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 value shall be appraised at the current price of the products or goods at the time and place of payment.Take note that you should not confuse this with the rule when 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 constitution of the obligation.But if interest is payable in kind, it should be appraised at its value at the time of payment.General Rule: Accrued interest shall not earn interestExceptions:1. When judicially demanded (Art. 2212) 2. Express stipulation Also called compounding interest where the parties agree that accrued interest shall be added to the principal and the resulting total amount shall earn interest. A stipulation as to compounding interest must bein writing.How does compounding interest work?Lender lends P100,000 payable in 2 years at 10% interest compounded per annum.At the end of the first year, how much is due? Principal 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.II. GUARANTY AND SURETYSHIPCHAPTER 1 NATURE AND EXTENT OF GUARANTY

Art. 2047. By guaranty a person, called the guarantor, binds himself to the creditor to fulfill the obligation of the principal debtor in case the latter should fail to do so.

Sheryl IID 2002PAGE 11

If a person binds himself solidarily with the principal debtor, the provisions of 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 guarantor binds himself to the creditor to fulfill the obligation of the principal debtor in case the latter should fail to do so.In a contract of guaranty, the parties are the guarantor and the creditor.Characteristics of the Contract of Guaranty (A-SC-U-D)1. Accessory: It is dependent for its existence upon the principal obligation guaranteed by it. 2. Subsidiary and Conditional: It takes effect only when the principal 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 debtor should indemnify the guarantor, but this obligation is only incidental)

b. It may be entered into even without the intervention of the principal debtor.

4. Distinct Person: It requires that the person of the guarantor must be distinct 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 properties. Classification of Guaranty1. 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 mortgage or antichresis; If the guaranty is movable property: pledge or chatter mortgage 2. As to origin:

a. conventional: by agreement of the parties b. legal: imposed by law c. judicial: 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 principal obligation Sheryl IID 2002PAGE 12b. 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 thereof b. indefinite or simple: includes not only the principal obligation but also all its accessories, including judicial costs. Second Paragraph of Art. 2047: SuretyshipIf a person binds himself solidarily with the principal debtor, it is a contract of suretyship. The guarantor is called a surety. Suretyship is governed by Articles 1207 to 1222 of the Civil Code on solidary obligations. Suretyship dispenses 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 debtor and surety, after payment, may require that they be reimbursed. The difference is that the lender cannot go after the surety right away. There has to be default on the part of the principal debtor before the surety becomes liable. If it were mere solidarity among debtors, the creditor can go after any of the solidary debtors on due date.Nature of a Suretys Undertaking1. Contractual and Accessory BUT Direct: The contractual obligation of the surety is merely an accessory or collateral to the obligation contracted by the principal. BUT, his liability to the creditor is direct, primary, and absolute. 2. Liability is limited by the terms of the contract: The extent of a suretys liability is determined only by the terms of the contract and cannot be extended by implication. 3. Liability arises only if principal debtor is held liable: If the principal debtor and the surety are held liable, their liability to pay the creditor would be solidary. But, the surety does not incur liability unless and until the principal debtor is held liable. a. A surety is bound by a judgment against the principal even though the party was not a party to the proceedings.

b. The creditor may sue, separately or together, the principal debtor and the surety (since they are solidarily bound).

c. Generally, a demand or notice of default is not required to fix the suretys liability.

d. An accommodation party (one who signs an instrument as maker, 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 holder of the instrument, subject to reimbursement from the accommodated party.

Sheryl IID 2002PAGE 13Example: Tuks accommodates Shak so that he can obtain a loan from the bank. At the bottom of the loan agreement, the following signatures appear:(sgd) Tuks(sgd) ShakLino Chris KapunanSherwin ShakramyIs 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 hes 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 exhaustion 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 cannot claim that the surety breached its obligation to pay for the principal obligation because there is no obligation as between the surety and the debtor. If the surety does not pay, the principal debtor is still not relieved of his obligation. Guaranty Distinguished from Suretyship:GUARANTYSURETYSHIP

Guarantor promises to answer for the debt,Surety promises to answer for the debt, default or

default or miscarriage of the principalmiscarriage of the principal (same)

Liability of the guarantor depends upon anSurety assumes liability as a regular party to

independent agreement to pay the obligation ifthe undertaking

the primary debtor fails to do so

The engagement of the guarantor is a collateralSurety is charged as an original promisor

undertaking

The guarantor is secondarily liableA surety is primarily liable

MAIN DIFFERENCE: A surety undertakes to pay if the principal does not pay (insurer of the debt). A guarantor binds himself to pay if the principal cannot pay (insurer 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 pays only in the event that the principal is broke. Illustration:A borrows P10,000 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 were 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 the lender, a real estate mortgage is more advisable because you can collect against the property. In a guaranty/surety, you would have to go against the guarantor orSheryl IID 2002PAGE 14surety you would have to sue him, obtain judgment, and then execute judgment. This 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 contrary.

GENERAL RULE: Guaranty is gratuitous.EXCEPTION: Guaranty is onerous only if it is stipulated.What is the cause/consideration of a contract of guaranty?The 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 consideration 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 woman may guarantee an obligation without the husbands consent, but shall not thereby bind the conjugal partnership, except in cases provided by law.Art. 94 of the Family CodeThe absolute community of property shall be liable for:(3) Debts and obligations contracted by either spouse without the consent of the other to the extent that the family may have been benefited.

A married woman who acts as guarantor without the consent of the husband binds only her separate property unless the debt benefited the family.There is no express prohibition against a married woman acting as guarantor for her husband.Remember that now, in order to bind the absolute community, the consent of both spouses is needed. If only the consent of one spouse is obtained, the absolute community will not be liable unless the obligation redounded to the benefit of the community.When the husband acts as a guarantor for another person without the consent of the wife, the guaranty binds only the husband since the benefit really accrues to the principal debtor and not to the husband or his family. The exception is if the husband is really 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 1237 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 debtor, 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, the effect is like payment by a 3rd person:1. The guarantor can only recover insofar as the payment has been beneficial to the debtor.

2. The guarantor cannot compel the creditor to subrogate him in the creditors 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 guarantor is subrogated to all the rights which the creditor had against the debtor once he pays for the obligation.Illustration:Sheryl IID 2002PAGE 15A owes B P10,000. Without the knowledge of A, C guarantees the obligation. C pays 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 was only the extent to which A was benefited by his payment.If the loan was secured 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 without 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 without a valid principal obligation. So if the principal obligation is void, the guaranty is also void.BUT, a guraranty may be constituted to guarantee the following defective contracts and natural obligations:1. Voidable: because the contract is binding unless it is annulled

2. Unenforceable: because an unenforceable contract is not void.

3. 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 the debt is liquidated. A conditional obligation may also be secured.

Continuing Guaranty (def) A guaranty that is not limited to a single transaction but which contemplates a future course of dealings, covering a series of transactions generally for an indefinite time or until revoked.A continuing guaranty is generally prospective in its operation and is intended to secure future transactions (generally 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 obligation with a third person and you default, the third person just needs to inform the bank, and the bank will release the money. The money released will be considered as a loan from the bank to you. The bank will allow the release of the money so long as it doesnt exceed the ceiling. 2. To secure payment of any debt to be subsequently incurred If the contract states that the guaranty is to secure advances made from time to time, now in force or hereafter made, or uses the words any debt, any indebtedness, any sum, any transaction, the guaranty is a continuing guaranty. 3. To secure existing unliquidated debts Future debts may also mean debts that already 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 thing to remember in the guaranty of future debts is that there must be anSheryl IID 2002PAGE 16existing obligation already that is being guaranteed. Because without that existing obligation, the guaranty would be void. Guaranty is an accessory obligation, so it cannot exist without the principal.Example: G guarantees the 10K loan that B owes L and any other indebtedness that B may incur against L. This is a valid guaranty because there is already an existing obligation (the 10K loan).G guarantees the loan that B and L will enter into tomorrow. This is not valid. Although it is for a future debt, it is not valid under Article 2053 because there is no principal obligation yet. There is nothing to guarantee.Guaranty of Conditional ObligationsIf the principal obligation is subject to a suspensive condition, the guarantor is liable only after the fulfillment of the condition.If it is 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 the amount and the onerous nature of the conditions.Should he have bound himself for more, his obligations shall be reduced to the limits of that of the debtor.

Since the contract of guaranty is a subsidiary and accessory contract, the guarantors liability cannot exceed that of the principal obligation. If the guarantor binds himself for more than the liability of the principal debtor, his liability shall be reduced.However, if the creditor sues the guarantor, the guarantor may be made to pay costs, attorneys fees, and penalties even if this will make his liability exceed that of the principal.How do you opt out of this rule?Example: G guaranteed Bs 100K obligation to L to the extent of 100K. As an extra consideration for lending the money, L wants an additional 20K from guarantor (gravy, according to JPSP). Since 2054 provides that the guarantor cannot bind himself for more than the principal debtor, how do the parties opt out of the rule?Guarantor 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.

Art. 2055. A guaranty is not presumed; it must be express and cannot extend to more than what is stipulated therein.If it be simple or indefinite, it shall comprise not only the principal obligation, but also all its accessories, including the judicial costs, provided with respect to the latter, that the guarantor shall only be liable for those costs incurred after he has been judicially required to pay.

RULE: Guaranty is never presumed. It must be express.Reason for the rule: Because a guarantor assumes an obligation to pay for anothers debt without any benefit to himself. Thus, it has to be certain that he really intends to incur such an obligation and that he proceeds with consciousness of what he is doing.Form required for GuarantyGuaranty must be IN WRITINGSheryl IID 2002PAGE 17A contract of guaranty, to be enforceable, must be in writing because it falls under the Statute of Frauds as a special promise to answer for the debt, default or miscarriage of another. 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 covered by the SOF is being a solidary co-debtor.Construction of GuarantyA guaranty 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 resolved in favor of the guarantor or surety.Generally, a guarantor is liable only for the obligation of the debtor stipulated upon, andnot toobligations assumed PREVIOUS to the execution of the guaranty unless an intent to be so liable is clearly indicated. (Prospective application of the guaranty)However, this rule of construction is applicable only to an accommodation surety or one that is gratuitous. It does not apply in cases where the surety is compensated with consideration. In such cases, the agreement is interpreted against the surety company that prepared it.Is a stipulation that says that the guaranty will subsist only until maturity of the obligation valid?Generally, no. Such a stipulation would defeat the purpose of a guaranty which is to answer for the default of the principal 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 agreed: If the lender asked for a guaranty precisely because there was a danger of the borrower absconding or becoming insolvent prior to maturity date, then the guaranty is valid.2nd Paragraph of Art. 2055: Extent of Guarantors Liability1. 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 liability of the guarantor is limited to the principal obligation, it extends not only to the principal but also to all its accessories. This is because in entering into the agreement, the principal could have fixed the limits of his responsibility solely to 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 since 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 become 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 unconditional 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 is 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 2002PAGE 18

The guarantor shall be subject to the jurisdiction of the court of the place where 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 insolvent, 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 qualifications of a guarantor are the ff:1. Integrity

2. Capacity to bind himself

3. 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 obligation is to be fulfilled, in accordance with the rule that accessory follows the principal.Effect of Subsequent Loss of QualificationsThe qualifications need only to be present at the time of the perfection of the contract. The subsequent loss of the qualifications would not extinguish the liability of the guarantor, nor 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 of a crime involving dishonesty (since he loses integrity)

2. In case the guarantor becomes insolvent (since he loses sufficient property to answer for the obligation which he guarantees) there is no need for a judicial declaration of insolvencyWhat is the effect of the guarantors death on the guaranty?The guaranty survives the death of the guarantor. The general rule is that a partys contractual rights and obligations are transmissible to his successors. The rules on guaranty do not expressly provide that the guaranty is extinguished upon the death of the guarantor. Applying Art. 2057, the supervening incapacity of the guarantor does not extinguish the guaranty but merely gives the creditor the right to demand a replacement. But the creditor can waive this right and choose to hold the guarantor to his bargain. If he so chooses, the creditors claim passes to the heirs of the deceased guarantor.When may the creditor NOT demand another guarantor?Where the creditor has stipulated in the original 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 latter has exhausted all the property of the debtor, and has resorted to all the legal remedies against the debtor.

Sheryl IID 2002PAGE 19The 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 fulfilled:1. The creditor should have exhausted all the property of the debtor; and

2. The creditor has resorted to all legal remedies against the debtor (ex. Accion pauliana/ rescission of fraudulent alienations)

Can the creditor implead the guarantor as a co-defendant with the debtor?No. Except in cases provided in 2059, Article 2062 says that creditor should proceed against the principal debtor alone.

Art. 2059. This excussion shall not take place:1. If the guarantor has expressly renounced it;

2. If he has bound himself solidarily with the debtor;

3. In case of insolvency of the debtor;

4. When he has absconded, or cannot be sued within the Philippines unless he has left a manager or representative;

5. If it may be presumed that an execution on the property of the principal debtor would not result in the satisfaction of the obligation.

GENERAL RULE: The guarantor is entitled to demand that the creditor first exhaust the properties of the principal debtor before collecting from the guarantor.EXCEPTIONS:1. Under Art. 2059

2. If the guarantor does not comply with Art. 2060

3. If the guarantor is a judicial bondsman and sub-surety (Art. 2084)

4. Where a pledge or mortgage has been given by him as a special security.

5. 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 its practical insolvency meaning assets are less 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 case, 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 against these assets by the other creditors. They can still be accessed by L, and L can still file an action for collectionSheryl IID 2002PAGE 20of money against B. So in this case, even if B is insolvent on paper, his properties 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 date, 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 subrogatoria so that he can exercise Bs 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 guarantor. 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 useless formality. In this case, it is not even necessary that the debtor is judicially 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, he 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 latters demand for payment from him, and point out to the creditor available property of the debtor within Philippine territory sufficient to cover the amount of the debt.Art. 2061. The guarantor having fulfilled all the conditions required in the preceding article, the creditor who is negligent in exhausting the property pointed out shall suffer the loss, to the extent of said property, for the insolvency of the debtor resulting from such negligence.

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 guarantor in the suit against the principal is not the demand intended by law. Additional Requisites in Order to Claim the Benefit of ExcussionGuarantor tells Lender Exhaust Borrowers property first before collecting from me. Is this enough for the Guarantor 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 2002PAGE 211. 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 which 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 debtor. 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 principal debtor alone. He cannot sue the guarantor with the principal or the guarantor 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 given the benefit of exhaustion event after judgment is rendered against the principal 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 really a two-step process. The purpose of the two-step process is to allow the guarantor 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 against 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 the bank of the default and the bank releases the money. Its like a standing loan by 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 the guarantor but does not prejudice him. That which is entered into between the guarantor and the creditor benefits but does not prejudice the principal debtor.

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 compromise.Exception: If the compromise has a benefit in the nature of a stipulation in 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. Gs liability is also reduced to 8K in case D does not pay, since the compromise is beneficial to G.Sheryl IID 2002PAGE 22

Art. 2064. The guarantor of a guarantor shall enjoy the benefit of excussion both 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 principal debtor before he pays the creditor.

Art. 2065. Should there be several guarantors of only one debtor and for the same debt, the obligation to answer for the same is divided among all. The creditor cannot claim from the guarantors except the shares which they are respectively bound to pay, unless 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. There should be several guarantors

2. Of only one debtor

3. For the same debt

In this case, the liability of the co-guarantors is joint. They are not liable to 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 circumstances enumerated in Art. 2059 (RUSIA).2. If solidarity has been expressly stipulated.

Art. 2066. The guarantor who pays the debtor must be indemnified by the latter.The indemnity comprises:(1) The total amount of the debt;

(2) The legal interests thereon from the time the payment was made known to the creditor, even though it did not earn interest for the creditor;

(3) The expenses incurred by the guarantor after having notified the debtor that payment had been demanded of him;

(4) Damages, if they are due.

Once the guarantor pays the principal obligation, the principal debtor must pay him back consisting of:(TIED)1. The Total amount of the debt The guarantor has the right to demand reimbursement 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 not 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 payment 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 guarantor can collect interest even if the principal obligation was a loan without an interest. This is because Sheryl IID 2002PAGE 23the right of the guarantor is independent of the principal obligation to the creditor. 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 incurred by the guarantor after having notified the debtor that payment has been demanded 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 guarantor1. Where the guaranty is constituted without the knowledge or against the will of the debtor, the guarantor can only recover insofar as the payment had been beneficial to the debtor

2. Payment by a third person who does not intend to be reimbursed by the debtor is deemed to be a donation, which requires the debtors consent. But the payment is valid with respect to the creditor.

3. Waiver

Art. 2067. The guarantor who pays is subrogated by virtue thereof to all the rights 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 paid.

When the guarantor pays, he becomes subrogated to the rights of the creditor against the debtor. What happens really is just a change in creditor. The guarantor 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 reimburse him.The right of subrogation is given to the guarantor so that he can enforce his right to indemnity/ to be reimbursed.It arises by operation of law upon payment by the guarantor. The creditor need not formally cede his rights to the guarantor.But the right of subrogation is given only to the guarantor if he has the right to be reimbursed. If, for some reason, he has no right to be reimbursed, he cannot subrogate either.CompromiseB owes lender P1M. Lender was a good 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 from B, not the original P1M.Is there a situation where this rule would even be disadvantageous to the Debtor?Yes. Lets 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 should G become liable, he would only pay P500K. Since theres no rule, G tells B about 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 what 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 would be getting the same amount that he pays?Sheryl IID 2002PAGE 24How do you get out of this situation? B should hire G as his agent to broker the deal 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 happy.

Art. 2068. If the guarantor should pay without notifying the debtor, the latter may enforce against him all the defenses which he could have set up against the creditor at the time the payment was made.

Obligation of the guarantor before he pays the creditorBefore he pays the creditor, guarantor should first give notice to the principal debtor. If he does not give notice, the debtor may enforce 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 Guarantor that Debtor defaulted. So Guarantor pays, without telling Debtor. Guarantor makes a demand for reimbursement from Debtor. Is Debtor liable?No. Debtor can invoke the fact of payment to the Creditor against Guarantor. Had Guarantor given notice to Debtor, he would have known of the defenses that Debtor had against Creditor which would have made him think twice about paying. Guarantors 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 debtor 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 defaults, but there can be no default before the expiration of the period. If the guarantor still pays before the expiration of the period, he must wait for the period to expire before he can collect from the debtor.Exception: Guarantor need not wait for the period if the debtor ratifies payment or consents to it.

Art. 2070. If the guarantor has paid without notifying the debtor, and the latter not being aware of the payment, repeats the payment, the former has no remedy whatever against the debtor, but only against the creditor. Nevertheless, in case of gratuitous guaranty, if the guarantor was prevented by a fortuitous event from advising the debtor of the payment, and the creditor becomes insolvent, the debtor shall reimburse the guarantor for the amount paid.

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 paid. Guarantor will suffer the loss of his failure to comply with his one and only obligation before paying which is to notify the debtor.Exception: Guarantor may claim reimbursement from debtor if (requisites):1. It is a gratuitous guaranty

2. The guarantor was prevented by a fortuitous event from informing the debtor of payment

3. 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 three 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 2002PAGE 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 period has expired;

(4) When the debt has become demandable, by reason of the expiration of the period for payment;

(5) After the lapse of 10 years, when the principal obligation has no fixed period for its maturity unless it be of such nature that it cannot be extinguished except within a period longer than 10 years;

(6) If there are reasonable grounds to fear that the principal debtor intends to abscond;

(7) If the principal debtor is in imminent danger of becoming insolvent.

In all these cases, the action of the guarantor is to obtain release from the guaranty, or to demand a security that shall protect him from any proceedings by the creditor and from the danger of insolvency of the debtor.

Under these 7 circumstances, the guarantor has these rights against the debtor BEFORE he makes payment:1. Right to be released if lender agrees

Release from the guaranty requires that the lender consent because the guaranty is actually a contract between the lender and the guarantor2. Right to demand a security

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, becomes a guarantor for the debt of a third person who is not present, the guarantor who satisfies the debt may sue either the person so requesting or the debtor for reimbursement.

Art. 2073. When there are two or more guarantors of the same debtor and for the same debt, the one among them who has paid may demand of each of the others the share which is proportionately owing from him.If any of the guarantors should be insolvent, his share shall be borne by the others, including the payer, in the same proportion.The provisions of this article shall not be applicable, unless the payment has been made in virtue of a judicial demand or unless 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. by virtue of a judicial demand; or

2. when the principal debtor is insolvent.

The liability of the guarantors is joint. If one of them pays the entire obligation, he is entitled to be reimbursed the amount of the shares of the other guarantors.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 2002PAGE 26But unlike in an ordinary joint obligation, if one of the guarantors is insolvent, the co-guarantors must answer for his share. In this sense, the obligation behaves 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 Bs share. So their liabilities become 45K each. A can collect 45 K from C.

Art. 2074. In the case of the preceding article, the co-guarantors may set up against the one who paid, the same defenses which would have pertained to the principal debtor against the creditor, and which are not purely personal to the debtor.

Example: A, B, C guaranty the obligation of X. A pays even if the obligation has prescribed already. A demands reimbursement from B and C. Can they refuse to pay? Yes, they can invoke defenses 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 and C refuse to reimburse him on the ground that X is a minor? No, because the defense 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 of 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 that of the debtor, and for the same causes as all other obligations.

Because guaranty is an accessory and subsidiary contract, it is extinguished once the principal obligation is extinguished.But the extinguishment of the guaranty does not always carry with it the extinguishment of the principal obligation.Any agreement between the creditor and the principal debtor which essentially varies the terms of the principal contract without the consent of the surety will release the surety from liability. This is because the alteration would result in a novation of the principal contract which is consequently extinguished and replaced with a new one. Since the old principal contract is extinguished, the accessory contract of guaranty/surety is also extinguished.When is an alteration material?There must be a change which imposes a new obligation or added burden or which takes away some obligation already imposed, changing the legal effect of the contract.Examples:1. Increase in the principal amount, regardless of the extent of the liability assumed by the guarantor

2. Substitution of the principal debtor

3. 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 change since the guarantor cannot bind himself for more than the principal obligation.Sheryl IID 2002PAGE 27

Art. 2077. If the creditor voluntarily accepts immovable or other property in payment 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 the principal obligation, the accessory obligation is also extinguished and is not revived even if the creditor is subsequently evicted from the property.

Art. 2078. A release made by the creditor in favor of one of the guarantors, without the consent of the others, benefits all to the extent of the share of the guarantor to whom it has been granted.

A, B, C are guarantors of X for 90K. The creditor releases A without the consent of B and C. The release should benefit B and C to the extent of 30K (As 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 of itself constitute any extension of time referred to herein.

If the creditor grants the debtor an extension of time within which to comply with the principal obligation, the guaranty is extinguished. This is because the principal debtor could 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 right 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 as the period is extended, the guaranty is extinguished.The extension must be based on a new agreement between the debtor and creditor. If the creditor merely fails 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 though 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 BondsThe 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 2002PAGE 28PLEDGE AND MORTGAGEPROVISIONS 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 latter by pledging or mortgaging their own property.Article 2086. The provisions of 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 voidable 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 payment 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 involving 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.

What are the kinds of pledge?Pledge may be either:1. Voluntary or conventional (created by agreement of the parties);

2. 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 obligation 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 fulfillment of the principal obligation.

WHAT IS THE CONSIDERATION IN PLEDGE?If the pledgor is also the debtor, the consideration is the principal contract.If the pledgor is a third person, the cause it the compensation received or the liberality of the pledgor.

WHAT ARE THE DIFFERENCES BETWEEN PLEDGE AND MORTGAGE?1. Mobility pledge is constituted on movables; mortgage on immovables. 2. Delivery pledge requires delivery for perfection; mortgage does not. Cayo IID 2002PAGE 293. 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 SECURED BY BOTH A PLEDGE AND A GUARANTY. CAN THE CREDITOR REFUSE PAYMENT BY THE GUARANTOR AND CHOOSE TO FORECLOSE IN ORDER TO SATISFY THE DEBT?No, payment by the guarantor cannot be refused.

WHAT ARE THE ESSENTIAL REQUISITES OF PLEDGE AND MORTGAGE? [PRADO]1. Purpose - To secure fulfillment of principal obligation; 2. Real There must be 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 to dispose. 5. Ownership Pledgor/mortgagor must be the absolute owner of the thing;

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 that there hasnt been transfer of ownership.The principal obligation is of course not 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 direct 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 requirements 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 transfers 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, the 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 contract.

FREE DISPOSAL:

Cayo IID 2002PAGE 30WHAT DO FREE DISPOSAL AND CAPACITY TO DISPOSE OF THE PROPERTY MEAN?Free disposal means 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, the 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/mortgage. If what is to be pledged or mortgaged constitutes all of the corporations assets, 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 principal.

For married persons how to wiggle out of a pledge or mortgage agreement:Pledge or mortgage your conjugal property without your spouses signature. In case the property is foreclosed, you can raise the defense that there was no consent (remember, half consent is no consent!)What if the pledge was constituted to secure an obligation of the family business, doesnt 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 family business is constituting pledges.If you are the pledgee/mortgagee, check if pledgor/mortgagor has authority to dispose of the property.

Another example on free disposal or legal authority:Ex. Pledgor corporation is placed under receivership. The corporation cannot pledge shares of stock because pledge is a disposition requiring court approval.

OWNERSHIP:

CAN FUTURE PROPERTY BE PLEDGED?No, it is essential that the pledgor be the absolute owner of the thing.Note: It is the sale and not the registration in the LTO that transfers ownership of a vehicle. Note: A co-owner can only pledge/mortgage 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 BENEFICIAL AND LEGAL TITLE must vested in the pledgor/mortgagorEx. Trustee is legal owner of shares of stock; trustor is beneficial owner: Neither can pledge the shares.

Pledge/mortgage cant be constituted without a principal obligation even if there is a subsequent principal obligation. This is different from situation where the lender extends a credit line for 1M, though borrower has not yet drawn, the credit line can still be secured via pledge/mortgage.Ex. deed of assignment/absolute sale to secure fulfillment of obligation this is a mortgage or an implied trust according to the SC.

The pledgor/mortgagor must be absolute owner of the thing or the property. The creditor 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 that should put the pledgee on guard as to the pledgors right to pledge the thing.

Cayo IID 2002PAGE 31Though the pledgor must own the thing and have free disposal of it, see the following problem discussed in class:Ex. On day 1, stocks are sold to X with the condition that the sale will be effective if X tops the bar. On day 2, X pledges the stocks.On day 3, the bar exam results come out, with X in the number one spot. 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 binding as to third persons.Ex: Day 1 - X receives from A shares of stock with the resolutory 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 is binding on A.*But if you use the argument that the effects retroact, doesnt that mean that when X pledged the things, he wasnt the owner? I suppose the public instrument is stronger than the legal fiction.CAN THE CREDITOR IMMEDIATELY ACCEPT A PLEDGE FURNISHED BY A DEBTOR IF THE PLEDGE BELONGS TO A THIRD PERSON?No, the creditor cannot require on the word of the pledgor/mortgagor alone, he must exercise due care and make sure the pledge/mortgage has given consent. This is especially 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/MORTGAGOR?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 pledge 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 move 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 stipulation (pactum commissorium) is null and void.WHAT ARE THE REQUISITES FOR PACTUM COMMISSORIUM TO EXIST?1. There should be a pledge/mortgage;

2. There should be a stipulation for AUTOMATIC appropriation or the thing in case of default by the debtor. ARE THERE ANY EXCEPTIONS TO PACTUM COMMISSORIUM?Cayo IID 2002PAGE 32Yes, 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/MORTGAGE IF THERE IS A STIPULATION OF PACTUM COMMISSORIUM; IS IT VOID?No, only the stipulation is void; the principal contract will subsist.HOW CAN YOU OPT OUT OF THE PROHIBITION ON PACTO COMMISSORIO?1. You can enter into another contract subsequent to the pledge/mortgage. The prohibition applies only to stipulations made in the contract of pledge/mortgage.

2. The debtor can voluntarily cede the property to the creditor. This would in effect be a novation of the pledge/mortgage.

3. There can be a stipulation where the debtor merely promises to sell; non-compliance would give the creditor, not a right to the property, but an action for damages.

4. There can be a stipulation granting the creditor authority to take possession and not ownership of the property upon foreclosure.

Examples on pactum commissorium:Ex. X corporation pledges shares; the pledge agreement states that pledgee 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 automatically.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 thing 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 upon 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 which, there is automatic transfer of ownership.

Article 2089. A pledge or mortgage is indivisible, even though the debt may be divided among the successors in interest of the debtor or of the creditor.Therefore, the debtors 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 creditors heir who has received his share of the debt return the pledge or 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 determinate portion of credit.The debtor, in this case, shall have the right to the extinguishment of the pledge or mortgage as the portion of the debt for which each thing 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 solidarily liable.

Cayo IID 2002PAGE 33WHAT 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 schedule, there was payment of 100K, can you ask release of corresponding amount of units?No release. Pledge is indivisible.WHAT ARE THE EXCEPTIONS TO INDIVISIBILITY:1. Where each one of several thing guarantees a determinate portion of credit.Ex: If you have 100 mortgages securing corresponding portion of the loan, then 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/mortgage and constitute a new pledge/mortgage.The downside is that you must again pay doc. stamps and reg. fees, unlike in the document with 100 mortgages, where the 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 corresponding portion of the REM to be released. 3. Where there was failure of consideration. Creditor took over management but the business failed.

Article 2091. The contract of pledge or mortgage may secure all kinds of obligations, be they pure or subject to a suspensive or resolutory condition.

Pledge/mortgage may secure all sorts of valid, voidable, unenforceable obligations.

Article 2092. A promise to constitute a pledge or mortgage gives rise only to a personal action between the contracting parties, without prejudice to the criminal responsibility incurred by him who defrauds another, by offering in pledge or mortgage as unencumbered, things which he knew were subject to some burden, or by misrepresenting himself 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 necessary, in order to constitute the contract of pledge, that the thing pledged be placed in the possession of the creditor, or of a third person by common agreement.

Remember. Pledge/mortgage are real contracts.If you agree, but dont deliver to the pledgee or a third person/s, there is no pledge but there is an agreement to enter into a pledge.Can delivery be made to the pledgor?Yes, if he is acting as agent of pledgee or where the thing pledged is so unwieldy as to make delivery 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 not negotiable so no indorsement is required, however, for safety reasons, the same may be required.

Article 2094. All movables which are within commerce may be pledged, provided they are susceptible of possession.

Cayo IID 2002PAGE 34

Article 2095. Incorporeal rights, evidenced by negotiable instruments, bills of lading, shares of stock, bonds, warehouse receipts and similar documents may also 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: how do third persons check if the thing is pledged when the thing isnt represented by some sort of title which can be annotated?They cant 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 owner, 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 pledgee to secure a loan. Pledge is in a public instrument. Pledgor sell property to third 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 administrative 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 the 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 reimbursement of the expenses made for its preservation, and is liable for its loss or deterioration, in conformity with the provisions of this Code.Article 2100. The pledgee cannot deposit the thing pledged with a third person, unless there is a stipulation 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 authorization, can the pledgor demand resolution of the pledge agreement?Yes. Substantial 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, its a principal breach.

Article 2101. The pledgor has the same responsibility as a bailor in commodatum in the case under article 1951.[The pledgor who, knowing the flaws of the thing pledged, does not advise the pledgee of the same, shall be liable to the latter of the damages which he may suffer by reason thereof.]Article 2102. 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.

Cayo IID 2002PAGE 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 stipulation 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 fruits 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 the 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 goats milk and offspring and compensate against what is owing him even if the obligation is not yet due.

Article 2103. Unless the thing pledged is expropriated, the debtor continues to be the owner thereof.Nevertheless, the creditor may bring the actions which pertain to the owner of the thing pledged in order to recover it from, or defend it against a third 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 of 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 creditor but only for that purpose.

The creditor can only use the thing if he is authorized or its preservation requires use. If he misuses it, the pledgor can demand 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 through the negligence or willful act of the pledgee, the thing pledged is in danger 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 obligation is fulfilled, if the thing pledged is in danger of being lost or impaired through the pledgees willful act or negligence, he may require its deposit with a third person.

Article 2107. If there are reasonable grounds to fear the destruction or impairment of the thing pledged, without the fault of the pledgee, the pledgor may demand the return of the thing, upon offering another thing in pledge, 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 delay, 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 proceeds of the auction shall be a security for the principal obligation in the same manner as the thing originally pledged.

If the thing is in danger of diminution or destruction, without the pledgees fault, the pledgor may demand its return, provided he replaces it with another of the same kind and quality.Despite the pledgors right above, in the same situation, the pledgee may opt to sell the thing and keep the proceeds; the pledgees right takes precedence over the pledgors. In this case, the proceeds of the sale shall be security for the debt.In 2108, upon due date, if the cash value is less than the principal obligation, the creditor can still recover the balance from the debtor, unlike in foreclosure. this looks important.Cayo IID 2002PAGE 36The 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 immediate payment of the principal obligation.

This is an instance where the debtor loses the benefit of the period: If the debtor dupes the creditor as to the quality of the thing, the creditor may demand immediate payment or delivery of another 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 CONTRARY 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 thing 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 presumption is that it was returned and extinction of the pledge, UNLESS the owner 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 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.

PROBLEM: TO SECURE HIS LOAN, BORROWER PLEDGED HIS CAR TO LENDER. OUT OF THE KINDNESS 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, LENDER SPOTTED BORROWER WITH LENDERS WIFE AND FELT VERY ANGRY AND JEALOUS.WHEN BORROWER RECEIVED THE LETTER, HE WENT TO LENDERS HOUSE TO RECOVER THE CAR BUT LENDER REFUSED AND TOLD BORROWER TO PISS OFF. CAN LENDER REFUSE TO RETURN THE CAR?No. See Article 2111.

Article 2112. The creditor to whom the credit has not been satisfied in due time, may proceed before a Notary Public to the sale of the thing pledged. 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 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 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 and 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 the intervention of a notary public.

How is the public sale conducted?Default rule: Proceed before a Notary Public and ask him to conduct a notarial sale. The notary 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 2002PAGE 37No 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 obtain an injunction.

Can it be a private sale?Ex: stocks pledged, listed on the PSE and just coursed through a broker. Yes there is no express prohibition. But see 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 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 is allowed to bid and all things being equal, his bid shall be preferred over that of others. The law wants to conserve the property in the owner.The pledgee may also bid, but his offer shall not be valid if he is the only bidder because the law seeks to prevent fraud. Fraud is possible if the parties had stipulated that the debtor shall be allowed to the excess and the creditor, who is bidding 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 deemed 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 it is otherwise agreed. If the price of the sale is less, neither shall the creditor be entitled to recover the deficiency, notwithstanding any stipulation to the 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 STIPULATE THAT THE DEBTOR WILL BE ENTITLED TO THE EXCESS BUT YOU CANT 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 ENTITLED 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 SITUATION OF NOT BEING ABLE TO RECOVER THE DEFICIENCY IF YOU ARE THE PLEDGEE?Set a minimum bid (if this is actually allowed; JPSP says yes, book says no) ORInstead of selling the thing, just sue for the entire obligation.Cayo IID 2002PAGE 38ORStipulate that if the value of the pledge goes under a certain amount, then the 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 the debtor will be obliged to pledge additional securities.

Without such a stipulation, can Article 2108 have the same effect?Ex: 1M obligation, 1.5M worth of stocks 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 the profits as security, pursuant to 2108?JPSP says: Maybe but speculative. Probably not if the change in price is just a day-to-day fluctuation.

PROBLEM: 1M IS SECURED BY A 700K MORTGAGE AND A 900K PLEDGE. IF YOU ARE THE LENDER, AND THE BORROWER DEFAULTS, WHICH SECURITY TO YOU GO AFTER FIRST?Go against the REM first, then 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, as a default rule.

Article 2116. After the public auction, the pledgee shall promptly advise the pledgor or owner of the result thereof.

This is to allow the debtor to take reasonable steps if he suspects that the sale was not honest.

Article 2117. Any third person who has any right in or to the thing pledged may satisfy 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 property 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 any, 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, DELIVERING THE SURPLUS TO THE DEBTOR.The pledgee has the duty to collect any due credits, in line with the ordinary diligence required of him.

Article 2119. If two or more things are pledged, the pledgee 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 necessary 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 securing 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 2077 to 2081.

Cayo IID 2002PAGE 39He is not prejudiced by any waiver of defense by the principal obligor.

The third party pledgor is entitled to:1. Indemnity;

2. Subrogation;

3. Pledgor is released if creditor accepts property in payment of debt;

4. Release in favor of one pledgor benefits all;

5. Extension granted to debtor extinguishes pledge;

6. Pledgors are released from obligation if by some act of the creditor, there can be no subrogation;

7. 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 possession, 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 the 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 thing 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 to 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 expenses until he is reimbursed. He who works on a movable may retain the same until paid for the work. Depositary may retain thing until paid for the deposit. Agent may retain objects of agency until reimbursed by principal. Laborers wages are considered a lien on goods manufactured or work done. How about any deficiency? I think creditor will be entitled to recover because here, he did not accept the pledge voluntarily and the reason for prohibiting recovery is absent (the reason being that creditors should know not to lend more than what can be secured).

Article 2123. With regard to pawnshops and other establishments, which are engaged in making loans secured by pledges, the special laws and regulations concerning them shall be observed, and subsidiarily, the provisions of this Title.

Cayo IID 2002PAGE 40REAL MORTGAGE

Art. 2124. Only the following property may be the object of a contract of mortgage:(1) Immovables;

(2) Alienable real rights in accordance with the laws, imposed upon immovables.

Nevertheless, movables may be the object of a chattel mortgage.

Mortgage (def). A real estate mortgage is a contract whereby the debtor secures to the creditor the fulfillment of a principal obligation, specially subjecting to such security immovable property or real rights over immovable property in 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.However, it is not an essential requisite of the contract of mortgage that the property 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 other contract.What is the consideration in a contract of mortgage?Since mortgage is an accessory contract, the consideration is the same as that of the principal contract.What are the kinds of real mortgage?1. Voluntary Agreed to between the parties or constituted by the will of the owner of the property 2. Legal Required by law to be executed in favor of certain persons

3. Equitable Lacks the proper formalities of mortgage but shows the intention of the parties to make the property as a security for a debt. What is the subject matter of real mortgage1. 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 constitute a mortgage on any other property he might have now and those he might acquire in theCayo IID 2002PAGE 41future. Remember that one of the essential requisites of mortgage is that the mortgagor should be the absolute owner of the thing mortgaged.But a stipulat