Article 1226 – 1242

Atty. Emiko Antonette T. Escovilla

OBLIGATIONS WITH A PENAL CLAUSE

A penal clause is an accessory undertaking to assume greater liability in case of breach.

It is attached to an obligation in order to insure performance and has a double function:
(1) to provide for liquidated damages, and (2) to strengthen the coercive force of the obligation
by the threat of greater responsibility in the event of breach. (Filinvest Land vs. CA)

A Penal clause is merely an accessory and not an essential requisite of an obligation it's me or
me not be present without such stipulation there would be no such undertaking to take so why
is a penal clause included in an obligation? As mentioned it is imposed if parties want to agree
on a fixed amount for damages that will be suffered by the aggrieved party in case of breach so
that in case of breach, there would be no need for either of them to prove for the amount of
damages just prove that there was a breach and whatever the amount stipulated there would
be the liability.
Now in case of delay if it is stipulated that if a party incur delay usually they would say 1% of the
contract price for every day of delay, that would now constitute the liquidated damages in the
concept of stipulated damages or as penalty to strengthen the coercive force of the obligation
because if he breaches the obligation he would be liable for a penalty. So it makes the
obligation more difficult to breach for the obligor.

Article 1226
In obligations with a penal clause, the penalty shall substitute the indemnity for damages and
the payment of interests in case of noncompliance, if there is no stipulation to the contrary.
Nevertheless, damages shall be paid if the obligor refuses to pay the penalty or is guilty of fraud
in the fulfillment of the obligation.

The penalty may be enforced only when it is demandable in accordance with the provisions of
this Code.

So under 1226 when there is final cost the penalty shall include the indemnity for damages or
the payment of interest. Now but this is the general rule but of course there are exceptions and
these are:
1. When there is a stipulation to the contrary.
Meaning if even if there is a penalty imposed the innocent party can still recover damages and
interest as the contract expressly stipulates that they can recover damages and interests.
2. Another exception is if the obligor refuses to pay the penalty or is guilty of fraud in the
fulfillment of the obligations, in which they can also recover damages instead of the penalty as
stated in the penalty clause.

Article 1227
The debtor cannot exempt himself from the performance of the obligation by paying the
penalty, save in the case where this right has been expressly reserved for him. Neither can the
creditor demand the fulfillment of the obligation and the satisfaction of the penalty at the same
time, unless this right has been clearly granted him. However, if after the creditor has decided
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Atty. Emiko Antonette T. Escovilla
to require the fulfillment of the obligation, the performance thereof should become impossible
without his fault, the penalty may be enforced.

So 1227 is telling us the debtor cannot see OK I will pay the penalty and not fulfill the obligation
unless this right has been expressly granted meaning stipulated in the contract. neither can the
creditor demand the fulfillment of the obligation and the satisfaction of the penalty at the same
time unless again this right has been clearly however it does not have to be stipulated in the
contract as long as it is clearly granted to him.
Now what's an what's an exception to the rule on expressed stipulation?
If by nature of the obligation it is clear that the creditor is allowed to demand the fulfillment of
an obligation plus the penalty. so for example a borrowed 10 million from B which is payable on
December 31 2021. in case of default he would pay 2% interest per month, so that's the penalty.
now come December 31 2021 under the law the creditor cannot demand fulfillment and
satisfaction of the penalty at the same time. The right of the creditor to ask for the payment of
the principal plus penalty however is granted in the very nature of the obligation. Kasi diba this
is a loan, kelangan bayaran nya yung principal amount plus the interest. And the interest is also
the penalty na for being in default. but again if performance is impossible after the creditor has
decided to require the fulfillment of the obligation the penalty may be enforced. So, halimbawa
the agreement is to deliver a specific thing and there is a penalty clause, but you really want the
artwork to be delivered but it's impossible because the artist you commissioned refuses to work
otherwise you know diba it will become involuntary servitude. so in that case because you
cannot seek specific performance then the penalty can be enforced instead.

Article 1228
Proof of actual damages suffered by the creditor is not necessary in order that the penalty may
be demanded.

Rationale: When a penal clause has been agreed upon in a contract, more as a punishment for
the infraction thereof than a mere security, it is a lawful means for repairing losses and
damages, and upon evidence of the violation of the conditions stipulated, the injured party is
not obliged to prove losses and damages suffered, nor the extent of the same in order to
demand the enforcement of the penal clause agreed upon. (Palacious v. Municipality of Cavite)

So in short, because it is already an amount agreed upon by the parties as sufficient to cover the
losses and damages of the injured party there is no need for the injured party to prove the
losses and damages suffered, kasi nga the penalty clause for the penal clause is already an
approximation of what is the foreseeable cost and damage of the failure to perform the
obligation on the part of the injured party. so that is what is meant by 1228.

Article 1229
The judge shall equitably reduce the penalty when the principal obligation has been partly or
irregularly complied with by the debtor.
Even if there has been no performance, the penalty may also be reduced by the courts if it is
iniquitous or unconscionable.
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Atty. Emiko Antonette T. Escovilla
So under article 1229 even if the parties voluntarily knowingly willingly and intelligently agreed
to the stipulation as to the amount of penalty there are cases when the court may still reduce
the penalty, these cases are:
1. When there has been partial performance - So partial performance means incomplete like
halimbawa 70% completed lang xa, that is partial performance.
2. When there has been irregular performance - So complete performance but not strictly in
accordance with the terms of the contract.
3. When the penalty is iniquitous or unconscionable - these are the cases when the courts are
the judge may reduce the penalty even if there is a stipulation which was voluntary entered
into.

Now if there are instances where the court may intervene or reduce the sentence, are there also
instances where the creditor cannot enforce the penal clause? The answer obviously is yes on
your side there are three instances…

A penal clause cannot be enforced if:

1. The breach is the fault of the creditor - and this is pretty obvious, this is a parallel to the
extinguishment of an obligation if the creditor prevents its fulfillment then it's the same with the
penal clause as well the creditor cannot enforce a penal clause if it is his fault hat the debtor
could no longer perform the obligation under the original contract.

2. Or a fortuitous event intervened, unless the debtor expressly agreed on his liability in case of
fortuitous events - so obviously because the if it's a fortuitous event, then it is no one's fault and
therefore both of them cannot or rather the debtor cannot be made to pay if it is without the
fault of the debtor. So the exception to this is if the creditor and the debtor agree that the
debtor would be liable despite the fortuitous event and this agreement would be completely
valid this is just like your normal obligations diba? where the debtor could still agree to pay
despite the occurrence of a fortuitous event.

2. The debtor is not yet in default - then obviously the penal cause cannot also be enforced
because the obligation in order for the final clause to arise and be activated should already be
due and demandable. Precisely because kung hindi pa due and demandable, hindi mo pa pwede
singilin dba? There can also be no penalty, because there is yet no breach of the obligation.

Article 1230
The nullity of the penal clause does not carry with it that of the principal obligation.
The nullity of the principal obligation carries with it that of the penal clause.

A penalty clause for a penal clause, like we said earlier, is just an accessory undertaking and an
obligation so it can or cannot exist. Being an accessory undertaking, it's existence is dependent
upon the nullity of the principle obligation, if the principal obligation is void then the accessory
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Atty. Emiko Antonette T. Escovilla
obligation is also void. It cannot stand alone without a principal, but if the penalty clause is void
the principal can still stand it will not affect the existence of the principal obligation. OK

The first case is the case of the Ligutan versus Court of Appeals. So here you have Tolomeo
Ligutan and Leonidas Delaliana, obtained a loan in the amount of 120,000 from security bank.
The Ligutans executed a promissory note binding themselves jointly and severally to pay the
sum borrowed with an interest of 15% per annum upon maturity and to pay a penalty of 5%
every month on the outstanding principle and interest in case of default. In addition they agreed
to pay 10% of the total amount due by way of attorney’s fees if the matter were endorsed to a
lawyer for collection or if a suit were instituted to enforce payment. Now the obligation
matured but the bank granted an extension, still the Ligutans defaulted in their obligation. Now
one of the issues here is whether the Ligutans should be made to pay the penalty as stated in
the penalty clause. SC said, a penalty clause expressly recognized by laws is an accessory
undertaking to assume greater liability on the part of an obligor in case of breach of an
obligation. Although court may not at liberty ignore the freedom of the parties to agree on such
terms and conditions, as they see fit to contravene neither law nor good nor morals good
customs etcetera etcetera nevertheless the penalty cause may be equitably reduced by the
courts if it is in iniquitous or unconscionable or if the principle obligation has been party or
irregularly complied with. the question of whether a penalty is reasonable or iniquitous can be
partly subjective and partly objective. its resolution would depend on such factors as but not
necessarily confined to the type, extent and purpose of the penalty the nature of the obligation
the mode of breach and its consequences the supervening realities the standing and
relationship of the parties and the like. The application of which by and large is addressed to the
sound discretion of the court. so in this case an anticipated interest of 15% per annum this was
first actually questioned by the Ligutans already on appeal, so the question is whether the same
is reasonable and the Supreme Court said the essence or rational for the payment of interest it
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Atty. Emiko Antonette T. Escovilla
often referred to as a cost of money it's not exactly the same as that of a surcharge or a penalty.
A penalty stipulation is not necessarily preclusive of interest if there is an agreement to that
effect. The two being distinct concepts which may separately be demanded, but may justify a
court in not allowing the creditor to impose full surcharges and penalties despite an express
stipulation therefore in a valid agreement may not equally justify the non payment or reduction
of interest. Indeed, the interest prescribed and loan financing arrangements is a fundamental
part of the banking business and the core of a bank's existence. So in this case, The SC said
there is no reason to intervene considering that the interest is part of the penalty and is in
fact actually quite reasonable, and was even willingly agreed upon between the parties.

The next case is Florentino v Super Value. In this case you have a lessee who despite the
agreement that she would secure the prior written consent of the lesser made improvements
without consent to the area which she leased. So because of that SM wanted to forfeit the
security deposit that she made. So the issue in this case is whether the penalty that was
included in the lease agreement between Florentino and super value is unconscionable and if so
whether the same can be reduced by the courts. And the Supreme Court in this case considered
the breach that occurred and said that if you look at the penalty it is in fact unconscionable or
iniquitous. so it said in asserting whether the penalty is unconscionable or not the following
standard, citing the Ligutan versus Court of Appeals it was discussed; so it can be partly
subjective and partly objective etcetera. In the instant case the forfeiture of the entire amount
of the security deposits in the sum of 192k was excessive and unconscionable. Considering that
the gravity of the breaches committed by Florentino is not of such degree that the that SM
would be unduly prejudice thereby therefore the Supreme Court stepped in and reduced the
penalty of Florentino to 50% of the total amount of security deposits. So this is the exercise of
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Atty. Emiko Antonette T. Escovilla
it's sound discretion that this court temper the penalty for the breaches committed by the
petitioner to 50% of the amount of the security deposits. The forfeiture of the entire sum of
192,000 is clearly a usurious and iniquitous penalty for the transgressions committed by the
petitioner. the respondent is there for under the obligation to return the 50% to the petitioner
so in this case is Supreme Court deemed it proper to intervene.

In this case Rivera obtained a loan from the spouse Chua which is evidenced by a promissory
note executed by the riveras in favor of the spouses. the clause in the promissory note relevant
to the discussion reads:
It is agreed and understood that failure on my part to pay the amount of 120,000 on December
31 1995 I agree to pay the sum equivalent to 5% interest monthly from the date of default until
the entire obligation is fully paid for. So the question is: Is this a penalty clause or is this merely
a stipulation for the payment of interest?
Supreme Court said in this instance the parties stipulated that in case of default Rivera will pay
the interest at the rate of 5% a month or 60% per annum on this score the applet court held it
bears emphasizing that the undertaking based on the note clearly states the date of payment to
be 31 December 1995. given the circumstance the man by the creditor is no longer necessary in
order that delay may exist since the contract itself already expressed his hope declare so this is
a memorable lesson for you in your obligations, the mere failure of spouses shua to immediately
demand or collect payment of the value of the note does not exonerate Rivera from his liability
therefrom. As observed by Rivera stipulated interest of 5% per month or 60% per annum in
addition to legal interests and attorneys fees is actually highly iniquitous and unreasonable. so
stipulate that interest rates are illegal if they are unconscionable and the court is allowed to
temper interest rates when necessary. Since the interest rate agreed upon is void the parties are
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Atty. Emiko Antonette T. Escovilla
considered to have no stipulation regarding the interest rate and therefore the rate of interest
should be 12% per annum computed from the date of judicial or extrajudicial demand.
So in this case the Supreme Court said that the interest rate is actually also in the form of a
penalty clause which could be reduced equitably by the courts.

We have the case of lara's gifts and decors v midtown. so here lara's gifts and decors is engaged
in the business of manufacturing selling and exporting handicraft handicraft products. On the
other hand midtown is engaged in the business of selling industrial and construction materials,
and lara's gifts and decors is one of midtown's customers. So midtown alleged that from
January 2007 up to December 2007, lara's gifts and decors purchased from midtown various
industrial and construction materials And the total amount of a million/ 1,200,000. The
purchases were on a 60 day credit term with the condition that 24% interest per annum would
be charged on all accounts over two as stated in the sales invoices. So lara's gifts and decors
paid for its purchases by issuing several China bank postdated checks in favor of midtown.
problem was when midtown deposited these checks the checks bounced. One of the defenses of
lara's gifts and decors is that the materials that were delivered by midtown were actually
substandard. so the issue here relevant to our discussion is whether the interest of 24% per
annum is unconscionable?
So in this case again go back to the question of how you measure whether the penalty is
iniquitous or unconscionable. and whether what kind of interest is being imposed here is it also
is it just in interest or does it also function as a penalty?
In this case the Supreme Court said that this is compensatory interest, and it is also subject to
the unconscionability standard. So citing 1229 and 2227:
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Atty. Emiko Antonette T. Escovilla
the Supreme Court said that looking at the terms of the agreement, the interest rate is in fact
not iniquitous or unconscionable. because if you look at the examples that were cited here you
have the case of ibarra versus avaro where it also struck down a penalty claus for being a
repugnant spoilation at an iniquitous deprivation of property, in other words sobrang steep ng
interest rate.
Then you also have palomares versus Court of Appeals: which involved a 30,000 loan payable in
two months with an interest at 6% per annum that would be compounded pa every month and
there was also a penalty charge of 3% and attorneys fees equivalent to 25% of the total amount
due and unpaid. So eto yung example kung ano ang unconscionable and iniquitous.
But in this case Supreme Court said that the 24% interest street is a compensatory interest
imposed as indemnity for damages caused by the delay in the payment of the raw materials
purchase price. so in this case and 24% is actually a reasonable, the problem is that since
interest on interest under article 1212 is impossible only on stipulated or conventional monetary
interest the 12% 6% interest cannot be imposed on the 24 interest due on overdue accounts.
Start over since interest on interest under article 2212 it is by nature also a compensatory
interest they impose it on top of the city the 24% compensatory interest would be superfluous.
So 24% interest rate per annum was fair but charge another interest on the interest would be
superfluous because the 24% interest was also already in the nature of a compensatory interest
and therefore it would be superfluous to charge another interest on top of the interest of 24%.

Article 1231
Obligations are extinguished:
(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.
Other causes of extinguishment of obligations, such as annulment, rescission, fulfillment of a
resolutory condition, and prescription, are governed elsewhere in this Code. (1156a)

Now proceed to the extinguishment of obligations you have to memorize the modes in article
1231 OK? Mukha xang madami, pero maiksi lang yan, memorise nyo lang yung 2131.

So the first mode is payment or performance which we will discuss in the preceding/in the next
few articles:
So first this…

Article 1232
Payment means not only the delivery of money but also the performance in any other manner
of an obligation.
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Atty. Emiko Antonette T. Escovilla
When we talk about payment we usually think of payment na bayad no? of course kasi payment
nga, but actually it could also mean performance of an obligation.

Now what are the requisites for a valid payment:

1. The very thing or service contemplated must be paid
2. he fulfillment of the service or delivery of the thing must be complete

So how is payment or performance paid if the debt is a monetary obligation then you have to
deliver the money. The amount must be paid in full unless of course it is stipulated in the
contract that it could be paid in installments or portions.Ssecond if the debt is the delivery of a
thing or things then you have to deliver the thing or things required. Third if the debt is the
doing of a personal undertaking and you need to perform the personal undertaking. Like if you
were asked to paint something for someone then you have to repeat make that painting and
that is the only way that you can extinguish the obligation by a performance. Last if the debt is
not doing of something then obviously you can fulfill that obligation by refraining from doing
the action.

Article 1233
A debt shall not be understood to have been paid unless the thing or service in which the
obligation consists has been completely delivered or rendered as the case may be.

Like we said earlier payment must be in full and this is what is being emphasized in article
1233-- it is one requisite for a valid payment. When the debt is 1,000,000 you should pay the
entire one million. If it bears interest then you should also pay the interest. If it is performance
you should completely perform the presentation as agreed upon. So if you offer only 1/2 you
cannot compel the creditor to accept only half it is not the valid tender of payment. For you to
be able to compel the creditor to accept it should be in full unless again the parties agreed to an
installment payment but if it is not a stipulated installment you should pay in full.