e. Compensation

When a property is saved from destruction by another person without the knowledge of the owner

When during a fire, flood, storm, or other calamity, property is saved from destruction by another person without the knowledge of the owner, the latter is bound to pay the former just compensation. (Art. 2168, NCC)

When the government, upon the failure of any person to comply with health or safety regulations concerning property, undertakes to do the necessary work, even over his objection, he shall be liable to pay the expenses (Art. 2169, NCC)

For example, a municipal ordinance prohibits the throwing of spoiled food outside of the house in a waste can without any plastic bag. A does not abide by the said ordinance and continually throws spoiled food in a wooden garbage container. To prevent the spread of disease, the municipal government can put the spoiled food inside a plastic bag first and then provide the owner of the house with a garbage can at the owner's expense even if he does not want to. (Sta. Maria, 2017)

When by accident or other fortuitous event, movables separately pertaining to two or more persons are commingled or confused, the rules on co-ownership shall be applicable

The commingling here is unintentional as it is the result of an accident or fortuitous event. (Sta. Maria, 2017)

Rent

The compensation either in money, provisions, chattels, or labor, received by the lessor from the lessee. (Tolentino and Manio v. Gonzalez Sy Chiam, G.R. No. 26085, August 12, 1927)

As to Character

• Gratuitous - agent receives no compensation for his services (CIVIL CODE, Art. 1875)
• Onerous - agent receives compensation for his services (CIVIL CODE, Art. 1875)

Compensation

General rule: Agency is presumed to be for compensation, unless there is proof to the contrary. (CIVIL CODE, Art. 1875)

The agent does not have to prove that the agency is for compensation.

Exception: The presumption that the agency is for compensation is prima facie, meaning it may be disproved by contrary evidence (CIVIL CODE, Art.1875)

Broker

Negotiates contracts relative to property in behalf of others and for a compensation/fee (Litonjua v. Eternit Corp., G.R. No. 144805, June 8, 2006.)

COMMENT (part 2 of 2)

Article 1286. Compensation takes place by operation of law, even though the debts may be payable at different places, but there shall be an indemnity for expenses of exchange or transportation to the place of payment. (1199a)

Article 1287. Compensation shall not be proper when one of the debts arises from a depositum or from the obligations of a depositary or of a bailee in commodatum.

Neither can compensation be set up against a creditor who has a claim for support due by gratuitous title, without prejudice to the provisions of paragraph 2 of article 301. (1200a)

Article 1288. Neither shall there be compensation if one of the debts consists in civil liability arising from a penal offense. (n)

Article 1289. If a person should have against him several debts which are susceptible of compensation, the rules on the application of payments shall apply to the order of the compensation. (1201)

Article 1290. When all the requisites mentioned in article 1279 are present, compensation takes effect by operation of law, and extinguishes both debts to the concurrent amount, even though the creditors and debtors are not aware of the compensation. (1202a)

SECTION 6

Novation

Article 1291. Obligations may be modified by:

(1) Changing their object or principal conditions;

(2) Substituting the person of the debtor;

(3) Subrogating a third person in the rights of the creditor. (1203)

Article 1292. In order that an obligation may be extinguished by another which substitute the same, it is imperative that it be so declared in unequivocal terms, or that the old and the new obligations be on every point incompatible with each other. (1204)

Article 1293. Novation which consists in substituting a new debtor in the place of the original one, may be made even without the knowledge or against the will of the latter, but not without the consent of the creditor. Payment by the new debtor gives him the rights mentioned in articles 1236 and 1237. (1205a)

Article 1294. If the substitution is without the knowledge or against the will of the debtor, the new debtor's insolvency or non-fulfillment of the obligations shall not give rise to any liability on the part of the original debtor. (n)

Article 1295. The insolvency of the new debtor, who has been proposed by the original debtor and accepted by the creditor, shall not revive the action of the latter against the original obligor, except when said insolvency was already existing and of public knowledge, or known to the debtor, when he delegated his debt. (1206a)

Article 1296. When the principal obligation is extinguished in consequence of a novation, accessory obligations may subsist only insofar as they may benefit third persons who did not give their consent. (1207)

Article 1297. If the new obligation is void, the original one shall subsist, unless the parties intended that the former relation should be extinguished in any event. (n)

Article 1298. The novation is void if the original obligation was void, except when annulment may be claimed only by the debtor or when ratification validates acts which are voidable. (1208a)

Article 1299. If the original obligation was subject to a suspensive or resolutory condition, the new obligation shall be under the same condition, unless it is otherwise stipulated. (n)

Article 1300. Subrogation of a third person in the rights of the creditor is either legal or conventional. The former is not presumed, except in cases expressly mentioned in this Code; the latter must be clearly established in order that it may take effect. (1209a)

Article 1301. Conventional subrogation of a third person requires the consent of the original parties and of the third person. (n)

Article 1302. It is presumed that there is legal subrogation:

(1) When a creditor pays another creditor who is preferred, even without the debtor's knowledge;

(2) When a third person, not interested in the obligation, pays with the express or tacit approval of the debtor;

(3) When, even without the knowledge of the debtor, a person interested in the fulfillment of the obligation pays, without prejudice to the effects of confusion as to the latter's share. (1210a)

Article 1303. Subrogation transfers to the persons subrogated the credit with all the rights thereto appertaining, either against the debtor or against third person, be they guarantors or possessors of mortgages, subject to stipulation in a conventional subrogation. (1212a)

Article 1304. A creditor, to whom partial payment has been made, may exercise his right for the remainder, and he shall be preferred to the person who has been subrogated in his place in virtue of the partial payment of the same credit. (1213)

COMPENSATION

It is a mode of extinguishing obligations that take place when two persons, in their own right, are creditors and debtors of each other. (NCC, Art. 1278)

It is the offsetting of the respective obligation of two persons who stand as principal creditors and debtors of each other, with the effect of extinguishing their obligations to their concurrent amount.

Effects of compensation:

• Both debts are extinguished;
• Interests stop accruing on the extinguished obligation or the part extinguished;
• The period of prescription stops with respect to the obligation or part extinguished; and
• All accessory obligations of the principal obligation which has been extinguished are also extinguished.

Q: Team Image and Solar Team both breached each other’s duties in their compromise agreement. As a result, both owe each other 2,000,000. Is compensation proper?

A: YES. In order that compensation may be proper, it is necessary: (1) That each one of the obligors be bound principally, and that he be at the same time a principal creditor of the other; (2) That both debts consist in a sum of money, or if the things due are consumable, they be of the same kind, and also of the same quality if the latter has been stated; (3) That the two debts be due; (4) That they be liquidated and demandable; (5) That over neither of them there be any retention or controversy, commenced by third persons and communicated in due time to the debtor. (Team Image Entertainment, Inc., And Felix S. Co. v. Solar Team Entertainment, Inc., G.R. No. 191652, September 13, 2017; Solar Team Entertainment, Inc. v. Team Image Entertainment, Inc., And Felix S. Co, G.R. No. 191658, September 13, 2017)

Q: X, who has a savings deposit with Y Bank in the sum of P1,000,000.00, incurs a loan obligation with the said bank in the sum of P800,000.00 which has become due. When X tried to withdraw his deposit, Y Bank allowed only P200,000.00 to be withdrawn, less service charges, claiming that compensation has extinguished its obligation under the savings account to the concurrent amount of X's debt. X contends that compensation is improper when one of the debts, as here, arises from a contract of deposit. Assuming that the promissory note signed by X to evidence the loan does not provide for compensation between said loan and his savings deposit, who is correct? (1998 Bar)

A: Y Bank is correct. All the requisites of Art. 1279, Civil Code are present. Compensation shall take place when two persons are reciprocally creditor and debtor of each other. In this connection, it has been held that the relation existing between a depositor and a bank is that of creditor and debtor. As a general rule, a bank has a right of set off of the deposits in its hands for the payment of any indebtedness to it on the part of a depositor. (Gullas v. PNB, G.R. No. L43191, November 13, 1935) Hence, compensation took place between the mutual obligations of X and Y Bank.

Q: Foodmasters, Inc. (FI) had outstanding loan obligations to both Union Bank’s predecessor-in-interest, Bancom Development Corporation (Bancom), and to DBP. On May 21, 1979, FI and DBP, among others, entered into a Deed of Cession of Property in Payment of Debt (dacion en pago) whereby the former ceded in favor of the latter certain properties (including a processing plant in Marilao, Bulacan [processing plant]) in consideration of the following: (a) the full and complete satisfaction of FI’s loan obligations to DBP; and (b) the direct assumption by DBP of FI’s obligations to Bancom in the amount of ₱17,000,000.00 (assumed obligations).

On the same day, DBP, as the new owner of the processing plant, leased back for 20 years the said property to FI (Lease Agreement) which was, in turn, obliged to pay monthly rentals to be shared by DBP and Bancom. DBP also entered into a separate agreement with Bancom (Assumption Agreement) whereby the former: (a) confirmed its assumption of FI’s obligations to Bancom; and (b) undertook to remit up to 30% of any and all rentals due from FI to Bancom (subject rentals) which would serve as payment of the assumed obligations, to be paid in monthly installments.

Claiming that the subject rentals have not been duly remitted despite its repeated demands, Union Bank filed, on June 20, 1984, a collection case against DBP before the RTC, docketed as Civil Case No. 7648. In opposition, DBP countered, among others, that the obligations it assumed were payable only out of the rental payments made by FI. Thus, since FI had yet to pay the same, DBP’s obligation to Union Bank had not arisen. In addition, DBP sought to implead FW as third party-defendant in its capacity as FI’s assignee and, thus, should be held liable to Union Bank. Was there legal compensation?

A: There was NO legal compensation. The rule on legal compensation is stated in Article 1290 of the Civil Code which provides that "when all the requisites mentioned in Article 1279 are present, compensation takes effect by operation of law, and extinguishes both debts to the concurrent amount, even though the creditors and debtors are not aware of the compensation." Therefore, compensation could not have taken place between these debts for the apparent reason that requisites 3 and 4 under Article 1279 of the Civil Code are not present. Since DBP’s assumed obligations to Union Bank for remittance of the lease payments are – in the Court’s words – “contingent on the prior payment thereof by FW to DBP," it cannot be said that both debts are due. (3rd requisite of Article 1279 of the Civil Code)

Also, the Court observed that any deficiency that DBP had to make up for the full satisfaction of the assumed obligations, "cannot be determined until after the satisfaction of FW’s obligation to DBP." In this regard, it cannot be concluded that the same debt had already been liquidated, and thereby became demandable. (4th requisite of Article 1279 of the Civil Code) Thus, CA correctly upheld the denial of Union Bank’s motion to affirm legal compensation. (Union Bank Of The Philippines vs. Development Bank Of The Philippines, G.R. No. 191555, January 20, 2014)

Q: May the parties agree upon the compensation of debts which are not due?

A: YES. Under Art. 1282, conventional or voluntary compensation is not limited to obligations which are not yet due. The parties may compensate by agreement any obligations, in which the objective requisites provided for legal compensation are not present. It is necessary, however, that the parties should have the capacity to dispose of credits which they compensate, because the extinguishment of the obligations in this case arise from their wills and not from law.

Q: May rescissible or voidable debts which are already compensated be rescinded or annulled? What are its effects?

A: YES. Although a rescissible or voidable debt can be compensated before it is rescinded or annulled, the decree of rescission or annulment has retroactive effect, and the compensation must be considered as cancelled. And as rescission or annulment requires mutual restitution, the party whose obligation is annulled or rescinded can thus recover to the extent that his credit was extinguished by the compensation; because to that extent, he is deemed to have made a payment.

Compensation v. Payment

Compensation v. Confusion

Compensation v. Counterclaim or Set-off

Debts or obligations not subject to compensation

• A depositary may not set up compensation against the depositor’s claim arising from depositum; the depositor may invoke compensation when its requisites are met (NCC, Art. 1287);
• Debts arising from obligations of a depositary;
• Debts arising from obligations of a bailee in commodatum;
• Claims for support due by gratuitous title;
• The person owing civil liability arising from a penal offense may not set up compensation against that liability; the offended party may invoke compensation when its requisites are met (NCC, Art. 1288); and
• Certain obligations in favor of government.

e.g. Taxes, fees, duties, and others of a similar in nature

There can be no off-setting of taxes against the claims that the taxpayer may have against the government. A person cannot refuse to pay a tax on the ground that the government owes him an amount equal to or greater than the tax being collected. Internal revenue taxes cannot be the subject of compensation because government and taxpayer are not mutually creditors and debtors of each other. Taxes are not in the nature of contracts between parties. (Francia v. IAC, G.R. No. L-67649, June 28, 1988)

NOTE: Compensation takes place by operation of law, even though the debts may be payable at different places, but there shall be an indemnity for expenses of exchange or transportation to the place of payment. (NCC, Art. 1286)

If all the requisites under Art. 1279 are present, compensation takes place by operation of law.

The parties need not to notify each other that they intend to have their debts compensated.

Q: When is compensation not proper?

A: Under Art. 1287, compensation shall not be proper when one of the debts arises from a depositum or from the obligations of a depositary or of a bailee in commodatum. Neither can compensation be set up against a creditor who has a claim for support due by gratuitous title without prejudice to the rule under Article 203 of the Family Code that support in arrears may be compensated.

NOTE: Only the depositary and the borrower in commodatum cannot set up compensation. The depositor can set up his deposit against the depositary, and the lender can set up his loan against a credit of the borrower.

Neither shall there be compensation if one of the debts consists in civil liability arising from a penal offense.

NOTE: The person who has the civil liability arising from crime is the only party who cannot set up the compensation; but the offended party is entitled to indemnity can set up his claim in compensation of his debt.

KINDS OF COMPENSATION

• Legal compensation – by operation of law;
• Conventional – by agreement of the parties
• Judicial (set-off) – by judgment of the court when there is a counterclaim duly pleaded, and the compensation decreed; and
• Facultative – may be claimed or opposed by one of the parties.

Q: De Leon sold and delivered to Silahis various merchandise. Due to Silahis' default, De Leon filed a complaint for the collection of said accounts. Silahis asserts, as affirmative defense, a debit memo as unrealized profit for a supposed commission that Silahis should have received from De Leon from the sale made directly to DOLE Philippines, Inc. (DOLE). Was there legal compensation?

A: NONE. Silahis admits the validity of his outstanding accounts with De Leon. But whether De Leon is liable to pay Silahis a commission on the subject sale to DOLE is disputed. This circumstance prevents legal compensation from taking place. (Silahis Marketing Corp. v. IAC, G. R. No. L-74027, December 7, 1989).

NOTE: Compensation is not proper where the claim of the person asserting the set-off against the other is not clear or liquidated; compensation cannot extend to unliquidated, disputed claim existing from breach of contract. (Silahis Marketing Corp. v. IAC, G.R. No. L-74027, December 7, 1989).

Q: Atty. Laquihon, in behalf of Pacweld, filed a pleading addressed to MPCC titled “motion to direct payment of attorney's fee”, invoking a decision wherein MPCC was adjudged to pay Pacweld the sum of P10, 000. 00 as attorney's fees. MPCC filed an opposition stating that the said amount is set-off by a like sum of P10, 000. 00, collectible in its favor from Pacweld also by way of attorney's fees which MPCC recovered from the same CFI of Manila in another civil case. Was there legal compensation?

A: YES. MPCC and Pacweld were creditors and debtors of each other, their debts to each other consisting in final and executory judgments of the CFI in two separate cases. The two obligations, therefore, respectively offset each other, compensation having taken effect by operation of law and extinguished both debts to the concurrent amount of P10,000.00, pursuant to the provisions of Articles 1278, 1279 and 1290 of the Civil Code, since all the requisites provided in Art. 1279 of the said Code for automatic compensation "even though the creditors and debtors are not aware of the compensation" were present. (Mindanao Portland Cement Corp. v. CA, G.R. No. L-62169, February 28, 1983)

Conventional compensation

It is one that takes place by agreement of the parties.

Facultative compensation

One of the parties has a choice of claiming or opposing the compensation but waives his objection thereto such as an obligation of such party is with a period for his benefit alone and he renounces the period to make the obligation become due.

Facultative compensation is unilateral and does not require mutual agreement; voluntary or conventional compensation requires mutual consent.

e.g. X owes Y P100,000 demandable and due on April 1, 2012. Y owes X P100, 000 demandable and due on or before April 15, 2012. Y, who was given the benefit of the term, may claim compensation on April 1, 2012. On the other hand, X, who demands compensation, can be properly opposed by Y because Y could not be made to pay until April 15, 2012.

NOTE: Compensation can be renounced either at the time an obligation is contracted or afterwards. (Tolentino, 1991) It can be renounced expressly or impliedly.

Examples of implied renunciation:

• By not setting it up in the litigation;
• By consenting to the assignment of credit under NCC, Art. 1285; or
• By paying debt voluntarily, with knowledge that it has been extinguished by compensation.

Q: Eduardo was granted a loan by XYZ Bank for the purpose of improving a building which XYZ leased from him. Eduardo executed the promissory note in favor of the bank, with his friend Ricardo as cosignatory. In the PN, they both acknowledged that they are “individually and collectively” liable and waived the need for prior demand. To secure the PN, Ricardo executed a real estate mortgage on his own property. When Eduardo defaulted on the PN, XYZ stopped payment of rentals on the building on the ground that legal compensation had set in. Since there was still a balance due on the PN after applying the rentals, XYZ foreclosed the real estate mortgage over Ricardo’s property. Ricardo opposed the foreclosure on the ground that he is only a co-signatory; that no demand was made upon him for payment, and assuming he is liable, his liability should not go beyond half of the balance of the loan. Further, Ricardo said that when the bank invoked compensation between the rentals and the amount of the loan, it amounted to a new contract or novation, and had the effect of extinguishing the security since he did not give his consent (as owner of the property under the real estate mortgage) thereto.

• Can XYZ Bank validly assert legal compensation?
• Can Ricardo’s property be foreclosed to pay the full balance of the loan?
• Does Ricardo have basis under the Civil Code for claiming that the original contract was novated?

A:

• NO. Legal compensation has not automatically taken place because the rentals are not yet due (NCC, Arts. 1279 and 1290). If the period for paying rent was established for XYZ Bank’s benefit, it may waive that period and claim facultative compensation (NCC, Art. 1196). The principal obligation of loan, for which both Eduardo and Ricardo are bound solidarily, is due and demandable without need of demand.
• YES, if the secured obligation is due and unpaid and the other foreclosure requirements under the loan and mortgage terms are met. If the PN validly dispenses with demand, the absence of a separate demand on Ricardo does not, by itself, invalidate foreclosure (NCC, Art. 1169[1]). Default must be assessed under NCC, Art. 1169 and the governing loan and mortgage terms; a separate demand is not invariably required.

In the case of DBP v. Licuanan (G.R. No. 150097, February 26, 2007), it was held that: “the issue of whether demand was made before the foreclosure was effected is essential. If demand was made and duly received by the respondents and the latter still did not pay, then they were already in default and foreclosure was proper. However, if demand was not made, then the loans had not yet become due and demandable. This meant that the respondents had not defaulted in their payment and the foreclosure was premature.”

• NO. Since none of the three kinds of novation is applicable. There is no objective novation, whether express or implied, because there is no change in the object or principal conditions of the obligation. There is no substitution of debtors, either. Compensation is considered as abbreviated or simplified payment and since Ricardo bound himself solidarily with Eduardo, any facultative compensation which occurs does not result in partial legal subrogation. Eduardo is the principal debtor, while Ricardo, as a solidary co-debtor, is interested in fulfillment of the obligation under NCC, Art. 1302(3). The asserted compensation does not, merely by occurring, establish partial legal subrogation in Ricardo’s favor.

Obligations subject to facultative compensation

When one of the debts arises from:

• Depositum;
• Obligations of a depositary;
• Obligations in commodatum;
• Support; and

GR: Compensation cannot be set up against a claim for support due by gratuitous title.

XPN: Support in arrears may be compensated; future support may not be offset on that basis.

• Civil liability from a crime.

NOTE: NCC, Art. 1288 prohibits compensation if one of the debts consists in civil liability arising from a penal offense. However, the victim is allowed to claim compensation.

If one or both debts are rescissible or voidable

When one or both debts are rescissible or voidable, they may be compensated against each other before they are judicially rescinded or avoided. (NCC, Art. 1284) If all requisites for legal compensation were met before either debt prescribed, compensation took effect at that time and is not undone by subsequent prescription. (NCC, Arts. 1279 and 1290) If a debt is subsequently rescinded or annulled, the parties must make the restitution required by law; the earlier compensation does not bar that relief. (NCC, Arts. 1284, 1385 and 1398)

Effects of assignment on compensation of debts

• After the compensation took place

GR: An assignment after legal compensation cannot transfer the portion already extinguished; any unextinguished balance may still be assigned, subject to the debtor’s consent or reservation of the right to compensation (Civil Code, Arts. 1285 and 1290).

XPN: When the assignment was made with the consent of the debtor.

NOTE: Such consent operates as a waiver of the rights to compensation.

XPN to the XPN: At the time he gave his consent, he reserved his right to the compensation.

• Before compensation took place
• With the consent of the debtor – Compensation cannot be set up except when the right to compensation is reserved.
• With the knowledge but without consent of the debtor – Compensation can be set up regarding debts previous to the cession or assignment but not subsequent ones.
• Without the knowledge of debtor - Can set up compensation for credits arising before the assignment, as well as later credits arising before he learned of the assignment, subject to the requisites for compensation (Civil Code, Art. 1285).

Explanation of the above:

• In a case where the debt is assigned by the creditor to another such as discounting of notes
• If the assignment took place after the "compensation", there is not really an assignment made since the debt is already extinguished by operation of law
• Except when, even after compensation, assignment is made with the consent of the debtor and such will operate as a waiver to the right of compensation
• If the assignment is made prior to compensation taking place, and if with the debtor's consent, compensation cannot be validly set up except if the right to compensation is reserved
• But if it is with the knowledge of the debtor but without consent, compensation may be set up for debts incurred prior to assignment
• If the debtor had no knowledge of the assignment, he may set up compensation for credits arising before the assignment and for later credits arising before he learned of it, provided the requisites for compensation are met (Civil Code, Arts. 1279 and 1285)

Renunciation of compensation

Compensation can be renounced expressly or impliedly. It can also be renounced either at the time an obligation is contracted or afterwards. It rests upon a potestative right, and a unilateral declaration of the debtor would be sufficient renunciation.

PRACTICE QUESTIONS (part 4 of 5)

Q: The parties entered into a lease agreement whereby Santos Car Check Center agreed to lease a property to Comglasco Corp. for five (5) years. However, a year after, Comglasco advised Santos Car Check Center that it will be pre- terminating the contract, to which the latter refused. Despite refusal, Comglasco vacated the property and stopped paying rentals. Santos Car Check then filed a suit for breach of contract. Comglasco relied on the provision of the lease contract whereby pre-termination is allowed with cause in the first three years. Citing business reverses which it ascribed to the 1997 Asian Financial Crisis, Comglasco insists that under Article 1267 of the NCC, it is exempted from its obligation, because its business setback is the “cause” contemplated in their lease. Is Comglasco correct?

A: NO, Comglasco is not correct. The payment of lease rentals does not involve a prestation “to do” envisaged in Arts. 1266 and 1267. Art. 1267 speaks of a prestation involving service which has been rendered difficult by unforeseen subsequent events as to be manifestly beyond the contemplation of the parties. Additionally, the Asian Currency Crisis befell from July 1997 and for some time thereafter, but Comglasco cannot be permitted to blame its difficulties on the said regional economic phenomenon because it entered into the subject lease only on August Aug. 2000, more than three years after it began, and by then Comglasco had known what business risks it assumed when it opened a new shop in Iloilo City. (Comglasco Corp. v. Santos Car Check Center Corp., G.R. No. 202989, 25 Mar. 2015)

Q: Team Image and Solar Team both breached each other’s duties in their compromise agreement. As a result, both owe each other 2,000,000. Is compensation proper?

A: YES. In order that compensation may be proper, it is necessary: (1) That each one of the obligors be bound principally, and that he be at the same time a principal creditor of the other; (2) That both debts consist in a sum of money, or if the things due are consumable, they be of the same kind, and also of the same quality if the latter has been stated; (3) That the two debts be due; (4) That they be liquidated and demandable; (5) That over neither of them there be any retention or controversy, commenced by third persons and communicated in due time to the debtor. (Team Image Entertainment, Inc., And Felix S. Co. v. Solar Team Entertainment, Inc., G.R. No. 191652, 13 Sept. 2017)

Q: X, who has a savings deposit with Y Bank in the sum of P1,000,000.00, incurs a loan obligation with the said bank in the sum of P800,000.00 which has become due. When X tried to withdraw his deposit, Y Bank allowed only P200,000.00 to be withdrawn, less service charges, claiming that compensation has extinguished its obligation under the savings account to the concurrent amount of X's debt. X contends that compensation is improper when one of the debts, as here, arises from a contract of deposit. Assuming that the promissory note signed by X to evidence the loan does not provide for compensation between said loan and his savings deposit, who is correct? (1998 BAR)

A: Y Bank is correct. All the requisites of Art. 1279, Civil Code are present. Compensation shall take place when two persons are reciprocally creditor and debtor of each other. In this connection, it has been held that the relation existing between a depositor and a bank is that of creditor and debtor. As a general rule, a bank has a right of set off of the deposits in its hands for the payment of any indebtedness to it on the part of a depositor. (Gullas v. PNB, G.R. No. L-43191, 13 Nov. 1935) Hence, compensation took place between the mutual obligations of X and Y Bank.

Q: Foodmasters, Inc. (FI) had outstanding loan obligations to both Union Bank’s predecessor- in-interest, Bancom Development Corporation (Bancom), and to DBP. On 21 May 1979, FI and DBP, among others, entered into a Deed of Cession of Property in Payment of Debt (dacion en pago) whereby the former ceded in favor of the latter certain properties (including a processing plant in Marilao, Bulacan [processing plant]) in consideration of the following: (a) the full and complete satisfaction of FI’s loan obligations to DBP; and (b) the direct assumption by DBP of FI’s obligations to Bancom in the amount of ₱17,000,000.00 (assumed obligations).

On the same day, DBP, as the new owner of the processing plant, leased back for 20 years the said property to FI (Lease Agreement) which was, in turn, obliged to pay monthly rentals to be shared by DBP and Bancom. DBP also entered into a separate agreement with Bancom (Assumption Agreement) whereby the former: (a) confirmed its assumption of FI’s obligations to Bancom; and (b) undertook to remit up to 30% of any and all rentals due from FI to Bancom (subject rentals) which would serve as payment of the assumed obligations, to be paid in monthly installments.

Claiming that the subject rentals have not been duly remitted despite its repeated demands, Union Bank filed, on 20 June 1984, a collection case against DBP before the RTC, docketed as Civil Case No. 7648. In opposition, DBP countered, among others, that the obligations it assumed were payable only out of the rental payments made by FI. Thus, since FI had yet to pay the same, DBP’s obligation to Union Bank had not arisen. In addition, DBP sought to implead FW as third party-defendant in its capacity as FI’s assignee and, thus, should be held liable to Union Bank. Was there legal compensation?

A: NO, there was no legal compensation. The rule on legal compensation is stated in Article 1290 of the NCC which provides that "when all the requisites mentioned in Art. 1279 are present, compensation takes effect by operation of law, and extinguishes both debts to the concurrent amount, even though the creditors and debtors are not aware of the compensation." Therefore, compensation could not have taken place between these debts for the apparent reason that requisites 3 and 4 under Art. 1279 of the NCC are not present. Since DBP’s assumed obligations to Union Bank for remittance of the lease payments are – in the Court’s words – “contingent on the prior payment thereof by FW to DBP," it cannot be said that both debts are due. (Art. 1279(3), NCC)

Also, the Court observed that any deficiency that DBP had to make up for the full satisfaction of the assumed obligations, "cannot be determined until after the satisfaction of FW’s obligation to DBP." In this regard, it cannot be concluded that the same debt had already been liquidated, and thereby became demandable. (4th requisite of Art. 1279 of the NCC) Thus, CA correctly upheld the denial of Union Bank’s motion to affirm legal compensation. (Union Bank Of The Philippines v. Development Bank Of The Philippines, G.R. No. 191555, 20 Jan. 2014)

Q: De Leon sold and delivered to Silahis various merchandise. Due to Silahis' default, De Leon filed a complaint for the collection of said accounts. Silahis asserts, as affirmative defense, a debit memo as unrealized profit for a supposed commission that Silahis should have received from De Leon from the sale made directly to DOLE Philippines, Inc. (DOLE). Was there legal compensation?

A: NONE. Silahis admits the validity of his outstanding accounts with De Leon. But whether De Leon is liable to pay Silahis a commission on the subject sale to DOLE is disputed. This circumstance prevents legal compensation from taking place. (Silahis Marketing Corp. v. IAC, G. R. No. L-74027, 7 Dec. 1989)

NOTE: Compensation is not proper where the claim of the person asserting the set-off against the other is not clear or liquidated; compensation cannot extend to unliquidated, disputed claim existing from breach of contract. (Ibid.)

Q: Atty. Laquihon, in behalf of Pacweld, filed a pleading addressed to MPCC titled “motion to direct payment of attorney's fee”, invoking a decision wherein MPCC was adjudged to pay Pacweld the sum of P10, 000. 00 as attorney's fees. MPCC filed an opposition stating that the said amount is set-off by a like sum of P10, 000. 00, collectible in its favor from Pacweld also by way of attorney's fees which MPCC recovered from the same CFI of Manila in another civil case. Was there legal compensation?

A: YES. MPCC and Pacweld were creditors and debtors of each other, their debts to each other consisting in final and executory judgments of the CFI in two separate cases. The two obligations, therefore, respectively offset each other, compensation having taken effect by operation of law and extinguished both debts to the concurrent amount of P10,000.00, pursuant to the provisions of Articles 1278, 1279 and 1290 of the Civil Code, since all the requisites provided in Art. 1279 of the said Code for automatic compensation "even though the creditors and debtors are not aware of the compensation" were present. (Mindanao Portland Cement Corp. v. CA, G.R. No. L-62169, 28 Feb. 1983)

Q: Eduardo was granted a loan by XYZ Bank for the purpose of improving a building which XYZ leased from him. Eduardo executed the promissory note in favor of the bank, with his friend Ricardo as cosignatory. In the PN, they both acknowledged that they are “individually and collectively” liable and waived the need for prior demand. To secure the PN, Ricardo executed a real estate mortgage on his own property. When Eduardo defaulted on the PN, XYZ stopped payment of rentals on the building on the ground that legal compensation had set in. Since there was still a balance due on the PN after applying the rentals, XYZ foreclosed the real estate mortgage over Ricardo’s property. Ricardo opposed the foreclosure on the ground that he is only a co-signatory; that no demand was made upon him for payment, and assuming he is liable, his liability should not go beyond half of the balance of the loan. Further, Ricardo said that when the bank invoked compensation between the rentals and the amount of the loan, it amounted to a new contract or novation, and had the effect of extinguishing the security since he did not give his consent (as owner of the property under the real estate mortgage) thereto.

a. Can XYZ Bank validly assert legal compensation?

A: NO. Legal compensation has not taken place because XYZ Bank’s rental obligation is not yet due, so not all the requisites of Art. 1279, NCC are present; compensation therefore does not take effect by operation of law under Art. 1290, NCC. The bank may, however, assert partial facultative compensation on this ground only if the rental period was established solely for its benefit and it waives that benefit; the parties may also agree to compensation despite the rental obligation not yet being due. (Civil Code, Arts. 1196 and 1282) The principal obligation of loan, where both Eduardo and Ricardo are bound solidarily and therefore any of them is bound principally to pay the entire loan, is due and demandable without need of demand.

b. Can Ricardo’s property be foreclosed to pay the full balance of the loan?

A: Subject to owner check, YES, if the waiver of prior demand is valid, the secured loan has matured, and a balance remains unpaid: lack of a separate demand on Ricardo alone does not bar foreclosure of his mortgaged property. (Civil Code, Arts. 1169 and 2087; Act No. 3135)

A waiver of prior demand in the PN is not, by itself, against public policy. Under Art. 1169 of the Civil Code, demand may be unnecessary when the obligation expressly so declares. If the waiver is valid and the secured obligation has matured and remains unpaid, the absence of a separate demand does not alone make foreclosure premature or null and void. Act No. 3135 governs extrajudicial foreclosure of a real estate mortgage; it does not impose the asserted requirement of prior demand on Ricardo.

In the case of DBP v. Licuanan (G.R. No. 150097, 26 Feb. 2007), it was held that: “the issue of whether demand was made before the foreclosure was effected is essential. If demand was made and duly received by the respondents and the latter still did not pay, then they were already in default and foreclosure was proper. However, if demand was not made, then the loans had not yet become due and demandable. This meant that the respondents had not defaulted in their payment and the foreclosure was premature.”

c. Does Ricardo have basis under the Civil Code for claiming that the original contract was novated? (2008 Bar)

A: NO. Since none of the three kinds of novation is applicable. There is no objective novation, whether express or implied, because there is no change in the object or principal conditions of the obligation. There is no substitution of debtors, either. Compensation is considered as abbreviated or simplified payment and since Ricardo bound himself solidarily with Eduardo, any facultative compensation which occurs does not result in partial legal subrogation. Ricardo’s interest in fulfilling the obligation does not, by itself, establish that compensation novated the loan or discharged his mortgage. (Civil Code, Art. 1302(3))

Q: The Arco and Lim allegedly agreed that Arco would either pay Lim the value of the raw materials or deliver to him their finished products of equivalent value. Lim alleged that when he delivered the raw materials, Arco issued a post-dated check as partial payment. When he deposited the check, however, it was dishonored for being drawn against a closed account. Thereafter, Arco and Sy executed a memorandum of agreement where Arco bound themselves to deliver their finished products to Megapack Container Corporation owned by Sy. According to the memorandum, the raw materials would be supplied by Lim. Was the obligation between Arco and Lim novated because of the agreement entered into by Arco and Sy?

A: NO. Novation must be stated in clear and unequivocal terms to extinguish an obligation. It cannot be presumed and may be implied only if the old and new contracts are incompatible on every point. In this case, Lim was not privy to the memorandum of agreement, thus, his conformity to the contract need not be secured. If the memorandum of agreement was intended to novate the original agreement between the parties, Lim must have first agreed to the substitution of Sy as his new debtor. The memorandum of agreement must also state in clear and unequivocal terms that it has replaced the original obligation of petitioner Arco to Lim. Neither of these circumstances is present in this case. Since there was no novation, petitioner Arco’s obligation to respondent remains valid and existing. Petitioner Arco Pulp and Paper, therefore, must still pay respondent the full amount. (Arco Pulp and Paper Co., Inc. v. Lim, G.R. No. 206806, 25 June 2014)

Q: DBP guaranteed Galleon’s foreign loans. In return, Galleon undertook to secure a first mortgage on its five new vessels and two second-hand vessels. Pursuant to Letter of Instructions No. 1155, Galleon's stockholders and NDC entered into a Memorandum of Agreement, where NDC and Galleon undertook to prepare and sign a share purchase agreement covering 100% of Galleon's equity for P46,740,755.00. The share purchase agreement also provided for the release of Sta. Ines, Cuenca, Tinio and Construction Development Corporation of the Philippines from the personal counter-guarantees they issued in DBP's favor under the Deed of Undertaking. Sta. Ines, Cuenca, Tinio, Cuenca Investment, and Universal Holdings claimed that DBP can no longer go after them for any deficiency judgment since NDC had been subrogated in their place as borrowers, hence the Deed of Undertaking between Sta. Ines, Cuenca Investment, Universal Holdings, Cuenca, and Tinio and DBP had been extinguished and novated." Did the Memorandum of Agreement novate the Deed of Undertaking executed between DBP and Sta. Ines, Cuenca Investment, Universal Holdings, Cuenca, and Tinio?

A: NO. It should be noted that in order to give novation its legal effect, the law requires that the creditor should consent to the substitution of a new debtor. The general rule is that, “in the absence of an authority from the board of directors, no person, not even the officers of the corporation, can validly bind the corporation.” Aside from Ongpin being the concurrent head of DBP and NDC at the time the Memorandum of Agreement was executed, there was no proof presented that Ongpin was duly authorized by the DBP to give consent to the substitution by NDC as a co-guarantor of Galleon’s debts. Ongpin is not DBP, therefore, it is wrong to assume that DBP impliedly gave its consent to the substitution simply by virtue of the personality of its Governor.

Novation is never presumed. The animus novandi, whether partial or total, “must appear by express agreement of the parties, or by their acts which are too clear and unequivocal to be mistaken.” There was no such animus novandi in the case at bar between DBP and respondents, thus, respondents have not been discharged as Galleon’s co- guarantors under the Deed of Undertaking and they remain liable to DBP. (Development Bank of the Philippines v. Sta. Ines Melale Forest Products Corp., G.R. No. 193068, 01 Feb. 2017)