Republic

of
the
Philippines
SUPREME COURT
SECOND DIVISION
G.R. No. 150197 July 28, 2005
PRUDENTIAL
BANK, Petitioner,
vs.
DON A. ALVIAR and GEORGIA B.
ALVIAR, Respondents.
DECISION
Tinga, J.:
Before us is a petition for review on certiorari under
Rule 45 of the Rules of Court. Petitioner Prudential
Bank seeks the reversal of the Decision1 of the
Court of Appeals dated 27 September 2001 in CAG.R. CV No. 59543 affirming the Decision of the
Regional Trial Court (RTC) of Pasig City, Branch
160, in favor of respondents.
Respondents, spouses Don A. Alviar and Georgia B.
Alviar, are the registered owners of a parcel of land
in San Juan, Metro Manila, covered by Transfer
Certificate of Title (TCT) No. 438157 of the
Register of Deeds of Rizal. On 10 July 1975, they
executed a deed of real estate mortgage in favor of
petitioner Prudential Bank to secure the payment of
a loan worth P250,000.00.2 This mortgage was
annotated at the back of TCT No. 438157. On 4
August
1975,
respondents
executed
the
corresponding promissory note, PN BD#75/C-252,
covering the said loan, which provides that the loan
matured on 4 August 1976 at an interest rate of 12%
per annum with a 2% service charge, and that the
note is secured by a real estate mortgage as
aforementioned.3 Significantly, the real estate
mortgage contained the following clause:
That for and in consideration of certain loans,
overdraft and other credit accommodations obtained
from the Mortgagee by the Mortgagor and/or
________________ hereinafter
referred to,
irrespective of number, as DEBTOR, and to secure
the payment of the same and those that may
hereafter be obtained, the principal or all of which is
hereby fixed at Two Hundred Fifty Thousand
(P250,000.00) Pesos, Philippine Currency, as well
as those that the Mortgagee may extend to the
Mortgagor and/or DEBTOR, including interest and
expenses or any other obligation owing to the
Mortgagee, whether direct or indirect, principal or
secondary as appears in the accounts, books and
records of the Mortgagee, the Mortgagor does
hereby transfer and convey by way of mortgage
unto the Mortgagee, its successors or assigns, the
parcels of land which are described in the list

inserted on the back of this document, and/or

appended hereto, together with all the buildings and
improvements now existing or which may hereafter
be erected or constructed thereon, of which the
Mortgagor declares that he/it is the absolute owner
free from all liens and incumbrances. . . .4
On 22 October 1976, Don Alviar executed another
promissory
note,
PN
BD#76/C-345
for P2,640,000.00, secured by D/A SFDX #129,
signifying that the loan was secured by a "hold-out"
on the mortgagors foreign currency savings
account with the bank under Account No. 129, and
that the mortgagors passbook is to be surrendered
to the bank until the amount secured by the "holdout" is settled.5
On 27 December 1976, respondent spouses
executed for Donalco Trading, Inc., of which the
husband and wife were President and Chairman of
the Board and Vice President,6 respectively, PN
BD#76/C-430 coveringP545,000.000. As provided
in the note, the loan is secured by "Clean-Phase out
TOD CA 3923," which means that the temporary
overdraft incurred by Donalco Trading, Inc. with
petitioner is to be converted into an ordinary loan in
compliance with a Central Bank circular directing
the discontinuance of overdrafts.7
On 16 March 1977, petitioner wrote Donalco
Trading, Inc., informing the latter of its approval of
a straight loan ofP545,000.00, the proceeds of
which shall be used to liquidate the outstanding loan
of P545,000.00 TOD. The letter likewise mentioned
that the securities for the loan were the deed of
assignment on two promissory notes executed by
Bancom Realty Corporation with Deed of
Guarantee in favor of A.U. Valencia and Co. and the
chattel mortgage on various heavy and
transportation equipment.8
On 06 March 1979, respondents paid
petitioner P2,000,000.00, to be applied to the
obligations of G.B. Alviar Realty and Development,
Inc. and for the release of the real estate mortgage
for the P450,000.00 loan covering the two (2) lots
located at Vam Buren and Madison Streets, North
Greenhills, San Juan, Metro Manila. The payment
was acknowledged by petitioner who accordingly
released the mortgage over the two properties.9
On 15 January 1980, petitioner moved for the
extrajudicial foreclosure of the mortgage on the
property covered by TCT No. 438157. Per
petitioners computation, respondents had the total
obligation of P1,608,256.68, covering the three (3)
promissory notes, to wit: PN BD#75/C-252

for P250,000.00,
PN
BD#76/C-345
for P382,680.83,
and
PN
BD#76/C-340
for P545,000.00, plus assessed past due interests
and penalty charges. The public auction sale of the
mortgaged property was set on 15 January 1980.10
Respondents filed a complaint for damages with a
prayer for the issuance of a writ of preliminary
injunction with the RTC of Pasig,11 claiming that
they have paid their principal loan secured by the
mortgaged property, and thus the mortgage should
not be foreclosed. For its part, petitioner averred
that the payment of P2,000,000.00 made on 6
March 1979 was not a payment made by
respondents, but by G.B. Alviar Realty and
Development Inc., which has a separate loan with
the bank secured by a separate mortgage.12
On 15 March 1994, the trial court dismissed the
complaint and ordered the Sheriff to proceed with
the extra-judicial foreclosure.13 Respondents sought
reconsideration of the decision.14 On 24 August
1994, the trial court issued an Order setting aside its
earlier decision and awarded attorneys fees to
respondents.15 It found that only the P250,000.00
loan is secured by the mortgage on the land covered
by TCT No. 438157. On the other hand,
the P382,680.83 loan is secured by the foreign
currency deposit account of Don A. Alviar, while
the P545,000.00 obligation was an unsecured loan,
being a mere conversion of the temporary overdraft
of Donalco Trading, Inc. in compliance with a
Central Bank circular. According to the trial court,
the "blanket mortgage clause" relied upon by
petitioner applies only to future loans obtained by
the mortgagors, and not by parties other than the
said mortgagors, such as Donalco Trading, Inc., for
which respondents merely signed as officers
thereof.
On appeal to the Court of Appeals, petitioner made
the following assignment of errors:
I. The trial court erred in holding that the real estate
mortgage covers only the promissory note
BD#75/C-252 for the sum of P250,000.00.
II. The trial court erred in holding that the
promissory note BD#76/C-345 for P2,640,000.00
(P382,680.83 outstanding principal balance) is not
covered by the real estate mortgage by expressed
agreement.
III. The trial court erred in holding that Promissory
Note BD#76/C-430 for P545,000.00 is not covered
by the real estate mortgage.
IV. The trial court erred in holding that the real
estate mortgage is a contract of adhesion.

V. The trial court erred in holding defendantappellant liable to pay plaintiffs-appellees attorneys
fees forP20,000.00.16
The Court of Appeals affirmed the Order of the trial
court but deleted the award of attorneys fees.17 It
ruled that while a continuing loan or credit
accommodation based on only one security or
mortgage is a common practice in financial and
commercial institutions, such agreement must be
clear and unequivocal. In the instant case, the
parties executed different promissory notes agreeing
to a particular security for each loan. Thus, the
appellate court ruled that the extrajudicial
foreclosure sale of the property for the three loans is
improper.18
The Court of Appeals, however, found that
respondents have not yet paid the P250,000.00
covered by PN BD#75/C-252 since the payment
of P2,000,000.00 adverted to by respondents was
issued for the obligations of G.B. Alviar Realty and
Development, Inc.19
Aggrieved, petitioner filed the instant petition,
reiterating the assignment of errors raised in the
Court of Appeals as grounds herein.
Petitioner maintains that the "blanket mortgage
clause" or the "dragnet clause" in the real estate
mortgage expressly covers not only the P250,000.00
under PN BD#75/C-252, but also the two other
promissory notes included in the application for
extrajudicial
foreclosure
of
real
estate
20
mortgage. Thus, it claims that it acted within the
terms of the mortgage contract when it filed its
petition for extrajudicial foreclosure of real estate
mortgage. Petitioner relies on the cases of Lim
Julian v. Lutero,21 Tad-Y v. Philippine National
Bank,22 Quimson v. Philippine National Bank,23 C &
C
Commercial
v.
Philippine
National
Bank,24 Mojica v. Court of Appeals,25 andChina
Banking Corporation v. Court of Appeals,26 all of
which upheld the validity of mortgage contracts
securing future advancements.
Anent the Court of Appeals conclusion that the
parties did not intend to include PN BD#76/C-345
in the real estate mortgage because the same was
specifically secured by a foreign currency deposit
account, petitioner states that there is no law or rule
which prohibits an obligation from being covered
by more than one security.27Besides, respondents
even continued to withdraw from the same foreign
currency account even while the promissory note
was still outstanding, strengthening the belief that it
was the real estate mortgage that principally secured

all of respondents promissory notes.28 As for PN

BD#76/C-345, which the Court of Appeals found to
be exclusively secured by the Clean-Phase out TOD
3923, petitioner posits that such security is not
exclusive, as the "dragnet clause" of the real estate
mortgage covers all the obligations of the
respondents.29
Moreover, petitioner insists that respondents
attempt to evade foreclosure by the expediency of
stating that the promissory notes were executed by
them not in their personal capacity but as corporate
officers. It claims that PN BD#76/C-430 was in fact
for home construction and personal consumption of
respondents. Thus, it states that there is a need to
pierce the veil of corporate fiction.30
Finally, petitioner alleges that the mortgage contract
was executed by respondents with knowledge and
understanding of the "dragnet clause," being highly
educated individuals, seasoned businesspersons, and
political personalities.31 There was no oppressive
use of superior bargaining power in the execution of
the promissory notes and the real estate mortgage.32
For their part, respondents claim that the "dragnet
clause" cannot be applied to the subsequent loans
extended to Don Alviar and Donalco Trading, Inc.
since these loans are covered by separate
promissory notes that expressly provide for a
different form of security.33 They reiterate the
holding of the trial court that the "blanket mortgage
clause" would apply only to loans obtained jointly
by respondents, and not to loans obtained by other
parties.34Respondents also place a premium on the
finding of the lower courts that the real estate
mortgage clause is a contract of adhesion and must
be strictly construed against petitioner bank.35
The instant case thus poses the following issues
pertaining to: (i) the validity of the "blanket
mortgage clause" or the "dragnet clause"; (ii) the
coverage of the "blanket mortgage clause"; and
consequently, (iii) the propriety of seeking
foreclosure of the mortgaged property for the nonpayment of the three loans.
At this point, it is important to note that one of the
loans sought to be included in the "blanket
mortgage clause" was obtained by respondents for
Donalco Trading, Inc. Indeed, PN BD#76/C-430
was executed by respondents on behalf of Donalco
Trading, Inc. and not in their personal capacity.
Petitioner asks the Court to pierce the veil of
corporate fiction and hold respondents liable even
for obligations they incurred for the corporation.
The mortgage contract states that the mortgage

covers "as well as those that the Mortgagee may

extend to the Mortgagor and/or DEBTOR,
including interest and expenses or any other
obligation owing to the Mortgagee, whether direct
or indirect, principal or secondary." Well-settled is
the rule that a corporation has a personality separate
and distinct from that of its officers and
stockholders. Officers of a corporation are not
personally liable for their acts as such officers
unless it is shown that they have exceeded their
authority.36 However, the legal fiction that a
corporation has a personality separate and distinct
from stockholders and members may be disregarded
if it is used as a means to perpetuate fraud or an
illegal act or as a vehicle for the evasion of an
existing obligation, the circumvention of statutes, or
to confuse legitimate issues.37 PN BD#76/C-430,
being an obligation of Donalco Trading, Inc., and
not of the respondents, is not within the
contemplation of the "blanket mortgage clause."
Moreover, petitioner is unable to show that
respondents are hiding behind the corporate
structure to evade payment of their obligations.
Save for the notation in the promissory note that the
loan was for house construction and personal
consumption, there is no proof showing that the
loan was indeed for respondents personal
consumption. Besides, petitioner agreed to the terms
of the promissory note. If respondents were indeed
the real parties to the loan, petitioner, a big, wellestablished institution of long standing that it is,
should have insisted that the note be made in the
name of respondents themselves, and not to
Donalco Trading Inc., and that they sign the note in
their personal capacity and not as officers of the
corporation.
Now on the main issues.
A "blanket mortgage clause," also known as a
"dragnet clause" in American jurisprudence, is one
which is specifically phrased to subsume all debts
of past or future origins. Such clauses are "carefully
scrutinized and strictly construed."38 Mortgages of
this character enable the parties to provide
continuous dealings, the nature or extent of which
may not be known or anticipated at the time, and
they avoid the expense and inconvenience of
executing a new security on each new
transaction.39 A "dragnet clause" operates as a
convenience and accommodation to the borrowers
as it makes available additional funds without their
having to execute additional security documents,
thereby saving time, travel, loan closing costs, costs

of extra legal services, recording fees, et

cetera.40 Indeed, it has been settled in a long line of
decisions that mortgages given to secure future
advancements are valid and legal contracts, 41 and
the amounts named as consideration in said
contracts do not limit the amount for which the
mortgage may stand as security if from the four
corners of the instrument the intent to secure future
and other indebtedness can be gathered.42
The "blanket mortgage clause" in the instant case
states:
That for and in consideration of certain loans,
overdraft and other credit accommodations obtained
from the Mortgagee by the Mortgagor and/or
________________ hereinafter
referred to,
irrespective of number, as DEBTOR, and to secure
the payment of the same and those that may
hereafter be obtained, the principal or all of which
is hereby fixed at Two Hundred Fifty Thousand
(P250,000.00) Pesos, Philippine Currency, as well
as those that the Mortgagee may extend to the
Mortgagor and/or DEBTOR, including interest
and expenses or any other obligation owing to
the Mortgagee, whether direct or indirect,
principal or secondary as appears in the accounts,
books and records of the Mortgagee, the Mortgagor
does hereby transfer and convey by way of
mortgage unto the Mortgagee, its successors or
assigns, the parcels of land which are described in
the list inserted on the back of this document, and/or
appended hereto, together with all the buildings and
improvements now existing or which may hereafter
be erected or constructed thereon, of which the
Mortgagor declares that he/it is the absolute owner
free from all liens and incumbrances. . . .
43
(Emphasis supplied.)
Thus, contrary to the finding of the Court of
Appeals, petitioner and respondents intended the
real estate mortgage to secure not only
the P250,000.00 loan from the petitioner, but also
future credit facilities and advancements that may
be obtained by the respondents. The terms of the
above provision being clear and unambiguous, there
is neither need nor excuse to construe it otherwise.
The cases cited by petitioner, while affirming the
validity of "dragnet clauses" or "blanket mortgage
clauses," are of a different factual milieu from the
instant case. There, the subsequent loans were not
covered by any security other than that for the
mortgage deeds which uniformly contained the
"dragnet clause."

In the case at bar, the subsequent loans obtained by

respondents were secured by other securities, thus:
PN BD#76/C-345, executed by Don Alviar was
secured by a "hold-out" on his foreign currency
savings account, while PN BD#76/C-430, executed
by respondents for Donalco Trading, Inc., was
secured by "Clean-Phase out TOD CA 3923" and
eventually by a deed of assignment on two
promissory notes executed by Bancom Realty
Corporation with Deed of Guarantee in favor of
A.U. Valencia and Co., and by a chattel mortgage
on various heavy and transportation equipment. The
matter of PN BD#76/C-430 has already been
discussed. Thus, the critical issue is whether the
"blanket mortgage" clause applies even to
subsequent advancements for which other securities
were intended, or particularly, to PN BD#76/C-345.
Under American jurisprudence, two schools of
thought have emerged on this question. One school
advocates that a "dragnet clause" so worded as to be
broad enough to cover all other debts in addition to
the one specifically secured will be construed to
cover a different debt, although such other debt is
secured by another mortgage.44The contrary
thinking maintains that a mortgage with such a
clause will not secure a note that expresses on its
face that it is otherwise secured as to its entirety, at
least to anything other than a deficiency after
exhausting the security specified therein,45 such
deficiency being an indebtedness within the
meaning of the mortgage, in the absence of a special
contract excluding it from the arrangement.46
The latter school represents the better position. The
parties having conformed to the "blanket mortgage
clause" or "dragnet clause," it is reasonable to
conclude that they also agreed to an implied
understanding that subsequent loans need not be
secured by other securities, as the subsequent loans
will be secured by the first mortgage. In other
words, the sufficiency of the first security is a
corollary component of the "dragnet clause." But of
course, there is no prohibition, as in the mortgage
contract in issue, against contractually requiring
other securities for the subsequent loans. Thus,
when the mortgagor takes another loan for which
another security was given it could not be inferred
that such loan was made in reliance solely on the
original security with the "dragnet clause," but
rather, on the new security given. This is the
"reliance on the security test."
Hence, based on the "reliance on the security test,"
the California court in the cited case made an

inquiry whether the second loan was made in

reliance on the original security containing a
"dragnet clause." Accordingly, finding a different
security was taken for the second loan no intent that
the parties relied on the security of the first loan
could be inferred, so it was held. The rationale
involved, the court said, was that the "dragnet
clause" in the first security instrument constituted a
continuing offer by the borrower to secure further
loans under the security of the first security
instrument, and that when the lender accepted a
different security he did not accept the offer.47
In another case, it was held that a mortgage with a
"dragnet clause" is an "offer" by the mortgagor to
the bank to provide the security of the mortgage for
advances of and when they were made. Thus, it was
concluded that the "offer" was not accepted by the
bank when a subsequent advance was made because
(1) the second note was secured by a chattel
mortgage on certain vehicles, and the clause therein
stated that the note was secured by such chattel
mortgage; (2) there was no reference in the second
note or chattel mortgage indicating a connection
between the real estate mortgage and the advance;
(3) the mortgagor signed the real estate mortgage by
her name alone, whereas the second note and chattel
mortgage were signed by the mortgagor doing
business under an assumed name; and (4) there was
no allegation by the bank, and apparently no proof,
that it relied on the security of the real estate
mortgage in making the advance.48
Indeed, in some instances, it has been held that in
the absence of clear, supportive evidence of a
contrary intention, a mortgage containing a "dragnet
clause" will not be extended to cover future
advances unless the document evidencing the
subsequent advance refers to the mortgage as
providing security therefor.49
It was therefore improper for petitioner in this case
to seek foreclosure of the mortgaged property
because of non-payment of all the three promissory
notes. While the existence and validity of the
"dragnet clause" cannot be denied, there is a need to
respect the existence of the other security given for
PN BD#76/C-345. The foreclosure of the
mortgaged property should only be for
the P250,000.00 loan covered by PN BD#75/C-252,
and for any amount not covered by the security for
the second promissory note. As held in one case,
where deeds absolute in form were executed to
secure any and all kinds of indebtedness that might
subsequently become due, a balance due on a note,

after exhausting the special security given for the

payment of such note, was in the absence of a
special agreement to the contrary, within the
protection of the mortgage, notwithstanding the
giving of the special security.50 This is recognition
that while the "dragnet clause" subsists, the security
specifically executed for subsequent loans must first
be exhausted before the mortgaged property can be
resorted to.
One other crucial point. The mortgage contract, as
well as the promissory notes subject of this case, is
a contract of adhesion, to which respondents only
participation was the affixing of their signatures or
"adhesion" thereto.51 A contract of adhesion is one
in which a party imposes a ready-made form of
contract which the other party may accept or reject,
but which the latter cannot modify.52
The real estate mortgage in issue appears in a
standard form, drafted and prepared solely by
petitioner, and which, according to jurisprudence
must be strictly construed against the party
responsible for its preparation.53 If the parties
intended that the "blanket mortgage clause" shall
cover subsequent advancement secured by separate
securities, then the same should have been indicated
in the mortgage contract. Consequently, any
ambiguity is to be taken contra proferentum, that is,
construed against the party who caused the
ambiguity which could have avoided it by the
exercise of a little more care.54 To be more
emphatic, any ambiguity in a contract whose terms
are susceptible of different interpretations must be
read against the party who drafted it,55 which is the
petitioner in this case.
Even the promissory notes in issue were made on
standard forms prepared by petitioner, and as such
are likewise contracts of adhesion. Being of such
nature, the same should be interpreted strictly
against petitioner and with even more reason since
having been accomplished by respondents in the
presence of petitioners personnel and approved by
its manager, they could not have been unaware of
the import and extent of such contracts.
Petitioner, however, is not without recourse. Both
the Court of Appeals and the trial court found that
respondents have not yet paid the P250,000.00, and
gave no credence to their claim that they paid the
said
amount
when
they
paid
petitioner P2,000,000.00. Thus, the mortgaged
property could still be properly subjected to
foreclosure proceedings for the unpaid P250,000.00
loan, and as mentioned earlier, for any deficiency

after D/A SFDX#129, security for PN BD#76/C345, has been exhausted, subject of course to
defenses which are available to respondents.
WHEREFORE, the petition is DENIED. The
Decision of the Court of Appeals in CA-G.R. CV
No. 59543 is AFFIRMED.
Costs against petitioner.
SO ORDERED.

Republic
of
the
Philippines
SUPREME
COURT
Manila
EN BANC
G.R. No. L-17500
May 16, 1967
PEOPLE'S BANK AND TRUST CO. and
ATLANTIC GULF AND PACIFIC CO. OF
MANILA, plaintiffs-appellants,
vs.
DAHICAN LUMBER COMPANY, DAHICAN
AMERICAN LUMBER CORPORATION and
CONNELL BROS. CO. (PHIL.), defendantsappellants.
Angel S. Gamboa for defendants-appellants.
Laurel Law Offices for plaintiffs-appellants.
DIZON, J.:
On September 8, 1948, Atlantic Gulf & Pacific
Company of Manila, a West Virginia corporation
licensed to do business in the Philippines
hereinafter referred to as ATLANTIC sold and
assigned all its rights in the Dahican Lumber
concession to Dahican Lumber Company
hereinafter referred to as DALCO for the total
sum of $500,000.00, of which only the amount of
$50,000.00 was paid. Thereafter, to develop the
concession, DALCO obtained various loans from
the People's Bank & Trust Company hereinafter
referred to as the BANK amounting, as of July
13, 1950, to P200,000.00. In addition, DALCO
obtained, through the BANK, a loan of $250,000.00
from the Export-Import Bank of Washington D.C.,
evidenced by five promissory notes of $50,000.00
each, maturing on different dates, executed by both
DALCO and the Dahican America Lumber
Corporation, a foreign corporation and a
stockholder of DALCO, hereinafter referred to
as DAMCO, all payable to the BANK or its order.
As security for the payment of the abovementioned
loans, on July 13, 1950 DALCO executed in favor
of the BANK the latter acting for itself and as
trustee for the Export-Import Bank of Washington
D.C. a deed of mortgage covering five parcels of
land situated in the province of Camarines Norte
together with all the buildings and other
improvements existing thereon and all the personal
properties of the mortgagor located in its place of
business in the municipalities of Mambulao and
Capalonga, Camarines Norte (Exhibit D). On the
same date, DALCO executed a second mortgage on
the same properties in favor of ATLANTIC to
secure payment of the unpaid balance of the sale

price of the lumber concession amounting to the

sum of $450,000.00 (Exhibit G). Both deeds
contained the following provision extending the
mortgage lien to properties to be subsequently
acquired referred to hereafter as "after acquired
properties" by the mortgagor:
All property of every nature and description
taken in exchange or replacement, and all
buildings, machinery, fixtures, tools
equipment and other property which the
Mortgagor may hereafter acquire, construct,
install, attach, or use in, to, upon, or in
connection with the premises, shall
immediately be and become subject to the
lien of this mortgage in the same manner
and to the same extent as if now included
therein, and the Mortgagor shall from time
to time during the existence of this mortgage
furnish the Mortgagee with an accurate
inventory of such substituted and
subsequently acquired property.
Both mortgages were registered in the Office of the
Register of Deeds of Camarines Norte. In addition
thereto DALCO and DAMCO pledged to the
BANK 7,296 shares of stock of DALCO and 9,286
shares of DAMCO to secure the same obligations.
Upon DALCO's and DAMCO's failure to pay the
fifth promissory note upon its maturity, the BANK
paid the same to the Export-Import Bank of
Washington D.C., and the latter assigned to the
former its credit and the first mortgage securing it.
Subsequently, the BANK gave DALCO and
DAMCO up to April 1, 1953 to pay the overdue
promissory note.
After July 13, 1950 the date of execution of the
mortgages mentioned above DALCO purchased
various machineries, equipment, spare parts and
supplies in addition to, or in replacement of some of
those already owned and used by it on the date
aforesaid. Pursuant to the provision of the mortgage
deeds quoted theretofore regarding "after acquired
properties," the BANK requested DALCO to submit
complete lists of said properties but the latter failed
to do so. In connection with these purchases, there
appeared in the books of DALCO as due to Connell
Bros. Company (Philippines) a domestic
corporation who was acting as the general
purchasing agent of DALCO thereinafter called
CONNELL the sum of P452,860.55 and to
DAMCO, the sum of P2,151,678.34.
On December 16, 1952, the Board of Directors of
DALCO, in a special meeting called for the

purpose, passed a resolution agreeing to rescind the

alleged sales of equipment, spare parts and supplies
by CONNELL and DAMCO to it. Thereafter, the
corresponding agreements of rescission of sale were
executed between DALCO and DAMCO, on the
one hand and between DALCO and CONNELL, on
the other.
On January 13, 1953, the BANK, in its own behalf
and that of ATLANTIC, demanded that said
agreements be cancelled but CONNELL and
DAMCO refused to do so. As a result, on February
12, 1953; ATLANTIC and the BANK, commenced
foreclosure proceedings in the Court of First
Instance of Camarines Norte against DALCO and
DAMCO. On the same date they filed an exparte application for the appointment of a Receiver
and/or for the issuance of a writ of preliminary
injunction to restrain DALCO from removing its
properties. The court granted both remedies and
appointed George H. Evans as Receiver. Upon
defendants' motion, however, the court, in its order
of February 21, 1953, discharged the Receiver.
On March 2, 1953, defendants filed their answer
denying the material allegations of the complaint
and alleging several affirmative defenses and a
counterclaim.
On March 4 of the same year, CONNELL, filed a
motion for intervention alleging that it was the
owner and possessor of some of the equipments,
spare parts and supplies which DALCO had
acquired subsequent to the execution of the
mortgages sought to be foreclosed and which
plaintiffs claimed were covered by the lien. In its
order of March 18,1953 the Court granted the
motion, as well as plaintiffs' motion to set aside the
order discharging the Receiver. Consequently,
Evans was reinstated.
On April 1, 1953, CONNELL filed its answer
denying the material averment of the complaint, and
asserting affirmative defenses and a counterclaim.
Upon motion of the parties the Court, on September
30, 1953, issued an order transferring the venue of
the action to the Court of First Instance of Manila
where it was docketed as Civil Case No. 20987.
On August 30, 1958, upon motion of all the parties,
the Court ordered the sale of all the machineries,
equipment and supplies of DALCO, and the same
were subsequently sold for a total consideration of
P175,000.00 which was deposited in court pending
final determination of the action. By a similar
agreement one-half (P87,500.00) of this amount
was considered as representing the proceeds

obtained from the sale of the "undebated properties"

(those not claimed by DAMCO and CONNELL),
and the other half as representing those obtained
from the sale of the "after acquired properties".
After due trial, the Court, on July 15, 1960,
rendered judgment as follows:
IN VIEW WHEREFORE, the Court:
1. Condemns Dahican Lumber Co. to pay
unto People's Bank the sum of P200,000,00
with 7% interest per annum from July 13,
1950, Plus another sum of P100,000.00 with
5% interest per annum from July 13, 1950;
plus 10% on both principal sums as
attorney's fees;
2. Condemns Dahican Lumber Co. to pay
unto Atlantic Gulf the sum of P900,000.00
with 4% interest per annum from July 3,
1950, plus 10% on both principal as
attorney's fees;
3. Condemns Dahican Lumber Co. to pay
unto Connell Bros, the sum of P425,860.55,
and to pay unto Dahican American Lumber
Co. the sum of P2,151,678.24 both with
legal interest from the date of the filing of
the respective answers of those parties, 10%
of the principals as attorney's fees;
4. Orders that of the sum realized from the
sale of the properties of P175,000.00, after
deducting the recognized expenses, one-half
thereof be adjudicated unto plaintiffs, the
court no longer specifying the share of each
because of that announced intention under
the stipulation of facts to "pool their
resources"; as to the other one-half, the same
should be adjudicated unto both plaintiffs,
and defendant Dahican American and
Connell Bros. in the proportion already set
forth on page 9, lines 21, 22 and 23 of the
body of this decision; but with the
understanding that whatever plaintiffs and
Dahican American and Connell Bros. should
receive from the P175,000.00 deposited in
the Court shall be applied to the judgments
particularly rendered in favor of each;
5. No other pronouncement as to costs; but
the costs of the receivership as to the
debated properties shall be borne by
People's Bank, Atlantic Gulf, Connell Bros.,
and Dahican American Lumber Co., prorata.
On the following day, the Court issued the
following supplementary decision:

IN VIEW WHEREOF, the dispositive part

of the decision is hereby amended in order
to add the following paragraph 6:
6. If the sums mentioned in paragraphs 1
and 2 are not paid within ninety (90) days,
the Court orders the sale at public auction of
the lands object of the mortgages to satisfy
the said mortgages and costs of foreclosure.
From the above-quoted decision, all the parties
appealed.
Main contentions of plaintiffs as appellants are the
following: that the "after acquired properties" were
subject to the deeds of mortgage mentioned
heretofore; that said properties were acquired from
suppliers other than DAMCO and CONNELL; that
even granting that DAMCO and CONNELL were
the real suppliers, the rescission of the sales to
DALCO could not prejudice the mortgage lien in
favor of plaintiffs; that considering the foregoing,
the proceeds obtained from the sale of the "after
acquired properties" as well as those obtained from
the sale of the "undebated properties" in the total
sum of P175,000.00 should have been awarded
exclusively to plaintiffs by reason of the mortgage
lien they had thereon; that damages should have
been awarded to plaintiffs against defendants, all of
them being guilty of an attempt to defraud the
former when they sought to rescind the sales
already mentioned for the purpose of defeating their
mortgage lien, and finally, that defendants should
have been made to bear all the expenses of the
receivership, costs and attorney's fees.
On the other hand, defendants-appellants contend
that the trial court erred: firstly, in not holding that
plaintiffs had no cause of action against them
because the promissory note sued upon was not yet
due when the action to foreclose the mortgages was
commenced; secondly, in not holding that the
mortgages aforesaid were null and void as regards
the "after acquired properties" of DALCO because
they were not registered in accordance with the
Chattel Mortgage Law, the court erring, as a
consequence, in holding that said properties were
subject to the mortgage lien in favor of plaintiffs;
thirdly, in not holding that the provision of the
fourth paragraph of each of said mortgages did not
automatically make subject to such mortgages the
"after acquired properties", the only meaning
thereof being that the mortgagor was willing to
constitute a lien over such properties; fourthly, in
not ruling that said stipulation was void as against
DAMCO and CONNELL and in not awarding the

proceeds obtained from the sale of the "after

acquired properties" to the latter exclusively; fifthly,
in appointing a Receiver and in holding that the
damages suffered by DAMCO and CONNELL by
reason of the depreciation or loss in value of the
"after
acquired
properties"
placed
under
receivership was damnum absque injuria and,
consequently, in not awarding, to said parties the
corresponding
damages
claimed
in
their
counterclaim; lastly, in sentencing DALCO and
DAMCO to pay attorney's fees and in requiring
DAMCO and CONNELL to pay the costs of the
Receivership, instead of sentencing plaintiffs to pay
attorney's fees.
Plaintiffs' brief as appellants submit six assignments
of error, while that of defendants also as appellants
submit a total of seventeen. However, the
multifarious issues thus before Us may be resolved,
directly or indirectly, by deciding the following
issues:
Firstly, are the so-called "after acquired properties"
covered by and subject to the deeds of mortgage
subject of foreclosure?; secondly, assuming that
they are subject thereto, are the mortgages valid and
binding on the properties aforesaid inspite of the
fact that they were not registered in accordance with
the provisions of the Chattel Mortgage Law?;
thirdly, assuming again that the mortgages are valid
and binding upon the "after acquired properties",
what is the effect thereon, if any, of the rescission of
sales entered into, on the one hand, between
DAMCO and DALCO, and between DALCO and
CONNELL, on the other?; and lastly, was the action
to foreclose the mortgages premature?
A. Under the fourth paragraph of both deeds of
mortgage, it is crystal clear that all property of
every nature and description taken in exchange or
replacement, as well as all buildings, machineries,
fixtures, tools, equipments, and other property that
the mortgagor may acquire, construct, install,
attach; or use in, to upon, or in connection with the
premises that is, its lumber concession "shall
immediately be and become subject to the lien" of
both mortgages in the same manner and to the same
extent as if already included therein at the time of
their execution. As the language thus used leaves no
room for doubt as to the intention of the parties, We
see no useful purpose in discussing the matter
extensively. Suffice it to say that the stipulation
referred to is common, and We might say logical, in
all cases where the properties given as collateral are
perishable or subject to inevitable wear and tear or

were intended to be sold, or to be used thus

becoming subject to the inevitable wear and tear
but with the understanding express or implied
that they shall be replaced with others to be
thereafter acquired by the mortgagor. Such
stipulation is neither unlawful nor immoral, its
obvious purpose being to maintain, to the extent
allowed by circumstances, the original value of the
properties given as security. Indeed, if such
properties were of the nature already referred to, it
would be poor judgment on the part of the creditor
who does not see to it that a similar provision is
included in the contract.
B. But defendants contend that, granting without
admitting, that the deeds of mortgage in question
cover the "after acquired properties" of DALCO,
the same are void and ineffectual because they were
not registered in accordance with the Chattel
Mortgage Law. In support of this and of the
proposition that, even if said mortgages were valid,
they should not prejudice them, the defendants
argue (1) that the deeds do not describe the
mortgaged chattels specifically, nor were they
registered in accordance with the Chattel Mortgage
Law; (2) that the stipulation contained in the fourth
paragraph thereof constitutes "mere executory
agreements to give a lien" over the "after acquired
properties" upon their acquisition; and (3) that any
mortgage stipulation concerning "after acquired
properties" should not prejudice creditors and other
third persons such as DAMCO and CONNELL.
The stipulation under consideration strongly belies
defendants contention. As adverted to hereinbefore,
it states that all property of every nature, building,
machinery etc. taken in exchange or replacement by
the mortgagor "shall immediately be and become
subject to the lien of this mortgage in the same
manner and to the same extent as if now included
therein". No clearer language could have been
chosen.
Conceding, on the other hand, that it is the law in
this jurisdiction that, to affect third persons, a
chattel mortgage must be registered and must
describe the mortgaged chattels or personal
properties sufficiently to enable the parties and any
other person to identify them, We say that such law
does not apply to this case.
As the mortgages in question were executed on July
13, 1950 with the old Civil Code still in force, there
can be no doubt that the provisions of said code
must govern their interpretation and the question of
their validity. It happens however, that Articles 334

and 1877 of the old Civil Code are substantially

reproduced in Articles 415 and 2127, respectively,
of the new Civil Code. It is, therefore, immaterial in
this case whether we take the former or the latter as
guide in deciding the point under consideration.
Article 415 does not define real property but
enumerates what are considered as such, among
them being machinery, receptacles, instruments or
replacements intended by owner of the tenement for
an industry or works which may be carried on in a
building or on a piece of land, and shall tend
directly to meet the needs of the said industry or
works.
On the strength of the above-quoted legal
provisions, the lower court held that inasmuch as
"the chattels were placed in the real properties
mortgaged to plaintiffs, they came within the
operation of Art. 415, paragraph 5 and Art. 2127 of
the New Civil Code".
We find the above ruling in agreement with our
decisions on the subject:
(1) In Berkenkotter vs. Cu Unjieng, 61 Phil. 663,
We held that Article 334, paragraph 5 of the Civil
Code (old) gives the character of real property to
machinery, liquid containers, instruments or
replacements intended by the owner of any building
or land for use in connection with any industry or
trade being carried on therein and which are
expressly adapted to meet the requirements of such
trade or industry.
(2) In Cu Unjieng e Hijos vs. Mabalacat Sugar Co.,
58 Phil. 439, We held that a mortgage constituted on
a sugar central includes not only the land on which
it is built but also the buildings, machinery and
accessories installed at the time the mortgage was
constituted as well as the buildings, machinery and
accessories belonging to the mortgagor, installed
after the constitution thereof .
It is not disputed in the case at bar that the "after
acquired properties" were purchased by DALCO in
connection with, and for use in the development of
its lumber concession and that they were purchased
in addition to, or in replacement of those already
existing in the premises on July 13, 1950. In Law,
therefore, they must be deemed to have
been immobilized, with the result that the real estate
mortgages involved herein which were registered
as such did not have to be registered a second
time as chattel mortgages in order to bind the "after
acquired properties" and affect third parties.
But defendants, invoking the case of Davao
Sawmill Company vs. Castillo, 61 Phil. 709, claim

that the "after acquired properties" did not

become immobilized because DALCO did not own
the whole area of its lumber concession all over
which said properties were scattered.
The facts in the Davao Sawmill case, however, are
not on all fours with the ones obtaining in the
present. In the former, the Davao Sawmill
Company, Inc., had repeatedly treated the
machinery therein involved as personal property by
executing chattel mortgages thereon in favor of
third parties, while in the present case the parties
had treated the "after acquired properties" as real
properties by expressly and unequivocally agreeing
that they shall automatically become subject to the
lien of the real estate mortgages executed by them.
In the Davao Sawmill decision it was, in fact, stated
that "the characterization of the property as chattels
by the appellant is indicative of intention
and impresses upon the property the character
determined by the parties" (61 Phil. 112, emphasis
supplied). In the present case, the characterization
of the "after acquired properties" as real property
was made not only by one but by both interested
parties. There is, therefore, more reason to hold that
such consensus impresses upon the properties the
character determined by the parties who must now
be held in estoppel to question it.
Moreover, quoted in the Davao Sawmill case was
that of Valdez vs. Central Altagracia, Inc. (225 U.S.
58) where it was held that while under the general
law of Puerto Rico, machinery placed on property
by a tenant does not become immobilized, yet,
when the tenant places it there pursuant to contract
that it shall belong to the owner, it then becomes
immobilized as to that tenant and even as against
his assignees and creditors who had sufficient
notice of such stipulation. In the case at bar it is not
disputed that DALCO purchased the "after acquired
properties" to be placed on, and be used in the
development of its lumber concession, and agreed
further that the same shall become immediately
subject to the lien constituted by the questioned
mortgages. There is also abundant evidence in the
record that DAMCO and CONNELL had full notice
of such stipulation and had never thought of
disputed validity until the present case was filed.
Consequently all of them must be deemed barred
from denying that the properties in question had
become immobilized.
What We have said heretofore sufficiently disposes
all the arguments adduced by defendants in support
their contention that the mortgages under

foreclosure are void, and, that, even if valid, are

ineffectual as against DAMCO and CONNELL.
Now to the question of whether or not DAMCO
CONNELL have rights over the "after acquired
properties" superior to the mortgage lien constituted
thereon in favor of plaintiffs. It is defendants'
contention that in relation to said properties they are
"unpaid sellers"; that as such they had not only a
superior lien on the "after acquired properties" but
also the right to rescind the sales thereof to
DALCO.
This contention it is obvious would have
validity only if it were true that DAMCO and
CONNELL were the suppliers or vendors of the
"after acquired properties". According to the record,
plaintiffs did not know their exact identity and
description prior to the filing of the case bar
because DALCO, in violation of its obligation
under the mortgages, had failed and refused
theretofore to submit a complete list thereof. In the
course of the proceedings, however, when
defendants moved to dissolve the order of
receivership and the writ of preliminary injunction
issued by the lower court, they attached to their
motion the lists marked as Exhibits 1, 2 and 3
describing the properties aforesaid. Later on, the
parties agreed to consider said lists as identifying
and describing the "after acquire properties," and
engaged the services of auditors to examine the
books of DALCO so as to bring out the details
thereof. The report of the auditors and its annexes
(Exhibits V, V-1 V4) show that neither DAMCO
nor CONNELL had supplied any of the goods of
which they respective claimed to be the unpaid
seller; that all items were supplied by different
parties, neither of whom appeared to be DAMCO or
CONNELL that, in fact, CONNELL collected a 5%
service charge on the net value of all items it claims
to have sold to DALCO and which, in truth, it had
purchased for DALCO as the latter's general agent;
that CONNELL had to issue its own invoices in
addition to those o f the real suppliers in order to
collect and justify such service charge.
Taking into account the above circumstances
together with the fact that DAMCO was a
stockholder and CONNELL was not only a
stockholder but the general agent of DALCO, their
claim to be the suppliers of the "after acquired
required properties" would seem to be preposterous.
The most that can be claimed on the basis of the
evidence is that DAMCO and CONNELL probably
financed some of the purchases. But if DALCO still

owes them any amount in this connection, it is clear

that, as financiers, they can not claim any right over
the "after acquired properties" superior to the lien
constituted thereon by virtue of the deeds of
mortgage under foreclosure. Indeed, the execution
of the rescission of sales mentioned heretofore
appears to be but a desperate attempt to better or
improve DAMCO and CONNELL's position by
enabling them to assume the role of "unpaid
suppliers" and thus claim a vendor's lien over the
"after acquired properties". The attempt, of course,
is utterly ineffectual, not only because they are not
the "unpaid sellers" they claim to be but also
because there is abundant evidence in the record
showing that both DAMCO and CONNELL had
known and admitted from the beginning that the
"after acquired properties" of DALCO were meant
to be included in the first and second mortgages
under foreclosure.
The claim that Belden, of ATLANTIC, had given
his consent to the rescission, expressly or otherwise,
is of no consequence and does not make the
rescission valid and legally effective. It must be
stated clearly, however, in justice to Belden, that, as
a member of the Board of Directors of DALCO, he
opposed the resolution of December 15, 1952
passed by said Board and the subsequent rescission
of the sales.
Finally, defendants claim that the action to foreclose
the mortgages filed on February 12, 1953 was
premature because the promissory note sued upon
did not fall due until April 1 of the same year,
concluding from this that, when the action was
commenced, the plaintiffs had no cause of action.
Upon this question the lower court says the
following in the appealed judgment;
The other is the defense of prematurity of
the causes of action in that plaintiffs, as a
matter of grace, conceded an extension of
time to pay up to 1 April, 1953 while the
action was filed on 12 February, 1953, but,
as to this, the Court taking it that there is
absolutely no debate that Dahican Lumber
Co., was insolvent as of the date of the filing
of the complaint, it should follow that the
debtor thereby lost the benefit to the period.
x x x unless he gives a guaranty or security
for the debt . . . (Art. 1198, New Civil
Code);
and as the guaranty was plainly inadequate
since the claim of plaintiffs reached in the
aggregate, P1,200,000 excluding interest

while the aggregate price of the "afteracquired" chattels claimed by Connell under
the rescission contracts was P1,614,675.94,
Exh. 1, Exh. V, report of auditors, and as a
matter of fact, almost all the properties were
sold afterwards for only P175,000.00, page
47, Vol. IV, and the Court understanding that
when the law permits the debtor to enjoy the
benefits of the period notwithstanding that
he is insolvent by his giving a guaranty for
the debt, that must mean a new and efficient
guaranty, must concede that the causes of
action for collection of the notes were not
premature.
Very little need be added to the above. Defendants,
however, contend that the lower court had no basis
for finding that, when the action was commenced,
DALCO was insolvent for purposes related to
Article 1198, paragraph 1 of the Civil Code. We
find, however, that the finding of the trial court is
sufficiently supported by the evidence particularly
the resolution marked as Exhibit K, which shows
that on December 16, 1952 in the words of the
Chairman of the Board DALCO was "without
funds, neither does it expect to have any funds in
the foreseeable future." (p. 64, record on appeal).
The remaining issues, namely, whether or not the
proceeds obtained from the sale of the "after
acquired properties" should have been awarded
exclusively to the plaintiffs or to DAMCO and
CONNELL, and if in law they should be distributed
among said parties, whether or not the distribution
should be pro-rata or otherwise; whether or not
plaintiffs are entitled to damages; and, lastly,
whether or not the expenses incidental to the
Receivership should be borne by all the parties on a
pro-rata basis or exclusively by one or some of
them are of a secondary nature as they are already
impliedly resolved by what has been said
heretofore.
As regard the proceeds obtained from the sale of the
of after acquired properties" and the "undebated
properties", it is clear, in view of our opinion
sustaining the validity of the mortgages in relation
thereto, that said proceeds should be awarded
exclusively to the plaintiffs in payment of the
money obligations secured by the mortgages under
foreclosure.
On the question of plaintiffs' right to recover
damages from the defendants, the law (Articles
1313 and 1314 of the New Civil Code) provides
that creditors are protected in cases of contracts

intended to defraud them; and that any third person

who induces another to violate his contract shall be
liable for damages to the other contracting party.
Similar liability is demandable under Arts. 20 and
21 which may be given retroactive effect (Arts.
225253) or under Arts. 1902 and 2176 of the Old
Civil Code.
The facts of this case, as stated heretofore, clearly
show that DALCO and DAMCO, after failing to
pay the fifth promissory note upon its maturity,
conspired jointly with CONNELL to violate the
provisions of the fourth paragraph of the mortgages
under foreclosure by attempting to defeat plaintiffs'
mortgage lien on the "after acquired properties". As
a result, the plaintiffs had to go to court to protect
their rights thus jeopardized. Defendants' liability
for damages is therefore clear.
However, the measure of the damages suffered by
the plaintiffs is not what the latter claim, namely,
the difference between the alleged total obligation
secured by the mortgages amounting to around
P1,200,000.00, plus the stipulated interest and
attorney's fees, on the one hand, and the proceeds
obtained from the sale of "after acquired
properties", and of those that were not claimed
neither by DAMCO nor CONNELL, on the other.
Considering that the sale of the real properties
subject to the mortgages under foreclosure has not
been effected, and considering further the lack of
evidence showing that the true value of all the
properties already sold was not realized because
their sale was under stress, We feel that We do not
have before Us the true elements or factors that
should determine the amount of damages that
plaintiffs are entitled recover from defendants. It is,
however, our considered opinion that, upon the facts
established, all the expenses of the Receivership,
which was deemed necessary to safeguard the rights
of the plaintiffs, should be borne by the defendants,
jointly and severally, in the same manner that all of
them should pay to the plaintiffs, jointly a severally,
attorney's fees awarded in the appealed judgment.
In consonance with the portion of this decision
concerning the damages that the plaintiffs are
entitled to recover from the defendants, the record
of this case shall be remanded below for the
corresponding proceedings.
Modified as above indicated, the appealed judgment
is affirmed in all other respects. With costs.

Republic
of
the
Philippines
SUPREME
COURT
Manila
SECOND DIVISION
G.R. No. 169211
March 6, 2013
STAR TWO (SPV-AMC), INC.,1 Petitioner,
vs.
PAPER CITY CORPORATION OF THE
PHILIPPINES, Respondent.
DECISION
PEREZ, J.:
For review before this Court is a Petition for
Review on Certiorari filed by Rizal Commercial
Banking Corporation now substituted by Star Two
(SPV-AMC), Inc. by virtue of Republic Act No.
91822 otherwise known as the "Special Purpose
Vehicle Act of 2002," assailing the 8 March 2005
Decision and 8 August 2005 Resolution of the
Special Fourth Division of the Court of Appeals
(CA) in CA-G.R. SP No. 82022 upholding the 15
August 2003 and 1 December 2003 Orders of the
Valenzuela Regional Trial Court (RTC) ruling that
the subject machineries and equipments of Paper
City Corporation (Paper City) are movable
properties by agreement of the parties and cannot be
considered as included in the extrajudicial
foreclosure sale of the mortgaged land and building
of Paper City.3
The facts as we gathered from the records are:
Rizal Commercial Banking Corporation (RCBC),
Metropolitan Bank and Trust Co. (Metrobank) and
Union Bank of the Philippines (Union Bank) are
banking corporations duly organized and existing
under the laws of the Philippines.
On the other hand, respondent Paper City is a
domestic corporation engaged in the manufacture of
paper products particularly cartons, newsprint and
clay-coated paper.4
From 1990-1991, Paper City applied for and was
granted the following loans and credit
accommodations in peso and dollar denominations
by RCBC: P10,000,000.00 on 8 January
1990,5 P14,000,000.00
on
19
July
1990,6P10,000,000.00
on
28
June
1991,7 and P16,615,000.00 on 28 November
1991.8 The loans were secured by four (4) Deeds of
Continuing Chattel Mortgages on its machineries
and equipments found inside its paper plants.
On 25 August 1992, a unilateral Cancellation of
Deed of Continuing Chattel Mortgage on Inventory
of Merchandise/Stocks-in-Trade was executed by

RCBC through its Branch Operation Head Joey P.

Singh and Asst. Vice President Anita O. Abad over
the merchandise and stocks-in-trade covered by the
continuing chattel mortgages.9
On 26 August 1992, RCBC, Metrobank and Union
Bank (creditor banks with RCBC instituted as the
trustee bank) entered into a Mortgage Trust
Indenture (MTI) with Paper City. In the said MTI,
Paper City acquired an additional loan of One
Hundred Seventy Million Pesos (P170,000,000.00)
from the creditor banks in addition to the previous
loan from RCBC amounting to P110,000,000.00
thereby increasing the entire loan to a total
of P280,000,000.00.
The
old
loan
of P110,000,000.00 was partly secured by various
parcels of land covered by TCT Nos. T-157743, V13515, V-1184, V-1485, V-13518 and V-13516
situated in Valenzuela City pursuant to five (5)
Deeds of Real Estate Mortgage dated 8 January
1990, 27 February 1990, 19 July 1990, 20 February
1992 and 12 March 1992.10 The new loan obligation
of P170,000,000.00 would be secured by the same
five (5) Deeds of Real Estate Mortgage and
additional real and personal properties described in
an annex to MTI, Annex "B."11 Annex "B" of the
said MTI covered the machineries and equipments
of Paper City.12
The MTI was later amended on 20 November 1992
to increase the contributions of the RCBC and
Union Bank toP80,000,000.00 and P70,000,000.00,
respectively. As a consequence, they executed a
Deed of Amendment to MTI13 but still included as
part of the mortgaged properties by way of a first
mortgage the various machineries and equipments
located in and bolted to and/or forming part of
buildings generally described as:
Annex "A"
A. Office
Building
Building 1, 2, 3, 4, and 5
Boiler
House
Workers
Quarter/Restroom
Canteen
Guardhouse, Parking Shed, Elevated
Guard
Post and other amenities
B. Pollution Tank Nos. 1 and 2.
Reserve Water Tank and Swimming
Pool
Waste Water Treatment Tank
Elevated Concrete Water Tank
And other Improvements listed in
Annex "A"

C. Power Plants Nos. 1 and 2

Fabrication
Building
Various Fuel, Water Tanks and
Pumps
Transformers
Annex "B"
D. D. Material Handling Equipment
Paper Plant No. 3
A Second Supplemental Indenture to the 26 August
1992 MTI was executed on 7 June 1994 to increase
the amount of the loan from P280,000,000.00
to P408,900,000.00 secured against the existing
properties composed of land, building, machineries
and equipments and inventories described in
Annexes "A" and "B."14
Finally, a Third Supplemental Indenture to the 26
August 1992 MTI was executed on 24 January 1995
to increase the existing loan obligation
of P408,900,000.00 to P555,000,000.00 with an
additional security composed of a newly
constructed two-storey building and other
improvements, machineries and equipments located
in the existing plant site.15
Paper City was able to comply with its loan
obligations until July 1997. But economic crisis
ensued which made it difficult for Paper City to
meet the terms of its obligations leading to payment
defaults.16 Consequently, RCBC filed a Petition for
Extrajudicial Foreclosure Under Act No. 3135
Against the Real Estate Mortgage executed by
Paper City on 21 October 1998.17 This petition was
for the extra-judicial foreclosure of eight (8) parcels
of land including all improvements thereon
enumerated as TCT Nos. V-9763, V-13515, V13516, V-13518, V-1484, V-1485, V-6662 and V6663 included in the MTI dated 26 August 1992,
Supplemental
MTI dated 20 November 1992, Second
Supplemental Indenture on the MTI dated 7 June
1994 and Third Supplemental Indenture on the MTI
dated 24 January 1995.18 Paper City then had an
outstanding obligation with the creditor banks
adding up to Nine Hundred One Million Eight
Hundred One Thousand Four Hundred Eighty-Four
and 10/100 Pesos (P901,801,484.10), inclusive of
interest and penalty charges.19
A Certificate of Sale was executed on 8 February
1999 certifying that the eight (8) parcels of land
with improvements thereon were sold on 27
November 1998 in the amount of Seven Hundred
Two Million Three Hundred Fifty-One Thousand
Seven Hundred Ninety-Six Pesos and 28/100

(P702,351,796.28) in favor of the creditor banks

RCBC, Union Bank and Metrobank as the highest
bidders.20
This foreclosure sale prompted Paper City to file a
Complaint21 docketed as Civil Case No. 164-V-99
on 15 June 1999 against the creditor banks alleging
that the extra-judicial sale of the properties and
plants was null and void due to lack of prior notice
and attendance of gross and evident bad faith on the
part of the creditor banks. In the alternative, it
prayed that in case the sale is declared valid, to
render the whole obligation of Paper City as fully
paid and extinguished. Also prayed for was the
return of P5,000,000.00 as excessive penalty and
the payment of damages and attorneys fees.
In the meantime, Paper City and Union Bank
entered into a Compromise Agreement which was
later approved by the trial court on 19 November
2001. It was agreed that the share of Union Bank in
the proceeds of the foreclosure shall be up to
34.23% of the price and the remaining possible
liabilities of Paper City shall be condoned by the
bank. Paper City likewise waived all its claim and
counter charges against Union Bank and agreed to
turn-over its proportionate share over the property
within 120 days from the date of agreement.22
On the other hand, the negotiations between the
other creditor banks and Paper City remained
pending. During the interim, Paper City filed with
the trial court a Manifestation with Motion to
Remove and/or Dispose Machinery on 18
December 2002 reasoning that the machineries
located inside the foreclosed land and building were
deteriorating. It posited that since the machineries
were not included in the foreclosure of the real
estate mortgage, it is appropriate that it be removed
from the building and sold to a third party.23
Acting on the said motion, the trial court, on 28
February 2003 issued an Order denying the prayer
and ruled that the machineries and equipments were
included in the annexes and form part of the MTI
dated 26 August 1992 as well as its subsequent
amendments. Further, the machineries and
equipments are covered by the Certificate of Sale
issued as a consequence of foreclosure, the
certificate stating that the properties described
therein with improvements thereon were sold to
creditor banks to the defendants at public auction.24
Paper City filed its Motion for Reconsideration 25 on
4 April 2003 which was favorably granted by the
trial court in its Order dated 15 August 2003. The
court justified the reversal of its order on the finding

that the disputed machineries and equipments are

chattels by agreement of the parties through their
inclusion in the four (4) Deeds of Chattel Mortgage
dated 28 January 1990, 19 July 1990, 28 June 1991
and 28 November 1991. It further ruled that the
deed of cancellation executed by RCBC on 25
August 1992 was not valid because it was done
unilaterally and without the consent of Paper City
and the cancellation only refers to the
merchandise/stocks-in-trade and not to machineries
and equipments.26
RCBC in turn filed its Motion for Reconsideration
to persuade the court to reverse its 15 August 2003
Order. However, the same was denied by the trial
court through its 1 December 2003 Order reiterating
the finding and conclusion of the previous Order.27
Aggrieved, RCBC filed with the CA a Petition for
Certiorari under Rule 65 to annul the Orders dated
15 August 2003 and 1 December 2003 of the trial
court,28 for the reasons that:
I. Paper City gave its conformity to consider
the subject machineries and equipment as
real properties when the president and
Executive Vice President of Paper City
signed the Mortgage Trust Indenture as well
as its subsequent amendments and all pages
of the annexes thereto which itemized all
properties that were mortgaged.29
II. Under Section 8 of Act No. 1508,
otherwise known as "The Chattel Mortgage
Law" the consent of the mortgagor (Paper
City) is not required in order to cancel a
chattel mortgage. Thus the "Cancellation of
Deed of Continuing Chattel Mortgage on
Inventory of Merchandise/Stocks-in-Trade"
dated August 25, 1992 is valid and binding
on the Paper City even assuming that it was
executed unilaterally by petitioner RCBC.30
III. The four (4) Deeds of Chattel Mortgage
that were attached as Annexes "A" to "D" to
the December 18, 2003 "Manifestation with
Motion to Remove and/or Dispose of
Machinery" were executed from January 8,
1990 until November 28, 1991. On the other
hand, the "Cancellation of Deed of
Continuing Chattel Mortgage" was executed
on August 25, 1992 while the MTI and the
subsequent
supplemental
amendments
thereto were executed from August 26, 1992
until January 24, 1995. It is of the contention
of RCBC that Paper Citys unreasonable
delay of ten

(10) years in assailing that the disputed

machineries and equipments were personal
amounted to estoppel and ratification of the
characterization that the same were real
properties.31
IV. The removal of the subject machineries
or equipment is not among the reliefs prayed
for by the Paper City in its June 11, 1999
Complaint. The Paper City sought the
removal of the subject machineries and
equipment only when it filed its December
18, 2002 Manifestation with Motion to
Remove and/or Dispose of Machinery.32
V. Paper City did not specify in its various
motions filed with the respondent judge the
subject machineries and equipment that are
allegedly excluded from the extrajudicial
foreclosure sale.33
VI. The machineries and equipments
mentioned in the four (4) Deeds of Chattel
Mortgage that were attached on the
Manifestation with Motion to Remove
and/or Dispose of Machinery are the same
machineries and equipments included in the
MTI and supplemental amendments, hence,
are treated by agreement of the parties as
real properties.34
In its Comment,35 Paper City refuted the claim of
RCBC that it gave its consent to consider the
machineries and equipments as real properties. It
alleged that the disputed properties remained within
the purview of the existing chattel mortgages which
in fact were acknowledged by RCBC in the MTI
particularly in Section 11.07 which reads:
Section 11.07. This INDENTURE in respect of the
MORTGAGE OBLIGATIONS in the additional
amount not exceeding TWO HUNDRED TWENTY
MILLION
SIX
HUNDRED
FIFTEEN
THOUSAND PESOS (P220,615,000.00) shall be
registered with the Register of Deeds of Valenzuela,
Metro Manila, apportioned based on the
corresponding loanable value of the MORTGAGED
PROPERTIES, viz:
a. Real Estate Mortgage P206,815,000.00
b. Chattel Mortgage P13,800,000.0036
Paper City argued further that the subject
machineries and equipments were not included in
the foreclosure of the mortgage on real properties
particularly the eight (8) parcels of land. Further,
the Certificate of Sale of the Foreclosed Property
referred only to "lands and improvements" without

any specification and made no mention of the

inclusion of the subject properties.37
In its Reply,38 RCBC admitted that there was indeed
a provision in the MTI mentioning a chattel
mortgage in the amount of P13,800,000.00.
However, it justified that its inclusion in the MTI
was merely for the purpose of ascertaining the
amount of the loan to be extended to Paper City.39 It
reiterated its position that the machineries and
equipments were no longer treated as chattels but
already as real properties following the MTI.40
On 8 March 2005, the CA affirmed 41 the challenged
orders of the trial court. The dispositive portion
reads:
WHEREFORE, finding no grave abuse of
discretion committed by public respondent, the
instant petition is hereby DISMISSED for lack of
merit. The assailed Orders dated 15 August and 2
December 2003, issued by Hon. Judge Floro P.
Alejo are hereby AFFIRMED. No costs at this
instance.42
The CA relied on the "plain language of the MTIs:
Undoubtedly, nowhere from any of the MTIs
executed by the parties can we find the alleged
"express" agreement adverted to by petitioner.
There is no provision in any of the parties MTI,
which expressly states to the effect that the parties
shall treat the equipments and machineries as real
property. On the contrary, the plain and
unambiguous language of the aforecited MTIs,
which described the same as personal properties,
contradicts petitioners claims.43
It was also ruled that the subject machineries and
equipments were not included in the extrajudicial
foreclosure sale. The claim of inclusion was
contradicted by the very caption of the petition
itself, "Petition for Extra-Judicial Foreclosure of
Real Estate Mortgage Under Act No. 3135 As
Amended." It opined further that this inclusion was
further stressed in the Certificate of Sale which
enumerated only the mortgaged real properties
bought by RCBC without the subject properties.44
RCBC sought reconsideration but its motion was
denied in the CAs Resolution dated 8 August 2005.
RCBC before this Court reiterated all the issues
presented before the appellate court:
1. Whether the unreasonable delay of ten
(10) years in assailing that the disputed
machineries and equipments were personal
properties amounted to estoppel on the part
of Paper City;

2. Whether the Cancellation of Deed of

Continuing Mortgage dated 25 August 1992
is valid despite the fact that it was executed
without the consent of the mortgagor Paper
City;
3. Whether the subsequent contracts of the
parties such as Mortgage Trust Indenture
dated 26 August 1992 as well as the
subsequent supplementary amendments
dated 20 November 1992, 7 June 1992, and
24 January 1995 included in its coverage of
mortgaged
properties
the
subject
machineries and equipment; and
4. Whether the subject machineries and
equipments
were
included
in the
extrajudicial foreclosure dated 21 October
1998 which in turn were sold to the creditor
banks as evidenced by the Certificate of Sale
dated 8 February 1999.
We grant the petition.
By contracts, all uncontested in this case,
machineries and equipments are included in the
mortgage in favor of RCBC, in the foreclosure of
the mortgage and in the consequent sale on
foreclosure also in favor of petitioner.
The mortgage contracts are the original MTI of 26
August 1992 and its amendments and supplements
on 20 November 1992, 7 June 1994, and 24 January
1995. The clear agreements between RCBC and
Paper City follow:
The original MTI dated 26 August 1992 states that:
MORTGAGE TRUST INDENTURE
This
MORTGAGE TRUST INDENTURE,
executed on this day of August 26, 1992, by and
between:
PAPER CITY CORPORATION OF THE
PHILIPPINES, x x x hereinafter referred to as the
"MORTGAGOR");
-andRIZAL
COMMERCIAL
BANKING
CORPORATION, x x x (hereinafter referred to as
the "TRUSTEE").
xxxx
WHEREAS, against the same mortgaged properties
and additional real and personal properties more
particularly described in ANNEX "B" hereof, the
MORTGAGOR desires to increase their borrowings
to TWO HUNDRED EIGHTY MILLION PESOS
(P280,000,000.00) or an increase of ONE
HUNDRED SEVENTY MILLION PESOS
(P170,000,000.00) xxx from various banks/financial
institutions;

xxxx
GRANTING CLAUSE
NOW,
THEREFORE,
this
INDENTURE
witnesseth:
THAT the MORTGAGOR in consideration of the
premises and of the acceptance by the TRUSTEE of
the trust hereby created, and in order to secure the
payment of the MORTGAGE OBLIGATIONS
which shall be incurred by the MORTGAGOR
pursuant to the terms hereof xxx hereby states that
with the execution of this INDENTURE it will
assign, transfer and convey as it has hereby
ASSIGNED, TRANSFERRED and CONVEYED
by way of a registered first mortgage unto RCBC x
x x the various parcels of land covered by several
Transfer Certificates of Title issued by the Registry
of Deeds, including the buildings and existing
improvements thereon, as well as of the machinery
and equipment more particularly described and
listed that is to say, the real and personal properties
listed in Annexes "A" and "B" hereof of which the
MORTGAGOR is the lawful and registered
owner.45(Emphasis and underlining ours)
The Deed of Amendment to MTI dated 20
November 1992 expressly provides:
NOW, THEREFORE, premises considered, the
parties considered have amended and by these
presents do further amend the Mortgage Trust
Indenture dated August 26, 1992 including the Real
Estate Mortgage as follows:
xxxx
2. The Mortgage Trust Indenture and the Real
Estate Mortgage are hereby amended to include as
part of the Mortgage Properties, by way of a first
mortgage and for pari-passu and pro-rata benefit of
the existing and new creditors, various machineries
and equipment owned by the Paper City, located in
and bolted to and forming part of the following,
generally describes as x x x more particularly
described and listed in Annexes "A" and "B" which
are attached and made integral parts of this
Amendment. The machineries and equipment listed
in Annexes "A" and "B" form part of the
improvements listed above and located on the
parcels of land subject of the Mortgage Trust
Indenture
and
the
Real
Estate
Mortgage.46 (Emphasis and underlining ours)
A Second Supplemental Indenture to the 26 August
1992 MTI executed on 7 June 1994 to increase the
amount
of
loan
from P280,000,000.00
to P408,900,000.00 also contains a similar
provision in this regard:

WHEREAS, the Paper City desires to increase its

borrowings to be secured by the INDENTURE from
PESOS: TWO HUNDRED EIGHTY MILLION
(P280,000,000.00) to PESOS: FOUR HUNDRED
EIGHT MILLION NINE HUNDRED THOUSAND
(P408,900,000.00) or an increase of PESOS: ONE
HUNDRED TWENTY EIGHT MILLION NINE
HUNDRED THOUSAND (P128,900,000.00) x x x
which represents additional loan/s granted to the
Paper City to be secured against the existing
properties composed of land, building, machineries
and equipment and inventories more particularly
described in Annexes "A" and "B" of the
INDENTURE x x x.47
(Emphasis and underlining ours)
Finally, a Third Supplemental Indenture to the 26
August 1992 MTI executed on 24 January 1995
contains a similar provision:
WHEREAS,
in
order
to
secure
NEW/ADDITIONAL LOAN OBLIGATION under
the Indenture, there shall be added to the collateral
pool subject of the Indenture properties of the Paper
City composed of newly constructed two (2)-storey
building, other land improvements and machinery
and equipment all of which are located at the
existing Plant Site in Valenzuela, Metro Manila and
more particularly described in Annex "A" hereof x x
x.48 (Emphasis and underlining ours)
Repeatedly, the parties stipulated that the properties
mortgaged by Paper City to RCBC are various
parcels of land including the buildings and existing
improvements thereon as well as the machineries
and equipments, which as stated in the granting
clause of the original mortgage, are "more
particularly described and listed that is to say, the
real and personal properties listed in Annexes A
and B x x x of which the Paper City is the lawful
and registered owner." Significantly, Annexes "A"
and "B" are itemized listings of the buildings,
machineries and equipments typed single spaced in
twenty-seven pages of the document made part of
the records.
As held in Gateway Electronics Corp. v. Land Bank
of the Philippines,49 the rule in this jurisdiction is
that the contracting parties may establish any
agreement, term, and condition they may deem
advisable, provided they are not contrary to law,
morals or public policy. The right to enter into
lawful contracts constitutes one of the liberties
guaranteed by the Constitution.
It has been explained by the Supreme Court in
Norton Resources and Development Corporation v.

All Asia Bank Corporation50 in reiteration of the

ruling in Benguet Corporation v. Cabildo51 that:
x x x A court's purpose in examining a contract is to
interpret the intent of the contracting parties, as
objectively manifested by them. The process of
interpreting a contract requires the court to make a
preliminary inquiry as to whether the contract
before it is ambiguous. A contract provision is
ambiguous if it is susceptible of two reasonable
alternative interpretations. Where the written terms
of the contract are not ambiguous and can only be
read one way, the court will interpret the contract as
a matter of law. x x x
Then till now the pronouncement has been that if
the language used is as clear as day and readily
understandable by any ordinary reader, there is no
need for construction.52
The case at bar is covered by the rule.
The plain language and literal interpretation of the
MTIs must be applied. The petitioner, other creditor
banks and Paper City intended from the very first
execution of the indentures that the machineries and
equipments enumerated in Annexes "A" and "B" are
included. Obviously, with the continued increase in
the amount of the loan, totaling hundreds of
millions of pesos, Paper City had to offer all
valuable properties acceptable to the creditor banks.
The plain and obvious inclusion in the mortgage of
the machineries and equipments of Paper City
escaped the attention of the CA which, instead,
turned to another "plain language of the MTI" that
"described the same as personal properties." It was
error for the CA to deduce from the "description"
exclusion from the mortgage.
1. The MTIs did not describe the equipments and
machineries as personal property. Had the CA
looked into Annexes "A" and "B" which were
referred to by the phrase "real and personal
properties," it could have easily noted that the
captions describing the listed properties were
"Buildings," "Machineries and Equipments," "Yard
and Outside," and "Additional Machinery and
Equipment." No mention in any manner was made
in the annexes about "personal property." Notably,
while "personal" appeared in the granting clause of
the original MTI, the subsequent Deed of
Amendment specifically stated that:
x x x The machineries and equipment listed in
Annexes "A" and "B" form part of the
improvements listed above and located on the
parcels of land subject of the Mortgage Trust
Indenture and the Real Estate Mortgage.

The word "personal" was deleted in the

corresponding granting clauses in the Deed of
Amendment and in the First, Second and Third
Supplemental Indentures.
2. Law and jurisprudence provide and guide that
even if not expressly so stated, the mortgage
extends to the improvements.
Article 2127 of the Civil Code provides:
Art. 2127. The mortgage extends to the natural
accessions, to the improvements, growing fruits,
and the rents or income not yet received when the
obligation becomes due, and to the amount of the
indemnity granted or owing to the proprietor from
the insurers of the property mortgaged, or in virtue
of expropriation for public use, with the
declarations, amplifications
and limitations
established by law, whether the estate remains in the
possession of the mortgagor, or it passes into the
hands of a third person. (Underlining ours)
In the early case of Bischoff v. Pomar and Cia.
General de Tabacos,53 the Court ruled that even if
the machinery in question was not included in the
mortgage expressly, Article 111 of the old Mortgage
Law provides that chattels permanently located in a
building, either useful or ornamental, or for the
service of some industry even though they were
placed there after the creation of the mortgage shall
be considered as mortgaged with the estate,
provided they belong to the owner of said estate.
The provision of the old Civil Code was cited.
Thus:
Article 1877 provides that a mortgage includes the
natural accessions, improvements, growing fruits,
and rents not collected when the obligation is due,
and the amount of the indemnities granted or due
the owner by the underwriters of the property
mortgaged or by virtue of the exercise of eminent
domain by reason of public utility, with the
declarations, amplifications, and limitations
established by law, in case the estate continues in
the possession of the person who mortgaged it, as
well as when it passes into the hands of a third
person.54
The case of Cu Unjieng e Hijos v. Mabalacat Sugar
Co.55 relied on this provision. The issue was
whether the machineries and accessories were
included in the mortgage and the subsequent sale
during public auction. This was answered in the
affirmative by the Court when it ruled that the
machineries were integral parts of said sugar central
hence included following the principle of law that
the accessory follows the principal.

Further, in the case of Manahan v. Hon. Cruz, 56 this

Court denied the prayer of Manahan to nullify the
order of the trial court including the building in
question in the writ of possession following the
public auction of the parcels of land mortgaged to
the bank. It upheld the inclusion by relying on the
principles laid upon in Bischoff v. Pomar and Cia.
General de Tabacos57 and Cu Unjieng e Hijos v.
Mabalacat Sugar Co.58
In Spouses Paderes v. Court of Appeals, 59 we
reiterated once more the Cu Unjieng e Hijos ruling
and approved the inclusion of machineries and
accessories installed at the time the mortgage, as
well as all the buildings, machinery and accessories
belonging to the mortgagor, installed after the
constitution thereof.
3. Contrary to the finding of the CA, the ExtraJudicial Foreclosure of Mortgage includes the
machineries and equipments of respondent. While
captioned as a "Petition for Extra-Judicial
Foreclosure of Real Estate Mortgage Under Act No.
3135 As Amended," the averments state that the
petition is based on "x x x the Mortgage Trust
Indenture, the Deed of Amendment to the Mortgage
Trust Indenture, the Second Supplemental Indenture
to the Mortgage Trust Indenture, and the Third
Supplemental Indenture to the Mortgage Trust
Indenture (hereinafter collectively referred to as the
Indenture) duly notarized and entered as x x
x."60 Noting that herein respondent has an
outstanding obligation in the total amount of Nine
Hundred One Million Eight Hundred One Thousand
Four Hundred Eighty Four and 10/100 Pesos
(P901,801,484.10), the petition for foreclosure
prayed that a foreclosure proceedings "x x x on the
aforesaid
real
properties,
including
all
improvements thereon covered by the real estate
mortgage be undertaken and the appropriate auction
sale be conducted x x x."61
Considering that the Indenture which is the
instrument of the mortgage that was foreclosed
exactly states through the Deed of Amendment that
the machineries and equipments listed in Annexes
"A" and "B" form part of the improvements listed
and located on the parcels of land subject of the
mortgage, such machineries and equipments are
surely part of the foreclosure of the "real estate
properties, including all improvements thereon" as
prayed for in the petition.
Indeed, the lower courts ought to have noticed the
fact that the chattel mortgages adverted to were
dated 8 January 1990, 19 July 1990, 28 June 1991

and 28 November 1991. The real estate mortgages

which specifically included the machineries and
equipments were subsequent to the chattel
mortgages dated 26 August 1992, 20 November
1992, 7 June 1994 and 24 January 1995. Without
doubt, the real estate mortgages superseded the
earlier chattel mortgages.1wphi1
The real estate mortgage over the machineries and
equipments is even in full accord with the
classification of such properties by the Civil Code
of the Philippines as immovable property. Thus:
Article 415. The following are immovable property:
(1) Land, buildings, roads and constructions of all
kinds adhered to the soil;
xxxx
(5) Machinery, receptacles, instruments or
implements intended by the owner of the tenement
for an industry or works which may be carried on in
a building or on a piece of land, and which tend
directly to meet the needs of the said industry or
works;
WHEREFORE, the petition is GRANTED.
Accordingly, the Decision and Resolution of the
Court of Appeals dated 8 March 2005 and 8 August
2005 upholding the 15 August 2003 and 1
December 2003 Orders of the Valenzuela Regional
Trial Court are hereby REVERSED and SET
ASIDE and the original Order of the trial court
dated 28 February 2003 denying the motion of
respondent to remove or dispose of machinery is
hereby REINSTATED.
SO ORDERED.

Republic
of
the
Philippines
SUPREME
COURT
Manila
FIRST DIVISION
G.R. No. 158891
June 27, 2012
PABLO
P.
GARCIA, Petitioner,
vs.
YOLANDA VALDEZ VILLAR, Respondent.
DECISION
LEONARDO-DE CASTRO, J.:
This is a petition for review on certiorari1 of the
February 27, 2003 Decision2 and July 2, 2003
Resolution3 of the Court of Appeals in CA-G.R. SP
No. 72714, which reversed the May 27, 2002
Decision4 of the Regional Trial Court (RTC),
Branch 92 of Quezon City in Civil Case No. Q-9939139.
Lourdes V. Galas (Galas) was the original owner of
a piece of property (subject property) located at
Malindang St., Quezon City, covered by Transfer
Certificate of Title (TCT) No. RT-67970(253279).5
On July 6, 1993, Galas, with her daughter, Ophelia
G. Pingol (Pingol), as co-maker, mortgaged the
subject property to Yolanda Valdez Villar (Villar) as
security for a loan in the amount of Two Million
Two Hundred Thousand Pesos (P2,200,000.00).6
On October 10, 1994, Galas, again with Pingol as
her co-maker, mortgaged the same subject property
to Pablo P. Garcia (Garcia) to secure her loan of
One Million Eight Hundred Thousand Pesos
(P1,800,000.00).7
Both mortgages were annotated at the back of TCT
No. RT-67970 (253279), to wit:
REAL ESTATE MORTGAGE
Entry No. 6537/T-RT-67970(253279) MORTGAGE
In favor of Yolanda Valdez Villar m/to Jaime
Villar to guarantee a principal obligation in the sum
of P2,200,000- mortgagees consent necessary in
case of subsequent encumbrance or alienation of the
property; Other conditions set forth in Doc. No. 97,
Book No. VI, Page No. 20 of the Not. Pub. of Diana
P. Magpantay
Date of Instrument: 7-6-93
Date of Inscription: 7-7-93
SECOND REAL ESTATE MORTGAGE
Entry No. 821/T-RT-67970(253279) MORTGAGE
In favor of Pablo Garcia m/to Isabela Garcia to
guarantee a principal obligation in the sum
of P1,800,000.00 mortgagees consent necessary in
case of subsequent encumbrance or alienation of the
property; Other conditions set forth in Doc. No. 08,

Book No. VII, Page No. 03 of the Not. Pub. of

Azucena Espejo Lozada
Date of Instrument: 10/10/94
Date of Inscription: 10/11/94
LRC Consulta No. 1698
On November 21, 1996, Galas sold the subject
property to Villar for One Million Five Hundred
Thousand Pesos (P1,500,000.00), and declared in
the Deed of Sale9 that such property was "free and
clear of all liens and encumbrances of any kind
whatsoever."10
On December 3, 1996, the Deed of Sale was
registered and, consequently, TCT No. RT67970(253279) was cancelled and TCT No. N16836111 was issued in the name of Villar. Both
Villars and Garcias mortgages were carried over
and annotated at the back of Villars new TCT.12
On October 27, 1999, Garcia filed a Petition for
Mandamus with Damages13 against Villar before the
RTC, Branch 92 of Quezon City. Garcia
subsequently amended his petition to a Complaint
for Foreclosure of Real Estate Mortgage with
Damages.14 Garcia alleged that when Villar
purchased the subject property, she acted in bad
faith and with malice as she knowingly and
willfully disregarded the provisions on laws on
judicial and extrajudicial foreclosure of mortgaged
property. Garcia further claimed that when Villar
purchased the subject property, Galas was relieved
of her contractual obligation and the characters of
creditor and debtor were merged in the person of
Villar. Therefore, Garcia argued, he, as the second
mortgagee, was subrogated to Villars original
status as first mortgagee, which is the creditor with
the right to foreclose. Garcia further asserted that he
had demanded payment from Villar,15 whose refusal
compelled him to incur expenses in filing an action
in court.16
Villar, in her Answer,17 claimed that the complaint
stated no cause of action and that the second
mortgage was done in bad faith as it was without
her consent and knowledge. Villar alleged that she
only discovered the second mortgage when she had
the Deed of Sale registered. Villar blamed Garcia
for the controversy as he accepted the second
mortgage without prior consent from her. She
averred that there could be no subrogation as the
assignment of credit was done with neither her
knowledge nor prior consent. Villar added that
Garcia should seek recourse against Galas and
Pingol, with whom he had privity insofar as the
second mortgage of property is concerned.

On May 23, 2000, the RTC issued a Pre-Trial

Order18 wherein the parties agreed on the following
facts and issue:
STIPULATIONS OF FACTS/ADMISSIONS
The following are admitted:
1. the defendant admits the second mortgage
annotated at the back of TCT No. RT-67970
of Lourdes V. Galas with the qualification
that the existence of said mortgage was
discovered only in 1996 after the sale;
2. the defendant admits the existence of the
annotation of the second mortgage at the
back of the title despite the transfer of the
title in the name of the defendant;
3. the plaintiff admits that defendant
Yolanda Valdez Villar is the first mortgagee;
4. the plaintiff admits that the first mortgage
was annotated at the back of the title of the
mortgagor Lourdes V. Galas; and
5. the plaintiff admits that by virtue of the
deed of sale the title of the property was
transferred from the previous owner in favor
of defendant Yolanda Valdez Villar.
xxxx
ISSUE
Whether or not the plaintiff, at this point in time,
could judicially foreclose the property in question.
On June 8, 2000, upon Garcias manifestation, in
open court, of his intention to file a Motion for
Summary Judgment,19 the RTC issued an
Order20 directing the parties to simultaneously file
their respective memoranda within 20 days.
On June 26, 2000, Garcia filed a Motion for
Summary Judgment with Affidavit of Merit21 on the
grounds that there was no genuine issue as to any of
the material facts of the case and that he was
entitled to a judgment as a matter of law.
On June 28, 2000, Garcia filed his
Memorandum22 in support of his Motion for
Summary Judgment and in compliance with the
RTCs June 8, 2000 Order. Garcia alleged that his
equity of redemption had not yet been claimed since
Villar did not foreclose the mortgaged property to
satisfy her claim.
On August 13, 2000, Villar filed an Urgent Ex-Parte
Motion for Extension of Time to File Her
Memorandum.23This, however, was denied24 by the
RTC in view of Garcias Opposition.25
On May 27, 2002, the RTC rendered its Decision,
the dispositive portion of which reads:
WHEREFORE, the foregoing premises considered,
judgment is hereby rendered in favor of the plaintiff

Pablo P. Garcia and against the defendant Yolanda

V. Villar, who is ordered to pay to the former within
a period of not less than ninety (90) days nor more
than one hundred twenty (120) days from entry of
judgment, the sum ofP1,800,000.00 plus legal
interest from October 27, 1999 and upon failure of
the defendant to pay the said amount within the
prescribed period, the property subject matter of the
2nd Real Estate Mortgage dated October 10, 1994
shall, upon motion of the plaintiff, be sold at public
auction in the manner and under the provisions of
Rules 39 and 68 of the 1997 Revised Rules of Civil
Procedure and other regulations governing sale of
real estate under execution in order to satisfy the
judgment in this case. The defendant is further
ordered to pay costs.26
The RTC declared that the direct sale of the subject
property to Villar, the first mortgagee, could not
operate to deprive Garcia of his right as a second
mortgagee. The RTC said that upon Galass failure
to pay her obligation, Villar should have foreclosed
the subject property pursuant to Act No. 3135 as
amended, to provide junior mortgagees like Garcia,
the opportunity to satisfy their claims from the
residue, if any, of the foreclosure sale proceeds.
This, the RTC added, would have resulted in the
extinguishment of the mortgages.27
The RTC held that the second mortgage constituted
in Garcias favor had not been discharged, and that
Villar, as the new registered owner of the subject
property with a subsisting mortgage, was liable for
it.28
Villar appealed29 this Decision to the Court of
Appeals based on the arguments that Garcia had no
valid cause of action against her; that he was in bad
faith when he entered into a contract of mortgage
with Galas, in light of the restriction imposed by the
first mortgage; and that Garcia, as the one who gave
the occasion for the commission of fraud, should
suffer. Villar further asseverated that the second
mortgage is a void and inexistent contract
considering that its cause or object is contrary to
law, moral, good customs, and public order or
public policy, insofar as she was concerned.30
Garcia, in his Memorandum,31 reiterated his
position that his equity of redemption remained
"unforeclosed" since Villar did not institute
foreclosure proceedings. Garcia added that "the
mortgage, until discharged, follows the property to
whomever it may be transferred no matter how
many times over it changes hands as long as the
annotation is carried over."32

The Court of Appeals reversed the RTC in a

Decision dated February 27, 2003, to wit:
WHEREFORE, the decision appealed from is
REVERSED and another one entered DISMISSING
the complaint for judicial foreclosure of real estate
mortgage with damages.33
The Court of Appeals declared that Galas was free
to mortgage the subject property even without
Villars consent as the restriction that the
mortgagees consent was necessary in case of a
subsequent encumbrance was absent in the Deed of
Real Estate Mortgage. In the same vein, the Court
of Appeals said that the sale of the subject property
to Villar was valid as it found nothing in the records
that would show that Galas violated the Deed of
Real Estate Mortgage prior to the sale.34
In dismissing the complaint for judicial foreclosure
of real estate mortgage with damages, the Court of
Appeals held that Garcia had no cause of action
against Villar "in the absence of evidence showing
that the second mortgage executed in his favor by
Lourdes V. Galas [had] been violated and that he
[had] made a demand on the latter for the payment
of the obligation secured by said mortgage prior to
the institution of his complaint against Villar."35
On March 20, 2003, Garcia filed a Motion for
Reconsideration36 on the ground that the Court of
Appeals failed to resolve the main issue of the case,
which was whether or not Garcia, as the second
mortgagee, could still foreclose the mortgage after
the subject property had been sold by Galas, the
mortgage debtor, to Villar, the mortgage creditor.
This motion was denied for lack of merit by the
Court of Appeals in its July 2, 2003 Resolution.
Garcia is now before this Court, with the same
arguments he posited before the lower courts. In his
Memorandum,37 he added that the Deed of Real
Estate Mortgage contained a stipulation, which is
violative of the prohibition on pactum
commissorium.
Issues
The crux of the controversy before us boils down to
the propriety of Garcias demand upon Villar to
either pay Galass debt of P1,800,000.00, or to
judicially foreclose the subject property to satisfy
the aforesaid debt. This Court will, however,
address the following issues in seriatim:
1. Whether or not the second mortgage to
Garcia was valid;
2. Whether or not the sale of the subject
property to Villar was valid;

3. Whether or not the sale of the subject

property to Villar was in violation of the
prohibition on pactum commissorium;
4. Whether or not Garcias action for
foreclosure of mortgage on the subject
property can prosper.
Discussion
Validity of second mortgage to Garcia
and sale of subject property to Villar
At the onset, this Court would like to address the
validity of the second mortgage to Garcia and the
sale of the subject property to Villar. We agree with
the Court of Appeals that both are valid under the
terms and conditions of the Deed of Real Estate
Mortgage executed by Galas and Villar.
While it is true that the annotation of the first
mortgage to Villar on Galass TCT contained a
restriction on further encumbrances without the
mortgagees prior consent, this restriction was
nowhere to be found in the Deed of Real Estate
Mortgage. As this Deed became the basis for the
annotation on Galass title, its terms and conditions
take precedence over the standard, stamped
annotation placed on her title. If it were the
intention of the parties to impose such restriction,
they would have and should have stipulated such in
the Deed of Real Estate Mortgage itself.
Neither did this Deed proscribe the sale or
alienation of the subject property during the life of
the mortgages. Garcias insistence that Villar should
have judicially or extrajudicially foreclosed the
mortgage to satisfy Galass debt is misplaced. The
Deed of Real Estate Mortgage merely provided for
the options Villar may undertake in case Galas or
Pingol fail to pay their loan. Nowhere was it stated
in the Deed that Galas could not opt to sell the
subject property to Villar, or to any other person.
Such stipulation would have been void anyway, as it
is not allowed under Article 2130 of the Civil Code,
to wit:
Art. 2130. A stipulation forbidding the owner from
alienating the immovable mortgaged shall be void.
Prohibition on pactum commissorium
Garcia claims that the stipulation appointing Villar,
the mortgagee, as the mortgagors attorney-in-fact,
to sell the property in case of default in the payment
of the loan, is in violation of the prohibition on
pactum commissorium, as stated under Article 2088
of the Civil Code, viz:
Art. 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.
The power of attorney provision in the Deed of Real
Estate Mortgage reads:
5. Power of Attorney of MORTGAGEE. Effective
upon the breach of any condition of this Mortgage,
and in addition to the remedies herein stipulated, the
MORTGAGEE is likewise appointed attorney-infact of the MORTGAGOR with full power and
authority to take actual possession of the mortgaged
properties, to sell, lease any of the mortgaged
properties, to collect rents, to execute deeds of sale,
lease, or agreement that may be deemed convenient,
to make repairs or improvements on the mortgaged
properties and to pay the same, and perform any
other act which the MORTGAGEE may deem
convenient for the proper administration of the
mortgaged properties. The payment of any expenses
advanced by the MORTGAGEE in connection with
the purpose indicated herein is also secured by this
Mortgage. Any amount received from the sale,
disposal or administration abovementioned maybe
applied by assessments and other incidental
expenses and obligations and to the payment of
original indebtedness including interest and
penalties thereon. The power herein granted shall
not be revoked during the life of this Mortgage and
all acts which may be executed by the
MORTGAGEE by virtue of said power are hereby
ratified.38
The following are the elements of pactum
commissorium:
(1) There should be a property mortgaged by
way of security for the payment of the
principal obligation; and
(2) There should be a stipulation for
automatic appropriation by the creditor of
the thing mortgaged in case of non-payment
of the principal obligation within the
stipulated period.39
Villars purchase of the subject property did not
violate the prohibition on pactum commissorium.
The power of attorney provision above did not
provide that the ownership over the subject property
would automatically pass to Villar upon Galass
failure to pay the loan on time. What it granted was
the mere appointment of Villar as attorney-in-fact,
with authority to sell or otherwise dispose of the
subject property, and to apply the proceeds to the
payment of the loan.40 This provision is customary
in mortgage contracts, and is in conformity with
Article 2087 of the Civil Code, which reads:

Art. 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.
Galass decision to eventually sell the subject
property to Villar for an additional P1,500,000.00
was well within the scope of her rights as the owner
of the subject property. The subject property was
transferred to Villar by virtue of another and
separate contract, which is the Deed of Sale. Garcia
never alleged that the transfer of the subject
property to Villar was automatic upon Galass
failure to discharge her debt, or that the sale was
simulated to cover up such automatic transfer.
Propriety
of
Garcias
action
for foreclosure of mortgage
The real nature of a mortgage is described in Article
2126 of the Civil Code, to wit:
Art. 2126. The mortgage directly and immediately
subjects the property upon which it is imposed,
whoever the possessor may be, to the fulfillment of
the obligation for whose security it was constituted.
Simply put, a mortgage is a real right, which
follows the property, even after subsequent transfers
by the mortgagor.1wphi1 "A registered mortgage
lien is considered inseparable from the property
inasmuch as it is a right in rem."41
The sale or transfer of the mortgaged property
cannot affect or release the mortgage; thus the
purchaser or transferee is necessarily bound to
acknowledge and respect the encumbrance.42 In
fact, under Article 2129 of the Civil Code, the
mortgage on the property may still be foreclosed
despite the transfer, viz:
Art. 2129. The creditor may claim from a third
person in possession of the mortgaged property, the
payment of the part of the credit secured by the
property which said third person possesses, in terms
and with the formalities which the law establishes.
While we agree with Garcia that since the second
mortgage, of which he is the mortgagee, has not yet
been discharged, we find that said mortgage subsists
and is still enforceable. However, Villar, in buying
the subject property with notice that it was
mortgaged, only undertook to pay such mortgage or
allow the subject property to be sold upon failure of
the mortgage creditor to obtain payment from the
principal debtor once the debt matures. Villar did
not obligate herself to replace the debtor in the
principal obligation, and could not do so in law
without the creditors consent.43 Article 1293 of the
Civil Code provides:

Art. 1293. Novation which consists in substituting a

new debtor in the place of the original one, may be
made even without the knowledge or against the
will of the latter, but not without the consent of the
creditor. Payment by the new debtor gives him the
rights mentioned in articles 1236 and 1237.
Therefore, the obligation to pay the mortgage
indebtedness remains with the original debtors
Galas and Pingol.44The case of E.C. McCullough &
Co. v. Veloso and Serna45 is square on this point:
The effects of a transfer of a mortgaged property to
a third person are well determined by the Civil
Code.1wphi1According to article 187946 of this
Code, the creditor may demand of the third person
in possession of the property mortgaged payment of
such part of the debt, as is secured by the property
in his possession, in the manner and form
established by the law. The Mortgage Law in force
at the promulgation of the Civil Code and referred
to in the latter, provided, among other things, that
the debtor should not pay the debt upon its maturity
after judicial or notarial demand, for payment has
been made by the creditor upon him. (Art. 135 of
the Mortgage Law of the Philippines of 1889.)
According to this, the obligation of the new
possessor to pay the debt originated only from the
right of the creditor to demand payment of him, it
being necessary that a demand for payment should
have previously been made upon the debtor and the
latter should have failed to pay. And even if these
requirements were complied with, still the third
possessor might abandon the property mortgaged,
and in that case it is considered to be in the
possession of the debtor. (Art. 136 of the same law.)
This clearly shows that the spirit of the Civil Code
is to let the obligation of the debtor to pay the debt
stand although the property mortgaged to secure the
payment of said debt may have been transferred to a
third person. While the Mortgage Law of 1893
eliminated these provisions, it contained nothing
indicating any change in the spirit of the law in this
respect. Article 129 of this law, which provides the
substitution of the debtor by the third person in
possession of the property, for the purposes of the
giving of notice, does not show this change and has
reference to a case where the action is directed only
against the property burdened with the mortgage.
(Art. 168 of the Regulation.)47
This pronouncement was reiterated in Rodriguez v.
Reyes48 wherein this Court, even before quoting the
same above portion in E.C. McCullough & Co. v.
Veloso and Serna, held:

We find the stand of petitioners-appellants to be

unmeritorious and untenable. The maxim "caveat
emptor" applies only to execution sales, and this
was not one such. The mere fact that the purchaser
of an immovable has notice that the acquired realty
is encumbered with a mortgage does not render him
liable for the payment of the debt guaranteed by the
mortgage, in the absence of stipulation or condition
that he is to assume payment of the mortgage debt.
The reason is plain: the mortgage is merely an
encumbrance on the property, entitling the
mortgagee to have the property foreclosed, i.e.,
sold, in case the principal obligor does not pay the
mortgage debt, and apply the proceeds of the sale to
the satisfaction of his credit. Mortgage is merely an
accessory undertaking for the convenience and
security of the mortgage creditor, and exists
independently of the obligation to pay the debt
secured by it. The mortgagee, if he is so minded,
can waive the mortgage security and proceed to
collect the principal debt by personal action against
the original mortgagor.49
In view of the foregoing, Garcia has no cause of
action against Villar in the absence of evidence to
show that the second mortgage executed in favor of
Garcia has been violated by his debtors, Galas and
Pingol, i.e., specifically that Garcia has made a
demand on said debtors for the payment of the
obligation secured by the second mortgage and they
have failed to pay.
WHEREFORE, this Court hereby AFFIRMS the
February 27, 2003 Decision and March 8, 2003
Resolution of the Court of Appeals in CA-G.R. SP
No. 72714.
SO ORDERED.