G.R. No. and Date: G.R. No. L-7790, March 19, 1914

FACTS:
El Banco Español-Filipino (the Bank) filed an action to collect on a promissory note dated April 10, 1911, executed by the firm McKay & Zoeller in favor of Levy Hermanos. The note promised payment of P4,600 three months and five days after date. The Bank alleged that on July 7, 1911, Levy Hermanos indorsed and transferred the note to it for value, making the Bank the owner and holder.

In their Answer, the defendants admitted their identities but denied the other allegations. As a special defense, they alleged that the note was not negotiable; that it was transferred to the Bank for collection only, making Levy Hermanos the real party in interest; and that the note was given as partial payment for diamonds purchased from Levy Hermanos. They claimed the sale was induced by false representations (the diamonds were guaranteed to be “genuine, first-class, blue-water diamonds” but were not) and that they had offered to rescind the contract and return the diamonds. They prayed that Levy Hermanos be made a party, for rescission of the sale, cancellation of the note, and judgment for the P4,600 cash paid.

The Bank demurred to the Answer, arguing its allegations were insufficient to constitute a defense. The trial court sustained the demurrer, and upon the defendants’ refusal to amend, rendered judgment on the pleadings in favor of the Bank.

ISSUE:
1. Whether the promissory note is a negotiable instrument under the Code of Commerce.
2. Whether the trial court erred in sustaining the plaintiff’s demurrer to the defendants’ Answer.

RULING:
The Supreme Court REVERSED the judgment of the trial court and REMANDED the case for trial.

1. On the Negotiability of the Note: The Court held the note was not a negotiable instrument under the Code of Commerce. While it met most formal requirements of Article 531, it lacked an essential element: it did not show on its face that it arose from a commercial transaction (acto de comercio), as required by Article 532. The Court rejected the argument that this defect could be supplied by extrinsic evidence. It ruled that the negotiable or non-negotiable character of an instrument is determined solely by its face. An instrument non-negotiable on its face cannot be made negotiable by proof, and vice-versa. Since the note was non-negotiable, the Bank acquired it by mere assignment, not by negotiation, and therefore took it subject to all defenses and equities (like fraud in the inducement) that the makers had against the original payee, Levy Hermanos.

2. On the Sufficiency of the Defense: The allegations in the Answer, specifically the defense of fraud in the inducement of the contract for which the note was given, constituted a complete defense against the Bank as a mere assignee of a non-negotiable instrument. Consequently, the trial court erred in sustaining the demurrer, which should have been overruled.

Additional Points:
The Court noted that the defendants’ failure to deny the note’s execution under oath admitted its genuineness, but this rule did not extend to admitting the truth of the endorsement.
Other alleged defects in the note (e.g., lack of a specific place of payment, lack of the words “bill of exchange” or “promissory note”) were deemed not fatal to its form.
* The Court distinguished prior cases and clarified the doctrine: for a promissory note payable to order to be commercial, it must appear from the instrument itself that it originated in a commercial transaction.