Berkenkotter vs. Cu Unjieng e Hijos

Machinery and equipment installed in a mortgaged sugar central in lieu of less-capacity units, for the purpose of carrying on the central's industrial functions and increasing production, constitute permanent improvements subject to the mortgage constituted on the central, and neither a private agreement to hold them as security for a separate credit nor a subsequent sale to the financing creditor vests the latter with ownership free of the prior mortgage.

The Mabalacat Sugar Co., Inc. owned a sugar central in Mabalacat, Pampanga. On April 26, 1926, it obtained a loan from Cu Unjieng e Hijos secured by a first mortgage over two parcels of land together with all buildings, improvements, the sugar-cane mill, steel railway, telephone line, apparatus, utensils, and whatever forms part of or is a necessary complement of the mill — whether existing at the time or arising in the future. Berkenkotter was an employee of the Mabalacat Sugar Co. who, in addition to advancing purchase money for new machinery, held an unpaid salary credit against the corporation. The dispute arose when the corporation failed to obtain an additional loan from the mortgagees to reimburse Berkenkotter, and Berkenkotter sought to assert rights over the new machinery superior to those of the mortgagees.

On April 26, 1926, the Mabalacat Sugar Co., Inc., owner of a sugar central in Mabalacat, Pampanga, obtained a loan from Cu Unjieng e Hijos secured by a first mortgage over two parcels of land together with "all its buildings, improvements, sugar-cane mill, steel railway, telephone line, apparatus, utensils and whatever forms part or is necessary complement of said sugar-cane mill, steel railway, telephone line, now existing or that may in the future exist." The mortgage expressly covered not only existing improvements but also those that might arise in the future.

Shortly after the mortgage was constituted, on October 5, 1926, the Mabalacat Sugar Co. decided to increase the capacity of its sugar central from 150 to 250 tons daily by purchasing additional machinery and equipment at an estimated cost of approximately ₱100,000. B.A. Green, president of the corporation, proposed to Berkenkotter that he advance the necessary funds, promising reimbursement as soon as an additional loan could be obtained from the mortgagees, Cu Unjieng e Hijos. In a letter dated October 5, 1926 (Exhibit E), Green further undertook that should he fail to secure the additional loan, the machinery and equipment would become security for Berkenkotter's credit, and Green bound himself not to mortgage or encumber them to anyone until Berkenkotter was fully reimbursed. Berkenkotter agreed and, beginning October 9, 1926, delivered a total of ₱25,750 to Green. Berkenkotter also held a credit of ₱22,000 against the corporation for unpaid salary. With the ₱25,750 loan and the ₱22,000 salary credit, the Mabalacat Sugar Co. purchased the additional machinery and equipment now in litigation and installed them in the sugar central.

On June 10, 1927, Green applied to Cu Unjieng e Hijos for an additional loan of ₱75,000, offering as security the additional machinery and equipment acquired and installed after the execution of the original mortgage. Green failed to obtain the loan. Thereafter, an alleged sale of the machinery and equipment to Berkenkotter was effected, after the machinery had been permanently incorporated into the sugar central and while the mortgage in favor of Cu Unjieng e Hijos remained in force.

Berkenkotter filed a complaint against Cu Unjieng e Hijos and the other defendants seeking to assert his rights over the additional machinery and equipment. The Court of First Instance of Manila dismissed the complaint, declaring the additional machinery and equipment subject to the mortgage deed executed in favor of Cu Unjieng e Hijos. Berkenkotter appealed, assigning six alleged errors.

• Non-Permanent Character of Installation: Berkenkotter contended that the installation of the machinery and equipment in the sugar central was not permanent in character, because Green, in his letter (Exhibit E), had represented that the machinery would serve as security for Berkenkotter's credit and had bound himself not to mortgage or encumber it to anyone else until full reimbursement.
• Ownership by Virtue of Sale: Berkenkotter asserted ownership over the machinery and equipment by virtue of an alleged sale effected by the Mabalacat Sugar Co. to him after the machinery had been incorporated into the central.

• Inclusion of After-Acquired Machinery in Mortgage: Whether the additional machinery and equipment installed in the mortgaged sugar central are subject to the mortgage deed executed in favor of Cu Unjieng e Hijos.
• Effect of Private Security Agreement on Permanence: Whether Green's undertaking to hold the machinery as security for Berkenkotter's credit and to refrain from mortgaging or encumbering it alters the permanent character of the machinery's incorporation with the sugar central.
• Effect of Subsequent Sale to Creditor: Whether the sale of the machinery and equipment to Berkenkotter after their permanent incorporation into the mortgaged sugar central vests him with ownership thereof free of the prior mortgage.

• Inclusion of After-Acquired Machinery in Mortgage: Yes. The installation of machinery and equipment in a mortgaged sugar central, in lieu of less-capacity units, for the purpose of carrying on the central's industrial functions and increasing production, constitutes a permanent improvement subject to the mortgage under Article 1877 of the Civil Code.
• Effect of Private Security Agreement on Permanence: No. The private undertaking to hold the machinery as security and to refrain from encumbering it does not alter the permanent character of its incorporation with the sugar central, as nothing prevents the owner from giving the machinery as security at least under a second mortgage.
• Effect of Subsequent Sale to Creditor: No. The sale of the machinery after its permanent incorporation into the mortgaged central does not vest the creditor with ownership but merely with a right of redemption, subject to the mortgagee's first mortgage.

• Inclusion of After-Acquired Machinery in Mortgage: Article 1877 of the Civil Code provides that a mortgage includes all natural accessions, improvements, growing fruits, and rents not collected when the obligation falls due, whether the estate remains with the mortgagor or passes to a third person. The mortgage deed in this case expressly covered "whatever forms part or is necessary complement of said sugar-cane mill … now existing or that may in the future exist." In Bischoff vs. Pomar and Compañia General de Tabacos (12 Phil., 690), approved in Cea vs. Villanueva (18 Phil., 538), the Court established that all objects permanently attached to a mortgaged building or land, even if placed there after the mortgage was constituted, are included, unless the parties expressly stipulated their exclusion. No such exclusion was stipulated here. Article 334, paragraph 5, of the Civil Code classifies as real property machinery, instruments, or implements intended by the owner of any building or land for use in connection with any industry or trade carried on therein and expressly adapted to meet the requirements of such trade or industry. The additional machinery and equipment, installed to replace less-capacity units and enable the central to mill 250 tons daily instead of 150, were essential and principal elements of the sugar central — without them the central could not function. Because the central is permanent in character, the necessary machinery installed for carrying on its industrial purpose must likewise be permanent. Upon acquisition by the Mabalacat Sugar Co. with funds borrowed from Berkenkotter, the corporation became the owner of the machinery; Green, as president, could not have offered it as security otherwise. The machinery's permanent incorporation into the central thus brought it within the scope of the existing mortgage.

• Effect of Private Security Agreement on Permanence: Green's undertaking to hold the machinery as security for Berkenkotter's credit and to refrain from mortgaging or encumbering it until full reimbursement is not incompatible with the permanent character of the machinery's incorporation with the sugar central. Nothing prevented Green from giving the machinery as security at least under a second mortgage. The private arrangement between Green and Berkenkotter could not override the prior mortgage lien already constituted in favor of Cu Unjieng e Hijos, nor could it alter the legal character of the machinery as real property once permanently installed.

• Effect of Subsequent Sale to Creditor: The sale of the machinery and equipment to Berkenkotter after its permanent incorporation into the mortgaged sugar central, and while the mortgage in favor of Cu Unjieng e Hijos remained in force, transferred only the right of redemption of the vendor — the Mabalacat Sugar Co. — in the sugar central with which the machinery had been incorporated. That right of redemption remained subject to the rights of the mortgagees under the first mortgage. Berkenkotter thus acquired no ownership free of the prior lien; he stood in no better position than a subsequent purchaser of mortgaged property.

• Mortgage Extends to After-Acquired Improvements and Fixtures — Under Article 1877 of the Civil Code and Articles 110 and 111 of the Mortgage Law, a mortgage of real estate includes all improvements, buildings, and machinery permanently attached to the mortgaged property, even if placed there after the mortgage was constituted. For machinery and other objects to be excluded from the mortgage when the mortgage expressly covers improvements, buildings, and machinery, the exclusion must be stipulated between the contracting parties. The Court applied this doctrine to hold that the additional machinery and equipment installed in the sugar central fell within the mortgage's express terms covering "whatever forms part or is necessary complement of said sugar-cane mill … now existing or that may in the future exist."

• Machinery as Real Property by Destination (Art. 334[5], Civil Code) — Machinery, liquid containers, instruments, or implements intended by the owner of any building or land for use in connection with any industry or trade being carried on therein, and expressly adapted to meet the requirements of such trade or industry, are real property. The Court applied this provision to classify the additional machinery and equipment as real property by reason of their purpose — they were essential and principal elements of the sugar central, without which it could not function — and therefore their incorporation was permanent in character.

• Sale of Mortgaged Property Conveys Only Right of Redemption — A sale of property already incorporated into a mortgaged estate, while the mortgage remains in force, transfers only the vendor's right of redemption, subject to the mortgagee's rights under the prior mortgage. The Court applied this principle to hold that Berkenkotter's alleged purchase of the machinery after its permanent incorporation into the mortgaged central gave him no more than a redeemable interest subordinate to the first mortgage.

• "It is a rule, established by the Civil Code and also by the Mortgage Law, with which the decisions of the courts of the United States are in accord, that in a mortgage of real estate, the improvements on the same are included; therefore, all objects permanently attached to a mortgaged building or land, although they may have been placed there after the mortgage was constituted, are also included." — This passage, drawn from Bischoff vs. Pomar and Compañia General de Tabacos, states the controlling doctrine that after-acquired permanent improvements fall within the scope of an existing mortgage, the ratio decidendi for the first issue.

• "If the installation of the machinery and equipment in question in the central of the Mabalacat Sugar Co., Inc., in lieu of the other of less capacity existing therein, for its sugar industry, converted them into real property by reason of their purpose, it cannot be said that their incorporation therewith was not permanent in character because, as essential and principal elements of a sugar central, without them the sugar central would be unable to function or carry on the industrial purpose for which it was established." — This passage articulates the reasoning by which machinery essential to a sugar central's operation is deemed permanently incorporated and thus real property by destination under Article 334(5) of the Civil Code.

• "the sale of the machinery and equipment in question by the purchaser who was supplied the purchase money, as a loan, to the person who supplied the money, after the incorporation thereof with the mortgaged sugar central, does not vest the creditor with ownership of said machinery and equipment but simply with the right of redemption." — This passage states the holding on the third issue: a post-incorporation sale of mortgaged machinery transfers only a right of redemption, not ownership free of the mortgage lien.

• Bischoff vs. Pomar and Compañia General de Tabacos, 12 Phil., 690 — Controlling precedent cited and applied. Established the doctrine that a mortgage of real estate includes all improvements and fixtures permanently attached to the mortgaged property, even those placed after the mortgage was constituted, unless the parties expressly stipulate their exclusion. The Court relied on this case as the principal authority for holding the additional machinery subject to the prior mortgage.

• Cea vs. Villanueva, 18 Phil., 538 — Followed precedent in which the doctrine from Bischoff vs. Pomar was cited with approval, reinforcing the rule that after-acquired permanent improvements are included in the mortgage.

• Article 1877, Civil Code — Provides that a mortgage includes all natural accessions, improvements, growing fruits, and rents not collected when the obligation falls due, whether the estate remains with the mortgagor or passes to a third person. Applied as the statutory basis for holding that the additional machinery and equipment, as permanent improvements on the mortgaged sugar central, fell within the scope of the mortgage.

• Article 334, paragraph 5, Civil Code — Classifies as real property machinery, liquid containers, instruments, or implements intended by the owner of any building or land for use in connection with any industry or trade being carried on therein and expressly adapted to meet the requirements of such trade or industry. Applied to classify the additional machinery and equipment as real property by destination, making their incorporation with the sugar central permanent in character.

• Articles 110 and 111, Mortgage Law — Cited in Bischoff vs. Pomar as supporting the rule that improvements on mortgaged real estate are included in the mortgage. Applied in conjunction with Article 1877 of the Civil Code to confirm the mortgagees' lien over the after-acquired machinery.

Malcolm, Imperial, Butte, and Goddard, JJ., concurred.