Credit Transaction Reviewer

INTRODUCTION MEANING AND SCOPE OF CREDIT TRANSACTIONS

Credit transactions include all transactions involving the purchase or loan of goods, services, or money in the present with a promise to pay or deliver in the future. TWO TYPES OF CREDIT TRANSACTIONS/ CONTRACTS CONTRACTS OF SECURITY

1. Secured transactions or contracts of real security – supported by a collateral or an encumbrance of property

2. Unsecured transactions or contracts of personal security – fulfillment by the debtor is supported only by a promise to pay or the personal commitment of another EXAMPLES OF CREDIT TRANSACTIONS TRANSACTIONS

1. Bailment contracts 2. Contracts of guaranty and suretyship 3. Mortgage 4. Antichresis 5. Concurrence and preference of credits MEANING OF SECURITY Security (def). Something given, deposited, or serving as a means to ensure the fulfillment or enforcement of an obligation or of protecting some interest in property. KINDS OF SECURITY

1. Personal Security - when an individual becomes a surety or a guarantor 2. Property or Real Security – when a mortgage, pledge, antichresis, charge, or lien or other device used to have property held, out of which the person to be made secure can be compensated for loss. BAILMENT Bailment (def). The delivery of property of one person to another in trust for a specific purpose,

with a contract, that the trust shall be faithfully executed and the property returned or duly accounted for when the special purpose is accomplished or kept until the bailor reclaims it. To be legally enforceable, a bailment must contain all the elements of a valid contract, which are consent, object, object, and cause or consideration. consideration. However, However, a bailment may also be created by operation of law.

PARTIES IN BAILMENT Bailor – the giver; the one who delivers the possession of the thing bailed 2. Bailee – the 1. Bailor –

recipient; the one who receives the possession or custody of the thing delivered KINDS OF BAILMENT 1. For the sole benefit of t he bailor Examples: gratuitou gratuitous s deposit and mandatum (bailment of

goods where the bailee gratuitously undertakes to do some act with respect to the property)

Sheryl IID 2002 PAGE 1

Ex. My tito from the States makes padala a balikbayan box filled with spam through another relative who’s who’s flying to the Philippines on vacation. vacation. It only benefits my tito (the bailor). Or, Helen deposits Polsci’s Polsci’s baby chair with the mysterious little guy who who doesn’t smile in the bag depository depository counter outside the the lib. In this case, only Helen benefits (based on a true story). 2. For the sole benefit of the bailee Examples: commodatum commodatum and gratuitous simple

loan or mutuum Ex. Xilca borrows my white blouse because she forgot to bring clothes to change from her Pasay Pasay City Jail outfit. Only Xilca is benefited, not me. Or, Xilca borrows borrows P10 from me without interest. 3. For the benefit of both parties Examples: deposit for a compensation, involuntary

deposit, pledge, bailments bailment s for hire Ex. Ansky pawns her huge diamond earrings at Villarica Villari ca Pawnshop. Pawnshop. The pawnshop gives her P10,000 and a pawn ticket. Both parties benefit – Ansky gets fast cash, while the pawnshop gets to keep the huge diamond earrings to make sure that Ansky pays, and in case she doesn’t they can sell the earrings. 1 and 2 are gratuitous bailments. There is no consideration because they are considered more as a favor by one party to the other. Bailments under number 3 are mutual-benefit bailments, and they usually result from business transactions. BAILMENT FOR HIRE Bailment for hire arises when goods are left with the bailee for some use or service by him always for some compensation. KINDS OF BAILMENT FOR HIRE

1. Hire of things – goods are delivered for the temporary use of the hirer 2. Hire of service – goods are delivered for some work or labor upon it by the bailee 3. Hire for carriage of goods – goods are delivered either to a common carrier or to a private

person for the purpose of being carried from place to place 4. Hire of custody – goods are delivered for storage

I. LOAN GENERAL PROVISIONS Art. 1933. By the contract of loan, one of the parties delivers to another, either something something not consumable so that the latter may use the same for a certain time and return it, i n which case the contract is called a commodatum; or money or other consumable thing, upon condition that the same amount of the same kind and quality shall be paid, in which case the contract is simply called a loan or mutuum. Commodatum is essentially gratuitous. Simple loan may be gratuitous or with a stipulation to pay interest. In commodatum the bailor retains the ownership of the thing loaned, while in simple loan, ownership passes to the borrower. Art. 1934. An accepted promise to deliver something by way of commodatum or simple loan is binding upon the parties, but the commodatum or simple loan itself shall not be perfected until the delivery of the object of the contract.


ESSENTIAL ELEMENTS OF A CONTRACT IN THE CONTEXT OF A LOAN Consent of the parties Borrower and Lender Object Property Cause or Consideration For the lender: right to demand the return of the thing

For the borrower: acquisition of the thing

CHARACTERISTICS CHARACTERISTICS OF THE CONTRACT OF LOAN

1. A real contract – the delivery of the thing loaned is necessary for the perfection of the contract

2. A unilateral contract – once the subject matter has been delivered, it creates obligations on the part of only one of the parties (the borrower) CAUSE OR CONSIDERATION IN A CONTRACT OF LOAN

1. As to the borrower: the acquisition of the thing 2. As to the lender: the right to demand its return or of its equivalent KINDS OF LOAN non-consumable thing 1. Commodatum – where the lender delivers to the borrower a non-consumable

so that the latter may use it for a certain time and return the identical thing

2. Simple loan or mutuum – where the lender delivers to the borrower money or other consumable thing upon the condition that the latter shall pay the same amount of the same kind and quality. LOANS DISTINGUISHED FROM CREDIT Credit means the ability of an individual to borrow money or things by virtue of the

confidence confidence or trust reposed by a lender that he will pay what he may promise within a specified period. Loan means the delivery by one party and the receipt by the other party of a given sum of money or other consumable consumable thing upon an agreement to repay the same amount

of the same kind and quality, with or without interest. The concession of a credit necessarily involves involves the granting of loans up to the limit of the amount fixed in the credit. As opposed to debt, credit is a debt considered considered from the creditor’s standpoint. standpoint. It is that which is due to any person.


DISTINCTIONS BETWEEN COMMODATUM AND SIMPLE LOAN COMMODATUM SIMPLE LOAN SUBJECT MATTER Not consumable Money or other consumable

thing OWNERSHIP Retained by the lender Transferred to the borrower GRATUITOUS? Gratuitous Default rule is that it is gratuitous BUT the parties may

stipulate interest, in which case, it becomes onerous PAYMENT BY BORROWER Borrower must return the samething loaned Borrower need only pay the same amt of the same kind and qual ity KIND OF PROPERTY Real or personal Personal only PURPOSE Temporary use or possession Consumption WHEN LENDER MAY DEMAND Lender may demand return of the thing before the expiration of the term in case of urgent need

LOSS OF THE THING

Suffered by the lender (since he is the owner)Lender may not demand return of the thing before the lapse of the term agreed upon Suffered by the borrower even if through fortuitous event

In commodatum, if you do not return the thing when it is due, you will be liable for estafa because ownership of the property is not transferred to the borrower. In loan, the borrower who who does not pay is not criminally liable for estafa. His liability is only a civil liability for the breach of the obligation to pay. This is because in loan, ownership ownership of the thing is transferred to the borrower, borrower, so there is no unlawful taking of property belonging belonging to another. ACCEPTED PROMISE TO MAKE A FUTURE LOAN

Borrower goes to Lender and asks if he he could borrow P10K at 6% interest per annum. Lender says okay, I will lend you the money. money. This is an accepted accepted promise promise to make a future future loan. loan. It is a consensual contract contract and is binding upon the parties. But is there a contract of loan at this point? No, because loan is a real contract and is perfected only only upon delivery of the thing. thing. FORM OF LOAN

There are no formal requisites for the validity of a contract of loan except if there is a stipulation for the payment payment of interest. A stipulation for the payment payment of interest must be in writing.

CHAPTER 1 COMMODATUM Art. 1935. The bailee in commodatum acquires the use of the thing loaned but not its fruits; if any compensation is to be paid by him who acquires the use, the contract ceases to be a commodatum. KINDS OF COMMODATUM

1. Ordinary commodatum 2. Precarium – one whereby the bailor may demand the thing loaned at will


NATURE OF COMMODATUM Commodatum in simple terms is hiram – A agrees to lend his guard dog to his friend B for a week for free. B is entitled to use the dog dog for this period. At the end of the week, B must return the dog to A. If the dog gives birth while it is in the custody of B, the puppies (fruits) belong to A.

1. The bailee acquires the use of the thing but not its fruits , unless there is a stipulation to the contrary. 2. It is essentially gratuitous. 3. The purpose of the contract is the temporary use of the thing loaned for a certain time. (So if the bailee is i s not entitled to use the thing, it i s not commodatum but it may be a deposit.)

4. The subject matter is generally non-consumable non-consumable real or personal property, though consumable consumable goods may also be the subject of commodatum if the purpose is not the consumption of the object (ex. Display of a bottle of wine).

5. The lender need not be the owner of the thing loaned. It is enough that he has possessory interest interest in the thing or right to use it which he may assert against the bailee and third persons though not against the rightful owner. (Ex. A lessee may sublet the thing leased).

6. It is purely personal in character. The consequences of this are the following: a. The death of either party extinguishes the contract unless there is a contrary stipulation for the commodatum to subsist until the purpose is accomplished

b. The borrower cannot lend or lease the thing to a third person . However, members of the borrower’s household may make use of the thing loaned except:

i. if there is a stipulation to the contrary; or ii. if the nature of the thing forbids it.

7. The parties may stipulate that the borrower may use the fruits of the thing, but this must only be incidental to the use of the thing itself (because if it is the main cause, the contract may be one of usufruct).

OBLIGATIONS OF THE BORROWER

1. Liability for ordinary expenses – The borrower should defray the expenses for the use and preservation of the thing loaned.

2. Liability for loss of the thing – The general rule is the borrower is not liable for loss or damage due to a fortuitous event . The owner bears the loss. But in the following cases, the borrower is liable for loss through a fortuitous event:

a. if he devotes the thing to a purpose different from that for which it was loaned (bad faith) this is a breach breach of the the tenor of the obligation

b. if he keeps it longer than the period stipulated or after the accomplishment accomplishment of the use for which the commodatum has been constituted ( delay )

c. if the thing loaned has been delivered with appraisal of its value unless there is a stipulation exempting the bailee from responsibility in case of a fortuitous event this is equivalent to an assumption of risk; Sheryl IID 2002 PAGE 5

d. if he lends or leases the thing to a third person who is not a member of his household household also a breach of the the tenor of the obligation; obligation;

e. if, being able to save either the thing borrowed or his own thing, he chose to save his own ( ingratitude). 3. Liability for deterioration of the thing - The borrower is not liable for the ordinary deterioration or wear and tear of the thing that comes as a natural consequence consequence of its use. This is borne by the lender. Reason: Because the lender retains ownership so he should bear the loss from from ordinary deterioration. deterioration. Also, because the purpose purpose of commodatum is for the borrower borrower to use the thing. Deterioration is a natural result result of such use.

4. Obligation to return the thing loaned – The borrower must return the thing as soon as the period stipulated expires or the the purpose has been accomplished. accomplished. He cannot keep the thing as security for anything that the lender may owe him, except for a claim for damages suffered because of the flaws of the thing loaned. So for example, Xilca earlier won a bet with Cayo, as a result of which, Cayo owes her a tuna sandwich. Cayo loaned loaned Alvin Ang’s Frisbee Frisbee to Xilca Xilca for 10 10 days. At the end of the 10 days, Xilca cannot refuse refuse to return Alvin Ang’s frisbee frisbee to Cayo and hold it hostage until until Cayo delivers delivers the sandwich. sandwich. Why? Because Xilca’s Xilca’s obligation as a borrower is to return the thing after the period expires, and she cannot keep it as a security for anything that Cayo may owe her. Or, Xilca borrows Kim Chong’s Chong’s car for 10 days. While the car is in Xilca’s possession, a tire explodes. explodes. Xilca has to buy buy a new tire for P3,000. P3,000. At the end of the 10 days, Xilca refuses to return the car unless Kim Chong pays her the P3,000. Can Xilca refuse to return? No. In this case, Kim Chong owes Xilca P3,000 as an extraordinary expense for the preservation of the thing. But even if Kim Chong owes Xilca money in connection with the thing that he loaned, Xilca still cannot retain the car as security. Exception: If the thing loaned has hidden defects and the borrower suffers damages as a result of the hidden defect, the borrower borrower can claim damages against the lender. Pending payment of the damages by lender to borrower, borrower can keep the thing as a security. (see discussion below)

5. Liability of two or more bailees – When there are two or more borrowers to whom a thing is loaned in one contract, there liability is solidary . OBLIGATIONS OF THE LENDER

1. Obligation to respect the duration of the loan – The lender cannot demand the return of the thing until after the expiration of the period or after the accomplishment of the use for which the commodatum was constituted. However , he may demand its return or temporary use if he should have urgent need of the thing.

2. Precarium – Precarium is a kind of commodatum where the lender may demand the thing at will . Precarium exists exists in the following following cases:

a. If there is no stipulation as to the duration of the contract or to the use to which the thing loaned should be devoted b. If the use of the thing is merely tolerated by the lender

BUT, the lender may not demand the thing capriciously, arbitrarily, or whimsically, since this would give rise to an action on the part of borrower for abuse of right under Articles 19, 20, and 21. Sheryl IID 2002 PAGE 6

3. Right to demand return of thing for acts of ingratitude – If the borrower commits any of the acts enumerated in Art. 765 of the Civil Code, the lender may demand the immediate return of the thing from the borrower. (This applies to ordinary commodatum, since in precarium the lender can demand at will, subject to the provisions against abuse of right) 4. Obligation to refund extraordinary expenses

a. Extraordinary expenses expenses for the preservation of the thing – The lender should refund the borrower the extraordinary expenses for the preservation of the thing, provided that the borrower informs the lender before incurring the expense, unless the need is so urgent that the lender cannot be notified without danger. expenses arising from actual use of the thing – b. Extraordinary expenses

Extraordinary expenses arising on the occasion of the actual use of the thing shall be borne by the lender and borrower on a 50-50 basis , unless there is a contrary stipulation. 5. All other expenses are for the account of the borrower.

6. Liability for damages for known hidden flaws - Requisites: (F-HADD) a. There is a flaw or defect in the thing loaned;b. The flaw or defect is hiddenc. The lender is aware of the flaw d. The lender does not advise the borrower of the flaw e. The borrower suffers damages by reason of the flaw or defect The lender is penalized for his failure to disclose a hidden flaw which causes damage because he is in a position to prevent the damage from happening. ( HOT HOT TIP) Example: Borrower borrows a 1970 Mitsubishi Lancer from Lender. Unfortunately, Unfortunately, Lender forgets to tell borrower that the car has a tendency to overheat after 10 minutes. So Borrower drives, drives, and after 10 minutes, the car stalls and overheats. Borrower opens the hood and sees lots of steam. He opens the radiator cap to put water inside. Radiator water scalds his face, and he suffers suffers from burns. burns. Can he claim damages from Lender and can he keep the car as security?

No, because in this case, Buyer should should have known. known. He was, at least, in a position to know that the car just might be prone prone to overheating since it was old already. And when he opened the hood and saw lots of steam, he should have known that if he opened the radiator, radiator, very hot water would spray out. out. He should have have taken precautions when he opened the hood or he should have gone to a gas station or mechanic to have it fixed. But since he was negligent, negligent, he has only himself to blame for the damage damage caused. The defect defect was not really really hidden since since Borrower Borrower was in a position to know of it even if Lender did not not inform him. Had he been more careful, careful, he would not have been scalded. ABANDONMENT OF THING BY THE LENDER

Can the lender tell Borrower: Borrower: I don’t want to pay for the extraordinary expenses and damages that I owe you. Just keep the thing, thing, and let’s forget forget about my obligation. obligation. No. The lender cannot exempt himself from the payment of the expenses or damages by

abandoning the thing to the borrower. This is because the expenses and damages may exceed the value of the thing loaned, and it would, therefore, be unfair to allow the lender to just abandon the thing instead of paying for the expenses and damages.


CHAPTER 2 SIMPLE LOAN OR MUTUUM DEFINITION Simple loan (def). A contract whereby one of the parties delivers to another money or other consumable thing with the understanding that the same amount of the same kind and quality shall be paid.

A simple loan involves the payment of the equivalent and not the identical thing because the borrower acquires ownership of the thing loaned. loaned. The term “return” “return” is not used since the distinguishing character of the simple l oan from commodatum is the consumption of the thing. CONSIDERATION What is the c onsideration in this kind of contract? The promise of the borrower to pay is the consideration for the obligation of the lender to furnish the loan . NO CRIMINAL LIABILITY FOR ESTAFA FOR FAILURE TO PAY

There is no criminal liability for failure to pay a simple loan because the borrower acquires ownership of the thing. FUNGIBLE AND CONSUMABLE THINGS Fungible things (def). Those which are usually dealt with by number, weight, or measure,

so that any given unit or portion is treated as the equivalent of any other unit or portion. Those which may be replaced by a thing of equal quality and quantity. (ex. Rice, oil, sugar). If it cannot be replaced with an equivalent thing, then it is non-fungible. non-fungible. Consumable things (def). Those which cannot be used without being consumed.

Whether a thing is consumable or not depends upon its nature. Whether a thing is fungible or not depends on the intention of the parties.

BARTER Barter (def). A contract where one of the parties binds himself to give one thing in

consideration of the other’s promise to give another thing. (in short, exchange of property) If one person agrees to transfer the ownership of non-fungible non-fungible things to another with the obligation on the part of the latter to give things of the same kind, quantity, and quality, the contract is a contract of barter. DISTINCTIONS BETWEEN MUTUUM, COMMODATUM, AND BARTER MUTUUM COMMODATUM BARTER SUBJECT MATTER

Money or other fungiblethings Non-fungible things Non-fungible things OBLIGATION OF BORROWER Return Return the equivalent Return equivalent THE the identical thing borrowedReturn borrowedReturn the GRATUITOUS? May be gratuitous or onerousAlways gratuitous Onerous


FORM OF PAYMENT

1. If the object is money – Payment must be made in the currency stipulated; otherwise it is payable in the currency currency which is legal tender in the Philippines. Philippines. According to Art. 1955, Art. 1250, is applicable in payments payments of loans. 1250 provides that that in case of extraordinary inflation or devaluation, the value of the currency at the time of the establishment establishment of the obligation (not at the time of payment) should should be the basis for payment. BUT JPSP thinks that this is rarely applied because it would create a bad precedent and would wreak havoc on the economy. It would also shift the loss to the lender, which shouldn’t be the case since the loan is primarily for the benefit of the borrower. So unless there’s a drastic economic situation, we shouldn’t adjust the value of the currency. The obligation should be paid based on the value of the currency at the time of payment.

Ex: In 2000, Borrower borrowed $1,000 from Lender at the peso-dollar exchange rate of P50$1, P50$1, payable in 2004. In 2004, FPJ becomes becomes President, and as a result, the rate becomes P60$1. P60$1. If the parties had agreed that payment payment would be in dollars, Borrower still has to pay $1,000. If the parties had agreed that payment payment would be in pesos, Borrower should pay at the rate of P60 to a dollar, or P60,000. Why? You cannot apply 1250 and base the amount due on the value of the currency in 2000 because the inflation is not so extraordinary as to warrant the adjustment.

2. If the object is a fungible thing other than money – Borrower must pay lender another thing of the same kind, kind, quality, and quantity. In case it is impossible to do so, the borrower shall pay its value at the time of the perfection of the loan. Why does the law require that the value of the thing be based on its value at the time of the perfection of the the loan? There’s a historical explanation: explanation: the rule was created at a time when there were still interest ceilings. Thus, the reason for requirement requirement is to prevent circumvention circumvention of the interest ceilings. Even if there are no longer longer any interest ceilings, this rule is still applicable. So how do you opt out out of it? Stipulate! Put a stipulation that says that if it is impossible to to pay a thing of the same kind, quality, and quantity, borrower shall pay the market value of the thing at the time of payment . INTEREST Requisites for Recovery of Interest:

1. The payment of interest must be expressly stipulated. 2. in writing [3. And the interest must be lawful ( but since there is no Usury Law anymore, then there is no such thing as unlawful interest, so I don’t think this requisite is still included )] )] There is no Usury Law anymore, but an interest rate may still be struck down for being unconscionable. unconscionable. The test of an unconscionable unconscionable interest rate is relative and there is a need to look at the parity/disparity in the status of the parties and in their access to information during the negotiations. Stipulation of interest

1. The interest rate stipulated by the parties, not the legal rate of interest, is applicable. 2. Default rule: If the parties do not stipulate an interest rate, rate, the legal rate for

loans and forbearances of money is 12%.


For other sources of obligations, such as sale, and damages arising from injury to persons and loss of property which do not involve a loan, the legal rate of interest is 6%. 3. Increases in interest must also be expressly stipulated. 4. It is only in contracts of loan, with or without security, that interest may be stipulated and demanded. 5. Stipulation of interest must be mutually agreed upon by the parties and may not be unilaterally increased increased by only one of the parties. This would violate consensuality consensuality and mutuality of contract (PNB (PNB v. CA). But the parties can agree upon a formula formula for determining the interest rate, over which neither party has control (ex: interest will be adjusted quarterly quarterly at a rate of 3% plus the the prevailing 91-day 91-day T-bill rate, etc.). But if the formula says “interest will be based on T-bill rates and other interest-setting policies as the bank may determine,” this is not valid. Escalation Clause – A clause which authorizes the automatic increase in interest rate.

An escalation clause is valid when it is accompanied by a De-Escalation Clause. A deescalation clause is a clause which provides that the rate of interest agreed upon will also be automatically reduced. reduced. There must be a specified formula formula for arriving at the adjusted interest rate, over which neither party has any discretion. When the borrower is liable for interest even without a stipulation:

1. Indemnity for damages – The debtor in delay is liable to pay legal interest as indemnity for damages even without a stipulation for the payment of interest. Where to base the rate of damages: a. Rate in the penalty clause agreed upon by the parties b. If there is no penalty clause, additional interest based on the regular interest rate of the loan c. If there is no regular interest, additional interest is equivalent to the legal interest rate (12%) Example: Lender lends P10K at 10% interest with penalty interest of 6%. On due date, Borrower fails to pay. Borrower only pays a year after. How much should he pay? Borrower should pay the principal + interest on the loan + penalty interest = 10K + 10% of 10K + 6% of 10K = 10K + 1K + .6K = 11,600 Lender lends lends P10K at 10% interest. interest. On due date, Borrower Borrower fails to pay. pay. Borrower only pays a year after. How much should he pay? Borrower should pay 10K + 10% of 10K (interest on the loan) + 10% of 10K (penalty interest) = 10K + 1K + 1K = 12,000 The penalty interest in this case is 10% since there is no penalty interest stipulated. The additional interest is based on the regular interest of the loan. Lender lends P10K, no interest. On due due date, Borrower fails to pay. How much should Borrower pay a year later?

Borrower should pay P10K + 12% of P10K = 11,200. The penalty interest is 12% since there is no interest on the loan nor nor a penalty interest stipulated. The extra interest is based on the legal rate of interest. Sheryl IID 2002 PAGE 10

2. Interest accruing from unpaid interest – Interest due shall earn interest from the time it is judicially demanded although the obligation may be silent on this point (Art. 2212.) If interest is payable in kind:

If interest is payable in kind, its value shall be appraised at the current price of the products or goods at the time and place of payment. Take note that you should not confuse this with the rule when the principal obligation consists of goods other than money. If the principal obligation consists in the payment of goods and it is impossible i mpossible to deliver the goods, the borrower should should pay the value of the thing at the time of the constitution of the obligation. But if interest is payable in kind, it should be appraised at its value at the time of payment. General Rule: Accrued interest shall not earn interest Exceptions:

1. When judicially demanded (Art. 2212) 2. Express stipulation – Also called compounding interest where the parties agree that accrued interest shall be added to the principal and the resulting total amount shall earn interest. A stipulation as to compounding interest must be in writing . How does compounding interest work?

Lender lends P100,000 payable in 2 years at 10% interest compounded per annum. At the end of the first year, how much is due? Principal plus 10% interest = 110,000. On the second year, the 110,000 becomes the new principal amount amount and it is what will earn the 10% interest. So at the end of the second year, how much is due? 110,000 + 10% of 110,000 = 110,000 + 11,000 = 121,000 In compounding interest, you add add the unpaid interest to the principal. The resulting amount is your new principal which will then earn interest again. What if the borrower pays interest when there is no stipulation providing for it?

If the debtor pays unstipulated interest by mistake , he may recover, since this is a case of solutio indebiti or undue payment. But if the debtor voluntarily pays interest (either unstipulated or stipulated by not in writing) because of some moral moral obligation, he cannot later recover. recover. The obligation to return the interest is a natural obligation.

II. GUARANTY AND SURETYSHIP CHAPTER 1 NATURE AND EXTENT OF GUARANTY Art. 2047. By guaranty a person, called the guarantor, binds himself to the creditor to fulfill the obligation of the principal debtor in case the latter should fail to do so.


If a person binds himself solidarily with the principal debtor, the provisions of Section 4, Chapter 3, Title 1 of this this Book shall be observed. observed. In such case the the contract is called a suretyship. Guaranty (def.) A contract whereby the guarantor binds himself to the creditor to fulfill the obligation of the principal debtor in case the latter should fail to do so.

In a contract of guaranty, the parties are the guarantor and the creditor. Characteristics of the Contract of Guaranty (A-SC-U-D)

1. A ccessory: It is dependent for its existence upon the principal obligation guaranteed by it.

2. S ubsidiary and Conditional: Conditional : It takes effect only when the principal debtor fails in his obligation.

3. U nilateral: a. It gives rise to obligations on the part of the guarantor in relation to the creditor and not vice-versa. (Although after its fulfillment, fulfillment, the principal debtor should should indemnify the guarantor, but this obligation is only incidental) b. It may be entered into even without the intervention of the principal debtor. debtor.

4. D istinct Person: It requires that the person of the guarantor must be distinct from the person of the principal debtor (you cannot guaranty your own debt). However, in a real guaranty, guaranty, a person may guarantee his own obligation with his own properties. Classification of Guaranty

1. In the broad sense:

a. personal: the guaranty is the credit given by the person who guarantees the fulfillment of the principal obligation (guarantor)

b. real: the guaranty is property. If the guaranty guaranty is immovable immovable property: property: real mortgage or antichresis; If the guaranty is movable property: pledge or chatter mortgage 2. As to origin:

a. conventional: by agreement of the parties b. legal: imposed by law c. judicial: required by a court to guarantee the eventual right of one of the parties in a case 3. As to consideration: consideration:

a. gratuitous: the guarantor does not receive anything for acting as guarantor b. onerous: the guarantor receives valuable consideration for acting as guarantor 4. As to the person guaranteed:

a. single: constituted solely to guarantee or secure performance of the principal obligation


b. double or sub-guaranty: constituted to secure fulfillment of a prior guaranty; guarantees the obligation of a guarantor 5. As to scope and extent:

a. definite: limited to the principal obligation only or to a specific portion thereof thereof b. indefinite or simple: includes not only the principal obligation but also all its accessories, including judicial costs.

Second Paragraph of Art. 2047: Suretyship

If a person binds himself solidarily with the principal debtor, it is a contract of suretyship. The guarantor is called a surety. Suretyship is governed by Articles 1207 to 1222 of the Civil Code on solidary obligations. Suretyship dispenses with certain legal requirements/conditions precedent for proceeding against a guarantor. What is the difference between passive solidarity (solidarity among among debtors) and suretyship?

Review of oblicon: oblicon: According to Tolentino, Tolentino, the two are similar in the following ways:

1. A solidary debtor, like a surety, stands for some other person. 2. Both debtor and surety, after payment, may require that they be reimbursed. The difference is that the lender cannot cannot go after the surety right away. away. There has to be default on the part of the principal debtor before before the surety becomes becomes liable. If it were mere

solidarity among debtors, the creditor can go after any of the solidary debtors on due date. Nature of a Surety’s Undertaking

1. Contractual and Accessory BUT Direct : The contractual obligation of the surety is merely an accessory or collateral collateral to the obligation contracted by the principal. principal. BUT, his liability to the creditor is direct, primary, and absolute.

2. Liability is limited by the terms of the contract : The extent of a surety’s liability is determined only by the terms of the contract and cannot be extended by implication.

3. Liability arises only if principal debtor is held liable : If the principal debtor and the surety are held liable, their liability to pay the creditor would would be solidary. But, the surety does not incur liability unless and until the principal debtor is held liable. a. A surety is bound by a judgment against the principal even though though the party was not a party to the proceedings. proceedings. b. The creditor may sue, separately or together, the principal debtor and the surety (since they are solidarily bound). c. Generally, a demand or notice of default is not required to fix the surety’s liability. d. An accommodation party (one who signs an instrument as maker, drawer,

acceptor, or indorser without consideration and only for the purpose of lending his name) is, in effect, a surety. He is thus liable to pay the holder of the instrument, instrument, subject to reimbursement reimbursement from the accommodated party.


Example: Tuks accommodates Shak so that he can obtain a loan from the bank. At the bottom of the loan agreement, agreement, the following signatures signatures appear:

(sgd) Tuks (sgd) Shak Lino Chris Kapunan Sherwin Shakramy Is Tuks a surety or a solidary debtor? According to JPSP, based on this document above, above, Tuks is a solidary debtor. Remember the rule? rule? I promise to pay signed by two parties = solidary. solidary. To make sure that that he’s merely a guarantor or surety, Tuks should sign a separate guaranty agreement. Besides, a guaranty guaranty must be express. express. It is not presumed. presumed. e. A surety bond is void where there is no principal debtor. exhaustion: A surety is not entitled to the exhaustion 4. Surety is not entitled to exhaustion:

of the properties of the principal debtor since the surety assumes a solidary liability for the fulfillment of the principal obligation.

5. The undertaking is to the CREDITOR, not to the principal debtor : The debtor cannot claim that the surety breached its obligation to pay for the principal obligation because there is no obligation as between the surety surety and the debtor. If the surety does not pay, the principal debtor is still not relieved of his obligation. Guaranty Distinguished from Suretyship: GUARANTY SURETYSHIP Guarantor promises to answer for the debt,

default or miscarriage of the principalSurety principalSurety promises to answer for the debt, default or miscarriage of the principal (same) Liability of the guarantor depends upon an The engagement of the guarantor is a independent agreement to pay the collateral undertakingSurety assumes obligation if the primary debtor fails to do so liability as a regular party to the undertaking Surety is charged as an original promisor The guarantor is secondarily liable A surety is primarily liable MAIN DIFFERENCE: A surety undertakes to pay if the principal does not pay (insurer of the debt). A guarantor binds himself to pay if the principal cannot pay (insurer of the solvency of the debtor). Since the obligation of the surety is to pay so l ong as the principal does not pay (even if he can; even if he is solvent), the undertaking of the surety is more onerous than that of a guarantor who pays only in the event that the principal is broke. Illustration: A borrows P10,000 P10,000 from B, with C agreeing to be the surety. surety. A refuses to pay B out of spite. In this case, since C is a surety, B can immediately demand payment from C. If, in this case, C is a guarantor instead, B would have to exhaust all the property of A before he can collect collect from C. it is not enough enough that that A refuses to pay even if he can; in order for for C to be liable, A would have to be unable to pay. If you were a lender and the borrower offers as security either X as guarantor or

a real estate mortgage, which one would you choose?

Choose the mortgage. mortgage. If you were the lender, a real estate mortgage mortgage is more advisable because you can collect collect against the property. In a guaranty/surety, guaranty/surety, you would have to go against the guarantor or


surety – you would have to sue him, obtain judgment, and then execute judgment. This is subject to a lot of delays. delays. The guarantor guarantor or surety can stall your claim. Art. 2048. A guaranty is gratuitous, unless there is a stipulation to the contrary. GENERAL RULE: Guaranty is gratuitous. EXCEPTION: Guaranty Guaranty is onerous only if it is stipulated. What is the c ause/consideration ause/consideration of a contract of guaranty?

The cause of a contract of guaranty is the same cause which supports the principal obligation of the principal debtor. There is no need for an independent consideration considera tion in order for the contract contract of guaranty to be valid. The guarantor need need not have a direct interest in the obligation nor receive receive any benefit from it. It is enough that the principal obligation has has consideration. Art. 2049 A married woman may guarantee an obligation without the husband’s consent, but shall not thereby bind the conjugal partnership, partnership, except in cases provided by law. Art. 94 of the Family Code The absolute community of property shall be liable for: (3) Debts and obligations contracted by either spouse without the consent of the other to the extent that the family may have been benefited. A married woman who acts as guarantor without the consent of the husband binds only her separate property unless the debt benefited the family. There is no express prohibition against a married woman acting as guarantor for her husband. Remember that now, in order to bind the absolute community, the consent of both spouses is needed. If only the consent of one spouse is obtained, the absolute community will not be liable unless the obligation redounded to the benefit of the community. When the husband acts as a guarantor for another person without the consent of the wife, the guaranty binds only the husband since the benefit really accrues to the principal debtor and not to the husband or his family. The exception is if the husband husband is really engaged in the business of guaranteeing obligations because in this case, his occupation or business is deemed to be undertaken for the benefit of the family. Art. 2050. If a guaranty is entered into without the knowledge or consent, or against the will of the principal debtor, the provisions of articles 1236 and 1237 shall apply. A contract of guaranty is between the the guarantor and the creditor. creditor. It can be instituted without the knowledge or even against the will of the debtor, since the purpose of the contract is to give the creditor all the possible measures to secure payment. payment. However, if the contract of guaranty is entered into without the knowledge or consent or against the will of the principal debtor, the effect is like payment by a 3 person:

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1. The guarantor can only recover insofar as the payment has been beneficial to the debtor. 2. The guarantor cannot compel the creditor to subrogate him in the creditor’s rights such as those arising from a mortgage, guaranty or penalty.

If the guaranty was entered into with the consent of the principal debtor, the guarantor is subrogated to all the rights which the creditor had against the debtor once he pays for the obligation. Illustration:


A owes B P10,000. Without the knowledge of A, C guarantees the obligation. obligati on. C pays A P10,000. C tries to collect the P10,000 from A, but A tells him that he has already paid B 4,000. In this case, C can only collect P6,000 from A since it was only the extent to which A was benefited by his payment. If the loan was secured by a mortgage, C cannot foreclose foreclose the mortgage if A does not pay him because he is not subrogated to the rights of B. Art. 2052. A guaranty cannot exist without a valid obligation. Nevertheless, Nevertheless, a guaranty may be constituted to guarantee the performance of a voidable or unenforceable unenforceable contract. contract. It may also guarantee a natural obligation. obligation. A guaranty is an accessory contract contract and cannot exist without without a valid principal obligation. So if the principal obligation is void, the guaranty is also void. BUT, a guraranty may be constituted to guarantee the following defective contracts and natural obligations: 1. Voidable: because the contract is binding unless it is annulled 2. Unenforceable: because an unenforceable contract is not void. 3. Natural obligations: even if the principal obligation is not civilly enforceable, the creditor may still go after the guarantor Art. 2053. A guaranty may also be given as security for future debts, the amount of which is not yet known; there there can be no claim against the guarantor until until the debt is liquidated. A conditional obligation may also be secured. Continuing Guaranty ( Guaranty (def) – A guaranty that is not limited to a single transaction but which contemplates a future course of dealings, covering a series of transactions generally for an indefinite time or until revoked .

A continuing guaranty is generally prospective in its operation and is intended to secure future transactions (generally does not include past transactions). Examples:

1. Common example given by JPSP is the credit line – The bank allows you to borrow up to a certain ceiling, but there is no release of funds funds yet. If you have an obligation with a third person and you default, the third person just needs to inform the bank, and the bank will release the money. The money released will will be considered as a loan from the bank to you. The bank will allow the release of the money so long as it doesn’t exceed the ceiling.

2. To secure payment of any debt to be subsequently incurred – If the contract states that the guaranty is to secure advances made “from time to time,” “now in force or hereafter made,” or uses the words “any debt,” “any indebtedness,” “any sum,” “any transaction,” the guaranty is a continuing guaranty. guaranty.

3. To secure existing unliquidated debts – Future debts may also mean debts that already exist but whose amount is still unknown.

Art. 2053 may be misleading because it says that a guaranty may be constituted to secure future debts. The important thing to remember in the guaranty of future debts is that there must be an


existing obligation already that that is being guaranteed. Because without that existing existing obligation, the guaranty would be void. void. Guaranty is an accessory obligation, obligation, so it cannot exist without the principal. Example: G guarantees the 10K loan that B owes L and any other indebtedness that

B may incur against L. This is a valid guaranty because there is already an existing obligation (the 10K loan). G guarantees the loan that B and L will enter into tomorrow. tomorrow. This is not valid. Although it is for a future debt, it is not valid under Article 2053 because there is no principal obligation yet. There is nothing to guarantee. Guaranty of Conditional Obligations

If the principal obligation is subject to a suspensive condition, condition, the guarantor is liable only after the fulfillment of the condition. If it is subject to a resolutory condition, the happening of the condition extinguishes both the principal obligation and the guaranty. Art. 2054. A guarantor may bind himself for less, but not for more than the principal debtor, both as regards the amount and the onerous nature of the conditions. Should he have bound himself himself for more, his obligations shall be reduced to the limits of that of the debtor. Since the contract of guaranty is a subsidiary and accessory contract, the guarantor’s liability cannot exceed that of the principal obligation. obligation. If the guarantor binds himself for more than the liability of the principal debtor, his li ability shall be reduced. However, if the creditor sues the guarantor, the guarantor may be made to pay costs, attorney’s fees, and penalties even if this will make his liability exceed that of the principal. How do you opt out of this rule? Example: G guaranteed B’s 100K obligation obligation to L to the extent of 100K. 100K. As an extra

consideration for lending the money, L wants an additional 20K from guarantor (gravy, according to JPSP). Since 2054 provides that the guarantor cannot bind himself for more than the principal debtor, how do the parties opt out of the rule? Guarantor and Lender should enter into a new and separate agreement. They should take it out of the context of the guaranty and have a new agreement in which L would (kunwari) perform some service for G in consideration of the additional 20K. Art. 2055. A guaranty is not presumed; it must be express and cannot extend to more than what is stipulated therein. If it be simple or indefinite, it shall comprise not only the principal obligation, but also all its accessories, including including the judicial costs, provided with respect to the latter, that the guarantor shall only be liable for those costs incurred after he has been judicially required to pay. RULE: Guaranty is never presumed. presumed. It must be express. Reason for the rule: Because a guarantor assumes an obligation to pay for another’s debt

without any benefit to himself. Thus, it has to be certain that he really intends to incur such an obligation and that he proceeds with consciousness of what he is doing.

Form required for Guaranty

Guaranty must be IN WRITING Sheryl IID 2002 PAGE 17

A contract of guaranty, to be enforceable, must be in writing because it falls under the Statute of Frauds as a “special promise to answer for the debt, default or miscarriage of another.” De Leon textbook textbook says that surety is not covered covered by the Statute of Frauds. Frauds. JPSP says that a surety is still covered by the SOF since it i s still a promise to answer for the default of another person. What is not covered by the SOF is being a solidary co-debtor. Construction of Guaranty

A guaranty is strictly construed against the creditor and in favor of the guarantor and is not to be extended beyond its terms or specific specific limits. Doubts should should be resolved in favor of the guarantor or surety. Generally, a guarantor is liable only for the obligation of the debtor stipulated upon, and not to obligations assumed PREVIOUS to the execution of the guaranty unless an intent to be so liable is clearly indicated. indicated. (Prospective (Prospective application of the guaranty) guaranty) However, this rule of construction is applicable only to an accommodation surety or one that is gratuitous. It does not apply in cases cases where the the surety is compensated compensated with consideration. In such cases, the agreement agreement is interpreted against the surety company company that prepared it. Is a stipulation that says that the guaranty will subsist only until maturity of the obligation valid?

Generally, no. Such a stipulation stipulat ion would defeat the purpose of a guaranty which is to answer for the default of the principal debtor. debtor. If the guaranty is only up to the date of maturity, maturity, there is no way that the guarantor can be liable since default comes only at maturity date. But Cayo pointed out a situation in class where where this might be possible and JPSP agreed: agreed: If the lender asked for a guaranty precisely because there was a danger of the borrower absconding or becoming insolvent insolvent prior to maturity date, then the guaranty is valid. 2nd Paragraph of Art. 2055: Extent of Guarantor’s Liability guaranty – The liability of the guarantor is limited to the principal debt, 1. Definite guaranty –

to the exclusion of accessories.

2. Indefinite or simple guaranty – If the agreement does not specify that the liability of the guarantor is limited to the principal obligation, it extends not only to the principal but also to all its accessories.

This is because in entering into the agreement, the principal could have fixed the limits of his responsibility solely to the principal. If he did not not fix it, it is presumed that he wanted to be bound not only to the principal but also to all its accessories. GENERAL RULE: It is not necessary for the CREDITOR to expressly accept the contract of guaranty since the contract is unilateral; only the guarantor binds himself to do something. EXCEPTION:

If the guarantor merely offers to become a guaranty, it does not become a binding obligation unless the creditor accepts and notice of acceptance is given to the guarantor. On the other hand, if the guarantor makes a direct or unconditional unconditional promise of guaranty

(and not merely an offer), there is no need for acceptance and notice of such acceptance from the creditor. Art. 2056. One who is obliged to furnish a guarantor shall present a person who possesses integrity, capacity to bind himself, and sufficient property to answer for the obligation which he guarantees.


The guarantor shall be subject to the jurisdiction of the court of the place where this obligation is to be complied with. Art. 2057. If the guarantor should be convicted in first instance of a crime involving dishonesty or should become insolvent, the creditor may demand another who has all the qualifications required in the the preceding article. The case is excepted excepted where the creditor creditor has required and stipulated that a specified person should be the guarantor. Ideally, the qualifications of a guarantor are the ff: 1. Integrity 2. Capacity to bind himself 3. Sufficient property property to answer for the obligation which he guarantees But the creditor can waive these requirements. Jurisdiction over the guarantor:

Jurisdiction over the guarantor belongs to the court where the principal obligation is to be fulfilled, in accordance with the rule that accessory follows the principal. Effect of Subsequent Loss of Qualifications

The qualifications need only to be present at the time of the perfection of the contract. The subsequent loss of the qualifications would not extinguish the liability of the guarantor, guarantor, nor will it extinguish the contract of guaranty. However, the creditor may demand another guarantor with the proper qualifications. When may the creditor demand another guarantor?

1. In case the guarantor is convicted in the first i nstance of a crime involving dishonesty (since he loses integrity)

2. In case the guarantor becomes insolvent (since he loses sufficient property property to answer for the obligation which he guarantees) there is no need for a judicial declaration decla ration of insolvency What is the effect of the guarantor’s death on the guaranty?

The guaranty survives survives the death of the guarantor. guarantor. The general rule is that a party’s contractual rights and obligations obligations are transmissible to his successors. successors. The rules on guaranty guaranty do not expressly provide that the guaranty is extinguished upon the death of the guarantor. Applying Art. 2057, the supervening incapacity of the guarantor does not extinguish the guaranty but merely gives gives the creditor the right to demand a replacement. replacement. But the creditor can waive this right and choose to hold the the guarantor to his bargain. If he so chooses, the creditor’s claim passes to the heirs of the deceased guarantor. guarantor. When may the creditor NOT demand another guarantor?

Where the creditor has stipulated in the original agreement that a specified person should be the guarantor, he is bound by the terms of the agreement and he cannot thereafter deviate from it.

CHAPTER 2 EFFECTS OF GUARANTY Art. 2058. The guarantor cannot be compelled to pay the creditor unless the latter has

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