Contracts of adhesion

Contracts play an integral role in our daily lives, extending beyond the realms of law and business. They serve as the cornerstone of agreements between parties to ensure clarity and accountability in everyday transactions. However, not all contracts are created equal; and some can raise valid questions about fairness, equality, and consent.

In this article, we talk about contracts of adhesion.

A contract of adhesion is defined as one in which one of the parties imposes a ready-made form of contract, which the other party may accept or reject, but which the latter cannot modify. One party prepares the stipulation in the contract, while the other party merely affixes his signature or his “adhesion” thereto, giving no room for negotiation and depriving the latter of the opportunity to bargain on equal footing.

Simply put, in such a contract, one party prepares the contract and its contents while the other party is to decide whether to accept or decline the terms. Accordingly, the other party is free to reject it entirely or, if he “adheres”, he gives his consent. (Apelanio v . Arcanys, Inc. , GR No. 227098, November 14, 2018)

These types of contracts have been declared as binding as ordinary contracts, the reason being that the party who adheres to the contract is free to reject it entirely.

We can see these types of contracts in banking transactions such as loan agreements, promissory notes, real estate mortgages, credit card applications, insurance contracts, and, at times, employment contracts usually for the rank-and-file level.

READ: Tips on reading a contract

The easiest way to spot a contract of adhesion is one of the usual agreements in writing which comes in a ready-made form contract given by one party to another with blank spaces to fill in names, dates, and amounts where the other details are already printed.

Trap for weaker the party

In many cases, the Supreme Court has declared that while a contract of adhesion is not illegal, it is considered a veritable trap for the weaker party which the courts are bound to protect from abuse and imposition. In case of doubt, the contract will be construed strictly against the party who prepared it.

A case in point is a recent case decided by the Supreme Court, which declared void an extrajudicial foreclosure of property by a bank against the property of a debtor.

Sometime in 1990, Elena Quiambao borrowed P1.4 million from China Banking Corp. to increase the working capital of her general merchandising business. Her common-law husband, Daniel Sy, executed a Real Estate Mortgage (REM) over a parcel of land to secure the loan.

The REM was amended several times from 1993 to 1997 to increase the loan to P4 million and contained a “blanket mortgage clause” or “dragnet clause.”

This dragnet clause subsumes all debts, past or future, of the borrower to be covered by the security given for the loan, and makes additional funds available to the borrower without the need to execute separate security documents.

Later in 2004, the borrower executed eight promissory notes, which renewed promissory notes dated 2000 and 2001, for a total additional loan of  P5 million.

A year later, the bank filed a petition for foreclosure of the REM with the court, and an extrajudicial sale of the property was conducted via public auction, where China Bank was declared the highest bidder.

Elena filed a petition to nullify the mortgage and foreclosure proceedings before the court, claiming that the REM only covered her loan of 1990 and its amendments until 1997, but not the other loans totaling P5 million. During the trial, Elena testified that she was made to sign blank documents and blank promissory notes when she transacted with the bank.

The Regional Trial Court granted the petition of the borrower and canceled the mortgage sale of the property. This was reversed by the Court of Appeals, which decided that the REM was intended to secure all succeeding obligations of Elena due to the dragnet clause.

The Supreme Court reversed the Court of Appeals. The REM and its amendments were declared to be contracts of adhesion drafted and prepared by the bank in standard forms.

The court declared that in a contract of adhesion, one imposes a ready-made contract to the other whose sole participation is either to accept or reject the agreement. The parties do not bargain on equal footing in the execution of this kind of contract given that the debtor is limited “to take it or leave it” option and there is no room for negotiation.

However, such a contract is not entirely prohibited. The one adhering is free to give his consent inasmuch as he is also free to reject it completely.

In such contracts, any doubt or ambiguity in the provisions of these documents must be interpreted against the bank or the one who prepared it. (Quiambao v. China Banking Corporation, GR 238462, May 12, 2021)

While the dragnet clause contained in the amendments to the REM Elena signed is not disallowed, its terms and conditions must be carefully examined.

In such cases, the court declared that the future debts must be specifically described or must come fairly within the terms of the mortgage contract.

The rule is that a mortgage containing a dragnet clause will not be extended to cover future advances unless the document evidencing the subsequent advance refers to the mortgage as providing security therefor, or unless there are clear and supportive evidence to the contrary.

Foreclosure proceedings declared void

Here, the eight promissory notes failed to allude to Elena and Daniel’s liability under the latest amendment to the REM dated April 29, 1997. Moreover, the promissory notes do not even make any reference to the REM as a security.

In addition to the foregoing, the bank’s loan assistant categorically testified that one of the promissory notes was not the subject of the REM.

The court ruled that any doubt must be construed against the bank or the party who prepared the contracts. In this case, the court found that the additional promissory notes were not secured by the mortgage.

The personal circumstances of Elena and Daniel were also considered by the court. It found that Elena only finished high school while Daniel reached only grade two such that they cannot be expected to understand all the technicalities and foresee the legal implications of the transactions despite their business experience. In other words, they lacked the adeptness to fully comprehend the effects of the amendments to the REM.

On the other hand, the bank merely concluded that Elena and Daniel freely, voluntarily, and willingly entered into the amendments to the REM but did not prove, let alone allege, that it made an effort to explain to them and ensure that they indeed understand the stipulations in the contract. Hence, the Court found good reason to step in and protect the interest of the weaker party.

In the end, the Supreme Court declared the foreclosure proceedings void and that the bank cannot validly foreclose a mortgage based on non-payment of unsecured promissory notes.

We can see that in cases where the  Supreme Court is called to determine the validity and enforceability of contracts, it will take into consideration the peculiar circumstances obtained in each case and the situation of the parties concerned.

Moreover, considering that the loan documents were found to be contracts of adhesions, a more strict or stringent treatment was applied pursuant to the mandate that in all contractual, property, or other relations, when one of the parties is at a disadvantage on account of his moral dependence, ignorance, indigence, mental weakness, tender age or other handicap, the courts must be vigilant for its protection.

(The author, Atty. John Philip C. Siao, is a practicing lawyer and founding Partner of Tiongco Siao Bello & Associates Law Offices, an Arbitrator of the Construction Industry Arbitration Commission of the Philippines, and teaches law at the De La Salle University Tañada-Diokno School of Law. He may be contacted at [email protected]. The views expressed in this article belong to the author alone.)