In the landscape of project finance and public-private partnerships, a recurring legal question arises: Can a contract with the Republic of the Philippines or its instrumentalities be used as collateral for a loan? For many contractors and suppliers, government contracts represent their most valuable asset. Utilizing these contracts as security is essential for maintaining liquidity and ensuring project completion.
Under Philippine law, the use of government contracts as collateral—specifically through the assignment of credit—is legally valid, provided it adheres to strict statutory requirements and administrative regulations.
1. The Fundamental Legal Basis: Assignment of Credit
The primary legal mechanism for using a government contract as collateral is found in the Civil Code of the Philippines, specifically under Articles 1624 to 1635 (Assignment of Credits).
- Article 1624: Establishes that an assignment of credit is a contract by which the owner of a credit (the assignor) transfers to another (the assignee) the right to collect from the debtor.
- Validity: A government contract is an "incorporeal right." In the eyes of the law, the money due or to become due to a contractor from a government agency is a property right that can be validly assigned to a financing institution.
2. Essential Requirements for Validity
For an assignment of government contract proceeds to be legally binding and enforceable against the government and third parties, several conditions must be met:
A. Notice to the Debtor (The Government Agency)
Under Article 1626 of the Civil Code, the debtor who pays the creditor before having knowledge of the assignment shall be released from the obligation. Therefore, the contractor must provide formal written notice to the concerned government agency. Without this notice, the government is legally justified in paying the contractor directly, even if a loan agreement exists.
B. Consent of the Government Agency
Most government contracts—standardized under Republic Act No. 9184 (Government Procurement Reform Act)—contain a clause prohibiting the assignment of the contract itself without prior written consent from the Procuring Entity.
- Distinction: There is a legal distinction between assigning the performance of the contract (which is generally prohibited to prevent "brokerage" of contracts) and assigning the proceeds/receivables of the contract (which is generally allowed for financing purposes).
C. Public Instrument Requirement
To affect third persons, the assignment must appear in a public instrument (notarized document), as per Article 1625 of the Civil Code.
3. The Role of the PPSA (Republic Act No. 11057)
The Personal Property Security Act (PPSA), enacted in 2018, significantly modernized the use of "accounts receivable" (such as government contract proceeds) as collateral.
- Security Interest: The PPSA allows for the creation of a security interest in accounts receivable.
- Perfection: A security interest in contract proceeds is perfected by registration in the centralized registry established by the Land Registration Authority (LRA). Perfection ensures the lender has priority over other creditors.
- Future Receivables: The PPSA explicitly allows for security interests in "future property," meaning a contractor can pledge proceeds from a government contract that has been signed but not yet fully performed.
4. Limitations and Restrictions
While legally valid, certain restrictions apply to ensure public funds are protected:
- Non-Assignment of Obligations: The contractor cannot assign their responsibility to perform the work. The contractor remains solely liable to the government for the quality and completion of the project.
- Government Liens and Set-offs: The assignee (the bank) takes the credit "subject to equities." If the contractor owes the government liquidated damages for delays or unpaid taxes, the government may deduct these amounts from the proceeds before paying the bank.
- The "Anti-Graft" Perspective: Under R.A. 3019, assignments must not be used to facilitate "influence peddling" or provide unwarranted benefits to government officials.
5. Jurisprudential Overview
The Philippine Supreme Court has generally upheld the validity of assignments of credit involving government funds, provided the administrative requirements of the Commission on Audit (COA) are met.
Historically, the COA has required that:
- The assignment is not prohibited by the specific terms of the contract.
- The assignment is approved by the head of the agency.
- The payment is made via Check or LDDAP-ADA specifically naming the assignee, ensuring a clear paper trail for the disbursement of public funds.
Summary Table: Government Contract as Collateral
| Feature | Legal Status / Requirement |
|---|---|
| Legal Nature | Assignment of Credit (Civil Code) / Security Interest (PPSA) |
| Primary Asset | Accounts Receivable (The right to be paid) |
| Notice Requirement | Mandatory; must be served to the Disbursing Officer/Agency Head |
| Form | Must be in a Public Instrument (Notarized) and registered under PPSA |
| Contractor Liability | Contractor remains 100% liable for project performance |
| Government Defense | The government retains the right to set-off liquidated damages |
Conclusion
In the Philippine context, government contracts are legally potent forms of collateral. While the government cannot be forced to recognize an assignment that violates the terms of the original procurement, the shift toward the PPSA framework has made it easier for contractors to leverage their state-backed receivables. For the lender, the validity of the collateral rests on due diligence—ensuring the underlying contract is valid, the notice of assignment is acknowledged by the state, and the security interest is duly registered.