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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)

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.

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.

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.

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 thing loaned

Borrower need only pay the 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 the thing before the expiration of the term in case of urgent need

Lender may not demand return of the thing before the lapse of the term agreed upon

LOSS OF THE THING

Suffered by the lender (since he is the owner)

Suffered by the borrower even if through fortuitous event

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.

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

NATURE OF COMMODATUM

Commodatum 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;

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.

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.

At the end of the 10 days,

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.

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.

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.

The defect was not really hidden since

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.

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.

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 things

Non-fungible things

Non-fungible things

OBLIGATION OF THE BORROWER

Return the equivalent

Return the identical thing borrowed

Return the equivalent

GRATUITOUS?

May be gratuitous or onerous

Always gratuitous

Onerous

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%.

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.

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. 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.

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

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.

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 Lino Chris Kapunan

(sgd) Shak 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, default or miscarriage of the principal

Surety promises to answer for the debt, default or miscarriage of the principal (same)

Liability of the guarantor depends upon an independent agreement to pay the obligation if the primary debtor fails to do so

Surety assumes liability as a regular party to the undertaking

The engagement of the guarantor is a collateral undertaking

Surety is charged as an original promisor

The guarantor is secondarily liable

A surety is primarily liable

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).

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

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 3 rd 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:

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

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

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.

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.

2 nd 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.

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

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

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

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:

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.)

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.

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

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?

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.

(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.

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.

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.

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.

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:

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.

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?

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.

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 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.

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.

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?

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.

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.

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.

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

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 3 rd persons. This is similar to the requirement in pledge that the pledge be in a public document.

Can there be an oral mortgage?

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.

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.

doc stamp tax will be based on the ceiling and not on the actual amount released.

But this is costly, since the

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.

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 2 nd 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.

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.)

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…

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

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

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. 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).

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.

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.

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.

This is because the mortgagor, having defaulted in the principal obligation,

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?

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.

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

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.

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.

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.