The Supreme Court ruled that an absolutely simulated contract of sale is void from the beginning, meaning it transfers no ownership. Consequently, a buyer in such a simulated sale cannot validly mortgage the property, and any subsequent foreclosure sale will not confer title to the buyer. This protects original landowners from losing their property due to fraudulent transactions involving simulated sales and mortgages.

Simulated Sales and Mortgages: When Is a Bank Really a “Mortgagee in Good Faith?”

In Edilberto Cruz and Simplicio Cruz v. Bancom Finance Corporation (now Union Bank of the Philippines), the central issue revolved around the validity of deeds of sale and a subsequent mortgage. The Cruz brothers claimed they were defrauded into executing a simulated sale of their land. This sale allowed a third party to obtain a loan from Bancom using the land as collateral. When the borrower defaulted, Bancom foreclosed the mortgage. The Cruzes then fought to reclaim their land, arguing the original sale was a sham. This led the Supreme Court to examine whether Bancom acted in good faith when it accepted the property as collateral.

The general rule is that the terms of a contract, when clear, govern the parties’ intent. However, if the words contradict the apparent intent, the latter prevails. Simulation occurs when parties do not genuinely intend for their contract to have legal effects. It can be absolute (parties intend no binding effect) or relative (parties conceal their true agreement). Absolute simulation renders a contract void from the start, as no real transaction occurred. In this instance, while the deed of sale stated a consideration of P150,000, no money exchanged hands. Fr. Edilberto Cruz testified, corroborated by Candelaria Sanchez, that the sale was solely to enable Sanchez to borrow money from a bank.

Another crucial factor was the buyers’ failure to assert ownership rights. Sanchez and Sulit never took possession or acted as owners, which reinforced the simulation. The two deeds of sale were executed on the same day, and just days later, the property was mortgaged. This series of events strongly indicated a scheme to use the property as collateral, with no real intent to transfer ownership. Consequently, because the original deeds were void, Sulit had no valid title to mortgage to Bancom. Article 1409 of the Civil Code stipulates that contracts that are absolutely simulated are void and inexistent from the beginning. Possession is crucial.

Building on the point of mortgagee rights, even though land registration systems aim for reliability, a person deprived of land through fraud can seek reconveyance. But there are stipulations – This is where the concept of an “innocent purchaser for value” becomes central. An innocent purchaser (or mortgagee) is someone who buys or lends against property without knowledge of defects in the seller’s/borrower’s title. Banks, however, aren’t viewed the same way. Banks are expected to exercise a higher degree of care. The Court emphasized that financial institutions must conduct thorough due diligence before entering a mortgage contract. Ascertaining the property’s status as loan security is not only expected but should be a fundamental and indispensable part of a bank’s operating procedure.

However, banks should adhere to protocol. In the past, The Supreme Court has ruled that banks failing to diligently investigate properties were not considered mortgagees in good faith. Rural Bank of Compostela v. CA clearly states that the rule of relying solely on the certificate of title does not apply to banks, for they should take great care when dealing with registered lands due to their fiduciary duty. In Adriano v. Pangilinan, the same stringent standards of diligence extended to those regularly involved in money lending secured by real estate mortgages.

Bancom failed to meet these standards. They neglected to conduct an ocular inspection of the property and to ask questions that might reveal underlying issues with the sale and land transfer. A representative failed to come out and consider ownership details, a common best practice for banks prior to approving a loan. Had they done so, they would have come upon more glaring, but specific details and questions that they also did not follow through on. Given Bancom’s expertise and experience, it could easily have inspected the property located in Bulacan.

Furthermore, Bancom was aware of adverse claims and a notice of lis pendens (a pending legal action) when the mortgage was registered. Section 51 of PD NO. 1529 states that registration is essential for a mortgage to affect third parties. As petitioners registered first, the real estate mortgage became bound between the mortgagor and petitioners who were the injured third parties and were, by law, no longer bound to Sulit. A lien recorded before registration dictates precedence in this kind of case. According to Article 2085 of the Civil Code, only an absolute owner can create a legitimate mortgage. Since Sulit’s title came from simulated sales, the real estate mortgage held no water.

FAQs

What was the key issue in this case?	The central question was whether a bank could be considered a “mortgagee in good faith” when the underlying sale of the mortgaged property was later proven to be simulated.
What is a simulated contract of sale?	A simulated contract is one where the parties don’t intend to be bound by the agreement, often used to mask a different transaction or obtain a loan. If the sale is considered absolutely simulated, the contract is null and void.
Why is a bank expected to exercise a higher standard of care as a mortgagee?	Banks hold public trust and are expected to be more diligent in their transactions to protect depositors’ money. This higher standard applies to registered land transactions as well.
What is a notice of lis pendens?	A lis pendens is a recorded notice of a pending lawsuit that affects the title to or possession of real property, providing notice to prospective buyers or lenders of a claim.
What does it mean to be an “innocent purchaser/mortgagee for value”?	It means acquiring property or a mortgage without knowledge of any defects or claims against the title, after paying a fair price. One will then be legally protected.
How does the principle of ‘prior registration’ apply in this case?	If a lien (like an adverse claim or lis pendens) is registered before a mortgage, the prior registration creates a preference, meaning the earlier claim takes priority.
What due diligence measures should banks undertake before approving a mortgage?	Ocular inspection of the property, verification of ownership claims, scrutiny of transaction history, and an overall check of any irregularities or adverse claims associated with the title, will always serve a bank well.
Can a Certificate of Title always guarantee ownership?	Not necessarily; A certificate of title that stems from simulated, unlawful or fraudulent transaction does not automatically confer ownership to a party, because simulated deeds or those transactions are by nature unlawful.
What is the key takeaway for landowners after Cruz v. Bancom?	The most vital thing is for Landowners to be aware and cautious about signing any documents they do not fully understand, and that those owners always seek legal counsel during the negotiation process of potential transactions affecting their land.

Ultimately, the Supreme Court prioritized the rights of the original landowners due to the absolutely simulated nature of the sales and the failure of the bank to take appropriate precautions to determine if the party actually and legally owned that which they sought to have collateralize a large amount of money.

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: Edilberto Cruz and Simplicio Cruz v. Bancom Finance Corporation, G.R. No. 147788, March 19, 2002