Dear Attorney,

I hope this message finds you well. I am writing to request your professional guidance regarding my plan to sell my car through a “pasalo” arrangement. For personal reasons, I need to transfer my vehicle’s financing obligations to another individual who is willing to assume the remaining loan balance and payments. This is not a straightforward sale of a fully paid vehicle, but rather an assumption of my existing contractual obligations with the financing institution.

Given that I have a chattel mortgage on the car, I want to ensure that all legal requirements under Philippine law are strictly complied with. I also wish to protect myself against potential liabilities, particularly if the new buyer fails to make the necessary monthly payments. Could you kindly advise me on the various legal considerations and possible risks involved, as well as any recommended best practices or alternative options?

Thank you in advance for your insights. I appreciate your time and expertise in this matter.

Sincerely,

A Regretful Seller

LEGAL ARTICLE: EVERYTHING YOU NEED TO KNOW ABOUT PASALO CAR SALES UNDER PHILIPPINE LAW

Introduction to “Pasalo” Arrangements
A “pasalo” arrangement, in the context of motor vehicle financing in the Philippines, generally refers to the informal practice where an original borrower transfers to a third party the responsibility for continuing the monthly loan amortizations of a car still subject to a chattel mortgage. Under Philippine law, this scenario often arises when the original borrower (the “seller”) encounters financial difficulties or simply wishes to pass on the obligation to someone else (“the buyer” or “the new payer”). Although a “pasalo” sale seems convenient, it is not as straightforward as a typical sale of a fully paid vehicle. Because the car is still encumbered by a financing agreement, there are multiple legal steps involved to ensure the transaction is valid, enforceable, and does not violate any terms of the existing loan.

In practice, many “pasalo” transactions are done without the express approval or knowledge of the lending institution, which can create risks for both parties. This guide is intended to illustrate the comprehensive legal considerations, common pitfalls, and best practices that prudent individuals must observe when contemplating a “pasalo” car sale in the Philippines.

Legal Framework and Relevant Laws
The primary legal framework that governs “pasalo” arrangements for motor vehicles in the Philippines can be found under (a) the Civil Code of the Philippines, particularly its provisions on contracts and obligations; (b) the Chattel Mortgage Law (Act No. 1508), which regulates mortgaged personal property; and (c) relevant rules and regulations of the Land Transportation Office (LTO). Additionally, consumer protection statutes, as well as the terms and conditions set forth in the specific loan or financing agreement, play pivotal roles.

When a car loan is taken out, the financing entity usually requires the borrower to execute a chattel mortgage over the vehicle. Under Section 3 of Act No. 1508, a valid chattel mortgage must be in writing, identifying the motor vehicle with particularity, and duly registered with the appropriate government agency. This mortgage gives the lender the right to repossess the vehicle in case of default.

Nature of Contractual Obligations
In a typical loan scenario, the borrower is contractually bound to pay monthly amortizations until the full settlement of the principal and interest. The chattel mortgage adds an additional layer of security for the lender. When a “pasalo” arrangement takes place, the new payer informally steps into the shoes of the original borrower—continuing monthly payments and, in many instances, taking de facto possession of the vehicle. However, absent official lender approval, the original borrower remains the party primarily liable for the debt.

If the new payer defaults, the lender can still pursue the original borrower for the outstanding balance. Moreover, the vehicle can be repossessed and sold at auction. If the sale proceeds are insufficient, the original borrower might end up having to pay the deficiency, not the new payer, unless the lender chooses to recognize the latter as the new debtor. This underscores the importance of securing the lender’s approval for a formal assignment or novation of the loan.

Novation and Assignment of Rights
Under Articles 1291 to 1304 of the Civil Code, novation is the process by which an existing obligation is extinguished and replaced by a new one. In the context of a “pasalo” arrangement, novation typically occurs if the lender consents to substituting the original borrower with the new payer. A properly executed novation arrangement will effectively free the original borrower from liability, transferring all obligations to the new payer.

Alternatively, an assignment of credit or rights can be carried out under Articles 1624 to 1635 of the Civil Code. However, assignment requires the consent of the lender, as the transfer of the contract must be recognized. If the lender does not give formal permission, the new payer remains an informal substitute, and the original borrower continues to be liable for the loan. Ensuring that the financing institution issues a written acceptance of the substitution is paramount in providing security and clarity for all parties involved.

Risks for the Original Borrower (Seller)
One of the greatest risks a “pasalo” seller faces arises when the new payer fails to meet monthly installments. Because the loan remains under the original borrower’s name (absent a novation), collection agencies or the financing institution could still come after the latter for payment. This can significantly impact the credit standing of the original borrower and could subject them to additional financial burdens if repossession and deficiency obligations follow.

Another common complication is potential legal liability if the new payer uses the vehicle illegally or gets involved in accidents or traffic violations. Official ownership and registration may still be in the original borrower’s name if a proper transfer has not been processed with the LTO, leading to possible entanglements with traffic enforcement agencies, third parties, or even criminal liability (e.g., if the vehicle is used in illicit activities).

Risks for the New Payer (Buyer)
The new payer, on the other hand, must be aware of several potential pitfalls. If the lender is not informed or does not approve the arrangement, the new payer’s right to possess the vehicle is precarious. If the original borrower defaults on other obligations or if the new payer misses payments, the lender may repossess the vehicle without recognizing any financial contributions the new payer has already made.

Additionally, without a formal assignment or amendment of the loan, the new payer has no direct privity of contract with the lender. This means the new payer may find it difficult to negotiate terms, request restructuring, or deal directly with the lender if needed. In short, the new payer’s investment is insecure unless the financing institution officially acknowledges their assumption of the loan.

Steps to Obtain Lender Approval
To ensure a legally sound “pasalo” transaction, the primary step is for both the original borrower and the potential new payer to approach the financing institution. The lender may require (a) a credit evaluation of the new payer, (b) updated documents such as proof of income, identification, and credit checks, and (c) a formal request letter or application for assumption of mortgage or loan novation.

Once the lender reviews and approves the new payer as a qualified substitute, an amendment or novation agreement may be drafted. The financing institution could then issue a new promissory note or loan agreement in the name of the new payer. At this juncture, the original borrower would be formally released from the debt obligations, and the new payer becomes the primary debtor under the chattel mortgage. All relevant details, such as updated amortization schedules, interest rates, penalties, and other stipulations, should be specified to avoid ambiguity.

Drafting a Valid Contract for Pasalo
When entering into any arrangement involving the transfer of obligation, a written contract is strongly recommended. A well-drafted “pasalo” contract typically includes the following essential elements:
Parties to the Agreement – Identifying both the original borrower and the new payer, along with their addresses and pertinent details.
Loan Details – Outlining the original amount of the loan, the remaining balance, interest rate, payment schedule, maturity date, and any penalties.
Transfer of Rights and Obligations – Clearly specifying that the new payer will assume responsibility for monthly amortizations and any ancillary obligations, while the original borrower intends to be released from further liability.
Consideration – Stipulating any upfront payment or compensation the new payer may give to the original borrower for the equity already paid on the car.
Warranty and Representation – Requiring each party to state that all information is true, that the original borrower has disclosed any existing arrears or pending legal claims involving the vehicle, and that the new payer understands the scope of obligations being assumed.
Lender Consent – Incorporating a clause that the agreement is contingent upon or subject to the lender’s written approval, ensuring legal compliance.

It is always best to involve legal counsel in drafting or reviewing this contract, as the final text should align with the loan terms, existing regulations, and the particular preferences of the parties.

Registration and Transfer of Ownership
In a legitimate “pasalo” transaction, once the lender has approved the novation or assignment of the loan, the change in ownership should also be reflected in the records of the LTO. In many cases, the chattel mortgage must be updated or re-registered to reflect the new debtor. Failing to register the updated information can cause complications for the new payer if they later decide to sell or mortgage the vehicle.

Under the Land Transportation and Traffic Code (Republic Act No. 4136), the transfer of ownership of a motor vehicle must be reported within a specified period, typically within three to five days from the date of sale or transfer, to the LTO. Ensuring that all forms (e.g., Deed of Sale, Confirmation of Ownership, updated mortgage documents) are completed in a timely manner is crucial for the legitimacy and security of the transaction.

Practical Tips and Best Practices
To minimize risk, both parties should follow these best practices:

Obtain Credit Clearance: Confirm that the original borrower is up to date with loan payments and that there are no arrears or penalties before finalizing the arrangement.
Use Legal Counsel: Consult a lawyer to draft or review the agreement, ensuring it satisfies all legal requirements.
Document All Transactions: Keep copies of receipts, bank statements, and formal communications with the lender.
Verify the Vehicle’s Status: Check with the LTO to confirm that the vehicle has no outstanding violations or encumbrances beyond the existing chattel mortgage.
Secure Lender Approval Early: Attempt to obtain formal approval from the financing institution before allowing the new payer to take possession of the car or start making monthly payments.
Formalize Ownership Transfer: Complete all LTO documentation required to reflect the change in ownership once novation is accomplished.

Potential Legal Remedies in Case of Disputes
If disputes arise, the parties can resort to various remedies. Under Philippine laws, these typically include:

Judicial Demand for Specific Performance: If the “pasalo” contract or the novation agreement is valid, a party can compel the other to comply with its stipulations.
Damages: A party who suffers losses due to the other’s breach of contract may seek compensatory, moral, or even exemplary damages, depending on the circumstances.
Repossession and Foreclosure: In case of default, the lender may repossess the vehicle under the terms of the chattel mortgage, or the original borrower may need to repossess it if the “pasalo” transaction did not receive lender approval and the new payer has defaulted.
Criminal Complaints: If there are allegations of fraud or misrepresentation, a criminal action may be initiated, though this is usually a more serious step reserved for clear instances of deceit, bouncing checks, or other fraudulent acts.

Litigation is typically costly and time-consuming, so it is best to avoid disputes by ensuring that all parties fully understand their rights and obligations from the outset.

Effects on Credit Standing
For the original borrower, a well-executed novation with the lender’s consent means that their credit standing will no longer be jeopardized by late or missed payments on the vehicle loan. However, if the arrangement is informal and the new payer defaults, the original borrower’s credit score could suffer.

For the new payer, having the loan formally transferred and recognized in their name may help build a favorable credit history if they diligently meet all payment schedules. On the other hand, an informal “pasalo” that leads to repossession or default can tarnish the reputations of both parties, especially if disputes escalate and come to the attention of the lender or credit bureaus.

Alternative Options to Consider
Before committing to a “pasalo” arrangement, the original borrower may wish to explore alternative solutions:

Loan Refinancing or Restructuring: Some financing institutions offer revised payment terms, reduced interest rates, or extended payment periods to help borrowers cope with financial difficulties.
Selling the Vehicle Outright: It may be more straightforward to fully settle the car loan, have the mortgage cancelled, and sell the car without encumbrances. Though this option might require additional funds, it eliminates potential complications.
Negotiating with the Lender for a Balloon Payment: Some borrowers manage to pay a lump sum to reduce the monthly installments, thus making the loan more attractive to a prospective buyer who can then enter into a more formal assumption with minimal risk.

New payers, on the other hand, might explore alternative ways to purchase a used vehicle, like getting their own financing or buying from someone who has already fully paid for their car. This way, the chain of liability is clear, and the risk of dealing with a hidden encumbrance is minimized.

Documentation Requirements with the LTO
After obtaining lender approval, the parties should submit certain documents to the LTO to effect a valid transfer of ownership. These commonly include:

Original Certificate of Registration (CR) and the latest Official Receipt (OR) of payment of the motor vehicle tax.
Deed of Sale or Deed of Assignment executed by the original borrower to the new payer.
Chattel Mortgage Release or Amendment (if the mortgage is re-registered under the new payer’s name).
Valid IDs and authorization letters where necessary.

Adherence to the LTO’s rules prevents complications, such as failing to receive a new CR showing the updated owner’s name. If the LTO records still reflect the original borrower’s name, any traffic violation notices or vehicle-related legal concerns will be directed to them, even if they no longer physically possess or use the car.

Tax Implications and Fees
Although typically overshadowed by the contractual intricacies, there are tax implications and fees to consider in a “pasalo” transaction. For instance, the Bureau of Internal Revenue (BIR) imposes a Documentary Stamp Tax (DST) on certain documents, including chattel mortgage instruments. However, whether a separate sale transaction triggers capital gains tax or other taxes depends on the structure of the agreement. In most “pasalo” cases, the original borrower has not technically made a capital gain if they are simply assigning a loan, but any equity or goodwill payment they receive might be subject to tax if it qualifies as income.

Moreover, the LTO imposes its own fees for transferring motor vehicle ownership. Both parties should factor in these costs when negotiating the terms of the “pasalo,” as they can affect the net financial benefit to the original borrower and the cost to the new payer.

Enforceability of Informal Pasalo Agreements
Many Filipinos engage in “pasalo” deals informally, with nothing more than a handshake or a handwritten note. While the law does recognize verbal or informal contracts in certain circumstances, the absence of lender approval or a formal deed greatly complicates matters. Enforceability before courts can become an uphill battle, often boiling down to evidence of the parties’ real intentions, the existence of partial performance, or admissions of liability.

This underscores why it is highly advisable to reduce any agreement to writing and, most importantly, to secure explicit consent from the financing institution. Doing so bestows legal certainty upon everyone involved and reduces the risk of future legal confrontations or misunderstandings.

Conclusion: Proactive Steps Lead to Secure Transactions
Selling a car under a “pasalo” arrangement is a delicate undertaking that requires full awareness of its legal implications. Both the original borrower and the new payer must proceed with caution, ensuring that the lender’s approval is obtained and that the terms of the sale are spelled out in a legally binding contract. Proper registration with the LTO, together with an updated chattel mortgage or novation agreement, remains crucial to avoid future liabilities and disputes.

Parties are encouraged to consult legal counsel before finalizing any “pasalo” transaction. An experienced lawyer can help prepare or review all necessary documents, protect the interests of each party, and ensure compliance with all statutory requirements. By doing so, the original borrower can relieve themselves of debt obligations with confidence, while the new payer acquires a vehicle without the fear that their investment might be lost due to unforeseen legal barriers.

Final Thoughts and Best Practices

Always Conduct Due Diligence: Whether you are the seller or the buyer in a “pasalo” deal, verify the car’s financial and legal status.
Insist on Written Agreements: Uphold the principle of “no documentation, no transaction.”
Consult the Financing Institution: Promptly disclose your intention for a “pasalo” to avoid unauthorized transactions.
Update LTO Records: Expedite the change of registration once the lender consents.
Be Vigilant About Potential Scams: There have been instances where unscrupulous individuals collect installment payments from buyers but never remit them to the lender, leading to repossession.

Ultimately, a “pasalo” arrangement can be beneficial for both parties if it is carried out responsibly, in accordance with Philippine law, and with the express involvement of the financing institution. Failure to address legal requirements, however, can result in costly disputes, repossession, and irreparable harm to one’s financial reputation. Being mindful, transparent, and proactive is the key to making this arrangement work successfully.