PCI Leasing and Finance, Inc. vs. Trojan Metal Industries Incorporated, et al.

A sale-and-leaseback arrangement over equipment already owned by the lessee is not financial leasing under RA 5980 or RA 8556; it is a simulated lease disguising a loan secured by a chattel mortgage, and the creditor-mortgagee may seize and sell the property only to foreclose the mortgage, with any excess proceeds refundable to the mortgagor.

PCI Leasing and Finance, Inc. (PCILF) is a financing company, while Trojan Metal Industries, Inc. (TMI) is a corporation whose President and Vice-President were Walfrido and Elizabeth Dizon. The transaction at issue was executed on 8 April 1997, when financial leasing was governed by Republic Act No. 5980 and its implementing rules, later supplemented by Republic Act No. 8556. Those statutes define financial leasing as a mode of extending credit through a non-cancelable lease under which the lessor acquires, at the lessee’s instance, property for the lessee’s use over an obligatory period.

Sometime in 1997, respondent Trojan Metal Industries, Inc. (TMI) came to petitioner PCI Leasing and Finance, Inc. (PCILF) to seek a loan. Instead of extending a loan, PCILF offered to buy various equipment TMI owned, namely: a Verson double action hydraulic press with cushion, a Hinohara powerpress 75-tons capacity, a USI-clearing powerpress 60-tons capacity, a Watanabe powerpress 60-tons capacity, a YMGP powerpress 30-tons capacity, a YMGP powerpress 15-tons capacity, a lathe machine, a vertical milling machine, and a radial drill. Hard-pressed for money, TMI agreed. PCILF and TMI immediately executed deeds of sale evidencing TMI’s sale to PCILF of the various equipment in consideration of the total amount of ₱2,865,070.00.

PCILF and TMI then entered into a lease agreement, dated 8 April 1997, whereby TMI leased from PCILF the various equipment it previously owned. Pursuant to the lease agreement, TMI issued postdated checks representing 24 monthly installments. The monthly rental for the Verson double action hydraulic press with cushion was ₱62,328.00; for the Hinohara powerpress 75-tons capacity, the USI-clearing powerpress 60-tons capacity, the Watanabe powerpress 60-tons capacity, the YMGP powerpress 30-tons capacity, and the YMGP powerpress 15-tons capacity, the monthly rental was ₱49,259.00; and for the lathe machine, the vertical milling machine, and the radial drill, the monthly rental was ₱22,205.00. The lease agreement required TMI to give PCILF a guaranty deposit of ₱1,030,350.00, which would serve as security for the timely performance of TMI’s obligations under the lease agreement, to be automatically forfeited should TMI return the leased equipment before the expiration of the lease agreement. Further, spouses Walfrido and Elizabeth Dizon, as TMI’s President and Vice-President, respectively, executed in favor of PCILF a Continuing Guaranty of Lease Obligations. Under the continuing guaranty, the Dizon spouses agreed to immediately pay whatever obligations would be due PCILF in case TMI failed to meet its obligations under the lease agreement.

To obtain additional loan from another financing company, TMI used the leased equipment as temporary collateral. PCILF considered the second mortgage a violation of the lease agreement. At this time, TMI’s partial payments had reached ₱1,717,091.00. On 8 December 1998, PCILF sent TMI a demand letter for the payment of the latter’s outstanding obligation. PCILF’s demand remained unheeded.

On 7 May 1999, PCILF filed in the Regional Trial Court (Branch 79) of Quezon City a complaint against TMI, spouses Dizon, and John Doe for recovery of sum of money and personal property with prayer for the issuance of a writ of replevin, docketed as Civil Case No. Q-99-37559. On 7 September 1999, the RTC issued the writ of replevin PCILF prayed for, directing the sheriff to take custody of the leased equipment. Not long after, PCILF sold the leased equipment to a third party and collected the proceeds amounting to ₱1,025,000.00.

In their answer, respondents claimed that the sale with lease agreement was a mere scheme to facilitate the financial lease between PCILF and TMI. Respondents explained that in a simulated financial lease, property of the debtor would be sold to the creditor to be repaid through rentals; at the end of the lease period, the property sold would revert back to the debtor. Respondents prayed that they be allowed to reform the lease agreement to show the true agreement between the parties, which was a loan secured by a chattel mortgage.

• Nature of the Transaction: PCILF contended that the transaction between the parties was a sale and leaseback financing arrangement where the client sells movable property to a financing company, which then leases the same back to the client; PCILF insisted the transaction is not financial leasing, which contemplates extension of credit to assist a buyer in acquiring movable property which the buyer can use and eventually own.
• Validity and Enforceability: PCILF claimed that the sale and leaseback financing arrangement is not contrary to law, morals, good customs, public order, or public policy.
• Forfeiture of Guaranty Deposit: PCILF stressed that the guaranty deposit should be forfeited in its favor, as provided in the lease agreement.
• Violation of Lease: PCILF pointed out that this case does not involve mere failure to pay rentals; it deals with a flagrant violation of the lease agreement.

• Simulated Transaction: Respondents countered that from the very beginning, transfer to PCILF of ownership over the subject equipment was never the intention of the parties; the sale with lease agreement was a mere scheme to facilitate a financial lease, and they prayed for reformation to show a loan secured by a chattel mortgage.
• Guaranty Deposit: Respondents claimed that under the lease agreement, the guaranty deposit would be forfeited if TMI returned the leased equipment to PCILF before the expiration of the lease agreement; since TMI never returned the leased equipment voluntarily, but through a writ of replevin ordered by the RTC, the guaranty deposit should not be forfeited.

• Nature of the Transaction: Whether the sale with lease agreement the parties entered into was a financial lease or a loan secured by chattel mortgage.
• Refund: Whether PCILF should pay TMI, by way of refund, the amount of ₱1,166,826.52.

• Nature of the Transaction: No. The sale with lease agreement was not a financial lease; because TMI already owned the equipment, the transaction was a loan secured by a chattel mortgage, and PCILF could seize and sell the property only as creditor-mortgagee for foreclosure.
• Refund: Yes, but not in the exact amount fixed by the Court of Appeals. Section 14 of the Chattel Mortgage Law entitles the debtor-mortgagor to the balance of the sale proceeds after satisfaction of the secured obligation; the case was remanded to the RTC to compute the excess using the formula specified, with 12% interest per annum from finality until fully paid.

• Nature of the Transaction: The lease agreement was executed on 8 April 1997, so RA 5980, as implemented by its New Rules and Regulations, governed; RA 8556 later gave statutory recognition to the definition. Under Section 1(j) of the implementing rules and Section 3(d) of RA 8556, financial leasing is a mode of extending credit through a non-cancelable lease under which the lessor purchases or acquires, at the lessee’s instance, machinery or equipment in consideration of periodic payments sufficient to amortize at least 70% of the purchase price or acquisition cost over an obligatory period, with no obligation or option on the lessee’s part to purchase the property at the end. In a true financial leasing, the finance company purchases on behalf of a cash-strapped lessee the equipment the latter wants to buy but cannot; the finance company then leases it to the lessee for periodic rentals. Here, TMI already owned the subject equipment before it transacted with PCILF; therefore, the transaction cannot be financial leasing as defined by law. The facts are analogous to Cebu Contractors Consortium Co. vs. Court of Appeals, where equipment already owned by the client was made to appear sold to the financing company and leased back, and the Court held the transaction was a loan secured by a chattel mortgage, not financial leasing. Investors Finance Corporation vs. Court of Appeals similarly held that where the borrower-lessee already owned the heavy equipment and machinery, the lease was simulated to disguise a simple loan secured by the borrower’s equipment; financial leasing contemplates extension of credit to assist a buyer in acquiring movable property he can use and eventually own. Since the equipment already belonged to TMI, the transaction was a loan secured by the equipment. Under Articles 1359 and 1362 of the Civil Code, reformation was proper because the true intention of the parties was not expressed in the instrument; under Article 1144, the ten-year prescriptive period ran from the 8 April 1997 execution, and TMI timely exercised the right when it filed its answer on 14 February 2000 asking for reformation. Had the true transaction been expressed, it would have been a simple loan secured by a chattel mortgage; upon TMI’s default, PCILF was entitled to seize the mortgaged equipment not as owner but as creditor-mortgagee for foreclosure, and its sale to a third party and collection of proceeds could be deemed an exercise of that right.
• Refund: The Court of Appeals correctly ruled that the transaction was a loan secured by a chattel mortgage, but it should have taken into account the amount PCILF paid TMI for the equipment less the guaranty deposit paid by TMI in reckoning the principal obligation. Records show PCILF paid TMI ₱2,865,070.00 for the equipment, and TMI gave PCILF a guaranty deposit of ₱1,030,350.00; thus the principal loan was ₱1,834,720.00, the net amount actually received by TMI. Against this principal plus applicable interest should be deducted TMI’s loan payments totaling ₱1,717,091.00. Since PCILF sold the mortgaged equipment to a third party for ₱1,025,000.00, the proceeds should be applied to offset the remaining balance on the principal loan plus applicable interest. The exact date of the sale, needed to compute interest on the remaining balance, cannot be gleaned from the record; the case was therefore remanded to the RTC for computation of the total amount due from the date of demand on 8 December 1998 until the date of sale to a third party, which amount due shall be offset against the proceeds. In the absence of stipulation, the applicable interest on the remaining balance is the legal rate of 12% per annum computed from 8 December 1998, when PCILF sent its demand letter; no interest can be charged before that date because TMI was not yet in default. The interest due also earns legal interest from the time it is judicially demanded under Article 2212 of the Civil Code. Applying Eastern Shipping Lines, Inc. vs. Court of Appeals, the remaining balance of the principal loan must earn legal interest of 12% per annum, which interest, as long as unpaid, also earns legal interest of 12% per annum computed from the filing of the complaint on 7 May 1999. The Court provided the formula: TOTAL AMOUNT DUE = [principal – partial payments made] + [interest + interest on interest], where Interest = remaining balance x 12% per annum x no. of years from due date (8 December 1998 when demand was made) until date of sale to a third party; Interest on interest = interest computed as of the filing of the complaint on 7 May 1999 x 12% x no. of years until date of sale to a third party. From the computed total amount should be deducted ₱1,025,000.00 representing the proceeds of the sale already in PCILF’s hands; the difference represents overpayment by TMI, which the law requires PCILF to refund. Section 14 of the Chattel Mortgage Law provides that the proceeds of sale shall be applied to the costs and expenses of keeping and sale, then to the payment of the demand or obligation secured by the mortgage, and the balance shall be paid to the mortgagor on demand. Section 14 expressly entitles the debtor-mortgagor to the balance of the proceeds upon satisfaction of the principal loan and costs, and prevailing jurisprudence bars the creditor-mortgagee from retaining the excess. TMI’s right to refund accrued from the time PCILF received the proceeds of the sale, but because TMI never made a counterclaim or demand for refund due on the resulting overpayment after offsetting the proceeds against the remaining balance plus applicable interest, no interest applies on the amount of refund due. Nonetheless, in accord with prevailing jurisprudence, the excess amount PCILF must refund is subject to interest at 12% per annum from finality of the Decision until fully paid.

• Financial leasing vs. loan secured by chattel mortgage — Financial leasing is a mode of extending credit through a non-cancelable lease under which the lessor purchases or acquires, at the lessee’s instance, machinery, equipment, or other movable property in consideration of periodic payments sufficient to amortize at least 70% of the purchase price or acquisition cost over an obligatory period, with no obligation or option on the lessee’s part to purchase the property at the end. In a true financial leasing, the finance company buys on behalf of a cash-strapped lessee the equipment the latter wants to buy but cannot; if the lessee already owns the equipment, a sale-and-leaseback arrangement is simulated and the true transaction is a loan secured by a chattel mortgage. The Court applied this doctrine because TMI already owned the equipment before transacting with PCILF, so the transaction was not financial leasing but a loan secured by the equipment.
• Reformation of instruments — Under Articles 1359 and 1362 of the Civil Code, when the true intention of the parties is not expressed in the instrument by reason of mistake, fraud, inequitable conduct, or accident, a party may ask for reformation; if one party was mistaken and the other acted fraudulently or inequitably, the former may ask for reformation. The action prescribes in ten years under Article 1144. The Court applied the doctrine because TMI timely sought reformation of the lease agreement in its answer filed on 14 February 2000, within ten years from the 8 April 1997 execution, to show the true agreement of loan secured by chattel mortgage.
• Foreclosure and disposition of proceeds under the Chattel Mortgage Law — Upon default, the creditor-mortgagee may seize the mortgaged property as creditor, not as owner, for the purpose of foreclosing the chattel mortgage. Section 14 of Act No. 1508 provides that the proceeds of sale shall be applied to the costs and expenses of keeping and sale, then to the payment of the demand or obligation secured by the mortgage, and the balance shall be paid to the mortgagor on demand. The Court applied this doctrine because PCILF’s sale of the equipment to a third party was deemed an exercise of its right to foreclose; any excess after satisfying the loan and costs must be refunded to TMI.
• Computation of legal interest — Under Eastern Shipping Lines, Inc. vs. Court of Appeals, when an obligation consisting in the payment of a sum of money is breached, the interest due is that stipulated in writing; absent stipulation, the rate is 12% per annum computed from default, i.e., from judicial or extrajudicial demand. The interest due itself earns legal interest from the time it is judicially demanded. When the judgment awarding a sum of money becomes final and executory, the legal interest is 12% per annum from finality until satisfaction. The Court applied these rules by computing 12% interest on the remaining balance from the 8 December 1998 demand, interest on interest from the 7 May 1999 filing of the complaint, and 12% interest on the refund from finality until fully paid.

• "Thus, in a true financial leasing, whether under RA 5980 or RA 8556, a finance company purchases on behalf of a cash-strapped lessee the equipment the latter wants to buy but, due to financial limitations, is incapable of doing so. The finance company then leases the equipment to the lessee in exchange for the latter’s periodic payment of a fixed amount of rental." — Defines true financial leasing and distinguishes it from the transaction in this case.
• "In the present case, since the transaction between PCILF and TMI involved equipment already owned by TMI, it cannot be considered as one of financial leasing, as defined by law, but simply a loan secured by the various equipment owned by TMI." — States the ratio decidendi that the transaction was a loan secured by a chattel mortgage.
• "Section 14 of the Chattel Mortgage Law expressly entitles the debtor-mortgagor to the balance of the proceeds, upon satisfaction of the principal loan and costs. Prevailing jurisprudence also holds that the Chattel Mortgage Law bars the creditor-mortgagee from retaining the excess of the sale proceeds." — States the statutory basis for refunding excess sale proceeds to the mortgagor.
• "In the absence of stipulation, the applicable interest due on the remaining balance of the loan is the legal rate of 12% per annum, computed from the date PCILF sent a demand letter to TMI on 8 December 1998. No interest can be charged prior to this date because TMI was not yet in default prior to 8 December 1998." — States the rate and default date for the remaining loan balance, which the Court used to remand for computation.

• Cebu Contractors Consortium Co. vs. Court of Appeals, G.R. No. 107199, 22 July 2003, 407 SCRA 154 — Analogous controlling precedent; where the client already owned equipment but needed working capital and the finance company purchased it intending to lease it back, the lease was simulated to disguise a loan with security, not financial leasing.
• Investors Finance Corporation vs. Court of Appeals, G.R. No. 91334, 7 February 1991, 193 SCRA 701 — Followed; held that where the borrower-lessee already owned the heavy equipment and machinery, the transaction was not true financial leasing but a simple loan secured by the borrower’s equipment; financial leasing contemplates extension of credit to assist a buyer in acquiring movable property he can use and eventually own.
• Eastern Shipping Lines, Inc. vs. Court of Appeals, G.R. No. 97412, 12 July 1994, 234 SCRA 78 — Applied; laid down the rules on computation of legal interest, including 12% per annum from default and interest on interest from judicial demand.
• PAMECA Wood Treatment Plant, Inc. vs. CA, 369 Phil. 544 (1999) — Cited as prevailing jurisprudence holding that the Chattel Mortgage Law bars the creditor-mortgagee from retaining the excess of the sale proceeds.
• Cuyco vs. Cuyco, G.R. No. 168736, 19 April 2006, 487 SCRA 693 — Cited as prevailing jurisprudence supporting the award of 12% per annum interest on the refund from finality of the Decision until fully paid.

• Republic Act No. 5980, Section 1(j) of the New Rules and Regulations to Implement RA 5980 — Defines financial leasing as a mode of extending credit through a non-cancelable contract under which the lessor purchases or acquires at the lessee’s instance heavy equipment, motor vehicles, industrial machinery, appliances, business and office machines, and other movable property in consideration of periodic payment of a fixed amount sufficient to amortize at least 70% of the purchase price or acquisition cost, over the lease period, with no obligation or option on the lessee’s part to purchase the leased property at the end. The Court used this definition to hold that the transaction was not financial leasing because TMI already owned the equipment.
• Republic Act No. 8556, Section 3(d) — Provides the statutory definition of financial leasing, essentially similar to the implementing rules, requiring the lessor to purchase or acquire at the lessee’s instance machinery, equipment, motor vehicles, appliances, business and office machines, and other movable or immovable property for periodic payments amortizing at least 70% of the purchase price or acquisition cost over an obligatory period of not less than two years, with no obligation or option on the lessee’s part to purchase the property at the end. The Court cited it as statutory recognition of the definition.
• Civil Code, Article 1359 — Allows reformation of an instrument when the true intention of the parties is not expressed by reason of mistake, fraud, inequitable conduct, or accident. The Court applied it to allow TMI to reform the lease agreement to reflect the true loan secured by chattel mortgage.
• Civil Code, Article 1362 — Allows the mistaken party to ask for reformation if the other party acted fraudulently or inequitably in a way that the instrument does not show their true intention. The Court cited it as part of the basis for reformation.
• Civil Code, Article 1144 — Sets a ten-year prescriptive period for actions upon a written contract and for reformation of an instrument. The Court applied it to hold that TMI timely filed its answer on 14 February 2000, within ten years from the 8 April 1997 execution of the lease agreement.
• Civil Code, Article 2212 — Provides that interest due shall earn legal interest from the time it is judicially demanded, although the obligation may be silent. The Court applied it to allow interest on interest from the filing of the complaint.
• Act No. 1508 (Chattel Mortgage Law), Section 14 — Provides that the proceeds of sale shall be applied first to costs and expenses of keeping and sale, then to the payment of the demand or obligation secured by the mortgage, and the residue to subsequent mortgages, with the balance paid to the mortgagor on demand. The Court applied it to require PCILF to refund the excess proceeds to TMI.
• Rules of Court, Rule 45 — The petition for review was filed under Rule 45.

Antonio Eduardo B. Nachura, Diosdado M. Peralta, Roberto A. Abad, and Jose C. Mendoza concurred. The text records no separate concurring opinion.