Security Transactions Chapter 1.

The Concept of
Security A. General Concepts

A contract of security, or a security transaction1 , in

the context of credit transactions, is defined as the
means by which the parties to a principal obligation
ensure its en- forcement, protect an interest in
property, or ensure that the person to be made
secure, or the secured creditor, can be compensated
for loss. 2 It is an accessory obligation that mitigates
the risk that the debtor will default on a principal
obligation.
Generally, therefore, a principal obligation the
enforce- ment of which is ensured by a contract of
security is a se- cured obligation, and one that is not,
is an unsecured ob- ligation.
1. Distinguished from Securities
Securities, in the context of the Securities Regulation
Code3, are defined as follows:
R. A. No. 8799, Sec. 3.1. "Securities" are shares,
participation or interests in a corporation or in a
commercial enterprise or profit-making venture and
evidenced by a certificate, contract, instru- ment,
whether written or electronic in character
It includes:(a)... bonds, debentures, notes, evidences
of in- debtedness, asset-backed securities...

As has been discussed 4, bonds, notes, and

debentures are evidences of indebtedness and are the
common commer- cial forms that contracts of loan
take.5 In the context of the Securities Regulation Code,
therefore, theses contracts of simple loan or mutuum,
are securities,6 whether they
are secured or unsecured.
Distinguished from Securitization
Securitization, on the other hand, is defined as the
process by which loans and other debts with an
expected cash payment stream (such as interest in
the case of sim- ple loans) are sold on a without
recourse basis by a seller to a special purpose entity
(the issuer) which in turn is- sues securities (such as a
bond or other instrument) that depend, for their
repayment, on the expected cash pay- ment stream.7
To securitize, therefore, is to convert assets (such as
interest receivable from a simple loan) into secur- ities
for resale in the financial market, allowing the seller to
remove assets from its books, and thereby improve its
capital ratio and liquidity, and to make new loans with
the proceeds from the sale of the new security, if it so
chooses.

is a process of distributing the risk of de-

Securitization
fault or non-payment of loans and other debts by
aggre- gating these debts and then issuing new
securities backed by the aggregated debt.9 The
securities issued by the spe- cial purpose entity (or
issuer) are thus called asset-backed securities.10 The
contracts of loan and the expected prin- cipal and
interest payments, which are sold by the origi- nal
creditors to a special purpose entity, are aggregated
into tranches based on risk, and packaged as new
securi- ties." The securities with higher risks provide
higher yields. Unlike a security transaction that
mitigates risk, the process of securitization distributes
the risk of default or non-payment to those willing to
assume it.
Events of Default
The essential condition of a security transaction is
that if the principal obligation is duly complied with,
then, pro- ceeding from its accessory character, the
security is auto- matically extinguished. Otherwise
stated, once the prin- cipal obligation is complied
with, the security transaction becomes, ipsofacto, null
and void.12
If, however, the principal obligation becomes due and
the debtor defaults, the creditor may elect to bring an
ordi- nary action for specific performance of the
principal obli- gation or, as a secured creditor, elect to
enforce the secu-
rity, in accordance with its terms.

The three requisites necessary for a finding of default

are:
1. The principal obligation is demandable and liqui-
dated;
2. The debtor delays performance; and
3. The creditor judicially or extrajudicially requires the
1
debtor's performance.
in credit transactions, it is customary for the parties to
define other events of default
acceleration clause is valid and bind- ing on the
parties and the creditor is justified in invoking it to
declare the entire principal obligation immediately
14
due and payable, and to enforce the security.

C. Kinds of Security Transactions

1. Personal Security Transactions

2. Real Security Transactions

A personal security transaction is a contractual

obligation for the repayment of a debt binding a
person, as distin- guished from property.'5 It is an
obligation of a person, whether natural or juridical,
other than the principal deb-
tor to ensure the fulfillment of a principal obligation.
In a contract of personal security, such as a guaranty,
the
faithful performance of the obligation by the principal

debtor is secured by the personal commitment of

another.16

A real security transaction is an encumbrance of

proper- ty17 (the collateral) given to guarantee the
fulfillment of
an obligation, especially the assurance that a creditor
will be repaid any money or credit extended to a
debtor, usually with interest.18
In a contract of real security, such as a mortgage (from
the Latin, dead security' 9), the creditor acquires a
security in- terest in the collateral for purposes of
ensuring the fulfillment of the principal obligation.20 A
security interest is

a property interest created by agreement or by

operation of law to secure the performance of an
obligation.21 Spe- cifically, it is:
a property interest in goods, documents or in-
struments to secure performance of an obligation and
includes title, whether or not expressed to be
absolute, whenever such title is in substance tak-
en or retained for security only.22
In the Context of Insolvency
The Financial Rehabilitation and Insolvency Act (FRIA)
of 201023, defines the condition of being insolvent as
fol-
lows:R.A. No. 10142, Sec. 4... (p) Insolvent shall refer
to the financial condition of a debtor thatis generally
unable to pay its or his liabilities as they fall due in
the ordinary course of business or has liabilities that
are greater than its or his as- sets.(s) Liabilities shall
refer to monetary claims against the debtor...
And the FRIA classifies creditors as follows:Sec. 4...
(11) Secured party shall refer to a secured creditor or
the agent or representative of such se- cured creditor.
(kk)Secured creditor shall refer to a creditor with a
secured claim.(jj) Secured claim shall refer to a claim
that is se- cured by a lien.

Unsecured creditor shall refer to a creditor with an

unsecured claim.(pp) Unsecured claim shall refer to a
claim that is not secured by a lien.

(t) Lien shall refer to a statutory or contractual claim

or judicial charge on real or personal prop- erty that
legally entitles a creditor to resort to said property for
payment of the claim or debt secured
by such lien.
Letters of Credit A. General Concepts
Code of Commerce, Art. 567. Letters of credit are
those issued by one merchant to another, or for the
purpose of attending to a commercial transac- tion.
Art. 568. The essential conditions of letters of cre- dit
shall be:
1. To be issued in favor of a determined person and
not to order.
2. To be limited to a fixed and specified amount, or to
one or more undetermined amounts, but all within a
maximum the limit of which must be
stated exactly.Those which do not have one of these
conditions
shall be considered as mere letters of
recommendation.
The Code of Commerce defines a letter of credit as an
in- strument issued by one merchant to another, or
for at-
tending to a commercial transaction.
Clearly, a letter of credit is sue generis,but to
understand it as a security transaction, it is
appropriately viewed as an original undertaking by the
issuer to substitute its finan- cial strength for that of
another (the applicant) with the undertaking to be
conditioned on the presentation of a draft or a demand
for payment (by the beneficiary).2 With a letter of credit
from an issuer, the applicant may confidently present
the letter of credit to the beneficiary as security to
convince the beneficiary to enter into a trans- action. On
the other hand, the beneficiary of the letter of credit is
assured of being empowered to call on the letter of
credit and obtain its proceeds as security in case the
applicant fails to perform its obligation.
Art. 2. Acts of commerce, whether those who ex-
ecute them be merchants or not, and whether
spe- cified in this Code or not,should be
governed by the provisions contained in it,in
theirabsence,
by the usages of commerce generally observed
in each place and in the absence of both rules,by
those of the civil law.Those acts contained in
this Code and all others of analogous character
shall be deemed acts of commerce.
Kinds of Letters of Credit
1. Commercial Letters of Credit

2. Standby Letters of Credit

In commercial transactions, a letter of credit (or
commer- cial letter of credit or commercial credit) is
used as a me- thod of payment in a contract of sale of
goods, so that the seller (the beneficiary) can obtain
payment directly from the issuer instead of from the
buyer
Because commercial credits involve the payment of
mon- ey under a contract of sale, they become payable
upon the presentation by the seller-beneficiary of
documents that show it has taken affirmative steps to
comply with the contract of sale. The seller-beneficiary of
a commercial credit must demonstrate by documents
that it has per- formed its obligations under the
contract.

2. Standby Letters of Credit

In non-sale transactions, a letter of credit (or standby
let- ter of credit or standby credit) is used to
guarantee, or secure, either a monetary or a
nonmonetary obligation, whereby the issuer agrees to
pay the creditor (the benefi- ciary) if the debtor (the
applicant or issuer's customer), defaults on the
obligation.8 It is used to reduce the risk of
nonperformance of a contractual obligation of the
debtor-
applicant.
In a standby credit, the credit is payable upon
certification of the debtor-applicant's nonperformance
of the obliga- tion. The creditor-beneficiary of the
standby credit must certify that the debtor-applicant
has not performed the principal obligation. 9
Under the rule of strict compliance, the documents
ten- dered by the beneficiary must strictly conform to
the terms of the letter of credit. T
Independence Principle
The independence principle in letters of credit assures
the beneficiary of prompt payment independent of any
breach of the underlying or principal obligation and
prec- ludes the issuer from determining whether the
underly- ing or principal obligation is actually
accomplished or not.

he let- ter of credit is separate and distinct from the

underlying or principal obligation. The settlement of a
dispute be- tween the parties is not a pre-requisite for
the release of funds under a letter of credit.
The independence principle admits of an exception, re-
ferred to as the fraud exception rule. The
untruthfulness of a certificate accompanying a demand
for payment un- der a letter of credit may qualify as
fraud, sufficient to
support an injunction against payment. However,
injunc- tion should not be granted unless:
1. There is clear proof of fraud;

2. The fraud constitutes fraudulent abuse of the inde-

pendent purpose of the letter of credit and not only
fraud under the underlying obligation; and
3. Irreparable injury might follow if injunction is not
granted or the recovery of damages would be seriously
12
affected.
Trust Receipts A. General Concepts
P.D. No. 1151, Sec. 4. What constitutes a trust re- ceipt
transaction. - A trust receipt transaction, within the
meaning of this Decree, is any transac- tion by and
between a person referred to in this Decree as the
entruster, and
another person referred to in this Decree as en-
trustee,whereby the entruster, who owns or holds
abso- lute title or security interests over certain speci-
fied goods, documents or instruments,
releases the same to the possession of the entrus- tee
upon the latter's execution and delivery to the en-
truster of a signed document called a "trust re- ceipt"
wherein the entrustee binds himself to hold the
designated goods, documents or instruments in
trust for the entruster andto sell or otherwise dispose
of the goods, docu- ments or instrumentswith the
obligation to turn over to the entruster the proceeds
thereof to the extent of the amount owing to the
entruster oras appears in the trust receipt orthe
goods, documents or instruments themselves if they
are unsold or not otherwise disposed of,in accordance
with the terms and conditions spe- cified in the trust
receipt, or for other purposes substantially equivalent
to any of the following: 1. In the case of goods or
documents, (a) to sell the goods or procure their sale;
or(b)to manufacture or process the goods with the
purpose of ultimate sale;Provided, That, in the case of
goods delivered under trust receipt for the purpose of
manufactur- ing or processing before its ultimate sale,
the en- truster shall retain its title over the goods
whether in its original or processed form until the
entrus- tee has complied fully with his obligation
under the trust receipt; or(c) to load, unload, ship or
tranship or otherwise deal with them in a manner
preliminary or neces- sary to their sale; or2. In the case
of instruments,(a) to sell or procure their sale or
exchange; or(b) to deliver them to a principal; or(c) to
effect the consummation of some transac- tions
involving delivery to a depository or regis- ter; or(d) to
effect their presentation, collection or re- newal.The
sale of goods, documents or instruments by a person
in the business of selling goods, docu- ments or
instruments for profit who,at the outset of the
transaction,has, as against the buyer, general
property rights in such goods, documents or
instruments, or who sells the same to the buyer on
credit, retaining title or other interest as security for
the payment of the purchase price,does not constitute
a trust receipt transaction and is outside the purview
and coverage of this De- cree.
Sec. 3... (b) "Entrustee" shall refer to the person
having or taking possession of goods, documents or
instruments under a trust receipt transaction, andany
successor in interest of such person for the purpose
or purposes specified in the trust receipt agreement.
(c) "Entruster" shall refer to the person holding title
over the goods, documents, or instruments subject of
a trust receipt transaction, andany successor in
interest of such person.
(a) "Document" shall mean written or printed
evidence of title to goods.
(d) "Goods" shall include chattels and personal
property other than: money, things in action, or things
so affixed to land as to become a part the- reof.
(e) "Instrument" means any negotiable instru- ment
as defined in the Negotiable Instrument Law;any
certificate of stock, or bond or debenture for the
payment of money issued by a public or pri- vate
corporation, or
any certificate of deposit, participation certificate or
receipt,any credit or investment instrument of a sort
marketed in the ordinary course of business or
finance, whereby the entrustee, after the issuance of
the trust receipt, appears by virtue of posses- sion
and the face of the instrument to be the owner.
"Instrument" shall not include a document as de- fined
in this Decree.
(f) "Purchase" means taking by sale, conditional sale,
lease, mortgage, or pledge, legal or equita- ble.(g)
"Purchaser" means any person taking by pur- chase.
(h)"Security Interest" means a property interest in
goods, documents or instruments to secure per-
formance of some obligations of the entrustee or of
some third persons to the entruster and in- cludes
title, whether or not expressed to be abso- lute,
whenever such title is in substance taken or retained
for security only.
(i) "Person" means, as the case may be, an indi-
vidual, trustee, receiver, or other fiduciary, part-
nership, corporation, business trust or other asso-
ciation, and two more persons having a joint or
common interest.
(k)"Value" means any consideration sufficient to
support a simple contract.
A trust receipt transaction is a real security
transaction where a person who owns or holds
absolute title or secu- rity interests over certain
specified goods, documents or instruments (the
entruster) releases the same to the pos- session of
another person (the entrustee) who binds him- self to
hold the goods, documents or instruments in trust for
the entruster and to sell or otherwise dispose of the
goods, documents or instruments, with the obligation
to turn over to the entruster the proceeds thereof, to
the ex- tent of the amount owing to the entruster, or
the goods, documents or instruments themselves, if
they are unsold or not otherwise disposed of, in
accordance with the terms and conditions specified in
the trust receipt.
Form of Trust Receipts

Sec. 3... (j) "Trust Receipt" shall refer to the writ- ten
or printed document signed by the entrustee in favor
of the entruster containing terms and conditions
substantially complying with the pro- visions of this
Decree.
No further formality of execution or authentica- tion
shall be necessary to the validity of a trust receipt.
Sec. 5. Form of trust receipts; contents. - A trust
receipt need not be in any particular form, but
every such receipt must substantially contain(1) a
description of the goods, documents or in- struments
subject of the trust receipt;(2) the total invoice value
of the goods and the amount of the draft to be paid by
the entrustee;(3) an undertaking or a commitment of
the en- trustee(a) to hold in trust for the entruster the
goods, documents or instruments therein described;
(b) to dispose of them in the manner provided for in
the trust receipt; and(c) to turn over the proceeds of
the sale of the goods, documents or instruments to
the entruster to the extent of the amount owing to the
entruster oras appears in the trust receipt orto return
the goods, documents or instruments in the event of
their non-sale within the period spe- cified therein.The
trust receipt may contain other terms and conditions
agreed upon by the parties in addition to those
hereinabove enumerated provided that such terms
and conditions shall not be contrary to
the provisions of this Decree, any existing laws, public
policy or morals, public order or good cus- toms.
Sec. 6. Currency in which a trust receipt may be
denominated. - A trust receipt may be denomi- nated
inthe Philippine currency or
any foreign currency acceptable and eligible as part of
international reserves of the Philippines, the
provisions of existing law, executive orders, rules and
regulations to the contrary notwith- standing:
Provided, however, That in the case of trust re- ceipts
denominated in foreign currency, payment shall be
made in its equivalent in Philippine cur- rency
computed at the prevailing exchange rate on the date
the proceeds of sale of the goods, documents or
instruments held in trust by the en- trustee are
turned over to the entruster or on such other date as
may be stipulated in the trust receipt or other
agreements executed between the entrus- ter and the
entrustee.
A trust receipt is a formal contract because, although
the law states that a trust receipt need not be in any
particular form, the Trust Receipts Law requires that it
must be written or printed and must contain specific
terms. 3
Rights of Entruster
Sec. 7. Rights of the entruster. - The entruster shall be
entitledto the proceeds from the sale of the goods,
docu- ments or instruments released under a trust re-
ceipt to the entrustee to the extent of the amount
owing to the entruster or as appears in the trust
receipt,or

to the return of the goods, documents or instru- ments

in case of non-sale, and
to the enforcement of all other rights conferred on him
in the trust receipt provided such are not con- trary to
the provisions of this Decree.The entruster may cancel
the trust and take pos- session
of the goods, documents or instruments subject of the
trust orof the proceeds realized therefromat any time
upon default or failure of the entrus- tee to comply
with any of the terms and condi- tions of the trust
receipt or any other agreement between the entruster
and the entrustee, and
the entruster in possession of the goods, docu- ments
or instruments may, on or after default, give notice to
the entrustee of the intention to sell, and may, not
less than five days after serving or sending of such
notice, sell the goods, docu- ments or instruments at
public or private sale, and the entruster may, at a
public sale, become a purchaser.
The proceeds of any such sale, whether public or
private, shall be applied(a) to the payment of the
expenses thereof;(b) to the payment of the expenses
of re-taking, keeping and storing the goods,
documents or in- struments;(c) to the satisfaction of
the entrustee's indebted- ness to the entruster. The
entrustee shall receive any surplus but shall be liable
to the entruster for any deficiency. Notice of sale shall
be deemed sufficiently given if in writing, and either
perso- nally served on the entrustee or sent by post-
paid ordinary mail to the entrustee's last known busi-
ness address.
Sec. 8. Entruster not responsible on sale by en-
trustee. - The entruster holding a security inter-
est shall not,merely by virtue of such interest orhaving
given the entrustee liberty of sale or other disposition
of the goods, documents or instru- ments under the
terms of the trust receipt transac- tionbe responsible
as principal or as vendor under any sale or contract to
sell made by the entrustee.
D. Obligations of Entrustee

Sec. 9. Obligations of the entrustee. - The en- trustee

shall(1) hold the goods, documents or instruments in
trust for the entruster and shall dispose of them
strictly in accordance with the terms and condi- tions
of the trust receipt;
(2) receive the proceeds in trust for the entruster and
turn over the same to the entruster to the ex- tent of
the amount owing to the entruster or as
Appearson the trust receipt;(3) insure the goods for
their total value against
loss from fire, theft, pilferage or other casualties; (4)
keep said goods or proceeds thereof whether in
money or whatever form, separate and capable
of identification as property of the entruster;(5) return
the goods, documents or instruments in the event of
non-sale or upon demand of the en-
truster; and(6) observe all other terms and conditions
of the
trust receipt not contrary to the provisions of this
Decree.
Sec. 10. Liability of entrustee for loss. - The risk of loss
shall be borne by the entrustee.Loss of goods,
documents or instruments which are the subject of a
trust receipt, pending their disposition, irrespective of
whether or not it was due to the fault or negligence of
the entrustee, shall not extinguish his obligation to the
entrus- ter for the value thereof.
Sec. 12. Validity of entruster's security interest as
against creditors. - The entruster's security in- terest
in goods, documents, or instruments pur-
suant to the written terms of a trust receipt shall be
valid as against all creditors of the entrustee for the
duration of the trust receipt agreement.

Sec. 13. Penalty clause. - The failure of an en- trustee

to turn over the proceeds of the sale of the goods,
documents or instruments covered by a trust receipt
to the extent of the amount owing to the entruster or
as appears in the trust receipt or to return said
goods, documents or instruments if they were not
sold or disposed of in accordance with the terms of the
trust receiptshall constitute the crime of estafa,
punishable under the provisions of Article Three
hundred and fifteen, paragraph one (b) of Act
Numbered Three thousand eight hundred and fifteen,
as amended, otherwise known as the Revised Penal
Code.
If the violation or offense is committed by a cor-
poration, partnership, association or other juridi- cal
entities, the penalty provided for in this De- cree shall
be imposed upon the directors, officers, employees or
other officials or persons therein responsible for the
offense, without prejudice to the civil liabilities arising
from the criminal of- fense.
E. Rights of Purchaser

Sec. 11. Rights of purchaser for value and in good

faith. - Any purchaser
of goods from an entrustee with right to sell, orof
documents or instruments through their cus-
tomary form of transfer,who buys the goods,
documents, or instruments for value and in good faith
from the entrustee, acquires said goods, documents
or instruments free from the entruster's security
interest.
Guaranty A. General Concepts
Art. 2047. By guaranty a person, called the gua-
rantor, binds himself to the creditor to fulfill the
obligation of the principal debtor in case the lat-
ter should fail to do so.If a person binds himself
solidarily with the
principal debtor, the provisions of Section 4, Chapter
3, Title I of this Book shall be observed.
In such case the contract is called a suretyship.
Art. 2048. A guaranty is gratuitous, unless there is a
stipulation to the contrary.
Art. 2051. A guaranty may beconventional, legal or
judicial,gratuitous, or by onerous title.It may also be
constituted, not only in favor of the principal debtor,
but also in favor of the other guarantor, with the
latter's consent, or without his knowledge, or even
over his objection.
A guaranty is a promise to answer for the payment of
some debt or the performance of some duty, in case of
the failure of another who is liable in the first instance.'
It is a personal security transaction that involves the
condi- tional obligation of a person (the guarantor) to
fulfill a principal obligation in favor of a creditor, in case
the deb- tor fails to do so. The obligations of the
guarantor always arise2 as a conse- quence of
contract, whether the guaranty is conventional, legal,
or judicial.
Form of Guaranty
Art. 2055. A guaranty is not presumed; it must be
express and cannot extend to more than what is
stipulated therein.If it be simple or indefinite, it shall
compromise not only the principal obligation, but also
all its accessories,
including the judicial costs, provided with re- spect to
the latter, that the guarantor shall only be liable for
those costs incurred after he has been judicially
required to pay.
By definition, a guaranty constitutes(b) A special
promise to answer for the debt, de-
4
fault, or miscarriage of another; hence, it is
unenforceable by action, unless the same, or some
note or memorandum, thereof, be in writ- ing, and
subscribed by the party charged, or by his agent;
evidence, therefore, of the agreement cannot be
received without the writing, or a sec- ondary evidence
of its contents.5

Obligations Secured
Art. 2052. A guaranty cannot exist without a valid
obligation.Nevertheless, a guaranty may be
constituted to guarantee the performance of a
voidable or an unenforceable contract. It may also
guarantee a natural obligation.
Art. 2053... A conditional obligation may also be
secured.
Art. 2054. A guarantor may bind himself for less, but
not for more than the principal debtor, both as regards
the amount and the onerous nature of the conditions.
Should he have bound himself for more, his ob-
ligations shall be reduced to the limits of that of the
debtor.
Art. 2053. A guaranty may also be given as securi- ty
for future debts, the amount of which is not yet known;
there can be no claim against the guaran-
tor until the debt is liquidated...
Article 2053 is the basis for contracts denominated
as a continuing guaranty, a type of guaranty that
governs
a course of dealing for an indefinite time or by a
succes-
sion of credits.6
object of a continuing
guaranty is to grant to the principal debtor a standing
credit to be used from time to time either indefinitely
or
until a certain period. The use of the phrases "any
debt," "any indebtedness," "any sum," "any
transaction," or
Moneyto be furnished the principal debtor "from time to
time," "atany time," or "on such time" that the principal
debtor may require, have been construed to indicate a
7
continuing guaranty.
Parties to a Guaranty
Art. 2056. One who is obliged to furnish a guaran- tor
shall present a person who possesses integri- ty,
capacity to bind himself, and sufficient prop- erty to
answer for the obligation which he guar- antees. The
guarantor shall be subject to the ju- risdiction of the
court of the place where this ob- ligation is to be
complied with.
Art. 2057. If the guarantor should be convicted in first
instance of a crime involving dishonesty or should
become insolvent, the creditor may de- mand another
who has all the qualifications re- quired in the
preceding article. The case is ex- cepted where the
creditor has required and stipu- lated that a specified
person should be the gua-
rantor.
Art. 2049. A married woman may guarantee an
obligation without the husband's consent, but shall
not thereby bind the conjugal partnership, except in
cases provided by law.

Art. 2064. The guarantor of a guarantor shall en- joy

the benefit of excussion, both with respect to the
guarantor and to the principal debtor.

Art 2065. Should there be several guarantors of only

one debtor and for the same debt, the obliga- tion to
answer for the same is divided among all...
Generally, there are at least three parties to a
guaranty8 :
1. The creditor,
2. The debtor of the principal obligation, and

3. The guarantor.

A sub-guarantor is a guarantor of a guarantor. A co-

guarantor is one of several guarantors of only one
debtor for the same debt.
The law imposes the following qualifications for a gua-
rantor:
1. A guarantor must possess integrity, capacity to con-
tract and sufficient property for the guaranteed obliga-
tion. Loss of these qualifications gives the creditor the
right to demand a new guarantor unless the creditor
had stipulated a specified person to act as guarantor.
2. A married woman requires the consent of her
husband to bind conjugal property.
Benefit of Excussion
Art. 2062. In every action by the creditor,which must
be against the principal debtor alone, except in the
cases mentioned in Article 2059,

the former shall ask the court to notify the gua- rantor
of the action.
The guarantor may appear so that he may, if he so
desire, set up such defenses as are granted him by
law. The benefit of excussion mentioned in Ar- ticle
2058 shall always be unimpaired, even if judgment
should be rendered against the prin- cipal debtor and
the guarantor in case of appear- ance by the latter.
Art. 2058. The guarantor cannot be compelled to pay
the creditor unlessthe latter has exhausted all the
property of the debtor, and

has resorted to all the legal remedies against the

debtor.
Art. 2059. The excussion shall not take place:(1) If the
guarantor has expressly renounced it;(2) If he has
bound himself solidarily with the debtor;(3) In case of
insolvency of the debtor;(4) When he has absconded,
or cannot be sued within the Philippinesunless he has
left a manager or representative;(5) If it may be
presumed that an execution on the property of the
principal debtor would not result in the satisfaction of
the obligation.
Art. 2060. In order that the guarantor may make use
of the benefit of exclusion, he must

set it up against the creditor upon the latter's de-

mand for payment from him, andpoint out to the
creditor available property of the debtor within
Philippine territory, sufficient to cover the amount of
the debt.
2061. The guarantor having fulfilled all the conditions
required in the preceding article,
the creditor who is negligent in exhausting the
property pointed out shall suffer the loss, to the
extent of said property, for the insolvency of the
debtor resulting from such negligence.
Art. 2063. A compromise between the creditor and
the principal debtor benefits the guarantor but does
not prejudice him.That which is entered into between
the guarantor and the creditor benefits but does not
prejudice the principal debtor.
Art. 2064. The guarantor of a guarantor shall en- joy
the benefit of excussion, both with respect to the
guarantor and to the principal debtor.
Art. 2081. The guarantor may set up against the
creditor all the defenses which pertain to the principal
debtor and are inherent in the debt; but not those that
are personal to the debtor.
The benefit of excussion (or exhaustion or exclusion) is
the right of the guarantor to demand that the creditor
first:
1. Exhaust all of the properties of the principal debtor,
and
2. Resort to all legal remedies against the principal
debtor,
before the guarantor is liable to fulfill the obligation of
the principal debtor. It is the distinguishing element of
a gua- ranty.

For the creditor to enforce a guaranty:

1. The creditor must bring an action against the
principal debtor alone (except in the cases mentioned
in Article 2059).
2. The creditor shall ask the court to notify the
guarantor of the action.
3. The guarantor may appear so that it may, if it so
de- sires, set up such defenses as are granted by law.
The benefit of excussion shall always be unimpaired,
even if judgment should be rendered against the
principal debtor and the guarantor in case of
appearance by the latter.
4. In order that the guarantor may make use of the
bene- fit of excussion, it must:
a. Set it up against the creditor upon demand for pay-
ment, and
b. Point out to the creditor available property of the
deb- tor within Philippine territory, sufficient to cover
the amount of the debt.
. Right to Protection

Art. 2071. The guarantor, even before having paid,

may proceed against the principal debtor:
1) When he is sued for the payment;(2) In case of
insolvency of the principal debtor; (3) When the
debtor has bound himself to relieve him from the
guaranty within a specified period, and this period has
expired;(4)When the debt has become demandable,
by reason of the expiration of the period for pay-
ment;(5) After the lapse of ten years, when the
princip- al obligation has no fixed period for its
maturity, unless it be of such nature that it cannot be
extin- guished except within a period longer than ten
years;(6) If there are reasonable grounds to fear that
the principal debtor intends to abscond;(7) If the
principal debtor is in imminent danger of becoming
insolvent.In all these cases, the action of the guarantor
isto obtain release from the guaranty, or

to demand a securitythat shall protect him from any

proceedings by the creditor and from the danger of
insolvency of the debtor.
The right to protection is the right of the guarantor as
against the principal debtor to:
1. Obtain release from the guaranty, or 2. Demand
security.
The purpose is to for the guarantor to protect itself
from:
1. Any proceeding by the creditor, and

2. The danger of insolvency of the debtor.

2071 provides for the protection of the guarantor

before it has paid but after it has become liable to do so.
It is a protective remedy before payment and is
therefore preliminary in nature. Its purpose is to give
to the guaran- tor a remedy in anticipation of the
payment of a debt that is due and demandable. The
only procedure to enforce the right to protection is by
action, but while the guaran- tor has the right to
obtain a judgment against the princip- al debtor, it will
not be allowed to realize on the judg- ments to the
point of actual collection until it has satisfied or caused
to be satisfied the principal obligation. Other- wise,
collusion and improper practices between the gua-
rantor and the principal debtor may prejudice the
13
credi- tor.
Article 2071 is not clear on how the guarantor will
obtain release from the guaranty, when by definition,
the guarantor binds itself to the credi- tor. Logically.
only the creditor can grant a release from the guaranty.
Consequently, the only way for the guaran- tor to seek
effective release from the guaranty by proceed- ing
against the debtor is to compel the debtor to extin-
guish the principal obligation.

Right to Indemnification
Art. 2066. The guarantorwho pays for a debtor
must be indemnified by the latter.The indemnity
comprises:(1) The total amount of the debt;
(2) The legal interests thereon from the time the
payment was made known to the debtor, even though
it did not earn interest for the creditor;(3) The
expenses incurred by the guarantor after having
notified the debtor that payment had been demanded
of him;
(4) Damages, if they are due.
Art. 2050. If a guaranty is entered into without the
knowledge or consent, or against the will of the
principal debtor, the provisions of Articles 1236 and
1237 shall apply.

Art. 2050. If a guaranty is entered into without the

knowledge or consent, or against the will of the
principal debtor, the provisions of Articles 1236 and
1237 shall apply.

Art. 1236. The creditor is not bound to accept

payment or performance by a third person who has no
interest in the fulfillment of the obliga- tion, unless
there is a stipulation to the contrary. Whoever pays for
another may demand from the debtor what he has
paid, except that if he paid without the knowledge or
against the will of the debtor, he can recover only
insofar as the pay- ment has been beneficial to the
debtor.

Art. 2069. If the debt was for a period and the gu-
arantor paid it before it became due,he cannot
demand reimbursement of the debtor until the
expiration of the period
unless the payment has been ratified by the deb- tor.
Art. 2070. If the guarantor has paid without noti- fying
the debtor, and the latter not being aware of
the payment, repeats the payment,the former has no
remedy whatever against the debtor, but only against
the creditor. Nevertheless, in case of a gratuitous
guaranty, if
theguarantor was prevented by a fortuitous event
from advising the debtor of the payment, and the
creditor becomes insolvent, the debtor shall reimburse
the guarantor for the amount paid.
Art. 2072. If one, at the request of another, be- comes
a guarantor for the debt of a third person who is not
present,the guarantor who satisfies the debt may sue
ei- ther the person so requesting or the debtor for
reimbursement.
The right to indemnification is the substantive right of
action of the guarantor, after it has paid the principal
debt, as against the principal debtor,'16 to recover:
1. The total amount of the debt;2. The legal interests
thereon from the time the payment
was made known to the debtor, even though it did not
earn interest for the creditor;
3. The expenses incurred by the guarantor after
having notified the debtor that payment had been
demanded of it; and
4. Damages, if they are due.

Right to Subrogation
Art. 2067. The guarantor who paysis subrogated by
virtue thereof to all the rights which the creditor had
against the debtor.If the guarantor has compromised
with the credi- tor, he cannot demand of the debtor
more than what he has really paid.
Art. 2050. If a guaranty is entered into without the
knowledge or consent, or against the will of the
principal debtor, the provisions of Articles 1236 and
1237 shall apply.

Art. 1237. Whoever pays on behalf of the debtor

without the knowledge or against the will of the
latter, cannot compel the creditor to subrogate him in
his rights, such as those arising from a mortgage,
guaranty, or penalty.

Art2068. If the guarantor should pay without no-

tifying the debtor,the latter may enforce against him
all the de- fenses which he could have set up against
the creditor at the time the payment was made.
Art. 2080. The guarantors, even though they be
solidary, are released from their obligation whenever
by some act of the creditor they cannot be subrogated
to the rights, mortgages, and prefe-
rence of the latter.
Rights of Co-Guarantors 1. Benefit of Division
Art. 2065. Should there be several guarantors of only
one debtor and for the same debt, the obliga- tion to
answer for the same is divided among all. The creditor
cannot claim from the guarantors except the shares
which they are respectively bound to pay, unless
solidarity has been expressly stipu- lated.The benefit
of division against the co-guarantors ceases in the
same cases and for the same reasons as the benefit of
excussion against the principal debtor.
Art. 2078. A release made by the creditor in favor of
one of the guarantors,without the consent of the
others,benefits all to the extent of the share of the
gua- rantor to whom it has been granted.

There is a co-guaranty when two or more persons (or

co- guarantors) answer for the same debt of the same
debtor. Among co-guarantors, the benefit of division is
the right of a co-guarantor, as against the creditor, to
pay only the divided share that it is bound to pay. It
may be claimed by a co-guarantor from the very
moment the obligation is contracted, except where
there is a stipulation to the con- trary. But the benefit
of division will cease, in which case, the creditor may
claim the entire amount from a co- guarantor, if:

a. The co-guarantor against whom the creditor is

making the claim has expressly renounced the benefit
of division; b. The co-guarantor has bound itself
solidarily with the co-guarantor;

c. In case of insolvency of the co-guarantor;

d. When a co-guarantor has absconded, or cannot be

sued within the Philippines unless it has left a manager
or representative;
E.If it may be presumed that an execution on the
proper- ty of the co-guarantor would not result in the
satisfaction of the obligation.19

Right to Reimbursement
Art. 2073. When there are two or more guarantors of
the same debtor and for the same debt,the one among
them who has paidmay demand of each of the others
the share which is proportionally owing from him.
If any of the guarantors should be insolvent, his share
shall be borne by the others, including the payer, in
the same proportion.The provisions of this article shall
not be appli- cable, unless the payment has been
made by vir- tue of a judicial demand or unless the
principal debtor is insolvent.
Art. 2074. In the case of the preceding article, the co-
guarantors may set up against the one who paid, the
same defenses which would have per- tained to the
principal debtor against the creditor, and which are
not purely personal to the debtor.
Art. 2075. A sub-guarantor, in case of the insol- vency
of the guarantor for whom he bound him- self, is
responsible to the co-guarantors in the
same terms as the guarantor.
The right to reimbursement is the right of the co-
guarantor who pays, as against the other co-
guarantors,
o recover the shares due from the co-guarantors, but
only
if the following conditions concur:a. There are two or
more guarantors of the same debtor
and for the same debt.b. One of the co-guarantors has
paid.
c. Payment is made by virtue of a judicial demand or
the principal debtor is insolvent.
If any of the co-guarantors is insolvent, the share of
the insolvent co-guarantor shall be born by the other
co- guarantors, including the co-guarantor paying, in
the same proportion as that established in the co-
guaranty.
Extinguishment and Right of Release
Art. 2076. The obligation of the guarantor is ex-
tinguished at the same time as that of the debtor, and
for the same causes as all other obligations.
Art. 2077. If the creditor voluntarily accepts im-
movable or other property in payment of the debt,
even if he should afterwards lose the same through
eviction,
the guarantor is released.Art. 2079. An extension
granted to the debtor by the creditor without the
consent of the guarantor extinguishes the guaranty.
The mere failure on the part of the creditor to demand
payment after the debt has become due does not of
itself constitute any extension of time referred to
herein.
art 2080. The guarantors, even though they be
solidary, are released from their obligation
whenever by some act of the creditor they cannot be
subrogated to the rights, mortgages, and prefe-
rence of the latter.
SuretyA. General Concepts
Art. 2047. By guaranty a person, called the gua-
rantor, binds himself to the creditor to fulfill the
obligation of the principal debtor in case the lat- ter
should fail to do so.
If a person binds himself solidarily with the principal
debtor, the provisions of Section 4, Chapter 3, Title I of
this Book shall be observed. In such case the contract
is called a suretyship.
Art. 1211. Solidarity may exist although the credi- tors
and the debtors may not be bound in the same
manner and by the same periods and condi- tions.
Art. 1216. The creditor may proceed against any one
of the solidary debtors or some or all of them
simultaneously. The demand made against one of
them shall not be an obstacle to those which may
subsequently be directed against the others, so long
as the debt has not been fully collected.

Art. 2082. The bondsman who is to be offeredin virtue

of a provision of law orof a judicial ordershall have the
qualifications prescribed in Article 2056 and in special
laws.
Art. 2083. If the person bound to give a bond in the
cases of the preceding article, should not be able to do
so, a pledge or mortgage considered

Art. 2084. A judicial bondsman cannot demand the

exhaustion of the property of the principal debtor. A
sub-surety in the same case, cannot demand the
exhaustion of the property of the debtor of the surety.
isunenforceable by action, unless the same, or
Surety
some note or memorandum, thereof, be in writ-
ing, and subscribed by the party charged, or by
his agent; evidence, therefore, of the agreement
cannot be received without the writing, or a sec-
ondary evidence of its contents.8
But it is worth stressing that the rule holding sureties
to be "favorites of the law," and their contracts to be
strictis- simi juris, does not apply to compensated
sureties.
Article 2053 applies to suretyships as well.

Art. 2053. A guaranty may also be given as securi- ty

for future debts, the amount of which is not yet
known; there can be no claim against the guaran-
tor until the debt is liquidated....
A continuing surety therefore, is not limited to a single
transaction but contemplates a prospective or future
course of dealing, covering a series of transactions,
which are within the stipulations of the contract of
surety, until the expiration or termination thereof. It
applies to a suc- cession of liabilities, for which the
surety becomes liable as they accrue.13

D. Distinguished from Standby Letter of Credit

Although both a suretyship and a standby letter of

credit ensure against the debtor's nonperformance,
they func- tion in different ways.
Upon the debtor's default, the surety undertakes to
com- plete the debtor's performance. Enforcement of
a surety- ship often involves costs to determine
whether the debtor defaulted and the costs of
performance. The benefit of the suretyship to the
creditor is that the creditor knows that the surety will
perform if the debtor does not.
The creditor-beneficiary of a standby credit, on the
other hand, expects that it will promptly receive cash
in the event of nonperformance, and that it will
receive it before any litigation over the nature of the
debtor-applicant's performance takes place. The
standby credit has this op- posite effect of the
suretyship: it reverses the financial burden of parties
during litigation.

Distinguished from Guaranty

A suretyship is distinguished from a guaranty in that a
guarantor is the insurer of the solvency of the debtor
and binds itself to pay if the principal debtor fails or is
unable to pay, while a surety is the insurer of the debt,
and obli- gates itself to pay if the principal debtor does
not pay.
The use of the term "guarantee" does not ipso facto
mean that the contract is one of guaranty. Authori-
ties recognize that the word "guarantee" is fre-
quently employed in business transactions to de-
scribe not the security of the debt but an intention to
be bound by a primary or independent obliga- tion. As
aptly observed by the trial court, the inter- pretation
of a contract is not limited to the title alone but to the
contents and intention of the par- ties.
Distinguished from Joint and Solidary Obligations
Art. 2047... If a person binds himself solidarily with
the principal debtor, the provisions of Sec- tion 4,
Chapter 3, Title I of this Book shall be ob- served. In
such case the contract is called a sure-

tyship.
While it appears that, from the perspective of the
princip- al creditor, no apparent distinction exists
between a sure- ty and a joint and several debtor,
because the right of the creditor to compel full payment
is the same, a suretyship is distinguished from a joint
and solidary obligation in that a surety has the right
to indemnification and the right to subrogation as
against the principal debtor, while a joint and solidary
debtor has only a right to reim- bursement as against
the co-debtors.
Articles 2066 and 2067 of the Civil Code apply to
surety- ships, thus giving the surety the right to
indemnification as against the principal debtor for,
among others, the total amount of the debt that the
surety has paid, and the right
Art. 2066. The [surety] who pays for a debtor must be
indemnified by the latter. The indemnity
comprises:(1) The total amount of the debt;(2) The
legal interests thereon from the time the payment was
made known to the debtor, even though it did not earn
interest for the creditor;(3) The expenses incurred by
the [surety] after having notified the debtor that
payment had been demanded of him;(4) Damages, if
they are due.
Art. 2067. The [surety] who pays is subrogated by
virtue thereof to all the rights which the creditor had
against the debtor.If the [surety] has compromised
with the creditor, he cannot demand of the debtor
more than what he has really paid.
Article 1217 of the Civil Code, on the other hand,
applies to joint and solidary debtors, giving the joint
and solidary debtor the right to be reimbursed for the
share that cor- responds to each co-debtor.
Art. 1217. Payment made by one of the solidary
debtors extinguishes the obligation. If two or more
solidary debtors offer to pay, the creditor
may choose which offer to accept.He who made the
payment may claim from his co-debtorsonly the share
which corresponds to each, with the interest for the
payment already made. If the payment is made
before the debt is due, no inter- est for the intervening
period may be demanded.
When one of the solidary debtors cannot, because of
his insolvency, reimburse his share to the deb- tor
paying the obligation, such share shall be borne by all
his co-debtors, in proportion to the debt of each.
Thus, although Article 2047 provides that the provisions
of Section 4, Chapter 3, Title I, Book IV of the Civil Code
on joint and several obligations shall be observed in the
case of suretyships, these provisions cannot be made
ap- plicable without first considering the nature of a
surety- ship as an accessory, ancillary or collateral
obligation.
Pledge and Mortgage A. General Concepts
Art. 2085. The following requisites are essential to the
contracts of pledge and mortgage:(1) That they be
constituted to secure the fulfill- ment of a principal
obligation;
(2) That the pledgor or mortgagor be the absolute
owner of the thing pledged or mortgaged;(3) That the
persons constituting the pledge or mortgage have the
free disposal of their property, and in the absence
thereof, that they be legally authorized for the
purpose.
Third persons who are not parties to the principal
obligation may secure the latter by pledging or
mortgaging their own property.
Art. 2087. It is also of the essence of these con- tracts
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.
As it is an essential requisite for the validity of a pledge
or mortgage that the pledgor or mortgagor be the
absolute owner of the collateral, a pledge or mortgage
is void and ineffective if it were constituted over future
property.

Obligations Secured
Art. 2086. The provisions of Article 2052 are ap-
plicable to a pledge or mortgage.
Art. 2052. A [pledge or mortgage] cannot exist
without a valid obligation.
Nevertheless, a [pledge or mortgage] may be con-
stituted to guarantee the performance ofa voidable or
an unenforceable contract.
It may also guarantee a natural obligation.
Art. 2091. The contract of pledge or mortgage may
secure all kinds of obligations,
be they pure orsubject to a suspensive or resolutory
condition.

Like a guaranty and suretyship, a pledge and

mortgage are accessory obligations. Consequently,
their validity is dependent on the existence of a valid
principal obligation, whether the latter is voidable,
4
unenforceable, natural, pure or conditional.

Contract to Pledge or to Mortgage

Art. 2092. A promise to constitute a pledge or
mortgage gives rise only to a personal action be-
tween the contracting parties, without prejudice to the
criminal responsibility incurred by him who defrauds
another,
by offering in pledge or mortgage as unencum- bered,
things which he knew were subject to some burden, or
by misrepresenting himself to be the owner of the
same.
A contract to pledge or to mortgage, or a promise to
con- stitute a pledge or mortgage, is a valid
consensual con- tract.
Remedies of Pledgee and Mortgagee
A foreclosure is a legal proceeding to terminate a pled-
gor's or mortgagor's interest in the collateral. The credi-
tor (the pledgee or mortgagee, as the case may be)
insti- tutes the foreclosure, either to gain title, or to
force a sale, in order to satisfy the unpaid obligation
secured by the collateral.

Ifthe principal obligation becomes due and the debtor

de- faults, the pledgee or mortgagee may elect to
foreclose the pledge or mortgage, in accordance with
its terms, or, elect to waive the security and bring,
instead, an ordinary action for specific performance to
recover the indebted- ness.
A pledgee or mortgagee may pursue either of the two
re- medies, but not both.

Indivisibility of a Pledge or Mortgage

Art. 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 credi-
tor.
Therefore, the debtor's heir who has paid a part

of the debt cannot ask for the proportionate ex-

tinguishment of the pledge or mortgage as long as the
debt is not completely satisfied.Neither can the
creditor's heir who received his share of the debt
return the pledge or cancel the mortgage, to the
prejudice of the other heirs who have not been paid.
From these provisions is excepted the case in which,
there being several things given in mort- gage or
pledge, each one of them guarantees only a
determinate portion of the credit.
The debtor, in this case, shall have a right to the
extinguishment of the pledge or mortgage as the
portion of the debt for which each thing is spe- cially
answerable is satisfied.
Art. 2090. The indivisibility of a pledge or mort- gage
is not affected by the fact that the debtors are not
solidarily liable.

Pactum Commissorium
Art. 2087. It is also of the essence of these con- tracts
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.
Art. 2088. The creditor cannot appropriate the things
given by way *of pledge or mortgage, or dispose of
them. Any stipulation to the contrary is null and void.
ElementsThe essence of a pledge or mortgage is that,
when the
principal obligation becomes due, the collateral may be
lienated for purposes of payment to the creditor. How-
ever, the law requires resort to a legal proceeding (or
fo- reclosure) to terminate a pledgor's or mortgagor's
owner- ship of the collateral.

The elements of a pactum commissorium

are:

a. There is property pledged or mortgaged (or

collateral) by way of security for the payment of the
principal obli- gation, and
b. There is a stipulation for automatic appropriation by
the creditor of the collateral in case of non-payment of
the principal obligation within the stipulated period.

Effect on Pledge or Mortgage

The nullity of the pactum commissorium does not
substan- tially affect the validity of the contract of
pledge or mort- gage.

G. Equitable Mortgage
Art. 1602. The contract 9
shall be presumed to be an
equitable mortgage, in any of the following cases:
(1) When the price of a sale with right to repur- chase
is unusually inadequate;
(2) When the vendor remains in possession as lessee
or otherwise;(3) When upon or after the expiration of
the right to repurchase another instrument extending
the period of redemption or granting a new period is
executed;
(4) When the purchaser retains for himself a part of
the purchase price;(5) When the vendor binds himself
to pay the taxes on the thing sold;
(6) In any other case where it may be fairly in- ferred
that the real intention of the parties is that the
transaction shall secure the payment of a debt
or the performance of any other obligation.In any of
the foregoing cases, any money, fruits, or other benefit
to be received by the vendee as rent or otherwise
shall be considered as interest which shall be subject
to the usury laws.
Art. 1603. In case of doubt, a contract purporting to be
a sale with right to repurchase shall be con- strued as
an equitable mortgage.
Art. 1604. The provisions of Article 1602 shall also
apply to a contract purporting to be an absolute sale.
Art. 1605. In the cases referred to in Articles 1602 and
1604, the apparent vendor may ask for the re-
formation of the instrument.
An equitable mortgage is a contract, which, although
lacking in some formality, or form or words, or other
requisites demanded by a statute, nevertheless reveals
the intention of the parties to charge property as
security for a debt, but contains nothing impossible or
contrary to law. Its essential requisites are:
. The parties entered into a contract denominated as a
contract of sale; and
2. Their true intention was to secure an existing debt by
way of a mortgage.20
Articles 1602, 1603 and 1604 were designed to
prevent the circumvention of the laws on usury and the
prohibition against pactum commissorium. 21