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Escalation of interest rates in loan contracts void without written

notice to and written consent of the borrower


Plain Language summary:
Case title: Spouses Ignacio F.
Juico and Alice P. Juico,
Petitioners, -versus- China
Banking Corporation,
Respondent, G.R. No. 187678,
April 10, 2013
Ruling: The escalation clause is
void because it granted China
Banking the power to impose an
increased rate of interest without
a written notice to the Juico
couple and their written
consent.
Definition: Escalation clauses
refer to stipulations allowing an
increase in the interest rate
agreed upon by the contracting
parties.
Doctrine: There is nothing
inherently wrong with escalation
clauses which are valid
stipulations in commercial
contracts to maintain fiscal
stability and to retain the value
of money in long term
contracts.
But an escalation clause is void
where the creditor unilaterally
determines and imposes an
increase in the stipulated rate of
interest without the express
conformity of the debtor.
New Sampaguita Builders
Construction, Inc. v. Philippine
National Bank(July 30, 2004)

Note: The Supreme Court


rulings on escalation clauses also
apply to credit card agreements.
Polotan, Sr. v. CA (Eleventh
Div.), 357 Phil. 250 (1998)

Background facts
Spouses Ignacio and Alice Juico got a loan from China Banking Corporation as
evidenced by 2 promissory notes. The loan was secured by a Real Estate Mortgage over
the Juico couples property located at White Plains, Quezon City. The notes contained the
following escalation clause stating that the interest rate would change every month based
on the prevailing market rate:
I/We hereby authorize the CHINA BANKING CORPORATION to increase or decrease as
the case may be, the interest rate/service charge presently stipulated in this note without
any advance notice to me/us in the event a law or Central Bank regulation is passed or
promulgated by the Central Bank of the Philippines or appropriate government entities,
increasing or decreasing such interest rate or service charge.
The Juicos failed to pay the monthly amortizations due. As of February 23, 2001, the
amount due on the two promissory notes totaled P19,201,776.63 representing the principal,
interests, penalties and attorneys fees. The mortgaged property was sold at public auction,
with China Bank as the highest bidder for the amount of Php 10,300,000.
After the auction, China Bank filed a collection case with the Regional Trial Court (RTC)
of Makati City for Php 8,901,776.63, the amount of deficiency after applying the proceeds of
the foreclosure sale to the mortgage debt.
In their Answer, the Juicos admitted their debt but claimed that the principal of the
loan was already paid when the mortgaged property was extrajudicially
foreclosed and sold for Php 10,300,000. They contended that should they be held liable for
any deficiency, it should be only for Php 55,000 representing the difference between the
total outstanding obligation of Php 10,355,000 and the bid price of Php 10,300,000.
At the trial, China Bank presented Ms. Annabelle Cokai Yu, its Senior Loans Assistant, as
witness. She testified that she handled the account of the Juicos and assisted them in
processing their loan application. She called them monthly to inform them of the prevailing
rates to be used in computing interest due on their loan.
On cross-examination, Ms. Yu reiterated that the interest rate changes every month

based on the prevailing market rate and she notified the Juicos of the prevailing rate
by calling them monthly before their account becomes past due. When asked if there
was any written authority from the Juicos to increase the interest rate unilaterally, Ms. Yu
answered that they signed a promissory note indicating that they agreed to pay interest at
the prevailing rate.
In defense, Ignacio Juico testified that before the loans release, he was required to sign a
blank promissory note and was informed that the interest rate on the loan will be based on
prevailing market rates. On cross-examination, Ignacio testified that he is a Doctor of
Medicine and also engaged in the business of distributing medical supplies. Ignacio
admitted having read the promissory notes and that he is aware of his obligation
under them before he signed them.

The RTC rules against the Juicos


The trial court held that:
(1) Ignacios claim that he signed the promissory notes in blank cannot negate or mitigate
his liability since he admitted reading the Promissory Notes before signing them.
(2) Considering the substantial amount involved, it is unbelievable that the Juicos threw all
caution to the wind and simply signed the documents without reading and understanding
the contents.

The Court of Appeals affirms RTC ruling


The CA recognized China Banks right to claim the deficiency because the proceeds of the
foreclosure sale were insufficient to cover the amount of the debt.
Also, the CA found as valid the stipulation in the promissory notes that interest will be based
on the prevailing rate. It noted that the parties agreed on the interest rate which was not
unilaterally imposed by the bank but was the rate offered daily by all commercial banks as
approved by the Monetary Board. Having signed the promissory notes, the Juicos are
bound by the stipulations.

Supreme Court rules partly for the Juicos and partly for China Bank
The Juico couple appealed to the Supreme Court. According to the Juicos, the issues
are:
(1) The interest rates imposed by China Bank are not valid as they were not by virtue of any
law or Bangko Sentral ng Pilipinas regulation or any regulation that was passed by an

appropriate government entity. They insist that the interest rates were unilaterally imposed
by the bank and thus violate the principle of mutuality of contracts.
(2) The escalation clause in the promissory notes does not give China Bank the unbridled
authority to increase the interest rate unilaterally. Any change must be mutually agreed
upon.
The Courts ruling in favor of the Juicos:
(1) Escalation clauses are not necessarily void. These clauses are valid stipulations in
commercial contracts to maintain fiscal stability and to retain the value of money in long
term contracts.
(2) The Juicos were not coerced into signing the promissory notes and they did not protest
the new rates imposed on their loan. Nevertheless, an escalation clause granting the
creditor an unbridled right to adjust the interest independently and upwardly, completely
depriving the debtor of the right to assent to an important modification in the agreement is
void. A stipulation of this nature violates the principle of mutuality of contracts under Article
1308 of the New Civil Code.
(3) An escalation clause is void where the creditor unilaterally determines and
imposes an increase in the stipulated rate of interest without the express conformity
of the debtor.
(4) Changes in the rate of interest for loans under an escalation clause must be the
result of an agreement between the parties.
(5) China Bank should have given a detailed billing statementbased on the new
imposed interest with corresponding computation of the total debt. The statement would
have enabled the Juicos to make an informed decision. China Bank should also have
provided an appropriate form to be signed by the Juicos to indicate their conformity
to the new rates.
The Courts ruling in favor of China Bank:
The Court ordered the Juicos to pay China Bank Php 4,761 ,865. 79 (instead of Php
8,901,776.63, the amount originally claimed) representing the amount of deficiency
inclusive of interest, penalty charge and attorneys fees.

Overview of Supreme Court rulings on escalation cases

The controlling case and ruling on escalation clauses is New Sampaguita Builders
Construction, Inc. v. Philippine National Bank.The Court ruled that an escalation clause
is void where the creditor unilaterally determines and imposes an increase in the stipulated
rate of interest without the express conformity of the debtor. The Court explained:
Courts have the authority to strike down or to modify provisions in promissory notes that
grant the lenders unrestrained power to increase interest rates, penalties and other charges
at the latters sole discretion and without giving prior notice to and securing the consent of
the borrowers. This unilateral authority is anathema to the mutuality of contracts and enable
lenders to take undue advantage of borrowers. Although the Usury Law has been effectively
repealed, courts may still reduce iniquitous or unconscionable rates charged for the use of
money. Furthermore, excessive interests, penalties and other charges not revealed in
disclosure statements issued by banks, even if stipulated in the promissory notes, cannot
be given effect under the Truth in Lending Act.
Posted below are some other cases on escalation clauses.

Banco Filipino Savings & Mortgage


Bank v. Navarro, No. L-46591, July 28,
1987, 152 SCRA 346, 353

Ruling:

Philippine National Bank v. Court of


Appeals, G.R. No. 107569, November 8,
1994, 238 SCRA 20

Ruling:

Escalation clause void because: Circular No.


494 issued by the Monetary Board on January
I/We hereby authorize Banco Filipino to 2,1976, because said circular is not a law
correspondingly increase the interest rate although it has the force and effect of law
stipulated in this contract without
Escalation clause has no provision for reducing
advance notice to me/us in the event a
the stipulated interest in the event that the
law should be enacted increasing the
applicable maximum rate of interest is reduced
lawful rates of interest that may be
by law or by the Monetary Board (decharged on this particular kind of loan. escalation clause).

Although the contract included a de-escalation


clause, increases unilaterally imposed by PNB
The promissory notes authorized PNB to violated the principle of mutuality essential in
increase the stipulated interest per annum contracts.
within the limits allowed by law at any
time depending on whatever policy
[PNB] may adopt in the future; Provided,
that, the interest rate on this note shall be
correspondingly decreased in the event

that the applicable maximum interest rate


is reduced by law or by the Monetary
Board. Philippine National Bank v.
Court of Appeals, 273 Phil. 789 (1991)
Philippine National Bank v. Court of
Appeals, 328 Phil. 54, 61-62 (1996)
Escalation clause authorized PNB to raise
the stipulated interest rate at any time
without notice, within the limits allowed
by law.

Ruling:
PNB did not secure the conformity of the
borrower to the successive increases in the
interest rate. The borrowers assent to the
increases cannot be implied from lack of
response to the letters sent by PNB, informing
them of the increases.

Philippine Savings Bank v. Castillo, G.R. Ruling:


No. 193178, May 30, 2011, 649 SCRA
527
Escalation clause void despite provision for deescalation.
The rate of interest and/or bank charges
herein stipulated, during the terms of this The increase or decrease of interest rates under
promissory note, its extensions, renewals such clause hinges solely on the discretion of
or other modifications, may be increased, petitioner as it does not require the conformity
decreased or otherwise changed from
of the maker before a new interest rate could be
time to time within the rate of interest
enforced. We also said that respondents assent
and charges allowed under present or
to the modifications in the interest rates cannot
future law(s) and/or government
be implied from their lack of response to the
regulation(s) as the [PSBank] may
memos sent by petitioner, informing them of the
prescribe for its debtors.
amendments, nor from the letters requesting for
reduction of the rates.

Some observations:
[1] The Juicos should have asked for the reduction of the attorneys fees demanded by
China Bank amounting to 10% or about Php 1.36 million. In New Sampaguita Builders
Construction, Inc. v. Philippine National Bank, the Supreme Court equitably reduced the
attorneys fees to just 1%.
[2] The Supreme Court rulings on escalation clauses also apply to credit card agreements.
See Polotan, Sr. v. CA (Eleventh Div.), 357 Phil. 250 (1998).