The Supreme Court of the Philippines addressed a case involving Security Bank Corporation and Spouses Mercado, focusing on the principles of mutuality in contracts and the validity of foreclosure sales. The Court ruled that interest rate provisions allowing the bank to unilaterally determine rates without a clear market-based reference violated the mutuality of contracts. Additionally, the Court invalidated the foreclosure sales due to significant errors in the published notices, emphasizing the need for strict compliance with publication requirements to protect potential bidders.

When a Bank’s Discretion Undermines Loan Mutuality: Examining Foreclosure Validity

This case, Security Bank Corporation v. Spouses Mercado, revolves around a revolving credit line agreement where the interest rates were determined by Security Bank. The spouses Mercado secured the credit line with real estate mortgages on their properties. When the spouses defaulted, Security Bank initiated extrajudicial foreclosure proceedings. However, the published notices of the foreclosure sales contained errors in the technical descriptions of the properties. The spouses Mercado challenged the foreclosure, arguing the interest rates were unilaterally imposed and the publication requirements were not properly met.

At the heart of this case is the principle of the mutuality of contracts, enshrined in Article 1308 of the New Civil Code, which mandates that contracts must bind both parties and cannot be left to the will of one. This principle ensures fairness and equality in contractual relationships. As the Supreme Court emphasized, “The contract must bind both contracting parties; its validity or compliance cannot be left to the will of one of them.” This means that any term in a contract, including interest rates, must be agreed upon by both parties.

The Supreme Court found that the interest rate provisions in the revolving credit line agreement violated this principle. The agreement allowed Security Bank to unilaterally determine the interest rates without a clear, market-based reference. The Court noted that the reference rate of “Security Bank’s prevailing lending rate” was not pegged on a market-based reference rate, as required by the Bangko Sentral ng Pilipinas (BSP). This lack of a defined reference rate gave Security Bank unchecked discretion, making the interest rate stipulation potestative, meaning it depended solely on the will of one party.

Moreover, the Court highlighted that any change in a contract, especially regarding interest rates, requires mutual agreement. The absence of written consent from the spouses Mercado for the interest rate adjustments further weakened Security Bank’s position. As such, the Court declared that the interest provisions are akin to those invalidated in previous cases, emphasizing that one-sided impositions do not have the force of law between the parties.

Aside from the interest rate issue, the Court also addressed the validity of the foreclosure sales. Act No. 3135, as amended, governs extrajudicial foreclosure sales and requires strict compliance with the publication requirements. Section 3 of the Act states:

Sec. 3. Notice shall be given by posting notices of the sale for not less than twenty days in at least three public places of the municipality or city where the property is situated, and if such property is worth more than four hundred pesos, such notice shall also be published once a week for at least three consecutive weeks in a newspaper of general circulation in the municipality or city.

The Court has consistently emphasized the importance of the notice of sale and its publication to give the foreclosure sale a reasonably wide publicity, securing bidders, and preventing a sacrifice of the property. Any substantial error in a notice of sale will render the notice insufficient and vitiate the sale.

In this case, the published notices contained errors in the technical descriptions of the properties and omitted the exact locations. The Court found these errors to be substantial because they could deter or mislead bidders, depreciate the value of the properties, or prevent the process from fetching a fair price. The Court cited San Jose v. Court of Appeals, emphasizing that a valid notice of sale must contain the correct title number and the correct technical description of the property to be sold.

While Security Bank published an erratum to correct the errors, the Court ruled that a single erratum did not cure the defect. The Court held that the corrected notice should have been published once a week for three consecutive weeks, as required by Act No. 3135. The failure to comply with this publication requirement rendered the foreclosure sales void.

The Court then addressed the issue of interest and penalties. The spouses Mercado argued that interest and penalties should only be imposed after the finality of the decision, relying on the doctrine of operative facts. However, the Court distinguished this case from Andal v. Philippine National Bank, noting that the spouses Mercado never denied defaulting on the principal obligation.

While the Court upheld the imposition of interest, it reduced the penalty of 2% per month (24% per annum) to 6% per annum, finding the original rate to be iniquitous and unconscionable. Article 1229 of the Civil Code allows the judge to equitably reduce the penalty when it is unconscionable.

Finally, the Court modified the amount of the outstanding obligation. Since the foreclosure sale of the property in Lipa City was not affected by the annulment proceedings, the proceeds from that sale should be applied to the principal obligation, plus interest and penalty from the extrajudicial demand until the date of the foreclosure sale. The resulting deficiency would then earn legal interest.

FAQs

What was the key issue in this case?	The key issues were the validity of the interest rate provisions in the loan agreement and the validity of the foreclosure sales, particularly concerning compliance with publication requirements. The Court examined whether the bank had unilaterally imposed unfair terms and whether the public was adequately notified of the foreclosure.
Why were the foreclosure sales declared void?	The foreclosure sales were declared void because the published notices contained errors in the technical descriptions of the properties and omitted their locations. The Court found that these errors could mislead potential bidders and depreciate the value of the properties, failing to strictly comply with the publication requirements of Act No. 3135.
What is the principle of mutuality of contracts?	The principle of mutuality of contracts, as stated in Article 1308 of the New Civil Code, means that a contract must bind both contracting parties, and its validity or compliance cannot be left to the will of one of them. This ensures fairness and equality in contractual relationships, preventing one party from unilaterally imposing terms.
Why were the interest rate provisions deemed invalid?	The interest rate provisions were deemed invalid because they allowed Security Bank to unilaterally determine the interest rates without a clear, market-based reference. The Court found that the reference rate of “Security Bank’s prevailing lending rate” was not pegged on a market-based reference rate, giving the bank unchecked discretion.
What is a potestative condition?	A potestative condition is a condition in a contract that depends solely on the will of one of the contracting parties. Such conditions are generally considered invalid because they undermine the principle of mutuality of contracts, giving one party undue control over the agreement.
How did the Court address the issue of penalties?	While the Court upheld the imposition of penalties for default, it reduced the penalty from 2% per month (24% per annum) to 6% per annum. The Court found the original rate to be iniquitous and unconscionable, exercising its power under Article 1229 of the Civil Code to equitably reduce the penalty.
What was the significance of the Lipa City property?	The foreclosure sale of the property in Lipa City was not affected by the annulment proceedings. Therefore, the proceeds from that sale were applied to the principal obligation, plus interest and penalty, up to the date of the foreclosure sale, reducing the deficiency owed by the spouses Mercado.
What interest rate applies when the stipulated rate is invalid?	In the absence of a valid stipulated interest rate, the legal interest rate applies. The Court ruled that the outstanding obligation would earn legal interest at 12% per annum from January 5, 2001, until June 30, 2013, and then at 6% per annum from July 1, 2013, until the finality of the judgment.

The Supreme Court’s decision in Security Bank Corporation v. Spouses Mercado underscores the importance of fairness and transparency in loan agreements and foreclosure proceedings. It serves as a reminder to banks to ensure that interest rate provisions are mutually agreed upon and based on clear, market-based references. It also highlights the necessity of strict compliance with publication requirements in foreclosure sales to protect the rights of borrowers and potential bidders. By upholding these principles, the Court reinforces the integrity of contractual relationships and the protection of property rights.

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: Security Bank Corporation v. Spouses Rodrigo and Erlinda Mercado, G.R. No. 192934, June 27, 2018