SECURED TRANSACTIONS

Bar Review Notes

Assoc. Dean Ernesto C. Salao

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.

Credit transactions are really contracts of security.

Security

Something given, deposited, or serving as a means to ensure the fulfillment

or enforcement of an obligation or of protecting some interest in property.

2 Kinds

(a) Personal security, as when an individual becomes a surety or a guaran-

tor; or a

(b) Property or real security, as 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.

Thus, a secured creditor is one who holds a security from his debtor for pay-
ment of the latter’s debts.

Security Type Collateral

PPSA Property Personal Property

REM Property Real Property

Guaranty Personal None

Surety Personal None

Letter of Credit Personal None

Pactum Commissorium

A stipulation empowering the creditor to appropriate the thing given as guar-

anty for the fulfillment of the obligation in the event the obligor fails to live
up to his undertakings without further formality, such as foreclosure proceed-
ings, and a public sale. (Martires v. Chua, G.R. No. 174240, March 20, 2013)

Expressly prohibited by Art. 2088 of the Civil Code.

Article 2088 of the Civil Code prohibits the creditor from appropriating the
things given by way of pledge or mortgage, or from disposing of them; any
stipulation to the contrary is null and void.

Elements for Pactum Commissorium

(a) there should be a pledge or mortgage wherein property is pledged or

mortgaged by way of security for the payment of the principal obligation; and

(b) there should be a stipulation for an automatic appropriation by the credi-

tor of the thing pledged or mortgaged in the event of non-payment of the
principal obligation within the stipulated period.

Agoncillo v. Javier (1918)

The agreement to convey the house and lot xxx in the event of failure to pay
the debt in money at its maturity is, however, in our opinion, perfectly valid.
It is simply an undertaking that if the debt is not paid in money, it will be
paid in another way. As we read the contract, the agreement is not open to
the objection that the stipulation is a pacto commissorio.

1. Personal Property Securities Act

Republic Act (RA) No. 11057, otherwise known as the “Personal Prop-
erty Security Act (PPSA),” was signed into law on 17 August 2018.

Purpose of the law

Aims to promote economic activity by increasing access to least cost

credit, particularly for micro, small, and medium enterprises (MSMEs)
by:

1. Establishing a unified and modern legal framework for securing

obligations with personal property

2. Strengthen the secured transactions legal framework

a. Creation
b. Perfection
c. Determination of priority
d. Establishment of a centralized notice registry
e. Enforcement of security interests in personal property
Unified Legal Framework
PPSA (Sec. 66) repealed the following laws, and all laws, decrees, or-
ders, and issuances or portions thereof, which are inconsistent with the
provisions of this Act, are hereby repealed, amended, or modified ac-
cordingly:
(a) Sections 1 to 16 of Act No. 1508, otherwise known as “The Chattel
Mortgage Law";

(b) Articles 2085-2123, 2127, 2140-2141, 2241, 2243, and 2246-2247

of Republic Act No. 386, otherwise known as the “Civil Code of the
Philippines";

Note: Art. 2085 – 2092 (Provisions Common the Pledge and

Mortgage)
Art. 2093 – 2123 (Pledge)
Art. 2127 - The mortgage extends to the natural
accessions, to the improvements, growing fruits, and the
rents or income not yet received when the obligation be-
comes due, and to the amount of the indemnity granted
or owing to the proprietor from the insurers of the proper-
ty mortgaged, or in virtue of expropriation for public use,
with the declarations, amplifications and limitations estab-
lished by law, whether the estate remains in the posses-
sion of the mortgagor, or it passes into the hands of a
third person.
Art. 2140 – 2141 – Chattel Mortgage
Art. 2241, 2243 – Classification of Credits
Art. 2246-2247 – Order of Preference of Credits

(c) Section 13 of Republic Act No. 5980, as amended by Republic Act

No. 8556, otherwise known as the “Financing Company Act of 1998”;

(d) Sections 114-116 of Presidential Decree No. 1529, otherwise

known as the “Property Registration Decree";

(e) Section 10 of Presidential Decree No. 1529, insofar as the provision

thereof is inconsistent with this Act; and

(f) Section 5(e) of Republic Act No. 4136, otherwise known as the
“Land Transportation and Traffic Code”.

Security Interest (Sec. 3[j])

A property right in collateral that:
(1) secures payment or other performance of an obligation, re-
gardless of whether the parties have denominated it as a se-
curity interest, and regardless of the type of asset, the status
of the grantor or secured creditor, or the nature of the se-
cured obligation;
(2) buyer of accounts receivable and
(3) lessor under an operating lease for not less than one (1)
year.
Creation of Security Interests in Personal Property (Sec. 5)

A security interest shall be created by a security agreement.

A security interest may be created over all forms of tangible or intan-

gible asset or personal property as defined by the Civil Code, including
but not limited to:

(a) Rights arising from contracts, including but not limited to:
1. Securities
2. Commodity contracts
3. Lease of goods including financial leases and operating
leases for a period of not less than 1 year
(b) Equipment
(c) Inventory
(d) Deposit accounts
(e) Negotiable instruments
(f) Negotiable documents of title
(g) Consumer goods
(h) Intellectual property
(i) Livestock
(j) Fixtures, accessions, and commingled goods, or
(k) Future property or after-acquired assets

Provided, that a security interest can only be created on the asset

which the grantor has a legal right.

Commodity contract
a commodity futures contract, an option on a commodity futures con-
tract, a commodity option, or another contract if the contract or option
is:
(1) Traded on or subject to the rules of a board of trade that has
been designated as a contract market for such a contract; or
(2) Traded on a foreign commodity board of trade, exchange, or
market, and is carried on the books of a commodity intermedi-
ary for a commodity customer;

Grantor
(1) The person who grants a security interest in collateral to secure its
own obligation or that of another person;
(2) A buyer or other transferee of a collateral that acquires its right
subject to a security interest;
(3) A transferor in an outright transfer of an accounts receivable; or
(4) A lessee of goods;
Secured creditor
a person that has a security interest. For the purposes of registration
and priority only, it includes a buyer of account receivable and a lessor
of goods under an operating lease for not less than one (1) year;

Scope

This Act shall apply to all transactions of any form that secure an
obligation with movable collateral, except interests in aircrafts subject
to Republic Act No. 9497, or the "Civil Aviation Authority Act of 2008",
and interests in ships subject to Presidential Decree No. 1521, or the
"Ship Mortgage Decree of 1978". (Sec. 4)

Creation of a Security Interest (Sec. 5)

(a) A security interest shall be created by a security agreement,
(b) A security agreement may provide for the creation of a security in-
terest in a future property, but the security interest in that property
is created only when the grantor acquires rights in it or the power to
encumber it.

Security Agreement (Sec. 6)

A security agreement must be contained in a written contract signed
by the parties. It may consist of one or more writings that, taken to-
gether, establish the intent of the parties to create a security interest.

Description of Collateral (Sec. 7)

A description of collateral shall be considered sufficient, whether it is
specific or general, if it reasonably identifies the collateral.
A description such as "all personal property", "all equipment", "all in-
ventory", or "all personal property within a generic category" of the
grantor shall be sufficient.

Right to Proceeds and Commingled Funds and Money (Sec. 8)

(a) A security interest in personal property shall extend to its identifi-
able or traceable proceeds.
(b) Where proceeds in the form of funds credited to a deposit account
or money are commingled with other funds or money:
(1) The security interest shall extend to the commingled money or
funds, notwithstanding that the proceeds have ceased to be identi-
fiable to the extent they remain traceable:
(2) The security interest in the commingled funds or money shall
be limited to the amount of the proceeds immediately before they
were commingled: and
 (3) If at any time after the commingling, the balance credited to
the deposit account or the amount of the commingled money is
less than the amount of the proceeds immediately before they
were commingled, the security interest against the commingled
funds or money shall be limited to the lowest amount of the com-
mingled funds or money between the time when the proceeds were
commingled and the time the security interest in the proceeds is
claimed.

Continuity of Security Interest (Sec. 9)

A security interest shall continue in collateral notwithstanding sale,
lease, license, exchange, or other disposition of the collateral, except
as otherwise provided in Section 21 of this Act, or agreed upon by the
parties.

Contractual Limitation on the Creation of a Security Interest

(Sec. 10)
(a) A security interest in an account receivable shall be effective not-
withstanding any agreement between the grantor and the account
debtor or any secured creditor limiting in any way the grantor’s right to
create a security interest.
(b) Nothing in this section shall affect any obligation or liability of the
grantor for breach of the agreement in subsection (a).
(c) Any stipulation limiting the grantor’s right to create a security in-
terest shall be void.
(d) This section shall apply only to accounts receivable arising from:
(1) A contract for the supply or lease of goods or services other
than financial services;
(2) A construction contract or a contract for the sale or lease of
real property; and
(3) A contract for the sale, lease or license of intellectual property.

Asset-Specific Rules

i. Security Interest over Future property (Sec. 3.05 IRR)

A security agreement may provide for the creation of a secu-

rity interest in future property or after-acquired assets, but
the security interest in that property is created only when
the grantor acquires rights in it or the power encumber it.

ii. Security Interest over Rights to proceeds and commin-

gled funds (Sec. 8)
(a) A security interest in personal property shall extend to
its identifiable or traceable proceeds.
 (b) Where proceeds in the form of funds credited to a de-
posit account or money are commingled with other funds or
money:
(1) The security interest shall extend to the commingled
money or funds, notwithstanding that the proceeds have
ceased to be identifiable to the extent they remain trace-
able:
(2) The security interest in the commingled funds or
money shall be limited to the amount of the proceeds
immediately before they were commingled: and
(3) If at any time after the commingling, the balance
credited to the deposit account or the amount of the
commingled money is less than the amount of the pro-
ceeds immediately before they were commingled, the se-
curity interest against the commingled funds or money
shall be limited to the lowest amount of the commingled
funds or money between the time when the proceeds
were commingled and the time the security interest in the
proceeds is claimed.

iii. Security Interest over Tangible assets commingled in a

mass (Sec. 3.07)

(a) A security interest in a tangible asset that is commin-

gled in a mass extends to the mass.

(b) A security interest that extends to a mass is limited to

the same proportion of the mass as the quantity of the
encumbered asset bore to the quantity of the entire
mass immediately after the commingling.

iv. Security Interest over Accounts receivables (Sec.

3.08)

(a) A security interest in an account receivable shall be

effective notwithstanding any agreement between the
grantor and the account debtor or any secured credi-
tor limiting in any way the grantor’s right to create a
security interest; Provided that: Nothing in this sec-
tion affects the right of a buyer to create a security
interest over the account receivable. Provided, fur-
ther: that any release of information is subject to
agreements on confidentiality.

(b) Nothing in this section shall affect any obligation or

liability of the grantor for breach of the agreement is
subsection (a)
 (c) Any stipulation limiting the grantor’s right to create a
security interest shall be void.

(d) This section shall apply only to accounts receivable

arising from:

(i) A contract for the supply or lease of goods or

services other than financial services;
(ii) A construction contract or contract for the sale or
lease of real property; and
(iii) A contract for the sale, lese or license of intellec-
tual property

Perfection of security interests (Sec. 11)

(a) A security interest shall be perfected when it has been created and
the secured creditor has taken one of the actions in accordance with
Section 12.
(b) On perfection, a security interest becomes effective against third
parties.

Means of Perfection (Sec. 12)

A security interest may be perfected by:
(a) Registration of a notice with the Registry;
(b) Possession of the collateral by the secured creditor; and
(c) Control of investment property and deposit account.
A security interest in any tangible asset may be perfected by registra-
tion or possession. A security interest in investment property and de-
posit account may be perfected by registration or control.

Application:

Registration Possession Control

Tangible assets ✔ ✔ ✖

Investment ✔ ✖ ✔

Deposit account ✔ ✖ ✔

Perfection by Control (Sec. 13)

(a) A security interest in a deposit account or investment property may
be perfected by control through:
 (1) The creation of the security interest in favor of the deposit-
taking institution or the intermediary;
(2) The conclusion of a control agreement; or
(3) For an investment property that is an electronic security not
held with an intermediary, the notation of the security interest in
the books maintained by or on behalf of the issuer for the pur-
pose of recording the name of the holder of the securities.
(b) Nothing in this Act shall require a deposit-taking institution or an
intermediary to enter into a control agreement, even if the grantor so
requests. A deposit-taking institution or an intermediary that has en-
tered into such an agreement shall not be required to confirm the exis-
tence of the agreement to another person unless requested to do so
by the grantor.

Perfection in Proceeds (Sec. 14)

(a) Upon disposition of collateral, a security interest shall extend to
proceeds of the collateral without further act and be continuously per-
fected, if the proceeds are in the form of money, accounts receivable,
negotiable instruments or deposit accounts.
(b) Upon disposition of the collateral, if the proceeds are in a form dif-
ferent from money, accounts receivable, negotiable instruments or de-
posit accounts, the security interest in such proceeds must be perfect-
ed by one of the means applicable to the relevant type of collateral
within fifteen (15) days after the grantor receives such proceeds; oth-
erwise, the security interest in such proceeds shall not be effective
against third parties.

Change in Means of Perfection (Sec. 15)

A security interest shall remain perfected despite a change in the
means for achieving perfection: Provided, That there was no time
when the security interest was not perfected.

Assignment of Security Interest (Sec. 16)

If a secured creditor assigns a perfected security interest, an amend-
ment notice may be registered to reflect the assignment.

Registration

Establishment of Electronic Registry (Sec. 26)

(a) The Registry shall be established in and administered by the Land
Registration Authority (LRA).
(b) The Registry shall provide electronic means for registration and
searching of notices.
Public Record (Sec. 27)
(a) Information contained in a registered notice shall be considered as
a public record.
(b) Any person may search notices registered in the Registry.
(c) The electronic records of the Registry shall be the official records.

Sufficiency of Notice (Sec. 28)

(a) An initial notice of security interest shall not be rejected:
(1) If it identifies the grantor by an identification number, as fur-
ther prescribed in the regulations;
(2) If it identifies the secured creditor or an agent of the se-
cured creditor by name;
(3) If it provides an address for the grantor and secured creditor
or its agent;
(4) If it describes the collateral: and
(5) If the prescribed fee has been tendered, or an arrangement
has been made for payment of fees by other means.
(b) If the Registry rejects to register a notice, it shall promptly com-
municate the fact of and reason for its rejection to the person who
submitted the notice.
(c) Each grantor must authorize the registration of an initial notice by
signing a security agreement or otherwise in writing.
(d) A notice may be registered before a security agreement is conclud-
ed. Once a security agreement is concluded, the date of registration of
the notice shall be reckoned from the date the notice was registered.
(e) A notice of lien may be registered by a lien holder without the con-
sent of the person against whom the lien is sought to be enforced.
(f) Description of the collateral in a notice shall be entered in English.

One Notice Sufficient for Security Interests Under Multiple Se-

curity Agreements (Sec. 29)
The registration of a single notice may relate to security interests cre-
ated by the grantor under one (1) or more than one security agree-
ment.

Effectiveness of Notice (Sec. 30)

(a) A notice shall be effective at the time it is discoverable on the
records of the Registry.
(b) A notice shall be effective for the duration of the term indicated in
the notice unless a continuation notice is registered before the term
lapses.
(c) A notice substantially complying with the requirements of this
Chapter shall be effective unless it is seriously misleading.
(d) A notice that may not be retrieved in a search of the Registry
against the correct identifier of the grantor shall be ineffective with re-
spect to that grantor.

Seriously Misleading Notice (Sec. 31)

A notice that does not provide the identification number of the grantor
shall be seriously misleading.

Amendment of Notice (Sec. 32)

(a) A notice may be amended by the registration of an amendment no-
tice that:
(1) Identifies the initial notice by its registration number; and
(2) Provides the new information.
(b) An amendment notice that adds collateral that is not proceeds
must be authorized by the grantor in writing.
(c) An amendment notice that adds a grantor must be authorized by
the added grantor in writing.
(d) An amendment notice shall be effective only as to each secured
creditor who authorizes it.
(e) An amendment notice that adds collateral or a grantor shall be ef-
fective as to the added collateral or grantor from the date of its regis-
tration.

Continuation of Notice (Sec. 33)

(a) The period of effectiveness of a notice may be continued by regis-
tering an amendment notice that identifies the initial notice by its reg-
istration number.
(b) Continuation of notice may be registered only within six (6)
months before the expiration of the effective period of the notice.

Termination of Effectiveness of a Notice (Sec. 34)

(a) The effectiveness of a notice may be terminated by registering a
termination notice that:
(1) Identifies the initial notice by its registration number; and
(2) Identifies each secured creditor who authorizes the registra-
tion of the termination notice.
(b) A termination notice terminates effectiveness of the notice as to
each authorizing secured creditor.

Registry Duties (Sec. 35)

(a) For each registered notice, the Registry shall:
(1) Assign a unique registration number;
(2) Create a record that bears the number assigned to the initial
notice and the date and time of registration; and
(3) Maintain the record for public inspection.
(b) The Registry shall index notices by the identification number of the
grantor and, for notices containing a serial number of a motor vehicle,
by serial number.
(c) The Registry shall provide a copy of the electronic record of the no-
tice, including the registration number and the date and time of regis-
tration to the person who submitted it.
(d) The Registry shall maintain the capability to retrieve a record by
the identification number of the grantor, and by serial number of a mo-
tor vehicle.
(e) The Registry shall maintain records of lapsed notices for a period of
ten (10) years after the lapse.
(f) The duties of the Registry shall be merely administrative in nature.
By registering a notice or refusing to register a notice, the Registry
does not determine the sufficiency, correctness, authenticity, or validi-
ty of any information contained in the notice.

Search of Registry Records and Certified Report (Sec. 36)

(a) The Registry shall communicate the following information to any
person who requests it:
(1) Whether there are in the Registry any unlapsed notices that
indicate the grantor's identification number or vehicle serial
number that exactly matches the relevant criterion provided by
the searcher;
(2) The registration number, and the date and time of registra-
tion of each notice; and
(3) All of the information contained in each notice.
(b) If requested, the Registry shall issue a certified report of the re-
sults of a search that is an official record of the Registry and shall be
admissible into evidence in judicial proceedings without extrinsic evi-
dence of its authenticity.

Disclosure of Information (Sec. 37)

(a) The secured creditor must provide to the grantor at its request:
 (1) The current amount of the unpaid secured obligation; and
(2) A list of assets currently subject to a security interest.
(b) The secured creditor may require payment of a fee for each re-
quest made by the grantor in subsection (a) in this section, but the
grantor is entitled to a reply without charge once every six (6) months.
(c) A security interest in a deposit account shall not:
(1) Affect the rights and obligations of the deposit-taking institu-
tion without its consent; or
(2) Require the deposit-taking institution to provide any infor-
mation about the deposit account to third parties.

Fees Set by Regulation (Sec. 38)

(a) The fees for registering a notice and for requesting a certified
search report shall be set by regulation issued by the DOF for the re-
covery of reasonable costs of establishing and operating the Registry.
(b) The fee structure or any change thereof under subsection (a) shall
further consider that the same shall not be burdensome to either
lender or grantor.
(c) There shall be no fee for electronic searches of the Registry records
or for the registration of termination notices.
(d) The Registry may charge fees for services not mentioned above.

When the Grantor May Demand Amendment or Termination of

Notice (Sec. 39)
A grantor may give a written demand to the secured creditor to amend
or terminate the effectiveness of the notice if:
(a) All the obligations under the security agreement to which the regis-
tration relates have been performed and there is no commitment to
make future advances;
(b) The secured creditor has agreed to release part of the collateral
described in the notice;
(c) The collateral described in the notice includes an item or kind of
property that is not a collateral under a security agreement between
the secured creditor and the grantor;
(d) No security agreement exists between the parties; or
(e) The security interest is extinguished in accordance with this Act.

Matters That May be Required by Demand (Sec. 40)

Upon receipt of the demand submitted under Section 39, the secured
creditor must register, within fifteen (15) working days, an amendment
or termination notice:
(a) Terminating the registration in a case within subsections (a), (d) or
(e) of Section 39;
(b) Amending the registration to release some property that is no
longer collateral in a case within subsection (c) of Section 39 or that
was never collateral under a security agreement between the secured
creditor and the grantor in a case within subsection (c) of Section 39.

Procedure for Noncompliance with Demand (Sec. 41)

If the secured creditor fails to comply with the demand within fifteen
(15) working days after its receipt, the person giving the demand un-
der Section 39 may ask the proper court to issue an order terminating
or amending the notice as appropriate.

Compulsory Amendment or Termination by Court Order (Sec.

42)
(a) The court may, on application by the grantor, issue an order that
the notice be terminated or amended in accordance with the demand,
which order shall be conclusive and binding-on the LRA: Provided, That
the secured creditor who disagrees with the order of the court may
appeal the order.
(b) The court may make any other order it deems proper for the pur-
pose of giving effect to an order under subsection (a) of this section.
(c) The LRA shall amend or terminate a notice in accordance with a
court order made under subsection (a) of this section as soon as rea-
sonably practicable after receiving the order.

No Fee for Compliance of Demand (Sec. 43)

A secured creditor shall not charge any fee for compliance with a de-
mand received under Section 39.

When Registration and Search Constitutes Interference with

Privacy of Individual (Sec. 44)
A person who submitted a notice for registration or carried out a
search of the Registry with a frivolous, malicious or criminal purpose or
intent shall be subject to civil and criminal penalties according to the
relevant laws.

Priority Rules (Sec. 17)

The priority of security interests and liens in the same collateral shall
be determined according to time of registration of a notice or perfec-
tion by other means, without regard to the order of creation of the se-
curity interests and liens.
Priority for Perfection by Control (Sec. 18)
(a) A security interest in a deposit account with respect to which the
secured creditor is the deposit-taking institution or the intermediary
shall have priority over a competing security interest perfected by any
method.
(b) A security interest in a deposit account or investment property that
is perfected by a control agreement shall have priority over a compet-
ing security interest except a security interest of the deposit-taking in-
stitution or the intermediary.
(c) The order of priority among competing security interests in a de-
posit account or investment property that were perfected by the con-
clusion of control agreements shall be determined on the basis of the
time of conclusion of the control agreements.
(d) Any rights to set-off that the deposit-taking institution may have
against a grantor’s right to payment of funds credited to a deposit ac-
count shall have priority over a security interest in the deposit account.
(e) A security interest in a security certificate perfected by the secured
creditor’s possession of the certificate shall have priority over a com-
peting security interest perfected by registration of a notice in the Reg-
istry.
(f) A security interest in electronic securities not held with an interme-
diary perfected by a notation of the security interests in the books
maintained for that purpose by or on behalf of the issuer shall have
priority over a security interest in the same securities perfected by any
other method.
(g) A security interest in electronic securities not held with an interme-
diary perfected by the conclusion of a control agreement shall have
priority over a security interest in the same securities perfected by
registration of a notice in the Registry.
(h) The order of priority among competing security interests in elec-
tronic securities not held with an intermediary perfected by the conclu-
sion of control agreements is determined on the basis of the time of
conclusion of the control agreements.

Priority for Instruments and Negotiable Documents (Sec. 19)

A security interest in an instrument or negotiable document that is
perfected by possession of the instrument or the negotiable document
shall have priority over a security interest in the instrument or nego-
tiable document that is perfected by registration of a notice in the Reg-
istry.

Priority and Plight of Retention by Operation of Law (Sec. 20)

A person who provides services or materials with respect to the goods,
in the ordinary course of business, and retains possession of the goods
shall have priority over a perfected security interest in the goods until
payment thereof.

Transferee Exceptions (Sec. 21)

Any party who obtains, in the ordinary course of business, any mov-
able property containing a security interest shall take the same free of
such security interest provided he was in good faith. No such good
faith shall exist if the security interest in the movable property was
registered prior to his obtaining the property.

Effect of the Grantor’s Insolvency on the Priority of a Security

Interest (Sec. 22)
Subject to the applicable insolvency law, a security interest perfected
prior to the commencement of insolvency proceedings in respect of the
grantor shall remain perfected and retain the priority it had before the
commencement of the insolvency proceedings.

Purchase Money Security Interest (Sec. 23)

(a) A purchase money security interest in equipment and its proceeds
shall have priority over a conflicting security interest, if a notice relat-
ing to the purchase money security interest is registered within three
(3) business days after the grantor receives possession of the equip-
ment.
(b) A purchase money security interest in consumer goods that is per-
fected by registration of notice not later than three (3) business days
after the grantor obtains possession of the consumer goods shall have
priority over a conflicting security interest.
(c) A purchase money security interest in inventory, intellectual prop-
erty or livestock shall have priority over a conflicting perfected security
interest in the same inventory, intellectual property or livestock if:
(1) The purchase money security interest is perfected when the
grantor receives possession of the inventory or livestock, or ac-
quires rights to intellectual property; and
(2) Before the grantor receives possession of the inventory or
livestock, or acquires rights in intellectual property, the purchase
money secured creditor gives written notification to the holder
of the conflicting perfected security interest in the same types of
inventory, livestock, or intellectual property. The notification
sent to the holder of the conflicting security interest may cover
multiple transactions between the purchase money secured
creditor and the grantor without the need to identify each trans-
action.
(d) The purchase money security interest in equipment or consumer
goods perfected timely in accordance with subsections (a) and (b),
shall have priority over the rights of a buyer, lessee, or lien holder
which arise between delivery of the equipment or consumer goods to
the grantor and the time the notice is registered.

Livestock (Sec. 24)

A perfected security interest in livestock securing an obligation in-
curred to enable the grantor to obtain food or medicine for the live-
stock shall have priority over any other security interest in the live-
stock, except for a perfected purchase money security interest in the
livestock, if the secured creditor providing credit for food or medicine
gives written notification to the holder of the conflicting perfected se-
curity interest in the same livestock before the grantor receives pos-
session of the food or medicine.

Fixtures, Accessions, and Commingled Goods (Sec. 25)

A perfected security interest in a movable property which has become
a fixture, or has undergone accession or commingling shall continue
provided the movable property involved can still be reasonably traced.
In determining ownership over fixtures, accessions, and commingled
goods, the provisions of Book II of Republic Act No. 386 or the "Civil
Code of the Philippines" shall apply.

Enforcement With or Without Judicial Process (Sec. 7.01)

The secured creditor may enforce its security interest whether through
a judicial process or through an extra-judicial process, including the
sale of the secured assets through either a public or private disposition.
Any judicial enforcement of security interests, including the disposition
of collateral shall be governed by rules promulgated by the Supreme
Court.

Expedited Repossession of the Collateral (Without Judicial

Process) (Sec. 7.02)

The secured creditor may take possession of the collateral without judi-
cial process if the security agreement so stipulates: Provided, that pos-
session can be taken without a breach of peace. Breach of peace shall
include entering the private residence of the grantor without permis-
sion, resorting to physical violence or intimidation, or being accompa-
nied by a law enforcement officer when taking possession or con-
fronting the grantor.

If the collateral is a fixture, the secured creditor, if it has priority over

all owners and mortgages, may remove the fixture from the real prop-
erty to which it is affixed without judicial process. The secured creditor
shall exercise due care in removing the fixture.

Expedited Repossession of the Collateral (With Judicial Process)

(Sec. 7.03)

If upon default, the secured creditor cannot take possession of collater-

al without breach of peace, the secured creditor may proceed as fol-
lows:

(a) The secured creditor shall be entitled to an expedited hearing

upon application for an order granting the secured creditor pos-
session of the collateral. Such application shall include a state-
ment by the secured creditor, under oath, verifying the existence
of the security agreement attached to the application and identi-
fying at least one event of default by the debtor under the secu-
rity agreement;

(b) The secured creditor shall provide a debtor, grantor, and if the
collateral is a fixture, any real estate mortgage, a copy of the
application, including all supporting documents and evidence for
the order granting the secured creditor possession of the collat-
eral; and

(c) The secured creditor is entitled to an order granting possession

of the collateral upon the court finding that a default has oc-
curred under the security agreement and that the secured credi-
tor has a right to take possession of the collateral. The court may
direct the grantor to take such action as the court deems neces-
sary and appropriate so that the secured creditor may take pos-
session of the collateral.

Right of Redemption (Sec. 45)

(a) Any person who is entitled to receive a notification of disposition in
accordance with this Chapter is entitled to redeem the collateral by
paying or otherwise performing the secured obligation in full, including
the reasonable cost of enforcement.
(b) The right of redemption may be exercised, unless:
(1) The person entitled to redeem has not, after the default,
waived in writing the right to redeem;
(2) The collateral is sold or otherwise disposed of, acquired or
collected by the secured creditor or until the conclusion of an
agreement by the secured creditor for that purpose; and
(3) The secured creditor has retained the collateral.

Right of Higher-Ranking Secured Creditor to Take Over En-

forcement (Sec. 46)
(a) Even if another secured creditor or a lien holder has commenced
enforcement, a secured creditor whose security-interest has priority
over that of the enforcing secured creditor or lien holder shall be enti-
tled to take over the enforcement process.
(b) The right referred to in subsection (a) of this section may be in-
voked at any time before the collateral is sold or otherwise disposed of,
or retained by the secured creditor or until the conclusion of an
agreement by the secured creditor for that purpose.
(c) The right of the higher-ranking secured creditor to take over the
enforcement process shall include the right to enforce the rights by
any method available to a secured creditor under this Act.

Expedited Repossession of the Collateral (Sec. 47)

(a) The secured creditor may take possession of the collateral without
judicial process if the security agreement so stipulates: Provided, That
possession can be taken without a breach of the peace.
(b) If the collateral is a fixture, the secured creditor, if it has priority
over all owners and mortgagees, may remove the fixture from the real
property to which it is affixed without judicial process. The secured
creditor shall exercise due care in removing the fixture.
(c) If, upon default, the secured creditor cannot take possession of col-
lateral without breach of the peace, the secured creditor may proceed
as follows:
(1) The secured creditor shall be entitled to an expedited hear-
ing upon application for an order granting the secured creditor
possession of the collateral. Such application shall include a
statement by the secured creditor, under oath, verifying the ex-
istence of the security agreement attached to the application
and identifying at least one event of default by the debtor under
the security agreement;
(2) The secured creditor shall provide the debtor, grantor, and, if
the collateral is a fixture, any real estate mortgagee, a copy of
the application, including all supporting documents and evidence
for the order granting the secured creditor possession of the col-
lateral; and
(3) The secured creditor is entitled to an order granting posses-
sion of the collateral upon the court finding that a default has
occurred under the security agreement and that the secured
creditor has a right to take possession of the collateral. The
court may direct the grantor to take such action as the court
deems necessary and appropriate so that the secured creditor
may take possession of the collateral: Provided, That breach of
the peace shall include entering the private residence of the
grantor without permission, resorting to physical violence or in-
timidation, or being accompanied by a law enforcement officer
when taking possession or confronting the grantor.
Recovery in Special Cases (Sec. 48)
Upon default, the secured creditor may without judicial process:
(a) Instruct the account debtor to make payment to the secured credi-
tor, and apply such payment to the satisfaction of the obligation se-
cured by the security interest after deducting the secured creditor’s
reasonable collection expenses. On request of the account debtor, the
secured creditor shall provide evidence of its security interest to the
account debtor when it delivers the instruction to the account debtor;
(b) In a negotiable document that is perfected by possession, proceed
as to the negotiable document or goods covered by the negotiable
document;
(c) In a deposit account maintained by the secured creditor, apply the
balance of the deposit account to the obligation secured by the deposit
account; and
(d) I n other cases of security interest in a deposit account perfected
by control, instruct the deposit-taking institution to pay the balance of
the deposit account to the secured creditor’s account.

Section 49. Right to Dispose of Collateral.—

(a) After default, a secured creditor may sell or otherwise dispose of
the collateral, publicly or privately, in its present condition or following
any commercially reasonable preparation or processing.
(b) The secured creditor may buy the collateral at any public disposi-
tion, or at a private disposition but only if the collateral is of a kind
that is customarily sold on a recognized market or the subject of wide-
ly distributed standard price quotations.

Commercial Reasonableness Required (Sec. 50)

(a) In disposing of collateral, the secured creditor shall act in a com-
mercially reasonable manner.
(b) A disposition is commercially reasonable if the secured creditor
disposes of the collateral in conformity with commercial practices
among dealers in that type of property.
(c) A disposition is not commercially unreasonable merely because a
better price could have been obtained by disposition at a different time
or by a different method from the time and method selected by the se-
cured creditor.
(d) If a method of disposition of collateral has been approved in any
legal proceeding, it is conclusively commercially reasonable.

Notification of Disposition (Sec. 51)

(a) Not later than ten (10) days before disposition of the collateral, the
secured creditor shall notify:
 (1) The grantor;
(2) Any other secured creditor or lien holder who, five (5) days
before the date notification is sent to the grantor, held a security
interest or lien in the collateral that was perfected by registra-
tion; and
(3) Any other person from whom the secured creditor received
notification of a claim of an interest in the collateral if the notif-
ication was received before the secured creditor gave notif-
ication of the proposed disposition to the grantor.
(b) The grantor may waive the right to be notified.
(c) A notification of disposition is sufficient if it identifies the grantor
and the secured creditor; describes the collateral; states the method of
intended disposition; and states the time and place of a public disposi-
tion or the time after which other disposition is to be made.
(d) The requirement to send a notification under this section shall not
apply if the collateral is perishable or threatens to decline speedily in
value or is of a type customarily sold on a recognized market.

Application of Proceeds (Sec. 52)

(a) The proceeds of disposition shall be applied in the following order:
(1) The reasonable expenses of taking, holding, preparing for
disposition, and disposing of the collateral, including reasonable
attorneys’ fees and legal expenses incurred by the secured cred-
itor;
(2) The satisfaction of the obligation secured by the security in-
terest of the enforcing secured creditor; and
(3) The satisfaction of obligations secured by any subordinate
security interest or hen in the collateral if a written demand and
proof of the interest are received before distribution of the pro-
ceeds is completed.
(b) The secured creditor shall account to the grantor for any surplus,
and, unless otherwise agreed, the debtor is liable for any deficiency.

Rights of Buyers and Other Third Parties (Sec. 53)

(a) If a secured creditor sells the collateral under this Chapter, the
buyer shall acquire the grantor’s right in the asset free of the rights of
any secured creditor or lien holder.
(b) If a secured creditor leases or licenses the collateral under this
Chapter, the lessee or licensee shall be entitled to the benefit of the
lease or license during its term.
(c) If a secured creditor sells, leases or licenses the collateral not in
compliance with this Chapter, the buyer, lessee or licensee of the col-
lateral shall acquire the rights or benefits described in subsections (a)
and (b) of this section: Provided, That it had no knowledge of a viola-
tion of this Chapter that materially prejudiced the rights of the grantor
or another person.

Retention of Collateral by Secured Creditor (Sec. 54)

(a) After default, the secured creditor may propose to the debtor and
grantor to take all or part of the collateral in total or partial satisfaction
of the secured obligation, and shall send a proposal to:
(1) The debtor and the grantor;
(2) Any other secured creditor or lien holder who, five (5) days
before the proposal is sent to the debtor and the grantor, per-
fected its security interest or lien by registration; and
(3) Any other person with an interest in the collateral who has
given a written notification to the secured creditor before the
proposal is sent to the debtor and the grantor.
(b) The secured creditor may retain the collateral in the case of:
(1) A proposal for the acquisition of the collateral in full satisfaction of
the secured obligation, unless the secured creditor receives an objec-
tion in writing from any person entitled to receive such a proposal
within twenty (20) days after the proposal is sent to that person; or
(2) A proposal for the acquisition of the collateral in partial satisfaction
of the secured obligation, only if the secured creditor receives the af-
firmative consent of each addressee of the proposal in writing within
twenty (20) days after the proposal is sent to that person.

Interpretation of Transitional Provisions (Sec. 55)

For this Chapter, unless the context otherwise requires:
(a) Existing secured creditor – means a secured creditor with a prior
security interest;
(b) Prior law – means any law that existed or in force before the effec-
tivity of this Act;
(c) Prior interest – means a security interest created or provided for by
an agreement or other transaction that was made or entered into be-
fore the effectivity of this Act and that had not been terminated before
the effectivity of this Act, but excludes a security interest that is re-
newed or extended by a security agreement or other transaction made
or entered into on or after the effectivity of this Act; and
(d) Transitional period - means the period from the date of effectivity
of this Act until the date when the Registry has been established and
operational.

Creation of Prior Interest (Sec. 56)

(a) Creation of prior interest shall be determined by prior laws.
(b) A prior interest remains effective between the parties not-
withstanding its creation did not comply with the creation require-
ments of this Act.

Perfection of Prior Interest (Sec. 57)

(a) A prior interest that was perfected under prior law continues to be
perfected under this Act until the earlier of:
(1) The time the prior interest would cease to be perfected un-
der prior law; and
(2) The expiration of the transitional period.
(b) If the perfection requirements of this Act are satisfied before the
perfection of a prior interest ceases in accordance with subsection (a)
of this section, the prior interest continues to be perfected under this
Act from the time when it was perfected under the prior law.
(c) If the perfection requirements of this Act are not satisfied before
the perfection of a prior interest ceases in accordance with subsection
(a) of this section, the prior interest is perfected only from the time it
is perfected under this Act.
(d) A written agreement between a grantor and a secured creditor cre-
ating a prior interest is sufficient to constitute authorization by the
grantor of the registration of a notice covering assets described in that
agreement under this Act.
(e) If a prior interest referred to in subsection (b) of this section was
perfected by the registration of a notice under prior law, the time of
registration under the prior law shall be the time to be used for pur-
poses of applying the priority rules of this Act.

Priority of Prior Interest (Sec. 58)

(a) The priority of a prior interest as against the rights of a competing
claimant is determined by the prior law if:
(1) The security interest and the rights of all competing claimant
arose before the effectivity of this Act; and
(2) The priority status of these rights has not changed since the
effectivity of this Act.
(b) For purposes of subsection (a)(2) of this section, the priority status
of a prior interest has changed only if:
(1) It was perfected when this Act took effect, but ceased to be
perfected; or
(2) It was not perfected under prior law when this Act took ef-
fect, and was only perfected under this Act.

Enforcement of Prior Interest (Sec. 59)

 (a) If any step or action has been taken to enforce a prior interest be-
fore the effectivity of this Act, enforcement may continue under prior
law or may proceed under this Act.
(b) Subject to subsection (a) of this section, prior law shall apply to a
matter that is the subject of proceedings before a court before the ef-
fectivity of this Act.

Extinguishment of Security Interest (Sec. 3.12)

A security interest is extinguished when all secured obligations have

been discharged and there are no outstanding commitments to extend
credit secured by the security interest.

2. Real Estate Mortgage Law (Act 3135, as amended by R.A. 4118)

Definition and characteristics

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 which obligation shall
be satisfied with the proceeds of the sale of said property or rights in
case the said obligation is not complied with at the time stipulated.

A mortgage may be:

(1) Voluntary. — one which is agreed to between the parties or consti-

tuted by the will of the owner of the property on which it is created
(Art. 138, Spanish Mortgage Law.); or

(2) Legal. — one required by law to be executed in favor of certain

persons (see Art. 2125, par. 2; Arts. 2082, 2083.); or

(3) Equitable. — one which, although it lacks the proper formalities or

other requisites of a mortgage required by law, nevertheless reveals
the intention of the parties to burden real property as a security for a
debt, and contains nothing impossible or contrary to law.

An equitable mortgage is not different from a real estate mortgage,

and the lien created thereby ought not to be defeated by requiring
compliance with the formalities necessary to the validity of a voluntary
real estate mortgage.

Characteristics of REM

It is a formal, accessory, and subsidiary contract. It is also unilateral

because it creates only an obligation on the part of the creditor who
must free the property from the encumbrance once the obligation is
fulfilled.
Object of real estate mortgage

Only the following property may be the object of a contract of mort-

gage:
(1) Immovables;
(2) Alienable real rights in accordance with the laws, imposed upon
immovables.
Nevertheless, movables may be the object of a chattel mortgage. (Art.
2124)

Hence, only immovable properties may be subject matter of a real es-

tate mortgage.

Estoppel

There are instances when certain movables are treated as real proper-
ties by estoppel. Parties may be estopped (parties treat movables as
immovable) although innocent third parties are not affected. (People’s
Bank v. Dahican Lumber, G.R. No. L-17500, May 16, 1967)

Effect of Mortgage

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. (Art. 2126)

The mortgage constitutes an encumbrances on the real property. The

registered mortgage follows the property even if there is a change of
ownership.

Security Interest

Only security interest is acquired, the right to possession and jus

disponendi are not included.

In Case the Mortgagor is Not the Debtor

The accommodation mortgagor is not personally liable to pay the

obligation because the right of the mortgagee is only limited to a line
on the mortgaged property.

Mortgagee’s Right to Rely on the Torrens Title

A mortgagee in good faith has the right to rely on the inscription of the
mortgage on the title. The mortgagee in good faith will not be affected
by a claim of a third person.

Banks Cannot Merely Rely on the Title

By the nature of their functions, banks are required to go beyond the
title because they are required to exercise the highest degree of dili-
gence. They are required to investigate the title and the property. (Ur-
sal v. CA, 473 SCRA 58)

Mortgages in favor of banks will be annulled if there are circumstances

that would indicate the bank’s bad faith or negligence. (Gaotian v.
Gaffund, 27 SCRA 706)

Failure to conduct exhaustive investigation on the history of title is

negligence. (Cavite Development Bank v. Lim, 324 SCRA 346)

Essential requisites

1. Requisites stated as common to pledge and mortgage

2. It appears in a public document duly recorded in the Registry of
Property. (Art. 2125)

Requisites Common to Pledge and Mortgage

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. (Art. 2085)

Registration
In addition to the requisites stated in article 2085, it is indispensable,
in order that a mortgage may be validly constituted, that the docu-
ment in which it appears be recorded in the Registry of Property. If the
instrument is not recorded, the mortgage is nevertheless binding be-
tween 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. 2125)
Registration Requirement

1. Matter of right as to the mortgagee

2. Ministerial act on part of Register of Deeds
3. Registration without prejudice to better right (e.g. Deed of Absolute
Sale prior to mortgage. But not over Contract to Sell where owner-
ship is vested only after full payment)

Summary of the Rule

 Mortgage Validity Effect

In public document Valid Valid even to third

and registered parties

In public document Valid only bet par- Third parties not af-
but NOT registered ties fected

In private document Not Valid Loan still valid.

(cannot be registered Creditor has right to
because it’s private) compel debtor to ex-
ecute mortgage in
public instrument.

(1) Where mortgage in a private document. — No valid mortgage is

constituted where the alleged deed of mortgage is a mere private
document and, therefore, is not registered. (Hechanova vs. Adil,
144 SCRA 450 [1986].) The creditor may recover the loan, al-
though the mortgage document evidencing the loan was non-reg-
istrable being a purely private document. He has the right to com-
pel the debtor to execute a contract of mortgage in a public in-
strument. (see Arts. 1357, 1358.)

(2) Where mortgage not registered. — However, an additional provi-

sion is made that if the instrument of mortgage is not recorded,
the mortgage is nevertheless binding between the parties.” (Report
of the Code Commission, p. 158.) In other words, registration only
operates as a notice of the mortgage to others but neither adds to
its validity nor converts an invalid mortgage into a valid one be-
tween the parties. (Samanilla vs. Cajucom, 107 Phil. 432 [1960].)

Presumption of Validity

A duly executed mortgage is presumed to be valid until the contrary is

shown. To the party attacking, rests the burden of proving its invalidity
due to fraud, duress or illegality. The right to attack the validity of a
mortgage may be lost by a waiver of defects and objections, or by un-
reasonable delay to act amounting to ratification. (San Juan vs. Court
of Appeals, 363 SCRA 387 [2001].)

Obligations secured by real estate mortgage

General rule – the amount mentioned in the mortgage.

Mortgage with “dragnet’’ clauses to secure future

loans

(1) Usefulness of mortgage with a “dragnet clause.’’

 A “dragnet clause” operates as a convenience and accommoda-
tion to the borrowers as it makes available additional funds
without their having to execute additional security documents,
thereby saving time, travel, loan closing costs, costs of extra le-
gal services, recording fees, et cetera. (Cuyco vs. Cuyco, 487
SCRA 693 [2006].)

(2) Construction of mortgage with a “dragnet’’ clause.

(a) Such dragnet clauses are “carefully scrutinized and strictly

construed” particularly where the mortgage contract is one of
adhesion. (Premiere Development Bank vs. Central Surety & In-
surance Co., Inc., 579 SCRA 359 [2009].).

Example:

Thus, in a case where the sole issue was whether in the foreclo-
sure of a real estate mortgage, the penalties stipulated in two
(2) promissory notes secured by the mortgage may be charged
against the mortgagors as part of the sums secured although
the mortgage contract does not mention the said penalties, it
was held that construing the silence or ambiguity against the
petitioner bank, no penalty was intended to be included in the
amount covered by the mortgage and, therefore, proceeding by
the general rule, such penalty cannot be recovered on the fore-
closure of the mortgage. (Phil. Bank of Communications vs.
Court of Appeals, 253 SCRA 241 [1996])

(b) Where the plain terms of the mortgage evidence the inten-
tion of the mortgagor to secure a larger amount, the action to
foreclose may be for the larger amount. In such case, the spe-
cific amount mentioned in the mortgage is not controlling. (Lim
Julian vs. Lutero, 49 Phil. 703 [1926].)

(c) But where the obligation is not a series of indeterminate

sums incurred over a period of time but two specific amounts
procured in a single instance, what applies is the general rule
stated above (Phil. Bank of Communications vs. Court of Ap-
peals, 253 SCRA 241 [1996].), that an action to foreclose a
mortgage must be limited to the amount mentioned in the
mortgage.

(3) Mortgage, a continuing security

A mortgage (or pledge) given to secure future advancements is

a continuing security and is not discharged by the repayment of
the amount named in the mortgage, until the full amount of the
advancements are paid.

In fact, it has also been held that “where the annotation on the
 back of a certificate of title about a first mortgage states ‘that
the mortgage secured the payment of a certain sum of money
plus interest plus other obligations arising thereunder,’ there was
no necessity for any notation of the later loans on the mort-
gagor’s title. (Tady-Y vs. Phil. National Bank, 12 SCRA 19
[1964].)

Extent of mortgage

A real estate mortgage constituted on immovable property is not limit-

ed to the property itself but also extends to all its accessions, im-
provements, growing fruits and rents or income as well as to the pro-
ceeds of insurance should the property be destroyed, or the expropria-
tion value of the property should it be expropriated. (Art. 2127)

Reason

The law is predicated on the assumption that the ownership of such

accessions and accessories and improvements subsequently introduced
also belongs to the mortgagor is the owner of the principal. (Castro, Jr.
vs. Court of Appeals, 250 SCRA 661 [1995].)

To exclude them, it is necessary that there be an express stipulation to

that effect.

Thus, the following are deemed included in a mortgage of real proper-

ty:

(1) new plantings;

(2) fruits, except those collected before the obligation falls due,
and those removed and stored when it falls due;
(3) accrued and unpaid rents as well as those which should have
to be paid while the credit remains wholly unsatisfied (National
Bank vs. Alejano, 55 Phil. 811 [1931].);
(4) buildings, machinery and accessories belonging to the mort-
gage debtor installed on a mortgaged sugar central (Cu Unjieng
& Hijos vs. Mabalacat Sugar Co., 58 Phil. 439 [1933].);
(5) all objects permanently attached to a mortgaged land or
building, although they may have been placed there after the
execution of the mortgage are also included (Cea vs. Villanueva,
18 Phil. 538 [1911].); and
(6) a more costly building erected in place of the mortgaged
building which was torn down by the debtor. (Phil. Sugar Estates
Dev. Co. vs. Campos, 36 Phil. 85 [1917].)

After-Acquired Properties

Stipulation to include after-acquired properties is valid.

This kind of stipulation is common and indeed, logical, in all cases
where the properties given as collateral are perishable or subject to
inevitable wear and tear or were intended to be sold or to be used but
with the understanding, express or implied, that they shall be replaced
with others to be thereafter acquired by the mortgagor. Such stipula-
tion is neither unlawful nor immoral, its obvious purpose being to
maintain, to the extent allowed by the circumstances, the original val-
ue of the properties given as security. (Mendoza vs. Court of Appeals,
G.R. No. 116710, June 25, 2001.)

Attachment of lien retroactive

When a mortgage is made to include new or future improvements on

registered land, said lien attaches and vests not at the time said im-
provements are constructed but on the date of the recording and
registration of the deed of mortgage. (Luzon Lumber & Hardware
Co., Inc. vs. Quiambao, 94 Phil. 663 [1954].)

Right to alienate mortgage credit

The mortgage credit may be alienated or assigned to a third person, in

whole or in part, with the formalities required by law. (Art. 2128)

Indeed, a mortgage credit is a real right, thus, the formality required

by law for its transfer or assignment, i.e., it must be in a public in-
strument and must be registered and should be complied with in order
to bind third person. (Sps. Litonjua v. L& R Corp. (G.R. No. 130722,
Dec. 9, 1999)

Article 1625 of the Civil Code provides that [a]n assignment of a cred-
it, right or action shall produce no effect as against third person, un-
less it appears in a public instrument, or the instrument is recorded in
the Registry of Property in case the assignment involves real property.

Right To Alienate Collateral

A stipulation forbidding the owner from alienating the immovable

mortgaged shall be void. (Art. 2130)

Insofar as the validity of the questioned stipulation prohibiting the

mortgagor from selling his mortgaged property without the consent of
the mortgagee is concerned, therefore, the ruling in the
Tambunting case is still the controlling law. Indeed, we are fully in ac-
cord with the pronouncement therein that such a stipulation
violates Article 2130 of the New Civil Code. (Sps. Litonjua v. L& R
Corp. (G.R. No. 130722, Dec. 9, 1999)

Remedies Available To Mortgagee Upon Default Of The Mort-

gagor

Foreclosure is the remedy available to the mortgagee by which he sub-

jects the mortgaged property to the satisfaction of the obligation to
secure which the mortgage was given. (59 C.J.S. 482.)

Kinds Of Foreclosure

(1) Judicial (Rule 68)

(2) Extrajudicial (Act No. 3135 and SC Circ. No. A.M. No. 99-10-05-
0)

These two (2) types of foreclosure sale are to be distinguished from an

ordinary execution sale which is governed by the pertinent provisions
of Rule 39 of the Rules of Court on “Execution, Satisfaction and Effect
of Judgments.’’

Each of these three (3) common types of forced sales arising from a
failure to pay a mortgage debt, peculiarly has its own requirements.
The parties are not precluded from imposing additional requirements.
(Concepcion vs. Court of Appeals, 274 SCRA 614 [1997].)

Judicial Foreclosure Under The Rules Of Court

(a) Quasi in rem. Based on personal claim sough to be enforced

against a specific property of a person named party defendant.
Notice should be given to the mortgagor because he or she is
supposed to be impleaded as a defendant in a case.

(b) No right of redemption. What is available is Equity of Redemp-

tion (exercised before the foreclosure sale. Right of redemption
means prerogative to re-acquire mortgaged property after regis-
tration of the foreclosure sale – exists only in extrajudicial fore-
closure of mortgage.

(c) Possession. Mortgagor is entitled to possession before the finali-

ty of the Court’s order of confirmation or before the expiration of
the redemption period for banks. The purchaser shall be entitled
to such possession after the finality of the order of confirmation.

(d) Deficiency judgment. Court, upon motion, shall render judgment

against the defendant for any such balance.

(e) Excess. The residue after satisfying the obligation and cost shall
be given to the mortgagor.

(f) Registration. Not required since no right of redemption except

mortgages with banks. Registration of the sale is required only
in extrajudicial foreclosure sale because the date of the registra-
tion is the reckoning point for the exercise of the right of re-
demption.
 Steps

1 File an action. Venue – where property or portion thereof

is located

2 Court to order mortgagor to pay w/in period of not less

than 90 days nor more than 120 days from entry of
judgment

3 Upon motion, court shall order property sold at public

auction

4 Confirmation sale – court to confirm sale, upon motion

5 Execution of judgment (Proper remedy is to file appeal

and not to annul sale)

6 Apply proceeds of the sale

7 Sheriff’s certificate

(1) Judicial action for the purpose. — A mortgage may be foreclosed

judicially by bringing an action for that purpose, in the proper court
which has jurisdiction over the area wherein the real property involved
or a portion thereof, is situated. (see Sec. 1, Rule 4, Rules of Court.)

(2) Order to mortgagor to pay mortgage debt. — If the court finds the
complaint to be well-founded, it shall order the mortgagor to pay the
amount due upon the mortgage debt or obligation with interest and
other charges within a period of not less than 90 days nor more than
120 days from the entry of judgment. (Sec. 2, Rule 68, Ibid.)

(3) Sale to highest bidder at public auction. — If the mortgagor fails to

pay at the time directed in the order, the court, upon motion, shall or-
der the property to be sold to the highest bidder at public auction.
(Sec. 3, Ibid.)

(4) Confirmation of sale. — The sale when confirmed by an order of

the court, also upon motion, shall operate to divest the rights of all
parties to the action and to vest their rights in the purchaser subject to
such right of redemption as may be allowed by law. (Ibid.)
Before the confirmation of a judicial foreclosure sale, the court retains
control of the proceedings by exercising a sound discretion in regard to
it, either granting or withholding confirmation as the rights and inter-
ests of the parties and the ends of justice may require. From this
standpoint, any order which neither sets aside nor confirms the fore-
closure is merely interlocutory in character. (Salazar vs. De Torres, 108
Phil. 209 [1960].)
(5) Execution of judgment. — No judgment rendered in an action for
foreclosure or mortgage can be executed otherwise than in the manner
prescribed by the law on mortgages, because parties to an action are
not authorized to change the procedure which it prescribed. (Piano vs.
Cayanong, 7 SCRA 397 [1963].)
It has been held that the proper remedy to seek reversal of a judg-
ment in an action for foreclosure of real estate mortgage is not a peti-
tion for annulment of judgment but an appeal from the judgment itself
or from the order confirming the sale of the foreclosed real estate. Af-
ter failing to avail of appeal without sufficient justification, the mort-
gagor cannot conveniently resort to the action for annulment for oth-
erwise he would benefit from his own inaction and negligence. (Agbada
vs. Inter-Urban Developers, Inc., 389 SCRA 430 [2002].)

(6) Application of proceeds of sale. — The proceeds of the sale shall be

applied to the payment of the:
(a) costs of the sale;
(b) the amount due the mortgagee;
(c) claims of junior encumbrancers or persons holding subsequent
mortgages in the order of their priority; and
(d) the balance if any, shall be paid to the mortgagor or his duly au-
thorized agent, or to the person entitled to it. (Sec. 4, Rule 68, Rules
of Court.) If the mortgagee is retaining more of the proceeds of the
sale than he is entitled to, this fact alone will not affect the validity of
the foreclosure sale but simply gives the mortgagor a cause of action
to recover such surplus. The mortgagee who has been ordered by the
court to return the surplus, but fails to do so, may be cited for con-
tempt. (Sulit vs. Court of Appeals, 268 SCRA 441 [1997].)

(7) Execution of sheriff’s certificate. — In judicial foreclosures, the

“foreclosure” is not complete until the sheriff’s certificate is executed,
acknowledged and recorded. In the absence of a Certificate of Sale, no
title passes by the foreclosure proceedings to the vendee. It is only
when the foreclosure proceedings are completed and the mortgaged
property sold to the purchaser that all interests of the mortgagor are
cut off from the property. Therefore, the mortgagor is liable for addi-
tional interests properly chargeable on the balance of the mortgage
indebtedness during the period from the notice of sale to actual sale.
This principle is applicable to extrajudicial foreclosures. (Development
Bank of the Phils. vs. Zaragoza, 84 SCRA 668 [1978].)
A sheriff’s report on the auction sale is clothed with the presumption of
regularity especially where no objection has been raised against it.
(Sayson vs. Luna, 433 SCRA 502 [2004].)

Extrajudicial Foreclosure Under Act No. 3135

Requisites:

(1) Failure to pay the obligation

(2) Loan secured by REM
(3) Mortgagee has express authority in the REM authorizing extra-
judicial sale.

Note: Authority not extinguished by death of mortgagor or mortgagee.

—The authority to sell is not extinguished by the death of the mort-
gagor (or mortgagee) as it is an essential and inseparable part of a bi-
lateral agreement. (Perez vs. Phil. National Bank, 17 SCRA 833
[1966].)

Procedure

(1) File petition with Executive Judge, through the Clerk of Court,
who is also the Ex-Officio Sheriff of the city or province where
property is locate.

(2) Posting requirement of notice of sale in 3 public places

(3) Publication requirement of notice of auction sale

Purpose. Publication is required to give the foreclosure sale a

reasonably wide publicity such that those interested might at-
tend the public sale. (Ouano vs. Court of Appeals, 398 SCRA
525 [2003].)

Jurisdictional defect. Failure to comply with the statutory re-

quirements as to publication of notice of auction sale constitutes
a jurisdictional defect which invalidates the sale or at least ren-
der the sale voidable. Even slight deviations therefrom are not
allowed. (Lucena vs. Court of Appeals, 313 SCRA 47 [1999].)

Void sale. A sale held after the scheduled date indicated in the
notice of sale is void. (Development Bank of the Phils. vs.
Aguirre, 364 SCRA 755 [2001])

Sufficiency of newspaper publication. The phrase “such notice

shall be published once a week for at least three consecutive
weeks’’ does not mean notice should be published for three full
weeks. Thus, it was held that the publication of notice on June
30, July 7, and July 14, 1968 satisfied the publication require-
ment notwithstanding the fact that June 31 to July 14 is only 14
days.

Prima facie evidence. The affidavit of publication, executed by

the publisher, business/advertising manager of a newspaper that
it is “a newspaper of general circulation in Rizal and that the No-
tice of Sheriff’s sale was published in said paper on June 30, July
7 and July 14, 1983’’ constitutes prima facie evidence of compli-
ance with the requisite publication.

Newspaper of general circulation. It is enough that “it is pub-

 lished for the dissemination of local news and general informa-
tion; that it has a bona fide subscription list of paying sub-
scribers; that it is published at regular intervals.’’ It need not
have the largest circulation as long as it is of general circulation.
(Bonnevie vs. Court of Appeals, 125 SCRA 122 [1983].)

Need for republication in case of postponement. Republication

in the manner prescribed by Act No. 3135 is necessary for the
validity of a postponed extrajudicial foreclosure sale. (Develop-
ment Bank of the Philippines vs. Court of Appeals)

Personal notice to the mortgagor when and when not needed.

Section 3 of Act No. 3135 (Appendix 2.) which contains the re-
quirement on notice in extrajudicial foreclosure sales, does not
require personal notice or any particular notice on the mort-
gagor (Government Service and Insurance System vs. Court of
Appeals, 170 SCRA 533 [1989]) where there is no contractual
stipulation therefor. (Phil. National Bank vs. International Corpo-
rate Bank, 199 SCRA 508 [1991])

Hence, unless required in the mortgage contract, the lack of

personal notice to the mortgagor is not a ground to set aside a
foreclosure sale. Such notice is not necessary as publication of
notice in a newspaper is more than sufficient compliance.

Loans not exceeding P100,000.00. For real estate mortgages

covering loans not exceeding P100,000.00, exclusive of interests
due and unpaid, granted by rural banks (RA No. 7353, Sec. 6)
or thrift banks (RA No. 7906, Sec. 18), publication in a newspa-
per shall be dispensed with, it being sufficient that the notices of
foreclosure are posted for a period of sixty (60) days immedi-
ately preceding the public auction in the most conspicuous areas
of the municipal building, the municipal public market, the rural
bank, the barangay hall, and the barangay public market, if any,
where the land mortgaged is situated. Proof of publication shall
be accomplished by an affidavit of the Sheriff and shall be at-
tached to the records of the case.

Possession by purchaser of foreclosed property

Purchaser may petition the Court to give him possession thereof during
the redemption period, furnishing bond in an amount equivalent to the
use of the property for a period of twelve months, to indemnify the
debtor in case it be shown that the sale was made without violating
the mortgage or without complying with the requirements of this Act.

Right of mortgagee to recover deficiency

Mortgage merely a security, not a satisfaction of an obligation

 If there be a balance due to the mortgagee after applying the proceeds
of the sale, the mortgagee is entitled to recover the deficiency. (Devel-
opment Bank of the Phils. vs. Mirang, 66 SCRA 141 [1975].)

In judicial foreclosure, the Rules of Court specifically gives the mort-

gagee the right to claim for deficiency in case deficiency exists (Sec. 6,
Rule 68.) while Act No. 3135 governing extrajudicial foreclosures of
mortgage does not give a mortgagee the right to recover deficiency
after the public auction sale, neither does it expressly or impliedly pro-
hibit such recovery. To recover deficiency, the extra-judicial foreclo-
sure must be valid. (Development Bank of the Philippines vs. Licuanan,
516 SCRA 644 [2007].)

Where a third person is the mortgagor, he is not liable for any deficien-
cy in the absence of a contrary stipulation. The action for the recovery
of such deficiency must be directed against the debtor.

Prescriptive period of action. The action to recover a deficiency after

foreclosure prescribes after ten (10) years from the time the right of
action accrues as provided in Article 1144(2) of the Civil Code.

3. Guaranty

Definition

By guaranty a person, called the guarantor, binds himself to the credi-

tor to fulfill the obligation of the principal debtor in case the latter
should fail to do so.

If a person binds himself solidarily with the principal debtor, xxx the
contract is called a suretyship. (Art. 2047)

Principal debtor becomes liable to indemnify the guarantor (Art. 2066.)

but this is merely an incident of the contract

May be entered into even without the intervention of the principal

debtor (Art. 2050.).

Guarantor must be a distinct person from debtor. Person cannot be

both the primary debtor and the guarantor of his own debt as this is
inconsistent with the very purpose of a guarantee.

Characteristics

1) Accessory

(2) Subsidiary and conditional

takes effect only when the principal debtor fails in his obligation
 subject to limitation (see Arts. 2053, 2058, 2063, 2065.);

(3) It is unilateral—

Not a Formal Contract. A contract of guaranty is not a formal contract

and shall be valid in whatever form it may be, provided that it com-
plies with the statute of frauds. (Macondray v. Perfecto Pinon, et al)

Guaranty covered by the Statute of Frauds. Must also be reduced to

writing. It is “a special promise to answer for the debt, default or mis-
carriage of another.”

Kinds

A guaranty may be conventional, legal or judicial, gratuitous, or by

onerous title. (Sec. 2015)

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 with-
out his knowledge, or even over his objection.

As to its origin:

(a) Conventional. constituted by agreement of the parties (Art. 2051,

par. 1.);

(b) Legal. imposed by virtue of a provision of law; or

(c) Judicial. required by a court to guarantee the eventual right of one

of the parties in a case.

As to consideration:

(a) Gratuitous. guarantor does not receive any price or remuneration

for acting as such (Art. 2048.); or

(b) Onerous. guarantor receives valuable consideration for his guaran-

ty. (Ibid.)

As to the person guaranteed:

(a) Single. secure performance by the debtor of the principal obligation

(Art. 2051, par. 2.); or

(b) Double or sub-guaranty. secure the fulfillment by the guarantor of

a prior guaranty. (Ibid.)

Guaranty in the broad sense:

(a) Personal. This refers to guaranty properly so-called or guaranty in

the strict sense. (Art. 2047.) Here, the guarantee is the credit given by
the person who guarantees the fulfillment of the principal obligation;
or

(b) Real. Here, the guaranty is property, movable or immovable.

Note: Guaranty may also be continuing or not. (see Art. 2053.)

As to its scope and extent (Art. 2055):

(a) Definite. — guaranty is limited to the principal obligation only, or

to a specific portion thereof (Art. 2055, par. 2.); or

(b) Indefinite or simple. — One where the guaranty includes not only
the principal obligation but also all its accessories (e.g., interests) in-
cluding judicial costs. (Ibid.)

Guaranty cannot be presumed

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, pro-
vided with respect to the latter, that the guarantor shall only be liable
for those costs incurred after he has been judicially required to pay.
(Art. 2055)

Obligation secured by guaranty

A guaranty cannot exist without a valid obligation.

Nevertheless, a guaranty may be constituted to guarantee the perfor-

mance of a voidable or an unenforceable contract. It may also guaran-
tee a natural obligation. (Art. 2052)

Reason for voidable contract. contract is binding, unless it is annulled.

Reason for unenforceable contract. because such contract is not void.

Reason for natural obligation. the creditor may proceed against the
guarantor although he has no right of action against the principal
debtor for the reason that the latter’s obligation is not civilly enforce-
able. (Art. 1423.9) When the debtor himself offers a guaranty for his
natural obligation, he impliedly recognizes his liability, thereby trans-
forming the obligation from natural into a civil one.

Guaranty of future debts

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 se-
cured. (Art. 2053)

Continuing Guaranty Or Suretyship.

It is one which is not limited to a single transaction but which contem-

plates a future course of dealings, covering a series of transactions
generally for an indefinite time or until revoked.

Guarantor’s liability cannot exceed principal obligation.

A guarantor may bind himself for less, but not for more than the prin-
cipal 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. (ART. 2054)

REASON: Guaranty is a subsidiary and accessory contract

Extent of Guarantor’s Liability

(1) Where guaranty definite. The obligation of the guarantor under the
terms of the contract is limited in whole or in part to the principal debt,
to the exclusion of the accessories.

(2) Where guaranty indefinite or simple. As provided in Article 2055

(par. 2.), “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 in-
curred after he has been judicially required to pay.”

Reason: the guarantor, in entering into the contract, could have fixed
the limits of his responsibility solely to the strict terms of the principal
obligation and if he did not do so, it must be presumed that he wanted
to be bound to the extent so established.

Benefit of Excussion

The guarantor cannot be compelled to pay the creditor unless the lat-
ter has exhausted all the property of the debtor, and has resorted to all
the legal remedies against the debtor.

If the principal debtor fulfills the obligation guaranteed, the guarantor

is discharged from any responsibility. (Art. 2058)

The law requires the creditor to resort “to all legal remedies against
the debtor” including the bringing of actions for the rescission of
fraudulent alienations of property made by the debtor. This is what is
otherwise known as the “benefit of excussion.’’
All Legal Remedies Against Debtor To Be First Exhausted

To warrant recourse against the guarantor for payment, it may not be

a sufficient reason that the debtor appears insolvent.

Reason: Such insolvency may be simulated.

Exceptions to the Benefit of Excussion

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 Philip-
pines unless he has left a manager or representative;
(5) If it may be PRESUMED that an execution on the property of the
principal debtor would not result in the satisfaction of the obligation.
(Art. 2059)

How to Avail the Benefit of Excussion

In order that the guarantor may make use of the benefit of excussion,
he must:
(1) Set it up against the creditor upon the latter’s demand for payment
from him, and
(2) Point out to the creditor available property of the debtor within
Philippine territory, sufficient to cover the amount of the debt. (ART.
2060)

Effect of Negligence of Creditor

The guarantor having fulfilled all the conditions required in the preced-
ing 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. 2061)

Notice to Guarantor

In every action by the creditor, which must be against the principal

debtor alone, except in the cases mentioned in Article 2059, the for-
mer shall ask the court to notify the guarantor of the action. The guar-
antor 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 Arti-
cle 2058 shall always be unimpaired, even if judgment should be ren-
dered against the principal debtor and the guarantor in case of ap-
pearance by the latter. (Art. 2062)

Effect of Compromise
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. 2063)

Where prejudicial. cannot prejudice the guarantor or the debtor, as the

case may be, when he is not a party to such compromise.

Where beneficial. even if the guarantor or debtor is not a party to such

compromise, the same can benefit him as it is in the nature of a stipu-
lation in favor of a third person which the guarantor or debtor may ac-
cept unless it has been revoked before his acceptance. (Art. 1311, par.
2.)

Sub-Guarantor’s Right To Excussion

The guarantor of a guarantor shall enjoy the benefit of excussion, both

with respect to the guarantor and to the principal debtor. (Art. 2064)

Benefit Of Division Among Several Guarantors

Should there be several guarantors of only one debtor and for the
same debt, the obligation to answer for the same is divided among all.
The creditor cannot claim from the guarantors except the shares which
they are respectively bound to pay, unless solidarity has been express-
ly stipulated. (Art. 2065)

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.

It is not required that he point out the property of his co-guarantors.

Reason: obligation of the guarantor with respect to his co-guarantors

is NOT SOLIDARY, but direct and does not depend as to its origin on
the solvency or insolvency of the latter, although afterwards, if one of
them should turn out to be insolvent, his share has to be borne by the
others. (Art. 2073, par. 2.)

Right to Indemnification

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

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 credi-
tor;
(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.

Guarantor’s Right to Subrogation

The guarantor who pays is subrogated by virtue thereof to all the

rights which the creditor had against the debtor. (Art. 2067)

Subrogation arises by operation of law upon payment by the guaran-

tor. It is not necessary that the creditor cede to the guarantor the
former’s rights against the debtor. (Perez vs. Barcia, 52 Phil. 197
[1928])

It is thus not a contractual right. The guarantor is subrogated, by

virtue of the payment, to the rights of the creditor, not those of the
debtor. (Art. 2067, par. 2.)

When right not available. Where the guarantor has no right to be re-
imbursed.

Payment By Guarantor Without Notice To Debtor

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. (Art. 2068)

Repeat Payment By Debtor

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 a gratuitous guaranty, if the guarantor was
prevented by a fortuitous event from advising the debtor of the pay-
ment, and the creditor becomes insolvent, the debtor shall reimburse
the guarantor for the amount paid. (Art. 2070)

General rule. If he fails to give such notice of payment to the debtor

and the debtor repeats the payment, the guarantor’s only remedy is to
collect from the creditor, but he has no cause of action against the
debtor for the return of the amount paid by him (guarantor) even if
the creditor should become insolvent. Being at fault for not advising
the debtor, the guarantor must bear the loss.

Exception. Guarantor may still claim reimbursement from the debtor in

spite of lack of notice if the following conditions are present:
(a) the creditor becomes insolvent;
(b) the guarantor was prevented by fortuitous event to advise the
debtor of the payment; and
(c) the guaranty is gratuitous.
Right Of Guarantor To Proceed Against Debtor BEFORE Pay-
ment

The guarantor, even before having paid, may proceed against the prin-
cipal 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 guar-
anty within a specified period, and this period has expired;
(4) When the debt has become demandable, by reason of the expira-
tion of the period for payment;
(5) After the lapse of ten years, when the principal obligation has no
fixed period for its maturity, unless it be of such nature that it cannot
be extinguished except within a period longer than ten years;
(6) If there 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. (Art. 2071)

General rule. Guarantor has no cause of action against the debtor un-
til after the former has paid the obligation.

Exceptions. Article 2071

Remedy To Which Guarantor Entitled

1. To obtain release from the guaranty or

2. To demand a security that shall protect him from any proceedings

by the creditor, and against the danger of insolvency of the debtor.

The guarantor’s remedies are alternative. He has the right to choose

the action to bring.

Extinguishment of guaranty

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.
(Art. 2076)

Guaranty is also terminated when the principal obligation is extin-

guished.

The causes of extinguishment of obligations, in general

(a) payment or performance;

(b) loss of the thing due;
(c) condonation or remission of the debt;
(d) confusion or merger of the rights of the creditor and debtor;
(e) compensation; and
(f) novation.

Other causes of extinguishment:

1. annulment
2. rescission
3. fulfillment of a resolutory condition,
4. and prescription. (Art. 1231.)

Death of the principal is NOT a defense a surety can use to wipe out
its monetary obligation under a performance bond.

REASON: The obligation is merely passed on to the decedent’s estate.

A surety’s liability to the creditor or promisee of the principal is direct

and primary like the principal. (Stronghold Insurance Company, Inc.
vs. Republic Asahi Glass Corporation, 492 SCRA 179 [2006].)
The guaranty itself may be directly extinguished although the principal
obligation still remains such as in the case of the release of the guar-
antor made by the creditor. (see Art. 2078.)

Material Alteration Of Principal Contract

It is fundamental in the law of suretyship that 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. (Security Bank and Trust Co., Inc. vs. Cuenca,
341 SCRA 781 [2000].)

When Alteration Material

There must be change which imposes new obligation or added burden

on the party promising or which takes away some obligation already
imposed, changing the legal effect of the original contract and not
merely the form thereof. (NASSCO vs. Torrento, 20 SCRA 427 [1967].)

Examples:

(a) Novation where the credit of P40,000.00 is increased by an

additional P30,000.00 (National Bank vs. Veraguth, 50 Phil.
253 [1927].)
(b) Principal debtor is substituted (Barretto y Cia vs. Albo, 62
Phil. 593 [1935].)
(c) Where the agency to sell granted to the debtor is extended
to places other than that covered by the contract of agency
(Asiatic Petroleum vs. Hizon, 45 Phil. 532 [1923]
Interest rates. It has been held, however, that the increase in the in-
terest rates without the guarantor’s consent does not release the guar-
antor where the creditor is demanding only the original and not the in-
creased rate of interest. (National Bank vs. Escueta, 50 Phil. 991
[1927].)

Release By Conveyance Of Property

If the creditor voluntarily accepts immovable or other property in pay-

ment of the debt, even if he should afterwards lose the same through
eviction, the guarantor is released. (Art. 2077)

Release Of Guarantor Without Consent Of Others

A release made by the creditor in favor of one of the guarantors, with-

out the consent of the others, benefits all to the extent of the share of
the guarantor to whom it has been granted. (Art. 2078)

Release By Extension Of Term Granted By Creditor To Debtor

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. 2079)

Where Release Without Consent Of Guarantor

If the creditor grants an extension of time to the debtor without the

consent of the guarantor (or surety), the latter is discharged from his
undertaking.
The reason for the rule is the necessity of avoiding prejudice to the
guarantor.

Legal and judicial bonds

The bondsman who is to be offered in virtue of a provision of law or of

a judicial order shall have the qualifications prescribed in Article 2056
and in special laws. (Art. 2082)

Meaning And Form Of Bond

A bond, when required by law, is commonly understood to mean an

undertaking that is sufficiently secured, and not cash or currency. Of
course, whatever surety bonds are submitted are subject to any objec-
tions as to their sufficiency or as to the solvency of the bondsman.
(Comm. of Customs vs. Alikpala, 36 SCRA 208 [1970].)

Qualifications Of Personal Bondsman.

 A bondsman is a surety (Art. 2047, par. 2.) offered in virtue of a provi-
sion of law or a judicial order. He must have the qualifications required
of a guarantor (Art. 2056.) and in special laws like the Rules of Court
(Secs. 12, 13, Rule 114, Rules of Court.1);

Nature Of Bonds

All bonds including “judicial bonds” are contractual in nature. Bonds

exist only in consequence of a meeting of minds under the conditions
essential to a contract. (see Art. 1305.)

Pledge Or Mortgage In Lieu Of Bond

If the person bound to give a bond in the cases of the preceding arti-
cle, should not be able to do so, a pledge or mortgage considered suf-
ficient to cover his obligation shall be admitted in lieu thereof. (Art.
2083)

Bondsman Not Entitled To Excussion

ART. 2084. A judicial bondsman cannot demand the exhaustion of the

property of the principal debtor. (Art. 2084)

A sub-surety in the same case, cannot demand the exhaustion of the

property of the debtor or of the surety.

A judicial bondsman and the sub-surety are not entitled to the benefit
of excussion because they are not mere guarantors, but sureties
whose liability is primary and solidary. (see Almarza vs. Salas, 47 Phil.
724 [1925].)

Effect Of Negligence Of Creditor

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

4. Surety

a. Concept

If a person binds himself solidarily with the principal debtor, the provi-
sions of Section 4, Chapter 3, Title I of this Book shall be observed. In
such case the contract is called a SURETYSHIP.

A surety is one who directly, equally, and absolutely binds himself/her-

self with the principal debtor for the payment of the debt. (Sps. Ong v.
PCIB, 489 Phil. 673 (2005)


Nature of surety’s undertaking.

(1) Direct, Immediate, Primary and Absolute. (DIPA)

(2) Liability is limited by terms of contract (contractual). cannot be

extended by implication beyond the terms of the contract.

(3) Liability arises only if principal debtor is held liable. made princi-
pally for the benefit of the creditor-obligee and this is ensured
by the solidary nature of the surety undertaking. (Intra Strata
Assurance Corp. vs. Republic, supra.)

(4) Surety is not entitled to exhaustion. — Art. 2059[2]. Surety as-

sumes a solidary liability for the fulfillment of the principal oblig-
ation.

(5) Undertaking is to creditor, not to debtor. Principal cannot claim

that there has been a breach of the surety’s obligation when
surety fails or refuses to pay the debt for the principal’s account.
Such failure or refusal does not have the effect of relieving the
principal of his obligation to pay.

(6) Surety is not entitled to notice of principal’s default.

(7) Prior demand by the creditor upon principal not required. Com-
mencement of the suit is a sufficient demand. A creditor’s right
to proceed against the surety alone exists independently of his
right to proceed against the principal where both principal and
surety are equally bound.

(8) Surety is not exonerated by neglect of creditor to sue principal.

Surety Differed From Guaranty

Surety Guaranty

What is insured the debt solvency of debtor

Undertaking the debt shall be paid the debtor shall pay

Obligation pay if principal does not pay if principal failed to

without regard to his pay after due diligence
ability to pay of the creditor
 Surety distinguished from joint and solidary obligations

Surety Solidary

Parties (1) obligor (2) obligee (1) obligor (2) co-

(3) surety obligor (3) obligee

Contract ancillary principal

Reimbursement total amount of debt proportional share of

other co-obligors

5. Letters of credit

Definition and purpose

A financial device developed by merchants as a convenient and rela-

tively safe mode of dealing with sales of goods.

Purpose: to satisfy irreconcilable interests of the seller and the buyer

Absolute undertakings to pay the money advanced or the amount for

which credit is given on the faith of the instrument. They are primary
obligations and not accessory contracts and while they are security
arrangements, they are not converted thereby into contracts of guar-
anty. What distinguishes letters of credit from other accessory con-
tracts, is the engagement of the issuing bank to pay the seller once
the draft and other required shipping documents are presented to it.
They are definite undertakings to pay at sight once the documents
stipulated therein are presented. (MWSS v. Daway)

Governing law

Uniform customs and Practice for Documentary Credits (UCP) issued

by the International Chamber of Commerce.

To the extent that they are pertinent, the application in our jurisdiction
of the international credit regulatory set of rules known as the UCP,
which we said in Bank of the Philippine Islands v. Nery was justified
under Art. 2 of the Code of Commerce, which states: “Acts of
commerce, whether those who execute them be merchants or not, and
whether specified in this Code or not should be governed by the provi-
sions contained in it; in their absence, by the usages of commerce
generally observed in each place; and in the absence of both rules, by
those of the civil law.” (Feati Bank and Trust Company v. Court of Ap-
peals and Bank of America NT & SA v. Court of Appeals)

Parties to a Letter of Credit

Parties to a commercial letter of credit include:

(1) Buyer (importer) – one who procures the letter of credit and
obliges himself to reimburse the issuing bank upon receipt of docu-
ments of title. 


(2) Seller (beneficiary) – one who ships the goods to the buyer in
compliance with a contract of sale and delivers the documents of title
and draft to the issuing bank to recover payment.

(3) Issuing Bank (or Opening bank) – the bank which undertakes: (a)
to pay the seller upon receipt of the draft and proper documents of ti-
tle; and (b) to surrender the documents to the buyer upon reimburse-
ment.

Other parties:

(1)Advising/Notifying Bank – the bank which conveys to the seller the

existence of the credit.

Liability - No liability except to notify and/or transmit to the seller

the existence of the letter of credit.

Reason: Notifying bank is not a privy to the contract of sale be-

tween the buyer and the seller. Its relationship is only with that of
the issuing bank and not with the beneficiary to whom he assumes
no liability.

Note - The bank may suggest to the seller its willingness to negoti-
ate, but this fact alone does not imply that the notifying bank
promises to accept the draft drawn under the documentary credit
[Feati Bank and Trust Co. (1991)]

(2)Confirming Bank – the bank which lends credence to the letter of

credit issued by a lesser known issuing bank.
Liability - The bank assumes a direct obligation to the seller and its
liability is a primary one as if the bank itself had issued the letter of
credit [Feati Bank]

(3)Negotiating Bank – the bank which discounts the draft presented by

the seller. 


Liability - Its liability is dependent upon the stage of the negotia-

tion. If BEFORE negotiation, it has no liability with respect to the
seller but AFTER negotiation, a contractual relationship will then
 prevail between the negotiating bank and the seller [Feati Bank]

(4)Paying Bank – the bank which undertakes to encash the drafts

drawn by the seller.

Kinds of letters of credit

COMMERCIAL LC vs. STANDBY LC (or DEMAND GUARANTY)

COMMERCIAL LC STANDBY LC

Transaction se- Sale Non-sale (e.g. con-

cured struction)

Purpose Reduce risk of non- Reduce risk of non-per-

payment formance

Payment Upon presentation of Upon certification of

documents (draft) non-performance

Beneficiary Must strictly comply Must certify that oblig-

with the requirements or has not performed
the contract

Rule of strict compliance

The settled rule in commercial transactions involving letters of credit

requires that the documents tendered by the seller must strictly con-
form to the terms of the letter of credit.
Otherwise, the issuing bank or the concerned correspondent bank is
not obliged to perform its undertaking under the contract.

Independence principle

Banks assume no liability or responsibility for the form, sufficiency, ac-

curacy, genuineness, falsification or legal effect of any documents, or
for the general and/or particular conditions stipulated in the docu-
ments or superimposed thereon, nor do they assume any liability or
responsibility for the description, quantity, weight, quality, condition,
packing, delivery, value or existence of the goods represented by any
documents, or for the good faith or acts and/or omissions, solvency,
performance or standing of the consignor, the carriers, or the insurers
of the goods, or any other person whomsoever [Transfield Philippines
v. Luzon Hydro, G.R. No. 146717 (2004]
Fraud Exception Principle

The principle that limits the application of the independence principle

only to instances where it would serve the commercial function of the
credit and not when fraud attends the transaction.

The untruthfulness of a certificate accompanying a demand for pay-

ment under a standby credit may qualify as fraud sufficient to support
an injunction against payment. The remedy of injunction is available
when the following are present:

(1) Clear proof of fraud; 


(2) Fraudulent abuse of the independent purpose of the letter of credit

and only fraud under the main agreement and 


(3) Irreparable injury might follow if injunction is not granted or the

recovery of damages would be seriously damaged