In a contract dispute between Spouses Bernardo and Union Bank, the Supreme Court clarified the rights of banks following a borrower’s default on a compromise agreement. The court held that Union Bank could pursue foreclosure despite the compromise agreement because the Bernados failed to meet the terms of the restructured loan. This ruling underscores that compromise agreements do not automatically extinguish the original mortgage, and banks retain the right to foreclose if borrowers fail to comply with the compromise terms.

When Debtors Fail: Upholding Mortgage Rights After Compromise

The case originates from a loan obtained by Spouses Anthony and Ma. Martha Bernardo from Union Bank, secured by a real estate mortgage on their family home. When the spouses defaulted on their payments, the bank initiated foreclosure proceedings. Subsequently, the parties entered into a compromise agreement, approved by the Regional Trial Court (RTC), allowing the spouses to buy back the property under a new payment scheme. Unfortunately, the Bernados defaulted again, leading Union Bank to consolidate its title over the property.

The legal battle centered on whether the compromise agreement novated the original loan obligation and whether Union Bank could still exercise its rights under the real estate mortgage. The RTC initially sided with the spouses, but the Court of Appeals (CA) reversed this decision, a move affirmed by the Supreme Court. The Supreme Court emphasized that a compromise agreement, once approved by the court, has the effect of res judicata, meaning it is considered a final judgment. The court’s role is to enforce it, not to modify its terms unless there is a grave abuse of discretion.

The Civil Code defines a compromise as:

“A contract whereby the parties, by making reciprocal concessions, avoid a litigation or put an end to one already commenced.” (CIVIL CODE, Article 2028.)

However, the Court clarified that the compromise agreement in this case did not extinguish the original loan obligation. The agreement merely provided a new payment scheme, without any substitution of debtor or subrogation of a third party. Therefore, novation, which would have extinguished the original debt, did not occur. The court referenced Article 1291 of the Civil Code concerning novation, underscoring that the original obligation must be truly altered for novation to take effect.

The pivotal aspect of the case was the interpretation of the compromise agreement’s terms regarding Union Bank’s remedies in case of default. The agreement explicitly stated that if the spouses failed to comply, Union Bank was entitled to:

“exercise…its rights and remedies under the Real Estate Mortgage.” (Rollo, p. 39.)

This clause allowed the bank to forfeit payments as rental, pursue legal action for the purchase price, or enforce the real estate mortgage. As the spouses failed to meet their obligations under the compromise, Union Bank was within its rights to consolidate its title over the foreclosed property. The Supreme Court criticized the RTC for limiting the bank’s remedies, stating that the RTC gravely abused its discretion by disregarding the clear terms of the compromise agreement.

This ruling has significant implications for both lenders and borrowers. It reinforces that compromise agreements are binding contracts that must be strictly adhered to. Failure to comply with the terms of a compromise agreement can lead to the enforcement of original obligations, including foreclosure. Banks are not deemed to have waived their rights under the original mortgage simply by entering into a compromise agreement. Instead, these rights remain valid and enforceable if the borrower defaults on the compromise terms.

FAQs

What was the key issue in this case?	The key issue was whether a compromise agreement extinguished the original loan obligation and the bank’s right to foreclose.
Did the compromise agreement novate the original loan?	No, the Supreme Court held that the compromise agreement did not novate the original loan because it only provided a new payment scheme without changing the debtor or creditor.
What remedies did Union Bank have upon the spouses’ default?	Union Bank could forfeit payments as rental, sue for the purchase price, or exercise its rights under the real estate mortgage, including foreclosure.
What is the significance of res judicata in this case?	The compromise agreement, once approved by the court, had the effect of res judicata, making it a final and binding judgment.
What was the RTC’s error in this case?	The RTC erred by limiting Union Bank’s remedies and disregarding the clear terms of the compromise agreement that allowed the bank to exercise its mortgage rights.
What is the meaning of novation?	Novation is the substitution or alteration of an obligation by a new one, which extinguishes the old obligation.
What does the Civil Code say about compromise agreements?	The Civil Code defines a compromise as a contract where parties make reciprocal concessions to avoid or end litigation.
What was the final ruling of the Supreme Court?	The Supreme Court affirmed the CA’s decision, ruling in favor of Union Bank and upholding its right to foreclose on the property.

In conclusion, the Supreme Court’s decision underscores the importance of adhering to compromise agreements and clarifies that banks retain their mortgage rights even after restructuring loans if borrowers fail to comply with the new terms. This ruling provides clarity and reinforces the enforceability of contracts, offering important guidance for future disputes involving loan obligations and compromise settlements.

For inquiries regarding the application of this ruling to specific circumstances, please contact ASG Law through contact or via email at frontdesk@asglawpartners.com.

Disclaimer: This analysis is provided for informational purposes only and does not constitute legal advice. For specific legal guidance tailored to your situation, please consult with a qualified attorney.
Source: Spouses Anthony Rogelio Bernardo and Ma. Martha Bernardo vs. Union Bank of the Philippines, G.R. No. 208892, September 18, 2019