In the case of Cebu Contractors Consortium Co. vs. Court of Appeals, the Supreme Court clarified that a sale and leaseback agreement can be treated as an equitable mortgage rather than a financial lease if its primary intent is to secure a loan, not to enable the lessee to acquire and use the equipment. This ruling means that businesses entering into such agreements need to carefully consider the implications, as the properties involved might be subject to different legal treatments than initially anticipated, especially concerning foreclosure and redemption rights.

Financial Leasing or Equitable Mortgage: Unveiling the True Intent

Cebu Contractors Consortium Company (CCCC) sought financial assistance from Makati Leasing and Finance Corporation (MLFC) for a road construction project. Instead of a conventional loan, MLFC proposed a sale and leaseback scheme: CCCC would sell its equipment to MLFC and then lease it back, with the lease rentals serving as installment payments. CCCC later argued this was actually an equitable mortgage. The central question before the Supreme Court was whether the sale and leaseback arrangement was a legitimate financial lease or a disguised loan secured by a mortgage.

The Court examined the true nature of the transaction. It differentiated between a genuine financial leasing agreement and a loan disguised as a lease. A true **financial lease**, as defined in Republic Act No. 5980 (Financing Company Act), involves a financing company purchasing equipment at the instance of the lessee, enabling the lessee to acquire and use the property over time. However, the Court noted that if the lessee already owns the equipment and enters into a sale and leaseback agreement primarily to obtain working capital, the transaction is likely a disguised loan with the equipment serving as collateral.

The Court referenced its prior ruling in Investors Finance Corporation v. Court of Appeals, highlighting that a sale and leaseback should not be a mere disguise for a loan secured by a mortgage. In this case, MLFC itself admitted that CCCC already owned the equipment when the transaction occurred. The Court determined that the agreement was designed to extend a loan to CCCC, with the sale and leaseback structure used as a security arrangement. Because the intent was not to enable CCCC to acquire the equipment, it was deemed to be an equitable mortgage.

Because the agreement was, in truth, an equitable mortgage, CCCC properly sought a reformation of the instrument so that their true agreement could be expressed. The remedy of reformation, governed by Articles 1359 and 1362 of the Civil Code, allows for contracts to be revised to reflect the parties’ actual intentions when a written agreement fails to do so because of mistake, fraud or inequitable conduct. The Court found that CCCC’s claim for reformation, brought as a counterclaim in 1978, was filed within the ten-year prescriptive period outlined in Article 1144 of the Civil Code.

MLFC also argued that CCCC’s deed of assignment of its receivables from the Ministry of Public Highways, intended to pay the debt, extinguished the obligation, thus barring MLFC from collecting further. The Supreme Court disagreed with this argument. While the deed’s language appeared to be absolute, the Court looked at the circumstances surrounding the assignment, including CCCC’s actions after the deed’s execution. Evidence revealed that CCCC made partial payments even after the assignment, undermining the claim that it fully extinguished CCCC’s debts. In addition, the fact that a chattel mortgage was executed *after* the assignment showed the original obligation under the lease agreement persisted.

Finally, CCCC argued it overpaid MLFC, a claim the Court also refuted. MLFC presented evidence of outstanding penalties incurred from CCCC’s rental defaults that CCCC’s calculation failed to account for. The Court found the amount claimed by the MLFC was sound and therefore affirmed it.

In the final ruling, the Supreme Court held that the transaction was an equitable mortgage, not a true financial lease, but affirmed that Cebu Contractors Consortium Company was still indebted to Makati Leasing & Finance Corporation.

FAQs

What was the key issue in this case?	The key issue was whether the sale and leaseback agreement between Cebu Contractors Consortium Co. and Makati Leasing & Finance Corporation was a legitimate financial lease or a disguised loan secured by a mortgage. The Court ruled that it was a disguised loan (equitable mortgage).
What is a financial lease?	A financial lease is a contract where a lessor purchases equipment at the lessee’s request, allowing the lessee to use it in exchange for periodic payments, which amortize a significant portion of the equipment’s cost. The lessee does not automatically have the right to purchase the equipment at the end of the lease.
What is an equitable mortgage?	An equitable mortgage is a transaction that appears to be a sale with right to repurchase or a lease, but is actually intended as security for a loan. Courts will look beyond the form of the contract to determine the true intention of the parties.
When can a sale and leaseback be considered an equitable mortgage?	A sale and leaseback is considered an equitable mortgage if the intent is primarily to secure a loan, rather than to facilitate the acquisition and use of the asset. This is common when the “lessee” (original owner) already owned the property prior to the agreement.
What is the significance of the Deed of Assignment in this case?	Cebu Contractors executed a Deed of Assignment assigning payments receivable from another party to MLFC to settle their obligation. The Court found this Deed didn’t fully release CCCC from its obligations.
How did the Court determine the intent of the parties?	The Court looked beyond the literal terms of the contracts. Instead, it considered contemporaneous acts and surrounding circumstances to establish the parties’ true intent, thereby distinguishing a true financial lease from an equitable mortgage.
What does the remedy of reformation mean, in this context?	Reformation is a legal remedy by which a contract is revised to reflect the true intentions of the parties, especially when the written agreement does not accurately represent their understanding due to mistake or fraud. CCCC’s counterclaim requested the contract be reformed to reflect what they claimed to be the actual nature of the transaction.
Was CCCC’s claim of overpayment upheld?	No, the Court ruled that CCCC had not overpaid. The appellate court found that CCCC’s calculation excluded the penalties the company incurred by defaulting on their payments, thus miscalculating the total owed.

This case highlights the importance of carefully evaluating the true intent behind sale and leaseback agreements. The Supreme Court’s decision underscores that the substance of the transaction will prevail over its form, especially when the rights of the parties are at stake.

For inquiries regarding the application of this ruling to specific circumstances, please contact ASG Law through contact or via email at frontdesk@asglawpartners.com.

Disclaimer: This analysis is provided for informational purposes only and does not constitute legal advice. For specific legal guidance tailored to your situation, please consult with a qualified attorney.
Source: Cebu Contractors Consortium Co. vs. Court of Appeals, G.R. No. 107199, July 22, 2003