How Are Commercial Lease Improvements Divided After Marital Separation?
Introduction
When spouses jointly operate a business and improve a rented commercial space, separation raises two separate questions: who owns or controls the improvements, and how their value should be accounted for during the liquidation of the marital property regime.
The answer depends on the spouses’ property regime, the source of the funds, the lease contract, the nature of the improvements, and the legal consequences of the lease’s termination. Commercial fixtures, renovations, partitions, equipment installations, and other improvements should not be treated automatically as ordinary marital assets or as the exclusive property of the spouse who paid for them.
Governing Property Regimes Between Spouses
The spouses’ marriage settlement determines whether their property relations are governed by absolute community of property, conjugal partnership of gains, complete separation of property, or another valid regime. In the absence of a valid marriage settlement, the system of absolute community of property generally governs under Article 75 of the Family Code of the Philippines (Executive Order No. 209).
The applicable regime is important because it determines whether the funds used for the commercial improvements were community, conjugal, or exclusive funds. It also affects how the business, leasehold interest, receivables, equipment, and reimbursement claims are classified and divided.
Are Leasehold Improvements Automatically Marital Property?
No. An improvement placed on leased premises is not automatically owned by both spouses merely because it was constructed during the marriage or used in a family business.
The spouses must distinguish between:
- the improvements themselves;
- the contractual right to use the leased premises;
- the right to remove or recover the value of the improvements;
- the business assets used to pay for the improvements; and
- any reimbursement or indemnity claim against the lessor.
Article 120 of the Family Code applies to improvements made on the separate property of a spouse at the expense of the conjugal partnership or through the efforts of either or both spouses. It provides rules on ownership and reimbursement when the property improved belongs to one spouse. It does not, by itself, determine ownership of improvements made on property leased from a third person (Family Code of the Philippines, Executive Order No. 209).
Rights of a Lessee Who Introduces Improvements
Article 1678 of the Civil Code generally governs useful improvements introduced by a lessee in good faith, when the improvements are suitable for the intended use of the lease and do not alter the form or substance of the leased property.
Upon termination of the lease, the lessor generally has the option either to pay the lessee one-half of the value of the improvements at that time or to allow the lessee to remove them, subject to the statutory limitations. Ornamental expenses are treated differently: the lessee is generally not entitled to reimbursement for them but may remove the ornamental objects if removal does not damage the principal property and the lessor does not elect to retain them by paying their value.
The Supreme Court has recognized that a lessee’s rights over improvements are governed by Article 1678 rather than by the rules applicable to a builder in good faith under Article 448. In Lopez v. Sarabia, G.R. No. 140357, 2004, the Court treated the lessee’s claim according to the special rules governing improvements introduced by a lessee. The same statutory rule was quoted and applied in Land Bank of the Philippines v. AMS Farming Corporation, G.R. No. 174971, 2008.
The Lease Contract May Change the Result
Article 1678 is not always the final answer. The lease contract may contain a valid provision stating that improvements will belong to the lessor upon installation or upon termination of the lease, with or without reimbursement.
In Bermon Marketing Communication Corporation v. Yaco, G.R. No. 224552, 2021, the Supreme Court held that a lessee may expressly waive reimbursement for useful improvements when the waiver is stipulated in the lease and is not contrary to law, morals, public order, or public policy. The Court recognized that the parties’ freedom to contract may govern the allocation of improvements.
Accordingly, the spouses should first examine provisions concerning:
- ownership of fixtures and renovations;
- the lessor’s right to require restoration;
- the lessee’s right to remove improvements;
- reimbursement upon expiration or termination;
- the treatment of installed equipment; and
- the consequences of early termination, default, or assignment.
How the Marital Property Regime Affects the Improvements
Conjugal Partnership of Gains
Under the conjugal partnership of gains, the analysis generally focuses on whether partnership funds or the spouses’ industry paid for the improvements and whether the improvements generated a recoverable economic benefit.
If the leasehold improvements remain subject to a reimbursement claim against the lessor, the claim may be treated as an asset of the conjugal partnership when it was acquired through partnership funds or the spouses’ joint efforts. If the lease contract provides that the improvements belong to the lessor without reimbursement, the spouses may instead have a loss or accounting issue rather than a divisible improvement asset.
Upon dissolution, the conjugal partnership’s assets and liabilities must be identified, valued, and liquidated. In Quiao v. Quiao, et al., G.R. No. 176556, 2012, the Supreme Court explained that Article 129 of the Family Code applies to the liquidation of a conjugal partnership of gains after dissolution. The Court also recognized that the net profits subject to the applicable consequences are determined under the Family Code’s liquidation rules.
Absolute Community of Property
Under absolute community of property, the classification of the funds and business assets generally differs from the analysis under conjugal partnership. The spouses must identify property excluded from the community, property acquired during the marriage, business liabilities, and any rights arising from the lease.
Even under absolute community, however, a leasehold improvement may be subject to the lease’s terms. The community may own a reimbursement claim, removal right, or business-related economic interest rather than the physical structure itself.
Complete Separation of Property
Under complete separation of property, the spouse who paid for an improvement or incurred the contractual obligation may generally assert the corresponding right, subject to proof of payment, the lease terms, and any agreement between the spouses concerning the business.
Joint payment, joint management, or the use of shared business funds may support a claim for reimbursement or co-ownership between the spouses, but those facts must be established by competent evidence.
Valuing the Improvements
The relevant value is not always the original construction cost. Article 1678 refers to the value of useful improvements at the time of lease termination. Depreciation, wear, remaining useful life, obsolescence, and the improvement’s suitability for the premises may affect the valuation.
A proper valuation should distinguish among:
| Item | Possible treatment |
|---|---|
| Permanent structural renovation | May be subject to the lessor’s option, restoration obligation, or contractual ownership clause. |
| Removable business equipment | May remain a business asset if removal is allowed and does not materially damage the premises. |
| Decorative or ornamental work | Generally treated differently from useful improvements under Article 1678. |
| Security deposits and advance rentals | May constitute recoverable contractual claims, subject to the lease and outstanding obligations. |
| Unpaid construction obligations | Should be treated as liabilities before determining the net value distributable between the spouses. |
Typical Scenarios
Both Spouses Paid for the Renovation
If both spouses used marital business funds to renovate the premises, the economic value of any remaining reimbursement claim, removal right, or transferable business asset should ordinarily be included in the liquidation accounting, subject to the applicable property regime and lease terms.
One Spouse Paid Using Exclusive Funds
If one spouse can prove that exclusive funds paid for the improvements, that spouse may assert an exclusive-property claim or reimbursement claim. The claim may be reduced or defeated if the lease expressly transferred the improvements to the lessor without reimbursement or if the improvements were paid for as an ordinary business expense.
The Lease Has Ended and the Lessor Retains the Improvements
If the lessor retains useful improvements, the spouses should determine whether the lessor exercised the contractual or statutory option to retain them and whether payment is due. Any resulting receivable should be included in the liquidation of the marital property regime.
The Business Continues Under One Spouse
If one spouse continues operating the business in the same location, the parties should separately value the leasehold interest, improvements, equipment, inventory, goodwill, and liabilities. The spouse retaining the business may assume the obligation to pay the other spouse for the latter’s share, subject to an agreement or court determination.
Evidence Needed for the Allocation
The valuation and classification of leasehold improvements ordinarily require documentary and financial evidence, including:
- the original lease and amendments;
- lessor approvals for construction or renovation;
- building permits, plans, and completion documents;
- invoices, receipts, bank records, and accounting entries;
- photographs and inventories of the improvements;
- appraisals showing present value and useful life;
- business financial statements; and
- communications concerning ownership, removal, restoration, or reimbursement.
Courts may also consider the parties’ conduct, including who negotiated the lease, who paid rent and construction costs, who operated the business, and whether either spouse acknowledged the improvements as a business or marital asset.
Recommended Process for Separation or Liquidation
- Identify the property regime. Review the marriage settlement, if any, and confirm whether the spouses are governed by absolute community, conjugal partnership, or separation of property.
- Review the lease. Determine who owns the improvements, whether reimbursement is waived, and whether removal or restoration is required.
- Separate improvements from movable assets. Fixtures, equipment, furniture, inventory, and improvements may have different legal treatment.
- Determine the present economic value. Use the value at lease termination or the valuation date required by the agreement or applicable law.
- Account for liabilities. Deduct unpaid rent, construction debts, taxes, restoration costs, and other obligations before dividing the net value.
- Document the settlement. A written agreement should identify the assets, liabilities, valuation method, payment schedule, possession rights, and responsibility for dealings with the lessor.
Important Limitations
A spouse cannot ordinarily transfer or remove a structural improvement without considering the lessor’s rights and the lease’s requirements. Removal may also create liability if it damages the premises or violates a restoration clause.
Likewise, a spouse’s unilateral claim that an improvement is “conjugal” or “exclusive” does not resolve the issue. The court or the parties’ settlement must account for the source of funds, the legal property regime, the lease contract, the nature of the improvement, and the improvement’s value at the relevant time.
Conclusion
Commercial leasehold improvements made during a marriage should be treated as part of a broader accounting of the business and the spouses’ property relations. The physical improvements may belong to, or be retained by, the lessor, while the spouses may instead own a reimbursement claim, a right of removal, or an economic interest in the continuing business.
The most reliable approach is to review the lease first, classify the funds and business assets under the applicable marital property regime, obtain a current valuation, and document the allocation in a written settlement. When the parties cannot agree, the issue should be presented together with the liquidation of the marital property regime rather than treated as an isolated construction-cost dispute.
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