In Paradigm Development Corporation of the Philippines v. Bank of the Philippine Islands, the Supreme Court ruled that a bank’s failure to comply with a contractual obligation to provide personal notice to a mortgagor before foreclosure invalidates the foreclosure proceedings. The Court also emphasized that a mortgage can only cover specifically described debts, protecting third-party mortgagors from liability for debts beyond the agreed scope. This decision reinforces the importance of adhering to contractual terms and clearly defining the scope of mortgage agreements, offering crucial protection to property owners and borrowers alike.

Third-Party Mortgage: Did the Bank Follow the Rules?

Paradigm Development Corporation of the Philippines (PDCP) mortgaged its properties to secure a credit line of Sengkon Trading (Sengkon) with Far East Bank and Trust Company (FEBTC). Sengkon later defaulted, leading FEBTC, now BPI, to foreclose on PDCP’s properties. PDCP challenged the foreclosure, alleging lack of notice, improper inclusion of other debts, and novation due to Sengkon’s change to Sengkon Trading, Inc. (STI). The Regional Trial Court (RTC) ruled in favor of PDCP, but the Court of Appeals (CA) reversed this decision. The Supreme Court then took up the case to resolve these critical issues.

At the heart of the matter was whether the bank, BPI, validly foreclosed on PDCP’s properties. PDCP argued that FEBTC’s registration of both real estate mortgages (REMs) was against their initial intent, and that the foreclosure included obligations beyond the agreed credit line. PDCP also contended that it did not receive proper notice of the foreclosure proceedings, and that the change from Sengkon to STI constituted a novation, releasing PDCP from its obligations. These claims hinged on proving that the bank failed to adhere to both contractual and statutory requirements in the foreclosure process.

The Supreme Court began by addressing the validity of the REMs. It reiterated the principle that registration is not essential for a mortgage to be binding between the parties. Citing Article 2125 of the Civil Code, the Court emphasized that even if an instrument is not recorded, “the mortgage is nevertheless binding between the parties.”

Article 2125. In addition to the requisites stated in Article 2085, it is indispensable, in order that a mortgage may be validly constituted, that the document in which it appears be recorded in the Registry of Property. If the instrument is not recorded, the mortgage is nevertheless binding between the parties.

Therefore, even if FEBTC registered both REMs against the initial intent, this did not automatically invalidate the mortgage contracts themselves. The Court found that PDCP’s act of surrendering the property titles to FEBTC demonstrated an intent to mortgage all four properties, further weakening PDCP’s claim of vitiated consent.

Next, the Court addressed the issue of novation. PDCP argued that the change in Sengkon’s name to STI effectively novated the original obligation, releasing PDCP. However, the Court cited Article 1293 of the Civil Code and established jurisprudence to clarify that novation requires an express release of the old debtor and a clear assumption of the obligation by the new debtor, with the creditor’s consent. The court cited Ajax Marketing and Development Corporation v. CA,

The well-settled rule is that novation is never presumed. Novation will not be allowed unless it is clearly shown by express agreement, or by acts of equal import. Thus, to effect an objective novation it is imperative that the new obligation expressly declare that the old obligation is thereby extinguished, or that the new obligation be on every point incompatible with the new one. In the same vein, to effect a subjective novation by a change in the person of the debtor it is necessary that the old debtor be released expressly from the obligation, and the third person or new debtor assumes his place in the relation. There is no novation without such release as the third person who has assumed the debtor’s obligation becomes merely a co-debtor or surety.

The Court found that PDCP failed to prove that Sengkon was expressly released from its obligations and that STI fully assumed them. The absence of a signed Deed of Assumption further undermined PDCP’s claim, making the alleged novation unsubstantiated.

The Supreme Court then delved into whether the foreclosure covered obligations beyond the secured credit line. The RTC had found that Sengkon’s availment under the credit line was limited to a specific period, and no evidence showed any availment beyond this period. The Supreme Court agreed with the RTC’s finding that Sengkon did not avail under the credit line, and thus, the foreclosure was tainted.

The Court also noted that PDCP had requested a segregation of Sengkon’s availments under the Credit Line, a valid request that FEBTC failed to honor. As a third-party mortgagor, PDCP’s liability was limited to the specific obligations secured by its properties. The Supreme Court stressed that,

An obligation is not secured by a mortgage unless it comes fairly within the terms of the mortgage contract.

The Court found no clear evidence that the promissory notes (PNs) used in the foreclosure proceedings corresponded to availments under the Credit Line, further invalidating the foreclosure.

The CA had applied the dragnet clause in PDCP’s REMs, arguing that the properties could answer for Sengkon’s obligations in other credit facilities. The Supreme Court clarified that while a dragnet clause can extend a mortgage’s coverage, it does not apply when subsequent loans are secured by other securities or when there is no clear intention to rely solely on the original security. In this case, the Court found that the PNs lacked any reference to PDCP’s availments, further weakening the applicability of the dragnet clause.

Finally, the Supreme Court addressed the critical issue of notice. The REMs stipulated that “all correspondence relative to this mortgage, including demand letters, summonses, subpoenas, or notifications of any judicial or extrajudicial action shall be sent to the [PDCP] at _______________ or at the address that may hereafter be given in writing by the [PDCP] to the [FEBTC].”

The Court emphasized that despite the blank space for the mortgagor’s address, FEBTC’s failure to send personal notice to PDCP was a breach of contract. The Court referenced Metropolitan Bank v. Wong, stating that, “when petitioner failed to send the notice of foreclosure sale to respondent, he committed a contractual breach sufficient to render the foreclosure sale on November 23, 1981 null and void.” The bank’s failure to comply with the contractual obligation to provide notice was fatal to the foreclosure proceedings.

What was the key issue in this case?	The key issue was whether the bank validly foreclosed on Paradigm Development Corporation’s mortgaged properties, considering issues of notice, scope of the mortgage, and alleged novation.
Is registration essential for the validity of a mortgage?	No, registration is not essential for the mortgage to be valid between the parties, but it is required for validity against third parties.
What are the requirements for a valid novation?	A valid novation requires the express release of the old debtor, the assumption of the obligation by a new debtor, and the consent of the creditor.
What is a dragnet clause in a mortgage?	A dragnet clause extends the coverage of a mortgage to other debts beyond those initially specified; however, it does not apply if there is no clear intention to rely on the original security.
Was the bank required to give personal notice of the foreclosure?	Yes, because the mortgage contract stipulated that all correspondence, including notifications of extrajudicial action, should be sent to the mortgagor.
What happens if the bank fails to provide the required notice?	Failure to provide the required notice constitutes a breach of contract that can invalidate the foreclosure proceedings.
What is the significance of being a third-party mortgagor?	As a third-party mortgagor, liability is limited to the specific obligations secured by the mortgaged properties, as defined in the mortgage contract.
Can a mortgage secure future loans or advancements?	Yes, but these future debts must be specifically described in the mortgage contract to be secured.

The Supreme Court’s decision in Paradigm Development Corporation v. BPI underscores the importance of strict compliance with contractual stipulations and legal requirements in foreclosure proceedings. It reinforces the principle that a mortgage’s coverage is limited to the debts explicitly agreed upon, protecting third-party mortgagors from undue liability. This ruling serves as a reminder to financial institutions to adhere to the terms of their contracts and provide proper notice to mortgagors, ensuring fairness and transparency in their dealings.

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: PARADIGM DEVELOPMENT CORPORATION OF THE PHILIPPINES, V. BANK OF THE PHILIPPINE ISLANDS, G.R. No. 191174, June 07, 2017