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Security and Credit Transactions

SECURITY & CREDIT TRANSACTIONSINTRODUCTION

Meaning and scope of credit transactions Credit transactions include all transactions involving the

o Purchase or loan of goods, services, or money in the presento With a promise to pay or deliver in the future

Credit transactions are really contracts of security. Two types:

o Secured transactions or contracts of real security Supported by a collateral or an encumbrance of

property Pledge, mortgage, antichresis, etc

o Unsecured transactions or contracts of personal security Secured or supported only by a promise to pay or the

personal commitment of another Guarantor or surety

Meaning and kinds of security Security is something given, deposited, or serving as a means to ensure

the fulfillment or enforcement of an obligation or of protecting some interest in property

Meaning of bailment Delivery of property of one person to another in trust for a specific

purpose With a contract, express or implied, that the trust shall be faithfully

executed and the property returned or duly accounted for when the special purpose is accomplished or kept until the bailor reclaims it

It may be created by a contractual relation or by operation of law

Parties in bailment Bailor – the giver, the one who delivers the possession of the thing

bailed Bailee – the recipient, the party who receives the possession or custody

of the thing delivered

Kinds of contractual bailment1. For the sole benefit of the bailor

Gratuitous deposit, mandatum

2. Sole benefit of the bailee Commodatum and gratuitous simple loan or mutuum

3. Benefit of both parties Deposit for a compensation, involuntary deposit, pledge, bailments

for hire

1. The first two kinds are gratuitous bailments, really no consideration.2. The last one involves business transactions, also known as mutual-

benefit bailments.3. But in all cases, there is an obligation on the part of the bailee to restore

the subject of the bailment in the same or in altered form or to account therefore.

What are bailments for hire? They arise when goods are left with the bailee for some use or service

by him Always for some compensation

o Hire of things (locatio rei) – where goods are delivered for the temporary use of the hirer (lease)

o Hire for service (locatio operas faciendi) – where goods are delivered for some work or labor upon itby the bailee (contract for a piece of work)

o Hire for carriage of goods (locatio operas mercium vehendarum) – where goods are delivered either to a common carrier or to a private person for the purpose of being carried from place to place

o Hire for custody (locatio custodiae) – where goods are delivered for storage

I – LOANGENERAL PROVISIONS

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

Commodatum is essentially gratuitous.

Mickey InglesAteneo Law 2012Librat

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

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

Characteristics of the loan contract1. Real (delivery of thing loaned is necessary for the perfection of the

contract)2. Unilateral (once the subject matter has been delivered, it creates

obligations on the part of only the borrower)

Kinds of loan1. Commodatum

Bailor (lender) delivers to the bailee (borrower) a non-consumable thing so that the latter ay use it for a certain time and return the identical thing

2. Simple loan or mutuum Lender delivers to the borrower money or other consumable

thing upon the condition that the latter shall pay the same amount of the same kind and quality

A thing is consumable when it is consumed when used in a manner appropriate to its purpose, or nature.

What’s the difference between a loan and credit? The credit of an individual means his ability to borrow money or things

by virtue of the confidence or trust reposed by a lender that he will pay what he may promise within a specified period

A loan means the delivery by one party and receipt by another of a given sum or money other consumable thing, which has to be repaid.

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

What’s the difference between a loan and discounting of paper?

Loan Discount Interest taken at the expiration

of a credit Single-named paper Loaned P1000 at 16% interest,

borrower would pay P1,160 at

Interest is deducted in advance

Double-named paper Loaned P1000 at 16% interest,

borrower gets P840 but would

the end of the year pay back P1000 at the end of the year

What’s the difference between a commodatum and a mutuum?

Commodatum MutuumObject

Ownership

Consideration

Obligation

Property

Purpose

Demand

Loss

Not consumable

Retained by lender

Gratuitous

Borrower must return the same thing loaned

Real or personal

Use or temporary possession

Bailor may demand the return of the thing loaned before the expiration of the term in case of urgent need

Suffered by the bailor

Money or other consumable thing

Transferred to borrower

Gratuitous or onerous, with stipulation of interest

Need only pay the same amount of same kind and quality

Personal

Loan for consumption

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

Suffered by the borrower even if caused exclusively by a fortuitous event and he is not discharged from his duty to pay

Kinds of commodatum1. Ordinary2. Precarium (bailor may demand the thing loaned at will)

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


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Delivery is essential to perfection of loan Delivery is necessary in view of the purpose of the contract which is to

transfer either the use or ownership of the thing loaned.

But, an accepted promise to lend also has binding effects. An accepted promise to make a future loan is a consensual contract,

and binding upon the parties but it is only after delivery, will the real contract of loan arise.

o If an application for a loan of money was approved and the corresponding mortgage was executed and registered, there arises a perfected consensual contract of loan. While a perfect contract of loan can give rise to an action for damages, said contract does not constitute the real contract of loan. (In this case, the money had yet to be given)

o A lender gives a check to the borrower for a loan. The borrower mortgages his house. But the borrower has not encashed or deposited the check, there is no real contract still, as there is a need to encash the check to effect payment, according to the Civil Code. So lender cannot foreclose the mortgage (Naguiat case)

CHAPTER TWOCOMMODATUMSECTION ONE – NATURE OF COMMODATUM

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

Commodatum is essential gratuitous. The contract ceases to be a commodatum if any compensation is to be

paid by the borrower who acquires its use. o In such a case, there arises a lease contract

Extent of bailee’s right of use Right to use is limited to the thing loaned

o Not to its fruits unless there is a stipulation to the contrary (Art 1940)

o As the owner of the thing loaned, the bailor is naturally entitled to its fruits

What’s the purpose of a commodatum anyway? The purpose must be temporary use of the thing loaned.

o If the bailee is not entitled to the use of the thing, the contract may be a deposit (Art 1962)

It is an essential feature of the contract of commodatum that the use of the property of another shall be for a certain time.

Art 1936 Consumable goods may be the subject of commodatum if the purpose of the contract is not the consumption of the object, as when it is merely for exhibition.

Art 1937 Movable or immovable property may be the object of commodatum.

General rule: Subject matter of commodatum is generally non-consumable, whether real or not.

o Exception: Consumable goods may be the subject, when it is merely for exhibition.

o Oversized bottle of mango juice (gasgas na yung wine example eh.) borrowed by a museum. The bottle of mango juice was actually owned by Jose Rizal.

Example of a commodatum involving real property A person allowed another to build a mixed martial arts gym on the

former’s land so that the latter may use the property for a certain period without any payment of rentals

Art 1938 The bailor in commodatum need not be the owner of the thing loaned.

Bailor need not be owner Bailor need not be the owner of the thing loaned since by the loan,

ownership does not pass to the borrower. The borrower may not lend nor lease the thing loaned to him to a third

person. Sufficient that the bailor has such possessory interest in the subject

matter or right to its use which he may assert against the bailee and the third persons although not against the rightful owner (?)


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Art 1939 Commodatum is purely personal in character. Consequently:1. The death of either the bailor or the bailee extinguishes

the contract;2. The bailee can neither lend nor lease the object of the

contract to a third person. However, the members of the bailee’s household may make use of the thing loaned, unless there is a stipulation to the contrary, or unless the nature of the thing forbids such use.

Purely personal nature of a commodatum Unlike mutuum, commodatum is a purely personal contract, the lender

having in view the character, credit, and conduct of the borrower. Hence, the general rule: the death of either party terminates the contract

o Exception: Unless by stipulation, the commodatum is transmitted to the heirs of either or both parties.

o NB: If there are two or more borrowers, the death of one does not extinguish the contract in the absence of stipulation to the contrary

This article is an exception to the general rule that all rights acquired in virtue of an obligation are transmissible.

Right of bailee to lend thing loaned to third persons General rule: Bailee can neither lend nor lease the object of the contract

to a third person, in absence of some understanding or agreement to that effect.

o Exception: The use of the thing loaned may extend to the members of the bailee’s household (those who live in the same home)

Exception to the exception: There is a stipulation to the contrary, or The nature of the thing forbids such use.

Art 1940 A stipulation that the bailee may make use of the fruits of the thing loaned is valid.

General rule: In commodatum, the bailor gets the fruits of the thing loaned.

o Exception: When there is a stipulation that the bailee may also make use of the fruits of the thing.

SECTION II – OBLIGATIONS OF THE BAILEE

Art 1941 The bailee is obliged to pay for the ordinary expenses for the use and preservation of the thing loaned.

Bailee liable for ordinary expenses Borrower is liable for the expenses for the use and preservation of the

thing loaned.o Example: Draco borrows Mr. Weasley’s car. He must pay for

the gasoline, motor oil, washing, greasing and spraying. Draco can’t demand reimbursement.

As a rule, the borrower must take good care of the thing with the diligence of a good father of a family.

As to extraordinary expenses, check 1949

Art 1942 The bailee is liable for the loss of thing, even if should be through a fortuitous event:

1. If he devotes the thing to any purpose different from that for which it has been loaned;

2. If he keeps it longer than the period stipulated, or after the accomplishment of the use for which the commodatum has been constituted;

3. If the thing loaned has been delivered with appraisal of its value, unless there is a stipulation exempting the bailee from responsibility in case of a fortuitous event;

4. If he lends or leases the thing to a third person, who is not a member of his household;

5. If, being able to save either the thing borrowed or his own thing, he chose to save the latter.

Liability for loss of thing loaned General rule: Bailee is not liable for loss or damage due to a fortuitous

event. (Because bailor retains the ownership of the thing loaned)o Exception: 5 instances in Article 1942

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

Bailor Liable for deterioration of thing loaned


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In the absence of agreement to the contrary, the depreciation caused by the reasonable and natural use of the thing is borne by the bailor.

Art 1944 Bailee cannot retain the thing loaned on the ground that the bailor owes him something, even though it may be by reason of expenses. However, the bailee has a right of retention for damages mentioned in Art 1951.

Obligation to return thing loaned General rule: Bailee must return the thing loaned, even if bailor owes

him for expenses – whether ordinary or extraordinary.o Exception: If he has a right of retention for damages against

the bailor because of the flaws of the thing loaned (Art 1951).

Art 1945 When there are two or more bailees to whom a thing is loaned in the same contract, they are liable solidarily.

The law presumes that the bailor takes into account the personal integrity and responsibility of all the bailees and that he would not have constituted the commodatum if there were only one bailee.

SECTION III – OBLIGATIONS OF THE BAILOR

Art 1946 – The bailor cannot demand the return of the thing loaned till after the expiration of the period stipulated, or after the accomplishment of the use for which the commodatum has been constituted. However, if in the meantime, he should have urgent need of the thing, he may demand its return or temporary use.

In case of temporary use by the bailor, the contract of commodatum is suspended while thing is in the possession of the bailor.

Bailor’s obligation to respect duration of loan General rule: Bailor can’t demand return thing loaned until

1. After the expiration of the period stipulated, or2. After the accomplishment of the use for which the

commodatum has been constituted Exception: Bailor can demand return of the thing when:

1. He should have an urgent need of the thing2. Borrower commits an act of ingratitude (Art 1948)

Art 1947 – The bailor may demand the thing at will, and the contractual relation is called a precarium, in the following cases:

1. If neither the duration of the contract nor the use to which the thing loaned should be devoted, has been stipulated; or

2. If the use of the thing is merely tolerated by the owner.

What’s a precarium? Kind of commodatum where the bailor may demand the thing at will. Precarium in the following cases:

1. No duration of the contract2. No use of thing to be devoted has been stipulated3. Use of the thing is merely tolerated by the owner

Art 1948 The bailor may demand the immediate return of the thing if the bailee commits any acts of ingratitude specified in Art 765.

Right of bailor to demand return of thing for acts of ingratitude1. If the bailee should commit some offenses against the person, the honor

or the property of the bailor, or of his wife or children under his parental authority

2. If the bailee imputes to the bailor any criminal offense, or any act involving moral turpitude, even though he should prove it, unless the crime or the act has been committed against the bailee himself, his wife or children under his authority, and

3. If the bailee unduly refuses the bailor support when the bailee is legally or morally bound to give support to the bailor.

Art 1949 The bailor shall refund the extraordinary expenses during the contract for the preservation of the thing loaned, provided the bailee brings the same to the knowledge of the bailor before incurring them, except when they are so urgent that the reply to the notification cannot be awaited without danger.

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

Article covers extraordinary expenses Preservation of the thing loan Arising from the actual use of thing loaned


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Preservation for the thing loaned General rule: Expenses shall be borne by the bailor. As a rule, notice is

required because it is possible that the bailor may not want to incur the extraordinary expenses at all.

o Exception to the NOTICE rule: When the expenses are so urgent that the reply to the notification cannot be awaited without danger

Arising from the actual use of the thing General rule Such expenses (caused by fortuitous event) arising on the

occasion of the actual use of the thing loaned shall be borne by both on a 50-50 basis.

o Exception: Parties however may, by stipulation, provide for a different apportionment of such expenses, or that they shall be borne by the bailee or bailor only.

Art 1950 If, for the purpose of making use of the thing, the bailee incurs expenses other than those referred to in Articles 1941 and 1949, he is not entitled to reimbursment.

Expenses for ostentation are to be borne by the bailee because they are not necessary for the preservation of thing.

Art 1951 The bailor, who, knowing the flaws of the thing loaned, does not advise the bailee of the same, shall be liable to the latter for the damages which he may suffer by reason thereof.

Liability to pay damages for known hidden flaws Requisites for Art 1951 to apply:

1. There is a hidden flaw or defect in the thing loaned2. Bailor is aware of it3. Does not advise the bailee of the same4. Bailee suffers damages by reason of said flaw or defect

The bailee is given the right of retention until he is paid damages. Where the defect is not known to the bailor, he is not liable because

commodatum is gratuitous.

Art 1952 The bailor cannot exempt himself from the payment of expenses or damages by abandoning the thing to the bailee.

Summary: Who pays what? Bailee pays for:

o Ordinary expenses for the use and preservation of the thingo Half of the extraordinary expenses arising from actual use of

the thing (unless stipulated otherwise)o Not necessary for the preservation of the thing

Bailor pays for:o Deterioration of the thing loanedo Extraordinary expenses for the preservation of the thing loanedo Half of the extraordinary expenses arising from the actual use

of the thing (unless stipulated otherwise)

CHAPTER TWOSIMPLE LOAN OR MUTUUM

Art 1953 A person who receives a loan of money or any other fungible thing acquires the ownership thereof, and is bound to pay to the creditor an equal amount of the same kind and quality.

What’s a simple loan or mutuum? Contract whereby one of the parties delivers to another money or other

consumable thing with the understanding that the same amount of the same kind and quality shall be paid.

Involves the return of the equivalent only and not the identical thing Borrower acquires ownership Object: Money or any other fungible thing No criminal liability for failure to pay

oo No estafa is committed by a person who refuses to pay his debt or denies its existence

Simple loan distinguished from contract of rentSimple loan distinguished from contract of rentSimple loan Contract of Rent

Delivery of money or some other consumable thing, with promise to repay an equivalent amount

Relation is that of obligor and

One delivers to another some non-consumable thing in order that the latter may use it during a certain period and return it to the former. Owner or lessor does not lose his ownership

Relation is that of landlord and


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obligee Creditor receives payment

tenant Owner receives compensation

Meaning of fungible things Those which are usually dealt with by number, weight or measure Any given unit or portion is treated as equivalent of any other unit or

portion Depends upon the intention of the parties (compared to consumable

which depend upon the nature of the thing itself)

Art 1954 A contract whereby one person transfers the ownership of non-fungible things to another with the obligation on the part of the latter to give things of the same kind, quantity, and quality shall be considered a barter.

Barter is a contract whereby one of the parties bind himself to give one thing in consideration of the other’s promise to give another thing.Commodatum and Mutuum Barter

Subject matter: Money or any other fungible thing

Commodatum: Bailee bound to return the identical thing

May be gratuitous (mutuum) Always gratuitous

(commodatum)

Non-fungible (non-consumable) thing

Equivalent thing is given in return for what has been received

Onerous contract

Art 1955 The obligation of a person who borrows money shall be governed by the provisions of Articles 1249 and 1250 of this Code.

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

Form of payment Loan of money

o Payment must be made in the currency stipulated, if possible to deliver such currency

o Otherwise, it is payable in the currency which is legal tender in the Philippines

o In case of extraordinary inflation or deflation, the basis of payment shall be the value of the currency at the time of the creation of the obligation

Draco borrowed from Harry P500 payable after five years. On the maturity of the obligation, the value of P500 dropped to P250 because of inflation.In this case, the basis of payment shall be the equivalent value of the currency today five years ago. Hence, D is liable to pay P1000 unless there is an agreement to the contrary.

Consumable or fungibleo The borrwer is under obligation to pay the lender another thing

of the same kind, quality and quantityo In case it is impossible to do so, the borrower shall pay its

value at the time of the perfection of the loan

Draco borrowed from Harry two sacks of rice of a certain kind and quality. At the time the loan was perfected, the price of each sack was P400.Draco should return to Harry two sacks of rice of the same kind and quality although at the time of the payment, the price had increase to P500. If on the due date of the obligation, the same kind or rice could not be delivered by Draco because it was not available for some reason, then Draco should pay Harry the sum of P800 instead, the value of the rice at the time of the perfection of the loan.

Art 1956 No interest shall be due unless it has been expressly stipulated in writing.

Requisites for recovery of interest1. Payment of interest must be expressly stipulated2. Agreement must be in writing3. Interest must be lawful

Existence of stipulation to pay interest1. If a particular rate of interest has been expressly stipulated by the

parties, that interest shall be applied.2. If the exact rate of the interest is not mentioned, the legal rate of 12%

shall be payable.


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In this case, interest was stipulated upon, but the parties just didn’t say at what rate.

General rule: No interest unless it has been expressly stipulated in writing.

Exception: Liability for interest comes in even in the absence of stipulation when:1. Indemnity for damages2. Interest accruing from unpaid interest

Interest due shall earn interest from the time it is judicially demanded although the obligation may be silent upon this point (Art 2212)

o Applicable only where interest has been stipulated by the parties

o Art 2212 contemplates the presence of stipulated or conventional interest which has accrued when demand was judicially made

o In cases where no interest has been stipulated by the parties, no accrued conventional interest could further earn interest upon judicial demand

See Usury part for the interest computations.

Doctrines on interests No increase in interest shall be due unless such increase has also been

expressly stipulated. Sales invoices or slips issued by a store to its customers, stating

interests and attorney’s fees in the usual printed forms as terms and conditions, without the signature of the obligor, do not constitute the express stipulation required by Art 1956. Therefore, the obligor is not liable for the interest except only the legal interest (6% since not loan or forbearance) under Art 2209 on the amount due in case of delay.

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

The receipt by the creditor of interest payment up to a certain date on a loan that has already matured does not ipso facto result in the renewal or extension of maturity period of the loan up to said date.

Escalation clauses cannot depend solely on the will of a creditor. They should always be a reference rate upon which to peg such variable interest rates and there must always be a de-escalation clause stipulated.

Banks aren’t required to pay interests at the time they were prohibited by the Central Bank. (Overseas Bank and Ramos v CB cases)

Art 1957 Contracts and stipulations, under any cloak or device whatever, intended to circumvent the laws against usury shall be void. The borrower may recover in accordance with the laws on usury.

Parol evidence is admissible to show that a written document though legal in form was in fact a cloak or device to cover usury

A usurious contract should not be considered void in its entirety but only as to the interest involved

The whole interest is void, not just the balance above the lawful interest. (Borrower may recover ENTIRE interest)

Art 1958 In the determination of the interest, if it is payable in kind, its value shall be appraised at the current price of the products or goods at the time and place of payment.

Determination of interest payable in kind Appraised the current price at the time and place of payment

Draco borrowed P100 from Harry payable in palay in 1 year which shall be appraised at the current market price at the time and place of payment. When the contract was entered into, the price per cavan of palay was P50. On the date of the loan, the price increased to P60.In this case, the value of the palay shall be appraised at P60, the price at the time and place of payment.

Art 1959 Without prejudice to the provisions of Article 2212, interest due and unpaid shall not earn interest. However, the contracting parties may by stipulation capitalize the interest due and unpaid, which as added prinipal, shall earn new interest.

When unpaid interest earns interst General rule: Accrued interest (interest due and unpaid) shall not earn

interest except in two instances:o Judicially demanded as provided for in Art 2212o Express stipulation made by the parties that the interest

due and unpaid shall be added to the principal obligation


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and the resulting total amount shall earn interest (must be in writing)

See Usury part for clearer explanations.Art 1960 If the borrower pays interest when there has been no stipulation therefore, the provisions of this Code concerning solutio indebiti, or natural obligations, shall be applied, as the case may be.

If unstipulated interest is paid by mistake, the debtor may recover as this would be a case of unjust enrichment.

But where the stipulated interest, or interest stipulated, there being a stipulation but it is not in writing, is paid voluntarily because the debtor feels morally obliged to do so, there can be no recovery as in the case of natural obligations.

Art 1961 Usurious contracts shall be governed by the Usury Law and other special laws, so far as they are not inconsistent with this code.

II – THE USURY LAW Suspended by CB Circular 905 While there are no more ceilings on interests, courts can still lower them

if they are iniquitous Elements of usury

1. Loan or forbearance2. Understanding between the parties that the loan shall or may be

returned3. An unlawful intent to take more than the legal rate for the sue of

money or its equivalent4. The taking or agreeing to take for the use of the loan of something

in excess of what is allowed by law

Rules on interests (Eastern Shipping Lines v CA, 1994 and from Atty Lerma’s lecture)

1. When an obligation, regardless of its source, is breached, the contravenor can be held liable for damages.

2. If obligation consists in the payment of a sum of money (loan, forbearance of money, judgment money)

a. Interest due is what has been stipulated by the parties

b. The interest shall earn legal interest from the time of judicial demand

c. If there’s no stipulation, the rate is 12% from default (judicial or extrajudicial demand)

3. If obligation is not a loan or forbearance of moneya. Interest on the amount of damages awarded may be imposed

at the discretion of the court at 6%b. No interest shall be adjudged on unliquidated claims or

damages, except when or until the amount can be established with reasonable certainty

c. Where the amount is established with reasonable certainty, the interest shall begin from the time the claim is made judicially or extrajudicially

d. But when such certainty cannot be so reasonably established the time the demand is made, the interest shall begin to run only from the date the judgment of the court is made

e. The actual base (principal) for the computation of the legal interest shall, in any case, be on the amount finally adjudged.

4. When judgment of court awarding a sum of money becomes final and executory, 12% interest from such until its payment

Examples1. X sued Y for nonpayment of debt (no stipulation on interest1)no demand letter, only judicial demand

12% 12%

due date filing of case final judgment

with demand letter

12% 12% 12%

due date demand filing of case final judgment

1 2c applies here, Art 1169


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2. X sued Y for nonpayment of debt (interest stipulated upon, but no rate specified)

12% 12% 12% + 12%2 12%

due date demand decision final judgment

3. X sued Y for nonpayment of debt (stipulated interest 10%)

10% 10% 10% + 12%3 12%

due date demand final judgment

4. X sued Y for nonpayment of debt (stipulated interest 10% compounded)

10%c 10%c 10%c + 12%c4 12%


5. X sued Y for non-delivery of goodsReasonable certainty of amount

No interest no interest 6% 12%


No reasonable certainty of amount5

No interest no interest no interest 6% 12%

due date demand decision (of TC) finality

2 Of the accrued interest at time of demand3 Of the accrued interest at time of demand4 Of the accrued interest at time of demand5 interest shall begin to run only from the date the judgment of the court is made (at which time the quantification of damages may be deemed to have been reasonably ascertained)

6. X sued Y for non-delivery of goods (penalty clause of 10% - which is considered “interest”)

10% 10% + 12%6 12%

due date demand judicial demand final judgment

7. X sued Y for a loan (15% interest, 18% penalty clause)

15% 15% 15% 15% 18% 18%

12% of 15%7

12% of 18%8 12% due date demand letter judicial demand final judgment

Check the case of RCBC v Alfa RTW Manufacturing (368 SCRA 611) for a good explanation of application of charges

V-GUARANTY AND SURETYSHIP

CHAPTER ONENATURE AND EXTENT OF GUARANTY

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

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

Characteristics of the contract1. Accessory

6 of the accrued penalty amount at the time of judicial demand7 12% of the accrued interest at time of judicial demand8 12% of the accrued penalty charge at the time of judicial demand


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2. Subsidiary and conditional (takes effect only when the principal debtor fails in his obligation subject to limitation)

3. Unilateral4. Requires that the guarantor must be a person distinct from the debtor

because a person cannot be the personal guarantor of himself

Guarantor Surety Liability depends upon an

independent agreement to pay the obligation if the primary debtor fails to do so

Collateral undertaking Secondarily or subsidiarily liable Not bound to know if principal

debtor’s default Often discharged by the mere

indulgence of the creditor of the principal, not liable unless notified of the default of the principal

Binds himself to pay if the principal cannot or unable to pay

Assumes liability as a regular party

Charged as an original promisor Primarily liable (undertakes

directly for the payment without reference to the solvency of the principal)

Held to know every default of his principal

Not be discharged either by the mere indulgence of the creditor or by want of notice of the default of the principal

Binds himself to pay if the principal does not pay

Essence of the obligation of the surety is to pay the creditor without qualification if the principal debtor does not pay

Guarantor does not contract that the principal will pay, but simply that he is able to do so.

Guarantor Indorsement Contract of security Liability more extensive Warrants the solvency of the

promisor Cannot be sued as promisor

Contract of transfer May be sued as promisor

Guaranty Warranty Contract by which a person is

bound to another for the fulfillment of a promise or engagement of a third party

Undertaking that the title, quality or quantity of the subject matter of a contract is what is has been represented to be, and relates to some agreement made

ordinarily by the party who makes the warranty

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

General rule: Guaranty is gratuitous

Cause of contract of guaranty Cause of the contract is the same cause which supports the obligation

as to the principal debtor Not necessary to prove any consideration as between the guarantor or

surety and the creitor Consideration which supports the obligation as to the principal debtor is

sufficient consideration to support the obligation of a guarantor or surety Valid despite absence of any direct consideration received by guarantor

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

Married woman as guarantor Married woman ordinarily binds only her separate property She may also bind the community or conjugal partnership property with

her husband’s consent, and even without the consent of her husband, in cases provided by law (such as when the guaranty has redounded to the benefit of the family)

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

Guaranty undertaken without knowledge of debtor Guaranty exists for the benefit of the creditor and not for the benefit of

the principal debtor who is not a party to the contract of guaranty Creditor has every right to take all possible measures to secure the

payment of his credit

Rights of third person who pays Against the will of the debtor or without the knowledge of the debtor


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o He can only recover insofar as the payment has been beneficial to the debtor, AND

o He cannot compel to creditor to subrogate him the creditor’s rights

With knowledge or consent of the debtoro Third person subrogated by virtue of payment to all the rights

which the creditor had against the debtor

Draco owes Harry P100. Without the knowledge of Draco, Ginny agrees to guarantee the obligation of Draco.If Ginny pays Harry P100, she can ask reimbursement for P100 from Draco. If P40 had already been paid by Draco, then Ginny is entitle to be reimbursed only P60, that which was beneficial to Draco. Ginny can recover the P40 from Harry who should not have accepted it.

Suppose the obligation of Draco is secured by the chattel mortgage of his wand. Payment by Ginny without the knowledge or against the will of Draco does not give Ginny the right to foreclose because Ginny has no right to subrogation.

Art 2051 A guaranty may be conventional, legal or judicial, gratuitous, or by onerous title.

It may also be constituted, not only in favor of the principal debtor, but also in favor of the other guarantor, with the latter’s consent, or without his knowledge, or even over his objection.

According to manner of creation: legal, conventional or judicial (one constituted by decree of court)

Paragraph 2 refers to a double or sub-guaranty – not to be confused with several guarantors (Art 2065 and 2073)

Art 2052 A guaranty cannot exist without a valid obligation.Nevertheless, a guaranty may be constituted to guarantee the

performance of a voidable or an unenforceable contract. It may also guarantee a natural obligation.

A guaranty is an accessory contract Indispensable condition for its existence that there must be a principal

obligation Void principal obligation, void guaranty

Article 2052 speaks about a valid obligation, as distinguished from a void obligation, and not an existing or current obligation

o Under Article 2053, a guaranty may also be given as security for future debts, the amount of which is not yet known

o A signatory to a guaranty agreement is liable on a promissory note for an unpaid loan obtained under that agreement although he did not sign the promissory note

A guaranty may secure the performance of ao Voidable contacto Unenforceable contracto Natural obligation, so that the creditor may proceed against the

guarantor although he has no right of action against the principal debtor for the reason that the latter’s obligation is not civilly enforceable

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

Guaranty of future debts – continuing guaranty or suretyship Continuing gurranty or suretyship

o Not limited to a single transactiono Contemplates a future course of dealings, covering a series of

transactions generally for an indefinite time or until revokedo Prospective in its operationo Generally intended to provide security with respect to future

transactions Future debts, even if the amount is not yet known, may be guaranteed

but there can be no claim against the guarantor until the amount of the debt is

o Ascertained, oro Fixed and demandable

NB: By no means however is it meant that in all instances a contract of guaranty or suretyship should be prospective in application

o It will only be construed as continuing when by the terms thereof it is evident that the object is to give a standing credit to the principal debtor to be used from time to time either indefinitely or until a certain period, especially if the right to recall the guaranty is expressly reserved


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“Future debts” may also refer to debts existing at the time of the constitution of the guaranty but the amount thereof is unknown and not to debts not yet incurred and existing at that time.

Guaranty of conditional obligations If principal obligation is subject to a suspensive condition, the guarantor

is liable only after the fulfillment of the condition. If it is subject to a resolutory condition, the happening of the condion

extinguishes both the principal obligation and the guaranty.

i. Draco and Harry are partners in business. Ginny may guarantee the payment by Draco of Harry’s share from the profit of the business which has not yet been ascertained.Under Article 2053, Ginny cannot be liable to Harry before such share is liquidated.

ii. Harry sold his land to Draco with Ginny as guarantor for the payment of the purchase price. It was agreed that Harry would give to Ginny the title papers showing that Harry is in fact the owner of the land sold. Draco became insolvent.In this case, Ginny is liable only after the fulfillment of the suspensive condition – the production of the proper papers.

iii. Suppose, in ii, Harry was given two months within which to arrange and complete the papers relating to the property with the understanding that in case of failure of Harry to complete the title papers within said period, the contract of sale shall be deemed automatically cancelled. In this case, the fulfillment of the condition subsequent – the failure to complete the title papers within the period – extinguishes the principal obligation of Draco to pay the price as well as Ginny’s guaranty.

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

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

The guarantor cannot bind himself for more than the principal debtor, and even if he does, his liability shall be reduced to the limits of that of the debtor.

But a guarantor may bind himself for less than that of the principal. NB: Creditors suing on a surety bond may recover from the surety as

part of their damages:o Interest, at the legal rate

Runs from the filing of the complaint or from the time demand was made upon the surety until the principal obligation is paid

o Judicial costso Attorney’s fees when appropriateo Even without stipulation and even in surety would thereby

become liable to pay more than the total amount stipulated in the bond

Draco borrowed from Harry P100. If Ginny guarantees to answer for P150, the guaranty is rendered void but she can be made to pay only P100 because her obligation cannot exceed the limits of the principal obligation.If the debt is not secured by a mortgage, and Ginny mortgaged the Burrow in favor of Harry, Harry may not foreclose the mortgage otherewise, Ginny’s liability would be more onerous than that of Draco, the principal debtor.

Draco borrowed from Harry P150 with Ginny limiting her guarantee to P100. Draco was able to pay only P100. In this case, Harry can still claim from Ginny the balance of P50 by virtue of the guaranty. This is so because the payment by Draco must be applied first to the unsecured portion of P100 for as regards him, it is more onerous as to the unsecured amount of P50.

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

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

Guaranty not presumed Guaranty require the expression of const on the part of the guarantor to

be bound. It cannot be presumed because of the existence of a contract or principal obligation.

Guaranty must be in writing. It’s covered by the Statute of Frauds.


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Guaranty strictly construed, and its consequences Strictly interpreted against the creditor and in favor of the guarantor and

is not to be extended beyond its terms or specified limits A guarantor is liable only for the obligation of the debtor stipulated upon,

and not to obligations assumed previous to the execution of the guaranty unless an intent to be so liable is clearly indicated

To hold the guarantor liable for debts contracted prior to the guaranty is, in effect, to make him answer for debts incurred outside of the guaranteed period, and this cannot be done without his express consent

When liability of surety limited to a fixed period, the surety cannot be bound, unless the contract has been renewed

o Where, however, one of the conditions of the bond filed by the surety provides that the latter’s liability will expire on the date of the maturity of the principal obligation, such stipulation is unfair for it practically nullifies that nature of the surety undertaking

A contract of suretyship or guaranty is only prospective, and not retroactive in operation unless a contrary intent is clearly shown

The extent of a surety’s liability is determined only by the clause of the contract of suretyship

Application of strictissimi juris Applicable only to an accommodation surety, or one who does so

gratuitously Not applicable to compensated sureties

Extent of guarantor’s liability Where guaranty definite

o Obligation of the guarantor under the terms of the contract is limited in whole or in part to the principal debt, to the exclusion of the accessories

o If the amount to be paid or the service to be performed by the person guaranteed is specified in the contract of guaranty, then the obligation of the guarantor extends no further than the sum or services so specified

Where guaranty indefinite or simpleo If the terms of the contract of guaranty are general and

indefinite and do not specify in clear and express manner that the liability of the guarantor is limited to the principal obligation, it extends not only to the said principal obligation but also to all its accessories, they being comprehended within the principal because the guaranty has secured it with all its consequences

o Mickey: So, general rule is that it’s indefinite. Since the it is needed that the terms of the contract be limited for it to be definite. Without a specification that it’s limited, Manresa considers it indefinite. (What do you think?)

Liability of guarantor for judicial costs Guarantor shall answer for such judicial costs only as have been

incurred after he has been judicially required to pay

Acceptance of guaranty by creditor and notice thereof to guarantor In declaring that guaranty must be express, the law refers solely and

exclusively to the obligation of the guarantor because it is he alone who binds himself by his acceptance

With respect to the creditor, no such requirement needs to be prescribed because he binds himself to nothing

When necessaryo Where there is merely an offer of a guaranty, it does not

become a binding obligation until is accepted and until notice of such acceptance by the creditor is given to, or acquired by, the guarantor, or until has notice or knowledge that the creditor has performed the condition and intends to act upon the guaranty

o Acceptance need not be in writing When not necessary

o Where the transaction is not merely an offer of guaranty, but it amounts to direct or unconditional promise of guaranty, all that is necessary to make the promise binding is that promisee (creditor) should act upon it, and notice of acceptance is not necessary the reason being that the contract of guaranty is unilateral

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 to be complied with.

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


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Qualifications of a guarantor1. Possesses integrity2. Capacity to bind himself, and3. Sufficient property to answer for the obligation which he guarantees

Of course, the creditor can waive the requirements. Need only be present at the time of the perfection of the contract Subsequent loss of integrity or property or supervening incapacity of the

guarantor would not operate to exonerate the guarantor of the eventual liability he has contracted, and the contract of guaranty continues

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

But he may waive it if he chooses and hold the guarantor to his bargain.

Judicial declaration of insolvency is not necessary in order for the creditor to have the right to demand another guarantor

Does a guarantor’s liability extinguish upon his death? The Civil Code contains no provision that the guaranty is extinguished

upon the death of the guarantor or the surety From this article, it is immediately apparent that the supervening

incapacity of the guarantor does not terminate the contract but merely entitles the creditor to demand a replacement of the guarantor. But the step remains optional in the creditor.

o It is his right, not his duty; he may waive it if he choose and hold the guarantor to his bargain.

The contracts of suretyship entered, not being intransmissible, his eventual liability thereunder necessarily passed upon his death to his heirs.

Selection of guarantor Where the creditor has required and stipulated that a specified person

should be a guarantor, the substitution of guarantor may not be demanded.

Guarantor personally designated by the creditoro Where the guarantor is personally designated by the creditor, it

is because he considers him to have the qualifications for the purpose, and the responsibility for the selection should, therefore, fall upon him, and not on the debtor.

Guarantor selected by principal debtor

o Where the guarantor is selected by the principal debtor, the latter answers for the integrity, capacity, and solvency of the former because the guarantor must possess the qualifications not only at the moment the guaranty is given, but also until the extinguishment of the debt.

CHAPTER TWOEFFECTS OF GUARANTY

SECTION I – EFFECTS OF GUARANTY BETWEEN THE GURANTOR AND THE CREDITOR

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

Right of guarantor to benefit of excussion or exhaustion 1. Guarantor only secondarily liable2. All legal remedies against debtor must be first exhausted

Includes rescission of fraudulent alienations of property made by the debtor

not applicable to contracts of suretyship

Right of creditor to secure judgment against guarantor prior to exhaustion

General rule: An ordinary personal guarantor (not a pledgor or mortgagor), may demand exhaustion of all the property of the debtor before he can be compelled to pay.

However, the creditor may secure a judgment against the guarantor before the exhaustion of the debtor’s properties. In this case, the guarantor shall be entitled to a deferment of the execution of the judgment against him until after the properties of the debtor have been exhausted. (based on trial convenience)

Art 2059 This excussion shall not take place:


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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 (debtor) has absconded, or cannot be sued within the

Philippines unless he has left a manager or representative;5. If it be presumed that an execution on the property of the

principal debtor would not result in the satisfaction of the obligation.

Exceptions to benefit of excussion1. those provided in Art 20592. if he does not comply with Art 2060;3. if he is a judicial bondsman and sub-surety (Art 2084);4. where a pledge or mortgage has been given by him as a special

security5. if he fails to interpose it as a defense before judgment is rendered

against him

Exceptions provided in 20591. Express renunciation 2. Binds himself solidarily, as a surety3. Insolvency of debtor

Must be proven by unsatisfied writ of execution Judicial declaration of insolvency not enough

4. Debtor absconds or cannot be locally sued5. Resort to all legal remedies would be a useless formality

If such judicial actions including execution would not satisfy the obligation, the guarantor can no longer require the creditor to resort to all such remedies

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

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

Duty of creditor to make prior demand for payment from guarantor1. Demand for payment by the creditor upon the guarantor can be made

only after judgment on the debt.2. Actual demand must be made.

1. Joining the guarantor in the suit against the principal debtor is not the demand intended by law.

Duty of guarantor to set up benefit of excussionAs soon as he is required to pay, the guarantor must

1. Claim the benefit of excussion2. Also point out to the creditor available property (not in litigation

or encumbered) of the debtor within the Philippines

Duty of creditor to resort to all legal remedies1. Exhaust all the property of the debtor pointed out by the guarantor2. Resort to all legal remedies against the debtor

If he fails to do so because of negligence, he shall suffer the loss, but only to the extent of the value of said property, for the insolvency of the debtor

3. Creditor must notify the guarantor of the debtor’s inability to pay (Art 2062)

General rule: Guarantor, not being a joint contractor with his principal cannot be sued with his principal.Exception: Adherence to this rule is not required when it would serve merely to delay the accounting of the guarantor.

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

Procedure when creditor sues1. Creditor must sue principal alone. 2. Notice to guarantor of the action so that he may choose to appear


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a. If he appears, he is still given the benefit of exhaustion. Voluntary appearance does not constitute a renunciation of his right to excussion.

b. If he does not appear, he cannot set up the defenses which are allowed to him by law by appearing. It may no longer be possible for him to question the validity of the judgment rendered against the debtor.

3. Hearing before execution an be issued against guarantora. Where he is not a party in the case involving his principle, the

guarantor is entitled to be heard before an execution can be issued against him.

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

Effects of compromiseA compromise is a contract whereby the parties, by making reciprocal concessions, avoid a litigation or put an end to one already commenced.

Debtor owes creditor P100, with Jojo as guarantor. 1. Debtor and creditor agree to reduce debt to P70. Jojo also liable for

P70, as it benefited him.2. Debtor and creditor agree to increase debt to P130. Jojo only liable for

P100, as it prejudiced him.3. Creditor and Jojo agree to extend time. Extension also applies to debtor

as it was to his benefit.4. Creditor and Jojo shortened the period of payment. Not binding to

debtor as it prejudiced him.

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

Sub-guarantors also have a right to excussion, both with respect to the guarantor and to the principal debtor

Art 2065 Should there be several guarantors of only one debtor and for the same debt, the obligation to answer for the same is divided among all. The creditor cannot claim from the guarantors except the shares

which they are respectively bound to pay, unless solidarity has been expressly stipulated.

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

Art 2065 only applies to instances wherein1. Several guarantors2. Only one debtor3. Same debt

Benefit of division among several guarantors1. General rule: Liability is only joint

Guarantors are not liable to the creditor beyond the shares which they are respectively bound to pay

2. Exception: solidarity, but must be stipulated and those cases in 2059, but with respect to guarantors, not the principal debtor

Draco owes Harry P100. Ginny and Ron are guarantors.1. Harry can only demand P50 each from Ginny and Ron.2. If they Ginny and Ron bound themselves solidarily, creditor can hold

either of them liable for P100. Moreover, credtor can demand from Ginny or Ron the entire obligation in cases mentioned in 2059 as where Ginny or Ron has expressly renounced the benefit of division.

Debtor Draco and debtor Dumbledore jointly and severally owe creditor Harry P100. Ginny and Ron are their respective guarantors.1. Creditor Harry can hold Ginny and Ron responsible as guarantor for the

entire amount of P100. Here, the debtors are distinct and the guarantors are bound by distinct ties to different debtors.

2. If the obligation of Draco and Dumbledore is joint, there are actually two debts – Draco’s debt of P500 and Dumbledore’s debt of P500. Guarantor Ginny cannot demand that the claim of creditor Harry for P500 against Dumbledore be divided between guarantor Ginny and guarantor Ron.

NB. In this example, as Ginny guaranteed for Draco, and Ron guaranteed for Dumbledore, the guarantors are only liable for their respective principal debtors.

Benefit of excussion among several guarantors


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While it is needed to point out to the creditor the debtor’s available property in order to set up the guarantor’s benefit of exhaustion, this is not needed for a guarantor to be entitled to the benefit of division.

Obligation of guarantor with co-guarantors is not subsidiary, but direct and does not depend as to its origin on the solvency or insolvency of the latter.

Although afterwards, if one of them should turn out to be insolvent, his share has to be borne by the others. (Art 2073)

SECTION II – EFFECTS OF GUARANTY BETWEEN THE DEBTOR AND THE GUARANTOR

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

The indemnity comprises:1. The total amount of the debt;2. The legal interests thereon from the time the payment

was made known to the debtor, even though it did not earn interest for the creditor;

3. The expenses incurred by the guarantor after having notified the debtor that payment had been demanded of him;

4. Damages, if they are due.

Guaranty, a contract of indemnity1. Total amount of debt (of course, he cannot collect more than what he

paid)2. Legal interest thereon

Starting from the time notice of payment of debt was made known to the debtor

Immaterial that the debt did not earn interest for the creditor Guarantor’s right to legal interest is granted by law

3. Expenses incurred by the guarantor Only those that the guarantor has to satisfy in accordance with law

as a consequence of the guaranty (Art 2055, par 2 - judicial costs, attorney’s fees etc); not those which depend upon his will or by his fault

Limited to those incurred by the guarantor after having notified the debtor that payment has been demanded of him by the creditor

4. Damages, if they are due

Exceptions to right to indemnity or reimbursement1. Guaranty constituted without knowledge or against the will of the debtor,

recovery only insofar as the payment has been beneficial to the debtor (Art 2050)

2. Payment by a third person who does NOT intend to be reimbursed by the debtor is deemed a donation, which requires the debtor’s consent. (Art 1238)

3. Right to demand reimbursement is subject to waiver.

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

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

Guarantor’s right to subrogationSubrogation transfers to the person subrogated, the credit with all the rights thereto appertaining either against the debtor or against third persons, be they guarantors or possessors of mortgages, subject to stipulation in conventional subrogation (Art 1303). Simply said, except for the change of person of the creditor by the guarantor, the obligation subsists in all respects as before payment.

1. Right of subrogation is necessary to enable the guarantor to enfore the indemnity given in Art 2066.

a. Arises by operation of law upon payment by the guarantor.b. Not a contractual rightc. Guarantor is subrogated, by virtue of the payment, to the rights

of the creditor, not those of the debtor

If guarantor paid a smaller amount to the creditor by virtue of a compromise, he cannot demand more than he actually paid.Cannot be invoked in those cases where the guarantor has not right to be reimbursed.

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

Effect of payment by guarantor without notice to debtor


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See codal. If the debtor has already paid the creditor, when the guarantor pays, the debtor can set up against the guarantor the defense of previous extinguishment of the obligation by payment.

NB. Do not confuse this with Art 2050. In that article, no guaranty exists to begin with. Here, there is an existing guaranty relationship and the guarantor goes ahead and pays.

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

Art 2069 applies when:1. Debt has a period/maturity date2. Guarantor pays the debt before due date

Effect of payment by guarantor before maturityGeneral rule: Guarantor not entitled to reimbursement since there is no necessity for accelerating payment. He can only demand for reimbursement upon expiration of the period.Exception: If payment is ratified or with consent by the debtor (then the guarantor can demand reimbursement even before maturity)

NB: If guarantor pays before due date, the interest does not run even if debtor has been notified.

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

Art 2070 applies when:1. Guarantor pays without notice to debtor2. Debtor, without knowledge, repeats payment to creditor

General rule: Guarantor’s only remedy is to collect from the creditor. He has no cause of action against the debtor even if the creditor should become

insolvent. It’s his fault for not advising the debtor that he was going to pay. Before the guarantor pays the creditor, he must first notify the debtor.

Exception: Guarantor may still claim from debtor in spite of lack of notice if the following conditions are present:

1. Guaranty is gratuitous2. Creditor becomes insolvent3. Guarantor was prevented by fortuitous even to advise the debtor of

the payment if creditor is solvent, guarantor must still recover from him

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

1. When he is sued for the payment;2. In case of insolvency of the principal debtor;3. When the debtor has bound himself to relieve him from the

guaranty within a specified period, and this period has expired;

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

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

6. If there be reasonable grounds to feat that the principal debtor intends to abscond;

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

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

Right of guarantor to proceed against debtor before paymentGeneral rule: The guarantor has no cause of action against the debtor until after the former has paid the obligation (Art 2066)

Exception: The seven instances in Art 2071. Here, the guarantor may proceed against the debtor even before payment.


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The purpose is to enable the guarantor to take measures for the protection of his interest in view of the probability that he would be called upon to pay the debt.

NB: In Art 2071 (1), the creditor doesn’t have to be the one to sue the guarantor, as the law does not distinguish.

Remedy to which guarantor entitled1. Obtain release from the guaranty2. Demand a security that shall protect him from any proceedings by the

creditor, and against the danger of insolvency of the debtor

Guarantor cannot demand reimbursement for indemnity because he has yet to pay the obligation.

Remedies are alternative. Guarantor has the right to choose the action to bring.

Remember that there are certain cases when the guarantor cannot claim the benefit of excussion and in such cases it is but proper that the guarantor be given the right to proceed against the debtor. (?)

Suit by guarantor against creditor before payment Action for release can only be exercised against the principal debtor and

not against the debtoro The creditor is not compellable to release the guarantor before

payment of his credit against his will.o Especially should this be the case where the principal debtor

has become insolvent, for the purpose of a guaranty is exactly to protect the creditor against such a contingency

Absent the creditor’s consent, the principal debtor may only proceed to protect the demanding guarantor by a counterbond or counter-guranty as is authorized by 2071.

2066 2071 Provides for enforcement of the

rights of the guarantor against the debtor AFTER he has paid the debt

Right of action after payment

Provides for protection BEFORE he has paid but AFTER he has become liable

Protective remedy before

Substantive right

payment

Preliminary remedy

Recovery by surety against indemnitor even before payment1. Indemnity agreement for benefit of surety2. Indemnity agreement may be against actual loss as well as liability

a. Indemnity agreement against loss – indemnitor will not be liable until the person to be indemnified makes payment of sustains loss

b. Indemnity agreement against liability – indemnitor’s liability arises as soon as the liability of the person to be indemnified has arisen without regard to whether or not he has sufferered actual loss

3. A stipulation in an indemnity agreement providing that the indemniotr shall pay the surety as soon as the latter becomes liable to make payments to the creditor under the terms of the bond, regardless of whether the surety has made payment actually or not, is valid and enforceable. Where the principal debtors are simultaneously the same persons

who executed the indemnity agreement, the position occupied by them is that of a principal debtor and indemnitor at the same time, and their liability being joint and several with the surety, the creditor may proceed against either.

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

Art 2072 applies when:1. Person requests a guarantor2. To guarantee a debt of an absentee

Guarantor, after satisfying the debt, can seek reimbursement from:1. The person who requested, or2. The debtor


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SECTION III – EFFECTS OF GUARANTY AS BETWEEN CO-GUARANTORS

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

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

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

Applies when:

1. Several guarantors2. One debt3. One guarantor has paid the debt and is seeking reimbursement4. Payment was made either by

a. In virtue of a judicial demand, orb. Because the principal debtor is insolvent

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

The right of the guarantor who has paid the debt is acquired ipso jure by the guarantor by virtue of said payment without the need of obtaining from the creditor any prior cession of rights to such guarantor

Ginny, Ron and Fred are Draco’s guarantors of a debt of P900 in favor of Harry.If Draco becomes insolvent, the right of Ginny, Ron and Fred to proportionate division of their obligation ceases as far as Harry is concerned (art 2065, 2059). Harry may demand payment of the entire obligation from any of the guarantors. If Ginny pays the whole debt of P900 he can later demand from Ron and Fred P300 each. But if Ron is insolvent, his share shall be borne by Ginny and Fred proportionately. Thus, Ginny can demand from Fred P450.

If the benefit of division ceases for reasons other than the insolvency of the principal debtor (Art 2059), the right to reimbursement granted to Ginny against Ron and Fred may only be exercised if Ginny makes payment in virtue of a judicial demand by Harry.

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

Defenses available to co-guarantors In the action filed by the paying guarantor against his co-guarantors for

their proportionate shares in the obligation, the latter may avail themselves of all defenses which the debtor would have interposed against the creditor but not those which cannot be transmitted for being purely personal to the debtor.

In the example above, if Ginny sues Ron and Fred, the latter may raise the defense of payment by Draco by virtue of which the obligation was extinguished. But if Draco was a minor at the time the obligation was contracted, the defense of minority is not available to Ron and Fred because it is personal to Draco.

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

Liability of sub-guarantor in case of insolvency of guarantor In case of the insolvency of the guarantor for whom he bound himself, a

sub-guarantor is liable to the co-guarantors in the same manner as the guarantor whom he guaranteed.

In the example above, if Hermione (co-guarantor) is the guarantor of Ron, and Ron becomes insolvent, Hermoine is liable to Ginny for P300 or P450 if Fred is also insolvent.

CHAPTER THREE 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.


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Causes of extinguishment of guaranty Guaranty being accessory and subsidiary, it is also terminated when the

principal obligation is extinguished. The guaranty itself may be directly extinguished although the principal

obligation still remains as in the case of the release of the guarantor made by the creditor (art 2078)

Material alteration of principal contract Effect of material alteration

o Any agreement between the creditor and the principal debtor which essentially varies the terms of the principal contract without the consent of the surety, will release the surety from liability

o Such material alteration would constitute a novation or change of the principal contract which is consequently extinguished

When alteration materialo The guarantor or surety will not be released by a change in the

principal contract where such change does not have the effect of making its obligation more onerous

o There must be change which imposes new obligation or added burden on the party promising or which takes away some obligation already imposed, changing the legal effect of the original contract and not merely the form thereof

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.

Release by conveyance of property Any substitute paid in lieu of money which is accepted by the creditor

extinguishes the obligation and in consequence, the guaranty. If the creditor accepts property in payment of a debt from the debtor, the

guarantor is relieved from responsibility. This is also true even inc ase the creditor is subsequently evicted from the property.

o Eviction revives the principal obligation but not the guaranty.

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

Release of guarantor without consent of others

As a rule, the guarantors enjoy the benefit of division. However, if any of them should be insolvent all the other guarantors

must bear his share. So, a release made by the creditor in favor of one of the guarantors without the consent of the others may thus prejudice the latter should a guarantor become insolvent.

Ginny, Ron and Fred are guarantors for a debt of P900. If Ginny is released without the consent of Ron and Fred, then Ron and Fred will each be liable only for P300. They are benefited to the extent of P300, the share of Ginny.

If the release is made with their consent, Ron and Fred will each be responsible for P450. If Ginny is released with the consent only of Ron, Ron is liable for P600, while Fred is liable for P300.

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

Release by extension of the term granted by creditor to debtor If the creditor grants an extension of time to the debtor without the

consent of the guarantor (or surety), the latter is discharged from his undertaking.

o Reason: To avoid prejudice to the guarantor. The debtor may become insolvent during the extension, and guarantor loses right to be reimbursed.

With regard to payables in installments and acceleration clauses:o Where a guarantor is liable for different payments, such as

installments for rents, or upon a series of promissory notes, an extension of time as to one or more will not affect the liability of the surety for the others.

Draco owes Harry P900, payable by P300 at the end of each month. Ginny guaranteed each month’s payable. Harry granted an extension to Draco for the first month’s payment. Ginny is discharged from liability in the first month’s payment, but not the others.

o But if the whole unpaid balance has become automatically due (acceleration clause), the act of the creditor of extending the payment of said installment, without the guarantor’s consent,


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discharges the guarantor because the extension constitutes in fact an extension of the payment of the whole amount of the indebtedness.

Of course, the guarantor may waive in advance his right to be notified or to give consent to the release by the creditor of securities given or to the extension of the time of payment.

The benefit of excussion, as well as the requirement of consent to the extensions of payment, are protective devices pertaining to and conferred on the guarantor which the latter may invoke as defenses to bar any unwarranted enforcement of the guarantee. However, the guarantor may opt not to avail of these defenses by paying the obligation according to the tenor of the guarantee once demand is made on him by the creditor.

Where under the indemnity agreement, whereby the indemnitors bound themselves jointly and severally to the surety for the faithful compliance with the terms of the surety bond issued by the surety in favor of the creditor to secure a credit line extended to the principal debtor, the indemnitors remained simply such bound to the surety but not to the creditor. Such creditor cannot directly demand payment of the principal obligations from the indemnitors.

o The indemnitors are second-tier parties so far as the creditor is concerned and any extension of time granted by the creditor to any of the first-tier obligors (principal debtor and the surety) cannot prejudice the second-tier parties. (whut?)

It is unimportant whether the extension given has actually proved prejudicial or not to the guarantor or surety.

The extension of the term must be based on some new agreement between the creditor and the principal debtor by virtue of which the creditor deprives himself of his claim.

It should appear that the extension was for a definite period, pursuant to an enforceable agreement between the principal and the creditor, and that it was made without the consent of the surety or with a reservation of rights with respect to him.

o The mere failure or neglect on the part of the creditor to enforce payment as soon as the debt matures, does not constitute an extension of the term of the obligation, meaning the liability of the guarantor is not extinguished.

o The rule applies even if the debtor should become insolvent subsequent to the maturity of the debt. The reason is that the guarantor would not be prejudiced since he could avail himself

of the right granted him under Art 2071, namely, to ask the debtor for a release or to demand a security.

Draco owes Harry P900, due on January 31, 2010. Ginny guaranteed the debt. Come February, Harry neglected to demand from Draco. Is Ginny discharged? No.

Supposing Draco becomes insolvent after the debt matured, is Ginny discharged? No. She can, however, ask Draco for a release from the guaranty or demand a security.

The creditor is under no obligation to display any diligence in the enforcement of his rights as a creditor. His mere inaction, indulgence, etc in proceeding against the principal debtor, or the fact that he did not enforrce the guaranty or apply on the payment of such funds as were available constitutes no defense at all for the surety, unless the contract expressly requires diligence and promptness on the part of the creditor.

o Why? There is nothing to prevent the creditor from proceeding against the principal at any time. At any rate, if the surety is dissatisfied with the degree of the activity displayed by the creditor in the pursuit of his principal, he may pay the debt himself and become subrogated to all the rights and remedies of the creditor.

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

Release when guarantor cannot be subrogated The guarantor who pays is entitled to be subrogated to all the rights of

the creditor. If there can be no subrogation because of the fault of the creditor, as

when the creditor releases or fails to register a mortgage, the guarantors are thereby released. (Applies even if guarantors are solidary)

o Why? The act of one cannot prejudice another. It also avoids opportunity for collusion between the creditor and the debtor or a third person

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


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Defenses available to guarantor against creditor Defenses available to a debt as against a guarantor are provided in Art

2068, and those available to co-guarantors in Art 2074 This article provides for the defenses, except those which are purely

personal to the debtor, that may be interposed by the guarantor as against the creditor

In summary, when is a guarantor discharged from liability?1. When principal obligation is extinguished (Art 2076)2. When creditor accepts immovable or other property in payment of the

debt (Art 2077)3. When creditor releases one of the guarantors (Art 2078)4. When an extension is granted to the debtor without the consent of the

guarantor (Art 2079)5. When, by the act of the creditor, they cannot be subrogated to the

rights, mortgages and preferences of the creditor (Art 2080)

CHAPTER FOURLEGAL AND JUDICIAL BONDS

Art 2082 The bondsman who is to be offered in virtue of a provision of law or of judicial order shall the qualifications prescribed in Art 2056 and in special laws.

What is a bond? An undertaking that is sufficiently secured, and Not cash or currency Whatever surety bonds are submitted are subject to any objections as to

their sufficiency or as to the solvency of the bondsman

Qualifications of personal bondsman A bondsman is a surety offered in virtue of a provision of law or a

judicial order He must qualifications

o Required of a guarantor (Art 2056)o Rules of Court (Sec 12, 13, Rule 114)

Resident owner of real estate within the Philippines Only one surety? His real estate must be worth at

least the amount of the undertaking, and

Two or more sureties? They may justify severally in amounts less than that expressed in the undertaking, if the entire sum justified to is equivalent to the whole amount of bail demanded.

In all cases, every surety must be worth the amount specified in the undertaking over and above all just debts, obligations and property exempt from execution.

Art 2083 If the person bound to give a bond in the cases of the preceding article, should not be able to do so, a pledge or mortgage considered sufficient to cover his obligation shall be admitted in lieu thereof.

Guaranty or suretyship is a personal security. On the other hand, pledge or mortgage is a property or real security. If the person required to give a legal or judicial bond should not be able

to do so, a pledge or mortgage sufficient to cover the obligation shall be admitted in lieu thereof.

Art 2084 A judicial bondsman cannot demand the exhaustion of the property of the principal debtor.

A sub-surety in the same case, cannot demand the exhaustion of the property of the debtor or of the surety.

A judicial bondsman and the sub-surety are not entitled to the benefit of excussion.

o Because they are not mere guarantors, but sureties whose liability is primary and solidary.

The contract of suretyship is not that the creditor will see that the principal debtor pays his debt or fulfills his contract, but that the surety will see that the debtor pays or performs.

o So, mere negligence on the part of the creditor in collecting from the debtor will not relieve the surety from liability.

VI PLEDGE


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CHAPTER ONEPROVISIONS COMMON TO PLEDGE AND MORTGAGE

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

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

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

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

Third persons who are not parties to the principal obligation may secure the latter by pledging or mortgaging their own property.

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

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

What is a pledge? Contract by virtue of which the debtor delivers to the creditor or to a third

person o a movableo or document evidencing incorporeal rights,

for the purpose of securing the fulfillment of a principal obligation with the understanding that when the obligation is fulfilled, the thing delivered shall be returned with all its fruits and accessions.

Kinds of pledge1. Voluntary or conventional2. Legal, or created by operation of law

Characteristics of the contract of pledge1. Real contract (perfected by the delivery of thing pledged)2. Accessory

3. Unilateral (creates an obligation solely on the part of the creditor to return the thing upon the fulfillment of the principal obligation)

4. Subsidiary (obligation incurred does not arise until the fulfillment of the principal obligation which is secured)

Cause or consideration in pledge If he (pledgor) is the debtor, the cause is the principal obligation If he is not the debtor, the cause is the compensation stipulated for the

pledge or the mere liberality of the pledgor

Essential requirements of pledge and mortgage1. Constituted to secure fulfillment of a principal obligation2. Constituted by the absolute owner of the thing pledged or mortgaged

1. Or at least by the pledgor or mortgagor with the authority or consent of the owner of the property pledged or mortgaged

2. Why? In anticipation of the foreclosure sale.o Future property cannot be pledged or mortgagedo A pledge or mortgage executed before the pledgor or

mortgagor became the owner of the property is void and ineffective

o A mortgage of conjugal property by one of the spouses is valid only as to ½ of the entire property

3. Pledgor or mortgagor has free disposal of property or has legal authority Free disposal meaning the property must not be subject to any

claim of a third person Capacity to dispose of property means the pledgor or mortgagor

has the capacity or the authority to make a disposition of the property

o Read with reference to special powers of attorney, since this an act of strict ownership

4. The thing pledged must be delivered to the creditor or to a third person by common agreement (Art 2093) Without delivery there can be no pledge because in this delivery

lies the security of the pledge In a contract of mortgage, the mortgagor, as a general rule, retains

the possession of the property mortgaged.5. Thing pledged or mortgaged may be alienated

You can’t pledge your nephew, no matter how annoying he is

What is the doctrine of the mortgagee in good faith?


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The requirement that the mortgagor must have the free disposal of the property or at least have legal authority to do so, does not apply where the property involved is registered under the Torrens System.

While it is true that the mortgagor be the absolute owner of the property mortgaged, a mortgagee has the right to rely upon what appears in the certificate of title and does not have to inquire further.

o So if Draco mortgages his land to Harry, and Harry relies on the TCT given by Draco, then the mortgage is valid – even if it turns out that the land wasn’t Draco’s, but is actually Ron’s.

An innocent purchaser for value (like mortgagee) relying on a Torrens system title is protected.

Based on the public interest in upholding the indefeasibility of a certificate of title.

Exception: This rule does not apply to banks (and analogously to the GSIS) which should exercise more care and prudence in dealing with registered lands, than private individuals, for their business is one affected with public interest. The bank must observe due diligence in ascertaining the real owner of the registered land given as security for a loan.

Pledgor or mortgagor may be a third person Not necessary that the principal debtor should always be the pledgor or

mortgagor As long as valid consent was given by the pledgor or mortgagor, it’s

valid, even if no benefit redounded to the pledgor or motgagor Difference with mortgages/pledges by debtor:

Creditor is required to exercise due care and prudence by making proper inquiry where the debtor borrows money

Pledge Mortgage Movables Property delivered to

pledgee, or by common consent to a third person

Not valid against third persons unless a description of the thing pledged and the date of the pledge appear in a public instrument

Immovables Delivery is not necessary Not valid against third

persons if not registered

Art 2088 The creditor cannot appropriate the things given by way of pledge or mortgage, or dispose of them. Any stipulation to the contrary is null and void.

Creditor is merely entitled to move for the sale of the thing pledged or mortgaged, with the formalities required by law in order to collect the amount of his claim from the proceeds.

The default does not operate to vest in the pledgee or mortgagee the ownership of the property for any such effect is against public policy.

Pactum commissorium Requisites:

1. There should be a pledge, mortgage, antichresis of property by way of security for the payment of the principal obligation; and

2. There should be a stipulation for an automatic appropriation b the creditor of the property in the event of non-payment of the obligation within the stipulated period

In the event that there is a pactum commissorium, only the stipulation is void, not the principal obligation

Permissible stipulations Subsequent agreements (like dacion en pago) Cession of property voluntarily I promise to sell (because not necessarily to the creditor)

o But “I promise to sell to you, my creditor” is void Authority to take possession (but not ownership!)

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

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

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

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


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

Art 2090 The indivisibility of a pledge or mortgage is not affected by the fact that the debtors are not solidarily liable.

Pledge or mortgage indivisible A pledge or mortgage is one and indivisible as to the contracting parties Rule applies even if the obligation is joint and not solidary

o Divisibility of the principal obligation is not affected by the indivisibility of the pledge or mortgage

Consequences:o Single thing pledged – every portion of the property

pledged or mortgaged is answerable for the whole obligation as soon as it falls due.

o Several things pledged – all of them are liable for the totality of the debt and the creditor does not have to divide his action by distributing the debt, among the various things pledged or mortgaged. Even when only a part of the debt remains unpaid, all the things are liable for such balance.

o Debtor’s heir/creditor’s heir – the debtor’s heir who has paid a part of the debt cannot ask for the proportionate extinction or mortgage; nor can the creditor’s heir who has received his share of the debt return the pledge or cancel the mortgage if the debt is not completely satisfied

Exceptions to the general rule that mortgage or pledge indivisible1. Where there are several things given in pledge or mortgage and each

one of them guarantees only a determinate portion of the credit As many pledges or mortgages as there are things given in pledge

or mortgage2. Where only portion of loan was released

Case of Central Bank v CA, 139 SCRA 46 Bank approved a loan for P80k, secured by mortgage of property.

But they only release P17k. SC said they can foreclose 21% of the property.

SC also said that Art 2089 presupposes several heirs of the debtor or creditor. (Atty. Lerma said that it’s a bad decision and that this wasn’t the spirit of the law. SC should have ruled on equity instead..

3. Where there was failure of consideration4. Where there is no debtor-creditor relationship

Although a mortgage or pledge is indivisible as to the contracting parties, it is not so with respect to a third person who did not take part in the constitution thereof either personally or through and agent.

Indivisibility arises only when there is a debt.

1. Draco borrowed from Harry P200, and to guarantee payment, Draco pledged his broomstick worth P150 and his wand worth P50.

If Draco pays P150, he cannot ask for the return of the broomstick because both the broomstick and the wand are given to secure payment of the entire obligation of P200. Harry may cause the sale of either or both for the payment of his credit. The same is true if Draco dies leaving Junior and Bella as his heirs and Junior pays 150 to Harry.

If the creditors are Harry and Hermione, and Draco pays P150, Harry cannot return the broomstick to the prejudice of Hermione who has not received her share. The same is true if Harry is the only creditor and he dies leaving Severus and Albus as his heirs and Draco pays Severus P150.

However, if it was agreed that the broomstick was given to secure the payment of P150, and the wand for the balance of P50, and Draco (or his heir) pays P150, Draco can demand the return of the ring. (Example of exception 1)

2. Draco and Voldemort are jointly liable to Harry in the sum of P200 secured by Draco’s broomstick and Voldemort’s wand worth P50. If Draco pays P150, he cannot demand the return of the ring even if their liability is only joint or proportionate because pledge is indivisible. Remember children, indivisibility is not the same as solidarity. The former refers to the object or prestation of the obligation, while the latter, to the legal tie of the obligation.

Foreclosure of mortgage constituted on several properties The rule that real property, consisting of several lots, should be sold

separately, applies to sales in execution and not to foreclosure of mortgages.

A mortgage, even if constituted on two or more properties, is one and indivisible, it cannot be divided among the different properties. The


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mortgagee has the right to have the properties either or both – jointly or singly, sold to satisfy his claim.

What if the real mortgage and chattel mortgage is in one instrument? Does not have the effect of fusing both securities into an indivisible

whole Both remain distinct agreements, differing not only in the subject matter

of the contract, but also in the governing legal provisions. Mortgagee may legally foreclose the real estate mortgage extrajudicially

and waive the chattel mortgage foreclosure, and maintain instead a personal action for the recovery of the unpaid balance of the credit.

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

Art 2092 A promise to constitute a pledge or mortgage gives rise only to a personal action between the contracting parties, without prejudice to the criminal responsibility incurred by him who defrauds another, by offering in pledge or mortgage as unencumbered, things which he knew were subject to some burden, or by misrepresenting himself to be the owner of the same.

A promise to constitute a pledge or mortgage, if accepted, gives rise only to a personal right binding upon the parties and creates no real right in the property.

What exists is only a right of action to compel the fulfillment of the promise but there is no pledge or mortgage yet. (But isn’t this an obligation to do, which can not be compelled by specific performance?)

CHAPTER TWOPROVISIONS APPLICABLE ONLY TO PLEDGE

Art. 2093. In addition to the requisites prescribed in Article 2085, it is necessary, in order to constitute the contract of pledge, that the thing pledged be placed in the possession of the creditor, or of a third person by common agreement. (1863)

Transfer of possession essential in pledge A pledge is a real contract which requires delivery for its perfection

An agreement to constitute a pledge only gives rise to a personal action between the contracting parties

Unless the movable given as security by way of pledge be delivered to and placed in the possession of the creditor or of a third person designated by common agreement, the creditor acquires no right to the property because pledge is merely a lien and possession is indispensable to the right of a lien

For the contract to affect third persons, apart from being in a public instrument, possession of the thing pledged must, in addition, be delivered to the pledgee

Type of delivery depends upon the nature of the thing pledged The delivery of possession referred to in this article means actual

possession of the property pledged and a mere symbolic delivery is not sufficient

However, it has been held in an earlier case, that the symbolic transfer of the goods by means of the delivery of the keys to the warehouse where the goods were stored was sufficient to show that the depositary appointed by common consent of the parties was legally placed in possession of the goods, since the owner, as pledgor, could no longer dispose of the same, the pledgee being the only one authorized to do so through the depositary and special agent who represented him

Whether or not a symbolic or constructive delivery is sufficient to validate a pledge would depend on the peculiar nature of the thing pledged

Art. 2094. All movables which are within commerce may be pledged, provided they are susceptible of possession. (1864)

Art. 2095. Incorporeal rights, evidenced by negotiable instruments, bills of lading, shares of stock, bonds, warehouse receipts and similar documents may also be pledged. The instrument proving the right pledged shall be delivered to the creditor, and if negotiable, must be indorsed. (n)

What’s the subject matter of a pledge? A pledge is confined and limited to personal property and it cannot be

extended or made to apply to real property. The movable must be within the commerce of men and susceptible of

possession.


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Incorporeal rights evidenced by documents whether negotiable or not may also be pledged.

The document must be delivered to the creditor, if negotiable, it must be indorsed in favor of the creditor.

Art. 2096. A pledge shall not take effect against third persons if a description of the thing pledged and the date of the pledge do not appear in a public instrument. (1865a)

Public instrument necessary to bind third persons Even if all the essential requisites provided in Art 2085 and 2093 are

present, the contract of pledge is not effective against third persons unless in addition to the delivery of the thing pledged, it is embodied in a public document

In the public document, it shall appear the description of the thing pledged and the date of the pledge

This article prescribes a requirement without which the contract of pledge cannot adversely affect third persons such as the innocent buyer of the thing pledged notwithstanding that the pledgee has already taken possession of the same

The object is to forestall fraud because a debtor may attempt to conceal his property from his creditors when he sees it in danger of execution by simulating a pledge thereof with an accomplice

Art. 2097. With the consent of the pledgee, the thing pledged may be alienated by the pledgor or owner, subject to the pledge. The ownership of the thing pledged is transmitted to the vendee or transferee as soon as the pledgee consents to the alienation, but the latter shall continue in possession. (n)

Alienation by the pledgor of thing pledged The pledgor retains his ownership of the thing pledged He may therefore sell the same provided the pledgee consents to the

sale. As soon as the pledgee gives his consent, the ownership of the thing

pledged is transferred to the vendee subject to the rights of the pledgee, namely:

o that the thing sold may be alienated to satisfy the obligation; and

o that the pledgee must continue in possession during the existence of the pledge.

But again, the pledge would not bind third persons unless Art 2096 has been followed

This is one of the rare cases where ownership is transferred without actual delivery of the thing alienated

Art. 2098. The contract of pledge gives a right to the creditor to retain the thing in his possession or in that of a third person to whom it has been delivered, until the debt is paid. (1866a)

Right of the pledgee to retain thing pledged The possession of the pledgee constitutes his security The debor cannot demand for its return until the debt secured by it is

paid. But the right of retention is limited only to the fulfillment of the principal

obligation for which the pledge was created. (One debt, one pledge)

Draco owes Harry P500. As security, Draco pledged his wand. Later, Draco again borrowed P200.Harry has a right to retain the thing until the P500 is paid. But Harry cannot retain the thing until he has been paid the remaining debt of P200. Harry’s right of retention is limited to the payment of the P500 for which the ring was given in pledge.

Art. 2099. The creditor shall take care of the thing pledged with the diligence of a good father of a family; he has a right to the reimbursement of the expenses made for its preservation, and is liable for its loss or deterioration, in conformity with the provisions of this Code. (1867)

Obligation of pledgee to take due care of the thing pledged Upon fulfillment of the principal obligation, the pledgee msut return the

thing pledged Having possession of the property, he has the obligation to take care of

the same with the diligence of a good father of the family. He is, however, entitled to reimbursement of the expenses incurred for

its preservation. In case of the loss or deterioration of the thing pledged due to a

fortuitous event, the pledgee cannot be held responsible but he is liable for loss or deterioration by reason of fraud, negligence, delay or violation of the terms of the contact.


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Atty Lerma said that the creditor also has the right to retention for costs not yet paid.

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

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

Obligation of pledgee not to deposit thing pledged with another General rule: While the pledgee is entitled to retain the possession of

the thing pledged until the debt is paid, he is not authorized to transfer possession to a third person.

Exception: When there is stipulation authorizing him to do so. The difference between this article and Art 2093 is that in the former, the

pledgee is in possession already, while in the latter article, both the pledgor and pledgee choose the third person.

Is the pledgee responsible for acts of his employees or agents? Yes, because their acts are, in legal effect, deemed his.

Art. 2101. The pledgor has the same responsibility as a bailor in commodatum in the case under Article 1951. (n)

See Article 1951 which talks about hidden defects of the thing pledged, the liability of the pledgor, and the pledgee’s right of retention.

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

In case of a pledge of animals, their offspring shall pertain to the pledgor or owner of animals pledged, but shall be subject to the pledge, if there is no stipulation to the contrary. (1868a)

Right of pledgee to compensate earnings of pledge with debt The pledgee has no right to use the thing pledged or to appropriate the

fruits thereof without the authority of the owner. (Art 2104) But the pledgee can apply the fruits, income, dividends, or interests

earned or produced by the thing pledged to:

o the payment of interest, if owing; and o thereafter to the principal of his credit

Unless there is a stipulation to the contrary, the interest and earnings of the right pledged and in case of animals, their offspring are included in the pledge.

Draco borrowed from Harry P100 at 12% interest, with certificates of stocks as security. The interest is payable six months after the execution of the contract.If the stocks earn dividends, the same shall also be subject to the pledge, if there is no stipulation to the contrary. Harry shall apply such dividends to the interest, if any, owing him after six months. If none is owing him or insofar as the dividends may exceed the interest due, Harry shall credit it to the principal of P100 when it matures.

Art. 2103. Unless the thing pledged is expropriated, the debtor continues to be the owner thereof.

Nevertheless, the creditor may bring the actions which pertain to the owner of the thing pledged in order to recover it from, or defend it against a third person. (1869)

Right of pledgee against third persons Except as provided in Article 2112, the pledgor remains the owner of the

property pledged. The creditor to whom the property pledged has been delivered is

obliged to take care of it with the diligence of a good pop of family. He is authorized to bring such action as pertaining to the owner in order

to recover it or defend it, against claims of third persons. Unless given the right, the creditor might be prejudiced by the

negligence of the owner. The right of a pledgee is a real right enforceable against third persons

but it is necessary that the contract of pledge be embodied in a public instrument which shall contain a description of the thing pledged and the date of the pledge. (See Art 2096. Does this mean that if it’s not in a public instrument, the pledgee can’t defend the thing against third persons?)

Art. 2104. The creditor cannot use the thing pledged, without the authority of the owner, and if he should do so, or should misuse the thing in any other way, the owner may ask that it be judicially or extrajudicially deposited. When the preservation of the thing pledged


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requires its use, it must be used by the creditor but only for that purpose. (1870a)

Obligation of the pledgee not to use thing pledged General rule: Pledgee can’t make use of the thing pledged. Exceptions:

1. When he has the permission or authority of the owner2. When the preservation of the thing pledged requires its use

(but it must be used only for that purpose) If from the use of the property, profits are derived, the pledgee must

account therefore to the pledgor and apply the net proceeds of such use to the payment of his claim

This rule is similar to the rule in deposits

When can the pledgor ask that the thing pledged be deposited? In the following cases, the owner may ask that the thing pledged be

deposited judicially or extrajudicially:1. If the creditor use the thing without authority2. If he misuses the thing in any other way3. If the thing is in danger of being lost or impaired because of the

negligence or willful act of the pledgee.

Art. 2105. The debtor cannot ask for the return of the thing pledged against the will of the creditor, unless and until he has paid the debt and its interest, with expenses in a proper case. (1871)

Right of pledgor to demand return of the thing pledged The pledgor/debtor cannot ask for its return until said obligation is fully

paid including interest due thereon and expenses incurred for its preservation. (See Art 2099)

Prescription will not begin to run on the action to demand the return of the thing pledged while the obligation subsists, neither will the possession of the pledgee as such ripen into ownership by prescription because such possession is not in the concept of an owner.

Exception: the pledgor is allowed to substitute the thing pledged which is in danger of destruction or impairment with another thing of the same kind and quality

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

Right of pledgor to ask for deposit of the thing pledged This article talks about the remedy of the pledgor whenever the pledgee

is at fault If the thing should be exposed to loss or impairment through the

negligence or willful act of the pledgee, the pledgor may demand that it be deposited with a third person.

The pledgor may also require such deposit should the pledgee use the thing without authority or misuse it in any other way. (see Art 2104)

Art. 2107. If there are reasonable grounds to fear the destruction or impairment of the thing pledged, without the fault of the pledgee, the pledgor may demand the return of the thing, upon offering another thing in pledge, provided the latter is of the same kind as the former and not of inferior quality, and without prejudice to the right of the pledgee under the provisions of the following article.

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

Right of pledgor to substitute thing pledged As compared to Article 2106, this article applies when there is no fault

on the part of the pledgee Two remedies are actually granted by this article:

1. To the pledgor, the right to demand the return of the thing pledged upon offering another thing in pledge

2. To the pledgee, the right to cause the same to be sold at a public sale (Art 2108)

The following are the requisites for this article to apply:1. The pledgor has reasonable grounds to fear the destruction or

impairment of the thing pledged2. There is no fault on the part of the pledgee3. The pledgor is offering in place of the thing, another thing in pledge

which is of the same kind and quality as the former, and4. The pledgee does not choose to exercise his right to cause the

thing pledged to be sold at public auction.

As can be seen from the codal provision and the requisites, it is the pledgee who has first dibs on what to do with the thing pledged. If he


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does not want to sell it, only then will the pledgor be allowed to substitute the thing.

Art. 2108. If, without the fault of the pledgee, there is danger of destruction, impairment, or diminution in value of the thing pledged, he may cause the same to be sold at a public sale. The proceeds of the auction shall be a security for the principal obligation in the same manner as the thing originally pledged. (n)

Right of pledgee to cause sale of thing pledged Atty Lerma says this article is absurd. The sale must be a public sale. The pledgee shall keep the proceeds of

the sale as security for the fulfillment of the principal obligation. In other words, they shall belong to the pledgor.

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

Right of pledgee to demand substitute or immediate payment In case the pledgee is deceived as to the substance or quality of the

thing pledge, he has two options:1. Claim another thing in pledge, or2. Demand immediate payment of the principal obligation

The remedies are alternative, the pledgee can choose only one.

Art. 2110. If the thing pledged is returned by the pledgee to the pledgor or owner, the pledge is extinguished. Any stipulation to the contrary shall be void.

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

Extinguishment of pledge by return of thing pledged One of the essential requisites of the pledge is that the object be placed

in the possession of the creditor, or of a third person by common agreement.

Hence, the pledge is extinguished if the object is returned by the pledgee, and this is true notwithstanding any stipulation that the pledge would continue although the pledgee is no longer in possession.

The pledge is also extinguished by:1. Payment of the debt2. Renunciation or abandonment of the pledge (See Art 2111)3. Sale of the thing pledged at public auction4. Other causes of extinguishment like loss, merger, etc

Presumption of extinguishment of pledge The possession by the debtor or owner of the thing pledged subsequent

to the perfection of the pledge gives rise to a prima facie presumption that the thing has been returned and therefore that the pledge has been extinguished

The presumption may be rebutted by the evidence to the contrary, as for example, that the return was merely for the substitution of the thing pledged, or that the thing was stolen and given by the thief to the pledgor or owner

There is even authority supporting the proposition that the pledgee can temporarily entrust the physical possession of the chattel pledged to the pledgor without invalidating the pledge, thereby making the pledgor a trustee for the pledgor

In any case, only the accessory obligation of pledge is presumed remitted, not the principal obligation itself.

Art. 2111. A statement in writing by the pledgee that he renounces or abandons the pledge is sufficient to extinguish the pledge. For this purpose, neither the acceptance by the pledgor or owner, nor the return of the thing pledged is necessary, the pledgee becoming a depositary. (n)

Extinguishment of pledge by renunciation or abandonment The pledge is a personal right of the pledgee which may be waived Renunciation or abandonment must be in writing to extinguish the

pledge, and such renunciation is not conditioned upon the acceptance by the pledgor or owner nor upon the return of the thing pledged.

The waiver transforms the pledgee into a depositary with the rights and obligations of one. (See Chapter on Deposit)

The principal debt, however, is not affected by the waiver of the pledge, but the waiver of the principal obligation carries with it that of the pledge.


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The thing pledged remains in the possession of the pledgee. Hence, the wavier must be in writing.

Under the previous article, the pledge is extinguished even in the absence of waiver if the thing pledged is returned to the pledgor.

Art. 2112. The creditor to whom the credit has not been satisfied in due time, may proceed before a Notary Public to the sale of the thing pledged. This sale shall be made at a public auction, and with notification to the debtor and the owner of the thing pledged in a proper case, stating the amount for which the public sale is to be held. If at the first auction the thing is not sold, a second one with the same formalities shall be held; and if at the second auction there is no sale either, the creditor may appropriate the thing pledged. In this case he shall be obliged to give an acquittance for his entire claim. (1872a)

Right of pledgee to cause sale of thing pledged One of the essential requisites of pledge is that the object pledged may

be alienated for the payment to the creditor when the principal obligation becomes due

The formalities required for such sale under the above article are as follows:1. The debt is due and unpaid2. The sale must be at a public auction3. There must be notice to the pledgor and owner, stating the amount

due; and4. The sale must be made with the intervention of a notary public

Note that this article does not required posting of the notice of sale and publication

Notification to the pledgor and the owner of the thing pledged is sufficient.

Only a notary public can conduct a public auction after proper notice is sent to the pledgor and owner of the thing pledged.

Right of pledgee to appropriate thing pledged The pledgee may appropriate the thing pledged if after the first and

second auctions, the thing is not sold. This is an exception to the prohibition against pactum commissorio.

If the creditor appropriates the thing, it shall be considered as full payment for his entire claim. He is thus obliged to give an acquittance9 for the same.

The debtor is not entitled to the excess in case the value of the thing pledged is more than the principal obligation.

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

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

Right of pledgor and pledgee to bid at public sale If the debt is not paid and a public sale takes place, both the pledgor

and the pledgee may bid. The pledgor shall be preferred if he offers the same terms as the highest

bidder. To avoid fraud, the pledgee is not allowed to acquire the thing pledged if

he is the only bidder.

Art. 2114. All bids at the public auction shall offer to pay the purchase price at once. If any other bid is accepted, the pledgee is deemed to have been received the purchase price, as far as the pledgor or owner is concerned. (n)

Bid must be for cash All bids, including that of the pledgor, must be for cash. If the pledgee accepts a bid other than for cash, the pledgor or owner

has the right to consider that the pledgee has received the purchase price in cash.

Art. 2115. The sale of the thing pledged shall extinguish the principal obligation, whether or not the proceeds of the sale are equal to the amount of the principal obligation, interest and expenses in a proper case. If the price of the sale is more than said amount, the debtor shall not be entitled to the excess, unless it is otherwise agreed. If the price of the sale is less, neither shall the creditor be entitled to recover the deficiency, notwithstanding any stipulation to the contrary. (n)

9 a legal document evidencing the discharge of a debt or obligation


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What is the effect of the sale of the thing pledged? The sale of the thing pledged extinguishes the principal obligation

whether the price of the sale is more than the amount due. If the price of the sale is more than the amount due the creditor, the

debtor is not entitled to the excess unless the contrary is provided. If the price of the sale is less than the amount due, the creditor is not

entitled to recovery the deficiency. A contrary stipulation is void.

Right of debtor to excess General rule: The debtor is not entitled to the excess. Exception: If there is an agreement to the contrary. This is to compensate the creditor for his risk of not being able to

recover the deficiency in case the thing pledged is sold below the amount of the principal obligation.

Compare with: Under the Chattel Mortgage Law, the mortgagor is entitled to recover the excess of the proceeds of the sale in foreclosure proceedings.

No right of creditor to recovery deficiency General rule: The creditor is not entitled to recover the deficiency in ALL

cases. By electing to sell the thing pledged, instead of suing on the principal

obligation, the creditor waives any other remedy, and must abide by the results of the sale.

The creditor may sue on the principal obligation instead of electing to sell the thing pledged, and in such case, he may recover the deficiency from the debtor.

Art. 2116. After the public auction, the pledgee shall promptly advise the pledgor or owner of the result thereof. (n)

Obligation of pledgee to advise pledgor or owner of result of sale The purpose of this article is to enable the pledgor or owner to take

steps for the protection of his rights where he has reasonable grounds to believe that the sale was not an honest one

Art. 2117. Any third person who has any right in or to the thing pledged may satisfy the principal obligation as soon as the latter becomes due and demandable.(n)

Right of third person to satisfy obligation

Under this article, a third person who has any right in or to the thing pledged (as when the pledgor has contracted to sell it to him) may pay the debt as soon as it becomes due and demandable, and the creditor cannot refuse to accept the payment.

Art. 2118. If a credit which has been pledged becomes due before it is redeemed, the pledgee may collect and receive the amount due. He shall apply the same to the payment of his claim, and deliver the surplus, should there be any, to the pledgor. (n)

Right of pledgee to collect and receive amount due on credit pledged It would seem that it is not obligatory for the pledgee to collect and

receive the amount due on the credit pledged. He is given merely the right to do so.

However, in view of Article 2009 which imposes upon him the obligation to take care of the thing pledged with the diligence of a good father of a family, he has the duty to collect if delay would endanger the recovery of the credit.

Art. 2119. If two or more things are pledged, the pledgee may choose which he will cause to be sold, unless there is a stipulation to the contrary. He may demand the sale of only as many of the things as are necessary for the payment of the debt. (n)

Right of pledgee to choose which of several things pledged shall be sold General rule: The pledgee can choose which of the things pledged he

shall cause to be sold. Exception: When there is a contrary stipulation After sufficient property has been sold to satisfy the obligation plus

interests and expenses, no more shall be sold. Usually the value of the property pledged exceeds the amount of the

debt guaranteed.

Art. 2120. If a third party secures an obligation by pledging his own movable property under the provisions of Article 2085 he shall have the same rights as a guarantor under Articles 2066 to 2070, and Articles 2077 to 2081. He is not prejudiced by any waiver of defense by the principal obligor. (n)

Right of third person who pledged his own property


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The law grants the third person who pledged his own property the same rights as a guarantor (see Arts 2066-2070, 2077-2081), and he cannot be prejudiced by any waiver of defense by the principal debtor.

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

Art. 2122. A thing under a pledge by operation of law may be sold only after demand of the amount for which the thing is retained. The public auction shall take place within one month after such demand. If, without just grounds, the creditor does not cause the public sale to be held within such period, the debtor may require the return of the thing. (n)

Instances of pledge by operation of law1. Right of retention by the possessor in good faith (Art 546)2. Right of retention by the worker upon a movable (Art 1731)3. Right of retention by the agent of things of the agency until paid

reimbursement (Art 1914)4. Right of laborers to lien on the goods manufactured for wages (Art

1707)5. Depositary (Art 1994)6. Legal pledge of a hotelkeeper (Art 2004)

Rules in cases of pledge by operation of law What are the provisions applicable to pledges created by operation of

law? They are the provisions on:1. Possession (Art 2098)2. Care (Art 2099)3. Sale of the thing pledged (Art 2112)4. Extinguishment of the thing pledged (Art 2110, 2111)

In legal pledge, there is no definite period for the payment of the principal obligation. The pledgee must, therefore, make a demand for the payment of the amount due him. Without such demand, he cannot exercise the right of sale at public auction.

The pledgee must proceed with the sale within one month after demand, otherwise, the debtor may require him to return the thing retained.

Art. 2123. With regard to pawnshops and other establishments, which are engaged in making loans secured by pledges, the special laws and regulations concerning them shall be observed, and subsidiarily, the provisions of this Title. (1873a)

Meh.

Let’s summarize this!

What are the obligations of the pledgee?1. To take care of the thing with the diligence (Art 2099)2. To not deposit it with a third person, unless stipulated (Art 2100)3. To not use the thing pledged (Art 2104)4. To make an acquittance for his entire claim when it is sold at a public

sale (Art 2112)5. To advise pledgor or owner of result of sale (Art 2116)

What are the rights of the pledgee?1. Retain the thing pledged until paid the debt and expenses (Art 2098)2. Compensate earnings of pledge with interest (if owing) and debt (Art

2102)3. Bring actions against third persons to recover the pledge (Art 2103)4. Cause sale of thing pledged when it is in danger of destruction, etc

when he is not at fault (Art 2018)5. Cause sale of thing pledged when the debt has not been satisfied in due

time (Art 2012)6. Appropriate the thing pledged when it has yet to be sold after two

auctions (Art 2012)7. Demand substitute or immediate payment when he is deceived (Art

2109)8. Bid at a public sale, provided he is not the sole bidder (Art 2113)9. Collect and receive amount due on credit pledged (Art 2118)10. Choose which of several things pledged shall be sold (Art 2119)

What are the rights of the pledgor?1. To alienate the thing pledged, subject to the rights of the pledgee (Art

2097)2. Ask that the thing be deposited when the creditor uses the thing without

authority or if he misuses the thing in any other way (Art 2104)


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3. Ask that the thing be deposited when it is in danger of being lost or impaired by the fault of the pledgee (Art 2106)

4. Substitute thing pledged when there’s reasonable ground to fear the destruction or impairment of the thing without the fault of the pledgee, provided the pledgee doesn’t want to sell it (Art 2107)

5. Bid at a public sale (Art 2113)6. To the excess in a public sale, provided there was a stipulation to that

effect (Art 2115)7. To demand the thing once the principal obligation or the pledge is

extinguished (implied from Art 2105)

VII REAL MORTGAGE

CHAPTER 3MORTGAGE 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. (1874a)

What’s mortgage? Mortgage is a contract whereby the debtor secures to the creditor the

fulfillment of a principal obligation,o specially subjecting to such security immovable property or real

rights over immovable propertyo which obligation shall be satisfied with the proceeds of the sale

of said property or rights in case the obligation is not complied with at the time stipulated.

Characteristics of mortgage1. Real2. Accessory3. Subsidiary4. Unilateral (only on the creditor who must free the property from

encumbrance once the obligation is fulfilled)

Who has possession of the property mortgaged? Generally, the mortgagor-debtor retains possession of the property

mortgaged as security for the payment of the sum borrowed from the mortgagee-creditor. Why?

o Because the debtor merely subjects the property to a lien but ownership thereof is not parted with.

o As this is the case, it follows that one’s status as a mortgagee cannot be the basis of ownership.

It is not, however, an essential requisite of the contract of mortgage that the property mortgaged remains in the possession of the mortgagor. Hence, the mortgagor may deliver said property to the mortgagee, without altering the nature of the contract.

Is payment of interest on mortgage credit essential? No, it is not an essential requisite of the contract of mortgage that the

principal of the mortgage credit bears interest, or that the interest as compensation for the use of the principal and enjoyment of its fruits be in the form of a certain percent thereof.

The interest may be in the form of fruits of the mortgaged property, without the contract’s losing thereby its character of a mortgage credit.

o In such case, the mortgagee shall be subject to the obligation of an antichresis creditor.

But if it is expressly agreed that the creditor shall apply the fruits of the property, “to the payment of interest, if owing, and thereafter to the principal of his credit”, the contract is a true antichresis as defined in Art 2132.

Cause or consideration in mortgage As it is an accessory contract, its consideration is the same as of the

principal contact from which it receives its life, and without which it cannot exist as an independent contract, although the obligation secured is incurred by a third person.

Being an accessory contract, its validity would depend on the validity of the loan secured by it.

Kinds of mortgage1. Voluntary – one agreed to between the parties or by the will of the

owner of the property on which it is created


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2. Legal – one required by law to be executed in favor of certain persons (Art 2125, 2082, 2083)

3. Equitable – one which, although it lacks the proper formalities of a mortgage required by law, nevertheless shows the intention of the parties to burden the property as a security for a debt (See Art 1602)

What’s the subject matter of a mortgage?1. Immovables, and2. Alienable real rights imposed upon immovables.

Future property cannot be object of mortgage Future property cannot be object of a contract of mortgage. However, a stipulation subjecting to the mortgage lien, properties

(improvements) which the mortgagor may subsequently acquire, install, or use in connection with real property already mortgaged belong to the mortgagor is valid. (see Art 2127 to know more on after-acquired properties)

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

The persons in whose favor the law establishes a mortgage have no other right than to demand the execution and the recording of the document in which the mortgage is formalized. (1875a)

Essential requisites of mortgage6. Constituted to secure fulfillment of a principal obligation7. Constituted by the absolute owner of the thing pledged or mortgaged, or

at least by the pledgor or mortgagor with the authority or consent of the owner of the property pledged or mortgaged

8. Pledgor or mortgagor has free disposal of property or has legal authority9. Thing pledged or mortgaged may be alienated10. Must appear in a public document duly recorded in the Registry of

Property

No valid mortgage is constituted where the alleged deed of mortgage is a mere private document, and therefore, is not registered.

The creditor may recover the loan, although the mortgage document evidencing the loan was non-registrable being a purely private

document. He has the right to compel the debtor to execute a contract of mortgage in a public document.

But keep in mind that registration only operates as a notice of the mortgage to others but neither adds to its validity nor converts an invalid mortgage into a valid one between the parties.

Remember that if the instrument is not recorded, the mortgage is nevertheless binding between the parties.

o Hence, an order for foreclosure cannot be refused on the ground that the mortgage has not been registered provided no innocent third parties are involved.

Legal mortgages The second paragraph refers to legal mortgages. It is in conformity with the rule established which gives to the contracting

parties the right to compel each other to observe the form required by law like the execution of a document or other special forms provided the contract between them is valid and enforceable.

Registration of mortgage The mortgagee is entitled to registration of mortgage as a matter of

right.o Once a mortgage has been signed in due form, the mortgagee

is entitled to its registration as a matter of right.o By executing the mortgage, the mortgagor is understood to

have given his consent to its registration, and he cannot be permitted to revoke it unilaterally.

The proceedings for registration do not determine the validity of mortgage or its effect

o Registration is a mere ministerial act by which a deed, contract or instrument is sought to be inscribed in the records of the Office of the RD and annotated at the back of the certificate of title covering the land.

o The mere fact that a mortgage was registered does not stop any party to it from setting up that is has no force and effect and ask for the avoidance of the deed and the cancellation of its registration

Registration without prejudice to better right of third partieso A registered mortgage right over property previously sold is

inferior to the buyer’s unregistered right.


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o A registered mortgage, however, is superior to a contract to sell, subject to any liabilities the owner may have incurred in favor of the buyer.

Effect of invalidity of mortgage on principal obligation Where a mortgage is not valid (like when it is executed by one who is

not the owner of the property, or the consideration of the contract is simulated or false), the principal obligation which it guarantees is not rendered null and void.

o What is lost only is the right to foreclose the mortgage as a special remedy for satisfying or settling the indebtedness which is the principal obligation.

In case of nullity, the mortgage deed remains as evidence or proof of a personal obligation of the debtor and the amount due to the creditor may be enforced in an ordinary personal action.

What is the doctrine of the mortgagee in good faith? See page 26 of this reviewer.

Art. 2126. The mortgage directly and immediately subjects the property upon which it is imposed, whoever the possessor may be, to the fulfillment of the obligation for whose security it was constituted. (1876)

What are the effects of mortgage?It creates a real right A registered mortgage creates right in rem, a real right, a lien

inseparable from the property mortgaged, which is enforceable against the whole world, affording specific security for the satisfaction of the debt.

The personality of the owner is disregarded. Until discharged upon payment of the obligation, it follows the property where it goes and subsists notwithstanding changes of ownership.

So, if the mortgagor sells the mortgaged property, the property remains subject to the fulfillment of the obligation secured by it.

o All subsequent purchasers of the property must respect the mortgage, whether the transfer to them be with or without the consent of the mortgagee.

But the mortgage must be registered, or if not registered, the buyer must know of its existence, his

knowledge of the prior unregistered mortgage having the object of registration as to him.

The mortgagee has a right to rely in good faith on what appears on the certificate of title of the mortgagor to the property given as security and in the absence of anything to excite suspicion, he is under no obligation to look behind the certificate and investigate the title of the mortgagor appearing on the face of the certificate.

o Accordingly, the right or lien of an innocent mortgagee for value upon the mortgaged property must be respected and protected, even if the mortgagor obtained his title through fraud.

o The remedy here is to bring an action for damages against the person who caused the fraud, and if the latter is insolvent, an action against the Treasurer of the Philippines may be filed for the recovery of damages against the Assurance Fund.

While an innocent mortgagee is not expected to conduct an exhaustive investigation on the history of the mortgagor’s title, in the case of banks, a mortgagee must exercise due diligence before entering into said contract.

o Judicial notice is taken of the standard practice for banks, before approving a loan, to send representatives to the premises of the land offered as collateral and to investigate who the real owner thereof.

o Banks and persons regularly engaged in the business of lending money secured by real estate mortgages are expected to exercise greater care and prudence in its dealings, including those involving registered lands.

If a person is the first mortgagee over a property which was sold in a public auction sale by the second mortgagee, the only right left to him is to collect his mortgage credit from the purchaser thereof during the sale conducted.

In a suit to nullify an existing Torrens title in which a real estate mortgage is annotated, the mortgagee is an indispensable party.

It creates merely an encumbrance. A mortgage does not involve a transfer, cession or conveyance of

property but only constitutes a lien thereon. It gives the mortgagee no right or claim to the possession of the

property, and therefore, a mere mortgagee has no right to eject an occupant of the property mortgaged. (kapal mo boy!)


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A mortgage does not give a mortgagee a right to the possession of the property unless the mortgage should contain some provision to that effect.

It is merely a security for a debt, an encumbrance upon the property, and does not extinguish the title of the debtor who does not lose his principal attribute as owner, that is, the right to dispose.

In fact, the law considers void any stipulation forbidding the owner from alienating immovable property.

Actually, what is delimited is not the mortgagor’s jus disponendi, as an attribute of ownership, but merely the rights conferred by such act of disposal which may correspondingly be restricted.

o The only right of a mortgagee in case of non-payment of a debt secured by mortgage would be to foreclose the mortgage and have the encumbered property sold to satisfy the outstanding indebtedness.

o The mortgagor’s default does not opertate to vest in the mortgagee the ownership of the encumbered property. His failure to redeem the property does not automatically vest ownership of the property to the mortgagee which would grant the latter the right to appropriate the property or dispose of it for such effect is against public policy which prohibits pactum commissorium.

o Since the mortgagor remains the absolute owner of the property during the redemption period and has the free disposal of his property, there would be compliance with Article 2085 of the Civil Code for the constitution of another mortgage of the property.

o By mortgaging his property, a debtor merely subjects it to lien, but ownership thereof is not parted with.

o Upon payment of the mortgage debt, there is no more mortgage, and therefore, there is no more basis or reason for the mortgagee’s refusal to return the certificate of title to the mortgagor.

Art. 2127. The mortgage extends to the natural accessions, to the improvements, growing fruits, and the rents or income not yet received when the obligation becomes due, and to the amount of the indemnity granted or owing to the proprietor from the insurers of the property mortgaged, or in virtue of expropriation for public use, with the declarations, amplifications and limitations established by law, whether the estate remains in the possession of the mortgagor, or it passes into the hands of a third person. (1877)

Extent of the mortgage A real estate mortgage constituted on immovable property is not limited

to the property itself but also extends to all: (AIGRiPE)1. Its accessions, 2. Improvements,3. Growing fruits,4. Rents or income,5. Proceeds of insurance should the property be destroyed6. Expropriation value of the property should it be expropriated.

To exclude them, it is necessary that there be an express stipulation to that effect.

Stipulation in mortgage contract including after-acquired properties This kind of stipulation is common and indeed, logical, in all cases

where the properties given as collateral are perishable or subject to inevitable wear and tear or were intended to be sold or to be used but with the understanding, express or implied that they shall be replaced with others to be thereafter acquired by the mortgagor.

Its obvious purpose being to maintain, to the extent allowed by the circumstances, the original value of the properties given as security.

When a mortgage is made to include new or future improvements on registered land, said lien attaches and vests not at the time said improvements are constructed but on the date of the recording and registration of the deed of mortgage.

o Example: “all property of every nature and description taken in exchange or replacement, as well as all buildings, machineries, fixtures, tools, equipments and others that the mortgagor may acquire, construct, install, attach, or use in its lumber concession shall immediately be and become subject to the lien of this mortgage in the same manner and to the extent as if not included therein.”

Mortgage to secure future advancements There must be a stipulation to secure future advancements. As a general rule, an action to foreclose a mortgage must be limited to

the amount mentioned in the mortgage.o But the amounts named as consideration in a contract of

mortgage do not limit the amount for which the mortgaged may stand as security, if from the four corners of the instrument the


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intent to secure future loans or advancements and other indebtedness can be gathered.

o Example: “for the payment of loan of P20,000 and such other loans or other advances already obtained or still to be obtained by the mortgagors as makers.” Or “as well as those that the mortgagee may extend to the mortgagor.”

A blanket or dragnet mortgage clause is one which is specifically phrased to subsume all debts of past or future origin. They are to be strictly construed particularly where the mortgage contract is one of adhesion.

A mortgage must sufficiently describe the debt sought to be secured, and an obligation is not secured by a mortgage unless it comes fairly within the terms of the mortgage.

o Where the plain terms of the mortgage evidence the intention of the mortgagor to secure a larger amount, the action to foreclose may be for the larger amount.

Mortgage with a dragnet clause enable the parties to provide continuous dealings, the nature or extent of which may not be known at that time, and they avoid the expense and inconvenience of executing a new security on each new transaction. A dragnet clause operates as a convenience and accommodation to the borrower.

What do you mean by a mortgage as a continuing security? A mortgage given to secure future advancements is a continuing

security and is not discharged by the repayment of the amount named in the mortgage, until the full amount of the advancements are paid.

Where the annotation on the back of a certificate of tile about a first mortgage states “that the mortgage secured the payment of a certain sum of money plus interest plus other obligations arising thereunder,” there was no necessity for any notation of the later loans on the mortgagor’s title.

o It was incumbent upon any subsequent mortgagee or encumbrance of the property in question to examine the books and records of the bank, as first mortgagee regarding the credit standing of the debtor.

Art. 2128. The mortgage credit may be alienated or assigned to a third person, in whole or in part, with the formalities required by law. (1878)

Alienation or assignment of mortgage credit

The mortgage credit (the right of the mortgagee) is a real right and directly and immediately subjects the mortgaged property to the fulfillment of the principal obligation.

Such real right may be alienated or assigned to a third person, in whole or in part, by the mortgagee who is the owner of said right and the assignee may foreclose the mortgage in case of nonpayment of the mortgage indebtedness.

The alienation or assignment is valid even if it is not registered. Registration is necessary only to affect third pesons.

There is no need to obtain the consent of the debtor/mortgagor.

Art. 2129. The creditor may claim from a third person in possession of the mortgaged property, the payment of the part of the credit secured by the property which said third person possesses, in the terms and with the formalities which the law establishes. (1879)

Right of creditor against transferee of mortgaged property The fact that the mortgagor has transferred the mortgaged property to a

third person does not relieve him from his obligation to pay the debt to the mortgage creditor in the absence of novation.

The mortgage on the property may still be foreclosed despite the transfer.

A recorded real estate mortgage is merely an accessory contract. It is inseparable from the property subject thereto regardless of who its owner may subsequently be.

The mortgage credit being a real right which follows the property, the creditor may demand from any possessor the payment only of the part of the credit secured by said property. It is necessary, however, that prior demand for payment must have been made on the debtor and the latter failed to pay.

Draco mortgaged his land worth P500 in favor of Harry to secure Draco’s debt of P600. Draco then sold his land to Hermione.

In this case, the obligation of Draco to pay the debt is not affected by the transfer. On the due date of the obligation, Harry may demand payment from Draco and if Draco fails to pay, Harry may foreclose the mortgage. Harry has the right to claim from Ron the payment of P500 which is part of the credit secured by the property sold to Ron.

Ron is not liable for any deficiency in the absence of a contrary stipulation. “The spirit of the law is to let the obligation of the debtor to pay


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the debt to stand although the property mortgaged to secure the payment of said debt may have been transferred to a third person.”

The remedy of Ron is to proceed against Draco.

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

What about stipulations forbidding alienation of mortgaged property? They are void. Read this with Article 2126, which allows the mortgagor to alienate the

property.

What about stipulations granting rights of first refusal? There is nothing wrong in a stipulation granting the mortgagee the right

of first refusal over the mortgaged property in the event the mortgagor decides to sell the same.

The consideration for the loan-mortgage may be said to include the consideration for the right of first refusal.

Thus, while the mortgagor has every right to sell the mortgaged property without securing the consent of the mortgagee, he has the obligation under a right of first refusal provision which is perfectly valid, to notify the mortgagee of his intention to sell the property and give him priority over other buyers.

o A sale made in violation of the mortgagee’s contractual right of first refusal is rescissible.

o The buyer is presumed to have been notified thereof by the registration of the mortgage deed containing such stipulation, which equates to notice to the whole world.

Art. 2131. The form, extent and consequences of a mortgage, both as to its constitution, modification and extinguishment, and as to other matters not included in this Chapter, shall be governed by the provisions of the Mortgage Law and of the Land Registration Law. (1880a)

What does foreclosure of mortgage mean ba ? Foreclosure is the remedy available to the mortgagee by which he

subjects the mortgaged property to the satisfaction of the obligation to secure which the mortgage was given

It presupposes something more than a mere demand to surrender possession of the object of the mortgage.

It denotes the procedure adopted by the mortgagee to terminate the rights of the mortgagor on the property and includes the sale itself

Validity and effect of foreclosure Foreclosure is but a necessary consequence of non-payment of a

mortgage indebtedness. The mortgage can be foreclosed only when the debt remains unpaid at the time it is due.

In a real estate mortgage, when the principal obligation is not paid when due, the mortgagee has the right to foreclose the mortgage and to have the property seized and sold with a view to applying the proceeds to the payment of the principal obligation.

o Foreclosure is valid where the debtor is in default in the payment of his obligation.

o It must be limited to the amount mentioned in the mortgage document.

If there is an acceleration clause, the failure of the mortgagor to pay any installment will trigger the activation of the acceleration clause and give the mortgagee the right to foreclose the mortgage against the convention of prematurity.

Once the proceeds have been applied to the payment of the obligation, the debtor cannot anymore be required to pay, unless there is a deficiency between the amount of the loan and the foreclosure sale price.

The only rights which a mortgagor can legally transfer, cede and convey after the foreclosure of his property are the right to redeem the same and the possession, use, and enjoyment of the same during the period of redemption.

Kinds of foreclosure Foreclosure may either be judicially or extrajudicially, that is, by ordinary

action or by foreclosure under power of sale contained in the mortgage. These two types are to be distinguished from an ordinary execution sale

(governed by Rule 39, RoCourt) Each of these 3 common types of forced sales arising from a failure to

pay a mortgage debt, peculiarly has its own requirements.

Judicial foreclosure under the Rules of Court (Rule 68): Steps and Application of Proceeds


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1. A mortgage may be foreclosed judicially by bringing an action for that purpose, in the proper court which has jurisdiction over the area wherein the real property is situated. (Judicial action for the purpose)

2. The court shall order the mortgagor to pay the amount due upon the mortgage debt with interest and other charges within a period of not less than 90 days nor more than 120 days from the entry of judgment. (Order to mortgagor to pay mortgage debt)

3. If the mortgagor fails to pay at the time directed in the order, the court, upon motion, shall order the property to be sold to the highest bidder at public auction. (Sale to highest bidder at public auction)

4. The sale when confirmed by an order of the court, also upon motion, shall operate to divest the rights of all parties to the action and to vest their rights in the purchaser subject to such right of redemption as may be allowed by law. (Confirmation of sale) Before the confirmation of a judicial foreclosure sale, the court

retains control of the proceedings by exercising a sound discretion in regard to it.

5. No judgment rendered in an action for foreclosure or mortgage can be executed otherwise than in the manner prescribed by the law on mortgages. (execution of judgment) The proper remedy to seek reversal is an appeal from the judgment

itself or from the order confirming the sale of the foreclosed real estate. (and not a petition for annulment of judgment)

6. The proceeds of the sale shall be applied to the payment of the:a. Costs of the sale;b. The amount due the mortgagee;c. Claims of junior encumbrancers or persons holding subsequent

mortgages in the order of their priority, andd. The balance if any shall be paid to the mortgagor or his duly

authorized agent or to the person entitled to it. (If the mortgagee retains it, the mortgagor has a cause of action to recover such surplus)

7. In judicial foreclosures, the “foreclosure” is not complete until the sheriff’s certificate is executed, acknowledged and recorded. Without a Certificate of Sale, no title passes by the foreclosure proceedings to the vendee. It is only when the foreclosure proceedings are completed ant he mortgaged property sold to the purchaser that all interests of the mortgagor are cut off from the property. (Execution of certificate)

Extrajudicial foreclosure under Act 3135 The law covers only real estate mortgages.

A mortgage may be foreclosed extrajudicially where there is inserted in the contract a clause giving the mortgagee the power upon default of the debtor, to foreclose the mortgage by an extrajudicial sale of the mortgaged property.

The authority to sell is not extinguished by the death of the mortgagor (or mortgagee).

The sale, which cannot be made legally outside of the province in which the property is situated, shall be made at public auction, after the giving of proper notice (posting of notice in 3 public places and publication in a newspaper in said city or municipality).

Failure to comply with the statutory requirements as to publication of notice of auction sale constitutes a jurisdictional defect which invalidates the sale or at least renders the sale voidable. A sale held after the scheduled date indicated in the notice of sale is void.

Certificate of posting not required. What the law requires is the posting of the notice, not the execution of the certificate of posting.

Personal notice to the mortgagor is not generally required. Unless required in the mortgage contract, the lack of personal notice to

the mortgagor is not a ground to set aside a foreclosure sale.

What happens to surplus money in extrajudicial foreclosure? They are constructively real property and belong to the mortgagor or his

assigns. Surplus money, in case of foreclosure sale, gains significance when

there are junior encumbrancers on the mortgaged property. When there are several liens upon the property, the surplus money must be applied to their discharge in the order of their priority.

The lien of the junior mortgagee on the property, after satisfying any prior mortgage, is transferred to the surplus fund.

Let’s talk about the right of redemption in extrajudicial foreclosure. (ok!) The debtor (natural person) has the right to redeem the property sold

within the term of one year from and after the date of the sale. The reckoning date in cases of sale of registered land is from the

registration of the certificate of sale since it is only from the date that the sale takes effect as a conveyance.

In the case of juridical persons, they have the right to redeem the property until, but not after the registration of the certificate of foreclosure sale which in no case shall be more than 3 months after foreclosure, whichever is earlier.


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Procedure in extrajudicial foreclosure sales1. All applications shall be filed with the Executive Judge, through the

Clerk of Court.2. Upon receipt of an application, it shall be duty of the Clerk of Court to:

a. Receive and docket said application and to stamp thereon the corresponding file number, date and time of filing;

b. Collect the filing fees, and issue the official receiptc. Examine whether the application has complied with all the

requirements of Sec 4, Act 3135 before the public auction is conducted

d. Sign and issue the certificate of sale, approved by the Executive Judge or the Vice-Executive Judge. No certificate of sale shall be issued in favor of the highest bidder until all fees provided for shall have been paid.

e. After the certificate of sale has been issued to the highest bidder, keep the complete records, while awaiting any redemption within 1 year from the date of registration of the certificate of sale with the RD concerned, after which the records shall be archived. (Different for juridical persons)

3. The notices of auction sale in extrajudicial foreclosure for publication of the sheriff or by a notary shall be published in a newspaper of general circulation.

4. The Executive Judge shall raffle applications for extrajudicial foreclosure of mortgage under the direction of the sheriff among all sheriffs.

5. The names of the bides shall be reported by the sheriff or the notary public who conducted the sale before the issuance of the certificate of sale.

Right of mortgagee to recover deficiency If there be a balance due to the mortgagee after applying the proceeds

of the sale, the mortgagee is entitled to recover the deficiency. In judicial foreclosure, the Rules of Court specifically gives the

mortgagee the right to claim for deficiency. While in extrajudicial foreclosure, Act 3135 is silent on the matter. In both judicial and extrajudicial foreclosures, the principle is the same –

that the mortgage is but a security and not a satisfaction of the indebtedness.

Where a third person is the mortgagor, he is not liable for any deficiency in the absence of a contrary stipulation. The action for the recovery must be directed against the debtor.

The action to recover a deficiency after foreclosure prescribes in 10 years from the time the right of action accrues.

Stipulation of upset price in mortgage contract void A stipulation in a mortgage of real property fixing an upset price (tipo), ie

the minimum price at which the property shall be sold, to become operative in the event of a foreclosure sale at public auction, is null and void for the property must be sold to the highest bidder.

Effect of inadequacy of price in foreclosure sale General rule: Where there is a right to redeem, inadequacy of price is

not material because the judgment of debtor may reacquire the property or else sell his right to redeem and thus recover any loss he claims to have suffered by reason of the price obtained at the auction sale.

Mere inadequacy of the price obtained at the sheriff’s sale will nto be sufficient to set aside the sale unless the price is so inadequate as to shock the conscience of the court.

The value of the mortgaged property has no bearing on the bid price at the public auction, provided that the pubic auction was regularly and honestly conducted.

Waiver of security by creditor The mortgagee ay waive the right to foreclose his mortgage and

maintain a personal action for recovery of the indebtedness. He is entitled to obtain a deficiency judgment for whatever sum might be due after the liquidation of the property covered by the mortgage.

The mortgagee cannot have both remedies. He has only one cause of action; hence, he cannot split up his cause of action but filing a complaint for payment of the debt, and another complaint for foreclosure.

The secured creditor hold a real estate mortgage has 3 distinct, independent and mutually exclusive remedies that can be pursued by him in case the mortgagor dies:1. To waive the mortgage and claim the entire debt from the estate of

the mortgagor as an ordinary claim;2. To foreclose the mortgage judicially and prove any deficiency as an

ordinary claim3. To rely on the mortgage exclusively, foreclosing the same at any

time before it is barred by prescription without any right to file a claim for any deficiency.


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o This includes extrajudicial foreclosure which bars any subsequent deficiency against the estate of the deceased

Foreclosure retroacts to date of registration of mortgage A foreclosure sale retroacts to the date of the registration of the mortgge

and that a person who takes a mortgage in good faith and for value, the record showing clear title to the mortgagor, will be protected against equitable claims on the title in favor of third persons of which he had no actual or constructive notice

A notice of adverse claim annotated after the registration of the mortgage but before the foreclosure cannot affect the rights of the mortgagee.

Redemption of foreclosed property Redemption may be defined as a transaction by which the mortgagor

reacquires or buys back the property which may have passed under the mortgage or divests the property of the lien which the mortgage may have created.

It is allowed in cases of foreclosures in favor of banking and credit institutions and in extradjudicial foreclosures.

Kinds of redemption1. Equity of redemption or the right of the mortgagor in case of judicial

foreclosure to redeem the mortgaged property after his default in the performance of the conditions of the mortgage but before the confirmation of the sale of the mortgaged property.

2. Right of redemption or the right of the mortgagor in case of extrajudicial foreclosure to redeem the mortgaged property within a certain period after it was sold for the satisfaction of the mortgage debt.

Equity of redemption In judicial foreclosure, the mortgagor may exercise his equity of

redemption before but not after the sale is confirmed by the court. It is simply the right of the defendant mortgagor to extinguish the mortgage and retain ownership of the property by paying the secured debt within the 90-day period after the judgment become final in accordance with Rule 68, or even after the foreclosure sale but prior to its confirmation.

Where the foreclosure is judicially effected, no equivalent right of redemption exists.

In judicial foreclosure of real estate mortgage, the general rule is that the mortgagor cannot exercise his right of redemption after the sale is confirmed.

Confirmation of the sale of mortgaged real property cuts off all the rights or interests of the mortgagor and of the mortgagee, and with them the equity of redemption in the property and vests them in the purchaser.

o However, if the property has been mortgaged in favor of the PNBank, redemption is allowed within one year from the confirmation of the sale.

A second mortgagee acquires only the equity of redemption vested in the mortgagor, and his rights are strictly subordinate to the superior lien of the first mortgagee.

The subsequent sale by the purchaser to a third person of the mortgaged property does not prevent the court from granting the mortgagor a period within which to redeem the property by paying the judgment debt and the expenses of the sale and costs.

Notice and hearing of a motion for confirmation of sale are essential to the validity of the order of confirmation. An order of confirmation, void for lack of notice and hearing, may be set aside anytime and the mortgagor may still redeem the mortgaged property.

Right of redemption In all cases of extrajudicial sale, the mortgagor may redeem the property

at any time within the term of one year from and after the date of registration of the certificate of sale with the appropriate Registry of deeds

Redemption being optional and not compulsory, a formal offer to redeem, accompanied by a bona fide tender of the redemption price within the prescribed period of redemption is only essential to preserve the right of redemption for future enforcement even beyond such period.

o In sum, what constitutes a condition precedent is either a formal offer to redeem or the filing of an action in court together with consignation of the redemption price within the reglementary period.

RA 8791 limits the redemption period of juridical mortgagors to only 3 months, to begin from the date of the foreclosure sale but not after the registration of the certificate of foreclosure sale which ever comes first.

Periods of redemption

Judicial Foreclosure Extrajudicial Foreclosure


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Mortgagee banks non-banks

banks non-banks

Individual debtors/mortgagors

1 year from registration of sale

X 1 year from registration of sale


Juridical persons as debtors/mortgagors


X Until registration of certificate of sale or 3 months from sale whichever is earlier


A sale by the mortgagor to a third party of the mortgaged property during the period of redemption transfers only the right to redeem the property and the right to possess, use and enjoy the same during the said period. The judgment debtor remains in possession of the property foreclosed and sold, during the period of redemption, but he cannot make a conveyance of the ownership of the property as said ownership belongs to the purchaser at the foreclosure sale.

Requisites for valid redemption1. Redemption must be made within the reglementary period.2. Payment of the purchase price plus 1% interest/month with taxes paid

by the purchaser and the amount of his prior lien, with the same rate of interest computed from the date of registration of the sale up to the time of redemption

3. Written notice of the redemption must be served on the officer who made the sale and a duplicate filed with the RD

4. In judicial foreclosure, the general rule is that the mortgagor of real estate can no longer exercise his right of redemption after the sale is confirmed by the court (exception: mortgagee is a bank)

5. Tender of payment must be for the full amount of the purchase price.

Allowing a redemption after the lapse of the statutory period, when the buyer at the foreclosure sale does not object but even consents to the redemption, will uphold the policy of the law which is to aid rather than defeat the right of redemption. There is nothing in the law which prevents a waiver of the statutory period for redemption.

Junior mortgagees After the foreclosure sale, there remains in the second mortgagee a

mere right of redemption. His remedy is limited to the right to redeem by paying off the debt secured by the first mortgage.

o The second mortgagee is entitled to the payment of his credit the excess of the proceeds of the auction sale, after covering the mortgagor’s obligations to the first mortgagee.

o In case the credit of the first mortgagee has absorbed the entire proceeds of the sale, the second mortgagee is extinguished with it because said mortgage cannot be enforced by the second mortgagee beyond the total value of the mortgaged property. The property passes to the purchaser free from the second mortgage.

CHAPTER FOURANTICHRESIS Art. 2132. By the contract of antichresis the creditor acquires the right to receive the fruits of an immovable of his debtor, with the obligation to apply them to the payment of the interest, if owing, and thereafter to the principal of his credit. (1881)

Define for me please the contract of antichresis Antichresis is a contract whereby the creditor acquires the right to

receive the fruits of an immovable of his debtor, with the obligation to apply them to the payment of the interest, if owning, and thereafter to the principal of his credit.

What are the characteristics of the contract?1. Accessory contract2. Formal because it must be in a specified form to be valid

De Leon points to Article 2134 which states it is the amount of the principal and of the interest which must be in writing, otherwise the contract of antichresis shall be void

However, he also states in page 454, that antichresis is perfected by mere consent and is a consensual contract

Delivery of property Antichresis requires the delivery by the debtor of the property given as

security to the creditor. But such delivery is required only in order that


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the creditor may receive the fruits and not that the contract shall be binding.

o In fact, it is permissible that the land will still be in the possession of the debtor, with a stipulation th

The contract does not cover the immovable but only its fruits. Keep in mind that the mere turnover of the property to pay the obligation

does not necessarily mean antichresis, it must be so stipulated. (It might be a dacion en pago or a different contract.)

Right of creditor to the fruits Antichresis normally covers all the fruits of the encumbered property,

but the law gives the parties the freedom to stipulate otherwise. The reduction of fruits available to the creditor does not vary the nature

of the contract. So, stipulating that the creditor will receive only ½ of the total fruits is

totally fine.

Obligation to pay interest not essential The obligation to pay interest is not of the essence of the contract of

antichresis, any more than it is indispensable in a contract of loan. The words “if owing” reveal that it is not essential that the loan should

earn interest in order that it can be guaranteed with a contract of antichresis.

Antichresis PledgeReal property Personal propertyPerfected by mere consent Perfected by the delivery of the thing

pledgedConsensual contract Real contract Both are similar in that the debtor loses control of the subject matter of

the contract

Antichresis Real MortgageProperty is delivered to the creditor (but Atty Lerma says it doesn’t always have to be delivered)

Debtor usually retains possession of the property

Creditor acquires only the right to receive the fruits of the property, hence it does not produce a real right

Creditor does not have any right to receive the fruits, but it creates a real right over the property which is enforceable against the whole world

Creditor is obliged to pay the taxes Creditor has no such obligation

and charges upon the estate, unless there is a contrary stipulationCreditor to apply the fruits to the payment of interest, if owing, and thereafter to the principal of the credit

No such obligation

Both are similar in that the subject matter is real property. Like pledge and mortgage, antichresis gives a real and not merely a personal right if it is registered in the Registry of Property

Application of the fruits to interest and then to principal It is not an essential requisite to a mortgage that possession of

mortgaged premises be retained by the mortgagor To be antichresis, it must expressly agreed between creditors and

debtor that the former, having been given possession of the properties given as security, is to apply their fruits to the payment of interest, if owing, and thereafter to the principal of his credit (but again, Atty Lerma said that it is not necessary that the possession of the property be given to the creditor)

o So, if in a contract of loan with security does not stipulate the payment of interest but provides for the delivery to the creditor by the debtor of the real property constituted as security for the payment therefor, in order that the creditor may administer the same and avail himself of its fruits, without stating that said fruits are to be applied to the payment of interest, if any, and afterwards to that of the principal of the credit, the contract shall be considered to be one of mortgage, and not of antichresis.

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

Measure of application of fruits to interest and principal The fruits of the immovable which is the object of the antichresis must

be appraised at their actual market value at the time of the application

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


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Form of the contract This article is an instance when the law requires that a contract be in

some form in order that it may be valid and not only to affect third persons

Even if the antichresis is void, the principal obligation, however, is still valid

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

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

The sums spent for the purposes stated in this article shall be deducted from the fruits. (1882)

What are the obligations of the antichretic creditor?1. Pay the taxes and charges upon the estate

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

Where the debtor ahs paid for the taxes on the property which the creditor should have paid the amount is to be applied to the payment of the debt, and the debtor is entitled to the return of the property free from all encumbrances if he, by advancing the taxes, had already discharged the debt

2. Apply the fruits, after receiving them, to the interest (if owing) and thereafter to the principal The creditor also has the duty to render an account of said fruits to

the debtor, and the corresponding right of the debtor to apply the said fruits to the debt

The sums spent by the creditor in fulfillment of the obligations under the article shall be charged against the fruits of the property

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

But the latter, in order to exempt himself from the obligations imposed upon him by the preceding article, may always compel the debtor to enter again upon the enjoyment of the property, except when there is a stipulation to the contrary. (1883)

Right of antichretic debtor to reacquire enjoyment of property

The property delivered stands as a security for the payment of the obligation of the debtor in antichresis. Hence, the debtor cannot demand its return until the debt is totally paid.

However, if the creditor does not want to pay the taxes and incur the expenses necessary for the preservation and repair of the property, he may compel the debtor to reacquire the enjoyment of the same except when there is a contrary stipulation

This does not terminate the antichresis. The debtor just keeps the property, while the creditor still gets the fruits.

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

Every stipulation to the contrary shall be void. But the creditor may petition the court for the payment of the debt or the sale of the real property. In this case, the Rules of Court on the foreclosure of mortgages shall apply. (1884a)

What is the remedy of the creditor in case of nonpayment of debt? If the debt is not paid, the creditor does not acquire ownership of the

real estate since what was transferred is not the ownership but merely the right to receive its fruits

A stipulation authorizing the antichretic creditor to appropriate the property upon the nonpayment of the debt within the period agreed upon is void

The remedy of the creditor is1. To bring an action for specific performance, or2. To petition for the sale of the real property as in a foreclosure of

mortgages under Rule 68 of the Rules of Court The parties may agree on an extrajudicial foreclosure in the same

manner as they are allowed in contracts of mortgage and pledge

Acquisition by creditor of property by prescription… possible? The creditor in antichresis and his successors-in-interest cannot

ordinarily acquire by prescription the land given to him, any agreement to the contrary being void

The creditor cannot acquire the ownership of the real estate subject of the antichresis unless he repudiates his status as an antichretic creditor

Art. 2138. The contracting parties may stipulate that the interest upon the debt be compensated with the fruits of the property which is the object of the antichresis, provided that if the value of the fruits should


47



exceed the amount of interest allowed by the laws against usury, the excess shall be applied to the principal. (1885a)

Interest in antichresis subject to the Usury Law The antichretic creditor is under obligation to apply the fruits of the

property in satisfaction, first, of whatever interest on the debt is due, and secondly, to the payment of the principal

The fruits must be appraised on the basis of their actual market value at the time of the application.

If their value should exceed the amount of interest allowed by the usury law, the excess shall be applied to the principal.

Art. 2139. The last paragraph of Article 2085, and Articles 2089 to 2091 are applicable to this contract. (1886a)

Third party antichresis is allowed! Indivisibility rule (Article 2089)

CHAPTER 5CHATTEL MORTGAGE Art. 2140. By a chattel mortgage, personal property is recorded in the Chattel Mortgage Register as a security for the performance of an obligation. If the movable, instead of being recorded, is delivered to the creditor or a third person, the contract is a pledge and not a chattel mortgage. (n)

Define chattel mortgage Chattel mortgage is that contract by virtue of which personal property is

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

Characteristics of chattel mortgage1. Accessory (it is to secure performance of a principal obligation) 2. Formal (for it to be valid, it must be registered in the Chattel Mortgage

Register)3. Unilateral (produces only obligations on the part of the creditor to free

the thing from the encumbrance on fulfillment of the obligation)

Chattel Mortgage PledgeDelivery Not necessary Necessary

Registration Required by law in the CM Register

Not necessary

Procedure Sec 14, Act 1508 Article 2112, Civil CodeExcess if foreclosed and sold

Excess over the amount due goes to the debtor

Debtor is not entitled to the excess unless otherwise agreed upon or in a legal pledge

In cases of deficiency

The creditor is entitled to recover the deficiency from the debtor except if the chattel mortgage is a security for the purchase of personal property in installments

Creditor is not entitled to recover the deficiency notwithstanding any stipulation to the contrary

Both are similar in that their subject matter is movable property As in pledge and real mortgage, ownership of the mortgagor is an

essential requirement of a valid chattel mortgage contract

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

What are the laws governing the chattel mortgage?1. Chattel Mortgage Law2. Civil Code3. Revised Administrative Code4. Revised Penal Code

Offenses involving chattel mortgage1. Knowingly removing any personal property mortgaged under the CM

Law to any province or city other than the one in which it was located at the time of the execution of the mortgage without written consent of the mortgagee; and

2. Selling or pledging personal property already mortgaged, or any part thereof, under the terms of the CM Law without the consent of the mortgagee written on the back of the mortgage and duly recorded in the CM Register.

An essential element is that the property removed or repledged should be the same property that was mortgaged or pledged before such removal or pledging.


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The mortgagor is not relieved of criminal liability even if the mortgage indebtedness is thereafter paid in full.

When are the provisions on pledge applicable? The provisions on pledge shall apply to a chattel mortgage only insofar

as they are not in conflict with any provision of the CM Law; otherwise, the provisions of the latter will apply.

The CM Law is silent on the matter of recovering deficiency after the foreclosure sale of the mortgaged chattel.

Subject matter of chattel mortgage The subject matter of chattel mortgage must always be personal or

movable property. However, certain deviations have been allowed for various reasons, like

the following:1. Shares of stock in a corporation2. An interest in business3. Machinery treated by the parties as personal property

o But if the machinery has been treated as real property, being considered “after acquired properties”, then they can not be considered personal property (estopped!)

4. Vessels but it is essential that the mortgage is recorded in the office of the Philippine Coast Guard of the port of documentation

5. Motor vehicles, but the mortgage must also be registered in the LTO

o NB: A mortgage of any motor vehicle in order to affect third persons should not only be registered in the CM Registry, but the same should also be recorded in the LTO as required by Law.

o The failure of the mortgagee to report the mortgage executed in his favor has the effect of making said mortgage ineffective against a purchaser in good faith who registers his purchase of the same vehicle in the LTO

6. House of mixed materials7. House intended to be demolished8. House built on rented land

o Parties to a deed of chattel mortgage may agree to consider a house as personal property for the purpose of said contract, but it is good only insofar as the contracting parties are concerned.

o But the registration of a building of strong materials produces no effect as far as the building is concerned. As a building is an immovable property, it cannot be divested of its character of a realty by the fact that it belongs to another.

o If the status of the building were to depend on the ownership of the land, a situation would be created where a permanent fixture changes its nature as the ownership of the land changes hands.

o As personal properties could only be the subject of a chattel mortgage, the execution of a chattel mortgage on a building is invalid and a nullity, and the registration of the document in the chattel mortgage register is merely a futile act and cannot affect the rights of a subsequent real estate mortgagee of the same property

Mortgage of improvements on land For purposes of the CM Law, both growing crops and large cattle are

personal property and capable of being mortgaged. Although the parties to a contract may treat certain improvements and

crops as chattels, insofar as they are concerned, it is now settled in our jurisdiction that, in general, and so far as the public is concerned, such improvements, if falling under Article 415 of the CC are immovable property.

o As a consequence, a mortgage constituted on said improvements must be susceptible of registration as a real estate mortgage and of annotation on the certificate of title to the land of which they form part, although the land itself may not be subject to said encumbrance.

Subject matter to be described and identified The CM Law does not demand a minute and specific description of

every chattel mortgaged, but only requires that the description of the mortgaged property be such as to enable the parties to the mortgage or any other person to identify the same after a reasonable investigation and inquiry.

In other words, reasonable description.

Extent of chattel mortgage A chattel mortgage shall be deemed to cover only the property

described therein and not like or substituted property thereafter acquired


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by the mortgagor and placed in the same depositary as the property originally mortgaged, anything in the mortgage to the contrary notwithstanding.

The limitation found in this provision makes reference to “like or substituted property thereafter acquired”, not to those already existing and originally included at the date of the constitution of the mortgage.

The above-quoted provision does not apply “to stores open to the public for retail business where the goods are constantly sold and substituted with new stock, such as drugstores, grocery stores, dry good stores, etc.”

A stipulation in the mortgage, extending its scope and effect to after-acquired property is valid and binding, where the after-acquired property is in renewal of, or in substitution for, goods on hand when the mortgage was executed, or is purchased with the proceeds of the sale of such goods, etc.

Chattel mortgage of after-incurred obligations A pledge, real estate mortgage, or antichresis may exceptionally secure

after-incurred obligations so long as these future debts are accurately described.

A chattel mortgage, however, can only cover obligations existing at the time the mortgage is constituted.

Although a promise expressed in a chattel mortgage to include debts that yet to be contracted can be a binding commitment that can be compelled upon, the security itself, however, does not come into existence or arise until after a chattel mortgage agreement covering the newly contracted debt is executed either by concluding a fresh chattel mortgage or by amending the old contract conformably with the form prescribed by the CM Law.

Creation of a chattel mortgage The law as it now stands provides for only one way for executing a valid

chattel mortgage – the registration of the personal property in the Chattel Mortgage Register as security for the performance of an obligation.

Under the CM Law, if the property is situated in a different province from that in which the mortgagor resides, the registration must be in both registers; otherwise, the chattel mortgage is void

It has been ruled that if the chattel mortgage is not recorded, it is nevertheless binding between the parties (which seems contrary to the nature of a chattel mortgage as per 2140)

When should the registration be made? The law does not provide any specific time within which a chattel

mortgage should be recorded in the Chattel Mortgage Register. Just do it asap.

What are the effects of registration?1. Creates real right

The registration is an effective and binding notice to other creditors of its existence and creates a real right or a lien which, being recorded, follows the chattel wherever it goes.

The registration gives the mortgagee symbolical possession. The lien of a chattel mortgagee over the mortgaged property is

superior to the levy made on the same by the assignee of the unsecured judgment creditor of the chattel mortgagor.

2. Adds nothing to mortgage The efficacy of the act of recording a chattel mortgage consists in

the fact that it operates as a constructive notice of the existence of the contract, and the legal effects of the contract must be discovered in the instrument itself in relation with the fact of notice.

Registration adds nothing to the instrument, considered as a source of title and affects nobody’s rights except as a species of notice.

Registration of assignment of mortgage not required It appears that a chattel mortgage credit may be alienated or assigned

to a third person There is no law expressly requiring the recording of the assignment of a

mortgage. While such assignment may be recorded, the law is permissive and not mandatory.

What is the nature of the duty of the Register of Deeds? Ministerial.

What is an affidavit of good faith? The affidavit of good faith is an oath in a contract of chattel mortgage

wherein the parties “severally swear that the mortgage is made for the purpose of securing the obligation specified in the conditions thereof and for no other purposes and that the same is a just and valid obligation and one not entered into for the purpose of fraud.”

The absence of the affidavit vitiates a mortgage only as against third persons without notice like creditors and subsequent encumbrances


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The special affidavit is required only for the purpose of transforming an already valid mortgage into “preferred mortgage.” Thus, it is not necessary for the validity of the chattel mortgage itself but only to give it a preferred status.

It is obvious that the debt referred to in the law is a current, not an obligation that s yet merely contemplated.

A deed of chattel mortgage is void where it provides that the security stated therein “is for the payment of any and all obligations hereinbefore contracted and which may hereafter be contracted by the mortgagor in favor of the mortgagee.”

A mortgage that contains a stipulation in regard to future advances in the credit will take effect only from the date the same are made and nto from the date of the mortgage.

A chattel mortgage can only cover obligations existing at the time the mortgage is constituted. Once said obligations are paid, there can be no foreclosure in new loans concluded after the execution of the chattel mortgage since there is no longer any mortgage.

Right of redemption (before foreclosure)1. When the condition of a chattel mortgage is broken, the following may

redeem:a. The mortgagorb. A person holding a subsequent mortgage, orc. A subsequent attaching creditor.

2. An attaching creditor who so redeems shall be subrogated to the rights of the mortgagee and entitled to foreclose the mortgage in the same manner that the mortgagee could foreclose it.

3. The redemption is made by paying or delivering to the mortgagee the amount due on such mortgage and the costs and expenses incurred by such breach of condition

Right acquired by second mortgagee and subsequent purchaser Before payment of debt

o After a chattel mortgage is executed, there remains in the mortgagor a mere right of redemption and only this right passes to the second mortgagee in case of a second mortgage

o As between the first and second mortgagees, therefore, the latter can only recover the property from the former by paying him the mortgage debt

o Even when the second mortgagee goes through the formality of an extrajudicial foreclosure, the purchaser acquires no more than the right of redemption from the first mortgagee

After payment of debto If the only leviable or attachable interest of a chattel mortgagor

in a mortgaged property is his right of redemption, it follows that the judgment or attaching creditor who purchased the property at the execution sale could not acquire anything except such right of redemption.

o He is not entitled to the actual possession and delivery of the property without first paying the mortgage debt

Right of mortgagee to possession After default

o When default occurs and the creditor desires to foreclose, the right of the creditor to take the mortgaged property is clearly implied from the provision which gives him the right to sell

Before defaulto A chattel mortgagee is not entitled to the possession of the

property upon the execution of the chattel mortgage for otherwise, the contract becomes a pledge and ceases to be a chattel mortgage

Where mortgagor refuses to surrender possessiono Where the debtor refuses to yield the property, the creditor’s

remedy is to institute an action either to effect a judicial foreclosure directly or to secure possession as a preliminary to the sale contemplated in Sec 14, Act 1508

o The creditor cannot lawfully take the property be force against the will of the debtor.

o Nor can the public officer, such as a sheriff, upon whom the law places the responsibility of conducting the sale, seize the property where the creditor could not, as it is manifest that such officer proceeding under the authority of Section 14 becomes the mere agent of the creditor.

o Where the mortgagor plainly refuses to deliver the chattel subject of the mortgage upon his failure to pay two or more installments, or if he conceals the chattel to place it beyond the reach of the mortgagee, the necessary expenses incurred in the prosecution by the mortgagee of the action for replevin so that he can regain possession of the chattel should be borne by the mortgagor.


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Where right of mortgage conceded/disputedo Where the right of the plaintiff to the possession of the specific

property is so conceded or evident, the action need only be maintained against him who so possesses the property

Foreclosure of chattel mortgage After payment of the debt or the performance of the condition specified

in the Chattel Mortgage, the mortgagee must discharge the mortgage in the manner provided by law otherwise, he may be held liable for damages by any person entitled to redeem the mortgage

Public Saleo If the mortgagor defaults in the payment of the secured debt or

otherwise fails to comply with the conditions of the mortgage, the creditor has no right to appropriate to himself the personal property because he is permitted only to recover his credit from the proceeds of the sale of the property at public auction through a public officer.

o Section 14 allows the mortgagee to have the property mortgaged sold in almost the same manner as that allowed by Act 3135 which governs the extrajudicial foreclosure of real estate mortgage.

o The mere fact that the mortgagee was the sole bidder for the mortgaged property in the public sale does not warrant the conclusion that the transaction was attended with fraud.

Private saleo There is nothing illegal or immoral in an agreement for the

private sale of the personal properties covered by the chattel mortgage

Period to foreclose mortgage The mortgagee may, after 30 days from the time of the condition

broken, cause the mortgaged property to be sold at public auction by a public officer.

The 30-day period to foreclose a chattel mortgage is the minimum period after violation of the mortgage condition for the mortgage creditor to cause the sale at public auction of the mortgaged chattel with at least 10 days notice to the mortgagor and posting of public notice of time, place, and purpose of such sale, and is a period of grace for the mortgagor, to discharge the mortgage obligation.

Within this 30-day period, the debtor has to pay or “redeem” the property

o Who may redeem property?1. The mortgagor2. A person holding a subsequent mortgage, or3. A subsequent attaching creditor.

Compare with the period in real estate mortgages which, in case of judicial foreclosure, is not less than 90 days nor more than 120 days from the entry of judgment on foreclosure.

Civil action to recover credit The mortgagee is not obligated to file an independent action for the

enforcement of his credit. To require him to do so would be a nullification of his lien and would defeat the purpose of the chattel mortgage which is to give him preference over the mortgage chattels for the satisfaction of his credit.

A mortgagee who sues and obtains a personal judgment against a mortgagor upon his credit waives thereby his right to enforce the mortgage securing it. By instituting a civil action to recover the amount of the loan from the mortgagor and by securing a judgment in his favor, the mortgagee abandons his mortgage lien on the mortgaged chattel.

Ordinary action to recover possession of chattel In case of refusal of the mortgagor to surrender the possession of the

mortgaged chattel sold by the sheriff, the remedy of the purchaser is to bring an ordinary action for recovery of possession, instead of merely asking for a writ of possession, in order to give the mortgagor the opportunity to be heard not only regarding possession but also regarding the obligation covered by the mortgage.

The CM Law does not contain provisions similar to Sec 6-7 of Act 3135 governing extrajudicial foreclosure of real estate mortgages, which make the provisions of Rule 39 of the Rules of Court on redemption in case of execution sales applicable to an extrajudicial foreclosure of a real estate mortgage. (whut.)

Skipped the action for replevin as a remedy. If you want to know more about it, check page 484.

Right of mortgagee to recover deficiency General rule: The creditor may maintain an action for the deficiency

although the CM Law is silent on this point. Exception: Where mortgage constituted as security for purchase of

personal property payable in installments. (Art 1484)


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o In this case, the mortgagee has 3 options:1. Exact fulfillment of the obligation, should the vendee fail to

pay In this case, the mortgagee-vendor is entitled to

deficiency where the mortgaged property is subsequently attached and sold, since the execution sale is not a foreclosure sale. (Sales!)

2. Cancel the sale, should the vendee’s failure to pay cover two or more installments

3. Foreclose the chattel mortgage on the thing sold, should the vendee fail to pay two or more installments,

Both the CM Law and Act 3135 (which governs extrajudicial foreclosure of real estate mortgage) do not contain any provision precluding the mortgagee from recovering deficiency of the principal obligation.

Application of proceeds of sale1. Costs and expenses of keeping and sale;2. Payment of the obligation secured by the mortgage;3. Claims of persons holding subsequent mortgages in their order; and4. The balance, if any, shall be paid to the mortgagor, or person holding

under him.

In pledge, the sale of the thing pledged extinguishes the entire principal obligation such that the pledgor may no longer recover the proceeds of the sale in excess of the amount of the principal obligation.

In chattel mortgage, the law expressly entitles the mortgagor to the balance of the proceeds upon satisfaction of the principal obligation and costs.

Since the CM Law bars the creditor-mortgagee from retaining the excess of the sale proceeds, there is a corollary obligation on the part of the debtor-mortgagor to pay the deficiency in case of a reduction in the price at public auction.

XCONCURRENCE AND PREFERENCEOF CREDITS

Nothing in the Civil Code indicates that its provisions on concurrence

and preference of credits are applicable only to the insolvent debtor.

Meaning of concurrence of credits Concurrence of credits implies the possession by two or more creditors

of equal rights or privileges over the same property or all of the property of a debtor

Meaning of preference of credit Preference of credit is the right held by a creditor to be preferred in the

payment of his claim above others (to be paid first) out of the debtor’s assets.

Nature and effect of preference A preference is an exception to the general rule. Hence, the law as to

preferences is strictly construed. Preference does not create an interest in property. It creates simply a

right of one creditor to be paid first in the proceeds of the sale of property as against another creditor.

It creates no lien on property, but merely a preference in application of the proceeds after the sale.

The law does not give the creditor who has a preference a right to take the property or sell it as against another creditor. Again, it is one of the application of the proceeds after the sale.

The right of preference is one which can be made effective only by being asserted and maintained. If the right claimed is not asserted and maintained, it is lost.

When are the rules on preference of credits applicable? The rules apply only where:

1. There are two or more creditors who have separate and distinct claims

2. against the same debtor who has insufficient property. The preferential right of credit attains significance only after the

properties of the debtor have been inventoried and liquidated, and the claims held by his various creditors have been established.

There is a need for 1. Inventory, 2. Liquidation, and 3. Establishment of claims of other creditors.

The credits must already be due. The law on the concurrence of credits cannot be applied in a mere

action to collect from the obligor. There must be an insolvency or other type of in rem proceeding of obligor’s estate. (PSB v Lantin)


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Distinguish between preference of credit and lien A preference applies only to claims which do not attach to specific

properties. It is but a preference in application. A lien creates a charge on a particular property.

CHAPTER 1GENERAL PROVISIONS Art. 2236. The debtor is liable with all his property, present and future, for the fulfillment of his obligations, subject to the exemptions provided by law. (1911a)

Liability of debtor’s property for his obligations The creditors have the right to pursue the property in possession of the

debtor to satisfy their claims. As a rule, a debtor is liable with all his property, present and future, for

the fulfillment of his obligations. To this rule, the law provides for property which are exempt from such fulfillment

What are the exempt property?1. With respect to present property of the debtor, the following are

exempted:a. The family home (except for non-payment of taxes, debts

incurred prior to the constitution of the family home, debts secured by mortgages on the premises before or after such constitution, and for debts due to laborers who have rendered service for the construction of the building)

b. Right to receive supportc. Those mentioned in Rule 39 of the Rules of Court

(Ordinary tools, necessary clothing, lettered gravestones, three cows, etc)

2. With respect to future property, a debtor who obtains a discharge from his debts on account of his insolvency, is not liable for the unsatisfied claims of his creditors with said property subject to certain exceptions expressly provided by law.

3. Property under legal custody and those owned by municipal corporations necessary for governmental purposes have been held exempt from attachment or execution.

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

Insolvency governed by special laws The Civil Code prevails in case of conflict with special laws on

insolvency unless otherwise provided in the latter. Insolvency proceedings, as well as liquidation proceedings have only

one aim – to conserve all the remaining assets of the insolvent/liquidate person/corporation for distribution to the creditors, after payment of taxes

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

Exemption of conjugal partnership or absolute community property The assents of the conjugal partnership or the absolute community do

not pass to the assignee in insolvency elected by the creditors or appointed by the court as they do not belong to the individual spouses, but a distinct entity: the partnership or the community.

The exemption applies, provided that:1. The partnership or community subsists; and2. The obligations of the insolvent spouse have not redounded to

the benefit of the family. The insolvency of the husband does not have the effect of dissolving the

conjugal partnership or the absolute community

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

Rule involving undivided share or interest of a co-owner


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If there is a co-ownership and one of the co-owners is the insolvent debtor, his undivided share or interest in the property shall be possessed by the assignee in insolvency proceedings because it is part of his assets

The share of the other co-owners cannot, of course, be taken possession of by the assignee.

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

CHAPTER TWOCLASSIFICATION OF CREDITS Art. 2241. With reference to specific movable property of the debtor, the following claims or liens shall be preferred:

(1) Duties, taxes and fees due thereon to the State or any subdivision thereof;

(2) Claims arising from misappropriation, breach of trust, or malfeasance by public officials committed in the performance of their duties, on the movables, money or securities obtained by them;

(3) Claims for the unpaid price of movables sold, on said movables, so long as they are in the possession of the debtor, up to the value of the same; and if the movable has been resold by the debtor and the price is still unpaid, the lien may be enforced on the price; this right is not lost by the immobilization of the thing by destination, provided it has not lost its form, substance and identity; neither is the right lost by the sale of the thing together with other property for a lump sum, when the price thereof can be determined proportionally;

(4) Credits guaranteed with a pledge so long as the things pledged are in the hands of the creditor, or those guaranteed by a chattel mortgage, upon the things pledged or mortgaged, up to the value thereof;

(5) Credits for the making, repair, safekeeping or preservation of personal property, on the movable thus made, repaired, kept or possessed;

(6) Claims for laborers' wages, on the goods manufactured or the work done;

(7) For expenses of salvage, upon the goods salvaged;

(8) Credits between the landlord and the tenant, arising from the contract of tenancy on shares, on the share of each in the fruits or harvest;

(9) Credits for transportation, upon the goods carried, for the price of the contract and incidental expenses, until their delivery and for thirty days thereafter;

(10) Credits for lodging and supplies usually furnished to travellers by hotel keepers, on the movables belonging to the guest as long as such movables are in the hotel, but not for money loaned to the guests;

(11) Credits for seeds and expenses for cultivation and harvest advanced to the debtor, upon the fruits harvested;

(12) Credits for rent for one year, upon the personal property of the lessee existing on the immovable leased and on the fruits of the same, but not on money or instruments of credit;

(13) Claims in favor of the depositor if the depositary has wrongfully sold the thing deposited, upon the price of the sale. In the foregoing cases, if the movables to which the lien or preference attaches have been wrongfully taken, the creditor may demand them from any possessor, within thirty days from the unlawful seizure. (1922a)

General categories of credit1. Special preferred credits listed in Articles 2241 and 2242 (they attach or

refer to particular properties)2. Ordinary preferred credits listed in Article 2244 (order here is important)3. Common credits under Article 2245 (whatever is left of assets)

Preferred credits with respect to specific movable property Articles 2241 and 2242 do not give the order of preference or priority of

payment. They merely enumerate the credits which enjoy preference with respect

to specific movables or immovables. With respect to the same specific movable or immovable, creditors, with

the exception of the State, merely concur. There is no preference among them, there is only concurrence.

The credit of a mortgagee of a motor vehicle cannot be considered preferred until it has been recorded in the LTO.

Wrongful taking of movables to which lien attaches


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The last paragraph of Article 2241 applies only when the right of ownership in such property continues in the debtor, and, therefore, it is not applicable to cases where the debtor has parted with his ownership therein, as where he has sold the property

The lessor of property under a contract which stipulates that the permanent improvements made by the lessee on the leased premises shall belong to the lessor, has a better right to such improvements than the manufacturer thereof who sold the same on credit to the lessee and has not been paid, where said improvements were delivered and installed in the leased premises, because ownership thereof was transferred to the lessee upon delivery and to the lessor, upon installation. Payment of the purchase price is not essential to the transfer of ownership as long as the thing sold has been delivered.

Art. 2242. With reference to specific immovable property and real rights of the debtor, the following claims, mortgages and liens shall be preferred, and shall constitute an encumbrance on the immovable or real right:

(1) Taxes due upon the land or building;(2) For the unpaid price of real property sold, upon the

immovable sold; (3) Claims of laborers, masons, mechanics and other

workmen, as well as of architects, engineers and contractors, engaged in the construction, reconstruction or repair of buildings, canals or other works, upon said buildings, canals or other works;

(4) Claims of furnishers of materials used in the construction, reconstruction, or repair of buildings, canals or other works, upon said buildings, canals or other works;

(5) Mortgage credits recorded in the Registry of Property, upon the real estate mortgaged;

(6) Expenses for the preservation or improvement of real property when the law authorizes reimbursement, upon the immovable preserved or improved;

(7) Credits annotated in the Registry of Property, in virtue of a judicial order, by attachments or executions, upon the property affected, and only as to later credits;

(8) Claims of co-heirs for warranty in the partition of an immovable among them, upon the real property thus divided;

(9) Claims of donors or real property for pecuniary charges or other conditions imposed upon the donee, upon the immovable donated;

(10) Credits of insurers, upon the property insured, for the insurance premium for two years. (1923a)

Preferred credits with respect to specific immovable property This article merely enumerates the preferred claims on specific

immovables. The enumeration is not an order of preference. With the sole exception of the State, the creditors with respect to the

same specific immovable merely concur.

Unpaid price of real property sold This article makes no distinction between registered and unregistered

vendor’s lien (2). Hence, any lien of that kind enjoys the preferred credit status.

Unlike, however, the unpaid price of real property sold, mortgage credits (5), in order to be given preference, should be recorded in the Registry of Property.

But a recorded mortgage credit is superior to an unrecorded unpaid vendor’s lien.

Recorded mortgage credits A mortgage directly and immediately subjects the property upon which it

is imposed, whoever the possessor may be, to the fulfillment of the obligation for whose security it was constituted.

A recorded mortgage credit is a special preferred credit. The preference given to workers by Article 110 of the Labor code, when

not falling within Article 2241 (6) and Article 2242 (3) and not attached to any specific property, is an ordinary preferred credit although its impact is to move it from second priority to first priority in the order of preference established by Article 2244.

Between an unrecorded sale of a house of a prior date and a recorded mortgage of the same property of a later date, the former is preferred to the latter for the reason that, if the original owner had parted with his ownership of the thing sold, then he no longer had the ownership and free disposal of the thing so as to be able to mortgage it.

While a pacto de retro sale of a house which is in reality an equitable mortgage is valid as between the parties, it cannot prevail over a subsequent recorded mortgage over the same priority. Preference of mortgage credits is determined by the priority of registration of the mortgages, following the maxim “prior tempore potior jure.”


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Credits annotated in virtue of judicial order The priority rule applies to credits annotated in the Registry of Property As to the credits mentioned in No 7 of Article 2242, there is preference

among the attachments or executions according to the order of the time they were levied upon the property.

The pro rata rule in Article 2249 does not apply, otherwise, the result would be absurd. The preference of a credit annotated by an attachment or execution could be defeated by simply obtaining a writ of attachment or execution, no matter how much later.

Refectionary credit Refectionary credit is primarily an indebtedness incurred in the repair or

reconstruction of something previously made, such repair or construction being necessary by the deterioration or destruction of the thing as it formerly existed.

The liberal interpretation of refectionary credit to include new construction has been adopted by the Supreme Court.

Art. 2243. The claims or credits enumerated in the two preceding articles shall be considered as mortgages or pledges of real or personal property, or liens within the purview of legal provisions governing insolvency. Taxes mentioned in No. 1, Article 2241, and No. 1, Article 2242, shall first be satisfied. (n)

Nature of claims or credits in Articles 2241 and 2242 As provided in this article, they shall be considered as mortgages or

pledges of real or personal property. Hence, the provisions on pledge and mortgage are also applicable. In case of the insolvency of the debtor, such claims or credits shall be

considered as liens within the purview of legal provisions governing insolvency. Hence, they are not included in the insolvent debtor’s assets.

Articles 2241 and 2242 only find application when there is a concurrence of credits, i.e. when the same speicific property of the debtor is subjected to the claims of several creditors and the value of such property is insufficient to pay in full all the creditors.

In such a situation, the question of preference will arise, there will be a need to determine which of the creditors will be paid ahead of the others.

Due process will dictate that this statutory lien should then only be enforced in the context of some kind of a proceeding where the claims of all the preferred creditors may be bindingly adjudicated, such as insolvency or estate proceedings.

A preferred creditor’s third-party claim to the proceeds of a foreclosure sale by the mortgagee is not he proceeding contemplated by law for the enforcement of preferences under Articles 2241 and 2242 unless the claimant is enforcing a credit for taxes that enjoy absolute priority.

Art. 2244. With reference to other property, real and personal, of the debtor, the following claims or credits shall be preferred in the order named:

(1) Proper funeral expenses for the debtor, or children under his or her parental authority who have no property of their own, when approved by the court;

(2) Credits for services rendered the insolvent by employees, laborers, or household helpers for one year preceding the commencement of the proceedings in insolvency;

(3) Expenses during the last illness of the debtor or of his or her spouse and children under his or her parental authority, if they have no property of their own;

(4) Compensation due the laborers or their dependents under laws providing for indemnity for damages in cases of labor accident, or illness resulting from the nature of the employment;

(5) Credits and advancements made to the debtor for support of himself or herself, and family, during the last year preceding the insolvency;

(6) Support during the insolvency proceedings, and for three months thereafter;

(7) Fines and civil indemnification arising from a criminal offense;

(8) Legal expenses, and expenses incurred in the administration of the insolvent's estate for the common interest of the creditors, when properly authorized and approved by the court;

(9) Taxes and assessments due the national government, other than those mentioned in Articles 2241, No. 1, and 2242, No. 1;

(10) Taxes and assessments due any province, other than those referred to in Articles 2241, No. 1, and 2242, No. 1;

(11) Taxes and assessments due any city or municipality, other than those indicated in Articles 2241, No. 1, and 2242, No. 1;


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(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 a final judgment, if they have been the subject of litigation. These credits shall have preference among themselves in the order of priority of the dates of the instruments and of the judgments, respectively. (1924a)

Order of preference with respect to other properties of the debtor Article 2244 not only enumerates the preferred credits with respect to

other property, real and personal, of the debtor, but also gives their order of preference “in the order named.”

Note that in this article, taxes and assessments are mentioned only as Nos 9, 10 and 11. If the property is specific, duties and taxes (not fees) on said property are placed as No. 1 in the order of preference.

In contrast with Articles 2241 and 2242, this article creates no liens on determinate property which follow such property.

What Article 2244 creates are simply rights in favor of certain creditors to have the cash and other assets of the insolvent applied I a certain sequence or order of priority.

Order of priority with respect to insolvent’s “free property”1. Specially preferred credits – Credits which are specially preferred

because they constitute liens take precedence over ordinary preferred credits so far as concerns of the property to which the liens have attached

o If the value of the specific property involved is greater than the sum total of tax liens and other specially preferred credits, the residual value will form part of the “free property” of the insolvent, or property not impressed with liens by operation of Articles 2241 and 2242.

o If the value of the specific property is less than the aggregate of the tax liens and other specially preferred credits, the unsatisfied balance of the tax liens and other such credits are to be treated as ordinary preferred credits under Article 2244 and to be paid in the order of preference therein provided.

2. Ordinary preferred credits – Only in respect of the insolvent’s “free property” is an order of priority established by Article 2244.

Preference of claims for unpaid wags and other monetary claims Article 110 of the Labor Code does not purport to create a lien in favor

of workers or employees for unpaid wages and other monetary claims either upon all of the properties or upon any particular property owned by their employer.

Claims for unpaid wages do not, therefore, fall at all within the category of specially preferred claims established under Articles 2241 and 2242 except to the extent that such claims for unpaid wages are already covered by 2241 (6) and 2242 (3)

It did not upgrade the workers’ claim as absolutely preferred credit. It did not alter Articles 2241 and 2242 so much that creditors with liens over a certain property are still given special preferences over the proceeds of that property.

To the extent that claims for unpaid wages fall outside the scope fo said provisions, they would come within the ambit of the category of ordinary preferred credits under Article 2244.

What it intends to modify is the order of preference in Article 2244, which relates to the free property of the insolvent debtor. Article 110 of the Labor Code has modified Article 2244 of the Civil Code in two respects:

1. By removing the one-year limitation found in Article 2244 (2), and

2. By moving up claims for unpaid wages (and other monetary claims) of laborers or workers of the insolvent from second priority to first priority in the order of preference establish by Article 2244.

However, Atty Lerma said that taxes and labor always get paid first. So now I’m confused. (Or maybe I just heard wrong.)

Preference of credits evidenced by public instruments and final judgments Under the last paragraph, credits evidence by a public instrument and

those evidenced by a final judgment are placed in the same order of preference. Preference among them is determined by considering the priority of the dates of the instruments and of the final judgments.

Statutory preference not applicable to the government Article 2244 (No 4a) confers a preference on credits constituted in the

form of a duly notarized instrument over credits not so constituted, such preference being determined in the order of priority of the respective dates of notarization

It is a recognized doctrine that the State is always solvent.


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The provisions of Article 2244 (14.1) were not intended to apply and do not apply to obligations of the Republic.

Art. 2245. Credits of any other kind or class, or by any other right or title not comprised in the four preceding articles, shall enjoy no preference. (1925)

Non-preferred or common credits Credits other than those mentioned in Articles 2241,2242, and 2244

shall enjoy no preference and such common credits shall be paid pro rata regardless of dates.

Insolvency proceedings involving banks After a bank is declared insolvent by the Monetary Board of the CB, a

depositor cannot bring a separate action against it, his remedy being to intervene in the judicial proceedings for liquidation instituted by the Board thru the Solicitor General.

The reason is that the execution of the final judgment rendered in a separate suit will cause the bank’s assets to be unduly depleted to the obvious prejudice of other depositors and creditors.

All claims against the insolvent bank should be filed in the liquidation proceedings to obviate the proliferation of litigations and to avoid injustice and arbitrariness.

However, taking into account different circumstances and in the interst of justice, a deviation from the procedure may be allowed.

Is a final judgment a preferred claim against the insolvent bank?o Bank deposits are considered simple loans, and as such, are

not preferred credits. o Article 2244 (14, b) does not apply to judgments for the

payment of deposits in an insolvent bank which were obtained after the declaration of insolvency. A contrary rule would be productive of injustice – it would allow depositors to rush to the courts to secure judgments, where less alert depositors would be prejudiced.

o The effect of the final judgment is only to fix the amount of the debt, and not give priority over other depositors and creditors. After its insolvency, one cannot obtain an advantage or preference over another by an attachment, execution or otherwise.

CHAPTER 3

ORDER OF PREFERENCE OF CREDITS Art. 2246. Those credits which enjoy preference with respect to specific movables, exclude all others to the extent of the value of the personal property to which the preference refers.

Art. 2247. If there are two or more credits with respect to the same specific movable property, they shall be satisfied pro rata, after the payment of duties, taxes and fees due the State or any subdivision thereof. (1926a)Art. 2248. Those credits which enjoy preference in relation to specific real property or real rights, exclude all others to the extent of the value of the immovable or real right to which the preference refers.

Art. 2249. If there are two or more credits with respect to the same specific real property or real rights, they shall be satisfied pro rata, after the payment of the taxes and assessments upon the immovable property or real right. (1927a)

Art. 2250. The excess, if any, after the payment of the credits which enjoy preference with respect to specific property, real or personal, shall be added to the free property which the debtor may have, for the payment of the other credits. (1928a)

Art. 2251. Those credits which do not enjoy any preference with respect to specific property, and those which enjoy preference, as to the amount not paid, shall be satisfied according to the following rules:(1) In the order established in Article 2244;(2) Common credits referred to in Article 2245 shall be paid pro rata regardless of dates. (1929a)

Two-tier order of preference1. First-tier includes only taxes, duties and feeds due on a specific

movable or immovable property.2. Second-tier includes all other special preferred (non-tax) credits to be

satisfied pari passu and pro rata, out of any residual value of the specific property to which such other credits relate. NB: The pro rata rule does not apply to credits annotated in the

Registry of Property (judicial order, attachments, executions) which are preferred to “as later credits”. In satisfying several credits


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annotated by attachments or executions, the rule is still preference according to the priority of the credits in the order of time.

Satisfaction of other credits1. With order of preference - Credits which do not enjoy any preference

with respect to specific property because they are not among those mentioned in 2241 and 2242 and those while included in said articles are unpaid because the value of he property to which the preference refers is less than the preferred credit or credits, shall be satisfied in the order established in 2244 with reference to the other real and/or personal property of the debtor.

2. Without any order of preference - Common credits are those which do not fall under 2241, 2242 and 2244. They do not enjoy any preference (2245) and shall be paid pro rata regardless of dates.

Atty Lerma’s flowchart

Sample problem 1:Draco has the following assets:1. Car – P100,0002. Land – P2,000,0003. TV – P500,000

Draco has the following obligations:1. To Toyota, for unpaid balance of car, secured – P200,0002. Unpaid real estate taxes to Makati – P750,0003. Real estate mortgage to Bank 1, January 1, 2000 – P250,0004. Real estate mortgage to Bank 2, Feb 2, 1999 – P250,0005. Manila Memorial funeral – P500,0006. Unpaid income taxes to BIR – P450,0007. Loan to Harry – P100,0008. Loan to Ron – P100,000

Solve.

Car P100,000 Land P2,000,000Toyota 200,000 State 750,000Toyota P100,000 P1,250,000(Toyota has balance of P100k) Bank2 250,000

P1,000,000 Bank1 250,000

P750,000

P750,000 (excess) + 500,000 (tv) P1,250,000 (free property)

Manila Memorial 500,000 750,000


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Excess?

Excess?

2241Distribute creditsSpecific movable

2242Distribute credits

Specific Immovables

Free Property(cash, excess of 2241, 2242,

etc)

Apply 2244 (in order)

Apply 2245(all to share pro

rata)

2241 2242

Deficient?

2245pro rata



BIR 450,000 300,000 (Who’s left? Harry, Ron and Toyota –

don’t forget Toyota!)Final answerToyota – P200,000Makati – P750,000Bank1 – P250,000Bank2 – P250,000Manila Memorial – P500,000BIR – P450,000Harry – P100,000Ron – P100,000Everyone gets fully paid!

But what if the debt to BIR is P500,000, instead of P450,000?Same process, until we reach the point where we deduct the debt of BIR.

P750,000 (excess) + 500,000 (tv) P1,250,000 (free property)

Manila Memorial 500,000 750,000

BIR 500,000 250,000

So, there’s P250,000 left for the debts to Ron, Harry and the unpaid balance to Toyota. What to do? Pro rata that baby.

Harry 100/300 x 250 = 83,333.33Ron 100/300 x 250 = 83,333.33Toyota 100/300 x 250 = 83.333.33

Final answer Toyota – P183,333.33Makati – P750,000Bank1 – P250,000Bank2 – P250,000Manila Memorial – P500,000BIR – P450,000Harry – P83,333.33Ron – P83,333.33

Sample problem 2 (from book)Albus is an insolvent. These are his assets:1. Car – P248,0002. Land – P112,0003. Cash – P24,000

These are his obligations:1. To the State for unpaid taxes on the car – P8,0002. To Boris, for unpaid balance of the price of said car which he bought

from Boris – P160,0003. To Charlie, for cost of repair on the car by Charlie – P16,0004. To Draco, for loan secured by a chattel mortgage on the car – P80,0005. To Ernie, for the funeral expenses of the child of Albus who died –

P48,0006. To Franco, for medicines purchased during the last illnes of his wife –

P16,0007. To the State, for unpaid business taxes – P11,2008. To Greta, for an unsecured loan in 2005 – P32,0009. To Helga, for an unsecured loan in 2005 – P96,000

Taxes first!Car P248,000Taxes 8,000

240,000

Special preferred credits next! But merely concurrence among them! So, claims of Boris, Charlie and Draco shall be pro rata. (P256,000 is their total claim)

Boris – 160,000/256,000 x 240,000 = P150,000Charlie- 16,000/256,000 x 240,000 = P 15,000Draco - 80,000/256,000 x 240,000 = P 75,000

P240,000

Boris, Charlie and Draco are entitled to have the unpaid portions of their credits satsifed from the other property of Albus subject to the right of preference of other creditors (Art 2244).

Assuming that the credit of Draco is only P48,000, the excess of P16,000 with respect to the car after deducting the creditors of the State, Boris,


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Charlie and Draco (P248,000-P232,000), shall be added to the other property of A for the payment of his other obligations.

With respect to the P16,000 excess, the parcel of land worth P111,200 and the P24,000 cash, a total of P151,200, the other credits shall be paid in the following order.

P151,200 (free property)Ernie 48,000

103,200Franco 16,000

87,200State 11,200

76,000

Greta and Helga shall be paid pro rata regardless of the dates of their credits.

If the car of Albus has been totally destroyed, the unpaid tax of P8000 on the car shall be satisfied after the payment of the credits of Ernie and Franco. (No car, no preference, then you become ordinary credit)

Greta – 32,000/128,000 x 76,000 = P16,000Helga – 96,000/128,000 x 76,000 = P48,000

Final answer (assuming the credit of Draco is only P48,000)State – P8,000Boris – P160,000Charlie – P16,000Draco – P48,000Ernie – P48,000Franco – P16,000State 2 – P11,200Greta – P16,000Helga – P48,000

The Insolvency LawAct No 1956, as amended

Insolvency Defined

Insolvency denotes the state of a person whose liabilities are more than his assets (balance sheet test)

It is also used to express inability of a person to pay his debts as they become due in the ordinary course of his business, and it is in this sense, that the term is used when traders or merchants are said to be insolvent. (equity test)

Insolvency is primarily governed by the Civil Code, and subsidiarily, by the Insolvency Law.

Purposes of the Insolvency Law1. To effect an equitable distribution of the bankrupt’s property among his

creditors, and2. To benefit the debtor in discharging him from his liabilities and enabling

him to start afresh with the property set apart to him as exempt3. Regulatory and unifying influence of the law on credit transactions and

business usage throughout the country

What may be permitted of a debtor by the Insolvency Law In the event of insolvency, a principal objective should be to effect an

equitable distribution of the insolvent’s property among his creditors There must first be some proceeding where notice to all of the

insolvent’s creditors may be given and where the claims of preferred creditors may be bindingly adjudicated

An insolvent debtor may be permitted:1. To petition the court to suspend payments of his debts; or2. To be discharged from his debts and liabilities by voluntary or

involuntary insolvency proceedings

Suspension of Payments (Sec 2-13)

Suspension of payments defined Suspension of payments is the postponement, by court order, of the

payment of debts of one who, while possessing sufficient property to cover his debts, foresees the impossibility of meeting them when they respectively fall due.

What is the purpose and basis of suspension of payments?Purpose: To suspend or delay the payment of debts the amount of which is not affected although a postponement is declared


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Basis: the probability of the debtor’s inability to meet his obligations when they respectively fall due, despite the fact that he has sufficient assets to cover all his liabilities. According to Atty Lerma, one is not liquid (not enough cash) to pay liabilities.

What are the steps in suspension of payments?1. Filing of the petition by the debtor2. Issuance by the court of an order calling a meeting of creditors3. Publication of the order and service of summons4. Meeting of creditors for the consideration of the debtor’s proposition5. Approval by the creditors of the debtor’s proposition6. Objections, if any, to the decision which must be made within 10 days

following the meeting7. Issuance of order by the court directing that the agreement be carried

out in case the decision is declared valid, or when no objection to said decision has been presented

Requisites of petition for suspension of payments The petition is filed by a debtor…

1. Possession sufficient property to cover all his debts2. Foreseeing the impossibility of meeting them when they

respectively fall due, and3. Petitioning that he be declared in the state of suspension of

payments. The petition need not be verified.

What documents should accompany the petition?1. A verified schedule containing a full and true statement of the debts and

liabilities of the petitioner together with a list of creditors (and any existing pledge, lien, security)

2. A verified inventory containing a list of creditors, an accurate description of all the property of the petitioner including property exempt from execution

3. Statement of his assets and liabilities4. Proposed agreements he requests of his creditors Only creditors included in the schedules filed by the debtor shall be cited

to appear and to take part in the meeting. Those who did not appear because they were not informed of the proceedings are unaffected by the same.

But if you were notified, and still didn’t appear, then you are deemed to have waived.

What are the effects of filing of petition?1. No disposition in any manner of his property may be made by the

petitioner EXCEPT insofar as concerns the ordinary operations of commerce

or of industry in which he is engaged2. No payments may be made by the petitioner

EXCEPT in the ordinary course of his business or industry (debtor can’t pay debts, etc)

3. Upon request to the court, all pending executions against the debtor shall be suspended (so foreclosures are suspended – Atty Lerma) EXCEPT execution against property especially mortgaged.

What happens to the preference of credits? It is maintained but the foreclosure is delayed.

What is the rule of double majority in the meeting of creditors? The majority shall be 2/3 of the creditors voting upon the same

proposition, which 2/3 represent at least 3/5 of the total liabilities of the debtor

2/3 of the creditor refers to the head count

When is the petition for suspension deemed rejected?1. When the number of creditors representing at least 3/5 of the liabilities

do not attend, or2. When the majorities required are not in favor of the proposed

agreement.

Who has jurisdiction? For individuals, the regular courts. For corporations, partnerships and associations, proceed to commercial

courts. (Atty Lerma) If a case was already filed in the SEC, it will be transferred to the regular

courts.o EXCEPT when a management committee has been

appointed. Then it will stay in the SEC. o If no management committee, then it will be transferred to

the regular courts.

Voluntary Insolvency (14-19)


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What is voluntary insolvency? An insolvent debtor owing debts exceeding in amount of P1000, may

apply to be discharged from his debts and liabilities by petition to the RTC of the province or city in which he has resided for 6 months next preceding the filing of the petition.

What is its purpose? To discharge the debtor from the payment of his debts, by liquidation “Save me! Let me go on with my life without debts (and without assets

too!)” – Atty Lerma

Suspension of Payments InsolvencyPurpose Suspend or delay the payment of

debtsDischarge the debtor from the payment of debts

Property Debtor has sufficient property Debtor does NOT have sufficient property

Amount ofIndebtedness

Amount of indebtedness is not affected

Creditors receive less than their credits, and in case there are preferences, some creditors may not receive any amount at all

Number of creditors

Immaterial Three or more creditors are required (in INVOLUNTARY insolvency)

What are the steps in voluntary insolvency proceedings?1. Filing of the petition by the debtor praying for the declaration of

insolvency in the regular courts2. Issuance of an order of adjudication declaring the petitioner insolvent3. Publication and service of the order4. Meeting of the creditors to elect the assignee in insolvency5. Conveyance of the debtor’s property by the clerk of court to the

assignee6. Liquidation of the debtor’s assets and payment of his debts7. Composition, if agreed upon

8. Discharge of the debtor on his application, except a corporation9. Objection to the discharge (if any)10. Appeal to the Supreme Court in certain cases

Requisites of petition for voluntary insolvencyThe petition which must be verified is to be filed by:1. An insolvent debtor2. Owing debts exceeding in amount of P10003. In the RTC of the province or city in which he has resided for 6 months

next preceding the filing of such petition, and 4. Setting forth in his petition the following:

a. His place of residenceb. The period of his residence therein immediately prior to filing

said petitionc. His inability to pay all his debt in fulld. His willingness to surrender all his property, estate and effects

not exempt from execution for the benefit of his creditorse. An application to be adjudged an insolvent.

What is the effect of the filing of petition? Once the petition is filed, it ipso facto takes away and deprives the

petitioner of the right to do or commit any act of preference as to creditors, pending the final adjudication.

What are the effects of the court order declaring the debtor insolvent?1. All the assets of the debtor not exempt from execution are taken

possession of by the sheriff until the appointment of a receiver or assignee

2. The payment to the debtor of any debts to him and the delivery to the debtor or to any person for him of any property belonging to him, and the transfer of any property by him are forbidden

3. All civil proceedings (collection cases) pending against the insolvent debtor shall be stayed

4. Mortgages or pledges, attachments or executions on property of the debtor duly recorded and not dissolved are not affected by the order.

What are the documents required to be attached to the petition?1. a verified schedule which must contain:

a. a full and true statement of all debts and liabilities of the insolvent debtor


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b. an outline of the facts giving rise or which might give rise to a cause of action against such insolvent debtor

2. A verified inventory which must containa. An accurate description of all the personal and real property of

the insolvent exempt or not from execution including a statement as to its value, location and encumbrances thereon; and

b. An outline of the facts giving rise or which might give rise to a right of action in favor of the insolvent debtor

The filing of the schedule and inventory is jurisdictional.

What if the inventory erroneously omits or ambiguously describes the property? It will not affect the title of purchasers in the insolvency proceedings. If the insolvent omits property from his inventory, it is the duty of the

assignee to have the inventory amended as to included it and to take possession and administer it.

Even property exempt from execution must be included in order to preclude possible fraudulent omissions. (But where the petitioner did not attach an inventory, alleging under oath that it had no property, the lack of inventory was not fatal)

What happens if the debt exceeds the secured property? For example, the debt is P5M, but the property secured is P2.5m? To the extent of the unsecured portion, the creditor can join the

proceedings. Lesson? Be vigilant! If the creditor wants to participate as an ordinary creditor, he has to let

go of the mortgage.

Involuntary Solvency (20-28)

What is involuntary solvency? It is an adjudication of insolvency made on the petition of three or more

creditors, residents of the Philippines, whose credits or demands accrued in the Philippines, and the amount of which are in the aggregate of not less than P1000.

What is its purpose?

It is not a mere personal action against the insolvent for the collection of debts, but its purpose is to impound all of his non-exempt property, to distribute it equitably among his creditors, and release him from further liability.

It is a proceeding in rem and in personam. It is in rem in the sense that it determines the status of the insolvent.

Forgiveness is the end goal. – Atty Lerma

Who may petition for involuntary insolvency? Persons who may validly petition for involuntary solvency must possess

two things:1. They have the qualifications required by the Insolvency Law2. Their credits must be those contemplated by the Insolvency Law

What are the steps in involuntary insolvency?1. Filing of the petition by three or more creditors2. Issuance of order requiring the debtor to show cause why he should not

be adjudged insolvent (Prove that you are NOT insolvent, you ingrateful debtor!)

3. Service of order to show cause 4. Filing of answer or motion to dismiss5. Hearing of the case6. Issuance of order or decision adjudging debtor insolvent7. Publication and service of order8. Meeting of creditors for election of an assignee in insolvency (simple

majority. Simple majority of debts, and simple majority of creditors)9. Conveyance of debtor’s property by clerk of court to the assignee10. Liquidation of assets and payment of debts11. Composition, if agreed upon12. Discharge of the debtor on his application, except a corporation13. Objection, if any, to the discharge14. Appeal to the Supreme Court in certain cases

The publication must be in a newspaper of general circulation in the province or city in which the petition is filed. If there be none, in a newspaper which will best give notice to the creditors of said insolvent.

Being intended as notice only to creditors, it cannot affect the whole world like those who, in good faith and for a valuable consideration, may have taken a mortgage with reference to the debtor’s real property covered by a TCT.


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Requisites of petition for involuntary insolvencyThe petition is to be filed by1. Three or more creditors2. None of whom has become such a creditor by assignment, within 30

days prior to the filing of said petition3. Whose credits accrued in the Philippines4. Total amount of which is not less than P10005. In the RTC of the province or city in which the debtor resides or has

principal place of business.

The petition must 1. Be verified by at least 3 petitioning creditors2. Set forth one or more acts of insolvency mentioned in the law3. Be accompanied by a bond, approved by the court with at least two

sureties, in such penal sum as the court shall direct.

A surety for the debtor is not a creditor. He cannot institute insolvency proceedings. All he can do is prove his claim.

What’s the purpose of the 30 day rule? To prevent collusion To prevent unjustifiable preference in favor of some creditors to the

detriment of others

What are the acts of insolvency? In voluntary insolvency, the filing of a petition for voluntary insolvency is

an act of insolvency. In involuntary insolvency, the following are considered:

1. Intention to depart or departure from the Philippines to defraud creditors

2. Absence from the Philippines to defraud creditors3. Concealment of debtor to avoid legal process4. Concealment or removal of his property to avoid legal process5. Confession of judgment in favor of any creditor to defraud other

creditors6. Allowing default judgment in favor of a creditor to defraud other

creditors7. Allowing his property to be taken under legal process in preference

of a particular creditor to defraud other creditors8. Making conveyance, assignment or transfer of his property to

defraud his creditors

9. Making conveyance, assignment or transfer of his property in contemplation of insolvency

10. Default of a merchant or tradesman to pay his current obligations for a period of 30 days

11. Failure to pay money on deposit or received in a fiduciary capacity for a period of 30 days after demand

12. Insufficiency of property to satisfy an execution issued against him Any debtor who commits an act of insolvency may be adjudged

insolvent The date of adjudication of insolvency retroacts to the date of the filing

of the petition for insolvency

Voluntary InvoluntaryNumber of creditors One ThreeFiled by: Insolvent debtor 3 or more creditors with

qualifications set by lawActs of insolvency Must NOT be guilty Must have committed

one or moreAmount of indebtedness

Must exceed P1000 (P1000.01)

Not less than P1000 (P1000.00)

Bond Not required RequiredOrder of adjudication

May be granted ex parte Granted only after hearing

Length of residence (for RTC)

Province or city in which debtor has resided for 6 months prior to petition

Immaterial

When does the court order the adjudication?

Upon fiiing of the voluntary petition

Only until after hearing the case

If you are a mortgage creditor, what happens? Anything subject to a mortgage will not be passed to the assignee. The mortgagee is sitting pretty, unless the security is insufficient. If it is,

it might be better to give up your security and join in the general distribution of the assets.

Assignees (29-47)

What is an assignee?


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An assignee is person elected by the creditor or appointed by the court to whom an insolvent debtor makes an assignment of all his property for the benefit of all his creditors.

An assignee in insolvency takes title to the property of the insolvent by virtue of the transfer of the insolvent’s property by the clerk of court; but this instrument relates back to the commencement of the proceedings in insolvency with the result that the title of the assignee is determined as of the date when the petition of insolvency is filed.

o It is necessary that such proceedings be recorded in the registry of deeds from their commencement and the assignment be likewise recorded.

The assignee represents the insolvent as well as the creditors in voluntary and involuntary proceedings.

All property of the debtor shall be in the control of the assignee.

What are the effects of assignment?1. The assignee takes the property in the plight and conditions that the

insolvent held it2. Upon appointment, the legal title to all the property of the insolvent is

vested in the assignee, and the control of the property is vested in the court

3. All actions to recover all the estate, debts and effects of the insolvent shall be brought by the assignee and not by the creditor

4. The assignment shalla. Dissolve any attachment levied within one month next

preceding the commencement of insolvency proceedingsb. Vacate and set aside judgment entered in any action

commenced within 30 days immediately prior to the commencement of insolvency proceedings

c. Vacate and set aside any execution issued thereon;d. Vacate and set aside any judgment entered by default or

consent of the debtor within 30 days prior to the commencement of insolvency proceedings.

1. After his election, the assignee is required to give a bond for the faithful performance of his duties.

2. Courts have the power to appoint receivers to hold the property of individuals or corporations although no insolvency proceedings are involved. A receiver appointed by a court before the institution of the insolvency proceedings may be appointed the permanent assignee in such proceedings.

What are the properties that pass to the assignee?1. All real and personal property, estate and effects of the debtor including

all deeds, books and papers in relation thereto2. Properties fraudulently conveyed3. Right of action for damages to real property4. The undivided share or interest of the insolvent debtor in property held

under co-ownership

What are the properties that DO NOT pass to the assignee?1. Those exempt from execution2. Those held in trust3. Property of the conjugal partnership or absolute community so long as

the partnership exists except insofar as the obligations have redounded to the benefit of the partnership or community

4. Property over which a mortgage or pledge exists unless the creditor surrenders his security or lien

5. After-acquired property except fruits and income of property owner by the debtor and which had passed to the assignee in the insolvency

6. Non-leviable assets like a life insurance policy7. Right of action for tort which is purely personal in nature

What are the powers of the assignee?1. To sue and recover all the estate, debts and claims belonging to or due

to the debtor2. To take into possession all the estate of the debtor except those exempt3. In case of a non-resident or absconding or concealed debtor, to demand

and receive of every sheriff all the property and moneys in his possession belonging to the debtor

4. To sell any estate of the debtor which has come into his possession (needs order of court)

5. To redeem all mortgages and pledges and to satisfy any judgment which may be an encumbrance on any property sold by him

6. To settle all accounts between the debtor and his debtors, subject to the approval of the court

7. To compound, under the order of the court, with any person indebted to such debtor, and

8. To recover any property fraudulently conveyed by the debtor

What are the duties of the assignee?1. Register the assignment to him of the real estate of the debtor


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2. File the schedule and inventory of the property 3. Convert the state, real and personal, into money4. Keep a regular account of all moneys received by him as assignee5. Petition the court to allow the private sale of the debtor’s property if it

appears it is for the best interest of the estate6. File a just and true account of all receipts and payments7. File accounts upon order of the court on motion of two or more creditors8. Distribute such dividends as hey may be required9. File his final account within one year from the date of order of

adjudication

In sale of assets, the insolvent will not generally be permitted to purchase the assets, either in his own name or acting through a dummy.

What is a dividend in insolvency? It is a parcel of the fund arising from the assets of the estate, rightfully

allotted to a creditor entitled to share in the fund, whether in the same proportion with other creditors or in a different proportion.

It is paid by the assignee only upon order of the court. Whenever any dividend has been duly declared, the distribution of it

shall not be stayed or affected by reason of debts subsequently proved. However, any creditor proving such a debt shall be entitled ot a dividend equal to those already received by the other creditors before any further dividend is mare to the latter, if the failure to prove such claim shall not have resulted from his own neglect.

Classification and preference of creditors (48-50)

What is the order of distribution?1. Equitable claims (see page 589 of the book)2. 2241 and 22423. 22444. common or ordinary credits pro rataPartnerships and corporations (51-52)

Proof of debts (53-62)

Composition (63)

What is composition?

It is an agreement, made upon a sufficient consideration, between an insolvent debtor and his creditor, whereby the latter for the sake of immediate or sooner payment, agree to accept a dividend less than the whole amount of their claims, to be distributed pro rata, in discharge and satisfaction of the whole debt.

In short, it’s a compromise whereby the creditors agree to take a pro rata share in the disposition of assets.

It designates an arrangement between a debtor and the whole body of his creditors for the liquidation of their claims by the dividend offered.

o Vs an accord, which is an agreement between a debtor an a single creditor for a discharge of the obligation by a part payment or on different terms.

Requirements for a valid offer of composition1. The offer must be made after the filing in the court of the schedule of

property and submission of the list of creditors2. The offer must be accepted in writing by a majority of the creditors

representing a majority of the claims which have been allowed3. It must made after depositing in such place designated by the court, the

consideration to be paid and the costs of the proceedings, and4. The terms of the composition must be approved or confined by the

court.

What are the effects?1. The consideration shall be distributed as the judge shall direct2. The insolvency proceedings shall be dismissed3. The title to the insolvent’s property shall revest in him4. The insolvent shall be released from his debts

Discharge (64-69)

What is discharge? Discharge is the formal and judicial release of an insolvent debtor from

his debts with the exception of those expressly reserved by law. This is what you pray for. It forgives you of all your sins. DOES NOT apply to corporations. Why should it? Corporations don’t

have souls (see CLV blog on partnership/joint venture agreements)

What debts are released by discharge?1. All claims, debts and liabilities, and demands set forth in the schedule,

and


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2. All claims, debts, liabilities and demands which were or might have been proved against the estate in the insolvency.

What are the legal effects of discharge?1. it releases the debtor from all claims, debts, liabilities and demand set

forth in the schedule or which were or might have been proved against his estate in insolvency. Hence, non-provable debts are not affected whether or not they were properly scheduled.

2. Operates as a discharge of the insolvent and future acquisitions, but permits mortgagees and other lien creditors to have their satisfaction out of the mortgage or subject of the lien

3. It is a special defense which may be pleaded and be a complete bar to all suits brought on any such debts, etc

4. Does not operate to release any person liable for the same debt, for or with the debtor, either as partner, indorser, surety or otherwise

5. Certificate of discharge is prima facie evidence of the fact of release and the regularity of such discharge.

Why are secured creditors not affected by the disharge? Because the law tries to protect the secured creditor.

Fraudulent preferences and transfers (70)

What is a fraudulent transfer? Any act which is intended to unlawfully favor particular creditors over the

others A creditor who becomes a creditor within the 30 day period is deemed to

have been a creditor by fraudulent preference It covers any payment, mortgages, assignments, sales, or any

conveyance when 1. Debtor is insolvent or in contemplation of insolvency2. Transaction is done within 30 days prior to the filing (whether

voluntary or involuntary)3. There is a view of giving preference to these creditors4. The creditor has reasonable cause to believe that a preference is

given to him, or that the debtor is insolvent

What is the legal effect? Transfer is void.

Are all transfers within the 30 day period a fraudulent transfer?

No. It must be in view of giving preference. Determine whether there was an equal value given and received. If

there was, then there was no fraudulent transaction to begin with. Example of not a fraudulent transfer: selling property for the proper

market value, since the cash can be used to pay off the debts.

Corporation RehabilitationBreathing new life to a corporationAM NO 00-8-10-SC

Where to file? To regular courts. The SEC no longer has its quasi-judicial powers. RTC where corporation has its principal office as indicated in the articles

of incorporation.

What kind of proceeding? In rem. Jurisdiction over the corporation and all the creditors acquired by

the publication. (compare to suspension of payments.)

What is the nature of the case? Summary and non-adversarial. File a petition, comment, and decide. You can’t file motions to dismiss, etc.

Upon motion, rules allow for protection of certain information like trade secrets.

After filing of petition, 5 days after, the court will issue a stay order.

What does the stay order do?1. Suspends everything.2. Appoints receiver3. Stays enforcement of all claims – debtors, guarantors and sureties not

solidarily liable. 4. No disposition of property except in the course of ordinary business5. No payment of liabilities except liabilities in the course of ordinary

business, administrative fees, and loans approved by the rehab committee

6. Fixes the initial hearing7. Directs publication


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8. Directs all creditors and interested parties to file and serve one the debtor a verified comment on or opposition to the position within 15 days prior to hearing.

9. Direct creditors to get copy from the court. 10. Effective against case is dismissed or plan is approved

Creditors can seek relief from the stay order upon showing that:1. Any of the allegations in the petition, or any of the contents of any

attachment, or the verification thereof has ceased to be true;2. A creditor does not have adequate protection over property securing its

claim; or3. The debtor’s secured obligation is more than the market value of the

property subject of the stay and such property is not necessary for the rehabilitation of the debtor;

4. The property covered by the stay order is not essential or necessary to the rehab and the creditor’s failure to enforce its claim will cause more damage to the creditor than to the debtor.

When does the creditor lack adequate protection?1. the debtor fails to honor a pre-existing agreement with the creditor to

keep the property insured;2. the debtor fails or refuses to take commercially reasonable steps to

maintain the property; or3. the property has depreciated to an extent that creditor is undersecured.

What will the court do in these cases?1. Make arrangements to provide for the insurance or maintenance of the

property, or2. Make payments or otherwise provide additional or replacement security

such that the obligation is fully secured. Id these aren’t feasible, the court shall modify the stay order to allow the

secured creditor lacking adequate protection to enforce its claim against the debtor, provided that the court may deny the creditor the remedies if such would prevent the continuation of the debtor as a going concern or prevent the implementation of the rehab plan.

Why is the stay order so important? Why nga ba? :P

Who is the receiver? What does he do?

The receiver is an officer of the court who oversees the operations of the debtor.

He DOES NOT take over management or the corporation. (compare to an assignee)

He is the court-appointed snitch. – Atty Lerma He is immune to suit. Usually lawyers or accountants.

What is a rehab plan? Should contain desired business targets, implementation plan, financial

commitments and how to implement the plan. Payment period should not exceed 15 years. It’s binding on all the

creditors 3 types of rehab:

1. Debtor-initiated – debtor foresees the impossibility of meeting his debts (you can file as a group of companies for the rehab of the corporation)o Debtor nominates receiverso Plan needs to be approved by 2/3 of the liabilities and more

than 50% of the secured creditors and more than 50% of the unsecured creditors

2. Creditor-initiated – creditor should be holding more than 20% of the liabilities

3. Pre-negotiated (approved by 2/3 of the liabilities and more than 50% of the secured creditors and more than 50% of the unsecured creditors)

Medyo half-baked yung stuff on Corporate Rehab. Sorry. Check the codal na lang.

Title XII. - DEPOSIT CHAPTER ONEDEPOSIT IN GENERAL AND ITS DIFFERENT KINDS Art. 1962. A deposit is constituted from the moment a person receives a thing belonging to another, with the obligation of safely keeping it and of returning the same. If the safekeeping of the thing delivered is not the principal purpose of the contract, there is no deposit but some other contract. (1758a)


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Definition of contract of deposit A deposit is constituted from the moment a person receives

o A thing belonging to anothero With the obligation of safely keeping ito And of returning the same

Characteristics of the contract1. Real contract because it is perfected by delivery of the subject matter2. Unilateral (when gratuitous) or bilateral (when it is for compensation)

Safekeeping, principal purpose of the contract The principal purpose of the contract of deposit is the safekeeping of the

thing delivered so that if safekeeping is only an accessory or secondary obligation of the recipient of the thing, deposit is not constituted but some other contract (like lease, commodatum, or agency)

The depositary cannot make use of the thing deposited except only in the two instances mentioned in Art 1977

Deposit MutuumPrincipal purpose is safekeeping or mere custody

Principal purpose is the consumption of the subject matter

Depositor can demand the return of the subject matter at will

The lender must wait until the expiration of the period granted to the debtor

Object: Both movable and immovable

Object: Only money and any other fungible thing

Deposit CommodatumPurpose: Safekeeping Purpose: Transfer of the useMay be gratuitous Essentially and always gratuitousObject: only movable (corporeal) things (extrajudicial deposit)

Object: Both movable and immovable

Art. 1963. An agreement to constitute a deposit is binding, but the deposit itself is not perfected until the delivery of the thing. (n)

Where there has been no delivery yet, there is merely an agreement to deposit which, however, is binding and enforceable upon the parties

A contract of future deposit is consensual.

Art. 1964. A deposit may be constituted judicially or extrajudicially. (1759)

A deposit may be created by virtue of a court order or by law and bot by the will of the parties.

What are the kinds of deposit?1. Judicial

Takes place when an attachment or seizure of property in litigation is ordered

2. Extrajudicial Voluntary

o Delivery is made by the will of the depositor or by two or more persons each of whom believes himself entitled to the thing deposited

Necessaryo One made in compliance with a legal obligation, or on the

occasion of any calamity, or by travelers in hotels and inns, or by travelers with common carriers

Art. 1965. A deposit is a gratuitous contract, except when there is an agreement to the contrary, or unless the depositary is engaged in the business of storing goods. (1760a)

Contract of deposit is generally gratuitous General rule: A contract of deposit is generally gratuitous Exceptions:

1. When there is contrary stipulations2. Where depositary is engaged in the business of storing goods3. Where property saved from destruction without knowledge of the

owner In involuntary deposit, where property is saved from

destruction during a calamity by another person without the knowledge of the owner, the latter is bound to pay the former just compensation

Art. 1966. Only movable things may be the object of a deposit. (1761)

What is the subject matter of a deposit? Only movable or personal property may be the object of extrajudicial

deposit, whether voluntary or necessary


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o So, delivery of the keys of a house cannot be considered as a deposit of the same, and entrusting its care and custody is, judicially, an agency.

However, Judicial deposit may cover movable as well as immovable, its purpose being to protect the rights of parties to a suit.

What about incorporeal property? This article does not embrace incorporeal or intangible property, like

rights and actions, for it follows the person of the owner, wherever he goes, and is not, by reason of its incorporeality, susceptible of custody in the tangible sense that deposit is judicially understood.

But the tangible evidence can be deposited.

Art. 1967. An extrajudicial deposit is either voluntary or necessary. (1762)

What are the kinds of extrajudicial deposit? Deposit is generally voluntary. It becomes necessary in the three cases in Articles 1996 and 1998:

1. When made in compliance with a legal obligation2. On the occasion of any calamity3. By travelers in hotels and inns4. By travelers or passengers with common carriers

CHAPTER TWOVOLUNTARY DEPOSIT SECTION ONE. – GENERAL PROVISIONS

Art. 1968. A voluntary deposit is that wherein the delivery is made by the will of the depositor. A deposit may also be made by two or more persons each of whom believes himself entitled to the thing deposited with a third person, who shall deliver it in a proper case to the one to whom it belongs. (1763)

What is a voluntary deposit? One where in the delivery is made by the will of the depositor Usually, there are only two persons involved. But sometimes, the

depositary may be a third person.

The main difference with voluntary and necessary deposit is that in the former, the depositor has complete freedom in choosing the depositary, wherein the latter, there is lack of free choice in the depositor.

Does the depositor need to be the owner of the thing? No. Generally, the depositor must be the owner of the thing deposited. But it may belong to a person other than the depositor. Thus, a carrier, commission agent, a lessee may deposit goods

temporarily in his possession considering that the contract does not involve the transfer of ownership.

As a matter of fact, the depositary cannot dispute the title of the depositor to the thing deposited. The depositary is in estoppel.

Where there are several depositors Two or more persons each claiming to be entitled to a thing may deposit

the same with a third person. In such case, the third person assumes the obligation to deliver to the one to whom it belongs.

The action to compel the depositors to settle their conflicting claims would be in the nature of an interpleader. Here, one of the depositors is not the owner. (you are NOT the father!)

Here, the third party is usually a neutral party who waits while the two other parties battle out the issue of ownership.

Art. 1969. A contract of deposit may be entered into orally or in writing. (n)

Except for the delivery of the thing, there are no formalities required for the existence of the contract.

Art. 1970. If a person having capacity to contract accepts a deposit made by one who is incapacitated, the former shall be subject to all the obligations of a depositary, and may be compelled to return the thing by the guardian, or administrator, of the person who made the deposit, or by the latter himself if he should acquire capacity. (1764)

What happens when the depositary is capacitated and the depositor is incapacitated? If the depositary is capacitated, he is subject to all the obligations of a

depositary whether or not the depositor is capacitated.


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In the latter case, the depositary must return the property to the legal representative of the incapacitated or the depositor himself if he should acquire capacity.

People who are capable cannot allege the incapacity of those with whom they contract.

Art. 1971. If the deposit has been made by a capacitated person with another who is not, the depositor shall only have an action to recover the thing deposited while it is still in the possession of the depositary, or to compel the latter to pay him the amount by which he may have enriched or benefited himself with the thing or its price. However, if a third person who acquired the thing acted in bad faith, the depositor may bring an action against him for its recovery. (1765a)

What happens when the depositary is incapacitated and the depositor is capacitated? The incapacitated depositary does not incur the obligations of a

depositary. However, he is liable:

1. To return the thing deposited while still in his possession2. To pay the depositor the amount by which he may have benefited

himself with the thing or its price subject to the right of any person who acquired the thing in good faith

Albus deposited a wand with Bruno, a minor who sold it to Caris.If Caris acted in bad faith, Albus may recover the watch from him. But if Caris acted in good faith, Albus’ only recourse is against Bruno to compel him to return the price received for the watch or the amount by which he may have benefited himself.

SECTION TWO – OBLIGATIONS OF THE DEPOSITARY

Art. 1972. The depositary is obliged to keep the thing safely and to return it, when required, to the depositor, or to his heirs and successors, or to the person who may have been designated in the contract. His responsibility, with regard to the safekeeping and the loss of the thing, shall be governed by the provisions of Title I of this Book.

If the deposit is gratuitous, this fact shall be taken into account in determining the degree of care that the depositary must observe. (1766a)

What are the two primary obligations of the depositary?1. Safekeeping of the thing2. Return of the thing when required

The degree of care a depositary must exercise over the thing deposited is the same diligence as he would exercise over his property. Why?

o It is an essential requisite of the judicial relation which involves the depositor’s confidence in his good faith and trustworthiness, and

o Because of the presumption that the depositor, in choosing the depositary, took into account the diligence which the depositary is accustomed with respect to his own property.

The depositary cannot excuse himself form liability in the event of loss by claiming that he exercised the same amount of care toward the thing deposited as he would toward his own if such care is less than that required by the circumstances.

The liability of the depositary for the care and delivery of the thing is governed by the rules on obligations.

o He is liable if the lose occurs through his fault or negligence, even if the thing was insured.

o The loss of the thing while in his possession, ordinarily raises a presumption of fault on his part.

o The required degree of care is greater if the deposit is for compensation than when it is gratuitous. But even when it is gratuitous, due care must still be exercised.

The thing deposited must be returned to the depositor whenever he claims it, even though a specified term or time for such may have been stipulated in the contract.

Art. 1973. Unless there is a stipulation to the contrary, the depositary cannot deposit the thing with a third person. If deposit with a third person is allowed, the depositary is liable for the loss if he deposited the thing with a person who is manifestly careless or unfit. The depositary is responsible for the negligence of his employees. (n)

Obligation not to transfer deposit Unless authorized by express stipulation, the depositary is not allowed

to deposit the thing with a third person because a deposit is founded on trust and confidence.

The depositary is liable for the loss of the thing deposited if


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1. He transfers the deposit with a third person without authority although there is no negligence on his part and the third person

2. He deposits the thing with a third person who is manifestly careless or unfit although authorized, even in the absence of negligence, or

3. The thing is lost through the negligence of his employees whether the latter are manifestly careless or not.

He is NOT responsible in case the thing is lost without negligence of the third person with whom he was allowed to deposit the thing if such third person is not “manifestly careless or unfit”

Art. 1974. The depositary may change the way of the deposit if under the circumstances he may reasonably presume that the depositor would consent to the change if he knew of the facts of the situation. However, before the depositary may make such change, he shall notify the depositor thereof and wait for his decision, unless delay would cause danger. (n)

Obligation not to change way of deposit General rule: Depositary may not change way of deposit Exception: If there are circumstances indicating that the depositor would

consent to the changeo However, the depositary should first notify the depositor and

wait for the latter’s decision. Notice need not be given when delay would cause

danger.

Art. 1975. The depositary holding certificates, bonds, securities or instruments which earn interest shall be bound to collect the latter when it becomes due, and to take such steps as may be necessary in order that the securities may preserve their value and the rights corresponding to them according to law.

The above provision shall not apply to contracts for the rent of safety deposit boxes. (n)

Obligation to collect interest If the thing deposited should earn interest, the depositary is under the

obligation to:1. To collect the interest as it becomes due

2. To take such steps as may be necessary to preserve its value and the rights corresponding to it

3. To collect not only the interest but also the capital itself when due

Contract for rent of safety deposit boxes A contract for the rent of safety deposit boxes is not an ordinary contract

of lease of things but a special kind of deposit, hence it is not to be strictly governed by the provisions of deposit

The prevailing rule in the US is that the relation between a bank renting out safe-deposit boxes and its customer with respect to the contents of the box is that of bailor and bailee

Case doctrine Any stipulation exempting the depositary of liability is void.

Art. 1976. Unless there is a stipulation to the contrary, the depositary may commingle grain or other articles of the same kind and quality, in which case the various depositors shall own or have a proportionate interest in the mass. (n)

Obligation not to commingle things deposited if so stipulated General rule: The depositary is permitted to commingle grain or other

articles of the same kind and quality. In such case, the various depositors of the mingled goods shall own the

entire mass in common and each depositor shall be entitled to such portion of the entire mass as the amount deposited by him bears to the whole.

Exception: When it is so stipulated that he can’t commingle.

Art. 1977. The depositary cannot make use of the thing deposited without the express permission of the depositor.

Otherwise, he shall be liable for damages.However, when the preservation of the thing deposited

requires its use, it must be used but only for that purpose. (1767a)

Obligation not to make use of thing deposited unless authorized General rule: Depositary cannot make use of thing deposited. Exceptions:

1. When he is has the express permission of the depositor


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2. When the preservation of the thing deposited requires its use, but it must be used only for that purpose

Art. 1978. When the depositary has permission to use the thing deposited, the contract loses the concept of a deposit and becomes a loan or commodatum, except where safekeeping is still the principal purpose of the contract.The permission shall not be presumed, and its existence must be proved. (1768a)

What if the permission to use is given? If thing deposited is non-consumable, the contract loses the character of

a deposit and becomes a commodatum despite the fact that the parties may have denominated it as a deposit, unless safekeeping is still the principal purpose of the contract.

If the thing deposited is money or other consumable thing, the permission to use it will result in its consumption and converts the contract into a simple loan or mutuum. But if safekeeping is still the principal purpose of the contract, it is still a deposit, but an irregular deposit. Bank deposits are in the nature of irregular deposits but they are really loans governed by the law on loans.

Atty Lerma: The use must still be for preservation.

Irregular Deposit MutuumMay be demanded at will by the irregular depositor for whose benefit the deposit has been constituted

Lender is bound by the provisions of the contract and cannot seek restitution until time for payment, as provided in the contract has arisen

Only benefit is that which accrues to the depositor

Essential cause for the transaction is the necessity of the borrower. A loan with a stipulation to pay interest is for the benefit of both parties

Depositor has preference over other creditors

Common creditors enjoy no preference in the distribution of the debtor’s property

If a depositary appropriated to his personal benefit money deposited, he is liable for estafa. Failure to claim at one or delay for some time demanding restitution of the thing deposited, which was immediately due, does no imply such persmission to use the thing deposited as would covert the deposit into a loan. (US v Igpuara)

Art. 1979. The depositary is liable for the loss of the thing through a fortuitous event:

(1) If it is so stipulated;(2) If he uses the thing without the depositor's permission; (3) If he delays its return; (4) If he allows others to use it, even though he himself may

have been authorized to use the same. (n)

Liability for loss through fortuitous event General rule: Depositary is not liable for loss through a fortuitous event

without his fault. Exceptions: The 4 instances in this article.

Loss due to fortuitous event Not due to fortuitous eventGeneral rule: Depositor bears the loss.Exception:

1. Stipulated2. Use without consent3. Delay4. Allows others to use it

(Art 1979)

Palacio case states that the depositary must prove the fortuitous event.

Presumption: Depositary is at fault (Art 1265)

Art. 1980. Fixed, savings, and current deposits of money in banks and similar institutions shall be governed by the provisions concerning simple loan. (n)

Relation between bank and depositor Deposits of money in banks, whether fixed, savings, and current, are

really loans to a bank because the bank can use the same for its ordinary transactions and for the banking business in which it is engaged.

Bank deposits are in the nature of irregular deposits; they are really loans because they earn interest.


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Such deposits are governed by the provisions on mutuum or simple loan.

The relation between a depositor and a bank is that of a creditor and a debtor.

The general rule is that a bank can compensate or set off the deposit in its hands for the payment of any indebtedness to it on the part of the depositor.

o In a true deposit, compensation is not allowed. The money received is termed a “deposit”, although it is not strictly so, as the depositor does not expect to receive the identical money in return but an equivalent sum.

A bank which had fallen into a distressed financial situation by order of the Central Bank cannot excuse it from its obligations to depositors who had nothing whatever to do with the Central Bank actuations or the events leading to the bank’s distressed state. (Serrano v CBP)

Claims for recovery of time deposits from a distressed bank and recovery of damages are not proper in actions for mandamus and prohibition but should be ventilated in the Court of First Instance by the proper party. (Serrano)

A bank deposit is an irregular deposit so there is not breach of trust to talk about. (Serrano)

Art. 1981. When the thing deposited is delivered closed and sealed, the depositary must return it in the same condition, and he shall be liable for damages should the seal or lock be broken through his fault.

Fault on the part of the depositary is presumed, unless there is proof to the contrary.

As regards the value of the thing deposited, the statement of the depositor shall be accepted, when the forcible opening is imputable to the depositary, should there be no proof to the contrary. However, the courts may pass upon the credibility of the depositor with respect to the value claimed by him.

When the seal or lock is broken, with or without the depositary's fault, he shall keep the secret of the deposit. (1769a)

Art. 1982. When it becomes necessary to open a locked box or receptacle, the depositary is presumed authorized to do so, if the key has been delivered to him; or when the instructions of the depositor as regards the deposit cannot be executed without opening the box or receptacle. (n)

Where thing deposited is delivered closed and sealed The obligations of the depositary when the thing is delivered closed and

sealed are:1. Return the thing deposited when delivered closed and sealed, in

the same condition2. Pay for damages should the seal or lock be broken through his fault

which is presumed unless proved otherwise3. Keep the secret of the deposit when the seal or lock is broken, with

or without his fault The depositary is authorized to open the thing which is closed and

sealed when there is:1. Presumed authority (if the key has been delivered to him or when

the instructions cannot be executed without opening the box or receptacle); or

2. Necessity.

Art. 1983. The thing deposited shall be returned with all its products, accessories and accessions.

Should the deposit consist of money, the provisions relative to agents in article 1896 shall be applied to the depositary. (1770)

Obligation to return products, accessories, and accessions The depositary must return not only the thing itself but also all its

products, accessions and accessories which are a consequence of ownership.

Obligation to pay interest on sums converted to personal use If what has been deposited is money, the depositary has no right to

make use thereof and therefore he is not liable to pay interest If the depositary be in delay or has used the money without permission,

he shall be liable for interest as indemnity. The depositary owes interest on the sums he has applied to his own use

from the day on which he did so, and those which he still owes after the extinguishment of the deposit.

Art. 1984. The depositary cannot demand that the depositor prove his ownership of the thing deposited.

Nevertheless, should he discover that the thing has been stolen and who its true owner is, he must advise the latter of the deposit.


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If the owner, in spite of such information, does not claim it within the period of one month, the depositary shall be relieved of all responsibility by returning the thing deposited to the depositor.

If the depositary has reasonable grounds to believe that the thing has not been lawfully acquired by the depositor, the former may return the same. (1771a)

Depositor need not prove his ownership The depositary who receives the thing in deposit cannot require that the

depositor prove his ownership over the thing To constitute a deposit, it is not essential that the depositor be the

owner of the thing deposited

What happens when a third person appears to be the owner? The depositor should:

o Advise the true owner of the deposito If the true owner does not claim it within one month, the

depositary shall be relieved of all responsibility by returning the thing deposited to the depositor

o If the depository has reasonable ground to believe that the thing has not been lawfully acquired by the depositor, the former may return the same

Paragraph 2 and 4 are similar except that for the application of paragraph 2, two conditions must exist:1. The thing deposited must be stolen, and2. The depositary knows who its true owner is

Art. 1985. When there are two or more depositors, if they are not solidary, and the thing admits of division, each one cannot demand more than his share.

When there is solidarity or the thing does not admit of division, the provisions of Articles 1212 and 1214 shall govern. However, if there is a stipulation that the thing should be returned to one of the depositors, the depositary shall return it only to the person designated. (1772a)

Right of two or more depositors If the thing deposited is divisible and there are two or more depositors

who are not solidary, each one can demand only his share proportionate thereto.

If the obligation is solidary, or if the thing is not divisible, the rules on active solidarity shall apply, to the effect that each one of the solidary depositors may do whatever may be useful to the others but not anything which may be prejudicial to the latter. (Review your oblicon!)

If by stipulation the thing should be returned to one of the depositors, the depositary is bound to return it only to the person designated although he has not made any demand for its return.

Art. 1986. If the depositor should lose his capacity to contract after having made the deposit, the thing cannot be returned except to the persons who may have the administration of his property and rights. (1773)

Person to whom return must be made The depositary is obliged to return the thing deposited, when required,

to the depositor, to his heirs and successors, or to the person who may have been designated in the contract.

If the depositor was incapacitated at the time of making the deposit, the property must be returned to his guardian or administrator or the person who made the deposit or the to the depositor himself should he acquire capacity.

Even if the depositor had capacity at the time of making the deposit but he subsequently loses his capacity during the deposit, the thing must be returned to his legal representative.

Art. 1987. If at the time the deposit was made a place was designated for the return of the thing, the depositary must take the thing deposited to such place; but the expenses for transportation shall be borne by the depositor.

If no place has been designated for the return, it shall be made where the thing deposited may be, even if it should not be the same place where the deposit was made, provided that there was no malice on the part of the depositary. (1774)

Place of return The thing must be returned:

1. At the place agreed upon by the parties, and2. In the absence of stipulation, at the place where the thing deposited

might be even if it should not be the same place where the original


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deposit was made, provided the transfer was accomplished without malice on the part of the depositary.

In the first case, the expenses for the transportation shall be borne by the depositor. This is just because the deposit is constituted for the benefit of the depositor and not the depositary who assumes no more than the safekeeping and the return of the thing.

Art. 1988. The thing deposited must be returned to the depositor upon demand, even though a specified period or time for such return may have been fixed.

This provision shall not apply when the thing is judicially attached while in the depositary's possession, or should he have been notified of the opposition of a third person to the return or the removal of the thing deposited. In these cases, the depositary must immediately inform the depositor of the attachment or opposition. (1775)

Time of return General rule: The depositor can demand the return of the thing

deposited at will and this is true whether a period has been stipulated or not. (But the period is generally binding upon the depositary)

If the deposit is for compensation, the depositary is entitled to the compensation corresponding to the entire period. In this case, the period is also for the benefit of the depositary.

Compare this to the rule in commodatum (1946: Generally, the bailor cannot demand the return of thing before the period expires.)

When depositary not obliged to return thing deposited The right to immediate restitution is subject to these two cases:

1. When the thing is judicially attached while in the depositary’s possession, or

2. When the depositary has been notified of the opposition of a third person to the return or the removal of the thing deposited

In the first case, if the depositor returns the thing, he would be disobeying the judicial order of attachment.

Art. 1989. Unless the deposit is for a valuable consideration, the depositary who may have justifiable reasons for not keeping the thing deposited may, even before the time designated, return it to the

depositor; and if the latter should refuse to receive it, the depositary may secure its consignation from the court. (1776a)

Right of depositary to return thing deposited The depositary may return the thing deposited notwithstanding that a

period has been fixed for the deposit if:1. The deposit is gratuitous, AND2. Justifiable reasons exist for its return.

o In case the depositor refuses to receive the thing, the depositary may deposit the thing at the disposal of judicial authority.

If the deposit is for a valuable consideration, the depositary has NO right to return the thing deposited before the expiration of the time designated even if he should suffer inconvenience as a consequence. He is bound by the period and restitution before its expiration constitutes a breach of his obligation.

Art. 1990. If the depositary by force majeure or government order loses the thing and receives money or another thing in its place, he shall deliver the sum or other thing to the depositor. (1777a)

Liability for loss by force majeure or government order The depositary has the obligation to return the thing deposited. But he is not liable for loss of the thing by force majeure or by

government order. However, if in place of the thing he receives money or another thing, he

has the duty to deliver to the depositor what he has received otherwise, he would enrich himself at the expense of the depositor.

Read with Article 1979.

Art. 1991. The depositor's heir who in good faith may have sold the thing which he did not know was deposited, shall only be bound to return the price he may have received or to assign his right of action against the buyer in case the price has not been paid him. (1778)

Alienation in good faith by depositary’s heir The obligation of the heir is limited to the return of the price received or

to assign the right to collect the same if it has not been paid and not the real value of the thing.

But if the heir acts in bad faith, he is liable for damages.


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Believing in good faith that the thing deposited by Albus with Barney, worth P1000 belong to Barney, Charlie (heir of Albus), sold the thing to Draco who paid him P800.Charlie is bound to return to Albus P800, the price he received (and not the P1000).If Charlie acted in bad faith, he is liable to pay Albus P1000 plus damages which Albus may have suffered. Charlie is also liable for estafa.

In summary, what are the obligations of the depositary?1. Keep the thing and return it (1972)2. Not to transfer deposit, unless authorized by express stipulation (1973)3. Not to change way of deposit, unless for circumstances where the

depositor would probably consent (1974)4. To collect interest and take steps to preserve the value of securities

(1975)5. Not to commingle things deposited if so stipulated (1976)6. Not to make use of thing deposited, unless authorized or if needed to

preserve it (1977)7. When delivered closed and sealed, to return the thing in the same

condition; and if opened, to keep the secret of the deposit (1981)8. Return products, accessories and accessions (1983)9. Pay interest on sums converted to personal use (1983)

SECTION THREE – OBLIGATIONS OF THE DEPOSITOR

Art. 1992. If the deposit is gratuitous, the depositor is obliged to reimburse the depositary for the expenses he may have incurred for the preservation of the thing deposited. (1779a)

Obligation to pay expenses for preservation The above article applies only if the deposit is gratuitous. Without the duty of reimbursement imposed by the article, the depositor

would be enriching himself at the expense of the depositary. Compare with the rule in commodatum (1941 - Bailee pays and has no

right to reimbursement) The right to reimbursement coves all expenses for preservation,

whether ordinary or extraordinary expenses. The law refers to necessary expenses; so useful and luxurious

expenses are not covered.

Deposit for compensation If the deposit is for a valuable consideration, he expenses of

preservation are borne by the depositary because they are deemed included in the compensation. There can, however, be a contrary stipulation.

Art. 1993. The depositor shall reimburse the depositary for any loss arising from the character of the thing deposited, unless at the time of the constitution of the deposit the former was not aware of, or was not expected to know the dangerous character of the thing, or unless he notified the depositary of the same, or the latter was aware of it without advice from the depositor. (n)

Obligation to pay losses incurred due to character of thing deposited General rule: The depositary must be reimbursed for loss suffered by

him because of the character of the thing deposited. Exceptions: The depositor is freed from responsibility, when Aa the time

of the constitution of the thing:1. The depositor was not aware of, or 2. Was not expected to know the dangerous character of the thing, or3. Unless he notified the depositary of the same, or4. The depositary was aware of it without the advice from the

depositor.

Query: Albus deposited his pet crocodile with Bruno. The crocodile lashed out at Bruno and tore out his arm. Is Albus liable?

Art. 1994. The depositary may retain the thing in pledge until the full payment of what may be due him by reason of the deposit. (1780)

Depositary’s right of retention This is actually an example of a pledge created by the operation of law. The thing retained serves as security for the payment of what ma be

due to the depositary by reason of the deposit (1965-compensation, 1992 and 1993-reimbursement for expenses and losses)

The rule is different in commodatum (1951 - where the bailee’s right of retention only arises from damages by reason of defects)

Art. 1995. A deposit its extinguished:(1) Upon the loss or destruction of the thing deposited;


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(2) In case of a gratuitous deposit, upon the death of either the depositor or the depositary. (n)

These causes are not exclusive. If the deposit is gratuitous, the death of either the depositor or

depositary extinguishes the deposit.o The law really means that the depositary is not obliged to

continue with the contract of deposit. If it is for compensation, the deposit is not extinguished by the death of

either party because it is an onerous deposit, and not personal in nature.

o Hence, the rights and obligations arising therefrom are transmissible to their respective heirs.

CHAPTER 3NECESSARY 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. (1781a)

Art. 1997. The deposit referred to in No. 1 of the preceding article shall be governed by the provisions of the law establishing it, and in case of its deficiency, by the rules on voluntary deposit.

The deposit mentioned in No. 2 of the preceding article shall be regulated by the provisions concerning voluntary deposit and by Article 2168. (1782)

When deposit is necessary1. Made in compliance with a legal obligation2. Takes place on the occasion of any calamity3. Made by travelers in hotels or inns4. Made by passengers with common carriers

Some examples of necessary deposit in compliance with a legal obligation Judicial deposit of a thing the possession of which is being disputed in

litigation Deposit of a thing pledged when the creditor uses the same without the

authority of the owner or misuses it in any other way See book for other examples

A deposit made in compliance with law is governed primarily by the provisions of such law, and in default thereof, by the rules on voluntary deposit.

Necessary deposit made on the occasion of any calamity The possession of movable property passes from one person to another

by accident or fortuitously through force of circumstances and which the law imposes on the recipient the obligations of a bailee. (If Zico saves Albus’ tv in a flood, Zico is supposed to be its depositary.)

Such a quasi-bailment is ordinarily distinguished by the name involuntary bailment or involuntary deposit.

In cases like these, the owner is bound to pay the other person just compensation (Art 2168)

Art. 1998. The deposit of effects made by the travellers in hotels or inns shall also be regarded as necessary. The keepers of hotels or inns shall be responsible for them as depositaries, provided that notice was given to them, or to their employees, of the effects brought by the guests and that, on the part of the latter, they take the precautions which said hotel-keepers or their substitutes advised relative to the care and vigilance of their effects. (1783)

Art. 1999. The hotel-keeper is liable for the vehicles, animals and articles which have been introduced or placed in the annexes of the hotel. (n)

Deposit by travelers in hotels and inns Before keepers of hotels or inns may be held responsible as

depositaries with regard to the effects of their guests, the following elements must concur:1. They have been previously informed about the effects brought by

their guests; and2. The latter have taken the precautions prescribed regarding their

safekeeping.

Extent of liability of keepers of hotels and inns The liability is not limited to effects lost or damged in the hotel rooms,

but include those lost or damaged in hotel annexes such as vehicles in the hotel’s garage

The responsibility imposed extends to all those who offer lodging for a compensation, whatever may be their character.


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Terms shmerms “Travelers” and “gusts” are synonymous. It refers to transients and not

to boarders. Boarders are governed by the rules on lease. “Hotel-keeper” and “inn-keeper” are also synonymous. For the definitions of “hotel”, “inn” and “motel”, consult your dictionary.

Art. 2000. The responsibility referred to in the two preceding articles shall include the loss of, or injury to the personal property of the guests caused by the servants or employees of the keepers of hotels or inns as well as strangers; but not that which may proceed from any force majeure. The fact that travellers are constrained to rely on the vigilance of the keeper of the hotels or inns shall be considered in determining the degree of care required of him. (1784a)

Art. 2001. The act of a thief or robber, who has entered the hotel is not deemed force majeure, unless it is done with the use of arms or through an irresistible force. (n)

Art. 2002. The hotel-keeper is not liable for compensation if the loss is due to the acts of the guest, his family, servants or visitors, or if the loss arises from the character of the things brought into the hotel. (n)

When, oh when, is the hotel-keeper liable? The hotel keeper is liable regardless of the amount of care exercised, in

the following cases:1. The loss or injury caused by his servants or employees as well as

by strangers, provided that notice has been given and proper precautions taken; and

2. The loss is caused by the act of a thief or robber done without the use of arms and irresistible force, for in this case, the hotel-keeper is apparently negligent.

When is the hotel-keeper not liable?1. The loss or injury is caused by force majeure, theft or robbery by a

stranger with the use of arms or irresistible force, unless he is guilty of fault or negligence in failing to provide against the loss or injury from his cause

2. The loss is due to the acts of the guests, his family, servants, or visitors, and

3. The loss arises from the character of the things brought into the hotel.

Art. 2003. The hotel-keeper cannot free himself from responsibility by posting notices to the effect that he is not liable for the articles brought by the guest. Any stipulation between the hotel-keeper and the guest whereby the responsibility of the former as set forth in articles 1998 to 2001 is suppressed or diminished shall be void. (n)

Exemption or diminution of liability Any stipulation to that effect is void. Hotel-keepers and inn-keepers should be subject to an extraordinary

degree of responsibility for the protection and safety of travelers who have no alternative but rely on the good faith and care of those with whom they take lodging.

In fact, authorities are to the effect that it is not necessary in order to hold an inn-keeper liable that the effects of the guests be actually delivered to him or his employees; it is enough that they are within the inn (De Los Santos v Tan Khey – case where the pants were stolen)

Art. 2004. The hotel-keeper has a right to retain the things brought into the hotel by the guest, as a security for credits on account of lodging, and supplies usually furnished to hotel guests. (n)

Hotel-keepers right to retain The right of retention recognized in this article is in the nature of a

pledge created by operation of law. It is given to the hotel-keepers to compensate them for the liabilities

imposed upon them by law.

CHAPTER 4SEQUESTRATION OR JUDICIAL DEPOSIT Art. 2005. A judicial deposit or sequestration takes place when an attachment or seizure of property in litigation is ordered. (1785)

Art. 2006. Movable as well as immovable property may be the object of sequestration. (1786)

Art. 2007. The depositary of property or objects sequestrated cannot be relieved of his responsibility until the controversy which gave rise thereto has come to an end, unless the court so orders. (1787a)


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Art. 2008. The depositary of property sequestrated is bound to comply, with respect to the same, with all the obligations of a good father of a family. (1788)

When does judicial deposit take place? Judicial deposit or sequestration takes place when an attachment or

seizure of property in litigation is ordered by a court.

Nature and purpose of judicial deposit The deposit is judicial because it auxiliary to a case pending in court The purpose is to maintain the status quo during the pendency of the

litigation or to insure the right of the parties to the property in case of a favorable judgment

Obligation of depositary of sequestrated property The depositary of sequestrated property is the person appointed by the

court. He has the obligation to take care of the property with the diligence of a

good father of a family and he may not be relieved of his responsibility until the litigation is ended or the court so orders.

Judicial ExtrajudicialCause Will of the court Will of the parties,

contractualPurpose Security and to secure

the right of a party to recover in case of a favorable judgment

Custody and safekeeping of the thang (whut up?!)

Subject matter Movable or immovable Only movableremuneration Always onerous May be compensated or not,

but generally gratuitousIn whose behalf it is held

Behalf of the person who, by the judgment, has a right

Behalf of the depositor or third person designated

Art. 2009. As to matters not provided for in this Code, judicial sequestration shall be governed by the Rules of Court. (1789)

Chart Commodatum Mutuum Deposit Barter

(1954)Object Not

consumable; real or personal

Money of other consumable thing; personal

Movable (corporeal) and immovable (judicial deposit)

Non-consumable

Purpose Use or temporary possession

Consumption Safekeeping

Exchange or commerce

Primary obligation of the bailee/depositary

Must return the same thing loaned

Need only pay the same amount, kind and quality

Safekeeping and return when required

Equivalent thing is given in return for what has been received

Status of ownership of the thing given

Not transferred

Transferred Not transferred

Transferred

Ability of owner of the thing given to demand return

May demand the return of the thing before the expiration of term in case of urgent need

May not demand its return before the lapse of the term

May demand the return of the thing at will

n/a

Compensation Essentially gratuitous

Gratuitous or onerous

Gratuitous or onerous

Onerous

GOOD LUCK! Refuse on one the good on which he has a claim when it is in your power to do it for him. Say not to your neighbor “Go, and come again, tomorrow, I will give,” when you can give at once. Plot no evil against your neighbor, against him who lives at peace with you. Quarrel not with a man without cause, with one who has done you no harm. Envy not the lawless man and choose none of his ways;To the Lord the perverse man is an abomination; but with the upright is his friendship. – Proverbs 4:27-32


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