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GR No. L-69255 (148 SCRA 166)
February 27, 1987

Isabela Wood Const & Dev’t Corp PNB = Petitioner Machinenfabric Augsburg Nunberg
Aceros = Respondents
 Isabela Wood Const & Dev’t Corp. (ISABELA) opened w/ PNB, a savings account in amount of P2M, w/c is subject of 2 conflicting claims:
o One claim was asserted by the Aceros -- Gloria Acero, Arnolfo Acero, and Soledad Acero, judgment creditors of ISABELA — who seek to
enforce against said savings account the final and executory judgment rendered in their favor by the CFI of Rizal QC.
 The judgment ordered payment by ISABELA to the ACEROS of P1,532,000.07. Notice of garnisment was served to PNB, pursuant to
the writ of execution.
o The other claim is by PNB, which claims that there occurred a mutual set-off between PNB and ISABELA, which effectively precluded the
Aceros' recourse to that deposit.
 PNB's claim to P2M deposit in question is based on agreement between PNB and ISABELA which provides --
(1) the deposit was made by ISABELA as "collateral" with its indebtedness to PNB
(2) in event of ISABELA's failure to fulfill those undertakings, PNB was empowered to apply deposit to payment of the indebtedness
 CFI: ruled in favor of Aceros.
 CFI, on MR: ruled in favor of PNB; opined that under the circumstances, there had been a valid assignment by ISABELA to PNB of amount
deposited, which effectively placed that amount beyond the reach of the Aceros.
o CFI ruled "ISABELA entered into a Credit Agreement with PNB for letter of credit in favor of Machinenfabric Augsburg Nunberg (MAN) of
Germany from whom ISABELA purchased 35 units of MAN trucks. As collateral, ISABELA assigned proceeds of its contract with Dept of
Public Works for construction of a bridge for P2M. ISABELA said the P2M shall remain in the savings account with PNB until ISABELA is
able to comply with delivery and registration of mortgage in favor of PNB of the Paranaque property. Since ISABELA failed to deliver the
mortgage to PNB, and considering that the obligation of ISABELA to PNB have been due, PNB applied the amount of P 2M in ISABELA's
savings account."
o CFI reiterated “When ISABELA subsequently came to be indebted to PNB on account of ISABELA's breach of terms of the Credit Agreement,
and therefore ISABELA and PNB became at the same time creditors and debtors of each other, compensation automatically took place
between them, in accordance with Article 1278 of the Civil Code. The amounts due from each other were, in its view, applied by operation
of law to satisfy and extinguish their respective credits.”
 IAC: ruled in favor of Aceros

ISSUE: WoN PNB and ISABELA had extinguished their obligation by way of compensation. --NO

PNB averred: There was legal compensation between PNB and ISABELA (ISABELA having failed to provide the mortage) precluding Aceros access
to the P2M savings deposit by way of garnishment.
Invokes Art 1278 of Civil Code "Compensation shall take when two persons, in their own right, are creditors and debtors of each other.

Court ruled (with Aceros/IAC): Art 1278 does not apply to the case at bar.
 PNB first theory that it is a creditor of ISABELA must fail. PNB has not proven by competent evidence that it is a creditor of ISABELA. The only
evidence present by PNB consists of 2 docs which do not prove any indebtedness of ISABELA to PNB. These docs do not show that credit was
ever availed by ISABELA's foreign correspondent MAN. (ELAM: Hindi naman pala clear kung inavail ni MAN ung letter of credit by ISABELA thru
PNB, so it could not be said that PNB is a creditor to ISABELA.)
o PNB never even attempted to offer other evidence, which is a certain indication that PNB does not really have these proofs at all (ELAM: In
that PNB is not a creditor of ISABELA.)
 PNB advanced a second theory which is that the P2M deposit had been assigned to it by ISABELA as "collateral" - that ISABELA had explicitly
authorized PNB to apply the P2M deposit in payment of its indebtedness. This alternative theory is as untenable as the first.
o In the first place, there being no indebtedness by ISABELA to PNB, there is then no occasion to speak of any mutual set-off or
compensation, whether it be legal (by operation of law) or voluntary (takes place by agreement of parties)
o The strongest argument against PNB’s claim is PNB’s act in itself when it deposited the whole amount of P2M, not in its name, but in the
name of ISABELA without any accompanying statement even remotely intimating that PNB was the owner of the deposit, or that an
assignment thereof was intended, or that some condition or lien was meant to burden it.
o Court said that even if it be assumed that such an assignment had indeed been made, and PNB had been really authorized to apply the P2M
deposit to the satisfaction of ISABELA's indebtedness to it, nevertheless, since the record reveals that the application was attempted to be
made by PNB only on February 26, 1980, that application was ineffectual and futile because at that time, the deposit was already in
custodia legis, since notice of garnishment has been served to PNB on January 9, 1980 (pursuant to the writ of execution issued by CFI on
for the enforcement of the partial judgment in Aceros' favor).
o Court added, that one final factor precludes according validity to PNB's arguments. On the assumption that the P2M deposit was in truth
assigned as some sort of "collateral" to PNB — although as PNB insists, it was not in the form of a pledge — the agreement postulated by
PNB that it had been authorized to assume ownership of the fund upon the coming into being of ISABELA s indebtedness is void ab initio, it
being in the nature of a pactum commisorium, which is proscribed for being contrary to public policy. (ELAM: pactum commisorium as per
Webster is the automatic appropriation by the creditor of the thing pledged or mortgaged upon the failure of the debtor to pay the
principal obligation = ipinagbabawal and automatic appropriation)

WHEREFORE, the judgment of IAC subject of the instant appeal, being fully in accord with the facts and the law, is hereby affirmed in toto.
Costs against Petitioner.