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OBLICON_Chapter 3_Obligation with a penal clause (50 pages)

(1) (General Insurance and Surety Corp. v. Republic, G.R. No. L-13873, January 31, 1963)
(5) (Land Bank v. David, G.R. No. 176344, August 22, 2008)
(7) (Compagnie Franco-Indochinoise v. Deutsch Australische Dampschiffs Gesellschaft, G.R. No. 11169, March 31, 1917)
(14) (Filinvest Land Inc. v. Court of Appeals, G.R. No. 138980, September 20, 2005)
(19) (Laureano v. Kilayco, G.R. No. 10419, November 10, 1915)
(22) (Pamintuan v. Court of Appeals, G.R. No. L-26339, December 14, 1979)
(25) SSS v. Moonwalk Development & Housing Corp., G.R. No. 73345, April 07, 1993)
(31) (Lo v. Court of Appeals, G.R. No. 141434, September 23, 2003)
(33) (Ligutan v. Court of Appeals, G.R. No. 138677, February 12, 2002)
(37) (Commercial Credit Corp. of Cagarayan De Oro v. Court of Appeals, G.R. No. 78315, January 02, 1989)
(40) (Insular Bank of Asia and America v. Spouses Salazar, G.R. No. 82082, March 25, 1988)
(43) (Garcia v. Court of Appeals, G.R. Nos. 82282-83, November 24, 1988)

(General Insurance and Surety Corp. v. Republic, payment of salaries of its teachers, past, present,
G.R. No. L-13873, January 31, 1963) and future."

EN BANC 4. ID.; ID.; PENAL NATURE OF BOND. A bond,


[G.R. No. L-13873. January 31, 1963.] which is penal in nature, may be forfeited for its full
GENERAL INSURANCE and SURETY CORPORATION, amount of P10,000.00 although the amount
petitioner, vs. REPUBLIC OF THE PHILIPPINES and involved in connection with its violation is
CENTRAL LUZON EDUCATIONAL FOUNDATION, INC., considerably much less, pursuant to Article 1226 of
respondents. the Civil Code, which provides that in obligations
Guido Advincula for petitioner. with penal clause the penalty shall substitute the
Solicitor General for respondents. indemnity for damages and the payment of
interests in case of non-compliance, if there is no
SYLLABUS stipulation to the contrary, and the party to whom
payment is to be made is entitled to recover the
1. SURETYSHIP; ACCRUAL OF ACTION FROM sum stipulated without need of proving damages
EXECUTION OF BOND IN PRESENT CASE; because one of the primary purposes of a penalty
PRESCRIPTION OF ACTION BASED ON WRITTEN clause is to avoid such necessity. (Art. 1228, Civil
CONTRACTS. By the terms of the bond, the surety Code; Lambert vs. Fox, 26 Phil. 588; Palacios vs.
guaranteed to the Government compliance by the Municipality of Cavite, 12 Phil. 140; Manila Racing
Foundation with all obligations, including the Club vs. Manila Jockey Club, 69 Phil. 55). The mere
payment of the salaries of its teachers and non-performance of the principal obligation gives
employees, "past, present and future." Before the rise to the right to the penalty. (IV Tolentino, Civil
execution of the bond, the Foundation was already Code of the Philippines, p. 247.)
indebted to two of its teachers for past salaries.
When the bond, therefore, was executed, the right DECISION
of the Government to proceed against it on
account of the unpaid salaries of said teachers REGALA, J p:
accrued. The fact that the action was filed one
year after the expiration of the bond does not On May 15, 1954, the Central Luzon Educational
militate against the action, because actions based Foundation, Inc. and the General Insurance and
on written contracts prescribe in ten years. (Article Surety Corporation posted in favor of the
1144, par. 1, Civil Code.) Department of Education a bond, the terms of
which read as follows:
2. ID.; ID.; SIXTY-DAY NOTICE IN PRESENT BOND NOT
A PERIOD OF PRESCRIPTION OF ACTION. The 60- "KNOW ALL MEN BY THESE PRESENTS:
day notice required in the bond in question is not a WHEREAS, the Department of Education has
period of prescription of action. If at all, it is a required the Central Luzon Educational Foundation,
limitation on the right of the surety to withdraw. Inc., operating the Sison & Aruego Colleges, of
Urdaneta, Pangasinan, Philippines an institution of
3. ID.; ID.; GOVERNMENT, NOT THE TEACHERS, THE learning to file a bond to guarantee the adequate
PROPER PARTY IN PRESENT CASE. The filing by the and efficient administration of said school or
Government of an action on a bond on account of college and the observance of all regulations
its violation by the principal in not paying the prescribed by the Secretary of Education and
salaries of two of its teachers, cannot be assailed compliance with all obligations, including the
on the ground that the teachers were not the payment of the salaries of all its teachers and
parties to the bond nor beneficiaries of a stipulation employees, past, present, and future, and the
pour autrui, because the action is not one by the payment of all other obligations incurred by, or in
teachers against the surety, but one brought by the behalf of said school;
Government to hold the surety liable on its bond for
the same has been violated when the principal NOW, THEREFORE, in compliance with said
failed to comply "with all obligations, including the requirement, we, CENTRAL LUZON EDUCATIONAL
FOUNDATION, INC., operating the Sison and Aruego
1|OBLICON_Chapter 3_Obligation with a penal clause
Colleges, represented by Dr. Jose Aruego, its Vice- forfeiture of the bond, in the Court of First Instance
Chairman, as principal, and the GENERAL of Manila on July 11, 1956.
INSURANCE AND SURETY CORPORATION, a
corporation duly organized and existing under and In due to surety the Foundation and prayed that
by virtue of the laws of the Philippines, as surety, are the complaint be dismissed and that it be
held end firmly bound, jointly and firmly, unto the indemnified by the Foundation of any amount it
Department of Education of the Republic of the might be required to pay the Government, plus
Philippines in the sum of TEN THOUSAND PESOS attorney's fees.
(P10,000.00) Philippine currency, for the payment
thereof we bind ourselves, our heirs, executors, For its part, the Foundation denied the cross-claim
administrators, successors, and assigns, jointly and and contended that, because Remedios Laoag
severally firmly by these presents; owed Fr. Cinense the amount of P820.65, there was
no basis for the action; that the bond is illegal and
WHEN the Secretary of Education is satisfied that that the Government has no capacity to sue.
said institution of learning had defaulted in any of
the foregoing particulars, this bond may The surety also filed a third-party complaint against
immediately thereafter be declared forfeited and Teofilo Sison and Jose M. Aruego on the basis of the
for the payment of the amount above-specified, indemnity agreement. While admitting the
we bind ourselves, our heirs, executors, successors, allegations of the third-party complaint, Sison and
administrators, and assigns, jointly and severally. Aruego claimed that because of the cancellation
and withdrawal of the bond, the indemnity
We further bind ourselves, by these presents, to give agreement ceased to be of force and effect.
the Department of Education at least sixty (60) days
notice of the intended withdrawal or cancellation Hearing was held and on December 18, 1956, the
of this bond, in order that the Department can take Court of First Instance rendered judgment holding
such action as may be necessary to protect the the principal and the surety jointly and severally
interests of such teachers, employees or creditors of liable to the Government in the sum of P10,000.00
the school and of the Government. with legal interest from the date of filing of the
complaint, until the sum is fully paid and ordering
LIABILITY of Surety under this bond will expire on the principal to reimburse the surety whatever
June 15, 1955, unless sooner revoked. amount it may be compelled to pay to the
Government by reason of the judgment, with costs
IN WITNESS WHEREOF, we signed this present against both principal and the surety.
guaranty at the City of Manila, Philippines, this 15th
day of May, 1954." The surety filed a motion for reconsideration and a
request to decide the third party complaint which
On the same day, May 15, 1954, the Central Luzon the trial court denied.
Educational Foundation, Inc., Teofilo Sison and Jose
M. Aruego executed an indemnity agreement On appeal, the Court of Appeals rendered a
binding themselves jointly and severally to decision, the dispositive portion of which reads:
indemnify the surety of "any damages, prejudices,
loss, costs, payments, advances and expenses of "WHEREFORE, the appealed judgment is hereby
whatever kind and nature, including attorney's fees modified in the following manner:
and legal costs, which the COMPANY may, at any
time sustain or incur, as well as to reimburse to said "(a) Ordering Central Luzon Educational
COMPANY all sums and amounts of money which Foundation, Inc., and General Insurance and Surety
the COMPANY or its representatives shall or may Corporation to pay jointly and severally the
pay or cause to be paid or become liable to pay, Republic of the Philippines the sum of P10,000.00,
on account of or arising from the execution of the plus costs and legal interests from July 11, 1956 until
above mentioned Bond." fully paid; and

On June 25, 1954, the surety advised the Secretary "(b) Ordering Central Luzon Educational
of Education that it was withdrawing and Foundation, Inc., Teofilo Sison and Jose M. Aruego
cancelling its bond. Copies of the letter were sent to reimburse, jointly and severally, the General
to the Bureau of Private Schools and to the Central Insurance and Surety Corporation of all amounts it
Luzon Educational Foundation, Inc. may be forced to pay the Republic of the
Philippines by virtue of this judgment, plus costs and
It appears that on the date of execution of the P2,000 for counsel's fees."
bond, the Foundation was indebted to two of its
teachers for salaries, to wit: to Remedios Laoag, in From this decision, the surety appealed to this Court
the sum of P685.64, and to H.B. Arandia, in the sum by way of certiorari, raising questions of law. 1
of P820.00, or a total of P1,505.64.
In its first four assignments of error, the surety
Demand for the above amount having been contends that it was no longer liable on its bond
refused, the Solicitor General, in behalf of the after August 24, 1954 (when the 60-day notice of
Republic of the Philippines, filed a complaint for the cancellation and withdrawal ended) or, at the
2|OBLICON_Chapter 3_Obligation with a penal clause
latest, after June 15, 1955. For support, the Surety against Vicente Diosomito or in the event that any
invokes the following provisions of the bond: of the warranties contained in that certain deed of
sale executed by the undersigned principal on this
"WE further bind ourselves, by these presents to give 13th day of February, 1933, be invalidated, a copy
the Department of Education at least sixty (60) days of which is hereto attached and made an integral
notice of the intended withdrawal or cancellation part hereof, marked Exhibit A."
of this bond, in order that the Department can take
such action as may be necessary to protect the According to the bond, "the liability of Luzon Surety
interest of such teacher, employees Creditor to the Company, Inc., under this bond will expire twelve
government. (12) months from date hereof." The date referred to
was February 13, 1933. This Court absolved the
"LIABILITY of the Surety under this bond will expire on surety of liability because the acts for which the
June 15, 1955, unless sooner revoked." bond was posted happened after its expiration.
Thus, We held in that case:
On the other hand, the Government contends that
since the salaries of the teachers were due and ". . . The acts provided therein by reason of which
payable when the bond was still in force, the surety the contract of suretyship was executed could
has become liable on its bond from the moment of have taken place within the stipulated period of
its execution on May 15, 1954. twelve months. Hence, the parties fixed that period
exactly at twelve months, limiting thereby the
We agree with this contention of the Government. obligation of the appellee to answer for the
payment to the appellant of the aforesaid sum of
P7,500 to not more than the stipulated period. . . ."

It must be remembered that, by the terms of the Here, on the other hand, the right of the
bond, the surety guaranteed to the Government Government to collect on the bond arose while the
"compliance (by the Foundation) with all bond was in force, because, as earlier noted, even
obligations, including the payment of the salaries of before the execution of the bond, the principal had
its teachers and employees, past, present and already been in debt to its teachers.
future, and the payment of all other obligations
incurred by, or in behalf of said school." Now, it is Neither does the NARIC case support the surety's
not disputed that even before the execution of the position. In that case, the bond provided that
bond, the Foundation was already indebted to two
of its teachers for past salaries. From the moment, "This bond expires on March 20th, 1949 and will be
therefore, the bond was executed, the right of the cancelled TEN DAYS after the expiration, unless the
Government to proceed against the bond accrued surety is notified of any existing obligation
because since then, there has been violation of the thereunder, or unless the surety renews or extends it
terms of the bond regarding payment of past in writing for another term."
salaries of teachers at the Sison and Aruego
Colleges. The fact that the action was filed only on and We held that giving notice of existing
July 11, 1956 does not militate against this position obligation was a condition precedent to further
because actions based on written contracts liability of the surety and that in default of such
prescribe in ten years. (Art. 1144, par. 1, Civil Code). notice, liability on the bond automatically ceased.
Similarly, in the case of Santos, et al. vs. Mejia, et al.,
The surety also cites our decision in the cases of G.R. No. L-6383, December 29, 1953, the bond
Jollye vs. Barcelon and Luzon Surety Co., Inc., 68 provided that
Phil. 164 and National Rice and Corn Corp. (NARIC)
vs. Rivera, et al., G.R. No. L-4023, February 29, 1952. "Liability of the surety on this bond will expire on
But there is nothing in these cases that supports the THIRTY DAYS and said bond will be cancelled 10
proposition that the liability of a surety for DAYS after its expiration unless surety is notified of
obligations arising during the life of a bond ceases any existing obligation thereunder."
upon the expiration of the bond.
and We held that the surety could not be held
In the Jollye case, the bond provided: liable because the bond was cancelled when no
notice of existing obligations was given within ten
"Whereas, the above bounded principal, on 13th days.
day of February, 1933 entered into an agreement In the present case, there is no provision that the
with H. P. L Jollye of Manila, P.I., to fully and faithfully bond will be cancelled unless the surety is notified
refund to said Mr. H.P.L. Jollye the above stated of any claim and so no condition precedent has to
sum of P7,500 representing the purchase price of be complied with by the Government before it can
the 75 shares of the capital stock of the North bring an action. Indeed, the provision of the bond
Electric Company (certificate No. 38) paid by said in the NARIC and Santos cases that it would be
Mr. H.P.L. Jollye to the undersigned principal, Mr. cancelled ten days after its expiration unless notice
Emeterio Barcelon, in the event the title thereto of of claim was given was inserted precisely because,
said Mr. Barcelon is invalidated by any judgment without such a provision, the surety's liability for
which may be rendered by the court of Cavite
3|OBLICON_Chapter 3_Obligation with a penal clause
obligations arising while the bond was in force the Department of Education is an instrumentality,
would subsist even after its expiration. to hold the surety liable on its bond for the same
has been violated when the principal failed to
Thus, in Pao Chuan Wek vs. Nomorosa, 54 O.G. No. comply "with all obligations, including the payment
11, 3490, We held that under a provision that the of salaries of its teachers, past, present and future."
surety "will not be liable for any claim not
discovered and presented to the company within There is nothing against public policy in forfeiting
three months from the expiration of this bond and the bond for the full amount. The bond is penal in
that the obligee hereby waives his right to file any nature. Article 1226 of the Code states that in
court action against the surety after the termination obligation with a penal clause, the penalty shall
of the period of three months above mentioned," substitute the indemnity for damages and the
the giving of notice is a condition precedent to be payment of interests in case of non-compliance, if
complied with. there is no stipulation to the contrary, and the party
to whom payment is to be made is entitled to
And suppose this action were filed while the bond recover the sum stipulated without need of proving
was in force, as the surety would have the damages because one of the primary purposes of
Government do, but the same remained pending a penalty clause is to avoid such necessity. (Art.
after June 15, 1955, would the surety suggest that 1228, Civil Code. Lambert vs. Fox, 26 Phil. 588;
the judgment that may be rendered in such action Palacios vs. Municipality of Cavite, 12 Phil. 140;
could not longer be enforced against it because Manila Racing Club vs. Manila Jockey Club, 69 Phil.
the bond says that its liability under it has expired? 55). The mere non-performance of the principal
obligation gives rise to the right to the penalty (IV
And what of the provision on 60-day notice? The Tolentino, Civil Code of the Philippines 247.)
surety urges that all actions on the bond must be
brought within that period or they would all be In its first and second "alternative assignments of
barred. The surety misread the provision. The 60-day error," the surety contends that it was released from
notice is not a period of prescription of action. The its obligation under the bond when on February 4,
provision merely means that the surety can 1955, Remedios Laoag and the Foundation agreed
withdraw as in fact it did in this case even that the latter would pay the former's salaries, which
before June 15, 1955 provided it gave notice of its were then already due, on March 1, 1955. In
intention to do so at least 60 days in advance. If at support of this proposition, the surety cites Article
all, the condition is a limitation on the right of the 2079 of the Code which provides as follows:
surety to withdraw rather than a limitation of action
on the bond. This is clear also from the Manual of "An extension granted to the debtor by the creditor
Information of Private Schools 2 which states that with out the consent of the guarantor extinguishes
"The bond furnished by a school may not be the guaranty. . . ."
withdrawn by either or both of the bondsmen
except by giving the Director of Private Schools sixty But the above provision does not apply to this case.
days notice." The supposed extension of time was granted not by
the Department but by the Department of
In its fifth assignment of error, the surety contends: Education or the Government but by the teachers.
As already stated, the creditors on the bond are
1. That the bond is void for being contrary to public not the teachers but the Department of Education
policy insofar as it requires the surety to pay or the Government.
P10,000.00 regardless of the amount of the salaries
of the teachers. 3 It is claimed that to enforce Even granting that an extension of time was
forfeiture of the bond for the full amount would be granted without the consent of the surety, still that
to allow the Government to enrich itself since the fact would not help the surety, because as earlier
unpaid salaries of the teachers amount to P1,318.84 pointed out, the Foundation was also in arrears in
only. the payment of the salaries of H. B. Arandia. The
case of Arandia alone would be enough basis for
2. That, under Article 1311 of the Civil Code, 4 since the Government to proceed against the bond.
teachers of Sison and Aruego Colleges are not
parties to the bond, "the bond is not effective and Lastly, in its third and fourth "alternative assignments
binding upon the obligors (principal and surety) as of error," the surety contends that it cannot be
far as it guarantees payment of the 'past salaries' of made to answer for more than the unpaid salaries
the teachers of said school." This is the same as of H. B. Arandia, which it claimed amounted to
saying that the surety is not liable to teachers of P720.00 only, because Article 2054 states that
Sison and Aruego Colleges because the latter are
not parties to the bond nor are they the
beneficiaries of a stipulation pour autrui. But this
argument is based on the false premise that the "A guarantor may bind himself for less, but not for
teachers are trying to enforce the obligation of the more than the principal debtor, both as regards the
bond, which is not the case here. This is not an amount and the onerous nature of the conditions.
action filed by the teachers against the surety. This
is an action brought by the Government, of which
4|OBLICON_Chapter 3_Obligation with a penal clause
"Should he have bound himself for more, his
obligations shall be reduced to the limits of that of P165,146.85 to settle the penalty & interest
the debtor."
135, 476.70 to partially pay the
What We said about the penal nature of the bond
would suffice to dispose of this claim. For whatever ========== principal
may be the amount of salaries due the teachers,
the fact remains that the condition of the bond was P300,625.55
violated and so the surety became liable for the b) The remaining principal balance of PESOS: EIGHT
penalty provided for therein. HUNDRED SEVENTY THOUSAND EIGHT HUNDRED
FORTY THREE & 63/100 (P870,843.63) after above
WHEREFORE, the decision of the Court of Appeals is application shall be charged interest at 17% per
hereby affirmed, with costs against the surety. annum (p.a.) effective March 1, 1996. The
restructured loan shall be paid in fifteen quarterly
Padilla, Bautista Angelo, Labrador, Concepcion, amortizations of PESOS: SEVENTY NINE THOUSAND
Reyes, J.B.L., Barrera, Paredes, Dizon and (P79,000.00) starting April 30, 1996, and every
Makalintal, JJ ., concur. quarter thereafter after fully paid.

Bengzon, C . J ., took no part. 2. Failure of the BORROWER to remit two


consecutive quarterly amortizations shall be
(Land Bank v. David, G.R. No. 176344, August 22, sufficient ground to initiate foreclosure proceedings;
2008)
xxx xxx xxx
SECOND DIVISION
5. All other terms and conditions of the original Loan
[G.R. No. 176344. August 22, 2008.] Agreement as well as existing collateral documents
not inconsistent herewith shall remain in force and
LAND BANK OF THE PHILIPPINES, petitioner, vs. effect. 5 (Emphasis supplied)
YOLANDA G. DAVID, respondent.
Respondent defaulted in the payment of monthly
DECISION amortizations of the loan; hence, the entire
balance of the loan became due and
CARPIO-MORALES, J p: demandable 6 which, as of March 31, 1997, stood
at P971,324.89. 7 Despite demand, 8 respondent
Respondent, Yolanda G. David, doing business failed to settle her obligation, prompting petitioner
under the trade name David Poultry Farm with to initiate foreclosure proceedings. 9 ISCaDH
address at Arayat, Pampanga, obtained on April
21, 1993 a P1,100,000 loan from petitioner, Land Respondent thereupon filed on July 28, 1997 before
Bank of the Philippines (Land Bank), to bear interest the Regional Trial Court (RTC) of San Fernando,
"based on the prevailing lender's rates/special Pampanga a Complaint with prayer for Preliminary
financing rate" 1 and penalty charge of 12% per Injunction 10 against petitioner, the Clerk of Court
annum in case of default in the settlement thereof. and Ex-Officio Sheriff of the RTC of Pampanga, and
To secure the payment of the loan, respondent Sheriff Efren Cannivel. Arguing that the interest on
mortgaged 2 a parcel of land covered by Transfer the loan is usurious, respondent prayed:
Certificate of Title No. 334702-R. 3 HIACEa
1. That immediately upon the filing of th[e] action, a
Due to serious business reverses suffered by Restraining Order issue, prohibiting and stopping the
respondent, she and petitioner executed on April defendant from proceeding with the Sale of the
18, 1996 a Restructuring Agreement 4 with the aforesaid property on July 28 and until the final
following terms: resolution of th[e] case;

As conditions for restructuring, the BORROWER 2. After hearing converting said Restraining Order
hereby undertakes and promises, without need for into a Writ of Preliminary Injunction;
any notice or demand or any act or deed to
perform the following: 3. After trial:

1. Restructuring of BORROWER's subject's [sic] a. Declaring CB Circular No. 905 basis of high
outstanding obligation of PESOS: ONE MILLION ONE interest rate and any other circular floating the
HUNDRED SEVENTY ONE THOUSAND FOUR HUNDRED interest rate as without legal basis whatsoever and
SIXTY SEVEN & 18/100 CTS. (P1,171, 467.18) as of therefore null and void;
February 29, 1996 as follows:
b. Declaring PD No. 116 which authorizes the CB
a) Upfront payment of PESOS: THREE HUNDRED now BSP to fix interest rates or ceiling as
THOUSAND SIX HUNDRED TWENTY THREE & 55/100 unconstitutional for being among others an undue
CTS. (P300,623.55) presently lodged to Accounts delegation of legislative power.
Payable (A/P) shall be applied as follows:
5|OBLICON_Chapter 3_Obligation with a penal clause
c. Declaring that all payments made by the plaintiff rate from March 29, 1999, upon payment of which
to defendant be considered as payment of the appellee LBP shall RETURN title of the mortgaged
principal without interest whatsoever; property to plaintiff-appellant and RESTORE her in
possession thereof.
d. Ordering defendant Bank to pay attorney's fee
of P50,000.00. 11 (Underscoring supplied) The award of moral and exemplary damages,
attorney's fees and expenses of litigation to
As prayed for by respondent, the Executive Judge defendant LBP is SET ASIDE.
Presiding Judge of Branch 42 of the San
Fernando, Pampanga RTC immediately issued a SO ORDERED. 22 (Emphasis in the original)
Temporary Restraining Order. 12
Its Motion for Reconsideration 23 having been
Petitioner filed its Answer (With Compulsory denied, 24 petitioner filed the present Petition for
Counterclaim [for damages and attorney's fees]). Review on Certiorari, 25 raising the following issues:
ESCDHA
After conducting a hearing on respondent's
application for the issuance of writ of preliminary (A)
injunction, Branch 43 of the San Fernando RTC to
which the case was raffled denied the application WHETHER OR NOT THE INTEREST RATE OF 17% PER
by Order 13 of January 28, 1998. DAaIHT ANNUM, AS PROVIDED IN THE RESTRUCTURING
AGREEMENT, AS WELL AS THE PENALTY CHARGES OF
Respondent subsequently filed on June 8, 1998 a 12% PER ANNUM CAN BE CONSIDERED AS
Supplemental Complaint 14 alleging that even EXORBITANT AND UNCONSCIONABLE.
before the denial of her application for writ of
preliminary injunction, the mortgaged property was (B)
sold at public auction for P1,298,460.88, pursuant to
which a Certificate of Sale 15 was issued. She thus WHETHER OR NOT THE FORECLOSURE PROCEEDINGS
prayed for the annulment of the Certificate of Sale CAN BE NULLIFIED ON THE GROUND THAT THE
on the ground that "the amount for which INTEREST RATES IMPOSED BY LAND BANK WAS
[petitioner sought] to have the property sold at UNCONSCIONABLE. 26
public auction is mostly an accumulation of usurious
interest . . . ." 16 The Supplemental Complaint was The petition fails.
admitted 17 by the trial court as was a
subsequently filed Amended Supplemental Jurisprudence empowers courts to equitably
Complaint. 18 reduce interest rates. 27 And the law empowers
them to reduce penalty charges. Thus, Article 1229
After trial, the trial court, by Decision 19 of April 18, of the Civil Code provides:
2000, dismissed respondent's complaint and, acting
on petitioner's Counterclaim, ordered respondent The judge shall equitably reduce the penalty when
to pay moral damages, exemplary damages, the principal obligation has been partly or
attorney's fees, expenses of litigation, and costs of irregularly complied with by the debtor. Even if
suit. there has been no partial performance, the penalty
may also be reduced by the courts if it is iniquitous
On appeal, 20 the Court of Appeals, noting that the or unconscionable. (Emphasis and underscoring
loan extended to respondent was part of the social supplied)
assistance program to improve the plight of
farmers, found the interest rate of 17% per annum Whether an interest rate or penalty charge is
and the penalty charge of 12% per annum reasonable or iniquitous is addressed to the sound
exorbitant and thus reduced them to 12% per discretion of the courts. 28 In determining what is
annum and 5% per annum, respectively. And it iniquitous and unconscionable, courts must
nullified the sale at public auction of the consider the circumstances of each case, 29 for
mortgaged property. Thus the appellate court what may be just in one case may be iniquitous
disposed in its challenged Decision of July 22, 2005: and unconscionable in another. 30 Thus, while this
21 Court sustained the validity of a 21% per annum
interest in Spouses Bautista v. Pilar Development
WHEREFORE, in view of the foregoing, the Decision Corporation, 31 it reduced an 18% per annum
dated April 18, 2000 is hereby MODIFIED. interest rate to 12% per annum in Trade &
Accordingly, the Extrajudicial Foreclosure Sale of Investment Development Corporation of the Phils. v.
the property covered by TCT No. 334702-R of the Roblett: 32
Registry of Deeds of Pampanga is hereby declared
NULL and VOID. Section 24 of R.A. No. 8435 (The Agriculture and
Fisheries Modernization Act of 1997) provides that
Appellant is, however, directed to PAY appellee "[t]he Land Bank of the Philippines shall, in
LBP the amount of Five Hundred Ninety Two accordance with its original mandate, focus
Thousand and Seven Hundred Ninety Two Pesos primarily on plans and programs in relation to the
and 42/100 (P592,792.42) with interest at the legal financing of agrarian reform and the delivery of
6|OBLICON_Chapter 3_Obligation with a penal clause
credit services to the agriculture and fisheries for being excessive, iniquitous, and exorbitant. . . .
sectors, especially to small farmers and fisherfolk." In (Emphasis and underscoring supplied) 38 AICTcE
the case at bar, the purpose of the loan was to
finance the construction of two broiler houses and WHEREFORE, the petition is, in light of the foregoing
a feeds warehouse. 33 The observation by the disquisition, DENIED.
Court of Appeals that the loan extended to
respondent was part of the social assistance SO ORDERED.
program to improve the plight of farmers is thus
well-taken. ScAHTI Quisumbing, Tinga, Velasco, Jr. and Brion, JJ.,
concur.
The Court notes respondent's claim, that even after
the restructuring on April 18, 1996 of the original (Compagnie Franco-Indochinoise v. Deutsch
loan, which was not refuted by petitioner, her profits Australische Dampschiffs Gesellschaft, G.R. No.
greatly diminished due to the poor quality of feeds 11169, March 31, 1917)
provided by Vitarich such that in April 1997, she
earned a profit of only P8,236.43. 34 EN BANC

Given the business losses that respondent suffered, [G.R. No. 11169. March 31, 1917.]
coupled with the fact that she had made partial
payments on both the original loan and the COMPAGNIE FRANCO-INDOCHINOISE, plaintiff-
restructured loan, 35 the reduction by the appellate appellant, vs. DEUTSCH AUSTRALISCHE
court of the interest rate and penalty charge is DAMPSCHIFFS GESELLSCHAFT, defendant-appellant.
justified. 36
Lawrence, Ross & Block for plaintiff-appellant.
While, as petitioner argues, the nullity of the interest
rate and penalty charge does not affect its right to Crossfield & O'Brien for defendant-appellant.
recover the principal amount of the loan, the
public auction of the mortgaged property is SYLLABUS
nevertheless void, 37 the amount indicated as
mortgage indebtedness having included excessive, 1. SHIPPING; DEVIATING TO TAKE REFUGE IN NEUTRAL
iniquitous, and exorbitant interest rate and penalty PORT; DAMAGES. A German merchant vessel,
charge. the Esslingen, which had just finished taking on a
cargo of rice-meal in the port of Saigon, at the
outbreak of the war, under a contract of
affreightment with a French shipper to deliver the
. . . The nullity of the stipulation on the usurious cargo in certain designated ports in Europe, fled
interest does not . . . affect the lender's right to from the port of Saigon and took refuge in the Bay
recover the principal of the loan. Nor would it of Manila; Held: In accord with the doctrine
affect the terms of the real estate mortgage. The announced in No. 10986 just decided, that neither
right to foreclose the mortgage remains with the the master nor the shipowner is liable in damages
creditors, and said right can be exercised upon the for the deviaton from the voyage prescribed in the
failure of the debtors to pay the debt due. The debt charter party nor for the resultant losses to the
due is to be considered without the stipulation of cargo owner.
the excessive interest. 2. ID.; ID.; DAMAGES FOR DETERIORATION OF
CARGO. Held: Nevertheless, that the shipowner is
While the terms of the Real Estate Mortgage remain responsible for losses resulting from the
effective, the foreclosure proceedings held on 31 DETERIORATION of the cargo by heating and as a
October 1990 cannot be given effect. In the Notice result of the inroads of weevils, as a consequence
of Sheriff's Sale dated 5 October 1990, and in the of the detention of this perishable cargo aboard
Certificate of Sale dated 31 October 1990, the the vessel for an unreasonable length of time in
amount designated as mortgage indebtedness Manila Bay, it appearing that the master failed and
amounted to P874,125.00. Likewise, in the demand neglected to take any measures looking to the sale
letter dated 12 December 1989, Zoilo Espiritu of the cargo, and that he refused to any measures
demanded from the Spouses Landrito the amount looking to the sale of the cargo, and that he
of P874,125.00 for the unpaid loan. Since the debt refused to deliver it to its owner upon demand, after
due is limited to the principal of P350,000.00 with it had lain in the hold of the vessel for about five
12% per annum as legal interest, the previous weeks, unless the cargo owner would comply with
demand for payment of the amount of P874,125.00 his wholly unjustifiable requirement of a deposit of
cannot be considered as a valid demand for P70,000 cash, on account of freight to which he
payment. For an obligation to become due, there had no lawful claim; and it appearing further that
must be a valid demand. Nor can the foreclosure he persisted in that refusal until proceedings were
proceedings be considered valid since the total instituted, after the perishable cargo had lain in the
amount of the indebtedness during the foreclosure hold of the vessel for more than two months without
proceedings was pegged at P874,125.00 which adequate ventilation.
included interest and which this Court now nullifies 3. ID.; ID.; MODIFICATION OF JUDGMENT. So
much of the judgment as provides for delivery to
7|OBLICON_Chapter 3_Obligation with a penal clause
the plaintiff of the proceeds of the judicial sale of "'It is stipulated and agreed by the parties in the
the cargo (P57,823.35) affirmed; but so much above action through their respective attorneys
thereof as allows damages for the breach of the that the following are the facts in this action in
charter party (P68,376.04) reversed; and the case addition to those admitted by the pleading, viz:
sent back for a new trial as to the amount of "'1. That the contrast of the charter party referred to
damages which should be allowed for the unlawful paragraph 2 of the complaint and paragraph 2 of
detention of the cargo aboard the vessel in Manila the answer is as is shown by the copy thereof
Bay. hereto attached, marked Exhibit A, which is made
DECISION a part of this stipulation.
"'2. That the steamship, Esslingen is and at all times
CARSON, J p: herein mentioned has been a steamship owned by
the defendant and registered in Germany, sailing
For a statement of this case on appeal we cannot under the German flag; that on the first day of
do better than to set forth the substance of the August, 1914, the said steamship was in the French
carefully prepared opinion in the court below, and port of Saigon engaged in loading a cargo of rice-
the assignments of error by counsel on the appeals meal belonging to plaintiff, in accordance with the
brought here by both parties. terms of the charter party Exhibit A hereto
"This is an action by the Compagnie Franco- attached; that on or before the said first day of
Indochinoise, a corporation organized and existing August the master of the said steamship received
under the laws of the Republic of France, against telegraphic instructions from the defendant to
the Deutsch-Australische Dampschiffs Gesellschaft, proceed to the port of Manila in the Philippine
a corporation organized and existing under the Islands and there await further orders, the
laws of the Empire of Germany, asking that a instructions being given on account of the
receiver be appointed to take possession of the threatening aspect of war between Germany and
cargo of the German steamship Esslingen, France; that on the said first day of August the
consisting of 126,028 sacks of rice-meal and 600 master of the said steamship delivered to plaintiff a
wooden ventilators, and to dispose of the same letter, a copy of which is hereto attached, marked
and to hold the proceeds thereof subject to the Exhibit B and is made a part of this stipulation; that
order of the court; and also praying that a on the same day the plaintiff delivered to the
judgment be given in favor of the plaintiff and master of the said steamship a letter in answer to
against the defendant for the delivery of the cargo, the said Exhibit B, a copy of which marked Exhibit C
or for the value thereof, if such delivery cannot be is attached hereto and made a part of this
made, and for damages and costs. stipulation; that the said steamship remained in the
"Pursuant to a stipulation of the parties, the court port of Saigon and continued to load said cargo
below, on October 16, 1914, appointed as joint and completed the loading of the same on or
receivers in this cause Messrs. H. T. Fox and D. H. before the 4th day of August, 1914; that on the
Jacoby to take possession of the cargo of the same fourth day of August the said steamship left
Esslingen, consisting of 116,808 sacks of white rice- the port of Saigon for the port of Manila, pursuant
meal, 9,220 sacks of cargo-meal, and 600 wooden to the aforesaid instructions from the owners; that
ventilators, and to sell and dispose of the same, plaintiff at the time of the departure of the said
and to hold and deposit the proceeds of such sale steamship from Saigon had full knowledge of the
subject to the further order of the court. intention of her master to proceed to Manila,
"The defendant, by its answer, admitted that the plaintiff's agents in Saigon being also the
plaintiff is a corporation organized and existing defendant's agents, and at the instance of the
under the laws of the Republic of France, and is master, plaintiff through its agents, secured a bill of
represented in the Philippine Islands and the city of health and other necessary clearance papers for
Manila by Mr. Paul Emile Nestor Colas; that the the voyage of the steamship to Manila; that war
defendant is a corporation organized and existing between the Republic of France and Empire of
under the laws of the Empire of Germany, and is Germany began on the third day of August, 1914,
represented in the Philippine Islands, in the city of and has continued from that date to the present
Manila, by Behn, Meyer & Company (Limited), and time; that neither the master of the said steamship
by Captain Sparmann, master of the steamship nor any other representative thereof or any other
Esslingen, then in the port of Manila. person sought to obtain from the French authorities
"The defendant also admitted by its answer the at the port of Saigon a lassez passer or clearance,
allegations of the plaintiff that on the 9th day of or other permission to proceed from Saigon to the
June, 1914, in the city of Paris, France, plaintiff and ports of Liverpool, England, and Hamburg,
defendant executed in writing a contract of Germany, or either of them, and that at the time of
charter party whereby defendant undertook that said steamship's leaving Saigon for Manila it was
the German steamship Esslingen should proceed to understood between the plaintiff and the
the port of Saigon, in the French colony of Indo- defendant that the steamship should proceed only
China, and there load a cargo of rice-meal, to Hamburg and the port of Liverpool was to be left
belonging to plaintiff, not exceeding seven out; that if the said steamship was justified in
thousand tons. seeking refuge in a neutral port under the
"On January 22, 1915, the parties signed and filed a conditions existing, Manila was a reasonable and
statement of facts as follows: proper port of refuge; and that the rice-meal and
cargo-meal constituting the cargo of the said
8|OBLICON_Chapter 3_Obligation with a penal clause
steamship is a food product used principally for supplemental answer, and that such general
animals. average should be determined under the York-
"'3. That the said steamship arrived at the port of Antwerp Rules as provided in the charter party; (3)
Manila from Saigon in due time and has since that the whole of the expenses and costs incurred
remained and still remains in the said port of Manila; by the defendant as set forth in paragraph 1 of the
that the said cargo if delivered at its destination, supplemental answer was still due from plaintiff to
Hamburg, as contemplated by the charter party, defendant by way of general average charges
Exhibit A, would have been worth at such place at against the cargo of the steamship, of which cargo
least its value at the time and place of plaintiff alleged itself to be the owner; (4) that the
embarkation, plus the freight from Saigon to steamship Esslingen was still unable to resume its
Hamburg. voyage under the charter party owing to the
"'4. That on the 14th day of September, 1914, and at conditions of war which still existed and that the
other times thereafter up to the time of filing of the defendant was unable to state when such voyage
complaint herein, plaintiff demanded delivery of could be resumed, and that other and further
the cargo of the said steamship from the master, expenses and costs would be incurred by the
and that defendant's agent has at all times been plaintiff in addition to those set forth, which will be a
willing to deliver said cargo upon deposit in cash of charge against the cargo to the plaintiff as the
the full amount for freight from Saigon to alleged owner thereof by way of general average,
destination as stated in the charter party, and the amount of such future and additional costs
amounting to nearly P70,000, Philippine currency, and expenses the defendant was then unable to
and has refused to deliver said cargo except upon state; (5) that there was justly due and owing from
the making of such deposit, and that plaintiff has at plaintiff to defendant for freight on the cargo of the
all times refused to deposit the freight charges as Esslingen the sum of P68,376.04 in accordance with
aforesaid; that the cash deposit was required in the terms of the contract between the plaintiff and
order to insure the payment of whatever freight be defendant as appears in the charter party, no part
found due upon adjustment under the terms of the of which freight had been paid or assured in any
charter party. way; that this amount constitutes a lien upon the
"'5. That the receivers appointed by this court in this cargo and the product of the sale thereof by way
action have taken possession of the cargo of said of general average between all the entities in the
steamship and have sold the same for P61,154.58; adventure undertaken in accordance with the
that in making such sale the receivers, have terms of the charter party, and that the general
necessarily incurred expenses as will be shown by average between the parties had not yet been
their report, and are entitled to fees which may be adjusted.
fixed by the court for their services; that the net "The defendant prayed that judgment be entered
proceeds of the sale of the cargo to be determined against the plaintiff for the sum of P94,493.02 with
by the deduction from the aforesaid gross legal interest thereon, and that such sum be
proceeds and the expenses and fees and fees of declared a lien upon the proceeds of the sale of
the receivers is the true and fair value of the cargo the cargo as made by the receivers theretofore
of the said steamship in the port of Manila. appointed.
"'6. It is further stipulated that without the "Thereafter, on February 13, 1915, the defendant
introduction of testimony the judgment of the court filed a motion to strike out that portion of
may be entered upon the questions of law arising paragraph 6 of the stipulation of facts made by
from the foregoing stipulation and the pleadings in counsel for both parties under date of January 22,
the above entitled action.' 1915, which states that without the introduction of
testimony judgment may be entered, and that the
"On the same day, by stipulation of the parties, the defendant be allowed to present evidence in
defendant filed an additional and supplemental relation to past and future expenses as alleged in
answer, alleging substantially as follows: (1) That defendant's additional and supplemental answer
since the arrival of the steamship Esslingen in Manila which was filed by stipulation of the parties.
Bay, it had been unable to resume its voyage or to "This motion to strike out a portion of the agreed
leave this port of refuge on account of conditions statement of facts was overruled by the court
following the declaration of war and now existing, below on the ground that the court had no power
and that the plaintiff-defendant had incurred costs or authority to strike out any part of an agreed
and expenses on account of coming into and statement of facts on the motion of one party
remaining in this port of refuge as itemized in the without the consent of the other; but the court
answer, aggregating the sum of P26,116.98; (2) that permitted the defendant to present evidence in
the receivers of the cargo of the steamship relation to past and future expenses as alleged in
Esslingen had sold the cargo for the sum of defendant's additional and supplemental answer
P61,158.58, and that defendant claimed a lien for for the reason that the court was of opinion that
the amount of costs and expenses as set forth in there was no basis for the rendition of judgment
paragraph 1 against the proceeds of the sale of upon the allegations of the answer without the
the cargo, and prayed that the lien be determined taking of evidence or the filing of an additional
by way of adjustment of liability through general agreed statement of facts.
average of all entities interested in the adventure "The evidence introduced upon the additional and
as evidenced by the charter party, a copy of which supplemental answer was substantially as follows:
was attached to and made a part of the
9|OBLICON_Chapter 3_Obligation with a penal clause
"It was stipulated that the amount of the freight to "'5. That the provision in the charter party for the
which reference is made in the stipulation of facts delivery of the cargo at Hamburg and of Liverpool,
as about P70,000 is the amount of P68,376.04. "or so near thereunto as she may safely get" is no
"Captain Sparmann, master of the steamship excuse or authority for entering Manila Bay to avoid
Esslingen, testified over the objection of the plaintiff, the seizure or capture of the ship by an enemy of
as to which the ruling of the court was reserved, Germany, as that clause was intended only to
that since coming to Manila he had incurred justify the master of the ship in discharging the
expenses in the maintenance of the crew and of cargo at some outside anchorage, when by reason
the vessel itself, as shown by Exhibit A, which is a of her draft or obstructions to navigation she could
statement of expenses amounting to P49,501.87 not reach the usual wharf or anchorage of a
incurred from the time the ship put in at Manila Bay designated port. (See Meissner vs. Brun, 128 U. S.,
up to the 15th of April, 1915; the total of Exhibit B for 474, 32 Law Ed., 496.)
wages being the first item in Exhibit A, Captain "'6. That there can be no general average unless
Sparmann claimed a lien on the ship's cargo on there has been a voluntary and successful sacrifice
account of these expenses. He said that it would be of a part of the maritime adventure for the benefit
impossible for the ship to leave Manila harbor of the whole adventure and for no other purpose;
during the European war, and that future expenses in other words, there must be an intentional
would be incurred for which a lien was also sacrifice of a part of the property on board the
claimed. vessels for the purposes of saving the remainder
"Exhibits A and B were offered in evidence against from a common peril, or extraordinary expenditures
the objection of the plaintiff that they tend to prove must be incurred for the purpose of saving the
general average expenses, although the pleadings property in peril. (McAndrews vs. Thatcher, 3 Wall.,
and the stipulation of facts show that no general 347, 366; The Star of Hope vs. Annan, 9 Wall., 203,
average had been claimed and no lien for general 228; Fowler vs. Rathbone, 12 Wall., 102, 114; Hobson
average had been claimed by the defendant; vs. Lord, 92 U. S., 397. 404; Ralli vs. Troop, 157 U. S.
and, as plaintiff insisted, the general average could 356, 393; Barnard vs. Adams, 10 How., 270, 303;
in no event be charged against the cargo after Philippine Code of Commerce, articles 806, 808, 811
demand was made for the delivery of the cargo, and 812.)
and in no event could charges be attributed to the
cargo after it was actually disposed of. "'7. That inasmuch as the French cargo was
"Upon consideration of all the facts in evidence absolutely safe in the French port of Saigon, and
and of the arguments of counsel, the authorities the deviation of the steamship Esslingen from her
cited and other authorities, pertinent to the intended voyage to Hamburg and Liverpool and
question at issue in this cause, the trial court set her entry into Manila Bay were induced by the fear
forth the following conclusions as to the law: of the captain of the vessel by one of the
"'1. That the court has jurisdiction of the parties and belligerents at war with Germany, the alleged peril
of the subject-matter in this action. which induced the master of said vessel to come to
"'2. That it was the duty of the defendant under the Manila was not common to both ship and cargo as
terms of the charter party in evidence, to transport required by the York-Antwerp Rules as a condition
the cargo in question from Saigon to Hamburg or precedent to the levying of a general average;
Liverpool, via Suez Canal, under steam all the way that this cargo under the law of nations was not
(unless disabled), or so near thereunto as she might subject to confiscation by any enemy of Germany,
safely get, and there to deliver the said cargo and the cargo not having been imperiled, the
(always afloat) in any safe dock or berth which the expenses and loss to the ship and its owners
charterers or their agents might appoint. occasioned by the deviation and by taking refuge
"'3. That the freight on the cargo having been in Manila Bay during the European War were not for
made payable on delivery at Hamburg or the benefit of the cargo, but for the sole benefit of
Liverpool, and the transportation of the cargo the ship and its crew; and therefore the cargo
having been abandoned by defendant at Manila, should not in any event be called upon for
no part of the freight was earned without such contribution under general average.
delivery, in the absence of an agreement that the "'8. That it was the duty of the defendant under the
shipowner should become entitled to a proportion charter party to transport said cargo to Hamburg or
of the freight on delivery of the cargo in a port of Liverpool in the steamer Esslingen but if, for any
refuge. (Carver on Carriage of Goods by Sea, reason, the transportation could not be effected in
section 307.) that vessel within a reasonable time, owing to the
"'4. That the fear of the owners and master of the perishable nature of the cargo, it was the legal duty
seizure or capture of the said steamship Esslingen by of the owners of said vessels and of the master
one of the belligerent powers at war with Germany thereof to make the shipment in another vessel.
was not the result of force majeure and was not a (Carver on Carriage of Goods by Sea, sections 304,
legal or sufficient excuse for having fled with a 305.)
French cargo from Saigon, a French port, to Manila,
or for the failure of the defendant to transport and "'9. That the defendant is liable to the plaintiff for the
deliver the said cargo to the consignees at damage caused in not having delivered the said
Hamburg or Liverpool, or for the failure to tranship cargo to Hamburg or Liverpool in accordance with
the same and cause it to be delivered in the terms of the charter party; and the
accordance with the terms of the charter party. transportation of the cargo having been
10 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
abandoned by the defendant at Manila, and the result of force majeure and was not a legal or
defendant not having earned the freight money, sufficient excuse for leaving a French port or for
the value of the cargo at Saigon must be the basis failing to deliver the cargo to the consignee at the
for determining the damages suffered by the ports of delivery or to tranship same and deliver in
plaintiff. accordance with the charter party.
"'10. That since the report of the receivers "4. The court erred in finding that the provisions of
appointed by this court, upon the agreement of the the charter party for the delivery of cargo at
parties, to sell said cargo at Manila and to hold the Hamburg or Liverpool or so near thereunto as she
proceeds subject to the order of the court, shows may safely get was no excuse for entering Manila
that said cargo was sold for the gross sum of Bay to avoid capture.
P61,154.58, with expense of the sale amounting to "5. The court erred in finding that the entry of the S.
P267.89, and the court having allowed the receivers S. Esslingen into Manila Bay to avoid capture was
the sum of P3,043.34 for their services in making said not ground for general average between the
sale, there now remains subject to the order of the steamship, the cargo and freight.
court the net sum of P57,823.35. "6. The trial court erred in finding that the entry of
"'11. That it having been alleged in the complaint the S. S. Esslingen into Manila Bay was not caused
and admitted in the answer that the value of the by peril common to both ship and cargo under the
cargo at Saigon was the equivalent of P145,600.91, York-Antwerp Rules or any other.
Philippine currency; and it having been agreed in "7. The court erred in finding that the defendant
the statement of facts that the value of the cargo was bound to transport the cargo in another vessel
in Manila is the price for which it was sold by the if it could not be done by the chartered vessel,
receivers, P61,154.58 less the receivers' fees and when no other vessels were available.
expenses as above stated, the court finds that the "8. The court erred in finding that the defendant
plaintiff is damaged by the acts of the defendant was liable for damages for not having delivered the
complained of in the amount of the difference cargo at Hamburg or Liverpool.
between the agreed value of the cargo at Saigon "9. The court erred in finding that the transportation
(P145,600.91) and the net proceeds of the sale in of the cargo had been abandoned at Manila and
Manila (P57,823.35), or P87,777.56; but the court that no freight having been earned the value of the
further finds that by paragraph 29 of the charter cargo at Saigon created the basis for the damages
party the penalty which must be imposed in case of suffered by the plaintiff.
nonperformance of said agreement is the amount "10. The court erred in finding, as set forth in
of the damages proved, provided same do not paragraph 10 of its decision, that any sum of money
exceed the estimated amount of freight which in as proceeds of the sale of cargo was subject to the
this case is P68,376.04.' order of the court.
"Therefore, let judgment be entered in this case in "11. The court erred in finding that the plaintiff was
favor of the plaintiff and against the defendant for damaged by the acts of the defendant in the sum
the said sum of fifty-seven thousand eight hundred of the difference between the value of the cargo
and twenty-three and 35/100 pesos (57,823.35) less at Saigon and the net proceeds from the sale
any commissions of the clerk of this court, free and thereof in Manila.
clear of all liens, claims or charges asserted by the "12. The court erred in entering judgment in any sum
defendant in this cause, with legal interest on said whatever in favor of the plaintiff and against the
sum from the date of the filing of the complaint in defendant before general average had been
this case until paid; and further, that the plaintiff adjusted between ship, the cargo and freight, as
have and recover of and from the defendant in this provided by the terms of the charter party.
cause the sum of sixty-eight thousand three "13. The court erred in dismissing defendant's cross
hundred and seventy-six and 4/100 pesos complaint and counterclaim."
(P68,3760.04) as and for actual damages suffered Counsel for the plaintiff appellant made the
by the plaintiff by the defendant's breach of following assignments of error:
charter party in evidence, with interest thereon "1. The court found that paragraph 29 of the
from the date of the filing of the complaint in this charter party, Exhibit A of the agreed statement of
case until paid. fats, limits defendant's liability for damages to the
"The defendant's cross complaint and counterclaim estimated amount of freight, P68,376.04.
is hereby dismissed with the costs of this case "2. The court ordered judgment for damages in the
against the defendant. sum of P68,376.04 instead of P87,777.56."
"It is so ordered." xxx xxx xxx
Counsel for the defendant-appellant made the From a comparison of the foregoing statement of
following assignment of errors on appeal: this case with the statement of the case set forth in
"1. The court erred in finding that it has jurisdiction of the opinion just filed in the case of Sambia
the persons and subject-matter of this action. (Compagnie de Commerce et de Navigation
"2. The court erred in finding that no part of the d'Extreme Orient vs. The Hamburg Amerika
freight became due until delivery of the cargo at Packetfacht Actien Gessellschaft, (p. 590, ante), it
Hamburg or Liverpool and, in the absence of an will be seen that the controlling facts in both cases
agreement, that the shipowner would not entitled are strikingly similar, with the exception of the facts
to a proportion on delivery at a port of refuge. touching the disposition of the cargoes of the two
"3. The court erred in finding that the fear of the vessels by their respective masters after they had
owner and master of the S. S. Esslingen was not the taken refuge in the port of Manila.
11 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
Our rulings upon the various contentions of counsels were joint receivers appointed to sell the cargo and
in the former case may, therefor, be regarded as to hold and deposit the proceeds subject to the
renewed with relation to like contentions in the order of the court.
case at bar, except only as to the contention that In our opinion in the case of the Sambia we
the shipowner should be held liable for the discussed at some length the duty and the liability
damages suffered by the cargo aboard the of the master and the shipowner as to the
Esslingen, while the vessel lay in Manila Bay, disposition of her cargo after the vessel had taken
because of the failure of the master to proceed refuge in Manila Bay, and we held, substantially,
with reasonable promptness to take proper that the master had complied with the duty resting
measures for the disposition of this perishable cargo upon him, in the absence of the owner of the
by sale or otherwise, and because of his refusal to cargo, to sell this perishable cargo which had been
deliver it to its owner when lawful demand was intrusted to him under a contract of affreightment
made therefor. which he found himself unable to execute; and
In the case of the Sambia it appeared that the that we could not say, from the facts disclosed by
vessel arrived from Saigon in Manila Bay on the 8th the record, that he had taken an unreasonable
of August, 1914; that two telegrams were time in deciding upon the course he finally
dispatched by the local agent of the shipowner adopted, so as to charge the shipowner with
and of the master, to the duly authorized damages resulting from the deterioration of the
representative of the cargo owner in Saigon, one cargo while on board the vessel in Manila Bay.
on the day of arrival and another a week later,
advising him of the situation; that these cablegrams In the case at bar, however, we think that under
were not delivered presumably because of the the doctrine laid down in the case of the Sambia,
interruption of cable communication following the the master, and therefore the shipowner, must be
outbreak of war; that later two letters were held responsible for the damage suffered by the
forwarded but remained unanswered until after the cargo aboard the Esslingen while it lay in Manila
master has sought and secured judicial authority to Bay. Not only did he fail and neglect to take any
sell the cargo -- the answer when it was received measures looking to the sale of the cargo, but he
being a flat refusal on the part of the Saigon actually refused to deliver this perishable cargo to
representative of the cargo owner to give any its owner upon demand, after it had lain in the hold
instructions or assume any responsibility; that on of the vessel for about five weeks, unless the cargo
September 4, 1914, the master of the Sambia had a owner would comply with his wholly unjustifiable
survey made of the cargo, by a qualified marine requirement of a deposit of P70,000 cash, on
surveyor, who reported that it "showed signs of account of freight to which he had not the shadow
heating and being infested with weevils" and of a lawful claim; and he persisted in that refusal
recommended that it be sold in the interest of all until legal proceedings were instituted after the
concerned; that on September 10, 1914, the master perishable cargo had lain in the hold of the vessel
not having been able to get into communication for about five weeks, unless the cargo owner would
with the cargo owners, or their representative in comply with his wholly unjustifiable requirement of a
Saigon, sought and secured judicial authority to sell deposit of P70,000 cash, on account of freight to
the cargo; and that the cargo was sold under which he had not the shadow of a lawful claim;
judicial authority in accordance with the provisions and he persisted in that refusal until legal
of local law made and provided in such cases. proceedings were instituted after the perishable
In the case of the Esslingen which arrived in Manila cargo had lain in the hold of the vessel for more
Bay on the 7th of August, 1914, it does not than two months under the rays of a tropical sun,
affirmatively appear that the master took any and as was admitted in argument, without
measures whatever looking to the protection of the adequate ventilation, it being impossible to secure
interests of the cargo owners; and, on the contrary, such ventilation while the vessel lay at anchor.
it appears that although the duly authorized In the light of these facts, it would seem to be
representative of the cargo owner was in Manila, unnecessary to add anything to what was said in
and made demand upon the master for delivery of our former opinion in order to sustain our ruling in
the cargo on September 14, 1914, "and at other the case at bar, but it may not be amiss to insert
times thereafter, up to the time of the filing of the here the following citations from Carver's Carriage
complaint in this action" on October 15, 1914, the of Goods by Sea, 5th ed., which set forth the
master and the local agent of the shipowner doctrine and the grounds upon which it rests in the
refused to make delivery without a deposit in cash clearest and most explicit terms:
of the full amount of freight charges agreed upon "309. The master is entitled to delay for such a
in the charter party, amounting to nearly P70,000, period as may be reasonable under the
"to insure the payment of whatever freight might be circumstances, before deciding on the course he
found due upon adjustment under the terms of the will adopt. He may claim a fair opportunity of
charter party;" that not until the day following the carrying out the contract, and earning the freight,
filing of the complaint in this action, praying for whether by repairing or transhipping. (See The
damages and the appointment of a receiver to Blenheim [1885] 54 L. J., Adm. 81; 10 P. D., 167; 5
take possession and dispose of the cargo, that is to Asp. M. C., 522.) Should the repair of the ship be
say not until October 16, 1914, seventy days after undertaken it must be proceeded with diligently;
the arrival of the vessel in the port of refuge, and and if so done, the freighter will have no ground of
then only upon stipulation of counsel in open court, complaint, although the consequent delay be a
12 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
long one. Unless, indeed, the cargo is perishable, stipulation as to the market value in Manila of a
and likely to be injured by the delay. Where that is similar cargo of rice-meal in good condition at the
the case, it ought to be forwarded, or sold, or given time when the damaged cargo was sold. We are
up, as the case may be, without waiting for the unable to say, therefore, how much of the loss
repairs, or proper steps, if such are possible, taken should be attributed to deterioration in quality; how
to prevent the cargo suffering by the delay. Any much should be attributed to a difference in values
failure on the part of the shipowner or master to between the undamaged cargo of rice-meal in
perform his duty in these respects will be ground for Saigon and a like cargo of undamaged rice-meal
an action by the owner of the cargo. (Hansen vs. in Manila Bay. In the absence of any evidence of
Dunn [1906], 11 Com. Ca., 100; 22 T. L. R., 458.) record on which to base a finding as to what the
"304a. A shipowner, or shipmaster (if cargo would have brought had it not deteriorated
communication with the shipowner is impossible) in Manila Bay, we are wholly unable to fix the
will be allowed a reasonable time in which to damages for which the shipowner should be held
decide what course he will adopt in such cases as responsible, unless we assume without proof a value
those under discussion; time must be allowed to him to be set on undamaged rice-meal in Manila which
to ascertain the facts, and to balance the neither party included or intended to include in the
conflicting interests involved, of shipowner, cargo agreed statement of facts upon which the case
owner, underwriters on ship, cargo, and freight. But was submitted for adjudication.
once that time has elapsed, he is bound to act Under our rulings in the Sambia case, the owners of
promptly according as he has elected either to the Esslingen are not liable for losses resulting from
repair or abandon the voyage, or tranship. If he the flight of that vessel from Saigon and the
delays, and owing to that delay a perishable cargo carrying of the cargo to Manila; so that if the
suffers damage, the shipowner will be liable for that undamaged cargo was worth less in Manila Bay
damage; he cannot escape that obligation by than in the port of Saigon, the loss must be borne by
pleading the absence of definite instructions from the cargo owner. As we have already indicated,
the owners of cargo or their underwriters, since he the measures of the damages for which the
has control of the cargo and is entitled to elect. shipowner can be held responsible is the amount of
Thus, in Hansen vs. Dunn ([1906] 11 Com. Ca., 100; the deterioration of the cargo in Manila Bay, he
22 T. L. R., 458) the shipowner was held liable for being held responsible therefor, because of the
damage suffered by a cargo of maize, which he master's failure to take prompt measures looking to
had kept in the ship's hold during an unreasonable the sale of this perishable cargo; and because of
delay in electing what course he should adopt. 'If his wholly unjustifiable refusal to turn it over to its
instead of promptly transshipping, he preferred to owners, on demand, after the voyage
negotiate for that to which he was not entitled, a contemplated in the charter party had been
pro rata freight on discharge of the maize at Cape abandoned.
Town, he had no right in order to obtain that Since we must reverse so much of the judgment
advantage to keep the goods meanwhile where entered in the court below as allows damages in
he knew that they were daily suffering damage the sum of P57,823.35 for the alleged breach of the
and might thereby become unmerchantable. If he contract to transport the cargo from Saigon to
wished, for his own advantage, to delay action, it Dunkirk or Hamburg, and are unable from the
could only be done, in common fairness, by his agreed statement of facts to fix the amount of the
incurring the expense involved in his doing his best damages which should be allowed because of the
for the goods by discharging them out of The failure of the master, after arriving in Manila Bay, to
Closeburn's hold.' (Kennedy, J., 11 Com. Ca., at p. turn over the cargo to its owners and "to take such
105.)" measures in the interests of the shipper as might
It is impossible, however, in the condition of the reasonably be required of a prudent man under
record brought here on appeal, to determine the the existing conditions," we are of opinion that a
amount of the deterioration and consequent loss in new trial should be allowed on this branch of the
value of the cargo which should be attributed to its case.
detention on board the Esslingen in Manila Bay. The Since we would not hesitate, upon the record now
value of the cargo in Saigon was admittedly before us, to fix the amount of the damages
307,214.44 francs or P145,600.91, and its "true and suffered by the shipper as a result of the
fair value" in the condition in which it was found at deterioration of the cargo in Manila Bay at the
the time when it was sold in Manila was expressly difference between the proceeds of the sale of the
agreed to be the net proceeds of the sale, that is to damaged cargo and the amount which could
say, P57,823.35; but how much of this heavy loss in have been gotten for such a cargo of rice-meal in
value was due to the deterioration in the quality of an undamaged condition in Manila Bay at the time
the cargo while it lay in the hold of the vessel in when the damaged cargo was sold, if this latter
Manila Bay, we are unable to determine from the amount could be determined from the record, it will
agreed statement of facts upon which the case make for the convenience of the parties and an
was submitted. There is no stipulation as to what this early termination of this litigation, to limit the scope
cargo of rice-meal would have brought had it been of the inquiry on the new trial to the determination
thrown on the market in Manila in the condition in of this latter amount, judgment to be entered,
which it was when it was brought into Manila Bay, thereafter, in conformity with the doctrine of liability
and before it began to deteriorate as a result of its herein announced.
detention on board the vessel, nor is there a
13 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
We conclude that so much of the judgment off any discussion into the factual issue raised
entered in the court below as provides for the before the Court of Appeals. In effect, Filinvest has
delivery to the plaintiff of the sum of P57,823.35, the yielded to the decision of the Court of Appeals,
net proceeds of the sale of the cargo of the affirming that of the trial court, in deferring to the
Esslingen now on deposit subject to the order of the factual findings of the commissioner assigned to the
court below, less commissions of the clerk of that parties' case. Besides, as a general rule, factual
court, but free and clear of all liens, claims or matters cannot be raised in a petition for review on
charges asserted by the defendant in this cause certiorari. This Court at this stage is limited to
should be affirmed; but that so much thereof as reviewing errors of law that may have been
provides for the recovery of P68,376.04, with committed by the lower courts. We do not perceive
interest, as and for actual damages suffered by the here any of the exceptions to this rule; hence, we
plaintiff by the defendant's breach of the charter are restrained from conducting further scrutiny of
party, should be reversed; and that so much the findings of fact made by the trial court which
thereof as provides for the recovery of the legal have been affirmed by the Court of Appeals. Verily,
interest upon the amount of the proceeds of the factual findings of the trial court, especially when
sale of the cargo should be modified by substituting affirmed by the Court of Appeals, are binding and
therefor a provision for the recovery of any interest conclusive on the Supreme Court.
allowances which may have accumulated in any
bank or other institution wherein the said net 2.CIVIL LAW; OBLIGATIONS AND CONTRACTS;
proceeds of the sale of the cargo may have been OBLIGATIONS WITH A PENAL CLAUSE; PENAL
deposited subject to the order of the court, and CLAUSE; FUNCTIONS. A penal clause is an
thus modified should be affirmed; and that the accessory undertaking to assume greater liability in
record should be returned to the court wherein it case of breach. It is attached to an obligation in
originated with instructions to grant a new trial, order to insure performance and has a double
wherein the inquiry will be limited to the function: (1) to provide for liquidated damages,
determination of the amount which could have and (2) to strengthen the coercive force of the
been gotten for the cargo taken on board in obligation by the threat of greater responsibility in
Saigon, if such cargo had been offered for sale in the event of breach. Article 1226 of the Civil Code
an undamaged condition in Manila Bay at the time states: "Art. 1226. In obligations with a penal clause,
when the damaged cargo was sold, judgment to the penalty shall substitute the indemnity for
be entered, thereafter, in conformity with the damages and the payment of interests in case of
doctrine of liability hereinbefore announced, noncompliance, if there is no stipulation to the
without costs in both instances. So ordered. contrary. Nevertheless, damages shall be paid if the
obligor refuses to pay the penalty or is guilty of
Torres, Trent and Araullo, JJ., concur. fraud in the fulfillment of the obligation. The penalty
may be enforced only when it is demandable in
(Filinvest Land Inc. v. Court of Appeals, G.R. No. accordance with the provisions of this Code."
138980, September 20, 2005)
3.ID.; ID.; ID.; PENALTY, WHEN MAY BE EQUITABLY
SECOND DIVISION REDUCED BY COURTS. As a general rule, courts
are not at liberty to ignore the freedom of the
[G.R. No. 138980. September 20, 2005.] parties to agree on such terms and conditions as
they see fit as long as they are not contrary to law,
FILINVEST LAND, INC., petitioner, vs. HON. COURT OF morals, good customs, public order or public policy.
APPEALS, PHILIPPINE AMERICAN GENERAL Nevertheless, courts may equitably reduce a
INSURANCE COMPANY, and PACIFIC EQUIPMENT stipulated penalty in the contract in two instances:
CORPORATION, respondents. (1) if the principal obligation has been partly or
irregularly complied; and (2) even if there has been
Buag Kapunan Migallos & Perez for petitioner. no compliance if the penalty is iniquitous or
unconscionable in accordance with Article 1229 of
Arturo D. Vallar and Antonio C. Pesigan for Pacific the Civil Code which provides: "Art. 1229. The judge
Equipment Corp. shall equitably reduce the penalty when the
principal obligation has been partly or irregularly
Reloj Law Office for Phil. American Gen. Ins. Co. complied with by the debtor. Even if there has
been no performance, the penalty may also be
SYLLABUS reduced by the courts if it is iniquitous or
unconscionable."
1.REMEDIAL LAW; CIVIL PROCEDURE; APPEALS;
PETITION FOR REVIEW ON CERTIORARI UNDER RULE 4.ID.; ID.; ID.; A DISTINCTION BETWEEN A PENALTY
45 OF THE RULES OF COURT; LIMITED TO REVIEW OF CLAUSE IMPOSED AS PENALTY IN CASE OF BREACH
QUESTIONS OF LAW; CASE AT BAR. Section 1, Rule AND A PENALTY CLAUSES IMPOSED AS INDEMNITY
45 of the 1997 Rules of Court states in no uncertain FOR DAMAGES SHOULD BE MADE IN CASES WHERE
terms that this Court's jurisdiction in petitions for THERE HAVE BEEN NEITHER PARTIAL NOR IRREGULAR
review on certiorari is limited to "questions of law COMPLIANCE WITH THE TERMS OF THE CONTRACT.
which must be distinctly set forth." By assigning only The Supreme Court in Laureano instructed that a
one legal issue, Filinvest has effectively cordoned distinction between a penalty clause imposed
14 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
essentially as penalty in case of breach and a finish the contracted works. (Annexes G, I and K,
penalty clause imposed as indemnity for damages Complaint). On 16 October 1979, plaintiff wrote
should be made in cases where there has been defendant Pacific advising the latter of its intention
neither partial nor irregular compliance with the to takeover the project and to hold said defendant
terms of the contract. In cases where there has liable for all damages which it had incurred and will
been partial or irregular compliance, as in this case, incur to finish the project. (Annex "L", Complaint).
there will be no substantial difference between a
penalty and liquidated damages insofar as legal On 26 October 1979, plaintiff submitted its claim
results are concerned. . . . Thus, we lamented in one against defendant Philamgen under its
case that "(t)here is no justification for the Civil performance and guarantee bond (Annex M,
Code to make an apparent distinction between a Complaint) but Philamgen refused to acknowledge
penalty and liquidated damages because the its liability for the simple reason that its principal,
settled rule is that there is no difference between defendant Pacific, refused to acknowledge liability
penalty and liquidated damages insofar as legal therefore. Hence, this action.
results are concerned and that either may be
recovered without the necessity of proving actual In defense, defendant Pacific claims that its failure
damages and both may be reduced when proper." to finish the contracted work was due to inclement
weather and the fact that several items of finished
5.ID.; ID.; ID.; FACTORS IN DETERMINING WHETHER A work and change order which plaintiff refused to
PENALTY IS REASONABLE OR INIQUITOUS. In accept and pay for caused the disruption of work.
Ligutan v. Court of Appeals, we pointed out that Since the contractual relation between plaintiff and
the question of whether a penalty is reasonable or defendant Pacific created a reciprocal obligation,
iniquitous can be partly subjective and partly the failure of the plaintiff to pay its progressing bills
objective as its "resolution would depend on such estops it from demanding fulfillment of what is
factors as, but not necessarily confined to, the type, incumbent upon defendant Pacific. The
extent and purpose of the penalty, the nature of acquiescence by plaintiff in granting three
the obligation, the mode of breach and its extensions to defendant Pacific is likewise a waiver
consequences, the supervening realities, the of the former's right to claim any damages for the
standing and relationship of the parties, and the delay. Further, the unilateral and voluntary action of
like, the application of which, by and large, is plaintiff in preventing defendant Pacific from
addressed to the sound discretion of the court." completing the work has relieved the latter from the
obligation of completing the same.
DECISION
On the other hand, Philamgen contends that the
CHICO-NAZARIO, J p: various amendments made on the principal
contract and the deviations in the implementation
This is a petition for review on certiorari of the thereof which were resorted to by plaintiff and co-
Decision 1 of the Court of Appeals dated 27 May defendant Pacific without its (defendant
1999 affirming the dismissal by the Regional Trial Philamgen's) written consent thereto, have
Court of Makati, Branch 65, 2 of the complaint for automatically released the latter from any or all
damages filed by Filinvest Land, Inc. (Filinvest) liability within the purview and contemplation of the
against herein private respondents Pacific coverage of the surety bonds it has issued. Upon
Equipment Corporation (Pecorp) and Philippine agreement of the parties to appoint a
American General Insurance Company. commissioner to assist the court in resolving the
issues confronting the parties, on 7 July 1981, an
The essential facts of the case, as recounted by the order was issued by then Presiding Judge Segundo
trial court, are as follows: M. Zosa naming Architect Antonio Dimalanta as
Court Commissioner from among the nominees
On 26 April 1978, Filinvest Land, Inc. ("FILINVEST", for submitted by the parties to conduct an ocular
brevity), a corporation engaged in the inspection and to determine the amount of work
development and sale of residential subdivisions, accomplished by the defendant Pacific and the
awarded to defendant Pacific Equipment amount of work done by plaintiff to complete the
Corporation ("PACIFIC", for brevity) the project.
development of its residential subdivisions consisting
of two (2) parcels of land located at Payatas, On 28 November 1984, the Court received the
Quezon City, the terms and conditions of which are findings made by the Court Commissioner. In
contained in an "Agreement". (Annex A, arriving at his findings, the Commissioner used the
Complaint). To guarantee its faithful compliance construction documents pertaining to the project
and pursuant to the agreement, defendant Pacific as basis. According to him, no better basis in the
posted two (2) Surety Bonds in favor of plaintiff work done or undone could be made other than
which were issued by defendant Philippine the contract billings and payments made by both
American General Insurance ("PHILAMGEN", for parties as there was no proper procedure followed
brevity). (Annexes B and C, Complaint). TADIHE in terminating the contract, lack of inventory of
work accomplished, absence of appropriate
Notwithstanding three extensions granted by record of work progress (logbook) and inadequate
plaintiff to defendant Pacific, the latter failed to
15 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
documentation and system of construction therefore agrees with the commissioner's findings
management. with respect to

Based on the billings of defendant Pacific and the 1.Cost to repair deficiency or defect P532,324.02
payments made by plaintiff, the work
accomplished by the former amounted to 2.Unpaid balance of work done by defendant
P11,788,282.40 with the exception of the last billing P1,939,191.67
(which was not acted upon or processed by
plaintiff) in the amount of P844,396.42. The total 3.Additional work/change order (due to
amount of work left to be accomplished by plaintiff defendant) P475,000.00
was based on the original contract amount less
value of work accomplished by defendant Pacific The unpaid balance due defendant therefore is
in the amount of P681,717.58 (12,470,000- P1,939,191.67. To this amount should be added
11,788,282.42). additional work performed by defendant at
plaintiff's instance in the sum of P475,000.00. And
As regards the alleged repairs made by plaintiff on from this total of P2,414,191.67 should be deducted
the construction deficiencies, the Court the sum of P532,324.01 which is the cost to repair
Commissioner found no sufficient basis to justify the the deficiency or defect in the work done by
same. On the other hand, he found the additional defendant. The commissioner arrived at the figure
work done by defendant Pacific in the amount of of P532,324.01 by getting the average between
P477,000.00 to be in order. plaintiff's claim of P758,080.37 and defendant's
allegation of P306,567.67. The amount due to
On 01 April 1985, plaintiff filed its objections to the defendant per the commissioner's report is
Commissioner's Resolution on the following grounds: therefore P1,881,867.66.

a)Failure of the commissioner to conduct a joint Although the said amount of P1,881,867.66 would
survey which according to the latter is be owing to defendant Pacific, the fact remains
indispensable to arrive at an equitable and fair that said defendant was in delay since April 25,
resolution of the issues between the parties; 1979. The third extension agreement of September
15, 1979 is very clear in this regard. The pertinent
b)The cost estimates of the commissioner were paragraphs read:
based on pure conjectures and contrary to the
evidence; and, a)You will complete all the unfinished works not
later than Oct. 15, 1979. It is agreed and
c)The commissioner made conclusions of law which understood that this date shall DEFINITELY be the
were beyond his assignment or capabilities. LAST and FINAL extension & there will be no further
extension for any cause whatsoever.
In its comment, defendant Pacific alleged that the
failure to conduct joint survey was due to plaintiff's b)We are willing to waive all penalties for delay
refusal to cooperate. In fact, it was defendant which have accrued since April 25, 1979 provided
Pacific who initiated the idea of conducting a joint that you are able to finish all the items of the
survey and inventory dating back 27 November contracted works as per revised CPM; otherwise
1983. And even assuming that a joint survey were you shall continue to be liable to pay the penalty
conducted, it would have been an exercise in up to the time that all the contracted works shall
futility because all physical traces of the actual have been actually finished, in addition to other
conditions then obtaining at the time relevant to damages which we may suffer by reason of the
the case had already been obliterated by plaintiff. delays incurred.

On 15 August 1990, a Motion for Judgment Based Defendant Pacific therefore became liable for
on the Commissioner's Resolution was filed by delay when it did not finish the project on the date
defendant Pacific. agreed on October 15, 1979. The court however,
finds the claim of P3,990,000.00 in the form of
On 11 October 1990, plaintiff filed its opposition penalty by reason of delay (P15,000.00/day from
thereto which was but a rehash of objections to the April 25, 1979 to Jan. 15, 1980) to be excessive. A
commissioner's report earlier filed by said plaintiff. 3 forfeiture of the amount due defendant from
plaintiff appears to be a reasonable penalty for the
On the basis of the commissioner's report, the trial delay in finishing the project considering the
court dismissed Filinvest's complaint as well as amount of work already performed and the fact
Pecorp's counterclaim. It held: that plaintiff consented to three prior extensions.

In resolving this case, the court observes that the The foregoing considered, this case is dismissed. The
appointment of a Commissioner was a joint counterclaim is likewise dismissed.
undertaking among the parties. The findings of facts
of the Commissioner should therefore not only be No Costs. 4
conclusive but final among the parties. The court

16 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
The Court of Appeals, finding no reversible error in Coming now to the main matter, Filinvest argues
the appealed decision, affirmed the same. that the penalty in its entirety should be respected
as it was a product of mutual agreement and it
Hence, the instant petition grounded solely on the represents only 32% of the P12,470,000.00 contract
issue of whether or not the liquidated damages price, thus, not shocking and unconscionable
agreed upon by the parties should be reduced under the circumstances. Moreover, the penalty
considering that: (a) time is of the essence of the was fixed to provide for actual or anticipated
contract; (b) the liquidated damages was fixed by liquidated damages and not simply to ensure
the parties to serve not only as penalty in case compliance with the terms of the contract; hence,
Pecorp fails to fulfill its obligation on time, but also pursuant to Laureano v. Kilayco, 9 courts should be
as indemnity for actual and anticipated damages slow in exercising the authority conferred by Art.
which Filinvest may suffer by reason of such failure; 1229 of the Civil Code.
and (c) the total liquidated damages sought is only
32% of the total contract price, and the same was We are not swayed.
freely and voluntarily agreed upon by the parties.
There is no question that the penalty of P15,000.00
At the outset, it should be stressed that as only the per day of delay was mutually agreed upon by the
issue of liquidated damages has been elevated to parties and that the same is sanctioned by law. A
this Court, petitioner Filinvest is deemed to have penal clause is an accessory undertaking to
acquiesced to the other matters taken up by the assume greater liability in case of breach. 10 It is
courts below. Section 1, Rule 45 of the 1997 Rules of attached to an obligation in order to insure
Court states in no uncertain terms that this Court's performance 11 and has a double function: (1) to
jurisdiction in petitions for review on certiorari is provide for liquidated damages, and (2) to
limited to "questions of law which must be distinctly strengthen the coercive force of the obligation by
set forth." 5 By assigning only one legal issue, the threat of greater responsibility in the event of
Filinvest has effectively cordoned off any discussion breach. 12 Article 1226 of the Civil Code states:
into the factual issue raised before the Court of
Appeals. 6 In effect, Filinvest has yielded to the Art. 1226.In obligations with a penal clause, the
decision of the Court of Appeals, affirming that of penalty shall substitute the indemnity for damages
the trial court, in deferring to the factual findings of and the payment of interests in case of
the commissioner assigned to the parties' case. noncompliance, if there is no stipulation to the
Besides, as a general rule, factual matters cannot contrary. Nevertheless, damages shall be paid if the
be raised in a petition for review on certiorari. This obligor refuses to pay the penalty or is guilty of
Court at this stage is limited to reviewing errors of fraud in the fulfillment of the obligation.
law that may have been committed by the lower
courts. 7 We do not perceive here any of the The penalty may be enforced only when it is
exceptions to this rule; hence, we are restrained demandable in accordance with the provisions of
from conducting further scrutiny of the findings of this Code.
fact made by the trial court which have been
affirmed by the Court of Appeals. Verily, factual As a general rule, courts are not at liberty to ignore
findings of the trial court, especially when affirmed the freedom of the parties to agree on such terms
by the Court of Appeals, are binding and and conditions as they see fit as long as they are
conclusive on the Supreme Court. 8 Thus, it is settled not contrary to law, morals, good customs, public
that: order or public policy. 13 Nevertheless, courts may
equitably reduce a stipulated penalty in the
contract in two instances: (1) if the principal
obligation has been partly or irregularly complied;
(a)Based on Pecorp's billings and the payments and (2) even if there has been no compliance if the
made by Filinvest, the balance of work to be penalty is iniquitous or unconscionable in
accomplished by Pecorp amounts to P681,717.58 accordance with Article 1229 of the Civil Code
representing 5.47% of the contract work. This means which provides:
to say that Pecorp, at the time of the termination of
its contract, accomplished 94.53% of the contract Art. 1229.The judge shall equitably reduce the
work; penalty when the principal obligation has been
partly or irregularly complied with by the debtor.
(b)The unpaid balance of work done by Pecorp Even if there has been no performance, the penalty
amounts to P1,939,191.67; may also be reduced by the courts if it is iniquitous
or unconscionable.
(c)The additional work/change order due Pecorp
amounts to P475,000.00; In herein case, the trial court ruled that the penalty
charge for delay pegged at P15,000.00 per day
(d)The cost to repair deficiency or defect, which is of delay in the aggregate amount of P3,990,000.00
for the account of Pecorp, is P532,324.02; and was excessive and accordingly reduced it to
P1,881,867.66 "considering the amount of work
(e)The total amount due Pecorp is P1,881,867.66. already performed and the fact that [Filinvest]
consented to three (3) prior extensions." The Court
17 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
of Appeals affirmed the ruling but added as well failure to comply with its terms, courts will rigidly
that the penalty was unconscionable "as the apply the doctrine of strict construction against the
construction was already not far from completion." enforcement in its entirety of the indemnification,
Said the Court of Appeals: where it is clear from the terms of the contract that
the amount or character of the indemnity is fixed
Turning now to plaintiff's appeal, We likewise agree without regard to the probable damages which
with the trial court that a penalty interest of might be anticipated as a result of a breach of the
P15,000.00 per day of delay as liquidated damages terms of the contract; or, in other words, where the
or P3,990,000.00 (representing 32% penalty of the indemnity provided for is essentially a mere penalty
P12,470,000.00 contract price) is unconscionable having for its principal object the enforcement of
considering that the construction was already not compliance with the contract. But the courts will be
far from completion. Penalty interests are in the slow in exercising the jurisdiction conferred upon
nature of liquidated damages and may be them in article 1154 17 so as to modify the terms of
equitably reduced by the courts if they are an agreed upon indemnification where it appears
iniquitous or unconscionable (Garcia v. Court of that in fixing such indemnification the parties had in
Appeals, 167 SCRA 815, Lambert v. Fox, 26 Phil. 588). mind a fair and reasonable compensation for
The judge shall equitably reduce the penalty when actual damages anticipated as a result of a
the principal obligation has been partly or breach of the contract, or, in other words, where
irregularly complied with by the debtor. Even if the principal purpose of the indemnification agreed
there has been no performance, the penalty may upon appears to have been to provide for the
also be reduced by the courts if it is iniquitous or payment of actual anticipated and liquidated
unconscionable (Art. 1229, New Civil Code). damages rather than the penalization of a breach
Moreover, plaintiff's right to indemnity due to of the contract. (Emphases supplied)
defendant's delay has been cancelled by its
obligations to the latter consisting of unpaid works. Filinvest contends that the subject penalty clause
falls under the second type, i.e., the principal
This Court finds no fault in the cost estimates of the purpose for its inclusion was to provide for payment
court-appointed commissioner as to the cost to of actual anticipated and liquidated damages
repair deficiency or defect in the works which was rather than the penalization of a breach of the
based on the average between plaintiff's claim of contract. Thus, Filinvest argues that had Pecorp
P758,080.37 and defendant's P306,567.67 completed the project on time, it (Filinvest) could
considering the following factors: that "plaintiff did have sold the lots sooner and earned its projected
not follow the standard practice of joint survey income that would have been used for its other
upon take over to establish work already projects.
accomplished, balance of work per contract still to
be done, and estimate and inventory of repair" Unfortunately for Filinvest, the above-quoted
(Exhibit "H"). As for the cost to finish the remaining doctrine is inapplicable to herein case. The
works, plaintiff's estimates were brushed aside by Supreme Court in Laureano instructed that a
the commissioner on the reasoned observation that distinction between a penalty clause imposed
"plaintiff's cost estimate for work (to be) done by the essentially as penalty in case of breach and a
plaintiff to complete the project is based on a penalty clause imposed as indemnity for damages
contract awarded to another contractor (JPT), the should be made in cases where there has been
nature and magnitude of which appears to be neither partial nor irregular compliance with the
inconsistent with the basic contract between terms of the contract. In cases where there has
defendant PECORP and plaintiff FILINVEST." 14 been partial or irregular compliance, as in this case,
there will be no substantial difference between a
We are hamstrung to reverse the Court of Appeals penalty and liquidated damages insofar as legal
as it is rudimentary that the application of Article results are concerned. 18 The distinction is thus more
1229 is essentially addressed to the sound discretion apparent than real especially in the light of certain
of the court. 15 As it is settled that the project was provisions of the Civil Code of the Philippines which
already 94.53% complete and that Filinvest did provides in Articles 2226 and Article 2227 thereof:
agree to extend the period for completion of the
project, which extensions Filinvest included in Art. 2226.Liquidated damages are those agreed
computing the amount of the penalty, the upon by the parties to a contract to be paid in
reduction thereof is clearly warranted. cCHETI case of breach thereof.

Filinvest, however, hammers on the case of Art. 2227.Liquidated damages, whether intended as
Laureano v. Kilayco, 16 decided in 1915, which an indemnity or a penalty, shall be equitably
cautions courts to distinguish between two kinds of reduced if they are iniquitous or unconscionable.
penalty clauses in order to better apply their ISHCcT
authority in reducing the amount recoverable. We
held therein that: Thus, we lamented in one case that "(t)here is no
justification for the Civil Code to make an apparent
. . . [I]n any case wherein there has been a partial distinction between a penalty and liquidated
or irregular compliance with the provisions in a damages because the settled rule is that there is no
contract for special indemnification in the event of difference between penalty and liquidated
18 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
damages insofar as legal results are concerned amount of P1,881,867.66. Thus, all things considered,
and that either may be recovered without the we find no reversible error in the Court of Appeals'
necessity of proving actual damages and both exercise of discretion in the instant case.
may be reduced when proper." 19
Before we write finis to this legal contest that had
Finally, Filinvest advances the argument that while it spanned across two and a half decades, we take
may be true that courts may mitigate the amount note of Pecorp's own grievance. From its Comment
of liquidated damages agreed upon by the parties and Memorandum, Pecorp, likewise, seeks
on the basis of the extent of the work done, this affirmative relief from this Court by praying that not
contemplates a situation where the full amount of only should the instant case be dismissed for lack of
damages is payable in case of total breach of merit, but that Filinvest should likewise be made to
contract. In the instant case, as the penalty clause pay "what the Court Commissioner found was due
was agreed upon to answer for delay in the defendant" in the "total amount of P2,976,663.65
completion of the project considering that time is of plus 12% interest from 1979 until full payment thereof
the essence, "the parties thus clearly contemplated plus attorneys fees." 24 Pecorp, however, cannot
the payment of accumulated liquidated damages recover that which it seeks as we had already
despite, and precisely because of, partial denied, in a Resolution dated 21 June 2000, its own
performance." 20 In effect, it is Filinvest's position petition for review of the 27 May 1999 decision of
that the first part of Article 1229 on partial the Court of Appeals. Thus, as far as Pecorp is
performance should not apply precisely because, concerned, the ruling of the Court of Appeals has
in all likelihood, the penalty clause would kick in already attained finality and can no longer be
situations where Pecorp had already begun work disturbed.
but could not finish it on time, thus, it is being
penalized for delay in its completion. WHEREFORE, premises considered, the Decision of
the Court of Appeals dated 27 May 1999 is
AFFIRMED. No pronouncement as to costs.

The above argument, albeit sound, 21 is insufficient SO ORDERED.


to reverse the ruling of the Court of Appeals. It must
be remembered that the Court of Appeals not only Puno, Austria-Martinez, Callejo, Sr. and Tinga, JJ.,
held that the penalty should be reduced because concur.
there was partial compliance but categorically
stated as well that the penalty was (Laureano v. Kilayco, G.R. No. 10419, November 10,
unconscionable. Otherwise stated, the Court of 1915)
Appeals affirmed the reduction of the penalty not
simply because there was partial compliance per EN BANC
se on the part of Pecorp with what was incumbent
upon it but, more fundamentally, because it [G.R. No. 10419. November 10, 1915.]
deemed the penalty unconscionable in the light of
Pecorp's 94.53% completion rate. TaCDcE FELIX LAUREANO, plaintiff-appellant, vs. EUGENIO
KILAYCO and CELSA LIZARES DE KILAYCO,
In Ligutan v. Court of Appeals, 22 we pointed out defendants-appellees.
that the question of whether a penalty is
reasonable or iniquitous can be partly subjective Laguda, Ledesma, Jalbuena & Villalobos for
and partly objective as its "resolution would depend appellant.
on such factors as, but not necessarily confined to,
the type, extent and purpose of the penalty, the Lawrence, Ross & Block for appellees.
nature of the obligation, the mode of breach and
its consequences, the supervening realities, the SYLLABUS
standing and relationship of the parties, and the
like, the application of which, by and large, is 1. CHATTEL MORTGAGES; RECOVERY OF
addressed to the sound discretion of the court." 23 PENALTIES UNDER CHATTEL MORTGAGE LAW. The
penalties prescribed in section 12 of the Chattel
In herein case, there has been substantial Mortgage Law (Act No. 1508) cannot be imposed
compliance in good faith on the part of Pecorp in a civil action; and the recovery by a party,
which renders unconscionable the application of injured by a violation of sections 9, 10 and 11 of the
the full force of the penalty especially if we Act, of one-half the fine which may be imposed for
consider that in 1979 the amount of P15,000.00 as such violation can be had only in the course of the
penalty for delay per day was quite steep indeed. criminal action contemplated in that section.
Nothing in the records suggests that Pecorp's delay 2. CONTRACT; INCREASED RATE OF INTEREST
in the performance of 5.47% of the contract was AND INDEMNITY FOR BREACH. Defendants
due to it having acted negligently or in bad faith. obligated themselves to pay the sum of P10,200 in
Finally, we factor in the fact that Filinvest is not free monthly installments of P500, and obligated
of blame either as it likewise failed to do that which themselves, in the event of failure to pay any of the
was incumbent upon it, i.e., it failed to pay Pecorp installments on the date on which such installments
for work actually performed by the latter in the total fell due, to pay interest at the rate of 15 per cent on
19 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
all such overdue and unpaid installments until the 8. ID.; ACTION FOR BREACH; EFFECT OF
date of payment; and, further, in the event that the TENDER. While a tender of payment, made after
plaintiff should be compelled to have recourse to action has been instituted, does not necessarily
the courts for the recovery of the money lent, to relieve the defendant, in an action for a sum of
pay to the plaintiff, by way of indemnification, the money, from the costs incurred prior to the date of
sum of P2,000. Held: That the provisions of the the tender, it may and generally should relieve him
contract for the payment of interest at an from all costs accruing thereafter in the event that
increased rate and for the payment of an idemnity plaintiff declines to accept payment as tendered,
of P2,000 were penal clauses, as defined by the and if it appears that the tender actually made was
terms of articles 1152, 1153 and 1154 of the Civil for the full amount then due. In such cases it rests in
Code. the sound discretion of the court whether the costs
3. ID.; ID.; LIMITATION OF RIGHT TO RECOVER. will be divided or adjudged against one or other of
Held: That, under the circumstances of this case the parties.
as set out in the opinion, the trial judge properly DECISION
limited plaintiff's right to recover under these penal
clauses to the amount of the stipulated interest at CARSON, J p
an increased rate upon the installments unpaid at
the time when they fell due. On the 20th day of February, 1913, the defendants
4. ID., RULES GOVERNING PENAL PROVISIONS. in this action executed a written agreement
"The rules and prescriptions governing penal wherein, for and in consideration of certain money
matters are fundamentally applicable to the penal lent to them by the plaintiff, they obligated
sanctions of civil character" which are referred to in themselves to pay the sum of P10,200 in monthly
book 4, title 1, chapter 3, section 6 of the Civil installments of P500, payable on the 15th day of
Code. (Decision of the supreme court of Spain, each month, the first installment to be paid on the
June 13, 1906.) 15th day of April, 1913. By way of security for the
5. ID.; PARTIAL PERFORMANCE; RULES OF loan they executed a chattel mortgage upon
CONSTRUCTION IN RECOVERY OF INDEMNITY. It certain property, including the fittings and stock of
follows that, in any case wherein there has been a a certain drug store. They obligated themselves,
partial or irregular compliance with the provisions in also, in the event of failure to pay any of the
a contract for a special indemnification in the installments on the date upon which such
event of failure to comply with its terms, courts will installments fell due, to pay interest at the rate of 15
rigidly apply the doctrine of strict construction per cent on all such overdue and unpaid
against the enforcement in its entirety of the installments until the date of payment; and, further,
indemnification, where it is clear from the terms of in the event that the plaintiff should be compelled
the contract that the amount and character of the to have recourse to the courts for the recovery of
indemnity is fixed without regard to the probable the money lent, to pay to plaintiff, by way of
damages which might be anticipated as a result of indemnification, the sum of P2,000. At the time of
a breach of the terms of the contract; or, in other the trial, which took place in the month of October,
words, where the indemnity provided for is 1914, it appeared that there was still due and
essentially a mere penalty having for its principal unpaid under the contract the sum of P3,433.75,
object the enforcement of compliance with the including in that amount the last installment due on
contract. the 15th day of November, 1914, and interest at the
6. ID.; ID.; ID. But courts will be slow in rate of 15 per cent upon the installments due and
exercising the jurisdiction conferred upon them by unpaid prior to the date of the trial. The defendants
article 1154 of the Civil Code so as to modify the there and then offered to pay the total amount of
terms of an agreed upon indemnification where it P3,433.75 which appeared to be due on account
appears that in fixing the indemnification the of unpaid installments under the contract, including
parties had in mind a fair and reasonable interest at the rate of 15 per cent from the date
compensation for actual damages anticipated as when such installments fell due; and, their offer
a result of a breach of the contract; or, in other having been declined in open court. deposited
words, where the principal purpose of the that amount with the clerk of the court, for
indemnification agreed upon appears to have payment to the plaintiff in full settlement of their
been to provide for the payment of actual obligation under the contract.
anticipated and liquidated damages rather than Counsel for plaintiff declined to accept the money
the penalization of a breach of the contract. thus tendered and contended that he was entitled
7. ID.; ID.; ID. The application of these to receive not only the amount of the unpaid
principles to the particular facts in any case installments due upon the debt, but also, by way of
wherein there has been a "partial or irregular indemnification, the indemnity of P2,000 which
performance" of the condition of a contract which defendants obligated themselves to pay to plaintiff
provides 3 penalty or liquidated damages for in the event that he should find it necessary to
noncompliance therewith leads to results institute proceedings in court to recover the debt;
substantially identical with those arrived at in like and, alleging that defendants had unlawfully sold,
cases in the United States under the generally without plaintiff's knowledge or consent, the drug
accepted doctrine touching the enforcement of store on which the defendants had executed a
such contracts. chattel mortgage, counsel claimed also the sum of

20 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
P10,000 under the provisions of section 12 of Act No. that plaintiff should find it necessary to institute
1508 (Chattel Mortgage Law). proceedings for the enforcement of the contracts
The trial judge, being of opinion that the deposit by must be construed as penalties in the sense in
the defendants with the clerk of the court of the which that term is used in articles 1152, 1153, 1154
sum of P3,433.75 constituted a settlement in full of and 1155 of the Civil Code.
their indebtedness under the contract, dismissed
the complaint at the cost of the plaintiff. In its decision dated March 24, 1909, the supreme
From this judgment plaintiff appealed and assigns court of Spain held that "el sealamiento de
as error: crecidos intereses para el caso de satisfacer el
"1. The failure of the trial court to give judgment capital al vencer la obligacion, debe interpretarse
against the defendants for the sum of P2,000, the como clausula penal." (The fixing of an increased
indemnification agreed upon in the event that rate of interest in the event of paying off the
plaintiff should be compelled to institute legal principal when the obligation becomes due should
proceedings to recover the debt. be construed as a penal clause.)
2. The costs of the action. It needs no citation of authority to sustain a holding
"3. The sum of P10,000 to which he claims he is that a stipulation for the payment of P2,000 by way
entitled under the provisions of section 12 of Act No. of indemnification, in the event of the failure to pay
1508, read together with section 10 of the same all or any part of an indebtedness of P10,200 in the
Act." event that the creditor should find it necessary to
We will examine the last assignment of error first. have recourse to the courts in the enforcement of
Sections 10 and 12 of Act No. 1508 are as follows: the debt, is a penalty which, under the provisions of
"SEC. 10. A mortgagor of personal property article 1154 of the code, the courts are authorized
shall not sell or pledge such property, or any part to modify in the sound exercise of their discretion
thereof, mortgaged by him without the consent of when the principal obligation has been complied
the mortgagee in writing on the back of the with by the debtor either in part or irregularly ("en
mortgage and on the margin of the record thereof parte o irregularmente") .
in the office where such mortgage is recorded. In its decision of November 20, 1907, the supreme
"SEC. 12. If a mortgagor violates either of the court of Spain held that "aun estipulado en la
three last preceding sections he shall be fined a escritura que en su caso serian de cuenta y cargo
sum double the value of the property so wrongfully del deudor las costas, daos y perjuicios, la
removed from the province sold, pledged or aplicacion de esta penalidad queda sometida al
mortgaged, one-half to the use of the party injured prudente arbitrio de los Tribunales." (Even when it is
and the other half to the use of the Treasury of the stipulated in the instrument that, in a given case,
Philippine Islands, or he may be imprisoned for a the cost, losses and damages shall be chargeable
period not exceeding six months, or punished by to the debtor and be borne by him, the application
both such fine and imprisonment, in the discretion of this penalty shall rest in the sound discretion of
of the court." the courts.)
Without stopping to consider the legal effect of a Under all the circumstances of this cases wherein
chattel mortgage purporting to subject to the principal indebtedness appears to have been
mortgage the stock of a store, where it manifestly amply secured by a chattel mortgage, and
appears that it is the intent of the parties that the wherein the greater part of the indebtedness had
owner of the store shall continue the business been paid at the time when the action was
without interruption, it is a sufficient answer to the brought, and wherein the debtor tendered
contentions of plaintiff in this regard to direct payment in full pending the proceedings in the
attention to the terms of section 12 of the Act, court below and deposited the amount of the
which clearly contemplate that the fine and indebtedness then unpaid, together with 15 per
imprisonment which may be imposed thereunder cent interest, in the hands of the clerk of the court
are to be imposed in the course of a criminal for the benefit of the creditor, and wherein
action, wherein the accused is entitled to the substantial payments upon the principal obligation,
benefit of the safeguards which the law of criminal amounting to some P2,000, had been made by the
procedure throws about the accused in every case debtor and accepted by the creditor not long prior
in which he is charged with the commission of an to the institution of the action, we are of opinion
offense defined and penalized by law. It follows, of that the trial judge properly exercised the discretion
course, that plaintiff's claim of one-half of the fine conferred upon him under article 1164 of the Civil
which he alleges should be imposed upon the Code by modifying the penalties prescribed under
defendants because of the alleged sale of the the contract so as to limit the right of the plaintiff
mortgaged property cannot be enforced in this thereunder to interest at the rate of 15 per cent
action. upon the last installments which had become
Plaintiff's claim to the agreed upon indemnity of overdue under the terms of the contract.
P2,00 raises a question of greater difficulty. It is true that it was said in a former decision
We are of opinion, however, that the clauses of the (Lambert vs. Fox, 26 Phil. Rep., 588) that in this
contract providing for the payment of interest at an jurisdiction there is no substantial difference
increased rate in the event of failure to pay any of between a penalty and liquidated damages so far
the installments at the date upon which they fell as legal results are concerned; but this statement is
due and providing further for the payment, by way to be construed in connection with the case with
of indemnification, of the sum of P2,000 in the event reference to which it was made and, on
21 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
examination, it will be found that it is strictly contended by plaintiff, that a tender of payment
applicable only to cases wherein there has been made after action has been instituted does not
neither a "partial or irregular" compliance with the necessarily relieve a defendant, in an action for a
terms of the contract, so that the courts have no sum of money, from the costs incurred prior to the
authority to proceed under the provisions of article date of the tender, it may and as a general rule
1154 of the Civil Code which is as follows: should relieve him of all costs thereafter in the event
"The judge shall equitably mitigate the penalty if the that plaintiff declines to accept payment as
principal obligation should have been partly or tendered, and if it thereafter appears that the
irregularly fulfilled by the debtor." tender actually made was for the full amount due
As was said by the supreme court of Spain in its at the time when it was made. In the case at bar
sentence dated June 13, 1906, construing the the total amount ultimately found due by the trial
provisions of book 4, title 1, chapter 3, section 6 of court was paid into court during the course of the
the Civil Code: trial, and we are of opinion that under all the
"The rules and prescriptions governing penal circumstances of the case no error was committed
matters are fundamentally applicable to the penal by the trial judge in the exercise of his discretion in
sanctions of civil character." imposing the costs of the trial upon plaintiff, who
It follows that, in any case wherein there has been a declined to accept tender of payment of the full
partial or irregular compliance with the provisions in amount due and thus terminate the proceedings
a contract for special indemnification in the event without further cost or expense to either party.
of failure to comply with its terms, courts will rigidly (Section 487, Code of Civil Procedure.)
apply the doctrine of strict construction against the We conclude that the judgment entered in the
enforcement in its entirety of the indemnification, court below should be affirmed, with the costs of
where it is clear from the terms of the contract that this instance against the appellant. So ordered.
the amount or character of the indemnity is fixed Arellano, C.J., Torres, Trent and Araullo, JJ., concur.
without regard to the probable damages which
might be anticipated as a result of a breach of the (Pamintuan v. Court of Appeals, G.R. No. L-26339,
terms of the contract; or, in other words; where the December 14, 1979)
indemnity provided for is essentially a mere penalty
having for its principal object the enforcement of SECOND DIVISION
compliance with the contract. But the courts will be [G.R. No. L-26339. December 14, 1979.]
slow in exercising the jurisdiction conferred upon MARIANO C. PAMINTUAN, petitioner-appellant, vs.
them in article 1154 so as to modify the terms of an COURT OF APPEALS and YU PING KUN CO., INC.,
agreed upon indemnification where it appears that respondent-appellees.
in fixing such indemnification the parties had in V. E. del Rosario & Associates for appellant.
mind a fair and reasonable compensation for Sangco & Sangalang for private respondent.
actual damages anticipated as a result of a
breach of the contract, or, in other words, where DECISION
the principal purpose of the indemnification agreed AQUINO, J p:
upon appears to have been to provide for the This case is about the recovery of compensatory
payment of actual anticipated and liquidated damages for breach of a contract of sale in
damages rather than the penalization of a breach addition to liquidated damages.
of the contract.
It will readily be seen that the application of these Mariano C. Pamintuan appealed from the
principles to the particular facts in any case in judgment of the Court of Appeals wherein he was
which there has been a "partial or irregular ordered to deliver to Yu Ping Kun Co., Inc. certain
performance" of the condition of a contract which plastic sheetings and, if he could not do so, to pay
provides a penalty or liquidated damages for the latter P100,559.28 as damages with six percent
noncompliance therewith will lead to results interest from the date of the filing of the complaint.
substantially identical with those arrived at in like The facts and the findings of the Court of Appeals
cases in the United States under generally are as follows:
accepted doctrine touching the enforcement of
such contracts. (Cf. Ency. of U. S. Supreme Court In 1960, Pamintuan was the holder of a barter
Reports, vol. 5, p. 176, "Liquidated Damages," and license wherein he was authorized to export to
cases there cited.) Japan one thousand metric tons of white flint corn
The application of these principles to the case at valued at forty-seven thousand United States dollars
bar leaves no doubt in our mind as to the propriety in exchange for a collateral importation of plastic
of the action of the court below in restricting the sheetings of an equivalent value.
right of the plaintiff to recover under the penal
clauses set forth in his contract the interest at the By virtue of that license, he entered into an
rate of 15 per cent agreed upon by the parties in agreement to ship his corn to Tokyo Menka Kaisha,
the event of failure to pay the various installments Ltd. of Osaka, Japan in exchange for plastic
of his indebtedness on the day and date when they sheetings. He contracted to sell the plastic
fell due. sheetings to Yu Ping Kun Co., Inc. for two hundred
As to the third assignment of error, touching the sixty-five thousand five hundred fifty pesos. The
judgment of the court against plaintiff for costs, we company undertook to open an irrevocable
need only indicate that while it is true, as
22 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
domestic letter of credit for that amount in favor of process, Pamintuan requested that he be paid
Pamintuan. immediately.

It was further agreed that Pamintuan would deliver Consequently, Pamintuan and the president of the
the plastic sheetings to the company at its bodegas company, Benito Y.C. Espiritu, agreed to fix the
in Manila or suburbs directly from the piers "within price of the plastic sheetings at P0.782 a yard,
one month upon arrival of" the carrying vessels. Any regardless of the kind, quality or actual invoice
violation of the contract of sale would entitle the value thereof. The parties arrived at that figure by
aggrieved party to collect from the offending party dividing the total price of P265,550 by 339,440 yards,
liquidated damages in the sum of ten thousand the aggregate quantity of the shipments.
pesos (Exh. A).
After Pamintuan had delivered 224,150 yards of
On July 28, 1960, the company received a copy of sheetings of inferior quality valued at P163,047.87,
the letter from the Manila branch of Toyo Menka he refused to deliver the remainder of the
Kaisha, Ltd. confirming the acceptance by shipments with a total value of P102,502.13 which
Japanese suppliers of firm offers for the were covered by (1) Firm Offer No. 330, containing
consignment to Pamintuan of plastic sheetings 26,000 yards valued at P29,380; (2) Firm Offer No.
valued at forty-seven thousand dollars. Acting on 343, containing 18,440 yards valued at P13,023.25;
that information, the company lost no time in (3) Firm Offer No. 217, containing 30,000 yards
securing in favor of Pamintuan an irrevocable letter valued at P30,510 and (4) Firm Offer No. 329
of credit for two hundred sixty-five thousand five containing 40,850 yards valued at P29,588.88 (See
hundred fifty pesos. pp. 243-2, Record on Appeal).

Pamintuan was apprised by the bank on August 1, As justification for his refusal, Pamintuan said that
1960 of that letter of credit which made reference the company failed to comply with the conditions
to the delivery to Yu Ping Kun Co., Inc. on or before of the contract and that it was novated with
October 31, 1960 of 336, 360 yards of plastic respect to the price.
sheetings (p. 21, Record on Appeal).
On December 2, 1960, the company filed its
On September 27 and 30 and October 4, 1960, the amended complaint for damages against
Japanese suppliers shipped to Pamintuan, through Pamintuan. After trial, the lower court rendered the
Toyo Menka Kaisha, Ltd., the plastic sheetings in judgment mentioned above but including moral
four shipments to wit: (1) Form Offer No. 327 for damages.
50,000 yards valued at $9,000; (2) Firm Offer No. 328
for 70,000 yards valued at $8,050; (3) Firm Offers The unrealized profits awarded as damages in the
Nos. 329 and 343 for 175,000 and 18,440 yards trial court's decision were computed as follows (pp.
valued at $22,445 and $2,305, respectively, and (4) 248-9, Record on Appeal):
Firm Offer No. 330 for 26,000 yards valued at $5,200,
or a total of 339,440 yards with an aggregate value (1) 26,000 yards with a contract
of $47,000 (pp. 4-5 and 239-40, Record on Appeal). price of P1.13 per yard and
a selling price at the time of
The plastic sheetings arrived in Manila and were delivery of P1.75 a yard P16,120.00
received by Pamintuan. Out of the shipments, (2) 18,000 yards with a contract
Pamintuan delivered to the company's warehouse price of P0.7062 per yard and
only the following quantities of plastic sheetings: selling price of P1.20 per yard
at the time of delivery 9,105.67
November 11, 1960 140 cases, size 48 inches by (3) 30,000 yards with a contract
50 yards. price of P1.017 per yard and
November 14, 1960 258 cases out of 352 cases. a selling price of P1.70 per yard 20,490.00
November 15, 1960 11 cases out of 352 cases. (4) 40,850 yards with a contract
November 15, 1960 10 cases out of 100 cases. price of P0.7247 per yard and
November 15, 1960 30 cases out of 100 cases. a selling price of P1.25 a yard
Pamintuan withheld delivery of (1) 50 cases of at the time of delivery 21,458.50
plastic sheetings containing 26,000 yards valued at
$5,200; (2) 37 cases containing 18,440 yards valued Total unrealized profits P67,174.17
at $2,305; (3) 60 cases containing 30,000 yards The overpayment of P12,282.26 made to Pamintuan
valued at $5,400 and (4) 83 cases containing 40,850 by Yu Ping Kun Co., Inc. for the 224,150 yards, which
yards valued at $5,236.97. the trial court regarded as an item of damages
suffered by the company, was computed as follows
While the plastic sheetings were arriving in Manila, (p. 71, Record on Appeal):
Pamintuan informed the president of Yu Ping Kun
Co., Inc. that he was in dire need of cash with Liquidation value of 224,150 yards
which to pay his obligations to the Philippine at P0.7822 a yard P175,330.13
National Bank. Inasmuch as the computation of the Actual peso value of 224,150 yards as
prices of each delivery would allegedly be a long per firm offers or as per contract 163,047.87

23 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
Overpayment P12,282.26 aggrieved party to collect from the offending party
To these two items of damages (P67,174.17 as liquidated damages in the sum of P10,000".
unrealized profits and P12,282.26 as overpayment),
the trial court added (a) P10,000 as stipulated Pamintuan relies on the rule that a penalty and
liquidated damages, (b) P10,000 as moral liquidated damages are the same (Lambert vs. Fox,
damages, (c) P1,102.85 as premium paid by the 26 Phil. 588); that "in obligations with a penal clause,
company on the bond of P102,502.13 for the the penalty shall substitute the indemnity for
issuance of the writ of preliminary attachment and damages and the payment of interests in case of
(d) P10,000 as attorney's fees, or total damages of noncompliance, if there is no stipulation to the
P110,559.28) p. 250, Record on Appeal). The Court contrary" (1st sentence of Art. 1226, Civil Code)
of Appeals affirmed that judgment with the and, it is argued, there is no such stipulation to the
modification that the moral damages were contrary in this case and that "liquidated damages
disallowed (Resolution of June 29, 1966). are those agreed upon by the parties to a contract,
to be paid in case of breach thereof" (Art. 2226,
Pamintuan appealed. The Court of Appeals in its Civil Code).
decision of March 18, 1966 found that the contract
of sale between Pamintuan and the company was We hold that appellant's contention cannot be
partly consummated. The company fulfilled its sustained because the second sentence of article
obligation to obtain the Japanese suppliers' 1226 itself provides that "nevertheless, damages
confirmation of their acceptance of firm offers shall be paid if the obligor . . . is guilty of fraud in the
totalling $47,000. Pamintuan reaped certain fulfillment of the obligation". "Responsibility arising
benefits from the contract. Hence, he is estopped from fraud is demandable in all obligations" (Art.
to repudiate it; otherwise, he would unjustly enrich 1171, Civil Code). "In case of fraud, bad faith,
himself at the expense of the company. malice or wanton attitude, the obligor shall be
responsible for all damages which may be
The Court of Appeals found that the writ of reasonably attributed to the nonperformance of
attachment was properly issued. It also found that the obligation" (Ibid, art. 2201).
Pamintuan was guilty of fraud because (1) he was
able to make the company agree to change the
manner of paying the price by falsely alleging that
there was a delay in obtaining confirmation of the The trial court and the Court of Appeals found that
suppliers' acceptance of the offer to buy; (2) he Pamintuan was guilty of fraud because he did not
caused the plastic sheetings to be deposited in the make a complete delivery of the plastic sheetings
bonded warehouse of his brother and then and he overpriced the same. That factual finding is
required his brother to make him (Pamintuan), his conclusive upon this Court. LLphil
attorney-in-fact so that he could control the
disposal of the goods; (3) Pamintuan, as attorney- There is no justification for the Civil Code to make
in-fact of the warehouseman, endorsed to the an apparent distinction between penalty and
customs broker the warehouse receipts covering liquidated damages because the settled rule is that
the plastic sheetings withheld by him and (4) he there is no difference between penalty and
overpriced the plastic sheetings which he delivered liquidated damages insofar as legal results are
to the company. concerned and that either may be recovered
without the necessity of proving actual damages
The Court of Appeals described Pamintuan as a and both may be reduced when proper (Arts. 1229,
man "who, after having succeeded in getting 2216 and 2227, Civil Code. See observations of
another to accommodate him by agreeing to Justice J.B.L. Reyes, cited in 4 Tolentino's Civil Code,
liquidate his deliveries on the basis of P0.7822 per p. 251).
yard, irrespective of invoice value, on the pretense
that he would deliver what in the first place he Castan Tobeas notes that the penal clause in an
ought to deliver anyway, when he knew all the obligation has three functions: "1. Una funcion
while that he had no such intention, and in the coercitiva o de garantia consistente en estimular al
process delivered only the poorer or cheaper kind deudor al complimiento de la obligacion principal,
or those which he had predetermined to deliver ante la amenaza de tener que pagar la pena. 2.
and did not conceal in his brother's name and thus Una funcion liquidadora del dao, o sea la de
deceived the unwary party into overpaying him the evaluar por anticipado los perjuicios que habria de
sum of P12,282.26 for the said deliveries, and would ocasionar al acreedor el incumplimiento o
thereafter refuse to make any further delivery in cumplimiento inadecuado de la obligacion. 3. Una
flagrant violation of his plighted word, would now funcion estrictamente penal, consistente en
ask us to sanction his actuation" (pp. 61-62, Rollo). sancionar o castigar dicho incumplimiento o
cumplimiento inadecuado, atribuyndole
The main contention of appellant Pamintuan is that consecuencias m s onerosas para el deudor que
the buyer, Yu Ping Kun Co., Inc., is entitled to las que normalmente lleva aparejadas la infraccion
recover only liquidated damages. That contention contractual." (3 Derecho Civil Espaol, 9th Ed., p.
is based on the stipulation "that any violation of the 128).
provisions of this contract (of sale) shall entitle the

24 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
The penalty clause is strictly penal or cumulative in SYLLABUS
character and does not partake of the nature of 1. CIVIL LAW; OBLIGATIONS; PENAL DEFINED. A
liquidated damages (pena sustitutiva) when the penal clause has been defined as "an accessory
parties agree "que el acreedor podra pedir, en el obligation which the parties attach to a principal
supuesto incumplimiento o mero retardo de la obligation for the purpose of insuring the
obligacion principal, adem s de la pena, los daos performance thereof by imposing on the debtor a
y perjuicios. Se habla en este caso de pena special presentation (generally consisting in the
cumulativa a differencia de aquellos otros payment of a sum of money) in case the obligation
ordinarios, en que la pena es sustitutiva de la is not fulfilled or is irregularly or inadequately fulfilled"
reparacion ordinaria." (Ibid, Castan Tobeas, p. (3 Castan 8th Ed. p. 118).
130).
2. ID.; ID.; ACCESSORY OBLIGATION, DEFINED. An
After a conscientious consideration of the facts of accessory obligation has been defined as that
the case, as found by Court of Appeals and the trial attached to a principal obligation in order to
court, and after reflecting on the tenor of the complete the same or take its place in the case of
stipulation for liquidated damages herein, the true breach (4 Puig Pea Part 1 p. 76). Note therefore
nature of which is not easy to categorize, we further that an accessory obligation is dependent for its
hold that justice would be adequately done in this existence on the existence of a principal obligation.
case by allowing Yu Ping Kun Co., Inc. to recover A principal obligation may exist without an
only the actual damages proven and not to award accessory obligation but an accessory obligation
to it the stipulated liquidated damages of ten cannot exist without a principal obligation. For
thousand pesos for any breach of the contract. The example, the contract of mortgage is an accessory
proven damages supersede the stipulated obligation to enforce the performance of the main
liquidated damages. obligation of indebtedness. An indebtedness can
exist without the mortgage but a mortgage cannot
This view finds support in the opinion of Manresa exist without the indebtedness, which is the
(whose comments were the bases of the new principal obligation. In the present case, the
matter found in article 1226, not found in article principal obligation is the loan between the parties.
1152 of the old Civil Code) that in case of fraud the The accessory obligation of a penal clause is to
difference between the proven damages and the enforce the main obligation of payment of the
stipulated penalty may be recovered (Vol. 8, part. I, loan. If therefore the principal obligation does not
Codigo Civil, 5th Ed., 1950, p. 483). LexLib exist the penalty being accessory cannot exist.

Hence, the damages recoverable by the firm 3. ID.; ID.; PENALTY; WHEN DEMANDABLE. A
would amount to ninety thousand five hundred fifty- penalty is demandable in case of non performance
nine pesos and twenty-eight centavos (P90,559.28), or late performance of the main obligation. In other
with six percent interest a year from the filing of the words in order that the penalty may arise there
complaint. must be a breach of the obligation either by total
or partial non fulfillment or there is non fulfillment in
With that modification the judgment of the Court of point of time which is called mora or delay. The
Appeals is affirmed in all respects. No costs in this debtor therefore violates the obligation in point of
instance. time if there is mora or delay. Now, there is no mora
or delay unless there is a demand. It is noteworthy
SO ORDERED. that in the present case during all the period when
Barredo, Concepcion Jr. and Santos, JJ., concur. the principal obligation was still subsisting, although
Abad Santos, J., concurs in the result. there were late amortizations there was no demand
made by the creditor, plaintiff-appellant for the
SSS v. Moonwalk Development & Housing Corp., payment of the penalty. Therefore up to the time of
G.R. No. 73345, April 07, 1993) the letter of plaintiff-appellant there was no
demand for the payment of the penalty, hence the
SECOND DIVISION debtor was no in mora in the payment of the
[G.R. No. 73345. April 7, 1993.] penalty.
SOCIAL SECURITY SYSTEM, petitioner, vs.
MOONWALK DEVELOPMENT & HOUSING 4. ID.; ID.; ID.; DUAL FUNCTION OF A PENAL CLAUSE.
CORPORATION, ROSITA U. ALBERTO, ROSITA U. A penal clause is an accessory undertaking to
ALBERTO, JMA HOUSE, INC., MILAGROS SANCHEZ assume greater liability in case of breach. 6 It has a
SANTIAGO, in her capacity as Register of Deeds for double function: (1) to provide for liquidated
the Province of Cavite, ARTURO SOLITO, in his damages, and (2) to strengthen the coercive force
capacity as Register of Deeds for Metro Manila of the obligation by the threat of greater
District IV, Makati, Metro Manila and the responsibility in the event of breach. From the
INTERMEDIATE APPELLATE COURT, respondents. foregoing, it is clear that a penal clause is intended
The Solicitor General for petitioner. to prevent the obligor from defaulting in the
K.V. Faylona & Associates for private respondents. performance of his obligation. Thus, if there should
be default, the penalty may be enforced. One
commentator of the Civil Code wrote; "Now when is
the penalty deemed demandable in accordance
25 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
with the provisions of the Civil Code? We must 1, 1979 when SSS issued a Statement of Account to
make a distinction between a positive and a Moonwalk. And in accordance with said statement,
negative obligation. With regard to obligations Moonwalk paid its loan in full. What is clear,
which are positive (to give and to do), the penalty therefore, is that Moonwalk was never in default
is demandable when the debtor is in mora; hence, because SSS never compelled performance.
the necessity of demand by the debtor unless the Though it tried to foreclose the mortgages, SSS itself
same is excused . . ." 4 E.P. Caguioa, Comments desisted from doing so upon the entreaties of
and Cases on Civil Law 280 (1983 ed.) Moonwalk. If the Statement of Account could
properly be considered as demand for payment,
5. ID.; ID.; DEFAULT, WHEN INCURRED; WHEN the demand was complied with on time. Hence, no
DEMAND NOT NECESSARY; NOT APPLICABLE IN delay occurred and there was, therefore, no
CASE AT BAR. Under the Civil Code, delay begins occasion when the penalty became demandable
from the time the obligee judicially or extrajudicially and enforceable. Since there was no default in the
demands from the obligor the performance of the performance of the main obligation payment of
obligation. There are only three instances when the loan SSS was never entitled to recover any
demand is not necessary to render the obligor in penalty, not at the time it made the Statement of
default. These are the following: "(1) When the Account and certainly, not after the extinguishment
obligation or the law expressly so declares; (2) of the principal obligation because then, all the
When from the nature and the circumstances of more that SSS had no reason to ask for the
the obligation it appears that the designation of the penalties. Thus, there could never be any occasion
time when the thing is to be delivered or the service for waiver or even mistake in the application for
is to be rendered was a controlling motive for the payment because there was nothing for SSS to
establishment of the contract; or (3) When the waive as its right to enforce the penalty did not
demand would be useless, as when the obligor has arise.
rendered it beyond his power to perform." (Civil
Code, Art. 1169) This case does not fall within any of DECISION
the established exceptions. Hence, despite the CAMPOS, JR., J p:
provision in the promissory note that "(a)ll Before Us is a petition for review on certiorari of
amortization payments shall be made every first five decision 1 of the then Intermediate Appellate Court
(5) days of the calendar month until the principal affirming in toto the decision of the former Court of
and interest on the loan or any portion thereof First Instance of Rizal, Seventh Judicial District,
actually released has been fully paid," petitioner is Branch XXIX, Pasay City.
not excused from making a demand. It has been
established that at the time of payment of the full The facts as found by the Appellate Court are as
obligation, private respondent Moonwalk has long follows:
been delinquent in meeting its monthly arrears and
in paying the full amount of the loan itself as the "On February 20, 1980, the Social Security System,
obligation matured sometime in January, 1977. But SSS for brevity, filed a complaint in the Court of First
mere delinquency in payment does not necessarily Instance of Rizal against Moonwalk Development &
mean delay in the legal concept. Housing Corporation, Moonwalk for short, alleging
that the former had committed an error in failing to
6. ID.; ID.; ID.; REQUISITES; NOT PRESENT IN CASE AT compute the 12% interest due on delayed
BAR. To be in default ". . . is different from mere payments on the loan of Moonwalk resulting in a
delay in the grammatical sense, because it involves chain of errors in the application of payments
the beginning of a special condition or status which made by Moonwalk and, in an unpaid balance on
has its own peculiar effects or results." In order that the principal loan agreement in the amount of
the debtor may be in default it is necessary that the P7,053.77 and, also in not reflecting in its statement
following requisites be present: (1) that the or account an unpaid balance on the said
obligation be demandable and already liquidated; penalties for delayed payments in the amount of
(2) that the debtor delays performance; and (3) P7,517,178.21 as of October 10, 1979.
that the creditor requires the performance judicially
and extrajudicially. Default generally begins from Moonwalk answered denying SSS' claims and
the moment the creditor demands the asserting that SSS had the opportunity to ascertain
performance of the obligation. Nowhere in this the truth but failed to do so. LLjur
case did it appear that SSS demanded from
Moonwalk the payment of its monthly The trial court set the case for pre-trial at which pre-
amortizations. Neither did it show that petitioner trial conference, the court issued an order giving
demanded the payment of the stipulated penalty both parties thirty (30) days within which to submit a
upon the failure of Moonwalk to meet its monthly stipulation of facts.
amortization. What the complaint itself showed was
that SSS tried to enforce the obligation sometime in The Order of October 6, 1980 dismissing the
September, 1977 by foreclosing the real estate complaint followed the submission by the parties on
mortgages executed by Moonwalk in favor of SSS. September 19, 1980 of the following stipulation of
But this foreclosure did not push through upon Facts:
Moonwalk's requests and promises to pay in full. The
next demand for payment happened on October
26 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
"1. On October 6, 1971, plaintiff approved the December 21, 1979 of the defendant's counsel to
application of defendant Moonwalk for an interim the plaintiff are admitted.
loan in the amount of THIRTY MILLION PESOS
(P30,000,000.00) for the purpose of developing and "Manila for Pasay City, September 2, 1980." 2
constructing a housing project in the provinces of
Rizal and Cavite; On October 6, 1990, the trial court issued an order
dismissing the complaint on the ground that the
"2. Out of the approved loan of THIRTY MILLION obligation was already extinguished by the
PESOS (P30,000,000.00), the sum of P9,595,000.00 payment by Moonwalk of its indebtedness to SSS
was released to defendant Moonwalk as of and by the latter's act of cancelling the real estate
November 28, 1973; mortgages executed in its favor by defendant
Moonwalk. The Motion for Reconsideration filed by
"3. A third Amended Deed of First Mortgage was SSS with the trial court was likewise dismissed by the
executed on December 18, 1973 Annex `D' latter.
providing for restructuring of the payment of the
released amount of P9,595,000.00. These orders were appealed to the Intermediate
Appellate Court. Respondent Court reduced the
"4. Defendants Rosita U. Alberto and Rosita U. errors assigned by the SSS into this issue: ". . . are
Alberto, mother and daughter respectively, under defendants-appellees, namely, Moonwalk
paragraph 5 of the aforesaid Third Amended Deed Development and Housing Corporation, Rosita U.
of First Mortgage substituted Associated Alberto, Rosita U. Alberto, JMA House, Inc. still liable
Construction and Surveys Corporation, Philippine for the unpaid penalties as claimed by plaintiff-
Model Homes Development Corporation, Mariano appellant or is their obligation extinguished?" 3 As
Z. Velarde and Eusebio T. Ramos, as solidary We have stated earlier, the respondent Court held
obligors; that Moonwalk's obligation was extinguished and
affirmed the trial court.

Hence, this Petition wherein SSS raises the following


"5. On July 23, 1974, after considering additional grounds for review: cdll
releases in the amount of P2,659,700.00, made to
defendant Moonwalk, defendant Moonwalk "First, in concluding that the penalties due from
delivered to the plaintiff a promissory note for Moonwalk are "deemed waived and/or barred,"
TWELVE MILLION TWO HUNDRED FIFTY FOUR the appellate court disregarded the basic tenet
THOUSAND SEVEN HUNDRED PESOS (P12,254,700.00) that waiver of a right must be express, made in a
Annex `E', signed by Eusebio T. Ramos, and the said clear and unequivocal manner. There is no
Rosita U. Alberto and Rosita U. Alberto; evidence in the case at bar to show that SSS made
a clear, positive waiver of the penalties, made with
"6. Moonwalk made a total payment of full knowledge of the circumstances.
P23,657,901.84 to SSS for the loan principal of
P12,254,700.00 released to it. The last payment Second, it misconstrued the ruling that SSS funds are
made by Moonwalk in the amount of trust funds, and SSS, being a mere trustee, cannot
P15,004,905.74 were based on the Statement of perform acts affecting the same, including
Account, Annex "F" prepared by plaintiff SSS for condonation of penalties, that would diminish
defendant; property rights of the owners and beneficiaries
thereof. (United Christian Missionary Society v.
"7. After settlement of the account stated in Annex Social Security Commission, 30 SCRA 982, 988
'F' plaintiff issued to defendant Moonwalk the [1969]).
Release of Mortgage for Moonwalk's mortgaged
properties in Cavite and Rizal, Annexes 'G' and 'H' Third, it ignored the fact that penalty at the rate of
on October 9, 1979 and October 11, 1979 12% p.a. is not inequitable.
respectively.
Fourth, it ignored the principle that equity will
"8. In letters to defendant Moonwalk, dated cancel a release on the ground of mistake of fact."
November 28, 1979 and followed up by another 4
letter dated December 17, 1979, plaintiff alleged
that it committed an honest mistake in releasing The same problem which confronted the
defendant. respondent court is presented before Us: Is the
penalty demandable even after the extinguishment
"9. In a letter dated December 21, 1979, of the principal obligation?
defendant's counsel told plaintiff that it had
completely paid its obligations to SSS; The former Intermediate Appellate Court, through
Justice Eduard P. Caguioa, held in the negative. It
"10. The genuineness and due execution of the reasoned, thus:
documents marked as Annex (sic) 'A' to 'O'
inclusive, of the Complaint and the letter dated "2. As we have explained under No. 1, contrary to
what the plaintiff-appellant states in its Brief, what is
27 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
sought to be recovered in this case is not the 12% complete payment of its obligation as stated in
interest on the loan but the 12% penalty for failure Exhibit F. Because of this payment the obligation of
to pay on time the amortization. What is sought to Moonwalk was considered extinguished, and
be enforced therefore is the penal clause of the pursuant to said extinguishment, the real estate
contract entered into between the parties. mortgages given by Moonwalk were released on
October 9, 1979 and October 10, 1979 (Exhibits G
Now, what is a penal clause. A penal clause has and H). For all purposes therefore the principal
been defined as obligation of defendant-appellee was deemed
extinguished as well as the accessory obligation of
"an accessory obligation which the parties attach real estate mortgage; and that is the reason for the
to a principal obligation for the purpose of insuring release of all the Real Estate Mortgages on October
the performance thereof by imposing on the 9 and 10, 1979 respectively. LibLex
debtor a special presentation (generally consisting
in the payment of a sum of money) in case the Now, besides the Real Estate Mortgages, the penal
obligation is not fulfilled or is irregularly or clause which is also an accessory obligation must
inadequately fulfilled" (3 Castan 8th Ed. p. 118). also be deemed extinguished considering that the
principal obligation was considered extinguished,
Now an accessory obligation has been defined as and the penal clause being an accessory
that attached to a principal obligation in order to obligation. That being the case, the demand for
complete the same or take its place in the case of payment of the penal clause made by plaintiff-
breach (4 Puig Pea Part 1 p. 76). Note therefore appellant in its demand letter dated November 28,
that an accessory obligation is dependent for its 1979 and its follow up letter dated December 17,
existence on the existence of a principal obligation. 1979 (which parenthetically are the only demands
A principal obligation may exist without an for payment of the penalties) are therefore
accessory obligation but an accessory obligation ineffective as there was nothing to demand. It
cannot exist without a principal obligation. For would be otherwise, if the demand for the payment
example, the contract of mortgage is an accessory of the penalty was made prior to the
obligation to enforce the performance of the main extinguishment of the obligation because then the
obligation of indebtedness. An indebtedness can obligation of Moonwalk would consist of: 1) the
exist without the mortgage but a mortgage cannot principal obligation 2) the interest of 12% on the
exist without the indebtedness, which is the principal obligation and 3) the penalty of 12% for
principal obligation. In the present case, the late payment for after demand, Moonwalk would
principal obligation is the loan between the parties. be in mora and therefore liable for the penalty.
The accessory obligation of a penal clause is to
enforce the main obligation of payment of the Let it be emphasized that at the time of the
loan. If therefore the principal obligation does not demand made in the letters of November 28, 1979
exist the penalty being accessory cannot exist. and December 17, 1979 as far as the penalty is
concerned, the defendant-appellee was not in
Now then when is the penalty demandable? A default since there was no mora prior to the
penalty is demandable in case of non performance demand. That being the case, therefore, the
or late performance of the main obligation. In other demand made after the extinguishment of the
words in order that the penalty may arise there principal obligation which carried with it the
must be a breach of the obligation either by total extinguishment of the penal clause being merely an
or partial non fulfillment or there is non fulfillment in accessory obligation, was an exercise in futility.
point of time which is called mora or delay. The
debtor therefore violates the obligation in point of 3. At the time of the payment made of the full
time if there is mora or delay. Now, there is no mora obligation on October 10, 1979 together with the
or delay unless there is a demand. It is noteworthy 12% interest by defendant-appellee Moonwalk, its
that in the present case during all the period when obligation was extinguished. It being extinguished,
the principal obligation was still subsisting, although there was no more need for the penal clause. Now,
there were late amortizations there was no demand it is to be noted that penalty at anytime can be
made by the creditor, plaintiff-appellant for the modified by the Court. Even substantial
payment of the penalty. Therefore up to the time of performance under Art. 1234 authorizes the Court
the letter of plaintiff-appellant there was no to consider it as complete performance minus
demand for the payment of the penalty, hence the damages. Now, Art, 1229 Civil Code of the
debtor was no in mora in the payment of the Philippines provides:
penalty.
"ART. 1229. The judge shall equitably reduce the
However, on October 1, 1979, plaintiff-appellant penalty when the principal obligation has been
issued its statement of account (Exhibit F) showing partly or irregularly complied with by the debtor.
the total obligation of Moonwalk as P15,004,905.74, Even if there has been no performance, the penalty
and forthwith demanded payment from may also be reduced by the courts if it is iniquitous
defendant-appellee. Because of the demand for or unconscionable."
payment, Moonwalk made several payments on
September 29, October 9 and 19, 1979 respectively, If the penalty can be reduced after the principal
all in all totalling P15,004,905.74 which was a obligation has been partly or irregularly complied
28 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
with by the debtor, which is nonetheless a breach a negative obligation. With regard to obligations
of the obligation, with more reason the penal which are positive (to give and to do), the penalty
clause is not demandable when full obligation has is demandable when the debtor is in mora; hence,
been complied with since in that case there is no the necessity of demand by the debtor unless the
breach of the obligation. In the present case, there same is excused . . ." 8
has been as yet no demand for payment of the
penalty at the time of the extinguishment of the When does delay arise? Under the Civil Code,
obligation, hence there was likewise an delay begins from the time the obligee judicially or
extinguishment of the penalty. extrajudicially demands from the obligor the
performance of the obligation.
"Art. 1169. Those obliged to deliver or to do
something incur in delay from the time the obligee
Let Us emphasize that the obligation of defendant- judicially or extrajudicially demands from them the
appellee was fully complied with by the debtor, fulfillment of their obligation."
that is, the amount loaned together with the 12%
interest has been fully paid by the appellee. That There are only three instances when demand is not
being so, there is no basis for demanding the penal necessary to render the obligor in default. These are
clause since the obligation has been extinguished. the following:
Here there has been a waiver of the penal clause "(1) When the obligation or the law expressly so
as it was not demanded before the full obligation declares;
was fully paid and extinguished. Again, emphasis
must be made on the fact that plaintiff-appellant (2) When from the nature and the circumstances of
has not lost anything under the contract since in the obligation it appears that the designation of the
got back in full the amount loan (sic) as well as the time when the thing is to be delivered or the service
interest thereof. The same thing would have is to be rendered was a controlling motive for the
happened if the obligation was paid on time, for establishment of the contract; or
then the penal clause, under the terms of the
contract would not apply. Payment of the penalty (3) When the demand would be useless, as when
does not mean gain or loss of plaintiff-appellant the obligor has rendered it beyond his power to
since it is merely for the purpose of enforcing the perform." 9
performance of the main obligation has been fully
complied with and extinguished, the penal clause This case does not fall within any of the established
has lost its raison d' entre." 5 exceptions. Hence, despite the provision in the
promissory note that "(a)ll amortization payments
We find no reason to depart from the appellate shall be made every first five (5) days of the
court's decision. We, however, advance the calendar month until the principal and interest on
following reasons for the denial of this petition. the loan or any portion thereof actually released
has been fully paid," 10 petitioner is not excused
Article 1226 of the Civil Code provides: from making a demand. It has been established
that at the time of payment of the full obligation,
"Art. 1226. In obligations with a penal clause, he private respondent Moonwalk has long been
penalty shall substitute the indemnity for damages delinquent in meeting its monthly arrears and in
and the payment of interests in case of paying the full amount of the loan itself as the
noncompliance, if there is no stipulation to the obligation matured sometime in January, 1977. But
contrary. Nevertheless, damages shall be paid if the mere delinquency in payment does not necessarily
obligor refuses to pay the penalty or is guilty of mean delay in the legal concept. To be in default ".
fraud in the fulfillment of the obligation. . . is different from mere delay in the grammatical
sense, because it involves the beginning of a
The penalty may be enforced only when it is special condition or status which has its own
demandable in accordance with the provisions of peculiar effects or results." 11 In order that the
this Code." (Emphasis Ours.) debtor may be in default it is necessary that the
following requisites be present: (1) that the
A penal clause is an accessory undertaking to obligation be demandable and already liquidated;
assume greater liability in case of breach. 6 It has a (2) that the debtor delays performance; and (3)
double function: (1) to provide for liquidated that the creditor requires the performance judicially
damages, and (2) to strengthen the coercive force and extrajudicially. 12 Default generally begins from
of the obligation by the threat of greater the moment the creditor demands the
responsibility in the event of breach. 7 From the performance of the obligation. 13
foregoing, it is clear that a penal clause is intended Nowhere in this case did it appear that SSS
to prevent the obligor from defaulting in the demanded from Moonwalk the payment of its
performance of his obligation. Thus, if there should monthly amortizations. Neither did it show that
be default, the penalty may be enforced. One petitioner demanded the payment of the
commentator of the Civil Code wrote: prcd stipulated penalty upon the failure of Moonwalk to
"Now when is the penalty deemed demandable in meet its monthly amortization. What the complaint
accordance with the provisions of the Civil Code? itself showed was that SSS tried to enforce the
We must make a distinction between a positive and obligation sometime in September, 1977 by
29 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
foreclosing the real estate mortgages executed by Thus, We agree with the decision of the respondent
Moonwalk in favor of SSS. But this foreclosure did court on the matter which We quote, to wit:
not push through upon Moonwalk's requests and
promises to pay in full. The next demand for "Note that the above case refers to the
payment happened on October 1, 1979 when SSS condonation of the penalty for the non remittance
issued a Statement of Account to Moonwalk. And of the premium which is provided for by Section
in accordance with said statement, Moonwalk paid 22(a) of the Social Security Act . . . In other words,
its loan in full. What is clear, therefore, is that what was sought to be condoned was the penalty
Moonwalk was never in default because SSS never provided for by law for non remittance of premium
compelled performance. Though it tried to for coverage under the Social Security Act.
foreclose the mortgages, SSS itself desisted from
doing so upon the entreaties of Moonwalk. If the The case at bar does not refer to any penalty
Statement of Account could properly be provided for by law nor does it refer to the non
considered as demand for payment, the demand remittance of premium. The case at bar refers to a
was complied with on time. Hence, no delay contract of loan entered into between plaintiff and
occurred and there was, therefore, no occasion defendant Moonwalk Development and Housing
when the penalty became demandable and Corporation. Note, therefore, that no provision of
enforceable. Since there was no default in the law is involved in this case, nor is there any penalty
performance of the main obligation payment of imposed by law nor a case about non-remittance
the loan SSS was never entitled to recover any of premium required by law. The present case refers
penalty, not at the time it made the Statement of to a contract of loan payable in installments not
Account and certainly, not after the extinguishment provided for by law but by agreement of the
of the principal obligation because then, all the parties. Therefore, the ratio decidendi of the case
more that SSS had no reason to ask for the of United Christian Missionary Society vs. Social
penalties. Thus, there could never be any occasion Security Commission which plaintiff-appellant relies
for waiver or even mistake in the application for is not applicable in this case; clearly, the Social
payment because there was nothing for SSS to Security Commission, which is a creature of the
waive as its right to enforce the penalty did not Social Security Act cannot condone a mandatory
arise. provision of law providing for the payment of
premiums and for penalties for non remittance. The
SSS, however, in buttressing its claim that it never life of the Social Security Act is in the premiums
waived the penalties, argued that the funds it held because these are the funds from which the Social
were trust funds and as trustee, the petitioner could Security Act gets the money for its purposes and the
not perform acts affecting the funds that would non-remittance of the premiums is penalized not by
diminish property rights of the owners and the Social Security Commission but by law.
beneficiaries thereof. To support its claim, SSS cited
the case of United Christian Missionary Society v. xxx xxx xxx
Social Security Commission. 14
It is admitted that when a government created
We looked into the case and found out that it is not corporation enters into a contract with private
applicable to the present case as it dealt not with party concerning a loan, it descends to the level of
the right of the SSS to collect penalties which were a private person. Hence, the rules on contract
provided for in contracts which it entered into but applicable to private parties are applicable to it.
with its right to collect premiums and its duty to The argument therefore that the Social Security
collect the penalty for delayed payment or non- Commission cannot waive or condone the
payment of premiums. The Supreme Court, in that penalties which was applied in the United Christian
case, stated: Missionary Society cannot apply in this case. First,
because what was not paid were installments on a
"No discretion or alternative is granted respondent loan but premiums required by law to be paid by
Commission in the enforcement of the law's the parties covered by the Social Security Act.
mandate that the employer who fails to comply Secondly, what is sought to be condoned or
with his legal obligation to remit the premiums to waived are penalties not imposed by law for failure
the System within the prescribed period shall pay a to remit premiums required by law, but a penalty for
penalty of three (3%) per month. The prescribed non payment provided for by the agreement of the
penalty is evidently of a punitive character, parties in the contract between them . . ." 15
provided by the legislature to assure that employers
do not take lightly the State's exercise of the police WHEREFORE, in view of the foregoing, the petition is
power in the implementation of the Republic's DISMISSED and the decision of the respondent court
declared policy "to develop, establish gradually is AFFIRMED. LLpr
and perfect a social security system which shall be SO ORDERED.
suitable to the needs of the people throughout the Narvasa, C .J ., Padilla, Regalado and Nocon, JJ .,
Philippines and (to) provide protection to employers concur.
against the hazards of disability, sickness, old age
and death . . ."

30 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
(Lo v. Court of Appeals, G.R. No. 141434, September 2. ID.; ID.; ID.; ID.; REASONABLENESS OF PENALTY
23, 2003) ADDRESSED TO THE SOUND DISCRETION OF THE
COURT AND SUCH FACTORS RELATIVE TO
THIRD DIVISION SURROUNDING CIRCUMSTANCES. The question of
[G.R. No. 141434. September 23, 2003.] whether a penalty is reasonable or iniquitous is
ANTONIO LO, petitioner, vs. THE HON. COURT OF addressed to the sound discretion of the court and
APPEALS AND NATIONAL ONIONS GROWERS depends on several factors, including, but not
COOPERATIVE MARKETING ASSOCIATION, INC., limited to, the following: the type, extent and
respondents. purpose of the penalty, the nature of the
obligation, the mode of breach and its
SYNOPSIS consequences, the supervening realities, the
Petitioner acquired in an auction sale two parcels standing and relationship of the parties.
of land with an office building constructed thereon,
then leased by private respondent. Upon expiration 3. ID.; ID.; ID.; ID.; ID.; CASE AT BAR. In this case,
of the lease contract, however, private respondent the stipulated penalty was reduced by the
refused to vacate the premises as it was contesting appellate court for being unconscionable and
petitioner's acquisition of the land in an action for iniquitous. As provided in the Contract of Lease,
annulment of sale, redemption and damages. private respondent was obligated to pay a monthly
When petitioner thereafter filed an action for rent of P30,000. On the other hand, the stipulated
ejectment, both the MTC and the RTC ruled in favor penalty was pegged at P5,000 for each day of
of petitioner, granting the stipulated penalty of delay or P150,000 per month, an amount five times
P5,000 per day of delay in surrendering possession the monthly rent. This penalty was not only
of the property to petitioner. The Court of Appeals, exorbitant but also unconscionable, taking into
on the other hand, while also ruling in favor of account that private respondent's delay in
petitioner, modified the amount of penalty to surrendering the leased premises was because of a
P1,000. aScITE well-founded belief that its right of preemption to
purchase the subject premises had been violated.
Whether the reduced amount of penalty by the Considering further that private respondent was an
Court of Appeals to P1,000.00 was proper, the Court agricultural cooperative, collectively owned by
ruled in the affirmative. Per stipulation, the monthly farmers with limited resources, ordering it to pay a
rental of the premises was P30,000; the daily penalty penalty of P150,000 per month on top of the
for delay in surrendering possession thereof was monthly rent of P30,000 would seriously deplete its
P5,000 or P150,000 per month. This penalty of income and drive it to bankruptcy. In Rizal
P150,000.00 per month is not only exorbitant but Commercial Banking Corp. vs. Court of Appeals,
also unconscionable, taking into account that the the Court tempered the penalty charges after
delay in surrendering the leased premises was taking into account the debtor's pitiful financial
because of a well-founded belief that private condition.
respondent's right of pre-emption to purchase the
premises had been violated. Also considered is the DECISION
fact that private respondent is an agricultural CORONA, J p:
cooperative collectively owned by farmers with Assailed in the instant petition for review on
limited resources. certiorari under Rule 45 of the Rules of Court is the
May 26, 1998 decision 1 of the Court of Appeals
SYLLABUS modifying the decision of the Regional Trial Court of
l. CIVIL LAW; OBLIGATIONS AND CONTRACTS; Malabon, Branch 74:
OBLIGATIONS WITH A PENAL CLAUSE; COURTS MAY
EQUITABLY REDUCE STIPULATED PENALTY IF WHEREFORE, the assailed decision is hereby
INIQUITOUS OR UNCONSCIONABLE. Generally, AFFIRMED with the MODIFICATION that the penalty
courts are not at liberty to ignore the freedom of imposed for each day of delay in surrendering the
the parties to agree on such terms and conditions leased property is reduced from P5,000.00 to
as they see fit as long as they are not contrary to P1,000.00 per day of delay. 2
law, morals, good customs, public order or public
policy. Nevertheless, courts may equitably reduce a At the core of the present controversy are two
stipulated penalty in the contract if it is iniquitous or parcels of land measuring a total of 2,147 square
unconscionable, or if the principal obligation has meters, with an office building constructed thereon,
been partly or irregularly complied with. This power located at Bo. Potrero, Malabon, Metro Manila and
of the courts is explicitly sanctioned by Article 1229 covered by TCT Nos. M-13166 and M-13167.
of the Civil Code which provides: Article 1229. The
judge shall equitably reduce the penalty when the Petitioner acquired the subject parcels of land in an
principal obligation has been partly or irregularly auction sale on November 9, 1995 for P20,170,000
complied with by the debtor. Even if there has from the Land Bank of the Philippines (Land Bank).
been no performance, the penalty may also be
reduced by the courts if it is iniquitous or Private respondent National Onion Growers
unconscionable. Cooperative Marketing Association, Inc., an
agricultural cooperative, was the occupant of the
disputed parcels of land under a subsisting contract
31 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
of lease with Land Bank. The lease was valid until authority of the Court of Appeals to reduce the
December 31, 1995. penalty awarded by the trial court, the same
having been stipulated by the parties in their
Upon the expiration of the lease contract, petitioner Contract of Lease.
demanded that private respondent vacate the
leased premises and surrender its possession to him. The petition has no merit.
Private respondent refused on the ground that it
was, at the time, contesting petitioner's acquisition Generally, courts are not at liberty to ignore the
of the parcels of land in question in an action for freedom of the parties to agree on such terms and
annulment of sale, redemption and damages. conditions as they see fit as long as they are not
contrary to law, morals, good customs, public order
On February 23, 1996, petitioner filed an action for or public policy. Nevertheless, courts may equitably
ejectment before the Metropolitan Trial Court of reduce a stipulated penalty in the contract if it is
Malabon, Branch 55. He asked, inter alia, for the iniquitous or unconscionable, or if the principal
imposition of the contractually stipulated penalty of obligation has been partly or irregularly complied
P5,000 per day of delay in surrendering the with. 5
possession of the property to him. On September 3,
1996, the trial court decided the case in favor of This power of the courts is explicitly sanctioned by
petitioner: Article 1229 of the Civil Code which provides:

WHEREFORE, premises considered, the Court Article 1229. The judge shall equitably reduce the
considers the allegations of the complaint to be penalty when the principal obligation has been
true and duly substantiated except as to the partly or irregularly complied with by the debtor.
amount of damages and attorney's fees, which are Even if there has been no performance, the penalty
reduced accordingly, a decision is hereby may also be reduced by the courts if it is iniquitous
rendered in favor of the plaintiffs and against the or unconscionable.
defendant, ordering the latter and all persons
claiming rights under it: The question of whether a penalty is reasonable or
iniquitous is addressed to the sound discretion of the
1) To vacate the leased premises immediately and court and depends on several factors, including,
turn over the same peacefully to the plaintiffs; but not limited to, the following: the type, extent
and purpose of the penalty, the nature of the
2) To pay plaintiff Antonio Lo the sum of P5,000.00 obligation, the mode of breach and its
for every day of delay from the time defendant is consequences, the supervening realities, the
supposed to have vacated the premises; standing and relationship of the parties. 6

3) To pay the sum of P36,000.00 a month from In this case, the stipulated penalty was reduced by
January 1996 until it finally vacates the premises as the appellate court for being unconscionable and
payment for reasonable compensation for the use iniquitous. As provided in the Contract of Lease,
and occupancy thereof; private respondent was obligated to pay a monthly
rent of P30,000. On the other hand, the stipulated
4) To pay the sum of P20,000.00 by way of penalty was pegged at P5,000 for each day of
reasonable attorney's fees; and delay or P150,000 per month, an amount five times
the monthly rent. This penalty was not only
5) To pay the costs of suit. 3 exorbitant but also unconscionable, taking into
account that private respondent's delay in
On appeal to the Regional Trial Court of Malabon, surrendering the leased premises was because of a
Branch 74, the MTC decision was affirmed in toto on well-founded belief that its right of preemption to
August 29, 1997. 4 Private respondent's subsequent purchase the subject premises had been violated.
motion for reconsideration of the RTC decision was Considering further that private respondent was an
denied on November 26, 1997. agricultural cooperative, collectively owned by
farmers with limited resources, ordering it to pay a
From the adverse decision of the trial court, private penalty of P150,000 per month on top of the
respondent elevated the case to the Court of monthly rent of P30,000 would seriously deplete its
Appeals via a petition for review. income and drive it to bankruptcy. In Rizal
Commercial Banking Corp. vs. Court of Appeals, 7
On May 26, 1999, the Court of Appeals rendered its the Court tempered the penalty charges after
assailed decision affirming the decision of the trial taking into account the debtor's pitiful financial
court, with the modification that the penalty condition.
imposed upon private respondent for the delay in
turning over the leased property to petitioner was Accordingly, we rule that the Court of Appeals did
reduced from P 5,000 to P1000 per day. not commit any reversible error in the exercise of its
discretion when it reduced the award of penalty
Unsatisfied with the decision of the Court of damages from P5,000 to P1,000 for each day of
Appeals, petitioner filed the instant petition for delay.
review, raising the sole issue of the alleged lack of
32 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
WHEREFORE, petition is hereby DENIED. The decision The issue of reasonableness of interest rate cannot
of the Court of Appeals reducing the amount of be raised for the first time on appeal. In any event,
penalty damages against private respondent is the Court held that the stipulated interest of
AFFIRMED. IaCHTS 15.189% per annum is not excessive.

SO ORDERED. An obligation to pay a sum of money is not


extinctively novated by a new instrument which
Puno, Panganiban, Sandoval-Gutierrez and Carpio- merely supplements the old contract.
Morales, JJ ., concur.
SYLLABUS
(Ligutan v. Court of Appeals, G.R. No. 138677, 1. CIVIL LAW; OBLIGATIONS AND CONTRACTS;
February 12, 2002) PENALTY CLAUSE, CONSTRUED. A penalty clause,
expressly recognized by law, is an accessory
THIRD DIVISION undertaking to assume greater liability on the part
of an obligor in case of breach of an obligation. It
[G.R. No. 138677. February 12, 2002.] functions to strengthen the coercive force of the
obligation and to provide, in effect, for what could
TOLOMEO LIGUTAN and LEONIDAS DE LA LLANA, be the liquidated damages resulting from such a
petitioners, vs. HON. COURT OF APPEALS & SECURITY breach. The obligor would then be bound to pay
BANK & TRUST COMPANY, respondents. the stipulated indemnity without the necessity of
proof on the existence and on the measure of
Florimundo C. Rous for petitioners. damages caused by the breach. Although a court
may not at liberty ignore the freedom of the parties
Castro Bias Samillano & Mangrobang for private to agree on such terms and conditions as they see
respondent. fit that contravene neither law nor morals, good
customs, public order or public policy, a stipulated
SYNOPSIS penalty, nevertheless, may be equitably reduced
Petitioners obtained a loan from respondent bank by the courts if it is iniquitous or unconscionable or if
in the amount of P120,000.00 at 15.189% interest per the principal obligation has been partly or
annum with a 5% penalty per month in case of irregularly complied with.
default and 10% attorney's fees if a suit were
instituted for collection. When petitioners defaulted 2. ID.; ID.; ID.; 3% PENALTY INTEREST A MONTH,
in payment, respondent bank sued for recovery of REASONABLE; CASE AT BAR. The question of
the amount due. Two years after the case was whether a penalty is reasonable or iniquitous can
submitted for decision without petitioners be partly subjective and partly objective. Its
presenting their evidence, petitioners filed a motion resolution would depend on such factors as, but not
for reconsideration of the order declaring them as necessarily confined to, the type, extent and
having waived their right to present evidence and purpose of the penalty, the nature of the
prayed that they be allowed to prove their case. obligation, the mode of breach and its
The motion was denied by the trial court which consequences, the supervening realities, the
eventually rendered a decision in favor of standing and relationship of the parties, and the
respondent bank ordering petitioners to pay the like, the application of which, by and large, is
amount due with the agreed interest rate of addressed to the sound discretion of the court. The
15.189%, 5% penalty charge and 10% attorney's Court of Appeals, exercising its good judgment in
fees. The decision was affirmed on appeal by the the instant case, has reduced the penalty interest
Court of Appeals. On reconsideration, the from 5% a month to 3% a month which petitioner still
appellate court reduced the penalty interest from disputes. Given the circumstances, not to mention
5% to 3%. Petitioners filed a second motion for the repeated acts of breach by petitioners of their
reconsideration and to admit newly discovered contractual obligation, the Court sees no cogent
evidence that the real estate mortgage they ground to modify the ruling of the appellate court.
executed novated the contract of loan. The HEcaIC
mortgage, however, did not contain an express
stipulation that the parties intended to supersede 3. ID.; ID.; ID.; INTEREST STIPULATION, FUNDAMENTAL
the existing loan agreement but was an accessory PART OF THE BANKING BUSINESS AND THE CORE OF
contract to secure the loan. The Court of Appeals A BANK'S EXISTENCE. Anent the stipulated interest
denied the same. Hence, this recourse, with of 15.189% per annum, petitioners, for the first time,
petitioners raising for the first time the question its reasonableness and prays that the
reasonableness of the interest rate. Court reduce the amount. This contention is a fresh
issue that has not been raised and ventilated
A penalty clause is an accessory undertaking to before the courts below. In any event, the interest
strengthen the coercive force of the obligation and stipulation, on its face, does not appear as being
that the 3% penalty interest rate considering the that excessive. The essence or rationale for the
repeated acts of breach of petitioners' contractual payment of interest, quite often referred to as cost
obligations is not iniquitous. of money, is not exactly the same as that of a
surcharge or a penalty. A penalty stipulation is not
necessarily preclusive of interest, if there is an
33 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
agreement to that effect, the two being distinct money is not extinctively novated by a new
concepts which may separately be demanded. instrument which merely changes the terms of
What may justify a court in not allowing the creditor payment or adding compatible covenants or
to impose full surcharges and penalties, despite an where the old contract is merely supplemented by
express stipulation therefor in a valid agreement, the new one. When not expressed, incompatibility is
may not equally justify the non-payment or required so as to ensure that the parties have
reduction of interest. Indeed, the interest prescribed indeed intended such novation despite their failure
in loan financing arrangements is a fundamental to express it in categorical terms. The
part of the banking business and the core of a incompatibility, to be sure, should take place in any
bank's existence. of the essential elements of the obligation, i.e., (1)
the juridical relation or tie, such as from a mere
4. ID.; DAMAGES; PAYMENT OF 10% ATTORNEY'S commodatum to lease of things, or from
FEES, REASONABLE IN CASE AT BAR. Petitioners negotiorum gestio to agency, or from a mortgage
next assail the award of 10% of the total amount of to antichresis, or from a sale to one of loan; (2) the
indebtedness by way of attorney's fees for being object or principal conditions, such as a change of
grossly excessive, exorbitant and unconscionable the nature of the prestation; or (3) the subjects,
vis-a-vis the time spent and the extent of services such as the substitution of a debtor or the
rendered by counsel for the bank and the nature of subrogation of the creditor. Extinctive novation
the case. Bearing in mind that the rate of attorney's does not necessarily imply that the new agreement
fees has been agreed to by the parties and should be complete by itself; certain terms and
intended to answer not only for litigation expenses conditions may be carried, expressly or by
but also for collection efforts as well, the Court, like implication, over to the new obligation. CSTHca
the appellate court, deems the award of 10%
attorney's fees to be reasonable. DECISION
VITUG, J p:
5. REMEDIAL LAW; CIVIL PROCEDURE; NEW TRIAL; Before the Court is a petition for review on certiorari
NEWLY DISCOVERED EVIDENCE; MUST NOT BE under Rule 45 of the Rules of Court, assailing the
EXISTING AT TIME WHEN APPEAL OR FIRST MOTION decision and resolutions of the Court of Appeals in
FOR RECONSIDERATION WAS FILED; CASE AT BAR. CA-G.R. CV No. 34594, entitled "Security Bank and
Neither can the appellate court be held to have Trust Co. vs. Tolomeo Ligutan, et al."
erred in rejecting petitioners' call for a new trial or to
admit newly discovered evidence. As the appellate Petitioners Tolomeo Ligutan and Leonidas dela
court so held in its resolution of 14 May 1999 Llana obtained on 11 May 1981 a loan in the
"Under Section 2, Rule 52 of the 1997 Rules of Civil amount of P120,000.00 from respondent Security
Procedure, no second motion for reconsideration of Bank and Trust Company. Petitioners executed a
a judgment or final resolution by the same party promissory note binding themselves, jointly and
shall be entertained. Considering that the instant severally, to pay the sum borrowed with an interest
motion is already a second motion for of 15.189% per annum upon maturity and to pay a
reconsideration, the same must therefore be penalty of 5% every month on the outstanding
denied. "Furthermore, it would appear from the principal and interest in case of default. In addition,
records available to this court that the newly- petitioners agreed to pay 10% of the total amount
discovered evidence being invoked by due by way of attorney's fees if the matter were
defendants-appellants have actually been existent indorsed to a lawyer for collection or if a suit were
when the case was brought on appeal to this court instituted to enforce payment. The obligation
as well as when the first motion for reconsideration matured on 8 September 1981; the bank, however,
was filed. Hence, it is quite surprising why granted an extension but only up until 29
defendants-appellants raised the alleged newly- December 1981.
discovered evidence only at this stage, when they
could have done so in the earlier pleadings filed Despite several demands from the bank, petitioners
before this court. failed to settle the debt which, as of 20 May 1982,
amounted to P114,416.10. On 30 September 1982,
6. CIVIL LAW; OBLIGATIONS AND CONTRACTS; the bank sent a final demand letter to petitioners
EXTINCTIVE NOVATION; REQUISITES. Extinctive informing them that they had five days within which
novation requires, first, a previous valid obligation; to make full payment. Since petitioners still
second, the agreement of all the parties to the new defaulted on their obligation, the bank filed on 3
contract; third, the extinguishment of the November 1982, with the Regional Trial Court of
obligation; and fourth, the validity of the new one. Makati, Branch 143, a complaint for recovery of the
In order that an obligation may be extinguished by due amount.
another which substitutes the same, it is imperative
that it be so declared in unequivocal terms, or that
the old and the new obligation be on every point
incompatible with each other. After petitioners had filed a joint answer to the
complaint, the bank presented its evidence and,
7. ID.; ID.; ID.; MUST PRODUCE INCOMPATIBILITY IN on 27 March 1985, rested its case. Petitioners,
ANY OF THE ESSENTIAL ELEMENTS OF THE instead of introducing their own evidence, had the
OBLIGATION. An obligation to pay a sum of hearing of the case reset on two consecutive
34 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
occasions. In view of the absence of petitioners "In the case at bar, defendants-appellants
and their counsel on 28 August 1985, the third executed a promissory note where they undertook
hearing date, the bank moved, and the trial court to pay the obligation on its maturity date 'without
resolved, to consider the case submitted for necessity of demand.' They also agreed to pay the
decision. interest in case of non-payment from the date of
default.
Two years later, or on 23 October 1987, petitioners
filed a motion for reconsideration of the order of the "xxx xxx xxx
trial court declaring them as having waived their
right to present evidence and prayed that they be "While we maintain that defendants-appellants
allowed to prove their case. The court a quo must be bound by the contract which they
denied the motion in an order, dated 5 September acknowledged and signed, we take cognizance of
1988, and on 20 October 1989, it rendered its their plea for the application of the provisions of
decision, 1 the dispositive portion of which read: Article 1229 . . . .

"WHEREFORE, judgment is hereby rendered in favor "Considering that defendants-appellants partially


of the plaintiff and against the defendants, ordering complied with their obligation under the promissory
the latter to pay, jointly and severally, to the note by the reduction of the original amount of
plaintiff, as follows: P120,000.00 to P114,416.00 and in order that they
will finally settle their obligation, it is our view and we
"1. The sum of P114,416.00 with interest thereon at so hold that in the interest of justice and public
the rate of 15.189% per annum, 2% service charge policy, a penalty of 3% per month or 36% per
and 5% per month penalty charge, commencing annum would suffice.
on 20 May 1982 until fully paid;
"xxx xxx xxx
"2. To pay the further sum equivalent to 10% of the
total amount of indebtedness for and as attorney's "WHEREFORE, the decision sought to be
fees; and reconsidered is hereby MODIFIED. The defendants-
appellants Tolomeo Ligutan and Leonidas dela
"3. To pay the costs of the suit." 2 Llana are hereby ordered to pay the plaintiff-
appellee Security Bank and Trust Company the
Petitioners interposed an appeal with the Court of following:
Appeals, questioning the rejection by the trial court
of their motion to present evidence and assailing "1. The sum of P114,416.00 with interest thereon at
the imposition of the 2% service charge, the 5% per the rate of 15.189% per annum and 3% per month
month penalty charge and 10% attorney's fees. In penalty charge commencing May 20, 1982 until
its decision 3 of 7 March 1996, the appellate court fully paid;
affirmed the judgment of the trial court except on
the matter of the 2% service charge which was "2. The sum equivalent to 10% of the total amount of
deleted pursuant to Central Bank Circular No. 783. the indebtedness as and for attorney's fees." 5
Not fully satisfied with the decision of the appellate
court, both parties filed their respective motions for On 16 November 1998, petitioners filed an omnibus
reconsideration. 4 Petitioners prayed for the motion for reconsideration and to admit newly
reduction of the 5% stipulated penalty for being discovered evidence, 6 alleging that while the case
unconscionable. The bank, on the other hand, was pending before the trial court, petitioner
asked that the payment of interest and penalty be Tolomeo Ligutan and his wife Bienvenida Ligutan
commenced not from the date of filing of executed a real estate mortgage on 18 January
complaint but from the time of default as so 1984 to secure the existing indebtedness of
stipulated in the contract of the parties. petitioners Ligutan and dela Llana with the bank.
Petitioners contended that the execution of the
On 28 October 1998, the Court of Appeals resolved real estate mortgage had the effect of novating
the two motions thusly: the contract between them and the bank.
Petitioners further averred that the mortgage was
"We find merit in plaintiff-appellee's claim that the extrajudicially foreclosed on 26 August 1986, that
principal sum of P114,416.00 with interest thereon they were not informed about it, and the bank did
must commence not on the date of filing of the not credit them with the proceeds of the sale. The
complaint as we have previously held in our appellate court denied the omnibus motion for
decision but on the date when the obligation reconsideration and to admit newly discovered
became due. evidence, ratiocinating that such a second motion
for reconsideration cannot be entertained under
"Default generally begins from the moment the Section 2, Rule 52, of the 1997 Rules of Civil
creditor demands the performance of the Procedure. Furthermore, the appellate court said,
obligation. However, demand is not necessary to the newly-discovered evidence being invoked by
render the obligor in default when the obligation or petitioners had actually been known to them when
the law so provides. the case was brought on appeal and when the first
motion for reconsideration was filed. 7
35 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
The question of whether a penalty is reasonable or
Aggrieved by the decision and resolutions of the iniquitous can be partly subjective and partly
Court of Appeals, petitioners elevated their case to objective. Its resolution would depend on such
this Court on 9 July 1999 via a petition for review on factors as, but not necessarily confined to, the type,
certiorari under Rule 45 of the Rules of Court, extent and purpose of the penalty, the nature of
submitting thusly the obligation, the mode of breach and its
consequences, the supervening realities, the
"I. The respondent Court of Appeals seriously erred standing and relationship of the parties, and the
in not holding that the 15.189% interest and the like, the application of which, by and large, is
penalty of three (3%) percent per month or thirty-six addressed to the sound discretion of the court. In
(36%) percent per annum imposed by private Rizal Commercial Banking Corp. vs. Court of
respondent bank on petitioners' loan obligation are Appeals, 14 just an example, the Court has
still manifestly exorbitant, iniquitous and tempered the penalty charges after taking into
unconscionable. account the debtor's pitiful situation and its offer to
settle the entire obligation with the creditor bank.
"II. The respondent Court of Appeals gravely erred The stipulated penalty might likewise be reduced
in not reducing to a reasonable level the ten (10%) when a partial or irregular performance is made by
percent award of attorney's fees which is highly the debtor. 15 The stipulated penalty might even
and grossly excessive, unreasonable and be deleted such as when there has been
unconscionable. substantial performance in good faith by the
obligor, 16 when the penalty clause itself suffers
"III. The respondent Court of Appeals gravely erred from fatal infirmity, or when exceptional
in not admitting petitioners' newly discovered circumstances so exist as to warrant it. 17
evidence which could not have been timely
produced during the trial of this case. The Court of Appeals, exercising its good judgment
in the instant case, has reduced the penalty interest
"IV. The respondent Court of Appeals seriously erred from 5% a month to 3% a month which petitioner still
in not holding that there was a novation of the disputes. Given the circumstances, not to mention
cause of action of private respondent's complaint the repeated acts of breach by petitioners of their
in the instant case due to the subsequent execution contractual obligation, the Court sees no cogent
of the real estate mortgage during the pendency ground to modify the ruling of the appellate court.
of this case and the subsequent foreclosure of the
mortgage." 8 Anent the stipulated interest of 15.189% per annum,
petitioners, for the first time, question its
Respondent bank, which did not take an appeal, reasonableness and prays that the Court reduce
would, however, have it that the penalty sought to the amount. This contention is a fresh issue that has
be deleted by petitioners was even insufficient to not been raised and ventilated before the courts
fully cover and compensate for the cost of money below. In any event, the interest stipulation, on its
brought about by the radical devaluation and face, does not appear as being that excessive. The
decrease in the purchasing power of the peso, essence or rationale for the payment of interest,
particularly vis-a-vis the U.S. dollar, taking into quite often referred to as cost of money, is not
account the time frame of its occurrence. The Bank exactly the same as that of a surcharge or a
would stress that only the amount of P5,584.00 had penalty. A penalty stipulation is not necessarily
been remitted out of the entire loan of P120,000.00. preclusive of interest, if there is an agreement to
9 that effect, the two being distinct concepts which
may separately be demanded. 18 What may justify
A penalty clause, expressly recognized by law, 10 is a court in not allowing the creditor to impose full
an accessory undertaking to assume greater liability surcharges and penalties, despite an express
on the part of an obligor in case of breach of an stipulation therefor in a valid agreement, may not
obligation. It functions to strengthen the coercive equally justify the nonpayment or reduction of
force of the obligation 11 and to provide, in effect, interest. Indeed, the interest prescribed in loan
for what could be the liquidated damages resulting financing arrangements is a fundamental part of
from such a breach. The obligor would then be the banking business and the core of a bank's
bound to pay the stipulated indemnity without the existence. 19
necessity of proof on the existence and on the
measure of damages caused by the breach. 12 Petitioners next assail the award of 10% of the total
Although a court may not at liberty ignore the amount of indebtedness by way of attorney's fees
freedom of the parties to agree on such terms and for being grossly excessive, exorbitant and
conditions as they see fit that contravene neither unconscionable vis-a-vis the time spent and the
law nor morals, good customs, public order or extent of services rendered by counsel for the bank
public policy, a stipulated penalty, nevertheless, and the nature of the case. Bearing in mind that
may be equitably reduced by the courts if it is the rate of attorney's fees has been agreed to by
iniquitous or unconscionable or if the principal the parties and intended to answer not only for
obligation has been partly or irregularly complied litigation expenses but also for collection efforts as
with. 13 well, the Court, like the appellate court, deems the
award of 10% attorney's fees to be reasonable.
36 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
categorical terms. The incompatibility, to be sure,
Neither can the appellate court be held to have should take place in any of the essential elements
erred in rejecting petitioners' call for a new trial or to of the obligation, i.e., (1) the juridical relation or tie,
admit newly discovered evidence. As the appellate such as from a mere commodatum to lease of
court so held in its resolution of 14 May 1999 things, or from negotiorum gestio to agency, or
from a mortgage to antichresis, 25 or from a sale to
"Under Section 2, Rule 52 of the 1997 Rules of Civil one of loan; 26 (2) the object or principal
Procedure, no second motion for reconsideration of conditions, such as a change of the nature of the
a judgment or final resolution by the same party prestation; or (3) the subjects, such as the
shall be entertained. Considering that the instant substitution of a debtor 27 or the subrogation of the
motion is already a second motion for creditor. Extinctive novation does not necessarily
reconsideration, the same must therefore be imply that the new agreement should be complete
denied. by itself; certain terms and conditions may be
carried, expressly or by implication, over to the new
"Furthermore, it would appear from the records obligation.
available to this court that the newly-discovered
evidence being invoked by defendants-appellants WHEREFORE, the petition is DENIED.
have actually been existent when the case was
brought on appeal to this court as well as when the SO ORDERED.
first motion for reconsideration was filed. Hence, it is
quite surprising why defendants-appellants raised Melo, Panganiban, Sandoval-Gutierrez and Carpio,
the alleged newly-discovered evidence only at this JJ., concur.
stage when they could have done so in the earlier
pleadings filed before this court. (Commercial Credit Corp. of Cagarayan De Oro v.
Court of Appeals, G.R. No. 78315, January 02, 1989)
"The propriety or acceptability of such a second
motion for reconsideration is not contingent upon FIRST DIVISION
the averment of 'new' grounds to assail the [G.R. No. 78315. January 2, 1989.]
judgment, i.e., grounds other than those theretofore COMMERCIAL CREDIT CORPORATION OF
presented and rejected. Otherwise, attainment of CAGAYAN DE ORO, petitioner, vs. THE COURT OF
finality of a judgment might be stayed off APPEALS and THE CAGAYAN DE ORO COLISEUM,
indefinitely, depending on the party's ingeniousness INC., respondents.
or cleverness in conceiving and formulating
'additional flaws' or 'newly discovered errors' SYLLABUS
therein, or thinking up some injury or prejudice to 1. REMEDIAL LAW; CIVIL PROCEDURE; JUDICIAL
the rights of the movant for reconsideration." 20 COMPROMISE; WITH FORCE AND EFFECT OF RES
JUDICATA. It is axiomatic that a compromise
At any rate, the subsequent execution of the real judgment is final and immediately executory. Once
estate mortgage as security for the existing loan a judgment becomes final and executory, the
would not have resulted in the extinguishment of prevailing party can have it executed as a matter
the original contract of loan because of novation. of right and the execution becomes a ministerial
Petitioners acknowledge that the real estate duty on the part of the court. A judicial compromise
mortgage contract does not contain any express has the force and effect of res judicata.
stipulation by the parties intending it to supersede
the existing loan agreement between the 2. ID.; ID.; ID.; NOT SUBJECT TO AMENDMENT EXCEPT
petitioners and the bank. 21 Respondent bank has FOR VICES IN CONSENT OR FORGERY. A final and
correctly postulated that the mortgage is but an executory judgment cannot be modified or
accessory contract to secure the loan in the amended. If an amendment is to be made, it may
promissory note. SAHEIc consist only of supplying an omission, striking out a
Extinctive novation requires, first, a previous valid superfluity or interpreting an ambiguous phrase
obligation; second, the agreement of all the parties therein in relation to the body of the decision which
to the new contract; third, the extinguishment of gives it life. A compromise judgment should not be
the obligation; and fourth, the validity of the new disturbed except for vices in consent or forgery. In
one. 22 In order that an obligation may be the present case, the compromise agreement was
extinguished by another which substitutes the same, voluntarily entered into by the parties assisted by
it is imperative that it be so declared in unequivocal their respective counsel and was duly approved by
terms, or that the old and the new obligation be on the trial court. Indeed, it was confirmed by the
every point incompatible with each other. 23 An respondent appellate court to be lawful. There was,
obligation to pay a sum of money is not extinctively therefore, no cogent basis for the respondent
novated by a new instrument which merely appellate court to modify said compromise
changes the terms of payment or adding agreement by reducing the penalty and attorney's
compatible covenants or where the old contract is fees provided for therein.
merely supplemented by the new one. 24 When
not expressed, incompatibility is required so as to 3. ID.; ID.; ID.; MODIFICATION OF COMPROMISE
ensure that the parties have indeed intended such JUDGMENT UNDER ARTICLE 1229 OF THE N.C.C. NOT
novation despite their failure to express it in APPLICABLE TO A FINAL AND EXECUTORY
37 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
JUDGMENT. Article 1229 of the Civil Code applies such therefore, the issue raised by the herein
only to obligations or contract, subject of a petitioners in the above entitled case has become
litigation, the condition being that the same has moot and academic;
been partly or irregularly complied with by the 2. That, by virtue of the aforementioned, the
debtor. The provision also applies even if there has Cagayan de Oro Coliseum, Inc. thru its Board of
been no performance, as long as the penalty is Directors and represented by its President, Mr.
iniquituous or unconscionable. It cannot apply to a Johnny Wilson, hereby admits its total outstanding
final and executory judgment. When the parties obligation to herein Respondent Commercial Credit
entered into the said compromise agreement and Corporation of Cagayan de Oro in the amount of
submitted the same for the approval of the trial TWO HUNDRED FORTY NINE THOUSAND TWO
court, its terms and conditions must be the HUNDRED SIXTY THREE & 23/100 PESOS (P249,263.23),
primordial consideration why the parties voluntarily as of February 15, 1980, including therein the sum of
entered into the same. The trial court approved it P10,000.00 representing attorney's fees for
because it is lawful, and is not against public policy Respondent Commercial Credit Corporation of
or morals. Even the respondent Court of Appeals Cagayan de Oro;
upheld the validity of the said compromise 3. That the Cagayan de Oro Coliseum, Inc. has
agreement. Hence, the respondent court has no agreed to pay the above obligation plus interest on
authority to reduce the penalty and attorney's fees diminishing balance computed yearly at sixteen
therein stipulated which is the law between the (16) percent per annum, thus:
parties and is res judicata. Total Account P249,263.23

DECISION Total Interest P76,138.60


GANCAYCO, J p:
In this petition for review of a decision of the Court Total payable P325,401.83
of Appeals in CA G.R. SP No. 10888 1 the issue is
whether or not a compromise judgment which was 4. That, the Cagayan de Oro Coliseum, Inc. hereby
found by the Court of Appeals to be lawful may be agrees to pay the aforegoing obligation in
modified by the same court. paragraph (3) hereof in equal monthly installments
of P11,000.00, the first installment shall be payable in
Sometime in 1978 private respondent Cagayan De February, 1980 and every month thereafter until the
Oro Coliseum, Inc. executed a promissory note in whole account payable as aforementioned is fully
the amount of P329,852.54 in favor of petitioner paid;
Commercial Credit Corporation of Cagayan de
Oro, payable in 36 monthly installments. The note is 5. That, failure on the part of Respondent Cagayan
secured by a real estate mortgage duly executed de Oro Coliseum, Inc. to pay any of the installments
by private respondent in favor of petitioner. As said as they shall become due, the whole amount then
respondent defaulted in the payment of the outstanding and unpaid shall immediately become
monthly installments due, petitioner proceeded due and payable in its entirety and shall render the
with the extrajudicial foreclosure of the real estate judgment herein to be immediately final,
mortgage in September, 1979. unappealable and executory; and the overdue
and unpaid installments shall earn a three (3%) per
Five minority stockholders of private respondent cent per month penalty charge until fully paid, plus
then instituted Special Civil Action No. 68111 in the five percent (5%) of the outstanding balance as
then Court of First Instance (CFI) of Misamis Oriental additional attorney's fee;
questioning the power of the private respondent to
execute the real estate mortgage without the 6. That, Respondent Commercial Credit
consent of its stockholders. In due course a Corporation of Cagayan de Oro hereby agrees to
compromise agreement was entered into by the withdraw its application with Respondent City
parties on the basis of which a compromise Sheriff of Cagayan de Oro for the extra judicial
judgment was rendered by the trial court on March foreclosure of the real estate mortgage subject of
11, 1980 which reads as follows: this complaint;

"JUDGMENT 7. That, the Parties herein waive in favor of each


The parties in the above-entitled case assisted by other any and all forms of damage arising out of,
their respective counsel, submitted for the approval connected with and/or as a result of this action.
of the Court the following Compromise Agreement,
to wit: WHEREFORE, the Parties respectfully pray of this
COMES NOW, Parties, Petitioners and Respondents, Honorable Court that judgment in accordance with
represented by their respective counsels, unto this the Compromise Agreement be rendered." (Pages
Honorable Court, most respectfully submit for 25-27, Rollo)
approval the following Compromise Agreement:
1. That, Petitioners herein hereby state that they However as private respondent failed to comply
ratified and approved the loan and real estate with the terms of the judgment for failure to pay
mortgage entered into and assigned by the several installments in the amount of P70,152.65
Cagayan de Oro Coliseum, Inc. to the Commercial which matured on July 13, 1982, petitioner filed an
Credit Corporation of Cagayan de Oro and as ex-parte motion for the issuance of a writ of
38 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
execution on March 4, 1983. The Court granted the
said motion in an order dated March 10, 1983. A And in view of such disposition.
notice of auction sale was issued on March 11,
1983. Private respondent filed a motion for 1) THE JUDGMENT DATED MARCH 11, 1980 AND THE
reconsideration of said order alleging that it had ORDER DATED NOVEMBER 26, 1986 OF RESPONDENT
paid its obligation. The execution of the writ was COURT ARE HEREBY DECLARED MODIFIED
suspended pending consideration of said motion. CONFORMABLY WITH THE FEBRUARY 13, 1987
An opposition thereto was filed by petitioner to DECISION OF THE COURT; and
which a reply was filed by the private respondent
and, in turn, the comment of the petitioner was also 2) THE WRIT OF EXECUTION ISSUED BY RESPONDENT
submitted. On November 26, 1986, the trial court CLERK OF COURT, AND THE SHERIFF'S NOTICE OF
denied said motion for reconsideration and, SALE, THE PUBLIC AUCTION SALE AND THE
accordingly, a writ of execution was issued on CERTIFICATE OF SALE ARE DECLARED NULL AND
December 4, 1986. The Deputy Provincial Sheriff set VOID IN SO FAR AS THEY ARE NOT IN ACCORDANCE
the auction sale for January 23, 1987. However, said WITH AND IN EXCESS OF THE NOW MODIFIED
auction sale did not take place as scheduled due JUDGMENT AND MODIFIED ORDER OF THE
to some internal problems in the office of sheriff. RESPONDENT COURT DATED MARCH 11, 1980 AND
LexLib NOVEMBER 26, 1986, RESPECTIVELY." (Page 148,
Rollo)
Private respondent then filed a special civil action
in the Court of Appeals to annul said compromise
judgment, alleging that the trial court acted in
serious violation of law and/or in grave abuse of Hence, the herein petition for review on certiorari
discretion. In due course, a decision was rendered wherein petitioner alleges the following reasons as
by said appellate court on February 13, 1987, the warranting the grant of the petition:
dispositive part of which reads as follows:
"a) THE HONORABLE COURT OF APPEALS
"WHEREFORE, the present petition is DENIED due COMMITTED GRAVE ABUSE OF DISCRETION
course and is hereby DISMISSED. Effective March 16, AMOUNTING TO LACK OR IN EXCESS OF
1983, the overdue and unpaid installments shall JURISDICTION WHEN IT MODIFIED THE TRIAL COURTS
earn one half per cent (1/2%) per month penalty COMPROMISE JUDGMENT AFTER IT DENIED DUE
charge until fully paid, plus two per cent (2%) of the COURSE AND DISMISSED THE PETITION FOR
outstanding balance as additional attorney's fees." ANNULMENT OF RESPONDENT COLISEUM.
(Page 33, Rollo)
b) THE HONORABLE COURT OF APPEALS COMMITTED
A motion for reconsideration of the decision was GRAVE AND REVERSIBLE ERROR IN APPLYING
filed by petitioner. On March 23, 1987 a resolution ARTICLE 1229 OF THE CIVIL CODE IN THE CASE AT
denying the motion was issued by the respondent BAR.
appellate court.
c) THE HONORABLE COURT OF APPEALS COMMITTED
On the other hand, private respondent also filed a GRAVE AND REVERSIBLE ERROR WHEN IT MODIFIED
motion for reconsideration and comment on the THE EFFECTS OF THE 3% PENALTY INTEREST AND
petitioner's motion for reconsideration. On May 19, ATTORNEY'S FEES, AFTER IT UPHELD THE LEGALITY OF
1987, respondent Court issued a resolution, the THE COMPROMISE JUDGMENT OF THE TRIAL COURT."
dispositive part of which reads as follows: (Page 14, Rollo)

"Acting on the said first part of the petitioner's The petition is impressed with merit. It is axiomatic
motion for reconsideration as well as the private that a compromise judgment is final and
respondent's comment thereon, the aforestated immediately executory. Once a judgment
grounds for said motion having been already taken becomes final and executory, the prevailing party
up by this Court in reaching the said February 13, can have it executed as a matter of right and the
1987 decision, and finding no reason to disturb the execution becomes a ministerial duty on the part of
same, the said motion as to its said first part, is the court. 2 A judicial compromise has the force
DENIED for lack of merit. and effect of res judicata. 3

As to the said second part of petitioner's motion for Such a final and executory judgment cannot be
reconsideration, for clarity, the dispositive portion of modified or amended. If an amendment is to be
the February 13, 1987 decision is re-worded to read made, it may consist only of supplying an omission,
as follows: striking out a superfluity or interpreting an
ambiguous phrase therein in relation to the body of
"WHEREFORE, the present petition is GRANTED in the the decision which gives it life. 4 A compromise
sense that effective March 16, 1983, the overdue judgment should not be disturbed except for vices
and unpaid installments shall earn one half per cent in consent or forgery. 5
(1/2%) per month penalty charge until fully paid,
plus two per cent (2%) of the outstanding balance In the present case, the compromise agreement
as additional attorney's fees." was voluntarily entered into by the parties assisted
39 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
by their respective counsel and was duly approved (Insular Bank of Asia and America v. Spouses
by the trial court. Indeed, it was confirmed by the Salazar, G.R. No. 82082, March 25, 1988)
respondent appellate court to be lawful. There was,
therefore, no cogent basis for the respondent THIRD DIVISION
appellate court to modify said compromise [G.R. No. 82082. March 25, 1988.]
agreement by reducing the penalty and attorney's INSULAR BANK OF ASIA AND AMERICA, plaintiff-
fees provided for therein. cdphil appellant, vs. SPOUSES EPIFANIA SALAZAR and
RICARDO SALAZAR, defendants-appellants.
In spite of the protestation of private respondent
that the penalty and interests provided in the SYLLABUS
compromise agreement was violative of the Usury 1. MERCANTILE LAW; BANKING; ESCALATION
Law, the respondent appellate court, applying the CLAUSE; CONDITION FOR ENFORCEABILITY. It is
provisions of Central Bank Circular No. 721, found the rule that escalation clauses are valid stipulations
no violation thereof as in fact the imposition of the in commercial contracts to maintain fiscal stability
penalty is sanctioned by Article 1226 of the Civil and to retain the value of money in long term
Code. The respondent court cited the De Venecia contracts. However, the enforceability of such
vs. Del Rosario 6 where this Court held that in the stipulations are subject to certain conditions. The
absence of a stipulation to the contrary, recovery Central Bank took the position that the issuance of
of both the penalty and the interest until full its circulars is a valid exercise of its authority to
payment of the debt is allowed under existing laws. prescribe maximum rates of interest and based on
the general principles of contract, the Escalation
The modification of said compromise judgment by Clause is a valid provision in the loan agreement
the respondent appellate court is predicated on provided that (1) the increased rate imposed or
the provision of Article 1229 of the Civil Code which charged by petitioner does not exceed the ceiling
provides as follows: fixed by law or the Monetary Board; (2) the increase
is made effective not earlier than the effectivity of
"ART. 1229. The Judge shall equitably reduce the the law or regulation authorizing such an increase
penalty when the principal obligation has been and (3) the remaining maturities of the loans are
partly or irregularly complied with by the debtor. more than 730 days as of the effectivity or the law
Even if there has been no performance, the penalty or regulation authorizing such an increase.
may also be reduced by the courts if it is iniquitous (Emphasis supplied)
or unconscionable."
2. ID.; ID.; PENALTY CLAUSE; AGREEMENT THEREON,
The foregoing provision of the law applies only to VALID. With respect to the penalty clause, we
obligations or contract, subject of a litigation, the have upheld the validity of such agreements in
condition being that the same has been partly or several cases. As the Court stated in the case of
irregularly complied with by the debtor. The Government Service Insurance System v. Court of
provision also applies even if there has been no Appeals (145 SCRA 311, 321): "In the Bachrach case
performance, as long as the penalty is iniquituous or (supra) the Supreme Court ruled that the Civil Code
unconscionable. It cannot apply to a final and permits the agreement upon a penalty apart from
executory judgment. the interest. Should there be such an agreement,
the penalty does not include the interest, and as
When the parties entered into the said compromise such the two are different and distinct things which
agreement and submitted the same for the may be demanded separately. Reiterating the
approval of the trial court, its terms and conditions same principle in the later case of Equitable
must be the primordial consideration why the Banking Corp. (supra), where this Court held that
parties voluntarily entered into the same. The trial the stipulation about payment of such additional
court approved it because it is lawful, and is not rate partakes of the nature of a penalty clause,
against public policy or morals. Even the which is sanctioned by law."
respondent Court of Appeals upheld the validity of
the said compromise agreement. Hence, the 3. ID.; ID.; ID.; STIPULATION AS TO PAYMENT OF
respondent court has no authority to reduce the ADDITIONAL RATE; SANCTIONED BY LAW. In the
penalty and attorney's fees therein stipulated which case of Equitable Banking Corporation v. Liwanag
is the law between the parties and is res judicata. (32 SCRA 293, 297), the Court explained: " . . . The
stipulation about payment of such additional rate
WHEREFORE, the petition is GRANTED. The decision partakes of the nature of a penalty clause, which is
of the respondent Court of Appeals dated February sanctioned by law, (Art. 1226, Civil Code of the
13, 1987 and its resolutions dated March 23, 1987 Philippines), although 'the penalty may also be
and May 19, 1987 are hereby SET ASIDE and reduced by the courts if it is iniquitous or
another judgment is hereby rendered affirming in unconscionable.' (Art. 1229, Civil Code of the
toto the compromise judgment of the trial court Philippines) . . ."
dated March 11, 1980, with costs against private
respondent. This decision is immediately executory. DECISION
SO ORDERED. GUTIERREZ, JR., J p:
Narvasa, Cruz, Grio-Aquino and Medialdea, JJ., This is an appeal by the Insular Bank of Asia and
concur. America (IBAA) from the judgment of the Regional
40 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
Trial Court of Leyte in Civil Case No. 6932 for
collection of a sum of money with preliminary Plaintiff-appellant now raises the following assigned
attachment. The appeal was originally brought to errors:
the Court of Appeals but was certified to us by that
tribunal because it raises only a question of law. I. THE LOWER COURT ERRED IN NOT AWARDING TO
PLAINTIFF-APPELLANT PENALTY CHARGES OR
The facts are not disputed. LIQUIDATED DAMAGES IN THE AMOUNT OF 2% PER
MONTH ON ALL AMOUNTS DUE AND UNPAID;
On November 22, 1978, defendants-appellees
Epifania Salazar and Ricardo Salazar obtained a II. THE LOWER COURT ERRED IN NOT AWARDING
loan from the plaintiff-appellant in the amount of INTEREST ON THE LOAN AT 21% PER ANNUM;
Forty Two Thousand and Fifty Pesos (P42,050.00)
payable on or before December 12, 1980. This loan III. THE LOWER COURT ERRED IN THE COMPUTATION
transaction was evidenced by a promissory note OF THE AMOUNT OF OBLIGATION DUE FROM
where the defendants-appellees bound themselves DEFENDANTS-APPELLEES IN FAVOR OF PLAINTIFF-
jointly and severally to pay the amount with interest APPELLANT;
at 19% per annum and with the express authority to
increase without notice the rate of interest up to IV. THE LOWER COURT ERRED IN NOT AWARDING
the maximum allowed by law and subject further to PLAINTIFF-APPELLANT ATTORNEY'S FEES EQUIVALENT
penalty charges or liquidated damages upon TO 25% OF THE AMOUNT DUE AND EXPENSES OF
default equivalent to 2% per month on any amount LITIGATION; and
due and unpaid. In the event the account was
referred to an attorney for collection, the V. THE LOWER COURT ERRED IN NOT ORDERING
defendants-appellees were also bound to pay 25% DEFENDANTS-APPELLEES TO JOINTLY AND SEVERALLY
of any amount due as attorney's fees plus expenses PAY THE OBLIGATION. (pp. 4-5, Plaintiff-Appellant's
of litigation and costs. Brief)

In accordance with the agreement, the plaintiff- The Escalation Clause provided in the promissory
appellant increased the rate of interest to 21% note reads:
pursuant to Central Bank Circular No. 705 dated
December 1, 1979. "The interest herein charged shall be subject to
increase, without notice, depending on whatever
The promissory note matured but the defendants- policy IBAA may in the future adopt conformable to
appellees failed to pay their account. It was only law, especially to compensate for any increase in
after several demands that the defendants- Central Bank interests or rediscounting rates."
appellees were able to make partial payment. As
of November 25, 1983, they were able to pay a Finding strength in the argument that the promissory
total of P68,676.75 which payments were applied to note is the contract between the parties and,
partially satisfy the penalty and interest charges. under the law, obligations arising from contracts
have the force of law between the parties, the
On September 12, 1984, the plaintiff-appellant filed plaintiff-appellant increased the interest rate to 21%
a complaint with the Regional Trial Court alleging per annum effective December 1, 1979 pursuant to
that the defendants-appellees were indebted to Central Bank Circular No. 705. LexLib
IBAA in the amount of P87,647.19 as of September
15, 1984, including interest at 21% per annum, In line with the Court's ruling in the case of Banco
penalty charges, and attorney's fees. Cdpr Filipino v. Navarro (G.R. No. L-46591, July 28, 1987),
the interest rate may not be increased by the
At the pre-trial on October 31, 1984, the parties and plaintiff-appellant in the instant case. It is the rule
their counsels appeared. The defendant-spouses that escalation clauses are valid stipulations in
admitted the execution of the promissory note in commercial contracts to maintain fiscal stability
consideration of P48,050.00. The trial court then and to retain the value of money in long term
rendered a summary judgment the dispositive contracts. However, the enforceability of such
portion of which reads: stipulations are subject to certain conditions.

"WHEREFORE, judgment is hereby ordered in favor In the Banco Filipino case, the borrower questioned
of the plaintiff ordering the defendant spouses the additional interest charges on the loan of
Ricardo Salazar and Epifania Salazar to pay Insular P41,300.00 she obtained when the interest rates
Bank of Asia and America (IBAA) the sum of Eleven were increased from 12% to 17% per Central Bank
Thousand Two Hundred Fifty Three Pesos and Circular No. 494, issued on January 2, 1976. In a
Twenty Five Centavos (P11,253.25), with interest letter written by the Central Bank to the borrower,
thereon at the rate of 19% per annum from the filing some clarifications were made. Pertinent portions of
of the complaint on September 12, 1984 until fully the letter read:
paid. The defendants are further ordered to pay
the plaintiff attorney's fees in the amount of One "In this connection, please be advised that the
Thousand Pesos( P1,000.00) and to pay the costs." Monetary Board, in its Resolution No. 1155 dated
(p.4, Plaintiff-Appellant's Brief). June 11, 1976 adopted the following guidelines to
41 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
govern interest rate adjustments by banks and non- different and distinct things which may be
banks performing quasi-banking functions on loans demanded separately. Reiterating the same
already existing as of January 3, 1976, in the light of principle in the later case of Equitable Banking
Central Bank Circulars Nos. 492-498: Corp. (supra), where this Court held that the
stipulation about payment of such additional rate
"1. Only banks and non-bank financial partakes of the nature of a penalty clause, which is
intermediaries performing quasi-banking functions sanctioned by law."
may increase interest rates on loans already existing
as of January 2, 1976, provided that: In the case of Equitable Banking Corporation v.
Liwanag (32 SCRA 293, 297), the Court explained:
"a. The pertinent loan contract documents contain
escalation clauses expressly authorizing lending xxx xxx xxx
bank or non-bank performing quasi-banking
functions to increase the rate of interest stipulated ". . . We have not overlooked the 14% interest that
in the contract, in the event that any law or Central appellant has been sentenced to pay. This may
Bank regulation is promulgated increasing the appear to be usurious, but it is not so. The rate
maximum interest rate for loans; and stipulated was 9%, subject, however, to an
additional rate of 6%, in the event of default. The
"b. Said loans were directly granted by them and stipulation about payment of such additional rate
the remaining maturities thereof were more than partakes of the nature of a penalty clause, which is
730 days as of January 2, 1976; and sanctioned by law, (Art. 1226, Civil Code of the
Philippines), although 'the penalty may also be
"2. The increase in the rate of interest can be reduced by the courts if it is iniquitous or
effective only as of January 2, 1976 or on a later unconscionable.' (Art. 1229, Civil Code of the
date." (emphasis supplied) Philippines) . . ."

Moreover, in its comment and supplemental Admittedly, the defendants-appellees in the instant
comment submitted upon orders of this Court, the case failed to pay the loan on the due date.
Central Bank took the position that the issuance of However, with earnest efforts, they tried to pay the
its circulars is a valid exercise of its authority to loan little by little so that as of November 25, 1983, a
prescribe maximum rates of interest and based on total of P68,676.75 had been paid. The plaintiff-
the general principles of contract, the Escalation appellant, on the other hand, merely applied this
Clause is a valid provision in the loan agreement amount to satisfy the penalty and interest charges
provided that (1) the increased rate imposed or which it additionally imposed. We do not find any
charged by petitioner does not exceed the ceiling evidence of bad faith on the part of the
fixed by law or the Monetary Board; (2) the increase defendants-appellees in their failure to pay the loan
is made effective not earlier than the effectivity of on time. Efforts were indeed made to make good
the law or regulation authorizing such an increase their promise. We note the trial court's observation
and (3) the remaining maturities of the loans are that the plaintiff-appellant did not even state in the
more than 730 days as of the effectivity or the law complaint that the defendants-appellees had
or regulation authorizing such an increase. made partial payments, making it appear that the
(Emphasis supplied) spouses Salazars refused to pay the loan. In their
answer with counterclaim, the defendants-
In the case at bar, the loan was obtained on appellees alleged that the bank neglected to
November 21, 1978 and was payable on or before credit said payments in the defendant's account
November 12, 1980. Central Bank Circular No. 705, folio and subjected it as it did to the additional
authorizing the increase from 19% to 21% was issued charges. Furthermore, we agree with the trial court
on December 1, 1979. Obviously, as of this date, that the bank has already profited considerably
December 1, 1979, the remaining maturity of the from the loan. In a span of about six (6) years, the
loan was less than 730 days. Hence, the plaintiff- bank was enriched by P26,626.75 (p. 17, Records).
appellant's second assignment of error is without The penalty charges of 2% a month are, therefore,
merit. LexLib out of proportion to the damage incurred by the
bank. In accordance with Article 1229 of the Civil
With respect to the penalty clause, we have upheld Code, the Court is constrained to reduce the
the validity of such agreements in several cases. As penalty for being highly iniquitous.
the Court stated in the case of Government Service
Insurance System v. Court of Appeals (145 SCRA With respect to the attorney's fees, the court is
311, 321): likewise empowered to reduce the same if they are
unreasonable or unconscionable notwithstanding
the express contract for attorney's fees. The award
of one thousand (P1,000.00) pesos by the trial court
"In the Bachrach case (supra) the Supreme Court appears to be enough.
ruled that the Civil Code permits the agreement
upon a penalty apart from the interest. Should The promissory note signed by the defendants-
there be such an agreement, the penalty does not appellants states that the loan of P42,050.00 shall
include the interest, and as such the two are bear interest at the rate of 19% per annum. This
42 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
would yield interest of P7,989.50 per annum or a circumstances, the respondent bank was entitled to
total of P46,339.10 from November 22, 1978 to summary judgment (Philippine National Bank v. Phil.
September 12, 1984, the date of filing the Leather Co., Inc., et al. 105 Phil. 400; See also
complaint. Penalty interest of 1% a month or 12% Mercado, et al. v. Court of Appeals supra).
per annum is reasonable so that from December
12, 1980 up to September 12, 1984, penalty charges 3. ID.; ID.; ID.; BY GENUINE ISSUE IS MEANT AN ISSUE
should be P19,202.83. Considering that the OF FACT WHICH CALLS FOR PRESENTATION OF
defendants-appellees have paid the amount of EVIDENCE; DISTINGUISHED FROM A SHAM;
P68,676.75, they, therefore, owed the bank the FICTITIOUS; CONTRIVED ISSUE. By genuine issue is
amount of P38,915.18 when the complaint was meant an issue of fact which calls for the
filed. There is no indication in the records as to the presentation of evidence (Cadirao v. Estenzo, 132
fluctuation of actual interest rates from 1984 and, SCRA 93) as distinguished from an issue which is
therefore, we order interest at the legal rate of 12% sham, fictitious, contrived, set up in bad faith, or
per annum on the unpaid amount. patently unsubstantial as not to constitute a
genuine issue for trial. (Vergara, Sr. v. Suelto, et al.,
WHEREFORE, the decision of the lower court is G.R. No. 74766 December 21, 1987, Cadirao v.
MODIFIED. The defendants-appellants Ricardo Estenzo supra; Mercado, et al. v. Court of Appeals,
Salazar and Epifania Salazar are ordered to pay G.R. No. L-44001 June 10, 1988) This can be
Insular Bank of Asia and America (IBAA) the sum of determined by the court on the basis of the
THIRTY-EIGHT THOUSAND NINE HUNDRED FIFTEEN pleadings, admissions, documents, affidavits and/or
PESOS and EIGHTEEN CENTAVOS (P38,915.18) with counter-affidavits submitted by the parties to the
interest thereon at the rate of Twelve Percent (12%) court. (Section 3, Rule 34, Revised Rules of Court;
per annum from the filing of the complaint until fully Vergara v. Suelto supra; Cadirao v. Estenzo supra).
paid.
4. CIVIL LAW; OBLIGATIONS AND CONTRACTS;
SO ORDERED. OBLIGATIONS WITH A PENAL CLAUSE; PENALTY
INTERESTS ARE IN THE NATURE OF LIQUIDATED
Fernan, Feliciano and Cortes, JJ., concur. DAMAGES AND MAY BE EQUITABLY REDUCED BY
COURTS IF INIQUITOUS OR UNCONSCIONABLE.
Bidin, J.,took no part. Penalty interests are in the nature of liquidated
damages (Cumagun v. Philippine American
(Garcia v. Court of Appeals, G.R. Nos. 82282-83, Insurance Co., Inc., et al. G.R. No. 81453 August 15,
November 24, 1988) 1988; Lambert v. Fox, 26 Phil. 588) and may be
equitably reduced by the courts if they are
THIRD DIVISION iniquitous or unconscionable. (See Articles 1229,
[G.R. Nos. 82282-83. November 24, 1988.] 2227, New Civil Code).
ANTONIO M. GARCIA, DYNETICS, INC., and MATRIX
MANAGEMENT CORPORATION, petitioners, vs. DECISION
COURT OF APPEALS and SECURITY BANK AND TRUST GUTIERREZ, JR., J p:
COMPANY, respondents. In a summary judgment rendered by the Regional
Sycip, Salazar, Hernandez & Gatmaitan for Trial Court of Makati in Civil Case No. 10398, the
petitioners. complaint was dismissed for lack of merit and the
Bengzon, Zarraga, Narciso, Cudala, Pecson & petitioners were ordered to pay the private
Bengson for private respondent. respondent the following: (a) the unpaid principal
sum of P15 million remaining unpaid out of
SYLLABUS Chemark's availment of the P20 million credit line,
1. REMEDIAL LAW; CIVIL PROCEDURE; SUMMARY plus 18% interest per annum and 36% as penalty per
JUDGMENT; HOW IT MAY BE RENDERED. A annum for Promissory Note No. DLS/74/540/83 from
Summary Judgment may be rendered by a court March 23, 1984 until fully paid; and plus 24% interest
upon motion of a party before trial and after per annum and 36% as penalty per annum for
submission of pleadings, admissions, documents Promissory Note No. DLS/74/1358/83 from August 9,
and/or affidavits and counter affidavits when it is 1983 until fully paid; (b) attorney's fees equivalent to
clear that "except as to the amount of damages, 10% of the total amount of plaintiffs' obligations and
there is no genuine issue as to any material fact (c) costs of suit.
and that the moving party is entitled to a judgment
as a matter of law." (Rule 34, Rules of Court). The summary judgment was affirmed by the Court
of Appeals. The appellate court's decision and the
2. ID.; ID.; ID.; CASE AT BAR. The affidavit and resolution denying a motion for reconsideration are
supporting documents were attached to the now challenged by the petitioners in the instant
respondent bank's motion for summary judgment. petition.
The petitioners failed to oppose Marquez' affidavit
in their "Oppositions" to the motion for summary The antecedent facts relevant to the instant
judgment. Neither did they submit counter- petition are as follows:
affidavits, as was their right, to oppose these
amounts due from them including the increased On April 23, 1985 petitioners Dynetics, Inc., Matrix
interests and penalty charges. Under these Management and Trading Corporation and
43 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
Antonio M. Garcia filed a complaint for declaratory as the general principles of equity, especially the
relief and/or injunction with damages against doctrine of the 'rebus sic stantibus' and 'the
respondent Security Bank and Trust Company frustration of the commercial object or frustration of
(SBTC). The plaintiffs sought a judicial declaration enterprise' and under Article 1267 of the New Civil
that they were not liable to the defendant bank Code, when the service has become so difficult as
under certain Indemnity Agreements they to be manifestly beyond the contemplation of the
executed in favor of Chemark Electric Motors, Inc. parties, the obligor may be released therefrom;
which had been extended a credit
accommodation of about P20,000,000.00 by the g) In addition to the reasons stated in paragraphs e
defendant bank. They also prayed for payment of and f hereof, Chemark, the principal obligor, is not
attorney's fees and costs of suit. Thus, they alleged liable for its obligations under the credit
in their complaint: accommodations extended to it by the defendant
because it has been prohibited from complying
xxx xxx xxx therewith by a lawful authority. Under the law on
guaranty and surety, the guarantor or the surety,
"a) There is no valid consideration for the execution not being a principal debtor, is not liable for the
of the said instruments; obligations unless the principal obligor is likewise
liable. (Article 2054 of the New Civil Code; Hospicio
b) The said instruments had become invalid and de San Jose v. Fidelity and Surety Co., 52 Phil. 926;
ineffective at the time the defendant finally Uy Isabelo v. Yandoc, CA-G.R. No. 8801-R, June 20,
extended the loan accommodation to Chemark 1956). The debtor in obligations to do shall also be
and that the parties to the said instruments did not released when the prestation becomes legally
intend the said instruments to cover Chemark's impossible without the fault of the obligor. (Article
obligations to the defendant which were 1266 of the New Civil Code);
subsequently granted under separate and
independent transactions; h) Assuming, without conceding, that the plaintiffs
are liable under the Indemnity Agreement
c) Assuming, without conceding, that there is a instruments, they are not liable for the amounts
valid consideration for the execution of the being claimed by the defendant, considering that
aforesaid instruments and that the said instruments the said amounts include the payment of
continued to be valid and effective when the exorbitant interests, excessive penalties and
defendant extended a credit accommodation to amounts imputed to be due which are not, in fact,
Chemark, said instruments are null and void insofar due." (Rollo, pp. 106-107)
as Dynetics is concerned as it is ultra vires, being
contrary to the purposes of Dynetics, its powers, On June 11, 1985 the respondent bank filed its
licenses and franchise; Answer and Counterclaim with prayer for
preliminary attachment. The defendant alleged in
d) Assuming, without conceding, that the Indemnity its counterclaim:
Agreement instruments are valid and enforceable,
the obligations of the plaintiffs thereunder have ALLEGATIONS COMMON TO ALL DEFENDANTS
been extinguished, either by novation or by the
acts and conduct of the defendant, who, under "21. Sometime in August, 1981, Chemark was
the circumstances, in refusing the valid and granted by plaintiff a credit line of P4.0 million
legitimate plea of Chemark for a reasonable consisting of an import LC-TR line of P2.0 million and
restructuring plan of its obligations has practically an export loan line of P2.0 million.
rendered it impossible for Chemark to pay its
obligations to its creditors and to the plaintiffs in the 22. Said credit line was increased in February, 1982
event plaintiffs are legally obligated to pay from P4.0 million to P20.0 million, to wit:
Chemark's obligations to the defendant;
Export loan line from P2.0 million to P15.0 million
e) In the light of present economic conditions, in
general, and the condition of Chemark in Import LC-TR from P2.0 million to P5.0 million.
particular, as well as the financial condition of the
plaintiffs, the demand of the defendant for the The terms and conditions of this P20.0 million credit
plaintiffs to pay the Chemark obligations would are reflected in the Amended Credit Line
constitute an abuse of right as defined in the New Agreement dated February 8, 1982 attached as
Civil Code; Annex "1" hereof;

f) Considering the present adverse economic 23. Chemark availed of said credit line and as
conditions plaguing the entire country, the terms evidence of said availments, Chemark executed
and conditions of the credit accommodation and several promissory notes covering the following
the Indemnity Agreement instruments, assuming amounts drawn against this credit line, viz;
that the latter are valid and enforceable, have
become so manifestly difficult as to be beyond the a) The sum of P6,350,750.00 drawn on March 23,
contemplation of the parties. Under the provisions 1983 with interest and penalty at the rate indicated
of Human Relations of the New Civil Code, as well
44 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
in Promissory Note No. DLS/74/540/83 to mature on and by virtue of the aforesaid credit line
June 21, 1983, a copy is attached as Annex "3"; accommodation including the substitutions,
renewals, extensions, increases and other
b) The sum of P8,649,250.00 drawn on August 9, amendments of the aforesaid credit
1983 with interest and penalty at the rate indicated accommodations, as well as of the amount of such
in Promissory Note No. DLS/74/1358/83 to mature on other obligations that Chemark may owe the
September 8, 1983 copy of which is hereto defendant.
attached as Annex "4".
31. Accordingly, Matrix through its duly authorized
24. Chemark defaulted in paying its obligations officers, executed an Indemnity Agreement dated
under the aforesaid promissory notes when these February 8, 1982, a copy of which is attached
became due. Despite repeated demands, hereto as Annex "A" and incorporated herein by
Chemark failed and refused to pay its valid and just reference.
obligations to the defendant which, as of
December 11, 1984, amounted to P13,130,596.93 32. Under the terms of the foregoing indemnity
under Promissory Note No. DLS/74/540/83 and agreement executed by Matrix, it further bound
P17,357,117.51 under PN No. DLS/74/1358/83. itself solidarily with Chemark in favor of defendant
for the faithful compliance of all the terms and
CAUSE OF ACTION AGAINST ANTONIO M. GARCIA conditions contained in the Credit Line Agreement
(Annex "B").
25. Plaintiff Garcia personally bound himself jointly
and severally without Chemark, to pay defendant 33. Defendant demanded from Matrix the payment
upon demand and without benefit of excussion, of of the outstanding obligation of Chemark in a letter
whatever amount or amounts Chemark may be dated October 26, 1984, a copy of which is made
indebted to defendant under and by virtue of the Annex "5" to form part hereof. Defendant reiterated
aforesaid credit line accommodation, including the said demand on April 25, 1985.
substitutions, renewals, extensions, increases and
other amendments of the aforesaid credit 34. Notwithstanding said demands, Matrix failed
accommodations, as well as all other obligations and refused, as it still fails and refuses, to pay its
that Chemark may owe the defendant. obligation pursuant to the indemnity agreement it
executed in plaintiff's favor.

CAUSE OF ACTION AGAINST DYNETICS, INC.


26. Accordingly, plaintiff Garcia executed two (2)
Indemnity Agreements, one dated January 20, 35. Plaintiff Dynetics bound itself jointly and severally
1982, a copy of which is attached hereto and with Chemark in favor of the defendant for the
made integral part hereof as Annex "E" and the payment, upon demand and without benefit of
other, an Indemnity Agreement dated February 8, excussion, of whatever amount or amounts
1982, as Annex "B" of the Complaint; Chemark may be indebted to defendant under
and by virtue of the aforesaid credit line
27. Under the terms of the foregoing Indemnity accommodation including the substitutions,
Agreements executed by plaintiff Garcia, he further renewals, extensions, increases and other
bound himself solidarily with Chemark in favor of amendments of the aforesaid credit
defendant for the faithful compliance of all the accommodations, as well as of the amount of such
terms and conditions contained in the Amended obligations that Chemark may owe the defendant.
Credit Line Agreement (Annex "1").
36. Dynetics executed an indemnity agreement
28. Defendant demanded from plaintiff Garcia the dated February 8, 1982, copy of which is attached
payment of the outstanding obligation of Chemark as annex "A" of the Complaint.
in a letter dated October 26, 1984, a copy of which
is made Annex "5" to form part hereof. Defendant 37. Under the terms of the foregoing Indemnity
reiterated said demand on April 15, 1985. Agreement executed by Dynetics, it further bound
itself solidarily with Chemark in favor of defendant
29. Notwithstanding said demands, plaintiff Garcia for the faithful compliance of all the terms and
failed and refused, as he still fails and refuses to pay conditions contained in the Amended Credit Line
his obligation pursuant to the indemnity Agreement (Annex "1").
agreements he executed.
38. Defendant demanded from Dynetics the
CAUSES OF ACTION AGAINST MATRIX payment of the outstanding obligation of Chemark
MANAGEMENT & TRADING CORPORATION in a letter dated October 26, 1984, a copy of which
is made Annex "5", to form part hereof. Defendant
30. Plaintiff Matrix bound itself jointly and severally reiterated said demand on April 25, 1985.
with Chemark in favor of the defendant for the
payment, upon demand and without benefit of 39. Notwithstanding said demands, Dynetics failed
excussion, of whatever amount or amounts and refused, as it still fails and refuses to pay its
Chemark may be indebted to defendant under
45 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
obligation pursuant to the indemnity agreement it The petitioners submit that the appellate court
executed in defendant's favor." (Rollo, pp. 108-111) committed such an error, to wit:

On August 21, 1985, the petitioners manifested that "a. The rendition of Judge Mendoza's Summary
". . . they are adopting all allegations in their Judgment was improper because petitioners'
Complaint as their answer to the respective Complaint and SBTC's Answer with Counterclaim
counterclaim against each of them." (Original raise triable issues of fact. The Court of Appeals,
Records, p. 229) therefore, erred when it sustained Judge Mendoza's
Summary Judgment.
On September 18, 1985, the respondent bank filed
a motion for summary judgment on the ground that b. Assuming (the untrue) that there were no
the answer to the counterclaim "tenders no 'genuine issues as to any material fact,' the awards
genuine issue as to any material fact, and consists set out in Judge Mendoza's Summary Judgment
of mere conclusions of law and fact, and in were rendered in violation of rules of evidence and
paragraph 4 thereof, plaintiffs expressly laws and jurisprudence on interest, penalties and
acknowledged their obligation to defendant and attorney's fees. The appellate court, therefore,
indemnity agreements dated February 8, 1982 committed the same violation when it upheld
when they admitted "under said instruments, it was Judge Mendoza's Summary Judgment." (Rollo, p.
basically provided that for and in consideration of 325).
the credit accommodation in the total amount of
Twenty Million (20,000,000.00) Pesos, granted by A Summary Judgment may be rendered by a court
defendant in favor of Chemark Electric Motors, Inc., upon motion of a party before trial and after
a corporation duly organized and existing under submission of pleadings, admissions, documents
the laws of the Philippines, plaintiffs agreed to and/or affidavits and counter affidavits when it is
indemnify defendant in the event Chemark should clear that "except as to the amount of damages,
fail to comply with its obligations.'" (Original there is no genuine issue as to any material fact
Records, p. 248) In support of the motion, the and that the moving party is entitled to a judgment
respondent bank attached the affidavit dated as a matter of law." (Rule 34, Rules of Court). By
September 17, 1985 of Ms. Charis Marquez, Senior genuine issue is meant an issue of fact which calls
Assistant Manager, corporate banking group, SBTC for the presentation of evidence (Cadirao v.
including its annexes. Estenzo, 132 SCRA 93) as distinguished from an issue
which is sham, fictitious, contrived, set up in bad
The petitioners filed an opposition to the motion for faith, or patently unsubstantial as not to constitute a
summary judgment but to no avail. The lower court genuine issue for trial. (Vergara, Sr. v. Suelto, et al.,
rendered a decision granting the motion for G.R. No. 74766 December 21, 1987, Cadirao v.
summary judgment. The petitioners' complaint was Estenzo, supra; Mercado, et al. v. Court of Appeals,
dismissed and they were ordered to pay the G.R. No. L-44001 June 10, 1988) This can be
respondent bank under the indemnity agreements. determined by the court on the basis of the
pleadings, admissions, documents, affidavits and/or
The petitioners then filed with the Court of Appeals: counter-affidavits submitted by the parties to the
1) an appeal from the summary judgment and 2) a court. (Section 3, Rule 34, Revised Rules of Court;
special civil action for certiorari and prohibition with Vergara v. Suelto, supra; Cadirao v. Estenzo, supra).
a prayer for preliminary injunction to annul the
orders of the lower court granting motion for The pleadings, admissions and affidavits submitted
summary judgment and granting motion for in court in this case reveal the following facts:
execution pending appeal. The two cases were
consolidated. In August 1981, Chemark was granted by
respondent bank a credit line of P4.0 million which
The appellate court sustained the summary was increased in February 1982 to P20.0 million, to
judgment. Both petitions were dismissed with costs wit; Export loan line from P2.0 million to P15.00
against the petitioners. A motion for reconsideration million; Import LC/TR from P2.0 million to P5.0
thereto was denied. million. The terms and conditions of this P20 million
credit are stated in the Credit Line Agreement
Hence, this petition. dated February 8, 1982 (p. 254, Records). On this
same day, February 8, 1982 the petitioners
On March 30, 1988, we issued a temporary executed separate, but with similar terms,
restraining order to enjoin the enforcement of the indemnity agreements whereby they bound
questioned decision of the appellate court. In a themselves jointly and severally with Chemark to
Resolution dated June 6, 1988, we gave due course pay respondent bank upon demand and without
to the petition. excussion of whatever amount Chemark may be
indebted to said bank by virtue of said credit line
The issue raised in the petition is whether or not the accommodation including the substitution,
appellate court committed reversible error when it renewals, extensions, increases and other
sustained the trial court's summary judgment. amendments thereof; and that upon default of
Chemark, proper demands to pay were made on
the petitioners to comply with their obligations. The
46 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
three indemnity agreements binding each of the
petitioners contain the following provisions: Signed in the Presence of:

INDEMNITY AGREEMENT (SGD.) JONA C. CAJUYONG

KNOW ALL MEN BY THESE PRESENTS: That (SGD.) TERESITA A. DE GUZMAN"

"DYNETICS, INC., a corporation duly organized and (Original Records, pp. 306-307)
existing under and by virtue of the laws of the
Philippines, with offices at the FTI Complex, Taguig, Both Dynetics and Matrix were authorized by their
Metro Manila for and in consideration of the respective board of directors to execute the
credit accommodation in the total amount of indemnity agreements. In the case of Dynetics,
TWENTY MILLION (P20,000,000.00) PESOS granted by Corporate Secretary Antonio Pastelero certified
the SECURITY BANK & TRUST COMPANY, a that during a meeting of the Board of Directors held
commercial banking corporation duly organized on December 29, 1981 at its office address, it was
and existing under and by virtue of the laws of the unanimously adopted that the corporation ". . .
Philippines, with offices at 6778 Ayala Avenue, undertake to jointly and severally guarantee the
Makati, Metro Manila, hereinafter, referred to as the credit line of CHEMARK ELECTRIC MOTORS, INC. in
BANK, in favor of CHEMARK ELECTRIC MOTORS, favor of the SECURITY BANK & TRUST COMPANY, in
INC., . . . a corporation duly organized and existing an amount not to exceed TWENTY MILLION
under and by virtue of the laws of the Philippines, (20,000,000.00) PESOS" (p. 264, Original Records). In
with offices at the 2nd Floor, Princess Building, the case of MATRIX, Corporate Secretary Rene J.
Esteban Street, Legaspi Village, Makati, Metro Katigbak certified that at the meeting of the Board
Manila, hereinafter referred to as the CLIENT, with of Directors held on December 28, 1981, a
the stipulated interests and charges thereon, resolution was unanimously adopted to have the
evidenced by that/those certain AMENDED CREDIT corporation ". . . jointly and severally guarantee the
LINE AGREEMENT made and executed by and credit line of CHEMARK ELECTRIC MOTORS, INC. in
between the CLIENT and the BANK on even date favor of the SECURITY BANK & TRUST COMPANY, in
hereby bind(s) himself/themselves jointly and an amount not to exceed TWENTY MILLION
severally with the CLIENT in favor of the BANK for the (P20,000,000.00) PESOS." (Original Records p. 262)
payment, upon demand and without benefit of
excussion, of whatever amount or amounts the Chemark then availed of the P20.0 million credit line
CLIENT may be indebted to the BANK under and by and executed two (2) promissory notes covering
virtue of aforesaid credit accommodation(s) the following amounts drawn against the Export
including the substitutions, renewals, extensions, Loan Line, to wit:
increases, amendments, conversions and revivals of
the aforesaid credit accommodation(s), as well as "a) The sum of P6,350,750.00 drawn on March 23,
of the amount or amounts of such other obligations 1983 with interest and penalty at the rate indicated
that the CLIENT may owe the BANK, whether direct in Promissory Note No. DLS/74/540/83 to mature on
or indirect, principal or secondary, as appears in June 21, 1983" (p. 255, Original Records)
the accounts, books and records of the BANK, plus
interest and expenses arising from any agreement "b) The sum of P8,649,250.00 drawn on August 9,
or agreements that may have heretofore been 1983 with interest and penalty at the rate indicated
made, or may hereafter be executed by and in Promissory Note No. DLS/74/1358/83 to mature on
between the parties thereto, including the September 3, 1983" (p. 256, Original Records)
substitutions, renewals, extensions, increases,
amendments, conversions and revivals of the These obligations were not paid by Chemark when
aforesaid credit accommodation(s), and further they became due. Hence, the respondent bank
bind(s) himself themselves with the CLIENT in favor demanded from the petitioners under the
of the BANK for the faithful compliance of all the indemnity agreements the payment of the
aforesaid credit accommodation(s), all of which outstanding obligations of Chemark.
are incorporated herein and made part hereof by
reference. Undoubtedly, the obligations of the petitioners to
the respondents are clearly defined in the
pleadings, admissions and the unrebutted affidavit
of Ms. Marquez who handles the Chemark
IN WITNESS WHEREOF, these presents are signed at account.
Makati, Metro Manila on this 8th day of February,
1982 . . . and/or its trust accounts funding this loan Nevertheless, the petitioners insist that their
complaint for declaratory relief tenders genuine
issues which should be threshed out in a full-blown
DYNETICS, INC. trial, to wit:

(SGD.) ANTONIO M. GARCIA xxx xxx xxx

(SGD.) DOMINADOR GAMEZ


47 | O B L I C O N _ C h a p t e r 3 _ O b l i g a t i o n w i t h a p e n a l c l a u s e
"11.1 First Defense: that the principal obligation has loans and that SBTC extended the loan solely on
not yet matured because SBTC, agreed to allow Chemark's viability as a business enterprise.
Chemark a grace period within which to recover its
liquidity and pay the debt. "11.2A The Complaint pleads this defense in the
following paragraphs:
11.1A This defense is pleaded in the following
allegations of the Complaint: '5. . . . when the defendant finally extended the
loan to Chemark, it did so not because of the
"'6. In the aftermath of the assassination of Senator aforesaid instrument (referring to the Indemnity
Benigno S. Aquino, Jr., on August 21, 1983, the Agreements) previously executed by the
Philippine economy was plunged into a deep crisis. (petitioners) which, in the meantime, were no
There was a massive flight of capital; the country's longer valid and effective and intended by the
balance of payments deteriorated; business and parties as collateral security for future Chemark
industry practically stood still; and the foreign debts loans, but because of defend assessment of the
of the country could not be serviced; banks viability of Chemark's business operations and
collapsed, the exchange rate between the interest income expected to be generated from
Philippine Peso and US Dollar tripled and there was the loans to Chemark.' (Emphasis supplied) (Rollo,
practically no foreign exchange available in the pp. 329-330).
country. The resultant extremely adverse economic
conditions were not foreseen or contemplated by xxx xxx xxx
persons entities who became parties to a contract.
None of the parties to a contract expected nor did "11.3 Third Defense: that Dynetic's execution of the
they intend that the terms and conditions they Indemnity Agreement is contrary to its purposes and
agreed upon would operate under extreme is therefore ultra vires and unenforceable against it.
adverse economic conditions.
11.3A This defense is pleaded in the Complaint as
'7. Because of the recent economic developments follows:
here and abroad, the failure of one of the
stockholders of Chemark to comply with its '13. Plaintiffs are not liable to the defendant under
commitments and Chemark's inability to collect the Indemnity Agreement instruments . . . for the
substantial receivables from its marketing following reasons:
representatives in the United States, Chemark
started to suffer liquidity problems. As a xxx xxx xxx
consequence, it was unable to pay its creditors,
among whom is the defendant. However, Chemark (c) Assuming, without, conceding, that there is a
had more than sufficient assets to pay all its valid consideration for the execution of the
obligations including its obligations to the aforesaid instruments and that said instruments
defendant, except that its liquidity problems continued to be valid and effective when the
prevented it from paying its creditors. defendant extended a credit accommodation to
Chemark, said instruments are null and void insofar
'8. Chemark started negotiating with the defendant as Dynetics is concerned as it is ultra vires, being
for the restructuring of its obligations to the latter. contrary to the purpose of Dynetics, its powers,
For this purpose, it submitted several proposed licenses and franchise. (Emphasis supplied)'" (Rollo,
courses of action to the defendant whereby in time pp. 332-333)
all of its obligations to the defendant would be
paid. We find no material questions of facts tendered by
these defenses as to the main issue on whether or
'9. In the meantime, the defendant demanded not the petitioners can be held liable to the
payment from the plaintiffs of the obligations of respondent bank under their indemnity
Chemark. Although plaintiffs are not legally liable agreements.
for the payment of such obligations, they
nonetheless, proposed to the defendant that the The issue tendered in the first defense is "sham and
latter allow Chemark to recover its liquidity until fictitious" in the light of the terms of the indemnity
such time that it shall have recovered its ability to agreements. Thus, under the indemnity
pay its obligations. An agreement in principle was agreements, the petitioners bound themselves
reached on this proposal and this defendant jointly and severally with Chemark in favor of the
committed itself to allow Chemark to recover from respondent bank for the payment, upon demand
its liquidity problems and to refrain from demanding and without benefit of excussion, of whatever
payment the loans of Chemark from the plaintiffs. amount or amounts Chemark may be indebted to
(Emphasis supplied)." (Rollo, pp. 328-329). the respondent bank under and by virtue of the
credit accommodations. (Emphasis supplied) The
xxx xxx xxx economic conditions of the country are immaterial
to the issue on the liability of the petitioners under
"11.2 Second Defense: that SBTC and the petitioners their indemnity agreements.
did not intend to use petitioners' Indemnity
Agreements as collateral security for Chemark's
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The issue raised in the second defense, on whether "Then Dynetics argues that it has raised the issue of
or not the indemnity agreements were intended as novation in light of the new loan contracts between
collaterals for future Chemark loans is likewise sham Security Bank and Chemark. Again, the alleged
and fictitious. Under the indemnity agreements, the new contracts are established facts and need not
petitioners bound themselves to pay whatever be the subject of trial. Upon their basis, the court
amount Chemark may be indebted to the bank can conclude whether there is novation of
"under and by virtue of aforesaid credit contract." (Rollo, p. 125)
accommodation(s) including the substitutions,
renewals, extensions, increases, amendments, The petitioners also assail the awards of penalty
conversions and revivals of the aforesaid credit charges at 36% per annum and interest at 18% and
accommodation(s) . . . ." (Emphasis supplied) 24% per annum respectively on the loans. They
contend that the interests are excessive and are
The argument as to whether or not Dynetics' not sustained by the evidence because the rate of
execution of the indemnity agreement is contrary interest stipulated in the promissory notes is only 11%
to its purposes and therefore ultra vires and per annum.
unenforceable against it does not tender a
genuine issue. The record shows that Dynetics was The lower courts based the computation of interests
authorized to execute the indemnity agreements and penalty charges on the affidavit of Charis
evidenced by the Corporate Secretary's certificate Marquez, Assistant Manager of the Corporate
(p. 38, 264 Original Records). Banking Group of Security Bank & Trust Co. Marquez
was the account officer who handled the account
This was not rebutted. of Chemark. The pertinent portions of the affidavit
read as follows:
Indeed, we find no genuine issues raised in the
complaint which can not be resolved by the "22. As per statements of Accounts dated June 15,
pleadings, admissions and the affidavit of Charis 1985, under the said promissory notes (Annexes '2'
Marquez submitted to the court. As the appellate and '3' hereof) covered by the subject Indemnity
court said: Agreements (Annexes '4' '7' and '8' hereof), the total
outstanding obligation of Dynetics, Inc., Matrix
"Dynetics, Garcia and Matrix attempted to avoid Management & Trading Corporation and Antonio
liability by trying hard to create factual issues fit for M. Garcia to Security Bank & Trust Co. was
trial. The attempt is but a hodgepodge of legal P38,189,038.27, including interest and charges.
arguments and conclusions which can be resolved Attached hereto as Annexes '9' and '10' are copies
without the rituals of trial. Thus, Dynetics urges that of said Statements of Accounts dated June 15,
there is need for trial to determine whether it can 1985;
be compelled to pay considering that SEC by its
Order of September 27, 1984 has prohibited 23. In the said Statements of Accounts dated June
Chemark from paying its creditors. The issue is strictly 15, 1985, we charged 18% and 25% per annum,
legal and can be decided by determining the respectively, because the subject loans (Annexes '2'
character of liability of Dynetics as joint and solidary and '3' hereof) were intended to be rediscounted
debtor. Dynetics also argues that it raised the issue at the Central Bank at 11% per annum. However,
of lack of consideration which must be tried on the when Chemark Electric Motors, Inc. failed to give us
merits. The issue deserves scant consideration for the required letter of credit which was a
the parties' Indemnity Agreement, specifies the requirement of the Central Bank, we charged them
consideration to be the grant of credit 18% and 24% instead of 11% interest per annum.
accommodation to Chemark in the sum of P20 M. These higher interest charges were based on and
Also what is posed is a legal issue resolvable in light authorized under our Credit Proposal, copies of
of the character of Dynetics as a joint and solidary which are hereto attached as Annexes '11' to '11-
debtor. Dynetics also asseverates that it did not B'." (Original Records, p. 252)
intend its Indemnity Agreement as collaterals for
future Chemark loans. This is a clear pretense The increased interest rates are expressly provided
considering that again under its Indemnity for in the amended credit line agreement and in
Agreement, Dynetics clearly bound itself to pay the two promissory notes executed by Chemark in
whatever amount Chemark may be indebted to favor of Security Bank & Trust Co. We find no
Security Bank 'under and by virtue of the aforesaid reversible error in the award of interests.
credit accommodation(s) including the
substitutions, renewals, extensions, increases, The penalty of 36% per annum is provided in the
amendments, conversions and revivals of aforesaid promissory notes (Annexes "3", "4" Affidavit), as
credit accommodation(s.)' There is nothing on follows:
record to substantiate the pretense of mistake of
Dynetics." (Rollo, p. 121) "If this note is not fully paid when due, the
undersigned shall pay, in addition to the stipulated
interest, a penalty of 3% per month on the total
outstanding principal and interest due and unpaid.
xxx xxx xxx . . ." (Original Records, p. 256)

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The affidavit and supporting documents were Affidavit of Charis Marquez) (Original Records, p.
attached to the respondent bank's motion for 255)
summary judgment. The petitioners failed to oppose
Marquez' affidavit in their "Oppositions" to the The award for attorney's fees is justified and, in fact,
motion for summary judgment. Neither did they is even lower than that agreed upon by the parties.
submit counter-affidavits, as was their right, to
oppose these amounts due from them including WHEREFORE, the instant petition is DISMISSED. The
the increased interests and penalty charges. Under questioned decision and resolution of the Court of
these circumstances, the respondent bank was Appeals are AFFIRMED except for the award of
entitled to summary judgment (Philippine National penalty charges which is stricken from the
Bank v. Phil. Leather Co., Inc., et al., 105 Phil. 400; judgment. The Temporary Restraining Order issued
See also Mercado, et al. v. Court of Appeals, on March 30, 1988 is LIFTED. Costs against the
supra). As earlier stated, the lower court committed petitioners.
no reversible error in awarding the questioned
interests. We cannot, however, agree with the SO ORDERED.
appellate court as regards the award of penalty
charges at 36% per annum. Fernan, C.J., Bidin and Cortes, JJ ., concur.

Penalty interests are in the nature of liquidated Feliciano, J., took no part. Petitioners are
damages (Cumagun v. Philippine American represented by my former firm.
Insurance Co., Inc., et al., G.R. No. 81453 August 15,
1988; Lambert v. Fox, 26 Phil. 588) and may be
equitably reduced by the courts if they are
iniquitous or unconscionable. (See Articles 1229,
2227, New Civil Code).

The records show that on the first loan, the principal


of which is P6,350,750.00, the penalty charges as of
June 15, 1985 are already equivalent to
P6,774,378.06 (p. 265, Original Records) and that on
the second loan, the principal of which is
P8,649,250.00 the penalty charges as of June 15,
1985 are equivalent to P8,662,008.53. (p. 266,
Original Records) The P6,774,378.06 penalty charges
in the first loan would have been earned by the
private respondent after only 725 days (1 year and
360 days) of delay in the payment of the loan while
the P8,662,008.53 penalty charges would have
been earned by the private respondent after only
646 days (1 year and 281 days) of delay in the
payment of the loan. The figures from 1985 to 1988
would amount to several times the principal loans.

We agree with the petitioner that the penalty


charges excessive and unconscionable. The
interest charges are enough punishment for the
petitioners' failure to comply with their obligations.

Finally, the petitioners question the amount for


attorney's fees equivalent to 10% of their obligation.

Again, Chemark's promissory notes provide for the


award of attorney's fees in case of default to pay
the loans, to wit:

xxx xxx xxx

"If this note is not fully paid when due, the


undersigned shall pay, in addition to the stipulated
interest, a penalty of 3% per month on the total
outstanding principal and interest due and unpaid.
The undersigned shall also pay, as and for attorney's
fee, a sum equivalent to 20% of the total amount
due under this note plus expenses and costs of
collection, in case this note is placed in the hands
of an attorney for collection." (See Annexes '2', '3',
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