the RTC where he has resided for
the last six months prior to the filing of the petition. In voluntary insolvency, the debtor himself
is the petitioner.

The date of the filing of the petition is important for purposes of reckoning certain periods, such
as the residency requirement.

Distinctions between suspension of payments and insolvency (in general)

INSOLVENCY SUSPENSION OF
PAYMENTS
PURPOSE To discharge the debtor from To suspend or delay the
the payment of debts payment of debts
SOLVENCY OF DEBTOR Debtor does not have Debtor has sufficient property
sufficient property to pay his to pay his debts
debts
EFFECT ON AMOUNT OF The amount is affected. The amount of indebtedness
INDEBTEDNESS Creditors receive less than is not affected.
their credits; and where there
are preferences, some
creditors may not receive
anything at all.
NUMBER OF CREDITORS There must be three or more The number of creditors is
creditors if it is involuntary immaterial.
insolvency.

What are the jurisdictional requirements for the petition for voluntary insolvency?

In the petition, the debtor shall indicate:

1. his place of residence and the period of residence therein prior to the filing of the
petition;
2. his inability to pay all his debts in full;
3. his willingness to surrender all his property, estate, and effects not exempt from
execution for the benefit of his creditors;
4. an application to be adjudged insolvent.

The petition shall be accompanied by:

1. A verified schedule containing:

a. a full and true statement of all debts and liabilities of the insolvent debtor, and
b. an outline of the facts giving rise or which might give rise to a cause of action
against the insolvent debtor

Cayo IID 2002 PAGE 88


2. A verified inventory containing:

a. an accurate description of all the personal and real property of the insolvent,
whether or not exempt from execution, including a statement as to its value,
location, and encumbrances thereon; and

b. an outline of the facts giving rise or which might give rise to a right of action in
favor of the insolvent debtor.

What is the procedure for voluntary insolvency?

1. Filing of the petition by the debtor praying to be declared insolvent.

Unlike in involuntary insolvency, in voluntary insolvency, there need not be an


allegation of an act of insolvency by the creditors of the debtor. This is because in
voluntary insolvency, the one petitioning is the debtor himself. The very act of filing the
petition is the act of insolvency. In contrast, in involuntary insolvency, the ones
petitioning are the debtor’s creditors.

2. Issuance of an order of adjudication declaring the debtor insolvent.

The court need not conduct a hearing before declaring the debtor insolvent and
taking his assets. This is because the petition is voluntary on the part of the debtor. It is
not adversarial.

3. Publication and service of the order to creditors.

4. Meeting of the creditors to elect the assignee in insolvency.

5. Conveyance of the debtor’s property by the clerk of court to the assignee.

6. Liquidation of the debtor’s assets and payment of his debts.

7. Composition, if agreed upon.

8. Discharge of the debtor, upon his application, except if the debtor is a corporation.

9. Objection, if any, to the discharge.

10. Appeal to the Supreme Court in certain cases.

What are the effects of an order declaring the petitioning debtor insolvent?

1. The sheriff takes possession of all the assets of the debtor which are not exempt from
execution until the appointment of a receiver or an assignee.

2. The payment to the debtor of any debts due to him and the delivery to the debtor or to
any person for him any property belonging to him, and the transfer of any property by
him are forbidden.

3. All civil proceedings pending against the insolvent debtor shall be stayed.

Cayo IID 2002 PAGE 89


4. Mortgages or pledges, attachments or executions on property of the debtor duly
recorded and not dissolved are not, however, affected by the order.

If the petitioner is a corporation, JPSP thinks that the better route is still to file for suspension of
payments under PD 902-A instead of filing for voluntary insolvency.

If the petitioner is a natural person, his only incentive to file a petition for voluntary insolvency is
that he will get a discharge from past debts and liabilities (corporations do not get this
discharge). But otherwise, there are very few advantages in filing for voluntary insolvency. The
debtor should just fight it out with his creditors, since filing for voluntary insolvency is not just
demeaning but will even affect the debtor’s credit-worthiness later on. After filing for voluntary
insolvency, no one will trust that debtor enough to lend him money again.

III. INVOLUNTARY INSOLVENCY

What is the purpose of involuntary insolvency?

A petition for involuntary insolvency is not an ordinary personal action for collection of debts. Its
purpose is to impound all of the non-exempt property of the debtor, to distribute it equitably
among his creditors, and to release him from further liability.

Distinctions between Voluntary Insolvency and Involuntary Insolvency

VOLUNTARY INSOLVENCY INVOLUNTARY


INSOLVENCY
NUMBER OF CREDITORS One creditor is sufficient Three or more creditors
PETITIONER The insolvent debtor Three or more creditors who
must possess the
qualifications provided by law
ACTS OF INSOLVENCY Debtor must not be guilty of Debtor must have committed
any act of insolvency one or more of the 13 acts
AMOUNT OF Must be greater than P1,000 Must be P1,000 or more
INDEBTEDNESS
BOND Not required Petition must be accompanied
by a bond
HEARING Not necessary; may be Petition is granted only after
granted ex parte hearing
RESIDENCY REQUIREMENT Petition must be filed with Petition must be filed with
RTC where debtor has RTC where debtor resides or
resided for at least 6 months has his place of business; no
residency requirement
ISSUANCE OF THE ORDER Upon the filing of the Upon hearing of the case
OF ADJUDICATION voluntary petition
DECLARING THE DEBTOR
INSOLVENT

Cayo IID 2002 PAGE 90


Who may petition for involuntary insolvency?

The petitioners must be:

1. at least three creditors of one debtor


2. who are residents of the Philippines,
3. whose credits accrued in the Philippines,
4. the aggregate amount of which is at least P1,000.
5. In addition, the credits of these three creditors should NOT have accrued within 30
days prior to the filing of the petition.

Why does it have to be three creditors? Why is it not enough for one creditor to file the
petition?

Insolvency proceedings contemplate competing claims of several creditors over the assets of
the insolvent debtor. If there is only one creditor, there are no competing claims. The creditor
can just go to court and file a simple action to collect.

Õ But if you’re the single creditor of one debtor, there may be instances when you would
want to file a petition for involuntary insolvency against the debtor.

First, how do you do this? Since you’re only one creditor, you cannot file the petition because
the Insolvency Law requires that it be filed by at least three creditors. To get around this
requirement, you should assign some of the credit to at least two other persons. After waiting
for 30 days (cooling-off period), you can file the petition.

Why would you want to do this?

The petition for involuntary insolvency can be used as a tool to harass or pressure a debtor into
settling his obligation with the single creditor.

Example: Creditor extends a loan to a Foreign Company, which is publicly listed in the Hong
Kong Stock Exchange. Foreign Company fails to pay, and since it is a foreign company, it has
no assets in the Philippines which Creditor can run after. What should Creditor do?

Creditor should first assign some of the credit to two other companies, wait 30 days, then file
the petition for involuntary insolvency against Foreign Company. News of the Foreign
Company’s insolvency will reach Hong Kong, and the price of its shares will go down. To stop
the share prices from going down, Foreign Company will be forced to settle the obligation, so
that Creditor will withdraw the petition. (According to JPSP, Creditor can do this even if Foreign
Company is not actually insolvent. It’s just a legal tactic to get Foreign Company to settle the
obligation.)

What are the requisites of the petition for involuntary insolvency?

The petition must:

1. be verified by the petitioners

2. set forth one or more acts of insolvency mentioned in the law

Cayo IID 2002 PAGE 91


What are acts of insolvency?

There are 13 acts of insolvency mentioned in Sec. 20 of the Insolvency Law. These
may be grouped into three general categories (See p. 568 of De Leon for the complete
list):

a. the debtor committed acts to ensure that the debtor will not be able to pay
b. the debtor committed acts in fraud of creditors
c. the debtor committed acts giving preference to one creditor in favor of other
creditors

But the petition should allege at least one of the 13 specific acts of insolvency
mentioned in the law. This is a jurisdictional requirement.

3. be accompanied by a bond, approved by the court with at least two sureties, in such
penal sum as the court shall direct.

The purpose of the bond is for the petitioners to answer for the costs, expenses, and
damages resulting in the filing of the petition. For example, in the earlier case of the
single creditor who files the petition against the Foreign Company just to humiliate him,
the bond will answer for damages that Foreign Company can prove as a result of the
wrongful filing of the petition.

What are the steps in filing a petition for involuntary insolvency?

1. Filing of the petition by three or more creditors in the RTC where the debtor resides or
has his place of business.

2. Issuance of the order requiring the debtor to show cause why he should not be
adjudged insolvent.

3. Service to debtor of the order to show cause.

4. Filing of the debtor’s answer or motion to dismiss.

5. Hearing of the case.

This is in contrast with voluntary insolvency, where there is no need for a hearing. In
involuntary insolvency, there is a hearing because the proceedings are adversarial. The
debtor is given a chance to refute the claim of the petitioners that he is insolvent.

6. Issuance of the order or decision adjudging the debtor insolvent.

Note that between the filing of the petition and the adjudication of the case by the
court, there is a period of time during which the debtor still has his assets. While the
case is being decided by the court, the debtor can dissipate his assets in the meantime.
To protect themselves from this situation, the creditors should either ask the court for an
injunction or for a receiver who will hold the properties of the debtor.

7. Publication and service of the order.

8. Meeting of creditors for election of an assignee in insolvency.

Cayo IID 2002 PAGE 92


The assignee must be elected within two to eight weeks from the date of the order of
the adjudication.

9. Conveyance of the debtor’s property by the clerk of court to the assignee.

10. Liquidation of the assets of the debtor and payment of his debts.

11. Composition, if agreed upon.

12. Discharge of the debtor on his application, except if the debtor is a corporation.

13. Objection, if any, to the discharge.

14. Appeal to the Supreme Court, in certain cases.

IV. ASSIGNEES

What is an assignee?

An assignee is the person elected by the creditors or appointed by the court to whom an
insolvent debtor makes an assignment of all his property for the benefit of his creditors. The
assignment vests title to all the assets of the debtor in favor of the assignee.

The assignee represents the insolvent as well as the creditors in voluntary and involuntary
proceedings.

Who can participate in the election of the assignee?

Creditors who have filed their claims in the office of the clerk of court at least two days prior
to the scheduled election may participate.

As a general rule, a secured creditor cannot participate in the election, unless:

1. he has asked for the fixing of the value of the security;

OR

2. he has surrendered the security to the sheriff or receiver of the estate of the insolvent.

If you were the secured creditor, why would you surrender the security?

If the security is not enough to cover the obligation, you might as well participate in the election
if you think that the portion that will be allotted to you will be greater than the value that you will
realize from the sale of the security.

How do the creditors choose the assignee?

The creditors will meet in order to elect the assignee.

Cayo IID 2002 PAGE 93


In order to validly elect an assignee, the majority of the creditors both in number and in the
amount of credit they represent (another case of double majority) should vote for the same
assignee.

If the creditors do not attend the meeting or fail or refuse to elect an assignee, or if the
assignee fails to qualify or subsequently becomes incapacitated, the court will appoint the
assignee.

What should the assignee do once he is elected?

The assignee is required to give a bond for the faithful performance of his duties, within five
days from his election, in an amount to be fixed by the court, with two or more sureties. The
bond will answer for any liability that the assignee may incur to persons aggrieved by his
actions as assignee.

If you were given an opportunity, will you act as an assignee?

Yes, because the assignee earns a substantial fee. According to Section 42 of the Insolvency
Law, the assignee earns commissions at the following rates:

7% for the first P1,000 that he will be able to liquidate from the properties of the debtor;
5% for sums exceeding P1,000 but less than P10,000; and
4% for sums exceeding P10,000.

So if the amount that you can liquidate is P100M, you will earn P4M.

Aside from this fee, the assignee will also have other benefits, such as reimbursements of his
expenses and the opportunity to refer legal or accounting matters to his firm, if he is a lawyer or
a CPA.

What are the effects of assignment?

1. The assignee takes the property in the same conditions that the insolvent held it.

2. Upon appointment, the legal title to all the property of the insolvent is vested in the
assignee, and the control of the property is vested in the court. But the title of the
assignee retroacts to the date of the filing of the petition for insolvency.

3. All actions to recover all the estate, debts, and effects of the insolvent shall be brought
by the assignee and not by the creditors.

4. If there was an attachment or a judgment against the insolvent debtor made 30


days before the filing of the petition for insolvency, it will be set aside.

What are the powers and duties of the assignee?

The assignee has the powers of administration over the property of the insolvent. Having
these powers, he can sue and recover claims belonging to the debtor, take into possession all
of the property of the debtor, recover property fraudulently conveyed by the debtor, etc (for a
complete enumeration, see p. 586-587 of De Leon).

Cayo IID 2002 PAGE 94


The assignee does not have powers of disposition. For acts of disposition, such as sale of
the property of the insolvent debtor or payment of the creditor’s shares, the assignee must
obtain a court order.

Section 37 of the Insolvency Law: Penalty for Embezzlement

Take note of Section 37, which provides that if any person, who knows of the pending or
imminent insolvency proceedings concerning the debtor, embezzles or disposes of any of the
property of the insolvent, he shall be liable for a penalty equal to double the value of the
property embezzled or disposed. The penalty will go to the estate of the insolvent.

This relates only to embezzlement of the debtor’s property, and not to assignments of credit
made by the creditors behind each other’s backs.

What is a dividend in insolvency?

It is a part of the fund arising from the assets of the estate of the insolvent debtor, rightfully
allocated to a creditor entitled to a share in the fund. It is paid by the assignee only upon order
of the court.

Õ According to JPSP, if you’re a creditor, you may not want to do involuntary insolvency
because there are a lot of costs – assignee’s fees, legal costs, etc. It might be better is you
could obtain a global settlement. (I don’t know, though, what “global” means.)

V. CLASSIFICATION AND PREFERENCE OF CREDITORS

Disregard the rules in Sec. 48-50 of the Insolvency Law. The applicable rules are those under
the Civil Code on Concurrence and Preference of Credits (Articles 2236-2251).

But take note of Section 48, which provides that property found among the property of the
insolvent debtor but which are not really owned by him should be taken out of the proceedings.
Examples are property held in trust or as a lessor or usufructuary, etc. After taking them out,
apply the rules under the Civil Code.

VI. PARTNERSHIPS AND CORPORATIONS

Who may petition for declaration of insolvency of a partnership?

In case of voluntary insolvency, the petition may be filed by all or any of the partners.

In case of involuntary insolvency, the petition may be filed by three or more creditors of the
partnership or one or more of the partners.

Which properties are covered in insolvency proceedings?

1. All the property of the partnership; and


2. All the separate property of each of the general partners, except

a. separate properties of limited partners; and


b. properties which are exempt by law

Cayo IID 2002 PAGE 95


Can a partnership be declared insolvent even if the partners constituting the same are
solvent?

Yes. A partnership may be declared insolvent notwithstanding the solvency of the partners
constituting it. The creditors of the partnership, after first exhausting its assets, may proceed
against the solvent general partners who are proportionately liable with their separate property.

What happens to the partnership when any of the partners becomes insolvent?

The partnership is automatically dissolved by the insolvency of any partner or of the partnership
(Art. 1830, Civil Code).

What is the benefit given by the Insolvency Law to partnerships?

Partnerships get a discharge from the obligations, if they apply for one. In contrast,
corporations do not get a discharge.

Why doesn’t the law give corporations a discharge?

Corporations do not get a discharge because their creditors can only go after the assets of the
corporation. The creditors cannot collect any deficiency from the stockholders. If the
stockholders want a fresh start, they can just put up a new corporation and start with a clean
slate. There is no need to get a discharge in order to have a fresh start.

But if it’s a partnership, and the assets of the partnership are not enough to cover its liabilities,
the creditors can still go after the general partners for the deficiency. This is why it makes
sense to give them a discharge.

How do you distribute the net proceeds of the properties of the partnership?

1. The net proceeds of the partnership property shall be used to pay the debts of the
partnership.

2. The net proceeds of the individual estate of each partner shall be used to pay individual
debts.

3. If there is any surplus in the property of any general partner after paying his individual
debts, a proportionate part of this surplus will be added to the partnership assets and
will be used to pay partnership debts.

4. If there is any surplus in the property of the partnership, the surplus shall be added to
the assets of the individual partners in proportion to their interests in the partnership.

What is the effect of a declaration that a corporation is insolvent?

The property and assets of the corporation will be distributed to the creditors. Unlike in
partnership, the property of the stockholders of the corporation cannot be used to pay the
creditors of the corporation. However, the corporation will not be allowed to get a discharge.

VII. PROOF OF DEBTS

Cayo IID 2002 PAGE 96


What are the debts which may be proved (collected) against the estate of the insolvent
debtor?

1. All debts due and payable at the time of the adjudication of insolvency;

2. All debts existing at the time of the adjudication of insolvency but not payable until a
future time.

3. Any debt of the insolvent arising from his liability as indorser, surety, bail or
guarantor, where such liability became absolute after the adjudication of insolvency
but before the final dividend shall have been declared;

4. Other contingent debts and liabilities contracted by the insolvent if the contingency
shall happen before the order of final dividend; and

5. Any claim for reimbursement of a person who has answered, in whole or in part, for the
insolvent’s debt as bail, surety, or guarantor or otherwise.

What is a contingent claim?

It is a claim in which the liability depends on a future and uncertain event. For example, the
claim of a surety is a contingent claim because the surety can only claim reimbursement from
the principal debtor once he himself has paid the obligation. But before the surety pays the
principal obligation, he has no claim for reimbursement against the principal debtor.

A claim based on a contingency which has not happened at the time of the pendency of the
proceedings cannot be proved in the proceedings, since there is no real claim yet. But, if the
contingency happens after the termination of the proceedings, the creditor can still claim from
the debtor. The discharge granted the debtor from his existing debts does not cover those
debts that could not have been proved in the insolvency proceedings.

What happens to obligations of the insolvent debtor that arise after the commencement
of the proceedings?

These debts cannot be proved in the proceedings. But the creditor can still collect from the
debtor, since the discharge given to the debtor cannot apply to claims that could not have been
proved in the insolvency proceedings.

Which debts cannot be proved at the insolvency proceedings?

1. Those barred by prescription;

2. Claims of secured creditors unless they waive the right to foreclose or surrender the
security;

3. Claims of creditors who hold an attachment or execution on property of the debtor,


provided that this was issued at least 30 days before the institution of the insolvency
proceedings;

4. Claims on account of which a fraudulent preference was made or given;

Cayo IID 2002 PAGE 97


5. Support

6. Damages arising out of a tort

Can a creditor set up compensation/offset his own debts against the insolvent debtor?

This is the case of Uy-Tong v. Silva. Compensation can be set up against the insolvent debtor
but only for those debts which arose at least 30 days before the filing of the insolvency
proceedings. If the claim arose within the 30-day period before the filing of the petition, there
can be no compensation. The rule on preferences would be disregarded if the set-off were
allowed. It would, in effect, give the one claiming compensation undue preference over other
creditors.

VIII. COMPOSITIONS

What is composition?

Composition is an agreement, made upon a sufficient consideration, between the insolvent


or financially embarrassed debtor and all of his creditors whereby the creditors agree to
accept a dividend less than the amount of their claims, for the sake of getting paid sooner.

What are the requisites?

1. The offer of the terms of composition must be made after the filing in court of the
schedule of property and submission of the list of creditors;

2. The offer must be accepted in writing by a double majority of the creditors – majority
of the number of creditors representing a majority of the claims;

3. It must be made after depositing the consideration to be paid and the cost of the
proceedings;

4. The court must approve the terms of the composition.

When can composition be set aside?

It can be challenged by any party in interest within six months after it has been confirmed on the
ground of fraud.

IX. DISCHARGE

What is discharge?

Discharge is the privilege given to the insolvent, freeing him from all liabilities proved during the
insolvency proceedings.

Is the discharge automatically given to the insolvent debtor?

No. The debtor must ask for it within three months to one year after he is adjudicated insolvent.

Cayo IID 2002 PAGE 98


Which debts are released by discharge?

1. All those set forth in the schedule; and


2. All those which were or might have been proved against the estate in the insolvency
proceedings.

Which debts are not released?

1. Taxes
2. Debts arising from any act of swindling (because you don’t reward a person who
violated a law or a trust)
3. Debts of a surety, guarantor, indorser, or any person liable for the same debt, for or with
the insolvent debtor (This is because the discharge only benefits the principal debtor,
not his co-debtors or guarantors).
4. Debts of a corporation
5. Claims for support
6. Debts which were not proved and could not have been proved during the insolvency
proceedings
7. Debts arising from tort
8. Claims of secured creditors
9. Debts which were not yet existing at the time of the discharge
10. Contingent claims

When can the petition to get a discharge be denied?

The debtor cannot get a discharge if he is in bad faith or does acts to the prejudice of his
creditors.

Once granted, when may a discharge be revoked?

A discharge may be revoked by the court if a creditor can prove that it was fraudulently
obtained. The creditor must file the petition to revoke it within one year from the date of the
discharge.

X. FRAUDULENT PREFERENCES AND TRANSFERS

What is a preferential transfer?

It is a parting with the property of the insolvent for the benefit of a creditor with the result that
the estate of the insolvent is diminished and other creditors are prejudiced.

What is a fraudulent preference?

It is a disposition of property by the debtor under the following conditions:

1. he is insolvent or is in contemplation of insolvency;

2. the transaction is made within 30 days before the filing of the petition for insolvency;

3. it is made with a view to giving preference to any creditor;

Cayo IID 2002 PAGE 99


4. the person receiving a benefit has reason to believe that the debtor is insolvent and that
the transfer is made in order to defeat or prejudice the rights of other creditors.

What is a fraudulent conveyance/transfer?

It is any disposition of property made by the insolvent within one month before the filing of
the petition for insolvency, except for valuable consideration in good faith.

What is the status of the fraudulent conveyance?

If made within 30 days before the filing of insolvency proceedings, the transfer is void.

If made after the filing of insolvency proceedings, it is rescissible for being in fraud of creditors.

Another remedy of the creditors is to file a criminal complaint against the insolvent debtor.

Is there a presumption of fraud?

There is a rebuttable presumption that a conveyance is fraudulent when:

1. it is not made in the usual and ordinary cause of business of the debtor; or
2. it is made under a confession of judgment.

Within 30 days before the filing of the petition for insolvency, Debtor sells a car worth
P1M to Buyer for 900K. Is this a fraudulent conveyance?

No. There is a fair exchange of value, so the transaction does not really prejudice the creditors.

DEPOSIT

CHAPTER 1 DEPOSIT IN GENERAL AND ITS DIFFERENT KINDS

Art. 1962. A deposit is constituted from the moment a person receives a thing belonging to
another, with the obligation of safely keeping it and of returning the same. If the safekeeping
of the thing delivered is not the principal purpose of the contract, there is no deposit but some
other contract.

What is the contract of deposit?

It is the receipt by a person of a thing belonging to another with the obligation of safely
keeping it and of returning it.

Õ It is essential that the depositary is not the owner of the property deposited.

What are the characteristics of the contract of deposit?

1. Real contract – Deposit is perfected by the delivery of the subject matter

2. Unilateral if the deposit is gratuitous – because only the depositary has an obligation;

Cayo IID 2002 PAGE 100


Bilateral if the deposit is for compensation – gives rise to obligations on the part of both
the depositary and the depositor.

What is the principal purpose of the contract of deposit?

The principal purpose is the safekeeping of the thing delivered. If safekeeping is merely an
accessory or secondary obligation, it is not a deposit, but another contract, such as
commodatum, lease, or agency.

What is the subject matter in deposit?

Only movables can be the subject matter of deposit. If you leave a kid a Gymboree or at Kids
at Work, it’s not a deposit, but maybe a contract of service.

JPSP Examples:

1. You park your car at the car park of Powerplant. Is it a contract of deposit? No,
because the purpose is not safekeeping. The purpose is merely convenience, so that
you have a place to leave your car while you shop or watch a movie or go to school.

2. You park your car at the Dela Rosa car park. Is it a contract of deposit? Still, no, even
if, unlike the car park of Powerplant, the sole reason for the existence of the Dela Rosa
car park is for people to leave their cars there. It’s still not a deposit because the
purpose is not safekeeping. People who park there just want the space. It’s a short-
term lease of space.

So, legally, it is not a deposit. And even for practical purposes, it should not be treated
as a deposit. If it were a deposit, if the car is lost, the owner of the car park (the
depositary) will shoulder the loss. The direct result of this is that parking fees will go up
because it would have to cover insurance costs in addition to the regular parking fee.

Deposit distinguished from Simple Loan (mutuum)

DEPOSIT SIMPLE LOAN


PURPOSE Safekeeping Consumption
WHEN RETURN CAN BE Depositor can demand return Lender must wait until the
DEMANDED of the thing at will expiration of the period
granted to the debtor
SUBJECT MATTER Movable and immovable Only money and any other
property (if deposit is judicial) fungible thing

Deposit distinguished from Commodatum

DEPOSIT COMMODATUM
PURPOSE Safekeeping Transfer of use of the subject
matter
GRATUITOUS? May be gratuitous, may be Always gratuitous
onerous
SUBJECT MATTER In extra-judicial deposit, only Both movable and immovable
movables property

Cayo IID 2002 PAGE 101


Art. 1963. An agreement to constitute a deposit is binding, but the deposit itself is not
perfected until the delivery of the thing.

A: “I will deposit my car in your garage at 8 a.m. tomorrow.”


B: “Okay.”

Is there a contract of deposit at this point?

No. Deposit is a real contract and requires delivery of the subject matter in order to be
perfected.

Is there a contract at this point?

Yes, there is a contract. It is a contract of future deposit. It is perfected by mere consent, and
is binding upon the parties.

Art. 1964. A deposit may be constituted judicially or extrajudicially.

Kinds of Deposit

1. Judicial – takes place when an attachment or seizure of property in litigation is ordered

2. Extra-judicial

(a) Voluntary – delivery is made by the will of the depositor or by two or more
persons each of whom believes himself entitled to the thing deposited; or

(b) Necessary – made in compliance with a legal obligation, or on the occasion


of any calamity, or by travelers in hotels and inns, or by travelers with common
carriers.

Art. 1965. A deposit is a gratuitous contract except when there is an agreement to the
contrary or unless the depositary is engaged in the business of storing goods.

GENERAL RULE: Deposit is gratuitous.

EXCEPTIONS:

1. Contrary stipulation

2. Depositary is engaged in business of storing goods – ex. A warehouseman

3. Where property is saved from destruction without knowledge of the owner – In this case,
the owner is bound to pay the person who saved his property just compensation

Art. 1966. Only movable things may be the object of deposit.

This applies only to an extra-judicial deposit, whether voluntary or necessary.

Reason: The main purpose of deposit is safekeeping. Since real property may not disappear or
may not be lost, there is no point in entrusting them to someone for safekeeping.

Cayo IID 2002 PAGE 102


A gives the keys to his house to B for safekeeping. Is this a deposit of the house? No, since
the house is an immovable which cannot be the proper subject matter of deposit. The
relationship is an agency.

But if it is a judicial deposit, even immovable property can be a valid subject matter. The
reason is that the purpose of a judicial deposit is different. It is to protect the rights of the
parties to the suit.

Art. 1967. An extra-judicial deposit is either voluntary or necessary.

GENERAL RULE: Deposit is voluntary.

EXCEPTIONS: Deposit is necessary in the following cases: (See discussion under


necessary deposit)

1. if made in compliance with a legal obligation;

2. if it takes place on the occasion of any calamity, such as fire, storm, flood, pillage,
shipwreck, or other similar events;

3. deposit of effects made by travelers in hotels or inns

4. deposit of goods made by travelers or passengers with common carriers

CHAPTER 2 VOLUNTARY DEPOSIT

Section 1 General Provisions

Art. 1968. A voluntary deposit is that wherein the delivery is made by the will of the depositor.
A deposit may also be made by two or more persons each of whom believes himself entitled
to the thing deposited with a third person, who shall deliver it in a proper case to the one to
whom it belongs.

What is voluntary deposit?

Deposit wherein delivery is made by the will of the depositor.

What is the distinction between voluntary and necessary deposit?

The main difference is that in voluntary deposit, the depositor is free to choose the depositary.
In necessary deposit, the depositor lacks the freedom to choose the depositary.

Does the depositor have to be the owner of the thing deposited?

Generally, the depositor should be the owner of the thing, but it is not an essential element of
deposit. The depositary cannot even require the depositor to prove that he is the owner of the
thing.

When there are several depositors:

Cayo IID 2002 PAGE 103


If there are two or more persons each claiming the rightful ownership of a thing, pending the
resolution of their conflicting claims, they may deposit the thing with a third person. The third
person assumes the obligation to deliver to the person to whom it belongs. The depositary can
file an action for interpleader to compel the depositors to settle their conflicting claims.

Ex: A and B both claim to own a dog. While they are trying to settle the ownership of the dog,
they can deposit the dog with C. C can file an action for interpleader to compel A and B to
settle the ownership of the dog. C’s obligation is to eventually deliver the dog to whomever is
the rightful owner.

Art. 1969. A contract of deposit may be entered into orally or in writing.

There are no formal requirements for the validity of a contract of deposit. The only thing
necessary is delivery of the thing.

Art. 1970. If a person having capacity to contract accepts a deposit made by one who is
incapacitated, the former shall be subject to all the obligations of the depositary, and may be
compelled to return the thing by the guardian, or administrator or the person who made the
deposit or by the latter himself if he should acquire capacity.

X, who is insane, deposits her basketball with Boy-B. Can Boy-B refuse to return the
basketball later on, on the ground that the deposit was not valid because of the incapacity
of X?

No. If the depositary is capacitated, he is subject to all the obligations of a depositary whether
or not the depositor is capacitated. Hence, he must return the property to the legal
representative of X or to X herself if she should recover sanity. Persons who are capacitated
cannot allege the incapacity of those with whom they contract.

JPSP example: Five tinedyers aged 13 to 15 check into a hotel to go on a drinking binge.
They deposit some jewelry at the front desk for safekeeping.

Is there a valid deposit?

Yes, but it may be annulled for want of capacity of the tinedyers. It’s actually a
voidable contract, which is valid until annulled.

The tinedyers, at the end of their drinking binge, go to the front desk and ask for the return
of the jewelry. What should the hotel do?

The hotel should return the jewelry to their legal representative. The hotel should
not return to the tinedyers because if subsequently, the tinedyers lose the jewelry,
the hotel could be made liable for the loss. But definitely, the hotel cannot retain
the jewelry, or else, its personnel would be liable for estafa.

Art. 1971. If the deposit has been made by a capacitated person with another who is not, the
depositor shall only have an action to recover the thing deposited while it is still in the
possession of the depositary, or to compel the latter to pay him the amount by which he may
be enriched or benefited himself with the thing or its price. However, if a third person who
acquired the thing acted in bad faith, the depositor may bring an action against him for its
recovery.

Cayo IID 2002 PAGE 104


This is the rule that applies if you deposit with a minor or other incapacitated person.

If the depositary is incapacitated, while the depositor is capacitated, the incapacitated does not
incur the obligations of a depositary.

The incapacitated is liable only:

(1) to return the thing deposited if it is still in his possession; or


(2) to pay the depositor the amount by which he may have benefited through the thing or
its price if the incapacitated is no longer in possession

If the thing was transferred to a third person who was in bad faith, the depositor can recover the
thing from him. If the transferee was in good faith, the depositor cannot recover from him. The
depositor can only go after the incapacitated for the value of the thing.

Boy-B deposits his watch with X, who looks like she’s 22 but is actually 13. Can Boy-B
recover the watch?

If the watch is still in the possession of X, Boy-B can recover the watch itself from X.

If X has already sold the watch to Hon, a buyer in good faith and for value, Boy-B cannot
recover the watch. He can only compel X to return the price that Hon paid for the watch (the
benefit that X received from the sale of the watch). So if the watch is worth P10,000 but X sold
it to Hon for P5,000, Boy-B can only recover P5,000 from X.

But if Hon was a buyer in bad faith, Boy-B can recover the watch itself from Hon.

Section 2 Obligations of the Depositary

Art. 1972. The depositary is obliged to keep the thing safely and to return it, when required, to
the depositor or to his heirs and successors, or to the person who may have been designated
in the contract. His responsibility with regard to the safekeeping and loss of the thing shall be
governed by the provisions of Title I of this Book.

If the deposit is gratuitous, this fact shall be taken into account in determining the
degree of care that the depositary must observe.

Primary obligations of the depositary:

1. Safekeeping
2. Return of the thing, but only when required

Duty of Safekeeping

What is the degree of care required of the depositary?

As a general rule, the depositary must exercise the same diligence as he would exercise
over his OWN property. He should exercise the diligence of a good father of a family. The
reasons for this rule are:

Cayo IID 2002 PAGE 105


1. Because the contract of deposit involves the depositor’s confidence in the depositary’s
good faith and trustworthiness; and

2. Because it is presumed that the depositor, in choosing the depositary, took into account
the diligence which the depositary normally exercises with respect to his own property.

BUT, if under the circumstances, a greater degree of care towards the thing deposited is
necessary, the depositary must exercise such extraordinary care. If, in this case, the thing
deposited is lost and the depositary only exercised the same diligence as he would towards his
own property, he is liable to the depositor for the loss.

The loss of the thing while it is in the possession of the depositary raises a presumption of fault
on his part.

Duty of Returning the Thing

The thing deposited must be returned to the depositor when he claims it, even though a
specified term or time for such may have been stipulated in the contract and such time has not
yet expired.

Art. 1973. Unless there is a stipulation to the contrary, the depositary cannot deposit the thing
with a third person. If deposit with a third person is allowed, the depositary is liable for the
loss if he deposited the thing with a person who is manifestly careless or unfit. The depositary
is responsible for the negligence of his employees.

GENERAL RULE: The depositary cannot deposit the thing with a third person.

Reason for the rule: Deposit is founded on trust and confidence. It is presumed that in
choosing the depositary, the depositor took into account his personal qualifications.

EXCEPTION: The parties may stipulate that the depositary may deposit the thing with a
third person. But there is a limitation – the depositary cannot choose a third person who is
manifestly careless or unfit.

What happens if the depositary deposits the thing with a third person, and it is lost?

1. If there is no stipulation allowing him to deposit with a third person, he is liable


for the loss, whether it was through his or the third person’s fault or through
fortuitous event.

2. Generally, if the thing is deposited with a third person with permission of the
depositor, and the thing is lost through fortuitous event, the depositary is
not liable for the loss.

However, if he deposits it with a person who is manifestly careless or unfit,


even if there is no negligence or even if the loss was through fortuitous
event, the depositary is liable for the loss.

3. If the thing is lost through the negligence of the depositary’s employees, the
depositary is liable for the loss (The employee is the agent of the depositary;
principal bears the loss resulting from the negligence of his agent). Here, it
is not necessary that the employees be manifestly careless or unfit, but it is
necessary that the loss be through negligence.

Cayo IID 2002 PAGE 106


Art. 1974. The depositary may change the way of the deposit if under the
circumstances he may reasonable presume that the depositor would consent to
the change if he knew of the facts of the situation. However, before the
depositary may make such change, he shall notify the depositor thereof and wait
for his decision, unless delay would cause danger.

GENERAL RULE: The depositary should not change the way or manner of the deposit as
agreed upon.

EXCEPTION: The depositary may change it if there are circumstances indicating that
the depositor would consent to the change. However, the depositary should first
notify and wait for the decision of the depositor.

If delay would cause danger, the depositary need not wait for the consent of the
depositor. Notice to the depositor of the change is sufficient.

JPSP example:

A deposited jewelry with B, a resident of Lamitan. B did not feel so secure with the jewelry
in Lamitan, so he deposited the jewelry with a bank in Davao. A sued B for damages for
depositing the jewelry with a third person without A’s authorization. What is B’s defense?

B can invoke Article 1974. Under the circumstances, B can infer that A would
consent to the change of the manner of deposit.

Art. 1975. The depositary holding certificates, bonds, securities or instruments


which earn interest shall be bound to collect the latter when it becomes due, and
to take such steps as may be necessary in order that the securities may preserve
their value and the rights corresponding to them according to law.

The above provision shall not apply to contracts for the rent of safety
deposit boxes.

What are the obligations of the depositary if the thing earns interest?

1. Collect the interest, as well as the capital, as it becomes due; and


2. Take such steps as may be necessary to preserve its value and the rights
corresponding to it.

Ex: Depositary of a negotiable instrument should give notice of dishonor to


all parties secondarily liable, or else these parties would be discharged.

JPSP example:

A deposits to B a promissory note payable to A or order. Can B collect accrued interests on


the note?

No. The instrument is an order instrument. B cannot collect the interest due on it
because he is neither an indorsee nor an authorized agent of A.

Õ Therefore, Art. 1975 really applies only to BEARER instruments. If it is an order


instrument, there is a need for an indorsement or at least, a special power of
attorney, to enable the depositary to collect the interest and capital when due.

Cayo IID 2002 PAGE 107


Safety Deposit Boxes

The contract for rent of safety deposit boxes is not an ordinary contract of lease of
things because the full and absolute possession and control of the safety deposit
box is not given to the party renting.

It is actually a special kind of deposit. It is a contractual relation between the


parties. The liability rules are governed by the Civil Code provisions on obligations
and contracts, and not on donations.

Is a stipulation which exempts the bank from liability for the things contained in the safety
deposit box valid?

The stipulation is void. Even if as a rule, the Bank may limit its liability to some
extent by agreement or stipulation, the agreement or stipulation must not be
contrary to law and public policy.
The law on deposit provides that the depositary is liable for loss due to fraud,
negligence, delay, or contravention of the tenor of the agreement. Any contrary
stipulation would be void.

Art. 1976. Unless there is a stipulation to the contrary, the depositary may
commingle grain or other articles of the same kind and quality, in which case the
various depositors shall own or have a proportionate interest in the mass.

GENERAL RULE: The depositary may commingle grain or other articles of the same kind and
quality.

EXCEPTION: If there is a contrary stipulation

De Leon example:

A, depositary, received the following:

from B: 30 cavans of rice


from C: 20 cavans of rice
from D: 10 cavans of rice

The rice was of the same kind and quality.

Can A put all of the rice together?

Yes, since there is no stipulation forbidding it. B will own 30/60 or ½ of the whole
pile; C will own 20/60 or 1/3; and D will own 10/60 or 1/6.

But if the articles deposited by different depositors are not of the same kind and
quality, or if there is a stipulation forbidding it, the depositary must keep them
separate or at least identifiable, since he must return to each depositor the very
same thing deposited.

Art. 1977. The depositary cannot make use of the thing deposited without the
express permission of the depositor.

Cayo IID 2002 PAGE 108


Otherwise, he shall be liable for damages.

However, when the preservation of the things deposited requires its use, it
must be used but only for that purpose.

GENERAL RULE: The depositary CANNOT make use of the thing deposited.

EXCEPTIONS:

1. When the depositor has expressly given his permission. Permission cannot be
implied, and it is not presumed.

2. When the preservation of the thing requires its use, it may be used but only for
that purpose.

Ex: When you deposit a car with someone for a week, the depositary should
start the car everyday, in order to prevent the battery from getting
discharged.

Reason for the rule: The principal purpose of deposit is safekeeping, not use of the
thing. If the purpose is use, it is not deposit anymore.

If the depositary uses the thing deposited without permission of the depositor, he
shall be liable for damages. In addition, if the thing is lost even through fortuitous
event, the depositary shall bear the loss.

Art. 1978. When the depositary has permission to use the thing deposited, the
contract loses the concept of a deposit and becomes a loan or commodatum,
except where safekeeping is still the principal purpose of the contract.

The permission shall not be presumed, and its existence must be proved.

What happens if the depositor gives the depositary permission to use the thing?

It depends.

If the principal purpose is still safekeeping, it retains its character as deposit.


However, if the thing deposited is money or other consumable thing and the
principal purpose is still safekeeping, it is an irregular deposit.

If the purpose has become use or consumption of the thing:

1. It becomes commodatum if the thing deposited is non-consumable.


2. It becomes simple loan or mutuum if the thing deposited is money or other
consumable thing.

Bank deposits are in the nature of an irregular deposit but they are really loans (See
Article 1980).

Art. 1979. The depositary is liable for the loss of the thing through a fortuitous
event:

(1) If it is so stipulated;

Cayo IID 2002 PAGE 109


(2) If he uses the thing without the depositor’s permission;

(3) If he delays its return;

(4) If he allows others to use it, even though he himself may have been
authorized to use the same.

GENERAL RULE: The depositary is not liable for loss of the thing through fortuitous event.

EXCEPTIONS:

1. Stipulation

2. If he uses it without the depositor’s permission – this is breach/


contravention of the tenor of the obligation

3. Delay in return – this is default

4. If he allows others to use it – also a breach

Take note that the rule is different in commodatum. In commodatum, the


members of the borrower’s household are allowed to use the thing without
liability on the part of the borrower.

If the thing is lost in the custody of the depositary, the presumption is that it was
lost through his fault. He has the burden of proving that the loss was not due to
his own fault.

Art. 1980. Fixed, savings, and current deposits of money in banks and similar
institutions shall be governed by the provisions concerning simple loan.

Nature of Bank Deposits

Bank deposits are really loans to a bank because the bank has the obligation to pay
the depositor the amount deposited, but not the exact same money that was
deposited (as in deposit).

Since they are loans, they are governed by the provisions concerning mutuum or
simple loan, not deposits.

Relationship is Debtor-Creditor

The relationship between the bank and its depositors is thus that of debtor (bank)
and creditor (depositor). Hence:

1. If the bank fails to pay its obligation to the depositor, it is not a breach of
trust arising from the depositary’s failure to return the subject matter of the
deposit. Since there is no breach of trust, it will not constitute estafa
through misappropriation.

Cayo IID 2002 PAGE 110


2. A bank can generally compensate or set off the deposit in its hands for the
payment of any indebtedness to it on the part of the depositor, provided that
the legal requisites of compensation are present. In a true deposit,
compensation is not allowed.

Art. 1981. When the thing deposited is delivered closed and sealed, the
depositary must return it in the same condition, and he shall be liable for
damages should the seal or lock be broken through his fault.

Fault on the part of the depositary is presumed, unless there is proof to the
contrary.

As regards the value of the thing deposited, the statement of the depositor
shall be accepted, when the forcible opening is imputable to the depositary,
should there be no proof to the contrary. However, the courts may pass upon the
credibility of the depositor with respect to the value claimed by him.

When the seal or lock is broken, with or without the depositary’s fault, he
shall keep the secret of the deposit.

Art. 1982. When it becomes necessary to open a locked box or receptacle, the
depositary is presumed authorized to do so, if the key has been delivered to him;
or when the instructions of the depositor as regards the deposit cannot be
executed without opening the box or receptacle.

A delivers a locked baul to B for safekeeping. What are B’s obligations?

1. B must return the baul in the same condition – it must be locked when
returned.

2. If the lock of the baul is broken through B’s fault, he shall be liable to A for
damages. B is presumed negligent until proved otherwise.

How is the value of the thing determined in case the baul is opened?
Ultimately, the court will decide the value of damages that B should pay,
since the parties will always get into a dispute over the value of the thing
(i.e. A would inflate the price, B would undervalue it, etc.)

3. If the lock of the baul is broken, with or without B’s fault, B must keep the
secret of the deposit.

If the contents of the baul turn out to be illegal – shabu, a dead body, a
bloody bolo – the depositary should immediately call the cops. He may still
be held liable for the breach of his obligation as depositary but at least he
knows that he has done a greater good to society by reporting the dastardly
deed to the authorities. The court just might exonerate him of liability for
the breach because of his fulfillment of a civic duty. Besides, I think that if
he keeps these things a secret, he can even be liable as an accessory to the
crime for helping conceal it.

When may B open the baul?

Cayo IID 2002 PAGE 111


1. When there is presumed authority – authority is presumed if the key has been
delivered to him; or

2. When there is necessity for opening the box in order to execute the
instructions of the depositor as regards the deposit

JPSP example:

Shakadivas delivers a locked box to Tuks for deposit. Shak leaves right away without giving
Tuks an opportunity to ask him why there is a ticking sound coming from inside the box.
Tuks is afraid that it might be a bomb. Can he open it without liability?

Tuks cannot. The only instances when a depositary can open the box without
incurring liability is if there is presumed authority or if there is necessity for
opening it in order to execute the instructions of the depositor. These two
instances are not present in the situation of Tuks. He should just hope and pray
that it’s just a watch in there.

Art. 1983. The thing deposited shall be returned with all its products, accessories,
and accessions.

Should the deposit consist of money, the provisions relative to agents in


article 1896 shall be applied to the depositary.

The obligation of the depositary is to return the thing when the depositor demands,
along with all its products, accessories, and accessions. The depositor is entitled
to the products, accessories, and accessions of the thing because he is the owner
of the thing.

Art. 1984. The depositary cannot demand that the depositor prove his ownership
of the thing deposited.

Nevertheless, should he discover that the thing has been stolen and who its
true owner is, he must advise the latter of the deposit.

If the owner, in spite of such information, does not claim it within the
period of one month, the depositary shall be relieved of all responsibility by
returning the thing deposited to the depositor.

If the depositary has reasonable grounds to believe that the thing has not
been lawfully acquired by the depositor, the former may return the same.

The depositary cannot demand that the depositor prove his ownership of the thing
deposited. This is because it is not essential that the depositor be the owner of the
thing deposited.

When a third person appears to be the owner of the thing:

1. If the depositary finds out that the thing was stolen AND he knows the real
owner, his obligation is to INFORM the real owner of the deposit (it is not to
return the thing to the real owner yet).

Cayo IID 2002 PAGE 112


The real owner must claim the thing within one month. If he claims it within
a month, the depositary should give it to the real owner. If the real owner
fails to make a claim within a month, the depositary’s obligation will be
extinguished by returning the thing to the depositor.

2. If the depositary has reasonable grounds to believe that the thing has not
been lawfully acquired by the depositor, the depositary may return the thing
to the depositor (not to the real owner, since in this case, the real owner is
not known).

Õ But according to JPSP, if the depositary discovers that the thing was stolen and
someone else is claiming to be the real owner, the more prudent thing to do would
be to file an action for interpleader and consign the thing in court. It is not safe to
follow 1984 because if the claim of the alleged real owner turns out to be false, the
depositary will be liable for giving the thing to someone else or for refusing to
return it to the depositor (estafa).

Art. 1985. When there are two or more depositors, if they are not solidary, and
the thing admits of division, each one cannot demand more than his share.

When there is solidarity or the thing does not admit of division, the provisions of
Articles 1212 and 1214 shall govern. However, if there is a stipulation that the
thing should be returned to one of the depositors, the depositor shall return it
only to the person designated.

When there are two or more depositors, the default rule is like that in joint
obligations – each depositor cannot demand more than his share from the
depositary. This rule applies if the thing is divisible and there is no solidarity
among the depositors.

If there is solidarity or if the thing is indivisible, the rule on solidary obligations is


applicable. Each one of the depositors may do whatever may be useful to the
others but not anything which may be prejudicial. The depositary can return the
thing deposited to any of the depositors unless a demand for its return has been
made by one of them, in which case, delivery should be made to him who made the
demand.

The parties may also stipulate that the thing be returned to a specific depositor. In
this case, the depositary can only return to the depositor stipulated, even if he
does not make a demand.

Art. 1986. If the depositor should lose his capacity to contract after having made
the deposit, the thing cannot be returned except to the persons who may have
the administration of his property and rights.

The thing deposited must be returned only to a person who is capacitated. If the
depositor should subsequently lose capacity, the depositary should return it to his
representative.

(See discussion under Article 1970 on deposit by tinedyers)

Cayo IID 2002 PAGE 113


Art. 1987. If at the time the deposit was made a place was designated for the
return of the thing, the depositary must take the thing deposited to such place;
but the expenses for transportation shall be borne by the depositor.

If no place has been designated for the return, it shall be made where the
thing deposited may be, even if it should not be the same place where the deposit
was made, provided that there was no malice on the part of the depositary.

Where to return the thing deposited:

1. First, follow the stipulation of the parties. The expenses for transportation
shall be borne by the depositor since the deposit was constituted for his
benefit.

2. If there is no stipulation, follow 1987 – the thing should be returned at the


place where the thing deposited may be, even if it was not the same place
where the deposit was constituted.

However, there must be no malice on the part of the depositary. For


example, the depositary, not wanting to return the thing anymore, moves it
to the Cordillera mountains, so that the depositor would have a hard time
claiming it. In this case, the depositary would be liable for damages.

Art. 1988. The thing deposited must be returned to the depositor upon demand
even though a specified period of time for such return may have been fixed.

This provision shall not apply when the thing is judicially attached while in
the depositary’s possession or should he have been notified of the opposition of a
third person to the return or the removal of the thing deposited. In these cases,
the depositary must immediately inform the depositor of the attachment or
opposition.

GENERAL RULE: The depositary must return the thing upon demand by the depositor even if
the period for the deposit has not lapsed.

If the deposit is for compensation, and the depositor demands the return of the
thing before the period for deposit has lapsed, the depositor must still pay the
depositary the full compensation agreed upon. This is because the period in this
case is for the benefit of both the depositary and the depositor.

EXCEPTION TO THE GENERAL RULE: The depositary should not return the thing to the
depositor if there is a court order enjoining him from returning the thing to the
depositor (when there is attachment).

The law says that the depositary can also refuse to return the thing if there is an
opposition to its return by a third person (here, there is no court order). However,
as discussed earlier, the more prudent thing to do in this case is not to refuse to
return the thing to the depositor but to file an action for interpleader because there
is a danger that the depositary would be liable for damages if the claim of the third
person turns out to be false.

Art. 1989. Unless the deposit if for a valuable consideration, the depositary who
may have justifiable reasons for not keeping the thing deposited may, even

Cayo IID 2002 PAGE 114


before the time designated, return it to the depositor; and if the latter should
refuse to receive it, the depositary may secure its consignation from the court.

As a general rule, the depositary should wait for either the period of the deposit to
lapse or for the depositor to demand the return of the thing before he can return
the thing deposited.

But, if the following requisites are present, he may return the thing to the
depositor even before the period of the deposit has lapsed or before it is
demanded:

1. The deposit must be gratuitous; and


2. There must be a justifiable reason.

If the depositary refuses to accept, the depositor can consign the thing in court.

But if the deposit is for compensation, the depositary cannot return the thing until
the expiration of the period or until it is demanded by the depositor.

Art. 1990. If the depositary by force majeure or government order loses the thing
and receives money or another thing in its place, he shall deliver the sum or the
thing to the depositor.

The depositary is not liable for the loss of the thing either by force majeure or
government order.

But, if in place of the thing lost, the depositary receives money or another thing, he
must deliver it to the depositor.

Ex: If the thing is expropriated by the government, the indemnity paid by the
government must be turned over by the depositary to the depositor.

Art. 1991. The depositor’s heir who in good faith may have sold the thing which
he did not know was deposited, shall only be bound to return the price he may
have received or to assign his right of action against the buyer in case the price
has not been paid him.

First, take note that there seems to be a typo in this provision: it should read “The
depositary’s heir…” if it is to make any sense.

This contemplates the following situation:

A deposits a car with B. While the car is still in B’s custody, B dies. C, B’s son,
finds the car among his dad’s stuff and thinks that the car belonged to his dad. C
sells the car to D. What are the liabilities of C?

If D has already paid C, C must return to A the price that D paid for the car (not the
value of the car).

If D has not yet paid, C may assign to A his right to collect from D the selling price
of the car.

Cayo IID 2002 PAGE 115


Take note that A has no right to recover the car itself. Also, there must be good
faith on the part of the heir and the third party buyer. If there was bad faith, the
depositor can recover the car itself. Moreover, the heir will be liable for estafa.

Section 3 Obligations of the Depositor

Art. 1992. If the deposit is gratuitous, the depositor is obliged to reimburse the
depositary for the expenses he may have incurred for the preservation of the
thing deposited.

If the deposit is gratuitous, the depositor should shoulder the costs of preservation
because he is the owner of the thing.

If the deposit is for compensation, the depositary should shoulder the costs of
preservation of the thing because the compensation is deemed to include the costs
of preservation.

Example: A deposits a dog with B for 30 days for a compensation of P500. B buys a sack of
dog food. By the 10th day, the dog food has run out. Can B ask for more money from A?

A can refuse to give more money and argue that in charging the compensation for
the deposit, B should have factored in the expected expenses of preserving the
dog. But it still depends on the intention of the parties.

Art. 1993. The depositor shall reimburse the depositary for any loss arising from
the character of the thing deposited, unless at the time of the constitution of the
deposit, the former was not aware of, or was not expected to know the
dangerous character of the thing, or unless he notified the depositary of the
same, or the latter was aware of it without advice from the depositor.

GENERAL RULE: The depositor should compensate the depositary for any loss that the
depositary may suffer from the character of the thing deposited.

Example: A deposits a dog with B. It turns out that the dog has rabies. The dog
bites B, and as a result, B has to get anti-rabies shots. A must pay for the damage
caused and the cost of B’s shots.

EXCEPTIONS: In the following cases, the depositor need not reimburse the
depositary for any loss arising from the character of the thing deposited:

1. If at the time of the deposit, the depositor was not aware of the dangerous
character of the thing;

2. If at the time of the deposit, the depositor was not expected to know the
dangerous character of the thing;

3. If the depositor notified the depositary of the dangerous character of the


thing; or

4. If the depositary was aware of the dangerous character of the thing even
without the advice of the depositor.

Cayo IID 2002 PAGE 116


Art. 1994. The depositary may retain the thing in pledge until full payment of
what may be due him by reason of the deposit.

This is an example of a pledge created by operation of law. The depositary may


keep the thing deposited as a security for anything that the depositor may owe
him, but it has to be by reason of the deposit.

Compare this rule with the rule in commodatum, in which the borrower may
generally not retain the thing as a security for anything that the lender may owe
him (remember the frisbee example?).

Art. 1995. A deposit is extinguished:

(1) Upon the loss or destruction of the thing deposited;

(2) In case of a gratuitous deposit, upon the death of either the depositor or the
depositary.

Causes for extinguishment of deposit:

1. loss or destruction of the thing deposited


2. In case of gratuitous deposit, upon the death of either the depositor or the
depositary

But if the deposit is for compensation, it is not extinguished by the death of


either party since it is not personal in nature. Hence, the rights and
obligations of the parties are transmissible to their heirs.

3. return of the thing


4. novation
5. merger
6. expiration of the term
7. fulfillment of resolutory condition

CHAPTER 3 NECESSARY DEPOSIT

Art. 1996. A deposit is necessary:

(1) When it is made in compliance with a legal obligation;

(2) When it takes place on the occasion of any calamity, such as fire, storm,
flood, pillage, shipwreck, or other similar events.

Art. 1997. The deposit referred to in No. 1 of the preceding article shall be
governed by the provisions of the law establishing it, and in case of its deficiency,
by the rules on ordinary deposit.

The deposit mentioned in No. 2 of the preceding article shall be regulated


by the provisions concerning voluntary deposit and by article 2168.

Art. 1998. The deposit of effects made by travelers in hotels or inns shall also be
regarded as necessary. The keepers of hotels or inns shall be responsible for
them as depositaries, provided that notice was given to them, or to their

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employees, of the effects brought by the guests and that, on the part of the latter,
they take the precautions which said hotel-keepers or their substitutes advised
relative to the care and vigilance of their effects.

Art. 1999. The hotel-keeper is liable for the vehicles, animals and articles which
have been introduced or placed in the annexes of the hotel.

Art. 2168. When during a fire, flood, story, or other calamity, property is saved
from destruction by another person without the knowledge of the owner, the
latter is bound to pay the former just compensation.

What are the instances when deposit is NECESSARY?

There are FOUR instances/ examples of necessary deposit:

1. Deposit made in compliance with a legal obligation


2. Deposit that takes place on the occasion of any calamity
3. Deposit of effects made by travelers in hotels or inns
4. Deposit of goods with common carriers

1. Deposit made in compliance with a legal obligation

Example:

In pledge, when the creditor uses the thing pledged without the authority of
the owner or misuses it in any other way, the owner may ask that it be
judicially or extrajudicially deposited.

2. Deposit that takes place on the occasion of any calamity

Example: A fire razes Y’s house. X goes inside and gets Y’s TV for the
purpose of saving it. X becomes the depositary of the TV.

The relationship of X and Y, being a deposit, is governed by the provisions on


voluntary deposit. But in addition, it is also governed by Art. 2168 on quasi-
contracts. Art. 2168 says that the owner of the thing should pay the depositary
just compensation for his expenses in preserving the thing. So unlike a
voluntary deposit, which is by default gratuitous, this kind of necessary
deposit is, by express provision of law, for compensation.

3. Deposit of effects made by travelers in hotels or inns

Requisites before the hotel or inn may be held responsible as depositary:

a. The hotel or inn should have been previously informed about the effects
brought by the guests; and

b. The guests have taken the precautions prescribed regarding their


safekeeping.

The liability extends not just to effects inside the rooms but also to property
of the guests in the annexes, such as cars in the garage.

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Example: You go to Edsa Shangri-La to eat at the Garden Café. You turn your car
over to the valet. Is there a contract of deposit?

Yes. You don’t have to actually get a room in order to be considered a


guest for purposes of constituting the contract of deposit with the hotel. As
long as you use the main facilities of the hotel, you’re considered a guest.

What if you wanted to shop in Megamall, but since you didn’t want to go through the
trouble of looking for parking in Megamall, you just used the Edsa Shangri-La valet
service – are you still a guest?

No. Although you need not check-in in order to be considered a guest, you
must at least use the principal services of the hotel – the gym, the pool,
meeting place at the lobby, etc. Valet parking is not a principal service of
the hotel.

If you’re the guest, you should: (a) give notice to the hotel of the effects you
have brought into the hotel and (b) take the precautions prescribed for their
safekeeping.

But do you need to give an itemized listing of your valuables every time you go into
a hotel?

No. Constructive notice to the employees of the hotel is enough. It is


sufficient that you bring in your personal effects and the hotel personnel see
them.

4. Deposit of goods with common carriers

This is governed by Articles 1733, 1734, 1735 of the Civil Code under Lease.
Common carriers are generally responsible for the loss, destruction, and
deterioration of the goods, unless due to fortuitous event or the fault of the
owner of the goods.

Art. 2000. The responsibility referred to in the two preceding articles shall include
the loss of, or injury to the personal property of the guests caused by the
servants or employees of the keepers of hotels or inns as well as by strangers;
but not that which may proceed from any force majeure. The fact that travelers
are constrained to rely on the vigilance of the keeper of the hotels or inn shall be
considered in determining the degree of care required of him.

Art. 2001. The act of a thief or robber, who has entered the hotel is not deemed
force majeure, unless it is done with the use of arms or through an irresistible
force.

Art. 2002. The hotel-keeper is not liable for compensation if the loss is due to the
acts of the guests, his family, servants or visitors, or if the loss arises from the
character of the things brought into the hotel.

When is the hotel liable for the loss of the effects of its guests?

Cayo IID 2002 PAGE 119


1. When the loss is caused by the employees of the hotel or by strangers,
provided the guest followed the two requisites under Art. 1998 (notice and
precaution).

2. When the loss is caused by the act of a thief or a robber done without the
use of arms and irresistible force.

When is the hotel NOT liable?

1. When the loss or injury is caused by force majeure, like flood, fire, theft or
robbery by a stranger with the use of arms or irresistible force, UNLESS the
hotel-keeper is guilty of fault or negligence in failing to provide against the
loss or injury from this cause.

So as a general rule, if armed men enter the hotel and steal your things, the
hotel is excused from liability because it is considered a fortuitous event.
However, if the hotel failed to take reasonable precautions (ex: secluded
island with only one security guard stationed near the shore and lots of
foreigners checked in), it will still be liable for its negligence.

2. When the loss is due to the acts of the guest (who is the owner of the thing),
his family, servants, or visitors; and

3. When the loss arises from the character of the things brought into the hotel

Example of thing where the loss arises from the character of the thing: If
you bring a Dalmatian, or a snake, or Cyrus’ pet hamster into the hotel, by
the very nature of these pets, they could easily get lost in the premises.

Art. 2003. The hotel-keeper cannot free himself from responsibility by posting
notices to the effect that he is not liable for the articles brought by the guest.
Any stipulation between the hotel-keeper and the guest whereby the
responsibility of the former as set forth in Articles 1998 to 2001 is suppressed or
diminished shall be void.

Even if the hotel-keeper posts signs or puts these little fine-print stipulations that
it is not liable for any loss, it cannot escape its liabilities as a depositary under
Articles 1998 to 2001.

Reason: You cannot waive the liability of one who is guilty of gross negligence.
Gross negligence is equivalent to fraud or bad faith. And as we all know, a waiver
of future fraud is void. It is contrary to law, morals, and public policy.

However, this only applies to a contract of deposit. In the case of carparks, the
fine print on the tickets always contains a waiver of liability by the owner of the
carpark for any loss within its premises. This waiver is valid because, as discussed
already, the contract with the carpark is not a deposit but only a short-term lease.

Art. 2004. The hotel-keeper has a right to retain the things brought into the hotel
by the guest, as a security for credits on account of lodging, and supplies usually
furnished to hotel guests.

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This is another pledge created by operation of law. If you do not pay your hotel
bills, the hotel can keep your stuff as a security. Moreover, you will be liable for
estafa.

CHAPTER 4 SEQUESTRATION OR JUDICIAL DEPOSIT

Art. 2005. A judicial deposit or sequestration takes place when an attachment or


seizure of property in litigation is ordered.

Art. 2006. Movable as well as immovable property may be object of


sequestration.

Art. 2007. The depositary of property or objects sequestrated cannot be relieved


of his responsibility until the controversy which gave rise thereto has come to an
end, unless the court so orders.

Art. 2008. The depositary of property sequestrated is bound to comply, with


respect to the same, with all the obligations of a good father of a family.

What is judicial deposit?

Judicial deposit is a deposit pursuant to a court order – when an attachment or


seizure of property in litigation is ordered by a court.

Examples:

1. attachment of properties by sheriff upon the filing of a complaint


2. garnishment of money
3. receiver may be appointed by the court to administer and preserve the
property in litigation
4. personal property may be seized by the sheriff in suits of replevin

What is the purpose of judicial deposit?

Unlike extra-judicial deposit, where the purpose is safekeeping, the purpose of


judicial deposit is to maintain the status quo during the pendency of the litigation to
insure the right of the parties to the property in case of a favorable judgment. This
means that in case of favorable judgment, the party will be assured that there will
be property to satisfy the execution of the judgment.

What may be the object of judicial deposit?

Unlike extra-judicial deposit, where the object must be a movable, a judicial


deposit can cover both movable and immovable property.

How do you deposit an immovable?

You annotate the attachment on the title with the Register of Deeds.

What are the obligations of the depositary of sequestrated property?

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The person appointed by the court as depositary has the obligation to take care of
the thing with the diligence of a good father of a family. He may not be relieved of
his responsibility until the litigation is ended or until the court so orders.

DISTINCTIONS BETWEEN JUDICIAL AND EXTRA-JUDICIAL DEPOSIT

JUDICIAL DEPOSIT EXTRA-JUDICIAL DEPOSIT


CAUSE OR ORIGIN By will of the court By will of the parties;
hence there is a contract
PURPOSE To secure the right of a Safekeeping
party to recover in case of
favorable judgment
SUBJECT MATTER Movable or immovable Only movable property
property
REMUNERATION The depositary is always As a rule, it is gratuitous,
compensated; therefore it though the parties may
is onerous stipulate otherwise
IN WHOSE BEHALF IT IS In behalf of the person In behalf of the depositor
HELD who, by the judgment, or the third person
has a right designated

Art. 2009. As to matters not provided for in this Code, judicial sequestration shall
be governed by the Rules of Court.

That’s all folks. Sorry, I didn’t include Warehouse Receipts Law anymore
because it’s probably going to be just 5% of the exam, according to JPSP.
Good luck!

May the power of greyskull be with us all ☺

Cayo IID 2002 PAGE 122