In Philippine National Bank vs. Heirs of Benedicto and Azucena Alonday, the Supreme Court clarified the application of “all-embracing” or dragnet clauses in real estate mortgage contracts. The Court ruled that while these clauses can secure both present and future debts, they do not automatically apply to pre-existing debts unless such debts are explicitly mentioned in the mortgage contract. This means that a mortgage intended to secure a specific loan cannot be used to foreclose on a separate, prior loan if the mortgage agreement does not clearly state that it also covers the pre-existing debt. The decision protects borrowers by requiring lenders to be explicit about the extent of a mortgage’s coverage, preventing the unforeseen foreclosure of properties for debts not clearly included in the mortgage agreement.

Mortgage Mystery: Can an ‘All-Embracing Clause’ Cover a Forgotten Debt?

The case revolves around Spouses Benedicto and Azucena Alonday who obtained two loans from Philippine National Bank (PNB). The first was an agricultural loan secured by a property in Davao del Sur, and the second was a commercial loan secured by a different property in Davao City. Both mortgage contracts contained an identical “all-embracing clause,” also known as a dragnet clause, designed to secure not only the specific loan but also any other obligations the mortgagor might have with the bank. The Spouses Alonday fully paid the commercial loan, but PNB later foreclosed on the property used as security for this loan, claiming that the all-embracing clause allowed them to do so because the agricultural loan remained unpaid. The heirs of the Alondays challenged this foreclosure, arguing that the mortgage for the commercial loan should have been released upon its full payment.

The central legal question is whether the all-embracing clause in the second mortgage contract could validly extend the mortgage’s security to cover the pre-existing agricultural loan, even though the commercial loan had been fully paid. The Regional Trial Court (RTC) ruled in favor of the Alondays, finding that PNB should have made an express reservation if they intended the second mortgage to secure the first loan. The Court of Appeals (CA) affirmed this decision, emphasizing that the mortgage contract was a contract of adhesion and should be construed strictly against PNB, the party that drafted it.

The Supreme Court began its analysis by acknowledging the validity of all-embracing or dragnet clauses. Such clauses are designed to secure debts of both future and past origin. However, the Court also emphasized that these clauses must be “carefully scrutinized and strictly construed,” quoting DBP vs. Mirang. This means that not all debts automatically fall under the umbrella of a dragnet clause. The Court elaborated that for a debt to be secured by such a clause, it must “fairly within the terms of the mortgage contract.” For future loans, this requires a sufficient description in the mortgage contract. The court reasoned that if a future loan needs to be described, a past loan, already existing and known, should certainly require explicit mention.

Building on this principle, the Court noted that PNB had the opportunity to include a reference to the agricultural loan in the second mortgage contract but failed to do so. This omission strongly suggested that the parties treated each loan separately, explaining why they were secured by different mortgages. Moreover, the Court pointed to the ruling in Prudential Bank v. Alviar, which introduced the “reliance on the security test.” This test suggests that when a mortgagor takes another loan and provides a different security for it, it cannot be inferred that the loan was made solely on the original security with the dragnet clause. The Court found that the execution of the subsequent mortgage indicated that the parties intended to treat each loan distinctly, securing them individually.

Furthermore, the Supreme Court concurred with the lower courts’ assessment that the mortgage contracts were contracts of adhesion, prepared exclusively by PNB. Under Article 1306 of the Civil Code, parties are free to establish stipulations in their contracts, provided they are not contrary to law, morals, good customs, public order, or public policy. However, contracts of adhesion are often scrutinized because they can negate the autonomy of the weaker party. In such cases, courts will construe any obscurity in the contract against the party who prepared it, presuming them to be the stronger party. Therefore, because PNB drafted the mortgage contract and failed to explicitly include the pre-existing agricultural loan, the Court interpreted this against PNB.

Regarding the valuation of the foreclosed property, the Supreme Court found the RTC’s valuation of P3,000.00 per square meter to be speculative and without basis. The Court highlighted that actual damages must be proven with certainty, not based on guesswork or conjecture. The Court also emphasized that reliefs granted by courts cannot exceed what is prayed for in the pleadings. Consequently, the Supreme Court reduced the valuation to P1,200.00 per square meter, as originally claimed by the Spouses Alonday in their complaint, resulting in a total of P717,600.00 as actual damages. This underscored the importance of providing concrete evidence when claiming damages in court.

The Court also addressed the issue of interest on the judgment obligation. It clarified the distinction between monetary interest and compensatory interest, referencing Siga-an v. Villanueva. Monetary interest is fixed by the parties for the use of money and must be expressly stipulated in writing, as per Article 1956 of the Civil Code. Compensatory interest, on the other hand, is imposed by law or courts as penalty or indemnity for damages, even without an express stipulation. The Court held PNB liable for compensatory interest on the actual damages of P717,600.00, reckoned from the date of judicial demand (filing of the action). The interest rate was set at 12% per annum until June 30, 2013, and 6% per annum from July 1, 2013, until full payment, following the guidelines in Nacar v. Gallery Frames.

In summary, the Supreme Court affirmed the CA’s decision with modifications, emphasizing the need for explicit inclusion of pre-existing debts in mortgage contracts with dragnet clauses. This ruling protects borrowers from unexpected foreclosures and requires lenders to be transparent about the full extent of the mortgage’s coverage. By strictly construing contracts of adhesion against the drafting party, the Court reinforces the principle of fairness in contractual relationships. The imposition of compensatory interest further ensures that the injured party is adequately compensated for the damages suffered due to the unwarranted foreclosure.

FAQs

What is a dragnet clause in a mortgage contract?	A dragnet clause, also known as an all-embracing clause, is a provision in a mortgage contract that secures not only the specific loan but also any other obligations the mortgagor has or may have with the mortgagee. It aims to provide additional security for various debts under a single mortgage.
Does a dragnet clause automatically cover all debts?	No, a dragnet clause does not automatically cover all debts. The Supreme Court has ruled that for a pre-existing debt to be covered, it must be explicitly mentioned or clearly intended to be included in the mortgage contract.
What is a contract of adhesion?	A contract of adhesion is a contract where one party (usually a large corporation or institution) sets the terms, and the other party has little or no ability to negotiate and must simply “take it or leave it.” These contracts are valid but are strictly construed against the party who drafted them.
What is the “reliance on the security test”?	The “reliance on the security test,” as established in Prudential Bank v. Alviar, suggests that when a borrower obtains a subsequent loan and provides a different security for it, it cannot be assumed that the loan was made solely on the original security with the dragnet clause. This indicates an intent to treat each loan separately.
What kind of evidence is needed to prove damages in court?	To prove actual damages, the evidence must be concrete and reliable, not speculative or based on conjecture. Claimants must provide tangible proof of the loss suffered, such as market values or documented expenses.
What is the difference between monetary and compensatory interest?	Monetary interest is the compensation fixed by the parties for the use of money and must be stipulated in writing. Compensatory interest is imposed by law or courts as a penalty or indemnity for damages, even without an agreement, when there is a breach of contract.
What interest rates apply to judgments for monetary obligations?	For judgments involving monetary obligations, the interest rate is 12% per annum from the time of judicial demand until June 30, 2013, and 6% per annum from July 1, 2013, until full payment, as per the guidelines in Nacar v. Gallery Frames.
Can a court award damages exceeding what was claimed in the complaint?	No, courts cannot grant reliefs or damages that exceed what was prayed for in the pleadings. The amount of damages awarded must be within the bounds of what the party sought in their initial claim.

This case underscores the importance of clear and explicit language in mortgage contracts, particularly when using all-embracing clauses. Lenders must ensure that borrowers are fully aware of the extent to which their properties are encumbered, and borrowers must carefully review mortgage agreements to understand their obligations and rights. This decision reinforces the principles of fairness and transparency in financial transactions, protecting the interests of both borrowers and lenders.

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: PNB vs. Heirs of Alonday, G.R. No. 171865, October 12, 2016