Foreclosure of Equitable Mortgage in the Philippines: Legal Requirements and Remedies

I. Nature and Concept of Equitable Mortgage

An equitable mortgage in Philippine law is a transaction that, although clothed in the form of a sale (usually an absolute sale or deed of absolute sale), is in reality intended by the parties as security for the payment of a loan or fulfillment of an obligation. The true agreement is a loan secured by the property, with the property serving as collateral, but the contract is deliberately drafted as a sale to avoid the formalities of a mortgage or to circumvent usury laws, registration requirements, or other restrictions.

The concept is enshrined in Articles 1602 to 1607 of the Civil Code of the Philippines, which establish a rebuttable presumption that certain contracts are equitable mortgages rather than true sales. The policy behind these provisions is protective: to prevent the unjust enrichment of creditors who exploit the necessity of debtors by obtaining outright ownership of valuable property for grossly inadequate consideration.

Article 1602 expressly provides the circumstances that raise the presumption:

The contract shall be presumed to be an equitable mortgage, in any of the following cases:
(1) When the price of the sale with right to repurchase is unusually inadequate;
(2) When the vendor remains in possession as lessee or otherwise;
(3) When upon or after the expiration of the right to repurchase another instrument extending the period of redemption or granting a new period is executed;
(4) When the purchaser retains for himself a part of the purchase price;
(5) When the vendor binds himself to pay the taxes on the thing sold;
(6) In any other case where it may be fairly inferred that the real intention of the parties is that the transaction shall secure the payment of a debt or the performance of any other obligation.

Article 1603 adds that in case of doubt, the contract shall be construed as an equitable mortgage.

Article 1604 declares the presumption juris tantum (rebuttable by proof of true intent to sell), but jurisprudence has consistently held that the presumption is extremely strong and can only be overcome by clear, satisfactory, and convincing evidence.

Once the presumption is established and not sufficiently rebutted, the contract is treated in all respects as a mortgage — specifically, a real estate mortgage if the property is immovable, or a chattel mortgage if movable — with all the legal consequences that attach to a mortgage contract.

II. Absolute Prohibition of Pactum Commissorium (Article 2088, Civil Code)

The most critical consequence of an equitable mortgage is that any stipulation authorizing the creditor to appropriate the property upon default (pactum commissorium) is null and void.

Article 2088 expressly provides:

The creditor cannot appropriate the things given by way of pledge or mortgage, or dispose of them. Any stipulation to the contrary is null and void.

This prohibition applies with full force to equitable mortgages. Consequently, even if the deed of absolute sale contains a provision that ownership automatically consolidates upon failure to repay, such provision is void. The creditor who consolidates title without foreclosure commits unlawful appropriation and may be compelled to reconvey the property upon payment of the debt, plus damages in proper cases.

The nullity of the pactum commissorium does not invalidate the principal obligation (the loan) or the security interest itself. The creditor retains the right to recover the debt through proper legal remedies, including foreclosure.

III. Remedies of the Debtor (Apparent Vendor/True Owner)

The debtor has several powerful remedies, all designed to restore the true nature of the transaction and prevent forfeiture.

1. Action for Reformation of Instrument (Article 1605)
   The debtor may file an action to reform the deed of absolute sale into a deed of real estate mortgage or loan with security. This action prescribes in 10 years from the date of execution of the instrument.

2. Action to Declare the Contract an Equitable Mortgage and for Redemption
   Even without reformation, the debtor may simply ask the court to declare the existence of an equitable mortgage and allow redemption upon payment of the principal debt plus legal interest and any allowable charges. This is the most common remedy.

3. Right of Redemption
   The debtor has the right to redeem the property at any time before valid foreclosure sale and confirmation/consolidation of title in favor of the creditor or third-party purchaser. There is no fixed period of redemption in equitable mortgage unless stipulated (and even then, the stipulation must not violate pactum commissorium rules). Redemption is effected by paying the full amount of the debt, legal interest (6% per annum since 2013 under BSP rules, unless otherwise stipulated and not iniquitous), and necessary expenses incurred by the creditor.

4. Recovery of Possession and Damages
   If the creditor has already taken possession and refuses to allow redemption, the debtor may file accion publiciana or reivindicatoria with damages, plus accounting of fruits.

5. Defense in Ejectment or Unlawful Detainer Actions
   When sued for ejectment by the apparent vendee, the debtor may raise the defense of equitable mortgage. Philippine courts uniformly hold that ejectment will not lie when ownership is disputed on the ground of equitable mortgage; the issue must be resolved in a full-blown trial (accion reivindicatoria or declaratory relief).

IV. Remedies of the Creditor (Apparent Vendee/True Mortgagee)

The creditor is not without remedy. Despite the void stipulation for automatic appropriation, the creditor may enforce the security through proper foreclosure.

A. Available Remedies

1. Judicial Foreclosure of Mortgage (Primary and almost exclusive remedy for equitable mortgages
   Because equitable mortgages are almost never registered as mortgages with the required special power of attorney to sell extrajudicially, extrajudicial foreclosure under Act No. 3135 is not available. The creditor must resort to judicial foreclosure under Rule 68, Rules of Court.

2. Ordinary Action for Collection of Sum of Money
   The creditor may simply sue to recover the loan, with prayer for preliminary attachment. However, this does not enforce the security interest directly.

3. Specific Performance with Subsidiary Foreclosure
   In some cases, the creditor files for specific performance to compel execution of a formal mortgage deed, with subsidiary prayer for foreclosure.

B. Judicial Foreclosure Procedure for Equitable Mortgage (Rule 68, Rules of Court)

The procedure is essentially the same as ordinary judicial foreclosure, with the additional requirement of proving the existence of the equitable mortgage.

1. Filing of Verified Complaint

   • Venue: RTC of the province/city where the property or any part is situated
   • Contents:
     • Description of the property
     • Allegation and proof of the true loan transaction
     • Proof that the contract is an equitable mortgage (invoking Art. 1602 presumptions and evidence)
     • Amount of principal, interest, attorney’s fees, etc.
     • Fact of default and demand

2. Summons and Answer
   Debtor will usually admit the loan but assert equitable mortgage and offer to pay.

3. Judgment
   If the court finds the existence of an equitable mortgage and default, it renders judgment:

   • Ordering the defendant (debtor) to pay the amount due within a period not less than 90 days nor more than 120 days from entry of judgment
   • If payment is made within the period, case is dismissed and mortgage extinguished
   • If not paid, the court orders the sale of the property at public auction

4. Public Auction
   Conducted by the sheriff under the same rules as execution sales.

5. Confirmation of Sale
   Upon motion, the court confirms the sale. Title then vests in the highest bidder.

6. Right of Redemption After Confirmation

   • If the mortgagee is NOT a bank or banking institution: No right of redemption. Ownership consolidates immediately upon confirmation.
   • If the mortgagee is a bank or quasi-bank: Debtor has one (1) year from registration of the certificate of sale to redeem (Section 47, General Banking Law, as amended).

7. Deficiency Judgment
   The creditor may move for deficiency judgment if the proceeds are insufficient to cover the debt (except when the creditor is a bank in extrajudicial foreclosure, where deficiency is recoverable via separate action).

8. Writ of Possession
   After consolidation of title, the purchaser (creditor or third party) is entitled to a writ of possession, even against parties who entered after the filing of the case.

V. Prescription Periods

• Action to declare equitable mortgage or reform the instrument: 10 years from execution of the deed
• Action to foreclose the mortgage: 10 years from the date the cause of action accrued (usually from default or maturity of the obligation) – Article 1142, Civil Code
• Action to recover the principal loan (written contract): 10 years from default

After prescription of the principal obligation, the mortgage accessory likewise prescribes.

VI. Special Considerations and Jurisprudential Rules

1. The presumptions in Article 1602 apply even if the debtor signed a deed acknowledging receipt of full payment. Gross inadequacy of price + continued possession is almost conclusive.

2. Even long lapse of time (20–30 years) does not bar the action if possession was never really delivered or if other indicia persist.

3. Family members or heirs of the debtor may invoke equitable mortgage after the debtor’s death.

4. Notarial rescission of the “sale” is void if it constitutes pactum commissorium.

5. If the creditor sells the property to a third person who had knowledge of the equitable mortgage, the sale is voidable; if the buyer is in good faith, the debtor’s remedy is damages against the original creditor.

VII. Conclusion

An equitable mortgage is one of the most debtor-protective doctrines in Philippine law. The creditor who attempts to disguise a loan as a sale in order to acquire outright ownership does so at great peril: any automatic appropriation clause is void, extrajudicial foreclosure is unavailable, and the creditor is forced into full litigation to enforce the security. The debtor, on the other hand, enjoys strong presumptions, liberal redemption rights, and a relatively long prescription period.

The only safe and lawful way for the creditor to acquire absolute ownership of the collateral upon default is through judicial foreclosure after the court has confirmed the existence of an equitable mortgage and the debtor has failed to pay within the ordered period. Any shortcut risks nullity of title and liability for damages.

Parties are therefore well-advised to execute formal, registered mortgage contracts rather than resort to disguised sales. The equitable mortgage provisions exist precisely to remedy the abuses that arise from such subterfuges.