Credit Transactions Reviewer

INTRODUCTION MEANING AND SCOPE OF CREDIT TRANSACTIONS Credit transactions include all transactions involving the purchase or loan of goods, services, or money in the present with a promise to pay or deliver in the future. TWO TYPES OF CREDIT TRANSACTIONS/ CONTRACTS OF SECURITY

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

2. Unsecured transactions or contracts of personal security – fulfillment by the debtor is supported only by a promise to pay or the personal commitment of another EXAMPLES OF CREDIT TRANSACTIONS 1. 2. 3. 4. 5.

Bailment contracts Contracts of guaranty and suretyship Mortgage Antichresis Concurrence and preference of credits

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

1. Personal Security - when an individual becomes a surety or a guarantor 2. Property or Real Security – when a mortgage, pledge, antichresis, charge, or lien or other device used to have property held, out of which the person to be made secure can be compensated for loss. BAILMENT Bailment (def). The delivery of property of one person to another in trust for a specific purpose, with a contract, that the trust shall be faithfully executed and the property returned or duly accounted for when the special purpose is accomplished or kept until the bailor reclaims it. To be legally enforceable, a bailment must contain all the elements of a valid contract, which are consent, object, and cause or consideration. However, a bailment may also be created by operation of law. PARTIES IN BAILMENT

1. Bailor – the giver; the one who delivers the possession of the thing bailed 2. Bailee – the recipient; the one who receives the possession or custody of the thing delivered KINDS OF BAILMENT 1. For the sole benefit of the bailor Examples: gratuitous deposit and mandatum (bailment of goods where the bailee gratuitously undertakes to do some act with respect to the property)

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Ex. My tito from the States makes padala a balikbayan box filled with spam through another relative who’s flying to the Philippines on vacation. It only benefits my tito (the bailor). Or, Helen deposits Polsci’s baby chair with the mysterious little guy who doesn’t smile in the bag depository counter outside the lib. In this case, only Helen benefits (based on a true story). 2. For the sole benefit of the bailee Examples: commodatum and gratuitous simple loan or mutuum Ex. Xilca borrows my white blouse because she forgot to bring clothes to change from her Pasay City Jail outfit. Only Xilca is benefited, not me. Or, Xilca borrows P10 from me without interest. 3. For the benefit of both parties Examples: deposit for a compensation, involuntary deposit, pledge, bailments for hire Ex. Ansky pawns her huge diamond earrings at Villarica Pawnshop. The pawnshop gives her P10,000 and a pawn ticket. Both parties benefit – Ansky gets fast cash, while the pawnshop gets to keep the huge diamond earrings to make sure that Ansky pays, and in case she doesn’t they can sell the earrings. 1 and 2 are gratuitous bailments. There is no consideration because they are considered more as a favor by one party to the other. Bailments under number 3 are mutual-benefit bailments, and they usually result from business transactions. BAILMENT FOR HIRE Bailment for hire arises when goods are left with the bailee for some use or service by him always for some compensation. KINDS OF BAILMENT FOR HIRE

1. Hire of things – goods are delivered for the temporary use of the hirer 2. Hire of service – goods are delivered for some work or labor upon it by the bailee 3. Hire for carriage of goods – goods are delivered either to a common carrier or to a private person for the purpose of being carried from place to place

4. Hire of custody – goods are delivered for storage

I. LOAN GENERAL PROVISIONS Art. 1933. By the contract of loan, one of the parties delivers to another, either something not consumable so that the latter may use the same for a certain time and return it, in which case the contract is called a commodatum; or money or other consumable thing, upon condition that the same amount of the same kind and quality shall be paid, in which case the contract is simply called a loan or mutuum. Commodatum is essentially gratuitous. Simple loan may be gratuitous or with a stipulation to pay interest. In commodatum the bailor retains the ownership of the thing loaned, while in simple loan, ownership passes to the borrower. Art. 1934. An accepted promise to deliver something by way of commodatum or simple loan is binding upon the parties, but the commodatum or simple loan itself shall not be perfected until the delivery of the object of the contract.

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ESSENTIAL ELEMENTS OF A CONTRACT Consent of the parties Object Cause or Consideration

IN THE CONTEXT OF A LOAN Borrower and Lender Property For the lender: right to demand the return of the thing For the borrower: acquisition of the thing

CHARACTERISTICS OF THE CONTRACT OF LOAN

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

2. A unilateral contract – once the subject matter has been delivered, it creates obligations on the part of only one of the parties (the borrower) CAUSE OR CONSIDERATION IN A CONTRACT OF LOAN 1. 2.

As to the borrower: the acquisition of the thing As to the lender: the right to demand its return or of its equivalent

KINDS OF LOAN

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

2. Simple loan or mutuum – where the lender delivers to the borrower money or other consumable thing upon the condition that the latter shall pay the same amount of the same kind and quality. LOANS DISTINGUISHED FROM CREDIT Credit means the ability of an individual to borrow money or things by virtue of the confidence or trust reposed by a lender that he will pay what he may promise within a specified period. Loan means the delivery by one party and the receipt by the other party of a given sum of money or other consumable thing upon an agreement to repay the same amount of the same kind and quality, with or without interest. Õ The concession of a credit necessarily involves the granting of loans up to the limit of the amount fixed in the credit. As opposed to debt, credit is a debt considered from the creditor’s standpoint. It is that which is due to any person.

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DISTINCTIONS BETWEEN COMMODATUM AND SIMPLE LOAN SUBJECT MATTER

COMMODATUM Not consumable

OWNERSHIP GRATUITOUS?

Retained by the lender Gratuitous

PAYMENT BY BORROWER

Borrower must return the same thing loaned

KIND OF PROPERTY PURPOSE WHEN LENDER MAY DEMAND

Real or personal Temporary use or possession Lender may demand return of the thing before the expiration of the term in case of urgent need Suffered by the lender (since he is the owner)

LOSS OF THE THING

SIMPLE LOAN Money or other consumable thing Transferred to the borrower Default rule is that it is gratuitous BUT the parties may stipulate interest, in which case, it becomes onerous Borrower need only pay the same amt of the same kind and quality Personal only Consumption Lender may not demand return of the thing before the lapse of the term agreed upon Suffered by the borrower even if through fortuitous event

Õ In commodatum, if you do not return the thing when it is due, you will be liable for estafa because ownership of the property is not transferred to the borrower. Õ In loan, the borrower who does not pay is not criminally liable for estafa. His liability is only a civil liability for the breach of the obligation to pay. This is because in loan, ownership of the thing is transferred to the borrower, so there is no unlawful taking of property belonging to another. ACCEPTED PROMISE TO MAKE A FUTURE LOAN Borrower goes to Lender and asks if he could borrow P10K at 6% interest per annum. Lender says okay, I will lend you the money. This is an accepted promise to make a future loan. It is a consensual contract and is binding upon the parties. But is there a contract of loan at this point? No, because loan is a real contract and is perfected only upon delivery of the thing. FORM OF LOAN There are no formal requisites for the validity of a contract of loan except if there is a stipulation for the payment of interest. A stipulation for the payment of interest must be in writing.

CHAPTER 1 COMMODATUM Art. 1935. The bailee in commodatum acquires the use of the thing loaned but not its fruits; if any compensation is to be paid by him who acquires the use, the contract ceases to be a commodatum. KINDS OF COMMODATUM 1. 2.

Ordinary commodatum Precarium – one whereby the bailor may demand the thing loaned at will

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

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

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

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

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

6. It is purely personal in character. The consequences of this are the following: a. The death of either party extinguishes the contract unless there is a contrary stipulation for the commodatum to subsist until the purpose is accomplished

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

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

7. The parties may stipulate that the borrower may use the fruits of the thing, but this must only be incidental to the use of the thing itself (because if it is the main cause, the contract may be one of usufruct). OBLIGATIONS OF THE BORROWER

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

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

a. if he devotes the thing to a purpose different from that for which it was loaned (bad faith)

this is a breach of the tenor of the obligation

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

c. if the thing loaned has been delivered with appraisal of its value unless there is a stipulation exempting the bailee from responsibility in case of a fortuitous event is equivalent to an assumption of risk; Sheryl IID 2002

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this

d. if he lends or leases the thing to a third person who is not a member of his household

also a breach of the tenor of the obligation;

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

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

4. Obligation to return the thing loaned – The borrower must return the thing as soon as the period stipulated expires or the purpose has been accomplished. He cannot keep the thing as security for anything that the lender may owe him, except for a claim for damages suffered because of the flaws of the thing loaned. So for example, Xilca earlier won a bet with Cayo, as a result of which, Cayo owes her a tuna sandwich. Cayo loaned Alvin Ang’s Frisbee to Xilca for 10 days. At the end of the 10 days, Xilca cannot refuse to return Alvin Ang’s frisbee to Cayo and hold it hostage until Cayo delivers the sandwich. Why? Because Xilca’s obligation as a borrower is to return the thing after the period expires, and she cannot keep it as a security for anything that Cayo may owe her. Or, Xilca borrows Kim Chong’s car for 10 days. While the car is in Xilca’s possession, a tire explodes. Xilca has to buy a new tire for P3,000. At the end of the 10 days, Xilca refuses to return the car unless Kim Chong pays her the P3,000. Can Xilca refuse to return? No. In this case, Kim Chong owes Xilca P3,000 as an extraordinary expense for the preservation of the thing. But even if Kim Chong owes Xilca money in connection with the thing that he loaned, Xilca still cannot retain the car as security. Exception: If the thing loaned has hidden defects and the borrower suffers damages as a result of the hidden defect, the borrower can claim damages against the lender. Pending payment of the damages by lender to borrower, borrower can keep the thing as a security. (see discussion below)

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

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

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

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

b.

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

BUT, the lender may not demand the thing capriciously, arbitrarily, or whimsically, since this would give rise to an action on the part of borrower for abuse of right under Articles 19, 20, and 21. Sheryl IID 2002

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3. Right to demand return of thing for acts of ingratitude – If the borrower commits any of the acts enumerated in Art. 765 of the Civil Code, the lender may demand the immediate return of the thing from the borrower. (This applies to ordinary commodatum, since in precarium the lender can demand at will, subject to the provisions against abuse of right) 4. Obligation to refund extraordinary expenses

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

b. Extraordinary expenses arising from actual use of the thing – Extraordinary expenses arising on the occasion of the actual use of the thing shall be borne by the lender and borrower on a 50-50 basis, unless there is a contrary stipulation. 5. All other expenses are for the account of the borrower.

6. Liability for damages for known hidden flaws - Requisites: (F-HADD) a. b. c. d. e.

There is a flaw or defect in the thing loaned; The flaw or defect is hidden The lender is aware of the flaw The lender does not advise the borrower of the flaw The borrower suffers damages by reason of the flaw or defect

The lender is penalized for his failure to disclose a hidden flaw which causes damage because he is in a position to prevent the damage from happening. (HOT TIP) Example: Borrower borrows a 1970 Mitsubishi Lancer from Lender. Unfortunately, Lender forgets to tell borrower that the car has a tendency to overheat after 10 minutes. So Borrower drives, and after 10 minutes, the car stalls and overheats. Borrower opens the hood and sees lots of steam. He opens the radiator cap to put water inside. Radiator water scalds his face, and he suffers from burns. Can he claim damages from Lender and can he keep the car as security? No, because in this case, Buyer should have known. He was, at least, in a position to know that the car just might be prone to overheating since it was old already. And when he opened the hood and saw lots of steam, he should have known that if he opened the radiator, very hot water would spray out. He should have taken precautions when he opened the hood or he should have gone to a gas station or mechanic to have it fixed. But since he was negligent, he has only himself to blame for the damage caused. The defect was not really hidden since Borrower was in a position to know of it even if Lender did not inform him. Had he been more careful, he would not have been scalded. ABANDONMENT OF THING BY THE LENDER Can the lender tell Borrower: I don’t want to pay for the extraordinary expenses and damages that I owe you. Just keep the thing, and let’s forget about my obligation. No. The lender cannot exempt himself from the payment of the expenses or damages by abandoning the thing to the borrower. This is because the expenses and damages may exceed the value of the thing loaned, and it would, therefore, be unfair to allow the lender to just abandon the thing instead of paying for the expenses and damages.

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CHAPTER 2 SIMPLE LOAN OR MUTUUM DEFINITION Simple loan (def). A contract whereby one of the parties delivers to another money or other consumable thing with the understanding that the same amount of the same kind and quality shall be paid. A simple loan involves the payment of the equivalent and not the identical thing because the borrower acquires ownership of the thing loaned. The term “return” is not used since the distinguishing character of the simple loan from commodatum is the consumption of the thing. CONSIDERATION What is the consideration in this kind of contract? The promise of the borrower to pay is the consideration for the obligation of the lender to furnish the loan. NO CRIMINAL LIABILITY FOR ESTAFA FOR FAILURE TO PAY There is no criminal liability for failure to pay a simple loan because the borrower acquires ownership of the thing. FUNGIBLE AND CONSUMABLE THINGS Fungible things (def). Those which are usually dealt with by number, weight, or measure, so that any given unit or portion is treated as the equivalent of any other unit or portion. Those which may be replaced by a thing of equal quality and quantity. (ex. Rice, oil, sugar). If it cannot be replaced with an equivalent thing, then it is non-fungible. Consumable things (def). Those which cannot be used without being consumed. Õ Whether a thing is consumable or not depends upon its nature. Whether a thing is fungible or not depends on the intention of the parties. BARTER Barter (def). A contract where one of the parties binds himself to give one thing in consideration of the other’s promise to give another thing. (in short, exchange of property) If one person agrees to transfer the ownership of non-fungible things to another with the obligation on the part of the latter to give things of the same kind, quantity, and quality, the contract is a contract of barter. DISTINCTIONS BETWEEN MUTUUM, COMMODATUM, AND BARTER

SUBJECT MATTER OBLIGATION OF THE BORROWER GRATUITOUS?

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MUTUUM Money or other fungible things Return the equivalent May be gratuitous or onerous

COMMODATUM Non-fungible things

BARTER Non-fungible things

Return the identical thing borrowed Always gratuitous

Return the equivalent Onerous

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FORM OF PAYMENT

1. If the object is money – Payment must be made in the currency stipulated; otherwise it is payable in the currency which is legal tender in the Philippines. According to Art. 1955, Art. 1250, is applicable in payments of loans. 1250 provides that in case of extraordinary inflation or devaluation, the value of the currency at the time of the establishment of the obligation (not at the time of payment) should be the basis for payment. BUT JPSP thinks that this is rarely applied because it would create a bad precedent and would wreak havoc on the economy. It would also shift the loss to the lender, which shouldn’t be the case since the loan is primarily for the benefit of the borrower. So unless there’s a drastic economic situation, we shouldn’t adjust the value of the currency. The obligation should be paid based on the value of the currency at the time of payment. Ex: In 2000, Borrower borrowed $1,000 from Lender at the peso-dollar exchange rate of P50$1, payable in 2004. In 2004, FPJ becomes President, and as a result, the rate becomes P60$1. If the parties had agreed that payment would be in dollars, Borrower still has to pay $1,000. If the parties had agreed that payment would be in pesos, Borrower should pay at the rate of P60 to a dollar, or P60,000. Why? You cannot apply 1250 and base the amount due on the value of the currency in 2000 because the inflation is not so extraordinary as to warrant the adjustment.

2. If the object is a fungible thing other than money – Borrower must pay lender another thing of the same kind, quality, and quantity. In case it is impossible to do so, the borrower shall pay its value at the time of the perfection of the loan. Why does the law require that the value of the thing be based on its value at the time of the perfection of the loan? There’s a historical explanation: the rule was created at a time when there were still interest ceilings. Thus, the reason for requirement is to prevent circumvention of the interest ceilings. Even if there are no longer any interest ceilings, this rule is still applicable. So how do you opt out of it? Stipulate! Put a stipulation that says that if it is impossible to pay a thing of the same kind, quality, and quantity, borrower shall pay the market value of the thing at the time of payment. INTEREST Requisites for Recovery of Interest:

1. The payment of interest must be expressly stipulated. 2. in writing [3. And the interest must be lawful (but since there is no Usury Law anymore, then there is no such thing as unlawful interest, so I don’t think this requisite is still included)] There is no Usury Law anymore, but an interest rate may still be struck down for being unconscionable. The test of an unconscionable interest rate is relative and there is a need to look at the parity/disparity in the status of the parties and in their access to information during the negotiations. Stipulation of interest 1.

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

2.

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

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For other sources of obligations, such as sale, and damages arising from injury to persons and loss of property which do not involve a loan, the legal rate of interest is 6%. 3.

Increases in interest must also be expressly stipulated.

4.

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

5.

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

Escalation Clause – A clause which authorizes the automatic increase in interest rate. An escalation clause is valid when it is accompanied by a De-Escalation Clause. A de-escalation clause is a clause which provides that the rate of interest agreed upon will also be automatically reduced. There must be a specified formula for arriving at the adjusted interest rate, over which neither party has any discretion. When the borrower is liable for interest even without a stipulation:

1. Indemnity for damages – The debtor in delay is liable to pay legal interest as indemnity for damages even without a stipulation for the payment of interest. Where to base the rate of damages: a. Rate in the penalty clause agreed upon by the parties b. If there is no penalty clause, additional interest based on the regular interest rate of the loan c. If there is no regular interest, additional interest is equivalent to the legal interest rate (12%) Example: Lender lends P10K at 10% interest with penalty interest of 6%. On due date, Borrower fails to pay. Borrower only pays a year after. How much should he pay? Borrower should pay the principal + interest on the loan + penalty interest = 10K + 10% of 10K + 6% of 10K = 10K + 1K + .6K = 11,600 Lender lends P10K at 10% interest. On due date, Borrower fails to pay. Borrower only pays a year after. How much should he pay? Borrower should pay 10K + 10% of 10K (interest on the loan) + 10% of 10K (penalty interest) = 10K + 1K + 1K = 12,000 The penalty interest in this case is 10% since there is no penalty interest stipulated. The additional interest is based on the regular interest of the loan. Lender lends P10K, no interest. On due date, Borrower fails to pay. How much should Borrower pay a year later? Borrower should pay P10K + 12% of P10K = 11,200. The penalty interest is 12% since there is no interest on the loan nor a penalty interest stipulated. The extra interest is based on the legal rate of interest. Sheryl IID 2002

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2. Interest accruing from unpaid interest – Interest due shall earn interest from the time it is judicially demanded although the obligation may be silent on this point (Art. 2212.) If interest is payable in kind: If interest is payable in kind, its value shall be appraised at the current price of the products or goods at the time and place of payment. Take note that you should not confuse this with the rule when the principal obligation consists of goods other than money. If the principal obligation consists in the payment of goods and it is impossible to deliver the goods, the borrower should pay the value of the thing at the time of the constitution of the obligation. But if interest is payable in kind, it should be appraised at its value at the time of payment. General Rule: Accrued interest shall not earn interest Exceptions: 1.

When judicially demanded (Art. 2212)

2. Express stipulation – Also called compounding interest where the parties agree that accrued interest shall be added to the principal and the resulting total amount shall earn interest. Õ A stipulation as to compounding interest must be in writing. How does compounding interest work? Lender lends P100,000 payable in 2 years at 10% interest compounded per annum. At the end of the first year, how much is due? Principal plus 10% interest = 110,000. On the second year, the 110,000 becomes the new principal amount and it is what will earn the 10% interest. So at the end of the second year, how much is due? 110,000 + 10% of 110,000 = 110,000 + 11,000 = 121,000 In compounding interest, you add the unpaid interest to the principal. The resulting amount is your new principal which will then earn interest again. What if the borrower pays interest when there is no stipulation providing for it? If the debtor pays unstipulated interest by mistake, he may recover, since this is a case of solutio indebiti or undue payment. But if the debtor voluntarily pays interest (either unstipulated or stipulated by not in writing) because of some moral obligation, he cannot later recover. The obligation to return the interest is a natural obligation.

II. GUARANTY AND SURETYSHIP CHAPTER 1 NATURE AND EXTENT OF GUARANTY Art. 2047. By guaranty a person, called the guarantor, binds himself to the creditor to fulfill the obligation of the principal debtor in case the latter should fail to do so.

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If a person binds himself solidarily with the principal debtor, the provisions of Section 4, Chapter 3, Title 1 of this Book shall be observed. In such case the contract is called a suretyship. Guaranty (def.) A contract whereby the guarantor binds himself to the creditor to fulfill the obligation of the principal debtor in case the latter should fail to do so. In a contract of guaranty, the parties are the guarantor and the creditor. Characteristics of the Contract of Guaranty (A-SC-U-D)

1. Accessory: It is dependent for its existence upon the principal obligation guaranteed by it. 2. Subsidiary and Conditional: It takes effect only when the principal debtor fails in his obligation.

3. Unilateral: a.

It gives rise to obligations on the part of the guarantor in relation to the creditor and not vice-versa. (Although after its fulfillment, the principal debtor should indemnify the guarantor, but this obligation is only incidental)

b.

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

4. Distinct Person: It requires that the person of the guarantor must be distinct from the person of the principal debtor (you cannot guaranty your own debt). However, in a real guaranty, a person may guarantee his own obligation with his own properties. Classification of Guaranty 1.

In the broad sense:

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

b. real: the guaranty is property. If the guaranty is immovable property: real mortgage or antichresis; If the guaranty is movable property: pledge or chatter mortgage 2.

As to origin:

a. conventional: by agreement of the parties b. legal: imposed by law c. judicial: required by a court to guarantee the eventual right of one of the parties in a case 3.

As to consideration:

a. gratuitous: the guarantor does not receive anything for acting as guarantor b. onerous: the guarantor receives valuable consideration for acting as guarantor 4.

As to the person guaranteed:

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

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b. double or sub-guaranty: constituted to secure fulfillment of a prior guaranty; guarantees the obligation of a guarantor 5.

As to scope and extent:

a. definite: limited to the principal obligation only or to a specific portion thereof b. indefinite or simple: includes not only the principal obligation but also all its accessories, including judicial costs. Second Paragraph of Art. 2047: Suretyship If a person binds himself solidarily with the principal debtor, it is a contract of suretyship. The guarantor is called a surety. Suretyship is governed by Articles 1207 to 1222 of the Civil Code on solidary obligations. Suretyship dispenses with certain legal requirements/conditions precedent for proceeding against a guarantor. What is the difference between passive solidarity (solidarity among debtors) and suretyship? Review of oblicon: According to Tolentino, the two are similar in the following ways:

1. A solidary debtor, like a surety, stands for some other person. 2. Both debtor and surety, after payment, may require that they be reimbursed. The difference is that the lender cannot go after the surety right away. There has to be default on the part of the principal debtor before the surety becomes liable. If it were mere solidarity among debtors, the creditor can go after any of the solidary debtors on due date. Nature of a Surety’s Undertaking

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

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

3. Liability arises only if principal debtor is held liable: If the principal debtor and the surety are held liable, their liability to pay the creditor would be solidary. But, the surety does not incur liability unless and until the principal debtor is held liable. a.

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

b.

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

c.

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

d.

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

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Example: Tuks accommodates Shak so that he can obtain a loan from the bank. At the bottom of the loan agreement, the following signatures appear: (sgd) Tuks Lino Chris Kapunan

(sgd) Shak Sherwin Shakramy

Is Tuks a surety or a solidary debtor? According to JPSP, based on this document above, Tuks is a solidary debtor. Remember the rule? I promise to pay signed by two parties = solidary. To make sure that he’s merely a guarantor or surety, Tuks should sign a separate guaranty agreement. Besides, a guaranty must be express. It is not presumed. e.

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

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

5. The undertaking is to the CREDITOR, not to the principal debtor: The debtor cannot claim that the surety breached its obligation to pay for the principal obligation because there is no obligation as between the surety and the debtor. If the surety does not pay, the principal debtor is still not relieved of his obligation. Guaranty Distinguished from Suretyship: GUARANTY Guarantor promises to answer for the debt, default or miscarriage of the principal Liability of the guarantor depends upon an independent agreement to pay the obligation if the primary debtor fails to do so The engagement of the guarantor is a collateral undertaking The guarantor is secondarily liable

SURETYSHIP Surety promises to answer for the debt, default or miscarriage of the principal (same) Surety assumes liability as a regular party to the undertaking Surety is charged as an original promisor A surety is primarily liable

Õ MAIN DIFFERENCE: A surety undertakes to pay if the principal does not pay (insurer of the debt). A guarantor binds himself to pay if the principal cannot pay (insurer of the solvency of the debtor). Õ Since the obligation of the surety is to pay so long as the principal does not pay (even if he can; even if he is solvent), the undertaking of the surety is more onerous than that of a guarantor who pays only in the event that the principal is broke. Illustration: A borrows P10,000 from B, with C agreeing to be the surety. A refuses to pay B out of spite. In this case, since C is a surety, B can immediately demand payment from C. If, in this case, C is a guarantor instead, B would have to exhaust all the property of A before he can collect from C. it is not enough that A refuses to pay even if he can; in order for C to be liable, A would have to be unable to pay. If you were a lender and the borrower offers as security either X as guarantor or a real estate mortgage, which one would you choose? Choose the mortgage. If you were the lender, a real estate mortgage is more advisable because you can collect against the property. In a guaranty/surety, you would have to go against the guarantor or

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surety – you would have to sue him, obtain judgment, and then execute judgment. This is subject to a lot of delays. The guarantor or surety can stall your claim. Art. 2048. A guaranty is gratuitous, unless there is a stipulation to the contrary. GENERAL RULE: Guaranty is gratuitous. EXCEPTION: Guaranty is onerous only if it is stipulated. What is the cause/consideration of a contract of guaranty? The cause of a contract of guaranty is the same cause which supports the principal obligation of the principal debtor. There is no need for an independent consideration in order for the contract of guaranty to be valid. The guarantor need not have a direct interest in the obligation nor receive any benefit from it. It is enough that the principal obligation has consideration. Art. 2049 A married woman may guarantee an obligation without the husband’s consent, but shall not thereby bind the conjugal partnership, except in cases provided by law. Art. 94 of the Family Code The absolute community of property shall be liable for: (3) Debts and obligations contracted by either spouse without the consent of the other to the extent that the family may have been benefited. A married woman who acts as guarantor without the consent of the husband binds only her separate property unless the debt benefited the family. There is no express prohibition against a married woman acting as guarantor for her husband. Remember that now, in order to bind the absolute community, the consent of both spouses is needed. If only the consent of one spouse is obtained, the absolute community will not be liable unless the obligation redounded to the benefit of the community. When the husband acts as a guarantor for another person without the consent of the wife, the guaranty binds only the husband since the benefit really accrues to the principal debtor and not to the husband or his family. The exception is if the husband is really engaged in the business of guaranteeing obligations because in this case, his occupation or business is deemed to be undertaken for the benefit of the family. Art. 2050. If a guaranty is entered into without the knowledge or consent, or against the will of the principal debtor, the provisions of articles 1236 and 1237 shall apply. A contract of guaranty is between the guarantor and the creditor. It can be instituted without the knowledge or even against the will of the debtor, since the purpose of the contract is to give the creditor all the possible measures to secure payment. However, if the contract of guaranty is entered into without the knowledge or consent or against the will of the principal debtor, the effect is like payment by a 3rd person: 1.

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

2.

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

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

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A owes B P10,000. Without the knowledge of A, C guarantees the obligation. C pays A P10,000. C tries to collect the P10,000 from A, but A tells him that he has already paid B 4,000. In this case, C can only collect P6,000 from A since it was only the extent to which A was benefited by his payment. If the loan was secured by a mortgage, C cannot foreclose the mortgage if A does not pay him because he is not subrogated to the rights of B. Art. 2052. A guaranty cannot exist without a valid obligation. Nevertheless, a guaranty may be constituted to guarantee the performance of a voidable or unenforceable contract. It may also guarantee a natural obligation. A guaranty is an accessory contract and cannot exist without a valid principal obligation. So if the principal obligation is void, the guaranty is also void. BUT, a guraranty may be constituted to guarantee the following defective contracts and natural obligations: 1.

Voidable: because the contract is binding unless it is annulled

2.

Unenforceable: because an unenforceable contract is not void.

3.

Natural obligations: even if the principal obligation is not civilly enforceable, the creditor may still go after the guarantor

Art. 2053. A guaranty may also be given as security for future debts, the amount of which is not yet known; there can be no claim against the guarantor until the debt is liquidated. A conditional obligation may also be secured. Continuing Guaranty (def) – A guaranty that is not limited to a single transaction but which contemplates a future course of dealings, covering a series of transactions generally for an indefinite time or until revoked. A continuing guaranty is generally prospective in its operation and is intended to secure future transactions (generally does not include past transactions). Examples:

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

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

3. To secure existing unliquidated debts – Future debts may also mean debts that already exist but whose amount is still unknown. Art. 2053 may be misleading because it says that a guaranty may be constituted to secure future debts. The important thing to remember in the guaranty of future debts is that there must be an

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existing obligation already that is being guaranteed. Because without that existing obligation, the guaranty would be void. Guaranty is an accessory obligation, so it cannot exist without the principal. Example: G guarantees the 10K loan that B owes L and any other indebtedness that B may incur against L. This is a valid guaranty because there is already an existing obligation (the 10K loan). G guarantees the loan that B and L will enter into tomorrow. This is not valid. Although it is for a future debt, it is not valid under Article 2053 because there is no principal obligation yet. There is nothing to guarantee. Guaranty of Conditional Obligations If the principal obligation is subject to a suspensive condition, the guarantor is liable only after the fulfillment of the condition. If it is subject to a resolutory condition, the happening of the condition extinguishes both the principal obligation and the guaranty. Art. 2054. A guarantor may bind himself for less, but not for more than the principal debtor, both as regards the amount and the onerous nature of the conditions. Should he have bound himself for more, his obligations shall be reduced to the limits of that of the debtor. Since the contract of guaranty is a subsidiary and accessory contract, the guarantor’s liability cannot exceed that of the principal obligation. If the guarantor binds himself for more than the liability of the principal debtor, his liability shall be reduced. However, if the creditor sues the guarantor, the guarantor may be made to pay costs, attorney’s fees, and penalties even if this will make his liability exceed that of the principal. How do you opt out of this rule? Example: G guaranteed B’s 100K obligation to L to the extent of 100K. As an extra consideration for lending the money, L wants an additional 20K from guarantor (gravy, according to JPSP). Since 2054 provides that the guarantor cannot bind himself for more than the principal debtor, how do the parties opt out of the rule? Guarantor and Lender should enter into a new and separate agreement. They should take it out of the context of the guaranty and have a new agreement in which L would (kunwari) perform some service for G in consideration of the additional 20K. Art. 2055. A guaranty is not presumed; it must be express and cannot extend to more than what is stipulated therein. If it be simple or indefinite, it shall comprise not only the principal obligation, but also all its accessories, including the judicial costs, provided with respect to the latter, that the guarantor shall only be liable for those costs incurred after he has been judicially required to pay. RULE: Guaranty is never presumed. It must be express. Reason for the rule: Because a guarantor assumes an obligation to pay for another’s debt without any benefit to himself. Thus, it has to be certain that he really intends to incur such an obligation and that he proceeds with consciousness of what he is doing. Form required for Guaranty Guaranty must be IN WRITING Sheryl IID 2002

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A contract of guaranty, to be enforceable, must be in writing because it falls under the Statute of Frauds as a “special promise to answer for the debt, default or miscarriage of another.” De Leon textbook says that surety is not covered by the Statute of Frauds. JPSP says that a surety is still covered by the SOF since it is still a promise to answer for the default of another person. What is not covered by the SOF is being a solidary co-debtor. Construction of Guaranty A guaranty is strictly construed against the creditor and in favor of the guarantor and is not to be extended beyond its terms or specific limits. Doubts should be resolved in favor of the guarantor or surety. Õ Generally, a guarantor is liable only for the obligation of the debtor stipulated upon, and not to obligations assumed PREVIOUS to the execution of the guaranty unless an intent to be so liable is clearly indicated. (Prospective application of the guaranty) However, this rule of construction is applicable only to an accommodation surety or one that is gratuitous. It does not apply in cases where the surety is compensated with consideration. In such cases, the agreement is interpreted against the surety company that prepared it. Is a stipulation that says that the guaranty will subsist only until maturity of the obligation valid? Generally, no. Such a stipulation would defeat the purpose of a guaranty which is to answer for the default of the principal debtor. If the guaranty is only up to the date of maturity, there is no way that the guarantor can be liable since default comes only at maturity date. But Cayo pointed out a situation in class where this might be possible and JPSP agreed: If the lender asked for a guaranty precisely because there was a danger of the borrower absconding or becoming insolvent prior to maturity date, then the guaranty is valid. 2nd Paragraph of Art. 2055: Extent of Guarantor’s Liability

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

2. Indefinite or simple guaranty – If the agreement does not specify that the liability of the guarantor is limited to the principal obligation, it extends not only to the principal but also to all its accessories. This is because in entering into the agreement, the principal could have fixed the limits of his responsibility solely to the principal. If he did not fix it, it is presumed that he wanted to be bound not only to the principal but also to all its accessories. GENERAL RULE: It is not necessary for the CREDITOR to expressly accept the contract of guaranty since the contract is unilateral; only the guarantor binds himself to do something. EXCEPTION: If the guarantor merely offers to become a guaranty, it does not become a binding obligation unless the creditor accepts and notice of acceptance is given to the guarantor. On the other hand, if the guarantor makes a direct or unconditional promise of guaranty (and not merely an offer), there is no need for acceptance and notice of such acceptance from the creditor. 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.

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The guarantor shall be subject to the jurisdiction of the court of the place where this obligation is to be complied with. Art. 2057. If the guarantor should be convicted in first instance of a crime involving dishonesty or should become insolvent, the creditor may demand another who has all the qualifications required in the preceding article. The case is excepted where the creditor has required and stipulated that a specified person should be the guarantor. Ideally, the qualifications of a guarantor are the ff: 1. 2. 3.

Integrity Capacity to bind himself Sufficient property to answer for the obligation which he guarantees

Õ But the creditor can waive these requirements. Jurisdiction over the guarantor: Jurisdiction over the guarantor belongs to the court where the principal obligation is to be fulfilled, in accordance with the rule that accessory follows the principal. Effect of Subsequent Loss of Qualifications The qualifications need only to be present at the time of the perfection of the contract. The subsequent loss of the qualifications would not extinguish the liability of the guarantor, nor will it extinguish the contract of guaranty. However, the creditor may demand another guarantor with the proper qualifications. When may the creditor demand another guarantor? 1.

In case the guarantor is convicted in the first instance of a crime involving dishonesty (since he loses integrity)

2. In case the guarantor becomes insolvent (since he loses sufficient property to answer for the obligation which he guarantees)

there is no need for a judicial declaration of insolvency

What is the effect of the guarantor’s death on the guaranty? The guaranty survives the death of the guarantor. The general rule is that a party’s contractual rights and obligations are transmissible to his successors. The rules on guaranty do not expressly provide that the guaranty is extinguished upon the death of the guarantor. Applying Art. 2057, the supervening incapacity of the guarantor does not extinguish the guaranty but merely gives the creditor the right to demand a replacement. But the creditor can waive this right and choose to hold the guarantor to his bargain. If he so chooses, the creditor’s claim passes to the heirs of the deceased guarantor. When may the creditor NOT demand another guarantor? Where the creditor has stipulated in the original agreement that a specified person should be the guarantor, he is bound by the terms of the agreement and he cannot thereafter deviate from it.

CHAPTER 2 EFFECTS OF GUARANTY 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.

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The liability of the guarantor is only accessory and subsidiary. Thus, in order for the creditor to collect from the guarantor, the ff. conditions must be fulfilled: 1.

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

2.

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

Can the creditor implead the guarantor as a co-defendant with the debtor? No. Except in cases provided in 2059, Article 2062 says that creditor should proceed against the principal debtor alone. Art. 2059. This excussion shall not take place: 1. If the guarantor has expressly renounced it; 2. If he has bound himself solidarily with the debtor; 3. In case of insolvency of the debtor; 4. When he has absconded, or cannot be sued within the Philippines unless he has left a manager or representative; 5. If it may be presumed that an execution on the property of the principal debtor would not result in the satisfaction of the obligation. GENERAL RULE: The guarantor is entitled to demand that the creditor first exhaust the properties of the principal debtor before collecting from the guarantor. EXCEPTIONS: 1. 2. 3. 4. 5.

Under Art. 2059 If the guarantor does not comply with Art. 2060 If the guarantor is a judicial bondsman and sub-surety (Art. 2084) Where a pledge or mortgage has been given by him as a special security. If he fails to interpose it as a defense before judgment is rendered against him.

EXCEPTIONS UNDER ART. 2059 (RUSIA)

1. When the right is Renounced or waived. •

The waiver must be made in express terms.

2. When the liability assumed by the guarantor is Solidary. •

In this case, he becomes a surety with primary liability.

3. When the principal debtor is Insolvent. What kind of insolvency? JPSP says it’s practical insolvency meaning assets are less than liabilities, but it still depends on the situation. Examples: B borrows 100K from L guaranteed by G. B has 1M in assets which are all still with him and 1.5M in liabilities. B defaults. Can L collect from G right away? No. In this case, G still has the benefit of excussion. Why? Because even if B is apparently insolvent, since his liabilities exceed his assets, there is still no claim against these assets by the other creditors. They can still be accessed by L, and L can still file an action for collection Sheryl IID 2002

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of money against B. So in this case, even if B is insolvent on paper, his properties are still with him, and he can still pay L. Therefore, G still should still have the benefit of excussion. B borrows 100K from L guaranteed by G. On due date, B defaults and has zero assets but has a 200K credit/receivable from X. Can L collect from G. Still no. L must file an action for collection and an accion subrogatoria so that he can exercise B’s right to collect the money from X. Only if these actions fail can L then collect from G.

4. When the principal debtor Absconds or cannot be locally sued. So even if the borrower has fled to the Bahamas, if he still has properties here, Lender must sue against the property first before collecting from the guarantor.

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

If exhausting the properties of the debtor would be useless since it would still not satisfy the obligation, the guarantor cannot require the creditor to resort to these legal remedies against the debtor anymore, since doing so would be a useless formality. In this case, it is not even necessary that the debtor is judicially declared insolvent or bankrupt.

How does the lender get around this requirement? If the lender wants to be able to go against the guarantor right away without having to go through excussion, he must get the guarantor to either sign a waiver of the benefit of excussion or make him solidarily liable (a surety). Example: B borrowed 100k guaranteed by G. B defaulted. Lender made a demand for payment against G. G paid. Later, G found out that he had the benefit of excussion. He demanded reimbursement from Lender. Can G recover? G cannot recover. Payment constitutes a waiver of the benefit. Art. 2060. In order that the guarantor may make use of the benefit of excussion, he must set it up against the creditor upon the latter’s demand for payment from him, and point out to the creditor available property of the debtor within Philippine territory sufficient to cover the amount of the debt. Art. 2061. The guarantor having fulfilled all the conditions required in the preceding article, the creditor who is negligent in exhausting the property pointed out shall suffer the loss, to the extent of said property, for the insolvency of the debtor resulting from such negligence. To collect from the guarantor, the creditor must make a prior demand for payment from the guarantor. 1.

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

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

Additional Requisites in Order to Claim the Benefit of Excussion Guarantor tells Lender “Exhaust Borrower’s property first before collecting from me.” Is this enough for the Guarantor to claim the benefit of excussion? No. In order to demand that the creditor exhaust the properties of the principal debtor, the guarantor must:

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1.

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

2. Point out to the creditor available property of the debtor within Philippine territory sufficient to cover the amount of debt. (Therefore, property located abroad or which is not easily available is not included among those that the guarantor can point out to the creditor.) Õ Once the guarantor has fulfilled the requisites for making use of the benefit of excussion, the creditor has the duty to exhaust all the property of the debtor and to resort to all legal remedies against the debtor. If he fails to do so, he shall suffer the loss to the extent of the value of the property. Art. 2062. In every action by the creditor, which must be against the principal debtor alone, except in the cases mentioned in Article 2059, the former shall ask the court to notify the guarantor of the action. The guarantor may appear so that he may, if he so desires, set up such defenses as are granted him by law. The benefit of excussion mentioned in article 2058 shall always be unimpaired, even if judgment should be rendered against the principal debtor and the guarantor in case of appearance by the latter. The creditor must sue the principal debtor alone. He cannot sue the guarantor with the principal or the guarantor alone except in the cases mentioned in Art. 2059 where the guarantor loses the benefit of excussion. The guarantor must be notified so that he may appear and set up his defenses if he wants to. If the guarantor appears, he is still given the benefit of exhaustion event after judgment is rendered against the principal debtor. If he does not appear, judgment is not binding on him. Lender must sue the guarantor to claim against him. So, collecting from the guarantor is really a two-step process. The purpose of the two-step process is to allow the guarantor to make use of the benefit of excussion. The disadvantage is that there is a time lag between the judgment against the principal debtor and the one against the guarantor, which allows the guarantor to hide his assets in the meantime. How to get around this two-step process: A bank guaranty or a letter of credit. In a bank guaranty, if the debtor does not pay, the creditor need only inform the bank of the default and the bank releases the money. It’s like a standing loan by the bank in favor of the debtor to answer for a debt in favor of third persons, in case he is unable to pay.

Art. 2063. A compromise between the creditor and the principal debtor benefits the guarantor but does not prejudice him. That which is entered into between the guarantor and the creditor benefits but does not prejudice the principal debtor. Reason: A compromise binds only the parties thereto and not third persons. Thus, it cannot prejudice the guarantor or debtor who was not a party to the compromise. Exception: If the compromise has a benefit in the nature of a stipulation in favor of a third person, the compromise may bind that third person. Example: D owes C 10K with G as guarantor. D and C agree to reduce the debt to 8K. G’s liability is also reduced to 8K in case D does not pay, since the compromise is beneficial to G.

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Art. 2064. The guarantor of a guarantor shall enjoy the benefit of excussion both with respect to the guarantor and to the principal debtor. A sub-guarantor can demand the exhaustion of the properties both of the guarantor and of the principal debtor before he pays the creditor. Art. 2065. Should there be several guarantors of only one debtor and for the same debt, the obligation to answer for the same is divided among all. The creditor cannot claim from the guarantors except the shares which they are respectively bound to pay, unless solidarily has been expressly stipulated. The benefit of division among the co-guarantors ceases in the same cases and for the same reasons as the benefit of excussion against the principal debtor. When is there a benefit of division among several guarantors? The following conditions must concur in order that several guarantors may claim the benefit of division: 1. 2. 3.

There should be several guarantors Of only one debtor For the same debt

In this case, the liability of the co-guarantors is joint. They are not liable to the creditor beyond the shares which they are bound to pay. Exceptions: 1.The co-guarantors cannot avail themselves of the benefit of division under the circumstances enumerated in Art. 2059 (RUSIA). 2. If solidarity has been expressly stipulated. Art. 2066. The guarantor who pays the debtor must be indemnified by the latter. The indemnity comprises: (1) The total amount of the debt; (2) The legal interests thereon from the time the payment was made known to the creditor, even though it did not earn interest for the creditor; (3) The expenses incurred by the guarantor after having notified the debtor that payment had been demanded of him; (4) Damages, if they are due. Once the guarantor pays the principal obligation, the principal debtor must pay him back consisting of: (TIED)

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

2. Interest – The guarantor is entitled to interest from the time notice of payment of the debt was made known to the debtor. The notice is a demand upon the debtor to pay the guarantor. If he delays, he is liable for damages in the form of interest. The guarantor can collect interest even if the principal obligation was a loan without an interest. This is because Sheryl IID 2002

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

3. Expenses – This refers only to those expenses that the guarantor has to satisfy in accordance with law as a consequence of the guaranty. This is limited to those expenses incurred by the guarantor after having notified the debtor that payment has been demanded of him by the creditor.

4. Damages – Guarantor is entitled to damages only if they are due. Exceptions to the right to indemnity of the guarantor 1.

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

2.

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

3.

Waiver

Art. 2067. The guarantor who pays is subrogated by virtue thereof to all the rights which the creditor had against the debtor. If the guarantor has compromised with the creditor, he cannot demand of the debtor more than what he has really paid. When the guarantor pays, he becomes subrogated to the rights of the creditor against the debtor. What happens really is just a change in creditor. The guarantor becomes the creditor, but the obligation subsists in all other aspects. He may, for example, foreclose a mortgage in case of failure of the debtor to reimburse him. The right of subrogation is given to the guarantor so that he can enforce his right to indemnity/ to be reimbursed. It arises by operation of law upon payment by the guarantor. The creditor need not formally cede his rights to the guarantor. But the right of subrogation is given only to the guarantor if he has the right to be reimbursed. If, for some reason, he has no right to be reimbursed, he cannot subrogate either. Compromise B owes lender P1M. Lender was a good friend of Guarantor and agreed that if G became liable, he would only have to pay P500K. If B defaults and Guarantor pays P500K, he can only recover P500K from B, not the original P1M. Is there a situation where this rule would even be disadvantageous to the Debtor? Yes. Let’s say there was no such rule. B owes L P1M. G, who was a compadre of L, brokered a deal with L, in which they agreed that should G become liable, he would only pay P500K. Since there’s no rule, G tells B about the deal with L. G tells B that if G pays the P500K, B should reimburse him P600K. This would give B a savings of P400 K, while G earns P100K. Everyone will be happy. But since there is a rule that says that G cannot ask for more than what he has actually paid, G has no inducement, no incentive to broker that deal with his compadre L. Why would he go through the trouble when in any case, he would be getting the same amount that he pays?

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How do you get out of this situation? B should “hire” G as his agent to broker the deal with L. As compensation for the service rendered by G, B will pay him P100K. So the agreement is taken out of the context of the guaranty and everyone is happy. Art. 2068. If the guarantor should pay without notifying the debtor, the latter may enforce against him all the defenses which he could have set up against the creditor at the time the payment was made. Obligation of the guarantor before he pays the creditor Before he pays the creditor, guarantor should first give notice to the principal debtor. If he does not give notice, the debtor may enforce all the defenses which he could have set up against the creditor at the time of payment. Example: Debtor pays Creditor. But Creditor is sneaky and tells Guarantor that Debtor defaulted. So Guarantor pays, without telling Debtor. Guarantor makes a demand for reimbursement from Debtor. Is Debtor liable? No. Debtor can invoke the fact of payment to the Creditor against Guarantor. Had Guarantor given notice to Debtor, he would have known of the defenses that Debtor had against Creditor which would have made him think twice about paying. Guarantor’s remedy here is against sneaky Creditor. Art. 2069. If the debt was for a period and the guarantor paid it before it become due, he cannot demand reimbursement of the debtor until the expiration of the period unless the payment has been ratified by the debtor. If the principal debt was one with a period, it becomes demandable only upon expiration of the period. Guarantor is only liable if the debtor defaults, but there can be no default before the expiration of the period. If the guarantor still pays before the expiration of the period, he must wait for the period to expire before he can collect from the debtor. Exception: Guarantor need not wait for the period if the debtor ratifies payment or consents to it. Art. 2070. If the guarantor has paid without notifying the debtor, and the latter not being aware of the payment, repeats the payment, the former has no remedy whatever against the debtor, but only against the creditor. Nevertheless, in case of gratuitous guaranty, if the guarantor was prevented by a fortuitous event from advising the debtor of the payment, and the creditor becomes insolvent, the debtor shall reimburse the guarantor for the amount paid. This is like the situation in 2068, only this time, the guarantor pays before the debtor pays. Even in such a case, guarantor still cannot recover from debtor because he should have informed debtor of his intention to pay. Had he informed debtor, debtor would not have paid. Guarantor will suffer the loss of his failure to comply with his one and only obligation before paying which is to notify the debtor. Exception: Guarantor may claim reimbursement from debtor if (requisites): 1. 2. 3.

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

Remember that the culprit here, aside from the guarantor who did not inform the debtor, is the sneaky creditor who nonchalantly received payment twice. If he is solvent, the guarantor must collect from him. But if he is insolvent and the three requisites above are present, the guarantor can reimburse from the principal debtor. Art. 2071. The guarantor, even before having paid, may proceed against the principal debtor: (1) When he is sued for payment;

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(2) In case of insolvency of the principal debtor; (3) When the debtor has bound himself to relieve him from the guaranty within a specified period, and this period has expired; (4) When the debt has become demandable, by reason of the expiration of the period for payment; (5) After the lapse of 10 years, when the principal obligation has no fixed period for its maturity unless it be of such nature that it cannot be extinguished except within a period longer than 10 years; (6) If there are reasonable grounds to fear that the principal debtor intends to abscond; (7) If the principal debtor is in imminent danger of becoming insolvent. In all these cases, the action of the guarantor is to obtain release from the guaranty, or to demand a security that shall protect him from any proceedings by the creditor and from the danger of insolvency of the debtor. Under these 7 circumstances, the guarantor has these rights against the debtor BEFORE he makes payment: 1.

Right to be released if lender agrees Release from the guaranty requires that the lender consent because the guaranty is actually a contract between the lender and the guarantor

2.

Right to demand a security

The purpose is to enable the guarantor to take measures to protect his interest in view of the probability that debtor would default and he would be called upon to answer for the obligation. Art. 2072. If one, at the request of another, becomes a guarantor for the debt of a third person who is not present, the guarantor who satisfies the debt may sue either the person so requesting or the debtor for reimbursement. Art. 2073. When there are two or more guarantors of the same debtor and for the same debt, the one among them who has paid may demand of each of the others the share which is proportionately owing from him. If any of the guarantors should be insolvent, his share shall be borne by the others, including the payer, in the same proportion. The provisions of this article shall not be applicable, unless the payment has been made in virtue of a judicial demand or unless the principal debtor is insolvent. This article applies only if there are two or more guarantors of the same debtor for the same debt and one of them has paid: 1. 2.

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

The liability of the guarantors is joint. If one of them pays the entire obligation, he is entitled to be reimbursed the amount of the shares of the other guarantors. Example: A, B, C guaranty the 90K loan of X. A pays 90K. A can collect 30 K each from B and C.

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But unlike in an ordinary joint obligation, if one of the guarantors is insolvent, the co-guarantors must answer for his share. In this sense, the obligation behaves like a solidary obligation. Example: A, B, C guaranty the 90K loan of X. A pays 90K. B becomes insolvent. A and C must shoulder B’s share. So their liabilities become 45K each. A can collect 45 K from C. Art. 2074. In the case of the preceding article, the co-guarantors may set up against the one who paid, the same defenses which would have pertained to the principal debtor against the creditor, and which are not purely personal to the debtor. Example: A, B, C guaranty the obligation of X. A pays even if the obligation has prescribed already. A demands reimbursement from B and C. Can they refuse to pay? Yes, they can invoke defenses inherent in the obligation, such as prescription, against the co-guarantor who pays. A, B, C guaranty the obligation of X who was a minor. A pays. Can B and C refuse to reimburse him on the ground that X is a minor? No, because the defense is personal to X. Art. 2075. A sub-guarantor, in case of the insolvency of the guarantor for whom he bound himself, is responsible to the co-guarantors in the same terms as the guarantor. A, B, C are guarantors of X. D is a guarantor of A. C pays the entire obligation. A becomes insolvent. Can C reimburse from D? Yes, according to Art. 2075.

CHAPTER 3 EXTINGUISHMENT OF GUARANTY Art. 2076. The obligation of the guarantor is extinguished at the same time as that of the debtor, and for the same causes as all other obligations. Because guaranty is an accessory and subsidiary contract, it is extinguished once the principal obligation is extinguished. But the extinguishment of the guaranty does not always carry with it the extinguishment of the principal obligation. Any agreement between the creditor and the principal debtor which essentially varies the terms of the principal contract without the consent of the surety will release the surety from liability. This is because the alteration would result in a novation of the principal contract which is consequently extinguished and replaced with a new one. Since the old principal contract is extinguished, the accessory contract of guaranty/surety is also extinguished. When is an alteration material? There must be a change which imposes a new obligation or added burden or which takes away some obligation already imposed, changing the legal effect of the contract. Examples: 1. 2. 3.

Increase in the principal amount, regardless of the extent of the liability assumed by the guarantor Substitution of the principal debtor Extension or shortening of the term of the principal debt

In these cases, the guaranty is extinguished altogether. Decrease in the amount of the principal obligation: The guaranty subsists and is benefited by the change since the guarantor cannot bind himself for more than the principal obligation.

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Art. 2077. If the creditor voluntarily accepts immovable or other property in payment of the debt, even if he should afterwards lose the same through eviction, the guarantor is released. This is a case of dacion. Since dacion extinguishes the principal obligation, the accessory obligation is also extinguished and is not revived even if the creditor is subsequently evicted from the property. Art. 2078. A release made by the creditor in favor of one of the guarantors, without the consent of the others, benefits all to the extent of the share of the guarantor to whom it has been granted. A, B, C are guarantors of X for 90K. The creditor releases A without the consent of B and C. The release should benefit B and C to the extent of 30K (A’s share). They shall be liable only for 60K or 30K each. A, B, C are guarantors of X for 90K. The creditor releases A with the consent of B and C. Since B and C consented to the release, their liability is still 90K or 45K each. Art. 2079. An extension granted to the debtor by the creditor without the consent of the guarantor extinguishes the guaranty. The mere failure on the part of the creditor to demand payment after the debt has become due does not of itself constitute any extension of time referred to herein. If the creditor grants the debtor an extension of time within which to comply with the principal obligation, the guaranty is extinguished. This is because the principal debtor could become insolvent during the extension period, and the guarantor would not be able to ask for reimbursement. But if the guarantor consents or waives his right under this article in advance, the extension will not extinguish the guaranty. It is immaterial whether the guarantor suffers actual prejudice as a result of the extension. The length of time of the extension is also immaterial. As long as the period is extended, the guaranty is extinguished. The extension must be based on a new agreement between the debtor and creditor. If the creditor merely fails to make a demand on due date, it is not an extension. Can the guarantor sue the creditor for his delay in making a demand, thereby lengthening the risk of the insolvency of the principal debtor? No. Art. 2080. The guarantors, even though they are solidary, are released from their obligation whenever by some act of the creditor they cannot be subrogated to the rights, mortgages and preference of the latter. Art. 2081. The guarantor may set up against the creditor all the defenses which pertain to the principal debtor and are inherent in the debt; but not those that are purely personal to the debtor.

Chapter 4 Legal and Judicial Bonds The only important thing you have to remember about a legal bond is that it is a surety. Therefore there is no benefit of excussion.

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

(1)That they be constituted to secure the fulfillment of a principal obligation; (2)That the pledgor or mortgagor be the absolute owner of the thing pledged or mortgaged; (3)That the persons constituting the pledge or mortgage have the free disposal of their property and in the absence thereof, that they be legally authorized for the purpose. (4)Third persons who are not parties to the principal obligation may secure the latter by pledging or mortgaging their own property. Article 2086. The provisions of article 2052 are applicable to a pledge or mortgage. [A guaranty cannot exist without a valid obligation. However, it may guarantee the performance of a voidable or unenforceable contract or a natural obligation] Article 2087. It is also of the essence of these contracts that when the principal obligation becomes due, the things in which the pledge or mortgage consists may be alienated for the payment to the creditor. WHAT IS PLEDGE? It is a contract by virtue of which the debtor delivers to the creditor or to a third person a movable or a document involving incorporeal rights for the purpose of securing the fulfillment of a principal obligation with the understanding that when the obligation is fulfilled, the thing delivered shall be returned with all its fruits and accessions. What are the kinds of pledge? Pledge may be either: 1.

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

2.

Legal (by operation of law).

What are the characteristics of pledge? [RAUS] Pledge is:

1. Real, because it is perfected by delivery of the thing pledged. 2. Acessory, because it has no independent existence. 3. Unilateral, because it creates an obligation solely on the part of the creditor to return the thing pledged upon fulfillment of the principal obligation.

4. Subsidiary, because the obligation of the creditor does not arise until fulfillment of the principal obligation. WHAT IS THE CONSIDERATION IN PLEDGE? If the pledgor is also the debtor, the consideration is the principal contract. If the pledgor is a third person, the cause it the compensation received or the liberality of the pledgor. WHAT ARE THE DIFFERENCES BETWEEN PLEDGE AND MORTGAGE?

1. Mobility – pledge is constituted on movables; mortgage on immovables. 2. Delivery – pledge requires delivery for perfection; mortgage does not.

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3. Requisites to bind third person/s – pledge, to bind third persons must be in a public instrument; mortgage, must be registered in the proper registry. A LOAN IS SECURED BY BOTH A PLEDGE AND A GUARANTY. CAN THE CREDITOR REFUSE PAYMENT BY THE GUARANTOR AND CHOOSE TO FORECLOSE IN ORDER TO SATISFY THE DEBT? No, payment by the guarantor cannot be refused. WHAT ARE THE ESSENTIAL REQUISITES OF PLEDGE AND MORTGAGE? [PRADO]

1. Purpose - To secure fulfillment of principal obligation; 2. Real – There must be delivery of the thing. 3. Alienation – when the principal obligation becomes due and the debtor defaults, the thing may be alienated to satisfy the former.

4. Disposal – Pledgor/mortgagor must have free disposal of the thing or capacity to dispose. 5. Ownership – Pledgor/mortgagor must be the absolute owner of the thing;

PURPOSE: To secure fulfillment of a principal obligation WHAT IF THE THING PLEDGED/MORTGAGED IS SUBSEQUENTLY LOST; WHO BEARS THE LOSS? IS THE PRINCIPAL OBLIGATION EXTINGUISHED? The pledgor bears the loss. Remember that there hasn’t been transfer of ownership. The principal obligation is of course not extinguished, the pledge/mortgage is only accessory. However, the debtor must replace the thing or lose the benefit of the period. Pledge/mortgage is a direct lien on the property. It is better than guarantee because the property pledged can be sold upon default by the debtor, unlike in guaranty where several requirements have to be complied with first. PROBLEM: D TRANSFERS PROPERTY TO C AND AT THE SAME TIME EXECUTES AN INDEMNITY AGREEMENT; OR D TRANSFERS PROPERTY TO C TO SECURE AN EXISTING OBLIGATION. HOW WILL THE TRANSFER BE CHARACTERIZED? Both transfers will be characterized as pledges.

REAL: There must be delivery of the thing to perfect the contract. An agreement to pledge, when there is breach, gives rise to damages.

ALIENATION: When the principal obligation becomes due and the debtor defaults, the thing may be alienated to satisfy the former. DOES THE CREDITOR HAVE TO GO TO COURT TO ENFORCE THE PLEDGE OR MORTGAGE? No, to require litigation would be to nullify the lien and defeat the purpose of the contract.

FREE DISPOSAL:

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WHAT DO “FREE DISPOSAL” AND “CAPACITY TO DISPOSE” OF THE PROPERTY MEAN? Free disposal means that the property is not subject to any claim by a third person. Capacity to dispose means that though the pledgor/mortgagor does not have free disposal, the third person with a claim authorized him to dispose (tingin ko lang). In case of corporations, the board should adopt a resolution to approve the pledge/mortgage. If what is to be pledged or mortgaged constitutes all of the corporation’s assets, 2/3 of outstanding capital stock must approve. Rule on consent: If pledgor/mortgagor is married, consent of spouse is needed; if agent, authorization of principal. For married persons – how to wiggle out of a pledge or mortgage agreement: Pledge or mortgage your conjugal property without your spouse’s signature. In case the property is foreclosed, you can raise the defense that there was no consent (remember, half consent is no consent!) What if the pledge was constituted to secure an obligation of the family business, doesn’t this redound to the benefit of the conjugal partnership? No, JPSP said that the pledge of conjugal property con only be considered to redound to the benefit of the partnership if the family business is constituting pledges. If you are the pledgee/mortgagee, check if pledgor/mortgagor has authority to dispose of the property. Another example on free disposal or legal authority: Ex. Pledgor corporation is placed under receivership. The corporation cannot pledge shares of stock because pledge is a disposition requiring court approval.

OWNERSHIP: CAN FUTURE PROPERTY BE PLEDGED? No, it is essential that the pledgor be the absolute owner of the thing. Note: It is the sale and not the registration in the LTO that transfers ownership of a vehicle. Note: A co-owner can only pledge/mortgage his ideal share in the co-ownership. Note: A mortgagor can rely on what is on the face of the Torrens title. WHAT IS MEANT BY ABSOLUTE OWNERSHIP? BOTH BENEFICIAL AND LEGAL TITLE must vested in the pledgor/mortgagor Ex. Trustee is legal owner of shares of stock; trustor is beneficial owner: Neither can pledge the shares. Pledge/mortgage can’t be constituted without a principal obligation even if there is a subsequent principal obligation. This is different from situation where the lender extends a credit line for 1M, though borrower has not yet drawn, the credit line can still be secured via pledge/mortgage. Ex. deed of assignment/absolute sale to secure fulfillment of obligation implied trust according to the SC.

this is a mortgage or an

The pledgor/mortgagor must be absolute owner of the thing or the property. The creditor may rely on the title/stock certificate if there is no notice of defect in title. However, failure of the pledgor to present the thing is a red flag that should put the pledgee on guard as to the pledgor’s right to pledge the thing.

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Though the pledgor must own the thing and have free disposal of it, see the following problem discussed in class: Ex. On day 1, stocks are sold to X with the condition that the sale will be effective if X tops the bar. On day 2, X pledges the stocks. On day 3, the bar exam results come out, with X in the number one spot. Is the pledge valid? Yes, the pledge is valid. Remember Oblicon, conditional obligations? The effects of a conditional obligation to give, when the condition happens, retroact to the date of the constitution of the obligation. OWNERSHIP RETROACTS TO DAY 1. In the above condition, what if the condition is resolutory? As long as the pledge is registered in a public document, it is valid and binding as to third persons. Ex: Day 1 - X receives from A shares of stock with the resolutory condition that they shall be returned to A if X does not pass the bar. Day 2 – X pledges the shares. Day 3 – X fails the bar. Is the pledge valid? Yes. As long as the pledgee registered the pledge in a public instrument, such pledge is binding on A. *But if you use the argument that the effects retroact, doesn’t that mean that when X pledged the things, he wasn’t the owner? I suppose the public instrument is stronger than the legal fiction. CAN THE CREDITOR IMMEDIATELY ACCEPT A PLEDGE FURNISHED BY A DEBTOR IF THE PLEDGE BELONGS TO A THIRD PERSON? No, the creditor cannot require on the word of the pledgor/mortgagor alone, he must exercise due care and make sure the pledge/mortgage has given consent. This is especially true in the banking industry, which is impressed with public interest. WHAT IS THE CONSEQUENCE THEN IF THE CREDITOR DOES NOT VERIFY WITH THE PLEDGOR/MORTGAGOR? The pledge/mortgage is null and void. Article 599 gives the owner of a movable who has been unlawfully deprived thereof the right to recover the same.

(1) Article 2088. The creditor cannot appropriate the things given by way of pledge or mortgage, or dispose of them. Any stipulation to the contrary is null and void. WHAT DOES THE CREDITOR WITH THE PLEDGE/MORTGAGE WHEN THE DEBTOR DEFAULTS? The creditor can move for the sale of the thing pledged or mortgaged. WHAT IF THE CREDITOR WANTS TO ACQUIRE THE THING? He may purchase it at the public auction. WHAT IF THERE IS A STIPULATION THAT THE CREDITOR WILL ACQUIRE THE THING UPON DEFAULT? The stipulation (pactum commissorium) is null and void. WHAT ARE THE REQUISITES FOR PACTUM COMMISSORIUM TO EXIST? 1.

There should be a pledge/mortgage;

2. There should be a stipulation for AUTOMATIC appropriation or the thing in case of default by the debtor. ARE THERE ANY EXCEPTIONS TO PACTUM COMMISSORIUM? Cayo IID 2002

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Yes, Article 2112 provides that if the thing pledged or mortgaged is not sold in two public auctions, the creditor may appropriate the same. WHAT IS THE REASON FOR THE PROHIBITION? The value of the thing pledged or mortgaged is usually more than the amount of the obligation. WHAT HAPPENS TO THE CONTRACT OF PLEDGE/MORTGAGE IF THERE IS A STIPULATION OF PACTUM COMMISSORIUM; IS IT VOID? No, only the stipulation is void; the principal contract will subsist. HOW CAN YOU OPT OUT OF THE PROHIBITION ON PACTO COMMISSORIO? 1.

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

2.

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

3.

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

4. There can be a stipulation granting the creditor authority to take possession and not ownership of the property upon foreclosure. Examples on pactum commissorium: Ex. X corporation pledges shares; the pledge agreement states that pledgee has authority to instruct Corporate Secretary of X to transfer shares in name of pledgee in case of default. VALID? NO. The execution of document transferring the shares is only a confirmation of the sale that was already consummated automatically. Ex. If the agreement is that, upon default, pledgee sells the things pledged at market price and applies profits to the outstanding obligation. Valid? Yes. There is no automatic transfer of ownership. In fact, the sale of the thing to satisfy the obligation is the essence of pledge. Ex. Upon default, pledgor conveys property to pledgee by dation; and for the purpose, pledgee is attorney in fact of pledgor. Valid? YES. It is not automatic; there is need for another agreement to be entered into. Ex. Pledgee has the option to purchase the thing upon default at price certain. Valid? Yes. There must be a subsequent sale; it is not automatic. Remember, for PC to exist, the EFFECTIVE ACT IS DEFAULT, upon which, there is automatic transfer of ownership. Article 2089. A pledge or mortgage is indivisible, even though the debt may be divided among the successors in interest of the debtor or of the creditor. Therefore, the debtor’s heir who has paid a part of the debt cannot ask for the proportionate share of extinguishment of the pledge or mortgage as long as the debt is not completely satisfied. Neither can the creditor’s heir who has received his share of the debt return the pledge or cancel the mortgage, to the prejudice of the other heirs who have not yet been paid. From these provisions is excepted the case in which, there being several things given in mortgage or pledge, each one of them guarantees only a determinate portion of credit. The debtor, in this case, shall have the right to the extinguishment of the pledge or mortgage as the portion of the debt for which each thing is specially answerable is satisfied. Article 2090. The indivisibility of a pledge or mortgage is not affected by the fact that the debtors are not solidarily liable. Cayo IID 2002

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WHAT DO YOU MEAN PLEDGE/MORTGAGE IS INDIVISIBLE? Ex: 1M Loan. It was secured by REM. The REM covered several (100) condominium units. In accordance with the schedule, there was payment of 100K, can you ask release of corresponding amount of units? No release. Pledge is indivisible. WHAT ARE THE EXCEPTIONS TO INDIVISIBILITY: 1. Where each one of several thing guarantees a determinate portion of credit. Ex: If you have 100 mortgages securing corresponding portion of the loan, then when the corresponding portion is paid, the corresponding pledge/mortgage is extinguished. All 100 mortgages may be in the same document. Or, if the parties agree to allow partial discharge of the pledge/mortgage. How? Cancel pledge/mortgage and constitute a new pledge/mortgage.The downside is that you must again pay doc. stamps and reg. fees, unlike in the document with 100 mortgages, where the fees are only paid once. 2. If there was only partial release of the loan. CB v. CA. The bank only released a portion of the loan; the court ordered a corresponding portion of the REM to be released. 3. Where there was failure of consideration. Creditor took over management but the business failed. Article 2091. The contract of pledge or mortgage may secure all kinds of obligations, be they pure or subject to a suspensive or resolutory condition. Pledge/mortgage may secure all sorts of valid, voidable, unenforceable obligations. Article 2092. A promise to constitute a pledge or mortgage gives rise only to a personal action between the contracting parties, without prejudice to the criminal responsibility incurred by him who defrauds another, by offering in pledge or mortgage as unencumbered, things which he knew were subject to some burden, or by misrepresenting himself to be the owner of the same.

PROVISIONS APPLICABLE ONLY TO PLEDGE Article 2093. In addition to the requisites prescribed in article 2085, it is necessary, in order to constitute the contract of pledge, that the thing pledged be placed in the possession of the creditor, or of a third person by common agreement. Remember. Pledge/mortgage are real contracts. If you agree, but don’t deliver to the pledgee or a third person/s, there is no pledge but there is an agreement to enter into a pledge. Can delivery be made to the pledgor? Yes, if he is acting as agent of pledgee or where the thing pledged is so unwieldy as to make delivery impossible, constructive delivery is allowed. What may be the objects of pledge? Movables within the commerce of man. Delivery may be the actual thing or a title (certificates of deposit, stocks). Must be indorsed. Shares of stock not negotiable so no indorsement is required, however, for safety reasons, the same may be required. Article 2094. All movables which are within commerce may be pledged, provided they are susceptible of possession.

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Article 2095. Incorporeal rights, evidenced by negotiable instruments, bills of lading, shares of stock, bonds, warehouse receipts and similar documents may also be pledged. The instrument proving the right pledged shall be delivered to the creditor, and if negotiable, must be indorsed. Article 2096. A pledge shall not take effect against third persons if a description of the thing pledged and the date of the pledge do not appear in a public instrument. The problem here is: how do third persons check if the thing is pledged when the thing isn’t represented by some sort of title which can be annotated? They can’t but they should exercise diligence. Red flags would be failure or inability of debtor to show the thing or the title to the thing. No requirement as to form but to affect third persons, it must be in a public instrument (notarized document). Article 2097. With the consent of the pledgee, the thing pledged may be alienated by the pledgor or owner, subject to the pledge. The ownership of the thing pledged is transmitted to the vendee or transferee as soon as the pledgee consents to the alienation, but the latter shall continue in possession. Ex: pledgor pledges property to pledgee to secure a loan. Pledge is in a public instrument. Pledgor sell property to third person/s without notice to pledgee – sale is valid but transfer of ownership is suspended until pledgee consents. Why would the pledgee want to be informed – administrative purposes; who gets property when obligation is paid. Article 2098. The contract of pledge gives a right to the creditor to retain the thing in his possession or in that of a third person to whom it has been delivered, until the debt is paid. Article 2099. The creditor shall take care of the thing pledged with the diligence of a good father of a family; he has a right to the reimbursement of the expenses made for its preservation, and is liable for its loss or deterioration, in conformity with the provisions of this Code. Article 2100. The pledgee cannot deposit the thing pledged with a third person, unless there is a stipulation authorizing him to do so. The pledgee is responsible for the acts of his agents or employees with respect to the thing pledged. Remedy of pledgor if pledgee deposits it with a third party without authority? The pledgor may demand extrajudicial deposit of the thing under 2104 or deposit with a third person/s in 2106. If the pledgee deposits the thing with a third person without authorization, can the pledgor demand resolution of the pledge agreement? Yes. Substantial breach under 1191 gives the injured party the right to resolve the obligation. It can be argued that the principal consideration was that the custodian be the pledgee; now if the creditor transfers possession, it’s a principal breach. Article 2101. The pledgor has the same responsibility as a bailor in commodatum in the case under article 1951. [The pledgor who, knowing the flaws of the thing pledged, does not advise the pledgee of the same, shall be liable to the latter of the damages which he may suffer by reason thereof.] Article 2102. If the pledge earns or produces fruits, income, dividends, or interests, the creditor shall compensate what he receives with those which are owing him; but if none are owing him, or insofar as the amount may exceed that which is due, he shall apply it to the principal. Unless there is a stipulation to the contrary, the pledge shall extend to the interest and earnings of the right pledged. Cayo IID 2002

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In case of a pledge of animals, their offspring shall pertain to the pledgor or owner of animals pledged, but shall be subject to the pledge, if there is no stipulation to the contrary. The creditor who receives the fruits should apply them to whatever amount is owing (obligations due and payable), if not due, the fruits just form part of the pledge. If the period is for the benefit of the pledgee, even if the obligation is not due, he may compensate against the interest or the principal, as the case may be. Ex: Lender lends Borrower money, payable upon demand. To secure the loan, B pledges a goat. Here the benefit of the period is for the creditor, L. L may then take the goat’s milk and offspring and compensate against what is owing him even if the obligation is not yet due. Article 2103. Unless the thing pledged is expropriated, the debtor continues to be the owner thereof. Nevertheless, the creditor may bring the actions which pertain to the owner of the thing pledged in order to recover it from, or defend it against a third person. If the thing is expropriated, the thing will continue with respect to the thing given.

labo!

Article 2104. The creditor cannot use the thing pledged, without the authority of the owner, and if he should do so, or should misuse the thing in any other way, the owner may ask that it be judicially or extrajudicially deposited. When the preservation of the thing pledged requires its use, it must be used by the creditor but only for that purpose. The creditor can only use the thing if he is authorized or its preservation requires use. If he misuses it, the pledgor can demand extrajudicial deposit. Article 2105. The debtor cannot ask for the return of the thing pledged against the will of the creditor, unless and until he has paid the debt and its interest, with expenses in a proper case. Article 2106. If through the negligence or willful act of the pledgee, the thing pledged is in danger of being lost or impaired, the pledgor may require that it be deposited with a third person. Though the pledgor cannot demand return of the thing unless the obligation is fulfilled, if the thing pledged is in danger of being lost or impaired through the pledgee’s willful act or negligence, he may require its deposit with a third person. Article 2107. If there are reasonable grounds to fear the destruction or impairment of the thing pledged, without the fault of the pledgee, the pledgor may demand the return of the thing, upon offering another thing in pledge, provided the latter is of the same kind as the former and not of inferior quality, and without prejudice to the right of the pledgee under the provisions of the following article. The pledgee is bound to advise the pledgor, without delay, of any danger to the thing pledged. Article 2108. If, without the fault of the pledgee, there is danger of destruction, impairment, or diminution in value of the thing pledged, he may cause the same to be sold at a public sale. The proceeds of the auction shall be a security for the principal obligation in the same manner as the thing originally pledged. If the thing is in danger of diminution or destruction, without the pledgee’s fault, the pledgor may demand its return, provided he replaces it with another of the same kind and quality. Despite the pledgor’s right above, in the same situation, the pledgee may opt to sell the thing and keep the proceeds; the pledgee’s right takes precedence over the pledgor’s. In this case, the proceeds of the sale shall be security for the debt. In 2108, upon due date, if the cash value is less than the principal obligation, the creditor can still recover the balance from the debtor, unlike in foreclosure. this looks important. Cayo IID 2002

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The pledgor can question the sale, alleging that he could have obtained a better price. Article 2109. If the creditor is deceived on the substance or quality of the thing pledged, he may either claim another thing in its stead, or demand immediate payment of the principal obligation. This is an instance where the debtor loses the benefit of the period: If the debtor dupes the creditor as to the quality of the thing, the creditor may demand immediate payment or delivery of another security. Article 2110. If the thing pledged is returned by the pledgee to the pledgor or owner, the pledge is extinguished. ANY STIPULATION TO THE CONTRARY SHALL BE VOID. If subsequent to the perfection of the pledge, the thing is in the possession of the pledgor or owner, there is a prima facie presumption that the same has been returned by the pledgee. This same presumption exists if the thing pledged is in the possession of a third person who has received it from the pledgor or owner after the constitution of the pledge. If after the perfection of the pledge, the property is in the possession of the pledgor, as owner, the presumption is that it was returned and extinction of the pledge, UNLESS the owner holds it as agent of the pledgee. *Article 2111. A statement in writing by the pledgee that he renounces or abandons the pledge is sufficient to extinguish the pledge. For this purpose, neither the acceptance by the pledgor or owner, nor the return of the thing pledged is necessary, the pledgee becoming a depositary. PROBLEM: TO SECURE HIS LOAN, BORROWER PLEDGED HIS CAR TO LENDER. OUT OF THE KINDNESS OF HIS HEART, LENDER COMPOSED A LETTER RENOUNCING THE PLEDGE. HE USED THE CAR TO DRIVE TO THE POST OFFICE AND MAILED THE LETTER. WHILE DRIVING HOME, LENDER SPOTTED BORROWER WITH LENDER’S WIFE AND FELT VERY ANGRY AND JEALOUS. WHEN BORROWER RECEIVED THE LETTER, HE WENT TO LENDER’S HOUSE TO RECOVER THE CAR BUT LENDER REFUSED AND TOLD BORROWER TO PISS OFF. CAN LENDER REFUSE TO RETURN THE CAR? No. See Article 2111. Article 2112. The creditor to whom the credit has not been satisfied in due time, may proceed before a Notary Public to the sale of the thing pledged. This sale shall be made at a public auction, and with notification to the debtor and the owner of the thing pledged in a proper case, stating the amount for which the public sale is to be held. If at the first auction the thing is not sold, a second one with the same formalities shall be held; and if at the second auction there is no sale either, the creditor may appropriate the thing pledged. In this case he shall be obliged to give an acquittance for his entire claim. WHAT ARE THE FORMALITIES REQUIRED FOR THE NOTARIAL SALE? (1) the debt is due and unpaid; (2) the sale must be at a public auction; (3) there must be notice to the pledgor and owner, stating the amount due; and (4) the sale must be with the intervention of a notary public. How is the public sale conducted? Default rule: Proceed before a Notary Public and ask him to conduct a notarial sale. The notary supervises the sale of the pledged property, drafts the rules and notifies the debtor and the owner. Is there a period required for notification?

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No particular period is required by law. Notice can be given right before close of office the day preceding the sale. Before that date, debtor already defaulted; he should have known a notarial sale was forthcoming. The reason, according to JPSP, is, if there were a period, the pledgor would be able to litigate and obtain an injunction. Can it be a private sale? Ex: stocks pledged, listed on the PSE and just coursed through a broker. Yes – there is no express prohibition. But see the de Leon book under Article 2112. Exception to pactum commissorium if the thing is not sold after two sales, the creditor may appropriate the thing and it shall be considered as full payment for the entire obligation. Article 2113. At the public auction, the pledgor or owner may bid. He shall, moreover, have a better right if he should offer the same terms as the highest bidder. The pledgee may also bid, but his offer shall not be valid if he is the only bidder. The pledgor is allowed to bid and all things being equal, his bid shall be preferred over that of others. The law wants to conserve the property in the owner. The pledgee may also bid, but his offer shall not be valid if he is the only bidder because the law seeks to prevent fraud. Fraud is possible if the parties had stipulated that the debtor shall be allowed to the excess and the creditor, who is bidding alone, bids low. Article 2114. All bids at the public auction shall offer to pay the purchase price at once. If any other bid is accepted, the pledgee is deemed to have been received the purchase price, as far as the pledgor or owner is concerned. Pledgee can waive cash requirement, but that is his lookout. Article 2115. The sale of the thing pledged shall extinguish the principal obligation, whether or not the proceeds of the sale are equal to the amount of the principal obligation, interest and expenses in a proper case. If the price of the sale is more than said amount, the debtor shall not be entitled to the excess, unless it is otherwise agreed. If the price of the sale is less, neither shall the creditor be entitled to recover the deficiency, notwithstanding any stipulation to the contrary. The obligation is extinguished when the pledge is sold regardless of whether the proceeds are less or more than the amount of the obligation. Unlike in a mortgage, there can be recovery of deficiency. IN PLEDGE, YOU CAN STIPULATE THAT THE DEBTOR WILL BE ENTITLED TO THE EXCESS BUT YOU CAN’T STIPULATE THAT THE CREDITOR WILL BE ALLOWED TO RECOVER DEFICIENCY. PROBLEM: IN THE PLEDGE AGREEMENT, THE PARTIES STIPULATED THAT, IN CASE OF NOTARIAL SALE, THE PLEDGOR SHALL BE ENTITLED TO THE EXCESS AND THE PLEDGEE SHALL BE ENTITLED TO RECOVER THE DEFICIENCY. ARE THE STIPULATIONS VALID? The stipulation that the debtor shall be entitled to the excess is valid. The stipulation giving the creditor the right to recover the deficiency is void. See Article 2115. HOW DO YOU GUARD AGAINST THE SITUATION OF NOT BEING ABLE TO RECOVER THE DEFICIENCY IF YOU ARE THE PLEDGEE? Set a minimum bid (if this is actually allowed; JPSP says yes, book says no) OR Instead of selling the thing, just sue for the entire obligation.

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OR Stipulate that if the value of the pledge goes under a certain amount, then the debtor shall be obliged to pledge additional securities. Ex: 1M obligation, 1.5M worth of stocks pledged; stipulate that if the value goes below 1.3M then the debtor will be obliged to pledge additional securities. Without such a stipulation, can Article 2108 have the same effect? Ex: 1M obligation, 1.5M worth of stocks pledged. When the stocks go down top 1.4M, can you claim that the value of the pledge is diminishing and then choose to sell the stocks for 1.4M, keeping the profits as security, pursuant to 2108? JPSP says: “Maybe but speculative.” Probably not if the change in price is just a day-to-day fluctuation. PROBLEM: 1M IS SECURED BY A 700K MORTGAGE AND A 900K PLEDGE. IF YOU ARE THE LENDER, AND THE BORROWER DEFAULTS, WHICH SECURITY TO YOU GO AFTER FIRST? Go against the REM first, then take the whole pledge and make $$$! In REM, unlike in pledge, the debtor is entitled to the excess and the creditor is entitled to recover the deficiency, as a default rule. Article 2116. After the public auction, the pledgee shall promptly advise the pledgor or owner of the result thereof. This is to allow the debtor to take reasonable steps if he suspects that the sale was not honest. Article 2117. Any third person who has any right in or to the thing pledged may satisfy the principal obligation as soon as the latter becomes due and demandable. The creditor cannot refuse payment by a third person WITH AN INTEREST in the thing pledged. Third party can be a buyer of the thing or someone with a junior lien. Why would a third person with a junior lien want to pay the obligation? The property may be more valuable than the obligation and he may want his lien to become senior. Article 2118. If a credit which has been pledged becomes due before it is redeemed, the pledgee may collect and receive the amount due. He shall apply the same to the payment of his claim, and deliver the surplus, should there be any, to the pledgor. Under this article, the thing pledged is a credit which has become due. The creditor can thus collect the amount due and compensate, DELIVERING THE SURPLUS TO THE DEBTOR.

The pledgee has the duty to collect any due credits, in line with the ordinary diligence required of him. Article 2119. If two or more things are pledged, the pledgee may choose which he will cause to be sold, unless there is a stipulation to the contrary. He may demand the sale of only as many of the things as are necessary for the payment of the debt. PROBLEM: A 1.5M DEBT IS SECURED BY 2M WORTH OF SMC SHARES. IF YOU ARE THE PLEDGEE, HOW WOULD YOU SELL? Sell all. You are not required to sell by piece. Pledgor can restrict only if there are two pledges securing the obligation. Article 2120. If a third party secures an obligation by pledging his own movable property under the provisions of article 2085 he shall have the same rights as a guarantor under articles 2066 to 2070, and articles 2077 to 2081.

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He is not prejudiced by any waiver of defense by the principal obligor. The third party pledgor is entitled to: 1.

Indemnity;

2.

Subrogation;

3.

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

4.

Release in favor of one pledgor benefits all;

5.

Extension granted to debtor extinguishes pledge;

6.

Pledgors are released from obligation if by some act of the creditor, there can be no subrogation;

7.

Pledgor may set up defenses inherent in the debt.

Article 2121. Pledges created by operation of law, such as those referred to in articles 546, 1731, and 1994, are governed by the foregoing articles on the possession, care and sale of the thing as well as on the termination of the pledge. However, after payment of the debt and expenses, the remainder of the price of the sale shall be delivered to the obligor. Article 2122. A thing under a pledge by operation of law may be sold only after demand of the amount for which the thing is retained. The public auction shall take place within one month after such demand. If, without just grounds, the creditor does not cause the public sale to be held within such period, the debtor may require the return of the thing. In pledges by operation of law, the remainder of the sale price shall be delivered to the debtor. The foregoing articles govern the following pledges by operation of law; BUT after sale, the excess, if any, is returned to the pledgor:

•

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

•

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

•

Depositary may retain thing until paid for the deposit.

•

Agent may retain objects of agency until reimbursed by principal.

•

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

I think creditor will be entitled to recover because here, he did not How about any deficiency? accept the pledge voluntarily and the reason for prohibiting recovery is absent (the reason being that creditors should know not to lend more than what can be secured). Article 2123. With regard to pawnshops and other establishments, which are engaged in making loans secured by pledges, the special laws and regulations concerning them shall be observed, and subsidiarily, the provisions of this Title.

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REAL MORTGAGE Art. 2124. Only the following property may be the object of a contract of mortgage: (1) Immovables; (2) Alienable real rights in accordance with the laws, imposed upon immovables. Nevertheless, movables may be the object of a chattel mortgage. Mortgage (def). A real estate mortgage is a contract whereby the debtor secures to the creditor the fulfillment of a principal obligation, specially subjecting to such security immovable property or real rights over immovable property in case the principal obligation is not complied with at the time stipulated.

What are the characteristics of the contract of mortgage? Mortgage is a real, accessory, and subsidiary contract.

Who takes possession of the mortgaged property? As a general rule, the mortgagor retains possession of the property mortgaged. However, it is not an essential requisite of the contract of mortgage that the property remains in the possession of the mortgagor. If the mortgagor delivers the property to the mortgagee, it can still be a contract of mortgage, plus some other contract.

What is the consideration in a contract of mortgage? Since mortgage is an accessory contract, the consideration is the same as that of the principal contract.

What are the kinds of real mortgage? 1. Voluntary – Agreed to between the parties or constituted by the will of the owner of the property 2. Legal – Required by law to be executed in favor of certain persons 3. Equitable – Lacks the proper formalities of mortgage but shows the intention of the parties to make the property as a security for a debt.

What is the subject matter of real mortgage 1. Immovables 2. Alienable rights imposed upon immovables

Can you mortgage future property? Future property CANNOT be the object of a contract of mortgage. One cannot constitute a mortgage on “any other property he might have now and those he might acquire in the Cayo IID 2002

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future.” Remember that one of the essential requisites of mortgage is that the mortgagor should be the absolute owner of the thing mortgaged. But a stipulation which says that the mortgage covers future improvements upon real property already mortgaged is valid. This is because these future improvements are deemed included in the real property by accession; they are not separate from the real property already subject of the mortgage. Art. 2125. In addition to the requisites stated in Article 2085, it is indispensable, in order that a mortgage may be validly constituted, that the document in which it appears be recorded in the Registry of Property. If the instrument is not recorded, the mortgage is nevertheless binding between the parties. The persons in whose favor the law establishes a mortgage have no other right than to demand the execution and the recording of the document in which the mortgage is formalized. Art. 1357. If the law requires a document or other special form, as in the acts and contracts enumerated in the following article, the contracting parties may compel each other to observe that form, once the contract has been perfected. This right may be exercised simultaneously with the action upon the contract. Art. 1358. The following must appear in a public document: (1) Acts and contracts which have for their object the creation, transmission, modification, or extinguishment of real rights over immovable property…

What are the requisites of real mortgage? 1. It must be constituted to secure a principal obligation. 2. The mortgagor must be the absolute owner of the thing mortgaged. 3. He must have free disposal of the thing or otherwise be authorized to do so. 4. When the principal obligation becomes due, the property mortgaged may be alienated for the payment to the creditor. 5. To prejudice third persons, the mortgage must be recorded in the Registry of Property. If the first four requisites are present, there is already a valid mortgage between the parties – mortgagor and mortgagee. But to affect third persons, there is a need to comply with the fifth requisite: The document of mortgage must be recorded in the Registry of Property. This is because recording the document in the Registry of Property serves as notice to 3rd persons. This is similar to the requirement in pledge that the pledge be in a public document.

Can there be an oral mortgage?

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As between the parties, YES. As long as the four essential requisites above are present, there is already a mortgage between the parties. It need not be in writing in order to be enforceable since it is not covered by the Statute of Frauds. But the oral mortgage is not binding against third persons. And the mortgagee cannot register the mortgage in the Registry of Property if it is an oral mortgage. So his remedy is to invoke Art. 1357 and 1358. 1357 provides that if there is already a valid contract, one party can compel the other party to observe the proper form. In this case, since there is already a valid mortgage between the parties, the mortgagee can compel the mortgagor to execute a public document of mortgage, so that the mortgagee can then register it in the Registry of Property. Remember that 1357 is only for convenience. Its purpose is to compel the mortgagor to execute a public document, so that the mortgagee can register the mortgage. It does not determine the validity or even the enforceability of the mortgage between the parties. Before you can invoke it, there has to be a valid mortgage first. Once the previously oral mortgage is in a public document and is subsequently registered in the Registry of Property, it becomes binding on third persons.

Procedure: What happens when you enter into a contract of mortgage? Step 1: Execute the document of mortgage Step 2: Go to a notary public, who will notarize the document. Step 3: Pay the documentary stamp tax within the first five days of the succeeding month. The doc stamp tax is a percentage of the value of the property mortgaged. Step 4: Go to the Office of the Register of Deeds and pay the registration fees. Before you pay the registration fees, the government will require you to update payment of realty taxes on the property. After payment of the registration fees, the mortgage will be annotated on the title. Problem: Mortgagor mortgages a house and lot worth 500K to Mortgagee to secure a principal obligation of “100K and any and all future indebtedness.” The mortgage is registered. Meanwhile, Mortgagor owes another creditor, X, 500K. The total indebtedness of Mortgagor to Mortgagee eventually reaches 500K. On due date, Mortgagor fails to pay both X and Mortgagee. The house and lot is his only property. X is able to obtain a writ or attachment on the house and lot. Who has a better right to the house and lot – X or mortgagee? Mortgagee has a better right with respect only to 1/5 of the house and lot. This is because the mortgage was registered only to the extent of 100K, and not to the “any and all future debts.” Therefore, the mortgage is binding on third persons only with respect to the 100K debt, or 1/5 of the house. X can argue on two grounds: 1. That Mortgagee paid doc stamp taxes based only on the 100K debt, not on the succeeding 400K debt. So he even cheated the government of its revenues in this case. Cayo IID 2002

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2. Besides, at the time of the mortgage, the 400K debt was non-existent. Therefore, X has a better right with respect to the 4/5 which was not registered. How does mortgagee opt out of this problem? 1. He can do a credit line arrangement in which he will give the debtor a ceiling up to which he can borrow. The mortgage deed will say that the principal obligation is 500K, but debtor has the choice of asking for a release of funds below this ceiling. This way, the mortgagee is sure that the entire 500K loan is registered. But this is costly, since the doc stamp tax will be based on the ceiling and not on the actual amount released. 2. The better solution is that the mortgagee should execute and register a new document each time he releases funds to the mortgagor/debtor.

What happens if the mortgage is void? If for some reason, the mortgage is void, the principal obligation subsists. What is lost is only the right of the creditor to foreclose the mortgage in order to satisfy the principal obligation. Moreover, even if the mortgage itself is void, the mortgage deed remains as proof of the principal obligation. Art. 2126. The mortgage directly and immediately subjects the property upon which it is imposed, whoever the possessor may be, to the fulfillment of the obligation for whose security it was constituted. In guaranty, the property of the guarantor is not subjected to a lien. The action of the creditor is against the guarantor himself and not against his property. The creditor would still have to sue the guarantor, obtain judgment, execute it, etc. On the other hand, in mortgage, the property is subjected to a lien. It creates a real right which is inseparable from the property mortgaged. It is enforceable against the whole world (provided it is registered). Until the principal obligation is discharged, the mortgage follows the property wherever it goes and subsists even if the ownership changes. So if the mortgagor sells the mortgaged property, the property still remains subject to the fulfillment of the obligation secured by it. All subsequent purchasers must respect the mortgage, as long as it is registered, or even if it is not registered, if the purchaser knew that it was mortgaged. The mortgagee has a right to rely in good faith on what appears on the certificate of title of the mortgagor. In the absence of anything to excite suspicion, he is under no obligation to look beyond the certificate.

Does the mortgagor lose his title to the property mortgaged? No. A mortgage does not involve a transfer, cession, or conveyance of property but only constitutes a lien thereon. It does not extinguish the title of the debtor. The mortgagor/debtor continues to be the owner. The only right of the mortgagee is to foreclose the mortgage and sell the property to satisfy the obligation. The mortgagor’s default does not operate to vest in the mortgagee the ownership of the encumbered property. Cayo IID 2002

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Since the mortgagor retains ownership of the mortgaged property, he can even mortgage it again to another mortgagor (junior lien/encumbrance). Art. 2127. The mortgage extends to the natural accessions, to the improvements, growing fruits, and rents or income not yet received when the obligation becomes due, and to the amount of the indemnity granted or owing to the proprietor from the insurers of the property mortgaged, or in virtue of expropriation for public use, with the declarations, amplifications and limitations established by law, whether the estate remains in the possession of the mortgagor, or it passes into the hands of a third person. Future property, in themselves, cannot be the subject matter of mortgage. But, the future improvements, accessions, and fruits of property already mortgaged are also covered by the mortgage. This is because they are deemed to be part of the principal thing which was already existing at the time of the constitution of the mortgage. To exclude these things, there must be an express stipulation to that effect. Examples: 1. The mortgage deed contains a provision that “all property taken in exchange or replacement, as well as all buildings, machineries, and, equipment, and others that the mortgagor may acquire, construct, install, attach, or use in its lumber concession shall immediately become subject to the mortgage.” This is a valid stipulation, especially where the property mortgaged is subject to deterioration (such as machinery and equipment). The purpose of this stipulation is to maintain the value of the property mortgaged. 2. JPSP example: In the mortgage deed, Mortgagor mortgages house and lot #1 and another house and lot which he will acquire next month. The deed is registered. Is this a valid mortgage? Between mortgagor and mortgagee, the mortgage is valid with respect to both house and lot #1 and #2. The remedy of the mortgagee, once mortgagor acquires the second house and lot, is to compel the mortgagor to execute a public document evidencing the mortgage of the 2nd house and lot and to register it, so that it would be binding on third parties. But, as against third parties, the mortgage is only valid with respect to the first house and lot but not to the second house and lot, until the latter is registered.

What happens if the thing mortgaged is expropriated? The security becomes the cash given by the government as indemnity. Upon default, the mortgagee can apply the cash as payment for the obligation. Art. 2128. The mortgage credit may be alienated or assigned to a third person, in whole or in part, with the formalities required by law.

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The mortgage credit is a real right, and under property law, real rights over immovables are also considered immovables in themselves. Thus, they may be alienated or assigned to third persons, in whole or in part, by the mortgagee who is the owner of the right. The assignee may then foreclose the mortgage in case of nonpayment of the principal obligation. The alienation or assignment of the mortgage credit is valid even if it is not registered. Registration is only necessary to affect third persons. Art. 2129. The creditor may claim from a third person in possession of the mortgaged property, the payment of the part of the credit secured by the property which said third person possesses, in the terms and with the formalities which the law establishes. Art. 2129 does not really apply to all third persons in possession of the property. It only applies to those in possession of the mortgaged property in the concept of owner. If the possession by a third person is only as lessee, the creditor may not collect the credit from that third person. When a mortgagor alienates/sells the mortgaged property to a third person, the creditor may demand from him the payment of the principal obligation. This is because the mortgage credit is a real right, which follows the property wherever it goes, even if its ownership changes. However, before the creditor can collect from the third person, he must have made a demand on the debtor, and the latter should have failed to pay. Example: A mortgaged his land worth P5M in favor of B to secure a debt of P6M. A sold the land to C.

On due date, B should demand payment of the P6M from A. If A fails to pay, B may foreclose the mortgage. B may also choose to collect P5M (not P6M) from C, which is the part of the principal obligation secured by the property sold to C. C is not liable for the deficiency of P1M in the absence of a contrary stipulation. If C pays B, C can go after A for reimbursement. Art. 2130. A stipulation forbidding the owner from alienating the immovable mortgaged shall be void. A stipulation forbidding the owner from alienating the mortgaged property is void for being contrary to public policy because it is an undue impediment or interference on the transmission of property. However, if the mortgagor alienates the property, the transferee must respect the mortgage because it is a real right. A stipulation that requires the mortgagor to notify the mortgagee in writing before he sells the property is VALID. This is not a prohibition but a mere regulation. The mortgagee would want to regulate the disposition of the property by the mortgagor because first, he would want to know the type of person from whom he might have to collect the credit later on. Second, any disposition of the mortgaged property by the mortgagor is a red flag that may indicate that the mortgagor/debtor may not be able to pay the debt later on (Because why is he suddenly disposing of his property? Maybe he doesn’t have money anymore.) Art. 2131. The form, extent and consequences of a mortgage, both as to its constitution, modification and extinguishment, and as to the other matters not included in this Chapter shall be governed by the provisions of the Mortgage Law and of the Land Registration Law. Cayo IID 2002

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

What is foreclosure? It is the remedy available to the mortgagee by which he subjects the mortgaged property to the satisfaction of the obligation. It denotes the procedure adopted by the mortgagee to terminate the rights of the mortgagor on the property and includes the sale itself.

How do you foreclose? There are two types of foreclosure – judicial and extra-judicial foreclosure. The default rule is judicial foreclosure. You can only do extra-judicial foreclosure if the mortgage deed has a provision which gives the mortgagee the special power of attorney to sell the mortgaged property in accordance with Act 3135. But these are only default rules. The parties may also stipulate that the sale will be a private sale.

Mortgage to a Foreigner – RA 133 Can you mortgage to a foreigner? Yes, since foreigners are only prohibited from owning real property in the Philippines, not from being mortgagees. The situation is governed by RA 133. However, if the mortgagor defaults, the foreigner CANNOT foreclose extra-judicially. He can only foreclose judicially. Moreover, he cannot bid or take part in any sale of the real property in case of foreclosure.

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

Can the foreigner take possession of the property upon default of the mortgagor? The foreigner can take possession of the mortgaged property upon default but only for the purpose of foreclosure and receivership in accordance with the prescribed judicial procedures, AND in no case exceeding five years. When confronted with a foreclosure problem…

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First, check if there’s a stipulation saying that there will be a private sale. If there is such a stipulation, the property can be sold at a private sale. If there is no such stipulation, then there will be either judicial or extra-judicial foreclosure. Second, look for the following tell-tale signs: 1. Is the mortgagee a foreigner? If it’s a foreigner, it’s automatically judicial foreclosure (Act 133). 2. If the mortgagee is not a foreigner, look for a stipulation in the mortgage agreement which gives the mortgagee the special power of attorney to carry out the extrajudicial foreclosure in accordance with Act 3135. If you find this stipulation, it is an extra-judicial foreclosure. 3. If there is no stipulation for extra-judicial foreclosure under Act 3135, it is a judicial foreclosure governed by Rule 68 of the Rules of Court. Third, if it’s an extra-judicial foreclosure, look at the parties. Who is foreclosing? 1. If it is a bank, the governing law is Act 3135, but there will be certain exceptions applicable only to banking institutions, provided in Section 47 of the General Banking Act. 2. If the mortgagee is not a bank, the extra-judicial foreclosure will be governed by Act 3135. Fourth, now that you know whether it’s judicial or extra-judicial foreclosure, let’s go through each of the processes… JUDICIAL FORECLOSURE UNDER RULE 68, RULES OF COURT

STEP 1: The mortgagee should file a petition for judicial foreclosure in the court which has jurisdiction over the area where the property is situated STEP 2: The court will conduct a trial. If, after trial, the court finds merit in the petition, it will render judgment ordering the mortgagor/debtor to pay the obligation within a period not less than 90 nor more than 120 days from the finality of judgment. STEP 3: Within this 90 to 120 day period, the mortgagor has the chance to pay the obligation to prevent his property from being sold. This is called the EQUITY OF REDEMPTION PERIOD. STEP 4: If mortgagor fails to pay within the 90-120 days given to him by the court, the property shall be sold to the highest bidder at public auction to satisfy the judgment. STEP 5: There will be a judicial confirmation of the sale. After the confirmation of the sale, the purchaser shall be entitled to the possession of the property, and all the rights of the mortgagor with respect to the property are severed or terminated. The equity of redemption period actually extends until the sale is confirmed. Even after the lapse of the 90 to 120 day period, the mortgagor can still redeem the property, so long as there has been no confirmation of the sale yet. Therefore, the equity of Cayo IID 2002

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redemption can be considered as the right of the mortgagor to redeem the property BEFORE the confirmation of the sale. Õ IMPORTANT: After the confirmation of the sale, the mortgagor does not have a right to redeem the property anymore. This is the general rule in judicial foreclosures – there is no right of redemption after the sale is confirmed. The exception to this rule is when the judicial foreclosure is done by a BANK. In such a case, there is still a right of redemption within one year from the registration of the sale. STEP 6: The proceeds of the sale of the property will be disposed as follows: 1. First, the costs of the sale will be deducted from the price at which the property was sold 2. The amount of the principal obligation and interest will be deducted 3. The junior encumbrances will be satisfied 4. Õ If there is still an excess, the excess will go back to the mortgagor. In mortgage, the mortgagee DOES NOT get the excess (unlike in pledge). Õ If there is a deficiency, the mortgagee can ask for a DEFICIENCY JUDGMENT which can be imposed on other property of the mortgagor. This is unlike the rule in pledge, where the pledgee cannot collect any deficiency. This is also unlike the rule in extra-judicial foreclosure where the mortgagee must go to court and file another action for the collection of the deficiency. In this case, there is no need to file an action. The mortgagee just has to file a motion in court for the deficiency judgment.

Why should you stay away from judicial foreclosure? Judicial foreclosure is costly, since the parties would need to hire lawyers. Moreover, in judicial foreclosure, the parties have very little control over the sale because there is court intervention. Judicial foreclosure is also more susceptible to stalling/dilatory tactics by the mortgagor, since he can file all sorts of motions in court to prevent the sale. EXTRA-JUDICIAL FORECLOSURE UNDER ACT 3135

When is extra-judicial foreclosure proper? There must be a provision in the mortgage giving the mortgagee the special power of attorney to carry out the extra-judicial foreclosure under Act 3135.

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

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What is the procedure? STEP 1: File a complaint for extra-judicial foreclosure with the Executive Judge STEP 2: Notice of the sale There are two kinds of notices required: 1. Posting in at least 3 public places 20 days before the sale – usually in the Sheriff’s office, the Assessor’s office, and the Register of Deeds. 2. Publication in a newspaper of general circulation, once a week for at least three consecutive weeks if the value of the property exceeds P400 This need not be done within a span of 21 days. For example, you can publish on August 30, which is a Friday, then on September 2, which is a Monday, and then on September 9, which is also a Monday. In this case, publication for three consecutive weeks is completed within 11 days. The notice should contain the description of the property to be sold, date, time, and place of the sale, and the principal obligation to be satisfied by the sale of the mortgaged property. There is no need for personal notice to the mortgagor, unlike in a guaranty. This is because the mortgagor, having defaulted in the principal obligation, should expect that a foreclosure is forthcoming. This is because the mortgagor, having defaulted in the principal obligation, should expect that a foreclosure is forthcoming. If you’re the mortgagee, you would want to surprise the mortgagor so the he cannot employ dilatory tactics such as getting an injunction in order to delay the foreclosure. If you’re nasty, you should publish it in Abante, which is a newspaper of general circulation, but which nobody consults for the purpose of checking if their mortgaged property is about to be foreclosed. STEP 3: Public Auction Time for conducting the public sale: Between 9 am to 4 pm Manner of conducting the sale: The sale should be under the direction of the sheriff of the province, the justice or auxiliary justice of the peace of the municipality, or of a notary public of the municipality, who shall be compensated with FIVE PESOS for each day of actual work performed (wow $$$). Who may bid: Anyone may bid at the sale, unless there are exceptions stipulated in the mortgage deed. Even the mortgagee/creditor may bid. And unlike in pledge, even if the mortgagee/creditor is the sole bidder, the sale is still valid. This is because there is a right to redeem in extra-judicial foreclosure. Therefore, the lower the price at which it is sold, the better the chances of the mortgagor/debtor to redeem the property.

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

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

What is the effect of inadequacy of the price at which the property is sold at auction? If there is a right to redeem, inadequacy of price is not material because the debtor may reacquire the property. It will even make it easier for him to redeem it if it is sold at a low price. Mere inadequacy of price will not be sufficient to set aside the sale unless the price is so inadequate as to shock the conscience. What happens if there is an excess? The excess should first be applied to satisfy the junior liens and encumbrances on the property. If there is still an excess, it goes to the mortgagor.

What happens if there is a deficiency? The mortgagee must go to court and file an action to collect the deficiency. He may file an action for a deficiency judgment even during the period of redemption.

STEP 4: Possession of the Property Upon foreclosure, if the mortgagor is in possession of the property, he will retain possession during the redemption period (one year from the date of the sale). However, if the winning bidder already wants possession of the property, he may file a petition in court to gain possession. He must give a bond equivalent to the rent for the use of the property for 12 months. The bond will answer for any loss to the mortgagor if it is later found that he was not in default in the mortgage obligation or that the conduct of the sale violated Act 3135. Upon approval of the bond, the court will issue a writ of possession in favor of the purchaser. Õ Exception to this rule: If the party foreclosing is a BANK, Sec 47 of the General Banking Law provides that the purchaser shall immediately have the right to take possession of the property upon confirmation of the sale.

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

STEP 5: Redemption

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The debtor has the right to redeem the property sold within one year from the date of the sale, reckoned from date of execution of the certificate of sale since it is only from that date that the sale takes effect as a conveyance. Õ Exception: If the mortgagee foreclosing is a BANK and the mortgagor is a JURIDICAL PERSON, the juridical person shall have the right to redeem the property BEFORE the registration of the certificate of sale but NOT EXCEEDING 90 DAYS FROM THE DATE OF THE FORECLOSURE. Õ What is the difference between the RIGHT OF REDEMPTION and EQUITY OF REDEMPTION? The right of redemption is the right of the mortgagor to redeem the mortgaged property within a certain period (in most cases, within 1 year) AFTER the sale of the property in satisfaction of the mortgage debt. It is available to the mortgagor only when the mortgage is foreclosed extrajudicially. It is not available in judicial foreclosures, except when the mortgagee foreclosing is a bank. On the other hand, equity of redemption is the right of the mortgagor in a judicial foreclosure to pay the amount of his obligation BEFORE the confirmation of the sale of the mortgaged property. Who may redeem? The debtor, his successors in interest, or any judicial creditor or judgment creditor of the debtor, or any person having a junior encumbrance or lien on the property may exercise the right of redemption. Example: Mortgagor mortgaged a house and lot to A. Later, Mortgagor also mortgaged it to B. A foreclosed the mortgage and bought the house and lot at the auction. In this case, upon the sale of the property to A, the only right that B as second mortgagee has is the right to redeem. He may exercise the right by paying off the debt secured by the first mortgage. B’s exercise of Mortgagor’s equity of redemption is equivalent to foreclosure of the junior mortgage. How much should the one exercising the right of redemption pay? The mortgagor (or whoever is redeeming the property) should pay the PURCHASE PRICE of the property (not the amount of the original obligation anymore) plus INTEREST OF 1% PER MONTH (this is according to De Leon, citing Rule 39 Section 28 of the Rules of Court. JPSP says interest is at 2% per month). Õ Exception: If the mortgagee foreclosing is a BANK, under Sec 47 of the General Banking Law, the mortgagor should pay the amount of the ORIGINAL OBLIGATION (not the purchase price) plus INTEREST AT THE ORIGINAL RATE stipulated in the mortgage contract plus all COSTS and expenses incurred by the bank from the sale of the property. What happens if the debtor/mortgagor fails to redeem the property within the prescribed period?

If the debtor/mortgagor fails to redeem the property within the prescribed period, the purchaser has the absolute right to a writ of possession. From then on, the mortgagor loses his right over the property. Cayo IID 2002

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

What is the effect of the timely exercise of the right of redemption? If the debtor/mortgagor is able to exercise the right of redemption on time, he does not really recover property since he does not lose ownership until after the expiration of the redemption period. He merely frees it of the encumbrance created by the mortgage. What happens if the mortgagor sells the property to a third person within the redemption period?

The third person, in buying the property, is actually buying not the property itself but the right to redeem the property and the right to possess it within the redemption period. X mortgaged property to a Bank to secure a P1M loan at 17% interest. The mortgage was foreclosed. At the sale, the property was sold to the Bank as the highest bidder for P800K. The bank then sold the property to Y for P1.5M. If X wants to redeem the property, to whom should he pay and how much?

X should pay to the Bank. He should pay only P1M - the amount of the principal obligation plus interest at 17%, plus costs (Sec 47 General Banking Law: Remember, this is the exception to the general rule that the mortgagor should pay the purchase price and 1% interest per month). Y would then have a right to seek reimbursement from the Bank. The right of redemption may be exercised by the mortgagee under the same terms, even if the property is subsequently sold to a third party. A different rule would make it easy for the buyer at the foreclosure sale to render the right of redemption nugatory simply by making a conveyance of the property for an amount beyond the capacity of the mortgagor to pay.

Can the right of redemption be waived by the mortgagor in advance? It depends if there is a fair exchange of value and information between the parties. If the mortgagor is a farmer who mortgages his parcel of land and he waives the right to redeem, he can later argue that the waiver was not valid for being contrary to the public policy of preserving the property in the hands of the owner. But if the mortgagor is a businessman who waives the right to redeem in exchange for lower interest rates, this waiver is valid because there is a fair exchange of value. SUMMARY OF EXCEPTIONS UNDER SECTION 47 OF THE GENERAL BANKING LAW OF 2000

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When the party foreclosing the mortgage is a BANK, the same procedure as in judicial or extrajudicial foreclosure, as the case may be, is followed. However, the following are the exceptions to the general rules, applicable only to banks: 1. In judicial foreclosures, there is still a right to redeem As a general rule, there is no right of redemption in judicial foreclosure. Upon confirmation of the sale, the mortgagor cannot redeem the property anymore.

But if the mortgagor foreclosing judicially is a bank, the mortgagor shall have a right to redeem within one year from the sale. 2. Redemption Price In ordinary extra-judicial foreclosure, the redemption price is the purchase price plus interest at 1% (or 2%?) per month.

In extra-judicial foreclosure by a bank, the redemption price consists of: a. the amount of the mortgage obligation b. plus the interest on the loan at the rate stipulated in the mortgage contract c. plus costs of the sale incurred by the bank 3. Automatic Right of Possession In ordinary extra-judicial foreclosure, the mortgagor retains possession of the property within the redemption period. If the purchaser wishes to have possession within the redemption period, he must file a petition for the issuance of a writ of possession with a corresponding bond.

In extra-judicial foreclosure by a bank, the purchaser automatically has the right to take possession after the confirmation of the sale. 4. Injunction If anybody wants to enjoin the conduct of foreclosure proceedings instituted by a bank, the petitioner must file a bond fixed by the court to satisfy whatever damage the bank may suffer by the injunction.

There is no such provision in the case of ordinary extra-judicial foreclosure. 5. Period of Redemption for Juridical Persons In ordinary extra-judicial foreclosure, the mortgagor may redeem the property after it is sold within one year from the execution of the certificate of sale. There is no distinction, whether the party redeeming is a natural or juridical person. If the party foreclosing extrajudicially is a bank, the same rule as above is applicable to natural persons. BUT, juridical persons may redeem the property subject only to the following conditions:

a. it must be BEFORE the registration of the sale Cayo IID 2002

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b. and, it must not be later than 90 days from the date of the sale EFFECTS ON THE JUNIOR MORTGAGE What happens if there was a second mortgage constituted on the property that was foreclosed? If the property was mortgaged a second time, the second mortgage is subordinate to the first mortgage. The first mortgagor has the right to foreclose the mortgage upon default by the debtor. The following are the rights of a junior mortgagee: 1. If the first mortgagee forecloses judicially, before the sale is effected, the junior mortgagee may exercise the equity of redemption vested in the mortgagor. The junior mortgagee may satisfy the obligation of the mortgagor to prevent the sale of the property. What happens to the ownership of the property when the second mortgagee exercises the right of redemption? There are two interpretations – one under the Rules of Court and another under the Civil Code. When the second mortgagee exercises the equity of redemption by paying the obligation of the mortgagor/debtor, the mortgagor/debtor has 60 days to reimburse the second mortgagee what he paid. If the original debtor fails to pay within this period, ownership will be consolidated in the second mortgagee who paid. This interpretation is according to Section 28 Rule 39 of the Rules of Court. But according to the Civil Code rules on payment (oblicon), the effect should be like payment of an obligation by a third person, in which case, the second mortgagee merely becomes subrogated in the right of the first mortgagee to foreclose the mortgage. 2. When an extra-judicial sale is made, the junior mortgagee may exercise the mortgagor’s right to redeem within one year from the sale. De Leon says that he should pay the amount of the original obligation. JPSP says that the junior mortgagee exercising the right to redeem should follow Act 3135 – he should pay the price at which the property was sold. 3. If the property is sold for more than the amount of the obligation to the first mortgagee, the excess should be applied to the payment of the obligation to the second mortgagee. But if there is no excess, the second mortgage is extinguished. Õ If you’re the second mortgagee, you can also foreclose, not the property (since you cannot do that because the right of the first mortgagee is superior), but the

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

CHATTEL 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. What is chattel mortgage? Chattel mortgage is the contract by virtue of which personal property is recorded in the Chattel Mortgage Register as a security for the performance of an obligation. This definition under the Chattel Mortgage Law is no longer applicable. It is the definition under Art. 2140 of the Civil Code that applies now. What are the characteristics of the contract of chattel mortgage? 1. It is an accessory contract because it secures performance of a principal obligation 2. It is a formal contract because it requires registration in the Chattel Mortgage Register for its validity (but only against third persons) 3. It is a unilateral contract because it produces only obligations on the part of the creditor to free the thing from the encumbrance on fulfillment of the obligation. What is the subject matter of chattel mortgage? The subject matter of chattel mortgage is personal or movable property. What are the requisites for a valid chattel mortgage?

1. It must be constituted to secure a principal obligation. 2. The mortgagor must be the absolute owner of the thing mortgaged. 3. He must have free disposal of the thing or otherwise be authorized to do so. 4. When the principal obligation becomes due, the property mortgaged may be alienated for the payment to the creditor. 5. To prejudice third persons, the mortgage must be recorded in the Chattel Mortgage Registry. If the first four requisites are present, there is already a valid mortgage between the parties – mortgagor and mortgagee.

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But to affect third persons, there is a need to comply with the fifth requisite: The document of mortgage must be recorded in the Chattel Mortgage Registry. This is because recording the document in the Chattel Mortgage Registry serves as notice to 3rd persons. This is similar to the requirement in pledge that the pledge be in a public document and the requirement in Real Estate Mortgage that it must be recorded in the Registry of Property. Note that unlike in pledge, there is no need for actual delivery of the personal property to the mortgagee. DISTINCTIONS BETWEEN CHATTEL MORTGAGE AND PLEDGE DELIVERY OF THE PERSONAL PROPERTY REGISTRATION IN THE REGISTRY OF PROPERTY PROCEDURE FOR SALE RIGHT TO EXCESS OF PROCEEDS OF SALE RIGHT TO RECOVER DEFICIENCY

CHATTEL MORTGAGE Not necessary Necessary for validity of the chattel mortgage against third persons Governed by Section 14 of the Chattel Mortgage Law Excess goes to the debtor/mortgagor Creditor/mortgagee can recover deficiency from the debtor/mortgagor, except if covered by Recto Law

PLEDGE Delivery is necessary for validity of the pledge Not necessary; public document is enough to bind third persons Governed by Article 2112 of the Civil Code Excess goes to the pledgee/creditor unless otherwise stipulated Creditor/pledgee is not entitled to recover any deficiency after the property is sold, notwithstanding any contrary stipulation

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 mortgage. THE CHATTEL MORTGAGE LAW How do you constitute a chattel mortgage? To constitute a chattel mortgage, the parties must register the personal property mortgaged in the Chattel Mortgage Register as security for the performance of an obligation. However, if the chattel mortgage is not registered, it is still valid and binding as between the parties. The requirement of registration is not for validity but only for binding third parties. What is the effect of registration? The registration of the chattel mortgage creates a real right or lien which follows the personal property wherever it goes. Registration gives the mortgagee symbolic possession.

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What is the form required for a chattel mortgage? According to Sec. 5 of the Chattel Mortgage Law, the following form should be sufficient: FORM OF CHATTEL MORTGAGE AND AFFIDAVIT This mortgage made this Fifth day of October 2002 by Sheryl Tanquilut, a resident of municipality of Taytay, Province of Rizal Philippines, mortgagor, to Anna del Castillo a resident of the municipality of Cainta, Province of Rizal Philippines, mortgagee, witnesseth: That the said mortgagor hereby conveys and mortgages to the said mortgagee all of the following-described personal property situated in the municipality of Taytay Province of Rizal, and now in the possession of said mortgagor, to wit: A PAIR OF SKY BLUE NIKE PRESTO SNEAKERS, SIZE 3XS This mortgage is given as security for the payment to the said Anna del Castillo, mortgagee, of the sum of fifty pesos, with interest thereon at the rate of twenty-five per centum per annum due on 25 December 2002. The conditions of this obligation are such that if the mortgagor, his heirs, executors, or administrators shall well and truly perform the full obligation above stated according to the terms thereof, then this obligation shall be null and void. Executed at the municipality of Taytay in the Province of Rizal this Fifth day of October 2002. In the presence of:

Sgd. Sheryl Tanquilut

Sgd. Xilca Alvarez Sgd. Helen Arevalo FORM OF OATH (affidavit of good faith) [Tip: know the contents of an affidavit of good faith. JPSP might ask us to make one in the exam. Lumabas sa past exam] We severally swear that the foregoing mortgage is made for the purpose of securing the obligation specified in the conditions thereof, and for no other purpose, and that the same is a just and valid obligation, and one not entered into for the purpose of fraud. FORM OF CERTIFICATE OF OATH In the Province of Rizal, personally appeared Sheryl Tanquilut, Xilca Alvarez, and Helen Arevalo, the parties who signed the foregoing affidavit and made oath to the truth thereof before me. Cayo IID 2002

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Sgd. Bhoy-B Notary public

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What happens if there is no affidavit of good faith? The mortgage is still valid between the parties, but it will not bind third persons, such as creditors and subsequent encumbrancers. If there is no affidavit of good faith, the mortgage will not be preferred as against these third persons. Can you constitute a chattel mortgage to secure a future obligation or “a current obligation plus any and all obligations hereinafter contracted by the mortgagor in favor of the mortgagee”? No. You can only constitute a chattel mortgage to secure debts or obligations that are existing at the time the mortgage is constituted. If it is constituted to secure an obligation that is not yet existent, it is void. The affidavit of good faith executed by the mortgagor states that the mortgage is constituted to secure the obligation specified therein and for no other purpose. What the parties should do is to execute a new document/ deed of chattel mortgage to cover the newly contracted obligation. Can you mortgage future property? Section 7 of the Chattel Mortgage Law provides that as a general rule, you cannot mortgage property that you do not own at the time of the constitution of the mortgage. Therefore, you cannot mortgage future property. But as an exception to this rule, the inventory of retail stores can be the subject of chattel mortgage, even if technically, they may be acquired by the mortgagor after the mortgage is constituted. This is because the after-acquired property is actually in renewal or in replenishment of goods on hand when the mortgage was executed. The SC came up with this exception in order not to hamper the circulation of capital in the industry. What happens when the mortgagor pays the obligation? If the mortgagor pays the obligation, he gets a discharge from the mortgagee so that he can then cancel the lien annotated on the title and in the Chattel Mortgage Registry. What happens when the mortgagor defaults on the obligation? 1. Right of Redemption In case of default, the following persons may redeem the property before it is sold, by paying the amount of the obligation plus costs and expenses incurred from the breach: a. the mortgagor b. a subsequent mortgagee c. a subsequent attaching creditor If an attaching creditor redeems, he is subrogated to the rights of the mortgagor. He can foreclose the mortgage.

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But once the property is sold at auction, there can be no redemption anymore. 2. Right of Mortgagee to Possession If the creditor/mortgagee wants to foreclose upon default, he has the implied right to take the mortgaged property. If the debtor/mortgagor refuses to surrender the property, the creditor should file an action for replevin to take possession or for judicial foreclosure. 3. Foreclosure The parties can stipulate for a private sale upon default. If there is no stipulation, the applicable rule is Section 14 of the Chattel Mortgage Law. According to Section 14, the creditor/mortgagee can cause the property to be sold at public auction thirty days after default. This is a minimum grace period given to the mortgagor to redeem the property before it is sold at auction. There is no maximum time period for holding the sale. The procedure is the same as that for extra-judicial foreclosure of a real estate mortgage, except for the notice requirements. In chattel mortgage, the only notice requirement is posting at two or more public places in the municipality and personal notice to the mortgagor and junior mortgagees at least ten days before the date of the sale (no publication). The proceeds of the sale will be applied as follows: a. Costs and expenses of the sale b. Payment of the obligation secured by the mortgage c. Claims of persons holding subsequent mortgages in their order; and d. The balance, if any, shall be given to the mortgagor Can the mortgagee recover any deficiency after the sale of the property? Unlike in pledge, the creditor can still file an action for recovery of any deficiency in case the proceeds of the sale do not satisfy the entire obligation, unless the situation is covered by the Recto Law. PROBLEMS ON REAL AND CHATTEL MORTGAGE Mortgagor mortgaged property worth 120K to secure a 100K loan. Mortgagor defaulted. Mortgagee foreclosed. The property was sold to X for 70K. Should mortgagor redeem the property? Yes, because he can sell it for more than 70K and realize more than the amount of the principal obligation. But if, in the example above, the mortgagor has creditors running after him for debts worth 300K, should he redeem? Cayo IID 2002

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No, he should not redeem. If he redeems, he spends 70K in order to re-acquire property, which he may thereafter lose again to his other creditors. Borrower borrows P1M from Lender. Borrower executes a deed of assignment by way of security over the shares of stock in favor of Lender in order to secure payment of the loan. It is stipulated that upon payment of the loan by Borrower, Lender will re-convey the shares of stock to Borrower. What is this arrangement? This can either be a PLEDGE or an IMPLIED TRUST. It’s not really a pledge because there is an absolute conveyance of ownership by the supposed pledgor in favor of the pledgee. But the Supreme Court has treated this in several cases as a pledge. JPSP likes the implied trust theory better because there is a statutory basis. Art. 1454 of the Civil Code provides that if an absolute conveyance of property is made in order to secure the performance of an obligation of the grantor toward the grantee, a TRUST by virtue of law is established. If the fulfillment of the obligation is offered by the grantor when it becomes due, he may demand the reconveyance of the property to him. If it’s a trust, there is no need to foreclose (actually, there’s no right to foreclose). What happens if there’s default? Art. 1454 does not cover this situation, which is probably why the Supreme Court has characterized this type of transaction as a pledge instead. JPSP thinks that if there’s default, ownership will be consolidated in the lender/trustee. But if the parties don’t want any problem, they should stipulate the precise effect of default. Borrower borrows P10M from Lender. Borrower offers the following securities to Lender: (1) a GUARANTY by X who is worth P100M (2) a PLEDGE of shares of stock worth P10M (3) a REAL ESTATE MORTGAGE worth P15M Which one should Lender choose? It really depends on the circumstances, but here are the considerations: 1. If he chooses the pledge, it is easier to foreclose, and he can get the excess in case the shares of stock are sold for more than P10M. 2. If he chooses the guaranty, it is good only if he is sure that the guarantor will pay. If the guarantor is any of the following, persons, the guaranty would be a good choice: a. the Government – because it is never insolvent b. a Bank – in the form of a bank guaranty through a letter of credit c. Insurance Company – though in some cases, it is also hard to collect from an insurance company (also, take note that they would be governed, not by the Civil Code provisions on guaranty, but by the Insurance Code).

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But the disadvantage of choosing the guaranty is that the guarantor who is worth P100M can afford to hire good lawyers who can stall the Lender’s claim. 3. In the case of the real estate mortgage, it depends on how easy it would be to dispose of the property. If it’s property at a prime spot in Makati, this might be a good choice since it can probably be sold at a good price right away. But if it’s located in the boondocks, the Lender may have a very difficult time selling it. Borrower borrows P10M from Lender. The loan is secured by a guaranty by X, who is worth P100M, a real estate mortgage worth P8M, and a pledge worth P8M. If Borrower defaults, what is the best way for Lender to proceed? 1. Foreclose the real estate mortgage first. Then get a deficiency judgment for the remaining P2M. 2. Then, foreclose the pledge because in pledge, he gets to keep the excess – resulting in an upside of P6M. 3. The Guarantor is not yet an option since he has the benefit of excussion. The Lender must first go through steps 1 and 2 and other remedies before running after X. Borrower borrows P10M from Lender. The loan is secured by a pledge worth P8M and a guaranty by X. How should the Lender proceed in case of default by Borrower? If Lender forecloses the pledge, he will have a deficiency of P2M, which he cannot collect anymore. On the other hand, he cannot proceed against the guarantor without foreclosing the pledge first. So what should he do? He should sue Borrower in his capacity as debtor, not as a pledgor, for collection of the debt. Then, he should attach the property pledged. When judgment in his favor is rendered, he can then execute it against the attached shares. The shares can be sold at an ordinary execution sale, not a foreclosure sale. In this way, the shares will be taken out of the context of the pledge, and any deficiency in the sale can still be recovered by the lender. After the execution of the judgment on the shares, the Lender can then go after the Guarantor for the deficiency.

ANTICHRESIS 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. What is antichresis? Antichresis is a contract by which the creditor acquires the right to receive the fruits of an immovable belonging to the debtor, with the obligation to apply them to the payment of the interest, if owing, and thereafter to the principal of his credit. Cayo IID 2002

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What are the characteristics of antichresis? 1. Accessory – It secures the performance of a principal obligation. Manresa, however, believes that it is an independent contract. 2. Formal Contract – It must be in specified form to be valid (in writing). Is delivery of the property to the creditor required? Delivery is not required for the validity of the contract itself. BUT, it is required in order that the creditor may receive the fruits. Does antichresis apply to all of the fruits of the immovable concerned? GENERAL RULE: The general rule is that the contract of antichresis covers ALL the fruits of the encumbered property. If the parties do not want all of the fruits to be subject to the antichresis, they must STIPULATE otherwise. Is it essential for the contract to have a stipulation for interest in order to have an accessory contract of antichresis?

No. It is not essential to the contract of antichresis that the loan that it guarantees should have interest. There is nothing in the law that says that antichresis can only guarantee interestbearing loans. What are the differences between antichresis and real mortgage?

ANTICHRESIS Property is delivered to the creditor Creditor acquires only the right to receive the fruits of the property; not a real right General rule is that creditor must pay the taxes and charges upon the estate; parties must stipulate otherwise Expressly stipulated that the creditor shall apply the fruits to the payment of interest, if owing, and thereafter to the principal

REAL MORTGAGE Debtor usually retains possession of the property Creditor has no right to receive the fruits, but mortgage creates a real right over the property which is enforceable against the world Creditor has no obligation to pay taxes and charges No obligation on the part of the mortgagee to apply the fruits to interest and principal

Õ Antichresis and real mortgage are similar in that the subject matter is real property. Õ Like pledge and mortgage, antichresis gives a real right if it is registered in the Registry of Property. Example: A borrowed P1M from B. To secure the loan, A delivered a parcel of land with coconut trees to B, giving B the power to administer it and harvest the coconuts. What is the nature of the contract? Cayo IID 2002

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Answer: The contract is one of mortgage, not antichresis. In order for it to be a contract of antichresis, it must be expressly agreed between creditor and debtor that the creditor, having been given possession of the property, is to apply the fruits to the payment of interest, if owing, and thereafter, to the principal. Art. 2133. The actual market value of the fruits at the time of the application thereof to the interest and principal shall be the measure of such application. When it is time to apply the fruits to the payment of the interest or the principal, the creditor must base the value of the fruits on their market value at the time of the application. Example:

The property subject of the contract of antichresis has mango trees. In January, one kilo of mangoes costs P50/kilo. But in May, when mangoes are in season, one kilo costs 25/kilo. If interest is due in January, the creditor must apply the fruits to the payment of interest based on the price of P50/kilo. If interest is due in May, he should compute at the price of P35/kilo. Art. 2134. The amount of the principal and of the interest shall be specified in writing; otherwise, the contract of antichresis shall be void. Is there a form required for the contract of antichresis?

Yes. The contract must state the amount of the principal and the interest IN WRITING. If this form is not followed, the contract of antichresis is VOID. The requirement that it be in writing is necessary not merely to bind third persons but to make the contract valid. But even if the antichresis is void, the principal obligation is still valid. Art. 2135. The creditor, unless there is a stipulation to the contrary, is obliged to pay the 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. What are the obligations of the creditor under the contract of antichresis?

1. Pay the taxes and charges upon the estate – If the creditor does not pay the taxes, he is required by law to pay indemnity for damages to the debtor. If the debtor pays the taxes on the property which the creditor should have paid, the amount is to be applied to the payment of the debt. If the amount of taxes paid by the debtor is enough to satisfy the principal obligation, then the loan and the antichresis are extinguished; the creditor must return the property to the debtor. What if the creditor does not want to pay the taxes and charges? They must so stipulate in their agreement OR see the next article.

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2. Apply the fruits The creditor must apply the fruits of the property to the payment of interest, if owing, and thereafter to the principal.

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. When can the debtor get back the property subject of the antichresis?

The debtor can get it back only when he has totally paid the principal obligation. This is because the property stands as a security for the payment of the principal obligation. Is there an exception?

Yes. The exception to this rule is if the creditor does not want to pay the taxes and charges upon the estate. In such a case, the creditor may compel the debtor to get the property back, UNLESS there is a contrary stipulation (exception to the exception). But this has the effect of extinguishing the contract of antichresis. Art. 2137. The creditor does not acquire the ownership of the real estate for nonpayment 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. What happens when the debtor defaults on the principal obligation?

The creditor DOES NOT acquire ownership of the real estate. Any stipulation to the contrary shall be void. This is because the contract of antichresis covers only the right to receive the fruits from the estate, and not its ownership. Also, this is pactum commisorium, which is void. The creditor has the following remedies in case of default: 1. Bring an action for specific performance. 2. Petition for the sale of the real property in judicial foreclosure proceedings under Rule 68 of the Rules of Court. Can the parties stipulate on an extra-judicial foreclosure? Yes, in the same manner that they are allowed in pledge and mortgage. Can the creditor acquire the property given in antichresis by prescription?

No, and any stipulation to the contrary shall be void. In order to acquire property be prescription, possession must be in the concept of owner. The antichretic creditor possesses the property merely as a holder. Cayo IID 2002

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Exception: Just like in a co-ownership, if the creditor repudiates the antichresis, he can acquire the property by prescription. 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 exceed the amount of interest allowed by the laws against usury, the excess shall be applied to the principal. The creditor must first apply the fruits to the payment of the interest. If the value of the fruits exceeds the value of the interest due, then the creditor should apply the excess to the principal. The second part of this provision is no longer applicable, since there is no Usury Law anymore. Art. 2139. The last paragraph of article 2085, and articles 2089 to 2091, are applicable to this contract. Other characteristics of Antichresis:

1. A third person, who is not a party to the principal contract, may offer his immovable under the contract of antichresis to secure the debt of another. (2085) 2. The contract of antichresis is indivisible. (2089) 3. The indivisibility of the antichresis is not affected by the fact that the debtors are not solidarily liable. (2090) 4. The contract of antichresis may secure all kinds of obligations – pure or conditional. (2091)

CONCURRENCE AND PREFERENCE OF CREDITS What is concurrence of credits?

Concurrence of credits implies the possession by two or more creditors of equal rights or privileges over the same property or all of the property of a debtor. What is preference of credit?

It is the right held by a creditor to be preferred in the payment of his claim out of the debtor’s assets above others. In other words, it is the right to be paid first. Nature and Effect of Preference

1. Exception to the general rule – Because, generally, you have to pay your creditors when the debt becomes due. There should be no rules as to who should be paid first. Preference applies only when there are two or more creditors with separate claims against a debtor who has insufficient property. Since it is an exception to the general rule, the law as to preferences is strictly construed.

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2. Does not create an interest in property – Preference simply creates a right to be paid first from the proceeds of the sale of property of the debtor. It does not create a lien on the property itself, but merely a preference in the application of the proceeds of the property after it is sold. 3. The creditor does not have the right to TAKE the property or SELL it as against another creditor – Preference is not a question as to who may take and sell property belonging to the debtor. Preference applies after a sale, and it is a question of application of the proceeds of the sale to satisfy the debt. 4. It must be asserted – If the right claimed is not asserted and maintained, it is lost. If property has not been seized, it is open to seizure by another. 5.

It must be maintained – Where a creditor released his levy, leaving the property in possession of the debtor, thereby indicating that he did not intend to press his claim further as to that specific property, he is deemed to have abandoned his claim of preference.

When are the rules on preference of credits applicable?

The rules apply only where: 1. 2. 3. 4.

there are two or more creditors with separate and distinct claims against the same debtor who has insufficient property.

There must be a proceeding such as an insolvency proceeding wherein the creditors can file their claims. The right becomes significant only after the properties of the debtor have been inventoried and liquidated, and the claims of the various creditors have been established. Because before that, you have no way of knowing who the creditors are, and you have no liquidated property out of which you can pay them. What is the difference between preference of credit and a lien?

A preference applies only to claims which do not attach to specific properties. A lien, on the other hand, creates a charge on a particular property. Can a creditor whose credit is not yet due assert a right to preference?

No. The title on Concurrence and Preference of Credits refers only to credits which are already due.

CHAPTER 1 GENERAL 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. General Rule: A debtor is liable with ALL his property, present and future, for the fulfillment of his obligations.

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Exceptions: Exemptions provided by law, such as future support, the family home, property in custodia legis, etc. See page 489-492 of De Leon for the list (not very important) Art. 2237. Insolvency shall be governed by special laws insofar as they are not inconsistent with this Code.

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 or absolute community may, by order of the court, be transferred to the wife or to a third person other than the assignee. If one of the spouses is insolvent, the assets of the CPG or AC do not pass to the assignee in insolvency elected by the creditors or appointed by the court. The reason for this is that the CPG or AC is distinct from the individual spouses. The exemption applies provided that: 1. The CPG or AC subsists; and 2. The obligations of the insolvent spouse have not redounded to the benefit of the family. The insolvency of the husband does not dissolve the CPG or AC. Art. 2239. If there is property, other than that mentioned in the preceding article, owned 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 obligation. If there is a co-ownership (other than CPG or AC) and one of the co-owners becomes insolvent, only his undivided share or interest in the property can be possessed by the assignee in insolvency proceedings. Of course, the shares of the other co-owners cannot 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. In a trust, the trustee is not the owner of the property, though he has legal title thereto. Since he is not the absolute owner of the property held in trust, these properties should not be included in insolvency proceedings.

CHAPTER 2 CLASSIFICATION OF CREDITS The Civil Code classifies credits against a particular insolvent into three general categories: 1. special preferred credits listed in 2241 and 2242 2. ordinary preferred credits listed in 2244 3. common credits under 2245

Special Preferred Credits (2241 and 2242)

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The items in bold face are the important/relevant ones: 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, repairs, 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 travelers 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.

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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. First, you must remember that, aside from item (1) on taxes imposed in connection with the movable, 2141 does establish the order of priority among these claims. It just enumerates the preferred claims with respect to specific movables. With respect to the same specific movable or immovable, creditors merely concur. There is no preference among them, except that the State always gets paid the taxes imposed on the property first. (1) Taxes The tax must be due on the movable itself. (2) Misappropriation, breach of trust, malfeasance of public officers The acquisition must have been in the performance of official functions. Also, the property must still be in the hands of the public official. If it is sold to a purchaser for value and in good faith, there can be no more claim on the movable. (4) Guaranteed with a pledge or chattel mortgage

To be a preferred credit: If it’s a pledge, it must be in a public instrument. If it’s a chattel mortgage, it must be registered in the chattel mortgage registry. Last paragraph of 2241

If the movable is wrongfully taken, the preferred creditor may get it back within 30 days through an accion subrogatoria, exercising the right of the debtor to recover property wrongfully taken from him granted under Article 559. Problem: The Debtor’s only property is a Jaguar worth P2.5M. His liabilities are:

a. to the Government:

Income tax of P1M Import duties on the car worth P1M

b. chattel mortgage on the car worth P2M c. unpaid price of the car of P1M d. P1M promissory note (notarized) What are the preferred claims with respect to the Jaguar? 1. P1M import duties on the car 2. P2M chattel mortgage 3. P1M unpaid price Cayo IID 2002

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These are the only preferred claims because they are the ones attached to the movable itself. The income tax and the promissory note are not preferred because they are not attached to the car. How do you prioritize the preferred claims?

1. P1M import duties – the State is always the priority with respect to preferred claims 2. The chattel mortgagee and the unpaid seller will then proportionally share the P1.5M left: P1M will go to the mortgagee and 500K will go to the unpaid seller. Note, however, that taxes are not always preferred. For example, income tax is not preferred with respect to the Jaguar. In order to be preferred, the tax must be imposed on the movable itself. Õ This has to be done in the context of insolvency proceedings. Problem: Government official used public funds to acquire a Jaguar from a seller in good faith. Government official becomes insolvent. The Government wants to recover the car. If you’re government counsel, how should you proceed?

The textbook answer would be that the government can go after the car in insolvency proceedings. It has a preferred claim over the car under par. (2) of 2241. But, the disadvantage of this is that, unlike the government claim for tax credits, it is not prioritized over other special preferred claims. The government would have to share with the other creditors who likewise have a special preferred claim on the Jaguar, such as an unpaid seller. The better alternative is to characterize it as an implied TRUST. When funds belonging to another (in this case, the government) are used to purchase a movable under the name of another person (the corrupt government official), there is an implied trust. The trustor is the government, while the trustee is the government official. The trustor/government actually owns the car. There is thus no need to go through the insolvency proceedings, since the Jaguar is not among the properties of the insolvent debtor. Under a trust agreement, X gave Investment House some money. Investment House placed the money in a time deposit. Investment House issued promissory notes for its obligations to other creditors.

If Investment House becomes insolvent, X can show that the money is not owned by Investment House, so it should be excluded from the insolvency proceedings. 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; Cayo IID 2002

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(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-heir in the partition of an immovable among them, upon the real property thus divided; (9) Claims of donors of 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. (1) Taxes Capital gains tax is NOT a preferred credit because it is really a tax on income and not on the property itself. This provision covers real property taxes. (2) Unpaid Seller There is no need to register the sale in order for the unpaid seller to have a preferred claim against the immovable. (5) Mortgage The mortgage must be registered in the Registry of Property in order for the credit to be a preferred claim against the immovable. (7) Credits annotated in the Registry of Property in virtue of judicial order, attachment, or execution

The credits must also be registered in order to be preferred. The preference is only with respect to LATER CREDITS. The credit is preferred only with respect to other attachments, not to other kinds of credit. Therefore, this does not share equally with the other claims. It merely provides that a credit by virtue of judicial order, attachment, or execution that is first registered in the Registry of Property is preferred over other credits of the same nature, which are registered at a later date. Unlike the other special preferred credits, these credits do not share proportionately in the property upon which they are imposed. To determine the Cayo IID 2002

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order of priority among several credits of this kind, their dates should be the basis. The first one to be registered will be prioritized over the others. Õ Again, 2242, is not an order of priority, with the exception of taxes imposed upon the immovable, which is prioritized. 2242 is merely an enumeration. Why isn’t there a provision for malfeasance or misfeasance with respect to immovables?

Corrupt public officials can easily hide movables, which is why it would be more difficult to recover them. Hence, there is a provision giving the government preference with respect to movables. But in the case of immovables, the corrupt public officials cannot really hide them. The government can establish a preferred claim over them simply by attaching. (This is the reason given by JPSP. For the reason of the Code Commission, ask Pelagio Cuison). Problem: Debtor’s only assets are a house and lot worth P5M, a car worth P1M, and jewelry worth 500K. Among Debtor’s liabilities are a real estate mortgage on the house and lot to secure a loan worth P3M and a chattel mortgage on the car to secure a loan worth P500K. Debtor has other obligations worth P6M. What are the preferred credits? How much free property does Debtor have?

With respect to the house and lot, the real estate mortgage is preferred. With respect to the car, the chattel mortgage is preferred. To determine the value of the Debtor’s free property, pay off the preferred claims first: House and Lot worth P5M – P3M REM obligation = P2M excess Car worth P1M – 500K chattel mortgage obligation = 500K excess The excess after the preferred claims have been satisfied will go to the free property of the debtor: Free property = Jewelry worth 500K + P2M excess from House and Lot + 500K excess from car = 500K + 2M + 500K = 3M The free property of Debtor is worth P3M. The other creditors for P6M will then line up for this portion according to the order of priority established in Art. 2244 if they are ordinary preferred credits and 2245 if they are common credits. Problem: Realty Company entered into a contract to sell with X. Under the contract to sell, X will sell the lot to Realty Company, and Realty Company will pay the price in installments. Realty Company failed to pay the installments in full. The lot was used in a condominium project. How can X collect from Realty Company, in case it becomes insolvent?

X should claim that he still owns the lot since the contract was merely a contract TO sell. Therefore, the lot should not be included in the insolvency proceedings concerning Realty Company. X can also claim that the condominium project on the lot cannot be included in the insolvency proceedings either because it is an improvement on a lot owned by X, not by Realty Company. This way, if Realty Company becomes insolvent, X does not have to line up and compete with other creditors’ claims, because he can say that he is the owner of the property.

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Õ JPSP says that if you’re a creditor, you should avoid the preferred claim route because you would rather not line up along with the other creditors. You should find a way to be the owner of the thing that you’re after – such as, proving that it’s an implied trust or a contract to sell, etc. Art. 2243. The claims or credits enumerated in the two preceding articles shall be 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. 2243 gives the rule that taxes due on the movable or on the immovable concerned should be satisfied first. The rest of the special preferred claims share equal preference among themselves.

Ordinary Preferred Credits (2244) 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 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 case of labor accident, or illness resulting from the nature of the employment; (5) Credits and advancements made to the debtor for support of himself or herself, and family, during the last year preceding the insolvency; (6) Support during the insolvency proceedings, and for three months thereafter; (7) Fines and civil indemnification arising from a criminal offense; (8) Legal expenses, and expenses incurred in the administration of the insolvent’s estate 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; (12) Damages for death or personal injuries caused by a quasi-delict; Cayo IID 2002

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(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.

Once the special preferred claims under 2241 and 2242 have been satisfied, the property remaining constitute the debtor’s free property. The debtor’s free property will then be used to pay ordinary preferred claims in the order established in 2244. Unlike 2241 and 2242, 2244 is not merely an enumeration; it establishes the order of priority. Also, unlike 2241 and 2242, 2244 does not establish a preference with respect to specific property of the debtor. The preference is with respect to the mass of properties of the debtor remaining after the special preferred claims have been satisfied. Important Items (2) Labor Claims Art. 110 of the Labor Code has modified 2244 by moving labor claims to number (1), ahead of funeral expenses. Labor claims are still not in the level of special preferred claims under 2241 and 2242. The Labor Code merely moved it up to the top of the list of ordinary preferred claims. Also, Art. 110 of the Labor Code has removed the one-year limitation. (9), (10), (11) Taxes Note that this is unlike special preferred claims where a tax is imposed upon a specific movable or immovable property. Special preferred claims, as provided by 2243, enjoy first preference with respect to the property upon which they are imposed. Under 2244, on the other hand, taxes of other kinds are only ordinary preferred credits and are only 9th, 10th, and 11th priorities with respect to the free portion of the property of the debtor. Examples are income tax, license fees, and capital gains tax. These are not imposed on specific property of the debtor, so they are ordinary preferred claims, which can be collected against the debtor’s free property. Taxes owing the national government should be satisfied first, followed by the provincial government, then the city or municipal government. (14) Credits appearing in a public instrument or in a final judgment This paragraph contains the rule of preference when you have several credits appearing in public instruments or in a final judgment. To determine the order of preference among them, just consider the date. First in time, priority in right, sabi nga ni CLV. This does not include those registered credits which fall under 2241 and 2242, such as those arising from a pledge or mortgage, or an attachment of specific real property. Example: The claims are as follows: A notarized promissory note dated May 1, 2002. A promissory note in a private document dated January 1, 2002. A judgment for sum of money dated October 1, 2002. Cayo IID 2002

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What is the order of priority? 1. 2. 3.

Notarized promissory note dated May 1, 2002 Judgment dated October 1, 2002 Promissory note in a private document dated January 1, 2002

Common Credits Art. 2245. Credits of any other kind or class, or by any other right or title not comprised in the four preceding articles, shall enjoy no preference. If it is not among those mentioned in 2241, 2242, and 2244, it is a common credit. Creditors with common credits have to line up for the excess of the debtor’s property after claims under 2241, 2242, and 2244 have been satisfied. There is no order of preference among common creditors; they share whatever is left in proportion to their credit, regardless of date.

CHAPTER 3 ORDER OF PREFERENCE OF CREDITS Art. 2246. Those credits which enjoy preference with respect to specific movables, exclude all 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. 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. 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 other credits. Art. 2251. Those credits which do not enjoy any preference with respect to specific property and those which enjoy preference, as to the amount 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.

APPLYING THE RULES STEP 1: MAKE AN INVENTORY OF ASSETS List down all the assets of the debtor. Group these assets into two: the Preferred Group and the Free Property Group. Those assets with special preferred claims under 2241 and 2242 imposed upon them belong to the Preferred Group. Cayo IID 2002

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Those without special preferred claims will constitute the debtor’s Free Property. Remember to take out property held by the debtor only in the capacity of trustee. He may have legal title to it, but the beneficial title and ownership actually belong to another person. Since the property does not belong to the debtor, they should not be included in the proceedings. The same goes for property of the AC of CPG, property held as lessee or usufructuary, etc. STEP 2: GROUP THE CLAIMS Make four groups – (1) special preferred credits on movables, (2) special preferred credits on immovables, (3) ordinary preferred credits, and (4) common credits. For the special preferred claims, look out for the following because they are the most common: 1.

For movables: a. b. c.

2.

import duties/other taxes imposed directly on the movable an obligation secured by a pledge (in a public instrument) or a chattel mortgage (registered) claim of unpaid seller for the price of the movable

For immovables: a. b. c. d.

real estate taxes an obligation secured by a real estate mortgage (registered) claim of unpaid seller for the price of the immovable credits annotated in the Registry of Property by attachment or execution upon the immovable

Put the ordinary preferred claims under 2244 together. List them down according to the order under 2244, since 2244 already gives the order of preference. Remember, though, that labor claims are on top. The most common are: 1. 2. 3.

labor claims taxes other than those imposed directly upon a movable or an immovable, such as income taxes and license fees (In the following order: national government, provincial government, city or municipal government). credits in a final judgment or in a public document, such as notarized promissory notes

Put the other credits not falling under these three together. These are the common claims. The usual example is a promissory note in a private instrument. STEP 3: SATISFY THE SPECIAL PREFERRED CLAIMS First: Take the value of the specific movable/immovable upon which the preferred claim is imposed. Second: Pay the taxes due on the property. Third: Pay the preferred claim of the creditor. What if you have more than one preferred creditor over the same property? Ex: The claims against a car are: import duties, chattel mortgage, and unpaid seller. In this case, pay the taxes first. Since the mortgage creditor and the unpaid seller are both special preferred creditors, they will share the balance proportionately. There will only be proportionate sharing in case the value of the thing after payment of taxes is not enough to

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satisfy all of the special preferred claims against it. If the value of the thing is sufficient, then all the special preferred claims must be paid in full. Fourth: If, after paying the taxes and other special preferred claims, there is an excess, take the value of the excess and add it to the debtor’s Free Property. Fifth: If the value of the specific property is not enough to satisfy the taxes and other special preferred claims, and there is a deficiency, follows these rules: a. If the deficiency is in a credit arising from a pledge, real mortgage, or chattel mortgage, put the deficiency in the ordinary preferred credits group. Why do we know right away that it is an ordinary preferred credit? It is a credit in a public instrument, so it is an ordinary preferred credit under (14) of 2244. You know it’s in a public instrument because it was treated at first as a special preferred credit, and the requirement under 2241 and 2242 is that these transactions be registered (for real and chattel mortgage) or be in a public document (for pledge). b. If the deficiency is in a credit arising from a transaction that is not in a public document or is not contained in a final judgment (ex: unrecorded sale), put the deficiency in the common credits group. STEP 4: UPDATE THE INVENTORY AND LIST OF CREDITS After you have satisfied all of the special preferred claims, update the following: 1.

The inventory of assets You may have to add to the Free Property Group if, after satisfying the special preferred claims, you have an excess. Make sure that you add the excess to the Free Property Group. Add up the entire value of the Free Property Group because this is what you will use to settle the ordinary preferred claims and the common claims.

2.

The list of ordinary preferred claims If there was a deficiency in satisfying the special preferred claims, the deficiency will be an ordinary preferred credit if it is notarized or is contained in a final judgment.

3.

The list of common claims If there was a deficiency in satisfying the special preferred claims, the credit will be a common credit if it is not notarized or contained in a final judgment.

STEP 5: SATISFY THE ORDINARY PREFERRED CLAIMS List down all the ordinary preferred claims in the order in which they are listed in 2244. This is the order of preference among them. Most probably, there will be several credits in public instruments and final judgments. Arrange these by date. Those falling on the same date will enjoy equal preference and will share the balance of the free property proportionately. STEP 6: SATISFY THE COMMON CLAIMS Whatever is remaining of the debtor’s free property will be used to satisfy the common claims. Since these will not be enough to cover the debtor’s remaining liabilities (he’s insolvent), the common creditors will share the balance in proportion to the amount of their credit, regardless of the date.

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Most probably, JPSP will just ask us to list the order of preference of several credits. So my suggestion is to make the lists mentioned above and just update the list of ordinary preferred claims and common claims after satisfying the special preferred claims, in case there is an excess or deficiency. Examples: On January 1, 2002, Debtor executes a promissory note for 500K in a private instrument. On March 1, 2002, he executes a Real Estate Mortgage over his house and lot worth P3M to secure a P5M loan. On the same date, he also executes a notarized promissory note for P1M. On September 1, 2002, a creditor is able to obtain a favorable judgment against Debtor for P100K. Debtor becomes insolvent. What is the order of priority of his creditors’ claims? 1.

The mortgage credit should be satisfied first. But since it is for P5M and the house and lot is only worth P3M, there will be a deficiency of P2M. The P2M will be an ordinary preferred credit.

2.

Next in priority are the notarized promissory note for P1M and the P2M deficiency on the mortgage credit. They are both ordinary preferred credits under (14) of 2244. Since they were executed on the same date, they enjoy the same order of preference and will share proportionately in the free property of the Debtor.

3.

The last to be satisfied will be the promissory note in a private instrument, which is a common credit.

The debtor’s assets are a house and lot, a car, and cash. He is insolvent. His obligations are as follows: A real estate mortgage dated June 1, 2002 Chattel mortgage on the car dated March 1, 2002 Real property tax on the house and lot Income tax Import duty on the car Unpaid seller of the lot, sold to him on March 1, 2002 License fee owing the city government for business of Debtor Notarized promissory note dated March 1, 2002 Acknowledgment receipt of debt dated March 1, 2002 Judgment dated March 1, 2002, with attachment on house and lot dated January 1, 2002 What is the order of preference? First, make the inventory: Immovable Property with Special Preferred Claim House and Lot Movable Property with Special Preferred Claim Car Free Property Cash Second, group the credits:

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SPECIAL PREFERRED CLAIMS OVER IMMOVABLE PROPERTY Real estate mortgage dated June 1, 2002 Real property tax on the house and lot

SPECIAL PREFERRED CLAIMS OVER MOVABLE PROPERTY

ORDINARY PREFERRED CLAIMS

Import duty on the car

Income tax

Chattel mortgage on the car dated March 1, 2002

License fee owing the city government for business of Debtor

Unpaid seller of the lot, sold on March 1, 2002 Judgment dated March 1, 2002, with attachment on house dated January 1, 2002

COMMON CLAIMS

Acknowledgment receipt of debt dated March 1, 2002

Notarized promissory note dated March 1, 2002

Third, satisfy special preferred claims: With respect to the House and Lot 1. 2.

Real property tax The following will share proportionately the balance after the payment of the real property tax: a. b. c.

Real estate mortgage creditor Unpaid seller Judgment dated March 1, 2002 with attachment on house and lot dated January 1, 2002

[Let’s assume that there was a deficiency in settling the claims of these three creditors] With respect to the Car 1. 2.

Import duty Chattel mortgage creditor

Fourth, update the list of credits: ORDINARY PREFERRED CLAIMS Income tax License fee owing the city government for business of Debtor

COMMON CLAIMS Acknowledgment receipt of debt dated March 1, 2002

Notarized promissory note dated March 1, 2002 Add: Deficiency in claim of Real estate mortgage creditor dated June 1, 2002 Deficiency in claim of unpaid seller of the lot, sold on March 1, 2002 Deficiency in claim from judgment dated March 1, 2002

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Fifth, pay the ordinary preferred claims out of free property in the following order: 1.

Income tax

2.

License fees

3.

Proportionate sharing: Notarized promissory note dated March 1, 2002 Unpaid seller’s deficiency, sale dated March 1, 2002 Deficiency in judgment credit, dated March 1, 2002

4.

Deficiency in real estate mortgage, dated June 1, 2002

Sixth, pay the common claims out of free property Acknowledgment receipt of debt

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INSOLVENCY LAW What is insolvency? It denotes the state of a person whose liabilities are more than his assets. The Insolvency Law provides for three remedies: 1. 2. 3.

Suspension of Payments Petition for Voluntary Insolvency Petition for Involuntary Insolvency

I. SUSPENSION OF PAYMENTS What is suspension of payments? Suspension of payments is the postponement, by court order, of the payment of debts of one who, while possessing sufficient property to cover his debts, foresees the impossibility of meeting them when they respectively fall due (solvent but not liquid). What are the laws governing suspension of payments? A debtor may file a petition for suspension of payments either under The Insolvency Law or PD 902-A.

SUSPENSION OF PAYMENTS UNDER PD 902-A Who may file for suspension of payments under PD 902-A?

A corporation may file for suspension of payments under PD 902-A if it is either: 1. Solvent but not liquid; OR 2. Insolvent and under the management of a Rehabilitation Receiver or Management Committee A Rehabilitation Receiver or Management Committee is a group of persons appointed by the court to take over the assets of the insolvent corporation in order to turn it around. Õ A natural person cannot file for suspension of payments under PD 902-A,

Where do you file a petition for suspension of payments under PD 902-A? You file the petition with the RTC (it used to be with the SEC, but the law was amended).

What are the advantages of filing a petition for suspension of payments? The advantages of filing a petition for suspension of payments are: 1. The debtor has continued access to the assets and resources of the corporation; and

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2. It gives the debtor leverage or a framework for negotiation (that is, if he files it under PD 902-A, not the Insolvency Law). The debtor can delay payment for as long as the court allows, so it’s a good chance to bargain with creditors in the meantime.

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If you were the debtor corporation, what are the advantages of filing the petition for suspension of payments under PD 902-A instead of under the Insolvency Law? 1. PD 902-A is more lenient than the Insolvency Law. Under the Insolvency Law, the debtor must be solvent but not liquid. Under PD 902-A, even if the corporation is insolvent, as long as it is under Rehabilitation Receiver or Management Committee, it can file for suspension of payments. 2. Under the Insolvency Law, the creditors have a say on whether to grant the petition. Under PD 902-A, only the court decides. 3. Under PD 902-A even secured creditors are covered by the suspension; there are no exceptions. All claims are suspended. Under the Insolvency Law, secured creditors are not covered by the suspension; they may foreclose upon default. SUSPENSION OF PAYMENTS UNDER THE INSOLVENCY LAW (SECTIONS 2-13)

What are the requisites of the petition for suspension of payments under the Insolvency Law? The petition must be filed by a debtor: 1. possessing sufficient property to cover all his debts (SOLVENT) 2. foreseeing the impossibility of meeting them when they respectively fall due (NOT LIQUID) 3. petitioning that he be declared in the state of suspension of payments. The debtor may either be a natural or juridical person (Although, as mentioned already, if you’re a corporation, it would be better to file the petition under PD 902-A, not under the Insolvency Law). The petition need not be verified.

What is the procedure for suspension of payments? 1. File a petition with the RTC where the debtor has resided for six months prior to the filing of the petition. The petition should be accompanied by a verified list of all of his creditors, debts and liabilities, a statement of his assets and liabilities, and the proposed agreement that he requests from his creditors. 2. The court will issue an order calling for the meeting of all creditors. The meeting should take place not less than 2 weeks nor more than 8 weeks from the date of the order. 3. The order will be published and notice sent to all the creditors of the debtor.

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4. There will be a meeting of creditors in which they will decide whether to grant the petition. Take note that the amount of the debt is not reduced. The debtor merely buys more time to satisfy his obligations. Quorum Requirement: To have a valid meeting, the creditors present must represent at least 60% of the total liabilities of the debtor. Ex: A has liabilities worth P10,000 as follows: creditor X: 3,000; creditor Y: 3,000, and creditor Z: 4,000. If X and Y are present, there will be a quorum because they represent 6,000 or 60% of the total liabilities of A. 5. The creditors will approve the proposition of the debtor. Majority required to approve the proposal: A double majority consisting in 2/3 of the number of creditors voting, which 2/3 must represent at least 60% of the total liabilities of the debtor. Example: There are 99 creditors representing total liabilities worth P100K. What is the majority required to approve any proposal? The majority required is 66 creditors (2/3 of the number of creditors voting), who must, in addition, represent at least P60K worth of liabilities. What if the debtor owes one creditor a total of P60K, is his single vote a valid majority? No. Because although he met the requirement of 60% of the liabilities, he does not constitute 2/3 of the number of creditors voting. There must be a double majority. 6. Objections, if any, to the decision must be made within 10 days following the meeting. 7. Issuance of the order of the court directing that the agreement be carried out in case the decision is declared valid, or when no objection to said decision has been presented. What are the effects of filing of the petition?

1. No disposition of his property may be made by the debtor except those made in the ordinary course of business; 2. No payments may be made by the debtor except those made in the ordinary course of business; 3. Upon request to the court, all pending executions against the debtor shall be suspended except execution against property especially mortgaged. Why is it in the interest of the debtor to refrain from making any disposition or payment other than those in the ordinary course of business?

Dispositions or payments made which are not in the ordinary course of business may indicate that the debtor connived with a creditor into voting in favor of the suspension of payments by buying his vote. Also, this shows that the debtor is liquid after all, and therefore, does not need to be placed in a state of suspension of payments.

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Are all of the creditors of the debtor affected by the filing of the petition? Only those creditors included in the schedules filed by the debtor will be called upon to take part in the meeting. Hence, those who did not appear because they were not informed of the proceedings will not be affected. The debtor is obliged to disclose all of his creditors in the petition. The disclosure shall be verified or confirmed under oath.

Which creditors are not affected by the order of suspension of payments? Aside from those creditors to whom notice was not given, the following creditors are also not covered by the suspension: 1. Persons having claims for personal labor, maintenance, expense of last illness and funeral of the wife or children of the debtor incurred in the 60 days immediately preceding the filing of the petition; and 2. Persons having legal or contractual mortgages. They can foreclose upon default in spite of the suspension of payment. (But take note that this does not apply if the petition was filed under PD 902-A, in which case, ALL creditors are covered by the suspension of payments. This rule applies only when the petition is filed under the Insolvency Law.)

What are the grounds for questioning the decision of the meeting? 1. Procedural defects in the calling and holding of the meeting, and the deliberations conducted, which caused prejudice to the rights of the creditors; 2. Fraudulent connivance between a creditor and the debtor for the creditor to vote in favor of the proposed agreement; If there is proof that the debtor somehow bribed the creditor or bought his vote, the decision of the meeting can be set aside. However, it is legal to give OTHER incentives to the creditor, such as higher interest rates. These are not bribes but merely incentives to induce them to vote in favor of suspension. 3. Fraudulent conveyance of claims by a creditor for the purpose of obtaining a majority. Ex: There are 99 creditors with claims worth P100K total. 1 creditor represents 60K worth of credits, while the other 98 creditors represent a total of 40K. The one creditor is in favor of suspension of payments, while the other 98 are against it. How will this one creditor manipulate the situation in order to approve the petition?

He has already complied with the 60% requirement. His problem is the 2/3 of the creditors requirement, since he only represents 1/99 of the creditors. What he can do is to assign some of his credits to 200 other people. That way, they will represent 201/299 of the creditors, with a total claim of 60K. This is enough to meet the double majority requirement. BUT, this is a ground for questioning the decision of the meeting.

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II. VOLUNTARY INSOLVENCY What is the concept of voluntary insolvency? An insolvent debtor whose liabilities exceed P1,000 may apply to be discharged from his debts and liabilities by filing a petition for voluntary insolvency in the RTC where he has resided for the last six months prior to the filing of the petition. In voluntary insolvency, the debtor himself is the petitioner. The date of the filing of the petition is important for purposes of reckoning certain periods, such as the residency requirement. Distinctions between suspension of payments and insolvency (in general) INSOLVENCY PURPOSE SOLVENCY OF DEBTOR EFFECT ON AMOUNT OF INDEBTEDNESS

NUMBER OF CREDITORS

To discharge the debtor from the payment of debts Debtor does not have sufficient property to pay his debts The amount is affected. Creditors receive less than their credits; and where there are preferences, some creditors may not receive anything at all. There must be three or more creditors if it is involuntary insolvency.

SUSPENSION OF PAYMENTS To suspend or delay the payment of debts Debtor has sufficient property to pay his debts The amount of indebtedness is not affected.

The number of creditors is immaterial.

What are the jurisdictional requirements for the petition for voluntary insolvency? In the petition, the debtor shall indicate: 1. his place of residence and the period of residence therein prior to the filing of the petition; 2. his inability to pay all his debts in full; 3. his willingness to surrender all his property, estate, and effects not exempt from execution for the benefit of his creditors; 4. an application to be adjudged insolvent. The petition shall be accompanied by: 1. A verified schedule containing: a. a full and true statement of all debts and liabilities of the insolvent debtor, and b. an outline of the facts giving rise or which might give rise to a cause of action against the insolvent debtor

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2. A verified inventory containing: a. an accurate description of all the personal and real property of the insolvent, whether or not exempt from execution, including a statement as to its value, location, and encumbrances thereon; and b. an outline of the facts giving rise or which might give rise to a right of action in favor of the insolvent debtor. What is the procedure for voluntary insolvency? 1. Filing of the petition by the debtor praying to be declared insolvent. Unlike in involuntary insolvency, in voluntary insolvency, there need not be an allegation of an act of insolvency by the creditors of the debtor. This is because in voluntary insolvency, the one petitioning is the debtor himself. The very act of filing the petition is the act of insolvency. In contrast, in involuntary insolvency, the ones petitioning are the debtor’s creditors. 2. Issuance of an order of adjudication declaring the debtor insolvent. The court need not conduct a hearing before declaring the debtor insolvent and taking his assets. This is because the petition is voluntary on the part of the debtor. It is not adversarial. 3. Publication and service of the order to creditors. 4. Meeting of the creditors to elect the assignee in insolvency. 5. Conveyance of the debtor’s property by the clerk of court to the assignee. 6. Liquidation of the debtor’s assets and payment of his debts. 7. Composition, if agreed upon. 8. Discharge of the debtor, upon his application, except if the debtor is a corporation. 9. Objection, if any, to the discharge. 10. Appeal to the Supreme Court in certain cases. What are the effects of an order declaring the petitioning debtor insolvent? 1. The sheriff takes possession of all the assets of the debtor which are not exempt from execution until the appointment of a receiver or an assignee. 2. The payment to the debtor of any debts due to him and the delivery to the debtor or to any person for him any property belonging to him, and the transfer of any property by him are forbidden. 3. All civil proceedings pending against the insolvent debtor shall be stayed.

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4. Mortgages or pledges, attachments or executions on property of the debtor duly recorded and not dissolved are not, however, affected by the order. If the petitioner is a corporation, JPSP thinks that the better route is still to file for suspension of payments under PD 902-A instead of filing for voluntary insolvency. If the petitioner is a natural person, his only incentive to file a petition for voluntary insolvency is that he will get a discharge from past debts and liabilities (corporations do not get this discharge). But otherwise, there are very few advantages in filing for voluntary insolvency. The debtor should just fight it out with his creditors, since filing for voluntary insolvency is not just demeaning but will even affect the debtor’s credit-worthiness later on. After filing for voluntary insolvency, no one will trust that debtor enough to lend him money again.

III. INVOLUNTARY INSOLVENCY What is the purpose of involuntary insolvency? A petition for involuntary insolvency is not an ordinary personal action for collection of debts. Its purpose is to impound all of the non-exempt property of the debtor, to distribute it equitably among his creditors, and to release him from further liability. Distinctions between Voluntary Insolvency and Involuntary Insolvency VOLUNTARY INSOLVENCY NUMBER OF CREDITORS PETITIONER

One creditor is sufficient The insolvent debtor

ACTS OF INSOLVENCY

Debtor must not be guilty of any act of insolvency Must be greater than P1,000

AMOUNT OF INDEBTEDNESS BOND HEARING RESIDENCY REQUIREMENT

ISSUANCE OF THE ORDER OF ADJUDICATION DECLARING THE DEBTOR INSOLVENT

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Not required Not necessary; may be granted ex parte Petition must be filed with RTC where debtor has resided for at least 6 months Upon the filing of the voluntary petition

INVOLUNTARY INSOLVENCY Three or more creditors Three or more creditors who must possess the qualifications provided by law Debtor must have committed one or more of the 13 acts Must be P1,000 or more Petition must be accompanied by a bond Petition is granted only after hearing Petition must be filed with RTC where debtor resides or has his place of business; no residency requirement Upon hearing of the case

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Who may petition for involuntary insolvency? The petitioners must be: 1. 2. 3. 4. 5.

at least three creditors of one debtor who are residents of the Philippines, whose credits accrued in the Philippines, the aggregate amount of which is at least P1,000. In addition, the credits of these three creditors should NOT have accrued within 30 days prior to the filing of the petition.

Why does it have to be three creditors? Why is it not enough for one creditor to file the petition? Insolvency proceedings contemplate competing claims of several creditors over the assets of the insolvent debtor. If there is only one creditor, there are no competing claims. The creditor can just go to court and file a simple action to collect. Õ But if you’re the single creditor of one debtor, there may be instances when you would want to file a petition for involuntary insolvency against the debtor. First, how do you do this? Since you’re only one creditor, you cannot file the petition because the Insolvency Law requires that it be filed by at least three creditors. To get around this requirement, you should assign some of the credit to at least two other persons. After waiting for 30 days (cooling-off period), you can file the petition. Why would you want to do this? The petition for involuntary insolvency can be used as a tool to harass or pressure a debtor into settling his obligation with the single creditor. Example: Creditor extends a loan to a Foreign Company, which is publicly listed in the Hong Kong Stock Exchange. Foreign Company fails to pay, and since it is a foreign company, it has no assets in the Philippines which Creditor can run after. What should Creditor do? Creditor should first assign some of the credit to two other companies, wait 30 days, then file the petition for involuntary insolvency against Foreign Company. News of the Foreign Company’s insolvency will reach Hong Kong, and the price of its shares will go down. To stop the share prices from going down, Foreign Company will be forced to settle the obligation, so that Creditor will withdraw the petition. (According to JPSP, Creditor can do this even if Foreign Company is not actually insolvent. It’s just a legal tactic to get Foreign Company to settle the obligation.) What are the requisites of the petition for involuntary insolvency? The petition must: 1. be verified by the petitioners 2. set forth one or more acts of insolvency mentioned in the law

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What are acts of insolvency? There are 13 acts of insolvency mentioned in Sec. 20 of the Insolvency Law. These may be grouped into three general categories (See p. 568 of De Leon for the complete list): a. the debtor committed acts to ensure that the debtor will not be able to pay b. the debtor committed acts in fraud of creditors c. the debtor committed acts giving preference to one creditor in favor of other creditors But the petition should allege at least one of the 13 specific acts of insolvency mentioned in the law. This is a jurisdictional requirement. 3. be accompanied by a bond, approved by the court with at least two sureties, in such penal sum as the court shall direct. The purpose of the bond is for the petitioners to answer for the costs, expenses, and damages resulting in the filing of the petition. For example, in the earlier case of the single creditor who files the petition against the Foreign Company just to humiliate him, the bond will answer for damages that Foreign Company can prove as a result of the wrongful filing of the petition. What are the steps in filing a petition for involuntary insolvency? 1. Filing of the petition by three or more creditors in the RTC where the debtor resides or has his place of business. 2. Issuance of the order requiring the debtor to show cause why he should not be adjudged insolvent. 3. Service to debtor of the order to show cause. 4. Filing of the debtor’s answer or motion to dismiss. 5. Hearing of the case. This is in contrast with voluntary insolvency, where there is no need for a hearing. In involuntary insolvency, there is a hearing because the proceedings are adversarial. The debtor is given a chance to refute the claim of the petitioners that he is insolvent. 6. Issuance of the order or decision adjudging the debtor insolvent. Note that between the filing of the petition and the adjudication of the case by the court, there is a period of time during which the debtor still has his assets. While the case is being decided by the court, the debtor can dissipate his assets in the meantime. To protect themselves from this situation, the creditors should either ask the court for an injunction or for a receiver who will hold the properties of the debtor. 7. Publication and service of the order. 8. Meeting of creditors for election of an assignee in insolvency. Cayo IID 2002

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The assignee must be elected within two to eight weeks from the date of the order of the adjudication. 9. Conveyance of the debtor’s property by the clerk of court to the assignee. 10. Liquidation of the assets of the debtor and payment of his debts. 11. Composition, if agreed upon. 12. Discharge of the debtor on his application, except if the debtor is a corporation. 13. Objection, if any, to the discharge. 14. Appeal to the Supreme Court, in certain cases.

IV. ASSIGNEES What is an assignee? An assignee is the person elected by the creditors or appointed by the court to whom an insolvent debtor makes an assignment of all his property for the benefit of his creditors. The assignment vests title to all the assets of the debtor in favor of the assignee. The assignee represents the insolvent as well as the creditors in voluntary and involuntary proceedings. Who can participate in the election of the assignee? Creditors who have filed their claims in the office of the clerk of court at least two days prior to the scheduled election may participate. As a general rule, a secured creditor cannot participate in the election, unless: 1. he has asked for the fixing of the value of the security; OR 2. he has surrendered the security to the sheriff or receiver of the estate of the insolvent. If you were the secured creditor, why would you surrender the security? If the security is not enough to cover the obligation, you might as well participate in the election if you think that the portion that will be allotted to you will be greater than the value that you will realize from the sale of the security. How do the creditors choose the assignee? The creditors will meet in order to elect the assignee.

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In order to validly elect an assignee, the majority of the creditors both in number and in the amount of credit they represent (another case of double majority) should vote for the same assignee. If the creditors do not attend the meeting or fail or refuse to elect an assignee, or if the assignee fails to qualify or subsequently becomes incapacitated, the court will appoint the assignee. What should the assignee do once he is elected? The assignee is required to give a bond for the faithful performance of his duties, within five days from his election, in an amount to be fixed by the court, with two or more sureties. The bond will answer for any liability that the assignee may incur to persons aggrieved by his actions as assignee. If you were given an opportunity, will you act as an assignee? Yes, because the assignee earns a substantial fee. According to Section 42 of the Insolvency Law, the assignee earns commissions at the following rates: 7% for the first P1,000 that he will be able to liquidate from the properties of the debtor; 5% for sums exceeding P1,000 but less than P10,000; and 4% for sums exceeding P10,000. So if the amount that you can liquidate is P100M, you will earn P4M. Aside from this fee, the assignee will also have other benefits, such as reimbursements of his expenses and the opportunity to refer legal or accounting matters to his firm, if he is a lawyer or a CPA. What are the effects of assignment? 1. The assignee takes the property in the same conditions that the insolvent held it. 2. Upon appointment, the legal title to all the property of the insolvent is vested in the assignee, and the control of the property is vested in the court. But the title of the assignee retroacts to the date of the filing of the petition for insolvency. 3. All actions to recover all the estate, debts, and effects of the insolvent shall be brought by the assignee and not by the creditors. 4. If there was an attachment or a judgment against the insolvent debtor made 30 days before the filing of the petition for insolvency, it will be set aside. What are the powers and duties of the assignee? The assignee has the powers of administration over the property of the insolvent. Having these powers, he can sue and recover claims belonging to the debtor, take into possession all of the property of the debtor, recover property fraudulently conveyed by the debtor, etc (for a complete enumeration, see p. 586-587 of De Leon).

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The assignee does not have powers of disposition. For acts of disposition, such as sale of the property of the insolvent debtor or payment of the creditor’s shares, the assignee must obtain a court order. Section 37 of the Insolvency Law: Penalty for Embezzlement Take note of Section 37, which provides that if any person, who knows of the pending or imminent insolvency proceedings concerning the debtor, embezzles or disposes of any of the property of the insolvent, he shall be liable for a penalty equal to double the value of the property embezzled or disposed. The penalty will go to the estate of the insolvent. This relates only to embezzlement of the debtor’s property, and not to assignments of credit made by the creditors behind each other’s backs. What is a dividend in insolvency? It is a part of the fund arising from the assets of the estate of the insolvent debtor, rightfully allocated to a creditor entitled to a share in the fund. It is paid by the assignee only upon order of the court. Õ According to JPSP, if you’re a creditor, you may not want to do involuntary insolvency because there are a lot of costs – assignee’s fees, legal costs, etc. It might be better is you could obtain a global settlement. (I don’t know, though, what “global” means.)

V. CLASSIFICATION AND PREFERENCE OF CREDITORS Disregard the rules in Sec. 48-50 of the Insolvency Law. The applicable rules are those under the Civil Code on Concurrence and Preference of Credits (Articles 2236-2251). But take note of Section 48, which provides that property found among the property of the insolvent debtor but which are not really owned by him should be taken out of the proceedings. Examples are property held in trust or as a lessor or usufructuary, etc. After taking them out, apply the rules under the Civil Code.

VI. PARTNERSHIPS AND CORPORATIONS Who may petition for declaration of insolvency of a partnership? In case of voluntary insolvency, the petition may be filed by all or any of the partners. In case of involuntary insolvency, the petition may be filed by three or more creditors of the partnership or one or more of the partners. Which properties are covered in insolvency proceedings? 1. All the property of the partnership; and 2. All the separate property of each of the general partners, except a. separate properties of limited partners; and b. properties which are exempt by law Cayo IID 2002

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Can a partnership be declared insolvent even if the partners constituting the same are solvent? Yes. A partnership may be declared insolvent notwithstanding the solvency of the partners constituting it. The creditors of the partnership, after first exhausting its assets, may proceed against the solvent general partners who are proportionately liable with their separate property. What happens to the partnership when any of the partners becomes insolvent? The partnership is automatically dissolved by the insolvency of any partner or of the partnership (Art. 1830, Civil Code). What is the benefit given by the Insolvency Law to partnerships? Partnerships get a discharge from the obligations, if they apply for one. In contrast, corporations do not get a discharge. Why doesn’t the law give corporations a discharge? Corporations do not get a discharge because their creditors can only go after the assets of the corporation. The creditors cannot collect any deficiency from the stockholders. If the stockholders want a fresh start, they can just put up a new corporation and start with a clean slate. There is no need to get a discharge in order to have a fresh start. But if it’s a partnership, and the assets of the partnership are not enough to cover its liabilities, the creditors can still go after the general partners for the deficiency. This is why it makes sense to give them a discharge. How do you distribute the net proceeds of the properties of the partnership? 1. The net proceeds of the partnership property shall be used to pay the debts of the partnership. 2. The net proceeds of the individual estate of each partner shall be used to pay individual debts. 3. If there is any surplus in the property of any general partner after paying his individual debts, a proportionate part of this surplus will be added to the partnership assets and will be used to pay partnership debts. 4. If there is any surplus in the property of the partnership, the surplus shall be added to the assets of the individual partners in proportion to their interests in the partnership. What is the effect of a declaration that a corporation is insolvent? The property and assets of the corporation will be distributed to the creditors. Unlike in partnership, the property of the stockholders of the corporation cannot be used to pay the creditors of the corporation. However, the corporation will not be allowed to get a discharge.

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What are the debts which may be proved (collected) against the estate of the insolvent debtor? 1. All debts due and payable at the time of the adjudication of insolvency; 2. All debts existing at the time of the adjudication of insolvency but not payable until a future time. 3. Any debt of the insolvent arising from his liability as indorser, surety, bail or guarantor, where such liability became absolute after the adjudication of insolvency but before the final dividend shall have been declared; 4. Other contingent debts and liabilities contracted by the insolvent if the contingency shall happen before the order of final dividend; and 5. Any claim for reimbursement of a person who has answered, in whole or in part, for the insolvent’s debt as bail, surety, or guarantor or otherwise. What is a contingent claim? It is a claim in which the liability depends on a future and uncertain event. For example, the claim of a surety is a contingent claim because the surety can only claim reimbursement from the principal debtor once he himself has paid the obligation. But before the surety pays the principal obligation, he has no claim for reimbursement against the principal debtor. A claim based on a contingency which has not happened at the time of the pendency of the proceedings cannot be proved in the proceedings, since there is no real claim yet. But, if the contingency happens after the termination of the proceedings, the creditor can still claim from the debtor. The discharge granted the debtor from his existing debts does not cover those debts that could not have been proved in the insolvency proceedings. What happens to obligations of the insolvent debtor that arise after the commencement of the proceedings? These debts cannot be proved in the proceedings. But the creditor can still collect from the debtor, since the discharge given to the debtor cannot apply to claims that could not have been proved in the insolvency proceedings. Which debts cannot be proved at the insolvency proceedings? 1. Those barred by prescription; 2. Claims of secured creditors unless they waive the right to foreclose or surrender the security; 3. Claims of creditors who hold an attachment or execution on property of the debtor, provided that this was issued at least 30 days before the institution of the insolvency proceedings; 4. Claims on account of which a fraudulent preference was made or given; Cayo IID 2002

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5. Support 6. Damages arising out of a tort Can a creditor set up compensation/offset his own debts against the insolvent debtor? This is the case of Uy-Tong v. Silva. Compensation can be set up against the insolvent debtor but only for those debts which arose at least 30 days before the filing of the insolvency proceedings. If the claim arose within the 30-day period before the filing of the petition, there can be no compensation. The rule on preferences would be disregarded if the set-off were allowed. It would, in effect, give the one claiming compensation undue preference over other creditors.

VIII. COMPOSITIONS What is composition? Composition is an agreement, made upon a sufficient consideration, between the insolvent or financially embarrassed debtor and all of his creditors whereby the creditors agree to accept a dividend less than the amount of their claims, for the sake of getting paid sooner. What are the requisites? 1. The offer of the terms of composition must be made after the filing in court of the schedule of property and submission of the list of creditors; 2. The offer must be accepted in writing by a double majority of the creditors – majority of the number of creditors representing a majority of the claims; 3. It must be made after depositing the consideration to be paid and the cost of the proceedings; 4. The court must approve the terms of the composition. When can composition be set aside? It can be challenged by any party in interest within six months after it has been confirmed on the ground of fraud.

IX. DISCHARGE What is discharge? Discharge is the privilege given to the insolvent, freeing him from all liabilities proved during the insolvency proceedings. Is the discharge automatically given to the insolvent debtor? No. The debtor must ask for it within three months to one year after he is adjudicated insolvent.

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Which debts are released by discharge? 1. All those set forth in the schedule; and 2. All those which were or might have been proved against the estate in the insolvency proceedings. Which debts are not released? 1. Taxes 2. Debts arising from any act of swindling (because you don’t reward a person who violated a law or a trust) 3. Debts of a surety, guarantor, indorser, or any person liable for the same debt, for or with the insolvent debtor (This is because the discharge only benefits the principal debtor, not his co-debtors or guarantors). 4. Debts of a corporation 5. Claims for support 6. Debts which were not proved and could not have been proved during the insolvency proceedings 7. Debts arising from tort 8. Claims of secured creditors 9. Debts which were not yet existing at the time of the discharge 10. Contingent claims When can the petition to get a discharge be denied? The debtor cannot get a discharge if he is in bad faith or does acts to the prejudice of his creditors. Once granted, when may a discharge be revoked? A discharge may be revoked by the court if a creditor can prove that it was fraudulently obtained. The creditor must file the petition to revoke it within one year from the date of the discharge.

X. FRAUDULENT PREFERENCES AND TRANSFERS What is a preferential transfer? It is a parting with the property of the insolvent for the benefit of a creditor with the result that the estate of the insolvent is diminished and other creditors are prejudiced. What is a fraudulent preference? It is a disposition of property by the debtor under the following conditions: 1. he is insolvent or is in contemplation of insolvency; 2. the transaction is made within 30 days before the filing of the petition for insolvency; 3. it is made with a view to giving preference to any creditor; Cayo IID 2002

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4. the person receiving a benefit has reason to believe that the debtor is insolvent and that the transfer is made in order to defeat or prejudice the rights of other creditors. What is a fraudulent conveyance/transfer? It is any disposition of property made by the insolvent within one month before the filing of the petition for insolvency, except for valuable consideration in good faith. What is the status of the fraudulent conveyance? If made within 30 days before the filing of insolvency proceedings, the transfer is void. If made after the filing of insolvency proceedings, it is rescissible for being in fraud of creditors. Another remedy of the creditors is to file a criminal complaint against the insolvent debtor. Is there a presumption of fraud? There is a rebuttable presumption that a conveyance is fraudulent when: 1. it is not made in the usual and ordinary cause of business of the debtor; or 2. it is made under a confession of judgment. Within 30 days before the filing of the petition for insolvency, Debtor sells a car worth P1M to Buyer for 900K. Is this a fraudulent conveyance? No. There is a fair exchange of value, so the transaction does not really prejudice the creditors.

DEPOSIT CHAPTER 1 DEPOSIT IN GENERAL AND ITS DIFFERENT KINDS Art. 1962. A deposit is constituted from the moment a person receives a thing belonging 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. What is the contract of deposit? It is the receipt by a person of a thing belonging to another with the obligation of safely keeping it and of returning it. Õ It is essential that the depositary is not the owner of the property deposited. What are the characteristics of the contract of deposit? 1. Real contract – Deposit is perfected by the delivery of the subject matter 2. Unilateral if the deposit is gratuitous – because only the depositary has an obligation; Cayo IID 2002

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Bilateral if the deposit is for compensation – gives rise to obligations on the part of both the depositary and the depositor. What is the principal purpose of the contract of deposit? The principal purpose is the safekeeping of the thing delivered. If safekeeping is merely an accessory or secondary obligation, it is not a deposit, but another contract, such as commodatum, lease, or agency. What is the subject matter in deposit?

Only movables can be the subject matter of deposit. If you leave a kid a Gymboree or at Kids at Work, it’s not a deposit, but maybe a contract of service. JPSP Examples:

1. You park your car at the car park of Powerplant. Is it a contract of deposit? No, because the purpose is not safekeeping. The purpose is merely convenience, so that you have a place to leave your car while you shop or watch a movie or go to school. 2. You park your car at the Dela Rosa car park. Is it a contract of deposit? Still, no, even if, unlike the car park of Powerplant, the sole reason for the existence of the Dela Rosa car park is for people to leave their cars there. It’s still not a deposit because the purpose is not safekeeping. People who park there just want the space. It’s a shortterm lease of space. So, legally, it is not a deposit. And even for practical purposes, it should not be treated as a deposit. If it were a deposit, if the car is lost, the owner of the car park (the depositary) will shoulder the loss. The direct result of this is that parking fees will go up because it would have to cover insurance costs in addition to the regular parking fee. Deposit distinguished from Simple Loan (mutuum)

DEPOSIT

SIMPLE LOAN

PURPOSE WHEN RETURN CAN BE DEMANDED

Safekeeping Depositor can demand return of the thing at will

SUBJECT MATTER

Movable and immovable property (if deposit is judicial)

Consumption Lender must wait until the expiration of the period granted to the debtor Only money and any other fungible thing

Deposit distinguished from Commodatum

PURPOSE GRATUITOUS? SUBJECT MATTER

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DEPOSIT Safekeeping May be gratuitous, may be onerous In extra-judicial deposit, only movables

COMMODATUM Transfer of use of the subject matter Always gratuitous Both movable and immovable property

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Art. 1963. An agreement to constitute a deposit is binding, but the deposit itself is not perfected until the delivery of the thing. A: “I will deposit my car in your garage at 8 a.m. tomorrow.” B: “Okay.” Is there a contract of deposit at this point? No. Deposit is a real contract and requires delivery of the subject matter in order to be perfected. Is there a contract at this point?

Yes, there is a contract. It is a contract of future deposit. It is perfected by mere consent, and is binding upon the parties. Art. 1964. A deposit may be constituted judicially or extrajudicially. Kinds of Deposit

1. Judicial – takes place when an attachment or seizure of property in litigation is ordered 2. Extra-judicial (a) Voluntary – delivery is made by the will of the depositor or by two or more persons each of whom believes himself entitled to the thing deposited; or (b) Necessary – 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. GENERAL RULE: Deposit is gratuitous. EXCEPTIONS:

1. Contrary stipulation 2. Depositary is engaged in business of storing goods – ex. A warehouseman 3. Where property is saved from destruction without knowledge of the owner – In this case, the owner is bound to pay the person who saved his property just compensation Art. 1966. Only movable things may be the object of deposit. This applies only to an extra-judicial deposit, whether voluntary or necessary. Reason: The main purpose of deposit is safekeeping. Since real property may not disappear or may not be lost, there is no point in entrusting them to someone for safekeeping. Cayo IID 2002

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A gives the keys to his house to B for safekeeping. Is this a deposit of the house? No, since the house is an immovable which cannot be the proper subject matter of deposit. The relationship is an agency. But if it is a judicial deposit, even immovable property can be a valid subject matter. The reason is that the purpose of a judicial deposit is different. It is to protect the rights of the parties to the suit. Art. 1967. An extra-judicial deposit is either voluntary or necessary. GENERAL RULE: Deposit is voluntary. EXCEPTIONS: Deposit is necessary in the following cases: (See discussion under necessary deposit)

1. if made in compliance with a legal obligation; 2. if it takes place on the occasion of any calamity, such as fire, storm, flood, pillage, shipwreck, or other similar events; 3. deposit of effects made by travelers in hotels or inns 4. deposit of goods made by travelers or passengers with common carriers

CHAPTER 2 VOLUNTARY DEPOSIT Section 1 General Provisions Art. 1968. A voluntary deposit is that wherein the delivery is made by the will of the depositor. A deposit may also be made by two or more persons each of whom believes himself entitled to the thing deposited with a third person, who shall deliver it in a proper case to the one to whom it belongs. What is voluntary deposit?

Deposit wherein delivery is made by the will of the depositor. What is the distinction between voluntary and necessary deposit? The main difference is that in voluntary deposit, the depositor is free to choose the depositary. In necessary deposit, the depositor lacks the freedom to choose the depositary. Does the depositor have to be the owner of the thing deposited?

Generally, the depositor should be the owner of the thing, but it is not an essential element of deposit. The depositary cannot even require the depositor to prove that he is the owner of the thing. When there are several depositors:

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If there are two or more persons each claiming the rightful ownership of a thing, pending the resolution of their conflicting claims, they may deposit the thing with a third person. The third person assumes the obligation to deliver to the person to whom it belongs. The depositary can file an action for interpleader to compel the depositors to settle their conflicting claims. Ex: A and B both claim to own a dog. While they are trying to settle the ownership of the dog, they can deposit the dog with C. C can file an action for interpleader to compel A and B to settle the ownership of the dog. C’s obligation is to eventually deliver the dog to whomever is the rightful owner. Art. 1969. A contract of deposit may be entered into orally or in writing. There are no formal requirements for the validity of a contract of deposit. The only thing necessary is delivery of the thing. 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 the depositary, and may be compelled to return the thing by the guardian, or administrator or the person who made the deposit or by the latter himself if he should acquire capacity. X, who is insane, deposits her basketball with Boy-B. Can Boy-B refuse to return the basketball later on, on the ground that the deposit was not valid because of the incapacity of X?

No. If the depositary is capacitated, he is subject to all the obligations of a depositary whether or not the depositor is capacitated. Hence, he must return the property to the legal representative of X or to X herself if she should recover sanity. Persons who are capacitated cannot allege the incapacity of those with whom they contract. JPSP example: Five tinedyers aged 13 to 15 check into a hotel to go on a drinking binge. They deposit some jewelry at the front desk for safekeeping. Is there a valid deposit? Yes, but it may be annulled for want of capacity of the tinedyers. It’s actually a voidable contract, which is valid until annulled. The tinedyers, at the end of their drinking binge, go to the front desk and ask for the return of the jewelry. What should the hotel do? The hotel should return the jewelry to their legal representative. The hotel should not return to the tinedyers because if subsequently, the tinedyers lose the jewelry, the hotel could be made liable for the loss. But definitely, the hotel cannot retain the jewelry, or else, its personnel would be liable for estafa.

Art. 1971. If the deposit has been made by a capacitated person with another who is not, 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 be 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.

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This is the rule that applies if you deposit with a minor or other incapacitated person. If the depositary is incapacitated, while the depositor is capacitated, the incapacitated does not incur the obligations of a depositary. The incapacitated is liable only: (1) to return the thing deposited if it is still in his possession; or (2) to pay the depositor the amount by which he may have benefited through the thing or its price if the incapacitated is no longer in possession If the thing was transferred to a third person who was in bad faith, the depositor can recover the thing from him. If the transferee was in good faith, the depositor cannot recover from him. The depositor can only go after the incapacitated for the value of the thing. Boy-B deposits his watch with X, who looks like she’s 22 but is actually 13. Can Boy-B recover the watch?

If the watch is still in the possession of X, Boy-B can recover the watch itself from X. If X has already sold the watch to Hon, a buyer in good faith and for value, Boy-B cannot recover the watch. He can only compel X to return the price that Hon paid for the watch (the benefit that X received from the sale of the watch). So if the watch is worth P10,000 but X sold it to Hon for P5,000, Boy-B can only recover P5,000 from X. But if Hon was a buyer in bad faith, Boy-B can recover the watch itself from Hon.

Section 2 Obligations of the Depositary Art. 1972. The depositary is obliged to keep the thing safely and to return it, when required, 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 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. Primary obligations of the depositary:

1. Safekeeping 2. Return of the thing, but only when required Duty of Safekeeping What is the degree of care required of the depositary?

As a general rule, the depositary must exercise the same diligence as he would exercise over his OWN property. He should exercise the diligence of a good father of a family. The reasons for this rule are:

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1. Because the contract of deposit involves the depositor’s confidence in the depositary’s good faith and trustworthiness; and 2. Because it is presumed that the depositor, in choosing the depositary, took into account the diligence which the depositary normally exercises with respect to his own property. BUT, if under the circumstances, a greater degree of care towards the thing deposited is necessary, the depositary must exercise such extraordinary care. If, in this case, the thing deposited is lost and the depositary only exercised the same diligence as he would towards his own property, he is liable to the depositor for the loss. The loss of the thing while it is in the possession of the depositary raises a presumption of fault on his part. Duty of Returning the Thing

The thing deposited must be returned to the depositor when he claims it, even though a specified term or time for such may have been stipulated in the contract and such time has not yet expired. 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. GENERAL RULE: The depositary cannot deposit the thing with a third person. Reason for the rule: Deposit is founded on trust and confidence. It is presumed that in choosing the depositary, the depositor took into account his personal qualifications. EXCEPTION: The parties may stipulate that the depositary may deposit the thing with a third person. But there is a limitation – the depositary cannot choose a third person who is manifestly careless or unfit.

What happens if the depositary deposits the thing with a third person, and it is lost? 1. If there is no stipulation allowing him to deposit with a third person, he is liable for the loss, whether it was through his or the third person’s fault or through fortuitous event. 2. Generally, if the thing is deposited with a third person with permission of the depositor, and the thing is lost through fortuitous event, the depositary is not liable for the loss. However, if he deposits it with a person who is manifestly careless or unfit, even if there is no negligence or even if the loss was through fortuitous event, the depositary is liable for the loss. 3. If the thing is lost through the negligence of the depositary’s employees, the depositary is liable for the loss (The employee is the agent of the depositary; principal bears the loss resulting from the negligence of his agent). Here, it is not necessary that the employees be manifestly careless or unfit, but it is necessary that the loss be through negligence. Cayo IID 2002

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Art. 1974. The depositary may change the way of the deposit if under the circumstances he may reasonable 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. GENERAL RULE: The depositary should not change the way or manner of the deposit as agreed upon. EXCEPTION: The depositary may change it if there are circumstances indicating that the depositor would consent to the change. However, the depositary should first notify and wait for the decision of the depositor. If delay would cause danger, the depositary need not wait for the consent of the depositor. Notice to the depositor of the change is sufficient. JPSP example: A deposited jewelry with B, a resident of Lamitan. B did not feel so secure with the jewelry in Lamitan, so he deposited the jewelry with a bank in Davao. A sued B for damages for depositing the jewelry with a third person without A’s authorization. What is B’s defense? B can invoke Article 1974. Under the circumstances, B can infer that A would consent to the change of the manner of deposit. 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. What are the obligations of the depositary if the thing earns interest? 1. Collect the interest, as well as the capital, as it becomes due; and 2. Take such steps as may be necessary to preserve its value and the rights corresponding to it. Ex: Depositary of a negotiable instrument should give notice of dishonor to all parties secondarily liable, or else these parties would be discharged. JPSP example: A deposits to B a promissory note payable to A or order. Can B collect accrued interests on the note? No. The instrument is an order instrument. B cannot collect the interest due on it because he is neither an indorsee nor an authorized agent of A. Õ Therefore, Art. 1975 really applies only to BEARER instruments. If it is an order instrument, there is a need for an indorsement or at least, a special power of attorney, to enable the depositary to collect the interest and capital when due. Cayo IID 2002

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Safety Deposit Boxes The contract for rent of safety deposit boxes is not an ordinary contract of lease of things because the full and absolute possession and control of the safety deposit box is not given to the party renting. It is actually a special kind of deposit. It is a contractual relation between the parties. The liability rules are governed by the Civil Code provisions on obligations and contracts, and not on donations. Is a stipulation which exempts the bank from liability for the things contained in the safety deposit box valid? The stipulation is void. Even if as a rule, the Bank may limit its liability to some extent by agreement or stipulation, the agreement or stipulation must not be contrary to law and public policy. The law on deposit provides that the depositary is liable for loss due to fraud, negligence, delay, or contravention of the tenor of the agreement. Any contrary stipulation would be 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. GENERAL RULE: The depositary may commingle grain or other articles of the same kind and quality. EXCEPTION: If there is a contrary stipulation De Leon example: A, depositary, received the following: from B: 30 cavans of rice from C: 20 cavans of rice from D: 10 cavans of rice The rice was of the same kind and quality. Can A put all of the rice together? Yes, since there is no stipulation forbidding it. B will own 30/60 or ½ of the whole pile; C will own 20/60 or 1/3; and D will own 10/60 or 1/6. But if the articles deposited by different depositors are not of the same kind and quality, or if there is a stipulation forbidding it, the depositary must keep them separate or at least identifiable, since he must return to each depositor the very same thing deposited. Art. 1977. The depositary cannot make use of the thing deposited without the express permission of the depositor.

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Otherwise, he shall be liable for damages. However, when the preservation of the things deposited requires its use, it must be used but only for that purpose. GENERAL RULE: The depositary CANNOT make use of the thing deposited. EXCEPTIONS: 1. When the depositor has expressly given his permission. Permission cannot be implied, and it is not presumed. 2. When the preservation of the thing requires its use, it may be used but only for that purpose. Ex: When you deposit a car with someone for a week, the depositary should start the car everyday, in order to prevent the battery from getting discharged. Reason for the rule: The principal purpose of deposit is safekeeping, not use of the thing. If the purpose is use, it is not deposit anymore. If the depositary uses the thing deposited without permission of the depositor, he shall be liable for damages. In addition, if the thing is lost even through fortuitous event, the depositary shall bear the loss. 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. What happens if the depositor gives the depositary permission to use the thing? It depends. If the principal purpose is still safekeeping, it retains its character as deposit. However, if the thing deposited is money or other consumable thing and the principal purpose is still safekeeping, it is an irregular deposit. If the purpose has become use or consumption of the thing: 1. It becomes commodatum if the thing deposited is non-consumable. 2. It becomes simple loan or mutuum if the thing deposited is money or other consumable thing. Bank deposits are in the nature of an irregular deposit but they are really loans (See Article 1980). Art. 1979. The depositary is liable for the loss of the thing through a fortuitous event: (1) If it is so stipulated; Cayo IID 2002

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(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. GENERAL RULE: The depositary is not liable for loss of the thing through fortuitous event. EXCEPTIONS: 1. Stipulation 2. If he uses it without the depositor’s permission – this is breach/ contravention of the tenor of the obligation 3. Delay in return – this is default 4. If he allows others to use it – also a breach Take note that the rule is different in commodatum. In commodatum, the members of the borrower’s household are allowed to use the thing without liability on the part of the borrower. If the thing is lost in the custody of the depositary, the presumption is that it was lost through his fault. He has the burden of proving that the loss was not due to his own fault. Art. 1980. Fixed, savings, and current deposits of money in banks and similar institutions shall be governed by the provisions concerning simple loan. Nature of Bank Deposits Bank deposits are really loans to a bank because the bank has the obligation to pay the depositor the amount deposited, but not the exact same money that was deposited (as in deposit). Since they are loans, they are governed by the provisions concerning mutuum or simple loan, not deposits. Relationship is Debtor-Creditor The relationship between the bank and its depositors is thus that of debtor (bank) and creditor (depositor). Hence: 1. If the bank fails to pay its obligation to the depositor, it is not a breach of trust arising from the depositary’s failure to return the subject matter of the deposit. Since there is no breach of trust, it will not constitute estafa through misappropriation.

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2. A bank can generally compensate or set off the deposit in its hands for the payment of any indebtedness to it on the part of the depositor, provided that the legal requisites of compensation are present. In a true deposit, compensation is not allowed. Art. 1981. When the thing deposited is delivered closed and sealed, 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. 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. A delivers a locked baul to B for safekeeping. What are B’s obligations? 1. B must return the baul in the same condition – it must be locked when returned. 2. If the lock of the baul is broken through B’s fault, he shall be liable to A for damages. B is presumed negligent until proved otherwise. How is the value of the thing determined in case the baul is opened? Ultimately, the court will decide the value of damages that B should pay, since the parties will always get into a dispute over the value of the thing (i.e. A would inflate the price, B would undervalue it, etc.) 3. If the lock of the baul is broken, with or without B’s fault, B must keep the secret of the deposit. If the contents of the baul turn out to be illegal – shabu, a dead body, a bloody bolo – the depositary should immediately call the cops. He may still be held liable for the breach of his obligation as depositary but at least he knows that he has done a greater good to society by reporting the dastardly deed to the authorities. The court just might exonerate him of liability for the breach because of his fulfillment of a civic duty. Besides, I think that if he keeps these things a secret, he can even be liable as an accessory to the crime for helping conceal it. When may B open the baul?

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1. When there is presumed authority – authority is presumed if the key has been delivered to him; or 2. When there is necessity for opening the box in order to execute the instructions of the depositor as regards the deposit JPSP example: Shakadivas delivers a locked box to Tuks for deposit. Shak leaves right away without giving Tuks an opportunity to ask him why there is a ticking sound coming from inside the box. Tuks is afraid that it might be a bomb. Can he open it without liability? Tuks cannot. The only instances when a depositary can open the box without incurring liability is if there is presumed authority or if there is necessity for opening it in order to execute the instructions of the depositor. These two instances are not present in the situation of Tuks. He should just hope and pray that it’s just a watch in there. Art. 1983. The thing deposited shall be returned with all its products, accessories, and accessions. Should the deposit consist of money, the provisions relative to agents in article 1896 shall be applied to the depositary. The obligation of the depositary is to return the thing when the depositor demands, along with all its products, accessories, and accessions. The depositor is entitled to the products, accessories, and accessions of the thing because he is the owner of the thing. 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. 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. The depositary cannot demand that the depositor prove his ownership of the thing deposited. This is because it is not essential that the depositor be the owner of the thing deposited. When a third person appears to be the owner of the thing: 1. If the depositary finds out that the thing was stolen AND he knows the real owner, his obligation is to INFORM the real owner of the deposit (it is not to return the thing to the real owner yet).

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The real owner must claim the thing within one month. If he claims it within a month, the depositary should give it to the real owner. If the real owner fails to make a claim within a month, the depositary’s obligation will be extinguished by returning the thing to the depositor. 2. If the depositary has reasonable grounds to believe that the thing has not been lawfully acquired by the depositor, the depositary may return the thing to the depositor (not to the real owner, since in this case, the real owner is not known). Õ But according to JPSP, if the depositary discovers that the thing was stolen and someone else is claiming to be the real owner, the more prudent thing to do would be to file an action for interpleader and consign the thing in court. It is not safe to follow 1984 because if the claim of the alleged real owner turns out to be false, the depositary will be liable for giving the thing to someone else or for refusing to return it to the depositor (estafa). 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 depositor shall return it only to the person designated. When there are two or more depositors, the default rule is like that in joint obligations – each depositor cannot demand more than his share from the depositary. This rule applies if the thing is divisible and there is no solidarity among the depositors. If there is solidarity or if the thing is indivisible, the rule on solidary obligations is applicable. Each one of the depositors may do whatever may be useful to the others but not anything which may be prejudicial. The depositary can return the thing deposited to any of the depositors unless a demand for its return has been made by one of them, in which case, delivery should be made to him who made the demand. The parties may also stipulate that the thing be returned to a specific depositor. In this case, the depositary can only return to the depositor stipulated, even if he does not make a demand. 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. The thing deposited must be returned only to a person who is capacitated. If the depositor should subsequently lose capacity, the depositary should return it to his representative. (See discussion under Article 1970 on deposit by tinedyers)

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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. Where to return the thing deposited: 1. First, follow the stipulation of the parties. The expenses for transportation shall be borne by the depositor since the deposit was constituted for his benefit. 2. If there is no stipulation, follow 1987 – the thing should be returned at the place where the thing deposited may be, even if it was not the same place where the deposit was constituted. However, there must be no malice on the part of the depositary. For example, the depositary, not wanting to return the thing anymore, moves it to the Cordillera mountains, so that the depositor would have a hard time claiming it. In this case, the depositary would be liable for damages. Art. 1988. The thing deposited must be returned to the depositor upon demand even though a specified period of time for such return may have been fixed. This provision shall not apply when the thing is judicially attached while 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. GENERAL RULE: The depositary must return the thing upon demand by the depositor even if the period for the deposit has not lapsed. If the deposit is for compensation, and the depositor demands the return of the thing before the period for deposit has lapsed, the depositor must still pay the depositary the full compensation agreed upon. This is because the period in this case is for the benefit of both the depositary and the depositor. EXCEPTION TO THE GENERAL RULE: The depositary should not return the thing to the depositor if there is a court order enjoining him from returning the thing to the depositor (when there is attachment). The law says that the depositary can also refuse to return the thing if there is an opposition to its return by a third person (here, there is no court order). However, as discussed earlier, the more prudent thing to do in this case is not to refuse to return the thing to the depositor but to file an action for interpleader because there is a danger that the depositary would be liable for damages if the claim of the third person turns out to be false. Art. 1989. Unless the deposit if for a valuable consideration, the depositary who may have justifiable reasons for not keeping the thing deposited may, even Cayo IID 2002

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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. As a general rule, the depositary should wait for either the period of the deposit to lapse or for the depositor to demand the return of the thing before he can return the thing deposited. But, if the following requisites are present, he may return the thing to the depositor even before the period of the deposit has lapsed or before it is demanded: 1. The deposit must be gratuitous; and 2. There must be a justifiable reason. If the depositary refuses to accept, the depositor can consign the thing in court. But if the deposit is for compensation, the depositary cannot return the thing until the expiration of the period or until it is demanded by the depositor. Art. 1990. If the depositary by force majeure or government order loses the thing and receives money or another thing in its place, he shall deliver the sum or the thing to the depositor. The depositary is not liable for the loss of the thing either by force majeure or government order. But, if in place of the thing lost, the depositary receives money or another thing, he must deliver it to the depositor. Ex: If the thing is expropriated by the government, the indemnity paid by the government must be turned over by the depositary to the depositor. Art. 1991. The depositor’s heir who in good faith may have sold the thing 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. First, take note that there seems to be a typo in this provision: it should read “The depositary’s heir…” if it is to make any sense. This contemplates the following situation: A deposits a car with B. While the car is still in B’s custody, B dies. C, B’s son, finds the car among his dad’s stuff and thinks that the car belonged to his dad. C sells the car to D. What are the liabilities of C? If D has already paid C, C must return to A the price that D paid for the car (not the value of the car). If D has not yet paid, C may assign to A his right to collect from D the selling price of the car.

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Take note that A has no right to recover the car itself. Also, there must be good faith on the part of the heir and the third party buyer. If there was bad faith, the depositor can recover the car itself. Moreover, the heir will be liable for estafa.

Section 3 Obligations of the Depositor Art. 1992. If the deposit is gratuitous, the depositor is obliged to reimburse the depositary for the expenses he may have incurred for the preservation of the thing deposited. If the deposit is gratuitous, the depositor should shoulder the costs of preservation because he is the owner of the thing. If the deposit is for compensation, the depositary should shoulder the costs of preservation of the thing because the compensation is deemed to include the costs of preservation. Example: A deposits a dog with B for 30 days for a compensation of P500. B buys a sack of dog food. By the 10th day, the dog food has run out. Can B ask for more money from A? A can refuse to give more money and argue that in charging the compensation for the deposit, B should have factored in the expected expenses of preserving the dog. But it still depends on the intention of the parties. 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. GENERAL RULE: The depositor should compensate the depositary for any loss that the depositary may suffer from the character of the thing deposited. Example: A deposits a dog with B. It turns out that the dog has rabies. The dog bites B, and as a result, B has to get anti-rabies shots. A must pay for the damage caused and the cost of B’s shots. EXCEPTIONS: In the following cases, the depositor need not reimburse the depositary for any loss arising from the character of the thing deposited: 1. If at the time of the deposit, the depositor was not aware of the dangerous character of the thing; 2. If at the time of the deposit, the depositor was not expected to know the dangerous character of the thing; 3. If the depositor notified the depositary of the dangerous character of the thing; or 4. If the depositary was aware of the dangerous character of the thing even without the advice of the depositor.

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Art. 1994. The depositary may retain the thing in pledge until full payment of what may be due him by reason of the deposit. This is an example of a pledge created by operation of law. The depositary may keep the thing deposited as a security for anything that the depositor may owe him, but it has to be by reason of the deposit. Compare this rule with the rule in commodatum, in which the borrower may generally not retain the thing as a security for anything that the lender may owe him (remember the frisbee example?). Art. 1995. A deposit is extinguished: (1) Upon the loss or destruction of the thing deposited; (2) In case of a gratuitous deposit, upon the death of either the depositor or the depositary. Causes for extinguishment of deposit: 1. loss or destruction of the thing deposited 2. In case of gratuitous deposit, upon the death of either the depositor or the depositary But if the deposit is for compensation, it is not extinguished by the death of either party since it is not personal in nature. Hence, the rights and obligations of the parties are transmissible to their heirs. 3. 4. 5. 6. 7.

return of the thing novation merger expiration of the term fulfillment of resolutory condition

CHAPTER 3 NECESSARY DEPOSIT Art. 1996. A deposit is necessary: (1) When it is made in compliance with a legal obligation; (2) When it takes place on the occasion of any calamity, such as fire, storm, flood, pillage, shipwreck, or other similar events. Art. 1997. The deposit referred to in No. 1 of the preceding article shall be governed by the provisions of the law establishing it, and in case of its deficiency, by the rules on ordinary deposit. The deposit mentioned in No. 2 of the preceding article shall be regulated by the provisions concerning voluntary deposit and by article 2168. Art. 1998. The deposit of effects made by travelers 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 Cayo IID 2002

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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. 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. Art. 2168. When during a fire, flood, story, or other calamity, property is saved from destruction by another person without the knowledge of the owner, the latter is bound to pay the former just compensation. What are the instances when deposit is NECESSARY? There are FOUR instances/ examples of necessary deposit: 1. 2. 3. 4.

Deposit Deposit Deposit Deposit

made in compliance with a legal obligation that takes place on the occasion of any calamity of effects made by travelers in hotels or inns of goods with common carriers

1. Deposit made in compliance with a legal obligation Example: In pledge, when the creditor uses the thing pledged without the authority of the owner or misuses it in any other way, the owner may ask that it be judicially or extrajudicially deposited. 2. Deposit that takes place on the occasion of any calamity Example: A fire razes Y’s house. X goes inside and gets Y’s TV for the purpose of saving it. X becomes the depositary of the TV. The relationship of X and Y, being a deposit, is governed by the provisions on voluntary deposit. But in addition, it is also governed by Art. 2168 on quasicontracts. Art. 2168 says that the owner of the thing should pay the depositary just compensation for his expenses in preserving the thing. So unlike a voluntary deposit, which is by default gratuitous, this kind of necessary deposit is, by express provision of law, for compensation. 3. Deposit of effects made by travelers in hotels or inns Requisites before the hotel or inn may be held responsible as depositary: a. The hotel or inn should have been previously informed about the effects brought by the guests; and b. The guests have taken the precautions prescribed regarding their safekeeping. The liability extends not just to effects inside the rooms but also to property of the guests in the annexes, such as cars in the garage. Cayo IID 2002

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Example: You go to Edsa Shangri-La to eat at the Garden Café. You turn your car over to the valet. Is there a contract of deposit? Yes. You don’t have to actually get a room in order to be considered a guest for purposes of constituting the contract of deposit with the hotel. As long as you use the main facilities of the hotel, you’re considered a guest. What if you wanted to shop in Megamall, but since you didn’t want to go through the trouble of looking for parking in Megamall, you just used the Edsa Shangri-La valet service – are you still a guest? No. Although you need not check-in in order to be considered a guest, you must at least use the principal services of the hotel – the gym, the pool, meeting place at the lobby, etc. Valet parking is not a principal service of the hotel. If you’re the guest, you should: (a) give notice to the hotel of the effects you have brought into the hotel and (b) take the precautions prescribed for their safekeeping. But do you need to give an itemized listing of your valuables every time you go into a hotel? No. Constructive notice to the employees of the hotel is enough. It is sufficient that you bring in your personal effects and the hotel personnel see them. 4. Deposit of goods with common carriers This is governed by Articles 1733, 1734, 1735 of the Civil Code under Lease. Common carriers are generally responsible for the loss, destruction, and deterioration of the goods, unless due to fortuitous event or the fault of the owner of the goods. 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 by strangers; but not that which may proceed from any force majeure. The fact that travelers are constrained to rely on the vigilance of the keeper of the hotels or inn shall be considered in determining the degree of care required of him. Art. 2001. The act of a thief or robber, who has entered the hotel is not deemed force majeure, unless it is done with the use of arms or through an irresistible force. Art. 2002. The hotel-keeper is not liable for compensation if the loss is due to the acts of the guests, his family, servants or visitors, or if the loss arises from the character of the things brought into the hotel. When is the hotel liable for the loss of the effects of its guests?

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1. When the loss is caused by the employees of the hotel or by strangers, provided the guest followed the two requisites under Art. 1998 (notice and precaution). 2. When the loss is caused by the act of a thief or a robber done without the use of arms and irresistible force. When is the hotel NOT liable? 1. When the loss or injury is caused by force majeure, like flood, fire, theft or robbery by a stranger with the use of arms or irresistible force, UNLESS the hotel-keeper is guilty of fault or negligence in failing to provide against the loss or injury from this cause. So as a general rule, if armed men enter the hotel and steal your things, the hotel is excused from liability because it is considered a fortuitous event. However, if the hotel failed to take reasonable precautions (ex: secluded island with only one security guard stationed near the shore and lots of foreigners checked in), it will still be liable for its negligence. 2. When the loss is due to the acts of the guest (who is the owner of the thing), his family, servants, or visitors; and 3. When the loss arises from the character of the things brought into the hotel Example of thing where the loss arises from the character of the thing: If you bring a Dalmatian, or a snake, or Cyrus’ pet hamster into the hotel, by the very nature of these pets, they could easily get lost in the premises. 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. Even if the hotel-keeper posts signs or puts these little fine-print stipulations that it is not liable for any loss, it cannot escape its liabilities as a depositary under Articles 1998 to 2001. Reason: You cannot waive the liability of one who is guilty of gross negligence. Gross negligence is equivalent to fraud or bad faith. And as we all know, a waiver of future fraud is void. It is contrary to law, morals, and public policy. However, this only applies to a contract of deposit. In the case of carparks, the fine print on the tickets always contains a waiver of liability by the owner of the carpark for any loss within its premises. This waiver is valid because, as discussed already, the contract with the carpark is not a deposit but only a short-term lease. Art. 2004. The hotel-keeper has a right to retain the things brought into the hotel by the guest, as a security for credits on account of lodging, and supplies usually furnished to hotel guests.

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This is another pledge created by operation of law. If you do not pay your hotel bills, the hotel can keep your stuff as a security. Moreover, you will be liable for estafa.

CHAPTER 4 SEQUESTRATION OR JUDICIAL DEPOSIT Art. 2005. A judicial deposit or sequestration takes place when an attachment or seizure of property in litigation is ordered. Art. 2006. Movable as well as immovable property may be object of sequestration. 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. 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. What is judicial deposit? Judicial deposit is a deposit pursuant to a court order – when an attachment or seizure of property in litigation is ordered by a court. Examples: 1. attachment of properties by sheriff upon the filing of a complaint 2. garnishment of money 3. receiver may be appointed by the court to administer and preserve the property in litigation 4. personal property may be seized by the sheriff in suits of replevin What is the purpose of judicial deposit? Unlike extra-judicial deposit, where the purpose is safekeeping, the purpose of judicial deposit is to maintain the status quo during the pendency of the litigation to insure the right of the parties to the property in case of a favorable judgment. This means that in case of favorable judgment, the party will be assured that there will be property to satisfy the execution of the judgment. What may be the object of judicial deposit? Unlike extra-judicial deposit, where the object must be a movable, a judicial deposit can cover both movable and immovable property. How do you deposit an immovable? You annotate the attachment on the title with the Register of Deeds. What are the obligations of the depositary of sequestrated property?

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The person appointed by the court as depositary has the obligation to take care of the thing with the diligence of a good father of a family. He may not be relieved of his responsibility until the litigation is ended or until the court so orders. DISTINCTIONS BETWEEN JUDICIAL AND EXTRA-JUDICIAL DEPOSIT CAUSE OR ORIGIN PURPOSE SUBJECT MATTER REMUNERATION IN WHOSE BEHALF IT IS HELD

JUDICIAL DEPOSIT By will of the court To secure the right of a party to recover in case of favorable judgment Movable or immovable property The depositary is always compensated; therefore it is onerous In behalf of the person who, by the judgment, has a right

EXTRA-JUDICIAL DEPOSIT By will of the parties; hence there is a contract Safekeeping Only movable property As a rule, it is gratuitous, though the parties may stipulate otherwise In behalf of the depositor or the third person designated

Art. 2009. As to matters not provided for in this Code, judicial sequestration shall be governed by the Rules of Court.

That’s all folks. Sorry, I didn’t include Warehouse Receipts Law anymore because it’s probably going to be just 5% of the exam, according to JPSP. Good luck! May the power of greyskull be with us all ☺

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