Dear PAO,

Henry obtained a loan from me and furnished his house and lot as security for his debt. We also agreed that if he cannot pay his debt, we will execute a deed of absolute sale where he will sell his property to me, with his outstanding debt and interest forming part of the price. I would then pay him the difference if the fair market value of the property exceeded his debt. Henry defaulted on payment, and I have already demanded payment in writing. I told him that if he wanted to pay, he could sell me his property, as this was clear in our previous agreement. He, however, refused and told me that the said term in our agreement cannot be given effect because the sale of the mortgaged property to me is prohibited by law. According to him, such an agreement is pactum commissorium.

Janus

Dear Janus,

Payment is one of the modes of extinguishing an obligation, like in your contract of loan with Henry. This is in consonance with Article 1231 (1) of the New Civil Code of the Philippines (NCCP). Relative thereto, Article 1232 of the same law provides that payment means not only the delivery of money but also the performance, in any other manner, of an obligation.

Payment may also be in the form of property, which is called “dation in payment.” This is governed by Article 1245, also of the NCCP, which states, “[d]ation in payment, whereby property is alienated to the creditor in satisfaction of a debt in money, shall be governed by the law of sales.”

However, while dation in payment is allowed, pactum commissorium is prohibited. Article 2088 of the NCCP provides that 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 elements of pactum commissorium were enumerated in Bustamante v. Rosel and Rosel, GR 126800 Nov. 29, 1999, Associate Justice Bernardo Pardo, to wit:

“xxx (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.”

Nonetheless, an agreement to sell to the creditor the mortgaged property furnished by the debtor as security for his loan is not prohibited per se and does not fall under pactum commissorium. This is exactly the pronouncement in the case entitled Ruby Shelter Builders and Realty Development Corporation v. Tan et al., GR 217368, Aug. 5, 2024, where the Supreme Court, speaking through Chief Justice Alexander Gesmundo, stated:

“Verily, pactum commissorium does not extend to a mutual agreement between the debtor and the creditor that the property subject of the mortgage is sold to the latter to extinguish the obligation. When the parties entered into a separate Deed of Absolute Sale, it proves that there was no automatic transfer of ownership, and therefore, no pactum commissorium.

“It must be emphasized that the evil is sought to be avoided in a pactum commissorium is not the alienation of the mortgaged properties to the creditor upon default of the debtor per se. Pactum commissorium is a stipulation for automatic vesting of title over the security in the creditor in case of the debtor’s default. The prohibition is intended to protect the obligor, pledger, or mortgagor against being overreached by their creditor who holds a pledge or mortgage over property whose value is much more than the debt. It includes a situation where the deed of sale with pacto de retro allowed the conveyance of ownership of the mortgaged property without the necessity of drawing another deed of absolute sale. Clearly, what is being prevented, is the unilateral and instant arrogation by the creditor of ownership over the mortgaged property, to the prejudice of the debtor’s interest who may have only consented to an assignment of rights, and without releasing the property from the mortgage contract.”

Applying the above-quoted decision in your situation, the prohibition on pactum commissorium does not extend to your agreement with Henry involving the sale of his mortgaged property in case of non-payment of his debt. This is for the simple reason that the second element of pactum commissorium, which is the automatic appropriation by the creditor of the mortgaged property in case of default in payment by the debtor, is lacking, i.e., there is still a need for the parties to execute a separate deed conveying ownership of the mortgaged property. To reiterate, the evil sought to be avoided in pactum commissorium is the automatic appropriation of the mortgaged property, and it will not cover mutual contracts whereby the debtor consents to the sale of his mortgaged property to the creditor in the event of default in payment.

We hope that we are able to answer your queries. This advice is based solely on the facts you have narrated and our appreciation of the same. Our opinion may vary when other facts are changed or elaborated.

Thank you for your continued trust and support.

Editor’s note: Dear PAO is a daily column of the Public Attorney’s Office. Questions for Chief Acosta may be sent to [email protected]