Sheryl Sectrans Reviewer

INTRODUCTION

MEANING AND SCOPE OF CREDIT TRANSACTIONS

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

TWO TYPES OF CREDIT TRANSACTIONS/ CONTRACTS OF SECURITY

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

2. Unsecured transactions or contracts of personal security – fulfillment by the debtor issupported only by a promise to pay or the personal commitment of another

EXAMPLES OF CREDIT TRANSACTIONS

1. Bailment contracts2. Contracts of guaranty and suretyship3. Mortgage4. Antichresis5. Concurrence and preference of credits

MEANING OF SECURITY

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

KINDS OF SECURITY

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

2. Property or Real Security – when a mortgage, pledge, antichresis, charge, or lien orother device used to have property held, out of which the person to be made secure can becompensated for loss.

BAILMENT

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

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

PARTIES IN BAILMENT

1. Bailor – the giver; the one who delivers the possession of the thing bailed2. Bailee – the recipient; the one who receives the possession or custody of the thing delivered

KINDS OF BAILMENT

1. For the sole benefit of the bailorExamples: gratuitous deposit and mandatum (bailment of goods where the bailee gratuitouslyundertakes to do some act with respect to the property)

Sheryl IID 2002 PAGE 1

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

2. For the sole benefit of the baileeExamples: commodatum and gratuitous simple loan or mutuum

Ex. Xilca borrows my white blouse because she forgot to bring clothes to change from herPasay City Jail outfit. Only Xilca is benefited, not me. Or, Xilca borrows P10 from me withoutinterest.

3. For the benefit of both partiesExamples: deposit for a compensation, involuntary deposit, pledge, bailments for hire

Ex. Ansky pawns her huge diamond earrings at Villarica Pawnshop. The pawnshop givesher P10,000 and a pawn ticket. Both parties benefit – Ansky gets fast cash, while thepawnshop gets to keep the huge diamond earrings to make sure that Ansky pays, and in caseshe doesn’t they can sell the earrings.

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

BAILMENT FOR HIRE

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

KINDS OF BAILMENT FOR HIRE

1. Hire of things – goods are delivered for the temporary use of the hirer2. Hire of service – goods are delivered for some work or labor upon it by the bailee3. Hire for carriage of goods – goods are delivered either to a common carrier or to a private

person for the purpose of being carried from place to place4. Hire of custody – goods are delivered for storage

I. LOAN

GENERAL PROVISIONS

Art. 1933. By the contract of loan, one of the parties delivers to another, either something notconsumable so that the latter may use the same for a certain time and return it, in which case thecontract is called a commodatum; or money or other consumable thing, upon condition that thesame amount of the same kind and quality shall be paid, in which case the contract is simply calleda loan or mutuum.

Commodatum is essentially gratuitous.

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

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

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


ESSENTIAL ELEMENTS OF A CONTRACT IN THE CONTEXT OF A LOANConsent of the parties Borrower and LenderObject PropertyCause or Consideration For the lender: right to demand the return of the

thing

For the borrower: acquisition of the thing

CHARACTERISTICS OF THE CONTRACT OF LOAN

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

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

CAUSE OR CONSIDERATION IN A CONTRACT OF LOAN

1. As to the borrower: the acquisition of the thing2. As to the lender: the right to demand its return or of its equivalent

KINDS OF LOAN

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

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

LOANS DISTINGUISHED FROM CREDIT

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

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

The concession of a credit necessarily involves the granting of loans up to the limit of the amountfixed in the credit.

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


DISTINCTIONS BETWEEN COMMODATUM AND SIMPLE LOAN

COMMODATUM SIMPLE LOANSUBJECT MATTER Not consumable Money or other consumable

thingOWNERSHIP Retained by the lender Transferred to the borrower

GRATUITOUS? Gratuitous Default rule is that it isgratuitous BUT the parties maystipulate interest, in which case,

it becomes onerousPAYMENT BY BORROWER Borrower must return the same

thing loanedBorrower need only pay the

same amt of the same kind andquality

KIND OF PROPERTY Real or personal Personal onlyPURPOSE Temporary use or possession Consumption

WHEN LENDER MAY DEMAND Lender may demand return ofthe thing before the expirationof the term in case of urgent

need

Lender may not demand returnof the thing before the lapse of

the term agreed upon

LOSS OF THE THING Suffered by the lender (since heis the owner)

Suffered by the borrower even ifthrough fortuitous event

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

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

ACCEPTED PROMISE TO MAKE A FUTURE LOAN

Borrower goes to Lender and asks if he could borrow P10K at 6% interest per annum. Lender saysokay, I will lend you the money. This is an accepted promise to make a future loan. It is aconsensual contract and is binding upon the parties. But is there a contract of loan at this point? No, because loan is a real contract and is perfected onlyupon delivery of the thing.

FORM OF LOAN

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

CHAPTER 1 COMMODATUM

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

KINDS OF COMMODATUM

1. Ordinary commodatum2. Precarium – one whereby the bailor may demand the thing loaned at will


NATURE OF COMMODATUM

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

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

2. It is essentially gratuitous.

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

4. The subject matter is generally non-consumable real or personal property, thoughconsumable goods may also be the subject of commodatum if the purpose is not theconsumption of the object (ex. Display of a bottle of wine).

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

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

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

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

i. if there is a stipulation to the contrary; or ii. if the nature of the thing forbids it.

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

OBLIGATIONS OF THE BORROWER

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

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

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

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

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


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

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

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

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

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

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

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

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

OBLIGATIONS OF THE LENDER

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

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

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

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

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


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

4. Obligation to refund extraordinary expenses

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

b. Extraordinary expenses arising from actual use of the thing – Extraordinaryexpenses arising on the occasion of the actual use of the thing shall be borne by thelender and borrower on a 50-50 basis, unless there is a contrary stipulation.

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

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

a. There is a flaw or defect in the thing loaned;b. The flaw or defect is hiddenc. The lender is aware of the flawd. The lender does not advise the borrower of the flawe. The borrower suffers damages by reason of the flaw or defect

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

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

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

ABANDONMENT OF THING BY THE LENDER

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

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


CHAPTER 2 SIMPLE LOAN OR MUTUUM

DEFINITION

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

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

CONSIDERATION

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

NO CRIMINAL LIABILITY FOR ESTAFA FOR FAILURE TO PAY

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

FUNGIBLE AND CONSUMABLE THINGS

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

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

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

BARTER

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

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

DISTINCTIONS BETWEEN MUTUUM, COMMODATUM, AND BARTER

MUTUUM COMMODATUM BARTERSUBJECT MATTER Money or other fungible

thingsNon-fungible things Non-fungible things

OBLIGATION OF THEBORROWER

Return the equivalent Return the identicalthing borrowed

Return the equivalent

GRATUITOUS? May be gratuitous oronerous

Always gratuitous Onerous


FORM OF PAYMENT

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

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

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

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

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

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

INTEREST

Requisites for Recovery of Interest:

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

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

Stipulation of interest

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

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


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

3. Increases in interest must also be expressly stipulated.

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

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

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

An escalation clause is valid when it is accompanied by a De-Escalation Clause. A de-escalationclause is a clause which provides that the rate of interest agreed upon will also be automaticallyreduced. There must be a specified formula for arriving at the adjusted interest rate, over whichneither party has any discretion.

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

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

Where to base the rate of damages:a. Rate in the penalty clause agreed upon by the partiesb. If there is no penalty clause, additional interest based on the regular interest rate of

the loanc. If there is no regular interest, additional interest is equivalent to the legal interest rate

(12%)

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

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

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

Borrower should pay 10K + 10% of 10K (interest on the loan) + 10% of 10K (penaltyinterest)

= 10K + 1K + 1K= 12,000

The penalty interest in this case is 10% since there is no penalty interest stipulated.The additional interest is based on the regular interest of the loan.

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

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


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

If interest is payable in kind:

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

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

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

General Rule: Accrued interest shall not earn interestExceptions:

1. When judicially demanded (Art. 2212)2. Express stipulation – Also called compounding interest where the parties agree that

accrued interest shall be added to the principal and the resulting total amount shall earninterest.

A stipulation as to compounding interest must be in writing.

How does compounding interest work?

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

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

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

110,000 + 10% of 110,000 = 110,000 + 11,000= 121,000

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

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

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

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

II. GUARANTY AND SURETYSHIP

CHAPTER 1 NATURE AND EXTENT OF GUARANTY

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


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

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

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

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

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

2. S ubsidiary and Conditional: It takes effect only when the principal debtor fails in hisobligation.

3. U nilateral:

a. It gives rise to obligations on the part of the guarantor in relation to the creditor andnot vice-versa. (Although after its fulfillment, the principal debtor should indemnifythe guarantor, but this obligation is only incidental)

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

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

Classification of Guaranty

1. In the broad sense:

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

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

2. As to origin:

a. conventional: by agreement of the parties

b. legal: imposed by law

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

3. As to consideration:

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

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

4. As to the person guaranteed:

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


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

5. As to scope and extent:

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

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

Second Paragraph of Art. 2047: Suretyship

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

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

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

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

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

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

Nature of a Surety’s Undertaking

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

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

3. Liability arises only if principal debtor is held liable: If the principal debtor and thesurety are held liable, their liability to pay the creditor would be solidary. But, the surety doesnot incur liability unless and until the principal debtor is held liable.

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

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

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

d. An accommodation party (one who signs an instrument as maker, drawer, acceptor, orindorser without consideration and only for the purpose of lending his name) is, ineffect, a surety. He is thus liable to pay the holder of the instrument, subject toreimbursement from the accommodated party.


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

(sgd) Tuks (sgd) ShakLino Chris Kapunan Sherwin Shakramy

Is Tuks a surety or a solidary debtor? According to JPSP, based on this documentabove, Tuks is a solidary debtor. Remember the rule? I promise to pay signed by twoparties = solidary. To make sure that he’s merely a guarantor or surety, Tuks shouldsign a separate guaranty agreement. Besides, a guaranty must be express. It is notpresumed.

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

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

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

Guaranty Distinguished from Suretyship:

GUARANTY SURETYSHIPGuarantor promises to answer for the debt,default or miscarriage of the principal

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

Liability of the guarantor depends upon anindependent agreement to pay the obligation ifthe primary debtor fails to do so

Surety assumes liability as a regular party tothe undertaking

The engagement of the guarantor is a collateralundertaking

Surety is charged as an original promisor

The guarantor is secondarily liable A surety is primarily liable

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

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

Illustration:

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

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

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

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


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

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

GENERAL RULE: Guaranty is gratuitous.EXCEPTION: Guaranty is onerous only if it is stipulated.

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

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

Art. 2049 A married woman may guarantee an obligation without the husband’s consent, but shallnot thereby bind the conjugal partnership, except in cases provided by law.

Art. 94 of the Family CodeThe absolute community of property shall be liable for:

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

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

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

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

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

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

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

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

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

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

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

Illustration:


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

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

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

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

Nevertheless, a guaranty may be constituted to guarantee the performance of a voidable orunenforceable contract. It may also guarantee a natural obligation.

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

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

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

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

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

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

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

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

Examples:

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

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

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

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


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

Example: G guarantees the 10K loan that B owes L and any other indebtedness that B mayincur against L. This is a valid guaranty because there is already an existing obligation (the10K loan).

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

Guaranty of Conditional Obligations

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

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

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

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

Since the contract of guaranty is a subsidiary and accessory contract, the guarantor’s liabilitycannot exceed that of the principal obligation. If the guarantor binds himself for more than theliability of the principal debtor, his liability shall be reduced.

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

How do you opt out of this rule?

Example: G guaranteed B’s 100K obligation to L to the extent of 100K. As an extraconsideration for lending the money, L wants an additional 20K from guarantor (gravy,according to JPSP). Since 2054 provides that the guarantor cannot bind himself for more thanthe principal debtor, how do the parties opt out of the rule?

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

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

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

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

Reason for the rule: Because a guarantor assumes an obligation to pay for another’s debt withoutany benefit to himself. Thus, it has to be certain that he really intends to incur such an obligation andthat he proceeds with consciousness of what he is doing.

Form required for Guaranty

Guaranty must be IN WRITING


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

Construction of Guaranty

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

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

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

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

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

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

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

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

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

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

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

EXCEPTION:

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

On the other hand, if the guarantor makes a direct or unconditional promise of guaranty (and notmerely an offer), there is no need for acceptance and notice of such acceptance from the creditor.

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


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

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

Ideally, the qualifications of a guarantor are the ff:

1. Integrity2. Capacity to bind himself3. Sufficient property to answer for the obligation which he guarantees

But the creditor can waive these requirements.

Jurisdiction over the guarantor:

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

Effect of Subsequent Loss of Qualifications

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

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

When may the creditor demand another guarantor?

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

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

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

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

When may the creditor NOT demand another guarantor?

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

CHAPTER 2 EFFECTS OF GUARANTY

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


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

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

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

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

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

Art. 2059. This excussion shall not take place:

1. If the guarantor has expressly renounced it;

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

3. In case of insolvency of the debtor;

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

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

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

EXCEPTIONS:

1. Under Art. 2059 2. If the guarantor does not comply with Art. 20603. If the guarantor is a judicial bondsman and sub-surety (Art. 2084)4. Where a pledge or mortgage has been given by him as a special security.5. If he fails to interpose it as a defense before judgment is rendered against him.

EXCEPTIONS UNDER ART. 2059 (RUSIA)

1. When the right is Renounced or waived. • The waiver must be made in express terms.

2. When the liability assumed by the guarantor is Solidary. • In this case, he becomes a surety with primary liability.

3. When the principal debtor is Insolvent.

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

Examples:

B borrows 100K from L guaranteed by G. B has 1M in assets which are all still with him and1.5M in liabilities. B defaults. Can L collect from G right away?

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


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

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

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

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

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

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

• If exhausting the properties of the debtor would be useless since it would still not satisfythe obligation, the guarantor cannot require the creditor to resort to these legal remediesagainst the debtor anymore, since doing so would be a useless formality.

• In this case, it is not even necessary that the debtor is judicially declared insolvent orbankrupt.

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

Example: B borrowed 100k guaranteed by G. B defaulted. Lender made a demand forpayment against G. G paid. Later, G found out that he had the benefit of excussion. Hedemanded reimbursement from Lender. Can G recover?

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

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

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

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

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

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

Additional Requisites in Order to Claim the Benefit of Excussion

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

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


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

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

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

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

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

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

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

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

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

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

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

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

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

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

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


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

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

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

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

When is there a benefit of division among several guarantors?

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

1. There should be several guarantors2. Of only one debtor3. For the same debt

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

Exceptions:

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

2. If solidarity has been expressly stipulated.

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

The indemnity comprises:

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

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

(TIED)

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

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


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

3. E xpenses – This refers only to those expenses that the guarantor has to satisfy in accordancewith law as a consequence of the guaranty. This is limited to those expenses incurred by theguarantor after having notified the debtor that payment has been demanded of him by thecreditor.

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

Exceptions to the right to indemnity of the guarantor

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

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

3. Waiver

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

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

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

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

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

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

Compromise

B owes lender P1M. Lender was a good friend of Guarantor and agreed that if G became liable, hewould only have to pay P500K. If B defaults and Guarantor pays P500K, he can only recover P500Kfrom B, not the original P1M.

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

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

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


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

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

Obligation of the guarantor before he pays the creditor

Before he pays the creditor, guarantor should first give notice to the principal debtor. If he does notgive notice, the debtor may enforce all the defenses which he could have set up against the creditor atthe time of payment.

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

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

Art. 2069. If the debt was for a period and the guarantor paid it before it become due, he cannotdemand reimbursement of the debtor until the expiration of the period unless the payment has beenratified by the debtor.

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

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

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

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

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

1. It is a gratuitous guaranty 2. The guarantor was prevented by a fortuitous event from informing the debtor of payment3. Creditor becomes insolvent

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

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

(1) When he is sued for payment;


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

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

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

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

(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 asecurity that shall protect him from any proceedings by the creditor and from the danger ofinsolvency of the debtor.

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

1. Right to be released if lender agrees Release from the guaranty requires that the lender consent because the guaranty is actually

a contract between the lender and the guarantor

2. Right to demand a security

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

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

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

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

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

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

1. by virtue of a judicial demand; or2. when the principal debtor is insolvent.

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

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


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

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

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

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

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

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

A, B, C are guarantors of X. D is a guarantor of A. C pays the entire obligation. A becomes insolvent.Can C reimburse from D? Yes, according to Art. 2075.

CHAPTER 3 EXTINGUISHMENT OF GUARANTY

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

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

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

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

When is an alteration material?

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

Examples:

1. Increase in the principal amount, regardless of the extent of the liability assumed by theguarantor

2. Substitution of the principal debtor3. Extension or shortening of the term of the principal debt

In these cases, the guaranty is extinguished altogether.

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


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

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

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

A, B, C are guarantors of X for 90K. The creditor releases A without the consent of B and C. Therelease should benefit B and C to the extent of 30K (A’s share). They shall be liable only for 60K or30K each.

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

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

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

But if the guarantor consents or waives his right under this article in advance, the extension will notextinguish the guaranty.

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

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

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

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

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

Chapter 4 Legal and Judicial Bonds

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


PLEDGE AND MORTGAGE

PROVISIONS COMMON TO PLEDGE AND MORTGAGEArticle 2085. The following requisites are essential to the contracts of pledge and mortgage:

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

(2)That the pledgor or mortgagor be the absolute owner of the thing pledged or mortgaged;

(3)That the persons constituting the pledge or mortgage have the free disposal of their propertyand in the absence thereof, that they be legally authorized for the purpose.

(4)Third persons who are not parties to the principal obligation may secure the latter by pledging ormortgaging their own property.

Article 2086. The provisions of article 2052 are applicable to a pledge or mortgage.

[A guaranty cannot exist without a valid obligation. However, it may guarantee the performance of avoidable or unenforceable contract or a natural obligation]

Article 2087. It is also of the essence of these contracts that when the principal obligation becomesdue, the things in which the pledge or mortgage consists may be alienated for the payment to thecreditor.

WHAT IS PLEDGE?

It is a contract by virtue of which the debtor delivers to the creditor or to a third person a movableor a document involving incorporeal rights for the purpose of securing the fulfillment of aprincipal obligation with the understanding that when the obligation is fulfilled, the thing deliveredshall be returned with all its fruits and accessions.

What are the kinds of pledge?

Pledge may be either:

1. Voluntary or conventional (created by agreement of the parties);

2. Legal (by operation of law).

What are the characteristics of pledge? [RAUS]

Pledge is:

1. Real, because it is perfected by delivery of the thing pledged.

2. Acessory, because it has no independent existence.

3. Unilateral, because it creates an obligation solely on the part of the creditor to return thething pledged upon fulfillment of the principal obligation.

4. Subsidiary, because the obligation of the creditor does not arise until fulfillment of theprincipal obligation.

WHAT IS THE CONSIDERATION IN PLEDGE?

If the pledgor is also the debtor, the consideration is the principal contract.

If the pledgor is a third person, the cause it the compensation received or the liberality of the pledgor.

WHAT ARE THE DIFFERENCES BETWEEN PLEDGE AND MORTGAGE?

1. Mobility – pledge is constituted on movables; mortgage on immovables.

2. Delivery – pledge requires delivery for perfection; mortgage does not.

Cayo IID 2002 PAGE 29

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

A LOAN IS SECURED BY BOTH A PLEDGE AND A GUARANTY. CAN THE CREDITOR REFUSEPAYMENT BY THE GUARANTOR AND CHOOSE TO FORECLOSE IN ORDER TO SATISFY THEDEBT?

No, payment by the guarantor cannot be refused.

WHAT ARE THE ESSENTIAL REQUISITES OF PLEDGE AND MORTGAGE? [PRADO]

1. Purpose - To secure fulfillment of principal obligation;

2. Real – There must be delivery of the thing.

3. Alienation – when the principal obligation becomes due and the debtor defaults, the thingmay be alienated to satisfy the former.

4. Disposal – Pledgor/mortgagor must have free disposal of the thing or capacity to dispose.

5. Ownership – Pledgor/mortgagor must be the absolute owner of the thing;

PURPOSE: To secure fulfillment of a principal obligation

WHAT IF THE THING PLEDGED/MORTGAGED IS SUBSEQUENTLY LOST; WHO BEARS THELOSS? IS THE PRINCIPAL OBLIGATION EXTINGUISHED?

The pledgor bears the loss. Remember that there hasn’t been transfer of ownership.

The principal obligation is of course not extinguished, the pledge/mortgage is only accessory.However, the debtor must replace the thing or lose the benefit of the period.

Pledge/mortgage is a direct lien on the property. It is better than guarantee because the propertypledged can be sold upon default by the debtor, unlike in guaranty where several requirements haveto be complied with first.

PROBLEM: D TRANSFERS PROPERTY TO C AND AT THE SAME TIME EXECUTES ANINDEMNITY AGREEMENT; OR D TRANSFERS PROPERTY TO C TO SECURE AN EXISTINGOBLIGATION. HOW WILL THE TRANSFER BE CHARACTERIZED?

Both transfers will be characterized as pledges.

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

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

ALIENATION: When the principal obligation becomes due and thedebtor defaults, the thing may be alienated to satisfy the former.

DOES THE CREDITOR HAVE TO GO TO COURT TO ENFORCE THE PLEDGE OR MORTGAGE?

No, to require litigation would be to nullify the lien and defeat the purpose of the contract.

FREE DISPOSAL:


WHAT DO “FREE DISPOSAL” AND “CAPACITY TO DISPOSE” OF THE PROPERTY MEAN?

Free disposal means that the property is not subject to any claim by a third person.

Capacity to dispose means that though the pledgor/mortgagor does not have free disposal, the thirdperson with a claim authorized him to dispose (tingin ko lang).

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

Rule on consent:

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

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

Pledge or mortgage your conjugal property without your spouse’s signature. In case the property isforeclosed, you can raise the defense that there was no consent (remember, half consent is noconsent!)

What if the pledge was constituted to secure an obligation of the family business, doesn’t this redoundto the benefit of the conjugal partnership?

No, JPSP said that the pledge of conjugal property con only be considered to redound to the benefit ofthe partnership if the family business is constituting pledges.

If you are the pledgee/mortgagee, check if pledgor/mortgagor has authority to dispose of theproperty.

Another example on free disposal or legal authority:

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

OWNERSHIP:

CAN FUTURE PROPERTY BE PLEDGED?

No, it is essential that the pledgor be the absolute owner of the thing.

Note: It is the sale and not the registration in the LTO that transfers ownership of a vehicle.

Note: A co-owner can only pledge/mortgage his ideal share in the co-ownership.

Note: A mortgagor can rely on what is on the face of the Torrens title.

WHAT IS MEANT BY ABSOLUTE OWNERSHIP?

BOTH BENEFICIAL AND LEGAL TITLE must vested in the pledgor/mortgagor

Ex. Trustee is legal owner of shares of stock; trustor is beneficial owner: Neither can pledge theshares.

Pledge/mortgage can’t be constituted without a principal obligation even if there is a subsequentprincipal obligation. This is different from situation where the lender extends a credit line for 1M,though borrower has not yet drawn, the credit line can still be secured via pledge/mortgage.

Ex. deed of assignment/absolute sale to secure fulfillment of obligation this is a mortgage or animplied trust according to the SC.

The pledgor/mortgagor must be absolute owner of the thing or the property. The creditor may rely onthe title/stock certificate if there is no notice of defect in title.

However, failure of the pledgor to present the thing is a red flag that should put the pledgee on guardas to the pledgor’s right to pledge the thing.


Though the pledgor must own the thing and have free disposal of it, see the following problemdiscussed in class:

Ex. On day 1, stocks are sold to X with the condition that the sale will be effective if X tops the bar.

On day 2, X pledges the stocks.

On day 3, the bar exam results come out, with X in the number one spot.

Is the pledge valid?

Yes, the pledge is valid. Remember Oblicon, conditional obligations? The effects of a conditionalobligation to give, when the condition happens, retroact to the date of the constitution of theobligation. OWNERSHIP RETROACTS TO DAY 1.

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

As long as the pledge is registered in a public document, it is valid and binding as to third persons.

Ex: Day 1 - X receives from A shares of stock with the resolutory condition that they shall be returnedto A if X does not pass the bar.

Day 2 – X pledges the shares.

Day 3 – X fails the bar.

Is the pledge valid?

Yes. As long as the pledgee registered the pledge in a public instrument, such pledge is binding on A.

*But if you use the argument that the effects retroact, doesn’t that mean that when X pledged thethings, he wasn’t the owner? I suppose the public instrument is stronger than the legal fiction.

CAN THE CREDITOR IMMEDIATELY ACCEPT A PLEDGE FURNISHED BY A DEBTOR IF THEPLEDGE BELONGS TO A THIRD PERSON?

No, the creditor cannot require on the word of the pledgor/mortgagor alone, he must exercise duecare and make sure the pledge/mortgage has given consent. This is especially true in the bankingindustry, which is impressed with public interest.

WHAT IS THE CONSEQUENCE THEN IF THE CREDITOR DOES NOT VERIFY WITH THEPLEDGOR/MORTGAGOR?

The pledge/mortgage is null and void. Article 599 gives the owner of a movable who has beenunlawfully deprived thereof the right to recover the same.

(1)Article 2088. The creditor cannot appropriate the things given by way of pledge or mortgage, ordispose of them. Any stipulation to the contrary is null and void.

WHAT DOES THE CREDITOR WITH THE PLEDGE/MORTGAGE WHEN THE DEBTOR DEFAULTS?

The creditor can move for the sale of the thing pledged or mortgaged.

WHAT IF THE CREDITOR WANTS TO ACQUIRE THE THING?

He may purchase it at the public auction.

WHAT IF THERE IS A STIPULATION THAT THE CREDITOR WILL ACQUIRE THE THING UPONDEFAULT?

The stipulation (pactum commissorium) is null and void.

WHAT ARE THE REQUISITES FOR PACTUM COMMISSORIUM TO EXIST?

1. There should be a pledge/mortgage;

2. There should be a stipulation for AUTOMATIC appropriation or the thing in case of default bythe debtor.

ARE THERE ANY EXCEPTIONS TO PACTUM COMMISSORIUM?


Yes, Article 2112 provides that if the thing pledged or mortgaged is not sold in two public auctions,the creditor may appropriate the same.

WHAT IS THE REASON FOR THE PROHIBITION?

The value of the thing pledged or mortgaged is usually more than the amount of the obligation.

WHAT HAPPENS TO THE CONTRACT OF PLEDGE/MORTGAGE IF THERE IS A STIPULATION OFPACTUM COMMISSORIUM; IS IT VOID?

No, only the stipulation is void; the principal contract will subsist.

HOW CAN YOU OPT OUT OF THE PROHIBITION ON PACTO COMMISSORIO?

1. You can enter into another contract subsequent to the pledge/mortgage. The prohibitionapplies only to stipulations made in the contract of pledge/mortgage.

2. The debtor can voluntarily cede the property to the creditor. This would in effect be a novationof the pledge/mortgage.

3. There can be a stipulation where the debtor merely promises to sell; non-compliance wouldgive the creditor, not a right to the property, but an action for damages.

4. There can be a stipulation granting the creditor authority to take possession and notownership of the property upon foreclosure.

Examples on pactum commissorium:

Ex. X corporation pledges shares; the pledge agreement states that pledgee has authority to instructCorporate Secretary of X to transfer shares in name of pledgee in case of default. VALID?

NO. The execution of document transferring the shares is only a confirmation of the sale that wasalready consummated automatically.

Ex. If the agreement is that, upon default, pledgee sells the things pledged at market price andapplies profits to the outstanding obligation. Valid?

Yes. There is no automatic transfer of ownership. In fact, the sale of the thing to satisfy the obligationis the essence of pledge.

Ex. Upon default, pledgor conveys property to pledgee by dation; and for the purpose, pledgee isattorney in fact of pledgor. Valid?

YES. It is not automatic; there is need for another agreement to be entered into.

Ex. Pledgee has the option to purchase the thing upon default at price certain. Valid?

Yes. There must be a subsequent sale; it is not automatic.

Remember, for PC to exist, the EFFECTIVE ACT IS DEFAULT, upon which, there is automatic transferof ownership.

Article 2089. A pledge or mortgage is indivisible, even though the debt may be divided among thesuccessors in interest of the debtor or of the creditor.

Therefore, the debtor’s heir who has paid a part of the debt cannot ask for the proportionate share ofextinguishment of the pledge or mortgage as long as the debt is not completely satisfied.

Neither can the creditor’s heir who has received his share of the debt return the pledge or cancel themortgage, to the prejudice of the other heirs who have not yet been paid.

From these provisions is excepted the case in which, there being several things given in mortgage orpledge, each one of them guarantees only a determinate portion of credit.

The debtor, in this case, shall have the right to the extinguishment of the pledge or mortgage as theportion of the debt for which each thing is specially answerable is satisfied.

Article 2090. The indivisibility of a pledge or mortgage is not affected by the fact that the debtorsare not solidarily liable.


WHAT DO YOU MEAN PLEDGE/MORTGAGE IS INDIVISIBLE?

Ex: 1M Loan. It was secured by REM. The REM covered several (100) condominium units. Inaccordance with the schedule, there was payment of 100K, can you ask release of correspondingamount of units?

No release. Pledge is indivisible.

WHAT ARE THE EXCEPTIONS TO INDIVISIBILITY:

1. Where each one of several thing guarantees a determinate portion of credit.

Ex: If you have 100 mortgages securing corresponding portion of the loan, then when thecorresponding portion is paid, the corresponding pledge/mortgage is extinguished. All 100 mortgagesmay be in the same document.

Or, if the parties agree to allow partial discharge of the pledge/mortgage. How? Cancelpledge/mortgage and constitute a new pledge/mortgage.The downside is that you must again paydoc. stamps and reg. fees, unlike in the document with 100 mortgages, where the fees are only paidonce.

2. If there was only partial release of the loan. CB v. CA. The bank only released a portion of theloan; the court ordered a corresponding portion of the REM to be released.

3. Where there was failure of consideration. Creditor took over management but the businessfailed.

Article 2091. The contract of pledge or mortgage may secure all kinds of obligations, be they pureor subject to a suspensive or resolutory condition.

Pledge/mortgage may secure all sorts of valid, voidable, unenforceable obligations.

Article 2092. A promise to constitute a pledge or mortgage gives rise only to a personal actionbetween the contracting parties, without prejudice to the criminal responsibility incurred by himwho defrauds another, by offering in pledge or mortgage as unencumbered, things which he knewwere subject to some burden, or by misrepresenting himself to be the owner of the same.

PROVISIONS APPLICABLE ONLY TO PLEDGE

Article 2093. In addition to the requisites prescribed in article 2085, it is necessary, in order toconstitute the contract of pledge, that the thing pledged be placed in the possession of thecreditor, or of a third person by common agreement.

Remember. Pledge/mortgage are real contracts.

If you agree, but don’t deliver to the pledgee or a third person/s, there is no pledge but there is anagreement to enter into a pledge.

Can delivery be made to the pledgor?

Yes, if he is acting as agent of pledgee or where the thing pledged is so unwieldy as to make deliveryimpossible, constructive delivery is allowed.

What may be the objects of pledge?

Movables within the commerce of man.

Delivery may be the actual thing or a title (certificates of deposit, stocks).

Must be indorsed. Shares of stock not negotiable so no indorsement is required, however, for safetyreasons, the same may be required.

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


Article 2095. Incorporeal rights, evidenced by negotiable instruments, bills of lading, shares ofstock, bonds, warehouse receipts and similar documents may also be pledged. The instrumentproving the right pledged shall be delivered to the creditor, and if negotiable, must be indorsed.

Article 2096. A pledge shall not take effect against third persons if a description of the thingpledged and the date of the pledge do not appear in a public instrument.

The problem here is: how do third persons check if the thing is pledged when the thing isn’trepresented by some sort of title which can be annotated?

They can’t but they should exercise diligence. Red flags would be failure or inability of debtor to showthe thing or the title to the thing.

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

Article 2097. With the consent of the pledgee, the thing pledged may be alienated by the pledgor orowner, subject to the pledge.

The ownership of the thing pledged is transmitted to the vendee or transferee as soon as the pledgeeconsents to the alienation, but the latter shall continue in possession.

Ex: pledgor pledges property to pledgee to secure a loan. Pledge is in a public instrument. Pledgor sellproperty to third person/s without notice to pledgee – sale is valid but transfer of ownership issuspended until pledgee consents.

Why would the pledgee want to be informed – administrative purposes; who gets property whenobligation is paid.

Article 2098. The contract of pledge gives a right to the creditor to retain the thing in his possessionor in that of a third person to whom it has been delivered, until the debt is paid.

Article 2099. The creditor shall take care of the thing pledged with the diligence of a good father ofa family; he has a right to the reimbursement of the expenses made for its preservation, and isliable for its loss or deterioration, in conformity with the provisions of this Code.

Article 2100. The pledgee cannot deposit the thing pledged with a third person, unless there is astipulation authorizing him to do so.

The pledgee is responsible for the acts of his agents or employees with respect to the thing pledged.

Remedy of pledgor if pledgee deposits it with a third party without authority?

The pledgor may demand extrajudicial deposit of the thing under 2104 or deposit with a thirdperson/s in 2106.

If the pledgee deposits the thing with a third person without authorization, can the pledgor demandresolution of the pledge agreement?

Yes. Substantial breach under 1191 gives the injured party the right to resolve the obligation. It canbe argued that the principal consideration was that the custodian be the pledgee; now if the creditortransfers possession, it’s a principal breach.

Article 2101. The pledgor has the same responsibility as a bailor in commodatum in the case underarticle 1951.

[The pledgor who, knowing the flaws of the thing pledged, does not advise the pledgee of the same,shall be liable to the latter of the damages which he may suffer by reason thereof.]

Article 2102. If the pledge earns or produces fruits, income, dividends, or interests, the creditorshall compensate what he receives with those which are owing him; but if none are owing him, orinsofar as the amount may exceed that which is due, he shall apply it to the principal. Unless thereis a stipulation to the contrary, the pledge shall extend to the interest and earnings of the rightpledged.


In case of a pledge of animals, their offspring shall pertain to the pledgor or owner of animalspledged, but shall be subject to the pledge, if there is no stipulation to the contrary.

The creditor who receives the fruits should apply them to whatever amount is owing (obligations dueand payable), if not due, the fruits just form part of the pledge.

If the period is for the benefit of the pledgee, even if the obligation is not due, he may compensateagainst the interest or the principal, as the case may be.

Ex: Lender lends Borrower money, payable upon demand. To secure the loan, B pledges a goat. Herethe benefit of the period is for the creditor, L. L may then take the goat’s milk and offspring andcompensate against what is owing him even if the obligation is not yet due.

Article 2103. Unless the thing pledged is expropriated, the debtor continues to be the ownerthereof.

Nevertheless, the creditor may bring the actions which pertain to the owner of the thing pledged inorder to recover it from, or defend it against a third person.

If the thing is expropriated, the thing will continue with respect to the thing given. labo!

Article 2104. The creditor cannot use the thing pledged, without the authority of the owner, and ifhe should do so, or should misuse the thing in any other way, the owner may ask that it bejudicially or extrajudicially deposited.

When the preservation of the thing pledged requires its use, it must be used by the creditor but onlyfor that purpose.

The creditor can only use the thing if he is authorized or its preservation requires use.

If he misuses it, the pledgor can demand extrajudicial deposit.

Article 2105. The debtor cannot ask for the return of the thing pledged against the will of thecreditor, unless and until he has paid the debt and its interest, with expenses in a proper case.

Article 2106. If through the negligence or willful act of the pledgee, the thing pledged is in danger ofbeing lost or impaired, the pledgor may require that it be deposited with a third person.

Though the pledgor cannot demand return of the thing unless the obligation is fulfilled, if the thingpledged is in danger of being lost or impaired through the pledgee’s willful act or negligence, he mayrequire its deposit with a third person.

Article 2107. If there are reasonable grounds to fear the destruction or impairment of the thingpledged, without the fault of the pledgee, the pledgor may demand the return of the thing, uponoffering another thing in pledge, provided the latter is of the same kind as the former and not ofinferior quality, and without prejudice to the right of the pledgee under the provisions of thefollowing article.

The pledgee is bound to advise the pledgor, without delay, of any danger to the thing pledged.

Article 2108. If, without the fault of the pledgee, there is danger of destruction, impairment, ordiminution in value of the thing pledged, he may cause the same to be sold at a public sale. Theproceeds of the auction shall be a security for the principal obligation in the same manner as thething originally pledged.

If the thing is in danger of diminution or destruction, without the pledgee’s fault, the pledgor maydemand its return, provided he replaces it with another of the same kind and quality.

Despite the pledgor’s right above, in the same situation, the pledgee may opt to sell the thing andkeep the proceeds; the pledgee’s right takes precedence over the pledgor’s. In this case, the proceedsof the sale shall be security for the debt.

In 2108, upon due date, if the cash value is less than the principal obligation, the creditor can stillrecover the balance from the debtor, unlike in foreclosure. this looks important.


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

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

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

Article 2110. If the thing pledged is returned by the pledgee to the pledgor or owner, the pledge isextinguished. ANY STIPULATION TO THE CONTRARY SHALL BE VOID.

If subsequent to the perfection of the pledge, the thing is in the possession of the pledgor or owner,there is a prima facie presumption that the same has been returned by the pledgee. Thissame presumption exists if the thing pledged is in the possession of a third person who hasreceived it from the pledgor or owner after the constitution of the pledge.

If after the perfection of the pledge, the property is in the possession of the pledgor, as owner, thepresumption is that it was returned and extinction of the pledge, UNLESS the owner holds it as agentof the pledgee.

*Article 2111. A statement in writing by the pledgee that he renounces or abandons the pledge issufficient to extinguish the pledge. For this purpose, neither the acceptance by the pledgor orowner, nor the return of the thing pledged is necessary, the pledgee becoming a depositary.

PROBLEM: TO SECURE HIS LOAN, BORROWER PLEDGED HIS CAR TO LENDER. OUT OF THE KINDNESSOF HIS HEART, LENDER COMPOSED A LETTER RENOUNCING THE PLEDGE. HE USED THE CAR TODRIVE TO THE POST OFFICE AND MAILED THE LETTER.

WHILE DRIVING HOME, LENDER SPOTTED BORROWER WITH LENDER’S WIFE AND FELT VERY ANGRYAND JEALOUS.

WHEN BORROWER RECEIVED THE LETTER, HE WENT TO LENDER’S HOUSE TO RECOVER THE CAR BUTLENDER REFUSED AND TOLD BORROWER TO PISS OFF. CAN LENDER REFUSE TO RETURN THE CAR?

No. See Article 2111.

Article 2112. The creditor to whom the credit has not been satisfied in due time, may proceedbefore a Notary Public to the sale of the thing pledged. This sale shall be made at a public auction,and with notification to the debtor and the owner of the thing pledged in a proper case, stating theamount for which the public sale is to be held.

If at the first auction the thing is not sold, a second one with the same formalities shall be held; andif at the second auction there is no sale either, the creditor may appropriate the thing pledged. Inthis case he shall be obliged to give an acquittance for his entire claim.

WHAT ARE THE FORMALITIES REQUIRED FOR THE NOTARIAL SALE?

(1) the debt is due and unpaid;

(2) the sale must be at a public auction;

(3) there must be notice to the pledgor and owner, stating the amount due; and

(4) the sale must be with the intervention of a notary public.

How is the public sale conducted?

Default rule: Proceed before a Notary Public and ask him to conduct a notarial sale. The notarysupervises the sale of the pledged property, drafts the rules and notifies the debtor and the owner.

Is there a period required for notification?


No particular period is required by law. Notice can be given right before close of office the daypreceding the sale. Before that date, debtor already defaulted; he should have known a notarial salewas forthcoming.

The reason, according to JPSP, is, if there were a period, the pledgor would be able to litigate andobtain an injunction.

Can it be a private sale?

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

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

Article 2113. At the public auction, the pledgor or owner may bid. He shall, moreover, have a betterright if he should offer the same terms as the highest bidder.

The pledgee may also bid, but his offer shall not be valid if he is the only bidder.

The pledgor is allowed to bid and all things being equal, his bid shall be preferred over that of others.The law wants to conserve the property in the owner.

The pledgee may also bid, but his offer shall not be valid if he is the only bidder because the lawseeks to prevent fraud. Fraud is possible if the parties had stipulated that the debtor shall be allowedto the excess and the creditor, who is bidding alone, bids low.

Article 2114. All bids at the public auction shall offer to pay the purchase price at once. If any otherbid is accepted, the pledgee is deemed to have been received the purchase price, as far as thepledgor or owner is concerned.

Pledgee can waive cash requirement, but that is his lookout.

Article 2115. The sale of the thing pledged shall extinguish the principal obligation, whether or notthe proceeds of the sale are equal to the amount of the principal obligation, interest and expensesin a proper case.

If the price of the sale is more than said amount, the debtor shall not be entitled to the excess,unless it is otherwise agreed. If the price of the sale is less, neither shall the creditor be entitled torecover the deficiency, notwithstanding any stipulation to the contrary.

The obligation is extinguished when the pledge is sold regardless of whether the proceeds are less ormore than the amount of the obligation. Unlike in a mortgage, there can be recovery of deficiency.

IN PLEDGE, YOU CAN STIPULATE THAT THE DEBTOR WILL BE ENTITLED TO THE EXCESSBUT YOU CAN’T STIPULATE THAT THE CREDITOR WILL BE ALLOWED TO RECOVERDEFICIENCY.

PROBLEM: IN THE PLEDGE AGREEMENT, THE PARTIES STIPULATED THAT, IN CASE OF NOTARIALSALE, THE PLEDGOR SHALL BE ENTITLED TO THE EXCESS AND THE PLEDGEE SHALL BE ENTITLED TORECOVER THE DEFICIENCY. ARE THE STIPULATIONS VALID?

The stipulation that the debtor shall be entitled to the excess is valid. The stipulation giving thecreditor the right to recover the deficiency is void. See Article 2115.

HOW DO YOU GUARD AGAINST THE SITUATION OF NOT BEING ABLE TO RECOVER THE DEFICIENCYIF YOU ARE THE PLEDGEE?

Set a minimum bid (if this is actually allowed; JPSP says yes, book says no)

OR

Instead of selling the thing, just sue for the entire obligation.


OR

Stipulate that if the value of the pledge goes under a certain amount, then the debtor shall be obligedto pledge additional securities.

Ex: 1M obligation, 1.5M worth of stocks pledged; stipulate that if the value goes below 1.3M then thedebtor will be obliged to pledge additional securities.

Without such a stipulation, can Article 2108 have the same effect?

Ex: 1M obligation, 1.5M worth of stocks pledged. When the stocks go down top 1.4M, can you claimthat the value of the pledge is diminishing and then choose to sell the stocks for 1.4M, keeping theprofits as security, pursuant to 2108?

JPSP says: “Maybe but speculative.” Probably not if the change in price is just a day-to-dayfluctuation.

PROBLEM: 1M IS SECURED BY A 700K MORTGAGE AND A 900K PLEDGE. IF YOU ARE THE LENDER,AND THE BORROWER DEFAULTS, WHICH SECURITY TO YOU GO AFTER FIRST?

Go against the REM first, then take the whole pledge and make $$$! In REM, unlike in pledge, thedebtor is entitled to the excess and the creditor is entitled to recover the deficiency, as a default rule.

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

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

Article 2117. Any third person who has any right in or to the thing pledged may satisfy the principalobligation as soon as the latter becomes due and demandable.

The creditor cannot refuse payment by a third person WITH AN INTEREST in the thing pledged.

Third party can be a buyer of the thing or someone with a junior lien.

Why would a third person with a junior lien want to pay the obligation? The property may be morevaluable than the obligation and he may want his lien to become senior.

Article 2118. If a credit which has been pledged becomes due before it is redeemed, thepledgee may collect and receive the amount due. He shall apply the same to the payment of hisclaim, and deliver the surplus, should there be any, to the pledgor.

Under this article, the thing pledged is a credit which has become due. The creditor can thus collectthe amount due and compensate, DELIVERING THE SURPLUS TO THE DEBTOR.

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

Article 2119. If two or more things are pledged, the pledgee may choose which he will cause to besold, unless there is a stipulation to the contrary.

He may demand the sale of only as many of the things as are necessary for the payment of the debt.

PROBLEM: A 1.5M DEBT IS SECURED BY 2M WORTH OF SMC SHARES. IF YOU ARE THE PLEDGEE,HOW WOULD YOU SELL?

Sell all. You are not required to sell by piece.

Pledgor can restrict only if there are two pledges securing the obligation.

Article 2120. If a third party secures an obligation by pledging his own movable property under theprovisions of article 2085 he shall have the same rights as a guarantor under articles 2066 to2070, and articles 2077 to 2081.


He is not prejudiced by any waiver of defense by the principal obligor.

The third party pledgor is entitled to:

1. Indemnity;

2. Subrogation;

3. Pledgor is released if creditor accepts property in payment of debt;

4. Release in favor of one pledgor benefits all;

5. Extension granted to debtor extinguishes pledge;

6. Pledgors are released from obligation if by some act of the creditor, there can be nosubrogation;

7. Pledgor may set up defenses inherent in the debt.

Article 2121. Pledges created by operation of law, such as those referred to in articles 546, 1731,and 1994, are governed by the foregoing articles on the possession, care and sale of the thing aswell as on the termination of the pledge. However, after payment of the debt and expenses, theremainder of the price of the sale shall be delivered to the obligor.

Article 2122. A thing under a pledge by operation of law may be sold only after demand of theamount for which the thing is retained.

The public auction shall take place within one month after such demand. If, without just grounds,the creditor does not cause the public sale to be held within such period, the debtor may requirethe return of the thing.

In pledges by operation of law, the remainder of the sale price shall be delivered to the debtor.

The foregoing articles govern the following pledges by operation of law; BUT after sale, the excess, ifany, is returned to the pledgor:

• Possessor in good faith may retain the thing on which he spent for necessary expenses untilhe is reimbursed.

• He who works on a movable may retain the same until paid for the work.

• Depositary may retain thing until paid for the deposit.

• Agent may retain objects of agency until reimbursed by principal.

• Laborer’s wages are considered a lien on goods manufactured or work done.

How about any deficiency? I think creditor will be entitled to recover because here, he did notaccept the pledge voluntarily and the reason for prohibiting recovery is absent (the reason being thatcreditors should know not to lend more than what can be secured).

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


REAL MORTGAGE

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

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

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

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

What are the characteristics of the contract of mortgage?

Mortgage is a real, accessory, and subsidiary contract. Who takes possession of the mortgaged property?

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

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

What is the consideration in a contract of mortgage?

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

What are the kinds of real mortgage?

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

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

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

What is the subject matter of real mortgage

1. Immovables2. Alienable rights imposed upon immovables

Can you mortgage future property?

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


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

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

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

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

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

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

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

What are the requisites of real mortgage?

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

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

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

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

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

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

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

Can there be an oral mortgage?


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

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

Remember that 1357 is only for convenience. Its purpose is to compel the mortgagor toexecute a public document, so that the mortgagee can register the mortgage. It does notdetermine the validity or even the enforceability of the mortgage between the parties. Beforeyou can invoke it, there has to be a valid mortgage first.

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

Procedure: What happens when you enter into a contract ofmortgage?

Step 1: Execute the document of mortgage

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

Step 3: Pay the documentary stamp tax within the first five days of the succeeding month. Thedoc

stamp tax is a percentage of the value of the property mortgaged.

Step 4: Go to the Office of the Register of Deeds and pay the registration fees. Before you paythe

registration fees, the government will require you to update payment of realty taxes onthe property. After payment of the registration fees, the mortgage will be annotated onthe title.

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

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

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


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

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

How does mortgagee opt out of this problem?

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

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

What happens if the mortgage is void?

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

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

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

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

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

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

Does the mortgagor lose his title to the property mortgaged?

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


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

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

Future property, in themselves, cannot be the subject matter of mortgage. But, the futureimprovements, accessions, and fruits of property already mortgaged are also covered by themortgage. This is because they are deemed to be part of the principal thing which was alreadyexisting at the time of the constitution of the mortgage. To exclude these things, there must be an express stipulation to that effect.

Examples:

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

This is a valid stipulation, especially where the property mortgaged is subject todeterioration (such as machinery and equipment). The purpose of this stipulation is tomaintain the value of the property mortgaged.

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

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

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

What happens if the thing mortgaged is expropriated?

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

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


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

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

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

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

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

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

On due date, B should demand payment of the P6M from A. If A fails to pay, B may foreclosethe mortgage. B may also choose to collect P5M (not P6M) from C, which is the part of theprincipal obligation secured by the property sold to C. C is not liable for the deficiency of P1Min the absence of a contrary stipulation. If C pays B, C can go after A for reimbursement.

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

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

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

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

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


FORECLOSURE

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

What is foreclosure?

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

How do you foreclose?

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

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

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

Mortgage to a Foreigner – RA 133

Can you mortgage to a foreigner?

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

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

Can the foreigner take possession of the property during themortgage?

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

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

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

When confronted with a foreclosure problem…


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

Second, look for the following tell-tale signs:

1. Is the mortgagee a foreigner? If it’s a foreigner, it’s automatically judicial foreclosure(Act 133).

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

3. If there is no stipulation for extra-judicial foreclosure under Act 3135, it is a judicialforeclosure governed by Rule 68 of the Rules of Court.

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

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

2. If the mortgagee is not a bank, the extra-judicial foreclosure will be governed by Act3135.

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

JUDICIAL FORECLOSURE UNDER RULE 68, RULES OF COURT

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

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

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

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

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

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


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

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

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

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

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

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

3. The junior encumbrances will be satisfied

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

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

Why should you stay away from judicial foreclosure?

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

EXTRA-JUDICIAL FORECLOSURE UNDER ACT 3135

When is extra-judicial foreclosure proper?

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

Where should the sale be made?

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


What is the procedure?

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

STEP 2: Notice of the sale

There are two kinds of notices required:

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

2. Publication in a newspaper of general circulation, once a week for at least threeconsecutive weeks if the value of the property exceeds P400

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

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

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

STEP 3: Public Auction

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

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

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

Can the parties stipulate a minimum price at which the propertyshall be sold?


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

What is the effect of inadequacy of the price at which the property issold at auction?

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

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

What happens if there is an excess?

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

What happens if there is a deficiency?

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

STEP 4: Possession of the Property

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

However, if the winning bidder already wants possession of the property, he may file a petitionin court to gain possession. He must give a bond equivalent to the rent for the use of theproperty for 12 months. The bond will answer for any loss to the mortgagor if it is later foundthat he was not in default in the mortgage obligation or that the conduct of the sale violated Act3135. Upon approval of the bond, the court will issue a writ of possession in favor of thepurchaser.

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

Remedy of the Mortgagor

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

STEP 5: Redemption


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

Exception: If the mortgagee foreclosing is a BANK and the mortgagor is a JURIDICALPERSON, the juridical person shall have the right to redeem the property BEFORE theregistration of the certificate of sale but NOT EXCEEDING 90 DAYS FROM THE DATE OFTHE FORECLOSURE .

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

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

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

Who may redeem?

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

Example: Mortgagor mortgaged a house and lot to A. Later, Mortgagor alsomortgaged it to B. A foreclosed the mortgage and bought the house and lot at theauction. In this case, upon the sale of the property to A, the only right that B assecond mortgagee has is the right to redeem. He may exercise the right by payingoff the debt secured by the first mortgage. B’s exercise of Mortgagor’s equity ofredemption is equivalent to foreclosure of the junior mortgage.

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

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

Exception: If the mortgagee foreclosing is a BANK, under Sec 47 of the GeneralBanking Law, the mortgagor should pay the amount of the ORIGINAL OBLIGATION(not the purchase price) plus INTEREST AT THE ORIGINAL RATE stipulated in themortgage contract plus all COSTS and expenses incurred by the bank from the saleof the property.

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

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


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

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

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

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

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

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

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

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

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

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

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

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

SUMMARY OF EXCEPTIONS UNDER SECTION 47 OF THE GENERAL BANKING LAWOF 2000


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

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

As a general rule, there is no right of redemption in judicial foreclosure. Uponconfirmation of the sale, the mortgagor cannot redeem the property anymore.

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

2. Redemption Price

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

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

a. the amount of the mortgage obligation b. plus the interest on the loan at the rate stipulated in the mortgage contractc. plus costs of the sale incurred by the bank

3. Automatic Right of Possession

In ordinary extra-judicial foreclosure, the mortgagor retains possession of theproperty within the redemption period. If the purchaser wishes to have possessionwithin the redemption period, he must file a petition for the issuance of a writ ofpossession with a corresponding bond.

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

4. Injunction

If anybody wants to enjoin the conduct of foreclosure proceedings instituted by abank, the petitioner must file a bond fixed by the court to satisfy whatever damagethe bank may suffer by the injunction.

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

5. Period of Redemption for Juridical Persons

In ordinary extra-judicial foreclosure, the mortgagor may redeem the property afterit is sold within one year from the execution of the certificate of sale. There is nodistinction, whether the party redeeming is a natural or juridical person.

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

a. it must be BEFORE the registration of the sale


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

EFFECTS ON THE JUNIOR MORTGAGE

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

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

The following are the rights of a junior mortgagee:

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

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

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

When the second mortgagee exercises the equity of redemption by payingthe obligation of the mortgagor/debtor, the mortgagor/debtor has 60 daysto reimburse the second mortgagee what he paid. If the original debtor failsto pay within this period, ownership will be consolidated in the secondmortgagee who paid. This interpretation is according to Section 28 Rule 39of the Rules of Court.

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

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

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

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

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


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

CHATTEL MORTGAGE

Art. 2140. By a chattel mortgage, personal property is recorded in the ChattelMortgage Register as a security for the performance of an obligation. If themovable, instead of being recorded, is delivered to the creditor or a third person,the contract is a pledge and not a chattel mortgage.

What is chattel mortgage?

Chattel mortgage is the contract by virtue of which personal property is recorded inthe Chattel Mortgage Register as a security for the performance of an obligation.

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

What are the characteristics of the contract of chattel mortgage?

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

2. It is a formal contract because it requires registration in the Chattel MortgageRegister for its validity (but only against third persons)

3. It is a unilateral contract because it produces only obligations on the part ofthe creditor to free the thing from the encumbrance on fulfillment of theobligation.

What is the subject matter of chattel mortgage?

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

What are the requisites for a valid chattel mortgage?

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

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

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

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

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

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


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

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

DISTINCTIONS BETWEEN CHATTEL MORTGAGE AND PLEDGE

CHATTEL MORTGAGE PLEDGEDELIVERY OF THE PERSONALPROPERTY

Not necessary Delivery is necessary forvalidity of the pledge

REGISTRATION IN THEREGISTRY OF PROPERTY

Necessary for validity ofthe chattel mortgageagainst third persons

Not necessary; publicdocument is enough tobind third persons

PROCEDURE FOR SALE Governed by Section 14 ofthe Chattel Mortgage Law

Governed by Article 2112of the Civil Code

RIGHT TO EXCESS OFPROCEEDS OF SALE

Excess goes to thedebtor/mortgagor

Excess goes to thepledgee/creditor unlessotherwise stipulated

RIGHT TO RECOVERDEFICIENCY

Creditor/mortgagee canrecover deficiency fromthe debtor/mortgagor,except if covered by RectoLaw

Creditor/pledgee is notentitled to recover anydeficiency after theproperty is sold,notwithstanding anycontrary stipulation

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

THE CHATTEL MORTGAGE LAW

How do you constitute a chattel mortgage?

To constitute a chattel mortgage, the parties must register the personal propertymortgaged in the Chattel Mortgage Register as security for the performance of anobligation. However, if the chattel mortgage is not registered, it is still valid andbinding as between the parties. The requirement of registration is not for validitybut only for binding third parties.

What is the effect of registration?

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


What is the form required for a chattel mortgage?

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

FORM OF CHATTEL MORTGAGE AND AFFIDAVIT

This mortgage made this Fifth day of October 2002 by SherylTanquilut, a resident of municipality of Taytay, Province of Rizal Philippines,mortgagor, to Anna del Castillo a resident of the municipality of Cainta,Province of Rizal Philippines, mortgagee, witnesseth:

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

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

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

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

Executed at the municipality of Taytay in the Province of Rizal thisFifth day of October 2002.

Sgd. Sheryl TanquilutIn the presence of:

Sgd. Xilca AlvarezSgd. Helen Arevalo

FORM OF OATH (affidavit of good faith)

[Tip: know the contents of an affidavit of good faith. JPSP might ask us to make one in the exam. Lumabas sa past exam]

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

FORM OF CERTIFICATE OF OATH

In the Province of Rizal, personally appeared Sheryl Tanquilut, XilcaAlvarez, and Helen Arevalo, the parties who signed the foregoing affidavitand made oath to the truth thereof before me.


Sgd. Bhoy-BNotary public


What happens if there is no affidavit of good faith?

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

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

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

What the parties should do is to execute a new document/ deed of chattelmortgage to cover the newly contracted obligation.

Can you mortgage future property?

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

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

What happens when the mortgagor pays the obligation?

If the mortgagor pays the obligation, he gets a discharge from the mortgagee sothat he can then cancel the lien annotated on the title and in the Chattel MortgageRegistry.

What happens when the mortgagor defaults on the obligation?

1. Right of Redemption

In case of default, the following persons may redeem the property before itis sold, by paying the amount of the obligation plus costs and expensesincurred from the breach:

a. the mortgagorb. a subsequent mortgageec. a subsequent attaching creditor

If an attaching creditor redeems, he is subrogated to the rights of themortgagor. He can foreclose the mortgage.


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

2. Right of Mortgagee to Possession

If the creditor/mortgagee wants to foreclose upon default, he has theimplied right to take the mortgaged property. If the debtor/mortgagorrefuses to surrender the property, the creditor should file an action forreplevin to take possession or for judicial foreclosure.

3. Foreclosure

The parties can stipulate for a private sale upon default.

If there is no stipulation, the applicable rule is Section 14 of the ChattelMortgage Law.

According to Section 14, the creditor/mortgagee can cause the property tobe sold at public auction thirty days after default. This is a minimum graceperiod given to the mortgagor to redeem the property before it is sold atauction. There is no maximum time period for holding the sale.

The procedure is the same as that for extra-judicial foreclosure of a realestate mortgage, except for the notice requirements. In chattel mortgage,the only notice requirement is posting at two or more public places in themunicipality and personal notice to the mortgagor and junior mortgagees atleast ten days before the date of the sale (no publication).

The proceeds of the sale will be applied as follows:

a. Costs and expenses of the saleb. Payment of the obligation secured by the mortgagec. Claims of persons holding subsequent mortgages in their order;

andd. The balance, if any, shall be given to the mortgagor

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

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

PROBLEMS ON REAL AND CHATTEL MORTGAGE

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

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

But if, in the example above, the mortgagor has creditors running after him for debts worth300K, should he redeem?


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

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

This can either be a PLEDGE or an IMPLIED TRUST.

It’s not really a pledge because there is an absolute conveyance of ownership bythe supposed pledgor in favor of the pledgee. But the Supreme Court has treatedthis in several cases as a pledge.

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

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

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

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

(1) a GUARANTY by X who is worth P100M(2) a PLEDGE of shares of stock worth P10M(3) a REAL ESTATE MORTGAGE worth P15M

Which one should Lender choose?

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

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

2. If he chooses the guaranty, it is good only if he is sure that the guarantorwill pay. If the guarantor is any of the following, persons, the guarantywould be a good choice:

a. the Government – because it is never insolventb. a Bank – in the form of a bank guaranty through a letter of creditc. Insurance Company – though in some cases, it is also hard to collect

from an insurance company (also, take note that they would begoverned, not by the Civil Code provisions on guaranty, but by theInsurance Code).


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

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

Borrower borrows P10M from Lender. The loan is secured by a guaranty by X, who is worthP100M, a real estate mortgage worth P8M, and a pledge worth P8M. If Borrower defaults,what is the best way for Lender to proceed?

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

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

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

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

If Lender forecloses the pledge, he will have a deficiency of P2M, which he cannotcollect anymore. On the other hand, he cannot proceed against the guarantorwithout foreclosing the pledge first.

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

ANTICHRESIS

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

What is antichresis?

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


What are the characteristics of antichresis?

1. Accessory – It secures the performance of a principal obligation. Manresa, however,believes that it is an independent contract.

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

Is delivery of the property to the creditor required?

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

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

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

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

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

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

What are the differences between antichresis and real mortgage?

ANTICHRESIS REAL MORTGAGEProperty is delivered to the creditor Debtor usually retains possession of the

propertyCreditor acquires only the right to receive thefruits of the property; not a real right

Creditor has no right to receive the fruits, butmortgage creates a real right over the propertywhich is enforceable against the world

General rule is that creditor must pay thetaxes and charges upon the estate; partiesmust stipulate otherwise

Creditor has no obligation to pay taxes andcharges

Expressly stipulated that the creditor shallapply the fruits to the payment of interest, ifowing, and thereafter to the principal

No obligation on the part of the mortgagee toapply the fruits to interest and principal

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

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

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


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

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

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

Example:

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

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

Is there a form required for the contract of antichresis?

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

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

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

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

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

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

1. Pay the taxes and charges upon the estate –

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

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

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


2. Apply the fruits

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

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

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

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

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

Is there an exception?

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

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

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

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

What happens when the debtor defaults on the principal obligation?

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

The creditor has the following remedies in case of default:

1. Bring an action for specific performance.2. Petition for the sale of the real property in judicial foreclosure proceedings under Rule

68 of the Rules of Court.

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

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

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


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

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

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

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

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

Other characteristics of Antichresis:

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

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

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

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

CONCURRENCE AND PREFERENCE OF CREDITS

What is concurrence of credits?

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

What is preference of credit?

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

Nature and Effect of Preference

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


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

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

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

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

When are the rules on preference of credits applicable?

The rules apply only where:

1. there are two or more creditors2. with separate and distinct claims3. against the same debtor4. who has insufficient property.

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

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

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

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

CHAPTER 1 GENERAL PROVISIONS

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

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


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

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

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

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

1. The CPG or AC subsists; and2. The obligations of the insolvent spouse have not redounded to the benefit of the

family.

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

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

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

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

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

CHAPTER 2 CLASSIFICATION OF CREDITS

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

1. special preferred credits listed in 2241 and 22422. ordinary preferred credits listed in 22443. common credits under 2245

Special Preferred Credits (2241 and 2242)


The items in bold face are the important/relevant ones:

Art. 2241. With reference to specific movable property of the debtor, the following claims orliens shall be preferred:

(1) Duties, taxes and fees due thereon to the State or any subdivision thereof;

(2) Claims arising from misappropriation, breach of trust, or malfeasance by publicofficials committed in the performance of their duties, on the movables, money orsecurities obtained by them;

(3) Claims for the unpaid price of movables sold, on said movables, so long as theyare in the possession of the debtor, up to the value of the same, and if the movablehas been resold by the debtor and the price is still unpaid, the lien may be enforcedon the price; this right is not lost by the immobilization of the thing by destination,provided it has not lost its form, substance and identity; neither is the right lost bythe sale of the thing together with other property for a lump sum, when the pricethereof can be determined proportionally;

(4) Credits guaranteed with a pledge so long as the things pledged are in the handsof the creditor, or those guaranteed by a chattel mortgage, upon the thingspledged or mortgaged, up to the value thereof;

(5) Credits for the making, repairs, safekeeping or preservation of personal property, on themovable thus made, repaired, kept or possessed;

(6) Claims for laborers’ wages, on the goods manufactured or the work done;

(7) For expenses of salvage, upon the goods salvaged;

(8) Credits between the landlord and the tenant, arising from the contract of tenancy onshares, on the share of each in the fruits or harvest;

(9) Credits for transportation, upon the goods carried, for the price of the contract andincidental expenses, until their delivery and for thirty days thereafter;

(10) Credits for lodging and supplies usually furnished to travelers by hotel keepers, on themovables belonging to the guest as long as such movables are in the hotel, but not for moneyloaned to the guests;

(11) Credits for seeds and expenses for cultivation and harvest advanced to the debtor, uponthe fruits harvested;

(12) Credits for rent for one year, upon the personal property of the lessee existing on theimmovable leased and on the fruits of the same, but not on money or instruments of credit;

(13) Claims in favor of the depositor if the depositary has wrongfully sold the thing deposited,upon the price of the sale.


In the foregoing cases, if the movables to which the lien or preference attacheshave been wrongfully taken, the creditor may demand them from any possessor, withinthirty days from the unlawful seizure.

First, you must remember that, aside from item (1) on taxes imposed in connection with themovable, 2141 does establish the order of priority among these claims. It just enumerates thepreferred claims with respect to specific movables.

With respect to the same specific movable or immovable, creditors merely concur. There is nopreference among them, except that the State always gets paid the taxes imposed on theproperty first.

(1) Taxes

The tax must be due on the movable itself.

(2) Misappropriation, breach of trust, malfeasance of public officers

The acquisition must have been in the performance of official functions.

Also, the property must still be in the hands of the public official. If it is sold to a purchaser for valueand in good faith, there can be no more claim on the movable.

(4) Guaranteed with a pledge or chattel mortgage

To be a preferred credit:

If it’s a pledge, it must be in a public instrument.

If it’s a chattel mortgage, it must be registered in the chattel mortgage registry.

Last paragraph of 2241

If the movable is wrongfully taken, the preferred creditor may get it back within 30 days throughan accion subrogatoria, exercising the right of the debtor to recover property wrongfully takenfrom him granted under Article 559.

Problem: The Debtor’s only property is a Jaguar worth P2.5M. His liabilities are:

a. to the Government: Income tax of P1MImport duties on the car worth P1M

b. chattel mortgage on the car worth P2M

c. unpaid price of the car of P1M

d. P1M promissory note (notarized)

What are the preferred claims with respect to the Jaguar?

1. P1M import duties on the car2. P2M chattel mortgage3. P1M unpaid price


These are the only preferred claims because they are the ones attached to the movable itself.The income tax and the promissory note are not preferred because they are not attached to thecar.

How do you prioritize the preferred claims?

1. P1M import duties – the State is always the priority with respect to preferred claims2. The chattel mortgagee and the unpaid seller will then proportionally share the P1.5M

left: P1M will go to the mortgagee and 500K will go to the unpaid seller.

Note, however, that taxes are not always preferred. For example, income tax is not preferredwith respect to the Jaguar. In order to be preferred, the tax must be imposed on the movableitself.

This has to be done in the context of insolvency proceedings.

Problem: Government official used public funds to acquire a Jaguar from a seller in goodfaith. Government official becomes insolvent. The Government wants to recover the car. Ifyou’re government counsel, how should you proceed?

The textbook answer would be that the government can go after the car in insolvencyproceedings. It has a preferred claim over the car under par. (2) of 2241. But, thedisadvantage of this is that, unlike the government claim for tax credits, it is not prioritized overother special preferred claims. The government would have to share with the other creditorswho likewise have a special preferred claim on the Jaguar, such as an unpaid seller.

The better alternative is to characterize it as an implied TRUST. When funds belonging toanother (in this case, the government) are used to purchase a movable under the name ofanother person (the corrupt government official), there is an implied trust. The trustor is thegovernment, while the trustee is the government official. The trustor/government actually ownsthe car. There is thus no need to go through the insolvency proceedings, since the Jaguar isnot among the properties of the insolvent debtor.

Under a trust agreement, X gave Investment House some money. Investment House placedthe money in a time deposit. Investment House issued promissory notes for its obligationsto other creditors.

If Investment House becomes insolvent, X can show that the money is not owned byInvestment House, so it should be excluded from the insolvency proceedings.

Art. 2242. With reference to specific immovable property and real rights of the debtor, thefollowing claims, mortgages and liens shall be preferred, and shall constitute an encumbranceon the immovable or real right:

(1) Taxes due upon the land or building;

(2) For the unpaid price of real property sold, upon the immovable sold;

(3) Claims of laborers, masons, mechanics and other workmen, as well as of architects,engineers and contractors, engaged in the construction, reconstruction or repair of buildings,canals or other works, upon said buildings, canals, or other works;


(4) Claims of furnishers of materials used in the construction, reconstruction or repair ofbuildings, canals or other works, upon said buildings, canals or other works;

(5) Mortgage credits recorded in the Registry of Property upon the real estatemortgaged;

(6) Expenses for the preservation or improvement of real property when the law authorizesreimbursement upon the immovable preserved or improved;

(7) Credits annotated in the Registry of Property, in virtue of a judicial order, byattachments or executions, upon the property affected, and only as to later credits;

(8) Claims of co-heir in the partition of an immovable among them, upon the real property thusdivided;

(9) Claims of donors of real property for pecuniary charges or other conditions imposed uponthe donee, upon the immovable donated;

(10) Credits of insurers, upon the property insured, for the insurance premium for two years.

(1) Taxes

Capital gains tax is NOT a preferred credit because it is really a tax on income and not on theproperty itself.

This provision covers real property taxes.

(2) Unpaid Seller

There is no need to register the sale in order for the unpaid seller to have a preferred claimagainst the immovable.

(5) Mortgage

The mortgage must be registered in the Registry of Property in order for the credit to be apreferred claim against the immovable.

(7) Credits annotated in the Registry of Property in virtue of judicial order, attachment, orexecution

The credits must also be registered in order to be preferred.

The preference is only with respect to LATER CREDITS.

The credit is preferred only with respect to other attachments, not to other kinds of credit.Therefore, this does not share equally with the other claims. It merely provides that a credit byvirtue of judicial order, attachment, or execution that is first registered in the Registry ofProperty is preferred over other credits of the same nature, which are registered at a later date.

Unlike the other special preferred credits, these credits do not shareproportionately in the property upon which they are imposed. To determine the


order of priority among several credits of this kind, their dates should be the basis.The first one to be registered will be prioritized over the others.

Again, 2242, is not an order of priority, with the exception of taxes imposed upon theimmovable, which is prioritized. 2242 is merely an enumeration.

Why isn’t there a provision for malfeasance or misfeasance with respect to immovables?

Corrupt public officials can easily hide movables, which is why it would be more difficult torecover them. Hence, there is a provision giving the government preference with respect tomovables. But in the case of immovables, the corrupt public officials cannot really hide them.The government can establish a preferred claim over them simply by attaching. (This is thereason given by JPSP. For the reason of the Code Commission, ask Pelagio Cuison).

Problem: Debtor’s only assets are a house and lot worth P5M, a car worth P1M, and jewelryworth 500K. Among Debtor’s liabilities are a real estate mortgage on the house and lot tosecure a loan worth P3M and a chattel mortgage on the car to secure a loan worth P500K.Debtor has other obligations worth P6M. What are the preferred credits? How much freeproperty does Debtor have?

With respect to the house and lot, the real estate mortgage is preferred. With respect to thecar, the chattel mortgage is preferred.

To determine the value of the Debtor’s free property, pay off the preferred claims first:

House and Lot worth P5M – P3M REM obligation = P2M excess

Car worth P1M – 500K chattel mortgage obligation = 500K excess

The excess after the preferred claims have been satisfied will go to the free property of thedebtor:

Free property = Jewelry worth 500K + P2M excess from House and Lot + 500K excess fromcar

= 500K + 2M + 500K= 3M

The free property of Debtor is worth P3M. The other creditors for P6M will then line up for thisportion according to the order of priority established in Art. 2244 if they are ordinary preferredcredits and 2245 if they are common credits.

Problem: Realty Company entered into a contract to sell with X. Under the contract to sell,X will sell the lot to Realty Company, and Realty Company will pay the price in installments.Realty Company failed to pay the installments in full. The lot was used in a condominiumproject. How can X collect from Realty Company, in case it becomes insolvent?

X should claim that he still owns the lot since the contract was merely a contract TO sell.Therefore, the lot should not be included in the insolvency proceedings concerning RealtyCompany. X can also claim that the condominium project on the lot cannot be included in theinsolvency proceedings either because it is an improvement on a lot owned by X, not by RealtyCompany. This way, if Realty Company becomes insolvent, X does not have to line up andcompete with other creditors’ claims, because he can say that he is the owner of the property.


JPSP says that if you’re a creditor, you should avoid the preferred claim route because youwould rather not line up along with the other creditors. You should find a way to be the ownerof the thing that you’re after – such as, proving that it’s an implied trust or a contract to sell, etc.

Art. 2243. The claims or credits enumerated in the two preceding articles shall be consideredas mortgages or pledges of real or personal property, or liens within the purview of legalprovisions governing insolvency. Taxes mentioned in No. 1 article 2241, and No. 1, article2242, shall first be satisfied.

2243 gives the rule that taxes due on the movable or on the immovable concerned should besatisfied first. The rest of the special preferred claims share equal preference amongthemselves.

Ordinary Preferred Credits (2244)

Art. 2244. With reference to other property, real and personal of the debtor, the followingclaims or credits shall be preferred in the order named:

(1) Proper funeral expenses for the debtor, or children under his or her parental authority whohave no property of their own, when approved by the court;

(2) Credits for services rendered the insolvent by employees, laborers, orhousehold helpers for one year preceding the commencement of the proceedings ininsolvency;

(3) Expenses during the last illness of the debtor or his or her spouse and children under hisor her parental authority, if they have no property of their own;

(4) Compensation due the laborers or their dependents under laws providing for indemnity fordamages in case of labor accident, or illness resulting from the nature of the employment;

(5) Credits and advancements made to the debtor for support of himself or herself, and family,during the last year preceding the insolvency;

(6) Support during the insolvency proceedings, and for three months thereafter;

(7) Fines and civil indemnification arising from a criminal offense;

(8) Legal expenses, and expenses incurred in the administration of the insolvent’s estate forthe common interest of the creditors, when properly authorized and approved by the court;

(9) Taxes and assessments due the national government other than those mentioned inArticles 2241, No. 1, and 2242, No. 1;

(10) Taxes and assessments due any province, other than those referred to in Articles2241, No. 1, and 2242, No. 1;

(11) Taxes and assessments due any city or municipality, other than those indicated inArticles 2241, No. 1, and 2242, No. 1;

(12) Damages for death or personal injuries caused by a quasi-delict;


(13) Gifts due to public and private institutions of charity or beneficence;

(14) Credits which, without special privilege, appear in (a) a public instrument; or (b) in afinal judgment, if they have been the subject of litigation. These credits shall havepreference among themselves in the order of priority of the dates of the instruments andof the judgments respectively.

Once the special preferred claims under 2241 and 2242 have been satisfied, the propertyremaining constitute the debtor’s free property. The debtor’s free property will then be used topay ordinary preferred claims in the order established in 2244. Unlike 2241 and 2242, 2244 isnot merely an enumeration; it establishes the order of priority. Also, unlike 2241 and 2242,2244 does not establish a preference with respect to specific property of the debtor. Thepreference is with respect to the mass of properties of the debtor remaining after the specialpreferred claims have been satisfied.

Important Items

(2) Labor Claims

Art. 110 of the Labor Code has modified 2244 by moving labor claims to number (1), ahead of funeralexpenses. Labor claims are still not in the level of special preferred claims under 2241 and 2242. TheLabor Code merely moved it up to the top of the list of ordinary preferred claims. Also, Art. 110 of theLabor Code has removed the one-year limitation.

(9), (10), (11) Taxes

Note that this is unlike special preferred claims where a tax is imposed upon a specific movable orimmovable property. Special preferred claims, as provided by 2243, enjoy first preference withrespect to the property upon which they are imposed.

Under 2244, on the other hand, taxes of other kinds are only ordinary preferred credits and are only9th, 10th, and 11th priorities with respect to the free portion of the property of the debtor. Examplesare income tax, license fees, and capital gains tax. These are not imposed on specific property of thedebtor, so they are ordinary preferred claims, which can be collected against the debtor’s freeproperty.

Taxes owing the national government should be satisfied first, followed by the provincial government,then the city or municipal government.

(14) Credits appearing in a public instrument or in a final judgment

This paragraph contains the rule of preference when you have several credits appearing in publicinstruments or in a final judgment. To determine the order of preference among them, just considerthe date. First in time, priority in right, sabi nga ni CLV.

This does not include those registered credits which fall under 2241 and 2242, such as those arisingfrom a pledge or mortgage, or an attachment of specific real property.

Example:

The claims are as follows:

A notarized promissory note dated May 1, 2002.A promissory note in a private document dated January 1, 2002.A judgment for sum of money dated October 1, 2002.


What is the order of priority?

1. Notarized promissory note dated May 1, 20022. Judgment dated October 1, 20023. Promissory note in a private document dated January 1, 2002

Common Credits

Art. 2245. Credits of any other kind or class, or by any other right or title not comprised in the fourpreceding articles, shall enjoy no preference.

If it is not among those mentioned in 2241, 2242, and 2244, it is a common credit. Creditors withcommon credits have to line up for the excess of the debtor’s property after claims under 2241, 2242,and 2244 have been satisfied. There is no order of preference among common creditors; they sharewhatever is left in proportion to their credit, regardless of date.

CHAPTER 3 ORDER OF PREFERENCE OF CREDITS

Art. 2246. Those credits which enjoy preference with respect to specific movables, exclude all othersto the extent of the value of the personal property to which the preference refers.

Art. 2247. If there are two or more credits with respect to the same specific movable property, theyshall be satisfied pro rata, after the payment of duties, taxes and fees due the State or anysubdivision thereof.

Art. 2248. Those credits which enjoy preference in relation to specific real property or real rights,exclude all others to the extent of the value of the immovable or real right to which the preferencerefers.

Art. 2249. If there are two or more credits with respect to the same specific real property or realrights they shall be satisfied pro rata, after the payment of the taxes and assessments upon theimmovable property or real right.

Art. 2250. The excess, if any, after the payment of the credits which enjoy preference with respectto specific property, real or personal, shall be added to the free property which the debtor mayhave, for the payment of other credits.

Art. 2251. Those credits which do not enjoy any preference with respect to specific property andthose which enjoy preference, as to the amount paid, shall be satisfied according to the followingrules:

(1) In the order established in article 2244;

(2) Common credits referred to in article 2245 shall be paid pro rata regardless of dates.

APPLYING THE RULES

STEP 1: MAKE AN INVENTORY OF ASSETS

List down all the assets of the debtor.

Group these assets into two: the Preferred Group and the Free Property Group.

Those assets with special preferred claims under 2241 and 2242 imposed upon them belong to thePreferred Group.


Those without special preferred claims will constitute the debtor’s Free Property.

Remember to take out property held by the debtor only in the capacity of trustee. He may have legaltitle to it, but the beneficial title and ownership actually belong to another person. Since the propertydoes not belong to the debtor, they should not be included in the proceedings. The same goes forproperty of the AC of CPG, property held as lessee or usufructuary, etc.

STEP 2: GROUP THE CLAIMS

Make four groups – (1) special preferred credits on movables, (2) special preferred credits onimmovables, (3) ordinary preferred credits, and (4) common credits.

For the special preferred claims, look out for the following because they are the most common:

1. For movables:

a. import duties/other taxes imposed directly on the movableb. an obligation secured by a pledge (in a public instrument) or a chattel mortgage

(registered)c. claim of unpaid seller for the price of the movable

2. For immovables:

a. real estate taxesb. an obligation secured by a real estate mortgage (registered)c. claim of unpaid seller for the price of the immovabled. credits annotated in the Registry of Property by attachment or execution upon the

immovable

Put the ordinary preferred claims under 2244 together. List them down according to the order under2244, since 2244 already gives the order of preference. Remember, though, that labor claims are ontop. The most common are:

1. labor claims2. taxes other than those imposed directly upon a movable or an immovable, such as income

taxes and license fees (In the following order: national government, provincialgovernment, city or municipal government).

3. credits in a final judgment or in a public document, such as notarized promissory notes

Put the other credits not falling under these three together. These are the common claims. The usualexample is a promissory note in a private instrument.

STEP 3: SATISFY THE SPECIAL PREFERRED CLAIMS

First: Take the value of the specific movable/immovable upon which the preferred claim is imposed.

Second: Pay the taxes due on the property.

Third: Pay the preferred claim of the creditor.

What if you have more than one preferred creditor over the same property?

Ex: The claims against a car are: import duties, chattel mortgage, and unpaid seller.

In this case, pay the taxes first. Since the mortgage creditor and the unpaid seller are bothspecial preferred creditors, they will share the balance proportionately. There will only beproportionate sharing in case the value of the thing after payment of taxes is not enough to


satisfy all of the special preferred claims against it. If the value of the thing is sufficient, thenall the special preferred claims must be paid in full.

Fourth: If, after paying the taxes and other special preferred claims, there is an excess, take the valueof the excess and add it to the debtor’s Free Property.

Fifth: If the value of the specific property is not enough to satisfy the taxes and other special preferredclaims, and there is a deficiency, follows these rules:

a. If the deficiency is in a credit arising from a pledge, real mortgage, or chattel mortgage,put the deficiency in the ordinary preferred credits group. Why do we know right awaythat it is an ordinary preferred credit? It is a credit in a public instrument, so it is anordinary preferred credit under (14) of 2244. You know it’s in a public instrument becauseit was treated at first as a special preferred credit, and the requirement under 2241 and2242 is that these transactions be registered (for real and chattel mortgage) or be in apublic document (for pledge).

b. If the deficiency is in a credit arising from a transaction that is not in a public document oris not contained in a final judgment (ex: unrecorded sale), put the deficiency in thecommon credits group.

STEP 4: UPDATE THE INVENTORY AND LIST OF CREDITS

After you have satisfied all of the special preferred claims, update the following:

1. The inventory of assets

You may have to add to the Free Property Group if, after satisfying the special preferredclaims, you have an excess. Make sure that you add the excess to the Free Property Group.

Add up the entire value of the Free Property Group because this is what you will use to settlethe ordinary preferred claims and the common claims.

2. The list of ordinary preferred claims

If there was a deficiency in satisfying the special preferred claims, the deficiency will be anordinary preferred credit if it is notarized or is contained in a final judgment.

3. The list of common claims

If there was a deficiency in satisfying the special preferred claims, the credit will be a commoncredit if it is not notarized or contained in a final judgment.

STEP 5: SATISFY THE ORDINARY PREFERRED CLAIMS

List down all the ordinary preferred claims in the order in which they are listed in 2244. This is theorder of preference among them.

Most probably, there will be several credits in public instruments and final judgments. Arrange theseby date. Those falling on the same date will enjoy equal preference and will share the balance of thefree property proportionately.

STEP 6: SATISFY THE COMMON CLAIMS

Whatever is remaining of the debtor’s free property will be used to satisfy the common claims. Sincethese will not be enough to cover the debtor’s remaining liabilities (he’s insolvent), the commoncreditors will share the balance in proportion to the amount of their credit, regardless of the date.


Most probably, JPSP will just ask us to list the order of preference of several credits. So mysuggestion is to make the lists mentioned above and just update the list of ordinary preferred claimsand common claims after satisfying the special preferred claims, in case there is an excess ordeficiency.

Examples:

On January 1, 2002, Debtor executes a promissory note for 500K in a private instrument.On March 1, 2002, he executes a Real Estate Mortgage over his house and lot worth P3M tosecure a P5M loan. On the same date, he also executes a notarized promissory note forP1M. On September 1, 2002, a creditor is able to obtain a favorable judgment againstDebtor for P100K. Debtor becomes insolvent. What is the order of priority of his creditors’claims?

1. The mortgage credit should be satisfied first. But since it is for P5M and the house and lot isonly worth P3M, there will be a deficiency of P2M. The P2M will be an ordinary preferredcredit.

2. Next in priority are the notarized promissory note for P1M and the P2M deficiency on themortgage credit. They are both ordinary preferred credits under (14) of 2244. Since theywere executed on the same date, they enjoy the same order of preference and will shareproportionately in the free property of the Debtor.

3. The last to be satisfied will be the promissory note in a private instrument, which is a commoncredit.

The debtor’s assets are a house and lot, a car, and cash. He is insolvent. His obligationsare as follows:

A real estate mortgage dated June 1, 2002Chattel mortgage on the car dated March 1, 2002Real property tax on the house and lotIncome taxImport duty on the carUnpaid seller of the lot, sold to him on March 1, 2002License fee owing the city government for business of DebtorNotarized promissory note dated March 1, 2002Acknowledgment receipt of debt dated March 1, 2002Judgment dated March 1, 2002, with attachment on house and lot dated January 1, 2002

What is the order of preference?

First, make the inventory:

Immovable Property with Special Preferred Claim

House and Lot

Movable Property with Special Preferred Claim

Car

Free Property

Cash

Second, group the credits:


SPECIAL PREFERREDCLAIMS OVERIMMOVABLEPROPERTY

SPECIAL PREFERREDCLAIMS OVER

MOVABLE PROPERTY

ORDINARYPREFERRED CLAIMS

COMMON CLAIMS

Real estate mortgagedated June 1, 2002

Real property tax onthe house and lot

Unpaid seller of the lot,sold on March 1, 2002

Judgment dated March1, 2002, withattachment on housedated January 1, 2002

Import duty on the car

Chattel mortgage onthe car dated March 1,2002

Income tax

License fee owing thecity government forbusiness of Debtor

Notarized promissorynote dated March 1,2002

Acknowledgmentreceipt of debt datedMarch 1, 2002

Third, satisfy special preferred claims:

With respect to the House and Lot

1. Real property tax2. The following will share proportionately the balance after the payment of the real property

tax:

a. Real estate mortgage creditorb. Unpaid sellerc. Judgment dated March 1, 2002 with attachment on house and lot dated January 1,

2002

[Let’s assume that there was a deficiency in settling the claims of these three creditors]

With respect to the Car

1. Import duty2. Chattel mortgage creditor

Fourth, update the list of credits:

ORDINARY PREFERRED CLAIMS COMMON CLAIMSIncome tax

License fee owing the city government forbusiness of Debtor

Notarized promissory note dated March 1, 2002

Add:

Deficiency in claim of Real estate mortgage creditor dated June 1, 2002

Deficiency in claim of unpaid seller of the lot, soldon March 1, 2002

Deficiency in claim from judgment dated March 1,2002

Acknowledgment receipt of debt dated March 1,2002


Fifth, pay the ordinary preferred claims out of free property in the following order:

1. Income tax

2. License fees

3. Proportionate sharing:Notarized promissory note dated March 1, 2002Unpaid seller’s deficiency, sale dated March 1, 2002Deficiency in judgment credit, dated March 1, 2002

4. Deficiency in real estate mortgage, dated June 1, 2002

Sixth, pay the common claims out of free property

Acknowledgment receipt of debt


INSOLVENCY LAW

What is insolvency?

It denotes the state of a person whose liabilities are more than his assets.

The Insolvency Law provides for three remedies:

1. Suspension of Payments2. Petition for Voluntary Insolvency3. Petition for Involuntary Insolvency

I. SUSPENSION OF PAYMENTS

What is suspension of payments?

Suspension of payments is the postponement, by court order, of the payment of debts of one who,while possessing sufficient property to cover his debts, foresees the impossibility of meeting themwhen they respectively fall due (solvent but not liquid).

What are the laws governing suspension of payments?

A debtor may file a petition for suspension of payments either under The Insolvency Law or PD902-A.

SUSPENSION OF PAYMENTS UNDER PD 902-A

Who may file for suspension of payments under PD 902-A?

A corporation may file for suspension of payments under PD 902-A if it is either:

1. Solvent but not liquid; OR2. Insolvent and under the management of a Rehabilitation Receiver or Management

Committee

A Rehabilitation Receiver or Management Committee is a group of persons appointed by thecourt to take over the assets of the insolvent corporation in order to turn it around.

A natural person cannot file for suspension of payments under PD 902-A,

Where do you file a petition for suspension of payments under PD902-A?

You file the petition with the RTC (it used to be with the SEC, but the law was amended).

What are the advantages of filing a petition for suspension ofpayments?

The advantages of filing a petition for suspension of payments are:

1. The debtor has continued access to the assets and resources of the corporation; and


2. It gives the debtor leverage or a framework for negotiation (that is, if he files it under PD902-A, not the Insolvency Law). The debtor can delay payment for as long as the courtallows, so it’s a good chance to bargain with creditors in the meantime.


If you were the debtor corporation, what are the advantages of filing the petition forsuspension of payments under PD 902-A instead of under the Insolvency Law?

1. PD 902-A is more lenient than the Insolvency Law. Under the Insolvency Law, thedebtor must be solvent but not liquid. Under PD 902-A, even if the corporation isinsolvent, as long as it is under Rehabilitation Receiver or Management Committee, itcan file for suspension of payments.

2. Under the Insolvency Law, the creditors have a say on whether to grant the petition.Under PD 902-A, only the court decides.

3. Under PD 902-A even secured creditors are covered by the suspension; there are noexceptions. All claims are suspended. Under the Insolvency Law, secured creditors arenot covered by the suspension; they may foreclose upon default.

SUSPENSION OF PAYMENTS UNDER THE INSOLVENCY LAW (SECTIONS 2-13)

What are the requisites of the petition for suspension of paymentsunder the Insolvency Law?

The petition must be filed by a debtor:

1. possessing sufficient property to cover all his debts (SOLVENT)

2. foreseeing the impossibility of meeting them when they respectively fall due (NOTLIQUID)

3. petitioning that he be declared in the state of suspension of payments.

The debtor may either be a natural or juridical person (Although, as mentioned already, if you’rea corporation, it would be better to file the petition under PD 902-A, not under the InsolvencyLaw).

The petition need not be verified.

What is the procedure for suspension of payments?

1. File a petition with the RTC where the debtor has resided for six months prior to thefiling of the petition.

The petition should be accompanied by a verified list of all of his creditors, debts andliabilities, a statement of his assets and liabilities, and the proposed agreement that herequests from his creditors.

2. The court will issue an order calling for the meeting of all creditors. The meeting shouldtake place not less than 2 weeks nor more than 8 weeks from the date of the order.

3. The order will be published and notice sent to all the creditors of the debtor.


4. There will be a meeting of creditors in which they will decide whether to grant thepetition. Take note that the amount of the debt is not reduced. The debtor merely buysmore time to satisfy his obligations.

Quorum Requirement: To have a valid meeting, the creditors present must representat least 60% of the total liabilities of the debtor.

Ex: A has liabilities worth P10,000 as follows: creditor X: 3,000; creditor Y: 3,000, andcreditor Z: 4,000. If X and Y are present, there will be a quorum because they represent6,000 or 60% of the total liabilities of A.

5. The creditors will approve the proposition of the debtor.

Majority required to approve the proposal: A double majority consisting in 2/3 of thenumber of creditors voting, which 2/3 must represent at least 60% of the total liabilitiesof the debtor.

Example: There are 99 creditors representing total liabilities worth P100K. What is themajority required to approve any proposal?

The majority required is 66 creditors (2/3 of the number of creditors voting), whomust, in addition, represent at least P60K worth of liabilities.

What if the debtor owes one creditor a total of P60K, is his single vote a valid majority?

No. Because although he met the requirement of 60% of the liabilities, he does notconstitute 2/3 of the number of creditors voting. There must be a double majority.

6. Objections, if any, to the decision must be made within 10 days following the meeting.

7. Issuance of the order of the court directing that the agreement be carried out in case thedecision is declared valid, or when no objection to said decision has been presented.

What are the effects of filing of the petition?

1. No disposition of his property may be made by the debtor except those made in theordinary course of business;

2. No payments may be made by the debtor except those made in the ordinary course ofbusiness;

3. Upon request to the court, all pending executions against the debtor shall be suspendedexcept execution against property especially mortgaged.

Why is it in the interest of the debtor to refrain from making any disposition or paymentother than those in the ordinary course of business?

Dispositions or payments made which are not in the ordinary course of business may indicatethat the debtor connived with a creditor into voting in favor of the suspension of payments bybuying his vote. Also, this shows that the debtor is liquid after all, and therefore, does not needto be placed in a state of suspension of payments.


Are all of the creditors of the debtor affected by the filing of thepetition?

Only those creditors included in the schedules filed by the debtor will be called upon to take partin the meeting. Hence, those who did not appear because they were not informed of theproceedings will not be affected. The debtor is obliged to disclose all of his creditors in thepetition. The disclosure shall be verified or confirmed under oath.

Which creditors are not affected by the order of suspension ofpayments?

Aside from those creditors to whom notice was not given, the following creditors are also notcovered by the suspension:

1. Persons having claims for personal labor, maintenance, expense of last illness andfuneral of the wife or children of the debtor incurred in the 60 days immediatelypreceding the filing of the petition; and

2. Persons having legal or contractual mortgages. They can foreclose upon default inspite of the suspension of payment.

(But take note that this does not apply if the petition was filed under PD 902-A, in whichcase, ALL creditors are covered by the suspension of payments. This rule applies onlywhen the petition is filed under the Insolvency Law.)

What are the grounds for questioning the decision of the meeting?

1. Procedural defects in the calling and holding of the meeting, and the deliberationsconducted, which caused prejudice to the rights of the creditors;

2. Fraudulent connivance between a creditor and the debtor for the creditor to vote infavor of the proposed agreement;

If there is proof that the debtor somehow bribed the creditor or bought his vote, thedecision of the meeting can be set aside. However, it is legal to give OTHER incentivesto the creditor, such as higher interest rates. These are not bribes but merely incentivesto induce them to vote in favor of suspension.

3. Fraudulent conveyance of claims by a creditor for the purpose of obtaining a majority.

Ex: There are 99 creditors with claims worth P100K total. 1 creditor represents 60Kworth of credits, while the other 98 creditors represent a total of 40K. The one creditoris in favor of suspension of payments, while the other 98 are against it. How will thisone creditor manipulate the situation in order to approve the petition?

He has already complied with the 60% requirement. His problem is the 2/3 of thecreditors requirement, since he only represents 1/99 of the creditors. What he can do isto assign some of his credits to 200 other people. That way, they will represent 201/299of the creditors, with a total claim of 60K. This is enough to meet the double majorityrequirement. BUT, this is a ground for questioning the decision of the meeting.


II. VOLUNTARY INSOLVENCY

What is the concept of voluntary insolvency?

An insolvent debtor whose liabilities exceed P1,000 may apply to be discharged from his debtsand liabilities by filing a petition for voluntary insolvency in the RTC where he has resided forthe last six months prior to the filing of the petition. In voluntary insolvency, the debtor himselfis the petitioner.

The date of the filing of the petition is important for purposes of reckoning certain periods, suchas the residency requirement.

Distinctions between suspension of payments and insolvency (in general)

INSOLVENCY SUSPENSION OFPAYMENTS

PURPOSE To discharge the debtor fromthe payment of debts

To suspend or delay thepayment of debts

SOLVENCY OF DEBTOR Debtor does not havesufficient property to pay hisdebts

Debtor has sufficient propertyto pay his debts

EFFECT ON AMOUNT OFINDEBTEDNESS

The amount is affected.Creditors receive less thantheir credits; and where thereare preferences, somecreditors may not receiveanything at all.

The amount of indebtednessis not affected.

NUMBER OF CREDITORS There must be three or morecreditors if it is involuntaryinsolvency.

The number of creditors isimmaterial.

What are the jurisdictional requirements for the petition for voluntary insolvency?

In the petition, the debtor shall indicate:

1. his place of residence and the period of residence therein prior to the filing of thepetition;

2. his inability to pay all his debts in full;3. his willingness to surrender all his property, estate, and effects not exempt from

execution for the benefit of his creditors; 4. an application to be adjudged insolvent.

The petition shall be accompanied by:

1. A verified schedule containing:

a. a full and true statement of all debts and liabilities of the insolvent debtor, andb. an outline of the facts giving rise or which might give rise to a cause of action

against the insolvent debtor


2. A verified inventory containing:

a. an accurate description of all the personal and real property of the insolvent,whether or not exempt from execution, including a statement as to its value,location, and encumbrances thereon; and

b. an outline of the facts giving rise or which might give rise to a right of action infavor of the insolvent debtor.

What is the procedure for voluntary insolvency?

1. Filing of the petition by the debtor praying to be declared insolvent.

Unlike in involuntary insolvency, in voluntary insolvency, there need not be anallegation of an act of insolvency by the creditors of the debtor. This is because involuntary insolvency, the one petitioning is the debtor himself. The very act of filing thepetition is the act of insolvency. In contrast, in involuntary insolvency, the onespetitioning are the debtor’s creditors.

2. Issuance of an order of adjudication declaring the debtor insolvent.

The court need not conduct a hearing before declaring the debtor insolvent andtaking his assets. This is because the petition is voluntary on the part of the debtor. It isnot adversarial.

3. Publication and service of the order to creditors.

4. Meeting of the creditors to elect the assignee in insolvency.

5. Conveyance of the debtor’s property by the clerk of court to the assignee.

6. Liquidation of the debtor’s assets and payment of his debts.

7. Composition, if agreed upon.

8. Discharge of the debtor, upon his application, except if the debtor is a corporation.

9. Objection, if any, to the discharge.

10. Appeal to the Supreme Court in certain cases.

What are the effects of an order declaring the petitioning debtor insolvent?

1. The sheriff takes possession of all the assets of the debtor which are not exempt fromexecution until the appointment of a receiver or an assignee.

2. The payment to the debtor of any debts due to him and the delivery to the debtor or toany person for him any property belonging to him, and the transfer of any property byhim are forbidden.

3. All civil proceedings pending against the insolvent debtor shall be stayed.


4. Mortgages or pledges, attachments or executions on property of the debtor dulyrecorded and not dissolved are not, however, affected by the order.

If the petitioner is a corporation, JPSP thinks that the better route is still to file for suspension ofpayments under PD 902-A instead of filing for voluntary insolvency.

If the petitioner is a natural person, his only incentive to file a petition for voluntary insolvency isthat he will get a discharge from past debts and liabilities (corporations do not get thisdischarge). But otherwise, there are very few advantages in filing for voluntary insolvency. Thedebtor should just fight it out with his creditors, since filing for voluntary insolvency is not justdemeaning but will even affect the debtor’s credit-worthiness later on. After filing for voluntaryinsolvency, no one will trust that debtor enough to lend him money again.

III. INVOLUNTARY INSOLVENCY

What is the purpose of involuntary insolvency?

A petition for involuntary insolvency is not an ordinary personal action for collection of debts. Itspurpose is to impound all of the non-exempt property of the debtor, to distribute it equitablyamong his creditors, and to release him from further liability.

Distinctions between Voluntary Insolvency and Involuntary Insolvency

VOLUNTARY INSOLVENCY INVOLUNTARYINSOLVENCY

NUMBER OF CREDITORS One creditor is sufficient Three or more creditorsPETITIONER The insolvent debtor Three or more creditors who

must possess thequalifications provided by law

ACTS OF INSOLVENCY Debtor must not be guilty ofany act of insolvency

Debtor must have committedone or more of the 13 acts

AMOUNT OFINDEBTEDNESS

Must be greater than P1,000 Must be P1,000 or more

BOND Not required Petition must be accompaniedby a bond

HEARING Not necessary; may begranted ex parte

Petition is granted only afterhearing

RESIDENCY REQUIREMENT Petition must be filed withRTC where debtor hasresided for at least 6 months

Petition must be filed withRTC where debtor resides orhas his place of business; noresidency requirement

ISSUANCE OF THE ORDEROF ADJUDICATIONDECLARING THE DEBTORINSOLVENT

Upon the filing of thevoluntary petition

Upon hearing of the case


Who may petition for involuntary insolvency?

The petitioners must be:

1. at least three creditors of one debtor 2. who are residents of the Philippines, 3. whose credits accrued in the Philippines, 4. the aggregate amount of which is at least P1,000. 5. In addition, the credits of these three creditors should NOT have accrued within 30

days prior to the filing of the petition.

Why does it have to be three creditors? Why is it not enough for one creditor to file thepetition?

Insolvency proceedings contemplate competing claims of several creditors over the assets ofthe insolvent debtor. If there is only one creditor, there are no competing claims. The creditorcan just go to court and file a simple action to collect.

But if you’re the single creditor of one debtor, there may be instances when you wouldwant to file a petition for involuntary insolvency against the debtor.

First, how do you do this? Since you’re only one creditor, you cannot file the petition becausethe Insolvency Law requires that it be filed by at least three creditors. To get around thisrequirement, you should assign some of the credit to at least two other persons. After waitingfor 30 days (cooling-off period), you can file the petition.

Why would you want to do this?

The petition for involuntary insolvency can be used as a tool to harass or pressure a debtor intosettling his obligation with the single creditor.

Example: Creditor extends a loan to a Foreign Company, which is publicly listed in the HongKong Stock Exchange. Foreign Company fails to pay, and since it is a foreign company, it hasno assets in the Philippines which Creditor can run after. What should Creditor do?

Creditor should first assign some of the credit to two other companies, wait 30 days, then filethe petition for involuntary insolvency against Foreign Company. News of the ForeignCompany’s insolvency will reach Hong Kong, and the price of its shares will go down. To stopthe share prices from going down, Foreign Company will be forced to settle the obligation, sothat Creditor will withdraw the petition. (According to JPSP, Creditor can do this even if ForeignCompany is not actually insolvent. It’s just a legal tactic to get Foreign Company to settle theobligation.)

What are the requisites of the petition for involuntary insolvency?

The petition must:

1. be verified by the petitioners

2. set forth one or more acts of insolvency mentioned in the law


What are acts of insolvency?

There are 13 acts of insolvency mentioned in Sec. 20 of the Insolvency Law. Thesemay be grouped into three general categories (See p. 568 of De Leon for the completelist):

a. the debtor committed acts to ensure that the debtor will not be able to payb. the debtor committed acts in fraud of creditorsc. the debtor committed acts giving preference to one creditor in favor of other

creditors

But the petition should allege at least one of the 13 specific acts of insolvencymentioned in the law. This is a jurisdictional requirement.

3. be accompanied by a bond, approved by the court with at least two sureties, in suchpenal sum as the court shall direct.

The purpose of the bond is for the petitioners to answer for the costs, expenses, anddamages resulting in the filing of the petition. For example, in the earlier case of thesingle creditor who files the petition against the Foreign Company just to humiliate him,the bond will answer for damages that Foreign Company can prove as a result of thewrongful filing of the petition.

What are the steps in filing a petition for involuntary insolvency?

1. Filing of the petition by three or more creditors in the RTC where the debtor resides orhas his place of business.

2. Issuance of the order requiring the debtor to show cause why he should not beadjudged insolvent.

3. Service to debtor of the order to show cause.

4. Filing of the debtor’s answer or motion to dismiss.

5. Hearing of the case.

This is in contrast with voluntary insolvency, where there is no need for a hearing. Ininvoluntary insolvency, there is a hearing because the proceedings are adversarial. Thedebtor is given a chance to refute the claim of the petitioners that he is insolvent.

6. Issuance of the order or decision adjudging the debtor insolvent.

Note that between the filing of the petition and the adjudication of the case by thecourt, there is a period of time during which the debtor still has his assets. While thecase is being decided by the court, the debtor can dissipate his assets in the meantime.To protect themselves from this situation, the creditors should either ask the court for aninjunction or for a receiver who will hold the properties of the debtor.

7. Publication and service of the order.

8. Meeting of creditors for election of an assignee in insolvency.


The assignee must be elected within two to eight weeks from the date of the order ofthe adjudication.

9. Conveyance of the debtor’s property by the clerk of court to the assignee.

10. Liquidation of the assets of the debtor and payment of his debts.

11. Composition, if agreed upon.

12. Discharge of the debtor on his application, except if the debtor is a corporation.

13. Objection, if any, to the discharge.

14. Appeal to the Supreme Court, in certain cases.

IV. ASSIGNEES

What is an assignee?

An assignee is the person elected by the creditors or appointed by the court to whom aninsolvent debtor makes an assignment of all his property for the benefit of his creditors. Theassignment vests title to all the assets of the debtor in favor of the assignee.

The assignee represents the insolvent as well as the creditors in voluntary and involuntaryproceedings.

Who can participate in the election of the assignee?

Creditors who have filed their claims in the office of the clerk of court at least two days priorto the scheduled election may participate.

As a general rule, a secured creditor cannot participate in the election, unless:

1. he has asked for the fixing of the value of the security;

OR

2. he has surrendered the security to the sheriff or receiver of the estate of the insolvent.

If you were the secured creditor, why would you surrender the security?

If the security is not enough to cover the obligation, you might as well participate in the electionif you think that the portion that will be allotted to you will be greater than the value that you willrealize from the sale of the security.

How do the creditors choose the assignee?

The creditors will meet in order to elect the assignee.


In order to validly elect an assignee, the majority of the creditors both in number and in theamount of credit they represent (another case of double majority) should vote for the sameassignee.

If the creditors do not attend the meeting or fail or refuse to elect an assignee, or if theassignee fails to qualify or subsequently becomes incapacitated, the court will appoint theassignee.

What should the assignee do once he is elected?

The assignee is required to give a bond for the faithful performance of his duties, within fivedays from his election, in an amount to be fixed by the court, with two or more sureties. Thebond will answer for any liability that the assignee may incur to persons aggrieved by hisactions as assignee.

If you were given an opportunity, will you act as an assignee?

Yes, because the assignee earns a substantial fee. According to Section 42 of the InsolvencyLaw, the assignee earns commissions at the following rates:

7% for the first P1,000 that he will be able to liquidate from the properties of the debtor; 5% for sums exceeding P1,000 but less than P10,000; and4% for sums exceeding P10,000.

So if the amount that you can liquidate is P100M, you will earn P4M.

Aside from this fee, the assignee will also have other benefits, such as reimbursements of hisexpenses and the opportunity to refer legal or accounting matters to his firm, if he is a lawyer ora CPA.

What are the effects of assignment?

1. The assignee takes the property in the same conditions that the insolvent held it.

2. Upon appointment, the legal title to all the property of the insolvent is vested in theassignee, and the control of the property is vested in the court. But the title of theassignee retroacts to the date of the filing of the petition for insolvency.

3. All actions to recover all the estate, debts, and effects of the insolvent shall be broughtby the assignee and not by the creditors.

4. If there was an attachment or a judgment against the insolvent debtor made 30days before the filing of the petition for insolvency, it will be set aside.

What are the powers and duties of the assignee?

The assignee has the powers of administration over the property of the insolvent. Havingthese powers, he can sue and recover claims belonging to the debtor, take into possession allof the property of the debtor, recover property fraudulently conveyed by the debtor, etc (for acomplete enumeration, see p. 586-587 of De Leon).


The assignee does not have powers of disposition. For acts of disposition, such as sale ofthe property of the insolvent debtor or payment of the creditor’s shares, the assignee mustobtain a court order.

Section 37 of the Insolvency Law: Penalty for Embezzlement

Take note of Section 37, which provides that if any person, who knows of the pending orimminent insolvency proceedings concerning the debtor, embezzles or disposes of any of theproperty of the insolvent, he shall be liable for a penalty equal to double the value of theproperty embezzled or disposed. The penalty will go to the estate of the insolvent.

This relates only to embezzlement of the debtor’s property, and not to assignments of creditmade by the creditors behind each other’s backs.

What is a dividend in insolvency?

It is a part of the fund arising from the assets of the estate of the insolvent debtor, rightfullyallocated to a creditor entitled to a share in the fund. It is paid by the assignee only upon orderof the court.

According to JPSP, if you’re a creditor, you may not want to do involuntary insolvencybecause there are a lot of costs – assignee’s fees, legal costs, etc. It might be better is youcould obtain a global settlement. (I don’t know, though, what “global” means.)

V. CLASSIFICATION AND PREFERENCE OF CREDITORS

Disregard the rules in Sec. 48-50 of the Insolvency Law. The applicable rules are those underthe Civil Code on Concurrence and Preference of Credits (Articles 2236-2251).

But take note of Section 48, which provides that property found among the property of theinsolvent debtor but which are not really owned by him should be taken out of the proceedings.Examples are property held in trust or as a lessor or usufructuary, etc. After taking them out,apply the rules under the Civil Code.

VI. PARTNERSHIPS AND CORPORATIONS

Who may petition for declaration of insolvency of a partnership?

In case of voluntary insolvency, the petition may be filed by all or any of the partners.

In case of involuntary insolvency, the petition may be filed by three or more creditors of thepartnership or one or more of the partners.

Which properties are covered in insolvency proceedings?

1. All the property of the partnership; and2. All the separate property of each of the general partners, except

a. separate properties of limited partners; andb. properties which are exempt by law


Can a partnership be declared insolvent even if the partners constituting the same aresolvent?

Yes. A partnership may be declared insolvent notwithstanding the solvency of the partnersconstituting it. The creditors of the partnership, after first exhausting its assets, may proceedagainst the solvent general partners who are proportionately liable with their separate property.

What happens to the partnership when any of the partners becomes insolvent?

The partnership is automatically dissolved by the insolvency of any partner or of the partnership(Art. 1830, Civil Code).

What is the benefit given by the Insolvency Law to partnerships?

Partnerships get a discharge from the obligations, if they apply for one. In contrast,corporations do not get a discharge.

Why doesn’t the law give corporations a discharge?

Corporations do not get a discharge because their creditors can only go after the assets of thecorporation. The creditors cannot collect any deficiency from the stockholders. If thestockholders want a fresh start, they can just put up a new corporation and start with a cleanslate. There is no need to get a discharge in order to have a fresh start.

But if it’s a partnership, and the assets of the partnership are not enough to cover its liabilities,the creditors can still go after the general partners for the deficiency. This is why it makessense to give them a discharge.

How do you distribute the net proceeds of the properties of the partnership?

1. The net proceeds of the partnership property shall be used to pay the debts of thepartnership.

2. The net proceeds of the individual estate of each partner shall be used to pay individualdebts.

3. If there is any surplus in the property of any general partner after paying his individualdebts, a proportionate part of this surplus will be added to the partnership assets andwill be used to pay partnership debts.

4. If there is any surplus in the property of the partnership, the surplus shall be added tothe assets of the individual partners in proportion to their interests in the partnership.

What is the effect of a declaration that a corporation is insolvent?

The property and assets of the corporation will be distributed to the creditors. Unlike inpartnership, the property of the stockholders of the corporation cannot be used to pay thecreditors of the corporation. However, the corporation will not be allowed to get a discharge.

VII. PROOF OF DEBTS


What are the debts which may be proved (collected) against the estate of the insolventdebtor?

1. All debts due and payable at the time of the adjudication of insolvency;

2. All debts existing at the time of the adjudication of insolvency but not payable until afuture time.

3. Any debt of the insolvent arising from his liability as indorser, surety, bail orguarantor, where such liability became absolute after the adjudication of insolvencybut before the final dividend shall have been declared;

4. Other contingent debts and liabilities contracted by the insolvent if the contingencyshall happen before the order of final dividend; and

5. Any claim for reimbursement of a person who has answered, in whole or in part, for theinsolvent’s debt as bail, surety, or guarantor or otherwise.

What is a contingent claim?

It is a claim in which the liability depends on a future and uncertain event. For example, theclaim of a surety is a contingent claim because the surety can only claim reimbursement fromthe principal debtor once he himself has paid the obligation. But before the surety pays theprincipal obligation, he has no claim for reimbursement against the principal debtor.

A claim based on a contingency which has not happened at the time of the pendency of theproceedings cannot be proved in the proceedings, since there is no real claim yet. But, if thecontingency happens after the termination of the proceedings, the creditor can still claim fromthe debtor. The discharge granted the debtor from his existing debts does not cover thosedebts that could not have been proved in the insolvency proceedings.

What happens to obligations of the insolvent debtor that arise after the commencementof the proceedings?

These debts cannot be proved in the proceedings. But the creditor can still collect from thedebtor, since the discharge given to the debtor cannot apply to claims that could not have beenproved in the insolvency proceedings.

Which debts cannot be proved at the insolvency proceedings?

1. Those barred by prescription;

2. Claims of secured creditors unless they waive the right to foreclose or surrender thesecurity;

3. Claims of creditors who hold an attachment or execution on property of the debtor,provided that this was issued at least 30 days before the institution of the insolvencyproceedings;

4. Claims on account of which a fraudulent preference was made or given;


5. Support

6. Damages arising out of a tort

Can a creditor set up compensation/offset his own debts against the insolvent debtor?

This is the case of Uy-Tong v. Silva. Compensation can be set up against the insolvent debtorbut only for those debts which arose at least 30 days before the filing of the insolvencyproceedings. If the claim arose within the 30-day period before the filing of the petition, therecan be no compensation. The rule on preferences would be disregarded if the set-off wereallowed. It would, in effect, give the one claiming compensation undue preference over othercreditors.

VIII. COMPOSITIONS

What is composition?

Composition is an agreement, made upon a sufficient consideration, between the insolventor financially embarrassed debtor and all of his creditors whereby the creditors agree toaccept a dividend less than the amount of their claims, for the sake of getting paid sooner.

What are the requisites?

1. The offer of the terms of composition must be made after the filing in court of theschedule of property and submission of the list of creditors;

2. The offer must be accepted in writing by a double majority of the creditors – majorityof the number of creditors representing a majority of the claims;

3. It must be made after depositing the consideration to be paid and the cost of theproceedings;

4. The court must approve the terms of the composition.

When can composition be set aside?

It can be challenged by any party in interest within six months after it has been confirmed on theground of fraud.

IX. DISCHARGE

What is discharge?

Discharge is the privilege given to the insolvent, freeing him from all liabilities proved during theinsolvency proceedings.

Is the discharge automatically given to the insolvent debtor?

No. The debtor must ask for it within three months to one year after he is adjudicated insolvent.


Which debts are released by discharge?

1. All those set forth in the schedule; and2. All those which were or might have been proved against the estate in the insolvency

proceedings.

Which debts are not released?

1. Taxes2. Debts arising from any act of swindling (because you don’t reward a person who

violated a law or a trust)3. Debts of a surety, guarantor, indorser, or any person liable for the same debt, for or with

the insolvent debtor (This is because the discharge only benefits the principal debtor,not his co-debtors or guarantors).

4. Debts of a corporation5. Claims for support6. Debts which were not proved and could not have been proved during the insolvency

proceedings7. Debts arising from tort8. Claims of secured creditors9. Debts which were not yet existing at the time of the discharge10. Contingent claims

When can the petition to get a discharge be denied?

The debtor cannot get a discharge if he is in bad faith or does acts to the prejudice of hiscreditors.

Once granted, when may a discharge be revoked?

A discharge may be revoked by the court if a creditor can prove that it was fraudulentlyobtained. The creditor must file the petition to revoke it within one year from the date of thedischarge.

X. FRAUDULENT PREFERENCES AND TRANSFERS

What is a preferential transfer?

It is a parting with the property of the insolvent for the benefit of a creditor with the result thatthe estate of the insolvent is diminished and other creditors are prejudiced.

What is a fraudulent preference?

It is a disposition of property by the debtor under the following conditions:

1. he is insolvent or is in contemplation of insolvency;

2. the transaction is made within 30 days before the filing of the petition for insolvency;

3. it is made with a view to giving preference to any creditor;


4. the person receiving a benefit has reason to believe that the debtor is insolvent and thatthe transfer is made in order to defeat or prejudice the rights of other creditors.

What is a fraudulent conveyance/transfer?

It is any disposition of property made by the insolvent within one month before the filing ofthe petition for insolvency, except for valuable consideration in good faith.

What is the status of the fraudulent conveyance?

If made within 30 days before the filing of insolvency proceedings, the transfer is void.

If made after the filing of insolvency proceedings, it is rescissible for being in fraud of creditors.

Another remedy of the creditors is to file a criminal complaint against the insolvent debtor.

Is there a presumption of fraud?

There is a rebuttable presumption that a conveyance is fraudulent when:

1. it is not made in the usual and ordinary cause of business of the debtor; or2. it is made under a confession of judgment.

Within 30 days before the filing of the petition for insolvency, Debtor sells a car worthP1M to Buyer for 900K. Is this a fraudulent conveyance?

No. There is a fair exchange of value, so the transaction does not really prejudice the creditors.

DEPOSIT

CHAPTER 1 DEPOSIT IN GENERAL AND ITS DIFFERENT KINDS

Art. 1962. A deposit is constituted from the moment a person receives a thing belonging toanother, with the obligation of safely keeping it and of returning the same. If the safekeepingof the thing delivered is not the principal purpose of the contract, there is no deposit but someother contract.

What is the contract of deposit?

It is the receipt by a person of a thing belonging to another with the obligation of safelykeeping it and of returning it.

It is essential that the depositary is not the owner of the property deposited.

What are the characteristics of the contract of deposit?

1. Real contract – Deposit is perfected by the delivery of the subject matter

2. Unilateral if the deposit is gratuitous – because only the depositary has an obligation;


Bilateral if the deposit is for compensation – gives rise to obligations on the part of boththe depositary and the depositor.

What is the principal purpose of the contract of deposit?

The principal purpose is the safekeeping of the thing delivered. If safekeeping is merely anaccessory or secondary obligation, it is not a deposit, but another contract, such ascommodatum, lease, or agency.

What is the subject matter in deposit?

Only movables can be the subject matter of deposit. If you leave a kid a Gymboree or at Kidsat Work, it’s not a deposit, but maybe a contract of service.

JPSP Examples:

1. You park your car at the car park of Powerplant. Is it a contract of deposit? No,because the purpose is not safekeeping. The purpose is merely convenience, so thatyou have a place to leave your car while you shop or watch a movie or go to school.

2. You park your car at the Dela Rosa car park. Is it a contract of deposit? Still, no, evenif, unlike the car park of Powerplant, the sole reason for the existence of the Dela Rosacar park is for people to leave their cars there. It’s still not a deposit because thepurpose is not safekeeping. People who park there just want the space. It’s a short-term lease of space.

So, legally, it is not a deposit. And even for practical purposes, it should not be treatedas a deposit. If it were a deposit, if the car is lost, the owner of the car park (thedepositary) will shoulder the loss. The direct result of this is that parking fees will go upbecause it would have to cover insurance costs in addition to the regular parking fee.

Deposit distinguished from Simple Loan (mutuum)

DEPOSIT SIMPLE LOANPURPOSE Safekeeping ConsumptionWHEN RETURN CAN BEDEMANDED

Depositor can demand returnof the thing at will

Lender must wait until theexpiration of the periodgranted to the debtor

SUBJECT MATTER Movable and immovableproperty (if deposit is judicial)

Only money and any otherfungible thing

Deposit distinguished from Commodatum

DEPOSIT COMMODATUMPURPOSE Safekeeping Transfer of use of the subject

matterGRATUITOUS? May be gratuitous, may be

onerousAlways gratuitous

SUBJECT MATTER In extra-judicial deposit, onlymovables

Both movable and immovableproperty


Art. 1963. An agreement to constitute a deposit is binding, but the deposit itself is notperfected until the delivery of the thing.

A: “I will deposit my car in your garage at 8 a.m. tomorrow.”B: “Okay.”

Is there a contract of deposit at this point?

No. Deposit is a real contract and requires delivery of the subject matter in order to beperfected.

Is there a contract at this point?

Yes, there is a contract. It is a contract of future deposit. It is perfected by mere consent, andis binding upon the parties.

Art. 1964. A deposit may be constituted judicially or extrajudicially.

Kinds of Deposit

1. Judicial – takes place when an attachment or seizure of property in litigation is ordered

2. Extra-judicial

(a) Voluntary – delivery is made by the will of the depositor or by two or morepersons each of whom believes himself entitled to the thing deposited; or

(b) Necessary – made in compliance with a legal obligation, or on the occasionof any calamity, or by travelers in hotels and inns, or by travelers with commoncarriers.

Art. 1965. A deposit is a gratuitous contract except when there is an agreement to thecontrary or unless the depositary is engaged in the business of storing goods.

GENERAL RULE: Deposit is gratuitous.

EXCEPTIONS:

1. Contrary stipulation

2. Depositary is engaged in business of storing goods – ex. A warehouseman

3. Where property is saved from destruction without knowledge of the owner – In this case,the owner is bound to pay the person who saved his property just compensation

Art. 1966. Only movable things may be the object of deposit.

This applies only to an extra-judicial deposit, whether voluntary or necessary.

Reason: The main purpose of deposit is safekeeping. Since real property may not disappear ormay not be lost, there is no point in entrusting them to someone for safekeeping.


A gives the keys to his house to B for safekeeping. Is this a deposit of the house? No, sincethe house is an immovable which cannot be the proper subject matter of deposit. Therelationship is an agency.

But if it is a judicial deposit, even immovable property can be a valid subject matter. Thereason is that the purpose of a judicial deposit is different. It is to protect the rights of theparties to the suit.

Art. 1967. An extra-judicial deposit is either voluntary or necessary.

GENERAL RULE: Deposit is voluntary.

EXCEPTIONS: Deposit is necessary in the following cases: (See discussion undernecessary deposit)

1. if made in compliance with a legal obligation;

2. if it takes place on the occasion of any calamity, such as fire, storm, flood, pillage,shipwreck, or other similar events;

3. deposit of effects made by travelers in hotels or inns

4. deposit of goods made by travelers or passengers with common carriers

CHAPTER 2 VOLUNTARY DEPOSIT

Section 1 General Provisions

Art. 1968. A voluntary deposit is that wherein the delivery is made by the will of the depositor.A deposit may also be made by two or more persons each of whom believes himself entitledto the thing deposited with a third person, who shall deliver it in a proper case to the one towhom it belongs.

What is voluntary deposit?

Deposit wherein delivery is made by the will of the depositor.

What is the distinction between voluntary and necessary deposit?

The main difference is that in voluntary deposit, the depositor is free to choose the depositary.In necessary deposit, the depositor lacks the freedom to choose the depositary.

Does the depositor have to be the owner of the thing deposited?

Generally, the depositor should be the owner of the thing, but it is not an essential element ofdeposit. The depositary cannot even require the depositor to prove that he is the owner of thething. When there are several depositors:


If there are two or more persons each claiming the rightful ownership of a thing, pending theresolution of their conflicting claims, they may deposit the thing with a third person. The thirdperson assumes the obligation to deliver to the person to whom it belongs. The depositary canfile an action for interpleader to compel the depositors to settle their conflicting claims.

Ex: A and B both claim to own a dog. While they are trying to settle the ownership of the dog,they can deposit the dog with C. C can file an action for interpleader to compel A and B tosettle the ownership of the dog. C’s obligation is to eventually deliver the dog to whomever isthe rightful owner.

Art. 1969. A contract of deposit may be entered into orally or in writing.

There are no formal requirements for the validity of a contract of deposit. The only thingnecessary is delivery of the thing.

Art. 1970. If a person having capacity to contract accepts a deposit made by one who isincapacitated, the former shall be subject to all the obligations of the depositary, and may becompelled to return the thing by the guardian, or administrator or the person who made thedeposit or by the latter himself if he should acquire capacity.

X, who is insane, deposits her basketball with Boy-B. Can Boy-B refuse to return thebasketball later on, on the ground that the deposit was not valid because of the incapacityof X?

No. If the depositary is capacitated, he is subject to all the obligations of a depositary whetheror not the depositor is capacitated. Hence, he must return the property to the legalrepresentative of X or to X herself if she should recover sanity. Persons who are capacitatedcannot allege the incapacity of those with whom they contract.

JPSP example: Five tinedyers aged 13 to 15 check into a hotel to go on a drinking binge.They deposit some jewelry at the front desk for safekeeping.

Is there a valid deposit?

Yes, but it may be annulled for want of capacity of the tinedyers. It’s actually avoidable contract, which is valid until annulled.

The tinedyers, at the end of their drinking binge, go to the front desk and ask for the returnof the jewelry. What should the hotel do?

The hotel should return the jewelry to their legal representative. The hotel shouldnot return to the tinedyers because if subsequently, the tinedyers lose the jewelry,the hotel could be made liable for the loss. But definitely, the hotel cannot retainthe jewelry, or else, its personnel would be liable for estafa.

Art. 1971. If the deposit has been made by a capacitated person with another who is not, thedepositor shall only have an action to recover the thing deposited while it is still in thepossession of the depositary, or to compel the latter to pay him the amount by which he maybe enriched or benefited himself with the thing or its price. However, if a third person whoacquired the thing acted in bad faith, the depositor may bring an action against him for itsrecovery.


This is the rule that applies if you deposit with a minor or other incapacitated person.

If the depositary is incapacitated, while the depositor is capacitated, the incapacitated does notincur the obligations of a depositary.

The incapacitated is liable only:

(1) to return the thing deposited if it is still in his possession; or(2) to pay the depositor the amount by which he may have benefited through the thing or

its price if the incapacitated is no longer in possession

If the thing was transferred to a third person who was in bad faith, the depositor can recover thething from him. If the transferee was in good faith, the depositor cannot recover from him. Thedepositor can only go after the incapacitated for the value of the thing.

Boy-B deposits his watch with X, who looks like she’s 22 but is actually 13. Can Boy-Brecover the watch?

If the watch is still in the possession of X, Boy-B can recover the watch itself from X.

If X has already sold the watch to Hon, a buyer in good faith and for value, Boy-B cannotrecover the watch. He can only compel X to return the price that Hon paid for the watch (thebenefit that X received from the sale of the watch). So if the watch is worth P10,000 but X soldit to Hon for P5,000, Boy-B can only recover P5,000 from X.

But if Hon was a buyer in bad faith, Boy-B can recover the watch itself from Hon.

Section 2 Obligations of the Depositary

Art. 1972. The depositary is obliged to keep the thing safely and to return it, when required, tothe depositor or to his heirs and successors, or to the person who may have been designatedin the contract. His responsibility with regard to the safekeeping and loss of the thing shall begoverned by the provisions of Title I of this Book.

If the deposit is gratuitous, this fact shall be taken into account in determining thedegree of care that the depositary must observe.

Primary obligations of the depositary:

1. Safekeeping2. Return of the thing, but only when required

Duty of Safekeeping

What is the degree of care required of the depositary?

As a general rule, the depositary must exercise the same diligence as he would exerciseover his OWN property. He should exercise the diligence of a good father of a family. Thereasons for this rule are:


1. Because the contract of deposit involves the depositor’s confidence in the depositary’sgood faith and trustworthiness; and

2. Because it is presumed that the depositor, in choosing the depositary, took into accountthe diligence which the depositary normally exercises with respect to his own property.

BUT, if under the circumstances, a greater degree of care towards the thing deposited isnecessary, the depositary must exercise such extraordinary care. If, in this case, the thingdeposited is lost and the depositary only exercised the same diligence as he would towards hisown property, he is liable to the depositor for the loss.

The loss of the thing while it is in the possession of the depositary raises a presumption of faulton his part.

Duty of Returning the Thing

The thing deposited must be returned to the depositor when he claims it, even though aspecified term or time for such may have been stipulated in the contract and such time has notyet expired.

Art. 1973. Unless there is a stipulation to the contrary, the depositary cannot deposit the thingwith a third person. If deposit with a third person is allowed, the depositary is liable for theloss if he deposited the thing with a person who is manifestly careless or unfit. The depositaryis responsible for the negligence of his employees.

GENERAL RULE: The depositary cannot deposit the thing with a third person.

Reason for the rule: Deposit is founded on trust and confidence. It is presumed that inchoosing the depositary, the depositor took into account his personal qualifications.

EXCEPTION: The parties may stipulate that the depositary may deposit the thing with athird person. But there is a limitation – the depositary cannot choose a third person who ismanifestly careless or unfit.

What happens if the depositary deposits the thing with a third person, and it is lost?

1. If there is no stipulation allowing him to deposit with a third person, he is liablefor the loss, whether it was through his or the third person’s fault or throughfortuitous event.

2. Generally, if the thing is deposited with a third person with permission of the

depositor, and the thing is lost through fortuitous event, the depositary isnot liable for the loss.

However, if he deposits it with a person who is manifestly careless or unfit,even if there is no negligence or even if the loss was through fortuitousevent, the depositary is liable for the loss.

3. If the thing is lost through the negligence of the depositary’s employees, thedepositary is liable for the loss (The employee is the agent of the depositary;principal bears the loss resulting from the negligence of his agent). Here, itis not necessary that the employees be manifestly careless or unfit, but it isnecessary that the loss be through negligence.


Art. 1974. The depositary may change the way of the deposit if under thecircumstances he may reasonable presume that the depositor would consent tothe change if he knew of the facts of the situation. However, before thedepositary may make such change, he shall notify the depositor thereof and waitfor his decision, unless delay would cause danger.

GENERAL RULE: The depositary should not change the way or manner of the deposit asagreed upon.

EXCEPTION: The depositary may change it if there are circumstances indicating thatthe depositor would consent to the change. However, the depositary should firstnotify and wait for the decision of the depositor.

If delay would cause danger, the depositary need not wait for the consent of thedepositor. Notice to the depositor of the change is sufficient.

JPSP example:

A deposited jewelry with B, a resident of Lamitan. B did not feel so secure with the jewelryin Lamitan, so he deposited the jewelry with a bank in Davao. A sued B for damages fordepositing the jewelry with a third person without A’s authorization. What is B’s defense?

B can invoke Article 1974. Under the circumstances, B can infer that A wouldconsent to the change of the manner of deposit.

Art. 1975. The depositary holding certificates, bonds, securities or instrumentswhich earn interest shall be bound to collect the latter when it becomes due, andto take such steps as may be necessary in order that the securities may preservetheir value and the rights corresponding to them according to law.

The above provision shall not apply to contracts for the rent of safetydeposit boxes.

What are the obligations of the depositary if the thing earns interest?

1. Collect the interest, as well as the capital, as it becomes due; and2. Take such steps as may be necessary to preserve its value and the rights

corresponding to it.

Ex: Depositary of a negotiable instrument should give notice of dishonor toall parties secondarily liable, or else these parties would be discharged.

JPSP example:

A deposits to B a promissory note payable to A or order. Can B collect accrued interests onthe note?

No. The instrument is an order instrument. B cannot collect the interest due on itbecause he is neither an indorsee nor an authorized agent of A.

Therefore, Art. 1975 really applies only to BEARER instruments. If it is an orderinstrument, there is a need for an indorsement or at least, a special power ofattorney, to enable the depositary to collect the interest and capital when due.


Safety Deposit Boxes

The contract for rent of safety deposit boxes is not an ordinary contract of lease ofthings because the full and absolute possession and control of the safety depositbox is not given to the party renting.

It is actually a special kind of deposit. It is a contractual relation between theparties. The liability rules are governed by the Civil Code provisions on obligationsand contracts, and not on donations.

Is a stipulation which exempts the bank from liability for the things contained in the safetydeposit box valid?

The stipulation is void. Even if as a rule, the Bank may limit its liability to someextent by agreement or stipulation, the agreement or stipulation must not becontrary to law and public policy.The law on deposit provides that the depositary is liable for loss due to fraud,negligence, delay, or contravention of the tenor of the agreement. Any contrarystipulation would be void.

Art. 1976. Unless there is a stipulation to the contrary, the depositary maycommingle grain or other articles of the same kind and quality, in which case thevarious depositors shall own or have a proportionate interest in the mass.

GENERAL RULE: The depositary may commingle grain or other articles of the same kind andquality.

EXCEPTION: If there is a contrary stipulation

De Leon example:

A, depositary, received the following:

from B: 30 cavans of ricefrom C: 20 cavans of ricefrom D: 10 cavans of rice

The rice was of the same kind and quality.

Can A put all of the rice together?

Yes, since there is no stipulation forbidding it. B will own 30/60 or ½ of the wholepile; C will own 20/60 or 1/3; and D will own 10/60 or 1/6.

But if the articles deposited by different depositors are not of the same kind andquality, or if there is a stipulation forbidding it, the depositary must keep themseparate or at least identifiable, since he must return to each depositor the verysame thing deposited.

Art. 1977. The depositary cannot make use of the thing deposited without theexpress permission of the depositor.


Otherwise, he shall be liable for damages.

However, when the preservation of the things deposited requires its use, itmust be used but only for that purpose.

GENERAL RULE: The depositary CANNOT make use of the thing deposited.

EXCEPTIONS:

1. When the depositor has expressly given his permission. Permission cannot beimplied, and it is not presumed.

2. When the preservation of the thing requires its use, it may be used but only forthat purpose.

Ex: When you deposit a car with someone for a week, the depositary shouldstart the car everyday, in order to prevent the battery from gettingdischarged.

Reason for the rule: The principal purpose of deposit is safekeeping, not use of thething. If the purpose is use, it is not deposit anymore.

If the depositary uses the thing deposited without permission of the depositor, heshall be liable for damages. In addition, if the thing is lost even through fortuitousevent, the depositary shall bear the loss.

Art. 1978. When the depositary has permission to use the thing deposited, thecontract loses the concept of a deposit and becomes a loan or commodatum,except where safekeeping is still the principal purpose of the contract.

The permission shall not be presumed, and its existence must be proved.

What happens if the depositor gives the depositary permission to use the thing?

It depends.

If the principal purpose is still safekeeping, it retains its character as deposit.However, if the thing deposited is money or other consumable thing and theprincipal purpose is still safekeeping, it is an irregular deposit.

If the purpose has become use or consumption of the thing:

1. It becomes commodatum if the thing deposited is non-consumable.2. It becomes simple loan or mutuum if the thing deposited is money or other

consumable thing.

Bank deposits are in the nature of an irregular deposit but they are really loans (SeeArticle 1980).

Art. 1979. The depositary is liable for the loss of the thing through a fortuitousevent:

(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 beenauthorized to use the same.

GENERAL RULE: The depositary is not liable for loss of the thing through fortuitous event.

EXCEPTIONS:

1. Stipulation

2. If he uses it without the depositor’s permission – this is breach/contravention of the tenor of the obligation

3. Delay in return – this is default

4. If he allows others to use it – also a breach

Take note that the rule is different in commodatum. In commodatum, themembers of the borrower’s household are allowed to use the thing withoutliability on the part of the borrower.

If the thing is lost in the custody of the depositary, the presumption is that it waslost through his fault. He has the burden of proving that the loss was not due tohis own fault.

Art. 1980. Fixed, savings, and current deposits of money in banks and similarinstitutions shall be governed by the provisions concerning simple loan.

Nature of Bank Deposits

Bank deposits are really loans to a bank because the bank has the obligation to paythe depositor the amount deposited, but not the exact same money that wasdeposited (as in deposit).

Since they are loans, they are governed by the provisions concerning mutuum orsimple loan, not deposits.

Relationship is Debtor-Creditor

The relationship between the bank and its depositors is thus that of debtor (bank)and creditor (depositor). Hence:

1. If the bank fails to pay its obligation to the depositor, it is not a breach oftrust arising from the depositary’s failure to return the subject matter of thedeposit. Since there is no breach of trust, it will not constitute estafathrough misappropriation.


2. A bank can generally compensate or set off the deposit in its hands for thepayment of any indebtedness to it on the part of the depositor, provided thatthe legal requisites of compensation are present. In a true deposit,compensation is not allowed.

Art. 1981. When the thing deposited is delivered closed and sealed, thedepositary must return it in the same condition, and he shall be liable fordamages should the seal or lock be broken through his fault.

Fault on the part of the depositary is presumed, unless there is proof to thecontrary.

As regards the value of the thing deposited, the statement of the depositorshall be accepted, when the forcible opening is imputable to the depositary,should there be no proof to the contrary. However, the courts may pass upon thecredibility 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, heshall keep the secret of the deposit.

Art. 1982. When it becomes necessary to open a locked box or receptacle, thedepositary is presumed authorized to do so, if the key has been delivered to him;or when the instructions of the depositor as regards the deposit cannot beexecuted without opening the box or receptacle.

A delivers a locked baul to B for safekeeping. What are B’s obligations?

1. B must return the baul in the same condition – it must be locked whenreturned.

2. If the lock of the baul is broken through B’s fault, he shall be liable to A fordamages. B is presumed negligent until proved otherwise.

How is the value of the thing determined in case the baul is opened?Ultimately, the court will decide the value of damages that B should pay,since the parties will always get into a dispute over the value of the thing(i.e. A would inflate the price, B would undervalue it, etc.)

3. If the lock of the baul is broken, with or without B’s fault, B must keep thesecret of the deposit.

If the contents of the baul turn out to be illegal – shabu, a dead body, abloody bolo – the depositary should immediately call the cops. He may stillbe held liable for the breach of his obligation as depositary but at least heknows that he has done a greater good to society by reporting the dastardlydeed to the authorities. The court just might exonerate him of liability forthe breach because of his fulfillment of a civic duty. Besides, I think that ifhe keeps these things a secret, he can even be liable as an accessory to thecrime for helping conceal it.

When may B open the baul?


1. When there is presumed authority – authority is presumed if the key has beendelivered to him; or

2. When there is necessity for opening the box in order to execute theinstructions of the depositor as regards the deposit

JPSP example:

Shakadivas delivers a locked box to Tuks for deposit. Shak leaves right away without givingTuks an opportunity to ask him why there is a ticking sound coming from inside the box.Tuks is afraid that it might be a bomb. Can he open it without liability?

Tuks cannot. The only instances when a depositary can open the box withoutincurring liability is if there is presumed authority or if there is necessity foropening it in order to execute the instructions of the depositor. These twoinstances are not present in the situation of Tuks. He should just hope and praythat it’s just a watch in there.

Art. 1983. The thing deposited shall be returned with all its products, accessories,and accessions.

Should the deposit consist of money, the provisions relative to agents inarticle 1896 shall be applied to the depositary.

The obligation of the depositary is to return the thing when the depositor demands,along with all its products, accessories, and accessions. The depositor is entitledto the products, accessories, and accessions of the thing because he is the ownerof the thing.

Art. 1984. The depositary cannot demand that the depositor prove his ownershipof the thing deposited.

Nevertheless, should he discover that the thing has been stolen and who itstrue owner is, he must advise the latter of the deposit.

If the owner, in spite of such information, does not claim it within theperiod of one month, the depositary shall be relieved of all responsibility byreturning the thing deposited to the depositor.

If the depositary has reasonable grounds to believe that the thing has notbeen lawfully acquired by the depositor, the former may return the same.

The depositary cannot demand that the depositor prove his ownership of the thingdeposited. This is because it is not essential that the depositor be the owner of thething deposited.

When a third person appears to be the owner of the thing:

1. If the depositary finds out that the thing was stolen AND he knows the realowner, his obligation is to INFORM the real owner of the deposit (it is not toreturn the thing to the real owner yet).


The real owner must claim the thing within one month. If he claims it withina month, the depositary should give it to the real owner. If the real ownerfails to make a claim within a month, the depositary’s obligation will beextinguished by returning the thing to the depositor.

2. If the depositary has reasonable grounds to believe that the thing has notbeen lawfully acquired by the depositor, the depositary may return the thingto the depositor (not to the real owner, since in this case, the real owner isnot known).

But according to JPSP, if the depositary discovers that the thing was stolen andsomeone else is claiming to be the real owner, the more prudent thing to do wouldbe to file an action for interpleader and consign the thing in court. It is not safe tofollow 1984 because if the claim of the alleged real owner turns out to be false, thedepositary will be liable for giving the thing to someone else or for refusing toreturn it to the depositor (estafa).

Art. 1985. When there are two or more depositors, if they are not solidary, andthe 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 ofArticles 1212 and 1214 shall govern. However, if there is a stipulation that thething should be returned to one of the depositors, the depositor shall return itonly to the person designated.

When there are two or more depositors, the default rule is like that in jointobligations – each depositor cannot demand more than his share from thedepositary. This rule applies if the thing is divisible and there is no solidarityamong the depositors.

If there is solidarity or if the thing is indivisible, the rule on solidary obligations isapplicable. Each one of the depositors may do whatever may be useful to theothers but not anything which may be prejudicial. The depositary can return thething deposited to any of the depositors unless a demand for its return has beenmade by one of them, in which case, delivery should be made to him who made thedemand.

The parties may also stipulate that the thing be returned to a specific depositor. Inthis case, the depositary can only return to the depositor stipulated, even if hedoes not make a demand.

Art. 1986. If the depositor should lose his capacity to contract after having madethe deposit, the thing cannot be returned except to the persons who may havethe administration of his property and rights.

The thing deposited must be returned only to a person who is capacitated. If thedepositor should subsequently lose capacity, the depositary should return it to hisrepresentative.

(See discussion under Article 1970 on deposit by tinedyers)


Art. 1987. If at the time the deposit was made a place was designated for thereturn of the thing, the depositary must take the thing deposited to such place;but the expenses for transportation shall be borne by the depositor.

If no place has been designated for the return, it shall be made where thething deposited may be, even if it should not be the same place where the depositwas made, provided that there was no malice on the part of the depositary.

Where to return the thing deposited:

1. First, follow the stipulation of the parties. The expenses for transportationshall be borne by the depositor since the deposit was constituted for hisbenefit.

2. If there is no stipulation, follow 1987 – the thing should be returned at theplace where the thing deposited may be, even if it was not the same placewhere the deposit was constituted.

However, there must be no malice on the part of the depositary. Forexample, the depositary, not wanting to return the thing anymore, moves itto the Cordillera mountains, so that the depositor would have a hard timeclaiming it. In this case, the depositary would be liable for damages.

Art. 1988. The thing deposited must be returned to the depositor upon demandeven though a specified period of time for such return may have been fixed.

This provision shall not apply when the thing is judicially attached while inthe depositary’s possession or should he have been notified of the opposition of athird person to the return or the removal of the thing deposited. In these cases,the depositary must immediately inform the depositor of the attachment oropposition.

GENERAL RULE: The depositary must return the thing upon demand by the depositor even ifthe period for the deposit has not lapsed.

If the deposit is for compensation, and the depositor demands the return of thething before the period for deposit has lapsed, the depositor must still pay thedepositary the full compensation agreed upon. This is because the period in thiscase is for the benefit of both the depositary and the depositor.

EXCEPTION TO THE GENERAL RULE: The depositary should not return the thing to thedepositor if there is a court order enjoining him from returning the thing to thedepositor (when there is attachment).

The law says that the depositary can also refuse to return the thing if there is anopposition to its return by a third person (here, there is no court order). However,as discussed earlier, the more prudent thing to do in this case is not to refuse toreturn the thing to the depositor but to file an action for interpleader because thereis a danger that the depositary would be liable for damages if the claim of the thirdperson turns out to be false.

Art. 1989. Unless the deposit if for a valuable consideration, the depositary whomay have justifiable reasons for not keeping the thing deposited may, even


before the time designated, return it to the depositor; and if the latter shouldrefuse to receive it, the depositary may secure its consignation from the court.

As a general rule, the depositary should wait for either the period of the deposit tolapse or for the depositor to demand the return of the thing before he can returnthe thing deposited.

But, if the following requisites are present, he may return the thing to thedepositor even before the period of the deposit has lapsed or before it isdemanded:

1. The deposit must be gratuitous; and2. There must be a justifiable reason.

If the depositary refuses to accept, the depositor can consign the thing in court.

But if the deposit is for compensation, the depositary cannot return the thing untilthe expiration of the period or until it is demanded by the depositor.

Art. 1990. If the depositary by force majeure or government order loses the thingand receives money or another thing in its place, he shall deliver the sum or thething to the depositor.

The depositary is not liable for the loss of the thing either by force majeure orgovernment order.

But, if in place of the thing lost, the depositary receives money or another thing, hemust deliver it to the depositor.

Ex: If the thing is expropriated by the government, the indemnity paid by thegovernment must be turned over by the depositary to the depositor.

Art. 1991. The depositor’s heir who in good faith may have sold the thing whichhe did not know was deposited, shall only be bound to return the price he mayhave received or to assign his right of action against the buyer in case the pricehas not been paid him.

First, take note that there seems to be a typo in this provision: it should read “Thedepositary’s heir…” if it is to make any sense.

This contemplates the following situation:

A deposits a car with B. While the car is still in B’s custody, B dies. C, B’s son,finds the car among his dad’s stuff and thinks that the car belonged to his dad. Csells the car to D. What are the liabilities of C?

If D has already paid C, C must return to A the price that D paid for the car (not thevalue of the car).

If D has not yet paid, C may assign to A his right to collect from D the selling priceof the car.


Take note that A has no right to recover the car itself. Also, there must be goodfaith on the part of the heir and the third party buyer. If there was bad faith, thedepositor can recover the car itself. Moreover, the heir will be liable for estafa.

Section 3 Obligations of the Depositor

Art. 1992. If the deposit is gratuitous, the depositor is obliged to reimburse thedepositary for the expenses he may have incurred for the preservation of thething deposited.

If the deposit is gratuitous, the depositor should shoulder the costs of preservationbecause he is the owner of the thing.

If the deposit is for compensation, the depositary should shoulder the costs ofpreservation of the thing because the compensation is deemed to include the costsof preservation.

Example: A deposits a dog with B for 30 days for a compensation of P500. B buys a sack ofdog food. By the 10th day, the dog food has run out. Can B ask for more money from A?

A can refuse to give more money and argue that in charging the compensation forthe deposit, B should have factored in the expected expenses of preserving thedog. But it still depends on the intention of the parties.

Art. 1993. The depositor shall reimburse the depositary for any loss arising fromthe character of the thing deposited, unless at the time of the constitution of thedeposit, the former was not aware of, or was not expected to know thedangerous character of the thing, or unless he notified the depositary of thesame, or the latter was aware of it without advice from the depositor.

GENERAL RULE: The depositor should compensate the depositary for any loss that thedepositary may suffer from the character of the thing deposited.

Example: A deposits a dog with B. It turns out that the dog has rabies. The dogbites B, and as a result, B has to get anti-rabies shots. A must pay for the damagecaused and the cost of B’s shots.

EXCEPTIONS: In the following cases, the depositor need not reimburse thedepositary for any loss arising from the character of the thing deposited:

1. If at the time of the deposit, the depositor was not aware of the dangerouscharacter of the thing;

2. If at the time of the deposit, the depositor was not expected to know thedangerous character of the thing;

3. If the depositor notified the depositary of the dangerous character of thething; or

4. If the depositary was aware of the dangerous character of the thing evenwithout the advice of the depositor.


Art. 1994. The depositary may retain the thing in pledge until full payment ofwhat may be due him by reason of the deposit.

This is an example of a pledge created by operation of law. The depositary maykeep the thing deposited as a security for anything that the depositor may owehim, but it has to be by reason of the deposit.

Compare this rule with the rule in commodatum, in which the borrower maygenerally not retain the thing as a security for anything that the lender may owehim (remember the frisbee example?).

Art. 1995. A deposit is extinguished:

(1) Upon the loss or destruction of the thing deposited;

(2) In case of a gratuitous deposit, upon the death of either the depositor or thedepositary.

Causes for extinguishment of deposit:

1. loss or destruction of the thing deposited2. In case of gratuitous deposit, upon the death of either the depositor or the

depositary

But if the deposit is for compensation, it is not extinguished by the death ofeither party since it is not personal in nature. Hence, the rights andobligations of the parties are transmissible to their heirs.

3. return of the thing4. novation5. merger6. expiration of the term7. fulfillment of resolutory condition

CHAPTER 3 NECESSARY DEPOSIT

Art. 1996. A deposit is necessary:

(1) When it is made in compliance with a legal obligation;

(2) When it takes place on the occasion of any calamity, such as fire, storm,flood, pillage, shipwreck, or other similar events.

Art. 1997. The deposit referred to in No. 1 of the preceding article shall begoverned by the provisions of the law establishing it, and in case of its deficiency,by the rules on ordinary deposit.

The deposit mentioned in No. 2 of the preceding article shall be regulatedby the provisions concerning voluntary deposit and by article 2168.

Art. 1998. The deposit of effects made by travelers in hotels or inns shall also beregarded as necessary. The keepers of hotels or inns shall be responsible forthem 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 precautions which said hotel-keepers or their substitutes advisedrelative to the care and vigilance of their effects.

Art. 1999. The hotel-keeper is liable for the vehicles, animals and articles whichhave been introduced or placed in the annexes of the hotel.

Art. 2168. When during a fire, flood, story, or other calamity, property is savedfrom destruction by another person without the knowledge of the owner, thelatter is bound to pay the former just compensation.

What are the instances when deposit is NECESSARY?

There are FOUR instances/ examples of necessary deposit:

1. Deposit made in compliance with a legal obligation2. Deposit that takes place on the occasion of any calamity3. Deposit of effects made by travelers in hotels or inns4. Deposit of goods with common carriers

1. Deposit made in compliance with a legal obligation

Example:

In pledge, when the creditor uses the thing pledged without the authority ofthe owner or misuses it in any other way, the owner may ask that it bejudicially or extrajudicially deposited.

2. Deposit that takes place on the occasion of any calamity

Example: A fire razes Y’s house. X goes inside and gets Y’s TV for thepurpose of saving it. X becomes the depositary of the TV.

The relationship of X and Y, being a deposit, is governed by the provisions onvoluntary deposit. But in addition, it is also governed by Art. 2168 on quasi-contracts. Art. 2168 says that the owner of the thing should pay the depositaryjust compensation for his expenses in preserving the thing. So unlike avoluntary deposit, which is by default gratuitous, this kind of necessarydeposit is, by express provision of law, for compensation.

3. Deposit of effects made by travelers in hotels or inns

Requisites before the hotel or inn may be held responsible as depositary:

a. The hotel or inn should have been previously informed about the effectsbrought by the guests; and

b. The guests have taken the precautions prescribed regarding theirsafekeeping.

The liability extends not just to effects inside the rooms but also to propertyof the guests in the annexes, such as cars in the garage.


Example: You go to Edsa Shangri-La to eat at the Garden Café. You turn your carover to the valet. Is there a contract of deposit?

Yes. You don’t have to actually get a room in order to be considered aguest for purposes of constituting the contract of deposit with the hotel. Aslong as you use the main facilities of the hotel, you’re considered a guest.

What if you wanted to shop in Megamall, but since you didn’t want to go through thetrouble of looking for parking in Megamall, you just used the Edsa Shangri-La valetservice – are you still a guest?

No. Although you need not check-in in order to be considered a guest, youmust at least use the principal services of the hotel – the gym, the pool,meeting place at the lobby, etc. Valet parking is not a principal service ofthe hotel.

If you’re the guest, you should: (a) give notice to the hotel of the effects youhave brought into the hotel and (b) take the precautions prescribed for theirsafekeeping.

But do you need to give an itemized listing of your valuables every time you go intoa hotel?

No. Constructive notice to the employees of the hotel is enough. It issufficient that you bring in your personal effects and the hotel personnel seethem.

4. Deposit of goods with common carriers

This is governed by Articles 1733, 1734, 1735 of the Civil Code under Lease.Common carriers are generally responsible for the loss, destruction, anddeterioration of the goods, unless due to fortuitous event or the fault of theowner of the goods.

Art. 2000. The responsibility referred to in the two preceding articles shall includethe loss of, or injury to the personal property of the guests caused by theservants or employees of the keepers of hotels or inns as well as by strangers;but not that which may proceed from any force majeure. The fact that travelersare constrained to rely on the vigilance of the keeper of the hotels or inn shall beconsidered in determining the degree of care required of him.

Art. 2001. The act of a thief or robber, who has entered the hotel is not deemedforce majeure, unless it is done with the use of arms or through an irresistibleforce.

Art. 2002. The hotel-keeper is not liable for compensation if the loss is due to theacts of the guests, his family, servants or visitors, or if the loss arises from thecharacter of the things brought into the hotel.

When is the hotel liable for the loss of the effects of its guests?


1. When the loss is caused by the employees of the hotel or by strangers,provided the guest followed the two requisites under Art. 1998 (notice andprecaution).

2. When the loss is caused by the act of a thief or a robber done without theuse of arms and irresistible force.

When is the hotel NOT liable?

1. When the loss or injury is caused by force majeure, like flood, fire, theft orrobbery by a stranger with the use of arms or irresistible force, UNLESS thehotel-keeper is guilty of fault or negligence in failing to provide against theloss or injury from this cause.

So as a general rule, if armed men enter the hotel and steal your things, thehotel is excused from liability because it is considered a fortuitous event.However, if the hotel failed to take reasonable precautions (ex: secludedisland with only one security guard stationed near the shore and lots offoreigners checked in), it will still be liable for its negligence.

2. When the loss is due to the acts of the guest (who is the owner of the thing),his family, servants, or visitors; and

3. When the loss arises from the character of the things brought into the hotel

Example of thing where the loss arises from the character of the thing: Ifyou bring a Dalmatian, or a snake, or Cyrus’ pet hamster into the hotel, bythe very nature of these pets, they could easily get lost in the premises.

Art. 2003. The hotel-keeper cannot free himself from responsibility by postingnotices to the effect that he is not liable for the articles brought by the guest.Any stipulation between the hotel-keeper and the guest whereby theresponsibility of the former as set forth in Articles 1998 to 2001 is suppressed ordiminished shall be void.

Even if the hotel-keeper posts signs or puts these little fine-print stipulations thatit is not liable for any loss, it cannot escape its liabilities as a depositary underArticles 1998 to 2001.

Reason: You cannot waive the liability of one who is guilty of gross negligence.Gross negligence is equivalent to fraud or bad faith. And as we all know, a waiverof future fraud is void. It is contrary to law, morals, and public policy.

However, this only applies to a contract of deposit. In the case of carparks, thefine print on the tickets always contains a waiver of liability by the owner of thecarpark for any loss within its premises. This waiver is valid because, as discussedalready, the contract with the carpark is not a deposit but only a short-term lease.

Art. 2004. The hotel-keeper has a right to retain the things brought into the hotelby the guest, as a security for credits on account of lodging, and supplies usuallyfurnished to hotel guests.


This is another pledge created by operation of law. If you do not pay your hotelbills, the hotel can keep your stuff as a security. Moreover, you will be liable forestafa.

CHAPTER 4 SEQUESTRATION OR JUDICIAL DEPOSIT

Art. 2005. A judicial deposit or sequestration takes place when an attachment orseizure of property in litigation is ordered.

Art. 2006. Movable as well as immovable property may be object ofsequestration.

Art. 2007. The depositary of property or objects sequestrated cannot be relievedof his responsibility until the controversy which gave rise thereto has come to anend, unless the court so orders.

Art. 2008. The depositary of property sequestrated is bound to comply, withrespect to the same, with all the obligations of a good father of a family.

What is judicial deposit?

Judicial deposit is a deposit pursuant to a court order – when an attachment orseizure of property in litigation is ordered by a court.

Examples:

1. attachment of properties by sheriff upon the filing of a complaint2. garnishment of money3. receiver may be appointed by the court to administer and preserve the

property in litigation4. personal property may be seized by the sheriff in suits of replevin

What is the purpose of judicial deposit?

Unlike extra-judicial deposit, where the purpose is safekeeping, the purpose ofjudicial deposit is to maintain the status quo during the pendency of the litigation toinsure the right of the parties to the property in case of a favorable judgment. Thismeans that in case of favorable judgment, the party will be assured that there willbe property to satisfy the execution of the judgment.

What may be the object of judicial deposit?

Unlike extra-judicial deposit, where the object must be a movable, a judicialdeposit can cover both movable and immovable property.

How do you deposit an immovable?

You annotate the attachment on the title with the Register of Deeds.

What are the obligations of the depositary of sequestrated property?


The person appointed by the court as depositary has the obligation to take care ofthe thing with the diligence of a good father of a family. He may not be relieved ofhis responsibility until the litigation is ended or until the court so orders.

DISTINCTIONS BETWEEN JUDICIAL AND EXTRA-JUDICIAL DEPOSIT

JUDICIAL DEPOSIT EXTRA-JUDICIAL DEPOSITCAUSE OR ORIGIN By will of the court By will of the parties;

hence there is a contractPURPOSE To secure the right of a

party to recover in case offavorable judgment

Safekeeping

SUBJECT MATTER Movable or immovableproperty

Only movable property

REMUNERATION The depositary is alwayscompensated; therefore itis onerous

As a rule, it is gratuitous,though the parties maystipulate otherwise

IN WHOSE BEHALF IT ISHELD

In behalf of the personwho, by the judgment,has a right

In behalf of the depositoror the third persondesignated

Art. 2009. As to matters not provided for in this Code, judicial sequestration shallbe governed by the Rules of Court.

That’s all folks. Sorry, I didn’t include Warehouse Receipts Law anymore because it’s probably going to be just 5% of the exam, according to JPSP.

Good luck!

May the power of greyskull be with us all ☺


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Sheryl Sectrans Reviewer