The Supreme Court (SC) has reminded that while lenders can acquire the properties used as collaterals in case of non-payment of loans, ownership over the properties cannot be transferred automatically to them.
To do so, the transfer would constitute pactum commissorium, a prohibited agreement under Article 2088 of the Civil Code.
The prohibition states that a lender cannot automatically gain ownership of the collateral if the borrower fails to make payments.
However, the SC clarified that the prohibition only applies to automatic transfers of ownership. Borrowers are free to voluntarily sell their collateral to lenders as repayment, it said.
In a decision written by Chief Justice Alexander G. Gesmundo, the SC explained that pactum commissorium occurs when a property is used as collateral for a loan, and the loan agreement includes a provision automatically transferring ownership of the collateral to the lender if the borrower fails to pay.
A summary issued by the SC’s Public Information Office (SC-PIO) stated that the SC decision upheld the transfer of ownership of the land owned by Ruby Shelter Builders and Realty Development Corporation (Ruby Shelter) to its creditors, Romeo Y. Tan and Roberto L. Obiedo.
It said the SC ruled that the transfer was based on a valid agreement and did not violate the law prohibiting the automatic transfer of collateral ownership.
The summary stated: “Ruby Shelter borrowed money from Tan and Obiedo, using several properties as collateral. When the outstanding loan reached P95 million, the parties signed a Memorandum of Agreement (MOA) allowing Ruby Shelter more time to repay the loan.
“Under the MOA, Ruby Shelter agreed that if it failed to pay the loan, Tan and Obiedo could register the deeds of absolute sale and transfer ownership of the properties to themselves.
“The MOA also required Tan and Obiedo to pay P5 million to Ruby Shelter for the sale of the properties. Ruby Shelter later executed the deeds of absolute sale for each collateral property.
“However, Ruby Shelter later sought to negotiate a settlement to repay the loan and regain its properties. When the parties failed to reach an agreement, Tan and Obiedo notarized the deeds of absolute sale prematurely, prompting Ruby Shelter to file a case in the Regional Trial Court (RTC).
“Ruby Shelter argued that the deeds were invalid as they constituted pactum commissorium, a prohibited agreement under Article 2088 of the Civil Code. This provision states that a lender cannot automatically gain ownership of the collateral if the borrower fails to make payments.
“The RTC dismissed the complaint, ruling that the MOA did not constitute pactum commissorium because Ruby Shelter agreed to sell the properties to Tan and Obiedo in case of default.
“The Court of Appeals (CA) initially ruled in favor of Ruby Shelter but later reversed its decision, upholding the RTC’s ruling. Ruby Shelter then appealed to the SC.
“The SC affirmed the validity of the MOA, holding that it did not constitute pactum commissorium.
“The SC explained that pactum commissorium occurs when (1) a property is used as collateral for a loan; and (2) the loan agreement includes a provision automatically transferring ownership of the collateral to the lender if the borrower fails to pay.
“The SC emphasized that pactum commissorium is prohibited to protect borrowers from losing properties that may be worth more than their debt. Ownership can only be transferred through foreclosure and a public auction.
“In this case, Ruby Shelter willingly entered into a separate agreement to sell its properties to Tan and Obiedo as payment for the loan. This was not an automatic transfer and, therefore, did not violate the prohibition against pactum commissorium.”