MODULE 2: CREDIT TRANSACTION

Essential Requisites of Contract of Pledge and Mortgage

A. That they be constituted to secure the fulfillment of a principal obligation
➔ As a rule: the principal obligation must be a valid obligation because being accessory contracts,
pledge and mortgage owe their existence upon the principal obligation.

Accessory Contract:
➔ a pledge or mortgage, being an accessory contract, cannot exist without a valid obligation or
a principal contract.

Types of obligations/contracts that a pledge/mortgage may secure:

1. Pure obligations
2. Conditional obligations (whether resolutory or suspensive)
3. Obligations with a term (whether resolutory or suspensive)
4. Natural Obligations
5. Rescissible contracts
6. Voidable contracts
7. Unenforceable contracts
Note: They cannot, however, secure a void obligation/contract.

Right to foreclose:
➔ it is also of the essence of these contracts that when the principal obligation becomes due,
the things in which the pledge or mortgage consists may be alienated for the payment to the
creditor.

B. That the pledgor or mortgagor be the absolute owner of the thing pledged or mortgaged
➔ the pledger or mortgagor must be the absolute owner of the thing pledged or mortgaged at
the time the pledge is constituted, Therefore, a pledge or mortgage on future property is void.
➔ a third person may pledge or mortgage their property, it is not required for the validity of a
pledge or mortgage that the debtor be the owner of a thing pledged or mortgaged.

Third persons:
➔ who are not parties to the principal obligations may secure the latter by pledging or
mortgaging their own property.
• they can be held liable only to the extent of the value of their property.
• with respect to mortgage, they may be held liable for any deficiency in case of foreclosure
if they expressly agreed to assume the principal obligation.

C. 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
➔ free from disposal - the property being given in pledge or mortgage is free from claims or
encumbrances.
Can the thing pledged or mortgaged be sold or alienated to pay the debt?
➔ before maturity — as a rule, NO because the payment of the debt cannot yet be compelled;
• except, if the pledger or mortgagor fails to fulfill certain conditions such as a violation
that would make the debt due.
➔ at maturity — upon default of the debtor to pay the obligation at maturity, the thing pledged
or mortgaged may be sold or otherwise alienated to pay the creditor (proceeds only after
foreclosure but the creditor cannot automatically be the owner of the property pledged or
mortgaged).
 The creditor cannot appropriate the thing pledged or the mortgaged property.
a. If there is a stipulation that the creditor can appropriate the thing pledged or
mortgaged property, such stipulation is considered void.
b. Automatic Appropriation/Pactum Commissorium
➔ this is an agreement whereby the creditor automatically becomes the owner of
the thing given by the way of pledge or mortgage or dispose of them in case of non-
payment.
➔ a stipulation which enables the mortgagee or pledgee to acquire ownership of
the pledged or mortgaged property without the need of any foreclosure
proceeding or public action, such stipulation is considered null and void.
• Note that the contract of loan and contract of pledge or mortgage remain to be valid.
c. Exceptions:
1. Dacion en Pago (subsequent voluntary act on the part of the debtor)
➔ the transfer of the property to the creditor extinguishes the monetary debt.
2. In case of pledge
➔ accessory contract by virtue of which personal property delivered to the creditor as
a security for an obligation with the agreement that it can be sold at a public auction
➔ if at the first and second auction sale the thing is not sold, the creditor may
appropriate the thing pledged.

Indivisibility of Contract
• As a rule, a pledge or mortgage is indivisible, even though the debt may be divided among the
successors in the interest of the debtor or of the creditor. This rule applies even if the debtors are
jointly liable.
o Rule of indivisibility NOT applicable:
▪ the pledge or mortgage is divisible if several things are given in pledge or mortgage
and each of them guarantees only a determinate portion of the credit.

Therefore:
1. The debtor’s heir who has paid a part of the debt cannot ask for the proportionate extinguishment
of the pledge or mortgage as long as the debt is not completely satisfied.
2. Neither can the creditor’s heir who received his share of the debt return the pledge or cancel the
mortgage, to the prejudice of the other heirs who have not been paid.

PLEDGE
• contract by virtue of which the debtor delivers to the creditor or to a third person a movable or
instrument evidencing incorporeal rights for the purpose of securing the fulfillment of a principal
obligation with the understanding that when the obligation is fulfilled, the thing delivered shall be
returned with all its fruits and accessions.

Contracting Parties
1. Pledgor (debtor) — refers to the person who delivers his personal property to the creditor-pledgee
to secure the principal contract of loan
2. Pledgee (creditor) — refers to the person whose loan receivable is secured by the personal property

Kinds of Pledge
a. Voluntary or conventional — created by agreements of parties
b. Legal — created by operation of law
Characteristics
1. Real Contract — perfected by the delivery of the thing pledged (movable or instrument evidencing
incorporeal rights)
2. Accessory Contract — no independent existence of its owner
3. Unilateral — creates an obligation solely on the part of the creditor to return the thing pledged upon
the fulfillment of the principal obligation
4. Subsidiary — obligation incurred does not arise until the fulfillment of the principal obligation which
is secured
5. Indivisible — it creates a lien on the whole or all of the properties pledged, which lien continues
until the obligation is secures has been fully paid
6. Nominate — it has a name given to it by law and there specific rules that govern the same

Subject Matter of Pledge:

1. All movable property or personal property
➔ the property is within the commerce of man and susceptible of possession
➔ if the movable property is unlawful, there is no contract of pledge because of the absence of the
object.
2. Incorporeal rights or intangible assets
➔ evidenced by negotiable instruments, bills of lading, shares of stocks, bonds, etc.

Cause or Considerations:
1. Pledgor/Debtor — the principal obligation
2. Pledgor not the debtor — compensation stipulated or mere liberality

Essential Requisite of a Pledge

a. The pledge must be constituted to secure the fulfillment of a principal obligation;
Can an after incurred obligation be secured by an already existing pledge?
➔ Yes, provided such an obligation is accurately described.
b. The pledgor must be the absolute owner of the thing pledged or mortgaged.
c. The pledgor must have free disposal of the property.

Additional Essential Requisite of a Pledge

a. The thing pledged should be placed in the possession of the creditor or of a third person by
common agreement.
Note: Actual delivery must be made and not symbolic delivery.
b. To take effect against third persons the description of the thing pledged and the date of the pledge
must appear in a public instrument.

Form of Contract of pledge

• there is no form (can be oral or written) required to constitute a contract of pledge as long as all
the essential requisites are present. However, this is only binding with the contracting parties
(pledgee and pledgor).
o In order to bind a third person:
a. there must be a public instrument
b. the public instrument contains:
i. the description of the thing pledged; and
ii. the date of the pledge

Alienation (sale) of the thing pledged; is allowed with consent of the pledgee
➔ the ownership of the thing pledged is transferred to the vendee or transferee as soon as the
pledgee consents to the alienation but the creditor-pledgee shall continue in possession.
Creditor-pledgee:
a. To take care of the thing pledged with the diligence of a good father of a family.
b. To be liable for the loss or deterioration of the thing pledged unless it is due to a fortuitous event.
c. Not to deposit the thing pledged with a third person unless ordered by the court.
d. To be responsible for the acts of his agents or employees with respect to the thing pledged.
e. Not to use the thing pledged except when he is authorized by the owner or when the use of the
thing is necessary for its preservation.
f. To deliver to the debtor the surplus after paying his claim from what he has collected on a credit
that was pledged and which has become due before it is redeemed.
g. If the pledge earns or produces fruits, income, dividends, or interests, the creditor shall
compensate what he receives with those which are owing him; but if none are owing him, or insofar
as the amount may exceed that which is due, he shall apply it to the principal. Unless there is a
stipulation to the contrary, the pledge shall extend to the interest and earnings of the right
pledged.
Note: As a general rule, the creditor cannot use the thing pledged, without the authority of the owner.
➔ Unless, there is an authority from the owner (pledgor), or when the preservation of the thing
pledged requires its use, it must be used by the creditor but only for that purpose.

Rights of the creditor-pledgee

a. To retain in his possession the thing pledged until the debt is paid.
b. To demand reimbursement of the expenses made for the preservation of the thing pledged.
c. To bring actions which pertain to the owner of the thing pledged to recover it from or defend it
against third person.
d. To use the thing pledged if he is authorized to do so, or when its use is necessary for the
preservation of the thing.
e. To cause the sale of the thing pledged at a public sale, if there is a danger of destruction,
impairment, or diminution of value of the thing pledged without his fault.
f. To collect and receive the amount due if the thing pledged is a credit which becomes due before
it is redeemed, and to apply the same to the payment of his claim.
g. To sell the thing pledged upon default of the debtor.
h. To appropriate the thing pledged in case the thing pledged is not sold in at least two public
auctions.
i. To exercise the right of choice in selecting among the things pledged that one that be sold in
public auction in satisfaction of the secured debt.

Pledgor:
1. the pledge who, knowing the flaws if the thing pledged does not advise the pledgee of the same,
shall be liable to the latter for the damages which he may suffer by reason thereof.
2. 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 interests, with expenses in a proper case.

Rights if the debtor-pledgor

a. To alienate, with the consent of the pledgee, the thing pledged but the thing pledged will still be
subject to the contract of pledge.
b. To continue to be the owner of the thing pledged unless it is expropriated or sold in public auction
after default by the principal debtor.
c. To ask for the return of the thing pledged after he has paid the debt and its interest, with expenses
in a proper case.
d. To ask that the thing pledged be judicially or extra-judicially deposited if it is used without authority
or for purposes other than for its preservation.
 e. To require that the thing be deposited with a third person if it is in danger of being lost or impaired
through the negligence or willful act of the pledgee.
f. To demand the return of the thing pledged, upon offering another thing in pledge, provided the
latter is of the same kind and quality, if there are reasonable grounds to fear the destruction or
impairment of the thing pledged without the fault of the pledgee. This right is without prejudice to
the right of the pledgee to have the thing sold at a public sale. However, the pledgee is bound to
advise the pledgor, without delay, of any danger to the thing pledged.
g. Incase of a pledge of animals, their offspring shall pertain to the pledgor or owner of animals
pledged, but shall be subject to the pledge, if there is no stipulation to the contrary.

Obligations of the debtor-pledgor

a. To pay the debt and its interest, with expenses, in property case, when they are due if the pledgor
is also the debtor.
b. To pay damages that the pledgee may suffer by reason of the flaws of the thing pledged if he was
aware of such flaws but did not advise the pledgee of the same.
c. To pay for the expenses which are necessary for the preservation of the thing pledged.

Public Auction
• The creditor to whom the credit has not been satisfied in due time, may proceed before a notary
public for the sale of the thing pledged. This sale shall be;
a. made at a public auction
b. with the intervention of the notary public
c. with notification to the debtor and the owner of the thing pledged in a proper case
d. the notice must state the date for which the public sale is to be made.
Note:
➔ If at the first auction sale the thing is not sold, a second one with the same formalities shall be
held; and if at the second auction there is no sale either, the creditor may appropriate the thing
pledged. In this case, the creditor shall be obliged to give an acquittance for his entire claim.
➔ At the public auction, the pledgor or the owner may bid. He shall moreover, have a better right
if he should offer the same terms as the highest bidder. The pledgee may also bid but his offer
shall not be valid if he is the ONLY bidder.
➔ The pledgor or owner has no right to redeem the property after the public auction. However,
there is equity of redemption, that is the pledgor or owner may satisfy the obligation after it
becomes due and before the public sale.

Rules on Deficiency and Excess

1. Deficiency cannot be recovered
a. the sale of the thing pledged shall extinguish the principal obligation, whether or not the
proceeds of the auction sale are equal to the amount of the principal obligation, interest and
expenses in a proper case. The creditor is not entitled to recover the deficiency even if there is
a stipulation to the contrary.
b. the price of the sale is less than the amount of the principal obligation, the creditor is not
entitled to the deficiency even though there is a stipulation to the contrary.
2. Excess belongs to the creditor-pledgee
a. if the price of the sale is more than the amount of the obligation, the debtor shall not be entitled
to the excess. Exceptions are:
1) If it is otherwise agreed.
2) In legal pledge or pledge by operation of law, after payment of the debt and expenses,
the remainder of the price of the sale shall be delivered to the obligor.
Null and void stipulations in a contract of pledge
a. A stipulation which provides that the pledge is not extinguished by the return of the thing pledged.
b. A stipulation allowing the automatic appropriation by the pledge of the thing pledged in case of
default of the debtor.
c. A stipulation for the recovery of deficiency in case the proceeds from the sale of the thing pledged
is less than the amount of the obligation.

Legal Pledge
• refers to the right of a person to retain a thing until he receives payment of his claim.
• Examples:
➔ A possessor in good faith may retain the movable upon which he has incurred necessary and
useful expenses until he has been reimbursed therefore.
➔ He who has executed work upon movable has a right to retain it by way of pledge until he is
paid.
➔ The depositary may retain the thing deposited until the full payment of what may have been due
from him by reason of the deposit.

Contact of or Conventional pledge vs Legal pledge

CONVENTIONAL PLEDGE LEGAL PLEDGE
the excess in foreclosure sale in conventional the excess in the public sale in legal pledge will
contract of pledge will generally go to the go to the debtor
pledgee in the absence of stipulation to the
contrary
the deficiency in foreclosure sale in conventional the deficiency in public sale in legal pledge can
contract of pledge can never be recovered by the be recovered by the creditor
pledgee

Extinguishment of Pledge
1. Indirect Mode of Extinguishment
➔ When the principal obligation or contract of loan secured by the contract of pledge is
extinguished.
2. Direct Modes of Extinguishment of contract of pledge that do not extinguish the secured contract
of loan:
a. If the thing pledged is returned by the pledgee to the pledgor or owner and any stipulation to
the contrary shall be void;
b. A statement in writing by the pledgee that he renounces or abandons the pledge is sufficient
to extinguish the pledge. For this purpose, neither the acceptance by the pledgor or owner nor
the return of the thing pledged is necessary, the pledgee becoming a depositary.
3. Direct Modes of Extinguishment of contract of pledge that also extinguish the secured contract of
loan
a. Sale of the thing pledged regardless of the net proceeds of the sale.
b. Appropriation of the thing pledged by the pledgee if the thing pledged is not sold in at least
two public auctions.

REAL ESTATE MORTGAGE

• a contract whereby the debtor or third person secures to the creditor the fulfillment of a principal
obligation, specially subjecting to such security immovable property or real rights over immovable
property in case the principal obligation is not complied with at the time stipulated.
Contracting Parties:
a. Mortgagor — refers to the person who uses his real property as collateral for the principal contract
of loan.
b. Mortgagee — refers to the person whose loan receivable is secured by the real property.

Characteristics of real estate mortgage:

1. Accessory — It cannot exist without a principal obligation such as a contract of loan.
2. Indivisible — It creates a lien on the whole or all of the properties mortgaged, which continues
until the obligation it secures has been fully paid.
3. Inseparable — It subjects the property upon which it is imposed, whoever the possessor may
be, to the fulfillment of the obligation for whose security it was constituted.
4. Real Right — It creates a lien on the property mortgaged.
5. Consensual Contract — It is perfected by mere consent.
6. Nominate — It has a name given to it by law.
7. Unilateral — creates an obligation solely on the part of the creditor to return the thing
8. Subsidiary — obligation incurred does not arise until the fulfillment of the principal obligation
which is secured

Subject matter of contracts of real estate mortgage

1. Immovable Property
2. Rights on immovable property

Kinds of real estate mortgage

a. Conventional real estate mortgage
➔ created by the agreement of the parties.
b. Legal mortgage
➔ executed pursuant, to an express requirement of a provision of law.
c. Equitable mortgage
➔ although it lacks certain formality, form or words or other requisites provided by statute, the
facts show the intention of the parties to charge the real property as a security for a debt and
contains nothing contrary to law. The remedy of the injured party is to file an action for reformation
of the instrument.

Form of Contract of Real Estate Mortgage

• there is no form (can be oral or written) required to constitute a contract of real estate mortgage as
long as all the essential requisites are present. However, this is only binding with the contracting
parties (mortgagee and mortgagor).
o In order to affect a third person:
a. there must be a public instrument (only a requirement for the convenience of the parties
but not to bind the third person)
b. the public instrument contains;
1) the description of the thing pledged; and
2) the same should be recorded in the Registry of Property (in order to bind the
parties)

Foreclosure
• remedy available to the mortgagee by which he subjects the property mortgaged to the
satisfaction of the obligation secured when the principal obligation is not paid when due or when
there is any violation of any condition, stipulation or warranty by the mortgagor.
Kinds of Foreclosure of Real Estate Mortgage
a. Judicial foreclosure
➔ under Rule 68 of the Rules of Court
➔ with the intervention of the court
b. Extrajudicial foreclosure
➔ under Act No. 3135
➔ without the intervention of the court

Notice of Foreclosure Sale

a. Judicial
➔ not required, unless stipulated.
b. Extrajudicial
➔ posting in 3 public places at least 20 days prior to sale and publication of the notice of sale in a
newspaper of general circulation.

Equity of Redemption
a. Judicial
➔ The judgment debtor/mortgagor has a period of not less than 90 days nor more than 120 days
from the entry of judgment to pay his liability to prevent the public sale of his mortgaged property.
b. Extrajudicial
➔ The mortgagor may pay his obligation to prevent the public sale of his property in the grace
period given by the mortgagee.

Right of Redemption
a. Judicial
➔ The judgment debtor/mortgagor is not generally allowed to repurchase the property sold in
public auction in judicial foreclosure unless a special law allows. As an exception to the general
rule, a mortgagor in judicial foreclosure made by mortgagee-bank may still exercise the right of
redemption in accordance with the redemption period provided by General Banking Law.
b. Extrajudicial
➔ The mortgagor may repurchase the property sold in public auction within a period of:
o Generally, within 12 months or 1 year from public sale (Act No. 3135 – Real Estate Mortgage
Law)
o Exceptionally within 3 months or 90 days from public sale if the mortgagee is a bank and
the mortgagor is a juridical or artificial person. (General Banking Law)

Rules on Deficiency and Excess (Proceeds)

1. More than the unpaid amount
➔ the mortgagor shall be entitled to the excess.
2. Less than the unpaid amount
➔ the mortgagor shall be entitled to recover the deficiency.

Null and void stipulations in a contract of mortgage

a. A stipulation which provides for tipo or upset price in the foreclosure sale of mortgaged property.
b. A stipulation allowing the automatic appropriation by the mortgagee of the thing pledged in case
of default of the debtor.
c. A stipulation prohibiting the mortgagor from disposing or selling his property.
CHATTEL MORTGAGE
• It is a contract by virtue of which personal property is recorded in the Chattel Mortgage Register as
a security for the performance of an obligation.

Contracting Parties:
a. Mortgagor — refers to the person who uses his real property as collateral for the principal contract
of loan.
b. Mortgagee — refers to the person whose loan receivable is secured by the real property.

Characteristics of chattel mortgage:

1. Accessory — It cannot exist without a principal obligation such as a contract of loan.
2. Indivisible — It creates a lien on the whole or all of the properties mortgaged, which continues until
the obligation it secures has been fully paid.
3. Inseparable — It subjects the property upon which it is imposed, whoever the possessor may be, to
the fulfillment of the obligation for whose security it was constituted.
4. Formal contract — It is perfected by the registration to chattel mortgage register.
5. Nominate — It has a name given to it by law.

Subject Matter of Chattel Mortgage

1. Personal Property
2. Movable Property

Foreclosure
• Foreclosure shall be done extrajudicially.
o Note: Rule 68 of the Rules of Court does not apply to foreclosure of a chattel mortgage.
o Notice: required 10 days prior to sale; posting in two or more public places 10 days before
auction.

Rules on Deficiency and Excess (Proceeds)

1. More than the unpaid amount
➔ the mortgagor shall be entitled to the excess in the absence of stipulation to the contrary.
2. Less than the unpaid amount
a. General Rule: the mortgagee can recover the deficiency in the absence of stipulation to the
contrary.
➔ Exception: if the object is subject of a sale in installment and covered by the Recto Law
which prohibits collection of unpaid amount once the creditor (unpaid seller) already
foreclosed the chattel mortgage on the property itself.