Security Bank Corporation vs. Spouses Mercado

Extrajudicial foreclosure sales are void for non-compliance with statutory publication requirements when the notice contains substantial errors that mislead bidders, and a single erratum publication does not cure the defect; interest rate stipulations that grant a bank unbridled discretion to determine rates without a mutually agreed market-based reference rate violate the principle of mutuality of contracts.

Security Bank granted Spouses Mercado a revolving credit line secured by real estate mortgages over several properties. Upon default, the bank initiated extrajudicial foreclosure. The published notices of sale contained errors in the lot numbers and omitted the locations of the properties. The bank attempted to correct these through a single erratum publication. The spouses contested the validity of the foreclosure and the imposed interest rates and penalties.

• Original Filing: RTC of Batangas City, Branch 84 (Civil Case No. 5808 — Annulment of foreclosure; LRC Case No. N-1685 — Writ of Possession)
• Lower Court Decision: February 26, 2007, as amended June 19, 2007 — RTC declared the foreclosure sales void (except for the Lipa City property over which it had no jurisdiction), voided the interest rates for being potestative, and fixed the principal obligation at P7,500,000.00 with 6% interest.
• Appeal: CA-G.R. CV No. 90031
• CA Decision: July 19, 2010 — CA affirmed the RTC with modifications. Agreed the foreclosure was void and interest provisions violated mutuality. Modified the outstanding obligation to P7,516,880.00, imposed 12% legal interest from extrajudicial demand, and imposed the stipulated 2% monthly penalty.
• SC Action: Consolidated Petitions for Review on Certiorari filed by both Security Bank and Spouses Mercado.

• The Credit Line and Mortgages: On September 13, 1996, Security Bank granted Spouses Mercado a P1,000,000.00 revolving credit line, later increased by P7,000,000.00. The agreement stipulated interest on outstanding availments at a per annum rate determined solely by Security Bank based on its prevailing lending rate. The addendum provided a ceiling but gave the bank continuing consent without need of additional confirmation. A 2% monthly late payment charge was also stipulated. The spouses executed two Real Estate Mortgages covering five parcels of land in Lipa City, San Jose, and Batangas City.
• Default and Foreclosure: Spouses Mercado defaulted. Security Bank sent a final demand on March 31, 1999, and filed petitions for extrajudicial foreclosure with the RTCs of Lipa City and Batangas City.
• Defective Publication: The notices of foreclosure sale were published once a week for three consecutive weeks. However, the notices contained errors: (1) TCT No. 33150: "Lot 952-C-1" instead of "Lot 952-C-1-B"; (2) TCT No. 89822: "Lot 1931 Cadm-164-D" instead of "Lot 1931 Cadm 464-D"; and (3) the notices omitted the locations of the properties. Security Bank published an erratum only once.
• Auction Sale: On October 19 and 29, 1999, the properties were sold at public auction with Security Bank as the winning bidder.
• Attempted Redemption and Suit: On September 18, 2000, Spouses Mercado offered to redeem the properties for P10,000,000.00, but Security Bank refused and counter-offered P15,000,000.00. On November 8, 2000, Spouses Mercado filed a complaint for annulment of foreclosure sale, damages, and accounting.

• Security Bank:
  • The foreclosure sale is valid; errors in the notice are minor and inconsequential, affecting only a letter and number without altering the actual size, location, or title number. Relied on OCA Circular No. 14, which allegedly does not require full technical descriptions.
  • The interest rate provisions observe mutuality of contracts. Absolute discretion is wanting because a ceiling exists in the addendum, and market forces dictate the rate. Cited Polotan, Sr. v. Court of Appeals.
• Spouses Mercado:
  • The CA erred in imposing interest and penalty from the date of extrajudicial demand until finality. Under the doctrine of operative facts (Andal v. PNB), interest and penalty were considered paid by the auction sale; thus, interest should only run from the finality of the decision.
  • The penalty should be excused due to economic crises and lack of bad faith.

• Spouses Mercado (responding to Security Bank): The foreclosure is invalid for non-compliance with publication requirements; the interest rates are void for being potestative.
• Security Bank (responding to Spouses Mercado): Opposed the application of Andal v. PNB and maintained the validity of the penalty charges.

• Procedural Issues: N/A
• Substantive Issues:
  • Whether the foreclosure sales of the parcels of land in Batangas City and San Jose, Batangas are valid.
  • 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.
  • 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:
  • Foreclosure Validity: The foreclosure sales are void. The errors in the notice (wrong lot numbers and omitted locations) are substantial because they misidentify the properties and deprive prospective bidders of information crucial to determining market price. A single erratum publication does not cure the defect; an erratum is considered a new notice that must comply with the statutory requirement of being published once a week for at least three consecutive weeks. OCA Circular No. 14 still requires salient portions like lot numbers and boundaries.
  • Mutuality of Contracts: The interest rate provisions are void. The authority to change the interest rate was given to Security Bank alone without need of the spouses' written assent. The reference rate of "Security Bank's prevailing lending rate" is not pegged on a market-based reference rate (like MRRs or T-Bill Rates) as required by the BSP MORB. Unlike Polotan, where "prevailing market rate" was valid because it is beyond the bank's control, "Security Bank's prevailing lending rate" is determined solely by the bank. Without a valid stipulated rate, legal interest applies from the time of default.
  • Interest and Penalty: Andal v. PNB does not apply. In Andal, no default was declared because the bank's arbitrary interest rates caused the default. Here, Spouses Mercado never denied defaulting on the principal obligation. Default on the principal is sufficient for legal interest to run from extrajudicial demand. The 2% monthly penalty (24% per annum) is iniquitous and unconscionable; the SC equitably reduced it to 6% per annum under Article 1229 of the Civil Code.

• Mutuality of Contracts — Contracts must bind both contracting parties; its validity or compliance cannot be left to the will of one of them (Art. 1308). Stipulations allowing a bank unbridled discretion to unilaterally modify or determine interest rates without the written assent of the borrower and without a mutually agreed market-based reference rate are void.
• Strict Compliance with Foreclosure Publication Requirements — Statutory provisions governing the publication of notice of mortgage foreclosure sales must be strictly complied with; slight deviations invalidate the notice and render the sale voidable. Substantial errors that deter or mislead bidders vitiate the sale. A single erratum publication does not cure a defective notice; it is treated as a new notice requiring full compliance with the 3-week publication rule.
• Equitable Reduction of Penalties — Courts may equitably reduce penalty clauses if they are iniquitous or unconscionable (Art. 1229). A 2% monthly (24% annual) penalty is unconscionable and may be reduced to 6% per annum.

• Act No. 3135, Sec. 3 — Requires publication of the notice of sale once a week for at least three consecutive weeks in a newspaper of general circulation. The SC held that errors in lot numbers and omitted locations are substantial, and a single erratum publication does not satisfy this requirement.
• Civil Code, Art. 1308 — The contract must bind both contracting parties; its validity or compliance cannot be left to the will of one of them. The SC applied this to strike down interest rate stipulations giving the bank sole discretion.
• Civil Code, Art. 1956 — No interest shall be due unless it has been expressly stipulated in writing. The SC noted that without a valid stipulated rate, legal interest applies.
• Civil Code, Art. 1229 — The judge shall equitably reduce the penalty when it is iniquitous or unconscionable. The SC applied this to reduce the 2% monthly penalty to 6% per annum.
• BSP Manual of Regulations for Banks, § X305.3 — Floating rates of interest must be based on market-based reference rates (MRRs, T-Bill Rates, etc.) plus a margin agreed upon by the parties. The SC held that "Security Bank's prevailing lending rate" does not comply with this requirement.