Leung Yee vs. Frank L. Strong Machinery Company

A building of strong materials is real property regardless of how the parties chose to deal with it, and good faith is an essential requisite for the preferential effect of registration under Article 1473 of the Civil Code; one who purchases real property with knowledge of another's prior claim and possession is not a purchaser in good faith and cannot prevail over the party who first took possession in good faith.

The "Compania Agricola Filipina" purchased rice-cleaning machinery from the Frank L. Strong Machinery Company and installed it in a building of strong materials. To secure the purchase price, the company executed a chattel mortgage that included both the machinery and the building. Separately, the "Compania Agricola Filipina" also mortgaged the same building to Leung Yee to secure the balance of indebtedness arising from a construction contract under which Leung Yee had built the structure. Both mortgages were on the building alone, separate and apart from the land on which it stood. The dispute thus arose from competing claims over the same building, with one creditor relying on the chattel mortgage registry and the other on the land registry.

The "Compania Agricola Filipina" purchased a considerable quantity of rice-cleaning machinery from the Frank L. Strong Machinery Company and executed a chattel mortgage thereon to secure payment of the purchase price. The mortgage deed included the building of strong materials in which the machinery was installed, without any reference to the land on which it stood. The chattel mortgage was registered in the chattel mortgage registry. When the indebtedness fell due and remained unpaid, the mortgaged property was sold by the sheriff in pursuance of the mortgage terms, and the machinery company bought it in. The sale was annotated in the chattel mortgage registry on December 29, 1913. The machinery company went into possession of the building at or about December 1913 and has continued in possession ever since.

A few weeks after the sheriff's sale, on or about January 14, 1914, the "Compania Agricola Filipina" executed a deed of sale of the land upon which the building stood in favor of the machinery company. This deed, although executed in a public document, was not registered. It made no reference to the building and appeared to have been executed to cure any defects in the machinery company's title to the building under the sheriff's certificate of sale.

At or about the time the chattel mortgage was executed in favor of the machinery company, the mortgagor also executed a separate mortgage on the building to the plaintiff, Leung Yee, to secure the balance of indebtedness arising from the construction contract under which Leung Yee had built the structure. Upon the mortgagor's failure to pay, Leung Yee secured judgment for the amount owed, levied execution upon the building, and bought it in at a sheriff's sale on or about December 18, 1914. The sheriff's certificate of sale was registered in the land registry of the Province of Cavite.

At the time execution was levied, the machinery company, which was then in possession, filed with the sheriff a sworn statement setting up its claim of title and demanding release of the property from the levy. Thereafter, upon the sheriff's demand, the plaintiff executed an indemnity bond in the sum of ₱12,000, in reliance upon which the sheriff sold the property at public auction to the plaintiff as the highest bidder. The plaintiff then instituted this action to recover possession of the building from the machinery company.

• Nature of the Building: Whether a building of strong materials, dealt with by the parties separate and apart from the land on which it stood, is personal or real property for purposes of registration.
• Effect of Chattel Mortgage Registry: Whether annotation of a deed of sale of real property in the chattel mortgage registry has the legal effect of inscription in the registry of real property under Article 1473 of the Civil Code.
• Good Faith as Requisite of Registration: Whether good faith is an essential requisite for registration to have the preferential effect contemplated in the second paragraph of Article 1473, notwithstanding the absence of an express good-faith requirement in that paragraph.
• Superiority of Claims: Whether the plaintiff was a purchaser in good faith and whether the machinery company's prior possession in good faith gives it superior rights under Article 1473.

• Nature of the Building: The building is real property. The mere fact that the parties dealt with it separate and apart from the land did not change its character as real property.
• Effect of Chattel Mortgage Registry: No. Annotation of a deed of sale of real property in the chattel mortgage registry cannot be given the legal effect of an inscription in the registry of real property, the chattel mortgage registry being intended solely for personal property.
• Good Faith as Requisite of Registration: Yes. Good faith is an essential requisite of registration under Article 1473; the force and effect given by law to an inscription in a public record presupposes the good faith of the person who enters it, and rights predicated upon inscription do not accrue to one who registers in bad faith.
• Superiority of Claims: The machinery company prevails. The plaintiff was not a purchaser in good faith, having purchased with full knowledge of the machinery company's prior claim and possession; under the third paragraph of Article 1473, the machinery company, which first took possession in good faith, has superior rights.

• Nature of the Building: The building of strong materials in which the rice-cleaning machinery was installed was real property. The Court reasoned that the mere fact that the parties dealt with it separate and apart from the land on which it stood in no wise changed its character as real property. It followed that neither the original registry in the chattel mortgage registry of the instrument purporting to be a chattel mortgage of the building, nor the annotation in that registry of the sale of the mortgaged property, had any effect whatever so far as the building was concerned.

• Effect of Chattel Mortgage Registry: The registry referred to in Article 1473 is the registry of real property. By its express terms, the Chattel Mortgage Law contemplates and makes provision for mortgages of personal property, and the sole purpose of the chattel mortgage registry is to provide for the registration of chattel mortgages — that is, mortgages of personal property executed in the manner prescribed by statute. An annotation or inscription of a deed of sale of real property in a chattel mortgage registry therefore cannot be given the legal effect of an inscription in the registry of real property. The trial court's reliance on the chattel mortgage registry annotation as conferring priority was thus misplaced.

• Good Faith as Requisite of Registration: Although the second paragraph of Article 1473 does not expressly require good faith in relation to inscription (while the first and third paragraphs expressly require it for possession and title), the Court rejected the argument that good faith is not essential for registration. It reasoned that it could not have been the intention of the legislator to base a preferential right upon an inscription made in bad faith, as such an interpretation would open the door to fraud and collusion. The public records cannot be converted into instruments of fraud and oppression by one who secures an inscription in bad faith. The force and effect given by law to an inscription presupposes the good faith of the person who enters it. The Court cited the sentencia of the Supreme Court of Spain of May 13, 1908, construing the second paragraph of the same article, which held that the provision must always be understood on the basis of the good faith mentioned in the first paragraph, and that the legislator could not have wished to sanction bad faith merely to comply with a formality.

• Superiority of Claims: The agreed statement of facts disclosed that the plaintiff, when he bought the building at the sheriff's sale and inscribed his title in the land registry, was duly notified that the machinery company had bought the building from the plaintiff's judgment debtor, had gone into possession long prior to the sheriff's sale, and was in possession at the time of the levy. The execution of the indemnity bond by the plaintiff after the machinery company had filed its sworn claim of ownership confirmed that the plaintiff had full knowledge of the company's claim. Having bought with such knowledge, the plaintiff could not be deemed a purchaser in good faith, and his subsequent inscription of the sheriff's certificate was tainted with the same defect. Under the third paragraph of Article 1473, which provides that where there is no entry the property shall belong to the person who first took possession in good faith, the machinery company's prior possession in good faith conferred superior rights. The Court clarified that it did not question the genuineness of the plaintiff's claim against the common debtor, nor find collusion or fraud in the ordinary sense; but because the plaintiff had knowledge of the machinery company's well-founded claim when he purchased, he took the risk and must stand by the consequences.

• Good faith as an essential requisite of registration under Article 1473 — Although the second paragraph of Article 1473 of the Civil Code, governing double sale of real property, does not expressly require good faith for inscription (while the first and third paragraphs expressly require it for possession and title), good faith is nonetheless an essential requisite. The force and effect given by law to an inscription in a public record presupposes the good faith of the person who enters it; rights predicated upon inscription do not accrue to one who registers in bad faith. The provision must always be understood on the basis of the good faith mentioned in the first paragraph, as the legislator could not have intended to sanction bad faith merely to comply with a formality.

• Building of strong materials as real property — A building of strong materials is real property, and the mere fact that the parties dealt with it separate and apart from the land on which it stood does not change its character as real property. Consequently, registration in the chattel mortgage registry has no legal effect upon it; only inscription in the registry of real property can serve the purposes of Article 1473.

• Knowledge of prior claim defeats good faith — One who purchases real estate with knowledge of a defect or lack of title in his vendor cannot claim to have acquired title in good faith as against the true owner. The same rule applies to one who has knowledge of facts which should have put him upon such inquiry and investigation as might be necessary to acquaint him with the defects in the vendor's title. A purchaser cannot close his eyes to facts which should put a reasonable man upon guard and then claim good faith. Good faith is a state or condition of mind judged by conduct and outward acts; proof of knowledge overcomes the presumption of good faith in which courts indulge in the absence of proof to the contrary.

• "The public records cannot be converted into instruments of fraud and oppression by one who secures an inscription therein in bad faith. The force and effect given by law to an inscription in a public record presupposes the good faith of him who enters such inscription; and rights created by statute, which are predicated upon an inscription in a public registry, do not and cannot accrue under an inscription 'in bad faith,' to the benefit of the person who thus makes the inscription." — This passage articulates the ratio decidendi on the requirement of good faith for registration under Article 1473, establishing that the preferential effect of inscription presupposes good faith even though the second paragraph does not expressly require it.

• "The building of strong materials in which the rice-cleaning machinery was installed by the 'Compania Agricola Filipina' was real property, and the mere fact that the parties seem to have dealt with it separate and apart from the land on which it stood in no wise changed its character as real property." — This defines the controlling rule on the nature of buildings of strong materials and the irrelevance of the parties' characterization to the property's legal classification.

• "One who purchases real estate with knowledge of a defect or lack of title in his vendor cannot claim that he has acquired title thereto in good faith as against the true owner of the land or of an interest therein; and the same rule must be applied to one who has knowledge of facts which should have put him upon such inquiry and investigation as might be necessary to acquaint him with the defects in the title of his vendor." — This states the canonical formulation of the notice doctrine as applied to good-faith purchasers, frequently cited in subsequent Philippine jurisprudence on double sale and good faith.

• Sentencia of the Supreme Court of Spain, May 13, 1908 — Cited as persuasive authority construing the second paragraph of Article 1473 of the Civil Code, holding that the preference accorded to the first-recorded title must always be understood on the basis of the good faith mentioned in the first paragraph, and that the legislator could not have intended to sanction bad faith merely to comply with a formality. The Court relied on this ruling to support its conclusion that good faith is an essential requisite of registration.

• Wilder vs. Gilman, 55 Vt. 504, 505 — Cited for the proposition that good faith, or the want of it, is not a visible, tangible fact but a state or condition of mind which can only be judged by actual or fancied tokens or signs. Also cited were Cardenas vs. Miller, 108 Cal. 250; Breaux-Renoudet, Cypress Lumber Co. vs. Shadel, 52 La. Ann. 2094–2098; and Pinkerton Bros. Co. vs. Bromley, 119 Mich. 8, 10, 17.

• Article 1473, Civil Code of Spain (as then in force in the Philippines) — Governs double sale of the same thing to different vendees. For personal property, ownership transfers to the person who first took possession in good faith. For real property, it belongs to the person who first recorded it in the registry. Where there is no entry, the property belongs to the person who first took possession in good faith, and in the absence thereof, to the person who presents the oldest title, provided there is good faith. The Court applied the third paragraph (possession in good faith) to uphold the machinery company's claim, while clarifying that the second paragraph (inscription) also requires good faith.

• Chattel Mortgage Law — Cited for the proposition that by its express terms it contemplates and makes provision for mortgages of personal property only, and that the sole purpose of the chattel mortgage registry is to provide for the registration of chattel mortgages. The Court held that annotation of a deed of sale of real property in the chattel mortgage registry cannot have the legal effect of inscription in the registry of real property.

Arellano, C.J., Johnson, Araullo, Street, and Malcolm, JJ., concurred. Torres, Avanceña, and Fisher, JJ., did not take part.