Mortgage in Bad Faith: When a Bank's Claim Is Trumped by a Prior Sale

The Philippine Supreme Court has long protected banks that rely on the clean certificate of title of a mortgagor. But that protection has limits: a bank that takes a mortgage with knowledge of a prior sale — or that forecloses and consolidates title during a pending case — cannot hide behind the "mortgagee in good faith" doctrine. In The Malayan Bank v. Lagrama (G.R. No. 144884, April 27, 2001), the Court showed exactly when a bank's claim loses to an earlier buyer's equitable right.

The Facts

Demetrio Llego inherited a portion of land from his father, but title remained in the father's name. In 1976, Llego sold his share to his uncle Agustin Lagrama and aunt Paz Abastillas, to be paid in installments. No deed of sale was executed because the title was not yet in Llego's name, but the buyers took possession and later paid the full balance.

In 1979, Llego and his co-heirs extrajudicially partitioned the property, and a new title was issued to Llego for the very portion he had already sold. In 1982, Llego, through his attorney-in-fact, mortgaged the land to Republic Planters Bank (now Malayan Bank) for P45,000. When Llego defaulted, the bank foreclosed and bought the property at auction. Llego failed to redeem.

In 1983, the Lagramas filed a complaint for specific performance against Llego, his attorney-in-fact, and the bank. The trial court ruled in favor of the Lagramas, declaring them the absolute owners and ordering Llego to execute the necessary conveyance. The bank appealed, but its appeal was dismissed for failure to file a brief on time, making the decision final.

When the Lagramas sought to execute the judgment, they discovered the bank had consolidated title in its name. The trial court then ordered the bank to execute a deed of reconveyance. The bank refused, insisting it was a mortgagee in good faith.

The Issue

Could the bank be compelled to execute a deed of reconveyance in favor of the Lagramas, or was it protected as a mortgagee in good faith?

The Ruling

The Supreme Court affirmed the Court of Appeals and ordered the bank to reconvey the property. The Court rejected the bank's arguments on three grounds.

First, the bank was bound by the final judgment. The bank was impleaded as a defendant in the original case. The trial court's decision became final when the bank's appeal was dismissed. The Court noted that the bank cannot now claim it is not bound by the order to reconvey, especially since it consolidated title while the case was pending.

Second, the bank was a transferee pendente lite. Under Rule 39, Section 47(b) of the Rules of Court, a transferee pendente lite stands exactly in the shoes of the transferor and is bound by any judgment against the transferor. The Court rejected the bank's argument that the foreclosure sale "retroacts" to the date of the mortgage. When the mortgage was constituted, the bank was only a mortgagee, not a transferee. It became a transferee only when it acquired the property at the foreclosure sale — which happened after the case was filed.

Third, the bank acted in bad faith. The Court emphasized that the bank was aware of the charge of fraud against Llego — that he mortgaged property he had already sold. The trial court found fraud, and the bank consolidated title despite knowing of the pending litigation. A bank that acquires land with knowledge of fraud cannot claim to be a purchaser in good faith.

Why the Bank's Defense Failed

The bank cited St. Dominic Corp. v. Intermediate Appellate Court (151 SCRA 577, 1987), where a mortgagee was protected because the title appeared clean. The Court distinguished that case: in St. Dominic, the mortgagee had no notice of any flaw, and a notice of lis pendens was not carried over to subsequent titles. Here, the bank had actual knowledge of the prior sale and the fraud, and it was impleaded in the case. The facts were simply different.

Practical Takeaways

• A mortgagee in good faith is protected only when it has no notice of defects. A bank that knows — or should know — that the mortgagor has already sold the property to another cannot claim good faith.
• A mortgagee is not the same as a transferee. The "retroaction" rule for foreclosure sales does not protect a bank that becomes an actual transferee only during a pending case.
• Transferees pendente lite are bound by the judgment. Anyone who acquires property while a case is pending takes it subject to the outcome of that case.
• Final judgments bind all parties impleaded. A bank that fails to perfect an appeal cannot later relitigate issues already decided.
• A bank's remedy is against the borrower, not the innocent buyer. The Court noted the bank could still pursue its claim against Llego and his attorney-in-fact for the unpaid debt.

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This article is general information and not legal advice. For your specific situation, consult a lawyer or ask ASG Legal AI.