1- Obligations and Contracts

REVIEW NOTES IN BUSINESS LAW

2013 EDITION

RANDY BISA BLANZA Lawyer Certified Public Accountant Master of Public Administration Career Executive Service Eligible ActingDean: Tabaco College, College of Law Faculty Member: Divine Word College of Legazpi, College of Business Education Aquinas University of Legazpi, College of Business Management & Accountancy

Copyright By

RANDY BISA BLANZA

______________________________ ALL RIGHTS RESERVED Any copy of this book without the original signature of the author on this page shall be considered as having proceeded from illegal source

Published and Printed By:

PISPIS PRINTING SERVICES Ligao City

PREFACE

The "Business Law and Taxation" subject in the CPA board exam will now officially be treated as two (2) separate subjects in the said exam starting on OCTOBER 2013 board exam. It is now imperative that focus shall be given to all topics included in the syllabus for the CPA Licensure Examinations for Business Law to increase the chances of passing the CPA licensure Examinations. The topics are incorporated in this Review Notes, and discussed in a manner that can easily be understood by accounting students and CPA reviewees. The author adopted the outline approach, with illustrations used to explain the provisions of law. Additionally, end of chapter assessments varying from True or False, Multiple Choice Questions, Enumeration Types and similar diagnostic means are included in this book to determine the competency and understanding of the student/reviewee of the topics covered under the business law course. The author wishes that this book will help students and CPA reviewees to better understand the concept of business law and its applications, and further help them to achieve their desire to become a full-pledged Certified Public Accountant in the future. Malilipot, Albay, Philippines. September 1, 2013

R.B. Blanza

ACKNOWLEDGEMENT

The author wishers to express his sincerest thanks to the following persons who inspire him to devote time and efforts to create his first ever book: To Divine Word College of Legazpi, Aquinas University of Legazpi and Tabaco College, for the support and patronizing the author’s book as reference materials for their subjects in business law and other related subjects; To his family, Mama, Mama Kikay, Mama Ding, Mama Iya; and siblings Jean, Gerardo, Darwin, Glena, Gilbert, Myzel, Norvin, Rianne and Feevrey; and pamangkins Lyndon and Jack Francis Bibal, Ma. Andrianna and Ma. Alyzel Blanza, Ernest James and Darwin James Blanza, Symon James and Ayrinne Gaile Blanza,and Princess Genn Blanza for their unending support, motivation and care; To his bestfriends, Darwin Bonagua, Rodel Lorico and Carmela Monica Borromeo, for the valuable encouragement and moral support to take the path where his passion is. To Margarita Cheska Alonzo, for the inspiration to strive hard to reach goals in life. To his students accountancy and law students, for their comments, recommendations and suggestions to improve this book. And above all, to Almighty God, the giver of all things, and the source of all wisdom.

R.B. Blanza

THE CPA LICENSURE EXAMINATIONS SYLLABUS FOR BUSINESS LAW This subject tests the candidates' knowledge of the legal implications of business transactions, business associations, and negotiable instruments, particularly as they relate to accounting and auditing situations. Candidates should know and understand the pertinent legal provisions, general principles, concepts, and underlying philosophy of the law. The business law examination is not intended to test the candidates' competence to practice law or their expertise in legal matters but to determine that their knowledge is sufficient to enable them to recognize the legal implications of business situations, apply the underlying principles of law to accounting and auditing, and know when to seek legal counsel or recommend that it be sought. Each examination will contain a minimum of 50 and maximum of 70 multiple choice questions, allocated to the different subject areas, as indicated below: I. LAW ON BUSINESS TRANSACTIONS Obligations and Contracts 1.1 Obligations a. Sources of obligations and their concepts 1. Law 2. Contracts 3. Quasi-contracts 4. Delicts 5. Quasi-delicts b. Kinds of obligations in general under the Civil Code c. Specific circumstances affecting obligations in general 1. Fortuitous events 2. Fraud 3. Negligence 4. Delay 5. Breach of contract d. Duties of the obligor in obligation to do or not to do e. Extinguishment of obligation with special emphasis on 1. Payment of debts of money 2. Mercantile documents as means of payment 3. Special forms or modes of payment 4. Remission or condonation, confusion, compensation and novation 5. Effect of insolvency and bankruptcy on extinguishment of obligation 1.2 Contracts a. Concepts and classification b. Elements and stages c. Freedom from contract and limitation

d. Persons bound e. Consent 1. Capacitated persons 2. Requisites 3. Vices of consent f. Objects of contracts g. Considerations of contracts h. Formalities of contracts i. Interpretation and reformation of contract j. Defective contracts 1. Rescissible 2. Voidable 3. Unenforceable 4. Void 2.0 Contract of Sales 2.1 Nature, forms and requisites 2.2 Distinguished from a. Dacion en pago b. Cession in payment c. Contract for a piece of work d. Barter 2.3 Earnest money as distinguished from option money 2.4 Rights/obligations of vendor and vendee 2.5 Remedies of unpaid seller 2.6 Warranties (in relation to consumer laws) 2.7 Sale with a right to repurchase or conventional redemption, legal redemption 2.8 Sale on credit 2.9 Installment sales a. Personal property - Recto Law b. Real property - Maceda Law c. PD 957 / Condominium Act 3.0 Contract of Agency, Pledge and Mortgage 3.1 Contract of agency a. Nature, forms and kinds of agency b. Obligations of agents and principals c. Guaranty of commission agents d. Modes of extinguishing an agency 3.2 Pledge a. Nature and binding effect on third persons b. Obligations/rights of pledgor and pledge c. Pactum commissorium d. Modes of extinguishments 3.3 Mortgage a. Real and chattel 1. Nature 2. Requisites 3. Rights and obligations of mortgagor and mortgagee 4. Requisites to have binding effect on third persons

5. Mode of extinguishment II.LAW ON BUSINESS ASSOCIATIONS 4.0 Partnership 4.1 Nature and as distinguished from corporation 4.2 Elements and kinds 4.3 Formalities required 4.4 Rules of management 4.5 Distribution of profits and losses 4.6 Sharing of losses and liabilities 4.7 Modes of dissolution 4.8 Limited partnership 5.0 Corporations 5.1 Nature and classes of corporation 5.2 Requirements for organization 5.3 Powers of a corporation a. Expressed b. Implied c. Incidental 5.4 Board of Directors/Corporate Officers a. Qualifications b. Election and removal c. Powers and fiduciary duties 5.5 Classes of stocks a. Concepts b. Subscriptions 5.6 Powers, duties, rights and obligations of stockholders 5.7 Majority and minority control 5.8 Corporate reorganization a. Mergers b. Consolidations c. Other business combinations 5.9 Modes of dissolution and liquidation 5.10 Foreign corporations a. License to do business 1. Purpose of the license 2. Requirements for application/ issuance of license 3. Consequence of doing business without a license b. Definition and rights of foreign corporation c. Definition of doing business and its relation to foreign investments d. Resident agent (purpose, qualifications) e. Suits against foreign corporations f. Suspension/revocation of license g. Withdrawal from business 5.11 Kinds and availability of corporate books III.LAW ON NEGOTIABLE INSTRUMENTS 6.0 Negotiable Instruments Law 6.1 Negotiability of instrument 6.2 Functions and kinds of negotiable instruments

6.3 Construction of ambiguous instrument 6.4 Parties and their liabilities 6.5 Indorsements 6.6 Accommodation party 6.7 Consideration 6.8 Manner and consequence of transfer of instruments 6.9 Dishonored instruments and its effects (including clearing house rules and BP 22) 6.10 Requisites of holder in due course 6.11 Defense of parties 6.12 Forgery and its effects 6.13 Discharge of negotiable instruments and the parties secondarily liable.

TABLE OF CONTENTS I. Obligations ………………………………………………………………………….. End of Chapter Questions True or False …………………………………………………………. Multiple Choice …………………………………………………………. Answers …………………………………………………………. II. Contracts ………………………………………………………………………….. End of Chapter Questions True or False …………………………………………………………. Multiple Choice …………………………………………………………. Answers …………………………………………………………. III. Sales …………………………………………………………………………... End of Chapter Questions True or False ………………………………………………………….. Multiple Choice ………………………………………………………….. Answers …………………………………………………………… IV. Agency …………………………..……………………………………………….. End of Chapter Questions True or False ……………………………………………………………. Multiple Choice ……………………………………………………………. Answers ……………………………………………………………. V. Pledge, Mortgage and Antichresis …………………………………………………………. End of Chapter Questions True or False …………………………………………………………… Multiple Choice …………………………………………………………… Answers ……………………………………………………………. VI. Partnership ……………………………………………………………………. End of Chapter Questions True or False …………………………………………………………… Multiple Choice …………………………………………………………… Answers ………………………………………………………….. VI. Corporations …………………………………………………………………… End of Chapter Questions True or False …………………………………………………………… Multiple Choice …………………………………………………………… Answers …………………………………………………………… VII. Negotiable Instruments …………………………………………………………………… End of Chapter Questions True or False …………………………………………………………… Multiple Choice …………………………………………………………… Answers ……………………………………………………………

OBLIGATIONS Obligation, defined An obligation is a juridical necessity to give, to do or not to do. (Article 1156, New Civil Code). Obligation is used in reference to anything that an individual is required to do because of a promise, vow, oath, contract, or law. It refers to a legal or moral duty that an individual can be forced to perform or penalized for neglecting to perform. Juridical necessity means that the court can be asked to order the obligor to perform the obligation. Elements of Obligation 1. Active Subject (creditor/obligee) - one who has the right to demand performance of the obligation 2. Passive Subject (debtor/obligor) - one who is obliged to perform the obligation. 3. Prestation – the subject matter of the obligation. It may consist of giving, doing or not doing. Prestations in real obligation is the thing, whether determinate or generic and the services or acts in personal obligations. 4. Efficient cause - the vinculum or the legal or juridical tie that binds the parties to an obligation. It may consist of any of the five sources of obligation (law, contract, quasicontract, delict and quasi-delict). Requisites of a valid obligation 1. It must be licit 2. It must be possible, physically and judicially 3. It must be determinate or determinable 4. It must have pecuniary value  Vinculum juris – the legal/juridical tie that binds the parties to the obligation  Causa (causa debendi/causa obligationes) – why obligation exist Examples: 1. Obligation to give – “X promise to give A P2,000 monthly allowance until the latter finishes college”. Here, A is the active subject; X is the passive subject; the P2,000 monthly allowance is the prestation; and the right to support is the efficient cause. 2. Obligation to do – “M obliged himself to pay N the amount of P100,000, as full payment of land he purchased from the latter.” N is the active subject; M is the passive subject; the amount of P100,000 as payment is the prestation; and the contract of sale is the efficient cause. 3. Obligation not to do – “P bound himself not to construct a fence in his land so as to obstruct the free passage of rainwater from the land of Q”. Here, Q is the active subject; P is the passive subject; the non-construction of fence is the prestation; and the right of easement is the efficient cause.

Civil obligation vs. natural obligation Article 1423 of the New Civil Code classifies obligations into civil or natural. "Civil obligations are a right of action to compel their performance. Natural obligations, not being based on positive law but on equity and natural law, do not grant a right of action to enforce their performance, but after voluntary fulfillment by the obligor, they authorize the retention of what has been delivered or rendered by reason thereof".

Civil obligation

Natural obligation

1. Based on law

1. Based on equity and moral justice

2. Enforceable by court actions

3. Cannot be enforced by court action

Examples of natural obligation: 1. X is indebted to A for the amount of P10,000 covered by a promissory note with maturity date of December 31, 2000. Despite demand from A, X failed to pay the amount in the PN. On June 1, 2013 (after the lapse of more than 12 years), X paid A the amount of P10,000. When X learned that the PN has already prescribed (and therefore not anymore enforceable), he now seeks to recover from A the P10,000. Can he recover the amount paid to A? Answer: NO. The obligation becomes a natural obligation and the debtor who voluntarily pays can no longer recover what he has given based on equity and moral justice. 2. X died leaving two heirs, A and B. At the time of his death, X has an assets of P1,000,000 and liabilities of P1,200,000, thus leaving a net liabilities of P200,000. A and B paid the creditor of X for the corresponding amount. However, after payment, the heirs learned that they are only liable to the extent of value of assets inherited from the decedent. Can A and B recover the P200,000 they paid to the creditor of X? Answer: NO. The obligation is a natural obligation and the heir/s who voluntarily pays the decedent’s creditor can no longer recover what he has given based on equity and moral justice. Forms of obligation 1. Oral 2. In writing 3. Partly oral and partly in writing Obligation according to subject matter

1. Real obligation (obligation to give) – the subject matter is the thing which the obligor must deliver to the obligee Example. A bounds himself to deliver to B 10 sacks of rice 2. Personal obligation (obligation to do or not to do) – the subject matter is the act to be done or not to be done o Positive personal obligation – obligation to do or to render service Example: A bounds himself to paint the house of B o Negative personal obligation – obligation not to do ( which naturally includes “not to give”) Example: X binds himself not to construct a fence on a portion of his lot in favor of W who is entitled to right of way. Sources of Obligation 1. Law - Obligations arising from law are not presumed. Those expressly determined in the code or in special laws, etc., are the only demandable ones. We cannot presume existence of an obligation if no express provision is stated in our laws. Examples: obligation to pay taxes under the National Internal Revenue Code; obligation to render personal military or civil service in the fulfillment of this duty all citizens may be required by law under Section 2, Article II of the Constitution of the Philippines; obligation to give mutual support between husband and wife. 2. Contracts – meeting of minds between two persons/parties whereby one binds himself, with respect to the other, to give something or to render some service. Obligations arising from contracts have legal force between the contracting parties and must be fulfilled in accordance with their stipulations. (Arts. 1090 and 1091.) Examples: contract of sale, contract of lease, contract for piece of work, simple loan, deposits, mortgages, etc. 3. Quasi-contracts– Certain lawful, voluntary and unilateral acts done by a person giving rise to a juridical relation to the end that no one shall be unjustly enriched by another (Art.2142). Kinds of Quasi-contracts: 1. Negotiorum Gestio – voluntary administration of the property, business, or affairs of another without the latter’s consent or authority. It is a type of spontaneous agency or interference by a person, called a negotiorum gestor, in the affairs of another, in his absence. The gestor is only entitled to reimbursement for expenses and not to remuneration. For example, while X is traveling abroad, a typhoon hits his home town and the roofing of his house is in danger. To avoid the catastrophic situation, his neighbor A does something urgently necessary. X is the 'principal' and A here is the 'gestor". The act of which saved X’s house is the 'negotiorum gestio.” X must reimburse A for such expense.

2. Solutio Indebiti – refers to the juridical relation which arises whenever a person unduly delivers a thing through mistake to another who has no right to demand it. If something is received when there is no right to demand it, and it was unduly delivered through mistake, the obligation to return it arises. (Art. 2154, NCC) Example: C, a Filipino resident of the US sent to his father D in Manila $500 through ABC Bank. Due to mistake of the employees of the Bank, D was paid $5,000 instead. Upon discovery of the mistake, the Bank demanded from D the return of $4,500. D refused and the Bank sued him. Is the Bank entitled to recover from D? Answer: YES, the Bank is entitled to recover the $4,500 from D. We have in this case an example of a quasi-contract of solutio indebiti which arises whenever a person unduly delivers a thing through mistake to another who has no right to demand 4. Delicts – also known as crimes or felonies. These are act or omissions punishable by law. According to the Revised Penal Code, the commission of a crime makes the offender also civilly liable. Article 100 of the Revised Penal code provides, “Every person criminally liable for a felony is also civilly liable”. Article 104. The civil liability of this Code includes: 1. Restitution; 2. Reparation of the damage caused; 3. Indemnification for consequential damages.

Example: The obligation of the thief to return the stolen car. The obligation of the killer to indemnify the heirs of the victim. 5. Quasi-delicts – also known as “tort” or “culpa aquiliana”. These are acts or omissions that cause damage to another, there being no contractual relation between the parties (Art.2176). It refers to a negligent act or omission which causes harm or damage to the person or property of another, and thus exposes a person to civil liability as if the act or omission was intentional Requisites of Quasi-Delict: a. There must be an act or omission

b. There must be fault, negligence or imprudence not legally excusable c. There must be damage caused d. There is a direct relation between of cause and effect between the act or omission and the damage; and e. There is no pre-existing contractual relations between the parties Example: X and Y were playing baseball near the house of A. X hit the ball and it breaks A’s windows. X and Y are liable for damages to A. Distinction between Crime and Quasi-Delict Crime There is malicious intent Purpose is punishment Affects public interest 2 liabilities – criminal and civil Criminal liability cannot be compromised Guilt of the accused must be prove beyond reasonable doubt

Quasi-Delict There is negligence Purpose is indemnification of parties Affects private interest Only civil liability Liability can be the subject of compromise Negligence need to be proved only by preponderance of evidence

NATURE AND EFECT OF OBLIGATION Determinate thing and generic thing 1. Determinate or specific thing - a thing is determinate when it is particularly designated or physically segregated from all others of the same class (Article 1460). A thing is determinate or specific when it is distinct from all others of the same class. A determinate thing is distinct because of its individuality. Examples of a determinate thing are: the laptop you are viewing this website on, your car (if you own only one), the lot on 443 Sto. Cristo, Guagua, Pampanga. 2. Indeterminate or generic thing – a thing is indeterminate when it is not particularly designated or particularly segregated from all others of the same class. Examples are car, watch, sacks of rice, P100,000. Importance of knowing whether the thing is determinate or indeterminate Loss of indeterminate things due does not extinguish the obligation. While loss of determinate things when due, extinguishes the obligation. Obligation of the obligor to give determinate thing 1. Every person obliged to give something is also obliged to take care of it with the proper diligence of a good father of a family, unless the law or the stipulation of the parties requires another standard of care. ( Art. 1163) Diligence of a good father of a family or ordinary diligence means the ordinary care that an average person exercises in taking care of his property. It means the care

and attention that is expected from and is ordinarily exercised by a reasonable and prudent person under the circumstances. Extra-ordinary diligence represents that extreme measure of care and caution which persons of unusual prudence and circumspection use for securing and preserving their own property or rights. 2. To deliver the thing. Delivery involves the transfer of possession and/or control of property, real or personal, from the obligor to the oblige, either actual or constructive. 3. To deliver the fruits of the thing. The fruits may be (Art. 442) a. Natural fruits – refers to the spontaneous products of the soil and the young and other products of animals. There must be no human intervention in the production of the said fruits. Examples are the trees and shrubs that grow without intervention of human labor, the calf of the cow, and the young of farm animals are natural fruits. b. Industrial fruits – refers to those produced by land of any king through cultivation of labor. Examples are the grapes that are harvested from vineyards, rice, corn and other crops produced through human cultivation are industrial fruits. c. Civil fruits – are those which are the result of a juridical relation such as the rent of a building, price of lease of land and other property and the amount of perpetual life annuities. When creditor has a right to the fruits of determinate thing Under Art. 1164, the creditor has a right to the fruits of the thing from the time the obligation to deliver it arises. However, he shall acquire no real right over it until the same has been delivered to him. When obligation to deliver the thing arises 1. Without period or condition – upon perfection of the obligation 2. With period or condition – upon arrival of the term or upon perfection of the condition Example: “D promise to deliver to E a red Honda car after E passes the CPA board exams. The obligation to deliver the thing arises only upon passing of CPA exams by E. Rights of the creditor 1. Personal right – the right of a legal subject specified in an agreement or contract. This refers to the right that may be enforced by one person on another, such as the right of the creditor to demand delivery of the things, together with all its fruits from the debtor.

2. Real right – refers to the right of the owner over the specific thing, such as possession and ownership. This right is enforceable against the whole world. Real right over the thing is acquired by the creditor when it is delivered to him by the debtor 4. To deliver its accessions and accessories even if they have not been mentioned (Art. 1166) Accessions – include everything that is produced by a thing or is incorporated or attached thereto, either naturally or artificially. (Art. 440), such as alluvium, the soil gradually deposited by current of a river on a river bank, or whatever planted or sown on a parcel of land. For example, a person who owns property along a river also takes ownership of any additional land that builds up along the riverbank. This right may extend to additions that result from the work or skill of another person. The buyer of a car who fails to make scheduled payments cannot get back his new spark plugs after the car is repossessed because they have become a part of the whole car Accessories – are those joined to or included with the principal thing for the latter’s better use, perfection or enjoyment. Examples are the keys to the house, the bracelet of a wristwatch, the stereo in a car). Remedies of the creditor 1. If the debtor fails to perform his obligation to deliver a determinate thing a. The creditor may compel delivery from the debtor (Art. 1165) b. Demand for damages from the debtor Example: D obliged himself to deliver to E a 2012 model Honda City white car with Plate No. LUV 143 on June 31, 2013.” On due date, D can only compel E to deliver the said specific car. If E still fails to deliver despite demand, D can ask for damages from E. 2. If the debtor fails to perform his obligation to deliver an indeterminate thing a. Ask that the obligation be complied with at the expense of the debtor b. To demand for damages from the debtor Example: A promises to deliver to B 10 bags of cement. On due date, A failed to deliver the thing. Here, B can ask another person to deliver the 10 bags of cement at the expense of A. B can likewise demand damages from A. 3. If the debtor fails to perform his obligation in obligation to do  If the debtor fails to perform the obligations or perform it in contravention of the tenor thereof a. The creditor may have the obligation executed at the expense of the debtor b. He may also demand damages from the debtor

Example: X contracted Y to build his residential house. The contract stipulates the design of the house, the materials to be used, and the construction period of 120-days from signing of the contract by the parties. If Y does not perform the obligation, X may himself, or ask another contractor to build the house at Y’s expense. X may likewise demand damages from Y. The same is true if Y performs his obligation in contravention of the tenor of their agreement. Note: X cannot compel Y to perform the obligation against the latter’s will, as this will be in violation of constitutional prohibition against involuntary servitude.  a. b.

If the debtor performs the obligation but does it poorly The creditor may have the same be undone at the expense of the debtor The creditor may also demand damages from the debtor Example: in the above example, if Y uses sub-standard materials in building X’s house, X can have it undone by another person or even himself at the expense of Y. X can also claim for damages from Y.

4. If the debtor does what has been forbidden to him a. The creditor may demand that what has been done be undone b. He may also demand damages from the debtor Example: D bought a portion of parcel of land from E. D likewise paid E a certain amount for the right of way, with the condition that E would not construct a fence or any improvement on the said right of way. Sometimes thereafter, however, E constructed a fence in the said right of way thereby blocking the free access of D to the provincial road. D can demand from E to remove the fence, or he may ask other person or even himself, to remove the fence at the expense of E. D can also demand damages from E. When is the debtor/obligor liable for damages? Under Art. 1170, liability for damages shall be demanded from those who in the performance of their obligations are guilty of a. fraud (dolo) b. negligence (culpa) c. delay (mora) d. those who in any manner contravene the tenor thereof. Concept of damages

Damages refer to the harm done. This requires compensation for causing loss or injury through negligence or a deliberate act, or a court's estimate or award of a sum as a fine for breach of a contract or of a statutory duty. Injury refers to the wrongful, unlawful and tortuous act. It is the legal wrong to be redressed. Kinds of damages ( M-E-N-T-A-L) 1. Moral damages – include physical suffering, mental anguish, fright, serious anxiety, besmirched reputation, wounded feelings, moral shock, social humiliation, and similar injury. Though incapable of pecuniary computation, moral damages may be recovered if they are the proximate result of the defendant's wrongful act for omission (Art. 2217) 2. Exemplary damages or corrective damages - are imposed, by way of example or correction for the public good, in addition to the moral, temperate, liquidated or compensatory damages (Art. 2229) 3. Nominal damages - are adjudicated in order that a right of the plaintiff, which has been violated or invaded by the defendant, may be vindicated or recognized, and not for the purpose of indemnifying the plaintiff for any loss suffered by him (Art.2221) 4. Temperate damages or moderate damages - are more than nominal but less than compensatory damages, may be recovered when the court finds that some pecuniary loss has been suffered but its amount cannot, from the nature of the case, be provided with certainty (Art. 2224) Temperate damages must be reasonable under the circumstances (Art.2225) 5. Actual damages – these refers to pecuniary loss (such as loss in business or profession) that may be recovered. It includes loss of possible earnings. Indemnification for damages shall comprehend not only the value of the loss suffered, but also that of the profits which the obligee failed to obtain (Art. 2200) Note: proof of pecuniary loss is required unless provided by law or stipulation 6. Liquidated damages - are those agreed upon by the parties to a contract, to be paid in case of breach thereof (Art.2226) Important: proof is NOT required in order that moral, nominal, temperate or liquidated or exemplary damages may be adjudicated. The assessment of such damages, except liquidated ones, is left to the discretion of the court, according to the circumstances of each case. Fraud, defined

Fraud is the deliberate or intentional evasion by the debtor/obligor of the fulfillment of his obligation in a normal manner. The commission of fraud gives rise to liability to pay damages to the aggrieved party. Kinds of fraud a. Causal fraud and incidental fraud 1. Causal fraud (dolo causante) - is the fraud committed to obtain the consent of another party, without which consent would not have been given. This type of fraud renders the contract voidable. Example: A bought a pair of “diamond” earrings to B, who told him that the diamonds are genuine. A is a long time jeweler and B honestly accept the representation of A that it is indeed a true diamond, when A knew all along that it was fake. Here, B’s consent was obtained through fraudulent representation made by A. The contract is thus voidable. 2. Incidental fraud (dolo incidente) – refers to fraud where consent would still be given but the person giving it would have agreed on a different terms. The resulting contract is valid but the party employing the fraud shall be liable for damages. Example: A agreed to buy from to B sacks of well-milled rice at P1,500 per sack. However, the rice B is selling is actually regular-milled rice at P1,200 per sack. Had A known the said fact, A would still agree to buy from B anyway but for a reduced price. The fraud here is incidental and B only liable for damages. b. Past fraud and future fraud 1. Past fraud – fraud already committed by one of the parties. A waiver of an action for past fraud may be made, since the commission of fraud can no longer be encouraged. Such waiver is an act of liberality on the part of the creditor. 2. Future fraud – fraud which a party intends to commit in the future. A waiver of an action for future fraud cannot be made. Agreement made for waiver of future fraud is void. It is thus held that the debtor/obligor will still be liable for damages if he commits fraud in the performance of his obligation despite of waiver previously agreed upon by both parties. Negligence, defined Negligence is the omission of that diligence required by the nature of the obligation and corresponds with the circumstances of the person, time and place. (Art. 1173) The required degree of diligence to be observed by the debtor is provided by law or stipulation of parties.

If the law or contract does not state the diligence which is o be observed in the performance of the obligation, the debtor must exercise the diligence of a good father of a family. Examples: 1. Required by law – the owner of a public utility transport is required by law to observe extra-ordinary diligence in transporting its passengers from point of embarkation until disembarkation. Thus, when passengers are injured because of vehicular accident, regardless of which vehicles is/are at fault, the owner is guilty of negligence. 2. Required by circumstance – if the obligation is to deliver highly flammable materials, the obligor shall observe extra-ordinary diligence of care. Any slightest fault that results to damage to the product or to any third person will held the obligor guilty of negligence 3. If a driver drive’s without or with expired driver’s license, drives at night without headlight, or driving while texting in his cellular phone, will be considered guilty of negligence under the circumstances Kinds of negligence 1. Contractual negligence (culpa contractual) – refers to the negligence in the performance of a contract. A common example is the contract of carriage between the owner of public utility jeepneys and its passenger. Thus, when negligence is committed by the driver, causing death or injury to its passenger, the owner of the said PUJ is liable for damages. In contractual negligence, the master-servant rule applies. The master (owner) is liable for the negligent acts of his servant (driver). The defense of diligence of good father of family (as when the owner employed strict procedures in selection and supervision of drivers) is not a valid defense of the owner to escape liability, but this can mitigate the liability min some instances. 2. Civil negligence (culpa aquiliana, tort, quasi-delict or culpa ex-contractual) – these are acts or omission that cause damage to another, there being no contractual relation between the parties. Civil negligence arise from acts which a prudent man expected to observe, has failed to do so resulting to damage to another person, such as when a person is throwing a stone in a busy street, resulting to damaging the window or causing physical injury to a passenger in a passing vehicle, is liable for culpa aquiliana. The master-servant rule does not apply here. Thus, when a pedestrian is hit by a bus because of his reckless driver, the negligence of the servant (driver) is not the negligence of the master (owner). The defense of ordinary diligence in the careful selection and supervision of its driver is a valid defense by the owner to escape liability.

3. Criminal negligence (culpa criminal) – refers o negligence that results to a commission of a crime. Examples are reckless imprudence resulting to homicide, physical injuries and/or damage to properties. Defense of diligence of good father of a family will not prosper because when the driver is held guilty of criminal negligence, it automatically makes the owner civilly liable when the said driver is insolvent. Thus, it has been held in vehicular accidents that:  The passenger of the public transport may bring action of culpa contractual against the owner by reason of breach of contract of carriage. He may also bring an action for culpa criminal against the driver for physical injuries resulting from reckless imprudence.  The pedestrian may bring action for culpa aquiliana against the owner to recover damages. He may likewise file a case for culpa criminal against the driver for injuries sustained because of the latter’s reckless driving. When the driver is held guilty, but declared insolvent, the owner is automatically held liable for damages by reasonof culpa aquiliana, Delay, defined Delay, default or mora is the non-fulfillment of an obligation with respect to time Kinds of default 1. Mora solvendi, mora accipiendi and compensatio morae a. Mora solvendi – delay on the part of the debtor, as when the debtor fails to deliver the thing when it is due and after the demand made by the creditor. b. Mora accipiendi – delay on the part of the creditor, as when the creditor refuses to accept delivery of the thing due without justifiable reason. c. Compensatio morae – delay by both parties in reciprocal obligations, as when in a contract of sale, the buyer delays in payment while the seller was also in delay in the delivery of the thing due. Here, it is as if there is no delay. 2. Mora ex re and mora ex persona a. Ex re – delay in real obligation (obligation to give) b. Ex persona – delay in personal obligation (obligation to do) Note: there is no delay in obligation not to do as one cannot be held in delay for doing nothing.

Requisites before a debtor is considered in delay

General rule: (NO DEMAND, NO DELAY) The debtor incurs delay from the time the creditor demands fulfillment of the obligation but the debtor fails to comply with such demand. Thus, the requisites of delay are: a. The debtor does not perform his obligation on the date it is due b. The creditor demands the performance of the obligation c. The debtor does not comply with the creditor’s demand Example: D promised to pay E the amount of P100,000 on June 31, 2013. On due date, D failed to comply his obligation. E was a busy businessman and he only noticed that the obligation has already matured on July 15, 2013, and immediately demand payment from D on the said date. If despite the demand made, D still fails to perform his obligation, he is considered in delay only after the demand made on July 15, 2013. Exceptions: the debtor is considered in delay even without demand from creditor in the following cases: 1. When the law so provides Thus, demand from the government is not necessary for the taxpayer (debtor) be considered in delay for non-payment of income tax due on or before April 15 of the year following the close of the taxable period. 2. When the obligation expressly stipulates that demand in not necessary to put the obligor in delay. Example: “A promises to pay B the amount of P10,000 on December 31, 2013. Notice of demand waived.” Here, the parties expressly stipulate that no demand is necessary on maturity date to put the debtor in delay. 3. When time is of the essence of the contract Example: “X obliged himself to deliver a wedding cake for Y’s wedding reception on September 8, 2013 at Casablanca Hotel in Legazpi City.” If on the said date, X failed to deliver the wedding cake, demand is not necessary to put X on delay since time is the controlling motive of the obligation. 4. When demand would be useless A debtor is considered in delay even without demand from the creditor if the thing he is obliged to deliver has been destroyed through his fault or he has delivered it to another person. 5. In reciprocal obligations, here the obligations arise out of the same cause and must be fulfilled at the same time. From the moment one of the parties fulfills his obligation, the other party becomes in delay notwithstanding the absence of a demand. Fortuitous event, defined Events that cannot be foreseen, or which though foreseen, are inevitable (Art.1174) Examples of fortuitous event

1. Natural calamities or acts of God – such as lightning, earthquakes, typhoon, flashfloods and similar catastrophe 2. Acts of man – such as war and armed robbery Characteristics of fortuitous event a. The cause must be independent of the debtor’s will b. The event must be impossible to foresee, or even can be foreseen, it is inevitable c. The occurrence of the event must be of such character as to render it impossible for the debtor to perform his obligation in a normal manner. Liabilities for fortuitous event General rule: No person shall be liable for fortuitous event, thus the obligation is extinguished. Exceptions: Under Art.1174 of the New Civil Code, the debtor is still liable even in case of fortuitous event in the following circumstances: 1. When the law expressly provides for liability even in case of fortuitous event, as when the obligor is liable for fortuitous event if he delays or has promised to deliver the same thing to two or more persons who do not have the same interest. 2. When the parties stipulate that the obligor is liable even in case of fortuitous event. 3. When the nature of the obligation requires the assumption of risk such as the obligation of the insurer to indemnify the policy holder or his beneficiary even if the loss is through fortuitous event is the caused thereof is the risk insured against. Presumption on receipt of principal or later installment, concept 1. The receipt of the principal without reservation as to interest shall gives rise to the presumption that the interests have already been paid. Thus, if A obtained a loan from B the amount of P100,000 with interest rate of 15% per annum, and with maturity date on December 31, 2013. On maturity date, B issued an official receipt in the name of A for P100,000, it is presumed that the interests has also been paid, unless there is a reservation to the contrary that the payment does not include the interests. 2. The receipt of a later installment without reservation as to prior installment/s shall give rise to a presumption that such prior installments have been paid. The above presumptions are disputable; hence, they may be rebutted by contrary evidence. Kinds of presumption

1. Conclusive presumption – no evidence may be admitted to dispute the presumption. 2. Disputable presumption (prima facie) – assumed to be true unless a contrary evidence is presented and admitted Remedies of creditor to enforce payment of his claims against debtor (Art. 1177) 1. Pursue the property in possession of the debtor, except those exempt by law This remedy allows the creditor to protect his interest by filing an action for attachment before the court. Attachment is a legal process by which a court of law, at the request of a creditor, designates specific property owned by the debtor to be transferred to the creditor, or sold for the benefit of the creditor. The property attached can be sold to a public auction and the proceeds thereof will be applied as payment for the obligation. 2. Exercise all the rights and ring action of the debtor except those personal to him (accion subrogatoria) Example: D owes C a sum of money. Meanwhile A is indebted to D. C can file an action to collect from D, and likewise include in his prayer that the court to order A not to pay D the amount he owed to the latter. The court may further required A to pay directly to C as a consequence of accion subrogatoria. 3. Impugn the acts which the debtor may have done to defraud his creditors (accion pauliana) Example: A is indebted to B for the amount of P100,000. To defraud B, A “sold” the only parcel of land to his cousin X, who knows the intention of A. here, B can ask the court to rescind the fraudulent sale between A and X. Rules on transmissibility of rights General rule: all rights acquired by virtue of an obligation are transmissible. Thus, a creditor may assign his credit to a third person, or such right is transmitted to his heirs upon his death. Exception: the following rights are intransmissible 1. If the law prohibits the transmission of rights Examples: The rights of a general partner in a partnership are not transmitted to the heirs upon his death. 2. If the parties stipulates that the right in not transmissible. The parties may freely stipulates that the rights and obligations between them shall not be transmitted to their heirs, assigns or any third person. 3. If the right by its nature is intransmissible

Examples: the right to scholarship grant is not transmissible. Personal rights such as the right to vote, right to run for public office, marital and parental rights, and hereditary rights are not transmissible. DIFFERENT KINDS OF OBLIGATIONS Classification of obligations 1. Pure obligation 2. Conditional obligation 3. Obligation with a period 4. Alternative obligation 5. Facultative obligation 6. Joint obligation 7. Solidary obligation 8. Divisible obligation 9. Indivisible obligation 10. Obligation with a penal clause Pure and conditional obligations Pure obligation, defined A pure obligation is a debt which is not subject to any conditions and no specific date is mentioned for its fulfillment. A pure obligation is immediately demandable. Example: D obliges himself to pay C P 1,000,000. The obligation is immediately demandable because there is no condition & no date is mentioned for its fulfillment. Conditional obligation, defined A conditional obligation is one whose demandability or extinguishment depends upon the happening of a condition. The execution of which is suspended by a condition which has not been accomplished and subject to which it has been contracted. Example: “I will support your studies in college if Mr. A dies.” The obligation becomes demandable only after Mr. A dies. When the condition happens, it gives rise to an obligation. This condition is referred to as suspensive condition. “I will support your studies in college until Mr. A dies.” Here, the obligation is demandable at once. When the condition happens, it extinguishes the obligation. This condition is referred to as resolutory condition. Condition, defined Condition is a future event, which may or may not happen. It is a future and uncertain event, fact, or circumstance whose existence or occurrence is necessary for the existence or determining the extent of an obligation or liability

Classification of condition 1. Suspensive and resolutory a. Suspensive condition – a future event, the happening of which will give rise to the obligation. This is also known as condition antecedent or precedent. (example: I oblige myself to deliver a red car to A if she passes the CPA board exam) b. Resolutory condition – a future event, the happening of which extinguishes the obligation. It is demandable at once but upon happening of the condition, it shall be extinguished. This is also referred to as condition subsequent. (example: I oblige myself to give P2,000 monthly to B until he passes the CPA board exams) 2. Potestative, casual and mixed a. Potestative – depends upon the will of one of the contracting parties a.1. Potestative on the part of the debtor –  If suspensive - the obligation is void. Even if the condition is fulfilled, it will not cure the defect. (example: M promise to pay X the sum of P10,000 if M will marry this year)  If resolutory – the obligation is valid. (example: M promise to pay X P10,000 as monthly allowance until M marries this year) a.2. Potestative on the part of the creditor – the obligation is valid whether the condition is suspensive or resolutory. (examples: “M promise to pay X the sum of P10,000 if X marries this year,” “M promise to pay X P10,000 as monthly allowance until X marries this year) b. Casual – depends upon chance or upon the will of a third person. (example: X will deliver a Honda car to B, if Ms. Philippines will be crowned as Ms. Universe 2013) c. Mixed – depends upon the will of one of the contracting parties and partly upon the chance of the will of a third person. (example: X will give P100,000 to A, if A marries B this year) 3. Possible and impossible a. Possible – capable of fulfillment by its nature and by law b. Impossible – not capable of fulfillment because of its nature or due to operation of law. In this case, the obligation and the conditions are void. (example: “I will give you my condo unit if you can bring to me the Eiffel Tower”, “I will pay you P100,000 if you will deliver to X 10 grams of shabu”)

Note: if the condition is not to do an impossible thing, it shall be deemed as not having been agreed upon (Art.1183 NCC). Hence, the obligation is valid and demandable. (example: “I will give you P500 if you will not bring me an internal organ of a dinosaur,” “I will pay you P10,000 if you will not deliver me 10 grams of shabu”) 4. Positive and negative a. Positive – the condition that some future event will happen. The obligation is extinguished if after the lapse of the future event, the condition did not happen, or it has indubitable that the event will not happen. (examples: “F obliges to give C P100,000 if C will marry M this year”. The obligation to give is extinguish if (a) C does not marry M this year, or (b) if M dies, or marries anther than C, thus C cannot anymore marry her. The obligation is extinguish on such date since the condition to marry will not take place anymore. b. Negative – the condition that some event will not happen at a determinate time. The obligation becomes effective as soon as the time indicated has elapsed or it has become evident that the event will not occur. (example: F oblige to give C P100,000 if C will not marry M this year. The obligation becomes effective if (a) C does not marry M this year, (b) C marries another this year, or (c) M dies, or marries another than C. The obligation becomes effective on that date since the condition to marry will not be fulfilled anymore. 5. Divisible and indivisible a. Divisible – when capable of partial performance. The law provides (Art. 1183 NCC) that, if the obligation is divisible, the part thereof which is not affected by the impossible or unlawful condition shall be valid. Thus, if B obliges himself to give C a car if C graduated cum laude or higher in college, and P50,000 if C can forged his school records and make it appear that it is the school records of B. The obligation to deliver the car arises when C graduated cum laude or higher in college. The condition to forged school records is unlawful. Hence, even C complied such condition, he cannot demand the payment of P50,000. b. Indivisible – not capable of partial performance by its nature or by law or by agreement of the parties. (example: B promise to give C a car if C graduated cum laude or higher, and passes the CPA board exams. C must comply both conditions – graduating cum laude or higher AND passing the CPA board exam, before he can ask for the delivery of the car. Effects of fulfillment of suspensive condition (Art. 1187) General Rule: The effect of the fulfillment of the suspensive condition retroacts to the day of the constitution of the obligation. Thus, if on June 1, 2013, A promises to give a car to B if

B passes the CPA exams. B passes the CPA exam on May 2014. Upon fulfillment of the condition, B is considered the owner of the car since June 1, 2013. Exceptions: there shall be no retroactive effect with respect to the fruits and interests as follows: 1. In reciprocal obligations, the fruits and interests shall be deemed to have mutually compensated, i.e., each party shall keep the fruits and interests received by him prior to the fulfillment of the condition. Example: On June 1, 2010, A agreed to sell his land to B, and B likewise agreed to pay the price of P500,000 to A, on the condition that B would marry X. it was only on June 1, 2012, or two years later, that B marries X. From June 1, 2010 to May 31, 2012, A is entitled to keep the fruits and/or produce of the land, while B is likewise entitled to keep the interests on the price. 2. In unilateral obligation, the debtor keeps the fruits and interests received before the fulfillment of the condition. Thus, if on June 1, 2010, A promise to give B a parcel of land if B would marry X. it was only on July 1, 2012 that the condition was fulfilled. Duringthe pendency of the condition, A can keep the fruits and produce of the said land. Rights of the parties before the fulfillment of the condition (Art. 1188) 1. Creditor – he may bring the appropriate actions for the preservation of his right. A creditor may register his claim with the Registry of Deeds (in case of land), if appropriate, or notify third persons of his claim.

2. Debtor - he may recover what during the same time he has paid by mistake in case of a suspensive condition.

Rules in case of loss, deterioration or improvement of determinate thing before the fulfillment of the suspensive condition (Art. 1189) 1. Loss of the thing a. Without debtor’s fault – the obligation is extinguished b. With debtor’s fault – debtor is obliged to pay damages. It is understood that the thing is lost when it perishes, or goes out of commerce, or disappears in such a way that its existence is unknown or it cannot be recovered; Examples: (a) thing perishes – A promises to give C a house if C marries this year. During the pendency of the condition, a fire broke out in the neighborhood, and houses were burned and turned to ashes, including the subject house. (b) goes out of commerce – A promised to deliver to B a pair of Philippine eagle if B passes the veterinary exams. During the pendency of the condition, a law was passed prohibiting the sale, private breeding, and domestication of Philippine eagle.

(c) disappears or cannot be recovered – A promised to give B a certain diamond ring soon as A disembarks to a Philippine port. During A’s travel, the said diamond ring was dropped and sank on the Pacific ocean, that it’s recovery would be impossible. Note: to exempt from liability, the debtor/obligor must not be at fault. Thus in the first example, if A places inflammable materials to his house which causes the fire, then A must pay C damages if C marries this year. 2. Deterioration of the thing a. Without the fault of the debtor - the impairment is to be borne by the creditor; b. With debtor’s fault - the creditor may choose between the (a) rescission of the obligation and (b) its fulfillment, with indemnity for damages in either case; Deterioration is the decline in the quality of equipment or structures over a period of time due to the chemical or physical action of the environment. It includes the physical wear and tear of the thing, and damages that do not result to a total loss of the thing. Thus, it has been held that the debtor is not liable for the physical wear and tear of the car pending the fulfillment of the suspensive condition. However, if a car is damaged because of accident due to debtor’s fault or negligence, the creditor may choose between (a) rescission of the contract and ask for damages, or (b) demand delivery of the car in its deteriorated state plus damages. 3. Improvement of the thing a. By nature or time – the improvement shall inure to the benefit of the creditor. (example: A promised to give C a parcel of land if C passes the CPA board exams. It was only after 5 years that C finally passes the CPA exams. In the meantime, the land was now covered with timber and other vegetation that grows to the said land without any cultivation made by parties. After the fulfillment of the suspensive condition, A must deliver to C the land together with the timber and vegetations. b. At the expense of the debtor - he shall have no other right than that granted to the usufructuary. Art. 562. Of the New Civil Code defines usufructuary. Usufruct gives a right to enjoy the property of another with the obligation of preserving its form and substance, unless the title constituting it or the law otherwise provides. The debtor may remove the improvement f no damage will be caused to the principal thing. If the improvement cannot be removed without damage from the principal thing, he shall deliver the thing together with its improvement to the creditor without any right on the part of the debtor to

indemnity. He may, however, set-off the improvement against any damage to the thing. Rules in case of fulfillment of resolutory condition (Art. 1190) 1. Upon fulfillment of a resolutory condition, the obligation is extinguished 2. The parties shall return to each other what they have received 3. In case of loss, deterioration or improvement of the thing, the provision of the above rule (Art.1189), which pertain to the debtor shall be applied to the party who is bound to return. Obligation with a period Obligation with a period, defined It is an obligation whose demandability or extinguishment is dependent to the occurrence or happening of a future event which must necessarily come. Examples of obligation with a period: (a) “X promises to deliver a 6-wheel truck to A on December 10, 2014.” The obligation becomes demandable on December 10, 2014 by reason arrival of the period. (b) “X obliged himself to give A the sum of P100,000 two years from today.” The obligation becomes demandable only two years from today by reason of expiration of the period. (c) “X delivered a 6-wheel truck to B for the latter’s personal use until December 31, 2014.” The obligation is demandable at once but will be extinguished on December 14, 2014, upon the arrival of the period. (d) “X obliged himself to give A P100,000 semi-annually until two years from today.” The obligation is demandable at once but will be extinguished two years from today, after the lapse of the period. Happening or arrival of the period gives rise to an obligation such as in the above examples (a) and (b). The period with a suspensive effect is known as ex die. Here, the obligation becomes demandable upon the lapse of the period. (Art. 1193) Concept of period and day certain Period is a space of time which determines the effectivity or extinguishment of an obligation. If “X promises to pay Y the amount of P10,000 60 days from today,” or “X promises to give P500 to A until 60 days from today,” the lapse of 60-day period will determine whether the obligation will arise or will be extinguished. A day certain is a future event, which must necessarily come although it may not be known when. (Art. 1193) An example of this is the death of a person, which will sure to come, although the exact date cannot be known. Period distinguished from condition Period

Condition

As to fulfillment

As to time

As to influence on the obligation

Future event that must necessarily come, at a date known beforehand, or at a time that cannot be determined Always refer to the future

Merely fixes the time for the efficaciousness of an obligation

Future event which may or may not happen

May refer to the future or to a past event unknown to the parties Cause an obligation to arise or extinguish

Other kinds of period 1. Legal – one that is fixed by law (examples: taxpayers shall file and pay their annual tax due on or before April 15 of the year following the taxable period; within 30 days from notice of tax assessment, the taxpayer must file his protest with the BIR, otherwise , the assessment become final and executor). 2. Voluntary period – one that is fixed by both parties. (example: X obliged himself to finish the construction of the house of Y within 90 days from today) 3. Judicial period – one that is fixed by the court (example: the court may order the parties to submit their respective memoranda or position paper within 30 days after the termination of Pre-trial) Pay when his means permit him to do so An obligation which states “I will pay you P100,000 when my means permit me to do so,” has been held by the court to be an obligation with a period. The creditor has the right to demand from the debtor to fix the period of payment. Otherwise, the creditor may ask the court to fix the period in accordance with Art. 1180 and 1197 of the Civil Code, and once the court has fixed the period, the parties are bound thereto and they may no longer change it as it becomes part of their agreement. Art. 1197 provides, If the obligation does not fix a period, but from its nature and the circumstances it can be inferred that a period was intended, the courts may fix the duration thereof. The courts shall also fix the duration of the period when it depends upon the will of the debtor.

Who has the benefit of the period? Article 1196 of the Civil Code provides, “whenever a period is designated in an obligation, it shall be presumed to have been established for the benefit of both the creditor and the debtor, unless from the tenor of the obligation or other circumstances, it should appear that it has been constituted for the benefit of only one of the parties. Therefore, the debtor cannot be compelled to perform, and the creditor cannot be compelled to accept performance, before the term expires.

Thus, it has been held that when a debtor borrow money from a creditor, with a stipulations that the loan shall bear interest of 12% per annum, and both the principal and interest payable at maturity two years from the execution of the Promissory Note, the debtor cannot be compelled to pay, and the creditor cannot be compelled to receive payment prior to the maturity date of the Promissory Note. The debtor will be deprive by the use of money until maturity, and the creditor, likewise, will e deprive to earn interest for the remaining term. When period is for the benefit of one of the parties 1. For the benefit of the debtor – he cannot be compelled to pay or perform his obligation before the expiration of the term. However, he may choose to perform his obligation before such expiration at his option. Example: “W promises to pay Z the amount of P100,000 on or before December 31, 2014.” W cannot be compelled to pay the amount before December 31, 2014. W, however, has the option to pay his obligation on maturity date or at any time before December 31, 2014. 2. For the benefit of the creditor – he cannot be compelled to accept payment or performance before the expiration of the term. He can, however, choose to demand performance before such expiration at his option. Example: “W promises to pay Z the amount of P100,000 on or before December 31, 2014, at the option of Z,” or “W borrowed from Z the amount of P100,000 collectible on or before December 31, 2014.” Z may demand payment on December 31, 2014 or at any time before the said date. Z, however, cannot be compelled to accept payment before the maturity date. When debtor losses his right to make use of the period When debtor loses the right to make use of the period, the obligation becomes demandable at once, and the creditor may demand performance even before the arrival of the period or the expiration of the term. The following rules shall apply under Art. 1198: 1. When after the obligation has been contracted, he becomes insolvent, unless he gives a guaranty or security for the debt; Insolvency refers to the incapacity to pay debts upon the date when they become due in the ordinary course of business. It is the condition of an individual whose property and assets are inadequate to discharge the person's debts. Thus, if “A oblige himself to pay to B the amount of P20,000 on December 31, 2014. On June 30, 2013, total assets of A is P500,000 while his total liabilities was P800,000, the obligation becomes demandable at once. B may compel payment on June 20, 2013, unless A gives guaranty or security for the debt.

2. When he does not furnish to the creditor the guaranties or securities which he has promised; Example: X borrowed money from Y the amount of P50,000 payable on November 10, 2013. To secure the payment of the said loan, X promised to pledge his diamond ring to Y five days after the receipt of amount. X, however, failed to deliver the thing pledged to Y within the period agreed upon. Here, Y can demand immediate payment even before the maturity date of the obligation. 3. When by his own acts he has impaired said guaranties or securities after their establishment, and when through a fortuitous event they disappear, unless he immediately gives new ones equally satisfactory; Example: A obtained a loan from B in the amount of P500,000, payable on December 31, 2014, secured with a real estate mortgage over their residential house and lot. On December 1, 2013, the house was burned after B stored inflammable materials in his house. B may demand payment immediately even without waiting for the expiration of term. This is true even if the cause of loss, damage or impairment was not due to the fault of B. 4. When the debtor violates any undertaking, in consideration of which the creditor agreed to the period; Example: M obtained a loan of P100,000 from P for purpose of starting up a small business. The loan maturity date is December 31, 2014. However, M spent the money for their family travel in Hongkong. Here, P can demand immediate payment from M for violation of the undertaking in consideration of the loan granted. 5. When the debtor attempts to abscond. Example: X obtained a loan of P100,000 from A payable 60 days thereafter. After the receipt of the loaned amount, X started to dispose his properties with the intention of leaving his residence or place of business to escape creditors. A can demand payment from X immediately even though the obligation has not yet mature. Alternative and Facultative Obligations Kinds of obligation according to the number of prestation 1. Simple – where there is only one prestation 2. Compound – when there are several prestation. This may be – a. Conjunctive – several prestation are due, and ALL must be performed. (example: D obliged himself to deliver a car, a b. Distributive or disjunctive – maybe either horse and 5 sacks of rice to E. D must deliver all of them) alternative or facultative

Alternative obligation, defined An obligation is alternative when two things are equally due, under an alternative. The obligor is bound to render only one of two or more items of performance. Under Aricle 1199 of the Civil Code, a person alternatively bound by different prestations shall completely perform one of them, is sufficient to extinguish an obligation. For example, A agrees to give B, upon a sufficient consideration, a horse, a secondhand car or piano. The delivery of any of the three items will extinguish the obligation. Who has the right to choose? Under Art. 1200, the right of choice belongs to the debtor, unless it has been expressly granted to the creditor, subject to the following limitations: a. The debtor must completely perform the prestation chosen. The creditor cannot be compelled to receive part of one and part of the other undertaking b. The debtor shall have no right to choose those prestations which are impossible, unlawful or which could not have been the object of the obligation. When obligation ceases to be an alternative obligation 1. Art. 1201 - When the debtor has communicated his choice to the creditor 2. Art. 1202 – When among the prestations whereby the debtor is alternatively bound, only one prestation is practicable. 3. Art. 1205 – when the creditor has communicated is choice to the debtor, if the creditor has been expressly given the right of choice. Loss of the things and/or impossibility of services in alternative obligation Under Article 1204, the creditor shall have a right to indemnity for damages when, through the fault of the debtor, all the things which are alternatively the object of the obligation have been lost, or the compliance of the obligation has become impossible. The indemnity shall be fixed taking as a basis the value of the last thing which disappeared, or that of the service which last became impossible. Damages other than the value of the last thing or service may also be awarded. Example: D obliged himself to deliver to E a specific race horse, a 2008 Toyota corolla model with Plate No. ABA 106, or a specific diamond ring. The obligation does not specify who will have the right to choose. Hence, the law states that the right to choose is granted to D, the obligor.

a. If the specific race horse is lost, with or without the fault of D, or lost through a fortuitous event, D may deliver any of the prestation left - a 2008 Toyota corolla model with Plate No. ABA 106, or a specific diamond ring. D cannot be held liable for damages since he can still perform his obligation by delivering any of the two prestations left. b. If both the specific race horse lost and the specific diamond is lost, with or without the fault of D, or lost through a fortuitous event, D may deliver the prestation left - a 2008 Toyota corolla model with Plate No. ABA 106. D cannot be held liable for damages since he can still perform his obligation by delivering the prestations left. The obligation is converted into a simple obligation. c. If all the prestations are lost through fortuitous event, D’s obligation is extinguished d. If all the prestations are lost through the fault of D, D is liable for damages equivalent to the value of the last prestation lost, plus damages. e. If both the specific race horse lost and the specific diamond are lost through the fault of D, D may still deliver the prestation left - a 2008 Toyota corolla model with Plate No. ABA 106. The obligation is converted into a simple obligation. If later the said car was lost through fortuitous event, the obligation of D is extinguished. When right of choice is expressly granted to the creditor Under Article 1205. When the choice has been expressly given to the creditor, the obligation shall cease to be alternative from the day when the selection has been communicated to the debtor. Until then the responsibility of the debtor shall be governed by the following rules: (1) If one of the things is lost through a fortuitous event, he shall perform the obligation by delivering that which the creditor should choose from among the remainder, or that which remains if only one subsists; (2) If the loss of one of the things occurs through the fault of the debtor, the creditor may claim any of those subsisting, or the price of that which, through the fault of the former, has disappeared, with a right to damages; (3) If all the things are lost through the fault of the debtor, the choice by the creditor shall fall upon the price of any one of them, also with indemnity for damages. The same rules shall be applied to obligations to do or not to do in case one, some or all of the prestations should become impossible.

Example: D obliged himself to deliver to E a specific race horse, a 2008 Toyota corolla model with Plate No. ABA 106, or a specific diamond ring. The obligation specifically stipulates that the right to choose belongs to E. a. If the specific race horse is lost through a fortuitous event, D may deliver any of the prestation left - a 2008 Toyota corolla model with Plate No. ABA 106, or a specific diamond ring at the choice of D. b. If both the specific race horse lost and the specific diamond is lost through a fortuitous event, D may deliver the prestation left - a 2008 Toyota corolla model with Plate No. ABA 106. The obligation is converted into a simple obligation. If later the car was lost though the fault of D, he shall be liable for damages. c. If all the prestations are lost through fortuitous event, D’s obligation is extinguished d. If all the prestations are lost through the fault of D, E may claim the price of any of the prestation, plus damages. e. If both the specific race horse lost and the specific diamond are lost through the fault of D, the obligation is converted NOT into a simple obligation. E may choose between delivery of the thing left - a 2008 Toyota corolla model with Plate No. ABA 106, OR payment of price of the horse or the ring, plus damages. Facultative obligation, defined An obligation where only one prestation is due, but the debtor may deliver another in substitution. Rules in case of loss of the principal thing and substitute 1. Before substitution ( before the debtor informed the creditor his intention to deliver the substitute ) a. Loss of principal thing  If through fortuitous event – the obligation is extinguished  If through the fault of the debtor – the debtor shall pay damages b. Loss of the substitute – no effect. Whether the loss of the substitute is through fortuitous event or though the fault of the debtor, the debtor is not liable. He must still deliver the principal thing. 2. After substitution ( after the debtor informed the creditor his intention to deliver the substitute ) a. Loss of the principal thing - no effect. After the substitution, the obligation is converted into a simple obligation. The thing now due is the substitute. Whether the loss of the principal thing is through fortuitous event or though the fault of the debtor, the debtor is not liable. He must now deliver the substitute.

b. Loss of the substitute  If through fortuitous event – the obligation is extinguished  If through the fault of the debtor – the debtor shall pay damages

As to number of prestation/s

As to void prestation

or

impossible

As to who has the right of choice

Alternative obligation Several prestations are due, but the performance of one extinguishes the obligation. If there are one or more void prestation, the other/s may still be valid, hence, the obligation remains Belongs to the debtor, unless expressly given to the creditor

Facultative obligation Only one prestation is due – the principal. If the principal thing is void, the obligation is not valid. The debtor is not required to deliver the substitute Always belong to the debtor

Joint and Solidary Obligations Joint and solidary obligations, defined Joint and several obligations is a form of liability that is used in civil cases where two or more people are found liable for damages. In a joint and solidary obligation, there is a concurrence of two or more debtors and/or two or more creditors in one and the same obligation Joint obligation arises when each debtor is liable only for proportionate part of debt and each creditor is entitled only to a proportionate part of the credit. In the absence of contrary stipulations, obligations of two or more debtors or collectibles of two or more creditors are presumed joint. Examples: 1. Joint debtor – “A and B borrowed money amounting to P80,000 from C”. Here, A is liable only to pay C for P40,000 and B is likewise liable to C for P40,000, their proportionate share in the liability. 2. Joint creditor – “A borrowed money from X and Y the amount of P50,000.” On due date, X can only collect P25,000 from A, and likewise Y can also collect P25,000 from A, their proportionate shares in the credit. 3. Joint debtors and joint creditors – “A and B borrowed P300,000 from X, Y, and Z. the liability/rights of the parties are as follows: A is liable to X for P 50,000 to Y for P 50,000 to Z for P 50,000 B is liable to X for P 50,000 to Y for P 50,000 to Z for P 50,000

X can collect from A for P 50,000 from B for P50,000 Y can collect from A for P 50,000 from B for P50,000 Z can collect from A for P 50,000

from B for P50,000

Solidary obligation arises when the parties agreed that each debtor is liable for the whole obligation, and each creditor is entitled to demand payment of the whole obligation. In short, it’s an obligation under which any of two or more obligors can be held liable for the entire performance like payment of a debt Other terms for solidary obligation are: 1. jointly and severally 2. individually and collectively 3. in solidum 4. mancomunada solidaria 5. juntos o separademente Kinds of Solidary obligations 1. Passive solidarity ( solidarity on the part of the debtors ) Example: A and B jointly and severally borrowed money amounting to P80,000 from C”. Here, C can demand payment of full amount from either A or B. if A pays the P80,000, he can demand reimbursement from B of the latter’s share of P40,000. 2. Active solidarity ( solidarity on the part of the creditors ) Example: A borrowed money from X and Y, solidary creditors, the amount of P50,000.” On due date, either X or Y can demand full payment from A. If A pays X the whole amount, the obligation is extinguished and X must deliver to Y the latter’s share in the credit amounting to P25,000. 3. Mixed solidarity ( solidarity on both part of the debtors and creditors ) Example: “A and B, in solidum, borrowed P300,000 from X, Y, and Z, solidary creditors. On due date, either X, Y or Z can demand full payment from either A or B.  Assuming A paid to X the P300,000 – the obligation is extinguished. B must reimbursed A the amount of P150,000 for the latter’s share in the obligation. X must likewise deliver to Y the P100,000 and Z for P100,000, their respective share in the credits. 

Assuming A partially paid X for only P200,000. – the obligation is not yet extinguished. Either X, Y, or Z can demand from either A or B, the unpaid balance.

Rules is case there is concurrence of two or more debtors and/or two or more creditors in one and the same obligation General rule: the obligation is presumed joint. Exceptions: there is solidary liability only in the following cases:

1. When the obligation expressly so states, as when parties agreed to be bound solidarily 2. When the law so requires Example: Article 1915 provides that if two or more persons have appointed an agent for a common transaction or undertaking, they shall be solidarily liable to the agent for all the consequences of the agency. 3. When the nature of the obligation requires solidarity. Liability of partners for the compensation for injuries or death of their workers under the Workmen Compensation Act is solidary Under Art. 1207 of the New Civil Code, it states that “there is solidary liability only when the obligation expressly so states, or when the law or the nature of the obligation requires solidarity. Since the Workmen's Compensation Act was enacted to give full protection to the employee, reason demands that the nature of the obligation of the employers to pay compensation to the heirs of their employee who died in line of duty, should be solidary; otherwise, the purpose of the law could not be attained. Rules on solidary obligation 1. Solidarity may exist although the creditors and the debtors may not be bound in the same manner and by the same periods and conditions (Art. 1211) Example: X, Y and Z, solidary debtors, are indebted to M for P 90,000. The parties further agreed that the share of X shall be payable on demand; Y after Y pass the CPA exams; and Z on December 31, 2014. The following are the effects of this obligation  M may demand the payment of X’s share in the obligation for P30,000 anytime from either X, Y or Z, or both or all of them. 

If Y passes the CPA exams (assuming he passes the exam before Dec. 31, 2014), M may demand the payment of Y’s share in the obligation for P30,000 from either X, Y or Z. If there was no previous payment made, M may demand payment of P60,000 (comprising X and Y shares in the obligation) from either X, Y, or Z, or both or all of them.



On December 31, 2014, M may demand the payment of Z’s share in the obligation for P30,000 from either X, Y or Z, or both or all of them. If there was no previous payment made, M may demand payment of P90,000 (comprising X, Y and Z’s shares in the obligation) from either X, Y, or Z, or both or all of them.

2. Each one of the solidary creditors may do whatever may be useful to the others, but not anything which may be prejudicial to the latter (Article 1212). Thus, it was held that a solidary creditor can demand payment in behalf of the other creditors should he has knowledge of the circumstances where the debtor/s loses the right to make use of the period. But a solidary creditor cannot renounce the debt in favor of the debtor/s without the latter’s consent as this will cause prejudice to the other creditors. 3. A solidary creditor cannot assign his rights without the consent of the others (Art.1213) Assignment is the act by which one person transfers to another, or causes to vest in that other, the whole of the right, interest, or property which he has in any realty or personalty, in possession or in action, or any share, interest, or subsidiary estate therein. 4. The debtor may pay any one of the solidary creditors; but if any demand, judicial or extrajudicial, has been made by one of them, payment should be made to him (Art. 1214) 5. Novation, compensation, confusion or remission of the debt, made by any of the solidary creditors or with any of the solidary debtors, shall extinguish the obligation, without prejudice to the provisions of article 1219. The creditor who may have executed any of these acts, as well as he who collects the debt, shall be liable to the others for the share in the obligation corresponding to them. Examples: a. A, B and C, solidary debtors, executed a negotiable promissory note in favor of E for P10,000. E endorsed the note to F, F endorsed the note to G, G then endorsed the note to C. The confusion in C extinguishes the whole obligation, subject to the right of reimbursement from A and B for their respective shares. b. A, B, and C, solidary debtors, are indebted to X, Y and Z, solidary creditors, for P300,000. Because of personal family ties, Y renounced the debt. The whole obligation is thus extinguished. The solidary debtors are benefitted from the renunciation obtained by one of them. But the creditor who renounced the obligation without the consent of other creditors shall be liable to pay for the share of other creditors who did not give their consent to such act. 6. The creditor may proceed against any one of the solidary debtors or some or all of them simultaneously. The demand made against one of them shall not be an obstacle to those which may subsequently be directed against the others, so long as the debt has not been fully collected ( Article 1216 )

7. Payment made by one of the solidary debtors extinguishes the obligation. If two or more solidary debtors offer to pay, the creditor may choose which offer to accept. He who made the payment may claim from his co-debtors only the share which corresponds to each, with the interest for the payment already made. If the payment is made before the debt is due, no interest for the intervening period may be demanded. When one of the solidary debtors cannot, because of his insolvency, reimburse his share to the debtor paying the obligation, such share shall be borne by all his codebtors, in proportion to the debt of each (Article 1217) 8. Payment by a solidary debtor shall not entitle him to reimbursement from his co-debtors if such payment is made after the obligation has prescribed or become illegal (Article 1218) By prescription, the obligation loses its validity through passage of time. Under the Philippine law, obligation becomes prescribed after the lapse of ten (10) years from the last demand was made. 9. The remission made by the creditor of the share which affects one of the solidary debtors does not release the latter from his responsibility towards the co-debtors, in case the debt had been totally paid by anyone of them before the remission was effected (Article 1219) 10. If the thing has been lost or if the prestation has become impossible without the fault of the solidary debtors, the obligation shall be extinguished. If there was fault on the part of any one of them, all shall be responsible to the creditor, for the price and the payment of damages and interest, without prejudice to their action against the guilty or negligent debtor. If through a fortuitous event, the thing is lost or the performance has become impossible after one of the solidary debtors has incurred in delay through the judicial or extrajudicial demand upon him by the creditor, the provisions of the preceding paragraph shall apply. (Article 1221) 11. A solidary debtor may, in actions filed by the creditor, avail himself of all defenses which are derived from the nature of the obligation and of those which are personal to him, or pertain to his own share. With respect to those which personally belong to the others, he may avail himself thereof only as regards that part of the debt for which the latter are responsible ( Article 1222) Divisible and Indivisible Obligations Divisible and indivisible obligation, defined

An obligation is divisible when the object of the performance is susceptible of division. When the obligation has for its object the execution of a certain number of days of work, the accomplishment of work by metrical units, or analogous things which by their nature are susceptible of partial performance, it is divisible. Examples: 1. Capable to be executed for certain number of hours – obligation to construct the fence in the house for 2 weeks, obligation to teach 3 hours a day for 1 semester; 2. Capable of measurement of work by metrical units – obligation to deliver 100 sack s of rice, obligation to deliver 10,000 liters of gasoline 3. Analogous things susceptible of partial performance An obligation is indivisible when the object of the performance, because of its nature or because of the intent of the parties, is not susceptible of division. The following are indivisible obligations: 1. Obligation to give a definite thing – obligation to give a specific race horse 2. Those not susceptible of partial performance – obligation to sing the national anthem during Manny Pacquiao fight 3. Although the object is divisible, the law provides its indivisibility – such as when the court award moral damages of P100,000 against the accused, partial performance of the obligation is not allowed 4. Although the object is indivisible, the parties stipulate its invisibility – such as when the obligation to deliver 10 sacks of rice and the parties agreed that the obligation is indivisible, hence, the obligor cannot made partial delivery. Obligation with a Penal Clause Obligation with a penal clause, defined An obligation with a penal clause is one which provide greater liability on the part of the obligor in case of non-compliance. A penal clause is an accessory undertaking to assume greater liability in case of breach. It has a double function: 1. To provide for liquidated damages, and To strengthen the coercive force of the obligation by the threat of greater responsibility in the event of breach. A penal clause is intended to prevent the obligor from defaulting in the performance of his obligation. Thus, if there should be default, the penalty may be enforced

Example: D promises to deliver to E a specific car on September 30, 2013. The parties agreed that should D fails to deliver on the specified date, D shall pay E the penalty of P300,000. Kinds of penal clause 1. Legal and conventional a. Legal – imposed by law, such as a penalty of 25% p.a. interest and 25%-50% surcharge imposed on the basic assessed tax for everyday of delay in payment. b.

Conventional – imposed by the agreement of parties.

2. Subsidiary and joint a. Subsidiary – when only the penalty may be enforced b. Joint – when both the obligation and the penalty may be enforced Rules in obligation with a penal clause General rule: the penalty takes the place of the damages and interest in case of noncompliance. Exception: aside from penalty, damages and interests may also be demanded in the following instances: 1. When there is stipulation to that effect 2. When the debtor refuses to pay the penalty 3. When the debtor is guilty of fraud in the performance of his obligation Other rules applicable to obligations with a penal clause 1. The debtor cannot exempt himself from the performance of the obligation by paying the penalty, save in the case where this right has been expressly reserved for him (Article 1227) 2. Neither can the creditor demand the fulfillment of the obligation and the satisfaction of the penalty at the same time, unless this right has been clearly granted him 3. Proof of actual damages suffered by the creditor is not necessary in order that the penalty may be demanded (Article 1228) 4. The judge shall equitably reduce the penalty when the principal obligation has been partly or irregularly complied with by the debtor. Even if there has been no performance, the penalty may also be reduced by the courts if it is iniquitous or unconscionable. (Article 1229)

5. The nullity of the penal clause does not carry with it that of the principal obligation. The nullity of the principal obligation carries with it that of the penal clause (Article 1230) EXTINGUISHMENT OF OBLIGATIONS Modes of extinguishment of obligations (Pa-Lo-Re-Me-Co-No) 1. By payment or performance; 2. By the loss of the thing due; 3. By the condonation or remission of the debt; 4. By the confusion or merger of the rights of creditor and debtor; 5. By compensation; 6. By novation. 7. Other causes of extinguishment of obligations, such as annulment, rescission, fulfillment of a resolutory condition, and prescription Payment or Performance Payment (or performance) defined Payment means not only the delivery of money but also the performance, in any other manner, of an obligation. A debt shall not be understood to have been paid unless the thing or service in which the obligation consists has been completely delivered or rendered, as the case may be. Rules on payment or performance 1. Obligation to give a specific thing – the debtor must deliver the thing agreed by parties. Thus, the debtor cannot compel the creditor to accept a different one, although the latter may be of the same value, or more valuable than which is due. Example: A promises to deliver B a specific gold ring. On due date, B, however, deliver a diamond ring instead. Here, B can refuse to accept the diamond ring even it is more valuable than the gold ring. If B, however, accept the delivery, then the obligation is extinguish because the deficiency in consent was cured. 2. Obligation to give a generic thing – the debtor cannot deliver inferior quality, nor the creditor cannot demand delivery of superior quality. The purpose of the circumstances shall be taken into consideration. Example: X is obliged to deliver to Y a horse. Y is engaged in horseracing activities and all his horses are used for horse-racing events. X is fully aware of this fact. Under this circumstance, X must deliver a horse for horse-race and cannot deliver a horse used for calesa. 3. Obligation to do or not to do – an act or forbearance cannot be substituted by another act or forbearance against the will of the obligee. Examples:

a. A obliged himself to paint B’s residential house. He cannot substitute it with an obligation to paint B’s commercial building without B’s consent. b. S agreed to provide T monthly support of P10,000 for 5 years, provided that T will not enter into any beerhouse. T cannot ask S that the “obligation not to enter any beerhouse” be substituted with “not to drink or smoke” during the term of their agreement. 4. If the obligation is a monetary obligation, the payment must be in legal tender Legal tender – is the money or currency which the debtor may compel his creditor to accept payment of debt whether public or private. Legal tender consist of currencies and coins issued by the Bangko Sentral ng Pilipinas in the commercial transactions in the Philippines. The parties, however, may stipulate that payment be made other than the Philippine legal tender at the time of payment (R.A. 8083) Under Section 52 of the R.A. No. 7653 or the New Central Bank Act, the following are legal tender in the Philippines a. 10-centavo (P 0.10) coins or less – legal tender up to P20 b. 25-centavo (P0.25) – legal tender up to P50 c. One peso (P1.00) and above – legal tender up to any amount Inflation and deflation, its effect to obligation Inflation - is defined as the rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling. Deflation – is the opposite of inflation. It arises when there is persistent decrease in the level of consumer prices or a persistent increase in the purchasing power of money because of a reduction in available currency and credit. As a rule, inflation and deflation do not affect the monetary obligations as these are common occurrence in a market-driven economy. But in case of extraordinary inflation or deflation, In case an extraordinary inflation or deflation of the currency stipulated should supervene, the value of the currency at the time of the establishment of the obligation shall be the basis of payment, unless there is an agreement to the contrary. Example: A promises to pay B the amount of P1,000,000 payable after 10 years. On maturity date, how much must A pays B? a. Ordinary inflation and ordinary deflation – no effect. A must pay B the amount of P1,000,000

b. Extraordinary inflation – suppose that before the maturity, because of extraordinary inflation, the purchasing power was reduced to ½. (say P1,000,000 now can buy 1 hectare of land, while 10 years after, your P1,000,000 can only buy one-half hectare of the same type of land). In this case, A must pay the amount of P2,000,000 to B on the maturity date. Below is the computation: Maturity value = = = =

Original obligation x Present value/Future value P 1,000,000 x 1,000,000/500,000 P 1,000,000 x 2 P 2,000,000

c. Extraordinary deflation – suppose that before the maturity, because of extraordinary deflation, the purchasing power was increased four (5) times (say P1,000,000 now can buy 1 hectare of land, while 10 years after because of economic boom, your P1,000,000 can now buy five (5) hectares of the same type of land). In this case, A must pay the amount of P200,000 to B on the maturity date. Below is the computation: Maturity value = = = =

Original obligation x Present value/Future value P 1,000,000 x 1,000,000/5,000000 P 1,000,000 x 0.20 P 200,000

Can payment be made in check or other instrument? No. The delivery of promissory notes payable to order, or bills of exchange or other mercantile documents shall produce the effect of payment only a. when they have been cashed, or b. when through the fault of the creditor they have been impaired. Additional rules on payment or performance 1. Article 1233 - A debt shall not be understood to have been paid unless the thing or service in which the obligation consists has been completely delivered or rendered, as the case may be. Exceptions: a. If the obligation has been substantially performed in good faith, the obligor may recover as though there had been a strict and complete fulfillment, less damages suffered by the oblige (Article 1234) Example: D agreed to deliver to E 100 pcs. of good lumber. After D delivered 90 pcs. of good lumber to E, the government passed a lwa

prohibiting the sale of good lumber. Hence, E can no longer comply with is obligation. Here, S can demand payment for 100 pcs. of lumber from B, less damages suffered by B in the circumstance. b. Article 1235 - When the obligee accepts the performance, knowing its incompleteness or irregularity, and without expressing any protest or objection, the obligation is deemed fully complied with Example: A obliged himself to construct a concrete fence for B’s land. The fence shall enclose the whole land of B and it shall be 5 feet tall. If A constructed a fence with a height of only 4 1’2 feet, and B accepted the latter’s performance without any objections, B’s obligation is deemed to fully complied with his obligation. 2. When payment made to the creditor by the debtor after the debtor has been judicially ordered to retain the debt shall not be valid. Partial payment or performance not allowed The creditor cannot be compelled to receive, and the debtor cannot be compelled to make, partial payments. Exceptions: 1. When there is an agreement to that effect 2. When the debt is in part liquidated and in part unliquidated, the creditor may demand and the debtor may effect the payment of the liquidated portion without waiting for the liquidation of the latter. The unliquidated part, once it is finally determined, must also be paid, to extinguish the obligation. Examples: S is indebted to T the amount of P500,000 payable 3 months thereafter. On maturity date, S does not have enough cash in the meantime but has enough property to settle his obligations. S sold his several parcels of land worth P800,000, and the proceeds to be used to settle his obligations to T. Buyer 1 immediately pays P300,000 for the price of 1 lot. Buyer 2 will pay the price of P500,000 one month after the sale. Upon payment of Buyer 1, S may demand payment for the liquidated portion of P300,000 without awaiting of the payment from Buyer 2. Of course, when Buyer 2 pays the price, S may demand the payment of the balance. Who must make payment? Payment shall be made by the debtor who must have the following: 1. The free disposal of the thing due Free disposal of the thing due means that the property delivered should not be subject to any claim by, or encumbrances in favor of, third persons

The following does not have free disposal of the thing due  The mortgaged property of the mortgagor cannot be used as payment to the creditor other than the mortgagee. The property can be made answer for the debt secured in case of foreclosure of mortgage  Deposits garnished by court cannot be used to pay an obligation contracted by the debtor  The property under the custody of law (custodial legis), such as those confiscated vehicles due to traffic violations or vehicular accidents, cannot be uses as payment to the creditor. 2. The capacity to alienate thing – the debtor must not be incapable of giving consent. Effect of payment of debtor who does not have the free disposal of the thing due and/or has no capacity to alienate thing  If payment is made the debtor who does not have the free disposal of the thing due. the payment shall not be valid except in cases provided by the law The injured party may seek to recover the payment. 

If payment is made by incapacitated person, the guardian of the incapacitated person or the incapacitated himself when he regains capacity, may seek the annulment of payment.

Effects of payment made by third person General Rule: the creditor is not bound to accept payment or performance by a third person, except in the following cases: 1. When there is a stipulation to that effect

2. When the third person has an interest in the fulfillment of the obligation such as guarantor or a co-debtor

Rights of the third person who makes the payment 1. When payment is with the knowledge and consent of the debtor 

He can recover what he has paid



He is entitled to be subrogated in the rights of the creditor such as those arising from mortgage, guaranty or penalty

Example: X is indebted to Y for P200,000 secured by a mortgage of X’s residential house and lot. M, a third person, pays the amount to Y with the consent of X. M is thus subrogated with the rights of Y. If on maturity date, X failed to pay, then M can foreclose the mortgaged property of X.

2. When payment was made without the knowledge or against the will of the debtor. 

He can recover what he has paid only insofar as it is beneficial to the debtor.



He is not entitled to be subrogated in the rights of the creditor.

Example: O is indebted to P for P200,000 secured by a mortgage of P’s residential house and lot. M, a third person, pays the amount to P without the knowledge of O. Unknown to M, O has previously made partial payments to P totaling P80,000. Thus, M can only recover from O the amount of P120,000, the extent of payment beneficial to O. If on maturity date, O failed to pay, M cannot foreclose the mortgaged property of X since he is not subrogated by the rights of the previous creditor.

3. When payment was made by a third person who don’t want to be reimbursed 

The payment shall be deemed as donation which requires the debtor’s consent



If the debtor does not consent, the payment shall have the same effect of payment made without the knowledge or against the will of the debtor

To whom shall payment be made? 1. To the creditor himself 2. To the creditor’s successors-in-interest, such as heirs and /or assigns

3. To the person authorized to receive payment ( such as guardians in case of incapacitated persons, executors and administrators in case of deceased creditors, partner/s in a partnership) Payment to incapacitated person The creditor must be capacitated to received payments. Payment to an incapacitated person shall not be valid, except: 1. If he has kept the thing delivered Thus, if a minor who receives payment from a creditor, has kept the same to his piggy bank (alkansya), the payment was held to be valid. 2. Insofar as the payment has been beneficial to him Accordingly, when a minor or other incapacitated person received payment and squandered the same, such as the money was used for betting in illegal gambling and the like, the payment to the minor was held invalid. If, for example, the minor receives P20,000 as payment from the debtor and he spent P10,000 to pay his school fees, another P6,000 was used to buy groceries for their family consumption, and the remaining P4,000 was used to bet in illegal gambling, then the payment to the extent of P16,000 was held valid since it is the amount of payment that was beneficial to the minor. Payment to unauthorized third person Payment to an authorized third person is not valid, except in the following cases: 1. Art. 1241 - If the payment has redounded to the benefit of the creditor, which benefit need not be proved in the following cases: (1) If after the payment, the third person acquires the creditor's rights (subrogation) Example: A is indebted to B supported by a promissory note for P20,000. On maturity date of the promissory note, A pays to X, a third person. Meanwhile, B has assigned the same promissory note of A in favor of X. Hence, the payment is held to be valid. (2) If the creditor ratifies the payment to the third person (ratification) Example: A is indebted to B supported by a promissory note for P20,000. On maturity date of the promissory note, A pays to X, a third person. Upon knowledge of payment to X, B informed A that X is his employee and the payment has already been remitted to him. The act of ratification by B makes the payment valid. (3) If by the creditor's conduct, the debtor has been led to believe that the third person had authority to receive the payment (estoppel) Example: A is indebted to B supported by a promissory note for P20,000. On maturity date of the promissory note, A pays to X, a third

person. Then A went to the office of B to inform him that he has already paid the note to X. Upon knowledge of payment to X, B keep silent, and neither confirmed nor denied the authority of X o receive payment in his behalf. The conduct of B constitutes estoppels thus, he cannot set up the defense of want of authority of X to accept payment in his behalf. 2. Art. 1242 – If payment is made in good faith to any person in possession of the credit. In this case. The person possess both the credit and the instrument of credit. Example: A makes a negotiable promissory note payable to the order of bearer in the amount of P100,000. He then gave the note to B as proof of his indebtedness. On maturity date, the promissory note is in the possession of F, who demanded payment from A for the amount of the note. Payment of A in good faith to F is a valid payment. Where payment must be made? 1. In the place stipulated by the parties 2. If no place of payment was stipulated, a. In obligation to give a determinate thing, wherever the thing might be at the time the obligation was constituted b. In obligation to give a generic thing, or an obligation to do, then at the domicile of the debtor What are the special forms of payment? 1. Dation in payment or decion en pago 2. Application of payment 3. Payment by cession 4. Tender of payment and consignation

Dation in Payment Dation in payment, defined Dation in payment ( dacion en pago, adjudicacion en pago, datio en solutum, or payment in kind ), is mode of extinguishing an obligation whereby the debtor alienates in favor of the creditor property for the satisfaction of monetary debt. The obligation is extinguish up to amount of property unless there is a contrary stipulation. Conditions for a valid dacion 1. If creditor consents, for a sale presupposes the consent of both parties 2. If dacion will not prejudice the other creditors 3. If debtor is not judicially declared insolvent is a special form of payment whereby property is alienated by debtor in favor of the creditor as payment of the former’s debt.

Example: X is indebted to Y for P500,000. On maturity date, X has no sufficient cash to pay his liabilities to Y. The parties agreed that X will deliver his Honda Civic car with Plate No. PEG 155 to Y to settle the former’s accountabilities. a. In the absence of contrary stipulations, the delivery of the car shall extinguish the whole obligation regardless of the value of the property at the time it was used for payment under dacion en pago. b. The parties may stipulate that the obligation will be extinguished to the extent of the value of the property at the time it was used for payment. Thus –  If the value of property is less than the amount of obligation, then the obligation is partially extinguished  If the value of the property is more than the amount of obligation, the parties may stipulate that the creditor shall pay the debtor the balance. ( Note: dacion en pago is governed by the law on sales ) Application of Payment Application of payment, when applied? It is the designation of the debt to which payment shall be applied when the debtor owes several debts in favor of the same creditor (Art. 1252). For the application of payments be made, the following requisites must concur: 1. There must be two or more debts 2. The debts must be of the same kind 3. The debts are owed by the same debtor to the same creditor 4. All debts are due, except: a. When the parties have stipulated that payment may be applied to a debt niot yet due b. When the application is made by the party for whose benefit he term has been constituted. 5. The payment is insufficient to cover all the debts Note: If the debt produces interest, payment of the principal shall not be deemed to have been made until the interests have been covered. (Art. 1253) How application is made? a. Debtor has the preference of choice - The debtor is given the preferential right to designate which debt/s to apply the payment; b. Creditor as the right to choose if debtor fails to choose - If the debtor doe not exercise his right, the debtor shall choose the application of payment and indicates the debt being paid in his receipt. If the debtor accepts the receipt from the creditor, the debtor cannot complain unless there is a just cause of invalidating the contract; c. Application of payment by operation of law should both the debtor and creditor failed to choose - If neither the debtor nor the creditor makes the designation or application

cannot be inferred from the circumstances, payment shall be applied by operation of law as follows: 1. Payment shall be applied to debt, among those due, which is the most onerous to the debtor 2. If the debt are of the same kind and nature, payment shall be applied to all debts due proportionately Note: a debt is onerous if it is more burdensome to the debtor. Thus, it has been held that obligations bearing interest, those secured with pledge and mortgages, those contracted with guaranty and surety, are considered onerous debts. Examples: A is indebted to B for the following: (a) P10,000 due on August 31, 2013; (b) P20,000 due on August 31, 2013; and (c) P20,000 with 15% per annum on September 30, 2013.  assuming on August 31, 2013, B has only P15,000 cash on hand, the rules on application of payment will be as follows: - the application shall be made in accordance with the agreement of the parties. If both parties agreed that the P15,000 will be applied first to the obligation with 15% interest rate, then the agreement shall be followed even though the debt does not yet mature -

the debtor may choose how the P15,000 will be applied

-

if the creditor does not choose, the creditor shall have the right of choice. Thus, if the creditor specified that the P15,000 shall be applied as full payment of P10,000 debt and partial payment of P5,000 for the other debt, the creditor cannot complain on the same application unless there is a just cause to invalidate the application of payments.

-

If neither the debtor nor the creditor chooses which debt/s it is to be applied, the law provides that it should be proportionately applied to both debts. Thus P5,0001 payment for the P10,000 debt; and P10,0002 payment for the P20,000 debt. 1 2 = ( P15,000 x 10,000/30,000) = (P15,000 x 20,000/30,000)

Note: the debt not yet due on August 31 cannot be included in the application of payment Payment by Cession Payment be cession, defined

Payment by cession is the assignment or abandonment by the debtor of all his propertie in favor of his creditors so that the latter may sell them and e\recover claims out of the proceeds. Under Article 1255, the debtor may cede or assign his property to his creditors in payment of his debts. This cession, unless there is stipulation to the contrary, shall only release the debtor from responsibility for the net proceeds of the thing assigned. The agreements which, on the effect of the cession, are made between the debtor and his creditors shall be governed by special laws Requisites of payment be cession 1. There must be two or more creditors 2. The debtor in insolvent 3. The debtor abandons or assigns ALL his properties except those exempt from execution, in favor of his creditors 4. The creditors accept the abandonment or assignment Kinds of payment by cession 1. Voluntary or conventional – agreed upon by parties 2. Legal – cession by operation of law How the payment by cession made? 1. The insolvent debtor assigns his rights over the property to the creditors, with the agreement of all the creditors. The court, upon petition of parties; or creditor may appoint from among themselves the administrator/s to sell the said properties 2. The properties are sold at public auction. 3. The proceeds are applied to the respective claims of the creditors. The debtor is release only of his accountabilities to the extent of the proceeds of the properties sold, unless the creditors agreed to release him completely of his debts.

Payment by cession and dation in payment, distinguished

As to number of creditors Properties involved

Transfer of ownership

Insolvency of the debtor

Payment by cession There must be 2 or more creditors Affects ALL the debtor’s properties, except those exempt from execution No transfer of ownership. The creditors are only authorized to sell the debtor’s properties The debtor must be insolvent

Dation in payment No requirement for the number of creditors Doe not affect all the debtor’s properties The creditor becomes the owner of the property given as payment The debtor need not be insolvent

Extinguishment of obligation

The obligation is extinguished up to the extent of the proceeds of the sale from properties, unless the creditors agreed to release the debtor from his obligations

Obligation is extinguished as a rule

Tender of payment and consignation Concept of tender of payment and consignation Tender of payment is the act of the debtor of offering to the creditor what is due to him Consignation, on the other hand, is the act of depositing the sum or thing due with judicial authorities whenever the creditor refuses without just cause to accept the same, or in cases where the creditor cannot accept it by. Tender of payment must be accompanied by consignation of the sum or thing due to extinguish an obligation. How to make a valid tender of payment and consignation? a. There must be a valid tender of payment. The tender must be in the thing contemplated, in legal tender, complete, made on maturity date or expiration of the term, as the case may be, in the place and time agreed upon by the parties, as among the requisites for a valid payment. b. The creditor refuses without just cause to receive the payment c. The person interested in the fulfillment of the obligation must be notified by the debtor of his intention to deposit the sum or thing due with judicial authorities. The notice will enable the sureties, co-debtor, mortgagors, guarantors among others, to reconsider accepting the payment to avoid litigation. The notice is also required to give the creditor the opportunity to accept the payment since the expenses for consignation will be charged to him for his non-acceptance of the valid tender of payment. d. The sum or the thing due is deposited with judicial authorities e. The person interested in the fulfillment of the obligation must again be notified by the debtor that the consignation has been made. Effects of consignation duly made If the consignation has been duly made, the debtor may ask the judge to order the cancellation of the obligation. The obligation shall be extinguished after the creditor has accepted the consignation or the judge has declared that the consignation has been properly made (Art.1260)

Can the debtor withdraw the sum or thing consigned? a. Before acceptance by the creditor of the consignation or the declaration by the judge that the consignation has been properly made, the creditor may withdraw the sum or thing deposited as a matter of right. The consent of the creditor is not required. It produces the following effects: 1. The obligation shall remain in full force 2. The co-debtors, guarantors, and sureties are not released b. After the acceptance by the creditor of the consignation or the declaration by the judge that the consignation has been properly made, the creditor may still withdraw the sum or thing deposited with the consent of the creditor. It produces the following effects: 1. The obligation shall be revived 2. The creditor shall lose every preference which may have over the thing 3. The guarantors and sureties are released. If there are several debtors and their obligation is solidary, such obligation will become a joint obligation. Hence, the creditor can no longer proceed to the guarantor or surety if the principal debtor becomes insolvent or will not pay the latter’s obligation. In the same manner, solidary debtors will now be bound jointly, and their liability shall be to the extent of their proportionate share in the obligation. General Rule: there must be a previous tender of payment, and the creditor does not accept the payment without valid reason, before consignation of the sum or thing due can be made. Exception: Consignation alone shall produce the effect of payment in the following circumstances: (1) When the creditor is absent or unknown, or does not appear at the place of payment; (2) When he is incapacitated to receive the payment at the time it is due; (3) When, without just cause, he refuses to give a receipt; (4) When two or more persons claim the same right to collect; (5) When the title of the obligation has been lost. Loss of the Thing Due Definition of loss A thing is considered lost when it perishes, goes out of commerce, or disappears in such a way that its existence is unknown or cannot be recovered (Art.1189). Loss includes the physical or legal impossibility of the service in which the obligation consists. Examples of loss: 1. It perishes – when the house is burned to ashes, liquid chemicals that evaporated 2. Goes out of commerce – an old model of IBM laptop already phased out in the market.

3. It disappears that its existence is unknown – a certain cellular phone lost and the owner did not know whether it was stolen of left somewhere, which despite diligent efforts, cannot be located anymore. 4. Cannot be recovered – a specific ring thrown at the Pacific Ocean Physical vs. Legal impossibility a. Physical impossibility refers to impossibility due to the fact that act cannot be physically achieved, like the obligation to paint a mansion house for 7 days using a watercolor paint only. b. Legal impossibility refers to an impossibility arising due to the fact that what the obligor’s intended to give or to do illegal, such as obligation to appear as counsel for the accused when the lawyer was now appointed as trial court judge, or the obligation to deliver narra lumber when the government has declared the total ban for the sale and distribution of narra lumber. Effects of loss in the obligation 1. Loss of a determinate thing General Rule: the loss of a determinate thing shall extinguish the obligation. Exceptions: a. When the loss id due to the fault of the debtor (Art. 1262). – the loss is presumed to be due to the fault of the debtor, unless prove otherwise. This presumption does not apply in cases of earthquake, flood, storm or other natural calamity. b. When the debtor has incurred a delay c. When the law so provides – as when the debtor has promised to deliver the same thing to two or more persons who do not have the same interests (Art.1165) d. When it is stipulated by the parties e. When the nature of the obligation requires the assumption of risk f.

When the debt proceeds from a criminal offense, unless the person who should receive it refuses to accept it without just cause (Art. 1268)

2. Loss of a generic thing In an obligation to deliver a generic thing, the loss or destruction of anything of the same kind does not extinguish the obligation (Art. 1263). However, when the generic thing is “delimited” in a sense that it is segregated from the rest, such as “100 sacks of palay harvested from my land at Arimbay, Legazpi City”, is lost without the fault of the debtor, the obligation is extinguished.

3. Loss in personal obligation (obligation to do) a. When the prestation becomes legally or physically impossible without the fault of the debtor, the obligation is extinguished. (Art. 1266) b. When the service has become so difficult as to be manifestly beyond the contemplation of the parties, the obligor may also be released there from, in whole or in part (Art. 1267) Effects of partial loss Under Article 1264, it provides that “the courts shall determine whether, under the circumstances, the partial loss of the object of the obligation is so important as to extinguish the obligation.” If the loss is caused by a third person The obligation having been extinguished by the loss of the thing, the creditor shall have all the rights of action which the debtor may have against third persons by reason of the loss (Article 1269) Condonation or Remission of Debt Condonation or Remission of Debt, defined Condonation or remission of debt is the gratuitous abandonment by the creditor of his rights. To condone means to forget the indebtedness of the debtor without expecting payment in return. For condonation or remission to extinguish an obligation, it requires the debtor’s consent (Art. 1270) Reason for debtor’s consent: No one is bound to accept the generosity of another Kinds of condonation or remission 1. As to amount or extent a. Total condonation – when the obligation (both principal and accessory obligation) is condoned b. Partial condonation – when only part of the obligation, or only the accessory obligation is condoned 2. As to form a. Express – when made orally or in writing. It must be valid, unequivocal and must conform with the formalities of donation as follows:  When the remission involves immovable property, the remission and the acceptance must be in a public instrument. The public document must specify the property remitted and the value of the charges that the debtor (done) must satisfy

 -

-

When the remission involves movable/personal property – If the value of the property exceeds P5,000, the remission and acceptance must be in writing (public or private) If the value of the property is P5,000 or less, the remission and acceptance may be in any form ( maybe oral, in writing or partly oral and partly in writing). The emission orally made, however, requires simultaneous delivery of the thing or the document representing the right remitted

b. Implied – when it can be inferred from the conduct of the parties, such as when the creditor voluntarily delivers the private document evidencing the credit to the debtor, or when the holder of the promissory note intentionally burned or tear down the said document. Legal presumptions in the condonation or remission of debt 1. Art. 1272 – Whenever the private document in which the debt appears is found in the possession of the debtor, it shall be presumed that the creditor delivered it voluntarily, unless the contrary is proved. 2. Article 1273 - The renunciation of the principal debt shall extinguish the accessory obligations; but the waiver of the latter shall leave the former in force. This is in accordance with the general rule that accessory follows the principal. Thus, in a loan secured with mortgage on real property, if the loan was condoned by the creditor, the mortgage shall also be considered condoned. However, the condonation of the mortgage does not carry with it the extinguishment of the principal loan contract. 3. Art. 1274 - It is presumed that the accessory obligation of pledge has been remitted when the thing pledged, after its delivery to the creditor, is found in the possession of the debtor, or of a third person who owns the thing Confusion or merger Confusion or merger, defined Confusion or merger is the meeting in one person of the qualities or characters of creditor and debtor. Simply put, the debtor becomes a creditor of himself. For example: S delivers a negotiable promissory note payable to A for P100,000 payable on December 31, 2014. A then indorse the promissory note to B, B to C, C to D and D to S. in this case, S is a debtor (maker of promissory note) and likewise a creditor (holder of the promissory note). The obligation is extinguished by reason of confusion or merger of rights. Effects of confusion merger

1. Effects to guarantor - Merger which takes place in the person of the principal debtor or creditor benefits the guarantors (Art. 1276). This is in consonance with the rule that “accessory follows the principal” However, when the confusion takes place in the person of guarantor, only the guaranty is extinguished. Such as when, S delivers a promissory note to A, with X as a guarantor. Then A indorse the note to B, B to C, then C to X (guarantor). X as the holder of the note is subrogated with the rights of the creditor, hence can demand payment from A. The principal contract remains following the rule that “extinguishment of the subsidiary does not carry with it the extinguishment of the principal.” 2. Effect in joint obligation - Confusion does not extinguish a joint obligation except as regards the share corresponding to the creditor or debtor in whom the two characters concur (Art. 1277). Thus, if X, Y and Z, joint debtors, delivers a promissory note to W for P60,000. Then W indorse the note to A, A to B, and B to Y. The confusion shall only affect the share of Y. Therefore, Y can collect from both X and Z their respective shares in the obligation, with Y being now the new creditor. 3. Effect in solidary obligation - Confusion or merger in one of the solidary debtors or solidary creditors extinguishes the whole obligation. The solidary debtor in whom merger takes place may demand reimbursement from his co-debtors. Similarly, the solidary creditor whom merger occurs is liable for the share of co-creditors corresponding to them.  Effects to solidary debtors: Thus, if X, Y and Z, solidary debtors, delivers a promissory note to W for P60,000. Then W indorse the note to A, A to B, and B to Y. The confusion shall extinguish the obligation. However, Y can demand reimbursement from both X and Z their respective shares in the obligation. 

Effects to solidary creditors: P is indebted to X, Y and Z, solidary creditors, as evidenced by a promissory note for P60,000 in favor of the latter. Then Either X, Y or Z can indorse the note. Then X indorse the note to A, A to B, and B to P. The confusion on the part of P (now being a creditor and debtor at the same time) shall extinguish the obligation. However, Y must reimburse both X and Z their respective shares in the obligation.

Compensation Compensation, defined Compensation shall take place when two persons, in their own right, are creditors and debtors of each other (Art. 1278). In layman’s term, it’s the setting off of the obligations when parties are both debtors and creditors of each other.

Requisites of a valid compensation In order that compensation may be proper, it is necessary: 1. That each one of the obligors be bound principally, and that he be at the same time a principal creditor of the other; 2.

That both debts consist in a sum of money, or if the things due are consumable, they be of the same kind, and also of the same quality if the latter has been stated;

3.

That the two debts be due;

4.

That they be liquidated and demandable;

5.

That over neither of them there be any retention or controversy, commenced by third persons and communicated in due time to the debtor

Hence, there can be no valid compensation in the following cases;  Between a creditor and a guarantor 

When one party is oblige to do an act, and the other to deliver a sum of money



When one of the obligation is a conditional obligation or obligation with a period, unless both parties agreed to the compensation



When one of the obligations is not yet liquidated



When one of the obligation is subject to right of third person, such as property is under garnishment.

Kinds of compensation 1. As to amount or extent a. Total – when the debts are of the same amount b. Partial – when the debts are of different amounts 2. As to cause or origin a. Legal compensation – this takes place by operation of law. The obligation is extinguished to the extent of the debts of parties (may be total or partial). Legal compensation takes place even though the debts are payable at different places and the debtor and the creditor is not aware of the compensation. The follow are requisites for legal compensation.  That the obligor be bound principally, and that he at the same time a principal creditor of the other

Thus, if A owes B P10,000 and B owes A P10,000, and both debts are due, legal compensation takes place by operation of law. 

That both debts consist in a sum of money, or if the things due are consumable, they be of the same kind, and also the same quality if the latter has been stipulated Thus, if A obliged himself to deliver to B 10 sacks of sinadomeng rice, and likewise, B also promises ro deliver the same kind and quantity of rice, legal compensation will extinguish both obligations.



That both debts are due The debt must have already matured before legal compensation sets in. Hence, if A owes B P10,000 payable on Jan. 10, 2014 and B owes C P10,000 due on February 15, 2014, there can be no legal compensation to this effect.



That both debts are liquidated and demandable. For a debt to be “liquidated”, the amount of debts has already been determined or readily determinable. For a debt to be “demandable”, it must be enforceable in court. Thus, if the obligation falls under statute of frauds, or has already prescribed, legal compensation cannot take effect.



That over neither of them there be any retention or controversy, commenced by third persons and communicated in due time to the debtor Example: A owes B P100,000. B likewise owes A P100,000. Both debts are due and demandable. X, a creditor of A, secured a judgment from court asking B to pay directly to X from the former’s obligation to A. Here, there can be no legal compensation to take place since one of the debt was subjected to court order.

b. Voluntary or conventional – takes place when compensation is agreed upon by parties. They may agree that to the compensation of debts not yet due (Art.1282) c. Judicial – when compensation is ordered by the court. Under Art. 1283, if one of the parties to a suit over an obligation has a claim for damages against the other, the former may set it off by proving his right to said damages and the amount thereof

d. Facultative – compensation that may be claimed or opposed by one of the parties, such as when not all the requisites for legal compensation are present. In facultative compensation, the aggrieved party has the right to set up compensation to extinguish the obligation. The following are instances when facultative compensation can be made:  When one of the debts arises from a deposit A deposit is constituted from the moment a person receives a thing belonging to another, with the obligation of safely keeping it and of returning the same (Art. 1962). Only the depositor can claim facultative compensation. Thus, if A deposits to B a 24-carat gold ring for purpose of safekeeping it, A is the depositor and B becomes the depository. On a later date, A obliged himself to deliver to B a 24-carat gold ring. On the due date, A fails to deliver the ring to B. 1) Can A demand the return of the ring previously deposited to B? YES. The depository shall return the thing deposited upon demand by the depositor. 2) Can B refused to return the ring and set up compensation? NO. There can be no legal compensation since the obligations are of different kind. Obligation of A to B is obligation to give arising from a simple contract; while the obligation of B to A arises from contract of deposit. 3) Can A (depositor) set up compensation to extinguish the obligation? YES. This refers to facultative compensation. The depositor has the option to set-off his obligation, that instead of delivering a 24-carat ring to B, the ring previously deposited to B be appropriated in the latter’s favor. When one of the debs arises from the obligation of a bailee in commodatum. Commodatum is a contract whereby the bailee acquires the use of the thing without compensation, but not its fruits. Here, only the lender (bailee) may claim the compensation. Thus, if X borrowed from Y an owner-type jeep for 1 month, free of rent, X is the borrower (bailor) and Y is the lender (bailee). On a later date, Y promises to deliver to X an owner-type jeep. On due date, Y fails to deliver. 

1) Can Y demand the return of the jeep previously lent to X for free? YES. The bailor in commodatum shall return the thing deposited upon demand by the depositor after the lapse of the term.

2) Can X refused to return the jeep and set up compensation? NO. There can be no legal compensation since the obligations are of different kind. Obligation of X to Y is obligation to return the thing subject of commodatum; while the obligation of Y to X arises from obligation to deliver a specific thing. 3) Can Y (bailee) set up compensation to extinguish the obligation? YES. This refers to facultative compensation. The bailee has the option to set-off his obligation, that instead of delivering an ownertype jeep to B, the jeep previously lent to B be appropriated in the latter’s favor. 

When one of the debts arises because of claim of support by gratuitous title. The support referred to here is future support and not support in arrears. Only the party entitled to support may claim or oppose the compensation. Example: In a case of legal separation, the court ordered H, husband, to provide for monthly support of P30,000 to W, his wife. For the present month, H has not yet given the monthly support to W. However, W borrowed money for P30,000 from H supported by a promissory note payable on demand. 1) Can H set up compensation? NO. There can be no legal compensation since the obligations are of different kind. Obligation of H to W is obligation to give support; while the obligation of W to H arises from simple contract of loan. 2) Can W set up compensation to extinguish the obligation? YES. This refers to facultative compensation. The party entitled to support has the option to set-off his obligation.

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When one of the debts consists in civil liability arising from a penal offense. Here, only the offended party may set up compensation. Example: X broke into the house of Y and was able to stole cash and other properties estimated at P300,000. A case was filed against for robbery and X was held guilty. The court ordered the imprisonment of X as well as reparation of actual and moral damages totaling to P500,000. Previously, however, Y borrowed money for P500,000 from X supported by a promissory note payable on demand.

3) Can X set up compensation? NO. There can be no legal compensation since the obligations are of different kind. Obligation of X to Y is obligation arising from penal offense; while the obligation of Y to X arises from simple contract of loan. 4) Can Y set up compensation to extinguish the obligation? YES. This refers to facultative compensation. The offended party has the option to set-off his obligation.

Can rescissible or voidable debt/s be the subject of compensation? When one or both debts are rescissible or voidable, they may be compensated against each other before they are judicially rescinded or avoided. (Art. 1284) When debts are payable at different places Compensation takes place by operation of law, even though the debts may be payable at different places, but there shall be an indemnity for expenses of exchange or transportation to the place of payment (Article 1286). Rules when several debts are susceptible of compensation If a person should have against him several debts which are susceptible of compensation, the rules on the application of payments shall apply to the order of the compensation (Article 1289). Effects of assignment on compensation of debts 1. When the assignment was with debtor’s consent – he cannot set up against the assignee the compensation that would pertain to him unless against the assignor unless he reserved the right to the compensation. Example: A delivers a promissory note in favor of B for P100,000, with maturity date on December 31, 2013. B, however, is also indebted to A for P70,000 also payable on December 31, 2013. On November 3, 2013, B assigned the promissory note partially for P100,000 to M. On maturity date, M demanded payment. Howe much M can collect?  If the assignment was made with the knowledge and consent of A, M can demand payment of P100,000 from A 

If A reserved his right to the compensation when he consented to the assignment, M can only collect the remaining P30,000 from A. of course, M can collect the P70,000 from B.

2. When the debtor was notified of the assignment but he did not give his consent – the debtor may set up compensation of debts maturing before the assignment but not for the subsequent ones.

Example: S is indebted to T for P100,000 payable on December 31,2013. Likewise, T issued promissory notes to S for the following:  P 10,000 payable on August 31, 2013  P 20,000 payable on September 30, 2013  P 50,000 payable on December 31, 2013 On October 5, 2013, T assigned his credit to X. T notified S of the assignment but S did not give his consent to the same. In this case, S can already set up compensation for the obligations already matured - ( P10,000 due on 8/31/2013) and (P20,000 due on 9/30/2013). 3.

If the assignment was made without the knowledge of the debtor, he can set up compensation of all debts maturing before the time he obtains knowledge of the assignment. Example: S is indebted to T for P100,000 payable on December 31,2013. Likewise, T issued promissory notes to S for the following:  P 10,000 payable on August 31, 2013  P 20,000 payable on September 30, 2013  P 10,000 payable on October 31, 2013  P 50,000 payable on December 31, 2013 On September 5, 2013, T assigned his credit to X without the knowledge of S. It was only on November 10, 2013 that S obtains knowledge of the said assignment. In this case, S can set up compensation for the obligations that matured prior to his knowledge of the assignment - ( P10,000 due on 8/31/2013), (P20,000 due on 9/30/2013) and (P10,000 due on 10/31/2013).

Compensation in solidary obligation When compensation was set up in favor of any solidary debtors or solidary creditors, the whole obligation is extinguished. The solidary debtor can demand reimbursement from his codebtors, and likewise the solidary creditor must reimburse his co-creditors for their respective shares. Examples: 1. Solidary debtors – A, B and C, solidary debtors, owes X for P30,000. X also owes A P30,000. When both obligations becomes due, compensation will extinguish the obligation. A, however, can demand reimbursement from B and C for their respective shares in the debt. 2. Solidary creditors – A owes X, Y and Z, solidary creditors, for P12,000. Z also owes A P12,000. Both debts are due and demandable. Compensation will extinguish the obligation. Z, however, must reimburse X and Y for their respective shares in the credit. 3. Mixed solidarity – A, B and C, jointly and severally liable to X, Y and Z, solidary creditors for P90,000. X owes C P90,000. Both debts are due and demandable. The obligation is

extinguished by compensation. C can demand reimbursement of P30,000 each from A and B. X must also reimburse Y and Z or their respective shares in credit. Novation

Novation, defined Novation is the extinguishment of obligation by creating another obligation either by: 1. Changing their object or principal conditions 2. Substituting the person of the debtor 3. Subrogating a third person in the rights of the creditor In order that an obligation may be extinguished by another which substitute the same, it is imperative that it be so declared in unequivocal terms, or that the old and the new obligations be on every point incompatible with each other (Article 1292). Requisites of a valid novation 1. There must be a valid obligation 2. There must be an agreement between the parties to modify or extinguish the obligation, except in the following: a. When a creditor pays another creditor who is preferred, even without the debtor's knowledge b. When a third person, not interested in the obligation, pays with the express or tacit approval of the debtor c. When, even without the knowledge of the debtor, a person interested in the fulfillment of the obligation pays, without prejudice to the effects of confusion as to the latter's share. 3. The original/old obligation is extinguished 4.

The new obligation must be valid

Kinds of novation 1. According to purpose a. Real or objective - novation by changing the object or principal condition Example: A obliged himself to deliver to B white race horse. Due to difficulty in obtaining the said horse, the parties agreed that A now deliver to B an ordinary white horse instead of the original one. b. Novation buy change of the parties (debtor or creditor)  Substituting the person of the debtor – always requires the consent of the creditor

b.1. Expromission – the third person initiates the substitution and assumes the obligation even without the knowledge or against the will of the debtor. - The new debtor can only recover insofar as the payment has been beneficial to the debtor - The new debtor’s insolvency or non-fulfillment of the obligation shall not give rise to any liability on the part of the original debtor. The original debtor is released from liability. b.2. Delegacion – debtor initiates the substitution. This requires the consent of all parties (original debtor, creditor, and new debtor) - if the new debtor makes payment, he can recover what he has paid and is entitled to subrogation - if the new debtor is insolvent, the creditor cannot proceed against the original debtor, except:  When the insolvency of the new debtor was already existing and of public knowledge when the original debtor delegated the debt  When the insolvency of the new debtor was already existing and known to the original debtor at the time he delegated the debt 

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

Kinds of subrogation a. Conventional subrogation – change of creditor by the agreement of the parties (old debtor, creditor, new creditor) b. Legal subrogation – subrogation by operation of law. It is presumed that there is legal subrogation: (1) When a creditor pays another creditor who is preferred, even without the debtor's knowledge Example: A owes B P100,000 secured by a mortgage. A also owes X another P50,000 secured by a 2nd mortgage on the same property. If X pays B the P100,000, X is subrogated of the right of B for the 1st mortgage. On due date and A fails to pay the obligation, X can foreclose both mortgages. (2) When a third person, not interested in the obligation, pays with the express or tacit approval of the debtor

(3) When, even without the knowledge of the debtor, a person interested in the fulfillment of the obligation pays, without prejudice to the effects of confusion as to the latter's share. Example: A owes B P100,000 with G as the guarantor. If G pays B, then G is subrogated of the rights of B. The guaranty is extinguished because of confusion or merger of rights of G as both the creditor and guarantor at the same time. 2. According to form a. Express – novation declared in unequivocal terms Example: A obliged himself to deliver to X a specific Honda Civic car. If on later date, the parties agreed that A’s obligation will now be to deliver a specific public utility jeepney instead of the car, there is an express novation. b. Implied – when the old and new obligation are on every point incompatible with each other. Example: D entered into a contract with E to construct E’s residential house on the latter’s 300 sq.m. parcel of land. A new contract was then again entered into by parties whereby D will construct a 4-storey commercial building to the same parcel of land. The parties, however, failed to stipulate whether they will not proceed with the construction of the residential house. Since the area can only hold either a residential house or a 4-storey building, but not both, the original contract was impliedly novated because the construction of 2 structures on the same lot is not possible. 3. According to extent a. Total or extinctive – the whole obligation is extinguished b. Partial or modificatory – the old obligation remains in force, except that it has been modified such as change in the place of payment, change of maturity date, etc. Effects of novation 1. Effects to accessory obligation - When the principal obligation is extinguished in consequence of a novation, accessory obligations may subsist only insofar as they may benefit third persons who did not give their consent (Article 1296) Example: D delivers a promissory note to E for P 100,000, payable on maturity and bearing an interest rate of 16% per annum. The parties stipulate that the monthly interests on the note shall be paid to X. On a later date, D and E agreed to novate the contract that D now would just paint the house of E instead of payment of the sum of money. The principal obligation here is extinguished because of novation, but the accessory obligation of interest payment to X shall subsists, unless X gave his consent to the said novation.

2. Effect if the new obligation is void - If the new obligation is void, the original one shall subsist, unless the parties intended that the former relation should be extinguished in any event (Article 1297) 3. Effect if the original obligation is void - The novation is void if the original obligation was void. A void obligation cannot be novated. 4. Effect if the original obligation is voidable – the novation is valid provided that annulment may be claimed only by the debtor or when ratification extinguishes acts which are voidable. The novation cures whatever defects resent in the original obligation. 5. Effect if the original obligation is subject to suspensive or resolutory condition - If the original obligation was subject to a suspensive or resolutory condition, the new obligation shall be under the same condition, unless it is otherwise stipulated (Article 1299) 6. Preference to creditor in case of partial payment - A creditor, to whom partial payment has been made, may exercise his right for the remainder, and he shall be preferred to the person who has been subrogated in his place in virtue of the partial payment of the same credit (Article 1304)

CONTRACTS Contract, defined Article 1305 defines a contract is a meeting of minds between two persons whereby one binds himself, with respect to the other, to give something or to render some service Elements of a contract 1. Essential elements – those without which, there is no contract ( C-O-C) a. Consent of the contracting parties b. Object certain which is the subject matter of the contract c. Cause of the obligation which must be established 2. Natural elements – those found in certain contracts unless set aside or suppressed by parties (such as warranty against eviction and warranty against hidden defects in a contract of sale) 3. Accidental elements – those that refer to particular stipulations by parties such as the time and place of payment, interest rate, currency to be used, and other stipulations that the parties agreed. Stages of a Contract 1. Preparatory or conception – process of formation such as bargaining, negotiation to arrive at a define contract 2.

Perfection or birth – there is now a meeting of minds to arrive at a definite agreement as to the subject matter, cause or consideration, terms and conditions of contract.

3.

Consummation or death or termination – which is the fulfillment or performance of the terms and conditions agreed upon in the contract may be said to have been fully accomplished or executed

Classification of contracts 1. According to form a. Oral - by word of mouth of the parties b. Written - the agreement which is reduced in writing which may be public or private or private document c. Partly oral and partly written

2. According to perfection or formation a. Consensual – those perfected by mere consent (i.e. sale or lease) b. Real contracts – those that are perfected by the delivery of the object of the contract such as depositum, pledge and commodatum. c. Formal or solemn contracts – those must be executed in the form provided by law for their perfection such as donation of real property, where both the donation and acceptance must appear in public instrument for the said acts to be valid. 3. According to cause a. Onerous – where there is an exchange of valuable consideration between parties such as contract of sale and barter. For each contracting party, the cause is the prestation or the promise of a thing or service by the other. b. Gratuitous or pure beneficence – where one receives no equivalent consideration. The cause of the contract is the pure liberality of the benefactor. This would include contract of donation and commodatum. c. Remuneratory – the cause is the service rendered or benefit remunerated such as payment for rendered service as the lawyer-counsel who agreed to pay P10, 000 for said services 4. According to dependence of one upon another a. Principal – one that can stand on its own such as contract of loan, sale and deposits b. Accessory – one whose existence depends upon validity of another contract such as pledge, mortgages and guaranty c. Preparatory – those which are created in order that a future transaction or contract may be entered into by the parties such as contract of partnership or agency. 5. According to name or designation a. Nominate – one which has particular name or designation such as sale, agency, partnership, barter, etc. b. Innominate – those without particular name. The following are innominate contracts:  Do ut des (I give that you may give) – this may actually be a barterm hence it is nominate  Do ut facias (I give that you may do)  Facio et des (I do that you may give)  Facio ut facias (I do that you may do) 6. According to risk involve or fulfillment

a. Commutative - where there is an exchange of values, such as lease and sale b. Aleatory - one which the fulfillment of the obligation depends upon chance such as contract of insurance 7. According to the obligation of parties a. Unilateral– where only one has an obligation to perform such as contract of donation and commodation b. Bilateral – where both parties have reciprocal obligation to perform. Ex. Sale 8. According to subject matter a. Contract involving things such as pledge, sale, barter or mortagage b. Contract involving rights such as assignment of rights and usufructuary c. Contract involving services such as contract of agency 9. According to the time of fulfillment a. Executed contracts – those that are already consummated / performed b. Executor – those that has not yet performed 10. According to the number of persons physically entering the contract a. Ordinary contract – where parties are represented by different persons such as buyer and seller in the contract of sale, debtor and creditor in the contract of loan, and mortgagor and mortgagee in the contract of mortgage b. Auto-contract – where only one person represents the two opposite parties to the contract, such as in the contract of sale, where the agent represents both the buyer and the seller at the same time, or when an agent lends money of his principal to the borrower he also represents. This requires consent of all parties. 11. According to the number of person who participated in drafting and preparation of contract a. Ordinary – where both parties participated in the drafting of the contract such as contract of sale, contract of loan, etc. b. Contract of adhesion – where only one of the party drafted the contract, while the other party merely signify his consent to the prepared contract. This includes contract of insurance, contract of carriage and the like. Characteristics of Contracts 1. Freedom to contract – this refers to the freedom of the parties to stipulate. They may establish terms and conditions as they may deem convenient. The contracting parties

may establish such stipulations, clauses, terms and conditions as they may deem convenient, provided they are not contrary to law, morals, good customs, public order, or public policy (Art. 1306) 2.

Consensuality of contract – contracts are perfected by mere consent, except in case provided by law which must complied for its validity and enforceability, such as: a. Real contracts, such as deposit, pledge and commodatum, are not perfected until the delivery of the object of the obligation (Art. 1316) b. Formal or solemn contract, which required some contracts to be in the form provided by law to be perfected, such as those required to be in writing or be made in public instrument.

3.

Relativity – it is binding only upon the parties and their successors. Contracts take effect only between the parties, their assigns and heirs, except: a. in case where the rights and obligations arising from the contract are not transmissible by their nature; or b. by stipulation; or c. by provision of law

4.

Obligatory force – it constitutes the law as between the parties and compliance in good faith is expected from them. Upon perfection of the contract, the parties are bound to the following: a. The fulfillment of what has been expressly stipulated b. All the consequence which, according to their nature, maybe in keeping with good faith, usage and law

5.

Mutuality – the contract must bind the parties. Its validity and performance cannot be left to the will of only one of the parties.

ESSENTIAL REQUISITES OF CONTRACTS ( Consent, Object, Cause) Consent, defined Consent is manifested by the meeting of the offer and the acceptance upon the thing and the cause which are to constitute the contract (Article 1319). Consent may be express or implied. Express consent is communicated by the spoken or written word, while implied consent is inferred from signs, actions, or facts, or by inaction or silence as nodding, making thumbs up sign and similar gestures that a reasonable man will understand that it is a manifestation of giving consent.

Rules on consent 1. To give a valid consent, the parties must have the capacity to enter into a contract. The following cannot give consent to a contract (Art. 1327): a. Unemancipated minors – refers to a person who is 17 years old and below. The age of majority in the Philippines is 18 years old.

Note: provisions in the Civil Code of the Philippines on emancipation of minors are repealed by the Family Code of 1987. Under the new law, emancipation takes place when the person attains the age of majority.

b. Insane or demented persons Insanity refers to mental illness of such a severe nature that a person cannot distinguish fantasy from reality, cannot conduct her/his affairs due to psychosis, or is subject to uncontrollable impulsive behavior. Insane person at some point of time (referred to as lucid interval), is capable of perfect enjoyment of his mental faculties.

Lucid Interval refers to that space of time between two fits of insanity, during which a person non compos mentis is completely restored to the perfect enjoyment of reason upon every subject upon which the mind was previously cognizant . Article 1328 provides that “Contracts entered into during a lucid interval are valid”.

Dementia is a form of insanity resulting from degeneration or disorder of the brain (ideo- pathic or traumatic, but not congenital) and characterized by general mental weakness and decrepitude, forgetfulness, loss of coherence, and total inability to reason. A demented person is absolutely no capacity to give a valid consent

c. Deaf-mutes who do not know how to write. The deaf-mute who knows sign language and can communicate his thoughts and action to other persons is capable of giving an intelligent consent.

Effects when consent is given by incapacitated persons enumerated above: 

When one of the contracting parties is incapacitated person – the contract is voidable

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When both contracting parties are incapacitated – contract is unenforceable

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The incapacitated person must pay reasonable price for food and other necessaries sold to him Kinds of incapacity to give consent a. Absolute incapacity – where the incapacity pertains to all transactions such as those referred to above ( minor, insane, deaf-mute who do not know how to right)

b. Relative incapacity – where a person is prohibited from giving consent on certain transactions. This include: 

Article 1490 - The husband and the wife cannot sell property to each other, except: (1) When a separation of property was agreed upon in the marriage settlements; or (2)



When there has been a judicial separation of property under article 191.

Article 1491 - The following persons cannot acquire by purchase, even at a public or judicial auction, either in person or through the mediation of another: (1) The guardian, the property of the person or persons who may be under his guardianship; (2) Agents, the property whose administration or sale may have been intrusted to them, unless the consent of the principal has been given;

(3) Executors and administrators, the property of the estate under administration; (4) Public officers and employees, the property of the State or of any subdivision thereof, or of any government-owned or controlled corporation, or institution, the administration of which has been intrusted to them; this provision shall apply to judges and government experts who, in any manner whatsoever, take part in the sale; (5) Justices, judges, prosecuting attorneys, clerks of superior and inferior courts, and other officers and employees connected with the administration of justice, the property and rights in litigation or levied upon an execution before the court within whose jurisdiction or territory they exercise their respective functions; this prohibition includes the act of acquiring by assignment and shall apply to lawyers, with respect to the property and rights which may be the object of any litigation in which they may take part by virtue of their profession; (6) Any others specially disqualified by law 2. Contracts agreed to in a state of drunkenness or during a hypnotic spell are voidable (Art. 1328). Te consent here is not freely and intelligently given.

3. A contract where consent is given through mistake, violence, intimidation, undue influence, or fraud is voidable (Art. 1330). These refer to as vices of consent.

Rules on offer and acceptance 1. The offer must be certain and the acceptance absolute. A qualified acceptance constitutes a counter-offer.

An offer is a specific proposal to enter into an agreement with another. An offer is essential to the formation of an enforceable contract. An offer and acceptance of the offer creates the contract.

a. Offer is uncertain – Example: A offered for sale a parcel of land to B for P200,000. However, A owns several parcels of land, and it was unclear which land is being offered for sale. The offer here is uncertain, hence, it is an invalid offer.

b. Offer is certain – Example: S offers his motorcycle for sale to T for P50,000. Now, S has only motorcycle, and this is known by T. In this case, it is clear that the parties both know the specific motorcycle subject of the offer. The offer her is certain, hence, it is a valid offer.

c. Acceptance is absolute – if in example (b) above, S accepted the offer of T and parties agreed on other accidental elements, the contract is perfected by such absolute acceptance.

d. Qualified acceptance constituting counter-offer – in the same example (b) above, S accepted the offer but asked for a reduction of price to P40,000, this constitutes a counter-offer. For the contract to be perfected, the counter-offer must be accepted by the original offeror unconditionally

Note: Business advertisements are not definite offers. Under Article 1325, unless it appears otherwise, business advertisements of things for sale are not definite offers, but mere invitations to make an offer. Examples: 

An advertisement posted on the car which read “For sale: Toyota Corolla 2004 Model, Price: P250,000, please contact 01979112110”. This is not an offer but mere invitation to make offer.



An advertisement in the newspaper which read as follows: “For sale: Blue Toyota Corolla GXi Model 2004, Chassis No. 1254-MNL-00123, Motor No. RTY1256489, with Plate Number XXX 199. Price: P250,000”. This is a definite offer because it contains all the matters required in the contract.

2. An offer becomes ineffective upon the death, civil interdiction, insanity, or insolvency of either party before acceptance is conveyed (Article 1323).

3. When the offerer has allowed the offeree a certain period to accept, the offer may be withdrawn at any time before acceptance by communicating such withdrawal, except when the option is founded upon a consideration, as something paid or promised (Art.1324)

Option – is a contract whereby the offerer gives the offeree the privilege to purchase or not a certain object for a fixed price at any time within an agreed period for a fixed price. Option may or may not be for a valuable consideration.

Can the offerer withdraw the offer?

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If there is no consideration for the option, the offerer may withdraw the offer at anytime within the option period provided here has not been any acceptance.

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If there is a consideration, the offeror may not withdraw the offer within the option period. Otherwise he will be held liable to the offeree of breach of contract.

Note: Offer is extinguished upon the lapse of the option period, unless in the meantime, the offeree has accepted the offer. This is true in both cases whether the offer has a consideration or not.

4. The person making the offer may fix the time, place, and manner of acceptance, all of which must be complied with (Art. 1321). Failure to comply with the stipulations agreed, there will be no meeting of minds between the parties.

5. Acceptance made by letter or telegram does not bind the offerer except from the time it came to his knowledge. The contract, in such a case, is presumed to have been entered into in the place where the offer was made (Art. 1319). Thus, if on June 1, 2013, A offered to sell his specific watch to B for P10,000 and the offer was sent through regular mail and was received by B five (5) days later. On June 8, 2013, B sent his acceptance of the offer also by mail. However, B withdraws the offer on the same day and sold the same to X. B here is not liable to A since he is not bound by the acceptance prior to his actual knowledge of the acceptance. 6. An acceptance may be express or implied – acceptance is express if made orally or in writing. It is implied if it can be inferred from the conduct of parties. Thus, if X offers to sell to Y a canned softdrinks, and Y opened the said canned softdrinks and begin to drink one and also opened the rest for his coemployees, it is deemed an implied acceptance of the offer.

7. An offer made through an agent is accepted from the time acceptance is communicated to him. The agent is authorized to accept offer in behalf of his principal.

Vices of consent A contract where consent is given through mistake, violence, intimidation, undue influence, or fraud is voidable (Art.1330). These are referred to as vices of consent, or that causes which vitiate the consent.

Kinds of vices of consent 1. Mistake – is an unintentional act, omission, or error. Mistakes are categorized as mistake of fact, mistake of law, or mutual mistake.



Mistake of Fact - occurs when a person believes that a condition or event exists when it does not. (ex. A delivered to B a pair of pigs for breeding purposes. However, the boar (male pig) has found to be sterile and thus cannot breed. The sterility of the pig is unknown to the parties. B can ask for the annulment of the contract.

In contract, a mistake of fact may be raised as a defense by a party seeking to avoid liability under the contract. Also, a mistake of fact can be used affirmatively to cancel, rescind, or reform a contract. A mistake of fact can affect a contract only if the mistaken fact was material, or important, to the agreement. (ex. A in indebted to B P100,000, secured with A’s house. A and B entered into a contract of sale with pacto de retro, believing that it had the same legal effect as mortgage. This mistake of law is a ground for annulment of contract).

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Mistake of Law - is made by a person who has knowledge of the correct facts but is wrong about the legal consequences of an act or event. Generally, a mistaken belief about a law is no defense to a violation of that law. All persons are presumed to know and understand the law, except minors, persons who lack mental capacity to contract with others, and, in criminal cases, persons who are insane.



Mutual mistake - arises when two or more parties have a shared intention that has been induced by a common misbelief.

When mistake will vitiate consent? a. If the mistake refers to the substance of the thing which is the object of the contract. Example: A bought a parcel of agricultural land from B for farming purposes. However, the land subject to sale is classified as commercial, and no land is allowed other than for commercial use. A here can demand for the annulment of the contract.

b. If the mistake refers to those conditions which have principally move one or both parties to enter into a contract. Example: X is in urgent need of money for the medical operation of his child. X then sold his land to Y. However, the Deed of Sale signed by parties showed that the price would be paid in 4 equal monthly installments. Y can

demand annulment of the contract because of the mistake as to the condition of the contract.

c. If the mistake refers to the identity or qualifications of one of the parties if such identity or qualification have been the principal cause of the contract. Example: F sold to S a parcel of residential land for only 50% of the actual price, believing that S is his half-brother. It turns out that S is a total stranger. The identity of S was material to the contract; hence, F can have the contract annulled for mistake as to the identity of the vendee.

d. If the mistake refers to the legal effect of an agreement when the real purpose of the parties is frustrated and the same is mutual (Art. 1334). This refers to mistake of law. Mistake of law is a ground for invalidating a contract.

When mistake does not vitiate consent? a. If the mistake refers to simple mistake of account which shall be corrected, such as when the error arises from mathematical computation, it will not invalidate a contract. Example: S sold to B on account 10 sacks of rice at P1,200 per sack. B delivers a promissory note in favor of S for P10,000, instead of the correct amount of P12,000. The error will not invalidate the contract. It will just give rise to the correction of the amount in the PN.

b. If the party alleging it knew the doubt, contingency or risk affecting the object of the contract (Art. 1333). Example: X sold to Y a brand new iphone 5 cell phone for only P2,000. The usual price for original iphone 5 cell phone range from P30,000 – P50,000. Y cannit allege mistake if the said cell phone turns to be a fake. The fact that it was offered to him at very low price should have put him on guard that it might be an imitation or even come from illegal source.

2. Violence – this refers to physical coercion. There is violence when in order to wrest consent, serious or irresistible force is employed. Violence shall annul the obligation, although it may have been employed by a third person who did not take part in the contract. Example: A signed a Deed of Donation in favor of B, while B was twisting the hand of A and threatening to break his arms if A will not sign the document.

3. Intimidation – this refers to moral coercion. There is intimidation when one of the contracting parties is compelled by a reasonable and well-grounded fear of an imminent and grave evil upon his person or property, or upon the person or property of his spouse, descendants or ascendants, to give his consent. Example: A signed Deed of Donation in favor of B, while B holding a pistol pointed on A’s forehead, threatening to shoot him if he will not sign the said document.

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To determine the degree of intimidation, the age, sex and condition of the person shall be borne in mind.

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There must be a well-grounded belief that the person making the threat or intimidation can carry out his threat or intimidation.

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Intimidation shall annul the obligation, although it may have been employed by a third person who did not take part in the contract.

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A threat to enforce one's claim through competent authority, if the claim is just or legal, does not vitiate consent. (Art. 1335). Thus, if a creditor threatens to file a case against the debtor to collect the amount due, plus interests and damages, knowing that the debtor is afraid of going to courts, this will not be considered intimidation to invalidate a contract

4. Undue influence – there is undue influence when a person takes improper advantage of his power over the will of another, depriving the latter of a reasonable freedom of choice.

The following circumstances shall be considered: a. the confidential, family, spiritual and other relations between the parties, or b. the fact that the person alleged to have been unduly influenced was suffering from mental weakness, or was ignorant or c. in financial distress.

Example: A is in dire financial need for the operation of his youngest child scheduled the next day. The doctor advised him to produce P500,000 for the operation. A then find a buyer, X, for his residential house and lot, who knows the situation of A. the actual market value of the said property is appraised at P2,000,000. Taking advantage of the situation, X offered to buy the property for P500,000, to which A agreed. The sale here can be invalidated since the buyer’s consent was vitiated of the undue influence.

5. Fraud - is a false representation of a matter of fact—whether by words or by conduct, by false or misleading allegations, or by concealment of what should have been disclosed— that deceives and is intended to deceive another so that the individual will act upon it to her or his legal injury. Fraud exists in the following situations:

a. There is fraud when, through insidious words or machinations of one of the contracting parties, the other is induced to enter into a contract which, without them, he would not have agreed to (Art. 1338). Example: X induced Y to buy the specific ring which he claimed to be genuine gold. X knew all along that the gold is not a genuine but just an imitation.

b. Failure to disclose facts, when there is a duty to reveal them, as when the parties are bound by confidential relations, constitutes fraud (Art. 1339). Example: X and Y are partners in a manufacturing business. X met A, a wholesaler and is looking for a manufacturer who can supply him with goods on a regular basis. X then buy-out the share of Y in the partnership, which the latter acceded. Thereafter, X, now a sole proprietor, entered into a contract with A as the supplier for A’s wholesale business for a huge profit. The sale of interest in partnership of Y in favor of X is voidable on the ground of fraud. X was duty bound to disclose to Y the proposal of A, being bound by trust and confidence as partners.

c. To make the contract voidable by reason of fraud, it must be (a) serious, and (b) the fraud must not have been employed by both parties. 

Incidental fraud only obliges the person employing it to pay damages

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If both parties employed fraud, the contract is valid. The law will consider them both in good faith. He who comes to court must come with clean hands.

There is no fraud in the following circumstances: 1. The usual exaggerations in trade, when the other party had an opportunity to know the facts. Sales talk and dealers talk are not fraudulent by nature, and will not invalidate a contract. Some expressions include.. o

The most effective detergent bar

o

99.99% in germ killing

o

“Babad lang, walang kusot, tanggal agad ang mantsa sa damit”

2. In case of a mere expression of an opinion, unless made by an expert and the other party has relied on the former’s special knowledge (Art. 1341).

Example: X, a farmer, found a ring in his farm. X then sold the ring to his neighbor Y, honestly believing that it was a gold ring. It turns out that the ring is just made up of from melted P5 coin. There is no misrepresentation here since X is not an expert in gems. However, if X is a known jeweler, Y can annul the sale on the ground of fraud committed by X.

3. Misrepresentation by a third person does not vitiate consent, unless such misrepresentation has created substantial mistake and the same is mutual (Art. 1342).

However, if the third person connived with a party in the contract in making misrepresentation, the consent is vitiated, and thus the aggrieved party may demand annulment of the contract.

Examples: a. X offered for sale a parcel of agricultural land to Y, to be planted with coconut trees. However, both parties do not know if the condition of the land is suitable for coconut planting, so they decided to consult a M, a third person, who told them that it is suitable for that purpose. It was found out, however, that 20% of the said land is not suitable for coconut planting. Here, the mistake in the representation of third person will not invalidate a contract.

b. Suppose in the same example, it was found out that 60% of the land is not suitable for coconut planting. The contract here can be annulled, since the misrepresentation has created substantial mistake and the same was mutual.

4. Misrepresentation made in good faith is not fraudulent but may constitute error (Art.1343). Example: A offered to B a pair of earrings which he believes to have adorned by diamond. B buys the said earrings also believing it to be such. Later it was found out that it was another gemstone but of lesser value. There exist no fraud but this only constitutes merely an error. B may, however, annul the contract on the ground of mistake of fact.

Kinds of fraud 1. Fraud in obtaining consent - this kind of fraud has an effect on the validity of the contract as this occurs before and during the formulation of contract. The remedies available to the offended party would depend if the fraud is causal or incidental. a. Causal Fraud or Dolo Causante – fraud done that without it, consent would’ve not been given. This renders the contract voidable. Example: X applied for a part-time teaching work at Divine Word College of Legazpi. His resume would show that he is a Certified Public Accountant. The school then hired X and was given teaching loads for accounting major subjects. Later, it was known, however, that X is only an accountancy graduate and not a CPA. Had the school knew this fact, X would not been hired. The fraud here committed is a causal fraud which the aggrieved party may seek annulment of contract. b. Incidental Fraud or Dolo Incidente – fraud done that without it, the creditor would’ve agreed in different terms. The contract remains valid but the party offended is entitled to damages. In the same example above, the resume of X would show that he is a CPA, and been teaching accounting subject for the last 10 years. In reality, however, X has been teaching accounting subjects for only 2 years. Had the school knew that fact, it would still hire X and allows him to teach accounting subjects, however, his hourly rate would be lesser than what has agreed by parties. The fraud here is only incidental. This would only gives right to recover damages from A fro the overpayments of hourly rates made. 2. Fraud in the performance of the obligation – the deliberate or intentional evasion by the debtor of the fulfillment of his obligation in a normal manner. This type of fraud does not affect the validity of the contract. Those who in the performance of their obligations are guilty of fraud, negligence, or delay, and those who in any manner contravene the tenor thereof, are liable for damages (Art. 1170) Simulated contracts, defined Simulated contract is a contract that, by mutual agreement, does not express the true intent of the parties. It does not have legal effect and does not create juridical tie between the parties. The following are types of simulated contracts:

1. Absolutely simulated contracts - when the parties intend that the contract will impose no obligations. Such a contract cannot enforce any obligations on the parties. Being fictitious, it is void. Example: A and B are friends. A wishes to obtain a loan from XXX Lending Corporation, but the said corporation require a proof that A has enough assets under his name. A however, has limited assets under his name so he seek for B’s help. B then executed a Deed of Donation in favor of A for a parcel of land for purposes of showing the Deed of Donation and the title of land to the lending corporation. The Deed of Donation between B and A is absolutely simulated. 2. Relative simulation – refers to the contract where the parties intend a simulated contract to impose obligations which are different from the ones stated in the contract. The intended obligations are enforceable if all relevant conditions are met. . A relative simulation, when it does not prejudice a third person and is not intended for any purpose contrary to law, morals, good customs, public order or public policy binds the parties to their real agreement. Example: 1. X donated to Y a specific car worth P100,000. However, the parties agreed to execute a Deed of Sale instead of Deed of Donation for purpose of expediency. The sale is relatively simulated. Here, the contract is valid and the parties are bound by their true intentions. 2.

X sold to Y a parcel of land for P1,000,000. To minimize the tax payments for capital gains and other transfer tax, the parties agreed that the consideration to appear in the Deed of Sale is only P500,000. The relative simulation is contrary to law, as this constitutes tax evasion. Hence, the contract here is void. Objects of the Contract

What may be the object of contracts? Under Article 1347 of the Civil Code, the following may be the object of the contract: 1.

All things which are not outside the commerce of men, including future things, may be the object of a contract. Examples of future things: o The crops that the specific land may produced o The egg that may be produced by the poultry farm o The wine that may be produces from grapes vineyards The following may not be the object of contracts: a. Outside the commerce of men - public plaza, sidewalks, seashores, bridge and other similar public infrastructures

b. Contrary to law – illegal drugs, human body parts (such as kidney, eyes, and other internal organ) prohibited by law for commercial transactions. c. Impossible objects – the “Excalibur” sword of King Arthur, rock from planet Uranus, the legendary “fountain of youth” chalice. d. Indeterminate object – such as a watch, a ring, a horse, a cow, etc. Article 1349 provides that “The object of every contract must be determinate as to its kind. The fact that the quantity is not determinate shall not be an obstacle to the existence of the contract, provided it is possible to determine the same, without the need of a new contract between the parties” 2.

All rights which are not intransmissible may also be the object of contracts. a. Transmissible right – rights that may be transferred from one person to another. These rights can be sold, conveyed or transferred from one person to another. This include leasehold rights, usufructuary rights and credit rights b. Intransmissible right – rights that belong to a person that cannot be transferred to another. This includes strictly personal rights such as parental right, marital rights, right to run for public office and right of suffrage.

3.

All services which are not contrary to law, morals, good customs, public order or public policy may likewise be the object of a contract. Cause of Contracts

Cause, defined Cause is the essential reason or the driving force why a party enters into a contract. Cause of Contracts 1. Onerous contract - the cause is understood to be, for each contracting party, the prestation or promise of a thing or service by the other. In a reciprocal contract like of sale, the cause for the seller is the payment or the promise to pay, while the cause for the buyer is the delivery or the promise to deliver the thing. Thus, if S sold to B a specific car for P200,000, the cause for S is the payment of P200,000, while the cause for B is the delivery of the specific car. 2. Remuneratory contract - the service or benefit which is remunerated. Example: X painted the house of Y for 3 days. Y then paid P1,500. The act of painting of X here is the service remunerated.

3. Gratuitous contract or contracts of pure beneficence – the mere liberality of the benefactor. When a third person pays a debt of another without the intention of reimbursement, or in cases of donation, the cause is the mere liberality of the donor. Example: X, a lawyer, provided free legal services to his client A. X does not ask for reimbursement for traveling and other legal expenses of the cae. Here, the cause of the contract is the pure beneficence of X. Rules on cause 1. Although the cause is not stated in the contract, it is presumed that it exists and is lawful, unless the debtor proves the contrary (Article 1354) Example: A make a promissory note in favor of B for P100,000. There is a presumption that a lawful cause exist between the parties, unless A proves the contrary. 2. Contracts without cause, or with unlawful cause, produce no effect whatever. The cause is unlawful if it is contrary to law, morals, good customs, public order or public policy (Article 1352) Example: B promise to give C P300,000 if C would assassinate X. The cause of B here (assassination of X) is unlawful, hence the contract is void. 3. The statement of a false cause in contracts shall render them void, if it should not be proved that they were founded upon another cause which is true and lawful (Article 1353). Example: The contract stated that S sold to B a residential land for P 500,000. The fact, however, is that S actually sold to B an apartment for the same amount. The cause of the contract here is false, however, it is not void since the true cause – sale of apartment, is valid and legal. 4. Except in cases specified by law, lesion or inadequacy of cause shall not invalidate a contract, unless there has been fraud, mistake or undue influence (Article 1355) Lesion or inadequacy of cause shall not invalidate a contract, except in the following cases: a. When there was fraud, mistake or undue influence b. In cases provided by law such as when the ward or absentee suffers lesion by more than one-fourth (1/4) of the value of the object of contract. Examples;  X owns a parcel of land with a market value of P1,000,000. X sold the said land to Y for only P700,000. The lesion or inadequacy of price here does not affect the validity of contract.

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Suppose X sold the land to Y because of the latter’s death threats to the family of X. The inadequacy of price resulted from the intimidation made by Y, the contract here can be annulled.

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Suppose X is only a guardian of M, the registered owner of land. The lesion suffered by the minor is more than one-fourth (1/4) of the value of property. This makes the contract rescissible. The minor upon reaching the age of majority, can demand rescission of the contract entered into by X and Y.

Form of Contracts Required forms of contract Contracts shall be obligatory, in whatever form they may have been entered into, provided all the essential requisites for their validity are present. Thus, a contract is valid, even if it is orally entered into, was put in writing or contracted partly oral and partly in writing. Exceptions: When the law requires that a contract be in some form in order that it may be valid or enforceable or that a contract be proved in a certain way, that requirement is absolute and indispensable. 1. When the contract required by law to be in a certain form provided by law for its validity, otherwise, the contract is void. Example: donation of real property must be in writing and must be made in public instrument. The acceptance of the donation be made on the same public instrument. 2. If the law requires a document or other special form, the contracting parties may compel each other to observe that form, once the contract has been perfected. This right may be exercised simultaneously with the action upon the contract. Example: sale of personal properties when the amount is more than P500 must be in writing, otherwise, the contract is unenforceable. Contracts that must be in writing for validity and enforceability 1. The following contracts must be appear in public instrument, otherwise, it shall be void (Art. 1358) a. Acts and contracts which have for their object the creation, transmission, modification or extinguishment of real rights over immovable property. (Examples: Contract for easement of right-of-way, donation of real property, real estate mortgage) b. Sales of real property or of an interest therein

(Examples: sale of land, conditional sale, sale of portion of undivided land) c. The cession, repudiation or renunciation of hereditary rights or of those of the conjugal partnership of gains d. The power to administer property, or any other power which has for its object an act appearing or which should appear in a public document, or should prejudice a third person. (Example: special power of attorney authorizing the agent to sell, mortgage or encumbered the real property belonging to theprincipal must be in public instrument) e. The cession of actions or rights proceeding from an act appearing in a public document. (Examples: assignment of mortgage credit must also be in public instrument, just as the original real estate mortgage must be in public instrument)

2. The following contracts must be in writing, even a private one, otherwise it is unenforceable. a. All other contracts where the amount involved exceeds five hundred pesos (P500) must appear in writing. b. Those contracts covered by Statute of Fraud (Art. 1403)  An agreement that by its terms is not to be performed within a year from the making thereof 

A special promise to answer for the debt, default, or miscarriage of another

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An agreement made in consideration of marriage, other than a mutual promise to marry

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An agreement for the sale of goods, chattels or things in action, at a price not less than five hundred pesos, unless the buyer accept and receive part of such goods and chattels

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An agreement for the leasing for a longer period than one year, or for the sale of real property or of an interest therein

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A representation as to the credit of a third person.

REFORMATION OF INSTRUMENTS

Reformation of Instruments, defined Reformation is the remedy to correct a written instrument so that it conforms to the original intent of the parties to such an instrument. Legal documents, such as contracts, deeds, mortgages, and trusts, are all proper subjects for reformation. Since the original intent of the parties must control, however, a totally new agreement cannot be created through reformation.

Requisites for reformation 1. There must have meeting of the minds of the parties to a contract 2. Their true intention is not expressed in the instrument purporting to embody the agreement, 3. The reason was mistake, fraud, inequitable conduct or accident Who may ask reformation? 1. If the mistake was mutual – by either party, or his successors in interest - his heirs or assigns 2. In other cases, the injured party, his heirs or assigns can ask for reformation of instrument Some important notes in reformation of instruments  If mistake, fraud, inequitable conduct, or accident has prevented a meeting of the minds of the parties, the proper remedy is not reformation of the instrument but annulment of the contract. 

Reformation is a remedy that is granted at the discretion of the court only where the facts and circumstances of a particular case warrant it. It will not be granted where an entirely new agreement would result between the parties or where unwarranted hardships would be imposed upon them.

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Only an individual who has acted in good faith can apply to the court to have an instrument reformed.

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Reformation is not available as a remedy to correct every minor error, such as typographical errors; rather, it is granted where there has been a mutual mistake that substantially affects the parties' rights and obligations.

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The mistake must have been in existence at the time the instrument was drawn up. A mistake in the description of land and its boundaries ordinarily justifies reformation of an agreement where the purchaser and seller intended that all the seller's property be sold to the purchaser.

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In addition, a Mistake of Law by which both parties to the instrument have incorrectly comprehended the legal effect of the facts and the document might also result in reformation.

When is reformation of instrument proper? 1. When a mutual mistake of the parties causes the failure of the instrument to disclose their real agreement 2. If one party was mistaken and the other acted fraudulently or inequitably in such a way that the instrument does not show their true intention, the former may ask for the reformation of the instrument. 3. When one party was mistaken and the other knew or believed that the instrument did not state their real agreement, but concealed that fact from the former. 4. When through the ignorance, lack of skill, negligence or bad faith on the part of the person drafting the instrument or of the clerk or typist, the instrument does not express the true intention of the parties, the courts may order that the instrument be reformed. 5. If two parties agree upon the mortgage or pledge of real or personal property, but the instrument states that the property is sold absolutely or with a right of repurchase, reformation of the instrument is proper. There shall be no reformation in the following cases: 1. Simple donations inter vivos wherein no condition is imposed Reason: donation inter vivos is an act of liberality of the donor. However, if the donation contains certain conditions to be fulfilled by the done before donation to be enforceable, reformation is allowed so as to show the true intent of the donor as regards to conditions. 2. Wills Reason: wills can be revoked anytime by the testator during his lifetime. The act of making a will is purely personal act on the p[art of the testator, and upon his death, the will shall undergo probate proceedings before the distribution of estate can be made. 3. When the real agreement is void Reason: void contract produces no legal effect, hence, there s nothing to reform

4. When one of the parties has brought an action to enforce the instrument, he cannot subsequently ask for its reformation. Reason: when parties sought to enforce the instrument, it cleanses the defect in it. This will be equivalent to ratification, waiver and estoppel. INTERPRETATION OF CONTRACTS Rules in Interpretation of Contracts 1. If the terms of a contract are clear and leave no doubt upon the intention of the contracting parties, the literal meaning of its stipulations shall control. 2. If the words appear to be contrary to the evident intention of the parties, the latter shall prevail over the former. In order to judge the intention of the contracting parties, their contemporaneous and subsequent acts shall be principally considered (Article 1371) Example: A and B executed a Deed of Sale with Right of Repurchase over a parcel of land for P500,000, giving A the right to repurchase the land from B within 5 years from the date of sale. However, the parties intended that the said land will only be considered as collateral for the P500,000 owed by A. A continue to possess and cultivate the land, while B safekeep the title of the land in his safety deposit box at XXX branch. From the intention and the subsequent actions of A and B, the contract they actually entered into was a real estate mortgage and not a sale with right of repurchase. The parties rights mst be governed by the provisions of law on mortgages. 3. However general the terms of a contract may be, they shall not be understood to comprehend things that are distinct and cases that are different from those upon which the parties intended to agree. Example: X sold to Y all the sacks of rice in X’s warehouse. However, also stored in X’s warehouse was 100 sacks of rice belonging to M. The sale between X and Y should be interpreted not to include those sacks of rice owned by M. 4. If some stipulation of any contract should admit of several meanings, it shall be understood as bearing that import which is most adequate to render it effectual. Example: S sold to B a parcel of land for B to construct the proposed 4storey commercial building. Now, S has 2 parcels of land – an irrigated Riceland and a commercial lot. Despite the failure to stipulate which lot was the subject matter of the sale, the commercial lot is deemed to have been sold since such will render the contract effectual. 5. The various stipulations of a contract shall be interpreted together, attributing to the doubtful ones that sense which may result from all of them taken jointly.

6. Words which may have different significations shall be understood in that which is most in keeping with the nature and object of the contract. Example: X gave authority to his agent A to exact payment by legal means all his loans and advances to different borrowers. A then sent letters to borrowers and give the latter 10 days from receipt of letter to pay the amount. M, a borrower, failed to pay on the specified period. A then filed a civil case for collection of sum of money against M. M questioned the authority of A in filing the case, claiming that A’s authority to exact payment does not include filing of case. The court ruled that filing of case is necessarily included in the term “to exact payment by legal means.” 7. The usage or custom of the place shall be borne in mind in the interpretation of the ambiguities of a contract, and shall fill the omission of stipulations which are ordinarily established. In a contract for service of work, A hired B to harvest the palays in A’s farmland. There was no stipulation on the compensation for B’s services. In this case, the rate thereof shall be the rate that is customarily paid in the place where the services was rendered 8. The interpretation of obscure words or stipulations in a contract shall not favor the party who caused the obscurity. Thus, in a contract of adhesion such as insurance contracts and contract for common carriage, or loan contracts with banks and financial institutions, any ambiguity shall be interpreted against the party who prepared the contract. Adhesion contracts do not result from mutual negotiation between the parties. Only one party prepare the contract while the other simply “adhere” if he choose to be bound but cannot change any stipulations or agreement. 9. When it is absolutely impossible to settle doubts by the rules established in the preceding articles, the following shall apply: a. If the doubts refer to incidental circumstances of a gratuitous contract, the least transmission of rights and interests shall prevail Example: X delivered to Y a specific car for personal use of the latter. It was not, however, clear whether the car was donated or only given in commodatum. The contract shall be interpreted as commodatum as this will transmit lesser rights than donation. b. If the contract is onerous, the doubt shall be settled in favor of the greatest reciprocity of interests. Example: A borrowed P100,000 from B covered by a promissory note, which bears an interest of 12% per annum. The parties fail to stipulate the maturity date whether the loan is payable on demand or oneyear after the date of the PN. The repayment period shall be interpreted for one year because A will have more time to use the money, while C will earn the full 1-year interest.

c.

If the doubts are cast upon the principal object of the contract in such a way that it cannot be known what may have been the intention or will of the parties, the contract shall be null and void. Example: A sold to B a parcel of agricultural land. The parties fail to stipulate the particular description and boundaries of the aforesaid lot. Now, A has 3 parcels of agricultural lots, and the parties fail to agree which lot has been the object of sale. The contract is thus declared null and void.

DEFECTIVE CONTRACTS Defective contracts, defined Defective contracts are valid contracts which lacks legal sufficiency due, for example, to incorrect or incomplete following of a required or statutory procedure, and may not be enforceable by the courts. These may either be (a) rescissible contracts; (b) voidable contracts; and (c) unenforceable contracts. Rescissible contract, defined Rescissible contracts are those which have caused a particular economic damage either to one of the parties or to a 3rd person and which may be set aside even if valid. It may be set aside in whole or in part, to the extent of the damage caused. Rescission is the remedy allowed by law to the contracting parties and to third person\s to repair the damage cause them by a contract. What are rescissible contracts? ( Art. 1381) (1) Those which are entered into by guardians whenever the wards whom they represent suffer lesion by more than one-fourth of the value of the things which are the object thereof; Example: G, a guardian of minor, entered into a Lease Contract Agreement with X over one of the commercial building owned by the minor. The annual lease was P120,000, when the commercial rate for lease on other building occupants was P200,000 per annum. The contract is rescissible since the lesion is more than ¼ of P200,000 (P50,000). (2) Those agreed upon in representation of absentees, if the latter suffer the lesion stated in the preceding number; Under Art. 381 of the Civil Code, an absentee is a person who disappears from his domicile, his whereabouts being unknown, and without leaving an agent to administer his property. Thus, if the representative of an absentee sold the former’s property at a price where the absentee would suffer lesion of more than ¼ of the actual value of the thing, the sale is rescissible.

(3) Those undertaken in fraud of creditors when the latter cannot in any other manner collect the claims due them; Example: A has only 1 property left – a parcel of land worth P500,000. He has a creditor B, which he owes P400,000. To escape payment, A donated his land to his cousin M, thus rendering A insolvent. The donation made was for fraudulent purpose and thus may be rescinded. (4) Those which refer to things under litigation if they have been entered into by the defendant without the knowledge and approval of the litigants or of competent judicial authority; Example: A parcel of land was the subject of litigation between parties. A, B and C are co-heirs, however, the land was registered under the name of B only, as trustee for his other co-heirs. B sold the entire lot to X, who has knowledge of the pending claims of other co-heirs. The sale between B and X is rescissible. (5) All other contracts specially declared by law to be subject to rescission. Under Article 1382, Payments made in a state of insolvency for obligations to whose fulfillment the debtor could not be compelled at the time they were effected, are also rescissible. Thus, if X owes the following creditors: A-100,000; B-50,000 and C-200,000. X was in state of insolvency where he has only P120,000 worth of asset left. X then paid the whole P120,000 to C. The payment made by X to C is prejudicial to the rights of other creditors, thus rescissible. Requisites before there can be a valid rescission 1. The action for rescission is subsidiary; it cannot be instituted except when the party suffering damage has no other legal means to obtain reparation for the same. Rescission shall be the last recourse (Art. 1383) 2. Rescission shall be only to the extent necessary to cover the damages caused (Art. 1384). Example: A has only 2 properties left – a parcel of land worth P200,000 and a bank deposit of P400,000. He has a creditor B, which he owes P400,000. To escape payment, A donated the land to his cousin M, and the bank deposit was also donated to his friend Y, thus rendering A insolvent. The donation made was for fraudulent purpose and thus may be rescinded. However, rescission can only be made to the donation to Y, since rescission shall only be to the extent necessary to cover the damages. 3. In rescission, there must be mutual restitution. Rescission creates the obligation to return the things which were the object of the contract, together with their fruits, and the price with its interest; consequently, it can be carried out only when he who demands rescission can return whatever he may be obliged to restore (Art. 1385)

A party seeking rescission must return whatever he obtained from the contract. The rescission will not lie if the party seeking it cannot comply with such obligation. 4. Neither shall rescission take place when the things which are the object of the contract are legally in the possession of third persons who did not act in bad faith. In this case, indemnity for damages may be demanded from the person causing the loss Example: A has only 1 property left – a parcel of land worth P500,000. He has a creditor B, which he owes P400,000. To escape payment, A donated his land to his cousin M, thus rendering A insolvent. The donation made was for fraudulent purpose and thus may be rescinded. However, before the contract was rescinded, M was able to secure a new title over the property by virtue of such donation and was registered under his name. M then sold the same land to X, who was in good faith and has no knowledge of the infirmities in the old title. Rescission in this case is not tenable. 5. The action for rescission must be brought within the time period allowed by law 

For person under guardianship – within 4 years from termination of incapacity

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For absentee – within 4 years from the time the absentee’s domicile is known

Alienations in fraud of creditors 1. Alienation by gratuitous title - all contracts by virtue of which the debtor alienates property by gratuitous title are presumed to have been entered into in fraud of creditors, when the donor did not reserve sufficient property to pay all debts contracted before the donation (Art. 1387). Thus, if a debtor, has total assets of P1,000,000 and liabilities of P600,000, donates assets more than P400,000, such donation is presumed fraudulent because it will make the debtor insolvent – with a liability of P600,000 and assets of less than P600,000. 2. Alienations by onerous title – these are also presumed fraudulent when made by persons against whom some judgment has been rendered in any instance or some writ of attachment has been issued. The decision or attachment need not refer to the property alienated, and need not have been obtained by the party seeking the rescission. Example: A borrowed money from B for P500,000. On the maturity date, B failed to pay the loan, hence, B filed a civil case for collection for sum of money. The court decided in favor of B and then issued Writ of Attachment to 2 parcels of land of A, with total value of P600,000. During the pendency of execution of the case decision, A sold the attached land in favor of X. The sale is presumed fraudulent since it was made against the Writ of Attachment issued by court. The same is also true if A sold his specific car to a third person. The law

provides that attachment need not refer to the property alienated, and need not have been obtained by the party seeking the rescission. Attachment – is the legal process of seizing property to ensure satisfaction of a judgment. Real and personal properties, stocks or shares, debts and credits, can be the subject of attachment. Liability of person acquiring things in alienation in fraud of creditors 1. If the purchase was made in good faith – he shall not be liable notwithstanding the fraudulent intention of the debtor in disposing the property. Rescission will not be a remedy in this case. If there are subsequent transfers, the transferees shall not be liable for damages even they were in bad faith. 2. If the purchaser is in bad faith (as he knows the intention of the seller to defraud the creditors at the time of sale), he shall indemnify the creditors for damages suffered by them on account of the alienation, whenever, due to any cause, it should be impossible for him to return them (Art. 1388). This rule applies even if the loss be due to fortutios event. If there are two or more alienations, the first acquirer shall be liable first, and so on successively. Example: A has only 1 property left – a parcel of land worth P500,000. He has a creditor B, which he owes P400,000. To escape payment, A donated his land to his cousin M, thus rendering A insolvent. The donation made was for fraudulent purpose and thus may be rescinded. However, before the contract was rescinded, M was able to secure a new title over the property by virtue of such donation and was registered under his name. M then sold the same land to X. 

If X acted in good faith, the sale between M and X is not rescissible. This is true even if M had previous knowledge of the fraudulent purpose why A donated the property to him.

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If X acted in bad faith, as when knew beforehand that the property was originally transferred to M to defraud creditor B, the sale between M and X can be rescinded. Voidable Contracts

Voidable Contracts, defined Voidable contract refers to a contract that is valid and binding unless avoided or declared void by a party to the contract who is legitimately exercising a power to avoid the contractual obligations. A contract may be voidable on the grounds of fraud, mistake, misrepresentation, lack of capacity, duress, undue influence, or abuse of a fiduciary relationship.

A contract that is based on one of these grounds is not automatically void but is voidable at the option of the party entitled to avoid it.

When is a contract voidable? 1. When one of the contracting parties is incapable of giving consent to a contract.

The following are incapable of giving consent: a. Unemancipated minors

b. Insane or demented person

c. Deaf-mutes who do not know how to write

2. When consent is vitiated by mistake, violence, intimidation, undue influence or fraud

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Mistake - an error in comprehending facts, meaning of words or the law, which causes one party or both parties to enter into a contract without understanding the obligations or results.

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Violence - Physical force exerted for the purpose of violating, damaging, or abusing a person.

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Intimidation - implies the presence or operation of a fear-inspiring force to frighten into submission, compliance, or acquiescence

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Undue influence - refers to any improper or wrongful constraint, machination, or urgency of persuasion, by which one's will is overcome and he is induced to do or forbear an act which he would not do, or would do, if left to act freely. Undue

influence may result from family affiliations, religious affiliations and similar group influence. 

Fraud – refers to deception deliberately practiced in order to secure unfair or unlawful gain.

Rules on annulment of voidable contracts 1. Prescriptive period of annulment – the action for annulment must be brought within the time prescribed by law. Otherwise, the contract can no longer be set aside. The action for annulment shall be brought within four (4) years. This period shall begin:  In cases of intimidation, violence or undue influence, from the time the defect of the consent ceases. 

In case of mistake or fraud, from the time of the discovery of the same

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When the action refers to contracts entered into by minors or other incapacitated persons, from the time the guardianship ceases.

2. Who may bring action for annulment? The action for the annulment of contracts may be instituted by all who are thereby obliged principally or subsidiarily. However, persons who are capable cannot allege the incapacity of those with whom they contracted; nor can those who exerted intimidation, violence, or undue influence, or employed fraud, or caused mistake base their action upon these flaws of the contract. Thus, the following person can bring action for annulment: a. The guardian, during the incapacity of his ward b. The incapacitated person after he has attained capacity c. The party whose consent is vitiated by mistake, violence, intimidation, undue influence or fraud. 3. Effects of annulment An obligation having been annulled, the contracting parties shall restore to each other the things which have been the subject matter of the contract (Article 1398). Thus, a. In obligation to give – parties shall return to each other the thing which have been the subject matter of the contract, with the fruits, and the price together with interests. Example: M, minor, sold a parcel of land to B for P300,000. After 5 years and M attained the age of majority, he brought an action to annul the sale with B. When the contract is annulled, M is obliged to return to B the price of P300,000 plus the legal interest (12% per annum). B on the

other hand, shall return to M the parcel of land plus the fruits of the land for the last 5 years while B is in the possession of it. b. In obligation to render service, the value thereof shall be the basis of damage. c. When the defect of the contract consists in the incapacity of one of the parties, the incapacitated person is not obliged to make any restitution except insofar as he has been benefited by the thing or price received by him. Example: M, a minor, sold his Samsung Galaxy Notepad to X for P1,000. M then spent the P1,000 for internet video games. Upon knowledge of the sale, the guardian of M immediately asked for annulment of contract. X must return the notepad to the minor, but M has no obligation to make restitution ( return the P1,000). If, however, he minor spent P500 to buy materials for his school projects, and spent the rest for internet computer games, then the minor is obliged to return the P300 he benefited from the transaction. d. Whenever the person obliged by the decree of annulment to return the thing cannot do so because it has been lost through his fault, he shall return the fruits received and the value of the thing at the time of the loss, with interest from the same (Art. 1400). e. As long as one of the contracting parties does not restore what in virtue of the decree of annulment he is bound to return, the other cannot be compelled to comply with what is incumbent upon him. Example: M, minor, sold a parcel of land to B for P300,000. M then placed the amount in a time deposit with XXX Bank, for a maturity term of 5 years. After 5 years and M attained the age of majority, he brought an action to annul the sale with B. XXX Bank however was closed, and the deposit of M was frozen and cannot be withdrawn. B cannot be compelled to return the land and its fruits, unless M delivers the price plus interests to B. Mutual restitution is required in annulment of contracts between parties. Effects of loss of the thing while in the possession of the party 1. If lost by the party who can bring the action for annulment ( incapacitated, those consent was vitiated )  If lost through his fault, the action for annulment is extinguished, whether such party is incapacitated or his consent is vitiated. 

If lost without his fault and the party is incapacitated, he cans still bring an action for annulment. However, he will be required to return the value of the thing and its fruits, and only up to the extent he has benefited.

2. If lost by party who employ force, intimidation, undue influence etc., he is still oblige to pay the value of damages in case the contract is annulled. Ratification, meaning Ratification is the adoption, confirmation or affirmation of the previous act. Ratification cleanses the defects in consent and the effect retroacts on the date the contract was originally constituted. Rules governing ratification 1. How ratification is made? a. Express ratification – when made orally or in writing b. Implied or tacit ratification - It is understood that there is a tacit ratification if, with knowledge of the reason which renders the contract voidable and such reason having ceased, the person who has a right to invoke it should execute an act which necessarily implies an intention to waive his right (Art. 1393). Example: X threatens Y to kill the latter if Y will not execute a Deed of Sale a parcel of land in favor of X payable 3 months later. Meanwhile, X and Y fixed their personal differences and become good acquaintances. After 3 months, Y delivers to X the title of the land and other documents needed for the transfer of title from Y to X. The act of X constitutes ratification of the preivous sale transaction executed between parties. 2. Who may ratify? a. The guardian of the incapacitated person during the latter’s incapacity b. The incapacitated person after he has attained capacity c. The party whose consent is vitiated by mistake, violence, intimidation, undue influence or fraud. Notes:  

Person who can ratify are also those person who can bring action for annulment. Ratification does not require the conformity of the person who has no right to bring the action for annulment.

3. Effects of ratification a. It extinguishes the action to annul a voidable contract b. It cleanses the contract from its all defect from the moment it was constituted. Thus, the contract is considered not defective from the very beginning. Unenforceable contracts Unenforceable contracts, defined

Unenforceable contract is a contract which cannot be legally enforced because of some deficiency in the agreement. It cannot be enforced unless ratified. Who may avail the defense of unenforceability of the contract? Only the contracting parties can avail the defense of unenforceability of the contract. Unenforceable contracts cannot be assailed by third persons (Art. 1408). The following are unenforceable contracts (Art. 1403) 1. Those entered into in the name of another person by one who has been given no authority or legal representation, or who has acted beyond his powers Under Article 1317 of the Civil Code, it states that “No one may contract in the name of another without being authorized by the latter, or unless he has by law a right to represent him. A contract entered into in the name of another by one who has no authority or legal representation, or who has acted beyond his powers, shall be unenforceable, unless it is ratified, expressly or impliedly, by the person on whose behalf it has been executed, before it is revoked by the other contracting party.” Examples: a. Given no authority – “X sold a parcel of land to Y. The registered owner of the said land is M. Y cannot enforce the contract to M as X has given no authority to sell the land in M’s behalf. b. Agent acted in excess of authority – “M authorized X to sell his land for P1,000,000 cash. X then sold the land to Y for P1,000,000 payable in installment. Y cannot enforce the contract to M, since the agent X acted in excess of his authority. 2. Those that do not comply with the Statute of Frauds. Statute of Frauds is type of law, modeled after an old English Law that requires certain types of contracts to be in writing. Hence, an agreement hereafter made shall be unenforceable by action, unless the same, or some note or memorandum, thereof, be in writing, and subscribed by the party charged, or by his agent; evidence, therefore, of the agreement cannot be received without the writing, or a secondary evidence of its contents: a. An agreement that by its terms is not to be performed within a year from the making thereof; Example: On January 1, 2013, X orally obliged himself to paint the house of Y starting on February 1, 2014. The contract is unenforceable; neither party can demand performance of the obligation on Feb. 1, 2014. b. A special promise to answer for the debt, default, or miscarriage of another; Example: A is indebted to B for P100,000. G orally made the guaranty for the payment of A’s debt. On maturity date, A fails to pay the

loan. B now demands payment from G as guarantor. Held: The contract of guaranty in unenforceable since it was orally entered into. c. An agreement made in consideration of marriage, other than a mutual promise to marry; Example: M promises to give P100,000 as a wedding gift to A should he marry B within the year. The promise was orally made. A then married B during the year. The promise of M in consideration of marriage cannot be enforce since it is orally made. d. An agreement for the sale of goods, chattels or things in action, at a price not less than five hundred pesos (P500). Note: sale of goods, chattels or thing in action at a price not less than P500 is enforceable even orally entered in the following instances:  the buyer accept and receive part of such goods and chattels, the evidences, or some of them, of such things in action or pay at the time some part of the purchase money; 

when a sale is made by auction and entry is made by the auctioneer in his sales book, at the time of the sale, of the amount and kind of property sold, terms of sale, price, names of the purchasers and person on whose account the sale is made, it is a sufficient memorandum;

e. An agreement for the leasing for a longer period than one year, f.

The sale of real property or of an interest therein (regardless of price)

g. A representation as to the credit of a third person The representation must have the effect of inducing the party to whom the representation is made to grant credit to another. Example: B want to borrow money from C for P100,000. C then ask X about the credit standing of B. X orally tells B that C is a good borrower and he never fails to pay his obligations when it matures. On maturity date, B fails to pay the loan. C cannot sue X for damages arising from misrepresentation of credit since it was made orally – hence unenforceable. 3. Those where both parties are incapable of giving consent to a contract. Thus, the contract is unenforceable if both parties are minor, or insane or deaf-mute who do not know how to write. Ratification of Unenforceable contracts

Ratification cleanses the defect in the contract, and thus ratification makes the contract enforceable against parties Ratification, how made? 1. By execution of the contract of either or both parties – either partial of oral Examples:  X sold a parcel of land to Y for P500,000. The registered owner of the said land is M. Y cannot enforce the contract to M as X has given no authority to sell the land in M’s behalf. Upon knowledge of the sale, M demanded payment from Y, to which Y readily paid the amount. The acts of M show ratification of the sale. Y can now demand execution of Deed of Absolute Sale and the delivery of the land he purchased. 

On January 1, 2013, X orally obliged himself to paint the house of Y starting on February 1, 2014. The contract is unenforceable; neither party can demand performance of the obligation on Feb. 1, 2014. If however, on Feb. 1, 2014, X started to paint the house of Y. Obligation between parties can now be enforced as the act of X constitutes ratification of the contract.

2. Contracts infringing the Statute of Frauds, referred to in No. 2 of article 1403, are ratified by the failure to object to the presentation of oral evidence to prove the same, or by the acceptance of benefit under them (Art. 1405). 3. Ratification of contracts entered into by incapacitated persons can be made by their parents or guardians.  When only the parent or guardian of one of the contracting parties ratifies, the contract becomes voidable 

When the parents or guardian of both contracting parties ratify, the contract shall be considered valid and enforceable from its inception.

Void or Inexistent Contracts Void contracts, defined Void contract is that which is null and completely without legal force or binding effect. A void contract is not a contract at all because the parties are not, and cannot be, bound by its terms. Therefore, no action can be maintained for breach of a void contract, and it cannot be made valid by ratification. Because it is nugatory, a void contract need not be rescinded or otherwise declared invalid in a court of law. Contracts that are void from the very beginning (Art. 1409)

1. Those whose cause, object or purpose is contrary to law, morals, good customs, public order or public policy. (ex. Sale of illegal drugs, contract of forced labor to pay-off the loan, sale of animals with contagious disease, etc.) 2. Those which are absolutely simulated or fictitious. (ex. Marriage solemnize in theatrical plays) 3. Those whose cause or object did not exist at the time of the transaction. (ex. Sale of the “black pearl” which existence is still unknown) 4. Those whose object is outside the commerce of men. (ex. Sale of public plaza, lease of San Juanico Bridge, etc) 5. Those which contemplate an impossible service. (ex. Contract to appear as counsel for the accused when the lawyer was already appointed as Justice of the Supreme Court) 6. Those where the intention of the parties relative to the principal object of the contract cannot be ascertained. (ex. Sale of parcel of land where the seller has 3 parcels of land and the parties fails to agree and ascertain which parcel of land is the subject matter of the sale) 7. Those expressly prohibited or declared void by law (ex. Sale and distribution of pirated CDs and VCDs, camcording – taking video camera in the movie house is declared illegal by law). Characteristics of void contract 1. It cannot be ratified Example: A orally sold to B 10 grams of shabu for P1,000. B then paid the price and demanded the delivery of shabu from A. A cannot be compelled to deliver the thing since the contract is void ab initio. The payment made by B cannot cleanse the defect in the contract. 2. The right to set up illegality cannot be waived. The illegality of contract can be raised at any stage of proceedings, even on appeal. 3. The action or defense for the declaration of the inexistence of a contract does not prescribe. Thus, passage of time does not make the void contract valid. 4. The defense of illegality of contract is not available to third persons whose interests are not directly affected. Example: Husband sells his land to his wife. The sale shall be void, as the law prohibits sale between spouses during the validity of their marriage. A third person cannot assail the nullity of sale unless the third person’s interest in

affected by such sale. Such as when the third person is the creditor of the husband and the sale was intended to defraud the creditor. 5. A contract which is the direct result of a previous illegal contract, is also void and inexistent (Art. 1422) What are illegal contracts? Illegal contracts are those entered into by parties in violation of statute, regulation or ordinance, which may be criminal or merely not in conformity. Thus, an armed robbery is illegal, and so is an access road which is narrower than the county allows, but the violation is not criminal. The following are illegal contracts: 1. When contract constitute criminal offense a. If both parties are guilty ( in pari delicto ), the following shall apply:  They shall have no right of action against each other 

Both shall be criminally prosecuted

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The effects and instruments of the crime shall be confiscated in favor of the government

Example: S sold to B 10 dried marijuana leaves for P1,000. B advanced P400 as partial payment to S, who will deliver the marijuana the next day. B cannot compel S to deliver the marijuana, neither S can compel B to pay the unpaid price. Both S and B can be criminally prosecuted, and the marijuana and the money can be confiscated in favor of the government. b. If only one party is guilty, the following rules shall apply:  The guilty party will be criminally prosecuted 

Neither one may compel the other to comply with his undertaking

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The instrument will be confiscated in favor of the government

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The innocent party shall not be bound to comply with is promise if he has not yet given anything, and if he had given, he may claim for it return.

Example: S sold to B 100 sacks of rice stored in S’ warehouse for P150,000. B made an advance payment to S for P50,000. It was found out, however, that the rice was smuggled. S cannot be compelled to deliver the smuggled rice to B, the contract being void because of illegal object. S can be criminally prosecuted and he cannot compel B to pay the balance. B can recover the P50,000 advance payment. The smuggled rice will be confiscated in favor of the government.

2. When contract does not constitute a criminal offense a. If both parties are guilty, neither may recover what he has given or demand the performance of the other’s undertaking. Example: A and B agreed to live each other as husband and wife without the benefit of marriage. While the contract maybe contrary to moral standards, but the law does not consider it criminal offense. It was agreed that A will provide monthly financial support to B. Neither party may demand fulfillment of the other’s obligation. If A already provided monthly support, he cannot anymore recover it. b. If only one party is guilty, the following rules shall apply:  The guilty party cannot recover what he has given nor he ask for the fulfillment of what has been promised him 

The innocent party may demand the return of what he has given without any obligation to comply with his promise.

In the preceding example, assuming that A is actually a married man and the fact was unknown to B. During the period of their cohabitation, B promises to give to A parcel of land she will inherit from her parents. In this case, A cannot recover the financial support he has already given to B, nor he can compel A to deliver the inherited land he promised to him. Cases where recovery may be made despite the parties being in pari delicto 1. Interest paid in excess of the interest allowed by the usury laws may be recovered by the debtor, with interest thereon from the date of the payment (Art. 1413). Usury is defined as (a) Contracting for or receiving something in excess of the amount allowed by law for the forbearance of money, goods or things in action or (b) Any amount of interest paid or stipulated to be paid in excess of that fixed by law The Usury Law is Act 2655, as amended by Presidential Decree No. 116, which provides, among others, that the legal rate of interest for the loan or forbearance of any money, goods or credits, where such loan or renewal or forbearance is secured in whole or in part by a mortgage upon real estate the title to which is duly registered, in the absence of express contract as to such rate of interest, shall be 12% per annum. Any amount of interest paid or stipulated to be paid in excess of that fixed by law is considered usurious, therefore unlawful. However, pursuant to Central Bank Circular No. 905, adopted on 22 December 1982, the Supreme Court declared that the Usury law is now "legally inexistent”. It should be clarified that CB Circular No. 905 did not repeal nor in anyway

amend the Usury Law but simply suspended the latter's effectivity. Usury has been legally non-existent in our jurisdiction. Interest can now be charged as lender and borrower may agree upon. 2. When money is paid or property delivered for an illegal purpose, the contract may be repudiated by one of the parties before the purpose has been accomplished, or before any damage has been caused to a third person. In such case, the courts may, if the public interest will thus be subserved, allow the party repudiating the contract to recover the money or property (Art. 1414). Example: X hired Y to hack the server of COMELEC to manipulate the data regarding the forthcoming elections. X made a down payment of P200,000 and the balance of P800,000 payable after the election. Later, however, X changes his mind and informed Y not to proceed with the hacking activities anymore. X may be allowed to recover the downpayment he gave to Y. 3. Where one of the parties to an illegal contract is incapable of giving consent, the courts may, if the interest of justice so demands allow recovery of money or property delivered by the incapacitated person (Art. 1415). Example: S sold to M, a minor, a prohibited drug. The court may allow M to recover the amount he paid to S if the interest of justice demands. 4. When the agreement is not illegal per se but is merely prohibited, and the prohibition by the law is designed for the protection of the plaintiff, he may, if public policy is thereby enhanced, recover what he has paid or delivered (Art. 1416). Example: T, tenant, was awarded a parcel of land by the Department of Agrarian Reform through its implementation of CARP law. T then sold the said land to B, a third person. Here, T is allowed to recover the land he sold to a third person. The law provides that tenant-beneficiaries who acquires the land by virtue of CARP cannot alienate, sell or convey the said land to other person for a certain period of time. 5. When the price of any article or commodity is determined by statute, or by authority of law, any person paying any amount in excess of the maximum price allowed may recover such excess (Art. 1417). Example: After calamity, the Department of Trade and Industry issued a circular prohibiting any increase of price of basic commodities from its original price prior to the calamity. S sold to B 2 sacks of rice for P5,000, when its original price is only P1,500 per sack. The contract is deemed void, since it is contrary to law. However, B may be allowed to recover the excess payment made to S. 6. When the law fixes, or authorizes the fixing of the maximum number of hours of labor, and a contract is entered into whereby a laborer undertakes to work longer than the maximum thus fixed, he may demand additional compensation for service rendered beyond the time limit.

Example: E, employee signed a contract of employment requiring him to work 7 days a week, without overtime pay. The contact is void, being contrary to labor laws. If, however, E has already rendered services, he may be demand additional compensation for his overtime works. 7. When the law sets, or authorizes the setting of a minimum wage for laborers, and a contract is agreed upon by which a laborer accepts a lower wage, he shall be entitled to recover the deficiency. In the preceding example, if E agreed to receive a wage less than the minimum allowed by law, he is entitled to recover the deficiency. When illegal contract has divisible or indivisible terms 1. If divisible - if the illegal terms can be separated from the legal ones, the latter may be enforced. Example: X promises to deliver to Y a cow, a specific car and 10 dried marijuana leaves. X can be compelled to deliver the cow and the specific car. 2. If indivisible – the whole contract is void. No part thereof may be enforced. In the preceding example, if the obligation of X to deliver is indivisible, as when Y paid X the amount of P400,000 in consideration of a cow, a specific car, and 10 dried marijuana leaves, the whole obligation is void.