Defective Contracts: Obligations and Contracts (OBLICON) PDF

1 OBLICON Week 12 2 DEFECTIVE CONTRACTS 3 4 Defective contracts are categorized into four types: 5 6 1. Rescissible Contracts (Articles 1380-1389) 7 These are valid contracts but can be rescinded (cancelled) due to damage or prejudice to one of 8 the parties or third persons. Examp...

1 OBLICON Week 12 2 DEFECTIVE CONTRACTS 3 4 Defective contracts are categorized into four types: 5 6 1. Rescissible Contracts (Articles 1380-1389) 7 These are valid contracts but can be rescinded (cancelled) due to damage or prejudice to one of 8 the parties or third persons. Examples include: 9 Contracts entered into on behalf of wards or absentees that cause them injury 10 Those executed in fraud of creditors (to defeat their rights) 11 Those undertaken in cases of litigation without court approval 12 13 The Philippine Civil Code classifies defective contracts into four types: rescissible, voidable, 14 unenforceable, and void or inexistent contracts. Each category is defined by specific legal 15 characteristics and consequences, as discussed in jurisprudence. 16 17 1.a. Spouses Jaime and Matilde Poon vs. Prime Savings Bank (2016) – 18 The Court ruled on the partial rescission of a lease contract due to the bank’s closure, which was 19 considered a fortuitous event. 20 I. Legal Issues: 21 1. Whether the lease contract entered into by the spouses Poon and Prime Savings Bank is 22 subject to rescission due to the bank’s closure. 23 2. Whether the closure of the bank constituted a fortuitous event warranting the rescission 24 of the contract. 25 II. Chronology of Facts: 26 1. Lease Agreement: 27 o Spouses Jaime and Matilde Poon (lessors) entered into a lease contract with 28 Prime Savings Bank (lessee) for the bank's use of their commercial property. 29 o The contract stipulated the lease period, rental terms, and other conditions. 30 2. Bank Closure: 31 o The Bangko Sentral ng Pilipinas (BSP) ordered the closure of Prime Savings Bank 32 due to financial insolvency. 33 o As a result, the bank ceased operations and stopped paying rent. 34 3. Filing for Rescission: 35 o The spouses demanded compliance with the lease contract, but the bank was 36 unable to fulfill its obligations. 37 o They filed a case for rescission of the lease contract and claimed damages. 38 39 III. Rulings at Each Level of Courts: 40 1. Trial Court (RTC) Ruling: 41 o The RTC ruled in favor of the spouses Poon, holding that the bank’s closure did 42 not constitute a fortuitous event that would justify non-payment of rent. 43 o The court ordered the rescission of the contract and required the bank to pay 44 damages. OBLICON Week 12 Defective Contracts. ETBeltran, 2025) 1|Page  1 2. Court of Appeals (CA) Ruling: 2 o The CA reversed the RTC ruling, holding that the bank’s closure was a fortuitous 3 event beyond its control. 4 o Since fortuitous events exempt a party from liability, the contract could be 5 rescinded without damages. 6 3. Supreme Court (SC) Ruling: 7 o The SC partially affirmed the CA decision. 8 o It ruled that the lease contract could be rescinded due to the bank’s closure, but 9 the Court clarified that this does not automatically exempt the bank from its 10 obligations. 11 o The SC emphasized that fortuitous events must meet specific legal criteria and 12 that the effects on the parties should be fairly considered. 13 14 IV. Doctrine Established: 15 Rescission applies to contracts where one party suffers damage due to the non- 16 fulfillment of obligations. 17 A fortuitous event must be unforeseeable and unavoidable to justify exemption from 18 liability. 19 Even in cases of rescission, parties may still be required to equitably restore what was 20 given or received. 21 22 1.b. Mayfair Theater, Inc. vs. Equitable Realty Development, Inc. 23 (2001) – 24 The Supreme Court rescinded a contract of sale for violating the lessee’s right of first refusal. 25 Case Digest: Mayfair Theater, Inc. vs. Equitable Realty Development, Inc. 26 G.R. No. 133879, November 21, 2001 27 28 I. Legal Issues: 29 1. Whether the sale of the leased property by Equitable Realty Development, Inc. (seller) to 30 a third party violated the right of first refusal of Mayfair Theater, Inc. (lessee). 31 2. Whether the sale should be rescinded in favor of the lessee. 32 33 34 II. Chronology of Facts: 35 1. Lease Agreement with Right of First Refusal: 36 o Mayfair Theater, Inc. leased a commercial property owned by Equitable Realty 37 Development, Inc. 38 o The lease contract contained a right of first refusal, which meant that if the 39 owner decided to sell, the lessee should be given the first opportunity to 40 purchase the property under the same terms offered to third parties. 41 2. Sale to a Third Party: 42 o Despite this agreement, Equitable Realty sold the property to a third party 43 without notifying Mayfair Theater, Inc. 44 o The lessee later discovered the sale and demanded the enforcement of its right 45 of first refusal, but the owner refused to recognize it. OBLICON Week 12 Defective Contracts. ETBeltran, 2025) 2|Page  1 3. Legal Action for Rescission: 2 o Mayfair Theater, Inc. filed a case to annul the sale, arguing that the seller violated 3 its contractual right. 4 o It sought the rescission of the sale and recognition of its right to purchase the 5 property. 6 7 III. Rulings at Each Level of Courts: 8 1. Trial Court (RTC) Ruling: 9 o The RTC dismissed the case, holding that there was no enforceable right of first 10 refusal because there was no specific price or detailed agreement on the sale. 11 2. Court of Appeals (CA) Ruling: 12 o The CA affirmed the RTC ruling, reasoning that a right of first refusal does not 13 automatically give the lessee the right to buy the property unless the full terms 14 of the sale were explicitly agreed upon. 15 3. Supreme Court (SC) Ruling: 16 o The SC reversed the CA decision and ruled in favor of Mayfair Theater, Inc. 17 o The Court held that the right of first refusal is a legally enforceable obligation, 18 and Equitable Realty’s failure to honor it justified the rescission of the sale. 19 o The SC ordered the seller to offer the property to Mayfair Theater, Inc. under the 20 same terms given to the third-party buyer. 21 22 IV. Doctrine Established: 23 A right of first refusal in a lease agreement is legally binding, and a property owner must 24 first offer the property to the lessee before selling it to others. 25 Failure to comply with a contractual right of first refusal constitutes a breach, warranting 26 the rescission of the unauthorized sale. 27 Rescission applies when one party is unjustly deprived of a contractual benefit, ensuring 28 fairness and compliance with agreements. 29 30 2. Voidable Contracts (Articles 1390-1402) 31 These are valid and binding unless annulled by the court due to defects in consent. 32 Grounds for annulment: 33 o Lack of legal capacity (e.g., minors, insane persons). 34 o Vitiated consent (mistake, violence, intimidation, undue influence, or fraud). 35 o Contracts agreed upon without proper authority. 36 37 2.a. First Philippine Holdings Corporation vs. Sandiganbayan (2009) – 38 The sale of shares was annulled due to intimidation and threats affecting consent. 39 40 I. Legal Issues: 41 1. Whether the sale of shares in favor of First Philippine Holdings Corporation (FPHC) was 42 void due to illegality and violation of public policy. 43 2. Whether the Republic of the Philippines, through the Presidential Commission on Good 44 Government (PCGG), had the right to recover the shares. 45 OBLICON Week 12 Defective Contracts. ETBeltran, 2025) 3|Page  1 II. Chronology of Facts: 2 1. Ownership of Shares: 3 o First Philippine Holdings Corporation (FPHC) acquired shares in Meralco (Manila 4 Electric Company), which were originally owned by Philippine Investment 5 Management Consultants, Inc. (PHILCOMSAT). 6 o The shares were linked to the assets of Marcos cronies, which were sequestered 7 by the PCGG after the 1986 People Power Revolution. 8 2. Government Sequestration: 9 o The PCGG sequestered the shares, alleging that they were part of the ill-gotten 10 wealth of former President Ferdinand Marcos and his associates. 11 o The government sought to nullify the sale of the shares and recover them for the 12 state. 13 3. Case Filed Before Sandiganbayan: 14 o The government, through the Office of the Solicitor General (OSG), filed a case 15 before the Sandiganbayan, arguing that the transfer of shares to FPHC was void 16 for being contrary to public policy and illegally acquired. 17 18 III. Rulings at Each Level of Courts: 19 1. Sandiganbayan Ruling: 20 o The Sandiganbayan ruled in favor of the Republic of the Philippines, declaring the 21 sale void ab initio (invalid from the beginning). 22 o The court held that the shares were part of the ill-gotten wealth and should be 23 returned to the government. 24 2. Supreme Court (SC) Ruling: 25 o The SC affirmed the Sandiganbayan decision, holding that: 26 ▪ The transfer of sequestered shares was void because they were under 27 government sequestration and subject to recovery. 28 ▪ The sale violated public policy as it involved assets linked to corrupt 29 practices during the Marcos regime. 30 ▪ Since a void contract produces no legal effect, the sale was deemed non- 31 existent, and the shares were ordered returned to the government. 32 33 IV. Doctrine Established: 34 Contracts involving ill-gotten wealth are void ab initio, meaning they never had legal 35 effect from the start. 36 The government has the right to recover sequestered assets linked to corruption and 37 misuse of public funds. 38 A void contract cannot be ratified, and no party can claim rights under it. 39 40 2.b. Spouses Mariano Z. Velarde and Avelina D. Velarde vs. Court of 41 Appeals, G.R. No. 108346, July 11, 2001 42 43 I. Legal Issues: 44 1. Whether the contract entered into by Spouses Velarde and the respondents was 45 voidable due to vitiated consent. OBLICON Week 12 Defective Contracts. ETBeltran, 2025) 4|Page  1 2. Whether the contract should be annulled based on a substantial breach of reciprocal 2 obligations. 3 3. Whether the failure to pay the agreed purchase price constituted grounds for rescission. 4 5 II. Chronology of Facts: 6 1. Sale Agreement: 7 o Spouses Mariano and Avelina Velarde entered into a contract with David A. 8 Raymundo and George Raymundo for the sale of real property. 9 o The agreement stipulated that payment would be made within a specified 10 period. 11 2. Failure to Pay: 12 o The buyers failed to pay the full purchase price as agreed. 13 o Spouses Velarde demanded payment, but the buyers refused, citing mistake or 14 misrepresentation in the agreement. 15 3. Legal Action for Annulment and Rescission: 16 o The Spouses Velarde filed a case for annulment or rescission of the contract, 17 arguing that: 18 ▪ Their consent was vitiated due to a substantial mistake. 19 ▪ The buyers failed to comply with their obligation to pay, warranting 20 rescission of the contract. 21 22 III. Rulings at Each Level of Courts: 23 1. Trial Court (RTC) Ruling: 24 o The RTC ruled in favor of Spouses Velarde, declaring the contract voidable due to 25 vitiated consent. 26 o The court also ruled that the buyers’ failure to pay justified rescission. 27 2. Court of Appeals (CA) Ruling: 28 o The CA reversed the RTC decision, ruling that: 29 ▪ The alleged mistake or misrepresentation was not substantial enough to 30 warrant annulment. 31 ▪ The failure to pay was not a total breach, meaning rescission was not 32 automatically justified. 33 ▪ The buyers should be given a chance to fulfill their obligations. 34 3. Supreme Court (SC) Ruling: 35 o The SC partially affirmed the CA decision, but emphasized that: 36 ▪ A contract may be annulled if consent was obtained through substantial 37 mistake. 38 ▪ A party’s failure to perform a material obligation (such as payment) can 39 be grounds for rescission. 40 ▪ However, rescission should be exercised with caution, and courts must 41 evaluate the extent of non-performance before granting rescission. 42 43 IV. Doctrine Established: 44 A contract is voidable when consent is vitiated by substantial mistake, fraud, 45 intimidation, undue influence, or misrepresentation. OBLICON Week 12 Defective Contracts. ETBeltran, 2025) 5|Page 1 Failure to perform a major contractual obligation (such as payment) may justify 2 rescission, but courts must consider the gravity of the breach. 3 Rescission is not automatically granted and requires a judicial determination of whether 4 non-performance was substantial. 5 6 7 3. Unenforceable Contracts (Articles 1403-1408) 8 These cannot be enforced in court unless ratified. 9 Examples: 10 o Contracts that must be in writing under the Statute of Frauds. 11 o Contracts made without authority on behalf of another. 12 o Agreements where both parties lack legal capacity. 13 3.a. Rosencor Development Corporation vs. Inquing (2010) 14 The Supreme Court ruled that an oral contract for the sale of land was unenforceable under 15 the Statute of Frauds. 16 17 I. Legal Issues: 18 1. Whether the oral contract for the sale of real property was unenforceable under the 19 Statute of Frauds. 20 2. Whether partial performance by the buyer could remove the contract from the 21 application of the Statute of Frauds. 22 23 II. Chronology of Facts: 24 1. Oral Sale Agreement: 25 o Rosencor Development Corporation (seller) and Inquing (buyer) allegedly 26 entered into an oral agreement for the sale of real property. 27 o No written contract was executed between the parties. 28 2. Buyer’s Partial Performance: 29 o Inquing made partial payments towards the purchase price. 30 o Inquing also took possession of the property and made improvements. 31 3. Seller’s Refusal to Honor the Agreement: 32 o Rosencor Development Corporation later refused to transfer ownership, arguing 33 that the oral contract was unenforceable under the Statute of Frauds (which 34 requires agreements involving land to be in writing). 35 o Inquing filed a case to compel the seller to execute the deed of sale. 36 37 III. Rulings at Each Level of Courts: 38 1. Trial Court (RTC) Ruling: 39 o The RTC ruled in favor of Inquing, holding that: 40 ▪ Although the agreement was not in writing, the buyer’s partial 41 performance (payment, possession, and improvements) took the contract 42 outside the Statute of Frauds. 43 ▪ The seller was bound to honor the agreement and execute the necessary 44 documents. 45 2. Court of Appeals (CA) Ruling: OBLICON Week 12 Defective Contracts. ETBeltran, 2025) 6|Page  1 oThe CA affirmed the RTC’s decision, ruling that: 2 ▪ The buyer's substantial acts of performance (payments and 3 improvements) indicated a valid and enforceable contract. 4 ▪ The seller’s refusal to honor the agreement was unjustified. 5 3. Supreme Court (SC) Ruling: 6 o The SC affirmed the CA’s decision, ruling that: 7 ▪ The Statute of Frauds does not apply when a contract has been partially 8 executed. 9 ▪ Since Inquing took possession and made payments, the contract was no 10 longer executory but partially performed, making it valid and enforceable. 11 ▪ The seller could not invoke the Statute of Frauds to escape its obligations. 12 13 IV. Doctrine Established: 14 An oral contract for the sale of land is generally unenforceable under the Statute of 15 Frauds unless there is partial performance. 16 Partial performance (such as possession, payment, and improvements) may remove a 17 contract from the application of the Statute of Frauds. 18 A seller cannot use the Statute of Frauds to avoid obligations under a contract that has 19 already been partially executed. 20 21 3.b PNB vs. Philippine Milling Co., Inc. (1969) 22 – The contract was unenforceable as it was not signed by the party sought to be bound. 23 24 I. Legal Issues: 25 1. Whether the contract between PNB and Philippine Milling Co., Inc. was unenforceable 26 under the Statute of Frauds. 27 2. Whether a contract that was not signed by the party sought to be charged could be 28 enforced. 29 30 II. Chronology of Facts: 31 1. Loan Agreement and Collateral Pledge: 32 o Philippine Milling Co., Inc. (respondent) entered into an agreement with 33 Philippine National Bank (PNB), where the company would secure a loan from 34 the bank. 35 o As part of the agreement, Philippine Milling was supposed to pledge certain 36 assets as collateral. 37 2. Lack of a Signed Contract: 38 o While negotiations took place, no written contract was signed by Philippine 39 Milling. 40 o PNB later sought to enforce the agreement, arguing that there was a valid oral 41 contract. 42 3. Refusal to Recognize Obligation: 43 o Philippine Milling refused to acknowledge the contract, arguing that since it was 44 not in writing and not signed, it was unenforceable under the Statute of Frauds. 45 o PNB filed a case to enforce the agreement. OBLICON Week 12 Defective Contracts. ETBeltran, 2025) 7|Page  1 2 III. Rulings at Each Level of Courts: 3 1. Trial Court (RTC) Ruling: 4 o The RTC ruled in favor of Philippine Milling Co., Inc., holding that: 5 ▪ Since the agreement was not signed by the party sought to be charged, it 6 fell under the Statute of Frauds and was unenforceable. 7 2. Supreme Court (SC) Ruling: 8 o The SC affirmed the RTC decision, ruling that: 9 ▪ Under the Statute of Frauds, contracts must be in writing and signed by 10 the party to be charged to be enforceable. 11 ▪ Since Philippine Milling did not sign any written agreement, the contract 12 was unenforceable. 13 ▪ The absence of a written contract meant PNB could not demand 14 enforcement of the pledge agreement. 15 16 IV. Doctrine Established: 17 Contracts falling under the Statute of Frauds must be in writing and signed by the party 18 to be charged to be enforceable. 19 An oral agreement for a loan or pledge of collateral is unenforceable if not evidenced by 20 a signed document. 21 A party cannot be compelled to fulfill obligations under an agreement that does not 22 meet the legal writing requirement. 23 24 25 4. Void or Inexistent Contracts (Articles 1409-1422) 26 These contracts are absolutely void and cannot be ratified. 27 Examples: 28 o Contracts with an illegal or immoral cause. 29 o Agreements that violate the law, public policy, or public order. 30 o Contracts entered into by persons absolutely incapable of giving consent. 31 o Fictitious or simulated contracts. 32 : 33 4.a First Philippine Holdings Corporation vs. Sandiganbayan 34 G.R. No. 179505, December 4, 2009 35 A contract was declared void ab initio due to illegality and violation of public policy. 36 37 I. Legal Issues: 38 1. Whether the sale of shares involving First Philippine Holdings Corporation (FPHC) was 39 void for being contrary to law and public policy. 40 2. Whether the government, through the Presidential Commission on Good Government 41 (PCGG), had the right to recover the shares as part of ill-gotten wealth. 42 3. Whether FPHC acquired valid ownership of the shares despite their alleged illegal origin. 43 44 II. Chronology of Facts: 45 1. Ownership of Shares in Meralco: OBLICON Week 12 Defective Contracts. ETBeltran, 2025) 8|Page  1 o The shares in question were originally owned by Meralco Foundation, Inc. (MFI), 2 an entity allegedly controlled by cronies of former President Ferdinand Marcos. 3 o After the 1986 People Power Revolution, the PCGG sequestered these shares, 4 claiming they were part of ill-gotten wealth. 5 2. Sale of Shares to FPHC: 6 o Despite the sequestration, the shares were sold to First Philippine Holdings 7 Corporation (FPHC), a Lopez-owned corporation. 8 o The government challenged this sale as void, arguing that sequestered assets 9 cannot be transferred without proper clearance. 10 3. PCGG’s Action to Recover the Shares: 11 o The government, through the Office of the Solicitor General (OSG), filed a case 12 before the Sandiganbayan to nullify the sale and recover the shares. 13 14 III. Rulings at Each Level of Courts: 15 1. Sandiganbayan Ruling: 16 o The Sandiganbayan ruled in favor of the government, declaring the sale void ab 17 initio (invalid from the beginning). 18 o It held that: 19 ▪ The shares were illegally acquired by Marcos cronies and were subject to 20 recovery by the state. 21 ▪ Any subsequent sale did not confer valid ownership, as the assets were 22 under sequestration and litigation. 23 2. Supreme Court (SC) Ruling: 24 o The SC affirmed the Sandiganbayan’s decision, ruling that: 25 ▪ The sale of the shares was void for being contrary to law and public 26 policy. 27 ▪ Sequestered assets remain under government control until their 28 ownership is properly determined. 29 ▪ Since the sale involved ill-gotten wealth, it had no legal effect, and the 30 shares must be returned to the government. 31 32 IV. Doctrine Established: 33 A contract involving ill-gotten wealth is void ab initio, meaning it has no legal effect from 34 the start. 35 Sequestered assets cannot be transferred or sold without clearance from the 36 government, as they are subject to litigation. 37 Ownership cannot be validly transferred when the original acquisition was tainted with 38 illegality. 39 40 4.b Philippine National Bank (PNB) vs. Court of Appeals 41 G.R. No. L-26001, May 18, 1972 42 43 – A contract was ruled void for being contrary to law and public policy. 44 45 OBLICON Week 12 Defective Contracts. ETBeltran, 2025) 9|Page  1 I. Legal Issues: 2 1. Whether the contract between PNB and the other party was void for being contrary to 3 law and public policy. 4 2. Whether PNB had the legal right to enforce the contract despite claims of illegality. 5 3. Whether the principle of unjust enrichment applied in this case. 6 7 II. Chronology of Facts: 8 1. Loan Agreement and Collateral Pledge: 9 o Philippine National Bank (PNB) entered into an agreement with a borrower, 10 granting a loan secured by a mortgage on certain properties. 11 o The borrower defaulted on the loan, and PNB sought to foreclose the mortgage. 12 2. Legal Challenge Against the Foreclosure: 13 o The borrower argued that the contract was void because it violated legal 14 provisions and public policy. 15 o The borrower claimed that the mortgage covered properties that could not 16 legally be mortgaged or foreclosed under existing laws. 17 3. Case Filed to Nullify the Contract: 18 o The borrower filed a case to invalidate the mortgage and prevent foreclosure, 19 alleging that the agreement was unenforceable and void. 20 21 III. Rulings at Each Level of Courts: 22 1. Trial Court (RTC) Ruling: 23 o The RTC ruled in favor of the borrower, declaring the mortgage contract void for 24 being contrary to law and public policy. 25 o The court held that since the contract was illegal, PNB could not enforce 26 foreclosure proceedings. 27 2. Court of Appeals (CA) Ruling: 28 o The CA affirmed the RTC decision, ruling that: 29 ▪ A contract contrary to law and public policy is void ab initio (invalid from 30 the beginning). 31 ▪ PNB could not claim any right under the void contract, even if it had 32 already provided the loan. 33 ▪ The borrower was not obligated to honor an illegal agreement. 34 3. Supreme Court (SC) Ruling: 35 o The SC affirmed the CA ruling, declaring that: 36 ▪ A contract that violates the law or public policy is void and produces no 37 legal effects. 38 ▪ PNB could not enforce the foreclosure because the mortgage itself was 39 null and void. 40 ▪ The Court acknowledged that PNB had given a loan, but since the 41 contract was void, it had no legal basis to recover through foreclosure. 42 43 IV. Doctrine Established: 44 A contract that violates law or public policy is void ab initio and cannot be enforced. 45 A party to a void contract cannot claim any rights or demand performance from the 46 other party. OBLICON Week 12 Defective Contracts. ETBeltran, 2025) 10 | P a g e 1 The principle of unjust enrichment does not apply when a contract is declared void due 2 to illegality. 3 OBLICON Week 12 Defective Contracts. ETBeltran, 2025) 11 | P a g e