34.2 Credit Transactions & Security Mechanisms

Credit Transactions & Security Mechanisms

Credit transactions encompass contracts entered into to facilitate borrowing, lending, safekeeping, and the provision of collateral to secure the fulfillment of a principal obligation. In Philippine commercial law, credit transactions are classified into principal contracts (such as loans and deposits) and accessory contracts of security (such as guaranty, suretyship, real estate mortgage, and personal property security agreements under the Personal Property Security Act). Understanding the operational boundaries, formalities, and remedies of these contracts is essential for passing the RFBT section of the CPALE.

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1. Contracts of Loan: Commodatum vs. Mutuum (Simple Loan)

Under Article 1933 of the Civil Code, by the contract of loan, one of the parties delivers to another either something not consumable so that the latter may use the same for a certain time and return it (in which case the contract is called commodatum), or money or other consumable thing, upon the condition that the same amount of the same kind and quality shall be paid (in which case the contract is called simple loan or mutuum).

Interest Rates and Central Bank Regulations

• No Interest Without Written Stipulation (Article 1956): No interest shall be due unless it has been expressly stipulated in writing.
• Suspension of the Usury Law: Under Central Bank Circular No. 905 (effective January 1, 1983), the ceilings prescribed by the Usury Law (Act 2655) were suspended, allowing parties to freely stipulate interest rates. However, the Supreme Court consistently rules that stipulated interest rates that are iniquitous, unconscionable, or contrary to morals (such as rates of 3% to 5% per month or higher) are void ab initio, and courts will reduce them to the prevailing legal interest rate.
• Legal Interest Rate under BSP Circular No. 799: Effective July 1, 2013, the legal rate of interest for loans, forbearance of money, goods, or credits, and the rate allowed in monetary judgments (in the absence of an express valid written agreement) is 6% per annum (reducing the former 12% rate under Central Bank Circular No. 416).

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2. Contracts of Deposit: Voluntary vs. Necessary Deposits

Under Article 1962, a contract of deposit is constituted from the moment a person receives a thing belonging to another, with the obligation of safely keeping it and returning the same. The principal purpose of the contract is custody and safekeeping.

Classification of Deposits

1. Judicial Deposit (Sequestration): Takes place when an attachment or seizure of property in litigation is ordered by a court (Articles 2005-2008).
2. Extrajudicial Deposit:
   • Voluntary Deposit (Articles 1968-1995): Made by the free will of the depositor.
   • Necessary Deposit (Articles 1996-2004): Made in compliance with a legal obligation, on the occasion of a calamity (such as fire, storm, flood, or shipwreck—known as depositum miserabile), or by travelers in hotels and inns.

Core Rules Governing Depositary Obligations

• Prohibition on Use (Article 1977): The depositary cannot make use of the thing deposited without the express permission of the depositor. If permission is granted, the contract ceases to be a deposit and becomes a commodatum or mutuum, unless safekeeping is still the principal purpose.
• Standard of Care (Article 1972): The depositary is obliged to exercise ordinary diligence in the preservation of the thing deposited.
• Hotel and Innkeepers (Article 1998): Hotel keepers are liable for vehicles, animals, and articles introduced into the hotel by guests, provided notice was given and guests observed safety directions. Hotel keepers cannot disclaim liability through posted notices ("hotel not responsible for lost items"); such notices are null and void under Article 2003.

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3. Guaranty and Suretyship: Subsidiary vs. Solidary Security

Under Article 2047, by guaranty a person, called the guarantor, binds himself to the creditor to fulfill the obligation of the principal debtor in case the latter should fail to do so. If a person binds himself solidarily with the principal debtor, the contract is called a suretyship.

The Benefit of Excussion (Beneficio de Excusion) & Exceptions (Article 2059)

The creditor cannot compel the guarantor to pay the creditor until the creditor has exhausted all the property of the debtor, and has resorted to all the legal remedies against the debtor. Under Article 2059, excussion shall not take place in any of the following cases:

1. If the guarantor has expressly renounced it;
2. If the guarantor has bound himself solidarily with the debtor (suretyship);
3. In case of insolvency of the debtor;
4. When the debtor has absconded, or cannot be sued within the Philippines, unless he has left a manager or representative;
5. If it may be presumed that an execution on the property of the principal debtor would not result in the satisfaction of the obligation.

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4. Pledge, Real Mortgage, and Chattel Mortgage Compared

Common requisites (Article 2085): the contract secures the fulfillment of a principal obligation; the pledgor or mortgagor is the absolute owner of the thing; and the pledgor or mortgagor has the free disposal of it or is legally authorized. Third persons who are not parties to the principal obligation may secure it by pledging or mortgaging their own property.

Indivisibility (Article 2089): a pledge or mortgage is indivisible even if the debt is divisible. Partial payment does not release any part of the collateral until the whole debt is paid, and a debtor's heir who pays their share cannot demand the proportionate release of the property.

Rights and obligations: the pledgee must take care of the thing with the diligence of a good father of a family and may not use it without authority. The mortgagor keeps ownership and may alienate the property, but the mortgage follows it.

Extinguishment: payment of the principal obligation, loss of the thing, renunciation by the creditor, return of the pledged thing to the pledgor (which gives rise to a presumption that the pledge was remitted), and sale at foreclosure.

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5. Real Estate Mortgage (REM) & Foreclosure Framework

Definition and Requisites (Articles 2085 and 2124-2131)

A Real Estate Mortgage is an accessory contract whereby the debtor or a third party (mortgagor) guarantees the performance of a principal obligation by subjecting real property or real rights to a lien in favor of the creditor (mortgagee). Requisites:

1. Secured obligation must be valid;
2. Mortgagor must be the absolute owner of the immovable;
3. Mortgagor must have free disposal of the property, or legal authorization;
4. Mortgagor retains legal title and possession of the mortgaged property.

Prohibition of Pactum Commissorium (Article 2088)

Under Article 2088, the creditor cannot appropriate the things given by way of pledge or mortgage, or dispose of them. Any stipulation to the contrary is null and void.

                         Elements of Void Pactum Commissorium
                                          │
         ┌────────────────────────────────┴────────────────────────────────┐
         ▼                                                                 ▼
 Accessory Security Agreement                                   Automatic Appropriation Clause
• There is a valid mortgage, pledge,                            • A stipulation that the creditor
  or personal security agreement                                  automatically becomes owner of the
• Securing a principal debt                                       collateral upon debtor's non-payment

Legal Effect: The stipulation for automatic ownership transfer is void, but the mortgage itself and the principal obligation to repay the loan remain valid. The creditor's remedy upon default is to foreclose the mortgage, never automatic appropriation.

Foreclosure Procedures: Judicial vs. Extrajudicial

Rights of Redemption: Equity of Redemption vs. Statutory Right of Redemption

                                  Mortgage Redemption Windows
                                               │
         ┌─────────────────────────────────────┴─────────────────────────────────────┐
         ▼                                                                           ▼
    Equity of Redemption                                                    Statutory Right of Redemption
• Pertains to Judicial Foreclosure (Rule 68)                                • Pertains to Extrajudicial Foreclosure (Act 3135)
• Right to pay debt within 90 to 120 days                                   • Natural Persons: 1 YEAR from date of registration
  after entry of court judgment, or until                                     of Certificate of Sale with Register of Deeds
  court confirmation of foreclosure sale                                    • Juridical Entities mortgaging to BANKS (RA 8791):
• Extinguished once confirmation order is entered                             Until registration of sale, or maximum 3 MONTHS
  (no statutory redemption in judicial sales except for banks)                after foreclosure sale, whichever is EARLIER

CPALE Rule on Bank Foreclosure of Juridical Entities: Under Section 47 of the General Banking Law of 2000 (Republic Act No. 8791), where the mortgagor is a judicial person (corporation or partnership) and the mortgagee is a bank, the redemption period is strictly limited to three (3) months after the foreclosure sale or until registration of the certificate of sale, whichever comes first.

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6. Personal Property Security Act (PPSA - Republic Act No. 11057)

Enacted in August 2018, the Personal Property Security Act (RA 11057) established a modern, unified legal framework for secured transactions involving personal property. The PPSA overhauled the Chattel Mortgage Law (Act 1508) and Civil Code provisions on pledge, replacing fragmented security instruments with a uniform concept: the Security Interest.

The Three Pillars of the PPSA Framework

                                 PPSA Three-Pillar Architecture
                                                │
         ┌──────────────────────────────────────┼──────────────────────────────────────┐
         ▼                                      ▼                                      ▼
     Creation                               Perfection                               Priority
• Security Agreement in writing        • Notice registered in electronic PPSR • First-to-register or first-to-perfect
• Identifies collateral & debt           (Land Registration Authority)        • Perfected beats unperfected
• Enforceable between debtor & lender  • Possession of collateral by creditor • Purchase Money Security Interest (PMSI)
• Attachment occurs                    • Control (bank accounts, securities)    enjoys special statutory super-priority

1. Creation of a Security Interest

• A security interest is created by a Security Agreement, which must be in writing, signed by the parties, identify the collateral, and manifest the intention to create a security interest.
• It attaches to the collateral when the debtor has rights in the collateral or power to encumber it, and value is given by the secured creditor.

2. Perfection of a Security Interest

Perfection makes the security interest enforceable against third parties. The PPSA provides three distinct perfection methods:

1. Registration: Registration of a notice with the centralized, electronic Personal Property Security Registry (PPSR) established and managed by the Land Registration Authority (LRA);
2. Possession: Physical possession of tangible personal property collateral by the secured creditor;
3. Control: Execution of a control agreement over deposit accounts, intermediated investment securities, or commodity contracts.

3. Priority Rules Among Competing Claimants

• Perfected vs. Unperfected: A perfected security interest has priority over an unperfected security interest.
• Competing Perfected Interests: Priority is determined by the order of perfection or registration (the first-to-register or first-to-perfect rule).
• Purchase Money Security Interest (PMSI): A PMSI secures credit granted to enable the debtor to acquire the specific collateral (e.g., equipment financing). A PMSI in equipment has priority over a conflicting earlier-perfected security interest if perfected when the debtor receives possession or within ten (10) business days thereafter.

4. Enforcement and Disposition under PPSA

• Self-Help Repossession: The secured creditor may take possession of collateral without judicial process if the security agreement so provides, provided it can be accomplished peacefully without breach of the peace.
• Commercial Reasonableness: Every aspect of the disposition (private or public sale) must be commercially reasonable.
• Retention of Collateral: The secured creditor may propose to retain the collateral in full or partial satisfaction of the debt, provided the debtor consents and subordinate secured parties do not object within twenty (20) days.