11514698 Credit Transactions Reviewer

INTRODUCTION MEANING AND SCOPE OF CREDIT TRANSACTIONS Credit transactions include all transac tions involving the purchase or loan of goods, services, or money in the present with a promise to pay or deliver in the future. TWO TYPES OF CREDIT TRANSACTION S/ CONTRACTS OF SECURITY 1. Secured transactions or contracts of real security ± supported by a collateral or an encumbrance of property 2. Unsecured transactions or contracts of personal security ± fulfillment by the d ebtor is supported only by a promise to pay or the personal commitment of another EXAMPLE S OF CREDIT TRANSACTIONS 1. 2. 3. 4. 5. Bailment contracts Contracts of guaranty and suretyship Mortgage Antichresis Concurrence and preference of credits MEANING OF SECURITY Security (def). Something given, deposited, or serving as a means to ensure the fulfillment or enforcement of an obligation or of protecting some interest in property. KINDS OF SECURITY 1. Personal Security - when an individual becomes a surety or a guarantor 2. Pro perty or Real Security ± when a mortgage, pledge, antichresis, charge, or lien or other device used to have property held, out of which the person to be made secu re can be compensated for loss. BAILMENT Bailment (def). The delivery of propert y of one person to another in trust for a specific purpose, with a contract, tha t the trust shall be faithfully executed and the property returned or duly accou nted for when the special purpose is accomplished or kept until the bailor recla ims it. To be legally enforceable, a bailment must contain all the elements of a valid contract, which are consent, object, and cause or consideration. However, a bailment may also be created by operation of law. PARTIES IN BAILMENT 1. Bailor ± the giver; the one who delivers the possession of the thing bailed 2. Bailee ± the recipient; the one who receives the possession or custody of the thin g delivered KINDS OF BAILMENT 1. For the sole benefit of the bailor Examples: gratuitous dep osit and mandatum (bailment of goods where the bailee gratuitously undertakes to do some act with respect to the property) Sheryl IID 2002 PAGE 1

Ex. My tito from the States makes padala a balikbayan box filled with spam throu gh another relative who's flying to the Philippines on vacation. It only benefits my tito (the bailor). Or, Helen deposits Polsci's baby chair with the mysterious l ittle guy who doesn't smile in the bag depository counter outside the lib. In this case, only Helen benefits (based on a true story). 2. For the sole benefit of t he bailee Examples: commodatum and gratuitous simple loan or mutuum Ex. Xilca bo rrows my white blouse because she forgot to bring clothes to change from her Pas ay City Jail outfit. Only Xilca is benefited, not me. Or, Xilca borrows P10 from me without interest. 3. For the benefit of both parties Examples: deposit for a compensation, involuntary deposit, pledge, bailments for hire Ex. Ansky pawns h er huge diamond earrings at Villarica Pawnshop. The pawnshop gives her P10,000 a nd a pawn ticket. Both parties benefit ± Ansky gets fast cash, while the pawnshop gets to keep the huge diamond earrings to make sure that Ansky pays, and in case she doesn't they can sell the earrings. 1 and 2 are gratuitous bailments. There i s no consideration because they are considered more as a favor by one party to t he other. Bailments under number 3 are mutual-benefit bailments, and they usuall y result from business transactions. BAILMENT FOR HIRE Bailment for hire arises when goods are left with the bailee for some use or service by him always for so me compensation. KINDS OF BAILMENT FOR HIRE 1. Hire of things ± goods are delivered for the temporary use of the hirer 2. Hire of service ± goods are delivered for some work or labor upon it by the bailee 3. Hire for carriage of goods ± goods are delivered either to a common carrier or to a private person for the purpose of being carried from place to place 4. Hire of custody ± goods are delivered for storage I. LOAN GENERAL PROVISIONS Art. 1933. By the contract of loan, one of the parties delivers to another, eith er something not consumable so that the latter may use the same for a certain ti me and return it, in which case the contract is called a commodatum; or money or other consumable thing, upon condition that the same amount of the same kind an d quality shall be paid, in which case the contract is simply called a loan or m utuum. Commodatum is essentially gratuitous. Simple loan may be gratuitous or wi th a stipulation to pay interest. In commodatum the bailor retains the ownership of the thing loaned, while in simple loan, ownership passes to the borrower. Ar t. 1934. An accepted promise to deliver something by way of commodatum or simple loan is binding upon the parties, but the commodatum or simple loan itself shal l not be perfected until the delivery of the object of the contract. Sheryl IID 2002 PAGE 2

ESSENTIAL ELEMENTS OF A CONTRACT Consent of the parties Object Cause or Consider ation IN THE CONTEXT OF A LOAN Borrower and Lender Property For the lender: right to d emand the return of the thing For the borrower: acquisition of the thing CHARACTERISTICS OF THE CONTRACT OF LOAN 1. A real contract ± the delivery of the thing loaned is necessary for the perfect ion of the contract 2. A unilateral contract ± once the subject matter has been delivered, it creates obligations on the part of only one of the parties (the borrower) CAUSE OR CONSIDERATION IN A C ONTRACT OF LOAN 1. 2. As to the borrower: the acquisition of the thing As to the lender: the right to demand its return or of its equivalent KINDS OF LOAN 1. Commodatum ± where the lender delivers to the borrower a non-consumable thing s o that the latter may use it for a certain time and return the identical thing 2. Simple loan or mutuum ± where the lender delivers to the borrower money or othe r consumable thing upon the condition that the latter shall pay the same amount of the same kind and quality. LOANS DISTINGUISHED FROM CREDIT Credit means the abi lity of an individual to borrow money or things by virtue of the confidence or t rust reposed by a lender that he will pay what he may promise within a specified period. Loan means the delivery by one party and the receipt by the other party of a given sum of money or other consumable thing upon an agreement to repay th e same amount of the same kind and quality, with or without interest. The conces sion of a credit necessarily involves the granting of loans up to the limit of t he amount fixed in the credit. As opposed to debt, credit is a debt considered f rom the creditor's standpoint. It is that which is due to any person. Sheryl IID 2002 PAGE 3

DISTINCTIONS BETWEEN COMMODATUM AND SIMPLE LOAN SUBJECT MATTER OWNERSHIP GRATUIT OUS? COMMODATUM Not consumable Retained by the lender Gratuitous SIMPLE LOAN Mon ey or other consumable thing Transferred to the borrower Default rule is that it is gratuitous BUT the parties may stipulate interest, in which case, it becomes onerous Borrower need only pay the same amt of the same kind and quality Person al only Consumption Lender may not demand return of the thing before the lapse o f the term agreed upon Suffered by the borrower even if through fortuitous event PAYMENT BY BORROWER KIND OF PROPERTY PURPOSE WHEN LENDER MAY DEMAND Borrower must return the same thing loaned Real or personal Temporary use or pos session Lender may demand return of the thing before the expiration of the term in case of urgent need Suffered by the lender (since he is the owner) LOSS OF THE THING In commodatum, if you do not return the thing when it is due, you will be liable for estafa because ownership of the property is not transferred to the borrower . In loan, the borrower who does not pay is not criminally liable for estafa. Hi s liability is only a civil liability for the breach of the obligation to pay. T his is because in loan, ownership of the thing is transferred to the borrower, s o there is no unlawful taking of property belonging to another. ACCEPTED PROMISE TO MAKE A FUTURE LOAN Borrower goes to Lender and asks if he could borrow P10K at 6% interest per annum. Lender says okay, I will lend you the money. This is a n accepted promise to make a future loan. It is a consensual contract and is bin ding upon the parties. But is there a contract of loan at this point? No, becaus e loan is a real contract and is perfected only upon delivery of the thing. FORM OF LOAN There are no formal requisites for the validity of a contract of loan e xcept if there is a stipulation for the payment of interest. A stipulation for t he payment of interest must be in writing. CHAPTER 1 COMMODATUM Art. 1935. The bailee in commodatum acquires the use of the thing loaned but not its fruits; if any compensation is to be paid by him who acquires the use, the contract ceases to be a commodatum. KINDS OF COMMODATUM 1. 2. Ordinary commodatu m Precarium ± one whereby the bailor may demand the thing loaned at will Sheryl IID 2002 PAGE 4

NATURE OF COMMODATUM Commodatum in simple terms is hiram ± A agrees to lend his gu ard dog to his friend B for a week for free. B is entitled to use the dog for th is period. At the end of the week, B must return the dog to A. If the dog gives birth while it is in the custody of B, the puppies (fruits) belong to A. 1. The bailee acquires the use of the thing but not its fruits, unless there is a stipulation to the contrary. 2. It is essentially gratuitous. 3. The purpose of the contract is the temporary use of the thing loaned for a certain time. (So if the bailee is not entitled to use the thing, it is not commodatum but it may be a deposit.) 4. The subject matter is generally non-consumable real or personal property, tho ugh consumable goods may also be the subject of commodatum if the purpose is not the consumption of the object (ex. Display of a bottle of wine). 5. The lender need not be the owner of the thing loaned. It is enough that he ha s possessory interest in the thing or right to use it which he may assert against the bailee and third persons though not against the rightful owner. (Ex. A lessee may suble t the thing leased). 6. It is purely personal in character. The consequences of this are the followin g: a. The death of either party extinguishes the contract unless there is a cont rary stipulation for the commodatum to subsist until the purpose is accomplished b. The borrower cannot lend or lease the thing to a third person. However, members of the borrower's household may make use of the thing loaned except: i. ii . if there is a stipulation to the contrary; or if the nature of the thing forbi ds it. 7. The parties may stipulate that the borrower may use the fruits of the thing, but this must only be incidental to the use of the thing itself (because if it is the main cau se, the contract may be one of usufruct). OBLIGATIONS OF THE BORROWER 1. Liability for ordinary expenses ± The borrower should defray the expenses for t he use and preservation of the thing loaned. 2. Liability for loss of the thing ± The general rule is the borrower is not liabl e for loss or damage due to a fortuitous event. The owner bears the loss. But in the following cases, the borrower is liable for loss through a fortuitous event: a. if he devotes the thing to a purpose different from that for which it was loa ned (bad faith) this is a breach of the tenor of the obligation b. if he keeps it longer than the period stipulated or after the accomplishment of the use for which the commodatum has been constituted (delay) c. if the thing loaned has been delivered with appraisal of its value unless the re is a stipulation exempting the bailee from responsibility in case of a fortuitous eve

nt is equivalent to an assumption of risk; Sheryl IID 2002 PAGE 5 this

d. if he lends or leases the thing to a third person who is not a member of his household also a breach of the tenor of the obligation; e. if, being able to save either the thing borrowed or his own thing, he chose t o save his own (ingratitude). 3. Liability for deterioration of the thing - The borrower is not liable for the ordinary deterioration or wear and tear of the thing that comes as a natural consequence of its use. This is borne by the lender. Reason: Because the lender retains owne rship so he should bear the loss from ordinary deterioration. Also, because the purpose of commodatum is for the borrower to use the thing. Deterioration is a n atural result of such use. 4. Obligation to return the thing loaned ± The borrower must return the thing as s oon as the period stipulated expires or the purpose has been accomplished. He cannot keep t he thing as security for anything that the lender may owe him, except for a clai m for damages suffered because of the flaws of the thing loaned. So for example, Xilca earlier won a bet with Cayo, as a result of which, Cayo owes her a tuna s andwich. Cayo loaned Alvin Ang's Frisbee to Xilca for 10 days. At the end of the 1 0 days, Xilca cannot refuse to return Alvin Ang's frisbee to Cayo and hold it host age until Cayo delivers the sandwich. Why? Because Xilca's obligation as a borrowe r is to return the thing after the period expires, and she cannot keep it as a s ecurity for anything that Cayo may owe her. Or, Xilca borrows Kim Chong's car for 10 days. While the car is in Xilca's possession, a tire explodes. Xilca has to buy a new tire for P3,000. At the end of the 10 days, Xilca refuses to return the c ar unless Kim Chong pays her the P3,000. Can Xilca refuse to return? No. In this case, Kim Chong owes Xilca P3,000 as an extraordinary expense for the preservat ion of the thing. But even if Kim Chong owes Xilca money in connection with the thing that he loaned, Xilca still cannot retain the car as security. Exception: If the thing loaned has hidden defects and the borrower suffers damages as a res ult of the hidden defect, the borrower can claim damages against the lender. Pen ding payment of the damages by lender to borrower, borrower can keep the thing a s a security. (see discussion below) 5. Liability of two or more bailees ± When there are two or more borrowers to whom a thing is loaned in one contract, there liability is solidary. OBLIGATIONS OF THE LENDE R 1. Obligation to respect the duration of the loan ± The lender cannot demand the r eturn of the thing until after the expiration of the period or after the accomplishment o f the use for which the commodatum was constituted. However, he may demand its r eturn or temporary use if he should have urgent need of the thing. 2. Precarium ± Precarium is a kind of commodatum where the lender may demand the t hing at will. Precarium exists in the following cases: a. b. If there is no stipulati on as to the duration of the contract or to the use to which the thing loaned sh ould be devoted If the use of the thing is merely tolerated by the lender BUT, the lender may not demand the thing capriciously, arbitrarily, or whimsical ly, since this would give rise to an action on the part of borrower for abuse of right under Articles 19, 20, and 21. Sheryl IID 2002 PAGE 6

3. Right to demand return of thing for acts of ingratitude ± If the borrower commi ts any of the acts enumerated in Art. 765 of the Civil Code, the lender may demand the imm ediate return of the thing from the borrower. (This applies to ordinary commodat um, since in precarium the lender can demand at will, subject to the provisions against abuse of right) 4. Obligation to refund extraordinary expenses a. Extraordinary expenses for the preservation of the thing ± The lender should refund the borrower the extraordinary expenses for the preservation of the thing , provided that the borrower informs the lender before incurring the expense, un less the need is so urgent that the lender cannot be notified without danger. b. Extraordinary expenses arising y the lender and on. 5. All other

expenses arising from actual use of the thing ± Extraordinary on the occasion of the actual use of the thing shall be borne b borrower on a 50-50 basis, unless there is a contrary stipulati expenses are for the account of the borrower.

6. Liability for damages for known hidden flaws - Requisites: (F-HADD) a. b. c. d. e. There is a flaw or defect in the thing loaned; The flaw or defect is hidden The lender is aware of the flaw The lender does not advise the borrower of the flaw The borrower suffers damages by reason of the flaw or defect The lender is penalized for his failure to disclose a hidden flaw which causes d amage because he is in a position to prevent the damage from happening. (HOT TIP ) Example: Borrower borrows a 1970 Mitsubishi Lancer from Lender. Unfortunately, Lender forgets to tell borrower that the car has a tendency to overheat after 1 0 minutes. So Borrower drives, and after 10 minutes, the car stalls and overheat s. Borrower opens the hood and sees lots of steam. He opens the radiator cap to put water inside. Radiator water scalds his face, and he suffers from burns. Can he claim damages from Lender and can he keep the car as security? No, because i n this case, Buyer should have known. He was, at least, in a position to know th at the car just might be prone to overheating since it was old already. And when he opened the hood and saw lots of steam, he should have known that if he opene d the radiator, very hot water would spray out. He should have taken precautions when he opened the hood or he should have gone to a gas station or mechanic to have it fixed. But since he was negligent, he has only himself to blame for the damage caused. The defect was not really hidden since Borrower was in a position to know of it even if Lender did not inform him. Had he been more careful, he w ould not have been scalded. ABANDONMENT OF THING BY THE LENDER Can the lender te ll Borrower: I don't want to pay for the extraordinary expenses and damages that I owe you. Just keep the thing, and let's forget about my obligation. No. The lende r cannot exempt himself from the payment of the expenses or damages by abandonin g the thing to the borrower. This is because the expenses and damages may exceed the value of the thing loaned, and it would, therefore, be unfair to allow the lender to just abandon the thing instead of paying for the expenses and damages. Sheryl IID 2002 PAGE 7

CHAPTER 2 SIMPLE LOAN OR MUTUUM DEFINITION Simple loan (def). A contract whereby one of the parties delivers to another money or other consumable thing with the understanding that the same amo unt of the same kind and quality shall be paid. A simple loan involves the payme nt of the equivalent and not the identical thing because the borrower acquires o wnership of the thing loaned. The term ªreturnº is not used since the distinguishing character of the simple loan from commodatum is the consumption of the thing. C ONSIDERATION What is the consideration in this kind of contract? The promise of the borrower to pay is the consideration for the obligation of the lender to fur nish the loan. NO CRIMINAL LIABILITY FOR ESTAFA FOR FAILURE TO PAY There is no c riminal liability for failure to pay a simple loan because the borrower acquires ownership of the thing. FUNGIBLE AND CONSUMABLE THINGS Fungible things (def). T hose which are usually dealt with by number, weight, or measure, so that any giv en unit or portion is treated as the equivalent of any other unit or portion. Th ose which may be replaced by a thing of equal quality and quantity. (ex. Rice, o il, sugar). If it cannot be replaced with an equivalent thing, then it is non-fu ngible. Consumable things (def). Those which cannot be used without being consum ed. Whether a thing is consumable or not depends upon its nature. Whether a thin g is fungible or not depends on the intention of the parties. BARTER Barter (def ). A contract where one of the parties binds himself to give one thing in consid eration of the other's promise to give another thing. (in short, exchange of prope rty) If one person agrees to transfer the ownership of non-fungible things to an other with the obligation on the part of the latter to give things of the same k ind, quantity, and quality, the contract is a contract of barter. DISTINCTIONS B ETWEEN MUTUUM, COMMODATUM, AND BARTER MUTUUM Money or other fungible things Retu rn the equivalent May be gratuitous or onerous COMMODATUM Non-fungible things Re turn the identical thing borrowed Always gratuitous BARTER Non-fungible things R eturn the equivalent Onerous SUBJECT MATTER OBLIGATION OF THE BORROWER GRATUITOUS? Sheryl IID 2002 PAGE 8

FORM OF PAYMENT 1. If the object is money ± Payment must be made in the currency stipulated; other wise it is payable in the currency which is legal tender in the Philippines. According to A rt. 1955, Art. 1250, is applicable in payments of loans. 1250 provides that in c ase of extraordinary inflation or devaluation, the value of the currency at the time of the establishment of the obligation (not at the time of payment) should be the basis for payment. BUT JPSP thinks that this is rarely applied because it would create a bad precedent and would wreak havoc on the economy. It would als o shift the loss to the lender, which shouldn't be the case since the loan is prim arily for the benefit of the borrower. So unless there's a drastic economic situat ion, we shouldn't adjust the value of the currency. The obligation should be paid based on the value of the currency at the time of payment. Ex: In 2000, Borrower borrowed $1,000 from Lender at the peso-dollar exchange rate of P50$1, payable in 2004. In 2004, FPJ becomes President, and as a result, the rate becomes P60$1 . If the parties had agreed that payment would be in dollars, Borrower still has to pay $1,000. If the parties had agreed that payment would be in pesos, Borrow er should pay at the rate of P60 to a dollar, or P60,000. Why? You cannot apply 1250 and base the amount due on the value of the currency in 2000 because the in flation is not so extraordinary as to warrant the adjustment. 2. If the object is a fungible thing other than money ± Borrower must pay lender a nother thing of the same kind, quality, and quantity. In case it is impossible to do so , the borrower shall pay its value at the time of the perfection of the loan. Wh y does the law require that the value of the thing be based on its value at the time of the perfection of the loan? There's a historical explanation: the rule was created at a time when there were still interest ceilings. Thus, the reason for requirement is to prevent circumvention of the interest ceilings. Even if there are no longer any interest ceilings, this rule is still applicable. So how do y ou opt out of it? Stipulate! Put a stipulation that says that if it is impossibl e to pay a thing of the same kind, quality, and quantity, borrower shall pay the market value of the thing at the time of payment. INTEREST Requisites for Recov ery of Interest: 1. The payment of interest must be expressly stipulated. 2. in writing [3. And the interest must be lawful (but since there is no Usury Law anymore, th en there is no such thing as unlawful interest, so I don't think this requisite is still included)] There is no Usury Law anymore, but an interest rate may still be struck down for being unconscionable. The test of an unconscionable interest rate is relative and there is a need to look at the parity/disparity in the stat us of the parties and in their access to information during the negotiations. St ipulation of interest 1. 2. The interest rate stipulated by the parties, not the legal rate of interest, is applicable. Default rule: If the parties do not stip ulate an interest rate, the legal rate for loans and forbearances of money is 12 %. Sheryl IID 2002 PAGE 9

For other sources of obligations, such as sale, and damages arising from injury to persons and loss of property which do not involve a loan, the legal rate of i nterest is 6%. 3. 4. 5. Increases in interest must also be expressly stipulated. It is only in contracts of loan, with or without security, that interest may be stipulated and demanded. Stipulation of interest must be mutually agreed upon b y the parties and may not be unilaterally increased by only one of the parties. This would violate consensuality and mutuality of contract (PNB v. CA). But the parties can agree upon a formula for determining the interest rate, over which n either party has control (ex: interest will be adjusted quarterly at a rate of 3 % plus the prevailing 91-day T-bill rate, etc.). But if the formula says ªinterest will be based on T-bill rates and other interest-setting policies as the bank m ay determine,º this is not valid. Escalation Clause ± A clause which authorizes the automatic increase in interest r ate. An escalation clause is valid when it is accompanied by a De-Escalation Cla use. A de-escalation clause is a clause which provides that the rate of interest agreed upon will also be automatically reduced. There must be a specified formu la for arriving at the adjusted interest rate, over which neither party has any discretion. When the borrower is liable for interest even without a stipulation: 1. Indemnity for damages ± The debtor in delay is liable to pay legal interest as indemnity for damages even without a stipulation for the payment of interest. Where to base th e rate of damages: a. Rate in the penalty clause agreed upon by the parties b. I f there is no penalty clause, additional interest based on the regular interest rate of the loan c. If there is no regular interest, additional interest is equi valent to the legal interest rate (12%) Example: Lender lends P10K at 10% intere st with penalty interest of 6%. On due date, Borrower fails to pay. Borrower onl y pays a year after. How much should he pay? Borrower should pay the principal + interest on the loan + penalty interest = 10K + 10% of 10K + 6% of 10K = 10K + 1K + .6K = 11,600 Lender lends P10K at 10% interest. On due date, Borrower fails to pay. Borrower only pays a year after. How much should he pay? Borrower shoul d pay 10K + 10% of 10K (interest on the loan) + 10% of 10K (penalty interest) = 10K + 1K + 1K = 12,000 The penalty interest in this case is 10% since there is n o penalty interest stipulated. The additional interest is based on the regular i nterest of the loan. Lender lends P10K, no interest. On due date, Borrower fails to pay. How much should Borrower pay a year later? Borrower should pay P10K + 1 2% of P10K = 11,200. The penalty interest is 12% since there is no interest on t he loan nor a penalty interest stipulated. The extra interest is based on the le gal rate of interest. Sheryl IID 2002 PAGE 10

2. Interest accruing from unpaid interest ± Interest due shall earn interest from the time it is judicially demanded although the obligation may be silent on this point (Art. 2212.) If interest is payable in kind: If interest is payable in kind, its valu e shall be appraised at the current price of the products or goods at the time a nd place of payment. Take note that you should not confuse this with the rule wh en the principal obligation consists of goods other than money. If the principal obligation consists in the payment of goods and it is impossible to deliver the goods, the borrower should pay the value of the thing at the time of the consti tution of the obligation. But if interest is payable in kind, it should be appra ised at its value at the time of payment. General Rule: Accrued interest shall n ot earn interest Exceptions: 1. When judicially demanded (Art. 2212) accrued int erest shall be added to the principal and the resulting total amount shall earn interest. A stipulation as to compounding interest must be in writing. How does compounding interest work? Lender lends P100,000 payable in 2 years at 10% inter est compounded per annum. At the end of the first year, how much is due? Princip al plus 10% interest = 110,000. On the second year, the 110,000 becomes the new principal amount and it is what will earn the 10% interest. So at the end of the second year, how much is due? 110,000 + 10% of 110,000 = 110,000 + 11,000 = 121 ,000 In compounding interest, you add the unpaid interest to the principal. The resulting amount is your new principal which will then earn interest again. What if the borrower pays interest when there is no stipulation providing for it? If the debtor pays unstipulated interest by mistake, he may recover, since this is a case of solutio indebiti or undue payment. But if the debtor voluntarily pays interest (either unstipulated or stipulated by not in writing) because of some moral obligation, he cannot later recover. The obligation to return the interest is a natural obligation. 2. Express stipulation ± Also called compounding interest where the parties agree that II. GUARANTY AND SURETYSHIP CHAPTER 1 NATURE AND EXTENT OF GUARANTY Art. 2047. By guaranty a person, called the guarantor, binds himself to the cred itor to fulfill the obligation of the principal debtor in case the latter should fail to do so. Sheryl IID 2002 PAGE 11

If a person binds himself solidarily with the principal debtor, the provisions o f Section 4, Chapter 3, Title 1 of this Book shall be observed. In such case the contract is called a suretyship. Guaranty (def.) A contract whereby the guarant or binds himself to the creditor to fulfill the obligation of the principal debt or in case the latter should fail to do so. In a contract of guaranty, the parti es are the guarantor and the creditor. Characteristics of the Contract of Guaran ty (A-SC-U-D) 1. Accessory: It is dependent for its existence upon the principal obligation gu aranteed by it. 2. Subsidiary and Conditional: It takes effect only when the pri ncipal debtor fails in his obligation. 3. Unilateral: a. It gives rise to obligations on the part of the guarantor in relation to the creditor and not vice-versa. (Although after its fulfillment, the principal debt or should indemnify the guarantor, but this obligation is only incidental) It ma y be entered into even without the intervention of the principal debtor. b. 4. Distinct Person: It requires that the person of the guarantor must be distinc t from the person of the principal debtor (you cannot guaranty your own debt). However, in a real guaranty, a person may guarantee his own obligation with his own properti es. Classification of Guaranty 1. In the broad sense: a. personal: the guaranty is the credit given by the person who guarantees the fulfillment of the principal obligation (guarantor) b. real: the guaranty is property. If the guaranty is immovable property: real m ortgage or antichresis; If the guaranty is movable property: pledge or chatter mortgage 2. As to srcin: a. conventional: by agreement of the parties b. legal: imposed by law c. judicia l: required by a court to guarantee the eventual right of one of the parties in a case 3. As to consideration: a. gratuitous: the guarantor does not receive anything for acting as guarantor b . onerous: the guarantor receives valuable consideration for acting as guarantor 4. As to the person guaranteed: a. single: constituted solely to guarantee or secure performance of the principa l obligation Sheryl IID 2002 PAGE 12

b. double or sub-guaranty: constituted to secure fulfillment of a prior guaranty ; guarantees the obligation of a guarantor 5. As to scope and extent: a. definite: limited to the principal obligation only or to a specific portion t hereof b. indefinite or simple: includes not only the principal obligation but a lso all its accessories, including judicial costs. Second Paragraph of Art. 2047: Suretyship If a person binds himself solidarily with the principal debtor, it is a contrac t of suretyship. The guarantor is called a surety. Suretyship is governed by Art icles 1207 to 1222 of the Civil Code on solidary obligations. Suretyship dispens es with certain legal requirements/conditions precedent for proceeding against a guarantor. What is the difference between passive solidarity (solidarity among debtors) and suretyship? Review of oblicon: According to Tolentino, the two are similar in the following ways: 1. A solidary debtor, like a surety, stands for some other person. 2. Both debto r and surety, after payment, may require that they be reimbursed. The difference is that the lender cannot go after the surety right away. There h as to be default on the part of the principal debtor before the surety becomes l iable. If it were mere solidarity among debtors, the creditor can go after any o f the solidary debtors on due date. Nature of a Surety's Undertaking 1. Contractual and Accessory BUT Direct: The contractual obligation of the suret y is merely an accessory or collateral to the obligation contracted by the principal. BUT, h is liability to the creditor is direct, primary, and absolute. 2. Liability is limited by the terms of the contract: The extent of a surety's lia bility is determined only by the terms of the contract and cannot be extended by implicati on. 3. Liability arises only if principal debtor is held liable: If the principal de btor and the surety are held liable, their liability to pay the creditor would be solidary. B ut, the surety does not incur liability unless and until the principal debtor is held liable. a. b. c. d. A surety is bound by a judgment against the principal even though the party was not a party to the proceedings. The creditor may sue, separately or together, the principal debtor and the surety (since they are soli darily bound). Generally, a demand or notice of default is not required to fix t he surety's liability. An accommodation party (one who signs an instrument as make r, drawer, acceptor, or indorser without consideration and only for the purpose of lending his name) is, in effect, a surety. He is thus liable to pay the holde r of the instrument, subject to reimbursement from the accommodated party. Sheryl IID 2002 PAGE 13

Example: Tuks accommodates Shak so that he can obtain a loan from the bank. At t he bottom of the loan agreement, the following signatures appear: (sgd) Tuks Lin o Chris Kapunan (sgd) Shak Sherwin Shakramy Is Tuks a surety or a solidary debtor? According to JPSP, based on this document above, Tuks is a solidary debtor. Remember the rule? I promise to pay signed by two parties = solidary. To make sure that he's merely a guarantor or surety, Tuks should sign a separate guaranty agreement. Besides, a guaranty must be express. It is not presumed. e. A surety bond is void where there is no principal debtor . 4. Surety is not entitled to exhaustion: A surety is not entitled to the exhaust ion of the properties of the principal debtor since the surety assumes a solidary liability for the fulfillment of the principal obligation. 5. The undertaking is to the CREDITOR, not to the principal debtor: The debtor c annot claim that the surety breached its obligation to pay for the principal obligatio n because there is no obligation as between the surety and the debtor. If the su rety does not pay, the principal debtor is still not relieved of his obligation. Guaranty Distinguished from Suretyship: GUARANTY Guarantor promises to answer f or the debt, default or miscarriage of the principal Liability of the guarantor depends upon an independent agreement to pay the obligation if the primary debto r fails to do so The engagement of the guarantor is a collateral undertaking The guarantor is secondarily liable SURETYSHIP Surety promises to answer for the de bt, default or miscarriage of the principal (same) Surety assumes liability as a regular party to the undertaking Surety is charged as an srcinal promisor A su rety is primarily liable MAIN DIFFERENCE: A surety undertakes to pay if the principal does not pay (insur er of the debt). A guarantor binds himself to pay if the principal cannot pay (i nsurer of the solvency of the debtor). Since the obligation of the surety is to pay so long as the principal does not pay (even if he can; even if he is solvent ), the undertaking of the surety is more onerous than that of a guarantor who pa ys only in the event that the principal is broke. Illustration: A borrows P10,00 0 from B, with C agreeing to be the surety. A refuses to pay B out of spite. In this case, since C is a surety, B can immediately demand payment from C. If, in this case, C is a guarantor instead, B would have to exhaust all the property of A before he can collect from C. it is not enough that A refuses to pay even if he can; in order for C to be liable, A would have to be unable to pay. If you we re a lender and the borrower offers as security either X as guarantor or a real estate mortgage, which one would you choose? Choose the mortgage. If you were th e lender, a real estate mortgage is more advisable because you can collect again st the property. In a guaranty/surety, you would have to go against the guaranto r or Sheryl IID 2002 PAGE 14

surety ± you would have to sue him, obtain judgment, and then execute judgment. Th is is subject to a lot of delays. The guarantor or surety can stall your claim. Art. 2048. A guaranty is gratuitous, unless there is a stipulation to the contra ry. GENERAL RULE: Guaranty is gratuitous. EXCEPTION: Guaranty is onerous only if it is stipulated. What is the cause/consideration of a contract of guaranty? Th e cause of a contract of guaranty is the same cause which supports the principal obligation of the principal debtor. There is no need for an independent conside ration in order for the contract of guaranty to be valid. The guarantor need not have a direct interest in the obligation nor receive any benefit from it. It is enough that the principal obligation has consideration. Art. 2049 A married wom an may guarantee an obligation without the husband's consent, but shall not thereb y bind the conjugal partnership, except in cases provided by law. Art. 94 of the Family Code The absolute community of property shall be liable for: (3) Debts a nd obligations contracted by either spouse without the consent of the other to t he extent that the family may have been benefited. A married woman who acts as g uarantor without the consent of the husband binds only her separate property unl ess the debt benefited the family. There is no express prohibition against a mar ried woman acting as guarantor for her husband. Remember that now, in order to b ind the absolute community, the consent of both spouses is needed. If only the c onsent of one spouse is obtained, the absolute community will not be liable unle ss the obligation redounded to the benefit of the community. When the husband ac ts as a guarantor for another person without the consent of the wife, the guaran ty binds only the husband since the benefit really accrues to the principal debt or and not to the husband or his family. The exception is if the husband is real ly engaged in the business of guaranteeing obligations because in this case, his occupation or business is deemed to be undertaken for the benefit of the family . Art. 2050. If a guaranty is entered into without the knowledge or consent, or against the will of the principal debtor, the provisions of articles 1236 and 12 37 shall apply. A contract of guaranty is between the guarantor and the creditor . It can be instituted without the knowledge or even against the will of the deb tor, since the purpose of the contract is to give the creditor all the possible measures to secure payment. However, if the contract of guaranty is entered into without the knowledge or consent or against the will of the principal debtor, t he effect is like payment by a 3rd person: 1. 2. The guarantor can only recover insofar as the payment has been beneficial to the debtor. The guarantor cannot c ompel the creditor to subrogate him in the creditor's rights such as those arising from a mortgage, guaranty or penalty. If the guaranty was entered into with the consent of the principal debtor, the g uarantor is subrogated to all the rights which the creditor had against the debt or once he pays for the obligation. Illustration: Sheryl IID 2002 PAGE 15

A owes B P10,000. Without the knowledge of A, C guarantees the obligation. C pay s A P10,000. C tries to collect the P10,000 from A, but A tells him that he has already paid B 4,000. In this case, C can only collect P6,000 from A since it wa s only the extent to which A was benefited by his payment. If the loan was secur ed by a mortgage, C cannot foreclose the mortgage if A does not pay him because he is not subrogated to the rights of B. Art. 2052. A guaranty cannot exist with out a valid obligation. Nevertheless, a guaranty may be constituted to guarantee the performance of a voidable or unenforceable contract. It may also guarantee a natural obligation. A guaranty is an accessory contract and cannot exist witho ut a valid principal obligation. So if the principal obligation is void, the gua ranty is also void. BUT, a guraranty may be constituted to guarantee the followi ng defective contracts and natural obligations: 1. 2. 3. Voidable: because the c ontract is binding unless it is annulled Unenforceable: because an unenforceable contract is not void. Natural obligations: even if the principal obligation is not civilly enforceable, the creditor may still go after the guarantor Art. 2053. A guaranty may also be given as security for future debts, the amount of which is not yet known; there can be no claim against the guarantor until th e debt is liquidated. A conditional obligation may also be secured. Continuing G uaranty (def) ± A guaranty that is not limited to a single transaction but which c ontemplates a future course of dealings, covering a series of transactions gener ally for an indefinite time or until revoked. A continuing guaranty is generally prospective in its operation and is intended to secure future transactions (gen erally does not include past transactions). Examples: 1. Common example given by JPSP is the credit line ± The bank allows you to borrow up to a certain ceiling, but there is no release of funds yet. If you have an obligati on with a third person and you default, the third person just needs to inform th e bank, and the bank will release the money. The money released will be consider ed as a loan from the bank to you. The bank will allow the release of the money so long as it doesn't exceed the ceiling. 2. To secure payment of any debt to be subsequently incurred ± If the contract sta tes that the guaranty is to secure advances made ªfrom time to time,º ªnow in force or hereafte r made,º or uses the words ªany debt,º ªany indebtedness,º ªany sum,º ªany transaction,º the nty is a continuing guaranty. 3. To secure existing unliquidated debts ± Future debts may also mean debts that a lready exist but whose amount is still unknown. Art. 2053 may be misleading because it says that a guaranty may be constituted to secure future debts. The important th ing to remember in the guaranty of future debts is that there must be an Sheryl IID 2002 PAGE 16

existing obligation already that is being guaranteed. Because without that exist ing obligation, the guaranty would be void. Guaranty is an accessory obligation, so it cannot exist without the principal. Example: G guarantees the 10K loan th at B owes L and any other indebtedness that B may incur against L. This is a val id guaranty because there is already an existing obligation (the 10K loan). G gu arantees the loan that B and L will enter into tomorrow. This is not valid. Alth ough it is for a future debt, it is not valid under Article 2053 because there i s no principal obligation yet. There is nothing to guarantee. Guaranty of Condit ional Obligations If the principal obligation is subject to a suspensive conditi on, the guarantor is liable only after the fulfillment of the condition. If it i s subject to a resolutory condition, the happening of the condition extinguishes both the principal obligation and the guaranty. Art. 2054. A guarantor may bind himself for less, but not for more than the principal debtor, both as regards t he amount and the onerous nature of the conditions. Should he have bound himself for more, his obligations shall be reduced to the limits of that of the debtor. Since the contract of guaranty is a subsidiary and accessory contract, the guar antor's liability cannot exceed that of the principal obligation. If the guarantor binds himself for more than the liability of the principal debtor, his liabilit y shall be reduced. However, if the creditor sues the guarantor, the guarantor m ay be made to pay costs, attorney's fees, and penalties even if this will make his liability exceed that of the principal. How do you opt out of this rule? Exampl e: G guaranteed B's 100K obligation to L to the extent of 100K. As an extra consid eration for lending the money, L wants an additional 20K from guarantor (gravy, according to JPSP). Since 2054 provides that the guarantor cannot bind himself f or more than the principal debtor, how do the parties opt out of the rule? Guara ntor and Lender should enter into a new and separate agreement. They should take it out of the context of the guaranty and have a new agreement in which L would (kunwari) perform some service for G in consideration of the additional 20K. Ar t. 2055. A guaranty is not presumed; it must be express and cannot extend to mor e than what is stipulated therein. If it be simple or indefinite, it shall compr ise not only the principal obligation, but also all its accessories, including t he judicial costs, provided with respect to the latter, that the guarantor shall only be liable for those costs incurred after he has been judicially required t o pay. RULE: Guaranty is never presumed. It must be express. Reason for the rule : Because a guarantor assumes an obligation to pay for another's debt without any benefit to himself. Thus, it has to be certain that he really intends to incur s uch an obligation and that he proceeds with consciousness of what he is doing. F orm required for Guaranty Guaranty must be IN WRITING Sheryl IID 2002 PAGE 17

A contract of guaranty, to be enforceable, must be in writing because it falls u nder the Statute of Frauds as a ªspecial promise to answer for the debt, default o r miscarriage of another.º De Leon textbook says that surety is not covered by the Statute of Frauds. JPSP says that a surety is still covered by the SOF since it is still a promise to answer for the default of another person. What is not cov ered by the SOF is being a solidary co-debtor. Construction of Guaranty A guaran ty is strictly construed against the creditor and in favor of the guarantor and is not to be extended beyond its terms or specific limits. Doubts should be reso lved in favor of the guarantor or surety. Generally, a guarantor is liable only for the obligation of the debtor stipulated upon, and not to obligations assumed PREVIOUS to the execution of the guaranty unless an intent to be so liable is c learly indicated. (Prospective application of the guaranty) However, this rule o f construction is applicable only to an accommodation surety or one that is grat uitous. It does not apply in cases where the surety is compensated with consider ation. In such cases, the agreement is interpreted against the surety company th at prepared it. Is a stipulation that says that the guaranty will subsist only u ntil maturity of the obligation valid? Generally, no. Such a stipulation would d efeat the purpose of a guaranty which is to answer for the default of the princi pal debtor. If the guaranty is only up to the date of maturity, there is no way that the guarantor can be liable since default comes only at maturity date. But Cayo pointed out a situation in class where this might be possible and JPSP agre ed: If the lender asked for a guaranty precisely because there was a danger of t he borrower absconding or becoming insolvent prior to maturity date, then the gu aranty is valid. 2nd Paragraph of Art. 2055: Extent of Guarantor's Liability 1. Definite guaranty ± The liability of the guarantor is limited to the principal debt, to the exclusion of accessories. 2. Indefinite or simple guaranty ± If the agreement does not specify that the liab ility of the guarantor is limited to the principal obligation, it extends not only to the pri ncipal but also to all its accessories. This is because in entering into the agr eement, the principal could have fixed the limits of his responsibility solely t o the principal. If he did not fix it, it is presumed that he wanted to be bound not only to the principal but also to all its accessories. GENERAL RULE: It is not necessary for the CREDITOR to expressly accept the contract of guaranty sinc e the contract is unilateral; only the guarantor binds himself to do something. EXCEPTION: If the guarantor merely offers to become a guaranty, it does not beco me a binding obligation unless the creditor accepts and notice of acceptance is given to the guarantor. On the other hand, if the guarantor makes a direct or un conditional promise of guaranty (and not merely an offer), there is no need for acceptance and notice of such acceptance from the creditor. Art. 2056. One who i s obliged to furnish a guarantor shall present a person who possesses integrity, capacity to bind himself, and sufficient property to answer for the obligation which he guarantees. Sheryl IID 2002 PAGE 18

The guarantor shall be subject to the jurisdiction of the court of the place whe re this obligation is to be complied with. Art. 2057. If the guarantor should be convicted in first instance of a crime involving dishonesty or should become in solvent, the creditor may demand another who has all the qualifications required in the preceding article. The case is excepted where the creditor has required and stipulated that a specified person should be the guarantor. Ideally, the qua lifications of a guarantor are the ff: 1. 2. 3. Integrity Capacity to bind himse lf Sufficient property to answer for the obligation which he guarantees But the creditor can waive these requirements. Jurisdiction over the guarantor: Jurisdiction over the guarantor belongs to the court where the principal obligat ion is to be fulfilled, in accordance with the rule that accessory follows the p rincipal. Effect of Subsequent Loss of Qualifications The qualifications need on ly to be present at the time of the perfection of the contract. The subsequent l oss of the qualifications would not extinguish the liability of the guarantor, n or will it extinguish the contract of guaranty. However, the creditor may demand another guarantor with the proper qualifications. When may the creditor demand another guarantor? 1. In case the guarantor is convicted in the first instance o f a crime involving dishonesty (since he loses integrity) 2. In case the guarantor becomes insolvent (since he loses sufficient property t o answer for the obligation which he guarantees) there is no need for a judicial declaration of i nsolvency What is the effect of the guarantor's death on the guaranty? The guarant y survives the death of the guarantor. The general rule is that a party's contract ual rights and obligations are transmissible to his successors. The rules on gua ranty do not expressly provide that the guaranty is extinguished upon the death of the guarantor. Applying Art. 2057, the supervening incapacity of the guaranto r does not extinguish the guaranty but merely gives the creditor the right to de mand a replacement. But the creditor can waive this right and choose to hold the guarantor to his bargain. If he so chooses, the creditor's claim passes to the he irs of the deceased guarantor. When may the creditor NOT demand another guaranto r? Where the creditor has stipulated in the srcinal agreement that a specified person should be the guarantor, he is bound by the terms of the agreement and he cannot thereafter deviate from it. CHAPTER 2 EFFECTS OF GUARANTY Art. 2058. The guarantor cannot be compelled to pay the creditor unless the latt er has exhausted all the property of the debtor, and has resorted to all the leg al remedies against the debtor. Sheryl IID 2002 PAGE 19

The liability of the guarantor is only accessory and subsidiary. Thus, in order for the creditor to collect from the guarantor, the ff. conditions must be fulfi lled: 1. 2. The creditor should have exhausted all the property of the debtor; a nd The creditor has resorted to all legal remedies against the debtor (ex. Accio n pauliana/ rescission of fraudulent alienations) Can the creditor implead the guarantor as a co-defendant with the debtor? No. Ex cept in cases provided in 2059, Article 2062 says that creditor should proceed a gainst the principal debtor alone. Art. 2059. This excussion shall not take plac e: 1. If the guarantor has expressly renounced it; 2. If he has bound himself so lidarily with the debtor; 3. In case of insolvency of the debtor; 4. When he has absconded, or cannot be sued within the Philippines unless he has left a manage r or representative; 5. If it may be presumed that an execution on the property of the principal debtor would not result in the satisfaction of the obligation. GENERAL RULE: The guarantor is entitled to demand that the creditor first exhaus t the properties of the principal debtor before collecting from the guarantor. E XCEPTIONS: 1. 2. 3. 4. 5. Under Art. 2059 If the guarantor does not comply with Art. 2060 If the guarantor is a judicial bondsman and sub-surety (Art. 2084) Whe re a pledge or mortgage has been given by him as a special security. If he fails to interpose it as a defense before judgment is rendered against him. EXCEPTIONS UNDER ART. 2059 (RUSIA) 1. When the right is Renounced or waived. · The waiver must be made in express terms. 2. When the liability assumed by the guarantor is Solidary. · In this case, he becomes a surety with primary liability. 3. When the principal debtor is Insolvent. What kind of insolvency? JPSP says it's practical insolvency meaning assets are le ss than liabilities, but it still depends on the situation. Examples: B borrows 100K from L guaranteed by G. B has 1M in assets which are all still with him and 1.5M in liabilities. B defaults. Can L collect from G right away? No. In this c ase, G still has the benefit of excussion. Why? Because even if B is apparently insolvent, since his liabilities exceed his assets, there is still no claim agai nst these assets by the other creditors. They can still be accessed by L, and L can still file an action for collection Sheryl IID 2002 PAGE 20

of money against B. So in this case, even if B is insolvent on paper, his proper ties are still with him, and he can still pay L. Therefore, G still should still have the benefit of excussion. B borrows 100K from L guaranteed by G. On due da te, B defaults and has zero assets but has a 200K credit/receivable from X. Can L collect from G. Still no. L must file an action for collection and an accion s ubrogatoria so that he can exercise B's right to collect the money from X. Only if these actions fail can L then collect from G. 4. When the principal debtor Absconds or cannot be locally sued. So even if the borrower has fled to the Bahamas, if he still has properties here , Lender must sue against the property first before collecting from the guaranto r. 5. When resort to all legal remedies would be a Useless formality. · · If exhausting the properties of the debtor would be useless since it would still not satisfy the obligation, the guarantor cannot require the creditor to resort to these legal remedies against the debtor anymore, since doing so would be a u seless formality. In this case, it is not even necessary that the debtor is judi cially declared insolvent or bankrupt. How does the lender get around this requirement? If the lender wants to be able to go against the guarantor right away without having to go through excussion, h e must get the guarantor to either sign a waiver of the benefit of excussion or make him solidarily liable (a surety). Example: B borrowed 100k guaranteed by G. B defaulted. Lender made a demand for payment against G. G paid. Later, G found out that he had the benefit of excussion. He demanded reimbursement from Lender . Can G recover? G cannot recover. Payment constitutes a waiver of the benefit. Art. 2060. In order that the guarantor may make use of the benefit of excussion, he must set it up against the creditor upon the latter's demand for payment from him, and point out to the creditor available property of the debtor within Phili ppine territory sufficient to cover the amount of the debt. Art. 2061. The guara ntor having fulfilled all the conditions required in the preceding article, the creditor who is negligent in exhausting the property pointed out shall suffer th e loss, to the extent of said property, for the insolvency of the debtor resulti ng from such negligence. To collect from the guarantor, the creditor must make a prior demand for payment from the guarantor. 1. When should the demand be made? The demand can only be made after judgment on the debt. 2. How should it be made? The demand must be an actual demand. Joining the guara ntor in the suit against the principal is not the demand intended by law. Additional Req uisites in Order to Claim the Benefit of Excussion Guarantor tells Lender ªExhaust Borrower's property first before collecting from me.º Is this enough for the Guaran tor to claim the benefit of excussion? No. In order to demand that the creditor exhaust the properties of the principal debtor, the guarantor must: Sheryl IID 2002 PAGE 21

1. Set up the benefit of excussion against the creditor upon demand for payment by the creditor from him; and 2. Point out to the creditor available property of the debtor within Philippine territory sufficient to cover the amount of debt. (Therefore, property located abroad or w hich is not easily available is not included among those that the guarantor can point out to the creditor.) Once the guarantor has fulfilled the requisites for making use of the benefit of excussion, the creditor has the duty to exhaust all the property of the debtor and to resort to all legal remedies against the debt or. If he fails to do so, he shall suffer the loss to the extent of the value of the property. Art. 2062. In every action by the creditor, which must be against the principal debtor alone, except in the cases mentioned in Article 2059, the former shall ask the court to notify the guarantor of the action. The guarantor may appear so that he may, if he so desires, set up such defenses as are granted him by law. The benefit of excussion mentioned in article 2058 shall always be unimpaired, even if judgment should be rendered against the principal debtor and the guarantor in case of appearance by the latter. The creditor must sue the pr incipal debtor alone. He cannot sue the guarantor with the principal or the guar antor alone except in the cases mentioned in Art. 2059 where the guarantor loses the benefit of excussion. The guarantor must be notified so that he may appear and set up his defenses if he wants to. If the guarantor appears, he is still gi ven the benefit of exhaustion event after judgment is rendered against the princ ipal debtor. If he does not appear, judgment is not binding on him. Lender must sue the guarantor to claim against him. So, collecting from the guarantor is rea lly a two-step process. The purpose of the two-step process is to allow the guar antor to make use of the benefit of excussion. The disadvantage is that there is a time lag between the judgment against the principal debtor and the one agains t the guarantor, which allows the guarantor to hide his assets in the meantime. How to get around this two-step process: A bank guaranty or a letter of credit. In a bank guaranty, if the debtor does not pay, the creditor need only inform th e bank of the default and the bank releases the money. It's like a standing loan b y the bank in favor of the debtor to answer for a debt in favor of third persons , in case he is unable to pay. Art. 2063. A compromise between the creditor and the principal debtor benefits t he guarantor but does not prejudice him. That which is entered into between the guarantor and the creditor benefits but does not prejudice the principal debtor. Reason: A compromise binds only the parties thereto and not third persons. Thus , it cannot prejudice the guarantor or debtor who was not a party to the comprom ise. Exception: If the compromise has a benefit in the nature of a stipulation i n favor of a third person, the compromise may bind that third person. Example: D owes C 10K with G as guarantor. D and C agree to reduce the debt to 8K. G's liabi lity is also reduced to 8K in case D does not pay, since the compromise is benef icial to G. Sheryl IID 2002 PAGE 22

Art. 2064. The guarantor of a guarantor shall enjoy the benefit of excussion bot h with respect to the guarantor and to the principal debtor. A sub-guarantor can demand the exhaustion of the properties both of the guarantor and of the princi pal debtor before he pays the creditor. Art. 2065. Should there be several guara ntors of only one debtor and for the same debt, the obligation to answer for the same is divided among all. The creditor cannot claim from the guarantors except the shares which they are respectively bound to pay, unless solidarily has been expressly stipulated. The benefit of division among the co-guarantors ceases in the same cases and for the same reasons as the benefit of excussion against the principal debtor. When is there a benefit of division among several guarantors? The following conditions must concur in order that several guarantors may claim the benefit of division: 1. 2. 3. There should be several guarantors Of only on e debtor For the same debt In this case, the liability of the co-guarantors is joint. They are not liable t o the creditor beyond the shares which they are bound to pay. Exceptions: 1.The co-guarantors cannot avail themselves of the benefit of division under the circu mstances enumerated in Art. 2059 (RUSIA). 2. If solidarity has been expressly st ipulated. Art. 2066. The guarantor who pays the debtor must be indemnified by th e latter. The indemnity comprises: (1) The total amount of the debt; (2) The leg al interests thereon from the time the payment was made known to the creditor, e ven though it did not earn interest for the creditor; (3) The expenses incurred by the guarantor after having notified the debtor that payment had been demanded of him; (4) Damages, if they are due. Once the guarantor pays the principal obl igation, the principal debtor must pay him back consisting of: (TIED) 1. The Total amount of the debt ± The guarantor has the right to demand reimbursem ent only when he has actually paid the debt UNLESS there is a stipulation which gives him the right to demand reimbursement as soon as he becomes liable even if he has n ot yet paid. The guarantor cannot ask for more than what he has paid. 2. Interest ± The guarantor is entitled to interest from the time notice of paymen t of the debt was made known to the debtor. The notice is a demand upon the debtor to pay the guarantor. If he delays, he is liable for damages in the form of interest. The g uarantor can collect interest even if the principal obligation was a loan withou t an interest. This is because Sheryl IID 2002 PAGE 23

the right of the guarantor is independent of the principal obligation to the cre ditor. The basis of the right is the delay of the debtor in reimbursing. 3. Expenses ± This refers only to those expenses that the guarantor has to satisfy in accordance with law as a consequence of the guaranty. This is limited to those expenses inc urred by the guarantor after having notified the debtor that payment has been de manded of him by the creditor. 4. Damages ± Guarantor is entitled to damages only if they are due. Exceptions to the right to indemnity of the guarantor 1. 2. Where the guaranty i s constituted without the knowledge or against the will of the debtor, the guara ntor can only recover insofar as the payment had been beneficial to the debtor P ayment by a third person who does not intend to be reimbursed by the debtor is d eemed to be a donation, which requires the debtor's consent. But the payment is va lid with respect to the creditor. Waiver 3. Art. 2067. The guarantor who pays is subrogated by virtue thereof to all the rig hts which the creditor had against the debtor. If the guarantor has compromised with the creditor, he cannot demand of the debtor more than what he has really p aid. When the guarantor pays, he becomes subrogated to the rights of the credito r against the debtor. What happens really is just a change in creditor. The guar antor becomes the creditor, but the obligation subsists in all other aspects. He may, for example, foreclose a mortgage in case of failure of the debtor to reim burse him. The right of subrogation is given to the guarantor so that he can enf orce his right to indemnity/ to be reimbursed. It arises by operation of law upo n payment by the guarantor. The creditor need not formally cede his rights to th e guarantor. But the right of subrogation is given only to the guarantor if he h as the right to be reimbursed. If, for some reason, he has no right to be reimbu rsed, he cannot subrogate either. Compromise B owes lender P1M. Lender was a goo d friend of Guarantor and agreed that if G became liable, he would only have to pay P500K. If B defaults and Guarantor pays P500K, he can only recover P500K fro m B, not the srcinal P1M. Is there a situation where this rule would even be di sadvantageous to the Debtor? Yes. Let's say there was no such rule. B owes L P1M. G, who was a compadre of L, brokered a deal with L, in which they agreed that sh ould G become liable, he would only pay P500K. Since there's no rule, G tells B ab out the deal with L. G tells B that if G pays the P500K, B should reimburse him P600K. This would give B a savings of P400 K, while G earns P100K. Everyone will be happy. But since there is a rule that says that G cannot ask for more than w hat he has actually paid, G has no inducement, no incentive to broker that deal with his compadre L. Why would he go through the trouble when in any case, he wo uld be getting the same amount that he pays? Sheryl IID 2002 PAGE 24

How do you get out of this situation? B should ªhireº G as his agent to broker the d eal with L. As compensation for the service rendered by G, B will pay him P100K. So the agreement is taken out of the context of the guaranty and everyone is ha ppy. Art. 2068. If the guarantor should pay without notifying the debtor, the la tter may enforce against him all the defenses which he could have set up against the creditor at the time the payment was made. Obligation of the guarantor befo re he pays the creditor Before he pays the creditor, guarantor should first give notice to the principal debtor. If he does not give notice, the debtor may enfo rce all the defenses which he could have set up against the creditor at the time of payment. Example: Debtor pays Creditor. But Creditor is sneaky and tells Gua rantor that Debtor defaulted. So Guarantor pays, without telling Debtor. Guarant or makes a demand for reimbursement from Debtor. Is Debtor liable? No. Debtor ca n invoke the fact of payment to the Creditor against Guarantor. Had Guarantor gi ven notice to Debtor, he would have known of the defenses that Debtor had agains t Creditor which would have made him think twice about paying. Guarantor's remedy here is against sneaky Creditor. Art. 2069. If the debt was for a period and the guarantor paid it before it become due, he cannot demand reimbursement of the d ebtor until the expiration of the period unless the payment has been ratified by the debtor. If the principal debt was one with a period, it becomes demandable only upon expiration of the period. Guarantor is only liable if the debtor defau lts, but there can be no default before the expiration of the period. If the gua rantor still pays before the expiration of the period, he must wait for the peri od to expire before he can collect from the debtor. Exception: Guarantor need no t wait for the period if the debtor ratifies payment or consents to it. Art. 207 0. If the guarantor has paid without notifying the debtor, and the latter not be ing 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 gra tuitous guaranty, if the guarantor was prevented by a fortuitous event from advi sing the debtor of the payment, and the creditor becomes insolvent, the debtor s hall reimburse the guarantor for the amount paid. This is like the situation in 2068, only this time, the guarantor pays before the debtor pays. Even in such a case, guarantor still cannot recover from debtor because he should have informed debtor of his intention to pay. Had he informed debtor, debtor would not have p aid. Guarantor will suffer the loss of his failure to comply with his one and on ly obligation before paying which is to notify the debtor. Exception: Guarantor may claim reimbursement from debtor if (requisites): 1. 2. 3. It is a gratuitous guaranty The guarantor was prevented by a fortuitous event from informing the d ebtor of payment Creditor becomes insolvent Remember that the culprit here, aside from the guarantor who did not inform the debtor, is the sneaky creditor who nonchalantly received payment twice. If he is solvent, the guarantor must collect from him. But if he is insolvent and the th ree requisites above are present, the guarantor can reimburse from the principal debtor. Art. 2071. The guarantor, even before having paid, may proceed against the principal debtor: (1) When he is sued for payment; Sheryl IID 2002 PAGE 25

(2) In case of insolvency of the principal debtor; (3) When the debtor has bound himself to relieve him from the guaranty within a specified period, and this pe riod has expired; (4) When the debt has become demandable, by reason of the expi ration of the period for payment; (5) After the lapse of 10 years, when the prin cipal obligation has no fixed period for its maturity unless it be of such natur e that it cannot be extinguished except within a period longer than 10 years; (6 ) If there are reasonable grounds to fear that the principal debtor intends to a bscond; (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 g uaranty, or to demand a security that shall protect him from any proceedings by the creditor and from the danger of insolvency of the debtor. Under these 7 circ umstances, the guarantor has these rights against the debtor BEFORE he makes pay ment: 1. Right to be released if lender agrees Release from the guaranty require s that the lender consent because the guaranty is actually a contract between th e lender and the guarantor Right to demand a security 2. The purpose is to enable the guarantor to take measures to protect his interest in view of the probability that debtor would default and he would be called upon to answer for the obligation. Art. 2072. If one, at the request of another, bec omes a guarantor for the debt of a third person who is not present, the guaranto r who satisfies the debt may sue either the person so requesting or the debtor f or reimbursement. Art. 2073. When there are two or more guarantors of the same d ebtor and for the same debt, the one among them who has paid may demand of each of the others the share which is proportionately owing from him. If any of the g uarantors should be insolvent, his share shall be borne by the others, including the payer, in the same proportion. The provisions of this article shall not be applicable, unless the payment has been made in virtue of a judicial demand or u nless the principal debtor is insolvent. This article applies only if there are two or more guarantors of the same debtor for the same debt and one of them has paid: 1. 2. by virtue of a judicial demand; or when the principal debtor is inso lvent. The liability of the guarantors is joint. If one of them pays the entire obligat ion, he is entitled to be reimbursed the amount of the shares of the other guara ntors. Example: A, B, C guaranty the 90K loan of X. A pays 90K. A can collect 30 K each from B and C. Sheryl IID 2002 PAGE 26

But unlike in an ordinary joint obligation, if one of the guarantors is insolven t, the co-guarantors must answer for his share. In this sense, the obligation be haves like a solidary obligation. Example: A, B, C guaranty the 90K loan of X. A pays 90K. B becomes insolvent. A and C must shoulder B's share. So their liabilit ies become 45K each. A can collect 45 K from C. Art. 2074. In the case of the pr eceding article, the co-guarantors may set up against the one who paid, the same defenses which would have pertained to the principal debtor against the credito r, and which are not purely personal to the debtor. Example: A, B, C guaranty th e obligation of X. A pays even if the obligation has prescribed already. A deman ds reimbursement from B and C. Can they refuse to pay? Yes, they can invoke defe nses inherent in the obligation, such as prescription, against the co-guarantor who pays. A, B, C guaranty the obligation of X who was a minor. A pays. Can B an d C refuse to reimburse him on the ground that X is a minor? No, because the def ense is personal to X. Art. 2075. A sub-guarantor, in case of the insolvency of the guarantor for whom he bound himself, is responsible to the co-guarantors in the same terms as the guarantor. A, B, C are guarantors of X. D is a guarantor o f A. C pays the entire obligation. A becomes insolvent. Can C reimburse from D? Yes, according to Art. 2075. CHAPTER 3 EXTINGUISHMENT OF GUARANTY Art. 2076. The obligation of the guarantor is extinguished at the same time as t hat of the debtor, and for the same causes as all other obligations. Because gua ranty is an accessory and subsidiary contract, it is extinguished once the princ ipal obligation is extinguished. But the extinguishment of the guaranty does not always carry with it the extinguishment of the principal obligation. Any agreem ent between the creditor and the principal debtor which essentially varies the t erms of the principal contract without the consent of the surety will release th e surety from liability. This is because the alteration would result in a novati on of the principal contract which is consequently extinguished and replaced wit h a new one. Since the old principal contract is extinguished, the accessory con tract of guaranty/surety is also extinguished. When is an alteration material? T here must be a change which imposes a new obligation or added burden or which ta kes away some obligation already imposed, changing the legal effect of the contr act. Examples: 1. 2. 3. Increase in the principal amount, regardless of the exte nt of the liability assumed by the guarantor Substitution of the principal debto r Extension or shortening of the term of the principal debt In these cases, the guaranty is extinguished altogether. Decrease in the amount of the principal obligation: The guaranty subsists and is benefited by the chang e since the guarantor cannot bind himself for more than the principal obligation . Sheryl IID 2002 PAGE 27

Art. 2077. If the creditor voluntarily accepts immovable or other property in pa yment of the debt, even if he should afterwards lose the same through eviction, the guarantor is released. This is a case of dacion. Since dacion extinguishes t he principal obligation, the accessory obligation is also extinguished and is no t revived even if the creditor is subsequently evicted from the property. Art. 2 078. A release made by the creditor in favor of one of the guarantors, without t he consent of the others, benefits all to the extent of the share of the guarant or to whom it has been granted. A, B, C are guarantors of X for 90K. The credito r releases A without the consent of B and C. The release should benefit B and C to the extent of 30K (A's share). They shall be liable only for 60K or 30K each. A , B, C are guarantors of X for 90K. The creditor releases A with the consent of B and C. Since B and C consented to the release, their liability is still 90K or 45K each. Art. 2079. An extension granted to the debtor by the creditor without the consent of the guarantor extinguishes the guaranty. The mere failure on the part of the creditor to demand payment after the debt has become due does not o f itself constitute any extension of time referred to herein. If the creditor gr ants the debtor an extension of time within which to comply with the principal o bligation, the guaranty is extinguished. This is because the principal debtor co uld become insolvent during the extension period, and the guarantor would not be able to ask for reimbursement. But if the guarantor consents or waives his righ t under this article in advance, the extension will not extinguish the guaranty. It is immaterial whether the guarantor suffers actual prejudice as a result of the extension. The length of time of the extension is also immaterial. As long a s the period is extended, the guaranty is extinguished. The extension must be ba sed on a new agreement between the debtor and creditor. If the creditor merely f ails to make a demand on due date, it is not an extension. Can the guarantor sue the creditor for his delay in making a demand, thereby lengthening the risk of the insolvency of the principal debtor? No. Art. 2080. The guarantors, even thou gh they are solidary, are released from their obligation whenever by some act of the creditor they cannot be subrogated to the rights, mortgages and preference of the latter. Art. 2081. The guarantor may set up against the creditor all the defenses which pertain to the principal debtor and are inherent in the debt; but not those that are purely personal to the debtor. Chapter 4 Legal and Judicial Bonds The only important thing you have to remember about a legal bond is that it is a surety. Therefore there is no benefit of excussion. Sheryl IID 2002 PAGE 28

PLEDGE AND MORTGAGE PROVISIONS COMMON TO PLEDGE AND MORTGAGE Article 2085. The following requisites are essential to the contracts of pledge and mortgage: (1)That they be constituted to secure the fulfillment of a principal obligation; (2)That the pledgor or mortgagor be the absolute owner of the thing pledged or mortgaged; (3)That the persons constituting the pledge or mortgage have the free disposal of their property and in the absence thereof, that they be legally authorized for the purpose. (4) Third persons who are not parties to the principal obligation may secure the lat ter by pledging or mortgaging their own property. Article 2086. The provisions o f article 2052 are applicable to a pledge or mortgage. [A guaranty cannot exist without a valid obligation. However, it may guarantee the performance of a voida ble or unenforceable contract or a natural obligation] Article 2087. It is also of the essence of these contracts that when the principal obligation becomes due , the things in which the pledge or mortgage consists may be alienated for the p ayment to the creditor. WHAT IS PLEDGE? It is a contract by virtue of which the debtor delivers to the creditor or to a third person a movable or a document inv olving incorporeal rights for the purpose of securing the fulfillment of a princ ipal obligation with the understanding that when the obligation is fulfilled, th e thing delivered shall be returned with all its fruits and accessions. What are the kinds of pledge? Pledge may be either: 1. 2. Voluntary or conventional (cre ated by agreement of the parties); Legal (by operation of law). What are the characteristics of pledge? [RAUS] Pledge is: 1. Real, because it is perfected by delivery of the thing pledged. 2. Acessory, because it has no independent existence. 3. Unilateral, because it creates an ob ligation solely on the part of the creditor to return the thing pledged upon fulfillment of the principal obligation. 4. Subsidiary, because the obligation of the creditor does not arise until fulfi llment of the principal obligation. WHAT IS THE CONSIDERATION IN PLEDGE? If the pledgor is als o the debtor, the consideration is the principal contract. If the pledgor is a t hird person, the cause it the compensation received or the liberality of the ple dgor. WHAT ARE THE DIFFERENCES BETWEEN PLEDGE AND MORTGAGE? 1. Mobility ± pledge is constituted on movables; mortgage on immovables. 2. Delive ry ± pledge requires delivery for perfection; mortgage does not. Cayo IID 2002 PAGE 29

3. Requisites to bind third person/s ± pledge, to bind third persons must be in a public instrument; mortgage, must be registered in the proper registry. A LOAN IS SECUR ED BY BOTH A PLEDGE AND A GUARANTY. CAN THE CREDITOR REFUSE PAYMENT BY THE GUARA NTOR AND CHOOSE TO FORECLOSE IN ORDER TO SATISFY THE DEBT? No, payment by the gu arantor cannot be refused. WHAT ARE THE ESSENTIAL REQUISITES OF PLEDGE AND MORTG AGE? [PRADO] 1. Purpose - To secure fulfillment of principal obligation; 2. Real ± There must b e delivery of the thing. 3. Alienation ± when the principal obligation becomes due and the debtor defaults, the thing may be alienated to satisfy the former. 4. Disposal ± Pledgor/mortgagor must have free disposal of the thing or capacity t o dispose. 5. Ownership ± Pledgor/mortgagor must be the absolute owner of the thin g; PURPOSE: To secure fulfillment of a principal obligation WHAT IF THE THING PLEDGED/MORTGAGED IS SUBSEQUENTLY LOST; WHO BEARS THE LOSS? IS THE PRINCIPAL OBLIGATION EXTINGUISHED? The pledgor bears the loss. Remember tha t there hasn't been transfer of ownership. The principal obligation is of course n ot extinguished, the pledge/mortgage is only accessory. However, the debtor must replace the thing or lose the benefit of the period. Pledge/mortgage is a direc t lien on the property. It is better than guarantee because the property pledged can be sold upon default by the debtor, unlike in guaranty where several requir ements have to be complied with first. PROBLEM: D TRANSFERS PROPERTY TO C AND AT THE SAME TIME EXECUTES AN INDEMNITY AGREEMENT; OR D TRANSFERS PROPERTY TO C TO SECURE AN EXISTING OBLIGATION. HOW WILL THE TRANSFER BE CHARACTERIZED? Both tran sfers will be characterized as pledges. REAL: There must be delivery of the thing to perfect the contract. An agreement to pledge, when there is breach, gives rise to damages. ALIENATION: When the principal obligation becomes due and the debtor defaults, t he thing may be alienated to satisfy the former. DOES THE CREDITOR HAVE TO GO TO COURT TO ENFORCE THE PLEDGE OR MORTGAGE? No, to require litigation would be to nullify the lien and defeat the purpose of the co ntract. FREE DISPOSAL: Cayo IID 2002 PAGE 30

WHAT DO ªFREE DISPOSALº AND ªCAPACITY TO DISPOSEº OF THE PROPERTY MEAN? Free disposal me ans that the property is not subject to any claim by a third person. Capacity to dispose means that though the pledgor/mortgagor does not have free disposal, th e third person with a claim authorized him to dispose (tingin ko lang). In case of corporations, the board should adopt a resolution to approve the pledge/mortg age. If what is to be pledged or mortgaged constitutes all of the corporation's as sets, 2/3 of outstanding capital stock must approve. Rule on consent: If pledgor /mortgagor is married, consent of spouse is needed; if agent, authorization of p rincipal. For married persons ± how to wiggle out of a pledge or mortgage agreemen t: Pledge or mortgage your conjugal property without your spouse's signature. In c ase the property is foreclosed, you can raise the defense that there was no cons ent (remember, half consent is no consent!) What if the pledge was constituted t o secure an obligation of the family business, doesn't this redound to the benefit of the conjugal partnership? No, JPSP said that the pledge of conjugal property con only be considered to redound to the benefit of the partnership if the fami ly business is constituting pledges. If you are the pledgee/mortgagee, check if pledgor/mortgagor has authority to dispose of the property. Another example on f ree disposal or legal authority: Ex. Pledgor corporation is placed under receive rship. The corporation cannot pledge shares of stock because pledge is a disposi tion requiring court approval. OWNERSHIP: CAN FUTURE PROPERTY BE PLEDGED? No, it is essential that the pledgor be the abso lute owner of the thing. Note: It is the sale and not the registration in the LT O that transfers ownership of a vehicle. Note: A co-owner can only pledge/mortga ge his ideal share in the co-ownership. Note: A mortgagor can rely on what is on the face of the Torrens title. WHAT IS MEANT BY ABSOLUTE OWNERSHIP? BOTH BENEFI CIAL AND LEGAL TITLE must vested in the pledgor/mortgagor Ex. Trustee is legal o wner of shares of stock; trustor is beneficial owner: Neither can pledge the sha res. Pledge/mortgage can't be constituted without a principal obligation even if t here is a subsequent principal obligation. This is different from situation wher e the lender extends a credit line for 1M, though borrower has not yet drawn, th e credit line can still be secured via pledge/mortgage. Ex. deed of assignment/a bsolute sale to secure fulfillment of obligation implied trust according to the SC. this is a mortgage or an The pledgor/mortgagor must be absolute owner of the thing or the property. The c reditor may rely on the title/stock certificate if there is no notice of defect in title. However, failure of the pledgor to present the thing is a red flag tha t should put the pledgee on guard as to the pledgor's right to pledge the thing. Cayo IID 2002 PAGE 31

Though the pledgor must own the thing and have free disposal of it, see the foll owing problem discussed in class: Ex. On day 1, stocks are sold to X with the co ndition that the sale will be effective if X tops the bar. On day 2, X pledges t he stocks. On day 3, the bar exam results come out, with X in the number one spo t. Is the pledge valid? Yes, the pledge is valid. Remember Oblicon, conditional obligations? The effects of a conditional obligation to give, when the condition happens, retroact to the date of the constitution of the obligation. OWNERSHIP RETROACTS TO DAY 1. In the above condition, what if the condition is resolutory? As long as the pledge is registered in a public document, it is valid and bindi ng as to third persons. Ex: Day 1 - X receives from A shares of stock with the r esolutory condition that they shall be returned to A if X does not pass the bar. Day 2 ± X pledges the shares. Day 3 ± X fails the bar. Is the pledge valid? Yes. As long as the pledgee registered the pledge in a public instrument, such pledge i s binding on A. *But if you use the argument that the effects retroact, doesn't th at mean that when X pledged the things, he wasn't the owner? I suppose the public instrument is stronger than the legal fiction. CAN THE CREDITOR IMMEDIATELY ACCE PT A PLEDGE FURNISHED BY A DEBTOR IF THE PLEDGE BELONGS TO A THIRD PERSON? No, t he creditor cannot require on the word of the pledgor/mortgagor alone, he must e xercise due care and make sure the pledge/mortgage has given consent. This is es pecially true in the banking industry, which is impressed with public interest. WHAT IS THE CONSEQUENCE THEN IF THE CREDITOR DOES NOT VERIFY WITH THE PLEDGOR/MO RTGAGOR? The pledge/mortgage is null and void. Article 599 gives the owner of a movable who has been unlawfully deprived thereof the right to recover the same. (1) Article 2088. The creditor cannot appropriate the things given by way of ple dge or mortgage, or dispose of them. Any stipulation to the contrary is null and void. WHAT DOES THE CREDITOR WITH THE PLEDGE/MORTGAGE WHEN THE DEBTOR DEFAULTS? The creditor can mo ve for the sale of the thing pledged or mortgaged. WHAT IF THE CREDITOR WANTS TO ACQUIRE THE THING? He may purchase it at the public auction. WHAT IF THERE IS A STIPULATION THAT THE CREDITOR WILL ACQUIRE THE THING UPON DEFAULT? The stipulat ion (pactum commissorium) is null and void. WHAT ARE THE REQUISITES FOR PACTUM C OMMISSORIUM TO EXIST? 1. There should be a pledge/mortgage; the debtor. ARE THER E ANY EXCEPTIONS TO PACTUM COMMISSORIUM? Cayo IID 2002 PAGE 32 2. There should be a stipulation for AUTOMATIC appropriation or the thing in cas e of default by

Yes, Article 2112 provides that if the thing pledged or mortgaged is not sold in two public auctions, the creditor may appropriate the same. WHAT IS THE REASON FOR THE PROHIBITION? The value of the thing pledged or mortgaged is usually more than the amount of the obligation. WHAT HAPPENS TO THE CONTRACT OF PLEDGE/MORTG AGE IF THERE IS A STIPULATION OF PACTUM COMMISSORIUM; IS IT VOID? No, only the s tipulation is void; the principal contract will subsist. HOW CAN YOU OPT OUT OF THE PROHIBITION ON PACTO COMMISSORIO? 1. 2. 3. You can enter into another contra ct subsequent to the pledge/mortgage. The prohibition applies only to stipulatio ns made in the contract of pledge/mortgage. The debtor can voluntarily cede the property to the creditor. This would in effect be a novation of the pledge/mortg age. There can be a stipulation where the debtor merely promises to sell; non-co mpliance would give the creditor, not a right to the property, but an action for damages. ownership of the property upon foreclosure. Examples on pactum commiss orium: Ex. X corporation pledges shares; the pledge agreement states that pledge e has authority to instruct Corporate Secretary of X to transfer shares in name of pledgee in case of default. VALID? NO. The execution of document transferring the shares is only a confirmation of the sale that was already consummated auto matically. Ex. If the agreement is that, upon default, pledgee sells the things pledged at market price and applies profits to the outstanding obligation. Valid ? Yes. There is no automatic transfer of ownership. In fact, the sale of the thi ng to satisfy the obligation is the essence of pledge. Ex. Upon default, pledgor conveys property to pledgee by dation; and for the purpose, pledgee is attorney in fact of pledgor. Valid? YES. It is not automatic; there is need for another agreement to be entered into. Ex. Pledgee has the option to purchase the thing u pon default at price certain. Valid? Yes. There must be a subsequent sale; it is not automatic. Remember, for PC to exist, the EFFECTIVE ACT IS DEFAULT, upon wh ich, there is automatic transfer of ownership. Article 2089. A pledge or mortgag e is indivisible, even though the debt may be divided among the successors in in terest of the debtor or of the creditor. Therefore, the debtor's heir who has paid a part of the debt cannot ask for the proportionate share of extinguishment of the pledge or mortgage as long as the debt is not completely satisfied. Neither can the creditor's heir who has received his share of the debt return the pledge o r cancel the mortgage, to the prejudice of the other heirs who have not yet been paid. From these provisions is excepted the case in which, there being several things given in mortgage or pledge, each one of them guarantees only a determina te portion of credit. The debtor, in this case, shall have the right to the exti nguishment of the pledge or mortgage as the portion of the debt for which each t hing is specially answerable is satisfied. Article 2090. The indivisibility of a pledge or mortgage is not affected by the fact that the debtors are not solidar ily liable. Cayo IID 2002 PAGE 33 4. There can be a stipulation granting the creditor authority to take possession and not

WHAT DO YOU MEAN PLEDGE/MORTGAGE IS INDIVISIBLE? Ex: 1M Loan. It was secured by REM. The REM covered several (100) condominium units. In accordance with the sch edule, there was payment of 100K, can you ask release of corresponding amount of units? No release. Pledge is indivisible. WHAT ARE THE EXCEPTIONS TO INDIVISIBI LITY: 1. Where each one of several thing guarantees a determinate portion of cre dit. Ex: If you have 100 mortgages securing corresponding portion of the loan, t hen when the corresponding portion is paid, the corresponding pledge/mortgage is extinguished. All 100 mortgages may be in the same document. Or, if the parties agree to allow partial discharge of the pledge/mortgage. How? Cancel pledge/mor tgage and constitute a new pledge/mortgage.The downside is that you must again p ay doc. stamps and reg. fees, unlike in the document with 100 mortgages, where t he fees are only paid once. 2. If there was only partial release of the loan. CB v. CA. The bank only released a portion of the loan; the court ordered a corres ponding portion of the REM to be released. 3. Where there was failure of conside ration. Creditor took over management but the business failed. Article 2091. The contract of pledge or mortgage may secure all kinds of obligations, be they pur e or subject to a suspensive or resolutory condition. Pledge/mortgage may secure all sorts of valid, voidable, unenforceable obligations. Article 2092. A promis e to constitute a pledge or mortgage gives rise only to a personal action betwee n the contracting parties, without prejudice to the criminal responsibility incu rred by him who defrauds another, by offering in pledge or mortgage as unencumbe red, things which he knew were subject to some burden, or by misrepresenting him self to be the owner of the same. PROVISIONS APPLICABLE ONLY TO PLEDGE Article 2093. In addition to the requisites prescribed in article 2085, it is ne cessary, in order to constitute the contract of pledge, that the thing pledged b e placed in the possession of the creditor, or of a third person by common agree ment. Remember. Pledge/mortgage are real contracts. If you agree, but don't delive r to the pledgee or a third person/s, there is no pledge but there is an agreeme nt to enter into a pledge. Can delivery be made to the pledgor? Yes, if he is ac ting as agent of pledgee or where the thing pledged is so unwieldy as to make de livery impossible, constructive delivery is allowed. What may be the objects of pledge? Movables within the commerce of man. Delivery may be the actual thing or a title (certificates of deposit, stocks). Must be indorsed. Shares of stock no t negotiable so no indorsement is required, however, for safety reasons, the sam e may be required. Article 2094. All movables which are within commerce may be p ledged, provided they are susceptible of possession. Cayo IID 2002 PAGE 34

Article 2095. Incorporeal rights, evidenced by negotiable instruments, bills of lading, shares of stock, bonds, warehouse receipts and similar documents may als o be pledged. The instrument proving the right pledged shall be delivered to the creditor, and if negotiable, must be indorsed. Article 2096. A pledge shall not take effect against third persons if a description of the thing pledged and the date of the pledge do not appear in a public instrument. The problem here is: h ow do third persons check if the thing is pledged when the thing isn't represented by some sort of title which can be annotated? They can't but they should exercise diligence. Red flags would be failure or inability of debtor to show the thing or the title to the thing. No requirement as to form but to affect third persons , it must be in a public instrument (notarized document). Article 2097. With the consent of the pledgee, the thing pledged may be alienated by the pledgor or ow ner, subject to the pledge. The ownership of the thing pledged is transmitted to the vendee or transferee as soon as the pledgee consents to the alienation, but the latter shall continue in possession. Ex: pledgor pledges property to pledge e to secure a loan. Pledge is in a public instrument. Pledgor sell property to t hird person/s without notice to pledgee ± sale is valid but transfer of ownership is suspended until pledgee consents. Why would the pledgee want to be informed ± a dministrative purposes; who gets property when obligation is paid. Article 2098. The contract of pledge gives a right to the creditor to retain the thing in his possession or in that of a third person to whom it has been delivered, until th e debt is paid. Article 2099. The creditor shall take care of the thing pledged with the diligence of a good father of a family; he has a right to the reimburse ment of the expenses made for its preservation, and is liable for its loss or de terioration, in conformity with the provisions of this Code. Article 2100. The p ledgee cannot deposit the thing pledged with a third person, unless there is a s tipulation authorizing him to do so. The pledgee is responsible for the acts of his agents or employees with respect to the thing pledged. Remedy of pledgor if pledgee deposits it with a third party without authority? The pledgor may demand extrajudicial deposit of the thing under 2104 or deposit with a third person/s in 2106. If the pledgee deposits the thing with a third person without authoriza tion, can the pledgor demand resolution of the pledge agreement? Yes. Substantia l breach under 1191 gives the injured party the right to resolve the obligation. It can be argued that the principal consideration was that the custodian be the pledgee; now if the creditor transfers possession, it's a principal breach. Artic le 2101. The pledgor has the same responsibility as a bailor in commodatum in th e case under article 1951. [The pledgor who, knowing the flaws of the thing pled ged, does not advise the pledgee of the same, shall be liable to the latter of t he damages which he may suffer by reason thereof.] Article 2102. If the pledge e arns or produces fruits, income, dividends, or interests, the creditor shall com pensate what he receives with those which are owing him; but if none are owing h im, or insofar as the amount may exceed that which is due, he shall apply it to the principal. Unless there is a stipulation to the contrary, the pledge shall e xtend to the interest and earnings of the right pledged. Cayo IID 2002 PAGE 35

In case of a pledge of animals, their offspring shall pertain to the pledgor or owner of animals pledged, but shall be subject to the pledge, if there is no sti pulation to the contrary. The creditor who receives the fruits should apply them to whatever amount is owing (obligations due and payable), if not due, the frui ts just form part of the pledge. If the period is for the benefit of the pledgee , even if the obligation is not due, he may compensate against the interest or t he principal, as the case may be. Ex: Lender lends Borrower money, payable upon demand. To secure the loan, B pledges a goat. Here the benefit of the period is for the creditor, L. L may then take the goat's milk and offspring and compensate against what is owing him even if the obligation is not yet due. Article 2103. U nless the thing pledged is expropriated, the debtor continues to be the owner th ereof. Nevertheless, the creditor may bring the actions which pertain to the own er of the thing pledged in order to recover it from, or defend it against a thir d person. If the thing is expropriated, the thing will continue with respect to the thing given. labo! Article 2104. The creditor cannot use the thing pledged, without the authority o f the owner, and if he should do so, or should misuse the thing in any other way , the owner may ask that it be judicially or extrajudicially deposited. When the preservation of the thing pledged requires its use, it must be used by the cred itor but only for that purpose. The creditor can only use the thing if he is aut horized or its preservation requires use. If he misuses it, the pledgor can dema nd extrajudicial deposit. Article 2105. The debtor cannot ask for the return of the thing pledged against the will of the creditor, unless and until he has paid the debt and its interest, with expenses in a proper case. Article 2106. If thr ough the negligence or willful act of the pledgee, the thing pledged is in dange r of being lost or impaired, the pledgor may require that it be deposited with a third person. Though the pledgor cannot demand return of the thing unless the o bligation is fulfilled, if the thing pledged is in danger of being lost or impai red through the pledgee's willful act or negligence, he may require its deposit wi th a third person. Article 2107. If there are reasonable grounds to fear the des truction or impairment of the thing pledged, without the fault of the pledgee, t he pledgor may demand the return of the thing, upon offering another thing in pl edge, provided the latter is of the same kind as the former and not of inferior quality, and without prejudice to the right of the pledgee under the provisions of the following article. The pledgee is bound to advise the pledgor, without de lay, of any danger to the thing pledged. Article 2108. If, without the fault of the pledgee, there is danger of destruction, impairment, or diminution in value of the thing pledged, he may cause the same to be sold at a public sale. The pro ceeds of the auction shall be a security for the principal obligation in the sam e manner as the thing srcinally pledged. If the thing is in danger of diminutio n or destruction, without the pledgee's fault, the pledgor may demand its return, provided he replaces it with another of the same kind and quality. Despite the p ledgor's right above, in the same situation, the pledgee may opt to sell the thing and keep the proceeds; the pledgee's right takes precedence over the pledgor's. In this case, the proceeds of the sale shall be security for the debt. In 2108, upo n due date, if the cash value is less than the principal obligation, the credito r can still recover the balance from the debtor, unlike in foreclosure. this loo ks important. Cayo IID 2002 PAGE 36

The pledgor can question the sale, alleging that he could have obtained a better price. Article 2109. If the creditor is deceived on the substance or quality of the thing pledged, he may either claim another thing in its stead, or demand im mediate payment of the principal obligation. This is an instance where the debto r loses the benefit of the period: If the debtor dupes the creditor as to the qu ality of the thing, the creditor may demand immediate payment or delivery of ano ther security. Article 2110. If the thing pledged is returned by the pledgee to the pledgor or owner, the pledge is extinguished. ANY STIPULATION TO THE CONTRAR Y SHALL BE VOID. If subsequent to the perfection of the pledge, the thing is in the possession of the pledgor or owner, there is a prima facie presumption that the same has been returned by the pledgee. This same presumption exists if the t hing pledged is in the possession of a third person who has received it from the pledgor or owner after the constitution of the pledge. If after the perfection of the pledge, the property is in the possession of the pledgor, as owner, the p resumption is that it was returned and extinction of the pledge, UNLESS the owne r holds it as agent of the pledgee. *Article 2111. A statement in writing by the pledgee that he renounces or abandons the pledge is sufficient to extinguish th e pledge. For this purpose, neither the acceptance by the pledgor or owner, nor the return of the thing pledged is necessary, the pledgee becoming a depositary. PROBLEM: TO SECURE HIS LOAN, BORROWER PLEDGED HIS CAR TO LENDER. OUT OF THE KIN DNESS OF HIS HEART, LENDER COMPOSED A LETTER RENOUNCING THE PLEDGE. HE USED THE CAR TO DRIVE TO THE POST OFFICE AND MAILED THE LETTER. WHILE DRIVING HOME, LENDE R SPOTTED BORROWER WITH LENDER'S WIFE AND FELT VERY ANGRY AND JEALOUS. WHEN BORROW ER RECEIVED THE LETTER, HE WENT TO LENDER'S HOUSE TO RECOVER THE CAR BUT LENDER RE FUSED AND TOLD BORROWER TO PISS OFF. CAN LENDER REFUSE TO RETURN THE CAR? No. Se e Article 2111. Article 2112. The creditor to whom the credit has not been satis fied in due time, may proceed before a Notary Public to the sale of the thing pl edged. This sale shall be made at a public auction, and with notification to the debtor and the owner of the thing pledged in a proper case, stating the amount for which the public sale is to be held. If at the first auction the thing is no t sold, a second one with the same formalities shall be held; and if at the seco nd auction there is no sale either, the creditor may appropriate the thing pledg ed. In this case he shall be obliged to give an acquittance for his entire claim . WHAT ARE THE FORMALITIES REQUIRED FOR THE NOTARIAL SALE? (1) the debt is due a nd unpaid; (2) the sale must be at a public auction; (3) there must be notice to the pledgor and owner, stating the amount due; and (4) the sale must be with th e intervention of a notary public. How is the public sale conducted? Default rul e: Proceed before a Notary Public and ask him to conduct a notarial sale. The no tary supervises the sale of the pledged property, drafts the rules and notifies the debtor and the owner. Is there a period required for notification? Cayo IID 2002 PAGE 37

No particular period is required by law. Notice can be given right before close of office the day preceding the sale. Before that date, debtor already defaulted ; he should have known a notarial sale was forthcoming. The reason, according to JPSP, is, if there were a period, the pledgor would be able to litigate and obt ain an injunction. Can it be a private sale? Ex: stocks pledged, listed on the P SE and just coursed through a broker. Yes ± there is no express prohibition. But s ee the de Leon book under Article 2112. Exception to pactum commissorium if the thing is not sold after two sales, the creditor may appropriate the thing and it shall be considered as full payment for the entire obligation. Article 2113. At the public auction, the pledgor or owner may bid. He shall, moreover, have a be tter right if he should offer the same terms as the highest bidder. The pledgee may also bid, but his offer shall not be valid if he is the only bidder. The ple dgor is allowed to bid and all things being equal, his bid shall be preferred ov er that of others. The law wants to conserve the property in the owner. The pled gee may also bid, but his offer shall not be valid if he is the only bidder beca use the law seeks to prevent fraud. Fraud is possible if the parties had stipula ted that the debtor shall be allowed to the excess and the creditor, who is bidd ing alone, bids low. Article 2114. All bids at the public auction shall offer to pay the purchase price at once. If any other bid is accepted, the pledgee is de emed to have been received the purchase price, as far as the pledgor or owner is concerned. Pledgee can waive cash requirement, but that is his lookout. Article 2115. The sale of the thing pledged shall extinguish the principal obligation, whether or not the proceeds of the sale are equal to the amount of the principal obligation, interest and expenses in a proper case. If the price of the sale is more than said amount, the debtor shall not be entitled to the excess, unless i t is otherwise agreed. If the price of the sale is less, neither shall the credi tor be entitled to recover the deficiency, notwithstanding any stipulation to th e contrary. The obligation is extinguished when the pledge is sold regardless of whether the proceeds are less or more than the amount of the obligation. Unlike in a mortgage, there can be recovery of deficiency. IN PLEDGE, YOU CAN STIPULAT E THAT THE DEBTOR WILL BE ENTITLED TO THE EXCESS BUT YOU CAN'T STIPULATE THAT THE CREDITOR WILL BE ALLOWED TO RECOVER DEFICIENCY. PROBLEM: IN THE PLEDGE AGREEMENT , THE PARTIES STIPULATED THAT, IN CASE OF NOTARIAL SALE, THE PLEDGOR SHALL BE EN TITLED TO THE EXCESS AND THE PLEDGEE SHALL BE ENTITLED TO RECOVER THE DEFICIENCY . ARE THE STIPULATIONS VALID? The stipulation that the debtor shall be entitled to the excess is valid. The stipulation giving the creditor the right to recover the deficiency is void. See Article 2115. HOW DO YOU GUARD AGAINST THE SITUATIO N OF NOT BEING ABLE TO RECOVER THE DEFICIENCY IF YOU ARE THE PLEDGEE? Set a mini mum bid (if this is actually allowed; JPSP says yes, book says no) OR Instead of selling the thing, just sue for the entire obligation. Cayo IID 2002 PAGE 38

OR Stipulate that if the value of the pledge goes under a certain amount, then t he debtor shall be obliged to pledge additional securities. Ex: 1M obligation, 1 .5M worth of stocks pledged; stipulate that if the value goes below 1.3M then th e debtor will be obliged to pledge additional securities. Without such a stipula tion, can Article 2108 have the same effect? Ex: 1M obligation, 1.5M worth of st ocks pledged. When the stocks go down top 1.4M, can you claim that the value of the pledge is diminishing and then choose to sell the stocks for 1.4M, keeping t he profits as security, pursuant to 2108? JPSP says: ªMaybe but speculative.º Probab ly not if the change in price is just a day-to-day fluctuation. PROBLEM: 1M IS S ECURED BY A 700K MORTGAGE AND A 900K PLEDGE. IF YOU ARE THE LENDER, AND THE BORR OWER DEFAULTS, WHICH SECURITY TO YOU GO AFTER FIRST? Go against the REM first, t hen take the whole pledge and make $$$! In REM, unlike in pledge, the debtor is entitled to the excess and the creditor is entitled to recover the deficiency, a s a default rule. Article 2116. After the public auction, the pledgee shall prom ptly advise the pledgor or owner of the result thereof. This is to allow the deb tor to take reasonable steps if he suspects that the sale was not honest. Articl e 2117. Any third person who has any right in or to the thing pledged may satisf y the principal obligation as soon as the latter becomes due and demandable. The creditor cannot refuse payment by a third person WITH AN INTEREST in the thing pledged. Third party can be a buyer of the thing or someone with a junior lien. Why would a third person with a junior lien want to pay the obligation? The prop erty may be more valuable than the obligation and he may want his lien to become senior. Article 2118. If a credit which has been pledged becomes due before it is redeemed, the pledgee may collect and receive the amount due. He shall apply the same to the payment of his claim, and deliver the surplus, should there be a ny, to the pledgor. Under this article, the thing pledged is a credit which has become due. The creditor can thus collect the amount due and compensate, DELIVER ING THE SURPLUS TO THE DEBTOR. The pledgee has the duty to collect any due credits, in line with the ordinary d iligence required of him. Article 2119. If two or more things are pledged, the p ledgee may choose which he will cause to be sold, unless there is a stipulation to the contrary. He may demand the sale of only as many of the things as are nec essary for the payment of the debt. PROBLEM: A 1.5M DEBT IS SECURED BY 2M WORTH OF SMC SHARES. IF YOU ARE THE PLEDGEE, HOW WOULD YOU SELL? Sell all. You are not required to sell by piece. Pledgor can restrict only if there are two pledges s ecuring the obligation. Article 2120. If a third party secures an obligation by pledging his own movable property under the provisions of article 2085 he shall have the same rights as a guarantor under articles 2066 to 2070, and articles 20 77 to 2081. Cayo IID 2002 PAGE 39

He is not prejudiced by any waiver of defense by the principal obligor. The thir d party pledgor is entitled to: 1. 2. 3. 4. 5. 6. 7. Indemnity; Subrogation; Ple dgor is released if creditor accepts property in payment of debt; Release in fav or of one pledgor benefits all; Extension granted to debtor extinguishes pledge; Pledgors are released from obligation if by some act of the creditor, there can be no subrogation; Pledgor may set up defenses inherent in the debt. Article 2121. Pledges created by operation of law, such as those referred to in articles 546, 1731, and 1994, are governed by the foregoing articles on the poss ession, care and sale of the thing as well as on the termination of the pledge. However, after payment of the debt and expenses, the remainder of the price of t he sale shall be delivered to the obligor. Article 2122. A thing under a pledge by operation of law may be sold only after demand of the amount for which the th ing is retained. The public auction shall take place within one month after such demand. If, without just grounds, the creditor does not cause the public sale t o be held within such period, the debtor may require the return of the thing. In pledges by operation of law, the remainder of the sale price shall be delivered to the debtor. The foregoing articles govern the following pledges by operation of law; BUT after sale, the excess, if any, is returned to the pledgor: · · · · · Possessor in good faith may retain the thing on which he spent for necessary exp enses until he is reimbursed. He who works on a movable may retain the same unti l paid for the work. Depositary may retain thing until paid for the deposit. Age nt may retain objects of agency until reimbursed by principal. Laborer's wages are considered a lien on goods manufactured or work done. I think creditor will be entitled to recover because here, he did not How about any deficiency? accept the pledge voluntarily and the reason for prohibiting rec overy is absent (the reason being that creditors should know not to lend more th an what can be secured). Article 2123. With regard to pawnshops and other establ ishments, which are engaged in making loans secured by pledges, the special laws and regulations concerning them shall be observed, and subsidiarily, the provis ions of this Title. Cayo IID 2002 PAGE 40

REAL MORTGAGE Art. 2124. Only the following property may be the object of a contract of mortga ge: (1) Immovables; (2) Alienable real rights in accordance with the laws, impos ed upon immovables. Nevertheless, movables may be the object of a chattel mortga ge. Mortgage (def). A real estate mortgage is a contract whereby the debtor secu res to the creditor the fulfillment of a principal obligation, specially subject ing to such security immovable property or real rights over immovable property i n case the principal obligation is not complied with at the time stipulated. What are the characteristics of the contract of mortgage? Mortgage is a real, accessory, and subsidiary contract. Who takes possession of the mortgaged property? As a general rule, the mortgagor retains possession of the property mortgaged. H owever, it is not an essential requisite of the contract of mortgage that the pr operty remains in the possession of the mortgagor. If the mortgagor delivers the property to the mortgagee, it can still be a contract of mortgage, plus some ot her contract. What is the consideration in a contract of mortgage? Since mortgage is an accessory contract, the consideration is the same as that o f the principal contract. What are the kinds of real mortgage? 1. Voluntary ± Agreed to between the parties or constituted by the will of the own er of the property 2. Legal ± Required by law to be executed in favor of certain p ersons 3. Equitable ± Lacks the proper formalities of mortgage but shows the inten tion of the parties to make the property as a security for a debt. What is the subject matter of real mortgage 1. Immovables 2. Alienable rights imposed upon immovables Can you mortgage future property? Future property CANNOT be the object of a contract of mortgage. One cannot const itute a mortgage on ªany other property he might have now and those he might acqui re in the Cayo IID 2002 PAGE 41

future.º Remember that one of the essential requisites of mortgage is that the mor tgagor should be the absolute owner of the thing mortgaged. But a stipulation wh ich says that the mortgage covers future improvements upon real property already mortgaged is valid. This is because these future improvements are deemed includ ed in the real property by accession; they are not separate from the real proper ty already subject of the mortgage. Art. 2125. In addition to the requisites sta ted in Article 2085, it is indispensable, in order that a mortgage may be validl y constituted, that the document in which it appears be recorded in the Registry of Property. If the instrument is not recorded, the mortgage is nevertheless bi nding between the parties. The persons in whose favor the law establishes a mort gage have no other right than to demand the execution and the recording of the d ocument in which the mortgage is formalized. Art. 1357. If the law requires a do cument or other special form, as in the acts and contracts enumerated in the fol lowing article, the contracting parties may compel each other to observe that fo rm, once the contract has been perfected. This right may be exercised simultaneo usly with the action upon the contract. Art. 1358. The following must appear in a public document: (1) Acts and contracts which have for their object the creati on, transmission, modification, or extinguishment of real rights over immovable property¼ What are the requisites of real mortgage? 1. It must be constituted to secure a principal obligation. 2. The mortgagor mus t be the absolute owner of the thing mortgaged. 3. He must have free disposal of the thing or otherwise be authorized to do so. 4. When the principal obligation becomes due, the property mortgaged may be alienated for the payment to the cre ditor. 5. To prejudice third persons, the mortgage must be recorded in the Regis try of Property. If the first four requisites are present, there is already a va lid mortgage between the parties ± mortgagor and mortgagee. But to affect third pe rsons, there is a need to comply with the fifth requisite: The document of mortg age must be recorded in the Registry of Property. This is because recording the document in the Registry of Property serves as notice to 3rd persons. This is si milar to the requirement in pledge that the pledge be in a public document. Can there be an oral mortgage? Cayo IID 2002 PAGE 42

As between the parties, YES. As long as the four essential requisites above are present, there is already a mortgage between the parties. It need not be in writ ing in order to be enforceable since it is not covered by the Statute of Frauds. But the oral mortgage is not binding against third persons. And the mortgagee c annot register the mortgage in the Registry of Property if it is an oral mortgag e. So his remedy is to invoke Art. 1357 and 1358. 1357 provides that if there is already a valid contract, one party can compel the other party to observe the p roper form. In this case, since there is already a valid mortgage between the pa rties, the mortgagee can compel the mortgagor to execute a public document of mo rtgage, so that the mortgagee can then register it in the Registry of Property. Remember that 1357 is only for convenience. Its purpose is to compel the mortgag or to execute a public document, so that the mortgagee can register the mortgage . It does not determine the validity or even the enforceability of the mortgage between the parties. Before you can invoke it, there has to be a valid mortgage first. Once the previously oral mortgage is in a public document and is subseque ntly registered in the Registry of Property, it becomes binding on third persons . Procedure: What happens when you enter into a contract of mortgage? Step 1: Execute the document of mortgage Step 2: Go to a notary public, who will notarize the document. Step 3: Pay the documentary stamp tax within the first f ive days of the succeeding month. The doc stamp tax is a percentage of the value of the property mortgaged. Step 4: Go to the Office of the Register of Deeds an d pay the registration fees. Before you pay the registration fees, the governmen t will require you to update payment of realty taxes on the property. After paym ent of the registration fees, the mortgage will be annotated on the title. Probl em: Mortgagor mortgages a house and lot worth 500K to Mortgagee to secure a prin cipal obligation of ª100K and any and all future indebtedness.º The mortgage is regi stered. Meanwhile, Mortgagor owes another creditor, X, 500K. The total indebtedn ess of Mortgagor to Mortgagee eventually reaches 500K. On due date, Mortgagor fa ils to pay both X and Mortgagee. The house and lot is his only property. X is ab le to obtain a writ or attachment on the house and lot. Who has a better right t o the house and lot ± X or mortgagee? Mortgagee has a better right with respect on ly to 1/5 of the house and lot. This is because the mortgage was registered only to the extent of 100K, and not to the ªany and all future debts.º Therefore, the mo rtgage is binding on third persons only with respect to the 100K debt, or 1/5 of the house. X can argue on two grounds: 1. That Mortgagee paid doc stamp taxes b ased only on the 100K debt, not on the succeeding 400K debt. So he even cheated the government of its revenues in this case. Cayo IID 2002 PAGE 43

2. Besides, at the time of the mortgage, the 400K debt was non-existent. Therefo re, X has a better right with respect to the 4/5 which was not registered. How d oes mortgagee opt out of this problem? 1. He can do a credit line arrangement in which he will give the debtor a ceiling up to which he can borrow. The mortgage deed will say that the principal obligation is 500K, but debtor has the choice of asking for a release of funds below this ceiling. This way, the mortgagee is sure that the entire 500K loan is registered. But this is costly, since the doc stamp tax will be based on the ceiling and not on the actual amount released. 2. The better solution is that the mortgagee should execute and register a new doc ument each time he releases funds to the mortgagor/debtor. What happens if the mortgage is void? If for some reason, the mortgage is void, the principal obligation subsists. Wha t is lost is only the right of the creditor to foreclose the mortgage in order t o satisfy the principal obligation. Moreover, even if the mortgage itself is voi d, the mortgage deed remains as proof of the principal obligation. Art. 2126. Th e mortgage directly and immediately subjects the property upon which it is impos ed, whoever the possessor may be, to the fulfillment of the obligation for whose security it was constituted. In guaranty, the property of the guarantor is not subjected to a lien. The action of the creditor is against the guarantor himself and not against his property. The creditor would still have to sue the guaranto r, obtain judgment, execute it, etc. On the other hand, in mortgage, the propert y is subjected to a lien. It creates a real right which is inseparable from the property mortgaged. It is enforceable against the whole world (provided it is re gistered). Until the principal obligation is discharged, the mortgage follows th e property wherever it goes and subsists even if the ownership changes. So if th e mortgagor sells the mortgaged property, the property still remains subject to the fulfillment of the obligation secured by it. All subsequent purchasers must respect the mortgage, as long as it is registered, or even if it is not register ed, if the purchaser knew that it was mortgaged. The mortgagee has a right to re ly in good faith on what appears on the certificate of title of the mortgagor. I n the absence of anything to excite suspicion, he is under no obligation to look beyond the certificate. Does the mortgagor lose his title to the property mortgaged? No. A mortgage does not involve a transfer, cession, or conveyance of property b ut only constitutes a lien thereon. It does not extinguish the title of the debt or. The mortgagor/debtor continues to be the owner. The only right of the mortga gee is to foreclose the mortgage and sell the property to satisfy the obligation . The mortgagor's default does not operate to vest in the mortgagee the ownership of the encumbered property. Cayo IID 2002 PAGE 44

Since the mortgagor retains ownership of the mortgaged property, he can even mor tgage it again to another mortgagor (junior lien/encumbrance). Art. 2127. The mo rtgage extends to the natural accessions, to the improvements, growing fruits, a nd rents or income not yet received when the obligation becomes due, and to the amount of the indemnity granted or owing to the proprietor from the insurers of the property mortgaged, or in virtue of expropriation for public use, with the d eclarations, amplifications and limitations established by law, whether the esta te remains in the possession of the mortgagor, or it passes into the hands of a third person. Future property, in themselves, cannot be the subject matter of mo rtgage. But, the future improvements, accessions, and fruits of property already mortgaged are also covered by the mortgage. This is because they are deemed to be part of the principal thing which was already existing at the time of the con stitution of the mortgage. To exclude these things, there must be an express sti pulation to that effect. Examples: 1. The mortgage deed contains a provision tha t ªall property taken in exchange or replacement, as well as all buildings, machin eries, and, equipment, and others that the mortgagor may acquire, construct, ins tall, attach, or use in its lumber concession shall immediately become subject t o the mortgage.º This is a valid stipulation, especially where the property mortga ged is subject to deterioration (such as machinery and equipment). The purpose o f this stipulation is to maintain the value of the property mortgaged. 2. JPSP e xample: In the mortgage deed, Mortgagor mortgages house and lot #1 and another h ouse and lot which he will acquire next month. The deed is registered. Is this a valid mortgage? Between mortgagor and mortgagee, the mortgage is valid with res pect to both house and lot #1 and #2. The remedy of the mortgagee, once mortgago r acquires the second house and lot, is to compel the mortgagor to execute a pub lic document evidencing the mortgage of the 2nd house and lot and to register it , so that it would be binding on third parties. But, as against third parties, t he mortgage is only valid with respect to the first house and lot but not to the second house and lot, until the latter is registered. What happens if the thing mortgaged is expropriated? The security becomes the cash given by the government as indemnity. Upon default , the mortgagee can apply the cash as payment for the obligation. Art. 2128. The mortgage credit may be alienated or assigned to a third person, in whole or in part, with the formalities required by law. Cayo IID 2002 PAGE 45

The mortgage credit is a real right, and under property law, real rights over im movables are also considered immovables in themselves. Thus, they may be alienat ed or assigned to third persons, in whole or in part, by the mortgagee who is th e owner of the right. The assignee may then foreclose the mortgage in case of no npayment of the principal obligation. The alienation or assignment of the mortga ge credit is valid even if it is not registered. Registration is only necessary to affect third persons. Art. 2129. The creditor may claim from a third person i n possession of the mortgaged property, the payment of the part of the credit se cured by the property which said third person possesses, in the terms and with t he formalities which the law establishes. Art. 2129 does not really apply to all third persons in possession of the property. It only applies to those in posses sion of the mortgaged property in the concept of owner. If the possession by a t hird person is only as lessee, the creditor may not collect the credit from that third person. When a mortgagor alienates/sells the mortgaged property to a thir d person, the creditor may demand from him the payment of the principal obligati on. This is because the mortgage credit is a real right, which follows the prope rty wherever it goes, even if its ownership changes. However, before the credito r can collect from the third person, he must have made a demand on the debtor, a nd the latter should have failed to pay. Example: A mortgaged his land worth P5M in favor of B to secure a debt of P6M. A sold the land to C. On due date, B should demand payment of the P6M from A. If A fails to pay, B may foreclose the mortgage. B may also choose to collect P5M (not P6M) from C, whic h is the part of the principal obligation secured by the property sold to C. C i s not liable for the deficiency of P1M in the absence of a contrary stipulation. If C pays B, C can go after A for reimbursement. Art. 2130. A stipulation forbi dding the owner from alienating the immovable mortgaged shall be void. A stipula tion forbidding the owner from alienating the mortgaged property is void for bei ng contrary to public policy because it is an undue impediment or interference o n the transmission of property. However, if the mortgagor alienates the property , the transferee must respect the mortgage because it is a real right. A stipula tion that requires the mortgagor to notify the mortgagee in writing before he se lls the property is VALID. This is not a prohibition but a mere regulation. The mortgagee would want to regulate the disposition of the property by the mortgago r because first, he would want to know the type of person from whom he might hav e to collect the credit later on. Second, any disposition of the mortgaged prope rty by the mortgagor is a red flag that may indicate that the mortgagor/debtor m ay not be able to pay the debt later on (Because why is he suddenly disposing of his property? Maybe he doesn't have money anymore.) Art. 2131. The form, extent a nd consequences of a mortgage, both as to its constitution, modification and ext inguishment, and as to the other matters not included in this Chapter shall be g overned by the provisions of the Mortgage Law and of the Land Registration Law. Cayo IID 2002 PAGE 46

FORECLOSURE The essence of a mortgage is that upon default, the mortgagee can foreclose ± he c an sell the property and apply the proceeds of the sale to the payment of the pr incipal obligation. What is foreclosure? It is the remedy available to the mortgagee by which he subjects the mortgaged p roperty to the satisfaction of the obligation. It denotes the procedure adopted by the mortgagee to terminate the rights of the mortgagor on the property and in cludes the sale itself. How do you foreclose? There are two types of foreclosure ± judicial and extra-judicial foreclosure. The default rule is judicial foreclosure. You can only do extra-judicial foreclosure if the mortgage deed has a provision which gives the mortgagee the special powe r of attorney to sell the mortgaged property in accordance with Act 3135. But th ese are only default rules. The parties may also stipulate that the sale will be a private sale. Mortgage to a Foreigner ± RA 133 Can you mortgage to a foreigner? Yes, since foreigners are only prohibited from owning real property in the Phili ppines, not from being mortgagees. The situation is governed by RA 133. However, if the mortgagor defaults, the foreigner CANNOT foreclose extra-judicially. He can only foreclose judicially. Moreover, he cannot bid or take part in any sale of the real property in case of foreclosure. Can the foreigner take possession of the property during the mortgage? Pursuant to the mortgage, the alien-mortgagee cannot take possession of the prop erty during the mortgage. But, he can possess it as lessee. Can the foreigner take possession of the property upon default of the mortgagor? The foreigner can take possession of the mortgaged property upon default but onl y for the purpose of foreclosure and receivership in accordance with the prescri bed judicial procedures, AND in no case exceeding five years. When confronted with a foreclosure problem¼ Cayo IID 2002 PAGE 47

First, check if there's a stipulation saying that there will be a private sale. If there is such a stipulation, the property can be sold at a private sale. If the re is no such stipulation, then there will be either judicial or extra-judicial foreclosure. Second, look for the following tell-tale signs: 1. Is the mortgagee a foreigner? If it's a foreigner, it's automatically judicial foreclosure (Act 133) . 2. If the mortgagee is not a foreigner, look for a stipulation in the mortgage agreement which gives the mortgagee the special power of attorney to carry out the extrajudicial foreclosure in accordance with Act 3135. If you find this stip ulation, it is an extra-judicial foreclosure. 3. If there is no stipulation for extra-judicial foreclosure under Act 3135, it is a judicial foreclosure governed by Rule 68 of the Rules of Court. Third, if it's an extra-judicial foreclosure, l ook at the parties. Who is foreclosing? 1. If it is a bank, the governing law is Act 3135, but there will be certain exceptions applicable only to banking insti tutions, provided in Section 47 of the General Banking Act. 2. If the mortgagee is not a bank, the extra-judicial foreclosure will be governed by Act 3135. Four th, now that you know whether it's judicial or extra-judicial foreclosure, let's go through each of the processes¼ JUDICIAL FORECLOSURE UNDER RULE 68, RULES OF COURT STEP 1: The mortgagee should file a petition for judicial foreclosure in the cou rt which has jurisdiction over the area where the property is situated STEP 2: T he court will conduct a trial. If, after trial, the court finds merit in the pet ition, it will render judgment ordering the mortgagor/debtor to pay the obligati on within a period not less than 90 nor more than 120 days from the finality of judgment. STEP 3: Within this 90 to 120 day period, the mortgagor has the chance to pay the obligation to prevent his property from being sold. This is called t he EQUITY OF REDEMPTION PERIOD. STEP 4: If mortgagor fails to pay within the 90-120 days given to him by the cou rt, the property shall be sold to the highest bidder at public auction to satisf y the judgment. STEP 5: There will be a judicial confirmation of the sale. After the confirmation of the sale, the purchaser shall be entitled to the possession of the property, and all the rights of the mortgagor with respect to the proper ty are severed or terminated. The equity of redemption period actually extends u ntil the sale is confirmed. Even after the lapse of the 90 to 120 day period, th e mortgagor can still redeem the property, so long as there has been no confirma tion of the sale yet. Therefore, the equity of Cayo IID 2002 PAGE 48

redemption can be considered as the right of the mortgagor to redeem the propert y BEFORE the confirmation of the sale. IMPORTANT: After the confirmation of the sale, the mortgagor does not have a right to redeem the property anymore. This i s the general rule in judicial foreclosures ± there is no right of redemption afte r the sale is confirmed. The exception to this rule is when the judicial foreclo sure is done by a BANK. In such a case, there is still a right of redemption wit hin one year from the registration of the sale. STEP 6: The proceeds of the sale of the property will be disposed as follows: 1. First, the costs of the sale wi ll be deducted from the price at which the property was sold 2. The amount of th e principal obligation and interest will be deducted 3. The junior encumbrances will be satisfied 4. If there is still an excess, the excess will go back to the mortgagor. In mortgage, the mortgagee DOES NOT get the excess (unlike in pledge ). If there is a deficiency, the mortgagee can ask for a DEFICIENCY JUDGMENT whi ch can be imposed on other property of the mortgagor. This is unlike the rule in pledge, where the pledgee cannot collect any deficiency. This is also unlike th e rule in extra-judicial foreclosure where the mortgagee must go to court and fi le another action for the collection of the deficiency. In this case, there is n o need to file an action. The mortgagee just has to file a motion in court for t he deficiency judgment. Why should you stay away from judicial foreclosure? Judicial foreclosure is costly, since the parties would need to hire lawyers. Mo reover, in judicial foreclosure, the parties have very little control over the s ale because there is court intervention. Judicial foreclosure is also more susce ptible to stalling/dilatory tactics by the mortgagor, since he can file all sort s of motions in court to prevent the sale. EXTRA-JUDICIAL FORECLOSURE UNDER ACT 3135 When is extra-judicial foreclosure proper? There must be a provision in the mortgage giving the mortgagee the special power of attorney to carry out the extra-judicial foreclosure under Act 3135. Where should the sale be made? The sale can only be made in the province where the property is situated. So if several properties located in different provinces are mortgaged to secure one pr incipal obligation, the creditor must foreclose in each and every jurisdiction w here the property is located. Cayo IID 2002 PAGE 49

What is the procedure? STEP 1: File a complaint for extra-judicial foreclosure w ith the Executive Judge STEP 2: Notice of the sale There are two kinds of notices required: 1. Posting in at least 3 public places 20 days before the sale ± usually in the Sheriff's office, the Assessor's office, and the Register of Deeds. 2. Publication in a newspaper of general circulation, onc e a week for at least three consecutive weeks if the value of the property excee ds P400 This need not be done within a span of 21 days. For example, you can pub lish on August 30, which is a Friday, then on September 2, which is a Monday, an d then on September 9, which is also a Monday. In this case, publication for thr ee consecutive weeks is completed within 11 days. The notice should contain the description of the property to be sold, date, time, and place of the sale, and t he principal obligation to be satisfied by the sale of the mortgaged property. T here is no need for personal notice to the mortgagor, unlike in a guaranty. This is because the mortgagor, having defaulted in the principal obligation, should expect that a foreclosure is forthcoming. This is because the mortgagor, having defaulted in the principal obligation, should expect that a foreclosure is forth coming. If you're the mortgagee, you would want to surprise the mortgagor so the h e cannot employ dilatory tactics such as getting an injunction in order to delay the foreclosure. If you're nasty, you should publish it in Abante, which is a new spaper of general circulation, but which nobody consults for the purpose of chec king if their mortgaged property is about to be foreclosed. STEP 3: Public Aucti on Time for conducting the public sale: Between 9 am to 4 pm Manner of conductin g the sale: The sale should be under the direction of the sheriff of the provinc e, the justice or auxiliary justice of the peace of the municipality, or of a no tary public of the municipality, who shall be compensated with FIVE PESOS for ea ch day of actual work performed (wow $$$). Who may bid: Anyone may bid at the sa le, unless there are exceptions stipulated in the mortgage deed. Even the mortga gee/creditor may bid. And unlike in pledge, even if the mortgagee/creditor is th e sole bidder, the sale is still valid. This is because there is a right to rede em in extra-judicial foreclosure. Therefore, the lower the price at which it is sold, the better the chances of the mortgagor/debtor to redeem the property. Can the parties stipulate a minimum price at which the property shall be sold? Cayo IID 2002 PAGE 50

No, because the property must be sold to the highest bidder. Parties cannot, by agreement, contravene the law. However, this rule may not apply where the purcha ser happens to be the creditor or mortgagee himself. The mortgagor can argue tha t the stipulation should be binding on the mortgagee on the principle of estoppe l. What is the effect of inadequacy of the price at which the property is sold at a uction? If there is a right to redeem, inadequacy of price is not material because the d ebtor may reacquire the property. It will even make it easier for him to redeem it if it is sold at a low price. Mere inadequacy of price will not be sufficient to set aside the sale unless the price is so inadequate as to shock the conscie nce. What happens if there is an excess? The excess should first be applied to s atisfy the junior liens and encumbrances on the property. If there is still an e xcess, it goes to the mortgagor. What happens if there is a deficiency? The mortgagee must go to court and file an action to collect the deficiency. He may file an action for a deficiency judgment even during the period of redemptio n. STEP 4: Possession of the Property Upon foreclosure, if the mortgagor is in possession of the property, he will ret ain possession during the redemption period (one year from the date of the sale) . However, if the winning bidder already wants possession of the property, he ma y file a petition in court to gain possession. He must give a bond equivalent to the rent for the use of the property for 12 months. The bond will answer for an y loss to the mortgagor if it is later found that he was not in default in the m ortgage obligation or that the conduct of the sale violated Act 3135. Upon appro val of the bond, the court will issue a writ of possession in favor of the purch aser. Exception to this rule: If the party foreclosing is a BANK, Sec 47 of the General Banking Law provides that the purchaser shall immediately have the right to take possession of the property upon confirmation of the sale. Remedy of the Mortgagor If the winning bidder is able to obtain the writ of possession even before the e xpiration of the one-year period, the mortgagor may petition that the sale be se t aside and the writ of possession be cancelled on the ground that he was not in default or that the sale was not made in accordance with Act 3135. The petition must be filed within 30 days from the grant of the writ of possession. STEP 5: Redemption Cayo IID 2002 PAGE 51

The debtor has the right to redeem the property sold within one year from the da te of the sale, reckoned from date of execution of the certificate of sale since it is only from that date that the sale takes effect as a conveyance. Exception : If the mortgagee foreclosing is a BANK and the mortgagor is a JURIDICAL PERSON , the juridical person shall have the right to redeem the property BEFORE the re gistration of the certificate of sale but NOT EXCEEDING 90 DAYS FROM THE DATE OF THE FORECLOSURE. What is the difference between the RIGHT OF REDEMPTION and EQUITY OF REDEMPTION? The right of redemption is the right of the mortgagor to redeem the mortgaged p roperty within a certain period (in most cases, within 1 year) AFTER the sale of the property in satisfaction of the mortgage debt. It is available to the mortg agor only when the mortgage is foreclosed extrajudicially. It is not available i n judicial foreclosures, except when the mortgagee foreclosing is a bank. On the other hand, equity of redemption is the right of the mortgagor in a judicial fo reclosure to pay the amount of his obligation BEFORE the confirmation of the sal e of the mortgaged property. Who may redeem? The debtor, his successors in inter est, or any judicial creditor or judgment creditor of the debtor, or any person having a junior encumbrance or lien on the property may exercise the right of re demption. Example: Mortgagor mortgaged a house and lot to A. Later, Mortgagor al so mortgaged it to B. A foreclosed the mortgage and bought the house and lot at the auction. In this case, upon the sale of the property to A, the only right th at B as second mortgagee has is the right to redeem. He may exercise the right b y paying off the debt secured by the first mortgage. B's exercise of Mortgagor's equ ity of redemption is equivalent to foreclosure of the junior mortgage. How much should the one exercising the right of redemption pay? The mortgagor (or whoever is redeeming the property) should pay the PURCHASE PRICE of the property (not t he amount of the srcinal obligation anymore) plus INTEREST OF 1% PER MONTH (thi s is according to De Leon, citing Rule 39 Section 28 of the Rules of Court. JPSP says interest is at 2% per month). Exception: If the mortgagee foreclosing is a BANK, under Sec 47 of the General Banking Law, the mortgagor should pay the amo unt of the ORIGINAL OBLIGATION (not the purchase price) plus INTEREST AT THE ORI GINAL RATE stipulated in the mortgage contract plus all COSTS and expenses incur red by the bank from the sale of the property. What happens if the debtor/mortga gor fails to redeem the property within the prescribed period? If the debtor/mortgagor fails to redeem the property within the prescribed perio d, the purchaser has the absolute right to a writ of possession. From then on, t he mortgagor loses his right over the property. Cayo IID 2002 PAGE 52

Title to the property sold under a mortgage foreclosure remains with the mortgag or until the expiration of the redemption period. The right of the purchaser at the foreclosure sale is merely inchoate or contingent until after the period of redemption has expired without the right being exercised. When the debtor/mortga gor fails to redeem within the period for redemption, the purchaser's right become s final. What is the effect of the timely exercise of the right of redemption? If the debtor/mortgagor is able to exercise the right of redemption on time, he does not really recover property since he does not lose ownership until after th e expiration of the redemption period. He merely frees it of the encumbrance cre ated by the mortgage. What happens if the mortgagor sells the property to a third person within the re demption period? The third person, in buying the property, is actually buying not the property it self but the right to redeem the property and the right to possess it within the redemption period. X mortgaged property to a Bank to secure a P1M loan at 17% interest. The mortgag e was foreclosed. At the sale, the property was sold to the Bank as the highest bidder for P800K. The bank then sold the property to Y for P1.5M. If X wants to redeem the property, to whom should he pay and how much? X should pay to the Bank. He should pay only P1M - the amount of the principal o bligation plus interest at 17%, plus costs (Sec 47 General Banking Law: Remember , this is the exception to the general rule that the mortgagor should pay the pu rchase price and 1% interest per month). Y would then have a right to seek reimb ursement from the Bank. The right of redemption may be exercised by the mortgage e under the same terms, even if the property is subsequently sold to a third par ty. A different rule would make it easy for the buyer at the foreclosure sale to render the right of redemption nugatory simply by making a conveyance of the pr operty for an amount beyond the capacity of the mortgagor to pay. Can the right of redemption be waived by the mortgagor in advance? It depends if there is a fair exchange of value and information between the part ies. If the mortgagor is a farmer who mortgages his parcel of land and he waives the right to redeem, he can later argue that the waiver was not valid for being contrary to the public policy of preserving the property in the hands of the ow ner. But if the mortgagor is a businessman who waives the right to redeem in exc hange for lower interest rates, this waiver is valid because there is a fair exc hange of value. SUMMARY OF EXCEPTIONS UNDER SECTION 47 OF THE GENERAL BANKING LAW OF 2000 Cayo IID 2002 PAGE 53

When the party foreclosing the mortgage is a BANK, the same procedure as in judi cial or extrajudicial foreclosure, as the case may be, is followed. However, the following are the exceptions to the general rules, applicable only to banks: 1. In judicial foreclosures, there is still a right to redeem As a general rule, there is no right of redemption in judicial foreclosure. Upon confirmation of the sale, the mortgagor cannot redeem the property anymore. But if the mortgagor foreclosing judicially is a bank, the mortgagor shall have a right to redeem within one year from the sale. 2. Redemption Price In ordinary extra-judicial foreclosure, the redemption price is the purchase pri ce plus interest at 1% (or 2%?) per month. In extra-judicial foreclosure by a bank, the redemption price consists of: a. th e amount of the mortgage obligation b. plus the interest on the loan at the rate stipulated in the mortgage contract c. plus costs of the sale incurred by the b ank 3. Automatic Right of Possession In ordinary extra-judicial foreclosure, the mortgagor retains possession of the property within the redemption period. If the purchaser wishes to have possessio n within the redemption period, he must file a petition for the issuance of a wr it of possession with a corresponding bond. In extra-judicial foreclosure by a bank, the purchaser automatically has the rig ht to take possession after the confirmation of the sale. 4. Injunction If anybody wants to enjoin the conduct of foreclosure proceedings instituted by a bank, the petitioner must file a bond fixed by the court to satisfy whatever d amage the bank may suffer by the injunction. There is no such provision in the case of ordinary extra-judicial foreclosure. 5 . Period of Redemption for Juridical Persons In ordinary extra-judicial foreclosure, the mortgagor may redeem the property af ter it is sold within one year from the execution of the certificate of sale. Th ere is no distinction, whether the party redeeming is a natural or juridical per son. If the party foreclosing extrajudicially is a bank, the same rule as above is applicable to natural persons. BUT, juridical persons may redeem the property subject only to the following conditions: a. it must be BEFORE the registration of the sale Cayo IID 2002 PAGE 54

b. and, it must not be later than 90 days from the date of the sale EFFECTS ON THE JUNIOR MORTGAGE What happens if there was a second mortgage const ituted on the property that was foreclosed? If the property was mortgaged a seco nd time, the second mortgage is subordinate to the first mortgage. The first mor tgagor has the right to foreclose the mortgage upon default by the debtor. The f ollowing are the rights of a junior mortgagee: 1. If the first mortgagee foreclo ses judicially, before the sale is effected, the junior mortgagee may exercise t he equity of redemption vested in the mortgagor. The junior mortgagee may satisf y the obligation of the mortgagor to prevent the sale of the property. What happ ens to the ownership of the property when the second mortgagee exercises the rig ht of redemption? There are two interpretations ± one under the Rules of Court and another under the Civil Code. When the second mortgagee exercises the equity of redemption by paying the obligation of the mortgagor/debtor, the mortgagor/debt or has 60 days to reimburse the second mortgagee what he paid. If the srcinal d ebtor fails to pay within this period, ownership will be consolidated in the sec ond mortgagee who paid. This interpretation is according to Section 28 Rule 39 o f the Rules of Court. But according to the Civil Code rules on payment (oblicon) , the effect should be like payment of an obligation by a third person, in which case, the second mortgagee merely becomes subrogated in the right of the first mortgagee to foreclose the mortgage. 2. When an extra-judicial sale is made, the junior mortgagee may exercise the mortgagor's right to redeem within one year fro m the sale. De Leon says that he should pay the amount of the srcinal obligatio n. JPSP says that the junior mortgagee exercising the right to redeem should fol low Act 3135 ± he should pay the price at which the property was sold. 3. If the p roperty is sold for more than the amount of the obligation to the first mortgage e, the excess should be applied to the payment of the obligation to the second m ortgagee. But if there is no excess, the second mortgage is extinguished. If you'r e the second mortgagee, you can also foreclose, not the property (since you cann ot do that because the right of the first mortgagee is superior), but the Cayo IID 2002 PAGE 55

right of redemption instead. This is so that you would be the only one who can e xercise it when the proper time comes. CHATTEL MORTGAGE Art. 2140. By a chattel mortgage, personal property is recorded in the Chattel M ortgage Register as a security for the performance of an obligation. If the mova ble, instead of being recorded, is delivered to the creditor or a third person, the contract is a pledge and not a chattel mortgage. What is chattel mortgage? C hattel mortgage is the contract by virtue of which personal property is recorded in the Chattel Mortgage Register as a security for the performance of an obliga tion. This definition under the Chattel Mortgage Law is no longer applicable. It is the definition under Art. 2140 of the Civil Code that applies now. What are the characteristics of the contract of chattel mortgage? 1. It is an accessory c ontract because it secures performance of a principal obligation 2. It is a form al contract because it requires registration in the Chattel Mortgage Register fo r its validity (but only against third persons) 3. It is a unilateral contract b ecause it produces only obligations on the part of the creditor to free the thin g from the encumbrance on fulfillment of the obligation. What is the subject mat ter of chattel mortgage? The subject matter of chattel mortgage is personal or m ovable property. What are the requisites for a valid chattel mortgage? 1. It must be constituted to secure a principal obligation. 2. The mortgagor mus t be the absolute owner of the thing mortgaged. 3. He must have free disposal of the thing or otherwise be authorized to do so. 4. When the principal obligation becomes due, the property mortgaged may be alienated for the payment to the cre ditor. 5. To prejudice third persons, the mortgage must be recorded in the Chatt el Mortgage Registry. If the first four requisites are present, there is already a valid mortgage between the parties ± mortgagor and mortgagee. Cayo IID 2002 PAGE 56

But to affect third persons, there is a need to comply with the fifth requisite: The document of mortgage must be recorded in the Chattel Mortgage Registry. Thi s is because recording the document in the Chattel Mortgage Registry serves as n otice to 3rd persons. This is similar to the requirement in pledge that the pled ge be in a public document and the requirement in Real Estate Mortgage that it m ust be recorded in the Registry of Property. Note that unlike in pledge, there i s no need for actual delivery of the personal property to the mortgagee. DISTINCTIONS BETWEEN CHATTEL MORTGAGE AND PLEDGE DELIVERY OF THE PERSONAL PROPER TY REGISTRATION IN THE REGISTRY OF PROPERTY PROCEDURE FOR SALE RIGHT TO EXCESS O F PROCEEDS OF SALE RIGHT TO RECOVER DEFICIENCY CHATTEL MORTGAGE Not necessary Ne cessary for validity of the chattel mortgage against third persons Governed by S ection 14 of the Chattel Mortgage Law Excess goes to the debtor/mortgagor Credit or/mortgagee can recover deficiency from the debtor/mortgagor, except if covered by Recto Law PLEDGE Delivery is necessary for validity of the pledge Not necess ary; public document is enough to bind third persons Governed by Article 2112 of the Civil Code Excess goes to the pledgee/creditor unless otherwise stipulated Creditor/pledgee is not entitled to recover any deficiency after the property is sold, notwithstanding any contrary stipulation Art. 2141. The provisions of this Code on pledge, insofar as they are not in con flict with the Chattel Mortgage Law, shall be applicable to chattel mortgage. TH E CHATTEL MORTGAGE LAW How do you constitute a chattel mortgage? To constitute a chattel mortgage, the parties must register the personal property mortgaged in the Chattel Mortgage Register as security for the performance of an obligation. However, if the chattel mortgage is not registered, it is still valid and bindin g as between the parties. The requirement of registration is not for validity bu t only for binding third parties. What is the effect of registration? The regist ration of the chattel mortgage creates a real right or lien which follows the pe rsonal property wherever it goes. Registration gives the mortgagee symbolic poss ession. Cayo IID 2002 PAGE 57

What is the form required for a chattel mortgage? According to Sec. 5 of the Cha ttel Mortgage Law, the following form should be sufficient: FORM OF CHATTEL MORT GAGE AND AFFIDAVIT This mortgage made this Fifth day of October 2002 by Sheryl T anquilut, a resident of municipality of Taytay, Province of Rizal Philippines, m ortgagor, to Anna del Castillo a resident of the municipality of Cainta, Provinc e of Rizal Philippines, mortgagee, witnesseth: That the said mortgagor hereby co nveys and mortgages to the said mortgagee all of the following-described persona l property situated in the municipality of Taytay Province of Rizal, and now in the possession of said mortgagor, to wit: A PAIR OF SKY BLUE NIKE PRESTO SNEAKER S, SIZE 3XS This mortgage is given as security for the payment to the said Anna del Castillo, mortgagee, of the sum of fifty pesos, with interest thereon at the rate of twenty-five per centum per annum due on 25 December 2002. The condition s of this obligation are such that if the mortgagor, his heirs, executors, or ad ministrators shall well and truly perform the full obligation above stated accor ding to the terms thereof, then this obligation shall be null and void. Executed at the municipality of Taytay in the Province of Rizal this Fifth day of Octobe r 2002. In the presence of: Sgd. Xilca Alvarez Sgd. Helen Arevalo FORM OF OATH ( affidavit of good faith) [Tip: know the contents of an affidavit of good faith. JPSP might ask us to make one in the exam. Lumabas sa past exam] We severally sw ear that the foregoing mortgage is made for the purpose of securing the obligati on specified in the conditions thereof, and for no other purpose, and that the s ame is a just and valid obligation, and one not entered into for the purpose of fraud. FORM OF CERTIFICATE OF OATH In the Province of Rizal, personally appeared Sheryl Tanquilut, Xilca Alvarez, and Helen Arevalo, the parties who signed the foregoing affidavit and made oath to the truth thereof before me. Cayo IID 2002 PAGE 58 Sgd. Sheryl Tanquilut

Sgd. Bhoy-B Notary public Cayo IID 2002 PAGE 59

What happens if there is no affidavit of good faith? The mortgage is still valid between the parties, but it will not bind third persons, such as creditors and subsequent encumbrancers. If there is no affidavit of good faith, the mortgage w ill not be preferred as against these third persons. Can you constitute a chatte l mortgage to secure a future obligation or ªa current obligation plus any and all obligations hereinafter contracted by the mortgagor in favor of the mortgageeº? N o. You can only constitute a chattel mortgage to secure debts or obligations tha t are existing at the time the mortgage is constituted. If it is constituted to secure an obligation that is not yet existent, it is void. The affidavit of good faith executed by the mortgagor states that the mortgage is constituted to secu re the obligation specified therein and for no other purpose. What the parties s hould do is to execute a new document/ deed of chattel mortgage to cover the new ly contracted obligation. Can you mortgage future property? Section 7 of the Cha ttel Mortgage Law provides that as a general rule, you cannot mortgage property that you do not own at the time of the constitution of the mortgage. Therefore, you cannot mortgage future property. But as an exception to this rule, the inven tory of retail stores can be the subject of chattel mortgage, even if technicall y, they may be acquired by the mortgagor after the mortgage is constituted. This is because the after-acquired property is actually in renewal or in replenishme nt of goods on hand when the mortgage was executed. The SC came up with this exc eption in order not to hamper the circulation of capital in the industry. What h appens when the mortgagor pays the obligation? If the mortgagor pays the obligat ion, he gets a discharge from the mortgagee so that he can then cancel the lien annotated on the title and in the Chattel Mortgage Registry. What happens when t he mortgagor defaults on the obligation? 1. Right of Redemption In case of defau lt, the following persons may redeem the property before it is sold, by paying t he amount of the obligation plus costs and expenses incurred from the breach: a. the mortgagor b. a subsequent mortgagee c. a subsequent attaching creditor If a n attaching creditor redeems, he is subrogated to the rights of the mortgagor. H e can foreclose the mortgage. Cayo IID 2002 PAGE 60

But once the property is sold at auction, there can be no redemption anymore. 2. Right of Mortgagee to Possession If the creditor/mortgagee wants to foreclose u pon default, he has the implied right to take the mortgaged property. If the deb tor/mortgagor refuses to surrender the property, the creditor should file an act ion for replevin to take possession or for judicial foreclosure. 3. Foreclosure The parties can stipulate for a private sale upon default. If there is no stipul ation, the applicable rule is Section 14 of the Chattel Mortgage Law. According to Section 14, the creditor/mortgagee can cause the property to be sold at publi c auction thirty days after default. This is a minimum grace period given to the mortgagor to redeem the property before it is sold at auction. There is no maxi mum time period for holding the sale. The procedure is the same as that for extr a-judicial foreclosure of a real estate mortgage, except for the notice requirem ents. In chattel mortgage, the only notice requirement is posting at two or more public places in the municipality and personal notice to the mortgagor and juni or mortgagees at least ten days before the date of the sale (no publication). Th e proceeds of the sale will be applied as follows: a. Costs and expenses of the sale b. Payment of the obligation secured by the mortgage c. Claims of persons h olding subsequent mortgages in their order; and d. The balance, if any, shall be given to the mortgagor Can the mortgagee recover any deficiency after the sale of the property? Unlike in pledge, the creditor can still file an action for rec overy of any deficiency in case the proceeds of the sale do not satisfy the enti re obligation, unless the situation is covered by the Recto Law. PROBLEMS ON REA L AND CHATTEL MORTGAGE Mortgagor mortgaged property worth 120K to secure a 100K loan. Mortgagor defaulted. Mortgagee foreclosed. The property was sold to X for 70K. Should mortgagor redeem the property? Yes, because he can sell it for more than 70K and realize more than the amount of the principal obligation. But if, i n the example above, the mortgagor has creditors running after him for debts wor th 300K, should he redeem? Cayo IID 2002 PAGE 61

No, he should not redeem. If he redeems, he spends 70K in order to re-acquire pr operty, which he may thereafter lose again to his other creditors. Borrower borr ows P1M from Lender. Borrower executes a deed of assignment by way of security o ver the shares of stock in favor of Lender in order to secure payment of the loa n. It is stipulated that upon payment of the loan by Borrower, Lender will re-co nvey the shares of stock to Borrower. What is this arrangement? This can either be a PLEDGE or an IMPLIED TRUST. It's not really a pledge because there is an abso lute conveyance of ownership by the supposed pledgor in favor of the pledgee. Bu t the Supreme Court has treated this in several cases as a pledge. JPSP likes th e implied trust theory better because there is a statutory basis. Art. 1454 of t he Civil Code provides that if an absolute conveyance of property is made in ord er to secure the performance of an obligation of the grantor toward the grantee, a TRUST by virtue of law is established. If the fulfillment of the obligation i s offered by the grantor when it becomes due, he may demand the reconveyance of the property to him. If it's a trust, there is no need to foreclose (actually, the re's no right to foreclose). What happens if there's default? Art. 1454 does not cov er this situation, which is probably why the Supreme Court has characterized thi s type of transaction as a pledge instead. JPSP thinks that if there's default, ow nership will be consolidated in the lender/trustee. But if the parties don't want any problem, they should stipulate the precise effect of default. Borrower borro ws P10M from Lender. Borrower offers the following securities to Lender: (1) a G UARANTY by X who is worth P100M (2) a PLEDGE of shares of stock worth P10M (3) a REAL ESTATE MORTGAGE worth P15M Which one should Lender choose? It really depen ds on the circumstances, but here are the considerations: 1. If he chooses the p ledge, it is easier to foreclose, and he can get the excess in case the shares o f stock are sold for more than P10M. 2. If he chooses the guaranty, it is good o nly if he is sure that the guarantor will pay. If the guarantor is any of the fo llowing, persons, the guaranty would be a good choice: a. the Government ± because it is never insolvent b. a Bank ± in the form of a bank guaranty through a letter of credit c. Insurance Company ± though in some cases, it is also hard to collect from an insurance company (also, take note that they would be governed, not by the Civil Code provisions on guaranty, but by the Insurance Code). Cayo IID 2002 PAGE 62

But the disadvantage of choosing the guaranty is that the guarantor who is worth P100M can afford to hire good lawyers who can stall the Lender's claim. 3. In the case of the real estate mortgage, it depends on how easy it would be to dispose of the property. If it's property at a prime spot in Makati, this might be a good choice since it can probably be sold at a good price right away. But if it's loca ted in the boondocks, the Lender may have a very difficult time selling it. Borr ower borrows P10M from Lender. The loan is secured by a guaranty by X, who is wo rth P100M, a real estate mortgage worth P8M, and a pledge worth P8M. If Borrower defaults, what is the best way for Lender to proceed? 1. Foreclose the real est ate mortgage first. Then get a deficiency judgment for the remaining P2M. 2. The n, foreclose the pledge because in pledge, he gets to keep the excess ± resulting in an upside of P6M. 3. The Guarantor is not yet an option since he has the bene fit of excussion. The Lender must first go through steps 1 and 2 and other remed ies before running after X. Borrower borrows P10M from Lender. The loan is secur ed by a pledge worth P8M and a guaranty by X. How should the Lender proceed in c ase of default by Borrower? If Lender forecloses the pledge, he will have a defi ciency of P2M, which he cannot collect anymore. On the other hand, he cannot pro ceed against the guarantor without foreclosing the pledge first. So what should he do? He should sue Borrower in his capacity as debtor, not as a pledgor, for c ollection of the debt. Then, he should attach the property pledged. When judgmen t in his favor is rendered, he can then execute it against the attached shares. The shares can be sold at an ordinary execution sale, not a foreclosure sale. In this way, the shares will be taken out of the context of the pledge, and any de ficiency in the sale can still be recovered by the lender. After the execution o f the judgment on the shares, the Lender can then go after the Guarantor for the deficiency. ANTICHRESIS Art. 2132. By the contract of antichresis the creditor acquires the right to rec eive the fruits of an immovable of his debtor, with the obligation to apply them to the payment of the interest, if owing, and thereafter to the principal of hi s credit. What is antichresis? Antichresis is a contract by which the creditor a cquires the right to receive the fruits of an immovable belonging to the debtor, with the obligation to apply them to the payment of the interest, if owing, and thereafter to the principal of his credit. Cayo IID 2002 PAGE 63

What are the characteristics of antichresis? 1. Accessory ± It secures the perform ance of a principal obligation. Manresa, however, believes that it is an indepen dent contract. 2. Formal Contract ± It must be in specified form to be valid (in w riting). Is delivery of the property to the creditor required? Delivery is not r equired for the validity of the contract itself. BUT, it is required in order th at the creditor may receive the fruits. Does antichresis apply to all of the fru its of the immovable concerned? GENERAL RULE: The general rule is that the contr act of antichresis covers ALL the fruits of the encumbered property. If the part ies do not want all of the fruits to be subject to the antichresis, they must ST IPULATE otherwise. Is it essential for the contract to have a stipulation for interest in order to have an accessory contract of antichresis? No. It is not essential to the contract of antichresis that the loan that it gua rantees should have interest. There is nothing in the law that says that antichr esis can only guarantee interestbearing loans. What are the differences between antichresis and real mortgage? ANTICHRESIS Property is delivered to the creditor Creditor acquires only the right to receiv e the fruits of the property; not a real right General rule is that creditor mus t pay the taxes and charges upon the estate; parties must stipulate otherwise Ex pressly stipulated that the creditor shall apply the fruits to the payment of in terest, if owing, and thereafter to the principal REAL MORTGAGE Debtor usually retains possession of the property Creditor has no right to receive the fruits, but mortgage creates a real right over the property which is enforceable against the world Creditor has no obligation to pay taxes and charges No obligation on the part of the mortgagee to apply the fruits to in terest and principal Antichresis and real mortgage are similar in that the subject matter is real pro perty. Like pledge and mortgage, antichresis gives a real right if it is registe red in the Registry of Property. Example: A borrowed P1M from B. To secure the loan, A delivered a parcel of land with coconut trees to B, giving B the power to administer it and harvest the co conuts. What is the nature of the contract? Cayo IID 2002 PAGE 64

Answer: The contract is one of mortgage, not antichresis. In order for it to be a contract of antichresis, it must be expressly agreed between creditor and debt or that the creditor, having been given possession of the property, is to apply the fruits to the payment of interest, if owing, and thereafter, to the principa l. Art. 2133. The actual market value of the fruits at the time of the applicati on thereof to the interest and principal shall be the measure of such applicatio n. When it is time to apply the fruits to the payment of the interest or the pri ncipal, the creditor must base the value of the fruits on their market value at the time of the application. Example: The property subject of the contract of antichresis has mango trees. In January, one kilo of mangoes costs P50/kilo. But in May, when mangoes are in season, one kilo costs 25/kilo. If interest is due in January, the creditor must apply the fruits to the payment of interest based on the price of P50/kilo. If interest is due in May, he should compute at the price of P35/kilo. Art. 2134. The amount o f the principal and of the interest shall be specified in writing; otherwise, th e contract of antichresis shall be void. Is there a form required for the contract of antichresis? Yes. The contract must state the amount of the principal and the interest IN WRI TING. If this form is not followed, the contract of antichresis is VOID. The req uirement that it be in writing is necessary not merely to bind third persons but to make the contract valid. But even if the antichresis is void, the principal obligation is still valid. Art. 2135. The creditor, unless there is a stipulatio n to the contrary, is obliged to pay the taxes and charges upon the estate. He i s also bound to bear the expenses necessary for its preservation and repair. The sums spent for the purposes stated in this article shall be deducted from the f ruits. What are the obligations of the creditor under the contract of antichresis? 1. Pay the taxes and charges upon the estate ± If the creditor does not pay the ta xes, he is required by law to pay indemnity for damages to the debtor. If the de btor pays the taxes on the property which the creditor should have paid, the amo unt is to be applied to the payment of the debt. If the amount of taxes paid by the debtor is enough to satisfy the principal obligation, then the loan and the antichresis are extinguished; the creditor must return the property to the debto r. What if the creditor does not want to pay the taxes and charges? They must so stipulate in their agreement OR see the next article. Cayo IID 2002 PAGE 65

2. Apply the fruits The creditor must apply the fruits of the property to the payment of interest, i f owing, and thereafter to the principal. Art. 2136. The debtor cannot reacquire the enjoyment of the immovable without fi rst having totally paid what he owes the creditor. But the latter, in order to e xempt himself from the obligations imposed upon him by the preceding article, ma y always compel the debtor to enter again upon the enjoyment of the property, ex cept when there is a stipulation to the contrary. When can the debtor get back the property subject of the antichresis? The debtor can get it back only when he has totally paid the principal obligatio n. This is because the property stands as a security for the payment of the prin cipal obligation. Is there an exception? Yes. The exception to this rule is if the creditor does not want to pay the taxe s and charges upon the estate. In such a case, the creditor may compel the debto r to get the property back, UNLESS there is a contrary stipulation (exception to the exception). But this has the effect of extinguishing the contract of antich resis. Art. 2137. The creditor does not acquire the ownership of the real estate for nonpayment of the debt within the period agreed upon. Every stipulation to the contrary shall be void. But the creditor may petition the court for the paym ent of the debt or the sale of the real property. In this case, the Rules of Cou rt on the foreclosure of mortgages shall apply. What happens when the debtor defaults on the principal obligation? The creditor DOES NOT acquire ownership of the real estate. Any stipulation to t he contrary shall be void. This is because the contract of antichresis covers on ly the right to receive the fruits from the estate, and not its ownership. Also, this is pactum commisorium, which is void. The creditor has the following remed ies in case of default: 1. Bring an action for specific performance. 2. Petition for the sale of the real property in judicial foreclosure proceedings under Rul e 68 of the Rules of Court. Can the parties stipulate on an extra-judicial forec losure? Yes, in the same manner that they are allowed in pledge and mortgage. Can the creditor acquire the property given in antichresis by prescription? No, and any stipulation to the contrary shall be void. In order to acquire prope rty be prescription, possession must be in the concept of owner. The antichretic creditor possesses the property merely as a holder. Cayo IID 2002 PAGE 66

Exception: Just like in a co-ownership, if the creditor repudiates the antichres is, he can acquire the property by prescription. Art. 2138. The contracting part ies may stipulate that the interest upon the debt be compensated with the fruits of the property which is the object of the antichresis, provided that if the va lue of the fruits should exceed the amount of interest allowed by the laws again st usury, the excess shall be applied to the principal. The creditor must first apply the fruits to the payment of the interest. If the value of the fruits exce eds the value of the interest due, then the creditor should apply the excess to the principal. The second part of this provision is no longer applicable, since there is no Usury Law anymore. Art. 2139. The last paragraph of article 2085, an d articles 2089 to 2091, are applicable to this contract. Other characteristics of Antichresis: 1. A third person, who is not a party to the principal contract, may offer his i mmovable under the contract of antichresis to secure the debt of another. (2085) 2. The contract of antichresis is indivisible. (2089) 3. The indivisibility of the antichresis is not affected by the fact that the debtors are not solidarily liable. (2090) 4. The contract of antichresis may secure all kinds of obligation s ± pure or conditional. (2091) CONCURRENCE AND PREFERENCE OF CREDITS What is concurrence of credits? Concurrence of credits implies the possession by two or more creditors of equal rights or privileges over the same property or all of the property of a debtor. What is preference of credit? It is the right held by a creditor to be preferred in the payment of his claim o ut of the debtor's assets above others. In other words, it is the right to be paid first. Nature and Effect of Preference 1. Exception to the general rule ± Because, generally, you have to pay your credit ors when the debt becomes due. There should be no rules as to who should be paid first. Preference applies only when there are two or more creditors with separa te claims against a debtor who has insufficient property. Since it is an excepti on to the general rule, the law as to preferences is strictly construed. Cayo IID 2002 PAGE 67

2. Does not create an interest in property ± Preference simply creates a right to be paid first from the proceeds of the sale of property of the debtor. It does n ot create a lien on the property itself, but merely a preference in the applicat ion of the proceeds of the property after it is sold. 3. The creditor does not h ave the right to TAKE the property or SELL it as against another creditor ± Prefer ence is not a question as to who may take and sell property belonging to the deb tor. Preference applies after a sale, and it is a question of application of the proceeds of the sale to satisfy the debt. 4. It must be asserted ± If the right c laimed is not asserted and maintained, it is lost. If property has not been seiz ed, it is open to seizure by another. 5. It must be maintained ± Where a creditor released his levy, leaving the property in possession of the debtor, thereby ind icating that he did not intend to press his claim further as to that specific pr operty, he is deemed to have abandoned his claim of preference. When are the rules on preference of credits applicable? The rules apply only where: 1. 2. 3. 4. there are two or more creditors with sep arate and distinct claims against the same debtor who has insufficient property. There must be a proceeding such as an insolvency proceeding wherein the creditor s can file their claims. The right becomes significant only after the properties of the debtor have been inventoried and liquidated, and the claims of the vario us creditors have been established. Because before that, you have no way of know ing who the creditors are, and you have no liquidated property out of which you can pay them. What is the difference between preference of credit and a lien? A preference applies only to claims which do not attach to specific properties. A lien, on the other hand, creates a charge on a particular property. Can a creditor whose credit is not yet due assert a right to preference? No. The title on Concurrence and Preference of Credits refers only to credits wh ich are already due. CHAPTER 1 GENERAL PROVISIONS Art. 2236. The debtor is liable with all his property, present and future, for t he fulfillment of his obligations, subject to the exemptions provided by law. Ge neral Rule: A debtor is liable with ALL his property, present and future, for th e fulfillment of his obligations. Cayo IID 2002 PAGE 68

Exceptions: Exemptions provided by law, such as future support, the family home, property in custodia legis, etc. See page 489-492 of De Leon for the list (not very important) Art. 2237. Insolvency shall be governed by special laws insofar as they are not inconsistent with this Code. Art. 2238. So long as the conjugal partnership or absolute community subsists, i ts property shall not be among the assets to be taken possession of by the assig nee for the payment of the insolvent debtor's obligations, except insofar as the l atter have redounded to the benefit of the family. If it is the husband who is i nsolvent, the administration of the conjugal partnership or absolute community m ay, by order of the court, be transferred to the wife or to a third person other than the assignee. If one of the spouses is insolvent, the assets of the CPG or AC do not pass to the assignee in insolvency elected by the creditors or appoin ted by the court. The reason for this is that the CPG or AC is distinct from the individual spouses. The exemption applies provided that: 1. The CPG or AC subsi sts; and 2. The obligations of the insolvent spouse have not redounded to the be nefit of the family. The insolvency of the husband does not dissolve the CPG or AC. Art. 2239. If there is property, other than that mentioned in the preceding article, owned by two or more persons, one of whom is the insolvent debtor, his undivided share or interest therein shall be among the assets to be taken posses sion of by the assignee for the payment of the insolvent debtor's obligation. If t here is a co-ownership (other than CPG or AC) and one of the co-owners becomes i nsolvent, only his undivided share or interest in the property can be possessed by the assignee in insolvency proceedings. Of course, the shares of the other co -owners cannot be taken possession of by the assignee. Art. 2240. Property held by the insolvent debtor as a trustee of an express or implied trust, shall be ex cluded from the insolvency proceedings. In a trust, the trustee is not the owner of the property, though he has legal title thereto. Since he is not the absolut e owner of the property held in trust, these properties should not be included i n insolvency proceedings. CHAPTER 2 CLASSIFICATION OF CREDITS The Civil Code classifies credits against a particular insolvent into three gene ral categories: 1. special preferred credits listed in 2241 and 2242 2. ordinary preferred credits listed in 2244 3. common credits under 2245 Special Preferred Credits (2241 and 2242) Cayo IID 2002 PAGE 69

The items in bold face are the important/relevant ones: Art. 2241. With referenc e to specific movable property of the debtor, the following claims or liens shal l be preferred: (1) Duties, taxes and fees due thereon to the State or any subdi vision thereof; (2) Claims arising from misappropriation, breach of trust, or malfeasance by pub lic officials committed in the performance of their duties, on the movables, mon ey or securities obtained by them; (3) Claims for the unpaid price of movables s old, on said movables, so long as they are in the possession of the debtor, up t o the value of the same, and if the movable has been resold by the debtor and th e price is still unpaid, the lien may be enforced on the price; this right is no t lost by the immobilization of the thing by destination, provided it has not lo st its form, substance and identity; neither is the right lost by the sale of th e thing together with other property for a lump sum, when the price thereof can be determined proportionally; (4) Credits guaranteed with a pledge so long as th e things pledged are in the hands of the creditor, or those guaranteed by a chat tel mortgage, upon the things pledged or mortgaged, up to the value thereof; (5) Credits for the making, repairs, safekeeping or preservation of personal pro perty, on the movable thus made, repaired, kept or possessed; (6) Claims for lab orers' wages, on the goods manufactured or the work done; (7) For expenses of salv age, upon the goods salvaged; (8) Credits between the landlord and the tenant, a rising from the contract of tenancy on shares, on the share of each in the fruit s or harvest; (9) Credits for transportation, upon the goods carried, for the pr ice of the contract and incidental expenses, until their delivery and for thirty days thereafter; (10) Credits for lodging and supplies usually furnished to tra velers by hotel keepers, on the movables belonging to the guest as long as such movables are in the hotel, but not for money loaned to the guests; (11) Credits for seeds and expenses for cultivation and harvest advanced to the debtor, upon the fruits harvested; (12) Credits for rent for one year, upon the personal prop erty of the lessee existing on the immovable leased and on the fruits of the sam e, but not on money or instruments of credit; (13) Claims in favor of the deposi tor if the depositary has wrongfully sold the thing deposited, upon the price of the sale. Cayo IID 2002 PAGE 70

In the foregoing cases, if the movables to which the lien or preference attaches have been wrongfully taken, the creditor may demand them from any possessor, wi thin thirty days from the unlawful seizure. First, you must remember that, aside from item (1) on taxes imposed in connection with the movable, 2141 does establ ish the order of priority among these claims. It just enumerates the preferred c laims with respect to specific movables. With respect to the same specific movab le or immovable, creditors merely concur. There is no preference among them, exc ept that the State always gets paid the taxes imposed on the property first. (1) Taxes The tax must be due on the movable itself. (2) Misappropriation, breac h of trust, malfeasance of public officers The acquisition must have been in the performance of official functions. Also, the property must still be in the hand s of the public official. If it is sold to a purchaser for value and in good fai th, there can be no more claim on the movable. (4) Guaranteed with a pledge or c hattel mortgage To be a preferred credit: If it's a pledge, it must be in a public instrument. If it's a chattel mortgage, it must be registered in the chattel mortgage registry. Last paragraph of 2241 If the movable is wrongfully taken, the preferred creditor may get it back withi n 30 days through an accion subrogatoria, exercising the right of the debtor to recover property wrongfully taken from him granted under Article 559. Problem: The Debtor's only property is a Jaguar worth P2.5M. His liabilities are: a. to the Government: Income tax of P1M Import duties on the car worth P1M b. chattel mortgage on the car worth P2M c. unpaid price of the car of P1M d. P1 M promissory note (notarized) What are the preferred claims with respect to the Jaguar? 1. P1M import duties on the car 2. P2M chattel mortgage 3. P1M unpaid pr ice Cayo IID 2002 PAGE 71

These are the only preferred claims because they are the ones attached to the mo vable itself. The income tax and the promissory note are not preferred because t hey are not attached to the car. How do you prioritize the preferred claims? 1. P1M import duties ± the State is always the priority with respect to preferred claims 2. The chattel mortgagee and the unpaid seller will then proportionally s hare the P1.5M left: P1M will go to the mortgagee and 500K will go to the unpaid seller. Note, however, that taxes are not always preferred. For example, income tax is not preferred with respect to the Jaguar. In order to be preferred, the tax must be imposed on the movable itself. This has to be done in the context of insolvency proceedings. Problem: Government official used public funds to acquire a Jaguar from a seller in good faith. Government official becomes insolvent. The Government wants to r ecover the car. If you're government counsel, how should you proceed? The textbook answer would be that the government can go after the car in insolve ncy proceedings. It has a preferred claim over the car under par. (2) of 2241. B ut, the disadvantage of this is that, unlike the government claim for tax credit s, it is not prioritized over other special preferred claims. The government wou ld have to share with the other creditors who likewise have a special preferred claim on the Jaguar, such as an unpaid seller. The better alternative is to char acterize it as an implied TRUST. When funds belonging to another (in this case, the government) are used to purchase a movable under the name of another person (the corrupt government official), there is an implied trust. The trustor is the government, while the trustee is the government official. The trustor/governmen t actually owns the car. There is thus no need to go through the insolvency proc eedings, since the Jaguar is not among the properties of the insolvent debtor. Under a trust agreement, X gave Investment House some money. Investment House pl aced the money in a time deposit. Investment House issued promissory notes for i ts obligations to other creditors. If Investment House becomes insolvent, X can show that the money is not owned by Investment House, so it should be excluded from the insolvency proceedings. Art . 2242. With reference to specific immovable property and real rights of the deb tor, the following claims, mortgages and liens shall be preferred, and shall con stitute an encumbrance on the immovable or real right: (1) Taxes due upon the la nd or building; (2) For the unpaid price of real property sold, upon the immovab le sold; (3) Claims of laborers, masons, mechanics and other workmen, as well as of architects, engineers and contractors, engaged in the construction, reconstr uction or repair of buildings, canals or other works, upon said buildings, canal s, or other works; Cayo IID 2002 PAGE 72

(4) Claims of furnishers of materials used in the construction, reconstruction o r repair of buildings, canals or other works, upon said buildings, canals or oth er works; (5) Mortgage credits recorded in the Registry of Property upon the rea l estate mortgaged; (6) Expenses for the preservation or improvement of real pro perty when the law authorizes reimbursement upon the immovable preserved or impr oved; (7) Credits annotated in the Registry of Property, in virtue of a judicial order , by attachments or executions, upon the property affected, and only as to later credits; (8) Claims of co-heir in the partition of an immovable among them, upon the real property thus divided; (9) Claims of donors of real property for pecuniary char ges or other conditions imposed upon the donee, upon the immovable donated; (10) Credits of insurers, upon the property insured, for the insurance premium for t wo years. (1) Taxes Capital gains tax is NOT a preferred credit because it is re ally a tax on income and not on the property itself. This provision covers real property taxes. (2) Unpaid Seller There is no need to register the sale in order for the unpaid seller to have a preferred claim against the immovable. (5) Mort gage The mortgage must be registered in the Registry of Property in order for th e credit to be a preferred claim against the immovable. (7) Credits annotated in the Registry of Property in virtue of judicial order, a ttachment, or execution The credits must also be registered in order to be preferred. The preference is only with respect to LATER CREDITS. The credit is preferred only with respect to other attachments, not to other kinds of credit. Therefore, this does not share equally with the other claims. It merely provides that a credit by virtue of ju dicial order, attachment, or execution that is first registered in the Registry of Property is preferred over other credits of the same nature, which are regist ered at a later date. Unlike the other special preferred credits, these credits do not share proportio nately in the property upon which they are imposed. To determine the Cayo IID 2002 PAGE 73

order of priority among several credits of this kind, their dates should be the basis. The first one to be registered will be prioritized over the others. Again , 2242, is not an order of priority, with the exception of taxes imposed upon th e immovable, which is prioritized. 2242 is merely an enumeration. Why isn't there a provision for malfeasance or misfeasance with respect to immovab les? Corrupt public officials can easily hide movables, which is why it would be more difficult to recover them. Hence, there is a provision giving the government pr eference with respect to movables. But in the case of immovables, the corrupt pu blic officials cannot really hide them. The government can establish a preferred claim over them simply by attaching. (This is the reason given by JPSP. For the reason of the Code Commission, ask Pelagio Cuison). Problem: Debtor's only assets are a house and lot worth P5M, a car worth P1M, and jewelry worth 500K. Among Debtor's liabilities are a real estate mortgage on the h ouse and lot to secure a loan worth P3M and a chattel mortgage on the car to sec ure a loan worth P500K. Debtor has other obligations worth P6M. What are the pre ferred credits? How much free property does Debtor have? With respect to the house and lot, the real estate mortgage is preferred. With r espect to the car, the chattel mortgage is preferred. To determine the value of the Debtor's free property, pay off the preferred claims first: House and Lot wort h P5M ± P3M REM obligation = P2M excess Car worth P1M ± 500K chattel mortgage obliga tion = 500K excess The excess after the preferred claims have been satisfied wil l go to the free property of the debtor: Free property = Jewelry worth 500K + P2 M excess from House and Lot + 500K excess from car = 500K + 2M + 500K = 3M The f ree property of Debtor is worth P3M. The other creditors for P6M will then line up for this portion according to the order of priority established in Art. 2244 if they are ordinary preferred credits and 2245 if they are common credits. Problem: Realty Company entered into a contract to sell with X. Under the contra ct to sell, X will sell the lot to Realty Company, and Realty Company will pay t he price in installments. Realty Company failed to pay the installments in full. The lot was used in a condominium project. How can X collect from Realty Compan y, in case it becomes insolvent? X should claim that he still owns the lot since the contract was merely a contra ct TO sell. Therefore, the lot should not be included in the insolvency proceedi ngs concerning Realty Company. X can also claim that the condominium project on the lot cannot be included in the insolvency proceedings either because it is an improvement on a lot owned by X, not by Realty Company. This way, if Realty Com pany becomes insolvent, X does not have to line up and compete with other credit ors' claims, because he can say that he is the owner of the property. Cayo IID 2002 PAGE 74

JPSP says that if you're a creditor, you should avoid the preferred claim route be cause you would rather not line up along with the other creditors. You should fi nd a way to be the owner of the thing that you're after ± such as, proving that it's a n implied trust or a contract to sell, etc. Art. 2243. The claims or credits enu merated in the two preceding articles shall be considered as mortgages or pledge s of real or personal property, or liens within the purview of legal provisions governing insolvency. Taxes mentioned in No. 1 article 2241, and No. 1, article 2242, shall first be satisfied. 2243 gives the rule that taxes due on the movabl e or on the immovable concerned should be satisfied first. The rest of the speci al preferred claims share equal preference among themselves. Ordinary Preferred Credits (2244) Art. 2244. With reference to other property, real and personal of the debtor, th e following claims or credits shall be preferred in the order named: (1) Proper funeral expenses for the debtor, or children under his or her parental authority who have no property of their own, when approved by the court; (2) Credits for services rendered the insolvent by employees, laborers, or house hold helpers for one year preceding the commencement of the proceedings in insol vency; (3) Expenses during the last illness of the debtor or his or her spouse and chil dren under his or her parental authority, if they have no property of their own; (4) Compensation due the laborers or their dependents under laws providing for indemnity for damages in case of labor accident, or illness resulting from the n ature of the employment; (5) Credits and advancements made to the debtor for sup port of himself or herself, and family, during the last year preceding the insol vency; (6) Support during the insolvency proceedings, and for three months there after; (7) Fines and civil indemnification arising from a criminal offense; (8) Legal expenses, and expenses incurred in the administration of the insolvent's est ate for the common interest of the creditors, when properly authorized and appro ved by the court; (9) Taxes and assessments due the national government other than those mentioned in Articles 2241, No. 1, and 2242, No. 1; (10) Taxes and assessments due any province, other than those referred to in Art icles 2241, No. 1, and 2242, No. 1; (11) Taxes and assessments due any city or m unicipality, other than those indicated in Articles 2241, No. 1, and 2242, No. 1 ; (12) Damages for death or personal injuries caused by a quasi-delict; Cayo IID 2002 PAGE 75

(13) Gifts due to public and private institutions of charity or beneficence; (14) Credits which, without special privilege, appear in (a) a public instrument ; or (b) in a final judgment, if they have been the subject of litigation. These credits shall have preference among themselves in the order of priority of the dates of the instruments and of the judgments respectively. Once the special preferred claims under 2241 and 2242 have been satisfied, the p roperty remaining constitute the debtor's free property. The debtor's free property will then be used to pay ordinary preferred claims in the order established in 2 244. Unlike 2241 and 2242, 2244 is not merely an enumeration; it establishes the order of priority. Also, unlike 2241 and 2242, 2244 does not establish a prefer ence with respect to specific property of the debtor. The preference is with res pect to the mass of properties of the debtor remaining after the special preferr ed claims have been satisfied. Important Items (2) Labor Claims Art. 110 of the Labor Code has modified 2244 by moving labor cl aims to number (1), ahead of funeral expenses. Labor claims are still not in the level of special preferred claims under 2241 and 2242. The Labor Code merely mo ved it up to the top of the list of ordinary preferred claims. Also, Art. 110 of the Labor Code has removed the one-year limitation. (9), (10), (11) Taxes Note that this is unlike special preferred claims where a tax is imposed upon a speci fic movable or immovable property. Special preferred claims, as provided by 2243 , enjoy first preference with respect to the property upon which they are impose d. Under 2244, on the other hand, taxes of other kinds are only ordinary preferr ed credits and are only 9th, 10th, and 11th priorities with respect to the free portion of the property of the debtor. Examples are income tax, license fees, an d capital gains tax. These are not imposed on specific property of the debtor, s o they are ordinary preferred claims, which can be collected against the debtor's free property. Taxes owing the national government should be satisfied first, fo llowed by the provincial government, then the city or municipal government. (14) Credits appearing in a public instrument or in a final judgment This paragraph contains the rule of preference when you have several credits appearing in publi c instruments or in a final judgment. To determine the order of preference among them, just consider the date. First in time, priority in right, sabi nga ni CLV . This does not include those registered credits which fall under 2241 and 2242, such as those arising from a pledge or mortgage, or an attachment of specific r eal property. Example: The claims are as follows: A notarized promissory note da ted May 1, 2002. A promissory note in a private document dated January 1, 2002. A judgment for sum of money dated October 1, 2002. Cayo IID 2002 PAGE 76

What is the order of priority? 1. 2. 3. Notarized promissory note dated May 1, 2 002 Judgment dated October 1, 2002 Promissory note in a private document dated J anuary 1, 2002 Common Credits Art. 2245. Credits of any other kind or class, or by any other right or title no t comprised in the four preceding articles, shall enjoy no preference. If it is not among those mentioned in 2241, 2242, and 2244, it is a common credit. Credit ors with common credits have to line up for the excess of the debtor's property af ter claims under 2241, 2242, and 2244 have been satisfied. There is no order of preference among common creditors; they share whatever is left in proportion to their credit, regardless of date. CHAPTER 3 ORDER OF PREFERENCE OF CREDITS Art. 2246. Those credits which enjoy preference with respect to specific movable s, exclude all others to the extent of the value of the personal property to whi ch the preference refers. Art. 2247. If there are two or more credits with respe ct to the same specific movable property, they shall be satisfied pro rata, afte r the payment of duties, taxes and fees due the State or any subdivision thereof . Art. 2248. Those credits which enjoy preference in relation to specific real p roperty or real rights, exclude all others to the extent of the value of the imm ovable or real right to which the preference refers. Art. 2249. If there are two or more credits with respect to the same specific real property or real rights they shall be satisfied pro rata, after the payment of the taxes and assessments upon the immovable property or real right. Art. 2250. The excess, if any, after the payment of the credits which enjoy preference with respect to specific prop erty, real or personal, shall be added to the free property which the debtor may have, for the payment of other credits. Art. 2251. Those credits which do not e njoy any preference with respect to specific property and those which enjoy pref erence, as to the amount paid, shall be satisfied according to the following rul es: (1) In the order established in article 2244; (2) Common credits referred to in article 2245 shall be paid pro rata regardless of dates. APPLYING THE RULES STEP 1: MAKE AN INVENTORY OF ASSETS List down all the assets of the debtor. Grou p these assets into two: the Preferred Group and the Free Property Group. Those assets with special preferred claims under 2241 and 2242 imposed upon them belon g to the Preferred Group. Cayo IID 2002 PAGE 77

Those without special preferred claims will constitute the debtor's Free Property. Remember to take out property held by the debtor only in the capacity of truste e. He may have legal title to it, but the beneficial title and ownership actuall y belong to another person. Since the property does not belong to the debtor, th ey should not be included in the proceedings. The same goes for property of the AC of CPG, property held as lessee or usufructuary, etc. STEP 2: GROUP THE CLAIM S Make four groups ± (1) special preferred credits on movables, (2) special prefer red credits on immovables, (3) ordinary preferred credits, and (4) common credit s. For the special preferred claims, look out for the following because they are the most common: 1. For movables: a. b. c. 2. import duties/other taxes imposed directly on the movable an obligation secured by a pledge (in a public instrume nt) or a chattel mortgage (registered) claim of unpaid seller for the price of t he movable For immovables: a. b. c. d. real estate taxes an obligation secured by a real es tate mortgage (registered) claim of unpaid seller for the price of the immovable credits annotated in the Registry of Property by attachment or execution upon t he immovable Put the ordinary preferred claims under 2244 together. List them down according to the order under 2244, since 2244 already gives the order of preference. Remem ber, though, that labor claims are on top. The most common are: 1. 2. 3. labor c laims taxes other than those imposed directly upon a movable or an immovable, su ch as income taxes and license fees (In the following order: national government , provincial government, city or municipal government). credits in a final judgm ent or in a public document, such as notarized promissory notes Put the other credits not falling under these three together. These are the comm on claims. The usual example is a promissory note in a private instrument. STEP 3: SATISFY THE SPECIAL PREFERRED CLAIMS First: Take the value of the specific mo vable/immovable upon which the preferred claim is imposed. Second: Pay the taxes due on the property. Third: Pay the preferred claim of the creditor. What if yo u have more than one preferred creditor over the same property? Ex: The claims a gainst a car are: import duties, chattel mortgage, and unpaid seller. In this ca se, pay the taxes first. Since the mortgage creditor and the unpaid seller are b oth special preferred creditors, they will share the balance proportionately. Th ere will only be proportionate sharing in case the value of the thing after paym ent of taxes is not enough to Cayo IID 2002 PAGE 78

satisfy all of the special preferred claims against it. If the value of the thin g is sufficient, then all the special preferred claims must be paid in full. Fou rth: If, after paying the taxes and other special preferred claims, there is an excess, take the value of the excess and add it to the debtor's Free Property. Fif th: If the value of the specific property is not enough to satisfy the taxes and other special preferred claims, and there is a deficiency, follows these rules: a. If the deficiency is in a credit arising from a pledge, real mortgage, or ch attel mortgage, put the deficiency in the ordinary preferred credits group. Why do we know right away that it is an ordinary preferred credit? It is a credit in a public instrument, so it is an ordinary preferred credit under (14) of 2244. You know it's in a public instrument because it was treated at first as a special preferred credit, and the requirement under 2241 and 2242 is that these transact ions be registered (for real and chattel mortgage) or be in a public document (f or pledge). b. If the deficiency is in a credit arising from a transaction that is not in a public document or is not contained in a final judgment (ex: unrecor ded sale), put the deficiency in the common credits group. STEP 4: UPDATE THE IN VENTORY AND LIST OF CREDITS After you have satisfied all of the special preferre d claims, update the following: 1. The inventory of assets You may have to add t o the Free Property Group if, after satisfying the special preferred claims, you have an excess. Make sure that you add the excess to the Free Property Group. A dd up the entire value of the Free Property Group because this is what you will use to settle the ordinary preferred claims and the common claims. 2. The list o f ordinary preferred claims If there was a deficiency in satisfying the special preferred claims, the deficiency will be an ordinary preferred credit if it is n otarized or is contained in a final judgment. 3. The list of common claims If th ere was a deficiency in satisfying the special preferred claims, the credit will be a common credit if it is not notarized or contained in a final judgment. STE P 5: SATISFY THE ORDINARY PREFERRED CLAIMS List down all the ordinary preferred claims in the order in which they are listed in 2244. This is the order of prefe rence among them. Most probably, there will be several credits in public instrum ents and final judgments. Arrange these by date. Those falling on the same date will enjoy equal preference and will share the balance of the free property prop ortionately. STEP 6: SATISFY THE COMMON CLAIMS Whatever is remaining of the debt or's free property will be used to satisfy the common claims. Since these will not be enough to cover the debtor's remaining liabilities (he's insolvent), the common creditors will share the balance in proportion to the amount of their credit, re gardless of the date. Cayo IID 2002 PAGE 79

Most probably, JPSP will just ask us to list the order of preference of several credits. So my suggestion is to make the lists mentioned above and just update t he list of ordinary preferred claims and common claims after satisfying the spec ial preferred claims, in case there is an excess or deficiency. Examples: On Jan uary 1, 2002, Debtor executes a promissory note for 500K in a private instrument . On March 1, 2002, he executes a Real Estate Mortgage over his house and lot wo rth P3M to secure a P5M loan. On the same date, he also executes a notarized pro missory note for P1M. On September 1, 2002, a creditor is able to obtain a favor able judgment against Debtor for P100K. Debtor becomes insolvent. What is the or der of priority of his creditors' claims? 1. The mortgage credit should be satisfi ed first. But since it is for P5M and the house and lot is only worth P3M, there will be a deficiency of P2M. The P2M will be an ordinary preferred credit. Next in priority are the notarized promissory note for P1M and the P2M deficiency on the mortgage credit. They are both ordinary preferred credits under (14) of 224 4. Since they were executed on the same date, they enjoy the same order of prefe rence and will share proportionately in the free property of the Debtor. The las t to be satisfied will be the promissory note in a private instrument, which is a common credit. 2. 3. The debtor's assets are a house and lot, a car, and cash. He is insolvent. His obl igations are as follows: A real estate mortgage dated June 1, 2002 Chattel mortg age on the car dated March 1, 2002 Real property tax on the house and lot Income tax Import duty on the car Unpaid seller of the lot, sold to him on March 1, 20 02 License fee owing the city government for business of Debtor Notarized promis sory note dated March 1, 2002 Acknowledgment receipt of debt dated March 1, 2002 Judgment dated March 1, 2002, with attachment on house and lot dated January 1, 2002 What is the order of preference? First, make the inventory: Immovable Prop erty with Special Preferred Claim House and Lot Movable Property with Special Pr eferred Claim Car Free Property Cash Second, group the credits: Cayo IID 2002 PAGE 80

SPECIAL PREFERRED CLAIMS OVER IMMOVABLE PROPERTY Real estate mortgage dated June 1, 2002 Real property tax on the house and lot Unpaid seller of the lot, sold o n March 1, 2002 Judgment dated March 1, 2002, with attachment on house dated Jan uary 1, 2002 SPECIAL PREFERRED CLAIMS OVER MOVABLE PROPERTY Import duty on the car Chattel mo rtgage on the car dated March 1, 2002 ORDINARY PREFERRED CLAIMS Income tax License fee owing the city government for b usiness of Debtor Notarized promissory note dated March 1, 2002 COMMON CLAIMS Acknowledgment receipt of debt dated March 1, 2002 Third, satisfy special preferred claims: With respect to the House and Lot 1. 2. Real property tax The following will share proportionately the balance after th e payment of the real property tax: a. b. c. Real estate mortgage creditor Unpai d seller Judgment dated March 1, 2002 with attachment on house and lot dated Jan uary 1, 2002 [Let's assume that there was a deficiency in settling the claims of these three cr editors] With respect to the Car 1. 2. Import duty Chattel mortgage creditor Fourth, update the list of credits: ORDINARY PREFERRED CLAIMS Income tax License fee owing the city government for business of Debtor Notarized promissory note dated March 1, 2002 Add: Deficiency in claim of Real estate mortgage creditor da ted June 1, 2002 Deficiency in claim of unpaid seller of the lot, sold on March 1, 2002 Deficiency in claim from judgment dated March 1, 2002 COMMON CLAIMS Ackn owledgment receipt of debt dated March 1, 2002 Cayo IID 2002 PAGE 81

Fifth, pay the ordinary preferred claims out of free property in the following o rder: 1. 2. 3. Income tax License fees Proportionate sharing: Notarized promisso ry note dated March 1, 2002 Unpaid seller's deficiency, sale dated March 1, 2002 D eficiency in judgment credit, dated March 1, 2002 Deficiency in real estate mort gage, dated June 1, 2002 4. Sixth, pay the common claims out of free property Acknowledgment receipt of debt Cayo IID 2002 PAGE 82

INSOLVENCY LAW What is insolvency? It denotes the state of a person whose liabilities are more than his assets. The Insolvency Law provides for three remedies: 1. 2. 3. Suspen sion of Payments Petition for Voluntary Insolvency Petition for Involuntary Inso lvency I. SUSPENSION OF PAYMENTS What is suspension of payments? Suspension of payments is the postponement, by c ourt order, of the payment of debts of one who, while possessing sufficient prop erty to cover his debts, foresees the impossibility of meeting them when they re spectively fall due (solvent but not liquid). What are the laws governing suspen sion of payments? A debtor may file a petition for suspension of payments either under The Insolvency Law or PD 902-A. SUSPENSION OF PAYMENTS UNDER PD 902-A Who may file for suspension of payments under PD 902-A? A corporation may file for suspension of payments under PD 902-A if it is either : 1. Solvent but not liquid; OR 2. Insolvent and under the management of a Rehab ilitation Receiver or Management Committee A Rehabilitation Receiver or Manageme nt Committee is a group of persons appointed by the court to take over the asset s of the insolvent corporation in order to turn it around. A natural person cann ot file for suspension of payments under PD 902-A, Where do you file a petition for suspension of payments under PD 902-A? You file the petition with the RTC (it used to be with the SEC, but the law was amended). What are the advantages of filing a petition for suspension of payments? The advantages of filing a petition for suspension of payments are: 1. The debto r has continued access to the assets and resources of the corporation; and Cayo IID 2002 PAGE 83

2. It gives the debtor leverage or a framework for negotiation (that is, if he f iles it under PD 902-A, not the Insolvency Law). The debtor can delay payment fo r as long as the court allows, so it's a good chance to bargain with creditors in the meantime. Cayo IID 2002 PAGE 84

If you were the debtor corporation, what are the advantages of filing the petiti on for suspension of payments under PD 902-A instead of under the Insolvency Law ? 1. PD 902-A is more lenient than the Insolvency Law. Under the Insolvency Law, the debtor must be solvent but not liquid. Under PD 902-A, even if the corporat ion is insolvent, as long as it is under Rehabilitation Receiver or Management C ommittee, it can file for suspension of payments. 2. Under the Insolvency Law, t he creditors have a say on whether to grant the petition. Under PD 902-A, only t he court decides. 3. Under PD 902-A even secured creditors are covered by the su spension; there are no exceptions. All claims are suspended. Under the Insolvenc y Law, secured creditors are not covered by the suspension; they may foreclose u pon default. SUSPENSION OF PAYMENTS UNDER THE INSOLVENCY LAW (SECTIONS 2-13) What are the requisites of the petition for suspension of payments under the Ins olvency Law? The petition must be filed by a debtor: 1. possessing sufficient property to cov er all his debts (SOLVENT) 2. foreseeing the impossibility of meeting them when they respectively fall due (NOT LIQUID) 3. petitioning that he be declared in th e state of suspension of payments. The debtor may either be a natural or juridic al person (Although, as mentioned already, if you're a corporation, it would be be tter to file the petition under PD 902-A, not under the Insolvency Law). The pet ition need not be verified. What is the procedure for suspension of payments? 1. File a petition with the RTC where the debtor has resided for six months prio r to the filing of the petition. The petition should be accompanied by a verifie d list of all of his creditors, debts and liabilities, a statement of his assets and liabilities, and the proposed agreement that he requests from his creditors . 2. The court will issue an order calling for the meeting of all creditors. The meeting should take place not less than 2 weeks nor more than 8 weeks from the date of the order. 3. The order will be published and notice sent to all the cre ditors of the debtor. Cayo IID 2002 PAGE 85

4. There will be a meeting of creditors in which they will decide whether to gra nt the petition. Take note that the amount of the debt is not reduced. The debto r merely buys more time to satisfy his obligations. Quorum Requirement: To have a valid meeting, the creditors present must represent at least 60% of the total liabilities of the debtor. Ex: A has liabilities worth P10,000 as follows: credi tor X: 3,000; creditor Y: 3,000, and creditor Z: 4,000. If X and Y are present, there will be a quorum because they represent 6,000 or 60% of the total liabilit ies of A. 5. The creditors will approve the proposition of the debtor. Majority required to approve the proposal: A double majority consisting in 2/3 of the num ber of creditors voting, which 2/3 must represent at least 60% of the total liab ilities of the debtor. Example: There are 99 creditors representing total liabil ities worth P100K. What is the majority required to approve any proposal? The ma jority required is 66 creditors (2/3 of the number of creditors voting), who mus t, in addition, represent at least P60K worth of liabilities. What if the debtor owes one creditor a total of P60K, is his single vote a valid majority? No. Bec ause although he met the requirement of 60% of the liabilities, he does not cons titute 2/3 of the number of creditors voting. There must be a double majority. 6 . Objections, if any, to the decision must be made within 10 days following the meeting. 7. Issuance of the order of the court directing that the agreement be c arried out in case the decision is declared valid, or when no objection to said decision has been presented. What are the effects of filing of the petition? 1. No disposition of his property may be made by the debtor except those made in the ordinary course of business; 2. No payments may be made by the debtor excep t those made in the ordinary course of business; 3. Upon request to the court, a ll pending executions against the debtor shall be suspended except execution aga inst property especially mortgaged. Why is it in the interest of the debtor to refrain from making any disposition o r payment other than those in the ordinary course of business? Dispositions or payments made which are not in the ordinary course of business m ay indicate that the debtor connived with a creditor into voting in favor of the suspension of payments by buying his vote. Also, this shows that the debtor is liquid after all, and therefore, does not need to be placed in a state of suspen sion of payments. Cayo IID 2002 PAGE 86

Are all of the creditors of the debtor affected by the filing of the petition? Only those creditors included in the schedules filed by the debtor will be calle d upon to take part in the meeting. Hence, those who did not appear because they were not informed of the proceedings will not be affected. The debtor is oblige d to disclose all of his creditors in the petition. The disclosure shall be veri fied or confirmed under oath. Which creditors are not affected by the order of suspension of payments? Aside from those creditors to whom notice was not given, the following creditors are also not covered by the suspension: 1. Persons having claims for personal l abor, maintenance, expense of last illness and funeral of the wife or children o f the debtor incurred in the 60 days immediately preceding the filing of the pet ition; and 2. Persons having legal or contractual mortgages. They can foreclose upon default in spite of the suspension of payment. (But take note that this doe s not apply if the petition was filed under PD 902-A, in which case, ALL credito rs are covered by the suspension of payments. This rule applies only when the pe tition is filed under the Insolvency Law.) What are the grounds for questioning the decision of the meeting? 1. Procedural defects in the calling and holding of the meeting, and the deliber ations conducted, which caused prejudice to the rights of the creditors; 2. Frau dulent connivance between a creditor and the debtor for the creditor to vote in favor of the proposed agreement; If there is proof that the debtor somehow bribe d the creditor or bought his vote, the decision of the meeting can be set aside. However, it is legal to give OTHER incentives to the creditor, such as higher i nterest rates. These are not bribes but merely incentives to induce them to vote in favor of suspension. 3. Fraudulent conveyance of claims by a creditor for th e purpose of obtaining a majority. Ex: There are 99 creditors with claims worth P100K total. 1 creditor represents 60K worth of credits, while the other 98 creditors represent a total of 40K. The one creditor is in favor of suspension of payments, while the other 98 are agai nst it. How will this one creditor manipulate the situation in order to approve the petition? He has already complied with the 60% requirement. His problem is the 2/3 of the creditors requirement, since he only represents 1/99 of the creditors. What he c an do is to assign some of his credits to 200 other people. That way, they will represent 201/299 of the creditors, with a total claim of 60K. This is enough to meet the double majority requirement. BUT, this is a ground for questioning the decision of the meeting. Cayo IID 2002 PAGE 87

II. VOLUNTARY INSOLVENCY What is the concept of voluntary insolvency? An insolvent debtor whose liabilities exceed P1,000 may apply to be discharged f rom his debts and liabilities by filing a petition for voluntary insolvency in t he RTC where he has resided for the last six months prior to the filing of the p etition. In voluntary insolvency, the debtor himself is the petitioner. The date of the filing of the petition is important for purposes of reckoning certain pe riods, such as the residency requirement. Distinctions between suspension of pay ments and insolvency (in general) INSOLVENCY PURPOSE SOLVENCY OF DEBTOR EFFECT O N AMOUNT OF INDEBTEDNESS To discharge the debtor from the payment of debts Debto r does not have sufficient property to pay his debts The amount is affected. Cre ditors receive less than their credits; and where there are preferences, some cr editors may not receive anything at all. There must be three or more creditors i f it is involuntary insolvency. SUSPENSION OF PAYMENTS To suspend or delay the p ayment of debts Debtor has sufficient property to pay his debts The amount of in debtedness is not affected. NUMBER OF CREDITORS The number of creditors is immaterial. What are the jurisdictional requirements for the petition for voluntary insolven cy? In the petition, the debtor shall indicate: 1. his place of residence and th e period of residence therein prior to the filing of the petition; 2. his inabil ity to pay all his debts in full; 3. his willingness to surrender all his proper ty, estate, and effects not exempt from execution for the benefit of his credito rs; 4. an application to be adjudged insolvent. The petition shall be accompanie d by: 1. A verified schedule containing: a. a full and true statement of all deb ts and liabilities of the insolvent debtor, and b. an outline of the facts givin g rise or which might give rise to a cause of action against the insolvent debto r Cayo IID 2002 PAGE 88

2. A verified inventory containing: a. an accurate description of all the person al and real property of the insolvent, whether or not exempt from execution, inc luding a statement as to its value, location, and encumbrances thereon; and b. a n outline of the facts giving rise or which might give rise to a right of action in favor of the insolvent debtor. What is the procedure for voluntary insolvenc y? 1. Filing of the petition by the debtor praying to be declared insolvent. Unl ike in involuntary insolvency, in voluntary insolvency, there need not be an all egation of an act of insolvency by the creditors of the debtor. This is because in voluntary insolvency, the one petitioning is the debtor himself. The very act of filing the petition is the act of insolvency. In contrast, in involuntary in solvency, the ones petitioning are the debtor's creditors. 2. Issuance of an order of adjudication declaring the debtor insolvent. The court need not conduct a he aring before declaring the debtor insolvent and taking his assets. This is becau se the petition is voluntary on the part of the debtor. It is not adversarial. 3 . Publication and service of the order to creditors. 4. Meeting of the creditors to elect the assignee in insolvency. 5. Conveyance of the debtor's property by th e clerk of court to the assignee. 6. Liquidation of the debtor's assets and paymen t of his debts. 7. Composition, if agreed upon. 8. Discharge of the debtor, upon his application, except if the debtor is a corporation. 9. Objection, if any, t o the discharge. 10. Appeal to the Supreme Court in certain cases. What are the effects of an order declaring the petitioning debtor insolvent? 1. The sheriff t akes possession of all the assets of the debtor which are not exempt from execut ion until the appointment of a receiver or an assignee. 2. The payment to the de btor of any debts due to him and the delivery to the debtor or to any person for him any property belonging to him, and the transfer of any property by him are forbidden. 3. All civil proceedings pending against the insolvent debtor shall b e stayed. Cayo IID 2002 PAGE 89

4. Mortgages or pledges, attachments or executions on property of the debtor dul y recorded and not dissolved are not, however, affected by the order. If the pet itioner is a corporation, JPSP thinks that the better route is still to file for suspension of payments under PD 902-A instead of filing for voluntary insolvenc y. If the petitioner is a natural person, his only incentive to file a petition for voluntary insolvency is that he will get a discharge from past debts and lia bilities (corporations do not get this discharge). But otherwise, there are very few advantages in filing for voluntary insolvency. The debtor should just fight it out with his creditors, since filing for voluntary insolvency is not just de meaning but will even affect the debtor's credit-worthiness later on. After filing for voluntary insolvency, no one will trust that debtor enough to lend him mone y again. III. INVOLUNTARY INSOLVENCY What is the purpose of involuntary insolvency? A petition for involuntary insolv ency is not an ordinary personal action for collection of debts. Its purpose is to impound all of the non-exempt property of the debtor, to distribute it equita bly among his creditors, and to release him from further liability. Distinctions between Voluntary Insolvency and Involuntary Insolvency VOLUNTARY INSOLVENCY NU MBER OF CREDITORS PETITIONER ACTS OF INSOLVENCY AMOUNT OF INDEBTEDNESS BOND HEAR ING RESIDENCY REQUIREMENT One creditor is sufficient The insolvent debtor Debtor must not be guilty of any act of insolvency Must be greater than P1,000 Not req uired Not necessary; may be granted ex parte Petition must be filed with RTC whe re debtor has resided for at least 6 months Upon the filing of the voluntary pet ition INVOLUNTARY INSOLVENCY Three or more creditors Three or more creditors who must possess the qualifications provided by law Debtor must have committed one or more of the 13 acts Must be P1,000 or more Petition must be accompanied by a bond Petition is granted only after hearing Petition must be filed with RTC wher e debtor resides or has his place of business; no residency requirement Upon hea ring of the case ISSUANCE OF THE ORDER OF ADJUDICATION DECLARING THE DEBTOR INSOLVENT Cayo IID 2002 PAGE 90

Who may petition for involuntary insolvency? The petitioners must be: 1. 2. 3. 4 . 5. at least three creditors of one debtor who are residents of the Philippines , whose credits accrued in the Philippines, the aggregate amount of which is at least P1,000. In addition, the credits of these three creditors should NOT have accrued within 30 days prior to the filing of the petition. Why does it have to be three creditors? Why is it not enough for one creditor to file the petition? Insolvency proceedings contemplate competing claims of sever al creditors over the assets of the insolvent debtor. If there is only one credi tor, there are no competing claims. The creditor can just go to court and file a simple action to collect. But if you're the single creditor of one debtor, there may be instances when you would want to file a petition for involuntary insolven cy against the debtor. First, how do you do this? Since you're only one creditor, you cannot file the petition because the Insolvency Law requires that it be file d by at least three creditors. To get around this requirement, you should assign some of the credit to at least two other persons. After waiting for 30 days (co oling-off period), you can file the petition. Why would you want to do this? The petition for involuntary insolvency can be used as a tool to harass or pressure a debtor into settling his obligation with the single creditor. Example: Credit or extends a loan to a Foreign Company, which is publicly listed in the Hong Kon g Stock Exchange. Foreign Company fails to pay, and since it is a foreign compan y, it has no assets in the Philippines which Creditor can run after. What should Creditor do? Creditor should first assign some of the credit to two other compa nies, wait 30 days, then file the petition for involuntary insolvency against Fo reign Company. News of the Foreign Company's insolvency will reach Hong Kong, and the price of its shares will go down. To stop the share prices from going down, Foreign Company will be forced to settle the obligation, so that Creditor will w ithdraw the petition. (According to JPSP, Creditor can do this even if Foreign C ompany is not actually insolvent. It's just a legal tactic to get Foreign Company to settle the obligation.) What are the requisites of the petition for involunta ry insolvency? The petition must: 1. be verified by the petitioners 2. set forth one or more acts of insolvency mentioned in the law Cayo IID 2002 PAGE 91

What are acts of insolvency? There are 13 acts of insolvency mentioned in Sec. 2 0 of the Insolvency Law. These may be grouped into three general categories (See p. 568 of De Leon for the complete list): a. the debtor committed acts to ensur e that the debtor will not be able to pay b. the debtor committed acts in fraud of creditors c. the debtor committed acts giving preference to one creditor in f avor of other creditors But the petition should allege at least one of the 13 sp ecific acts of insolvency mentioned in the law. This is a jurisdictional require ment. 3. be accompanied by a bond, approved by the court with at least two suret ies, in such penal sum as the court shall direct. The purpose of the bond is for the petitioners to answer for the costs, expenses, and damages resulting in the filing of the petition. For example, in the earlier case of the single creditor who files the petition against the Foreign Company just to humiliate him, the b ond will answer for damages that Foreign Company can prove as a result of the wr ongful filing of the petition. What are the steps in filing a petition for invol untary insolvency? 1. Filing of the petition by three or more creditors in the R TC where the debtor resides or has his place of business. 2. Issuance of the ord er requiring the debtor to show cause why he should not be adjudged insolvent. 3 . Service to debtor of the order to show cause. 4. Filing of the debtor's answer o r motion to dismiss. 5. Hearing of the case. This is in contrast with voluntary insolvency, where there is no need for a hearing. In involuntary insolvency, the re is a hearing because the proceedings are adversarial. The debtor is given a c hance to refute the claim of the petitioners that he is insolvent. 6. Issuance o f the order or decision adjudging the debtor insolvent. Note that between the fi ling of the petition and the adjudication of the case by the court, there is a p eriod of time during which the debtor still has his assets. While the case is be ing decided by the court, the debtor can dissipate his assets in the meantime. T o protect themselves from this situation, the creditors should either ask the co urt for an injunction or for a receiver who will hold the properties of the debt or. 7. Publication and service of the order. 8. Meeting of creditors for electio n of an assignee in insolvency. Cayo IID 2002 PAGE 92

The assignee must be elected within two to eight weeks from the date of the orde r of the adjudication. 9. Conveyance of the debtor's property by the clerk of cour t to the assignee. 10. Liquidation of the assets of the debtor and payment of hi s debts. 11. Composition, if agreed upon. 12. Discharge of the debtor on his app lication, except if the debtor is a corporation. 13. Objection, if any, to the d ischarge. 14. Appeal to the Supreme Court, in certain cases. IV. ASSIGNEES What is an assignee? An assignee is the person elected by the creditors or appoi nted by the court to whom an insolvent debtor makes an assignment of all his pro perty for the benefit of his creditors. The assignment vests title to all the as sets of the debtor in favor of the assignee. The assignee represents the insolve nt as well as the creditors in voluntary and involuntary proceedings. Who can pa rticipate in the election of the assignee? Creditors who have filed their claims in the office of the clerk of court at least two days prior to the scheduled el ection may participate. As a general rule, a secured creditor cannot participate in the election, unless: 1. he has asked for the fixing of the value of the sec urity; OR 2. he has surrendered the security to the sheriff or receiver of the e state of the insolvent. If you were the secured creditor, why would you surrende r the security? If the security is not enough to cover the obligation, you might as well participate in the election if you think that the portion that will be allotted to you will be greater than the value that you will realize from the sa le of the security. How do the creditors choose the assignee? The creditors will meet in order to elect the assignee. Cayo IID 2002 PAGE 93

In order to validly elect an assignee, the majority of the creditors both in num ber and in the amount of credit they represent (another case of double majority) should vote for the same assignee. If the creditors do not attend the meeting o r fail or refuse to elect an assignee, or if the assignee fails to qualify or su bsequently becomes incapacitated, the court will appoint the assignee. What shou ld the assignee do once he is elected? The assignee is required to give a bond f or the faithful performance of his duties, within five days from his election, i n an amount to be fixed by the court, with two or more sureties. The bond will a nswer for any liability that the assignee may incur to persons aggrieved by his actions as assignee. If you were given an opportunity, will you act as an assign ee? Yes, because the assignee earns a substantial fee. According to Section 42 o f the Insolvency Law, the assignee earns commissions at the following rates: 7% for the first P1,000 that he will be able to liquidate from the properties of th e debtor; 5% for sums exceeding P1,000 but less than P10,000; and 4% for sums ex ceeding P10,000. So if the amount that you can liquidate is P100M, you will earn P4M. Aside from this fee, the assignee will also have other benefits, such as r eimbursements of his expenses and the opportunity to refer legal or accounting m atters to his firm, if he is a lawyer or a CPA. What are the effects of assignme nt? 1. The assignee takes the property in the same conditions that the insolvent held it. 2. Upon appointment, the legal title to all the property of the insolv ent is vested in the assignee, and the control of the property is vested in the court. But the title of the assignee retroacts to the date of the filing of the petition for insolvency. 3. All actions to recover all the estate, debts, and ef fects of the insolvent shall be brought by the assignee and not by the creditors . 4. If there was an attachment or a judgment against the insolvent debtor made 30 days before the filing of the petition for insolvency, it will be set aside. What are the powers and duties of the assignee? The assignee has the powers of a dministration over the property of the insolvent. Having these powers, he can su e and recover claims belonging to the debtor, take into possession all of the pr operty of the debtor, recover property fraudulently conveyed by the debtor, etc (for a complete enumeration, see p. 586-587 of De Leon). Cayo IID 2002 PAGE 94

The assignee does not have powers of disposition. For acts of disposition, such as sale of the property of the insolvent debtor or payment of the creditor's share s, the assignee must obtain a court order. Section 37 of the Insolvency Law: Pen alty for Embezzlement Take note of Section 37, which provides that if any person , who knows of the pending or imminent insolvency proceedings concerning the deb tor, embezzles or disposes of any of the property of the insolvent, he shall be liable for a penalty equal to double the value of the property embezzled or disp osed. The penalty will go to the estate of the insolvent. This relates only to e mbezzlement of the debtor's property, and not to assignments of credit made by the creditors behind each other's backs. What is a dividend in insolvency? It is a pa rt of the fund arising from the assets of the estate of the insolvent debtor, ri ghtfully allocated to a creditor entitled to a share in the fund. It is paid by the assignee only upon order of the court. According to JPSP, if you're a creditor , you may not want to do involuntary insolvency because there are a lot of costs ± assignee's fees, legal costs, etc. It might be better is you could obtain a globa l settlement. (I don't know, though, what ªglobalº means.) V. CLASSIFICATION AND PREFERENCE OF CREDITORS Disregard the rules in Sec. 48-50 of the Insolvency Law. The applicable rules ar e those under the Civil Code on Concurrence and Preference of Credits (Articles 2236-2251). But take note of Section 48, which provides that property found amon g the property of the insolvent debtor but which are not really owned by him sho uld be taken out of the proceedings. Examples are property held in trust or as a lessor or usufructuary, etc. After taking them out, apply the rules under the C ivil Code. VI. PARTNERSHIPS AND CORPORATIONS Who may petition for declaration of insolvency of a partnership? In case of volu ntary insolvency, the petition may be filed by all or any of the partners. In ca se of involuntary insolvency, the petition may be filed by three or more credito rs of the partnership or one or more of the partners. Which properties are cover ed in insolvency proceedings? 1. All the property of the partnership; and 2. All the separate property of each of the general partners, except a. separate prope rties of limited partners; and b. properties which are exempt by law Cayo IID 2002 PAGE 95

Can a partnership be declared insolvent even if the partners constituting the sa me are solvent? Yes. A partnership may be declared insolvent notwithstanding the solvency of the partners constituting it. The creditors of the partnership, aft er first exhausting its assets, may proceed against the solvent general partners who are proportionately liable with their separate property. What happens to th e partnership when any of the partners becomes insolvent? The partnership is aut omatically dissolved by the insolvency of any partner or of the partnership (Art . 1830, Civil Code). What is the benefit given by the Insolvency Law to partners hips? Partnerships get a discharge from the obligations, if they apply for one. In contrast, corporations do not get a discharge. Why doesn't the law give corpora tions a discharge? Corporations do not get a discharge because their creditors c an only go after the assets of the corporation. The creditors cannot collect any deficiency from the stockholders. If the stockholders want a fresh start, they can just put up a new corporation and start with a clean slate. There is no need to get a discharge in order to have a fresh start. But if it's a partnership, and the assets of the partnership are not enough to cover its liabilities, the cred itors can still go after the general partners for the deficiency. This is why it makes sense to give them a discharge. How do you distribute the net proceeds of the properties of the partnership? 1. The net proceeds of the partnership prope rty shall be used to pay the debts of the partnership. 2. The net proceeds of th e individual estate of each partner shall be used to pay individual debts. 3. If there is any surplus in the property of any general partner after paying his in dividual debts, a proportionate part of this surplus will be added to the partne rship assets and will be used to pay partnership debts. 4. If there is any surpl us in the property of the partnership, the surplus shall be added to the assets of the individual partners in proportion to their interests in the partnership. What is the effect of a declaration that a corporation is insolvent? The propert y and assets of the corporation will be distributed to the creditors. Unlike in partnership, the property of the stockholders of the corporation cannot be used to pay the creditors of the corporation. However, the corporation will not be al lowed to get a discharge. VII. PROOF OF DEBTS Cayo IID 2002 PAGE 96

What are the debts which may be proved (collected) against the estate of the ins olvent debtor? 1. All debts due and payable at the time of the adjudication of i nsolvency; 2. All debts existing at the time of the adjudication of insolvency b ut not payable until a future time. 3. Any debt of the insolvent arising from hi s liability as indorser, surety, bail or guarantor, where such liability became absolute after the adjudication of insolvency but before the final dividend shal l have been declared; 4. Other contingent debts and liabilities contracted by th e insolvent if the contingency shall happen before the order of final dividend; and 5. Any claim for reimbursement of a person who has answered, in whole or in part, for the insolvent's debt as bail, surety, or guarantor or otherwise. What is a contingent claim? It is a claim in which the liability depends on a future an d uncertain event. For example, the claim of a surety is a contingent claim beca use the surety can only claim reimbursement from the principal debtor once he hi mself has paid the obligation. But before the surety pays the principal obligati on, he has no claim for reimbursement against the principal debtor. A claim base d on a contingency which has not happened at the time of the pendency of the pro ceedings cannot be proved in the proceedings, since there is no real claim yet. But, if the contingency happens after the termination of the proceedings, the cr editor can still claim from the debtor. The discharge granted the debtor from hi s existing debts does not cover those debts that could not have been proved in t he insolvency proceedings. What happens to obligations of the insolvent debtor t hat arise after the commencement of the proceedings? These debts cannot be prove d in the proceedings. But the creditor can still collect from the debtor, since the discharge given to the debtor cannot apply to claims that could not have bee n proved in the insolvency proceedings. Which debts cannot be proved at the inso lvency proceedings? 1. Those barred by prescription; 2. Claims of secured credit ors unless they waive the right to foreclose or surrender the security; 3. Claim s of creditors who hold an attachment or execution on property of the debtor, pr ovided that this was issued at least 30 days before the institution of the insol vency proceedings; 4. Claims on account of which a fraudulent preference was mad e or given; Cayo IID 2002 PAGE 97

5. Support 6. Damages arising out of a tort Can a creditor set up compensation/o ffset his own debts against the insolvent debtor? This is the case of Uy-Tong v. Silva. Compensation can be set up against the insolvent debtor but only for tho se debts which arose at least 30 days before the filing of the insolvency procee dings. If the claim arose within the 30-day period before the filing of the peti tion, there can be no compensation. The rule on preferences would be disregarded if the set-off were allowed. It would, in effect, give the one claiming compens ation undue preference over other creditors. VIII. COMPOSITIONS What is composition? Composition is an agreement, made upon a sufficient conside ration, between the insolvent or financially embarrassed debtor and all of his c reditors whereby the creditors agree to accept a dividend less than the amount o f their claims, for the sake of getting paid sooner. What are the requisites? 1. The offer of the terms of composition must be made after the filing in court of the schedule of property and submission of the list of creditors; 2. The offer must be accepted in writing by a double majority of the creditors ± majority of th e number of creditors representing a majority of the claims; 3. It must be made after depositing the consideration to be paid and the cost of the proceedings; 4 . The court must approve the terms of the composition. When can composition be s et aside? It can be challenged by any party in interest within six months after it has been confirmed on the ground of fraud. IX. DISCHARGE What is discharge? Discharge is the privilege given to the insolvent, freeing hi m from all liabilities proved during the insolvency proceedings. Is the discharg e automatically given to the insolvent debtor? No. The debtor must ask for it wi thin three months to one year after he is adjudicated insolvent. Cayo IID 2002 PAGE 98

Which debts are released by discharge? 1. All those set forth in the schedule; a nd 2. All those which were or might have been proved against the estate in the i nsolvency proceedings. Which debts are not released? 1. Taxes 2. Debts arising f rom any act of swindling (because you don't reward a person who violated a law or a trust) 3. Debts of a surety, guarantor, indorser, or any person liable for the same debt, for or with the insolvent debtor (This is because the discharge only benefits the principal debtor, not his co-debtors or guarantors). 4. Debts of a corporation 5. Claims for support 6. Debts which were not proved and could not have been proved during the insolvency proceedings 7. Debts arising from tort 8. Claims of secured creditors 9. Debts which were not yet existing at the time of the discharge 10. Contingent claims When can the petition to get a discharge be denied? The debtor cannot get a discharge if he is in bad faith or does acts to the prejudice of his creditors. Once granted, when may a discharge be revoked? A discharge may be revoked by the court if a creditor can prove that it was frau dulently obtained. The creditor must file the petition to revoke it within one y ear from the date of the discharge. X. FRAUDULENT PREFERENCES AND TRANSFERS What is a preferential transfer? It is a parting with the property of the insolv ent for the benefit of a creditor with the result that the estate of the insolve nt is diminished and other creditors are prejudiced. What is a fraudulent prefer ence? It is a disposition of property by the debtor under the following conditio ns: 1. he is insolvent or is in contemplation of insolvency; 2. the transaction is made within 30 days before the filing of the petition for insolvency; 3. it i s made with a view to giving preference to any creditor; Cayo IID 2002 PAGE 99

4. the person receiving a benefit has reason to believe that the debtor is insol vent and that the transfer is made in order to defeat or prejudice the rights of other creditors. What is a fraudulent conveyance/transfer? It is any dispositio n of property made by the insolvent within one month before the filing of the pe tition for insolvency, except for valuable consideration in good faith. What is the status of the fraudulent conveyance? If made within 30 days before the filin g of insolvency proceedings, the transfer is void. If made after the filing of i nsolvency proceedings, it is rescissible for being in fraud of creditors. Anothe r remedy of the creditors is to file a criminal complaint against the insolvent debtor. Is there a presumption of fraud? There is a rebuttable presumption that a conveyance is fraudulent when: 1. it is not made in the usual and ordinary cau se of business of the debtor; or 2. it is made under a confession of judgment. W ithin 30 days before the filing of the petition for insolvency, Debtor sells a c ar worth P1M to Buyer for 900K. Is this a fraudulent conveyance? No. There is a fair exchange of value, so the transaction does not really prejudice the credito rs. DEPOSIT CHAPTER 1 DEPOSIT IN GENERAL AND ITS DIFFERENT KINDS Art. 1962. A deposit is constituted from the moment a person receives a thing be longing to another, with the obligation of safely keeping it and of returning th e same. If the safekeeping of the thing delivered is not the principal purpose o f the contract, there is no deposit but some other contract. What is the contrac t of deposit? It is the receipt by a person of a thing belonging to another with the obligation of safely keeping it and of returning it. It is essential that t he depositary is not the owner of the property deposited. What are the character istics of the contract of deposit? 1. Real contract ± Deposit is perfected by the delivery of the subject matter 2. Unilateral if the deposit is gratuitous ± becaus e only the depositary has an obligation; Cayo IID 2002 PAGE 100

Bilateral if the deposit is for compensation ± gives rise to obligations on the pa rt of both the depositary and the depositor. What is the principal purpose of th e contract of deposit? The principal purpose is the safekeeping of the thing del ivered. If safekeeping is merely an accessory or secondary obligation, it is not a deposit, but another contract, such as commodatum, lease, or agency. What is the subject matter in deposit? Only movables can be the subject matter of deposit. If you leave a kid a Gymbore e or at Kids at Work, it's not a deposit, but maybe a contract of service. JPSP Examples: 1. You park your car at the car park of Powerplant. Is it a contract of deposit? No, because the purpose is not safekeeping. The purpose is merely convenience, so that you have a place to leave your car while you shop or watch a movie or go to school. 2. You park your car at the Dela Rosa car park. Is it a contract of deposit? Still, no, even if, unlike the car park of Powerplant, the sole reason for the existence of the Dela Rosa car park is for people to leave their cars th ere. It's still not a deposit because the purpose is not safekeeping. People who p ark there just want the space. It's a shortterm lease of space. So, legally, it is not a deposit. And even for practical purposes, it should not be treated as a d eposit. If it were a deposit, if the car is lost, the owner of the car park (the depositary) will shoulder the loss. The direct result of this is that parking f ees will go up because it would have to cover insurance costs in addition to the regular parking fee. Deposit distinguished from Simple Loan (mutuum) DEPOSIT PURPOSE WHEN RETURN CAN BE DEMANDED SUBJECT MATTER Safekeeping Depositor can dem and return of the thing at will Movable and immovable property (if deposit is ju dicial) SIMPLE LOAN Consumption Lender must wait until the expiration of the period granted to the d ebtor Only money and any other fungible thing Deposit distinguished from Commodatum PURPOSE GRATUITOUS? SUBJECT MATTER DEPOSIT Safekeeping May be gratuitous, may be onerous In extra-judicial deposit, only movables COMMODATUM Transfer of use of the subject matter Always gratuitous Both movable and immovable property Cayo IID 2002 PAGE 101

Art. 1963. An agreement to constitute a deposit is binding, but lf is not perfected until the delivery of the thing. A: ªI will your garage at 8 a.m. tomorrow.º B: ªOkay.º Is there a contract nt? No. Deposit is a real contract and requires delivery of the n order to be perfected. Is there a contract at this point?

the deposit itse deposit my car in of deposit at this poi subject matter i

Yes, there is a contract. It is a contract of future deposit. It is perfected by mere consent, and is binding upon the parties. Art. 1964. A deposit may be cons tituted judicially or extrajudicially. Kinds of Deposit 1. Judicial ± takes place when an attachment or seizure of property in litigation is ordered 2. Extra-judicial (a) Voluntary ± delivery is made by the will of the d epositor or by two or more persons each of whom believes himself entitled to the thing deposited; or (b) Necessary ± made in compliance with a legal obligation, o r on the occasion of any calamity, or by travelers in hotels and inns, or by tra velers with common carriers. Art. 1965. A deposit is a gratuitous contract excep t when there is an agreement to the contrary or unless the depositary is engaged in the business of storing goods. GENERAL RULE: Deposit is gratuitous. EXCEPTIONS: 1. Contrary stipulation 2. Depositary is engaged in business of storing goods ± ex . A warehouseman 3. Where property is saved from destruction without knowledge o f the owner ± In this case, the owner is bound to pay the person who saved his pro perty just compensation Art. 1966. Only movable things may be the object of depo sit. This applies only to an extra-judicial deposit, whether voluntary or necess ary. Reason: The main purpose of deposit is safekeeping. Since real property may not disappear or may not be lost, there is no point in entrusting them to someo ne for safekeeping. Cayo IID 2002 PAGE 102

A gives the keys to his house to B for safekeeping. Is this a deposit of the hou se? No, since the house is an immovable which cannot be the proper subject matte r of deposit. The relationship is an agency. But if it is a judicial deposit, ev en immovable property can be a valid subject matter. The reason is that the purp ose of a judicial deposit is different. It is to protect the rights of the parti es to the suit. Art. 1967. An extra-judicial deposit is either voluntary or nece ssary. GENERAL RULE: Deposit is voluntary. EXCEPTIONS: Deposit is necessary in the foll owing cases: (See discussion under necessary deposit) 1. if made in compliance with a legal obligation; 2. if it takes place on the oc casion of any calamity, such as fire, storm, flood, pillage, shipwreck, or other similar events; 3. deposit of effects made by travelers in hotels or inns 4. de posit of goods made by travelers or passengers with common carriers CHAPTER 2 VOLUNTARY DEPOSIT Section 1 General Provisions Art. 1968. A voluntary deposit is that wherein the delivery is made by the will of the depositor. A deposit may also be made by two or more persons each of whom believes himself entitled to the thing deposited with a third person, who shall deliver it in a proper case to the one to whom it belongs. What is voluntary deposit? Deposit wherein delivery is made by the will of the depositor. What is the disti nction between voluntary and necessary deposit? The main difference is that in v oluntary deposit, the depositor is free to choose the depositary. In necessary d eposit, the depositor lacks the freedom to choose the depositary. Does the depositor have to be the owner of the thing deposited? Generally, the depositor should be the owner of the thing, but it is not an esse ntial element of deposit. The depositary cannot even require the depositor to pr ove that he is the owner of the thing. When there are several depositors: Cayo IID 2002 PAGE 103

If there are two or more persons each claiming the rightful ownership of a thing , pending the resolution of their conflicting claims, they may deposit the thing with a third person. The third person assumes the obligation to deliver to the person to whom it belongs. The depositary can file an action for interpleader to compel the depositors to settle their conflicting claims. Ex: A and B both clai m to own a dog. While they are trying to settle the ownership of the dog, they c an deposit the dog with C. C can file an action for interpleader to compel A and B to settle the ownership of the dog. C's obligation is to eventually deliver the dog to whomever is the rightful owner. Art. 1969. A contract of deposit may be entered into orally or in writing. There are no formal requirements for the vali dity of a contract of deposit. The only thing necessary is delivery of the thing . Art. 1970. If a person having capacity to contract accepts a deposit made by o ne who is incapacitated, the former shall be subject to all the obligations of t he depositary, and may be compelled to return the thing by the guardian, or admi nistrator or the person who made the deposit or by the latter himself if he shou ld acquire capacity. X, who is insane, deposits her basketball with Boy-B. Can Boy-B refuse to return the basketball later on, on the ground that the deposit was not valid because o f the incapacity of X? No. If the depositary is capacitated, he is subject to all the obligations of a depositary whether or not the depositor is capacitated. Hence, he must return th e property to the legal representative of X or to X herself if she should recove r sanity. Persons who are capacitated cannot allege the incapacity of those with whom they contract. JPSP example: Five tinedyers aged 13 to 15 check into a hotel to go on a drinkin g binge. They deposit some jewelry at the front desk for safekeeping. Is there a valid deposit? Yes, but it may be annulled for want of capacity of the tinedyer s. It's actually a voidable contract, which is valid until annulled. The tinedyers , at the end of their drinking binge, go to the front desk and ask for the retur n of the jewelry. What should the hotel do? The hotel should return the jewelry to their legal representative. The hotel should not return to the tinedyers beca use if subsequently, the tinedyers lose the jewelry, the hotel could be made lia ble for the loss. But definitely, the hotel cannot retain the jewelry, or else, its personnel would be liable for estafa. Art. 1971. If the deposit has been made by a capacitated person with another who is not, the depositor shall only have an action to recover the thing deposited while it is still in the possession of the depositary, or to compel the latter t o pay him the amount by which he may be enriched or benefited himself with the t hing or its price. However, if a third person who acquired the thing acted in ba d faith, the depositor may bring an action against him for its recovery. Cayo IID 2002 PAGE 104

This is the rule that applies if you deposit with a minor or other incapacitated person. If the depositary is incapacitated, while the depositor is capacitated, the incapacitated does not incur the obligations of a depositary. The incapacit ated is liable only: (1) to return the thing deposited if it is still in his pos session; or (2) to pay the depositor the amount by which he may have benefited t hrough the thing or its price if the incapacitated is no longer in possession If the thing was transferred to a third person who was in bad faith, the depositor can recover the thing from him. If the transferee was in good faith, the deposi tor cannot recover from him. The depositor can only go after the incapacitated f or the value of the thing. Boy-B deposits his watch with X, who looks like she's 22 but is actually 13. Can B oy-B recover the watch? If the watch is still in the possession of X, Boy-B can recover the watch itself from X. If X has already sold the watch to Hon, a buyer in good faith and for v alue, Boy-B cannot recover the watch. He can only compel X to return the price t hat Hon paid for the watch (the benefit that X received from the sale of the wat ch). So if the watch is worth P10,000 but X sold it to Hon for P5,000, Boy-B can only recover P5,000 from X. But if Hon was a buyer in bad faith, Boy-B can reco ver the watch itself from Hon. Section 2 Obligations of the Depositary Art. 1972. The depositary is obliged to keep the thing safely and to return it, when required, to the depositor or to his heirs and successors, or to the person who may have been designated in the contract. His responsibility with regard to the safekeeping and loss of the thing shall be governed by the provisions of Ti tle I of this Book. If the deposit is gratuitous, this fact shall be taken into account in determining the degree of care that the depositary must observe. Primary obligations of the depositary: 1. Safekeeping 2. Return of the thing, but only when required Duty of Safekeeping What is the degree of care required of the depositary? As a general rule, the depositary must exercise the same diligence as he would e xercise over his OWN property. He should exercise the diligence of a good father of a family. The reasons for this rule are: Cayo IID 2002 PAGE 105

1. Because the contract of deposit involves the depositor's confidence in the depo sitary's good faith and trustworthiness; and 2. Because it is presumed that the de positor, in choosing the depositary, took into account the diligence which the d epositary normally exercises with respect to his own property. BUT, if under the circumstances, a greater degree of care towards the thing deposited is necessar y, the depositary must exercise such extraordinary care. If, in this case, the t hing deposited is lost and the depositary only exercised the same diligence as h e would towards his own property, he is liable to the depositor for the loss. Th e loss of the thing while it is in the possession of the depositary raises a pre sumption of fault on his part. Duty of Returning the Thing The thing deposited must be returned to the depositor when he claims it, even th ough a specified term or time for such may have been stipulated in the contract and such time has not yet expired. Art. 1973. Unless there is a stipulation to t he contrary, the depositary cannot deposit the thing with a third person. If dep osit with a third person is allowed, the depositary is liable for the loss if he deposited the thing with a person who is manifestly careless or unfit. The depo sitary is responsible for the negligence of his employees. GENERAL RULE: The dep ositary cannot deposit the thing with a third person. Reason for the rule: Depos it is founded on trust and confidence. It is presumed that in choosing the depos itary, the depositor took into account his personal qualifications. EXCEPTION: The parties may stipulate that the depositary may deposit the thing w ith a third person. But there is a limitation ± the depositary cannot choose a thi rd person who is manifestly careless or unfit. What happens if the depositary deposits the thing with a third person, and it is lost? 1. If there is no stipulation allowing him to deposit with a third person , he is liable for the loss, whether it was through his or the third person's faul t or through fortuitous event. 2. Generally, if the thing is deposited with a th ird person with permission of the depositor, and the thing is lost through fortu itous event, the depositary is not liable for the loss. However, if he deposits it with a person who is manifestly careless or unfit, even if there is no neglig ence or even if the loss was through fortuitous event, the depositary is liable for the loss. 3. If the thing is lost through the negligence of the depositary's e mployees, the depositary is liable for the loss (The employee is the agent of th e depositary; principal bears the loss resulting from the negligence of his agen t). Here, it is not necessary that the employees be manifestly careless or unfit , but it is necessary that the loss be through negligence. Cayo IID 2002 PAGE 106

Art. 1974. The depositary may change the way of the deposit if under the circums tances he may reasonable presume that the depositor would consent to the change if he knew of the facts of the situation. However, before the depositary may mak e such change, he shall notify the depositor thereof and wait for his decision, unless delay would cause danger. GENERAL RULE: The depositary should not change the way or manner of the deposit as agreed upon. EXCEPTION: The depositary may c hange it if there are circumstances indicating that the depositor would consent to the change. However, the depositary should first notify and wait for the deci sion of the depositor. If delay would cause danger, the depositary need not wait for the consent of the depositor. Notice to the depositor of the change is suff icient. JPSP example: A deposited jewelry with B, a resident of Lamitan. B did n ot feel so secure with the jewelry in Lamitan, so he deposited the jewelry with a bank in Davao. A sued B for damages for depositing the jewelry with a third pe rson without A's authorization. What is B's defense? B can invoke Article 1974. Unde r the circumstances, B can infer that A would consent to the change of the manne r of deposit. Art. 1975. The depositary holding certificates, bonds, securities or instruments which earn interest shall be bound to collect the latter when it becomes due, and to take such steps as may be necessary in order that the securi ties may preserve their value and the rights corresponding to them according to law. The above provision shall not apply to contracts for the rent of safety dep osit boxes. What are the obligations of the depositary if the thing earns intere st? 1. Collect the interest, as well as the capital, as it becomes due; and 2. T ake such steps as may be necessary to preserve its value and the rights correspo nding to it. Ex: Depositary of a negotiable instrument should give notice of dis honor to all parties secondarily liable, or else these parties would be discharg ed. JPSP example: A deposits to B a promissory note payable to A or order. Can B collect accrued interests on the note? No. The instrument is an order instrumen t. B cannot collect the interest due on it because he is neither an indorsee nor an authorized agent of A. Therefore, Art. 1975 really applies only to BEARER in struments. If it is an order instrument, there is a need for an indorsement or a t least, a special power of attorney, to enable the depositary to collect the in terest and capital when due. Cayo IID 2002 PAGE 107

Safety Deposit Boxes The contract for rent of safety deposit boxes is not an ord inary contract of lease of things because the full and absolute possession and c ontrol of the safety deposit box is not given to the party renting. It is actual ly a special kind of deposit. It is a contractual relation between the parties. The liability rules are governed by the Civil Code provisions on obligations and contracts, and not on donations. Is a stipulation which exempts the bank from l iability for the things contained in the safety deposit box valid? The stipulati on is void. Even if as a rule, the Bank may limit its liability to some extent b y agreement or stipulation, the agreement or stipulation must not be contrary to law and public policy. The law on deposit provides that the depositary is liabl e for loss due to fraud, negligence, delay, or contravention of the tenor of the agreement. Any contrary stipulation would be void. Art. 1976. Unless there is a stipulation to the contrary, the depositary may commingle grain or other articl es of the same kind and quality, in which case the various depositors shall own or have a proportionate interest in the mass. GENERAL RULE: The depositary may c ommingle grain or other articles of the same kind and quality. EXCEPTION: If the re is a contrary stipulation De Leon example: A, depositary, received the follow ing: from B: 30 cavans of rice from C: 20 cavans of rice from D: 10 cavans of ri ce The rice was of the same kind and quality. Can A put all of the rice together ? Yes, since there is no stipulation forbidding it. B will own 30/60 or ½ of the w hole pile; C will own 20/60 or 1/3; and D will own 10/60 or 1/6. But if the arti cles deposited by different depositors are not of the same kind and quality, or if there is a stipulation forbidding it, the depositary must keep them separate or at least identifiable, since he must return to each depositor the very same t hing deposited. Art. 1977. The depositary cannot make use of the thing deposited without the express permission of the depositor. Cayo IID 2002 PAGE 108

Otherwise, he shall be liable for damages. However, when the preservation of the things deposited requires its use, it must be used but only for that purpose. G ENERAL RULE: The depositary CANNOT make use of the thing deposited. EXCEPTIONS: 1. When the depositor has expressly given his permission. Permission cannot be i mplied, and it is not presumed. 2. When the preservation of the thing requires i ts use, it may be used but only for that purpose. Ex: When you deposit a car wit h someone for a week, the depositary should start the car everyday, in order to prevent the battery from getting discharged. Reason for the rule: The principal purpose of deposit is safekeeping, not use of the thing. If the purpose is use, it is not deposit anymore. If the depositary uses the thing deposited without pe rmission of the depositor, he shall be liable for damages. In addition, if the t hing is lost even through fortuitous event, the depositary shall bear the loss. Art. 1978. When the depositary has permission to use the thing deposited, the co ntract loses the concept of a deposit and becomes a loan or commodatum, except w here safekeeping is still the principal purpose of the contract. The permission shall not be presumed, and its existence must be proved. What happens if the dep ositor gives the depositary permission to use the thing? It depends. If the prin cipal purpose is still safekeeping, it retains its character as deposit. However , if the thing deposited is money or other consumable thing and the principal pu rpose is still safekeeping, it is an irregular deposit. If the purpose has becom e use or consumption of the thing: 1. It becomes commodatum if the thing deposit ed is non-consumable. 2. It becomes simple loan or mutuum if the thing deposited is money or other consumable thing. Bank deposits are in the nature of an irreg ular deposit but they are really loans (See Article 1980). Art. 1979. The deposi tary is liable for the loss of the thing through a fortuitous event: (1) If it i s so stipulated; Cayo IID 2002 PAGE 109

(2) If he uses the thing without the depositor's permission; (3) If he delays its return; (4) If he allows others to use it, even though he himself may have been authorized to use the same. GENERAL RULE: The depositary is not liable for loss of the thing through fortuitous event. EXCEPTIONS: 1. Stipulation 2. If he uses it without the depositor's permission ± this is breach/ contravention of the tenor o f the obligation 3. Delay in return ± this is default 4. If he allows others to us e it ± also a breach Take note that the rule is different in commodatum. In commod atum, the members of the borrower's household are allowed to use the thing without liability on the part of the borrower. If the thing is lost in the custody of t he depositary, the presumption is that it was lost through his fault. He has the burden of proving that the loss was not due to his own fault. Art. 1980. Fixed, savings, and current deposits of money in banks and similar institutions shall be governed by the provisions concerning simple loan. Nature of Bank Deposits Ba nk deposits are really loans to a bank because the bank has the obligation to pa y the depositor the amount deposited, but not the exact same money that was depo sited (as in deposit). Since they are loans, they are governed by the provisions concerning mutuum or simple loan, not deposits. Relationship is Debtor-Creditor The relationship between the bank and its depositors is thus that of debtor (ba nk) and creditor (depositor). Hence: 1. If the bank fails to pay its obligation to the depositor, it is not a breach of trust arising from the depositary's failur e to return the subject matter of the deposit. Since there is no breach of trust , it will not constitute estafa through misappropriation. Cayo IID 2002 PAGE 110

2. A bank can generally compensate or set off the deposit in its hands for the p ayment of any indebtedness to it on the part of the depositor, provided that the legal requisites of compensation are present. In a true deposit, compensation i s not allowed. Art. 1981. When the thing deposited is delivered closed and seale d, the depositary must return it in the same condition, and he shall be liable f or damages should the seal or lock be broken through his fault. Fault on the par t of the depositary is presumed, unless there is proof to the contrary. As regar ds the value of the thing deposited, the statement of the depositor shall be acc epted, when the forcible opening is imputable to the depositary, should there be no proof to the contrary. However, the courts may pass upon the credibility of the depositor with respect to the value claimed by him. When the seal or lock is broken, with or without the depositary's fault, he shall keep the secret of the d eposit. Art. 1982. When it becomes necessary to open a locked box or receptacle, the depositary is presumed authorized to do so, if the key has been delivered t o him; or when the instructions of the depositor as regards the deposit cannot b e executed without opening the box or receptacle. A delivers a locked baul to B for safekeeping. What are B's obligations? 1. B must return the baul in the same c ondition ± it must be locked when returned. 2. If the lock of the baul is broken t hrough B's fault, he shall be liable to A for damages. B is presumed negligent unt il proved otherwise. How is the value of the thing determined in case the baul i s opened? Ultimately, the court will decide the value of damages that B should p ay, since the parties will always get into a dispute over the value of the thing (i.e. A would inflate the price, B would undervalue it, etc.) 3. If the lock of the baul is broken, with or without B's fault, B must keep the secret of the depo sit. If the contents of the baul turn out to be illegal ± shabu, a dead body, a bl oody bolo ± the depositary should immediately call the cops. He may still be held liable for the breach of his obligation as depositary but at least he knows that he has done a greater good to society by reporting the dastardly deed to the au thorities. The court just might exonerate him of liability for the breach becaus e of his fulfillment of a civic duty. Besides, I think that if he keeps these th ings a secret, he can even be liable as an accessory to the crime for helping co nceal it. When may B open the baul? Cayo IID 2002 PAGE 111

1. When there is presumed authority ± authority is presumed if the key has been de livered to him; or 2. When there is necessity for opening the box in order to ex ecute the instructions of the depositor as regards the deposit JPSP example: Sha kadivas delivers a locked box to Tuks for deposit. Shak leaves right away withou t giving Tuks an opportunity to ask him why there is a ticking sound coming from inside the box. Tuks is afraid that it might be a bomb. Can he open it without liability? Tuks cannot. The only instances when a depositary can open the box wi thout incurring liability is if there is presumed authority or if there is neces sity for opening it in order to execute the instructions of the depositor. These two instances are not present in the situation of Tuks. He should just hope and pray that it's just a watch in there. Art. 1983. The thing deposited shall be ret urned with all its products, accessories, and accessions. Should the deposit con sist of money, the provisions relative to agents in article 1896 shall be applie d to the depositary. The obligation of the depositary is to return the thing whe n the depositor demands, along with all its products, accessories, and accession s. The depositor is entitled to the products, accessories, and accessions of the thing because he is the owner of the thing. Art. 1984. The depositary cannot de mand that the depositor prove his ownership of the thing deposited. Nevertheless , should he discover that the thing has been stolen and who its true owner is, h e must advise the latter of the deposit. If the owner, in spite of such informat ion, does not claim it within the period of one month, the depositary shall be r elieved of all responsibility by returning the thing deposited to the depositor. If the depositary has reasonable grounds to believe that the thing has not been lawfully acquired by the depositor, the former may return the same. The deposit ary cannot demand that the depositor prove his ownership of the thing deposited. This is because it is not essential that the depositor be the owner of the thin g deposited. When a third person appears to be the owner of the thing: 1. If the depositary finds out that the thing was stolen AND he knows the real owner, his obligation is to INFORM the real owner of the deposit (it is not to return the thing to the real owner yet). Cayo IID 2002 PAGE 112

The real owner must claim the thing within one month. If he claims it within a m onth, the depositary should give it to the real owner. If the real owner fails t o make a claim within a month, the depositary's obligation will be extinguished by returning the thing to the depositor. 2. If the depositary has reasonable groun ds to believe that the thing has not been lawfully acquired by the depositor, th e depositary may return the thing to the depositor (not to the real owner, since in this case, the real owner is not known). But according to JPSP, if the depos itary discovers that the thing was stolen and someone else is claiming to be the real owner, the more prudent thing to do would be to file an action for interpl eader and consign the thing in court. It is not safe to follow 1984 because if t he claim of the alleged real owner turns out to be false, the depositary will be liable for giving the thing to someone else or for refusing to return it to the depositor (estafa). Art. 1985. When there are two or more depositors, if they a re not solidary, and the thing admits of division, each one cannot demand more t han his share. When there is solidarity or the thing does not admit of division, the provisions of Articles 1212 and 1214 shall govern. However, if there is a s tipulation that the thing should be returned to one of the depositors, the depos itor shall return it only to the person designated. When there are two or more d epositors, the default rule is like that in joint obligations ± each depositor can not demand more than his share from the depositary. This rule applies if the thi ng is divisible and there is no solidarity among the depositors. If there is sol idarity or if the thing is indivisible, the rule on solidary obligations is appl icable. Each one of the depositors may do whatever may be useful to the others b ut not anything which may be prejudicial. The depositary can return the thing de posited to any of the depositors unless a demand for its return has been made by one of them, in which case, delivery should be made to him who made the demand. The parties may also stipulate that the thing be returned to a specific deposit or. In this case, the depositary can only return to the depositor stipulated, ev en if he does not make a demand. Art. 1986. If the depositor should lose his cap acity to contract after having made the deposit, the thing cannot be returned ex cept to the persons who may have the administration of his property and rights. The thing deposited must be returned only to a person who is capacitated. If the depositor should subsequently lose capacity, the depositary should return it to his representative. (See discussion under Article 1970 on deposit by tinedyers) Cayo IID 2002 PAGE 113

Art. 1987. If at the time the deposit was made a place was designated for the re turn of the thing, the depositary must take the thing deposited to such place; b ut the expenses for transportation shall be borne by the depositor. If no place has been designated for the return, it shall be made where the thing deposited m ay be, even if it should not be the same place where the deposit was made, provi ded that there was no malice on the part of the depositary. Where to return the thing deposited: 1. First, follow the stipulation of the parties. The expenses f or transportation shall be borne by the depositor since the deposit was constitu ted for his benefit. 2. If there is no stipulation, follow 1987 ± the thing should be returned at the place where the thing deposited may be, even if it was not t he same place where the deposit was constituted. However, there must be no malic e on the part of the depositary. For example, the depositary, not wanting to ret urn the thing anymore, moves it to the Cordillera mountains, so that the deposit or would have a hard time claiming it. In this case, the depositary would be lia ble for damages. Art. 1988. The thing deposited must be returned to the deposito r upon demand even though a specified period of time for such return may have be en fixed. This provision shall not apply when the thing is judicially attached w hile in the depositary's possession or should he have been notified of the opposit ion of a third person to the return or the removal of the thing deposited. In th ese cases, the depositary must immediately inform the depositor of the attachmen t or opposition. GENERAL RULE: The depositary must return the thing upon demand by the depositor even if the period for the deposit has not lapsed. If the depos it is for compensation, and the depositor demands the return of the thing before the period for deposit has lapsed, the depositor must still pay the depositary the full compensation agreed upon. This is because the period in this case is fo r the benefit of both the depositary and the depositor. EXCEPTION TO THE GENERAL RULE: The depositary should not return the thing to the depositor if there is a court order enjoining him from returning the thing to the depositor (when there is attachment). The law says that the depositary can also refuse to return the thing if there is an opposition to its return by a third person (here, there is no court order). However, as discussed earlier, the more prudent thing to do in this case is not to refuse to return the thing to the depositor but to file an a ction for interpleader because there is a danger that the depositary would be li able for damages if the claim of the third person turns out to be false. Art. 19 89. Unless the deposit if for a valuable consideration, the depositary who may h ave justifiable reasons for not keeping the thing deposited may, even Cayo IID 2002 PAGE 114

before the time designated, return it to the depositor; and if the latter should refuse to receive it, the depositary may secure its consignation from the court . As a general rule, the depositary should wait for either the period of the dep osit to lapse or for the depositor to demand the return of the thing before he c an return the thing deposited. But, if the following requisites are present, he may return the thing to the depositor even before the period of the deposit has lapsed or before it is demanded: 1. The deposit must be gratuitous; and 2. There must be a justifiable reason. If the depositary refuses to accept, the deposito r can consign the thing in court. But if the deposit is for compensation, the de positary cannot return the thing until the expiration of the period or until it is demanded by the depositor. Art. 1990. If the depositary by force majeure or g overnment order loses the thing and receives money or another thing in its place , he shall deliver the sum or the thing to the depositor. The depositary is not liable for the loss of the thing either by force majeure or government order. Bu t, if in place of the thing lost, the depositary receives money or another thing , he must deliver it to the depositor. Ex: If the thing is expropriated by the g overnment, the indemnity paid by the government must be turned over by the depos itary to the depositor. Art. 1991. The depositor's heir who in good faith may have sold the thing which he did not know was deposited, shall only be bound to retu rn the price he may have received or to assign his right of action against the b uyer in case the price has not been paid him. First, take note that there seems to be a typo in this provision: it should read ªThe depositary's heir¼º if it is to make any sense. This contemplates the following situation: A deposits a car with B. While the car is still in B's custody, B dies. C, B's son, finds the car among his d ad's stuff and thinks that the car belonged to his dad. C sells the car to D. What are the liabilities of C? If D has already paid C, C must return to A the price that D paid for the car (not the value of the car). If D has not yet paid, C ma y assign to A his right to collect from D the selling price of the car. Cayo IID 2002 PAGE 115

Take note that A has no right to recover the car itself. Also, there must be goo d faith on the part of the heir and the third party buyer. If there was bad fait h, the depositor can recover the car itself. Moreover, the heir will be liable f or estafa. Section 3 Obligations of the Depositor Art. 1992. If the deposit is gratuitous, the depositor is obliged to reimburse t he depositary for the expenses he may have incurred for the preservation of the thing deposited. If the deposit is gratuitous, the depositor should shoulder the costs of preservation because he is the owner of the thing. If the deposit is f or compensation, the depositary should shoulder the costs of preservation of the thing because the compensation is deemed to include the costs of preservation. Example: A deposits a dog with B for 30 days for a compensation of P500. B buys a sack of dog food. By the 10th day, the dog food has run out. Can B ask for mor e money from A? A can refuse to give more money and argue that in charging the c ompensation for the deposit, B should have factored in the expected expenses of preserving the dog. But it still depends on the intention of the parties. Art. 1 993. The depositor shall reimburse the depositary for any loss arising from the character of the thing deposited, unless at the time of the constitution of the deposit, the former was not aware of, or was not expected to know the dangerous character of the thing, or unless he notified the depositary of the same, or the latter was aware of it without advice from the depositor. GENERAL RULE: The dep ositor should compensate the depositary for any loss that the depositary may suf fer from the character of the thing deposited. Example: A deposits a dog with B. It turns out that the dog has rabies. The dog bites B, and as a result, B has t o get anti-rabies shots. A must pay for the damage caused and the cost of B's shot s. EXCEPTIONS: In the following cases, the depositor need not reimburse the depo sitary for any loss arising from the character of the thing deposited: 1. If at the time of the deposit, the depositor was not aware of the dangerous character of the thing; 2. If at the time of the deposit, the depositor was not expected t o know the dangerous character of the thing; 3. If the depositor notified the de positary of the dangerous character of the thing; or 4. If the depositary was aw are of the dangerous character of the thing even without the advice of the depos itor. Cayo IID 2002 PAGE 116

Art. 1994. The depositary may retain the thing in pledge until full payment of w hat may be due him by reason of the deposit. This is an example of a pledge crea ted by operation of law. The depositary may keep the thing deposited as a securi ty for anything that the depositor may owe him, but it has to be by reason of th e deposit. Compare this rule with the rule in commodatum, in which the borrower may generally not retain the thing as a security for anything that the lender ma y owe him (remember the frisbee example?). Art. 1995. A deposit is extinguished: (1) Upon the loss or destruction of the thing deposited; (2) In case of a gratu itous deposit, upon the death of either the depositor or the depositary. Causes for extinguishment of deposit: 1. loss or destruction of the thing deposited 2. In case of gratuitous deposit, upon the death of either the depositor or the dep ositary But if the deposit is for compensation, it is not extinguished by the de ath of either party since it is not personal in nature. Hence, the rights and ob ligations of the parties are transmissible to their heirs. 3. 4. 5. 6. 7. return of the thing novation merger expiration of the term fulfillment of resolutory c ondition CHAPTER 3 NECESSARY DEPOSIT Art. 1996. A deposit is necessary: (1) When it is made in compliance with a lega l obligation; (2) When it takes place on the occasion of any calamity, such as f ire, storm, flood, pillage, shipwreck, or other similar events. Art. 1997. The d eposit referred to in No. 1 of the preceding article shall be governed by the pr ovisions of the law establishing it, and in case of its deficiency, by the rules on ordinary deposit. The deposit mentioned in No. 2 of the preceding article sh all be regulated by the provisions concerning voluntary deposit and by article 2 168. Art. 1998. The deposit of effects made by travelers in hotels or inns shall also be regarded as necessary. The keepers of hotels or inns shall be responsib le for them as depositaries, provided that notice was given to them, or to their Cayo IID 2002 PAGE 117

employees, of the effects brought by the guests and that, on the part of the lat ter, they take the precautions which said hotel-keepers or their substitutes adv ised relative to the care and vigilance of their effects. Art. 1999. The hotel-k eeper is liable for the vehicles, animals and articles which have been introduce d or placed in the annexes of the hotel. Art. 2168. When during a fire, flood, s tory, or other calamity, property is saved from destruction by another person wi thout the knowledge of the owner, the latter is bound to pay the former just com pensation. What are the instances when deposit is NECESSARY? There are FOUR inst ances/ examples of necessary deposit: 1. 2. 3. 4. Deposit Deposit Deposit Deposi t made in compliance with a legal obligation that takes place on the occasion of any calamity of effects made by travelers in hotels or inns of goods with commo n carriers 1. Deposit made in compliance with a legal obligation Example: In pledge, when t he creditor uses the thing pledged without the authority of the owner or misuses it in any other way, the owner may ask that it be judicially or extrajudicially deposited. 2. Deposit that takes place on the occasion of any calamity Example: A fire razes Y's house. X goes inside and gets Y's TV for the purpose of saving it. X becomes the depositary of the TV. The relationship of X and Y, being a deposi t, is governed by the provisions on voluntary deposit. But in addition, it is al so governed by Art. 2168 on quasicontracts. Art. 2168 says that the owner of the thing should pay the depositary just compensation for his expenses in preservin g the thing. So unlike a voluntary deposit, which is by default gratuitous, this kind of necessary deposit is, by express provision of law, for compensation. 3. Deposit of effects made by travelers in hotels or inns Requisites before the ho tel or inn may be held responsible as depositary: a. The hotel or inn should hav e been previously informed about the effects brought by the guests; and b. The g uests have taken the precautions prescribed regarding their safekeeping. The lia bility extends not just to effects inside the rooms but also to property of the guests in the annexes, such as cars in the garage. Cayo IID 2002 PAGE 118

Example: You go to Edsa Shangri-La to eat at the Garden Café. You turn your car ov er to the valet. Is there a contract of deposit? Yes. You don't have to actually g et a room in order to be considered a guest for purposes of constituting the con tract of deposit with the hotel. As long as you use the main facilities of the h otel, you're considered a guest. What if you wanted to shop in Megamall, but since you didn't want to go through the trouble of looking for parking in Megamall, you just used the Edsa Shangri-La valet service ± are you still a guest? No. Although you need not check-in in order to be considered a guest, you must at least use the principal services of the hotel ± the gym, the pool, meeting place at the lobb y, etc. Valet parking is not a principal service of the hotel. If you're the guest , you should: (a) give notice to the hotel of the effects you have brought into the hotel and (b) take the precautions prescribed for their safekeeping. But do you need to give an itemized listing of your valuables every time you go into a hotel? No. Constructive notice to the employees of the hotel is enough. It is su fficient that you bring in your personal effects and the hotel personnel see the m. 4. Deposit of goods with common carriers This is governed by Articles 1733, 1 734, 1735 of the Civil Code under Lease. Common carriers are generally responsib le for the loss, destruction, and deterioration of the goods, unless due to fort uitous event or the fault of the owner of the goods. Art. 2000. The responsibili ty referred to in the two preceding articles shall include the loss of, or injur y to the personal property of the guests caused by the servants or employees of the keepers of hotels or inns as well as by strangers; but not that which may pr oceed from any force majeure. The fact that travelers are constrained to rely on the vigilance of the keeper of the hotels or inn shall be considered in determi ning the degree of care required of him. Art. 2001. The act of a thief or robber , who has entered the hotel is not deemed force majeure, unless it is done with the use of arms or through an irresistible force. Art. 2002. The hotel-keeper is not liable for compensation if the loss is due to the acts of the guests, his f amily, servants or visitors, or if the loss arises from the character of the thi ngs brought into the hotel. When is the hotel liable for the loss of the effects of its guests? Cayo IID 2002 PAGE 119

1. When the loss is caused by the employees of the hotel or by strangers, provid ed the guest followed the two requisites under Art. 1998 (notice and precaution) . 2. When the loss is caused by the act of a thief or a robber done without the use of arms and irresistible force. When is the hotel NOT liable? 1. When the lo ss or injury is caused by force majeure, like flood, fire, theft or robbery by a stranger with the use of arms or irresistible force, UNLESS the hotel-keeper is guilty of fault or negligence in failing to provide against the loss or injury from this cause. So as a general rule, if armed men enter the hotel and steal yo ur things, the hotel is excused from liability because it is considered a fortui tous event. However, if the hotel failed to take reasonable precautions (ex: sec luded island with only one security guard stationed near the shore and lots of f oreigners checked in), it will still be liable for its negligence. 2. When the l oss is due to the acts of the guest (who is the owner of the thing), his family, servants, or visitors; and 3. When the loss arises from the character of the th ings brought into the hotel Example of thing where the loss arises from the char acter of the thing: If you bring a Dalmatian, or a snake, or Cyrus' pet hamster in to the hotel, by the very nature of these pets, they could easily get lost in th e premises. Art. 2003. The hotel-keeper cannot free himself from responsibility by posting notices to the effect that he is not liable for the articles brought by the guest. Any stipulation between the hotel-keeper and the guest whereby the responsibility of the former as set forth in Articles 1998 to 2001 is suppresse d or diminished shall be void. Even if the hotel-keeper posts signs or puts thes e little fine-print stipulations that it is not liable for any loss, it cannot e scape its liabilities as a depositary under Articles 1998 to 2001. Reason: You c annot waive the liability of one who is guilty of gross negligence. Gross neglig ence is equivalent to fraud or bad faith. And as we all know, a waiver of future fraud is void. It is contrary to law, morals, and public policy. However, this only applies to a contract of deposit. In the case of carparks, the fine print o n the tickets always contains a waiver of liability by the owner of the carpark for any loss within its premises. This waiver is valid because, as discussed alr eady, the contract with the carpark is not a deposit but only a short-term lease . Art. 2004. The hotel-keeper has a right to retain the things brought into the hotel by the guest, as a security for credits on account of lodging, and supplie s usually furnished to hotel guests. Cayo IID 2002 PAGE 120

This is another pledge created by operation of law. If you do not pay your hotel bills, the hotel can keep your stuff as a security. Moreover, you will be liabl e for estafa. CHAPTER 4 SEQUESTRATION OR JUDICIAL DEPOSIT Art. 2005. A judicial deposit or sequestration takes place when an attachment or seizure of property in litigation is ordered. Art. 2006. Movable as well as imm ovable property may be object of sequestration. Art. 2007. The depositary of pro perty or objects sequestrated cannot be relieved of his responsibility until the controversy which gave rise thereto has come to an end, unless the court so ord ers. Art. 2008. The depositary of property sequestrated is bound to comply, with respect to the same, with all the obligations of a good father of a family. Wha t is judicial deposit? Judicial deposit is a deposit pursuant to a court order ± w hen an attachment or seizure of property in litigation is ordered by a court. Ex amples: 1. attachment of properties by sheriff upon the filing of a complaint 2. garnishment of money 3. receiver may be appointed by the court to administer an d preserve the property in litigation 4. personal property may be seized by the sheriff in suits of replevin What is the purpose of judicial deposit? Unlike ext ra-judicial deposit, where the purpose is safekeeping, the purpose of judicial d eposit is to maintain the status quo during the pendency of the litigation to in sure the right of the parties to the property in case of a favorable judgment. T his means that in case of favorable judgment, the party will be assured that the re will be property to satisfy the execution of the judgment. What may be the ob ject of judicial deposit? Unlike extra-judicial deposit, where the object must b e a movable, a judicial deposit can cover both movable and immovable property. H ow do you deposit an immovable? You annotate the attachment on the title with th e Register of Deeds. What are the obligations of the depositary of sequestrated property? Cayo IID 2002 PAGE 121

The person appointed by the court as depositary has the obligation to take care of the thing with the diligence of a good father of a family. He may not be reli eved of his responsibility until the litigation is ended or until the court so o rders. DISTINCTIONS BETWEEN JUDICIAL AND EXTRA-JUDICIAL DEPOSIT CAUSE OR ORIGIN PURPOSE SUBJECT MATTER REMUNERATION IN WHOSE BEHALF IT IS HELD JUDICIAL DEPOSIT By will of the court To secure the right of a party to recover in case of favora ble judgment Movable or immovable property The depositary is always compensated; therefore it is onerous In behalf of the person who, by the judgment, has a rig ht EXTRA-JUDICIAL DEPOSIT By will of the parties; hence there is a contract Safe keeping Only movable property As a rule, it is gratuitous, though the parties ma y stipulate otherwise In behalf of the depositor or the third person designated Art. 2009. As to matters not provided for in this Code, judicial sequestration s hall be governed by the Rules of Court. That's all folks. Sorry, I didn't include Warehouse Receipts Law anymore because it's probably going to be just 5% of the exam, according to JPSP. Good luck! May the power of greyskull be with us all ☺ Cayo IID 2002 PAGE 122