G. Holdings, Inc. vs. CEPALCO

An absolutely simulated contract is void and produces no legal effect from the beginning, as the parties do not intend to be bound by it; simulation exists where the ostensible absolute transfer of ownership is contradicted by the parties’ true intent, as shown by contemporaneous writings and conduct, to retain essential control, operational rights, and beneficial use of the property conveyed.

CEPALCO supplied electricity to FPI’s ferro-alloy smelting plant at the PHIVIDEC Industrial Estate from March 1990. FPI defaulted, accumulating unpaid bills exceeding P29 million by May 1996, which led CEPALCO to disconnect power and file a collection suit before the RTC-Pasig. That court rendered a Partial Summary Judgment in 1999 and a final Decision in 2004, awarding CEPALCO over P25 million plus surcharges. While FPI’s appeal was pending, CEPALCO obtained a writ of execution pending appeal. Meanwhile, on March 11, 2003, FPI executed a Deed of Assignment purporting to transfer absolutely all its properties, equipment, and facilities to GHI—its sister company with substantially identical directors—in consideration of P50,366,926.71 in obligations. When the sheriff levied on FPI’s properties in April 2004, GHI filed suit to nullify the levy, claiming ownership under that Deed.

• Nature of the Action: GHI filed a complaint in RTC-CDO to nullify the sheriff’s levy and auction sale over properties it claimed as its own, to recover possession, and to obtain damages. The claim of ownership was anchored on a Deed of Assignment dated March 11, 2003, by which FPI purportedly transferred absolutely all its properties, equipment, and facilities to GHI in consideration of P50,366,926.71 in obligations as of December 31, 2002. CEPALCO answered with a compulsory counterclaim and cross-claim, seeking rescission of the Deed as simulated and fraudulent.

• The Underlying Debt and Judgment: CEPALCO supplied power to FPI’s smelting plant. FPI’s unpaid electric bills reached P29,509,240.89 as of May 1996, prompting CEPALCO to disconnect supply and sue for collection. RTC-Pasig rendered a Partial Summary Judgment in 1999 ordering FPI to pay P25,608,579.98, and a final Decision in 2004 affirming that amount plus surcharges and other charges. Execution pending appeal was granted, and a writ issued on March 30, 2004. The sheriff levied upon FPI’s personal and real properties in April 2004.

• The February 28, 2003 Letter: Eleven days before the Deed of Assignment, FPI sent GHI a letter (bearing GHI’s conformity) confirming the manner of settling FPI’s obligations. The letter stipulated that FPI’s right to the “Outokumpo” work process—described as essential to operate the smelting facility—would be retained by FPI and made available to GHI under two alternating options. Option A: FPI would operate the plant at its own expense and share 20% of EBITDA (minimum P10M annually) with GHI. Option B: GHI would operate the plant and pay FPI 10% of EBITDA (minimum P7.5M annually), with an option for GHI to acquire the process rights for P36M after a minimum of eight years. GHI was to choose first, with its choice binding for three years, after which FPI would choose for the next three years, with the cycle repeating if the plant had not operated for six years from assignment.

• The Deed of Assignment: Executed on March 11, 2003, the unilateral Deed recited that FPI, through its Acting President, “assigned, transferred, ceded and conveyed absolutely” in favor of GHI all of FPI’s properties, equipment, and facilities at the PHIVIDEC Industrial Estate. The stated consideration was FPI’s indebtedness to GHI amounting to P50,366,926.71. GHI and FPI were sister companies with substantially the same directors.

• Indicia of Absence of True Transfer: FPI’s Acting President admitted that GHI could not operate the equipment without the “Outokumpo” process retained by FPI, and GHI had never operated the plant. The equipment remained physically in the plant premises under FPI’s control; FPI continued to employ security and skeletal personnel there. The assets assigned were valued at approximately P280 million, far exceeding the P50 million consideration. The Deed was executed after the Partial Summary Judgment and during the pendency of the collection suit.

• Lower Courts’ Findings: RTC-CDO found badges of fraud—gross inadequacy of consideration, execution after the partial judgment while FPI was financially distressed, assignment of substantially all assets, and lack of exclusive possession by GHI—and rescinded the Deed. The CA affirmed but added that the Deed was absolutely simulated, reasoning that the letter revealed the parties never intended a true transfer but sought to keep the smelting facility intact and beyond CEPALCO’s reach.

• Non-payment of Filing Fees: GHI argued that CEPALCO’s counterclaim for rescission was permissive, not compulsory, and should have been dismissed for failure to pay docket fees.
• Validity of the Assignment: GHI maintained that the Deed of Assignment was a valid, binding contract, not absolutely simulated; there was actual consideration, and the parties genuinely intended to transfer ownership.
• Improper Rescission: GHI contended that rescission cannot be granted without an independent action specifically instituted for that purpose, and the lower courts erred in ordering rescission collaterally in an action for nullification of levy and recovery of possession.
• Absence of Fraud: GHI asserted that the Deed was not executed in fraud of creditors and that the badges of fraud identified by the lower courts were insufficient to invalidate the assignment.
• Entitlement to Damages: GHI claimed it was entitled to damages for the wrongful levy and attempted auction sale of properties it owned.

• Compulsory Nature of Counterclaim: CEPALCO countered that its counterclaim was compulsory because it arose from the same transaction—the Deed of Assignment—that GHI invoked as the basis of ownership; thus, when filed on April 26, 2004, it was not yet subject to docket fees under the amendment effective August 16, 2004.
• Absolute Simulation: CEPALCO argued the Deed was absolutely simulated, as FPI never intended to divest itself of title and control; the February 28, 2003 letter showed FPI retained the essential work process and operational rights, making the apparent absolute transfer a sham to place assets beyond CEPALCO’s reach.
• Fraud of Creditors: CEPALCO maintained that the Deed was executed in fraud of creditors under Article 1381(3) of the Civil Code, given the timing after the Partial Summary Judgment, the gross inadequacy of consideration, and FPI’s continued control of the premises, justifying rescission.

• Filing Fees: Whether the CA erred in not dismissing CEPALCO’s counterclaim for non-payment of docket fees.
• Absolute Simulation: Whether the CA erred in holding the Deed of Assignment absolutely simulated and thus void.
• Rescission without Independent Action: Whether the CA erred in effectively rescinding the Deed absent an independent action for rescission.
• Fraud of Creditors: Whether the CA erred in finding that the Deed was executed in fraud of creditors and that badges of fraud accompanied its execution.
• Damages: Whether GHI is entitled to its claims for damages.

• Filing Fees: CEPALCO’s counterclaim was compulsory. It arose directly from the same transaction or occurrence—the Deed of Assignment—that GHI relied upon to assert ownership and seek recovery. Under Rule 6, Section 7, a compulsory counterclaim does not require payment of docket fees. At the time of filing on April 26, 2004, the amendment to Rule 141 imposing fees on compulsory counterclaims (effective August 16, 2004) was not yet operative. No reversible error was committed.

• Absolute Simulation: The Deed of Assignment was absolutely simulated and therefore void. Article 1345 defines absolute simulation as a contract where the parties do not intend to be bound at all. The February 28, 2003 letter exposed the true intent: FPI retained the “Outokumpo” work process without which the plant could not operate, and the parties structured alternating operational rights and revenue-sharing schemes that permitted FPI to regain control and operate the assigned assets. The wordings of the Deed—“assigned, transferred, ceded and conveyed absolutely”—were belied by the letter and by FPI’s continued exercise of dominion. FPI’s admission that GHI could not operate the facilities without the retained process, the absence of physical delivery, and FPI’s maintenance of security and skeletal personnel further demonstrated that no genuine transfer was intended. The Deed was a sham, designed to place the assets beyond the reach of CEPALCO.

• Rescission without Independent Action: The RTC-CDO had ordered rescission on the ground of fraud, but the proper characterization of the Deed was absolute simulation rendering it void ab initio. Rescissible contracts under Article 1381 are initially valid and require a subsidiary action under Article 1383; void or inexistent contracts under Article 1409, including absolutely simulated ones, produce no legal effect from inception and may be declared null even collaterally. The CA correctly identified the Deed as absolutely simulated but erred in affirming rescission, as rescissible and void contracts are mutually exclusive categories. The error, however, did not warrant reversal because the Deed was void and could not confer ownership on GHI.

• Fraud of Creditors: The badges of fraud—gross disproportion between the P280 million asset value and the P50 million consideration, execution after the Partial Summary Judgment while FPI was insolvent, assignment of substantially all assets, absence of exclusivity in GHI’s possession, and retention of the essential work process—demonstrated an intent to defraud CEPALCO. These badges, however, fortified the conclusion of absolute simulation rather than mere rescissibility. The contract was not merely prejudicial to a creditor; it was fictitious, never intended to produce real legal effects.

• Damages: The declaration of the Deed as inexistent stripped GHI of any basis for its claim of ownership. Consequently, its complaint for recovery of possession and damages was dismissed for lack of cause of action. The issue of GHI’s entitlement to damages became moot.

• Absolute Simulation of Contracts — An absolutely simulated or fictitious contract is void and inexistent from the beginning under Article 1409(2) of the Civil Code. It is characterized by the lack of any genuine intent to be bound; the apparent contract is not desired or intended to produce legal effects or alter the juridical situation of the parties. Where a debtor simulates a transfer to another to place property beyond the reach of creditors, there is no real intention to divest title and control, and the deed is a sham. The action or defense for the declaration of inexistence does not prescribe, and the contract cannot be ratified. The Court applied this doctrine by treating the February 28, 2003 letter as proof that FPI never intended to part with beneficial ownership and operational control, despite the absolute terms of the Deed.

• Mutual Exclusivity of Rescissible and Void Contracts — Rescissible contracts are initially valid and enforceable until rescinded; they suffer from extrinsic lesion or prejudice to a party or third person but possess all essential requisites. Void or inexistent contracts, by contrast, are afflicted with an intrinsic vice in an essential element and produce no legal effect whatsoever. The two categories are mutually exclusive: a contract cannot simultaneously be rescissible and void. Rescission is a subsidiary remedy under Article 1383; nullity is a principal action that may be raised directly or collaterally. The Court clarified that although the lower courts found fraud, the Deed did not fall under Article 1381(3) because it was not a valid contract at all—it was absolutely simulated and therefore void ab initio.

• Compulsory Counterclaim and Docket Fees — Under Rule 6, Section 7 of the Rules of Court, a counterclaim that arises out of or is necessarily connected with the transaction or occurrence that is the subject matter of the opposing party’s claim is compulsory. Prior to the August 16, 2004 effectivity of the amendment to Rule 141 (A.M. No. 04-2-04-SC), no docket fees were required for compulsory counterclaims. The Court ruled that CEPALCO’s counterclaim seeking rescission of the Deed of Assignment arose from the very same Deed that GHI invoked as the foundation of its ownership claim, making it compulsory and exempt from filing fees at the time of filing.

• “[T]he characteristic of simulation is the fact that the apparent contract is not really desired or intended to produce legal effects or in any way alter the juridical situation of the parties. Thus, where a person, in order to place his property beyond the reach of his creditors, simulates a transfer of it to another, he does not really intend to divest himself of his title and control of the property; hence, the deed of transfer is but a sham.” — Quoting Vda. de Rodriguez v. Rodriguez, this passage defines the essence of absolute simulation and anchors the Court’s conclusion that the Deed of Assignment was a sham.

• “The lack of intention on the part of FPI to divest its ownership and control of ‘all of [its] properties, equipment and facilities …’ — in spite of the wordings in the Deed of Assignment … — is evident from the letter dated February 28, 2003 which reveals the true intention of FPI and GHI.” — This passage illustrates the Court’s method of piercing the ostensible contract by examining a contemporaneous document that disclosed the parties’ real agreement.

• “Rescissible contracts and void or inexistent contracts belong to two mutually exclusive groups. A void or inexistent contract cannot at the same time be a rescissible contract, and vice versa.” — This articulation of the doctrinal boundary clarifies that the lower court’s rescission-based ruling was legally incompatible with the finding of absolute simulation.

• Vda. de Rodriguez v. Rodriguez, 127 Phil. 294 (1967) — The seminal case defining absolute simulation; the Court relied on its pronouncement that a simulated transfer lacks the intent to divest ownership and is a mere sham, applied to the Deed of Assignment.
• Heirs of Spouses Intac v. CA, 697 Phil. 373 (2012) — Reiterated that in absolute simulation, the apparent contract has no substance and produces no legal effect; the parties may recover what they gave under the void contract. Cited to reinforce the inexistence of the Deed.
• Nacar v. Gallery Frames, 716 Phil. 267 (2013) — Applied to impose a 6% annual interest on the monetary award from the date of finality of the decision until full satisfaction, modifying the RTC-CDO Decision accordingly.

• Article 1345, Civil Code — Distinguishes absolute simulation (parties do not intend to be bound at all) from relative simulation (parties conceal their true agreement). The Deed fell squarely within absolute simulation.
• Article 1346, Civil Code — Declares an absolutely simulated contract void, and binds parties to their real agreement in case of relative simulation if lawful and no prejudice to third parties. The Deed was void under this article.
• Article 1381(3), Civil Code — Lists contracts undertaken in fraud of creditors as rescissible when the latter cannot collect their claims. The Court held the Deed did not fall here because it was void, not rescissible.
• Article 1383, Civil Code — Provides that an action for rescission is subsidiary and cannot be instituted except when no other legal means exist for reparation. Cited to distinguish rescission from nullity.
• Article 1409, Civil Code — Enumerates inexistent and void contracts, including absolutely simulated or fictitious ones; provides they cannot be ratified and the defense of illegality cannot be waived. The Deed was declared inexistent pursuant to this provision.
• Rule 6, Section 7, Rules of Court — Defines a compulsory counterclaim as one arising out of or connected with the transaction or occurrence constituting the subject matter of the opposing party’s claim. Applied to CEPALCO’s counterclaim.
• Rule 141, Section 7, as amended by A.M. No. 04-2-04-SC — Imposed docket fees on compulsory counterclaims effective August 16, 2004; not applicable to CEPALCO’s answer filed on April 26, 2004.

Peralta (Acting Chairperson), Perlas-Bernabe, and Reyes, Jr., JJ., concurred. Carpio, J., on official leave.