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U.P.

LAW CENTENNIAL TEXTBOOK PROJECT

Credit Transactions:
Notes and Cases
Volume I

STEPHANIE V. GOMEZ-SOMERA

UNIVERSITY OF THE PHILIPPINES


COLLEGE OF LAW
Diliman, Quezon City
Philippine Copyright © 2011

by

UNIVERSITY OF THE PHILIPPINES


COLLEGE OF LAW

and

STEPHANIE V. GOMEZ-SOMERA

ISBN No. 978-971-15-0419-9

No part of this book may be reproduced in any form, or


by any electronic or mechanical means, including infor-
mation storage and retrieval systems, without permission
in writing from the author and the publisher, except by a
reviewer who may quote brief passages in a review.

Publishedby U.P. College of Law


PROFILE OF THE AUTHOR

Stephanie V. Gomez-Somera is a practicing lawyer specializ-


ing in commercial law. After placing 11th in the 1987 bar ex-
aminations, she began her law practice with the firm Carpio
Villaraza and Cruz (now Villaraza Cruz Marcelo and Angang-
co), before working in the Office of the Chief Presidential Legal
Counsel during the term of President Fidel V. Ramos. She was
Vice President and Chief Legal Counsel of ABS-CBN Broad-
casting Corporation and the Communications Group of the
Lopez Group of Companies prior to embarking on her current
private practice. She is a graduate of the University of the
Philippines with degrees in Political Science (magna cum
laude) and Law. She teaches Credit Transactions at the College
of Law of the University of the Philippines.

0
WITH GRATITUDE

Senior Justice Antonio T. Carpio taught me this course, not on-


ly when he was my professor at the U.P. College of Law, but
also when he was my mentor in the practice of law.

During that time, and when I first lectured on corporate reha-


bilitation and taught credit transactions as a course, my prima-
ry resource was Atty. Hector S. De Leon's Comments and Cas-
es on Credit Transactions, which continues to be an invaluable
book on the subject.

It would have been inconceivable for me to teach, much less


consider writing a textbook, if it were not for the on-line re-
sources of the Supreme Court of the Philippines, the Arellano
Law Foundation, and the Chan Robles Virtual Law Library;
and the patience of the staff of the U.P. College of Law Library
and the CVC Law Library.

It was Dean Marvic Leonen of the U.P. College of Law, a for-


mer classmate, who invited me to teach this course and en-
couraged me to write this textbook. But my students, the U.P.
College of Law Classes of 2011, 2012 and 2013, inspired me to
see this thru.

I first learned the value of confidence from Dr. Francisca V.


Gomez and Col. Francisco M. Gomez, eventually bolstered by
the privilege of working with some of the best and brightest
minds.

And finally, it was TRC and Atty. Bienvenido I. Somera, Jr.


who taught and continue to teach me the meaning of trust.

Stephanie V. Gomez-Somera
PREFACE

CREDIT TRANSACTIONS: NOTES AND CASES

Credit Transaction: Notes and Cases is part of the Centennial


Textbook Project of the U.P. College of Law. It is intended as a
guide for the course on credit transactions taught at the Col-
lege.

Generally, the articles cited in this textbook are the articles of


the Civil Code of the Philippines. When provisions of special
laws are cited, the first cited provision is preceded by the title
of the special law.

The provisions of the cited laws are not necessarily presented


based on article or section number. Instead they are discussed
based on subject matter, and are repeated or excerpted, when
necessary, without any change in the actual language of the
law, in an effort to aid comprehension. Moreover, the provi-
sions are reformatted, again without any change in language.
The reformatting, itself an annotation, is intended to emphasize
important concepts, clarify meanings, and assist in the under-
standing of the law.

The cases presented in this textbook are excerpts of decisions of


the Supreme Court of the Philippines and are presented with-
out any change in the actual language used by the Court.
However, for clarity and focus, portions of the cases not rele-
vant to the subject matter, including footnotes and endnotes,
and the underscoring and emphasis provided by the Court,
have been deleted. Only cases cited in the decisions that are
relevant to the subject matter of this textbook are footnoted.
Finally, contract provisions excerpted in the cases are line-
bordered, for easy reference to facilitate contract review and
drafting.
TABLE OF CONTENTS

VOLUME I

Preface ........................................................................................... v

Introduction. The Concept of Credit ..................................... 1


A. Credit, Debt and Security ............................................... 1
B. Credit and Credit Transactions Defined ............ 2
C. Commercial Credit Transactions .................................. 8
D. The Relevance of Trust and Confidence ..................... 11

PART I. LOAN

Chapter 1. The Concept of Loan ............................................ 15


A. General Concepts .......................................................... 15
1. Obligation to Deliver .............................................. 17
2. Object of a Loan ........................................................ 22
3. Consideration of a Loan ......................................... 23
4. Obligation to Return or Pay .................................... 24
B. Contract to Loan ........................................................... 25
Chapter 2. Commodatum ..................................................... 56
A. General Concepts .......................................................... 56
1. Consideration in Commodatum ............................. 57
2. Object of Commodatum ......................................... 57
B. Parties to a Commodatum ............................................ 69
1. Ownership by Bailor ................................................. 70
2. Use by Bailee ............................................................. 70
3. Solidary Liability of Bailees .................................... 71
C. Liability for Expenses and Damages .......................... 71
1. Ordinary Expenses ................................................... 71
2. Extraordinary Expenses ........................................... 78
3. Other Expenses ........................................................ 79
4. Abandonment by Bailor ......................................... 80
5. Right of Retention by Bailee .................................... 80
D. Liability for Loss ........................................................... 81
E. Obligation to Return ...................................................... 87
viii I Credit Transactions: Notes and Cases

Chapter 3. Simple Loan .......................................................... 93


A. General Concepts .......................................................... 93
B. Obligation to Pay ............................................................ 108
C. Interest .............................................................................. 112
1. Conventional Interest ................................................ 112
2. Interest on Interest ..................................................... 130
3. Compensatory, Penalty or Indemnity Interest ....... 131
4. Finance Charges ........................ 156
5. Usury ............................................................................ 178
a. General Concepts .................................................. 178
b. Usurious Acts ........................................................ 183
c. Remedies ................................................................ 185
1) Remedy of Debtor .......................................... 190
2) Remedy of Creditor ....................................... 191

PART II. DEPOSIT

Chapter 1. The Concept of Deposit ....................................... 205


Chapter 2. Voluntary Deposit ................................................. 207
A. General Concepts ............................................................ 207
B. Obligation to Safekeep ................................................... 217
1. Way of the Deposit ..................................................... 217
2. Liability for Loss and Damages ................................ 234
a. Liability of Depositary ......................................... 236
b. Liability of Depositor ........................................... 238
3. Liability for Expenses ................................................ 238
C. Obligation to Return ....................................................... 239
1. By Whom and To Whom .................. 239
2. What to Return ........................................................... 241
3. Where to Return ......................................................... 241
4. When to Return .......................................................... 242
5. Right of Retention ...................................................... 243
Chapter 3. Necessary Deposit ................................................. 244
A. General Concepts ............................................................ 244
B. Examples of Necessary Deposit .................................... 244
1. Compliance with a Legal Obligation .......... 244
2. On the Occasion of a Calamity ................................. 245
3. Passenger Baggage with Common Carriers ........... 246
Table of Contents I ix

4. Hotels or Inns .............................................................. 246


Chapter 4. Judicial Deposit ..................................................... 261
Chapter 5. W arehouse Receipts .............................................. 262
A. General Concepts ............................................................ 262
B. Obligations and Rights of a Warehouseman ............... 265
1. Obligation to Deliver ................................................. 265
2. Liability for Goods ..................................................... 272
3. Warehouseman's Lien ............................................... 275
C. Negotiation and Transfer ............................................... 281
D. Criminal Liability ............................................................ 286
E. General Bonded W arehouses ........................................ 289

PART III. SECURITY TRANSACTIONS

Chapter 1. The Concept of Security ...................................... 305


A. General Concepts ......................... 305
1. Distinguished from Securities .................................. 305
2. Distinguished from Securitization ........................... 306
B. Events of Default ............................................................. 307
C. Kinds of Security Transactions ...................................... 309
1. Personal Security Transactions ................................. 309
2. Real Security Transactions ........................................ 309
3. in the Context of Insolvency .................................... 310
Chapter 2. Letters of Credit ..................................................... 312
A. General Concepts ............................................................ 312
B. Kinds of Letters of Credit ............................................... 315
1. Commercial Letters of Credit ................................... 315
2. Standby Letters of Credit .......................................... 315
C. Rule of Strict Compliance .............................................. 316
D. Independence Principle .................................................. 317
Chapter 3. Trust Receipts ........................................................ 319
A. General Concepts ............................................................ 319
B. Form of Trust Receipts ................................................... 323
C. Rights of Entruster .......................................................... 325
D. Obligations of Entrustee ................................................. 326
E. Rights of Purchaser ......................................................... 328
Chapter 4. Guaranty ................................................................. 336
A. General Concepts ........................................................... 336
x I Credit Transactions: Notes and Cases

B. Form of Guaranty ............................................................ 337


C. Obligations Secured ........................................................ 338
D. Parties to a Guaranty ...................................................... 340
E. Benefit of Excussion ........................................................ 341
F. Right to Protection .......................................................... 355
G. Right to Indemnification ................................................ 357
H . Right to Subrogation ....................................................... 360
I. Rights of Co-Guarantors ................................................ 361
1. Benefit of Division ...................................................... 361
2. Right to Reim bursem ent ........................................... 363
J. Extinguishment and Right of Release .......................... 364
Chapter 5. Surety ....................................................................... 366
A. General Concepts ............................................................ 366
B. Form of Surety ................................................................. 368
C. Obligations Secured ........................................................ 369
D. Distinguished from Standby Letter of Credit ............. 387
E. Distinguished from Guaranty ....................................... 388
F. Distinguished from Joint and Solidary Obligations... 434
Chapter 6. Pledge and M ortgage ............................................ 457
A. General Concepts ............................................................ 457
B. Obligations Secured ........................................................ 459
C. Contract to Pledge or to Mortgage ............................... 460
D. Remedies of Pledgee and Mortgagee ........................... 460
E. Indivisibility of a Pledge or Mortgage ......................... 461
F. Pactum Com missorium .................................................. 463
1. Elements ...................................................................... 463
2. Effect on Pledge or Mortgage ................................... 465
G. Equitable M ortgage ......................................................... 489
Chapter 7. Pledge ...................................................................... 492
A. General Concepts ............................................................ 492
B. Form of Pledge ................................................................. 493
C. Obligations Secured ........................................................ 494
D. Object of Pledge ............................................................... 494
E. Ownership of Collateral ................................................. 495
F. Rights of Third Party Pledgor ....................................... 504
G. Right to Possession ......................................................... 507
1. Right of Retention ...................................................... 508
2. Right to Paym ent ........................................................ 510
Table of Contents xi

H. Return of Collateral ......................................................... 538


I. Foreclosure of Pledge ..................................................... 539
1. Who May Bid .............................................................. 541
2. Effect of Notarial Sale ................................................ 541
a. Extinction of Principal Obligation ...................... 541
b. Right of Redemption .................. 542
c. Right to Surplus or Deficiency ............................ 555
J. Legal Pledges ................................................................... 555
1. Examples of Legal Pledges ........................................ 556
2. Foreclosure of Legal Pledge ...................................... 557

VOLUME I

Preface ........................................................................................... v

PART III. SECURITY TRANSACTIONS

Chapter 8. Chattel Mortgage ................................................... 559


A. General Concepts ............................................................ 559
B. Form of Chattel Mortgage .............................................. 570
C. Obligations Secured ........................................................ 572
D. Object of Chattel Mortgage ............................................ 579
1. Reasonable Description Rule .................................... 585
2. After Acquired Properties ......................................... 587
E. Ownership of Collateral ................................................. 588
F. Foreclosure of Chattel Mortgage ................................... 603
1. Equity of Redemption ................................................ 609
2. Right of Redemption .................................................. 610
3. Right to Possession ..................................................... 620
4. Right to Surplus or Deficiency ................................. 629
Chapter 9. Real Estate Mortgage ............................................ 639
A. General Concepts ............................................................ 639
B. Form of Real Estate Mortgage ....................................... 639
C. Obligations Secured ........................................................ 640
D. Object of Real Estate Mortgage ..................................... 653
1. After Acquired Properties ......................................... 655
2. Effect and Extent ........................................................ 672
xii I Credit Transactions: Notes and Cases

E. Right to Alienate Mortgage Credit ............................... 674


F. Right to Alienate Collateral ........................................... 674
G. Foreclosure of Real Estate Mortgage ............................ 676
1. Judicial Foreclosure .................................................... 676
a. Complaint for Foreclosure .................................. 676
b. Judgment on Foreclosure .................................... 677
c. Equity of Redemption .......................................... 682
d. Foreclosure Sale ................................................... 684
e. Right of Redemption ............................................ 690
f. Right to Surplus or Deficiency ............................ 706
2. Extrajudicial Foreclosure ........................................... 709
a. Special Powers ...................................................... 709
b. Foreclosure Sale .................................................... 709
1) Requirement of Notice .................................. 714
2) Conduct of Sale ............................................... 722
c. Right of Redemption ............................................ 723
1) Who may Redeem .......................................... 727
2) How to Redeem .............................................. 739
d. Right to Deficiency ............................................... 743
e. Right to Surplus .................................................... 745
f. Right to Possession ............................................... 760
1) During Redemption Period .......................... 760
2) After Consolidation of Ownership .............. 763
3) When Held by a Third Party .......... 764
Chapter 10. Antichresis ............................................................ 778
A. General Concepts ............................................................ 778
B. Form of Antichresis ......................................................... 780
C. Right of Retention ........................................................... 780
D. Foreclosure of Antichresis ............................................. 780

PART IV. INSOLVENCY

Chapter 1. The Concept of Insolvency .................................. 789


A. Nature of Insolvency Proceedings ................................ 795
B. Civil and Criminal Liability in
Insolvency Proceedings .................................................. 798
Chapter 2. Concurrence and Preference of Credits ............ 801
A. General Concepts ......................... 801
Table of Contents I xiii

B. Classification of Credits ................................................. 803


1. Special Preferred Credits ........................................... 803
2. Ordinary Preferred Credits ....................................... 832
3. Common Credits ........................................................ 837
Chapter 3. Suspension of Payments ...................................... 846
A. General Concepts ............................................................ 846
1. Automatic Stay ........................................................... 849
2. Suspension Order ....................................................... 849
3. Injunction Against Debtor ......................................... 850
B. Commissioner .................................................................. 851
C. Creditors' Meeting .......................................................... 852
D. Proposed Agreement ...................................................... 854
E. Treatment of Claims ....................................................... 856
1. Secured Creditor Claims ........................................... 857
2. Exempt Claims ............................................................ 858
3. Excluded Claims ......................................................... 859
Chapter 4. Rehabilitation ........................................................ 860
A. General Concepts ............................................................ 860
B. Court-Supervised Rehabilitation .................................. 863
1. Voluntary Proceedings .............................................. 863
2. Involuntary Proceedings ........................................... 866
3. Provisions Common to Voluntary and
Involuntary Rehabilitation Proceedings ................. 869
a. Commencement Order ........................................ 869
b. Stay or Suspension Order .................................... 876
1) General Concepts ........................................... 877
2) Exceptions to Stay or Suspension Order ..... 899
c. Subsequent Actions .............................................. 922
d. Rehabilitation Receiver ........................................ 925
1) General Concepts ........................................... 925
2) Powers, Duties and Responsibilities ........... 930
e. Creditors' Committees ......................................... 935
f. Management Committee ..................................... 937
g. Claims ..................................... 939
1) Determination of Claims ............................... 940
2) Treatment of Claims ...................................... 941
a) Secured Creditor Claims ........................ 941
b) Employee Claims ................................. ;... 944
xiv Credit Transactions: Notes and Cases

c) Excluded Claims ...................................... 945


h. Treatment of Assets .............................................. 945
1) Unencumbered Assets ................................... 946
2) Encumbered Assets ........................................ 948
i. Treatment of Contracts ........................................ 951
1) Confirmation or Termination of Contracts 951
2) Avoidance Proceedings ................................. 953
j. Rehabilitation Plan ............................................... 956
1) General Concepts ........................................... 956
2) Cram Down Effect .......................................... 960
k. Termination of Proceedings ................................ 974
1. Conversion to Liquidation Proceedings ............ 976
C. Pre-negotiated Rehabilitation ........................................ 977
D. Out-of-court Rehabilitation ............................................ 982
1. General Concepts ....................................................... 983
2. Benefits of Out-of-court Rehabilitation ................... 985
Chapter 5. Liquidation ............................................................. 989
A. General Concepts ............................................................ 989
B. Liquidation of Insolvent Individual Debtor ................ 992
1. Voluntary Liquidation ............................................... 992
2. Involuntary Liquidation ............................................ 993
a. Acts of Insolvency ................................................ 993
b. Show Cause Order; Injunction; Default ............ 996
c. Absent Individual Debtor ................................... 997
d. Custody of Property; Sale of Property ............... 998
C. Liquidation of Insolvent Juridical Debtors .................. 1001
1. Voluntary Liquidation ............................................... 1001
2. Involuntary Liquidation ............................................ 1003
D. Provisions Common to Liquidation
of Individual and Juridical Debtors .............................. 1005
1. Liquidation Order ...................................................... 1006
2. Liquidator .................................................................... 1009
a. General Concepts .................................................. 1009
b. Powers, Duties and Responsibilities .................. 1012
3. C laim s .......................................................................... 1015
a. Determination of Claims ..................................... 1016
b. Treatment of Claims ............................................. 1017
1) Secured Creditor Claims ............................... 1017
Table of Contents I xv

2) Unsecured Creditor Claims .......................... 1024


4. Treatment of Contracts .............................................. 1025
a. Termination or Breach of Contracts ................... 1025
b. Avoidance Proceedings ....................................... 1025
5. Liquidation Plan ......................................................... 1028
6. Termination of Proceedings ...................................... 1031
E. Ancillary Proceedings ..................................................... 1031
1. Securities Market Participant .................................... 1031
2. Banks and Other Financial Institutions
Under Rehabilitation Receivership
Pursuant to a State-funded or
State-Mandated Insurance System .......................... 1032
3. Cross-Border Insolvency Proceedings ..................... 1033
Introduction. The Concept of Credit

A. Credit, Debt and Security

William Shakespeare's play, "The Merchant of Venice,"


dramatizes the inherent tension between creditor and
debtor, and illustrates the evolution of the concepts of
credit and debt. In the play, the judge, Portia, unexpec-
tedly declares the forfeiture, in favor of the State of Ve-
nice, of all the lands and goods, not of the debtor, but of
the creditor, Shylock.'

In ancient times, that would have been unthinkable. Un-


der Greek law, non-payment of a debt was categorized as
a capital crime similar to murder. Under Roman law, a
creditor was allowed to seize the debtor and sell or kill
him in foreclosure, since a sum of money owed was
equated with human life. And under Judaic law, a credi-
tor was allowed to take the children of the debtor for
nonpayment of a debt. 2

Juxtapose the harshness of these legal concepts with the


constitutional mandate that
3
No person shall be imprisoned for debt...
and it becomes clear that centuries of social, cultural, and
political change have dramatically altered the concepts of
credit and debt.

But the historical tension between creditor and debtor,

I Reference to Shakespeare's Merchant of Venice was first made by the


author in a lecture on Corporate Rehabilitation for the 2006 Mandatory
Continuing Legal Education seminar of the Integrated Bar of the Phil-
ippines, Makati Chapter.
2 Newton, Corporate Bankruptcy 1 (2003).
3 Const. Article III, Section 20, Bill of Rights.
2 1 Credit Transactions: Notes and Cases

dramatized in "The Merchant of Venice," has obviously


not disappeared. In lieu of human life - the allegorical
pound of flesh - merchants had to devise a rational, and
kinder, system of ensuring the payment of debt. Hence
the concept of security, a transaction by which a creditor
mitigates the risk of non-payment of debt by equating a
sum of money owed with property or another person's
undertaking to pay.

It is intuitive that Shakespeare titled his play after Anto-


nio, the merchant, because it was the rise of the merchant
class, of mercantilism, of trade and commerce 4, which
greatly influenced this evolution. Without credit, and
without a rational system of dealing with non-payment of
debt, trade and commerce would not have flourished to
the levels that were seen in the 14th to the 19th century.5

By the 20th century, modem-day merchants were translat-


ing the concepts of credit, debt and security into increa-
singly complicated and sophisticated transactions re-
quired by the global economy. 6 But the metamorphosis
seemingly ignored the underlying premise and legal
framework of these concepts.

B. Credit and Credit Transactions Defined

The Civil Code does not provide a definition of credit.


Instead, it is the Truth in Lending Act 7 that provides a
legal definition:

4 Ferguson, The Ascent of Money (2009).


5 Ibid.
6 Morris, The Trillion Dollar Meltdown (2008).
7 Republic Act No. 3765 (1963), An Act to Require the Disclosure of
Finance Charges in Connection with Extensions of Credit, otherwise
known as the Truth in Lending Act.
The Concept of Credit I3

Republic Act No. 3765, Sec. 3. (2) "Credit" means


any loan, mortgage, deed of trust, advance, or dis-
count; any conditional sales contract; any contract
to sell, or sale or contract of sale of property or
services, either for present or future delivery, un-
der which part or all of the price is payable sub-
sequent to the making of such sale or contract;
any rental-purchase contract; any contract or ar-
rangement for the hire, bailment, or leasing of
property; any option, demand, lien, pledge, or
other claim against, or for the delivery of, proper-
ty or money; any purchase, or other acquisition
of, or any credit upon the security of, any obliga-
tion or claim arising out of any of the foregoing;
and any transaction or series of transactions hav-
ing a similar purpose or effect.

But this definition is primarily an enumeration of the cov-


erage of the law and applicable contracts, and does not
provide a conceptual framework by which to understand
credit.

Jurisprudence has defined credit as "a sum credited on


the books of a company to a person who appears to be en-
titled to it. It presupposes a creditor-debtor relationship,
and may be said to imply ability, by reason of property or
estates, to make a promised payment.... It is the correla-
tive to debt or indebtedness, ... that which is due to any
person, as distinguished from that which he owes." 8

Correlatively, debt has been defined as a demand for an


amount actually ascertained. There must be an ascer-
tained amount and not a mere unliquidated demand or

8 Republic of the Philippines v. Philippine National Bank, et al., G.R. No.


L-16106, December 30, 1961, 3 SCR 851.
4 1 Credit Transactions: Notes and Cases

liability, a certain sum that a person may recover "in nu-


mero and not to be repaired in damages." 9

People v. Concepcion, G.R. No. L-19190, Novem-


ber 29, 1922, 44 Phil 126.

By telegrams and a letter of confirmation to the


manager of the Aparri branch of the Philippine Na-
tional Bank, Venancio Concepcion, President of the
Philippine National Bank, between April 10, 1919,
and May 7, 1919, authorized an extension of credit
in favor of "Puno y Concepcion, S. en C." in the
amount of P300,000. This special authorization was
essential in view of the memorandum order of
President Concepcion dated May 17, 1918, limiting
the discretional power of the local manager at
Aparri, Cagayan, to grant loans and discount nego-
tiable documents to P5,000, which, in certain cases,
could be increased to P10,000. Pursuant to this au-
thorization, credit aggregating P300,000, was
granted the firm of "Puno y Concepcion, S. en C.,"
the only security required consisting of six demand
notes. The notes, together with the interest, were
taken up and paid by July 17,1919.

"Puno y Concepcion, S. en C." was a copartnership


capitalized at P100,000. Anacleto Concepcion con-
tributed P5,000; Clara Vda. de Concepcion, P5,000;
Miguel S. Concepcion, P20,000; Clemente Puno,
P20,000; and Rosario San Agustin, "casada con
Gral. Venancio Concepcion," P50,000. Member Mi-

9 Compania General de Tabacos de Filipinas v. French & Unson, G.R.


No. L-14027, November 8,1918,39 Phil 34.
The Concept of Credit 5

guel S. Concepcion was the administrator of the


company.

On the facts recounted, Venancio Concepcion, as


President of the Philippine National Bank and as
member of the board of directors of this bank, was
charged in the Court of First Instance of Cagayan
with a violation of section 35 of Act No. 2747. He
was found guilty by the Honorable Enrique V. Fi-
lamor, Judge of First Instance, and was sentenced
to imprisonment for one year and six months, to
pay a fine of P3,000, with subsidiary imprisonment
in case of insolvency, and the costs.

Section 35 of Act No. 2747, effective on February


20, 1918, just mentioned, to which reference must
hereafter repeatedly be made, reads as follows:
"The National Bank shall not, directly or indirectly,
grant loans to any of the members of the board of
directors of the bank nor to agents of the branch
banks." Section 49 of the same Act provides: "Any
person who shall violate any of the provisions of
this Act shall be punished by a fine not to exceed
ten thousand pesos, or by imprisonment not to ex-
ceed five years, or by both such fine and impri-
sonment." These two sections were in effect in 1919
when the alleged unlawful acts took place, but
were repealed by Act No. 2938, approved on Janu-
ary 30, 1921....

I. Was the granting of a credit of P300,000 to the


copartnership "Puno y Concepcion, S. en C." by
Venancio Concepcion, President of the Philippine
National Bank, a "loan" within the meaning of sec-
tion 35 of Act No. 2747?
6 1 Credit Transactions: Notes and Cases

Counsel argue that the documents of record do not


prove that authority to make a loan was given, but
only show the concession of a credit. In this state-
ment of fact, counsel is correct, for the exhibits in
question speak of a "credito" (credit) and not of a"
prestamo" (loan).

The "credit" of an individual means his ability to


borrow money by virtue of the confidence or trust
reposed by a lender that he will pay what he may
promise... A "loan" means the delivery by one par-
ty and the receipt by the other party of a given sum
of money, upon an agreement, express or implied,
to repay the sum loaned, 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."

II. Was the granting of a credit of P300,000 to the


copartnership "Puno y Concepcion, S. en C.," by
Venancio Concepcion, President of the Philippine
National Bank, a "loan" or a "discount"?

Counsel argue that while section 35 of Act No. 2747


prohibits the granting of a "loan," it does not pro-
hibit what is commonly known as a "discount."

In a letter dated August 7, 1916, H. Parker Willis,


then President of the National Bank, inquired of
the Insular Auditor whether section 37 of Act No.
2612 was intended to apply to discounts as well as
to loans. The ruling of the Acting Insular Auditor,
dated August 11, 1916, was to the effect that said
section referred to loans alone, and placed no re-
striction upon discount transactions. It becomes
The Concept of Credit 7

material, therefore, to discover the distinction be-


tween a "loan" and a "discount," and to ascertain if
the instant transaction comes under the first or the
latter denomination.

Discounts are favored by bankers because of their


liquid nature, growing, as they do, out of an actual,
live, transaction. But in its last analysis, to discount
a paper is only a mode of loaning money, with,
however, these distinctions: (1) In a discount, inter-
est is deducted in advance, while in a loan, interest
is taken at the expiration of a credit; (2) a discount
is always on double-name paper; a loan is general-
ly on single-name paper.

Conceding, without deciding, that, as ruled by the


Insular Auditor, the law covers loans and not dis-
counts, yet the conclusion is inevitable that the
demand notes signed by the firm "Puno y Concep-
cion, S. en C." were not discount paper but were
mere evidences of indebtedness, because (1) inter-
est was not deducted from the face of the notes, but
was paid when the notes fell due; and (2) they
were single-name and not double-name paper....

Justice Malcolm's definition of credit in People v. Con-


cepcion provides a conceptual framework for understand-
ing credit in relation to credit transactions. Borrowing
from Bouvier's Law Dictionary, he defined credit as a
person's "ability to borrow money by virtue of the confi-
dence or trust reposed by a lender that he will pay what
he may promise." He further explained that the "conces-
sion of a 'credit' necessarily involves the granting of
'loans' up to the limit of the amount fixed in the 'credit."'
8 1 Credit Transactions: Notes and Cases

This definition hews closely to the dictionary definition of


the word credit, which is, "belief; trust" 10 originating as it
does from the Latin credere, to trust, to believe".

Credit, therefore, is an evaluation, made in the present, by


virtue of the trust and confidence reposed by a creditor,
of a debtor's future worth or ability.

All obligations, that is, the juridical necessity to give, to


do or not to do,12 that arise as a consequence of this eval-
uation, are credit transactions.

C. Commercial Credit Transactions

Code of Commerce, Art. 1. For purposes of this


Code, merchants are:
1. Those who, having legal capacity to engage in
commerce, habitually devote themselves to it.
2. The commercial or industrial companies
which may be created in accordance with [exist-
ing legislation].

Art. 2. Acts of commerce, whether those who ex-


ecute them be merchants or not, and whether spe-
cified in this Code or not, should be governed by
the provisions contained in it, in their absence, by
the usages of commerce generally observed in
each place and in the absence of both rules, by
those of the civil law.
Those acts contained in this Code and all others
of analogous character shall be deemed acts of
commerce.

10 Blacks Law Dictionary, Ninth Edition (2009).


1 Webster Third New International Dictionary (2002).
12 Civil Code, Article 1156.
The Concept of Credit I9
Art. 3. The legal presumption of engaging habi-
tually in commerce shall exist from the moment
the person who intends to engage therein an-
nounces through circulars, newspapers, hand-
bills, posters exhibited to the public, or in any
other manner whatsoever, an establishment
which has for its object some commercial opera-
tion.

Although it is the Civil Code that is considered the gener-


al governing law, most credit transactions are commercial
in nature, that is, they are transactions habitually entered
into, generally, by merchants. Consequently, the Code of
Commerce and certain special commercial laws also go-
vern commercial credit transactions.

In its most common incarnation, a commercial credit


transaction is illustrated as follows:

A merchant (the depositor) deposits funds (a bank depo-


sit) with an institutional creditor (a bank) based on an
evaluation that the institutional creditor would be able to
repay the funds and pay interest after the expiration of a
period of time. The institutional creditor in turn lends
funds (a bank loan) to another merchant (the debtor)
based on an evaluation that the debtor would be able to
repay the funds and pay interest after the expiration of a
period of time. But to secure payment, the institutional
creditor requires a security, that is, an agreement that
creates or provides for an interest in specified real or per-
sonal property (a collateral) to guarantee the performance
of an obligation,'13 such as a mortgage over real or person-
al property owned by the debtor. The interest paid by the

13 Blacks Law Dictionary, Ninth Edition, (2009).


10 1 Credit Transactions: Notes and Cases

debtor is the source of revenue that the institutional credi-


tor uses to pay the interest of the depositor.

Each obligation in this illustration is a credit transaction.

Because commercial credit transactions are habitually en-


tered into, these usually take the form of ready-made con-
tracts. Indeed, it would be inefficient for a merchant not
to use a pre-printed form for such transactions. Although
this is more often than not required by the element of ha-
bituality, rather than the cunning use of "overwhelming
economic power,"'1 4 these form contracts are nevertheless
considered contracts by adherence, or contracts of adhe-
sion, agreements where one party imposes a ready-made
form of contract on the other who is free to reject it entire-
ly, or if it adheres, to give its consent.' 5 One party pre-
pares the stipulations in the contract, while the other par-
ty merely affixes its signature or its adhesion, leaving no
room for negotiation and bargaining.' 6

But commercial credit transactions, even though contracts


of adhesion, are just as binding as ordinary contracts, and
7
are not invalid per se, nor are they entirely prohibited.'
However, if there is any ambiguity in a contract of adhe-
sion, the rigid application of the rule on ambiguities be-

14 Qua Chee Gan v. Law Union & Rock Insurance Co., Ltd., G.R. No. L-
4611, December 17,1955,98 Phil 85.
15 Ong Yiu v. Court of Appeals, G.R. No. L-40597, June 29,1979,91 SCRA
223.
16 Tolentino v. Court of Appeals, G.R. No. 171354, March 7, 2007, 517
SCRA 732. It should be noted, however, that contracts of adhesion are
sometimes amended by separate contracts, usually a letter-agreement,
belying the view that the ready-made form of the contract may only be
accepted or rejected in its entirety.
17 Ibid.
The Concept of Credit 11

comes necessary 8 and it will be construed against the


party who prepared it. If, however, the stipulations are
not obscure, but are clear and leave no doubt as to the in-
tention of the parties, the literal meaning of the stipula-
tions will control. 19

D. The Relevance of Trust and Confidence

It is enlightening to view the use of money as a credit


transaction. Money, after all, is defined as anything gen-
erally accepted as payment in a transaction, recognized as
a standard of value, and authorized or adopted by a State
as part of its currency. 20 It has thus been viewed as "trust
inscribed," a "matter of belief" in the State issuing it.21 In
this sense, money approximates absolute credit as it
represents the trust and confidence reposed by the holder
in a State. For example, all Philippine notes or paper cur-
rencies state that the Republic of the Philippines will an-
swer for its notes. With what, is not of primary concern to
the holder for so long as the note continues to be accepted
by other persons in exchange for goods and services. It is
a matter of belief in the State.

In this sense, the use of money involves an evaluation,


made in the present, by virtue of the trust and confidence
reposed by the holder, of a State's future worth or ability.

But if money approximates absolute credit because it in-


volves the credit of States, then the concession of credit to

18 Qua Chee Gan v. Law Union & Rock Insurance Co., Ltd., G.R. No. L-
4611, December 17, 1955,98 Phil 85.
19 Tolentino v. Court of Appeals, G.R. No. 171354, March 7, 2007, 517
SCRA 732.
20 Ibid.
n Ferguson, The Ascent of Money 14-31 (2009).
12 1 Credit Transactions: Notes and Cases

persons, whether natural or juridical, clearly involves


greater risks. Consequently, for persons, credit was not
historically easy to come by. The parties willing to grant
credit devised valuation methods that were intended to
limit the risk of non-payment by debtors. Having lost the
ability to exact their pound of flesh, creditors required, as
security, property that was valued at a percentage of
present value. This gave rise to the common view that
only those with money could procure more money on
credit.

But by the 20 th century, social and economic changes had


altered the credit landscape, specifically in the United
States. Property that was to stand as security, was no
longer valued at present values but on a continuing trend
of appreciating values. And the evaluation of a debtor's
future worth or ability was based on the same appreciat-
ing values of the security, and not on the trust and confi-
dence reposed on the debtor's ability to pay. More deb-
tors became eligible for more credit under terms that mir-
rored this trend of rising property values. Consequently,
payments were deferred, interest was deferred, and
promises of higher credit were made. 22

The underlying credit transactions - a loan and mortgage


- were converted into a new breed of securities. 23 Credi-
tors issued an instrument that was backed by the ex-
pected revenue stream from payments, or receivables, of
the debtors. Buyers of this new instrument or security
were promised returns based on the expected receivables.
But the buyers of this new security looked no further than

22 Ferguson, The Ascent of Money (2009).


23 An instrument that evidences the holder's ownership interest in a firm,
the holder's creditor relationship with a firm or government, or the
holder's other rights. (Blacks law Dictionary, Ninth Edition, [2009]).
The Concept of Credit 1 13

the trust and confidence that they had in the creditors that
issued the new security, even though the underlying asset
that backed this security was a loan and mortgage ex-
ecuted by a debtor in whom no evaluation of trust and
confidence was made. 24

By 2007, the debtors who were lured by the deferred


payment terms failed to make payments as soon as the
higher interest terms kicked in. The expected revenue
stream dried up. The securities became worthless. And
the 21st century witnessed its first global credit crisis. The
personal tragedies of debtors in the United States were
just part of the "credit bubble" that triggered the fall of
once-venerable institutional creditors. So much so that
governments of the world had to take unprecedented ac-
tion to contain further damage. 25

But the credit landscape is not totally bleak. By the late


20 th century, microfinance and microcredit had gained
recognition as poverty alleviation strategies. 26 As a credit
and savings mobilization program exclusively for the
poor, the avowed purpose of microfinance is to improve
their asset base and expand their access to savings. It in-
volves the use of viable alternative credit schemes and
savings programs, including the extension of small loans,
simplified loan application procedures, group character
loans, collateral-free arrangements, alternative loan re-

24 Ferguson, The Ascent of Money (2009).


2 Morris, The Trillion Dollar Meltdown (2008).
26 See R. A. No. 8425 (1997), An Act Institutionalizing the Social Reform
and Poverty Alleviation Program, Creating for the Purpose the Nation-
al Anti-Poverty Commission, Defining its Powers and Functions and
For Other Purposes, or the Social Reform and Poverty Alleviation Act.
14 1 Credit Transactions: Notes and Cases

payments, minimum requirements for savings, and small


27
denominated savers' instruments.

The underlying credit transaction - quite simply a loan -


is unique because of the small amount of money involved,
the general absence of security over property, and the
partnering of private and public sector entities.

Thus, just as a credit transaction was the root of the 21st


century's first financial meltdown, sending hundreds to
the poorhouse, so too is it a tool for poverty alleviation.

The key is, and always will be, in the words of Justice
Malcolm, confidence and trust.

27 R.A. No. 8425 (1997), Section 2.


Part I. Loan

Chapter 1. The Concept of Loan

A. General Concepts

Art. 1933. By the contract of loan,


one of the parties delivers to another,
either something not consumable so that the lat-
ter may use the same for a certain time and return
it, in which case the contract is called a commoda-
tum;
or
money or other consumable thing, upon the con-
dition 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 stipula-
tion to pay interest.
In commodatum the bailor retains the ownership
of the thing loaned, while in simple loan, owner-
ship passes to the borrower.

Art. 1305. A contract is a meeting of minds be-


tween two persons whereby one binds himself,
with respect to the other, to give something or to
render some service.

Article 1933 of the Civil Code1 defines a loan as a contract


where one party delivers to another either something not
consumable so that the latter may use the same for a cer-
tain time and return it (commodatum), or money or other

I The provisions of the Civil Code that govern the contract of loan fall under
Book IV on Obligations and Contracts.
16 I Credit Transactions: Notes and Cases

consumable thing, upon the condition that the same


amount of the same kind and quality shall be paid (mu-
tuum). The clear import of the definition is that a loan is
an obligation that always arises 2 from contract, the meet-
ing of the minds of the creditor, the party who delivers
the thing or property, and the debtor, the party who rece-
ives the property and is consequently bound to return the
property or pay the same amount of the same kind and
quality to the creditor.

A loan, whether commodatum or mutuum, is a contract


for permissive use. In this sense, it is similar to a locatio
conductio, or lease, 3 that is, a contract by which one person
agrees to give another the use or enjoyment of a thing or
of services or labor in return for remuneration, referred to
as merces or rent.4 However, it is substantially different
from a lease with respect to the obligations of the parties,
the consideration of the contract, and the object of the
contract.

2 Civil Code, Art. 1157. Obligations arise from: (1) Law; (2) Contracts; (3)
Quasi-contracts; (4) Acts or omissions punished by law; and (5) Quasi-
delicts.
3 Civil Code, Art. 1642. The contract of lease may be of things, or of work

and service.
Art. 1643. In the lease of things, one of the parties binds himself to give to
another the enjoyment or use of a thing for a price certain, and for a period
which may be definite or indefinite. However, no lease for more than nine-
ty-nine years shall be valid.
Art. 1644. In the lease of work or service, one of the parties binds himself to
execute a piece of work or to render to the other some service for a price
certain, but the relation of principal and agent does not exist between them.
Art. 1645. Consumable goods cannot be the subject matter of a contract of
lease, except when they are merely to be exhibited or when they are acces-
sory to an industrial establishment.
4Blacks Law Dictionary, Ninth Edition (2009).
The Concept of Loan I 17

1. Obligation to Deliver

Art. 1934... (T)he commodatum or simple loan it-


self shall not be perfected until the delivery of
the object of the contract.

The primary obligation of the creditor in a loan is the de-


livery, that is, the formal act of transferring, or the giving
or yielding of possession or control,5 of property for per-
missive use by the debtor. It is for this reason that a loan,
whether commodatum or mutuum, is considered a real
contract, a contract in which property passes from one
party to another, requiring something more than mere
consent. 6 In the real contracts of commodatum and mu-
tuum, delivery by the creditor of the object of the contract
7
is essential for perfection.

Garcia v. Thio, G.R. No. 154878, March 16, 2007,


518 SCRA 433.

... Sometime in February 1995, respondent Rica


Marie S. Thio received from petitioner Carolyn M.
Garcia a crossed check dated February 24, 1995 in
the amount of US$100,000 payable to the order of a
certain Marilou Santiago. Thereafter, petitioner re-
ceived from respondent every month ... the amount
of US$3,000 and P76,500 on July 26, August 26,
September 26 and October 26,1995.

In June 1995, respondent received from petitioner


another crossed check dated June 29, 1995 in the

5 Ibid.
6 Ibid.
7 Civil Code, Art 1316. Real contracts, such as deposit, pledge and commo-
datum, are not perfected until the delivery of the object of the obligation.
18 1 Credit Transactions: Notes and Cases

amount of 12500,000, also payable to the order of


Marilou Santiago. Consequently, petitioner re-
ceived from respondent the amount of 220,000
every month...

According to petitioner, respondent failed to pay


the principal amounts of the loans (US$100,000 and
12500,000) when they fell due. Thus, on February
22, 1996, petitioner filed a complaint for sum of
money ... against respondent, seeking to collect the
sums of US$100,000, with interest thereon at 3% a
month from October 26, 1995 and 12500,000, with
interest thereon at 4% a month from November 5,
1995, plus attorney's fees and actual damages.

Petitioner alleged that on February 24, 1995, res-


pondent borrowed from her the amount of
US$100,000 with interest thereon at the rate of 3%
per month, which loan would mature on October
26, 1995. The amount of this loan was covered by
the first check. On June 29, 1995, respondent again
borrowed the amount of 12500,000 at an agreed
monthly interest of 4%, the maturity date of which
was on November 5, 1995. The amount of this loan
was covered by the second check. For both loans,
no promissory note was executed since petitioner
and respondent were close friends at the time.
Respondent paid the stipulated monthly interest
for both loans but on their maturity dates, she
failed to pay the principal amounts despite re-
peated demands.

Respondent denied that she contracted the two


loans with petitioner and countered that it was
Marilou Santiago to whom petitioner lent the mon-
The Concept of Loan 19

ey. She claimed she was merely asked by petitioner


to give the crossed checks to Santiago. She issued
the checks for P-76,000 and P20,000 not as payment
of interest but to accommodate petitioner's request
that respondent use her own checks instead of San-
tiago's.

In a decision dated February 28, 1997, the RTC


ruled in favor of petitioner. It found that respon-
dent borrowed from petitioner the amounts of
US$100,000 with monthly interest of 3% and
12500,000 at a monthly interest of 4%... On appeal,
the CA reversed the decision of the RTC and ruled
that there was no contract of loan between the par-
ties...

A loan is a real contract, not consensual, and as


such is perfected only upon the delivery of the ob-
ject of the contract... This is evident in Art. 1934 of
the Civil Code...

Upon delivery of the object of the contract of loan


(in this case the money received by the debtor
when the checks were encashed) the debtor ac-
quires ownership of such money or loan proceeds
and is bound to pay the creditor an equal amount.

It is undisputed that the checks were delivered to


respondent. However, these checks were crossed
and payable not to the order of respondent but to
the order of a certain Marilou Santiago. Thus the
main question to be answered is: who borrowed
money from petitioner - respondent or Santiago?
20 1 Credit Transactions: Notes and Cases

Petitioner insists that it was upon respondent's in-


struction that both checks were made payable to
Santiago. She maintains that it was also upon res-
pondent's instruction that both checks were deli-
vered to her (respondent) so that she could, in turn,
deliver the same to Santiago. Furthermore, she ar-
gues that once respondent received the checks, the
latter had possession and control of them such that
she had the choice to either forward them to San-
tiago (who was already her debtor), to retain them
or to return them to petitioner.

We agree with petitioner. Delivery is the act by


which the res or substance thereof is placed within
the actual or constructive possession or control of
another. Although respondent did not physically
receive the proceeds of the checks, these instru-
ments were placed in her control and possession
under an arrangement whereby she actually re-lent
the amounts to Santiago.

Several factors support this conclusion.

First, respondent admitted that petitioner did not


personally know Santiago. It was highly improba-
ble that petitioner would grant two loans to a com-
plete stranger without requiring as much as prom-
issory notes or any written acknowledgment of the
debt considering that the amounts involved were
quite big. Respondent, on the other hand, already
had transactions with Santiago at that time.

Second, Leticia Ruiz, a friend of both petitioner and


respondent (and whose name appeared in both
parties' list of witnesses) testified that respondent's
The Concept of Loan I 21
plan was for petitioner to lend her money at a
monthly interest rate of 3%, after which respondent
would lend the same amount to Santiago at a high-
er rate of 5% and realize a profit of 2%. This ex-
plained why respondent instructed petitioner to
make the checks payable to Santiago. Respondent
has not shown any reason why Ruiz' testimony
should not be believed.

Third, for the US$100,000 loan, respondent admit-


ted issuing her own checks in the amount of
P-76,000 each (peso equivalent of US$3,000) for
eight months to cover the monthly interest. For the
2500,000 loan, she also issued her own checks in
the amount of P20,000 each for four months. Ac-
cording to respondent, she merely accommodated
petitioner's request for her to issue her own checks
to cover the interest payments since petitioner was
not personally acquainted with Santiago. She
claimed, however, that Santiago would replace the
checks with cash. Her explanation is simply incred-
ible. It is difficult to believe that respondent would
put herself in a position where she would be com-
pelled to pay interest, from her own funds, for
loans she allegedly did not contract....

Fourth, in the petition for insolvency sworn to and


filed by Santiago, it was respondent, not petitioner,
who was listed as one of her (Santiago's) creditors.

Last, respondent inexplicably never presented San-


tiago as a witness to corroborate her story. The pre-
sumption is that "evidence willfully suppressed
would be adverse if produced." Respondent was
not able to overturn this presumption.
22 1 Credit Transactions: Notes and Cases

We hold that the CA committed reversible error


when it ruled that respondent did not borrow the
amounts of US$100,000 and P500,000 from peti-
tioner. We instead agree with the ruling of the RTC
making respondent liable for the principal
amounts of the loans....

WHEREFORE, the petition is hereby GRANTED


and the June 19, 2002 decision and August 20, 2002
resolution of the Court of Appeals in CA-G.R. CV
No. 56577 are REVERSED and SET ASIDE. The
February 28, 1997 decision of the Regional Trial
Court in Civil Case No. 96-266 is AFFIRMED with
the MODIFICATION that respondent is directed to
pay petitioner the amounts of US$100,000 and
P500,000 at 12% per annum interest from November
21, 1995 until the finality of the decision. The total
amount due as of the date of finality will earn in-
terest of 12% per annum until fully paid. The award
of actual damages and attorney's fees is deleted.

2. Object of a Loan

Art. 1933. By the contract of loan, one of the par-


ties delivers to another,
either something not consumable so that the lat-
ter may use the same for a certain time and return
it, in which case the contract is called a commoda-
hum; or
money or other consumable thing, upon the con-
dition 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...
In commodatum the bailor retains the ownership
of the thing loaned, while in simple loan, owner-
ship passes to the borrower.
The Concept of Loan 1 23

Art. 418. Movable property is either consumable


or non-consumable. To the first class belong
those movables which cannot be used in a man-
ner appropriate to their nature without their be-
ing consumed; to the second class belong all the
others.

The object (or subject) of a loan is either property that is


non- consumable, or money or other consumable prop-
erty.

On one hand, the property may be non-consumable,


whether it is movable or immovable, in which case the
purpose of the delivery by the creditor is for the permis-
sive use of the property by the debtor for a certain time,
with the creditor retaining ownership. This gives rise to
the obligation on the part of the debtor to return the very
same property to the creditor. The law calls this loan a
commodatum.

On the other hand, the object may be money or other


consumable property, in which case, the purpose of the
delivery by the creditor is for the permissive use of the
property by the debtor by taking ownership. Since, by
definition, use of consumable property results in its extin-
guishment 8 , the consequent obligation of the debtor is to
pay the same amount, or kind and quality to the creditor.
The law calls this type of loan a mutuum.

3. Consideration of a Loan

Art. 1933... Commodatum is essentially gratuit-


ous.

8 Blacks Law Dictionary, Ninth Edition (2009).


24 1 Credit Transactions: Notes and Cases

Simple loan may be gratuitous or with a stipula-


tion to pay interest.

A contract of loan is a reciprocal obligation, not a unila-


teral contract, as the promise of the debtor to pay is the
consideration for the obligation of the creditor to furnish
the loan.9

Article 1933 distinguishes commodatum from mutuum


based on consideration, that which motivates the parties1 O
to enter into the contract of loan. While mutuum may be
gratuitous or with a stipulation to pay interest, commoda-
tum is essentially gratuitous, that is, the only considera-
tion for the creditor is always liberality.

4. Obligation to Return or Pay

Art. 1933. By the contract of loan, one of the par-


ties delivers to another, either something not con-
sumable so that the latter may use the same for a
certain time and return it, in which case the con-
tract is called a commodatum; or
money or other consumable thing, upon the con-
dition 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...

Art. 1232. Payment means not only the delivery of


money but also the performance, in any other
manner, of an obligation.

9 Rose Packing Company, Inc. v. Court of Appeals, G.R. No. L-33084, No-
vember 14,1988,167 SCRA 309.
10
Blacks Law Dictionary, Ninth Edition (2009).
The Concept of Loan 1 25

Art. 1233. A debt shall not be understood to have


been paid unless the thing or service in which the
obligation consists has been completely delivered
or rendered, as the case may be.

Because of the difference in the nature of the objects of


the contracts, in a commodatum, the primary obligation
of the debtor is to return the very same property deli-
vered; while in a mutuum, the obligation of the debtor is
to pay the same amount, or kind and quality to the credi-
tor.

B. Contract to Loan

Art. 1934. An accepted promise to deliver some-


thing by way of commodatum or simple loan is
binding upon parties, but the commodatum or
simple loan itself shall not be perfected until the
delivery of the object of the contract.

Article 1934 defines a contract to loan as an accepted


promise to deliver either non-consumable or consumable
property. It is a binding obligation arising from contract
between a debtor, the party who promises to deliver the
property, and the creditor, the party who has accepted the
promise. It is perfected by mere consent and is therefore a
consensual contract.

It is distinguished from a contract of loan, which is a real


contract perfected, not by mere consent, but by the deli-
very of the object of the contract. Once the debtor in a
contract to loan delivers the property to the creditor, a
contract of loan is perfected and the roles of the parties
are effectively reversed.
26 1 Credit Transactions: Notes and Cases

Saura Import and Export Co. Inc. v. Development


Bank of the Philippines, G.R. No. L-24968, April
27,1972,44 SCRA 445.

... In July 1953 the plaintiff (hereinafter referred to


as Saura, Inc.) applied to the Rehabilitation Finance
Corporation (RFC), before its conversion into DBP,
for an industrial loan of P500,000.00, to be used as
follows: P250,000.00 for the construction of a facto-
ry building (for the manufacture of jute sacks);
P240,900.00 to pay the balance of the purchase
price of the jute mill machinery and equipment;
and P9,100.00 as additional working capital.

... On January 7, 1954 RFC passed Resolution No.


145 approving the loan application for P500,000.00,
to be secured by a first mortgage on the factory
building to be constructed, the land site thereof,
and the machinery and equipment to be installed...
Saura, Inc. was officially notified of the resolution
on January 9, 1954. The day before, however, evi-
dently having otherwise been informed of its ap-
proval, Saura, Inc. wrote a letter to RFC, requesting
a modification of the terms laid down by it... In
view of such request RFC approved Resolution No.
736 on February 4, 1954, designating of the mem-
bers of its Board of Governors, for certain reasons
stated in the resolution, "to reexamine all the as-
pects of this approved loan ... with special refer-
ence as to the advisability of financing this particu-
lar project based on present conditions obtaining in
the operations of jute mills, and to submit his find-
ings thereon at the next meeting of the Board."
The Concept of Loan I 27
... In connection with the reexamination of the
project to be financed with the loan applied for, as
stated in Resolution No. 736, the parties named
their respective committees of engineers and tech-
nical men to meet with each other and undertake
the necessary studies, although in appointing its
own committee Saura, Inc. made the observation
that the same "should not be taken as an acquies-
cence on (its) part to novate, or accept new condi-
tions to, the agreement already) entered into," re-
ferring to its acceptance of the terms and condi-
tions mentioned in Resolution No. 145.

On April 13, 1954 the loan documents were ex-


ecuted: the promissory note, with F.R. Hailing,
representing China Engineers, Ltd., as one of the
co-signers; and the corresponding deed of mort-
gage, which was duly registered on the following
April 17.

It appears, however, that despite the formal execu-


tion of the loan agreement the reexamination con-
templated in Resolution No. 736 proceeded. In a
meeting of the RFC Board of Governors on June 10,
1954, at which Ramon Saura, President of Saura,
Inc., was present, it was decided to reduce the loan
from P500,000.00 to P300,000.00... In the meantime
Saura, Inc. had written RFC requesting that the
loan of P500,000.00 be granted. The request was
denied by RFC, which added in its letter-reply that
it was "constrained to consider as cancelled the
loan of P300,000.00 ... in view of a notification ...
from the China Engineers Ltd., expressing their de-
sire to consider the loan cancelled insofar as they
are concerned."
28 1 Credit Transactions: Notes and Cases

On July 24, 1954 Saura, Inc. took exception to the


cancellation of the loan and informed RFC that
China Engineers, Ltd. "will at any time reinstate
their signature as co-signer of the note if RFC re-
leases to us the P500,000.00 originally approved by
you."

On December 17, 1954 RFC passed Resolution No.


9083, restoring the loan to the original amount of
P500,000.00, "it appearing that China Engineers,
Ltd. is now willing to sign the promissory notes
jointly with the borrower-corporation," but with
the following proviso:
"That in view of observations made of the shortage
and high cost of imported raw materials, the De-
partment of Agriculture and Natural Resources
shall certify to the following:
1. That the raw materials needed by the borrower-
corporation to carry out its operation are available
in the immediate vicinity; and
2. That there is prospect of increased production
thereof to provide adequately for the requirements
of the factory."

The action thus taken was communicated to Saura,


Inc. in a letter of RFC dated December 22, 1954,
wherein it was explained that the certification by
the Department of Agriculture and Natural Re-
sources was required "as the intention of the origi-
nal approval (of the loan) is to develop the manu-
facture of sacks on the basis of locally available raw
materials." This point is important, and sheds light
on the subsequent actuations of the parties. Saura,
Inc. does not deny that the factory he was building
in Davao was for the manufacture of bags from lo-
The Concept of Loan 1 29

cal raw materials... This fact, according to defen-


dant DBP, is what moved RFC to approve the loan
application in the first place, and to require, in its
Resolution No. 9083, a certification from the De-
partment of Agriculture and Natural Resources as
to the availability of local raw materials to provide
adequately for the requirements of the factory.
Saura, Inc. itself confirmed the defendant's stand
impliedly in its letter of January 21,1955: (1) stating
that according to a special study made by the Bu-
reau of Forestry "kenaf will not be available in suf-
ficient quantity this year or probably even next
year;" (2) requesting "assurances (from RFC) that
my company and associates will be able to bring in
sufficient jute materials as may be necessary for the
full operation of the jute mill;" and (3) asking that
releases of the loan be made as follows... On Janu-
ary 25, 1955 RFC sent to Saura, Inc. the following
reply... Your statement that you will have to rely
on the importation of jute and your request that we
give you assurance that your company will be able
to bring in sufficient jute materials as may be ne-
cessary for the operation of your factory, would
not be in line with our principle in approving the
loan.

With the foregoing letter the negotiations came to a


standstill. Saura, Inc. did not pursue the matter fur-
ther. Instead, it requested RFC to cancel the mort-
gage, and so, on June 17, 1955 RFC executed the
corresponding deed of cancellation and delivered it
to Ramon F. Saura himself as president of Saura,
Inc.
30 1 Credit Transactions: Notes and Cases

It appears that the cancellation was requested to


make way for the registration of a mortgage con-
tract, executed on August 6, 1954, over the same
property in favor of the Prudential Bank and Trust
Co., under which contract Saura, Inc. had up to
December 31 of the same year within which to pay
its obligation on the trust receipt heretofore men-
tioned. It appears further that for failure to pay the
said obligation the Prudential Bank and Trust Co.
sued Saura, Inc. on May 15, 1955.

On January 9, 1964, almost 9 years after the mort-


gage in favor of RFC was cancelled at the request
of Saura, Inc., the latter commenced the present
suit for damages, alleging failure of RFC (as prede-
cessor of the defendant DBP) to comply with its ob-
ligation to release the proceeds of the loan applied
for and approved, thereby preventing the plaintiff
from completing or paying contractual commit-
ments it had entered into, in connection with its
jute mill project.

The trial court rendered judgment for the plaintiff,


ruling that there was a perfected contract between
the parties and that the defendant was guilty of
breach thereof. The defendant pleaded below, and
reiterates in this appeal: (1) that the plaintiff's
cause of action had prescribed, or that its claim had
been waived or abandoned; (2) that there was no
perfected contract; and (3) that assuming there
was, the plaintiff itself did not comply with the
terms thereof.
We hold that there was indeed a perfected consen-
sual contract, as recognized in Article 1934 of the
Civil Code... There was undoubtedly offer and ac-
The Concept of Loan I 31

ceptance in this case: the application of Saura, Inc.


for a loan of P500,000.00 was approved by resolu-
tion of the defendant, and the corresponding mort-
gage was executed and registered. But this fact
alone falls short of resolving the basic claim that
the defendant failed to fulfill its obligation and the
plaintiff is therefore entitled to recover damages.

It should be noted that RFC entertained the loan


application of Saura, Inc. on the assumption that
the factory to be constructed would utilize locally
grown raw materials, principally kenaf. There is no
serious dispute about this. It was in line with such
assumption that when RFC, by Resolution No.
9083 approved on December 17, 1954, restored the
loan to the original amount of P500,000.00, it im-
posed two conditions, to wit: "(1) that the raw ma-
terials needed by the borrower-corporation to carry
out its operation are available in the immediate vi-
cinity; and (2) that there is prospect of increased
production thereof to provide adequately for the
requirements of the factory." The imposition of
those conditions was by no means a deviation from
the terms of the agreement, but rather a step in its
implementation. There was nothing in said condi-
tions that contradicted the terms laid down in RFC
Resolution No. 145, passed on January 7, 1954,
namely - "that the proceeds of the loan shall be
utilized exclusively for the following purposes: for
construction of factory building - P250,000.00; for
payment of the balance of purchase price of ma-
chinery and equipment - P240,900.00; for working
capital - P9,100.00." Evidently Saura, Inc. realized
that it could not meet the conditions required by
RFC, and so wrote its letter of January 21, 1955,
32 I Credit Transactions: Notes and Cases

stating that local jute "will not be able in sufficient


quantity this year or probably next year," and ask-
ing that out of the loan agreed upon the sum of
P67,586.09 be released "for raw materials and la-
bor." This was a deviation from the terms laid
down in Resolution No. 145 and embodied in the
mortgage contract, implying as it did a diversion of
part of the proceeds of the loan to purposes other
than those agreed upon.

When RFC turned down the request in its letter of


January 25, 1955 the negotiations which had been
going on for the implementation of the agreement
reached an impasse. Saura, Inc. obviously was in
no position to comply with RFC's conditions. So
instead of doing so and insisting that the loan be
released as agreed upon, Saura, Inc. asked that the
mortgage be cancelled, which was done on June 15,
1955. The action thus taken by both parties was in
the nature of mutual desistance - what Manresa
terms "mutuo disenso" - which is a mode of ex-
tinguishing obligations. It is a concept that derives
from the principle that since mutual agreement can
create a contract, mutual disagreement by the par-
ties can cause its extinguishment.

The subsequent conduct of Saura, Inc. confirms this


desistance. It did not protest against any alleged
breach of contract by RFC, or even point out that
the latter's stand was legally unjustified. Its request
for cancellation of the mortgage carried no reserva-
tion of whatever rights it believed it might have
against RFC for the latter's non-compliance. In
1962 it even applied with DBP for another loan to
finance a rice and corn project, which application
The Concept of Loan 1 33

was disapproved. It was only in 1964, nine years


after the loan agreement had been cancelled at its
own request, that Saura, Inc. brought this action for
damages. All these circumstances demonstrate
beyond doubt that the said agreement had been ex-
tinguished by mutual desistance - and that on the
initiative of the plaintiff-appellee itself...

The case of Saura Import and Export illustrates the im-


portance of a definitive acceptance of an offer, as opposed
to a counter-offer, for the perfection of the consensual
contract to loan.

BPI Investment Corporation v. Court of Appeals


and ALS Management & Development Corpora-
tion, G.R. No. 133632, February 15, 2002, 377 SCRA
117.

... Frank Roa obtained a loan at an interest rate of


16 1/4% per annum from Ayala Investment and
Development Corporation (AIDC), the predecessor
of petitioner BPIIC, for the construction of a house
on his lot in New Alabang Village, Muntinlupa.
Said house and lot were mortgaged to AIDC to se-
cure the loan. Sometime in 1980, Roa sold the
house and lot to private respondents ALS and An-
tonio Litonjua for P-850,000. They paid P-350,000 in
cash and assumed the 12500,000 balance of Roa's
indebtedness with AIDC. The latter, however, was
not willing to extend the old interest rate to private
respondents and proposed to grant them a new
loan of P-500,000 to be applied to Roa's debt and se-
cured by the same property, at an interest rate of
20% per annum and service fee of 1% per annum
on the outstanding principal balance payable with-
34 1 Credit Transactions: Notes and Cases

in ten years in equal monthly amortization of


P9,996.58 and penalty interest at the rate of 21% per
annum per day from the date the amortization be-
came due and payable.

Consequently, in March 1981, private respondents


executed a mortgage deed containing the above
stipulations with the provision that payment of the
monthly amortization shall commence on May 1,
1981.

On August 13, 1982, ALS and Litonjua updated


Roa's arrearages by paying BPIIC the sum of
P190,601.35. This reduced Roa's principal balance
to P-457,204.90 which, in turn, was liquidated when
BPIIC applied thereto the proceeds of private res-
pondents' loan of 2500,000.

On September 13, 1982, BPIIC released to private


respondents 27,146.87, purporting to be what was
left of their loan after full payment of Roa's loan.

In June 1984, BPIIC instituted foreclosure proceed-


ings against private respondents on the ground
that they failed to pay the mortgage indebtedness
which from May 1, 1981 to June 30,1984, amounted
to Four Hundred Seventy Five Thousand Five
Hundred Eighty Five and 31/100 Pesos
(P-475,585.31). A notice of sheriff's sale was pub-
lished on August 13, 1984.

On February 28, 1985, ALS and Litonjua filed Civil


Case No. 52093 against BPIIC. They alleged, among
others, that they were not in arrears in their pay-
ment, but in fact made an overpayment as of June
The Concept of Loan I 35

30, 1984. They maintained that they should not be


made to pay amortization before the actual release
of the P-500,000 loan in August and September
1982. Further, out of the P500,000 loan, only the to-
tal amount of P464,351.77 was released to private
respondents. Hence, applying the effects of legal
compensation, the balance of P35,648.23 should be
applied to the initial monthly amortization for the
loan.

On August 31, 1988, the trial court rendered its


judgment in Civil Case Nos. 11831 and 52093, thus:
WHEREFORE, judgment is hereby rendered in fa-
vor of ALS Management and Development Corpo-
ration and Antonio K. Litonjua and against BPI In-
vestment Corporation...

On February 28, 1997, the Court of Appeals prom-


ulgated its decision, the dispositive portion reads:
WHEREFORE, finding no error in the appealed de-
cision the same is hereby AFFIRMED in toto...

In its decision, the Court of Appeals reasoned that


a simple loan is perfected only upon the delivery of
the object of the contract. The contract of loan be-
tween BPIIC and ALS & Litonjua was perfected on-
ly on September 13, 1982, the date when BPIIC re-
leased the purported balance of the -P500,000 loan
after deducting therefrom the value of Roa's indeb-
tedness. Thus, payment of the monthly amortiza-
tion should commence only a month after the said
date, as can be inferred from the stipulations in the
contract. This, despite the express agreement of the
parties that payment shall commence on May 1,
1981. From October 1982 to June 1984, the total
36 1 Credit Transactions: Notes and Cases

amortization due was only P194,960.43. Evidence


showed that private respondents had an overpay-
ment, because as of June 1984, they already paid a
total amount of P201,791.96. Therefore, there was
no basis for BPIIC to extrajudicially foreclose the
mortgage and cause the publication in newspapers
concerning private respondents' delinquency in
the payment of their loan. This fact constituted
sufficient ground for moral damages in favor of
private respondents.

The motion for reconsideration filed by petitioner


BPIIC was likewise denied, hence this petition...

On the first issue, petitioner contends that the


Court of Appeals erred in ruling that because a
simple loan is perfected upon the delivery of the
object of the contract, the loan contract in this case
was perfected only on September 13, 1982. Peti-
tioner claims that a contract of loan is a consensual
contract, and a loan contract is perfected at the time
the contract of mortgage is executed conformably
with our ruling in Bonnevie v. Court of Appeals11 ... In
the present case, the loan contract was perfected on
March 31, 1981, the date when the mortgage deed
was executed, hence, the amortization and interests
on the loan should be computed from said date.

Petitioner also argues that while the documents


showed that the loan was released only on August
1982, the loan was actually released on March 31,
1981, when BPIIC issued a cancellation of mort-
gage of Frank Roa's loan. This finds support in the

11 G.R. No. L-49101, October 24,1983,125 SCRA 122.


The Concept of Loan I 37

registration on March 31, 1981 of the Deed of Abso-


lute Sale executed by Roa in favor of ALS, transfer-
ring the title of the property to ALS, and ALS ex-
ecuting the Mortgage Deed in favor of BPIIC.
Moreover, petitioner claims, the delay in the re-
lease of the loan should be attributed to private
respondents. As BPIIC only agreed to extend a
12500,000 loan, private respondents were required
to reduce Frank Roa's loan below said amount.
According to petitioner, private respondents were
only able to do so in August 1982.

... We agree with private respondents. A loan con-


tract is not a consensual contract but a real con-
tract. It is perfected only upon the delivery of the
object of the contract. Petitioner misapplied Bonne-
vie. The contract in Bonnevie declared by this Court
as a perfected consensual contract falls under the
first clause of Article 1934, Civil Code. It is an ac-
cepted promise to deliver something by way of
simple loan.

In Saura Import and Export Co. Inc. vs. Development


Bank of the Philippines12 ... (w)e recognized in this
case, a perfected consensual contract which under
normal circumstances could have made the bank
liable for not releasing the loan. However, since
the fault was attributable to petitioner therein, the
court did not award it damages.

A perfected consensual contract, as shown above,


can give rise to an action for damages. However,
said contract does not constitute the real contract of

12 G.R. No. L-24968, April 27,1972,44 SCRA 445.


38 1 Credit Transactions: Notes and Cases

loan which requires the delivery of the object of the


contract for its perfection and which gives rise to
obligations only on the part of the borrower.

In the present case, the loan contract between BPI,


on the one hand, and ALS and Litonjua, on the
other, was perfected only on September 13, 1982,
the date of the second release of the loan. Follow-
ing the intentions of the parties on the commence-
ment of the monthly amortization, as found by the
Court of Appeals, private respondents' obligation
to pay commenced only on October 13, 1982, a
month after the perfection of the contract.

We also agree with private respondents that a con-


tract of loan involves a reciprocal obligation,
wherein the obligation or promise of each party is
the consideration for that of the other. As averred
by private respondents, the promise of BPIIC to ex-
tend and deliver the loan is upon the consideration
that ALS and Litonjua shall pay the monthly amor-
tization commencing on May 1, 1981, one month
after the supposed release of the loan. It is a basic
principle in reciprocal obligations that neither par-
ty incurs in delay, if the other does not comply or is
not ready to comply in a proper manner with what
is incumbent upon him. Only when a party has
performed his part of the contract can he demand
that the other party also fulfills his own obligation
and if the latter fails, default sets in. Consequently,
petitioner could only demand for the payment of
the monthly amortization after September 13, 1982
for it was only then when it complied with its obli-
gation under the loan contract. Therefore, in com-
puting the amount due as of the date when BPIIC
The Concept of Loan I 39

extrajudicially caused the foreclosure of the mort-


gage, the starting date is October 13, 1982 and not
May 1, 1981.

... WHEREFORE, the decision dated February 28,


1997, of the Court of Appeals and its resolution
dated April 21,1998, are AFFIRMED WITH MOD-
IFICATION as to the award of damages. The
award of moral and exemplary damages in favor of
private respondents is DELETED, but the award to
them of attorney's fees in the amount of P50,000 is
UPHELD. Additionally, petitioner is ORDERED to
pay private respondents P25,000 as nominal dam-
ages. Costs against petitioner.

In the case of BPI Investment Corporation the "date of


the second release of the loan" (September 13, 1982) was
considered as the date of perfection of the contract of
loan. Why was not the date of the first release of a sub-
stantial amount of the loan (August 13, 1982) considered
the date of perfection of the contract of loan?

Pantaleon v. American Express International, Inc.,


G.R. No. 174269, August 25, 2010, 629 SCRA 276.

... AMEX is a resident foreign corporation engaged


in the business of providing credit services through
the operation of a charge card system. Pantaleon
has been an AMEX cardholder since 1980.

In October 1991, Pantaleon, together with his wife


... went on a guided European tour. On October 25,
1991, the tour group arrived in Amsterdar... The
next day, the group began their sightseeing at
around 8:50 a.m. with a trip to the Coster Diamond
40 1 Credit Transactions: Notes and Cases

House (Coster)... While at Coster, Mrs. Pantaleon


decided to purchase some diamond pieces worth a
total of US$13,826.00. Pantaleon presented his
American Express credit card to the sales clerk to
pay for this purchase. He did this at around 9:15
a.m. The sales clerk swiped the credit card and
asked Pantaleon to sign the charge slip, which was
then electronically referred to AMEX's Amsterdam
office at 9:20 a.m.

... At around 10 a.m., or 45 minutes after Pantaleon


presented his credit card, AMEX still had not ap-
proved the purchase. Since the city tour could not
begin until the Pantaleons were onboard the tour
bus, Coster decided to release at around 10:05 a.m.
the purchased items to Pantaleon even without
AMEX's approval.

When the Pantaleons finally returned to the tour


bus, they found their travel companions visibly ir-
ritated. This irritation intensified when the tour
guide announced that they would have to cancel
the tour because of lack of time as they all had to
be in Calais, Belgium by 3 p.m. to catch the ferry to
London... In all, it took AMEX a total of 78 mi-
nutes to approve Pantaleon's purchase and to
transmit the approval to the jewelry store... Upon
return to Manila, Pantaleon sent AMEX a letter
demanding an apology for the humiliation and in-
convenience he and his family experienced due to
the delays in obtaining approval for his credit card
purchases. AMEX responded by explaining that
the delay in Amsterdam was due to the amount
involved - the charged purchase of US$13,826.00
deviated from Pantaleon's established charge pur-
The Concept of Loan I 41
chase pattern. Dissatisfied with this explanation,
Pantaleon filed an action for damages against the
credit card company...

On August 5,1996, the RTC found AMEX guilty of


delay, and awarded Pantaleon P500,000.00 as mor-
al damages, P300,000.00 as exemplary damages,
P100,000.00 as attorney's fees, and P85,233.01 as lit-
igation expenses.

On appeal, the CA reversed the awards. While the


CA recognized that delay in the nature of mora ac-
cipiendi or creditor's default attended AMEX's ap-
proval of Pantaleon's purchases, it disagreed with
the RTC's finding that AMEX had breached its con-
tract, noting that the delay was not attended by
bad faith, malice or gross negligence... As there
was no proof that AMEX breached its contract, or
that it acted in a wanton, fraudulent or malevolent
manner, the appellate court ruled that AMEX could
not be held liable for any form of damages.

Pantaleon questioned this decision via a petition for


review on certiorariwith this Court.

In our May 8, 2009 decision, we reversed the appel-


late court's decision and held that AMEX was
guilty of mora solvendi, or debtor's default. AMEX,
as debtor, had an obligation as the credit provider
to act on Pantaleon's purchase requests, whether to
approve or disapprove them, with "timely dis-
patch." Based on the evidence on record, we found
that AMEX failed to timely act on Pantaleon's pur-
chases... In its motion for reconsideration, AMEX
argues that this Court erred when it found AMEX
42 1 Credit Transactions: Notes and Cases

guilty of culpable delay in complying with its obli-


gation to act with timely dispatch on Pantaleon's
purchases. While AMEX admits that it normally
takes seconds to approve charge purchases, it em-
phasizes that Pantaleon experienced delay in Ams-
terdam because his transaction was not a normal
one...

Because this was the biggest single transaction that


Pantaleon ever made using his AMEX credit card,
AMEX argues that the transaction necessarily re-
quired the credit authorizer to carefully review
Pantaleon's credit history and bank references.
AMEX maintains that it did this not only to ensure
Pantaleon's protection (to minimize the possibility
that a third party was fraudulently using his credit
card), but also to protect itself from the risk that
Pantaleon might not be able to pay for his purchas-
es on credit. This careful review, according to
AMEX, is also in keeping with the extraordinary
degree of diligence required of banks in handling
its transactions...

AMEX further points out that the proximate cause


of Pantaleon's humiliation and embarrassment was
his own decision to proceed with the purchase de-
spite his awareness that the tour group was wait-
ing for him and his wife. Pantaleon could have
prevented the humiliation had he cancelled the sale
when he noticed that the credit approval for the
Coster purchase was unusually delayed.

In his Comment dated February 24, 2010, Pantale-


on maintains that AMEX was guilty of mora solven-
di, or delay on the part of the debtor, in complying
The Concept of Loan 1 43

with its obligation to him. Based on jurisprudence,


a just cause for delay does not relieve the debtor in
delay from the consequences of delay; thus, even if
AMEX had a justifiable reason for the delay, this
reason would not relieve it from the liability aris-
ing from its failure to timely act on Pantaleon's
purchase.

... A credit card is defined as "any card, plate, cou-


pon book, or other credit device existing for the
purpose of obtaining money, goods, property, la-
bor or services or anything of value on credit." It
traces its roots to the charge card first introduced
by the Diners Club in New York City in 1950.
American Express followed suit by introducing its
own charge card to the American market in 1958.

In the Philippines, the now defunct Pacific Bank


was responsible for bringing the first credit card in-
to the country in the 1970s...

Nature of Credit Card Transactions


To better understand the dynamics involved in
credit card transactions, we turn to the United
States case of HarrisTrust & Savings Bank v. McCray
which explains:
The bank credit card system involves a tripartite
relationship between the issuer bank, the card-
holder, and merchants participating in the system.
The issuer bank establishes an account on behalf of
the person to whom the card is issued, and the two
parties enter into an agreement which governs
their relationship. This agreement provides that the
bank will pay for cardholder's account the amount
of merchandise or services purchased through the
44 1 Credit Transactions: Notes and Cases

use of the credit card and will also make cash loans
available to the cardholder. It also states that the
cardholder shall be liable to the bank for advances
and payments made by the bank and that the
cardholder's obligation to pay the bank shall not be
affected or impaired by any dispute, claim, or de-
mand by the cardholder with respect to any mer-
chandise or service purchased.
The merchants participating in the system agree to
honor the bank's credit cards. The bank irrevocably
agrees to honor and pay the sales slips presented
by the merchant if the merchant performs his un-
dertakings such as checking the list of revoked
cards before accepting the card...
These slips are forwarded to the member bank
which originally issued the card. The cardholder
receives a statement from the bank periodically
and may then decide whether to make payment to
the bank in full within a specified period, free of in-
terest, or to defer payment and ultimately incur an
interest charge.

We adopted a similar view in CIR v. American Ex-


press International, Inc. (Philippine branch)13, where
we also recognized that credit card issuers are not
limited to banks. We said:
Under RA 8484, the credit card that is issued by
banks in general, or by non-banks in particular, re-
fers to "any card ... or other credit device existing
for the purpose of obtaining ... goods ... or services
... on credit;" and is being used "usually on a re-
volving basis." This means that the consumer-
credit arrangement that exists between the issuer

13 G.R No. 152609, June 29,2005,462 SCRA 197.


The Concept of Loan I 45
and the holder of the credit card enables the latter
to procure goods or services "on a continuing basis
as long as the outstanding balance does not exceed
a specified limit." The cardholder is, therefore, giv-
en "the power to obtain present control of goods or
service on a promise to pay for them in the future."
Business establishments may extend credit sales
through the use of the credit card facilities of a
non-bank credit card company to avoid the risk of
uncollectible accounts from their customers. Under
this system, the establishments do not deposit in
their bank accounts the credit card drafts that arise
from the credit sales. Instead, they merely record
their receivables from the credit card company and
periodically send the drafts evidencing those recei-
vables to the latter.
The credit card company, in turn, sends checks as
payment to these business establishments, but it
does not redeem the drafts at full price. The
agreement between them usually provides for dis-
counts to be taken by the company upon its re-
demption of the drafts. At the end of each month, it
then bills its credit card holders for their respective
drafts redeemed during the previous month. If the
holders fail to pay the amounts owed, the company
sustains the loss.

Simply put, every credit card transaction involves


three contracts, namely: (a) the sales contract be-
tween the credit card holder and the merchant or
the business establishment which accepted the cre-
dit card; (b) the loan agreement between the credit
card issuer and the credit card holder; and lastly,
(c) the promise to pay between the credit card issu-
er and the merchant or business establishment.
46 1 Credit Transactions: Notes and Cases

Credit cardissuer - cardholderrelationship


When a credit card company gives the holder the
privilege of charging items at establishments asso-
ciated with the issuer, a necessary question in a le-
gal analysis is - when does this relationship begin?
There are two diverging views on the matter. In
City Stores Co. v. Henderson,another U.S. decision,
held that:
The issuance of a credit card is but an offer to ex-
tend a line of open account credit. It is unilateral
and supported by no consideration. The offer may
be withdrawn at any time, without prior notice, for
any reason or, indeed, for no reason at all, and its
withdrawal breaches no duty - for there is no duty
to continue it - and violates no rights.

Thus, under this view, each credit card transaction


is considered a separate offer and acceptance.

Novack v. Cities Service Oil Co. echoed this view,


with the court ruling that the mere issuance of a
credit card did not create a contractual relationship
with the cardholder.

On the other end of the spectrum is Gray v. Ameri-


can Express Company which recognized the card
membership agreement itself as a binding contract
between the credit card issuer and the card holder.
Unlike in the Novack and the City Stores cases,
however, the cardholder in Gray paid an annual fee
for the privilege of being an American Express
cardholder.

In our jurisdiction, we generally adhere to the Gray


ruling, recognizing the relationship between the
The Concept of Loan I 47
credit card issuer and the credit card holder as a
contractual one that is governed by the terms and
conditions found in the card membership agree-
ment. This contract provides the rights and liabili-
ties of a credit card company to its cardholders and
vice versa.

We note that a card membership agreement is a


contract of adhesion as its terms are prepared sole-
ly by the credit card issuer, with the cardholder
merely affixing his signature signifying his adhe-
sion to these terms. This circumstance, however,
does not render the agreement void; we have un-
iformly held that contracts of adhesion are "as
binding as ordinary contracts, the reason being that
the party who adheres to the contract is free to re-
ject it entirely." The only effect is that the terms of
the contract are construed strictly against the party
who drafted it.

On AMEX's obligations to Pantaleon


We begin by identifying the two privileges that
Pantaleon assumes he is entitled to with the is-
suance of his AMEX credit card, and on which he
anchors his claims. First, Pantaleon presumes that
since his credit card has no pre-set spending limit,
AMEX has the obligation to approve all his charge
requests. Conversely, even if AMEX has no such
obligation, at the very least it is obliged to act on
his charge requests within a specific period of time.
i. Use of credit card a mere offer to enter into loan
agreements
Although we recognize the existence of a relation-
ship between the credit card issuer and the credit
card holder upon the acceptance by the cardholder
48 1 Credit Transactions: Notes and Cases

of the terms of the card membership agreement


(customarily signified by the act of the cardholder
in signing the back of the credit card), we have to
distinguish this contractual relationship from the
creditor-debtor relationship which only arises after
the credit card issuer has approved the cardhold-
er's purchase request. The first relates merely to an
agreement providing for credit facility to the card-
holder. The latter involves the actual credit on loan
agreement involving three contracts, namely: the
sales contract between the credit card holder and
the merchant or the business establishment which
accepted the credit card; the loan agreement be-
tween the credit card issuer and the credit card
holder; and the promise to pay between the credit
card issuer and the merchant or business estab-
lishment.

From the loan agreement perspective, the contrac-


tual relationship begins to exist only upon the
meeting of the offer and acceptance of the parties
involved. In more concrete terms, when cardhold-
ers use their credit cards to pay for their purchases,
they merely offer to enter into loan agreements
with the credit card company. Only after the latter
approves the purchase requests that the parties en-
ter into binding loan contracts, in keeping with Ar-
ticle 1319 of the Civil Code...

This view finds support in the reservation found in


the card membership agreement itself, particularly
paragraph 10, which clearly states that AMEX "re-
serve[s] the right to deny authorization for any re-
quested Charge." By so providing, AMEX made its
position clear that it has no obligation to approve
The Concept of Loan 1 49

any and all charge requests made by its card hold-


ers.

ii. AMEX not guilty of culpable delay


Since AMEX has no obligation to approve the pur-
chase requests of its credit cardholders, Pantaleon
cannot claim that AMEX defaulted in its obligation.
Article 1169 of the Civil Code, which provides the
requisites to hold a debtor guilty of culpable delay,
states:
Article 1169. Those obliged to deliver or to do
something incur in delay from the time the obligee
judicially or extrajudicially demands from them the
fulfillment of their obligation...

The three requisites for a finding of default are: (a)


that the obligation is demandable and liquidated;
(b) the debtor delays performance; and (c) the cred-
itor judicially or extrajudicially requires the deb-
tor's performance.

Based on the above, the first requisite is no longer


met because AMEX, by the express terms of the
credit card agreement, is not obligated to approve
Pantaleon's purchase request. Without a demand-
able obligation, there can be no finding of default.

Apart from the lack of any demandable obligation,


we also find that Pantaleon failed to make the de-
mand required by Article 1169 of the Civil Code.
As previously established, the use of a credit card
to pay for a purchase is only an offer to the credit
card company to enter a loan agreement with the
credit card holder. Before the credit card issuer ac-
cepts this offer, no obligation relating to the loan
50 I Credit Transactions: Notes and Cases

agreement exists between them. On the other hand,


a demand is defined as the "assertion of a legal
right ... an asking with authority, claiming or chal-
lenging as due." A demand presupposes the exis-
tence of an obligation between the parties.

Thus, every time that Pantaleon used his AMEX


credit card to pay for his purchases, what the stores
transmitted to AMEX were his offers to execute
loan contracts. These obviously could not be classi-
fied as the demand required by law to make the
debtor in default, given that no obligation could
arise on the part of AMEX until after AMEX trans-
mitted its acceptance of Pantaleon's offers. Pan-
taleon's act of "insisting on and waiting for the
charge purchases to be approved by AMEX" is not
the demand contemplated by Article 1169 of the
Civil Code...

iii. On AMEX's obligation to act on the offer within a


specific period of time
... We originally held that AMEX was in culpable
delay when it acted on the Coster transaction, as
well as the two other transactions in the United
States which took AMEX approximately 15 to 20
minutes to approve. This conclusion appears valid
and reasonable at first glance, comparing the time
it took to finally get the Coster purchase approved
(a total of 78 minutes), to AMEX's "normal" ap-
proval time of three to four seconds (based on the
testimony of Edgardo Jaurigue, as well as Pantale-
on's previous experience). We come to a different
result, however, after a closer look at the factual
and legal circumstances of the case... We next ex-
The Concept of Loan I 51

amine the credit card membership agreement, the


contract that primarily governs the relationship be-
tween AMEX and Pantaleon. Significantly, there is
no provision in this agreement that obligates
AMEX to act on all cardholder purchase requests
within a specifically defined period of time. Thus,
regardless of whether the obligation is worded was
to "act in a matter of seconds" or to "act in timely
dispatch," the fact remains that no obligation exists
on the part of AMEX to act within a specific period
of time. Even Pantaleon admits in his testimony
that he could not recall any provision in the
Agreement that guaranteed AMEX's approval of
his charge requests within a matter of minutes.

Nor can Pantaleon look to the law or government


issuances as the source of AMEX's alleged obliga-
tion to act upon his credit card purchases within a
matter of seconds. As the following survey of Phi-
lippine law on credit card transactions demon-
strates, the State does not require credit card com-
panies to act upon its cardholders' purchase re-
quests within a specific period of time.

Republic Act No. 8484 ... or the Access Devices


Regulation Act of 1998, approved on February 11,
1998, is the controlling legislation that regulates
the issuance and use of access devices, including
credit cards. The more salient portions of this law
include the imposition of the obligation on a credit
card company to disclose certain important finan-
cial information to credit card applicants, as well as
a definition of the acts that constitute access device
fraud.
52 1 Credit Transactions: Notes and Cases

As financial institutions engaged in the business of


providing credit, credit card companies fall under
the supervisory powers of the Bangko Sentral ng
Pilipinas (BSP). BSP Circular No. 398 dated Au-
gust 21, 2003 embodies the BSP's policy when it
comes to credit cards -
The Bangko Sentral ng Pilipinas (BSP) shall foster
the development of consumer credit through inno-
vative products such as credit cards under condi-
tions of fair and sound consumer credit practices. The
BSP likewise encourages competition and transpa-
rency to ensure more efficient delivery of services
and fair dealings with customers...

Based on this Circular, "... [b]efore issuing credit


cards, banks and/or their subsidiary credit card
companies must exercise proper diligence by ascer-
taining that applicants possess good credit stand-
ing and are financially capable of fulfilling their
credit commitments." As the above-quoted policy
expressly states, the general intent is to foster "fair
and sound consumer credit practices." ...In light of
the foregoing, we find and so hold that AMEX is
neither contractually bound nor legally obligated
to act on its cardholders' purchase requests within
any specific period of time, much less a period of a
"matter of seconds" that Pantaleon uses as his
standard. The standard therefore is implicit and, as
in all contracts, must be based on fairness and rea-
sonableness, read in relation to the Civil Code pro-
visions on human relations, as will be discussed
below.

AMEX acted with goodfaith


Thus far, we have already established that: (a)
The Concept of Loan I 53

AMEX had neither a contractual nor a legal obliga-


tion to act upon Pantaleon's purchases within a
specific period of time; and (b) AMEX has a right
to review a cardholder's credit card history. Our
recognition of these entitlements, however, does
not give AMEX an unlimited right to put off action
on cardholders' purchase requests for indefinite
periods of time. In acting on cardholders' purchase
requests, AMEX must take care not to abuse its
rights and cause injury to its clients and/or third
persons. We cite in this regard Article 19, in con-
junction with Article 21, of the Civil Code, which
provide:
Article 19. Every person must, in the exercise of his
rights and in the performance of his duties, act
with justice, give everyone his due and observe
honesty and good faith.
Article 21. Any person who willfully causes loss or
injury to another in a manner that is contrary to
morals, good customs or public policy shall com-
pensate the latter for the damage.

... In the context of a credit card relationship, al-


though there is neither a contractual stipulation
nor a specific law requiring the credit card issuer to
act on the credit card holder's offer within a defi-
nite period of time, these principles provide the
standard by which to judge AMEX's actions... It is
an elementary rule in our jurisdiction that good
faith is presumed and that the burden of proving
bad faith rests upon the party alleging it. Although
it took AMEX some time before it approved Pan-
taleon's three charge requests, we find no evidence
to suggest that it acted with deliberate intent to
cause Pantaleon any loss or injury, or acted in a
54 1 Credit Transactions: Notes and Cases

manner that was contrary to morals, good customs


or public policy. We give credence to AMEX's
claim that its review procedure was done to ensure
Pantaleon's own protection as a cardholder and to
prevent the possibility that the credit card was be-
ing fraudulently used by a third person.

Pantaleon countered that this review procedure is


primarily intended to protect AMEX's interests, to
make sure that the cardholder making the pur-
chase has enough means to pay for the credit ex-
tended. Even if this were the case, however, we do
not find any taint of bad faith in such motive. It is
but natural for AMEX to want to ensure that it will
extend credit only to people who will have suffi-
cient means to pay for their purchases. AMEX, af-
ter all, is running a business, not a charity, and it
would simply be ludicrous to suggest that it would
not want to earn profit for its services. Thus, so
long as AMEX exercises its rights, performs its ob-
ligations, and generally acts with good faith, with
no intent to cause harm, even if it may occasionally
inconvenience others, it cannot be held liable for
damages.

... WHEREFORE, premises considered, we SET


ASIDE our May 8, 2009 Decision and GRANT the
present motion for reconsideration. The Court of
Appeals Decision dated August 18, 2006 is hereby
AFFIRMED. No costs.

The case of Panteleon discusses one of the most common


credit transactions - the credit card contract. If, as stated
in Pantaleon, the contractual relationship that arises be-
tween a credit card issuer and a credit card holder in a
The Concept of Loan 155

card membership agreement is an agreement providing


for a credit facility to the cardholder, is this a contract to
loan? Does it create a creditor-debtor relationship? Why
does the creditor-debtor relationship only arise after the
credit card issuer has approved the cardholder's purchase
request? Are the rights and obligations of the parties un-
der a contract to loan different from the rights and obliga-
tion of the same parties under a contract of loan?
Chapter 2. Commodatum

A. General Concepts

Art. 1933. By the contract of loan, one of the par-


ties delivers to another, either something not con-
sumable so that the latter may use the same for a
certain time and return it, in which case the con-
tract is called a commodatum... Commodatum is
essentially gratuitous... In commodatum the bai-
lor retains the ownership of the thing loaned...

Art. 1935. The bailee in commodatum acquires


the used of the thing loaned but not its fruits; if
any compensation is to be paid by him who ac-
quires the use, the contract ceases to be a commo-
datum.

Art. 1939. Commodatum is purely personal in


character. Consequently:
(1) The death of either the bailor or the bailee ex-
tinguishes the contract...

Commodatum, from the Latin commodare, to lend, or the


gratuitous lending of goods to be used by the borrower
and then returned undamaged to the lender,1 is perhaps
one of the first contracts that a child is taught - when a
child wishes to play with a toy that belongs to a sibling,
the parent instructs the child that he may borrow the toy
from a playmate and assures the playmate that it will be
returned. Except for the essential element of consent, the
concept of commodatum is clearly illustrated in this situa-
tion - the playmate parts with or delivers the toy to the
child who may play with it or use it for a certain time,

I Blacks Law Dictionary, Ninth Edition (2009).


Commodatum 157

provided the child returns the very same toy to the play-
mate.

Thus, commodatum is entered into regularly in ordinary


life. In fact under Roman law, it was considered one of
the "contracts of neighborliness ' 2. Borrowing clothes
from a sibling, a car from a friend, a book from a neigh-
bor, all of these instances illustrate a commodatum, that
is, a contract where the creditor (or bailor) gratuitously
delivers to the debtor (or bailee) non-consumable prop-
erty so that the latter may use the same for a certain time
and return it.

1. Consideration in Commodatum

Since commodatum is essentially gratuitous, liberality


on the part of the bailor is the consideration for the con-
tract. It is for this reason that commodatum is purely per-
sonal in character and that the death of either party to the
contract results in its extinguishment. If compensation is
to be paid by the bailee for the use of the property loaned
then the contract ceases to be a commodatum and is nec-
essarily some other contract.

On the part of the bailee, the consideration for the con-


tract is the permissive use of the property loaned.

2. Object of Commodatum

Art. 1937. Movable or immovable property may


be the object of commodatum.

Art. 1936. Consumable goods may be the subject


of commodatum if the purpose of the contract is

2 Radin, Handbook of Roman Law 195 (1927).


58 I Credit Transactions: Notes and Cases

not the consumption of the object, as when it is


merely for exhibition.

Generally, the object of commodatum is non-consumable


property, whether it is movable or immovable. Howev-
er, consumable property may be the object of commoda-
tum if the purpose of the contract is not the consumption
of the object. The delivery of first edition stamps or new-
ly minted coins or specially printed paper money, for
purposes of exhibition, gives rise to the obligation to re-
turn the very same property, thus, making the contract
one of commodatum.

Producers Bank of the Philippines v. Court of


Appeals, G.R. No. 115324, February 19, 2003, 397
SCRA 651.

...Sometime in 1979, private respondent Franklin


Vives was asked by his neighbor and friend An-
geles Sanchez to help her friend and townmate,
Col. Arturo Doronilla, in incorporating his busi-
ness, the Sterela Marketing and Services ("Sterela"
for brevity). Specifically, Sanchez asked private
respondent to deposit in a bank a certain amount
of money in the bank account of Sterela for pur-
poses of its incorporation. She assured private res-
pondent that he could withdraw his money from
said account within a month's time. Private res-
pondent asked Sanchez to bring Doronilla to their
house so that they could discuss Sanchez's request.

Thereafter, relying on the assurances and repre-


...
sentations of Sanchez and Doronilla, private res-
pondent issued a check in the amount of Two
Hundred Thousand Pesos (P-200,000.00) in favor of
Conmodatum I 59

Sterela. Private respondent instructed his wife,


Mrs. Inocencia Vives, to accompany Doronilla and
Sanchez in opening a savings account in the name
of Sterela in the Buendia, Makati branch of Produc-
ers Bank of the Philippines. However, only San-
chez, Mrs. Vives and Dumagpi went to the bank to
deposit the check. They had with them an authori-
zation letter from Doronilla authorizing Sanchez
and her companions, "in coordination with Mr. Ru-
fo Atienza," to open an account for Sterela Market-
ing Services in the amount of 12200,000.00. In open-
ing the account, the authorized signatories were
Inocencia Vives and/or Angeles Sanchez. A pass-
book for Savings Account No. 10-1567 was thereaf-
ter issued to Mrs. Vives.

Subsequently, private respondent learned that Ste-


rela was no longer holding office in the address
previously given to him. Alarmed, he and his wife
went to the Bank to verify if their money was still
intact. The bank manager referred them to Mr. Ru-
fo Atienza, the assistant manager, who informed
them that part of the money in Savings Account
No. 10-1567 had been withdrawn by Doronilla, and
that only 190,000.00 remained therein. He likewise
told them that Mrs. Vives could not withdraw said
remaining amount because it had to answer for
some postdated checks issued by Doronilla. Ac-
cording to Atienza, after Mrs. Vives and Sanchez
opened Savings Account No. 10-1567, Doronilla
opened Current Account No. 10-0320 for Sterela
and authorized the Bank to debit Savings Account
No. 10-1567 for the amounts necessary to cover
overdrawings in Current Account No. 10-0320. In
opening said current account, Sterela, through Do-
60 1 Credit Transactions: Notes and Cases

ronilla, obtained a loan of P175,000.00 from the


Bank. To cover payment thereof, Doronilla issued
three postdated checks, all of which were disho-
nored. Atienza also said that Doronilla could as-
sign or withdraw the money in Savings Account
No. 10-1567 because he was the sole proprietor of
Sterela.

Private respondent tried to get in touch with Doro-


nilla through Sanchez. On June 29, 1979, he re-
ceived a letter from Doronilla, assuring him that
his money was intact and would be returned to
him. On August 13, 1979, Doronilla issued a post-
dated check for Two Hundred Twelve Thousand
Pesos (P212,000.00) in favor of private respondent.
However, upon presentment thereof by private
respondent to the drawee bank, the check was dis-
honored. Doronilla requested private respondent
to present the same check on September 15, 1979
but when the latter presented the check, it was
again dishonored.

Private respondent referred the matter to a lawyer,


who made a written demand upon Doronilla for
the return of his client's money. Doronilla issued
another check for P212,000.00 in private respon-
dent's favor but the check was again dishonored
for insufficiency of funds.

Private respondent instituted an action for recov-


ery of sum of money in the Regional Trial Court ...
against Doronilla, Sanchez, Dumagpi and petition-
er... He also filed criminal actions against Doronil-
la, Sanchez and Dumagpi in the RTC. However,
Sanchez passed away on March 16, 1985 while the
Commodatum 61

case was pending before the trial court. On Octo-


ber 3, 1995, the RTC ... promulgated its Decision in
Civil Case No. 44485, the dispositive portion of
which reads:
IN VIEW OF THE FOREGOING, judgment is he-
reby rendered sentencing defendants Arturo J. Do-
ronila, Estrella Dumagpi and Producers Bank of
the Philippines to pay plaintiff Franklin Vives joint-
ly and severally -
(a) the amount of P200,000.00, representing the
money deposited, with interest at the legal rate
from the filing of the complaint until the same is
fully paid;
(b) the sum of R50,000.00 for moral damages and a
similar amount for exemplary damages;
(c) the amount of P-40,000.00 for attorney's fees;
and
(d) the costs of the suit.
SO ORDERED.

Petitioner appealed the trial court's decision to the


Court of Appeals. In its Decision dated June 25,
1991, the appellate court affirmed in toto the deci-
sion of the RTC. It likewise denied with finality pe-
titioner's motion for reconsideration in its Resolu-
tion dated May 5, 1994.

On June 30, 1994, petitioner filed the present peti-


tion... Petitioner contends that the transaction be-
tween private respondent and Doronilla is a simple
loan (mutuum) since all the elements of a mutuum
are present: first, what was delivered by private
respondent to Doronilla was money, a consumable
thing; and second, the transaction was onerous as
Doronilla was obliged to pay interest, as evidenced
62 1 Credit Transactions: Notes and Cases

by the check issued by Doronilla in the amount of


P212,000.00, or 212,000 more than what private
respondent deposited in Sterela's bank account.
Moreover, the fact that private respondent sued his
good friend Sanchez for his failure to recover his
money from Doronilla shows that the transaction
was not merely gratuitous but "had a business an-
gle" to it. Hence, petitioner argues that it cannot be
held liable for the return of private respondent's
.P200,000.00 because it is not privy to the transac-
tion between the latter and Doronilla.

It argues further that petitioner's Assistant Manag-


er, Mr. Rufo Atienza, could not be faulted for al-
lowing Doronilla to withdraw from the savings ac-
count of Sterela since the latter was the sole pro-
prietor of said company. Petitioner asserts that
Doronilla's May 8, 1979 letter addressed to the
bank, authorizing Mrs. Vives and Sanchez to open
a savings account for Sterela, did not contain any
authorization for these two to withdraw from said
account. Hence, the authority to withdraw there-
from remained exclusively with Doronilla, who
was the sole proprietor of Sterela, and who alone
had legal title to the savings account. Petitioner
points out that no evidence other than the testimo-
nies of private respondent and Mrs. Vives was pre-
sented during trial to prove that private respon-
dent deposited his P200,000.00 in Sterela's account
for purposes of its incorporation. Hence, petitioner
should not be held liable for allowing Doronilla to
withdraw from Sterela's savings account.

Petitioner also asserts that the Court of Appeals


erred in affirming the trial court's decision since
CommodatumI 63

the findings of fact therein were not accord with


the evidence presented by petitioner during trial to
prove that the transaction between private respon-
dent and Doronilla was a mutuum, and that it
committed no wrong in allowing Doronilla to
withdraw from Sterela's savings account.

Finally, petitioner claims that since there is no


wrongful act or omission on its part, it is not liable
for the actual damages suffered by private respon-
dent, and neither may it be held liable for moral
and exemplary damages as well as attorney's fees.

Private respondent, on the other hand, argues that


the transaction between him and Doronilla is not a
mutuum but an accommodation, since he did not
actually part with the ownership of his P-200,000.00
and in fact asked his wife to deposit said amount in
the account of Sterela so that a certification can be
issued to the effect that Sterela had sufficient funds
for purposes of its incorporation but at the same
time, he retained some degree of control over his
money through his wife who was made a signatory
to the savings account and in whose possession the
savings account passbook was given.

He likewise asserts that the trial court did not err in


finding that petitioner, Atienza's employer, is lia-
ble for the return of his money. He insists that
Atienza, petitioner's assistant manager, connived
with Doronilla in defrauding private respondent
since it was Atienza who facilitated the opening of
Sterela's current account three days after Mrs.
Vives and Sanchez opened a savings account with
petitioner for said company, as well as the approv-
64 1 Credit Transactions: Notes and Cases

al of the authority to debit Sterela's savings ac-


count to cover any overdrawings in its current ac-
count.

There is no merit in the petition... No error was


committed by the Court of Appeals when it ruled
that the transaction between private respondent
and Doronilla was a commodatum and not a mu-
tuum. A circumspect examination of the records
reveals that the transaction between them was a
commodatum. Article 1933 of the Civil Code distin-
guishes between the two kinds of loans... The
foregoing provision seems to imply that if the sub-
ject of the contract is a consumable thing, such as
money, the contract would be a mutuum. Howev-
er, there are some instances where a commodatum
may have for its object a consumable thing. Article
1936 of the Civil Code provides... Thus, if consum-
able goods are loaned only for purposes of exhibi-
tion, or when the intention of the parties is to lend
consumable goods and to have the very same
goods returned at the end of the period agreed
upon, the loan is a commodatum and not a mutuum.

The rule is that the intention of the parties thereto


shall be accorded primordial consideration in de-
termining the actual character of a contract. In case
of doubt, the contemporaneous and subsequent
acts of the parties shall be considered in such de-
termination.

As correctly pointed out by both the Court of Ap-


peals and the trial court, the evidence shows that
private respondent agreed to deposit his money in
the savings account of Sterela specifically for the
CommodatumI 65

purpose of making it appear "that said firm had


sufficient capitalization for incorporation, with the
promise that the amount shall be returned within
thirty (30) days." Private respondent merely "ac-
commodated" Doronifla by lending his money
without consideration, as a favor to his good friend
Sanchez. It was however clear to the parties to the
transaction that the money would not be removed
from Sterela's savings account and would be re-
turned to private respondent after thirty (30) days.

Doronilla's attempts to return to private respon-


dent the amount of 1P200,000.00 which the latter
deposited in Sterela's account together with an ad-
ditional 12,000.00, allegedly representing interest
on the mutuum, did not convert the transaction
from a commodatum into a mutuum because such
was not the intent of the parties and because the
additional 12,000.00 corresponds to the fruits of
the lending of the 12200,000.00. Article 1935 of the
Civil Code expressly states that "[t]he bailee in
commodatum acquires the use of the thing loaned
but not its fruits." Hence, it was only proper for
Doronlla to remit to private respondent the inter-
est accruing to the latter's money deposited with
petitioner.

Neither does the Court agree with petitioner's con-


tention that it is not solidarily liable for the return
of private respondent's money because it was not
privy to the transaction between Doronilla and
private respondent. The nature of said transaction,
that is, whether it is a mutuum or a commodatum,
has no bearing on the question of petitioner's lia-
bility for the return of private respondent's money
66 I Credit Transactions: Notes and Cases

because the factual circumstances of the case clear-


ly show that petitioner, through its employee Mr.
Atienza, was partly responsible for the loss of pri-
vate respondent's money and is liable for its resti-
tution... To begin with, the deposit was made in
defendant's Buendia branch precisely because
Atienza was a key officer therein. The records
show that plaintiff had suggested that the
-200,000.00 be deposited in his bank, the Manila
Banking Corporation, but Doronilla and Dumagpi
insisted that it must be in defendant's branch in
Makati for "it will be easier for them to get a certifi-
cation". In fact before he was introduced to plain-
tiff, Doronilla had already prepared a letter ad-
dressed to the Buendia branch manager authoriz-
ing Angeles B. Sanchez and company to open a
savings account for Sterela in the amount of
-200,000.00, as "per coordination with Mr. Rufo
Atienza, Assistant Manager of the Bank... This is a
clear manifestation that the other defendants had
been in consultation with Atienza from the incep-
tion of the scheme. Significantly, there were testi-
monies and admission that Atienza is the brother-
in-law of a certain Romeo Mirasol, a friend and
business associate of Doronilla.

Then there is the matter of the ownership of the


fund. Because of the "coordination" between Do-
ronilla and Atienza, the latter knew before hand
that the money deposited did not belong to Doro-
nilla nor to Sterela. Aside from such foreknow-
ledge, he was explicitly told by Inocencia Vives
that the money belonged to her and her husband
and the deposit was merely to accommodate Do-
Commodatum 167

ronilla. Atienza even declared that the money came


from Mrs. Vives.

Although the savings account was in the name of


Sterela, the bank records disclose that the only ones
empowered to withdraw the same were Inocencia
Vives and Angeles B. Sanchez. In the signature
card pertaining to this account (Exh. J), the autho-
rized signatories were Inocencia Vives &/or An-
geles B. Sanchez. Atienza stated that it is the usual
banking procedure that withdrawals of savings
deposits could only be made by persons whose au-
thorized signatures are in the signature cards on
file with the bank. He, however, said that this pro-
cedure was not followed here because Sterela was
owned by Doronilla. He explained that Doronilla
had the full authority to withdraw by virtue of
such ownership. The Court is not inclined to agree
with Atienza. In the first place, he was all the time
aware that the money came from Vives and did not
belong to Sterela. He was also told by Mrs. Vives
that they were only accommodating Doronilia so
that a certification can be issued to the effect that
Sterela had a deposit of so much amount to be sued
in the incorporation of the firm. In the second
place, the signature of Doronilla was not autho-
rized in so far as that account is concerned inas-
much as he had not signed the signature card pro-
vided by the bank whenever a deposit is opened.
In the third place, neither Mrs. Vives nor Sanchez
had given Doronilla the authority to withdraw.

Moreover, the transfer of fund was done without


the passbook having been presented. It is an ac-
cepted practice that whenever a withdrawal is
68 1 Credit Transactions: Notes and Cases

made in a savings deposit, the bank requires the


presentation of the passbook. In this case, such
recognized practice was dispensed with. The
transfer from the savings account to the current ac-
count was without the submission of the passbook
which Atienza had given to Mrs. Vives. Instead, it
was made to appear in a certification signed by Es-
trella Dumagpi that a duplicate passbook was is-
sued to Sterela because the original passbook had
been surrendered to the Makati branch in view of a
loan accommodation assigning the savings account
(Exh. C). Atienza, who undoubtedly had a hand in
the execution of this certification, was aware that
the contents of the same are not true. He knew that
the passbook was in the hands of Mrs. Vives for he
was the one who gave it to her. Besides, as assis-
tant manager of the branch and the bank official
servicing the savings and current accounts in ques-
tion, he also was aware that the original passbook
was never surrendered. He was also cognizant
that Estrella Dumagpi was not among those autho-
rized to withdraw so her certification had no effect
whatsoever.

The circumstance surrounding the opening of the


current account also demonstrate that Atienza's ac-
tive participation in the perpetration of the fraud
and deception that caused the loss. The records
indicate that this account was opened three days
later after the 2200,000.00 was deposited. In spite
of his disclaimer, the Court believes that Atienza
was mindful and posted regarding the opening of
the current account considering that Doronilla was
all the while in "coordination" with him. That it
was he who facilitated the approval of the authori-
CommodatumI 69

ty to debit the savings account to cover any over-


drawings in the current account (Exh. 2) is not hard
to comprehend... The foregoing shows that the
Court of Appeals correctly held that under Article
2180 of the Civil Code, petitioner is liable for pri-
vate respondent's loss and is solidarily liable with
Doronilla and Dumagpi for the return of the
-P200,000.00 since it is clear that petitioner failed to
prove that it exercised due diligence to prevent the
unauthorized withdrawals from Sterela's savings
account, and that it was not negligent in the selec-
tion and supervision of Atienza. Accordingly, no
error was committed by the appellate court in the
award of actual, moral and exemplary damages, at-
torney's fees and costs of suit to private respon-
dent....

If, as Producers Bank of the Philippines concludes, the


object of the commodatum was money, then was it the
intention of the parties for the bailee to return the very
same currency notes delivered? If the bailor in commoda-
turn retained ownership of the money delivered, then
what was the relationship between Sterela and Producers
Bank? Is the use of money for purposes of incorporation
even if only for "accommodation," the same as "exhibi-
tion"? How is the case reconciled with Article 1980 which
provides that fixed, savings, and current deposits of mon-
ey in banks are governed by the provisions on mutuum?

B. Parties to a Commodatum

The Civil Code refers to the parties in a commodatum as


the bailor (or creditor), and bailee (or debtor). The use of
these terms links the Roman law concept of commodatum
with the common law bailment, that is, the delivery of
70 I Credit Transactions: Notes and Cases

personal property by one person (the bailor) to another


(the bailee) who holds the property for a certain purpose
usually under an express or implied contract. 3

1. Ownership by Bailor

Art. 1938. The bailor in commodatum need not be


the owner of the thing loaned.

Art. 1933... In commodatum the bailor retains the


ownership of the thing loaned...

The bailor in commodatum need not be the owner of the


property loaned, but as against the bailee it is the bailor
who retains ownership of the property loaned.

2. Use by Bailee

Art. 1935. The bailee in commodatum acquires


the used of the thing loaned but not its fruits...

Art. 1940. A stipulation that the bailee may make


use of the fruits of the thing loaned is valid.

Art. 1939. Commodatum is purely personal in


character. Consequently:
... (2) The bailee can neither lend nor lease the
object of the contract to a third person.
However, the members of the bailee's household
may make use of the thing loaned,
unless there is a stipulation to the contrary, or
unless the nature of the thing forbids such use.

Generally, the bailee acquires the permissive use of the

Blacks Law Dictionary, Ninth Edition (2009).


Commodatun 171

property loaned but not its fruits. However, the parties


may validly stipulate that the bailee acquires the permis-
sive use of the fruits of the property.

Because commodatum is purely personal in character, the


general rule is that the bailee acquires the permissive use
of the property only for itself and can neither lend nor
lease the object of the commodatum to a third person.
However, the members of the bailee's household, such as
his family and those living with him, may make use of the
property loaned unless:

a. There is a stipulation to the contrary, and

b. The nature of the property forbids its use by anyone


other than the bailee.

3. Solidary Liability of Bailees

Art. 1945. When there are two or more bailees to


whom a thing is loaned in the same contract, they
are liable solidarily.

C. Liability for Expenses and Damages

1. Ordinary Expenses

Art. 1933... In commodatum the bailor retains the


ownership of the thing loaned...

Art. 1935. The bailee in commodatum acquires


the used of the thing loaned but not its fruits...

Art. 1941. The bailee is obliged to pay for the or-


dinary expenses for the use and preservation of
the thing loaned.
72 1 Credit Transactions: Notes and Cases

Art. 1943. The bailee does not answer for the de-
terioration of the thing loaned due only to the use
thereof and without his fault.

Having acquired the permissive use of the property


loaned and incurred the obligation to return the very
same property; it is the bailee who is liable for the ordi-
nary expenses for its use and preservation. However,
this does not mean that the bailee is liable for the deteri-
oration of the property loaned due only to the use thereof,
and without fault. It is to be expected that the property
loaned will suffer ordinary wear and tear that arises from
actual use by the bailee.

Pajuyo v. Court of Appeals, G.R. No. 146364, June


3, 2004, 430 SCRA 492.

... In June 1979, petitioner Colito T. Pajuyo ("Pa-


juyo") paid P-400 to a certain Pedro Perez for the
rights over a 250-square meter lot in Barrio Paya-
tas, Quezon City. Pajuyo then constructed a house
made of light materials on the lot... On 8 Decem-
ber 1985, Pajuyo and private respondent Eddie
Guevarra ("Guevarra") executed a Kasunduan or
agreement. Pajuyo, as owner of the house, allowed
Guevarra to live in the house for free provided
Guevarra would maintain the cleanliness and or-
derliness of the house. Guevarra promised that he
would voluntarily vacate the premises on Pajuyo's
demand.

In September 1994, Pajuyo informed Guevarra of


his need of the house and demanded that Guevarra
vacate the house. Guevarra refused.
CommodatumI 73

Pajuyo filed an ejectment case against Guevarra


with the Metropolitan Trial Court of Quezon City,
Branch 31 ("MTC").

In his Answer, Guevarra claimed that Pajuyo had


no valid title or right of possession over the lot
where the house stands because the lot is within
the 150 hectares set aside by Proclamation No. 137
for socialized housing. Guevarra pointed out that
from December 1985 to September 1994, Pajuyo did
not show up or communicate with him. Guevarra
insisted that neither he nor Pajuyo has valid title to
the lot.

On 15 December 1995, the MTC rendered its deci-


sion in favor of Pajuyo... Aggrieved, Guevarra
appealed to the Regional Trial Court of Quezon
City, Branch 81 ("RTC").

On 11 November 1996, the RTC affirmed the MTC


decision... On 3 January 1997, Guevarra filed his
petition for review with the Supreme Court.

On 8 January 1997, the First Division of the Su-


preme Court issued a Resolution referring the mo-
tion for extension to the Court of Appeals which
has concurrent jurisdiction over the case... On 21
June 2000, the Court of Appeals issued its decision
reversing the RTC decision...

The case for review before the Court of Appeals


was a simple case of ejectment. The Court of Ap-
peals refused to rule on the issue of physical pos-
session. Nevertheless, the appellate court held that
the pivotal issue in this case is who between Pajuyo
74 1 Credit Transactions: Notes and Cases

and Guevarra has the "priority right as beneficiary


of the contested land under Proclamation No. 137."
According to the Court of Appeals, Guevarra en-
joys preferential right under Proclamation No. 137
because Article VI of the Code declares that the ac-
tual occupant or caretaker is the one qualified to
apply for socialized housing... The Court of Ap-
peals' determination of Pajuyo and Guevarra's
rights under Proclamation No. 137 was premature.
Pajuyo and Guevarra were at most merely poten-
tial beneficiaries of the law. Courts should not
preempt the decision of the administrative agency
mandated by law to determine the qualifications of
applicants for the acquisition of public lands. In-
stead, courts should expeditiously resolve the issue
of physical possession in ejectment cases to prevent
disorder and breaches of peace.

Pajuyo is Entitled to Physical Possession of the Dis-


puted Property
Guevarra does not dispute Pajuyo's prior posses-
sion of the lot and ownership of the house built on
it. Guevarra expressly admitted the existence and
due execution of the Kasunduan. The Kasunduan
reads:
Ako, si COL[I]TO PAJUYO, may-ari ng bahay at
lote sa Bo. Payatas, Quezon City, ay nagbibigay
pahintulot kay G. Eddie Guevarra, na pansamanta-
lang manirahan sa nasabing bahay at lote ng "wa-
lang bayad." Kaugnay nito, kailangang panatilihin
nila ang kalinisan at kaayusan ng bahay at lote.
Sa sandaling kailangan na namin ang bahay at lote,
sila'y kusang aalis ng walang reklamo.
Commodatum 175

Based on the Kasunduan, Pajuyo permitted Guevar-


ra to reside in the house and lot free of rent, but
Guevarra was under obligation to maintain the
premises in good condition. Guevarra promised to
vacate the premises on Pajuyo's demand but Gue-
varra broke his promise and refused to heed Pa-
juyo's demand to vacate.

These facts make out a case for unlawful detainer.


Unlawful detainer involves the withholding by a
person from another of the possession of real prop-
erty to which the latter is entitled after the expira-
tion or termination of the former's right to hold
possession under a contract,express or implied.

Where the plaintiff allows the defendant to use his


property by tolerance without any contract, the de-
fendant is necessarily bound by an implied prom-
ise that he will vacate on demand, failing which, an
action for unlawful detainer will lie. The defen-
dant's refusal to comply with the demand makes
his continued possession of the property unlawful.
The status of the defendant in such a case is similar
to that of a lessee or tenant whose term of lease has
expired but whose occupancy continues by toler-
ance of the owner.

This principle should apply with greater force in


cases where a contract embodies the permission or
tolerance to use the property. The Kasunduan ex-
pressly articulated Pajuyo's forbearance. Pajuyo
did not require Guevarra to pay any rent but only
to maintain the house and lot in good condition.
Guevarra expressly vowed in the Kasunduan that
he would vacate the property on demand. Guevar-
76 1 Credit Transactions: Notes and Cases

ra's refusal to comply with Pajuyo's demand to va-


cate made Guevarra's continued possession of the
property unlawful.

We do not subscribe to the Court of Appeals'


theory that the Kasunduan is one of commodatum.

In a contract of commodatum, one of the parties de-


livers to another something not consumable so that
the latter may use the same for a certain time and
return it. An essential feature of commodatum is that
it is gratuitous. Another feature of commodatum is
that the use of the thing belonging to another is for
a certain period. Thus, the bailor cannot demand
the return of the thing loaned until after expiration
of the period stipulated, or after accomplishment of
the use for which the commodatum is constituted. If
the bailor should have urgent need of the thing, he
may demand its return for temporary use. If the
use of the thing is merely tolerated by the bailor, he
can demand the return of the thing at will, in
which case the contractual relation is called a preca-
rium. Under the Civil Code, precarium is a kind of
commodatum.

The Kasunduan reveals that the accommodation ac-


corded by Pajuyo to Guevarra was not essentially
gratuitous. While the Kasunduan did not require
Guevarra to pay rent, it obligated him to maintain
the property in good condition. The imposition of
this obligation makes the Kasunduan a contract dif-
ferent from a commodatum. The effects of the Ka-
sunduan are also different from that of a commoda-
tum. Case law on ejectment has treated relationship
based on tolerance as one that is akin to a landlord-
Commodatum 1 77

tenant relationship where the withdrawal of per-


mission would result in the termination of the
lease. The tenant's withholding of the property
would then be unlawful. This is settled jurispru-
dence.

Even assuming that the relationship between Pa-


juyo and Guevarra is one of commodatum, Guevarra
as bailee would still have the duty to turn over
possession of the property to Pajuyo, the bailor.
The obligation to deliver or to return the thing re-
ceived attaches to contracts for safekeeping, or con-
tracts of commission, administration and commoda-
tum. These contracts certainly involve the obliga-
tion to deliver or return the thing received.

Guevarra turned his back on the Kasunduan on the


sole ground that like him, Pajuyo is also a squatter.
Squatters, Guevarra pointed out, cannot enter into
a contract involving the land they illegally occupy.
Guevarra insists that the contract is void.

Guevarra should know that there must be honor


even between squatters. Guevarra freely entered
into the Kasunduan. Guevarra cannot now impugn
the Kasunduan after he had benefited from it. The
Kasunduan binds Guevarra.

The Kasunduan is not void for purposes of deter-


mining who between Pajuyo and Guevarra has a
right to physical possession of the contested prop-
erty. The Kasunduan is the undeniable evidence of
Guevarra's recognition of Pajuyo's better right of
physical possession. Guevarra is clearly a posses-
sor in bad faith. The absence of a contract would
78 1 Credit Transactions: Notes and Cases

not yield a different result, as there would still be


an implied promise to vacate... Pajuyo's with-
drawal of his permission to Guevarra terminated
the Kasunduan. Guevarra's transient right to pos-
sess the property ended as well. Moreover, it was
Pajuyo who was in actual possession of the proper-
ty because Guevarra had to seek Pajuyo's permis-
sion to temporarily hold the property and Guevar-
ra had to follow the conditions set by Pajuyo in the
Kasunduan. Control over the property still rested
with Pajuyo and this is evidence of actual posses-
sion.

... We sustain the 42300 monthly rentals the MTC


and RTC assessed against Guevarra. Guevarra did
not dispute this factual finding of the two courts.
We find the amount reasonable compensation to
Pajuyo. The 4300 monthly rental is counted from
the last demand to vacate, which was on 16 Febru-
ary 1995...

In the case of Pajuyo, the obligation to "maintain the


cleanliness and orderliness" of the property loaned was
equated with compensation. Thus, the contract was not
considered a commodatum, which after all is essentially
gratuitous. But expenses for "cleanliness and orderliness"
are undoubtedly ordinary expenses for use, which a bai-
lee is liable for. How is this case reconciled with Article
1941?

2. Extraordinary Expenses

Art. 1949. The bailor shall refund the extraordi-


nary expenses during the contract for the preser-
vation of the thing loaned,
Commodatum 179

provided the bailee brings the same to the know-


ledge of the bailor before incurring them,
except when they are so urgent that the reply to
the notification cannot be awaited without dan-
ger.

If the extraordinary expenses arise on the occa-


sion of the actual use of the thing by the bailee,
even though he acted without fault, they shall be
borne equally by both the bailor and the bailee,
unless there is a stipulation to the contrary.

Since the bailor retains the ownership of the property


loaned, the general rule is that the bailor is liable for the
extraordinary expenses for the preservation of the prop-
erty loaned. The exception is if the bailee incurs these
expenses without informing the bailor before incurring
them, in which case, it is the bailee who shall be liable.
However, if the extraordinary expenses for preservation
are so urgent that the reply of the bailor to the notification
cannot be awaited without danger to the property loaned,
then the general rule applies, that is, the bailor shall re-
main liable.

Since the bailor retains ownership of the property loaned,


and the bailee acquires its use, then it is the bailor and
bailee who are equally liable for extraordinary expenses
that arise from the actual use by the bailee. The parties,
however, may stipulate otherwise.

3. Other Expenses

Art. 1950. If, for the purpose of making use of the


thing, the bailee incurs expenses other than those
80 I Credit Transactions: Notes and Cases

referred to in Articles 1941 and 1949, he is not en-


titled to reimbursement.

The bailee is liable for all other expenses incurred for


purposes of making use of the property loaned, other
than ordinary and extraordinary expenses for use and
preservation. What would these other expenses cover?

4. Abandonment by Bailor

Art. 1952. The bailor cannot exempt himself from


the payment of expenses or damages by abandon-
ing the thing to the bailee.

The bailor cannot exempt himself from liability for ex-


penses and damages by abandoning the property loaned
to the bailee. The bailee has a right to compel the bailor to
pay for the pertinent expenses.

5. Right of Retention by Bailee

Art. 1944. The bailee cannot retain the thing


loaned on the ground that the bailor owes him
something, even though it may be by reason of
expenses. However, the bailee has a right of re-
tention for damages mentioned in Article 1951.

Art. 1951. The bailor who, knowing the flaws of


the thing loaned, does not advise the bailee of the
same, shall be liable to the latter for the damages
which he may suffer by reason thereof.

The primary obligation on the part of the bailee is to re-


turn the property loaned. Generally, the bailee has no
right of retention over the property loaned if the bailor
Commodatum I 81

refuses to pay for expenses and damages that pertain to it.


The right of action of the bailee is to demand payment for
the expenses and damages incurred that properly pertain
to the bailor.

The only exception is when the bailor, knowing the flaws


of the property loaned, does not advise the bailee of the
same, and the bailee suffers damages by reason thereof, in
which case, the bailee has a right of retention over the
property loaned until the bailor answers for the damages.

The object of any right of retention is to guarantee pay-


ment of what may be due. The principal characteristic of
the right of retention is its accessory character. It is acces-
sory to a principal obligation. This right of retention of the
property by the creditor is considered not a coercive
measure to oblige the debtor to pay, depriving him tem-
porarily of the enjoyment of the property, but as a means
of obtaining compensation for the debt and as a means of
4
extinguishing an obligation.

D. Liability for Loss

Art. 1933... In commodatum the bailor retains the


ownership of the thing loaned...

Art. 1942. The bailee is liable for the loss of the


thing, even if it should be through a fortuitous
event:
(1) If he devotes the thing to any purpose differ-
ent from that for which it has been loaned;
(2) If he keeps it longer than the period stipu-
lated, or after the accomplishment of the use for

4 Ortiz v. Kayanan, et a., G.R. No. L-32974, July 30,1979,92 SCRA 146.
82 1 Credit Transactions: Notes and Cases

which the commodatum has been constituted;


(3) 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;
(4) If he lends or leases the thing to a third per-
son, who is not a member of his household;
(5) If, being able to save either the thing bor-
rowed or his own thing, he chose to save the lat-
ter.

Since the bailor retains ownership of the property loaned,


the general rule is that it is the bailor who bears the liabil-
ity for loss of the property loaned due to fortuitous event.
However, the liability for loss whether due to fortuitous
event or not, is shifted to the bailee in the following in-
stances:

1. If the bailee devotes the property to a different pur-


pose. This amounts to a breach of the conditions of the
commodatum.

2. If the bailee keeps the property longer than the stipu-


lated period. This amounts to delay.

3. If the bailee keeps the property after the accomplish-


ment of the stated use. This also amounts to delay.

4. If the property loaned was delivered with an ap-


praised value. The intention of the parties is to shift the
liability for loss due to fortuitous event to the bailee.
However, if there is a stipulation that exempts the bailee
from loss due to fortuitous event, then the appraised val-
ue will not shift the liability to the bailee.
Commodatum 183

5. If the bailee lends or leases the property to a third per-


son that is not a member of the household. This amounts
to a breach of the conditions of the commodatum.

6. If being able to save the property loaned or property


owned by the bailee, the bailee chooses to save the latter.
Since the consideration of a commodatum is liberality on
the part of the bailor, this amounts to an act of ingrati-
tude.

Republic v. Bagtas, G.R. No. L-17474, October 25,


1962, 6 SCRA 262.

... On 8 May 1948 Jose V. Bagtas borrowed from


the Republic of the Philippines through the Bureau
of Animal Industry three bulls: a Red Sindhi with a
book value of P1,176.46, a Bhagnari, of P1,320.56
and a Sahiniwal, of P744.46, for a period of one
year from 8 May 1948 to 7 May 1949 for breeding
purposes subject to a government charge of breed-
ing fee of 10% of the book value of the bulls. Upon
the expiration on 7 May 1949 of the contract, the
borrower asked for a renewal for another period of
one year. However, the Secretary of Agriculture
and Natural Resources approved a renewal thereof
of only one bull for another year from 8 May 1949
to 7 May 1950 and requested the return of the other
two. On 25 March 1950 Jose V. Bagtas wrote to the
Director of Animal Industry that he would pay the
value of the three bulls. On 17 October 1950 he rei-
terated his desire to buy them at a value with a de-
duction of yearly depreciation to be approved by
the Auditor General. On 19 October 1950 the Direc-
tor of Animal Industry advised him that the book
value of the three bulls could not be reduced and
84 I Credit Transactions: Notes and Cases

that they either be returned or their book value


paid not later than 31 October 1950. Jose V. Bagtas
failed to pay the book value of the three bulls or to
return them. So, on 20 December 1950 in the Court
of First Instance of Manila the Republic of the Phil-
ippines commenced an action against him praying
that he be ordered to return the three bulls loaned
to him or to pay their book value in the total sum
of P3,241.45 and the unpaid breeding fee in the
sum of P199.62... On 5 July 1951 Jose V. Bagtas ...
answered that because of the bad peace and order
situation in Cagayan Valley, particularly in the
barrio of Baggao, and of the pending appeal he had
taken to the Secretary of Agriculture and Natural
Resources and the President of the Philippines
from the refusal by the Director of Animal Industry
to deduct from the book value of the bulls corres-
ponding yearly depreciation of 8% from the date of
acquisition, to which depreciation the Auditor
General did not object, he could not return the an-
imals nor pay their value and prayed for the dis-
missal of the complaint.

After hearing, on 30 July 1956 the trial court render


judgment ... sentencing the latter (defendant) to
pay the sum of P3,625.09 the total value of the three
bulls plus the breeding fees in the amount of
P626.17 with interest on both sums of (at) the legal
rate from the filing of this complaint and costs.

On 9 October 1958 the plaintiff moved ex parte for


a writ of execution which the court granted on 18
October and issued on 11 November 1958. On 2
December 1958 granted an ex-parte motion filed by
the plaintiff on November 1958 for the appoint-
Commodatum 1 85

ment of a special sheriff to serve the writ outside


Manila. Of this order appointing a special sheriff,
on 6 December 1958, Felicidad M. Bagtas, the sur-
viving spouse of the defendant Jose Bagtas who
died on 23 October 1951 and as administratrix of
his estate, was notified. On 7 January 1959 she file a
motion.... praying that the writ of execution be
quashed and that a writ of preliminary injunction
be issued ... the Court denied her motion. Hence,
this appeal certified by the Court of Appeals to this
Court...

It is true that on 26 June 1952 Jose M. Bagtas, Jr.,


son of the appellant by the late defendant, returned
the Sindhi and Bhagnari bulls to Roman Remorin,
Superintendent of the NVB Station, Bureau of An-
imal Industry, Bayombong, Nueva Vizcaya, as evi-
denced by a memorandum receipt signed by the
latter... She cannot be held liable for the two bulls
which already had been returned to and received
by the appellee.

The appellant contends that the Sahiniwal bull was


accidentally killed during a raid by the Huk in No-
vember 1953 upon the surrounding barrios of Ha-
cienda Felicidad Intal, Baggao, Cagayan, where the
animal was kept, and that as such death was due to
force majeure she is relieved from the duty of re-
turning the bull or paying its value to the appellee.
The contention is without merit. The loan by the
appellee to the late defendant Jose V. Bagtas of the
three bulls for breeding purposes for a period of
one year from 8 May 1948 to 7 May 1949, later on
renewed for another year as regards one bull, was
subject to the payment by the borrower of breeding
86 1 Credit Transactions: Notes and Cases

fee of 10% of the book value of the bulls. The ap-


pellant contends that the contract was commodatum
and that, for that reason, as the appellee retained
ownership or title to the bull it should suffer its
loss due to force majeure. A contract of commodatum
is essentially gratuitous. If the breeding fee be con-
sidered a compensation, then the contract would
be a lease of the bull. Under article 1671 of the Civil
Code the lessee would be subject to the responsibil-
ities of a possessor in bad faith, because she had
continued possession of the bull after the expiry of
the contract. And even if the contract be commoda-
tum, still the appellant is liable, because (of) article
1942 of the Civil Code...

The original period of the loan was from 8 May


1948 to 7 May 1949. The loan of one bull was re-
newed for another period of one year to end on 8
May 1950. But the appellant kept and used the bull
until November 1953 when during a Huk raid it
was killed by stray bullets. Furthermore, when lent
and delivered to the deceased husband of the ap-
pellant the bulls had each an appraised book value,
to with: the Sindhi, at P1,176.46, the Bhagnari at
P1,320.56 and the Sahiniwal at P744.46. It was not
stipulated that in case of loss of the bull due to for-
tuitous event the late husband of the appellant
would be exempt from liability... As the appellant
already had returned the two bulls to the appellee,
the estate of the late defendant is only liable for the
sum of P859.63, the value of the bull which has not
been returned to the appellee, because it was killed
while in the custody of the adninistratrix of his es-
tate. This is the amount prayed for by the appellee
in its objection on 31 January 1959 to the motion
CoMotum I 87

filed on 7 January 1959 by the appellant for the


quashing of the writ of execution.

Special proceedings for the administration and set-


tlement of the estate of the deceased Jose V. Bagtas
having been instituted in the Court of First In-
stance of Rizal (Q-200), the money judgment ren-
dered in favor of the appellee cannot be enforced
by means of a writ of execution but must be pre-
sented to the probate court for payment by the ap-
pellant, the administratrix appointed by the court...

E. Obligation to Return

Art. 1933. By the contract of loan, one of the par-


ties delivers to another, either something not con-
sumable so that the latter may use the same for a
certain time and return it, in which case the con-
tract is called a commodatum...

Art. 1946. The bailor cannot demand the return of


the thing loaned till after the expiration of the pe-
riod stipulated, or after the accomplishment of
the use for which the commodatum has been con-
stituted. However, if in the meantime, he should
have urgent need of the thing, he may demand its
return or temporary use.

In case of temporary use by the bailor, the con-


tract of commodatum is suspended while the
thing is in the possession of the bailor.

Art. 1947. The bailor may demand the thing at


will, and the contractual relation is called a preca-
rium, in the following cases:
88 1 Credit Transactions: Notes and Cases

(1) If neither the duration of the contract nor the


use to which the thing loaned should be devoted,
has been stipulated; or
(2) If the use of the thing is merely tolerated by
the owner.

Art. 1948. The bailor may demand the immediate


return of the thing if the bailee commits any act
of ingratitude specified in Article 765.

The primary obligation of the bailee in commodatum is to


return the property loaned. But generally, the obligation
to return arises only:

1. After the expiration of the period stipulated, or

2. After the accomplishment of the use for which the


commodatum was constituted.

The exceptions to this rule, implying that the bailor may


demand the return of the property loaned, are:

1. If the bailor has urgent need of the property loaned, in


which case the bailor may:

a. Demand the return of the property; extinguishing the


commodatum; or

b. Demand the temporary use of the property; suspend-


ing the commodatum while the property is in the posses-
sion of the bailor.

2. If the commodatum is a precarium, or a contractual


relation where the bailor may demand the property
loaned at will, specifically if:
Commodatum I 89

a. Neither the duration nor the use to which the property


loaned has been stipulated; or

b. Where the use by the bailee is merely tolerated by the


bailor.

3. Underscoring that the consideration of a commoda-


tum is the liberality of the bailor, if the bailee commits any
of the following acts of ingratitude:

a. The bailee commits some offense against the person,


the honor or the property of the bailor, or the bailor's wife
or children under parental authority;

b. The bailee imputes to the bailor any criminal offense,


or any act involving moral turpitude, even though it be
proved, unless the crime or the act has been committed
against the bailee, the bailee's wife or children under pa-
rental authority; or

c. The bailee unduly refuses the bailor support when the


bailee is legally or morally bound to give support to the
bailor.

Quintos v. Beck, G.R. No. L-46240, November 3,


1939, 69 Phil 108.

... The defendant was a tenant of the plaintiff and


as such occupied the latter's house on M. H. del Pi-
lar Street, No. 1175. On January 14, 1936, upon the
novation of the contract of lease between the plain-
tiff and the defendant, the former gratuitously
granted to the latter the use of the furniture de-
scribed in the third paragraph of the stipulation of
facts, subject to the condition that the defendant
90 1 Credit Transactions: Notes and Cases

would return them to the plaintiff upon the latter's


demand. The plaintiff sold the property to Maria
Lopez and Rosario Lopez and on September 14,
1936, these three notified the defendant of the con-
veyance, giving him sixty days to vacate the pre-
mises under one of the clauses of the contract of
lease. Thereafter the plaintiff required the defen-
dant to return all the furniture transferred to him
for them in the house where they were found. On
November 5, 1936, the defendant, through another
person, wrote to the plaintiff reiterating that she
may call for the furniture in the ground floor of the
house. On the 7th of the same month, the defen-
dant wrote another letter to the plaintiff informing
her that he could not give up the three gas heaters
and the four electric lamps because he would use
them until the 15th of the same month when the
lease was due to expire. The plaintiff refused to get
the furniture in view of the fact that the defendant
had declined to make delivery of all of them. On
November 15th, before vacating the house, the de-
fendant deposited with the Sheriff all the furniture
belonging to the plaintiff and they are now on de-
posit in the warehouse situated at No. 1521, Rizal
Avenue, in the custody of the said sheriff.

... To dispose of the case, it is only necessary to de-


cide whether the defendant complied with his ob-
ligation to return the furniture upon the plaintiff's
demand; whether the latter is bound to bear the
deposit fees thereof, and whether she is entitled to
the costs of litigation.

The contract entered into between the parties is one


of commodatum, because under it the plaintiff gra-
Commodatum j 91

tuitously granted the use of the furniture to the de-


fendant, reserving for herself the ownership the-
reof; by this contract the defendant bound himself
to return the furniture to the plaintiff, upon the lat-
ter's demand (clause 7 of the contract, Exhibit A;
articles 1740, paragraph 1, and 1741 of the Civil
Code). The obligation voluntarily assumed by the
defendant to return the furniture upon the plain-
tiff's demand, means that he should return all of
them to the plaintiff at the latter's residence or
house. The defendant did not comply with this ob-
ligation when he merely placed them at the dis-
posal of the plaintiff, retaining for his benefit the
three gas heaters and the four electric lamps... As
the defendant had voluntarily undertaken to return
all the furniture to the plaintiff, upon the latter's
demand, the Court could not legally compel her to
bear the expenses occasioned by the deposit of the
furniture at the defendant's behest. The latter, as
bailee, was not entitled to place the furniture on
deposit; nor was the plaintiff under a duty to ac-
cept the offer to return the furniture, because the
defendant wanted to retain the three gas heaters
and the four electric lamps... The costs in both in-
stances should be borne by the defendant because
the plaintiff is the prevailing party (section 487 of
the Code of Civil Procedure). The defendant was
the one who breached the contract of commodatum,
and without any reason he refused to return and
deliver all the furniture upon the plaintiff's de-
mand. In these circumstances, it is just and equita-
ble that he pay the legal expenses and other judicial
costs which the plaintiff would not have otherwise
defrayed.
92 1 Credit Transactions: Notes and Cases

The appealed judgment is modified and the defen-


dant is ordered to return and deliver to the plain-
tiff, in the residence to return and deliver to the
plaintiff, in the residence or house of the latter, all
the furniture described in paragraph 3 of the stipu-
lation of facts Exhibit A. The expenses which may
be occasioned by the delivery to and deposit of the
furniture with the Sheriff shall be for the account of
the defendant. The defendant shall pay the costs in
both instances.
Chapter 3. Simple Loan

A. General Concepts

Art. 1933. By the contract of loan, one of the par-


ties delivers to another... money or other con-
sumable thing, upon the 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...
Simple loan may be gratuitous or with a stipula-
tion to pay interest.
In ... simple loan, ownership passes to the bor-
rower.

Art. 1953. A person who receives a loan of money


or any other fungible thing acquires the owner-
ship thereof, and is bound to pay to the creditor
an equal amount of the same kind and quality.

Art. 1954. A contract whereby one person trans-


fers the ownership of non-fungible things to
another with the obligation on the part of the lat-
ter to give things of the same kind, quantity, and
quality shall be considered a barter.

Art. 1980. Fixed, savings, and current deposits of


money in banks and similar institutions shall be
governed by the provisions concerning simple
loan.

By a contract of simple loan or mutuum, the creditor de-


livers to the debtor (or borrower) money or other con-
sumable property upon the condition that the same
amount of the same kind and quality shall be paid.
94 1 Credit Transactions: Notes and Cases

The contract of simple loan, or loan for consumption', is


entered into regularly in ordinary life - borrowing an ex-
amination booklet from a friend or a cup of sugar from a
neighbor. But it is this type of simple loan, involving, as it
does, money, that serves as basis for most commercial
credit transactions. In fact, the most common of all com-
mercial credit transactions, the deposit by a depositor of
money in a fixed, savings or current deposit account with
a bank, is a simple loan.

In simple loan, as contrasted to commodatum, the bor-


rower acquires ownership of the money or consumable
property for the permissive use of the property loaned.
Being the owner, the borrower can dispose of the proper-
ty loaned and this act of disposition will not be consi-
2
dered misappropriation.

Use of consumable property generally results in its extin-


guishment, which is why the obligation of the borrower in
a simple loan is to pay an equal amount of the same kind
and quality, effectively replacing or substituting the
property loaned. It is for this reason that the provisions
on simple loan also refer to the object of a simple loan as
fungible property, that is, property commercially inter-
3
changeable with other property of the same kind:
Act No. 21374, Sec. 58... "Fungible goods" means
goods of which any unit is, from its nature by
mercantile custom, treated as the equivalent of
any other unit.
However, in simple loan, the primary purpose of the con-

' Radin, Handbook of Roman Law (1927).


2 Chee KiOng Yam, et al. v. Malik, et al., G.R. No. L-50550-52, October 31,
1979, 94 SCRA 30.
3 Blacks Law Dictionary, Ninth Edition (2009).
4 Act No. 2137 (1912), The Warehouse Receipts Law.
Simple Loan I 95

tract is still the permissive use of the money or consuma-


ble property. But since the use of a consumable generally
results in its consumption or extinguishment, ownership
is transferred as a necessary consequence of the permis-
sive use of the property loaned.

If the primary purpose of the contract is the transfer of


ownership of a non-fungible property and payment is
made by giving some thing of the same kind, quantity,
5
and quality, it is a contract of barter.

People v. Puig and Porras, G.R. No. 173654-765,


August 28, 2008, 563 SCRA 564.

... On 7 November 2005, the Iloilo Provincial Pros-


ecutor's Office filed before Branch 68 of the RTC in
Dumangas, Iloilo, 112 cases of Qualified Theft
against respondents Teresita Puig (Puig) and Ro-
meo Porras (Porras) who were the Cashier and
Bookkeeper, respectively, of private complainant
Rural Bank of Pototan, Inc...

The allegations in the Informations filed before the


RTC were uniform and pro-forma, except for the
amounts, date and time of commission, to wit:
... That on or about the 1st day of August, 2002, in
the Municipality of Pototan, Province of Hoilo,
Philippines, and within the jurisdiction of this Ho-
norable Court, above-named [respondents], con-

5 Civil Code, Art. 1638. By the contract of barter or exchange one of the par-
ties binds himself to give one thing in consideration of the other's promise
to give another thing.
Art 1641. As to all matters not specifically provided for in this Title (on
barter), barter shall be governed by the provisions of the preceding Title re-
lating to sales.
96 1 Credit Transactions: Notes and Cases

spiring, confederating, and helping one another,


with grave abuse of confidence, being the Cashier and
Bookkeeper of the Rural Bank of Pototan, Inc., Poto-
tan, Iloilo, without the knowledge and/or consent
of the management of the Bank and with intent of
gain, did then and there willfully, unlawfully and
feloniously take, steal and carry away the sum of
FIFTEEN THOUSAND PESOS (P15,000.00), Phi-
lippine Currency, to the damage and prejudice of
the said bank in the aforesaid amount.

After perusing the Informations in these cases, the


trial court did not find the existence of probable
cause that would have necessitated the issuance of
a warrant of arrest based on the following grounds:
(1) the element of 'taking without the consent of
the owners' was missing on the ground that it is
the depositors-clients, and not the Bank, which
filed the complaint in these cases, who are the
owners of the money allegedly taken by respon-
dents and hence, are the real parties-in-interest;
and

...A Motion for Reconsideration was filed on 17


April 2006, by the petitioner.

On 9 June 2006, an Order denying petitioner's Mo-


tion for Reconsideration was issued by the RTC...
Petitioner went directly to this Court via Petition
for Review on Certiorariunder Rule 45...

... Petitioner explains that under Article 1980 of the


New Civil Code, "fixed, savings, and current depo-
sits of money in banks and similar institutions shall
be governed by the provisions concerning simple
Simple Loan I 97

loans." Corollary thereto, Article 1953 of the same


Code provides that "a person who receives a loan
of money or any other fungible thing acquires the
ownership thereof, and is bound to pay to the cred-
itor an equal amount of the same kind and quali-
ty." Thus, it posits that the depositors who place
their money with the bank are considered creditors
of the bank. The bank acquires ownership of the
money deposited by its clients, making the money
taken by respondents as belonging to the bank.

Qualified Theft, as defined and punished under


...
Article 310 of the Revised Penal Code, is commit-
ted as follows, viz:
ART. 310. Qualified Theft. - The crime of theft shall
be punished by the penalties next higher by two
degrees than those respectively specified in the
next preceding article, if committed by a domestic
servant, or with grave abuse of confidence, or if the
property stolen is motor vehicle, mail matter or
large cattle or consists of coconuts taken from the
premises of a plantation, fish taken from a fish-
pond or fishery or if property is taken on the occa-
sion of fire, earthquake, typhoon, volcanic erup-
tion, or any other calamity, vehicular accident or
civil disturbance...

Theft, as defined in Article 308 of the Revised Penal


Code, requires the physical taking of another's
property without violence or intimidation against
persons or force upon things... It is beyond doubt
that tellers, Cashiers, Bookkeepers and other em-
ployees of a Bank who come into possession of the
monies deposited therein enjoy the confidence re-
posed in them by their employer. Banks, on the
98 1 Credit Transactions: Notes and Cases

other hand, where monies are deposited, are con-


sidered the owners thereof. This is very clear not
only from the express provisions of the law, but
from established jurisprudence. The relationship
between banks and depositors has been held to be
that of creditor and debtor. Articles 1953 and 1980
of the New Civil Code, as appropriately pointed
out by petitioner... In a long line of cases involv-
ing Qualified Theft, this Court has firmly estab-
lished the nature of possession by the Bank of the
money deposits therein, and the duties being per-
formed by its employees who have custody of the
money or have come into possession of it. The
Court has consistently considered the allegations in
the Information that such employees acted with
grave abuse of confidence, to the damage and pre-
judice of the Bank, without particularly referring to
it as owner of the money deposits, as sufficient to
make out a case of Qualified Theft... In summary,
the Bank acquires ownership of the money depo-
sited by its clients; and the employees of the Bank,
who are entrusted with the possession of money of
the Bank due to the confidence reposed in them,
occupy positions of confidence. The Informations,
therefore, sufficiently allege all the essential ele-
ments constituting the crime of Qualified Theft.

... WHEREFORE, premises considered, the Petition


for Review on Certiorari is hereby GRANTED. The
Orders dated 30 January 2006 and 9 June 2006 of
the RTC dismissing Criminal Cases No. 05-3054 to
05-3165 are REVERSED and SET ASIDE. Let the
corresponding Warrants of Arrest issue against
herein respondents TERESITA PUIG and ROMEO
PORRAS. The RTC Judge of Branch 68, in Duman-
Simple Loan 99

gas, floilo, is directed to proceed with the trial of


Criminal Cases No. 05-3054 to 05-3165, inclusive,
with reasonable dispatch. No pronouncement as to
costs.

BPI Family Bank v. Franco, G.R. No. 123498, No-


vember 23, 2007, 538 SCRA 184.

... On August 15, 1989, Tevesteco Arrastre-


Stevedoring Co., Inc. (Tevesteco) opened a savings
and current account with BPI-FB. Soon thereafter,
or on August 25, 1989, First Metro Investment Cor-
poration (FMIC) also opened a time deposit ac-
count with the same branch of BPI-FB with a depo-
sit of 12100,000,000.00, to mature one year thence.

Subsequently, on August 31, 1989, Franco opened


three accounts, namely, a current, savings, and
time deposit, with BPI-FB. The current and savings
accounts were respectively funded with an initial
deposit of -2500,000.00 each, while the time deposit
account had 121,000,000.00 with a maturity date of
August 31, 1990. The total amount of P-2,000,000.00
used to open these accounts is traceable to a check
issued by Tevesteco allegedly in consideration of
Franco's introduction of Eladio Teves, who was
looking for a conduit bank to facilitate Tevesteco's
business transactions, to Jaime Sebastian, who was
then BPI-FB SFDM's Branch Manager. In turn, the
funding for the -P2,000,000.00 check was part of the
P-80,000,000.00 debited by BPI-FB from FMIC's
time deposit account and credited to Tevesteco's
current account pursuant to an Authority to Debit
purportedly signed by FMIC's officers.
100 1 Credit Transactions: Notes and Cases

It appears, however, that the signatures of FMIC's


officers on the Authority to Debit were forged...
On September 8,1989, impelled by the need to pro-
tect its interests in light of FMIC's forgery claim,
BPI-FB, thru its Senior Vice-President, Severino Co-
ronacion, instructed Jesus Arangorin to debit Fran-
co's savings and current accounts for the amounts
remaining therein. However, Franco's time deposit
account could not be debited due to the capacity
limitations of BPI-FB's computer.

In the meantime, two checks drawn by Franco


against his BPI-FB current account were disho-
nored upon presentment for payment, and
stamped with a notation "account under garnish-
ment." Apparently, Franco's current account was
garnished by virtue of an Order of Attachment...
Notably, the dishonored checks were issued by
Franco and presented for payment at BPI-FB prior
to Franco's receipt of notice that his accounts were
under garnishment. In fact, at the time the Notice
of Garnishment dated September 27, 1989 was
served on BPI-FB, Franco had yet to be impleaded
in the Makati case where the writ of attachment
was issued.

It was only on May 15, 1990, through the service of


a copy of the Second Amended Complaint in Civil
Case No. 89-4996, that Franco was impleaded in
the Makati case. Immediately, upon receipt of such
copy, Franco filed a Motion to Discharge Attach-
ment which the Makati RTC granted on May 16,
1990. The Order Lifting the Order of Attachment
was served on BPI-FB on even date, with Franco
demanding the release to him of the funds in his
Simple Loan 101

savings and current accounts... On May 17, 1990,


Franco pre-terminated his time deposit account.
BPI-FB deducted the amount of P-63,189.00 from
the remaining balance of the time deposit account
representing advance interest paid to him...
Meanwhile, BPI-FB filed separate civil and criminal
cases against those believed to be the perpetrators
of the multi-million peso scam. In the criminal case,
Franco, along with the other accused, except for
Manuel Bienvenida who was still at large, were ac-
quitted of the crime of Estafa as defined and pena-
lized under Article 351, par. 2(a) of the Revised
Penal Code. However, the civil case remains under
litigation and the respective rights and liabilities of
the parties have yet to be adjudicated.

Consequently, in light of BPI-FB's refusal to heed


Franco's demands to unfreeze his accounts and re-
lease his deposits therein, the latter filed on June 4,
1990 with the Manila RTC the subject suit. In his
complaint, Franco prayed for the following reliefs:
(1) the interest on the remaining balance of his cur-
rent account which was eventually released to him
on October 31, 1991; (2) the balance on his savings
account, plus interest thereon; (3) the advance in-
terest paid to him which had been deducted when
he pre-terminated his time deposit account; and (4)
the payment of actual, moral and exemplary dam-
ages, as well as attorney's fees.

BPI-FB traversed this complaint, insisting that it


was correct in freezing the accounts of Franco and
refusing to release his deposits, claiming that it had
a better right to the amounts which consisted of
part of the money allegedly fraudulently with-
102 I Credit Transactions: Notes and Cases

drawn from it by Tevesteco and ending up in Fran-


co's accounts. BPI-FB asseverated that the claimed
consideration of P2,000,000.00 for the introduction
facilitated by Franco between George Daantos and
Eladio Teves, on the one hand, and Jaime Sebas-
tian, on the other, spoke volumes of Franco's par-
ticipation in the fraudulent transaction.

On August 4, 1993, the Manila RTC rendered


judgment, the dispositive portion of which reads as
follows:
WHEREFORE, in view of all the foregoing, judg-
ment is hereby rendered in favor of [Franco] and
against [BPI-FB], ordering the latter to pay to the
former the following sums:
1. P76,500.00 representing the legal rate of interest
on the amount of P450,000.00 from May 18, 1990 to
October 31, 1991;
2. P-498,973.23 representing the balance on [Fran-
co's] savings account as of May 18, 1990, together
with the interest thereon in accordance with the
bank's guidelines on the payment therefor;
3. P-30,000.00 by way of attorney's fees; and
4. P10,000.00 as nominal damages...

Unsatisfied with the decision, both parties filed


their respective appeals before the CA. Franco con-
fined his appeal to the Manila RTC's denial of his
claim for moral and exemplary damages, and the
diminutive award of attorney's fees. In affirming
with modification the lower court's decision, the
appellate court decreed, to wit:
WHEREFORE, foregoing considered, the appealed
decision is hereby AFFIRMED with modification
ordering [BPI-FB] to pay [Franco] P-63,189.00
Simple Loan 1103

representing the interest deducted from the time


deposit of plaintiff-appellant. P200,000.00 as moral
damages and P100,000.00 as exemplary damages,
deleting the award of nominal damages (in view of
the award of moral and exemplary damages) and
increasing the award of attorney's fees from
P30,000.00 to P75,000.00...

In this recourse, BPI-FB ascribes error to the CA


when it ruled that: (1) Franco had a better right to
the deposits in the subject accounts which are part
of the proceeds of a forged Authority to Debit; (2)
Franco is entitled to interest on his current account;
(3) Franco can recover the P-400,000.00 deposit in
Quiaoit's savings account; (4) the dishonor of
Franco's checks was not legally in order; (5) BPI-FB
is liable for interest on Franco's time deposit, and
for moral and exemplary damages; and (6) BPI-
FB's counter-claim has no factual and legal anchor.

We are in full accord with the common ruling of


the lower courts that BPI-FB cannot unilaterally
freeze Franco's accounts and preclude him from
withdrawing his deposits. However, contrary to
the appellate court's ruling, we hold that Franco is
not entitled to unearned interest on the time depo-
sit as well as to moral and exemplary damages.

First. On the issue of who has a better right to the


deposits in Franco's accounts, BPI-FB urges us that
the legal consequence of FMIC's forgery claim is
that the money transferred by BPI-FB to Tevesteco
is its own, and considering that it was able to re-
cover possession of the same when the money was
104 1 Credit Transactions: Notes and Cases

redeposited by Franco, it had the right to set up its


ownership thereon and freeze Franco's accounts.

BPI-FB contends that its position is not unlike that


of an owner of personal property who regains pos-
session after it is stolen, and to illustrate this point,
BPI-FB gives the following example: where X's tel-
evision set is stolen by Y who thereafter sells it to
Z, and where Z unwittingly entrusts possession of
the TV set to X, the latter would have the right to
keep possession of the property and preclude Z
from recovering possession thereof. To bolster its
position, BPI-FB cites Article 559 of the Civil Code,
which provides:
Article 559. The possession of movable property
acquired in good faith is equivalent to a title. Nev-
ertheless, one who has lost any movable or has
been unlawfully deprived thereof, may recover it
from the person in possession of the same. If the
possessor of a movable lost or of which the owner
has been unlawfully deprived, has acquired it in
good faith at a public sale, the owner cannot obtain
its return without reimbursing the price paid there-
for.

BPI-FB's argument is unsound. To begin with, the


movable property mentioned in Article 559 of the
Civil Code pertains to a specific or determinate
thing. A determinate or specific thing is one that is
individualized and can be identified or distin-
guished from others of the same kind.

In this case, the deposit in Franco's accounts con-


sists of money which, albeit characterized as a
movable, is generic and fungible. The quality of be-
Simple Loan I 105

ing fungible depends upon the possibility of the


property, because of its nature or the will of the
parties, being substituted by others of the same
kind, not having a distinct individuality.

Significantly, while Article 559 permits an owner


who has lost or has been unlawfully deprived of a
movable to recover the exact same thing from the
current possessor, BPI-FB simply claims ownership
of the equivalent amount of money, i.e., the value
thereof, which it had mistakenly debited from
FMIC's account and credited to Tevesteco's, and
subsequently traced to Franco's account. In fact,
this is what BPI-FB did in filing the Makati Case
against Franco, et al. It staked its claim on the
money itself which passed from one account to
another, commencing with the forged Authority to
Debit.

It bears emphasizing that money bears no ear-


marks of peculiar ownership, and this characteris-
tic is all the more manifest in the instant case which
involves money in a banking transaction gone
awry. Its primary function is to pass from hand to
hand as a medium of exchange, without other evi-
dence of its title. Money, which had passed
through various transactions in the general course
of banking business, even if of traceable origin, is
no exception.

Thus, inasmuch as what is involved is not a specif-


ic or determinate personal property, BPI-FB's illu-
strative example, ostensibly based on Article 559, is
inapplicable to the instant case.
106 1 Credit Transactions: Notes and Cases

There is no doubt that BPI-FB owns the deposited


monies in the accounts of Franco, but not as a legal
consequence of its unauthorized transfer of FMIC's
deposits to Tevesteco's account. BPI-FB conve-
niently forgets that the deposit of money in banks
is governed by the Civil Code provisions on simple
loan or mutuum. As there is a debtor-creditor rela-
tionship between a bank and its depositor, BPI-FB
ultimately acquired ownership of Franco's depo-
sits, but such ownership is coupled with a corres-
ponding obligation to pay him an equal amount on
demand. Although BPI-FB owns the deposits in
Franco's accounts, it cannot prevent him from de-
manding payment of BPI-FB's obligation by draw-
ing checks against his current account, or asking
for the release of the funds in his savings account.
Thus, when Franco issued checks drawn against
his current account, he had every right as creditor
to expect that those checks would be honored by
BPI-FB as debtor.

More importantly, BPI-FB does not have a unila-


teral right to freeze the accounts of Franco based on
its mere suspicion that the funds therein were
proceeds of the multi-million peso scam Franco
was allegedly involved in. To grant BPI-FB, or any
bank for that matter, the right to take whatever ac-
tion it pleases on deposits which it supposes are
derived from shady transactions, would open the
floodgates of public distrust in the banking indus-
try.

Our pronouncement in Simex International(Manila),


Inc. v. Court of Appeals 6 continues to resonate, thus:

6 G.R. No. 88013, March 19,1990,183 SCRA 360.


Simple Loan 1 107

The banking system is an indispensable institution


in the modem world and plays a vital role in the
economic life of every civilized nation. Whether as
mere passive entities for the safekeeping and sav-
ing of money or as active instruments of business
and commerce, banks have become an ubiquitous
presence among the people, who have come to re-
gard them with respect and even gratitude and,
most of all, confidence. Thus, even the humble
wage-earner has not hesitated to entrust his life's
savings to the bank of his choice, knowing that
they will be safe in its custody and will even earn
some interest for him. The ordinary person, with
equal faith, usually maintains a modest checking
account for security and convenience in the settling
of his monthly bills and the payment of ordinary
expenses... In every case, the depositor expects the
bank to treat his account with the utmost fidelity,
whether such account consists only of a few hun-
dred pesos or of millions. The bank must record
every single transaction accurately, down to the
last centavo, and as promptly as possible. This has
to be done if the account is to reflect at any given
time the amount of money the depositor can dis-
pose of as he sees fit, confident that the bank will
deliver it as and to whomever directs. A blunder
on the part of the bank, such as the dishonor of the
check without good reason, can cause the depositor
not a little embarrassment if not also financial loss
and perhaps even civil and criminal litigation. The
point is that as a business affected with public in-
terest and because of the nature of its functions, the
bank is under obligation to treat the accounts of its
depositors with meticulous care, always having in
mind the fiduciary nature of their relationship...
108 1 Credit Transactions: Notes and Cases

Ineluctably, BPI-FB, as the trustee in the fiduciary


relationship, is duty bound to know the signatures
of its customers. Having failed to detect the forgery
in the Authority to Debit and in the process inad-
vertently facilitate the FMIC-Tevesteco transfer,
BPI-FB cannot now shift liability thereon to Franco
and the other payees of checks issued by Teveste-
co, or prevent withdrawals from their respective
accounts without the appropriate court writ or a
favorable final judgment.

Further, it boggles the mind why BPI-FB, even


without delving into the authenticity of the signa-
ture in the Authority to Debit, effected the transfer
of P80,000,000.00 from FMIC's to Tevesteco's ac-
count, when FMIC's account was a time deposit
and it had already paid advance interest to FMIC.
Considering that there is as yet no indubitable evi-
dence establishing Franco's participation in the
forgery, he remains an innocent party. As between
him and BPI-FB, the latter, which made possible
the present predicament, must bear the resulting
loss or inconvenience.

... WHEREFORE, the petition is PARTIALLY


GRANTED. The Court of Appeals Decision dated
November 29, 1995 is AFFIRMED with the MOD-
IFICATION that the award of unearned interest on
the time deposit and of moral and exemplary dam-
ages is DELETED.

B. Obligation to Pay

Art. 1955. The obligation of a person who bor-


rows money shall be governed by the provisions
of Articles 1249 and 1250 of this Code.
Simple LoanI 109

If what was loaned is a fungible thing other than


money, the debtor owes another thing of the
same kind, quantity and quality, even if it should
change in value.
In case it is impossible to deliver the same kind,
its value at the time of the perfection of the loan
shall be paid.

Art. 1249. The payment of debts in money shall


be made in the currency stipulated,
and if it is not possible to deliver such currency,
then in the currency which is legal tender in the
Philippines.

The delivery of promissory notes payable to or-


der, or bills of exchange or other mercantile doc-
uments shall produce the effect of payment only
when they have been cashed, or when through
the fault of the creditor they have been impaired.

In the meantime, the action derived from the


original obligation shall be held in the abeyance.

Art. 1250. In case an extraordinary inflation or


deflation of the currency stipulated should su-
pervene 7,

7 Extraordinary inflation or deflation exists when there is a decrease or in-


crease in the purchasing power of the Philippine currency which is unusual
or beyond the common fluctuation in value, and such increase or decrease
could not have been reasonably foreseen or was manifestly beyond the
contemplation of the parties at the time of the establishment of the obliga-
tion. The supervening of extraordinary inflation or deflation is never as-
sumed. The party alleging it must lay down the factual basis for the appli-
cation of Article 1250. Moreover, the effects of extraordinary inflation or
deflation are not to be applied without an official declaration by competent
authorities. (Singson v. Caltex (Philippines), Inc., G.R. No. 137798, October
4, 2000, 342 SCRA 91.)
110 I Credit Transactions: Notes and Cases

the value of the currency at the time of the estab-


lishment of the obligation shall be the basis of
payment,
unless there is an agreement to the contrary.

In a simple loan or mutuum, the primary obligation of the


borrower is to pay. If the object of the simple loan is
money (the principal), then the general rules on payment
in money apply. The value of payment in money, or
payment of the principal, is generally determined at the
time of the establishment of the obligation, that is, the
time of delivery of the principal.

If the object of the simple loan is any other consumable


property, then the borrower owes payment in kind, that
is, another property of the same kind, quantity and quali-
ty. The value of the payment in kind is determined at the
time of perfection of the simple loan, that is, the time of
delivery of the object of the simple loan.

The obligation to pay may be evidenced by a written


promise to pay. In commercial credit transactions, the
most common are the:

1. Note, a written promise by one party (the maker) to


pay money to another party (the payee) or to bearer8 , or a
written promise to pay a specified amount to a certain
person on demand or on a specified date. 9

2. Bond, a written promise (by the issuer) to pay money


to the holders1O, or a written promise, issued by a gov-
ernment or corporation to holders, to pay the principal

8 Blacks Law Dictionary, Ninth Edition (2009).


9 Barron's Dictionary of Finance and Investment Terms, Fifth Edition (1998).
10 Blacks Law Dictionary, Ninth Edition (2009).
Simple Loan 111

amount of a loan at maturity and a specified sum of mon-


ey usually at specific intervals. 1

3. Debenture, from the Latin debentur, or there are owed,


an instrument acknowledging a debt secured only by the
issuer's earning power and not by a lien, or legal right or
interest that a creditor has 12, on any specific asset 3, or an
unsecured bond.14

All of these promises to pay are evidences of indebted-


ness and are the commercial forms that contracts of sim-
ple loan take:
Loans are transactions wherein the owner of a
property allows another party to use the property
and where customarily, the latter promises to re-
turn the property after a specified period with
payment for its use, called interest. On the other
hand, bonds are interest-bearing or discounted
government or corporate securities that obligate
the issuer to pay the bondholder a specified sum of
money, usually at specific intervals, and to repay
the principal amount of the loan at maturity. The
word "bond" means contract, agreement, or guar-
antee. All of these terms are applicable to the secur-
ities known as bonds. An investor who purchases
a bond is lending money to the issuer, and the
bond represents the issuer's contractual promise
to pay interest and repay principal according to
specific terms. 15 (Emphasis supplied)

11 Barron's Dictionary of Finance and Investment Terms, Fifth Edition (1998).


12 Blacks Law Dictionary, Ninth Edition (2009).
13 Ibid.
14 Barron's Dictionary of Finance and Investment Terms, Fifth Edition (1998).
15 Constantino Jr., et al. v. Cuisia, GR. No. 106064, October 13, 2005,472 SCRA
505.
112 1 Credit Transactions: Notes and Cases

C. Interest

1. Conventional Interest

Art. 1933... Simple loan may be gratuitous or with


a stipulation to pay interest.

Art. 1956. No interest shall be due unless


it has been expressly stipulated
in writing.

Art. 1253. If the debt produces interest, payment


of the principal shall not be deemed to have been
made until the interests have been covered.

Art. 1958. In the determination of the interest, if it


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.

Art. 1960. If the borrower pays interest when


there has been no stipulation therefor,
the provisions of this Code concerning solutio
indebiti, or
natural obligations,
shall be applied, as the case may be.
Art. 2154. If something is received when there is
no right to demand it, and it was unduly deli-
vered through mistake, the obligation to return it
arises.

Art. 1423. Obligations are civil or natural. Civil


obligations give a right of action to compel their
performance. Natural obligations, not being
based on positive law but on equity and natural
law, do not grant a right of action to enforce their
Simple Loan 1 113

performance, but after voluntary fulfillment by


the obligor, they authorize the retention of what
has been delivered or rendered by reason thereof.
Some natural obligations are set forth in the fol-
lowing articles.

Act No. 265516, Sec. 1. The rate of interest for


the loan or
forbearance of any money, goods, or credits and
the rate allowed in judgments,
in the absence of express contract as to such rate
of interest,
shall be six per centum per annum or such rate as
may be prescribed by the Monetary Board of the
Central Bank of the Philippines for that purpose
in accordance with the authority hereby
granted.17

A simple loan, whether the object is money or other con-


sumable thing, may be gratuitous or onerous. If it is
onerous, the compensation to be paid by the borrower is
referred to as interest.

Interest may be payable in money, in which case it may


be a stated amount (P1,000.00 per month), or a computed
amount based on an interest rate, that is, a percentage of
the principal payable for a given period 8 (10% per an-
num). It may be payable in kind (1 cavan of rice for

16 Act No. 2655 (1916), An Act Fixing Rates of Interest Upon Loans and Dec-
laring the Effect of Receiving or Taking Usurious Rates and for Other Pur-
poses, as amended by Presidential Decrees No. 116, 858, and 1684, is gen-
erally know as the Usury Law.
17 Currently 12% for loans and forbearance of money, goods, or credits pur-

suant to Central Bank Circular No. 416, series of 1974, which was issued
and promulgated by the Monetary Board pursuant to the authority granted
to the Central Bank by P.D. No. 116, which amended the Usury Law.
18 Blacks Law Dictionary, Ninth Edition (2009).
114 1 Credit Transactions: Notes and Cases

every 10 cavans), in which case its value shall be ap-


praised at the time of payment.

Payment of interest is allowed only if the following condi-


tions concur:

a. There is an express stipulation for the payment of in-


terest, and

b. The stipulation for the payment of interest is in writ-


ing.

If these conditions do not concur and yet the borrower in


a contract of simple loan pays interest then:

a. If the borrower paid through mistake, the creditor is


obliged to return what was delivered.

b. If the borrower voluntary paid the creditor, then the


creditor is authorized to retain what was delivered.

Interest paid as compensation in a simple loan is properly


referred to as conventional interest, as it is the interest
agreed to by the parties themselves as distinguished from
that prescribed by law. 19

Monetary interest or regular interest is the conventional


interest in a simple loan of money. The payment of both
principal and interest is made in money (an amortization,
literally, to deaden 2O)gradually extinguishing 2' the loan of

19 Ibid.
2DWebster Third New International Dictionary (2002).
21 Blacks Law Dictionary, Ninth Edition (2009).
Simple Loan I 115

money. Monetary interest is, therefore, generally viewed


as the cost of money. 22

Act No. 2655, or the Usury Law, applies the concept of


interest not only to:

a. The loan of money, goods, or credits, which must be


understood as simple loan or mutuum; but also to

b. The forbearance, that is, the act of refraining, tolerat-


ing or abstaining from enforcing a right or obligation, 23 of
money, goods, or credits, even if the principal obligation
or agreement is not a simple loan.

The applicable interest in contracts of simple loan or for-


bearance of money, goods, or credits shall be determined
as follows:

a. If there is an interest amount or rate stipulated (con-


ventional interest), then the interest as stipulated shall be
applicable.

b. If there is no stipulation on interest amount or rate,


then the interest prescribed by statute (or legal interest 24)
shall be applicable.

In contracts of loan or forbearance of money, goods, or


credit, the legal interest rate is currently 12%25 .

Escalation clauses are clauses in long-term credit transac-


tions that authorize the increase in conventional interest

22 Frias v. San Diego-Sison, G.R. No. 155223, April 3,2007,520 SCRA 244.
23 Blacks Law Dictionary, Ninth Edition (2009).
24 Ibid.
25
Central Bank Circular No. 416, series of 1974.
116 1 Credit Transactions: Notes and Cases

rates as a means of maintaining fiscal stability and retain-


ing the value of money. As a general rule, escalation
clauses are valid, as these do not contravene public policy.
However, to avoid any resulting one-sidedness, there
must effectively be a de-escalation clause that authorizes
a corresponding reduction in the interest rates.

Act No. 2655,26 Sec. 7... That parties to a loan


agreement, the proceeds of which may be availed
of partially or fully at some future time, may sti-
pulate that the rate of interest agreed upon at the
time the loan agreement is entered into, which
rate shall not exceed the maximum allowed by
law, shall prevail notwithstanding subsequent
changes in the maximum rates that may be made
by the Monetary Board...

Sec. 7-a. Parties to an agreement pertaining to a


loan or forbearance of money, goods or credits
may stipulate that the rate of interest agreed upon
may be increased in the event that the applicable
maximum rate of interest is increased by law or
by the Monetary Board; Provided, That such sti-
pulation shall be valid only if there is also a sti-
pulation in the agreement that the rate of interest
agreed upon shall be reduced in the event that
the applicable maximum rate of interest is re-
duced by law or by the Monetary Board; Pro-
vided, further, That the adjustment in the rate of
interest agreed upon shall take effect on or after
the effectivity of the increase or decrease in the
maximum rate of interest.

A valid escalation clause, however, does not give the

26 The Usury Law, as amended.


Simple Loan I 117

creditor the unbridled right to adjust interest rates unila-


terally. Any increase in the rates of interest made pur-
suant to a valid escalation clause must be the result of an
agreement between the parties, that is, a meeting of the
minds on the actual increase in interest rates. An un-
consented increase in interest rates is ineffective if it
2s
transgresses the principle of mutuality 27 of contracts.

Frias v. San Diego-Sison, G.R. No. 155223, April 3,


2007, 520 SCRA 244.

... Petitioner is the owner of a house and lot ...


which she acquired from Island Masters Realty and
Development Corporation (IMRDC) by virtue of a
Deed of Sale dated Nov. 16, 1990. The property is
covered by TCT No. 168173 of the Register of
Deeds of Makati in the name of IMRDC.

On December 7, 1990, petitioner, as the FIRST


PARTY, and Dra. Flora San Diego-Sison (respon-
dent), as the SECOND PARTY, entered into a Me-
morandum of Agreement over the property with
the following terms:
... 1. That the SECOND PARTY has a period of
Six (6) months from the date of the execution of
this contract within which to notify the FIRST
PARTY of her intention to purchase the aforemen-
tioned parcel of land together within (sic) the im-
provements thereon at the price of SIX MILLION
FOUR HUNDRED THOUSAND PESOS
(P-6,400,000.00). Upon notice to the FIRST PARTY

27 Civil Code, Article 1308. The contract must bind both contracting parties;
its validity or compliance cannot be left to the will of one of them.
28 Philippine National Bank v. Rocamora, G.R. No. 164549, September 18,
2009, 600 SCRA 395.
118 1 Credit Transactions: Notes and Cases

of the SECOND PARTY's intention to purchase the


same, the latter has a period of another six months
within which to pay the remaining balance of P3.4
million.
2. That prior to the six months period given to the
SECOND PARTY within which to decide whether
or not to purchase the above-mentioned property,
the FIRST PARTY may still offer the said property
to other persons who may be interested to buy the
same provided that the amount of P3,000,000.00
given to the FIRST PARTY BY THE SECOND
PARTY shall be paid to the latter including interest
based on prevailing compounded bank interest
plus the amount of the sale in excess of
P7,000,000.00 should the property be sold at a price
more than P7 million.
3. That in case the FIRST PARTY has no other
buyer within the first six months from the execu-
tion of this contract, no interest shall be charged by
the SECOND PARTY on the P3 million however, in
the event that on the sixth month the SECOND
PARTY would decide not to purchase the afore-
mentioned property, the FIRST PARTY has a pe-
riod of another six months within which to pay the
sum of 3 million pesos provided that the said
amount shall earn compounded bank interest for
the last six months only. Under this circumstance,
the amount of P3 million given by the SECOND
PARTY shall be treated as [a] loan and the proper-
ty shall be considered as the security for the mort-
gage which can be enforced in accordance with
law...

Petitioner received from respondent two million


pesos in cash and one million pesos in a post-dated
Simple Loan I 119

check dated February 28, 1990, instead of 1991,


which rendered said check stale. Petitioner then
gave respondent TCT No. 168173 in the name of
IMRDC and the Deed of Absolute Sale over the
property between petitioner and IMRDC.

Respondent decided not to purchase the property


and notified petitioner through a letter dated
March 20, 1991, which petitioner received only on
June 11, 1991, reminding petitioner of their agree-
ment that the amount of two million pesos which
petitioner received from respondent should be
considered as a loan payable within six months.
Petitioner subsequently failed to pay respondent
the amount of two million pesos.

On April 1, 1993, respondent filed with the Region-


al Trial Court (RTC) of Manila, a complaint for sum
of money with preliminary attachment against pe-
titioner...

Trial on the merits ensued. On January 31, 1996,


the RTC issued a decision... The RTC found that
petitioner was under obligation to pay respondent
the amount of two million pesos with compounded
interest pursuant to their Memorandum of Agree-
ment; that the fraudulent scheme employed by pe-
titioner to deprive respondent of her only security
to her loaned money when petitioner executed an
affidavit of loss and instituted a petition for the is-
suance of an owner's duplicate title knowing the
same was in respondent's possession, entitled res-
pondent to moral damages; and that petitioner's
bare denial cannot be accorded credence because
120 1 Credit Transactions: Notes and Cases

her testimony and that of her witness did not ap-


pear to be credible.

The RTC further found that petitioner admitted


that she received from respondent the two million
pesos in cash but the fact that petitioner gave the
one million pesos to Atty. Lozada was without res-
pondent's knowledge thus it is not binding on res-
pondent... Petitioner filed her appeal with the CA.
In a Decision dated June 18, 2002, the CA affirmed
the RTC decision with modification... The CA
found that: petitioner gave the one million pesos to
Atty. Lozada partly as her commission and partly
as a loan; respondent did not replace the mistaken-
ly dated check of one million pesos because she
had decided not to buy the property and petitioner
knew of her decision as early as April 1991... The
CA concluded that there was no basis for petitioner
to say that the interest should be charged for six
months only and no more; that a loan always bears
interest otherwise it is not a loan; that interest
should commence on June 7, 1991 with com-
pounded bank interest prevailing at the time the
two million was considered as a loan which was in
June 1991; that the bank interest rate for loans se-
cured by a real estate mortgage in 1991 ranged
from 25% to 32% per annum as certified to by Pru-
dential Bank, that in fairness to petitioner, the rate
to be charged should be 25% only.

Petitioner's motion for reconsideration was denied


by the CA... Hence the instant Petition for Review
on Certiorari filed by petitioner... Petitioner con-
tends that the interest, whether at 32% per annum
awarded by the trial court or at 25% per annum as
Simple Loan I 121

modified by the CA which should run from June 7,


1991 until fully paid, is contrary to the parties'
Memorandum of Agreement; that the agreement
provides that if respondent would decide not to
purchase the property, petitioner has the period of
another six months to pay the loan with com-
pounded bank interest for the last six months only;
that the CA's ruling that a loan always bears inter-
est otherwise it is not a loan is contrary to Art. 1956
of the New Civil Code which provides that no in-
terest shall be due unless it has been expressly sti-
pulated in writing.

We are not persuaded.

While the CA's conclusion, that a loan always


bears interest otherwise it is not a loan, is flawed
since a simple loan may be gratuitous or with a sti-
pulation to pay interest, we find no error commit-
ted by the CA in awarding a 25% interest per an-
num on the two-million peso loan even beyond the
second six months stipulated period.

The Memorandum of Agreement executed be-


tween the petitioner and respondent on December
7, 1990 is the law between the parties. In resolving
an issue based upon a contract, we must first ex-
amine the contract itself, especially the provisions
thereof which are relevant to the controversy. The
general rule is that if the terms of an agreement are
clear and leave no doubt as to the intention of the
contracting parties, the literal meaning of its stipu-
lations shall prevail. It is further required that the
various stipulations of a contract shall be inter-
preted together, attributing to the doubtful ones
122 1 Credit Transactions: Notes and Cases

that sense which may result from all of them taken


jointly.

In this case, the phrase "for the last six months on-
ly" should be taken in the context of the entire
agreement. We agree with and adopt the CA's in-
terpretation of the phrase in this wise:
Their agreement speaks of two (2) periods of six
months each. The first six-month period was given
to plaintiff-appellee (respondent) to make up her
mind whether or not to purchase defendant-
appellant's (petitioner's) property. The second six-
month period was given to defendant-appellant to
pay the P2 million loan in the event that plaintiff-
appellee decided not to buy the subject property in
which case interest will be charged "for the last six
months only", referring to the second six-month
period. This means that no interest will be charged
for the first six-month period while appellee was
making up her mind whether to buy the property,
but only for the second period of six months after
appellee had decided not to buy the property. This
is the meaning of the phrase "for the last six
months only". Certainly, there is nothing in their
agreement that suggests that interest will be
charged for six months only even if it takes defen-
dant-appellant an eternity to pay the loan.

The agreement that the amount given shall bear


compounded bank interest for the last six months
only, i.e., referring to the second six-month period,
does not mean that interest will no longer be
charged after the second six-month period since
such stipulation was made on the logical and rea-
sonable expectation that such amount would be
Simple Loan I 123

paid within the date stipulated. Considering that


petitioner failed to pay the amount given which
under the Memorandum of Agreement shall be
considered as a loan, the monetary interest for the
last six months continued to accrue until actual
payment of the loaned amount.

The payment of regular interest constitutes the


price or cost of the use of money and thus, until the
principal sum due is returned to the creditor, regu-
lar interest continues to accrue since the debtor
continues to use such principal amount. It has been
held that for a debtor to continue in possession of
the principal of the loan and to continue to use the
same after maturity of the loan without payment of
the monetary interest would constitute unjust
enrichment on the part of the debtor at the expense
of the creditor.

Petitioner and respondent stipulated that the


loaned amount shall earn compounded bank inter-
ests, and per the certification issued by Prudential
Bank, the interest rate for loans in 1991 ranged
from 25% to 32% per annum. The CA reduced the
interest rate to 25% instead of the 32% awarded by
the trial court which petitioner no longer assailed.

In Bautista v. Pilar Development Corp.29, we upheld


the validity of a 21% per annum interest on a
F142,326.43 loan. In Garciav. Court of Appeals3o, we
sustained the agreement of the parties to a 24% per
annum interest on an 28,649,250.00 loan. Thus, the

29 G.R. No. 135046, August 17,1999,371 Phil 533.


30 G.R. No. L-82282, November 24,1988,167 SCRA 815.
124 1 Credit Transactions: Notes and Cases

interest rate of 25% per annum awarded by the CA


to a F-2 million loan is fair and reasonable...

Concepcion v. Court of Appeals, et al., G.R. No.


122079, June 27,1997,274 SCRA 614.

... On 17 January 1979, the Home Savings Bank


and Trust Company (now Insular Life Savings and
Trust Company) granted to the Concepcions a loan
amounting to P1,400,000.00. The Concepcions, in
turn, executed in favor of the bank a promissory
note and a real estate mortgage over their property
located at 11 Albany St., Greenhills, San Juan, Me-
tro Manila. The loan was payable in equal quarter-
ly amortizations for a period of fifteen (15) years
and carried an interest rate of sixteen percent (16%)
per annum. The promissory note provided that the
Concepcions had authorized -
... the Bank to correspondingly increase the inter-
est rate presently stipulated in this transaction
without advance notice to me/us in the event the
Central Bank of the Philippines raises its redis-
count rate to member banks, and/or the interest
rate on savings and time deposit, and/or the inter-
est rate on such loans and/or advances.

In accordance with the above provision, the bank


unilaterally increased the interest rate from 16% to
21% effective 17 February 1980; from 21% to 30%
effective 17 October 1984; and from 30% to 38% ef-
fective 17 November 1984, increasing the quarterly
amortizations from P67,830.00 to, respectively,
P77,619.72, P104,661.10, and P123,797.05 for the pe-
riods aforestated. The Concepcions paid, under
protest, the increased amortizations of P77,619.72
Simple Loan I 125

and P104,661.10 until January 1985 but thereafter


failed to pay the quarterly amortization of
P123,797.05 (starting due date of 17 April 1985).

In a letter, dated 15 July 1985, the bank's President


made a demand on the Concepcions for the pay-
ment of the arrearages. The Concepcions failed to
pay, constraining the bank's counsel to send a final
demand letter, dated 26 August 1985, for the pay-
ment of P393,878.81, covering the spouses' due ac-
count for three quarterly payments plus interest,
penalty, and service charges. Still, no payment was
received.

On 14 April 1986, the bank finally filed with the Of-


fice of the Provincial Sheriff of Pasig City a petition
for extrajudicial foreclosure of the real estate mort-
gage executed by the Concepcions. A notice of sale
was issued on 15 May 1986, setting the public auc-
tion sale on 11 June 1986. The notice was published
in the newspaper "Mabuhay." A copy of the notice
was sent to the Concepcions at 59 Whitefield St.,
White Plains Subdivision, Quezon City and/or at
11 Albany St., Greenhills Subdivision, San Juan,
Metro Manila. The public auction sale went on as
scheduled with the bank emerging as the highest
bidder. A Certificate of Sale was issued in favor of
the bank.

The Concepcions were unable to exercise their


right of redemption within the one-year period
provided under Act No. 3135. The bank thus con-
solidated its title over the property and, after the
cancellation of the title in the name of the Concep-
cions, a new transfer certificate of title ... was is-
126 1 Credit Transactions: Notes and Cases

sued in the name of Home Savings Bank and Trust


Company.

On 31 July 1987, the bank executed a Deed of Abso-


lute Sale in favor of Asaje Realty Corporation and a
new certificate of title was issued in the latter's
name.

Meanwhile, on 29 July 1987, the Concepcions filed


an action against Home Savings Bank and Trust
Company, the Sheriff of San Juan, Metro Manila,
and the Register of Deeds of San Juan, Metro Mani-
la, for the cancellation of the foreclosure sale, the
declaration of nullity of the consolidation of title in
favor of the bank, and the declaration of nullity of
the unilateral increases of the interest rates on their
loan. The spouses likewise claimed damages
against the defendants. The Concepcions, having
learned of the sale of the property to Asaje Realty
Corporation, filed an amended complaint implead-
ing the realty corporation and so praying as well
for the cancellation of the sale executed between
said corporation and the bank and the cancellation
of the certificate of title issued in the name of Asaje.
On 31 August 1992, the trial court found for the de-
fendants... On 15 September 1995, the appellate
court affirmed the trial court's decision, with mod-
ification... The Concepcions forthwith filed with
this Court a petition for review on certiorari, con-
tending that they have been denied their contrac-
tually stipulated right to be personally notified of
the foreclosure proceedings on the mortgaged
property.

There is some merit in the petition... The validity


of "escalation" or "escalator" clauses in contracts, in
Simple Loan 1 127

general, was upheld by the Supreme Court in Ban-


co Filipino Savings and Mortgage Bank vs. Hon. Na-
varro and Del Valle.31 Hence:
Some contracts contain what is known as an "esca-
lator clause," which is defined as one in which the
contract fixes a base price but contains a provision
that in the event of specified cost increases, the sel-
ler or contractor may raise the price up to a fixed
percentage of the base. Attacks on such a clause
have usually been based on the claim that, because
of the open price-provision, the contract was too
indefinite to be enforceable and did not evidence
actual meeting of the minds of the parties or that
the arrangement left the price to be determined ar-
bitrarily by one party so that the contract lacked
mutuality. In most instances, however, these at-
tacks have been unsuccessful...

In PhilippineNational Bank vs. Court of Appeals32, the


Court further elucidated, as follows:
It is basic that there can be no contract in the true
sense in the absence of the element of agreement,
or of mutual assent of the parties. If this assent is
wanting on the part of one who contracts his act
has no more efficacy than if it had been done under
duress or by a person of unsound mind. Similarly,
contract changes must be made with the consent of
the contracting parties. The minds of all the parties
must meet as to the proposed modification espe-
cially when it affects an important aspect of the
agreement. In the case of loan contracts, it cannot
be gainsaid that the rate of interest is component,

31 G.R. No. L-46591, 28 July 1987,152 SCRA 346.


32 G.R. No. 88880,30 April 1991,196 SCRA 536.
128 1 Credit Transactions: Notes and Cases

for it can make or break a capital venture. Thus,


any change must be mutually agreed upon, other-
wise, it is bereft of any binding effect.

We cannot countenance petitioner bank's postur-


ing that the escalation clause at bench gives it un-
bridled right to unilaterallyupwardly adjust the in-
terest on private respondents' loan. That would
completely take away from private respondents the
right to assent to an important modification in their
agreement, and would negate the element of mu-
tuality in contracts. In Philippine National Bank v.
Court of Appeals, et al... we held -
... (T)he unilateral action of the PNB in increasing
the interest rate on the private respondent's loan
violated the mutuality of contracts ordained in Ar-
ticle 1308...

In order that obligations arising from contracts


may have the force of law between the parties,
there must be mutuality between the parties based
on their essential equality. A contract containing a
condition which makes its fulfillment dependent
exclusively upon the uncontrolled will of one of
the contracting parties, is void... Hence, even as-
suming that the ... loan agreement between the
PNB and the private respondent gave the PNB a li-
cense (although in fact there was none) to increase
the interest rate at will during the term of the loan,
that license would have been null and void for be-
ing violative of the principle of mutuality essential
in contracts. It would have invested the loan
agreement with the character of a contract of adhe-
sion, where the parties do not equal footing the
weaker party's (the debtor) participation being re-
Simple Loan 1 129

duced to the alternative to take it or leave it'...


Such a contract is a veritable trap for the weaker
party whom the courts of justice must protect
against abuse and imposition... Even if we were to
consider that petitioners were bound by their
agreement allowing an increase in the interest rate
despite the lack of advance notice to them, the es-
calation should still be subject, as so contractually
stipulated, to a corresponding increase by the Cen-
tral Bank of its rediscount rate to member banks, or
of the interest rate on savings and time deposit, or
of the interest rate on such loans and advances. The
notices sent to petitioners merely read:
Letter of 19 July 1984: Please be informed that the
Bank has increased the interest rate of your existing
loan from 21 to 30% per annum beginning October
17, 1984. This increase of interest rate is in accor-
dance with the provision of Section 2 of Presiden-
tial Decree No. 1684 23 amending Act No. 2655.
This provision of the decree is reiterated under pa-
ragraph 1 of your Promissory Note. Your quarterly
amortization has been increased to P104,661.10...
Letter of 14 November 1984: On account of the
prevailing business and economic condition, we
are compelled to increase the interest rate of your
existing loan from 30% to 38 % per annum effective
November 17, 1984. This increase is in accordance
with your agreement (escalation clause) in your
promissory note/s...

Given the circumstances, the Court sees no cogent


reasons to fault the appellate court in its finding
that there are no sufficient valid justifications aptly
shown for the unilateral increases by private res-
pondent bank of the interest rates on the loan.
130 1 Credit Transactions: Notes and Cases

WHEREFORE, the, decision of the appellate court


is AFFIRMED subject to the MODIFICATION that
private respondent Home Savings Bank and Trust
Company shall pay to petitioners the excess, if any,
of the bid price it received from Asaje Realty Cor-
poration for the foreclosed property in question
over and above the unpaid balance of the loan
computed at the original interest rate. This case is
REMANDED to the trial court for the above de-
termination. No costs.

2. Interest on Interest

Art. 1959. Without prejudice to the provisions of


Article 2212, interest due and unpaid shall not
earn interest. However, the contracting parties
may by stipulation capitalize the interest due and
unpaid, which as added principal, shall earn new
interest.

Art. 2212. Interest due shall earn legal interest


from the time it is judicially demanded, although
the obligation may be silent upon this point.

The general rule is that conventional interest is paid on


the principal only (simple interest).33

Consequently, interest on interest, that is, the compensa-


tion for interest that is due and unpaid, is generally not
demandable. It is only demandable if, in the first place,
there is conventional interest, that is, an express stipula-
tion in writing to pay interest in a contract of loan or for-

33 Blacks Law Dictionary, Ninth Edition (2009).


Simple Loan 1131

bearance of money, goods, or credit, and any or both of


the folowing instances are applicable:

a. When by stipulation of the parties, compounding or


capitalizing of interest is agreed upon, in which case pre-
viously accumulated interest is added as principal and
earns interest as such (compound interest). 34

b. When interest that is due and unpaid is judicially


demanded, whether or not there is an agreement or sti-
pulation to this effect. Judicial demand is reckoned from
the date of filing of a complaint in court. The rate of in-
terest shall be 12% since this involves a loan or forbear-
ance of money, goods, or credit.35

3. Compensatory, Penalty or Indemnity Interest

Art. 1169. Those obliged to deliver or to do some-


thing incur in delay from the time the obligee ju-
dicially or extrajudicially demands from them the
fulfillment of their obligation.
However, the demand by the creditor shall not be
necessary in order that delay may exist:
(1) When the obligation or the law expressly so
declare; or
(2) When from the nature and the circumstances
of the obligation it appears that the designation
of the time when the thing is to be delivered or
the service is to be rendered was a controlling
motive for the establishment of the contract; or
(3) When demand would be useless, as when the
obligor has rendered it beyond his power to per-
form.

34Ibid.
35
Central Bank Circular No. 416, series of 1974.
132 1 Credit Transactions: Notes and Cases

In reciprocal obligations, neither party incurs in


delay if the other does not comply or is not ready
to comply in a proper manner with what is in-
cumbent upon him. From the moment one of the
parties fulfills his obligation, delay by the other
begins.

Art. 1226. In obligations with a penal clause, the


penalty shall substitute the indemnity for dam-
ages and the payment of interests in case of non-
compliance, if there is no stipulation to the con-
trary. Nevertheless, damages shall be paid if the
obligor refuses to pay the penalty or is guilty of
fraud in the fulfillment of the obligation.
The penalty may be enforced only when it is de-
mandable in accordance with the provisions of
this Code.

Art. 2209. If the obligation consists in the pay-


ment of a sum of money, and the debtor incurs in
delay, the indemnity for damages,
there being no stipulation to the contrary,
shall be the payment of the interest agreed upon,
and
in the absence of stipulation, the legal interest,
which is six 36 per cent per annum.

Art. 2213. Interest cannot be recovered upon unli-


quidated claims or damages, except when the
demand can be established with reasonably cer-
tainty.

Art. 2226. Liquidated damages are those agreed

36 12% for loans and forbearance of money, goods, or credits pursuant to Cen-
tral Bank Circular No. 416, series of 1974.
Simple LoanI 133

upon by the parties to a contract, to be paid in


case of breach thereof.

Art. 2227. Liquidated damages, whether intended


as an indemnity or a penalty, shall be equitably
reduced if they are iniquitous or unconscionable.

Compensatory interest, or penalty interest, or indemnity


interest, is the indemnity for damages arising from delay
on the part of the debtor of an obligation consisting in the
payment of a sum of money. It is interest allowed by law
in the absence of a promise to pay, as compensation for
delay in paying a fixed sum or a delay in assessing and
37
paying damages.

Since a simple loan of money is necessarily an obligation


consisting in the payment of a sum of money, then com-
pensatory interest is demandable in case the borrower in a
simple loan of money incurs in delay. However, not every
simple loan is an obligation that consists in the payment
of a sum of money, as when the simple loan has for its ob-
ject a consumable thing and payment is in kind. Corolla-
rily, a simple loan of money is not the only obligation that
consists in the payment of a sum of money.

Although compensatory interest, unlike conventional in-


terest, need not be expressly stipulated in writing, the
parties may freely stipulate on compensatory interest
through a penalty or penal clause. A penal clause is an
accessory obligation of the debtor to assume greater lia-
bility in case of breach of a principal obligation. It streng-
thens the coercive nature of the principal obligation and
provides, in effect, liquidated damages resulting from a

37
Blacks Law Dictionary, Ninth Edition (2009).
134 I Credit Transactions: Notes and Cases

breach. The debtor is bound to pay the compensatory in-


terest without the necessity of proof of the existence or the
measure of damages caused by the breach. Although
compensatory interest is allowed by the freedom of the
parties to agree on such terms and conditions as they see
fit, provided these contravene neither law, morals, good
customs, public order or public policy 38, it may be equita-
bly reduced by the courts if it is iniquitous or unconscion-
able or if the principal obligation has been partly or irre-
39
gularly complied with.

Eastern Shipping Lines, Inc. v. Court of Appeals, G.R.


No. 97412, July 12, 1994, 234 SCRA 78, summarizes the
rules on compensatory interest as follows:

... Nonetheless, it may not be unwise, by way of


clarification and reconciliation, to suggest the fol-
lowing rules of thumb for future guidance.

I. When an obligation, regardless of its source, i.e.,


law, contracts, quasi-contracts, delicts or quasi-
delicts is breached, the contravenor can be held li-
able for damages. The provisions under Title XVIII
on "Damages" of the Civil Code govern in deter-
mining the measure of recoverable damages.

II. With regard particularly to an award of interest


in the concept of actual and compensatory damag-

38
Civil Code, Art. 1306. The contracting parties may establish such stipula-
tions, clauses, terms and conditions as they may deem convenient, pro-
vided they are not contrary to law, morals, good customs, public order, or
public policy.
3 Ligutan v. Court of Appeals, G.R No. 138677, February 12,2002,376 SCRA
560.
Simple Loan 1 135

es, the rate of interest, as well as the accrual the-


reof, is imposed, as follows:

1. When the obligation is breached, and it consists


in the payment of a sum of money, i.e., a loan or
forbearance of money, the interest due should be
that which may have been stipulated in writing.
Furthermore, the interest due shall itself earn legal
interest from the time it is judicially demanded. In
the absence of stipulation 4°, the rate of interest shall
be 12% per annum to be computed from default, i.e.,
from judicial or extrajudicial demand under and
subject to the provisions of Article 1169 of the Civil
Code.

2. When an obligation, not constituting a loan or


forbearance of money, is breached, an interest on
the amount of damages awarded may be imposed
at the discretion of the court at the rate of 6% per an-
num. No interest, however, shall be adjudged on
unliquidated claims or damages except when or
until the demand can be established with reasona-
ble certainty. Accordingly, where the demand is es-
tablished with reasonable certainty, the interest
shall begin to run from the time the claim is made
judicially or extrajudicially (Art. 1169, Civil Code)
but when such certainty cannot be so reasonably
established at the time the demand is made, the in-
terest shall begin to run only from the date the
judgment of the court is made (at which time the

40
As properly stated in State Investment House, Inc. v. Court of Appeals,
G.R. No. 90676, June 19,1991,198 SCRA 390: "...in the absence of a stipula-
tion of a particular rate of penalty interest, then the payment of additional
interest at a rate equal to the regular monetary interest; and if no regular
interest had been agreed upon, then payment of legal interest.."
136 1 Credit Transactions: Notes and Cases

quantification of damages may be deemed to have


been reasonably ascertained). The actual base for
the computation of legal interest shall, in any case,
be on the amount finally adjudged.

3. When the judgment of the court awarding a


sum of money becomes final and executory, the
rate of legal interest, whether the case falls under
paragraph 1 or paragraph 2, above, shall be 12%
per annum from such finality until its satisfaction,
this interim period being deemed to be by then an
equivalent to a forbearance of credit.

The Eastern Shipping Lines rules should, however, be


read in conjunction with the provisions of Article 2209.
Thus, the applicable compensatory interest in contracts of
simple loan is determined 4' as follows:

a. If there is a penal clause that stipulates the penalty or


indemnity, then the stipulated penalty or indemnity
shall be applicable.

b. If there is no penal clause, but there is a stipulation on


conventional or monetary interest, then the conventional
or monetary interest shall be applicable.

c. If there is no stipulation on the penalty or on conven-


tional interest, then the legal interest rate shall be appli-
cable. In contracts of simple loan of money, the legal in-
terest rate is 12%.42

41
Reinsurance Company of the Orient, Inc. v. Court of Appeals, G.R. No. L-
61250, June 3,1991,198 SCRA 19, and State Investment House, Inc. v. Court
of Appeals, G.R. No. 90676, June 19,1991,198 SCRA 390.
42 Central Bank Circular No. 416, series of 1974.
Simple Loan 1 137

Siga-an v. Villanueva, G.R. No. 173227, January


20, 2009, 576 SCRA 696.

... On 30 March 1998, respondent Alicia Villanueva


filed a complaint for sum of money against peti-
tioner Sebastian Siga-an... Respondent alleged
that she was a businesswoman engaged in supply-
ing office materials and equipments to the Philip-
pine Navy Office (PNO) located at Fort Bonifacio,
Taguig City, while petitioner was a military officer
and comptroller of the PNO from 1991 to 1996.

Respondent claimed that sometime in 1992, peti-


tioner approached her inside the PNO and offered
to loan her the amount of P540,000.00. Since she
needed capital for her business transactions with
the PNO, she accepted petitioner's proposal. The
loan agreement was not reduced in writing. Also,
there was no stipulation as to the payment of inter-
est for the loan.

On 31 August 1993, respondent issued a check


worth 2500,000.00 to petitioner as partial payment
of the loan. On 31 October 1993, she issued anoth-
er check in the amount of -2200,000.00 to petitioner
as payment of the remaining balance of the loan.
Petitioner told her that since she paid a total
amount of P-700,000.00 for the 2540,000.00 worth of
loan, the excess amount of 1160,000.00 would be
applied as interest for the loan. Not satisfied with
the amount applied as interest, petitioner pestered
her to pay additional interest. Petitioner threat-
ened to block or disapprove her transactions with
the PNO if she would not comply with his de-
mand. As all her transactions with the PNO were
138 1 Credit Transactions: Notes and Cases

subject to the approval of petitioner as comptroller


of the PNO, and fearing that petitioner might block
or unduly influence the payment of her vouchers
in the PNO, she conceded. Thus, she paid addi-
tional amounts in cash and checks as interests for
the loan. She asked petitioner for receipt for the
payments but petitioner told her that it was not ne-
cessary as there was mutual trust and confidence
between them. According to her computation, the
total amount she paid to petitioner for the loan and
interest accumulated to 11,200,000.00.

Thereafter, respondent consulted a lawyer regard-


ing the propriety of paying interest on the loan de-
spite absence of agreement to that effect. Her law-
yer told her that petitioner could not validly collect
interest on the loan because there was no agree-
ment between her and petitioner regarding pay-
ment of interest. Since she paid petitioner a total
amount of 11,200,000.00 for the P-540,000.00 worth
of loan, and upon being advised by her lawyer that
she made overpayment to petitioner, she sent a
demand letter to petitioner asking for the return of
the excess amount of P660,000.00. Petitioner, de-
spite receipt of the demand letter, ignored her
claim for reimbursement... In his answer to the
complaint, petitioner denied that he offered a loan
to respondent. He averred that in 1992, respondent
approached and asked him if he could grant her a
loan, as she needed money to finance her business
venture with the PNO. At first, he was reluctant to
deal with respondent, because the latter had a spot-
ty record as a supplier of the PNO. However, since
respondent was an acquaintance of his officemate,
Simple Loan 1139

he agreed to grant her a loan. Respondent paid the


loan in full.

Subsequently, respondent again asked him to give


her a loan. As respondent had been able to pay the
previous loan in full, he agreed to grant her anoth-
er loan. Later, respondent requested him to re-
structure the payment of the loan because she
could not give full payment on the due date. He
acceded to her request. Thereafter, respondent
pleaded for another restructuring of the payment
of the loan. This time he rejected her plea. Thus,
respondent proposed to execute a promissory note
wherein she would acknowledge her obligation to
him, inclusive of interest, and that she would issue
several postdated checks to guarantee the payment
of her obligation. Upon his approval of respon-
dent's request for restructuring of the loan, res-
pondent executed a promissory note dated 12 Sep-
tember 1994 wherein she admitted having bor-
rowed an amount of P1,240,000.00, inclusive of in-
terest, from petitioner and that she would pay said
amount in March 1995. Respondent also issued to
him six postdated checks amounting to
P1,240,000.00 as guarantee of compliance with her
obligation. Subsequently, he presented the six
checks for encashment but only one check was
honored. He demanded that respondent settle her
obligation, but the latter failed to do so. Hence, he
filed criminal cases for Violation of the Bouncing
Checks Law (Batas Pambansa Blg. 22) against res-
pondent... Petitioner insisted that there was no
overpayment because respondent admitted in the
latter's promissory note that her monetary obliga-
tion as of 12 September 1994 amounted to
140 I Credit Transactions: Notes and Cases

F-1,240,000.00 inclusive of interests. He argued that


respondent was already estopped from complain-
ing that she should not have paid any interest, be-
cause she was given several times to settle her ob-
ligation but failed to do so. He maintained that to
rule in favor of respondent is tantamount to con-
cluding that the loan was given interest-free.
Based on the foregoing averments, he asked the
RTC to dismiss respondent's complaint.

After trial, the RTC rendered a Decision on 26 Jan-


uary 2001 holding that respondent made an over-
payment of her loan obligation to petitioner and
that the latter should refund the excess amount to
the former. It ratiocinated that respondent's obli-
gation was only to pay the loaned amount of
-2540,000.00, and that the alleged interests due
should not be included in the computation of res-
pondent's total monetary debt because there was
no agreement between them regarding payment of
interest. It concluded that since respondent made
an excess payment to petitioner in the amount of
P660,000.00 through mistake, petitioner should re-
turn the said amount to respondent pursuant to the
principle of solutio indebiti... Petitioner appealed to
the Court of Appeals. On 16 December 2005, the
appellate court promulgated its Decision affirming
in toto the RTC Decision... Petitioner filed a mo-
tion for reconsideration of the appellate court's de-
cision but this was denied. Hence, petitioner
lodged the instant petition before us...

Interest is a compensation fixed by the parties for


the use or forbearance of money. This is referred to
as monetary interest. Interest may also be imposed
Simple Loan 141

by law or by courts as penalty or indemnity for


damages. This is called compensatory interest. The
right to interest arises only by virtue of a contract
or by virtue of damages for delay or failure to pay
the principal loan on which interest is demanded.

Article 1956 of the Civil Code, which refers to


monetary interest, specifically mandates that no in-
terest shall be due unless it has been expressly sti-
pulated in writing. As can be gleaned from the
foregoing provision, payment of monetary interest
is allowed only if: (1) there was an express stipula-
tion for the payment of interest; and (2) the agree-
ment for the payment of interest was reduced in
writing. The concurrence of the two conditions is
required for the payment of monetary interest.
Thus, we have held that collection of interest with-
out any stipulation therefor in writing is prohibited
by law.

It appears that petitioner and respondent did not


agree on the payment of interest for the loan. Nei-
ther was there convincing proof of written agree-
ment between the two regarding the payment of
interest. Respondent testified that although she ac-
cepted petitioner's offer of loan amounting to
2540,000.00, there was, nonetheless, no verbal or
written agreement for her to pay interest on the
loan.

Petitioner presented a handwritten promissory


note dated 12 September 1994 wherein respondent
purportedly admitted owing petitioner "capital
and interest." Respondent, however, explained
that it was petitioner who made a promissory note
142 1 Credit Transactions: Notes and Cases

and she was told to copy it in her own handwrit-


ing; that all her transactions with the PNO were
subject to the approval of petitioner as comptroller
of the PNO; that petitioner threatened to disap-
prove her transactions with the PNO if she would
not pay interest; that being unaware of the law on
interest and fearing that petitioner would make
good of his threats if she would not obey his in-
struction to copy the promissory note, she copied
the promissory note in her own handwriting; and
that such was the same promissory note presented
by petitioner as alleged proof of their written
agreement on interest. Petitioner did not rebut the
foregoing testimony. It is evident that respondent
did not really consent to the payment of interest for
the loan and that she was merely tricked and
coerced by petitioner to pay interest. Hence, it
cannot be gainfully said that such promissory note
pertains to an express stipulation of interest or
written agreement of interest on the loan between
petitioner and respondent.

Petitioner, nevertheless, claims that both the RTC


and the Court of Appeals found that he and res-
pondent agreed on the payment of 7% rate of inter-
est on the loan; that the agreed 7% rate of interest
was duly admitted by respondent in her testimony
in the Batas Pambansa Big. 22 cases he filed against
respondent; that despite such judicial admission by
respondent, the RTC and the Court of Appeals, cit-
ing Article 1956 of the Civil Code, still held that no
interest was due him since the agreement on inter-
est was not reduced in writing; that the application
of Article 1956 of the Civil Code should not be ab-
solute, and an exception to the application of such
Simple Loan 1143

provision should be made when the borrower ad-


mits that a specific rate of interest was agreed upon
as in the present case; and that it would be unfair
to allow respondent to pay only the loan when the
latter very well knew and even admitted in the Ba-
tas Pambansa Blg. 22 cases that there was an
agreed 7% rate of interest on the loan.

We have carefully examined the RTC Decision and


found that the RTC did not make a ruling therein
that petitioner and respondent agreed on the pay-
ment of interest at the rate of 7% for the loan. The
RTC clearly stated that although petitioner and
respondent entered into a valid oral contract of
loan amounting to 1540,000.00, they, nonetheless,
never intended the payment of interest thereon.
While the Court of Appeals mentioned in its Deci-
sion that it concurred in the RTC's ruling that peti-
tioner and respondent agreed on a certain rate of
interest as regards the loan, we consider this as
merely an inadvertence because, as earlier eluci-
dated, both the RTC and the Court of Appeals
ruled that petitioner is not entitled to the payment
of interest on the loan. The rule is that factual find-
ings of the trial court deserve great weight and re-
spect especially when affirmed by the appellate
court. We found no compelling reason to disturb
the ruling of both courts.

Petitioner's reliance on respondent's alleged ad-


mission in the Batas Pambansa Blg. 22 cases that
they had agreed on the payment of interest at the
rate of 7% deserves scant consideration. In the said
case, respondent merely testified that after paying
the total amount of loan, petitioner ordered her to
144 1 Credit Transactions: Notes and Cases

pay interest. Respondent did not categorically dec-


lare in the same case that she and respondent made
an express stipulation in writing as regards pay-
ment of interest at the rate of 7%. As earlier dis-
cussed, monetary interest is due only if there was
an express stipulation in writing for the payment of
interest.

There are instances in which an interest may be


imposed even in the absence of express stipulation,
verbal or written, regarding payment of interest.
Article 2209 of the Civil Code states that if the obli-
gation consists in the payment of a sum of money,
and the debtor incurs in delay, a legal interest of
12% per annum may be imposed as indemnity for
damages if no stipulation on the payment of inter-
est was agreed upon. Likewise, Article 2212 of the
Civil Code provides that interest due shall earn le-
gal interest from the time it is judicially demanded,
although the obligation may be silent on this point.

All the same, the interest under these two instances


may be imposed only as a penalty or damages for
breach of contractual obligations. It cannot be
charged as a compensation for the use or forbear-
ance of money. In other words, the two instances
apply only to compensatory interest and not to
monetary interest. The case at bar involves peti-
tioner's claim for monetary interest.

Further, said compensatory interest is not chargea-


ble in the instant case because it was not duly
proven that respondent defaulted in paying the
loan. Also, as earlier found, no interest was due on
Simple Loan 145

the loan because there was no written agreement as


regards payment of interest.

Apropos the second assigned error, petitioner ar-


gues that the principle of solutio indebiti does not
apply to the instant case. Thus, he cannot be com-
pelled to return the alleged excess amount paid by
respondent as interest.

Under Article 1960 of the Civil Code, if the bor-


rower of loan pays interest when there has been no
stipulation therefor, the provisions of the Civil
Code concerning solutio indebiti shall be applied.
Article 2154 of the Civil Code explains the prin-
ciple of solutio indebiti. Said provision provides
that if something is received when there is no right
to demand it, and it was unduly delivered through
mistake, the obligation to return it arises. In such a
case, a creditor-debtor relationship is created under
a quasi-contract whereby the payor becomes the
creditor who then has the right to demand the re-
turn of payment made by mistake, and the person
who has no right to receive such payment becomes
obligated to return the same. The quasi-contract of
solutio indebiti harks back to the ancient principle
that no one shall enrich himself unjustly at the ex-
pense of another. The principle of solutio indebiti
applies where (1) a payment is made when there
exists no binding relation between the payor, who
has no duty to pay, and the person who received
the payment; and (2) the payment is made through
mistake, and not through liberality or some other
cause. We have held that the principle of solutio in-
debiti applies in case of erroneous payment of un-
due interest.
146 I Credit Transactions: Notes and Cases

It was duly established that respondent paid inter-


est to petitioner. Respondent was under no duty to
make such payment because there was no express
stipulation in writing to that effect. There was no
binding relation between petitioner and respon-
dent as regards the payment of interest. The pay-
ment was clearly a mistake. Since petitioner re-
ceived something when there was no right to de-
mand it, he has an obligation to return it...
Records show that respondent received a loan
amounting to -P540,000.00 from petitioner. Respon-
dent issued two checks with a total worth of
P700,000.00 in favor of petitioner as payment of the
loan. These checks were subsequently encashed by
petitioner. Obviously, there was an excess of
1P160,000.00 in the payment for the loan. Petitioner
claims that the excess of F160,000.00 serves as in-
terest on the loan to which he was entitled. Aside
from issuing the said two checks, respondent also
paid cash in the total amount of P175,000.00 to peti-
tioner as interest. Although no receipts reflecting
the same were presented because petitioner re-
fused to issue such to respondent, petitioner, none-
theless, admitted in his Reply-Affidavit in the Batas
Pambansa Blg. 22 cases that respondent paid him a
total amount of 175,000.00 cash in addition to the
two checks. Section 26 Rule 130 of the Rules of
Evidence provides that the declaration of a party as
to a relevant fact may be given in evidence against
him. Aside from the amounts of P160,000.00 and
P175,000.00 paid as interest, no other proof of addi-
tional payment as interest was presented by res-
pondent. Since we have previously found that pe-
titioner is not entitled to payment of interest and
that the principle of solutio indebiti applies to the in-
Simple Loan 1 147

stant case, petitioner should return to respondent


the excess amount of 1F160,000.00 and 12175,000.00
or the total amount of 1-335,000.00. Accordingly,
the reimbursable amount to respondent fixed by
the RTC and the Court of Appeals should be re-
duced from -P660,000.00 to 12335,000.00... Article
2217 of the Civil Code provides that moral damag-
es may be recovered if the party underwent physi-
cal suffering, mental anguish, fright, serious anxie-
ty, besmirched reputation, wounded feelings, mor-
al shock, social humiliation and similar injury.
Respondent testified that she experienced sleepless
nights and wounded feelings when petitioner re-
fused to return the amount paid as interest despite
her repeated demands. Hence, the award of moral
damages is justified. However, its corresponding
amount of F-300,000.00, as fixed by the RTC and the
Court of Appeals, is exorbitant and should be
equitably reduced. Article 2216 of the Civil Code
instructs that assessment of damages is left to the
discretion of the court according to the circums-
tances of each case. This discretion is limited by
the principle that the amount awarded should not
be palpably excessive as to indicate that it was the
result of prejudice or corruption on the part of the
trial court. To our mind, the amount of P150,000.00
as moral damages is fair, reasonable, and propor-
tionate to the injury suffered by respondent.

Article 2232 of the Civil Code states that in a quasi-


contract, such as solutio indebiti, exemplary damag-
es may be imposed if the defendant acted in an op-
pressive manner. Petitioner acted oppressively
when he pestered respondent to pay interest and
threatened to block her transactions with the PNO
148 I Credit Transactions: Notes and Cases

if she would not pay interest. This forced respon-


dent to pay interest despite lack of agreement the-
reto. Thus, the award of exemplary damages is
appropriate. The amount of P-50,000.00 imposed as
exemplary damages by the RTC and the Court is
fitting so as to deter petitioner and other lenders
from committing similar and other serious wrong-
doings.

Jurisprudence instructs that in awarding attorney's


fees, the trial court must state the factual, legal or
equitable justification for awarding the same. In the
case under consideration, the RTC stated in its De-
cision that the award of attorney's fees equivalent
to 25% of the amount paid as interest by respon-
dent to petitioner is reasonable and moderate con-
sidering the extent of work rendered by respon-
dent's lawyer in the instant case and the fact that it
dragged on for several years. Further, respondent
testified that she agreed to compensate her lawyer
handling the instant case such amount. The award,
therefore, of attorney's fees and its amount equiva-
lent to 25% of the amount paid as interest by res-
pondent to petitioner is proper.

Finally, the RTC and the Court of Appeals imposed


a 12% rate of legal interest on the amount refunda-
ble to respondent computed from 3 March 1998 un-
til its full payment. This is erroneous.

We held in Eastern Shipping Lines, Inc. v. Court of


Appeals43 , that when an obligation, not constituting
a loan or forbearance of money is breached, an in-

43 G.R. No. 97412, July 12,1994,234 SCRA 78.


Simple Loan 1 149

terest on the amount of damages awarded may be


imposed at the rate of 6% per annum. We further
declared that when the judgment of the court
awarding a sum of money becomes final and ex-
ecutory, the rate of legal interest, whether it is a
loan/forbearance of money or not, shall be 12% per
annum from such finality until its satisfaction, this
interim period being deemed equivalent to a for-
bearance of credit.

In the present case, petitioner's obligation arose


from a quasi-contract of solutio indebiti and not
from a loan or forbearance of money. Thus, an in-
terest of 6% per annum should be imposed on the
amount to be refunded as well as on the damages
awarded and on the attorney's fees, to be com-
puted from the time of the extra-judicial demand
on 3 March 1998, up to the finality of this Decision.
In addition, the interest shall become 12% per an-
num from the finality of this Decision up to its sa-
tisfaction....

Ligutan v. Court of Appeals, G.R. No. 138677, Feb-


ruary 12, 2002, 376 SCRA 560.

... Petitioners Tolomeo Ligutan and Leonidas dela


Llana obtained on 11 May 1981 a loan in the
amount of P120,000.00 from respondent Security
Bank and Trust Company. Petitioners executed a
promissory note binding themselves, jointly and
severally, to pay the sum borrowed with an inter-
est of 15.189% per annum upon maturity and to
pay a penalty of 5% every month on the outstand-
ing principal and interest in case of default. In ad-
dition, petitioners agreed to pay 10% of the total
150 I Credit Transactions: Notes and Cases

amount due by way of attorneys fees if the matter


were indorsed to a lawyer for collection or if a suit
were instituted to enforce payment. The obligation
matured on 8 September 1981; the bank, however,
granted an extension but only up until 29 Decem-
ber 1981.

Despite several demands from the bank, petition-


ers failed to settle the debt which, as of 20 May
1982, amounted to P114,416.10. On 30 September
1982, the bank sent a final demand letter to peti-
tioners informing them that they had five days
within which to make full payment. Since petition-
ers still defaulted on their obligation, the bank filed
on 3 November 1982, with the Regional Trial Court
of Makati, Branch 143, a complaint for recovery of
the due amount... The court a quo ... on 20 Octo-
ber 1989, it rendered its decision, the dispositive
portion of which read:
WHEREFORE, judgment is hereby rendered in fa-
vor of the plaintiff and against the defendants, or-
dering the latter to pay, jointly and severally, to the
plaintiff, as follows:
1. The sum of P114,416.00 with interest thereon at
the rate of 15.189% per annum, 2% service charge
and 5% per month penalty charge, commencing on
20 May 1982 until fully paid;
2. To pay the further sum equivalent to 10% of the
total amount of indebtedness for and as attorneys
fees; and
3. To pay the costs of the suit.

Petitioners interposed an appeal with the Court of


Appeals... In its decision of 7 March 1996, the ap-
pellate court affirmed the judgment of the trial
Simple Loan[ 151

court except on the matter of the 2% service charge


which was deleted pursuant to Central Bank Circu-
lar No. 783. Not fully satisfied with the decision of
the appellate court, both parties filed their respec-
tive motions for reconsideration. Petitioners
prayed for the reduction of the 5% stipulated pe-
nalty for being unconscionable. The bank, on the
other hand, asked that the payment of interest and
penalty be commenced not from the date of filing
of complaint but from the time of default as so sti-
pulated in the contract of the parties.

On 28 October 1998, the Court of Appeals resolved


the two motions thusly:
We find merit in plaintiff-appellees claim that the
principal sum of P114,416.00 with interest thereon
must commence not on the date of filing of the
complaint as we have previously held in our deci-
sion but on the date when the obligation became
due. Default generally begins from the moment
the creditor demands the performance of the obli-
gation. However, demand is not necessary to rend-
er the obligor in default when the obligation or the
law so provides. In the case at bar, defendants-
appellants executed a promissory note where they
undertook to pay the obligation on its maturity
date 'without necessity of demand.' They also
agreed to pay the interest in case of non-payment
from the date of default... While we maintain that
defendants-appellants must be bound by the con-
tract which they acknowledged and signed, we
take cognizance of their plea for the application of
the provisions of Article 1229.... Considering that
defendants-appellants partially complied with
their obligation under the promissory note by the
152 I Credit Transactions: Notes and Cases

reduction of the original amount of P120,000.00 to


P114,416.00 and in order that they will finally settle
their obligation, it is our view and we so hold that
in the interest of justice and public policy, a penalty
of 3% per month or 36% per annum would suf-
fice...

On 16 November 1998, petitioners filed an omni-


bus motion for reconsideration and to admit newly
discovered evidence... The appellate court denied
the omnibus motion for reconsideration and to
admit newly discovered evidence... Aggrieved by
the decision and resolutions of the Court of Ap-
peals, petitioners elevated their case to this Court
on 9 July 1999 via a petition for review on certiorari
under Rule 45 of the Rules of Court...

Respondent bank, which did not take an appeal,


would, however, have it that the penalty sought to
be deleted by petitioners was even insufficient to
fully cover and compensate for the cost of money
brought about by the radical devaluation and de-
crease in the purchasing power of the peso, partic-
ularly vis-a-vis the U.S. dollar, taking into account
the time frame of its occurrence. The Bank would
stress that only the amount of P5,584.00 had been
remitted out of the entire loan of P120,000.00.

A penalty clause, expressly recognized by law, is


an accessory undertaking to assume greater liabili-
ty on the part of an obligor in case of breach of an
obligation. It functions to strengthen the coercive
force of the obligation and to provide, in effect, for
what could be the liquidated damages resulting
from such a breach. The obligor would then be
Simple Loan 1 153

bound to pay .the stipulated indemnity without the


necessity of proof on the existence and on the
measure of damages caused by the breach. Al-
though a court may not at liberty ignore the free-
dom of the parties to agree on such terms and con-
ditions as they see fit that contravene neither law
nor morals, good customs, public order or public
policy, a stipulated penalty, nevertheless, may be
equitably reduced by the courts if it is iniquitous or
unconscionable or if the principal obligation has
been partly or irregularly complied with.

The question of whether a penalty is reasonable or


iniquitous can be partly subjective and partly ob-
jective. Its resolution would depend on such factors
as, but not necessarily confined to, the type, extent
and purpose of the penalty, the nature of the obli-
gation, the mode of breach and its consequences,
the supervening realities, the standing and rela-
tionship of the parties, and the like, the application
of which, by and large, is addressed to the sound
discretion of the court... The stipulated penalty
might likewise be reduced when a partial or irre-
gular performance is made by the debtor. The sti-
pulated penalty might even be deleted such as
when there has been substantial performance in
good faith by the obligor, when the penalty clause
itself suffers from fatal infirmity, or when excep-
tional circumstances so exist as to warrant it.

The Court of Appeals, exercising its good judg-


ment in the instant case, has reduced the penalty
interest from 5% a month to 3% a month which pe-
titioner still disputes. Given the circumstances, not
to mention the repeated acts of breach by petition-
154 1 Credit Transactions: Notes and Cases

ers of their contractual obligation, the Court sees


no cogent ground to modify the ruling of the ap-
pellate court.

Anent the stipulated interest of 15.189% per an-


num, petitioners, for the first time, question its rea-
sonableness and prays that the Court reduce the
amount. This contention is a fresh issue that has
not been raised and ventilated before the courts be-
low. In any event, the interest stipulation, on its
face, does not appear as being that excessive. The
essence or rationale for the payment of interest,
quite often referred to as cost of money, is not ex-
actly the same as that of a surcharge or a penalty. A
penalty stipulation is not necessarily preclusive of
interest, if there is an agreement to that effect, the
two being distinct concepts which may separately
be demanded. What may justify a court in not al-
lowing the creditor to impose full surcharges and
penalties, despite an express stipulation therefor in
a valid agreement, may not equally justify the non-
payment or reduction of interest. Indeed, the inter-
est prescribed in loan financing arrangements is a
fundamental part of the banking business and the
core of a bank's existence... At any rate, the sub-
sequent execution of the real estate mortgage as se-
curity for the existing loan would not have resulted
in the extinguishment of the original contract of
loan because of novation. Petitioners acknowledge
that the real estate mortgage contract does not con-
tain any express stipulation by the parties intend-
ing it to supersede the existing loan agreement be-
tween the petitioners and the bank. Respondent
bank has correctly postulated that the mortgage is
Simple Loan I 155
but an accessory contract to secure the loan in the
promissory note.

Extinctive novation requires, first, a previous valid


obligation; second, the agreement of all the parties
to the new contract; third, the extinguishment of
the obligation; and fburth, the validity of the new
one. In order that an obligation may be extin-
guished by another which substitutes the same, it
is imperative that it be so declared in unequivocal
terms, or that the old and the new obligation be on
every point incompatible with each other. An obli-
gation to pay a sum of money is not extinctively
novated by a new instrument which merely
changes the terms of payment or adding compati-
ble covenants or where the old contract is merely
supplemented by the new one. When not ex-
pressed, incompatibility is required so as to ensure
that the parties have indeed intended such nova-
tion despite their failure to express it in categorical
terms. The incompatibility, to be sure, should take
place in any of the essential elements of the obliga-
tion, i.e., (1) the juridical relation or tie, such as
from a mere commodatum to lease of things, or from
negotiorum gestio to agency, or from a mortgage to
antichresis, or from a sale to one of loan; (2) the ob-
ject or principal conditions, such as a change of the
nature of the prestation; or (3) the subjects, such as
the substitution of a debtor or the subrogation of
the creditor. Extinctive novation does not necessar-
ily imply that the new agreement should be com-
plete by itself; certain terms and conditions may be
carried, expressly or by implication, over to the
new obligation...
156 1 Credit Transactions: Notes and Cases

4. Finance Charges

R. A. No. 3765," Sec. 4. Any creditor 45 shall fur-


nish to each person to whom credit is extended,
prior to the consummation of the transaction, a
clear statement in writing setting forth, to the ex-
tent applicable and in accordance with rules and
regulations prescribed by the Board 46 , the follow-
ing information:
(1) the cash price or delivered price of the proper-
ty or service to be acquired; (2) the amounts, if
any, to be credited as down payment and/or
trade-in;
(3) the difference between the amounts set forth
under clauses (1) and (2);
(4) the charges, individually itemized, which are
paid or to be paid by such person in connection
with the transaction but which are not incident to
the extension of credit;
(5) the total amount to be financed;
(6) the finance charge expressed in terms of pesos
and centavos; and
(7) the percentage that the finance charge bears to
the total amount to be financed expressed as a
simple annual rate on the outstanding unpaid
balance of the obligation.

44 R.A.No. 3765 (1963), The Truth in Lending Ac; its declared policy is to pro-
tect the State's "citizens from a lack of awareness of the true cost of credit
to the user by assuring a full disclosure of such cost with a view of prevent-
ing the uninformed use of credit to the detriment of the national economy."
45 RA. No. 3765 (1963), Sec. 3 (4) ... any person engaged in the business of
extending credit (including any person who as a regular business practice
make loans or sells or rents property or services on a time, credit, or in-
stallment basis, either as principal or as agent) who requires as an incident
to the extension of credit, the payment of a finance charge.
46 LA. No. 3765 (1963), Sec. 3 (1) ...
the Monetary Board of the Central Bank
of the Philippines.
Simple Loan 1 157

Sec. 6. (a) Any creditor who in connection with


any credit transaction fails to disclose to any per-
son any information in violation of this Act or
any regulation issued thereunder shall be liable
to such person in the amount of P100 or in an
amount equal to twice the finance charged re-
quired by such creditor in connection with such
transaction, whichever is the greater, except that
such liability shall not exceed P2,000 on any cre-
dit transaction. Action to recover such penalty
may be brought by such person within one year
from the date of the occurrence of the violation,
in any court of competent jurisdiction. In any ac-
tion under this subsection in which any person is
entitled to a recovery, the creditor shall be liable
for reasonable attorney's fees and court costs as
determined by the court.
(b) Except as specified in subsection (a) of this
section, nothing contained in this Act or any reg-
ulation contained in this Act or any regulation
thereunder shall affect the validity or enforceabil-
ity of any contract or transactions.
(c) Any person who willfully violates any provi-
sion of this Act or any regulation issued the-
reunder shall be fined by not less than P1,000 or
more than P5,000 or imprisonment for not less
than 6 months, nor more than one year or both.
(d) No punishment or penalty provided by this
Act shall apply to the Philippine Government or
any agency or any political subdivision thereof.
(e) A final judgment hereafter rendered in any
criminal proceeding under this Act to the effect
that a defendant has willfully violated this Act
shall be prima facie evidence against such defen-
dant in an action or proceeding brought by any
other party against such defendant under this Act
158 1 Credit Transactions: Notes and Cases

as to all matters respecting which said judgment


would be an estoppel as between the parties the-
reto.

As provided in the Truth in Lending Act, a finance


charge not only refers to conventional interest, but also
includes fees, service charges, discounts, and such other
charges incident to the extension of credit as the Monetary
Board of the Central Bank of the Philippines may by regu-
lation prescribe. 47

Unlike its Civil Code counterparts, the Truth in Lending


Act, a special commercial law, includes provisions crimi-
nalizing certain acts and omissions.

United Coconut Planters Bank v. Samuel and Be-


luso, G.R. No. 159912, August 17, 2007, 530 SCRA
567.

... On 16 April 1996, UCPB granted the spouses Be-


luso a Promissory Notes Line under a Credit
Agreement whereby the latter could avail from the
former credit of up to a maximum amount of 1P1.2
Million pesos for a term ending on 30 April 1997.
The spouses Beluso constituted, other than their
promissory notes, a real estate mortgage over par-
cels of land in Roxas City, covered by Transfer Cer-
tificates of Title No. T-31539 and T-27828, as addi-
tional security for the obligation. The Credit
Agreement was subsequently amended to increase
the amount of the Promissory Notes Line to a max-
imum of F-2.35 Million pesos and to extend the
term thereof to 28 February 1998.

47 R.A. No. 3765 (1963), Sec. 3 (3).


Simple LoanI 159

The spouses Beluso availed themselves of the cre-


dit line under the following Promissory
Notes... The three promissory notes were renewed
several times. On 30 April 1997, the payment of
the principal and interest of the latter two promis-
sory notes were debited from the spouses Beluso's
account with UCPB; yet, a consolidated loan for
P1.3 Million was again released to the spouses Be-
luso under one promissory note with a due date of
28 February 1998.

To completely avail themselves of the P2.35 Million


credit line extended to them by UCPB, the spouses
Beluso executed two more promissory notes for a
total of P350,000.00... However, the spouses Beluso
alleged that the amounts covered by these last two
promissory notes were never released or credited
to their account and, thus, claimed that the prin-
cipal indebtedness was only P2 Million.

In any case, UCPB applied interest rates on the dif-


ferent promissory notes ranging from 18% to 34%.
From 1996 to February 1998 the spouses Beluso
were able to pay the total sum of P763,692.03.

From 28 February 1998 to 10 June 1998, UCPB con-


tinued to charge interest and penalty on the obliga-
tions of the spouses Beluso... The spouses Beluso,
however, failed to make any payment of the fore-
going amounts.
On 2 September 1998, UCPB demanded that the
spouses Beluso pay their total obligation of
.2,932,543.00 plus 25% attorney's fees, but the
spouses Beluso failed to comply therewith. On 28
December 1998, UCPB foreclosed the properties
160 I Credit Transactions: Notes and Cases

mortgaged by the spouses Beluso to secure their


credit line, which, by that time, already ballooned
to P3,784,603.00.

On 9 February 1999, the spouses Beluso filed a Peti-


tion for Annulment, Accounting and Damages
against UCPB with the RTC of Makati City.

On 23 March 2000, the RTC ruled in favor of the


spouses Beluso... On 8 May 2000, the RTC denied
UCPB's Motion for Reconsideration, prompting
UCPB to appeal the RTC Decision with the Court
of Appeals. The Court of Appeals affirmed the
RTC Decision... On 9 September 2003, the Court of
Appeals denied UCPB's Motion for Reconsidera-
tion for lack of merit. UCPB thus filed the present
petition...

Validity of the Interest Rates


The Court of Appeals held that the imposition of
interest in the following provision found in the
promissory notes of the spouses Beluso is void, as
the interest rates and the bases therefor were de-
termined solely by petitioner UCPB:
FOR VALUE RECEIVED, I, and/or We, on or be-
fore due date, SPS. SAMUEL AND ODETTE BE-
LUSO (BORROWER), jointly and severally promise
to pay to UNITED COCONUT PLANTERS BANK
(LENDER) or order at UCPB Bldg., Makati Ave-
nue, Makati City, Philippines, the sum of
PESOS, (P ), Philippine Cur-
rency, with interest thereon at the rate indicative of
DBD retail rate or as determined by the Branch
Head.
Simple Loan 1 161

UCPB asserts that this is a reversible error, and


claims that while the interest rate was not numeri-
cally quantified in the face of the promissory notes,
it was nonetheless categorically fixed, at the time of
execution thereof, at the "rate indicative of the
DBD retail rate." UCPB contends that said provi-
sion must be read with another stipulation in the
promissory notes subjecting to review the interest
rate as fixed:
The interest rate shall be subject to review and may
be increased or decreased by the LENDER consi-
dering among others the prevailing financial and
monetary conditions; or the rate of interest and
charges which other banks or financial institutions
charge or offer to charge for similar accommoda-
tions; and/or the resulting profitability to the
LENDER after due consideration of all dealings
with the BORROWER.

In this regard, UCPB avers that these are valid ref-


erence rates akin to a "prevailing rate" or "prime
rate" allowed by this Court in Polotan v. Court of
Appeals48 . Furthermore, UCPB argues that even if
the proviso "as determined by the branch head" is
considered void, such a declaration would not ipso
facto render the connecting clause "indicative of
DBD retail rate" void in view of the separability
clause of the Credit Agreement, which reads:
Section 9.08 Separability Clause. If any one or
more of the provisions contained in this AGREE-
MENT, or documents executed in connection he-
rewith shall be declared invalid, illegal or unenfor-
ceable in any respect, the validity, legality and en-

48 G.R. No. 119379, September 25,1998,357 Phil 250.


162 1 Credit Transactions: Notes and Cases

forceability of the remaining provisions hereof


shall not in any way be affected or impaired.

According to UCPB, the imposition of the ques-


tioned interest rates did not infringe on the prin-
ciple of mutuality of contracts, because the spouses
Beluso had the liberty to choose whether or not to
renew their credit line at the new interest rates
pegged by petitioner. UCPB also claims that as-
suming there was any defect in the mutuality of
the contract at the time of its inception, such defect
was cured by the subsequent conduct of the spous-
es Beluso in availing themselves of the credit line
from April 1996 to February 1998 without airing
any protest with respect to the interest rates im-
posed by UCPB. According to UCPB, therefore,
the spouses Beluso are in estoppel.

We agree with the Court of Appeals, and find no


merit in the contentions of UCPB.

Article 1308 of the Civil Code provides...

The provision stating that the interest shall be at


the "rate indicative of DBD retail rate or as deter-
mined by the Branch Head" is indeed dependent
solely on the will of petitioner UCPB. Under such
provision, petitioner UCPB has two choices on
what the interest rate shall be: (1) a rate indicative
of the DBD retail rate; or (2) a rate as determined
by the Branch Head. As UCPB is given this choice,
the rate should be categorically determinable in
both choices. If either of these two choices presents
an opportunity for UCPB to fix the rate at will, the
bank can easily choose such an option, thus mak-
Simple Loan 1163

ing the entire interest rate provision violative of the


principle of mutuality of contracts.

Not just one, but rather both, of these choices are


dependent solely on the will of UCPB. Clearly, a
rate "as determined by the Branch Head" gives the
latter unfettered discretion on what the rate may
be. The Branch Head may choose any rate he or
she desires. As regards the rate "indicative of the
DBD retail rate," the same cannot be considered as
valid for being akin to a "prevailing rate" or "prime
rate" allowed by this Court in Polotan.

The interest rate in Polotan reads:


The Cardholder agrees to pay interest per annum
at 3% plus the prime rate of Security Bank and
Trust Company...

In this provision in Polotan, there is a fixed margin


over the reference rate: 3%. Thus, the parties can
easily determine the interest rate by applying sim-
ple arithmetic. On the other hand, the provision in
the case at bar does not specify any margin above
or below the DBD retail rate. UCPB can peg the in-
terest at any percentage above or below the DBD
retail rate, again giving it unfettered discretion in
determining the interest rate.

The stipulation in the promissory notes subjecting


the interest rate to review does not render the im-
position by UCPB of interest rates on the obliga-
tions of the spouses Beluso valid... It should be
pointed out that the authority to review the interest
rate was given UCPB alone as the lender. Moreo-
ver, UCPB may apply the considerations enume-
164 1 Credit Transactions: Notes and Cases

rated in this provision as it wishes. As worded in


the above provision, UCPB may give as much
weight as it desires to each of the following consid-
erations: (1) the prevailing financial and monetary
condition; (2) the rate of interest and charges which
other banks or financial institutions charge or offer
to charge for similar accommodations; and/or (3)
the resulting profitability to the LENDER (UCPB)
after due consideration of all dealings with the
BORROWER (the spouses Beluso). Again, as in the
case of the interest rate provision, there is no fixed
margin above or below these considerations.

In view of the foregoing, the Separability Clause


cannot save either of the two options of UCPB as to
the interest to be imposed, as both options violate
the principle of mutuality of contracts.

UCPB likewise failed to convince us that the


spouses Beluso were in estoppel.

Estoppel cannot be predicated on an illegal act. As


between the parties to a contract, validity cannot be
given to it by estoppel if it is prohibited by law or
is against public policy.

The interest rate provisions in the case at bar are il-


legal not only because of the provisions of the Civil
Code on mutuality of contracts, but also, as shall be
discussed later, because they violate the Truth in
Lending Act. Not disclosing the true finance
charges in connection with the extensions of credit
is, furthermore, a form of deception which we can-
not countenance. It is against the policy of the
State as stated in the Truth in Lending Act...
Simple Loan 1165

Moreover, while the spouses Beluso indeed agreed


to renew the credit line, the offending provisions
are found in the promissory notes themselves, not
in the credit line. In fixing the interest rates in the
promissory notes to cover the renewed credit line,
UCPB still reserved to itself the same two options -
(1) a rate indicative of the DBD retail rate; or (2) a
rate as determined by the Branch Head.

Error in Computation
UCPB asserts that while both the RTC and the
Court of Appeals voided the interest rates imposed
by UCPB, both failed to include in their computa-
tion of the outstanding obligation of the spouses
Beluso the legal rate of interest of 12% per annum.
Furthermore, the penalty charges were also deleted
in the decisions of the RTC and the Court of Ap-
peals. Section 2.04, Article II on "Interest and other
Bank Charges" of the subject Credit Agreement,
provides:
Section 2.04 Penalty Charges. In addition to the
interest provided for in Section 2.01 of this AR-
TICLE, any principal obligation of the CLIENT he-
reunder which is not paid when due shall be sub-
ject to a penalty charge of one percent (1%) of the
amount of such obligation per month computed
from due date until the obligation is paid in full. If
the bank accelerates the ... payment of availments
hereunder pursuant to ARTICLE VIII hereof, the
penalty charge shall be used on the total principal
amount outstanding and unpaid computed from
the date of acceleration until the obligation is paid
in full.
166 1 Credit Transactions: Notes and Cases

Paragraph 4 of the pronissory notes also states:


In case of non-payment of this Promissory Note
(Note) at maturity, I/We, jointly and severally,
agree to pay an additional sum equivalent to twen-
ty-five percent (25%) of the total due on the Note as
attorney's fee, aside from the expenses and costs of
collection whether actually incurred or not, and a
penalty charge of one percent (1%) per month on
the total amount due and unpaid from date of de-
fault until fully paid.

Petitioner further claims that it is likewise entitled


to attorney's fees, pursuant to Section 9.06 of the
Credit Agreement, thus:
If the BANK shall require the services of counsel
for the enforcement of its rights under this
AGREEMENT, the Note(s), the collaterals and oth-
er related documents, the BANK shall be entitled
to recover attorney's fees equivalent to not less
than twenty-five percent (25 %)of the total amounts
due and outstanding exclusive of costs and other
expenses.

Another alleged computational error pointed out


by UCPB is the negation of the Compounding In-
terest agreed upon by the parties under Section
2.02 of the Credit Agreement
Section 2.02 Compounding Interest. Interest not
paid when due shall form part of the principal and
shall be subject to the same interest rate as herein
stipulated.
and paragraph 3 of the subject promissory notes:
Interest not paid when due shall be added to, and
become part of the principal and shall likewise
bear interest at the same rate.
Simple Loan I 167

UCPB lastly avers that the application of the


spouses Beluso's payments in the disputed compu-
tation does not reflect the parties' agreement. The
RTC deducted the payment made by the spouses
Beluso amounting to P763,693.00 from the princip-
al of P2,350,000.00. This was allegedly inconsistent
with the Credit Agreement, as well as with the
agreement of the parties as to the facts of the case.
In paragraph 7 of the spouses Beluso's Manifesta-
tion and Motion on Proposed Stipulation of Facts
and Issues vis-a-vis UCPB's Manifestation, the par-
ties agreed that the amount of P763,693.00 was ap-
plied to the interest and not to the principal, in ac-
cord with Section 3.03, Article II of the Credit
Agreement on "Order of the Application of Pay-
ments," which provides:
Section 3.03Application of Payment. Payments
made by the CLIENT shall be applied in accor-
dance with the following order of preference:
1. Accounts receivable and other out-of-pocket
expenses
2. Front-end Fee, Origination Fee, Attorney's Fee
and other expenses of collection;
3. Penalty charges;
4. Past due interest;
5. Principal amortization/Payment in arrears;
6. Advance interest;
7. Outstanding balance; and
8. All other obligations of CLIENT to the BANK, if
any.

Thus, according to UCPB, the interest charges, pe-


nalty charges, and attorney's fees had been erro-
neously excluded by the RTC and the Court of Ap-
peals from the computation of the total amount
168 I Credit Transactions: Notes and Cases

due and demandable from spouses Beluso... We


agree with UCPB on this score. Default com-
mences upon judicial or extrajudicial demand. The
excess amount in such a demand does not nullify
the demand itself, which is valid with respect to
the proper amount. A contrary ruling would put
commercial transactions in disarray, as validity of
demands would be dependent on the exactness of
the computations thereof, which are too often con-
tested.

There being a valid demand on the part of UCPB,


albeit excessive, the spouses Beluso are considered
in default with respect to the proper amount and,
therefore, the interests and the penalties began to
run at that point.
As regards the award of 12% legal interest in favor
of petitioner, the RTC actually recognized that said
legal interest should be imposed, thus: "There be-
ing no valid stipulation as to interest, the legal rate
of interest shall be charged." It seems that the RTC
inadvertently overlooked its non-inclusion in its
computation.

The spouses Beluso had even originally asked for


the RTC to impose this legal rate of interest in both
the body and the prayer of its petition with the
RTC:
12. Since the provision on the fixing of the rate of
interest by the sole will of the respondent Bank is
null and void, only the legal rate of interest which
is 12% per annum can be legally charged and im-
posed by the bank, which would amount to only
about P599,000.00 since 1996 up to August 31,
1998...
Simple Loan 1169

All these show that the spouses Beluso had ac-


knowledged before the RTC their obligation to pay
a 12% legal interest on their loans. When the RTC
failed to include the 12% legal interest in its com-
putation, however, the spouses Beluso merely de-
fended in the appellate courts this non-inclusion,
as the same was beneficial to them. We see, how-
ever, sufficient basis to impose a 12% legal interest
in favor of petitioner in the case at bar, as what we
have voided is merely the stipulated rate of interest
and not the stipulation that the loan shall earn in-
terest.

We must likewise uphold the contract stipulation


providing the compounding of interest. The provi-
sions in the Credit Agreement and in the promisso-
ry notes providing for the compounding of interest
were neither nullified by the RTC or the Court of
Appeals, nor assailed by the spouses Beluso in
their petition with the RTC. The compounding of
interests has furthermore been declared by this
Court to be legal. We have held in Tan v. Court of
Appeals49, that:
Without prejudice to the provisions of Article 2212,
interest due and unpaid shall not earn interest.
However, the contracting parties may by stipula-
tion capitalize the interest due and unpaid, which
as added principal, shall earn new interest.

As regards the imposition of penalties, however,


although we are likewise upholding the imposition
thereof in the contract, we find the rate iniquitous.
Like in the case of grossly excessive interests, the

49 G.R. No. 116285, October 19, 2001, 419 Phil 857.


170 I Credit Transactions: Notes and Cases

penalty stipulated in the contract may also be re-


duced by the courts if it is iniquitous or uncons-
cionable.

We find the penalty imposed by UCPB, ranging


from 30.41% to 36%, to be iniquitous considering
the fact that this penalty is already over and above
the compounded interest likewise imposed in the
contract. If a 36% interest in itself has been de-
clared unconscionable by this Court, what more a
30.41% to 36% penalty, over and above the pay-
ment of compounded interest? UCPB itself must
have realized this, as it gave us a sample computa-
tion of the spouses Beluso's obligation if both the
interest and the penalty charge are reduced to
12%... In sum, we hold that spouses Beluso should
still be held liable for a compounded legal interest
of 12% per annum and a penalty charge of 12% per
annum. We also hold that, instead of awarding at-
torney's fees in favor of petitioner, we shall merely
affirm the deletion of the award of attorney's fees
to the spouses Beluso....

Liability for Violation of Truth in Lending Act


The RTC, affirmed by the Court of Appeals, im-
posed a fine of P26,000.00 for UCPB's alleged viola-
tion of Republic Act No. 3765, otherwise known as
the Truth in Lending Act.

UCPB challenges this imposition, on the argument


that Section 6(a) of the Truth in Lending Act which
mandates the filing of an action to recover such
penalty must be made under the following cir-
cumstances...
Simple Loan 1 171

According to UCPB, the Court of Appeals even


stated that "[a]dmittedly the original complaint did
not explicitly allege a violation of the 'Truth in
Lending Act' and no action to formally admit the
amended petition [which expressly alleges viola-
tion of the Truth in Lending Act] was made either
by [respondents] spouses Beluso and the lower
court..."

UCPB further claims that the action to recover the


penalty for the violation of the Truth in Lending
Act had been barred by the one-year prescriptive
period provided for in the Act. UCPB asserts that
per the records of the case, the latest of the subject
promissory notes had been executed on 2 January
1998, but the original petition of the spouses Beluso
was filed before the RTC on 9 February 1999,
which was after the expiration of the period to file
the same on 2 January 1999.

On the matter of allegation of the violation of the


Truth in Lending Act, the Court of Appeals ruled:
Admittedly the original complaint did not explicit-
ly allege a violation of the 'Truth in Lending Act'
and no action to formally admit the amended peti-
tion was made either by [respondents] spouses Be-
luso and the lower court. In such transactions, the
debtor and the lending institutions do not deal on
an equal footing and this law was intended to pro-
tect the public from hidden or undisclosed charges
on their loan obligations, requiring a full disclosure
thereof by the lender. We find that its infringe-
ment may be inferred or implied from allegations
that when [respondents] spouses Beluso executed
the promissory notes, the interest rate chargeable
172 1 Credit Transactions: Notes and Cases

thereon were left blank. Thus, [petitioner] UCPB


failed to discharge its duty to disclose in full to
[respondents] Spouses Beluso the charges applica-
ble on their loans.

We agree with the Court of Appeals. The allega-


tions in the complaint, much more than the title
thereof, are controlling. Other than that stated by
the Court of Appeals, we find that the allegation of
violation of the Truth in Lending Act can also be
inferred from the same allegation in the complaint
we discussed earlier:
b.) In unilaterally imposing an increased interest
rates (sic) respondent bank has relied on the provi-
sion of their promissory note granting respondent
bank the power to unilaterally fix the interest rates,
which rate was not determined in the promissory
note but was left solely to the will of the Branch
Head of the respondent Bank...

The allegation that the promissory notes grant


UCPB the power to unilaterally fix the interest
rates certainly also means that the promissory
notes do not contain a "clear statement in writing"
of "(6) the finance charge expressed in terms of pe-
sos and centavos; and (7) the percentage that the
finance charge bears to the amount to be financed
expressed as a simple annual rate on the outstand-
ing unpaid balance of the obligation." Furthermore,
the spouses Beluso's prayer "for such other reliefs
just and equitable in the premises" should be
deemed to include the civil penalty provided for in
Section 6(a) of the Truth in Lending Act
Simple Loan 1 173

UCPB's contention that this action to recover the


penalty for the violation of the Truth in Lending
Act has already prescribed is likewise without me-
rit. The penalty for the violation of the act is P100
or an amount equal to twice the finance charge re-
quired by such creditor in connection with such
transaction, whichever is greater, except that such
liability shall not exceed P2,000.00 on any credit
transaction. As this penalty depends on the finance
charge required of the borrower, the borrower's cause
of action would only accrue when such finance
charge is required. In the case at bar, the date of
the demand for payment of the finance charge is 2
September 1998, while the foreclosure was made
on 28 December 1998. The filing of the case on 9
February 1999 is therefore within the one-year pre-
scriptive period.

UCPB argues that a violation of the Truth in Lend-


ing Act, being a criminal offense, cannot be in-
ferred nor implied from the allegations made in the
complaint. Pertinent provisions of the Act read...
As can be gleaned from Section 6(a) and (c) of the
Truth in Lending Act, the violation of the said Act
gives rise to both criminal and civil liabilities. Sec-
tion 6(c) considers a criminal offense the willful vi-
olation of the Act, imposing the penalty therefor of
fine, imprisonment or both. Section 6(a), on the
other hand, clearly provides for a civil cause of ac-
tion for failure to disclose any information of the
required information to any person in violation of
the Act. The penalty therefor is an amount of P100
or in an amount equal to twice the finance charge
required by the creditor in connection with such
transaction, whichever is greater, except that the
174 1 Credit Transactions: Notes and Cases

liability shall not exceed 12,000.00 on any credit


transaction. The action to recover such penalty
may be instituted by the aggrieved private person
separately and independently from the criminal
case for the same offense.

In the case at bar, therefore, the civil action to re-


cover the penalty under Section 6(a) of the Truth in
Lending Act had been jointly instituted with (1) the
action to declare the interests in the promissory
notes void, and (2) the action to declare the foreclo-
sure void... In attacking the RTC's disposition on
the violation of the Truth in Lending Act since the
same was not alleged in the complaint, UCPB is ac-
tually asserting a violation of due process. Indeed,
due process mandates that a defendant should be
sufficiently apprised of the matters he or she
would be defending himself or herself against.
However, in the 1 July 1999 pre-trial brief filed by
the spouses Beluso before the RTC, the claim for
civil sanctions for violation of the Truth in Lending
Act was expressly alleged, thus:
Moreover, since from the start, respondent bank
violated the Truth in Lending Act in not informing
the borrower in writing before the execution of the
Promissory Notes of the interest rate expressed as a
percentage of the total loan, the respondent bank
instead is liable to pay petitioners double the
amount the bank is charging petitioners by way of
sanction for its violation.

In the same pre-trial brief, the spouses Beluso also


expressly raised the following issue:
b.) Does the expression indicative rate of DBD re-
tail (sic) comply with the Truth in Lending Act
Simple Loan 1 175

provision to express the interest rate as a simple


annual percentage of the loan?

These assertions are so clear and unequivocal that


any attempt of UCPB to feign ignorance of the as-
sertion of this issue in this case as to prevent it
from putting up a defense thereto is plainly hog-
wash.

Petitioner further posits that it is the Metropolitan


Trial Court which has jurisdiction to try and adju-
dicate the alleged violation of the Truth in Lending
Act, considering that the present action allegedly
involved a single credit transaction as there was
only one Promissory Note Line.
We disagree. We have already ruled that the ac-
tion to recover the penalty under Section 6(a) of the
Truth in Lending Act had been jointly instituted
with (1) the action to declare the interests in the
promissory notes void, and (2) the action to declare
the foreclosure void. There had been no question
that the above actions belong to the jurisdiction of
the RTC... Furthermore, opening a credit line does
not create a credit transaction of loan or mutuum,
since the former is merely a preparatory contract to
the contract of loan or mutuum. Under such credit
line, the bank is merely obliged, for the considera-
tions specified therefor, to lend to the other party
amounts not exceeding the limit provided. The
credit transaction thus occurred not when the cre-
dit line was opened, but rather when the credit line
was availed of. In the case at bar, the violation of
the Truth in Lending Act allegedly occurred not
when the parties executed the Credit Agreement,
where no interest rate was mentioned, but when
176 1 Credit Transactions: Notes and Cases

the parties executed the promissory notes, where


the allegedly offending interest rate was stipulated.

UCPB further argues that since the spouses Beluso


were duly given copies of the subject promissory
notes after their execution, then they were duly no-
tified of the terms thereof, in substantial com-
pliance with the Truth in Lending Act.

Once more, we disagree. Section 4 of the Truth in


Lending Act clearly provides that the disclosure
statement must be furnished prior to the consum-
mation of the transaction... The rationale of this
provision is to protect users of credit from a lack of
awareness of the true cost thereof, proceeding from
the experience that banks are able to conceal such
true cost by hidden charges, uncertainty of interest
rates, deduction of interests from the loaned
amount, and the like. The law thereby seeks to
protect debtors by permitting them to fully appre-
ciate the true cost of their loan, to enable them to
give full consent to the contract, and to properly
evaluate their options in arriving at business deci-
sions. Upholding UCPB's claim of substantial
compliance would defeat these purposes of the
Truth in Lending Act. The belated discovery of the
true cost of credit will too often not be able to re-
verse the ill effects of an already consummated
business decision.

In addition, the promissory notes, the copies of


which were presented to the spouses Beluso after
execution, are not sufficient notification from
UCPB. As earlier discussed, the interest rate provi-
sion therein does not sufficiently indicate with par-
Simple LoanI 177

ticularity the interest rate to be applied to the loan


covered by said promissory notes...

WHEREFORE, the Decision of the Court of Ap-


peals is hereby AFFIRMED with the following
MODIFICATIONS:
1. In addition to the sum of 22,350,000.00 as de-
termined by the courts a quo, respondent spouses
Samuel and Odette Beluso are also liable for the
following amounts:
a. Penalty of 12% per annum on the amount due
from the date of demand; and
b. Compounded legal interest of 12% per annum
on the amount due from date of demand;
2. The following amounts shall be deducted from
the liability of the spouses Samuel and Odette Be-
luso:
a. Payments made by the spouses in the amount
of 1-763,692.00. These payments shall be applied to
the date of actual payment of the following in the
order that they are listed, to wit:
i. penalty charges due and demandable as of the
time of payment;
ii. interest due and demandable as of the time of
payment;
iii. principal amortization/payment in arrears as of
the time of payment;
iv. outstanding balance.
b. Penalty under Republic Act No. 3765 in the
amount of P26,000.00. This amount shall be de-
ducted from the liability of the spouses Samuel and
Odette Beluso on 9 February 1999 to the following
in the order that they are listed, to wit:
i. penalty charges due and demandable as of time
of payment;
178 1 Credit Transactions: Notes and Cases

ii. interest due and demandable as of the time of


payment;
iii. principal amortization/payment in arrears as of
the time of payment;
iv. outstanding balance.
3. The foreclosure of mortgage is hereby declared
VALID. Consequently, the amounts which the Re-
gional Trial Court and the Court of Appeals or-
dered respondents to pay, as modified in this Deci-
sion, shall be deducted from the proceeds of the fo-
reclosure sale.

5. Usury

a. General Concepts

Art. 1175. Usurious transactions shall be governed


by special laws.

Art. 1957. Contracts and stipulations, under any


cloak or device whatsoever, intended to circum-
vent the laws against usury shall be void. The
borrower may recover in accordance with the
laws on usury.

Art. 1961. Usurious contracts shall be governed by


the Usury Law and other special laws, so far as
they are not inconsistent with this Code.

Act No. 265550, Sec. 1. The rate of interest for the


loan or
forbearance of any money goods, or credits and
the rate allowed in judgments,

50 Act No. 2655 (1916), The Usury Law, as amended.


Simple Loan 1 179

in the absence of express contract as to such rate


of interest,
shall be six per centum per annum or such rate as
may be prescribed by the Monetary Board of the
Central Bank of the Philippines for that purpose
in accordance with the authority hereby
granted.5 '

Sec. 1-a. The Monetary Board is hereby autho-


rized to prescribe the maximum rate or rates of
interest for the loan or renewal thereof or the for-
bearance of any money, goods or credits, and to
change such rate or rates whenever warranted by
prevailing economic and social conditions: Pro-
vided, That changes in such rate or rates may be
effected gradually on scheduled dates announced
in advance.

In the exercise of the authority herein granted the


Monetary Board may prescribe higher maximum
rates for loans of low priority, such as consumer
loans or renewals thereof as well as such loans
made by pawnshops, finance companies and oth-
er similar credit institutions although the rates
prescribed for these institutions need not neces-
sarily be uniform. The Monetary Board is also au-
thorized to prescribed different maximum rate or
rates for different types of borrowings, including
deposits and deposit substitutes, or loans of fi-
nancial intermediaries.

Sec. 4-a. The Monetary Board may eliminate, ex-


empt from, or suspend the effectivity of, interest

5112% for loans and forbearance of money, goods, or credits pursuant to Cen-
tral Bank Circular No. 416, series of 1974.
180 1 Credit Transactions: Notes and Cases

rate ceilings on certain types of loans or renewals


thereof or forbearances of money, goods, or cre-
dit,
whenever warranted by prevailing economic and
social conditions.

Sec. 4-b. In the exercise of its authority to fix the


maximum rate or rates of interest under this Act,
the Monetary Board shall be guided by the fol-
lowing:
1. The existing economic conditions in the coun-
try and the general requirements of the national
economy;
2. The supply of and demand for credit;
3. The rate of increase in the price levels; and
4. Such other relevant criteria as the Monetary
Board may adopt.

Sec. 5. In computing the interest on any obliga-


tion, promissory note or other instrument or con-
tract,
compound interest shall not be reckoned,
except by agreement;
Provided, That whenever compound interest is
agreed upon, the effective rate of interest charged
by the creditor shall not exceed the equivalent of
the maximum rate prescribed by the Monetary
Board, or,
in default thereof, whenever the debt is judicially
claimed, in which last case it shall draw six per
centum per annum interest or such rate as may be
prescribed by the Monetary Board.
No person or corporation shall require interest to
be paid in advance for a period of more than one
year;
Simple LoanI 181

Provided, however, That whenever interest is


paid in advance, the effective rate of interest
charged by the creditor shall not exceed the
equivalent of the maximum rate prescribed by
the Monetary Board.

Sec. 9-a. The Monetary Board shall promulgate


such rules and regulations as may be necessary to
implement effectively the provisions of this Act.

Central Bank Circular No. 905, Series of 1982, Sec.


1. The rate of interest, including commissions,
premiums, fees and other charges, on a loan or
forbearance of any money, goods, or credits, re-
gardless of maturity and whether secured or un-
secured, that may be charged or collected by any
person, whether natural or juridical, shall not be
subject to any ceiling prescribed under or pur-
suant to the Usury Law, as amended.

Historically, a general prejudice against the lending of


money at interest was evident. Under Roman law, limita-
tions were imposed on the rate that creditors could de-
mand. Interestingly enough, the rate limitation settled at
the 12% level, very close to the rate that our current laws
impose. An imposition of interest above the legal rate
was considered usury and although the loan itself was
not void, the usurious interest could not be collected. 52

This prejudice was most evident under Christian law,


which viewed usury as a sin and ground for excommuni-
cation. On the other hand, Judaic law only allowed usury

5
2 Radin, Handbook of Roman Law 182-188 (1927).
182 1 Credit Transactions: Notes and Cases

"unto a stranger" and a violation resulted in social exclu-


sion.53

Many centuries later, and in this jurisdiction, both the


Civil Code and Act No. 2655, as amended, or the Usury
Law, still declare usury, or the lending of money at inter-
est in excess of the maximum rates allowed by law, as il-
legal. However, Central Bank Circular No. 905 issued by
the Monetary Board of the Central Bank, pursuant to the
powers granted by the Usury Law, effectively lifted the
ceilings on interest rates. Consequently, usury, although
illegal, is legally non-existent and interest can be charged
as creditor and borrower may agree54 pursuant to the
freedom of contract principle embodied in the Civil Code:
Art. 1306. The contracting parties may establish
such stipulations, clauses, terms and conditions
as they may deem convenient, provided they are
not contrary to law, morals, good customs, public
order, or public policy.

But Central Bank Circular No. 905 did not repeal nor in
any way amend the Usury Law as it simply suspended its
effectivity. Since the illegality of usury is wholly the crea-
ture of legislation, a Central Bank circular cannot repeal
the illegality of usury. 5 In the event the Monetary Board
of the Central Bank re-imposes ceilings on the rate of in-
terest on loans or forbearance of money, goods, or credits,
then the provisions of the Usury Law shall again be effec-
tive.

53
Ferguson, The Ascent of Money 36-37 (2009).
54 Liam Law v. Olympic Sawmill Co. & CLi, G.R. No. L-30771, May 28, 1984,
129 SCRA 439.
55
First Metro Investment Corporation v. Este Del Sol Mountain Reserve, Inc.,
et al., G.R. No. 141811, November 15, 2001, 369 SCRA 99.
Simple LoanI 183

b. Usurious Acts

Act No. 2655, Sec. 2. No person or corporation


shall directly or indirectly
take or receive in money or other property, real or
personal, or choses in action,
a higher rate of interest or greater sum or value,
including commissions, premiums, fines and pe-
nalties, for the loan or renewal thereof or forbear-
ance of money, goods, or credits,
where such loan or renewal or forbearance is se-
cured in whole or in part by a mortgage upon real
estate the title to which is duly registered, or by
any document conveying such real estate or an in-
terest therein,
than twelve per centum per annum or the maxi-
mum rate prescribed by the Monetary Board and
in force at the time the loan or renewal thereof or
forbearance is granted:
Provided, That the rate of interest under this sec-
tion or the maximum rate of interest that may be
prescribed by the Monetary Board under this sec-
tion may likewise apply to loans secured by other
types of security as may be specified by the Mon-
etary Board.

Sec. 3. No person or corporation shall directly or


indirectly
demand, take, receive or agree to charge in money
or other property, real or personal,
a higher rate or greater sum or value for the loan
or forbearance of money, goods, or credits
where such loan or forbearance is not secured as
provided in Section two hereof,
than fourteen per centum per annum or the max-
imum rate or rates prescribed by the Monetary
184 1 Credit Transactions: Notes and Cases

Board and in force at the time the loan or forbear-


ance is granted.

Sec. 4. No pawnbroker or pawnbroker's agent


shall directly or indirectly
stipulate, charge, demand, take or receive
any higher rate or greater sum or value for any
loan or forbearance
than two and one-half per centum per month
when the sum lent is less than one hundred pe-
sos;
two per centum per month when the sum lent is
one hundred pesos or more, but not exceeding
five hundred pesos; and
fourteen per centum per annum when it is more
than the amount last mentioned; or
the maximum rate or rates prescribed by the
Monetary Board and in force at the time the loan
or forbearance is granted.
A pawnbroker or pawnbroker's agent shall be
considered such, for the benefits of this Act, only
if he be duly licensed and has an establishment
open to the public.

It shall be unlawful for a pawnbroker or


pawnbroker's agent to divide the pawn offered
by a person into two or more fractions in order to
collect greater interest than the permitted by this
section.

It shall also be unlawful for a pawnbroker or


pawnbroker's agent to require the pawner to pay
an additional charge as insurance premium for
the safekeeping and conservation of the article
pawned.
Simple Loan 1185

The Usury Law is applicable only in case of a loan or for-


bearance of money, goods, or credit. It does not apply to
other contracts such as conditional sales based on in-
stallment plans. The increase in the price of the article
sold is not considered a mere pretext to cover a usurious
loan. Such an increase in price when the sale is on credit,
commonly referred to as the time price differential, is not
interest within the meaning of the Usury Law. It serves
not only to cover the expenses generally entailed by such
transactions on credit, but also to encourage cash sales. It
is up to the buyer to decide which price he prefers in
making the purchase.5 6

On the other hand, an apparently lawful loan is usurious


when additional compensation for the loan is disguised as
an ostensibly unrelated contract providing for payment
by the borrower for the creditor's services which are of
little value or which are not in fact to be rendered.57

c. Remedies

Art. 1413. Interest paid in excess of the interest al-


lowed by the usury laws may be recovered by the
debtor, with interest thereon from the date of the
payment.

Act No. 2655, Sec. 6. Any person or corporation


who, for any such loan or renewal thereof or for-
bearance,

Emata v. Intermediate Appellate Court, et al., G.R. No. L-72714, June 29,
1989,174 SCRA 464.
57
First Metro Investment Corporation v. Este Del Sol Mountain Reserve, Inc.,
et al., G.R. No. 141811, November 15,2001,369 SCRA 99.
186 I Credit Transactions: Notes and Cases

shall have paid or delivered a higher rate or


greater sum or value than is hereinbefore allowed
to be taken or received,
may recover the whole interest, commissions,
premiums penalties and surcharges paid or deli-
vered with costs and attorneys' fees in such sum
as may be allowed by the court in an action
against the person or corporation who took or re-
ceived them
if such action is brought within two years after
such payment or delivery:
Provided, however, That the creditor shall not be
obliged to return the interest, commissions and
premiums for a period of not more than one year
collected by him in advance when the debtor
shall have paid the obligation before it is due,
provided such interest, and commissions and
premiums do not exceed the rates fixed in this
Act.

Sec. 7. All covenants and stipulations contained


in conveyances, mortgages, bonds, bills, notes,
and other contracts or evidences of debts, and all
deposits of goods or other things,
whereupon or whereby there shall be stipulated,
charged, demanded, reserved, secured, taken, or
received, directly or indirectly,
a higher rate or greater sum or value for the loan
or renewal or forbearance of money, goods, or
credits than is hereinbefore allowed,
shall be void;
Provided, however, That no merely clerical error
in the computation of interest, made without in-
tent to evade any of the provisions of this Act,
shall render a contract void:
Simple Loan 1 187

Provided, further, That parties to a loan agree-


ment, the proceeds of which may be availed of
partially or fully at some future time, may stipu-
late that the rate of interest agreed upon at the
time the loan agreement is entered into, which
rate shall not exceed the maximum allowed by
law, shall prevail notwithstanding subsequent
changes in the maximum rates that may be made
by the Monetary Board;
And Provided, finally, That nothing herein con-
tained shall be construed to prevent the purchase
by an innocent purchaser of a negotiable mercan-
tile paper, usurious or otherwise, for valuable
consideration before maturity, when there has
been no intention on the part of said purchaser to
evade the provisions of this Act and said pur-
chase was not a part of the original usurious
transaction. In any case, however, the maker of
said note shall have the right to recover from said
original holder the whole interest paid by him
thereon and, in case of litigation, also the costs
and such attorney's fees as may be allowed by the
court.

Sec. 8. All loans under which payment is to be


made in agricultural products or seed or in any
other kind of commodities shall also be null and
void
unless they provide that such products or seed or
other commodities shall be appraised at the time
when the obligation falls due at the current local
market price:
Provided, That unless otherwise stated in a doc-
ument written in a language or dialect intelligible
to the debtor and subscribed in the presence of
not less than two witnesses,
188 1 Credit Transactions: Notes and Cases

any contract advancing money to be repaid later


in agricultural products or seed or any other kind
of commodities shall be understood to be a loan,
and any person or corporation having paid oth-
erwise shall be entitled in case action is brought
within two years after such payment or delivery
to recover all the products or seed delivered as in-
terest, or the value thereof, together with the costs
and attorney's fees in such sum as may be al-
lowed by the court.
Nothing contained in this section shall be con-
strued to prevent the lender from taking interest
for the money lent, provided such interest be not
in excess of the rates herein fixed.

Sec. 9. The person or corporation sued shall file


its answer
in writing
under oath
to any complaint brought or filed against said
person or corporation before a competent court to
recover the money or other personal or real prop-
erty, seeds or agricultural products, charged or re-
ceived in violation of the provisions of this Act.
The lack of taking an oath to an answer to a com-
plaint will mean the admission of the facts con-
tained in the latter.

Sec. 10. Without prejudice to the proper civil ac-


tion,
violation of this Act and the implementing rules
and regulations promulgated by the Monetary
Board shall be subject to criminal prosecution
and the guilty person shall, upon conviction, be
sentenced to a fine of not less than fifty pesos nor
more than five hundred pesos, or to imprison-
Simple Loan 1 189

ment for not less than thirty days nor more than
one year, or both, in the discretion of the court,
and to return the entire sum received as interest
from the party aggrieved, and in the case of non-
payment, to suffer subsidiary imprisonment at
the rate of one day for every two pesos:
Provided, That in case of corporations, associa-
tions, societies, or companies the manager, ad-
ministrator or gerent or the person who has
charge of the management or administration of
the business shall be criminally responsible for
any violation of this Act.

In usurious loans, the entire obligation does not become


void because of an agreement for usurious interest. Al-
though the rule of pai delictos8 applies where a contract's
nullity proceeds from illegality of the cause or object of
the contract, a contract of loan with usurious interest con-
sists of principal and accessory stipulations; the principal
is to pay the debt; the accessory stipulation is to pay in-
terest. And these stipulations are divisible in the sense
that the principal can stand without the accessory. In a
simple loan with stipulation of usurious interest, the pres-
tation of the debtor to pay the principal debt, which is the
cause of the contract, is not illegal. The illegality lies only
as to the prestation to pay the stipulated interest. Being
separable, the latter only should be deemed void, since it

58 Civil Code, Art. 1411. When the nullity proceeds from the illegality of the
cause or object of the contract, and the act constitutes a criminal offense,
both parties being in pari delicto, they shall have no action against each oth-
er, and both shall be prosecuted. Moreover, the provisions of the Penal
Code relative to the disposal of effects or instruments of a crime shall be
applicable to the things or the price of the contract
This rule shall be applicable when only one of the parties is guilty; but the
innocent one may claim what he has given, and shall not be bound to
comply with his promise.
190 I Credit Transactions: Notes and Cases

is the only one that is illegal. Consequently, the loan is to


be considered without stipulation as to interest.59

1) Remedy of Debtor

With respect to the debtor, the amount paid as interest


under a usurious agreement is recoverable by it, since the
payment is made under restraint, rather than voluntarily.
Thus, there is no conflict between the Civil Code and the
Usury Law. Under Sec. 6 of the Usury Law, any person
who shall have paid a higher rate or greater sum or value
than is allowed by law, may recover the whole interest
paid. Article 1413 of the Civil Code states that interest
paid in excess of the interest allowed by the usury laws
may be recovered by the debtor, with interest thereon
from the date of payment. Interest paid in excess of the
interest allowed by the usury laws means the whole usu-
rious interest. It is in this case that the law does not allow
division. The whole stipulation as to interest is void, since
payment of the usurious interest is the cause or object,
which is illegal. The only change effected by Article 1413
is not to provide for the recovery of the interest paid in
excess of that allowed by law, which the Usury Law al-
ready provided for, but to add that the same can be re-
covered with interest thereon from the date of payment. 60

It should be noted that Section 9 of the Usury Law refers


to a complaint filed against an entity that has committed
usury, for the recovery of the usurious interest paid. In

w Angel Jose Warehousing Co., Inc. v. Chelda Enterprises & Syjueco, G.R.
No. L-25704, April 24, 1968, 23 SCRA 119 and First Metro Investment Cor-
poration v. Este Del Sol Mountain Reserve, Inc., et al., G.R. No. 141811,
November 15,2001,369 SCRA 99.
60 Angel Jose Warehousing Co., Inc. v. Chelda Enterprises & Syjueco, G.R.
No. L-25704, April 24,1968, 23 SCRA 119.
Simple Loan 1 191

that case, if the entity sued shall not file its answer under
oath denying the allegation of usury, the defendant shall
be deemed to have admitted the usury. The provision
does not apply to a case where it is the defendant, not the
61
plaintiff, who is alleging usury.

2) Remedy of Creditor

With respect to the creditor, the nullity of the stipulation


on the usurious interest does not affect its right to receive
the principal amount of the loan. Although the philoso-
phy of usury legislation is to discourage stipulations on
usurious interest, it does not result in the forfeiture even
of the principal, for this would unjustly enrich the debtor
at the expense of the creditor. The principal debt remain-
ing without stipulation for payment of interest can thus
be recovered by judicial action. And in case of such de-
mand, and the debtor incurs in delay, the debt earns in-
terest from the date of the demand. Such interest is not
due to stipulation, for there was none, the same being
void. Rather, it is due to the general provision of law that
in obligations to pay money, where the debtor incurs in
delay, it must pay interest by way of damages. 62

Carpo v. Chua & Dy Ng, G.R. Nos. 150773, Sep-


tember 30,2005,471 SCRA 471.

... The cases stemmed from a loan contracted by


petitioners. On 18 July 1995, they borrowed from
Eleanor Chua and Elma Dy Ng (respondents) the
amount of One Hundred Seventy-Five Thousand

61 Liam Law v. Olympic Sawmill Co. & Ci, G.I. No. L-30771, May 28, 1984,
129 SCRA 439.
62
Angel Jose Warehousing Co., Inc. v. Chelda Enterprises & Syjueco, G.R.
No. L-25704, April 24,1968, 23 SCRA 119, citing Civil Code, Article 2209.
192 I Credit Transactions: Notes and Cases

Pesos (175,000.00), payable within six (6) months


with an interest rate of six percent (6%) per month.
To secure the payment of the loan, petitioners
mortgaged their residential house and lot situated
at San Francisco, Magarao, Camarines Sur... Peti-
tioners failed to pay the loan upon demand. Con-
sequently, the real estate mortgage was extrajudi-
cially foreclosed and the mortgaged property sold
at a public auction on 8 July 1996. The house and
lot was awarded to respondents, who were the on-
ly bidders, for the amount of Three Hundred Sixty-
Seven Thousand Four Hundred Fifty-Seven Pesos
and Eighty Centavos (12367,457.80).

Upon failure of petitioners to exercise their right of


redemption, a certificate of sale was issued on 5
September 1997 by Sheriff Rolando A. Borja... and
... TCT No. 29338 was issued in the name of res-
pondents... On 23 July 1999, petitioners filed a
complaint for annulment of real estate mortgage
and the consequent foreclosure proceedings... Peti-
tioners consigned the amount of Two Hundred Fif-
ty-Seven Thousand One Hundred Ninety-Seven
Pesos and Twenty-Six Centavos (P257,197.26) with
the RTC... RTC Judge Filemon B. Montenegro
dismissed the complaint ... on the ground that it
was filed out of time and barred by laches. The
RTC proceeded from the premise that the com-
plaint was one for annulment of a voidable con-
tract and thus barred by the four-year prescriptive
period. Hence, the first petition for review now
under consideration was filed with this Court, as-
sailing the dismissal of the complaint... In G.R.
No. 150773, petitioners claim that following the
Simple Loan I 193

Court's ruling in Medel v. Court of Appeals63 the rate


of interest stipulated in the principal loan agree-
ment is clearly null and void. Consequently, they
also argue that the nullity of the agreed interest
rate affects the validity of the real estate mortgage.
Notably, while petitioners were silent in their peti-
tion on the issues of prescription and laches on
which the RTC grounded the dismissal of the com-
plaint, they belatedly raised the matters in their
Memorandum. Nonetheless, these points warrant
brief comment.

Petitioners contend that the agreed rate of interest


of 6% per month or 72% per annum is so excessive,
iniquitous, unconscionable and exorbitant that it
should have been declared null and void. Instead
of dismissing their complaint, they aver that the
lower court should have declared them liable to
respondents for the original amount of the loan
plus 12% interest per annum and 1% monthly pe-
nalty charge as liquidated damages in view of the
ruling in Medel v. Court of Appeals.

In Medel, the Court found that the interest stipu-


lated at 5.5% per month or 66% per annum was so
iniquitous or unconscionable as to render the stipu-
lation void.
Nevertheless, we find the interest at 5.5% per
month, or 66% per annum, stipulated upon by the
parties in the promissory note iniquitous or un-
conscionable, and, hence, contrary to morals ("con-
tra bonos mores"), if not against the law. The stipu-
lation is void. The Court shall reduce equitably li-

63 G.R. No. 131622, November 27,1998, 359 Phil 820.


194 1 Credit Transactions: Notes and Cases

quidated damages, whether intended as an indem-


nity or a penalty if they are iniquitous or uncons-
cionable.

In a long line of cases, this Court has invalidated


similar stipulations on interest rates for being ex-
cessive, iniquitous, unconscionable and exorbitant.
In Solangon v. Salazar64 we annulled the stipulation
of 6% per month or 72% per annum interest on a
P-60,000.00 loan. In Imperial v. Jaucian65, we reduced
the interest rate from 16% to 1.167% per month or
14% per annum. In Ruiz v. Court of Appeals 66, we
equitably reduced the agreed 3% per month or 36%
per annum interest to 1% per month or 12% per
annum interest. The 10% and 8% interest rates per
month on a 1,000,000.00 loan were reduced to
12% per annum in Cuaton v. Salud67 ._ Recently, this
Court, in Arrofo v. Quino68, reduced the 7% interest
per month on a 215,000.00 loan amounting to 84%
interest per annum to 18% per annum.

There is no need to unsettle the principle affirmed


in Medel and like cases. From that perspective, it is
apparent that the stipulated interest in the subject
loan is excessive, iniquitous, unconscionable and
exorbitant. Pursuant to the freedom of contract
principle embodied in Article 1306 of the Civil
Code, contracting parties may establish such stipu-
lations, clauses, terms and conditions as they may
deem convenient, provided they are not contrary

64 G.R. No. 125944. June 29, 2001, 412 Phil 816.


65 G.R. No. 149004,14 April 2004,427 SCRA 517.
66 G.R. No. 146942,22 April 2003,401 SCRA 410.
67 G.R. No. 158382,27 January 2004,421 SCRA 278.
68 G.R. No. 145794, 26 January 2005, 449 SCRA 284.
Simple Loan 1195

to law, morals, good customs, public order, or pub-


lic policy. In the ordinary course, the codal provi-
sion may be invoked to annul the excessive stipu-
lated interest.

In the case at bar, the stipulated interest rate is 6%


per month, or 72% per annum. By the standards set
in the above-cited cases, this stipulation is similarly
invalid. However, the RTC refused to apply the
principle cited and employed in Medel on the
ground that Medel did not pertain to the annulment
of a real estate mortgage, as it was a case for an-
nulment of the loan contract itself. The question
thus sensibly arises whether the invalidity of the
stipulation on interest carries with it the invalidity
of the principal obligation.

The question is crucial to the present petition even


if the subject thereof is not the annulment of the
loan contract but that of the mortgage contract. The
consideration of the mortgage contract is the same
as that of the principal contract from which it rece-
ives life, and without which it cannot exist as an
independent contract. Being a mere accessory con-
tract, the validity of the mortgage contract would
depend on the validity of the loan secured by it.

Notably in Medel, the Court did not invalidate the


entire loan obligation despite the inequitability of
the stipulated interest, but instead reduced the rate
of interest to the more reasonable rate of 12% per
annum. The same remedial approach to the wrong-
ful interest rates involved was employed or af-
firmed by the Court in Solangon, Imperial, Ruiz, Cu-
aton, and Arrofo.
196 1 Credit Transactions: Notes and Cases

The Court's ultimate affirmation in the cases


cited of the validity of the principal loan obligation
side by side with the invalidation of the interest
rates thereupon is congruent with the rule that a
usurious loan transaction is not a complete nullity
but defective only with respect to the agreed
interest.

We are aware that the Court of Appeals, on certain


occasions, had ruled that a usurious loan is wholly
null and void both as to the loan and as to the usu-
rious interest. However, this Court adopted the
contrary rule, as comprehensively discussed in
Briones v. Cammayo69:
In Gui Jong & Co. vs. Rivera, et al., 45 Phil. 778, this
Court likewise declared that, in any event, the deb-
tor in a usurious contract of loan should pay the
creditor the amount which he justly owes him, cit-
ing in support of this ruling its previous decisions
in Go Chioco, Supra, Aguilar vs. Rubiato, et al., 40
Phil. 570, and Delgado vs. Duque Valgona, 44 Phil.
739...
Then in Lopez and Javelona vs. El Hogar Filipino,
47 Phil. 249, We also held that the standing juri-
sprudence of this Court on the question under con-
sideration was clearly to the effect that the Usury
Law, by its letter and spirit, did not deprive the
lender of his right to recover from the borrower the
money actually loaned to and enjoyed by the latter.
This Court went further to say that the Usury Law
did not provide for the forfeiture of the capital in
favor of the debtor in usurious contracts, and that
while the forfeiture might appear to be convenient

69 G.R. No. L-23559, October 4,1971,148-B Phil 881.


Simple Loan 1 197

as a drastic measure to eradicate the evil of usury,


the legal question involved should not be resolved
on the basis of convenience.
Other cases upholding the same principle are Pali-
leo vs. Cosio, 97 Phil. 919 and Pascua vs. Perez, L-
19554, January 31, 1964, 10 SCRA 199, 200-202. In
the latter We expressly held that when a contract is
found to be tainted with usury "the only right of
the respondent (creditor)... was merely to collect
the amount of the loan, plus interest due thereon."
The view has been expressed, however, that the
ruling thus consistently adhered to should now be
abandoned because Article 1957 of the new Civil
Code - a subsequent law - provides that con-
tracts and stipulations, under any cloak or device
whatever, intended to circumvent the laws against
usury, shall be void, and that in such cases "the
borrower may recover in accordance with the laws
on usury." From this the conclusion is drawn that
the whole contract is void and that, therefore, the
creditor has no right to recover - not even his
capital.
The meaning and scope of our ruling in the cases
mentioned heretofore is clearly stated, and the
view referred to in the preceding paragraph is
adequately answered, in Angel Jose, etc. vs. Chelda
Enterprises, et al. (L-25704, April 24, 1968). On the
question of whether a creditor in a usurious con-
tract may or may not recover the principal of the
loan, and, in the affirmative, whether or not he
may also recover interest thereon at the legal rate,
We said the following:
... Appealing directly to Us, defendants raise two
questions of law: (1) In a loan with usurious inter-
198 I Credit Transactions: Notes and Cases

est, may the creditor recover the principal of the


loan?...
Great reliance is made by appellants on Art. 1411
of the New Civil Code...
Since, according to the appellants, a usurious loan
is void due to illegality of cause or object, the rule
of pari delicto expressed in Article 1411, supra, ap-
plies, so that neither party can bring action against
each other. Said rule, however, appellants add, is
modified as to the borrower, by express provision
of the law (Art. 1413, New Civil Code), allowing
the borrower to recover interest paid in excess of
the interest allowed by the Usury Law. As to the
lender, no exception is made to the rule; hence, he
cannot recover on the contract. So - they continue
- the New Civil Code provisions must be upheld
as against the Usury Law, under which a loan with
usurious interest is not totally void, because of Ar-
ticle 1961 of the New Civil Code, that: "Usurious
contracts shall be governed by the Usury Law and
other special laws, so far as they are not inconsis-
tent with this Code."
We do not agree with such reasoning. Article 1411
of the New Civil Code is not new; it is the same as
Article 1305 of the Old Civil Code. Therefore, said
provision is no warrant for departing from pre-
vious interpretation that, as provided in the Usury
Law (Act No. 2655, as amended), a loan with usu-
rious interest is not totally void only as to the inter-
est... [a]ppellants fail to consider that a contract of
loan with usurious interest consists of principal
and accessory stipulations; the principal one is to
pay the debt; the accessory stipulation is to pay in-
terest thereon.
Simple Loan 1199

And said two stipulations are divisible in the sense


that the former can still stand without the latter.
Article 1273, Civil Code, attests to this: "The renun-
ciation of the principal debt shall extinguish the ac-
cessory obligations; but the waiver of the latter
shall leave the former in force."
The question therefore to resolve is whether the il-
legal terms as to payment of interest likewise rend-
ers a nullity the legal terms as to payments of the
principal debt. Article 1420 of the New Civil Code
provides in this regard: "In case of a divisible con-
tract, if the illegal terms can be separated from the
legal ones, the latter may be enforced."
In simple loan with stipulation of usurious interest,
the prestation of the debtor to pay the principal
debt, which is the cause of the contract (Article
1350, Civil Code), is not illegal. The illegality lies
only as to the prestation to pay the stipulated inter-
est; hence, being separable, the latter only should
be deemed void, since it is the only one that is il-
legal... The principal debt remaining without sti-
pulation for payment of interest can thus be recov-
ered by judicial action. And in case of such de-
mand, and the debtor incurs in delay, the debt
earns interest from the date of the demand (in this
case from the filing of the complaint). Such interest
is not due to stipulation, for there was none, the
same being void. Rather, it is due to the general
provision of law that in obligations to pay money,
where the debtor incurs in delay, he has to pay in-
terest by way of damages (Art. 2209, Civil Code).
The court a quo therefore, did not err in ordering
defendants to pay the principal debt with interest
thereon at the legal rate, from the date of filing of
the complaint."
200 1 Credit Transactions: Notes and Cases

The Court's wholehearted affirmation of the rule


that the principal obligation subsists despite the
nullity of the stipulated interest is evinced by its
subsequent rulings, cited above, in all of which the
main obligation was upheld and the offending in-
terest rate merely corrected. Hence, it is clear and
settled that the principal loan obligation still stands
and remains valid. By the same token, since the
mortgage contract derives its vitality from the va-
lidity of the principal obligation, the invalid stipu-
lation on interest rate is similarly insufficient to
render void the ancillary mortgage contract.

It should be noted that had the Court declared the


loan and mortgage agreements void for being con-
trary to public policy, no prescriptive period could
have run. Such benefit is obviously not available to
petitioners.

Yet the RTC pronounced that the complaint was


barred by the four-year prescriptive period pro-
vided in Article 1391 of the Civil Code, which go-
verns voidable contracts. This conclusion was de-
rived from the allegation in the complaint that the
consent of petitioners was vitiated through undue
influence. While the RTC correctly acknowledged
the rule of prescription for voidable contracts, it
erred in applying the rule in this case. We are hard
put to conclude in this case that there was any un-
due influence in the first place.

There is ultimately no showing that petitioners'


consent to the loan and mortgage agreements was
vitiated by undue influence. The financial condi-
tion of petitioners may have motivated them to
Simple Loan 201

contract with respondents, but undue influence


cannot be attributed to respondents simply because
they had lent money. Article 1391, in relation to
Article 1390 of the Civil Code, grants the aggrieved
party the right to obtain the annulment of contract
on account of factors which vitiate consent. Article
1337 defines the concept of undue influence, as fol-
lows:
There is undue influence when a person takes im-
proper advantage of his power over the will of
another, depriving the latter of a reasonable free-
dom of choice. The following circumstances shall
be considered: the confidential, family, spiritual
and other relations between the parties or the fact
that the person alleged to have been unduly influ-
enced was suffering from mental weakness, or was
ignorant or in financial distress.

While petitioners were allegedly financially dis-


tressed, it must be proven that there is deprivation
of their free agency. In other words, for undue in-
fluence to be present, the influence exerted must
have so overpowered or subjugated the mind of a
contracting party as to destroy his free agency,
making him express the will of another rather than
his own. The alleged lingering financial woes of
petitioners per se cannot be equated with the pres-
ence of undue influence.

The RTC had likewise concluded that petitioners


were barred by laches from assailing the validity of
the real estate mortgage. We wholeheartedly agree.
If indeed petitioners unwillingly gave their consent
to the agreement, they should have raised this is-
sue as early as in the foreclosure proceedings. It
202 I Credit Transactions: Notes and Cases

was only when the writ of possession was issued


did petitioners challenge the stipulations in the
loan contract in their action for annulment of
mortgage. Evidently, petitioners slept on their
rights. The Court of Appeals succinctly made the
following observations:
In all these proceedings starting from the foreclo-
sure, followed by the issuance of a provisional cer-
tificate of sale; then the definite certificate of sale;
then the issuance of TCT No. 29338 in favor of the
defendants and finally the petition for the issuance
of the writ of possession in favor of the defendants,
there is no showing that plaintiffs questioned the
validity of these proceedings. It was only after the
issuance of the writ of possession in favor of the
defendants, that plaintiffs allegedly tendered to the
defendants the amount of P260,000.00 which the
defendants refused. In all these proceedings, why
did plaintiffs sleep on their rights?

Clearly then, with the absence of undue influence,


petitioners have no cause of action. Even assuming
undue influence vitiated their consent to the loan
contract, their action would already be barred by
prescription when they filed it. Moreover, petition-
ers had clearly slept on their rights as they failed to
timely assail the validity of the mortgage agree-
ment. The denial of the petition in G.R. No. 150773
is warranted... One final note. The issue on the
validity of the stipulated interest rates, regrettably
for petitioners, was not raised at the earliest possi-
ble opportunity. It should be pointed out though
that since an excessive stipulated interest rate may
be void for being contrary to public policy, an ac-
tion to annul said interest rate does not prescribe.
Simple LoanI 203

Such indeed is the remedy; it is not the action for


annulment of the ancillary real estate mortgage.
Despite the nullity of the stipulated interest rate,
the principal loan obligation subsists, and along
with it the mortgage that serves as collateral securi-
ty for it.

WHEREFORE, in view of all the foregoing, the pe-


titions are DENIED. Costs against petitioners.

Despite the fact that usury is legally non-existent, the rul-


ing in Carpo tells us that the courts will not hesitate to
void interest that is "excessive, iniquitous, unconscionable
and exorbitant" as this is violative of Article 1306 of the
Civil Code. Does this not lead to unnecessary litigation
because every borrower is given the right to question
whether or not interest charged is excessive, iniquitous,
unconscionable and exorbitant? Will it not aid the effi-
cient administration of justice if a ceiling for interest rates
is re-imposed, thereby making effective the Usury Law?
Part II. Deposit

Chapter 1. The Concept of Deposit

Art. 1962. A deposit is constituted from the mo-


ment a person receives a thing belonging to
another,
with the obligation of safely keeping it and
of returning the same.
If the safekeeping of the thing delivered is not
the principal purpose of the contract, there is no
deposit but some other contract.

Art. 1964. A deposit may be constituted judicially


or extrajudicially.

Art. 1967. An extrajudicial deposit is either volun-


tary or necessary.

Deposit, from the Roman law depositum, or the gratuitous


deposit of goods for the benefit of the depositor', is an ob-
ligation constituted from the moment of delivery of
property belonging to another for the purpose of safe-
keeping and eventual return. It is the other "contract of
neighborliness" of the Roman law.2 A person who asks a
neighbor to take care of a car while abroad, delivering the
car keys to that neighbor, has entered into a deposit of the
car with the neighbor.

1 Blacks Law Dictionary, Ninth Edition (2009).


2 The other being commodatuin. Radin, Handbook of Roman Law 195
(1927).

205
206 1 Credit Transactions: Notes and Cases

A deposit may be:

1. A judicial deposit, where the obligation arises 3 as a


consequence of a law allowing the issuance of a judicial
order constituting a deposit; or

2. An extrajudicial deposit, which may be:

a. A voluntary deposit, where the obligation arises as a


consequence of contract; or

b. A necessary deposit, where the obligation arises as a


consequence of law or quasi-contract4 .

But the principal obligation in any kind of deposit, and


its distinguishing characteristic, is the safekeeping of the
property and its eventual return.

3 Civil Code, Art. 1157. Obligations arise from: (1) Law; (2) Contracts; (3)
Quasi-contracts; (4) Acts or omissions punished by law; and (5) Quasi-
delicts.
4 Civil Code, Art 2142. Certain lawful, voluntary and unilateral acts give rise
to the juridical relation of quasi-contract to the end that no one shall be un-
justly enriched or benefited at the expense of another.
Chapter 2. Voluntary Deposit

A. General Concepts

Art. 1963. An agreement to constitute a deposit is


binding,
but the deposit itself is not perfected until the de-
livery of the thing.

Art. 1968. A voluntary deposit is that wherein the


delivery is made by the will of the depositor.
A deposit may also be made by two or more per-
sons each of whom believes himself entitled to
the thing deposited with a third person, who
shall deliver it in a proper case to the one to
whom it belongs.

Art. 1969. A contract of deposit may be entered in-


to orally or in writing.

Art. 1965. A deposit is a gratuitous contract, except


when there is an agreement to the contrary, or
unless the depositary is engaged in the business
of storing goods.

Art. 1966. Only movable things may be the object


of a deposit.

Art. 1995. A deposit is extinguished:


(1) Upon the loss or destruction of the thing de-
posited;
(2) In case of a gratuitous deposit, upon the death
of either the depositor or the depositary.

A voluntary deposit (or contract of deposit) is an extra-


judicial deposit that arises as a consequence of contract.
208 1 Credit Transactions: Notes and Cases

The delivery of the object of the deposit, which must be


movable property, is made by the will of the depositor,
but since it creates obligations arising from contract, it re-
quires a meeting of the minds' between the depositor and
the chosen depositary.

The depositor is the person who, for purposes of safe-


keeping, delivers, or formally transfers, gives or yields
possession or control, 2 of the movable property to the de-
positary, who does not own the property. It is for this
reason that a deposit is a real contract, that is, a contract
in which property passes from one party to another, re-
quiring something more than mere consent. 3 In the real
contract of deposit, delivery by the depositor of the object
4
of the contract is essential for perfection.

The law does not establish any formal requisites, as a vo-


luntary deposit may be an oral or written contract. Al-
though it is historically gratuitous, it may nevertheless be
onerous.

The principal obligation of the depositary is the safe-


keeping of the movable property and its eventual return
upon demand. If the principal purpose of the contract is
not safekeeping, then it is not a contract of deposit.

A contract to deposit, or an agreement to constitute a de-


posit, on the other hand, is a valid consensual contract.

1 Civil Code, Art 1305.


2 Blacks Law Dictionary, Ninth Edition (2009).
3 Ibid.
4 Civil Code, Art 1316. Real contracts, such as deposit pledge and commo-
datum, are not perfected until the delivery of the object of the obligation.
Voluntary Deposit 1 209

Bank of the Philippine Islands v. The Interme-


diate Appellate Court and Zshornack, G.R. No. L-
66826 August 19, 1988, 164 SCRA 630.

... mrhe complaint filed with the trial court alleged


that on December 8, 1975, Zshornack entrusted to
COMTRUST, thru Garcia, US $3,000.00 cash (popu-
larly known as greenbacks) for safekeeping, and that
the agreement was embodied in a document, a
copy of which was attached to and made part of
the complaint... It was also alleged in the com-
plaint that despite demands, the bank refused to
return the money.

In its answer, COMTRUST averred that the


US$3,000 was credited to Zshornack's peso current
account at prevailing conversion rates... During
trial, it was established that on December 8, 1975
Zshornack indeed delivered to the bank US $3,000
for safekeeping. When he requested the return of
the money on May 10, 1976, COMTRUST ex-
plained that the sum was disposed of in this man-
ner: US$2,000.00 was sold on December 29, 1975
and the peso proceeds amounting to P14,920.00
were deposited to Zshomack's current account per
deposit slip accomplished by Garcia; the remaining
US$1,000.00 was sold on February 3, 1976 and the
peso proceeds amounting to P8,350.00 were depo-
sited to his current account per deposit slip also ac-
complished by Garcia.

Aside from asserting that the US$3,000.00 was


properly credited to Zshornack's current account
at prevailing conversion rates, BPI now posits
another ground to defeat private respondent's
210 I Credit Transactions: Notes and Cases

claim. It now argues that the contract embodied in


the document is the contract of depositum (as de-
fined in Article 1962, New Civil Code), which
banks do not enter into. The bank alleges that Gar-
cia exceeded his powers when he entered into the
transaction. Hence, it is claimed, the bank cannot
be liable under the contract, and the obligation is
purely personal to Garcia... Having determined
that Garcia's act of entering into the contract binds
the corporation, we now determine the correct na-
ture of the contract, and its legal consequences, in-
cluding its enforceability.

The document which embodies the contract states


that the US$3,000.00 was received by the bank for
safekeeping. The subsequent acts of the parties also
show that the intent of the parties was really for
the bank to safely keep the dollars and to return it
to Zshornack at a later time, Thus, Zshornack de-
manded the return of the money on May 10, 1976,
or over five months later.

The above arrangement is that contract defined


under Article 1962, New Civil Code... Note that
the object of the contract between Zshornack and
COMTRUST was foreign exchange. Hence, the
transaction was covered by Central Bank Circular
No. 20, Restrictions on Gold and Foreign Exchange
Transactions, promulgated on December 9, 1949,
which was in force at the time the parties entered
into the transaction involved in this case. The circu-
lar provides:
... 4. (a) All receipts of foreign exchange shall be sold
daily to the Central Bank by those authorized to deal
in foreign exchange. All receipts of foreign ex-
Voluntary Deposit I 211

change by any person, firm, partnership, associa-


tion, branch office, agency, company or other unin-
corporated body or corporation shall be sold to the
authorized agents of the Central Bank by the reci-
pients within one business day following the receipt of
such foreign exchange. Any person, firm, partner-
ship, association, branch office, agency, company
or other unincorporated body or corporation, re-
siding or located within the Philippines, who ac-
quires on and after the date of this Circular foreign
exchange shall not, unless licensed by the Central
Bank, dispose of such foreign exchange in whole or
in part, nor receive less than its full value, nor de-
lay taking ownership thereof except as such delay
is customary; Provided, further, That within one
day upon taking ownership, or receiving payment,
of foreign exchange the aforementioned persons
and entities shall sell such foreign exchange to des-
ignated agents of the Central Bank.
... 8. Strict observance of the provisions of this Cir-
cular is enjoined; and any person, firm or corpora-
tion, foreign or domestic, who being bound to the
observance thereof, or of such other rules, regula-
tions or directives as may hereafter be issued in
implementation of this Circular, shall fail or refuse
to comply with, or abide by, or shall violate the
same, shall be subject to the penal sanctions provided
in the Central Bank Act.

Paragraph 4 (a) above was modified by Section 6 of


Central Bank Circular No. 281, Regulations on For-
eign Exchange, promulgated on November 26,
1969 by limiting its coverage to Philippine resi-
dents only. Section 6 provides:
SEC. 6. All receipts of foreign exchange by any resi-
212 1 Credit Transactions: Notes and Cases

dent person, firm, company or corporation shall be


sold to authorized agents of the Central Bank by
the recipients within one business day following
the receipt of such foreign exchange. Any resident
person, firm, company or corporation residingor lo-
cated within the Philippines,who acquires foreign ex-
change shall not, unless authorized by the Central
Bank, dispose of such foreign exchange in whole or
in part, nor receive less than its full value, nor de-
lay taking ownership thereof except as such delay
is customary; Provided, That, within one business
day upon taking ownership or receiving payment
of foreign exchange the aforementioned persons
and entities shall sell such foreign exchange to the
authorized agents of the Central Bank.

As earlier stated, the document and the subsequent


acts of the parties show that they intended the
bank to safekeep the foreign exchange, and return
it later to Zshomack, who alleged in his complaint
that he is a Philippine resident. The parties did not
intended to sell the US dollars to the Central Bank
within one business day from receipt. Otherwise,
the contract of depositum would never have been
entered into at all.

Since the mere safekeeping of the greenbacks,


without selling them to the Central Bank within
one business day from receipt, is a transaction
which is not authorized by CB Circular No. 20, it
must be considered as one which falls under the
general class of prohibited transactions. Hence,
pursuant to Article 5 of the Civil Code, it is void,
having been executed against the provisions of a
mandatory/prohibitory law. More importantly, it
Voluntary Deposit 1 213

affords neither of the parties a cause of action


against the other. "When the nullity proceeds from
the illegality of the cause or object of the contract,
and the act constitutes a criminal offense, both par-
ties being in pari delicto, they shall have no cause of
action against each other..." [Art. 1411, New Civil
Code.] The only remedy is one on behalf of the
State to prosecute the parties for violating the
law...

Triple-V Food Services, Inc. v. Filipino Merchants


Insurance Company, Inc., G.R. No. 160544, Febru-
ary 21, 2005, http://sc.judiciary.gov.ph/resolu-
tions/3rd/2005/3Feb/160544.htm.

... On March 2, 1997, at around 2:15 o'clock in the


afternoon, a certain Mary Jo-Anne De Asis (De
Asis) dined at petitioner's Kamayan Restaurantat 15
West Avenue, Quezon City. De Asis was using a
Mitsubishi Galant Super Saloon Model 1995 ... as-
signed to her by her employer Crispa Textile Inc.
(Crispa). On said date, De Asis availed of the valet
parking service of petitioner and entrusted her car
key to petitioner's valet counter. A corresponding
parking ticket was issued as receipt for the car. The
car was then parked by petitioner's valet attendant,
a certain Madridano, at the designated parking
area. Few minutes later, Madridano noticed that
the car was not in its parking slot and its key no
longer in the box where valet attendants usually
keep the keys of cars entrusted to them. The car
was never recovered. Thereafter, Crispa filed a
claim against its insurer, herein respondent Filipi-
no Merchants Insurance Company, Inc. (FMICI).
Having indemnified Crispa in the amount of
214 I Credit Transactions: Notes and Cases

P669.500 for the loss of the subject vehicle, FMICI,


as subrogee to Crispa's rights, filed with the RTC
at Makati City an action for damages against peti-
tioner Triple-V Food Services, Inc... In its answer,
petitioner argued that the complaint failed to aver
facts to support the allegations of recklessness and
negligence committed in the safekeeping and cus-
tody of the subject vehicle, claiming that it and its
employees wasted no time in ascertaining the loss
of the car and in informing De Asis of the discov-
ery of the loss. Petitioner further argued that in ac-
cepting the complimentary valet parking service,
De Asis received a parking ticket whereunder it is
so provided that "Management and staff will not
be responsible for any loss of or damage incurred
on the vehicle nor of valuables contained therein",
a provision which, to petitioner's mind, is an expli-
cit waiver of any right to claim indemnity for the
loss of the car; and that De Asis knowingly as-
sumed the risk of loss when she allowed petitioner
to park her vehicle, adding that its valet parking
service did not include extending a contract of in-
surance or warranty for the loss of the vehicle.

During trial, petitioner challenged FMICI's subro-


gation to Crispa's right to file a claim for the loss of
the car, arguing that theft is not a risk insured
against under FMICI's Insurance Policy No. PC-
5975 for the subject vehicle.

In a decision dated June 22, 2001, the trial court


rendered judgment for respondent FMICI... Ob-
viously displeased, petitioner appealed to the
Court of Appeals reiterating its argument that it
was not a depositary of the subject car and that it
Voluntary Deposit 1 215

exercised due diligence and prudence in the safe


keeping of the vehicle, in handling the car-napping
incident and in the supervision of its employees. It
further argued that there was no valid subrogation
of rights between Crispa and respondent FMICI.

In a decision dated October 21, 2003, the Court of


Appeals dismissed petitioner's appeal and af-
firmed the appealed decision of the trial court... In
so dismissing the appeal and affirming the ap-
pealed decision, the appellate court agreed with
the findings and conclusions of the trial court that:
(a) petitioner was a depositary of the subject ve-
hicle; (b) petitioner was negligent in its duties as a
depositary thereof and as an employer of the valet
attendant; and (c) there was a valid subrogation of
rights between Crispa and respondent FMICI.

Hence, petitioner's present recourse.

We agree with the two (2) courts below.

When De Asis entrusted the car in question to peti-


tioners valet attendant while eating at petitioner's
Kamayan Restaurant, the former expected the car's
safe return at the end of her meal. Thus, petitioner
was constituted as a depositary of the same car. Pe-
titioner cannot evade liability by arguing that nei-
ther a contract of deposit nor that of insurance, gu-
aranty or surety for the loss of the car was consti-
tuted when De Asis availed of its free valet parking
service.

In a contract of deposit, a person receives an object


belonging to another with the obligation of safely
216 I Credit Transactions: Notes and Cases

keeping it and returning the same. A deposit may


be constituted even without any consideration. It is
not necessary that the depositary receives a fee be-
fore it becomes obligated to keep the item en-
trusted for safekeeping and to return it later to the
depositor.

Specious is petitioner's insistence that the valet


parking claim stub it issued to De Asis contains a
clear exclusion of its liability and operates as an
explicit waiver by the customer of any right to
claim indemnity for any loss of or damage to the
vehicle.

The parking claim stub embodying the terms and


conditions of the parking, including that of reliev-
ing petitioner from any loss or damage to the car, is
essentially a contract of adhesion, drafted and pre-
pared as it is by the petitioner alone with no partic-
ipation whatsoever on the part of the customers,
like De Asis, who merely adheres to the printed
stipulations therein appearing. While contracts of
adhesion are not void in themselves, yet this Court
will not hesitate to rule out blind adherence thereto
if they prove to be one-sided under the attendant
facts and circumstances.

Hence, and as aptly pointed out by the Court of


Appeals, petitioner must not be allowed to use its
parking claim stub's exclusionary stipulation as a
shield from any responsibility for any loss or dam-
age to vehicles or to the valuables contained there-
in. Here, it is evident that De Asis deposited the car
in question with the petitioner as part of the latter's
enticement for customers by providing them a safe
Voluntary Deposit 1 217

parking space within the vicinity of its restaurant.


In a very real sense, a safe parking space is an add-
ed attraction to petitioner's restaurant business be-
cause customers are thereby somehow assured that
their vehicle are safely kept, rather than parking
them elsewhere at their own risk. Having entrusted
the subject car to petitioner's valet attendant, cus-
tomer De Asis, like all of petitioner's customers,
fully expects the security of her car while at peti-
tioner's premises/designated parking areas and its
safe return at the end of her visit at petitioner's res-
taurant... Anent the trial court's findings of negli-
gence on the part of the petitioner, which findings
were affirmed by the appellate court, we have con-
sistently ruled that findings of facts of trial courts,
more so when affirmed, as here, by the Court of
Appeals, are conclusive on this Court unless the
trial court itself ignored, overlooked or miscon-
strued facts and circumstances which, if consi-
dered, warrant a reversal of the outcome of the
case. This is not so in the case at bar. For, we have
ourselves reviewed the records and find no justifi-
cation to deviate from the trial court's findings...

Are all contracts for parking, contracts of deposit? Or are


there critical factors in the case of Triple-V Food Services
that, if not present in another situation, would lead to a
different conclusion?

B. Obligation to Safekeep

1. Way of the Deposit

Art. 1974. The depositary may change the way of


the deposit if
218 1 Credit Transactions: Notes and Cases

under the circumstances he may reasonably pre-


sume that the depositor would consent to the
change if he knew of the facts of the situation.
However, before the depositary may make such
change, he shall notify the depositor thereof and
wait for his decision, unless delay would cause
danger.

Art. 1975. The depositary holding certificates,


bonds, securities or instruments which earn in-
terest shall be bound to collect the latter when it
becomes due, and
to take such steps as may be necessary in order
that the securities may preserve their value and
the rights corresponding to them according to
law.

The above provision shall not apply to contracts


for the rent of safety deposit boxes.

Art. 1976. Unless there is a stipulation to the con-


trary, the depositary may commingle grain or
other articles of the same kind and quality, in
which case the various depositors shall own or
have a proportionate interest in the mass.

Art. 1977. The depositary cannot make use of the


thing deposited without the express permission
of the depositor.
Otherwise, he shall be liable for damages.
However, when the preservation of the thing de-
posited requires its use, it must be used but only
for that purpose.

Art. 1978. When the depositary has permission to


use the thing deposited, the contract loses the
Voluntary Deposit 1 219

concept of a deposit and becomes a loan or com-


modatum, except where safekeeping is still the
principal purpose of the contract.
The permission shall not be presumed, and its ex-
istence must be proved.

Art. 1981. When the thing deposited is delivered


closed and sealed, the depositary must return it in
the same condition, and he shall be liable for
damages should the seal or lock be broken
through his fault.
Fault on the part of the depositary is presumed,
unless there is proof to the contrary.
As regards the value of the thing deposited, the
statement of the depositor shall be accepted,
when the forcible opening is imputable to the
depositary, should there be no proof to the con-
trary. However, the courts may pass upon the cre-
dibility of the depositor with respect to the value
claimed by him.
When the seal or lock is broken, with or without
the depositary's fault, he shall keep the secret of
the deposit.

Art. 1982. When it becomes necessary to open a


locked box or receptacle, the depositary is pre-
sumed authorized to do so, if
the key has been delivered to him; or
when the instructions of the depositor as regards
the deposit cannot be executed without opening
the box or receptacle.

The Civil Code recognizes that the delivery to the deposi-


tary by the depositor of the object of the deposit for safe-
keeping may have been done in a specific manner, re-
220 1 Credit Transactions: Notes and Cases

ferred to as the way of the deposit, and provides rules to


be followed by the depositary:

a. The depositary may not change the way of the deposit


unless:

1) There is a presumption of consent based on the cir-


cumstances, and

2) The depositor notifies the depositor and waits for the


decision. The obligation to notify does not apply if delay
would cause danger to the object of the deposit.

b. The depositary must:

1) Collect the interest of certificates, bonds, securities or


instruments when they become due, and

2) Must take necessary measures to preserve their value


and corresponding rights. This obligation does not apply
if the certificates, bonds, securities or instruments are kept
pursuant to a contract for the rent of safety deposit boxes.

c. The depositary may commingle grain or other articles


of the same kind and quality unless there is a stipulation
to the contrary.

d. The depositary cannot use the thing deposited unless:

1) There is express and proven permission of the deposi-


tor, in which case the deposit is considered an irregular
deposit. In this first exception, the principal purpose of
the irregular deposit is still safekeeping. If safekeeping is
not the principal purpose, then the contract is not a depo-
sit and may be a loan.
Voluntary Deposit 1 221

2) The preservation of the object of the deposit requires


its use. In this second exception, use of the object by the
depositary is for the limited purpose of preservation.
e. The depositary must return a closed and sealed object
in the same condition and must keep the secret of the de-
posit if the seal or lock is broken.

f. The depositary may open a locked box or receptacle


only if:

1) There is express authority, since the parties are free to


stipulate on this.

2) There is presumed authority, such as when the key to


the lock has been delivered, or the instructions of the de-
positor as regards the deposit cannot be executed without
opening the box or receptacle.

CA Agro-Industrial Development Corporation v.


Court of Appeals and Security Bank and Trust
Company, G.R. No. 90027, March 3, 1993, 219
SCRA 426.

... On 3 July 1979, petitioner (through its President,


Sergio Aguirre) and the spouses Ramon and Paula
Pugao entered into an agreement whereby the
former purchased from the latter two (2) parcels of
land for a consideration of P350,625.00. Of this
amount, P75,725.00 was paid as downpayment
while the balance was covered by three (3) post-
dated checks. Among the terms and conditions of
the agreement embodied in a Memorandum of
True and Actual Agreement of Sale of Land were
that the titles to the lots shall be transferred to the
petitioner upon full payment of the purchase price
222 1 Credit Transactions: Notes and Cases

and that the owner's copies of the certificates of


titles thereto ... shall be deposited in a safety depo-
sit box of any bank. The same could be withdrawn
only upon the joint signatures of a representative
of the petitioner and the Pugaos upon full payment
of the purchase price. Petitioner, through Sergio
Aguirre, and the Pugaos then rented Safety Depo-
sit Box No. 1448 of private respondent Security
Bank and Trust Company... For this purpose, both
signed a contract of lease ... which contains, inter
alia, the following conditions:
13. The bank is not a depositary of the contents of
the safe and it has neither the possession nor con-
trol of the same.
14. The bank has no interest whatsoever in said
contents, except herein expressly provided, and it
assumes absolutely no liability in connection the-
rewith.

After the execution of the contract, two (2) renter's


keys were given to the renters - one to Aguirre
(for the petitioner) and the other to the Pugaos. A
guard key remained in the possession of the res-
pondent Bank. The safety deposit box has two (2)
keyholes, one for the guard key and the other for
the renter's key, and can be opened only with the
use of both keys. Petitioner claims that the certifi-
cates of title were placed inside the said box.

Thereafter, a certain Mrs. Margarita Ramos offered


to buy from the petitioner the two (2) lots at a price
of P225.00 per square meter which, as petitioner al-
leged in its complaint, translates to a profit of
P100.00 per square meter or a total of P280,500.00
for the entire property. Mrs. Ramos demanded the
Voluntary Deposit 1 223

execution of a deed of sale which necessarily en-


tailed the production of the certificates of title. In
view thereof, Aguirre, accompanied by the Pugaos,
then proceeded to the respondent Bank on 4 Octo-
ber 1979 to open the safety deposit box and get the
certificates of title. However, when opened in the
presence of the Bank's representative, the box
yielded no such certificates. Because of the delay in
the reconstitution of the title, Mrs. Ramos with-
drew her earlier offer to purchase the lots; as a con-
sequence thereof, the petitioner allegedly failed to
realize the expected profit of P280,500.00. Hence,
the latter filed on 1 September 1980 a complaint for
damages... In its Answer with Counterclaim, res-
pondent Bank alleged that the petitioner has no
cause of action because of paragraphs 13 and 14 of
the contract of lease... corollarily, loss of any of the
items or articles contained in the box could not
give rise to an action against it. It then interposed a
counterclaim for exemplary damages as well as at-
torney's fees in the amount of P20,000.00. Petition-
er subsequently filed an answer to the counter-
claim.

In due course, the trial court ... rendered a decision


adverse to the petitioner... The unfavorable ver-
dict is based on the trial court's conclusion that
under paragraphs 13 and 14 of the contract of lease,
the Bank has no liability for the loss of the certifi-
cates of title. The court declared that the said pro-
visions are binding on the parties.

Its motion for reconsideration having been denied,


petitioner appealed from the adverse decision to
the respondent Court of Appeals... In its Deci-
224 1 Credit Transactions: Notes and Cases

sion... respondent Court affirmed the appealed de-


cision principally on the theory that the contract
(Exhibit "2") executed by the petitioner and res-
pondent Bank is in the nature of a contract of lease
by virtue of which the petitioner and its co-renter
were given control over the safety deposit box and
its contents while the Bank retained no right to
open the said box because it had neither the pos-
session nor control over it and its contents. As
such, the contract is governed by Article 1643 of
the Civil Code which provides:
Art. 1643. In the lease of things, one of the parties
binds himself to give to another the enjoyment or
use of a thing for a price certain, and for a period
which may be definite or indefinite. However, no
lease for more than ninety-nine years shall be va-
lid.

which held that the owner


It invoked [the case] ...
of the property loses his control over the property
leased during the period of the contract - and Ar-
ticle 1975 of the Civil Code.... and then concluded
that "[c]learly, the defendant-appellee is not under
any duty to maintain the contents of the box. The
stipulation absolving the defendant-appellee from
liability is in accordance with the nature of the con-
tract of lease and cannot be regarded as contrary to
law, public order and public policy." The appellate
court was quick to add, however, that under the
contract of lease of the safety deposit box, respon-
dent Bank is not completely free from liability as it
may still be made answerable in case unauthorized
persons enter into the vault area or when the
rented box is forced open. Thus, as expressly pro-
Voluntary Deposit 1 225

vided for in stipulation number 8 of the contract in


question:
8. The Bank shall use due diligence that no unau-
thorized person shall be admitted to any rented
safe and beyond this, the Bank will not be respon-
sible for the contents of any safe rented from it.

Its motion for reconsideration having been denied


... petitioner took this recourse under Rule 45 of
the Rules of Court and urges Us to review and set
aside the respondent Court's ruling.... In a nut-
shell, petitioner maintains that regardless of no-
menclature, the contract for the rent of the safety
deposit box ... is actually a contract of deposit ...
Accordingly, it is claimed that the respondent Bank
is liable for the loss of the certificates of title pur-
suant to Article 1972 of the said Code...

The petition is partly meritorious.

We agree with the petitioner's contention that the


contract for the rent of the safety deposit box is not
an ordinary contract of lease as defined in Article
1643 of the Civil Code. However, We do not fully
subscribe to its view that the same is a contract of
deposit that is to be strictly governed by the provi-
sions in the Civil Code on deposit; the contract in
the case at bar is a special kind of deposit. It cannot
be characterized as an ordinary contract of lease
under Article 1643 because the full and absolute
possession and control of the safety deposit box
was not given to the joint renters - the petitioner
and the Pugaos. The guard key of the box re-
mained with the respondent Bank; without this
key, neither of the renters could open the box. On
226 1 Credit Transactions: Notes and Cases

the other hand, the respondent Bank could not


likewise open the box without the renter's key. In
this case, the said key had a duplicate which was
made so that both renters could have access to the
box.

Hence, the authorities cited by the respondent


Court on this point do not apply. Neither could Ar-
ticle 1975, also relied upon by the respondent
Court, be invoked as an argument against the de-
posit theory. Obviously, the first paragraph of such
provision cannot apply to a depositary of certifi-
cates, bonds, securities or instruments which earn
interest if such documents are kept in a rented safe-
ty deposit box. It is clear that the depositary cannot
open the box without the renter being present.

We observe, however, that the deposit theory itself


does not altogether find unanimous support even
in American jurisprudence. We agree with the peti-
tioner that under the latter, the prevailing rule is
that the relation between a bank renting out safe-
deposit boxes and its customer with respect to the
contents of the box is that of a bailor and bailee, the
bailment being for hire and mutual benefit. This is
just the prevailing view because:
There is, however, some support for the view that
the relationship in question might be more proper-
ly characterized as that of landlord and tenant, or
lessor and lessee. It has also been suggested that it
should be characterized as that of licensor and li-
censee. The relation between a bank, safe-deposit
company, or storage company, and the renter of a
safe-deposit box therein, is often described as con-
tractual, express or implied, oral or written, in
Voluntary Deposit 1 227

whole or in part. But there is apparently no juris-


diction in which any rule other than that applicable
to bailments governs questions of the liability and
rights of the parties in respect of loss of the con-
tents of safe-deposit boxes...

In the context of our laws which authorize banking


institutions to rent out safety deposit boxes, it is
clear that in this jurisdiction, the prevailing rule in
the United States has been adopted. Section 72 of
the General Banking Act pertinently provides:
Sec. 72. In addition to the operations specifically
authorized elsewhere in this Act, banking institu-
tions other than building and loan associations
may perform the following services:
(a) Receive in custody funds, documents, and val-
uable objects, and rent safety deposit boxes for the
safeguarding of such effects... The banks shall per-
form the services permitted under subsections (a),
(b) and (c) of this section as depositories or as
agents...

Note that the primary function is still found within


the parameters of a contract of deposit, i.e., the re-
ceiving in custody of funds, documents and other
valuable objects for safekeeping. The renting out of
the safety deposit boxes is not independent from,
but related to or in conjunction with, this principal
function. A contract of deposit may be entered into
orally or in writing and, pursuant to Article 1306 of
the Civil Code, the parties thereto may establish
such stipulations, clauses, terms and conditions as
they may deem convenient, provided they are not
contrary to law, morals, good customs, public or-
der or public policy. The depositary's responsibili-
228 1 Credit Transactions: Notes and Cases

ty for the safekeeping of the objects deposited in


the case at bar is governed by Title I, Book IV of the
Civil Code. Accordingly, the depositary would be
liable if, in performing its obligation, it is found
guilty of fraud, negligence, delay or contravention
of the tenor of the agreement. In the absence of any
stipulation prescribing the degree of diligence re-
quired, that of a good father of a family is to be ob-
served. Hence, any stipulation exempting the de-
positary from any liability arising from the loss of
the thing deposited on account of fraud, negligence
or delay would be void for being contrary to law
and public policy. In the instant case, petitioner
maintains that conditions 13 and 14 of the ques-
tioned contract of lease of the safety deposit box...
are void as they are contrary to law and public pol-
icy. We find Ourselves in agreement with this
proposition for indeed, said provisions are incon-
sistent with the respondent Bank's responsibility as
a depositary under Section 72(a) of the General
Banking Act. Both exempt the latter from any lia-
bility except as contemplated in condition 8 thereof
which limits its duty to exercise reasonable dili-
gence only with respect to who shall be admitted to
any rented safe... Furthermore, condition 13
stands on a wrong premise and is contrary to the
actual practice of the Bank. It is not correct to assert
that the Bank has neither the possession nor control
of the contents of the box since in fact, the safety
deposit box itself is located in its premises and is
under its absolute control; moreover, the respon-
dent Bank keeps the guard key to the said box. As
stated earlier, renters cannot open their respective
boxes unless the Bank cooperates by presenting
and using this guard key. Clearly then, to the ex-
Voluntary Deposit I 229

tent above stated, the foregoing conditions in the


contract in question are void and ineffective. It has
been said:
With respect to property deposited in a safe-
deposit box by a customer of a safe-deposit com-
pany, the parties, since the relation is a contractual
one, may by special contract define their respective
duties or provide for increasing or limiting the lia-
bility of the deposit company, provided such con-
tract is not in violation of law or public policy. It
must clearly appear that there actually was such a
special contract, however, in order to vary the or-
dinary obligations implied by law from the rela-
tionship of the parties; liability of the deposit com-
pany will not be enlarged or restricted by words of
doubtful meaning. The company, in renting safe-
deposit boxes, cannot exempt itself from liability
for loss of the contents by its own fraud or negli-
gence or that of its agents or servants, and if a pro-
vision of the contract may be construed as an at-
tempt to do so, it will be held ineffective for the
purpose...

Thus, we reach the same conclusion which the


Court of Appeals arrived at, that is, that the peti-
tion should be dismissed, but on grounds quite dif-
ferent from those relied upon by the Court of Ap-
peals. In the instant case, the respondent Bank's
exoneration cannot, contrary to the holding of the
Court of Appeals, be based on or proceed from a
characterization of the impugned contract as a con-
tract of lease, but rather on the fact that no compe-
tent proof was presented to show that respondent
Bank was aware of the agreement between the pe-
titioner and the Pugaos to the effect that the certifi-
230 1 Credit Transactions: Notes and Cases

cates of title were withdrawable from the safety


deposit box only upon both parties' joint signa-
tures, and that no evidence was submitted to reveal
that the loss of the certificates of title was due to
the fraud or negligence of the respondent Bank.
This in turn flows from this Court's determination
that the contract involved was one of deposit. Since
both the petitioner and the Pugaos agreed that each
should have one (1) renter's key, it was obvious
that either of them could ask the Bank for access to
the safety deposit box and, with the use of such key
and the Bank's own guard key, could open the said
box, without the other renter being present...

What is clear from the case of CA Agro-Industrial Devel-


opment Corporation is that a contract for the rent of a
safety deposit box is not a contract of lease. But why does
the Court first state that it does "not fully subscribe" to the
view that "the same is a contract of deposit that is to be
strictly governed by the provisions in the Civil Code on
deposit," characterizing it instead as a "special kind of
deposit" only to later conclude that "the contract involved
was one of deposit'?

The Roman Catholic Bishop of Jaro v. De La Pe-


na, G.R. No. L-6913, November 21, 1913, 26 Phil
144.

...It is established in this case that the plaintiff is


the trustee of a charitable bequest made for the
construction of a leper hospital and that father
Agustin de la Pefia was the duly authorized repre-
sentative of the plaintiff to receive the legacy. The
defendant is the administrator of the estate of Fa-
ther De la Pefia.
Voluntary Deposit 1 231

In the year 1898 the books of Father De la Pefia, as


trustee, showed that he had on hand as such trus-
tee the sum of P6,641, collected by him for the cha-
ritable purposes aforesaid. In the same year he de-
posited in his personal account P19,000 in the
Hongkong and Shanghai Bank at Iloilo. Shortly
thereafter and during the war of the revolution, Fa-
ther De la Pefia was arrested by the military au-
thorities as a political prisoner, and while thus de-
tained made an order on said bank in favor of the
United States Army officer under whose charge he
then was for the sum thus deposited in said bank.
The arrest of Father De la Pefia and the confiscation
of the funds in the bank were the result of the claim
of the military authorities that he was an insurgent
and that the funds thus deposited had been col-
lected by him for revolutionary purposes. The
money was taken from the bank by the military au-
thorities by virtue of such order, was confiscated
and turned over to the Government.

While there is considerable dispute in the case over


the question whether the P6,641 of trust funds was
included in the P19,000 deposited as aforesaid,
nevertheless, a careful examination of the case
leads us to the conclusion that said trust funds
were a part of the funds deposited and which were
removed and confiscated by the military authori-
ties of the United States.

Although the Civil Code states that "a person ob-


liged to give something is also bound to preserve it
with the diligence pertaining to a good father of a
family" (Art. 1094), it also provides, following the
principle of the Roman law, major casus est, cui hu-
232 I Credit Transactions: Notes and Cases

mana infirmitas resisterenon potest, that "no one shall


be liable for events which could not be foreseen, or
which having been foreseen were inevitable, with
the exception of the cases expressly mentioned in
the law or those in which the obligation so dec-
lares." (Art. 1105.)

By placing the money in the bank and mixing it


with his personal funds De la Pefia did not thereby
assume an obligation different from that under
which he would have lain if such deposit had not
been made, nor did he thereby make himself liable
to repay the money at all hazards. If the had been
forcibly taken from his pocket or from his house by
the military forces of one of the combatants during
a state of war, it is clear that under the provisions
of the Civil Code he would have been exempt from
responsibility. The fact that he placed the trust
fund in the bank in his personal account does not
add to his responsibility. Such deposit did not
make him a debtor who must respond at all ha-
zards.

We do not enter into a discussion for the purpose


of determining whether he acted more or less neg-
ligently by depositing the money in the bank than
he would if he had left it in his home; or whether
he was more or less negligent by depositing the
money in his personal account than he would have
been if he had deposited it in a separate account as
trustee. We regard such discussion as substantially
fruitless, inasmuch as the precise question is not
one of negligence. There was no law prohibiting
him from depositing it as he did and there was no
law which changed his responsibility be reason of
Voluntary Deposit 1 233

the deposit. While it may be true that one who is


under obligation to do or give a thing is in duty
bound, when he sees events approaching the re-
sults of which will be dangerous to his trust, to
take all reasonable means and measures to escape
or, if unavoidable, to temper the effects of those
events, we do not feel constrained to hold that, in
choosing between two means equally legal, he is
culpably negligent in selecting one whereas he
would not have been if he had selected the other.

Trent, J., dissenting:


I dissent. Technically speaking, whether Father De
la Pefia was a trustee or an agent of the plaintiff his
books showed that in 1898 he had in his possession
as trustee or agent the sum of P6,641 belonging to
the plaintiff as the head of the church. This money
was then clothed with all the immunities and pro-
tection with which the law seeks to invest trust
funds. But when De la Pefia mixed this trust fund
with his own and deposited the whole in the bank
to his personal account or credit, he by this act
stamped on the said fund his own private marks
and unclothed it of all the protection it had. If this
money had been deposited in the name of De la
Pefia as trustee or agent of the plaintiff, I think that
it may be presumed that the military authorities
would not have confiscated it for the reason that
they were looking for insurgent funds only. Again,
the plaintiff had no reason to suppose that De la
Pefia would attempt to strip the fund of its identity,
nor had he said or done anything which tended to
relieve De la Pefia from the legal reponsibility
which pertains to the care and custody of trust
funds... In fact the record shows that De la Pefia
234 1Credit Transactions: Notes and Cases

deposited on June 27, 1898, P5,259, on June 28 of


that year P3,280, and on August 5 of the same year
P6,000. The record also shows that these funds
were withdrawn and again deposited all together
on the 29th of May, 1900, this last deposit amount-
ing to P18,970. These facts strongly indicate that De
la Pefia had as a matter of fact been using the mon-
ey in violation of the trust imposed in him.

Considering that the contract between De la Pena and


the Hong Kong and Shanghai Bank was a simple loan,
and assuming that the contract between De la Pena
and the Bishop of Jaro was a contract of deposit, how
should the case of The Roman Catholic Bishop of Ja-
ro be decided?

2. Liability for Loss and Damages

Art. 1972. The depositary is obliged to keep the


thing safely and to return it, when required, to
the depositor, or
to his heirs and successors, or
to the person who may have been designated in
the contract.
His responsibility, with regard to the safekeeping
and the loss of the thing, shall be governed by the
provisions of Title I of this Book...

Art. 1973. Unless there is a stipulation to the con-


trary, the depositary cannot deposit the thing
with a third person.
If deposit with a third person is allowed, the de-
positary is liable for the loss if he deposited the
thing with a person who is manifestly careless or
unfit.
Voluntay Deposit j 235

The depositary is responsible for the negligence


of his employees.

Art. 1977. The depositary cannot make use of the


thing deposited without the express permission
of the depositor.
Otherwise, he shall be liable for damages.
However, when the preservation of the thing de-
posited requires its use, it must be used but only
for that purpose.

Art. 1978. When the depositary has permission to


use the thing deposited, the contract loses the
concept of a deposit and becomes a loan or com-
modatum, except where safekeeping is still the
principal purpose of the contract.
The permission shall not be presumed, and its ex-
istence must be proved.

Art. 1981. When the thing deposited is delivered


closed and sealed, the depositary must return it in
the same condition, and he shall be liable for
damages should the seal or lock be broken
through his fault.
Fault on the part of the depositary is presumed,
unless there is proof to the contrary.
As regards the value of the thing deposited, the
statement of the depositor shall be accepted,
when the forcible opening is imputable to the
depositary, should there be no proof to the con-
trary. However, the courts may pass upon the cre-
dibility of the depositor with respect to the value
claimed by him.
236 I Credit Transactions: Notes and Cases

Art. 1979. The depositary is liable for the loss of


the thing through a fortuitous event:
(1) If it is so stipulated;
(2) If he uses the thing without the depositor's
permission;
(3) If he delays its return;
(4) If he allows others to use it, even though he
himself may have been authorized to use the
same.

Art. 1990. If the depositary by force majeure or


government order loses the thing and receives
money or another thing in its place, he shall de-
liver the sum or other thing to the depositor.

Art. 1993. The depositor shall reimburse the de-


positary for any loss arising from the character of
the thing deposited,
unless at the time of the constitution of the depo-
sit the former was not aware of, or
was not expected to know the dangerous charac-
ter of the thing, or
unless he notified the depositary of the same, or
the latter was aware of it without advice from the
depositor.

The purpose of safekeeping is the distinguishing charac-


teristic of a contract of deposit. Consequently, responsi-
bility for loss and damage are subject to specific rules un-
der the Civil Code.

a. Liability of Depositary

Responsibility for loss and damage will attach to the de-


positary if:
Voluntary Deposit 1 237

1) The depositary deposits the object with a third person,


unless there is a stipulation allowing it.
2) If deposit with a third person is allowed, the deposita-
ry deposits the thing with a person who is manifestly
careless or unfit.

3) The employees of the depositary are negligent.

4) The depositary uses the object of the deposit, unless


there was express permission of the depositor, or the use
was necessary for the limited purpose of preservation.

5) The seal or lock of a thing delivered closed and sealed


is broken through the fault of the depositary. Fault is
presumed, unless there is proof to the contrary. If the forc-
ible opening of a thing delivered closed and sealed is im-
putable to the depositary, the value of the thing deposited
shall be based on the statement of the depositor, unless:

a) There is contrary proof, and

b) The courts determine otherwise based on the credibili-


ty of the depositor.

6) Even in case of a fortuitous event, the depositary is


liable if:

a) It has been stipulated,

b) The depositary uses the thing without the depositor's


permission,

c) The depositary delays the return of the object of the


deposit, or
238 1 Credit Transactions: Notes and Cases

d) The depositary allows others to use it, even though the


depositary may have been authorized to use the same.

7) Even if the depositary is not liable, if the depositary


loses the thing by force majeure or government order, but
receives money or a replacement, the depositary shall de-
liver the money or replacement to the depositor.

b. Liability of Depositor

On the other hand, responsibility for loss or damage will


attach to the depositor only if the depositor delivers a
thing the character of which causes any loss to the deposi-
tary, unless:

1) At the time of the constitution of the deposit the depo-


sitor was not aware of, or was not expected to know the
dangerous character of the thing, or

2) The depositor notified the depositary of the dangerous


character, or the depositary was in any case aware of the
character.

3. Liability for Expenses

Art. 1992. If the deposit is gratuitous, the deposi-


tor is obliged to reimburse the depositary for the
expenses he may have incurred for the preserva-
tion of the thing deposited.

If the deposit is gratuitous, the depositor bears the ex-


penses for the preservation of the thing deposited. If the
deposit is onerous, the depositary bears the expenses for
preservation.
Voluntary Deposit 1239

C. Obligation to Return

1. By Whom and To Whom

Art. 1972. The depositary is obliged to keep the


thing safely and to return it, when required, to
the depositor, or
to his heirs and successors, or
to the person who may have been designated in
the contract...

Art. 1970. If a person having capacity to contract


accepts a deposit made by one who is incapaci-
tated,
the former shall be subject to all the obligations
of a depositary, and
may be compelled to return the thing by the
guardian, or administrator, of the person who
made the deposit, or by the latter himself if he
should acquire capacity.

Art. 1971. If the deposit has been made by a capa-


citated person with another who is not,
the depositor shall only have an action to recover
the thing deposited while it is still in the posses-
sion of the depositary, or
to compel the latter to pay him the amount by
which he may have enriched or benefited himself
with the thing or its price.
However, if a third person who acquired the
thing acted in bad faith, the depositor may bring
an action against him for its recovery.

Art. 1984. The depositary cannot demand that the


depositor prove his ownership of the thing depo-
sited.
240 1 Credit Transactions: Notes and Cases

Nevertheless, should he discover that the thing


has been stolen and who its true owner is, he
must advise the latter of the deposit.
If the owner, in spite of such information, does
not claim it within the period of one month,
the depositary shall be relieved of all responsibil-
ity by returning the thing deposited to the depo-
sitor.
If the depositary has reasonable grounds to be-
lieve that the thing has not been lawfully ac-
quired by the depositor, the former may return
the same.

Art. 1985. When there are two or more depositors,


if they are not solidary, and the thing admits of
division, each one cannot demand more than his
share.
When there is solidarity or the thing does not
admit of division, the provisions of Articles 1212
and 1214 shall govern. However, if there is a sti-
pulation that the thing should be returned to one
of the depositors, the depositary shall return it
only to the person designated.

Art. 1212. Each one of the solidary creditors [de-


positors] may do whatever may be useful to the
others, but not anything which may be prejudi-
cial to the latter.

Art. 1214. The debtor [depositary] may pay any


one of the solidary creditors [depositors]; but if
any demand, judicial or extrajudicial, has been
made by one of them, payment should be made to
him.
Voluntary Deposit 1 241

Art. 1986. If the depositor should lose his capacity


to contract after having made the deposit, the
thing cannot be returned except to the persons
who may have the administration of his property
and rights.

Art. 1991. The depositor's heir who in good faith


may have sold the thing which he did not know
was deposited, shall only be bound to return the
price he may have received or to assign his right
of action against the buyer in case the price has
not been paid him.

2. What to Return

Art. 1983. The thing deposited shall be returned


with
all its products, accessories and accessions.
Should the deposit consist of money, the provi-
sions relative to agents in Article 1896 shall be
applied to the depositary.

Art. 1896. The agent [depositary] owes interest on


the sums he has applied to his own use from the
day on which he did so, and on those which he
still owes after the extinguishment of the agency
[deposit].

3. Where to Return

Art. 1987. If at the time the deposit was made


a place was designated for the return of the thing,
the depositary must take the thing deposited to
such place;
but the expenses for transportation shall be borne
by the depositor.
242 I Credit Transactions: Notes and Cases

If no place has been designated for the return, it


shall be made where the thing deposited may be,
even if it should not be the same place where the
deposit was made,
provided that there was no malice on the part of
the depositary.

4. When to Return

Art. 1988. The thing deposited must be returned


to the depositor upon demand,
even though a specified period or time for such
return may have been fixed.
This provision shall not apply when the thing is
judicially attached while in the depositary's pos-
session, or
should he have been notified of the opposition of
a third person to the return or the removal of the
thing deposited.
In these cases, the depositary must immediately
inform the depositor of the attachment or opposi-
tion.

Art. 1989. Unless the deposit is for a valuable


consideration,
the depositary who may have justifiable reasons
for not keeping the thing deposited may,
even before the time designated,
return it to the depositor; and
if the latter should refuse to receive it, the deposi-
tary may secure its consignation from the court.

In a deposit, delivery of the object to the depositary is


made for the principal purpose of safekeeping. Conse-
quently, one of the primary obligations of the depositary
is to return the object of the deposit to the depositor upon
Voluntary Deposit 1243

demand. The stipulation of a period is not an exception to


this rule.

The exceptions to this rule are:

a. If the thing deposited is judicially attached while in


the depositary's possession, or

b. If the depositary was notified of the opposition of a


third person to the return or the removal of the thing de-
posited.

In these cases, the depositary must immediately inform


the depositor of the attachment or opposition. However,
these instances do not imply that the obligation of the de-
positary to return ceases; rather, these are exceptions to
the obligation to return the thing deposited upon de-
mand, allowing the depositary to take such measures to
protect itself given the circumstances, including seeking
appropriate protective measures from a court.

5. Right of Retention

Art. 1994. The depositary may retain the thing in


pledge until the full payment of what may be due
him by reason of the deposit.

It has been noted that one of the primary obligations of


the depositary is to return the property deposited upon
demand. But Article 1994 grants the depositary a right of
retention over the property as a means or device by
which the depositary is able to obtain payment of what
may be due because of the deposit.5

5
See Ortiz v. Kayanan, et al., G.R. No. L-32974, July 30,1979.
Chapter 3. Necessary Deposit

A. General Concepts

Art. 1964. A deposit may be constituted judicially


or extrajudicially.

Art. 1967. An extrajudicial deposit is either volun-


tary or necessary.

Art. 1996. A deposit is necessary:


(1) When it is made in compliance with a legal
obligation;
(2) When it takes place on the occasion of any ca-
lamity, such as fire, storm, flood, pillage, ship-
wreck, or other similar events.

Art. 1966. Only movable things may be the object


of a deposit.

A necessary deposit is an extrajudicial deposit constituted


over movable property as a consequence of law or quasi-
contract', so that no unjust enrichment will result from
the juridical relation. The principal obligation of the de-
positary in a necessary deposit is still the safekeeping (or
preservation) of the movable property deposited.

B. Examples of Necessary Deposit

1. Compliance with a Legal Obligation

Art. 1996. A deposit is necessary:

1 Civil Code, Art 2142. Certain lawful, voluntary and unilateral acts give rise
to the juridical relation of quasi-contract to the end that no one shall be un-
justly enriched or benefited at the expense of another.
Necessary Deposit I 245

(1) When it is made in compliance with a legal


obligation...

Art. 1997. The deposit referred to in No. 1 of the


preceding article shall be governed by
the provisions of the law establishing it, and in
case of its deficiency,
by the rules on voluntary deposit....

2. On the Occasion of a Calamity

Art. 1996. A deposit is necessary


... (2) When it takes place on the occasion of any
calamity,
such as fire, storm, flood, pillage, shipwreck, or
other similar events.

Art. 1997... The deposit mentioned in No. 2 of the


preceding article shall be regulated by
the provisions concerning voluntary deposit and
by Article 2168.

Art. 2168. When during a fire, flood, storm, or


other calamity,
property is saved from destruction
by another person
without the knowledge of the owner,
the latter is bound to pay the former
just compensation.

The person who saves movable property from destruction


during a fire, flood, storm, or other calamity, without the
knowledge of the owner, is considered by law as the
depositary, and the owner of the property who is bound
to pay just compensation is considered by law as the
depositor.
246 1 Credit Transactions: Notes and Cases

3. Passenger Baggage with Common Carriers

Art. 1754. The provisions of Articles 1733 to 1753


shall apply to the passenger's baggage which is
not in his personal custody or in that of his em-
ployee.
As to other baggage, the rules in Articles 1998 and
2000 to 2003 concerning the responsibility of ho-
tel-keepers shall be applicable.

Common carriers are persons, corporations, firms or asso-


ciations engaged in the business of carrying or transport-
ing passengers or goods or both, by land, water, or air, for
compensation, offering their services to the public. 2 The
law on common carriers governs passenger baggage be-
ing transported by the common carrier that is not in the
custody of the passenger or of the passenger's employees,
requiring extraordinary diligence in the vigilance over
goods. 3 On the other hand, passenger baggage that is de-
posited with the common carrier by the passenger shall be
considered a necessary deposit subjecting the common
carrier, which is considered by law as the depositary, to
the same rules on necessary deposit as hotels or inns.

4. Hotels or Inns

Art. 1998. The deposit of effects made by the trav-


elers in hotels or inns shall also be regarded as

2 Civil Code, Art 1732.


3 Civil Code, Art 1733. Common carriers, from the nature of their business
and for reasons of public policy, are bound to observe extraordinary dili-
gence in the vigilance over the goods and for the safety of the passengers
transported by them, according to all the circumstances of each case.
Such extraordinary diligence in the vigilance over the goods is further ex-
pressed in Articles 1734, 1735, and 1745, Nos. 5, 6, and 7, while the extraor-
dinary diligence for the safety of the passengers is further set forth in Ar-
tiles 1755 and 1756.
Necessary Deposit 1 247

necessary. The keepers of hotels or inns shall be


responsible for them as depositaries,
provided that notice was given to them, or to their
employees, of the effects brought by the guests
and
that, on the part of the latter, they take the precau-
tions which said hotel-keepers or their substi-
tutes advised relative to the care and vigilance of
their effects.

Art. 1999. The hotel-keeper is liable for the ve-


hicles,
animals and
articles
which have been introduced or placed in the an-
nexes of the hotel.

Art. 2000. The responsibility referred to in the


two preceding articles shall include the loss of, or
injury to the personal property of the guests
caused by
the servants or employees of the keepers of hotels
or inns
as well as strangers;
but not that which may proceed from any force
majeure.
The fact that travelers are constrained to rely on
the vigilance of the keeper of the hotels or inns
shall be considered in determining the degree of
care required of him.

Art. 2001. The act of a thief or robber, who has en-


tered the hotel is not deemed force majeure,
unless it is done with the use of arms or
through an irresistible force.
248 1 Credit Transactions: Notes and Cases

Art. 2002. The hotel-keeper is not liable for com-


pensation
if the loss is due to the acts of the guest, his fami-
ly, servants or visitors, or
if the loss arises from the character of the things
brought into the hotel.

Art. 2003. The hotel-keeper cannot free himself


from responsibility by posting notices to the ef-
fect that he is not liable for the articles brought
by the guest.
Any stipulation between the hotel-keeper and the
guest whereby the responsibility of the former as
set forth in articles 1998 to 2001 is suppressed or
diminished shall be void.

Art. 2004. The hotel-keeper has a right to retain


the things brought into the hotel by the guest, as
a security for credits on account of lodging, and
supplies usually furnished to hotel guests.

Art. 2004 grants the hotel-keeper, as depositary, a right of


retention over the property as a means or device by
which the depositary is able to obtain payment of what
may be due because of the deposit.4

YHT Realty Corporation v. Court of Appeals, G.R.


No. 126780, February 17,2005,451 SCRA 638.

The primary question of interest before this Court


is the only legal issue in the case: It is whether a
hotel may evade liability for the loss of items left
with it for safekeeping by its guests, by having
these guests execute written waivers holding the

4 See Ortiz v. Kayanan et al., G.R. No. L-32974, July 30,1979.


Necessary DepositI 249

establishment or its employees free from blame for


such loss in light of Article 2003 of the Civil Code
which voids such waivers.

... Private respondent McLoughlin, an Australian


businessman-philanthropist, used to stay at Shera-
ton Hotel during his trips to the Philippines prior
to 1984 when he met Tan. Tan befriended
McLoughlin by showing him around, introducing
him to important people, accompanying him in vi-
siting impoverished street children and assisting
him in buying gifts for the children and in distri-
buting the same to charitable institutions for poor
children. Tan convinced McLoughlin to transfer
from Sheraton Hotel to Tropicana where Lainez,
Payam and Danilo Lopez were employed. Lopez
served as manager of the hotel while Lainez and
Payam had custody of the keys for the safety depo-
sit boxes of Tropicana... On 30 October 1987,
McLoughlin arrived from Australia and registered
with Tropicana. He rented a safety deposit box...
(and) was aware of the procedure observed by
Tropicana relative to its safety deposit boxes...
McLoughlin allegedly placed the following in his
safety deposit box: Fifteen Thousand US Dollars
(US$15,000.00) which he placed in two envelopes,
one envelope containing Ten Thousand US Dollars
(US$10,000.00) and the other envelope Five Thou-
sand US Dollars (US$5,000.00); Ten Thousand Aus-
tralian Dollars (AUS$10,000.00) which he also
placed in another envelope; two (2) other enve-
lopes containing letters and credit cards; two (2)
bankbooks; and a checkbook, arranged side by side
inside the safety deposit box.
250 1 Credit Transactions: Notes and Cases

On 12 December 1987, before leaving for a brief


trip to Hongkong, McLoughlin opened his safety
deposit box with his key and with the key of the
management and took therefrom the envelope con-
taining Five Thousand US Dollars (US$5,000.00),
the envelope containing Ten Thousand Australian
Dollars (AUS$10,000.00), his passports and his cre-
dit cards... When he arrived in Hongkong, he
opened the envelope which contained Five Thou-
sand US Dollars (US$5,000.00) and discovered
upon counting that only Three Thousand US Dol-
lars (US$3,000.00) were enclosed therein... After
returning to Manila, he checked out of Tropicana
on 18 December 1987 and left for Australia. When
he arrived in Australia, he discovered that the
envelope with Ten Thousand US Dollars
(US$10,000.00) was short of Five Thousand US Dol-
lars (US$5,000). He also noticed that the jewelry
which he bought in Hongkong and stored in the
safety deposit box upon his return to Tropicana
was likewise missing, except for a diamond brace-
let.

When McLoughlin came back to the Philippines on


4 April 1988... He again registered at Tropicana
and rented a safety deposit box. He placed therein
one (1) envelope containing Fifteen Thousand US
Dollars (US$15,000.00), another envelope contain-
ing Ten Thousand Australian Dollars
(AUS$10,000.00) and other envelopes containing
his traveling papers/documents. On 16 April 1988,
McLoughlin requested Lainez and Payam to open
his safety deposit box. He noticed that in the
envelope containing Fifteen Thousand US Dollars
(US$15,000.00), Two Thousand US Dollars
Necessary Deposit 1 251

(US$2,000.00) were missing and in the envelope


previously containing Ten Thousand Australian
Dollars (AUS$10,000.00), Four Thousand Five
Hundred Australian Dollars (AUS$4,500.00) were
missing.

When McLoughlin discovered the loss, he imme-


diately confronted Lainez and Payam who admit-
ted that Tan opened the safety deposit box with the
key assigned to him. McLoughlin went up to his
room where Tan was staying and confronted her.
Tan admitted that she had stolen McLoughlin's
key and was able to open the safety deposit box
with the assistance of Lopez, Payam and Lainez.
Lopez also told McLoughlin that Tan stole the key
assigned to McLoughlin while the latter was as-
leep.

McLoughlin requested the management for an in-


vestigation of the incident. Lopez got in touch
with Tan and arranged for a meeting with the po-
lice and McLoughlin. When the police did not ar-
rive, Lopez and Tan went to the room of McLough-
lin at Tropicana and thereat, Lopez wrote on a
piece of paper a promissory note dated 21 April
1988... Lopez requested Tan to sign the promisso-
ry note which the latter did and Lopez also signed
as a witness. Despite the execution of promissory
note by Tan, McLoughlin insisted that it must be
the hotel who must assume responsibility for the
loss he suffered. However, Lopez refused to accept
the responsibility relying on the conditions for
renting the safety deposit box entitled "Undertaking
For the Use Of Safety Deposit Box," specifically para-
graphs (2) and (4) thereof, to wit
252 1 Credit Transactions: Notes and Cases

2. To release and hold free and blameless TROPI-


CANA APARTMENT HOTEL from any liability
arising from any loss in the contents and/or use of
the said deposit box for any cause whatsoever, in-
cluding but not limited to the presentation or use
thereof by any other person should the key be
lost...
4. To return the key and execute the RELEASE in
favor of TROPICANA APARTMENT HOTEL upon
giving up the use of the box.

On 17 May 1988, McLoughlin went back to Aus-


tralia and he consulted his lawyers as to the validi-
ty of the abovementioned stipulations. They
opined that the stipulations are void for being viol-
ative of universal hotel practices and customs. His
lawyers prepared a letter dated 30 May 1988 which
was signed by McLoughlin and sent to President
Corazon Aquino. The Office of the President re-
ferred the letter to the Department of Justice (DOJ)
which forwarded the same to the Western Police
District (WPD)... Meetings were held between
McLoughlin and his lawyer which resulted to the
filing of a complaint for damages on 3 December
1990 against YHT Realty Corporation, Lopez, Lai-
nez, Payam and Tan (defendants) for the loss of
McLoughlin's money which was discovered on 16
April 1988. After filing the complaint, McLoughlin
left again for Australia to attend to an urgent busi-
ness matter. Tan and Lopez, however, were not
served with summons, and trial proceeded with
only Lainez, Payam and YHT Realty Corporation
as defendants... After trial, the RTC of Manila
rendered judgment in favor of McLoughlin... The
trial court found that McLoughlin's allegations as
Necessary Deposit 1 253

to the fact of loss and as to the amount of money he


lost were sufficiently shown by his direct and
straightforward manner of testifying in court and
found him to be credible and worthy of belief as it
was established that McLoughlin's money, kept in
Tropicana's safety deposit box, was taken by Tan
without McLoughlin's consent... As regards the
loss of Seven Thousand US Dollars (US$7,000.00)
and jewelry worth approximately One Thousand
Two Hundred US Dollars (US$1,200.00) which al-
legedly occurred during his stay at Tropicana pre-
vious to 4 April 1988, no claim was made by
McLoughlin for such losses in his complaint dated
21 November 1990 because he was not sure how
they were lost and who the responsible persons
were. But considering the admission of the defen-
dants in their pre-trial brief that on three previous
occasions they allowed Tan to open the box, the
trial court opined that it was logical and reasonable
to presume that his personal assets consisting of
Seven Thousand US Dollars (US$7,000.00) and je-
welry were taken by Tan from the safety deposit
box without McLoughlin's consent through the co-
operation of Payam and Lainez.

The trial court also found that defendants acted


with gross negligence in the performance and exer-
cise of their duties and obligations as innkeepers
and were therefore liable to answer for the losses
incurred by McLoughlin.

Moreover, the trial court ruled that paragraphs (2)


and (4) of the "Undertaking For The Use Of Safety
Deposit Box" are not valid for being contrary to the
express mandate of Article 2003 of the New Civil
254 1 Credit Transactions: Notes and Cases

Code and against public policy. Thus, there being


fraud or wanton conduct on the part of defendants,
they should be responsible for all damages which
may be attributed to the non-performance of their
contractual obligations.

The Court of Appeals affirmed the disquisitions


made by the lower court except as to the amount of
damages awarded... Unperturbed, YHT Realty
Corporation, Lainez and Payam went to this Court
in this appeal by certiorari... The petition is devoid
of merit.

... We are also not impressed by petitioners' argu-


ment that the finding of gross negligence by the
lower court as affirmed by the appellate court is
not supported by evidence. The evidence reveals
that two keys are required to open the safety depo-
sit boxes of Tropicana. One key is assigned to the
guest while the other remains in the possession of
the management. If the guest desires to open his
safety deposit box, he must request the manage-
ment for the other key to open the same. In other
words, the guest alone cannot open the safety de-
posit box without the assistance of the manage-
ment or its employees. With more reason that
access to the safety deposit box should be denied if
the one requesting for the opening of the safety
deposit box is a stranger. Thus, in case of loss of
any item deposited in the safety deposit box, it is
inevitable to conclude that the management had at
least a hand in the consummation of the taking, un-
less the reason for the loss is force majeure.
Necessary Deposit 1 255

Noteworthy is the fact that Payam and Lainez, who


were employees of Tropicana, had custody of the
master key of the management when the loss took
place. In fact, they even admitted that they as-
sisted Tan on three separate occasions in opening
McLoughlin's safety deposit box... Yet the man-
agement failed to notify McLoughlin of the inci-
dent and waited for him to discover the taking be-
fore it disclosed the matter to him. Therefore, Tro-
picana should be held responsible for the damage
suffered by McLoughlin by reason of the negli-
gence of its employees.

The management should have guarded against the


occurrence of this incident considering that Payam
admitted in open court that she assisted Tan three
times in opening the safety deposit box of
McLoughlin at around 6:30 A.M. to 7:30 A.M.
while the latter was still asleep. In light of the cir-
cumstances surrounding this case, it is undeniable
that without the acquiescence of the employees of
Tropicana to the opening of the safety deposit box,
the loss of McLoughlin's money could and should
have been avoided.

The management contends, however, that


McLoughlin, by his act, made its employees believe
that Tan was his spouse for she was always with
him most of the time. The evidence on record,
however, is bereft of any showing that McLoughlin
introduced Tan to the management as his wife.
Such an inference from the act of McLoughlin will
not exculpate the petitioners from liability in the
256 1 Credit Transactions: Notes and Cases

absence of any showing that he made the man-


agement believe that Tan was his wife or was duly
authorized to have access to the safety deposit box.
Mere close companionship and intimacy are not
enough to warrant such conclusion considering
that what is involved in the instant case is the very
safety of McLoughlin's deposit. If only petitioners
exercised due diligence in taking care of McLough-
lin's safety deposit box, they should have con-
fronted him as to his relationship with Tan consi-
dering that the latter had been observed opening
McLoughlin's safety deposit box a number of times
at the early hours of the morning. Tan's acts
should have prompted the management to investi-
gate her relationship with McLoughlin. Then, peti-
tioners would have exercised due diligence re-
quired of them. Failure to do so warrants the con-
clusion that the management had been remiss in
complying with the obligations imposed upon ho-
tel-keepers under the law.

Under Article 1170 of the New Civil Code, those


who, in the performance of their obligations, are
guilty of negligence, are liable for damages. As to
who shall bear the burden of paying damages, Ar-
ticle 2180, paragraph (4) of the same Code provides
that the owners and managers of an establishment or
enterprise are likewise responsible for damages
caused by their employees in the service of the
branches in which the latter are employed or on the
occasion of their functions. Also, this Court has
ruled that if an employee is found negligent, it is
presumed that the employer was negligent in se-
Necessary Deposit 1257

lecting and/or supervising him for it is hard for the


victim to prove the negligence of such employer.
Thus, given the fact that the loss of McLoughlin's
money was consummated through the negligence
of Tropicana's employees in allowing Tan to open
the safety deposit box without the guest's consent,
both the assisting employees and YHT Realty Cor-
poration itself, as owner and operator of Tropicana,
should be held solidarily liable pursuant to Article
2193.

The issue of whether the "Undertaking For The Use


of Safety Deposit Box" executed by McLoughlin is
tainted with nullity presents a legal question ap-
propriate for resolution in this petition. Notably,
both the trial court and the appellate court found
the same to be null and void. We find no reason to
reverse their common conclusion. Article 2003 is
controlling... Article 2003 was incorporated in the
New Civil Code as an expression of public policy
precisely to apply to situations such as that pre-
sented in this case. The hotel business like the
common carrier's business is imbued with public
interest. Catering to the public, hotelkeepers are
bound to provide not only lodging for hotel guests
and security to their persons and belongings. The
twin duty constitutes the essence of the business.
The law in turn does not allow such duty to the
public to be negated or diluted by any contrary sti-
pulation in so-called "undertakings" that ordinarily
appear in prepared forms imposed by hotel kee-
pers on guests for their signature.
258 1 Credit Transactions: Notes and Cases

In an early case, the Court of Appeals through its


then Presiding Justice (later Associate Justice of the
Court) Jose P. Bengzon, ruled that to hold hotel-
keepers or innkeeper liable for the effects of their
guests, it is not necessary that they be actually de-
livered to the innkeepers or their employees. It is
enough that such effects are within the hotel or inn.
With greater reason should the liability of the ho-
telkeeper be enforced when the missing items are
taken without the guest's knowledge and consent
from a safety deposit box provided by the hotel it-
self, as in this case.

Paragraphs (2) and (4) of the "undertaking" mani-


festly contravene Article 2003 of the New Civil
Code for they allow Tropicana to be released from
liability arising from any loss in the contents
and/or use of the safety deposit box for any cause
whatsoever... The New Civil Code is explicit that
the responsibility of the hotel-keeper shall extend
to loss of, or injury to, the personal property of the
guests even if caused by servants or employees of
the keepers of hotels or inns as well as by stran-
gers, except as it may proceed from any force maje-
ure. It is the loss through force majeure that may
spare the hotel-keeper from liability. In the case at
bar, there is no showing that the act of the thief or
robber was done with the use of arms or through
an irresistible force to qualify the same as force
majeure.

Petitioners likewise anchor their defense on Article


2002 which exempts the hotel-keeper from liability
Necessary Deposit 1 259

if the loss is due to the acts of his guest, his family,


or visitors. Even a cursory reading of the provision
would lead us to reject petitioners' contention. The
justification they raise would render nugatory the
public interest sought to be protected by the provi-
sion. What if the negligence of the employer or its
employees facilitated the consummation of a crime
committed by the registered guest's relatives or
visitor? Should the law exculpate the hotel from
liability since the loss was due to the act of the visi-
tor of the registered guest of the hotel? Hence, this
provision presupposes that the hotel-keeper is not
guilty of concurrent negligence or has not contri-
buted in any degree to the occurrence of the loss.
A depositary is not responsible for the loss of
goods by theft, unless his actionable negligence
contributes to the loss.

In the case at bar, the responsibility of securing the


safety deposit box was shared not only by the
guest himself but also by the management since
two keys are necessary to open the safety deposit
box. Without the assistance of hotel employees, the
loss would not have occurred. Thus, Tropicana
was guilty of concurrent negligence in allowing
Tan, who was not the registered guest, to open the
safety deposit box of McLoughlin, even assuming
that the latter was also guilty of negligence in al-
lowing another person to use his key. To rule oth-
erwise would result in undermining the safety of
the safety deposit boxes in hotels for the manage-
ment will be given imprimatur to allow any per-
son, under the pretense of being a family member
260 1 Credit Transactions: Notes and Cases

or a visitor of the guest, to have access to the safety


deposit box without fear of any liability that will
attach thereafter in case such person turns out to be
a complete stranger. This will allow the hotel to
evade responsibility for any liability incurred by its
employees in conspiracy with the guest's relatives
and visitors...

If a hotel guest gives the ignition key of his vehicle to the


parking attendant of a hotel, who in turn issues a valet
parking claim stub to the guest, parks the vehicle in the
annex of the hotel and places the ignition key in a safety
deposit box, is this a voluntary deposit or a necessary de-
posit?5 Will the characterization result in a difference as
to the liability of the hotel-keeper?

5 See Durban Apartments Corporation v. Pioneer Insurance and Surety Cor-


poration, G.R No. 179419, January 12, 2011.
Chapter 4. Judicial Deposit

Art. 1964. A deposit may be constituted judicially


or extrajudicially.

Art. 2005. A judicial deposit or sequestration


takes place when an attachment or seizure of
property in litigation is ordered.

Art. 2006. Movable as well as


immovable property
may be the object of sequestration.

Art. 2007. The depositary of property or objects


sequestrated cannot be relieved of his responsi-
bility until the controversy which gave rise there-
to has come to an end, unless the court so orders.

Art. 2008. The depositary of property sequestrated


is bound to comply, with respect to the same,
with all the obligations of a good father of a fami-
ly.

Art. 2009. As to matters not provided for in this


Code, judicial sequestration shall be governed by
the Rules of Court.

A judicial deposit (or sequestration) is a deposit consti-


tuted by judicial order as a consequence of litigation, and
is suppletorily governed by the Rules of Court on attach-
ment and seizure of property. It is the only type of depo-
sit that may have for its object immovable property.
Chapter 5. Warehouse Receipts

A. General Concepts

Act No. 21371, Sec. 1. Persons who may issue re-


ceipts. - Warehouse receipts may be issued by
any warehouseman.

Sec. 2. Form of receipts; essential terms. - Ware-


house receipts need not be in any particular form
but every such receipt must embody within its
written or printed terms:
(a) The location of the warehouse where the
goods are stored,
(b) The date of the issue of the receipt,
(c) The consecutive number of the receipt,
(d) A statement whether the goods received will
be delivered to the bearer, to a specified person or
to a specified person or his order,
(e) The rate of storage charges,
(f) A description of the goods or of the packages
containing them,
(g) The signature of the warehouseman which
may be made by his authorized agent,
(h) If the receipt is issued for goods of which the
warehouseman is owner, either solely or jointly
or in common with others, the fact of such owner-
ship, and
(i) A statement of the amount of advances made
and of liabilities incurred for which the ware-
houseman claims a lien. If the precise amount of
such advances made or of such liabilities incurred
is, at the time of the issue of, unknown to the wa-
rehouseman or to his agent who issues it, a state-

I Act No. 2137 (1912), The Warehouse Receipts Law.


Warehouse Receipts 1263

ment of the fact that advances have been made or


liabilities incurred and the purpose thereof is suf-
ficient.

A warehouseman shall be liable to any person in-


jured thereby for all damages caused by the
omission from a negotiable receipt of any of the
terms herein required.

Sec. 3. Form of receipts. - What terms may be


inserted. - A warehouseman may insert in a re-
ceipt issued by him any other terms and condi-
tions provided that such terms and conditions
shall not
(a) Be contrary to the provisions of this Act.
(b) In any wise impair his obligation to exercise
that degree of care in the safe-keeping of the
goods entrusted to him which is reasonably care-
ful man would exercise in regard to similar goods
of his own.

Sec. 4. Definition of non-negotiable receipt. - A


receipt in which it is stated that the goods re-
ceived will be delivered to the depositor or to any
other specified person, is a non-negotiable re-
ceipt.

Sec. 5. Definition of negotiable receipt. - A re-


ceipt in which it is stated that the goods received
will be delivered to the bearer or to the order of
any person named in such receipt is a negotiable
receipt.

No provision shall be inserted in a negotiable re-


ceipt that it is non-negotiable. Such provision, if
inserted shall be void.
264 1 Credit Transactions: Notes and Cases

Sec. 6. Duplicate receipts must be so marked. -


When more than one negotiable receipt is issued
for the same goods, the word "duplicate" shall be
plainly placed upon the face of every such re-
ceipt, except the first one issued. A warehouse-
man shall be liable for all damages caused by his
failure so to do to any one who purchased the
subsequent receipt for value supposing it to be an
original, even though the purchase be after the
delivery of the goods by the warehouseman to the
holder of the original receipt.

Sec. 7. Failure to mark "non-negotiable." - A


non-negotiable receipt shall have plainly placed
upon its face by the warehouseman issuing it
"non-negotiable," or "not negotiable." In case of
the warehouseman's failure so to do, a holder of
the receipt who purchased it for value supposing
it to be negotiable, may, at his option, treat such
receipt as imposing upon the warehouseman the
same liabilities he would have incurred had the
receipt been negotiable.

This section shall not apply, however, to letters,


memoranda, or written acknowledgment of an in-
formal character.

Act No. 2137 or the Warehouse Receipts Law is a


commercial law incarnation of the Civil Code concept
of deposit. The obligations and rights defined in the
law take into account the habitual nature of the is-
suance of warehouse receipts as a commercial credit
transaction.

The law does not define a warehouse receipt. How-


ever, from relevant provisions, a warehouse receipt is
Warehouse Receipts I 265

a contract issued by a warehouseman,


a person lawfully engaged in the business of stor-
ing goods for profit ....
2
as evidence of goods, or
chattels or merchandise in storage or which has
3
been or is about to be stored....
ina warehouse, that is,
every building, structure, or other protected en-
closure in which commodities are kept for sto-
4
rage.

It is a formal contract because, although the law states


that a warehouse receipt need not be in any particular
form, the Warehouse Receipts Law requires that it must
be written or printed and must contain specific terms.5

B. Obligations and Rights of a Warehouseman

1. Obligation to Deliver

Sec. 58... "Delivery" means voluntary transfer of


possession from one person to another...

2 Act No. 2137 (1912), Section 58.


3 Ibid.
4 Act No. 3893 (1932), as amended by Republic Act No. 247 (1948), The Gen-
eral Bonded Warehouse Act.
5 Civil Code, Art 1356. Contracts shall be obligatory, in whatever form they
may have been entered into, provided all the essential requisites for their
validity are present However, when the law requires that a contract be in
some form in order that it may be valid or enforceable, or that a contract be
proved in a certain way, that requirement is absolute and indispensable. In
such cases, the right of the parties stated in the following article cannot be
exercised.
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 par-
ties 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
266 1 Credit Transactions: Notes and Cases

"Person" includes a corporation or partnership or


two or more persons having a joint or common
interest.

Sec. 16. Warehouseman cannot set up title in


himself. - No title or right to the possession of
the goods, on the part of the warehouseman,
unless such title or right is derived directly or in-
directly from a transfer made by the depositor at
the time of or subsequent to the deposit for sto-
rage, or
from the warehouseman's lien,
shall excuse the warehouseman from liability for
refusing to deliver the goods according to the
terms of the receipt.

Sec. 8. Obligation of warehousemen to deliver.


- A warehouseman, in the absence of some law-
ful excuse provided by this Act, is bound to de-
liver the goods
upon a demand made either
by the holder of a receipt for the goods or
by the depositor;
if such demand is accompanied with:
(a) An offer to satisfy the warehouseman's lien;
(b) An offer to surrender the receipt, if negotia-
ble, with such indorsements as would be neces-
sary for the negotiation of the receipt; and
(c) A readiness and willingness to sign, when the
goods are delivered, an acknowledgment that
they have been delivered, if such signature is re-
quested by the warehouseman.
In case the warehouseman refuses or fails to de-
liver the goods in compliance with a demand by
the holder or depositor so accompanied, the bur-
Warehouse Receipts 1 267

den shall be upon the warehouseman to establish


the existence of a lawful excuse for such refusal.

Sec. 58... "Holder" of a receipt means a person


who has both actual possession of such receipt
and a right of property therein.

Sec. 9. Justification of warehouseman in deliver-


ing. - A warehouseman is justified in delivering
the goods, subject to the provisions of the three
following sections, to one who is:
(a) The person lawfully entitled to the posses-
sion of the goods, or
his agent;
(b) A person who is either himself entitled to de-
livery by the terms of a non-negotiable receipt is-
sued for the goods, or
who has written authority from the person so en-
titled either indorsed upon the receipt or written
upon another paper; or
(c) A person in possession of a negotiable re-
ceipt by the terms of which the goods are deliver-
able to him or order, or
to bearer, or
which has been indorsed to him or in blank by
the person to whom delivery was promised by
the terms of the receipt or by his mediate or im-
mediate indorser.

Sec. 58... "Order" means an order by indorsement


on the receipt.

Sec. 10. Warehouseman's liability for misdeli-


very. - Where a warehouseman delivers the
goods to one who is not in fact lawfully entitled
to the possession of them,
268 I Credit Transactions: Notes and Cases

the warehouseman shall be liable as for conver-


sion
to all having a right of property or possession in
the goods if he delivered the goods otherwise
than as authorized by subdivisions (b) and (c) of
the preceding section, and
though he delivered the goods as authorized by
said subdivisions, he shall be so liable, if prior to
such delivery he had either:
(a) Been requested, by or on behalf of the person
lawfully entitled to a right of property or posses-
sion in the goods, not to make such deliver; or
(b) Had information that the delivery about to be
made was to one not lawfully entitled to the pos-
session of the goods.

Sec. 11. Negotiable receipt must be cancelled


when goods delivered. - Except as provided in
section thirty-six, where a warehouseman deliv-
ers goods for which he had issued a negotiable
receipt, the negotiation of which would transfer
the right to the possession of the goods,
and fails to take up and cancel the receipt,
he shall be liable to any one who purchases for
value in good faith such receipt,
for failure to deliver the goods to him, whether
such purchaser acquired title to the receipt before
or after the delivery of the goods by the ware-
houseman.

Sec. 58... To "purchase" includes to take as mort-


gagee or as pledgee...
"Value" is any consideration sufficient to support
a simple contract. An antecedent or pre-existing
obligation, whether for money or not, constitutes
Warehouse Receipts 1 269

value where a receipt is taken either in satisfac-


tion thereof or as security therefor...
(b) A thing is done "in good faith" within the
meaning of this Act when it is in fact done ho-
nestly, whether it be done negligently or not.

Sec. 12. Negotiable receipts must be cancelled or


marked when part of goods delivered. - Except
as provided in section thirty-six, where a ware-
houseman delivers part of the goods for which he
had issued a negotiable receipt
and fails either to take up and cancel such receipt
or
to place plainly upon it a statement of what goods
or packages have been delivered,
he shall be liable to any one who purchases for
value in good faith such receipt,
for failure to deliver all the goods specified in the
receipt, whether such purchaser acquired title to
the receipt before or after the delivery of any por-
tion of the goods by the warehouseman.

Sec. 13. Altered receipts. - The alteration of a


receipt shall not excuse the warehouseman who
issued it from any liability if such alteration was:
(a) Immaterial,
(b) Authorized, or
(c) Made without fraudulent intent.
If the alteration was authorized, the warehouse-
man shall be liable according to the terms of the
receipt as altered.
If the alteration was unauthorized but made
without fraudulent intent, the warehouseman
shall be liable according to the terms of the re-
ceipt as they were before alteration.
270 1 Credit Transactions: Notes and Cases

Material and fraudulent alteration of a receipt


shall not excuse the warehouseman who issued it
from liability to deliver according to the terms of
the receipt as originally issued, the goods for
which it was issued
but shall excuse him from any other liability to
the person who made the alteration and to any
person who took with notice of the alteration.
Any purchaser of the receipt for value without
notice of the alteration shall acquire the same
rights against the warehouseman which such
purchaser would have acquired if the receipt had
not been altered at the time of purchase.

Sec. 14. Lost or destroyed receipts. - Where a


negotiable receipt has been lost or destroyed,
a court of competent jurisdiction may order the
delivery of the goods upon satisfactory proof of
such loss or destruction and
upon the giving of a bond with sufficient sureties
to be approved by the court to protect the ware-
houseman from any liability or expense, which
he or any person injured by such delivery may
incur by reason of the original receipt remaining
outstanding.
The court may also in its discretion order the
payment of the warehouseman's reasonable costs
and counsel fees.

The delivery of the goods under an order of the


court as provided in this section, shall not relieve
the warehouseman from liability to a person to
whom the negotiable receipt has been or shall be
negotiated for value without notice of the pro-
ceedings or of the delivery of the goods.
Warehouse Receipts I 271

Sec. 15. Effect of duplicate receipts. - A receipt


upon the face of which the word "duplicate" is
plainly placed is a representation and warranty
by the warehouseman that such receipt is
an accurate copy of an original receipt properly
issued and
uncanceled at the date of the issue of the dupli-
cate,
but shall impose upon him no other liability.

Sec. 17. Interpleader of adverse claimants. - If


more than one person claims the title or posses-
sion of the goods, the warehouseman may,
either as a defense to an action brought against
him for non-delivery of the goods or
as an original suit, whichever is appropriate,
require all known claimants to interplead.

Sec. 58... "Action" includes counterclaim, set-off,


and suits in equity as provided by law in these
islands.

Sec. 18. Warehouseman has reasonable time to


determine validity of claims. - If someone other
than the depositor or person claiming under him
has a claim to the title or possession of goods, and
the warehouseman has information of such claim,
the warehouseman shall be excused from liability
for
refusing to deliver the goods,
either to the depositor or person claiming under
him or
to the adverse claimant
until the warehouseman
has had a reasonable time to ascertain the validity
of the adverse claim or
272 1 Credit Transactions: Notes and Cases

to bring legal proceedings to compel claimants to


interplead.

Sec. 19. Adverse title is no defense except as


above provided. - Except as provided in the two
preceding sections and in sections nine and thir-
ty-six,
no right or title of a third person shall be a de-
fense to an action
brought by the depositor or person claiming un-
der him
against the warehouseman
for failure to deliver the goods according to the
terms of the receipt.

Sec. 36. Effect of sale. - After goods have been


lawfully sold to satisfy a warehouseman's lien, or
have been lawfully sold or disposed of because of
their perishable or hazardous nature,
the warehouseman shall not thereafter be liable
for failure to deliver the goods to the depositor or
owner of the goods or to a holder of the receipt
given for the goods when they were deposited,
even if such receipt be negotiable.

The obligation of the warehouseman to deliver under the


Warehouse Receipts Law is not the delivery required for
the perfection of real contracts, but is similar to the obliga-
tion of the depositary to return under the Civil Code. Be-
cause of the commercial nature of the transactions of a
warehouseman, this obligation to deliver is subjected to
stricter rules.

2. Liability for Goods

Sec. 20. Liability for non-existence or misde-


scription of goods. - A warehouseman shall be
Warehouse Receipts 1273

liable to the holder of a receipt for damages


caused by
the non-existence of the goods or
by the failure of the goods to correspond with the
description thereof in the receipt at the time of its
issue. If, however, the goods are described in a
receipt merely by a statement of marks or labels
upon them or upon packages containing them or
by a statement that the goods are said to be goods
of a certain kind or that the packages containing
the goods are said to contain goods of a certain
kind or by words of like purport, such state-
ments, if true, shall not make liable the ware-
houseman issuing the receipt, although the goods
are not of the kind which the marks or labels
upon them indicate or of the kind they were said
to be by the depositor.

Sec. 21. Liability for care of goods. - A ware-


houseman shall be liable for any loss or injury to
the goods caused by
his failure to exercise such care in regard to them
as a reasonably careful owner of similar goods
would exercise,
but he shall not be liable, in the absence of an
agreement to the contrary, for any loss or injury
to the goods which could not have been avoided
by the exercise of such care.

Sec. 22. Goods must be kept separate. - Except


as provided in the following section, a ware-
houseman shall keep the goods so far separate
from goods of other depositors and
from other goods of the same depositor for which
a separate receipt has been issued,
274 I Credit Transactions: Notes and Cases

as to permit at all times the identification and re-


delivery of the goods deposited.

Sec. 23. Fungible goods may be commingled if


warehouseman authorized. - If authorized by
agreement or by custom, a warehouseman may
mingle fungible goods with other goods of the
same kind and grade. In such case, the various
depositors of the mingled goods shall own the
entire mass in common and each depositor shall
be entitled to such portion thereof as the amount
deposited by him bears to the whole.

Sec. 58... "Fungible goods" means goods of


which any unit is, from its nature by mercantile
custom, treated as the equivalent of any other
unit.

Sec. 24. Liability of warehouseman to deposi-


tors of commingled goods. - The warehouseman
shall be severally liable to each depositor for
the care and
redelivery of his share of such mass to the same
extent and under the same circumstances as if the
goods had been kept separate.

Sec. 25. Attachment or levy upon goods for


which a negotiable receipt has been issued. - If
goods are delivered to a warehouseman
by the owner or by a person whose act in convey-
ing the title to them to a purchaser in good faith
for value would bind the owner, and
a negotiable receipt is issued for them,
they can not thereafter,
while in the possession of the warehouseman,
Warehouse Receipts 1 275

be attached by garnishment or otherwise, or be


levied upon under an execution
unless the receipt be first surrendered to the wa-
rehouseman or its negotiation enjoined.
The warehouseman shall in no case be compelled
to deliver up the actual possession of the goods
until the receipt is surrendered to him or im-
pounded by the court.

Sec. 58... "Owner" does not include mortgagee.

Sec. 26. Creditor's remedies to reach negotiable


receipts. - A creditor whose debtor is the owner
of a negotiable receipt shall be entitled to such
aid from courts of appropriate jurisdiction, by in-
junction and otherwise, in attaching such receipt
or in satisfying the claim by means thereof as is
allowed at law or in equity in these islands in re-
gard to property which can not readily be at-
tached or levied upon by ordinary legal process.

The liability of the warehouseman for the goods stored


under the Warehouse Receipts Law is similar to the liabil-
ity of the depositary for the safekeeping of the property
deposited under the Civil Code. The rules on the ware-
houseman's liability for goods take into consideration the
commercial nature of the credit transaction.

3. Warehouseman's Lien

Sec. 32. Warehouseman's lien does not preclude


other remedies. - Whether a warehouseman has
or has not a lien upon the goods,
he is entitled to all remedies allowed by law to a
creditor against a debtor for the collection from
the depositor of all charges and advances which
276 I Credit Transactions: Notes and Cases

the depositor has expressly or impliedly con-


tracted with the warehouseman to pay.

Sec. 27. What claims are included in the ware-


houseman's lien. - Subject to the provisions of
section thirty,
a warehouseman shall have a lien
on goods deposited or
on the proceeds thereof in his hands,
for all lawful charges for storage and preservation
of the goods;
also for all lawful claims for money advanced, in-
terest, insurance, transportation, labor, weighing,
coopering and other charges and expenses in rela-
tion to such goods,
also for all reasonable charges and expenses for
notice, and advertisements of sale, and
for sale of the goods where default had been
made in satisfying the warehouseman's lien.

Sec. 28. Against what property the lien may be


enforced. - Subject to the provisions of section
thirty, a warehouseman's lien may be enforced:
(a) Against all goods, whenever deposited, be-
longing to the person who is liable as debtor for
the claims in regard to which the lien is asserted,
and
(b) Against all goods belonging to others which
have been deposited at any time by the person
who is liable as debtor for the claims in regard to
which the lien is asserted if such person had been
so entrusted with the possession of goods that a
pledge of the same by him at the time of the de-
posit to one who took the goods in good faith for
value would have been valid.
Warehouse Receipts 1 277

Sec. 29. How the lien may be lost. - A ware-


houseman loses his lien upon goods:
(a) By surrendering possession thereof, or
(b) By refusing to deliver the goods when a de-
mand is made with which he is bound to comply
under the provisions of this Act.

Sec. 30. Negotiable receipt must state charges


for which the lien is claimed. - If a negotiable
receipt is issued for goods,
the warehouseman shall have no lien thereon
except for charges for storage of goods subse-
quent to the date of the receipt
unless the receipt expressly enumerated other
charges for which a lien is claimed. In such case,
there shall be a lien for the charges enumerated
so far as they are within the terms of section
twenty-seven although the amount of the charges
so enumerated is not stated in the receipt.

Sec. 31. Warehouseman need not deliver until


lien is satisfied. - A warehouseman having a
lien valid against the person demanding the
goods may
refuse to deliver the goods to him
until the lien is satisfied.

Sec. 33. Satisfaction of lien by sale. - A ware-


houseman's lien for a claim which has become
due may be satisfied as follows:
(a) An itemized statement of the warehouse-
man's claim, showing the sum due at the time of
the notice and the date or dates when it becomes
due,
(b) A brief description of the goods against
which the lien exists,
278 1 Credit Transactions: Notes and Cases

(c) A demand that the amount of the claim as


stated in the notice of such further claim as shall
accrue, shall be paid on or before a day men-
tioned, not less than ten days from the delivery of
the notice if it is personally delivered, or from the
time when the notice shall reach its destination,
according to the due course of post, if the notice
is sent by mail,
(d) A statement that unless the claim is paid
within the time specified, the goods will be ad-
vertised for sale and sold by auction at a specified
time and place.

In accordance with the terms of a notice so given,


a sale of the goods by auction may be had to sa-
tisfy any valid claim of the warehouseman for
which he has a lien on the goods.
The sale shall be had in the place where the lien
was acquired, or, if such place is manifestly un-
suitable for the purpose, at the nearest suitable
place.
After the time for the payment of the claim speci-
fied in the notice to the depositor has elapsed,
an advertisement of the sale, describing the goods
to be sold, and stating the name of the owner or
person on whose account the goods are held, and
the time and place of the sale, shall be published
once a week for two consecutive weeks in a
newspaper published in the place where such
sale is to be held.
The sale shall not be held less than fifteen days
from the time of the first publication. If there is
no newspaper published in such place, the idver-
tisement shall be posted at least ten days before
such sale in not less than six conspicuous places
therein.
Warehouse Receipts I 279

From the proceeds of such sale, the warehouse-


man shall satisfy
his lien including
the reasonable charges of notice, advertisement
and sale.
The balance, if any, of such proceeds shall be
held by the warehouseman and delivered on de-
mand to the person to whom he would have been
bound to deliver or justified in delivering goods.

At any time before the goods are so sold,


any person claiming a right of property or posses-
sion therein
may pay the warehouseman the amount neces-
sary to satisfy his lien and to pay the reasonable
expenses and liabilities incurred in serving notic-
es and advertising and preparing for the sale up
to the time of such payment.
The warehouseman shall deliver the goods to the
person making payment if he is a person entitled,
under the provision of this Act, to the possession
of the goods on payment of charges thereon.
Otherwise, the warehouseman shall retain the
possession of the goods according to the terms of
the original contract of deposit.

Sec. 34. Perishable and hazardous goods. - If


goods are of a perishable nature, or
by keeping will deteriorate greatly in value, or,
by their odor, leakage, inflammability, or explo-
sive nature, will be liable to injure other property,
the warehouseman may give such notice to the
owner or to the person in whose names the goods
are stored, as is reasonable and possible under
the circumstances,
to satisfy the lien upon such goods and
280 1 Credit Transactions: Notes and Cases

to remove them from the warehouse


and in the event of the failure of such person to
satisfy the lien and to receive the goods within
the time so specified,
the warehouseman may sell the goods at public
or private sale without advertising.
If the warehouseman, after a reasonable effort, is
unable to sell such goods, he may dispose of
them in any lawful manner and shall incur no
liability by reason thereof.

The proceeds of any sale made under the terms of


this section shall be disposed of in the same way
as the proceeds of sales made under the terms of
the preceding section.

Sec. 35. Other methods of enforcing lien. - The


remedy for enforcing a lien herein provided does
not preclude any other remedies allowed by law
for the enforcement of a lien against personal
property nor bar the right to recover so much of
the warehouseman's claim as shall not be paid by
the proceeds of the sale of the property.

Sec. 36. Effect of sale. - After goods have been


lawfully sold to satisfy a warehouseman's lien, or
have been lawfully sold or disposed of because of
their perishable or hazardous nature,
the warehouseman shall not thereafter be liable
for failure to deliver the goods to the depositor or
owner of the goods or to a holder of the receipt
given for the goods when they were deposited,
even if such receipt be negotiable.

The warehouseman's lien under the Warehouse Receipts


Law is the warehouseman's legal right or interest in the
Warehouse Receipts 1 281

depositor's property6 . It is similar to the depositary's


right of retention under the Civil Code, which is a means
or device by which the depositary is able to obtain pay-
7
ment of what may be due because of the deposit.

C. Negotiation and Transfer

Sec. 37. Negotiation of negotiable receipt of de-


livery. - A negotiable receipt may be negotiated
by delivery:
(a) Where, by terms of the receipt, the ware-
houseman undertakes to deliver the goods to the
bearer, or
(b) Where, by the terms of the receipt, the ware-
houseman undertakes to deliver the goods to the
order of a specified person, and such person or a
subsequent indorsee of the receipt has indorsed it
in blank or to bearer.

Where, by the terms of a negotiable receipt, the


goods are deliverable to bearer or
where a negotiable receipt has been indorsed in
blank or to bearer,
any holder may indorse the same to himself or to
any other specified person, and, in such case, the
receipt shall thereafter be negotiated only by the
indorsement of such indorsee.

Sec. 38. Negotiation of negotiable receipt by


indorsement. - A negotiable receipt may be ne-
gotiated by the indorsement of the person to
whose order the goods are, by the terms of the re-
ceipt, deliverable.

6 Blacks Law Dictionary, Ninth Edition (2009).


7See Ortiz v. Kayanan et al., G.R. No. L-32974, July 30, 1979.
282 1 Credit Transactions: Notes and Cases

Such indorsement may be in blank, to bearer or


to a specified person.
If indorsed to a specified person, it may be again
negotiated by the indorsement of such person in
blank, to bearer or to another specified person.
Subsequent negotiation may be made in like
manner.

Sec. 39. Transfer of receipt. - A receipt which


is not in such form that it can be negotiated by
delivery may be transferred by the holder
by delivery to a purchaser or donee.

A non-negotiable receipt cannot be negotiated,


and the indorsement of such a receipt gives the
transferee no additional right.

Sec. 40. Who may negotiate a receipt. - A nego-


tiable receipt may be negotiated:
(a) By the owner thereof, or
(b) By any person to whom the possession or cus-
tody of the receipt has been entrusted by the
owner, if, by the terms of the receipt, the ware-
houseman undertakes to deliver the goods to the
order of the person to whom the possession or
custody of the receipt has been entrusted, or if, at
the time of such entrusting, the receipt is in such
form that it may be negotiated by delivery.

Sec. 41. Rights of person to whom a receipt has


been negotiated. - A person to whom a negotia-
ble receipt has been duly negotiated acquires the-
reby:
(a) Such title to the goods as the person negotiat-
ing the receipt to him had or had ability to convey
to a purchaser in good faith for value, and also
Warehouse Receipts I 283

such title to the goods as the depositor or person


to whose order the goods were to be delivered by
the terms of the receipt had or had ability to con-
vey to a purchaser in good faith for value, and
(b) The direct obligation of the warehouseman to
hold possession of the goods for him according to
the terms of the receipt as fully as if the ware-
houseman and contracted directly with him.

Sec. 42. Rights of person to whom receipt has


been transferred. - A person to whom a receipt
has been transferred
but not negotiated
acquires thereby, as against the transferor, the
title of the goods subject to the terms of any
agreement with the transferor.

If the receipt is non-negotiable,


such person also acquires the right to notify the
warehouseman of the transfer to him of such re-
ceipt and
thereby to acquire the direct obligation of the wa-
rehouseman to hold possession of the goods for
him according to the terms of the receipt.

Prior to the notification of the warehouseman by


the transferor or transferee of a non-negotiable
receipt,
the title of the transferee to the goods and the
right to acquire the obligation of the warehouse-
man may be defeated
by the levy of an attachment or execution upon
the goods by a creditor of the transferor or
by a notification to the warehouseman by the
transferor or a subsequent purchaser from the
284 1 Credit Transactions: Notes and Cases

transferor of a subsequent sle of the goods by


the transferor.

Sec. 43. Transfer of negotiable receipt without


indorsement. - Where a negotiable receipt is
transferred for value by delivery and the in-
dorsement of the transferor is essential for nego-
tiation,
the transferee acquires a right against the transfe-
ror to compel him to indorse the receipt unless a
contrary intention appears. The negotiation shall
take effect as of the time when the indorsement is
actually made.

Sec. 44. Warranties on sale of a receipt. - A


person who, for value, negotiates or transfers a
receipt by indorsement or delivery, including one
who assigns for value a claim secured by a re-
ceipt, unless a contrary intention appears, war-
rants:
(a) That the receipt is genuine,
(b) That he has a legal right to negotiate or trans-
fer it,
(c) That he has knowledge of no fact which
would impair the validity or worth of the receipt,
and
(d) That he has a right to transfer the title to the
goods and that the goods are merchantable or fit
for a particular purpose whenever such warran-
ties would have been implied, if the contract of
the parties had been to transfer without a receipt
of the goods represented thereby.

Sec. 45. Indorser not a guarantor. - The in-


dorsement of a receipt shall not make the indors-
er liable for any failure on the part of the ware-
Warehouse Receipts 1 285

houseman or previous indorsers of the receipt to


fulfill their respective obligations.

Sec. 46. No warranty implied from accepting


payment of a debt. - A mortgagee, pledgee, or
holder for security of a receipt who, in good faith,
demands or receives payment of the debt for
which such receipt is security, whether from a
party to a draft drawn for such debt or from any
other person, shall not, by so doing, be deemed to
represent or to warrant the genuineness of such
receipt or the quantity or quality of the goods
therein described.

Sec. 47. When negotiation not impaired by


fraud, mistake or duress. - The validity of the
negotiation of a receipt is not impaired
by the fact that such negotiation was a breach of
duty on the part of the person making the negoti-
ation or
by the fact that the owner of the receipt was in-
duced by fraud, mistake or duress to entrust the
possession or custody of the receipt to such per-
son,
if the person to whom the receipt was negotiated
or a person to whom the receipt was subsequent-
ly negotiated paid value therefor, without notice
of the breach of duty, or fraud, mistake or duress.

Sec. 48. Subsequent negotiation. - Where a


person having sold, mortgaged, or pledged goods
which are in warehouse and for which a negotia-
ble receipt has been issued, or
having sold, mortgaged, or pledged the negotia-
ble receipt representing such goods,
286 1 Credit Transactions: Notes and Cases

continues in possession of the negotiable receipt,


the subsequent negotiation thereof by the person
under any sale or other disposition thereof to any
person receiving the same in good faith, for value
and without notice of the previous sale, mortgage
or pledge, shall have the same effect as if the first
purchaser of the goods or receipt had expressly
authorized the subsequent negotiation.

Sec. 49. Negotiation defeats vendor's lien. -


Where a negotiable receipt has been issued for
goods,
no seller's lien or right of stoppage in transitu
shall defeat the rights of any purchaser for value
in good faith to whom such receipt has been ne-
gotiated,
whether such negotiation be prior or subsequent
to the notification to the warehouseman who is-
sued such receipt of the seller's claim to a lien or
right of stoppage in transitu.
Nor shall the warehouseman be obliged to deliv-
er or justified in delivering the goods to an unpa-
id seller unless the receipt is first surrendered for
cancellation.

D. Criminal Liability

Sec. 50. Issue of receipt for goods not received.


- A warehouseman, or
an officer, agent, or servant of a warehouseman
who issues or
aids in issuing a receipt
knowing that the goods for which such receipt is
issued
have not been actually received by such ware-
houseman, or
Warehouse Receipts 1287

are not under his actual control at the time of is-


suing such receipt,
shall be guilty of a crime, and, upon conviction,
shall be punished for each offense by imprison-
ment not exceeding five years, or by a fine not ex-
ceeding ten thousand pesos, or both.

Sec. 51. Issue of receipt containing false state-


ment. - A warehouseman, or
any officer, agent or servant of a warehouseman
who fraudulently issues or
aids in fraudulently issuing a receipt for goods
knowing that it contains any false statement,
shall be guilty of a crime, and upon conviction,
shall be punished for each offense by imprison-
ment not exceeding one year, or by a fine not ex-
ceeding two thousand pesos, or by both.

Sec. 52. Issue of duplicate receipt not so


marked. - A warehouseman, or
any officer, agent, or servant of a warehouseman
who issues or
aids in issuing a duplicate or additional negotia-
ble receipt for goods
knowing that a former negotiable receipt for the
same goods or any part of them is outstanding
and uncancelled,
without plainly placing upon the face thereof the
word "duplicate"
except in the case of a lost or destroyed receipt af-
ter proceedings are provided for in section four-
teen,
shall be guilty of a crime, and, upon conviction,
shall be punished for each offense by imprison-
ment not exceeding five years, or by a fine not ex-
ceeding ten thousand pesos, or by both.
288 1 Credit Transactions: Notes and Cases

Sec. 53. Issue for warehouseman's goods or re-


ceipts which do not state that fact. - Where they
are deposited with or held by a warehouseman
goods of which he is owner, either solely or joint-
ly or in common with others,
such warehouseman, or
any of his officers, agents, or servants who,
knowing this ownership,
issues or aids in issuing a negotiable receipt for
such goods which does not state such ownership,
shall be guilty of a crime, and, upon conviction,
shall be punished for each offense by imprison-
ment not exceeding one year, or by a fine not ex-
ceeding two thousand pesos, or by both.

Sec. 54. Delivery of goods without obtaining


negotiable receipt. - A warehouseman, or
any officer, agent, or servant of a warehouseman,
who delivers goods out of the possession of such
warehouseman,
knowing that a negotiable receipt the negotiation
of which would transfer the right to the posses-
sion of such goods is outstanding and uncan-
celled,
without obtaining the possession of such receipt
at or before the time of such delivery, shall,
except in the cases provided for in sections four-
teen and thirty-six,
be found guilty of a crime, and, upon conviction,
shall be punished for each offense by imprison-
ment not exceeding one year, or by a fine not ex-
ceeding two thousand pesos, or by both.

Sec. 55. Negotiation of receipt for mortgaged


goods. - Any person who deposits goods to
which he has no title, or
Warehouse Receipts 1289

upon which there is a lien or mortgage, and


who takes for such goods a negotiable receipt
which he afterwards negotiates for value
with intent to deceive and
without disclosing his want of title or the exis-
tence of the lien or mortgage,
shall be guilty of a crime, and, upon conviction,
shall be punished for each offense by imprison-
ment not exceeding one year, or by a fine not ex-
ceeding two thousand pesos, or by both.

A fundamental distinction between special commercial


laws on credit transactions and their Civil Code counter-
parts, such as the Warehouse Receipts Law in relation to
deposit, is the inclusion of provisions criminalizing cer-
tain acts and omissions relating to the credit transaction.

E. General Bonded Warehouses

Act No. 38938, Sec. 2. As used in this Act, the term


"warehouse" shall be deemed to mean every
building, structure, or other protected enclosure
in which commodities are kept for storage. "Per-
son" including corporation or partnership or two
or more persons having joint or common interest;
"warehouseman" means a person engaged in the
business of receiving commodities for storage;
and "receipt" means any receipt issued by a wa-
rehouseman for commodities delivered to him.
For the purpose of this Act, the business of re-
ceiving commodities for storage shall include

8 Act No. 3893 (1932), as amended by Republic Act No. 247 (1948), The Gen-
eral Bonded Warehouse Act,.
290 1 Credit Transactions: Notes and Cases

(1) any contract or transaction wherein the wa-


rehouseman is obligated to return the very same
commodities delivered to him or pay its value;
(2) any contract or transaction wherein the com-
modities delivered is to be milled for and on ac-
count of the owner thereof;
(3) any contract or transaction wherein the com-
modities delivered is commingled with the com-
modities delivered by or belonging to other per-
sons and the warehouseman is obligated to return
the commodities of the same kind or pay its val-
ue.

Sec. 19... the word "commodity" shall mean any


farm, agricultural or horticultural product; animal
and animal husbandry or livestock, dairy or poul-
try product; water, marine or fish product; miner-
al, chemical, drug or medicinal product; forestry
product; and any raw, processed, manufactured
or finished product or by-product, good, article,
or merchandise, either of domestic or of foreign
production or origin, which may be traded or
dealt in openly and legally.

Sec. 3. No person shall engage in the business of


receiving commodities for storage without first
securing a license therefore from the Director of
the Bureau of Commerce and Industry. Said li-
cense shall be annual and shall expire on the thir-
ty-first day of December.

Sec. 4. Any person applying for a license to en-


gage in the business of receiving commodities for
storage shall set forth in the application the place

9 As amended by Republic Act No. 247 (1948).


Warehouse Receipts 1291

or places where the business and warehouse are


to be established or located and the maximum
quantity of commodities to be received. The ap-
plication shall be accompanied by a cash bond or
a bond secured by real estate or signed by a duly
authorized bonding company, the amount of
which shall be fixed by the Director of the Bu-
reau of Commerce and Industry at not less than
thirty-three and one third percent of the market
value of the maximum quantity or commodities
to be received. Said bond shall be so conditioned
as to respond for the market value of the com-
modities actually delivered and received at any
time the warehouseman is unable to return the
commodities or to pay its value. The bond shall
be approved by the Director of the Bureau of
Commerce and Industry before issuing a license
under this Act, to satisfy himself concerning the
sufficiency of such bond, and to determine
whether the warehouse for which such license is
applied for is suitable for the proper storage of
commodities.

Philippine National Bank v. Se et al., G.R. No.


119231. April 18,1996,256 SCRA 380.

The source of conflict herein is the question as to


whether the Philippine National Bank should pay
storage fees for sugar stocks covered by five (5)
Warehouse Receipts stored in the warehouse of
private respondents in the face of the Court of Ap-
peals' decision (affirmed by the Supreme Court)
declaring the Philippine National Bank as the own-
er of the said sugar stocks and ordering their deli-
very to the said bank. From the same facts but on a
292 1 Credit Transactions: Notes and Cases

different perspective, it can be said that the issue is:


Can the warehouseman enforce his warehouse-
man's lien before delivering the sugar stocks as or-
dered by the Court of Appeals or need he file a
separate action to enforce payment of storage fees?

... In accordance with Act No. 2137, the Warehouse


Receipts Law, Noah's Ark Sugar Refinery issued
on several dates, the following Warehouse Receipts
(Quedans): (a) March 1, 1989, Receipt No. 18062,
covering sugar deposited by Rosa Sy; (b) March 7,
1989, Receipt No. 18080, covering sugar deposited
by RNS Merchandising (Rosa Ng Sy); (c) March 21,
1989, Receipt No. 18081, covering sugar deposited
by St. Therese Merchandising; (d) March 31, 1989,
Receipt No. 18086, covering sugar deposited by St.
Therese Merchandising; and (e) April 1, 1989, Re-
ceipt No. 18087, covering sugar deposited by RNS
Merchandising. The receipts are substantially in
the form, and contains the terms, prescribed for
negotiable warehouse receipts by Section 2 of the
law.

Subsequently, Warehouse Receipts Nos. 18080 and


18081 were negotiated and endorsed to Luis T.
Ramos; and Receipts Nos. 18086, 18087 and 18062
were negotiated and endorsed to Cresencia K. Zo-
leta. Ramos and Zoleta then used the quedans as
security for two loan agreements - one for P15.6
million and the other for P23.5 million - obtained
by them from the Philippine National Bank. The
aforementioned quedans were endorsed by them
to the Philippine National Bank.
Warehouse Receipts 1293

Luis T. Ramos and Cresencia K. Zoleta failed to


pay their loans upon maturity on January 9, 1990.
Consequently, on March 16, 1990, the Philippine
National Bank wrote to Noah's Ark Sugar Refinery
demanding delivery of the sugar stocks covered by
the quedans endorsed to it by Zoleta and Ramos.
Noah's Ark Sugar Refinery refused to comply with
the demand alleging ownership thereof, for which
reason the Philippine National Bank filed with the
Regional Trial Court of Manila a verified complaint
for "Specific Performance with Damages and Ap-
plication for Writ of Attachment" against Noah's
Ark Sugar Refinery, Alberto T. Looyuko, Jimmy T.
Go and Wilson T. Go, the last three being identified
as the sole proprietor, managing partner, and Ex-
ecutive Vice President of Noah's Ark, respective-
ly...

Noah's Ark and its co-defendants filed an Answer


with Counterclaim and Third-Party Complaint in
which they claimed that they are the owners of the
subject quedans and the sugar represented therein,
averring as they did that:
"9... In an agreement dated April 1, 1989, defen-
dants agreed to sell to Rosa Ng Sy of RNS Mer-
chandising and Teresita Ng of St. Therese Mer-
chandising the total volume of sugar indicated in the
quedans stored at Noah's Ark Sugar Refinery for a total
consideration of P63,000,000.00... The correspond-
ing payments in the form of checks issued by the
vendees in favor of defendants were subsequently
dishonored by the drawee banks by reason of
'payment stopped' and 'drawn against insufficient
funds... Upon proper notification to said vendees
and plaintiff in due course, defendants refused to
294 1 Credit Transactions: Notes and Cases

deliver to vendees therein the quantity of sugar


covered by the subject quedans.
.10...Considering that the vendees and first endors-
ers of subject quedans did not acquire ownership
thereof, the subsequent endorsers and plaintiff it-
self did not acquire a better right of ownership
than the original vendees/first endorsers."

The Answer incorporated a Third-Party Complaint


by Alberto T. Looyuko, Jimmy T. Go and Wilson T.
Go, doing business under the trade name and style
Noah's Ark Sugar Refinery against Rosa Ng Sy and
Teresita Ng, praying that the latter be ordered to
deliver or return to them the quedans (previously
endorsed to PNB and the subject of the suit) and
pay damages and litigation expenses.

The Answer of Rosa Ng Sy and Teresita Ng, dated


September 6, 1990, one of avoidance, is essentially
to the effect that the transaction between them, on
the one hand, and Jimmy T. Go, on the other, con-
cerning the quedans and the sugar stocks covered
by them was merely a simulated one being part of
the latter's complex banking schemes and financial
maneuvers, and thus, they are not answerable in
damages to him.

On January 31, 1991, the Philippine National Bank


filed a Motion for Summary Judgment in favor of
the plaintiff as against the defendants for the reliefs
prayed for in the complaint.
On May 2,1991, the Regional Trial Court issued an
order denying the Motion for Summary Judgment.
Thereupon, the Philippine National Bank filed a
Petition for Certiorari with the Court of Appeals ...
Warehouse Receipts 1 295

On December 13, 1991, the Court of Appeals nulli-


fied and set aside the orders of May 2 and July 4,
1990 of the Regional Trial Court and ordered the
trial court to render summary judgment in favor of
the PNB. On June 18, 1992, the trial court rendered
judgment dismissing plaintiffs complaint against
private respondents for lack of cause of action and
likewise dismissed private respondents' counter-
claim against PNB and of the Third-Party Com-
plaint and the Third-Party Defendant's Counter-
claim.

On September 4, 1992, the trial court denied PNB's


Motion for Reconsideration.

On June 9, 1992, the PNB filed an appeal from the


RTC decision with the Supreme Court ... by way of
a Petition for Review on Certiorari under Rule 45
of the Rules of Court. This Court rendered judg-
ment on September 1, 1993, the dispositive portion
of which reads:
"WHEREFORE, the trial judge's decision in Civil
Case No. 90-53023, dated June 18, 1992, is reversed
and set aside and a new one rendered conformably
with the final and executory decision of the Court
of Appeals in CA-G.R SP. No. 25938, ordering the
private respondents Noah's Ark Sugar Refinery,
Alberto T. Looyuko, Jimmy T. Go and Wilson T.
Go, jointly and severally:
(a) to deliver to the petitioner Philippine National
Bank, 'the sugar stocks covered by the Warehouse
Receipts/Quedans which are now in the latter's
possession as holder for value and in due course;
or alternatively, to pay (said) plaintiff actual dam-
ages in the amount of P39.1 million,' with legal in-
296 I Credit Transactions: Notes and Cases

terest thereon from the filing of the complaint until


full payment; and
(b) to pay plaintiff Philippine National Bank attor-
ney's fees, litigation expenses and judicial costs he-
reby fixed at the amount of One Hundred Fifty
Thousand Pesos (P150,000.00) as well as the costs.
SO ORDERED."

On September 29,1993, private respondents moved


for reconsideration of this decision. A Supplemen-
tal/Second Motion for Reconsideration with leave
of court was filed by private respondents on No-
vember 8, 1993. We denied private respondents'
motion on January 10,1994..

Private respondents filed a Motion Seeking Clarifi-


cation of the Decision, dated September 1, 1993. We
denied this motion in this manner:
"It bears stressing that the relief granted in this
Court's decision of September 1, 1993 is precisely
that set out in the final and executory decision of
the Court of Appeals in CA-G.R. SP No. 25938,
dated December 13, 1991, which was affirmed in to-
to by this Court and which became unalterable
upon becoming final and executory. "

Private respondents thereupon filed before the trial


court an Omnibus Motion seeking among others
the deferment of the proceedings until private res-
pondents are heard on their claim for warehouse-
man's lien. On the other hand, on August 22,1994,
the Philippine National Bank fied a Motion for the
Issuance of a Writ of Execution and an Opposition
to the Omnibus Motion filed by private respon-
dents.
Warehouse Receipts 1 297

The trial court granted private respondents' Omni-


bus Motion on December 20,1994 and set reception
of evidence on their claim for warehouseman's
lien. The resolution of the PNB's Motion for Execu-
tion was ordered deferred until the determination
of private respondents' claim.

On February 21, 1995, private respondents' claim


for lien was heard and evidence was received in
support thereof. The trial court thereafter gave
both parties five (5) days to file respective memo-
randa.

On February 28,1995, the Philippine National Bank


filed a Manifestation with Urgent Motion to Nulli-
fy Court Proceedings. In adjudication thereof, the
trial court issued the following order on March 1,
1995:
"WHEREFORE, this court hereby finds that there
exists in favor of the defendants a valid ware-
houseman's lien under Section 27 of Republic Act
2137 and accordingly, execution of the judgment is
hereby ordered stayed and/ or precluded until the
full amount of defendants' lien on the sugar stocks
covered by the five (5) quedans subject of this ac-
tion shall have been satisfied conformably with the
provisions of Section 31 of Republic Act 2137."

Consequently, the Philippine National Bank filed


the herein petition to seek the nullification of the
above-assailed orders of respondent judge... The
issues presented before us in this petition revolve
around the legality of the questioned orders of res-
pondent judge, issued as they were after we had
298 1 Credit Transactions: Notes and Cases

denied with finality private respondents' conten-


tion that the PNB could not compel them to deliver
the stocks of sugar in their warehouse covered by
the endorsed quedans or pay the value of the said
stocks of sugar.

Petitioner's submission is on a technicality, that is,


that private respondents have lost their right to re-
cover warehouseman's lien on the sugar stocks
covered by the five (5) Warehouse Receipts for the
reason that they failed to set up said claim in their
Answer before the trial court and that private res-
pondents did not appeal from the decision in this
regard, dated June 18, 1992. Petitioner asseverates
that the denial by this Court on March 9, 1994 of
the motion seeking clarification of our decision,
dated September 1, 1993, has foreclosed private
respondents' right to enforce their warehouse-
man's lien for storage fees and preservation ex-
penses under the Warehouse Receipts Act.

On the other hand, private respondents maintain


that they could not have claimed the right to a wa-
rehouseman's lien in their Answer to the complaint
before the trial court as it would have been incon-
sistent with their stand that they claim ownership
of the stocks covered by the quedans since the
checks issued for payment thereof were disho-
nored. If they were still the owners, it would have
been absurd for them to ask payment for storage
fees and preservation expenses. They further con-
tend that our resolution, dated March 9, 1994, de-
nying their motion for clarification did not prec-
lude their right to claim their warehouseman's lien
under Sections 27 and 31 of Republic Act 2137, as
Warehouse Receipts 1 299

our resolution merely affirmed and adopted the


earlier decision, dated December 13, 1991, of the
Court of Appeals (6th Division) in CA-G.R. SP. No.
25938 and did not make any finding on the matter
of the warehouseman' s lien.

We find for private respondents on the foregoing


issue and so the petition necessarily must fail.

We have carefully examined our resolution, dated


March 9,1994, which denied Noah's Ark's motion
for clarification of our decision, dated September 1,
1993, wherein we affirmed in full and adopted the
Court of Appeals' earlier decision, dated December
13, 1991 ... We are not persuaded by the petition-
er's argument that our said resolution carried with
it the denial of the warehouseman's lien over the
sugar stocks covered by the subject Warehouse Re-
ceipts. We have simply resolved and upheld in our
decision, dated September 1, 1993, the propriety of
summary judgment which was then assailed by
private respondents. In effect, we ruled therein
that, considering the circumstances obtaining be-
fore the trial court, the issuance of the Warehouse
Receipts not being disputed by the private respon-
dents, a summary judgment in favor of PNB was
proper. We in effect further affirmed the finding
that Noah's Ark is a warehouseman which was ob-
liged to deliver the sugar stocks covered by the
Warehouse Receipts pledged by Cresencia K. Zole-
ta and Luis T. Ramos to the petitioner pursuant to
the pertinent provisions of Republic Act 2137.

In disposing of the private respondents' motion for


clarification, we could not contemplate the matter
300 1 Credit Transactions: Notes and Cases

of warehouseman's lien because the issue to be fi-


nally resolved then was the claim of private res-
pondents for retaining ownership of the stocks of
sugar covered by the endorsed quedans. Stated
otherwise, there was no point in taking up the is-
sue of warehouseman's lien since the matter of
ownership was as yet being determined. Neither
could storage fees be due then while no one has
been declared the owner of the sugar stocks in
question.

Of considerable relevance is the pertinent stipula-


tion in the subject Warehouse Receipts which pro-
vides for respondent Noah's Ark's right to impose
and collect warehouseman's lien:
"Storage of the refined sugar quantities mentioned
herein shall be free up to one (1) week from the
date of the quedans covering said sugar and the-
reafter, storage fees shall be charged in accordance
with the Refining Contract under which the refined
sugar covered by this Quedan was produced."

It is not disputed, therefore, that, under the subject


Warehouse Receipts provision, storage fees are
chargeable.

Petitioner anchors its claim against private respon-


dents on the five (5) Warehouse Receipts issued by
the latter to third-party defendants Rosa Ng Sy of
RNS Merchandising and Teresita Ng of St. Therese
Merchandising, which found their way to petition-
er after they were negotiated to them by Luis T.
Ramos and Cresencia K. Zoleta for a loan of P39.1
Million. Accordingly, petitioner PNB is legally
bound to stand by the express terms and condi-
Warehouse Receipts 1 301

tions on the face of the Warehouse Receipts as to


the payment of storage fees. Even in the absence of
such a provision, law and equity dictate the pay-
ment of the warehouseman' s lien pursuant to Sec-
tions 27 and 31 of the Warehouse Receipts Law
(R.A. 2137)...

Considering that petitioner does not deny the exis-


tence, validity and genuineness of the Warehouse
Receipts on which it anchors its claim for payment
against private respondents, it cannot disclaim lia-
bility for the payment of the storage fees stipulated
therein. As contracts, the receipts must be res-
pected by authority of Article 1159 of the Civil
Code, to wit:
"ART. 1159. Obligations arising from contracts
have the force of law between the contracting par-
ties and should be complied with in good faith."

Petitioner is in estoppel in disclaiming liability for


the payment of storage fees due the private res-
pondents as warehouseman while claiming to be
entitled to the sugar stocks covered by the subject
Warehouse Receipts on the basis of which it anc-
hors its claim for payment or delivery of the sugar
stocks. The unconditional presentment of the re-
ceipts by the petitioner for payment against private
respondents on the strength of the provisions of
the Warehouse Receipts Law (R.A. 2137) carried
with it the admission of the existence and validity
of the terms, conditions and stipulations written on
the face of the Warehouse Receipts, including the
unqualified recognition of the payment of ware-
houseman's lien for storage fees and preservation
expenses. Petitioner may not now retrieve the sug-
302 1 Credit Transactions: Notes and Cases

ar stocks without paying the lien due private res-


pondents as warehouseman.

In view of the foregoing, the rule may be simplified


thus: While the PNB is entitled to the stocks of
sugar as the endorsee of the quedans, delivery to it
shall be effected only upon payment of the storage
fees.

Imperative is the right of the warehouseman to


demand payment of his lien at this juncture, be-
cause, in accordance with Section 29 of the Ware-
house Receipts Law, the warehouseman loses his
lien upon goods by surrendering possession the-
reof. In other words, the lien may be lost where the
warehouseman surrenders the possession of the
goods without requiring payment of his lien, be-
cause a warehouseman's lien is possessory in na-
ture.

We, therefore, uphold and sustain the validity of


the assailed orders of public respondent, dated De-
cember 20, 1994 and March 1, 1995... we fail to see
any taint of abuse of discretion on the part of the
public respondent in issuing the questioned orders
which recognized the legitimate right of Noah's
Ark, after being declared as warehouseman, to re-
cover storage fees before it would release to the
PNB sugar stocks covered by the five (5) Ware-
house Receipts. Our resolution, dated March 9,
1994, did not preclude private respondents' unqua-
lified right to establish its claim to recover storage
fees which is recognized under Republic Act No.
2137. Neither did the Court of Appeals' decision,
dated December 13, 1991, restrict such right.
Warehouse Receipts 1 303

Our Resolution's reference to the decision by the


Court of Appeals, dated December 13, 1991 ... was
intended to guide the parties in the subsequent
disposition of the case to its final end. We certainly
did not foreclose private respondents' inherent
right as warehouseman to collect storage fees and
preservation expenses as stipulated n the face of
each of the Warehouse Receipts and as provided
for in the Warehouse Receipts Law (R.A. 2137)...
Part III. Security Transactions

Chapter 1. The Concept of Security

A. General Concepts

A contract of security, or a security transaction1 , in the


context of credit transactions, is defined as the means by
which the parties to a principal obligation ensure its en-
forcement, protect an interest in property, or ensure that
the person to be made secure, or the secured creditor, can
be compensated for loss. 2 It is an accessory obligation
that mitigates the risk that the debtor will default on a
principal obligation.

Generally, therefore, a principal obligation the enforce-


ment of which is ensured by a contract of security is a se-
cured obligation, and one that is not, is an unsecured ob-
ligation.

1. Distinguished from Securities

Securities, in the context of the Securities Regulation


Code 3, are defined as follows:
R. A. No. 8799, Sec. 3.1. "Securities" are shares,
participation or interests in a corporation or in a
commercial enterprise or profit-making venture
and evidenced by a certificate, contract, instru-
ment, whether written or electronic in character.

1 Samo v. People of the Philippines, et al., G.R. No. L-17603-04, May 31, 1962,
5 SCRA 354, and Vintola & Vintola v. Insular Bank of Asia & America, G.R.
No. L-73271, May 29, 1987, 150 SCRA 578, which characterized a trust re-
ceipt as a security transaction.
2 Navoa & Navoa v. Court of Appeals, et al., G.R. No. 59255, December 29,
1995,251 SCRA 545.
3 R. A. No. 8799 (2000).

305
306 1 Credit Transactions: Notes and Cases

It includes:
(a)... bonds, debentures, notes, evidences of in-
debtedness, asset-backed securities...
As has been discussed 4, bonds, notes, and debentures are
evidences of indebtedness and are the common commer-
cial forms that contracts of loan take.5 In the context of
the Securities Regulation Code, therefore, theses contracts
of simple loan or mutuum, are securities, 6 whether they
are secured or unsecured.

2. Distinguished from Securitization

Securitization, on the other hand, is defined as the


process by which loans and other debts with an expected
cash payment stream (such as interest in the case of sim-
ple loans) are sold on a without recourse basis by a seller
to a special purpose entity (the issuer) which in turn is-
sues securities (such as a bond or other instrument) that
depend, for their repayment, on the expected cash pay-
ment stream. 7 To securitize, therefore, is to convert assets
(such as interest receivable from a simple loan) into secur-
ities for resale in the financial market, allowing the seller
to remove assets from its books, and thereby improve its
capital ratio and liquidity, and to make new loans with
the proceeds from the sale of the new security, if it so
chooses.8

4 See discussion on the obligation to pay in Part 1, Chapter 3B.


5 Constantino Jr., et al v. Cuisia, G.R. No. 106064, October 13, 2005, 472
SCRA 505.
6 The Securities Regulation Code, however, provides specific instances when
certain securities may be exempt from the registration requirements im-
posed by the Code.
7 R. A. No. 9267 (2004), The Securitization Act of 2004.
8 Blacks Law Dictionary, Ninth Edition (2009).
The Concept of Security 1 307

Securitization is a process of distributing the risk of de-


fault or non-payment of loans and other debts by aggre-
gating these debts and then issuing new securities backed
by the aggregated debt.9 The securities issued by the spe-
cial purpose entity (or issuer) are thus called asset-backed
securities. 10 The contracts of loan and the expected prin-
cipal and interest payments, which are sold by the origi-
nal creditors to a special purpose entity, are aggregated
into tranches based on risk, and packaged as new securi-
ties." The securities with higher risks provide higher
yields. Unlike a security transaction that mitigates risk,
the process of securitization distributes the risk of default
or non-payment to those willing to assume it.

B. Events of Default

The essential condition of a security transaction is that if


the principal obligation is duly complied with, then, pro-
ceeding from its accessory character, the security is auto-
matically extinguished. Otherwise stated, once the prin-
cipal obligation is complied with, the security transaction
becomes, ipsofacto, null and void. 12

If, however, the principal obligation becomes due and the


debtor defaults, the creditor may elect to bring an ordi-
nary action for specific performance of the principal obli-
gation or, as a secured creditor, elect to enforce the secu-
rity, in accordance with its terms.

9 Barron's Dictionary of Finance and Investment Terms, Fifth Edition (1998).


10 R. A. No. 9267 (2004).
11
Barron's Dictionary of Finance and Investment Terms, Fifth Edition (1998).
12 ACME Shoe, Rubber & Plastic Corporation & Chua Pac v. Court of Ap-
peals, et al., G.R. No. 103576, August 22,1996, 260 SCRA 714.
308 1 Credit Transactions: Notes and Cases

It is settled that enforcement of the security is proper in


case of mora solvendi (debtor's default), or in case of de-
lay in the fulfillment of the principal obligation by reason
of a cause imputable to the debtor. The three requisites
necessary for a finding of default are:

1. The principal obligation is demandable and liqui-


dated;

2. The debtor delays performance; and

3. The creditor judicially or extrajudicially requires the


13
debtor's performance.

However, in credit transactions, it is customary for the


parties to define other events of default in the contract for
the principal obligation, such as, but not limited to, failure
to submit required reports, maintain and file appropriate
tax returns, and maintain and preserve the security.

In any case, if any event of default shall occur and be con-


tinuing, then the creditor is given the right to declare, or
accelerate, all outstanding obligations as immediately due
and payable. This acceleration clause is valid and bind-
ing on the parties and the creditor is justified in invoking
it to declare the entire principal obligation immediately
14
due and payable, and to enforce the security.

13 Civil Code, Art. 1169. Selegna Management & Development Corporation,


et al. v. United Coconut Planters Bank, G.R. No. 165662, May 3, 2006, 489
SCRA 125.
14 Mendoza v. Court of Appeals, et al., G.R. No. 116216, June 20, 1997, 274
SCRA 527, and Selegna Management & Development Corporation, et al. v.
United Coconut Planters Bank, G.R. No. 165662, May 3, 2006, 489 SCRA
125.
The Concept of Security 1 309

C. Kinds of Security Transactions

1. Personal Security Transactions

A personal security transaction is a contractual obligation


for the repayment of a debt binding a person, as distin-
guished from property.' 5 It is an obligation of a person,
whether natural or juridical, other than the principal deb-
tor to ensure the fulfillment of a principal obligation.

In a contract of personal security, such as a guaranty, the


faithful performance of the obligation by the principal
debtor is secured by the personal commitment of anoth-
16
er.

2. Real Security Transactions

A real security transaction is an encumbrance of proper-


ty17 (the collateral) given to guarantee the fulfillment of
an obligation, especially the assurance that a creditor will
be repaid any money or credit extended to a debtor,
usually with interest.18

In a contract of real security, such as a mortgage (from the


Latin, dead security' 9), the creditor acquires a security in-
terest in the collateral for purposes of ensuring the ful-
fillment of the principal obligation. 20 A security interest is

15 Blacks Law Dictionary, Ninth Edition (2009).


16 ACME Shoe Rubber & Plastic Corporation & Chua Pac v. Court of Ap-
peals, et al., G.R. No. 103576, August 22, 1996, 260 SCRA 714.
17 Ibid.
18 Blacks Law Dictionary, Ninth Edition (2009).
19 Webster Third New International Dictionary (2002).
20 Samo v. People of the Philippines, et al., G.R. No. L-17603-04, May 31,1962,
5 SCRA 354, and Vintola & Vintola v. Insular Bank of Asia and America,
G.R. No. L-73271, May 29,1987,150 SCRA 578.
310 I Credit Transactions: Notes and Cases

a property interest created by agreement or by operation


of law to secure the performance of an obligation. 21 Spe-
cifically, it is:
a property interest in goods, documents or in-
struments to secure performance of an obligation
and includes title, whether or not expressed to be
absolute, whenever such title is in substance tak-
en or retained for security only.22

3. In the Context of Insolvency

The Financial Rehabilitation and Insolvency Act (FRIA)


of 201023, defines the condition of being insolvent as fol-
lows:
R.A. No. 10142, Sec. 4... (p) Insolvent shall refer
to the financial condition of a debtor that
is generally unable to pay its or his liabilities as
they fall due in the ordinary course of business or
has liabilities that are greater than its or his as-
sets.
(s) Liabilities shall refer to monetary claims
against the debtor...

And the FRIA classifies creditors as follows:


Sec. 4... (11) Secured party shall refer to a secured
creditor or the agent or representative of such se-
cured creditor.
(kk) Secured creditor shall refer to a creditor with
a secured claim.
(jj) Secured claim shall refer to a claim that is se-
cured by a lien.
21
Blacks Law Dictionary, Ninth Edition (2009).
22 P.D. No. 115 (1973), Sec. 3(h).
23 R. A. No. 10142 (2010), An Act Providing for Rehabilitation or Liquidation
of Financially Distressed Enterprises and Individuals, otherwise known as
the Financial Rehabilitation and Insolvency Act (FRIA) of 2010.
The Concept of Security I 311

(qq) Unsecured creditor shall refer to a creditor


with an unsecured claim.
(pp) Unsecured claim shall refer to a claim that is
not secured by a lien.
(t) Lien shall refer to a statutory or contractual
claim or judicial charge on real or personal prop-
erty that legally entitles a creditor to resort to said
property for payment of the claim or debt secured
by such lien.

In the context of insolvency, therefore, a secured creditor


is a creditor that has in its favor a real security
transaction, that is, a claim secured by a statutory, con-
tractual or judicial charge on real or personal property
(the collateral) that legally entitles a creditor to resort to
the property for payment of its claim. Creditors who only
have in their favor a personal security transaction are
unsecured creditors.
Chapter 2. Letters of Credit

A. General Concepts

Code of Commerce, Art. 567. Letters of credit are


those issued by one merchant to another, or for
the purpose of attending to a commercial transac-
tion.

Art. 568. The essential conditions of letters of cre-


dit shall be:
1. To be issued in favor of a determined person
and not to order.
2. To be limited to a fixed and specified amount,
or to one or more undetermined amounts, but all
within a maximum the limit of which must be
stated exactly.
Those which do not have one of these conditions
shall be considered as mere letters of recommen-
dation.

The Code of Commerce defines a letter of credit as an in-


strument issued by one merchant to another, or for at-
tending to a commercial transaction.

Transfield Philippines, Inc. v. Luzon Hydro Cor-


poration Australia, et al., G.R. No. 146717, No-
vember 22,2004,443 SCRA 307.

... The letter of credit evolved as a mercantile spe-


cialty, and the only way to understand all its facets
is to recognize that it is an entity unto itself. The re-
lationship between the beneficiary and the issuer of
a letter of credit is not strictly contractual, because
both privity and a meeting of the minds are lack-
ing, yet strict compliance with its terms is an enfor-
Letters of Credit 1 313

ceable right. Nor is it a third-party beneficiary con-


tract, because the issuer must honor drafts drawn
against a letter regardless of problems subsequent-
ly arising in the underlying contract. Since the
bank's customer cannot draw on the letter, it does
not function as an assignment by the customer to
the beneficiary. Nor, if properly used, is it a con-
tract of suretyship or guarantee, because it entails a
primary liability following a default. Finally, it is
not in itself a negotiable instrument, because it is
not payable to order or bearer and is generally
conditional, yet the draft presented under it is of-
ten negotiable.

A letter of credit is an instrument under which the issuer


(usually a bank), at a customer's request (the applicant),
agrees to honor a draft or other demand for payment
made by a third party (the beneficiary) as long as the
draft or demand complies with specified conditions, and
regardless of whether any underlying obligation between
the applicant and the beneficiary is satisfied.'

Clearly, a letter of credit is sue generis, but to understand it


as a security transaction, it is appropriately viewed as an
original undertaking by the issuer to substitute its finan-
cial strength for that of another (the applicant) with the
undertaking to be conditioned on the presentation of a
2
draft or a demand for payment (by the beneficiary).
With a letter of credit from an issuer, the applicant may
confidently present the letter of credit to the beneficiary as
security to convince the beneficiary to enter into a trans-
action. On the other hand, the beneficiary of the letter of

I Blacks Law Dictionary, Ninth Edition (2009).


2 Dolan. The Law of Letters of Credit 2-4,2nd Edition (1991).
314 I Credit Transactions: Notes and Cases

credit is assured of being empowered to call on the letter


of credit and obtain its proceeds as security in case the
applicant fails to perform its obligation.

Because it has evolved as a "mercantile specialty," "a ubi-


quitous and important device in international trade," and
as a "creation of commerce and businessmen," a letter of
credit is unique because of the number of parties involved
and its supranational character. Consequently, a letter of
credit changes its nature as different transactions occur. If
carried through to completion it ends up as a binding con-
tract between the issuing and honoring entities without
any regard or relation to the underlying obligation of the
3
parties.

Since letters of credit have gained general acceptability in


international trade transactions, observance of the Uni-
form Customs and Practice (UCP) for Documentary Cre-
dits is justified by Article 2 of the Code of Commerce 4:
Art. 2. Acts of commerce, whether those who ex-
ecute them be merchants or not, and whether spe-
cified in this Code or not,
should be governed by the provisions contained
in it, in their absence,
by the usages of commerce generally observed in
each place and in the absence of both rules,
by those of the civil law.
Those acts contained in this Code and all others
of analogous character shall be deemed acts of
commerce.

3 Transfield Philippines, Inc. v. Luzon Hydro Corporation Australia, et al.,


G.R No. 146717, November 22,2004,433 SCRA 307.
4 Bank of the Philippine Islands v. De Reny Fabric Industries, Inc., G.R. No.
L-24821, October 16, 1970, 35 SCRA 256 (see footnotes) and FEATI Bank &
Trust Company v. Court of Appeals & Villaluz, G.R. No. 94209, April 30,
1991,1% SCRA 576.
Letters of Credit 1 315

B. Kinds of Letters of Credit

1. Commercial Letters of Credit

In commercial transactions, a letter of credit (or commer-


cial letter of credit or commercial credit) is used as a me-
thod of payment in a contract of sale of goods, so that the
seller (the beneficiary) can obtain payment directly from
the issuer instead of from the buyer (the applicant and is-
suer's customer).5 It is a financial device developed by
merchants as a convenient and relatively safe mode of
dealing with the sale of goods to satisfy the seemingly "ir-
reconcilable interests" of a seller-beneficiary, who refuses
to part with its goods before it is paid, and a buyer-
applicant, who wants to have control of the goods before
paying.6 Thus, it serves to reduce the risk of nonpayment
of the purchase price under a contract of sale.

Because commercial credits involve the payment of mon-


ey under a contract of sale, they become payable upon the
presentation by the seller-beneficiary of documents that
show it has taken affirmative steps to comply with the
contract of sale. The seller-beneficiary of a commercial
credit must demonstrate by documents that it has per-
formed its obligations under the contract. 7

2. Standby Letters of Credit

In non-sale transactions, a letter of credit (or standby let-


ter of credit or standby credit) is used to guarantee, or
secure, either a monetary or a nonmonetary obligation,

5 Blacks Law Dictionary, Ninth Edition (2009).


6 Transfield Philippines, Inc. v. Luzon Hydro Corporation Australia, et a].,
G.R. No. 146717, November 22, 2004, 433 SCRA 307.
7 Ibid.
316 I Credit Transactions: Notes and Cases

whereby the issuer agrees to pay the creditor (the benefi-


ciary) if the debtor (the applicant or issuer's customer),
defaults on the obligation.8 It is used to reduce the risk of
nonperformance of a contractual obligation of the debtor-
applicant.

In a standby credit, the credit is payable upon certification


of the debtor-applicant's nonperformance of the obliga-
tion. The creditor-beneficiary of the standby credit must
certify that the debtor-applicant has not performed the
principal obligation. 9

C. Rule of Strict Compliance

Under the rule of strict compliance, the documents ten-


dered by the beneficiary must strictly conform to the
terms of the letter of credit. The tender of documents
must include all documents required by the letter. An
honoring entity that departs from what has been stipu-
lated under the letter of credit, as when it accepts a faulty
tender, acts on its own risk and may not thereafter recover
from the applicant or the issuer, as the case may be, the
money thus paid to the beneficiary. An honoring entity
deals only with documents, and it is not in a position to
determine whether or not the documents required by the
letter of credit are material or superfluous. The mere fact
that the document was specified therein readily means
that the document is of vital importance to the applicant.10

8
Blacks Law Dictionary, Ninth Edition (2009).
9 Transfield Philippines, Inc. v. Luzon Hydro Corporation Australia et al.,
G.R. No. 146717, November 22,2004.
10 FEATI Bank & Trust Company v. Court of Appeals & Villaluz, G.R No.
94209, April 30,1991,1% SCRA 576.
Letters of Credit 1 317

D. Independence Principle

The independence principle in letters of credit assures


the beneficiary of prompt payment independent of any
breach of the underlying or principal obligation and prec-
ludes the issuer from determining whether the underly-
ing or principal obligation is actually accomplished or
not. Under this principle, issuers assume no liability or
responsibility for the form, sufficiency, accuracy, ge-
nuineness, falsification or legal effect of any documents,
or for the general or particular conditions stipulated in the
documents or superimposed thereon, nor do they assume
any liability or responsibility for the description, quantity,
weight, quality, condition, packing, delivery, value or ex-
istence of the goods represented by any documents, or for
the good faith or acts or omissions, solvency, performance
or standing of the consignor, the carriers, or the insurers
of the goods, or any other person. In other words, the let-
ter of credit is separate and distinct from the underlying
or principal obligation. The settlement of a dispute be-
tween the parties is not a pre-requisite for the release of
funds under a letter of credit. If a letter of credit were
drawable only after settlement of the dispute on the un-
derlying or principal obligation entered into by the appli-
cant and the beneficiary, there would be no practical and
beneficial use for letters of credit in commercial transac-
tions."

The independence principle admits of an exception, re-


ferred to as the fraud exception rule. The untruthfulness
of a certificate accompanying a demand for payment un-
der a letter of credit may qualify as fraud, sufficient to

11 Ibid.
318 1 Credit Transactions: Notes and Cases

support an injunction against payment. However, injunc-


tion should not be granted unless:

1. There is clear proof of fraud;

2. The fraud constitutes fraudulent abuse of the inde-


pendent purpose of the letter of credit and not only fraud
under the underlying obligation; and

3. Irreparable injury might follow if injunction is not


granted or the recovery of damages would be seriously
12
affected.

12Ibid.
Chapter 3. Trust Receipts

A. General Concepts

P.D. No. 1151, Sec. 4. What constitutes a trust re-


ceipt transaction. - A trust receipt transaction,
within the meaning of this Decree, is any transac-
tion by and between a person referred to in this
Decree as the entruster, and
another person referred to in this Decree as en-
trustee,
whereby the entruster, who owns or holds abso-
lute title or security interests over certain speci-
fied goods, documents or instruments,
releases the same to the possession of the entrus-
tee
upon the latter's execution and delivery to the en-
truster of a signed document called a "trust re-
ceipt"
wherein the entrustee binds himself to hold the
designated goods, documents or instruments in
trust for the entruster and
to sell or otherwise dispose of the goods, docu-
ments or instruments
with the obligation to turn over to the entruster
the proceeds thereof to the extent of the amount
owing to the entruster or
as appears in the trust receipt or
the goods, documents or instruments themselves
if they are unsold or not otherwise disposed of,
in accordance with the terms and conditions spe-
cified in the trust receipt, or for other purposes
substantially equivalent to any of the following:
1. In the case of goods or documents,

1 P.D. No. 115 (1973), The Trust Receipts Law.


320 1 Credit Transactions: Notes and Cases

(a) to sell the goods or procure their sale; or


(b) to manufacture or process the goods with the
purpose of ultimate sale;
Provided, That, in the case of goods delivered
under trust receipt for the purpose of manufactur-
ing or processing before its ultimate sale, the en-
truster shall retain its title over the goods whether
in its original or processed form until the entrus-
tee has complied fully with his obligation under
the trust receipt; or
(c) to load, unload, ship or tranship or otherwise
deal with them in a manner preliminary or neces-
sary to their sale; or
2. In the case of instruments,
(a) to sell or procure their sale or exchange; or
(b) to deliver them to a principal; or
(c) to effect the consummation of some transac-
tions involving delivery to a depository or regis-
ter; or
(d) to effect their presentation, collection or re-
newal.
The sale of goods, documents or instruments by a
person in the business of selling goods, docu-
ments or instruments for profit who,
at the outset of the transaction,
has, as against the buyer, general property rights
in such goods, documents or instruments, or who
sells the same to the buyer on credit, retaining
title or other interest as security for the payment
of the purchase price,
does not constitute a trust receipt transaction and
is outside the purview and coverage of this De-
cree.

Sec. 3... (b) "Entrustee" shall refer to the person


having or taking possession of goods, documents
Trust Receipts I 321

or instruments under a trust receipt transaction,


and
any successor in interest of such person for the
purpose or purposes specified in the trust receipt
agreement.
(c) "Entruster" shall refer to the person holding
title over the goods, documents, or instruments
subject of a trust receipt transaction, and
any successor in interest of such person.
(a) "Document" shall mean written or printed
evidence of title to goods.
(d) "Goods" shall include chattels and personal
property other than: money, things in action, or
things so affixed to land as to become a part the-
reof.
(e) "Instrument" means any negotiable instru-
ment as defined in the Negotiable Instrument
Law;
any certificate of stock, or bond or debenture for
the payment of money issued by a public or pri-
vate corporation, or
any certificate of deposit, participation certificate
or receipt,
any credit or investment instrument of a sort
marketed in the ordinary course of business or
finance, whereby the entrustee, after the issuance
of the trust receipt, appears by virtue of posses-
sion and the face of the instrument to be the
owner.
"Instrument" shall not include a document as de-
fined in this Decree.
(f) "Purchase" means taking by sale, conditional
sale, lease, mortgage, or pledge, legal or equita-
ble.
(g) "Purchaser" means any person taking by pur-
chase.
322 1 Credit Transactions: Notes and Cases

(h) "Security Interest" means a property interest


in goods, documents or instruments to secure per-
formance of some obligations of the entrustee or
of some third persons to the entruster and in-
cludes title, whether or not expressed to be abso-
lute, whenever such title is in substance taken or
retained for security only.
(i) "Person" means, as the case may be, an indi-
vidual, trustee, receiver, or other fiduciary, part-
nership, corporation, business trust or other asso-
ciation, and two more persons having a joint or
common interest.
(k) "Value" means any consideration sufficient to
support a simple contract.

A trust receipt is a convenient business device that assists


importers and merchants in solving their financing prob-
lems, and has gained popular acceptance in international
and domestic business practices, particularly in commer-
cial banking transactions. 2

A trust receipt transaction is a real security transaction


where a person who owns or holds absolute title or secu-
rity interests over certain specified goods, documents or
instruments (the entruster) releases the same to the pos-
session of another person (the entrustee) who binds him-
self to hold the goods, documents or instruments in trust
for the entruster and to sell or otherwise dispose of the
goods, documents or instruments, with the obligation to
turn over to the entruster the proceeds thereof, to the ex-
tent of the amount owing to the entruster, or the goods,
documents or instruments themselves, if they are unsold
or not otherwise disposed of, in accordance with the
terms and conditions specified in the trust receipt.
2 P.D.No. 115 (1973), Whereas Clause.
Trust Receipts I 323

B. Form of Trust Receipts

Sec. 3... (j) "Trust Receipt" shall refer to the writ-


ten or printed document signed by the entrustee
in favor of the entruster containing terms and
conditions substantially complying with the pro-
visions of this Decree.
No further formality of execution or authentica-
tion shall be necessary to the validity of a trust
receipt.

Sec. 5. Form of trust receipts; contents. - A trust


receipt need not be in any particular form, but
every such receipt must substantially contain
(1) a description of the goods, documents or in-
struments subject of the trust receipt;
(2) the total invoice value of the goods and the
amount of the draft to be paid by the entrustee;
(3) an undertaking or a commitment of the en-
trustee
(a) to hold in trust for the entruster the goods,
documents or instruments therein described;
(b) to dispose of them in the manner provided for
in the trust receipt; and
(c) to turn over the proceeds of the sale of the
goods, documents or instruments to the entruster
to the extent of the amount owing to the entruster
or
as appears in the trust receipt or
to return the goods, documents or instruments in
the event of their non-sale within the period spe-
cified therein.
The trust receipt may contain other terms and
conditions agreed upon by the parties in addition
to those hereinabove enumerated provided that
such terms and conditions shall not be contrary to
324 1 Credit Transactions: Notes and Cases

the provisions of this Decree, any existing laws,


public policy or morals, public order or good cus-
toms.

Sec. 6. Currency in which a trust receipt may be


denominated. - A trust receipt may be denomi-
nated in
the Philippine currency or
any foreign currency acceptable and eligible as
part of international reserves of the Philippines,
the provisions of existing law, executive orders,
rules and regulations to the contrary notwith-
standing:
Provided, however, That in the case of trust re-
ceipts denominated in foreign currency, payment
shall be made in its equivalent in Philippine cur-
rency computed at the prevailing exchange rate
on the date the proceeds of sale of the goods,
documents or instruments held in trust by the en-
trustee are turned over to the entruster or on such
other date as may be stipulated in the trust receipt
or other agreements executed between the entrus-
ter and the entrustee.

A trust receipt is a formal contract because, although


the law states that a trust receipt need not be in any
particular form, the Trust Receipts Law requires that it
must be written or printed and must contain specific
terms. 3

3 Civil Code, Art. 1356. Contracts shall be obligatory, in whatever form they
may have been entered into, provided all the essential requisites for their
validity are presenL However, when the law requires that a contract be in
some form in order that it may be valid or enforceable, or that a contract be
proved in a certain way, that requirement is absolute and indispensable. In
such cases, the right of the parties stated in the following article cannot be
exercised.
Art 1357. If the law requires a document or other special form, as in the
Trust Receipts 1 325

C. Rights of Entruster

Sec. 7. Rights of the entruster. - The entruster


shall be entitled
to the proceeds from the sale of the goods, docu-
ments or instruments released under a trust re-
ceipt to the entrustee to the extent of the amount
owing to the entruster or as appears in the trust
receipt, or
to the return of the goods, documents or instru-
ments in case of non-sale, and
to the enforcement of all other rights conferred on
him in the trust receipt provided such are not con-
trary to the provisions of this Decree.
The entruster may cancel the trust and take pos-
session
of the goods, documents or instruments subject of
the trust or
of the proceeds realized therefrom
at any time upon default or failure of the entrus-
tee to comply with any of the terms and condi-
tions of the trust receipt or any other agreement
between the entruster and the entrustee, and
the entruster in possession of the goods, docu-
ments or instruments may, on or after default,
give notice to the entrustee of the intention to
sell, and may, not less than five days after serving
or sending of such notice, sell the goods, docu-
ments or instruments at public or private sale,
and the entruster may, at a public sale, become a
purchaser.
The proceeds of any such sale, whether public or

acts and contracts enumerated in the following article, the contracting par-
ties 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
326 1 Credit Transactions: Notes and Cases

private, shall be applied


(a) to the payment of the expenses thereof;
(b) to the payment of the expenses of re-taking,
keeping and storing the goods, documents or in-
struments;
(c) to the satisfaction of the entrustee's indebted-
ness to the entruster. The entrustee shall receive
any surplus but shall be liable to the entruster for
any deficiency. Notice of sale shall be deemed
sufficiently given if in writing, and either perso-
nally served on the entrustee or sent by post-paid
ordinary mail to the entrustee's last known busi-
ness address.

Sec. 8. Entruster not responsible on sale by en-


trustee. - The entruster holding a security inter-
est shall not,
merely by virtue of such interest or
having given the entrustee liberty of sale or other
disposition of the goods, documents or instru-
ments under the terms of the trust receipt transac-
tion
be responsible as principal or as vendor under
any sale or contract to sell made by the entrustee.

D. Obligations of Entrustee

Sec. 9. Obligations of the entrustee. - The en-


trustee shall
(1) hold the goods, documents or instruments in
trust for the entruster and shall dispose of them
strictly in accordance with the terms and condi-
tions of the trust receipt;
(2) receive the proceeds in trust for the entruster
and turn over the same to the entruster to the ex-
tent of the amount owing to the entruster or as
Trust Receipts 1327

appears on the trust receipt;


(3) insure the goods for their total value against
loss from fire, theft, pilferage or other casualties;
(4) keep said goods or proceeds thereof whether
in money or whatever form, separate and capable
of identification as property of the entruster;
(5) return the goods, documents or instruments in
the event of non-sale or upon demand of the en-
truster; and
(6) observe all other terms and conditions of the
trust receipt not contrary to the provisions of this
Decree.

Sec. 10. Liability of entrustee for loss. - The


risk of loss shall be borne by the entrustee.
Loss of goods, documents or instruments which
are the subject of a trust receipt, pending their
disposition, irrespective of whether or not it was
due to the fault or negligence of the entrustee,
shall not extinguish his obligation to the entrus-
ter for the value thereof.

Sec. 12. Validity of entruster's security interest


as against creditors. - The entruster's security in-
terest in goods, documents, or instruments pur-
suant to the written terms of a trust receipt shall
be valid as against all creditors of the entrustee
for the duration of the trust receipt agreement.

Sec. 13. Penalty clause. - The failure of an en-


trustee to turn over the proceeds of the sale of the
goods, documents or instruments covered by a
trust receipt
to the extent of the amount owing to the entruster
or as appears in the trust receipt or to return said
goods, documents or instruments if they were not
328 1 Credit Transactions: Notes and Cases

sold or disposed of in accordance with the terms


of the trust receipt
shall constitute the crime of estafa, punishable
under the provisions of Article Three hundred
and fifteen, paragraph one (b) of Act Numbered
Three thousand eight hundred and fifteen, as
amended, otherwise known as the Revised Penal
Code.
If the violation or offense is committed by a cor-
poration, partnership, association or other juridi-
cal entities, the penalty provided for in this De-
cree shall be imposed upon the directors, officers,
employees or other officials or persons therein
responsible for the offense, without prejudice to
the civil liabilities arising from the criminal of-
fense.

E. Rights of Purchaser

Sec. 11. Rights of purchaser for value and in


good faith. - Any purchaser
of goods from an entrustee with right to sell, or
of documents or instruments through their cus-
tomary form of transfer,
who buys the goods, documents, or instruments
for value and in good faith from the entrustee,
acquires said goods, documents or instruments
free from the entruster's security interest.

Colinares & Veloso v. Court of Appeals, G.R. No.


90828, September 5, 2000, 339 SCRA 609.

In 1979 Melvin Colinares and Lordino Veloso (he-


reafter Petitioners) were contracted for a considera-
tion of P-40,000 by the Carmelite Sisters of Cagayan
de Oro City to renovate the latter's convent at Ca-
Trust Receipts 1 329

maman-an, Cagayan de Oro City.


On 30 October 1979, Petitioners obtained 5,376 SF
Solatone acoustical board 2'x4'x×2", 300 SF tanguile
wood tiles 12"x12", 260 SF Marcelo economy tiles
and 2 gallons UMYLIN cement adhesive from CM
Builders Centre for the construction project. The
following day, 31 October 1979, Petitioners applied
for a commercial letter of credit with the Philippine
Banking Corporation, Cagayan de Oro City branch
(hereafter PBC) in favor of CM Builders Centre.
PBC approved the letter of credit for 1222,389.80 to
cover the full invoice value of the goods. Petition-
ers signed a pro-forma trust receipt as security. The
loan was due on 29 January 1980.

...On 7 May 1980, PBC wrote to Petitioners de-


manding that the amount be paid within seven
days from notice. Instead of complying with PBC's
demand, Veloso confessed that they lost P-19,195.83
in the Carmelite Monastery Project and requested
for a grace period of until 15 June 1980 to settle the
account.

PBC sent a new demand letter to Petitioners on 16


October 1980 and informed them that their out-
standing balance as of 17 November 1979 was
-P20,824.40 exclusive of attorney's fees of 25%.

On 2 December 1980, Petitioners proposed that the


terms of payment of the loan be modified as fol-
lows: 12,000 on or before 3 December 1980, and
1,000 per month starting 31 January 1980 until the
account is fully paid. Pending approval of the pro-
posal, Petitioners paid 121,000 to PBC on 4 Decem-
ber 1980, and thereafter 12500 on 11 February 1981,
330 1 Credit Transactions: Notes and Cases

16 March 1981, and 20 April 1981. Concurrently


with the separate demand for attorney's fees by
PBC's legal counsel, PBC continued to demand
payment of the balance.

On 14 January 1983, Petitioners were charged with


the violation of P.D. No. 115 (Trust Receipts Law)
in relation to Article 315 of the Revised Penal Code
in an Information which was filed with Branch 18,
Regional Trial Court of Cagayan de Oro City...
During trial, petitioner Veloso insisted that the
transaction was a "clean loan" as per verbal guar-
antee of Cayo Garcia Tuiza, PBC's former manag-
er. He and petitioner Colinares signed the docu-
ments without reading the fine print, only learning
of the trust receipt implication much later. When
he brought this to the attention of PBC, Mr. Tuiza
assured him that the trust receipt was a mere for-
mality.

On 7 July 1986, the trial court promulgated its deci-


sion convicting Petitioners of estafa for violating
P.D. No. 115 in relation to Article 315 of the Re-
vised Penal Code... The trial court considered the
transaction between PBC and Petitioners as a trust
receipt transaction under Section 4, P.D. No. 115. It
considered Petitioners' use of the goods in their
Carmelite monastery project an act of "disposing"
as contemplated under Section 13, P.D. No. 115,
and treated the charge invoice for goods issued by
CM Builders Centre as a "document" within the
meaning of Section 3 thereof. It concluded that the
failure of Petitioners to turn over the amount they
owed to PBC constituted estafa.
Trust Receipts 1 331

Petitioners appealed from the judgment to the


Court of Appeals... In its decision 6 March 1989,
the Court of Appeals modified the judgment of the
trial court by increasing the penalty... On 25
March 1989, Petitioners filed a Motion for New
Trial/Reconsideration alleging that the "Disclosure
Statement on Loan/Credit Transaction" (hereafter
Disclosure Statement) signed by them and Tuiza
was suppressed by PBC during the trial. That doc-
ument would have proved that the transaction was
indeed a loan as it bears a 14% interest as opposed
to the trust receipt which does not at all bear any
interest. Petitioners further maintained that when
PBC allowed them to pay in installment, the
agreement was novated and a creditor-debtor rela-
tionship was created.

In its resolution of 16 October 1989 the Court of


Appeals denied the Motion for New Tri-
al/Reconsideration because the alleged newly dis-
covered evidence was actually forgotten evidence
already in existence during the trial, and would not
alter the result of the case.

Hence, Petitioners fied with us the petition in this


case... The core issues raised in the petition are the
denial by the Court of Appeals of Petitioners' Mo-
tion for New Trial and the true nature of the con-
tract between Petitioners and the PBC. As to the
latter, Petitioners assert that it was an ordinary
loan, not a trust receipt agreement under the Trust
Receipts Law...

Section 4, P.D. No. 115, the Trust Receipts Law, de-


fines a trust receipt transaction... There are two
332 I Credit Transactions: Notes and Cases

possible situations in a trust receipt transaction.


The first is covered by the provision which refers to
money received under the obligation involving the
duty to deliver it (entregarla) to the owner of the
merchandise sold. The second is covered by the
provision which refers to merchandise received
under the obligation to "return" it (devolvera) to
the owner.

Failure of the entrustee to turn over the proceeds of


the sale of the goods, covered by the trust receipt to
the entruster or to return said goods if they were
not disposed of in accordance with the terms of the
trust receipt shall be punishable as estafa under Ar-
ticle 315 (1) of the Revised Penal Code, without
need of proving intent to defraud.

A thorough examination of the facts obtaining in


the case at bar reveals that the transaction intended
by the parties was a simple loan, not a trust receipt
agreement.

Petitioners received the merchandise from CM


Builders Centre on 30 October 1979. On that day,
ownership over the merchandise was already
transferred to Petitioners who were to use the ma-
terials for their construction project. It was only a
day later, 31 October 1979, that they went to the
bank to apply for a loan to pay for the merchan-
dise.
This situation belies what normally obtains in a
pure trust receipt transaction where goods are
owned by the bank and only released to the impor-
ter in trust subsequent to the grant of the loan. The
bank acquires a "security interest" in the goods as
Trust Receipts I 333

holder of a security title for the advances it had


made to the entrustee. The ownership of the mer-
chandise continues to be vested in the person who
had advanced payment until he has been paid in
full, or if the merchandise has already been sold,
the proceeds of the sale should be turned over to
him by the importer or by his representative or
successor in interest. To secure that the bank shall
be paid, it takes full title to the goods at the very
beginning and continues to hold that title as his in-
dispensable security until the goods are sold and
the vendee is called upon to pay for them; hence,
the importer has never owned the goods and is not
able to deliver possession. In a certain manner,
trust receipts partake of the nature of a conditional
sale where the importer becomes absolute owner of
the imported merchandise as soon as he has paid
its price.

Trust receipt transactions are intended to aid in fi-


nancing importers and retail dealers who do not
have sufficient funds or resources to finance the
importation or purchase of merchandise, and who
may not be able to acquire credit except through
utilization, as collateral, of the merchandise im-
ported or purchased.

The antecedent acts in a trust receipt transaction


consist of the application and approval of the letter
of credit, the making of the marginal deposit and
the effective importation of goods through the ef-
forts of the importer.
PBC attempted to cover up the true delivery date
of the merchandise, yet the trial court took notice
even though it failed to attach any significance to
334 1 Credit Transactions: Notes and Cases

such fact in the judgment. Despite the Court of


Appeals' contrary view that the goods were deli-
vered to Petitioners previous to the execution of
the letter of credit and trust receipt, we find that
the records of the case speak volubly and this fact
remains uncontroverted. It is not uncommon for us
to peruse through the transcript of the stenograph-
ic notes of the proceedings to be satisfied that the
records of the case do support the conclusions of
the trial court... The Trust Receipts Law does not
seek to enforce payment of the loan, rather it pu-
nishes the dishonesty and abuse of confidence in
the handling of money or goods to the prejudice of
another regardless of whether the latter is the own-
er. Here, it is crystal clear that on the part of Peti-
tioners there was neither dishonesty nor abuse of
confidence in the handling of money to the preju-
dice of PBC. Petitioners continually endeavored to
meet their obligations, as shown by several receipts
issued by PBC acknowledging payment of the
loan.

The Information charges Petitioners with intent to


defraud and misappropriating the money for their
personal use. The mala prohibita nature of the al-
leged offense notwithstanding, intent as a state of
mind was not proved to be present in Petitioners'
situation. Petitioners employed no artifice in deal-
ing with PBC and never did they evade payment of
their obligation nor attempt to abscond. Instead,
Petitioners sought favorable terms precisely to
meet their obligation.
Also noteworthy is the fact that Petitioners are not
importers acquiring the goods for re-sale, contrary
to the express provision embodied in the trust re-
Trust Receipts 1 335

ceipt. They are contractors who obtained the fung-


ible goods for their construction project. At no time
did title over the construction materials pass to the
bank, but directly to the Petitioners from CM
Builders Centre. This impresses upon the trust re-
ceipt in question vagueness and ambiguity, which
should not be the basis for criminal prosecution in
the event of violation of its provisions.

The practice of banks of making borrowers sign


trust receipts to facilitate collection of loans and
place them under the threats of criminal prosecu-
tion should they be unable to pay it may be unjust
and inequitable, if not reprehensible. Such agree-
ments are contracts of adhesion which borrowers
have no option but to sign lest their loan be disap-
proved. The resort to this scheme leaves poor and
hapless borrowers at the mercy of banks, and is
prone to misinterpretation, as had happened in this
case. Eventually, PBC showed its true colors and
admitted that it was only after collection of the
money, as manifested by its Affidavit of Desis-
tance.

WHEREFORE, the challenged Decision of 6 March


1989 and the Resolution of 16 October 1989 of the
Court of Appeals in CA-GR. No. 05408 are RE-
VERSED and SET ASIDE. Petitioners are hereby
ACQUITTED of the crime charged, i.e., for viola-
tion of P.D. No. 115 in relation to Article 315 of the
Revised Penal Code. No costs.
Chapter 4. Guaranty

A. General Concepts

Art. 2047. By guaranty a person, called the gua-


rantor, binds himself to the creditor to fulfill the
obligation of the principal debtor in case the lat-
ter should fail to do so.
If a person binds himself solidarily with the
principal debtor, the provisions of Section 4,
Chapter 3, Title I of this Book shall be observed.
In such case the contract is called a suretyship.

Art. 2048. A guaranty is gratuitous, unless there is


a stipulation to the contrary.

Art. 2051. A guaranty may be


conventional, legal or judicial,
gratuitous, or by onerous title.
It may also be constituted, not only in favor of the
principal debtor, but also in favor of the other
guarantor, with the latter's consent, or without
his knowledge, or even over his objection.

A guaranty is a promise to answer for the payment of


some debt or the performance of some duty, in case of the
failure of another who is liable in the first instance.' It is a
personal security transaction that involves the condi-
tional obligation of a person (the guarantor) to fulfill a
principal obligation in favor of a creditor, in case the deb-
tor fails to do so.

1 Blacks Law Dictionary, Ninth Edition (2009).


Guaranty 337

The obligations of the guarantor always arise 2 as a conse-


quence of contract, whether the guaranty is conventional,
legal, or judicial.

B. Form of Guaranty

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 compromise
not only the principal obligation, but also all its
accessories,
including the judicial costs, provided with re-
spect to the latter, that the guarantor shall only be
liable for those costs incurred after he has been
judicially required to pay.

The obligation of the guarantor must be express and not


presumed and it cannot extend to more than what is sti-
pulated. The limits of the obligations of a guarantor must
therefore be determined from the terms of the guaranty
itself since the obligations of a guarantor cannot extend by
presumption beyond what is stipulated.

A guaranty that extends to the principal obligation as well


as accessories and judicial costs is a simple or indefinite
guaranty. A guaranty that extends only to a specified
amount is a definite guaranty. However, if the guaranty
specifies a fixed amount but nevertheless also provides
for liability for interest and expenses, the guarantor will
be liable for the latter amounts even if these exceed the
3
specified fixed amount.

2 Civil Code, Art 1157. Obligations arise from: (1) Law; (2) Contracts; (3)
Quasi-contracts; (4) Acts or omissions punished by law; and (5) Quasi-
delicts.
3 Dino & Uy v. Court of Appeals & Metropolitan Bank & Trust Company,
G.R. No. 89775, November 26,1992,216 SCRA 9.
338 I Credit Transactions: Notes and Cases

By definition, a guaranty constitutes


(b) A special promise to answer for the debt, de-
4
fault, or miscarriage of another;
hence, it is
unenforceable by action, unless the same, or
some note or memorandum, thereof, be in writ-
ing, and subscribed by the party charged, or by
his agent; evidence, therefore, of the agreement
cannot be received without the writing, or a sec-
ondary evidence of its contents.5

C. Obligations Secured

Art. 2052. A guaranty cannot exist without a valid


obligation.
Nevertheless, a guaranty may be constituted to
guarantee the performance of a voidable or an
unenforceable contract. It may also guarantee a
natural obligation.

Art. 2053... A conditional obligation may also be


secured.

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 ob-
ligations shall be reduced to the limits of that of
the debtor.

Art. 2053. A guaranty may also be given as securi-


ty for future debts, the amount of which is not yet

4 Civil Code, Art 1403.


5 Ibid.
GuarantyI 339

known; there can be no claim against the guaran-


tor until the debt is liquidated...

As an accessory obligation, a guaranty cannot exist if the


principal obligation is void. It depends for its validity on
a valid principal obligation, even if the latter is voidable,
unenforceable or a natural obligation or if it is a condi-
tional obligation.

As an accessory obligation, the obligations of the guaran-


tor cannot be more onerous, in terms of amount and con-
ditions, than the obligations of the principal debtor, al-
though they may be less. The law allows the reduction of
the obligations of the guarantor in the event that he binds
himself for more than the principal obligation.

A guaranty may be given to secure future debts, the


amount of which may not be known at the time the gua-
ranty is executed, provided the same are eventually liqui-
dated. Article 2053 is the basis for contracts denominated
as a continuing guaranty, a type of guaranty that governs
a course of dealing for an indefinite time or by a succes-
sion of credits. 6 A continuing guaranty is not limited to a
single transaction but contemplates a prospective or fu-
ture course of dealing, covering a series of transactions,
which are within the stipulations of the contract of gua-
ranty, until the expiration or termination thereof. It ap-
plies to a succession of liabilities, for which the guarantor
becomes liable as they accrue. The object of a continuing
guaranty is to grant to the principal debtor a standing
credit to be used from time to time either indefinitely or
until a certain period. The use of the phrases "any debt,"
"any indebtedness," "any sum," "any transaction," or

6 Blacks Law Dictionary, Ninth Edition (2009).


340 1 Credit Transactions: Notes and Cases

money to be furnished the principal debtor "from time to


time," "at any time," or "on such time" that the principal
debtor may require, have been construed to indicate a
7
continuing guaranty.

D. Parties to a Guaranty

Art. 2056. One who is obliged to furnish a guaran-


tor shall present a person who possesses integri-
ty, capacity to bind himself, and sufficient prop-
erty to answer for the obligation which he guar-
antees. The guarantor shall be subject to the ju-
risdiction of the court of the place where this ob-
ligation 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 de-
mand another who has all the qualifications re-
quired in the preceding article. The case is ex-
cepted where the creditor has required and stipu-
lated that a specified person should be the gua-
rantor.

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. 2064. The guarantor of a guarantor shall en-


joy the benefit of excussion, both with respect to
the guarantor and to the principal debtor.

7 Dino & Uy v. Court of Appeals & Metropolitan Bank & Trust Company,
G.R. No. 89775, November 26,1992,216 SCRA 9.
Guaranty 341

Art. 2065. Should there be several guarantors of


only one debtor and for the same debt, the obliga-
tion to answer for the same is divided among all...

Generally, there are at least three parties to a guaranty8 :

1. The creditor,

2. The debtor of the principal obligation, and

3. The guarantor.

A sub-guarantor is a guarantor of a guarantor. A co-


guarantor is one of several guarantors of only one debtor
for the same debt.

The law imposes the following qualifications for a gua-


rantor:

1. A guarantor must possess integrity, capacity to con-


tract and sufficient property for the guaranteed obliga-
tion. Loss of these qualifications gives the creditor the
right to demand a new guarantor unless the creditor had
stipulated a specified person to act as guarantor.
2. A married woman requires the consent of her husband
to bind conjugal property.

E. Benefit of Excussion

Art. 2062. In every action by the creditor,


which must be against the principal debtor alone,
except in the cases mentioned in Article 2059,

8
Escano &Silos v. Ortigas, Jr., G. R. No. 151953, June 29,2007,526 SCRA 26.
342 1 Credit Transactions: Notes and Cases

the former shall ask the court to notify the gua-


rantor of the action.
The guarantor may appear so that he may, if he so
desire, set up such defenses as are granted him by
law. The benefit of excussion mentioned in Ar-
ticle 2058 shall always be unimpaired, even if
judgment should be rendered against the prin-
cipal debtor and the guarantor in case of appear-
ance by the latter.

Art. 2058. The guarantor cannot be compelled to


pay the creditor unless
the latter has exhausted all the property of the
debtor, and
has resorted to all the legal remedies against the
debtor.

Art. 2059. The 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.

Art. 2060. In order that the guarantor may make


use of the benefit of exclusion, he must
set it up against the creditor upon the latter's de-
mand 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.
Guaranty 1343

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.

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.

Art. 2064. The guarantor of a guarantor shall en-


joy the benefit of excussion, both with respect to
the guarantor and to the principal debtor.

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 personal to the debtor.

The benefit of excussion (or exhaustion or exclusion) is


the right of the guarantor to demand that the creditor
first:

1. Exhaust all of the properties of the principal debtor,


and

2. Resort to all legal remedies against the principal


debtor,

before the guarantor is liable to fulfill the obligation of the


principal debtor. It is the distinguishing element of a gua-
ranty.
344 1 Credit Transactions: Notes and Cases

For the creditor to enforce a guaranty:

1. The creditor must bring an action against the principal


debtor alone (except in the cases mentioned in Article
2059).

2. The creditor shall ask the court to notify the guarantor


of the action.

3. The guarantor may appear so that it may, if it so de-


sires, set up such defenses as are granted by law. The
benefit of excussion shall always be unimpaired, even if
judgment should be rendered against the principal debtor
and the guarantor in case of appearance by the latter.

4. In order that the guarantor may make use of the bene-


fit of excussion, it must:

a. Set it up against the creditor upon demand for pay-


ment, and

b. Point out to the creditor available property of the deb-


tor within Philippine territory, sufficient to cover the
amount of the debt.

Tupaz IV & Tupaz v. Court of Appeals & Bank of


the Philippine Islands, G.R. No. 145578, Novem-
ber 18, 2005, 475 SCRA 398.

... Petitioners Jose C. Tupaz IV and Petronila C.


Tupaz ("petitioners") were Vice-President for Op-
erations and Vice-President/Treasurer, respective-
ly, of El Oro Engraver Corporation ("El Oro Corpo-
ration"). El Oro Corporation had a contract with
Guaranty 345

the Philippine Army to supply the latter with "sur-


vival bolos."

To finance the purchase of the raw materials for the


survival bolos, petitioners, on behalf of El Oro
Corporation, applied with respondent Bank of the
Philippine Islands ("respondent bank") for two
commercial letters of credit. The letters of credit
were in favor of El Oro Corporation's suppliers,
Tanchaoco Manufacturing Incorporated ("Tan-
chaoco Incorporated") and Maresco Rubber and
Retreading Corporation ("Maresco Corporation").
Respondent bank granted petitioners' application
and issued Letter of Credit No. 2-00896-3 for
.P564,871.05 to Tanchaoco Incorporated and Letter
of Credit No. 2-00914-5 for P294,000 to Maresco
Corporation.

Simultaneous with the issuance of the letters of


credit, petitioners signed trust receipts in favor of
respondent bank. On 30 September 1981, petitioner
Jose C. Tupaz IV ("petitioner Jose Tupaz") signed,
in his personal capacity, a trust receipt correspond-
ing to Letter of Credit No. 2-00896-3 (for
P564,871.05). Petitioner Jose Tupaz bound himself
to sell the goods covered by the letter of credit and
to remit the proceeds to respondent bank, if sold,
or to return the goods, if not sold, on or before 29
December 1981.

On 9 October 1981, petitioners signed, in their ca-


pacities as officers of El Oro Corporation, a trust
receipt corresponding to Letter of Credit No. 2-
00914-5 (for P294,000). Petitioners bound them-
selves to sell the goods covered by that letter of
346 1 Credit Transactions: Notes and Cases

credit and to remit the proceeds to respondent


bank, if sold, or to return the goods, if not sold, on
or before 8 December 1981... Petitioners did not
comply with their undertaking under the trust re-
ceipts... On 27 June 1983 and 28 June 1983, respon-
dent bank's counsel and its representative respec-
tively sent final demand letters to El Oro Corpora-
tion. El Oro Corporation replied that it could not
fully pay its debt because the Armed Forces of the
Philippines had delayed paying for the survival
bolos.

Respondent bank charged petitioners with estafa


under Section 13, Presidential Decree No. 115... Af-
ter preliminary investigation, the then Makati Fis-
cal's Office found probable cause to indict petition-
ers... Petitioners pleaded not guilty to the charges
and trial ensued. During the trial, respondent bank
presented evidence on the civil aspect of the cases...
On 16 July 1992, the trial court rendered judgment
acquitting petitioners of estafa on reasonable
doubt. However, the trial court found petitioners
solidarily liable with El Oro Corporation for the
balance of El Oro Corporation's principal debt un-
der the trust receipts... Petitioners appealed to the
Court of Appeals. Petitioners contended that (1)
their acquittal "operates to extinguish [their] civil
liability" and (2) at any rate, they are not personally
liable for El Oro Corporation's debts... In its Deci-
sion of 7 September 2000, the Court of Appeals af-
firmed the trial court's ruling. The appellate court
held:
It is dear from [Section 13, PD 115] that civil liabili-
ty arising from the violation of the trust receipt
agreement is distinct from the criminal liability
Guaranty I 347

imposed therein. In the case of Vintola v. Insular


Bank of Asia and America9, our Supreme Court held
that acquittal in the estafa case (P.D. 115) is no bar
to the institution of a civil action for collection.
This is because in such cases, the civil liability of
the accused does not arise ex delicto but rather
based ex contractu and as such is distinct and inde-
pendent from any criminal proceedings and may
proceed regardless of the result of the latter. Thus,
an independent civil action to enforce the civil lia-
bility may be filed against the corporation aside
from the criminal action against the responsible of-
ficers or employees... Appellants argued that they
cannot be held solidarily liable with their corpora-
tion, El Oro Engraver Corporation, alleging that
they executed the subject documents including the
trust receipt agreements only in their capacity as
such corporate officers. They said that these in-
struments are mere pro-forma and that they ex-
ecuted these instruments on the strength of a board
resolution of said corporation authorizing them to
apply for the opening of a letter of credit in favor of
their suppliers as well as to execute the other doc-
uments necessary to accomplish the same.
Such contention, however, is contradicted by the
evidence on record. The trust receipt agreement
indicated in clear and unmistakable terms that the
accused signed the same as surety for the corpora-
tion and that they bound themselves directly and
immediately liable in the event of default with re-
spect to the obligation under the letters of credit
which were made part of the said agreement,
without need of demand. Even in the application

9 G.R. No. L-73271, May 29,1987,150 SCRA 578.


348 1 Credit Transactions: Notes and Cases

for the letter of credit, it is likewise clear that the


undertaking of the accused is that of a surety as in-
dicated [in] the following words: "In consideration
of your establishing the commercial letter of credit
herein applied for substantially in accordance with
the foregoing, the undersigned Applicant and Su-
rety hereby agree, jointly and severally, to each and
all stipulations, provisions and conditions on the
reverse side hereof." ...Having contractually
agreed to hold themselves solidarily liable with El
Oro Engraver Corporation under the subject trust
receipt agreements with appellee Bank of the Phi-
lippine Islands, herein accused-appellants may not,
therefore, invoke the separate legal personality of
the said corporation to evade their civil liability
under the letter of credit-trust receipt arrangement
with said appellee, notwithstanding their acquittal
in the criminal cases filed against them. The trial
court thus did not err in holding the appellants so-
lidarily liable with El Oro Engraver Corporation...

Hence, this petition...


(1) Whether petitioners bound themselves perso-
nally liable for El Oro Corporation's debts under
the trust receipts;
(2) If so -
(a) whether petitioners' liability is solidary with El
Oro Corporation; and
(b) whether petitioners' acquittal of estafa under
Section 13, PD 115 extinguished their civil liabili-
ty... The petition is partly meritorious. We affirm
the Court of Appeals' ruling with the modification
that petitioner Jose Tupaz is liable as guarantor of
El Oro Corporation's debt under the trust receipt
dated 30 September 1981.
Guaranty 1 349

A corporation, being a juridical entity, may act


only through its directors, officers, and employees.
Debts incurred by these individuals, acting as such
corporate agents, are not theirs but the direct liabil-
ity of the corporation they represent. As an excep-
tion, directors or officers are personally liable for
the corporation's debts only if they so contractually
agree or stipulate.

Here, the dorsal side of the trust receipts contains


the following stipulation:
To the Bank of the Philippine Islands
In consideration of your releasing to ... under the
terms of this Trust Receipt the goods described
herein, I/We, jointly and severally, agree and
promise to pay to you, on demand, whatever sum
or sums of money which you may call upon me/us
to pay to you, arising out of, pertaining to, and/or
in any way connected with, this Trust Receipt, in
the event of default and/or non-fulfillment in any
respect of this undertaking on the part of the said
... I/we further agree that my/our liability in this
guarantee shall be DIRECT AND IMMEDIATE,
without any need whatsoever on your part to take
any steps or exhaust any legal remedies that you
may have against the said ... before making de-
mand upon me/us.

In the trust receipt dated 9 October 1981, petition-


ers signed below this clause as officers of El Oro
Corporation. Thus, under petitioner Petronila Tu-
paz's signature are the words "Vice-Pres-
Treasurer" and under petitioner Jose Tupaz's sig-
nature are the words "Vice-Pres-Operations." By
so signing that trust receipt, petitioners did not
350 1 Credit Transactions: Notes and Cases

bind themselves personally liable for El Oro Cor-


poration's obligation. In Ong v. Court of Appeals'O, a
corporate representative signed a solidary guaran-
tee clause in two trust receipts in his capacity as
corporate representative. There, the Court held
that the corporate representative did not undertake
to guarantee personally the payment of the corpo-
ration's debts, thus:
[P]etitioner did not sign in his personal capacity
the solidary guarantee clause found on the dorsal
portion of the trust receipts. Petitioner placed his
signature after the typewritten words "ARMCO
INDUSTRIAL CORPORATION" found at the end
of the solidary guarantee clause. Evidently, peti-
tioner did not undertake to guaranty personally
the payment of the principal and interest of AR-
MAGRI's debt under the two trust receipts.

Hence, for the trust receipt dated 9 October 1981,


we sustain petitioners' claim that they are not per-
sonally liable for El Oro Corporation's obligation.

For the trust receipt dated 30 September 1981, the


dorsal portion of which petitioner Jose Tupaz
signed alone, we find that he did so in his personal
capacity. Petitioner Jose Tupaz did not indicate
that he was signing as El Oro Corporation's Vice-
President for Operations. Hence, petitioner Jose
Tupaz bound himself personally liable for El Oro
Corporation's debts. Not being a party to the trust
receipt dated 30 September 1981, petitioner Petro-
nila Tupaz is not liable under such trust receipt...
As stated, the dorsal side of the trust receipt dated

10 G.R. No. 119858, April 29,2003,449 Phil 691.


Guaranty 1 351

30 September 1981 provides... The lower courts in-


terpreted this to mean that petitioner Jose Tupaz
bound himself solidarily liable with El Oro Corpo-
ration for the latter's debt under that trust receipt.

This is error.

In PrudentialBank v. Intermediate Appellate Court",


the Court interpreted a substantially identical
clause in a trust receipt signed by a corporate offic-
er who bound himself personally liable for the cor-
poration's obligation. The petitioner in that case
contended that the stipulation "we jointly and sev-
erally agree and undertake" rendered the corporate
officer solidarily liable with the corporation. We
dismissed this claim and held the corporate officer
liable as guarantor only. The Court further ruled
that had there been more than one signatories to
the trust receipt, the solidary liability would exist
between the guarantors. We held:
Petitioner [Prudential Bank] insists that by virtue
of the clear wording of the ... clause "... we jointly
and severally agree and undertake ..." and the con-
cluding sentence on exhaustion, [respondent] Chi's
liability therein is solidarity...
Our ... reading of the questioned solidary guaranty
clause yields no other conclusion than that the ob-
ligation of Chi is only that of a guarantor. This is
further bolstered by the last sentence which speaks
of waiver of exhaustion, which, nevertheless, is in-
effective in this case because the space therein for
the party whose property may not be exhausted
was not filled up. Under Article 2058 of the Civil

IIG.R. No. 74886, December 8,1992, 216 SCRA 257.


352 1 Credit Transactions: Notes and Cases

Code, the defense of exhaustion (excussion) may be


raised by a guarantor before he may be held liable
for the obligation. Petitioner likewise admits that
the questioned provision is a solidary guaranty
clause, thereby clearly distinguishing it from a con-
tract of surety. It, however, described the guaranty
as solidary between the guarantors; this would
have been correct if two (2) guarantors had signed
it. The clause "we jointly and severally agree and
undertake" refers to the undertaking of the two (2)
parties who are to sign it or to the liability existing
between themselves. It does not refer to the under-
taking between either one or both of them on the
one hand and the petitioner on the other with re-
spect to the liability described under the trust re-
ceipt... Furthermore, any doubt as to the import or
true intent of the solidary guaranty clause should
be resolved against the petitioner. The trust receipt,
together with the questioned solidary guaranty
clause, is on a form drafted and prepared solely by
the petitioner; Chi's participation therein is limited
to the affixing of his signature thereon. It is, there-
fore, a contract of adhesion; as such, it must be
strictly construed against the party responsible for
its preparation.

However, respondent bank's suit against petitioner


Jose Tupaz stands despite the Court's finding that
he is liable as guarantor only. First, excussion is not
a pre-requisite to secure judgment against a gua-
rantor. The guarantor can still demand deferment
of the execution of the judgment against him until
after the assets of the principal debtor shall have
been exhausted. Second, the benefit of excussion
may be waived. Under the trust receipt dated 30
Guaranty 1353

September 1981, petitioner Jose Tupaz waived ex-


cussion when he agreed that his "liability in [the]
guaranty shall be DIRECT AND IMMEDIATE,
without any need whatsoever on ... [the] part [of
respondent bank] to take any steps or exhaust any
legal remedies..." The clear import of this stipula-
tion is that petitioner Jose Tupaz waived the bene-
fit of excussion under his guarantee.

As guarantor, petitioner Jose Tupaz is liable for El


Oro Corporation's principal debt and other acces-
sory liabilities (as stipulated in the trust receipt and
as provided by law) under the trust receipt dated
30 September 1981. That trust receipt (and the trust
receipt dated 9 October 1981) provided for pay-
ment of attorney's fees equivalent to 10% of the to-
tal amount due and an "interest at the rate of 7%
per annum, or at such other rate as the bank may
fix, from the date due until paid..." In the applica-
tions for the letters of credit, the parties stipulated
that drafts drawn under the letters of credit are
subject to interest at the rate of 18% per annum.

The lower courts correctly applied the 18% interest


rate per annum considering that the face value of
each of the trust receipts is based on the drafts
drawn under the letters of credit. Based on the
guidelines laid down in Eastern Shipping Lines, Inc.
v. Court of Appeals12, the accrued stipulated interest
earns 12% interest per annum from the time of the
filing of the Informations in the Makati Regional
Trial Court on 17 January 1984. Further, the total
amount due as of the date of the finality of this De-
cision will earn interest at 18% per annum until fully
2G.R. No. 97412, July 12,1994, 234 SCRA 78.
354 1 Credit Transactions: Notes and Cases

paid since this was the stipulated rate in the appli-


cations for the letters of credit.

The accounting of El Oro Corporation's debts as of


23 January 1992, which the trial court used, is no
longer useful as it does not specify the amounts
owing under each of the trust receipts. Hence, in
the execution of this Decision, the trial court shall
compute El Oro Corporation's total liability under
each of the trust receipts dated 30 September 1981
and 9 October 1981 based on the following formu-
la:
TOTAL AMOUNT DUE = [principal + interest +
interest on interest] - partial payments made
Interest = principal x 18 % per annum x no. of
years from due date until finality of judgment
Interest on interest = interest computed as of the
filing of the complaint (17 January 1984) x 12% x
no. of years until finality of judgment
Attorney's fees is 10% of the total amount com-
puted as of finality of judgment
Total amount due as of the date of finality of
judgment will earn an interest of 18% per annum
until fully paid.

In so delegating this task, we reiterate what we


said ... where we also ordered the trial court to
compute the amount of obligation due based on a
formula substantially similar to that indicated
above:
The total amount due ... [under] the ... contract ...
may be easily determined by the trial court
through a simple mathematical computation based
on the formula specified above. Mathematics is an
exact science, the application of which needs no
further proof from the parties.
Guaranty I 355

... WHEREFORE, we GRANT the petition in part.


We AFFIRM the Decision of the Court of Appeals
dated 7 September 2000 and its Resolution dated 18
October 2000 with the following MODIFICA-
TIONS:
1) El Oro Engraver Corporation is principally lia-
ble for the total amount due under the trust re-
ceipts dated 30 September 1981 and 9 October 1981,
as computed by the Regional Trial Court, Makati,
Branch 144, upon finality of this Decision, based on
the formula provided above;
2) Petitioner Jose C. Tupaz IV is liable for El Oro
Engraver Corporation's total debt under the trust
receipt dated 30 September 1981 as thus computed
by the Regional Trial Court, Makati, Branch 144;
and
3) Petitioners Jose C. Tupaz IV and Petronila C.
Tupaz are not liable under the trust receipt dated 9
October 1981...

Despite the procedure provided in Article 2062 of the Civ-


il Code, the case of Tupaz is basis for saying that a credi-
tor may secure judgment against a guarantor even before
excussion has been resorted to. The Supreme Court in this
case stated that the remedy of the guarantor is to demand
deferment of the execution of the judgment against it until
after the assets of the principal debtor have been ex-
hausted. How is this reconciled with the clear mandate of
Article 2062?

F. Right to Protection

Art. 2071. The guarantor, even before having


paid,
may proceed against the principal debtor:
356 1 Credit Transactions: Notes and Cases

(1) When he is sued for the payment;


(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 pay-
ment;
(5) After the lapse of ten years, when the princip-
al obligation has no fixed period for its maturity,
unless it be of such nature that it cannot be extin-
guished except within a period longer than ten
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.
The right to protection is the right of the guarantor as
against the principal debtor to:

1. Obtain release from the guaranty, or

2. Demand security.

The purpose is to for the guarantor to protect itself from:

1. Any proceeding by the creditor, and

2. The danger of insolvency of the debtor.


Guaranty 1 357

Article 2071 provides for the protection of the guarantor


before it has paid but after it has become liable to do so. It
is a protective remedy before payment and is therefore
preliminary in nature. Its purpose is to give to the guaran-
tor a remedy in anticipation of the payment of a debt that
is due and demandable. The only procedure to enforce
the right to protection is by action, but while the guaran-
tor has the right to obtain a judgment against the princip-
al debtor, it will not be allowed to realize on the judg-
ments to the point of actual collection until it has satisfied
or caused to be satisfied the principal obligation. Other-
wise, collusion and improper practices between the gua-
rantor and the principal debtor may prejudice the credi-
tor. 13

Although the right to protection is obtained by the gua-


rantor thru an action against the principal debtor in the
instances provided by law, Article 2071 is not clear on
how the guarantor will obtain release from the guaranty,
when by definition, the guarantor binds itself to the credi-
tor. Logically. only the creditor can grant a release from
the guaranty. Consequently, the only way for the guaran-
tor to seek effective release from the guaranty by proceed-
ing against the debtor is to compel the debtor to extin-
guish the principal obligation.

G. Right to Indemnification

Art. 2066. The guarantor who pays for a debtor


must be indemnified by the latter.
The indemnity comprises:
(1) The total amount of the debt;

13 Kuenzle & Streiff v. Tan Sunco, et al., G.R No. L-5208, December 1, 1909,
16 Phil 70.
358 1 Credit Transactions: Notes and Cases

(2) The legal interests thereon from the time the


payment was made known to the debtor, 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.

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.

Art. 1236. The creditor is not bound to accept


payment or performance by a third person who
has no interest in the fulfillment of the obliga-
tion, unless there is a stipulation to the contrary.
Whoever pays for another may demand from the
debtor what he has paid, except that if he paid
without the knowledge or against the will of the
debtor, he can recover only insofar as the pay-
ment has been beneficial to the debtor.

Art. 2069. If the debt was for a period and the gu-
arantor paid it before it became due,
he cannot demand reimbursement of the debtor
until the expiration of the period
unless the payment has been ratified by the deb-
tor.

Art. 2070. If the guarantor has paid without noti-


fying 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 a gratuitous guaranty, if
Guaranty I 359

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.

Art. 2072. If one, at the request of another, be-


comes a guarantor for the debt of a third person
who is not present,
the guarantor who satisfies the debt may sue ei-
ther the person so requesting or the debtor for
reimbursement.

Generally, the guarantor binds itself to the principal credi-


tor, granting the latter the right to proceed against the gu-
arantor in case the principal debtor fails to perform the
principal obligation. However, in a guaranty there is also
a legal tie14 created between the guarantor and the prin-
cipal debtor to which the principal creditor is not privy.
The moment the guarantor fully answers to the principal
creditor for the obligation of the principal debtor, the
principal obligation is extinguished. But the principal
debtor now has the duty to indemnify or make good any
loss, damage, or liability 5 incurred by the guarantor.

The right to indemnification is the substantive right of


action of the guarantor, after it has paid the principal
debt, as against the principal debtor,'16 to recover:

1. The total amount of the debt;

2. The legal interests thereon from the time the payment

14 Escano & Silos v. Ortigas, Jr., G. R. No. 151953, June 29,2007,526 SCRA 26.
is Blacks Law Dictionary, Ninth Edition (2009).
16 Kuenzle & Streiff v. Tan Sunco, et al., G.R. No. L-5208, December 1, 1909,16
Phil 70.
360 1 Credit Transactions: Notes and Cases

was made known to the debtor, 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
it; and

4. Damages, if they are due.

The right to indemnification, therefore, is more than a


mere right to reimbursement of what was paid. But for
this right to exist in favor of the guarantor, the contract of
guaranty must have been entered into with the know-
ledge and consent of the principal debtor.

H. Right to Subrogation

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 credi-
tor, he cannot demand of the debtor more than
what he has really paid.

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.

Art. 1237. Whoever pays on behalf of the debtor


without the knowledge or against the will of the
latter, cannot compel the creditor to subrogate
him in his rights, such as those arising from a
mortgage, guaranty, or penalty.
Guaranty 1361

Art. 2068. If the guarantor should pay without no-


tifying the debtor,
the latter may enforce against him all the de-
fenses which he could have set up against the
creditor at the time the payment was made.

Art. 2080. The guarantors, even though they be


solidary, are released from their obligation
whenever by some act of the creditor they cannot
be subrogated to the rights, mortgages, and prefe-
rence of the latter.

The right to subrogation is the right of a guarantor who


pays, as against the principal debtor, to be substituted to
all the rights, remedies or securities 17 that the creditor had
against the principal debtor. Subrogation transfers to the
guarantor the credit with all the rights appertaining there-
to, against the principal debtor. 18 But for this right to exist
in favor of the guarantor, the contract of guaranty must
have been entered into with the knowledge and consent
of the principal debtor.

I. Rights of Co-Guarantors

1. Benefit of Division

Art. 2065. Should there be several guarantors of


only one debtor and for the same debt, the obliga-
tion to answer for the same is divided among all.
The creditor cannot claim from the guarantors ex-

17 Blacks Law Dictionary, Ninth Edition (2009).


18
Civil Code, Art. 1303. Subrogation transfers to the persons subrogated the
credit with all the rights thereto appertaining, either against the debtor or
against third person, be they guarantors or possessors of mortgages, sub-
ject to stipulation in a conventional subrogation.
362 1 Credit Transactions: Notes and Cases

cept the shares which they are respectively bound


to pay, unless solidarity has been expressly stipu-
lated.
The benefit of division against the co-guarantors
ceases in the same cases and for the same reasons
as the benefit of excussion against the principal
debtor.

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 gua-
rantor to whom it has been granted.

There is a co-guaranty when two or more persons (or co-


guarantors) answer for the same debt of the same debtor.
Among co-guarantors, the benefit of division is the right
of a co-guarantor, as against the creditor, to pay only the
divided share that it is bound to pay. It may be claimed
by a co-guarantor from the very moment the obligation is
contracted, except where there is a stipulation to the con-
trary. But the benefit of division will cease, in which case,
the creditor may claim the entire amount from a co-
guarantor, if:

a. The co-guarantor against whom the creditor is making


the claim has expressly renounced the benefit of division;
b. The co-guarantor has bound itself solidarily with the
co-guarantor;

c. In case of insolvency of the co-guarantor;

d. When a co-guarantor has absconded, or cannot be


sued within the Philippines unless it has left a manager or
representative;
Guaranty 1363

e. If it may be presumed that an execution on the proper-


ty of the co-guarantor would not result in the satisfaction
of the obligation.19

2. Right to 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 proportionally 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 appli-
cable, unless the payment has been made by vir-
tue of a judicial demand or unless the principal
debtor is insolvent.

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 per-
tained to the principal debtor against the creditor,
and which are not purely personal to the debtor.

Art. 2075. A sub-guarantor, in case of the insol-


vency of the guarantor for whom he bound him-
self, is responsible to the co-guarantors in the
same terms as the guarantor.

The right to reimbursement is the right of the co-


guarantor who pays, as against the other co-guarantors,

19 Cacho v. Valles, et aL, C& No. L-1940 August27' 19m, 45 Phil 107.
364 1 Credit Transactions: Notes and Cases

to recover the shares due from the co-guarantors, but only


if the following conditions concur:
a. There are two or more guarantors of the same debtor
and for the same debt.

b. One of the co-guarantors has paid.

c. Payment is made by virtue of a judicial demand or the


principal debtor is insolvent.

If any of the co-guarantors is insolvent, the share of the


insolvent co-guarantor shall be born by the other co-
guarantors, including the co-guarantor paying, in the
same proportion as that established in the co-guaranty.

J. Extinguishment and Right of Release

Art. 2076. The obligation of the guarantor is ex-


tinguished at the same time as that of the debtor,
and for the same causes as all other obligations.

Art. 2077. If the creditor voluntarily accepts im-


movable or other property in payment of the
debt,
even if he should afterwards lose the same
through eviction,
the guarantor is released.
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.
Guaranty 1 365

Art 2080. The guarantors, even though they be


solidary, are released from their obligation
whenever by some act of the creditor they cannot
be subrogated to the rights, mortgages, and prefe-
rence of the latter.
Chapter 5. Surety

A. General Concepts

Art. 2047. By guaranty a person, called the gua-


rantor, binds himself to the creditor to fulfill the
obligation of the principal debtor in case the lat-
ter should fail to do so.

If a person binds himself solidarily with the


principal debtor, the provisions of Section 4,
Chapter 3, Title I of this Book shall be observed.
In such case the contract is called a suretyship.

Art. 1211. Solidarity may exist although the credi-


tors and the debtors may not be bound in the
same manner and by the same periods and condi-
tions.

Art. 1216. The creditor may proceed against any


one of the solidary debtors or some or all of them
simultaneously. The demand made against one of
them shall not be an obstacle to those which may
subsequently be directed against the others, so
long as the debt has not been fully collected.

Art. 2082. The bondsman who is to be offered


in virtue of a provision of law or
of a judicial order
shall have the qualifications prescribed in Article
2056 and in special laws.

Art. 2083. If the person bound to give a bond in


the cases of the preceding article, should not be
able to do so, a pledge or mortgage considered
Surety 1367

sufficient to cover his obligation shall be admit-


ted in lieu thereof.

Art. 2084. A judicial bondsman cannot demand


the exhaustion of the property of the principal
debtor.
A sub-surety in the same case, cannot demand the
exhaustion of the property of the debtor of the
surety.

A suretyship is the legal relation that arises when one


party assumes liability for a debt, default or other failing
of a second party.' It is a contractual relation resulting
from an agreement whereby one person (the surety) en-
gages to be answerable for the debt, default or miscar-
riage of another (the principal or principal debtor).2 It is
a personal security transaction that involves the obliga-
tion of the surety to fulfill a principal obligation in case
the principal debtor, to whom the surety is solidarily
bound, does not do so.

Suretyship is an accessory, ancillary or collateral obliga-


tion. The surety's obligation is not an original and direct
one for the performance of its own act, but merely acces-
sory or collateral to the obligation contracted by the prin-
cipal debtor.3 Thus, although the surety is bound solida-
rily, the liability of a surety is consequent upon the liabil-
ity of the principal debtor and is so dependent on that of
the principal debtor that the surety is considered in law as
being the same party. The liabilities of the surety and
principal debtor are so interwoven and dependent as to

1 Blacks Law Dictionary, Ninth Edition (2009).


2 Garcia v. Court of Appeals & Lasal Development Corporation, G.R No.
80201, November 20,1990,191 SCRA 493.
3 Ibid.
368 1 Credit Transactions: Notes and Cases

be inseparable. If the principal debtor is liable, the liability


of the surety would be solidary, but the nature of the su-
rety's undertaking is such that it does not incur liability
4
unless the principal debtor is liable.

Nevertheless, although the obligation of the surety is in


essence secondary only to a valid principal obligation, a
surety's liability to the creditor is said to be direct, pri-
mary and absolute; in other words, a surety is directly
and equally bound with the principal. The surety there-
fore becomes liable for the debt or duty of another al-
though it possesses no direct or personal interest over the
5
obligations nor does it receive any benefit therefrom.

The obligations of a surety always arise 6 as a consequence


of contract even if the suretyship is legal (offered in virtue
of a provision of law) or judicial (offered in virtue of a
judicial order). The surety in a legal and judicial surety-
ship (the bondsman) must possess the qualifications re-
quired of a guarantor, that is the surety must possess in-
tegrity, capacity to bind itself, and sufficient property to
answer for the obligation which it guarantees.

B. Form of Surety

By definition, a surety constitutes


(b) A special promise to answer for the debt, de-
7
fault, or miscarriage of another;

4 Government of the Philippines v. Tizon, et al., G.R. No. L-22108, August 30,
1967,20 SCRA 1182.
5 Garcia v. Court of Appeals & Lasal Development Corporation, G.R. No.

80201, November 20, 1990, 191 SCRA 493 citing Sykes v. Everett, 167 NC
600 and Miner's Merchants Bank v. Gidley, 150 WVa 229,144 SE 2d 711.
6 Civil Code, Art. 1157. Obligations arise from: (1) Law; (2) Contracts; (3)
Quasi-contracts; (4) Acts or omissions punished by law; and (5) Quasi-
delicts.
7 Civil Code, Art 1403.
Surety I369

hence, it is
unenforceable by action, unless the same, or
some note or memorandum, thereof, be in writ-
ing, and subscribed by the party charged, or by
his agent; evidence, therefore, of the agreement
cannot be received without the writing, or a sec-
ondary evidence of its contents. 8

C. Obligations Secured

The peculiar nature of a suretyship is that it is valid de-


spite the absence of any direct consideration received by
the surety either from the principal debtor or from the
creditor. A contract of suretyship, like any other contract,
must generally be supported by a sufficient consideration.
However, the consideration necessary to support a sure-
ty's obligation need not pass directly to the surety; a con-
sideration moving to the principal debtor alone suffices. 9

The law looks upon the contract of suretyship with a jeal-


ous eye, and the rule is settled that the obligation of the
surety cannot be extended by implication beyond its spe-
cified limits. Nothing can be clearer, both upon principle
and authority, than the doctrine that the liability of a sure-
ty is not to be extended, by implication, beyond the terms
of the contract. To the extent, and in the manner, and un-
der the circumstances pointed out in the obligation, the
surety is bound, and no farther. 10

8 Ibid.
9 Garcia v. Court of Appeals & Lasal Development Corporation, G.R. No.
80201, November 20, 1990, 191 SCRA 493.
10
La Insular v. Go-Tauco & Co-Siong, G.R. No. L-13307, February 3,1919,39
Phil 567, citing Miller v. Stewart, 9 Wheat 680, 6 L. ed. 189, cited in Dino &
Uy v. Court of Appeals & Metropolitan Bank & Trust Company, G.R. No.
89775, November 26, 1992, 216 SCRA 9.
370 1 Credit Transactions: Notes and Cases

But it is worth stressing that the rule holding sureties to


be "favorites of the law," and their contracts to be strictis-
simi juris, does not apply to compensated sureties. The
underlying principle of the rule is that, formerly, parties
became sureties, not for hire but as a matter of accommo-
dation. Consequently, the strictissimijuris rule has no ap-
plication to sureties organized for the purpose of conduct-
ing an indemnity business at established rates of compen-
sation."

Although it is axiomatic that the contract of suretyship is


the law between the parties and the obligations of a surety
cannot extend beyond what is stipulated, 12 Article 2053
applies to suretyships as well.
Art. 2053. A guaranty may also be given as securi-
ty for future debts, the amount of which is not yet
known; there can be no claim against the guaran-
tor until the debt is liquidated....
A continuing surety therefore, is not limited to a single
transaction but contemplates a prospective or future
course of dealing, covering a series of transactions, which
are within the stipulations of the contract of surety, until
the expiration or termination thereof. It applies to a suc-
cession of liabilities, for which the surety becomes liable
13
as they accrue.

1 Pastoral v. Mutual Security Insurance Corporation, G.R. No. L-20469, Au-


gust 31, 1965, 14 SCRA 1011, citing United States Fidelity & Guaranty Co.
v. Golden Pressed & Fire Brick Co., 191 U.S. 416, 48 L. ed. 242.
12 Central Surety and Insurance Company, Inc. v. Ubay, G.R. No. L-40334,
February 28,1985,135 SCRA 58.
13 Dino & Uy v. Court of Appeals & Metropolitan Bank & Trust Company,
G.R. No. 89775, November 26, 1992, 216 SCRA 9, and Philippine Blooming
Mills, Inc., & Ching v. Court of Appeals, G.R. No. 142381, October 15,2003,
413 SCRA 445.
Surety 371

Security Bank & Trust Company v. Cuenca, G.R.


No. 138544. October 3, 2000, 341 SCRA 781.

Being an onerous undertaking, a surety agreement


is strictly construed against the creditor, and every
doubt is resolved in favor of the solidary debtor.
The fundamental rules of fair play require the cred-
itor to obtain the consent of the surety to any ma-
terial alteration in the principal loan agreement, or
at least to notify it thereof. Hence, petitioner bank
cannot hold herein respondent liable for loans ob-
tained in excess of the amount or beyond the pe-
riod stipulated in the original agreement, absent
any clear stipulation showing that the latter
waived his right to be notified thereof, or to give
consent thereto. This is especially true where, as in
this case, respondent was no longer the principal
officer or major stockholder of the corporate debtor
at the time the later obligations were incurred. He
was thus no longer in a position to compel the deb-
tor to pay the creditor and had no more reason to
bind himself anew to the subsequent obligations...

The Facts
..."The antecedent material and relevant facts are
that defendant-appellant Sta. Ines Melale ('Sta. In-
es') is a corporation engaged in logging opera-
tions...
"On 10 November 1980, [Petitioner] Security Bank
and Trust Co. granted appellant Sta. Ines Melale
Corporation [SIMC] a credit line in the amount of
[e]ight [m]llion [p]esos (P-8,000,000.00) to assist the
latter in meeting the additional capitalization re-
quirements of its logging operations.
"The Credit Approval Memorandum expressly
372 1 Credit Transactions: Notes and Cases

stated that the P-8M Credit Loan Facility shall be ef-


fective until 30 November 1981...
"To secure the payment of the amounts drawn by
appellant SIMC from the above-mentioned credit
line, SIMC executed a Chattel Mortgage dated 23
December 1980 ... over some of its machinery and
equipment in favor of [Petitioner] SBTC. As addi-
tional security for the payment of the loan, [Res-
pondent] Rodolfo M. Cuenca executed an Indemni-
ty Agreement dated 17 December 1980 ... in favor
of [Petitioner] SBTC whereby he solidarily bound
himself with SIMC...
"On 26 November 1981, four (4) days prior to the
expiration of the period of effectivity of the P28M-
Credit Loan Facility, appellant SIMC made a first
drawdown from its credit line with [Petitioner]
SBTC in the amount of [s]ix [m]illion [o]ne
[h]undred [t]housand [p]esos (P-6,100,000.00)...
"Sometime in 1985, [Respondent] Cuenca resigned
as President and Chairman of the Board of Direc-
tors of defendant-appellant Sta. Ines. Subsequently,
the shareholdings of [Respondent] Cuenca in de-
fendant-appellant Sta. Ines were sold at a public
auction...
"Subsequently, appellant SIMC repeatedly availed
of its credit line and obtained six (6) other loan[s]
from [Petitioner] SBTC in the aggregate amount of
[s]ix [m]illion [t]hree [h]undred [s]ixty-[n]ine
[t]housand [n]ineteen and 50/100 [p]esos
(P6,369,019.50)...
"Appellant SIMC, however, encountered difficulty
in making the amortization payments on its loans
and requested [Petitioner] SBTC for a complete re-
structuring of its indebtedness. SBTC accommo-
dated appellant SIMC's request and signified its
Surety 1 373

approval in a letter dated 18 February 1988 ...


wherein SBTC and defendant-appellant Sta. Ines,
without notice to or the prior consent of [Respon-
dent] Cuenca, agreed to restructure the past due
obligations of defendant-appellant Sta. Ines. [Peti-
tioner] Security Bank agreed to extend to defen-
dant-appellant Sta. Ines the following loans:
a. Term loan in the amount of [e]ight [m]illion
[e]ight [h]undred [t]housand [p]esos (P-8,800,000.
00), to be applied to liquidate the principal portion
of defendant-appellant Sta. Ines['] total outstand-
ing indebtedness to [Petitioner] Security Bank ...
and
b. Term loan in the amount of [t]hree [m]illion
[flour [hiundred [t]housand [p]esos (23,400,000.
00), to be applied to liquidate the past due interest
and penalty portion of the indebtedness of defen-
dant-appellant Sta. Ines to [Petitioner] Security
Bank...
"It should be pointed out that in restructuring de-
fendant-appellant Sta. Ines' obligations to [Peti-
tioner] Security Bank, Promissory Note No. TD-
TLS-3599-81 in the amount of [s]ix [m]illion [o]ne
[h]undred [t]housand [p]esos (P-6,100,000.00),
which was the only loan incurred prior to the expi-
ration of the P8M-Credit Loan Facility on 30 No-
vember 1981 and the only one covered by the In-
demnity Agreement dated 19 December 1980 ...
was not segregated from, but was instead lumped
together with, the other loans ... obtained by de-
fendant-appellant Sta. Ines which were not secured
by said Indemnity Agreement...
"To formalize their agreement to restructure the
loan obligations of defendant-appellant Sta. Ines,
[Petitioner] Security Bank and defendant-appellant
374 1 Credit Transactions: Notes and Cases

Sta. Ines executed a Loan Agreement dated 31 Oc-


tober 1989... Section 1.01 of the said Loan Agree-
ment dated 31 October 1989 provides:
'1.01 Amount - The Lender agrees to grant a loan
to the Borrower in the aggregate amount of
TWELVE MILLION TWO HUNDRED THOU-
SAND PESOS (122,200,000.00), Philippines
[c]urrency (the 'Loan'). The loan shall be released
in two (2) tranches of P8,800,000.00 for the first
tranche (the 'First Loan') and 23,400,000.00 for the
second tranche (the 'Second Loan') to be applied in
the manner and for the purpose stipulated herein-
below.
'1.02. Purpose - The First Loan shall be applied to
liquidate the principal portion of the Borrower's
present total outstanding indebtedness to the
Lender (the 'indebtedness') while the Second Loan
shall be applied to liquidate the past due interest
and penalty portion of the Indebtedness.'...
"From 08 April 1988 to 02 December 1988, defen-
dant-appellant Sta. Ines made further payments to
[Petitioner] Security Bank in the amount of [o]ne
[m]illion [s]even [h]undred [flifty-[s]even
[tihousand [p]esos (P1,757,000.00)...
"Appellant SIMC defaulted in the payment of its
restructured loan obligations to [Petitioner] SBTC
despite demands made upon appellant SIMC and
CUENCA, the last of which were made through
separate letters dated 5 June 1991...
"Appellants individually and collectively refused
to pay the [Petitioner] SBTC. Thus, SBTC filed a
complaint for collection of sum of money on 14
June 1993, resulting after trial on the merits in a de-
cision by the court a quo, ... from which [Respon-
dent] Cuenca appealed."
Surety 1375

Ruling of the Court of Appeals


In releasing Respondent Cuenca from liability, the
CA ruled that the 1989 Loan Agreement had no-
vated the 1980 credit accommodation earlier
granted by the bank to Sta. Ines. Accordingly, such
novation extinguished the Indemnity Agreement,
by which Cuenca, who was then the Board chair-
man and president of Sta. Ines, had bound himself
solidarily liable for the payment of the loans se-
cured by that credit accommodation. It noted that
the 1989 Loan Agreement had been executed with-
out notice to, much less consent from, Cuenca who
at the time was no longer a stockholder of the cor-
poration.

The appellate court also noted that the Credit Ap-


proval Memorandum had specified that the credit
accommodation was for a total amount of P8 mil-
lion, and that its expiry date was November 30,
1981. Hence, it ruled that Cuenca was liable only
for loans obtained prior to November 30, 1981, and
only for an amount not exceeding P8 million.

It further held that the restructuring of Sta. Ines'


obligation under the 1989 Loan Agreement was
tantamount to a grant of an extension of time to the
debtor without the consent of the surety. Under
Article 2079 of the Civil Code, such extension ex-
tinguished the surety.

The CA also opined that the surety was entitled to


notice, in case the bank and Sta. Ines decided to
materially alter or modify the principal obligation
after the expiry date of the credit accommodation.
376 1 Credit Transactions: Notes and Cases

Hence, this recourse to this Court.


The Issues
...First Issue: Original Obligation Extinguished by No-
vation
An obligation may be extinguished by novation,
pursuant to Article 1292 of the Civil Code, which
reads as follows:
"ART. 1292. In order that an obligation may be ex-
tinguished by another which substitute the same, it
is imperative that it be so declared in unequivocal
terms, or that the old and the new obligations be
on every point incompatible with each other."

Novation of a contract is never presumed. It has


been held that "[i]n the absence of an express
agreement, novation takes place only when the old
and the new obligations are incompatible on every
point." ... Indeed, the following requisites must be
established: (1) there is a previous valid obligation;
(2) the parties concerned agree to a new contract;
(3) the old contract is extinguished; and (4) there is
a valid new contract...

Petitioner contends that there was no absolute in-


compatibility between the old and the new obliga-
tions, and that the latter did not extinguish the ear-
lier one. It further argues that the 1989 Agreement
did not change the original loan in respect to the
parties involved or the obligations incurred. It adds
that the terms of the 1989 Contract were "not more
onerous." ... Since the original credit accomodation
was not extinguished, it concludes that Cuenca is
still liable under the Indemnity Agreement.
Surety 1 377

We reject these contentions. Clearly, the requisites


of novation are present in this case. The 1989 Loan
Agreement extinguished the obligation ...
obtained
under the 1980 credit accomodation. This is evident
from its explicit provision to "liquidate" the prin-
cipal and the interest of the earlier indebtedness...

Furthermore, several incompatibilities between the


1989 Agreement and the 1980 original obligation
demonstrate that the two cannot coexist. While the
1980 credit accommodation had stipulated that the
amount of loan was not to exceed P-8 million, ...
the
1989 Agreement provided that the loan was 1212.2
million. The periods for payment were also differ-
ent.

Likewise, the later contract contained conditions,


"positive covenants" and "negative covenants" not
found in the earlier obligation. As an example of a
positive covenant, Sta. Ines undertook "from time
to time and upon request by the Lender, [to] per-
form such further acts and/or execute and deliver
such additional documents and writings as may be
necessary or proper to effectively carry out the
provisions and purposes of this Loan Agreement."
...Likewise, SIMC agreed that it would not create
any mortgage or encumbrance on any asset owned
or hereafter acquired, nor would it participate in
any merger or consolidation...

Since the 1989 Loan Agreement had extinguished


the original credit accommodation, the Indemnity
Agreement, an accessory obligation, was necessari-
ly extinguished also, pursuant to Article 1296 of the
Civil Code, which provides:
378 1 Credit Transactions: Notes and Cases

"ART. 1296. When the principal obligation is extin-


guished in consequence of a novation, accessory
obligations may subsist only insofar as they may
benefit third persons who did not give their con-
sent."

Alleged Extension
Petitioner insists that the 1989 Loan Agreement
was a mere renewal or extension of the 128 million
original accommodation; it was not a novation...

This argument must be rejected. To begin with, the


1989 Loan Agreement expressly stipulated that its
purpose was to "liquidate," not to renew or extend,
the outstanding indebtedness. Moreover, respon-
dent did not sign or consent to the 1989 Loan
Agreement, which had allegedly extended the orig-
inal P-8 million credit facility. Hence, his obligation
as a surety should be deemed extinguished, pur-
suant to Article 2079 of the Civil Code...

In an earlier case 14 , the Court explained the ratio-


nale of this provision in this wise:
"The theory behind Article 2079 is that an exten-
sion of time given to the principal debtor by the
creditor without the surety's consent would de-
prive the surety of his right to pay the creditor and
to be immediately subrogated to the creditor's re-
medies against the principal debtor upon the ma-
turity date. The surety is said to be entitled to pro-
tect himself against the contingency of the princip-

14 Cochingyan
v. R & B Surety and Insurance Co., G.R. No. L-47369, June 30,
1987,151 SCRA 339.
Surety 1379

al debtor or the indemnitors becoming insolvent


during the extended period."

Binding Nature of the Credit Approval Memorandum


As noted earlier, the appellate court relied on the
provisions of the Credit Approval Memorandum
in holding that the credit accommodation was only
for P8 million, and that it was for a period of one
year ending on November 30, 1981. Petitioner ob-
jects to the appellate court's reliance on that docu-
ment, contending that it was not a binding agree-
ment because it was not signed by the parties. It
adds that it was merely for its internal use.

We disagree. It was petitioner itself which pre-


sented the said document to prove the accommo-
dation. Attached to the Complaint as Annex A was
a copy thereof "evidencing the accommodation." ...

Clearly, respondent is estopped from denying the


terms and conditions of the F8 million credit ac-
commodation as contained in the very document it
presented to the courts. Indeed, it cannot take ad-
vantage of that document by agreeing to be bound
only by those portions that are favorable to it,
while denying those that are disadvantageous.

Second Issue: Alleged Waiver of Consent


Pursuing another course, petitioner contends that
Respondent Cuenca "impliedly gave his consent to
any modification of the credit accommodation or
otherwise waived his right to be notified of, or to
give consent to, the same." ... Respondent's consent
or waiver thereof is allegedly found in the Indem-
nity Agreement, in which he held himself liable for
380 1 Credit Transactions: Notes and Cases

the "credit accommodation including [its] substitu-


tions, renewals, extensions, increases, amendments,
conversions and revival." It explains that the nova-
tion of the original credit accommodation by the
1989 Loan Agreement is merely its "renewal,"
which "connotes cessation of an old contract and
birth of another one"...

At the outset, we should emphasize that an essen-


tial alteration in the terms of the Loan Agreement
without the consent of the surety extinguishes the
latter's obligation. As the Court held in National
Bank v. Veraguth'5, "[ilt is fundamental in the law of
suretyship that any agreement between the credi-
tor and the principal debtor which essentially va-
ries the terms of the principal contract, without the
consent of the surety, will release the surety from
liability."

In this case, petitioner's assertion - that respondent


consented to the alterations in the credit accom-
modation - finds no support in the text of the In-
demnity Agreement, which is reproduced he-
reunder:
"Rodolfo M. Cuenca ...
for and in consideration of
the credit accommodation in the total amount of
eight million pesos (P-8,000,000.00) granted by the
SECURITY BANK AND TRUST COMPANY ... in
favor of STA. INES MELALE FOREST PRODUCTS
CORP., ... with the stipulated interests and charges
thereon, evidenced by that/those certain PROMIS-
SORY NOTE[(S)], made, executed and delivered by
the CLIENT in favor of the BANK hereby bind(s)

15 G.R No. L-26833, April 1,1927,50 Phil 253.


Surety 1 381

himself/themselves jointly and severally with the


CLIENT in favor of the BANK for the payment,
upon demand and without benefit of excussion of
whatever amount or amounts the CLIENT may be
indebted to the BANK under and by virtue of afo-
resaid credit accommodation(s) including the subs-
titutions, renewals, extensions, increases, amend-
ment, conversions and revivals of the aforesaid
credit accommodation(s), as well as of the amount
or amounts of such other obligations that the
CLIENT may owe the BANK, whether direct or in-
direct, principal or secondary, as appears in the ac-
counts, books and records of the BANK, plus inter-
est and expenses arising from any agreement or
agreements that may have heretofore been made,
or may hereafter be executed by and between the
parties thereto, including the substitutions, renew-
als, extensions, increases, amendments, conver-
sions and revivals of the aforesaid credit accom-
modation(s), and further bind(s) himself/them-
selves with the CLIENT in favor of the BANK for
the faithful compliance of all the terms and condi-
tions contained in the aforesaid credit accommoda-
tion(s), all of which are incorporated herein and
made part hereof by reference."

While respondent held himself liable for the credit


accommodation or any modification thereof, such
clause should be understood in the context of the
P-8 million limit and the November 30, 1981 term. It
did not give the bank or Sta. Ines any license to
modify the nature and scope of the original credit
accommodation, without informing or getting the
consent of respondent who was solidarily liable.
Taking the bank's submission to the extreme, res-
382 1 Credit Transactions: Notes and Cases

pondent (or his successors) would be liable for


loans even amounting to, say, 12100 billion obtained
100 years after the expiration of the credit accom-
modation, on the ground that he consented to all
alterations and extensions thereof.

Indeed, it has been held that a contract of surety


"cannot extend to more than what is stipulated. It
is strictly construed against the creditor, every
doubt being resolved against enlarging the liability
of the surety." Likewise, the Court has ruled that
"it is a well-settled legal principle that if there is
any doubt on the terms and conditions of the sure-
ty agreement, the doubt should be resolved in fa-
vor of the surety x x x. Ambiguous contracts are
construed against the party who caused the ambi-
guity."[32] In the absence of an unequivocal provi-
sion that respondent waived his right to be notified
of or to give consent to any alteration of the credit
accommodation, we cannot sustain petitioner's
view that there was such a waiver.

It should also be observed that the Credit Approval


Memorandum clearly shows that the bank did not
have absolute authority to unilaterally change the
terms of the loan accommodation. Indeed, it may
do so only upon notice to the borrower, pursuant
to this condition:
"5. The Bank reserves the right to amend any of the
aforementioned terms and conditions upon written
notice to the Borrower."

We reject petitioner's submission that only Sta. In-


es as the borrower, not respondent, was entitled to
be notified of any modification in the original loan
SuretyI 383

accommodation. Following the bank's reasoning,


such modification would not be valid as to Sta. Ines
if no notice were given; but would still be valid as
to respondent to whom no notice need be given.
The latter's liability would thus be more burden-
some than that of the former. Such untenable
theory is contrary to the principle that a surety
cannot assume an obligation more onerous than
that of the principal.

The present controversy must be distinguished


from Philamgen v. Mutuc 16, in which the Court sus-
tained a stipulation whereby the surety consented
to be bound not only for the specified period, "but
to any extension thereafter made, an extension ...
that could be had without his having to be noti-
fied."

In that case, the surety agreement contained this


unequivocal stipulation:
"It is hereby further agreed that in case of any ex-
tension of renewal of the bond, we equally bind
ourselves to the Company under the same terms
and conditions as herein provided without the ne-
cessity of executing another indemnity agreement
for the purpose and that we hereby equally waive
our right to be notified of any renewal or extension
of the bond which may be granted under this in-
demnity agreement."

In the present case, there is no such express stipula-


tion. At most, the alleged basis of respondent's
waiver is vague and uncertain. It confers no clear

16 G.R. No. L-19632, November 13,1974,61 SCRA 22.


384 I Credit Transactions: Notes and Cases

authorization on the bank or Sta. Ines to modify or


extend the original obligation without the consent
of the surety or notice thereto.

ContinuingSurety
Contending that the Indemnity Agreement was in
the nature of a continuing surety, petitioner main-
tains that there was no need for respondent to ex-
ecute another surety contract to secure the 1989
Loan Agreement.

This argument is incorrect. That the Indemnity


Agreement is a continuing surety does not author-
ize the bank to extend the scope of the principal ob-
ligation inordinately. In Dino v. CA 17, the Court
held that "a continuing guaranty is one which cov-
ers all transactions, including those arising in the
future, which are within the description or con-
templation of the contract of guaranty, until the
expiration or termination thereof."

To repeat, in the present case, the Indemnity


Agreement was subject to the two limitations of the
credit accommodation: (1) that the obligation
should not exceed P-8 million, and (2) that the ac-
commodation should expire not later than Novem-
ber 30, 1981. Hence, it was a continuing surety only
in regard to loans obtained on or before the afore-
mentioned expiry date and not exceeding the total
of P-8 million.

Accordingly, the surety of Cuenca secured only the


first loan of P6.1 million obtained on November 26,

17 G.R. No. 89775, November 26,1992, 216 SCRA 9.


Surety 1385

1991. It did not secure the subsequent loans, pur-


portedly under the 1980 credit accommodation,
that were obtained in 1986. Certainly, he could not
have guaranteed the 1989 Loan Agreement, which
was executed after November 30, 1981 and which
exceeded the stipulated P8 million ceiling.

Petitioner, however, cites the Dino ruling in which


the Court found the surety liable for the loan ob-
tained after the payment of the original one, which
was covered by a continuing surety agreement. At
the risk of being repetitious, we hold that in Dino,
the surety Agreement specifically provided that
"each suretyship is a continuing one which shall
remain in full force and effect until this bank is noti-
fied of its revocation."
Since the bank had not been notified of such revo-
cation, the surety was held liable even for the sub-
sequent obligations of the principal borrower.

No similar provision is found in the present case.


On the contrary, respondent's liability was con-
fined to the 1980 credit accommodation, the
amount and the expiry date of which were set
down in the Credit Approval Memorandum.

Special Nature of the JSS


It is a common banking practice to require the JSS
("joint and solidary signature") of a major stock-
holder or corporate officer, as an additional securi-
ty for loans granted to corporations. There are at
least two reasons for this. First, in case of default,
the creditor's recourse, which is normally limited
to the corporate properties under the veil of sepa-
rate corporate personality, would extend to the
386 I Credit Transactions: Notes and Cases

personal assets of the surety. Second, such surety


would be compelled to ensure that the loan would
be used for the purpose agreed upon, and that it
would be paid by the corporation.

Following this practice, it was therefore logical and


reasonable for the bank to have required the JSS of
respondent, who was the chairman and president
of Sta. Ines in 1980 when the credit accommodation
was granted. There was no reason or logic, howev-
er, for the bank or Sta. Ines to assume that he
would still agree to act as surety in the 1989 Loan
Agreement, because at that time, he was no longer
an officer or a stockholder of the debtor-
corporation. Verily, he was not in a position then to
ensure the payment of the obligation. Neither did
he have any reason to bind himself further to a
bigger and more onerous obligation.

Indeed, the stipulation in the 1989 Loan Agreement


providing for the surety of respondent, without
even informing him, smacks of negligence on the
part of the bank and bad faith on that of the prin-
cipal debtor. Since that Loan Agreement consti-
tuted a new indebtedness, the old loan having been
already liquidated, the spirit of fair play should
have impelled Sta. Ines to ask somebody else to act
as a surety for the new loan.

In the same vein, a little prudence should have im-


pelled the bank to insist on the JSS of one who was
in a position to ensure the payment of the loan.
Even a perfunctory attempt at credit investigation
would have revealed that respondent was no long-
er connected with the corporation at the time. As it
Surety 1 387

is, the bank is now relying on an unclear Indemnity


Agreement in order to collect an obligation that
could have been secured by a fairly obtained sure-
ty. For its defeat in this litigation, the bank has only
itself to blame.

In sum, we hold that the 1989 Loan Agreement ex-


tinguished by novation the obligation under the
1980 P8 million credit accommodation. Hence, the
Indemnity Agreement, which had been an acces-
sory to the 1980 credit accommodation, was also
extinguished. Furthermore, we reject petitioner's
submission that respondent waived his right to be
notified of, or to give consent to, any modification
or extension of the 1980 credit accommodation...

WHEREFORE, the Petition is DENIED and the as-


sailed Decision AFFIRMED. Costs against petition-
er.

D. Distinguished from Standby Letter of Credit

Although both a suretyship and a standby letter of credit


ensure against the debtor's nonperformance, they func-
tion in different ways.

Upon the debtor's default, the surety undertakes to com-


plete the debtor's performance. Enforcement of a surety-
ship often involves costs to determine whether the debtor
defaulted and the costs of performance. The benefit of the
suretyship to the creditor is that the creditor knows that
the surety will perform if the debtor does not.

The creditor-beneficiary of a standby credit, on the other


hand, expects that it will promptly receive cash in the
388 1 Credit Transactions: Notes and Cases

event of nonperformance, and that it will receive it before


any litigation over the nature of the debtor-applicant's
performance takes place. The standby credit has this op-
posite effect of the suretyship: it reverses the financial
burden of parties during litigation.

In the case of a suretyship, there is no duty to indemnify


the creditor until the creditor establishes the fact of the
debtor's non-performance. The creditor may have to es-
tablish that fact in litigation. During the litigation, the su-
rety holds the money and the creditor bears most of the
cost of delay in performance.

In the standby credit case, the creditor-beneficiary avoids


that litigation burden and receives its money promptly
upon presentation of the required documents. If the deb-
tor-applicant has, in fact, performed and the creditor-
beneficiary's presentation of those documents is not
rightful, the debtor-applicant may sue the creditor-
beneficiary in tort, in contract, or in breach of warranty;
but, during the litigation to determine whether the deb-
tor-applicant has in fact breached the obligation to per-
form, the creditor-beneficiary, not the debtor-applicant,
18
holds the money.

E. Distinguished from Guaranty

Art. 2047. By guaranty a person, called the gua-


rantor, binds himself to the creditor to fulfill the
obligation of the principal debtor in case the lat-
ter should fail to do so.
If a person binds himself solidarily with the
principal debtor, the provisions of Section 4,

18 Transfield Philippines, Inc. v. Luzon Hydro Corporation Australia et al.,


G.R. No. 146717, November 22, 2004.
Surety 1 389

Chapter 3, Title I of this Book shall be observed.


In such case the contract is called a suretyship.

A suretyship is distinguished from a guaranty in that a


guarantor is the insurer of the solvency of the debtor and
binds itself to pay if the principal debtor fails or is unable
to pay, while a surety is the insurer of the debt, and obli-
gates itself to pay if the principal debtor does not pay.

Consequently, although it is an accessory obligation, the


liability of a surety is solidary with that of the principal
debtor making it direct, primary and absolute. The sure-
ty's liability is equivalent to that of the principal debtor.

It is this nature of a surety's liability that prevents the su-


rety from availing of the benefit that defines a guaranty -
the benefit of excussion. 19

Palmares v. Court of Appeals & M.B. Lending


Corporation, G.R. No. 126490, March 31, 1998, 288
SCRA 422.

Where a party signs a promissory note as a co-


maker and binds herself to be jointly and severally
liable with the principal debtor in case the latter
defaults in the payment of the loan, is such under-
taking of the former deemed to be that of a surety
as an insurer of the debt, or of a guarantor who
warrants the solvency of the debtor?

Pursuant to a promissory note dated March 13,


1990, private respondent M.B. Lending Corpora-
tion extended a loan to the spouses Osmea and

19 Civil Code, Art 2059.


390 1 Credit Transactions: Notes and Cases

Merlyn Azarraga, together with petitioner Estrella


Palmares, in the amount of 1P30,000.00 payable on
or before May 12, 1990, with compounded interest
at the rate of 6% per annum to be computed every
30 days from the date thereof. On four occasions
after the execution of the promissory note and even
after the loan matured, petitioner and the Azarraga
spouses were able to pay a total of 16,300.00, the-
reby leaving a balance of 113,700.00. No payments
were made after the last payment on September 26,
1991.

Consequently, on the basis of petitioners solidary


liability under the promissory note, respondent
corporation filed a complaint against petitioner
Palmares as the lone party-defendant, to the exclu-
sion of the principal debtors, allegedly by reason of
the insolvency of the latter.

In her Amended Answer with Counterclaim, peti-


tioner alleged that sometime in August 1990, im-
mediately after the loan matured, she offered to
settle the obligation with respondent corporation
but the latter informed her that they would try to
collect from the spouses Azarraga and that she
need not worry about it; that there has already
been a partial payment in the amount of
217,010.00; that the interest of 6% per month com-
pounded at the same rate per month, as well as the
penalty charges of 3% per month, are usurious and
unconscionable; and that while she agrees to be li-
able on the note but only upon default of the prin-
cipal debtor, respondent corporation acted in bad
faith in suing her alone without including the
Azarragas when they were the only ones who be-
Surety I 391

nefited from the proceeds of the loan... On No-


vember 26, 1992, the Regional Trial Court of boilo
City, Branch 23, rendered judgment dismissing the
complaint without prejudice to the filing of a sepa-
rate action for a sum of money against the spouses
Osmea and Merlyn Azarraga who are primarily li-
able on the instrument. This was based on the find-
ings of the court a quo that the filing of the com-
plaint against herein petitioner Estrella Paimares,
to the exclusion of the Azarraga spouses,
amounted to a discharge of a prior party; that the
offer made by petitioner to pay the obligation is
considered a valid tender of payment sufficient to
discharge a persons secondary liability on the in-
strument; that petitioner, as co-maker, is only se-
condarily liable on the instrument; and that the
promissory note is a contract of adhesion.

Respondent Court of Appeals, however, reversed


the decision of the trial court, and rendered judg-
ment declaring herein petitioner Palmares liable to
pay respondent corporation... Contrary to the
findings of the trial court, respondent appellate
court declared that petitioner Palmares is a surety
since she bound herself to be jointly and severally
or solidarily liable with the principal debtors, the
Azarraga spouses, when she signed as a co-maker.
As such, petitioner is primarily liable on the note
and hence may be sued by the creditor corporation
for the entire obligation. It also adverted to the fact
that petitioner admitted her liability in her Answer
although she claims that the Azarraga spouses
should have been impleaded. Respondent court
ordered the imposition of the stipulated 6% interest
and 3% penalty charges on the ground that the
392 I Credit Transactions: Notes and Cases

Usury Law is no longer enforceable pursuant to


Central Bank Circular No. 905. Finally, it rationa-
lized that even if the promissory note were to be
considered as a contract of adhesion, the same is
not entirely prohibited because the one who ad-
heres to the contract is free to reject it entirely; if he
adheres, he gives his consent.

Hence this petition for review on certiorari...

The ... contentions of petitioner are denied and


contradicted in their material points by respondent
corporation. They are further refuted by accepted
doctrines in the American jurisdiction after which
we patterned our statutory law on suretyship and
guaranty. This case then affords us the opportunity
to make an extended exposition on the ramifica-
tions of these two specialized contracts, for such
guidance as may be taken therefrom in similar lo-
cal controversies in the future.

The basis of petitioner Palmares liability under the


promissory note is expressed in this wise:
ATTENTION TO CO-MAKERS: PLEASE READ
WELL
I, Mrs. Estrella Palmares, as the Co-maker of the
above-quoted loan, have fully understood the con-
tents of this Promissory Note for Short-Term Loan:
That as Co-maker, I am fully aware that I shall be
jointly and severally or solidarily liable with the
above principal maker of this note;
That in fact, I hereby agree that M.B. LENDING
CORPORATION may demand payment of the
above loan from me in case the principal maker,
Mrs. Merlyn Azarraga defaults in the payment of
Surety 1393

the note subject to the same conditions above-


contained.

... After a judicious evaluation of the arguments of


the parties, we are constrained to dismiss the peti-
tion for lack of merit, but to except therefrom the
issue anent the propriety of the monetary award
adjudged to herein respondent corporation.

At the outset, let it here be stressed that even as-


suming arguendothat the promissory note executed
between the parties is a contract of adhesion, it has
been the consistent holding of the Court that con-
tracts of adhesion are not invalid per se and that on
numerous occasions the binding effects thereof
have been upheld. The peculiar nature of such con-
tracts necessitates a close scrutiny of the factual mi-
lieu to which the provisions are intended to apply.
Hence, just as consistently and unhesitatingly, but
without categorically invalidating such contracts,
the Court has construed obscurities and ambigui-
ties in the restrictive provisions of contracts of ad-
hesion strictly albeit not unreasonably against the
drafter thereof when justified in light of the opera-
tive facts and surrounding circumstances. The fac-
tual scenario obtaining in the case before us war-
rants a liberal application of the rule in favor of
respondent corporation.

The Civil Code pertinently provides: Art. 2047...

It is a cardinal rule in the interpretation of contracts


that if the terms of a contract are clear and leave no
doubt upon the intention of the contracting parties,
the literal meaning of its stipulation shall control.
394 1 Credit Transactions: Notes and Cases

In the case at bar, petitioner expressly bound her-


self to be jointly and severally or solidarily liable
with the principal maker of the note. The terms of
the contract are clear, explicit and unequivocal that
petitioners liability is that of a surety.

Her pretension that the terms jointly and severally


or solidarily liable contained in the second para-
graph of her contract are technical and legal terms
which could not be easily understood by an ordi-
nary layman like her is diametrically opposed to
her manifestation in the contract that she fully un-
derstood the contents of the promissory note and
that she is fully aware of her solidary liability with
the principal maker. Petitioner admits that she vo-
luntarily affixed her signature thereto; ergo, she
cannot now be heard to claim otherwise. Any ref-
erence to the existence of fraud is unavailing.
Fraud must be established by clear and convincing
evidence, mere preponderance of evidence not
even being adequate. Petitioners attempt to prove
fraud must, therefore, fail as it was evidenced only
by her own uncorroborated and, expectedly, self-
serving allegations.

Having entered into the contract with full know-


ledge of its terms and conditions, petitioner is es-
topped to assert that she did so under a misappre-
hension or in ignorance of their legal effect, or as to
the legal effect of the undertaking. The rule that ig-
norance of the contents of an instrument does not
ordinarily affect the liability of one who signs it al-
so applies to contracts of suretyship. And the mis-
take of a surety as to the legal effect of her obliga-
Surety I 395

tion is ordinarily no reason for relieving her of lia-


bility.

Petitioner would like to make capital of the fact


that although she obligated herself to be jointly and
severally liable with the principal maker, her liabil-
ity is deemed restricted by the provisions of the
third paragraph of her contract wherein she agreed
that M.B. Lending Corporation may demand pay-
ment of the above loan from me in case the prin-
cipal maker, Mrs. Merlyn Azarraga defaults in the
payment of the note, which makes her contract one
of guaranty and not suretyship. The purported dis-
cordance is more apparent than real.

A surety is an insurer of the debt, whereas a gua-


rantor is an insurer of the solvency of the debtor. A
suretyship is an undertaking that the debt shall be
paid; a guaranty, an undertaking that the debtor
shall pay. Stated differently, a surety promises to
pay the principals debt if the principal will not pay,
while a guarantor agrees that the creditor, after
proceeding against the principal, may proceed
against the guarantor if the principal is unable to
pay. A surety binds himself to perform if the prin-
cipal does not, without regard to his ability to do
so. A guarantor, on the other hand, does not con-
tract that the principal will pay, but simply that he
is able to do so. In other words, a surety under-
takes directly for the payment and is so responsible
at once if the principal debtor makes default, while
a guarantor contracts to pay if, by the use of due
diligence, the debt cannot be made out of the prin-
cipal debtor.
396 1 Credit Transactions: Notes and Cases

Quintessentially, the undertaking to pay upon de-


fault of the principal debtor does not automatically
remove it from the ambit of a contract of surety-
ship. The second and third paragraphs of the afo-
requoted portion of the promissory note do not
contain any other condition for the enforcement of
respondent corporations right against petitioner. It
has not been shown, either in the contract or the
pleadings, that respondent corporation agreed to
proceed against herein petitioner only if and when
the defaulting principal has become insolvent. A
contract of suretyship, to repeat, is that wherein
one lends his credit by joining in the principal deb-
tors obligation, so as to render himself directly and
primarily responsible with him, and without refer-
ence to the solvency of the principal.

In a desperate effort to exonerate herself from lia-


bility, petitioner erroneously invokes the rule on
strictissimijuris, which holds that when the mean-
ing of a contract of indemnity or guaranty has once
been judicially determined under the rule of rea-
sonable construction applicable to all written con-
tracts, then the liability of the surety, under his
contract, as thus interpreted and construed, is not
to be extended beyond its strict meaning. The rule,
however, will apply only after it has been definite-
ly ascertained that the contract is one of suretyship
and not a contract of guaranty. It cannot be used as
an aid in determining whether a party's undertak-
ing is that of a surety or a guarantor.

Prescinding from these jurisprudential authorities,


there can be no doubt that the stipulation con-
tained in the third paragraph of the controverted
SuretyI 397

suretyship contract merely elucidated on and made


more specific the obligation of petitioner as gener-
ally defined in the second paragraph thereof. Re-
sultantly, the theory advanced by petitioner, that
she is merely a guarantor because her liability at-
taches only upon default of the principal debtor,
must necessarily fail for being incongruent with
the judicial pronouncements adverted to above.

It is a well-entrenched rule that in order to judge


the intention of the contracting parties, their con-
temporaneous and subsequent acts shall also be
principally considered. Several attendant factors in
that genre lend support to our finding that peti-
tioner is a surety. For one, when petitioner was in-
formed about the failure of the principal debtor to
pay the loan, she immediately offered to settle the
account with respondent corporation. Obviously,
in her mind, she knew that she was directly and
primarily liable upon default of her principal. For
another, and this is most revealing, petitioner pre-
sented the receipts of the payments already made,
from the time of initial payment up to the last,
which were all issued in her name and of the Azar-
raga spouses. This can only be construed to mean
that the payments made by the principal debtors
were considered by respondent corporation as cre-
ditable directly upon the account and inuring to
the benefit of petitioner. The concomitant and si-
multaneous compliance of petitioners obligation
with that of her principals only goes to show that,
from the very start, petitioner considered herself
equally bound by the contract of the principal
makers.
398 1 Credit Transactions: Notes and Cases

In this regard, we need only to reiterate the rule


that a surety is bound equally and absolutely with
the principal, and as such is deemed an original
pronisor and debtor from the beginning. This is
because in suretyship there is but one contract, and
the surety is bound by the same agreement which
binds the principal. In essence, the contract of a su-
rety starts with the agreement, which is precisely
the situation obtaining in this case before the
Court.

It will further be observed that petitioners under-


taking as co-maker immediately follows the terms
and conditions stipulated between respondent cor-
poration, as creditor, and the principal obligors. A
surety is usually bound with his principal by the
same instrument, executed at the same time and
upon the same consideration; he is an original deb-
tor, and his liability is immediate and direct. Thus,
it has been held that where a written agreement on
the same sheet of paper with and immediately fol-
lowing the principal contract between the buyer
and seller is executed simultaneously therewith,
providing that the signers of the agreement agreed
to the terms of the principal contract, the signers
were sureties jointly liable with the buyer. A surety
usually enters into the same obligation as that of
his principal, and the signatures of both usually
appear upon the same instrument, and the same
consideration usually supports the obligation for
both the principal and the surety.

There is no merit in petitioners contention that the


complaint was prematurely filed because the
principal debtors cannot as yet be considered in
Surety I 399

default, there having been no judicial or extra-


judicial demand made by respondent corporation.
Petitioner has agreed that respondent corporation
may demand payment of the loan from her in case
the principal maker defaults, subject to the same
conditions expressed in the promissory note.
Significantly, paragraph (G) of the note states that
should I fail to pay in accordance with the above
schedule of payment, I hereby waive my right to
notice and demand. Hence, demand by the creditor
is no longer necessary in order that delay may exist
since the contract itself already expressly so
declares. As a surety, petitioner is equally bound
by such waiver.

Even if it were otherwise, demand on the sureties


is not necessary before bringing suit against them,
since the commencement of the suit is a sufficient
demand. On this point, it may be worth mention-
ing that a surety is not even entitled, as a matter of
right, to be given notice of the principals default.
Inasmuch as the creditor owes no duty of active di-
ligence to take care of the interest of the surety, his
mere failure to voluntarily give information to the
surety of the default of the principal cannot have
the effect of discharging the surety. The surety is
bound to take notice of the principals default and
to perform the obligation. He cannot complain that
the creditor has not notified him in the absence of a
special agreement to that effect in the contract of
suretyship.

The alleged failure of respondent corporation to


prove the fact of demand on the principal debtors,
by not attaching copies thereof to its pleadings, is
400 1 Credit Transactions: Notes and Cases

likewise immaterial. In the absence of a statutory


or contractual requirement, it is not necessary that
payment or performance of his obligation be first
demanded of the principal, especially where de-
mand would have been useless; nor is it a requisite,
before proceeding against the sureties, that the
principal be called on to account. The underlying
principle therefor is that a suretyship is a direct
contract to pay the debt of another. A surety is lia-
ble as much as his principal is liable, and absolute-
ly liable as soon as default is made, without any
demand upon the principal whatsoever or any no-
tice of default. As an original promissor and debtor
from the beginning, he is held ordinarily to know
every default of his principal.

Petitioner questions the propriety of the filing of a


complaint solely against her to the exclusion of the
principal debtors who allegedly were the only ones
who benefited from the proceeds of the loan. What
petitioner is trying to imply is that the creditor,
herein respondent corporation, should have pro-
ceeded first against the principal before suing on
her obligation as surety. We disagree.

A creditors right to proceed against the surety ex-


ists independently of his right to proceed against
the principal. Under Article 1216 of the Civil Code,
the creditor may proceed against any one of the so-
lidary debtors or some or all of them simultaneous-
ly. The rule, therefore, is that if the obligation is
joint and several, the creditor has the right to pro-
ceed even against the surety alone. Since, general-
ly, it is not necessary for a creditor to proceed
against a principal in order to hold the surety lia-
Surety 401

ble, where, by the terms of the contract, the obliga-


tion of the surety is the same as that of the princip-
al, then as soon as the principal is in default, the
surety is likewise in default, and may be sued im-
mediately and before any proceedings are had
against the principal. Perforce, in accordance with
the rule that, in the absence of statute or agreement
otherwise, a surety is primarily liable, and with the
rule that his proper remedy is to pay the debt and
pursue the principal for reimbursement, the surety
cannot at law, unless permitted by statute and in
the absence of any agreement limiting the applica-
tion of the security, require the creditor or obligee,
before proceeding against the surety, to resort to
and exhaust his remedies against the principal,
particularly where both principal and surety are
equally bound.

We agree with respondent corporation that its


mere failure to immediately sue petitioner on her
obligation does not release her from liability.
Where a creditor refrains from proceeding against
the principal, the surety is not exonerated. In other
words, mere want of diligence or forbearance does
not affect the creditors rights vis-vis the surety,
unless the surety requires him by appropriate no-
tice to sue on the obligation. Such gratuitous in-
dulgence of the principal does not discharge the
surety whether given at the principal's request or
without it, and whether it is yielded by the creditor
through sympathy or from an inclination to favor
the principal, or is only the result of passiveness.
The neglect of the creditor to sue the principal at
the time the debt falls due does not discharge the
surety, even if such delay continues until the prin-
402 1 Credit Transactions: Notes and Cases

cipal becomes insolvent. And, in the absence of


proof of resultant injury, a surety is not discharged
by the creditors mere statement that the creditor
will not look to the surety, or that he need not
trouble himself. The consequences of the delay,
such as the subsequent insolvency of the principal,
or the fact that the remedies against the principal
may be lost by lapse of time, are immaterial.

The raison d'etre for the rule is that there is nothing


to prevent the creditor from proceeding against the
principal at any time. At any rate, if the surety is
dissatisfied with the degree of activity displayed
by the creditor in the pursuit of his principal, he
may pay the debt himself and become subrogated
to all the rights and remedies of the creditor.

It may not be amiss to add that leniency shown to a


debtor in default, by delay permitted by the credi-
tor without change in the time when the debt
might be demanded, does not constitute an exten-
sion of the time of payment, which would release
the surety. In order to constitute an extension dis-
charging the surety, it should appear that the ex-
tension was for a definite period, pursuant to an
enforceable agreement between the principal and
the creditor, and that it was made without the con-
sent of the surety or with a reservation of rights
with respect to him. The contract must be one
which precludes the creditor from, or at least hind-
ers him in, enforcing the principal contract within
the period during which he could otherwise have
enforced it, and which precludes the surety from
paying the debt.
SuretyI 403

None of these elements are present in the instant


case. Verily, the mere fact that respondent corpora-
tion gave the principal debtors an extended period
of time within which to comply with their obliga-
tion did not effectively absolve herein petitioner
from the consequences of her undertaking. Besides,
the burden is on the surety, herein petitioner, to
show that she has been discharged by some act of
the creditor, herein respondent corporation, failing
in which we cannot grant the relief prayed for...

E. Zobel, Inc. v. Court of Appeals, G.R. No.


113931, May 6, 1998,290 SCRA 1.

... Respondent spouses Raul and Elea Claveria,


doing business under the name "Agro Brokers,"
applied for a loan with respondent Consolidated
Bank and Trust Corporation (now SOLIDBANK) in
the amount of Two Million Eight Hundred Seventy
Five Thousand Pesos (22, 875,000.00) to finance the
purchase of two (2) maritime barges and one tug-
boat which would be used in their molasses busi-
ness. The loan was granted subject to the condition
that respondent spouses execute a chattel mortgage
over the three (3) vessels to be acquired and that a
continuing guarantee be executed by Ayala Inter-
national Philippines, Inc., now herein petitioner E.
Zobel, Inc. in favor of SOLIDBANK. The respon-
dent spouses agreed to the arrangement. Conse-
quently, a chattel mortgage and a Continuing Gua-
ranty were executed.

Respondent spouses defaulted in the payment of


the entire obligation upon maturity. Hence, on
January 31,1991, SOLIDBANK filed a complaint for
404 1 Credit Transactions: Notes and Cases

sum of money with a prayer for a writ of prelini-


nary attachment, against respondents spouses and
petitioner... Petitioner moved to dismiss the com-
plaint on the ground that its liability as guarantor
of the loan was extinguished pursuant to Article
2080 of the Civil Code of the Philippines. It argued
that it has lost its right to be subrogated to the first
chattel mortgage in view of SOLIDBANK's failure
to register the chattel mortgage with the appropri-
ate government agency.

SOLIDBANK opposed the motion contending that


Article 2080 is not applicable because petitioner is
not a guarantor but a surety.

On February 18, 1993, the trial court issued an Or-


der, portions of which reads:
... "WHEREFORE, the Motion to Dismiss is hereby
denied and defendant E. Zobel, Inc., is ordered to
file its answer to the complaint within ten (10) days
from receipt of a copy of this Order."

Petitioner moved for reconsideration but was de-


nied on April 26,1993.

Thereafter, petitioner questioned said Orders be-


fore the respondent Court of Appeals, through a
petition for certiorari, alleging that the trial court
committed grave abuse of discretion in denying the
motion to dismiss.

On July 13,1993, the Court of Appeals rendered the


assailed decision the dispositive portion of which
reads:
Surety 1 405

"WHEREFORE, finding that respondent Judge has


not committed any grave abuse of discretion in is-
suing the herein assailed orders, We hereby DIS-
MISS the petition."

A motion for reconsideration filed by petitioner


was denied for lack of merit on February 15,1994.

Petitioner now comes to us via this petition ar-


guing that the respondent Court of Appeals erred
in its finding: (1) that Article 2080 of the New Civil
Code ... is not applicable to petitioner; (2) that peti-
tioner's obligation to respondent SOLIDBANK un-
der the continuing guaranty is that of a surety; and
(3) that the failure of respondent SOLIDBANK to
register the chattel mortgage did not extinguish pe-
titioner's liability to respondent SOLIDBANK.

We shall first resolve the issue of whether or not


petitioner under the "Continuing Guaranty" obli-
gated itself to SOLIDBANK as a guarantor or a su-
rety.

A contract of surety is an accessory promise by


which a person binds himself for another already
bound, and agrees with the creditor to satisfy the
obligation if the debtor does not. A contract of gua-
ranty, on the other hand, is a collateral undertaking
to pay the debt of another in case the latter does
not pay the debt.

Strictly speaking, guaranty and surety are nearly


related, and many of the principles are common to
both. However, under our civil law, they may be
distinguished thus: A surety is usually bound with
406 I Credit Transactions: Notes and Cases

his principal by the same instrument, executed at


the same time, and on the same consideration. He
is an original promissor and debtor from the be-
ginning, and is held, ordinarily, to know every de-
fault of his principal. Usually, he will not be dis-
charged, either by the mere indulgence of the cred-
itor to the principal, or by want of notice of the de-
fault of the principal, no matter how much he may
be injured thereby. On the other hand, the contract
of guaranty is the guarantor's own separate under-
taking, in which the principal does not join. It is
usually entered into before or after that of the prin-
cipal, and is often supported on a separate consid-
eration from that supporting the contract of the
principal. The original contract of his principal is
not his contract, and he is not bound to take notice
of its non-performance. He is often discharged by
the mere indulgence of th creditor to the principal,
and is usually not liable unless notified of the de-
fault of the principal.

Simply put, a surety is distinguished from a gua-


ranty in that a guarantor is the insurer of the sol-
vency of the debtor and thus binds himself to pay
if the principal is unable to pay while a surety is
the insurer of the debt, and he obligates himself to
pay if the principal does not pay.

Based on the aforementioned definitions, it appears


that the contract executed by petitioner in favor of
SOLIDBANK, albeit denominated as a "Continuing
Guaranty," is a contract of surety. The terms of the
contract categorically obligates petitioner as "sure-
ty" to induce SOLIDBANK to extend credit to res-
Suty 1 407

pondent spouses. This can be seen in the following


stipulations:
"For and in consideration of any existing indebted-
ness to you of AGRO BROKERS, a single proprie-
torship owned by MR. RAUL P. CLAVERIA, of le-
gal age, married and with business address ... (he-
reinafter called the Borrower), for the payment of
which the undersigned is now obligated to you as
surety and in order to induce you, in your discre-
tion, at any time or from time to time hereafter, to
make loans or advances or to extend credit in any
other manner to, or at the request or for the ac-
count of the Borrower, either with or without pur-
chase or discount, or to make any loans or ad-
vances evidenced or secured by any notes, bills re-
ceivable, drafts, acceptances, checks or other in-
struments or evidences of indebtedness ... upon
which the Borrower is or may become liable as
maker, endorser, acceptor, or otherwise, the under-
signed agrees to guarantee, and does hereby guar-
antee, the punctual payment, at maturity or upon
demand, to you of any and all such instruments,
loans, advances, credits and/or other obligations
herein before referred to, and also any and all other
indebtedness of every kind which is now or may
hereafter become due or owing to you by the Bor-
rower, together with any and all expenses which
may be incurred by you in collecting all or any
such instruments or other indebtedness or obliga-
tions hereinbefore referred to, and or in enforcing
any rights hereunder, and also to make or cause
any and all such payments to be made strictly in
accordance with the terms and provisions of any
agreement (g), express or implied, which has
(have) been or may hereafter be made or entered
408 I Credit Transactions: Notes and Cases

into by the Borrower in reference thereto, regard-


less of any law, regulation or decree, now or he-
reafter in effect which might in any manner affect
any of the terms or provisions of any such agree-
ments(s) or your right with respect thereto as
against the Borrower, or cause or permit to be in-
voked any alteration in the time, amount or man-
ner of payment by the Borrower of any such in-
struments, obligations or indebtedness..."

... One need not look too deeply at the contract to


determine the nature of the undertaking and the
intention of the parties. The contract clearly dis-
closes that petitioner assumed liability to SOLID-
BANK, as a regular party to the undertaking and
obligated itself as an original promissor. It bound
itself jointly and severally to the obligation with
the respondent spouses. In fact, SOLIDBANK need
not resort to all other legal remedies or exhaust
respondent spouses' properties before it can hold
petitioner liable for the obligation. This can be
gleaned from a reading of the stipulations in the
contract, to wit:
'... If default be made in the payment of any of the
instruments, indebtedness or other obligation he-
reby guaranteed by the undersigned, or if the Bor-
rower, or the undersigned should die, dissolve, fail
in business, or become insolvent, ... or if any funds
or other property of the Borrower, or of the under-
signed which may be or come into your possession
or control or that of any third party acting in your
behalf as aforesaid should be attached or dis-
trained, or should be or become subject to any
mandatory order of court or other legal process,
then, or any time after the happening of any such
Surety I 409
event any or all of the instruments of indebtedness
or other obligations hereby guaranteed shall, at
your option become (for the purpose of this gua-
ranty) due and payable by the undersigned forth-
with without demand of notice, and full power and
authority are hereby given you, in your discretion,
to sell, assign and deliver all or any part of the
property upon which you may then have a lien he-
reunder at any broker's board, or at public or pri-
vate sale at your option, either for cash or for credit
or for future delivery without assumption by you
of credit risk, and without either the demand, ad-
vertisement or notice of any kind, all of which are
hereby expressly waived. At any sale hereunder,
you may, at your option, purchase the whole or
any part of the property so sold, free from any
right of redemption on the part of the undersigned,
all such rights being also hereby waived and re-
leased. In case of any sale and other disposition of
any of the property aforesaid, after deducting all
costs and expenses of every kind for care, safekeep-
ing, collection, sale, delivery or otherwise, you may
apply the residue of the proceeds of the sale and
other disposition thereof, to the payment or reduc-
tion, either in whole or in part, of any one or more
of the obligations or liabilities hereunder of the
undersigned whether or not except for disagree-
ment such liabilities or obligations would then be
due, making proper allowance or interest on the
obligations and liabilities not otherwise then due,
and returning the surplus, if any, to the under-
signed; all without prejudice to your rights as
against the undersigned with respect to any and all
amounts which may be or remain unpaid on any of
410 1 Credit Transactions: Notes and Cases

the obligations or liabilities aforesaid at any


time(s)"...
'Should the Borrower at this or at any future time
furnish, or should he heretofore have furnished,
another surety or sureties to guarantee the pay-
ment of his obligations to you, the undersigned he-
reby expressly waives all benefits to which the un-
dersigned might be entitled under the provisions
of Article 1837 of the Civil Code (beneficio divi-
sion), the liability of the undersigned under any
and all circumstances being joint and several;"...

The use of the term "guarantee" does not ipso facto


mean that the contract is one of guaranty. Authori-
ties recognize that the word "guarantee" is fre-
quently employed in business transactions to de-
scribe not the security of the debt but an intention
to be bound by a primary or independent obliga-
tion. As aptly observed by the trial court, the inter-
pretation of a contract is not limited to the title
alone but to the contents and intention of the par-
ties.

Having thus established that petitioner is a surety,


Article 2080 of the Civil Code, relied upon by peti-
tioner, finds no application to the case at bar. In Bi-
col Savings and Loan Association v. Guinhawa20 , we
have ruled that Article 2080 of the New Civil Code
does not apply where the liability is as a surety, not
as a guarantor.

But even assuming that Article 2080 is applicable,


SOLIDBANK's failure to register the chattel

2 G.R No. L-62415, August 20,1990,188 SCRA 647.


Surety 1 411

mortgage did not release petitioner from the obli-


gation. In the Continuing Guaranty executed in fa-
vor of SOLIDBANK, petitioner bound itself to the
contract irrespective of the existence of any colla-
teral. It even released SOLIDBANK from any fault
or negligence that may impair the contract. The
pertinent portions of the contract so provides:
"... the undersigned (petitioner) who hereby agrees
to be and remain bound upon this guaranty, irres-
pective of the existence, value or condition of any
collateral, and notwithstanding any such change,
exchange, settlement, compromise, surrender, re-
lease, sale, application, renewal or extension, and
notwithstanding also that all obligations of the
Borrower to you outstanding and unpaid at any
time(s) may exceed the aggregate principal sum
herein above prescribed.
'This is a Continuing Guaranty and shall remain in
full force and effect until written notice shall have
been received by you that it has been revoked by
the undersigned, but any such notice shall not re-
lease the undersigned from any liability as to any
instruments, loans, advances or other obligations
hereby guaranteed, which may be held by you, or
in which you may have any interest, at the time of
the receipt of such notice. No act or omission of
any kind on your part in the premises shall in any
event affect or impair this guaranty, nor shall same
be affected by any change which may arise by rea-
son of the death of the undersigned, of any partner
(s) of the undersigned, or of the Borrower, or of
the accession to any such partnership of any one or
more new partners."...
412 1 Credit Transactions: Notes and Cases

In fine, we find the petition to be without merit as


no reversible error was committed by respondent
Court of Appeals in rendering the assailed deci-
sion...

International Finance Corporation v. Imperial


Textile Mills, Inc., G.R. No. 160324, November 15,
2005,475 SCRA 149.

The terms of a contract govern the rights and obli-


gations of the contracting parties. When the obi-
gor undertakes to be "jointly and severally" liable,
it means that the obligation is solidary. If solidary
liability was instituted to "guarantee" a principal
obligation, the law deems the contract to be one of
suretyship.

The creditor in the present Petition was able to


show convincingly that, although denominated as
a "Guarantee Agreement," the Contract was actual-
ly a surety. Notwithstanding the use of the words
"guarantee" and "guarantor," the subject Contract
was indeed a surety, because its terms were clear
and left no doubt as to the intention of the parties.

... The facts are narrated by the appellate court as


follows:
"On December 17, 1974, [Petitioner] International
Finance Corporation (IFC) and [Respondent] Phi-
lippine Polyamide Industrial Corporation (PPIC)
entered into a loan agreement wherein IFC ex-
tended to PPIC a loan of US$7,000,000.00, payable
in sixteen (16) semi-annual installments of
US$437,500.00 each, beginning June 1, 1977 to De-
cember 1, 1984, with interest at the rate of 10% per
Surety 1413

annum on the principal amount of the loan ad-


vanced and outstanding from time to time. The in-
terest shall be paid in US dollars semi-annually on
June 1 and December 1 in each year and interest for
any period less than a year shall accrue and be pro-
rated on the basis of a 360-day year of twelve 30-
day months.
"On December 17, 1974, a 'Guarantee Agreement'
was executed with ... Imperial Textile Mills, Inc.
(ITM), Grand Textile Manufacturing Corporation
(Grandtex) and lFC as parties thereto. ITM and
Grandtex agreed to guarantee PPIC's obligations
under the loan agreement.
"PPIC paid the installments due on June 1, 1977,
December 1, 1977 and June 1, 1978. The payments
due on December 1, 1978, June 1, 1979 and Decem-
ber 1, 1979 were rescheduled as requested by
PPIC. Despite the rescheduling of the installment
payments, however, PPIC defaulted. Hence, on
April 1, 1985, IFC served a written notice of default
to PPIC demanding the latter to pay the outstand-
ing principal loan and all its accrued interests. De-
spite such notice, PPIC failed to pay the loan and
its interests.
"By virtue of PPIC's failure to pay, IFC, together
with DBP, applied for the extrajudicial foreclosure
of mortgages on the real estate, buildings, machi-
nery, equipment plant and all improvements
owned by PPIC, located at Calamba, Laguna, with
the regional sheriff of Calamba, Laguna. On July
30, 1985, the deputy sheriff of Calamba, Laguna is-
sued a notice of extrajudicial sale. IFC and DBP
were the only bidders during the auction sale.
IFC's bid was for P99,269,100.00 which was equiva-
lent to US$5,250,000.00 (at the prevailing exchange
414 1 Credit Transactions: Notes and Cases

rate of F18.9084 = US$1.00). The outstanding loan,


however, amounted to US$8,083,967.00 thus leav-
ing a balance of US$2,833,967.00. PPIC failed to
pay the remaining balance.
"Consequently, IFC demanded ITM and Grandtex,
as guarantors of PPIC, to pay the outstanding bal-
ance. However, despite the demand made by IFC,
the outstanding balance remained unpaid.
"Thereafter, on May 20, 1988, IFC filed a complaint
with the RTC of Manila against PPIC and ITM for
the payment of the outstanding balance plus inter-
ests and attorney's fees.
"The trial court held PPIC liable for the payment of
the outstanding loan plus interests. It also ordered
PPIC to pay IFC its claimed attorney's fees. How-
ever, the trial court relieved ITM of its obligation as
guarantor. Hence, the trial court dismissed IFC's
complaint against ITM...
"Thus, apropos the decision dismissing the com-
plaint against ITM, IFC appealed [to the CA]."

... The CA reversed the Decision of the trial court, in-


sofar as the latter exonerated ITM from any obliga-
tion to IFC. According to the appellate court, ITM
bound itself under the '"Guarantee Agreement" to
pay PPIC's obligation upon default. ITM was not
discharged from its obligation as guarantor when
PPIC mortgaged the latter's properties to IFC. The
CA, however, held that ITM's liability as a guarantor
would arise only if and when PPIC could not pay.
Since PPIC's inability to comply with its obligation
was not sufficiently established, ITM could not im-
mediately be made to assume the liability.
Surety 1 415

The September 30, 2003 Resolution of the CA de-


nied reconsideration. Hence, this Petition.

... IFC claims that, under the Guarantee Agree-


ment, ITM bound itself as a surety to PPIC's obli-
gations proceeding from the Loan Agreement. For
its part, ITM asserts that, by the terms of the Guar-
antee Agreement, it was merely a guarantor and
not a surety. Moreover, any ambiguity in the
Agreement should be construed against IFC - the
party that drafted it... The premise of the Guaran-
tee Agreement is found in its preambular clause,
which reads:
"Whereas,
"(A) By an Agreement of even date herewith be-
tween IFC and PHILIPPINE POLYAMIDE IN-
DUSTRIAL CORPORATION (herein called the
Company), which agreement is herein called the
Loan Agreement, IFC agrees to extend to the Com-
pany a loan (herein called the Loan) of seven mil-
lion dollars ($7,000,000) on the terms therein set
forth, including a provision that all or part of the
Loan may be disbursed in a currency other than
dollars, but only on condition that the Guarantors
agree to guarantee the obligations of the Company
in respect of the Loan as hereinafter provided.
"(B) The Guarantors, in order to induce IFC to en-
ter into the Loan Agreement, and in consideration
of IFC entering into said Agreement, have agreed
so to guarantee such obligations of the Company."

The obligations of the guarantors are meticulously


expressed in the following provision:
416 I Credit Transactions: Notes and Cases

"Section 2.01. The Guarantors jointly and several-


ly, irrevocably, absolutely and unconditionally
guarantee, as primary obligors and not as sureties
merely, the due and punctual payment of the prin-
cipal of, and interest and commitment charge on,
the Loan, and the principal of, and interest on, the
Notes, whether at stated maturity or upon prema-
turity, all as set forth in the Loan Agreement and in
the Notes."

The Agreement uses "guarantee" and "guarantors,"


prompting ITM to base its argument on those
words. This Court is not convinced that the use of
the two words limits the Contract to a mere gua-
ranty. The specific stipulations in the Contract
show otherwise... While referring to ITM as a gua-
rantor, the Agreement specifically stated that the
corporation was "jointly and severally" liable. To
put emphasis on the nature of that liability, the
Contract further stated that ITM was a primary ob-
ligor, not a mere surety. Those stipulations meant
only one thing: that at bottom, and to all legal in-
tents and purposes, it was a surety.

Indubitably therefore, ITM bound itself to be soli-


darily liable with PPIC for the latter's obligations
under the Loan Agreement with IFC. ITM thereby
brought itself to the level of PPIC and could not be
deemed merely secondarily liable.

Initially, ITM was a stranger to the Loan Agree-


ment between PPIC and IFC. ITM's liability com-
menced only when it guaranteed PPIC's obliga-
tion. It became a surety when it bound itself soli-
Surety 1417

darily with the principal obligor. Thus, the appli-


cable law is as follows:
"Article 2047... Relevant to this case is Article
1216...

Pursuant to this provision, petitioner (as creditor)


was justified in taking action directly against res-
pondent... The Court does not find any ambiguity
in the provisions of the Guarantee Agreement.
When qualified by the term "jointly and severally,"
the use of the word "guarantor" to refer to a "sure-
ty" does not violate the law. As Article 2047 pro-
vides, a suretyship is created when a guarantor
binds itself solidarily with the principal obligor.
Likewise, the phrase in the Agreement - "as pri-
mary obligor and not merely as surety" - stresses
that ITM is being placed on the same level as
PPIC. Those words emphasize the nature of their
liability, which the law characterizes as a surety-
ship.

The use of the word "guarantee" does not ipso fac-


to make the contract one of guaranty. This Court
has recognized that the word is frequently em-
ployed in business transactions to describe the in-
tention to be bound by a primary or an indepen-
dent obligation. The very terms of a contract go-
vern the obligations of the parties or the extent of
the obligor's liability. Thus, this Court has ruled in
favor of suretyship, even though contracts were
denominated as a "Guarantor's Undertaking" or a
'Continuing Guaranty."

Contracts have the force of law between the par-


ties, who are free to stipulate any matter not con-
418 1 Credit Transactions: Notes and Cases

trary to law, morals, good customs, public order or


public policy. None of these circumstances are
present, much less alleged by respondent. Hence,
this Court cannot give a different meaning to the
plain language of the Guarantee Agreement.

Indeed, the finding of solidary liability is in line


with the premise provided in the "Whereas" clause
of the Guarantee Agreement. The execution of the
Agreement was a condition precedent for the ap-
proval of PPIC's loan from IFC. Consistent with
the position of EFC as creditor was its requirement
of a higher degree of liability from ITM in case
PPIC committed a breach. ITM agreed with the
stipulation in Section 2.01 and is now estopped
from feigning ignorance of its solidary liability.
The literal meaning of the stipulations control
when the terms of the contract are clear and there
is no doubt as to the intention of the parties.

We note that the CA denied solidary liability, on


the theory that the parties would not have ex-
ecuted a Guarantee Agreement if they had in-
tended to name ITM as a primary obligor. The ap-
pellate court opined that ITM's undertaking was
collateral to and distinct from the Loan Agree-
ment. On this point, the Court stresses that a sure-
tyship is merely an accessory or a collateral to a
principal obligation. Although a surety contract is
secondary to the principal obligation, the liability
of the surety is direct, primary and absolute; or
equivalent to that of a regular party to the under-
taking. A surety becomes liable to the debt and
duty of the principal obligor even without possess-
ing a direct or personal interest in the obligations
Surety I 419

constituted by the latter... With the present find-


ing that ITM is a surety, it is clear that the CA erred
in declaring the former secondarily liable. A surety
is considered in law to be on the same footing as
the principal debtor in relation to whatever is ad-
judged against the latter. Evidently, the dispositive
portion of the assailed Decision should be modified
to require ITM to pay the amount adjudged in fa-
vor of IFC.

... WHEREFORE, the Petition is hereby


GRANTED, and the assailed Decision and Resolu-
tion MODIFIED in the sense that Imperial Textile
Mills, Inc. is declared a surety to Philippine Polya-
mide Industrial Corporation. ITM is ORDERED to
pay International Finance Corporation the same
amounts adjudged against PPIC in the assailed De-
cision. No costs.

Philippine Blooming Mills, Inc. & Ching, v.


Court of Appeals, G.R. No. 142381, October 15,
2003, 413 SCRA 445.

... Ching was the Senior Vice President of PBM. In


his personal capacity and not as a corporate officer,
Ching signed a Deed of Suretyship dated 21 July
1977 binding himself as follows:
... as primary obligor(s) and not as mere guaran-
tor(s), hereby warrant to the TRADERS ROYAL
BANK, its successors and assigns, the due and
punctual payment by the following individuals
and/or companies/firms, hereinafter called the
DEBTOR(S), of such amounts whether due or not,
as indicated opposite their respective names, to
wit:
420 1 Credit Transactions: Notes and Cases

NAME OF DEBTOR(S) AMOUNT OF OBLIGA-


TION
PHIL. BLOOMING MILLS CORP. TEN MILLION
PESOS...
owing to said TRADERS ROYAL BANK, hereafter
called the CREDITOR, as evidenced by all notes,
drafts, overdrafts and other credit obligations of
every kind and nature contracted/incurred by said
DEBTOR(S) in favor of said CREDITOR. In case of
default by any and/or all of the DEBTOR(S) to pay
the whole or part of said indebtedness herein se-
cured at maturity, I/We, jointly and severally,
agree and engage to the CREDITOR, its successors
and assigns, the prompt payment, without demand
or notice from said CREDITOR, of such notes,
drafts, overdrafts and other credit obligations on
which the DEBTOR(S) may now be indebted or
may hereafter become indebted to the CREDITOR,
together with all interests, penalty and other bank
charges as may accrue thereon and all expenses
which may be incurred by the latter in collecting
any or all such instruments.
I/WE further warrant the due and faithful perfor-
mance by the DEBTOR(S) of all the obligations to
be performed under any contracts evidencing in-
debtedness/ obligations and any supplements,
amendments, charges or modifications made there-
to, including but not limited to, the due and punc-
tual payment by the said DEBTOR(S).
I/WE hereby expressly waive notice of acceptance
of this suretyship, and also presentment, demand,
protest and notice of dishonor of any and all such
instruments, loans, advances, credits, or other in-
debtedness or obligations hereinbefore referred to.
MY/OUR liability on this Deed of Suretyship shall
Surety 1 421

be solidary, direct and immediate and not contin-


gent upon the pursuit by the CREDITOR, its suc-
cessors or assigns, of whatever remedies it or they
may have against the DEBTOR(S) or the securities
or liens it or they may possess; and I/WE hereby
agree to be and remain bound upon this surety-
ship, irrespective of the existence, value or condi-
tion of any collateral, and notwithstanding also
that all obligations of the DEBTOR(S) to you out-
standing and unpaid at any time may exceed the
aggregate principal sum herein above stated.
In the event of judicial proceedings, I/WE hereby
expressly agree to pay the creditor for and as attor-
ney's fees a sum equivalent to TEN PER CENTUM
(10%) of the total indebtedness (principal and in-
terest) then unpaid, exclusive of all costs or ex-
penses for collection allowed by law.

On 24 March and 6 August 1980, TRB granted PBM


letters of credit on application of Ching in his ca-
pacity as Senior Vice President of PBM. Ching lat-
er accomplished and delivered to TRB trust re-
ceipts, which acknowledged receipt in trust for
TRB of the merchandise subject of the letters of
credit. Under the trust receipts, PBM had the right
to sell the merchandise for cash with the obligation
to turn over the entire proceeds of the sale to TRB
as payment of PBM's indebtedness. Letter of Cre-
dit No. 479 AD, covered by Trust Receipt No. 106,
has a face value of US$591,043, while Letter of Cre-
dit No. 563 AD, covered by Trust Receipt No. 113,
has a face value of US$155,460.34.

Ching further executed an Undertaking for each


trust receipt, which uniformly provided that:
422 I Credit Transactions: Notes and Cases

6. All obligations of the undersigned under the


agreement of trusts shall bear interest at the rate of
- per centum (-%) per annum from the date due
until paid.
7. [I]n consideration of the Trust Receipt, the un-
dersigned hereby jointly and severally undertake
and agree to pay on demand on the said BANK, all
sums and amounts of money which said BANK
may call upon them to pay arising out of, pertain-
ing to, and/or in any manner connected with this
receipt. In case it is necessary to collect the draft
covered by the Trust Receipt by or through an at-
torney-at-law, the undersigned hereby further
agree(s) to pay an additional of 10% of the total
amount due on the draft as attorney's fees, exclu-
sive of all costs, fees and other expenses of collec-
tion but shall in no case be less than P200.00"

On 27 April 1981, PBM obtained a P3,500,000 trust


loan from TRB. Ching signed as co-maker in the
notarized Promissory Note evidencing this trust
loan. The Promissory Note reads:
FOR VALUE RECEIVED THIRTY (30) DAYS after
date, I/We, jointly and severally, promise to pay
the TRADERS ROYAL BANK or order, at its Office
in 4th Floor, Kanlaon Towers Bldg., Roxas Blvd.,
Pasay City, the sum of Pesos: THREE MILLION
FIVE HUNDRED THOUSAND ONLY (P3,500,000.
00), Philippine Currency, with the interest rate of
Eighteen Percent (18%) per annum until fully paid.
In case of non-payment of this note at maturity,
I/We, jointly and severally, agree to pay an addi-
tional amount equivalent to two per cent (2%) of
the principal sum per annum, as penalty and col-
Surety 1 423

lection charges in the form of liquidated damages


until fully paid, and the further sum of ten percent
(10%) thereof in full, without any deduction, as and
for attorney's fees whether actually incurred or
not, exclusive of costs and other judicial/extra-
judicial expenses; moreover, I/We jointly and sev-
erally, further empower and authorize the TRAD-
ERS ROYAL BANK at its option, and without no-
tice to set off or to apply to the payment of this
note any and all funds, which may be in its hands
on deposit or otherwise belonging to anyone or all
of us, and to hold as security therefor any real or
personal property which may be in its possession
or control by virtue of any other contract.

PBM defaulted in its payment of Trust Receipt No.


106 (Letter of Credit No. 479 AD) for P959,611.96,
and of Trust Receipt No. 113 (Letter of Credit No.
563 AD) for P1,191,137.13. PBM also defaulted on
its P3,500,000 trust loan.

On 1 April 1982, PBM and Ching filed a petition for


suspension of payments with the Securities and
Exchange Commission ("SEC"), docketed as SEC
Case No. 2250. The petition sought to suspend
payment of PBM's obligations and prayed that the
SEC allow PBM to continue its normal business
operations free from the interference of its credi-
tors. One of the listed creditors of PBM was TRB.

On 9 July 1982, the SEC placed all of PBM's assets,


liabilities, and obligations under the rehabilitation
receivership of Kalaw, Escaler and Associates.
424 1 Credit Transactions: Notes and Cases

On 13 May 1983, ten months after the SEC placed


PBM under rehabilitation receivership, TRB filed
with the trial court a complaint for collection
against PBM and Ching. TRB asked the trial court
to order defendants to pay solidarily the following
amounts:
(1) P-6,612,132.74 exclusive of interests, penalties,
and bank charges [representing its indebtedness
arising from the letters of credit issued to its vari-
ous suppliers];
(2) P-4,831,361.11, exclusive of interests, penalties,
and other bank charges [due and owing from the
trust loan of 27 April 1981 evidenced by a promis-
sory note];
(3) P783,300.00 exclusive of interests, penalties, and
other bank charges [due and owing from the mon-
ey market loan of 1 April 1981 evidenced by a
promissory note];
(4) To order defendant Ching to pay P10,000,000.00
under the Deed of Suretyship in the event plaintiff
can not recover the full amount of PBM's indeb-
tedness from the latter;
(5) The sum equivalent to 10% of the total sum due
as and for attorney's fees;
(6) Such other amounts that may be proven by the
plaintiff during the trial, by way of damages and
expenses for litigation.

On 25 May 1983, TRB moved to withdraw the


complaint against PBM on the ground that the SEC
had already placed PBM under receivership. The
trial court thus dismissed the complaint against
PBM.
Srety 1425

On 23 June 1983, PBM and Ching also moved to


dismiss the complaint on the ground that the trial
court had no jurisdiction over the subject matter of
the case. PBM and Ching invoked the assumption
of jurisdiction by the SEC over all of PBM's assets
and liabilities.

TRB filed an opposition to the Motion to Dismiss.


TRB argued that (1) Ching is being sued in his per-
sonal capacity as a surety for PBM; (2) the SEC de-
cision declaring PBM in suspension of payments is
not binding on TRB; and (3) Presidential Decree
No. 1758 ("PD No. 1758"), which Ching relied on to
support his assertion that all claims against PBM
are suspended, does not apply to Ching as the de-
cree regulates corporate activities only.

In its order dated 15 August 1983, the trial court


denied the motion to dismiss with respect to Ching
and affirmed its dismissal of the case with respect
to PBM. The trial court stressed that TRB was
holding Ching liable under the Deed of Suretyship.
As Ching's obligation was solidary, the trial court
ruled that TRB could proceed against Ching as su-
rety upon default of the principal debtor PBM. The
trial court also held that PD No. 1758 applied only
to corporations, partnerships and associations and
not to individuals.

Upon the trial court's denial of his Motion for Re-


consideration, Ching fied a Petition for Certiorari
and Prohibition before the Court of Appeals. The
appellate court granted Ching's petition and or-
dered the dismissal of the case. The appellate court
ruled that the SEC assumed jurisdiction over Ching
426 1 Credit Transactions: Notes and Cases

and PBM to the exclusion of courts or tribunals of


coordinate rank.
TRB assailed the Court of Appeals' Decision before
this Court. In Traders Royal Bank v. Court of Ap-
peals21 , this Court upheld TRB and ruled that Ching
was merely a nominal party in SEC Case No. 2250.
Creditors may sue individual sureties of debtor
corporations, like Ching, in a separate proceeding
before regular courts despite the pendency of a
case before the SEC involving the debtor corpora-
tion.

In his Answer dated 6 November 1989, Ching de-


nied liability as surety and accommodation co-
maker of PBM. He claimed that the SEC had al-
ready issued a decision approving a revised reha-
bilitation plan for PBM's creditors, and that PBM
obtained the credit accommodations for corporate
purposes that did not redound to his personal ben-
efit. He further claimed that even as a surety, he
has the right to the defenses personal to PBM.
Thus, his liability as surety would attach only if, af-
ter the implementation of payments scheduled un-
der the rehabilitation plan, there would remain a
balance of PBM's debt to TRB. Although Ching
admitted PBM's availment of the credit accommo-
dations, he did not show any proof of payment by
PBM or by him... The trial court found Ching lia-
ble to TRB for P19,333,558.16 under the Deed of Su-
retyship. The trial court explained:
[Tihe liability of Ching as a surety attaches inde-
pendently from his capacity as a stockholder of the
Philippine Blooming Mills. Indisputably, under

21 G.R No. 78412, September 26,1989,177 SCRA 788.


Surety 1 427

the Deed of Suretyship defendant Ching uncondi-


tionally agreed to assume PBM's liability to the
plaintiff in the event PBM defaulted in the pay-
ment of the said obligation in addition to whatever
penalties, expenses and bank charges that may oc-
cur by reason of default. Clear enough, under the
Deed of Suretyship (Exh. J), defendant Ching
bound himself jointly and severally with PBM in
the payment of the latter's obligation to the plain-
tiff. The obligation being solidary, the plaintiff
Bank can hold Ching liable upon default of the
principal debtor. This is explicitly provided in Ar-
ticle 1216 of the New Civil Code already quoted
above.

... On appeal, Ching stated that as surety and soli-


dary debtor, he should benefit from the changed
nature of the obligation as provided in Article 1222
of the Civil Code... The appellate court stated:
... As surety of a corporation placed under rehabil-
itation receivership, Ching can answer separately
for the obligations of debtor... The Court of Ap-
peals denied Ching's Motion for Reconsideration
for lack of merit.

Hence, this petition... Ching asserted that the Deed


of Suretyship dated 21 July 1977 could not answer
for obligations not yet in existence at the time of its
execution. Specifically, Ching maintained that the
Deed of Suretyship could not answer for debts con-
tracted by PBM in 1980 and 1981. Ching contended
that no accessory contract of suretyship could arise
without an existing principal contract of loan.
Ching likewise argued that TRB could no longer
claim on the trust receipts because TRB had al-
428 I Credit Transactions: Notes and Cases

ready taken the properties subject of the trust re-


ceipts. Ching likewise maintained that his obliga-
tion as surety could not exceed the R1,373,415 ap-
portioned to PBM under the SEC-approved reha-
bilitation plan.

In its Comment, TRB asserted that the first two as-


signed errors raised factual issues not brought be-
fore the trial court. Furthermore, TRB pointed out
that Ching never presented PBM's rehabilitation
plan before the trial court. TRB also stated that the
Supreme Court ruling in Traders Royal Bank v. Court
of Appeals constitutes res judicata between the par-
ties. Therefore, TRB could proceed against Ching
separately from PBM to enforce in full Ching's lia-
bility as surety... The case before us is an offshoot
of the trial court's denial of Ching's motion to have
the case dismissed against him. The petition is a
thinly veiled attempt to make this Court reconsider
its decision in the prior case of Traders Royal Bank v.
Court of Appeals. This Court has already resolved
the issue of Ching's separate liability as a surety
despite the rehabilitation proceedings before the
SEC. We held in Traders Royal Bank that:
Although Ching was impleaded in SEC Case No.
2250, as a co-petitioner of PBM, the SEC could not
assume jurisdiction over his person and properties.
The Securities and Exchange Commission was em-
powered, as rehabilitation receiver, to take custody
and control of the assets and properties of PBM on-
ly, for the SEC has jurisdiction over corporations
only [and] not over private individuals, except
stockholders in an intra-corporate dispute (Sec. 5,
P.D. 902-A and Sec. 2 of P.D. 1758). Being a no-
minal party in SEC Case No. 2250, Ching's proper-
SuretyI 429

ties were not included in the rehabilitation recei-


vership that the SEC constituted to take custody of
PBM's assets. Therefore, the petitioner bank was
not barred from filing a suit against Ching, as a su-
rety for PBM. An anomalous situation would arise
if individual sureties for debtor corporations may
escape liability by simply co-filing with the corpo-
ration a petition for suspension of payments in the
SEC whose jurisdiction is limited only to corpora-
tions and their corporate assets...

Ching can be sued separately to enforce his liability


as surety for PBM, as expressly provided by Article
1216 of the New Civil Code... It is elementary that a
corporation has a personality distinct and separate
from its individual stockholders and members. Be-
ing an officer or stockholder of a corporation does
not make one's property the property also of the
corporation, for they are separate entities...

Ching's act of joining as a co-petitioner with PBM


in SEC Case No. 2250 did not vest in the SEC juris-
diction over his person or property, for jurisdiction
does not depend on the consent or acts of the par-
ties but upon express provision of law...

Traders Royal Bank has fully resolved the issue re-


garding Ching's liability as a surety of the credit
accommodations TRB extended to PBM. The deci-
sion amounts to res judicata which bars Ching
from raising the same issue again. Hence, the only
question that remains is the amount of Ching's lia-
bility. Nevertheless, we shall resolve the issues
Ching has raised in his attempt to escape liability
under his surety.
430 I Credit Transactions: Notes and Cases

Whether Ching is liablefor obligations PBM contracted


after execution of the Deed of Suretyship
Ching is liable for credit obligations contracted by
PBM against TRB before and after the execution of
the 21 July 1977 Deed of Suretyship. This is evi-
dent from the tenor of the deed itself, referring to
amounts PBM "may now be indebted or may he-
reafter become indebted" to TRB.

The law expressly allows a suretyship for "future


debts". Article 2053 of the Civil Code provides...

Whether Ching 's liabilityis limited to the amount stated


in PBM's rehabilitationplan
Ching would like this Court to rule that his liability
is limited, at most, to the amount stated in PBM's
rehabilitation plan. In claiming this reduced liabili-
ty, Ching invokes Article 1222 of the Civil Code...
In granting the loan to PBM, TRB required Ching's
surety precisely to insure full recovery of the loan
in case PBM becomes insolvent or fails to pay in
full. This was the very purpose of the surety.
Thus, Ching cannot use PBM's failure to pay in full
as justification for his own reduced liability to TRB.
As surety, Ching agreed to pay in full PBM's loan
in case PBM fails to pay in full for any reason, in-
cluding its insolvency.

TRB, as creditor, has the right under the surety to


proceed against Ching for the entire amount of
PBM's loan. This is clear from Article 1216...

Whether Ching is liablefor the trust receipts


Ching is still liable for the amounts stated in the
letters of credit covered by the trust receipts. Other
Surety I 431

than his bare allegations, Ching has not shown


proof of payment or settlement with TRB. Atty.
Vicente Aranda, TRB's corporate secretary and
First Vice President of its Human Resource Man-
agement Department, testified that the conditions
in the TRB board resolution presented by Ching
were not met or implemented... Ching also claims
that TRB prevented PBM from fulfilling its obliga-
tions under the trust receipts when TRB, together
with other creditor banks, took hold of PBM's in-
ventories, including the goods covered by the trust
receipts. Ching asserts that this act of TRB released
him from liability under the suretyship. Ching
forgets that he executed, on behalf of PBM, sepa-
rate Undertakings for each trust receipt expressly
granting to TRB the right to take possession of the
goods at any time to protect TRB's interests. TRB
may exercise such right without waiving its right
to collect the full amount of the loan to PBM. The
Undertakings also provide that any suspension of
payment or any assignment by PBM for the benefit
of creditors renders the loan due and demandable.
Thus, the separate Undertakings uniformly pro-
vide:
2. That the said BANK may at any time cancel the
foregoing trust and take possession of said mer-
chandise with the right to Sell and dispose of the
same under such terms and conditions it may
deem best, or of the proceeds of such of the same
as may then have been sold, wherever the said
merchandise or proceeds may then be found and
all the provisions of the Trust Receipt shall apply
to and be deemed to include said above-mentioned
merchandise if the same shall have been made up
or used in the manufacture of any other goods, or
432 1 Credit Transactions: Notes and Cases

merchandise, and the said BANK shall have the


same rights and remedies against the said mer-
chandise in its manufactured state, or the product
of said manufacture as it would have had in the
event that such merchandise had remained [in] its
original state and irrespective of the fact that other
and different merchandise is used in completing
such manufacture. In the event of any suspension,
or failure or assignment for the benefit of creditors
on the part of the undersigned or of the non-
fulfillment of any obligation, or of the non-
payment at maturity of any acceptance made un-
der said credit, or any other credit issued by the
said BANK on account of the undersigned or of the
non-payment of any indebtedness on the part of
the undersigned to the said BANK, all obligations,
acceptances, indebtedness and liabilities whatsoev-
er shall thereupon without notice mature and be-
come due and payable and the BANK may avail of
the remedies provided herein.

Presidential Decree No. 115 ... expressly allows


TRB to take possession of the goods covered by the
trust receipts... Thus, even though TRB took pos-
session of the goods covered by the trust receipts,
PBM and Ching remained liable for the entire
amount of the loans covered by the trust receipts.

Absent proof of payment or settlement of PBM and


Ching's credit obligations with TRB, Ching's liabil-
ity is what the Deed of Suretyship stipulates, plus
the applicable interest and penalties. The trust re-
ceipts, as well as the Letter of Undertaking dated
16 April 1980 executed by PBM, stipulate in writ-
ing the payment of interest without specifying the
suety 1433

rate. In such a case, the applicable interest rate


shall be the legal rate, which is now 12% per an-
num. This is in accordance with Central Bank Cir-
cular No. 416...

On the other hand, the Promissory Note evidenc-


ing the 13,500,000 trust loan provides for 18% in-
terest per annum plus 2% penalty interest per an-
num in case of default. This stipulated interest
should continue to run until full payment of the
123,500,000 trust loan. In addition, the accrued in-
terest on all the credit accommodations should
earn legal interest from the date of filing of the
complaint pursuant to Article 2212 of the Civil
Code... The trial court found and the appellate
court affirmed that the outstanding principal
amounts as of the filing of the complaint with the
trial court on 13 May 1983 were 1-959,611.96 under
Trust Receipt No. 106, F1,191,137.13 under Trust
Receipt No. 113, and 13,500,000 for the trust loan.
As extracted from TRB's Statement of Account as
of 31 October 1991, the accrued interest on the trust
receipts and the trust loan as of the filing of the
complaint on 13 May 1983 were 1311,387.51 under
Trust Receipt No. 106, P-338,739.81 under Trust Re-
ceipt No. 113, and 11,287,616.44 under the trust
loan. The penalty interest on the trust loan
amounted to -2137,315.07. Ching did not rebut this
Statement of Account which TRB presented during
trial.

... WHEREFORE, we AFFIRM the decision of the


Court of Appeals with MODIFICATION. Petition-
er Alfredo Ching shall pay respondent Traders
Royal Bank the following (1) on the credit accom-
434 1 Credit Transactions: Notes and Cases

modations under the trust receipts, the total prin-


cipal amount of 22,150,749.09 with legal interest at
12% per annum from 14 May 1983 until full pay-
ment; (2) on the trust loan evidenced by the Prom-
issory Note, the principal sum of 1P3,500,000 with
20% interest per annum from 14 May 1983 until full
payment; (3) on the total accrued interest as of 13
May 1983, 1-2,075,058.84 with 12% interest per an-
num from 14 May 1983 until full payment. Peti-
tioner Alfredo Ching shall also pay attorney's fees
to respondent Traders Royal Bank equivalent to 5%
of the total principal and interest.

F. Distinguished from Joint and Solidary Obligations

Art. 2047... If a person binds himself solidarily


with the principal debtor, the provisions of Sec-
tion 4, Chapter 3, Title I of this Book shall be ob-
served. In such case the contract is called a sure-
tyship.

While it appears that, from the perspective of the princip-


al creditor, no apparent distinction exists between a sure-
ty and a joint and several debtor, because the right of the
creditor to compel full payment is the same, a suretyship
is distinguished from a joint and solidary obligation in
that a surety has the right to indemnification and the
right to subrogation as against the principal debtor, while
a joint and solidary debtor has only a right to reim-
bursement as against the co-debtors.

Articles 2066 and 2067 of the Civil Code apply to surety-


ships, thus giving the surety the right to indemnification
as against the principal debtor for, among others, the total
amount of the debt that the surety has paid, and the right
Surety 1435

to be subrogated to all the rights that the creditor had


against the principal debtor.
Art. 2066. The [surety] who pays for a 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 debtor, even
though it did not earn interest for the creditor;
(3) The expenses incurred by the [surety] after
having notified the debtor that payment had been
demanded of him;
(4) Damages, if they are due.

Art. 2067. The [surety] who pays is subrogated by


virtue thereof to all the rights which the creditor
had against the debtor.
If the [surety] has compromised with the creditor,
he cannot demand of the debtor more than what
he has really paid.

Article 1217 of the Civil Code, on the other hand, applies


to joint and solidary debtors, giving the joint and solidary
debtor the right to be reimbursed for the share that cor-
responds to each co-debtor.
Art. 1217. Payment made by one of the solidary
debtors extinguishes the obligation. If two or
more solidary debtors offer to pay, the creditor
may choose which offer to accept.
He who made the payment may claim from his
co-debtors
only the share which corresponds to each, with
the interest for the payment already made. If the
payment is made before the debt is due, no inter-
est for the intervening period may be demanded.
436 1 Credit Transactions: Notes and Cases

When one of the solidary debtors cannot, because


of his insolvency, reimburse his share to the deb-
tor paying the obligation, such share shall be
borne by all his co-debtors, in proportion to the
debt of each.

Thus, although Article 2047 provides that the provisions


of Section 4, Chapter 3, Title I, Book IV of the Civil Code
on joint and several obligations shall be observed in the
case of suretyships, these provisions cannot be made ap-
plicable without first considering the nature of a surety-
ship as an accessory, ancillary or collateral obligation.

Escano & Silos v. Ortigas, Jr., G. R. No. 151953,


June 29, 2007, 526 SCRA 26.

The main contention raised in this petition is that


petitioners are not under obligation to reimburse
respondent, a claim that can be easily debunked.
The more perplexing question is whether this ob-
ligation to repay is solidary, as contended by res-
pondent and the lower courts, or merely joint as
argued by petitioners.

On 28 April 1980, Private Development Corpora-


tion of the Philippines (PDCP) entered into a loan
agreement with Falcon Minerals, Inc. (Falcon)
whereby PDCP agreed to make available and lend
to Falcon the amount of US$320,000.00, for specific
purposes and subject to certain terms and condi-
tions. On the same day, three stockholders-officers
of Falcon, namely: respondent Rafael Ortigas, Jr.
(Ortigas), George A. Scholey and George T. Scho-
ley executed an Assumption of Solidary Liability
whereby they agreed "to assume in [their] indi-
SuretyI 437

vidual capacity, solidary liability with [Falcon] for


the due and punctual payment" of the loan con-
tracted by Falcon with PDCP. In the meantime,
two separate guaranties were executed to guaran-
tee the payment of the same loan by other stock-
holders and officers of Falcon, acting in their per-
sonal and individual capacities. One Guaranty
was executed by petitioner Salvador Escafio (Es-
cafro), while the other by petitioner Mario M. Silos
(Silos), Ricardo C. Silverio (Silverio), Carlos L. In-
ductivo (Inductivo) and Joaquin J. Rodriguez (Ro-
driguez).

Two years later, an agreement developed to cede


control of Falcon to Escafio, Silos and Joseph M.
Matti (Matti). Thus, contracts were executed whe-
reby Ortigas, George A. Scholey, Inductivo and
the heirs of then already deceased George T. Scho-
ley assigned their shares of stock in Falcon to Es-
cafio, Silos and Matti. Part of the consideration
that induced the sale of stock was a desire by Or-
tigas, et al., to relieve themselves of all liability
arising from their previous joint and several un-
dertakings with Falcon, including those related to
the loan with PDCP. Thus, an Undertaking dated
11 June 1982 was executed by the concerned par-
ties, namely: with Escafio, Silos and Matti identi-
fied in the document as "SURETIES," on one
hand, and Ortigas, Inductivo and the Scholeys as
"OBLIGORS," on the other. The Undertaking
reads in part:
3. That whether or not SURETIES are able to im-
mediately cause PDCP and PAIC to release OB-
LIGORS from their said guarantees [sic], SURE-
TIES hereby irrevocably agree and undertake to
438 1 Credit Transactions: Notes and Cases

assume all of OBLIGORs' said guarantees [sic] to


PDCP and PAIC under the following terms and
conditions:
a. Upon receipt by any of [the] OBLIGORS of any
demand from PDCP and/or PAIC for the pay-
ment of FALCON's obligations with it, any of
[the] OBLIGORS shall immediately inform SURE-
TIES thereof so that the latter can timely take ap-
propriate measures;
b. Should suit be impleaded by PDCP and/or
PAIC against any and/or all of OBLIGORS for col-
lection of said loans and/or credit facilities, SU-
RETIES agree to defend OBLIGORS at their own
expense, without prejudice to any and/or all of
OBLIGORS impleading SURETIES therein for con-
tribution, indemnity, subrogation or other relief in
respect to any of the claims of PDCP and/or
PAIC; and
c. In the event that any of [the] OBLIGORS is for
any reason made to pay any amount to PDCP
and/or PAIC, SURETIES shall reimburse OBLI-
GORS for said amount/s within seven (7) calen-
dar days from such payment;
4. OBLIGORS hereby waive in favor of SURETIES
any and all fees which may be due from FALCON
arising out of, or in connection with, their said
guarantees [sic].

Falcon eventually availed of the sum of


US$178,655.59 from the credit line extended by
PDCP. It would also execute a Deed of Chattel
Mortgage over its personal properties to further
secure the loan. However, Falcon subsequently
defaulted in its payments. After PDCP foreclosed
on the chattel mortgage, there remained a subsist-
SuretyI 439

ing deficiency of P5,031,004.07, which Falcon did


not satisfy despite demand.

On 28 April 1989, in order to recover the indeb-


tedness, PDCP filed a complaint for sum of money
with the Regional Trial Court of Makati (RTC)
against Falcon, Ortigas, Escafio, Silos, Silverio and
Inductivo.... For his part, Ortigas filed together
with his answer a cross-claim against his co-
defendants Falcon, Escaflo and Silos, and also ma-
nifested his intent to file a third-party complaint
against the Scholeys and Matti. The cross-claim
lodged against Escafio and Silos was predicated
on the 1982 Undertaking, wherein they agreed to
assume the liabilities of Ortigas with respect to the
PDCP loan.

Escafio, Ortigas and Silos each sought to seek a


settlement with PDCP. The first to come to terms
with PDCP was Escafo, who in December of 1993,
entered into a compromise agreement whereby
he agreed to pay the bank P1,000,000.00. In ex-
change, PDCP waived or assigned in favor of Es-
cafio one-third (1/3) of its entire claim in the com-
plaint against all of the other defendants in the
case. The compromise agreement was approved
by the RTC in a Judgment dated 6 January 1994.

Then on 24 February 1994, Ortigas entered into his


own compromise agreement with PDCP, allegedly
without the knowledge of Escafto, Matti and Silos.
Thereby, Ortigas agreed to pay PDCP
P1,300,000.00 as "full satisfaction of the PDCP's
claim against Ortigas," in exchange for PDCP's re-
lease of Ortigas from any liability or claim arising
440 1 Credit Transactions: Notes and Cases

from the Falcon loan agreement, and a renuncia-


tion of its claims against Ortigas.

In 1995, Silos and PDCP entered into a Partial


Compromise Agreement whereby he agreed to
pay 12500,000.00 in exchange for PDCP's waiver of
its claims against him.

In the meantime, after having settled with PDCP,


Ortigas pursued his claims against Escafio, Silos
and Matti, on the basis of the 1982 Undertaking.
He initiated a third-party complaint against Matti
and Silos, while he maintained his cross-claim
against Escafio. In 1995, Ortigas filed a motion for
Summary Judgment in his favor against Escafio,
Silos and Matti. On 5 October 1995, the RTC is-
sued the Summary Judgment, ordering Escafto, Si-
los and Matti to pay Ortigas, jointly and severally,
the amount of 1,300,000.00, as well as P20,000.00
in attorney's fees. The trial court ratiocinated that
none of the third-party defendants disputed the
1982 Undertaking, and that "the mere denials of
defendants with respect to non-compliance of Or-
tigas of the terms and conditions of the Undertak-
ing, unaccompanied by any substantial fact which
would be admissible in evidence at a hearing, are
not sufficient to raise genuine issues of fact neces-
sary to defeat a motion for summary judgment,
even if such facts were raised in the pleadings." In
an Order dated 7 March 1996, the trial court de-
nied the motion for reconsideration of the Sum-
mary Judgment and awarded Ortigas legal inter-
est of 12% per annum to be computed from 28
February 1994.
From the Summary Judgment, recourse was had
Surety 1 441

by way of appeal to the Court of Appeals. Escafio


and Silos appealed jointly while Matti appealed
by his lonesome. In a Decision dated 23 January
2002, the Court of Appeals dismissed the appeals
and affirmed the Summary Judgment... Hence,
the present petition for review filed by Escafio and
Silos. Two main issues are raised. First, petitioners
dispute that they are liable to Ortigas on the basis
of the 1982 Undertaking, a document which they
do not disavow and have in fact annexed to their
petition. Second, on the assumption that they are
liable to Ortigas under the 1982 Undertaking, peti-
tioners argue that they are jointly liable only, and
not solidarily. Further assuming that they are lia-
ble, petitioners also submit that they are not liable
for interest and if at all, the proper interest rate is
6% and not 12%... The vital issue actually raised
before us is whether petitioners were correctly
held liable to Ortigas on the basis of the 1982 Un-
dertaking in this Summary Judgment. An exami-
nation of the document reveals several clauses
that make it clear that the agreement was brought
forth by the desire of Ortigas, Inductivo and the
Scholeys to be released from their liability under
the loan agreement which release was, in turn,
part of the consideration for the assignment of
their shares in Falcon to petitioners and Matti. The
whereas clauses manifest that Ortigas had bound
himself with Falcon for the payment of the loan
with PDCP, and that "amongst the consideration
for OBLIGORS and/or thei