i. Interest

The two types of interest are the following:

• Monetary or conventional interest – refers to the compensation set by the parties for the use or forbearance of money; and
• Compensatory interest – interest that may be imposed by law or by courts as penalty for damages. (Hun Hyung Park v. Eung Won Choi, G.R. No. 220826, March 27, 2019)

Note: Compensatory/penalty/indemnity interest refers to damages paid arising from delay in paying a fixed sum of money or delay in assessing and paying damages. (Sps. Abella v. Sps. Abella, G.R. No. 195165, July 08, 2015)

Q: Company A contracted Company B to apply a granite wash-out finish on the exterior walls of one of its buildings. However, the finish began peeling off and falling from the walls. Company A got Company B to do minor repairs. Company A also got Company C to redo the entire finish after Company B manifested that it was not in a position to do new finishing work. Although, Company B expressed that it was willing to share part of the cost.

The Construction Industry Arbitration Commission (CIAC) decided that Company B was entitled to recover from Company A representing the cost of repairs done by another contractor. Company A assailed the portion on its liability for construction defects. The SC held that Company A was not liable for the amount claimed by Company B.

Company B moved for reconsideration arguing that its liability for interest should commence on the date on which the SC’s decision that granted Company A’s appeal became final and not on when the CIAC decision was issued.

What interest is involved, monetary or compensatory?

A: The interest is compensatory.

Monetary interest under Article 1956 of the Civil Code serves as compensation fixed by the parties for the use or forbearance of money. As can be gleaned from the foregoing provision, payment of monetary interest is allowed only if: (i) there was an express stipulation for the payment of interest; and (ii) the agreement for the payment of interest was reduced in writing. The concurrence of the two conditions is required for the payment of monetary interest.

Compensatory interest (i.e., interest awarded as damages under Articles 2209 to 2213 of the Civil Code) is that which is "allowed in actions for breach of contract or tort for the unlawful detention of money already due." As the governing provisions indicate, compensatory interest may be imposed by law or by the courts as penalty or indemnity for damages.

In the present case, the principal award represents the material cost adjustment incurred by Company A which Company B failed to pay. The award proceeds from Company B's breach of its construction contract with Company A — a contract which does not constitute a loan or forbearance of money. Accordingly, the interest disputed herein constitutes compensatory interest awarded pursuant to Article 2210 of the Civil Code. (Philippine Commercial and International Bank v. William Golangco Construction Corp. G.R. No. 195372, April 10, 2019)

When will interest due and unpaid earn interest?

Generally, interest due and unpaid shall not earn interest, except:

• Interest due shall earn legal interest at the rate of 6% per annum from the time it is judicially demanded until fully paid, although the obligation may be silent upon this point. (Art. 2212)
• If there is agreement to this effect. (Art. 1959)

Note: Interest on interest refers to interest due on conventional interest. (Sps. Abella v. Sps. Abella, G.R. No. 195165, July 08, 2015)

When will the debtor be liable for interest even in the absence of stipulation to pay interest?

Generally, no interest shall be due unless it has been expressly stipulated in writing. (Art. 1956)

In the following instances, interest is due even if not expressly stipulated:

• If the obligation consists in the payment of a sum of money, and the debtor incurs in delay, the indemnity for damages, there being no stipulation to the contrary, shall be the payment of the interest agreed upon, and in the absence of stipulation, the legal interest, which is six per cent per annum (Art. 2209); or
• Interest due shall earn legal interest from the time it is judicially demanded, although the obligation may be silent upon this point. (Art. 2212)

What is the legal interest rate?

Beginning July 1, 2013, the rate of interest on the loan or forbearance on money, goods, or credits and the rate allowed in judgments, in the absence of stipulation, shall be 6% per annum (BSP Circular No. 799).

However, for a money judgment on which legal interest began accruing before July 1, 2013, the applicable rate is 12% per annum through June 30, 2013 and 6% per annum from July 1, 2013 until satisfaction, as applicable (NACAR v. Gallery Frames Inc., G.R. No. 189871, 2013).

NOTE: The computation of the amount due must take into consideration the legal rate or rates (6% and/or 12% per annum) applicable throughout the duration of the period in which interest runs. (DPWH Secretary vs. Spouses Tecson, G.R. No. 179334, 2015)

What are the rules in the computation of legal interest? (Lara’s Gifts & Decors v. Midtown Industrial Sales, G.R. No. 225433, 2019)

• When the obligation is breached, and it consists in the payment of a sum of money, i.e., a loan or forbearance of money, goods, credits or judgments, the interest due shall be that which is stipulated by the parties in writing, provided it is not excessive and unconscionable, which, in the absence of a stipulated reckoning date, shall be computed from default, i.e., from extrajudicial or judicial demand in accordance with Article 1169 of the Civil Code, UNTIL FULL PAYMENT, without compounding any interest unless compounded interest is expressly stipulated by the parties, by law or regulation.
• Interest due on the principal amount accruing as of judicial demand shall SEPARATELY earn legal interest at the prevailing rate prescribed by the Bangko Sentral ng Pilipinas, from the time of judicial demand UNTIL FULL PAYMENT.
• In the absence of stipulated interest, in a loan or forbearance of money, goods, credits or judgments, the rate of interest on the principal amount shall be the prevailing legal interest prescribed by the Bangko Sentral ng Pilipinas, which shall be computed from default, i.e., from extrajudicial or judicial demand in accordance with Article 1169 of the Civil Code, UNTIL FULL PAYMENT, without compounding any interest unless compounded interest is expressly stipulated by law or regulation.
• Interest due on the principal amount accruing as of judicial demand shall SEPARATELY earn legal interest at the prevailing rate prescribed by the Bangko Sentral ng Pilipinas, from the time of judicial demand UNTIL FULL PAYMENT.
• When the obligation, not constituting a loan or forbearance of money, goods, credits or judgments, is breached, an interest on the amount of damages awarded may be imposed in the discretion of the court at the prevailing legal interest prescribed by the Bangko Sentral ng Pilipinas, pursuant to Article 2210 of the Civil Code. No interest, however, shall be adjudged on unliquidated claims or damages until the demand can be established with reasonable certainty.
• Accordingly, where the amount of the claim or damages is established with reasonable certainty, the prevailing legal interest shall begin to run from the time the claim is made extrajudicially or judicially (Art. 1169, Civil Code) UNTIL FULL PAYMENT, but when such certainty cannot be so reasonably established at the time the demand is made, the interest shall begin to run only from the date of the judgment of the trial court (at which time the quantification of damages may be deemed to have been reasonably ascertained) UNTIL FULL PAYMENT.
• The actual base for the computation of the interest shall, in any case, be on the principal amount finally adjudged, without compounding any interest unless compounded interest is expressly stipulated by law or regulation.

Must the manner of compounding the interest also be in writing?

In a loan agreement, compounding of interest has to be in writing to be valid. Payment of monetary interest shall be due only if: (1) there was an express stipulation for the payment of interest; and (2) the agreement for such payment was in writing. The first requirement does not only entail reducing in writing the interest rate to be earned but also the manner of earning the same, if it is to be compounded. (Albos v. Embisan, G.R. No. 210831, 2014)

Can the stipulated interest be modified?

Any modification of stipulated interest (e.g., allowing the creditor to unilaterally increase or decrease the interest rate at any time) must be mutually agreed upon, otherwise, it has no binding effect. Further, a borrower may not be required to prepay the loan if he is not agreeable to the arbitrary interest rates being imposed. (Spouses Silos v. PNB, G.R. No. 181045, 2014)

When is the Usury Law’s effectivity suspended?

The Monetary Board of Central Bank issued CB Circular 905, effective January 1, 1983, removed the ceilings on interest rate on loans or forbearance of money, goods, or credit. The Circular did not repeal nor in any way amend the Usury Law but simply suspended the latter’s effectivity. Interest can now be charged as lender and borrower may agree upon. (Medel v. Court of Appeals, G.R. No. 131622, September 27, 1999)

While it is true that the interest ceilings set by the Usury Law are no longer in force, it has been held that PD 1684 and CB Circular 905 merely allow contracting parties to stipulate freely on any adjustment in the interest rate on a loan by forbearance of money but do not authorize a unilateral increase of the interest rate by one party without the other's consent (Spouses Silos v. Philippine National Bank, G.R. No. 181045, July 2, 2014). To be valid, therefore, any change of interest must be mutually agreed upon by the parties (Dizon v. Magsaysay, G.R. No. L-23399, 1974)

Q: Is the interest payment of 5% per month excessive?

A: YES. The 5% per month interest rate was found unconscionable in light of the parties’ circumstances, not by applying an automatic percentage cutoff; the interest rate prescribed by the Bangko Sentral ng Pilipinas (BSP) for loans or forbearances of money, credits or goods will be the surrogate or substitute rate not only for the one-year interest period agreed upon but for the entire period that the loan of Zenaida remains unpaid. (Bulatao v. Estonactoc, G.R. No. 235020, 2019)

What is the consequence of having usurious interest?

In usurious loans, the entire obligation does not become void because of an agreement for usurious interest; the unpaid principal debt still stands and remains valid but the stipulation as to the usurious interest is void. Consequently, the debt is to be considered without stipulation as to the interest. (First Metro Investment Corp. v. Este Del Sol Mountain Reserve, Inc., G.R. No. 141811, 2001)

The principal debt remains recoverable without the void interest stipulation. In case of judicial or extrajudicial demand, and the debtor incurs in delay, the debt earns legal interest from the date of the demand. Such interest is not due to stipulation, for there was none, the same being void. Rather, it is due to the general provision of law that in obligations to pay money, where the debtor incurs in delay, he has to pay interest by way of damages (Art. 2209, Civil Code)

Distinguish escalation clauses from floating rate of interest clauses. (Security Bank Corp. v. Spouses Mercado, 2018)

Q: Petitioner X was granted a loan by Bank A secured by a real estate mortgage. The interest rate agreed upon by the parties was 17% per annum. When X failed to pay some amortizations, Bank A unilaterally escalated the interest rate from 17% to 24% without the knowledge of X or even an explanation as to why the interest rates were increased. X filed a complaint against Bank A. Bank A defended the escalation, saying it was based on a stipulation in the loan agreement that the interest rate would be subjected to escalations. Was the escalation of interest rate made by Bank A valid?

A: No. Even though there was a stipulation in the loan agreement that the interest rate would be subjected to escalations, Bank A failed to explain how it arrived to such interest rates. While escalation clauses are not wrong, they must not be solely potestative and should be based on reasonable grounds. Further, the interest rate imposed upon Petitioner X is violative of the principle of mutuality of contracts. Art. 1308 of the Civil Code provides that a contract must bind both parties; its validity or compliance cannot be left to the will of one of them. (Vasquez v. PNB, G.R. Nos. 228355 & 228397, August 28, 2019)

Exceptions: (StiRF)

• When the parties stipulate otherwise, damages and interest may be recovered in addition to the penalty;
• When the obligor refuses to pay the penalty; and
• When debtor is guilty of Fraud. (CIVIL CODE, art. 1226)

Causes for reduction of penalty

• Partial/irregular performance
• Penalty provided is iniquitous/ unconscionable (CIVIL CODE, art. 1229)

Although parties may voluntarily agree on any amount of interest, voluntariness does not make the stipulation on interest valid. The 5% per month, or 60% per annum, rate of interest was struck down as iniquitous in Menchavez, but unconscionability must be assessed in light of the circumstances of the transaction. (Menchavez v. Bermudez, G.R. No. 185368)

Parties have wide latitude to stipulate any rate of interest in view of BSP Circular 905, which suspended the ceiling on interest effective Jan. 1, 1983. However, whenever interest is unconscionable, the courts may declare it illegal. Compounded interest of 5% monthly, being iniquitous and unconscionable, is void and inexistent from the very beginning. Thus, the legal rate of 6% per annum must be imposed in lieu of the excessive interest agreed upon by the parties. (Benavidez v. Salvador, G.R. No. 173331)

COMMENT (part 1 of 2)

Iniquitous or unconscionable stipulations on interest rates are void, thus it is as if there was no express contract thereon. Hence, courts may reduce the interest rate as reason and equity demand. (MCMP Construction v. Monark Equipment Corp., G.R. No. 201001)

Extinguishment of Obligations – Civil Code, arts. 1231-1304

CHAPTER 4

Extinguishment of Obligations

General Provisions

Article 1231. Obligations are extinguished:

(1) By payment or performance;

(2) By the loss of the thing due;

(3) By the condonation or remission of the debt;

(4) By the confusion or merger of the rights of creditor and debtor;

(5) By compensation;

(6) By novation.

Other causes of extinguishment of obligations, such as annulment, rescission, fulfillment of a resolutory condition, and prescription, are governed elsewhere in this Code. (1156a)

SECTION 1

Payment or Performance

Article 1232. Payment means not only the delivery of money but also the performance, in any other manner, of an obligation. (n)

Article 1233. A debt shall not be understood to have been paid unless the thing or service in which the obligation consists has been completely delivered or rendered, as the case may be. (1157)

Article 1234. If the obligation has been substantially performed in good faith, the obligor may recover as though there had been a strict and complete fulfillment, less damages suffered by the obligee. (n)

Article 1235. When the obligee accepts the performance, knowing its incompleteness or irregularity, and without expressing any protest or objection, the obligation is deemed fully complied with. (n)

Article 1236. The creditor is not bound to accept payment or performance by a third person who has no interest in the fulfillment of the obligation, unless there is a stipulation to the contrary.

Whoever pays for another may demand from the debtor what he has paid, except that if he paid without the knowledge or against the will of the debtor, he can recover only insofar as the payment has been beneficial to the debtor. (1158a)

Article 1237. Whoever pays on behalf of the debtor without the knowledge or against the will of the latter, cannot compel the creditor to subrogate him in his rights, such as those arising from a mortgage, guaranty, or penalty. (1159a)

Article 1238. Payment made by a third person who does not intend to be reimbursed by the debtor is deemed to be a donation, which requires the debtor's consent. But the payment is in any case valid as to the creditor who has accepted it. (n)

Article 1239. In obligations to give, payment made by one who does not have the free disposal of the thing due and capacity to alienate it shall not be valid, without prejudice to the provisions of article 1427 under the Title on "Natural Obligations." (1160a)

Article 1240. Payment shall be made to the person in whose favor the obligation has been constituted, or his successor in interest, or any person authorized to receive it. (1162a)

Article 1241. Payment to a person who is incapacitated to administer his property shall be valid if he has kept the thing delivered, or insofar as the payment has been beneficial to him.

Payment made to a third person shall also be valid insofar as it has redounded to the benefit of the creditor. Such benefit to the creditor need not be proved in the following cases:

(1) If after the payment, the third person acquires the creditor's rights;

(2) If the creditor ratifies the payment to the third person;

(3) If by the creditor's conduct, the debtor has been led to believe that the third person had authority to receive the payment. (1163a)

Article 1242. Payment made in good faith to any person in possession of the credit shall release the debtor. (1164)

Article 1243. Payment made to the creditor by the debtor after the latter has been judicially ordered to retain the debt shall not be valid. (1165)

Article 1244. The debtor of a thing cannot compel the creditor to receive a different one, although the latter may be of the same value as, or more valuable than that which is due.

In obligations to do or not to do, an act or forbearance cannot be substituted by another act or forbearance against the obligee's will. (1166a)

Article 1245. Dation in payment, whereby property is alienated to the creditor in satisfaction of a debt in money, shall be governed by the law of sales. (n)

Article 1246. When the obligation consists in the delivery of an indeterminate or generic thing, whose quality and circumstances have not been stated, the creditor cannot demand a thing of superior quality. Neither can the debtor deliver a thing of inferior quality. The purpose of the obligation and other circumstances shall be taken into consideration. (1167a)

Article 1247. Unless it is otherwise stipulated, the extrajudicial expenses required by the payment shall be for the account of the debtor. With regard to judicial costs, the Rules of Court shall govern. (1168a)

Article 1248. Unless there is an express stipulation to that effect, the creditor cannot be compelled partially to receive the prestations in which the obligation consists. Neither may the debtor be required to make partial payments.

However, when the debt is in part liquidated and in part unliquidated, the creditor may demand and the debtor may effect the payment of the former without waiting for the liquidation of the latter. (1169a)

Article 1249. The payment of debts in money shall be made in the currency stipulated, and if it is not possible to deliver such currency, then in the currency which is legal tender in the Philippines.

The delivery of promissory notes payable to order, or bills of exchange or other mercantile documents shall produce the effect of payment only when they have been cashed, or when through the fault of the creditor they have been impaired.

In the meantime, the action derived from the original obligation shall be held in the abeyance. (1170)

Article 1250. In case an extraordinary inflation or deflation of the currency stipulated should supervene, the value of the currency at the time of the establishment of the obligation shall be the basis of payment, unless there is an agreement to the contrary. (n)

Article 1251. Payment shall be made in the place designated in the obligation.

There being no express stipulation and if the undertaking is to deliver a determinate thing, the payment shall be made wherever the thing might be at the moment the obligation was constituted.

In any other case the place of payment shall be the domicile of the debtor.

If the debtor changes his domicile in bad faith or after he has incurred in delay, the additional expenses shall be borne by him.

These provisions are without prejudice to venue under the Rules of Court. (1171a)

SUBSECTION 1. Application of Payments

Article 1252. He who has various debts of the same kind in favor of one and the same creditor, may declare at the time of making the payment, to which of them the same must be applied. Unless the parties so stipulate, or when the application of payment is made by the party for whose benefit the term has been constituted, application shall not be made as to debts which are not yet due.

If the debtor accepts from the creditor a receipt in which an application of the payment is made, the former cannot complain of the same, unless there is a cause for invalidating the contract. (1172a)

Article 1253. If the debt produces interest, payment of the principal shall not be deemed to have been made until the interests have been covered. (1173)

Article 1254. When the payment cannot be applied in accordance with the preceding rules, or if application can not be inferred from other circumstances, the debt which is most onerous to the debtor, among those due, shall be deemed to have been satisfied.

If the debts due are of the same nature and burden, the payment shall be applied to all of them proportionately. (1174a)

SUBSECTION 2. Payment by Cession

Article 1255. The debtor may cede or assign his property to his creditors in payment of his debts. This cession, unless there is stipulation to the contrary, shall only release the debtor from responsibility for the net proceeds of the thing assigned. The agreements which, on the effect of the cession, are made between the debtor and his creditors shall be governed by special laws. (1175a)

SUBSECTION 3. Tender of Payment and Consignation

Article 1256. If the creditor to whom tender of payment has been made refuses without just cause to accept it, the debtor shall be released from responsibility by the consignation of the thing or sum due.

Consignation alone shall produce the same effect in the following cases:

(1) When the creditor is absent or unknown, or does not appear at the place of payment;

(2) When he is incapacitated to receive the payment at the time it is due;

(3) When, without just cause, he refuses to give a receipt;

(4) When two or more persons claim the same right to collect;

(5) When the title of the obligation has been lost. (1176a)

Article 1257. In order that the consignation of the thing due may release the obligor, it must first be announced to the persons interested in the fulfillment of the obligation.

The consignation shall be ineffectual if it is not made strictly in consonance with the provisions which regulate payment. (1177)

Article 1258. Consignation shall be made by depositing the things due at the disposal of judicial authority, before whom the tender of payment shall be proved, in a proper case, and the announcement of the consignation in other cases.

The consignation having been made, the interested parties shall also be notified thereof. (1178)

Article 1259. The expenses of consignation, when properly made, shall be charged against the creditor. (1179)

Article 1260. Once the consignation has been duly made, the debtor may ask the judge to order the cancellation of the obligation.

Before the creditor has accepted the consignation, or before a judicial declaration that the consignation has been properly made, the debtor may withdraw the thing or the sum deposited, allowing the obligation to remain in force. (1180)

Article 1261. If, the consignation having been made, the creditor should authorize the debtor to withdraw the same, he shall lose every preference which he may have over the thing. The co-debtors, guarantors and sureties shall be released. (1181a)

SECTION 2

Loss of the Thing Due

Article 1262. An obligation which consists in the delivery of a determinate thing shall be extinguished if it should be lost or destroyed without the fault of the debtor, and before he has incurred in delay.

When by law or stipulation, the obligor is liable even for fortuitous events, the loss of the thing does not extinguish the obligation, and he shall be responsible for damages. The same rule applies when the nature of the obligation requires the assumption of risk. (1182a)

Article 1263. In an obligation to deliver a generic thing, the loss or destruction of anything of the same kind does not extinguish the obligation. (n)

Article 1264. The courts shall determine whether, under the circumstances, the partial loss of the object of the obligation is so important as to extinguish the obligation. (n)

Article 1265. Whenever the thing is lost in the possession of the debtor, it shall be presumed that the loss was due to his fault, unless there is proof to the contrary, and without prejudice to the provisions of article 1165. This presumption does not apply in case of earthquake, flood, storm, or other natural calamity. (1183a)

Article 1266. The debtor in obligations to do shall also be released when the prestation becomes legally or physically impossible without the fault of the obligor. (1184a)

Article 1267. When the service has become so difficult as to be manifestly beyond the contemplation of the parties, the obligor may also be released therefrom, in whole or in part. (n)

Article 1268. When the debt of a thing certain and determinate proceeds from a criminal offense, the debtor shall not be exempted from the payment of its price, whatever may be the cause for the loss, unless the thing having been offered by him to the person who should receive it, the latter refused without justification to accept it. (1185)

Article 1269. The obligation having been extinguished by the loss of the thing, the creditor shall have all the rights of action which the debtor may have against third persons by reason of the loss. (1186)

SECTION 3

Condonation or Remission of the Debt

Article 1270. Condonation or remission is essentially gratuitous, and requires the acceptance by the obligor. It may be made expressly or impliedly.

One and the other kind shall be subject to the rules which govern inofficious donations. Express condonation shall, furthermore, comply with the forms of donation. (1187)

Article 1271. The delivery of a private document evidencing a credit, made voluntarily by the creditor to the debtor, implies the renunciation of the action which the former had against the latter.

If in order to nullify this waiver it should be claimed to be inofficious, the debtor and his heirs may uphold it by proving that the delivery of the document was made in virtue of payment of the debt. (1188)

Article 1272. Whenever the private document in which the debt appears is found in the possession of the debtor, it shall be presumed that the creditor delivered it voluntarily, unless the contrary is proved. (1189)

Article 1273. The renunciation of the principal debt shall extinguish the accessory obligations; but the waiver of the latter shall leave the former in force. (1190)

Article 1274. It is presumed that the accessory obligation of pledge has been remitted when the thing pledged, after its delivery to the creditor, is found in the possession of the debtor, or of a third person who owns the thing. (1191a)

SECTION 4

Confusion or Merger of Rights

Article 1275. The obligation is extinguished from the time the characters of creditor and debtor are merged in the same person. (1192a)

Article 1276. Merger which takes place in the person of the principal debtor or creditor benefits the guarantors. Confusion which takes place in the person of any of the latter does not extinguish the obligation. (1193)

Article 1277. Confusion does not extinguish a joint obligation except as regards the share corresponding to the creditor or debtor in whom the two characters concur. (1194)

SECTION 5

Compensation

Article 1278. Compensation shall take place when two persons, in their own right, are creditors and debtors of each other. (1195)

Article 1279. 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. (1196)

Article 1280. Notwithstanding the provisions of the preceding article, the guarantor may set up compensation as regards what the creditor may owe the principal debtor. (1197)

Article 1281. Compensation may be total or partial. When the two debts are of the same amount, there is a total compensation. (n)

Article 1282. The parties may agree upon the compensation of debts which are not yet due. (n)

Article 1283. If one of the parties to a suit over an obligation has a claim for damages against the other, the former may set it off by proving his right to said damages and the amount thereof. (n)

Article 1284. When one or both debts are rescissible or voidable, they may be compensated against each other before they are judicially rescinded or avoided. (n)

Article 1285. The debtor who has consented to the assignment of rights made by a creditor in favor of a third person, cannot set up against the assignee the compensation which would pertain to him against the assignor, unless the assignor was notified by the debtor at the time he gave his consent, that he reserved his right to the compensation.

If the creditor communicated the cession to him but the debtor did not consent thereto, the latter may set up the compensation of debts previous to the cession, but not of subsequent ones.

If the assignment is made without the knowledge of the debtor, he may set up the compensation of all credits prior to the same and also later ones until he had knowledge of the assignment. (1198a)