Catindig_Revised 2007_NOSCL Supplement 2008

7/27/2019 Catindig_Revised 2007_NOSCL Supplement 2008

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2007 Supplement to the Notes on Selected Commercial Lawsby Atty. Tristan A. Catindig June 12, 2007 All rights reserved.

CHAPTER I: BANGKO SENTRAL NG PILIPINAS LAW

SUPPLEMENTTO PARAGRAPH 1.17 (A), PP. 12-13

On account of the issuance by the BSP of new coins in higher denominations after the affectivity

of the BSP Law in 1993, the BSP, pursuant to Section 52 of the BSP Law and Monetary Board

Resolution No. 862, dated July 6, 2006, issued Circular No. 537, dated July 18, 2006, which

adjusted the maximum amount of coins to be considered as legal tender as follows:

1. One Thousand Pesos (P1,000) for denominations of 1-Piso, 5-Piso and 10-Piso coins;

and

2. One Hundred Pesos (P100) for denominations of 1-sentimo, 5-sentimo, 10-sentimo,

and 25-sentimo coins.

CHAPTER II: GENERAL BANKING LAW OF 2000

SUPPLEMENTTO PARAGRAPH 2.31, PP. 32-33

Under BSP Circular No. 488, dated June 21, 2005, and BSP Circular No. 493, dated September 16,

2005, the BSP added the following functions, services or activities that banks could outsource

subject to prior approval of the Monetary Board:

1. Internal audit (subject to a number of conditions);

2. Marketing loans, deposits and other bank products and services, provided it does not

involve the actual opening of deposit accounts;

3. General bookkeeping and accounting services, provided that these activities do not

include servicing bank deposits or other inherent banking functions;

4. Offsite record storage services;

5. Back-up and data recovery operations.

Without need of prior Monetary Board approval, banks may outsource the following functions,

services or activities:

1. Printing of bank loan statements and other non-deposit records, bank forms and

promotional materials;

2. Transfer agent services for debt and equity securities;

3. Messenger, courier and postal services;

4. Security guard services;

5. Vehicle service contracts;

6. Janitorial services;

7. Public relations services, procurement services, and temporary staffing, provided that

these activities do not include servicing bank deposits or other inherent banking functions;

8. Sorting and bagging of notes and coins;

9. Maintenance of computer hardware;

10. Payroll of banking employees;

11. Telephone operator/receptionist services;

12. Sales/disposal of acquired assets;

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13. Personnel training and development;

14. Building, ground and other facilities maintenance;

15. legal services from local legal counsel; and

16. compliance risk assessment and testing.

ADDITIONAL SUPREME COURT CASE

Banks are required to assume a degree of diligence higher than that of a good father of a family

(Philippine Banking Corporation vs. CA, G.R. No. 127469, January 15, 2004)

The Court held that Section 2 of the General Banking Law of 2000 expressly imposes a fiduciary

duty on banks when it declares that the State recognizes the fiduciary nature of banking that

requires high standards of integrity and performance. For this reason, the fiduciary nature of

banking requires a bank to assume a degree of diligence higher than that of a good father of a

family. Thus, the Court ruled:

The BANK is liable to Marcos for offsetting his time deposits with a fictitious

promissory note. The existence of Promissory Note No. 20-979-83 could have

been easily proven had the BANK presented the original copies of the promissory

note and its supporting evidence. In lieu of the original copies, the BANK

presented the machine copies of the duplicate of the documents. These

substitute documents have no evidentiary value. The Banks failure to explain the

absence of the original documents and to maintain a record of the offsetting of this

loan with the time deposits bring to fore the Banks dismal failure to fulfill its

fiduciary duty to Marcos.

CHAPTER IV: PHILIPPINE DEPOSIT INSURANCE CORPORATION

REVISED CHAPTER IV, PP. 53-56

4.1 What is the purpose of the law? (Sec. 1)

The purpose of the law is to create a government-owned and controlled entity, the Philippine

Deposit Insurance Corporation, which shall insure the deposit liabilities of all banks entitled to the

benefits of insurance under the Act. Such insurance is intended to protect depositors from

situations that prevent banks from paying out deposits, as in bank failures or closures, and to

encourage people to deposit in banks.

4.2 What are the main functions of the PDIC?

(a) Insurance of banks (Sec. 5, et seq.) The PDIC insures the deposit liabilities of

banks. For this purpose, it assesses and collects insurance assessments from member-banks.

Whenever an insured bank is closed, the PDIC processes and services claims of insured deposits.

(b) Examination of banks (Secs. 8 and 9) The PDIC may examine a bank with the

prior approval of the Monetary Board of the Bangko Sentral ng Pilipinas. Such examination may

extend to all the affairs of the bank and includes the authority to investigate frauds, irregularities

and anomalies committed in the bank.

(c) Rehabilitation of banks (Sec. 17) Upon determination by the PDIC that (i) a

bank is in danger of closing, (ii) the continued operation of such bank is essential to provideadequate banking service in the community or maintain financial stability in the economy, and (iii)

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the actual liquidation and payoff of the bank will be more expensive than the extension of financial

assistance to the bank, the PDIC may make loans to, purchase the assets or assume the liabilities

of, or make deposits in, the said bank in order to prevent its closing. The foregoing authority may

also be exercised by the PDIC in respect of a closed bank.

(d) Receivership of closed banks (Secs. 8 and 10; see also Sec. 30, RA 7653) Asreceiver, the PDIC shall control, manage and administer the affairs of the closed bank for the

purpose of preserving its assets for the benefit of the creditors of the bank.

(e) Liquidation of closed banks (Sec. 30, RA 7653) If the closed bank cannot be

rehabilitated, the PDIC would proceed with its liquidation. This would involve the conversion of

the assets of the bank into cash for distribution to the creditors in accordance with the provisions of

the Civil Code on concurrence and preference of credits.

Insurance Coverage

4.3 Whose deposit liabilities are required to be insured with the PDIC? (Sec. 5)

The deposit liabilities of any bank, including the branches in the Philippines of foreign banks,

engaged in the business of receiving deposits are required to be insured with the PDIC.

4.4 Is PDIC insurance coverage required of foreign currency deposits maintained in

Philippine banks?

Yes. Section 9 of the Foreign Currency Deposit Act (RA 6426, as amended) and Section 79 of CB

Circular No. 1389, dated August 13, 1993, require foreign currency deposits to be insured under

the PDIC Law. Foreign currency depositors are entitled to receive payment in the same currency in

which the insured deposit is denominated.

4.5 Are the deposit liabilities of a local bank payable in its branch located abroad

covered by PDIC insurance? (Sec. 4[f])

No, they would not be covered by PDIC insurance. However, subject to PDIC approval, a local

bank that maintains a branch outside the Philippines may elect to include for insurance its deposit

obligations payable only at such branch.

4.6 When does the PDIC become liable to pay the insured deposits? (Sec. 14)

The PDIC becomes liable to pay the insured deposits in a bank when the bank is closed by the

Monetary Board of the Bangko Sentral ng Pilipinas, that is, prohibited from doing further business

in the Philippines, on account of insolvency and other grounds under the law (see Paragraph 1.10).

4.7 Does PDIC insurance cover risks other than bank closure?

No, PDIC insurance covers only the risk of bank closure ordered by the Monetary Board. Losses

that a bank may suffer due to natural calamities, theft, war, strike, etc. would not be covered by

PDIC insurance.

4.8 What is the extent of the PDICs liability to a bank depositor? (Sec. 4[g])

The PDICs liability is up to P250,000 per depositor per capacity.

4.9 What is an insured deposit? (Sec. 4[g]; see also PDIC Bulletin No. 2004-04, August 12,

2004)

An insured deposit is the amount due any depositor for deposits in an insured bank net of any

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matured or unmatured obligation of the depositor to the insured bank as of the date of closure but

not to exceed P250,000. In determining s depositors insured deposit, the PDIC shall add together

all deposits in the bank maintained by the depositor in the same right and capacity for his benefit

either in his own name or in the name of others. The outstanding balance of each account would

also be adjusted to take into account any interest earned by the account as of the date of closure ofthe bank less any withholding tax due on such interest.

4.10 How would joint accounts be insured and what rules would apply in the payment of

PDIC insurance to such accounts? (Sec. 4[g]; see also PDIC Bulletin No. 2004-04,

August 12, 2004)

(a) A joint account, regardless of whether the conjunction and, or, or and/or is used,

shall be insured separately from any individually-owned deposit account. The maximum insured

deposit of P250,000 shall be divided into as many equal shares as there are depositors unless a

different sharing is stipulated in the document of deposit.

Example: Pedro and Mario have P400,000 in a joint savings account with ABC

Bank. Pedro also has P300,000 in another savings account that he maintains with

the same bank solely in his name. Marios total deposit is P200,000 while that of

Pedro is P500,000. If ABC Bank were closed, Mario could claim P125,000 from

PDIC (representing his 50% share of the maximum insured deposit of the joint

account with Pedro) while Pedro could claim a total of P250,000 (P125,000,

representing his 50% share of the maximum insured deposit of the joint account

with Mario), plus P125,000 out of the savings account solely in his name.

(b) If the account were held by a juridical person jointly with one or more natural persons, the

maximum insured deposit shall be presumed to belong entirely to such juridical person or entity.

Example: XYZ Corporation and Pedro have P250,000 in a joint savings account

with ABC Bank. Pedro also has P250,000 in another savings account that hemaintains with the same bank solely in his name. If ABC Bank were closed, XYZ

Corporation could claim P250,000 from PDIC. The P250,000 in the joint account

would be presumed to belong entirely to XYZ Corporation.

(c) In case one of the co-depositors in a joint and/or or or account has an obligation to the

closed bank covered by a hold-out agreement (i.e., a security arrangement whereby the obligation

is secured by the account), the obligation secured by the said agreement shall be deducted from the

balance of the joint account regardless of the fact that only one of the co-depositors is indebted to

the closed bank.

Example: Pedro and Mario have P200,000 in a joint and/or savings account

with ABC Bank. Pedro borrowed P50,000 from the bank and secured it with ahold-out on the joint and/or savings account. If ABC Bank were closed, Pedro

and Mario could each claim only P75,000 from the PDIC.

(d) In case the deposit is a joint and account, the obligation shall be deducted only from the

share of the indebted co-depositor unless the other co-depositor is himself a co-signatory to the

hold-out agreement.

Example: If the account in the immediately preceding problem were a joint and

account, Pedro could claim only P50,000 from the PDIC. Mario could claim

P100,000.

(e) Where the deposit is not covered by a hold-out agreement, the obligation shall be deducted

only from the share of the indebted co-depositor regardless of whether the deposit is a joint and,or, or and/or account.

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Payment of Insured Deposits

4.11 Is the PDIC required to notify the depositors of a closed bank of the fact of such

closure and the need to file their claims? (Sec. 16)

Yes, The PDIC shall publish the notice to depositors once a week for three (3) consecutive weeks

in a newspaper of general circulation or, when appropriate, in a newspaper circulated in the

community or communities where the closed bank or its branches are located.

4.12 Is there a prescriptive period for the filing of claims with the PDIC by the depositors

of a closed bank? (Sec. 16[e])

Yes. A depositor of a closed bank must file his claim with the PDIC within 2 years from actual

takeover of the closed bank by PDIC. If he does not, all his rights against the PDIC in respect of

the insured deposits shall be barred. However, all the rights of the depositor against the closed

bank and its shareholders or the receivership estate to which PDIC may have become subrogatedshall thereupon revert to the depositor.

4.13 When is the PDIC required to settle a claim for an insured deposit? (Sec. 14)

The PDIC is required to settle the claim within 6 months from the date of filing thereof provided

that the claim was filed within 2 years from actual takeover of the closed bank by PDIC. The 6-

month period shall not apply if the documents of the claimant are incomplete or the validity of the

claim requires the resolution of issues of facts or law by another office, body or agency,

independently or in coordination with the PDIC.

4.14 When an insured bank is closed, how will payment of the insured deposits in such

bank be made by the PDIC? (Sec. 14)

The PDIC shall pay either (i) in cash or (ii) by making available to each depositor a transferred

deposit in another insured bank in an amount equal to the insured deposit of such depositor.

4.15 What is a transferred deposit? (Sec. 4[h])

It is a deposit in an insured bank made available to a depositor by the PDIC as payment of the

insured deposit of such depositor in a closed bank and assumed by another insured bank. By

paying its liabilities to depositors in this manner, the PDIC hopes to persuade these depositors to

keep their savings in banks where such funds could be lent out, rather than hoarded and kept out of

the banking system.

4.16 What is the effect of payment to the depositor of his insured deposit?

(Sec. 16[b])

It (i) discharges the PDIC from any further liability to the depositor, and (ii) subrogates the PDIC

to all the rights of the depositor against the closed bank to the extent of such payment.

4.17 What is the nature of the payments of insured deposits made by the PDIC and do

they enjoy any preference under Article 2244 of the Civil Code? (Sec. 15)

All payments by the PDIC of insured deposits in closed banks partake of the nature of public

funds, and as such, must be considered a preferred credit similar to taxes due to the National

Government in the order of preference under Article 2244 of the New Civil Code.

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4.18 If the deposit account in a closed bank were more than P250,000, would it still be

possible for the depositor to recover the excess?

Yes. Assuming that the bank is not rehabilitated or taken over by another bank, the depositor could

claim the excess amount from the liquidator of the closed bank. However, the liquidator might not

be able to pay the claim if the final liquidation of the remaining assets of the closed bank does not

generate enough cash to pay such claim. Such claim would also be subject to the provisions of the

Civil Code on concurrence and preference of credits. If the bank is rehabilitated or taken over by

another bank, the rehabilitator or the bank taking over the closed bank would usually assume the

liability for the payment of the excess deposits.

Powers of the PDIC

4.19 What is the extent of the power of the PDIC to examine banks? (Sec. 8)

The PDIC may examine a bank with the prior approval of the Monetary Board. However, no

examination can be conducted within 12 months from the last examination date.

4.20 Could the PDIC provide legal assistance to its directors, officers, employees or

agents? (Sec. 9[f])

Yes. The PDIC shall underwrite or advance the litigation expenses of, including legal fees and

other expenses of external counsel, or provide legal assistance to, its directors, officers, employees

or agents in connection with any civil, criminal, administrative or any other action or proceeding to

which such directors, officers, employees or agents are made a party by reason of, or in connection

with, their exercise of authority or performance of functions and duties under the PDIC Law.

4.21 As receiver, does the PDIC take over the powers, functions and duties of the

directors, officers and stockholders of the closed bank? (Sec. 10[b], 1st paragraph)

Yes. The PDIC as receiver shall control, manage and administer the affairs of the closed bank.

Effective immediately upon its takeover as receiver of such bank, the powers, functions and duties,

as well as all allowances, remunerations and perquisites of the directors, officers, and stockholders

of such bank are suspended, and the relevant provisions of the Articles of Incorporation and By-

laws of the closed bank are likewise deemed suspended.

4.22 What is the status of the assets of the closed bank under receivership? (Sec. 10[b], 2nd

paragraph)

The assets of the closed bank under receivership shall be deemed in custodia legis in the hands of

the receiver. From the time the closed bank is placed under such receivership, its assets shall notbe subject to attachment, garnishment, execution, levy or any other court processes.

4.23 What are some of the additional powers of the PDIC as a receiver? (Sec. 10[c])

(a) suspend or terminate the employment of officers and employees of the closed bank;

provided, that payment of separation pay or benefits shall be made only after the closed bank has

been placed under liquidation pursuant to the order of the Monetary Board under Section 30 of

R.A. 7653, and that such payment shall be made from available funds of the bank after deducting

reasonable expenses for receivership and liquidation;

(b) hire or retain private counsels as may be necessary;

(c) if the stipulated interest on deposits is unusually high compared with the prevailingapplicable interest rate, the PDIC as receiver may exercise such powers that may include a

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reduction of the interest rate to a reasonable rate; provided, that any modification or reduction shall

apply only to unpaid interest.

4.24 Is the PDIC required to pay docket and other court fees in the cases it might file as

receiver for the recovery, or involving any asset, of the closed bank? (Sec. 11)

Yes. However, payment of docket and other court fees shall be deferred until the action is

terminated with finality. Any such fees shall be a first lien on any judgment in favor of the closed

bank or, in case of unfavorable judgment, such fees shall be paid as administrative expenses during

the distribution of the assets of the closed bank.

CHAPTER V: TRUTH IN LENDING ACT

ADDITIONAL SUPREME COURT CASES

1. Excessive interests, penalties and other charges not revealed in disclosure statements

issued by banks, even if stipulated in the promissory notes, cannot be given effect under

the Truth in Lending Act (New Sampaguita Builders Construction, Inc., et al. vs.

Philippine National Bank, G.R. No. 148753, July 30, 2004)

The Court ruled in this case that excessive interests, penalties and other charges not revealed indisclosure statements issued by banks, even if stipulated in the promissory notes, cannot be given

effect under the Truth in Lending Act. The Court further said:

No penalty charges or increases thereof appear either in the Disclosure Statements or

in any of the clauses in the second and the third Credit Agreements earlier discussed.

While a standard penalty charge of 6 percent per annum has been imposed on the

amounts stated in all three Promissory Notes still remaining unpaid or unrenewed

when they fell due, there is no stipulation therein that would justify any increase in

that charges. The effect, therefore, when the borrower is not clearly informed of the

Disclosure Statements -- prior to the consummation of the availment or drawdown -- is

that the lender will have no right to collect upon such charge or increases thereof, even

if stipulated in the Notes. The time is now ripe to give teeth to the often ignored forty-one-year old Truth in Lending Act and thus transform it from a sniveling paper tiger to

a growling financial watchdog of hapless borrowers.

2. Failure to disclose required information in disclosure statement cured by disclosure

thereof in loan transaction documents (DBP vs. Arcilla, G.R. No. 161397, June 30,

2005)

The Court ruled that the failure of the DBP to disclose the required information in the disclosure

statement form authorized by the BSP was cured by the DBPs disclosure of such information in

the loan transaction documents (i.e., the deed of conditional sale and the supplement thereto, the

promissory notes, and the release sheet) between the DBP and Arcilla.

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CHAPTER VI: LETTERS OF CREDIT


1. Possible parties to a letter of credit transaction; nature of letter of credit-trust receiptarrangement (Lee, et al. vs. CA and Philippine Bank of Communications, G.R. No.

117913, February 1, 2002)

The pertinent parts of the Courts decision are set out below:

Modern letters of credit are usually not made between natural persons. They involve bank to bank

transactions. Historically, the letter of credit was developed to facilitate the sale of goods between,

distant and unfamiliar buyers and sellers. It was an arrangement under which a bank, whose credit

was acceptable to the seller, would at the instance of the buyer agree to pay drafts drawn on it by

the seller, provided that certain documents are presented such as bills of lading accompanied the

corresponding drafts. Expansion in the use of letters of credit was a natural development in

commercial banking. Parties to a commercial letter of credit include (a) the buyer or the importer,

(b) the seller, also referred to as beneficiary, (c) the opening bank which is usually the buyers

bank which actually issues the letter of credit, (d) the notifying bank which is the correspondent

bank of the opening bank through which it advises the beneficiary of the letter of credit, (e)

negotiating bank which is usually any bank in the city of the beneficiary. The services of the

notifying bank must always be utilized if the letter of credit is to be advised to the beneficiary

through cable, (f) the paying bank which buys or discounts the drafts contemplated by the letter of

credit, if such draft is to be drawn on the opening bank or on another designated bank not in the

city of the beneficiary. As a rule, whenever the facilities of the opening bank are used, the

beneficiary is supposed to present his drafts to the notifying bank for negotiation and (g) the

confirming bank which, upon the request of the beneficiary, confirms the letter of credit issued by

the opening bank.From the foregoing, it is clear that letters of credit, being usually bank to bank transactions,

involve more than just one bank. Consequently, there is nothing unusual in the fact that the drafts

presented in evidence by respondent bank were not made payable to PBCom. As explained by

respondent bank, a draft was drawn on the Bank of Taiwan by Ta Jih Enterprises Co., Ltd. of

Taiwan, supplier of the goods covered by the foreign letter of credit. Having paid the supplier, the

Bank of Taiwan then presented the bank draft for reimbursement by PBComs correspondent bank

in Taiwan, the Irving Trust Company which explains the reason why on its face, the draft was

made payable to the Bank of Taiwan. Irving Trust Company accepted and endorsed the draft to

PBCom. The draft was later transmitted to PBCom to support the latters claim for payment from

MICO. MICO accepted the draft upon presentment and negotiated it to PBCom.

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A trust receipt is considered as a security transaction intended to aid in financing importers and

retail dealers who do not have sufficient funds or resources to finance the importation or purchase

of merchandise, and who may not be able to acquire credit except through utilization, as collateral

of the merchandise imported or purchased. A trust receipt, therefor, is a document of security

pursuant to which a bank acquires a security interest in the goods under trust receipt. Under a

letter of credit-trust receipt arrangement, a bank extends a loan covered by a letter of credit, with

the trust receipt as a security for the loan. The transaction involves a loan feature represented by a

letter of credit, and a security feature which is in the covering trust receipt which secures an

indebtedness.

2. Commercial and standby letters of credit; independence principle; fraud exception rule

(Transfield Philippines, Inc. vs. Luzon Hydro Corporation, et al., G.R. No. 146717,

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November 22, 2004)

The relevant parts of the Courts decision are set out below:

At the core of the present controversy is the applicability of the independence principle and

fraud exception rule in letters of credit. Thus, a discussion of the nature and use of letters ofcredit, also referred to simply as credits, would provide a better perspective of the case.

The letter of credit evolved as a mercantile specialty, and the only way to understand all its facets

is to recognize that it is an entity unto itself. The relationship between the beneficiary and the

issuer of a letter of credit is not strictly contractual, because both privity and a meeting of the

minds are lacking, yet strict compliance with its terms is an enforceable right. Nor is it a third-

party beneficiary contract, because the issuer must honor drafts drawn against a letter regardless of

problems subsequently arising in the underlying contract. Since the banks customer cannot draw

on the letter, it does not function as an assignment by the customer to the beneficiary. Nor, if

properly used, is it a contract of suretyship or guarantee, because it entails a primary liability

following a default. Finally, it is not in itself a negotiable instrument, because it is not payable to

order or bearer and is generally conditional, yet the draft presented under it is often negotiable.In commercial transactions, a letter of credit is a financial device developed by merchants as a

convenient and relatively safe mode of dealing with sales of goods to satisfy the seemingly

irreconcilable interests of a seller, who refuses to part with his goods before he is paid, and a

buyer, who wants to have control of the goods before paying. The use of credits in commercial

transactions serves to reduce the risk of nonpayment of the purchase price under the contract for

the sale of goods. However, credits are also used in non-sale settings where they serve to reduce

the risk of nonperformance. Generally, credits in the non-sale settings have come to be known as

standby credits.

There are three significant differences between commercial and standby credits. First, commercial

credits involve the payment of money under a contract of sale. Such credits become payable upon

the presentation by the seller-beneficiary of documents that show he has taken affirmative steps tocomply with the sales agreement. In the standby type, the credit is payable upon certification of a

party's nonperformance of the agreement. The documents that accompany the beneficiary's draft

tend to show that the applicant has not performed. The beneficiary of a commercial credit must

demonstrate by documents that he has performed his contract. The beneficiary of the standby

credit must certify that his obligor has not performed the contract. [Underscoring supplied]

By definition, a letter of credit is a written instrument whereby the writer requests or authorizes the

addressee to pay money or deliver goods to a third person and assumes responsibility for payment

of debt therefor to the addressee. A letter of credit, however, changes its nature as different

transactions occur and if carried through to completion ends up as a binding contract between the

issuing and honoring banks without any regard or relation to the underlying contract or disputes

between the parties thereto.

Since letters of credit have gained general acceptability in international trade transactions, the ICC

has published from time to time updates on the Uniform Customs and Practice (UCP) for

Documentary Credits to standardize practices in the letter of credit area. The vast majority of

letters of credit incorporate the UCP. First published in 1933, the UCP for Documentary Credits

has undergone several revisions, the latest of which was in 1993.

In Bank of the Philippine Islands v. De Reny Fabric Industries, Inc. this Court ruled that the

observance of the UCP is justified by Article 2 of the Code of Commerce which provides that in

the absence of any particular provision in the Code of Commerce, commercial transactions shall be

governed by usages and customs generally observed. More recently, inBank of America, NT &

SA v. Court of Appeals, this Court ruled that there being no specific provisions which govern thelegal complexities arising from transactions involving letters of credit, not only between or among

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banks themselves but also between banks and the seller or the buyer, as the case may be, the

applicability of the UCP is undeniable.

Article 3 of the UCP provides that credits, by their nature, are separate transactions from the sales

or other contract(s) on which they may be based and banks are in no way concerned with or bound

by such contract(s), even if any reference whatsoever to such contract(s) is included in the credit.Consequently, the undertaking of a bank to pay, accept and pay draft(s) or negotiate and/or fulfill

any other obligation under the credit is not subject to claims or defenses by the applicant resulting

from his relationships with the issuing bank or the beneficiary. A beneficiary can in no case avail

himself of the contractual relationships existing between the banks or between the applicant and

the issuing bank.

Thus, the engagement of the issuing bank is to pay the seller or beneficiary of the credit once the

draft and the required documents are presented to it. The so-called independence principle

assures the seller or the beneficiary of prompt payment independent of any breach of the main

contract and precludes the issuing bank from determining whether the main contract is actually

accomplished or not. Under this principle, banks assume no liability or responsibility for the form,

sufficiency, accuracy, genuineness, falsification or legal effect of any documents, or for the

general and/or particular conditions stipulated in the documents 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.

The independent nature of the letter of credit may be: (a) independence in toto where the credit is

independent from the justification aspect and is a separate obligation from the underlying

agreement like for instance a typical standby; or (b) independence may be only as to the

justification aspect like in a commercial letter of credit or repayment standby, which is identical

with the same obligations under the underlying agreement. In both cases the payment may be

enjoined if in the light of the purpose of the credit the payment of the credit would constitute

fraudulent abuse of the credit.

Can the beneficiary invoke the independence principle?

Petitioner insists that the independence principle does not apply to the instant case and assuming it

is so, it is a defense available only to respondent banks. LHC, on the other hand, contends that it

would be contrary to common sense to deny the benefit of an independent contract to the very

party for whom the benefit is intended. As beneficiary of the letter of credit, LHC asserts it is

entitled to invoke the principle.

As discussed above, in a letter of credit transaction, such as in this case, where the credit is

stipulated as irrevocable, there is a definite undertaking by the issuing bank to pay the beneficiary

provided that the stipulated documents are presented and the conditions of the credit are complied

with. Precisely, the independence principle liberates the issuing bank from the duty of ascertaining

compliance by the parties in the main contract. As the principles nomenclature clearly suggests,

the obligation under the letter of credit is independent of the related and originating contract. In

brief, the letter of credit is separate and distinct from the underlying transaction.

Given the nature of letters of credit, petitioners argumentthat it is only the issuing bank that

may invoke the independence principle on letters of creditdoes not impress this Court. To say

that the independence principle may only be invoked by the issuing banks would render nugatory

the purpose for which the letters of credit are used in commercial transactions. As it is, the

independence doctrine works to the benefit of both the issuing bank and the beneficiary.

Letters of credit are employed by the parties desiring to enter into commercial transactions, not forthe benefit of the issuing bank but mainly for the benefit of the parties to the original transactions.

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With the letter of credit from the issuing bank, the party who applied for and obtained it may

confidently present the letter of credit to the beneficiary as a security to convince the beneficiary to

enter into the business transaction. On the other hand, the other party to the business transaction,

i.e., the beneficiary of the letter of credit, can be rest assured of being empowered to call on the

letter of credit as a security in case the commercial transaction does not push through, or theapplicant fails to perform his part of the transaction. It is for this reason that the party who is

entitled to the proceeds of the letter of credit is appropriately called beneficiary.

Petitioners argument that any dispute must first be resolved by the parties, whether through

negotiations or arbitration, before the beneficiary is entitled to call on the letter of credit in essence

would convert the letter of credit into a mere guarantee. Jurisprudence has laid down a clear

distinction between a letter of credit and a guarantee in that the settlement of a dispute between the

parties is not a pre-requisite for the release of funds under a letter of credit. In other words, the

argument is incompatible with the very nature of the letter of credit. If a letter of credit is drawable

only after settlement of the dispute on the contract entered into by the applicant and the

beneficiary, there would be no practical and beneficial use for letters of credit in commercial

transactions.

Professor John F. Dolan, the noted authority on letters of credit, sheds more light on the issue:

The standby credit is an attractive commercial device for many of the same

reasons that commercial credits are attractive. Essentially, these credits are

inexpensive and efficient. Often they replace surety contracts, which tend to

generate higher costs than credits do and are usually triggered by a factual

determination rather than by the examination of documents.

Because parties and courts should not confuse the different functions of the surety

contract on the one hand and the standby credit on the other, the distinction

between surety contracts and credits merits some reflection. The two commercial

devices share a common purpose. Both ensure against the obligorsnonperformance. They function, however, in distinctly different ways.

Traditionally, upon the obligors default, the surety undertakes to complete the

obligors performance, usually by hiring someone to complete that performance.

Surety contracts, then, often involve costs of determining whether the obligor

defaulted (a matter over which the surety and the beneficiary often litigate) plus

the cost of performance. The benefit of the surety contract to the beneficiary is

obvious. He knows that the surety, often an insurance company, is a strong

financial institution that will perform if the obligor does not. The beneficiary also

should understand that such performance must await the sometimes lengthy and

costly determination that the obligor has defaulted. In addition, the suretys

performance takes time.

The standby credit has different expectations. He reasonably expects that he will

receive cash in the event of nonperformance, that he will receive it promptly, and

that he will receive it before any litigation with the obligor (the applicant) over the

nature of the applicants performance takes place. The standby credit has this

opposite effect of the surety contract: it reverses the financial burden of parties

during litigation.

In the surety contract setting, there is no duty to indemnify the beneficiary until

the beneficiary establishes the fact of the obligors performance. The beneficiary

may have to establish that fact in litigation. During the litigation, the surety holds

the money and the beneficiary bears most of the cost of delay in performance.In the standby credit case, however, the beneficiary avoids that litigation burden

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and receives his money promptly upon presentation of the required documents. It

may be that the applicant has, in fact, performed and that the beneficiarys

presentation of those documents is not rightful. In that case, the applicant may sue

the beneficiary in tort, in contract, or in breach of warranty; but, during the

litigation to determine whether the applicant has in fact breached the obligation toperform, the beneficiary, not the applicant, holds the money. Parties that use a

standby credit and courts construing such a credit should understand this

allocation of burdens. There is a tendency in some quarters to overlook this

distinction between surety contracts and standby credits and to reallocate burdens

by permitting the obligor or the issuer to litigate the performance question before

payment to the beneficiary.

While it is the bank which is bound to honor the credit, it is the beneficiary who has the right to

ask the bank to honor the credit by allowing him to draw thereon. The situation itself emasculates

petitioners posture that LHC cannot invoke the independence principle and highlights its puerility,

more so in this case where the banks concerned were impleaded as parties by petitioner itself.

Respondent banks had squarely raised the independence principle to justify their releases of the

amounts due under the Securities. Owing to the nature and purpose of the standby letters of credit,

this Court rules that the respondent banks were left with little or no alternative but to honor the

credit and both of them in fact submitted that it was ministerial for them to honor the call for

payment.

- o -

Next, petitioner invokes the fraud exception principle. It avers that LHCs call on the Securities

is wrongful because it fraudulently misrepresented to ANZ Bank and SBC that there is already a

breach in the Turnkey Contract knowing fully well that this is yet to be determined by the arbitral

tribunals. It asserts that the fraud exception exists when the beneficiary, for the purpose of

drawing on the credit, fraudulently presents to the confirming bank, documents that contain,expressly or by implication, material representations of fact that to his knowledge are untrue. In

such a situation, petitioner insists, injunction is recognized as a remedy available to it.

[Underscoring supplied]

Citing Dolans treatise on letters of credit, petitioner argues that the independence principle is not

without limits and it is important to fashion those limits in light of the principles purpose, which

is to serve the commercial function of the credit. If it does not serve those functions, application of

the principle is not warranted, and the common law principles of contract should apply.

It is worthy of note that the propriety of LHCs call on the Securities is largely intertwined with

the fact of default which is the self-same issue pending resolution before the arbitral tribunals. To

be able to declare the call on the Securities wrongful or fraudulent, it is imperative to resolve,

among others, whether petitioner was in fact guilty of delay in the performance of its obligation.

Unfortunately for petitioner, this Court is not called upon to rule upon the issue of defaultsuch

issue having been submitted by the parties to the jurisdiction of the arbitral tribunals pursuant to

the terms embodied in their agreement.

Would injunction then be the proper remedy to restrain the alleged wrongful draws on the

Securities?

Most writers agree that fraud is an exception to the independence principle. Professor Dolan

opines that the untruthfulness of a certificate accompanying a demand for payment under a standby

credit may qualify as fraud sufficient to support an injunction against payment. The remedy for

fraudulent abuse is an injunction. However, injunction should not be granted unless: (a) there is

clear proof of fraud; (b) the fraud constitutes fraudulent abuse of the independent purpose of theletter of credit and not only fraud under the main agreement; and (c) irreparable injury might

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follow if injunction is not granted or the recovery of damages would be seriously damaged.

- o -

The pendency of the arbitration proceedings would not per se make LHCs draws on the Securities

wrongful or fraudulent for there was nothing in the Contract which would indicate that the partiesintended that all disputes regarding delay should first be settled through arbitration before LHC

would be allowed to call upon the Securities. It is therefore premature and absurd to conclude that

the draws on the Securities were outright fraudulent given the fact that the ICC and CIAC have not

ruled with finality on the existence of default.

Nowhere in its complaint before the trial court or in its pleadings filed before the appellate court,

did petitioner invoke the fraud exception rule as a ground to justify the issuance of an injunction.

What petitioner did assert before the courts below was the fact that LHCs draws on the Securities

would be premature and without basis in view of the pending disputes between them. Petitioner

should not be allowed in this instance to bring into play the fraud exception rule to sustain its

claim for the issuance of an injunctive relief.

- o -

With respect to the issue of whether the respondent banks were justified in releasing the amounts

due under the Securities, this Court reiterates that pursuant to the independence principle the banks

were under no obligation to determine the veracity of LHCs certification that default has occurred

Neither were they bound by petitioners declaration that LHCs call thereon was wrongful. To

repeat, respondent banks undertaking was simply to pay once the required documents are

presented by the beneficiary.

At any rate, should petitioner finally prove in the pending arbitration proceedings that LHCs

draws upon the Securities were wrongful due to the non-existence of the fact of default, its right to

seek indemnification for damages it suffered would not normally be foreclosed pursuant to general

principles of law.

CHAPTER VII: TRUST RECEIPTS


1. An entrustee does not have authority to mortgage goods covered by trust receipts (DBP vs.

Prudential Bank, G.R. No. 143772, November 22, 2005)

In 1973, Lirag Textile Mills, Inc. (Litex) opened an irrevocable commercial letter of credit with

Prudential Bank (Prudential) for the importation of 5,000 spindles and various accessories and

spare parts (the Articles) for use with spinning machinery. These Articles were released to Litexunder covering trust receipts it executed in favor of Prudential. Litex installed and used the

Articles in its textile mill located in Montalban, Rizal.

In 1980, DBP granted a foreign currency loan to Litex. To secure the loan, Litex executed real

estate and chattel mortgages on its plant site in Montalban, Rizal, including the buildings and other

improvements, machineries and equipments there. Among the machineries and equipments

mortgaged in favor of DBP were the Articles.

In 1982, Prudential informed DBP that it was the absolute and juridical owner of the Articles and

they were thus not part of the mortgaged assets that could be legally ceded to DBP.

In 1983, DBP extra-judicially foreclosed on the real estate and chattel mortgages, including the

Articles, and acquired the foreclosed properties as the highest bidder.In 1987, over the objections of Prudential, DBP sold the Litex properties it acquired at the

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foreclosure sale, including the Articles. to Lyon Textile Mills, Inc. (Lyon).

In 1988, Prudential filed a complaint for a sum of money with damages against DBP. The trial

court decided in favor of Prudential and its decision was affirmed in toto by the Court of Appeals

to which DBP appealed. DBP thereafter filed a petition for review on certiorari with the Supreme

Court.

The Court held that the Articles were owned by Prudential and Litex only held them in trust.

While it was allowed to sell the items, Litex had no authority to dispose of them or any part

thereof or their proceeds through conditional sale, pledge or any other means. Thus, Litex could

not have subjected them to a chattel mortgage. Their inclusion in the mortgage was void and had

no legal effect. There being no valid mortgage, there could also be no valid foreclosure or valid

auction sale. Thus, DBP could not be considered either as a mortgagee or as a purchaser in good

faith.

DBP merely stepped into the shoes of Litex as trustee of the Articles with an obligation to pay

their value or to return them on Prudentials demand. By its failure to pay or return them despite

Prudentials repeated demands and by selling them to Lyon without Prudentials knowledge andconformity, DBP became a trustee ex maleficio [i.e., one who acquires title to property through

actual fraud].

2. Acquittal in criminal case for estafa under Section 13 of the Trust Receipts Law does not

extinguish civil liability arising from breach of trust receipt contract (Tupaz IV, et al. vs.

CA and BPI, G.R. No. 145578, November 18, 2005

The relevant portion of the Courts decision is as follows:

The rule is that where the civil action is impliedly instituted with the criminal action, the civil

liability is not extinguished by acquittal -

[w]here the acquittal is based on reasonable doubt xxx as only preponderance ofevidence is required in civil cases; where the court expressly declares that the

liability of the accused is not criminal but only civil in nature xxx as, for instance,

in the felonies of estafa, theft, and malicious mischief committed by certain

relatives who thereby incur only civil liability (See Art. 332, Revised Penal Code);

and, where the civil liability does not arise from or is not based upon the criminal

act of which the accused was acquitted xxx. (Emphasis supplied)

Here, respondent bank chose not to file a separate civil action to recover payment under the trust

receipts. Instead, respondent bank sought to recover payment in Criminal Case Nos. 8848 and

8849. Although the trial court acquitted petitioner Jose Tupaz, his acquittal did not extinguish his

civil liability. As the Court of Appeals correctly held, his liability arose not from the criminal act

of which he was acquitted (ex delito) but from the trust receipt contract (ex contractu) of 30September 1981. Petitioner Jose Tupaz signed the trust receipt of 30 September 1981 in his

personal capacity.

CHAPTER XI: CHATTEL MORTGAGE LAW


1. Loss of vessel before foreclosure borne by mortgagors (Allied Banking Corporation vs.

Cheng Yong, et al., G.R. N0. 154109, October 6, 2005)

The loss of the mortgaged chattel brought about by its sinking must be borne not by Allied Bank

but by the spouses Cheng. As owners of the fishing vessel, it was incumbent upon the spouses to

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insure it against loss. Thus, when the vessel sank before the chattel mortgage could be foreclosed,

uninsured as it is, its loss must be borne by the spouses Cheng.

2. Creditor not obliged to foreclose chattel mortgage constituted to secure credit (Spouses

Rosario vs. PCI Leasing and Finance, Inc., G.R., No. 139233, November 11, 2005)Instead of foreclosing on the chattel mortgage on a motor vehicle constituted by the spouses

Rosario to secure the loan obtained by them from PCI Leasing, the latter filed a case for Sum of

Money with Damages with a Prayer for a Writ of Replevin.

The Court ruled that even if Article 1484 of the New Civil Code were to be applied, the chattel

mortgage had not been foreclosed; hence, PCI Leasing was not precluded from collecting the

balance of the account of the spouses Rosario. It held that the remedy of the unpaid seller under

Article 1484 of the New Civil Code is alternative and not cumulative. A creditor is not obliged to

foreclose a chattel mortgage even if there is one.

3. Entrustee, not being owner of articles covered by trust receipts and without authority from

owner, cannot mortgage said articles (DBP vs. Prudential Bank, G.R. No. 143772,

November 22, 2005)

Citing Article 2085 of the Civil Code (which requires that, in a contract of pledge or mortgage, the

pledgor or mortgagor should be the absolute owner of the thing pledged or mortgaged), the Court

ruled that Lirag Textile Mills, Inc. as the entrustee of the 5,000 spindles and related accessories in

question, had neither absolute ownership, free disposal nor the authority to freely dispose of the

said articles and could not have subjected them to a chattel mortgage inasmuch as the title to the

said articles belongs to the entruster, Prudential Bank. The inclusion of the articles in the real

estate and chattel mortgages constituted by Lirag Textile on its plant site in Montalban, Rizal to

secure the foreign currency loan it obtained from the DBP was void and had no legal effect. There

being no valid mortgage, there could also be no valid foreclosure or valid auction sale of such

articles.

4. Invalidity of loan invalidates mortgage intended to secure it (Spouses Saguid vs. Security

Finance, Inc., G.R. No. 159467, December 9, 2005)

The Court ruled that since it has been sufficiently established that there was no cause or

consideration for the promissory note, it follows that the chattel mortgage constituted on the

subject vehicle to secure the said promissory note cannot have any legal effect on the spouses

Saguid. It stated that a mortgage is a mere accessory contract and its validity would depend on the

validity of the loan secured by it. The chattel mortgage constituted over the subject vehicle is an

accessory contract to the loan obligation as embodied in the promissory note. It cannot exist as an

independent contract since its consideration is the same as that of the principal contract. Aprincipal obligation is an indispensable condition for the existence of an accessory contract.

5. Suing for collection of unpaid amortizations and at the same time suing for replevin not

allowed under Art. 1484, Civil Code (Magna Financial Services Group, Inc. vs. Colarina,

G.R. No. 158635, December 9, 2005)

Colarina bought on installment from Magna Financial Services a Suzuki Multicab and constituted

a chattel mortgage thereon to secure the unpaid balance of the purchase price thereof. On account

of Colarinas failure to pay the requisite installments, Magna filed against Colarina a Complaint

for Foreclosure of Chattel Mortgage with Replevin before the Municipal Trial Court in Cities

(MTCC). In its Complaint, Magna made the following prayer:

WHEREFORE, it is respectfully prayed that judgment render ordering defendant:

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1. To pay the principal sum of P131,607.00 with penalty charges at 4.5% per

month from January 1999 until paid plus liquidated damages.

2. Ordering defendant to reimburse the plaintiff for attorneys fee at 25% of the

amount due plus expenses of litigation at not less than P10,000.00.

3. Ordering defendant to surrender to the plaintiff the possession of the Multicab

described in paragraph 2 of the complaint.

4. Plaintiff prays for other reliefs just and equitable in the premises.

It is further prayed that pendent lite, an Order of Replevin issue commanding the

Provincial Sheriff at Legazpi City or any of his deputies to take such multicab into

his custody and, after judgment, upon default in the payment of the amount

adjudged due to the plaintiff, to sell said chattel at public auction in accordance

with the chattel mortgage law.

The MTCC decided in favor of Magna as follows:

WHEREFORE, judgment is hereby rendered in favor of plaintiff Magna FinancialServices Group, Inc. and against the defendant Elias Colarina, ordering the latter:

(a) to pay plaintiff the principal sum of one hundred thirty one thousand six

hundred seven (P131,607.00) pesos plus penalty charges at 4.5% per month

computed from January, 1999 until fully paid;

(b) to pay plaintiff P10,000.00 for attorneys fees; and

(c) to pay the costs.

The foregoing money judgment shall be paid within ninety (90) days from the entry

of judgment. In case of default in such payment, the one (1) unit of Suzuki

Multicab, subject of the writ of replevin and chattel mortgage, shall be sold at

public auction to satisfy the said judgment

Colarina appealed to the Regional Trial Court but the latter affirmed the MTCC decision. Colarina

then filed a petition for review with the Court of Appeals. The CA ruled as follows:

We find merit in petitioners assertion that the MTC and the RTC erred in ordering

the defendant to pay the unpaid balance of the purchase price of the subject vehicle

irrespective of the fact that the instant complaint was for the foreclosure of its

chattel mortgage. The principal error committed by the said courts was their

immediate grant, however erroneous, of relief in favor of the respondent for the

payment of the unpaid balance without considering the fact that the very prayer it

had sought was inconsistent with its allegation in the complaint.

Verily, it is beyond cavil that the complaint seeks the judicial foreclosure of the

chattel mortgage. The fact that the respondent had unconscionably sought the

payment of the unpaid balance regardless of its complaint for the foreclosure of the

said mortgage is glaring proof that it intentionally devised the same to deprive the

defendant of his rights. A judgment in its favor will in effect allow it to retain the

possession and ownership of the subject vehicle and at the same time claim against

the defendant for the unpaid balance of its purchase price. In such a case, the

respondent would luckily have its cake and eat it too. Unfortunately for the

defendant, the lower courts had readily, probably unwittingly, made themselves

abettors to respondents devise to the detriment of the defendant.

WHEREFORE, finding error in the assailed decision, the instant petition is hereby

GRANTED and the assailed decision is hereby REVERSED AND SET ASIDE.

Let the records be remanded to the court of origin. Accordingly, the foreclosure of

the chattel mortgage over the subject vehicle as prayed for by the respondent in its

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complaint without any right to seek the payment of the unpaid balance of the

purchase price or any deficiency judgment against the petitioners pursuant to

Article 1484 of the Civil Code of the Philippines, is hereby ORDERED

Having lost in the CA, Magna then filed a petition for review on certiorari with the Supreme Court

based on the sole issue: What is the true nature of a foreclosure of chattel mortgage, extrajudicialor judicial, as an exercise of the 3 rd option under Article 1484, paragraph 3 of the Civil Code?

In its Memorandum, petitioner assails the decision of the Court of Appeals and

asserts that a mortgage is only an accessory obligation, the principal one being the

undertaking to pay the amounts scheduled in the promissory note. To secure the

payment of the note, a chattel mortgage is constituted on the thing sold. It argues

that an action for foreclosure of mortgage is actually in the nature of an action for

sum of money instituted to enforce the payment of the promissory note, with

execution of the security. In case of an extrajudicial foreclosure of chattel

mortgage, the petition must state the amount due on the obligation and the sheriff,

after the sale, shall apply the proceeds to the unpaid debt. This, according to

petitioner, is the true nature of a foreclosure proceeding as provided under Rule 68,

Section 2 of the Rules of Court.[13]

On the other hand, respondent countered that the Court of Appeals correctly

set aside the trial courts decision due to the inconsistency of the remedies or reliefs

sought by the petitioner in its Complaint where it prayed for the custody of the

chattel mortgage and at the same time asked for the payment of the unpaid balance

on the motor vehicle.[14]

Article 1484 of the Civil Code explicitly provides:

ART. 1484. In a contract of sale of personal property the price of which ispayable in installments, the vendor may exercise any of the following remedies:

(1) Exact fulfillment of the obligation, should the vendee fail to pay;

(2) Cancel the sale, should the vendees failure to pay cover two or

more installments;

(3) Foreclose the chattel mortgage or the thing sold, if one has been

constituted, should the vendees failure to pay cover two or more installments. In

this case, he shall have no further action against the purchaser to recover any

unpaid balance of the price. Any agreement to the contrary shall be void.

Our Supreme Court in Bachrach Motor Co., Inc. v. Millan[15] held:

Undoubtedly the principal object of the above amendment (referring to Act 4122

amending Art. 1454, Civil Code of 1889) was to remedy the abuses committed in

connection with the foreclosure of chattel mortgages. This amendment prevents

mortgagees from seizing the mortgaged property, buying it at foreclosure sale for a

low price and then bringing the suit against the mortgagor for a deficiency

judgment. The almost invariable result of this procedure was that the mortgagor

found himself minus the property and still owing practically the full amount of hisoriginal indebtedness.

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x x x

In its Memorandum before us, petitioner resolutely declared that it has opted for the

remedy provided under Article 1484(3) of the Civil Code,[17] that is, to foreclose

the chattel mortgage.

It is, however, unmistakable from the Complaint that petitioner preferred to

avail itself of the first and third remedies under Article 1484, at the same time suing

for replevin. For this reason, the Court of Appeals justifiably set aside the decision

of the RTC. Perusing the Complaint, the petitioner, under its prayer number 1,

sought for the payment of the unpaid amortizations which is a remedy that is

provided under Article 1484(1) of the Civil Code, allowing an unpaid vendee to

exact fulfillment of the obligation. At the same time, petitioner prayed that

Colarina be ordered to surrender possession of the vehicle so that it may ultimately

be sold at public auction, which remedy is contained under Article 1484(3). Such a

scheme is not only irregular but is a flagrant circumvention of the prohibition of the

law. By praying for the foreclosure of the chattel, Magna Financial ServicesGroup, Inc. renounced whatever claim it may have under the promissory note.[18]

Article 1484, paragraph 3, provides that if the vendor has availed himself of

the right to foreclose the chattel mortgage, he shall have no further action against

the purchaser to recover any unpaid balance of the purchase price. Any agreement

to the contrary shall be void. In other words, in all proceedings for the foreclosure

of chattel mortgages executed on chattels which have been sold on the installment

plan, the mortgagee is limited to the property included in the mortgage.[19]

Contrary to petitioners claim, a contract of chattel mortgage, which is the

transaction involved in the present case, is in the nature of a conditional sale of

personal property given as a security for the payment of a debt, or the performance

of some other obligation specified therein, the condition being that the sale shall be

void upon the seller paying to the purchaser a sum of money or doing some other

act named.[20] If the condition is performed according to its terms, the mortgage

and sale immediately become void, and the mortgagee is thereby divested of his

title.[21] On the other hand, in case of non payment, foreclosure is one of the

remedies available to a mortgagee by which he subjects the mortgaged property to

the satisfaction of the obligation to secure that for which the mortgage was given.

Foreclosure may be effected either judicially or extrajudicially, that is, by ordinary

action or by foreclosure under power of sale contained in the mortgage. It may be

effected by the usual methods, including sale of goods at public auction.[22]

Extrajudicial foreclosure, as chosen by the petitioner, is attained by causing themortgaged property to be seized by the sheriff, as agent of the mortgagee, and have

it sold at public auction in the manner prescribed by Section 14 of Act No. 1508, or

the Chattel Mortgage Law.[23] This rule governs extrajudicial foreclosure of

chattel mortgage.

In sum, since the petitioner has undeniably elected a remedy of foreclosure

under Article 1484(3) of the Civil Code, it is bound by its election and thus may

not be allowed to change what it has opted for nor to ask for more. On this point,

the Court of Appeals correctly set aside the trial courts decision and instead

rendered a judgment of foreclosure as prayed for by the petitioner.

The next issue of consequence is whether or not there has been an actual

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foreclosure of the subject vehicle.

In the case at bar, there is no dispute that the subject vehicle is already in the

possession of the petitioner, Magna Financial Services Group, Inc. However,

actual foreclosure has not been pursued, commenced or concluded by it.

Where the mortgagee elects a remedy of foreclosure, the law requires the

actual foreclosure of the mortgaged chattel. Thus, in Manila Motor Co. v.

Fernandez,[24] our Supreme Court said that it is actual sale of the mortgaged

chattel in accordance with Sec. 14 of Act No. 1508 that would bar the creditor

(who chooses to foreclose) from recovering any unpaid balance.[25] And it is

deemed that there has been foreclosure of the mortgage when all the proceedings of

the foreclosure, including the sale of the property at public auction, have been

accomplished.[26]

That there should be actual foreclosure of the mortgaged vehicle wasreiterated in the case ofDe la Cruz v. Asian Consumer and Industrial Finance

Corporation:[27]

It is thus clear that while ASIAN eventually succeeded in taking possession

of the mortgaged vehicle, it did not pursue the foreclosure of the mortgage as

shown by the fact that no auction sale of the vehicle was ever conducted. As we

ruled in Filinvest Credit Corp. v. Phil. Acetylene Co., Inc. (G.R. No. 50449, 30

January 1982, 111 SCRA 421)

Under the law, the delivery of possession of the mortgaged property to the

mortgagee, the herein appellee, can only operate to extinguish appellants liability

if the appellee had actually caused the foreclosure sale of the mortgaged property

when it recovered possession thereof (Northern Motors, Inc. v. Sapinoso, 33 SCRA

356 [1970]; Universal Motors Corp. v. Dy Hian Tat, 28 SCRA 161 [1969]; Manila

Motors Co., Inc. v. Fernandez, 99 Phil. 782 [1956]).

Be that as it may, although no actual foreclosure as contemplated under the

law has taken place in this case, since the vehicle is already in the possession of

Magna Financial Services Group, Inc. and it has persistently and consistently

avowed that it elects the remedy of foreclosure, the Court of Appeals, thus, ruled

correctly in directing the foreclosure of the said vehicle without more.

WHEREFORE, premises considered, the instant petition is DENIED for lack

of merit and the decision of the Court of Appeals dated 21 January 2003 is

AFFIRMED. Costs against petitioner.

The Court ruled that it is unmistakable from the Complaint that Magna preferred to avail itself of

the first and third remedies under Article 1484, at the same time suing for replevin. Perusing the

Complaint, Magna, under its prayer number 1, sought for the payment of the unpaid amortizations

which is a remedy that is provided under Article 1484(1) of the Civil Code, allowing an unpaid

vendee to exact fulfillment of the obligation. At the same time, Magna prayed that Colarina be

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ordered to surrender possession of the vehicle so that it may ultimately be sold at public auction,

which remedy is contained under Article 1484(3). Such a scheme is not only irregular but is a

flagrant circumvention of the prohibition of the law. By praying for the foreclosure of the chattel,

Magna renounced whatever claim it may have under the promissory note. Article 1484, paragraph

3, provides that if the vendor has availed himself of the right to foreclose the chattel mortgage, heshall have no further action against the purchaser to recover any unpaid balance of the purchase

price. Any agreement to the contrary shall be void. In other words, in all proceedings for the

foreclosure of chattel mortgages executed on chattels which have been sold on the installment

plan, the mortgagee is limited to the property included in the mortgage.

The Court also ruled that it is the actual sale of the mortgaged chattel in accordance with Sec. 14 of

the Chattel Mortgage Law (Act No. 1508) that would bar the creditor who chooses to foreclose

from recovering any unpaid balance. There has been foreclosure of the mortgage when all the

proceedings of the foreclosure, including the sale of the property at public auction, have been

accomplished. In the case at bar, there is no dispute that the subject vehicle is already in the

possession of Magna Financial Services. However, actual foreclosure has not been pursued,

commenced or concluded by it. As it has persistently and consistently avowed that it elects theremedy of foreclosure, the Court ruled that the Court of Appeals has correctly directed Magna to

proceed with the foreclosure of the said vehicle without more.

CHAPTER XII: EXTRAJUDICIAL FORECLOSURE OF MORTGAGE LAW

Issues Prior to Foreclosure Sale

1. Blanket mortgage clause or dragnet clause (Spouses Cuyco vs. Spouses Cuyco, G.R. No.

168736, April 19, 2006)

According to the Court, the general rule is that a mortgage liability is usually limited to the amountmentioned in the contract. However, the amounts named as consideration in a contract of mortgage

do not limit the amount for which the mortgage may stand as security if from the four corners of

the instrument the intent to secure future and other indebtedness can be gathered. This stipulation

is valid and binding between the parties and is known in American Jurisprudence as the blanket

mortgage clause, also known as a dragnet clause.

A dragnet clause operates as a convenience and accommodation 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 legal services, recording fees, et cetera.

While a real estate mortgage may exceptionally secure future loans or advancements, these future

debts must be sufficiently described in the mortgage contract. An obligation is not secured by amortgage unless it comes fairly within the terms of the mortgage contract.

The pertinent provisions of the November 26, 1991 real estate mortgage reads:

That the MORTGAGOR is indebted unto the MORTGAGEE in the sum of ONE

MILLION FIVE THOUSAND PESOS (sic) (1,500,000.00) Philippine Currency,

receipt whereof is hereby acknowledged and confessed, payable within a period of

one year, with interest at the rate of eighteen percent (18%) per annum;

That for and in consideration of said indebtedness, the MORTGAGOR does hereby

convey and deliver by way of MORTGAGE unto said MORTGAGEE, the latters

heirs and assigns, the following realty together with all the improvements thereon

and situated at Cubao, Quezon City, and described as follows:

x x x x

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PROVIDED HOWEVER, that should the MORTGAGOR duly pay or cause to be

paid unto the MORTGAGEE or his heirs and assigns, the said indebtedness of

ONE MILLION FIVE HUNDRED THOUSAND PESOS (1,500,000.00),

Philippine Currency, together with the agreed interest thereon, within the agreed

term of one year on a monthly basis then this MORTGAGE shall be discharged,and rendered of no force and effect, otherwise it shall subsist and be subject to

foreclosure in the manner and form provided by law.

It is clear from a perusal of the aforequoted real estate mortgage that there is no stipulation that the

mortgaged realty shall also secure future loans and advancements. Thus, what applies is the

general rule above stated.

Even if the parties intended the additional loans of P150,000.00 obtained on May 30, 1992,

P150,000.00 obtained on July 1, 1992, and P500,00.00 obtained on September 5, 1992 to be

secured by the same real estate mortgage, as shown in the acknowledgement receipts, it is not

sufficient in law to bind the realty for it was not made substantially in the form prescribed by law.

In order to constitute a legal mortgage, it must be executed in a public document, besides beingrecorded. A provision in a private document, although denominating the agreement as one of

mortgage, cannot be considered as it is not susceptible of inscription in the property registry. A

mortgage in legal form is not constituted by a private document, even if such mortgage be

accompanied with delivery of possession of the mortgage property. Besides, by express provisions

of Section 127 of Act No. 496, a mortgage affecting land, whether registered under said Act or not

registered at all, is not deemed to be sufficient in law nor may it be effective to encumber or bind

the land unless made substantially in the form therein prescribed. It is required, among other

things, that the document be signed by the mortgagor executing the same, in the presence of two

witnesses, and acknowledged as his free act and deed before a notary public. A mortgage

constituted by means of a private document obviously does not comply with such legal

requirements.

What the parties could have done in order to bind the realty for the additional loans was to execute

a new real estate mortgage or to amend the old mortgage conformably with the form prescribed by

the law. Failing to do so, the realty cannot be bound by such additional loans, which may be

recovered by the respondents in an ordinary action for collection of sums of money.

2. Debtors default; liquidated debt (Selegna Management and Development Corporation, et

al. vs. UCPB, G.R. No. 165662, May 3, 2006)

In the words of the Court, it is a settled rule of law that foreclosure is proper when the debtors are

in default of the payment of their obligation. In fact, the parties stipulated in their credit

agreements, mortgage contracts and promissory notes that respondent was authorized to foreclose

on the mortgages, in case of a default by petitioners. That this authority was granted is not

disputed.

Mora solvendi, or debtors default, is defined as a delay in the fulfillment of an obligation, by

reason of a cause imputable to the debtor. There are three requisites necessary for a finding of

default. First, the obligation is demandable and liquidated; second, the debtor delays performance;

third, the creditor judicially or extrajudicially requires the debtors performance.

The Court also stated that a debt is liquidated when the amount is known or is determinable by

inspection of the terms and conditions of the relevant promissory notes and related documentation.

Failure to furnish a debtor a detailed statement of account does not ipso facto result in an

unliquidated obligation.

3. Remedies of mortgage creditor alternative, not successive or cumulative (Suico Rattan &

Buri Interiors, Inc., et al. vs. CA, et al., G.R. No. 138145, June 15, 2006; see also Caltex

Phils. Vs. IAC, et al., G.R. 74730, August 25, 1989)

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The Court ruled that it is settled that a mortgage creditor may, in the recovery of a debt secured by

a real estate mortgage, institute against the mortgage debtor either a personal action for debt or a

real action to foreclose the mortgage. These remedies available to the mortgage creditor are

deemed alternative and not cumulative. An election of one remedy operates as a waiver of the

other. In sustaining the rule that prohibits mortgage creditors from pursuing both the remedies of apersonal action for debt or a real action to foreclose the mortgage, the Court held in the case of

Bachrach Motor Co., Inc. v. Esteban Icarangal, et al. that a rule which would authorize the

plaintiff to bring a personal action against the debtor and simultaneously or successively another

action against the mortgaged property, would result not only in multiplicity of suits so offensive to

justice and obnoxious to law and equity, but also in subjecting the defendant to the vexation of

being sued in the place of his residence or of the residence of the plaintiff, and then again in the

place where the property lies. Hence, a remedy is deemed chosen upon the filing of the suit for

collection or upon the filing of the complaint in an action for foreclosure of mortgage, pursuant to

the provisions of Rule 68 of the Rules of Court. As to extrajudicial foreclosure, such remedy is

deemed elected by the mortgage creditor upon filing of the petition not with any court of justice

but with the office of the sheriff of the province where the sale is to be made, in accordance withthe provisions of Act No. 3135, as amended by Act No. 4118.

4. Mortgage invalid if mortgagor not the property owner; doctrine of mortgagee in good faith

not applicable (Erea vs. Querrer-Kaufman, G.R. No. 165853, June 22, 2006)

The Court explained the doctrine of mortgagee in good faith by citing its decision in Cavite

Development Bank v. Lim, 381 Phil. 355 (2000) as follows:

There is, however, a situation where, despite the fact that the mortgagor is not the owner

of the mortgaged property, his title being fraudulent, the mortgage contract and any

foreclosure sale arising therefrom are given effect by reason of public policy. This is the

doctrine of mortgagee in good faith based on the rule that all persons dealing with the

property covered by a Torrens Certificate of Title, as buyers or mortgagees, are not

required to go beyond what appears on the face of the title. The public interest inupholding the indefeasibility of a certificate of title, as evidence of lawful ownership of

the land or of any encumbrance thereon, protects a buyer or mortgagee who, in good

faith, relied upon what appears on the face of the certificate of title.

Indeed, a mortgagee has a right to rely in good faith on the certificate of title of the mortgagor of

the property given as security and in the absence of any sign that might arouse suspicion, has no

obligation to undertake further investigation. Hence, even if the mortgagor is not the rightful

owner of, or does not have a valid title to, the mortgaged property, the mortgagee in good faith is

nonetheless entitled to protection. This doctrine presupposes, however, that the mortgagor, who is

not the rightful owner of the property, has already succeeded in obtaining a Torrens title over the

property in his name and that, after obtaining the said title, he succeeds in mortgaging the property

to another who relies on what appears on the said title. The innocent purchaser (mortgagee in thiscase) for value protected by law is one who purchases a titled land by virtue of a deed executed by

the registered owner himself, not by a forged deed, as the law expressly states. Such is not the

situation of petitioner, who has been the victim of impostors pretending to be the registered owners

but who are not said owners. The doctrine of mortgagee in good faith does not apply to a situation

where the title is still in the name of the rightful owner and the mortgagor is a different person

pretending to be the owner. In such a case, the mortgagee is not an innocent mortgagee for value

and the registered owner will generally not lose his title. We thus agree with the following

discussion of the CA:

The trial court wrongly applied in this case the doctrine of mortgagee in good faith

which has been allowed in many instances but in a milieu dissimilar from this case. This

doctrine is based on the rule that persons dealing with properties covered by a Torrens

certificate of title are not required to go beyond what appears on the face of the title. But

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this is only in a sit

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