Tsai vs. Court of Appeals

Machineries treated by the parties as chattels under a chattel mortgage are not covered by after-acquired property clauses; under Section 7 of the Chattel Mortgage Law, a chattel mortgage covers only the property described therein and not like or substituted property thereafter acquired by the mortgagor, so that foreclosure of such after-acquired property is void and confers no title on the purchaser, rendering any subsequent sale thereof also void under the principle of nemo dat quod non habet.

Ever Textile Mills, Inc. (EVERTEX) was a textile manufacturing corporation that operated a factory on a lot covered by TCT No. 372097. Philippine Bank of Communications (PBCom) was its creditor, having extended two loans secured by mortgages over EVERTEX's real and personal properties. Mamerto R. Villaluz served as EVERTEX's assignee in insolvency proceedings. Ruby L. Tsai was a lessee and later purchaser of the factory premises from PBCom. The dispute arose in the context of the Insolvency Law (Act 1959) and the Chattel Mortgage Law (Act 1506), which governed the respective rights of a mortgagee bank and an insolvent mortgagor over collateral and after-acquired property.

On November 26, 1975, Ever Textile Mills, Inc. (EVERTEX) obtained a ₱3,000,000 loan from Philippine Bank of Communications (PBCom). As security, EVERTEX executed a deed of Real and Chattel Mortgage over the lot under TCT No. 372097 where its factory stood, together with the buildings and improvements thereon and the chattels located therein, specifically enumerated in a schedule attached to the mortgage contract. The contract was styled "Real and Chattel Mortgage" and included a separate "LIST OF MACHINERIES & EQUIPMENT" enumerating forty-eight units of Vayrow Knitting Machines, sixteen sets of Vayrow Knitting Machines, two Circular Knitting Machines, and four Winding Machines, each individually described by serial number and size. On April 23, 1979, PBCom granted a second loan of ₱3,356,000 to EVERTEX, secured by a Chattel Mortgage over personal properties enumerated in a list attached thereto, similar to those listed in the first mortgage deed.

After April 23, 1979, EVERTEX purchased various additional machines and equipment — specifically, fourteen Interlock Circular Knitting Machines, one Jet Drying Equipment, one Dryer Equipment, one Raisin Equipment, and one Heatset Equipment — valued at ₱4,000,000. These after-acquired properties were not listed in either the 1975 Real and Chattel Mortgage or the 1979 Chattel Mortgage. On November 19, 1982, due to business reverses, EVERTEX filed insolvency proceedings before the Court of First Instance of Pasay City, Branch XXVIII, docketed as SP Proc. No. LP-3091-P. The CFI declared the corporation insolvent on November 24, 1982, and all its assets were taken into the custody of the Insolvency Court, including the collateral securing the two mortgages.

Notwithstanding the insolvency proceedings, PBCom commenced extrajudicial foreclosure proceedings against EVERTEX under Act 3135 and Act 1506. A Notice of Sheriff's Sale was issued on December 1, 1982. The first public auction was held on December 15, 1982, where PBCom emerged as the highest bidder and a Certificate of Sale was issued the same day. A second auction was held on December 23, 1982, with PBCom again as the highest bidder. On March 7, 1984, PBCom consolidated its ownership over the lot and all properties in it. In November 1986, PBCom leased the entire factory premises to Ruby L. Tsai for ₱50,000 a month. On May 3, 1988, PBCom sold the factory, including the contested machineries, to Tsai for ₱9,000,000.

Prior to the sale, EVERTEX's counsel had sent Tsai a letter dated February 27, 1987, apprising her of EVERTEX's claim over the disputed properties. Tsai replied on March 9, 1987. PBCom likewise received and responded to a similar letter from EVERTEX's counsel on March 24, 1987. Despite knowledge of EVERTEX's claim, Tsai proceeded with the purchase on May 3, 1988.

On March 16, 1989, EVERTEX filed a complaint for annulment of sale, reconveyance, and damages with the Regional Trial Court against PBCom and Tsai, alleging that the extrajudicial foreclosure was in violation of the Insolvency Law and that the disputed after-acquired machineries were not included in either mortgage contract, the Notice of Sheriff's Sale, or the Certificates of Sale. The RTC found the lease and sale of the disputed properties irregular and illegal because they were not duly foreclosed nor sold at the December 15, 1982 auction, as they were not included in the schedules attached to the mortgage contracts. The Court of Appeals affirmed this finding, reducing the actual damages but deleting the exemplary damages award. Both PBCom and Tsai filed separate petitions for review with the Supreme Court.

• Classification of Machineries as Real Property: Tsai argued that the Court of Appeals erred in treating the 1981-acquired machineries as chattels rather than as real properties within the 1975 deed of Real and Chattel Mortgage or the 1979 deed of Chattel Mortgage, effectively making a contract for the parties.
• Nature of Disputed Properties: Tsai maintained that the disputed 1981 machineries are real properties deemed part of the mortgage, citing their size, weight, and manner of installation (bolted or cemented on the real property), as well as their assessment for real estate tax purposes.
• Good Faith Purchaser Status: Tsai contended that even assuming PBCom's title was a nullity, she was a purchaser in good faith and for value with a better right than EVERTEX, invoking the indefeasibility of the Torrens Title of the lot where the disputed properties were located.
• Prescription and Laches: Tsai argued that the Court of Appeals erred in holding against her arguments on prescription and laches.
• Damages: Tsai asserted that the assessment of actual damages, attorney's fees, and expenses of litigation lacked valid factual and legal basis.
• Inclusion in Foreclosure: PBCom argued that the Court of Appeals erred in decreeing the disputed machineries as personal property outside the 1975 deed of real estate mortgage, despite the after-acquired property clause in the 1975 deed and the fact that the machineries were heavy, bolted or cemented on the real property, and assessed for real estate tax purposes.
• Unjust Enrichment: PBCom contended that compelling it to return the machineries or pay damages, after it had taken possession in good faith, extended credit facilities totaling ₱9,547,095.28 as of 1982, spent for maintenance and security, and paid all back taxes of EVERTEX, would be tantamount to unjust enrichment against PBCom.

• Nature of Disputed Properties: Respondents countered that the controverted units of machinery were not "real properties" but chattels, and therefore were not part of the foreclosed real properties.
• Invalidity of Lease and Sale: Respondents argued that because the disputed machineries were chattels not covered by the mortgages, the lease and subsequent sale thereof to Tsai were a nullity.

• Classification of Machineries: Whether the disputed after-acquired machineries should be classified as real property or chattels for purposes of the mortgage contracts.
• Coverage of After-Acquired Property: Whether the after-acquired property clause in the 1975 mortgage extended to the disputed machineries acquired in 1981.
• Validity of Foreclosure and Sale: Whether the inclusion of the disputed machineries in the extrajudicial foreclosure and auction sale was proper, and whether the subsequent sale to Tsai was valid.
• Good Faith of Purchaser: Whether Tsai was a purchaser in good faith and for value.
• Prescription and Laches: Whether the action for reconveyance was barred by prescription or laches.
• Damages: Whether the awards of actual damages, exemplary damages, and attorney's fees were proper.

• Classification of Machineries: Chattels. The parties' intention, as expressed in the mortgage contracts, was to treat machineries and equipment as chattels, not as immovables, regardless of their physical characteristics.
• Coverage of After-Acquired Property: No. Under Section 7 of the Chattel Mortgage Law, a chattel mortgage covers only the property described therein and not like or substituted property thereafter acquired by the mortgagor, anything in the mortgage to the contrary notwithstanding.
• Validity of Foreclosure and Sale: Void. The disputed machineries were not included in either mortgage and could not be validly foreclosed; the auction sale to PBCom was void, and the subsequent sale to Tsai was likewise void under nemo dat quod non habet.
• Good Faith of Purchaser: No. Tsai had prior notice of EVERTEX's claim before purchasing the properties, as evidenced by her receipt of and reply to EVERTEX's counsel's letter dated February 27, 1987.
• Prescription and Laches: No. EVERTEX filed the action within the reglementary period and acted promptly upon petitioners' refusal to heed its claim; the doctrine of laches does not apply.
• Damages: Actual damages affirmed at ₱20,000/month; exemplary damages reinstated but reduced to ₱100,000; attorney's fees of ₱50,000 affirmed.

• Classification of Machineries: Petitioners contended that because the disputed machineries were heavy, bolted, or cemented on the real property, they were ipso facto immovable under Article 415(3) and (5) of the Civil Code. The Court rejected this assertion, holding that the physical characteristics alone do not settle the issue; the parties' intent must be examined. Both the RTC and the Court of Appeals found that the true intention of PBCom and EVERTEX was to treat machinery and equipment as chattels. This was evidenced by the fact that the 1975 mortgage contract was expressly styled "Real and Chattel Mortgage" with the phrase "real and chattel" typed in capital letters, and a separate "LIST OF MACHINERIES & EQUIPMENT" was attached. The 1979 contract referred solely to chattels, with an inventory of sixty-three individually described machineries. Had the parties intended to treat the machineries as immovables, there would have been no need to execute a separate chattel mortgage specifically listing them. The Court found no compelling reason to depart from this concurrent factual finding. Moreover, even assuming arguendo that the properties were immovable by nature, the parties could treat them as chattels to secure an obligation under the principle of estoppel, as held in Navarro vs. Pineda.

• Coverage of After-Acquired Property: Because the parties intended to treat the machineries as chattels, the Chattel Mortgage Law applied. Section 7 thereof provides that a chattel mortgage covers only the property described therein and not like or substituted property thereafter acquired by the mortgagor, anything in the mortgage to the contrary notwithstanding. The disputed machineries were acquired in 1981 and could not have been included in the 1975 or 1979 chattel mortgages. The after-acquired property clause in the 1975 mortgage was unavailing because the Chattel Mortgage Law expressly nullifies such clauses. Consequently, the sheriff's inclusion of the disputed machineries in the auction sale was erroneous.

• Validity of Foreclosure and Sale: Since the disputed machineries were not covered by either mortgage, the auction sale of those properties to PBCom was void, and no valid title passed to PBCom. Under the principle of nemo dat quod non habet — one cannot give what one does not have — the sale of the disputed machineries to Tsai was likewise a nullity. The Court affirmed the concurrent findings of the RTC and the Court of Appeals that the controverted machineries were not covered by or included in either mortgage, were not included in the Notice of Sheriff's Sale, and were not included in the Certificates of Sale.

• Good Faith of Purchaser: A purchaser in good faith is one who buys property without notice that another person has a right to or interest in such property and pays a full and fair price at the time of purchase. The burden of proving good faith rests on the person asserting it. Tsai failed to discharge this burden. Records showed that she received a letter from EVERTEX's counsel dated February 27, 1987, apprising her of EVERTEX's claim, and she replied on March 9, 1987. Despite this knowledge, she purchased the contested machineries on May 3, 1988. The RTC's finding that she was not a purchaser in good faith was therefore sustained. Her defense of indefeasibility of Torrens Title was unavailing because that doctrine refers to the sale of lands, not to properties situated therein, and the mere fact that the lot was in PBCom's name did not make PBCom the owner of everything found therein.

• Prescription and Laches: The Court found no cogent reason to disturb the consistent findings of both lower courts that the action for reconveyance was filed within the reglementary period. EVERTEX immediately filed an action to recover possession and ownership upon petitioners' refusal to heed its claim. There was no evidence of failure or neglect for an unreasonable and unexplained length of time. The doctrine of laches applies only where, by reason of lapse of time, it would be inequitable to allow a party to enforce legal rights. Except for very strong reasons, the Court is not disposed to apply laches to prejudice or defeat the rights of an owner.

• Damages: As to actual damages, the Court affirmed the Court of Appeals' reduction from ₱100,000 to ₱20,000 per month, noting that the testimonial evidence of John Chua was merely an opinion or projection and that there was no showing that someone was willing to rent the machineries for ₱100,000 a month. The CA's computation of net unrealized rental income at ₱20,000 per month was deemed realistic and fair. As to exemplary damages, the CA had deleted the award on the ground that there was no clear showing of malevolent, wanton, or oppressive conduct. The Supreme Court disagreed, finding that Tsai's act of purchasing the contested properties despite knowledge of EVERTEX's claim was oppressive and subjected the already insolvent respondent to gross disadvantage. PBCom's act of taking all properties in the factory, including those not covered by the mortgages, was equally oppressive and tainted with bad faith. Exemplary damages were therefore reinstated, but reduced from ₱200,000 to ₱100,000 in the exercise of balanced restraint and measured objectivity, following Inhelder Corporation vs. Court of Appeals. Attorney's fees of ₱50,000 were affirmed as reasonable, given that exemplary damages were awarded.

• Intent controls classification of property in mortgage contracts — The nature of property for purposes of mortgage is determined not solely by its physical characteristics but primarily by the intention of the parties as expressed in the contract. Even immovable property may be treated as chattel where the parties so stipulate, particularly when a chattel mortgage is executed over it as security for an obligation. The Court applied this principle by examining the mortgage contracts' styling, language, and attached schedules to conclude that the parties intended to treat machineries as chattels.

• After-acquired property clause in chattel mortgages is void under Section 7 of the Chattel Mortgage Law — Section 7 provides that a chattel mortgage shall be deemed to cover only the property described therein and not like or substituted property thereafter acquired by the mortgagor, anything in the mortgage to the contrary notwithstanding. The Court applied this provision to hold that the after-acquired machineries purchased in 1981 were not covered by the 1975 or 1979 chattel mortgages despite any after-acquired property clause.

• Nemo dat quod non habet — One cannot give what one does not have. Because the foreclosure sale of the disputed machineries was void, no valid title passed to PBCom, and consequently the sale to Tsai was also void.

• Purchaser in good faith — A purchaser in good faith and for value is one who buys property without notice that another person has a right to or interest in such property and pays a full and fair price at the time of purchase or before notice of the claim. The burden of proving good faith rests on the person asserting it. Knowledge of another's claim prior to purchase defeats good faith.

• Laches — Laches is the failure or neglect for an unreasonable and unexplained length of time to do that which, by exercising due diligence, could or should have been done earlier, such that it would be inequitable to allow enforcement of legal rights. The Court is generally not disposed to apply laches to prejudice or defeat the rights of an owner except for very strong reasons.

• Assessment of exemplary damages — Exemplary damages require that the wrongful act be accompanied by bad faith and that the guilty party acted in a wanton, fraudulent, oppressive, reckless, or malevolent manner. Judicial discretion in the assessment of damages must be exercised with balanced restraint and measured objectivity.

• "Mere nuts and bolts do not foreclose the controversy. We have to look at the parties' intent." — This passage articulates the ratio decidendi that the physical characteristics of property alone do not determine its classification for mortgage purposes; the parties' intent as expressed in the contract is controlling.

• "a chattel mortgage shall be deemed to cover only the property described therein and not like or substituted property thereafter acquired by the mortgagor and placed in the same depository as the property originally mortgaged, anything in the mortgage to the contrary notwithstanding." — This is the Court's quotation of Section 7 of the Chattel Mortgage Law, the controlling statutory provision that nullifies after-acquired property clauses in chattel mortgages and forms the statutory basis for voiding the foreclosure.

• "As the auction sale of the subject properties to PBCom is void, no valid title passed in its favor. Consequently, the sale thereof to Tsai is also a nullity under the elementary principle of nemo dat quod non habet, one cannot give what one does not have." — This passage states the conclusion that the void foreclosure sale produced no valid title, and the principle of nemo dat quod non habet extends that nullity to the subsequent sale to Tsai.

• "Except for very strong reasons, this Court is not disposed to apply the doctrine of laches to prejudice or defeat the rights of an owner." — This formulation reflects the Court's restrictive approach to the doctrine of laches, particularly in favor of the true owner's rights.

• Navarro vs. Pineda, 9 SCRA 631 (1963) — Followed. The Court relied on this case for the principle that an immovable may be considered personal property if there is a stipulation treating it as such, as when it is used as security in a chattel mortgage.

• Segura vs. Segura, 165 SCRA 368 (1988) — Cited in support of the nemo dat quod non habet principle applied to voidify the sale to Tsai.

• Noel vs. Court of Appeals, G.R. No. 59550, 240 SCRA 78 (1995) — Cited for the nemo dat quod non habet principle and for the proposition that laches should not be applied to prejudice the rights of an owner except for very strong reasons.

• Mathay vs. Court of Appeals, 295 SCRA 556 (1998) — Followed for the rule that the burden of proving the status of a purchaser in good faith rests on the person asserting it.

• Diaz-Duarte vs. Ong, 298 SCRA 388 (1998) — Followed for the definition of a purchaser in good faith and for value.

• Inhelder Corporation vs. Court of Appeals, G.R. No. L-52358, 122 SCRA 576 (1983) — Followed for the rule that judicial discretion in the assessment of damages must be exercised with balanced restraint and measured objectivity, which the Court applied to reduce exemplary damages from ₱200,000 to ₱100,000.

• Congregation of the Religious of the Virgin Mary vs. Court of Appeals, 291 SCRA 385 (1998) — Cited for the rule that the Supreme Court's jurisdiction in a Rule 45 petition is limited to errors of law, applied more stringently when RTC findings are affirmed by the CA.

• Section 7, Act 1506 (The Chattel Mortgage Law) — Provides that a chattel mortgage covers only the property described therein and not like or substituted property thereafter acquired by the mortgagor, anything in the mortgage to the contrary notwithstanding. This was the controlling provision that rendered the after-acquired property clause in the 1975 mortgage unavailing and the foreclosure of the disputed 1981 machineries void.

• Article 415(3) and (5), New Civil Code — Defines immovable property, including machinery and equipment attached to real property. The Court acknowledged these provisions but held that the parties' intent, as expressed in the mortgage contracts, prevailed over the physical characteristics of the machineries.

• Article 2216, New Civil Code — Provides that no proof of pecuniary loss is necessary for the adjudication of exemplary damages, their assessment being left to the discretion of the court according to the circumstances of each case. The Court applied this provision in reinstating and adjusting the exemplary damages award.

• Act 3135 (An Act to Regulate the Sale of Property under Special Powers Inserted in or Annexed to Real Estate Mortgages) — Governed the extrajudicial foreclosure proceedings initiated by PBCom. The Court found that the foreclosure was void insofar as it included properties not covered by the mortgages.

Bellosillo, Mendoza, Buena, and De Leon, Jr., JJ., concurred.