Development Bank of the Philippines vs. National Labor Relations Commission

Worker preference under Article 110 of the Labor Code, as amended by R.A. 6715, cannot be enforced absent bankruptcy or liquidation proceedings where all creditors are convened, their claims ascertained and inventoried, and preferences determined in a binding and conclusive manner. The right to preference given to workers under Article 110 cannot exist in any effective way prior to the time of its presentation in distribution proceedings.

The Development Bank of the Philippines (DBP) was the mortgage creditor of Lirag Textile Mills, Inc. (LIRAG), which ceased operations due to financial reverses. The Labor Alliance for National Development (LAND) was the bargaining representative of LIRAG's approximately 800 former rank-and-file employees. The dispute concerns the interplay between Article 110 of the Labor Code on worker preference in bankruptcy, the Civil Code's scheme on classification and preference of credits, and the Insolvency Law, particularly where a mortgage creditor has foreclosed on the debtor's properties.

The complainants in the two consolidated cases were former employees of Lirag Textile Mills, Inc. (LIRAG), a mortgage debtor of the Development Bank of the Philippines (DBP). The Labor Alliance for National Development (LAND) was the bargaining representative of approximately 800 former rank-and-file employees. Around September 1981, LIRAG began terminating employees on the ground of retrenchment; by December of that year, 180 regular employees had been separated. LIRAG has since ceased operations, presumably due to financial reverses.

In February 1982, Joselito Albay, one of the employees dismissed in September 1981, filed a complaint before the NLRC against LIRAG for illegal dismissal (Case No. 2-2090-82). On 1 March 1982, LAND, on behalf of 180 dismissed members, also filed a Complaint against LIRAG seeking separation pay, 13th month pay, gratuity pay, sick leave and vacation leave pay, and emergency allowance (Case No. 3-2581-82). The cases were consolidated and jointly heard, with supervisors and managers later joining the complainants. In a Decision dated 30 July 1982, Labor Arbiter Apolinar L. Sevilla ordered LIRAG to pay the individual complainants; the NLRC (Third Division) affirmed on 28 March 1982, and the judgment became final and executory.

On 15 April 1983, a Writ of Execution was issued. On the same day, DBP extrajudicially foreclosed the mortgaged properties for LIRAG's failure to pay its mortgage obligation. As the only bidder at the foreclosure sale, DBP acquired the properties for P31,346,462.90. Since DBP was the sole mortgagee, no actual payment was made; the bid amount was merely credited in partial satisfaction of LIRAG's indebtedness. The Writ of Execution in favor of the complainants remained unsatisfied, and a Notice of Levy on Execution on LIRAG's properties was entered.

On 7 December 1984, LAND filed a "Motion for Writ of Execution and Garnishment" of the foreclosure sale proceeds. On 30 May 1985, upon LAND's motion, Labor Arbiter Sevilla ordered DBP impleaded "in the interest of justice and due process" and required it to intervene. On 12 February 1986, over DBP's opposition, Labor Arbiter Sevilla granted the Writ of Garnishment and directed DBP to remit P6,292,380.00 to the NLRC out of the foreclosure proceeds. DBP sought reconsideration on grounds of lack of jurisdiction and deprivation of property without due process; Labor Arbiter Isabel P. Ortiguerra denied reconsideration on 25 May 1987, and DBP appealed to the NLRC.

In the meantime, on 3 February 1987, by virtue of Proclamation Nos. 50 and 50-A, the Asset Privatization Trust (APT) became the transferee of DBP's foreclosed assets of LIRAG. On 12 July 1989, the Court deemed APT impleaded as a party-petitioner. On 21 December 1987, a partial Compromise Agreement was entered into between APT and LAND (Litex Chapter) whereby APT paid the complainants-employees ex gratia the sum of P750,000.00 "in full settlement of their claims, past and present, with respect to all assets of LITEX transferred by DBP to APT." That amount was received by LAND's local President. However, on 25 January 1988, LAND, through its national President, filed its opposition to the Compromise Agreement for being contrary to law, morals, and public policy. On 25 March 1988, the NLRC (First Division) affirmed the appealed Order and dismissed DBP's appeal.

• Lack of Jurisdiction: DBP argued that the NLRC lacked jurisdiction over it because DBP was not a party to the case.
• Deprivation of Property Without Due Process: DBP contended that it was deprived of its property without due process of law.
• Mortgage Credit as Special Preferred Credit: DBP anchored its claim on a mortgage credit, which directly and immediately subjects the property upon which it is imposed to the fulfillment of the obligation, creating a real right enforceable against the whole world; a recorded mortgage credit is a special preferred credit under Article 2242(5) of the Civil Code.

• Satisfaction of Final Judgment: LAND sought to garnish the proceeds of the foreclosure sale to satisfy the final and executory judgment rendered in favor of LIRAG's workers.
• Worker Preference: LAND invoked Article 110 of the Labor Code, as amended by R.A. 6715, which grants workers first preference as regards their unpaid wages and other monetary claims, to be paid in full before the claims of the Government and other creditors.

• Jurisdiction Over DBP: Whether the NLRC had jurisdiction to implead DBP and issue orders against it for the satisfaction of the final judgment.
• Due Process: Whether DBP was deprived of its property without due process of law.
• Enforceability of Worker Preference: Whether the NLRC gravely abused its discretion in affirming the Order granting the Writ of Garnishment out of the proceeds of LIRAG's properties foreclosed by DBP, absent a formal declaration of bankruptcy or judicial liquidation.

• Jurisdiction Over DBP: Yes. Being an incident in the execution of the final judgment award, the NLRC retained jurisdiction and control over the case and could issue such orders as were necessary for the implementation of that award. DBP had to be impleaded for the proper satisfaction of a final judgment.
• Due Process: No. DBP was given the opportunity to be heard and to present its evidence; it filed its Opposition to the Motion for Execution and Garnishment, and the Order granting the Motion was issued only after hearing. DBP also appealed to the NLRC, thereby submitting to its jurisdiction.
• Enforceability of Worker Preference: Yes, the NLRC gravely abused its discretion. Worker preference under Article 110 of the Labor Code, as amended by R.A. 6715, cannot be enforced absent bankruptcy or liquidation proceedings where all creditors' claims may be adjudicated in a binding and conclusive manner.

• Jurisdiction Over DBP: The Court reasoned that although DBP was not an original party, it had to be impleaded for the proper satisfaction of a final judgment. Its inclusion as a party could not have been accomplished at the earlier stages of the proceedings because at the time of the filing of the Complaint, private respondents' cause of action was only against LIRAG. Being an incident in the execution of the final judgment award, the NLRC retained jurisdiction and control over the case.

• Due Process: The Court found that DBP was not deprived of due process because it was given the opportunity to be heard and to present its evidence. DBP had actually filed its Opposition to the Motion for Execution and Garnishment, and the Order granting the Motion was issued only after hearing. DBP had also addressed an appeal to the NLRC, thereby submitting to its jurisdiction.

• Enforceability of Worker Preference: The Court ruled that Article 110 of the Labor Code, as amended by R.A. 6715, cannot be viewed in isolation but must be read in relation to the Civil Code scheme on classification and preference of credits. The Court enumerated six considerations: (1) Article 110 must be read with the Civil Code provisions on classification, concurrence, and preference of credits, which find particular application in insolvency proceedings; (2) the Labor Law must be harmonized with the Civil Code and the Insolvency Law; (3) in the event of insolvency, a principal objective is equitable distribution of the insolvent's property among creditors, requiring a proceeding where notice to all creditors may be given and claims of preferred creditors bindingly adjudicated; (4) a distinction must be made between a preference of credit and a lien — Article 110 does not create a lien but is but a preference of credit, a preference in application; (5) a mortgage credit creates a real right enforceable against the whole world, and a recorded mortgage credit is a special preferred credit under Article 2242(5) of the Civil Code; and (6) even if Article 110 and its Implementing Rule should be interpreted to mean "absolute preference," the same should be given only prospective effect in line with the cardinal rule that laws shall have no retroactive effect, unless the contrary is provided, thereby avoiding infringement on the constitutional guarantee on non-impairment of the obligation of contracts. The Court concluded that the right to preference given to workers under Article 110 cannot exist in any effective way prior to the time of its presentation in distribution proceedings.

• Worker preference requires bankruptcy or liquidation proceedings — The right to preference given to workers under Article 110 of the Labor Code cannot exist in any effective way prior to the time of its presentation in distribution proceedings. It will find application when, in proceedings such as insolvency, unpaid wages shall be paid in full before the claims of the Government and other creditors may be paid. For an orderly settlement of a debtor's assets, all creditors must be convened, their claims ascertained and inventoried, and thereafter the preferences determined in the course of judicial proceedings which have for their object the subjection of the property of the debtor to the payment of his debts or other lawful obligations.

• Preference of credit distinguished from lien — A preference applies only to claims which do not attach to specific properties, while a lien creates a charge on a particular property. The right of first preference as regards unpaid wages recognized by Article 110 does not constitute a lien on the property of the insolvent debtor in favor of workers; it is but a preference of credit in their favor, a preference in application. It is a method adopted to determine and specify the order in which credits should be paid in the final distribution of the proceeds of the insolvent's assets.

• Prospective application of laws — Even if Article 110 and its Implementing Rule, as amended, should be interpreted to mean "absolute preference," the same should be given only prospective effect in line with the cardinal rule that laws shall have no retroactive effect, unless the contrary is provided (Article 4, Civil Code). Thereby, any infringement on the constitutional guarantee on non-impairment of the obligation of contracts is also avoided.

• "It is quite clear from the provision that a declaration of bankruptcy or a judicial liquidation must be present before the workers preference may be enforced. Thus, Article 110 of the Labor Code and its implementing rule cannot be invoked by the respondents in this case absent a formal declaration of bankruptcy or a liquidation order." — This passage, quoted from Development Bank of the Philippines vs. Santos, states the rule that a formal declaration of bankruptcy or judicial liquidation is required before worker preference may be enforced.

• "Article 110 of the Labor Code does not purport to create a lien in favor of workers or employees for unpaid wages either upon all of the properties or upon any particular property owned by their employer. Claims for unpaid wages do not therefore fall at all within the category of specially preferred claims established under Articles 2241 and 2242 of the Civil Code, except to the extent that such complaints for unpaid wages are already covered by Article 2241, number 6: 'claims for laborers wages, on the goods manufactured or the work done;' or by Article 2242, number 3: 'claims of laborers and other workers engaged in the construction, reconstruction or repair of buildings, canals and other works, upon said buildings, canals and other works.'" — This passage from Republic vs. Peralta clarifies that Article 110 creates a preference of credit, not a lien, and situates worker claims within the Civil Code's classification of credits.

• "A preference of credit bestows upon the preferred creditor an advantage of having his credit satisfied first ahead of other claims which may be established against the debtor. Logically, it becomes material only when the properties and assets of the debtors are insufficient to pay his debts in full; for if the debtor is amply able to pay his various creditors in full, how can the necessity exist to determine which of his creditors shall be paid first or whether they shall be paid out of the proceeds of the sale the debtor's specific property?" — This passage, quoted from DBP vs. Secretary of Labor, explains why preference of credit becomes material only in insolvency or liquidation contexts.

• Development Bank of the Philippines vs. Santos, G.R. Nos. 78261-62, 8 March 1989 — Controlling precedent holding that a declaration of bankruptcy or judicial liquidation must be present before worker preference may be enforced under Article 110 of the Labor Code.
• Republic vs. Peralta, G.R. No. L-56568, 20 May 1987, 150 SCRA 37 — Followed; establishes that Article 110 of the Labor Code does not create a lien in favor of workers and must be read in relation to the Civil Code provisions on classification and preference of credits.
• DBP vs. Secretary of Labor, G.R. No. 79351, 28 November 1989 — Quoted for the proposition that preference of credit becomes material only when the properties and assets of the debtor are insufficient to pay his debts in full.
• De Barretto vs. Villanueva, No. L-14938, 29 December 1962, 6 SCRA 928 — Cited for the principle that in the event of insolvency, there must be a proceeding where notice to all creditors may be given and claims of preferred creditors bindingly adjudicated.
• Philippine Savings Bank vs. Lantin, G.R. No. 33929, 2 September 1983, 124 SCRA 476 — Cited for the proposition that an orderly determination of preference of creditors' claims is assured through judicial proceedings.
• Kuenzle & Streiff (Ltd.) vs. Villanueva, 41 Phil 611 (1916) — Cited in DBP vs. Secretary of Labor for the principle that preferential right of credit attains significance only after the properties of the debtor have been inventoried and liquidated.

• Article 110, Labor Code (as amended by R.A. 6715) — Provides that in the event of bankruptcy or liquidation of an employer's business, workers shall enjoy first preference as regards their unpaid wages and other monetary claims, any provision of law to the contrary notwithstanding; such unpaid wages and monetary claims shall be paid in full before the claims of the Government and other creditors may be paid. The Court held that this provision cannot be enforced absent bankruptcy or liquidation proceedings.
• Section 10, Rule VIII, Book III, Revised Rules and Regulations Implementing the Labor Code (as amended) — Provides that in case of bankruptcy or liquidation of the employer's business, the unpaid wages and other monetary claims of the employees shall be given first preference and shall be paid in full before the claims of government and other creditors may be paid. The Court noted that the terms "declaration" of bankruptcy or "judicial" liquidation have been eliminated but held that liquidation proceedings have not been done away with.
• Articles 2241 and 2242, Civil Code — Classify special preferred credits, including claims for laborers' wages on goods manufactured or work done (Article 2241(6)) and claims of laborers and other workers engaged in construction, reconstruction, or repair of buildings (Article 2242(3)), and recorded mortgage credits (Article 2242(5)). The Court held that Article 110 must be read in relation to these provisions.
• Article 2244, Civil Code — Classifies ordinary preferred credits; the Court noted that worker claims falling outside Articles 2241(6) and 2242(3) come within the ambit of ordinary preferred credits under this provision.
• Article 4, Civil Code — Provides that laws shall have no retroactive effect unless the contrary is provided; the Court applied this to hold that even if Article 110 means "absolute preference," it should be given only prospective effect.
• Section 10, Article III, 1987 Constitution — The non-impairment of obligations of contracts clause; the Court held that giving Article 110 retroactive effect would infringe this guarantee.
• Section 29, Insolvency Law — Provides that a creditor holding a mortgage or lien of any kind as security is not permitted to vote in the election of the assignee in insolvency proceedings unless the value of his security is first fixed or he surrenders all such property to the receiver of the insolvent's estate.

Fernan, C.J., Narvasa, Gutierrez, Jr., Feliciano, Gancayco, Bidin, Cortes, Griño-Aquino, Medialdea, and Regalado, JJ., concurred.

• Justice Cruz — Dissented, reiterating his position as the lone dissenter in Republic vs. Peralta. He was convinced that it was the intention of the legislature to give absolute preference to the workers' claims pursuant to the social justice policy, and that the amendment of Article 110 of the Labor Code by R.A. 6715 strengthened that conviction. He quoted: "Social Justice is not a mere catch phrase to be mouthed with sham fervor in Labor Day celebrations for the delectation and seduction of the working class. It is a mandate we should pursue with energy and sincerity if we are to truly insure the dignity and well-being of the laborer."

• Justice Padilla — Dissented, arguing that the majority failed to fully take into account the radical change introduced by R.A. 6715 into the system of priorities or preferences among credits ordained by the Civil Code. He argued that a prior formal declaration of insolvency or bankruptcy or judicial liquidation is not a condition sine qua non to the operation of the preference accorded to workers under Article 110, because: (1) the majority reads into the law a qualification that is not there — the phrase "declaration of bankruptcy or judicial liquidation" has been deleted from the new implementing rule; and (2) a proceeding in rem is not essential to enforce the workers' preferential right because Article 110 itself bars the satisfaction of claims of other creditors until unpaid wages and monetary claims of the workers are first satisfied in full. He voted to DISMISS the DBP petition and AFFIRM the NLRC resolution in favor of LAND. Justice Paras concurred.

• Justice Sarmiento — Dissented, joining Justice Padilla's dissent. He opined that under R.A. 6715, the payment of unpaid wages and other benefits to labor enjoys preference over all other indebtedness, including taxes, with or without a declaration of insolvency, because labor enjoys protection not only from statute but from the very Constitution, citing Article II, Section 18 and Article XIII, Section 3 of the 1987 Constitution, as well as Articles 3 and 4 of the Labor Code and Articles 1700 and 1702 of the Civil Code.