MODULE 1 – CREDIT TRANSACTIONS

In our study about Credit Transactions, we will focus more on the important
provisions from the Civil Code of the Philippines. Specifically, our objective is to
know the differences between Real Mortgage, Chattel Mortgage and Pledge. We
also need to understand their purpose as well as the kind of properties to which they
are applicable.
The discussion below will tackle first Real Mortgage, followed by Chattel Mortgage
and then Pledge.
I
Real Mortgage

Real Mortgage is an accessory contract imposed on property for the security of a

principal obligation so that in case of non-fulfillment of the obligation, the property
mortgaged may be used for the satisfaction of the same. Simply stated, Real
Mortgage is being used by parties if the Borrower/Debtor wants to secure the
fulfillment of his / her obligations in favor of the Lender/Creditor. In real life, you
cannot just borrow money from any financial institutions or individuals engaged in
lending business without security. In fact, even those individuals that are not
engaged in lending business would normally ask for a security (sangla) from the
borrower to protect themselves should the borrower fails to pay.

Type Designation Illustration

An obligation of the
Loan Principal Creditor Debtor to pay the amount
Contract or of Php 1,000,000.00 to
Debtor the Creditor

Real Mortgage of House

Mortgage Accessory Mortgagor & Lot of the Debtor to
Contract or secure the fulfillment of
Mortgagee the principal Obligation
in the amount of Php
1,000,000.00 in-favor of
the Creditor.

In essence, the following are the essential requisites of a Real Mortgage, to wit:

1. Secures the fulfillment of a principal obligation;

2. Mortgagor, must be the absolute owner of the thing

mortgaged; and

3. Mortgagor must have free disposal of their property, or be

legally authorized for such purpose.
To easily recall the essential requisites. We can use SAF (Security, Absolute owner
& Free disposals) as our mnemonics. Just remember those three and you can easily
determine if the contract of mortgage can be validly executed. The said essential
requisites will be tackled in detail in the succeeding discussions.

Now, you might be wondering, what type of property may be the subject of Real
Mortgage? Well, the object of Real Mortgage is limited to immovable properties or
alienable real rights imposed on immovable properties. Hence, parties to a loan
transaction may not use Movable Properties or Personal Properties to secure an
obligation by way of Real Mortgage. And that is clearly stated in Article 2124 of the
Civil Code which expressly provides that:

“Article 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.

(1874a)”

This is the reason why Real Mortgage are being applied only if the property to be
used as security for the fulfillment of a loan or obligation is a Real Property or
Immovable Property. Now, what are examples of Real Properties or Immovable
Properties? Examples would be your House, Land, Building or anything that is
attached permanently from the soil or fix structure, such that you cannot remove the
same without destroying it, or the property to which it is permanently attached.
Stated otherwise, you cannot use your car, cellphone or jewelry as an object of Real
Mortgage because they are not Real or Immovable Properties, but rather are Personal
or Movable properties. So if you will be asked, what properties can be used as object
in Real Mortgage? To answer that, you just have to revisit and read again Article
2124 of the Civil Code of the Philippines.

Question: Is it possible to mortgage a movable property? Yes, remember there is

what they call Chattel Mortgage. Its stated in the last sentence of Article 2124. But
the same will be discussed in the last part of this notes.

Going back with Real Mortgage. There are certain forms that are needed to be
complied with in order for the Real Mortgage Contract be completely valid, effective
and binding as against all other persons. One of which is stated in Article 2125,
which provides that the instrument or contract must be recorded with the Registry of
Property, thus:

“Article 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. (1875a)”

As may be gleaned from above, the law expressly states that for it to be binding as
against third parties, the same instrument or contract needs to be registered in our
Registry of Deeds. Simply put, all those persons that are neither mortgagor nor
mortgagee will not be bound by the Contract of Real Mortgage if the same is not
recorded in the Registry of Deeds. You might wonder, how is it being recorded by
the Registry of Deeds? Let’s say your house and lot is mortgaged to the bank, how
will the Registry of Deeds record the instrument? Well, to record it simply means
that a copy of the instrument will be kept by the registry of deeds, and the same will
be annotated in the “Certificate of Title” of the property. After which, the annotation
will become an encumbrance in the title of the property. And it is only upon
recording and annotation of the said contract will it bind third persons too.

Without which, its validity or effectivity will be limited only to the parties acting as
Mortgagor and Mortgagee, and of course all other persons who have participated in
the execution of contract. Again, if you are the Mortgagee, you must ensure that the
contract of mortgage is valid, notarized by a Notary Public, as well as recorded in
the Registry of Deeds, and annotated at the back of the Certificate of Title.

Another unique characteristic of Real Mortgage is that it directly and immediately

subjects the property whoever the possessor may be, to wit:

“Article 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.
(1876)”

This is why even if the Mortgagor allows another person to possess the property
mortgaged during the existence of a contract of mortgage, the same property will
still be bound to answer the obligation of the Mortgagor / Borrower if the latter fails
to settle the principal obligations.

Problem: Mr. X mortgaged his House and Lot to Bank-Y to secure his obligations
in the amount of One million pesos (Php 1,000,000.00) payable in 10 equal monthly
installments or Php 100,000 per month. On the fifth month of amortization, Mr. X
leased the said property to his friend, Mr. Z, for a monthly rent in the amount of Php
10,000 and gave possession thereof to Mr. Z. During which time, however Mr. X
started failing to pay the monthly amortization of his loan.

Question: what will happen to the House and Lot?

This is answerable by Article 2126 which provides that a Real Mortgage directly and
immediately subjects the property mortgaged regardless of whoever is the possessor
thereof. As such, the House and Lot of Mr. X can still be foreclosed by Bank-Y even
though it is presently occupied or possessed by Mr. Z.

In other words, subsequent contracts involving properties that were already

mortgaged cannot defeat the contract of mortgage. Such that, even if the Mortgagor
sells or leases or donates his property to some other person, the same will still be
bound for the satisfaction of the principal obligation.

Now, what are normally covered in a Real Mortgage if you mortgage a property?
Will this be limited to the land and building or the property itself to which the Real
Mortgage was originally imposed? The answer is NO. Because, Article 2127
expressly states that Real Mortgage extends to natural accession, to the
improvements, growing fruits and the rents or income not yet received when the
obligation becomes due, thus:

“Article 2127. The mortgage extends to the natural accessions,

to the improvements, growing fruits, and the 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. (1877)”

As such, let’s say for example Mr. X mortgaged his vacant lot in 2008 to secure his
obligation to Bank-Y in the amount of Php 1,000,000.00 payable in one (1) year. In
2009, however, the obligation remains unpaid and Bank-Y was constrained to
foreclose the property. Mr. X now demands for the return of the expenses he spent
for the fence of the land. Is Mr. X correct?

Answer: No. Mr. X is not correct. Because Article 2127 expressly states that
Mortgage includes or extends to the improvements of the property mortgage. Herein,
Fence is an improvement of the property. As such, the foreclosure of the land extends
to the same.

You may also correlate it with Article 2102 which, again, expressly states that “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.”

Another characteristics of Real Mortgage is that it may be sold, alienated or assigned

to another person. You would notice that sometimes, the original creditor /
mortgagee does not want to wait anymore for the due date of the obligations. If such
is the case, the Creditor or the Mortgagee can sell, alienate or assign its interests over
the Real Mortgage to another person. And this is perfectly valid as long as there is
no prohibitions stated in the Contract of Mortgage by the original parties, thus:

“Article 2128. The mortgage credit may be alienated or

assigned to a third person, in whole or in part, with the formalities
required by law. (1878)”
Take note, however, that the process of selling, alienating or assigning to some other
persons your interests over the Real Mortgage contract must be compliant with the
formalities required by law. At the very least, therefore, it must be in writing also. It
cannot be done verbally.

On the other hand, what if it is the Mortgagor / Debtor himself who sold the property
to some other person pending full payment of its outstanding obligations? Usually it
happens through a Deed of Sale with Assumption of Mortgage (“DSAM”). In
DSAM, the owner of the property sells the same to another person on the condition
that the buyer will assume the obligation to pay the existing loan in-favor of the
Creditor or the Mortgagee. If that’s the case, the Creditor or the Mortgagee is
likewise expressly granted by Article 2129 the right to claim from such third person
to pay the existing balance as a fulfillment of the obligations, to wit:

“Article 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. (1879)”

Problem: Mr. X mortgaged his house and lot infavor of Bank-Y to secure his loan
obligation in the amount of Php 1,000,000. During the existence of their contract,
however, Mr. X decided to sell the said house and lot to his friend, Mr. Y. Upon
learning of the intention of Mr. X, Bank-Y immediately opposed on the same and
told Mr. X that his intention to sell the property to Mr. Y is prohibited under their
Real Mortgage.

Question: Is Bank-Y correct?

Answer: Bank-Y is not correct because any stipulation or agreement in the Real
Mortgage which prohibits the owner or mortgagor to sell the property to some other
persons is null and void. This is actually prohibited by Article 2130, to wit:

“Article 2130. A stipulation forbidding the owner from

alienating the immovable mortgaged shall be void. (n)”

As such, a mortgagor or owner of the property may still validly sell the property
subject or used as an object in the Real Mortgage agreement. This is especially true
because the mortgagor still remains to be the absolute owner of the property and
he/she can validly dispose of the same if he/she wants to do so.

Nonetheless, if the mortgagor / owner wants to sell it to another person during the
existence of the loan obligation, the subsequent buyer must be reminded of Article
2126 which provides that Real Mortgage “directly and immediately subjects the
property upon which it is imposed”. Simply put, even if the property is no longer in
the hands of the original owner or mortgagor, the property is still subject of the Real
Mortgage.

Moreover, Article 2129 is also clear that the buyer of the said property will be bound
or will necessarily assume the obligations secured by the property. As such, the
Creditor/Mortgagee may validly ask payment from the new owner consistent with
Article 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, xxxxx”.

Lastly, Article 2131 simply says that specials laws that may be passed by congress
relative to Mortgage Law, as well as the laws and rules governing Land Registration
may be applied to Real Mortgage Contract, and may prevail over the provisions of
the Civil Code, thus:

“Article 2131. The form, extent and consequences of a mortgage,

both as to its constitution, modification and extinguishment, and as to
other matters not included in this Chapter, shall be governed by the
provisions of the Mortgage Law and of the Land Registration Law.
(1880a)”

II
Pledge

Type Designation Illustration

An obligation of the
Loan Principal Creditor Debtor to pay the amount
Contract or of Php 1,000,000.00 to
Debtor the Creditor

Contract of Pledge over

Pledge Accessory Pledgor the Rolex Watch of the
Contract or Debtor to secure the
Pledgee fulfillment of the
principal Obligation in
the amount of Php
1,000,000.00 in-favor of
the Creditor.

What is pledge? Basically it’s also an accessory contract to secure an obligation. Its
purpose and essential requisites are almost the same with Mortgage. That is why
they have exactly the same essential requisites, thus:

1. Secures the fulfillment of a principal obligation;

2. Pledgor must be the absolute owner of the thing mortgaged; and
3. Pledgor must have free disposal of their property, or be legally
authorized for such purpose.

But despite having the same purpose and essential requisites, they do have some
differences. One of which is the possession of the property pending the fulfillment
of the obligations. Article 2093 is very explicit that the thing pledged shall be placed
in the possession of the creditor or a third person, thus:
 “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. (1863)”

Unlike in Real Mortgage, the usual set-up is that the property mortgaged remains in
the possession of the owner/mortgagor, and only the Certificate of Title is being
transferred to the possession of the Creditor/Mortgagee. In pledge, however, the
property will not remain in possession of Owner/Pledgor. It shall be placed in the
possession of the Creditor/Pledgee or third person by common agreement. Hence,
the Owner/Pledgor cannot retain possession over which without violating the
express provisions of the law.

That is why, in pawnshops, if you want to borrow money there and a pledge or
“sangla” is required, you cannot retain possession of the item such as your cellphone,
watch or jewelry. Why? Because, usually, those personal properties have no titles or
certificates proving ownership thereof that could protect the interests of the
Creditor/Pledgee.

As such, they need to actually possess the property. Unlike in Real Mortgage, you
don’t have to surrender possession of your house and lot to the Creditor/Mortgagee
because the evidence of ownership thereof is the Certificate of Title which can be
surrendered to the Creditor/Mortgagee. Also, you cannot remove an immovable
property to some other places to defraud your creditor/mortgagee. That is why an
immovable property made subject of a Contract of Mortgage need not be taken from
the hands of the Owner/Mortgagor.

Now, if Real Mortgage is limited to immovable properties, what can be the subject
of Pledge? Unlike with Real Mortgage, only movables that are susceptible of
possession can be the subject of Pledge. You cannot pledge immovable properties
such as House and Lot. And this is clearly stated in Article 2094, thus:

“Article 2094. All movables which are within commerce may be

pledged, provided they are susceptible of possession. (1864)”

This also includes incorporeal rights and other negotiable instruments, thus:

“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. (n)”

So if you want to pledge your shares of stocks in a corporation, you may validly do
so. You just have to surrender with the Creditor/Pledgee your certificate of stocks.
Similar with Real Mortgage, a contract of pledge requires to be made in a public
instrument to be binding as against third persons. So if you pledge your personal
property to your Creditor/Pledgee, and you forgot to execute a Public Instrument or
a Notarized Contract of Pledge, what is the status of the contract? Well, it remains
valid, but the contract of pledge is not binding as against third persons. This may be
gleaned in Article 2096 which states that:

“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. (1865a)”

Do not be confused, however, with the term “Public Instrument”. It simply requires
that the Contract or Instrument be acknowledged before a Notary Public. Once the
contract is notarized by the Notary Public, the said contract or document will now
become “Public”, because it will be recorded in the Notarial Book of the Lawyer as
a public document. Hence, all other persons are bound thereof, and it is no longer a
“Private” document whose effectivity is limited to the contracting parties.

Moving on to the next provision, you may be wondering if the Owner/Pledgor can
also sell the thing while in possession of the Pledgee/Creditor. Remember that in
Real Mortgage, prohibiting the Owner/Mortgagor to sell the thing mortgaged is null
and void. To illustrate, let’s look at the example below:

Problem: Mr. X pledged his Rolex Watch to Pawnshop-Y as a security for his
obligation in the amount of Php 100,000.00. The agreement was that the loan
obligation will be paid after one (1) year and the monthly interests is Two percent
(2%). Before the lapse of one (1) year, however, Mr. Z approached Mr. X if he could
buy the Rolex Watch for Php 300,000.00. Mr. X now is asking you if he can sell the
Rolex Watch before the lapse of agreed one (1) year period. How will you answer
him?

To help Mr. X, we can refer to Article 2097 of the Civil Code of the Philippines.
Therein, it is expressly stated that the sale of the thing pledged requires the consent
of the Pledgee/Creditor, to wit:

“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. (n)”

Unlike in Real Mortgage, Mr. X needs to secure prior consent of Pawnshop-Y to sell
the thing pledge in favor of Mr. Z. Note, however, that even though Pawnshop-Y
will give its consent to the sale transaction infavor or Mr. Z, the possession thereof
shall remain to Pawnshop-Y. This is expressly stated in the latter part of the
provision. This is because its rights as the pledgee/creditor prevails over Mr. Z who
is necessarily bound by the contract of pledge entered into by Mr. X over the Rolex
Watch.

In fact, Article 2098 strengthens the same by expressly granting the pledgee/creditor
the right to retain possession over the thing as long as the debt has not been paid,
thus:
 “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. (1866a)”

As such, the law is very clear that the pledgee/creditor may validly refuse to return
or surrender the thing pledged as long as the debt it secures has not been fully
satisfied. Ergo, if Mr. Z argues that he is now the owner of the Rolex Watch, and he
demands Pawnshop-Y to surrender possession thereof, Pawnshop-Y can validly
refuse citing Article 2098 of the Civil Code.

Now, who between the Owner/Pledgor or Creditor/ Pledgee is responsible to take

care of the thing pledged? This is answerable by Article 2099, to wit:

“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. (1867)”

If you will notice, this is an exception to what you have studied before in Obligations
and Contracts or Law on Sales that the owner bears the risk of loss or damage over
the property (res perit domino). The above provision is very clear that the
pledgee/creditor shall take care of the thing pledge with the diligence of a good father
of a family. BUT, he has the right to ask for reimbursements from the owner. As
such, if Pawnshop-Y spent Php 2,500.00 to preserve the Rolex Watch in good
condition, it may validly ask for reimbursements from the owner thereof, Mr. X.

In fact, Article 2100 on the other hand expressly imposed limitations on the
pledgee/creditor to deposit the thing pledge to some other person/entity. Mainly
because it is its primary duty to take care of the thing pledge. Note, however, that
this limitation is not absolute because the pledger/owner may authorize the
pledgee/creditor to deposit the same to other person/entity for safekeeping, thus:

“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. (n)”

Now, what if the thing pledged is damaged because of its hidden defect that was not
disclosed to the Creditor/Pledgor, who will be liable for the same? The question is
answerable by Article 2101 citing Article 1951, thus:

“Article 2101. The pledgor has the same responsibility as a

bailor in commodatum in the case under article 1951. (n)”

As such, we must visit also Article 1951 of the Civil Code to see what’s the extent
of responsibility of Pledgor if the thing pledged is damaged due to its hidden defect,
thus:
 “Article 1951. The bailor who, knowing the flaws of the thing
loaned, does not advise the bailee of the same, shall be liable to the
latter for the damages which he may suffer by reason thereof. (1752)”

Accordingly, the Owner/Pledgor is duty bound to disclose the flaws or defects of the
thing to be pledged to the creditor/pledgee. And if the thing was damage because of
the said flaw or defect, then the Owner/Pledgor can be made liable for damages that
the pledgee suffered by reason thereof.

Let us now move on to Article 2102 which provides for the treatment of the fruits,
income, dividends or interests that may be earned from the thing pledged. Article
2102 expressly provides that:

“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.

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. (1868a)”

To better understand the provision above, let’s give an example:

Problem: On January 01, 2008, to secure his obligation in the amount of Php
500,000.00, Mr. X pledged his “Certificate of 400 Stock Ownership of Company-Y
with par value of Php 1,000.00” in favor of Pawnshop-Z for two (2) years or until
December 31, 2009, with an annual interest rate of 6% or Php 30,000.00. This
company usually gives annual dividend of Php 100.00 per share. For year 2009, the
100 Stock Ownership of Mr. X earned him dividends in the amount of Php
40,000.00.

Question No. 1 - Mr. X now is asking you, who is entitled to the dividends earned
in 2009 in the amount of Php 40,000.00?

Answer: Mr. X is entitled to the dividends in the amount of Php 40,000.00.

However, Pawnshop-Z has the right to retain and offset the same from the annual
interest of the loan obligations in the amount Php 30,000.00. As such, only the
remaining Php 10,000.00 will be owned by Mr. X.

Question No. 2 – Mr. X is asking also, can he get the remaining Php 10,000.00 from
Pawnshop-Z?

Answer: No, because Article 2102 is very clear that whatever excess over the
interests shall be applied to the principal obligation. Hence, the said excess may be
deducted from the principal obligation in the amount of Php 10,000.00.
What if for instance the thing pledge is the Dog of Mr. X, and the same delivers a
puppy during the existence of the obligation, who will be entitled to the puppy? The
answer is Mr. X because the second paragraph of Article 2102 expressly states that
“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.”

Question No. 3: Can Mr. X recover the puppy from Pawnshop-Z?

Answer: No, because the law expressly states that the offspring shall become the
subject also of the pledge if there is no stipulation to the contrary. Meaning, as a
general rule, it will form part of the contract of pledge, and may not be recovered
from the Creditor/Pledgee during the existence of the Contract of Pledge or until the
obligation has been fully satisfied.

Now, Article 2103 simply states that the ownership of the thing pledged remains to
the Pledgor/Borrower, thus:

“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. (1869”

Similar with Contract of Mortgage, ownership over the thing remains with the
Pledgor. Note further that the Creditor/Pledgee may validly bring actions to court in
behalf of the Owner/Pledgor to protect the thing pledged as against third persons.
This is proper because as a Creditor/Pledgee of the thing pledged, it has interests
over the thing that needs to be protected also. That is why the law allows the
Creditor/Pledgee to initiate actions for and in behalf of the Pledgor/Owner.

With respect to the use of the property pledged. You may be wondering, can the
creditor/pledgee use the thing pledged during the contract of pledge? or Can
Pawnshop-Y allow its employees to wear the Rolex Watch of Mr. X? The answer is
No. Unless, the same is allowed by Mr. X. This is expressly stated in Article 2104,
thus:

“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. (1870a)”

In fact, if Pawnshop-Y will insist to use the Rolex Watch, Mr. X can demand that
the Rolex Watch be deposited to another person/entity. But what if the Rolex Watch
may be damaged if the same will not be used at-least 24 hours a week? Then, that is
the time that Pawnshop-Y can validly use the Rolex Watch of Mr. X.
Take note, however, that the purpose of Pawnshop-Y is limited to the same. It cannot
be used for any purpose other than preservation.

Problem: During the effectivity of the contract of pledge, Mr. X demands for the
return of his Rolex Watch from Pawnshop-Y because he wants to show it to Mr. Z
who will buy the same for Php 300,000.00. Pawnshop-Y refused because the
obligation secured by the Rolex Watch has not yet been paid. Is the refusal valid?

Answer: Yes, Pawnshop-Y is entitled to remain in possession over the Rolex Watch
until the obligation has been paid, and the Owner / Pledgor may not demand for its
return. This is very clear in Article 2105 which provides that:

“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. (1871)”

In fact, the above provision is just a reiteration of Article 2098 which provides that
“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.”

Now, you may wonder, are there exceptions to the rule? Meaning, can the thing
pledged be recovered or removed from the possession of Creditor/Pledgee?

The question is answerable by Article 2106-2107, which provides that:

“Article 2106. If through the negligence or wilful 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. (n)

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. (n)”

From the foregoing provision, it may be gleaned that if the thing pledged is in danger
of being lost or impaired, whether with or without fault on the part of the
Creditor/Pledgee, the Owner/Pledgor may validly ask that the same be deposited to
another person, or another thing of the same kind but not of inferior quality be
pledged to the Creditor/Pledgee.

Another remedy on the part of the Creditor/Pledgee to protect its interests is stated
in Article 2108 which allows him/her to sell the property at public auction if the
thing pledged is in danger of destruction of impairment, thus:
 “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. (n)”

Take note, however, that the right given above is available only if the danger of
destruction or impairment/diminution is without fault on the part of the
Creditor/Pledgee.

Question: What if Pawnshop-Y discovered that the Rolex Watch of Mr. X is fake?
What are the remedies available to Pawnshop-Y? The answer may be gleaned from
Article 2109 which provides that the Creditor/Pledgee may demand for its
replacement or the immediate payment of the obligation, thus:

“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. (n)”

As you may notice, the option is given to the Creditor/Pledgee. Meaning, Mr. X
cannot say to Pawnshop-Y that he will just replace it by a genuine Rolex Watch
because it is Pawnshop-Y who could choose whether he will allow Mr. X to replace
the thing pledged, or he should already pay the principal obligation.

Moving forward, the provisions of pledge consistently state that the possession over
the thing pledged will be given to the Creditor/Pledgee. And that will remain to be
true, until and unless the obligation has been fully paid.

Problem: Mr. X informed Pawnshop-Y that he misses so much his Rolex Watch.
As such, he asked for the return of his Rolex Watch from Pawnshop-Y, but promises
to return it to Pawnshop-Y if he fails to pay his monetary obligation. Considering
that Pawnshop-Y is very generous, it allowed Mr. X to recover his Rolex Watch
despite the continued existence of the principal obligation secured by the same. Mr.
Z, a second year BSA student of NEU, saw what happened. He now wants to know
if this is valid or not. As a brilliant classmate of Mr. Z, what will you tell him?

Answer: I will tell him that the contract of pledge is now extinguished because the
law provides that the thing pledged must remain in possession of the
Creditor/Pledgee. This is consistent with Article 2098 and Article 2105. As such, it
cannot be returned to Mr. X without extinguishing the Contract of Pledge. Moreover,
I will also tell Mr. Z that any stipulation or agreement to return the same is void. I
will also tell Mr. Z that had he studied well Article 2110, he would have known the
answer to his questions.

“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. (n)”

Note also that the law creates a presumption that if the thing pledged is in possession
of the Owner/Pledgor, it is presumed that the same has been returned by the
Creditor/Pledgee. As such, the return of the thing pledge to the owner/pledgor is one
of the modes of extinguishing the Contract of Pledge.

Problem: Pawnshop-Y wanted to return the Rolex Watch to Mr. X and extinguish
the Contract of Pledge. However, Pawnshop-Y could not locate nor contact Mr. X
for the return of his watch. Pawnshop-Y learned that you are currently enrolled in
NEU and is studying well the law on pledge. Pawnshop-Y then asked if it is possible
to extinguish the Contract of Pledge even without returning the thing pledged.

Answer: I will answer that Pawnshop-Y need not return the thing pledged to Mr. X
to extinguish the contract of pledge. In fact, a statement in writing that Pawnshop-Y
is now extinguishing the Contract of Pledge would suffice. Once Pawnshop-Y states
in writing that it is extinguishing the Contract of Pledge, it will become a mere
depositary and no longer duty bound as Pledgee. This is very clear under Article
2111 which provides that:

“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. (n)”

Problem: Mr. X failed to pay his obligations in the amount of Php 300,000.00.
Pawnshop-Y now is asking you what can it do to recover the amount of money it
extended to Mr. X.

Answer: I will tell Pawnshop-Y that it may go to a Notary Public and have the thing
pledged sold in a public auction. I will also tell Pawnshop-Y that whatever proceeds
that may be derived thereof may be used to satisfy the obligation incurred by Mr. X.

Problem: Pawnshop-Y informed you that during the public auction, there was no
other bidder willing to purchase the Rolex Watch.

Answer: I will tell Pawnshop-Y that it needs to initiate again another Public Auction
for the Rolex Watch because the law mandates at least two (2) attempts to sale the
same in a public auction.

The foregoing answers to questions of Pawnshop-Y are consistent with the provision
of Article 2112 which provides that:

“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. (1872a)”

A perusal of the above would readily reveal that the Creditor/Pledgee cannot just
appropriate the thing pledged if in case the Owner/Pledgor fails to pay the obligation.
A public auction is necessary. In fact, if there are no other bidders willing to purchase
the property, the Creditor/Pledgee is required to initiate another public auction. It is
only after two(2) failed attempts that the Creditor/Pledgee may appropriate the thing
pledge as its own for the satisfaction of the obligation.

Problem: During the Public Auction, Mr. X and Mr. Z bid for the Rolex Watch.
Both of them bid for the amount of Php 100,000.00. Mr. Z argued that he should
have a better right to purchase the Rolex Watch because he bid first for the same in
the amount of Php 100,000.00. Mr. X suddenly remembers that you once helped him
about this, so he is now asking you again if he can still recover his Rolex Watch
considering that Mr. Z bid for the same amount.

Answer: I will tell Mr. X that he has a better right over the thing pledged as against
all other Bidders because being the owner thereof, he has a better right if he should
offer the same terms as the highest bidder, to wit:

“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. (n)”

Moving on to Article 2114, are bidders allowed to pay their bid by installment? Let
say for instance that Mr. Z was declared to be the highest bidder in the public auction,
and his bid was Php 150,000.00. Is Mr. Z allowed to pay in three (3) equal monthly
installment? The answer is no because all bids shall offer to pay the purchase price
at once, to wit:

“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. (n)”

Problem: Mr. X failed to pay his obligation in the amount of Php 300,000.00. As
such, Pawnshop-Y was constrained to have the Rolex Watch sold at public auction.
The Rolex Watch was sold to Mr. Z for Php 150,000.00 who emerged as the highest
bidder. After realizing that the Rolex Watch was sold only for Php 150,000.00,
Pawnshop-Y now wants to know if it can still recover the deficiency in the amount
of Php 150,000.00 from Mr. X.
Answer: The answer is no. If the price of the sale is less, the creditor is not entitled
to recover the deficiency. And any stipulation to the contrary is void. As such, I will
tell Pawnshop-Y that it can no longer recover the same from Mr. X even though they
agreed for it before.

Question: What if Mr. Z bid for the Rolex Watch for Php 400,000.00. Can Mr. X
demand for the return of the excess Php 400,000.00 bid over the Php 300,000.00
amount of obligation? Meaning, can Mr. X ask for the Php 100,000.00 difference?

Answer: 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.

The foregoing answers are based on the provision of Article 2115, thus:

“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. (n)”

As may be gleaned from the above-provision. It is very clear that once the thing
pledged is sold at a public auction, the main obligation it secures will be
extinguished. This is true regardless of the amount for which the thing pledged was
sold. As such, even though the Rolex Watch of Mr. X is sold for Php 10,000.00 or
Php 1,000,000.00 the extinguishment of the principal obligation will remain to be
true.

Note also the difference if there is excess or deficiency in the price for which the
thing pledged had been sold. If the Rolex Watch is sold for less than the amount of
Principal Obligation, Pawnshop-Y can no longer recover the deficiency from Mr. X.
REGARDLESS IF THERE IS STIPULATION OR NOT.

On the other hand, if the thing pledged is sold for more than the amount of principal
obligation, Mr. X can ask for the excess proceeds IF THERE IS STIPULATION
between him and Pawnshop-Y.

“Article 2116. After the public auction, the pledgee shall

promptly advise the pledgor or owner of the result thereof. (n)”

Article 2116 simply provides for an obligation of the pledgee to inform the
Pledgor/Owner about the result. The purpose thereof is perhaps to protect the rights
of the Pledgor/Owner should the thing pledged be sold during the public auction at
a price higher than the principal obligation. Moreover, as an owner of the thing
pledged, it is wise to advise that the same has already been sold in the public auction
and that the previous Owner/Pledgor may no longer legally sell the same to some
other person since ownership thereof has already been transferred to the highest
bidder during the public auction. Finally, please remember that the Owner/Pledgor
is given a preferred right to purchase the thing pledged during the public auction is
his/her bid is equal to the bid of the highest bidder.

Problem: Mr. X wants to borrow another Php 300,000 from Pawnshop Y. But since
he has no extra Rolex Watch to pledge, he asked his friend, Mr. Z, if the latter can
pledge his own Rolex Watch to Pawnshop-Y to secure the second obligation being
borrowed by Mr. X from Pawnshop-Y. Mr. Z consented and surrendered his Rolex
Watch to Pawnshop-Y as a security to the obligation borrowed by Mr. X.

Question No.1 – Can the pledgor (Mr. Z) be a different person from the borrower
(Mr. X)?

Answer: Yes. Remember that a Contract of Pledge is just an accessory contract. It

is entered into by the parties to merely secure the fulfillment of the principal
obligation. As such, Mr. X is the principal borrower but he is not the pledgor.
Because the pledgor is the owner of the property pledged. In this case, the pledgor
is Mr. Z. And that is perfectly valid.

Question No. 2 – What if Mr. X can no longer pay his obligation in the amount of
Php 300,000.00 because he lost his job due to covid-19 pandemic? What can
Pawnshop-Y do to protect itself?

Answer: It can sell the Rolex Watch of Mr. Z in a public auction in accordance with
Article 2112.

Question No. 3 – What can Mr. Z do to prevent the sale of his Rolex Watch in a
public auction?

Answer: He can pay the principal obligation to Pawnshop-Y in behalf of Mr. X.

And that is perfectly allowed under Article 2117 because Mr. Z has the right to the
thing pledged being the owner of the Rolex Watch, thus:

“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. (n)”

Problem: On February 28, 2020, Mr. Z borrowed money from Mr. X in the amount
of Php 100,000.00. To formalize the same, Mr. Z executed a promissory note in-
favor of Mr. X promising to pay on December 31, 2020. However, Mr. X lost his
job on March 31, 2020 because of Covid-19 Pandemic. Since he cannot immediately
demand for the payment of obligation of Mr. Z because it is not yet due and
demandable, Mr. X was constrained to pledge the promissory note to Pawnshop-Y
for Php 50,000.00. Mr. X then promised to pay Pawnshop-Y on February 28, 2021.
Come December 31, 2020, Pawnshop-Y asked you again as to what it can do to the
Promissory Note of Mr. Z which was pledged to it by Mr. X.

Answer: I will tell Pawnshop-Y that it can directly collect from Mr. Z the amount
of Php 100,000.00 because his obligation pursuant to the Promissory Note is now
due and demandable.
Follow up Question: What if Mr. Z pays Pawnshop-Y the amount of Php
100,000.00? what is/are the obligation/s of Pawnshop-Y?

Answer: I will tell Pawnshop-Y that it shall apply the same to the payment of his
claim against Mr. X, and deliver the surplus, to Mr. X. As such, the excess of Php
100,000.00 collected from Mr. Z over the amount of loan borrowed from Pawnshop-
Y shall be remitted or delivered to Mr. X, which in this case, is Php 50,000.00.

The answers are in line with Article 2118, thus:

“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. (n)”

Follow-up question: What if Pawnshop-Y tells you that it has no stipulation or

agreement with Mr. X that the excess shall be delivered to Mr. X? what will you
say?

Answer: I will tell Pawnshop-Y that the necessity of stipulation or agreement as to

the return of excess to the Owner/Pledgor is applicable only in Public Auction as
stated in Article 2115. In this case, the thing pledged was not sold at public auction.
The proceeds thereof was not derived from the highest bidder, but rather from
collections of the promissory note. Hence, Article 2118 is the one applicable.

“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. (n)”

The above provision simply tells us that a contract of pledge may involve two or
more things. It is not limited to only one object. As such, if Mr. X desires to borrow
Php 600,000.00 from Pawnshop-Y, and the latter requires him to pledge at-least two
(2) Rolex Watches, then Mr. X may pledge two (2) Rolex Watches. He may even
ask Mr. Z to accommodate him and pledge his own Rolex Watch to secure the
obligation contracted by Mr. X.

“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. He is not prejudiced by any waiver of defense by
the principal obligor. (n)”

Article 2120 provides that a third party has the same rights with a guarantor. In our
example before, if Mr. Z would pledge his own Rolex Watch to secure the obligation
of Mr. X to Pawnshop-Y in the amount of Php 300,000.00, then Mr. Z has all the
rights similar with a guarantor. Technically speaking, Mr. Z in essence is acting as
guarantor and not mere pledgor because he is not the one principally liable for the
obligation.
As such, if Mr. Z pays for the obligation of Mr. X just to prevent the sale of his Rolex
Watch in a public auction by Pawnshop-Y, he may properly ask for reimbursements
from Mr. X. He may also ask for interests and expenses he incurred in settling the
obligation. In fact, Mr. Z is also entitled to payment of damages should in case he
proves that Mr. X maliciously refused to pay its obligation to the damage and
prejudice of Mr. Z, or if Mr. X really had no intention to pay the obligation that is
why he enticed Mr. Z to use his own Rolex Watch as pledge.

Moving on to legal pledges. There are instances wherein the parties become pledgee
and pledgor by operation of law. Meaning even if there is no agreement between the
parties, they become as such and they are deemed to have entered into a Contract of
Pledge.

“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. (n)”

The above provision is consistent with our Obligations and Contracts which provides
that one of the sources of our obligation is law.

Provision
Article 546. Necessary expenses
shall be refunded to every
possessor; but only the possessor
in good faith may retain the thing
until he has been reimbursed
therefor.
Useful expenses shall be
refunded only to the possessor in
good faith with the same right of
retention, the person who has
defeated him in the possession
having the option of refunding
the amount of the expenses or of
paying the increase in value
which the thing may have
acquired by reason thereof.
(453a)
Illustration
Problem: Mr. X leased his Toyota Fortuner
for two (2) months to his friend, Mr. Z.
During the existence of the lease agreement,
Mr. Z found out that the tires of the vehicle
needs replacements already. As such, he spent
Php 20,000.00 for the tires replacement of the
vehicle. Upon reading the Lease Contract, Mr.
X found out that the expenses for the same
should be paid by the owner, Mr. Z. As a good
friend also of Mr. X, he is asking you what he
can do if Mr. Z will refuse to reimburse him.
Answer: I will tell him that he can retain
possession of the Toyota Fortuner if Mr. Z will
refuse to reimburse him. I will further explain
that they have been deemed to have entered by
operation of law into a Contract of Pledge by
virtue of Article 2121 citing Article 546.

Mr. X approached his friend, Mr. Y if he can

remove the side mirrors of his Yamaha Mio
I125, and install a new one. Mr. Y answered
that he can perform the same for Php
10,000.00. Mr. X agreed hoping that he can
 ask for discount from Mr. Y after installing the
new side mirrors. Upon completion of the
work, however, Mr. Y did not give any
discount to Mr. X.
Article 1731. He who has
executed work upon a movable Mr. X now is asking, if he can recover his
has a right to retain it by way of Yamaha Mio i125 even without paying the
pledge until he is paid. (1600) professional fee of Mr. Y?

Answer: I will tell him that he cannot recover

the possession over the Yamaha Mio i125
without completely paying Mr. Y. I will
further explain that they have been deemed to
have entered into a Contract of Pledgeby
operation of law pursuant to Article 2121
citing Article 1731.

Mr. X entered into a Shangrila Hotel in Makati

City. He disclosed to the hotel Management
that he has some valuable jewelries with him
that needs to be taken care of, and he needs to
deposit it temporarily with the custody of the
Hotel. The total fee for its safekeeping
Article 1994. The depositary amounted to Php 10,000. Mr. X, however,
may retain the thing in pledge failed to pay the same because all his money
until the full payment of what was borrowed by Mr. Y.
may be due him by reason of the
deposit. (1780) Can Shangrila Hotel refuse to return the
Jewelries to Mr. X?

Answer: Yes. Because a depositary is allowed

to retain the thing in pledge until the full
payment of what may be due him, by reason of
the deposit. As such, Mr. X cannot compel
Shangrila Hotel for its return.

Now, in our illustrations above, we learned that a Contract of Pledge may be created
by operation of law. In the second illustration above, what if Mr. X, despite demand,
was not able to pay Mr. Y of the Php 10,000.00 service fee for the replacement of
the side mirror? What is the remedy of Mr. Y?

Answer: I will tell Mr. Y that if in case Mr. X fails to pay the said amount despite
demand, he can sell the motorcycle of Mr. X in a public auction, and use the proceeds
thereof to satisfy the obligation of Mr. X. I will also explain to Mr. Y that he needs
to initiate the sale of the Yamaha Mio i125 within one (1) month from the time of
his demand to Mr. X because his right to do so may be waived.
The above-problem is an illustration of Article 2122, to wit:

“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. (n)”

“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. (1873a).”

A reading of Article 2123 simply provides that special laws would prevail in
Contract of Pledge if the creditor/pledgee is really engage in the business of
extending loans secured by pledge. It follows then, that if you are not engaged in the
same line of business, and you just simply want to extend loan to your friend secured
by pledge, then the provisions of the civil code on pledge will prevail.

So the Mlhuiller, Cebuana, and other pawnshops in our country are primarily
governed by special laws on pledges, and the civil code of the Philippines will only
apply suppletorily.

===========================================================

III
Provisions Common to Pledge and Mortgage

Now that we have studied already Real Mortgage and Pledge, we can now compare
them and study the common provisions applicable to them.

“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.

Third persons who are not parties to the principal obligation

may secure the latter by pledging or mortgaging their own property.
(1857)”
Article 2085 simply provides that Real Mortgage and Pledge have things in
common. We have already memorized the essential requisites of Mortgage and
Pledge and even assigned a mnemonic (SAF) for the same. To go deeper with these,
below is the discussion of the essential requisites applicable to both pledge and
mortgage.

First, they are both constituted to secure the fulfillment of a principal obligation. So
if you want to secure a loan from someone, you may mortgage your House and Lot.
If you have none, you may pledge your personal property such as Watch, Cellphone
or Jewelry. The purpose of Mortgage and Pledge is limited to securing a principal
obligation. Remember that they are just accessory contracts, and without a principal
contract of loan, they cannot exist on their own. Meaning, you cannot have a
Contract of Mortgage or Pledge without a Principal Loan Obligation.

Second, the Mortgagor or Pledgor must be the absolute owner of the thing pledged
or mortgaged. As such, you cannot Mortgage or Pledge a property you do not own.
If for instance you want to secure your obligation by way of mortgage or pledge but
you do not have property of your own, you may ask your friend or relative who have
properties to mortgage or pledge the same for you. But in the said contract of
mortgage or pledge, the mortgagor or pledger will be your friend or relative as the
case may be. Mainly because, they are the absolute owner of the property. So again,
you can be the main borrower but the pledger or mortgagor is another person.

Third, the Mortgagor or Pledgor must have free disposal of the same. Meaning, not
only are you the owner of the property mortgaged or pledged, but you must have
also the capacity to freely dispose the property. The reason being is that when you
enter into a Contract of Mortgage or Pledge over your property, you are impliedly
allowing the Mortgagee or Pledgee to sell your property in a public auction should
in case you fail to pay for your obligations. So if you yourself have no free disposal
of the same in the first place, with more reason that a mere Mortgagee / Pledgee
cannot sell it in a public auction.

The last paragraph of Article 2085 is a mere reiteration of the concept that the
Borrower need not be the Mortgagor or Pledgor. The borrower may ask someone to
Mortgage or Pledge his or her own property as security for the loan of the borrower.

“Article 2086. The provisions of article 2052 are applicable to a

pledge or mortgage. (n)”

Article 2086 cites Article 2052, to wit

“Article 2052. A guaranty cannot exist without

a valid obligation.

Nevertheless, a guaranty may be constituted to

guarantee the performance of a voidable or an
unenforceable contract. It may also guarantee a
natural obligation. (1824a)”
Again, a Contract of Pledge or Mortgage is a mere accessory contract. They cannot
exist on their own because their very purpose is to secure an obligation. As such,
similar with a contract of guaranty, there must be a main or principal obligation
existing before entering into these types of contracts.

“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. (1858)”

Article 2087 is very clear that once the borrower fails to pay its obligation,
the Mortgagee or Pledgee can then initiate the foreclosure of the property or
its sale through public auction. Ergo, the enforceability of Contract of
Mortgage or Contract of Pledge is totally dependent on the main obligation
it secures.

“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. (1859a)”

This is the concept of pactum commissorium. The parties are not allowed to agree
that the thing pledged or mortgaged will be automatically appropriated by the
Mortgagee or Pledgee as his or her own should in case the Mortgagor or Pledgor
fails to pay for its obligations.

Problem: Mr. X borrowed Php 100,000.00 from Pawnshop-Y. As a security thereof,

Mr. X pledged his Rolex Watch to Pawnshop-Y. Included in their contract is an
agreement that the Rolex Watch will automatically belong to Pawnshop-Y once Mr.
X fails to pay its obligations. Assuming that Mr. X fails to pay, can Pawnshop-Y
already claims as its own the Rolex Watch of Mr. X?

Answer: No. Because their agreement that Rolex Watch will automatically belong
to Pawnshop-Y once Mr. X fails to pay its obligations is null and void because it is
prohibited by Article 2088. This is a classic example of Pactum Commissorium.

Follow-up question: Is Pawnshop-Y always required to conduct or initiate a

Foreclosure or Public Auction, and be the highest bidder just to become the owner
of Rolex Watch?

Answer: No. Because Mr. X and Pawnshop-Y can always novate their contract, and
enter into a Dacion en pago governed by the law on sale. They can agree thereon
that as payment of the obligation of Mr. X to Pawnshop-Y, he is selling his property
to Pawnshop-Y for the satisfaction of his obligation.

Accordingly, what is prohibited by law is the outright appropriation or automatic

transfer of ownership to the Mortgagee or Pledgee. The reason mainly is because the
value of the property mortgaged or pledged is usually higher than the value of the
loan. For instance, you borrowed Php 300,000.00 from the bank and as a security
thereof, you mortgaged your House and Lot. Now, the value of your House and Lot
is Php 1,000,000.00. If you will allow the mortgagee or pledgee to instantly
appropriate the said property by merely including in their previous Contract of
Mortgage or Pledge that the property will automatically belong to them once the
borrower or pledger/mortgagor fails to pay the obligation, then it would greatly
cause injustice or unfairness on the part of the owner of the property.

That is why, the Mortgagee or Pledgee is required to conduct a public auction or

foreclosure. So that if the property is sold for a value higher than the amount of the
principal obligation, the owner thereof may recover the excess and his or her losses
will be minimized. But again, nothing prevents the owner or pledger/mortgagor to
enter into another contract selling the property pledged/mortgaged infavor of the
pledgee/mortgagee.

Moving forward to Article 2089, let us first analyze the problem below:

Problem: X, Y and Z are siblings. They are co-owners of four (4) Residential Units
located in Batangas, which they inherited from their parents. X, Y and Z desire to
borrow money from Mr. A in the amount of Php 5,000,000.00. However, Mr. A,
wanting to ensure that the amount being borrowed will be paid, he asked X, Y and
Z to execute a Contract of Mortgage over their properties in Batangas. On January
01, 2021 X, Y and Z agreed and executed the said contract.

The parties stipulated therein that the obligation will be paid on or before December
31, 2021.

On June 30, 2021, the siblings were able to pay half of the total obligation in the
amount of Php 2,500,000.00. They are now asking you if they can legally compel
Mr. A to surrender at least two (2) out of the four (4) residential units that were
mortgaged to Mr. A.

Answer: No. Because Mortgage or Pledge is indivisible. As such, even though the
properties mortgaged are distinct from one another, they are still deemed indivisible.
Hence, Mr. A cannot be compelled to return some of the residential units until the
obligation is fully paid by the siblings.

This is answerable by the first two (2) paragraphs of Article 2089, to wit:

“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 extinguishment of the pledge or
mortgage as long as the debt is not completely satisfied.

Neither can the creditor's heir who received his share of the
debt return the pledge or cancel the mortgage, to the prejudice of the
other heirs who have not 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 the credit.

The debtor, in this case, shall have a right to the

extinguishment of the pledge or mortgage as the portion of the debt
for which each thing is specially answerable is satisfied. (1860)”

Follow-up question: What if aside from Mr. A, there was another creditor in the
person of Mr. B. Let us say that Mr. A and Mr. B equally contributed to the amount
of Php 5,000,000.00 extended to the siblings. And let us assume that the siblings
paid first Mr. A, can he return the title of two (2) residential units considering he has
already been paid by the siblings?

Answer: No. Because the creditor who received his share of the debt cannot return
the pledge or cancel the mortgage, to the prejudice of the other creditors who have
not been paid.

The answer above is based on the third paragraph of Article 2089 which provides
that “Neither can the creditor's heir who received his share of the debt return the
pledge or cancel the mortgage, to the prejudice of the other heirs who have not been
paid.”

Follow-up question: But let us assume that the siblings separately mortgaged their
two (2) residential units infavor of Mr. A and the other two (2) residential units were
mortgaged infavor of Mr. B, will the answer still be the same?

Answer: No. Because this time, each of the Residential Units guarantees only a
determinate portion of the credit. As such, Mr. A can legally return the other Two
(2) Residential Units in favor of the siblings.

The answer above is based on the fourth and fifth paragraphs of Article 2089 which
provides that “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 the credit. The debtor, in this case, shall have a 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. (n)”

Article 2090 again reiterated that a contract of pledge or mortgage is indivisible.

Meaning, unless and until the principal obligation has already been satisfied, the
thing will remain as a security of the same for the benefit of the pledgee or
mortgagee. If for instance A, B and C separately borrowed Php 100,000.00 from D,
and as a security thereof the house and lot of C is mortgaged to D. In this case, even
if B and C have already paid their corresponding obligation to D for a total amount
of Php 200,000.00, the house and lot of C will still remain as mortgaged security of
the obligation because the total obligation has not yet been satisfied. This is true
despite the fact that B and C have already paid what is due from them.
 “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. (1861)”

Article 2091 made it clear that all kinds of obligations may be secured by pledge or
mortgage. This is true even if the obligation is not pure but subject to conditions.

“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. (1862)”

Article 2092 merely emphasized the basic requirements of a contract of pledge and
mortgage. Remember the requirements mentioned in Article 2085? The second
requirement states that the pledgor or mortgagor must be the absolute owner of the
property to be mortgaged or pledged. The third requirements also requires that they
have the free disposal of the same. So it is not enough that you are the absolute owner
of the property. The pledgor or mortgagor needs to have free disposal of the property
also. Because there are instances that, even if you are the owner you cannot dispose
your property.

Problem: X owns a House and Lot in Batangas. X entered into a contract of lease
with his friend, Y, over the said house for five (5) years. Their contract includes
prohibition on the part of X to sell the house during the five (5) year duration of the
contract of lease. Assuming that X wants to mortgage the house and lot to Z, what
will be your advice?

Answer: I will advise X to inform Z about the prohibition to sell stated in their
contract of lease because X should not misrepresent to Z that the property is
unencumbered and that the same is within his immediate disposal. I will also tell
him that he may be sued criminally by Z if he proceeds with mortgaging his house
without telling Z about the limitations provided in the contract of lease as stated in
Article 2092.

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III
Chattel Mortgage
(Act 1508)

Chattel Mortgage is governed by Special Law (Act 1508) which means that the
provisions applicable for chattel mortgage are not in the Civil Code of the
Philippines. But for us to easily understand Chattel Mortgage, the discussion will
just focus on the type of the property involved, possession over the same, and the
required forms for its validity.

As we have previously discussed, Real Mortgage involves immovable property. But

what if the parties desire to enter into a Mortgage involving a personal property?
Again, this is possible. Remember Article 2124 of the Civil Code? Please read again
the last sentence of that provision. It provides an exception to the rule that only
immovable property may be mortgaged. Consistent thereof, the Chattel Mortgage
Law provides that all personal property may be subject to mortgage and shall be
termed chattel mortgage, to wit:

“Sec. 2. All personal property shall be subject to mortgage,

agreeably to the provisions of this Act, and a mortgage executed in
pursuance thereof shall be termed chattel mortgage.”
You might be aware already that if you buy a motorcycle via installment method,
the usual way is that the Bank who financed the purchase price will require you to
sign a Chattel Mortgage over the motorcycle. So much so that if you fail to pay for
your obligation, they can recover possession of the vehicle for the satisfaction of
your obligation.
Another unique characteristic of a Chattel Mortgage is that it actually serves as a
conditional sale of the personal property. Such that, if you fail to pay the obligation,
then the sale or conveyance of the personal property in-favor of the mortgagee will
remain valid. On the other hand, if you will be able to pay the entire obligation, then
the conditional sale of the property in favor of the Mortgagee will automatically
become null and void, you can read this under Sec. 3, thus:

“Sec. 3. Chattel mortgage defined. — A chattel mortgage is a

conditional sale of personal property as security for the payment of a
debt, or the performance of some other obligation specified therein,
the condition being that the sale shall be void upon the seller paying
to the purchaser a sum of money or doing some other act named. If
the condition is performed according to its terms the mortgage and
sale immediately become void, and the mortgagee is thereby divested
of his title.”
Problem: Mr. X desires to buy a motorcycle but he has no sufficient funds to pay
for its purchase price, Php 150,000.00. Mr. X then asked Bank-Y to finance the
transaction. Acting on the request of Mr. X, Bank-Y
paid in full the seller of the motorcycle and drafted a Contract of Chattel Mortgage
over the same. Thereafter, Bank-Y asked Mr. X to sign the Chattel Mortgage
Contract. In their agreement, Mr. X will pay in 2 years with a monthly installment
in the amount of Php 8,000 inclusive of interests. Assuming that Mr. X fails to pay,
what are the remedies of Bank-Y?
Answer: Bank-Y need not foreclose the property or sale the same in public auction
for the satisfaction of the obligation because legally speaking, Bank-Y is still the
owner of the property. Again, a Chattel Mortgage is actually a conditional sale of
the property infavor of mortgagee. In this Case, when Mr. X signed the Chattel
Mortgage, he actually executed a Deed of Conditional Sale in-favor of Bank-Y. Such
that, if he is able to pay the purchase price, the conditional sale will become null and
void, and ownership thereof will revert to Mr. X. On the contrary, if he fails to pay
his obligation to Bank-Y, the conditional sale will remain valid, effective and
existing. Hence, Bank-Y will become the absolute owner of the motorcycle.
Forms and Validity
Similar with Real Mortgage, the instrument or contract of Chattel mortgage shall be
recorded in the registry of deeds. Moreover, with respect to form, the Chattel
Mortgage is very particular that a contract is deemed to be sufficient if it is
substantially in accordance with the form provided by Act 1508.

“Sec. 4. Validity. — A chattel mortgage shall not be valid against any

person except the mortgagor, his executors or administrators, unless
the possession of the property is delivered to and retained by the
mortgagee or unless the mortgage is recorded in the office of the
register of deeds of the province in which the mortgagor resides at
the time of making the same, or, if he resides without the Philippine
Islands, in the province in which the property is situated: Provided,
however, That if the property is situated in a different province from
that in which the mortgagor resides, the mortgage shall be recorded
in the office of the register of deeds of both the province in which the
mortgagor resides and that in which the property is situated, and for
the purposes of this Act the city of Manila shall be deemed to be a
province.

Sec. 5. Form. — A chattel mortgage shall be deemed to be sufficient

when made substantially in accordance with the following form, and
shall be signed by the person or persons executing the same, in the
presence of two witnesses, who shall sign the mortgage as witnesses
to the execution thereof, and each mortgagor and mortgagee, or, in
the absence of the mortgagee, his agent or attorney, shall make and
subscribe an affidavit in substance as hereinafter set forth, which
affidavit, signed by the parties to the mortgage as above stated, and
the certificate of the oath signed by the authority administering the
same, shall be appended to such mortgage and recorded therewith.”

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SIMILARITIES AND DIFFERENCES
Real Pledge Chattel
Mortgage Mortgage
1. Property Involved Immovable Movable Movable
2. Possession Usually Must be Must remain in
Remains with placed in possession of
the Mortgagor possession of Mortgagor
the Pledgee
 3. Registration of Required n/a Required
Contract
4. Public Instrument Required Required Required
5. When perfected Upon signing Upon delivery Upon signing
of the contract of the thing of the contract
pledged
6. Ownership Mortgagor Pledgor must Mortgagor
must be the be the owner must be the
owner owner
7. Purpose To secure To secure To secure
fulfillment of fulfillment of fulfillment of
an obligation an obligation an obligation
8. Free Disposal of the Required Required Required
owner
9. Remedy of Creditor if Initiate a Initiate a n/a
not paid foreclosure Public
proceedings Auction
before a
Notary Public
10. Deficiency of Can recover Cannot Can recover
Proceeds during deficiency recover deficiency
public auction deficiency
even with
stipulation
11. Excess of proceeds Owner is Pledgor can Owner is
entitled to the recover if entitled to the
excess there is excess
stipulation
12. Type of Contract Accessory Accessory Accessory
13. Nature Indivisible Indivisible Indivisible
14. Pactum Prohibited Prohibited N/A
Commissorium

Copyright © 2021 by Atty. Aldrin Jose M. Cana, CPA & Atty. Nomela M. Cana. All rights reserved. No
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