TITLE XI.

LOAN Distinctions Between Mutuum and Commodatum

CREDIT MUTUUM COMMODATUM

- refers to belief or trust by a person in another’s ability to comply with an obligation; and “credit a) equivalent amount to be returned (subject a) same thing to be returned (subject matter is
transactions” refers to the contracts or agreements based on said trust or credit. matter is fungible) non-fungible)
b) may be gratuitous or onerous (with interest) b) essentially gratuitous (If there is
Scope of Credit Transactions compensation it ceases to be commodatum.)
The subject involves: c) ownership goes to borrower or bailee c) ownership retained bylender or bailor
(a) The PRINCIPAL contracts of loan (both commodatum and mutuum) and deposit (these are of d) refers to personal property only d) may involve real and personal property
course founded on “belief or “faith” or “trust”). e) referred to as loan for consumption e) referred to as loan for useor temporary
(b) The ACCESSORY contracts [which generally depend on the existence of the aforementioned possession
contracts and which tends to strengthen said “belief” or “trust” because of the f) borrower, because of his ownership, bears f) lender, because of his ownership, bears risk
security given: risks of loss of loss
1) personal guaranty (a person’s personal credit is involved as in guaranty proper and g) can be generally obliged to pay only at end g) while generally obliged to return object at
suretyship) of period end of period, still in some cases the return can
2) real guaranty (here the “belief” is strengthened with the use of property — if real be demanded even before the end of the
property, the contracts of real mortgage and antichresis; if personal property, the contracts period
of pledge and chattel mortgage). h) not personal in character h) personal in character
(c) Preference and concurrence of credits.
‘Consumable’ and ‘Non-consumable’ Distinguished
Art. 1933. By the contract of loan, one of the parties delivers to another, either something not (a) Consumable — a movable which cannot be used in a manner appropriate to its nature
consumable so that the latter may use the same for a certain time and return it, in which case
without its being consumed. (Art. 418). Example: gasoline.
the contract is called a commodatum; or money or other consumable thing, upon the condition
(b) Non-consumable — a movable which can be used in a manner appropriate to its nature
that the same amount of the same kind and quality shall be paid, in which case the contract is without its being consumed. (Art. 418). Example: a book.
simply called a loan or mutuum.
‘Fungible’ and ‘Non-Fungible’ Distinguished
Commodatum is essentially gratuitous.
(a) Fungible — if the intention is to allow a substitution of the thing given. (3 Manresa 58).
(b) Non-fungible — if the intention is to compel a return of the identical thing given. (3 Manresa
Simple loan may be gratuitous or with a stipulation to pay interest.
58).
In commodatum the bailor retains the ownership of the thing loaned, while in simple loan, [NOTE: Whether a thing is consumable or not depends on the nature of the thing; whether it is
ownership passes to the borrower.
fungible or not depends on the intention. (3 Manresa 58). Hence, sugar is consumable and
ordinarily fungible, but if the intention is merely to display the sugar for exhibition (ad
Two Kinds of Loans
ostentationem), then it is still consumable (nature) but non-fungible (intention).]
(a) mutuum or simple loan, and
(b) commodatum.
BAILMENT
Etymological — It is derived from the French word bailler, meaning to deliver.
Loans Under the Old Law
Real definition — The delivery of property by one person to another in trust for a specific
Prior to the new Civil Code, there were two kinds of loans: purpose, with a contract, express or implied, that the fi rst shall be faithfully executed and the
(a) civil loans — governed by the old Civil Code; and
property returned or duly accounted for when the special purpose is accomplished or kept until
(b) commercial loans — governed by the Code of Commerce. Under the new Civil Code this
the bailor reclaims it. (3 Ruling Case Law 73).
distinction has been abolished. (Art. 2270).
Parties in a Bailment
(a) Bailor — the giver; and [NOTE: An agent who uses for his own ends money or property of the principal is a depositary or
(b) Bailee — the recipient of the thing bailed. trustee of said funds and would be liable in case of failure to return. He cannot claim that only a
“loan” was involved for this would require the principal’s consent.]
Consideration or Cause in a Bailment of Loan
Insofar as the borrower is concerned, the cause is the acquisition of the thing; insofar as the
lender is concerned, it is the right to require the return of the same thing or its equivalent. If 'Loan’ Distinguished from ‘Irregular Deposit’
despite the issuance of a check to the prospective borrower, the money is not given, there is NO LOAN IRREGULAR DEPOSIT
contract of loan. (a) borrower can use and will return only at (a) depository can also use (as distinguished
end from a case of a regular deposit where
Definition of ‘Credit’ as Applied to ‘LOANS’ of period generally depositary cannot generally use)
The ability to borrow money or thing by virtue of the confidence or trust reposed by a lender that
the borrower will pay what he may promise (People v. Concepcion, 44 Phil. 126) is called (b) lender has no preference over other (b) irregular depositor has preference
“CREDIT” derived from the Latin “credere,” meaning “to trust.” creditors
(c) essential cause is NECESSITY of borrower (c) essential use is the special benefit for
* Under the Code of Civil Procedure, the failure to return a thing deposited rendered the depositor (as his money is being safeguarded)
depositary liable to imprisonment, but this would not be the case if the contract is one of loan
and not of deposit. ‘Loan’ Distinguished from ‘Sale’
LOAN SALE
* Under the Corporation Law, a sugar corporation cannot invest in a corporation dealing with (a) real contract (a) consensual contract
real estate, but can grant a loan to the latter. If a corporation should do this, its franchise can be (b) Generally unilateral because only borrower (b) bilateral and reciprocal
revoked.
[NOTE: If property is “sold” but the real intent is only to give the object as security for a debt —
‘Loan’ Distinguished from ‘Discounting of a Paper’ as when the “price” is comparatively small — there really is a contract of LOAN, with an
“equitable mortgage.”]
LOAN DISCOUNTING OF A PAPER
interest is taken at the expiration of a credit; interest is deducted in advance Form of Interest
always on double-name paper generally on single-name paper. A loan must be in the form of money or something circulating as money. It must be
repayable absolutely and in all events.
* The difference between a discount and a loan or forbearance is that the former does not have
to be repaid. Escalation Clause
- are valid stipulations in commercial contracts to maintain fiscal stability and to retain the value
Loan Distinguished from Deposit of money in long-term contracts
- are subject to certain conditions.
LOAN DEPOSIT - a valid provision in a loan agreement provided that:
(a) purpose — to grant its USE to borrower (a) purpose — SAFEKEEPING by depositary (1) the increased rate imposed by the lender does not exceed the ceiling fixed by law or the
(who generally cannot use) monetary board;
(b) generally, the borrower pays only at end of (b) the return of deposited things can be (2) the increase is made effective not earlier than the effectivity of the law or regulation
period demanded by the depositor at any time authorizing such increase; and
(c) relationship is that of lender (creditor) and (c) relationship is that of depositor and (3) the remaining maturities of the loans are more than 730 days as of the effectivity of the
borrower (debtor) depositary law or regulation authorizing such an increase.
(d) there can be compensation of credits (d) NO compensation of things deposited with
each other (except by mutual agreement).
* Central Bank (Bangko Sentral) Circ. 905 (lifting the ceiling on interest rates) could not be 1933 and 1935).
properly invoked to justify the escalation clauses requiring that the increase be “within the limits - derived from the Latin “commodum” (usefulness) or “commodo” (particular usefulness to a
allowed by law,” such circular not being a grant of specifi c authority. borrower). (See 11 Manresa 514).

Art. 1934. An accepted promise to deliver something by way of commodatum or simple loan is Features or Characteristics of Commodatum as a Contract
binding upon the parties, but the commodatum or simple loan itself shall not be perfected (a) real (because perfected by delivery)
until the delivery of the object of the contract. (b) principal (because it can stand alone by itself)
(c) gratuitous (otherwise, the contract is one of lease)
(d) personal in nature (because of the trust). (See Art.1939).
Nature of the Contract of Loan
Commodatum and loan - real contracts (perfected: delivery of the object loaned) What Bailee (Borrower) in Commodatum Acquires
Commodatum gives the right to the use (jus utendi) and not the right to the fruits (jus fruendi);
Need for Delivery otherwise, the contract may be one of usufruct. But of course a stipulation that the bailee may
To effect either a commodatum or a mutuum, a delivery, either real or constructive, is make use of the fruits of the thing loaned is valid. (Art. 1940). In such a case, however, the right
essential. This is so because unless there is delivery, the borrower in commodatum (for example) to get
cannot exercise due diligence over the thing loaned. (11 Manresa 507-508). the fruits is merely incidental and not the main cause of the contract.

Consent of the Parties Spanish Terms

The borrower and the lender must of course consent either personally or through an Bailor in commodatum (lender) is called comodatario in Spanish, bailee in commodatum
authorized agent, as in every obligation founded upon a contract. However, the necessary (borrower) is termed comodante.
acceptance need not be actual but may be implied from circumstances. (3 RCL 81).
Art. 1936. Consumable goods may be the subject of commodatum if the purpose of the
Consensual Contract of Future Loans contract is not the consumption of the object, as when it is merely for exhibition.
Aside from the real contracts of commodatum and loan, there can also be a consensual
contract created by an accepted promise to deliver something by way of commodatum or simple Subject Matter of Commodatum
loan. Usually, only non-consumable goods may be the object of a commodatum for the thing itself
should not be consumed and must be returned, but when a jar of vinegar is given merely for
Example: A promised to lend P1,000,000 to B. The promise was accepted by B. This contract exhibition, the thing itself is not consumed. It is only used ad ostentationem. Note that the
(consensual) is already binding upon the parties so that if A does not fulfi ll his promise, B has the vinegar in this case
right to demand compliance thereof. But note here that the real contract of loan does not yet is non-fungible, for the same vinegar must be returned.
exist.
Counterpart in the Contract of Lease
Chapter 1. COMMODATUM Note that this provision has a counterpart in the contract of lease, except when they are merely
to be exhibited or when they are accessory to an industrial establishment. (Art. 1645).
Section 1. NATURE OF COMMODATUM
Art. 1937. Movable or immovable property may be the object of commodatum.
Art. 1935. The bailee in commodatum acquires the use of the thing loaned but not its fruits; if
any compensation is to be paid by him who acquires the use, the contract Properties That May Be the Object of Commodatum
ceases to be a commodatum. (a) immovable property
(b) movable property
COMMODATUM
- a real, principal, essentially gratuitous, and personal contract where one of the parties (called
the bailor or lender) delivers to another (called the bailee or borrower) a non-consumable object,
so that the latter may USE the same for a certain period and later return it. (See Arts.
Example of Commodatum Involving Land Does Bailee Have Right to Use the Fruits?
A borrowed B’s land so that he can erect thereon a small barong-barong to be used for the time (a) As a rule, the bailee is not entitled to the fruits, otherwise the contract may be one of
that A works in B’s province. If there is no rental this is a case of commodatum, but if rental is usufruct. It should be noted that the right to use is distinct from the right to enjoy the fruits,
paid, this would be a lease. since under the law fruits should as a rule pertain to the owner of the thing producing the fruits.
(b) However, to stipulate that the bailee makes use of the fruits would not destroy the essence of
Art. 1938. The bailor in commodatum need not be the owner of the thing loaned. a commodatum, for liberality is still the actual cause or consideration of the contract.

Bailor (Lender) Need Not Be the Owner Example

Reason for the law: The contract of commodatum does not transfer ownership. All that is A is the bailee in commodatum of B’s land. Incidentally, they may stipulate that A can get some
required is that the bailor has the right to the use of the property which he is lending, and that lanzones from a lanzones tree on the land. Unless there is such a stipulation, A would not be
he be allowed to alienate this right to use. Hence, in lease for example, a lessee may become a entitled to the lanzones.
sub-lessor, unless he has been expressly prohibited to do so in the contract of lease. (Art. 1650,
Civil Code). Section 2. OBLIGATIONS OF THE BAILEE

* If a lessee, by a contract of a sub-lease, may transfer to another the enjoyment of the thing Art. 1941. The bailee is obliged to pay for the ordinary expenses for the use and preservation
leased for a consideration, there is no reason why he should be unable to cede gratuitously its of the thing loaned.
use to the commodatory.
Duty of Borrower to Pay Ordinary Expenses
Art. 1939. Commodatum is purely personal in character. Reason for the law: The bailee is supposed to return the identical thing (Art. 1933), so he is
Consequently: obliged to take care of the thing with, as a rule, the diligence of a good father of a family. (Art.
(1) The death of either the bailor or the bailee extinguishes the contract; 1163). It follows necessarily that ordinary expenses for the use and preservation of the thing
(2) The bailee can neither lend nor lease the object of the contract to a third person. However, loaned must be borne the bailee.
the members of the bailee’s household may make use of the thing loaned, unless there is a
stipulation to the contrary, or unless the nature of the thing forbids such use. Examples
(a) A borrowed an automatic Rolls Royce automobile. He repay for the gasoline, motor oil, and
Personal Nature of Commodatum expenses of greasing and spraying. He cannot ask reimbursement for these. (Art. 1941).
Old Civil Code - obligations and rights descended to the heirs of both contracting parties unless (b) A borrowed a horse for a journey. If the horse is exhausted, rest must be given to the horse;
the loan was made in consideration of the person of the borrower. (Art. 1742, old Civil Code). otherwise, if A continues the journey with a tired horse, he should be responsible for the
New Civil Code - changes this as purely personal. (Art. 1939, new Civil Code). consequences of his folly. (3 R.C.L. 111 and Higman Camody, 112 Ala. 267).

Example of the First Paragraph [NOTE: The rule is different in the case of extraordinary expenses. (See Art. 1949).]
A loaned to B the former’s car by way of commodatum. If either A or B dies, the contract is
extinguished. Art. 1942. The bailee is liable for the loss of the thing, even if it should be through a fortuitous
event:
(NOTE: If there are two or more borrowers, the death of one does not extinguish the (1) If he devotes the thing to any purpose different from that for which it has been loaned;
commodatum as to the other, unless there is stipulation to the contrary.) (2) If he keeps it longer than the period stipulated, or after the accomplishment of the use for
which commodatum has been constituted;
Example of the Second Paragraph (3) If the thing loaned has been delivered with appraisal of its value, unless there is a
A loaned to B a home theatre component by way of commodatum. B cannot lend or lease this to stipulation exempting the bailee from responsibility in case of a fortuitous event;
a friend. But the children of B in his household may use the same unless there is a stipulation to (4) If he lends or leases the thing to a third person, who is not a member of his household;
the contrary. But said component cannot be used as a chair, because the nature of the thing (5) If, being able to save either the thing borrowed or his own thing, he chose to save the
forbids such use. latter.

Art. 1940. A stipulation that the bailee may make use of the fruits of the thing loaned is valid.
Liability for Loss Due to a Fortuitous Event
As a rule, a debtor of a thing is not responsible for its loss thru a fortuitous event. This Article Solidary Liability of Bailees
gives the exceptions in a case of commodatum. This is one more instance when solidary liability is imposed by law.

Reason for the Law Section 3. OBLIGATIONS OF THE BAILOR

(a) Paragraph 1 — This amounts to bad faith or abuse of generosity considering the fact that
commodatum is gratuitous. Art. 1946. The bailor cannot demand the return of the thing loaned till after the expiration of
(b) Paragraph 2 — He is guilty of a certain kind of default (mora). the period stipulated, or after the accomplishment of the use for which the commodatum has
(c) Paragraph 3 — Evidently, the giving of the value was made to hold the bailee liable for after been constituted. However, if in the meantime, he should have urgent need of the thing, he
all this is not a sale, and neither is ownership transferred in commodatum. may demand its return or temporary use.
(Exception — when there is a stipulation to the contrary. It may in a sense be said that the
appraisal In case of temporary use by the bailor, the contract of commodatum is suspended while the
converts the commodatum into a mutuum.) thing is in the possession of the bailor.
(d) Paragraph 4 — This is prohibited by the law for it amounts to a violation of the personal
character of a commodatum. Generally, Bailor Cannot Demand Immediate Return
(e) Paragraph 5 — This amounts to an act of ingratitude and to a failure to exercise due A commodatum is for a certain time. (Art. 1933). This is the reason for the fi rst sentence, fi rst
diligence, considering the fact that commodatum is gratuitous. paragraph of Art. 1946. This is based on equitable grounds for otherwise, the bailee may not be
able to make proper use of the thing borrowed.
Misuse or Abuse
A misuse or abuse of the property is ordinarily a conversion for which the bailee is generally held Reason for Second Sentence, First Paragraph (Urgent Necessity)
responsible, to the full extent of the loss. (Fros v. Plumb, 16 Am. Rep. 18). A bailor usually lends his property because he does not need it. Hence, the reason for the
exception. NOTE that the return may be only temporary, but it can also be permanent. This is so
Art. 1943. The bailee does not answer for the deterioration of the thing loaned due only to the because the law uses “its return (meaning permanent) or temporary use.” “Or temporary use”
use thereof and without his fault. was a phrase added by the Code Commission. The gratuitous use by the borrower must yield the
necessity of the lender. This follows naturally from the gratuitous nature of a commodatum.
Non-liability for Deterioration Without Fault (Art.1948).
The reason for the Article is obvious.
Suspension of the Contract
Art. 1944. The bailee cannot retain the thing loaned on the ground that the bailor owes him Note that the contract is suspended when the lender has temporary use and possession of the
something, even though it may be by reason of expenses. However, the bailee has a right of object.
retention for damages mentioned in Article 1951.
Art. 1947. The bailor may demand the thing at will, and the contractual relation is called a
Generally, Borrower Cannot Retain precarium, in the following cases:
Example: (1) If neither the duration of the contract nor the use to which the thing loaned should be
A is indebted to B for P500,000. B later borrowed A’s car but refused to return it on the ground devoted, has been stipulated; or
that A owed him some money. B has no right to do this. This is so even if A had borrowed after B (2) If the use of the thing is merely tolerated by the owner.
had borrowed the car.
PRECARIUM
Reason for the Law (a) Precarium is a special form of commodatum. In a true commodatum, the possession of the
Bailment implies a trust that as soon as the time has expired, or the purpose accomplished, the borrower is more secure.
bailed property must be restored to the bailor. (Cobb v. Wallace, 5 Cold [Tenn.] 539.) (b) The possession of the borrower in precarium is precarious, that is, dependent on the lender’s
will, hence the name precarium.
Art. 1945. When there are two or more bailees to whom a thing is loaned in the same contract, (c) The two kinds of precarium are given in the Article.
they are liable solidarily.
Art. 1948. The bailor may demand the immediate return of the thing if the bailee commits any Art. 1950. If, for the purpose of making use of the thing, the bailee incurs expenses other than
act of ingratitude specifi ed in Article 765. those referred to in Articles 1941 and 1949, he is not entitled to reimbursement. (n)

Effect of Commission of Act of Ingratitude Other Expenses

The bailor can demand IMMEDIATE RETURN. Example: The borrower of a car buys an extra jack to be used as a reserve on a trip. Here, he is
not entitled to reimbursement.
Grounds of Ingratitude
Article 765 provides: Art. 1951. The bailor who, knowing the fl aws of the thing loaned, does not advise the bailee of
“The donation may also be revoked at the instance of the donor, by reason of ingratitude in the the same, shall be liable to the latter for the damages which he may suffer by reason thereof.
following cases:
“(1) If the donee should commit some offense against the person, the honor or the property of When Bailor Knows Flaws
the donor, or of his wife or children under his parental authority; Example:
“(2) If the donee imputes to the donor any criminal offense, or any act involving moral turpitude, A lent B a Fisher & Paykel, the electric connections of which were defective. If although he knows
even though he should prove it, unless the crime or the act has been committed against the said defect, A does not inform B thereof, A will be liable in case B is injured by reason thereof.
donee himself, his wife or children under his authority;
“(3) If he unduly refuses him support when the donee is legally or morally bound to give support Reason for the Law
to the donor.” When a person lends, he ought to confer a benefit, and not to do a mischief. If he does not reveal
the flaws, he is liable for his bad faith. (Gagnon v. Dana, 39 Atl. 982).
Art. 1949. The bailor shall refund the extraordinary expenses during the contract for the
preservation of the thing loaned, provided the bailee brings the same to the knowledge of the [NOTE: But the obligation of a gratuitous lender goes no further than this, and he cannot
bailor before incurring them, except when they are so urgent that the reply to the notification therefore be made liable for not communicating anything which he did not know, whether he
cannot be awaited without danger. ought to have known it or not. (Gagnon v. Dana, supra).]

If the extraordinary expenses arise on the occasion of the actual use of the thing by the bailee, Right of Retention
even though he acted without fault, they shall be borne equally by both the bailor and the For the damages spoken of in this Article, the bailee has the right of retention until paid of said
bailee, unless there is a stipulation to the contrary. damages. (Art. 1944, Civil Code).

Extraordinary Expenses Nature of the Flaws

(a) As a rule, the extraordinary expenses should be paid by the bailor because it is he who profits It is evident that the fl aws referred to in this Article are hidden defects, not obvious ones.
by said expenses; otherwise, the thing borrowed would be destroyed.
(b) Generally, notice is required because the bailor should be given discretion as to what he Art. 1952. The bailor cannot exempt himself from the payment of expenses or damages by
wants to do with his own property. abandoning the thing to the bailee.

Reason for the Second Paragraph (Actual Use by Bailee) Effect of Bailor’s Abandonment or Giving of the Object
This is an equitable solution. The bailee pays one half because of the benefit derived from the Example:
use of the thing loaned to him, and the bailor pays the other half because he is the owner and For extraordinary expenses on A’s car, B the borrower spent P125,000. A cannot exempt himself
the thing will be returned to him. (Report of the Code Commission, p. 151). from payment thereof by just giving B the thing borrowed.

(3) Example Reason for the Law

A borrowed a motorbike from B. While A was riding on it, he met an accident which greatly The value of the thing borrowed might be less than the value of the expenses or damages.
damaged the bike. A was not at fault for he was driving carefully. Both A and B should share
equally in the extraordinary expenses unless there is a stipulation to the contrary.
Chapter 2. SIMPLE LOAN OR MUTUUM how much is Castro liable?
HELD: Only for P3,000 plus interest. The extra P3,000 can be annulled insofar as Castro is
Art. 1953. A person who receives a loan of money or any other fungible thing acquires the concerned, not because of fraud (neither party — the Bank nor Castro — had committed
ownership thereof, and is bound to pay to the creditor an equal amount of the same kind and fraud), but because of mutual error caused by the fraud attributable to the Valencias. The
quality. mortgage over Castro’s lot is reduced insofar as it exceeds Castro’s personal loan.

Ownership Passes in Mutuum * The “behest” nature of the loans could not be reasonably known by a mere eye examination of
Ownership passes to the borrower, but, of course, he must pay later. the mortgage contracts.

Republic v. Jose Grijaldo Art. 1954. A contract whereby one person transfers the ownership of non-fungible things to
L-20240, Dec. 31, 1965 another with the obligation on the part of the latter to give things of the same kind, quantity,
FACTS: In 1943, Jose Grijaldo borrowed money from a bank, evidenced by fi ve promissory notes, and quality be considered a barter.
and secured by a chattel mortgage on the standing crops on his land. During the war, the crops
were destroyed as a result of enemy action. Barter of Non-Consumable Things
Issue: Must the borrower still pay? Here, the word non-fungible does not really mean nonfungible but non-consumable. Reason: If
HELD: Yes, for his obligation was to pay a generic thing — money representing the loan with the thing were really non-fungible, the identical thing must be returned. Here, an equivalent
interest. The chattel mortgage on the crops simply stood as security for the fulfillment of his thing is returned.
obligations, and therefore, the loss of the crops did NOT extinguish his obligation to pay, because
the account can still be paid from sources other than said mortgaged crops. Example
A got a fountain pen from B and he (A) became the
Bonnevie v. Court of Appeals owner thereof, with the obligation of giving another pen of the same kind and quality. This shall
GR 49101, Oct. 24, 1983 be considered a barter.
(1) A contract of loan is consensual (author believes it to be a real contract — a borrower of
money who has not yet been given the money is not yet a borrower; he is only a would-be It is not a commodatum nor a mutuum.
borrower).
(2) If a loan (money is given only some time after the execution of a mortgage, the mortgage is Art. 1955. The obligation of a person who borrows money shall be governed by the provisions
still valid. After all, the promissory note is only evidentiary of the debt. The late execution of the of Articles 1249 and 1250 of this Code.
promissory note does not mean that the mortgage had no consideration.
If what was loaned is a fungible thing other than money, the debtor owes another thing of the
Similarity to Abnormal Usufruct same kind, quantity and quality, even if it should change in value. In case it is impossible to
Mutuum is similar to an abnormal usufruct. deliver the same kind, its value at the time of the perfection of the loan shall be paid.

Bank Accounts Liability of Borrower of Money

Fixed, savings, and current deposits of money in banks and similar institutions shall be governed (a) Liability is governed by Arts. 1249 and 1250.
by the provisions concerning simple loans. (Art. 1980 and Gullas v. Phil. National (b) Art. 1249. The payment of debts in money shall be made in the currency stipulated, and if it is
Bank, 62 Phil. 519). not possible to deliver such currency, then in the currency which is legal tender in the
Philippines.
Effect of Mutual Error
Rural Bank of Caloocan v. Court of Appeals The delivery of promissory notes payable to order, or bills of exchange or other
L-32116, Apr. 21, 1981 mercantile documents shall produce the effect of payment only when they have been cashed, or
Thru fraud committed by a third party (the Valencia Spouses), Maxima Castro found herself when through the fault of the creditor they have been impaired.
indebted to a Rural Bank for a total debt of P6,000 (P3,000 was what she intended to borrow; the
Valencias added another P3,000 for themselves, with Castro signing the promissory note as co- In the meantime, the action derived from the original obligation shall be held in
maker). For abeyance.
(c) Art. 1250. In case an extraordinary inflation or deflation of the currency stipulated should rights of the parties with respect to interest for the three-month period between the making of
supervene, the value of the currency at the time of the establishment of the obligation shall be the contract and the date when the installment was to become due. With respect to the
the basis of payment, unless there is an agreement to the contrary. plaintiff’s right to interest after default, the situation is to be treated precisely as if nothing had
been said about interest at all.” (Zobel v. City of Manila, 47 Phil. 169).
Example of Second Paragraph (Loan of Things Other Than Money)
A borrowed from B five sacks of rice. At the time the loan was perfected, each sack cost P1,800. (b) In contracts for the payment of a sum of money, the measure of damages for delay is limited
Even if at the time of payment the price would change, five sacks of the same kind and quality of to the interest provided for by law. The deprivation of an opportunity for making money, which
rice should be returned. However, if it is impossible to deliver the same kind, P1,800 should be might have proved benefi cial or might have been ruinous is of too uncertain a character to be
paid. Note that the value at the time of PERFECTION (not payment) applies. weighed in the even balances of the law. (Lopez v. Del Rosario, 44 Phil. 98).

Art. 1956. No interest shall be due unless it has been expressly stipulated in writing. (c) Art. 2209 — If the obligation consists in the payment of a sum of money, and the debtor
incurs in delay, the indemnity for damages, there being no stipulation to the contrary, shall be
Formality for Interest (for Use of the Money) the payment of the interest agreed upon, and in the absence of stipulation, the legal interest,
The interest must be stipulated in WRITING. which is six per cent per annum. (The rate NOW is 12% per annum.)

Example Consolidation
A borrowed P1,000,000 from B. No mention was made of interest. No interest can be charged. Part of the contract reads: “The five latter installments shall draw interest at the rate of fi ve per
But if interest had been stipulated upon, but no rate was mentioned, then it is 12% per annum cent per annum, payable to the creditors upon the date when they shall respectively fall due.”
provided of course that the agreement as to interest was made in writing. Debtor was in default. How will interest be computed?

Kinds of Interest HELD: Interest must be allowed thereon at the contract rate of 5% per annum from the date of
Interest may be paid either as compensation for the use of the money (monetary interests) or as the contract; and the interest that had accrued up to the date of the fi ling of the complaint must
damages (compensatory interest). Art. 1956 refers to interest for use of the money. be consolidated as to that date with the capital, after which the whole shall bear interest at the
contract rate of fi ve per cent per annum until paid. Where interest is contracted for at a given
How Interest Arises rate, the contract of obligation to pay interest is not merged in the judgment but remains in full
The right to interest arises only by virtue of a contract or by virtue of damages for delay or failure force until the debt is paid. The circumstances that the rate stipulated was less than the lawful
to pay principal on which interest is demanded. (Barretto v. Santa Marina, 37 Phil. 568). rate does not alter the case. (Zobel v. City of Manila, supra).

When Interest Earns Interest Municipal Corporations Are Liable for Interest
Interest due shall earn legal interest from the time it is judicially demanded, although the A municipal corporation does not enjoy immunity from liability for interest when assessed as
obligation may be silent upon this point. (Art. 2212, Civil Code). damages for the nonpayment of a debt, to the same extent as the national government. (Zobel v.
City of Manila, supra).
Interest by Way of Damages
(a) Part of a contract said: “The fi rst installment (payable in 3 months) shall have no interest.” Interest During the Moratorium Laws
But debtor was in default. Should he pay interest for damages? Interest ran during the moratorium laws. If debtors had wanted to avoid liability for all the
interest falling due during the time that the moratorium laws were in effect, they could have
HELD: Yes, not interest for compensation but interest for damages. “The trial court appears to renounced the benefi ts of the said laws and paid the debts, or in the very least paid the interest
have considered that this stipulation deprived the plaintiff of the right to interest after default, as they accrued.
and no interest whatever was allowed by him upon this installment. This was error. (Warner, Barnes & Co. v. Yasay, et al., L-12984, Jul. 26, 1960).

The stipulation that this installment should draw no interest was made in the expectation that What the moratorium laws suspended was the running of the period of prescription of actions.
the obligation would be paid upon the date stipulated. After default occurred the defendant (Republic v. Grijaldo, L-20240, Dec. 31, 1965). Interest during the war years however can be
became liable for interest as damages regardless of the statement that his installment should eliminated if the creditors were enemies of the Japanese, for their payment to them could not
draw no interest. This statement in the contract was evidently intended merely to govern the have been made. (Ibid.)
Computations for Compensatory Damages [NOTE: In the problem given, no interest is charged on the accrued interest — interest that has
As already stated, this is interest not imposed for the use of the money, but to serve as penalty or accumulated up to the time demand is made because here the demand was only extrajudicial. If
damages for the breach of contractual obligations. This kind of interest need not be stipulated in the demand had been judicial, there would have been an additional interest on the accrued
writing, for the law gives the rate (6% per annum) in the absence of agreement as to the penalty. interest. The law says that “interest due shall earn legal interest from the time it is judicially
(Art. demanded,
2209, Civil Code). In the following examples, legal interest was computed at 6% per annum. Note although the obligation may be silent upon this point.” (Art. 2212, Civil Code).]
however that today the legal rate is 12% per annum. The examples must, therefore, be amended
correspondingly. Example:
B borrowed from C P1,000,000 for two (2) years. It was agreed in writing that interest would be
Examples: 6% per annum. At the end of two years, C made a JUDICIAL demand (a court action was
(a) B borrowed from C P1,000,000 for one year. No interest was agreed upon in writing. At the instituted). At the end of three (3) MORE years, B was ready to pay. How much all must B pay?
end of one year, C demanded payment, but B was unable or refused to pay. After two more
years, B was ready to pay. In addition to the principal sum of P1,000,000, how much interest, if ANS.: B must pay:
any, must B pay? 1) the principal — P1,000,000 (P60,000 a year for 6 years use of the money)
ANS.: B is not liable for interest for the use of the money (since this was not stipulated in writing) 2) moratory interest — P 300,000
BUT he is liable for interest in view of his default, as a punishment or penalty by way of damages 3) compensatory — P 180,000
for his breach of the contract. Please note that there is default after a demand is made (either 4) additional compensatory P 21,600
judicially or extra-judicially). (Art. 1169, Civil Code). The interest here given as penalty is 6% per interest on the interest due or accrued
annum — since there was no stipulation as to the penalty. (Art. 2209, Civil Code). B has been in ------------------------------------------------------------------
default for two years (counted from the demand). Hence, he is liable for interest (6%) for two Total Sum P1,501,600
years: 6% of P1,000,000 (P60,000 a year of default) (at the time judicial demand, interest for two years was already due
= P60,000 per year, P60,000 times 2 (years) = P120,000. This is the interest that he must pay. P20,000. The accrued interest itself earns interest from judicial demand to payment. P120,000 x
(Ibid.) 6% =
P7,200 a year. P7,200 times 3 years = P21,600).
(b) B borrowed from C P1,000,000 for two (2) years. It was agreed in writing that interest would
be 6% per annum. At the end of two years, C made an extrajudicial demand, but B was unable or * It is delay in the payment of such fi nal judgment that will cause the imposition of interest. The
refused to pay. At the end of three (3) MORE years, B was ready to pay. How much all in all must rate of interest is imposed on the total sum, from the fi ling of the complaint until paid; in other
B pay? words,
as part of the judgment for damages.
ANS.: Here B must pay:
1) the principal (P1,000,000) * Eliminating the interest on the various damages from the date of the fi ling of the suit is clearly
2) interest for the use of the money (6% per year –– for a total of 5 years, since from the time he an unwarranted act. It must be borne in mind that interest begins to accrue upon demand,
borrowed up to the time of payment, 5 years have elapsed). extrajudicial or judicial. A complaint is a judicial demand.
3) interest as penalty for the default (6% per year for a period of three [3] years — since he has
been in Art. 1957. Contracts and stipulations, under any cloak or device whatever, intended to
default for 3 years). circumvent the laws against usury shall be void. The borrower may recover in accordance
with the laws on usury.
Computation:
1) Principal — P1,000,000 Usury Law Should Not Be Circumvented
2) Moratory interest — P 300,000 (P60,000 a year times 5 years) The Article is self-explanatory.
3) Compensatory — P 180,000 (P60,000 a year times 3 years
----------------------------------------------------------------------------
P1,480,000 (Total sum to be paid.)
What Constitutes Usury The interest on accrued or capitalized interest is not considered interest on the original principal,
To constitute usury, there must be a loan or forbearance. And something must be exacted for the and should not be considered usurious, if, when added to the original interest, the sum should
use of money in excess of and in addition to interest allowed by law. exceed the rates allowed by the Usury Law. (Villareal v. Alvayda, 46 Phil. 277). In that case, the
original principal was P30,000 which had earned P3,600 at 12% interest for one year. The parties
Elements of Usury: added the P3,600 to
(1) a loan express or implied; the original P30,000, and thus constituted thereon a new principal debt. The debtor did not want
(2) understanding between the parties that the money lent shall or may be returned; to pay on the ground that the contract was usurious.
(3) for such loan a greater rate of interest that is allowed by law shall be paid or agreed to be
paid as the case may be; HELD: There is nothing illegal here. As a matter of fact, the Supreme Court in a subsequent case
(4) corrupt intent to take more than the legal rate for the use of money. Unless these four things held: “It is well settled in this jurisdiction that when there is an express agreement to charge
concur in every transaction, no case of usury can be declared. interest on interest, such fact should not be taken into consideration in determining whether or
not the stipulated interest exceeds the limit prescribed by the Usury Law.” (Gov’t. v. Conde, 61
Repeal of Usury Law Phil. 714 and Gov’t. v.
Central Bank (Bangko Sentral) Circular 905 has repealed the Usury Law. Today, there is no more Vaca & Calderon, 64 Phil. 6).
maximum rate of interest. The rate will just depend on the mutual agreement of the parties.
When Compound Interest Cannot Be Demanded
*For sometime now, usury has been legally non-existent. Interest can now be charged as lender Notice, however, that the agreement on compound interest must be expressly made. In one case
and borrower may agree upon. the following words were used: “Interest, to be computed upon the still unpaid capital of the
loan, shall be paid monthly, at the end of each month.” Does this allow compound interest?
Art. 1958. In the determination of the interest, if it is payable in kind, its value shall be
appraised at the current price of the products or goods at the time and place of payment. HELD: No. The language which we have quoted above does not justify the charging of interest
upon interest, so far as interest on the capital is concerned. The provision quoted merely
Determination of Interest if in Kind requires the debtor to pay interest monthly at the end of each month, such interest be
Value should be at time and place of PAYMENT. computed upon the capital of the load not yet paid. Clearly this provision does not justify the
charging of compound interest upon the interest accruing upon the capital monthly. (Co Unjieng
Art. 1959. Without prejudice to the provisions of Article 2212, interest due and unpaid shall v. Mabalacat Sugar Co., 54 Phil. 976).
not earn interest. However, the contracting parties may by stipulation capitalize the interest
due and unpaid, which as added principal, shall earn new interest. Reason Why Compound Interests Are Not Allowed Except in the Cases Provided for by Law
When Accrued Interest Earns Interest Debts would accumulate with a rapidity beyond all ordinary calculation and endurance. It would
The general rule is that accrued interest (interest due and unpaid) will not bear interest, BUT tend also to infl ame the avarice and harden the heart of the creditor. Some allowance must be
(a) if there is agreement to this effect (Art. 1959), or made for the indolence of mankind. (15 RCL36).
(b) if there is judicial demand. (Art. 2212).
Penalty clauses can be in the form of penalty or compensatory interest. The compounding of the
THEN such accrued interest will bear interest at the legal rate (Art. 2212) unless, a different rate penalty or compensatory interest is sanctioned by and allowed pursuant to the abovequoted
is provision of Art. 1959 of the new Civil Code considering that:
stipulated. (Hodges v. Regalado, 69 Phil. 588). 1. There is an express stipulation in the promissory note permitting the compounding of interest;
and
Compound Interest 2. Art. 2212 of the new Civil Code provides that “[i]nterest due shall earn legal interest from the
Compound interest is interest on accrued interest. It is valid to charge compound interest, but time it is judicially demanded, although the obligation may be silent upon this point.”
there must be a written agreement to this effect; otherwise said compound interest should not
be charged (Nolan v. Majinay, 12 Phil. 560) unless it be the interest charged upon judicial Art. 1960. If the borrower pays interest when there has been no stipulation therefor, the
demand. (Art. 2212). provisions of this Code concerning solutio indebiti, or natural obligations, shall be
applied as the case may be.
Usury Law Not Violated
Payment of Interest When There is No Stipulation a usurious loan. (Manila Trading v. Tamaraw, 47 Phil. 513). Such price is the selling price for a
(a) A borrower borrowed money. No interest was stipulated. If by mistake he pays, then this will sale made on the installment plan.
be a question of undue payment or solutio indebiti. We should then apply the rules on the
subject. Compound Interest
(b) If a borrower borrows money and orally agrees to pay In one case, it was held that an express agreement to charge compound interest is not to be
legal interest at 10% per annum, there is really no obligation to pay since the interest was not taken into consideration in determining whether or not the stipulated interest exceed the limit
agreed upon in writing. If he nevertheless pays because he considers it his moral obligation to prescribed by the Usury Law. (Gov’t. v. Conde, 61 Phil. 714). This was changed by a subsequent
pay said interest, he cannot recover the interest that he has given voluntarily. This will now be a case which held that charging compound interest violates the Usury Law when the sums charged
natural obligation, and the provisions on said subject should apply. as such added to the stipulated interest exceeds the average rate of interest that may legally be
charged for a loan. (Hodges v. Salas, 63 Phil. 567). In a still later case, the Supreme Court
Art. 1961. Usurious contracts shall be governed by the Usury Law and other special laws, so far reverted to the ruling in the Conde Case. (Gov’t v. Vaca and Calderon, 64 Phil. 6).
as they are not inconsistent with this Code.
Advance Interest
Usury Law Charging interest in advance is permissible provided said interest does not correspond to interest
Act 2655 as amended is our Usury Law, and was enacted on Feb. 24, 1916. The law was passed to for more than one year. (Hodges v. Salas, 63 Phil. 567).
curb usury, since the taking of excessive interest for the loan of money has been regarded with
abhorrence from the earliest times. (U.S. v. Constantino, 39 Phil. 552). How Much Interest Can Debtor Recover
If a debtor has paid usurious interest, how much can he get back from his creditor?
Rules on Construction
Since the Usury Law is penal in nature, it should be construed strictly. (Dickerman v. Pay, 7 Am. ANS.:
Rep. 156). Like other laws, prospective effect should be given to it, where such construction may (a) Under Art. 1961, in case of confl ict between the new Civil Code and the Usury Law, the new
be permitted. Laws adopted after the execution of a contract, changing or altering the rate of Civil Code applies, and therefore, the interest in excess of 12% or 14% may be recovered, with
interest, interest. (Art. 1413). However, in the case of Angel Jose Warehousing v. Chelda Enterprises &
cannot apply to such a contract without violating the provision of the Constitution which David Syjuico, L-25704, Apr. 24, 1968, the Supreme Court, ruled that the ENTIRE interest can be
prohibits the adoption of a law impairing the obligations of a contract. (U.S. v. Conde, 42 Phil. recovered by the debtor, for such a stipulation is VOID (thus, it is as if there is NO STIPULATION
766). as to interest). On the other hand, the principal contract of loan by itself is valid, hence this may
be recovered by the creditor. In case of demand, and if the debtor is in default, said principal
Criminal Liability debt earns interest from the date of the demand. This interest is not by way of compensation but
A lender and a borrower agreed that the rate of interest on an unsecured loan would be higher by way of damages.
than 14% per annum. But actually, the lender only received the lawful rate. Is the lender guilty of
usury by the mere fact that he agreed to charge a usurious rate? Sanchez v. Buenviaje
GR 57314, Nov. 29, 1983
HELD: Yes. Under Sec. 3 of the Usury Law, the prohibition is deemed to comprehend not only the Under the Usury Law (now repealed), the lender at usurious rates can still recover the principal
taking or receiving of a higher rate of interest than 14% per annum if such loan is not secured in (not the interest). Justice Ramon Aquino (later to become Chief Justice) consents because there
the manner provided in said section, but also the act of agreeing on such rate of interest. To this should be no unjust enrichment by the borrower. Justice Makasiar (later to become Chief Justice)
extent it differs from Sec. 2, under which a mere agreement to pay usurious interest is not dissents on the theory that the usurer has committed a crime and must therefore be penalized
criminal. (People v. Bernarte, C.A. 36 O.G. 2720). by barring him from the recovery of his capital.
(b) Under Arts. 1175 and 1957, the Usury Law prevails; and under Sec. 6 of said Usury Law (Act
When Usury Law Does Not Apply 2655), the person paying the usurious interest “may recover the whole interest, commission,
(a) A contract for the lease of property is not a loan; hence, the rental paid is not governed by the premiums, penalties, surcharges paid and delivered” as long as the action for recovery is
Usury Law. (Tolentinov. Gonzales, 50 Phil. 58). instituted within two years after such payment and the delivery (that is, all interest paid within
(b) The increase of the price of a thing sold on credit over its cash sale price is not interest within the last two years prior to litigation may be recovered).
the purview of the Usury Law, if the sale is made in good faith and not as a mere pretext to cover
(NOTE: It should be noted that under both theories, legal interest on the interest may also be
recovered.)
(NOTE: As has already been said, as of today, the Usury Law no longer exists.)

Lawful Interest Rates

Interest rates are now fixed from time to time by the Monetary Board.

Central Bank Circular 416

Pilipinas Bank v. CA
43 SCAD 990 (1993)
Circular No. 416, fi xing the rate of interest at 12% p.a., deals with:
(1) loans;
(2) forbearance of any money, goods or credit; and
(3) judgments.

[NOTE: Any increase in the rate of interest made pursuant to an escalation clause must be the
result of an agreement between the parties. (PNB v. CA, 72 SCAD 366, 258 SCRA 549).] Escalation
clauses are valid stipulations in commercial contracts to maintain fi scal stability and to retain the
value of money in long-term contracts. (Florendo v. CA, 77 SCAD 429, 265 SCRA 678 [1996]).]

[NOTE: Sec. 1 of Central Bank (Bangko Sentral) Circ. 905, Series of 1982, expressly removed the
interest ceilings prescribed by the Usury Law. Interest can now be charged as lender and
borrower may agree upon. (People v. Dizon, 73 SCAD 532, 260 SCRA 851 [1996]). The unilateral
determination and
imposition of increased interest rates by respondent bank is obviously violative of the principle of
mutuality of contracts. (Ibid.)]

[NOTE: The maximum rate of interest on a loan are forbearance of money secured by a mortgage
upon real estate the title to which is duly registered, shall be 12% per annum. (Sec. 2, The Usury
Law [PD 116, amending Act 2655]). All covenants and stipulations contained in conveyances,
mortgages,
and other contracts or evidences of debts, whereupon or whereby there shall be stipulated,
charged, demanded, reserved, secured, taken or received, directly or indirectly, secured, taken or
received, directly or indirectly, a higher rate or greater sum or value for the loan than is
hereinbefore allowed,
shall be void. (Sec. 7, Id., cited in Sps. Puerto vs. CA, supra).]