One of the problems commonly faced by start-up entrepreneurs is looking for funds to either open or expand their business. The idea and the motivation are there but only the money to make it happen is lacking.
Entrepreneurs can opt to borrow money from friends or relatives to do this or approach a third party for credit.
Credit at its most basic is an arrangement that allows a buyer to take possession of something now and pay for it later or over time. In general, credit refers to the belief or trust of a person in another person’s ability to comply with an obligation, such as an obligation to pay back a loan or to return a borrowed item.
That belief is strengthened when the borrower offers security for the loan and signs a contract for it. Such security often takes the form of a real guaranty; that is, a debtor guarantees to the creditor that he will fulfill his obligation, and as a sign of good faith pledges a piece of property or collateral that he forfeits if he fails to do so at the time agreed.
If the borrower pledges real property, the accessory contract is called a real estate mortgage; if he pledges personal property, such as shares of stock, bonds, negotiable instruments, motor vehicles, machinery, equipment and the like, the accessory contract is either a pledge or a chattel mortgage.
As the term “accessory” connotes, it is essential in both contracts of pledge and mortgage that they secure the fulfillment of a principal obligation. Third persons who are not parties to the principal obligation may also secure the same by pledging or mortgaging their own property. In addition, the pledger or mortgagor must be the absolute owner of the thing pledged or mortgaged, and in his absence, his duly authorized representatives must have the free disposal of the thing pledged or mortgaged.
The absence of any of these requirements renders the pledge or mortgage void, although the principal obligation continues to be valid between the parties. While the property pledged or mortgaged cannot be used to pay for the debt, the pledge or mortgage agreement being void, the lender may still initiate collection procedures against the borrower to recover the money owed him.
Unlike mortgaged property, the thing pledged must be placed in the possession of the creditor or a third person until the debt is paid. Once the principal obligation becomes due and the debtor cannot comply, the creditor may take over the thing pledged or mortgaged or sell it at an auction and use the proceeds to pay for the money owed him. During the term of the principal obligation, the ownership of the thing pledged or mortgaged continues to remain with the pledger or the mortgagor, but he may sell it only on the consent of the creditor and always subject to the pledge or mortgage.
If third parties are to be bound by the pledge or mortgage, the accessory contract must be made in a public instrument; that is, the pledger or mortgagor appears before a notary public and states that the instrument is complete, and that he had voluntarily signed off on it for the purposes stated in the instrument.
For pledges, the document must contain the description of the thing pledged and the date of the pledge. For mortgages, the document must be recorded in the Registry of Property, in case of real property, or in the Chattel Mortgage Register, in case of personal property. If the mortgage is constituted on a car or a water vessel, the mortgage must be recorded at the Land Transportation Office or at the port of entry, respectively, if it is to be binding on third parties.
This article was originally published in the August 2005 issue of Entrepreneur Philippines.