SECOND DIVISION

[G.R. No. 149221. April 7, 2009.]

PHILIPPINE NATIONAL BANK , petitioner, vs . MARCELINO BANATAO, ROSA

BANATAO, VICTORINA B. CADANGAN, AVELINO BANATAO, ROSALINDA
B. GUMABAY, EDNA B. CALUCAG, CATALINA BANATAO, ABDON
BANATAO, GELACIO BANATAO, CONSTANCIO BANATAO, DOMINGO
BANATAO, RICHARD BANATAO, ARNOLD BANATAO, SALVACION
BANATAO, LANIE BANATAO, VIVIAN BANATAO, ALVIN BANATAO,
ROLAND BANATAO, FE SACQUING, MAXIMO SACQUING, POMPEO
BANTAO, ANNIE MALUPENG, BONG MALUPENG, EDILBERTO
BANGAYAN, EVANGELINE BANGAYAN, ELPIDIO BANGAYAN, MARLIN
PAMITTAN, LOIDA PAMITTAN, VICENTE PAMITTAN, MICHAEL
PAMITTAN, EDGARDO PAMITTAN, LORINA BANATAO, ASSISTED BY
HUSBAND WILLY BANATAO, MARAVITA BANATAO, PAULINA BANATAO
ASSISTED BY HUSBAND DOMINGO CUNTAPAY, JULIETA BANATAO,
ROSITA PAMITTAN ASSISTED BY HUSBAND SALVADOR BANATO, AND
ELENA BANATAO , plaintiffs-respondents,

and MARCIANO CARAG, EUGENIO SORIANO, MARIA CAUILAN, PEDRO

SORIANO, PAZ TACACAY, BENJAMIN TACACAY, FAUSTA AGUSTIN,
MILAGAROS B. CARAG , defendants-respondents.

DECISION

BRION , J : p

This petition for review on certiorari 1 brings into focus: (1) the effect of a
compromise agreement entered into by some, but not all, of the parties to a litigation, and its
effect on the non-participating litigants; and (2) the prohibition against the encumbrance,
within the same periods prescribed by law, of lands granted under homestead patent. DHITCc

The facts as culled from the records are outlined below.

On November 16, 1962, Banatao, et al. (plaintiffs-respondents) initiated an action
docketed as Civil Case No. 1600 against Marciano Carag (one of the defendants-
respondents) before the Regional Trial Court (RTC), Branch IV, Tuguegarao, Cagayan. 2 The
action was for the recovery of real property (disputed property) situated at Malabac, Iguig,
Cagayan. The disputed property was a new land formation on the banks of the Cagayan River
— an accretion to Lot 3192 of the Iguig Cadastre — that the plaintiffs-respondents claimed
as the owners of the adjoining Lot 3192. The defendants-respondents, on the other hand,
were the occupants of the disputed property.
The records show that while the case was pending, the defendants-respondents
(particularly the spouses Pedro Soriano and Paz Tagacay, the spouses Eugenio Soriano and
Maria Cauilan, the spouses Benjamin Tagacay and Fausta Agustin, and Milagros B. Carag —
wife of Marciano Carag) were able to secure homestead patents evidenced by Original
Certi cates of Title (OCTs) issued in their names, denominated as OCT Nos. 24800, 24801,
25217, and 25802, respectively. 3 The OCTs were issued in 1965 and 1966 , and all bear
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 the proviso that, in accordance with the Public Land Act, the patented homestead shall
neither be alienated nor encumbered for ve (5) years from the date of the issuance of the
patent. 4
Armed with their OCTs, the defendants-respondents separately applied for loans with
the Philippine National Bank (PNB or the bank) secured by real estate mortgages on their
respective titled portions of the disputed property. The bank approved the mortgages,
relying solely on the OCTs which, at the time, did not contain any notice of lis pendens or
annotation of liens and encumbrances. The PNB mortgages were annotated on the
defendants-respondents' respective OCTs also in the years 1965 and 1966. 5
On February 22, 1968, the trial court decided the case in favor of the plaintiffs-
respondents and against defendant-respondent Carag, and ordered the return of the
disputed property to the plaintiffs-respondents. 6 Carag appealed the trial court decision to
the Court of Appeals (CA).
While the appeal was pending, the appellate court discovered that the disputed
property had been subject of homestead patents issued in the names of defendants-
respondents Carag, et al. Hence, in its Resolution dated April 16, 1969, the Special Fourth
Division of the CA set aside the February 22, 1968 decision of the RTC and ordered the
remand of the records to the trial court for further proceedings. 7 The appellate court
likewise ordered the necessary amendment of the complaint to implead the defendants-
respondents who were deemed indispensable parties to the case.
The plaintiffs-respondents led on October 14, 1970 the required amended complaint,
impleading as party defendants Eugenio Soriano, Maria Cauilan, Pedro Soriano, Paz Tagacay,
Benjamin Tagacay, Fausta Agustin, and Milagros B. Carag, as well as the bank. 8 The
plaintiffs-respondents also added two (2) additional causes of action, or a total of three (3)
causes of action, namely: (1) recovery of real property; (2) cancellation of the OCTs; and (3)
annulment of real estate mortgage. The bank was made a party to the case in view of the suit
for annulment of mortgage.
The records disclose that on March 29, 1973, while the case was pending before the
trial court, the bank extrajudicially foreclosed the property covered by OCT No. 24800 issued
to the spouses Pedro Soriano and Paz Tagacay. The bank was declared the highest bidder in
the ensuing public auction. The spouses Soriano failed to redeem the foreclosed property,
resulting in the consolidation of title in the bank's name; hence, the issuance on October 3,
1985 of TCT No. T-65664 in the name of the bank. 9
On February 28, 1991, the plaintiffs-respondents and the defendants-respondents
entered into a compromise agreement whereby ownership of virtually the northern half of the
disputed property was ceded to the plaintiffs-respondents, while the remaining southern half
was given to the defendants-respondents. 1 0 In the same compromise agreement, the
defendants-respondents acknowledged their indebtedness to petitioner PNB and bound
themselves to pay their respective obligations to the bank, including the interests accruing
thereon. Petitioner PNB, however, was not a party to the compromise agreement which
reads:
COMPROMISE AGREEMENT 1 1

Plaintiffs and defendants, by counsels, enter into and submit the following compromise
agreement: EHSTDA

xxx xxx xxx

(b) That the defendant, PEDRO SORIANO, acknowledges the plaintiffs as the
lawful owners of the NORTHERN PORTION of the land covered by
Original Certi cate of Title No. P-24800, with an area of 85,348 square
meters more or less and is more particularly described in the technical
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 description hereto attached as Annex "A" and forming part hereof;

(c) That the defendant, BENJAMIN TAGACAY, acknowledges the plaintiffs to

be the owners of the NORTHERN PORTION of the land covered by Original
Certi cate of Title No. P-25217, with an area of 98,790 square meters
more or less and is more particularly described in the technical
description hereto attached as Annex "B" and forming part hereof;

(d) That the defendant, MILAGROS B. CARAG, acknowledges the plaintiffs to

be the owners of the NORTHERN PORTION of the land covered by Original
Certi cate of Title No. P-24802, with an area of 58,378 square meters
more or less and is more particularly described in the technical
description attached hereto as Annex "C" and forming part hereof;

(e) That the defendant Pedro Soriano acknowledges indebtedness to the

Philippine National Bank and binds himself to pay his loan together with
the interest and other charges;

(f) That the defendant Benjamin Tagacay acknowledges indebtedness to

the Philippine National Bank and binds himself to pay his loan together
with the interest and other charges;

(g) That the defendant Milagros B. Carag acknowledges indebtedness to the

Philippine National Bank and binds himself to pay his loan together with
the interest and other charges;

(h) That the private defendants acknowledge the plaintiffs to be the owners
and possessors of the motherland otherwise known as Lot 3192 and the
area ceded to the plaintiffs by the private defendants;

(i) That the parties hereto submit the foregoing compromise agreement as
basis for the decision in the above-entitled case by the Honorable Court.

Tuguegarao, Cagayan, December 26, 1990.

On March 15, 1991, the trial court rendered its decision, approving and adopting in
toto the compromise agreement, and ordering the participating parties to strictly comply
with its terms. 1 2 The bank moved for reconsideration of the trial court's decision and for the
setting aside of the compromise agreement. The trial court denied the motion in its
Resolution of February 7, 1992, thus, compelled the bank to elevate the case to the CA. 1 3
The appellate court dismissed the appeal in its decision of March 30, 2001, ruling that
the bank is not an indispensable party to the compromise agreement that only settles the
actions for: (1) recovery of property; and (2) cancellation of OCTs. 1 4 On the third cause of
action for annulment of mortgage, the court held the bank is only a necessary party and
"the issue could be dealt with in a separate and distinct action." The appellate court in the
same decision proceeded to strike down the mortgages as void because the mortgagors
(defendants-respondents), not being the absolute owners of the disputed parcels of land as
agreed upon in the compromise agreement, did not have the right to constitute a mortgage
on these properties.
The PNB sought reconsideration of the dismissal of its appeal, but the appellate court
denied its motion in a Resolution dated July 27, 2001; 1 5 hence, this petition for review on
certiorari.
The PNB raises the following legal issue:
WHETHER THE COMPROMISE AGREEMENT ENTERED INTO BY AND BETWEEN THE
HEREIN PLAINTIFFS-RESPONDENTS AND DEFENDANTS-RESPONDENTS AND
APPROVED BY THE TRIAL COURT LEGALLY BINDS PETITIONER PNB WHICH IS NOT A
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 PARTY THERETO AND CONSTITUTES SUFFICIENT LEGAL BASIS TO NULLIFY PNB'S
MORTGAGE LIEN ON THE REALTY IN QUESTION.

In attacking the compromise agreement between the plaintiffs-respondents and the

defendants-respondents, the PNB argues that it is an indispensable, not merely a necessary,
party to all three causes of action, namely, for (1) recovery of real property; (2) cancellation
of the OCTs; and (3) annulment of mortgages. Arguing that the causes of action are closely
intertwined and intimately related, and that the compromise was entered into precisely to
put an end to the case, the PNB submits that its consent to the compromise agreement is
necessary to secure a nal and complete determination of the claims and defenses of all the
parties to the case. ICTacD

The PNB further argues that when the appellate court approved in toto the trial court's
judgment on the compromise agreement, it failed to consider that the bank was a
mortgagee in good faith. The bank claims good faith on the position that the OCTs
presented to it were all clean on their faces at the time the mortgages were applied for; that
there were no notices of lis pendens or any annotation of liens or encumbrances on all of
them; and that it had no knowledge, actual or constructive, of facts or circumstances to
warrant further inquiry into the titles of the defendants-respondents.
THE COURT'S RULING
We resolve to dismiss the petition for the reasons discussed below.
The compromise agreement disposed of the rst two causes of action led by
plaintiffs-respondents Banatao, et al. against defendants-respondents Carag, et al., namely,
the actions for (1) recovery of real property; and (2) cancellation of the OCTs, thereby
settling the question of ownership between them. The trial court approved the compromise
agreement in toto. The appellate court, in turn, upheld the trial court, but it proceeded to
discuss on the third cause of action (for annulment of mortgage), concluding that the
mortgages were void because the mortgagors were not the absolute owners of the
mortgaged properties. In the words of the appellate court:
The main cause of action here is the "Recovery of Realty and Reconveyance", the
"Annulment of Mortgage" is only an ancillary cause of action. In the decision approving
the compromise agreement it disposes and nally determined the "Recovery of Realty
and Reconveyance".

The moment ownership of the disputed real property was clearly proven to
be that of the [plaintiffs-respondents], the question of the validity of the
mortgage made by the [defendants-respondents] with [petitioner PNB] could
easily be determined.

xxx xxx xxx

The [defendants-respondents], not being the absolute owners and not having been
authorized to mortgage the subject real property, could not validly mortgage the
said real property with [petitioner PNB] . However, we are not unmindful of the
[defendants-respondents'] liability to [the bank]. But such issue could be dealt with
in a separate and distinct action. [Emphasis supplied.]

With the above ruling, the bank who was not a party to the agreement was therefore
affected; it was a mortgagee of a part of the disputed property, and had in fact foreclosed
the portion covered by OCT No. 24800.
It is basic in law that a compromise agreement, as a contract, is binding only upon the
parties to the compromise, and not upon non-parties. This is the doctrine of relativity of
contracts. Consistent with this principle, a judgment based entirely on a compromise
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 agreement is binding only on the parties to the compromise the court approved, and not
upon the parties who did not take part in the compromise agreement and in the proceedings
leading to its submission and approval by the court. Otherwise stated, a court judgment
made solely on the basis of a compromise agreement binds only the parties to the
compromise, and cannot bind a party litigant who did not take part in the compromise
agreement. In the case of Castañeda v. Heirs of Maramba, 1 6 we held that:
Judgment based on a compromise affects only participating litigants — A partial
decision, stemming from an amicable settlement among two of several parties to an
action, binds only the parties so participating in the settlement. This decision never
becomes nal with respect to the parties who did not take part in the
settlement confirmed by the partial decision aforesaid. [Emphasis supplied.]

Following Castañeda, the judgment on compromise rendered by the trial court in this
case, and later af rmed by the appellate court, is nal with respect only to the plaintiffs-
respondents and defendants-respondents, but not with respect to the PNB. Hence, the trial
court's judgment on compromise which settles the issue of ownership over the properties in
question is but a partial decision that does not completely decide the case and cannot bind
the PNB.
In its assailed decision, the CA, while recognizing the liability of the defendants-
respondents to the PNB, declared that the mortgagors, not being the absolute owners of the
mortgaged properties as agreed upon in the compromise agreement, do not have the right
to constitute the mortgage. This conclusion is legally incorrect as the CA capitalized on the
ownership issue settled between the plaintiffs-respondents and the defendants-
respondents in invalidating the PNB mortgages, without hearing the side of the PNB as
mortgagee, and later, co-owner of the disputed property. As discussed above, the
compromise agreement cannot bind the bank, a non-party to the agreement; necessarily, the
ownership issue which was settled by the compromise agreement cannot be made
applicable to the bank without hearing it. DTEIaC

Our own review of the records of the case shows that the appellate court was not
without basis to properly dispose of all the causes of action, including the annulment of
mortgage issue, had it fully scrutinized the records of the case. A glaring fact that escaped
the scrutiny of both the trial and appellate courts, and which would have led them to the
quick and correct disposition of the annulment issue (and of the entire case, given the
compromise agreement), is the proviso against alienation or encumbrance of lands granted
by homestead patent — a fact plainly evident upon a facial examination of the OCTs involved.
We conclude from our own examination of these OCTs that the mortgages cannot but
be void ab initio . On the faces of all the OCTs — secured through homestead patents — are
inscribed the following words that echo the mandatory provisions of law:
TO HAVE AND TO HOLD the said tract of land with the appurtenances thereunto . . .
subject to the provisions of Sections 118, 121, 122 and 124 of Commonwealth Act No.
141, as amended, which provide that except in favor of the Government or any of its
branches, units or institutions, THE LAND HEREBY ACQUIRED SHALL BE
INALIENABLE AND SHALL NOT BE SUBJECT TO [E]NCUMBRANCE FOR A
PERIOD OF FIVE (5) YEARS NEXT FOLLOWING THE DATE OF THIS PATENT ,
and shall not be liable for the satisfaction of any debt contracted prior to the expiration
of that period; . . . . 1 7 [Emphasis supplied.]

This inscription reproduces Section 118 1 8 of the Public Land Act, 1 9 as amended,
which contains a proscription against the alienation or encumbrance of homestead patents
within five years from issue. The rationale for the prohibition, reiterated in a line of cases, first
laid down in Pascua v. Talens 2 0 states that ". . . homestead laws were designed to distribute
disposable agricultural lots of the State to land-destitute citizens for their home and
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 cultivation. Pursuant to such benevolent intention the State prohibits the sale or
encumbrance of the homestead (Section 116, now Section 118) within ve years after the
grant of the patent. . . . . It aims to preserve and keep in the family of the homesteader that
portion of public land which the State had gratuitously given to him."
In the present case, the annotation of the mortgage liens occurred only months
after the date of the issuance of the homestead patents . The pertinent facts as seen
on the faces of the OCTs are illustrated below:

OCT No. Mortgagors Date of Date of Period from

Homestead Annotation/ Date of
Patent Inscription of Patent 2 1
Mortgage

P-24800 Pedro Soriano/ 28 Apr 1965 17 Sep 1965 5 Months

Paz Tagacay

P-24801 Eugenio Soriano/ 28 Apr 1965 27 Oct 1965 6 Months

Maria Cauilan

P-24802 Milagros B. Carag/ 28 Apr 1965 13 Oct 1965 6 Months

Marciano Carag

P-25217 Benjamin Tagacay/ 15 Feb 1966 25 Mar 1966 1 Month

Fausta Agustin

This situation is similar to that of Republic v. Heirs of Alejaga, Sr. 2 2 where the respondent
obtained a loan of P100,000.00 in 1981 from the PNB, secured by a real estate mortgage on the
patented land. The 1981 encumbrance was contracted two years from date of issuance of the
patent in 1979, for which reason the Court cited a violation of Section 118 of the Public Land
Act which proscribes the alienation or encumbrance of the patented land within ve years from
the date of the patent, and which proscription clearly appears as a proviso in the OCT issued in
the name of the respondent in the case. Consequently, the PNB mortgage was declared void.
The present case deserves exactly the same treatment, and the PNB cannot claim that
it is a mortgagee in good faith. The proscription against alienation or encumbrance is
unmistakable even on a cursory reading of the the OCTs. Thus, one who contracts with a
homestead patentee is charged with knowledge of the law's proscriptive provision that must
necessarily be read into the terms of any agreement involving the homestead. Under the
circumstances, the PNB simply failed to observe the diligence required in the handling of its
transactions and thus made the fatal error of approving the loans secured by mortgages of
properties that cannot, in the first place, be mortgaged.
Both the defendants-respondents and the bank are to be faulted for the invalidity of
the mortgages. We cannot, however, apply the doctrine of pari delicto in accordance with the
ruling that the doctrine does not apply when the contract is prohibited by law. 2 3 A saving
factor for the bank under the situation is that a mortgage is merely an accessory agreement
and does not affect the principal contract of loan. The mortgages, while void, can still be
considered as instruments evidencing the indebtedness of defendants-respondents to the
PNB in a proper case for the collection of the defendants-respondents' loans. IaECcH

Our conclusion on the nullity of mortgage issue renders it unnecessary to decide the
question of whether the compromise agreement between the plaintiffs-respondents and the
defendants-respondents should be set aside for its effect on the bank. With the mortgages
invalidated, the PNB no longer has any interest that the compromise agreement can affect. In
the absence of any other reason to impugn the lower court decisions approving the
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 compromise agreement, we af rm the approval of the compromise agreement and the
disposition of the case on the basis of compromise. Given our ruling on the invalidity of the
mortgages, a remand of this issue is no longer necessary. The parties' liabilities to PNB on
the loans they obtained are not issues before us for disposition, and are for the parties to act
upon as matters outside the coverage of this case.
WHEREFORE, we hereby DECLARE the mortgages constituted on OCT Nos. 24800,
24801, 25217 and 25802 VOID and, for this reason, we DISMISS the petition. We AFFIRM the
approval of the compromise agreement by the Court of Appeals and the disposition of the
case on the basis of compromise. The order to remand the case to the Regional Trial Court,
Branch IV, Tuguegarao, Cagayan, for further proceedings is therefore REVERSED.
Costs against petitioner PNB.
SO ORDERED.
Quisumbing, Carpio-Morales, Tinga and Velasco, Jr., JJ., concur.

Footnotes

1.Under Rule 45 of the Rules of Court.

2.Records, Vol. I, pp. 1-4.

3.Under Commonwealth Act No. 141 or CA No. 141, effective November 7, 1936.

4.CA No. 141, Section 118.

5.Exhibits "8", "9", "10", and "11", Record of Exhibits, pp. 55-57, 58-59, 60-62, and 63-64, respectively.

6.Records, Vol. I, pp. 180-202.

7.Id., Vol. II, pp. 238-240.

8.Id., pp. 246-255. SATDEI

9.Memorandum of PNB, rollo, p. 101.

10.Records, Vol. IV, pp. 877-878.

11.Ibid.

12.Records, Vol. IV, pp. 879-880.

13.Id., pp. 906-909, penned by Associate Justice Andres B. Reyes, Jr., with Associate Justice B.A.
Adefuin-De la Cruz (retired) and Associate Justice Josefina Guevarra-Salonga, concurring.

14.Rollo, pp. 26-37.

15.Id., p. 40.

16.G.R. No. L-25569, December 28, 1971, 42 SCRA 634.

17.Exhibits "8", "9", "10" and "11", Record of Exhibits, pp. 55-57, 58-59, 60-62, and 63-64, respectively.

18.SEC. 118.Except in favor of the Government or any of its branches, units, or institutions, or legally
constituted banking corporations lands acquired under free patent or homestead
provisions shall not be subject to encumbrance or alienation from the date of the
approval of the application and for a term of ve years from and after the date of
issuance of the patent or grant, nor shall they become liable to the satisfaction of
any debt contracted prior to the expiration of said period , but the improvements or
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 crops on the land may be mortgaged or pledged to quali ed persons, associations, or
corporations.

No alienation, transfer, or conveyance of any homestead after ve years and before twenty- ve
years after issuance of title shall be valid without the approval of the Secretary of Agriculture
and Natural Resources, which approval shall not be denied except on constitutional and legal
grounds. [Emphasis supplied.]

19.Supra note 3.

20.80 Phil. 792 (1948).

21.Approximation in months, from date of entry of homestead patent to date of annotation of the
mortgage.

22.G.R. No. 146030, December 3, 2002, 393 SCRA 361.

23.Philippine National Bank v. De los Reyes , G.R. Nos. 46898-99, November 28, 1989, 179 SCRA 619.
DEcITS

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