Security Bank Corporation vs. Spouses Mercado

Foreclosure sale notices containing substantial errors in property descriptions—such as incorrect lot numbers and omitted locations—that could deter or mislead prospective bidders render the foreclosure sale void; and contractual provisions granting the creditor sole and unbridled discretion to determine floating interest rates, without reference to market-based rates and without the borrower's written consent for modifications, violate the principle of mutuality of contracts and are void ab initio.

Spouses Rodrigo and Erlinda Mercado obtained a revolving credit line from Security Bank Corporation, which they secured with real estate mortgages over five parcels of land located in Lipa City, San Jose, and Batangas City. Following their default, Security Bank initiated extrajudicial foreclosure proceedings under Act No. 3135. The spouses contested the foreclosure sales and the interest rates imposed, leading to consolidated civil actions for annulment and petitions for writ of possession that eventually reached the Supreme Court on appeal.

• On September 13, 1996, Security Bank granted spouses Mercado a revolving credit line in the amount of P1,000,000.00, subsequently increased by an additional P7,000,000.00, secured by Real Estate Mortgages over five properties covered by TCT Nos. T-103519 (Lipa City), T-89822 (San Jose), and T-33150, T-34288, and T-34289 (Batangas City).
• The credit line agreement stipulated that interest on outstanding availments would be at a per annum rate "determined from time to time by Security Bank" based on its "prevailing lending rate," with a late payment penalty of 2% per month.
• An addendum provided that the annual rate would be computed monthly by Security Bank based on its "prevailing monthly rate," not exceeding the total monthly prevailing rate, and contained a clause stating "I hereby give my continuing consent without need of additional confirmation to the interests stipulated as computed by SBC."
• Upon default, Security Bank sent a final demand letter on March 31, 1999, and filed petitions for extrajudicial foreclosure under Act No. 3135 with the Office of the Clerk of Court and Ex-Officio Sheriff of RTC Lipa City and RTC Batangas City.
• The notices of foreclosure sale for the Batangas City and San Jose properties contained errors in the technical descriptions: TCT No. T-33150 listed "Lot 952-C-1" instead of "Lot 952-C-1-B," and TCT No. T-89822 listed "Lot 1931 Cadm-164-D" instead of "Lot 1931 Cadm 464-D," and omitted the location of the properties.
• Security Bank published an erratum correcting these errors only once, instead of the required three consecutive weeks.
• The foreclosure sales were conducted on October 19, 1999 (Lipa City) and October 29, 1999 (Batangas City and San Jose), with Security Bank as the winning bidder.
• On September 18, 2000, spouses Mercado offered to redeem the foreclosed properties for P10,000,000.00, which Security Bank allegedly refused, counter-offering P15,000,000.00 instead.

• Security Bank argued that the foreclosure sales were valid because it complied with the publication requirements of Act No. 3135, and that the errors in the technical descriptions were inconsequential minor typographical errors that did not affect the actual size, location, or title number of the properties.
• It contended that OCA Circular No. 14 does not require the complete technical description to be published, and that the single erratum publication was sufficient to cure any defect.
• It maintained that the interest rate provisions observed the principle of mutuality of contracts because there was a ceiling on the maximum applicable rate, and the rates were dictated by market forces (Singapore Rate, London Rate, Inter-Bank Rate) rather than solely by the bank's will.
• It asserted that the spouses Mercado were bound by the rates because they had freely and voluntarily assented to them, citing Polotan, Sr. v. Court of Appeals.

• Spouses Mercado argued that the foreclosure sales were void due to the defective notices and the improper consolidation of separate mortgages in a single sale.
• They claimed that under the doctrine of operative facts laid down in Spouses Caraig v. Alday and Andal v. Philippine National Bank, interest and penalty should only be imposed from the finality of the decision, as the auction sale had effectively "paid" the obligation.
• They asserted that they should be excused from paying the penalty due to economic crises and lack of bad faith.
• They contended that the interest rate provisions were void for being potestative and violative of mutuality of contracts.

• Procedural Issues: N/A
• Substantive Issues:
  • Whether the foreclosure sales of the parcels of land in Batangas City and San Jose, Batangas are valid considering the errors in the notices of sale and the single publication of the erratum.
  • Whether the provisions on interest rate in the revolving credit line agreement and its addendum are void for being violative of the principle of mutuality of contracts under Article 1308 of the New Civil Code.
  • Whether interest and penalty are due and demandable from the date of auction sale until finality of the judgment declaring the foreclosure void under the doctrine of operative facts.

• Procedural: N/A
• Substantive:
  • The foreclosure sales of the properties in Batangas City and San Jose are void for non-compliance with the publication requirements of Act No. 3135. The errors in the technical descriptions (wrong lot numbers and omitted locations) constitute substantial errors that could deter or mislead bidders, depreciate the value of the properties, or prevent them from bringing a fair price. The publication of a single erratum does not cure the defect, as the erratum itself constitutes a new notice subject to the same requirement of publication once a week for three consecutive weeks.
  • The interest rate provisions are void for violating the principle of mutuality of contracts. The stipulation granting Security Bank sole discretion to determine the "prevailing lending rate" without a stated market-based reference rate (such as Manila Reference Rates or T-Bill Rates) and without the written consent of the borrowers for modifications is potestative and one-sided. Unlike "prevailing market rate," "prevailing lending rate" is determined solely by the bank, lacking the objective standard required by the BSP Manual of Regulations for Banks.
  • The doctrine of operative facts is inapplicable because the spouses Mercado never denied defaulting on the principal obligation; they only contested the interest rates and penalties. Default is counted from the date of extrajudicial demand (March 31, 1999).
  • The penalty of 2% per month (24% per annum) is reduced to 6% per annum under Article 1229 of the Civil Code for being iniquitous and unconscionable.
  • The deficiency obligation is computed as P8,317,756.71, representing the principal of P8,000,000.00 plus 12% interest and 6% penalty from March 31, 1999 to October 19, 1999, less the P483,120.00 proceeds from the Lipa City foreclosure sale. This deficiency shall earn legal interest of 12% per annum from January 5, 2001 until June 30, 2013, and 6% per annum from July 1, 2013 until finality of judgment, and thereafter 6% per annum until full satisfaction.

• Mutuality of Contracts (Article 1308, New Civil Code) — Contracts must bind both contracting parties, and their validity or compliance cannot be left to the will of one of them. The Court applied this to invalidate interest rate provisions that allowed the creditor unilaterally to determine and modify the interest rate without a market-based reference rate or the borrower's written consent.
• Strict Compliance with Foreclosure Notice Requirements — The statutory requirements for publication of notice of foreclosure under Act No. 3135 are jurisdictional and mandatory. Failure to strictly comply, including substantial errors in the notice, renders the sale void.
• Substantial Error Test — An error in a foreclosure notice is substantial if it will deter or mislead bidders, depreciate the value of the property, or prevent it from bringing a fair price. Errors in lot numbers and omissions of location are substantial because they misidentify the property and compromise the determination of its probable market price.
• Floating Interest Rate Requirements — Under the BSP Manual of Regulations for Banks, floating rates of interest must be stated on the basis of market-based reference rates (e.g., Manila Reference Rates, T-Bill Rates) plus a margin as agreed upon by the parties. A rate based solely on the creditor's "prevailing lending rate" without such reference is invalid.
• Reduction of Unconscionable Penalties (Article 1229, New Civil Code) — Courts may equitably reduce the penalty when it is iniquitous or unconscionable, even if there has been no performance of the principal obligation.

• "The principal object of a notice of sale in a foreclosure of mortgage is not so much to notify the mortgagor as to inform the public generally of the nature and condition of the property to be sold, and of the time, place, and terms of the sale. Notices are given to secure bidders and prevent a sacrifice of the property."
• "Failure to advertise a mortgage foreclosure sale in compliance with the statutory requirements constitutes a jurisdictional defect, and any substantial error in a notice of sale will render the notice insufficient and will consequently vitiate the sale."
• "The contract must bind both contracting parties; its validity or compliance cannot be left to the will of one of them."
• "A contract containing a condition which makes its fulfillment dependent exclusively upon the uncontrolled will of one of the contracting parties, is void."
• "The Notice of Sheriff['s] Sale, to be valid, must contain the correct title number and the correct technical description of the property to be sold."

• Caubang v. Crisologo, G.R. No. 174581 (2015) — Cited for the principle that statutory provisions governing publication of notice of mortgage foreclosure sales must be strictly complied with and slight deviations therefrom will invalidate the notice.
• San Jose v. Court of Appeals, G.R. No. 106953 (1993) — Applied to hold that an incorrect title number in the notice is a substantial and fatal error that invalidates the entire notice, even if the technical description is correct.
• Philippine National Bank v. Court of Appeals, G.R. No. 98382 (1993) — Cited regarding the strict requirement that notice must be published once a week for at least three consecutive weeks.
• Philippine National Bank v. Court of Appeals, G.R. No. 88880 (1991) — Cited for the doctrine that unilateral modification of interest rates violates the mutuality of contracts under Article 1308.
• Philippine Savings Bank v. Castillo, G.R. No. 193178 (2011) — Cited for the rule that escalation clauses do not give the bank unbridled right to adjust interest rates without mutual agreement.
• Juico v. China Banking Corporation, G.R. No. 187678 (2013) — Cited for the requirement of written notice and written consent for interest rate modifications to preserve mutuality.
• Silos v. Philippine National Bank, G.R. No. 181045 (2014) — Cited for invalidating interest rate provisions based solely on the bank's will using subjective criteria without fixed standards.
• Polotan, Sr. v. Court of Appeals, G.R. No. 119379 (1998) — Distinguished; upheld escalation clauses based on "prevailing market rate" because fluctuation is beyond the bank's control, unlike "prevailing lending rate."
• Andal v. Philippine National Bank, G.R. No. 194201 (2013) — Distinguished; applied the doctrine of operative facts where no default could be declared due to arbitrary interest rates, which was not the case here as the spouses admitted default on the principal.
• Nacar v. Gallery Frames, G.R. No. 189871 (2013) — Cited for the current legal interest rates of 6% per annum in the absence of stipulation.
• MCMP Construction Corp. v. Monark Equipment Corp., G.R. No. 201001 (2014) — Cited for reducing a 36% per annum penalty to 6% as unconscionable.

• Act No. 3135, as amended, Section 3 — Requires publication of notice of foreclosure once a week for at least three consecutive weeks in a newspaper of general circulation if the property is worth more than four hundred pesos.
• Article 1308, New Civil Code — Establishes the principle of mutuality of contracts; contracts must bind both parties and validity cannot be left to the will of one.
• Article 1956, New Civil Code — Requires that no interest shall be due unless it has been expressly stipulated in writing.
• Article 1229, New Civil Code — Allows courts to equitably reduce the penalty when it is iniquitous or unconscionable.
• BSP Manual of Regulations for Banks, § X305.3 — Mandates that floating rates of interest must be stated on the basis of Manila Reference Rates, T-Bill Rates, or other market-based reference rates plus a margin as agreed upon by the parties.
• Rule 9, Section 1, Rules of Court — Provides that defenses and objections not pleaded in the answer or motion to dismiss are deemed waived.