In 1973, Lirag Textile Mills, Inc. (Litex) opened an irrevocable commercial letter of credit with respondent Prudential Bank for US$498,000. This was in connection with its importation of 5,000 spindles for spinning machinery with drawing frame, simplex fly frame, ring spinning frame and various accessories, spare parts and tool gauge. These were released to Litex under covering trust receipts it executed in favor of Prudential Bank. Litex installed and used the items in its textile mill located in Montalban, Rizal.
On October 10, 1980, DBP granted a foreign currency loan in the amount of US$4,807,551 to Litex. To secure the loan, Litex executed real estate and chattel mortgages on its plant site in Montalban, Rizal, including the buildings and other improvements, machineries and equipments there. Among the machineries and equipments mortgaged in favor of DBP were the articles covered by the trust receipts.
Sometime in June 1982, Prudential Bank learned about DBPs plan for the overall rehabilitation of Litex. In a July 14, 1982 letter, Prudential Bank notified DBP of its claim over the various items covered by the trust receipts which had been installed and used by Litex in the textile mill. Prudential Bank informed DBP that it was the absolute and juridical owner of the said items and they were thus not part of the mortgaged assets that could be legally ceded to DBP.
On the other hand, DBP argued that the items in controversy were procured by Lirag Textile Mills (LITEX) for the exclusive use of its textile mills. They were not procured – (a) to sell or otherwise procure their sale; (b) to manufacture or process the goods with the purpose of ultimate sale. Hence, the transactions between Litex and Prudential Bank were allegedly not trust receipt transactions within the meaning of PD 115. It follows that, contrary to the decisions of the trial court and the appellate court, the transactions were not governed by the Trust Receipts Law.
- Whether or not Prudential Bank was the absolute and juridical owner of the items covered by the trust receipts; and/or
- Whether or not said items can be mortgaged.
The various agreements between Prudential Bank and Litex commonly denominated as trust receipts were valid. As the Court of Appeals correctly ruled, their provisions did not contravene the law, morals, good customs, public order or public policy.
The agreements uniformly provided:
Received, upon the Trust hereinafter mentioned from the PRUDENTIAL BANK (hereinafter referred to as BANK) the following goods and merchandise, the property of said BANK specified in the bill of lading as follows:
and in consideration thereof, I/We hereby agree to hold said goods in trust for the BANK and as its property with liberty to sell the same for its account but without authority to make any other disposition whatsoever of the said goods or any part thereof (or the proceeds thereof) either by way of conditional sale, pledge, or otherwise.
The articles were owned by Prudential Bank and they were only held by Litex in trust. While it was allowed to sell the items, Litex had no authority to dispose of them or any part thereof or their proceeds through conditional sale, pledge or any other means.
Article 2085 (2) of the Civil Code requires that, in a contract of pledge or mortgage, it is essential that the pledgor or mortgagor should be the absolute owner of the thing pledged or mortgaged. Article 2085 (3) further mandates that the person constituting the pledge or mortgage must have the free disposal of his property, and in the absence thereof, that he be legally authorized for the purpose.
Litex had neither absolute ownership, free disposal nor the authority to freely dispose of the articles. Litex could not have subjected them to a chattel mortgage. Their inclusion in the mortgage was void and had no legal effect. There being no valid mortgage, there could also be no valid foreclosure or valid auction sale. Thus, DBP could not be considered either as a mortgagee or as a purchaser in good faith.
There appears to be a loophole in this decision of the Supreme Court, because while it agreed with the contention of DBP that “[h]ere, Litex was not engaged in the business of selling spinning machinery, its accessories and spare parts but in manufacturing and producing textile and various kinds of fabric. The articles were not released to Litex to be sold. Nor was the transfer of possession intended to be a preliminary step for the said goods to be ultimately or subsequently sold. Instead, the contemporaneous and subsequent acts of both Litex and Prudential Bank showed that the imported articles were released to Litex to be installed in its textile mill and used in its business”, which implies that the transaction of Litex and Prudential Life, at least with respect to the items in question, may not come within the operation of the Trust Receipts Law, because “in a trust receipt transaction, the release of the goods to the entrustee, on his execution of a trust receipt, is essentially for the purpose of their sale or is necessarily connected with their ultimate or subsequent sale”, it still ruled that “[t]he articles were owned by Prudential Bank and they were only held by Litex in trust” on the basis of “various agreements between Prudential Bank and Litex commonly denominated as trust receipts”, which were valid.
Nevertheless, the rulings of the Supreme Court as regards the above issues are clear: (1) That an entrustee in a trust receipt agreement merely holds the items subject of the agreement in trust for the entrustor, and so it is the latter who is the absolute and juridical owner thereof; and (2) That one who neither has a free disposal of nor authority to dispose of a personal property cannot mortgage it.