Art. 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. Prohibition Against pactum commissorium
(1) Stipulation null and void. = a stipulation whereby the thing pledged or mortgaged or under antichresis (Art. 2137) shall automatically become the property of the creditor in the event of nonpayment of the debt within the term fixed is known as pactum commissorium or pacto commisorio which is forbidden by law and declared null and void. (Art. 2088). = by such a stipulation, the creditor would be able to acquire ownership of the property given as security without need of public sale or foreclosure required by law. = this forfeiture clause has traditionally been outlawed because it is contrary to good morals and public policy. = the reason for the prohibition is that the amount of the loan is oridinarily much less than the real value of the thing pledged or mortgaged.

(2) Requisites. = there are two requisites or elements for pactum commissorium to exist, namely: a. There should be a pledge, mortgage, or antichresis of property by way of security for the payment of the principal obligation; and b. There should be a stipulation for an automatic appropriation by the creditor of the property on the event of nonpayment of the obligation within the stipulated period.

= it is immaterial that the questioned stipulation was voluntarily and freely entered into, pactum commissorium being void for being prohibited by law. (3) Stipulation presupposes existence of security contract. = pactum commissorium referred to in Arts. 2088 and 2137, therefore, presupposes the existence of mortgage or pledge or antichresis.

Art. 2088. The creditor cannot appropriate the things given by way of pledge or mortgage, or dispose them. Any stipulation to the contrary is null and void. Art. 2137. The creditor does not acquire the ownership of the real estate for non-payment of the debt within the period agreed upon. Every stipulation to the contrary shall be void. But the creditor may petition the court for the payment of the debt or the sale of the real property. In this case, the Rules of Court on the foreclosure of mortgages shall apply.

= thus it has been held that there was no pactum commissorium where pursuant to the contract of sale, the sums already paid by the vendee were forfeited for his failure to pay the stipulated installments in due time considering that the person to whom the property was forfeited (vendor) was the real and equitable owner of the same because title would not pass until payment of the last installment. = there is also no pactum commissorium where the alienation of the subject property was by way of secutiry

and not by way of satisfying or extinguishing the debt of the debtor. (4) Effect on security contract. = the vice of nullity which vitiates such a stipulation does not affect substantially the principal contract of pledge, mortgage, or antichresis with regard to its validity and efficacy for the reason that the contract, having been perfected, can subsist although the contracting parties have not agreed as to manner the creditor can recover his credit inasmuch as the law has expressly established the procedure in order that he may recover the same, in case the debtor does not comply with his obligation. = in short, the security contract remains valid; only the prohibited stipulation is void.
Illustrative Cases: (1) If the sum loaned is not paid, property of the debtor would be considered as absolutely sold to the creditor for said sum. Facts: D borrowed money from C under the agreement that if, at the expiration of the period stipulated, the sum loaned should not be paid, it would be understood that the house and lot owned by D, be considered as absolutely sold to C for the said sum. No payment was made by D within the time fixed. In view of the refusal of D to deliver the property, C brought action to recover the property and a rents from D. Issue: Is the contract in question in the nature of pactum commissorium? Held: No. We have in this case a contract of loan and a promise of sale of property, the price of which should be the amount loaned, if within a fixed period of time such amount should not be paid by the debtorvendor (D) of the property to the creditor-vendee (C) of the same. = The fact that the parties have agreed at the same time, in such a manner that the fulfillment of the promise of sale would depend upon

the nonpayment or return of the amount loaned, has not produced any change in the nature and legal conditions of either contract or any essential defect which would tend to nullify them. = Pactum commissorium indicates the existence of the contract of mortgage, or of pledge, or of antichresis, none of which has coincided in the loan in question. = the property does not appear mortgaged. Said property could not be pledged, not being personal property, and notwithstanding the said double contract the debtor (D) continued in possession thereof and the said property had never been occupied by the creditor (C). Neither was there any contract of antichresis by reason of said contract of loan inasmuch as C has never been in possession thereof, nor has he enjoyed the said property nor for one moment ever received its rents. (2) Buyer executed a deed of assignment in favor of seller of property sold, pursuant to a judgment rendered in an action for specific performance filed by the seller. Facts: B and S agreed on the sale of trucks by the latter (S) to the former (B). When B defaulted in the payment of the second and third installments, S filed an action in court for specific performance. The trial court rendered judgment for S and ordered B to pay the balance of his obligation and in case of failure to do so, to execute a deed of assignment pursuant to the judgment. Issue: Is the deed of assignment in the nature of pactum commissorium? Held: No. There was no contract of pledge or mortgage entered into by the parties; nor a case of automatic appropriation of the property by S because it took the intervention of the trial court to exact fulfillment of the obligation, by which its very nature is ....anathema to the concept of pacto commissorio. And even granting that the original agreement between the parties had the badges of pactum commissorium, the deed of assignment does not suffer the same fate as it was executed pursuant to a valid judgment as can be gleaned from its very terms and conditions.

Prohibition refers to stipulation authorizing automatic appropriation

What is prohibited by Art. 2088 in connection with pacto commissorio is the automatic appropriation by the creditor of the thing pledged or mortgaged upon failure of the debtor to pay his debt within the period agreed upon by virtue of authority or right previously given the creditor, thus: (1) A stipulation providing that the mortgaged property shall be considered in full payment without further action in court in case of nonpayment is null and void being in the form of pacto commissorio. (2) A stipulation in a purported pacto de retro sale that the owner that the ownership over the property sold would automatically pass to the vendee in case of no redemption was effected within the period stipulated, is contrary to the nature of a true pacto de retro sale, under which the vendee acquires ownership of the thing sold immediately upon the execution of the sale, subject only to the vendors right of redemption. = the said stipulation is a pactum commissorium which enables the mortgagee to acquire ownership of the mortgaged property without need of foreclosure. = it is void. Its insertion in the contract is an avowal of the intention of the mortgage, rather than to sell, the property.

Permissible stipulations

(1) Subsequent modification of original contract. = the stipulations that are prohibited by Arts. 2088 and 2137 (antichresis) are those executed or made simultaneously with the original contract, not those subsequently entered into. = the principle does not prohibit modification of the contract by subsequent agreement such as the parties may see fit to adopt. (2) Subsequent voluntary cession of property.

= the prohibition does not include s subsequent voluntary act of the debtor making cession of the property mortgaged in payment of the debt which amounts in its legal effect to a novation of the original contract and to a voluntary sale of the said property for the amount of the debt. (3) Promise to assign or sell. = neither is the prohibition applicable to a promise to assign or sell said property in payment of the obligation if, upon its maturity, it is not paid because the title thereto remains with the debtor. = the promise is merely a personal obligation of the mortgagor and does not in any way bind the property. (a)The mortgagor can validly sell the property to a third person and if there should be any action accruing to the mortgagee, it would be a personal action for damages against the mortgagor. (b)If the vendee contributed to the breach of the contract by the mortgagor, the former, together with the latter, may also be held liable for damages; or = if the vendee was guilty of fraud which would be a ground for rescission of the sale in his favor, the mortgagor and not the mortgagee would be the party entitled to bring the action of annulment.
Footnote: (1) Page 355 (Dulay vs. Aquiatin and Maximo, 47 Phil. 951; 1925) =Dissenting opinion, Justice Street said: It is not to be denied that a mortgagor of property may transfer the mortgaged property to the creditor in satisfaction of the mortgage debt after the mortgage has fallen due. But such transfer implies the independent exercise of the power vested in the mortgagor, as owner.... = by virtue of this stipulation (to the effect that in case the specified date should arrive and the debtor should be unable to pay the amount due, it should be paid with the property security), the debtor was bound to transfer the property to the creditor in satisfaction of the mortgaged debt, the mortgagor being unable at the time to pay the same.

= said stipulation should be declared invalid, as contrary to the spirit, if not the letter of Art. Of 1859 (now Art. 2088), as well as directly contrary to the general principles of jurisprudence applicable to the relation of mortgagor and mortgagee. = if a stipulation of this kind is valid, every mortgage in which such stipulation is inserted will become self-executing and the debtor, upon making default in the payment of the debt, will be bound to transfer the property in satisfaction of the mortgage, with the result that the right of redemption is lost from the mere fact that the debtor is unable to pay at the date stipulated.

(4) Authority to take possession of property upon foreclosure.= a stipulation authorizing the mortgagee, for the purpose therein specified, to take possession of the mortgaged premises upon foreclosure of a mortgage is not repugnant to either Art. 2088 or Art. 2137. = On the contrary, such a stipulation is in consonance with or analogous to the provisions of Arts. 2132, et seq. regarding antichresis and the provisions of the Rules of Court (Rule 59) regarding the appointment of a receiver as a convenient and feasible means of preserving and administering the property in litigation.
Illustrative cases: (1) Mortgagor appoints mortgagee in deed of assignment as attorney-in-fact with authority to dispose of mortgage properties in case of default of mortgagor and to apply the proceeds in the payment of loan. Facts: C, a grantee of a Fishpond Lease Agreement from the Govt, obtained from DBP three separate loans, each of which was covered by a promissory note. Simultaneous with the execution of the notes was the execution of Assignment of Leasehold Rights by C, as borrower of the mortgaged properties by way of security in the payment of the loans. Condition No. 12 provides for the appointment of DBP as attorney-in-fact with authority, among other things, to sell or otherwise dispose of the said real rights in case of default of C and to apply the proceeds to the payment of the loan. Issue:

(1) Whether the condition in question constitute pactum commissorium. (2) Whether the act of DBP in appropriating to itself Cs leasehold rights without foreclosure proceedings was contrary to Art. 2088 and, therefore, invalid. Held: (1) Elements of pactum commissorium are not present.= Condition No, 12 did not provide that the ownership over the leasehold rights would automatically pass to DBP upon Cubas failure to pay the loan on time. = This provision is standard condition in mortgage contracts and is in conformity with Art. 2087 of the CC, which authorizes the mortgagee to foreclose the mortgage and alienate the mortgage property for the payment of the principal obligation. (2) DBP exceeded the authority vested by condition.= However, DBP exceeded the authority vested by condition No. 12 for the Deed of Assignment. As admitted by it during the pre-trial, it had, without foreclosure proceedings, whether judicial or extrajudicial.... appropriated the leasehold rights of Cuba over the fishpond in question. = its contention that it limited itself to mere administration by posing caretakers is further belied by the deed of conditional sale it executed favor of Cuba. The deed stated: Whereas, the Vendor (DBP) by virtue of a deed of assignment executed in its favor by the herein vendees (Sps. Cuba) the former acquired all the rights and interest of the latter over the above-described property; The title to the real estate property and all its improvements thereon shall remain in the name of the vendor until after the purchase price, advances and interest shall have been fully paid. = it is obvious from the above-quoted paragraphs that DBP had appropriated and taken ownership of Cubas leasehold rights merely on the strength of the deed of assignment. =DBP cannot take refuge in Condition No. 12 of the deed of assignment to justify its act of appropriating the leasehold rights. As stated earlier condition No. 12 did not provide that Cubas default would operate to vest in DBP ownership of the rights. =Besides, an assignment to guarantee an obligation as in the present case, is virtually a mortgage and not an absolute conveyance of title which confers ownership on the assignee.

(1) The lender is given the option to buy at a certain price the
property given as collateral in the event the borrower fails to pay. Facts: C (respondent) entered into a loan agreement with B (petitioner) and her late husband, with the following terms and conditions: a. The spouses would borrow P100K from C, for a period of two years counted from Mar. 1, 1987; b. Interest rate is 18% per annum; c. To guaranty payment: put up as collateral 70sqm portion of a parcel of land, inclusive of the apartment therein; d. In the event the borrowers fail to pay, C has the option to buy or purchase the mortgaged property for a total consideration of P200K inclusive of the principal and interest. When the loan was about to mature on Mar. 1, 1989, C proposed to buy at the pre-set price of P200K the collateral given to guarantee the payment of the loan, but B refused to sell. On Mar. 1, 1989, B tendered payment of the loan to C which the latter refused to accept, insisting Bs signing a prepared deed of absolute sale. C consigned the amount of P47.5K with the trial court with which C filed a complaint for the specific performance. In arriving at the amount deposited, C considered the principal loan of P100K and 18% interest per annum thereon, which amounted to P52.5K, leaving a balance of P47.5K from the amount of P200K. On the other hand B filed a petition for consignation and deposited the amount of P153K with the trial court. Issue: Whether the stipulation in the loan contract was valid and enforceable. Held: 1. The stipulation embraced in concept of pactum commissorium. = B did not fail to pay the loan. When C refused to accept payment, B consigned the amount with the trial court. = a scrutiny of the stipulation of the parties reveals a subtle intention of the creditor to acquire the property given as security for the loan. This is embraced in the concept of pactum commisssorium, which is proscribed by law. = the elements of pactum commissorium are as follows: (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 nonpayment of the principal obligation within the stipulated period. 2. Intent to appropriate property given as collateral appears to be evident = a significant task in contract interpretation is the ascertainment of the intention of the parties and looking into the words used by the parties to project that intention. = In this case, the intent to appropriate the property given as collateral in favor of the creditor appears to be evident, for the debtor is obliged to dispose of the collateral at the pre-agreed consideration amounting to practically the same amount as the loan. = In effect, the creditor acquires the collateral in the event of nonpayment of the loan. This is within the concept of pactum commissorium. Such stipulation is void. 3. Duty of court to protect necessitious borrowers. = all persons in need of money are liable to enter into contractual relationships whatever the condition if only to alleviate their financial burden albeit temporarily. = hence, courts are duty bound to exercise caution in the interpretation and resolution of contracts lest the lenders devour the borrowers like vultures do with their prey. Note: Here, the agreement between the parties was not a sale with right to repurchase (pacto de retro sale), but a loan with interest of 18% per annum for a period of 2 years and if B fails to pay, C was given the option to purchase the property given as collateral for P200K. There was no stipulation for automatic appropriation by C of the property in case of non-payment of the loan within the stipulated period.

Risk of loss of property pledged or mortgaged

As the pledgee or mortgagee does not become the owner of the property and the ownership thereof remains with the debtor, therefore, under the maxim, res perit domino suo, the debtor-owner bears the loss of the property. = The principal obligation is not extinguished by the loss of the pledged or mortgaged property.