Law on Obligations Extinguishment of Obligations PDF

Page |1 LAW ON OBLIGATIONS EXTINGUISHMENT OF OBLIGATIONS Modes of extinguishment of obligations 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 confusi...

Page |1 LAW ON OBLIGATIONS EXTINGUISHMENT OF OBLIGATIONS Modes of extinguishment of obligations 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 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 extinguished 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. MGT 161 LAW ON BUSINESS TRANSACTIONS & TRANSPORTATION Atty. RODERICK F. BLANCO, CPA, Lecturer Source: Civil Code of the Philippines Annotated, Book IV, 18th ed. 2016, Justice Edgardo L. Paras  Page |2 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 consists 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. 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 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: MGT 161 LAW ON BUSINESS TRANSACTIONS & TRANSPORTATION Atty. RODERICK F. BLANCO, CPA, Lecturer Source: Civil Code of the Philippines Annotated, Book IV, 18th ed. 2016, Justice Edgardo L. Paras  Page |3 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 any 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. Art. 1233, NCC - 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 obligee (Art. 1234, NCC) 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 law prohibiting the sale of good lumber. Hence, D can no longer comply with his obligation. Here, D can demand payment for 100 pcs. of lumber from E, less damages suffered by E in the circumstance. b. Art. 1235, NCC - 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. 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 MGT 161 LAW ON BUSINESS TRANSACTIONS & TRANSPORTATION Atty. RODERICK F. BLANCO, CPA, Lecturer Source: Civil Code of the Philippines Annotated, Book IV, 18th ed. 2016, Justice Edgardo L. Paras  Page |4 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 (custodia 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 by 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. EXCEPTIONS: 1. When there is a stipulation to that effect MGT 161 LAW ON BUSINESS TRANSACTIONS & TRANSPORTATION Atty. RODERICK F. BLANCO, CPA, Lecturer Source: Civil Code of the Philippines Annotated, Book IV, 18th ed. 2016, Justice Edgardo L. Paras  Page |5 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 a. He can recover what he has paid b. 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. a. He can recover what he has paid only insofar as it is beneficial to the debtor. b. 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 1. The payment shall be deemed as donation which requires the debtor’s consent 2. 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 MGT 161 LAW ON BUSINESS TRANSACTIONS & TRANSPORTATION Atty. RODERICK F. BLANCO, CPA, Lecturer Source: Civil Code of the Philippines Annotated, Book IV, 18th ed. 2016, Justice Edgardo L. Paras  Page |6 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, NCC - 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 to 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 possesses 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; MGT 161 LAW ON BUSINESS TRANSACTIONS & TRANSPORTATION Atty. RODERICK F. BLANCO, CPA, Lecturer Source: Civil Code of the Philippines Annotated, Book IV, 18th ed. 2016, Justice Edgardo L. Paras  Page |7 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 dacion en pago 2. Application of payment 3. Payment by cession 4. Tender of payment and consignation Dation in Payment Dation in payment (dacion en pago, adjudicacion en pago, datio en solutum, or payment in kind), is a mode of extinguishing an obligation whereby the debtor alienates in favor of the creditor property for the satisfaction of monetary debt. The obligation is extinguished up to amount of property unless there is a contrary stipulation. Conditions for a valid dacion en pago 1. Creditor consents, for a sale presupposes the consent of both parties; 2. Dacion will not prejudice the other creditors; 3. Debtor is not judicially declared insolvent. 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, NCC). 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 not yet due MGT 161 LAW ON BUSINESS TRANSACTIONS & TRANSPORTATION Atty. RODERICK F. BLANCO, CPA, Lecturer Source: Civil Code of the Philippines Annotated, Book IV, 18th ed. 2016, Justice Edgardo L. Paras  Page |8 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, NCC) 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 has the right to choose if debtor fails to choose - If the debtor does 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: i. Payment shall be applied to debt, among those due, which is the most onerous to the debtor; ii. If the debts 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, 2023; (b) P20,000 due on August 31, 2023; and (c) P20,000 with 15% per annum on September 30, 2023. assuming on August 31, 2023, 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 P5,000 payment for the P10,000 debt (P15,000 x 10,000/30,000); and P10,000 payment for the P20,000 debt (P15,000 x 20,000/30,000). MGT 161 LAW ON BUSINESS TRANSACTIONS & TRANSPORTATION Atty. RODERICK F. BLANCO, CPA, Lecturer Source: Civil Code of the Philippines Annotated, Book IV, 18th ed. 2016, Justice Edgardo L. Paras  Page |9 Note: the debt not yet due on August 31 cannot be included in the application of payment Payment by Cession Payment by cession is the assignment or abandonment by the debtor of all his properties in favor of his creditors so that the latter may sell them and recover claims out of the proceeds. Under Article 1255, NCC, 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; 4. The debtor abandons or assigns ALL his properties except those exempt from execution, in favor of his creditors; 5. 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 released 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 Payment by Cession Dation in Payment As to number of There must be 2 or more No requirement for the creditors creditors number of creditors Properties involved Affects ALL the debtor’s Does not affect all of properties, except those debtor’s properties exempt from execution Transfer of ownership No transfer of ownership. The creditor becomes the The creditors are only owner of the property given authorized to sell the as payment debtor’s properties MGT 161 LAW ON BUSINESS TRANSACTIONS & TRANSPORTATION Atty. RODERICK F. BLANCO, CPA, Lecturer Source: Civil Code of the Philippines Annotated, Book IV, 18th ed. 2016, Justice Edgardo L. Paras  P a g e | 10 Insolvency of the The debtor must be The debtor need not be debtor insolvent insolvent Extinguishment of The obligation is Obligation is extinguished obligation extinguished up to the as a rule extent of the proceeds of the sale from properties, unless the creditors agreed to release the debtor from his obligations 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. 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, NCC) 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 debtor may withdraw the MGT 161 LAW ON BUSINESS TRANSACTIONS & TRANSPORTATION Atty. RODERICK F. BLANCO, CPA, Lecturer Source: Civil Code of the Philippines Annotated, Book IV, 18th ed. 2016, Justice Edgardo L. Paras  P a g e | 11 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 debtor 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 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, NCC). 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 MGT 161 LAW ON BUSINESS TRANSACTIONS & TRANSPORTATION Atty. RODERICK F. BLANCO, CPA, Lecturer Source: Civil Code of the Philippines Annotated, Book IV, 18th ed. 2016, Justice Edgardo L. Paras  P a g e | 12 a. Physical impossibility refers to impossibility due to the fact that the 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 is due to the fault of the debtor (Art. 1262, NCC) – the loss is presumed to be due to the fault of the debtor, unless proven 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, NCC) 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, NCC); 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, NCC). 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 Pastrana, Leyte”, 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, NCC) 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, NCC) 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 MGT 161 LAW ON BUSINESS TRANSACTIONS & TRANSPORTATION Atty. RODERICK F. BLANCO, CPA, Lecturer Source: Civil Code of the Philippines Annotated, Book IV, 18th ed. 2016, Justice Edgardo L. Paras  P a g e | 13 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 (Art.1269, NCC) CONDONATION OR REMISSION OF DEBT 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, NCC). 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 (donee) must satisfy. ▪ When the remission involves movable/personal property – a. If the value of the property exceeds P5,000, the remission and acceptance must be in writing (public or private); b. 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 remission 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, NCC – 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. Art. 1273, NCC - The renunciation of the principal debt shall extinguish the accessory obligations; but the waiver of the latter shall leave the former in force. MGT 161 LAW ON BUSINESS TRANSACTIONS & TRANSPORTATION Atty. RODERICK F. BLANCO, CPA, Lecturer Source: Civil Code of the Philippines Annotated, Book IV, 18th ed. 2016, Justice Edgardo L. Paras  P a g e | 14 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, NCC - 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 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, 2021. 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, NCC). 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, NCC). 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 MGT 161 LAW ON BUSINESS TRANSACTIONS & TRANSPORTATION Atty. RODERICK F. BLANCO, CPA, Lecturer Source: Civil Code of the Philippines Annotated, Book IV, 18th ed. 2016, Justice Edgardo L. Paras  P a g e | 15 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 shall take place when two persons, in their own right, are creditors and debtors of each other (Art. 1278, NCC). 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 obliged to do an act, and the other to deliver a sum of money; When one of the obligations 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 obligations 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. MGT 161 LAW ON BUSINESS TRANSACTIONS & TRANSPORTATION Atty. RODERICK F. BLANCO, CPA, Lecturer Source: Civil Code of the Philippines Annotated, Book IV, 18th ed. 2016, Justice Edgardo L. Paras  P a g e | 16 i. 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. ii. 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 sinandomeng rice, and likewise, B also promises to deliver the same kind and quantity of rice, legal compensation will extinguish both obligations. iii. 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 January 10, 2022 and B owes A P10,000 due on February 15, 2023, there can be no legal compensation to this effect. iv. 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. v. 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 debts 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, NCC) 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. Can Rescissible or Voidable debt/s be the subject of compensation? MGT 161 LAW ON BUSINESS TRANSACTIONS & TRANSPORTATION Atty. RODERICK F. BLANCO, CPA, Lecturer Source: Civil Code of the Philippines Annotated, Book IV, 18th ed. 2016, Justice Edgardo L. Paras  P a g e | 17 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, NCC) 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 (Art. 1286, NCC). 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 (Art. 1289, NCC). Effects of assignment on compensation of debts 1. When the assignment was with debtor’s consent – the debtor cannot set up against the assignee the compensation that would pertain to him 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, 2021. B, however, is also indebted to A for P70,000 also payable on December 31, 2021. On November 3, 2021, B assigned the promissory note partially for P100,000 to M. On maturity date, M demanded payment. How 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 31,2021. Likewise, T issued promissory notes to S for the following: P 10,000 payable on August 31, 2021 P 20,000 payable on September 30, 2021 P 50,000 payable on December 31, 2021 On October 5, 2021, 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 8/31/2021) and (P20,000 due on 9/30/2021). 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 31,2021. Likewise, T issued promissory notes to S for the following: P 10,000 payable on August 31, 2021 MGT 161 LAW ON BUSINESS TRANSACTIONS & TRANSPORTATION Atty. RODERICK F. BLANCO, CPA, Lecturer Source: Civil Code of the Philippines Annotated, Book IV, 18th ed. 2016, Justice Edgardo L. Paras  P a g e | 18 P 20,000 payable on September 30, 2021 P 10,000 payable on October 31, 2021 P 50,000 payable on December 31, 2021 On September 5, 2021, T assigned his credit to X without the knowledge of S. It was only on November 10, 2021 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 8/31/2021), (P20,000 due on 9/30/2021) and (P10,000 due on 10/31/2021). 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 co-debtors, 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 become 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 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 (Art. 1292, NCC). 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; MGT 161 LAW ON BUSINESS TRANSACTIONS & TRANSPORTATION Atty. RODERICK F. BLANCO, CPA, Lecturer Source: Civil Code of the Philippines Annotated, Book IV, 18th ed. 2016, Justice Edgardo L. Paras  P a g e | 19 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 by change of the parties (debtor or creditor) Substituting the person of the debtor – always requires the consent of the creditor i. 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. ii. 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 MGT 161 LAW ON BUSINESS TRANSACTIONS & TRANSPORTATION Atty. RODERICK F. BLANCO, CPA, Lecturer Source: Civil Code of the Philippines Annotated, Book IV, 18th ed. 2016, Justice Edgardo L. Paras  P a g e | 20 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. MGT 161 LAW ON BUSINESS TRANSACTIONS & TRANSPORTATION Atty. RODERICK F. BLANCO, CPA, Lecturer Source: Civil Code of the Philippines Annotated, Book IV, 18th ed. 2016, Justice Edgardo L. Paras  P a g e | 21 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 (Art. 1296, NCC) 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 subsist, 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 (Art. 1297, NCC) 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 present 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 (Art. 1299, NCC) 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 (Art. 1304, NCC) MGT 161 LAW ON BUSINESS TRANSACTIONS & TRANSPORTATION Atty. RODERICK F. BLANCO, CPA, Lecturer Source: Civil Code of the Philippines Annotated, Book IV, 18th ed. 2016, Justice Edgardo L. Paras