Pactum commissorium is an arrangement empowering the creditor to appropriate the thing given as security for the fulfillment of the obligation in the event the obligor fails to pay, without further formality, such as foreclosure proceedings, and a public sale.

It is a well-settled rule that dacion en pago sales, indicative of pactum commissorium, are prohibited and considered null and void under the New Civil Code.

However, in the recent case of Ruby Shelter Builders and Realty Development Corporation (Ruby Shelter) vs. Romeo Y. Tan et al:, the Supreme Court held that not all instances of alienation of mortgaged property by the debtor in favor of the creditor in the event of failure to timely pay the obligation will be declared void for being pactum commissorium. The prohibition does not extend to a mutual agreement between the debtor and creditor that the property subject of the mortgage is sold to the latter to extinguish the obligation.

In this case, petitioner Ruby Shelter obtained a loan from respondents Tan and Obiedo, secured by a Real Estate Mortgage covering five parcels of land. Subsequently, in order to secure an extension for the repayment of the loan, both parties executed a memorandum of agreement (MoA), which contains the provision, among others, that (i) petitioner shall, by way of dacion en pago, execute deeds of absolute sale over the mortgaged parcels of land in favor of respondents; (ii) that petitioner is allowed to pay off the indebtedness covered by the real estate mortgage, either by individual lots or the entire five parcels of land; and (iii) if the petitioner shall not be able to tender any amount for the payment of the indebtedness corresponding to any of the parcel of land, the respondents are allowed to present the deeds of absolute sale over the properties for registration with the Office of the Register of Deeds.

In upholding the validity of the MoA as not constituting pactum commissorium, the Court emphasized that pactum commissorium does not extend to a mutual agreement between the debtor and the creditor that the property subject of the mortgage is sold to the latter to extinguish the obligation. According to the Court, when the parties entered into a separate Deed of Absolute Sale, it proves that there was no automatic transfer of ownership, and therefore, no pactum commissorium.

As in this case, the Court appreciated the fact that it was petitioner, through its own offer, who voluntarily executed a deed of absolute sale as dation in payment which could not have given rise to a pactum commissorium. Respondents did not instantly acquire ownership over the mortgaged properties, as the parties had agreed to free them from the mortgage by executing a deed of absolute sale as dation in payment.

Noteworthy also is the High Court’s findings that there was no evidence presented to prove that petitioner and its president were hapless and powerless borrowers and were at a disadvantage in dealing with respondents.

Ultimately, the existence of pactum commissorium is a factual matter requiring the Court to assess the contractual terms and the parties’ intent to establish its presence.

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